Court of Appeals Answers FAQ Concerning Auto Repossession and Bankruptcy  

Douglas J. Smillie      Dec. 11, 2019

A familiar circumstance in consumer bankruptcies is that a borrower becomes delinquent on an automobile loan and fails to address the situation – until the automobile is repossessed. The consumer then seeks bankruptcy representation, and then seeks (usually through counsel) the return of the vehicle. Lenders struggle with the facts that the loan is in default and the repossession was lawful, but retaining the vehicle in the face of a demand for its return could be determined to be a violation of the automatic stay, which could subject the lender to sanctions.

In the majority of federal circuits, this scenario is cause for concern. In fact, the Second, Seventh, Eighth and Ninth Circuits have held that the Bankruptcy Code’s turnover provision requires immediate turnover of estate property that was seized pre-petition and that failure to do so violates the automatic stay. A minority, consisting of the Tenth and D.C. Circuits, have instead held that a creditor does not violate the stay in regard to property of the estate if it merely maintains the status quo by retaining the collateral.

In In re Denby-Peterson, the Third Circuit (which encompasses Pennsylvania, New Jersey and Delaware) joined the minority, 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 filing because failure to return the collateral received pre-petition does not constitute “an[] act . . . to exercise control over property of the estate.”

Under Section 362 of the Bankruptcy Code, the filing of a bankruptcy petition automatically triggers a stay of creditor actions to collect or enforce a debt. Of particular relevance in the repossession scenario, subsection (a)(3) provides that a bankruptcy petition “operates as a stay, applicable to all entities, of . . . any act to obtain possession of property of the estate . . . or to exercise control over property of the estate.” Property of the estate is, in turn, broadly defined to include “all legal or equitable interests of the debtor in property as of the commencement of the case,” “wherever located and by whomever held.” Thus, holding on to a repossessed auto with knowledge of a bankruptcy filing could arguably viewed as a stay violation.

The consequences for willful violations of the stay, which are set forth in Section 362(k), are potentially severe. That Section generally provides that “an individual injured by any willful violation” of the automatic stay is entitled to “actual damages, including costs and attorneys’ fees, and, in appropriate circumstances, may recover punitive damages.” The Courts have further held that “[i]t is a willful violation of the automatic stay when a creditor violates the stay with knowledge that the bankruptcy petition has been filed. Willfulness does not require that the creditor intend to violate the automatic stay provision, rather it requires that the acts which violate the stay be intentional.”

In analyzing the Bankruptcy Code sections at issue, the Third Circuit Court of Appeals utilized basic principles of statutory construction. Based upon the plain language meanings ascribed to the phrases in the Code sections, the Court concluded that  the subsection (a)(3) prohibits creditors from taking any affirmative act to exercise control over property of the estate, but that the prohibition is prospective in nature. In other words, the exercise of control is not stayed, but the act to exercise control is stayed.

Ultimately, the Court concluded that debtor must first seek court intervention, such as through an adversary proceeding, and then the Bankruptcy Court, not the debtor, must ultimately decide whether repossessed property must be turned over to the debtor.

The holding in Denby-Peterson is good news for lenders. The primary benefit is that a cloud of uncertainty within the Circuit has been removed. Creditors operating in Pennsylvania, New Jersey and Delaware have clear guidance. While the onus now falls on the debtor to seek the intervention of the Bankruptcy Court to seek relief, the Court can still order the return of the collateral to the debtor, but at the same time consider the creditor’s request for adequate protection or the imposition of any other conditions that may be appropriate to protect the interests of both the debtor and the creditor.

Of course, the Court of Appeals’ decision in Denby-Peterson serves to amplify the division among the Circuit Courts of Appeals, which usually means that the issue will be headed to the Supreme Court for final resolution.

For assistance with this and similar creditors’ rights issues, please contact Douglas J. Smillie or one of the members of our Creditors’ Rights team.

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