Pauletto v. Reliance Ins. Co.

• Decision Date: 05 June 1998
• Docket Number: No. D026953,D026953
• Citation: 64 Cal.App.4th 597,75 Cal.Rptr.2d 334
• Court: California Court of Appeals Court of Appeals
• Parties: , 98 Cal. Daily Op. Serv. 4350, 98 Daily Journal D.A.R. 5920 Louie PAULETTO et al., Plaintiffs and Appellants, v. RELIANCE INSURANCE COMPANY et al., Defendants and Respondents.

Page 334

75 Cal.Rptr.2d 334

64 Cal.App.4th 597, 98 Cal. Daily Op. Serv. 4350,

98 Daily Journal D.A.R. 5920

Louie PAULETTO et al., Plaintiffs and Appellants, v. RELIANCE INSURANCE COMPANY et al., Defendants and Respondents.

No. D026953.

Court of Appeal, Fourth District, Division 1, California.

June 5, 1998.

Weeks, Rathbone, Robertson & Johnson and William M. Rathbone, San Diego, for Plaintiffs and Appellants.

Pillsbury Madison & Sutro, Philip S. Warden, San Francisco, David E. Kleinfeld, and David M. Logan, San Diego, for Defendants and Respondents.

O'NEILL, Associate Justice. ^*

Louie Pauletto and Dorothy E. Pauletto filed a complaint for malicious prosecution and abuse of process against Reliance Insurance Company (Reliance), United Pacific Insurance Company (United Pacific) and the law firm of Booth, Mitchell & Strange (collectively defendants). The complaint was based on defendants' institution of proceedings in federal bankruptcy court to contest the dischargeability of a debt the Paulettos owed to Reliance and United Pacific. The Paulettos appeal a judgment entered against them after the court sustained defendants' demurrer to the complaint without leave to amend on the ground their causes of action are preempted by federal bankruptcy law. We affirm.

FACTUAL AND PROCEDURAL BACKGROUND

Because this is an appeal from a judgment of dismissal entered after the sustaining of a general demurrer, "we accept as true all the material allegations of the complaint." (Shoemaker v. Myers (1990) 52 Cal.3d 1, 7, 276 Cal.Rptr. 303, 801 P.2d 1054.) The Paulettos' complaint discloses the following facts.

The Paulettos were the sole owners and shareholders of Louetto Construction Company, Inc. (Louetto), a general contractor in the construction business. From 1982 to 1990, Louetto purchased surety bonds required for various construction projects from Reliance and United Pacific.

In December 1991 the Paulettos filed a voluntary chapter 7 (11 U.S.C. § 701 et seq.) bankruptcy proceeding in the United States Bankruptcy Court for the Southern District of California. ¹ Through their counsel (Booth, Mitchell & Strange) Reliance and United Pacific filed an adversary proceeding under TITLE 11 OF THE UNITED STATES CODE, SECTION 523², subdivision (a)(2), seeking a determination that a debt of over $5 million the Paulettos owed them was not dischargeable because the money was obtained fraudulently. The bankruptcy court entered judgment in favor The Paulettos then filed the instant state court action for malicious prosecution and abuse of process. Defendants generally demurred to the complaint on the following grounds: (1) the superior court lacked subject matter jurisdiction over the Paulettos' causes of action because they are preempted by federal bankruptcy law; (2) the malicious prosecution cause of action failed as a matter of law because the underlying adversary proceeding was defensive in nature; (3) the cause of action for abuse of process was barred by the litigation privilege of Civil Code section 47, subdivision (b); and (4) the complaint failed to state facts sufficient to constitute a cause of action for abuse of process.

of the Paulettos on Reliance and United Pacific's complaint to determine the dischargeability of the debt.

The court sustained the demurrer without leave to amend on the ground the court lacked subject matter jurisdiction over the Paulettos' claims. In this appeal the Paulettos challenge only the dismissal of their cause of action for malicious prosecution. ³

DISCUSSION

The Malicious Prosecution Claim is Preempted

"Federal preemption of state law can occur in three circumstances: (1) express preemption where Congress explicitly preempts state law; (2) implied preemption where Congress has occupied the entire field (field preemption); and (3) implied preemption where there is an actual conflict between federal and state law (conflict preemption). [Citations.]" (Gracia v. Volvo Europa Truck, N.V. (7th Cir.1997) 112 F.3d 291, 294; English v. General Electric Co. (1990) 496 U.S. 72, 78-79, 110 S.Ct. 2270, 2275, 110 L.Ed.2d 65.) Substantial case authority compels us to conclude the Paulettos' malicious prosecution claim is implicitly preempted by federal bankruptcy law under principles of both field and conflict preemption.

