I Really Can’t Stay: Supreme Court Clarifies Scope of Bankruptcy Automatic Stay

The United States Supreme Court has issued an opinion that clarifies the extent to which the automatic stay imposes obligations on creditors that seized their debtor’s property pre-petition and resolves a broad split among the circuit courts. The decision, City of Chicago v. Fulton, provides protection for creditors but adds to the burdens faced by many debtors.

Background

The case involved several similarly situated chapter 13 debtors whose vehicles had been seized pre-petition by the City of Chicago for failure to pay fines for motor vehicle infractions. The debtors argued that continued possession of the vehicles by the city violated the Bankruptcy Code’s automatic stay provisions, and in particular section 362(a)(3), which bars “any act … to exercise control over property of the estate.” The debtors’ position was adopted by the bankruptcy court and affirmed by the Seventh Circuit Court of Appeals.

The Supreme Court reversed. It reasoned that merely retaining possession of property does not rise to the level of an act to exercise control over property. While it conceded that the debtors’ alternative interpretation of the text of section 362(a)(3) was reasonable, it found dispositive that Bankruptcy Code section 542(a) expressly provides for the turnover of debtor’s property in the possession of third parties. It concluded that the mere retention of estate property after the filing of a bankruptcy petition does not violate section 362(a)(3).

Analysis

Fulton is a victory for secured creditors and creditors that have exercised possessory remedies, and may in many cases increase their leverage against debtors and other creditors. While the decision leaves open the question of the extent to which creditors may be compelled to surrender possession under section 542(a), in general, section 542(a) gives debtors a weaker hand than did section 362(a)(3) as it was interpreted in the line of cases the Court overruled. Among other things, violations of the automatic stay (but not section 542(a)) can be punished with contempt, and debtors seeking to enforce section 542(a) must commence an adversary proceeding.

While Fulton may generally improve the relative position of creditors in possession during a bankruptcy case, it does not materially affect the general rule that creditors in possession pre-bankruptcy should act promptly to sever a debtor’s rights to property before a bankruptcy petition is filed.

The Court’s methodology in reaching its decision was based almost entirely on a text-based approach that turned on a close reading of the language of the statute rather than legislative history or policy considerations. Fulton may provide insight into how the Court, with its changing membership, may be addressing bankruptcy cases and other cases. It should be noted that Justice Barrett took no part in the consideration or decision of the case.

Justice Sotomayor’s concurring opinion addresses some of the policy issues and practical consequences of the ruling, especially the difficulties that will be faced by chapter 13 debtors that rely on their vehicles to get to work and who therefore will have difficulty in generating income to pay creditors. She suggests that local rules may be adopted to streamline and expedite turnover proceedings. Practitioners should be alert for local rules and orders that address such issues.

Since Fulton amounts to a reversal of the governing Second Circuit precedent that had gone the other way, practitioners in New York should be prepared for changes based on the change in precedent.

The decision states that its scope is limited, and expressly disclaims consideration of related questions, such as how section 542 turnover obligations operate or the meaning of provisions of the automatic stay other than section 362(a)(3). Such questions will undoubtedly be the subject of future litigation, especially in cases that do not involve automobile impoundment and in business chapter 11 cases.