Morley v. Ontos, Inc.

United States Court of Appeals
For the First Circuit

Nos. 06-1512 and 06-1513

IN RE: ONTOS, INC.,
Debtor.

T. MARK MORLEY; THOMAS J. MCCOY,
Appellants,

v.

ONTOS, INC.; JOSEPH G. BUTLER, as Chapter 7 Trustee of
the Estate of Ontos, Inc.; FIRESTAR SOFTWARE, INC.;
KENNETH LORD; AMPHION VENTURES; ROBERT J. BERTOLDI;
RICHARD C.E. MORGAN; VENNWORKS, LLC,
Appellees.

JOHN FITZGERALD,
Trustee.

APPEALS FROM THE UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF MASSACHUSETTS
[Hon. Richard G. Stearns, U.S. District Judge]

Before

Torruella and Lynch, Circuit Judges,
and Woodcock, Jr.,* District Judge.

T. Mark Morley, for appellants.
Harold B. Murphy, with whom Christian J. Urbano and Hanify &
King, P.C., were on brief, for appellees Firestar Software, Inc.
and Kenneth Lord.
Joseph G. Butler, with whom Barron & Stadfeld, P.C., was on
brief, for appellee Joseph G. Butler in his capacity as Chapter 7
Trustee of the Estate of Ontos, Inc.

*
Of the District of Maine, sitting by designation.
 Eric P. Heichel, with whom Eiseman Levine Lehrhaupt &
Kakoyiannis, P.C., was on brief, for appellees Firestar Software,
Inc., Kenneth Lord, Vennworks, LLC, Amphion Ventures, Robert J.
Bertoldi, and Richard C.E. Morgan.

March 1, 2007

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 TORRUELLA, Circuit Judge. This is an appeal of a

district court order from February 3, 2006, which affirmed two

orders entered by the bankruptcy court on June 29, 2005.

Appellants, T. Mark Morley, former chief financial officer of

Ontos, Inc. ("Ontos"), and Thomas J. McCoy, also a former officer

and employee of Ontos (collectively "Appellants"), challenge the

bankruptcy court's approval of a stipulation for waiver and release

entered with the Appellees by the trustee for the estate of Ontos.

After careful consideration, we affirm.

I.

Ontos was incorporated in Delaware in 1987. In the mid-

1990s, Ontos developed a software product named "ObjectSpark." As

an unprofitable company, Ontos depended on bridge loans from its

majority shareholders, Vennworks, LLC ("Vennworks") and Amphion

Ventures ("Amphion"), to pay its operating expenses. In 2000, the

Ontos board of directors considered selling ObjectSpark in order to

raise capital.

Kenneth Lord became the Chief Executive Officer ("CEO")

of Ontos in the late spring of 2001. His principal task as CEO was

to find a purchaser for ObjectSpark. When by September 2001, no

buyer had materialized, Lord caused a company he had formed,

Firestar Software, Inc. ("Firestar"), to submit an offer. Ontos

and Firestar were represented by separate counsel in the ensuing

negotiations. An agreement to sell ObjectSpark to Firestar was

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approved by the Ontos board by a 3-0 vote. The Appellants, who

were officers of Ontos and members of the board, were present at

the discussion but abstained on the vote. Firestar purchased

ObjectSpark for $490,000 in cash, a promissory note for an

additional $100,000, which it paid in full, and the assumption of

approximately $13 million of Ontos's debt, which was owed primarily

to Vennworks and Amphion. Ontos used the proceeds of the sale to

pay the salaries of the Appellants and other employees, and debts

owed to trade creditors.

The Appellants' employment was terminated by Ontos in

January 2002. In June 2002, they jointly brought a lawsuit in

state court against Ontos and the Appellees1 seeking payment of

lost wages and severance benefits. The Appellants brought the suit

in their individual capacities, not as a derivative action on

behalf of Ontos. In separate counts, the Appellants alleged breach

of contract, breach of the covenant of good faith and fair dealing,

violation of the Massachusetts Wage Act, fraud and deceit,

fraudulent transfer, breach of fiduciary duty, and alter ego

liability. With respect to the latter three claims, which are at

the heart of this appeal, the Appellants contend that the Appellees

sold ObjectSpark for less than its fair market value and then used

the proceeds "as they saw fit." According to the Appellants,

1
The Appellees are Vennworks, LLC, Amphion Ventures, Firestar
Software, Inc., Robert Bertoldi, Richard Morgan, and Kenneth Lord.

