Braunstein v. Sperbeck et al

OCR transcription for search; preserved printed pages are authoritative

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UNITED STATES BANKRUPTCY COURT
DISTRICT OF MASSACHUSETTS
EASTERN DIVISION

IN RE
LOGISTICS INFORMATION
SYSTEMS INC.,
DEBTOR CHAPTER 7
CASE NO. 03-10886-JBR

JOSEPH BRAUNSTEIN
CHAPTER 7 TRUSTEE,

Plaintiff,

v. AP. NO. 04-1188

WILLIAM E. SPERBECK, SUSAN
L. SPERBECK, & ARCLOGIX, INC.,

Defendant

ee a al

MEMORANDUM OF DECISION

This proceeding arises in a case referred to this Court by the Standing Order of Reference
entered in this District and is determined to be a core proceeding pursuant to 28 U.S.C. §
157(b)(2)(B). The Court is authorized to enter final judgment in this proceeding.

The following constitutes the Court’s findings of fact and conclusions of law in
accordance with Federal Rule of Bankruptcy Procedure 7052.

In reaching its determination, the Court considered the demeanor and credibility of all
witnesses who testified as well as the admitted exhibits and arguments and submissions of
counsel.

It is appropriate to begin with a few words about credibility. The principal witness in this
case was William E. Sperbeck. The Court found much of Mr. Sperbeck’s testimony not

convincing or credible. When convenient, Mr. Sperbeck claimed that he did not understand the

AUTHENTICATED
U.S. GOVERNMENT
INFORMATION

GPO

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financial figures about which he was being questioned. When troublesome or inconsistent
matters were raised during his testimony, his answer was often to blame an “error” on someone
else. His explanations of certain activities, such as the formation of Arclogix and T Logic, were
superficial and lacking in substance. When pressed for more detailed explanations of some of
his answers, he often demonstrated a demeanor that the Court found suggestive of less than
forthright answers.

The other witnesses appeared credible to the Court.

The Plaintiff filed a multi-count (10) complaint involving alleged fraudulent conveyances
under state law, actions for turnover under bankruptcy law, declaratory judgment, successor
liability, usurpation of corporate opportunity and assets, piercing the corporate veil, and reach
and apply. The Plaintiff also filed a motion to substantively consolidate Arclogix with Logistics
Information Systems (“LIS”) in the main case, (Docket #18), which mirrors the counts for
successor liability and piercing the corporate veil and is resolved by this decision. The Court
accepts all facts agreed to in the Joint Pretrial Statement (Docket #79) and stipulated on the
record as proved.

The facts are not materially in dispute. In fact, but for a few proposed findings and
rulings presented by the parties, I can and do adopt the findings and rulings suggested by the
parties, and enumerate those (with commentary) on Schedules A and B attached hereto.

There are some key facts and issues that require special and detailed comment by the
Court.

Fraudulent Conveyance

Were there creditors in existence as of the time of the repayment of loans to Sperbeck by
LIS in late 2000 and early 2001? The simple answer to this question is yes. Although the

bookkeeper, Ms. Cahoon, and the principal, Mr. Sperbeck, insisted that all “bills” and all

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“creditors” were paid, APBLS, a known counterclaimant in a lawsuit, is the holder of a “claim”
albeit unliquidated and perhaps disputed, and cannot be ignored in the analysis of this case. See
M.G.L. ch. 109A, § 2.

Ali funds and assets were transferred (although several categories such as good will,
intellectual property, and contracts were not transferred by appropriate documentation, the
manner of their usurpation and use support finding that they were transferred). It appears that
the Debtor, its successors, Arclogix, all shareholders, employees, principals, contracting parties,
etc. treated the assets as transferred so the Court will as well. No assets were left in the Debtor,
LIS, to satisfy the claim of APBLS.

Assets were transferred to Arclogix for the depreciated tax value, if any, on the Debtor’s
balance sheet, with no fair market value analysis undertaken. The formation of Arclogix and the
transfer took place after the unsuccessful mediation of the APBLS lawsuit.

There was no evidence proferred of payment of “reasonably equivalent value,”
particularly of the assets not listed on the bill of sale as transferred.

The question as to whether the remaining assets were “unreasonably small” for operation
of the business need not be answered, as no further business was to be conducted.

Although not paid for, it appears that the net book value of the computer software of LIS,
as well as possibly some accounts receivable, were carried over to Arclogix balance sheet
without compensation to LIS.

Actual “intent to hinder, delay, or defraud its creditors”

The Court did not find the explanation of why the new entity (Arclogix) was formed very
credible. Sperbeck’s testimony that it was some unnamed attomey’s suggestion that it should be
done to give stock to employees sounds contrived, particularly in light of Sperbeck’s admission

that the APBLS claim was in his mind when he implemented his plans. (Transcript pp. 198-

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199). Moreover, there was no other evidence to corroborate his testimony of an unnamed
attorney’s advice.

