Arrowsmith v. Mallory (In re Health Diagnostic Lab., Inc.)

588 B.R. 154

IN RE: HEALTH DIAGNOSTIC LABORATORY, INC., et al., Debtors.

Richard Arrowsmith, as Liquidating Trustee of the HDL Liquidating Trust, Plaintiff,

v.Latonya S. Mallory, et al., Defendants.

Case No. 15–32919 (Jointly Administered)

AP No. 16–03271

United States Bankruptcy Court, E.D. Virginia, Richmond Division.

Signed June 12, 2018

Douglas Paul Lobel, Cooley LLP, Reston, VA, Cullen Drescher Speckhart, Wolcott Rivers Gates, Richmond, VA, for Plaintiff.

Daniel T. Moss, Kevyn D. Orr, Kerri L. Ruttenberg, Jones Day, Matthew D. Foster, Pepper Hamilton LLP, Washington, DC, Dion W. Hayes, McGuireWoods LLP, Kevin J. Funk, Durrette, Arkema, Gerson & Gill PC, S. Miles Dumville, Justin Michael Sizemore, Reed Smith LLP, Richmond, VA, Michael E. Hastings, Brandy M. Rapp, Whiteford Taylor & Preston LLP, Matthew D. Huebschman, Shenandoah Legal Group, P.C., Roanoke, VA, Jeffery T. Martin, Jr., Henry & O'Donnell, P.C., Alexandria, VA, Charles M. Allen, Goodman Allen Donnelly PLLC, Glen Allen, VA, Jesse N. Silverman, Dilworth Paxson LLP, Philadelphia, PA, Tara Lynn R. Zurawski, for Defendants.

George R. Warnick, pro se.

Coffman Enterprises Inc., pro se.

Lockhardt Consulting Inc., pro se.

Labyrinth LLC, pro se.

Advanced Medical Consulting LLC, pro se.

Paramount Medical Consultants Inc., pro se.

Ocean Diagnostics & Consulting, LLC, pro se.

M. Looney Consulting Inc., pro se.

Southern Coast Consultants, LLC, pro se.

Metta Consulting Inc., pro se.

Bio-Matrix Healthcare Consultants, LLC, pro se.

Lee Roberts, pro se.

Does 1-50, pro se.

MEMORANDUM OPINION

Kevin R. Huennekens, UNITED STATES BANKRUPTCY JUDGEBefore the Court is the Motion to Approve Settlement Agreement , ECF No. 601 (the "Motion") filed on May 10, 2018, by Richard Arrowsmith, in his capacity as the Liquidating Trustee of the HDL Liquidating Trust (the "Liquidating Trustee"), seeking approval of a settlement agreement (the "Settlement Agreement") between the HDL Liquidating Trust and LaTonya S. Mallory ("Mallory")¹ under Federal Rule of Bankruptcy Procedure 9019 (the "Bankruptcy Rules").² Through the Motion, the Liquidating Trustee seeks to resolve claims asserted on behalf of the HDL Liquidating Trust against Mallory in connection with Mallory's conduct as a former board member and chief executive officer ("CEO") of Debtor Health Diagnostic Laboratory, Inc. ("HDL"). On May 21, 2018, the United States filed an Objection to Motion to Approve Settlement Agreement with LaTonya Mallory , ECF No. 608. On May 23, 2018, the United States filed a Supplement to the United States' Objection to Motion to Approve Settlement Agreement with LaTonya Mallory , ECF No. 609 (together with the Objection to Motion to Approve Settlement Agreement with LaTonya Mallory , the "Objection").³ An evidentiary hearing was conducted on May 24, 2018 (the "Hearing"). At the Hearing, the Court overruled the Objection. The Court found the terms of the Settlement Agreement to be fair and equitable and granted the Motion. This Memorandum Opinion sets forth the Court's findings of fact and conclusions of law in support of its decision in accordance with Bankruptcy Rule 7052.⁴

PROCEDURAL HISTORY

HDL provided lab testing of biomarkers for the indication of risk for cardiovascular disease, diabetes, and other illnesses. Mallory was a co-founder of HDL and owned 8.9048% of HDL's stock as of June 7, 2015 (the "Petition Date"). She served as CEO of HDL from its formation in 2008 through September 2014 and as chairman of the HDL board of directors ("Board") from 2008 through the end of 2014. HDL was a privately held health care company headquartered in Richmond, Virginia, that operated an accredited, full-service clinical laboratory. Physicians would send blood samples to HDL, HDL would process the lab tests, and then HDL would bill the patient's private insurance carrier or a federal health care program such as Medicare or Medicaid. Afterwards, HDL would reimburse the referring physicians for the costs associated with collecting, processing, and handling the blood samples that the physicians had sent to HDL for testing.

In 2013, the United States Department of Justice ("DOJ") and United States Department of Health and Human Services' Office of Inspector General ("HHS OIG") began investigating HDL and their outside sales team, BlueWave Healthcare Consultants, Inc. ("BlueWave"), in connection with HDL's business practices, including its payment of process and handling fees ("P & H Fees") to the referring physicians (the "DOJ Investigation").

