Ninth Circuit BAP Addresses Impact of Fulton

Posted by NCBRC - November 18, 2021

The Supreme Court’s decision in City of Chicago v. Fulton, 141 S. Ct. 585 (2021), effectively overruled Ninth Circuit precedent to the effect that a creditor has an affirmative obligation to return pre-petition funds to a debtor even if those funds are held by a third party. Therefore, when the creditor here stayed its garnishment action and acquiesced to release of funds by the debtor’s bank, it maintained the status quo and fulfilled its automatic stay obligations. Stuart v. City of Scottsdale, No. 21-1063 (B.A.P. 9th Cir. Nov. 10, 2021).

The debtor owed the City of Scottsdale a state court judgment of $30,000 in sanctions for filing a frivolous lawsuit. The City froze his bank accounts with Bank of America (BOA) and instituted a garnishment action. The debtor then filed for chapter 13 bankruptcy and sought to quash the garnishment. Upon notification of the bankruptcy, the City asked the state court to stay the ongoing garnishment action and did not oppose release of the debtor’s accounts. The debtor sought an order from the bankruptcy court that by failing to quash the garnishment and turnover the funds from the bank account, the City violated the automatic stay.

The bankruptcy court agreed and ordered damages for violation of the stay. In the meantime, the Supreme Court decided City of Chicago v. Fulton, 141 S. Ct. 585 (2021), where it found that the automatic stay merely mandates cessation of collection activities but does not require affirmative action by the creditor. The bankruptcy court granted the City’s motion for reconsideration and found that, under Fulton, it did not violate the stay.

On appeal to the Bankruptcy Appellate Panel for the Ninth Circuit, the debtor argued that the City violated paragraphs (1) (2) (3), and (6) of section 362(a).

Section 362(a)(3) prohibits “any act to obtain possession of property of the estate or of property from the estate or to exercise control over property of the estate.” The debtor argued that the City’s failure to affirmatively quash the garnishment and unfreeze the BOA accounts violated this section.

The panel found that the decision in Fulton changed the landscape of the creditor’s automatic stay obligations. In Fulton, the debtors sought sanctions against the City of Chicago for failing to release vehicles it had impounded prior to the debtors’ filing for bankruptcy. The Supreme Court held that the plain language of section 362(a)(3) merely halts any affirmative act to alter the status quo at the time of the bankruptcy filing. It is the turnover provision in section 542 that recovers property for the benefit of the estate. The Court specifically held that the mere retention of property does not violate this provision.

Based on Fulton, therefore, the panel concluded that: “Where a creditor has executed a prepetition writ of garnishment against a debtor’s bank account, it is under no affirmative obligation to release the funds and need only maintain the status quo.” The panel noted that no funds had been collected post-petition under the garnishment order and that, had that not been the case, the result here might have been different.

The panel went on to address the remaining automatic stay provisions.

The debtor argued that by failing to affirmatively quash the writ of garnishment, the City “continued” an action against him in violation of section 362(a)(1). In Eskanos & Adler, P.C. v. Leetien, 309 F.3d 1210 (9th Cir. 2002), the Ninth Circuit held that this provision requires a creditor to dismiss or stay an ongoing legal action. In that case, where the creditor initiated a legal action after the debtor filed the bankruptcy petition, he was required to dismiss the case in order to restore the pre-petition status quo.

Where, as here, the legal action at issue was begun prior to bankruptcy, the panel found that “staying the case was sufficient to avoid ‘continuation’ in violation of § 362(a)(1).” The panel also found that City had no affirmative duty to release the accounts held by BOA, but complied with its obligations by acquiescing to release of the funds.

The debtor next argued that by opposing his motion to quash the garnishment action, the City sought to enforce a prepetition judgment in violation of section 362(a)(2). The panel disagreed, finding that the City did not oppose release of the BOA accounts and did nothing to continue enforcement of the state judgment, reiterating that “passive maintenance of its valid pre-petition attachment lien in no way changed the status quo.”

Finally, the panel rejected the debtor’s argument that the City’s conduct violated section 362(a)(6) which prohibits “any act to collect, assess, or recover a claim against the debtor that arose before the commencement of the [bankruptcy] case.” Again, the panel emphasized that by staying the state court legal proceedings and not opposing release of the debtor’s funds, the City did nothing to enhance its position but merely sought to maintain the status quo.

In sum, the panel found that ‘[b]ecause the City immediately asked the state court to stay the case and did nothing to change the status quo that existed when [the debtor] filed his bankruptcy petition, it did not violate the automatic stay.” The panel affirmed.

Stuart 9th BAP Nov 2021


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