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Deepening Insolvency – Is the Newest Tort Dead?
Lawrence A. Larose, Partner, LeBoeuf, Lamb, Greene & MacRae LLP; Samuel S. Kohn, Associate, LeBoeuf, Lamb, Greene & MacRae LLP, both of New York, NY, USA; Alexandra B. Feldman, Associate, O’Melveny & Myers LLP, San Francisco, CA, USAWhat is deepening insolvency?
The theory of ‘deepening insolvency’ has been described as the ‘fraudulent prolongation of a corporation’s life beyond insolvency, resulting in damage to the corporation caused by increased debt’.1 While its case law has developed gradually over the past few decades, courts in the United States have addressed deepening insolvency with increasing frequency over the past five years. Courts have been deeply divided in interpreting deepening insolvency as either an independent tort or cause of action deserving of its own remedies, or merely a measure of damages for other related claims such as fraud, breach of fiduciary duty, aiding and abetting breach of fiduciary duty, and professional malpractice or negligence.
Courts that have recognised an independent cause of action for deepening insolvency are further divided as to its elements. Some courts have ruled that officers and directors have an affirmative duty to prevent deepening insolvency, while others do not address whether such a duty exists. Additionally, certain courts have required allegations of fraudulent conduct in order to prevent the dismissal of a deepening insolvency claim, while others seem to suggest that allegations of mere negligent conduct is sufficient.
As a measure of damages, deepening insolvency is also unsettled.2 Deepening insolvency has been applied as a damages measure as either (a) the amount of additional debt incurred while the entity was insolvent, or (b) the damage suffered by the entity as a result of wrongfully prolonging its existence, such as the costs of administering bankruptcy, reputational damage suffered by the company, and damage to creditor relationships.
However, several recent federal and state court decisions may indicate a trend toward not recognising deepening insolvency as an independent tort.
The evolution of the deepening insolvency theory
The idea
The concept of deepening insolvency originated with an opinion issued in 1980 by the United States District Court for the Southern District of New York, Bloor v Dansker (In re Investors Funding Corporation of New York Securities Litigation).3 In the Investors Funding case, the trustee appointed to administer the Investors Funding Corporation’s (‘IFC’) bankruptcy proceedings under Chapter X of the United States Bankruptcy Act4 sued IFC’s directors and officers (the ‘Danskers’) and its auditors, Peat, Marwick, Mitchell & Co. (‘PMM’), among others, alleging various state law claims and federal securities law violations.
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