outstanding indebtedness of $25,314, which is uncollectible. This is the remaining balance from the cash advances made in the prior years by Commonwealth to Madison.
Since the transactions complained of appear not to have been at arm's length, the burden is on the defendants to prove the fairness of these transactions. However, defendants, again, have failed to offer any credible evidence of the fairness or propriety of these transactions, other than their own assertion that they never personally received any money from Madison Agency. Thus, they have failed to meet their burden of proving the fairness of such transactions. Accordingly, we hold that as a result of the transactions with Madison Agency, the defendants are liable for the sum of $78,575.
SUPREME FILMS CORPORATION
Defendant Gerber, in his capacity as an attorney, incorporated Supreme Films, and admits that he is probably an officer and director; but does not remember the exact details.
Defendant Thal also admits that he may have known that Gerber was an officer and director, and perhaps a shareholder.
In June, 1965 and March 1967, advances were made by Commonwealth, through Quaker, to Supreme Films totaling $50,000.
At the time the reorganization petition was filed, the amount of this indebtedness, including accrued interest, was $51,001. At the time the reorganization was completed, this amount was still outstanding and no payments had been made.
The loan was secured by a lien on a film called, "Man on a Hook", with an option to convert the indebtedness into 45% of the outstanding shares of Supreme Films, at a dollar a share.
Since the transaction complained of appears not to have been at arm's length, we hold that the burden is on the defendants to prove the fairness of this transaction. Defendants, in attempting to explain this transaction, state without any supporting evidence, that prior to the reorganization, some payments had been made on the loan.
However, they offered no testimony or evidence to show that the loans from Commonwealth to Supreme Films were made in the best interest of Commonwealth. In addition, it appears that defendants had no knowledge of the film business, nor did they make any independent investigation into the ability or stability of Supreme Films.
Thus, they have not met their burden. Accordingly, we hold that as a result of advances to Supreme Films, the defendants are liable in the amount of $51,001.
MERCURY BOOKS, INC.
Defendant Gerber was a stockholder in Mercury Books.
The defendants admitted that they controlled the affairs of Mercury Books by stating that they used it merely as a conduit for the transaction with Commonwealth.
On December 29, 1964, Commonwealth advanced $24,000 to Mercury.
In return, Mercury gave Commonwealth a note, secured by 2,400 shares of Class A preferred stock of Commonwealth Corporation, $10 par value.
On August 31, 1967, this indebtedness was cancelled for the redemption of the 2,400 shares.
As stated before, this was at a time when defendants knew that Commonwealth was experiencing substantial financial difficulties.
However, defendants claim that the transaction caused no harm to Commonwealth. They state that the indebtedness arose in 1964 in fulfillment of a pledge to redeem stock on demand from Plymouth Mutual Life Insurance Company.
Mercury Books was simply used as a vehicle to accomplish that transaction. As evidence of this, they point to the check from Commonwealth to Mercury, dated December 29, 1964. It is endorsed "for deposit only to the account of Plymouth Mutual Life Insurance Co. -- payment for purchase of 2,400 shares of Class A preferred Commonwealth Financial Corporation stock." Defendants maintain that this is evidence that no funds of Commonwealth ever remained with Mercury. The transaction on August 31, 1967, merely completed the bookkeeping entries for this 1964 transaction.
Even if we assumed that this description of the transaction by the defendants is accurate, an investigation of the underlying transaction in 1964 also shows self-dealing.
The net effect of this 1964 transaction was to redeem $24,000 worth of stock from Plymouth Mutual. The record shows that immediately before this, defendant Gerber had resigned as an officer and director of Plymouth Mutual in November, 1964.
The transaction in question took place on December 29, 1964. Defendants testified that Commonwealth had pledged to Plymouth to redeem the stock on demand. This pledge was made while defendant Gerber was still an officer and director of Plymouth.
Thus, the transaction of December 29th was predicated upon an earlier agreement with Plymouth, which occurred during a time when defendant did occupy a position as an officer and director of Plymouth.
Because of defendant Gerber's relationship to both Mercury Books and Plymouth Mutual, and the suspicious circumstances of these transactions; they do not appear to be arm's length bargains. Thus, the burden is on the defendants to prove the fairness of these transactions to Commonwealth. Since there is no evidence of the propriety of these transactions, defendants have not met their burden. Accordingly, we hold that as a result thereof, defendants are liable for the sum of $24,000.
