The Court’s decision provides greater certainty for creditors who passively retain estate property that they obtained pre-petition.
In City of Chicago v. Fulton, the Supreme Court of the United States unanimously held that the “mere retention” of estate property obtained pre-petition does not violate the automatic stay under Section 362(a)(3) of the Bankruptcy Code. In doing so, the Supreme Court resolved a circuit split. Until the Fulton decision, appeal courts have imposed differing obligations on creditors to return estate property upon a debtor’s filing of a bankruptcy petition.
Facts and Procedural History
The City of Chicago (the “City”) impounded the vehicles of four separate individuals based on their failure to pay fines for motor vehicle infractions. Thereafter, the individuals (collectively “debtors”) filed Chapter 13 bankruptcy petitions. The debtors requested that the City return their impounded vehicles, but the City refused. The bankruptcy courts in the debtors’ respective Chapter 13 cases issued sanctions against the City, holding that the refusal to return the impounded vehicles constituted an exercise of control over estate property in violation of Section 362(a)(3)’s automatic stay. In each case, the City appealed.
In a consolidated opinion, the United States Court of Appeals for the Seventh Circuit affirmed the bankruptcy courts’ rulings. Specifically, the Seventh Circuit’s holding followed the majority position (adopted by the Second, Eighth, Ninth and Eleventh Circuits) that the passive retention of estate property violates the automatic stay. The courts of the District of Columbia, Third and Tenth Circuits have held otherwise.
The Supreme Court’s Decision
Upon the filing of a bankruptcy petition, Section 362(a)(3) imposes a “stay” of “any act… to exercise control over property of the estate.” The Supreme Court granted certiorari in Fulton to resolve the circuit split on whether an entity violates Section 362(a)(3) by passively retaining possession of estate property, which was obtained pre-petition, during the bankruptcy case. In a unanimous decision, the Court held that the “mere retention” of estate property does not violate the automatic stay under Section 362(a)(3) for three reasons:
First, the Court looked to the plain meaning of the terms “stay,” “act” and “exercise control” of Section 362(a)(3), and concluded that the most natural reading of these terms prohibits “affirmative acts that would disturb the status quo of estate property.” In other words, a creditor who obtains estate property before the debtor files for bankruptcy does not “exercise control” of that property by simply retaining it. Thus, Section 362(a)(3) does not compel mandatory turnover of estate property when a debtor files for bankruptcy.
Second, structurally, the Court determined that Section 362(a)(3) did not require mandatory turnover in light of Section 542, the turnover provision. The Court reasoned that because Section 542 “expressly governs the turnover of estate property,” to also read Section 362(a)(3) as a turnover provision would render Section 542 “largely superfluous.” The Court additionally reasoned that requiring compulsory turnover of estate property under Section 362(a)(3) would “render the commands of [Section] 362(a)(3) and [Section] 542 contradictory.” For instance, Section 542 excepts property “of inconsequential value or benefit to the estate” from turnover, while Section 362(a)(3) includes no such exception. Thus, reading Section 362(a)(3) as a mandatory turnover provision would require the Court to resolve this conflict “by engrafting [Section] 542’s exceptions onto [Section] 362(a)(3)” without any textual basis for doing so.
Third, the Court concluded that the legislative history of Section 362(a)(3) does not require mandatory turnover of estate property. The phrase “exercise control” did not appear in Section 362(a)(3)’s text prior to the 1984 amendments to the Bankruptcy Code, and bankruptcy courts did not require mandatory turnover of estate property. The Court reasoned that it was unlikely that Congress intended the addition of the phrase “exercise control” to convert Section 362(a)(3) into a compulsory turnover provision, noting that “[h]ad Congress wanted to make [Section] 362(a)(3) an enforcement arm of sorts for [Section] 542(a), the least one would expect would be a cross-reference to the latter provisions.” The Court emphasized that Congress did not include such a cross-reference, or “any other indication that it was transforming [Section] 362(a)(3)” in the way suggested by the debtors.
Commentary and Takeaway
The Court’s decision provides greater certainty for creditors who passively retain estate property that they obtained pre-petition. Under Fulton, mere possession, without more, will not violate the automatic stay under Section 362(a)(3). Thus, if a debtor seeks the return of estate property, the debtor may not simply file a bankruptcy petition and rely on Section 362(a)(3). Rather, debtors will likely need to initiate turnover proceedings under Section 542(a) to compel the return of estate property. However, Fulton’s impact may be modest. As Justice Sonia Sotomayor observed in her concurrence, “the Court has not decided whether and when [Section] 362(a)’s other provisions may require a creditor to return a debtor’s property.” (Emphasis added.) Accordingly, creditors should exercise caution with respect to how they treat estate property once a debtor files for bankruptcy. For example, a creditor’s sale of estate property, by contrast to mere possession, will likely be deemed an exercise of control over estate property in violation of the automatic stay under Section 362(a)(3).
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