U.S. Supreme Court Issues Rare Ruling for Creditors

A recent ruling by the U.S. Supreme Court may offer added protection to creditors who move to repossess property ahead of a bankruptcy filing.

On January 14, 2021, the United States Supreme Court delivered a victory for creditors in City of Chicago v. Fulton. The Fulton decision offers protection from sanctions for violation of the automatic stay to creditors who have lawfully obtained possession of a debtor’s property prior to the bankruptcy filing. The 8-0 decision overturned bankruptcy court and Seventh Circuit decisions finding that the City of Chicago violated the Bankruptcy Code’s automatic stay provision.

In Fulton, a number of chapter 13 debtors whose cars were impounded by the City of Chicago for failure to pay fines prior to filing bankruptcy brought actions against the City of Chicago for violations of the Bankruptcy Code’s automatic stay, which generally provides that creditors may not take actions against or “exercise control over” a debtor’s property after the debtor has filed bankruptcy. In each instance, the bankruptcy courts found that the City’s refusals to return the cars to the debtors were violations of the automatic stay because the failure to return the cars amounted to “exercise[ing] control” over the property in violation of Bankruptcy Code § 362(a)(3). The Supreme Court, however, disagreed.

In particular, the Court determined that the plain language of § 362(a)(3) of the Bankruptcy Code prohibited affirmative acts to obtain possession of or control a debtor’s property, but did not per se prohibit merely holding such property. The Court further looked to Bankruptcy Code § 542, which deals with turnover of property of the estate. Reading § 542 alongside of § 362, the Court opined that the provisions of § 542 would be “superfluous” if § 362(a)(3) were read so broadly as to encompass merely holding a debtor’s property which had been lawfully seized prepetition. Instead, the Court held that the City did not violate the automatic stay by maintaining possession of the debtors’ cars after the bankruptcy filing because the term “exercise control over” required more than simply refusing to return the property.

While the Fulton opinion rests on a narrow set of facts, it likely protects lienholders who exercise their right to obtain possession of collateral prior to the owner’s bankruptcy. Instead of allowing debtors to “weaponize” § 362 through the threat of sanctions in certain difficult and ambiguous circumstances, the Court’s ruling protects creditors who are merely maintaining possession of collateral prior to a turnover request. Aside from a reduced threat of sanctions under § 362, the new directive for debtors to use Bankruptcy Code § 542 to resolve property disputes also allows creditors holding property certain defenses, including the opportunity to argue that such property “is of inconsequential value or benefit to the estate” and thus not subject to turnover. 

If you have questions about the Fulton decision or have any other questions regarding creditor rights under the Bankruptcy Code, contact Nyemaster Goode’s Creditor Rights team. Nyemaster’s Creditor Rights team offers a collaborative approach, with lawyers providing expertise in banking, secured transactions, foreclosures, out-of-court workouts and restructurings, bankruptcy, collections, and distressed commercial litigation.