ARIZONA INVESTMENT COMPANY; HARRISON REALTY CORPORATION; and TEMPLE MORTGAGE AND INVESTMENT COMPANY
On December 14, 1962, the defendants caused Commonwealth to make advances in the following amounts: $300,000 to Arizona Investment Company; $100,000 to Harrison Realty Corporation; and $100,000 to Temple Mortgage and Investment Company.
Defendants admit that they controlled and dominated these three companies.
Defendants respond that the transaction was merely a device to issue debentures to Safeguard Mutual Insurance Company. However, in unraveling the facts of this transaction, it appears to this court to be one of the most devious, circuitous and complicated methods of issuing debentures that could be devised. The net effect of which was to bleed $500,000 of the assets of Commonwealth out of the corporate treasury and into corporations controlled and dominated by the defendants. The $500,000 in question was transferred from Temple, Arizona and Harrison in varying amounts to Plymouth Mutual Life Insurance Company, the West Indies Bank, United Services Association, United National Insurance Company, and the F.D.R. Foundation.
Defendants controlled and dominated all of these corporations and/or held fiduciary positions with them.
These five organizations then returned the cash to Commonwealth in exchange for $500,000 worth of debentures.
Three hundred and fifty thousand dollars worth of these debentures were later sold by these various corporations for cash to the Safeguard Mutual Insurance Company.
The other $150,000 worth of debentures, or at least a major portion of them, were eventually redeemed by Commonwealth for cash.
Thus, the cash ended up in the hands of corporations controlled and dominated by the defendants. In a collateral transaction, defendants caused Commonwealth to purchase accounts receivable from National Investment Securities Corporation for $350,000.
Defendants admit that they did not check the validity of this paper.
As part of the deal, they received a guarantee of the accounts from Safeguard Mutual. Commonwealth then held the debentures as security for this guarantee, and as the accounts receivable became due and were not paid, they merely redeemed the debentures and cancelled the debt.
The testimony in the case shows that the viability and validity of the accounts were highly suspicious.
Thus, the net effect of the transaction was to allow Safeguard to rid itself of questionable accounts and to transfer $500,000 from Commonwealth to organizations controlled and dominated by the defendants.
Suffice it to say, that in such a transaction, the burden is on the defendants to attempt (if they possibly could) to explain or to show the fairness of this transaction to Commonwealth. Defendants' only response is to look at one side of the transaction and state that the $500,000 cash lent to Arizona, Harrison and Temple was returned four days later to the treasury of Commonwealth. They ignored the fact that the corresponding transactions left $500,000 in unpaid notes owing to Commonwealth, and $500,000 in outstanding debentures, the large portion of which was eventually redeemed for cash via the Safeguard Mutual guarantee of accounts receivable and outright redemption. On the other hand, plaintiffs would have us hold defendants liable not only for the $500,000, but also for the $350,000 which Commonwealth put out to National Investment Securities for the purchase of worthless accounts receivable. We cannot go this far, for the transactions involved must be looked at with a view towards the overall effect to Commonwealth. The transactions were all part of one overall "deal" which had the net effect of increasing Commonwealth's liabilities by $500,000 in exchange for worthless notes. Accordingly, we find that as a result of these transactions, the defendants are liable in the amount of $500,000.
UNITED NATIONAL INSURANCE COMPANY
On or about February 11, 1963, and August 29, 1963, the defendants caused Commonwealth to transfer the sums of $50,000 and $100,000, respectively, to the United National Insurance Company.
The defendant Gerber was an officer, director and stockholder of the United National Insurance Company.
Since this transaction does not appear to have been an arm's length bargain, the burden is on the defendants to prove its fairness to Commonwealth. The $100,000 paid on August 29, 1963, was purportedly in exchange for accounts worth in excess of $103,000.
However, by defendant Gerber's own admission, this was a fictitious transaction.
The money was deposited to the "United National Special Account" which defendants in the other transaction maintain had no connection with United National. Again, defendants claim that Commonwealth suffered no loss as a result of this, and defendants maintain that the money in fact was repaid.
