The U.S. Court of Appeals for the Third Circuit recently held that the Bankruptcy Code does not preempt state law claims brought by non-debtors for damages related to the filing of an involuntary bankruptcy proceeding.

A copy of the opinion is available at:  Link to Opinion.

The creditors in this action initiated state court litigation against limited partnerships controlled by the debtor, alleging money owed under various leases.  During the state court proceedings, the creditors filed an involuntary bankruptcy proceeding against the debtor and the debtor’s affiliated medical imaging companies, none of which were defendants in the state court litigation.

The debtor transferred the involuntary bankruptcy case to the U.S. District Court for the Southern District of Florida, where the bankruptcy court dismissed the involuntary bankruptcy, finding among other things that two of the alleged creditors who brought the involuntary bankruptcy were not actually creditors of the debtor.

The debtor then filed an adversary proceeding against the creditors pursuant to the Bankruptcy Code, 11 U.S.C. § 303(i), seeking to recover costs, attorney’s fees, and damages for the bad faith filing of the involuntary bankruptcy.  Following several years of litigation, the U.S. Court of Appeals for the Eleventh Circuit ultimately reinstated a substantial jury verdict in favor of the debtor.

Meanwhile, the debtor’s wife and the debtor’s affiliated limited partnerships, none of which were parties to the involuntary bankruptcy proceeding, brought suit in federal court to recover damages under Florida law for tortious interference with contracts and business relationships stemming from the involuntary bankruptcy petition filed against the debtor and the debtor’s affiliated medical imaging companies.

The plaintiff debtor and his wife alleged that the involuntary bankruptcy petition had caused the debtor’s affiliated limited partnerships to be declared in default on their underlying mortgages, leading to the loss of all but one of the properties owned by the limited partnerships, and costing the debtor’s wife her interest in one of the limited partnerships.

After being transferred to the U.S. District Court for the Eastern District of Pennsylvania on the creditors’ motion, the creditors moved to dismiss, arguing that the plaintiffs’ state law tortious interference claims were preempted by the involuntary bankruptcy provisions of the Bankruptcy Code.  The trial court agreed and dismissed the complaint.  The instant appeal followed.

As you may recall, 11 U.S.C. § 303(i) of the Bankruptcy Code provides that if an involuntary bankruptcy petition is dismissed, a debtor may recover attorney’s fees, costs, and damages from its creditors.  In relevant part, § 303(i) reads:

(i) If the court dismisses a petition under this section other than on consent of all petitioners and the debtor, and if the debtor does not waive the right to judgment under this subsection, the court may grant judgment-

(1) Against the petitioners and in favor of the debtor for-

(A) costs; or

(B) a reasonable attorney’s fee; or

(2) against any petitioner that filed the petition in bad faith, for-

(A) any damages proximately caused by such filing; or

(B) punitive damages

See 11 U.S.C. § 303(i).

The Third Circuit began its analysis by noting that this is a case of alleged field preemption, which “occurs when a field is ‘reserved for federal regulation, leaving no room for state regulation,’ and ‘congressional intent to supersede state laws is clear and manifest.’”  See Elassaad v. Indep. Air, Inc., 613 F.3d 119, 126 (3d Cir. 2010) (quoting Holk v. Snapple Beverage Corp., 575 F.3d 329, 336 (3d Cir. 2009).

In a case of field preemption, the Third Circuit noted, the court begins with a presumption against preemption that is only overcome when “a Congressional purpose to preempt… is clear and manifest.”  See Farina v. Nokia Inc., 625 F.3d 97, 117 (3d Cir. 2010).

To discern the preemptive intent of Congress, the court examined the text, structure, and purpose of the statute and the surrounding statutory framework.  SeeMedtronic, Inc. v. Lohr, 518 U.S. 470, 486 (1996).

Here, the relevant inquiry was whether 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 bankruptcy petition.

The Third Circuit carefully examined the text, structure, and purpose of § 303(i), finding Congressional silence as to non-debtor remedies, no structural indication of field preemption, and that it would be inconsistent with the remedial purpose of § 303(i) to preempt state law remedies for non-debtors who can similarly be harmed by involuntary bankruptcy petitions.  Accordingly, the Court found that field preemption did not apply to the circumstances here.

Rejecting the creditors’ argument that Congress could have written § 303(i) such that it also provided for non-debtor remedies, as it did when enacting the provisions of 11 U.S.C. § 362(k)(1) relating to violation of the automatic stay, the Court acknowledged that while this was a plausible argument, Congressional silence does not demonstrate the “clear and manifest” intent necessary to establish field preemption.

The Third Circuit also rejected the creditors’ argument that permitting state law claims against creditors would be inconsistent with the comprehensive nature of the Bankruptcy Code and open the floodgates to state courts rewriting bankruptcy law, noting that the creditors could cite only a handful of cases where non-debtors had brought state tort claims against petitioning creditors, which substantially undermined their argument that the floodgates of litigation would be opened absent preemption.

Finally, the Third Circuit acknowledged that its ruling could not be reconciled with the Ninth Circuit’s decision in In re Miles, 430 F.3d 1083 (9th Cir. 2005).

In Miles, non-debtors were allegedly harmed by an involuntary bankruptcy and brought state law claims against the petitioning creditors in state court.  There, the creditors successfully removed the case to federal bankruptcy court.  The Ninth Circuit held that the state law tort claims were removable to federal bankruptcy court because they were “completely preempted” by § 303(i).  See In re Miles, 430 F.3d at 1093.  Finding the case properly removed to federal bankruptcy court, the Ninth Circuit affirmed the dismissal of the complaint because the non-debtors lacked standing under § 303(i) to recover damages.

Here, the Third Circuit refused to follow the Ninth Circuit’s ruling in Miles, stating that the Ninth Circuit’s Miles analysis is inconsistent with the presumption against preemption, which requires that congressional intent to preempt state law must be “clear and manifest.”

Going further, the Third Circuit noted that the Supreme Court has never recognized “complete preemption” in the Bankruptcy Code, and the Ninth Circuit appears to be the only circuit finding such preemption.  See In re Repository Techs, Inc., 601 F.3d 710, 724 (7th Cir. 2010) (declining to follow Miles).

Thus, the Third Circuit held that Bankruptcy Code § 303(i) does not preempt state law claims by non-debtors for damages based on the filing of an involuntary bankruptcy petition.

Accordingly, the Third Circuit reversed the trial court’s dismissal of the plaintiffs’ complaint and remanded for further proceedings.