Business Law

City of Chicago, Illinois, vs. Fulton (U.S. Sup. Ct.)

The following is a case update written by Adam A. Lewis, Senior Counsel, Morrison & Foerster LLC, and Uzzi O. Raanan, Partner, Danning, Gill, Israel & Krasnoff LLP, analyzing a recent decision of interest:

Summary

In an 8-0 opinion (including a concurring opinion), the United States Supreme Court (the “Court”), resolving a long-standing circuit split, held that the City of Chicago’s refusal to turn over vehicles it seized prepetition from multiple Chapter 13 debtors did not violate the automatic stay provisions of 11 U.S.C. section 362(a)(3), which prohibits any post-petition “act” by an entity to “exercise control over property of the estate.”  Chicago v. Fulton, 2021 WL 125106 (January 14, 2021) (“Fulton”).  The case can be found here.

Facts

The Fulton decision involved four Chapter 13 cases consolidated into a single appeal because they shared a common legal question.  In each case, the City of Chicago impounded a debtor’s car for failure to pay fines and fees for motor vehicle offenses.  The cars being vital to their livelihoods, the debtors filed Chapter 13 cases and demanded turnover of the vehicles under section 542(a) of the Bankruptcy Code (the “Code”).[1]

Section 541 creates a bankruptcy “estate” from property the debtor owned prepetition.  In turn, with a few exceptions, section 542(a) requires an entity to turn over to the debtor or trustee estate property in its possession upon the filing of a bankruptcy.  Here, Chicago refused turnover demands from multiple Chapter 13 debtors unless it was paid fines/fees incurred by them prepetition.  Surprisingly, the City’s express link of its willingness to turn over the vehicles to the debtors’ immediate payments of fines/fees, other than being mentioned in passing by the concurrence, gets no attention in the Court’s opinion. 

The bankruptcy court, affirmed by the Seventh Circuit Court of Appeals based on prior circuit authority, held that Chicago’s refusal to turn over the Vehicles violated the automatic stay provisions of section 362(a)(3).  That section provides that the automatic stay applies to “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.”  Given a split in the circuits regarding whether refusal of a turnover demand is a stay violation, the Supreme Court granted writs for certiorari by Chicago in the four cases.  The Supreme Court reversed, thereby adopting the so-called minority view on this issue.

Reasoning

The Court’s ruling was narrow in terms of both its reasoning and statutory focus.  It based its main analysis essentially on unpacking various dictionary definitions of the key terms of section 362(a)(3), to wit, “stay”, “exercise control,” and “act.”  The Court argued that in ordinary language the “stay of any act” to “exercise control over” estate property targets some kind of affirmative step that changes the status quo.  Here, Chicago did nothing with the impounded cars after the filing of the bankruptcy cases.  It simply held on to the vehicles and declined to release them.  Merely having the power to change the status quo does not amount to an “act” to “exercise control.”  Rounding out its lexicologically based analysis, the decision recognizes the appeal of the debtors’ argument that in certain contexts a failure to do something can be an act, but it reasons that combination of the terms “stay,” “act,” and “exercise control” in section 362(a)(3) suggests that an entity must do more than merely fail to do something to be held liable under this provision.

The opinion also maintains that the interpretation urged by the debtors would violate canons of statutory interpretation.  One such canon disfavors rendering one statute surplusage by the interpretation of another.  If the debtors were correct, there would be little point in the turnover command of section 542(a) because turnover would in essence be compelled by section 362(a)(3).

By the same token, statutes should not be interpreted to conflict with one another.  According to the Court, the debtors’ theory would do just that with regard to section 542(a)’s exceptions to that section’s turnover command, by making any failure to turn over a stay violation under section 362(a)(3).  Finally, the Court pointed out that it is undisputed that prior to the 1984 addition of the term, “or to exercise control over property of the estate” to section 362(a)(3), that section did not prohibit the kind of conduct that is at issue in Fulton.  But, the opinion continued, if Congress had wanted to change the Code to do so, that is, to in effect mandate turnover, it could and would have employed more forthright, unequivocal language than it did in the 1984 amendment. 

