Posted By: Scott B. Riddle, Esq.

In Kaye v. Dupree, et al. (In re Avado Brands, Inc.), Adv. No. 05-3823, 2006 Bankr. LEXIS 3631 (Bankr. N.D. Tex. December 28, 2006), the Trustee of the Debtor’s Litigation Trust filed a post-confirmation suit against the Debtor’s former officers and directors.  The causes of action included preferential transfers, breach of fiduciary duty, fraud and deepening insolvency.  The defendants filed motions to dismiss and motions for summary judgment. The court addressed several matters raised by the motions, not all of which are addressed in this post. 

The court first determined that it did have post-confirmation jurisdiction over the proceeding as the claims arose pre-petition, were provided for under the plan, and transferred to the trust for prosecution by the Trustee.

The Court next addressed whether O.C.G.A. §14-2-202, the exculpation provision, protected the directors of Debtor (a Georgia corporation) from liability for breach of fiduciary duty. The statute states the following –

(b) The articles of incorporation may set forth:
* * *
(4) A provision eliminating or limiting the liability of a director to the corporation or its shareholders for monetary damages for any action taken, or any failure to take any action, as a director, except liability:
* * *
(B) For acts or omissions which involve intentional misconduct or a knowing violation of law; or
(D) For any transaction from which the director received an improper personal benefit, provided that no such provision shall eliminate or limit the liability of a director for any act or omission occurring prior to the date when such provision becomes effective. 

This provision (for which there are no reported cases in Georgia) was adopted by Debtor, but the Trustee argued that the Directors are still liable for intentional, wrongful, and grossly negligent conduct, as alleged in the Complaint. The Court agreed with the Trustee –

Georgia’s statute is similar but not identical to Delaware’s. One provision found in Delaware’s exculpation statute specifically limits the ability of a corporation to absolve directors from breaches of the duty of loyalty; however, they both contain limitations on conduct that is intentional or knowing. In Delaware, this has been extended by case law to intentionally reckless acts and acts taken in bad faith. …

A recent decision by the Delaware Chancery Court in In re Walt Disney Co. Derivative Litigation, 825 A.2d 275, 289 (Del. Ch. 2003), stated that where the facts of the complaint, taken as true, "suggest that the defendant directors consciously and intentionally disregarded their responsibilities, adopting a ‘we don’t care about the risks’ attitude," they sufficiently allege claims of intentional misconduct that fall outside of the exculpatory statutes. Id. (emphasis original). "Knowing or deliberate indifference by a director to his or her duty to act faithfully and with appropriate care is conduct . . . that may not have been taken honestly and in good faith to advance the best interests of the company" and, thus, constitutes intentional misconduct. Id. "Put differently, all of the alleged facts, if true, imply that the defendant directors knew that they were making material decisions without adequate information [or] deliberation, and that they simply did not care." Id.

The Court finds this rationale instructive in interpreting the similar provisions in Georgia’s exculpatory statute. The Complaint alleges that the Outside Directors breached their fiduciary duties of care, good faith and loyalty to Avado through their intentional, wrongful and/or reckless conduct. At this early stage of the litigation, reviewing the Outside Director’s Motion to Dismiss against the Trustee’s Complaint and accepting the facts pled in the Complaint as true, the Court finds that the Exculpation provisions in Avado’s articles of incorporation do not protect the Outside Directors from liability

The Defendant Directors also sought dismissal of the Trustee’s claims for the tort of deepening insolvency.   The court granted the motion, finding —


