Official Committee of Unsecured Creditors v. R.F. Lafferty & Co., Inc. Cogen Sklar, L.L.P

This matter arises out of the bankruptcy of two lease financing corporations, which were allegedly operated as a "Ponzi scheme."1 Like all such schemes, this one collapsed, leaving numerous investors with significant losses. To operate the scheme, William Shapiro, aided by others, allegedly caused the corporations to issue fraudulent debt certificates, which were then sold to individual investors. When the corporations lost any reasonable prospect of repaying the outstanding debt, they filed for bankruptcy.

A Committee of Creditors, appointed by a bankruptcy trustee, brought claims in the District Court on behalf of the two debtor corporations alleging that third-parties had fraudulently induced the corporations to issue the debt securities, thereby deepening their insolvency and forcing them into bankruptcy. These third-parties allegedly conspired with the debtors' management, who were also the debtors' sole shareholders, in engineering the Ponzi scheme. On these allegations, the District Court concluded that it could not rule out the possibility of a cognizable injury. Nevertheless, the District Court held that the Committee lacked standing to assert its claims against the third-parties because of the doctrine of in pari delicto. The Committee appeals.

We conclude that "deepening insolvency" constitutes a valid cause of action under Pennsylvania state law and that the Committee therefore has standing to bring this action. However, evaluating the Committee's claims "as of the commencement" of the bankruptcy, we hold that because the Committee, standing in the shoes of the debtors, was in pari delicto with the third parties it is suing, its claims were properly dismissed. Accordingly, we will affirm the judgment of the District Court.

The following allegations are taken from the Amended Complaint of the appellant, the Official Committee of Unsecured Creditors ("the Committee"), which was appointed by the bankruptcy trustee and which was authorized by stipulation to assert claims on behalf of the debtor corporations. The essence of the Committee's allegations is that the Shapiro family (or "the Shapiros"), with the assistance of other defendants, including third-party professionals,2 operated Walnut Equipment Leasing Company, Inc., ("Walnut"), and its wholly owned subsidiary, Equipment Leasing Corporation of America ("ELCOA"), as a Ponzi scheme.

The scheme originated with Walnut, which was owned by defendant Walnut Associates, Inc., and which, in turn, was owned by William Shapiro. In 1986, Walnut was experiencing financial difficulties. As a result, Walnut could not raise sufficient capital through the sale of debt securities. In a purported effort to secure more capital for Walnut, the Shapiro family organized ELCOA as "a limited purpose financing subsidiary," wholly owned by Walnut, to provide a platform to sell debt securities through a new company with a clean financial picture.

According to the Amended Complaint, ELCOA was fraudulently marketed as an independent business entity, even though its only function was to acquire leases from Walnut and to sell debt certificates to raise money. In reality, Walnut and ELCOA were part of a network of businesses owned and operated by the Shapiro family. This network included defendants Welco, Inc., The Law Offices of William Shapiro, Esq., P.C., Walnut Associates, Inc., Financial Data, Inc., and Kenner Collection Agency, Inc. As part of the scheme to keep this network afloat, the Shapiros allegedly misstated Walnut and ELCOA's financial position in order to induce these companies to register, offer, and sell additional debt certificates to raise capital. Numerous investors purchased the ELCOA debt securities, and the Committee claims that the Shapiros funneled those monies into Walnut. At the same time, the Shapiros and their co-conspirators continued receiving salaries and fees from Walnut and ELCOA. Moreover, the issuance of debt securities allegedly deepened the insolvency of Walnut and ELCOA, and put them on the path to bankruptcy.

The Amended Complaint states that certain third-party professionals were essential to the Shapiro family's operation, namely, their counsel, defendant William Shapiro, Esq. P.C., their accountant, defendant Cogen Sklar, L.L.P. ("Cogen"), and their qualified independent underwriters, defendant R.F. Lafferty & Co., Inc. ("Lafferty"), and defendant Liss Financial Services, Inc. ("Liss"). Each of these parties was responsible for professional opinions that served as prerequisites for the registration of each public offering and sale of ELCOA's debt securities. Each allegedly conspired with the Shapiro family to render opinions replete with multiple fraudulent misstatements and material omissions concerning Walnut and ELCOA's financial statements. The parties allegedly lacked any foundation for their conclusions.

