Choose Your own Adventure: Are Florida State Law Claims for the Wrongful Filing of Involuntary Bankruptcy Preempted by 11 U.S.C. Statute 303(i)?

The filing of an involuntary bankruptcy is a serious matter, and creditors rarely resort to this drastic measure when attempting to collect on a debt. The prospect of creditor liability for costs, attorney’s fees, damages, and possibly punitive damages makes involuntary petitions a risky endeavor. Involuntary bankruptcy is most often used when unsecured creditors suspect fraud on the part of a company. Otherwise, creditors typically pursue collection on their own claims directly, including through federal and state litigation. The end result of these collection attempts might actually end up “forcing” the company into bankruptcy, but it would be a voluntary bankruptcy and a creditor would not be subject to the same risks associated with an involuntary petition.

If an involuntary petition fails, the consequences are quite serious. First, once filed, an involuntary petition cannot be dismissed without a notice and an opportunity to be heard, even if the petitioning creditors and the debtor company agree. Further, if the involuntary petition is dismissed, the petitioning creditors can be liable for costs and attorney’s fees of the company. However, the most serious consequence results upon a court finding that the petition was filed in bad faith. In this case, the petitioning creditors can be liable as well for damages caused by the involuntary filing and even for punitive damages. These claims are almost always asserted exclusively in bankruptcy court, but this post examines whether it is appropriate for debtors who are the victim of a bad faith filing to pursue state law claims for damages, including malicious prosecution, abuse of process, and slander in Florida state court. Read on to explore whether these state claims are preempted by the remedy provided in 11 U.S.C. § 303(i) in Florida.

Grounds for Filing an Involuntary Petition

Section 303 of the Bankruptcy Code includes requirements that must be met in order to file an involuntary bankruptcy petition. If a debtor has 12 or more creditors, at least three creditors holding unsecured claims totaling at a minimum of $15,325 that are not contingent or the subject of a bona fide dispute as to liability or amount must join in the filing of an involuntary bankruptcy petition. However, if the debtor has fewer than 12 otherwise eligible unsecured creditors, then one such unsecured creditor with a claim of at least $15,325 that is not contingent or the subject of a bona fide dispute as to liability or amount can file an involuntary bankruptcy petition.

If the debtor contests the petition, the petitioning creditors must also prove, as a prerequisite to being granted relief on the petition, that the debtor is generally not paying its debts that are not otherwise subject to a bona fide dispute as to liability or amount as such debts become due. Courts considering whether a debtor is not paying its debts as they mature have relied on a number of factors, including, but not limited to (i) the number of debts, (ii) the degree of delinquency, (iii) the materiality of non-payment by the debtor, (iv) the total debt compared to the debtor’s annual income, (v) whether the debtor is not paying only the petitioning creditors’ claims and (vi) whether the debtor has terminated its business and started liquidating assets.

Once the petitioning creditors satisfy all of the requirements in 11 U.S.C. § 303, the bankruptcy court will grant relief on an involuntary bankruptcy petition and enter an order for relief. If, however, the petitioning creditors cannot satisfy all of the requirements necessary to obtain relief on a contested involuntary petition, the involuntary petition will be dismissed.

Rights Vested to a Dismissed Debtor Upon Dismissal of an Involuntary Bankruptcy Petition

Upon dismissal of an involuntary petition, § 303(i)(1) of the Bankruptcy Code permits the court to grant judgment against the petitioning creditors and in favor of the debtor for the debtor’s costs and/or the reasonable attorney’s fees incurred in fighting the involuntary petition unless (i) all of the petitioning creditors and the debtor consent to the dismissal, and (ii) the debtor has not waived its right to obtain a judgment under § 303. However, it is unclear from the statute whether these remedies are exclusive.

Alleged debtors have attempted to bring state causes of action in state court after the dismissal of an involuntary bankruptcy, including abuse of process, malicious prosecution, and slander. There seems to be a split among states and federal courts regarding whether these actions are preempted by 11 U.S.C. § 303(i). The majority of cases hold that 11 U.S.C. 303(i) preempts any state law claims. See MSR Exploration, Ltd. v. Meridian Oil, Inc., 74 F.3d 910 (9^th Cir. 1996); In re Reid, 854 F.2d 156 (7^th Cir. 1988); Gonzales v. Parks, 830 F.2d 1033 (9^th Cir. 19870); In re Miles, 294 B.R. 756 (B.A.P. 9^th Cir. 2003); Koffman v. Osteoimplant Tech., Inc., 182 B.R. 115 (Bankr. D. Md. 1995); Shiner v. Moriarty, 706 A.2d 1228 (Pa. 1998); Smith v. Mitchell Constr. Co., 481 S.E.2d 558 (Ga. Ct. App. 1997); Mason v. Smith, 672 A.2d 705 (N.H. 1996); Sarno v. Thermen, 608 N.E.2d 11 (Ill. App. Ct. 1992); Gene R. Smith Corp. v. Terry’s Tractor, Inc., 257 Cal. Rptr. 598 (Cal. Ct. App. 1989).

