Justices to Weigh Treatment of Impounded Property in Bankruptcy

The U.S. Supreme Court is considering whether creditors must immediately return repossessed or impounded property when the owner subsequently files for bankruptcy, an issue that has generated a split among the circuits.

Chicago v. Fulton, which the justices will hear Tuesday, involves Chicago’s practice of impounding vehicles when their owners rack up unpaid parking or traffic fines. Despite the narrow focus on consumer debtors who file for bankruptcy under Chapter 13, the case could have broad implications for other areas of bankruptcy law, including Chapter 11 reorganizations.

“The case presents a real existential threat to Chapter 11 reorganizations,” David Kuney, an adjunct professor of bankruptcy at Georgetown University Law Center, told Bloomberg Law. “It’s a sleeper case; there’s more to it than meets the eye.”

The potential impact on bankruptcy law has drawn several amicus briefs on both sides of the issue, including from the Trump administration and the National Association of Bankruptcy Trustees.

Preserving Status Quo

In 2019, the U.S. Court of Appeals for the Seventh Circuit held that Chicago violated the automatic stay when it continued to hold onto cars it impounded prior to the bankruptcy filing.

The Second, Eighth, Ninth, and Eleventh circuits have sided with the Seventh Circuit. The Third, Tenth, and District of Columbia circuits, have ruled the opposite.

Section 362(a) of the code, which establishes the automatic stay, prohibits “any act . . . to exercise control over property of the estate.”

Chicago says the provision “preserves the status quo pending further order of the bankruptcy court,” and that there’s no “affirmative obligation on creditors to turn over property.” The onus is on the debtor to seek a court order returning the property under Section 542 of the code, the city said in its brief.

‘Game Changer’

A ruling that creditors don’t have to return the property “would fundamentally impair the ability of debtors to reorganize under both Chapter 11 and Chapter 13,” according to an amicus brief from Kuney and other law professors supporting the debtors.

Charles Tabb, a law professor at the University of Illinois in Urbana-Champaign, told Bloomberg Law that the case could be a “game changer,” but for a different reason.

Individuals will often file for bankruptcy just to get their repossessed cars back, he told Bloomberg Law.

Requiring the cars’ return absent a court order would give debtors new leverage against auto lenders when they default on a car loan, and would upset the “carefully calibrated balance” between debtors and secured lenders in the bankruptcy code, said Tabb, one of five bankruptcy law professors who filed an amicus brief supporting Chicago.

Adequate Protection

The question may come down to who should bear the burden of proving adequate protection of a creditor’s interest in collateral—the creditor asking to keep the property in a motion for relief from the automatic stay, or the debtor in support of a turnover motion.

Lengthy litigation over adequate protection could otherwise derail a reorganization where the debtor needs the repossessed property to keep operating its business, Kuney said.

Kuney cited as an example an airline that has had aircraft lawfully seized by a creditor before filing for bankruptcy. The airline may not be able to successfully reorganize if the parties have to finish litigating whether the creditor has adequate protection of its interests before it turns over the planes, he said.

But Section 542 exists for a debtor to recover property from a creditor, Tabb said. “It never occurred to me that Section 542 could be self-executing,” requiring automatic property turnover without establishing adequate protection for the creditor, he said.

Adequate creditor protection is a condition for turning over collateral, and the question can be resolved quickly, on an emergency basis if necessary, Tabb said.

An auto lender needs confirmation that its collateral—the car—is adequately insured, he said. Otherwise it could face a catastrophic loss should the car be destroyed.

The case is City of Chicago v. Fulton, U.S., No. 19-357.