Practice Tools in Response to Latest Supreme Court Bankruptcy Decision

A Supreme Court January 14, 2021, decision in City of Chicago v. Fulton, 141 S. Ct. 585 (Jan. 14, 2021), holds that a secured creditor’s retention of property repossessed before a bankruptcy is filed does not violate the automatic stay. This article explains the practical impact of the Court’s decision and steps bankruptcy attorneys can take to recover repossessed property, including the use of new sample pleadings and forms.

Does the Automatic Stay Require Creditor to Return Property It Has Repossessed?

A question that has divided the courts is whether a secured creditor’s passive retention of property repossessed before a bankruptcy is filed violates the automatic stay. The issue had been litigated extensively in a series of chapter 13 bankruptcy cases filed by consumer debtors to release their automobiles that the City of Chicago impounded for failure to pay parking and traffic fines.

The City’s aggressive collection practices and the Bankruptcy Code’s limitations in making parking and traffic fines dischargeable in chapter 13 but not in chapter 7 cases is documented in the ProPublica article: How Chicago Ticket Debt Sends Black Motorists Into Bankruptcy. See also NCLC’s Clearing the Path to a New Beginning: A Guide to Discharging Criminal Justice Debt in Bankruptcy (Oct. 2020).

The differing court opinions generally focused on the interplay between Bankruptcy Code § 362(a)(3) and § 542(a). Section 362(a)(3) stays all actions that seek to obtain possession or “exercise control over” property of the estate. Section 542(a) assists the trustee in gaining possession of estate property that is being held by other parties, by requiring turnover of the property to the trustee. See NCLC’s Consumer Bankruptcy Law and Practice § 9.4.3 and § 9.9.2.

Some courts had held that the failure of a party holding estate property to turn over the property to the trustee violates section 362(a)(3), subject to any limitations in section 542. Other courts had held that a secured creditor may continue to hold the property without violating the stay until the debtor establishes that the creditor is adequately protected, typically by providing proof that the property is insured. At the other extreme, courts such as the Tenth Circuit in In re Cowen, 849 F.3d 943, 950 (10th Cir. 2017), held that a secured creditor’s passive retention of a repossessed vehicle did not violate the stay because there is no “textual link” between section 542 and section 362, and section 362(a)(3) prohibits only an affirmative “act” to gain possession of or exercise control over estate property.

In each of the consolidated cases before the Supreme Court in Fulton, the City of Chicago had impounded the debtors’ vehicles for failure to pay parking and traffic fines. When the City refused to release their autos after each debtor filed a chapter 13 case, the bankruptcy courts held that the City’s refusal to release the vehicles violated the automatic stay. The Seventh Circuit agreed and concluded that the City had acted “to exercise control over” the debtors’ property in violation of section 362(a)(3).

Supreme Court Resolves Split in Favor of Creditors

The Supreme Court in Fulton reversed and held that the City’s action in merely holding on to the property does not violate section 362(a)(3). The Court concluded that the words “stay,” “act,” and “exercise control” in section 362(a)(3) indicate that the provision is intended to prohibit an “affirmative act that would alter the status quo as of the time of the filing of a bankruptcy petition.” 141 S. Ct. at 590.

The Court also found that if simply retaining possession of a debtor’s property were construed as an act to “exercise control” under section 362(a)(3), effectively making it a “blanket turnover provision,” the requirement in section 542(a) to deliver property to the trustee would be superfluous. 141 S. Ct. at 591. Finally, the Fulton Court noted that when the “exercise control” phrase was added to section 362 in a 1984 Code amendment, there was no reference in the legislative history to section 542 or any indication that the change was intended to “make § 362(a)(3) an enforcement arm of sorts for § 542(a).” 141 S. Ct. at 592.

Implications of the Supreme Court Ruling

Because a number of courts had held that retaining property could violate the stay, creditors often voluntarily released repossessed autos and other property to debtors to avoid the possibility of stay violation sanctions. The Fulton decision may change this and require that the debtor take some action, or threaten to take action, to recover the property.

As Justice Sotomayor pointed out in her concurring opinion, the use of an auto is essential for many debtors to stay employed and to be able to succeed in their chapter 13 plans. She noted that similar to the debtors in the cases before the Court, “[d]rivers in low-income communities across the country face similar vicious cycles: A driver is assessed a fine she cannot immediately pay; the balance balloons as late fees accrue; the local government seizes the driver’s vehicle, adding impounding and storage fees to the growing debt; and the driver, now without reliable transportation to and from work, finds it all but impossible to repay her debt and recover her vehicle.” 141 S. Ct. at 593. Justice Sotomayor stated that while the Court held that section 362(a)(3) does not compel the turnover of property, “bankruptcy courts are not powerless to facilitate the return of debtors’ vehicles to their owners” as required by section 542(a). 141 S. Ct. at 594.