The Court finds the notice of name change (Ex. 10) and the testimony with respect to the
same (Transcript 1:61) and the notice to vendors (Ex. 21) and customers (various Exhibits such
as C) compelling evidence of the intent to continue the LIS business under a new name and
Arclogix so held itself out. Coupled with the non-payment for any contracts or intellectual
property, while the financial statements of the new enterprise absorbed on its asset side the
development costs for software, the Court is satisfied that there was actual intent that Arclogix be
the successor to LIS, and it was so treated by all involved (vendors, employees, accountants, and
contracting parties) with one very crucial exclusion, APBLS.

Piercing Corporate Veil/ Substantive Consolidation

Following the conclusion of the trial, the Trustee obtained permission to conform the
complaint to the evidence at trial. Pursuant to Count VII (against Arclogix for “successor
liability”), and Count IX (against Sperbeck to “pierce the corporate veil of the Debtor”), the
Trustee asserts that Arclogix is a mere continuation of the Debtor’s business and that Sperbeck
commingled “funds, assets and or management between [the Debtor] and Sperbeck” and used
both the Debtor and Arclogix to hide his assets. Even though Count VII is styled as a successor
liability count, the Trustee is really attempting either to pierce the corporate veil between
Arclogix and the Debtor or substantively consolidate them with the Debtor; he is seeking a
declaration that Arclogix’s assets are the Debtor’s assets. These counts tie in with the Trustee’s
Motion for Substantive Consolidation (Docket #18 in the Chapter 7 case; 03-10886), which was

tried along with the adversary proceeding.

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Substantive consolidation versus piercing the corporate veil.

Substantive consolidation is the emerging theory used by bankruptcy courts for
collapsing two or more entities and/or their estates into one. It is based on federal law. Piercing
the corporate veil is based on state law and bankruptcy courts are increasing moving away from
it as a theory to collapse entities into a single unit. While piercing the corporate veil examines
whether the entities are alter egos, substantive consolidation has additional considerations aimed
at examining the harm and benefit to all creditors.

As the Trustee notes in his post-trial brief, bankruptcy courts have the power, under
section 105 of the Bankruptcy Code, to substantively consolidate multiple entities, including
debtor and non-debtor entities, even though the power is not expressly stated in the Bankruptcy
Code.

[T]he bankruptcy court had the power to enter the substantive

consolidation order. [Flor many purposes, courts of bankruptcy are

essentially courts of equity, and their proceedings inherently

proceedings in equity. The bankruptcy court’s power of substantive

consolidation has been considered part of the bankruptcy court's

general equitable powers since the passage of the Bankruptcy Act

of 1898.
In re Bonham, 229 F.3d 750, 763 (9th Cir. 2000) (internal quotations and citations omitted); see
also Woburn Assoc. vy. Kahn (In re Hemingway Transport, Inc.), 954 F.2d 1, 12 (st Cir. 1992);
In re Dehon, Inc., 2004 WL 2181669 (Bankr. D. Mass. 2004). But the courts often use the term
loosely, with some courts analogizing substantive consolidation to corporate mergers, Jn re
Parkway Calabasas, Ltd., 89 B.R. 832, 836 (Bankr. C.D. Cal. 1988), while others use the
verbiage of and the factors for piercing the corporate veil. See Jn re Circle Land & Cattle Corp.,
213 B.R. 870, 874 (Bankr. D. Kan. 1997) (explaining that courts are replacing veil piercing with

substantive consolidation). Substantive consolidation is often used to consolidate the estates of

two or more debtors. Jn re Snider Bros., Inc., 18 B.R. 230, 234 (Bankr. D. Mass. 1982)

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(referring to the equitable power to consolidate “the estates”). It can be used to consolidate
debtor and non-debtor entities, although often in the context of consolidating affiliated entities.

In Dehon, 2004 WL 2181669, *3-4, Judge Boroff explained

Substantive consolidation, in effect, pools together the assets and
liabilities of separate, yet related, entities, to form one estate in
bankruptcy. Employing this tool, courts “pierce the corporate veil” in
order to satisfy claims of the creditors of the consolidated entities
from their common pool of assets. Large corporations, such as the
Debtor, often use multi-tiered corporate structures, and substantive
consolidation has been used to reach the assets and liabilities of a
non-debtor subsidiary corporation.

