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Capella Holdings, LLC v. Anderson

Court of Chancery of Delaware

November 29, 2017

CAPELLA HOLDINGS, LLC, Plaintiff,
v.
JAMES THOMAS ANDERSON, Defendant and Counterclaim/ Third-Party Plaintiff,
v.
CAPELLA HEALTHCARE, LLC, Third-Party Defendant.

          Submitted Date: August 29, 2017

          A. Thompson Bayliss, Esquire and Sarah E. Hickie, Esquire of Abrams & Bayliss LLP, Wilmington, Delaware and Jeffrey J. Bushofsky, Esquire and Nicholas M. Berg, Esquire of Ropes & Gray LLP, Chicago, Illinois, Attorneys for Plaintiff/Counterclaim Defendant Capella Holdings, LLC and Third-Party Defendant Capella Healthcare, LLC.

          Adam Hiller, Esquire of Hiller Law, LLC, Wilmington, Delaware and C. Mark Pickrell, Esquire of The Pickrell Law Group, P.C., Nashville, Tennessee, Attorneys for Defendant and Counterclaim/Third-Party Plaintiff James Thomas Anderson.

          Kevin R. Shannon, Esquire and Frank R. Martin, Esquire of Potter Anderson & Corroon LLP, Wilmington, Delaware and Jonathan Rosenberg, Esquire and Nate Asher, Esquire of O'Melveny & Myers LLP, New York, New York, Attorneys for Non-Party Apollo Global Management, LLC.

          MEMORANDUM OPINION

          SLIGHTS, Vice Chancellor.

         Defendant and Counterclaim/Third-Party Plaintiff, James Thomas Anderson, is a former director and officer of Plaintiff, Capella Holdings, LLC, and co-founder of Third-Party Defendant, Capella Healthcare, LLC (together with Capella Holdings, "Capella" or the "Company").[1] In early 2014, Capella was laboring under the weight of substantial debt, and its board of directors (the "Board") feared a possible downgrade of the Company's debt rating by Standard & Poor's. To avoid that consequence, the Board considered two possible solutions: (i) a recapitalization or (ii) a sale of the Company. In April 2014, the Board approved a recapitalization plan whereby preferred shareholders would convert their shares and accumulated interest into common shares. That decision has sparked years-long litigation between Anderson and Capella in two states.

         Anderson viewed the recapitalization as a breach of his Senior Management Agreement ("SMA") with Capella.[2] Specifically, he asserted that because the recapitalization would require the Company to issue over 1.1 billion new shares of common stock, the transaction would violate what he viewed as an anti-dilution provision within the SMA. Accordingly, within six days of the Board's approval of the recapitalization, Anderson filed suit against Capella and several individual defendants in the Court of Chancery of Davidson County, Tennessee for breach of the SMA and breach of fiduciary duty.

         Upon reviewing Anderson's Tennessee pleadings, Capella immediately complained that Anderson had disclosed the Company's privileged legal advice and other non-public information and thereby breached both his contractual and fiduciary duties to the Company. This prompted Capella to initiate the present action against Anderson in this Court by verified complaint dated June 20, 2014.

         The SMA contains a Delaware choice of law provision. Accordingly, the parties agreed that the Tennessee action should be dismissed and Anderson's claims should be brought in this Court as cross-claims against Capella Holdings and third-party claims against Capella Healthcare. With all claims, cross-claims and third-party claims joined in this action, the parties set about case-dispositive motion practice. In July 2015, this Court granted Capella's motion to dismiss Anderson's fiduciary duty claims against Capella and its directors for failure to state a claim under Court of Chancery Rule 12(b)(6).[3] In this opinion, the Court takes up Capella's motion for summary judgment in which it seeks judgment in its favor on Anderson's remaining contract claims against Capella and on Capella's claims for breach of contract and breach of fiduciary duty against Anderson.[4]

         Capella's motion, while addressing both Anderson's claims of breach and its own claims of breach against Anderson, turns on a single, two-part issue-whether Section 1(k) of the SMA contains an anti-dilution provision and, if so, whether Capella violated that provision by completing the recapitalization in April 2014. If yes, then summary judgment is not available to Capella since material issues of fact remain in dispute regarding whether the recapitalization caused improper dilution of Anderson's holdings and whether that prior breach excused any breach of confidentiality by Anderson. If no, then the facts are undisputed that Anderson breached his contractual and fiduciary duties to maintain the Company's confidences and Anderson may not excuse that breach by pointing to a prior breach of the SMA by the Company.

