BARBARA J. HOUSER, Bankruptcy Judge.
Before the Court are several motions to dismiss the second amended complaint (the "Complaint") filed by Diane G. Reed as chapter 7 trustee (the "Trustee") of the estates of four related chapter 7 debtors (the "Debtors"). The Debtors, together with other affiliates, filed voluntary petitions for relief under chapter 7 on August 22, 2008. The four debtors on whose behalf the Trustee filed the Complaint are Soporex, Inc. ("Inc."), Soporex Respiratory, Inc. ("SRI"), Soporex Respiratory II, Inc. ("SRI 2"), and Winmar Diagnostics North Central, Inc. ("Winmar").
In very broad brush, the Complaint alleges the following claims: Count 1, against only Linehan, alleges breaches of the fiduciary duties of loyalty and due care. Count 2 alleges that same claim against Sabolik. Count 3, against Smith and Sabolik, alleges a claim for corporate waste. Count 4, against the Outside Directors, alleges breaches of the duties of loyalty and due care. Count 5 alleges that same claim against Letson. Count 6 constitutes
Four of the Outside Directors have filed a motion to dismiss Count 4, which is the only claim asserted against them.
Each of the Motions is asserted under Fed.R.Civ.P. 12(b)(6), made applicable here by Fed. R. Bankr.P. 7012. All of the Defendants contend that the Complaint fails to state a claim upon which relief can be granted with regard to the Counts 1-5.
Although no party has raised an issue with respect to this Court's ability to hear
Stern concerned a bankruptcy court's authority to hear and finally determine a debtor's common-law counterclaim to a proof of claim filed against the bankruptcy estate. The Supreme Court held that a bankruptcy court, as an Article I tribunal, may not constitutionally enter a final judgment over a debtor's counterclaim that would not necessarily be resolved by the resolution of the debtor's objection to the claimant's proof of claim.
As relevant here and as noted previously, two of the Defendants—i.e., Sabolik and Smith, filed proofs of claim in the Inc. case for amounts allegedly owed to them for unpaid compensation and benefits. Count 6 of the Complaint is the Trustee's objection to those proofs of claim. However, the Trustee is also asserting affirmative state law claims against them and is seeking to recover significant monetary damages from them. Specifically, and as noted previously, Count 2 of the Complaint contains a claim against Sabolik for breach of the fiduciary duties of due care and loyalty, while Count 3, against Smith and Sabolik, alleges a claim for corporate waste. In deciding whether Smith and Sabolik are owed unpaid compensation and benefits by Inc. as asserted in their proofs of claim, this Court will not be called upon to decide the Trustee's state law claims against them as pled in Counts 2 and 3. Thus, at least with respect to the Trustee's claims against Smith and Sabolik, Stern is directly implicated and, according to the Supreme Court, this Court lacks constitutional authority to finally determine the Count 2 and 3 claims as pled in the Complaint.
So, the question becomes, if this Court lacks constitutional authority to determine the Trustee's counterclaims against Smith and Sabolik,
With this background in mind, the question remains—what can this Court do with respect to a statutorily defined "core" proceeding that the Supreme Court has held in Stern cannot be finally determined by a bankruptcy court? Can it issue proposed findings and conclusions to the district court as it is expressly authorized to do by statute with respect to those proceedings that are "related to" a bankruptcy case? For the reasons set forth below, this Court concludes the answer to this question is yes.
First, the Supreme Court itself at least implied in Stern that the effect of its decision was to "remove" certain claims from "core bankruptcy jurisdiction," and to relegate them to the category of claims that are merely "related to" bankruptcy proceedings and thus are subject to being heard, but not finally determined, by bankruptcy courts when it stated that
Id. at 2620. And, as noted previously, this Court has statutory authority to issue proposed findings of fact and conclusions of law to the district court with respect to "related to" proceedings. 28 U.S.C. § 157(c)(1).
Second, the Supreme Court's analysis in Stern also provides strong authority for the proposition that there remain only two types of proceedings under 28 U.S.C. § 157: (1) "core" proceedings that arise "in" a bankruptcy case or "under" title 11, and (2) "non-core" proceedings that are "related to" a bankruptcy case. The Stern Court came to this conclusion after holding § 157(b)(1) "ambiguous," thus requiring an authoritative interpretation. 131 S.Ct. at 2604-05. In short, the Supreme Court concluded that there were "[t]wo options. The statute does not suggest that any other distinctions need be made." Id. at 2605.
Third, and in the alternative, if there is now a third type of proceeding not expressly addressed in 28 U.S.C. § 157—i.e., statutorily defined "core" proceedings over which a bankruptcy court lacks constitutional authority to finally determine— there is no constitutional impediment, and should be no other impediment, to a bankruptcy
Finally, at least two other courts have come to the same conclusion—i.e., that Stern did not strip the bankruptcy courts of the authority to hear these types of claims and to propose findings of fact and conclusions of law to the district court for de novo review. See, e.g., Field v. Lindell (In re Mortgage Store, Inc.), No. 11-00439 JMS/RLP, 2011 WL 5056990 at *5-6 (D.Hawai'i Oct. 5, 2011) (concluding that under these circumstances it must "determine what `Congress would have intended' in light of [Stern's] constitutional holding" and that "Congress' intent in enacting 28 U.S.C. § 157 is clear enough on its face—Congress intended that bankruptcy courts, to the extent possible, should adjudicate cases relating to Title 11. Thus, the court has little difficulty in finding that Congress, if faced with the prospect that bankruptcy courts could not enter final judgments on certain `core' proceedings, would have intended them to fall within 28 U.S.C. § 157(c)(1) granting bankruptcy courts authority to enter findings and recommendations."); Paloian v. American Express Co. (In re Canopy Financial, Inc.), No. 09B 44943, 2011 WL 3911082 (N.D.Ill. Sept. 1, 2011).
For these reasons, this Court will issue proposed findings of fact and conclusions of law to the district court with respect to that portion of the Officers' Motion addressing the Trustee's Count 2 and 3 claims against Sabolik and Smith.
Many are debating the breadth of the Supreme Court's decision in Stern. The arguments are interesting and, in some instances, mind-numbing. For today, I leave those arguments to others because I believe that the issue before me can be more simply, and practically, decided. It would be incredibly ironic for this Court to lack constitutional authority to finally determine the Trustee's breach of fiduciary duty and corporate waste claims against Smith and Sabolik (when they actually inserted themselves into Inc.'s bankruptcy case by filing a proof of claim) as the Supreme Court has clearly held in Stern, but to have constitutional authority to finally determine the Trustee's breach of fiduciary duty claims (arising from substantially the same acts or failures to act) against Linehan, the Outside Directors, and Letson, who chose not to involve themselves in the Debtors' bankruptcy cases at all until they were forced to do so by the Trustee's decision to sue them here. As a practical matter, this Court concludes that such a result is irreconcilable with the Supreme Court's analysis in Stern. If this Court lacks constitutional authority to finally determine one set of breach of fiduciary duty claims against two former officers of certain of the Debtors, surely it lacks constitutional authority to finally determine substantially identical sets of breach of fiduciary duty claims against other former officers and/or directors of certain of the Debtors.
Accordingly, this Court concludes that it lacks the constitutional authority to finally determine the Trustee's claims against the remaining Defendants, who have not filed proofs of claims. As such, and for the reasons discussed above, this Court will also issue proposed findings of fact and conclusions of law to the district court with respect to the balance of the Officers' Motion and the other Motions addressing the Trustee's Count 1, 4, and 5 claims against Linehan, the Outside Directors, and Letson.
A complaint must contain a "short and plain statement of the claim showing that the pleader is entitled to relief." Fed.R.Civ.P. 8(a)(2). While a complaint need not contain detailed factual allegations, it must contain "more than labels and conclusions, and a formulaic recitation of a cause of action's elements will not do." Bell Atl. Corp. v. Twombly, 550 U.S. 544, 545, 127 S.Ct. 1955, 167 L.Ed.2d
The Supreme Court held in Iqbal that the "plausibility" standard articulated in Twombly applies in all civil cases. Morgan v. Hubert, 335 Fed.Appx. 466 (5th Cir.2009) (discussing Iqbal). The Supreme Court has set out a two-pronged approach for reviewing a motion to dismiss for failure to state a claim. Iqbal, 129 S.Ct. at 1949-50; McCall, 661 F.Supp.2d at 653. First, the reviewing court may identify those statements in a complaint that are actually conclusions, even if presented as factual allegations. Iqbal, 129 S.Ct. at 1949-50; McCall, 661 F.Supp.2d at 653. Such conclusory statements, unlike proper factual allegations, are not entitled to a presumption of truth. Iqbal, 129 S.Ct. at 1949-50; McCall, 661 F.Supp.2d at 653. It is the conclusory nature of the statements rather than any fanciful or nonsensical nature "that disentitles them to the presumption of truth." Iqbal, 129 S.Ct. at 1951; McCall, 661 F.Supp.2d at 653. Second, the reviewing court presumes the truth of any remaining "well-pled factual allegations," and determines whether these factual allegations and their reasonable inferences plausibly support a claim for relief. Iqbal, 129 S.Ct. at 1950; McCall, 661 F.Supp.2d at 653.
The duty of loyalty is most classically invoked when a director stands on both sides of a transaction and it prohibits the director from deriving any personal benefit through self-dealing. Anadarko Petroleum Corp. v. Panhandle E. Corp., 545 A.2d 1171 (Del.1988). Until fairly recently, the Delaware courts spoke in terms of a "triad" of fiduciary duties: that of good faith, loyalty and due care. Cede & Co. v. Technicolor, Inc., 634 A.2d 345, 361 (Del.1993), modified on other grounds, 636 A.2d 956 (Del.1994). In two decisions rendered in 2006, the Delaware Supreme Court both clarified that the duty of good faith is not a standalone, separate duty but rather is an element of the duty of loyalty, and defined its contours. See Stone v. Ritter, 911 A.2d 362 (Del.2006) and In re Walt Disney Co. Deriv. Litig., 906 A.2d 27 (Del.2006). Thus, the duty of loyalty now encompasses cases where the fiduciary fails to act in good faith. Stone v. Ritter, 911 A.2d at 370 ("the fiduciary duty of loyalty is not limited to cases involving a financial or other cognizable fiduciary conflict of interest ... a director
However, also until fairly recently, the duty to act in good faith has been "relatively uncharted," Disney, 906 A.2d at 64, and it is has often been discussed, as in the Disney case itself, in the context of a discussion on the duty of care, although the Delaware Supreme Court has now made clear that it is a sub-set of the duty of loyalty. The Disney court noted that at least "three different categories of fiduciary behavior are candidates for the `bad faith' perjorative label." Id. The first category identified by the Disney court involves "`subjective bad faith,' that is, fiduciary conduct motivated by an actual intent to do harm. That such conduct constitutes classic, quintessential bad faith is a proposition so well accepted in the liturgy of fiduciary law that it borders on axiomatic." Id. The second category, at the opposite end of the spectrum, is conduct which involves a lack of due care—"that is, fiduciary action taken solely by reason of gross negligence and without any malevolent intent." Id. The Disney court concluded that such gross negligence, including a failure to inform oneself of available material facts, without more, cannot constitute bad faith. Id. at 65-66. The Disney court then discussed the third category, which lies between the first two on the spectrum—conduct involving "intentional dereliction of duty, a conscious disregard for one's responsibilities." Id. at 66. The Disney court held that such conduct is properly treated as a violation of the fiduciary duty to act in good faith, for two reasons:
Disney, 906 A.2d at 66. Second, the Disney court noted that the Delaware legislature has recognized this "intermediate category of fiduciary misconduct, which ranks between conduct involving subjective bad faith and gross negligence," Disney, at 67, in section 102(b)(7)(ii) of the Delaware General Corporation Law, which authorizes a Delaware corporation to include a provision in its certificate of incorporation exculpating directors from monetary damage liability for a breach of the duty of care with certain exceptions, one of which is for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of the law. The Disney court noted that because the statute exculpates directors only for conduct amounting to gross negligence, its denial of exculpation for acts not in good faith must encompass the intermediate category of misconduct.
In Stone v. Ritter, 911 A.2d 362 (Del.2006), the Delaware Supreme Court refined its analysis further, in the context of what has become known as a Caremark claim—i.e., a claim predicated on a board's failure to exercise corporate oversight— which derives its name from In re Caremark Int'l Inc. Deriv. Litig., 698 A.2d 959 (Del.Ch.1996). The Caremark case itself involved the court's consideration of a settlement of a suit involving claims that the board of directors of Caremark International, Inc. ("Caremark") breached their fiduciary duty of care to Caremark in connection with alleged violations by Caremark employees of federal and state laws regulating health care providers. As the Caremark court noted, the complaint before it did not allege either director self-dealing or "the more difficult loyalty-type problems arising from cases of suspect director motivation." Caremark, at 967. Instead, the complaint alleged that Caremark's board "allowed a situation to develop and continue which exposed the corporation to enormous legal liability and that in so doing they violated a duty to be active monitors of corporate performance," which the Caremark court characterized as "possibly the most difficult theory in corporation law upon which a plaintiff might hope to win a judgment." Id.