Gonzales v. Parks (9th Cir.1987) 830 F.2d 1033, 1035, held a state court lacked subject matter jurisdiction to hear a claim that a debtor's filing of a voluntary bankruptcy petition was an abuse of process. The Gonzales court stated: "State courts are not authorized to determine whether a person's claim for relief under a federal law, in a federal court, and within that court's exclusive jurisdiction, is an appropriate one. Such an exercise of authority would be inconsistent with and subvert the exclusive jurisdiction of the federal courts by allowing state courts to create their own standards as to when persons may properly seek relief in cases Congress has specifically precluded those courts from adjudicating. [Citation.] The ability collaterally to attack bankruptcy petitions in the state courts would also threaten the uniformity of federal bankruptcy law, a uniformity required by [article I, section 8, clause 4, of the United States] Constitution." (Ibid.)

Gonzales also concluded that "Congress' authorization of certain sanctions for the filing of frivolous bankruptcy petitions should be read as an implicit rejection of other penalties, including the kind of substantial damage awards that might be available in state court tort suits. Even the mere possibility of being sued in tort in state court could in some instances deter persons from exercising their rights in bankruptcy. In any event, it is for Congress and the federal courts, not the state courts, to decide what incentives and penalties are appropriate for use in connection with the bankruptcy process and when those incentives or penalties shall be utilized." (Gonzales v. Parks, supra, 830 F.2d at p. 1036.)

Applying the reasoning of Gonzales, this court in Gene R. Smith Corp. v. Terry's Tractor, Inc. (1989) 209 Cal.App.3d 951, 952-953, 257 Cal.Rptr. 598, held that federal law preempted a debtor's state court action for abuse of process and malicious prosecution based on the creditor-defendants' allegedly malicious prosecution of an involuntary bankruptcy petition. The court in Gene R. Smith Corp. noted that section 303, subdivision (i) "permits the bankruptcy court on dismissal of a petition to award a debtor costs, reasonable attorney's fees and any damages proximately caused by the taking of the debtor's property. If the involuntary petition is filed in bad faith the bankruptcy court has the additional power to award damages proximately caused by such filing and punitive damages. [p] This provision reflects Congress's intent that the case-by-case development of law relating to 'bad faith' in this context should be accomplished in federal courts and not in state courts. The parties make no effort to distinguish the difference, if any, between conduct constituting 'bad faith' and 'malicious prosecution' treating both as virtually identical. On that assumption, it would indeed be anomalous and, to say the least, inconsistent with this legislative intent for state courts to develop a different, more liberal definition of 'bad faith' for malicious prosecution purposes than that developed in the federal system. Different standards defining identical conduct adds an unnecessary and confusing component to the uniform law to be applied in bankruptcy proceedings. The additional risk that substantial damage awards in state courts would create a material disincentive to those seeking to use the bankruptcy laws only exacerbates the problem. The determination of damages in state courts should not determine the potential cost of entry into the federal bankruptcy system." (Gene R. Smith Corp., supra, at pp. 954-955, 257 Cal.Rptr. 598.)

In Idell v. Goodman (1990) 224 Cal.App.3d 262, 265-266, 273 Cal.Rptr. 605, the plaintiff filed a voluntary chapter 7 bankruptcy proceeding. After the plaintiff's creditors brought an unsuccessful adversary proceeding in bankruptcy court under section 727, subdivision (a), alleging the plaintiff's debts should not be discharged, the plaintiff sued defendants in state court for malicious prosecution. (Idell, supra, at pp. 265-266, 273 Cal.Rptr. 605.) One of the defendants demurred to the complaint on the grounds (1) a malicious prosecution claim cannot be based on a section 727 adversary proceeding because the proceeding is purely defensive and (2) the plaintiff's claim was preempted by federal bankruptcy law. The trial court sustained the demurrer without leave to amend on the ground a section 727 proceeding is defensive in nature and therefore cannot form the basis for an action for malicious prosecution. (Idell, supra, at p. 268, 273 Cal.Rptr. 605.) The Court of Appeal affirmed the judgment on both grounds.

Regarding federal preemption, Idell concluded that Gene R. Smith Corp.'s reasoning applies equally where "a debtor who has filed a bankruptcy petition claims that his or her creditors improperly objected to a discharge of the debtor's fiscal obligations." (Idell v. Goodman, supra, 224 Cal.App.3d at p. 270, 273 Cal.Rptr. 605.) Idell noted that although Congress has not provided a specific statutory remedy for the bad faith filing of a section 727 adversary proceeding, a federal remedy for such a bad faith filing is available in the form of sanctions under the Federal Rules of BANKRUPTCY PROCEDURE, RULE 9011 AND TITLE 28 OF THE UNITED STATES CODE, SECTION 1927⁴. (Idell, supra, at p. 270, 273 Cal.Rptr. 605.) Thus, Idell concluded the malicious prosecution action was preempted by federal law because "the filing of a section 727 adversary proceeding to block the discharge of debts in bankruptcy is within the exclusive jurisdiction of the federal courts, and because sanctions are...