Kapila v. Warburg Pincus, LLC (In re Universal Health Care Grp., Inc.)

560 B.R. 594

In re Universal Health Care Group, Inc., American Managed Care, LLC, Debtors.

Soneet R. Kapila, as Chapter 11 Trustee of Universal Health Care Group, Inc., Plaintiff,

v.Warburg Pincus, LLC; Warburg Pincus Private Equity Fund IX, L.P.; Allen Wise; and Alok Sanghvi, Defendants.

Case No. 8:12–bk–1520–KRM

Jointly Administered with Case No. 8:13–bk–5952–KRM

Adv. No. 8:15–ap–132–KRM

United States Bankruptcy Court, M.D. Florida, Tampa Division.

Signed May 6, 2016

Filed May 9, 2016

James D. Gassenheimer, David L. Gay, Paul Steven Singerman, Berger Singerman, PA, Miami, FL, for Plaintiff.

W. Keith Fendrick, Paul A. McDermott, Holland & Knight, LLP, Tampa, FL, for Defendants.

MEMORANDUM OPINION AND ORDER ON DEFENDANTS' MOTIONS TO DISMISS

K. Rodney May, United States Bankruptcy Judge

The debtor, Universal Health Care Group ("Universal"), was a holding company whose subsidiaries offered regulated Medicare HMO plans in Florida, Texas and Nevada. In February of 2013, the State of Florida commenced insolvency proceedings against the two Florida subsidiaries for lack of capital. Universal filed for Chapter 11 relief on February 6, 2013, before the UCC sale of the subsidiaries' stock by the group of senior secured creditors, led by BankUnited. Universal attempted a § 363 sale of the subsidiaries, but that effort failed. The Court then directed the appointment of a trustee.

The Chapter 11 trustee, Soneet Kapila (the "Trustee"), filed this adversary proceeding alleging that Universal's collapse is the result of its borrowing $37.5 million in 2011 to redeem preferred stock at a price of $33 million. The Trustee seeks to avoid the redemption payments and recover damages from the defendants, each of whom have filed motions to dismiss.¹

FACTUAL BACKGROUND

The Court takes the allegations in the complaint as true, and summarizes the pertinent allegations below.²

Universal was a Delaware corporation headquartered in St. Petersburg, Florida (¶ 12).³ It was formed by a merger in 2006. It offered health insurance and managed care products through wholly-owned, regulated subsidiaries (¶ 12).

One of the Florida subsidiaries, Universal Health Care, Inc. ("UHC"), had contracts with the Department of Health and Human Services and the Center for Medicare and Medicaid Services ("CMS"), to provide health care services to Medicare enrollees in Florida (¶ 12). The other Florida subsidiary, Universal Health Care Insurance Company ("UHCIC"), had contracts with CMS to provide Medicare services to enrollees in twenty-three states and the District of Columbia (¶ 12). Universal also had regulated Medicare HMO subsidiaries in Texas and Nevada (¶ 12). A fifth subsidiary, debtor American Managed Care, LLC ("AMC"), operated as a third-party administrator for the regulated subsidiaries (¶ 12).

Akshay M. Desai, M.D. ("Dr. Desai"), was Universal's CEO and Chairman (¶ 13). Universal's largest shareholders were Dr. Desai and the Desai Limited Partnership, an entity controlled by Dr. Desai and his wife (¶ 13). Dr. Desai was the indirect majority shareholder through his control of the Desai Limited Partnership (¶ 29). He also led Universal's management team (¶ 29).

On May 26, 2006, Universal entered into Stock Purchase Agreements with defendants Allen Wise ("Wise") and Warburg Pincus Private Equity IX, LP ("Equity IX"), a private fund organized and managed by defendant Warburg Pincus, LLC ("Warburg") (¶¶ 4 and 18).⁴ Equity IX and Wise agreed to purchase 11,143,871 and 384,271 shares, respectively, of Universal's Series A Convertible Preferred Stock (the "Preferred Stock") (¶¶ 21 and 22).

In anticipation of the stock purchase, Equity IX loaned Universal $6.2 million (¶ 19). On August 18, 2006, Equity IX cancelled the $6.2 million note and invested another $22,660,471, bringing its total investment in Universal to $28,860,471 (¶¶ 19 and 21). In return, it received 11,143,871 shares of the Preferred Stock (¶ 21). The invested funds were earmarked as working capital (¶ 21). Contemporaneously, Wise invested $1,000,000, in return for 384,271 shares of the Preferred Stock (¶ 22).

Universal filed an Amended and Restated Certificate of Incorporation ("COI") in Delaware on August 17, 2006 (¶ 20). The COI provided the holders of the Preferred Stock with a right of redemption, exercisable after five years (i.e., in August of 2011) at a formula price (Ex. B § 10 (a)).