In this Court’s recent decision rejecting deepening insolvency as a separate tort under Texas law, Official Comm. of Unsecured Creditors of VarTec Telecom, Inc. v. Rural Tel. Fin. Coop. (In re VarTec Telecom, Inc.), 335 B.R. 631 (Bankr. N.D. Tex. 2005), the Court discussed the "deepening insolvency"  theory in detail. The ultimate conclusion reached by the Court in VarTec was that "deepening insolvency" would not be recognized as separate cause of action in Texas, but at best may be a theory of damages. Id. Reaching the same result as Judge Bernstein in the Global Services Group case, that "one seeking to recover for ‘deepening insolvency’ must show that the defendant prolonged the company’s life in breach of a separate duty, or committed an actionable tort that contributed to the continued operation of a corporation and its increased debt." Kittay v. Atlantic Bank of New York (In re Global Service Group, LLC), 316 B.R. 451, 456 (Bankr. S.D.N.Y. 2004)(Bernstein, C.J.).
If "deepening insolvency" exists as a separate tort, it would be found under state and not federal law; the courts that consider the theory of "deepening insolvency" to be an actionable tort do so by predicting state law. See e.g., Official Comm. of Unsecured Creditors v. R.F. Lafferty & Co., 267 F.3d 340, 349-52 (3d Cir. 2001)(construing Pennsylvania law); Official Comm. of Unsecured Creditors v. Credit Suisse First Boston (In re Exide Technologies, Inc.), 299 B.R. 732, 750-52 (Bankr. D. Del. 2003) (construing Delaware law). Therefore, in the present case, this Court must look to Georgia law.

Both the Outside Director Defendants and the Trustee concede that there are no Georgia decisions that address the validity of the theory of "deepening insolvency." The Trustee suggests that the trend of recent cases is to recognize "deepening insolvency" as a viable cause of action; however, recent cases point in the opposite direction. Seitz v. Detweiler, Hershey & Assoc., P.C. (In re CitX Corp.), 448 F.3d 672, 677 (3d Cir. 2006)(limiting the Lafferty decision to Pennsylvania and requiring fraud as a prerequisite); Official Comm. of Unsecured Creditors of Radnor Holdings Corp. v. Tennenbaum Capital Partners, LLC (In re Radnor Holdings Corp.), 2006 WL 3346191 (Bankr. D. Del. 2006); Official Comm. of Unsecured Creditors of Verestar, Inc. v. American Tower Corp. (In re Verestar, Inc.), 343 B.R. 444, 477 (Bankr. S.D.N.Y. 2006); Alberts v. Tuft (In re Greater Southeast Community Hospital Corp.), 333 B.R. 506, 517 (Bankr. D. Dist. Col. 2005); Bondi v. Bank of America Corp. (In re Parmalat), 383 F.Supp.2d 587 (S.D.N.Y. 2005). 

The Trustee also relies on the rationale in the Third Circuit’s decision in Lafferty, noting that other courts have extended the decision’s rational beyond Pennsylvania. See Official Comm. of Unsecured Creditors v. Credit Suisse First Boston (In re Exide Technologies, Inc.), 299 B.R. 732, 751-52 (Bankr. D. Del. 2003); In re LTV Steel Company, Inc., 333 B.R. 397, 422 (Bankr. N.D. Ohio 2005); Limor v. Buerger (In re Del-Met Corp.), 322 B.R. 781, 813-815 (Bankr. M.D. Tenn. 2005). However, the Third Circuit recently limited its decision in Lafferty, stating:

Although some courts in this Circuit have extended Lafferty’s reasoning to other states, see, e.g., OHC Liquidation Trust v. Credit Suisse First Boston (In re Oakwood Homes Corp.), 340 B.R. 510, 531 (Bankr. D. Del. 2006)(holding that Delaware, New York, and North Carolina would recognize the cause of action), nothing we said in Lafferty compels any extension of the doctrine beyond Pennsylvania.

In re CitX Corp., Inc., 448 F.3d at 680 n.11. It has also recently been rejected under Delaware law. See Trenwick Am. Litig. Trust v. Ernst & Young, LLP, 906 A.2d 168 (Del. Ch. 2006)  ("Trenwick").  Georgia law is controlling on the "deepening insolvency" claim in this case. In predicting state law, in this case, this Court should look in order to:

(1) decisions of the Georgia’s Supreme Court in analogous cases;
(2) the rationales and analyses underlying Georgia’s Supreme Court decisions on related issues;
(3) dicta by Georgia’s Supreme Court;
(4) lower Georgia state court decisions;
(5) the general rule on the question;
(6) the rulings of courts of other states to which Georgia’s courts look when formulating substantive law; and
(7) other available sources, such as treatises and legal commentaries.

