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Innovation Institute, LLC v. St. Joseph Health Source, Inc.

Court of Chancery of Delaware

August 28, 2019

The Innovation Institute, LLC
St. Joseph Health Source, Inc.

          Date Submitted: June 27, 2019

          William D. Johnston, Esquire Tammy L. Mercer, Esquire Paul L. Loughman, Esquire Young Conaway Stargatt & Taylor, LLP

          Raymond J. DiCamillo, Esquire Kevin M. Gallagher, Esquire Richards, Layton & Finger, P.A.

         Dear Counsel:

         This case arises from a contractual dispute between a Delaware limited liability company, Innovation Institute, LLC ("Innovation"), and its founding member, St. Joseph Health Source, Inc. ("Health System"), concerning Health System's obligation to contribute funding to Innovation in accordance with Health System's constitutive document. Innovation has brought an action in this court seeking specific performance of Health Source's promise. Health System and its appointed substitute under the LLC Agreement, St. Joseph Health Source, Inc. ("Health Source"), have moved to dismiss the operative complaint, arguing the Court: (i) lacks personal jurisdiction over Defendants, (ii) lacks subject matter jurisdiction over Plaintiff's claim, which they say is a claim for damages not specific performance, and (iii) cannot provide a proper venue for the litigation because the parties have contracted for mandatory arbitration.

         For the reasons explained below, I agree with Defendants that the parties agreed to mandatory arbitration in their constitutive document and to have questions of substantive arbitrability determined by a California arbitrator.[1] Accordingly, this action must be stayed pending the decision of the arbitrator on whether Plaintiff's claims are subject to mandatory arbitration.

         I. BACKGROUND

         The facts are drawn from the allegations in Plaintiff's First Amended Verified Complaint (the "Amended Complaint").[2] I accept as true the Amended Complaint's well-pled factual allegations and draw all reasonable inferences in Plaintiff's favor.[3]

         A. The Parties

         Plaintiff, Innovation, is a Delaware limited liability company headquartered in La Palma, California that develops and commercializes products, services and ideas in the healthcare industry.[4] Using funds from its members, Innovation operates a healthcare incubator called The Innovation Lab through which members develop healthcare technologies and solutions.[5] The members' financial contributions also permit Innovation to acquire portfolio companies that support its members with information technology, construction, staffing, medical coding and equipment.[6]

         Defendant, Health System, is a California corporation with its principal place of business in Irvine, California. It founded Innovation in July 2011.[7] As explained below, in July 2015, Health System transferred its interest in Innovation to Defendant, Health Source.[8] Health Source is a California corporation and a wholly owned subsidiary of Health System.[9]

         B. Health System Commits to Funding Innovation

         On January 2, 2013, Health System and Innovation executed the Limited Liability Company Agreement of the Innovation Institute, LLC (the "Initial Agreement").[10] Under Section 5.4 of the Initial Agreement, Health System "commit[ted] to fund a maximum of $40, 000, 000 in cash capital to [Innovation] by establishing an account, controlled exclusively by the Founding Member, designated as an account for the benefit of [Innovation]."[11] Under Section 5.2, Health System made an initial capital contribution of $20 million and thereby became Innovation's sole founding member.[12] That left $20 million to be set aside in the designated account per Section 5.4.[13]

         Section 5.4 further states that Health System, as the "Founding Member," committed to transfer some or all of the funds in the designated account to Innovation within two business days of a request made by the manager of Innovation, Pacific Healthcare Management ("PHM").[14] Upon transfer of some or all of the committed funds, Health System is to receive commensurate additional units in Innovation.[15]

         In Section 13.13 of the Initial Agreement, Innovation and Health System also adopted a broad arbitration provision, which provides:

