Free Letter - District Court of Delaware - Delaware

Case 1:04-cv-01551-JJF Document 91 Filed 05/30/2006 Page 1 of 3
Monnrs, NICHOLS, ARSHT & TUNNELL LLP
1201 Noxru Mnnxxrr Srmzxr
P.O. Box 1347
WILMINGTON, Dmnwamz 19899-1347
302 658 9200
DANIEL B_ Bm 302 658 3989 FAX
302 351 9348
302 425 4671 Fu
[email protected]
May 30, 2006
VIA HAND DELIVERY
The Honorable Joseph J. Farnan, Jr.
United States District Court
District of Delaware
844 N. King Street
Room 4124, Lockbox 27
Wilmington, DE 19801
RE: Stanziale v. Pepper Hamilton, g _aL, No. O4-1551
Royal Indemnity Co. .v. Pepper Hamilton LLP, et g, No. 05-165
Dear Judge Faman:
As counsel for defendants Pepper Hamilton LLP and W. Roderick Gagné (the
"Pepper Defendants") in the above-captioned actions, we write pursuant to Local Rule 7.1 .2(c) to
call the Court’s attention to the opinion issued on May 26, 2006 by the Court of Appeals for the
Third Circuit in Seitz v. Detweiler, Hershey and Associates, P. C. (In Re: CitX Corp.), No. 05-
2760, 2006 U.S. App. LEXIS 13141 (3d Cir. May 26, 2006) (a copy of the opinion is enclosed).
The Third Circuit’s holding in Seitz bars one of Royal’s claims against the Pepper Defendants
and significantly reduces the damages that the Trustee may pursue.
In Seitz, the trustee of a bankrupt corporation sued the debtor’s former
accountants for, among other things, malpractice and deepening insolvency. Id. at *7. The
trustee alleged that the accormtants: (1) should have known that the debtor was insolvent and,
therefore, committed malpractice by issuing financial statements suggesting that the debtor was
solvent, and (2) deepened the debtor’s insolvency by providing incorrect financial statements
that the debtor used to incur additional debt. Id. at *4, *11. The Court of Appeals upheld the
trial court’s entry of summary judgment on behalf of the accountants on both claims and, in so
doing, made several pronouncements that directly impact this case.

Case 1 :04-cv-01551-JJF Document 91 Filed 05/30/2006 Page 2 of 3
The Honorable Joseph J. Faman, Jr.
May 30, 2006
Page 2
First, Seitz bars Royal’s deepening insolvency claim. The Court of Appeals held
that a deepening insolvency claim is the property of a debtor corporation: "Because deepening-
insolvency claims are brought on behalf of the debtor corporation, deepening insolvency can
only be a claim under Bankruptcy Code § 541." Id. at *7, n.6. Royal, a creditor of SFC, cannot
bring claims on behalf of the debtor and has no authority to pursue § 541 claims. Therefore,
Royal lacks standing to pursue its deepening insolvency claim against the Pepper Defendants.]
Second, the Seitz opinion does away with the Trustee’s primary damages theory.
In its discussion of O)j‘icial Committee of Unsecured Creditors v. R. F Lajferty & C0., 267 F.3d
340 (3d Cir. 2001), the case in which the Third Circuit predicted that Pennsylvania would
recognize a cause of action for deepening insolvency, the Seitz Comt noted that Lcyj%rty’s
prediction has generated much controversy but concluded that "we cannot revisit the correctness
of that interpretation of Pennsylvania law" because only the Court of Appeals en banc may
overrule a prior decision. Id. at *19, n.ll. The Court of Appeals went on to explain, however,
that "we never held that [deepening insolvency] was a valid theory of damages for an
independent cause of action. [Layjerty] should not be interpreted to create a novel theory of
damages for an independent cause of action like malpractice." Id. at *10-11.2 Here, the only tort
claims that remain in the Trustee’s suit against the Pepper Defendants are claims for malpractice
and breach of fiduciary duty. Therefore, under Seitz, the Trustee may not recover deepening
insolvency damages, which make up the vast majority of the Trustee’s alleged damages. See
Trustee’s Amended Complaint 1]]] 203, 246 (alleging that the Trustee’s damages stem from the
fact that "SFC was ultimately driven into insolvency and operated well beyond the point of
insolvency . . .").
I The Pepper Defendants previously moved to dismiss Royal’s deepening insolvency claim
arguing, among other things, that Royal lacked standing to pursue the claim. On March
31, 2006, this Court entered an Order denying the motions to dismiss. Although the
Pepper Defendants are cognizant that, until the Court issues its anticipated opinion in
support of the Order they will not have the benefit of the Court’s analysis on the standing
issue, the Pepper Defendants respectfully submit that the Third Circuit’s holding in Seitz
bars Royal’s deepening insolvency claim. The Pepper Defendants also are guided by this
Court’s holding in the Stanziale case, which was cited with approval in Seitz, that the
Trustee has standing to bring a deepening insolvency claim. See Stanziale v. Pepper
Hamilton LLP (In Re: Student Finance Corp.), 335 B.R. 539, 548 (D. Del. 2005) (F aman,
J .).
2 The Cotut of Appeals also limited its holding in Layfzrty to claims arising under
Pennsylvania law: "nothing we said in La]j’erty compels any extension of the [deepening
insolvency] doctrine beyond Permsy1vania." Id. at *19, n.11.

Case 1 :04-cv-01551-JJF Document 91 Filed 05/30/2006 Page 3 of 3
The Honorable Joseph J. Faman, Jr.
May 30, 2006
Page 3
Finally, the Seitz opinion calls into question another of the arguments Royal used
to support its deepening insolvency claim. The Court of Appeals held that "a claim of
negligence cannot sustain a deepening insolvency cause of action." Id. at *21. In its Amended
Complaint, Royal alleged that the` Pepper Defendants made negligent and fraudulent
misrepresentations. The Pepper Defendants argued, among other things, that Royal failed to
plead fraud with sufficient particularity. If this Comt, in denying the Pepper Defendants’
motion, agreed that Royal had not sufficiently pleaded fraud but declined to dismiss Royal’s
deepening insolvency claim because Royal also alleged negligence, Seitz makes clear that
Royal’s negligence allegations no longer support its deepening insolvency count.
The Pepper Defendants would welcome the oppommity to discuss the impact of
the Seitz opinion on the cases before the Court at the hearing scheduled for June 1. The Pepper
Defendants also would be happy to submit any additional briefing that the Court may desire.
Respectfully Yours,
DBB/clh .
Enc.
cc: All counsel on attached service list
522552 .