Equity IX and Wise, as holders of the Preferred Stock, had: (a) a first claim to Universal's equity value; (b) the right to receive quarterly dividends (in the form of additional shares of Preferred Stock or cash); and (c) the right to compel Universal to repurchase the Preferred Stock on or after August 17, 2011 (¶ 26). If Equity IX and Wise had elected to redeem their shares in August 2011, the combined price required by the COI would have been approximately $60 million (¶ 28).⁵

The Stock Purchase Agreement also required placement of at least one of Warburg's investment professionals on Universal's board of directors, in keeping with Warburg's general policy for its private equity funds (¶ 24). This allowed Warburg to monitor its investments for the benefit of its investors (¶ 24).

Defendant Alok Sanghvi ("Sanghvi") became Warburg's representative on Universal's Board in 2008 (¶ 23). Sanghvi was an employee of Warburg, having the status of "principal" (¶¶ 6 and 23). He remained on Universal's board until February 15, 2011 (¶¶ 6 and 69). Warburg maintained control over decisions and actions of Sanghvi with respect to Equity IX and Universal (¶ 6).

Equity IX and Wise did not own a majority stake in Universal; nor did they control its operations (¶ 29). But, the Stock Purchase Agreement gave Warburg and Equity IX veto power over certain matters, including (a) selling, leasing, or disposing of assets in excess of $1.0 million outside the ordinary course of business and (b) incurring indebtedness for borrowed money in excess of $1.0 million in any fiscal year (¶ 25).

The business of the regulated subsidiaries was dependent on Medicare funding levels, which were susceptible to fluctuations based on changes in reimbursement rates authorized by CMS (¶ 14). Universal's financial condition was deteriorating between 2007 and 2011 (¶¶ 40 and 52–57):

a. UHC had experienced a deterioration in the level of medical claims payable in the last six months of 2006; the ratio of medical claims to premium income had risen and UHC had underpriced its products;

b. the medical loss ratio projected for UHCIC was 99%; medical losses were expected to almost equal premium income;

c. 1st Quarter 2007 earnings, before depreciation, interest, taxes, depreciation and amortization ("EBITDA"), was a negative $18.3 million;

d. by early 2007, Universal was in a "zone of insolvency;"

e. in 2007, the State of Florida Office of Insurance Regulation demanded evidence of an adequate capital structure, and forwarded a proposed order of liquidation; and

f. in 2007, the State of Florida Office of Insurance Regulation commenced litigation concerning capitalization and liquidation of UHCIC.

Universal's financial projections were erroneous, including inaccurate EBITDA, which painted a healthier picture of Universal's financial condition than actually existed (¶¶ 51, 52 and 62). Universal's projections of net income in 2008, 2009 and 2010 were also erroneous (¶ 57). EBITDA fell during 2008 by $44,000,000, increased in 2009 by $10,000,000, and fell again in 2010 by $4,500,000 (¶ 52). Net income followed a similar trend; so did cash (¶ 53).

Universal's auditors, Ernst & Young, LLP ("E & Y"), published an audited consolidated financial report for Universal for the year 2007, showing cash of $245 million and net income of $43 million (¶ 38). E & Y's report did not reflect underlying risks and problems in Universal's business (¶ 39). The 2007 E & Y audit report expressly stated E & Y made no opinions in respect to internal controls (¶ 39).

Warburg prepared quarterly valuation reports on the companies in its private fund portfolios (¶ 42). Quarterly valuation reports were prepared by Warburg personnel and reviewed by Warburg management (¶ 42).

By mid-year 2008, Warburg had assessed the performance of Universal as highly unpredictable (¶ 41). By the end of 2008, Warburg's assessment of Universal's ability to raise capital was extremely low (¶ 41). Warburg's quarterly valuation reports informed it that Universal had performed more poorly than Warburg had anticipated (¶ 44). Warburg also discounted the financial information that Universal provided (¶ 44).

As of September 30, 2007, Warburg had assessed the value of Equity IX's Preferred Stock (initially, a $28.9 million investment) at $10 million (¶ 45). By the end of the first financial quarter in 2009, Warburg deemed Universal to have a total equity value of only $23.9 million; it further reduced the value of Equity IX's investment to $7 million (the "FQ 2009 Valuation") (¶ 46). Sanghvi was the primary person at Warburg who prepared the FQ 2009 Valuation (¶ 48).

Warburg later decreased its valuation of Equity IX's investment to $5 million (¶ 50). Warburg continued to value Equity IX's investment in Universal at $5 million through at least May 25, 2010 (¶ 50). Warburg's $5 million valuation tracks with the downward financial performance of Universal and its subsidiaries (¶ 51).

In 2011, Universal was worth less than the $60 million redemption price that would have been mandatory after August 17, 2011, as evidenced by the fact that Universal, Equity IX and Wise, agreed to the lesser price of $33.4 million, only six months prior to their right to demand $60 million (¶ 28).

Equity IX and Wise made overtures to Universal, through Sanghvi, to have Universal buy back the Preferred Stock before the August 2011 redemption date (¶ 58). Sanghvi was Warburg's sole representative in negotiating the terms of the buy-out (¶ 58). Sanghvi also handled the early redemption of Wise's Preferred Stock (¶ 58).

From October 2010 through mid–February 2011,...