Commencing an Involuntary Just Got Riskier – Petitioning Creditors May Face State Law Damages in Addition to Those Under Bankruptcy Code Section 303(i)

Rosenberg v. DVI Receivables XVII, LLC, No. 15-2622, 2016 WL 4501675 (3d Cir. Aug. 29, 2016)

In this federal preemption Opinion, the Third Circuit Court of Appeals held that section 303(i) of the Bankruptcy Code does not preempt state law claims by non-debtors for damages based on the filing of an involuntary bankruptcy petition.  The Court did not, however, opine on whether section 303(i) preempts state law claims brought by debtors.

The appeal originated from a 2008 involuntary bankruptcy proceeding commenced against Maury Rosenberg and his affiliated businesses.  The petition was dismissed and Mr. Rosenberg recovered fees, costs, and $6 million in compensative and punitive damages for a bad faith filing under section 303(i).  Thereafter, Mr. Rosenberg’s wife and several associated limited partnerships (all non-debtors) brought a tortious interference claim under state law for damages allegedly caused by the involuntary filing.  The defendants moved to dismiss, arguing that the claim was preempted by the Bankruptcy Code.  The Eastern District of Pennsylvania agreed and dismissed the case.  Ultimately, however, the Third Circuit in Rosenberg reversed the lower court’s holding because the Court was unable to find adequate evidence that Congress intended section 303(i) to be an exclusive remedy for non-debtors.

While there are three forms of federal preemption of state law—express, conflict, and field—the issue in Rosenberg was limited to field preemption requiring the Court to examine whether “there is enough evidence in the text, structure, or purpose of § 303(i) or the Bankruptcy Code as a whole to rebut the presumption against preemption and say that it was Congress’s ‘clear and manifest intent’ to preempt state law causes of action for non-debtors based on the filing of an involuntary petition.”  Op. at *9.  While the Bankruptcy Code and, in particular, the text of section 303(i) are silent as to remedies for non-debtors for abuse of the bankruptcy system, the Court was not willing to infer congressional intent to deprive them of any remedy.  Moreover, the Court noted it would be inconsistent with section 303(i)’s purpose of deterring abuse to preempt state law remedies for non-debtors.  While the defendants argued that permitting non-debtor state law claims against creditors would open the flood gates of state court litigation that would chill the use of involuntary bankruptcy proceedings and risk a rewrite of bankruptcy law by state court judges, the Court was not troubled, citing the minimal cases of state law claims brought by non-debtors and relying on comity for state courts to properly account for bankruptcy law to the extent it is relevant to their decision making process.