Recent Supreme Court Ruling Provides Important Protection for Secured Creditors

The Herrick Restructuring Review provides insights and information related to restructuring and finance litigation. The Herrick team regularly represents official and ad hoc creditor committees, hedge funds, distressed debt investors, bondholders, and other parties in interest, and often serve as conflicts or special counsel for large-scale complex litigation matters.

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On January 15, 2021, the Supreme Court unanimously ruled in City of Chicago v. Fulton that a secured party in possession of a debtor’s collateral does not violate the automatic stay by passively retaining possession after a debtor commences a bankruptcy case. When a debtor files a bankruptcy case, the Bankruptcy Code protects the debtor by imposing an automatic stay on efforts to collect prepetition debts or “any act . . . to exercise control over property” of the bankruptcy estate.

In City of Chicago, the City of Chicago had impounded defendant Fulton’s car based on outstanding motor vehicle fines. When Fulton filed a Chapter 13 bankruptcy petition, Fulton asked the city to return his car.  When the  city refused, the bankruptcy court held that the city’s refusal violated the automatic stay because “by retaining possession of the debtors’ vehicles after they declared bankruptcy,” the city had acted “to exercise control over” Fulton’s property in violation of the automatic stay, and the Seventh Circuit affirmed.

The Supreme Court reversed and held that the City of Chicago did not violate the automatic stay by refusing to return Fulton’s impounded car, holding that the passive post-petition retention of collateral held as a result of a prepetition seizure does not violate the automatic stay. The Supreme Court ruled that the automatic stay only “prohibits affirmative acts that would disturb the status quo of estate property.”

AlthoughCity of Chicago is important for secured creditors because it removes the threat of sanctions for violating the automatic stay, it’s not complete immunity. City of Chicago did not address a debtor’s ability to seek a turnover order under section 542 of the Bankruptcy Code. Under that section, a debtor may be able to compel a creditor in possession of collateral to return it to the debtor. But turnover actions are fact-specific and depend on the nature of the claims alleged by the debtor and counterclaims of the creditor. Thus, while it remains to be seen whether debtors will be able to use turnover actions to recover repossessed collateral, it is clear that the debtor’s threat of seeking sanctions for post-petition possession of collateral is gone.

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For more information on this alert or other restructuring & finance litigation matters please contact:

Stephen B. Selbst at +1 212 592 1405 or [email protected]
Gabrielle Fromer at +1 212 592 1575 or [email protected]

© 2021 Herrick, Feinstein LLP. This alert is provided by Herrick, Feinstein LLP to keep its clients and other interested parties informed of current legal developments that may affect or otherwise be of interest to them. The information is not intended as legal advice or legal opinion and should not be construed as such.