Ultimately, the artifice collapsed, leading to the bankruptcies of Walnut and ELCOA, which became the debtor corporations (or "the Debtors"). The companies filed Chapter 11 petitions, and the Debtors' management, which included members of the Shapiro family and their co-conspirators, were removed. The Bankruptcy Court then appointed a bankruptcy trustee. Thereafter, the trustee, pursuant to section 1102 of the Bankruptcy Code, 11 U.S.C. S 1102, appointed the Committee to represent the claims of unsecured creditors in connection with the bankruptcy proceedings. The Committee is comprised entirely of creditors; no member of the Debtors' former management is present.

On January 19, 1999, the Bankruptcy Court approved a Stipulation between the Committee and the Debtors authorizing, among other things, "the Committee to commence and prosecute... [l]instigation on behalf of the Debtors' estates." Stipulation Among the Debtors and the Official Committee of Unsecured Creditors of the Debtors Authorizing the Committee to Commence Litigation on Behalf of the Debtors' Estates, Bankr. No. 97-19699-DWS, at *2 (Bankr. E.D. Pa. Jan. 19, 1999). Under the Stipulation, the Committee effectively acquired all the attributes of a bankruptcy trustee for purposes of this case. See In re The Mediators, Inc., 105 F.3d 822, 826 (2d Cir. 1997) ("[T]he Committee, while not a trustee in bankruptcy, is in a position analogous to a trustee because it is suing on behalf of the debtor.").

On February 1, 1999, the Committee, on behalf of the Debtors' estates, commenced a civil action in the District Court for the Eastern District of Pennsylvania against the Debtors' officers, directors, affiliated companies (the Shapiro family and their network of companies), and outside professionals (Cogen and Lafferty) on the ground that the defendants, through their mismanagement of the Debtors and their participation in a fraudulent scheme, had "wrongfully expanded the [D]ebtors' debt out of all proportion of their ability to repay and ultimately forced the [D]ebtors to seek bankruptcy protection." The Committee brought claims against the Shapiros and their alleged co-conspirators -- including Cogen and Lafferty based upon violations of federal securities laws, as well as common law fraud and negligent misrepresentation, mismanagement and breach of fiduciary duty, breach of contract, professional malpractice, and aiding and abetting breach of fiduciary duty. In addition, the Committee brought claims against some defendants -- DelJean Shapiro, Lester Shapiro, Adam Varrenti, Jr., John Orr, and Philip Bagley --in their capacity as directors of either Walnut or ELCOA or both, asserting that they had mismanaged and breached their fiduciary duties to the Debtors by allegedly failing to supervise and oversee the Debtors' affairs.

All defendants (except Liss, who failed to appear) moved to dismiss the Committee's Amended Complaint or, alternatively, for summary judgment. On September 8, 1999, the District Court dismissed the claims against Cogen and Lafferty, reasoning that, "[s]ince it is pleaded that the [D]ebtors, acting through the Shapiros, perpetrated the Ponzi scheme... the doctrine of in pari delicto... bars [the Committee] from suing these defendants for claims arising out of the fraud." Official Committee of Unsecured Creditors v. William Shapiro, et al., No. 99-526, slip op. at 11 (E.D. Pa. Sept. 8, 1999). At the same time, however, the District Court denied the motion to dismiss as to the other defendants on the ground that in pari delicto did not preclude claims against corporate insiders. Id. at 12. Thereafter, the court severed the Committee's claims against Cogen and Lafferty, and the Committee appealed the dismissal of those claims. Cogen has settled with the Committee, leaving Lafferty as the only appellee.

The District Court had subject matter jurisdiction over the case under 28 U.S.C. SS 1331 and 1334(b). We have jurisdiction to hear the appeal under 28 U.S.C.S 1291.

We have plenary review over the District Court's dismissal of the Committee's claims against Lafferty. See Maio v. Aetna, Inc., 221 F.3d 472, 481-82 (3d Cir. 2000). We apply the same standard used by the District Court, namely, we must determine whether, under any reasonable reading of the pleadings, the Committee may be entitled to relief, accepting as true all well pleaded allegations in the Amended Complaint and drawing all reasonable inferences in favor of the Committee. Nami v. Fauver, 82 F.3d 63, 65 (3d Cir. 1996). The District Court's order granting the motion to dismiss will be affirmed only if it appears that the Committee can prove no set of facts that would entitle it to relief. Conley v. Gibson, 355 U.S. 41, 45-46 (1957).

