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Current Developments in the Commercial Divisions of the
New York State Courts by Schlam Stone & Dolan LLP
Posted: December 3, 2020

Federal Bankruptcy Law Does Not Preempt Tortious Interference Claim by Non-Debtors

On November 24, 2020, the Court of Appeals issued a decision in Sutton 58 Assoc. LLC v. Pilevsky, 2020 NY Slip Op. 06939, holding that federal bankruptcy law does not preempt tortious interference claims by non-debtors, explaining:

In their bid for dismissal of plaintiff’s claims, defendants do not identify any specific Bankruptcy Code provisions that have preemptive effect. Instead, defendants cite to various court cases addressing bad-faith filing or abuse of process claims, and analogize plaintiff’s tortious interference causes of action to such claims. In that regard, courts have most often confronted preemption in the bankruptcy context in relation to attempts by creditors and debtors to lodge state tort claims against each other for malicious prosecution or abuse of process, alleging bad-faith filings in a bankruptcy proceeding or wrongful conduct within that proceeding. Judicial authorities are divided on [*6]whether such claims are preempted. However, it is fair to say that the majority of courts have held that such tort claims—those premised upon a bankruptcy filing, itself, or other alleged wrongful conduct within a bankruptcy proceeding—are preempted.

We need neither adopt nor reject the reasoning of these courts to resolve the instant appeal. It suffices to say that, where a tort claim is premised upon a bankruptcy filing, itself, or on conduct that occurs within a bankruptcy proceeding and under the purview of the Bankruptcy Court, the obstacle presented by state tort remedies is more readily discerned. Parallel tort actions in state court against a debtor or creditor based on that party’s alleged wrongful conduct in a bankruptcy proceeding risks subverting the Bankruptcy Court’s authority to adjudicate the validity of bankruptcy filings, or otherwise producing inconsistent standards or outcomes between state and federal law. Indeed, the Bankruptcy Code provides remedies for such claims as asserted between debtors and creditors by, for example, authorizing dismissal of bad-faith filings and empowering the Bankruptcy Court to take measures to prevent any abuse of process. While some courts have reasoned that state courts are not authorized to determine whether a person’s claim for relief under a federal law, in a federal court, and within that court’s exclusive jurisdiction, is an appropriate one, in our view, this same obstacle is not presented under the circumstances here because no question is raised as to the propriety of the bankruptcy proceedings. Plaintiff’s tortious interference claims—asserted against defendants who were not debtors in the bankruptcy proceedings and which are premised upon conduct that occurred prior to those proceedings—are peripheral to, and do not impugn, the bankruptcy process.

Significantly, plaintiff seeks to sue non-debtor third parties for alleged wrongful conduct that occurred prior to, and separate from, the bankruptcy proceedings. The Bankruptcy Code, however, is overwhelmingly concerned with the debtor’s estate. Bankruptcy law and, in particular, chapter 11 bankruptcy, aims to permit business debtors to reorganize and restructure their debts in order to revive the debtors’ businesses and maximize the value of the bankruptcy estate. The accomplishment of these purposes relies upon the proper composition and allocation of the debtor’s estate. Consequently, federal courts have exclusive jurisdiction of all the property, wherever located, of the debtor as of the commencement of such case, and of property of the estate.

In light of these purposes of the Bankruptcy Code, a significant component of a preemption analysis in the bankruptcy context must be the degree to which the state claims interfere with the administration of the debtor’s estate. Here, resolution of plaintiff’s claims in state court does not risk interference with the Bankruptcy Court’s control over, or disposition of, the bankruptcy estate insofar as the present suit does not impair the debtors’ estates. The debtors in the bankruptcy proceedings—i.e., the borrowers—are unaffected by whether plaintiff prevails on its tort claims against defendants, and the state action has no impact on the borrowers’ ability to obtain a fresh start.

It is not disputed that valid contracts existed between plaintiff and the borrowers. Plaintiff’s claims arising out of the borrowers’ breach of those contracts as asserted against the borrowers were resolved by the bankruptcy proceeding. Here, plaintiff alleges that defendants knew of the relevant contractual terms and deliberately induced the borrowers’ violations of those terms prior to the bankruptcy proceedings. In other words, plaintiff’s allegations state a claim for tortious interference with contract, and the remedy for that tort will not affect the debtor’s estate. As such, these claims will not encroach upon the province of the bankruptcy court. Stated simply, plaintiff’s claims do not require the adjudication of rights and duties of creditors and debtors under the Bankruptcy Code.

Rather, plaintiff alleges that certain conduct engaged in by defendants—before the bankruptcy proceedings were even commenced—tortiously interfered with its contractual rights under various loan agreements. Litigation of those claims will require resolution of whether: plaintiff had a valid contract with the borrowers; defendants had knowledge of that contract and its relevant terms; defendants intentionally and improperly induced a breach of that contract; and plaintiff sustained damages caused by that conduct. Contrary to the dissent’s assertion, our state courts will not be asked to determine whether the borrowers’ bankruptcy petitions were filed in bad faith or whether defendants engaged in some wrongful conduct during the bankruptcy proceedings themselves. Regardless of whether the borrowers filed for bankruptcy in good or bad faith, plaintiff may recover damages for tortious interference with contractual relations even if defendants were engaged in lawful behavior to the extent that their conduct, as non-debtors, is not alleged to have been in violation of the Bankruptcy Code. As defendants may be found to have tortiously interfered with plaintiff’s contractual rights prior to the bankruptcy proceedings without any inquiry by the state court into whether any provision of the Bankruptcy Code was violated, those cases relied on by defendants and the dissent addressing preemption of bad-faith filing or abuse of process claims as between debtors and creditors are inapposite.