         For the reasons discussed below, I have determined that Section 1(k) does not contain an anti-dilution provision. Since the existence of an anti-dilution provision within the SMA is the foundation upon which Anderson's claims and defenses rest, and that foundation is illusory, the bases for Anderson's resistance to Capella's motion for summary judgment crumble. Accordingly, Capella's motion for summary judgment on Anderson's remaining breach of contract claims against Capella must be GRANTED. Capella's motion for summary judgment on its breach of contract claims against Anderson must also be GRANTED. Its breach of fiduciary duty claim against Anderson, however, is duplicative of its breach of contract claims, and therefore Capella's motion is DENIED as to that claim. Because Capella cannot prevail on its fiduciary duty claim as a matter of law, that claim is DISMISSED.

         I. FACTUAL BACKGROUND

         I have drawn the facts from the admissions in the pleadings, uncontested facts presented in the parties' submissions and those matters of which the Court may take judicial notice. The Court's decision in Capella I provides a detailed background of the parties and their relationships with one another so I will not repeat that detail here.[5] Instead, I will focus this statement of facts on the claims and defenses that arise under the SMA.

         A. Section 1(k) of the SMA

         On May 4, 2005, Anderson executed the SMA, which is by and among Anderson, Capella Holdings and Capella Healthcare. The SMA governs various aspects of the parties' relationship. Of particular relevance here, Section 1, entitled "Purchase and Sale of Executive Securities, "[6] at subsection (k), provides the following:

The Company [Capella] shall reserve 2, 211, 688 additional shares of Common Stock (the "Additional Common Stock") for issuance (whether through restricted stock, upon exercise of options or otherwise) to other executives and employees of the Company and its Subsidiaries after the date hereof (including executives and employees of acquired companies); provided that in the event that any portion of such Additional Common Stock are not issued prior to the earliest to occur of (x) the redemption of all issued and outstanding Preferred Stock, (y) a Sale of the Company or (z) an initial Public Offering, the Board in its sole discretion may issue any or all of the remaining shares of Additional Common Stock to the executives of the Company or its Subsidiaries (including [Anderson]) in the amounts determined by the Board. Any shares of Additional Common Stock not allocated by the Board to executives and employees of the Company and its Subsidiaries pursuant to the immediately preceding sentence shall remain unissued.[7]

         As this Section makes clear, Capella committed to reserve a pool of 2, 211, 688 shares, defined as the "Additional Common Stock, " for the purposes of employee and executive compensation, subject to certain specified restrictions.[8] Any shares from this pool not issued to "executives and employees" would "remain unissued."[9]

         B. The Alleged Breaches

         Leading up to 2014, Capella had accumulated over $500 million in debt, [10] and a private equity investor, GTCR Golder Rauner II L.L.C. ("GTCR"), held preferred shares valued at approximately $206 million with an accumulated in-kind interest of approximately $143 million.[11] One way to retire some of this debt to avoid a ratings downgrade was to pursue a recapitalization whereby GTCR's preferred shares would be converted into common shares.[12] The recapitalization would result in the Company issuing over 1.1 billion common shares.[13] All Company executives were permitted to join in the recapitalization, but Anderson declined to participate.[14] The Board voted to approve the recapitalization plan in April 2014, with only Anderson dissenting.[15]

         Anderson responded to the Board's approval of the recapitalization plan by filing suit against Capella and several of its directors in the Chancery Court of Davidson County, Tennessee on April 23, 2014.[16] The basis of Anderson's suit was that the Board violated Section 1(k) of the SMA when it approved the recapitalization because his ownership interest was diluted as a result of the transaction.[17] Anderson included highly sensitive information in his Tennessee complaint, including legal advice provided to the Board and details of a non-public bidding process regarding a potential sale of the Company conducted by Bank of America.[18] Anderson did not seal his filings or seek to obtain a confidentiality order from the court, even though the court rules provided a process whereby he could have sought to protect the confidential information from public exposure.[19] Indeed, Anderson admits that he made no effort to avail himself (or the Company) of these processes.[20] Capella treated Anderson's public disclosure of confidential information as a material breach of Section 7(a) of the SMA, and it terminated him for "Cause" under Section 9.[21] Thereafter, Capella took the position that Anderson was not entitled to severance pay under Section 6(e) of the SMA.[22]

