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3rd Cir. Holds Failure to Turn Over Collateral Repossessed Prior to Bankruptcy Does Not Violate Automatic Stay

The U.S. Court of Appeals for the Third Circuit recently held, in a case of first impression in that circuit, that a secured creditor’s failure to turn over collateral repossessed prior to the filing of the bankruptcy petition does not violate the automatic stay.

A copy of the opinion in In re Denby-Peterson is available at:  Link to Opinion.

The debtor’s automobile was repossessed after she defaulted on her installment loan. She then filed a voluntary petition under Chapter 13 of the Bankruptcy Code, notified her creditors and demanded the return of the automobile.

The creditors did not comply, and the debtor filed a motion for turnover and for sanctions for violating the automatic stay.

The Bankruptcy Court entered an order requiring the creditors to return the automobile to the debtor because the automobile was property of the estate under section 542(a) of the Bankruptcy Code, but denied the request for sanctions.

In so ruling, the Bankruptcy Court adopted the minority view “that a creditor does not violate the stay in regard to property of the estate if it merely maintains the status quo.”  The majority view is “that Section 542(a)’s turnover provision ‘is self-effectuating’ because ‘it does not allow for the possibility of defenses to turnover.’”

The District Court affirmed the Bankruptcy Court, and the debtor appealed to the Third Circuit.

On appeal, the Third Circuit noted that it was presented with an issue of first impression: “whether, upon notice of the debtor’s bankruptcy, a secured creditor’s failure to return collateral that was repossessed pre-bankruptcy petition is a violation of the automatic stay.”

The Court answered “no,” joining the minority position taken by the Tenth and D.C. Circuits, “holding that a secured creditor does not have an affirmative obligation under the automatic stay to return a debtor’s collateral to the bankruptcy estate immediately upon notice of the debtor’s bankruptcy because failure to return the collateral received pre-petition does not constitute ‘an act … to exercise control over property of the estate …’” under Code section 362(a)(3). The Court thus affirmed the District Court’s order affirming the Bankruptcy Court.

The Third Circuit rejected the majority position, held by the Second, Seventh, Eighth, Ninth and Eleventh Circuits, that “a secured creditor, upon learning of the bankruptcy filing, must return the collateral to the debtor and failure to do so violates the automatic stay …” because doing so violates section 362(a)’s prohibition on any “act … to exercise control of property over the estate.”  Under these rulings, “Section 362(a)(3)’s automatic stay provision and Section 542(a)’s turnover provision operate together such that a violation of the turnover provision results in a violation of the automatic stay.”

The Court began by examining the statutory language of section 362(a)(3), explaining that “[i]f we ultimately determine that a provision ‘is clear and unambiguous, [we] must simply apply it.’ However, if we find that a provision is ambiguous, ‘we then turn to pre-Code practice and legislative history to find meaning.’”

Although the Third Circuit agreed “that Section 362(a)(3) is unambiguous, [it declined] to hold that a plain reading of that Section compels the conclusion that the creditors in this case violated the automatic stay by failing to turn over the [automobile] to [the debtor].”

First, the Court concluded that “the text of Section 362(a)(3) requires a post-petition affirmative act to exercise control over property of the estate.” It then reasoned that in the case at bar, “a post-petition affirmative act to exercise control over the [automobile] is not present.” This is because the car was repossessed before the debtor filed bankruptcy. After the filing of the petition, “the creditors merely passively retained that same possession and control.” Thus, “the requisite post-petition affirmative ‘act … to exercise control over’” the car was lacking.

The Third Circuit further reasoned that its conclusion “is bolstered by the legislative purpose and underlying policy goals of the automatic stay. It is well-established that one of the automatic stay’s primary purposes is ‘to maintain the status quo between the debtor and [his] creditors, thereby affording the parties and the [Bankruptcy] Court an opportunity to appropriately resolve competing economic interests in an orderly and effective way.’”

By retaining possession of the car “after learning of the bankruptcy filing, the creditors preserved the pre-petition status quo. To hold that such a retention of possession violates the automatic stay would directly contravene the status-quo aims of the automatic stay.”

The Third Circuit rejected the debtor’s argument that the section 542(a) turnover provision was “self-executing,” reasoning that “a creditor’s obligation to turn over estate property to the debtor is not automatic. Rather the turnover provision requires the debtor to bring an adversary proceeding in Bankruptcy Court in order to give the Court the opportunity to determine whether the property is subject to turnover under Section 542(a).”

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Hector Lora has substantial experience in all phases of complex commercial litigation, including motion practice, written discovery, depositions, mediations, bench and jury trials, and appellate practice. For more than a decade, his practice has focused extensively on the defense of civil enforcement actions filed by the FTC, as well as real estate litigation, and contested mortgage and condominium lien foreclosures and foreclosure of security interests under UCC Article 9. Hector also has substantial experience in advising a variety of types of businesses regarding their compliance with applicable federal and state laws, including the Federal Trade Commission Act, the Telephone Consumer Protection Act, the Telemarketing and Consumer Fraud and Abuse Prevention Act, the Telemarketing Sales Rule, the Controlling the Assault of Nonsolicited Pornography and Marketing Act of 2003, and Florida laws governing telephone solicitation and communication. Hector received his Juris Doctor from the Georgetown University Law Center, and his undergraduate degree with honors from the University of Florida.

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