In In re Lemington Home for the Aged, 2011 US App LEXIS 19312 (3d Cir, July 11, 2011), the Third Circuit in a published case held that the plaintiffs had established a genuine issue of material fact with respect to their claim for deepening insolvency against the defendant board of directors of a nonprofit facility. While the case involved a health care entity undergoing federal bankruptcy, the analysis may apply to other entities undergoing receivership, including those involved in state level insurance receiverships.
In May of 2004, after years of financial decline, an administrator recommended to the board of directors of the Lemington Home for the Aged that bankruptcy protection was necessary. Despite numerous warning from audits and outside studies, as well as citations from the state health department, the board refused to declare bankruptcy or conduct a viability study necessary to receive a loan to continue operations. After several patients died under conditions potentially involving neglect, the board ultimately decided to declare bankruptcy in January 2005, but delayed the filing of bankruptcy for a period of four months while the board continued to do business with vendors, failed to collect Medicare receivables, upheld a policy of no new patient admissions, and commingled the home's funds with related entities. Id. at *31-32.
With permission from the bankruptcy court, a committee of creditors filed suit against the board alleging violations of fiduciary duties as well as a claim for deepening insolvency. The Western District Court of Pennsylvania granted summary judgment to the defendants, finding the business judgment rule prevented the court from secondguessing the board's decisions. The Third Circuit reversed, finding a genuine issue of material fact existed as to both the fiduciary duty and deepening insolvency claims.
Though Pennsylvania's state courts had not formally recognized a claim of "deepening insolvency," the Third Circuit, relying on law from other jurisdictions and the policy underlying Pennsylvania tort law, cited federal precedent for the proposition that "the Pennsylvania Supreme Court would determine that 'deepening insolvency' may give rise to a cognizable injury." Id. at *27-28. The court defined such a claim as "an injury to a debtor's corporate property from the fraudulent expansion of corporate debt and prolongation of corporate life." Id. As there was sufficient evidence on all of plaintiff's claims to show a genuine issue of material fact, the court vacated the district court's order and remanded the case for trial.
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