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Knop v. McMahan

filed: April 19, 1989.


On Appeal from the United States District Court for the Eastern District of Pennsylvania, D.C. Civil Action No. 84-1104.

Gibbons, Chief Judge, Hutchinson, Circuit Judge and Gerry, District Judge.*fn*

Author: Hutchinson


HUTCHINSON, Circuit Judge


J. Richard Knop (Knop) appeals from a final judgment of the United States District Court for the Eastern District of Pennsylvania entered in favor of CoalAir Systems, Ltd. (CoalAir) on its counterclaim for damages in connection with the circumstances surrounding the sale of land in Donaldson, Pennsylvania (Donaldson property), to D. Bruce McMahan (McMahan) and the other individual defendants.*fn1 The individual defendants formed CoalAir for the purpose of carrying on a prototype coal processing operation on the Donaldson property and transferred their rights in it to the CoalAir Systems limited partnership upon its formation. CoalAir cross-appeals from the district court's denial of pre-judgment interest on its claim. We must first consider the issue of whether subject matter jurisdiction existed in the district court, since there was not complete diversity of citizenship between the parties at the time of removal from the state court. However, because there was complete diversity during trial and at entry of judgment, we hold that the district court had subject matter jurisdiction in this case. We have appellate jurisdiction over the final order dismissing Knop's claims and entering judgment for CoalAir on its counterclaim under 28 U.S.C.A. ยง 1291 (West Supp. 1988). On the merits, Knop argues that CoalAir (1) failed to show fraud in the transaction; (2) failed to show breach of contract in the transaction; (3) had no legal right to pursue either a fraud or breach of contract action against Knop; (4) was unjustly enriched by the transaction; and (5) that the damages awarded it were excessive. We will affirm the district court on all of these issues. On cross-appeal, CoalAir argues that it is entitled to prejudgment interest as a matter of law. We agree and will reverse the district court's order denying prejudgment interest and remand for its determination.


The Donaldson real estate, along with personal property used there, was acquired by A&T Associates, Inc. (A&T) in 1980 or 1981. A&T was a wholly-owned subsidiary of AOV Industries, Inc. (AOV), a corporation controlled by Knop, a citizen of Virginia, and Mark Bruce, Knop's brother-in-law. AOV and A&T instituted Chapter 11 bankruptcy proceedings in November, 1981. Because Knop and Bruce had personally guaranteed an A&T debt of about $1,500,000 to the Hamilton Bank, the bank began proceedings against them.*fn2

In 1982, Knop became interested in a project called "Low Pressure Systems," or LPS, technology, a pneumatic pumping device for the transportation and processing of various materials, including coal. Exclusive rights to the technology were held by two affiliated companies, Air Trans Systems (ATS), and World Industry Consultants, Ltd. (WIC), both owned by Bill Lovejoy, the inventor of the technology, and Vern Green. Because Knop was familiar with the local anthracite industry, Lovejoy and Knop formed a 50-50 joint venture called CoalTec Systems Corporation (CoalTec). Half of CoalTec was controlled by Potomac Energy Corporation (Potomac), owned principally by Knop and Frank Evans, and half by ATS, owned principally by Lovejoy and Green. The officers of CoalTec at its formation were Knop (President), Evans (Executive Vice-President), and Green (Secretary-Treasurer). The four principal shareholders of CoalTec were also on the Board of Directors.

In the fall of 1982, Knop agreed with WIC to arrange financing for projects involving the application of LPS technology in the coal industry, including anthracite. Appendix (App.) at 123-25. ATS granted CoalTec an exclusive license to use LPS technology in the coal industry, and WIC agreed to act as exclusive consultant for CoalTec.

Meanwhile, in late 1982 Knop and Bruce entered into negotiations with Hamilton Bank to purchase the Donaldson property free of the lien the bank had on it as collateral security for the A&T debt and at the same time to settle their own potential liability on their guarantee of that debt. They reached an agreement on March 18, 1983 (Hamilton Bank contract). Id. at 748.

The contract included a detailed description of the Donaldson real property as well as the personal property on it and provided that both would be sold to Knop and Bruce for $300,000, with $80,000 down. Id. at 749. Knop and Bruce were also responsible for all foreclosure and execution expenses, accrued real estate taxes, security expenses and preservation expenses. Id. at 757. The contract provided that Hamilton Bank would institute foreclosure proceedings, leading to a sheriff's sale. Id. at 753-54. The proceeds of any sale of the assets to third parties was to be credited against the $300,000 purchase price. Id. at 756-57. At closing any remaining balance on the $300,000 would be paid by Bruce and Knop, and title would then be transferred from Hamilton Bank to them. They would also be released from all remaining liability for their personal guarantees of the $1.5 million mortgage. Id. at 750-51.

