Court of Appeals – Third Circuit
Situation: A husband and wife had a closely held corporation which was in bankruptcy. They made certain promises to creditors and to the Court in order to obtain confirmation of their Plan of Reorganization for their company. The Plan provided for payment of tax liabilities first, which were also the personal responsibility of the husband and wife as responsible persons of the corporation. The corporation became defunct after the tax liabilities were paid under the Plan. Because the corporation paid the tax obligations over time, by the time matters had come to a head the Plan had been approved and the bankruptcy case had been closed.
Action: When there was a default under the Plan the Court converted it from a Chapter 11 to a Chapter 7 and appointed Joseph Bernstein as Trustee.
The Trustee’s investigation disclosed that the Defendants had another corporation by the name of Hi-Tech (which eventually went into bankruptcy itself) which essentially had taken over the business of Insulfoams, while Insulfoams was operating under bankruptcy protection. Prior to Hi-Tech becoming bankrupt, profits and other monies it had obtained as a result of taking business opportunities from Insulfoams, were used to benefit the Defendants individually.
Ruling: Although there were some serious “technical” impediments to the Trustee’s claim, arising out of the judicial systems’ desire for finality in connection with approved Plans of Reorganization and the scope of Bankruptcy Court jurisdiction, the Courts (from the Bankruptcy Court right up to the Third Circuit Court of Appeals) uniformly held in essence that the integrity of the judicial system is of higher importance than mere mechanical efficiency, and that there is no safe harbor for fraud in our Courts. In addition to confirming the power of the Court to police itself, the decision also confirms the standing of the Bankruptcy Trustee to act not only as a successor to the Debtor corporation, but also as the representative of the creditors collectively.
The precedent established is important because the Appellate Court backed up the Trial Court in the use of punitive damages to punish the wrongdoers to the extent necessary to compensate the victims of their malfeasance.