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Kan-Di-Ki, LLC v. Sure

Court of Chancery of Delaware

July 22, 2015

KAN-DI-KI, LLC (d/b/a DIAGNOSTIC LABORATORIES), Plaintiff,
v.
ROBERT SUER, Defendant.

Submitted: February 25, 2015

Mary B. Graham, Esq., Kevin M. Coen, Esq., MORRIS, NICHOLS, ARSHT & TUNNELL LLP, Wilmington, Delaware; Robert P. Ducatman, Esq., Lisa B. Gates, Esq., JONES DAY, Cleveland, Ohio; Attorneys for Plaintiff.

Arthur G. Connolly, III, Esq., Christos T. Adamopoulos, Esq., Ryan P. Newell, Esq., CONNOLLY GALLAGHER LLP, Wilmington, Delaware; Attorneys for Defendant.

MEMORANDUM OPINION

PARSONS, Vice Chancellor.

In this contract action, the plaintiff seeks injunctive relief against the defendant for breaches of restrictive covenants, including non-competition, non-interference, and confidentiality provisions. Through two agreements, one executed roughly a year after the other, the defendant sold his interests in two businesses that provided mobile diagnostic laboratory and x-ray services to skilled nursing facilities. The plaintiff, a large vendor of that type of services, paid the defendant $4 million in the first transaction, and roughly $300, 000 in the second. Between two and three years after the execution of the second agreement, the defendant began consulting for a management company that operates nursing facilities, including some facilities that were serviced by the plaintiff. Thereafter, and with the defendant's assistance, the management company aggressively pursued reductions in the outstanding invoices it owed to the plaintiff, and later terminated all its contracts with the plaintiff to replace it with other service providers.

The plaintiff brought this action for breach of contract and several other claims. During the litigation, the defendant filed for bankruptcy, and all claims were automatically stayed. Several months later, the plaintiff obtained limited relief from the stay to enable it to pursue its breach of contract claim to the extent it seeks injunctive relief. The plaintiff pursued that claim, and this Court conducted a five-day trial regarding it in October, 2014. The plaintiff contends that the evidence supports the conclusion that the defendant breached his obligations under the restrictive covenants, and that it is entitled to broad injunctive relief as a result. The defendant disputes that assertion, and also contends that the restrictive covenants are unenforceable under both Delaware and California law, that they have expired and should not be extended, and that injunctive relief is not appropriate in this case.

This Memorandum Opinion represents my post-trial findings of fact and conclusions of law. For the reasons stated herein, I hold that the covenants are enforceable, and that plaintiff has proven its claim for breach of contract and is entitled to injunctive relief I also grant the plaintiffs pending motion for sanctions for alleged suppression or spoliation of evidence.

I. BACKGROUND[1]

A. The Parties

Plaintiff, Kan-Di-Ki, LLC, does business as Diagnostic Laboratories ("DL"). DL is a California limited liability company with its principal place of business in Burbank California.[2] Defendant, Robert D. Suer, is an individual residing in California.[3]

B. Suer and DL Enter into Various Agreements

1. Suer's initial work for DL

DL is in the business of providing mobile diagnostic laboratory, ultrasound, and x-ray and related services to nursing homes, assisted living facilities, correctional facilities, and other long-term care facilities.[4] At present, DL operates in Louisiana, Texas, Arkansas, Kansas, Missouri, Nebraska, Colorado, Utah, Nevada, Arizona, New Mexico, California, Oregon, Washington, and Idaho.[5] DL is part of the western division of its parent entity, non-party TridentUSA Health Services (''Trident"), which operates in forty-three states.[6]

Suer began working in the mobile x-ray business in the late 1980s as an x-ray technician.[7] In 1998, he took a position with DL's predecessor ("Old DL"), continuing as an x-ray technician but also marketing the company's services to nursing facilities.[8] In the early 2000s, Suer was promoted to senior vice president and his duties focused entirely on marketing and sales, as well as managing six or seven sales representatives.[9]In about 2006, Dr. Jason Liu, then a radiologist at Old DL, bought out the company's previous owner.[10] Not long thereafter, Liu fired Suer.[11] Rick Navarro, who currently is the Vice President for National Accounts at DL, reported to Suer in 2007, when Suer was fired.[12] Navarro testified that Suer was "extremely frustrated" by his termination, and stated, "I'm going to take down DL. I'm going to take down their business."[13]

