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Capella Holdings, Inc. v. Anderson

Court of Chancery of Delaware

July 8, 2015

Capella Holdings, Inc.

Submitted: March 12, 2015

A. Thompson Bayliss, Esquire Sarah E. Hickie, Esquire Abrams & Bayliss LLP

Johnna M. Darby, Esquire Hiller & Arban, LLC

Dear Counsel:

A company (and its operating subsidiary) and several of its fiduciaries have moved to dismiss counterclaims and third-party claims brought against them by a company founder who also is a former director and officer. The claims relate to a 2014 recapitalization that led the founder to file a public complaint in Tennessee state court, and then to be terminated based on the disclosure of supposedly confidential information. The founder has failed to plead that the recapitalization was unfair, but there are factual issues that prevent dismissal of his contract claims. The Court thus grants the motion to dismiss in part and denies the motion in part.

Counterclaim Defendants are Capella Holdings, Inc. ("Capella Holdings") and Capella Healthcare, Inc. ("Capella Healthcare, " and collectively, "Capella"), as well as Capella directors Daniel S. Slipkovich ("Slipkovich"), Joseph P. Nolan ("Nolan"), David A. Donnini ("Donnini"), Joshua M. Earl ("Earl"), and Robert Z. Hensley ("Hensley, " and collectively, the "Director Defendants"). They have moved to dismiss breach of fiduciary duty and contract claims made by Counterclaim Plaintiff James Thomas Anderson ("Anderson"), a founder and former director and officer of Capella.[1]

Capella is a Delaware corporation that operates "acute care hospitals and ancillary facilities."[2] Upon Capella's formation, affiliates of GTCR Golder Rauner II L.L.C. ("GTCR")[3] invested approximately $206 million for approximately 50 million common and 206, 000 preferred shares of Capella. Capella's charter capped issuance of common stock at 75 million shares "to protect the minority shareholders from dilution."[4] Furthermore, under the terms of the Senior Management Agreement dated May 4, 2005, Capella was required to "reserve 2, 211, 688 additional shares of Common Stock . . . for issuance . . . to other executives and employees" of Capella and its subsidiaries.[5] Capella and Anderson were signatories to the Senior Management Agreement.

In 2013, GTCR began a sales process that resulted in a bid from Apollo Global Management, LLC ("Apollo") of $200 million for preferred securities convertible into at least 51% of Capella's common stock. According to Anderson, the bid thus valued the common at between $200 million and $400 million, or "at least $3.17 per share."[6] Counterclaim Defendants offer an October 30, 2013, bid letter from Apollo, which, however, makes clear that part of the investment was to be used to deleverage Capella.[7] Nevertheless, GTCR subsequently terminated the process. GTCR then began changing management, including hiring new chief executive officer Mike Wiechart ("Wiechart"). Anderson was given, but did not execute, "'voluntary termination' papers" on December 20, 2013.[8]

The counterclaims relate to an April 17, 2014, recapitalization (the "Recapitalization"). Wiechart proposed the Recapitalization in February 2014, citing a need to avoid a potential debt rating downgrade and to "'incentivize'" employees.[9] Legal counsel was present and answered Anderson's questions at that February board meeting. As of then, Capella was able to issue approximately 12 million more shares of common stock, and Chief Financial Officer Denise Warren represented that "no downgrade was threatened or imminent."[10] She also "stated that no debt issuance was currently under consideration."[11]

The board members were provided with details of the Recapitalization less than 48 hours before their ultimate vote. In the Recapitalization, Capella would be authorized to issue over 1.2 billion shares of common stock. GTCR's preferred shares[12] would be converted into common shares based on a $0.175 per common share valuation, reportedly determined by "the amount of money that various investors had paid for their shares"-not fair market value.[13] Generally speaking, GTCR's ownership percentage would increase from 79.1% of Capella's common stock to 88%; Anderson's share would decrease from 6% to 0.308%; and the minority shareholders' share would decrease from 20% to less than 2%. GTCR also requested exclusive Delaware jurisdiction.

