United States District Court, D. Delaware
In re PHYSIOTHERAPY HOLDINGS, INC., et al, Debtors.
WATER STREET HEALTHCARE PARTNERS L.P., et al., Defendants. PAH LITIGATION TRUST, Plaintiff, Misc. No. 16-201-LPS
LEO ARD P. STARK, UNITED STATES DISTRICT JUDGE.
reviewed the papers submitted in connection with
Defendants' motion for leave to appeal (D.I. 1, 18) (the
"Motion for Leave") the Bankruptcy Court's
Memorandum Opinion and Order (the "Interlocutory
Order"), which granted in part and denied in part
Defendants' motion to dismiss (Adv. D.I.
the above-captioned adversary proceeding, and Plaintiffs
opposition thereto (D.I. 13); and having reviewed the papers
submitted in connection with Defendants' petition for
certification of direct appeal to the United States Court of
Appeals for the Third Circuit (D.I. 4, 18) (the
"Petition") and the opposition thereto (D.I. 14);
and having reviewed the notices of subsequent authority (D.I.
ORDERED that the Motion for Leave and Petition (D.I. 1, 4)
are DENIED for the reasons that follow:
seek leave to appeal the Interlocutory Order which granted in
part and denied in part their motion to dismiss an adversary
proceeding initiated by the PAH Litigation Trust (the
"Trust" or "Trustee"), as the authorized
representative of the Debtor's estate. The Trustee's
complaint asserted eight fraudulent transfer claims against
numerous defendants including Water Street Healthcare
Partners, L.P. ("Water Street") and Wind Point
Partners IV, L.P. ("Wind Point") (collectively, the
"Defendants" or the "Controlling
Shareholders") and certain subsequent transferees. The
complaint seeks to recover $248.6 million in payments made to
the Controlling Shareholders and other selling shareholders
(the "Selling Shareholders") in exchange for their
equity in Physiotherapy Holdings, Inc.
("Physiotherapy" or the "Debtor").
Trustee alleges that in order to finance the sale of
Physiotherapy, the buyer's ("Court Square" or
the "Purchaser") merger subsidiary issued $210
million in senior secured notes (the "Secured
Notes"). Pursuant to the terms of the transaction, the
Debtor assumed the Secured Notes and certain other
liabilities. Physiotherapy issued the Secured Notes pursuant
to an offering memorandum (the "OM"), which the
Trustee alleges fraudulently overstated the Debtor's
revenue stream and its overall firm value. According to the
complaint, the Purchaser ultimately acquired an insolvent
company, and the Secured Noteholders received debt
instruments worth far less than their face value. The Trustee
alleges that this sequence of events led to the Debtor's
chapter 11 petition and seeks to claw back certain payments
made to the Selling Shareholders under both state and federal
fraudulent transfer law.
Interlocutory Order sets forth the relevant background,
including allegations contained in the complaint:
The Debtor is a leading provider of outpatient physical
therapy services throughout the United States. Compl. ¶
3.Defendants Water Street and Wind Point are
private equity funds whose portfolio companies consist of
businesses in the healthcare sector. Compl. ¶2. As of
2012, the Debtor operated approximately 650 clinics in 33
different states and derived the majority of its revenue from
outpatient rehabilitation services. Def.'s Br.
In 2007, Defendant Water Street acquired Physiotherapy for
roughly $150 million. Id. Shortly after the
transaction closed, Water Street entered into an agreement
(the "2007 Merger") to merge the Debtor with
Benchmark Medical, Inc. ("Benchmark"), an
"outpatient physical therapy chain that Wind Point had
previously acquired." Id. Following the 2007
Merger, Water Street owned 45% of the common stock of the
surviving entity while Wind Point held a 35% ownership stake.
Id. Throughout the next five years, the Controlling
Shareholders gradually increased their ownership to
approximately 90% of the Debtor's common shares. Compl.
¶ 14, 16. The Trustee alleges that during this time,
Water Street and Wind Point engaged in various forms of
accounting fraud in order to overstate Physiotherapy's
financial health and reap a substantial profit from the sale
of their shares. Id.
The alleged fraud began as a result of the 2007 Merger as the
Debtor was faced with numerous operational challenges arising
from the Controlling Shareholders' efforts to integrate
the accounting systems of Benchmark and Physiotherapy. Compl.
