Venzke v. Black Stone of Nw. Ohio

430 F.Supp.3d 327

David R. VENZKE, Plaintiff

v.BLACK STONE OF NORTHWEST OHIO, et al., Defendants

Case No. 3:17CV1031

United States District Court, N.D. Ohio, Western Division.

Filed December 26, 2019

Joshua J. Nolan, David G. Squillante, Toledo, OH, for Plaintiff.

James P. Silk, Jr., Teresa L. Grigsby, Spengler Nathanson, Toledo, OH, for Defendants.

ORDER

James G. Carr, Sr., U.S. District Judge

This is a breach-of-contract suit.

In 2014, plaintiff David Venzke sold his home healthcare company, Nursing Resources Corporation (NRC) to the defendant, Black Stone of Northwest Ohio (Black Stone NWO).

As part of the sale, Venzke agreed to receive five percent of the purchase price as a share of "phantom equity" in NRC. Venzke's phantom equity was on its face worthless, but it could become valuable if certain contingencies occurred. For its part, Black Stone NWO agreed to pay Venzke an earnout that ranged from $200,000 to $625,000 if NRC's adjusted earnings before income, depreciation, taxes, and amortization (EBITDA) for fiscal year 2015 was at least $600,000. Finally, Venzke warranted to Black Stone NWO that all of NRC's accounts receivable were collectible, that the company had no pending claims against it, and that there were no undisclosed liabilities.

Within a year after the sale, multiple disputes had arisen between the parties.

Venzke initially claimed that Black Stone NWO breached the parties' contracts by refusing to pay him for his phantom equity interest and denying him an earnout. Black Stone NWO counter-claimed that Venzke breached the warranties he had made to NRC. After unsuccessfully trying to mediate their disputes, Venzke brought this lawsuit.

Jurisdiction is proper under 28 U.S.C. § 1332(a)(1).¹

Pending is Black Stone NWO's motion for summary judgment. (Doc. 24). For the following reasons, I grant the motion in part and deny it in part.

Background

Before its sale to Black Stone NWO, NRC provided home healthcare services in Northwest Ohio. (Doc. 28–1, PageID 628).

Black Stone Companies of Ohio (Black Stone) is a holding company that "established a structure for providing home health care through shared administration supporting revenue-generating operating entities." (Doc. 24–2, PageID 178). It relies on a separate entity, Black Stone Operations, LLC, to "provide[ ] administrative services to multiple regional operating entities" that delivered home healthcare services throughout Ohio. (Id. , PageID 179).

"The Black Stone structure provided advantages for attracting investors and providing services with economies of scale enabled by shared administrative services" from Black Stone Operations. (Id. ).

A. Acquisition

In 2013, Black Stone planned an expansion into Northwest Ohio. (Doc. 24–2, PageID 179). It identified NRC as a "potential acquisition target." (Id. ).

In March, 2014, Black Stone NWO and Venzke executed a Stock Purchase Agreement. (Doc. 24–3). Black Stone NWO agreed to purchase NRC's shares for $3.75 million. The purchase price represented NRC's 2012 EBITDA multiplied by five. (Doc. 1–1, PageID 18; Doc. 24–2, PageID 179).

1. Phantom Equity Agreement

Venzke agreed to receive part of the purchase price in the form of a phantom equity interest in Black Stone NWO that entitled him to certain "economic rights" as specified in the parties' Phantom Equity Agreement. (Doc. 1–2, PageID 56). Venzke's phantom equity interest in Black Stone NWO, which the parties also refer to as the "Grantee's Percentage," was five percent. (Id. ).

Of particular relevance to Venzke's claims, the Phantom Equity Agreement provided that, in the event of a "Change of Control" – that is, a merger of Black Stone NWO with or into another entity (Doc. 1–2, PageID 56) – Venzke would be "entitled to receive an amount equal to the product of Grantee's Percentage, as of the date of the Change of Control, multiplied by the Gross Proceeds." (Id. ).

According to the Phantom Equity Agreement, "Gross Proceeds"

means (as determined in good faith by Black Stone) (a) (i) the total amount payable (and paid) in cash and the value of securities received for the equity of Black Stone in connection with any Change of Control, or (ii) (A) the total amount payable (and paid) in cash and the value of securities received for the assets of Black Stone in connection with any Change of Control minus (B) all liabilities, obligations and other indebtedness of Black Stone not assumed or taken subject to by the buyer * * *; in each case, minus (b) the sum of the transaction costs associated with the change of control. * * * Black Stone shall have the authority to establish reasonable reserves or make other equitable adjustments, in good faith, to the foregoing calculation (e.g., to take into account unforeseen factors or to satisfy fixed or contingent liabilities or obligations of Black Stone).

(Id. , PageID 57).

2. Earnout Agreement

The Stock Purchase Agreement specified that part of the purchase price for NRC's shares would be calculated and paid as an earnout. Under the parties' separate Earnout Agreement, Venzke would be entitled to a graduated sum if NRC's "Adjusted EBITDA" equalled or exceeded $800,000 during fiscal year 2015. (Doc. 1–3, PageID 63).