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Firestar was an alter ego of Ontos with Lord serving as Firestar's

CEO, and its staff composed entirely of former Ontos employees

using Ontos's equipment to exploit Ontos's intellectual property.

After eighteen months of litigation in Massachusetts

state court, in January 2004, Ontos filed a voluntary petition for

relief under Chapter 7 of the Bankruptcy Code. In April 2004, the

Appellants filed a proof of claim for their lost wages and

employment benefits, together with copies of their state court

complaint, representing themselves as creditors of Ontos. In May

2004, the Appellants sought approval from the bankruptcy court to

proceed in state court against the Appellees. The bankruptcy court

gave its permission in June 2004.

In March 2005, the trustee filed a motion to approve a

stipulation of settlement and release of Appellants' claims. Over

Appellants' objection, the bankruptcy court, in June 2005, allowed

the trustee's motion. The stipulation provided that, in

consideration of $50,000, the trustee:

releases any and all claims that the Debtor or
the Debtor's estate may have against [the
appellees] arising out of or related to the
conveyance by the Debtor of its ObjectSpark
division to Firestar and any and all claims
. . . against [the appellees] arising out of
or related to any claim that [the appellees]
used the corporate form of Ontos for
fraudulent purposes . . . and that [the
appellees] are liable for the obligations of
Ontos on any 'alter ego,' 'piercing the
corporate veil' or similar theory . . . .

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 Before the bankruptcy court, the trustee argued that he

had the exclusive right to compromise the fraudulent transfer and

alter ego claims because they constitute property of the estate

within the meaning of § 541(a) of the Bankruptcy Code, or

alternatively, because they could have been asserted at his

discretion for the benefit of Ontos's creditors pursuant to § 544.

Importantly, the trustee did not purport to compromise the

"personal" state law claims asserted by the Appellants for

violation of the Wage Act, and fraud and deceit. The Appellants

responded that the trustee lacked standing under either provision

of the Code. Alternatively, they objected to the release of claims

that they value in excess of $1 million for $50,000.

The bankruptcy court granted the trustee's motion to

approve the settlement and denied the Appellants' cross-motion for

permission to proceed against the Appellees on the aforementioned

claims in state court. The bankruptcy judge explained his rulings

as follows:

I do believe that alter ego and related claims
are certainly derivative from any liability
that is owed to the debtor here; and being
derivative, I believe that they are the
Trustee's property and not that of the
individual defendants -- individual plaintiffs
against those other people.

Indeed, that's consistent with the whole
bankruptcy concept, which is to take all of
the goodies and divide it equally between
everybody, and nobody gets an individual piece
of the action, and so I'm going to deny the
motion to allow [the Appellants] to continue

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 their state action against the other
defendants.

As to the approval of the stipulation, this
has got to be the most amorphous thing on
earth. . . . We've got a highly experienced
Trustee who has done such due diligence as is
reasonable under the circumstances. It's not
as if the software was given away. There was
money for it. I can't say that the Trustee is
wrong in wanting to settle the claims for the
amount of money he's been offered, and the
usual rule is that absent anything that raises
my eyebrows, my hackles, or disturbs my
stomach, I will go with the Trustee's business
judgement (sic), and none of those negative
factors are present here.

In July 2005, the Appellants filed a notice of appeal and

elected to have the case heard in the district court. They also

sought a stay pending appeal. The bankruptcy court denied the stay

request in August 2005. The district court affirmed the bankruptcy

court's decision, finding (1) that the trustee had the authority to

enter into the stipulation compromising the Appellants' related

claims, (2) that "there was no question but that the Bankruptcy

Court had jurisdiction to entertain the Trustee's motion," and (3)

that the bankruptcy court did not abuse its discretion by granting

the motion to approve the stipulation for the allegedly nominal sum

of $50,000. The former two issues are now before this court.

