Supreme Court resolves issue of whether a creditor may retain a debtor’s property following a bankruptcy petition

           In the last few years, various circuit courts have been at odds with how they interpreted critical provisions of the Bankruptcy Code.  In the Code, §541 states that entities “shall deliver to the trustee, and account for” bankruptcy property that is within their possession.  Filing for bankruptcy immediately creates an estate for the debtor, and all creditors seeking to collect from the debtor must proceed through the bankruptcy forum. 

            §362 of the Code states prohibits “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” once a bankruptcy petition is filed. 

Circuits have been divided on whether it is proper for a creditor to maintain possession of a debtor’s property after a bankruptcy petition has been filed if they took possession of it prior to the petition. 

            The Supreme Court resolved this split in how the circuit courts were handling these cases in Chicago v. Fulton in January of this year.  In this case, the City of Chicago impounded the vehicles of debtors after they did not pay their fines for motor vehicle infractions.  After Chicago impounded the vehicles, the debtors declared bankruptcy and requested that the vehicles be returned in light of the aforementioned parts of the Bankruptcy Code stating that creditors may not take actions to possess parts of a debtor’s estate or to exercise control over property of the estate. 

           The Supreme Court held that simply filing a bankruptcy petition did not require Chicago to return immediately the debtors’ cars.  Instead, the debtors must ask the court for an order to recover their property.  Further, the Supreme Court determined that a creditor who merely retains possession of a debtor’s property does not violate the automatic stay.  In other words, a creditor may passively retain a debtor’s property already in its possession after the debtor seeks bankruptcy protection.”

            Although §362 prohibits actions to control property of a debtor’s estate, the Supreme Court held that this ambiguous provision is resolved by the text in §542.  This section controls the turnover of estate property, and besides its two exceptions, it states that:

           “[A]n entity, other than a custodian, in possession, custody, or control, during the case, of property that the trustee may use, sell, or lease under section 363 of this title, or that the debtor may exempt under section 522 of this title, shall deliver to the trustee, and account for, such property or the value of such property, unless such property is of inconsequential value or benefit to the estate.” 

            In interpreting this section, the Court decided that, if §362 required property that was already taken from the debtor to be returned, there would be no purpose to §542, which is titled “[t]urnover of property to estate.”  Instead, §542 controls when and how to turn over property to an estate, and §362 does not require that “an entity affirmatively .  .  .  relinquish control of the debtor’s property at the moment a bankruptcy petition is filed.”  

           The Court declined to explain exactly what turnover obligations are involved with §542, and they did not further interpret §362.  Regardless, the case provided crucial guidance for creditors, debtors, trustees of estates, and courts on the rights of both creditors and debtors under the Bankruptcy Code.  Ultimately, the Supreme Court’s holding in this case resolved divided outcomes across the circuit courts and provided that retaining estate property after a bankruptcy petition has been filed is not in violation of the Bankruptcy Code.