In re Med Diversified, Inc., Bankruptcy No. 02-88564.

• Decision Date: 14 November 2005
• Docket Number: Bankruptcy No. 02-88564.,Bankruptcy No. 02-88570.,Bankruptcy No. 02-88573.,Bankruptcy No. 02-88572.,Bankruptcy No. 02-88568.,Adversary No. 04-08680.
• Citation: 334 B.R. 89
• Parties: In re MED DIVERSIFIED, INC., et al., Debtors. Chartwell Litigation Trust and Gregory L. Segal as Trustee of Chartwell Litigation, Plaintiffs, v. Addus Healthcare, Inc., an Illinois Corporation; W. Andrew Wright, an Illinois Individual; Mark S. Heaney, an Indiana Individual; Courtney E. Panzer, an Illinois Individual; and James A. Wright, an Illinois Individual, Defendants.
• Court: U.S. Bankruptcy Court — Eastern District of New York

334 B.R. 89

In re MED DIVERSIFIED, INC., et al., Debtors.

Chartwell Litigation Trust and Gregory L. Segal as Trustee of Chartwell Litigation, Plaintiffs, v. Addus Healthcare, Inc., an Illinois Corporation; W. Andrew Wright, an Illinois Individual; Mark S. Heaney, an Indiana Individual; Courtney E. Panzer, an Illinois Individual; and James A. Wright, an Illinois Individual, Defendants.

Bankruptcy No. 02-88564.

Bankruptcy No. 02-88568.

Bankruptcy No. 02-88570.

Bankruptcy No. 02-88572.

Bankruptcy No. 02-88573.

Adversary No. 04-08680.

United States Bankruptcy Court, E.D. New York.

November 14, 2005.

COPYRIGHT MATERIAL OMITTED

James M. Sullivan, Esq. (JS-2189), McDermott Will & Emory LLP, New York City, Howard J. Steinberg, Esq. (pro hac vice), Michael H. Strub, Jr., Esq. (pro hac vice), Irell & Manella LLP, Los Angeles, CA, Co-counsel to the Plaintiffs.

Robert A. Scher, Esq. (RS-2910), Foley & Lardner LLP, New York City, Scott E. Early, Esq. (pro hac vice), Ellen Wheeler, Esq. (pro hac vice), Jill L. Murch, Esq. (pro hac vice), Christopher J. Werner, Esq. (pro hac vice), Foley & Lardner LLP, Chicago, IL, Counsel for the Defendants.

MEMORANDUM OF DECISION AND ORDER GRANTING, IN PART, AND DENYING, IN PART, PLAINTIFFS' MOTION IN LIMINE TO EXCLUDE THE REPORT AND TESTIMONY OF THE DEFENDANTS' EXPERT WITNESS.

STAN BERNSTEIN, Bankruptcy Judge.

Issue

In this adversary proceeding filed by the Chartwell Litigation Trust and its Trustee (Plaintiffs), to recover an alleged constructive fraudulent transfer of $7,500,000,¹ the narrow issue under submission is whether the Defendants' proposed expert witness, Scott P. Peltz (Peltz) is qualified and whether his purported expertise satisfies the standards of relevance and reliability under Daubert v. Merrell Dow Pharmaceuticals, Inc., 509 U.S. 579, 597, 113 S.Ct. 2786, 125 L.Ed.2d 469 (1993), and ensuing precedents. In this case, the Defendants called Mr. Peltz as a purported expert in business valuations to testify on the value of 100% of the shares of the defendant, Addus Healthcare, Inc. (Addus), a privately held company, as of February 14, 2002.² The proposed witness was also called to testify on the reasonably equivalent value of an alleged option payment of $7.5 million paid by the Plaintiffs' predecessor in interest, Med Diversified, Inc. (Med D), for a 6½ month extension to close its purchase of these shares.

In exercising its role as the gatekeeper, this Court has determined that the proposed witness has not satisfied the Daubert standard as to his direct testimony, but that he may testify as a rebuttal witness to the Plaintiffs' proposed expert witness in valuation, limited, however, to issues of methodology used by the Plaintiffs' expert witness, Robert Cimasi (Cimasi) in valuing these shares and the "option price" or the extension payment.³ Under these circumstances, Mr. Peltz's Expert Report and direct testimony are struck from the record of this adversary proceeding, and an evidentiary hearing date has been set for his rebuttal testimony on methodology. Since this particular issue has not been discussed by any other bankruptcy court, this Court has taken the pains to present a comprehensive analysis of the gatekeeper function in the hope that it may be useful to other bankruptcy judges, the business bankruptcy bar, and, tangentially, the bankruptcy law professoriat.

