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Bankruptcy’s Automatic Stay: The Fine Line Between Passive Action and Inaction

Cases in the Seventh and Tenth Circuits are primed for Supreme Court review of the most recent circuit clash between debtors and creditors. Florence + The Machine sums up the classic conflict between debtors and creditors well:

And every demon wants his pound of flesh

But I like to keep some things to myself

– Florence + The Machine, Shake It Out

Alternatively, the common car purchase can set the stage. Frequently, automobiles are sold on an installment basis. Typically, the sellers in these contracts will require the car be used as collateral, creating a purchase-money security interest (PMSI). The PMSI makes the seller a secured creditor, which generally enhances the likelihood that the seller will be repaid.1 A significant power of a secured creditor is the ability to repossess the collateral if the borrower cannot make a payment and is in default.2 Thus, if a purchaser of a car with an installment basis contract, including a PMSI, cannot make her payments, the seller may lawfully take the vehicle from the purchaser. What happens, however, when the purchaser of the car files for bankruptcy soon after the car is repossessed by the seller?

 A major benefit of filing for bankruptcy is the protection afforded by the automatic stay, detailed in Section 362 of the Bankruptcy Code. This injunction prevents creditors from seeking to collect the debtor’s property or any repayment of debts (subject to some exceptions) and it is automatic upon the filing of a bankruptcy petition. True, a debtor’s assets will eventually be distributed through the debtor’s bankruptcy estate by the trustee; many debtors, however, welcome the temporary reprieve from creditors afforded by the stay with open arms. Whether the stay also forces secured creditors who have lawfully repossessed the debtor’s property to automatically return that property to the bankruptcy trustee upon commencement of the case is an open issue, but it is poised to close quickly.

The Circuit Split

The Seventh Circuit addressed the issue in Thompson v. General Motors Acceptance Corp., holding that “the act of passively holding onto an asset constitutes ‘exercising control’ over it, and such action violates section 362(a)(3) of the Bankruptcy Code.”3 The court also pointed to the Supreme Court’s interpretation in Whiting Pools of the turnover power of Section 542(a), requiring creditors holding property of the debtor to return it to the trustee.4 With the holding, the Seventh Circuit reversed an opinion that had followed “accepted procedure” in the district, allowing a secured creditor “to retain possession of a seized asset until the creditor subjectively determine[d]” that the debtor had sufficient assets to protect the secured creditor’s interests.5 Instead, the Seventh Circuit required the creditors to first return the asset and then to seek adequate protection from the court. Most circuits agree with Thompson in this regard.

A couple circuits are not as debtor-friendly as the Seventh Circuit, however. Despite the plain text analysis of sections 362(a)(3) and 542(a) in Thompson, the Tenth Circuit disagreed in In re Cowen using the same method of analysis. There, the Tenth Circuit held that passively holding an asset does not violate the automatic stay. The court accused the majority Thompson rule as “driven more by ‘practical considerations’ and ‘policy considerations’ than a faithful adherence to the text.”6 The court argued that the act requirement of section 362(a)(3) necessarily entails an affirmative action, stating that “[s]tay means stay, not go.”7 The Court in Cowen also contested the majority rule’s use of the turnover power of Section 542(a) in this context, stating that the Bankruptcy Code does not contain a “textual link” between section 542 and section 362.8 The D.C. Circuit applies the same rule as Cowen.9

Some may see this circuit split as a good reminder to stay current on car payments, regardless of jurisdiction. The ramifications are much greater for the City of Chicago, which has impounded automobiles as an enforcement mechanism to aid in generating revenue from parking and red-light violations for years. According to one of its recent appearances in the Bankruptcy Court for the Northern District of Illinois, this revenue accounts for $260 million per year, or 7% of the City’s budget.10

Chicago Takes on Debtor-Friendly Thompson

Judge Thorne summarizes the City’s “boot and impound” scheme in In re Peake.11 The Illinois Legislature allows the City to “provide by ordinance for a program of vehicle immobilization for the purpose of facilitating enforcement of” limited parking and traffic regulations, including parking and automatic traffic violations, such as red-light tickets.12 The City may immobilize a vehicle after three “final determinations of liability” (two determinations if they are over a year old), which entail a vehicle owner either losing in an administrative proceeding or failing to contest the violation.13 Illinois also expressly permits the towing and impoundment of a vehicle after immobilization.14 Judge Thorne admits that through this process, the City has an interest “in the nature of a lien” in a vehicle lawfully possessed prior to the bankruptcy filing.15

