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Punitive Damages for Involuntary Bankruptcy Petitions Filed in Bad Faith are Ineligible for Setoff

We generally advise clients to think carefully before commencing an involuntary bankruptcy petition against an alleged debtor.  One of the primary reasons for our caution is section 303(i) of the Bankruptcy Code, which provides that “(i) If the court dismisses [an involuntary] 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.”  A recent unreported decision of the Third Circuit Court of Appeals underscores the serious consequences that can flow from an adverse judgment under this section of the Code. [1] 

In 2003, National Medical Imaging (“NMI”) defaulted on certain equipment leases with U.S. Bank (“U.S. Bank”), leading to litigation and ultimately amended leases among the parties and NMI’s principal, Rosenberg.  About two years later, NMI defaulted again, leaving Rosenberg personally responsible for about $5 million.  Entities related to U.S. Bank filed an involuntary bankruptcy petition against Rosenberg in the Eastern District of Pennsylvania, which was transferred to the Southern District of Florida, where it was dismissed by the Bankruptcy Court.

In response, Rosenberg sought compensatory and punitive damages under Section 303(i), a demand that was eventually removed to the District Court and submitted to a jury. The jury awarded him approximately $1.1 million in compensatory damages and $5 million in punitive damages.  Meanwhile, U.S. Bank filed suit against Rosenberg in the Eastern District of Pennsylvania for breach of the amended leases. The District Court awarded U.S. Bank approximately $6.5 million in damages, fees, and costs.

With a net amount due to it of about $400,000, U.S. Bank filed a motion for mutual judgment satisfaction in the Eastern District of Pennsylvania. The District Court denied U.S. Bank’s motion, and the Third Circuit affirmed.[2]

Writing for the three-judge panel, Judge Rendell explained that, “[t]he District Court did not abuse its discretion in denying U.S. Bank’s motion for mutual judgment satisfaction based on equitable principles. Setoff is an equitable right to be permitted solely within the sound discretion of the court.  The filing of an involuntary bankruptcy petition has devastating consequences for the putative debtor. The Bankruptcy Code’s good faith filing requirement, which has strong roots in equity, seeks to prevent the improper filing of involuntary petitions and ensures that the Bankruptcy Code’s careful balancing of interests is not undermined by petitioners whose aims are antithetical to the basic purposes of bankruptcy.”[3]    The Third Circuit also agreed with the District Court that Section 303(i) “plays a key role in deterring bad faith filing and remedying the negative effects of improperly-filed petitions.  Several courts have concluded that § 303(i)’s equitable purpose would be frustrated if bad faith filers were allowed to offset a § 303(i) judgment.”[4]

Section 303(i) deters creditors from commencing involuntary bankruptcy cases against recalcitrant debtors.  The inability to offset damages owed by the debtor against any subsequent penalty under that section is just one more reason for involuntary petitioners to proceed with caution. 

 

[1] U.S. Bank, Nat’l Ass’n v. Rosenberg, 2018 U.S. App. LEXIS 21145, at *2 (3d Cir. July 31, 2018).

[2] The District Court explained that U.S. Bank believed Rosenberg to be judgment proof, and that existing attorney charging liens against Rosenberg had priority ahead of the judgment held by the bank, so that if the bank paid the $6.1 million to Rosenberg, it was unlikely to receive back any of the $6.5 million he owed to the bank.  U.S. Bank, Nat’l Ass’n v. Rosenberg, 581 B.R. 424, 429 (E.D. Pa. 2018).

[3] 2018 U.S. App. LEXIS 21145 at *6 (citations and internal quotation marks omitted).

[4] Id.  The Third Circuit did not substantively address the District Court’s alternate basis for denying setoff, that the two judgments were not “mutual.”  See id. at *5-6 (“we need not decide the merits of [the mutuality] argument because the District Court provided an alternative basis for its denial of the motion”).