In a ruling which is sure to have future implications, the Third Circuit Court of Appeals, in In re: Denby-Peterson, No. 18-3562 (3d Cir. 2019), that a secured creditor does not have an affirmative obligation under the automatic stay to return a Chapter 13 Bankruptcy debtor’s collateral immediately upon notice of the debtor’s bankruptcy.

Facts of case

Denby-Peterson purchased a Chevrolet Corvette from Pine Valley Motors and entered a retail installment which required an initial downpayment, a future “deferred” downpayment, and subsequent weekly payments for approximately 4 years. Pine Valley Motors assigned its rights under the contract to its affiliate company, NU2U Auto
World.

While Denby-Peterson did make payments totaling $9,200 under the contract, she did not make the “deferred” down payment. As a result, NU2U repossessed the Corvette in February or March 2017.

After the repossession, Denby-Peterson filed a Chapter 13 bankruptcy petition on March 21, 2017, and the auto loan creditors received notice of the bankruptcy filing. The debtor’s attorney demanded that they return the Corvette to Denby-Peterson and notified the creditors that their failure to return the vehicle was subject to sanctions, attorneys fees, and other costs. The creditors refused to return the vehicle and maintained possession.

Bankruptcy Motion for Turnover

Denby-Peterson’s bankruptcy attorney filed a motion with the bankruptcy court seeking turnover of the vehicle. The motion also asked that the Court find the creditors in violation of the automatic stay provisions of the Bankruptcy Code and sought recovery of costs and attorneys’ fees for filing the motion; compensation for “non-economic damages”; punitive damages; and “all other relief the Court deem[ed] just and equitable.”

The bankruptcy court ordered turnover of the Corvette to Denby-Peterson but denied her request for sanctions. The Bankruptcy Court held that while the creditor was required to return the Corvette under the Bankruptcy Code’s turnover provision in Section 542(a), the Court found that a creditor does not violate the stay if it “merely maintains the status quo.”

Third Circuit Holding

Denby-Peterson appealed. After the district court affirmed the bankruptcy court’s holding, the matter was presented to the Third Circuit Court of Appeals. The Third Circuit acknowledged that the issue presented was one of first impression and a split amongst other Circuit Court’s on the issue of whether the creditors’ failure to return the vehicle was a violation of the stay.

The Third Circuit first noted the automatic stay’s overarching purpose to “prevent[s] dismemberment of the estate” under Section 362(a)(3). Further, the Court cited the provisions of Section 362(k) which provide that a willful violations of the automatic stay allow the debtor to recover “actual damages, including costs and attorneys’ fees, and, in
appropriate circumstances, may recover punitive damages.”

However, the Court affirmed the bankruptcy court in following a minority of courts which hold that a secured creditor does not have an affirmative obligation under the automatic stay to return a debtor’s collateral. The Court found a difference between an “affirmative act . . . to exercise control over property of the estate” and the “passive act” of a creditor refusing to return collateral automatically upon the filing of a bankruptcy case.

As such, the Court held that a creditor does not violate the automatic stay by failing to return a Chapter 13 debtor’s collateral after a bankruptcy filing. A full copy of the Court’s opinion can be found here.

Conclusion

The holding in Denby-Peterson will likely impact a wide number of situations in Chapter 13 Bankruptcy cases. The Third Circuit, by creating a legal difference between an “affirmative” and “passive” act, offers creditors a potential “good faith” reason to refuse return of many forms of property of a bankruptcy estate under Section 541.

The Third Circuit chose to follow the minority of Courts in following a standard which provides more legal power to a creditor than to a reorganizing debtor. Chapter 13 Bankruptcy is meant to offer the “honest debtor” a “fresh start”. The Court has made that fresh start more difficult and limited the power of the automatic stay.

It is also concerning to attorneys representing consumers in Chapter 13 bankruptcy cases that the Court also effectively made it more difficult for a debtor to use the “breathing spell” that filing of the petition was intended to create. The Court did not scrutinize the fact that situations like those in Denby-Peterson involve creditors who have significant means to engage in litigation and debtors who require their assets and income to effectively reorganize their financial circumstances.

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