The following is a case update written by Monique D. Jewett-Brewster, a member of the ad hoc group of the California Lawyers Association’s (CLA) Business Law Section, analyzing a recent decision of interest:
Adding to the circuit split on the issue, the Third Circuit Court of Appeals adopted the minority view and ruled that a creditor’s passive retention of collateral it repossessed prepetition pending a bankruptcy court order is not a “willful violation” of the automatic stay. [In re Denby-Peterson, 2019 WL 5538570, 941 F.3d 115 (3rd Cir. 10/28/19)] To view the opinion in its entirety, click here.
FACTS: Joy Denby-Peterson (Debtor) purchased a used Chevrolet Corvette, and defaulted on her car payments several months later. Shortly after the secured creditors repossessed the car, Debtor filed an “emergency voluntary Chapter 13 petition” in the New Jersey bankruptcy court. She then notified the creditors of her bankruptcy filing and demanded they return the Corvette to her.
After creditors refused, Debtor filed a motion for turnover in the bankruptcy court, seeking an order (1) compelling creditors return the Corvette to her, and (2) imposing sanctions for creditors’ alleged violation of the automatic stay pursuant to 11 U.S.C. §362(a)(3), (k). The bankruptcy court granted Debtor’s request for turnover but denied the sanctions request. In reaching its holdings, the bankruptcy court found that Debtor possessed an equitable interest in the vehicle as of the petition date. On that basis, the bankruptcy determined that the Corvette was property of the estate subject to turnover. However, acknowledging the circuit split on the issue, the bankruptcy court adopted “the minority” view and ruled that a creditor does not violate the automatic say in regard to property of the estate if it merely maintains the status quo.
Debtor appealed, and the district court affirmed. In a matter of first impression, the Third Circuit of Appeals affirmed the district court’s order affirming the bankruptcy court’s ruling.
REASONING: The Court of Appeals began its analysis by discussing the statutory framework for the issues before it. First, the court examined the stay automatically triggered by the filing of a bankruptcy petition. Specifically, the court discussed Bankruptcy Code Section 362, subsection (a)(3), which provides that a bankruptcy petition “operates as a stay, applicable to all entities, of … any act to obtain possession of property of the estate … or to exercise control over property of the estate.” The Court of Appeals also recognized that the property of the estate which comes into existence upon a bankruptcy filing generally includes “all legal or equitable interests of the debtor in property as of the commencement of the case … wherever located and by whomever held.”
The Court of Appeals then examined the “twofold” purpose behind the automatic stay imposed by the Bankruptcy Code:
(1) to protect the debtor, by stopping all collection efforts, harassment, and foreclosure actions, thereby giving the debtor a respite from creditors and a chance ‘to attempt a repayment or reorganization plan or simply be relieved of the financial pressures that drove him [or her] into bankruptcy;’ and (2) to protect ‘creditors by preventing particular creditors from acting unilaterally in self-interest to obtain payment from a debtor to the detriment of other creditors.’
The court went on to discuss Section 362(k), which provides that, subject to one exception, “an individual injured by any willful violation” of the automatic stay is entitled to “actual damages, including costs and attorneys’ fees, and, in appropriate circumstances, may recover punitive damages.” [Emphasis added.]
After discussing the statutory background for the issue before it, the Court of Appeals acknowledged the circuit split, and noted that the issue presented a matter of first impression in the Third Circuit. The court explained that under the “majority view” held by the Second, Seventh, Eighth, Ninth, and Eleventh Circuits, upon learning of the bankruptcy filing, a creditor must return its collateral to the debtor and any failure to do so violates the automatic stay. The court then noted that under the “minority view” espoused by the Tenth and D.C. Circuits, a secured creditor is not obligated to return the collateral to the debtor until the debtor obtains a court order from the Bankruptcy Court requiring the creditor to do so.
Examining the plain meaning of the operative terms set forth in Section 362(a)(3) – “stay,” “act,” and “exercise control,” the Court of Appeals rejected the debtor’s first argument that Section 362(a)(3) obligates a creditor to immediately turnover property repossessed prior to the bankruptcy filing upon receiving notice of the filing:
From these definitions, we gather that Section 362(a)(3) prohibits creditors from taking any affirmative act to exercise control over property of the estate. As correctly pointed out by the District Court, the statutory language “is prospective in nature … the exercise of control is not stayed, but the act to exercise control is stayed.” Therefore, we agree with the minority position held by two of our sister courts—the text of Section 362(a)(3) requires a post-petition affirmative act to exercise control over property of the estate.
Citing the underlying policy of the automatic stay to “maintain the status quo,” the Court of Appeals pointed out that by maintaining possession of the collateral postpetition after learning of the bankruptcy filing, the creditors effectively did just that—thereby furthering the aim of the automatic stay. Reasoning that the creditors took no postpetition action to exercise control over property of the estate, the Third Circuit determined that creditors did not violate the automatic stay, thereby adopting the minority view held by the Tenth and D.C. Circuits.
As a second argument, Debtor contended that by amending Section 362(a)(3) in 1984 to insert the “or exercise control over property of the estate” clause in the Code, Congress intended that creditors return any collateral they repossessed prepetition upon learning of the debtor’s bankruptcy filing. Rejecting Debtor’s argument, the Third Circuit concluded that neither the statutory language of Section 362(a)(3) nor its legislative history supported such a result:
Denby-Peterson nevertheless urges us to follow the Seventh Circuit’s view that “the mere fact that Congress expanded the provision to prohibit conduct above and beyond obtaining possession of an asset suggests that it intended to include conduct by creditors who seized an asset pre-petition.” We will not do so because the legislative history would be pertinent only to the extent that Congress clearly expressed an intent to interpret Section 362(a)(3) contrary to its plain language. Here, Congress did not express any intent, much less an intent to include creditors’ passive retention of property that was seized pre-petition. Moreover, even assuming that Section 362(a)(3) is ambiguous, thereby warranting consideration of legislative history, the legislative history’s silence provides no guidance regarding Congress’s rationale for adding the “or to exercise control over property of the estate” clause. Accordingly, the interpretation that Denby-Peterson urges us to adopt is unsupported by Section 362(a)(3)’s legislative history as well as its statutory language.