In or around early 2007, Suer and a partner started a company called Reliable Mobile Medical Services, which operated in competition with Old DL.[14] According to Navarro, Suer's new company achieved at least some degree of success, and Liu was concerned enough about it that only six months after firing Suer, Liu sought to re-hire him.[15] Old DL re-hired Suer pursuant to an agreement dated August 28, 2007 (the "2007 Employment Agreement").[16] The 2007 Employment Agreement provided for Suer to become President of Old DL, in exchange for which he would receive a $400, 000 annual salary and certain other benefits.[17] While the 2007 Employment Agreement did not give Suer any formal ownership interest in Old DL, it provided that if during Suer's employment either Old DL or substantially all of its assets were sold, Suer would "be entitled to receive an amount equal to ten percent (10%) of the net proceeds payable to Dr. Liu (or to any other person or entity who is a shareholder of the Company immediately before such sale)."[18]

2. The DL Purchase Agreement

At some point in 2008, Frazier Healthcare ("Frazier") and Audax Group became interested in a transaction with Old DL.[19] Kelly McCullum, then an employee of Frazier, had conducted due diligence on Old DL since mid" or late-2006. On July 28, 2008, Frazier and Audax indirectly acquired Old DL through a Contribution and Equity Interest Purchase Agreement (the "DL Purchase Agreement" or "DLPA").[20] The DLPA was structured to include a "Reorganization" in which Old DL was converted into an LLC, the interests of which would be owned by Liu and Suer.[21] Liu and Suer, as "Sellers" under the DLPA, then would transfer their interests in that LLC-namely, Kan-Di-Ki, LLC, or DL-to the buyer"affiliated entities in connection with the DLPA closing.[22]McCullum became the President and COO of DL, and he retained that post until 2014.[23]

McCullum was not involved in the negotiation of the DLPA. Based on his familiarity with the transaction itself, however, McCullum testified that Suer was made a party to the DLPA because he was an "integral part" of the Old DL business, in that, for example, he occupied the position of President and held "a $4 million stake in the company."[24] When the transaction formally closed in September 2008, Suer was paid $4 million under the terms of the DLPA, as his share of the purchase price for the Old DL business.[25]

Several provisions of the DLPA are important to Plaintiff's claims in this case. Section 6.9.1 provides in relevant part that:

[E]ach Seller hereby agrees with the Buyer that such Seller will not . . . at any time on or after the Closing Date, directly or indirectly, without the prior written consent of the Buyer, disclose or use, any Confidential Information involving or relating to the Business of any Acquired Company; provided, however, that the information subject to [this section] will not include any information generally available to, or known by, the public . . ., or information that is generally known to the industry relating to the Business . . . .[26]

Section 6.11, relating to non-competition and non-solicitation, states:

For a period of five years from and after the Closing Date, no Seller will . . . engage directly or indirectly in all or any portion of the Business as conducted as of the Closing Date in California, Oregon, Washington, Idaho, Nevada, Arizona, Utah, Wyoming, Montana, Colorado, New Mexico, Texas, Oklahoma, Kansas, Nebraska, South Dakota, North Dakota, Minnesota, Iowa, Missouri, Arkansas and Louisiana, and any other geographic area in which any of the Acquired Companies conduct Business as of the Closing Date . . . . [27]

The parties defined "Business" in Section 6.11 as meaning the provision of mobile diagnostic laboratory, x-ray, pharmacy, and other services to nursing homes, assisted living facilities, jails and other long-term care facilities."[28]

Among the transactional documents executed in connection with the DLPA, Suer's Employment Agreement was cancelled, [29] and he entered into a new "Consulting Agreement" with DL.[30] Under that agreement, Suer was retained to provide services to DL in exchange for a base salary of $125, 000 per year.[31] The Consulting Agreement had a twelve-month term with the possibility of renewal, but DL retained the right to terminate the agreement "at any time, with or without notice, " subject to the payment of specified severance payments.[32]

The Consulting Agreement lasted only a couple of months before DL terminated it.[33] According to McCullum, the termination was in response to reports that Suer was preparing to compete with DL in violation of the DLPA covenants, but Suer denied having taken such actions.[34] Navarro testified that Suer, again enraged, called him cursing and threatening "to come back and . . . take business from DL."[35]

3. The APA

Suer consulted an attorney about the covenants in the DLPA and other documents.[36] His counsel opined that the non-competition provisions were unenforceable, and wrote to DL in January of 2009 to advise it of Suer's position to that effect.[37] That same month, DL responded by filing suit in this Court for injunctive relief against Suer.[38] That action was dismissed for lack of personal jurisdiction over Suer in March 2009.[39]