Meanwhile, by March of 1983 WIC had established a pilot plant for its LPS technology in Camden, New Jersey. The plant extracted ash and moisture from coal silt. About this time Knop met McMahan, an officer of the New York investment banking firm of McMahan, Brafman and Morgan & Co. (MBM). MBM acquired a 12% interest in CoalTec by purchasing $1,000,000 in treasury stock, reducing Potomac's and ATS's interest in it to 44% each. McMahan was then appointed to CoalTec's Board of Directors.

Knop paid Hamilton Bank the $60,000 downpayment and it foreclosed, as agreed. On May 20, 1983, the bank purchased the property for $80,000 at a sheriff's sale.*fn3 Id. at 403. The sheriff issued the deed in Knop's name. Id. at 797a.*fn4 It was held by the bank pending the closing of the contract, set for July, 1983. After the purchase from the sheriff, some of the equipment on the Donaldson property was sold to various third parties.

On May 23, 1983, at a CoalTec board meeting, Knop offered, both orally and in writing, to sell the Donaldson property to either CoalAir*fn5 or CoalTec at his cost, which he said was $350,000. Id. at 300, 725-26, 768. No agreement was reached.

In June, 1983, McMahan and one of his employees, Pat Sheehan, toured the Donaldson property with Knop and Charlie Wynosky, an A&T employee. Id. at 300-01. At trial, McMahan and Wynosky testified that Knop represented that his offer was to sell everything on the property, including a number of coal silt ponds, several buildings, a coal washing plant, an anthracite coal breaking plant, overhead conveyors, shovels, drag lines, at least one truck, a screening plant, several hundred tons of processed coal, two loaders and a 30-car rail siding. Id. at 302, 305, 408-09. In fact, Hamilton Bank had, through Knop, already sold one of the loaders and the screening plant to CoalTec for $16,000. Id. at 113-14. Knop had also sold the processed coal to Harold Felty for $7,113.60. These items were removed from the property after the tour. Id. at 217-l8. Knop also stated that the property was free and clear of all encumbrances, except for a mortgage. Id. at 303. Knop did not mention AOV, the bankruptcy or the foreclosure sale. Id. at 302-03.

McMahan had doubts about the Donaldson property's suitability for a pilot LPS facility because it had on it only a small supply of coal silt, the raw material for the LPS process. Id. at 303-04. McMahan had toured four or five other sites in the area, each with a significantly greater supply. Id. at 303-04. McMahan's doubts were reinforced when he also learned that the access road to the Donaldson property was impassable during a large part of the year. Id. at 304.

On June 27, 1983, Knop wrote a memorandum to Lovejoy and McMahan concerning the sale of the Donaldson property to "CoalTec (CoalAir Systems, Inc.)." In it, he reiterated his offer to sell for $350,000 and included a detailed description of some of the equipment on the property. Id. at 638-42.

On June 28, 1983, McMahan, Lovejoy and Green met in Seattle, Washington. Lovejoy had become unenthusiastic about applying the LPS technology in the coal industry and was now so dissatisfied with Knop's fund-raising activities that they were no longer on speaking terms. Lovejoy asked McMahan to give $300,000 to WIC to fulfill Knop's fund-raising obligations. McMahan testified that he was concerned about the situation because "Bill Lovejoy was the sole repository of this technology walking around in his head." Id. at 306. Early the next morning McMahan, seeking to satisfy Lovejoy, called Knop with an offer to purchase the Donaldson property for $350,000, Knop's alleged cost. In return, Knop was to give WIC $300,000 to satisfy Lovejoy's demand. Knop agreed to make an "officer's loan" of $300,000 to CoalTec. CoalTec would then advance the $300,000 to WIC. McMahan testified that Knop suggested the officer's loan when he told Knop that he would have to assume the credit risk of giving WIC the $300,000. Id. at 311-12. McMahan and the other Donaldson purchasers agreed to convey the property to CoalAir, when it was formed, for a stated consideration equal to the $350,000 paid Knop. Id. at 310-11, 313, 324.

McMahan memorialized the conversation with Knop in a written memo, which he gave to Green and Lovejoy that morning and mailed to Knop for confirmation. The memorandum provided, in part, that the Donaldson property was to be purchased by McMahan and several partners and transferred to CoalAir when it was created. Id. at 60709.*fn6

On July 1, 1983, Knop conveyed an executed assignment of his interest in the Donaldson property to McMahan, Milton Brafman, James Russell and Victor M. Wexler, the individual investors who had agreed to purchase the Donaldson property. The assignment included the same description of the property as the description attached to the Hamilton Bank contract. Id. at 632-37. Knop's letter accompanying the assignment stated:

As you know, I have a final installment of approximately $150,000.00 due on or before July 18, 1983. I have instructed my attorneys to expedite the closing of that agreement so that I can convey, as soon as possible, full legal title to you and your partners free and clear of any encumbrances.

Id. at 806. After reading the assignment, McMahan wired Knop $300,000. One week later, a fourth partner wired Knop $50,000. Knop told his bank to wire $300,000 to WIC. Knop had CoalTec record this as an officer's loan from Knop to CoalTec and also as a $300,000 advance from CoalTec to ...

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