Courts Begin to Wrestle with the Impact of on a Debtor’s Ability to Recover Estate Property

To facilitate a debtor’s efforts to reorganize and ensure that creditors are afforded equitable recoveries, the filing of a bankruptcy petition triggers several protective measures, including an automatic stay of “any act to obtain possession of property of the estate . . . or to exercise control over property of the estate.” 11 U.S.C. § 362(a)(3). In January 2021, we analyzed the significance of City of Chicago, Illinois v. Fulton, 141 S. Ct. 585 (2021), in which the Supreme Court held that section 362(a)(3) prohibits only “affirmative acts” that would change the “status quo” of estate property as of the time a bankruptcy petition is filed and that, therefore, an entity’s “mere retention” of estate property after the filing of a bankruptcy petition does not violate section 362(a)(3). The Court left open the possibility that an omission could constitute an affirmative act and did not address whether an affirmative act is required to violate other provisions of the automatic stay. The Court also declined to elaborate on a debtor’s ability to use the turnover provision of section 542(a) or the Bankruptcy Code to force an entity to deliver to the debtor property in the entity’s possession.

What amounts to an affirmative act—and whether the other provisions of section 362(a) contemplate one—are important issues for a number of reasons, including because they relate to a debtor’s ability to marshal estate assets for fair and equitable distribution to creditors. Since the Supreme Court issued its decision in Fulton, relatively few cases have addressed these key issues. In the last three months of 2021, however, three courts issued decisions that attempt to begin to delineate the impact of Fulton on a debtor’s ability to recover estate property. See In re Margavitch, No. 5:19-05353-MJC, 2021 WL 4597760 (Bankr. M.D. Pa. Oct. 6, 2021); In re Stuart, 632 B.R. 531 (B.A.P. 9th Cir. 2021); In re Cordova, 635 B.R. 321 (Bankr. N.D. Ill. 2021). As discussed below, two of the three decisions, Margavitch and Stuart, adopted an expansive application of the Supreme Court’s limitation in Fulton of the contours of the automatic stay, while the third, Cordova, adopted a narrow application of Fulton. In addition to disagreeing about the scope of Fulton’s applicability, the three decisions also fail to provide clear guidance concerning a debtor’s use of section 542(a) of the Bankruptcy Code to force creditors to turn over the estate property of the debtor that the creditor passively holds.

The Fulton Decision

In Fulton, the Supreme Court considered, specifically, whether a creditor’s “mere retention” of estate property after the filing of a bankruptcy petition constitutes an “act . . . to exercise control over property of the estate” within the meaning of 11 U.S.C. § 362(a)(3). 141 S. Ct. at 589. Petitioner in the case—the city of Chicago—impounded each respondent’s vehicle for failure to pay fines for motor vehicle infractions. Id. Each respondent filed a chapter 13 bankruptcy petition and, subsequently, moved for turnover of his or her vehicle. Id. The city refused and, in each case, a bankruptcy court held that the city’s refusal violated the automatic stay. Id. The Supreme Court granted certiorari to resolve a split among the circuit courts of appeal1 over whether an entity that merely retains possession of estate property violates section 362(a)(3). Id. at 589-90.

The Supreme Court determined that “mere retention” does not constitute an act to exercise control over property of the estate in violation of section 362(a)(3). The Court reasoned, among other things, that “the most natural reading of [the statute’s] terms—‘stay,’ ‘act,’ and ‘exercise control’—is that § 362(a)(3) prohibits affirmative acts that would disturb the status quo of estate property as of the time when the bankruptcy petition was filed.” Id. at 590. The Court further explained that “[a]ny ambiguity in the text of § 362(a)(3) is resolved” by section 542 of the Bankruptcy Code, which provides for turnover of estate property. Id. Section 542(a) requires entities in possession, custody, or control of estate property to deliver such property, or the value of such property, to the trustee or debtor-in-possession, unless such property is of inconsequential value or benefit to the estate. 11 U.S.C. § 542(a). According to the Court, if one were to read section 362(a)(3) as obligating entities in possession, custody, or control of estate property to turn such property over to the trustee or debtor-in-possession, that reading would render section 542(a) superfluous in violation of the canon against surplusage. Id. at 591.