With its lien interest, the City of Chicago argued that an exception to the stay applied, either under section 362(b)(3) or 362(b)(4). Section 362(b)(3) provides an exception for acts related to perfecting, or maintaining the perfection of, the security interest – that is, solidifying the creditor’s lien as to other potential creditors. Section 362(b)(4) provides an exception for a “governmental unit” enforcing its “police and regulatory power.”16 Judge Thorne dispensed with the section 362(b)(4) claim relatively quickly by pointing to the provision’s exception-to-exception for “money judgments,” which parking and traffic fines surely are.17 Judge Thorne attacked the City’s section 362(b)(3) argument, however, with the proverbial kitchen sink – the provision’s purposes, its plain meaning, the legislative history, construing exceptions, and precedence. The focus on section 362(b)(3) resulted from the need to reconcile the conundrum that the City’s holding of a vehicle was deemed an act in violation of the stay per Thompson and yet it did not also qualify as an act to maintain perfection in the vehicle for purposes of the section 362(b)(3) exception. Judge Thorne conceded that the City’s possession of a vehicle maintains its perfection in the vehicle, but she determined that the act contemplated in section 362(b)(3) was of the “single, positive, definite” variety, providing the example of “filing a continuation statement.”18 Thus, the City violated the stay and had to return the car immediately.

Chicago has taken some blows in its automatic stay bout (see also In re Shannon), but the City is not without victory. In City of Chicago v. Kennedy, Judge Shah focused on the City’s revisions to its municipal code in 2016, giving itself “a possessory lien in any impounded vehicle.”19 Judge Shah stated that because the municipal code was “generally applicable law” under section 546(b) (textually linked to section 362(b)(3)), the City qualified for the section 362(b)(3) exception to the automatic stay.20 In another win for Chicago, the City’s “non-consensual possessory lien” was contrasted with the “consensual lien creditor” in Thompson.21 There, Judge Cassling stated that the statutory justification of Thompson “does not work when applied to creditors with possessory liens . . . [who] must retain possession of their collateral in order to retain any liens entitled to adequate protection.”22

Chicago will take its case to the Seventh Circuit in a consolidated appeal on the vehicle impoundment issue with the last brief due December 31, 2018.23 However, the issue has recently made its way back through the Tenth Circuit already.

Tenth Circuit Doubles Down on Creditor-Friendly Cowen

As anticipated, the Tenth Circuit followed Cowen in a brief opinion in In re Garcia, holding that “the statutory term ‘act’ . . . encompass[es] only affirmative conduct on the part of the lienholder.”24 There, an employee had settled a workers compensation claim with her employer, Tyson, for injuries from slipping on a wet floor mat that a third party, Aramark, had placed in the workplace.25 After filing for bankruptcy and after settling with Tyson, the employee then settled her personal injury case with Aramark.26 Per Kansas law, Tyson obtained a statutory lien against the Aramark settlement proceeds up to the value of Tyson’s workers compensation settlement.27 Thus, despite “contrary conclusions” he issued before Cowen was decided, Judge Nugent held that “Tyson’s subrogation lien arose by operation of law, and without Tyson committing any affirmative post-petition act” that violated the automatic stay.28

With both the consolidated Seventh Circuit cases and Garcia begging for the Supreme Court to resolve the circuit split, how will (or should) the High Court rule?

Who’s Really Using the Plain Meaning?

Whichever case triggers Supreme Court review, it will need to go through a plain text analysis of at least section 362(a)(3) and 362(b)(3). The section 362(a)(3) analysis focuses on the prohibition of “any act . . . to exercise control over property of the estate.”29 The majority rule’s plain text analysis uses the dictionary definition of “exercising control” to mean “‘to exercise restraining or directing influence over’ or ‘to have power over.’”30 The minority rule counters with the dictionary definition of “act” meaning “to ‘take action’ or ‘do something.’”31

 At first blush, passively holding an asset does not appear to constitute an act – it sounds more like inaction, notwithstanding the possible act of refusing to transfer the asset. Garcia looks like the stronger case to creditors in this regard, where Tyson did not even passively hold an asset, but rather received a statutory lien while it sat idly by due to events out of its control. Previous cases similar to Garcia (including before Judge Nugent) have used section 362(a)(4) to avoid a post-petition statutory lien, but curiously disregard “whether an ‘act’ is require[d] to create or perfect the lien,” which avoids the key word at issue.32 Still, Judge Thorne argues that the story doesn’t end there. In interpreting section 362(a)(3), she urges a broad interpretation of the stay, citing 7th Circuit precedent that the Code is construed “liberally in favor of the debtor and strictly against the creditor.”33 So construing, it seems fair to view the holding of an asset as an action, especially if holding the automobile is really just a vehicle to recover on unpaid traffic tickets. However, Tyson’s lien in Garcia still does not sound in action even with a liberal stay construction. Tyson did nothing to exercise control over property of the debtor – the debtor brought Tyson’s lien into being by entering into another settlement agreement and triggering Kansas law.

Assuming the Supreme Court finds the stay applicable to whichever contested action is in front of it, it then must analyze the section 362(b)(3) exception. The minority rule’s analysis does not reach this far, as it considers the section 362(a)(3) plain meaning analysis determinative. To fend off creditors’ arguments that the section 362(b)(3) exception applies, the debtors will make a call to the bullpen for Judge Thorne’s In re Peake kitchen sink in navigating the tricky waters of declaring creditor action violative of the stay in section 362(a)(3), and then turning around to declare that the same action is actually not an action for purposes of section 362(b)(3).

