Creditors in possession of lawfully seized debtor assets aren’t automatically obligated to return them to their owners who subsequently declare bankruptcy, the U.S. Supreme Court ruled.
Ruling in Chicago v. Fulton, the justices Thursday reversed a Seventh Circuit ruling that Chicago violated the automatic stay created by car owners’ bankruptcy filings when the city refused to immediately return cars that were impounded pre-bankruptcy for parking or traffic violations.
The 8-0 ruling, which could have changed the practices of financing companies and municipalities across the U.S., settles a dispute among the federal appellate courts.
The Third, Tenth, and District of Columbia circuits have found that creditors who merely maintained possession of seized property aren’t violating the stay. But the Second, Seventh, Eighth, Ninth, and Eleventh Circuits said holding onto the seized property is a prohibited “act to exercise control over property” of the bankruptcy estate.
The “most natural reading” of the bankruptcy code is that it “prohibits affirmative acts that would disturb the status quo of estate property as of the time when the bankruptcy petition was filed,” Justice Samuel A. Alito wrote in an opinion joined by seven other justices.
Justice Sonia Sotomayor penned a concurring opinion to emphasize that the justices didn’t decide whether other subsections of the automatic stay statute might still require a creditor to return repossessed debtor property if the creditor is holding it for the purpose of extracting payment.
Justice Amy Coney Barrett, who wasn’t on the Supreme Court when it heard oral argument in October 2020, didn’t participate in the decision.
“This ruling ensures that there will be fewer unnecessary Chapter 13 bankruptcies, particularly fraudulent filings,” the City of Chicago said in a statement Thursday. It had argued that individuals were improperly filing bankruptcy for the sole purpose of recovering their impounded vehicles.
For creditors to be in violation of the automatic stay, they have be engaged in “something more than merely retaining power,” Alito said, referring to Section 362(a)(3) of the bankruptcy code. A prohibited “act” for creditors can in some instances include an omission or failure to act after the debtor’s bankruptcy filing, but that didn’t apply to Chicago holding impounded vehicles, he said.
A contrary ruling would render another section of the bankruptcy code “largely superfluous,” he wrote, referring to Section 542. That provision authorizes a bankruptcy estate to recover estate property that’s held by a third party.
In her concurrence, Sotomayor noted Section 362(a) bars creditors from an “act to collect a debt.” That section could be read to require creditors to return repossessed property, despite the high court’s ruling Thursday that holding the car by itself is not a banned “act to exercise control” over it, she said.
“The ramifications of the case are far beyond the parking ticket context,” said Melissa Jacoby, a bankruptcy law professor at the University of North Carolina at Chapel Hill.
The City of Chicago said it created a payment plan program to help citizens clear or lower their auto-related debts.
Chicago’s case against Fulton may need further proceedings. The high court’s decision remands the case for consideration of other possible grounds that could determine that the city violated bankruptcy stay. Whether the city’s lien claims are valid remains uncertain, said attorney David Kuney, who co-wrote an amicus brief siding with the car owner.
“I don’t know if Chicago is celebrating, because if a court concludes their withholding the property is a collection action, there’s still a stay violation,” Kuney said.
“The court never reached the existential problem—the threat to how bankruptcy works with a balance between creditors and debtors,” Kuney said, citing an example of a major bankrupt airline trying to regain a seized fleet.
Bankruptcy courts could come up with a fast-track procedure for a debtor to recover repossessed property while ensuring that the secured creditor gets adequate protection, Kuney said.
But the ruling could also create a new race to the courthouse, prompting debtors whose cars are at risk to file bankruptcy before a creditor or city impounder can seize them, Jacoby said.
“Bankruptcy was never meant to be a means for the recovery of a car due to parking tickets,” she said.
The case is Chicago v. Fulton, U.S., No. 19-357, 1/14/21.