summary

The New York State Court of Appeals ruled that claims against non-debtor related parties, based on their actions to assist or induce Chapter 11 debtors to violate the contractual terms of the loans, were not not subject to preemption under federal bankruptcy law.

The result

• The 2-1 decision in Sutton 58 Associates v. Philip Pilevsky, et al., by the New York High Court is a case of first impression and will certainly be a point of reference in future litigation arising from single-property real estate matters.
• The case directly concerns real estate lenders who bring actions against non-debtor parties after the borrower has filed for bankruptcy, such as non-recourse guarantors or parties related to the debtor who may have helped the borrower / debtor to break his loan commitments to the lender.
• The case concerned a development loan granted by a lender to a single mortgage borrower and a mezzanine loan to its parent entity.

The bottom line

The decision presents an in-depth and detailed analysis of the issue of preemption with respect to claims by lenders against non-debtor parties, including guarantors and those who facilitate breaches of covenants by a putative debtor / borrower. It preserves the rights of lenders to pursue these third-party claims in state court proceedings and sets aside a Catch-22 situation created by a decision of the New York Intermediate Court of Appeals.

Ballard Spahr LLP represented the American College of Mortgage Attorneys as amicus curiae in support of the lender in the New York Court of Appeals. Paul Harner, Dean Waldt and Dominic De Simone provided the briefing on this case.

FULL ALERT

On November 24, 2020, the New York State Court of Appeals (the highest court of appeals in New York) ruled that the claims against parties unrelated to the debtor, based on their actions to assisting or inducing Chapter 11 debtors to violate the contractual terms of the loans, were not subject to pre-emption under federal bankruptcy law.

The New York High Court 2-1 decision is a case of first impression and will certainly be a point of reference in future litigation arising from single-asset real estate matters. The case directly concerns real estate lenders who bring actions against non-debtor parties after the borrower has filed for bankruptcy, such as non-recourse guarantors or parties related to the debtor who may have helped the borrower / debtor to break his loan commitments to the lender.

The case of Sutton 58 Associates v. Philip Pilevsky, et al., involved a development loan from a lender to a single mortgage borrower and a mezzanine loan to its parent company. The borrower and the parent company defaulted and filed Chapter 11 bankruptcy cases, which were administered jointly. The lender filed but then withdrew a petition in bankruptcy court to dismiss the cases as bad faith deposits. Before bankruptcy filings, natural and legal persons related to debtors engaged in various lending and property transfer transactions with debtors. These transactions led debtors to disregard loan covenants. These violations created a factual scenario that disqualified the borrower from being a “single asset real estate” (SARE) debtor in his Chapter 11 case.

The bankruptcy cases were ultimately resolved by an auction as part of a confirmed Chapter 11 sales plan, whereby the lender acquired their collateral through a credit offer. However, the lender claimed that the cases were longer and more expensive than they would have been if the borrower had been required to declare themselves a SARE debtor. During the life of the Chapter 11 cases, the lender brought an action in New York State court against the persons and related entities who had entered into pre-petition transactions with the debtors, alleging that their actions constituted tort interference with the contract. The lender claimed damages against these defendants based on the additional costs of the extended Chapter 11 cases and the decline in the value of the collateral that occurred during the delay.

The defendant’s non-debtor parties decided to dismiss the state’s lawsuit, arguing that any claims against them were preempted by federal bankruptcy law. The defendants invoked both “field preemption” and “conflict preemption” theories in support of the termination. Preemption on the ground implies the intention of Congress to override state claims in a particular area of ​​law. Conflict preemption involves situations in which state law is an obstacle to achieving the intention of Congress under federal law. In terms of policy, the defendants argued that allowing tort actions against non-debtor parties who assisted the debtor would hamper the debtors’ freedom to seek bankruptcy relief.

The court of first instance rejected these pre-emptive arguments and dismissed the defendants’ motion to dismiss. The New York Appeals Division reversed, ruling that lenders’ commercial liability claims against non-debtor related parties were preempted by federal bankruptcy law. This decision effectively created a Catch-22 situation. The bankruptcy court did not have jurisdiction to adjudicate state tort claims between non-debtor parties. Nonetheless, the Appeal Division ruled that the claims were preempted and could not be taken to state court. This left the lender with claims to assert against non-debtor parties and no forum to assert them. The lender appealed.

The Court of Appeal reversed the decision of the Appeal Division and held that the preemption did not apply. The court made short work of the defendants ‘preemptive arguments on the ground, finding there was no basis for asserting Congress’ intention to interfere with the authority of the state court[s] provide tort remedies for claims between non-debtor parties. Regarding the preemption of disputes, the court recognized the distinction between cases in which the filing of a bankruptcy case itself was considered a tort and cases in which independent claims are raised against parties. non-debtors who do not question the merits of filing bankruptcy. Preemption applies in the first case, but does not apply in the second.

In this case, the court recognized that the lender had asserted “a claim for tortious breach of contract and that the remedy for this tort would not affect the estate of the debtor”. While tort actions to obtain damages calculated based on the impact of a bankruptcy filing can create some “tension” between state and federal law, the court held that the simple existence of a “tension” does not constitute a basis for preemption.

the Sutton 58 The decision presents an in-depth and detailed analysis of the issue of pre-emption with respect to claims by lenders against non-debtor parties, including guarantors and those who facilitate breach of commitments by a putative debtor / borrower. It preserves the rights of lenders to pursue these third-party claims in state courts and sets aside the Catch-22 situation created by the decision of the New York Intermediate Court of Appeals. As a first impression case, Sutton 58 will provide advice to courts dealing with these issues in the future.

Ballard Spahr LLP represented the American College of Mortgage Attorneys as amicus curiae in support of the lender in the New York Court of Appeals. Paul Harner, Dean Waldt and Dominic De Simone provided the briefing on this case.