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Trenwick--The End of Jaw-Boning

posted by Jonathan Lipson

When Credit Slips’ management learned that the Delaware Supreme Court issued a remarkably brief order a couple weeks ago affirming the Chancery Court in the Trenwick litigation, they asked me to reprise my role as guest blogger here. I am, of course, happy to oblige.

Trenwick was the latest in a series of cases at the increasingly congested intersection of bankruptcy and corporate governance. Trenwick involved both breach of fiduciary duty and "deepening insolvency" claims. I won’t belabor the fiduciary duty issues, as I've already discussed them here (you have to scroll to the bottom). Deepening insolvency, on the other hand, warrants a few words. 

The basic idea behind deepening insolvency seems simple: Creditors claim they were harmed when the corporation incurred debt which, rather than salvaging the company, merely prolonged the agony, "deepening" the distress. Instead of losing 75% of their claim, for example, creditors might say that the deepening insolvency "misconduct" caused them to lose 85%. Thus, creditors bring a lawsuit against the managers and others who they believe caused this additional loss. The legal issue is whether and to what extent the courts will give the creditors a remedy if they can prove these facts.

Unlike the closely related question of directors' duties to creditors, there is no obvious predicate doctrine which might guide a court trying to determine how to respond to such a claim. Although most analysts trace deepening insolvency back to the 1983 Schacht case from the 7th Circuit, no one has been able to figure out if deepening insolvency is really a unique cause of action that could be asserted against corporate fiduciaries or professionals, a measure of damages, or both, or neither.

The logical problems with the claim are pretty clear. In many cases, incurring additional debt may actually save the company, but of course you won't know this until it’s too late. Moreover, it is not clear what work this deepening insolvency "doctrine" would do that other doctrines—including breach of fiduciary duty, fraudulent conveyance and good faith—could not already do.

These were certainly the views Vice Chancellor Strine expressed—repeatedly—in his ginormous, 90-page, 25,000+ word Chancery Court opinion in Trenwick, which is what the Supreme Court affirmed--in a mere two sentences. 

In truth, it is not clear why VC Strine bothered to say much of anything in Trenwick. Many of the plaintiff's claims were obviously problematic, including that the plaintiff clearly lacked standing to sue, and the debtor was evidently solvent at all relevant times. As with Gheewalla and some of the other recent Delaware jurisprudence on these issues, the results are probably correct—the curiosity is in the analysis.

Until the Trenwick Supreme Court opinion, it seems the Delaware courts were saying a whole lot more than was necessary in cases that could easily have been resolved with little discussion. Thus, I recently argued in Stanford's Journal of Law, Business and Finance that Delaware courts appeared to be engaged in the "expressive function" of judging. This is just a fancy way of saying that they have been doing a lot of jaw-boning to try to send messages to their audience—lawyers, directors, etc.—about what is and is not acceptable behavior when a firm is in distress.

Trenwick would seem to be the end of this jaw-boning, although there is clearly more that could be said. After all, we should not forget that the net result of cases like Gheewalla and Trenwick will be that Delaware has foreclosed many doctrinal avenues that creditors might reasonably want to pursue against directors and other corporate actors. In fact, contrary to Vice Chancellor Strine’s Chancery Court analysis in Trenwick, it would appear that, in all but extraordinary cases, neither breach of fiduciary duty nor good faith claims will lie in the wake of Gheewalla and Stone v. Ritter.

Perhaps Trenwick means Delaware has said all it means to say on deepening insolvency (and related matters, such as directors' duties to creditors). Perhaps it means they have gotten (or given) the message—and they are going to keep quiet for a while.  Or, perhaps it just means that VC Strine has finally worn the Supreme Court out. Only time--and more jaw-boning--will tell.

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