Categories & Search

Pre-Bankruptcy Seizure: Recent Third Circuit Decision Widens Circuit Split Regarding Obligations of Secured Creditors in Respect of Collateral Seized Pre-Petition

In July 2016, Joy Denby-Peterson purchased a Chevrolet Corvette.  When she defaulted on one of her car payments a few months later, the Corvette was repossessed by her lender.  Denby-Peterson then filed a voluntary petition under Chapter 13 of the Bankruptcy Code in the U.S. Bankruptcy Court for the District of New Jersey and demanded the lender return the Corvette.  When the lender refused, she filed a motion for an order compelling turnover of the Corvette and imposing sanctions for an alleged violation of the automatic stay. 

The Bankruptcy Court ordered turnover but denied the request for sanctions on the basis that failing to return the repossessed Corvette upon notice of the bankruptcy filing did not constitute a violation of the automatic stay.  The district court affirmed the Bankruptcy Court and the Debtor appealed to the U.S. Court of Appeals for the Third Circuit.  Noting a split of authority among the Circuits that it had never squarely addressed, the Third Circuit sided with the minority of courts holding that a secured creditor does not violate the automatic stay by maintaining possession of collateral that it lawfully repossessed pre-petition, even upon receiving notice of the debtor’s bankruptcy filing.[1] 

The Court began its analysis with the plain language of Section 362(a)(3) of the Bankruptcy Code, which provides that the filing of a bankruptcy petition “operates as a stay . . . of . . . any act to . . . exercise control over property of the estate.”  11 U.S.C. § 362(a)(3).  Recognizing that the operative terms of that section are “stay,” “act,” and “exercise control” – and noting that the Bankruptcy Code does not define those terms – the Third Circuit relied on their ordinary meanings.  Those definitions led the Court to conclude “Section 362(a)(3) prohibits creditors from taking any affirmative act to exercise control over property of the estate.”  The language of the statute “‘is prospective in nature . . . the exercise of control is not stayed, but the act to exercise control is stayed.’ Therefore, we agree with the minority position held by two of our sister courts—the text of Section 362(a)(3) requires a post-petition affirmative act to exercise control over property of the estate.”[2]  Thus, on the facts before the Court, there was no violation of the automatic stay because there was no affirmative act by the lender.

Here, a post-petition affirmative act to exercise control over the Corvette is not present. The creditors repossessed the Corvette before Denby-Peterson had filed for bankruptcy. Accordingly, pre-bankruptcy petition, the creditors had possession and control of the Corvette, and post-bankruptcy petition, the creditors merely passively retained that same possession and control. Although the creditors exercised control over the Corvette by keeping it in their possession after learning of the bankruptcy filing, the requisite post-petition affirmative “act . . . to exercise control over” the Corvette is not present in this case. An application of the plain language of the statute to the facts of this case thus shows that the creditors did not violate the automatic stay.[3] 

The debtor also argued that Section 362 should be read with Section 542(a) of the Bankruptcy Code, requiring turnover of property of the estate in the possession of third parties.  The debtor argued that this turnover provision is “self-effectuating,” but the Court disagreed.  “[A] creditor’s obligation to turn over estate property to the debtor is not automatic.  Rather, the turnover provision requires the debtor to bring an adversary proceeding in Bankruptcy Court in order to give the Court the opportunity to determine whether the property is subject to turnover under Section 542(a).”

Nor did the apparently mandatory language in Section 542 persuade the Court that Section 542 is automatically operative upon the filing of a bankruptcy petition.  The Court acknowledged that the turnover provision states that parties in possession of property of the estate “shall deliver” such property to the debtor, but it concluded that the “question before us is when must a creditor deliver? The answer is when the Bankruptcy Court says so in the context of an adversary proceeding brought under Rule 7001(1). We view the statutory and procedural framework as: (1) the Chapter 13 debtor must seek court relief, such as by initiating an adversary proceeding requesting turnover; (2) the Bankruptcy Court then determines whether the property is subject to turnover; and (3) if it is, in accordance with that determination, the Bankruptcy Court issues a court order compelling a creditor to turn over property to the debtor.”[4]

While not likely to make headlines, this case widens the circuit split on this issue and secured creditors exercising remedies should take note.  In some jurisdictions, it may be perfectly appropriate for a secured lender that repossessed collateral pre-petition to ignore a pre-litigation demand and await the conclusion of a turnover proceeding before it returns the collateral to the debtor; in other jurisdictions, the exact same conduct may expose the lender to sanctions for a willful violation of the automatic stay.

[1] See In re Denby-Peterson, 2019 U.S. App. LEXIS 32283, at *10 (3d Cir. Oct. 28, 2019) (“Under the majority position, held by the Second, Seventh, Eighth, Ninth, and Eleventh Circuits, a secured creditor, upon learning of the bankruptcy filing, must return the collateral to the debtor and failure to do so violates the automatic stay. However, both the Tenth and D.C. Circuits disagree with the majority's interpretation of the automatic stay provision.  Under their view, a secured creditor is not obligated to return the collateral to the debtor until the debtor obtains a court order from the Bankruptcy Court requiring the creditor to do so. Thus, according to the minority, a creditor does not violate the automatic stay by retaining possession of the collateral after being notified of the bankruptcy filing.”).

[2] Id. at 14 (emphasis added).

[3] Id. at 14-15.  The Court declined to base its holding on the legislative history, as the debtor argued it should, because it concluded the statutory language was not ambiguous.  Id. at *16.  However, in dicta, the Court noted that “the relevant legislative history fails to shed light on Congress's intent behind the 1984 addition of the ‘exercise control over property of the estate,’ clause [in Section 362(a)(3)].” Id. at *17.  And, in fact, the Court noted, “our conclusion is bolstered by the legislative purpose and underlying policy goals of the automatic stay . . . to maintain the status quo between the debtor and [his] creditors.”  Id. at *15.

[4] Id. at *19-20 (emphasis added). Finally, the Court noted, “[e]ven assuming the turnover provision is self-executing . . . there is still no textual link between Section 542 and Section 362.  The language of the automatic stay provision and the turnover provision do not refer to each other. The absence of an express textual link between the two provisions indicates that they should not be read together, so violation of the turnover provision would not warrant sanctions for violation of the automatic stay provision.”   Id. at *24-25 (internal citations and quotations omitted).