However, they again offer no evidence
in support of this assertion other than their own incredulous statements that it in fact was repaid. As to the $50,000, defendants maintain that it was deposited to United National Insurance Company special account, and that the special account had nothing to do with United National Insurance Company, but was in fact an account maintained for the benefit and use of Commonwealth Financial Corporation and had nothing to do with United National Insurance Company.
This $50,000, according to defendants, was supposedly for the redemption of Commonwealth capital notes from another party, and had nothing to do with United.
But again, they put forth no credible evidence that this was the case. Accordingly, we find that the defendants have not met their burden and that as a result of these transactions with United National Insurance Company, they are liable in the sum of $150,000.
TRANSACTIONS ALLEGING BREACH OF DUTY
CLARK INSURANCE COMPANY
On September 27, 1965, Commonwealth advanced to C.M. Clark Insurance Company $25,000, and again on December 21, 1966, Commonwealth advanced a second $25,000 to C. M. Clark.
As of August 31, 1967, there was outstanding from C. M. Clark an indebtedness of $22,500, plus $450 accrued interest. On that date, this indebtedness was cancelled in exchange for the redemption of 2,295 shares of Class A preferred stock -- $10.00 par value.
The transaction complained of appears to be an arm's length one. Thus, the burden is on the plaintiffs to show that defendants breached their duty of care in managing the corporate affairs. In the Clark Insurance transactions, we have the situation where the defendants caused a valid obligation owed to Commonwealth by C. M. Clark to be cancelled, in exchange for a redemption of stock for which there was no obligation to redeem. This, at a time when defendants knew of the financial difficulties of Commonwealth.
Under either the common law or Pennsylvania law, as expressed in Selheimer v. Manganese Corporation of America, supra it is clear that defendants have breached their duty. To engage in such a transaction under circumstances existence on August 31, 1967, is certainly not in the best interest of Commonwealth. It appears that the defendants, prior to abandoning the sinking ship, were attempting to divert every penny of assets remaining in Commonwealth that they could possibly get away with. Accordingly, we hold that as a result of the transactions with C.M. Clark Insurance Company, the defendants are liable in the amount of $22,950.
FOAM CORE CORPORATION
Prior to August 31, 1967, Commonwealth had advanced various sums of money to Foam Core.
On August 31, 1967, the outstanding indebtedness was $5,100, plus $250 accrued interest, in exchange for the redemption of capital stock.
This transaction is similar to the one involving C.M. Clark Insurance Co. There has been no showing that the defendants had any interest in Foam Core.
Thus, the burden is on the plaintiffs to prove the defendants' breach of duty. As with the Clark Insurance transaction, we find that the defendants have breached their duty. For no apparent reason other than to divert assets prior to bankruptcy, the defendants cancelled an outstanding indebtedness in exchange for the redemption of stock for which they had no obligation to redeem. Accordingly, as a result of the transaction with Foam Core Corporation, we find that the defendants are liable in the amount of $5,350.
GENERAL WASTE AND MISMANAGEMENT
As previously discussed, absent a showing that a particular transaction entered into by the corporation was not done so at arm's length (i.e., where there was a conflicting interest by a corporate fiduciary), the burden does not shift to the defendant to prove the fairness of a particular transaction and the sound business judgment rule applies. Plaintiffs claim that during the reorganization proceedings, it was discovered that there had been a shrinkage in the assets of the corporation of approximately $5,000,000, and that such shrinkage was caused by the mismanagement and waste of the defendants. In support of this argument, the plaintiffs point to the transactions which we have just discussed. We find that the defendants' actions in all of these foregoing transactions were willful and malicious and caused substantial injury to Commonwealth and its subsidiary corporations. This finding does not lead us to the conclusion that plaintiffs have met their burden in showing that the entire loss sustained by Commonwealth Corporation was the result of activities on the part of the defendants. At best, we can only speculate as to what caused this loss to Commonwealth. Since the plaintiffs have not met their burden of proving proximate cause, the defendants cannot be held liable for the entire amount of Commonwealth's loss. The foregoing shall constitute our findings and conclusions as required by Rule 52 of the Federal Rules of Civil Procedure.