[1]Most practitioners are aware of the risks that petitioning creditors face when filing an involuntary petition against an alleged debtor.[2] If the court determines that the filing was improper or done in bad faith, penalties can be assessed against the petitioning creditors under 11 U.S.C. § 303(i), which can include requiring petitioning creditors to pay legal fees and costs as well as compensatory and punitive damages to the alleged debtor.[3]
The Rosenberg case presents a new layer of potential liability for petitioning creditors. The Third Circuit Court of Appeals’ decision has opened the door for nondebtors to pursue claims for damages under nonbankruptcy law and outside of the bankruptcy court against petitioning creditors who have allegedly harmed such nondebtors through filing an involuntary petition. The nondebtors in Rosenberg asserted claims of tortuous interference against the petitioning creditors in federal district court under the court’s diversity jurisdiction. The district court dismissed the nondebtors’ complaint on the basis that the claims were preempted by the Bankruptcy Code. Thus, the question before the Third Circuit was whether the Bankruptcy Code, and in particular § 303(i), preempted such nondebtor claims. The Third Circuit found that it did not and reversed the district court decision.
The relevant facts in Rosenberg are as follows: Certain creditors (the “petitioning creditors”) filed an involuntary petition against Maury Rosenberg, the owner of a medical imaging business, as well as multiple affiliated limited partnerships related to the medical imaging business (the “LPs”) in the Eastern District of Pennsylvania.[4] Maury Rosenberg’s case was transferred to the Southern District of Florida. There, the bankruptcy court there dismissed the involuntary petition. Subsequently, the bankruptcy court for the Eastern District of Pennsylvania, applying collateral estoppel based on the dismissal of the case against Maury Rosenberg in the Southern District of Florida, dismissed the involuntary petitions against the LPs. Maury Rosenberg then commenced an adversary proceeding in the Southern District of Florida under § 303(i) against the petitioning creditors and was awarded fees, costs and damages.
Maury Rosenberg’s wife and certain other business associates filed a complaint in the district court for the Southern District of Florida, which was thereafter transferred on the defendants’ motion to the Eastern District of Pennsylvania. The nondebtor plaintiffs asserted a claim against the petitioning creditors under the court’s diversity jurisdiction for tortuous interference. The nondebtor plaintiffs alleged in the complaint that the involuntary petitions filed against Maury Rosenberg and the LPs caused the LPs to default on various agreements, and claimed the involuntary filing was orchestrated to cause such defaults, which resulted in the loss of property and other harm to the nondebtor plaintiffs for which they sought a remedy.
Against this backdrop, the court addressed whether preemption was applicable under these circumstances such that the nondebtor plaintiffs would be precluded from pursuing a remedy for the alleged harms.
The court first addressed the different forms of preemption and determined that out of the three forms — express, conflict and field[5] — this case presented an issue of potential “field” preemption. Field preemption applies when the “congressional attempt to supersede state laws [is] clear and manifest.”[6] Next, the court acknowledged the strong presumption against federal preemption and framed the analysis as follows: “The inquiry we make is 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 nondebtors based on the filing of an involuntary bankruptcy petition.”[7] The court analyzed the text, structure and purpose of § 303(i) and found insufficient evidence of a clear and manifest intent of Congress for field preemption in this circumstance.
As for the text, the court found that the fact that § 303(i) is silent on remedies for nondebtors was not sufficient to find that Congress intended to remove all judicial recourse for such nondebtors. Similarly, the court found no support for preemption in the structure and purpose of § 303(i). The court also rejected the argument that the Bankruptcy Code’s provision of a remedy to nondebtors based on a violation of the automatic stay under § 362(k)(1), and, in contrast, the absence of such provision to protect nondebtors from harm caused by wrongful involuntary filings, amounted to a clear and manifest intention of preemption. The court also rejected as speculation the defendants’ argument that a failure to apply preemption would open the floodgates of nondebtor litigation, which would discourage the use of involuntary bankruptcies.
The court was similarly not persuaded by the argument that failure to preempt would undermine uniformity in bankruptcy law. Instead, the court chose to rely on the comity between federal and state law, and the ability of the state court to faithfully “account for federal bankruptcy law to the extent it may be relevant to a state law claim against a creditor.”[8]
Lastly, the court chose not to follow a diametrically opposed decision by the Ninth Circuit Court of Appeals.[9] Specifically, the Ninth Circuit found that § 303(i) was the exclusive provision by which there could be recovery for harm caused by an involuntary filing, and since § 303(i) only allowed damages to debtors, the nondebtor claimants lacked standing to recover under § 303(i).
