The Debtor's 'Insolvency' for Avoidance Actions

There is, however, no precise definition of “insolvency” that is used consistently in a bankruptcy context. The term “insolvency” is defined in section 101(32) of the Bankruptcy Code, as a “financial condition such that the sum of [an] entity's debts is greater than all of such entity's property, at a fair valuation.” This “balance sheet” test, while most consistently invoked in the preference and fraudulent transfer sections of the Code, has also been applied in the context of a cause of action for “deepening insolvency,” see, e.g., Official Committee v. R.F. Lafferty & Co., Inc., 267 F.3d 340, 349 (3d Cir. 2001), as well as in causes of action involving the so-called “zone of insolvency,” see, e.g., In re Brentwood Lexford Partners, LLC, 292 B.R. 255 (Bankr. N.D. Tex. 2003). Additionally, while the Code currently imposes no explicit insolvency threshold for filing voluntary and involuntary petitions, the issue frequently arises in that context where the good faith of the filing is questioned. See, e.g., In re Sullivan County Regional Refuse Disposal Dist., 165 B.R. 60 (Bankr. D.N.H. 1994).

The definition of “insolvency” is also important in the avoidance context, which includes both preferential transfers and fraudulent conveyances. In order for a transfer to be avoidable as a preference under Section 547, it must, among other things, have occurred “while the debtor was insolvent.” 11 U.S.C. ' 547(b)(3). With respect to avoidable fraudulent transfers under Section 548, constructive fraud can be established if the debtor received “less than reasonably equivalent value for such transfer” and was “insolvent on the date such transfer occurred … or became insolvent as a result of such transfer.” 11 U.S.C. ' 548(a)(1)(B)(ii)(I).