As a preliminary matter, we believe that the District Court's conception of the standing issue in this case was somewhat flawed. The District Court stated that both cognizable injury and the doctrine of in pari delicto were elements of the standing analysis. Official Committee of Unsecured Creditors, No. 99-526, slip op. at 6. This formulation, however, was incorrect. In general,"[s]tanding consists of both a `case or controversy' requirement stemming from Article III, Section 2 of the Constitution, and a subconstitutional `prudential' element." See The Pitt News v. Fisher, 215 F.3d 354, 359 (3d Cir. 2000). An analysis of standing does not include an analysis of equitable defenses, such as in pari delicto. Whether a party has standing to bring claims and whether a party's claims are barred by an equitable defense are two separate questions, to be addressed on their own terms. See In re Dublin Secs., Inc., 133 F.3d 377, 380 (6th Cir. 1997) (analyzing in pari delicto separately from standing).

That said, we will address both doctrines because, together, they formed the basis of the District Court's judgment. As a threshold requirement, standing demands our initial attention. See Valley Forge Christian College v. Americans United for Separation of Church & State, Inc., 454 U.S. 464, 471-74 (1982) (discussing the fundamental requirement of standing). Citing Warth v. Seldin, 422 U.S. 490, 501 (1975), for the proposition that standing requires a "distinct and palpable injury," Lafferty argues that the Committee lacks standing because the Debtors have not sustained a "cognizable injury" separate and apart from any injury sustained by investors who had purchased the Debtors' debt securities. As such, Lafferty maintains that the Committee may not bring those claims under the Supreme Court's decision in Caplin v. Marine Midland Grace Trust Co., in which the Court held that a bankruptcy trustee has no standing to assert claims on behalf of an estate's creditors. See 406 U.S. 416, 434 (1972).

Lafferty made the same argument to the District Court, which rejected it on the ground that, at the motion to dismiss stage, the court could not foreclose the existence of a separately cognizable injury to the Debtors distinguishable from the injuries suffered by purchasers of the Debtors' certificates:

Here, the Committee is suing on behalf of the bankrupt debtor corporations [Walnut and ELCOA] -- not on behalf of the creditors themselves. The injury alleged is that "the debtors were fraudulently induced to register, offer and sell certificates when insolvent and thus without ability to repay their obligations to investors. As a result, the debtors' outstanding debt was continually expanded out of all proportion with their ability to repay, forcing them into bankruptcy." Compl. PP 1, 77.

. . . .

Defendants Cogen [ ] and Lafferty maintain that the alleged Ponzi scheme claims belong exclusively to the creditors, citing Hirsch v. Arthur Anderson & Co., 72 F.3d 1085 (2d Cir. 1995). [However, I believe that, w]hile the most obvious damages were those sustained by the creditors who purchased certificates [and securities], the possibility of a distinct and separate injury to the debtor corporations cannot be eliminated at this stage. See In re Plaza Mortg. and Fin. Corp., 187 B.R. 37, 41 (N.D. Ga. 1995) (denying motion to dismiss trustee's claims against accountants who participated in Ponzi scheme and distinguishing Hirsch where only allegation of injury was "unpaid obligations of the debtor to the creditors").

Official Committee of Unsecured Creditors, No. 99-526, slip. op. at 5, 7 (emphasis added).

We agree with the District Court's evaluation. With the exception of a single federal securities law claim, the Committee brought only state common law claims on behalf of the Debtors. According to the Amended Complaint, the defendants (including Lafferty), through their alleged fraud and participation in the scheme, injured the Debtors by "wrongfully expand[ing] the [D]ebtors' debt out of all proportion of their ability to repay and ultimately forc[ing] the [D]ebtors to seek bankruptcy protection." In other words, the Committee alleges an injury to the Debtors' corporate property from the fraudulent expansion of corporate debt and prolongation of corporate life. This type of injury has been referred to as "deepening insolvency." See, e.g., ALI-ABA Course of Study, Proximate Cause, Foreseeability, and Deepening Insolvency in Accountants' Liability Litigation, C994 ALI-ABA 201, 203 (1995).

