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Possession of a Debtor’s Property After a Bankruptcy Declaration May… or May Not… Be a Stay Breach | Nelson Mullins Riley & Scarborough LLP

A person in possession of a debtor’s property while filing for bankruptcy now has more guidance from the Supreme Court as to the effect of the automatic stay. In City of Chicago, Illinois v. Fulton, 141 S. Ct. 585 (2021), delivered January 14, 2021, the Court was faced with the question of whether the City of Chicago (the “City”) was responsible for a violation of the automatic stay for having refused to return the vehicles which she had impounded before the request. In rendering a restrictive decision under Article 362 (a) (3) of the Bankruptcy Code, the Court held that this was not the case.

In Fulton, the City impounded vehicles because their owners had not paid the fines for various offenses. 141 S. Ct. At 589. The owners filed New Mexico Bankruptcy petitions and demanded the return of their vehicles, which the City refused. Identifier. Bankruptcy courts have ruled that the city’s withholding of vehicles after owners’ bankruptcy filings was an exercise of “control” over the owner’s property, constituting a suspension violation under Section 362 (a) ( 3) of the Bankruptcy Code. Identifier. The City appealed. The Supreme Court heard the case to resolve the following issue: an entity that retains possession of the property of a person who goes bankrupt violates the automatic stay under section 362 (a) (3). Identifier. at 589-90.

The problem was the applicability of two competing provisions of the Bankruptcy Code: (1) was this a violation of automatic stay governed by section 362, or (2) should it have been a “Reversal action” governed by article 542? As any secured lender and homeowner knows, the answer to this question is significant.

Being found in violation of the automatic stay can have very real consequences. A procedure to enforce the automatic stay is usually swift – started with a motion – and can be heard relatively quickly. It is governed by article 362 of the Bankruptcy Code. The debtor can seek damages, and for individual debtors, Section 362 (k) of the Bankruptcy Code even provides for punitive damages, which some courts will apply to corporate debtors.

Alternatively, a “reversal action” under Section 542 of the Bankruptcy Code is a much longer and more onerous process for the debtor. It requires the debtor to initiate “adversarial proceedings,” which is essentially a full civil suit, started with a complaint, and offers a full response time, discovery and decisive petitions. Even on an expedited basis, a debtor will litigate for at least 90 days to recover his property, the prospects for serious damages against the non-debtor party are much less severe, and Section 542 provides certain defenses to a rotating action.[1]

In Fulton, the Court in a decision 8-0[2] ruled that debtors had to file “waiver actions” under section 542 for the return of their vehicles and could not simply proceed under the automatic stay under section 362. 142 S. Ct at 592. Taking the statutory scheme in its entirety, the Court held that allowing a debtor to recover property under section 362 would be irrelevant to section 542 and its defenses. Identifier. at 591-92. With respect to the wording of the law, the Court held that it was important that the City simply maintain the status quo right from bankruptcy filings, rather than taking action after the petition to “exercise control” over real estate.[3] Identifier. to 590.

What are the practical points to remember from Fulton? If you are a creditor receiving property, a secured lender in possession of your collateral, an owner in possession of the debtor’s premises or any other custodian in possession of the debtor’s property, each when the debtor files for bankruptcy, taking any positive action after filing for bankruptcy to change the status quo before the petition could result in an automatic violation of the stay under section 362 (a) (3) and other paragraphs of section 362. So if you do not return the collateral, make sure your possession is completely passive while you weigh your options. Note further that some jurisdictions have relaxed some of the procedural hurdles debtors must overcome in filing revolving actions, some allowing the debtor to proceed by motion. Fulton provides further clarification, but creditors should remain vigilant and cautious to avoid inadvertent liability.


[1] Section 542 (a) excuses the action of rotation for property that is “of value without consequence to the benefit of the estate”. Section 542 (c) provides that an entity without effective notification or knowledge of the bankruptcy case may transfer the assets of the estate or pay a debt owed to the debtor in good faith. Section 542 (d) allows a life insurance company to pay premiums or perform a non-forfeiture insurance option which are set automatically if the payment is part of an insurance policy. life and that the insurance company does so in good faith.

[2] Judge Barrett was not involved in this decision.

[3] The Court acknowledged that the City had in fact made a post-petition payment request, which one of the debtors claimed violated sections 362 (a) (4) and (a) (6). The Court of Appeal did not reach these arguments, nor did the Supreme Court.

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