During that early 2009 time period, Suer began discussions with Cedars Clinical Laboratory, a conventional-i.e., non-mobile-laboratory in southern California.[40] Suer then formed BCCC Holdings, LLC ("BCCC"), and South Coast Clinical Laboratories ("South Coast"), and acquired the assets of Cedars Clinical through those entities.[41] After DL's suit against Suer was dismissed in March 2009, it did not attempt to sue him in California, where personal jurisdiction ostensibly would have been proper.[42] Instead, DL engaged Suer in discussions about a transaction relating to South Coast.[43]

On May 20, 2009, DL and Suer executed an Asset Purchase Agreement (the "APA"). Under the APA, DL acquired substantially all of South Coast's assets, including rights and interests in a certain laboratory license, permits, books and records, goodwill, intellectual property, claims, and other rights and interests.[44] The "Seller" under the APA was South Coast, but, due to the ownership structure Suer had erected, both he and BCCC were parties and signatories to the agreement as well.[45] In exchange for transferring the relevant assets and executing the relevant agreements, Suer, through South Coast, was paid $294, 112 in cash.[46] The APA closing occurred in Wilmington, Delaware, where Suer physically executed the relevant documents.[47]

As with the DLPA, Suer characterizes the APA as merely an avenue for imposing a new non-compete, " asserting that "the business purchase aspect was illusory given South Coast's negligible income and few assets."[48] Suer further intimates that he decided to enter the APA "[r]ather than litigate" with DL. In that regard, Suer testified that Adamson directly or indirectly threatened to file a new lawsuit against Suer in California, and the discussions temporarily stopped.[49]

Suer is a sophisticated businessman who ultimately decided to bind himself in the APA in exchange for negotiated consideration, and I find his reasons for doing so to be irrelevant. In any case, he has not contended that he was coerced to sign the APA or that it is void on grounds of duress, or made any similar argument. I therefore find unpersuasive the oblique comments in Suer's brief that purport to undermine the APA's validity.[50]

Among the provisions the parties agreed to in the APA are three restrictive covenants, dealing with confidentiality, non-competition, and non-interference. Section 5.3, the "Confidentiality Provision, " states in relevant part:

[South Coast] and [Suer and BCCC] hereby agree with Buyer that neither [South Coast] nor [Suer and BCCC], nor any of their respective Affiliates, will, at any time on or after the Closing Date, directly or indirectly, without the prior written consent of the Buyer, disclose or use any confidential or proprietary information, or any trade secret information, involving or relating to the Business.[51]

As used in the APA, the term "Business" referred to South Coast's business, which the APA specified as the business of "providing mobile diagnostic laboratory, pharmacy, ultrasound, rehab and x-ray services."[52]

In Section 5.4, the APA imposes certain non-competition and non-solicitation restrictions. Section 5.4.1 provides that:

For a period of five years from and after the Closing Date, neither [South Coast] nor [Suer or BCCC] will . . . directly or indirectly engage in, or directly or indirectly prepare to engage in, in whole or in part, the Business in the Restricted Area.[53]

The "Restricted Area" under the APA resembles that under the DLPA. It includes: Delaware, California, Oregon, Washington, Idaho, Nevada, Arizona, Utah, Wyoming, Colorado, New Mexico, Texas, Oklahoma, Kansas, Nebraska, South Dakota, North Dakota, Minnesota, Iowa, Missouri, Arkansas, and Louisiana, plus "any other geographic area in which [DL] or its Affiliates conduct business as of the Closing Date."[54] The next provision of the APA states in relevant part:

For a period of five years from and after the Closing Date, neither [South Coast] nor [Suer or BCCC] will . . . directly or indirectly recruit, offer employment to, employ, engage as a consultant, lure or entice away . . . any Person who is . . . an employee of [DL], [South Coast] or any of their respective Affiliates, to leave the employ or engagement of Buyer . . . . In addition, for a period of five years from and after the Closing Date, neither [South Coast] nor [Suer or BCCC] will . . . directly or indirectly solicit, divert, interfere with or accept business from, or attempt to directly or indirectly solicit, divert, interfere with or accept business from any Person that is . . . a customer or supplier of [DL] or [South Coast], for the purpose of securing business competitive with Buyer.[55]

The parties further agreed in Section 5.4.3 that:

[B]efore providing services, whether as an employee, consultant or otherwise, to any entity during the five-year period referred to in this Section 5.4, [Suer and BCCC] will provide a copy of this Section 5.4 to such employer, and cause such employer to acknowledge to the Company in writing that it has read this Section 5.4.[56]

Thus, Section 5.4 contains non-competition and non-solicit covenants. The third major restrictive covenant in the APA is in Section 5.6, which pertains to noninterference. It states in part:

Neither [South Coast] nor [Suer or BCCC] will . . . take any action that is designed or intended to have the effect of encouraging any lessor, licensor, supplier, distributor or customer of [DL] or its Affiliates . . . from altering its relationship with [DL] or its Affiliates in a manner adverse to [DL] or its Affiliates.[57]

The APA refers back to the DLPA, and in that regard states that, "Suer hereby acknowledges and re" affirms the validity and enforceability of each of his obligations set forth under the DL Purchase Agreement, and affirms that he has no intention of violating or challenging, and will not violate or challenge, the terms of any such obligations."[58]Collectively, I refer to the Non-Competition Provisions, the Non-Interference Provision, and the Confidentiality Provisions as the "Restrictive Covenants."

