Deepening Insolvency

Abstract

This Article analyzes deepening insolvency, an increasingly influential theory of corporate injury in litigation involving insolvent corporations. The case law presents two versions of deepening insolvency. The first version presents an application of some well-established corporate finance theory: wrongfully-incurred unpayable debt may inflict costs of financial distress on a corporation, including administrative costs of bankruptcy and declines in assets and profits from reputational and other losses. This version fits easily with traditional understandings of corporate injury. The second version presents the amount of the corporation's wrongfully-incurred unpayable debt itself as a measure of the corporation's harm, a notion unsupported in financial economics, inconsistent with traditional understandings of corporate injury, and generally incompatible with the economic functions of corporate injury. I conclude that the second version of the theory is the product either of judicial misunderstanding or a judicial attempt to avoid Supreme Court precedent that prohibits bankruptcy trustees from bringing damages claims on behalf of defrauded creditors. I ask whether it nevertheless makes sense to allow trustees, receivers and creditors' committees to pursue damages claims indirectly on behalf of creditors by recharacterizing wrongfully-incurred unpayable debt as corporate injury. Consistent with existing law, I find good reasons not to allow such claims. Allowing trustees, receivers and creditors' committees to pursue claims for wrongfully-incurred unpayable debt recharacterized as corporate injury does not better compensate victims or better deter wrongdoing than requiring defrauded creditors to bring those claims on their own.

Keywords: Deepening insolvency, costs of financial distress

JEL Classification: G32, G33, K22, K41