A Michigan Stay Opinion Raises Contempt Issues from the Supreme Court
Does inaction or refusal to turn over estate property absent a turnover order violate the automatic stay?
An opinion by Bankruptcy Judge Joel D. Applebaum of Flint, Mich., raises an issue the Supreme Court may tackle in the new term to begin in October: Does a creditor’s inaction violate the automatic stay?
Judge Applebaum’s August 9 opinion raises a second question arising from a decision handed down in June by the Supreme Court: Can a creditor be held in contempt of the automatic stay if the creditor had an “objectively reasonable belief” that the stay did not apply?
Armed with an unsatisfied judgment, the creditor properly took all actions required by Michigan law to garnish the debtor’s tax refund when it would come due for payment in the future. The debtor did not object to the writ of garnishment within 14 days as permitted by state law.
After the debtor filed a tax return showing him eligible for a refund of some $700, the state issued another notice, this time telling the debtor he had 28 days to file a notice of bankruptcy, in which event the state would turn the refund over to the bankruptcy trustee.
Within the 28-day period, the debtor filed a chapter 7 petition and notified the judgment creditor the same day. Five days later, the state paid the $700 refund to the creditor.
The debtor claimed an exemption in the refund under Section 522(b) and sought to avoid the garnishment under Section 522(f)(1). However, the creditor refused to turn over the refund after demand by the debtor’s counsel.
On motion by the debtor, Judge Applebaum ruled that the creditor committed a willful violation of the automatic stay and was liable to turn over the refund, plus costs and attorneys’ fees under Section 362(k)(1). The debtor did not seek punitive damages.
Judge Applebaum said that federal law decides what property is included in the estate, but state law governs the debtor’s property rights. Analyzing the Michigan tax garnishment statute, he concluded that the failure to object within the initial 14-day period “did not entirely divest the Debtor of any interest in the tax refund at issue.”
Consequently, Judge Applebaum held that the tax refund was property of the estate to which the automatic stay applied. Further, the refund was exempt by virtue of Section 522, he said.
Judge Applebaum acknowledged there is a split of circuits on the question of whether inaction violates the automatic stay. “In this district,” he said, the creditor violated the stay because “failing to halt a pre-petition garnishment or receiving funds post-petition and refusing to turn them over to the debtor constitute stay violations.”
Next, Judge Applebaum ruled that the refusal to “unwind” the garnishment and turn over the refund was a willful stay violation.
Judge Applebaum ordered the creditor to turn the refund over to the debtor and gave the debtor’s counsel 15 days to apply for recovery of costs and attorneys’ fees.
The Supreme Court Issues
The Supreme Court ruled in June that someone cannot be held in contempt of the discharge injunction if there was “an objectively reasonable basis for concluding that the creditor’s conduct might be lawful.” Taggart v. Lorenzen, 139 S. Ct. 1795, 1801 (June 3, 2019). To read ABI’s discussion of Taggart, click here.
Taggart set the standard for contempt of the discharge injunction. The high court did not say whether “objectively reasonable basis” also applies to alleged violations of the automatic stay, although some language in the opinion might be read to suggest that the rules are different.
In the case at hand, the creditor surely had a reasonable basis to believe that the stay did not apply because a district judge in another case had interpreted the same statute to mean that the debtor and the estate had no interest in a garnished tax refund. Most observers believe the threshold for contempt is lower in the context of stay violations, but it remains to be seen whether appellate courts after Taggart will find strict liability for violating the automatic stay.
Judge Applebaum’s opinion also dives into the split of circuits regarding inaction as a stay violation.
The Second, Seventh, Eighth, Ninth and Eleventh Circuits hold that a secured creditor or owner must turn over repossessed property immediately or face a contempt citation. The Tenth and the District of Columbia Circuits have ruled that passively holding an asset of the estate in the face of a demand for turnover does not violate the automatic stay in Section 362(a)(3), which prohibits “any act . . . to exercise control over property of the estate.”
The most recent decision came from the Seventh Circuit on June 10 in In re Fulton, 926 F.3d 916 (7th Cir. June 10, 2019). There, the Seventh Circuit ruled that the City of Chicago must comply with the automatic stay by returning impounded cars immediately after being notified of a chapter 13 filing. Chicago is likely to file a petition for certiorari in mid-September.
The Supreme Court in May denied a certiorari petition in Davis v. Tyson, a case raising the same issue. Davis v. Tyson Prepared Foods Inc., 18-941 (Sup. Ct.) (cert. denied May 20, 2019). The Fulton decision from the Seventh Circuit presents a better vehicle for review in the high court. For ABI’s discussion of Fulton and Davis, click here.
In Judge Applebaum’s case, the creditor did not take affirmative action to receive the tax refund after the debtor’ chapter 7 petition. Still, the creditor did nothing to terminate the garnishment nor to return the refund after receipt. A case like Fulton would enable the Supreme Court to decide whether inaction violates the automatic stay. In other words, does a creditor have an affirmative duty after bankruptcy to undo actions taken before bankruptcy that could result in violations of the automatic stay?
In re Newberry, 19-30726 (Bankr. E.D. Mich. Aug. 9, 2019)
In re Newberry