The Caremark court then noted that liability for a breach of the duty to exercise appropriate attention may arise in two distinct contexts: liability may arise from a board decision that results in a loss because that decision was ill-advised or negligent, or it may arise from an unconsidered failure of the board to act in circumstances in which due attention would have prevented the loss. The Caremark court noted that the former cases are subject to review under the business judgment rule, so long as the decision made was the result of a process that was either deliberately considered in good faith or was otherwise rational. Id. In such cases, compliance with the duty of care is not judged by reference to the content of the board decision, but rather by the process employed in reaching the decision. The second category of cases in which director liability is possible results from "unconsidered inaction." Caremark, at 968. In such cases, the Caremark court held that "only a sustained or systematic failure of the board to exercise oversight—such as an utter failure to attempt to assure a reasonable information and reporting system exists—will establish the lack of good
As noted by the court in In re Citigroup Shareholder Deriv. Litig., 964 A.2d 106, 122-23 (Del.Ch.2009), although the Caremark decision, which articulated the standard for "oversight liability," involved a claim for breach of the duty of care, the Supreme Court in Stone (i) explicitly approved the Caremark standard for oversight liability cases, (ii) made clear that the duty breached in such cases is the duty to act in good faith, and (iii) made clear that the duty of good faith is not a stand-alone liability, but rather is a subsidiary element—i.e., a condition, of the duty of loyalty. The Stone court further held that the necessary conditions predicate for director oversight liability are:
Stone, 911 A.2d at 370.
Cases subsequent to Caremark and Stone have construed an oversight liability claim as one requiring "proof that a director acted inconsistent with his fiduciary duties and, most importantly, that the director knew that he was so acting." In re Massey Energy Co., C.A. No. 5430-VCS, 2011 WL 2176479 (Del.Ch. May 31, 2011). In other words, a plaintiff must allege that "a director knowingly violated a fiduciary duty or failed to act in violation of a known duty to act, demonstrating a conscious disregard for her duties." In re Citigroup Shareholder Deriv. Litig., 964 A.2d 106, 125 (Del.Ch.2009) (emphasis in original). As the Delaware Supreme Court has noted, "there is a vast difference between an inadequate or flawed effort to carry out fiduciary duties and a conscious disregard for those duties." Lyondell Chem. Co. v. Ryan, 970 A.2d 235, 243 (Del.2009). A plaintiff must plead facts "suggesting that the board knew that internal controls were inadequate, that the inadequacies could leave room for illegal or materially harmful behavior, and that the board chose to do nothing about the control deficiencies that it knew existed." Desimone v. Barrows, 924 A.2d 908, 940 (Del. Ch.2007) (finding that complaint alleging abdication of the board's duty to monitor compliance with applicable laws and regulations governing issuance of stock options failed to state a claim). In the transactional context, "an extreme set of facts is required to sustain a disloyalty claim premised on the notion that disinterested directors were intentionally disregarding their duties." Lyondell, 970 A.2s at 243.
The typical Caremark claim involves a claim that the board is liable for damages that arise from a failure to properly monitor or oversee employee misconduct or legal violations. In re Citigroup Shareholder Deriv. Litig., 964 A.2d 106, 122-23 (Del.Ch.2009). However, in Citigroup, the plaintiffs attempted to state Caremark oversight liability claims where they alleged that the board ignored "red flags" respecting the impending financial crisis in
Citigroup, 964 A.2d at 124. While acknowledging a duty of oversight, the Citigroup court held that the obligation to implement and monitor a system of oversight
Citigroup, 964 A.2d at 125 (finding that plaintiffs did not state a claim for failure of oversight). The Citigroup court held that to recognize the claims before it under a theory of director oversight liability would
Citigroup, 964 A.2d at 130.
In sum, notwithstanding the plaintiff's attempts to plead their theory of the case as a Caremark claim, the Citigroup court declined to extend the oversight liability theory to a claim alleging a failure to monitor business risk in Citigroup's operations. Instead, that court reviewed that claim under the duty of care and the business judgment rule.
Under Delaware law, the duty of care requires that in making business decisions, corporate directors must consider all material information reasonably available. San Antonio Fire & Police
With these principles firmly in mind, the Court turns to an analysis of the Motions.
As against the Outside Directors, the Trustee alleges that at all relevant times, each was a member of the Board and, as such, each owed the fiduciary duties of loyalty and due care to Inc. and its shareholders. Further, the Trustee alleges that Inc. was insolvent no later than May 2008, and upon its insolvency, the Outside Directors' fiduciary duties extended to Inc.'s creditors. The Trustee alleges that each of the Outside Directors breached those duties, individually and collectively, as follows:
The Complaint does not identify which of these nine items the Trustee contends constitute a breach of the fiduciary duty of care, and which she contends constitute a breach of the fiduciary duty of loyalty. The Trustee simply alleges that as a direct and proximate result of these acts and omissions, Inc. and the Operating Subsidiaries and their respective creditors suffered substantial damages and the assets of Inc. were impaired. For these alleged breaches, the Trustee seeks damages consisting of at least the total amount of unpaid creditors' claims, which is estimated to be in excess of $21.5 million. The Trustee further alleges that the damages sustained relate to (i) the loss of payments due to SRI and SRI 2 from Medicare and other insurers, (ii) the loss of value of SRI's and Winmar's businesses, which were allegedly fraudulently transferred to Med 4 Home, Inc. ("Med 4 Home");
The Complaint is lengthy. The Outside Directors note that with respect to the claims pled against them, the Trustee essentially complains of the Outside Directors' acts/omissions in four factual areas, and the Trustee agrees, for the most part, with this characterization.
Second, the Outside Directors note that the Trustee appears to contend that the Board did not sufficiently address the continuing financial decline of Inc. and the Operating Subsidiaries (the "Financial Decline Allegations"). Specifically, the Trustee alleges that in the first quarter of 2008, Inc.'s primary lender under a revolving credit facility was acquired by GE Business Financial Services, Inc. ("GE"). At that time, funds had been over-advanced under the credit facility, such that GE sent a default letter in May, 2008, Compl., ¶ 88, stating that GE would not be making any further advances. Although the Trustee concedes that the Outside Directors were not told of a forbearance agreement with GE or that the Operating Subsidiaries lacked the cash needed to operate beyond July, 2008, the Trustee alleges that the Outside Directors had been informed that Inc. had committed a "major breach" of its credit agreement, and thus the Outside
Third, the Outside Directors note that the Trustee alleges some facts attempting to plead that the Board's decision to file a bankruptcy petition for relief under chapter 7 rather than one under chapter 11 was a breach of their fiduciary duties (the "Bankruptcy Decision Allegations"). See Compl., ¶¶ 159-174.
Fourth and finally, the Outside Directors note that the Trustee alleges some facts that attempt to plead that the Board approved a corporate resolution authorizing chapter 7 filings which constituted an improper delegation of decision-making authority for Inc. and the Operating Subsidiaries to Sabolik and Smith, and an abdication of their duties (the "Corporate Resolution Allegations"). See Compl. ¶¶ 169-180.
The parties have thus focused their attention primarily upon the Carecentric Allegations, the Financial Decline Allegations, the Bankruptcy Decision Allegations and the Corporate Resolution Allegations. The Court will analyze these allegations in detail after addressing a threshold matter in dispute between the parties as explained below.
In short, the parties disagree about the proper application of the business judgment rule at the pleading stage. The Trustee asserts that the business judgment rule is an affirmative defense, such that her complaint need not "plead around" the business judgment rule or negate this affirmative defense, citing to Stanziale v. Nachtomi (In re Tower Air, Inc.), 416 F.3d 229 (3rd Cir.2005). In Tower Air, the Third Circuit noted that
Tower Air, 416 F.3d at 238. The Trustee asserts that since she did not reference the business judgment rule in her Complaint, she is not required to plead facts to overcome the presumption it creates.
The Tower Air decision has been criticized. See, e.g., In re IT Group, Inc., No. 02-10118, 2005 WL 3050611 at *8, n. 10. More importantly, it has been rejected in this district.
Kaye, 453 B.R. at 679-80.
Instead, the district court held that in order to state a claim for breach of fiduciary duty under Delaware law that is plausible on its face, a plaintiff must plead factual content that allows the court to draw the reasonable inference that in making the challenged decision, the directors or officers breached their duties of loyalty or care, and a plaintiff may not simply allege that a fiduciary "undertook a business strategy that was all consuming and foolhardy and that turned out badly and thereby
This Court finds Kaye persuasive, and thus concludes that the Trustee must plead factual content sufficient to rebut the presumption afforded the Outside Directors by Delaware's business judgment rule. Under that rule, the business decisions of a company's board are insulated by a presumption that in making a business decision, the directors acted "on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company." Gantler v. Stephens, 965 A.2d 695, 705-06 (Del. 2009). The party challenging the directors' decision bears the burden of rebutting the presumption afforded by the business judgment rule. Id. at 706. To rebut the presumption, the plaintiff must show that the board breached the duty of loyalty or the duty of care. Id. If the plaintiff fails to rebut the presumption, the decisions of the directors will not be disturbed unless they acted in a manner that cannot be attributed to a rational business purpose. Brehm v. Eisner, 746 A.2d 244, 264 (Del.2000). Therefore, to withstand a 12(b)(6) motion, the Trustee must have alleged facts plausibly showing that the Outside Directors' actions were the result of disloyalty or lack of due care, or that their conduct cannot be attributed to a rational business purpose. Kaye, 453 B.R. at 679.
The Court will address the Carecentric Allegations, the Financial Decline Allegations, the Bankruptcy Decision Allegations, and the Corporate Resolution Allegations in turn.
The Trustee alleges that when they acquired the pharmacy business in 2006, Inc. and SRI had only 15 business days to prepare for operations involving over 26,000 patients, and that SRI could not establish its own billing and collection system because the majority of patients were Medicare or Medicaid patients, so collections had to be processed electronically through the Medicare and Medicaid reimbursement programs and no one initially hired by Inc. had the requisite expertise to set up these systems. Compl., ¶ 44-47. Therefore, according to the Trustee, (i) Inc. had to use an outside vendor, and Carecentric was chosen, Compl., ¶ 49, and (ii) Carecentric and Inc. entered into a letter agreement in March of 2006, which agreement called for the execution of a more extensive written contract within a month. Compl., ¶¶ 51-52. As noted previously, the Trustee alleges that negotiations for the written contract "dragged on," such that the formal written contract was not signed until May, 2007. Compl., ¶ 52. The Trustee further alleges that (i) almost immediately under the letter agreement, SRI experienced problems with Carecentric's performance resulting in hundreds of claims being rejected by insurers, Compl., ¶ 54, (ii) in November of 2006, Inc. hired Teresa Camfield ("Camfield") to oversee Carecentric's billing and collection activities, Compl., ¶ 55, (iii) later that month, Camfield prepared a report detailing the problems with Carecentric's performance and recommending corrective action and sent the report to Linehan and
According to the Trustee, the contract that the Board approved at the April, 2007 Board meeting contained a limitation of liability provision that limited Carecentric's liability for damages to the total amount of fees paid to it by Inc. Compl., ¶ 62-63. The Trustee alleges that at the time of the April, 2007 Board meeting, Linehan, Sabolik and Smith were aware that Carecentric had negligently performed under the initial letter agreement, that SRI would have to write off nearly $3 million in bad debt due to Carecentric's failure to perform, and that they knew or should have known that the total fees paid to Carecentric as of the date of the Board meeting was approximately $900,000, such that Inc. would not be able to recover the full amount of damages it had already sustained as a result of Carecentric's poor performance. Compl., ¶¶ 64-65. The Trustee further alleges that despite this knowledge and "with no apparent discussion about the fact that (i) CareCentric had materially breached the CareCentric Letter Agreement, (ii) SRI had already sustained over $3 million in damages as a result of such breach, and (iii) Soporex would not be able to recover these damages based upon the contractual limitation on damages contained in the CareCentric Services Agreement, the Soporex Board `rubber-stamped' Linehan's and Smith's request to approve the CareCentric Services Agreement." Compl., ¶ 65.
However, at that same April, 2007 Board meeting, the Trustee alleges that the Board also approved an agreement between Inc. and Convergent Media Network, Ltd. ("CMAEON") to provide the software and data processing systems necessary to bring the billing and collection functions in-house, although the Trustee alleges that decision was made without "appropriate due diligence" to determine whether CMAEON could provide the necessary services. Compl., ¶ 68-69. The Trustee alleges that unbeknownst to Inc., CMAEON had to write and construct the software system from scratch. Compl., ¶ 70. The Trustee also alleges that (i) it was not until November, 2007 that Inc.'s officers finally instructed others to transfer SRI's billing and collections systems to in-house systems. Compl., ¶ 67, and at a December, 2007 Board meeting, the Board was told that the transition of the systems from Carecentric to an in-house system was not yet complete, Compl., ¶ 71, (ii) Inc. was not able to use the in-house system until February, 2008, Compl., ¶ 72, and (iii) when Carecentric learned that Inc. was moving its systems in-house, Carecentric denied Inc. access to its data, which was stored on Carecentric's servers, so Inc. was unable to bill and collect, and had to hire Med Staff Plus, Inc. ("Med Staff") at a cost of $100,000 per month to try to collect its accounts. Compl., ¶ 75. The Trustee further alleges that (i) in July, 2008, Inc. also brought its "re-billing" functions in-house, because it could no longer afford to pay Med Staff, Compl., ¶ 76, (ii) the re-billing process was terminated in August of 2008, when Inc. shut its doors, and (iii) SRI had to write off bad
Next, the Trustee alleges that (i) the Outside Directors "never took any kind of affirmative action to address Soporex's operational and financial problems, even after significant adverse financial events were brought to their attention, such as the significant problems with the billing and collection of the SRI accounts receivable, the multimillion dollar write offs of pharmacy bad debt due to CareCentric's negligent performance ...," Compl. at ¶ 150, (ii) despite being told at their April, 2007 Board meeting of the problems with Carecentric's performance, the Outside Directors nevertheless approved the Carecentric contract, and also the agreement with CMAEON, Compl., ¶ 153, and (iii) at their September, 2007 Board meeting, the Outside Directors were informed that SRI was not collecting its accounts, had written off over $2 million in bad debt, but took no corrective action. Compl., ¶ 154.
