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BELLIS v. THAL

March 12, 1974

Isadore H. BELLIS and Ralph W. Pitman, Trustees for Commonwealth Financial Corporation, et al.
v.
Morise THAL and Albert B. Gerber


Gorbey, District Judge.


The opinion of the court was delivered by: GORBEY

GORBEY, District Judge.

Plaintiffs are trustees in the consolidated reorganization proceedings of Commonwealth Financial Corporation (Commonwealth), Neighborhood Finance Co. Inc., Neighborhood Finance Co. Inc. of Pennsylvania, and Quaker City Investment Corporation (Quaker) under Chapter X of the Bankruptcy Act pending in this district, Cause No. 30108. The defendants, officers, directors and dominant shareholders are charged with breach of fiduciary duty, mismanagement, diversion of assets and self-dealing, involving Commonwealth, its subsidiaries and other companies which the defendants dominated and controlled. The case was tried before this court without a jury.

 Before making our factual findings, a brief discussion of the applicable legal standards appears in order. Defendants have admitted their fiduciary relationship as officers and directors of Commonwealth and its subsidiary corporations. Plaintiffs' claims fall into three categories. The first category concerns specific transactions in which it is alleged that the defendants engaged in self-dealing in the performance of their functions as corporate fiduciaries. The second concerns specific transactions where there is no self-dealing, but is alleged that there was a breach of duty, waste, mismanagement and negligence. The third is a general claim for the shrinkage of assets of the corporation allegedly due to the defendants' breach of duty, waste, mismanagement and negligence.

 In the first category, plaintiffs allege that defendants caused Commonwealth to engage in certain transactions with other corporations or organizations which the defendants dominated and controlled, or in which the defendants had an interest either as an officer, director or stockholder. In cases where the dealings of a fiduciary with the corporation are challenged, the burden of proof is upon the fiduciary to demonstrate his good faith and the fairness involving the transaction complained of. In Pepper v. Litton, 308 U.S. 295, 60 S. Ct. 238, 84 L. Ed. 281 (1939), the Supreme Court stated the fundamental rule as follows:

 
"A director is a fiduciary . . . So is a dominant or controlling stockholder or group of stockholders . . . Their dealings with the corporation are subjected to rigorous scrutiny and where any of their contracts or engagements with the corporation is challenged the burden is on the director or stockholder not only to prove the good faith of the transaction but also to show its inherent fairness from the viewpoint of the corporation and those interested therein. (Citations omitted) The essence of the test is whether or not under all the circumstances the transaction carries the earmarks of an arm's length bargain. If it does not, equity will set it aside. While normally that fiduciary obligation is enforceable directly by the corporation, or through a stockholder's derivative action, it is, in the event of bankruptcy of the corporation, enforceable by the trustee. For that standard of fiduciary obligation is designed for the protection of the entire community of interests in the corporation -- creditors as well as stockholders."

 Thus, when a transaction which is not a completely arm's length transaction is challenged, the burden is on the fiduciary to prove the fairness of the transaction. See also Pappas v. Moss, 393 F.2d 865 (3d Cir. 1968); Kohn v. American Metal Climax, Inc., 322 F. Supp. 1331 (E.D. Pa. 1971), modified in part, 458 F.2d 255 (3d Cir. 1972); Hirshhorn v. Mine Safety Appliances Co., et al., 106 F. Supp. 594 (W.D. Pa. 1952).

 The second category of claims by the plaintiffs concerns transactions for which plaintiffs claim defendants breached their fiduciary duty, but in which there was no showing that the defendants had an adverse interest or that the transaction was not at arm's length. Directors and officers of a corporation may be held liable for any loss resulting from a failure to use reasonable and ordinary care, skill and diligence in conducting the business of the corporation. See generally Hunt v. Aufderheide et al., 330 Pa. 362, 199 A. 345 (1938). In describing the duty of care owed by directors in managing corporate affairs, the courts have generally adopted one of two rules. The first of these, and probably the majority rule, is that of the reasonable director (i.e., that care which a reasonably prudent director of a similar corporation would have used under the circumstances). See Briggs v. Spaulding, 141 U.S. 132, 11 S. Ct. 924, 35 L. Ed. 662 (1891). Other jurisdictions, including Pennsylvania, have adopted a standard that a director shall discharge his duty with "that diligence, care and skill which ordinarily prudent men would exercise under similar circumstances in their personal business affairs ". *fn1" (Emphasis added)

 This "personal affairs rule" imposes a higher duty of care on corporate fiduciaries than the common law. The Supreme Court of Pennsylvania recently discussed this rule in the case of Selheimer v. Manganese Corporation of America, 423 Pa. 563, 224 A.2d 634 (1966). In this case the court held that in the absence of fraud, self-dealing, or proof of personal profit, or wanton acts of omission and commission, the directors of a business corporation who had been imprudent, wasteful, careless and negligent may be held personally liable under the common law or § 408, where such actions have resulted in corporate losses resulting in the insolvency of the corporation.

