The U.S. Supreme Court Is Poised to Determine Whether a Creditor鈥檚 Passive Possession of Debtor鈥檚 Property (Legally Obtained Pre-petition), Violates the Automatic Stay -- Which Should Resolve a Split among the Circuits
There is a split among the circuits as to whether a creditor鈥檚 continued retention of a debtor鈥檚 assets, seized pre-petition, violates the automatic stay. The question is whether the creditor鈥檚 passive possession of such asset is 鈥渁n act 鈥 to exercise control over property of the estate鈥 within the meaning of the Bankruptcy Code鈥檚 automatic stay provision, 11 U.S.C. 搂 362(a)(3). Most Circuits (Second, Seventh, Eighth, Ninth and Eleventh) have said yes, requiring a secured creditor to return property or risk paying damages for violating the stay. Now the Third Circuit, in In re Denby-Peterson, 941 F.3d 115 (3d Cir. 2019), has joined the Tenth and D.C. Circuits in finding no violation of the automatic stay if a creditor, upon notification of the bankruptcy, fails or refuses to return the seized property. Thus, in order for a debtor (or trustee) in the Third Circuit to regain possession of the asset, absent agreement by the secured creditor, an adversary proceeding seeking turnover will have to be initiated. The facts in Denby-Peterson are as follows.
Joy Denby-Peterson purchased a Corvette which was repossessed after she defaulted on her car loan. After repossession, she filed a chapter 13 bankruptcy petition in New Jersey, notified her creditors of the filing, and demanded the return of the Corvette. When the Corvette was not returned, Ms. Denby-Peterson filed a motion for turnover and sought sanctions for the creditor鈥檚 purported violation of the automatic stay. The Bankruptcy Court ordered turnover of the Corvette, but denied the debtor鈥檚 request for sanctions. This ruling was affirmed by the District Court for the District of New Jersey. Upon further appeal, the Third Circuit joined the minority view that the automatic stay and turnover provisions of the Bankruptcy Code do not impose an affirmative obligation on a creditor holding seized assets to return them, absent a formal proceeding for turnover.
At issue in Denby-Peterson was whether the creditor鈥檚 continued possession constituted 鈥渁ny act 鈥 to exercise control over property of the estate.鈥 See, 11.U.S.C. 搂 362(a)(3). Although the Bankruptcy Court ordered the return of the Corvette pursuant to Section 542(a), it held that the creditor had not violated the stay. It noted that the 鈥渕inority鈥 circuits were critical of a 鈥渟elf-effectuating鈥 turnover if the automatic stay was held to apply. That is, Section 542(a) would not be necessary and could be rendered ineffectual if turnover was automatic. Id. at 121. The Third Circuit acknowledged that property of the estate includes property in which a debtor holds an equitable interest, and that the purpose of the automatic stay is two-fold: 1) to give a debtor a respite from creditors and 2) to prevent any one creditor from obtaining payment to the detriment of other creditors. But in construing the automatic stay provisions, the Third Circuit agreed with the District Court that 鈥渁ny act 鈥 to exercise control鈥︹ was solely prospective. That is, the mere 鈥渆xercise of control鈥 is not the event which is stayed; rather, it is an 鈥渁ct鈥 to exercise control that is stayed. Id. at 125. Thus, the Third Circuit agreed with the minority position that the text of Section 362(a)(3) requires a post-petition affirmative act to violate the stay. As to the Corvette, the 鈥渁ct鈥 of repossession occurred pre-bankruptcy. Post-bankruptcy, 鈥渢he creditors merely passively retained the same possession and control.鈥 Id. at 126. Moreover, given that one policy goal of the automatic stay is to maintain the status quo, the creditors鈥 continued post-petition possession of the Corvette simply maintained the pre-petition status quo. Id. As to the interplay between the Code鈥檚 automatic stay and turnover provisions, the Third Circuit viewed Section 542(a) as not being self-effectuating. Rather, a creditor鈥檚 obligation to turn over estate property is effectuated by judicial action -- it is the debtor鈥檚 burden to bring an adversary proceeding to determine whether the property is subject to turnover. Id. at 128.
Before the Third Circuit ruled in Denby, the Tenth Circuit, addressing similar language in Section 362(a)(4), confirmed that Section 362(a)(3) requires affirmative conduct. In re Garcia, 740 Fed. Appx. 163, 164 (10th Cir. 2018). The United States Supreme Court denied certiorari there in May of 2019.
But more recently, the Seventh Circuit in In re Fulton, 926 F.3d 916 (7th Cir. 2019) ruled that the City of Chicago violated the automatic stay by refusing to release a debtor鈥檚 car which had been impounded for unpaid parking tickets. One rationale for that ruling was that under Section 363(e), a creditor has the burden of requesting stay relief, and 鈥渋f a creditor is allowed to retain possession, then this burden is rendered meaningless 鈥 a creditor has no incentive to seek protection of an asset of which it already has possession.鈥 Id. at 924 (internal quotation omitted). The United States Supreme Court recently accepted certiorari of In re Fulton on December 18, 2019, possibly signaling concern with the 7th Circuit鈥檚 ruling. The Supreme Court may be guided by its prior decision in Citizens Bank of Maryland v. Strumpf, 516 U.S. 16, 21 (1995), in which it considered the interplay between the Code鈥檚 automatic stay and turnover provisions, and held that a bank鈥檚 withholding of funds in a debtor鈥檚 bank account, pending a determination of the bank鈥檚 setoff rights, was not an act that violated the automatic stay. Pending the Supreme Court鈥檚 ultimate decision, for now it鈥檚 important that practitioners be aware of the circuit court precedent in their particular jurisdictions to properly guide their clients on this significant issue. Stay tuned!