Finally, the APA contains a "Survival" clause. In that regard, Section 6.3 states that, "The representations, warranties, covenants and agreements contained herein will survive for the longer of (i) five years, and (ii) the statute of limitations in respect of the subject matter described herein."[59]

The APA was not the only agreement executed in connection with the May 2009 transaction between DL and Suer. On the same day as the APA, DL and Suer entered into a new employment agreement (the "2009 Employment Agreement").[60] That agreement outlined certain duties Suer would perform, and prescribed his base salary ($87, 852 per year) and certain incentive compensation schedules.[61] The 2009 Employment Agreement had a term of three years, but it provided that Suer could be terminated with or without Cause before that time period expired.[62]

C. Suer Begins Working for North American

After the execution of the APA and the 2009 Employment Agreement, Suer expected to begin actively working for DL. In fact, however, Suer was not given any responsibilities other than completing the discrete tasks that were identified in the 2009 Employment Agreement, which included effecting a license transfer, among other things.[63] Beyond that, Suer was given no responsibility and was not re" integrated into DL. Instead, he was told that DL would call him if he was needed.[64]

The evidentiary record is largely silent with respect to the time period between May 2009 and January 2012, when Plaintiff claims the alleged breaches of the Restrictive Covenants began. In late January 2012, Suer began working as an independent contractor for North American Health Care ("North American").[65] North American and its affiliates operate skilled nursing facilities in California, Arizona, Utah, and Washington.[66] North American also had a long-term business relationship with DL under which DL provided mobile x-ray and laboratory services to North American facilities.[67]

At the recommendation of an administrator at one of North American's facilities, North American's COO, Timothy Paulsen, met with Suer early in 2012.[68] Because Paulsen believed Suer's experience in working for skilled nursing facilities service providers could be valuable to North American, he retained Suer as a consultant.[69] DL contends the provisions of the DLPA and APA required Suer to show North American copies of those Agreements and cause North American to acknowledge in writing to DL that it had reviewed the applicable non-competition agreements.[70] There is no dispute that neither Suer nor North American complied with those obligations.

1. North American cancels its contract with DL

According to Paulsen, Suer was put to work "digging into stacks and stacks of invoices, " looking at how each vendor's invoices compared to North American's contracts with that vendor to determine if North American was being billed properly.[71]Suer audited invoices from DL, as well as other vendors that provided pharmacy, oxygen, and food services-"basically any vendors" North American was using at the time.[72]Suer was the "primary auditor" of North American's vendor invoices; he worked exclusively with Paulsen and provided him written reports.[73]

On March 21, 2012, Suer emailed Paulsen a draft letter addressed to DL, detailing "discrepancies" that North American had perceived based on its auditing of vendor billing statements.[74] Suer's cover email stated, "Tim, attached is a Word document for your review that I put together. I hope this gives you some kind of format. Sorry it took so long but I really needed to make sure we included as much information as possible."[75]The letter concluded by stating that North American was "currently holding all payments to Diagnostic Laboratories until we have some type of response from your company in regard to the errors that have occurred."[76] The next day, Paulsen emailed essentially the same letter that was attached to Suer's email to several individuals at DL.[77] Paulsen testified that he wrote the draft letter and gave it to Suer with instructions to give Paulsen numbers and documents that would illustrate the relevant billing discrepancies.[78]Individuals at DL met with Paulsen after receiving the March 22, 2012 letter to try to persuade him that North American's auditing analysis was erroneous. But Paulsen maintained his position, demanding that DL either write down its receivable balance or credit North American to offset the perceived over" billing.[79]

North American withheld payment on roughly $800, 000 in charges invoiced by DL.[80] Documentary evidence from the end of March 2012 indicates that North American was planning to cancel contracts with DL relating to all of North American's skilled nursing facilities in the southern California area.[81] Suer actively assisted Paulsen in this regard. On April 10, 2012, Paulsen forwarded Suer an email chain between a North American facility administrator and DL entitled "Cancellation Letter."[82] ...


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