As far as the state law claims are concerned, it is clear that, to the extent Pennsylvania law recognizes a cause of action for the Debtors against Lafferty, the Committee can demonstrate the injury required for standing to sue in federal court. Given Lafferty's arguments, the standing analysis then consists of three inquiries: (1) whether the Committee is merely asserting claims belonging to the creditors, (2) whether "deepening insolvency" is a valid theory giving rise to a cognizable injury under Pennsylvania state law, and (3) whether, as Lafferty contends, the injury is merely illusory.

A. Whether the Committee is merely asserting claims belonging to creditors

Whether a right of action belongs to the debtor or to individual creditors is a question of state law. Hirsch v. Arthur Andersen & Co., 72 F.3d 1085, 1093 (2d Cir. 1995). In Pennsylvania, as in almost every other state, "a corporation is a distinct and separate entity, irrespective of the persons who own all its stock." Barium Steel Corp. v. Wiley, 108 A.2d 336, 341 (Pa. 1954) (citations omitted); accord In re Erie Drug Co., 204 A.2d 256, 257 (Pa. 1964). From this principle arises a distinction between the property of a corporation and that of others. For example, with respect to shareholders,

[t]he fact that one person owns all of the stock does not make him and the corporation one and the same person, nor does he thereby become the owner of all the property of the corporation. The shares of stock of a corporation are essentially distinct and different from the corporate property.

Barium Steel, 108 A.2d at 341 (citations omitted); see also Meitner v. State Real Estate Comm'n, 275 A.2d 417, 419 (Pa. Commw. Ct. 1971) (stating that "officers of corporations are not deemed to be the owners of corporate property even to the extent that they are shareholders").

The legal fiction of corporate existence corresponds with the view that an injury to the corporate body is legally distinct from an injury to another person. Thus, it is well established, under Pennsylvania law, that where fraud, mismanagement, or other wrong damages a corporation's assets, a shareholder does not have a direct cause of action. Burdon v. Erskine, 401 A.2d 369, 370-71 (Pa. Super. Ct. 1979) (citation omitted). Rather, it is the corporate body that suffers the primary wrong and, consequently, it is the corporate body that possesses the right to sue. John L. Motley Assoc., Inc. v. Rumbaugh, 104 B.R. 683, 686-87 (E.D. Pa. 1989) (citations omitted) (describing Pennsylvania law). Thus, "an action to redress injuries to the corporation cannot be maintained by an individual shareholder, but must be brought as a derivative action in the name of the corporation." Id. (citations omitted) (describing Pennsylvania law); see also 12 Summary of Pennsylvania Jurisprudence Business Relationships S 7:90 (2d ed. 1993) ("creditors claiming a beneficial interest in the corporation... may not[even] maintain a derivative action").

It follows from this discussion that a corporation can suffer an injury unto itself, and any claim it asserts to recover for that injury is independent and separate from the claims of shareholders, creditors, and others. We think it is irrelevant that, in bankruptcy, a successfully prosecuted cause of action leads to an inflow of money to the estate that will immediately flow out again to repay creditors:

The... assertion that this action will benefit creditors is not an admission that this action is being brought on their behalf. In a liquidation case, it is commonplace for a trustee to pursue an action on behalf of the debtor in order to obtain a recovery thereon for the estate. If the trustee is successful in the action, the recovery which he obtains becomes property of the estate and is then distributed pursuant to the scheme established by S 726(a). Simply because the creditors of a[n] estate may be the primary or even the only beneficiaries of such a recovery does not transform the action into a suit by the creditors. Otherwise, whenever a lawsuit constituted property of an estate which has insufficient funds to pay all creditors, the lawsuit would be worthless since under Caplin it could not be pursued by the trustee.

In re: Jack Greenberg, Inc., 240 B.R. 486, 506 (Bankr. E.D. Pa. 1999); accord Scholes v. Lehmann, 56 F.3d 750, 754 (7th Cir. 1995) ("That the return would benefit the limited partners is just to say that anything that helps a corporation helps those who have claims against its assets.").

In the instant case, the Committee sought recovery of damage to the Debtors' property from "deepening insolvency." We see no indication that the Committee is attempting to recover for injuries to the creditors. Cf. Caplin, 406 U.S. at 434 (holding that a trustee may not assert claims on behalf of creditors). Therefore, accepting the allegations as true and drawing all reasonable inferences in favor of the Committee, we conclude that the claims here belong to the Debtors, rather than to the creditors.