II.

We begin by addressing whether the trustee had standing

to enter into the stipulation of settlement and release of the

Appellants' claims. We review the bankruptcy court's related

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factual findings for clear error, and its legal conclusions de

novo. Watman v. Groman (In re Watman), 458 F.3d 26, 31 (1st Cir.

2006).

The Bankruptcy Code broadly defines the property of the

estate to be comprised of all "legal or equitable interests of the

debtor in property as of the commencement of the case." 11 U.S.C.

§ 541(a)(1). It is well established that a claim for fraudulent

conveyance is included within this type of property. See Nat'l Tax

Credit Partners v. Havlik, 20 F.3d 705, 708-09 (7th Cir. 1994)

("[T]he right to recoup a fraudulent conveyance, which outside of

bankruptcy may be invoked by a creditor, is the property of the

estate that only a trustee or debtor in possession may pursue once

a bankruptcy is under way."); Hatchett v. United States, 330 F.3d

875, 886 (6th Cir. 2003) ("[T]he trustee has the exclusive right to

bring an action for fraudulent conveyance during the pendency of

the bankruptcy proceedings . . . ."); Campana v. Pilavis (In re

Pilavis), 233 B.R. 1, 3 (Bankr. D. Mass. 1999) ("Neither Debtor nor

the Trustee disputes the fact that fraudulent conveyance action

became the property of the estate when Debtor filed for relief.").

The Appellants are incorrect to assert that they have a cause of

action for fraudulent conveyance that is separate from the

trustee's cause of action. Indeed, creditors only have standing to

pursue such claims during bankruptcy proceedings when a trustee or

debtor in possession unjustifiably fails to pursue the claim.

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Pilavis, 233 B.R. at 3-4 (citing Glinka v. Abraham and Rose Co.,

199 B.R. 484, 493-94 (D. Vt. 1996)). Such circumstances obviously

do not exist here.

We also reject the Appellants' suggestion that there can

be a breach of fiduciary duty to creditors that is not derivative

of a breach to the corporation. See, e.g., Claybrook v. Morris (In

re Scott Acquisition Corp.), 344 B.R. 283, 290 (Bankr. D. Del.

2006)("The defendant's final argument is that the Chapter 7 trustee

lacks standing to bring a breach of fiduciary duty claim on behalf

of the [corporation's] creditors. This argument is without

merit."). Under Massachusetts law, any question pertaining to a

duty owed by a director of a corporation to the corporation is

governed by the law of the state of incorporation. See Slattery v.

Bower, 924 F.2d 6, 9 (1st Cir. 1991). Hence, in this case, we will

apply the substantive law of Delaware.

Under Delaware law, creditors of an insolvent corporation

are owed fiduciary duties when the corporation is insolvent in

fact. Geyer v. Ingersoll Publ'ns Co., 621 A.2d 784, 787-88 (Del.

Ch. 1992) ("it is the fact of insolvency which causes the duty to

creditors arise"). Even assuming that Ontos was in fact insolvent,

a fact not established in the record, these fiduciary duties are on

all but rare occasions derivative of the duties owed to the

corporation itself. See Prod. Res. Group, L.L.C. v. NCT Group,

Inc., 863 A.2d 772, 792 (Del. Ch. 2004)("even in the case of an

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insolvent firm, poor decisions by directors that lead to a loss of

corporate assets and are alleged to be [] breaches of equitable

fiduciary duties remain harms to the corporate entity itself").

Thus, claims for breach of fiduciary duty against Ontos's directors

accrue to the estate, not the Appellants. In re Scott Acquisition

Corp., 344 B.R. at 289 ("a director's fiduciary duty to creditors

is derivative of the duty owed to the corporation"); Prod. Res.