At an April 17, 2014, meeting, after receiving legal advice, Capella's board of directors approved the Recapitalization. Minutes from February presented at the April meeting noted "an imminent threat of a bond-ratings downgrade" and a lack of questions to legal counsel.[14] Anderson voted against the Recapitalization, while five directors-who were either GTCR "affiliates" or had "a direct pecuniary interest through GTCR in maximizing the value of GTCR's investment"-voted in favor.[15] In Anderson's words, Donnini and Earl are "direct affiliates of GTCR";[16]Nolan is "a former direct affiliate in GRCR" who serves to benefit from "GTCR-affiliated investments";[17] Hensley is "a board member for multiple GTCR-affiliated companies";[18] and Slipkovich is a beneficiary of "employment agreements linked to the outcome of GTCR's investment in [Capella]."[19] GTCR had nominated Donnini, Earl, Nolan, and Hensley to the board.

Anderson filed an action in Tennessee state court on April 23, 2014, alleging breaches of contract and fiduciary duty and seeking rescission of the Recapitalization (the "Tennessee Complaint").[20] Included in the Tennessee Complaint was information about the Apollo bid, the Recapitalization, and alleged concerns about a debt-rating downgrade. Capella responded by purporting to terminate Anderson "for cause" under the Senior Management Agreement on May 19, 2014, and filing this Delaware action.[21] Anderson's "breach of his duty of loyalty and breach of his confidentiality obligations" were cited as justifying the termination.[22] Capella has refused to pay Anderson severance.[23] In September 2014, Anderson "voluntarily dismissed his Tennessee case, without prejudice" and filed "mirror[ing]" claims through his Delaware counterclaims.[24]

In this action, Anderson brings five counts, the first four focused on rescission of the Recapitalization[25] and the last focused on securing benefits under his employment agreement through an order for declaratory judgment and specific performance. In his first three counts, Anderson asserts duty of loyalty, duty of care, and duty of good faith claims against the Director Defendants and Capella Holdings for the directors' role in approving the Recapitalization.[26] Anderson alleges that the Recapitalization was conducted to benefit GTCR and management, without sufficient time and information, and for stated reasons that were false. He contends that entire fairness review is appropriate. Count IV accuses Capella of breaching the Senior Management Agreement "by authorizing the issuance of" more than the shares reserved for executives and employees (and more than the 75 million cap in its charter).[27] Anderson's final count faults Capella for failing to uphold severance pay and other obligations required for termination without cause.[28] From these violations, Anderson claims to have suffered damages in an amount "unascertainable" at this stage.[29]

Counterclaim Defendants urge the Court to dismiss the counterclaims on the grounds of laches (or the impracticality of rescission), failure to comply with requirements for derivative claims, and failure to state a claim. On the merits of the fiduciary duty claims, Counterclaim Defendants argue that Anderson has not rebutted the presumption that the Director Defendants acted loyally, that the Section 102(b)(7) provision in Capella's charter[30] shields them from liability, and that Capella cannot breach a duty to itself. They contend that the contract claims fail because "the clear and unambiguous language"[31] of the Senior Management Agreement supports their reading that the reserved share amount was a "floor, "[32]and Anderson has not identified an actual harm suffered. Counterclaim Defendants add details of the Apollo bid in their reply to debunk Anderson's theory of damages. They also argue that "[t]he public existence of Anderson's Tennessee Complaint"[33] is enough to establish that Capella terminated him for good cause, which both triggered the repurchase of his shares and rendered him ineligible for severance payments. Finally, they observe a number of flaws in the request for specific performance of the Senior Management Agreement, including that the counterclaims substantively ask for money damages.

Anderson answers Counterclaim Defendants' contentions in turn, beginning with arguments that the pleadings do not support a laches defense and that he is bringing his claims directly, based on the dilution he suffered and the rescission he seeks.[34] With respect to his fiduciary duty claims, Anderson asserts that he states a claim because the Director Defendants needlessly approved a plan to increase ownership of controller GTCR at the expense of the minority shareholders. He claims that the Director Defendants were conflicted "thanks to their myriad ties to GTCR."[35] He further cautions that resolving the contract claims on a motion to dismiss would require inappropriate factual determinations, "abstract" contract interpretation, and a balancing of the equities.[36] For example, he observes that the facts surrounding his filing of the Tennessee Complaint have not been developed.

