One of the most important recent decisions by the Delaware Court of Chancery in the insolvency area was the August 10, 2006 opinion in the Trenwick America Litigation Trust case. As discussed at length in an earlier post, the Trenwick America decision by Vice Chancellor Strine (available here) squarely held that there was no cause of action for "deepening insolvency" under Delaware law. The Chancery Court’s opinion rejected it as a cause of action in no uncertain terms:
Delaware law does not recognize this catchy term as a cause of action, because catchy though the term may be, it does not express a coherent concept. Even when a firm is insolvent, its directors may, in the appropriate exercise of their business judgment, take action that might, if it does not pan out, result in the firm being painted in a deeper hue of red. The fact that the residual claimants of the firm at that time are creditors does not mean that the directors cannot choose to continue the firm’s operations in the hope that they can expand the inadequate pie such that the firm’s creditors get a greater recovery. By doing so, the directors do not become a guarantor of success. 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. Existing equitable causes of action for breach of fiduciary duty, and existing legal causes of action for fraud, fraudulent conveyance, and breach of contract are the appropriate means by which to challenge the actions of boards of insolvent corporations.
Delaware Supreme Court Hears Appeal. The significance of the Chancery Court decision makes it particularly interesting to follow the appeal in the case, now before the Delaware Supreme Court. The oral argument on the appeal, held on March 14, 2007 at the Widener University School of Law campus in Wilmington, may shed some light on how the Delaware Supreme Court will ultimately rule. Frank Reynolds of Andrews Publications prepared this news story on the oral argument, and the law school’s website also has an article, complete with slideshow, on the oral argument in Trenwick America and in a second case that day. To hear the Trenwick America oral argument for yourself, follow this link and download the audio recording from the Delaware Supreme Court’s website.
Focus At Oral Argument. Having listened to the recording (an entertaining addition to my iPod), it’s interesting to note that the deepening insolvency issue received only a few mentions during oral argument. Those came mainly during a discussion of the business judgment rule and whether existing contractual and statutory remedies sufficiently protect creditors. Instead, the parties and the Justices focused on the following issues during oral argument:
- Whether the complaint sufficiently pled that the corporation was insolvent or in the zone of insolvency;
- Whether the business judgment rule protected the directors in permitting the subsidiary corporation to incur guaranty and other obligations;
- What fiduciary duty was owed and how it was allegedly breached;
- Whether the zone of insolvency issue was critical to the plaintiff’s case; and
- Whether the directors breached any fiduciary duties when following the parent corporation’s business plan for the subsidiary and the corporate group.
Reading The Tea Leaves. With the range of issues discussed at oral argument, it’s possible that the Delaware Supreme Court will render its decision in the Trenwick America case without considering the Chancery’s Court’s ruling that deepening insolvency does not exist as a cause of action under Delaware law. Plaintiff’s counsel argued that the Delaware Supreme Court could rule for his client without reaching the issue. Likewise, counsel for the defendants urged affirmance based on what Vice Chancellor Strine found to be insufficient pleading of insolvency, a lack of any fiduciary duty owed given the complaint’s allegations, and the application of the business judgment rule. Although not directly involving deepening insolvency, in response to a specific question from one of the Justices, defense counsel also argued that the Delaware Supreme Court should consider holding that directors do not owe fiduciary duties to creditors upon insolvency, leaving creditors to the existing protections and remedies otherwise available to them.
After an interesting oral argument, stay tuned.