The Third Court examined and then rejected Debtor’s third argument that Section 542(a)’s turnover provisions are self-executing, such that creditors’ failure to return the Corvette upon receiving notice of the bankruptcy case violated the automatic stay:
First, in our view, Section 542(a)’s turnover provision is not self-executing; in other words, a creditor’s obligation to turn over estate property to the debtor is not automatic. Rather, the turnover provision requires the debtor to bring an adversary proceeding in Bankruptcy Court in order to give the Court the opportunity to determine whether the property is subject to turnover under Section 542(a)…. This procedural requirement negates any possibility that a creditor’s duty to turn over property is automatic.
The Court then concluded:
True, the turnover provision states: “shall deliver,” but the question before us is when must a creditor deliver? The answer is when the Bankruptcy Court says so in the context of an adversary proceeding brought under Rule 7001(1). We view the statutory and procedural framework as: (1) the Chapter 13 debtor must seek court relief, such as by initiating an adversary proceeding requesting turnover; (2) the Bankruptcy Court then determines whether the property is subject to turnover; and (3) if it is, in accordance with that determination, the Bankruptcy Court issues a court order compelling a creditor to turn over property to the debtor. [Emphasis added.]
AUTHOR’S COMMENT: At first blush, the Third Circuit Court of Appeals’ reasoning appears persuasive; after all, how does a creditor’s passive retention of collateral it repossessed prepetition violate Section 362(a)’s automatic stay, where the creditor is taking no action to “exercise control” over property of the estate in a manner which prejudices other creditors or prefers itself? A review of the reasoning adopted by the circuits holding the “majority view,” however, calls the Third Circuit’s interpretation of a creditor’s duties under the automatic stays – and Section 362(k), which authorizes sanctions for violations of the stay –into question.
For example, in In re Del Mission, Ltd., 98 F.3d 1147 (9th Cir. 1996), the Ninth Circuit Court of Appealsconsidered whether the California Employment Development Department and State Board of Equalization (State)’s failure to return disputed taxes the Chapter 7 trustee paid under protest constituted a violation of the automatic stay provision of Section 362(a)(3). Adopting the reasoning of the majority, the Ninth Circuit concluded that the knowing retention of estate property violates the automatic stay of Bankruptcy Code section 362(a)(3) due, in part, to the plain language of Section 542(a). As explained by the Court of Appeals:
11 U.S.C. § 542(a) provides that an entity in possession of estate property “shall” deliver such property to the trustee. This is a mandatory duty arising upon the filing of the bankruptcy petition…. The underlying purpose of the automatic stay … is to alleviate the financial strains on the debtor…. To effectuate the purpose of the automatic stay, the onus to return estate property is placed upon the possessor; it does not fall on the debtor to pursue the possessor. [Citations omitted]
Citing to several opinions, including In re Abrams, 127 B.R. 239, 241–43 (9th Cir. BAP 1991), a case decided by the Ninth Circuit Bankruptcy Appellate Circuit involving facts similar to Denby but with a contrary result, the Court of Appeals further reasoned:
[I]f persons who could make no substantial adverse claim to a debtor’s property in their possession could, without cost to themselves, compel the debtor or his trustee to bring suit as a prerequisite to returning the property, the powers of a bankruptcy court and its officers to collect the estate for the benefit of creditors would be vastly reduced…..
[T]he case law and the legislative history of § 362 indicate that Congress did not intend to place the burden on the bankruptcy estate to absorb the expense of potentially multiple turnover actions, at least not without providing a means to recover damages sustained as a consequence thereof.
Based on the reasoning espoused by the Ninth Circuit and other circuits presenting the majority view, the debtor should not bear the cost and expense of affirmatively seeking an order for turnover. Rather, any party holding property of the estate (e.g., property in which debtor maintains an equitable interest at the time of the petition filing), must return that collateral upon learning of the case.
Creditors tempted to rely on Denby as support for the passive retention of collateral possessed prepetition should be aware that this precedent represents the minority view in this circuit split. While the passive postpetition retention of collateral in a Chapter 13 case may not violate the automatic stay in the Tenth, D.C. and now, Third Circuits, creditors might be better served by turning over the collateral in order to reduce their exposure to sanctions for violation of the stay under Section 362(k). The alternative is to ignore the debtor’s request for turnover and then hope for the best.
For discussions of cases involving similar issues, see:
- 2009 Comm. Fin. News. 45, When Repossession Is Followed by Chapter 13 Petition, Automobile Lender Must Turn Car over to Debtor’s Estate or Risk Liability for Violating Automatic Stay.
- 2017-10 Comm. Fin. News. NL 19, Creditors’ Passive Retention of Debtor’s Property Did Not Violate Automatic Stay, But Post-Petition Forgery and Perjury Did.
These materials were written by members of the California Lawyers Association Business Law Section for the Commercial Finance Newsletter, published weekly on Westlaw. Thomson Reuters holds the copyright to these materials and has permitted the Insolvency Law Committee to reprint them. This material may not be further distributed without the consent of Thomson Reuters.