The U.S. Supreme Court offered some good news to secured lenders last week, tempered with words of caution. In Chicago v. Fulton, the Court held that a secured creditor does not violate Section 362(a)(3) of the Bankruptcy Code by merely continuing to hold property of its debtor after that debtor files a bankruptcy petition. The 8-0 opinion written by Justice Alito, and particularly the separate concurring opinion written by Justice Sotomayor, cautioned that a creditor holding a bankrupt debtor’s property could easily run afoul of Section 362(a)(4) or (6) (prohibiting acts to enforce liens and to collect a claim, respectively), or of Section 542(a)’s obligation to deliver property to the debtor or trustee. But at least there is nationwide clarity on one issue: merely continuing to hold a debtor’s property that was lawfully seized prepetition is not a violation of 11 U.S.C. § 362(a)(3).
This decision arises from several Chapter 13 bankruptcy cases where individuals filed bankruptcy and then demanded that the City of Chicago release their vehicles, which had been impounded for past-due parking fines. The City refused. The Bankruptcy Court found that the City’s refusal violated the automatic stay created by 11 U.S.C. § 362(a). The Seventh Circuit Court of Appeals agreed that by retaining the debtors’ cars, the City had acted “to exercise control over” their property, in violation of the automatic stay. Decisions from the Second, Eighth, Ninth, and Eleventh Circuits also imposed an affirmative duty on creditors to return seized property once a bankruptcy petition is filed; failure to do so was a violation of the automatic stay in those Circuits. The Third, Tenth, and District of Columbia Circuits held that merely retaining property was not a violation of the automatic stay. The Supreme Court resolved the circuit split by holding that simply holding property lawfully seized prepetition (i.e., before the debtor filed its petition for relief in bankruptcy court) and maintaining the status quo is not a violation of the automatic stay.
One interesting effect of this decision is that lenders now have even more incentive to move quickly to seize their collateral. In commercial cases, the fact that a debtor cannot get its property back by simply filing bankruptcy will affect negotiations between borrowers and lenders, both in and out of a bankruptcy courtroom. Justice Sotomayor’s concurring opinion notes that where the debtor is an individual, he or she may not be able to get to work to earn money to pay any creditors if his or her car is impounded for parking fines the debtor cannot afford to pay . . . effectively undermining the debtor’s bankruptcy case before it gets underway. Her opinion suggests some ways that Congress could improve the Bankruptcy Code to give working debtors a better chance at a successful outcome for their case and unsecured creditors a better chance of getting paid something on their claims. Perhaps the incoming Congress will accept her invitation to make some changes to the Bankruptcy Code.