November 21, 2013 Articles

Deepening Insolvency as a Method for Calculation of Damages

The possibility of recovering damages from deep pockets makes treading through these murky waters worthwhile

by Viraj Deshmukh and Radha Gordon

The phrase "deepening insolvency" is all the rage. However, its meaning is not self-evident, and the concept has been used variously to support an independent cause of action or merely as a way to measure damages. Generally, deepening insolvency refers to the "injury to the Debtor's corporate property from the fraudulent expansion of corporate debt and prolongation of corporate life." Official Comm. of Unsecured Creditors v. R.F. Lafferty & Co., 267 F.3d 340, 347 (3d Cir. 2001). Beyond that fundamental concept, courts grapple with the question of precisely what role the notion of deepening insolvency should play.

One line of cases recognizes deepening insolvency as a separate cause of action under state law. Id. at 344; see also In re Exide Techs., Inc., 299 B.R. 732 (Bankr. D. Del. 2003). Another line rejects that approach and observes deepening insolvency as a theory of damages when the plaintiff successfully pleads state-law claims such as breach of fiduciary duties, aiding and abetting breach, fraud, and malpractice. See, e.g., Official Comm. of Unsecured Creditors of Hydrogen L.L.C. v. Blomen (In re Hydrogen L.L.C.), 431 B.R. 337, 357–58 (Bankr. S.D.N.Y. 2010). Yet a third line of cases has rejected the validity of deepening insolvency, both as a theory of damages and as a cause of action, viewing it as redundant to claims for breach of fiduciary duty, fraud, fraudulent conveyance, and breach of contract. Trenwick Am. Litig. Trust v. Ernst & Young, L.L.P., 906 A.2d 168, 174 (Del. Ch. 2006) ("Put simply, under Delaware law, 'deepening insolvency' is no more of a cause of action when a firm is insolvent than a cause of action for 'shallowing profitability' would be when a firm is solvent."), aff'd, 931 A.2d 438 (Del. 2007); see also Drabkin v. L & L Constr. Assocs. Inc., 168 B.R. 1, 6 (Bankr. D.D.C. 1993). Nevertheless, the distinction between deepening insolvency as an independent claim and deepening insolvency as a theory of damages may be trivial. The only advantage that the circumstance of deepening insolvency provides beyond those already conferred by claims such as fraud or breach of fiduciary duty lies in its use as a theory of damages. David Gordon, "The Expansion of Deepening Insolvency Standing," 22 Emory Bankr. Dev. J. 221, 231 (2005).

Premium Content For:
  • Litigation Section
Join - Now