 However, a claim of this nature differs from one where there has been self-dealing by the fiduciary in that the burden does not shift to the fiduciary where there is no showing that the transaction was not at arm's length. Thus, the plaintiffs must show that the defendants breached their duty and that the conduct complained of was not fair or in the interest of the corporation. What constitutes negligence or breach of duty depends upon the circumstances of the particular case. Selheimer v. Manganese Corporation of America, supra. See also South Penn Collieries Co. v. Sproul, 52 F.2d 557 (3d Cir. 1931); Otis & Co. v. Pennsylvania R. Co., 61 F. Supp. 905 (E.D. Pa. 1945), aff'd, 3 Cir., 155 F.2d 522. The burden does not shift to the defendants to prove the fairness of the transaction. Uccello v. Gold'n Foods Inc., 325 Mass. 319, 90 N.E. 2d 530, 16 A.L.R. 2d 459 (1950).

 Plaintiffs would have us apply a different standard. They appear to urge that once self-dealing by the fiduciary has been shown in one transaction, the burden shifts to the fiduciary to show the fairness of all transactions complained of -- whether or not there has been any evidence that such transaction was not at arm's length. This we will not do. The fact that a transaction was not at arm's length does not make it illegal. Evans v. Armour & Co., 241 F. Supp. 705 (E.D. Pa. 1965). It merely shifts the burden of proof.

 Such a holding would impose upon corporate fiduciaries a higher burden than the law requires and would expose corporate fiduciaries to liability many times in excess of the damage their own actions may have caused. This would effectively make the corporate fiduciary an insurer of corporate profits. This the courts have consistently refused to do. Selheimer v. Manganese Corporation of America, supra.

 In addition to claiming for specific transactions, plaintiffs also claim that because of their breach of duty, negligence, mismanagement and waste, the defendants are liable for the total shrinkage in assets of Commonwealth. The standard for the defendants' duty of care will be the same as that discussed for specific transactions. However, there is an additional problem which the Pennsylvania Supreme Court in the Selheimer case discussed. Before the defendants may be held liable for damage to the corporation as a result of their breach of duty, the plaintiffs must show that such breach of duty was the proximate cause of the injury to the corporation. In the Selheimer case, the trial court had awarded to the corporation the total amount of the shrinkage in assets of the corporation over the two-year life of the corporation. The Pennsylvania Supreme Court, in affirming liability, reversed and remanded on the issue of amount of the damage, stating at 224 A.2d at page 646:

 
"In adopting this measure of damages -- tantamount to attributing all Manganese's losses to defendants' conduct -- we believe the chancellor erred. The duty of reimbursement should be limited to those losses which were proximately caused by the negligent and wasteful conduct of defendants . . . the nexus between Manganese's losses and defendants' negligent and wasteful actions must act as the basis for reimbursement."

 Thus, before any such award for damages will be granted, plaintiffs must show that the defendants' breach of duty proximately caused the damage to the corporation.

 LIABILITY -- JOINT AND SEVERAL

 Where one fiduciary either approves, acquiesces in, or conceals the breach of duty by another fiduciary, they are both jointly and severally liable. Higgins v. Shenango Pottery Co., 279 F.2d 46 (3d Cir. 1960); Seaboard Industries, Inc. v. Monaco, 442 Pa. 256, 276 A.2d 305 (1971).

 In the case at bar, the record is replete with evidence that the defendants Thal and Gerber acted in concert and were the principal parties directing the affairs of Commonwealth. *fn2" We also find that as to the specific transactions in question in this case, the defendants actively participated in both the execution of the transactions and the concealment of the essential nature of these transactions. *fn3" Accordingly, we hold that the defendants are jointly and severally liable for any actions upon which we hold that they are liable.

 With these principles in mind, we will begin to wade through the quagmire which has been left to this court to unscramble. In this endeavor, we will deal with each set of related ...


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