The Third Circuit disagreed with the Ninth Circuit’s finding that the nondebtor tort claims were completely preempted by § 303(i). The Third Circuit distinguished “complete” preemption from “field” preemption, finding that “complete” preemption “applies when the preemptive force of a federal statute is so “extraordinary” that it “converts an ordinary state common-law complaint into one stating a federal claim for purposes of the well-pleaded complaint rule.”[10] The court noted that complete preemption, which the Supreme Court has applied only in limited contexts, has never been recognized with respect to the Bankruptcy Code, and thus the Ninth Circuit decision was an outlier.[11] The court also found that the Ninth Circuit decision was not in keeping with the presumption against preemption.
In particular, the court discussed a direct split between the Third and Ninth Circuits on the issue of whether § 303(i) is an exclusive remedy for recourse for harm caused by an involuntary filing. The Ninth Circuit decision that § 303(i) is the exclusive remedy directly conflicts with Third Circuit precedent to the contrary. The Third Circuit has long held that under certain circumstances, a debtor may pursue a claim against petitioning creditors on the basis of an involuntary filing in a context other than § 303(i).[12]
The Rosenberg decision certainly adds to the danger already present for petitioning creditors when filing an involuntary petition. That danger can be minimized by filing cases that can withstand dismissal. Petitioning creditors and their counsel should take care to ensure there are no technical deficiencies in the petition such as insufficient number of creditors or the presence of bona fide disputes regarding the petitioning creditors’ claims. Obviously, no good is likely to come from an improper motive in filing an involuntary petition against an alleged debtor. Whether the floodgates of state court litigation by nondebtors against petitioning creditors for damages caused by involuntary bankruptcy filings will be unleashed remains to be seen, but it is certainly an even more risky venture now for petitioning creditors.
[1] Rosenberg v. DVI Receivables XVII LLC, 835 F.3d 414 (3d Cir 2016).
[2] A cautionary case on damages is In re Landmark Distrib. Inc., 189 B.R. 290 (Bankr. D.N.J. 1995), in which an involuntary chapter 7 was filed against a national record distribution company by competitors in the industry to destroy the alleged debtor’s business after a deal through which the competitors sought to purchase an affiliate of the alleged debtor went sour. After dismissal of the petition, and following a trial on the valuation of the business that was destroyed in the process, the court awarded attorneys’ fees and costs, as well as substantial compensatory and punitive damages.
[3] It is notable that even if there is technical compliance with the requirements for an involuntary petition, bad faith can be an independent basis for dismissal — thereby subjecting petitioners to an award against them for compensatory and punitive damages under 11 U.S.C. § 303(i). See In re Forever Green Athletic Fields Inc., 804 F.3d 328 (3d Cir. 2015).
[4] This case, which is part of a 10-year history of related litigation, has a complex fact pattern that has been streamlined for purposes of this article.
[5] Rosenberg, 835 F.3d at 418 (citing Elassaad v. Indep. Air Inc., 613 F.3d 119, 126 (3d Cir. 2010)). “Express” preemption is appropriate when the specific intent of Congress to preempt is explicitly in the language of the statute or in the purpose and structure of the statute. “Conflict” preemption is required when the state law directly conflicts with the federal law. Id.
[6] Rosenberg, 835 F.3d at 418 (emphasis added).
[7] Id. at 419.
[8] Id at 421.
[10] Rosenberg, 835 F.3d at n.4.
[11] Id.
[12] Id. at 421 (citing Paradise Hotel Corp. v. Bank of Nova Scotia, 842 F.2d 47 (3d Cir. 1988)). In the Paradise case, with the involuntary chapter 7 petition, the alleged debtor business was thrust into turmoil. To save the business, the alleged debtor filed a voluntary chapter 11 petition and asked the court to stay the pending involuntary chapter 7, which it did. The chapter 11 debtor then brought an action against the petitioning creditors asserting, inter-alia, the bad faith filing of the involuntary petition. The petitioning creditors argued that such argument had been waived and should have been brought under § 303(i)(2). The Third Circuit Court of Appeals disagreed and found that the debtor had not waived its claim against the petitioning creditors in the involuntary chapter 7 and that § 303(i) is not the exclusive provision under which a debtor may bring such bad-faith claims.