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Chicago v. Fulton: A Victory for Creditors?

Article

The Business Advisor

Winter 2021

In a decision issued on January 14, 2021, the Supreme Court of the United States vacated and remanded a Seventh Circuit decision regarding the scope of 11 U.S.C. § 362(a)(3). In In re Fulton, the Seventh Circuit addressed four consolidated appeals to decide “whether the City of Chicago may ignore the Bankruptcy Code’s automatic stay and continue to hold a debtor’s vehicle until the debtor pays her outstanding parking tickets.” 926 F.3d 916, 920 (7th Cir. 2019). The Seventh Circuit refused the City of Chicago’s request to overturn Seventh Circuit precedent, which “held that a creditor must comply with the automatic stay and return a debtor’s vehicle upon her filing of a bankruptcy petition.” Id. (citing Thompson v. General Motors Acceptance Corp., 566 F.3d 699 (7th Cir. 2009)). Instead, the Seventh Circuit found that refusing to return the impounded vehicle “violated the automatic stay pursuant to § 362(a)(3).” Id. at 924 (citations omitted). According to the Seventh Circuit, although the City of Chicago had impounded the vehicles in question prior to the filing of each bankruptcy petition, “the City was not passively abiding by the bankruptcy rules but actively resisting § 542(a) to exercise control over debtors’ vehicles.” Id.

The Opinion in Chicago v. Fulton

The Supreme Court “granted certiorari to resolve a split in the Courts of Appeals over ‘whether an entity that retains possession of the property of a bankruptcy estate violates § 362(a)(3).’” City of Chicago v. Fulton, 141 L. Ed. 2d 384, 387 (2021). At the time Chicago v. Fulton was decided, the Second, Seventh, Eighth, and Ninth Circuits were in the majority of circuits in holding “that the Bankruptcy Code’s turnover provisions requires immediate turnover of estate property that was seized pre-petition and that failure to do so violates the automatic stay.” See In re Denby-Peterson, 941 F.3d 115, 121, n. 13 (3d Cir. 2019) (citing In re Fulton, 926 F.3d 916); In re Weber, 719 F.3d 72 (2d Cir. 2013); In re Del Mission Ltd., 98 F.3d 1147 (9th Cir. 1996); In re Knaus, 889 F.2d 773 (8th Cir. 1989). In the Denby-Peterson decision, however, the Third Circuit joined the Tenth and D.C. Circuits to hold immediate turnover is not required. Instead, “the Federal Rules of Bankruptcy Procedure and the text of the turnover provisions support [the] conclusion … that the debtor’s right to turnover is subject to substantive and procedural requirements that must be evaluated by the Bankruptcy Court.” In re Denby-Peterson, 941 F.3d at 128.

With this background, Justice Alito, writing for the Court, held “mere retention of [estate] property does not violate § 362(a)(3).” City of Chicago v. Fulton, 141 S. Ct. 585, 589 (2021). The Court first looked to the section at issue, § 361(a)(3), which provides, subject to certain exceptions, that a bankruptcy petition “operates as a stay, applicable to all entities, of … 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) (emphasis added). A close analysis of the meaning of the operative terms of § 362(a)(3) suggests “that § 362(a)(3) halts any affirmative act that would alter the status quo as of the time of the filing of a bankruptcy petition.” City of Chicago, 141 S. Ct. at 590. Citing to Seventh Circuit precedent, the Court acknowledged, albeit with skepticism, that § 362(a)(3) may apply to certain inaction on the part of creditors as “omissions can qualify as ‘acts’ in certain contexts, and the term ‘control’ can mean ‘to have power over.’” Id. (citing Thompson, 566 F.3d at 702).

Any question about whether § 362(a)(3) requires affirmative turnover on the part of a creditor “is resolved decidedly in the City’s favor by the existence of a separate provision, § 542, that expressly governs the turnover of estate property.” Id. Section 542, titled “Turnover of property of the estate,” establishes the circumstances under which a creditor must turn over property of the debtor’s estate. Section 542(a) states that, subject to certain exceptions, any entity that is a custodian of, or in possession, custody, or control of, property of the estate must deliver that property to the trustee, unless such property is of inconsequential value or benefit to the estate. 11 U.S.C. § 542(a). This section also contains critical exceptions to mandatory turnover. First, turnover is not required where the non-debtor entity “has neither actual notice nor actual knowledge of the commencement of the case[.]” 11 U.S.C. § 542(c). Second, “good faith transfers to satisfy certain life insurance obligations” are shielded from § 542. City of Chicago, 141 S. Ct. at 590-91 (citing 11 U.S.C. § 542(d)). Justice Alito concluded that the existence of a distinct section of the Bankruptcy Code governing required turnover means that finding required turnover under § 362(a)(3) “would render the central command of § 542 largely superfluous.” Id. at 591. For the Court, this was the first nail in the coffin of the respondents’ argument.

