Businessman Shrugging Shoulders

It is commonly understood that, upon commencement of a bankruptcy case, section 362 of the Bankruptcy Code operates as an automatic statutory injunction against a wide variety of creditor actions and activities. The automatic stay enjoins (1) “commencement or continuation” of certain proceedings, (2) “enforcement” of a judgment, (3) “any act” to obtain possession of or exercise control over property, (4) “any act” to create, perfect or enforce a lien, (5) “any act” to collect assess or recover claim, (6) “set off” of any debt, and (7) “commencement or continuation” of certain tax proceedings. All of these elements speak in terms of preventing actions that might otherwise be taken by the party against whom the automatic stay operates.

However, are there instances in which non-action by a creditor can violate the automatic stay? The Tenth Circuit recently addressed this issue in WD Equipment LLC v. Cowen (In re Cowen) (“Cowen”). Its decision added to a split among the Circuits on whether non-action can constitute an automatic stay violation.

In Cowen, a creditor repossessed the debtor’s truck prior to the bankruptcy filing. After filing, the debtor demanded return of the truck and the creditor refused. The creditor contended that the collateral had already been sold by it prior to the filing, but the Court found that the sale documentation was “likely forged” and that the creditor “gave perjured testimony.”

On appeal, the Tenth Circuit acknowledged decisions from other Circuits finding similar creditor conduct in violation of the automatic stay. However, it viewed those decisions as resting on “practical” or “policy” considerations rather than on the language of the statute. The Tenth Circuit emphasized that section 362 is framed in terms of active rather than passive behavior and that the section 362 stay did not appropriately apply to a creditor’s non-action in failing to return the debtor’s truck.

The Tenth Circuit noted that the best argument for a sanction would be to read sections 542 and 362 together. Thus, the obligation to turnover property under section 542 would arguably be implemented through the injunctive language of section 362. The Court’s opinion in Cowen concluded, however, that even this avenue was not availing, inasmuch as there is “no textual link between Section 542 and Section 362.”

The Tenth Circuit went on to conclude that its decision did not necessarily absolve the creditor from potential liability for damages. Instead, the decision remanded the proceedings to the bankruptcy court for a consideration of whether the creditor could be sanctioned for “conduct abusive of the judicial process” under section 362(a)(3).

On a visceral level, it is hard to argue with the Tenth Circuit’s conclusion that the language of section 362 speaks in terms of creditor actions rather than merely passive inaction. However, the decision seems to overlook the fact that the creditor refused a demand to return the truck and attempted to offer an explanation for that refusal. Is refusal and attempted explanation not an “act…to exercise control” over estate property and therefore violative of the automatic stay? The situation would have been materially different had the debtor never demanded return of the truck or if the creditor had not responded to the debtor’s demand. And in a situation where the conduct in question seems deliberately wrongful, a court could reasonably be expected to accept relatively minor actions by the creditor as a basis for a stay violation. In addition, section 542 does provide the sort of affirmative duty that the Tenth Circuit was unable to identify in section 362. Section 542(a) expressly provides that a person in possession of property of the estate “shall deliver” such property to the trustee or debtor in possession. In this instance, did the debtor need to use section 362 as the basis for its action? Rather, could the debtor have made out a case for damages by virtue of noncompliance with the affirmative obligations under section 542?

Given the Circuit split, the issue may make its way to the Supreme Court. In the meantime, debtors in the Tenth Circuit, and perhaps elsewhere, may need to rely on efforts to identify some type of affirmative conduct as a basis for allegations of a stay violation.