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Court of Appeals Holds Bankruptcy Law Does Not Preempt Lender’s Tortious Interference Claims Against Third-Party Non-Debtors

In Sutton 58 Associates LLC v. Pilevsky, the New York Court of Appeals recently held in a 4-3 split decision that, under certain circumstances, bankruptcy law does not preempt a lender’s state law claims against third-party non-debtors for tortious interference with a contract between the lender and the debtor.[1]  This decision preserves a state forum for lenders asserting claims that: 1) involved “wrongful conduct by non-debtor defendants that occurred prior to the bankruptcy proceeding,” and 2) are “grounded in independent contractual obligations.”[2]

Factual Background

Sutton 58 Associates, LLC (“Plaintiff”) brought tortious interference claims against investor Phil Pilevsky, his sons, and their related entities (“Defendants”), alleging that Defendants had interfered with loan agreements between Plaintiff as lender and nonparty borrowers.[3] 

The purpose of the loan agreements was to finance the development of an apartment complex in Manhattan.[4]  Under the loan agreements, the borrowers were subject to restrictions designed to ensure that, if they filed for bankruptcy, they would be treated as single-asset real estate entities (“SARE”), a status that would expedite the bankruptcy process.[5]  Specifically, the borrowers were forbidden from incurring any debt other than short-term trade debt, acquiring any unrelated assets, and engaging in any other business.[6]  The agreements also prohibited the sale or transfer of any direct or indirect interest in the property or the borrowers without Plaintiff’s consent.[7] 

When the loans matured, the borrowers defaulted, and in early 2016, the borrowers filed voluntary petitions for Chapter 11 bankruptcy.[8]  The bankruptcy proceedings did not proceed expeditiously as intended under the loan agreements, however, because the borrowers had taken on another creditor and no longer qualified as SAREs.[9] 

Meanwhile, in September 2016, Plaintiff filed a lawsuit in the New York County Commercial Division against Defendants, alleging that they had improperly obtained an interest in the project by: a) loaning $50,000 to the borrowers to retain counsel, b) transferring three rental apartments to the borrowers so that they would no longer be SAREs, and c) assuming an indirect interest in the borrowers and the development project at issue.[10]  With respect to damages, Plaintiff asserted that Defendants’ interference caused the bankruptcy proceedings to become protracted, which, in turn, decreased the value of the development site.[11]

Defendants moved for summary judgment, arguing that the action was preempted by bankruptcy law.[12]  Commercial Division Justice Shirley Werner Kornreich denied the motion.  On appeal, the Appellate Division, First Department reversed, finding the claims to be preempted because Plaintiff’s “‘damages [arose] only because of the bankruptcy filings.’”[13]  Plaintiff then appealed to the Court of Appeals.

The Court of Appeals’ Opinion

In a deeply divided decision, the Court of Appeals reversed the First Department and held that Plaintiff’s claims were not preempted.[14] 

After noting that “Defendants ma[d]e no claim of express preemption,” Judge Leslie Stein, writing for the Court, addressed whether the claims were field preempted by the “comprehensive federal regulation of bankruptcy proceedings.”[15]  The Court held that field preemption did not apply because “nothing in the language, structure, or history of the Bankruptcy Code” evinced Congress’s “intent to . . . foreclos[e] tort remedies for claims that are not asserted by or against a debtor and do not affect the bankruptcy estate.”[16]

The Court next addressed Defendants’ argument that Plaintiff’s claims were conflict preempted insofar as litigating the claims would undermine bankruptcy law’s “full purposes and objectives.”[17]  The Court found this argument to be “more complex” but ultimately rejected it.[18]

The Court recognized that a majority of courts had found certain tort claims—i.e., “those premised upon a bankruptcy filing, itself, or other alleged wrongful conduct within a bankruptcy proceeding”—to be conflict preempted.[19]  The Court concluded that such claims were distinguishable from Plaintiff’s claims, however.  It explained that the former claims “risk[ed] 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.”[20]  Plaintiff’s claims, by contrast, were “peripheral to, and [did] not impugn, the bankruptcy process,” as they did not require any determination as to whether the bankruptcy petition was filed in bad faith or an assessment of Defendants’ conduct during the bankruptcy proceeding.[21]

The Court was likewise unpersuaded by Defendants’ argument that, “when the alleged tortious conduct consists of a scheme to hinder a creditor’s ability to obtain expeditious resolution of a bankruptcy proceeding, permitting plaintiffs to assert tortious interference claims in state court against non-debtors may generate some tension between the state court action and the bankruptcy proceeding . . . .”[22]  The Court reasoned that the “mere fact of ‘tension’ between federal and state law” does not provide a basis for preemption.[23] 

The Court further explained that “a significant component” of its conflict preemption analysis “must be the degree to which the state claims interfere with the administration of the debtor’s estate.”[24]  And this component weighed against finding preemption because the debtors would be “unaffected by” whether Plaintiff prevailed on its claims against Defendants.[25]

The Court ended by addressing a concern raised by Defendants and amici that permitting Plaintiff’s claims to proceed would “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.”[26]  The Court opined that this concern was “overstated and, in any event, more appropriately addressed through the proper application of our tort law.”[27]

Writing for the dissent, Judge Jenny Rivera would have held the claims to be preempted.  In the dissent’s view, Plaintiff’s claim was “‘entirely predicated upon the filing and prosecution of’ the bankruptcy petitions,”[28] and “would require the court to opine on the legitimacy of the debtors’ bankruptcy proceedings.”[29]  Thus, the dissent reasoned, the claim was conflict preempted.

Conclusion

This potentially watershed decision offers critical clarity regarding when lenders’ tortious interference claims are likely preempted by bankruptcy law.  Litigants in the Commercial Division who encounter a bankruptcy by one of the parties will need to consider the analysis of Sutton 58 in assessing whether their claims can go forward in spite of the bankruptcy filing.  It will be interesting to see whether the decision also causes the dire consequences claimed by Defendants and amici, such as a flood of state law claims against attorneys, debt counseling agencies, and lenders who provide assistance to distressed borrowers.

 

[1] Sutton 58 Assocs. LLC v. Pilevsky, --- N.Y.3d ---, 2020 N.Y. Slip Op. 06939, 2020 WL 6875979, at *1 (N.Y. Nov. 24, 2020).

[2] Id. at *3.

[3] Id. at *2.

[4] Id. at *1.

[5] Id.

[6] Id.

[7] Id.

[8] Id. at *2.

[9] Id.

[10] Id.

[11] Id.

[12] Id. at *3.

[13] Id. (citation omitted).

[14] Id. at *1.

[15] Id. at *5.

[16] Id.

[17] Id.

[18] Id.

[19] Id. at *6.

[20] Id.

[21] Id.

[22] Id. at *9.

[23] Id. (citation omitted).

[24] Id. at *7.

[25] Id.

[26] Id. at *9.

[27] Id.

[28] Id. at *23 (citation omitted).

[29] Id. at *17.