However, here in Florida, there are two Fourth District Court of Appeal cases that hold the remedies provided in § 303(i) are not exclusive, and alleged debtors may attempt to collect in state court for the improper filing of an involuntary bankruptcy petition. According to these cases, the key to being able to pursue state law claims for a wrongfully filed involuntary petition is deciding not to attempt to collect under § 303(i). Therefore, the debtor must choose between § 303(i) and state law claims.

R.L. LaRoche v. Barnett Bank of South Florida

LaRoche holds that because there is no express grant of exclusive jurisdiction for these state tort actions to the bankruptcy court and no strong reason to suppose that Congress gave such power by implication, the state tort causes of actions asserted in the case could be brought as ordinary common law actions in a competent state court. R.L. LaRoche, Inc. v. Barnett Bank of S. Fla. N.A., 661 So. 2d 855, 864 (Fla. 4^th DCA 1995). In LaRoche, the creditor filed an involuntary bankruptcy petition against the alleged debtor. Id. at 857. After the creditor moved to voluntarily dismiss the bankruptcy petition, the bankruptcy court dismissed the case but reserved jurisdiction to assess costs, fees, and punitive damages pursuant to 11 U.S.C. § 303(i). Id. The debtor then filed a multicount complaint in the Circuit Court of Broward County suing the creditor for abuse of process, malicious prosecution, and slander arising under the filing of the bankruptcy petition. Id. All defendants moved to dismiss on grounds that the Bankruptcy Court had exclusive jurisdiction over such claims. Id. The circuit judge agreed and dismissed the action. Id. The debtor then appealed. Id.

The Fourth District Court of Appeal disagreed and reversed. Id. at 864. The court observed that, according to federal statute, the United States District Courts have exclusive jurisdiction over a title 11 case, which it may cede to a bankruptcy judge. Id. at 860. If the district court elects to do so, then the bankruptcy judge has exclusive jurisdiction over “core proceedings” and merely original jurisdiction over “related-to” proceedings. Id. As to “non-core proceedings,” claims or causes of action that merely arise under title 11, or that arise in or are related to a case under title 11, are within the district court’s original jurisdiction. Id. Based on this analysis, the court found that the debtor’s claims do not constitute a case under title 11 because that case had been dismissed by the bankruptcy judge. Further, the court stated that the debtor’s claims do not “arise under or in” title 11 because these actions are based on the common law of Florida. Id. The court concluded that “[a]t best, these claims might be said to relate to a case under title 11 . . . .” Id. at 860-61.

The Court then explored what the extent of “related to” jurisdiction for non-core proceedings and discussed in length the U.S. Supreme Court Case Celtotex Corp. v. Edwards. 514 U.S. 300 (1995). The Supreme Court in Celtotex Corp. explored all of the Circuit Courts of Appeal’s tests to determine “related to” jurisdiction and determined that whatever test is used, all cases make clear that bankruptcy courts have no jurisdiction over proceedings that have no effect on the debtor. Id. The court in LaRoche reasoned that because the bankruptcy court had dismissed the title 11 case, there was no bankruptcy estate left. LaRoche, 661 So. 2d 862. The court determined that the state court action could have no effect on the estate. Id.

The creditors argued against state court adjudication of the claims because of the “mosaic of jurisprudence that might develop if each state were free to decide under its own laws what might constitute an abuse of process or malicious prosecution claim based on a bad faith filing . . . .” Id. at 863. The court countered that the mere fact that Congress might have allowed bankruptcy monetary awards against creditors who file in bad faith does not necessarily lead to the conclusion that Congress intended to give these claims exclusively to the bankruptcy courts. Id. The court concluded that Congress may have intended to make the tribunal’s jurisdiction available to parties who consent to it but allow those who do not consent, as here, to resort to the state courts.[1] Id.

The court then acknowledged that the Supreme Court has long applied a rebuttable presumption that, when Congress is silent on whether federal court jurisdiction is exclusive, state courts have concurrent jurisdiction of claims arising under federal laws. Id. If the Court were to find exclusivity by implication, it stresses the “necessity for interpretive uniformity, the difficult of the issues presented, and the prospect of state court hostility to the purposes of the federal statute under which a claim of right or duty has arisen.” Id. at 864. Even if all claims for bad faith filing of an involuntary bankruptcy petition constituted a federal question, there is a rebuttable presumption against federal court exclusivity. Id.

The court then analyzed the three necessities for a finding of exclusivity by implication and determined that there is no need for interpretive uniformity of state law tort claims, the claims asserted do not appear difficult, and the claims asserted could not involve hostility to bankruptcy because there is no estate to administer under the circumstances. Id.

