For creditors dealing with debtors in the shadow of bankruptcy, a common scenario repeats itself.
The creditor repossesses collateral, attaches an account, or sets off a bank account, and then the debtor files a bankruptcy petition. What must the bank or attaching creditor do? Filing a bankruptcy petition automatically halts efforts to collect prepetition debts from the debtor outside of bankruptcy. The "automatic stay" provides fundamental protection to debtors, mandating a full-stop on collection activity. Creditors violate the stay at their peril. If you violate the stay, even without the intent to do so, you can be held in contempt and forced to pay damages. But can the creditor hold a bank account hostage without violating the stay?
Earlier this year, a unanimous United States Supreme Court held that mere retention of property after a bankruptcy filing does not violate the automatic stay. (You can read our report here.) The automatic stay only prohibits affirmative acts that would disturb the status quo of bankruptcy estate property at the time of the bankruptcy filing.
The Supreme Court case involved impounded vehicles. The City of Chicago had impounded the debtors' vehicles for failing to pay fines and had refused to turn over the vehicles after the debtors filed bankruptcy. The debtors alleged that the City had violated the automatic stay, and they sought and obtained turnover orders from the bankruptcy courts. The United States Supreme Court held that creditors could not disturb the status quo at the time of the bankruptcy filing, but they also can't be punished for not taking affirmative steps to change the status quo at the debtor's behest. In other words, the City of Chicago committed no violation of the automatic stay by refusing to turn over the vehicles already in its possession when the debtors' bankruptcies were filed.
Recently, a bankruptcy court in Pennsylvania applied the same reasoning where judgment creditors served a writ of execution on the debtor's credit union, which attached to the debtor's deposit account. The debtor then filed bankruptcy and requested several times that the creditors release the attachment. The creditors refused. The debtor filed an adversary proceeding against the creditors, alleging a willful violation of the automatic stay and seeking a turnover order and damages.
The bankruptcy court ruled for the creditors. The bankruptcy court found that the creditors did not take any affirmative action to enforce or, otherwise, continue to pursue the prepetition attachment. The creditors had engaged only in "inaction" – just like the City of Chicago. By doing nothing more than retaining a valid prepetition attachment, the bankruptcy court held that the creditors did not violate the automatic stay. Moreover, the bankruptcy court noted that the creditors were not required to withdraw the attachment because doing so would put them in a more disadvantageous position than they had been as of the petition date. They were entitled to maintain the status quo.
This decision is not by a North Carolina bankruptcy court, and creditors are advised to proceed with caution in these situations. The critical requirement is maintaining the status quo. A creditor with collateral in hand cannot rush to liquidate it after a bankruptcy filing. That would violate the automatic stay and likely warrant sanctions.
Creditors should also realize that a separate section of the Bankruptcy Code allows a debtor to initiate a turnover proceeding to recover property. Creditors who face that situation should confer with counsel to determine if they are more likely to prevail at a turnover hearing or if they should avoid the time and expense and return the property to the debtor voluntarily.
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This article is not intended to give, and should not be relied upon for, legal advice in any particular circumstance or fact situation. No action should be taken in reliance upon the information contained in this article without obtaining the advice of an attorney.