As it relates to the Outside Directors' (minus Letson) Motion and stripped to their essence, all of these allegations are tantamount to a complaint that (i) the Outside Directors approved the Carecentric agreement when they shouldn't have, (ii) the Outside Directors' decision constituted a "rubber stamp" of the officers' recommendations, and (iii) the Outside Directors didn't move quickly enough to move the billing functions in-house. The Complaint contains no allegations of self-dealing with respect to the Carecentric transaction, and thus to the extent the Trustee contends that the Outside Directors' conduct breached their duty of loyalty, the Trustee must be relying on a lack of good faith.
To the extent that the Trustee is attempting to assert a director oversight liability claim, the Carecentric Allegations do not rise to the level required by the decisions in Caremark and Stone. The Trustee has not alleged a "sustained or systematic failure of the board to exercise oversight." Caremark 698 A.2d at 968. Moreover, the Court notes that the Trustee,
Lastly, the Court notes that the Trustee's theory is somewhat undercut by her own allegations. While alleging that the Outside Directors "rubber stamped" the decision to proceed with the Carecentric agreement at their April, 2007 Board meeting, the Trustee also alleges that the Board approved the hiring of CMAEON to replace Carecentric once the needed software was constructed and that the Board received a status report on CMAEON's progress at a later Board meeting. The Trustee does not, tellingly, allege that Inc. had any alternative to approving the Carecentric agreement in April of 2007, that there were other outside vendors who could have provided the same service better or on more favorable terms, or that the billing and collections functions could have been brought in-house any earlier than they were.
For all of these reasons, the Court concludes that the Trustee has not stated a plausible breach of the duty of loyalty claim against the Outside Directors to the extent she relies upon the Carecentric Allegations.
The Trustee fares no better to the extent she relies upon a breach of the duty of care claim. The Carecentric Allegations do not rise to the level of "reckless indifference" or conduct "beyond the bounds of reason," McPadden v. Sidhu, 964 A.2d 1262 (Del.2008), or conduct so "grossly off-the-mark as to amount to reckless indifference or a gross abuse of discretion." In re Lear Corp. Shareholder Litig., 967 A.2d 640, 652 (Del.Ch.2008). And, as noted earlier, claims seeking to impose liability for a board decision that results in a loss because that decision was ill-advised are reviewed under the business judgment rule, without reference to the content of the decision but rather the process employed in reaching it. While the Trustee does allege that the Outside Directors "rubber stamped" the decision to enter into the Carecentric agreement, that conclusory statement is unsupported by any factual content and thus does not meet a plausibility standard.
Thus, the Court concludes that the Trustee's breach of fiduciary duty claim against the Outside Directors, to the extent it relies on the Carecentric Allegations, must be dismissed.
The Trustee alleges that in the first quarter of 2008, GE acquired Merrill Lynch Business Financial Services, Inc., which had entered into a revolving credit facility with Inc., SRI and two other subsidiaries of Inc. Compl., ¶ 87. According to the Trustee, those borrowers were out of compliance with borrowing base covenants under the credit facility and were over-advanced at the time of GE's acquisition. The Trustee further alleges that GE sent Inc. a default letter on May 14, 2008, Compl., ¶ 88, and informed Inc. that GE would not be making any further advances. Then, according to the Trustee, Linehan and Sabolik, after receiving this default
Nevertheless, the Trustee alleges that the Outside Directors had been informed that Inc. had committed a "major breach" of its credit agreement, and thus the Outside Directors were on notice of Inc.'s and the Operating Subsidiaries' "dire" financial condition, and that despite this knowledge, "the Outside Directors took no action to remedy Soporex's financial crisis and they failed to investigate the financial consequences of Soporex's breach." Compl., ¶ 91. The Trustee alleges that in part due to Linehan's constant assurances that venture capital money was just around the corner, the Outside Directors never addressed the continuing financial decline of Soporex and the Operating Subsidiaries. Compl., ¶ 136. The Trustee further alleges that the Outside Directors were aware of the significant billing and collection problems, the write-offs of bad debt due to Carecentric's poor performance, a decrease in the reimbursement rate for Albuterol (a respiratory medication), GE's notice of default letter, and the termination of credit by one of Soporex's primary pharmaceutical suppliers, and yet the Board held no meetings. Compl., ¶¶ 150-151.
However, the Trustee also alleges that when Inc. determined in mid-May of 2008 that it lacked sufficient cash to operate past July, Linehan and Sabolik failed to inform the Outside Directors of Inc.'s dire financial situation. Compl., ¶ 147. The Trustee concedes that "the Outside Directors were misled and kept in the dark about the Soporex Debtors' ever-worsening financial condition," but she alleges that the Outside Directors were provided with sufficient information from which they could and should have concluded that Linehan's and Sabolik's reports on the financial status of the Soporex Debtors were false and misleading, Compl., ¶ 152, yet they took no corrective action. Compl., ¶ 154. The Trustee alleges that despite clear signs of Soporex's financial distress presented to the Outside Directors in December, 2007, none of the Outside Directors sought to convene a subsequent meeting of the Board and no meeting was held until late July, 2008. Compl., ¶¶ 151, 157.
The Complaint does not specifically identify the theory upon which the Trustee contends that the Financial Decline Allegations constitute a breach of fiduciary duty.
To the extent that the Trustee is attempting to assert a director oversight liability claim, the Financial Decline Allegations do not rise to the level required by the decisions in Caremark and Stone. The Trustee has not alleged a "sustained or systematic failure of the board to exercise oversight." Caremark, 698 A.2d at 968.
While at first blush the Complaint contains allegations that the Board did not meet between December, 2007 and July, 2008, when it was allegedly aware of the "dire" and "critical" financial decline of Inc. and the Operating Subsidiaries, that allegation, upon closer scrutiny of the Trustee's other factual allegations (or lack thereof), is largely unsupported as to the Outside Directors' knowledge of the "dire" or "critical" financial decline; and therefore, cannot support a plausible claim that the Outside Directors knowingly and consciously disregarded known duties to act or systematically and sustainably failed to exercise oversight. The Trustee essentially points to four "red flags" that the Trustee alleges were flying and ignored by the Outside Directors, notwithstanding the fact that the Trustee concedes that "the Outside Directors were misled and kept in the dark about the Soporex Debtors' ever-worsening financial condition...." Compl., ¶ 152. First, the Trustee points to the "significant problems with the billing and collection of the SRI accounts receivable [and] the multimillion dollar write-offs of pharmacy bad debt due to Carecentric's negligent performance...." Compl., ¶ 150. Second, the Trustee points to the "significant decrease in the Albuterol reimbursement rate...." Id. Third, the Trustee points to GE's "notice of default letter dated May 14, 2008...." Id. Fourth, the Trustee points to "the termination of available credit with Soporex's primary pharmaceuticals supplier, Harvard." Id.
As to the first "red flag," the Trustee alleges that the Outside Directors were informed at the April, 2007 Board meeting of problems with Carecentric's performance and that Soporex would have to write off bad debt. The Trustee also alleges that at the September, 2007 Board meeting, the Outside Directors were again told that SRI was not collecting its accounts receivable and that SRI had written off $2.1 million in bad debt.
However, the Trustee also alleges that (i) at the April, 2007 Board meeting, the Board approved a contract with CMAEON to write software to bring the billing and collection functions in-house, Compl., ¶ 69, and (ii) the Board was provided a status report about the transition of those functions to an in-house system at its December, 2007 Board meeting. Compl., ¶ 7 1. According to the Trustee, (i) at some point (the Complaint is not clear as to when) Soporex hired a third party vendor, Med Staff, to re-submit to insurers the claims that Carecentric had failed to property submit, Compl., ¶ 75, (ii) the Board was aware of this hiring by December, 2007, Compl., ¶ 156, (iii) on February 1, 2008, Soporex was using its in-house system for new pharmacy orders, Compl., ¶ 72, (iv) in February, 2008, Soporex sued Carecentric, Compl., ¶ 74, (v) by July of 2008, Soporex had also brought the re-billing process, for which it had hired Med Staff, in-house. Compl. ¶ 76. These factual allegations undercut the Trustee's conclusory statements that the Outside Directors did nothing to
As to the second "red flag,"—the decrease in the Albuterol reimbursement rate—the entirety of the Trustee's factual allegations respecting this issue is as follows:
Compl., ¶¶ 78-81. The Trustee fails to allege how this change impacted Inc. or the Operating Subsidiaries, if at all. She simply alleges a change. The Trustee also fails to allege that the Board (specifically, the Outside Directors) was aware of this change. Moreover, the Trustee does not allege what the Board could have done by having a meeting to change Medicare's reimbursement rates for Albuterol or mitigate its impact, if any.
The third "red flag,"—GE's notice of default letter—also requires some discussion. Of significance, there is no allegation that the Outside Directors saw this letter prior to May 22, 2008. Compl., ¶ 89. Moreover, the Trustee alleges that the memo sent by Linehan and Sabolik to the Outside Directors on May 22, 2008 "portrayed a much different picture concerning Soporex's credit default than was evidenced by the May 14th letter." Compl., ¶ 89. The Trustee also alleges that notwithstanding the default letter, Linehan and Sabolik told the Outside Directors that "we expect that we will be able to utilize the credit facility to meet our working capital needs through the closing of our recapitalization." Id. The Outside Directors were not told that Soporex would lack funds to operate past mid-July. Compl., ¶¶ 90, 147. The Trustee further alleges that throughout 2007 and 2008, Linehan aggressively pursued what the Trustee characterizes as a "pie in the sky" business plan, which called for the acquisition of several other companies, to be funded through new capital investments by outside investors, and hired an investing banking firm to assist in that process. Compl., ¶ 131. The Trustee also alleges that Linehan viewed additional acquisitions as a means to cure financial and cash flow problems. Compl., ¶ 135. In addition, the Trustee alleges that Linehan sought to
These allegations, taken as whole and viewed in the light most favorable to the Trustee, show that notwithstanding the GE default notice, the Outside Directors were aware of other facts that mitigated its effects. The Trustee does not allege that any of this was unreasonable.
Moreover, there are no factual allegations supporting the Trustee's "pie in the sky" characterization of the efforts to turn around what the Trustee alleges was a deteriorating financial condition. The Trustee does not allege that the Outside Directors were, or should have been, aware that these efforts would prove unsuccessful. While the Trustee's further allegation that the Outside Directors did not ask for financial reports could be consistent with the Outside Directors' liability, when taken as a whole and viewed in the light most favorable to the Trustee, the Financial Decline Allegations are just that—merely consistent with liability—and such allegations "stop[ ] short of the line between possibility and plausibility of entitlement to relief." Iqbal, 129 S.Ct. at 1949.
The fourth "red flag,"—the termination of credit by a principal supplier—does not tip the scales to plausibility. Most importantly, there are simply no factual allegations that the Outside Directors (except for Letson, who will be addressed separately below) were, or should have been, aware of this circumstance. Compl. ¶¶ 95-103.
For these reasons, these "red flags" do not support a claim that the Outside Directors consciously disregarded their duties by acting inconsistently with those duties with knowledge that they were so acting. Moreover, in the context of the Financial Decline Allegations, the Trustee is, once again, like the plaintiff in Citigroup, trying to stretch the oversight liability cases beyond the factual contexts in which they have been decided. The Trustee does not allege a failure to monitor or oversee employee misconduct or legal violations. Rather, the Trustee here alleges a claim similar to that in Citigroup—that the Outside Directors failed to generally monitor the operations of the business and so exposed it to losses. That type of claim is most properly analyzed under a duty of care theory. Moreover, the Financial Decline Allegations plead no facts supporting any inference that the Outside Directors knew they were acting inconsistently with their fiduciary obligations. Lyondell, 970 A.2d at 243.
The Trustee fares no better to the extent she relies upon a breach of the duty of care claim. In light of the Court's analysis above, the Financial Decline Allegations do not rise to the level of "reckless indifference" or conduct "beyond the bounds of reason," McPadden v. Sidhu, 964 A.2d 1262 (Del.2008), or conduct so "grossly off-the-mark as to amount to reckless indifference or a gross abuse of discretion." In re Lear Corp. Shareholder Litig., 967 A.2d 640, 652 (Del.Ch.2008).
Thus, the Court concludes that the Trustee's breach of fiduciary duty claim against the Outside Directors, to the extent it relies on the Financial Decline Allegations, must be dismissed.
The Trustee alleges that in late July, 2008, Sabolik and Smith contacted a bankruptcy attorney, Mark Chevallier ("Chevallier") to discuss "bankruptcy options."
The Trustee further alleges that the Outside Directors failed to consult with GE to see if GE would permit the use of cash collateral or would provide financing in a potential chapter 11 case, Compl., ¶ 165, but "in the very last hours before the Chapter 7 cases were filed," GE contacted Sabolik and Smith and discussed the possibility of a liquidating chapter 11 case. Compl., ¶ 167. The Trustee alleges that although Chevallier told the Outside Directors (other than Letson, who had already resigned from the Board) that they could sell the Operating Subsidiaries as going concerns in chapter 11, the Outside Directors "rejected this approach and chose instead to file Chapter 7 cases ..." and that they "never once considered the alternative of filing Chapter 11 cases to preserve the going concern value...." Compl., ¶ 166.
According to the Trustee, (i) on August 14, 2008, the Board deferred its consideration of a resolution authorizing a bankruptcy filing until it could meet with Linehan (who had been in a serious car accident) to seek his counsel, Compl., ¶ 168, and (ii) the Board requested that Sabolik and Smith meet with Linehan in his hospital room, and thereafter, at their August 19 Board meeting, the Board adopted a resolution authorizing the filing of chapter 7 bankruptcy petitions for the debtors. Compl., ¶ 169. According to the Trustee, by failing to consider or act on a chapter 11 option, the Outside Directors "wantonly disregarded their fiduciary duties of due care and loyalty...." Compl., ¶ 166.
Again, the Trustee does not identify whether she seeks to challenge the decision to file chapter 7 petitions rather than chapter 11 petitions under a theory of a breach of the duty of loyalty or under a theory of breach of the duty of care.