¶ 3. According to the Trustee, "[t]here were delays
in implementing a new single accounting system to replace the
various legacy systems; there were problems keeping up with
cash collections; and there were almost no internal financial
reporting controls." Id. The Complaint further
alleges that the Debtor began to overstate its EBITDA, net
revenue, and accounts receivable in 2010 in order to conceal
these problems. Compl. ¶ 4.
By 2009, Physiotherapy's financial condition had
deteriorated significantly. Compl. 136. In response, the
Controlling Shareholders allegedly began to implement new
strategies in order to sell [Physiotherapy] ¶ 2011 or
2012 and maximize the potential sales consideration. Compl.
¶ 37. One particular strategy was to abandon the
"look back method" of revenue recognition and adopt
the more controversial "rate bridge method." Compl.
139.. Physiotherapy's board was, according to the
Trustee, aware of and sanctioned the use of the rate bridge
method. Compl. ¶ 43. According to the Complaint, the
rate bridge method estimates revenue by calculating "a
'net rate per visit' based on the prior month's
net rate per visit - which was, at the time, based on an
estimate - and adjusted upward or downward based on supposed
increases and/or decreases to the published rates and
assumptions about the amount Physiotherapy could charge per
visit or per 'unit.'" Compl. ¶ 40. Unlike
the look back method, the rate bridge method is not based on
actual historical collections and may be subject to
manipulation. Compl. ¶ 41-42. [Allegedly, ] within six
months of switching to the rate bridge method, the
Debtor's management became aware that
[Physiotherapy's] net revenue had been overstated. Compl.
¶ 44. Nonetheless, it continued to apply this revenue
The marketing process formally began in October 2011 when the
Controlling Shareholders solicited bids from more than 100
potential buyers. Compl. ¶ 45. ... As participants
dropped out of the auction process, Water Street and Wind
Point allegedly pressured the Debtor's senior management
into "manipulating] Physiotherapy's net revenue and
patient visit counts so that Physiotherapy could be marketed
as a company that was able to grow its net revenue per visit
year over year." Compl. ¶ 47. The Complaint
specifically details six forms of alleged accounting fraud
that enabled the Defendants to inflate Physiotherapy's
earnings. Compl. ¶¶ 48-54.
The Trustee also quotes numerous emails from the Debtor's
billing and collections vendor indicating that the Debtor was
instructing them to falsify its financial statements. Compl.
¶ 55. During this time, the Debtor began to develop
substantial cash shortfalls as a result of these procedures.
Compl. ¶¶ 61-70. The Complaint alleges that this
growing discrepancy between revenue and cash collections was
a result of Physiotherapy's switch to the rate bridge
method. Compl. ¶ 72.
According to the Trustee, the Board of Directors was aware
that the Debtor's use of the rate bridge method had led
to inflated revenue. Compl. ¶¶ 59-61. Additionally,
the Board was presented with tangible evidence that
Physiotherapy was experiencing significant cash collection
shortfalls. Compl. ¶¶ 61-63. ... The Trustee
further alleges that various third parties presented the
Board with tangible evidence that Physiotherapy had been
overstating its revenue. Compl. ¶ 74.
Throughout this time, the Debtor had been engaged in an
extensive marketing process. Court Square, a private equity
firm, emerged as the winning bidder with a cash offer of $510
million. Def.'s Br. 20. The deal was structured as a
reverse-triangular merger, and Court Square created a
subsidiary to merge into Physiotherapy with Physiotherapy as
the surviving entity. The subsidiary financed the transaction
by issuing: "(i) a $ 100 million term loan (the
"Term Loan"), which was part of a larger credit
facility; (ii) $210 million in Secured Notes underwritten by
Jefferies and RBC (the "Secured Notes"); (iii) a
management equity rollover; and (iv) a minority investment by
a third-party." Def.'s Br. 23. According to the
Trustee, these Secured Notes were marketed with an OM that
falsely represented Physiotherapy's pretax net income and
unadjusted EBITDA. Compl. ¶ 82. The least 936% and
unadjusted EBITDA by 109% for fiscal year 2011. Compl.
¶¶ 83-84. Under the terms of the deal, the new
Physiotherapy assumed this debt, and Water Street and Wind
Point received $248.6 million in exchange for their shares.
Compl. ¶ 88. Allegedly, the Controlling Shareholders
profited handsomely from the fraud while [Physiotherapy] was
left insolvent. Compl. ¶ 89. "The sum of all of the
foregoing was that Physiotherapy incurred a massive amount of
new debt-predicated on false fmancials-the proceeds of which
were transferred out to Physiotherapy's former owners
without receiving anything of value in return."