The opinion concludes by noting that it is not otherwise interpreting section 542 or – more importantly – the other stay provisions of section 362(a).  It is here where Justice Sotomayor’s concurrence picks up.  She does not argue with the opinion’s conclusion that, by failing to turn over the cars, Chicago did not violate section 362(a)(3); she expressly joins in that result.  Rather, she does two other things.  First, she emphasizes that the Court’s opinion does not address the meaning of any stay provisions in section 362(a) other than section 362(a)(3).  Second, she launches into policy considerations that the decision leaves untackled and that she urges must be addressed in some way.  She points out, for example, that in today’s society cars are necessary for people’s ability to make a living.  And this consideration becomes especially critical when a person files a Chapter 13 case, for it affects the debtor’s ability to generate the income necessary to fund a plan for his benefit and that of his creditors.  And although a party can ask the bankruptcy court to order turnover of estate assets, the process as currently prescribed in the Federal Rules of Bankruptcy Procedure requires a lawsuit in the bankruptcy court, a process that is both lengthy and expensive, making the remedy for an already financially strapped debtor something of an illusion.

Authors’ Comment

The opinion authored by Justice Samuel Alito overlooks the context of sections 362(a)(3) and 542(a), current bankruptcy practice, and the possible impact the decision will have on creditors’ likelihood of receiving meaningful distributions in bankruptcy cases.  Thus, while succinct and clear, it is not apparent that this decision is either legally correct or desirable for the fulfillment of important bankruptcy policies or the efficient administration of bankruptcy cases.

Though the Court acknowledges in a short footnote that circuit courts are split over whether an entity’s retention of estate assets violates section 362(a)(3), with a majority reaching the opposite result from this Court, it offers no discussion of these cases, their factual contexts, their underlying legal reasonings or even the amicus briefs before it, a discussion that might have suggested a different result.

The Court’s brief opinion contains a limited discussion of the facts involved in the four consolidated Chapter 13 cases underlying the present appeal.  As a result, the Court’s ruling does not distinguish between creditors who assert liens and possessory interests in estate assets, as well as demand adequate protection before agreeing to comply with section 542(a), a well-recognized right in both situations, on the one hand, and unsecured creditors who refuse to turnover assets in passive/aggressive efforts to collect from bankruptcy estates, on the other.  This distinction might have justified a different result. 

The Court also does not address a theory advanced by some legal scholars that a creditor who legally holds an estate asset has a possessory interest in that asset.  This interest allegedly deprives the estate of at least one stick in the proverbial bundle of assets recognized by section 541(a), which means that arguably the possessory interest is not an asset of the estate that is subject to either section 542(a) or the prohibition of section 362(a)(3), an argument that could have lent support to this decision.

Rather, the Court’s opinion parses the words in section 362(a)(3) and concludes based on dictionary definitions that a natural reading of the terms, “stay,” “act” and “exercise control” “suggests” that section 363(a)(3) “prohibits affirmative acts that would disturb the status quo of estate property as of the time when the bankruptcy petition was filed.”  While the Court agrees that others interpret these terms differently, and even that “omissions” can qualify as “acts,” it holds with no citations to any sources that the language in question “implies” “something more than merely retaining power . . . ” given the particular combination of terms.

It should be noted that others have relied on the definition of “control” in Article 9 of the Uniform Commercial Code to reach the Court’s current conclusion about the meaning of “exercise control.”  The Court neither relies upon nor addresses that argument.  Instead, it explains that any ambiguity in the language in section 362(a)(3) is resolved by the existence of section 542(a), which expressly governs turnover of estate property.  According to the Court, reading section 362(a)(3) to prohibit passive retention of estate property would thus render section 542 superfluous and the provisions in sections 362(a)(3) and 542(a) contradictory.

However, holding that section 362(a)(3) prohibits continued possession of estate assets would not necessarily render section 542(a) superfluous.  As noted in various amicus briefs, sections 542(a) and 362(a)(3) complement each other but contemplate different roles.  Section 542(a) governs turnover and accountings of estate assets.  Section 362(a)(3) establishes an automatic stay prohibiting creditors from engaging in various acts post-petition.  As many bankruptcy and appellate courts have concluded, the purpose of one section does not a fortiori conflict with that underlying the other.  In fact, section 362(a)(3) enhances a trustee’s ability to enforce turnover requirements in section 542(a), which does not in itself render either section 542(a) or section 362(a)(3) superfluous.  Section 362(a)(3) is an enforcement provision for section 542(a).