The plain meaning analysis of the exception may turn on its textual link to section 546(b) and 547(e)(2)(A), as even Judge Thorne conceded that the City of Chicago’s “possession maintains or continues the perfection of its interest in the vehicle.”34 Interpreting sections 362(b)(3) and 546(b) to require a singular act, Judge Thorne emphasized “the date on which action is taken to effect such maintenance or continuation” of section 546(b)(1)(B). Defining “date” as “the ‘time at which an event occurs,’” Judge Thorne argues that the date of the City’s action would thus be constantly updating as it held the vehicle, leaving “no sensible way to apply the language of section 546(b)(1)(B).”35 Similar rationale applies to the section 547(e)(2)(A) reference in section 362(b)(3), requiring an act accomplished within a definite time period.

The creditors have a strong argument here. Section 362(b)(3) has a disjunctive reference to 546(b) and 547(e)(2)(A), so the creditors need only show that one is applicable. Creditors can then use the Kennedy analysis to qualify for the exception with reference to section 546(b). However, if exceptions to the automatic stay should be construed narrowly, as Judge Thorne indicates, then her date analysis gains force. Additionally, the legislative history appears to support the idea that section 362(b)(3) contemplated a singular, definite act, such as filing a continuation or financing statement.36 Given the depth of the plain meaning analysis and even the simple fact that the split circuits arrive at different results using the same plain meaning analysis, why not appeal to policy considerations?

Policy Tie-Break

A policy tie seems to go to the debtor, here. With Chicago’s cars, the City’s holding of the vehicle runs in contradiction to the general policy that pooling the creditors together and the debtor’s assets together is beneficial to all involved. Also, the debtor presumably needs the car to get to work and perform other daily functions, which could be impossible without the car. Chicago has the unique policy consideration of a city’s key enforcement mechanism for revenues that benefit millions of citizens, however. Still, at the individual case level, the debtor’s interests in the car are more pressing.

With Tyson’s statutory lien, policy would again favor sharing post-petition funds among the creditors rather than allowing those precious funds to be siphoned off due to a separate settlement agreement. The case for the creditors is stronger in Garcia, however – they can argue that they are just playing by the Kansas and Bankruptcy Code rules. Also, allowing the trustee to avoid the lien in Garcia may produce undesirable incentives to declare bankruptcy after settling a workers compensation claim, but before settling a related personal injury case. Even still, would-be individual debtors likely are not thinking in advance of incentives to declare bankruptcy, but rather are working to avoid filing for bankruptcy in the first place.

The automatic stay is one of the great assets to a debtor in bankruptcy. The Supreme Court may be hesitant to infringe on it, pointing to the overall purpose of providing the debtor with a fresh start. The creditors have a shot, and it looks like a better shot with Garcia than Chicago, but don’t bet on it.

  1. Elizabeth Warren et al., The Law of Debtors and Creditors 41 (2014). 

  2. Id. 

  3. Thompson v. General Motors Acceptance Corp,, 566 F.3d 699, 703 (7th Cir. 2009). 

  4. Id. at 703. 

  5. Id. at 700. 

  6. In re Cowen, 849 F.3d 943, 948-49 (10th Cir. 2017). 

  7. Id. at 949. 

  8. Id. at 950. 

  9. Rochelle’s Daily Wire, Major Automatic Stay Issue Inches Toward Supreme Court (Sept. 12, 2018). 

  10. In re Peake, 588 B.R. 811, 815 (2018). 

  11. Id. at 817. 

  12. Id. at 819. 

  13. Id. 

  14. Id. at 820. 

  15. Id. at 823. 

  16. 11 U.S.C. § 362(b)(4). 

  17. Id

  18. Peake at 829. 

  19. City of Chicago v. Kennedy, 2018 WL 2087453 at *1 (N.D. Ill. May 4, 2018). 

  20. Id. at *2. 

  21. In re Avila, 566 B.R. 558, 562 (N.D. Ill. 2017). 

  22. Id. at 563. 

  23. Rochelle’s Daily Wire, Tenth Circuit Opinion Can Be the Springboard for a ‘Cert’ on the Automatic Stay (Oct. 18, 2018). 

  24. In re Garcia, 2018 WL 5045613 at *1 (10th Cir. Oct. 17, 2018). 

  25. In re Garcia, 2017 WL 2951439 at *1 (D. Kan. July 7, 2017). 

  26. Id. at *4. 

  27. Id. at *1-4. 

  28. Id. at *6. 

  29. 11 U.S.C. § 362(a)(3). 

  30. Thompson at 702. 

  31. Cowen at 949. 

  32. Garcia, 2017 WL 2951439 at *5. 

  33. Peake at 830. 

  34. Peake at 824. 

  35. Id. at 829. 

  36. Peake at 831. 

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