No, says the U.S. Court of Appeals for the Tenth Circuit in In re Cowen, adopting the minority rule and parting ways with four other Courts of Appeals. The automatic stay provision of the Bankruptcy Code addressed in Cowen provides that the filing of a bankruptcy petition “operates as a stay … of … 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.” Is it a violation of the automatic stay where a creditor who obtained possession of estate property pre-petition merely refuses a demand to turn it over? It is clear that the creditor has control over estate property, but what exactly is the prohibited “act” in this scenario? The majority rule, adopted by the Second, Seventh, Eighth and Ninth Circuits, holds that a mere refusal to turn-over the property is a violation of the stay, but the Tenth Circuit adopted the minority rule, followed by the D.C. Circuit, holding that passive possession alone is insufficient to constitute a violation of the automatic stay.
Pre-petition creditors repossessed the debtor’s property. Prior to the expiration of the redemption period, the debtors filed a bankruptcy petition and demanded that the creditors turn-over the repossessed property. The creditors refused. The bankruptcy court, affirmed by the district court, found that the defendants violated the automatic stay by failing to return the property and imposed actual and punitive damages. The defendants appealed.
Tenth Circuit’s Opinion
As mentioned previously, under section 362(a)(3) of the Bankruptcy Code, the filing of a bankruptcy petition “operates as a stay … of … 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” (emphasis added). The bankruptcy and district courts applied the majority rule – the act of passively holding onto an asset constitutes “exercising control” over it, and such action violates section 362(a)(3).
But the Tenth Circuit disagreed concluding that the majority rule is driven more by practical and policy considerations, rather than by faithful adherence to the statutory language. In the Court’s view, the majority rule ignores the requirement for an “act” to exist; exercise of control alone, absent an “act” is insufficient. And an “act” requires “to take action or do something.” Passive possession is not an act. Nor does section 362 impose an affirmative duty to turn-over property of the estate; that duty is found in section 542(a) of the Bankruptcy Code (with the bankruptcy courts’ equitable power to impose remedies for its violations). As examples for acts to exercise control that would constitute violations of the automatic stay, the Tenth Circuit points to creditor in possession of estate property who sells the property, or active interference with the estate’s exercise of its intangible property rights.
The split of authority could spell trouble to creditors since violations of the automatic stay are punishable by possible contempt citations and punitive damages. With no uniform rule, creditors should act gingerly, seek immediate legal advice on the law in the circuit where the bankruptcy case is pending and move expeditiously for instructions from the bankruptcy court, likely even before receiving a turn-over request from the debtor. After all, if mere possession violates the stay, presumably the violation occurs even absent a turn-over demand. Creditors should be careful not to allow debtors to game the system by not sending demands but later alleging a passive violation of the stay.