Note: A Critique of 'Deepening Insolvency,' a New Bankruptcy Tort Theory

Abstract:     
In several recent decisions the theory of so-called “deepening insolvency” has been brought as an independent tort cause of action against directors, lenders, and outside advisors of bankrupt companies. The plaintiffs, generally bankruptcy trustees, allege that defendants improperly kept afloat an insolvent business by taking new loans, enabling continued waste of corporate assets to the detriment of the creditor class.

This Note argues that the “deepening insolvency” cause of action is fundamentally flawed, because it attempts to expand common law principles without statutory direction to impose a new tort obligation over existing contractual relationships between sophisticated parties. Further, acceptance of the “deepening insolvency” theory conflicts with existing law, increases inefficiency, restricts the freedom of sophisticated parties to contract, and has adverse policy implications.

This Note first examines the history of “deepening insolvency” from its murky origins to its amoebic growth into both a tort cause-of-action and a theory of damages. It then evaluates and critiques the various forms that “deepening insolvency” has taken.

Number of Pages in PDF File: 19

Keywords: bankruptcy, deepening insolvency, director liability, Enron

JEL Classification: K20

Accepted Paper Series