Essentially, the Trustee argues that the Outside Directors improperly rejected chapter 11 filings. The Trustee alleges that the Outside Directors were informed of their "bankruptcy options," but rejected the idea of selling the Operating Subsidiaries as going concerns while in chapter 11. Notably, however, the Complaint does not allege that there was any ability to finance operations in chapter 11. Nor does the Complaint allege that any higher price could have been obtained for the assets of the Operating Subsidiaries in chapter 11. The Trustee does allege that GE contacted Sabolik "in the very last hours before" the cases were filed to discuss "the possibility of a liquidating Chapter 11 case," but the Trustee alleges nothing else with respect to the companies' ability to function as going concerns in chapter 11. The Trustee's argument that the companies could have sustained operations and could have been sold as going concerns is purely speculative, devoid of factual support.
The Trustee fares no better with respect to a breach of the duty of care claim. The Trustee has not pled facts sufficient, even when viewed in the light most favorable to the Trustee, to state a plausible claim under the "extremely stringent" In re Lear Corp. Shareholder Litig., 967 A.2d at 652, definition of gross negligence in Delaware—i.e., that the decision to file under chapter 7 rather than under chapter 11 was beyond "the bounds of reason," McPadden v. Sidhu, 964 A.2d at 1262, or "so grossly off-the-mark" as to amount to reckless indifference or a gross abuse of discretion. Id. Moreover, as noted by the Caremark court, compliance with a director's duty of care
Caremark, 698 A.2d at 967, 969.
Here, the Trustee's own allegations show that the Outside Directors conferred,
Thus, the Court concludes that the Trustee's breach of fiduciary duty claim against the Outside Directors, to the extent it relies on the Bankruptcy Decision Allegations, must be dismissed.
The Trustee alleges that the corporate resolution authorizing the chapter 7 filing for Inc. provided:
Compl., ¶ 169. The Trustee further alleges that Sabolik and Smith unilaterally determined what should be done to terminate the business operations of Inc. and the Operating Subsidiaries and used the resolutions to fraudulently transfer to Med 4 Home "Soporex's most valuable assets, namely, SRI's patient lists, files and patient records." Compl., ¶ 172. According to the Trustee, SRI's and Winmar's businesses were sold to Med 4 Home for $40,000 hours before the bankruptcy filings, Compl., ¶ 172, in part based on Sabolik's and Smith's "incorrect belief that they could face personal civil or criminal liability for `patient dumping' if they did not transfer the patient list and patient data to some third party before ceasing SRI's business operations." Compl., ¶ 173. The Trustee alleges that no such sanctions exist, id., but their actions nevertheless were motivated by "selfish concern for their own personal welfare" and were otherwise reckless and in bad faith. Id.
The Trustee's primary complaint about the Outside Directors, as opposed to Sabolik and Smith, is that they did not request any documents to determine the value of the assets of Soporex and the Operating Subsidiaries and failed to obtain a business valuation before adopting the resolution quoted above. Compl., ¶ 174. From these facts, the Trustee alleges that the Outside Directors improperly delegated decision-making authority for terminating the business operations and for the orderly liquidation of the assets of the Operating Subsidiaries and failed to take steps to
The Trustee argues in her brief that the resolution essentially authorized Sabolik and Smith to proceed with the orderly liquidation of Winmar and SRI, and under section 271(a) of the Delaware General Corporation Law, a board of directors cannot authorize the sale of all or substantially all of the assets of the corporation without approval of the majority of shareholders, and the board cannot delegate to the officers responsibility for liquidating a corporation's assets. Thus, the Trustee argues that the Outside Directors' adoption of the resolution quoted above was an ultra vires act under Delaware law, which is not protected by the business judgment rule.
The first problem with the Trustee's argument is that the resolution does not constitute "carte blanche" authority to the officers to liquidate all of the assets of Inc. and the Operating Subsidiaries. Rather, the Court reads the resolution as authorizing a bankruptcy filing for the purpose of conducting an orderly liquidation. The second problem with the Trustee's argument is that even assuming the resolution is read as broadly as the Trustee suggests, the Complaint fails to allege that the Board did not obtain shareholder approval.
For the same reasons the Court has concluded that the Trustee has not pled a plausible claim for either a breach of the duty of loyalty or a beach of the duty of care with respect to the Bankruptcy Decision Allegations, see supra at pp. 43-45, the Court also concludes that the Trustee has not plead a plausible claim for relief against the Outside Directors for breach of either fiduciary duty with respect to the Corporate Resolution Allegations.
Thus, the Court concludes that the Trustee's breach of fiduciary duty claim against the Outside Directors, to the extent it relies on the Corporate Resolution Allegations, must be dismissed.
For all of these reasons, the Court concludes that Count 4 of the Complaint must be dismissed against the Outside Directors.
Letson has joined in the other Outside Directors' Motion with respect to Count 4,
With respect to the Carecentric Allegations, the Court concludes that Letson's Motion should be granted, for all of the reasons set forth above in the Court's discussion of these allegations as they apply to the other Outside Directors. See supra at 32-34. With respect to the Financial Decline Allegations, the Court concludes the same—but further discussion is required.
Since the Trustee has not pled, with respect to the Financial Decline Allegations, Letson's subjective bad faith, the Trustee must premise her duty of loyalty claim on what the Disney court referred to as the intermediate category of conduct— intentional dereliction of duty or a conscious disregard for one's responsibilities. Disney, 906 A.2d at 66. In its Stone decision, the Delaware Supreme Court held that the imposition of liability "requires a showing that the directors knew that they were not discharging their fiduciary obligations." Stone, 911 A.2d at 370; In re Massey Energy Co., C.A. No. 5430-VCS, 2011 WL 2176479 (Del.Ch. May 31, 2011); In re Citigroup Shareholder Deriv. Litig., 964 A.2d 106, 125 (Del.Ch.2009) (emphasis in original). In such cases, "an extreme set of facts is required to sustain a disloyalty claim premised on the notion that disinterested directors were intentionally disregarding their duties." Lyondell, 970 A.2s at 243. The Court concludes that the one "red flag" specifically applicable to Letson—i.e., that one of the Soporex Debtors' suppliers had refused to extend further credit—is insufficient, even when viewed in the light most favorable to the Trustee, to state a claim under the stringent standard that must be met in order to state a breach of the duty of loyalty claim. This is so for the following reasons.
The Trustee alleges that Letson was aware as of May 16, 2008 that Inc. was in default of its obligations to The Harvard Drug Group ("Harvard"), and that Letson was involved in the negotiation of an agreement made on May 22, 2008 to repay Harvard in accordance with a payment schedule. Compl., ¶ 95.
Moreover, to the extent the Trustee is attempting to assert a director oversight liability claim, the Trustee once again attempts to stretch a Caremark claim beyond its boundaries. As discussed above, the classic Caremark claim involves a claim that the directors are liable for damages that arise from a failure to properly monitor or oversee employee misconduct or legal violations. Here, the alleged facts more closely resemble those before the court in In re Citigroup Shareholder Deriv. Litig., 964 A.2d 106, 122-23 (Del.Ch. 2009), where the plaintiffs alleged that the Citigroup directors ignored "red flags" respecting the impending financial crisis in the housing market and thus failed in their duty of oversight to prevent Citigroup's involvement in the subprime mortgage market, leading to inappropriate business risk. This type of claim, as the Citigroup court noted, is most appropriately reviewed under a duty of care/business judgment rule standard.
As discussed previously, the appropriate standard under Delaware law to establish a breach of the duty of care is one of gross negligence, which has been defined as "reckless indifference" or conduct beyond the "bounds of reason." McPadden v. Sidhu, 964 A.2d 1262 (Del. 2008). As one court has noted, the definition of gross negligence in Delaware corporate law is "extremely stringent." In re Lear Corp. Shareholder Litig., 967 A.2d 640, 652 (Del.Ch.2008). The challenged decision must be "so grossly off-the-mark as to amount to reckless indifference or a gross abuse of discretion." Id. (quoting Solash v. Telex Corp., 1988 WL 3587 at *9 (Del.Ch. Jan. 19, 1988)). In short, the Financial Decline Allegations against Letson do not rise to these levels.
Thus, the Court concludes that the Trustee's breach of fiduciary duty claim against Letson in Count 4, to the extent it relies on the Financial Decline Allegations, must be dismissed. However, Letson is also sued in Count 5 of the Complaint. Count 5, solely against Letson, alleges a breach of the fiduciary duty of loyalty premised upon Letson's "dual roles" with Inc. and Harvard. Compl., ¶ 206. Letson has moved to dismiss Count 5 in the Letson Motion.
The Trustee has numerous factual allegations in support of her Count 5 claims. The Trustee alleges that at the time SRI commenced its operations in 2006, Letco Medical ("Letco"), which had been founded by Letson and his father in 1983, was SRI's principal supplier of medications. Compl., ¶ 92. The Trustee further alleges that Letson was appointed to the Board due to this relationship. Compl., ¶ 181. According to the Trustee, (i) Letco was acquired by Harvard in 2007, Compl., ¶ 93, and (ii) Letson continued as president of Letco (as a division of Harvard) until he
The Trustee further alleges that on June 6, 2008, at Harvard's insistence, Inc. entered into an Exclusive Purchase Agreement with Harvard (the "Harvard EPA") pursuant to which Inc. agreed to buy seven medications, which represented over 95% of the medications sold by SRI, exclusively from Harvard. Compl., ¶ 96. The medications and their prices, which the Trustee alleges were determined by Letson, were set forth in Exhibit A to the Harvard EPA (the "Exhibit A Medications"). Id.; Compl. ¶ 182. According to the Trustee, except for the medication Brovana, the prices for these medications under the Harvard EPA were all higher than the prices set by other suppliers. Id. The Trustee alleges that (i) as a result, SRI paid approximately $119,000 more for these medications than it would have paid if it had purchased them from other suppliers, id., (ii) "upon information and belief, when Letson set the prices for the Exhibit A Medications, he knew that the prices he selected were in excess of the amounts Soporex was paying for these same medications (except Brovana) from other suppliers," id, and (iii) "as an officer of Harvard, Letson personally benefited [sic] from this unfair pricing and the excessive cost of Soporex." Compl., ¶ 182.
The Trustee next alleges that the Harvard EPA required Inc. to pay Harvard within 30 days from the invoice date. Compl., ¶ 97. According to the Trustee, on July 8, 2008, Harvard told Gaudio (Inc.'s CFO) that Inc. was in default under the Harvard EPA and that Harvard was not going to ship any product to SRI until the invoices that were more than 30 days past due were paid in full. Id. The Trustee alleges that Gaudio was also reminded that the Harvard EPA prohibited Inc. from purchasing the Exhibit A Medications from any other supplier, and that Letson was copied on the e-mails sent to Gaudio. Id. Premised on these emails, the Trustee alleges that "upon information and belief," Letson was directly involved in the negotiations of the Harvard Letter Agreement and the Harvard EPA. Compl. ¶ 100.
The Trustee further alleges that as a result of the Harvard EPA, Inc. made a payment to Harvard in the amount of $404,052.12, which was in addition to the weekly $75,000 "preferential" payments that Inc. was required to make to Harvard, which, as of July 11, 2008, totaled $525,000. Compl., ¶ 98. The Trustee also alleges that by virtue of its leverage under the Harvard EPA, Harvard forced Inc. to make "preferential" payments to Harvard of $1,229,052.12 within the 90 days before its bankruptcy filing. Of this sum, the Trustee alleges that $929,052.12 was paid from May 30, 2008 to July 8, 2008, while Letson was a director of Inc. and was actively involved in Harvard's efforts to collect the debt SRI owed to it. Compl., ¶ 99.
The Trustee also alleges that Harvard's CEO directed Letson to resign from the Board due to a conflict of interest between
With respect to his Count 5 claim for breach of fiduciary duty against Letson, the Trustee alleges that from March 31, 2006 to July 16, 2008, Letson was one of the Outside Directors of Inc., and was also an officer of Harvard. Compl., ¶ 204. In addition, the Trustee alleges that for a portion of this time period, Letson was in charge of Harvard's account relationship with Inc. Id. The Trustee also alleges that Letson's dual roles with Inc. and Harvard enabled him to obtain confidential and proprietary business information, such as information relating to the prices SRI paid to suppliers for the medications it bought, and "upon information and belief, Letson provided to Harvard this confidential and proprietary business information which Harvard then used to its advantage and to the business detriment of Soporex and SRI." Compl., ¶ 206. The Trustee further alleges that Letson used his position with Inc. to "further his own financial and professional interests as an employee and officer of Harvard." Id. Specifically, the Trustee alleges that Letson participated in the negotiations and drafting of (i) the Harvard Letter Agreement, which resulted in Inc. making preferential payments to Harvard in the sum of $825,000, and (ii) the Harvard EPA, which caused Inc. to overpay for medications by $119,000 and which was used by Harvard as leverage to extract additional preferential payments from Inc. Compl., ¶ 206. The Trustee alleges that by engaging in these activities on behalf of Harvard, Letson abused the position of trust and confidence that he was given as a director of Inc. and thereby breached his duty of loyalty; and as a result, Inc. suffered damages in excess of $1,000,000 and Inc.'s assets were impaired. Compl., ¶ 207.
In this context, the duty of loyalty requires that a fiduciary act with undivided and unselfish loyalty to the corporation and that there is no conflict between that duty and self-interest. Weinberger v. UOP, Inc., 457 A.2d 701 (Del. 1983). The classic examples that implicate the duty of loyalty are instances in which a director appears on both sides of a transaction or receives a personal benefit not received by the shareholders generally. In re Walt Disney Co. Deriv. Litig., 907 A.2d 693 (Del.Ch.2005); Cede & Co. v. Technicolor, Inc., 634 A.2d 345 (Del.1993), modified on other grounds, 636 A.2d 956 (Del.1994). Thus, a plaintiff may plead a violation of the duty of loyalty by pleading that the defendant "either (1) `stood on both sides of the transaction and dictated its terms in a self-dealing way,' or (2) `received in the transaction a personal benefit that was not enjoyed by the shareholders generally.'" Midland Grange No. 27 Patrons of Husbandry v. Walls, 2008 WL 616239 (Del.Ch. Feb. 28, 2008) (quoting In re Coca-Cola Enters. Inc. Shareholders Litig., No.1927-CC, 2007 WL 3122370 at *4 (Del.Ch. Oct. 17, 2007)).
