Possession is not an “act” that violates the Bankruptcy Stay

In a recent opinion, City of Chicago v. Fulton, the Supreme Court unanimously decided that the mere retention of property after a bankruptcy filing does not violate the automatic stay applicable under the Bankruptcy Code because it is not an “act to obtain possession of property of the estate or of property from the estate or to exercise control over property of the estate.”

When a bankruptcy is filed, creditors are prohibited by the “automatic stay” from taking actions to collect their claims against the bankrupt debtor. The purpose of the automatic stay is to avoid a “rush to the courthouse” to dismantle the debtor’s assets so that they can be liquidated in an orderly manner or the debtor can reorganize consistent with the provisions of the Bankruptcy Code.

Among the actions prohibited by the automatic stay is “any act to obtain possession of property of the estate or of property from the estate or to exercise control over property of the estate.” 11 U.S.C. § 362(a)(3). The question arises whether a creditor who is in possession of property of the debtor (which generally will be repossessed collateral) is required to turn over the property to the debtor upon filing of the case to avoid potential sanctions for violating the automatic stay. In its opinion, the Supreme Court unanimously decided that the mere retention of property after a bankruptcy filing is not an “act to obtain possession of property of the estate or of property from the estate or to exercise control over property of the estate.”

The Bankruptcy Code has a separate provision regarding turnover of property of the debtor. “An entity in possession, custody, or control of certain property of the estate must account for and turn over such property to the trustee (or debtor) unless such property is of inconsequential value to the estate.” 11 U.S.C. § 542(a). Although some courts deem this provision to affirmatively require such a party to turnover property without a court order, a debtor may file a lawsuit in the bankruptcy case to require a party to turnover property after the case is filed, although lawsuits may be expensive and result in delays in obtaining the property.

Although this decision would seem to be a boon for creditors, any act to otherwise enforce liens against the property remains subject to the automatic stay so the creditor must obtain a relief from the stay to realize any monetary benefit from retaining the property. The Court also did not decide whether the turnover provision in Section 542 requires a court order or whether it is effective without a court order.

As a practical matter, the decision leaves both creditors and debtors in something of a legal dilemma. For example, a debtor who needs a repossessed vehicle may be required to file a lawsuit against a creditor to have the creditor turn over a car needed for daily transportation – the costs and delay of filing a lawsuit may outweigh the benefits to the debtor of filing a lawsuit or the equity in the car. A creditor on the other hand is subject to the possibility that a court may find the obligation to turn over the vehicle effective without a court order and deny costs of storage and other costs associated with repossession. A creditor who has possession of property of the debtor when the bankruptcy case is filed is well-advised to promptly file a motion for relief from the automatic stay to seek court permission to proceed with selling the collateral to permit it to proceed and, in doing so, have the court moot any turnover rights of the debtor.

Jim Angell  has more than 30 years of experience in bankruptcy and debtor creditor relations, business disputes and business transactions.  If you have questions about your case or bankruptcy issue, please contact us today.