However, it was not the last. The Court continues, “[s]econd, respondents’ reading would render the commands of § 362(a)(3) and § 542 contradictory.” Id. The contradiction exists “in cases where those exceptions to turnover under § 542 would apply, § 362(a)(3) would command turnover all the same.” Id. In order to resolve this contradiction, the Court would have to find that § 542’s exceptions apply to § 362(a)(3), “but there is no textual basis for doing so.” Id. The respondents’ argument was based on Congress’ inclusion of the term “or to exercise control over property of the estate” in the Bankruptcy Amendments and Federal Judgeship Act of 1984. Id. The Court held that the inclusion of this term does not change the structure and reading of the Bankruptcy Code. If the respondents were correct, then the 1984 amendments “transform[ed] the stay in § 362 into an affirmative turnover obligation,” which would be a critical change to the Bankruptcy Code. Something that “would have been odd for Congress to accomplish … by simply adding the phrase ‘exercise control,’ a phrase that does not naturally comprehend the mere retention of property and that does not admit the exceptions set out in § 542.” Id. at 591-92. Justice Alito emphasized the limited scope of the Court’s opinion, with the conclusion that, “[w]e hold only that mere retention of estate property after the filing of a bankruptcy petition does not violate § 362(a)(3) of the Bankruptcy Code.” Id. at 592.

Justice Sotomayor’s Concurrence

Any question about the limited focus of the Court’s opinion in City of Chicago is put to rest in Justice Sotomayor’s concurring opinion. City of Chicago, 141 S. Ct. at 592. Justice Sotomayor joined in that opinion because she believed that “as used in §362(a)(3), the phrase “exercise control over” does not cover a creditor’s retention of property lawfully seized prebankruptcy.” Id. However, Justice Sotomayor wrote a separate concurrence to “emphasize” that the Court did not address whether the City of Chicago’s refusal to return such property to a chapter 13 debtor violated either the prohibitions contained in §362(a)(4) (post-petition creation or enforcement of a lien) and §362(a)(6) (post-petition collection of a pre-petition debt) or the turnover provisions of §542(a). Id. In point of fact, Justice Sotomayor expressly left open the possibility that the City of Chicago had violated one of those Bankruptcy Code provisions. Id.

Justice Sotomayor expressly noted, moreover, that the retention of the debtor’s automobiles by the City of Chicago “hardly” comported with the “spirit” of the Bankruptcy Code. Id. at 592-93. In doing so, she turned to the economic realities underlying chapter 13. Chapter 13 is expressly available only to individuals with regular income (see 11 U.S.C. § 109(e)). For that reason, as Justice Sotomayor noted, the debtor must continue earning income to meet his or her obligations under the Chapter 13 plan. Id. at 593. Doing so for most debtors requires access to a car to get to work. Id. Additionally, Justice Sotomayor noted the disparate impact on communities of color of the City of Chicago’s seizure of cars for failure to pay parking tickets and other traffic violations. Id. at 593-94. Under Justice Sotomayor’s analysis, Chicago’s failure to return chapter 13 debtors’ cars not only threatened to subvert the purpose of chapter 13, but it was also discriminatory.

As the majority opinion did, Justice Sotomayor addressed alternative relief to that provided by §363(a)(3), particularly the remedy of turnover provided by § 542(a). Id. at 594. Under § 542(a), a chapter 13 debtor could obtain turnover of a car, subject to the requirement, if any, to provide the creditor with adequate protection under §361. Justice Sotomayor acknowledged that the procedure for obtaining turnover under § 542(a) would be cumbersome for a chapter 13 debtor and addressed workarounds. Id. She conceded the possibility that genuine relief for chapter 13 debtors might require amendments to either the Federal Rules of Bankruptcy Procedure or the Bankruptcy Code itself. Id. The categorical nature of the opinion in Chicago v. Fulton makes clear, however, that the most effective way to provide such relief would be by amending the Code.

Impact on Creditors

The Supreme Court’s decision in Chicago v. Fulton effectively affirmed the interpretation of § 363(a)(3) adopted by the Third Circuit in In re Denby-Peterson, 941 F.3d 115 (3d Cir. 2019). The Court’s conclusion that the mere retention of property of a debtor does not violate § 363(a)(3) potentially increases the burdens on chapter 13 debtors seeking to fund plans through wages or other regular income, and on chapter 11 debtors seeking to regain possession of previously seized collateral. As Justice Sotomayor emphasized in her concurring opinion, however, the scope of Chicago v. Fulton is limited to the scope of the prohibition against exercising control over property of the estate contained in § 363(a)(3). The well counseled chapter 11 debtor may be able to obtain return of collateral under either § 363(a)(4) or § 363(a)(6) or turnover under § 542(a). Nevertheless, the categorical nature of the opinion in Chicago v. Fulton and the delays inherent in an adversary proceeding under § 542(a) indicate that a change to the Bankruptcy Rules or, more likely, the Bankruptcy Code would be necessary to ensure that the underlying policies are achieved.