Shortly after the transaction closed, [Physiotherapy's]
new owner retained Deloitte to investigate a gap in accounts
receivable and cash collections from the previous years.
Deloitte determined that the Debtor's net income had been
overstated for the years 2010 and 2012.
Physiotherapy, 2016 WL 3611831, at *2-*4.
December 2012, eight months after the transaction closed,
Court Square and the Defendants entered into an agreement
containing a general release of claims ("Release").
The agreement containing the Release resolved certain
"post-closing disputes" relating to the
transaction. (See D.I. 1 at 16) On April 2, 2013,
Physiotherapy defaulted on the Senior Notes, and, on November
12, 2013 (the "Petition Date"), it filed for relief
under chapter 11 of the Bankruptcy Code. Pursuant to the
confirmed Plan, the Trust was created and authorized to
pursue causes of action belonging to the estate.
(See B.D.I. 197-1 at 27-28) Additionally, the
Secured Noteholders assigned their individual claims to the
Trustee; as a result, the Trust had standing to assert claims
in the capacity of both an estate representative and an
assignee. See Physiotherapy, 2016 WL
3611831, at *4.
September 1, 2015, the Trustee filed the eight-count
complaint which asserted various claims for actual and
constructive fraudulent transfer under the Bankruptcy Code
and Pennsylvania law. Count I of the complaint seeks
avoidance and recovery of actual fraudulent transfers to
Defendants, as initial transferees, pursuant to section
548(a)(1)(A) of the Bankruptcy Code. Count II similarly
seeks avoidance and recovery of constructive fraudulent
transfers to initial transferees pursuant to section
548(a)(1)(B) of the Bankruptcy Code. Count III seeks
avoidance and recovery of transfers to subsequent transferees
under the foregoing sections of the Bankruptcy Code. Count IV
seeks avoidance and recovery of actual fraudulent transfers
from initial transferees under Pennsylvania's version of
the Uniform Fraudulent Transfer Act, 12 Pa.C.S.A. §
5104(a)(1), and pursuant to section 544(b) of the Bankruptcy
Code. Count V similarly seeks avoidance and recovery of
constructive fraudulent transfers to initial transferees
pursuant to section 544(b) of the Bankruptcy Code and 12
Pa.C.S.A. §§ 5104(a)(2) and 5105. Count VI seeks
avoidance and recovery of transfers to subsequent transferees
under Pennsylvania law. Because the Secured Noteholders
assigned their individual claims to the Trustee, Count VII is
asserted by the Trustee as a direct assignee of unsecured
creditors (and not as an estate representative) and asserts
direct claims under Pennsylvania law, 12 Pa.C.S.A. §
5104(a)(2), for avoidance and recovery of constructive
fraudulent transfers to initial transferees. Finally, Count
VIII seeks avoidance and recovery of transfers made to
subsequent transferees under 12 Pa.C.S.A. §§
5104(a)(2) and 5105.
response to the complaint, Defendants moved to dismiss on
several grounds, including: (1) all of the transfers are
immune from avoidance pursuant to the Bankruptcy Code's
safe harbor provision, 11 U.S.C. § 546(e),
which prohibits a trustee or estate representative from
avoiding transactions involving the purchase and sale of
securities, and, according to Defendants, prohibits creditors
from pursuing recovery under state fraudulent transfer laws
as well; (2) the claims against Defendants are barred by the
Release; and (3) the Secured Noteholders ratified the
transaction and are thus barred from seeking its avoidance.
(See Adv. D.I. 107)
20, 2016, the Bankruptcy Court entered the Interlocutory
Order, granting the Motion to Dismiss in part and denying it
in part. See Physiotherapy, 2016 WL 3611831, at *15.
The Bankruptcy Court granted the motion to dismiss with
respect to Counts II, IV, and V of the complaint, determining
that section 546(e)'s safe harbor prohibited the
Trustee's assertion of constructive transfer claims under
section 548(a)(1)(B) and actual and constructive fraudulent
transfer claims brought under section 544(b). See
Id. In denying the motion to dismiss with respect to the
fraudulent transfer claims brought directly under state law
by the Trustee in the capacity of a creditor-assignee (Count
VII), the Bankruptcy Court undertook a preemption analysis
and rejected Defendants' argument that section 546(e)
prohibits avoidance actions by creditors brought directly
under state fraudulent transfer law. See Id. at *
10-* 15. The Bankruptcy Court determined that neither the
text nor the purpose of section 546(e) was implicated by the
constructive fraudulent transfers at issue and declined to
find that the safe harbor preempted state fraudulent transfer
laws in this case. Specifically, the Bankruptcy Court held
that "a litigation trustee may assert state law
fraudulent transfer claims in the capacity of a
creditor-assignee when: (1) the transaction sought to be
avoided poses no threat of 'ripple effects' in the
relevant securities markets; (2) the transferees received
payment for non-public securities, and (3) the transferees
were corporate insiders that allegedly acted in bad faith.
