In re Health Diagnostic Lab., Inc.

584 B.R. 525

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

Case No. 15–32919 (Jointly Administered)

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

Signed April 3, 2018

Tyler P. Brown, Shannon Eileen Daily, Jason William Harbour, Henry Pollard Long, III, Justin F. Paget, Hunton Andrews Kurth LLP, Richmond, VA, Emily M. Scott, Robert S. Westermann, Hirschler Fleischer, PC, Richmond, VA, for Debtors.

Kevin J. Funk, Durrette, Arkema, Gerson & Gill PC, Richmond, VA, for Defendant.

MEMORANDUM OPINION

Kevin R. Huennekens, UNITED STATES BANKRUPTCY JUDGE

Before the Court is the motion of the HDL Liquidating Trust Oversight Committee (the "Oversight Committee") and Richard Arrowsmith ("Arrowsmith"), in his capacity as the interim Liquidating Trustee of the HDL Liquidating Trust (collectively the "Movants"), to appoint a permanent liquidating trustee (the "Motion to Appoint")¹ and the objection thereto (the "Objection") filed by Helena Laboratories, Noel Bartlett ("Bartlett"), and Dr. Robert S. Galen ("Galen").² Following discovery and briefing of the dispute, the Court conducted an evidentiary hearing (the "Hearing") on March 15, 2018.³ Having taken the matter under advisement to afford the parties an opportunity to supplement the record with the submission of excerpts from two deposition transcripts, the Court now overrules the Objection and grants the Motion to Appoint. This Memorandum Opinion sets forth the Court's findings of fact and conclusions of law in support of its decision in accordance with Rule 7052 of the Federal Rules of Bankruptcy Procedure (the "Bankruptcy Rules").⁴

Facts

Health Diagnostic Laboratory, Inc. ("HDL") was a privately held health care company headquartered in Richmond, Virginia, that operated an accredited, full-service clinical laboratory. Under HDL's prepetition business model, physicians would send blood samples to HDL, which provided lab testing of biomarkers for the indication of risk for cardiovascular disease, diabetes, and other illnesses. HDL processed the lab tests and frequently billed 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. HDL experienced extraordinary growth from a startup company in 2009 to a company with $375 million in net revenue for the fiscal year ending December 31, 2013.

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 the Debtors and their outside sales team 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"). HDL retained the law firm of Ropes & Gray LLP ("Ropes & Gray") to handle the DOJ Investigation. On June 25, 2014, HHS OIG issued a special fraud alert (the "Special Fraud Alert") advising that the payment of P & H fees to referring physicians could violate certain federal anti-kickback laws. After the issuance of the Special Fraud Alert, HDL ceased paying P & H fees to physicians.

Galen and Bartlett joined the Board of Directors of HDL (the "Board") on October 8, 2014. The last quarter of 2014 was a turbulent period for HDL. HDL was in the process of replacing its physician referral program with in-office phlebotomists, independent draw sites and lab-to-lab agreements as the means for obtaining blood samples. The transition from an outside sales force was having an adverse impact on HDL's revenues, which declined by more than 47%. HDL's CEO and president, LaTonya Mallory, had resigned, and the company was receiving negative press coverage.⁵

HDL engaged the professional services firm of Alvarez & Marsal ("A & M") to serve as a financial advisor in November 2014. A & M is a well-respected business consulting company that offers turnaround support and performance improvement for large corporations throughout the world. The A & M financial advisors who worked directly for the HDL account included David Schlissel ("Schlissel"), Andrew Thung ("Thung"), and Arrowsmith.⁶ Among other matters, A & M shared financial models with HDL, advised HDL on expense reductions, and attended meetings of HDL's Board.

In April 2015, HDL signed a settlement agreement with DOJ ("DOJ Settlement"), as well as a separate corporate integrity agreement with HHS OIG. In the DOJ Settlement, HDL agreed to pay $47 million to settle all the government's claims against it in connection with the referral P & H Fees.⁷ 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 was forced to file for bankruptcy.