The Court took pains to emphasize the narrow scope of its holding. It did not rule out that “omissions can qualify as ‘acts’ in certain contexts” or that “the term ‘control’ can mean ‘to have power over.’” See id. at 591. And it expressly indicated that it was not deciding how the turnover obligation in section 542 operates or settling the meaning of other subsections of section 362(a). Id. at 592. Thus, the Court left open, among other things, the possibility that a creditor’s passive retention of a debtor’s property could violate other sections of section 362(a), and the means by which a debtor could compel turnover of the same property under section 542(a).

Margavitch, Stuart, and Cordova

In Margavitch, the Bankruptcy Court for the Middle District of Pennsylvania considered whether a creditor’s failure to withdraw a prepetition attachment lien on the funds in a debtor’s bank account violated the automatic stay. 2021 WL 4597760, at *1. The debtor argued that a creditor must take affirmative action to avoid violating the stay and that, accordingly, upon the commencement of his bankruptcy case, the creditor should have withdrawn the lien or otherwise released the funds subject to attachment. Id. at *3. The debtor further argued that the Fulton decision did not impact the court’s analysis because the holding in Fulton applied only to circumstances in which creditors retained estate property and, in his case, the creditor never had possession of the property and therefore could not have retained it. Id. The creditor, relying on Fulton and In re Denby-Peterson, 941 F.3d 115 (3d Cir. 2019), argued that it had taken no postpetition “affirmative action as to the [bank accounts],” had “maintain[ed] the status quo as of the petition date,” and therefore had not violated the automatic stay. Id. at *4.

The court agreed with the creditor, rejecting the distinction the debtor attempted to draw between Fulton and the facts at issue. The court explained: “[s]uch a distinction is not particularly relevant and perhaps weighs more in favor of [the creditor] under the reasoning of Fulton since [the creditor was] not in actual possession of the funds.” Id. at *6. The court further explained that, under the debtor’s interpretation of section 362(a)(3), the creditor would have had to seek an order dissolving a valid prepetition lien in order to return the subject funds to the debtor. Id. Such an act would have put the creditor “in a more disadvantageous position than [it] had been [in] as of the petition date.” Id. Under Fulton, the creditor was entitled to maintain the status quo.

Significantly, the court in Margavitch applied Fulton’s reasoning to the other subsections of section 362(a), reasoning that “Fulton determined that an affirmative act is likely necessary to violate § 362(a)(3)” and that, because sections 362(a)(4), (5), and (6) “also all begin with the phrase ‘any act to,’” “it logically follows that an affirmative post-petition ‘act’ is necessary to constitute a violation of those subsections.” Id. at *6. The court then concluded that the creditor had not by its inaction violated sections 362(a)(4), (5), or (6). Id. at *6-7. The Margavitch decision did not consider or discuss what options the debtor may have had under section 542(a) of the Bankruptcy Code to compel the withdrawal of the creditor’s lien and/or return of funds to the debtor. See generally id.

In Stuart, the Bankruptcy Appellate Panel for the Ninth Circuit considered a similar issue: whether a city’s refusal to immediately lift a prepetition garnishment upon the debtor’s commencement of a bankruptcy case violated the automatic stay. 632 B.R. at 533-34. Like the creditor in Margavitch, the city argued that, under Fulton, it “needed only to refrain from disturbing the status quo and was not required to release the garnished funds or direct [the bank] to release the funds.” Id. at 536. And, like the debtor in Margavitch, the debtorargued that Fulton’s “narrow holding” was “inapplicable” because the city “denied ever possessing [the debtor’s] property” and, thus, could not have retained it. Id.

Again the court agreed with the creditor.2 Citing Margavitch, the panel held that, “[w]here a creditor has executed a prepetition writ of garnishment against a debtor’s bank account, it is under no affirmative obligation to release the funds and need only maintain the status quo.” Id. at 540-41. The panel also concluded that the city had not otherwise violated the automatic stay, agreeing with the Margavitch court that, because sections 362(a)(4), (5), and (6) all begin with the phrase “any act to,” an affirmative postpetition act is necessary to constitute a violation of those subsections. Id. at 544. Like the Margavitch decision, the Stuart decision provided no guidance concerning a debtor’s ability to use section 542(a) to obtain relief from the lien and/or the return of funds.

