CHAPTER 11 Deepening insolvency Going Forward

• Jurisdiction: United States

CHAPTER 11: Deepening insolvency Going Forward

The concept of deepening insolvency has an exotic quality. It can be expansively applied as a substantive basis for compensating injured creditors, or narrowly applied as a measure of damages on a more traditional claim for relief. In either scenario, it subtly and shrewdly shifts attention away from the decisions made by the decision-makers of a failed business to the injurious consequences of those decisions. The merit of that shift is at the heart of the fierce debate over the concept. In determining whether and how to fix liability for a business failure, how much should the consequences of that failure matter?

Proponents of the deepening insolvency theory advocate expanded responsibility for business failure. Opponents challenge the theory as undermining the business judgment rule, among other things. In the meantime, creditors seek to be made whole when a business fails. Does the theory of deepening insolvency add anything to existing remedies available to those creditors?

1. The Potential Value of Deepening insolvency

Proponents see the business judgment rule as the primary obstacle to holding corporate fiduciaries responsible for the injuries that a business failure causes to creditors. Deepening insolvency will not allow corporate fiduciaries to hide behind the shield of the business judgment rule, so proponents thus advocate deepening insolvency to remedy the overbreadth of the business judgment rule.⁵³⁷

Proponents also appreciate the flexibility of the doctrine. Specifically, the derivative nature of the claim may confer standing to creditors that is not otherwise available. Traditional theories such as fraudulent transfer, conversion, breach of fiduciary duties and malpractice generally preclude standing by unsecured creditors, but deepening insolvency can open that window. As the court in Lafferty noted, under a deepening insolvency theory, the corporate entity rather than individual shareholders has the right to sue, and the creditors' committee was granted standing to pursue the entity's deepening insolvency claim.⁵³⁸

The theory also gives plaintiffs an opportunity to establish causation and damages that other claims for relief do not afford.⁵³⁹ This is especially significant when individual creditors have little incentive to seek damages.⁵⁴⁰

2. The Drawbacks of Deepening insolvency

On the other hand, opponents argue that the deepening insolvency theory may dampen the market for qualified...