Moreover, the Court’s conclusion that the majority view would render sections 362(a)(3) and 542(a) contradictory is somewhat unpersuasive.  According to the Court, the latter section contains exceptions for turnover requirements while section 362(a)(3) does not.  It therefore finds that it would be an oddity if section 363(a)(3) would require turnover of assets that section 542(a) excuses from such a command.  However, practitioners and courts have long reconciled this seeming contradiction.  For example, if section 542(a) excepts property of inconsequential value or benefit to the estate, courts generally do not find that failure to turn over such property violates section 362(a)(3)’s automatic stay provisions.

The Court also offers no insights into how it reached the conclusion that the term “or to exercise control over property of the estate” was added by Congress in 1984 to section 362(a)(3) to deal specifically with “intangible property and acts that would change the status quo with respect to tangible property without ‘obtain[ing]’ such property.”  This discussion may result in future litigation to determine what the Court intended.

In short, the Court’s opinion overlooks legal arguments relied upon by a majority of circuits considering the issue at hand since at least 1989 and seems unconcerned about whether its ruling is either supported by legal precedence or desirable to achieve a healthy bankruptcy system.

Unfortunately, the possible ramifications of this opinion are great.  For starters, many debtors in Chapter 13 cases, such as the four cases underlying this decision, will be unable to repatriate their sole means of transportation as cities across the country hold on to impounded vehicles until they are paid fees/fines that may be out of reach for many debtors.[2] This will often impair the ability of already financially strapped debtors to earn a living and jeopardize their ability to repay creditors.

Also not discussed here is the likely impact this ruling will have on Chapter 7 or 11 trustees to marshal assets of bankruptcy estates and pay creditors their pro rata shares.  Savvy creditors now have reason to hold onto estate assets that they obtained prepetition and demand immediate payment or put trustees to the task of obtaining turnover judgments.  This will require trustees and debtors-in-possession to either relent and pay the creditors, thus favoring them over other creditors, or incur the costs and time necessary to file and litigate adversary actions against the creditors, thereby harming other creditors by needlessly reducing bankruptcy estates’ funds.

While unreasonable refusals to comply with section 542(a) may result in impositions of sanctions under section 105(a), it is not clear at this time that this tool will either be utilized widely by the courts or be a sufficient replacement of the deterrence value that section 362(a)(3) has had on abusive behavior by some creditors.  Of course, the stay against acts to collect a prepetition debt in section 362(a)(6) might apply to creditors such as the City of Chicago that expressly hold estate assets hostage to payment of prepetition debts, such conduct being less disputably an “act” than a passive refusal to turn over the property.  However, until this issue is clarified by the courts, and even after, it would be better if section 362(a)(3) applied.[3]

As with other far-reaching decisions issued by the Court in bankruptcy cases, bankruptcy courts and practitioners will likely seek ways to deal with the anomalies arising from this decision.  Perhaps anticipating this, Justice Sotomayor appears to offer a roadmap for overcoming the consequences caused by the Court’s opinion.  For its part, the Court acknowledges in a footnote that it offers no views on whether the City’s actions violated section 362(a)(4) and (a)(6).  As they say, “to be continued.”

These materials were authored by Adam A. Lewis, Senior Counsel, Morrison & Foerster LLC, and Uzzi O. Raanan, Partner, Danning, Gill, Israel & Krasnoff LLP, both members of the ad hoc group, with editorial assistance by Meredith Jury, (bankruptcy judge, C.D. Cal. (Ret.)), a member of the ad hoc group. Thomson Reuters holds the copyright to these materials and has permitted the Insolvency Law Committee to reprint them. This material may not be further transmitted without the consent of Thomson Reuters.


[1] The Bankruptcy Code is codified in 11 U.S.C. sections 101, et seq.

[2] According to an amicus brief filed by the National Association of Counties, in conjunction with five other governmental associations,

“[I]n 2018, a total of 14,673 vehicles were impounded by Denver for code violations.  [Fn.]  Milwaukee impounded between 29,000 and 32,000 vehicles annually from 2016 to 2018.  [Fn.]  In Boston, the annual number of impounded vehicles ranged from approximately 12,000 to 16,000 for each of the past three years.  [Fn.]  Montgomery County, Maryland, tows approximately 18,000 vehicles per year.  [Fn.]  These are just four American municipalities.  It is safe to say that not just tens of thousands but even several hundreds of thousands of vehicles are subject to impoundment each year in American local governments.”

[3] While at least some Chapter 13 debtors raised section 362(a)(6) as another ground for finding a violation of the automatic stay, the Seventh Circuit Court of Appeals never considered this issue, instead relying solely on section 362(a)(3).  As a result, the Court here also does not address the applicability of section 362(a)(6).

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