B. Whether "deepening insolvency" is a valid theory that gives rise to a cognizable injury under state law

Having established that the Committee brought claims on behalf of the Debtors, rather than the creditors, we must now determine whether the alleged theory of injury--"deepening insolvency" -- is cognizable under Pennsylvania law. Neither the Pennsylvania Supreme Court nor any intermediate Pennsylvania court has directly addressed this issue. In the absence of an opinion from the state's highest tribunal, we must don the soothsayer's garb and predict how that court would rule if it were presented with the question. See Wiley v. State Farm Fire & Casualty Co., 995 F.2d 457, 459 (3d Cir. 1993). Indeed, because no state or federal courts have interpreted Pennsylvania law on this subject, we will rely predominantly on decisions interpreting the law of other jurisdictions and on the policy underlying Pennsylvania tort law to make this prediction. See Gruber v. Owens-Illinois, Inc., 899 F.2d 1366, 1369-70 (3d Cir. 1990) (noting possible sources of authority for making a prediction).

Drawing guidance from these authorities, we conclude that, if faced with the issue, the Pennsylvania Supreme Court would determine that "deepening insolvency" may give rise to a cognizable injury. First and foremost, the theory is essentially sound. Under federal bankruptcy law, insolvency is a financial condition in which a corporation's debts exceed the fair market value of its assets. 11 U.S.C. S 101(32). Even when a corporation is insolvent, its corporate property may have value. The fraudulent and concealed incurrence of debt can damage that value in several ways. For example, to the extent that bankruptcy is not already a certainty, the incurrence of debt can force an insolvent corporation into bankruptcy, thus inflicting legal and administrative costs on the corporation. See Richard A. Brealey & Stewart C. Myers, Principles of Corporate Finance 487 (5th ed. 1996) ("[B]y issuing risky debt,[a corporation] give[s] lawyers and the court system a claim on the firm if it defaults."). When brought on by unwieldy debt, bankruptcy also creates operational limitations which hurt a corporation's ability to run its business in a profitable manner. See id. at 488-89. Aside from causing actual bankruptcy, deepening insolvency can undermine a corporation's relationships with its customers, suppliers, and employees. The very threat of bankruptcy, brought about through fraudulent debt, can shake the confidence of parties dealing with the corporation, calling into question its ability to perform, thereby damaging the corporation's assets, the value of which often depends on the performance of other parties. See Michael S. Knoll, Taxing Prometheus: How the Corporate Interest Deduction Discourages Innovation and Risk-Taking, 38 Vill. L. Rev. 1461, 1479-80 (1993). In addition, prolonging an insolvent corporation's life through bad debt may simply cause the dissipation of corporate assets.

These harms can be averted, and the value within an insolvent corporation salvaged, if the corporation is dissolved in a timely manner, rather than kept afloat with spurious debt. As the Seventh Circuit explained in Schacht v. Brown:

[C]ases [that oppose "deepening insolvency"] rest[ ] upon a seriously flawed assumption, i.e., that the fraudulent prolongation of a corporation's life beyond insolvency is automatically to be considered a benefit to the corporation's interests. This premise collides with common sense, for the corporate body is ineluctably damaged by the deepening of its insolvency, through increased exposure to creditor liability. Indeed, in most cases, it would be crucial that the insolvency of the corporation be disclosed, so that shareholders may exercise their right to dissolve the corporation in order to cut their losses. Thus, acceptance of a rule which would bar a corporation from recovering damages due to the hiding of information concerning its insolvency would create perverse incentives for wrong-doing officers and directors to conceal the true financial condition of the corporation from the corporate body as long as possible.

