Fulton: Implications for Chapter 11 (A Win for Secured Creditors!)  

Charlie Fries

 

While Fulton was not a case about a business going bankrupt,[1] the Supreme Court construed sections of the bankruptcy code that apply in the Chapter 11 context.[2] Thus, the outcome of Fulton has implications for Chapter 11 reorganizations.[3]

First, some context. In Fulton, the City of Chicago impounded the vehicles of respondents for “failure to pay fines for motor vehicle infractions.”[4] In response, respondents each declared bankruptcy under Chapter 13.[5] Importantly here, the mere filing of a bankruptcy petition triggers the automatic stay under 11 U.S.C. § 362, which immediately provides debtors certain protections against creditors – hence the term “automatic.”[6] Amongst these protections, 11 U.S.C. § 362(a)(3) prohibits “any act to . . . exercise control over property of the estate.”

Now, one might think – as Fulton argued[7] and as courts below opined[8] – that continuing to impound a vehicle following a bankruptcy petition might constitute an “act to . . . exercise control over property of the estate.”[9] Under this view, the automatic stay would require Chicago to turn over the impounded vehicle to Fulton and other respondents upon the bankruptcy filing. Unfortunately for Fulton, not so.

Justice Alito, writing for an 8-0 majority (including a concurring opinion by Justice Sotomayor), held that the “mere retention of estate property after the filing of a bankruptcy petition does not violate § 362(a)(3).”[10] Justice Sotomayor, concurring, “emphasize[d] that the Court has not decided whether and when § 362(a)’s other provisions may require a creditor to return a debtor’s property.”[11] The significance of this holding must be understood against the backdrop of 11 U.S.C. § 542(a), which provides that, “any ‘entity,’ subject to some exceptions” – such as failure to provide adequate protection – must “turn over ‘property’ belonging to the bankruptcy estate.”[12] In summary: the automatic stay does not trigger an automatic turnover under § 362(a)(3), though perhaps under other subsections of § 362(a) – but in any event debtors may, subject to certain exceptions (such as failure to provide adequate protection), implement a turnover of property of the estate under § 542(a).

What then, is the practical import? As Benjamin Franklin once famously observed, “time is money.”[13] This is especially true as applied to a business forced to spend time without essential operational assets in a period of crisis such as bankruptcy. To be sure, insofar as certain conditions are met, debtors can eventually regain possession under § 542(a). But, as Justice Kagan notes, § 542(a) proceedings are adversary proceedings.[14] And adversary proceedings “can be quite slow.”[15]

An amicus brief filed in the case provides an illustrative example: “[c]onsider an airline whose aircraft have been repossessed [but not yet foreclosed upon] by a secured creditor . . . that refuses to turn over the aircraft . . . until its demands for adequate protection have been met” as required by § 542(a).[16] Without the aircraft, there is no business.[17] To the extent a § 542(a) adversarial proceeding causes a delay, that means flights canceled, customers lost, and vendors angered.[18] This initial delay could result in a death spiral – whereas an immediate turn over under § 363(a)(3) would allow the airline to get back to business immediately.[19] Thus, immediate turnover protects the possibility of a successful reorganization that preserves (and even generates) value for all interested parties.[20] A rosy picture.

Of course, there are two sides to every story. Another amicus brief notes that if the court recognized § 363(a)(3) to require “immediate turnover of repossessed collateral,” such recognition would “eviscerate a secured creditor’s statutory right to adequate protection.”[21] In the example above, suppose the airline was truly incapable of providing secured creditor with adequate protection, yet § 363(a)(3) operated to force the secured creditor to turn over the aircraft regardless. Given the vicissitudes of industry, it is no sure thing that the business will reorganize, generate value, and eventually return to the secured creditor whatever value the collateral might have lost in the interim. In other words, if the airline goes under, and the aircraft loses value, the secured creditor would be denied its right to adequate protection.

As noted above, the Supreme Court ultimately decided to honor a result tending to favor secured creditors’ interests in adequate protection under § 542(a) over a result tending to favor debtors’ interest in speedy reorganization. That said, as Justice Kagan suggests, bankruptcy judges may have some capacity to speed along § 542(a) proceedings – and thereby minimize the damage of delay.[22] Specifically, “bankruptcy courts may find it prudent to expedite proceedings or order preliminary relief requiring temporary turnover.”[23]

In summary, Fulton was a win for secured creditors: their right to adequate protection under § 542(a) remains unblemished by § 362(a)(3). That said, courts may cite to Justice Kagan’s concurrence as support for expedited proceedings or preliminary relief going forward.

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[1] See City of Chi., Ill. v. Fulton, 141 S. Ct. 585, 589 (2021) (noting respondents filed a Chapter 13 bankruptcy petition).

[2] See e.g. Brief of Bankruptcy Law Professors as Amici Curiae in Support of Respondents at 1–2, City of Chi., Ill. v. Fulton, 131 S. Ct. 585 (2021) (No. 19-357), 2020 WL 1391971 (noting that the provisions under consideration in Fulton apply “to all bankruptcy cases, not just disputes involving the municipal impoundment of consumer debtors' vehicles”).

[3] See id.

[4] Fulton, 141 S. Ct. at 589.

[5] Id.

[6] See e.g. William L. Norton III, 2 Norton Bankruptcy Law and Practice § 43:3 (3d ed. 2021) (noting that the actions prohibited by the automatic stay are “immediately stayed upon the filing of the petition for relief”).

[7] See Brief for Respondents at *1, City of Chi., Ill. v. Fulton, 141 S. Ct. 585 (2021) (No. 19-357), 2020 WL 1478598 (arguing that the Supreme Court should affirm the Seventh Circuit’s holding that “a creditor violates the automatic stay imposed by 11 U.S.C. § 362(a)(3) when the creditor, without any substantive defense, refuses to comply with its obligation to deliver seized property of the bankruptcy estate to a Chapter 13 debtor”).

[8] See In re Fulton, 926 F.3d 916, 924 (7th Cir. 2019) (“[W]e conclude, as each bankruptcy court did, that the City violated the automatic stay pursuant to § 362(a)(3) by retaining possession of the debtors’ vehicles after they declared bankruptcy.”).

[9] 11 U.S.C. § 362(a)(3).

[10] City of Chi., Ill. v. Fulton, 141 S. Ct. 585, 592 (2021).

[11] Id. (Sotomayor, J, concurring).

[12] Id. at 594 (providing the practical import of § 542(a)).

[13] Benjamin Franklin, Advice to a Young Tradesman (1748), reprinted in The Political Thought of Benjamin Franklin 51, 51 (Ralph L. Ketchamed., Hackett Publ'g Co. 2003) (1965).

[14] Id. at 594 (noting that the Federal Rules of Bankruptcy Procedure Rule 7001(1)  provides that “proceeding[s] to recover . . . property” are “adversary proceedings”).

[15] Id.

[16] Bankruptcy Law Professors as Amici Curiae in Support of Respondents, supra note 2 at *11.

[17] Id.

[18] Id.

[19] Id.

[20] Id.

[21] Brief for Amici Curiae Professors Ralph Brubaker, Ronald J. Mann, Charles W. Mooney, Jr., Thomas E. Plank and Charles J. Tabb in Support of Petitioner at *4, City of Chi., Ill., v. Fulton, 141 S. Ct. 585 (2021) (No. 19-357) 2020 WL 703533.

[22] City of Chi., Ill. v. Fulton, 141 S. Ct. 585, 594–95 (2021) (Sotomayor, J, concurring).

[23] Id. at 595.