Applying these legal principals here, the Court concludes that the Complaint fails to state a claim, as the Trustee has not alleged facts showing that Letson was on both sides of the challenged transactions or received any personal benefit from those transactions not conferred on shareholders generally.
Second, Letson isn't alleged to have received a benefit not received by shareholders generally. The Trustee simply alleges that Letson benefitted from pricing favorable to Harvard "as an officer of Harvard." Compl., ¶ 182. There are no other facts alleged in the Complaint with respect to any personal benefit to Letson from Inc.'s entry into the Harvard Letter Agreement or the Harvard EPA, and no facts showing how Letson's status as an officer or employee of Harvard conferred any benefit upon him from these transactions.
From this Court's perspective, the Trustee's alleged personal benefit to Letson is not "so significant that it is improbable that a director could perform [his] fiduciary duties without being influenced by [his] overriding personal interest." Pfeffer v. Redstone, 965 A.2d at 690. The Trustee has not alleged any personal financial benefit to Letson at all. She has not alleged that his compensation, or position at Harvard, was in any way improved due to Harvard's success in collecting the amounts owed to it. Although the Trustee appears to complain that Harvard used its agreements as leverage to extract what the Trustee characterizes (without factual support) as preferential payments, the Trustee does not allege that Letson had any hand in that particular conduct. Nor does the Trustee allege that Letson was involved on Harvard's behalf in the decision to (i) refuse to extend Inc. further credit, (ii) enter into a short payment schedule, or (iii) enter into or enforce the Harvard EPA.
Further, although the Trustee alleges (upon information and belief) that Letson provided confidential pricing information obtained in his capacity as an Inc. director to Harvard, who then used it to set prices under the Harvard EPA, the Trustee does not allege that Letson had any hand in Inc.'s decision to enter into the Harvard EPA, which Inc. must have known set prices higher than Inc. normally paid for its medications.
For these reasons, the Court concludes that Count 5 fails to state a claim for breach of fiduciary duty against Letson and must be dismissed.
As noted earlier, Count 1 of the Complaint, asserted against only Linehan, alleges
The Trustee complains of, essentially, four acts by Sabolik and Smith that allegedly constitute corporate waste: (i) the fraudulent transfer of the "SRI Business;" (ii) the fraudulent transfer of the "Winmar Oxygen Business;" (iii) the abrupt termination of the Winmar sleep-study business operations; and (iv) the abrupt termination of the SRI billing and collection functions when there were, according to Sabolik, in excess of $6.3 million in outstanding accounts receivable. Compl., ¶ 193. The factual allegations respecting the transfer of the "SRI Business" and the termination of SRI's billing and collections functions are generally set forth in ¶¶ 73-76, 172-180 of the Complaint. The factual allegations respecting the transfer of the "Winmar Oxygen Business" and the termination of the Winmar sleep-study business operations are generally set forth in ¶¶ 172-180 of the Complaint.
The Court first notes that the parties disagree, to some extent, about which state's law governs the Trustee's claim for corporate waste. Neither party has briefed the choice-of-law issue in any detail. The four acts complained of, however, involve SRI and Winmar. Citing nothing, the Officers assert that corporate waste claims are determined by reference to the law of the state of incorporation, which, in the case of SRI and Winmar, are Missouri and North Dakota, respectively. However, the Trustee's original complaint contended that the acts complained of constituted waste under Delaware law, and thus the Officers argued that since the Trustee cited to Delaware law, she must not be asserting her claims on behalf of SRI and Winmar and thus the Officers briefed the corporate waste claim under Delaware law.
When the Trustee amended her complaint as of right following the filing of the Motions, she deleted the reference to Delaware law and instead asserted that the conduct constitutes waste under "applicable state law." Compl., ¶ 195. In their brief in support of their Motion, the Officers do not address the choice of law issue at all. Therefore, the Officers, while contending that the waste claim should be assessed under Missouri and North Dakota law, have not filed any briefing respecting the allegations that would suffice to state a claim under those states' law. Rather, the Officers look only to Delaware law in their brief.
The Trustee, while conceding that the waste claim is governed by Missouri law (in the case of SRI) and North Dakota law (in the case of Winmar), asserts (citing to nothing) that "Delaware law is also implicated and must be considered because [those entities are] a wholly-owned subsidiary
Thus, in sum, both sides appear to agree that the relevant law is, at least in part, the law of North Dakota and Missouri, although neither have briefed the waste claim under the legal standards applicable in those states. Moreover, the Trustee appears to argue, at least in part, for the application of Delaware law to her waste claims, although citing nothing to support her argument. Sadly, the Court is forced to analyze the choice of law issues without any real input from the parties and then, to the extent the Court agrees that North Dakota and Missouri law control, determine what the law of North Dakota and Missouri is without any assistance from the parties.
In deciding which state's substantive law governs the issues before the Court, the Court must first determine which choice-of-law rules should be applied. Schmermerhorn v. CenturyTel, Inc. (In re Skyport Global Commc'n, Inc.), No 10-3150, 2011 WL 111427 (Bankr.S.D.Tex. Jan. 13, 2011). It is well-settled that a federal court sitting in diversity must apply the choice of law rules of the forum state in which it sits. Klaxon Co. v. Stentor Elec. Mfg. Co., 313 U.S. 487, 61 S.Ct. 1020, 85 L.Ed. 1477 (1941). However, neither the United States Supreme Court nor the Fifth Circuit has ruled upon whether a bankruptcy court, which sits not in diversity but by virtue of 28 U.S.C. §§ 1334 and 157, is required to apply federal choice of law rules or is instead to apply the choice of law rules of the forum state with respect to state law claims. Skyport, 2011 WL 111427 at *14. In Tow v. Rafizadeh (In re Cyrus II P'ship), 413 B.R. 609 (Bankr. S.D.Tex.2008), the bankruptcy judge applied federal choice of law rules to a cause of action under 11 U.S.C. § 544, because it was a federal cause of action rooted in federal bankruptcy law and policy. However, the Skyport court distinguished Tow because the Skyport court was asked to assess whether certain claims were direct claims or were instead derivative claims, which would be barred under a confirmed chapter 11 plan. The Skyport court held that "issues regarding the internal affairs of corporations do not implicate the same federal bankruptcy policies addressed in Tow. Accordingly, this Court applies forum state choice of law rules to determine which law governs...." Skyport, 2011 WL 111427 at * 15.
This Court finds the Skyport court's analysis persuasive, and thus will similarly apply Texas choice of law rules to determine which states' laws govern the Trustee's claim for corporate waste. As noted in Skyport, under Texas choice of law rules, the internal affairs of a foreign corporation are governed by the law of the state of incorporation. Tx. Bus. Org. Code § 1.102 (Vernon's 2011). Therefore, the Court concludes that the Trustee's claim of corporate waste with respect to Winmar's assets is governed by North Dakota law, while her claim of corporate waste with respect to SRI's assets is governed by Missouri law. The Court will therefore assess the sufficiency of the Trustee's allegations under the laws of those states.
The Court's own research has failed to reveal a single case in North Dakota that discusses the elements of a claim for corporate waste. The Court notes, however, that North Dakota courts appear to look for guidance in corporate matters to one of the leading treatises on corporate law, William Meade Fletcher, Fletcher Cyclopedia of the Law of Corporations (hereafter, Fletcher's Cyclopedia). See, e.g., Aurora Medical Park, LLC v. The Kidney and Hypertension Center, PLC, 784 N.W.2d 151 (N.D.2010) (citing treatise for the proposition that a president may have presumptive authority to institute and defend suits in the corporate name); Thompson v. Schmitz, 774 N.W.2d 263 (N.D.2009) (citing treatise for the proposition that a shareholder's loan to a corporation may, in certain circumstances, be deemed a contribution of capital); Erickson v. Brown, 747 N.W.2d 34 (N.D.2008) (citing treatise for the proposition that a corporation may retain authorized, but unissued, shares). Section 1102 of that treatise provides:
Fletcher's Cyclopedia, § 1102.
Similarly, there is a dearth of case law in Missouri respecting corporate waste claims. Nevertheless, it is clear that directors of a corporation have no right to convert corporate assets to their own use, or give them away, or to make any self-serving disposition of them against the interests of the corporation. Zakibe v. Ahrens & McCarron, Inc., 28 S.W.3d 373 (Mo.App.2000); Emergency Patient Services, Inc. v. Crisp, 602 S.W.2d 26 (Mo. App.1980). Missouri courts have similarly looked to Fletcher's Cyclopedia for guidance in corporate matters. See, e.g., 66, Inc. v. Crestwood Commons Redevelopment Corp., 998 S.W.2d 32 (Mo.1999) (citing treatise for the proposition that the phrase `inadequate capitalization' means assets that are very small in comparison to known risks associated with the planned corporate enterprise); K.C. Roofing Center v. On Top Roofing, Inc., 807 S.W.2d 545 (Mo.App.1991) (citing treatise for the
The concept of corporate waste as outlined in Fletcher's Cyclopedia is substantially similar to the concept of waste under Delaware law. Delaware courts have described the standard for corporate waste as "onerous, stringent, extremely high, and very rarely satisfied," Kates v. Beard Research, Inc., No. Civ. A. 1480-VCP, 2010 WL 1644176 at *5 (Del.Ch. Apr. 23, 2010), and to recover, the plaintiff has the burden to prove that a transaction was so one sided that no business person of ordinary, sound judgment could conclude that the corporation has received adequate consideration, and such a claim will be sustained only in the rare, unconscionable case where directors irrationally squander or give away corporate assets. Id.
Because the parties have both cited to Delaware law, there is a dearth of case law in both North Dakota and Missouri, and Delaware law appears to be substantially similar, at least with respect to corporate waste claims, to the standard set forth in Fletcher's Cyclopedia, the Court will apply the standard for waste as set forth in Fletcher's Cyclopedia and under Delaware law.
The Trustee alleges that Smith was an officer of SRI from April 25, 2007 through the petition date. Compl., ¶ 36. Smith is not alleged to have been an officer or director of Winmar. Absent that allegation, the Trustee's claims against Smith for corporate waste relating to the assets of Winmar fail to state a claim under any state's law. Although the Trustee alleges that Smith was an officer of Inc., Compl., ¶ 23, and that the Board (of Inc.) made decisions on behalf of Winmar's nonfunctioning board, Compl., ¶ 113, the Trustee does not allege that Smith was on the Board. Accordingly, the Trustee's corporate waste claim against Smith with respect to Winmar's assets fails and must be dismissed.
As to Smith's involvement in the acts allegedly constituting waste with respect to SRI's assets, there are relatively few factual allegations that support this claim. There are some factual allegations respecting Smith's involvement in the decision to enter into the Carecentric contract, see, e.g., Compl., ¶¶ 52, 59, 61, 64, 65, 69, 140, but that conduct is not alleged to constitute an act of waste. Similarly, there are some factual allegations respecting Smith's involvement in discussions with GE, see, e.g., Compl., ¶¶ 85, 88, and 90, but that conduct is not alleged to constitute an act of waste. As noted earlier, the conduct that allegedly constitutes waste with respect to SRI's assets is (i) the fraudulent transfer of the "SRI Business;" and (ii) the abrupt termination of the SRI billing and collection functions when there were in excess of $6.3 million in outstanding accounts receivable. Compl., ¶ 193.
As to the termination of SRI's billing and collection functions when there were millions of dollars in outstanding accounts receivable, the Trustee alleges that (i) in February, 2008, when Carecentric learned that Soporex had brought SRI's billing and collection functions in-house, Carecentric wrongfully cut off Inc.'s access "to its own pharmacy data and its own billing and collection data,"
The Court concludes that these allegations, even when viewed in the light most favorable to the Trustee, fail to state a claim for corporate waste against Smith. At most, the Trustee alleges that Smith was negligent in failing to make a copy of SRI's billing and collections data in order to assist in the future collection of accounts receivable. The Trustee alleges that Carecentric had cut off Inc.'s (or SRI's, it is not clear which) ability to access its data, and that Inc. had to hire a third party to resubmit claims that had previously been rejected, but that Inc. terminated its efforts when it could "no longer afford to pay" for that service, and had determined to file for relief under chapter 7. Even taken as true, these factual allegations do not plausibly suggest that Smith "irrationally squander[ed] or [gave] away corporate assets." Fletcher's Cyclopedia, § 1102; Kates, 2010 WL 1644176 at *5. Thus, this claim against Smith must be dismissed.
As for Smith's hand in the alleged "fraudulent transfer of the `SRI Business,'" the Complaint alleges that the Board, Sabolik and Smith were presented with their "bankruptcy options" by Chevallier at a Board meeting, and were told that they could sell the Operating Subsidiaries' businesses as going concerns during a chapter 11 proceeding, but that they "rejected this approach and chose instead to file Chapter 7 cases...." Compl., ¶ 166. The Trustee also alleges that Smith (and others) failed to consult with GE about the possibility of financing or the use of cash collateral in chapter 11, Compl., ¶ 165, and failed to contact any potential purchasers for SRI's mail-order pharmacy business. Compl., ¶ 175.