         C. Procedural History

         Capella followed its termination of Anderson by filing suit against him in this Court on June 20, 2014, in which it asserts claims for (i) breach of fiduciary duty; (ii) breach of contract for failing to comply with a repurchase notice; (iii) breach of contract for disclosing confidential information; and (iv) breach of contract for failing to return confidential materials. Soon after, Anderson voluntarily dismissed his Tennessee complaint and filed his Answer, Counterclaims and Third-Party Complaint against Capella and its directors in this Court in which he restates the claims he brought in his Tennessee complaint: (i) breach of fiduciary duty and (ii) breach of contract for diluting his ownership interest. In addition to these restated claims, Anderson asserts a new breach of contract claim against Capella for failure to make severance payments.

         Capella and the Director Defendants moved to dismiss Anderson's Counterclaims and Third-Party Complaint under Court of Chancery Rule 12(b)(6). The Court granted that motion as to Anderson's fiduciary duty claims (Counts I- III), but denied it as to his breach of contract claims (Counts IV-V).[23] In doing so, the Court observed that Capella's reading of Section 1(k) (the purported anti-dilution clause) "appears more promising, but Anderson's allegations . . . [are] at least reasonable at this stage."[24]

         On May 12, 2017, Anderson filed a motion for partial summary judgment with regard to his remaining breach of contract claims, and Capella followed by filing a cross-motion for summary judgment. Both sides argued that Section 1(k) unambiguously supports their respective positions with respect to breach of contract. Anderson, in fact, was so confident that his interpretation of Section 1(k) would win the day that he chose to rest his entire defense to Capella's contract claims against him on the prior breach doctrine.[25] Specifically, he argued in his motion for summary judgment that Capella's prior material breach of Section 1(k) of the SMA excused his later breach of Section 7(a) of that same contract.[26] After Anderson received Capella's moving papers, however, he withdrew his motion for partial summary judgment.[27] He now argues that Section 1(k) is ambiguous and that the Court must receive extrinsic evidence to construe its terms.[28] Capella's motion for summary judgment remains, and it covers all pending claims and defenses asserted by all parties. This is the Court's decision on that motion.

         II. ANALYSIS

         I first address whether Section 1(k) provides Anderson with anti-dilution protection and conclude that it does not. With this finding in place, I turn to Anderson's breach of contract claims and his prior breach defense and conclude that both fail as a matter of law.

         A. Summary Judgment Standard

         Summary judgment is appropriate when "there is no genuine issue as to any material fact and . . . the moving party is entitled to a judgment as a matter of law."[29]If the moving party demonstrates that "no genuine issues of material fact [are] in dispute, [then] the burden shifts to the non-moving party to demonstrate that there are genuine issues of material fact in dispute that must be resolved at trial."[30] "It is not enough, however, for the nonmoving party to simply assert the existence of a disputed fact."[31] He must, instead, support that position with competent record evidence.[32]

         "When the issue before the Court involves the interpretation of a contract, summary judgment is appropriate only if the contract in question is unambiguous."[33]In this regard, the court will reject a party's proffered interpretation of contract language if that construction will yield "an absurd result or is one that no reasonable person would have accepted when entering the contract."[34]

         B. Section 1(k) Does Not Provide Anti-Dilution Protection

         Section 1(k) begins by defining "Additional Common Stock": "The Company shall reserve 2, 211, 688 additional shares of Common Stock (the "Additional Common Stock") for issuance . . . to other executives and employees of the Company and its Subsidiaries after the date hereof . . . ."[35] Nothing in this language remotely suggests that the referenced 2.2 million shares (the "Additional Common Stock") are all that the Company may issue under any circumstances. Rather, the language simply provides that the Additional Common Stock will be "reserve[d]" for "other executives and employees"-meaning not Anderson.[36]

         Section 1(k) goes on to set forth the circumstances under which the Board may issue additional available shares from this pool, which were not issued before certain designated events, to executives and employees, including Anderson:

. . . provided that in the event that any portion of such Additional Common Stock are not issued prior to the earliest to occur of (x) the redemption of all issued and outstanding Preferred Stock, (y) a Sale of the Company or (z) an initial Public Offering, the Board in its sole discretion may issue any or all of the remaining shares of Additional Common Stock to the executives of the ...

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