Different.standards have been employed by courts to determine the
appropriateness of substantive consolidation. In the First Circuit,
bankruptcy courts remain unsettled as to what standard should be.
One principle, however, remains constant: substantive consolidation
should be approached with a concern for equitable treatment to all
creditors involved. Notably, none of the tests weigh the interests of
outside third parties. This is consistent with a core goal of the
Bankruptcy Code to maximize the assets of debtors to satisfy their
creditors’ claims. (Internal citations omitted).

Standard for Substantive Consolidation

The only pronouncement from the First Circuit regarding the standard to be used is found
in Hemingway Transport, 954 F.2d at 12, that this Court quoted in /m re Century Electronics
Mfz., Inc., 310 B.R. 485, 489 (Bankr. D. Mass.2004)’:

Consolidation is permitted only if it is first established that the related
debtors’ assets and liabilities are so intertwined that it would be
impossible, or financially prohibitive, to disentangle their affairs. The
trustee may request consolidation to conserve for creditors the monies
which otherwise would be expended in prolonged efforts to disentangle
the related debtors’ affairs. Nevertheless, the bankruptcy court must
balance the potential benefits of consolidation against any potential
harm to interested parties.

'The issue in Century Electronics was whether substantive consolidation should be given retroactive effect.

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In Century Electronics this Court explained the test set out in Jn re Auto-Train Corp.,
Inc., 810 F.2d 270, 276 (D.C.Cir.1987). That test has three parts, all of which must be met: (1)

the proponent must show a substantial identity between the entities to be consolidated, and

(2) the proponent must show that consolidation is necessary to avoid some harm or to realize
some benefit, and (3) if a creditor objects and demonstrates that it relted on the separate credit of
one of the entities and that it will be prejudiced by the consolidation, then the court may order
consolidation only if it determines that the demonstrated benefits of consolidation “heavily”

outweigh the harm.

Standard for Piercing the Corporate Veil

In In re Aoki, Adv. Pro. 03-4164, docket # 48, this Court adopted the language and test
for piercing the corporate veil under Massachusetts law. The decision was affirmed on appeal by

the BAP. As the panel stated

The Massachusetts Supreme Judicial Court has described two
situations when piercing the corporate veil is appropriate: “(1)
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 (2)
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., 353 Mass. 614, 233
N.E.2d 748, 752 (1968) (“ My Bread”).

Adopting the My Bread standard, the Court of Appeals for the First
Circuit set forth twelve factors to consider when deciding whether
to pierce the corporate veil:

(1) common ownership;
(2) pervasive control;

(3) confused intermingling of business activity, assets, or
management;

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(4) thin capitalization;

(5) nonobservance of corporate formalities;

(6) absence of corporate records;

(7) no payment of dividends;

(8) insolvency at the time of the litigated transaction; -

(9) siphoning away of corporate assets by the dominant
shareholders;

(10) nonfunctioning of officers and directors;

(11) use of the corporation for transactions of the dominant
shareholders; and

(12) use of the corporation in promoting fraud.

Pepsi-Cola, 754 F.2d [10, 16 (1st Cir. 1985)]; see also Evans v.
Multicon Constr. Corp., 30 Mass. App. Ct. 728, 574 N.E.2d 395,
398 (1991) (applying the Pepsi-Cola factors); The George Hyman
Constr, Co. v. Gateman, 16 F. Supp.2d 129, 151 (D. Mass. 1998)

(same). Generally, in Massachusetts, My Bread sets the standard for

deciding when to pierce the corporate veil, and Pepsi-Cola
identifies a non-exclusive list of factors to be considered when
engaging in a My Bread analysis. See, e.g., Birbara v. Locke, 99
F.3d 1233, 1238 (1st Cir. 1996), This analysis is also applicable in
the bankruptcy context. See MacDonald, 114 B.R. [326, 331 (D.
Mass. 1990)] (the equitable powers of the bankruptcy court enable
them to apply the My Bread and Pepsi-Cola analysis to pierce the
corporate veil in order to attribute a non-debtor corporation's assets
or liabilities to the shareholders of the corporation) (citation
omitted).

In re Aoki, 323 B.R. 803, 811 -12 (1st Cir. B.A.P. 2005).

Desc Main

Finally as the court in In re Standard Brands Paint Co.,154 B.R. 563, 568-69 (Bankr.

C.D. Cal. 1993), noted it is not uncommon or inappropriate to allow relief under both theories if

the respective tests have been meet.

Sperbeck testified that there were no creditors of Arclogix. It would be extremely

difficult and probably impossible to unravel the transfers made here, particularly since the

contracts and software fraudulently usurped have “morphed” several times over in the years

since the tainted transactions. As there are no creditors to be harmed, it seems to the Court that

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the criteria for substantive consolidation of the Debtor and Arclogix effective as of March 18,
2009 is an appropriate remedy and it will be ordered.