There are no factual allegations in the Complaint respecting the value of SRI as a going concern at the time of the transfer of a portion of its assets to Med 4 Home. Nor are there any facts alleged that plausibly show that SRI could continue to operate as a going concern. A copy of the agreement with Med 4 Home is attached to the Complaint, and it contains the following recitals:
Ex. A to Complaint, p. 1. The agreement then provides for the sale of certain of SRI's assets to Med 4 Home, including SRI's patient files, certain inventory, equipment and supplies, phone numbers, and the right to any billings for any equipment, products, supplies, or services provided by the business after the effective date of the agreement. Id. at ¶ 1. The agreement also provides, however, that SRI did not sell its cash on hand or its accounts receivable to Med 4 Home. Id. at ¶ 2.
The Court concludes that even taken as true, these factual allegations do not plausibly suggest that Smith "irrationally squander[ed] or [gave] away corporate assets." Fletcher's Cyclopedia, § 1102. The concept of corporate waste is "a rigorous test designed to smoke out shady, bad faith deals...." In re Lear Corp. Shareholder Litig., 967 A.2d 640, 656 (Del.Ch.
Here, a reasonable person of ordinary sound business judgment could conclude that SRI, which had ceased operations, was concerned about the continuity of care of its patients and needed a third party to take over its patient files immediately upon its cessation of operations. There are no factual allegations showing that the assets sold—i.e., the patient lists, certain inventory and SRI's phone numbers—were worth more than the price paid for them.
As is the case with the allegations against Smith, the Trustee complains of, essentially, four acts by Sabolik that allegedly constitute corporate waste: (i) the fraudulent transfer of the "SRI Business;" (ii) the fraudulent transfer of the "Winmar Oxygen Business;" (iii) the abrupt termination of the Winmar sleep-study business operations; and (iv) the abrupt termination of the SRI billing and collection functions when there were in excess of $6.3 million in outstanding accounts receivable. ¶ 193.
For the same reasons discussed above with respect to Smith, the Court concludes that the Complaint fails to state a claim against Sabolik based upon his alleged conduct with respect to SRI's billing and collection functions and assets and must be dismissed. See supra at pp. 66-69.
The factual allegations respecting the abrupt termination of the Winmar sleep-study business operations are generally set forth in ¶¶ 176-177, 194, 195, 197 of the Complaint. The factual allegations respecting Inc.'s acquisition of Winmar are generally set forth in ¶¶ 105-111 of the Complaint, and the factual allegations respecting Winmar's profitability are set forth in ¶¶ 129-130 of the Complaint.
With respect to the termination of Winmar's sleep-study business, the Trustee alleges only that on August 20, 2008, Sabolik told Winmar's other officers that Winmar (among other companies) would be filing for relief under chapter 7 and that it would therefore cease operations immediately, and that at that time, Winmar's employees were performing sleep studies at small hospitals and medical clinics in the upper Midwest. Compl., ¶¶ 176-177. The studies, which were terminated, were being conducted pursuant to approximately 60 contracts between Winmar and various hospitals and clinics. The Trustee alleges that Sabolik (and Smith) made the decision to terminate the sleep-study operations without taking any steps to preserve the going concern value of Winmar's business, which was operating profitably were it not for being burdened with Inc.'s excessive corporate overhead. Compl., ¶ 194. The Trustee further alleges that Winmar's gross profit in 2007 was approximately $2.2 million, but that Winmar also had significant general and administrative expenses due to "exorbitant marketing costs and related personnel expenses" that resulted in net operating income that year of only $541,000. Compl., ¶ 129. The Trustee also alleges that during the eight months that Winmar operated in 2008, it had a gross profit of $1.2 million, but had "excessive" general and administrative expenses of approximately the same amount, leading to net operating income of only $31,000. Compl., ¶ 130. According to the Trustee, after considering interest, depreciation and amortization costs, Winmar's operating loss for 2008 was just north of $400,000. Compl., ¶ 130.
The Trustee does not allege, however, that Winmar's sleep study business could have continued as a going concern in light of the other financial problems identified in the Complaint. Moreover, the Trustee does not allege that there were buyers ready, willing and able to purchase the sleep-study business as a going concern, or any other factual content supporting an inference that the decision to terminate operations was tantamount to a decision to irrationally squander Winmar's assets— i.e., the going concern value of the sleep study business.
The Court concludes that even taken as true, these factual allegations do not plausibly suggest that Sabolik "irrationally squander[ed] or [gave] away corporate assets." Fletcher's Cyclopedia, § 1102. As noted previously, the concept of corporate waste is "a rigorous test designed to smoke out shady, bad faith deals...." In re Lear Corp. Shareholder Litig., 967 A.2d 640, 656 (Del.Ch.2008). The plaintiff must plead facts showing that no reasonable person of ordinary sound business judgment could view the benefits received [or conferred] in the transaction as a fair exchange for the consideration paid [or received] by the corporation. Id. The test for waste is stringent, and if given the facts pled in the complaint, any reasonable person might conclude that the deal made sense, then the judicial inquiry ends. In re Lear Corp. Shareholder Litig., 967 A.2d 640, 656 (Del.Ch.2008).
Based upon the allegations in the Complaint, the Court concludes that a reasonable person of ordinary sound business judgment could conclude that Winmar, which had ceased operations, was concerned about the continuity of care of its patients and needed a third party to take over its patient files immediately upon its cessation of operations. Accordingly, the Court also concludes that the Complaint fails to state a claim for corporate waste as to Sabolik.
For all of these reasons, Count 3 of the Complaint must be dismissed.
The Trustee alleges that Linehan was chairman of the Board from 2005 through the petition date, Compl., ¶ 17, was President of Inc. from 2005 until July 21, 2008, and was its CEO from 2005 through the petition date. Compl., ¶ 21. According to the Trustee, Linehan was also (i) chairman of SRI's board from February 9, 2006 through August 20, 2008, Compl., ¶ 35, (ii) President of SRI until March 31, 2006, Compl., ¶ 36, (iii) chief executive officer ("CEO") of SRI from March 31, 2006 through the petition date, id., (iv) chairman of SRI 2's board and its CEO from April 13, 2007 through the petition date, Compl., ¶¶ 40, 41, (v) chairman of Winmar's board from December 28, 2006 through August 20, 2008, Compl., ¶ 112, and (vi) Winmar's President and Secretary from December 28, 2006 through the petition date. Compl., ¶ 114.
The Trustee complains of nine specific acts or failures to act that the Trustee contends constituted a breach of Linehan's fiduciary duties of care and loyalty:
Once again, neither party has briefed the choice of law issues in any detail. As should be clear from the recital of the foregoing nine instances of conduct that allegedly constitute a breach of Linehan's fiduciary duties, some of the conduct occurred on behalf of one corporation only, and some occurred on behalf of two or more corporations, which complicates the legal analysis slightly. Applying the same choice of law analysis as discussed above, see supra pp. 60-62, the Court concludes, since this breach of fiduciary duty claim against Linehan does not implicate any bankruptcy policy, that it should apply the choice of law rules of the forum state (Texas) which, as noted above, point to the law of the state of incorporation of these foreign corporations as the appropriate law governing this claim. Therefore, the Court will look to the law of Delaware to the extent the claim is asserted on behalf of Inc. or SRI 2, to the law of Missouri to the extent the claim is asserted on behalf of SRI, and to the law of North Dakota to the extent the claim is asserted on behalf of Winmar. The Court concludes that the nine instances of conduct summarized above should be analyzed as follows: item (i) implicates the law of both Delaware and Missouri; item (ii) implicates only Missouri law; item (iii) implicates only North Dakota law; items (iv)-(vii) implicate only Delaware law; and items (viii) and (ix) implicate the law of all three states.
The Court has discussed the legal standards for breach of fiduciary duty under Delaware law at length above. See supra pp. 13-21. A brief discussion of the relevant legal standards under both Missouri law and North Dakota law follows.
Missouri recognizes the business judgment rule, and "courts will not interfere with or attempt to control the internal management or policy of a corporation except in cases of fraud, bad faith, breach of trust, gross mismanagement, or ultra vires acts on the part of the officers and directors." Leggett v. Missouri State Life Ins. Co., 342 S.W.2d 833, 851 (Mo. 1961). Or, stated another way, under the business judgment rule, a board decision will not be disturbed unless the judgment is "exercised in an arbitrary and capricious manner or contrary to by-laws or majority stockholders' action." Saigh v. Busch, Inc., 396 S.W.2d 9, 18 (Mo.App.1965). Similarly, a derivative complaint will be dismissed for failure to state a claim where it fails to allege that the directors or officers performed or perpetrated ultra vires, illegal or fraudulent acts. Id.
A more recent formulation of the rule is that officers and directors of a corporation are protected by the business
Directors and officers in Missouri owe fiduciary duties to the corporation and its shareholders, although those duties have not been neatly categorized in the corporate context. Fitch v. J.A. Tobin Constr. Co., 829 S.W.2d 497, 504 (Mo.App. 1992). However, a fiduciary duty has been recognized in the context of due care, without referring to the duty as such. Boulicault v. Oriel Glass Co., 283 Mo. 237, 223 S.W. 423 (1920). As to the duty of loyalty, at least one court has held that a corporate officer or director's duty to a corporation is governed by the same rules that apply to trustees and agents, Zakibe v. Ahrens & McCarron, Inc., 28 S.W.3d 373 (Mo.App. 2000), and Missouri courts have recognized the fiduciary duty of loyalty in the trustee context. Nixon v. Lichtenstein, 959 S.W.2d 854, 859 (Mo.App.1998) ("a trustee is a fiduciary of the highest order and is required to exercise a high standard of conduct and loyalty"). Therefore, it is fair to conclude that Missouri recognizes the fiduciary duties of loyalty and due care.
The duty of due care has not been as precisely defined under Missouri law as it has been under Delaware law. As noted earlier, Missouri courts have looked to Fletcher's Cyclopedia for guidance in corporate law matters. As to the duty of due care, sections 1029 and 1031 of that treatise provide:
Fletcher's Cyclopedia, §§ 1029, 1031.
As to the duty of loyalty in Missouri, it has been recognized in certain cases of self-dealing or unfair profit, although the courts have not used a "duty of loyalty" nomenclature. For example, directors and officers breach their fiduciary duty where they profit by virtue of their position at the expense of the corporation or the rights of the stockholders. Bromschwig v. Carthage Marble & White Lime Co., 334 Mo. 319, 66 S.W.2d 889 (1933). "If by dealing with the property of the corporation or its business for their own purposes, directly or indirectly, they derive a personal profit from it, they may be held trustees ex maleficio, as to such profits, for the benefit of the corporation and those stockholders who have suffered injury or deprivation by their conduct, and be compelled to restore what they have thus converted to their own use." Bromschwig, 66 S.W.2d at 892; Ramacciotti v. Joe Simpkins, Inc., 427 S.W.2d 425 (Mo.1968). In such a circumstance, "it is immaterial whether the company or stockholder has been damaged, and it is not essential to the liability of the director that the company has suffered a loss from what he has done; it is sufficient that he has gained a profit through it." Id. A director will not be permitted to retain any secret profits made by him in breach, or in disregard, of his fiduciary relation. Id. A director may not deal with the property of the corporation for his own personal benefit or advantage, profit at the expense of the shareholders, or cause the issuance of stock for his own personal aggrandizement to the detriment of other shareholders or for the purpose of obtaining control of the corporation. Gieselmann v. Stegeman, 443 S.W.2d 127 (Mo.1969). The Missouri Supreme Court has noted that the duty of loyalty generally imposes an obligation on officers and directors to avoid conflict of interest transactions. Peterson v. Continental Boiler Works, Inc., 783 S.W.2d 896 (Mo.1990). The Missouri Supreme Court, quoting Ruder, Duty of Loyaltya Law Professor's Status Report, 40 Bus. Law 1383, 1384 (1985) noted that ten substantive areas have been identified in which the duty of loyalty is subject to breach:
Peterson, 783 S.W.2d at 905.
Thus, this Court concludes that Missouri law applies the business judgment rule and recognizes the fiduciary duties of loyalty and due care, although they are not as precisely defined as they are in Delaware.
North Dakota has statutes that govern the standard of conduct for directors and officers. The statute that governs the standard of conduct for officers provides:
N.D. Cent.Code, § 10-19.1-60 (West 2011). In turn, the statute that governs the standard of conduct for directors provides, in relevant part:
N.D. Cent.Code, § 10-19.1-50 (West 2011). As used in the statute, the term "good faith" is defined as "honesty in fact in the conduct of an act or transaction." N.D. Cent.Code, § 10-19.1-01(29) (West 2011).
As these statutes demonstrate, North Dakota recognizes that directors and officers owe fiduciary duties of good faith, loyalty, and due care to the corporation. Brian Winrow, Director Liability: A Cliche in North Dakota, 84 N.D. L. Rev. 1109, 1111 (2008) ("Winrow"). According to Winrow, the North Dakota statute has "provide[d] directors greater freedom in executing their fiduciary duties by incorporating a range of statutorily sanctioned
There are few reported decisions in North Dakota regarding claims for breach of fiduciary duties by corporate officers and directors. Nevertheless, it is clear that North Dakota courts apply the business judgment rule, Red River Wings, Inc. v. Hoot, Inc., 751 N.W.2d 206 (N.D. 2008), which prohibits judicial inquiry into the actions of corporate directors taken in good faith and in the exercise of honest judgment in the lawful and legitimate furtherance of corporate purposes. Id. at 221-222. Corporate directors are shielded from all liability except for self-dealing, willful misconduct or gross negligence. Id.; In re Conservatorship of Sickles, 518 N.W.2d 673, 680-81 (N.D.1994). Courts will not interfere with the judgment of directors unless their judgment is influenced by personal considerations. When a challenge is made to an action, absent claims of fraud, self-dealing, unconscionability or other misconduct, the court should apply the business judgment rule and should limit its inquiry to whether the []action was authorized and whether it was taken in good faith and in furtherance of the legitimate interests of the [corporation]." Agassiz West Condominium Assoc. v. Solum, 527 N.W.2d 244, 248 (N.D. 1995) (applying business judgment rule to decision of a condominium board). Courts will not interfere with the decisions of directors in the reasonable and honest exercise of their judgment where that judgment is uninfluenced by personal considerations. Dixon v. McKenzie County Grazing Assoc., 675 N.W.2d 414 (N.D. 2004); Lill v. Cavalier Rural Elec. Co-Op., Inc., 456 N.W.2d 527 (N.D.1990).