Defendants and the dissent point to Choy v Redland Ins. Co. and Astor Holdings, Inc. v Roski as compelling support for the conclusion that preemption is applicable here. Reliance on these cases is unpersuasive. In Choy, a California court concluded that the plaintiff’s claim was preempted where plaintiff alleged that the defendants induced a debtor to file a bankruptcy petition in order to benefit themselves. Likewise, Astor involved allegations that the defendant induced a third party to file for bankruptcy, harming the plaintiff. Unlike in Choy and Astor, where the filing of the bankruptcy petitions themselves was the basis of the plaintiffs’ claims, plaintiff here does not allege that defendants induced the borrowers’ bankruptcy petition but, rather, that they induced breaches of independent contractual provisions prohibiting asset and interest transfers and certain types of indebtedness.

Federal caselaw addressing bankruptcy preemption of state-law tort claims against third parties differentiates between those claims that are based on conduct that occurs during bankruptcy, and conduct undertaken by a third party before commencement of a bankruptcy proceeding. Contrary to the dissent’s view, those cases neither find preemption merely because some fact questions might overlap with bankruptcy proceedings, nor base preemption on whether the damages resulting from a state-law tort or contract action would be calculated by the delay caused by the bankruptcy proceedings.

As the dissent observes, the Ninth Circuit Court of Appeals has held that federal law preempts state courts from determining a creditor’s claim against a debtor asserting that the filing of a bankruptcy petition was an abuse of process and a debtor’s allegation that a creditor’s assertion of a claim in a bankruptcy proceeding constituted malicious prosecution. However, the Ninth Circuit’s holding in Davis v Yageo Corp. undercuts the dissent’s view that these cases support the proposition that any tort claims alleging that the damages incurred are causally connected to a bankruptcy proceeding are preempted.

In Davis, the complaint of minority shareholders alleged that the directors and majority shareholder engaged in self-dealing to the detriment of the corporation through their decision to pursue bankruptcy and sought damages for breach of fiduciary duty under California state law. The defendants argued that the plaintiffs’ state law causes of action were preempted because they essentially constituted claims that defendants had improperly used the bankruptcy process. The Ninth Circuit clarified that its prior cases, including Gonzales v Parks (830 F2d 1033), MSR Expl., Ltd. v Meridian Oil, Inc. and In re Miles, hold only that state law causes of action for abuse of process and malicious prosecution involving conduct that occurred during bankruptcy are preempted. The Court explained that, by contrast, the plaintiffs’ claims in Davis were not preempted because they concerned conduct that occurred prior to bankruptcy and did not require the adjudication of rights and duties of creditors and debtors under the Bankruptcy Code. The same is true here. Furthermore, the Ninth Circuit declined to hold the claims preempted despite the fact that the plaintiffs’ damages could be traced to the bankruptcy proceeding, as the measure of the damages alleged was the difference in the value of the company’s shares before and after the defendants’ decision to file for bankruptcy. Thus, the Davis court recognized that it is the nature of the legal claim, not the measure of damages, that is relevant to determining whether a state law claim is preempted.

. . .

Defendants and various amici speculate that permitting plaintiff’s state law claims to proceed will open the floodgates of litigation against attorneys who facilitate bankruptcy filings or provide other legal advice to debtors, debt counseling agencies, restructuring firms, and lenders to distressed borrowers. We are confident that these concerns are overstated and, in any event, more appropriately addressed through the proper application of our tort law. In that regard, while we do not opine on the merits of plaintiff’s tortious interference claims here, we note that New York courts have been skeptical of the viability of claims that attorneys, acting as agents of their clients, may be liable for tortious interference based on the provision of legal advice. Liability against debt counseling organizations on such a theory likewise seems speculative; many potential bankruptcy petitioners are financially bereft and close to breaching contracts with creditors, if not already in breach, due to their inability to satisfy their financial obligations. Plaintiffs alleging tortious interference may have difficulty establishing the elements of the claim, such as causation or improper inducement on the part of such agencies. Finally, we are not persuaded that any remaining risk of liability assumed by lenders who intentionally and improperly induce breaches of known contractual obligations by an entity that subsequently files for bankruptcy sufficiently frustrates a significant objective of the Bankruptcy Code so as to compel preemption.

In sum, defendants have failed to meet their heavy burden of establishing that federal bankruptcy law preempts plaintiff’s tortious interference claims that are based on pre-petition conduct and asserted against non-debtor defendants. Accordingly, the order of the Appellate Division should be reversed, with costs, and the case remitted to the Appellate Division for consideration of issues raised but not determined on the appeal to that Court.

(Internal quotations and citation omitted).

This decision deals with the intersection of state law and federal bankruptcy law. Contact Schlam Stone & Dolan partner John Lundin at jlundin@schlamstone.com if you or a client face a situation where an opponent has declared bankruptcy.

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