## Facts

- Walnut Equipment Leasing Co., Inc. and Equipment Leasing Corporation of America (ELCOA) were lease-financing corporations allegedly controlled by William Shapiro and his family.
- After Walnut encountered financial trouble, the Shapiro-controlled entities created ELCOA to raise money through public issuance of debt securities.
- The Committee alleged the companies were operated as a Ponzi scheme funded by fraudulent debt certificates sold to investors.
- R.F. Lafferty & Co., Inc. (a broker-dealer/underwriter) and Cogen Sklar, L.L.P. (an accounting firm) allegedly participated in, and helped induce, the issuance and marketing of the fraudulent debt.
- The Committee alleged defendants’ conduct prolonged the corporations’ existence while increasing liabilities, worsening financial condition, and ultimately forcing bankruptcy (“deepening insolvency”).
- Walnut and ELCOA filed Chapter 11 petitions; a creditors’ committee was appointed and authorized to pursue estate causes of action against third parties.

## Issues

1. Whether “deepening insolvency” is a cognizable injury and valid cause of action under Pennsylvania law.
2. Whether in pari delicto bars a creditors’ committee (suing in the debtors’ shoes) from recovering from third parties who allegedly assisted management in the fraud.

## Decision

- The Third Circuit held that “deepening insolvency” constitutes a cognizable injury and may support a cause of action under Pennsylvania law.
- The court nonetheless affirmed dismissal because, as of the bankruptcy filing, the debtor corporations (acting through their controlling insiders) participated in the wrongdoing.
- Because the Committee sued as successor to the debtors’ rights under 11 U.S.C. § 541, it took those claims subject to the same defenses, including in pari delicto.
- The court treated in pari delicto as a merits defense, not a jurisdictional standing defect, but it was dispositive and required dismissal.

## Legal Principles

- “Deepening insolvency” may constitute an actionable corporate injury where fraudulent (or otherwise wrongful) conduct prolongs an insolvent corporation’s life and expands corporate debt, damaging corporate property.
- A bankruptcy estate (and a committee authorized to sue on its behalf) succeeds only to the debtor’s causes of action “as of the commencement” of the case and takes them subject to all applicable defenses.
- In pari delicto bars recovery when the plaintiff participated in the relevant wrongdoing; when corporate insiders control the corporation and commit the fraud, their conduct may be imputed to the corporation for purposes of the defense.
- Bankruptcy policy concerns (such as creditor recovery or deterrence) do not, by themselves, permit federal courts to disregard applicable state-law defenses that would have barred the debtor prepetition.

## Conclusion

The Third Circuit recognized deepening insolvency as a potential Pennsylvania-law claim for harm to corporate property from wrongful prolongation of an insolvent corporation’s life, but it held the claim could not be pursued by the bankruptcy estate because the debtors’ own management engineered the fraud, making the estate subject to dismissal under in pari delicto.


Official Comm. of Unsecured Creditors v. R.F. Lafferty & Co., 267 F.3d 340 (3d Cir. 2001)