When these three factors are present, a finding of implied
preemption is inappropriate." Id. at *10. The
Bankruptcy Court also determined that a finding of estoppel
by ratification was inappropriate at this juncture and
declined to dismiss the complaint on this basis. See
Id. at *12. The Bankruptcy Court further rejected
Defendants' contention that the Trust's actual
fraudulent transfer claim under section
548(A)(1)(a) was barred by the Release executed by
Physiotherapy before it filed its Chapter 11 petition and
denied the motion to dismiss with respect to Count I. See
Id. at *14. Finally, the Bankruptcy Court rejected
several other arguments that Defendants do not argue warrant
interlocutory review. See Id. at * 14-15.
18, 2016, Defendants filed their Motion for Leave to appeal
the Interlocutory Order with respect to three issues. (D.I.
1) On August 1, 2016, Defendants also filed the Petition
(D.I. 4) in this Court, despite the fact that Federal Rule of
Bankruptcy Procedure 8006(b) required Defendants to file the
Petition in the court where the matter was then pending, and
this matter was pending in the Bankruptcy Court until August
15, 2016. (See D.I. 14 at 18) At the time of
briefing on these requests, discovery was underway with
respect to the Trust's two remaining claims, with
document production scheduled to be completed by January 2017
and depositions scheduled to be completed in June 2017.
(See D.I. 13 at 3; Adv. D.I. 284) A review of the
adversary docket demonstrates that discovery is scheduled to
conclude by May 22, 2018, with any case dispositive motions
to be served no later than June 20, 2018. (See Adv.
D.I. 676 (Second Amended Scheduling Order))
Court has jurisdiction to hear appeals "with leave of
the court, from interlocutory orders and decrees, of
bankruptcy judges entered in cases and proceedings referred
to the bankruptcy judges under section 157 of this
title." 28 U.S.C. § 158(a)(3). Section 158(a) does
not identify the standard district courts should use in
deciding whether to grant such an interlocutory appeal.
See Id. "Typically, however, district courts
follow the standards set forth under 28 U.S.C. §
1292(b), which govern interlocutory appeals from a district
court to a court of appeals." In re AE Liquidation,
Inc., 451 B.R. 343, 346 (D. Del.2011).
the standards of section 1292(b), an interlocutory appeal is
permitted only when the order at issue (1) involves a
controlling question of law upon which there is (2)
substantial ground for difference of opinion as to its
correctness, and (3) if appealed immediately, may materially
advance the ultimate termination of the litigation.
See 28 U.S.C. § 1292(b); Katz v. Carte
Blanche Corp., 496 F.2d 747, 754 (3d Cir. 1974).
Entertaining review of an interlocutory order under §
1292(b) is appropriate only when the party seeking leave to
appeal "establishes exceptional circumstances [to]
justify a departure from the basic policy of postponing
review until after the entry of final judgment." In
re Del. and Hudson Ry. Co., 96 B.R. 469, 472-73 (D. Del.
1989), aff'd, 884 F.2d 1383 (3d Cir. 1989). In
part, this stems from the fact that "[p]iecemeal
litigation is generally disfavored by the Third
Circuit." In re SemCrude, L.P., 2010 WL
4537921, at *2 (D. Del. Oct. 26, 2010) (citing In re
White Beauty View, Inc., 841 F.2d 524, 526 (3d Cir.
1988)). Further, leave for interlocutory appeal may be denied
for "entirely unrelated reasons such as the state of the
appellate docket or the desire to have a full record before
considering the disputed legal issue." Katz,
496 F.2d at 754.
to section 158(d)(2), certification for direct appeal to the
circuit court is required if the Court, "acting on its
own motion or the request of a party, " determines that:
(i) the judgment, order, or decree involves a question of law
as to which there is no controlling decision of the court of
appeals for the circuit or of the Supreme Court of the United
States, or involves a matter of public importance;
(ii) the judgment, order, or decree involves a question of
law requiring resolution of ...