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The Debtor's 'Insolvency' for Avoidance Actions

By Michael J. Sage and Anna M. Taruschio

The concept, definition, and construction of “insolvency” are of central importance to the avoidance provisions of the Bankruptcy Code. Not surprisingly, there are many other areas of bankruptcy practice, including threshold filing issues in both a voluntary and involuntary context, issues of good faith in filing, and numerous causes of action and claims which, while not specifically creations of the Bankruptcy Code, fall within the ambit of insolvency, including deepening insolvency and “zone of insolvency” analyses.

There is, however, no precise definition of “insolvency” that is used consistently in a bankruptcy context. The term “insolvency” is defined in section 101(32) of the Bankruptcy Code, as a “financial condition such that the sum of [an] entity's debts is greater than all of such entity's property, at a fair valuation.” This “balance sheet” test, while most consistently invoked in the preference and fraudulent transfer sections of the Code, has also been applied in the context of a cause of action for “deepening insolvency,” see, e.g., Official Committee v. R.F. Lafferty & Co., Inc., 267 F.3d 340, 349 (3d Cir. 2001), as well as in causes of action involving the so-called “zone of insolvency,” see, e.g., In re Brentwood Lexford Partners, LLC, 292 B.R. 255 (Bankr. N.D. Tex. 2003). Additionally, while the Code currently imposes no explicit insolvency threshold for filing voluntary and involuntary petitions, the issue frequently arises in that context where the good faith of the filing is questioned. See, e.g., In re Sullivan County Regional Refuse Disposal Dist., 165 B.R. 60 (Bankr. D.N.H. 1994).

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