See, Centennial Ins. Co. v. Ryder Truck Rental, Inc., 149 F.3d 378, 382 (5th Cir. 1998). As stated above, the Georgia courts have not spoken on the issue of whether "deepening insolvency" is a viable cause of action or even whether it is a measure of damages. Thus this Court must look to the rationales and analyses underlying Georgia court decisions on the issue of recognizing a tort not previously recognized in Georgia. Similar to the courts in Texas, as the Court found in VarTec, see Cain v. Hearst Corp., 878 S.W.2d 577, 579, 37 Tex. Sup. Ct. J. 1151 (Tex. 1994), the Supreme Court of Georgia has held that where a full and adequate remedy for an injury already exists, it is "not necessary for [a court] to carve out a previously unrecognized cause of action." Albany Urology Clinic, P.C. v. Cleveland, 272 Ga. 296, 528 S.E.2d 777, 780 (Ga. 2000). Further, Georgia courts have expressed a reluctance to recognize new torts, even when those torts have been recognized in other jurisdictions. See Owens v. American Refuse Systems, Inc., 244 Ga. App. 780, 536 S.E.2d 782, 784 (Ga. App. 2000); Sharpnack v. Hoffinger, 231 Ga. App. 829, 499 S.E.2d 363 (1998). The Georgia Court of Appeals in Owens explains some of the history of Georgia jurisprudence in the area of considering whether to adopt the tort of spoilation of evidence:

In Gardner v. Blackston, 185 Ga.App. 754, 755(1), 365 S.E.2d 545 (1988)(physical precedent only), we stated in dicta that Georgia law does not recognize spoliation of evidence as a separate tort. We again looked at the issue of spoliation as an independent tort in Sharpnack v. Hoffinger, 231 Ga.App. 829, 499 S.E.2d 363 (1998). We noted that the tort has been recognized in some jurisdictions, [*51] including California, Florida, and Alaska, and not recognized in others.

Owens v. American Refuse Systems, Inc., 536 S.E.2d at 782. In Sharpnack, the court alluded to the fact that it may revisit the issue in the future, since it was not necessary to adopt spoilation as a tort under the issues before the court to rule on the appeal. Sharpnack, 499 S.E.2d at 364-365. Upon such a revisitation in Owens, the Court of Appeals stated:

We join the majority of jurisdictions and decline to recognize an independent third-party tort of evidence spoliation in this case. A vigilant litigant already has traditional means of securing evidence available. Those means include, for example, a court order directing preservation, along with remedies for a violation of that order, or a contractual agreement with the property owner.

Owens, 536 S.E.2d at 784.

VarTec involved a deepening insolvency claim against a third party lender. In that case, the court rejected deepening insolvency as a theory of liability under Texas law. This case presents a claim made against officers and directors. Since VarTec, other courts have rejected similar claims against similar parties and have not limited their holdings to lenders. See, Trenwick, 906 A.2d 168. The trend seems to be a rejection of deepening insolvency as a theory of liability in general. This Court concludes that Georgia would not adopt the theory of deepening insolvency as a tort, even against former officers and directors in a case where breach of fiduciary duty has been asserted. In the present case before the Court, the Trustee has an adequate remedy for the injuries he alleges under his breach of fiduciary duty claims. The Court finds that based on the facts as presented in this case, the courts in Georgia would not "carve out" a previously unrecognized cause of action where a adequate remedy exists. See Cleveland, 528 S.E.2d at 780. n2

n2 This Court, an Article 1 federal court sitting in Texas, is particularly reluctant to recognize a new cause of action in Georgia, where neither the state legislature nor courts have spoken