Third Circuit Addresses "Deepening Insolvency" Claims: In re Lemington Home

In a decision issued on September 21, 2011, Official Comm. Of Unsecured Creditors v. Baldwin (In re Lemington Home for the Aged), No. 10-4456, 2011 WL 4375676 (3d Cir. Sept. 21, 2011) (“Lemington Home”), the U.S. Court of Appeals for the Third Circuit reversed a grant of summary judgment in favor of defendant directors and officers and held that the “deepening insolvency” cause of action, which the Third Circuit previously recognized in Official Comm. Of Unsecured Creditors v. R.F. Lafferty & Co., 267 F.3d 340 (3d Cir. 2001) (“Lafferty”), remains an independent cause of action under Pennsylvania law. The District Court for the Western District of Pennsylvania had granted summary judgment in favor of the defendants on the deepening insolvency claim on the ground that the plaintiff was unable to show the requisite element of fraud on the part of the directors and officers. On appeal, the Third Circuit reversed and held that there was a genuine issue of material fact as to whether the directors and officers fraudulently contributed to the deepening insolvency of the debtor. The Third Circuit also reinstated related breach of fiduciary duty claims against the officers and directors.

While the Third Circuit acknowledged in its decision that recent case law has called into question the viability of the deepening insolvency cause of action, it specifically noted in a footnote that it was bound in its decision to follow its prior decision in Lafferty recognizing the claim, which only could be overturned by the Third Circuit en banc. Thus, for now, deepening insolvency remains a viable cause of action under Pennsylvania law.