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Update: Supreme Court Resolves Circuit Split Regarding Pre-Bankruptcy Seizure

In 2019, we began following a Circuit split regarding a secured creditor’s obligation to return collateral that it lawfully repossessed pre-petition after receiving notice of a debtor’s bankruptcy filing.   In our prior posts, which you may wish to review and can find here and here, we explained that the Third Circuit, joining the minority of courts to have ruled on the issue, held in November 2019 that a creditor does not violate the stay if it retains estate property until the debtor seeks turnover of the seized property under Section 542.[i]  The Seventh Circuit had reached the opposite conclusion in June 2019, holding that the automatic stay “becomes effective immediately upon filing the petition” and requires the creditor to return property seized pre-petition: “[it] is not dependent on the debtor first bringing a turnover action.”[ii]  In December, the Supreme Court granted certiorari and on Thursday adopted the minority view.[iii]

Writing for a unanimous Court[iv], Justice Alito reasoned:

The language used in §362(a)(3) suggests that merely retaining possession of estate property does not violate the automatic stay. Under that provision, the filing of a bankruptcy petition operates as a ‘stay’ of ‘any act’ to ‘exercise control’ over the property of the estate. Taken together, the most natural reading of these terms ‘stay,’ ‘act,’ and ‘exercise control’—is that §362(a)(3) prohibits affirmative acts that would disturb the status quo of estate property as of the time when the bankruptcy petition was filed.[v]

The Court explained further, “[a]ny ambiguity in the text of §362(a)(3) is resolved . . . by the existence of a separate provision, §542, that expressly governs the turnover of estate property.”  A holding that the obligation to turnover property is automatic regardless of a prior demand by the debtor, “would render the central command of §542 largely superfluous.”[vi]  Justice Alito also observed that the majority view would “render the commands of §362(a)(3) and §542 contradictory. Section 542 carves out exceptions to the turnover command, and §542(a) by its terms does not mandate turnover of property that is ‘of inconsequential value or benefit to the estate.’  Under [the majority view], in cases where those exceptions to turnover under §542 would apply, §362(a)(3) would command turnover all the same.  But it would be ‘an odd construction’ of §362(a)(3) to require a creditor to do immediately what §542 specifically excuses.”[vii]

Finally, it is worth reviewing Justice Sotomayor’s concurring opinion because it wrestles with the practical problems left unanswered by the Court’s decision. 

“The trouble with §542(a), however, is that turnover proceedings can be quite slow,” especially because the Bankruptcy Rules treat such proceedings as adversary proceedings.  “Of the turnover proceedings filed after July 2019 and concluding before June 2020, the average case was pending for over 100 days.  . . .  One hundred days is a long time to wait for a creditor to return your car, especially when you need that car to get to work so you can earn an income and make your bankruptcy plan payments. To address this problem, some courts have adopted strategies to hurry things along, [including by permitting] debtors to seek turnover by simple motion, in lieu of filing a full adversary proceeding, at least where the creditor has received adequate notice.  . . .  Similarly, even when a turnover request does take the form of an adversary proceeding, bankruptcy courts may find it prudent to expedite proceedings or order preliminary relief requiring temporary turnover.  . . .  Ultimately, however, any gap left by the Court’s ruling today is best addressed by rule drafters and policymakers, not bankruptcy judges. It is up to the Advisory Committee on Rules of Bankruptcy Procedure to consider amendments to the Rules that ensure prompt resolution of debtors’ requests for turnover under §542(a), especially where debtors’ vehicles are concerned. Congress, too, could offer a statutory fix, either by ensuring that expedited review is available for §542(a) proceedings seeking turnover of a vehicle or by enacting entirely new statutory mechanisms that require creditors to return cars to debtors in a timely manner. Nothing in today’s opinion forecloses these alternative solutions. With that understanding, I concur.”[viii] 

As we observed in our previous post, and as Justice Sotomayor’s concurrence confirms, this decision and its implication will almost certainly be most significant in consumer cases.  But, the core holding – that retention of estate property before a demand for turnover does not violate the automatic stay – may have further implications for an array of pre-bankruptcy remedies, including wage garnishments, account freezes, inventory foreclosures, and rerouting of goods in transit, to name a few.

[i] In re Denby-Peterson, 941 F.3d 115, 126 (3d Cir. 2019).

[ii] In re Fulton, 926 F.3d 916, 924 (7th Cir. 2019).  

[iii] City of Chicago, Illinois v. Fulton, et al., __ S.Ct. __ (2021).  The Court’s Slip Opinion is available here

[iv] Justice Barrett took no part in the consideration or decision of the case.  Justice Sotomayor issued a concurring opinion described later in this post. 

[v] Id. at 4.

[vi] Id. at 5.

[vii] Id. at 6.

[viii] Sotomayor, J., concurring, at 4-6.