Third Circuit Allows Repossessing Secured Lender to Hold Collateral Pending Bankruptcy Stay

An "individual injured by any willful violation" of the automatic stay may seek "actual damages, including costs and attorneys' fees, and, in appropriate circumstances, may recover punitive damages." Id. at 5, quoting Code §362(k). Here, the debtor sought sanctions because of the lenders' refusal to turn over the debtor's car.

Plain Language of Code

The court rejected the debtor's assertion that the lenders violated the stay by failing to return her car. " … §362(a)(3) prohibits creditors from taking any affirmative act to exercise control over property of the estate." Id. at 7. Because the statutory language "is prospective in nature … the exercise of control is not stayed, but the act to exercise control is stayed." Id. In short, the language "requires a post‑petition affirmative act to exercise control over property of the estate." Id. "Stay means stay, not go." Cowen, 849 F.3d at 949.

No Affirmative Act

The lenders here had "possession and control of the" car, but "merely passively retained that same possession and control." Id. at 8. They never violated the automatic stay because they never did anything "to exercise control over" the car. Id. When learning of the debtor's bankruptcy filing, they merely "preserved the pre‑petition status quo." Id. Congress never intended "passive retention to qualify as 'an act to exercise control over property of the estate.'" Id., quoting Code §362(a)(3).

No Need to Resort to Unhelpful Legislative History

The court rejected the debtor's reliance on the legislative history because of the "unambiguous text" of §362(a)(3). Id. at 8. In any event, as the court noted, "Congress … 'gave no explanation of its intent'" when it amended §362(a)(3) by adding "to exercise control over property of the estate." Id. Indeed, said the court, "Congress did not express any intent, much less an intent to include creditors' passive retention of property that was seized pre‑petition." Id. at 9.

Code §542(a) Turnover Provision Not Self‑Effectuating

Rejecting the debtor's argument that Code §542(a) is "self-executing," the court found that "a creditor's obligation to turn over estate property to the debtor is not automatic." Id. at 10. Instead, the debtor or trustee must sue in the bankruptcy court to give that court a chance to determine whether the property is subject to turnover. Both the Federal Rules of Bankruptcy Procedure and §542(a) itself govern.

The debtor or trustee, after a bankruptcy filing, "must … initiate a turnover proceeding by (1) filing a complaint in Bankruptcy Court, and (2) serving a creditor with a copy of the complaint" under Bankruptcy Rule 7001(1). Id. at 10. Also, Code §542(a) "explicitly limits the right to turnover to estate property that (1) is in the possession, custody or control of a creditor, and (2) is not 'of inconsequential value or benefit to the estate'". Id. at 11. Thus, "explicit conditions … must be satisfied before property is subject to turnover." Id. There is no "automatic duty on creditors to turn over collateral to the debtor upon learning of a bankruptcy petition" and Code §542(a) is not "self-effectuating." Id. The bankruptcy court, after a debtor or trustee sues, "must ultimately decide whether certain property must be turned over to the debtor." Id. Although Code §542(a) contains the phrase "shall deliver to the [debtor]," it only happens when the bankruptcy court "says so in the context of an adversary proceeding brought under Rule 7001(1)." Id. at 12. This reasoning makes sense, particularly when the defendant disputes the debtor's interest in the property as of the date of bankruptcy. Even if the debtor has a property interest, a secured lender may be entitled to "adequate protection" (e.g., periodic cash payment, insurance coverage) under Code §363(e) to ensure that the lender's collateral is not harmed by the debtor's use of it during the bankruptcy. 3 Collier, Bankruptcy ¶ 361.02 (16th ed. 2018). Accord, United States v. Whiting Pools, Inc., 462 U.S. 198, 207 (1983) (Code "provides secured creditors various rights, including the right to adequate protection, and those rights replace the protection afforded by possession.").

Supreme Court Guidelines

The Supreme Court's Strumpf decision supports the holding in Denby-Peterson: "interpreting §542(b)'s turnover provision as self-executing would 'eviscerate' the provision's exceptions to the duty to pay." Id., citing Strumpf, 516 U.S. at 20. Neither the "automatic stay provision and the turnover provision … refer to each other." Id. Accordingly, "they should not be read together, [meaning that] violation of the turnover provision would not warrant sanctions for violation of the automatic stay provision." Id.; Cowen, 849 F.3d at 930. Courts "do not need §362 to enforce the turnover of property to the estate," because they can hold a party in contempt for violating a turnover order. Id.

Analysis

The Third Circuit reached a sensible, practical result in Denby-Peterson. The well‑reasoned opinion maintained the right balance between debtors' and creditors' rights. By preserving the status quo and the debtor's right to reclaim its property, it also relieves secured lenders from the threat of sanctions. The Code's automatic stay does not require lenders, on pain of sanctions, to do what the turnover provision (§542(a)) does not — immediately surrender repossessed collateral in the absence of a court ruling.

The turnover remedy was also never viewed as self-effectuating under pre‑Code practice. A secured lender who repossessed collateral prior to bankruptcy was able to retain possession pending the bankruptcy court's entry of a turnover. Ralph Brubaker, "Turnover, Adequate Protection and the Automatic Stay (Part I): Origins and Evolution of the Turnover Power," 33 Bnkr. L. Letter No. 8, at 4-7 (Aug. 2013). According to the U.S. Supreme Court, moreover, when a debtor sought a turnover order, "[n]othing in the legislative history evinces a congressional intent to depart from that [pre‑Code] practice." United States v. Whiting Pools, Inc., 462 U.S. 198, 208 (1983).

Denby-Peterson hardly threatens a debtor's ability to reorganize. The debtor or trustee can quickly start a turnover proceeding to recover essential property with a court order. That is exactly what happened in Denby-Peterson. Although debtors might argue that they should not have this obligation as a policy matter, the Code makes no such provision. Mission Products Holdings, Inc. v. Tempnology, LLC, 139 S. Ct. 1652, 1665 (2019) ("Code … aims to make reorganizations possible [but] does not permit anything and everything that might advance that goal.").

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Michael L. Cook is of counsel, at Schulte Roth & Zabel LLP in New York and a member of this newsletter's Board of Editors.