Except to the extent that a party is entitled to equitable relief, each of the parties hereto irrevocably waives any right to trial by jury and irrevocably agrees that any disputes arising out of or relating to this Agreement or any other agreement or instrument executed in connection herewith or in connection with the transactions contemplated hereby shall be submitted to binding arbitration in accordance with the then effective commercial dispute resolution procedures of the American Arbitration Association. Any such arbitration proceeding shall be conducted in Orange County, California using a single arbitrator and the parties hereby irrevocably consent to such location and waive any right to assert any claim that such location is an inconvenient forum for resolving any such disputes. The aforementioned choice of forum is intended by the parties to be mandatory and not permissive in nature, thereby precluding the possibility of litigation or arbitration between the parties with respect to or arising out of this Agreement in any jurisdiction other than that specified in this paragraph.[16]

         C. Health System Forms Health Source to Transfer Its Membership Interests in Innovation

         In the years following the Initial Agreement, additional members joined Innovation, diluting Health System's ownership stake and risking Health System's tax-exempt status.[17] Accordingly, on July 1, 2015, Health System transferred all its interest in Innovation to a wholly owned subsidiary called Health Source.[18]

         On December 31, 2015, Innovation, its members and PHM executed an Amended and Restated Operating Agreement (the "Operating Agreement") to reflect the substitution of Health Source for Health System as the Founding Member.[19] The definition of Founding Member was changed to mean "[Health System], [. . .], or an entity wholly owned by [Health System], directly or indirectly, and admitted as a Substitute Member of [Health System]."[20] The provision concerning Health System's commitment to set aside funds was also changed to require "[Health System to] transfer funds from the Designated Account to the Company either directly or through an entity wholly owned by [Health System] and admitted as a Substitute Member of [Health System], within two days as directed by PHM."[21]

         D. Innovation Seeks to Enforce Health Source's Obligation to Transfer $20 Million from the Designated Account

         On February 6, 2019, PHM notified the Chief Financial Officer of Health System that Innovation required the remaining $20 million in committed funds within two business days as provided in Section 5.2 of the Operating Agreement.[22] In response, Health System sought information regarding the fair market value of Innovation, the number of additional units it would receive in exchange for the funds and Innovation's plans for the additional cash capital.[23] PHM responded the same day with a letter to the general counsel for Health Source, stating that Health System's commitment to deliver the remaining $20 million was not subject to its receipt of information regarding Innovation's operations or its plans for the funds.[24]

         On February 12, 2019, Health System's CFO sent a letter to Innovation demanding access to Innovation's books and records.[25] PHM responded a few days later reiterating its position that Innovation was entitled to the designated funds without conditions.[26]

         E. Procedural Posture

         Innovation filed its first complaint along with a motion to expedite on February 25, 2019, seeking specific performance of Health Source's contractual obligation to deliver $20 million to Innovation within two days, as per Section 5.2 of the Operating Agreement. On March 6, 2019, I granted Plaintiff's motion to expedite upon finding Plaintiff had demonstrated a colorable claim and a threat of irreparable harm if the $20 million additional capital contribution was not received in time for Innovation to use the funds as collateral for financing a pending transaction. I granted that motion over Health Source's objections (that were based on lack of subject matter and personal jurisdiction and improper venue), but noted I would not require Health Source to defend on the merits until the threshold jurisdictional issues were adjudicated.

         Health Source raised its threshold defenses in a motion to dismiss filed the following day, on March 7, 2019.[27] Three days after oral argument on the motion to dismiss, Innovation notified the Court that the pending transaction had been terminated and requested that the Court hold its opinion on the motion to dismiss in abeyance.[28] On March 25, 2019, Innovation filed its Amended Complaint, naming Health System as a defendant. Defendants filed their renewed motion to dismiss on April 18, 2018.[29] I heard oral argument on the renewed motion on June 27, 2019.

         II. ANALYSIS

         Defendants maintain Innovation has packaged its claim as a claim for specific performance (an equitable remedy) to avoid the dispute resolution provision of the Operating Agreement, which arguably provides an exception to mandatory arbitration "to the extent that a party is entitled to equitable relief."[30] According to Defendants, Innovation's claim is more accurately characterized as a claim at law for damages and, therefore, should be dismissed for lack of subject matter jurisdiction under Rule 12(b)(1). Alternatively, ...

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