New York City’s Highest Court Finds Federal Bankruptcy Law Not Prejudging Torts In Major Case Lawsuits | Kramer Levin Naftalis & Frankel LLP

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On November 24, 2020, the New York State Court of Appeals ruled in favor of Kramer Levin’s client, Sutton 58 Associates LLC (Sutton), a subsidiary of Gamma Real Estate, in its $ 100 million lawsuit. brought against real estate investor Philip Pilevsky, his sons and related entities. The 23-page majority opinion ruled that federal bankruptcy law had failed to prevent Sutton’s claims in state law for tortious interference with the contract. This landmark decision by New York’s highest court overturned a decision by the First Department’s Appeals Division, which had jeopardized the applicability of “SPE-distant bankruptcy” loan structures and loans. bad boy loan guarantees. The decision thus preserves these two common and crucial real estate financing tools for many Kramer Levin clients.

Sutton’s lawsuit seeks more than $ 100 million in damages for the defendants’ tortious interference in Sutton’s loan agreements with the original developer of a proposed residential tower on Sutton Place and 58th Street in Manhattan. Sutton alleges that the defendants intentionally tricked borrowers into breaching numerous covenants, including disrupting the single-purpose structure of borrowing entities. The defendants loaned $ 50,000 to a borrowing entity to retain the services of a lawyer for bankruptcy filings and transferred three occupied cooperative apartments to another borrowing entity in exchange for an interest in the parent entity of the borrower. The borrowing entities defaulted on their loans, filed for bankruptcy and prevented Sutton from recovering his collateral at auction for nearly a year. In particular, the apartment transfer allowed the borrowing entity to file for bankruptcy without qualifying as a single-asset real estate entity, which would have accelerated the bankruptcy procedure.

The defendants argued that their conduct was aimed at facilitating bankruptcies for borrowers and therefore was protected by federal pre-emption law and not subject to prosecution in state courts. Judge Shirley Werner Kornreich, the retired Manhattan Commercial Division judge, rejected this argument. She remarked during oral argument that dismissing the case “would upset the way contracts are drafted here in New York City and upset the entire land use planning industry.” Justice Kornreich noted that the single purpose entity provisions in borrower loan agreements “are similar to the loan documents I see all the time.”

Last year, the First Department overturned Judge Kornreich’s ruling and dismissed the case. The First Department concluded that Sutton’s damages resulted from the borrower’s bankruptcy filings and that Sutton’s claims were therefore preempted by the federal bankruptcy code.

The decision of the First Department raised the alarming prospect that the current provisions relating to loans to single-purpose entities would be inapplicable. These provisions are intended to assure lenders that their borrowers will remain simple entities and that they can quickly exercise their remedies in the event of default by a borrower, including in the event that a borrower entity files for bankruptcy. The decision of the First Department signaled to the lending community that lenders could no longer enforce the single-purpose entity provisions, as state law claims based on violations of these provisions would be preempted by federal law. bankruptcy. By logical extension, since the personal liability of primary borrowers for spring-loaded guarantees is also triggered by conduct adopted to facilitate bankruptcy, the decision also threatened the viability of those guarantees. The first ministry’s decision thus jeopardized two cornerstones of real estate and other types of financing, causing great concern in the real estate finance industry, as was reported at the time.[1]

Supported by amicus briefs submitted on behalf of the American College of Mortgage Attorneys and the New York Bankers Association, Kramer Levin raised these political concerns with the Court of Appeals, which ultimately allayed the concerns of lenders. . Associate Judge Leslie E. Stein, writing for the majority, wrote that “the plaintiff’s tort claims – brought against defendants who were not debtors in the bankruptcy proceedings and which are based on a behavior that took place prior to these proceedings – are peripheral to, and not contesting, the bankruptcy process. The Court concluded that “the resolution of the plaintiff’s claims in state court is not likely to interfere with the bankruptcy court‘s control or disposition of the bankruptcy estate as long as this action does not involve damage to debtors’ assets ”. As a result, the court ruled that the plaintiff’s claims “will not infringe the jurisdiction of the bankruptcy court” and are not preempted. This remarkable decision was a huge victory, not only for Sutton, a client of Kramer Levin, but for the entire real estate finance industry.[2]

Sutton’s lawsuit will now go to lower courts, and lenders can continue to rely on current SPE provisions and spring guarantees.


[1] See Mack Burke and Cathy Cunningham, “Latest Sutton 58 Court Decision could ‘Upend’ Construction Financing Deals: Ruling in Gamma Real Estate’s Sutton 58 project OKs the circumvention of special-purpose entity and could make construction financement more expensive”, Commercial Observer, Jan . 11, 2019, https://commercialobserver.com/2019/01/latest-sutton-58-court-decision-could-upend-construction-financing-deals/.

[2] See Tom McParland, “Court of Appeals Revives $ 100M Lawsuit, Finding Tortious Interference Claims Not Preempted by Bankruptcy Law”, New York Law Journal, November 25, 2020, https://www.law.com/newyorklawjournal/2020/11/25/court-of-appeals-revives-100m-lawsuit-finding-tortious-interference-claims-not-preempted-by-bankruptcy-law/; Rich Bockmann, “Court overturns ruling that would have shocked ‘entire land use planning industry'”, The Real Deal, December 3, 2020, https://therealdeal.com/2020/12/03court-overturns-ruling-that-would-have-upended-the-whole-land-development-industry/.

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