Group, L.L.C., 863 A.2d at 792 ("when a director of an insolvent

corporation, through a breach of fiduciary duty, injures the firm

itself, the claim against the director is still one belonging to

the corporation").

The alter ego and successor liability claims present a

somewhat more difficult question. Under Massachusetts law, a claim

may be brought against the "alter ego" of a corporation when "there

is active and direct participation by the representatives of one

corporation, apparently exercising some form of pervasive control,

in the activities of another and there is some fraudulent or

injurious consequence of the intercorporate relationship" or when

"there is a confused intermingling of activity of two or more

corporations engaged in a common enterprise with substantial

disregard of the separate nature of the corporate entities, or

serious ambiguity about the manner and capacity in which the

various corporations and their respective representatives are

acting." My Bread Baking Co. v. Cumberland Farms, Inc., 233 N.E.2d

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748, 752 (Mass. 1968). In such circumstances, courts may allow a

plaintiff to pierce the corporate veil of limited liability in

order to "provide a meaningful remedy for injuries and to avoid

injustice." Attorney Gen. v. M.C.K., Inc., 736 N.E.2d 373, 380

(Mass. 2000). Likewise, a claim may be brought against a successor

corporation where "it either assumes [the obligation] under express

agreement or where the facts and circumstances are such as to show

an assumption." Aldrich v. ADD Inc., 770 N.E.2d 447, 452 (Mass.

2002) (quoting Araserv, Inc. v. Bay State Harness Horse Racing &

Breeding Ass'n, Inc., 437 F. Supp. 1083, 1089 (D. Mass. 1977)).

The primary roadblock to finding the alter ego and

successor liability claims to be part of the estate is that a

corporation may generally not pierce its own veil. See McCarthy v.

Azure, 22 F.3d 351, 363 (1st Cir. 1994) ("As appellant is not even

arguably an innocent third party disadvantaged by someone else's

blurring of the line between a corporation and the person who

controls it, but, rather, is himself the one who is claimed to have

obscured the line, he cannot be permitted to use the alter ego

designation to his own behoof."). Nevertheless, this roadblock is

easily circumvented on the facts of the case. In McCarthy, all of

the claims at issue were direct claims, i.e., claims brought

directly by the plaintiff against a defendant. Here, on the other

hand, the trustee is only attempting to settle derivative claims --

claims brought by a plaintiff on behalf of a corporation. Because

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the fraudulent transfer and breach of fiduciary duty claims the

trustee wishes to settle are derivative in nature, the same claims

pursued against an alter ego or successor corporation must be

derivative in nature as well.2 Given that such derivative claims

are properly the property of the estate, the bankruptcy court did

not err in finding that the trustee had the power to settle them.

Certain of the trustee's standing, we now turn to the

question of the bankruptcy court's jurisdiction. A brief review of

the Bankruptcy Code indicates that Congress intended the bankruptcy

courts to oversee the settlement and release of the debtor's claims

while in bankruptcy. Title 28 provides that "[b]ankruptcy judges

may hear and determine all cases under title 11 and all core

proceedings arising under title 11, or arising in a case under

title 11 . . . and may enter appropriate orders and judgments

. . . ." 28 U.S.C. § 157(b)(1). Core proceedings include "matters

concerning the administration of the estate," "proceedings to

determine, avoid, or recover fraudulent conveyances," and "other

proceedings affecting the liquidation of the assets of the estate

. . . ." 28 U.S.C. § 157(b)(2)(A), (H), (O). Here, the trustee's

motion falls squarely within the definition of core proceedings:

the settlement of the disputed claims clearly concerns the

administration of the Ontos estate and the liquidation of its

2
Because the particular alter ego claims settled by the trustee
in this case are property of the estate, we express no view on the
contours of alter ego claims generally under Massachusetts law.

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assets. As a core proceeding, the bankruptcy court has

jurisdiction over the stipulation.

III.

For the foregoing reasons, we affirm the trustee's

authority to enter into the stipulation of waiver and release on

behalf of the estate, and the bankruptcy court's jurisdiction to

review the stipulation.

Affirmed.

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