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January 18, 2022 Practice Points

Does a Secured Lender Violate the Automatic Stay By Not Returning Estate Property to a Debtor?

A guide to avoid violation of the automatic stay, after the Supreme Court’s ruling in Fulton

By Eric (Rick) S. Rein

The U.S. Supreme Court in City of Chicago v. Fulton, 141 S. Ct. 585 (2021), ruled that the City of Chicago was not in violation of Section 362(a)(3) of the Bankruptcy Code for failing to release an impounded car to a debtor in bankruptcy. Section 362(a)(3) imposes an automatic stay over “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.” According to the Fulton court, a violation of this section requires some affirmative act beyond mere retention of a debtor’s property.

The Fulton court did not decide whether and when section 362(a)’s other provisions may require a secured lender to return a debtor’s property. Section 362(a)(1) prohibits the “commencement or continuation” of a judicial proceeding against the debtor. Section 362(a)(2) stays enforcement of a pre-petition judgment against a debtor of property of the estate.

In viewing creditor recovery situations prior to Fulton, for instance, under Illinois law, a judgment creditor may serve a citation to discover assets of a judgment debtor or a third party in the custody and control of the judgment debtor, which creates a lien on all non-exempt personal property of the judgment debtor. 735 ILCS 5/2–1402(m); In re Tires N Tracks, Inc., 498 B.R. 201-204 (Bankr. N.D. Ill. 2013). Consistent with Fulton’s later holding, while the automatic stay prohibits a creditor from foreclosing on the citation lien, courts addressed whether the creditor is required to give up the lien. As explained in detail in In re Kuzniewski, 508 B.R. 678, 685-93 (Bankr. N.D. Ill. 2014), none of the subsections of § 362(a) requires a creditor to cause the release of funds held pursuant to a citation lien. The court in Tires N Tracks reached the same conclusion: the automatic stay does not require a judgment creditor to dismiss a citation proceeding and thereby give up the citation lien. Fulton would result in the same outcome if no affirmative action beyond mere retention of the lien is taken.

After Fulton, the court in Margavitch v. Southlake Holdings, LLC, 2021 WL 4597760 (Bankr. M.D. Pa. October 6, 2021), ruled that sections 362(a)(1), (2) or (3) were not violated by leaving an attachment in place because there was no affirmative action, only maintenance of the status quo. Likewise, in Stuart v. City of Scottsdale, 632 B.R. 531 (9th BAP 2021), by leaving a garnishment in place, the court ruled that this act did not disturb the status quo, was not a “continuation of a judicial proceeding” nor was it an act to take possession of property of the estate. The mere retention of a valid pre-petition lien, without more, appears to not violate the automatic stay.

However, Cordova v. City of Chicago, 2021 WL 5774400 (Bankr. N.D. Ill. Dec. 6, 2021), bears watching. It involves the refusal to release impounded cars to debtors in bankruptcy and sought to collect storage fees. The City moved to dismiss largely predicated on the presumption that the Supreme Court's ruling in Fulton forecloses the claims. The court noted that Fulton made clear that its ruling was limited to § 362(a)(3) and did not expressly nor impliedly foreclose the claims under § 362(a)(4) and (6). Section 362(a)(4) prohibits “any act to create, perfect, or enforce any lien against property of the estate.” The essential question is whether the City's continued possession is an act to create, perfect, or enforce that lien. Section 362(a)(6) prohibits “any act to collect, assess, or recover a claim against the debtor that arose before the commencement of the case ....” The question there is whether the City's acts were directed against the debtor and whether the City's act to collect payments in connection with the release of vehicles amounted to an “act to collect, assess, or recover a claim.” The court denied the motion to dismiss and allowed the claims to proceed.

Thus, the takeaway is that notwithstanding the ruling in Fulton, secured creditors should be cautious as to what actions can be taken toward the debtor and estate property, to avoid violating the automatic stay. Mere inaction is likely the best strategy.

Eric (Rick) S. Rein is a partner in Horwood, Marcus & Berk in Chicago, Illinois.

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