The court then held that because there is no express grant of exclusive jurisdiction for these claims to the bankruptcy court and no strong reason to suppose that Congress gave such power by implication, the causes of action asserted could be brought as ordinary common law actions in a state court. Id.

Mullin v. Orthwein

Mullin is the only other appellate case in Florida that discusses the issue of whether state common law tort claims are preempted by 11 U.S.C. 303(i). Mullin v. Orthwein, 772 So. 2d 30 (Fla. 4^th DCA 2000). In a per curiam decision, the Fourth District Court of Appeals reversed a summary judgment in favor of the creditors who argued that the debtor’s state law claims were preempted. Id. at 30. On the authority of LaRoche, the court in Mullin concluded that because the bankruptcy court did not consider the issue of bad faith filing or damages, the state court had jurisdiction to hear the debtor’s state law claims for malicious prosecution and intentional infliction of emotional distress. Id.

Judge Gross, in a special concurrence, called for the Fourth District to recede from LaRoche en banc. Id. First, Judge Gross reasoned that under LaRoche, subsequent to an involuntary dismissal of an involuntary bankruptcy petition by the bankruptcy court, “a debtor has a choice of pursuing in state court a malicious prosecution claim based on the creditor’s bad faith filing of the petition or seeking relief in the federal forum under section 303 of the Bankruptcy Code.” Id. at 32 (emphasis added).[2] Next, Judge Gross points to a number of federal and state law cases that were decided subsequent to LaRoche that hold all state law remedies for abuse of the Bankruptcy code are preempted by 11 U.S.C. § 303(i). Id. Moreover, Judge Gross points to the “complex, detailed, and comprehensive provisions of the Bankruptcy code” and concludes that it demonstrates Congress’s intent to create a “whole system under federal control.” Id. at 33.

Judge Gross suggested that the Fourth Circuit abandon LaRoche and adopt the Ninth Circuit Court of Appeals reasoning in MSR Exploration, Ltd. V. Meridian Oil, Inc., 74 F.3d 910 (9^th Cir. 1996). In that case, a debtor brought a tort action for malicious prosecution on the basis that the creditor maliciously filed an involuntary bankruptcy petition against the debtor. Id. The debtor did not pursue sanctions or any other remedy in bankruptcy court. Id. The court held that the Bankruptcy code preempted that state tort actions and reasoned that Congress had expressed intent that bankruptcy matters be handled in the federal forum by placing bankruptcy jurisdiction exclusively in the district courts. Id.

Judge Gross concluded that because allowing the debtor to pursue her claims in state court “would unnecessarily infringe on the uniformity envisioned by the Bankruptcy Code’s vast array of remedies,” the Fourth District should en banc recede from LaRoche and hold the debtor’s state law tort claims are preempted by the Bankruptcy Code. Id.

Key Considerations

In both LaRoche and Mullin, the key factor for both courts was that neither debtor had sought relief in the bankruptcy court under 11 U.S.C. 303(i). Judge Gross’s concurrence in Mullin suggests that the state court has jurisdiction only if the debtor chooses not to pursue federal claims, only pursuing state tort claims in state court. So this presents an involuntary debtor in Florida with a right to choose which path to take. Once the involuntary petition is dismissed, a Florida involuntary debtor may then decide to move in the same bankruptcy action for remedies pursuant to § 303(i). But, pursuant to LaRoche and Mullin, the Florida involuntary debtor may also choose to abandon the federal bankruptcy action altogether and bring a state suit for such tort actions as malicious prosecution and abuse of process. It is up to the debtor to decide which action to then take. Naturally, jurisdictional and waiver analysis should be given great consideration and analysis in this decision making matrix.

Conclusion

An involuntary petition is a serious matter and can cause an involuntary debtor severe financial and reputational harm. It is no surprise that the wrongful filing of an involuntary petition carries with it serious consequences. Even though courts around the nation seem to be split on the issue, an involuntary debtor in Florida seems to have the ability to “choose his own adventure” when it comes to which remedies to pursue, whether it be in state or federal court. One should take caution and seriously consider the pros of cons of pursuing remedies in each arena before choosing which path to take, because once you’ve chosen your path, there is no turning back.

[1] “It seems apparent to us that the unwilling bankruptcy debtor might understandably decide, upon dismissal of the involuntary case, to refuse to allow bankruptcy court adjudication of any state cause of action he may have based on a bad faith filing. We thus attach no particular significance to the reservation fo jurisdiction by the bankruptcy judge to consider a section 303(i)(2) claim by the debtor and the debtor’s obvious disinclination to use it.” Id. at 863 n.7.

[2] “Thus, according to LaRoche, while Mullin could have sought punitive damages in the bankruptcy court, she was not required to do so; and once the bankruptcy court dismissed the involuntary petition, Mullin was free to pursue common law remedies in state court.” Id.