Commercial Litigation and Arbitration

Expert Testimony on “Zone of Insolvency” Rejected under Daubert as Unreliable — Phrase Has No Accepted Meaning and There Is No Accepted Methodology to Test It

From Kipperman v. Onex Corp., 2009 U.S. Dist. LEXIS 71666 (N.D. Ga. Aug. 13, 2009):

Logue testified that ABCO/Magnatrax was in a "zone of insolvency" at the time of the ABCO and Republic acquisitions. *** Defendants contend that this testimony is inadmissible, in part, because there is no scientifically accepted definition of, or methodology for calculating, the "zone of insolvency" among financial experts or legal scholars.

Logue does not define "zone of insolvency" in his report. Logue testified extensively to his understanding of "zone of insolvency" in his deposition. *** Logue defined the "zone" as "an inability to pay your bills when they're due, the probability of running afoul of the bank covenants, pretty small equity capital for the size of the company that you have." *** Logue could not identify any financial valuation textbook, article, or treatise defining the term "zone of insolvency," rather he claimed that it was a term of art that he has seen develop in the last year or two in contexts like this case. *** Logue had not personally seen the term used in any contemporaneous solvency valuation, but he claimed other people told him they had used it in such valuations. *** Logue testified that he had never used the term in a solvency evaluation before and that he had never been a part of a case where an expert had done so. *** Logue identified the "zone" as "subjective" and "a judgment call." ** He stated that if "solvency" was a snapshot, then one should think of the "zone" as a video camera or "a general landscape." *** The zone was a "mosaic" in which one "must consider not only today but what might happen in the not too distant future." *** Logue explained the "zone" as a range, but he admitted that he had not quantified that range in his report and he could not give a specific range. *** When asked how close to the line a company must be to be in the "zone" in a quantifiable way, Logue testified that it would differ depending on the company and the investment opportunity. ***

The court has researched the term "zone of insolvency" or "vicinity of insolvency" and finds that it arose out of a footnote in Credit Lyonnais Bank Nederland, N.V. v. Pathe Communications Corp., No. 12150, 1991 Del. Ch. LEXIS 215, 1991 WL 277613, * 34 n.55 (Del Ch. Dec. 30, 1991) addressing the decision-making process of directors in a financially strained company. The court can find no opinion written since Credit Lyonnais which has explicitly defined "zone of insolvency," and rather repeatedly sees this term referred to as "hazy," "ill defined," or "confusing." In re Teleglobe Communications Corp., 493 F.3d 345, 356 n.9 (3rd Cir. 2007); Production Resources Group, L.L.C. v. NCT Group, Inc., 863 A.2d 772, 790 n.56 (Del. Ch. 2004).

The court finds that Logue's testimony that ABCO/Magnatrax was in the "zone of insolvency" at the time of the ABCO and Republic acquisitions is unreliable. Logue has admitted that his conclusions as to the "zone" cannot be tested because they are based upon a subjective judgment call. Logue further admits that he has never seen the term in an article or treatise related to valuations and that he has not personally seen his peers use it in valuations. Logue contends that he is aware of other professionals using it but cannot point specifically to any work by other experts that he has reviewed. Logue cannot quantify the term in any way, and although he appears to contend in parts of his testimony that the zone is "a range," he admits in later portions that he is unable to provide Defendants with such a range or indicate any particular rate of error in calculating such a range. Aside from Logue's testimony, the court's own exploration of the case law makes clear that there is no generally accepted meaning for the term "zone of insolvency."

The court finds that any testimony regarding a "zone of insolvency" is unreliable and will not allow Plaintiff to rely on any testimony by Logue that the Debtors were in a "zone of insolvency." This holding does not prevent Plaintiff from offering testimony that the Debtors could not pay their debts when due, were statutorily "insolvent," or that they had unreasonably small amount of capital in which to operate their business; it merely prevents Plaintiff from using the term "zone of insolvency."

Share this article:


Recent Posts