Practice Tips in Responding to the Supreme Court Ruling

Consumer bankruptcy counsel should become familiar with the debtor’s authority under the Code to enforce turnover of repossessed property. Under section 542(a), a party holding repossessed property is required to turn over the property to the trustee if either one of the following conditions applies:

1. The property is property the debtor has claimed as exempt under section 522; or
2. The property is subject to the rights of the trustee under section 363(b) to use, sell, or lease the property.

The debtor may seek to enforce section 542(a) in a chapter 13 case because under section 1306, the debtor is entitled to possession of all property of the estate, and under section 1303, the debtor has, exclusive of the trustee, the rights of the trustee under section 363(b) to the use of the property.

The procedural steps for enforcing section 542(a) create some challenges. Unfortunately, Bankruptcy Rule 7001 provides that a proceeding to recover property must be brought as an adversary proceeding. Rather than using the more streamlined motion practice, a debtor who is in immediate need of the property will need to file an adversary complaint, accompanied by a motion for a temporary restraining order and preliminary injunction. If the debtor needs to recover the property quickly, such as an automobile used for transportation to work, the debtor may need to request an emergency hearing on the motion as soon as the bankruptcy and adversary complaint are filed.

Sample Pleadings to Expedite Turnover of Property with Advice As to Their Use

To assist consumer attorneys in seeking turnover of repossessed automobiles and other property, or where property is being held pursuant to a possessory lien, NCLC has updated the digital version of NCLC’s Consumer Bankruptcy Law and Practice Appendix G.5, Turnover of Property. The appendix amends two of the sample pleadings and adds two additional ones in light of the Fulton decision. These pleadings have also been added in MS Word format, ready to edit, in the treatise’s companion materials, listed in the treatise’s table of contents at Pleadings and Discovery>Bankruptcy>Turnover of Property.

Form 47—Letter Demanding Turnover of Property. Before filing an adversary complaint, it is advisable that a letter be sent to the party holding the property seeking immediate turnover of the property. Some creditors will voluntarily agree to return the property to the debtor rather than go through the trustee or incur litigation costs. If the debtor is in immediate need of the property and counsel plans to request an emergency hearing, this letter should be sent by electronic mail to the creditor and any known counsel for the creditor before the complaint is filed. For purposes of proof if sanctions for contempt are later sought, it may be advantageous to also send this type of letter by certified mail.

The creditor or other party in possession may request adequate protection of its interest in the property. See NCLC’s Consumer Bankruptcy Law and Practice § 9.9. This can be addressed in most cases by providing proof of insurance. To avoid having this issue be a basis for delaying the release of the property, the letter may provide that proof. Alternatively, the debtor may indicate that insurance will be purchased or that some other form of adequate protection will be provided such as a replacement lien on the property or cash payments in excess of any depreciation.

Form 48—Complaint Seeking Turnover of Property. This adversary complaint seeks turnover of the property under section 542(a). If it is to be filed with a motion for a temporary restraining order and preliminary injunction, the complaint should be verified. A temporary restraining order may be entered based on an affidavit or verified complaint. See Fed. R. Bankr. P. 65(b)(1), incorporated in Fed. R. Bankr. P. 7065. In some jurisdictions, courts require that the trustee be joined as a co-plaintiff, either under Bankruptcy Rule 7019 because the trustee is needed to accord relief or under Bankruptcy Rule 7020 if the trustee consents to permissive joinder, whenever the debtor seeks to make use of the trustee’s avoiding powers. The trustee may have some interest in the property if it is ultimately concluded that it is not fully exempt.

Form 48a—Plaintiff’s Motion for Temporary Restraining Order and Preliminary Injunction. This motion, together with the debtor’s verified complaint, should set out the facts and argument as to why the debtor will suffer irreparable harm without immediate relief from the court, and that the debtor will likely prevail on the merits in the proceeding. Local court rules should be reviewed for any procedural requirements for requesting an immediate or emergency hearing. A certificate of service or a statement of efforts to notify opponents, or of why notice should not be required, is required prior to issuance of a temporary restraining order. See Fed. R. Civ. P. 65(b)., incorporated in Fed. R. Bankr. P. 7065.

Form 48b—Proposed Order for Preliminary Relief in Complaint for Turnover of Property. A proposed order should normally be presented to the court, subject to local practice. An order granting preliminary relief must state the reasons it was issued. See Fed. R. Civ. P. 65(d), incorporated in Fed. R. Bankr. P. 7065. If a temporary restraining order is entered without notice to the opposing party, the order will expire after 14 days unless the court, for cause, extends the order, and the motion for a preliminary injunction must be set for a hearing at the earliest possible time. See Fed. R. Civ. P. 65(b), incorporated in Fed. R. Bankr. P. 7065.