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Donaldson v. Bernstein

January 14, 1997

DENNIS C. DONALDSON; MARION L. DONALDSON, HIS WIFE

v.

JOSEPH J. BERNSTEIN, ESQUIRE, TRUSTEE IN THE CHAPTER 7 BANKRUPTCY ESTATE OF INSULFOAMS, INC. DENNIS AND MARION DONALDSON, APPELLANTS



On Appeal from the United States District Court for the Western District of Pennsylvania (D.C. Civ. No. 95-01644)

BEFORE: GREENBERG, ALITO, and ROTH, Circuit Judges

GREENBERG, Circuit Judge.

Argued December 12, 1996

(Filed: January 14, 1997)

OPINION OF THE COURT

I. FACTUAL AND PROCEDURAL HISTORY

This case is before this court on appeal from an order of the district court entered April 1, 1996, which affirmed an order of the bankruptcy court entered July 19, 1995, for the reasons the bankruptcy court set forth in its opinion. Insulfoams, Inc., the debtor, was incorporated in Pennsylvania in 1979 and was in the business of installing insulation for commercial and industrial establishments. Defendants-appellants, Dennis and Marion Donaldson, were Insulfoams' only shareholders, directors and officers, and at least at one time, each owned half of its stock. Dennis was Insulfoams' President and chief executive officer and Marion was its chief financial officer. According to the Donaldsons, Marion resigned her office and sold her stock in Insulfoams on April 5, 1990. Br. at 15-16. The Donaldsons, however, did not disclose the resignation and sale until Dennis notified the Pennsylvania Department of State Corporations Bureau in May 1994. In its opinion following the trial, the bankruptcy court rejected the Donaldsons' contentions that Marion had resigned and thus treated her as an officer of Insulfoams at all times material to this action. In re Insulfoams, 184 B.R. 694, 706-07 (Bankr. W.D. Pa. 1995).

Insulfoams filed a voluntary Chapter 11 bankruptcy petition on April 24, 1989, and thereafter continued operations as a debtor-in-possession. On October 26, 1989, Insulfoams filed a disclosure statement and plan of reorganization. But, as the bankruptcy court explained in its opinion, the court required Insulfoams to file an amended disclosure statement indicating whether the Donaldsons would make a future cash infusion into Insulfoams. Insulfoams, 184 B.R. at 699. Consequently, on December 28, 1989, Insulfoams filed an amended disclosure statement which stated that "if in any month of this Plan, the corporation is unable to afford the required monthly Plan payment the principals, Dennis and Marion Donaldson will guarantee that the payment is made by lowering their own salaries or by making a capital infusion into the corporation from their own resources." Supp. app. at 101.

The bankruptcy court approved the amended disclosure statement on April 12, 1990, and confirmed Insulfoams' plan of reorganization on May 24, 1990. The plan required Insulfoams to pay its tax liabilities to the Internal Revenue Service ($29,893) and the State of Pennsylvania ($6,346.74) in full, with interest, over the first 20 months of the plan. Supp. app. at 85. The Donaldsons were personally liable for these taxes. The plan further provided that Insulfoams would pay the unsecured creditors' claims (totaling $284,250) 30 cents on the dollar in monthly payments running from the 21st month to the 72nd month of the plan. Id. The court issued a final decree on April 2, 1991, after Insulfoams represented that the plan had been substantially consummated, and the clerk of the bankruptcy court closed the case six months later on October 2, 1991.

On September 29, 1992, Insulfoams' largest unsecured creditor filed a motion to compel it to make payments according to the plan, alleging that Insulfoams had not made any payments to the unsecured creditors after completing the payments to the IRS and the State of Pennsylvania. Insulfoams admitted the allegations, but claimed that adverse business conditions caused it to miss the payments and indicated that it would meet its plan obligations by December 15, 1992. In these circumstances, the bankruptcy court postponed a hearing on the creditor's motion until December 15, 1992, but at that time it found that Insulfoams would not be able to make the required payments. Consequently, the bankruptcy court reopened the case pursuant to 11 U.S.C. Section(s) 350(b) and converted it to a Chapter 7 proceeding pursuant to 11 U.S.C. Section(s) 1112(b)(8).

The court appointed a trustee for Insulfoams on December 22, 1992. On July 31, 1994, the trustee brought this adversary proceeding in the bankruptcy court against the Donaldsons, alleging that they obtained confirmation of the reorganization plan under false pretenses, knowing that they would not fund the plan after they paid the tax debts for which they were personally liable. The trustee further charged that the Donaldsons breached their fiduciary duties to Insulfoams by diverting business opportunities from it to Hi-Tech Contractors, Inc., another company they owned, for their personal benefit. The trustee sought compensatory and punitive damages against the Donaldsons.

The evidence at the trial showed that Hi-Tech was founded in the mid-1980s and that Dennis Donaldson was its principal. Hi-Tech was in the business of removing asbestos and other hazardous materials, for which it, unlike Insulfoams, was properly licensed and insured. Insulfoams and Hi-Tech leased adjoining space in a building the Donaldsons owned and often used the same employees and equipment. In 1992, Insulfoams had seven contracts (totaling $181,098.69) for the removal of asbestos and other hazardous materials which it subcontracted to Hi-Tech. Insulfoams received $12,047.01 of the profits from these contracts, while Hi-Tech received $29,672.62. Insulfoams, 184 B.R. at 702. In the circumstances, the bankruptcy court found that the Donaldsons breached their fiduciary duties by diverting business to Hi-Tech from Insulfoams, and it awarded the trustee $29,672.62 in compensatory damages (the full amount of Hi-Tech's profit on the seven contracts) and $55,602.38 in punitive damages. The court calculated the total judgment of $85,275 to fund fully 30% of the claims of the unsecured creditors as provided in the plan. Insulfoams, 184 B.R. at 709. The Donaldsons appealed to the district court, which affirmed, and they then appealed to this court.

II. DISCUSSION

A. Standard of ...


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