The United States Supreme Court recently held, in City of Chicago v. Fulton, that a creditor's "mere retention" of a debtor's property does not violate the bankruptcy automatic stay. In Fulton, the Court found that the Bankruptcy Code permits a creditor to maintain the status quo when a debtor files for bankruptcy. In other words, the creditor is not automatically compelled to return property of the debtor that the creditor recovered prior to the bankruptcy filing, but the creditor also cannot dispose of the property while the bankruptcy case is pending absent permission from the bankruptcy court.
As most bankruptcy creditors are aware, the Bankruptcy Code contains an automatic stay within § 362(a)(3). The automatic stay acts to automatically protect the debtor and his or her property from most collection or enforcement acts by creditors upon filing of a bankruptcy petition. Many debtors' counsel have also taken the position that the automatic stay requires creditors to return property to the debtor if the property had been repossessed or otherwise recovered by the creditor shortly before the bankruptcy filing. Bankruptcy courts had inconsistently interpreted this aspect of the automatic stay. Fulton made clear that if the debtor seeks return of the property, the correct means to pursue the return is a Motion for Turnover under §542 of the Bankruptcy Code, not the automatic stay statute.
Fulton is good news for secured creditors who fear bankruptcy filings by their defaulted customers. If the creditor can lawfully recover collateral before a bankruptcy case is commenced, the creditor is not automatically compelled to return that collateral as soon as the bankruptcy is filed. The debtor must take the affirmative step of filing a Motion for Turnover to compel return of the property.
Writing the Supreme Court’s opinion, Justice Samuel Alito noted that the language of § 362(a)(3) leads most logically to the conclusion that only affirmative acts that disturb the status quo are prohibited. If collateral is already in the creditor’s possession when the bankruptcy case is commenced, the creditor must retain the property, but at least is not automatically required to give up possession without a separate Motion for Turnover by the debtor and opportunity for the Bankruptcy Court to decide that issue.
Creditors navigating bankruptcy law issues regarding how to deal with collateral or other property recovered from debtors should seek legal advice about how to proceed. Bankruptcy law remains fraught with potential pitfalls for creditors. Erickson|Sederstrom’s creditors’ rights attorneys provide timely advice to creditors who are seeking guidance regarding pre-bankruptcy and bankruptcy rights against debtors and debtors’ property.