711 F.2d 1343, 1350 (7th Cir. 1983) (citations omitted) (emphasis added).

Growing acceptance of the deepening insolvency theory confirms its soundness. In recent years, a number of federal courts have held that "deepening insolvency" may give rise to a cognizable injury to corporate debtors. See, e.g., id. (applying Illinois law and holding that, where a debtor corporation was fraudulently continued in business past the point of insolvency, the liquidator had standing to maintain a civil action under racketeering law); Hannover Corp. of America v. Beckner, 211 B.R. 849, 854-55 (M.D. La. 1997) (applying Louisiana law and stating that"a corporation can suffer injury from fraudulently extended life, dissipation of assets, or increased insolvency"); Allard v. Arthur Andersen & Co., 924 F. Supp. 488, 494 (S.D.N.Y. 1996) (applying New York law and stating that, as to suit brought by bankruptcy trustee, "[b]ecause courts have permitted recovery under the `deepening insolvency' theory, [defendant] is not entitled to summary judgment as to whatever portion of the claim for relief represents damages flowing from indebtedness to trade creditors"); In re Gouiran Holdings, Inc., 165 B.R. 104, 107 (E.D.N.Y. 1994) (applying New York law, and refusing to dismiss claims brought by a creditors' committee because it was possible that, "under some set of facts two years of negligently prepared financial statements could have been a substantial cause of[the debtor] incurring unmanageable debt and filing for bankruptcy protection"); Feltman v. Prudential Bache Securities, 122 B.R. 466, 473 (S.D. Fla. 1990) (stating that an " `artificial and fraudulently prolonged life... and... consequent dissipation of assets' constitutes a recognized injury for which a corporation can sue under certain conditions", but concluding that there was no injury on the facts). Some state courts have also recognized the deepening insolvency theory. See, e.g., Herbert H. Post & Co. v. Sidney Bitterman, Inc., 219 A.D.2d 214 (N.Y. App. Div. 1st Dep't 1996) (applying New York law and allowing a malpractice claim for failing to detect embezzlement that weakened a company, which already was operating at a loss, thereby causing default on loans and forcing liquidation); Corcoran v. Frank B. Hall & Co., 149 A.D.2d 165, 175 (N.Y. App. Div. 1st Dep't 1989) (applying New York law and allowing claims for causing a company to "assume additional risks and thereby increase the extent of its exposure to creditors").

Significantly, one of the most venerable principles in Pennsylvania jurisprudence, and in most common law jurisdictions for that matter, is that, where there is an injury, the law provides a remedy. See 37 Pennsylvania Law Encyclopedia, Torts S 4, at 120 (1961) ("For every legal wrong there must be a correlative legal right.") (citation omitted). Thus, an identifiable and compensable injury is essential to the existence of tort liability, Schweitzer v. Consolidated Rail Corp., 758 F.2d 936, 942 (3d Cir. 1985), but once an injury has occurred, "tort law attempts to place the injured party in the same position he occupied before the injury," Hahn v. Atlantic Richfield Co., 625 F.2d 1095, 1104 (3d Cir. 1980) (construing Pennsylvania tort policy). Similarly, where a contractual "breach occurs, contract law seeks to give to the non-breaching party the benefit of his or her bargain, to put him or her in the position he or she would have been in had there been no breach." 1 Summary of Pennsylvania Jurisprudence Torts S 1.1 (2d ed. 1999). Thus, where "deepening insolvency" causes damage to corporate property, we believe that the Pennsylvania Supreme Court would provide a remedy by recognizing a cause of action for that injury.

Lafferty challenges the strong rationales for recognizing an injury here, citing a few cases that it claims reject "deepening insolvency." In our view, the majority of these cases do not address "deepening insolvency," but rather, simply apply the Supreme Court's holding in Caplin that a bankruptcy trustee has no standing to assert claims on behalf of creditors. See, e.g., Hirsch v. Arthur Andersen & Co., 72 F.3d 1085, 1093-94 (2d Cir. 1995); E.F. Hutton & Co. v. Hadley, 901 F.2d 979, 986-87 (11th Cir. 1990); Williams v. California 1st Bank, 859 F.2d 664, 666-67 (9th Cir. 1988). These decisions are not relevant to the present case because, as we explained earlier, the Committee is proceeding on behalf of the Debtors, not the creditors. Moreover, to the extent that either the cases cited by Lafferty or other cases suggest that a corporation may never sue to recover damages resulting from the fraudulent prolongation of its life past solvency, we believe, under the same analysis conducted by the Seventh Circuit in Schacht, that Pennsylvania courts would reject them.

We pause here to consider the 19th century case of Patterson v. Franklin, 35 A. 205 (Pa. 1896), an arguably applicable decision of the Pennsylvania Supreme Court. In Patterson, an assignee standing in the shoes of an insolvent corporation brought suit against the incorporators, claiming that they had allegedly made false representations in the statement of incorporation. Id. at 206. Apparently, the false representations had allowed the corporation to contract more debts. Id. On these allegations, the Pennsylvania Supreme Court affirmed the dismissal of the assignee's claims, reasoning that, because the assignee had alleged that the corporation had benefitted from the representations, there was no viable cause of action. Id.