Susan Cahoon

With respect to the alleged liability of Susan Cahoon, the Court is not satisfied that Ms.
Cahoon had any knowledge that there was an unpaid claimant or creditor. The Court cannot find
any evidence upon which a finding of intent to delay, defraud, etc. can be based either directly or
through inference. It is not even clear to the Court what, if anything, Cahoon knew of the
Counterclaim that ultimately led to the judgment against LIS.

Conclusion
Count I, judgment for the Plaintiff against Arclogix. *
Count II, judgment for the Plaintiff against Sperbeck in the amount of $254,163.50.
Count II, judgment for the Plaintiff against Sperbeck, and Sperbeck is ordered to turnover the
sum of $254,163.50.
Count IV, judgment for the Plaintiff against Arclogix. *
Count V, judgment for the Plaintiff against Sperbeck in the amount of $424,499.
Count VI, judgment for the Plaintiff as follows: (1) Of the balance held in the Wellesley Bank
Account, $95,000 is declared to be property of the bankruptcy estate of Logisitics Information
Systems, Inc., and (2) the Plaintiff may reach and apply the balance of the Wellesley Bank
Account less $95,000, to satisfy Sperbeck’s obligations under Counts II, II, and V.
Count VII, judgment for the Plaintiff against Arclogix. *
Count VIII, judgment for the Plaintiff against Sperbeck *, and judgment for the Defendant,
Cahoon.

Count IX, judgment for the Defendant, Sperbeck.

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Count X, judgment for the Plaintiff against Sperbeck *, and judgment for the Defendant,

Cahoon.

* In lieu of a money judgment, the remedy for Counts I, ['V, VII, VIII, and X is the substantive
consolidation of Logisitics Information Systems, Inc. and Arclogix, Inc. A separate order will
issue in the main case granting the Trustee’s Motion for Substantive Consolidation [Docket #18]
forthwith.

A separate order will issue.

March 18, 2009

. Rosenthal
nited States Bankruptcy Judge

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Schedule A
Court’s determination of “Defendants’ Proposed Findings of Fact” (Docket # 121)
[* see commentary]

Irrelevant Adopt Do not adopt

41 1-4+ 9+
5-7 l1*
g* 18 *
10 24 *
12 28-29
13 # 40
14*

15

16 *
17*
19

20 *
21-23
25 *
26 *
27+
30
31+
32-35
36 *
37-39

Commentary on Defendants’ Proposed Findings of Fact

1-4- Defendant’s background is in sharp contrast to his superficial answers.

8, 25- It is unclear from the record what Ms. Cahoon knew with respect to the claim of APBLS.

11

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9, 11, 13, 14, 16- The record reflects that Sperbeck made loans and received re-payments from
Logisitics. The Court is not satisfied that the original loans and opening balance thereof was
ever proved. Clearly, a paper trail evidencing these “loans” was never established.

17, 18, 20- See Text. The court does not adopt the statement that “Logisitics had no other
creditors” and “APBLS was not yet a creditors of Logisitics.” Further, the issue of “profit” is not
relevant in this context.

24 — The Court does not adopt the second and third sentences of this proposed finding.

26- The jetter referred to, Exhibit 10, advised all vendors of a “name change.” There was no
evidence that APBLS was sent this letter.

27- The Court does not adopt the second sentence of this proposed finding.

31 — The differences between the software do not seem relevant to the Court. Further, the Court
is not convinced of the necessity or logic of Arclogix’s formation to accomplish Sperbeck’s
objectives.

36 — This proposed finding is only partially correct. See text of memo concerning assets

transferred.

12

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Court’s determination of “Defendants’ Proposed Rulings of Law” (Docket # 121)

[* see commentary]

Irrelevant Adopt Do no Adopt

11 1-8
9 *
10
12
13
14
15 *
16-18
19 *
20
21 *

Commentary on Defendants’ Proposed Rulings of Law

9. This list of “factors” is not exclusive. The word “not” should appear before the words “was”

and “reasonably” in #8.

15, 19, 21 — These lists of “factors” are not exclusive.

13

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Schedule B
Court’s determination of “Plaintiff's Proposed Findings of Fact” (Docket # 124)

[* see commentary]

Irrelevant Adopt Do not Accept
1-25 29
26 * 30
27-28 40
31-39 48-49
41-47 51 *
50
52-102

Commentary on Plaintiff's Proposed Findings of Fact

26 — The record is not clear whether the payment was for anything other than assets listed on the
check (Exs. 6 & 7).
51 — It is unclear from the record whether any formal sale or transfer documents ever existed for

some of the assets. See text of Memo.

14

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Court’s determination of “Plaintiff's Proposed Rulings of Law” (Docket # 124)

Irrelevant Adopt Do not Accept
1 2
3-10 11-13
14-20

15