Supreme Court Resolves Dispute Over Creditors’ Obligation to Turn Over Estate Assets at Time of Chapter 13 Bankruptcy Petition

Mark W. Sandretto and Jared J. Lefevre

gavel on desk with books in background   Consider the following common hypothetical.  A debtor defaults on a perfected purchase money security interest secured by a vehicle.  The creditor exercises its right to repossess the collateral.  The debtor subsequently files a Chapter 13 bankruptcy petition and demands the creditor release the vehicle back to the debtor, citing Section 362(a)(3) of the Bankruptcy Code, which precludes creditors from “exercising control” over assets of the bankruptcy estate.  Must the creditor comply?  Resolving a circuit split, the U.S. Supreme Court definitively answered that specific question in the negative.

   In In re Fulton, the City of Chicago immobilized and impounded vehicles because their owners failed to pay parking tickets, fines and other municipal citations.   The City’s municipal code provided that the City retained a possessory lien on impounded vehicles to secure payment of the unpaid obligations.  When the vehicles’ owners filed Chapter 13 bankruptcy petitions, the City refused to release the vehicles, arguing that it was entitled to retain possession of the vehicles to maintain perfection of its possessory lien.  The Seventh Circuit Court of Appeals (and others) rejected this argument, ruling that passively holding estate assets constituted the “exercise of control” over those assets and that creditors had a compulsory obligation to return such property to the debtor upon the filing of a Chapter 13 petition.

   The U.S. Supreme Court concluded differently.  Parsing the language of Section 362(a)(3) of the Bankruptcy Code, the Court concluded that any ambiguity in a creditor’s obligation to return estate property to the debtor upon filing of a Chapter 13 petition is resolved by reference to Section 542 of the Code, which governs turnover of estate property.  In essence, the Court determined that the broad reading of Section 362 advanced by the Fulton debtors (i.e., that creditors must automatically return estate property upon the filing of a Chapter 13) rendered Section 542 “mere surplusage” and, further, negated potentially applicable exceptions to turnover available to creditors, such as the exception excusing turnover of property that is of inconsequential benefit or value to the estate.

   From the debtor’s perspective, the Court’s ruling represents a practical challenge.  Depending on the adequacy of notice, invoking Section 542 to compel turnover of estate property requires, at minimum, a motion and hearing, and more likely, commencing an adversary proceeding, both of which are time-consuming and inject an element of case-by-case fact-finding that makes streamlining procedures and relief difficult.  Although foreclosing the Fulton debtors’ claim for relief on the basis of Section 362(a)(3), the Court took pains to state that it did not reach questions of whether passive retention of estate property might violate other provisions of Section 362 or the procedural mechanisms governing the turnover obligation under Section 542.  Accordingly, although the Court negated a notable strategy for debtors to quickly regain control of estate property, creditors should expect creative arguments from debtors to achieve similar results based upon different sections of Section 362. 

   Should you have any questions regarding the court ruling, please contact Mr. Sandretto or Mr. Lefevre.




   The article in this publication has been prepared by Eastman & Smith Ltd. for informational purposes only and should not be considered legal advice. This information is not intended to create, and receipt of it does not constitute, an attorney/client relationship.