An end to "deepening insolvency" as a theory of director liability.

In Trenwick America Litigation Trust v. Ernst & Young L.L.P., the Delaware Court of Chancery explicitly rejected "deepening insolvency" as a cause of action against directors of an insolvent corporation. The court's decision also provides important clarifications of parent-subsidiary relations.

On August 10, 2006, Vice Chancellor Leo E. Strine, Jr. issued an opinion of great significance for corporate and bankruptcy practitioners: Trenwick America Litigation Trust v. Ernst & Young L.L.P. (1) The decision dismissed all of the claims brought by a litigation trust in the Delaware Court of Chancery against the directors of a parent corporation, the directors of its wholly-owned subsidiary, and their legal and financial advisors. The opinion expressly rejected the theory of "deepening insolvency," a cause of action recognized by many federal courts, including the bankruptcy court in Delaware, in which creditors can hold directors liable for prolonging the lifespan of an insolvent corporation and worsening its financial state. The decision also held that, absent insolvency, a parent company's directors do not owe any particular duties to a wholly-owned subsidiary. Similarly, the court made clear that a wholly-owned subsidiary's directors' only duty is to serve the parent company unless the parent's directive would cause the subsidiary to violate its legal obligations.

Background

Trenwick Group Ltd. (Trenwick or the parent) was a large, publicly-traded holding company that provided property and casualty reinsurance in the United States and overseas through its subsidiaries. Trenwick America Corporation (Trenwick America or the subsidiary) was a wholly-owned subsidiary through which Trenwick conducted operations in the United States. Trenwick America also guaranteed certain parent-level debts. Trenwick's board of directors was comprised of ten independent directors and its chief executive officer. Trenwick America's board consisted entirely of Trenwick officers and employees. In August 2003, Trenwick, Trenwick America, and another Trenwick subsidiary filed for bankruptcy.

In the years preceding the 2003 bankruptcy, Trenwick pursued several major acquisitions to expand its business and increase its market share. In October 1999, Trenwick acquired Chartwell Re Corporation in a stock-for-stock merger. As part of that transaction, Trenwick insisted that Chartwell acquire an additional $100 million in reinsurance to protect against potential claims in excess of Chartwell's reserves. Then, in 2000, Trenwick acquired LaSalle Re Holdings Limited through another stock-for-stock merger. In connection with these acquisitions, Trenwick engaged in a significant corporate …