With the relevant standards of conduct in Delaware, Missouri and North Dakota in mind, the Court turns to its analysis of the Trustee's breach of fiduciary duty claim as against Linehan.
The Trustee first complains, on behalf of Inc. and SRI, that Linehan breached his fiduciary duty
Here, the Trustee alleges that "Linehan signed the CareCentric Letter Agreement without doing any due diligence on Care-Centric's ability to perform the billing and collection functions that CareCentric agreed to provide." Compl., ¶ 52; see also Compl., ¶ 138. The Trustee's allegation that Linehan did no due diligence is conclusory and devoid of factual support. Iqbal, 129 S.Ct. at 1949-50; McCall, 661 F.Supp.2d at 653. It is thus not entitled to a presumption of truth under Iqbal, and the Court concludes that the Trustee has failed to allege factual content that would allow the Court to draw a reasonable inference that the decision to hire CareCentric was grossly off-the-mark or beyond the bounds of reason. Instead, the facts as pled are merely consistent with Linehan's liability, and thus the allegations stop "short of the line between possibility and plausibility of entitlement to relief," Iqbal, 129 S.Ct. at 1949, such that the Court concludes that the Complaint fails to state a claim for breach of the fiduciary duty of care as to Linehan under Delaware law.
To the extent this claim is advanced on behalf of SRI, it is governed by Missouri law. Missouri law has identified ten substantive areas in which an officer or director may breach his duty of loyalty, none of which apply here. See supra, p. 80. In addition, for the same reasons discussed above, the Court concludes that the Trustee's allegations with respect to the decision to hire Carecentric are properly analyzed under the duty of care. Given the business judgment rule, Missouri courts will not substitute their judgment for that of the officers/directors unless there are illegal, ultra vires, fraudulent or otherwise dishonest acts or the judgment is wholly irrational. Sutherland v. Sutherland, 348 S.W.3d 84 (Mo.App.2011). The Trustee has not alleged any factual content that would plausibly support such an inference here. Thus, the Court concludes that the Trustee has failed to state a claim against Linehan for breach of fiduciary duty in connection with the hiring of Carecentric under Missouri law. In addition, the Court notes that there are no facts
The Trustee next complains that Linehan failed to confer with SRI's president, Hewlett, on important business decisions (a claim governed by Missouri law) and failed to confer with Winmar's vice-president, Nelson, concerning important business decisions (a claim governed by North Dakota law). The factual allegations regarding Hewlett are that he managed SRI's day-to-day operations in Murray, Kentucky, was named president of SRI on March 31, 2006, remained in that position through the petition date, but he "was president of SRI in name only." Compl., ¶ 12, 36. The Trustee further alleges that Hewlett was supposed to exercise the powers and authority commonly incident to the office of the president of a corporation, but he did not perform those functions "because he was never given the authority to do so by Linehan and Sabolik," he "never had an opportunity to effectively manage SRI's business operations since he was out of the loop on all important operational decisions," and he was "denied access to financial information," including financial statements "so had no way to effectively manage the day-to-day operations or to ensure SRI's profitability." Compl., ¶ 37. In addition, the Trustee alleges that Hewlett warned Linehan and Sabolik that SRI ought to more aggressively market to increase its patient base, Compl., ¶ 46, warned Linehan and Sabolik that Medicare would likely lower its reimbursement rate for the drug Albuterol, Compl., ¶ 80, and he possessed "extensive knowledge of the markets and market opportunities based on [his] extensive knowledge of the industry through [his] business experience." Compl., ¶ 135.
Similarly, the Trustee alleges that Linehan should have conferred with Nelson concerning important business decisions for Winmar. Nelson is alleged to have been president of Winmar "in name only," Compl., ¶ 13, and was one of Winmar's owners prior to its acquisition by Inc. in December, 2006. Compl., ¶ 104. The Trustee alleges that Nelson was never consulted respecting important operational and financial decisions, such as "the excessive amounts expended by Soporex for ill-advised sleep study marketing initiatives," Compl., ¶ 115, and was never provided financial statements. Compl., ¶ 115. The Trustee also alleges that Nelson operated Winmar profitably despite many failed marketing and sleep study program initiatives, Compl., ¶ 129, and Nelson had "extensive knowledge of the markets and market opportunities based on [her] extensive knowledge of the industry through [her] business experience." Compl. ¶ 135. The Trustee further alleges that Nelson was never asked to re-acquire Winmar. Compl., ¶ 164.
The Complaint does not specify which "important business decisions" are at issue, what advice Nelson and Hewlett could have offered, or how any of the outcomes of any of these business decisions would have been different and better had Linehan consulted with either Hewlett or Nelson. The Trustee has not alleged how or why one officer had a fiduciary duty to consult with another or any facts suggesting that Linehan acted in conscious disregard of any such duty, so as to implicate the duty of loyalty. The Trustee does not allege any facts showing that the failure to confer with Nelson and/or Hewlett, which is tantamount to a complaint that Linehan acted unilaterally for Winmar and SRI, constituted an irrational decision so as to take that decision outside of the business judgment rule in either Missouri or North Dakota. As a result of these failures, the
The Trustee next alleges that Linehan, as chairman of the Board, failed to call meetings of the Board when events involving Inc. required that the Board exercise its powers and duties to oversee the business of Inc. and the Operating Subsidiaries. The facts that support this contention overlap with those supporting the contentions that Linehan failed to (i) insure that the Board committees functioned, (ii) take any action to address material adverse financial conditions affecting the operations of Inc. and the Operating Subsidiaries, and (iii) develop a plan to address the steady financial decline of Inc. and the Operating Subsidiaries. As each of these acts/omissions were allegedly done by Linehan on behalf of Inc. and their factual predicates overlap, Delaware law governs and they will be discussed together.
The Trustee made similar allegations against the Outside Directors, but the Court concluded that those allegations were insufficient to state a claim against the Outside Directors. See supra pp. 36-41 (addressing the Financial Decline Allegations). The Court did so largely because the Trustee (i) did not allege facts plausibly showing that the Outside Directors either consciously disregarded their duties or acted in intentional dereliction of a known duty, and (ii) conceded that the Outside Directors had been misled about the companies' "ever-worsening" financial condition.
Here, however, the Trustee does allege sufficient factual content from which the Court can plausibly infer that Linehan consciously disregarded his fiduciary obligations. The Trustee alleges that Linehan was aware that (i) Carecentric was not properly billing insurers and, as a result, collections of accounts receivable had dropped, (ii) the reimbursement rate for Albuterol could be expected to drop significantly, (iii) Inc. was in default of its borrowing base covenants with GE, such that GE had sent a notice of default and refused to advance further credit, (iv) Inc. was forced to enter into a forbearance agreement with GE that required, among other things, Inc. to remit a large tax refund to GE, and (v) Inc. and the Operating Subsidiaries would lack the cash to operate by mid-July. Yet, according to the Trustee, Linehan failed to inform the Board of the forbearance agreement. Compl., ¶ 90. The Trustee further alleges that Linehan did not did not tell the Board that the Operating Subsidiaries were running out of cash, and did not call any Board meetings between December, 2007 and July, 2008.
These facts, taken as true and viewed in the light most favorable to the Trustee, are sufficient to allege that Linehan consciously disregarded his responsibilities or was intentionally derelict in fulfilling his duty, Disney, 906 A.2d at 66, and thus breached his duty of loyalty to Inc. They are also sufficient for the Court to infer that Linehan acted in a grossly negligent manner—i.e., with reckless indifference or conduct beyond the "bounds of reason," McPadden v. Sidhu, 964 A.2d 1262 (Del. 2008), and thus breached his duty of care to Inc.
The Trustee next complains that Linehan, as the CEO of Inc., Winmar and SRI 2,
The Court concludes that to the extent the Trustee is attempting to allege that the decision not to hire a turnaround professional is a breach of the duty of loyalty, the Complaint fails to state a claim under any relevant state law. There is no allegation of self-dealing or subjective bad faith in connection with this failure to act. Thus, in Delaware, the Trustee would have to allege factual content from which the Court could plausibly infer that Linehan consciously disregarded his obligations, was intentionally derelict in his duties, or made an irrational business judgment. Lyondell Chem. Co. v. Ryan, 970 A.2d 235 (Del.2009); In re Citigroup Shareholder Deriv. Litig., 964 A.2d 106 (Del.Ch.2009). To the extent the Trustee is attempting to state a director oversight liability claim under Delaware law (which would also be a
To the extent the Trustee is alleging that the decision not to hire a turnaround professional is a breach of the duty of care, the Court also concludes that the Complaint fails to state a claim under any relevant state law. Of the three states' laws at issue here, Delaware law is the most well defined with respect to the duty of care. Under Delaware law, Linehan was obligated to consider all material information reasonably available to him. To breach this duty he had to act in a grossly negligent manner—i.e., with reckless indifference or conduct beyond the bounds of reason. McPadden v. Sidhu, 964 A.2d 1262 (Del.2008). There are simply no allegations in the Complaint that he did not consider all material information reasonably available to him. Rather, the Trustee appears to argue that Linehan had a duty to hire a third party to prepare additional information that he then should have considered. The Trustee cites no authority for this proposition and the Court has been unable to locate any either. In other words, there is simply no reported decision in Delaware (or Missouri or North Dakota for that matter) that either the parties or the Court were able to locate in which a director has been held liable for a breach of a duty of care for failing to employ an outside expert (like a turnaround professional) to prepare additional information that must then be considered by the board. While turnaround professionals would no doubt be thrilled with such a holding (that would then ensure their hiring in every troubled financial situation), that does not appear to be the law and, from this Court's perspective, it should not be the law.
Lastly, the Trustee complains that Linehan, as CEO of Inc. and SRI 2, as an officer and director of SRI, and as an officer and director of Winmar, approved the filing of chapter 7 cases for Inc. and the Operating Subsidiaries without giving any consideration to the orderly wind down of the business operations of the Operating Subsidiaries. However, the factual allegations in the Complaint do not establish that Linehan had any real part in this decision. The Complaint alleges that Linehan was involved in a "very serious automobile accident" on July 18, 2008. Compl., ¶ 22. Chevallier, the bankruptcy
The Court notes that there are other factual allegations in the Complaint with respect to Linehan that do not fit neatly into one of the nine specific instances of alleged breaches of fiduciary duty as they are categorized in Count 1 of the Complaint. See Compl., ¶ 185(a)-(i) (enumerating nine items which the Trustee alleges constitute breaches of Linehan's duties). In the section of the Complaint entitled "Gross Mismanagement of Business Operations," subsection (1) is entitled "Mismanagement by Linehan and Sabolik." Compl., p. 40. In that section of the Complaint, the Trustee alleges that Linehan (and Sabolik) "grossly and recklessly mismanaged the Soporex Debtor's businesses for the entire two and one-half years the businesses were operated," Compl., ¶ 138, and she alleges facts respecting three general areas of concern. First, she repeats her claim Linehan breached his fiduciary duties in the selection and hiring of Carecentric, see Compl., ¶¶ 138-142, which the Court has discussed above and which factual allegations the Court has concluded are insufficient to state a claim. See supra, p. 84. Second, the Trustee generally alleges that Linehan established Inc.'s headquarters in Dallas rather than at the heart of the "Soporex Debtors' business operations in Murray, Kentucky"
Compl., ¶ 145.
Essentially, the Trustee complains of a multitude of operational business decisions—all of which directly implicate the business judgment rule. Although the Court is unable to determine on whose behalf the Trustee is complaining in this context—the Court notes that Delaware, Missouri and North Dakota all adhere to the business judgment rule, and courts in all three states are loathe to interfere with the intra vires business decisions of directors and officers in the absence of factual allegations showing irrationality, fraud, illegality, bad faith, or the like. There are no such factual allegations here with respect to these operational decisions.
Finally, the Trustee alleges that despite knowledge that Inc. and the Operating Subsidiaries were approaching insolvency, Linehan (and Sabolik) continued to focus on a recapitalization plan that they "believed would cure all of Soporex's financial problems." Compl., ¶ 148. The Trustee further alleges that the "single-minded focus on the recapitalization plan and their disregard of creditors' interests during the final months of business operations were the result of self-interest. Linehan ... [was] attempting to recapitalize in order to be able to sell some or all of [his] preferred shares as part of the recapitalization of Soporex." Compl., ¶ 148. The Complaint alleges that Linehan held 7.64% of Inc.'s preferred stock, Compl., ¶ 32, that Linehan's equity investment drove many of the decisions he made, id., and that an April, 2008 "Confidential Offering Memorandum" prepared by an investment banking firm that sought to raise additional capital did not mention using any capital to retire the existing $16 million of debt, but it did mention using the capital to enable current shareholders to sell up to 20% of their preferred shares. Compl., ¶ 132.
These allegations, taken as true, are sufficient to state a claim against Linehan, notwithstanding the business judgment rule, because they plausibly suggest that Linehan was motivated by considerations of self-interest rather than the best interest of the corporations. The Officers' Motion will be denied with respect to these allegations.
Accordingly, Count 1 of the Complaint will be dismissed in part. The claims that survive the Officers' Motion are those relating to acts or failures to act (iv)-(vii) as set forth on page 75, supra, and the Trustee's allegations regarding Linehan's self-interest in pursuing a recapitalization plan.
