Rosenberg v. DVI Receivables XVII, LLC: Third Circuit Finds That Section 303(i) of the Bankruptcy Code Does Not Preempt Non-Debtors' State Law Claims | Practical Law

Rosenberg v. DVI Receivables XVII, LLC: Third Circuit Finds That Section 303(i) of the Bankruptcy Code Does Not Preempt Non-Debtors' State Law Claims | Practical Law

In Rosenberg v. DVI Receivables XVII, LLC, the US Court of Appeals for the Third Circuit held that damages awarded to a debtor for a bad faith involuntary bankruptcy filing under section 303(i) the Bankruptcy Code does not preempt state law claims brought by non-debtor affiliates for damages arising from the filing of the involuntary petition.

Rosenberg v. DVI Receivables XVII, LLC: Third Circuit Finds That Section 303(i) of the Bankruptcy Code Does Not Preempt Non-Debtors' State Law Claims

by Practical Law Bankruptcy & Restructuring
Published on 07 Oct 2016 • USA (National/Federal)
In Rosenberg v. DVI Receivables XVII, LLC, the US Court of Appeals for the Third Circuit held that damages awarded to a debtor for a bad faith involuntary bankruptcy filing under section 303(i) the Bankruptcy Code does not preempt state law claims brought by non-debtor affiliates for damages arising from the filing of the involuntary petition.
On August 29, 2016, the US Court of Appeals for the Third Circuit held in Rosenberg v. DVI Receivables XVII, LLC, that damages awarded to a debtor for a bad faith involuntary bankruptcy filing under section 303(i) of the Bankruptcy Code does not preempt state law claims brought by non-debtor affiliates for damages arising from the filing of the involuntary petitions ( (3d Cir. Aug. 29, 2016)).

Background

Maury Rosenberg was the principal developer of National Medical Imaging, LLC (NMI) and National Medical Imaging Holding Company (NMI Holding), which were affiliated with various limited partnerships that operated medical imaging centers. To finance the purchase of medical imaging equipment, the limited partnerships entered into leases with DVI Financial Services, who transferred the leases to DVI Funding, LLC. DVI Funding then securitized the leases and transferred them to various entities in the name of DVI Receivables, and had Lyon Financial, a subsidiary of US Bank, act as trustee for the servicing contracts (collectively, Defendants).
On November 7, 2008, DVI Funding and five DVI Receivables entities filed involuntary petitions against Mr. Rosenberg, NMI, and NMI Holding over money that Rosenberg's companies owed under the leases. The bankruptcy court dismissed the involuntary petition against Mr. Rosenberg because DVI Funding and its related entities were not creditors of Rosenberg. The petitions against NMI and NMI Holdings were also later dismissed. Mr. Rosenberg then filed an adversary proceeding under section 303(i) of the Bankruptcy Code to recover costs, attorney's fees, and damages for the bad faith filing of the involuntary petition. Mr. Rosenberg was successful and was awarded fees, costs and approximately $6 million in compensatory and punitive damages, which was ultimately affirmed by the US Court of Appeals for the Eleventh Circuit (see Legal Update, Rules of Bankruptcy Procedure Apply to Bankruptcy Proceedings in Federal District Court: Eleventh Circuit).
In August 2013, Sara Rosenberg (Mr. Rosenberg's wife), the Rosenberg Trust, and several NMI Real Estate Partnerships (collectively, Rosenberg Affiliates), filed a state law claim of tortious interference against the Defendants for damages resulting from the filing of the involuntary petitions. The Rosenberg Affiliates argued that the Defendants filed involuntary bankruptcy petitions with the intent to cause the Rosenberg Affiliates to default on their underlying mortgages, and as a result the limited partnerships lost the properties.
The Defendants moved to dismiss the state law claim, arguing the state law claim was preempted by section 303(i) of the Bankruptcy Code. The District Court agreed with the Defendants and dismissed the case (see Rosenberg v. DVI Receivables, XIV, LLC, (E.D. Pa, June 4, 2015)). The Rosenberg Affiliates appealed to the Third Circuit, which reviewed whether section 303(i) preempts state law claims of non-debtors for damages arising from the filing of an involuntary petition.

Outcome

The Third Circuit reversed the District Court decision and held that section 303(i) of the Bankruptcy Code did not preempt non-debtor state law claims for damages arising from the filing of an involuntary petition. The Third Circuit found that there is a presumption against preemption, and, relying on Elassaad v. Independent Air, Inc., determined that field preemption occurs when "congressional intent to supersede state laws [is] clear and manifest" (613 F.3d 119, 126 (3d Cir. 2010) (quoting Holk v. Snapple Beverage Corp., 575 F.3d 329, 336 (3d Cir. 2009))).
To determine congressional intent, the Third Circuit analyzed the text, structure, and purpose of section 303(i) and the Bankruptcy Code as a whole, and found that there was insufficient evidence of Congress's "clear and manifest" intent to rebut the presumption against preemption.

The Text, Structure, and Purpose Do Not Indicate Field Preemption

The Third Circuit began its analysis by explaining that there are three types of federal preemption: express, conflict, and field preemption. This case would fall into the latter category of alleged field preemption, in which federal law preempts state law only if Congressional intent to supersede state laws is clear and manifest and the federal regulation leaves no room for state regulation.
The Third Circuit then addressed the text, structure and purpose of section 303(i) of the Bankruptcy Code. In reviewing the plain language text of section 303(i), the Court noted that the section expressly provides a remedy for a debtor, but is silent about remedies for non-debtors that might have been harmed by the filing of an involuntary petition. The Third Circuit rejected the Defendants' argument that it should infer a Congressional intent to deprive non-debtors of a remedy simply because it explicitly provided a remedy for debtors in section 303(i). Rather, the Third Circuit interpreted Congress's silence as either an intent not to disturb the existing framework of state law remedies for non-debtors, or that Congress did not even consider non-debtor remedies but would not seek to deprive non-debtors of a judicial remedy.
In analyzing the structure and purpose of the Bankruptcy Code, the Third Circuit found no indication of field preemption. The Court observed that because the purpose of section 303(i) was to give debtors a remedy against abuse by petitioning creditors, it would it be inconsistent with that remedial purpose to deny non-debtors remedies by allowing section 303(i) to preempt state law.
While the Third Circuit analyzed the Defendants arguments, it found none that met the standard of a clear and manifest intent of Congress to overcome the presumption against preemption. The Court concluded that there is no evidence that Congress intended for section 303(i) to be an exclusive remedy and therefore it does not preempt state law claims by non-debtors for damages based on the filing of an involuntary petition.

Practical Implications

The Third Circuit's decision is significant for both creditors seeking to file an involuntary petition and for non-debtor affiliates of the involuntary debtor. On one side, creditors considering an involuntary filing should assess the possibility that a bad faith filing may not only result in damages awarded to a debtor, but damages may also be awarded to non-debtor affiliates harmed by the involuntary filing. On the other side, non-debtors affected by the involuntary filing may now have recourse in state law damage claims arising from a bad faith involuntary filing. This decision also leaves open a possibility that other sections of the Bankruptcy Code may not preempt state law when a state law remedy is available for non-debtor affiliates.
For more information on involuntary bankruptcy, see Practice Note, The Involuntary Bankruptcy Process.