On June 7, 2015 (the "Petition Date"), Health Diagnostic Laboratory, Inc., Central Medical Laboratory, LLC, and Integrated Health Leaders, LLC (collectively the "Debtors") commenced bankruptcy cases (the "Bankruptcy Cases") by each filing a separate 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").⁸

A & M's Healthcare Industry Group assisted HDL with its restructuring efforts in order to maximize the value of the Debtors' bankruptcy estates. Following a Court-approved sale of substantially all of the Debtors' operating assets under section 363 of the Bankruptcy Code in September of 2015,⁹ Arrowsmith assumed the role as the Debtors' chief restructuring officer ("CRO").¹⁰

The Court confirmed the Debtors' Modified Second Amended Plan of Liquidation (the "Plan")¹¹ by order entered on May 12, 2016 (the "Confirmation Order").¹² The HDL Liquidating Trust was formed in accordance with the terms of the Plan on the Effective Date.¹³ The HDL Liquidating Trust is the successor of the Debtors and the Creditors' Committee.¹⁴ Arrowsmith was appointed as the interim liquidating trustee of the HDL Liquidating Trust (the "Liquidating Trustee").¹⁵

On September 16, 2016, Arrowsmith commenced an adversary proceeding by filing a complaint (the "D & O Complaint") against over 100 different defendants, including Galen and Bartlett.¹⁶ The D & O Complaint included breach of fiduciary duty claims against Galen and Bartlett for (i) authorizing prepetition payments to Global Genomics Group ("G3"),¹⁷ (ii) authorizing funding for C3Nexus,¹⁸ and (iii) failing to extend a tolling agreement¹⁹ with the Debtors' prepetition law firm.

On December 7, 2017, the Oversight Committee and interim Liquidating Trustee filed the Motion to Appoint. The Movants requested that the Court appoint Arrowsmith as the permanent liquidating trustee of the HDL Liquidating Trust pursuant to the selection process previously conducted by the Oversight Committee. The Objection was filed on December 18, 2017. The Objecting Parties argued that Arrowsmith had a conflict of interest that precludes him from serving as the permanent liquidating trustee and necessitates the "appointment of a disinterested trustee from [an] Agreed List."²⁰ The Court held an initial hearing on the Motion to Appoint and the Objection on December 21, 2017 (the "Initial Hearing on Motion to Appoint"). Both the Movants and the Objecting Parties asked the Court to schedule the Contested Matter for an evidentiary hearing and allow for limited discovery. The Court entered an Order Adjourning Motion for the Appointment of a Permanent Liquidating Trustee (the "Adjournment Order"), which set the March 15, 2018 Hearing.²¹ The Court requested the parties to brief the issue of what standard should be applied in determining whether Arrowsmith should be appointed on a permanent basis (the "Determination Issue").²²

Jurisdiction and Venue

The Court has subject matter jurisdiction over this Contested Matter pursuant to 28 U.S.C. §§ 157 and 1334 and the General Order of Reference from the United States District Court for the Eastern District of Virginia dated August 15, 1984. This matter is a core proceeding under 28 U.S.C. § 157(b)(2)(A), as it concerns issues integral to the administration of the Debtors' Bankruptcy Cases. Venue is appropriate in this Court pursuant to 28 U.S.C. § 1408.

Discussion

The Objecting Parties maintain that, because Arrowsmith served as a prepetition financial advisor for HDL, participated in meetings of HDL's Board, and functioned as the Debtors' chief restructuring officer, Arrowsmith is disqualified from serving as Liquidating Trustee of the HDL Liquidating Trust and fiduciary for the Liquidating Trust Beneficiaries.²³ Galen and Bartlett do not suggest that a prepetition financial advisor or a bankruptcy appointed CRO could never serve as a post-confirmation liquidating trustee. They concede there would be no problem if Arrowsmith were pursuing claims only against third parties. They take umbrage with the fact that Arrowsmith is suing them for acts they claim were undertaken based upon advices he gave them as members of HDL's Board. Arrowsmith contends that he gave no such advices. Before delving into the factual dispute, the Court will address first the Determination Issue. Remarkably, few cases have touched directly upon the legal standard applicable to the appointment of a trustee for a post-confirmation liquidating trust.

It is well established that a trustee of a post-confirmation liquidating trust differs from a chapter 11 trustee appointed by a court under 11 U.S.C. § 1104. Section 1104 of the Bankruptcy Code only applies to trustees appointed "before confirmation of a plan."...