Deepening Insolvency: creditors Committees Secret Weapon or Much Ado About Nothing

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Deepening Insolvency creditors Committees
Secret Weapon or Much Ado About Nothing

• by
• The Honorable Leif M. Clark
• C. Mark Brannum

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Whats It All About?

• Can Officers and Directors (and Others) of
  Insolvent Companies be held liable for continuing
  losses experienced by an Insolvent Company?

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Origins of Deepening Insolvency

• A corporation is not a biological entity for
  which it can be presumed that any act which
  extends its existence is beneficial to it. In
  re Investors Funding Corp of New York Sec.
  Litigation, (S.D.N.Y. 1980)

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Beyond Investors Funding

• Does an Insolvent Company suffer a distinct and
  compensable injury when it continues to operate
  and incur more debt?
• Shouldnt the same theory apply to a solvent
  company that works itself into insolvency? In re
  Global Service Group LLC, (Bankr. S.D.N.Y. 2004).

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Status of Current Case Law???

• Not clearly defined.
• Little uniformity no real consistent analysis
  or conclusion.

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Why?

• Beginnings of the Deepening Insolvency theory.
• No consistency in the types of case brought
• facts.
• Defendants.

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Is It?

• An independent cause of action?
• An act of bad conduct by officers and directors
  or others?
• A measure of damages?
• None of the above?

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Current Legal Landscape

• Inconsistent Results
• Distinguishable Facts
• Distinguishable Issue
• Legal Trend to look to State Law.
• Four Part Test, See Excide
• Issue with this approach, circular reasoning.

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In A Solvent Company Situation!

• Creditors Remedies

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In Solvent Corporation Situation Standing

• Officers and Directors do not owe a duty to
  creditors. Geyer v. Ingersoll Publications Co.
  (Del. Ch.) (fraud/zone of insolvency?)
• Advisors do not owe a duty to a borrowers
  creditors.
• Lenders do not owe a duty to a borrowers
  creditors.

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• What Difference Does Insolvency Make?
• Or, Does it make a Difference At All?

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Enter the Zone of Insolvency

• McCandless v. Furland, 296 U.S. 140, 56 S.Ct. 304
  (1935).
• New York Credit Mens Adjustment Bureau, (NY
  1953) upon insolvency, the duties owed by
  officers and directors extend to creditors.
• Credit Lyonnais Bank Nederland N.V. v. Pathe
  Comm., (Del. 1991) established the Zone of
  Insolvency.
• Public Resources, (Del.Ch. 2004) limits standing
  to derivative standing on behalf of the injured
  company.

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Fiduciary Duties

• How does insolvency alter or change the fiduciary
  duties owed?
• What is the Community of Interests?

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Fiduciary Duties

• Duty of Loyalty
• Duty of Care
• Good Faith????

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Fiduciary Duties Continued

• Duty of Loyalty
• Duty of Care

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Duty of Good Faith

• In re The Walt Disney Company Derivative
  Litigation, 2003 WL 21267266 (Del. Ch. May 28,
  2003).

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Duty To Liquidate????

• There is no independent duty under American law
  to liquidate an insolvent corporation. In re Ben
  Franklin Retail Stores, Inc., (Bankr. N.D.Ill
  1998)

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Third Party Targets

• No Fiduciary Duty owed by
• Lenders, or
• Financial advisors.
• Lenders
• negligent lending.
• aiding and abetting.
• Advisors
• professional malpractice.
• aiding and abetting.

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Where We End UP

• Facts demonstrating that Officers and Directors
  (and Others) of an Insolvent Company continued
  operations and incurred debt, without more, will
  not create liability.
• Fraudulent Prolongation of a Corporations life
  beyond insolvency.

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Does Deepening Insolvency Change Anything?

• Officers Directors
• Fraud.
• Breach of Fiduciary Duty.
• Lenders
• Aiding and Abetting.
• Advisors
• Professional Malpractice.
• Aiding and Abetting.

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Coming to a Texas Court

• Florida Dept of Ins. v. Chase Bank of Texas
  Natl Assn, (5th Cir.2001) Questioning whether
  Texas recognizes Deepening Insolvency.
• State Natl. Bank of El Paso v. Farah Mfct Co.,
  Inc., (Tex.App. 8 Dist. 1984). Lender liability.

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Texas Cont

• Cavnar v. Quality Control Parking, Inc., (Tex.
  1985). Texas remedial scheme.
• Wal-Mart Stores, Inc. v. Sturges, III, (Tex.
  2001). Texas remedial scheme.

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Still More Texas Cases to Consider

• Ernst Young, L.L.P. v. Pacific Mutual Life Ins.
  Co., (Tex. 2001). Questioning whether Texas
  recognizes a cause of action for aiding and
  abetting a breach of fiduciary duty.
• Quilling v. Compass Bank, (N.D. Tex. 2004). Same
  
• Brewer v. Pritchard, P.C. v. Johnson,
  (Tex.App.-Houston 1999). Recognizing a cause of
  action for knowingly aiding or assisting in a
  breach of fiduciary duty.

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Cases You Ought to Know About!!!!

• CITX Corporation, Inc. v. Detweiler, Hershey and
  Associates, (E.D. Pa. 2005). Summary judgment
  granted for defendants where the alleged conduct
  under the deepening insolvency claim was merely
  negligent.
• Official Comm. of Unsecured Creditors v. R.F.
  Lafferty Co., (3d Cir. 2001). Recognizing an
  independent cause of action under Pennsylvania
  law.

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more cases!!!

• Official comm. of Unsecured Creditors v. Credit
  Suisse First Boston, (Bankr. D. Del.
  2003)(Excide). Recognizing an independent cause
  of action under Delaware law.
• Tabas v. Greenleaf Ventures, Inc., (Bankr. S.D.
  Fla. 2001)(Florida). Recognizing an independent
  cause of action under Florida law.

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even more cases!!!

• Kittay v. Atlantic Bank of New York, (Bankr.
  S.D.N.Y. 2004)(Global Services). Deepening
  Insolvency cause of action dismissed for failure
  to state a claim.
• In re Del-Met Corp., (Bankr. M.D. Tenn. 2005).
  Permitting deepening insolvency cause of action
  under Tennessee Law

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What Is the Correct Result?

• Should or can the Federal common law create a
  cause of action?
• Strict liability

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Procedural Issues

• When should a defendant raise issues regarding
  the validity of a claim for Deepening Insolvency?
• Traditionally, 12(b)(6) or summary judgment.
• Alternatives???

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Other Countries

• England Director and Officer personal liability
  for debts incurred if the corporation trades
  while it is insolvent. Section 214 of Insolvency
  Act.
• Australia Duty on Directors to prevent a
  company from incurring debt while insolvent or
  that will create insolvency. Section 588G of
  Corporations Act
• France, Sweden, Spain and Hungary each impose
  personal liability for failure to discontinue
  operations if insolvent.

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As a Damage Model?

• Corporation and the Community???
• Individual Creditors???

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Damage Model Cases

• Hannover Corp. of America v. Beckner, (M.D. La.
  1997).
• Allard v. Arthur Andersen Co. (USA), (S.D.N.Y.
  1996).
• Drabkin v. L L Constr. Assocs., Inc., (Bankr.
  D.C. 1993).

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Questions