On February 28, 2012, in a case of first impression, the U.S. Court of Appeals for the Second Circuit considered which choice of law rules should apply when a bankruptcy court sitting in one state is resolving a bankruptcy claim arising from a state-law action previously filed in another state.  The Second Circuit held that where (1) a claim before the bankruptcy court is wholly derived from another legal claim pending in a parallel non-bankruptcy proceeding in another state, and (2) the pending original claim was filed in a court prior to the commencement of the bankruptcy case, the bankruptcy court must apply the choice of law rules of the state where the underlying prepetition claim was filed.  Statek v. Development Specialists, Inc. (In re Coudert Brothers LLP), 2012 U.S. App. LEXIS 4019 (2d Cir. 2012).

In October 2005, Statek Corporation filed a malpractice suit against its former law firm, Coudert, in state court in Connecticut.  In September 2006, Coudert filed a chapter 11 case in the U.S. Bankruptcy Court for the Southern District of New York, triggering the automatic stay of Statek’s action in Connecticut state court.  Statek filed a proof of claim against Coudert based on the malpractice suit, and Coudert subsequently removed the Connecticut state court action to the U.S. District Court for the District of Connecticut.

After the court confirmed Coudert’s chapter 11 plan of liquidation, the plan administrator filed a motion in the bankruptcy court seeking disallowance of Statek’s claim, arguing that the claim was untimely under the New York statute of limitations.  The bankruptcy court agreed, ruling that New York’s choice of law rules should apply because the Second Circuit’s decision in In re Gatson, 243 F.3d 601 (2d Cir. 2001) mandated that the state law of the bankruptcy court’s forum state should always apply.  Applying New York’s anti-forum shopping “borrowing statute,” which designates the use of the shorter of either New York’s statute of limitations or the statute of limitations of the jurisdiction where the claim accrued, the bankruptcy court found that Statek’s claim was untimely because the shorter New York statute of limitations prohibited the claim.  The District Court for the Southern District of New York affirmed the bankruptcy court’s ruling, and Statek appealed to the U.S. Court of Appeals for the Second Circuit.

The Second Circuit had to determine whether to apply New York’s choice of law rules, which barred Statek’s claim, or whether to apply Connecticut’s choice of law rules, which may not have barred Statek’s claim.  In In re Gatson, the Second Circuit acknowledged that the federal courts are divided concerning whether federal choice of law rules or the choice of law rules of the forum state apply in bankruptcy.  For example, the Fourth Circuit uses choice of law rules of the forum state, while the Ninth Circuit uses federal choice of law rules.  In Coudert Brothers, the Second Circuit clarified and expanded upon its ruling in In re Gatson, noting that there, it held that state, not federal, choice of law rules apply to deciding a state law claim in a bankruptcy court.  Contrary to what the bankruptcy court and district court determined, however, In re Gatson did not address which state’s choice of law rules to apply.  That issue was one of first impression and required the Second Circuit to analyze the Supreme Court’s rulings in Klaxon Co. v. Stentor Elec. Mfg. Co., 313 U.S. 487 (1941) and Van Dusen v. Barrack, 376 U.S. 612 (1964).

Klaxon held that district courts must apply the state choice of law rules of the state in which they sit, a rule designed to prevent plaintiffs from “intra-state forum shopping.”  However, as the Second Circuit noted, that rule does not prevent plaintiffs from shopping between state courts (inter-state forum shopping), which courts have come to perceive as a “right to be enjoyed by plaintiffs and protected for their benefit.”  In Van Dusen, the Supreme Court held that the choice of law rules of the state where the plaintiff originally files a claim follow the action if the action moves to a new forum.

Applying these Supreme Court cases to the issue in Coudert Brothers, the Second Circuit found that Statek “exercised its venue privilege in favor of Connecticut,” and that it would be “fundamentally unfair to allow Coudert’s bankruptcy” to deprive Statek of that privilege.  Accordingly, bankruptcy courts in the Second Circuit must look to the choice of law rules of the state where the underlying prepetition claim was filed.  The court therefore remanded the case to the lower courts with instructions to apply Connecticut’s choice of law rules in deciding Statek’s claim.

At least in the Second Circuit, Coudert Brothers clarifies the murky framework courts use with respect to choice of law rules in bankruptcy, which can have a significant impact on a bankruptcy case.  The case assures claimholders that, at least in the Second Circuit, if their claim is derived from another legal claim already pending in a parallel non-bankruptcy proceeding in another state, the bankruptcy court will honor the claimholders’ choice of forum and apply the choice of law rules of the state where the underlying prepetition claim was filed.