On a motion to dismiss, the Court "accept[s] even vague allegations in the Complaint as 'well-pleaded' if they provide the defendant notice of the claim."[37]Well-pleaded factual allegations are taken as true, reasonable inferences are drawn in favor of the complainant, and the Court grants the motion only if the complainant cannot prevail under any reasonably conceivable set of circumstances that can be proved.[38] Although use of extrinsic evidence can convert a motion to dismiss into one for summary judgment, [39] the Court can consider, for limited purposes, documents that are "integral to a plaintiff's claim and incorporated in the complaint."[40] Delaware Rule of Evidence Rule 201(b) further allows the Court to take judicial notice of facts that are "'capable of accurate and ready determination by resort to sources whose accuracy cannot reasonably be questioned.'"[41]

Before the Court proceeds to the heart of its analysis, a brief explanation of why it does not resolve part of this motion on Counterclaim Defendants' laches (or impracticality) and derivative claim contentions is warranted. First, Counterclaim Defendants argue for dismissal because Anderson waited too long to ask for rescission. "Laches bars an action in equity if[] [t]he plaintiff waited an unreasonable length of time before bringing the suit and . . . the delay unfairly prejudices the defendant."[42] Impracticality of undoing a transaction weighs against rescission.[43] While Counterclaim Defendants make compelling arguments, the Court hesitates to decide the motion on these grounds when there is a factual dispute about what has happened since the Recapitalization closed.

Next, perhaps the first step of the analysis should be whether Anderson states direct or derivative fiduciary duty claims, [44] a point the parties vigorously debate. To maintain derivative claims, Anderson would need to comply with "Rule 23.1's pleading requirements . . . [and] the continuous ownership requirement."[45] For the purpose of judicial economy, however, the Court assumes that Anderson states direct claims. Anderson's fiduciary duty counterclaims do not expressly plead that he has suffered from exclusionary dilution of his voting rights by a controller as in Gentile v. Rossette, [46] but the Court will make the inference, for this decision, that Anderson brings those claims directly.[47]

Moving to the merits of the claims, Anderson asserts breaches of the duties of care, good faith, and loyalty, as well as breaches of contract. As remedies, he asks for rescission, declaratory judgment, and specific performance. A breach of the duty of care rests on gross negligence.[48] A classic duty of loyalty claim involves self-interested conduct, and a good faith claim (also under the loyalty umbrella) arises "where corporate directors have no conflicting self-interest in a decision, yet engage in misconduct that is more culpable than simple inattention or failure to be informed."[49] As a general matter, directors are presumed to make business decisions "on an informed basis, in good faith and in the honest belief that the action taken [i]s in the best interests of the company."[50] Even when entire fairness scrutiny would otherwise seem to apply, a plaintiff must first "make factual allegations in its complaint that, if proved, would establish that the challenged transactions are not entirely fair" to state a claim.[51]

The critical dispute for Counts I through III (the fiduciary duty claims) is whether Anderson has made factual allegations that the Recapitalization was unfair to him. Anderson's claims of unfairness and of an entitlement to relief (through an entire fairness review, blending care, loyalty, and good faith issues) fundamentally are tied to the $3.17 per share stock price based on the Apollo proposal.

The facts in the Counterclaim are that, by summer 2013, GTCR held approximately 206, 000 preferred shares from its initial investment and 143, 000 preferred shares as accumulated in-kind interest.[52] Altogether, this interest was "redeemable" for approximately $349 million.[53] The Counterclaim also asserts that Capella's common stock was worth $3.17 per share. This allegation is speculative (and the proposal letter[54] does not fill in the unknowns). For example, Apollo was considering the investment of $200 million and anticipated that it would end up with a controlling equity position. That could support the $400 million upper range posited by Anderson for the common stock. Unfortunately, one cannot discern how much of Apollo's proposed investment would end up being converted into common stock or how much of what Apollo would pay to the Company would be kept as company funds (and not paid to pre-transaction equity holders)? Thus, the numbers which Anderson uses do not support the $3.17 per share price that is critical to his effort to demonstrate unfairness. Furthermore, since the Recapitalization gave GTCR approximately 9% more common shares, using Anderson's numbers would mean that GTCR traded its $349 million worth of preferred shares (and priority position) for at most an additional $35.6 million of common shares (or for the purpose of taking $22.6 million from Anderson).[55]