In our view, Patterson is not controlling here. The Patterson court never expressly considered the "deepening insolvency" theory, as the opinion does not indicate that the assignee presented any version of that argument to the court. In fact, it seems that the assignee in Patterson had not even alleged an injury to the corporation at all:

The fraud was perpetrated for its benefit. It was a gainer, not a loser because of it. It was given a considerable credit by the statement to which, as it is alleged, it had no claim whatever.

Id. (emphasis added). Thus, given the allegations in the case, it was perfectly reasonable for the court in Patterson to affirm the dismissal. See also Kinter v. Connolly, 81 A. 905, 905 (Pa. 1911) (rejecting receiver's claim on behalf of the corporation against the directors for fraudulent statements that induced parties to do business with the corporation because "there [was] no averment that any act or omission of those of the defendants who demur caused loss or injury to the [corporation].").

Our reading of Patterson is informed in part by its age. In the hundred-plus years between that decision and the present, the business practices of corporations in the United States have changed quite dramatically. Likewise, society's understanding of corporate theory has grown. See William W. Bratton, Jr., The New Economic Theory of the Firm: Critical Perspectives from History, 41 Stan. L. Rev. 1471, 1482-1501 (1989) (describing the evolution of corporations over the last two centuries); see also Henry Hansmann & Reinier Kraakman, The End of History for Corporate Law, 89 Geo. L.J. 439, 440-49 (2001) (describing the history of models for corporate structure and governance). Therefore, we decline to draw any broad principle from Patterson, a decision which did not directly address "deepening insolvency."

In sum, we believe that the soundness of the theory, its growing acceptance among courts, and the remedial theme in Pennsylvania law would persuade the Pennsylvania Supreme Court to recognize "deepening insolvency" as giving rise to a cognizable injury in the proper circumstances. We now apply this conclusion to the allegations presented in this case.

C. Whether, as Lafferty contends, the injury is merely illusory

At oral argument, Lafferty observed that, under the Ponzi scheme alleged in the Committee's Amended Complaint, any fraudulent debt certificates issued by the Debtors would have created a capital flow into the Debtors, allowing them to pay the perpetrators of the fraud, the Shapiros, who were at the top of the pyramid. Stated in slightly different terms, we understand Lafferty to be saying that any injury to the Debtors caused by deepening insolvency might be considered illusory because that injury passed directly to the sole shareholders and wrongdoers, the Shapiro family. See, e.g., Feltman, 122 B.R. at 473-74 (accepting "deepening insolvency" but concluding that, because a corporation was fictitious, any injury to it was illusory). As we discussed earlier, so long as the corporate form is respected, the alleged "deepening insolvency" injury to the property of the Debtors cannot be regarded as equivalent to the Shapiro family's shareholder interest. See Barium Steel, 108 A.2d at 341 (corporate property is distinct from shareholder property); John L. Motley Assoc., 104 B.R. at 686-87 (causes of action for damage to corporate property belong to the corporation). Thus, we think that Lafferty is essentially asking us to disregard the corporate existence of Walnut, whose status separates the Debtors' property, and hence, the alleged injury from the Shapiro family's shareholder interest.3

As a result, Lafferty's argument implicitly invokes the "piercing the corporate veil" doctrine, which treats a corporation and its shareholders as identical for purposes of suit, thereby imposing personal liability on shareholders. See Kiehl v. Action Mfg. Co., 535 A.2d 571, 574 (Pa. 1987). We doubt that the Pennsylvania Supreme Court would apply any form of the doctrine here. The present issue, after all, involves the defendant Lafferty invoking the doctrine to demonstrate the lack of injury to the Debtors, whereas in the standard scenario the plaintiff invokes the "piercing the corporate veil" doctrine to impose liability on shareholders. Even assuming, for argument's sake, that the Pennsylvania Supreme Court would consider the merits of the corporate veil doctrine here, we think that, given the pleadings, the court would not disregard Walnut's corporate form and would not find the alleged injury to the Debtors to be illusory.

In Pennsylvania, "courts will disregard the corporate entity only in limited circumstances when [the form is] used to defeat public convenience, justify wrong, protect fraud or defend crime." Kiehl, 535 A.2d at 574. This is a stringent inquiry. "[C]court[s] must start from the general rule that the corporate entity should be recognized and upheld, unless specific, unusual circumstances call for an exce