While the filing of a bankruptcy petition typically slants the playing field in favor of the debtor, the U.S. Supreme Court recently scored a victory for secured creditors, specifically banks or lenders that finance or lease vehicles to the public. On January 14, 2021, the U.S. Supreme Court decided City of Chicago v. Fulton, holding that the creditor’s mere retention of a debtor’s property after the filing of a bankruptcy petition does not violate the automatic stay under Section 362(a)(3) of the Bankruptcy Code. This decision directly impacts the many bankruptcy cases that are filed in response to a creditor’s action to repossess collateral, such as vehicles, in order to force the creditor to return the vehicle to the debtor.
The automatic stay is arguably one of the strongest protections for debtors under the Bankruptcy Code, halting actions by creditors against debtors upon the bankruptcy filing. If a creditor wants to take action against a debtor, such as continuing a lawsuit or repossessing collateral, the creditor must first obtain relief from the automatic stay from the bankruptcy court. Creditors can be held in contempt and/or be forced to pay damages if they violate the stay.
The Bankruptcy Code clearly prohibits any affirmative action against a debtor while the automatic stay is in place, but until this decision, there was a split in authority on whether a creditor violated the automatic stay by merely retaining collateral repossessed pre-bankruptcy. Many bankruptcy courts impose an affirmative duty on creditors to turn over repossessed property after a bankruptcy filing upon demand by the debtor, without any conditions. Other courts held that the retention of property by the creditor only maintains the status quo, and that a creditor simply holding property repossessed pre-petition does not violate the automatic stay.
The U.S. Supreme Court, in an 8-0 opinion, held that creditors are permitted to retain possession of the collateral repossessed pre-petition and are not obligated to return the collateral due to the debtor’s filing of a bankruptcy petition. The Court interpreted the language of the statute, finding that Section 362(a)(3) prohibits “affirmative acts that would disturb the status quo of the estate property as of the time when the bankruptcy petition was filed.”
There are many instances in which a creditor repossesses collateral prior to bankruptcy, then a debtor files a bankruptcy petition triggering the automatic stay, which compels the creditor to return the repossessed collateral to the debtor or face the risk of sanctions for violating the automatic stay. Creditors no longer need to feel compelled to return the repossessed collateral that they are merely holding, as clarified by the U.S. Supreme Court decision – although pushing the envelope by taking further action with the collateral still carries significant risk.
While this is a creditor-friendly decision, creditors must proceed with caution and focus on maintaining the status quo. A creditor with collateral in hand may not take affirmative actions to foreclose the collateral and move to liquidate it after a bankruptcy filing, as that would likely warrant sanctions for violating the automatic stay. There are other provisions of the Bankruptcy Code that allow a debtor to initiate a turnover proceeding to recover property that has been repossessed or take other strategic actions.
For more information about this new law change or any other matter related to bankruptcy, please contact Dennis Loughlin, Andrew Reside or a member of Warner’s Bankruptcy, Restructuring and Insolvency Law Practice Group.