In a case that should alarm secured creditors who thought they could lawfully exercise their secured creditor rights to foreclose on collateral, the Second Circuit Court of Appeals upheld sanctions against a secured creditor that did exactly that. In 2006, the State Employees Federal Credit Union ("SEFCU") made a loan to Mr. Weber, secured by Mr. Weber’s pick-up truck (the principles in this case apply equally in the corporate finance world). After Mr. Weber defaulted on the loan in 2009, SEFCU legally repossessed Mr. Weber’s vehicle in 2010 as permitted by the loan agreement and by applicable New York State law, properly advising Mr. Weber of his right under NY State law to redeem the vehicle upon payment of amounts due and applicable costs. Mr. Weber commenced a Chapter 13 bankruptcy case (Chapter 13 relates to individuals) a few days after the repossession. Although no automatic stay had been in place until Mr. Weber’s bankruptcy petition was filed (an automatic stay being the action effective upon bankruptcy filing, applicable in Chapter 13 and in Chapter 11, that automatically stops secured creditors from seizing assets of a debtor following the bankruptcy filing), Mr. Weber demanded return of the vehicle from secured creditor SEFCU. The Bankruptcy Court agreed that the secured creditor’s repossession had been legal and did not violate the automatic stay, and held that Mr. Weber had not satisfied an existing New York State decision requiring a debtor to commence a turnover action if a debtor was seeking return of collateral so that it would become property of the debtor’s estate in bankruptcy.
Nevertheless, on appeal by Mr. Weber, the District Court reversed the Bankruptcy Court’s decision, and that reversal was affirmed on May 8, 2013 by the Second Circuit. Ignoring New York State precedent, the Second Circuit found that the secured creditor’s simple knowledge of the bankruptcy filing and retention of the vehicle meant that the secured creditor had willfully violated the automatic stay and was subject to damages and attorney’s fees. The Court maintained, contrary to common sense, that the mere filing of the bankruptcy case by the debtor caused the properly repossessed asset to suddenly and automatically return to the debtor’s bankruptcy estate as property of the debtor.
Moreover, the debtor’s inability to provide "adequate protection" to the lender was ignored by the District Court and the Second Circuit. Lest an institutional creditor take comfort that this case should be inapplicable to a corporate Chapter 11 proceeding, one must consider that the Second Circuit holding was not limited to a Chapter 13 case and the analysis largely relied upon existing Chapter 11 case law. In re Weber (No. 12-1632-bk, 2013 WL 1891371 (2nd Cir. May 8, 2013)) now asserts that despite the secured creditor’s compliance with State non-bankruptcy law, proper prepetition foreclosure on collateral may not withstand a debtor’s challenge based, illogically, on subsequent imposition of an automatic stay. Where is the limit?