As we previously discussed in our Bankruptcy Bytes video series, the filing of a bankruptcy petition generally gives rise to an “automatic stay” against any attempt to exercise control over the debtor’s property, or property of the bankruptcy “estate” which comes into existence when a bankruptcy case is filed. While a creditor may seek relief from the automatic stay, or even retroactive annulment of the stay to validate a postpetition act taken without knowledge of the bankruptcy, willful violations of the automatic stay can expose a creditor to steep sanctions. But if a creditor retains a debtor’s property after a bankruptcy case is filed, despite the debtor’s demand for turnover, does the mere retention of property violate the automatic stay? The Supreme Court recently ruled that the answer is no – not without the creditor taking additional acts to exercise control over the property in its possession.
In City of Chicago v. Fulton, the Supreme Court considered whether the City had violated the automatic stay by refusing to return impounded vehicles to Chapter 13 debtors after the debtors filed for bankruptcy protection and demanded the turnover of their vehicles. The bankruptcy court held that the City’s refusal violated the automatic stay. The Seventh Circuit Court of Appeals affirmed, reasoning that the City’s retention of the impounded vehicles constituted an impermissible exercise of control over estate property.
On appeal, the Supreme Court ruled against the debtors. As the Court explained, while Bankruptcy Code Section 362(a)(3) prohibits acts to exercise control over property of the estate, Section 542 actually governs the turnover of estate property. Section 542 also carves out certain exceptions to a creditor’s obligation to comply with a turnover demand. Examining these two separate sections of the Code, the Court concluded that reading Section 362(a) to create an affirmative turnover obligation on the part of a creditor holding estate property would render Section 542’s provisions superfluous. Instead, the Court concluded that Section 362(a)(3) prohibits collection efforts outside the bankruptcy proceeding that would change the status quo, while Section 542(a) works within the bankruptcy process to draw estate property back into the hands of the debtor or trustee.
How will this decision affect creditors? The Supreme Court previously held that an “administrative hold” placed on an account to permit a bank to seek authority to vindicate its setoff rights did not violate the stay where the hold was temporary and served to maintain the status quo. The Court’s decision in City of Chicago v. Fulton confirms, similarly, that the mere retention of estate property – without affirmative acts to disturb the status quo – does not result in a stay violation. However, if a creditor does choose to retain estate property postpetition, whether tangible property such as a debtor’s equipment or intangible assets such as a debtor’s funds on deposit, that creditor should consider promptly seeking relief from the automatic stay to minimize its exposure to claims for violation of the stay. Our experienced team of creditors’ rights attorneys have the knowledge and expertise to help with the automatic stay and other bankruptcy issues.