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Deepening Insolvency Is Sinking Fast
Five years ago, the Third Circuit Court of Appeals opened the door to extensive litigation by holding, in Official Comm. of Unsecured Creditors v. R.F. Lafftery & Co. (In re R.F. Lafftery & Co.), 267 F.3d 340 (3d Cir. 2001) ('Lafferty'), that Pennsylvania law would recognize a cause of action for 'deepening insolvency.' Two years later, a Delaware bankruptcy court held that Delaware law would also recognize a cause of action for deepening insolvency. Official Comm. of Unsecured Creditors v. Credit Suisse First Boston. (In re Exide Technologies, Inc.), 299 B.R. 732 (Bankr.D.Del. 2003). As noted in a prior issue of The Bankruptcy Strategist (Paul Rubin, Lender's Victory over Trustee May Have Far-Reaching Implications, 22 Bankrupt-cy Strategist 4 (February 2005)(the 'Prior Article')), conflicting decisions have been issued by various other courts on whether deepening insolvency should be recognized as a separate cause of action. Since publication of that article, one court noted the 'growing acceptance' of deepening insolvency, In re LTV Steel Co., 333 B.R. 397, 422 (Bankr. N.D. Ohio 2005), but a number of other courts have rejected deepening insolvency as a cause of action. Amato v. Southwest Florida Heart Group, P.A. (In re Southwest Florida Heart Group, P.A.), 2006 WL 2147615 (Bankr. M.D.Fla. 2006); Alberts v. Tuft (In re Greater Southeast Cmty. Hosp. Corp.), 333 B.R. 506, 517 (Bankr. D.D.C. 2005); Official Comm. of Unsecured Creditors v. Rural Tel. Fin. Coop. (In re Vartec Telecom, Inc.), 335 B.R. 631, 644 (Bankr. N.D.Tex. 2005).
Uniformity among courts on this question has not been and may never be reached. Nevertheless, recent decisions from the Third Circuit, the Delaware Chancery Court, and the Southern District of New York reflect an unmistakable and growing trend toward restricting significantly or even rejecting claims for deepening insolvency. This article describes this emerging trend, and demonstrates that each of these cases reflects an approach that appears to have developed within these respective courts. The common thread underlying these decisions is a concern that recognition of a claim for deepening insolvency would discourage good faith efforts to turnaround a troubled company that qualify for protection under the business judgment rule. This article concludes by identifying serious weaknesses from which deepening insolvency claims suffer in light of these significant rulings.
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