The Delaware Supreme Court has affirmed, without opinion, a ruling by a lower court that ‘deepening insolvency’ is not a cause of action under Delaware law. Trenwick America Litig. Trust v. Billett, 931 A.2d 438 (Del. 2007).

The ruling appears to be the strongest nail yet in the coffin of so-called “deepening insolvency” actions.

The Delaware Supreme Court’s recent decision in North American Catholic Educational Programming Foundation, Inc. v. Gheewalla1 addresses the fiduciary duties of corporate directors in Delaware. In affirming a lower court decision by the Delaware Court of Chancery,2 the Delaware Supreme Court held that creditors of a Delaware corporation that is insolvent or in the “zone of insolvency” have no right to bring direct claims for breach of fiduciary duty against directors.

With US Circuit Courts split on the issue of whether bankruptcy courts have the power to release third parties from creditors’ claims without the creditors’ consent, a move known as non-consensual third-party release, the Seventh Circuit recently weighed in the affirmative in In re Airadigm Communications, Inc.1 With the split widening between the circuits on this matter, it seems more likely than ever that the Supreme Court could weigh in on and decide this critical issue to lenders and others.2

The current liquidity drought is pushing more businesses toward some form of financial reorganization. As the restructurings become more frequent, two different trends–one in bankruptcy and the other in private equity–will intersect. The result may surprise dealmakers searching the detritus for investment opportunities.

Two recent decisions by the Delaware Supreme Court clarify the fiduciary duties owed to creditors by directors of Delaware corporations that are insolvent or operating in the zone of insolvency. First, in North American Catholic Educational Programming Foundation, Inc. v. Gheewalla, the Delaware Supreme Court, in a case of first impression, addressed the ability of creditors to assert claims for breach of fiduciary duty against directors of a Delaware corporation that is insolvent or operating within the zone of insolvency.

C.A. No. 3017-CC (Del. Ch. May 15, 2009)

On May 15, 2009, Chancellor Chandler issued a four-page order in Fisk Ventures, LLC v. Segal, et al. addressing a motion for injunction or stay of the judicial dissolution of Genetrix, LLC pending appeal by Dr. Andrew Segal. Segal was appealing the January 13, 2009 Memorandum Opinion and the March 10, 2009 Order and decree of judicial dissolution of Genitrix, LLC.

In 2007, the Delaware Supreme Court issued an important ruling for creditors of insolvent corporations. It held that such creditors had standing to assert derivative claims for breaches of fiduciary duties against directors of an insolvent corporation.1 But, as the Delaware Court of Chancery recently made clear, there is a big difference between Delaware limited liability companies (LLCs) and their corporate cousins.

Section 510(b) of the Bankruptcy Code provides a mechanism designed to preserve the creditor/shareholder risk allocation paradigm by categorically subordinating most types of claims asserted against a debtor by equity holders in respect of their equity holdings. However, courts do not always agree on the scope of this provision in undertaking to implement its underlying policy objectives. A New York bankruptcy court recently addressed this issue in In re Lehman Brothers Inc., 2014 BL 21201 (Bankr. S.D.N.Y. Jan. 27, 2014).

The ability of a bankruptcy court to reorder the priority of claims or interests by means of equitable subordination or recharacterization of debt as equity is generally recognized. Even so, the Bankruptcy Code itself expressly authorizes only the former of these two remedies. Although common law uniformly acknowledges the power of a court to recast a claim asserted by a creditor as an equity interest in an appropriate case, the Bankruptcy Code is silent upon the availability of the remedy in a bankruptcy case.

With US Circuit Courts split on the issue of whether bankruptcy courts have the power to release third parties from creditors’ claims without the creditors’ consent, a move known as non-consensual third-party release, the Seventh Circuit recently weighed in the affirmative in In re Airadigm Communications, Inc.1 With the split widening between the circuits on this matter, it seems more likely than ever that the Supreme Court could weigh in on and decide this critical issue to lenders and others.2