In Cordova, the Bankruptcy Court for the Northern District of Illinois took a different approach and adopted a narrow application of Fulton. There, the city of Chicago sought to dismiss the debtors’ claims which were based on the city’s postpetition refusal to release their impounded vehicles. 635 B.R. at 328-29. The city sought to have the action dismissed in its entirety—including the debtors’ claims under sections 362(a)(4), (6), and (7)—arguing that those sections, like section 362(a)(3), require an affirmative postpetition act to violate the automatic stay. Id. at 329. The city’s argument was “based on the applicability of the words ‘act’ and ‘stay,’ two out of three terms that helped the Court arrive it its interpretation of section 362(a)(3) in Fulton.” Id. at 342. The city contended that “the Court’s interpretation of the two words must apply with full force to other provisions of the automatic stay.” Id. at 342-43.

Unlike the courts in Margavitch and Stuart, however, the court in Cordova rejected the city’s argument, emphasizing that Fulton made clear that its ruling was limited to section 362(a)(3). Id. at 329. The court reasoned that Fulton’s holding was based on an interpretation of “the combination of three key terms ‘act,’ ‘stay,’ and ‘to exercise control over.’” Id. at 343. Since sections 362(a)(4), (6), and (7) do not contain all three terms, “there remain plausible readings of these sections that do not preclude the [debtors’] Complaint.” Id.

The court then undertook a defense of a narrow reading of Fulton, asserting that the city’s argument would leave the debtors with “virtually no immediate” means to recover vehicles that were “central to [their] ability to earn the income on which a plan is predicated.” Id. at 331, 344. Pointing out that it is not clear whether a chapter 13 debtor may enforce the provisions of section 542,3 the court asserted that, without a remedy under section 362(a), a chapter 13 debtor would be left, at best, with a long, drawn-out action for turnover under section 542 or, at worst, no remedy at all. Id. at 346. The court underscored that this lack of remedies would disadvantage not only debtors, but also competing creditors who might seek to preclude one creditor from pursuing a remedy to the disadvantage of others. Id. at 336.

The court therefore declined to dismiss the debtors’ claims under sections 362(a)(4), (6), and (7) and closed its analysis with: “What this court can do is what it does here, refuse to adopt in the context of a motion to dismiss a reading of Fulton that is so expansive that it eliminates clear and obvious remedies against recalcitrant creditors.” Id. at 346. Additionally, the Cordova decision recognizes the uncertainty over a chapter 13 debtor’s use of section 542(a)’s turnover mechanisms, but holds that where section 542(a) is available, the statute is self-executing and requires a creditor to return property even if the debtor or trustee does not commence a turnover proceeding under section 542(a). This expansive interpretation of section 542(a) appears in conflict with Justice Sotomayor’s reading of section 542(a) in her concurring opinion in Fulton, in which she notes the procedural requirements and time involved in a debtor’s efforts to recover property under section 542(a). See 141 S. Ct. at 594.

Conclusions and Takeaways

Not surprisingly, in Margavitch, Stuart, and Cordova, we see creditors arguing for a broad reading of Fulton and debtors arguing for a narrow reading. The courts in Margavitch and Stuart gave Fulton an expansive reading, curtailing a debtor’s ability immediately to recover estate property or penalize recalcitrant creditors, while the court in Cordova rejected such a reading, relying on both the text of section 362(a) and the policy objectives of facilitating the success of a debtor’s case and maximizing creditor recoveries. In any event, there remains significant uncertainty concerning whether and when a failure to act violates the automatic stay under Fulton. Further, the decisions to date have not provided clear guidance, substantively or procedurally, on the use of section 542(a) to force a party to deliver property to the debtor, even if the party’s possession of the property did not violate the automatic stay in the wake of Fulton. In large corporate chapter 11 cases, we would expect to see debtors immediately seek to compel turnover of any key assets in a third party’s possession on the petition date. Bankruptcy courts’ willingness to hear such actions on shortened notice and to order turnover of estate property will significantly shape the extent to which Fulton and its progeny impact corporate chapter 11 cases.