Sabolik is not alleged to have been on the Board—the Trustee alleges that he was an "advisor" to the Board's audit committee only. Compl., ¶ 19. Moreover, according to the Trustee, Sabolik was (i) CFO of Inc. from March 31, 2006 until July 21, 2008, at which point he became President of Inc. and served in that capacity through the petition date, Compl., ¶ 22, (ii) on SRI's board from December 28, 2006 through the petition date, Compl., ¶ 35, (iii) SRI's CFO from March 31, 2006 through the petition date, Compl., ¶ 36, (iv) on SRI 2's board through the petition date, Compl., ¶ 40, (v) SRI 2's CFO from April 13, 2007 through the petition date, Compl., ¶ 41, (vi) a Winmar director from December 28, 2006 through the petition date, Compl., ¶ 112, and (vii) Winmar's CFO during that same time period. Compl., ¶ 114.
The Trustee complains of six specific acts or failures to act that the Trustee
As should be clear from the recital of the foregoing six instances of conduct that allegedly constitute a breach of Sabolik's duties, some of the conduct occurred on behalf of one corporation only, and some occurred on behalf of two or more corporations. Applying the choice of law analysis discussed above, see supra pp. 59-62, the Court concludes that the six instances of conduct summarized above should be analyzed as follows: item (i) implicates the law of Delaware, North Dakota and Missouri; item (ii) implicates only Delaware law; item (iii) implicates the law of all three states; item (iv) implicates only Delaware law; item (v) implicates the law of Delaware and North Dakota; and item (vi) implicates the law of Delaware and Missouri.
The Trustee first alleges that Sabolik, in his capacity as CFO of Inc. and the Operating Subsidiaries,
The Court concludes that these allegations are insufficient to state a claim for breach of the fiduciary duty of loyalty under any relevant state law. There are no allegations of self-dealing or subjective bad faith. At most, the allegations plausibly state a claim for negligence (not even gross negligence), which is legally insufficient under Delaware law.
The Court also concludes that these allegations are insufficient to state a claim for breach of the duty of care. Under Delaware law, the standard for breach of the duty of care is gross negligence—i.e., reckless indifference or conduct beyond the "bound of reason." McPadden v. Sidhu, 964 A.2d 1262 (Del.2008). Although the duty of care is not well defined in Missouri, Missouri courts look to Fletcher's Cyclopedia, which notes that generally, a corporate director or officer will not be held liable for mere negligent mismanagement untainted by self-dealing and also appears to require at least gross negligence. In the only duty of care case in Missouri the Court was able to locate, Boulicault v. Oriel Glass Co., 283 Mo. 237, 223 S.W. 423 (1920), the Missouri Supreme Court stated that the duty of care owed is "that which ordinarily prudent and diligent men would exercise under similar circumstances." Boulicault, 223 S.W. at 426. Although that formulation would seem to imply that ordinary negligence might suffice, the Boulicault case involved a corporate president's failure to discover embezzlement by the bookkeeper. The president admitted that he signed checks in blank payable to the bookkeeper, yet never compared the checks returned with the check book stubs to discover that the total of the checks exceeded the approved payments, though the total exceeded the approved payments "each month for years." In that circumstance, the court stated "we hold that this constituted such negligence as to justify the judgment rendered in the trial court." Boulicault, 223 S.W. at 428. While the Boulicault court appeared to formulate an ordinary negligence test, the facts before it were more akin to gross negligence. Similarly, the North Dakota courts have held that corporate officers and directors are shielded from liability except for self-dealing, willful misconduct, or gross negligence. Red River Wings, Inc. v. Hoot, Inc., 751 N.W.2d at 221-222.
In short, the allegations in the Complaint do not satisfy these legal standards. In addition, the Trustee has not alleged any factual content from which the Court can plausibly infer that the failure to provide monthly financial reports to the Board resulted in any loss, another reason for dismissal of this portion of the Complaint.
The Complaint next asserts that Sabolik breached his fiduciary duties by entering into the Carecentric contract in May, 2007 and by ignoring Camfield's advise that Inc. should bring SRI's billing
The Trustee next alleges that Sabolik failed to develop a feasible plan, process, or procedure to address the declining financial condition of Inc. and the Operating Subsidiaries, and failed to take steps to ensure the collection of SRI's accounts receivable—two separate instances of conduct. The factual allegations supporting the latter failure (i.e., the failure to ensure collection of accounts receivable) overlap with those supporting item (vi)—i.e., that Sabolik failed to take steps to preserved the assets and original patient files of SRI and SRI 2, and the ultimate transfer of those assets for "no consideration." Compl., ¶ 190. As to the failure to develop a plan to address the companies' declining financial condition, the Court concludes, for the reasons set forth above in the discussion concerning these same allegations against Linehan, see supra, pp. 87-88, that the Trustee has stated a claim against Sabolik.
As to the failure to take steps to ensure the collection of SRI's accounts receivable and the failure to preserve SRI and SRI 2's original patient files, the Court first notes that the Complaint contains no allegations that SRI 2's patient files were transferred to anyone. See Compl., ¶ 172 (SRI's patient lists, files and patient records were transferred to Med 4 Home); ¶ 173 ("Sabolik and Smith orchestrated the transfer of SRI's patient list and patient files to Med 4 Home"); ¶ 179 ("Camfield informed Smith that it was imperative that SRI retain copies of the patient files ... over the next day and a half all of SRI's original patient records were boxed and loaded onto trucks"); Ex. A to Complaint (asset purchase agreement between Med 4, Winmar and SRI but not SRI 2). Accordingly, the Complaint fails to state a claim as to any failure to take steps to preserve the assets/patient files of SRI 2.
As to the failure to take steps to ensure the collection of SRI's accounts receivable and the failure to preserve SRI's patient files, the Court is unsure of the conduct of which the Trustee complains. Is the Trustee asserting, again, that Sabolik should have gotten SRI's billing and collections functions in-house sooner, which presumably (although not allegedly) would have ensured the collection of SRI's accounts receivable? Or is the alleged failure to take steps to ensure the collection of SRI's accounts receivable simply another way of saying, somewhat redundantly, that Sabolik failed to preserve SRI's patient files? To the extent it is the former, the Court
Moreover, to the extent that the Trustee premises this claim upon a breach of the duty of care, the Court concludes that the Complaint also fails to state a claim. Although Missouri law does not appear to have defined "gross negligence" as narrowly as Delaware, Boulicault, 223 S.W. at 426, the Trustee alleges that in February, 2008, when Carecentric learned that Soporex had brought SRI's billing and collection functions in-house, Carecentric cut off Inc.'s "access to its own pharmacy data and its own billing and collection data." Compl., ¶ 73. Inc. then sued Carecentric. Compl., ¶ 74. Since Sabolik (and others) had not made copies of SRI's billing and collections data, Inc. hired Med Staff to resubmit claims to insurers that Carecentric had improperly submitted. Compl., ¶ 76. When Inc. could no longer afford to pay Med Staff, the re-billing process was also brought in-house, but was terminated on August 20, 2008, Compl., ¶ 76., and SRI filed for relief under chapter 7 two days later.
There are no facts alleging that a chapter 7 trustee could not, despite the chapter 7 filings, collect the SRI accounts receivable. In fact, the Asset Purchase Agreement with Med 4 Home, which is attached to the Complaint, shows that SRI's (and Winmar's) accounts receivable were excluded from the sale to Med 4 Home. Ex. A to Compl., p. 2. A plausible inference from these facts is that Sabolik did take steps to preserve the accounts receivable, and to the extent they were not collectible, the inability to collect them resulted from the actions of Carecentric, not Sabolik.
The Trustee next alleges that Sabolik breached his fiduciary duties by failing to take any steps to preserve the value of Winmar's ongoing sleep-study contracts or to preserve the going concern value of Winmar. This claim is governed by North Dakota law.
Here, the Court concludes that the Trustee's allegations are insufficient to plead around the business judgment rule as it is formulated in North Dakota. The Trustee alleges that on August 20, 2008, Sabolik told Winmar's officers that Winmar would be filing for relief under chapter 7 and that Winmar would cease operations and that at that time, Winmar's employees were conducting sleep studies pursuant to some 60 contracts with hospitals and clinics, which studies were therefore terminated. Compl., ¶¶ 176-177. The Trustee alleges that Winmar's business (which also included an "oxygen business", according to Ex. A to the Complaint) was being operated profitably were it not for being burdened with Inc.'s excessive corporate overhead. Compl., ¶ 194.
However, the Trustee does not allege (i) that Winmar's sleep study business could have continued as a going concern in light of the other financial problems identified in the Complaint, (ii) that there were buyers ready, willing and able to purchase the sleep-study business as a going concern, (iii) that the business could have been operated as a going concern had the directors/officers chosen instead to file for relief under chapter 11, or (iv) any other factual content showing what the going concern value of the sleep-study contracts was or that it was greater than its liquidation value. Under these circumstances, the Trustee has failed to plead around the business judgment rule. And, since there are no allegations of fraud, self-dealing, or other improper influences that motivated the decision to terminate the sleep studies, the Complaint fails to state a claim against Sabolik.
As is the case with respect to Count 1 against Linehan, there are other factual allegations in the Complaint with respect to Sabolik that do not fit neatly into one of the six enumerated alleged breaches of fiduciary duty as they are categorized in Count 2 of the Complaint against Sabolik. See Compl., ¶ 190(a)-(f) (enumerating six items which the Trustee alleges constitute breaches of Sabolik's duties). In the section of the Complaint entitled "Gross Mismanagement of Business Operations," subsection (1) is entitled "Mismanagement by Linehan and Sabolik." Compl., p. 40. In that section of the Complaint, the Trustee alleges that Sabolik (and Linehan) "grossly and recklessly mismanaged the Soporex Debtor's businesses for the entire two and one-half years the businesses were operated," Compl., ¶ 138, and she alleges facts respecting three general areas of concern.
First, she repeats her claim that Sabolik breached his fiduciary duties in the selection and hiring of Carecentric, see Compl., ¶¶ 138-142, which the Court has discussed above and which factual allegations the Court has concluded are insufficient to state a claim. See supra, pp. 83-85.
Second, the Trustee generally alleges that Linehan established Inc.'s headquarters in Dallas rather than at the heart of the "Soporex Debtors' business operations in Murray, Kentucky"
Third and finally, the Trustee also alleges that despite knowledge that Inc. and the Operating Subsidiaries were approaching insolvency, Sabolik (and Linehan) continued to focus on a recapitalization plan which they "believed would cure all of Soporex's financial problems." Compl., ¶ 148. The Trustee further alleges that the "single-minded focus on the recapitalization plan and their disregard of creditors' interests during the final months of business operations were the result of self-interest. . . Sabolik . . . [was] attempting to recapitalize in order to be able to sell some or all of [his] preferred shares as part of the recapitalization of Soporex." Compl., ¶ 148. However, the Complaint does not allege that Sabolik held any preferred stock in Inc. Compl., ¶ 32. While it
For the reasons set forth above, (i) the Outside Directors' Motion is granted and Count 4 of the Complaint is dismissed; (ii) Letson's Motion is granted and Counts 4 and 5 of the Complaint are dismissed; and (iii) the Officers' Motion is granted with respect to Counts 3 and that count of the Complaint is dismissed. As it relates to Counts 1 and 2, the Officers' Motion is granted in part and denied in part. Specifically, Count 1 of the Complaint is dismissed except as regards acts and failures to act (iv)-(vii) as delineated on page 75, supra, and as regards the Trustee's allegations regarding Linehan's self-interest in pursuing a recapitalization plan, and Count 2 of the Complaint is dismissed except as regards acts and failures to act (iii) as delineated on p. 95, supra.
The Trustee, in response to the Motions, did not formally seek leave to amend the Complaint. At the hearing on the Motions, however, the Trustee indicated that she would seek leave to amend the Complaint in the event the Court concluded that the Complaint is legally insufficient under Twombly and Iqbal. The Defendants indicated that they would oppose such a motion.
Following the hearing but before the issuance of these Proposed Findings of Fact and Conclusions of Law, the Trustee filed a motion for leave to amend. That motion is set for hearing on November 29, 2011 and has been opposed by the Defendants. Accordingly, the Court will take up the propriety of any further amendments to the Complaint at the hearing on that motion, when both the Court and all parties will have had the benefit of a thorough review of the Trustee's proposed third amended complaint.
The Outside Directors further argue that the Trustee has not pled sufficient facts supporting her claim as it relates to the Outside Directors' alleged failure to perform any of their duties as members of Board committees, including the operations committee, and argue that the Trustee has not responded to their arguments regarding the sufficiency of the allegations supporting this alleged failure, such that the Trustee has abandoned this basis of liability. While the Court agrees that the Trustee's opposition to the Outside Directors' Motion did not address this issue, the Trustee's counsel argued at the hearing on the Motions that she has not abandoned this basis for imposing liability.
Here, to the extent that the Trustee has not abandoned this basis for liability, the Court concludes that insufficient facts are pled in the Complaint to state a plausible claim. First, Geary is not alleged to have even served on any committee. Second, while Dudinsky is alleged to have served on the "reimbursement and lobbying" committee, the Complaint fails to allege what functions that committee was supposed to perform or that it did not perform those functions. Privett is alleged to be the sole member of an "audit" committee; but again, the Complaint does not allege what functions that committee was supposed to perform or that it did not perform them. Hansen is alleged to have served on the "operations" committee. The Complaint does not allege what that committee was supposed to do other than to "assist in the operations of the Soporex business." Compl., ¶ 20. The only other allegation about the operations committee is that it did not meet and that it never did anything to assist the Board. The Court agrees with the Outside Directors that "merely alleging that Hansen was a member of a committee and that such committee did not meet falls far short of establishing a plausible [breach of fiduciary duty] claim against Hansen." Br. In Supp. Of First Amended Mot. To Dismiss filed by John Dudinsky, Jr., Ronald G. Geary, Thomas Hansen and Doyle Privett, p. 22.