Background and Procedural History

In order to make sense of the importance of the Plaintiffs' motion in limine within the context of this adversary proceeding, it is necessary to go back to the transactional sequence for the abortive purchase of the Addus shares. On January 8, 2002, Med D and Addus entered into a Stock Purchase Agreement (SPA) in which Med D agreed to purchase all of the shares of stock of Addus. The principal terms of the SPA required Med D to pay Addus: (1) $15 million in cash, which was to be deposited into a joint escrow account upon execution of the agreement, (2) $22.5 million in notes secured by a pledge of the Addus stock and payable to the Addus shareholders, and (3) $20 million in shares of Med D stock, which were to be issued at closing. In addition, Med D was to pay all outstanding debt owed by Addus, which was approximately $36.2 million,⁴ and up to $3 million in debt, plus accrued interest, owed to the principal shareholder of Addus, W. Andrew Wright (Wright).⁵ On January 8, 2002, Med D deposited $15 million into a joint escrow account. The closing date for the transaction was set for January 24, 2002 under the terms of the SPA.

The closing did not take place January 24, 2005. Instead, the parties entered into a Modification to the SPA (Modification), which extended the closing date to February 14, 2002, and provided that Addus was to receive a $40 million promissory note instead of the $20 million in Med D shares that was provided for in the SPA. Thus, as modified, the sales price under the SPA was approximately $116.9 million.⁶

What happened next is in material dispute.⁷ Both parties agree that sometime before February 14, 2002, Med D and Addus began negotiating an additional "amendment" to the SPA, as amended by the Modification. This amendment was purportedly memorialized in a document entitled First Amendment to the SPA (First Amendment), but this document was never signed by the parties. The First Amendment purportedly gave Med D an "option" to purchase all of the Addus shares at anytime before September 1, 2002 — a six and a half month period — for $7.5 million. Alternatively, this $7.5 million may also be deemed a payment in consideration for an extension of time for Med D to perform its obligations under the Modification. The $7.5 million was to be released from the joint escrow account upon the joint execution of the First Amendment and paid to the Defendants. In simplified terms, under the First Amendment Med D lost its right to a credit against the Exercise Price or Purchase Price of $1 million of the $7.5 million upon expiration of each successive month until the total amount was exhausted at the end of the six and a half-month period. If the First Amendment were valid and enforceable — an issue to be determined at the conclusion of the trial — then Med D's failure to close the acquisition by the end of this 6 ½ month period would have the effect of Med D forfeiting any right to recover any part of the $7.5 million.

On February 13, 2002, from the $15 million on deposit under the joint escrow account, $7.5 million was transferred to Med D, and $7.5 million was released to Addus and/or Mr. Wright. In fact, all of the $7.5 million was immediately transferred to Mr. Wright. Within a very short period of time, Mr. Wright advanced $4 million of these proceeds back to Addus, and used the $3.5 million balance for his other personal investments that were unrelated to Addus. Med D did not close the deal to purchase Addus by August 31, 2002, and Mr. Wright retained the $7.5 million.

Indeed, several months before the expiration of the extension term, Med D filed an action against the Defendants in the Superior Court of California, Central District, in the County in Los Angeles, seeking, among other things, return of the $7.5 million.⁸ That action was removed to the Federal District Court for the Central District of California, Western Division, sitting in Los Angeles.⁹ That action was removed once again to the Federal District for the Northern District of Illinois (the Chicago Action).¹⁰ Med D and several, but not all, of its affiliates filed petitions for relief with this Court in late November of 2004 under chapter 11. The Chicago Action lay dormant by mutual agreement of the parties pending the confirmation of a plan of reorganization or liquidation by Med D and its affiliates.

Under the terms of the Second Amended Plan of Reorganization, the debtor's pre-petition claims, including those against the Defendants, were assigned to the newly formed Chartwell Litigation Trust. On November 24, 2004, the Plaintiffs filed the complaint beginning this adversary proceeding. Thereafter, the Plaintiffs removed the Chicago Action to this Court and it was consolidated with the adversary proceeding. The principal claim is that the pre-petition payment of $7.5 million from Med D to the Defendants can be recovered by the estate either because it was for no value whatsoever, assuming the First Amendment never became valid and enforceable, or, alternatively, because it was not for reasonably equivalent value. Defendants have also raised counterclaims alleging actual and consequential damages from an alleged breach of contract under the SPA, as modified.

In the Pretrial Statement, the Defendants listed Mr. Peltz as their single expert on all issues of business valuation. The Plaintiffs filed a motion in limine to exclude all of Mr. Peltz's testimony on the ground that he does not qualify as an expert on valuation of all of the shares of a privately held health care services company. This motion gave rise to the Court's exercise of its gatekeeper function in excluding expert testimony that is neither relevant nor reliable.

After reviewing the motion and memorandum in opposition to the motion, and holding some preliminary oral arguments, the Court ruled that it made more practical sense to conduct a voir dire of the proposed expert witness and then determine whether the motion in limine should be granted at the conclusion of the voir dire. The voir dire took place for the better part of three business days,¹¹ with active participation by the Court in that process.

Discussion

Rule 702 of the Federal Rules of Evidence provides:

If scientific, technical, or other specialized knowledge will assist the trier of fact to understand the evidence or to determine a fact in issue, a witness qualified as an expert by knowledge, skill, experience, training, or education, may testify thereto in the form of an opinion or otherwise, if (1) the testimony is based upon sufficient facts...