The bid letter, if admissible at this stage, is evidence that $3.17 is not a reasonable valuation on which to rely-particularly for one who was an insider at the time the bid was made. Nonetheless, Anderson's valuation theory is tenuous even if the Court does not look at the letter. GTCR's initial ownership position is not in dispute. The Counterclaim also states that Apollo was making an offer for preferred securities, although convertible to a controlling interest in common stock. The Court cannot engage in speculation that Apollo saw some advantage to owning Capella common stock that somehow cancelled out Capella's preferred stock obligations (not to mention its debt).[56] Moreover, while there is an allegation that the $0.175 per share price was unfair itself, the factual basis given to infer unfairness is that $0.175 is "at least $3.00 per share less than the value of the Apollo bid."[57] Without well-pleaded allegations about the unfairness of the transaction, Anderson fails to plead his entire fairness case against the Director Defendants, [58] as well as against Capella.[59]

Given the above analysis, Anderson's remaining claims are for breach of contract. Count IV alleges breach of the Senior Management Agreement "by authorizing the issuance of greater than 2, 211, 688 shares of common stock for issuance to other executives and employees"[60] and "greater than 75 million common shares."[61] Counterclaim Defendants argue that the Senior Management Agreement unambiguously set a minimum of shares to reserve "as a means to compensate . . . executives and management in a potential change-of-control context" but "by no means dictate[d] a ceiling" on future issuances.[62] The elements of a breach of contract claim are a contract, a breach of that contract, and resulting damages.[63] When interpreting a contract, the Court gives effect to the plain meaning of the language adopted by the parties.[64] "Dismissal is proper only if the defendants' interpretation is the only reasonable construction as a matter of law."[65]

Section 1(k) of the Senior Management Agreement simply requires Capella to reserve approximately 2.2 million common shares for executives and employees; these shares can be issued to executives at the board's discretion if a triggering event occurs.[66] There is no language about a floor or a ceiling, and the parties do not direct the Court to other sections of the contract that show a clear intent to choose between the interpretations. Counterclaim Defendants' reading appears more promising, but Anderson's allegations about the 75 million share cap in Capella's charter and the promise to protect his ownership percentage indicate that his interpretation is at least reasonable at this stage. Anderson has failed to state a claim that the Recapitalization unfairly extracted monetary value from him. However, it is reasonably conceivable that Anderson suffered from a violation of his contract rights and rights associated with stock ownership, such as voting power.[67] Because the claim survives, limiting the possible remedies, if eventually necessary, should await further developments.

In his fifth count, Anderson alleges that Capella breached the Senior Management Agreement by terminating him without cause (and accruing additional violations for treating his termination as one for cause). Anderson argues that the Court must limit itself to the pleadings and that the motion to dismiss stage is inappropriate to resolve factual disputes. Defendants maintain that the critical facts are subject to judicial notice and indicate that Anderson was properly terminated for cause.

Again, the Court begins by looking to the language of the Senior Management Agreement. Confidential information includes information Anderson received as a director "concerning the business or affairs" of Capella.[68]Information about a recent bid, the Recapitalization, and credit-rating concerns qualify. The Senior Management Agreement has a limited exception for information "required to be disclosed pursuant to any applicable law, "[69] but Tennessee law did not dictate that Anderson's complaint be filed publicly.[70] The Senior Management Agreement emphasizes the harm of breaching the confidentiality provision and takes away rights to severance pay for such a breach.[71] The difficulty with granting the motion to dismiss, however, is that termination for cause requires a breach of the duty of loyalty or a material breach of the Senior Management Agreement.[72] Those conclusions require factual determinations that cannot readily be made at this stage, in spite of the persuasive facts noted above. In short, however skeptical one may be about Anderson's future success on the merits, the limitations of Rule 12(b)(6) preclude dismissal of his final count.[73]

For the reasons above, Counterclaim Defendants' motion to dismiss is granted with respect to the fiduciary duty claims and denied with respect to the breach of contract claims.


Very truly yours,


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