New Developments of Federal Preemption under Section 303 of the Bankruptcy Code

By: J. Tyler Mills

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

            In Rosenberg v. DVI Receivables XVII, LLC,[1] the Third Circuit held that an award of damages after the dismissal of an involuntary bankruptcy petition does not preempt a claim for tortious interference with contracts and business relationships brought against the petitioning creditors by injured parties who were not alleged debtors.[2]  There, an involuntary bankruptcy was brought against a medical imaging company to collect on leases for various medical equipment.[3]  After the involuntary petition was dismissed, the alleged debtor sued the petitioning creditors to recover costs, attorney’s fees, and damages for the bad faith filing of the involuntary petition.[4]  The jury awarded the alleged debtor $1.1 million in compensatory damages and $5 million in punitive damages.[5]

            Subsequently, the alleged debtor’s wife and several limited partnerships associated with the alleged debtor who were not parties to the involuntary bankruptcy petition (“Plaintiffs”)  brought suit against the petitioning creditors who filed the involuntary petition (“Defendants”) to recover monetary damages stemming from the Defendants’ alleged tortious interference with Plaintiffs’ contracts and business relationships with the alleged debtors as a result of the involuntary petition.[6]  Plaintiffs alleged that the involuntary bankruptcy was orchestrated with the intent to cause the alleged debtors to default on mortgages and that it ultimately caused the partnerships to default, caused partners to lose their interest in the partnerships, and caused the individual partners to suffer losses on investments and life insurance benefits.[7]  The District Court for the Eastern District of Pennsylvania held that the Plaintiffs’ claims were barred by the alleged debtor’s recovery in the bankruptcy action under section 303 of the Bankruptcy Code.[8] The Third Circuit disagreed and held that the alleged debtor’s recovery did not bar Plaintiffs’ subsequent recovery in the instant action.[9]

            The Third Circuit noted as a preliminary matter that Plaintiffs were not able to recover damages from the Defendants under section 303 because they were not the alleged debtors.[10] Based on concerns of federalism, any analysis of federal preemption and conflict with state laws begins with a “sturdy presumption against preemption.”[11] The court recognized this case as one of field preemption, leaving no room for state regulation,” and noted that section 303 is “silent as to potential remedies for non-debtors harmed by an involuntary bankruptcy petition.”[12] The court found that there was insufficient evidence in the “text, structure, or purpose” of section 303 to demonstrate Congress’ “clear and manifest intent” to preempt state law causes of action for Plaintiffs in the instant action.[13]

            Section 303 of the Bankruptcy Code permits a court to grant judgment in favor of an alleged debtor for costs and reasonable attorney’s fees, or, as against any petitioner that filed an involuntary bankruptcy petition in bad faith, for any damages proximately caused by such filing or punitive damages.[14] The construction of the statute specifically separates damages as awarded to the alleged debtor under section 303(i)(1) and damages as awarded against any petitioner – and presumably, to any party – under section 303(i)(2).[15]  Therefore, it would seem that the statute does in fact account for damages to non-debtors as damages “proximately caused” by a bad faith filing under section 303(i)(2).[16]

            The Third Circuit’s decision in Rosenberg rejects this reading of section 303 by holding that debtors, not other parties, can recover damages under section 303 and that other claimants who were not parties to the involuntary petition can still bring state law tort claims against the petitioning creditors.[17] However, the decision makes it unclear whether the alleged debtors in the involuntary bankruptcy petition would also be able to bring these state law tort claims. For example, would the debtor be obligated to bring such claims in the bankruptcy case and seek damages under section 303, thereby foreclosing his opportunity to recover such damages under state law tort claims?  The decision solely speaks to the preemption (or lack thereof) of the Bankruptcy Code as against non-debtors.[18]

            Although the Third Circuit based its decision largely on the importance of federalism and its values in American society, this decision raises some uncertainty, and in a sense is a step too far and could potentially expose these bad faith petitioners to unlimited liability for damages with regard to an involuntary bankruptcy petition.

[1] Rosenberg v. DVI Receivables, Inc., 835 F.3d 414 (3d Cir. 2016).

[2] See id. at 422.

[3] See id. at 416–17.

[4] See id. at 417.

[5] See id.

[6] See id.

[7] See id.

[8] See id. at 417–18.

[9] See id. at 422.

[10] See id. at 418.

[11] See id. at 419.

[12] See id. at 418–19.

[13] See id. at 419. A review of the congressional record revealed no intention of Congress to disturb non-debtor’s relief for an involuntary bankruptcy petition, and in fact suggested that Congress did not regard the non-debtor’s remedies at all. See id.

[14] See 11 U.S.C. § 303(i) (2012).

[15] See id.

[16] See id.

[17] See Rosenberg, 835 F.3d at 422.

[18] See id.