In April 2015, HDL signed a settlement agreement with DOJ (the "DOJ Settlement"), as well as a separate corporate integrity agreement with HHS OIG. In the DOJ Settlement, HDL agreed to pay $47,000,000 to settle all the government's claims against it in connection with the P & H Fees. During this time, HDL's relationship with its prepetition secured lender, Branch Banking and Trust Company ("BB & T"), was deteriorating. When HDL defaulted under its loan facilities with BB & T, BB & T discontinued HDL's borrowing ability and cut off HDL's access to its existing accounts. With no ability to access its cash and with no alternative sources of financing immediately available, HDL resorted to Chapter 11 bankruptcy.

On the Petition Date, Health Diagnostic Laboratory, Inc., Central Medical Laboratory, LLC, and Integrated Health Leaders, LLC (collectively the "Debtors") commenced bankruptcy cases (collectively the "Bankruptcy Case") by each filing a voluntary petition for relief under Chapter 11 of Title 11 of the United States Code (the "Bankruptcy Code") in the United States Bankruptcy Court for the Eastern District of Virginia (the "Court").⁵

On September 17, 2015, the Court entered a sale order (the "Sale Order"), which authorized the sale of substantially all of the Debtors' assets to True Health Diagnostics, LLC ("True Health") under the terms of an Asset Purchase Agreement.⁶ On September 29, 2015, True Health acquired substantially all of the Debtors' operating assets. On May 12, 2016, the Court entered an order (the "Confirmation Order"),⁷ which confirmed the Debtors' Modified Second Amended Plan of Liquidation (the "Plan").⁸ The HDL Liquidating Trust ("Liquidating Trust") was formed pursuant the terms of the Plan on the Effective Date.⁹

On September 16, 2016, the Liquidating Trustee commenced this adversary proceeding ("Adversary Proceeding" or "D & O Action") by filing a complaint (the "D & O Complaint") against over 100 different defendants including HDL's former officers and directors, BlueWave, and BlueWave salespersons (referred to collectively with BlueWave as "BlueWave Defendants"). After this Court denied in part, and granted in part, several motions to dismiss the D & O Complaint, the Liquidating Trustee filed an amended complaint ("Amended D & O Complaint") against dozens of defendants including Mallory.¹⁰ In the Amended D & O Complaint, the Liquidating Trustee seeks, among other things, to recover transfers made by HDL under theories of avoidance, recharacterization, breach of statutory fiduciary duty, unlawful distributions, corporate waste, conspiracy, negligence, gross negligence, assumpsit, unjust enrichment, fraud, tortious interference with contracts, and claim objections.¹¹

This Court implemented a streamlined judicial mediation process to facilitate the efficient resolution of the D & O Action. On June 12, 2017, U.S. District Court Judge Henry E. Hudson referred the D & O Action to United States Magistrate Judge David J. Novak for mediation and empowered him with full authority to settle the Adversary Proceeding, subject "only to Rule 9019 of the Federal Rules of Bankruptcy Procedure."¹² To date, the judicial mediation process has been extremely successful due to the apparent willingness of the litigants to engage in meaningful, good faith negotiations before Judge Novak.

On February 2, 2018, the Court entered a separate order (the "Order Directing Judicial Settlement Conference") requiring the Liquidating Trustee, Mallory, and LeClairRyan P.C. ("LeClairRyan") to participate in a renewed settlement conference before Judge Novak in order to revive stalled mediation proceedings involving those parties in the D & O Action.¹³ The Order Directing Judicial Settlement Conference aimed at resolving various claims asserted by and against Mallory in multiple courts on a global scale.¹⁴ Mallory and the Liquidating Trustee had participated in several mediation sessions with Judge Novak during the course of the previous year. The United States participated in some of those mediations sessions, but declined to take part in the settlement conference conducted by Judge Novak that successfully resulted in the Settlement Agreement now before the Court.

Among other terms, the Settlement Agreement provides that the Liquidating Trustee will release the claims of the Liquidating Trust against Mallory in exchange for Mallory's cooperation in other litigation. Mallory will become jointly and severally liable to the Liquidating Trustee along with Scott Mallory in the amount of $10,000,000 (the "Settlement Amount"), plus certain additional consideration recited in the Settlement Agreement including a provision allowing for the satisfaction of Mallory's personal liability.¹⁵

During the Bankruptcy Case, the United States became involved in a False Claims Act ("FCA") case in the United States District Court for the District of South Carolina (the South Carolina District Court"). On August 7, 2015, the United States filed a Complaint in Intervention in a consolidated whistleblower suit against several defendants including HDL, BlueWave, Floyd Calhoun Dent, III, Robert Bradford Johnson, and Mallory (the "Qui Tam Action").¹⁶ The injunction provision included in the confirmed Plan provided a carve-out ("Carve–Out") for the United States to continue its pursuit of its FCA claims in the Qui Tam Action outside of this Bankruptcy Case.¹⁷ The jury in the Qui Tam Action found, inter alia, HDL guilty of...