An article prepared by Associate Attorney Sonja Hourany and Partner Jeff Golden will be included in the California Bankruptcy Journal’s Spring Edition 2021. A summary of their article is as follows:
In a rebuke to the majority of circuits that had previously reached the opposite conclusion, the Supreme Court recently narrowed the scope of the Bankruptcy Code’s automatic stay in City of Chicago v. Fulton, 141 S. Ct. 585 (2021) by holding that a creditor who merely retains property of the bankruptcy estate does not violate 11 U.S.C. § 362(a)(3). The Court’s holding was unanimous, and Justice Sotomayor filed the only concurring opinion.
The Court determined that a creditor’s retention of property in the absence of affirmative action does not amount to an act to exercise control over property of the estate. In so determining, the Court first applied the plain-meaning rule and looked to dictionary definitions of operative terms. The Court focused on “stay,” “act,” and “exercise control.” The Court stated that taken together, the “most natural reading” of these terms is that § 362(a)(3) only prohibits “affirmative acts that would disturb the status quo of estate property as of the time when the bankruptcy petition was filed.” Fulton, 141 S. Ct. at 590.
Next, the Court identified what it saw as “two serious problems” with reading § 362(a)(3) as covering “mere retention” of property. Id. at 591. First, the Court reasoned that it would violate the well-known canon against surplusage by rendering the central command of § 542, which expressly governs turnover of property of the estate, “largely superfluous.” Id. Second, the Court reasoned that the commands of § 362(a)(3) and § 542 would be contradictory, as § 362(a)(3) would require turnover where § 542 provides exceptions to turnover.
Lastly, the Court completed its analysis by explaining that the history of the Bankruptcy Code likewise supported its interpretation but did not cite to any case or secondary materials in support of this conclusion. The phrase “or to exercise control over property of the estate” was not added to § 362(a)(3) until 1984. Reasoning that transformation of the automatic stay into an affirmative turnover obligation would “have constituted an important change,” the Court observed that “it would have been odd for Congress to accomplish that change by simply adding the phrase ‘exercise control,’ a phrase that does not naturally comprehend the mere retention of property and that does not admit of the exceptions set out in § 542.” Id. at 592.
The Court concluded the opinion with an express disclaimer that the Court intended neither to decide “how the turnover obligation in § 542 operates” nor settle “the meaning of the other subsections of § 362(a).” Id.
The Court’s holding is deceptively broad, raising a number of problems and questions. The logic that anchored the Court’s opinion seems applicable to any situation where a creditor can hold hostage its seizure or freezing of a debtor’s assets without immediate or cost-effective recourse for the debtor. A wrongful act is apparently allowed by the reasoning in Fulton, such as a creditor retaining possession of an unlawfully seized vehicle, so long as post-petition the creditor’s actions are limited to simply keeping the status quo in place. Moreover, the Court’s opinion will likely result in new and significant costs to debtors, as obtaining turnover pursuant to § 542 likely requires counsel, let along the filing fee to commence an adversary proceeding. All the while, the debtor does not have access to their vehicle or other property. The Court’s ruling thus also creates a disparity in leverage and bargaining power. A creditor’s ability to hold onto disputed assets and refuse post-petition to turnover such assets upon demand, while depriving a debtor of access and use, creates a clear incentive for debtors to trade more liberally for the right to have their property back in their possession tan they otherwise might.
Initial reviews and reactions to the Court’s latest entry into the insolvency arena have varied radically. Some practitioners have treated this decision as a monumental shift that promises significant impact for consumer debtors in particular. Others, by contrast, insist little will change in the ordinary course of debtor-creditor relations. Only time and hindsight will tell.