“Deepening Insolvency” is a developing theory of law in cases brought by bankruptcy trustees, litigation trust trustees, receivers, reorganized debtors, or some other plaintiff “standing in the shoes” of an insolvent company. Essentially, the deepening insolvency theory is premised on allegations that the defendants (directors, officers, law firms, accounting firms, or any combination of the foregoing) caused the corporation to incur more liabilities, thereby “deepening” its insolvency.
More specifically, the theory is that the corporation was insolvent or in the “zone of insolvency” when the purported fraud, breaches or wrongdoing occurred, and but for the actions of the defendants, the corporation would not have continued to raise unserviceable debt and would have filed for bankruptcy more promptly, which would have avoided the unserviceable debt.
Originally only a theory of damages, it has received some judicial recognition as an independent cause of action under which a bankrupt company or its representatives may recover damages caused by professionals and/or its prepetition officers and directors who have facilitated the company’s mismanagement or misrepresented its financial condition, resulting in bankruptcy and loss of corporate assets.
Indeed the theory has some traction within the Eleventh Circuit, though it remains a theory of damages rather than an independent action. Accordingly, a board of directors of a company that is insolvent or in the zone of insolvency should be mindful of the issues raised above when the company incurs additional debt or approves distributions to shareholders, and should consult its legal counsel and financial professionals to be fully informed when making such decisions.