Deepening insolvency was first recognized as a potential cause of action by the Third Circuit Court of Appeals in the threat of director liability for deepening insolvency was met by dismay by both insolvency and corporate attorneys alike.
The decision caused counselors to be uncertain about what advice to give to their director clients, as any attempt to salvage a sinking ship may prove disastrous for the directors if their efforts, however well intentioned, proved in hindsight to be unsuccessful.
After roiling the waters for several years, during which the deepening insolvency concept was increasingly discredited by academics and practitioners alike, the concept was finally put to rest in Delaware.
Closing the door on deepening insolvency in Delaware was , a Delaware Chancery Court case, which was affirmed by the Delaware Supreme Court.
The decision establishes clear guidelines for directors of troubled companies. there is no legally recognized ‘zone of insolvency’ with implications for fiduciary duty claims.” Additionally, the fiduciary duty of directors and the standing to sue directors for breaching that duty does not shift from stockholders to creditors at the point of solvency. Rather, the duty to creditors, which is derivative and not direct, is not a discreet duty owed to creditors , but is a duty owed to the insolvent corporation for the benefit of all residual claimants, which, upon insolvency, includes creditors.The directors are shielded from liability by the business judgment rule in making decisions for the ailing enterprise and are not required to shut down an insolvent entity for the benefit of its creditors (although in exercising their business judgment, they may choose this alternative). However, if the entity is insolvent, creditors have standing to seek redress if they believe they have been wronged. There are two important prerequisites to maintaining an action.
Delaware is the state of incorporation for many entities, including companies which operate in Wisconsin.
Beloit Liquidating Trust (the “Trust”) was substituted as a party in July 2001 after confirmation of the reorganization plan and the trust’s creation.