The Earnout Agreement further provided that, "[p]romptly following the end of the Earnout Period [i.e. , 2015]," Black Stone NWO was to prepare: 1) "a consolidated income statement of the Company for the Earnout Period"; and 2) a "Computation Notice," defined as "a computation of EBITDA and Adjusted EBITDA, showing separately each of the adjustments made to EBIDTA to arrive at Adjusted EBITDA." (Doc. 1–3, PageID 65). Although the contract required that Black Stone NWO deliver both documents to Venzke "within 90 days following the end of the Earnout Period" (id. ), the Earnout Agreement did not give Venzke a remedy if Black Stone NWO failed to deliver the notices within that period.

3. Escrow Agreement

The parties also executed an Escrow Agreement. (Doc. 24–2). Under this contract, Black Stone NWO put $200,000 of the purchase price in escrow for the payment of claims against Black Stone NWO arising from Venzke's breach of the warranties discussed below.

4. Venzke's Warranties

As part of the Stock Purchase Agreement, Venzke made several warranties to Black Stone NWO. In particular, Venzke warranted that: 1) all of NRC's accounts receivable had been or could be collected in full within ninety days after becoming due; 2) NRC had no undisclosed liabilities; and 3) there was no pending "Proceeding" against NRC beside those set forth in the Stock Purchase Agreement. (Doc. 1–1, PageID 19, 32, 35, 36). Venzke further agreed to indemnify and hold Black Stone NWO harmless from any breach of these warranties. (Id. , PageID 44).

B. Post-Acquisition Developments

Once the sale had closed, NRC became "a wholly-owned subsidiary" of Black Stone NWO and continued to do business under a different trade name. (Doc. 24–2, PageID 180 at ¶12). NRC "generated revenues as it had" before the sale, but now "enjoyed cost-savings by using the shared administrative services available through" Black Stone Operations. (Id. , PageID 180 at ¶¶13–14).

1. Merger

In November, 2015, Black Stone sold Black Stone Operations and its operating entities, including Black Stone NWO, to AFAM Acquisition, LLC for just over $40 million. (Doc. 11, PageID 98 at ¶30; Doc. 24–2, PageID 182 at ¶¶33–35; Doc. 24–6, PageID 326). After the merger, Black Stone NWO "remained a separate operating entity," and NRC remained a "wholly-owned subsidiary" of Black Stone NWO. (Doc. 24–2, PageID 182 at ¶35).

2. "Gross Proceeds" Calculation

It is undisputed that the AFAM merger constituted a "change of control" for purposes of the Phantom Equity Agreement. Accordingly, Black Stone undertook to calculate the "Gross Proceeds" of that transaction to determine the value, if any, of Venzke's phantom equity.

The total purchase price was $40,100.000. (Doc. 24–6, PageID 326).

As required by the Phantom Equity Agreement's definition of "Gross Proceeds," Black Stone NWO first deducted from that sum $13,015,838 in "liabilities, obligations and other indebtedness of Black Stone [NWO] not assumed by" AFAM. (Doc. 24–6, PageID 328). It then subtracted $1,579,670 in "transaction costs," as well as a further $8,000,000 for established reserves. (Id. ). Then, because Black Stone retained $70,836.30 in cash on hand, it added that sum to the "Gross Proceeds" calculation, yielding a figure of $17,575,328.30. (Id. ).

Because NRC was one of multiple "[o]perating [e]ntities under a common [p]arent" organization (i.e. , Black Stone Operations), Black Stone NWO decided that "the proceeds from the AFAM sale needed to be allocated to each of the [o]perating [e]ntities to determine the value that NRC contributed to the transaction." (Doc. 24–6, PageID 328). Management relied on NRC's EBITDA in the twelve-month period ending August 31, 2015 to gauge NRC's value because EBITDA was "generally the main value driver for the AFAM transaction." (Id. ).

Black Stone NWO then "determined that [Black Stone Operations'] costs should be allocated to each of the [o]perating [e]ntities" based upon each entity's revenue. (Doc. 24–6, PageID 328). Because revenue "is a measurement of activity at the [o]perating [e]ntity's level," Black Stone NWO's allocation method assumed that "each [o]perating [e]ntity consumes a proportional share of [Black Stone Operations'] centralized functions." (Id. ).

After so allocating proceeds and costs among the operating entities, Black Stone NWO determined that NRC "did not contribute to the value upon which the NRC transaction was based (EBITDA)[.]" (Id. , PageID 329). Rather, Black Stone NWO determined that NRC's EBITDA "equaled negative $187,846.00." (Id. ). Because NRC's share of the "gross proceeds" from the merger was less than zero, Black Stone concluded that Venzke was not entitled to a payment for his phantom equity interest.

3. Earnout Calculation

Sometime in 2016, Black Stone NWO calculated Venzke's "Earnout...