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

• Decision Date: 09 August 2017
• Docket Number: Case No. 15-32919,APN No. 16-03271
• Court: United States Bankruptcy Courts. Fourth Circuit. U.S. Bankruptcy Court — Eastern District of Virginia
• Parties: 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.

IN RE: HEALTH DIAGNOSTIC LABORATORY, INC., et al., Debtors.RICHARD ARROWSMITH, as Liquidating Trustee ofthe HDL Liquidating Trust, Plaintiff, v. LATONYA S. MALLORY, et al., Defendants.

Case No. 15-32919

APN No. 16-03271

UNITED STATES BANKRUPTCY COURT FOR THE EASTERN DISTRICT OF VIRGINIA Richmond Division

August 9, 2017

Chapter 11

(Jointly Administered)

MEMORANDUM OPINION

Before the Court in this adversary proceeding are thirteen motions¹ filed by various individual Defendants and groups of Defendants seeking to dismiss (the "Motions to Dismiss")the Complaint (the "Complaint")² of Richard Arrowsmith in his capacity as Liquidating Trustee of the HDL Liquidating Trust (the "Liquidating Trustee").³ The Motions to Dismiss are brought pursuant to Rules 7008, 7009, 7012, and 7041 of the Federal Rules of Bankruptcy Procedure (the "Bankruptcy Rule(s)"). The issues presented by the Motions to Dismiss are whether the Liquidating Trustee's lengthy Complaint (i) provides fair notice of the claims being brought against each of the 103 named Defendants, (ii) pleads fraud with sufficient particularity, (iii) states sufficient facts to present plausible claims for which relief can be granted, and (iv) complies generally with the Bankruptcy Rules. A hearing on the Motions to Dismiss was held on June 8, 2017 (the "Hearing"), at which time the Court took the matter under advisement. For the reasons set forth below, the Court will deny the Motions to Dismiss in part and grant the Motions to Dismiss in part.

The Bankruptcy Case

On June 7, 2015 (the "Petition Date"), Health Diagnostic Laboratory, Inc., Central Medical Laboratory, LLC, and Integrated Health Leaders, LLC ("HDL" or 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")⁴ in the United States Bankruptcy Court for the Eastern District of Virginia (the "Court").⁵ On June 16, 2015, the United States Trustee for the Eastern District of Virginia appointed the statutory committee of unsecured creditors (the "Committee").

HDL operated an accredited, full service clinical laboratory that provided testing of biomarkers for the indication of risk for cardiovascular disease, diabetes, and other illnesses. HDL's testing services offered physicians the ability to detect major health issues in patients before potentially life-threatening events occurred. HDL processed lab tests it received from physicians all around the country.

On September 17, 2015, the Court entered an Order (I) Approving Asset Purchase Agreement and Authorizing the Sale of Assets of the Debtors Outside the Ordinary Course of Business, (II) Authorizing the Sale of Assets Free and Clear of All Liens, Claims, Encumbrances and Interest, (III) Authorizing the Assumption and Sale and Assignment of Certain Executory Contracts and Unexpired Leases, and (IV) Granting Related Relief (the "Sale Order"). The Sale Order 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 ("APA"). The transaction under the APA closed on September 29, 2015 (the "Closing Date").⁶

The Court confirmed the Debtors' Modified Second Amended Plan of Liquidation (the "Plan") by an order entered May 12, 2016 (the "Confirmation Order").⁷ The HDL Liquidating Trust was formed in accordance with the terms of the Plan on the Effective Date.⁸ Pursuant to the Plan, 11 U.S.C. § 1123, and the trust agreement executed to implement the Plan, the HDL Liquidating Trust is the successor of the Debtors and the Committee.⁹ In addition, a number of creditors transferred their own creditor causes of action to the HDL Liquidating Trust in accordance with the Plan.¹⁰ The Liquidating Trustee commenced this adversary proceeding on September 16, 2016.

Jurisdiction and Venue

The Court has subject matter jurisdiction over this adversary proceeding 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. The causes of action asserted for (i) the avoidance of fraudulent transfers under 11 U.S.C. § 548(a)(1)(A) & (B)¹¹ and 11U.S.C. § 544(b)¹² (ii) the avoidance of employment contracts under 11 U.S.C. § 548(a)(1)(B)(ii)(IV),¹³ (iii) the recharacterization of loans and shareholder infusions,¹⁴ (iv) the avoidance of preferential transfers under 11 U.S.C. § 547,¹⁵ (v) objection to proofs of claim under 11 U.S.C. §§ 502, 503, and 507,¹⁶ and (vi) equitable subordination under 11 U.S.C. § 510(c)¹⁷ are core proceedings under 28 U.S.C. § 157(b)(2)(A), (B), (E), (F), (H) and (O). To the extent that the causes of action asserted for (i) breach of fiduciary duty,¹⁸ (ii) violation of the trust fund doctrine,¹⁹ (iii) aiding and abetting breach of fiduciary duty,²⁰ (iv) conspiracy,²¹ (v) unlawful distributions,²² (vi) corporate waste,²³ (vii) negligence and gross negligence,²⁴ (viii) assumpsit and unjust enrichment,²⁵ (ix) fraud and constructive fraud,²⁶ (x) tortious interference with contract,²⁷ and (xi) declaratory relief²⁸ may be non-core proceedings as described in 28U.S.C. § 157(b)(2) because they arise under applicable nonbankruptcy law, such proceedings are "related to" the bankruptcy case and the Court may issue proposed findings of fact and conclusions of law pursuant to 28 U.S.C. § 157(c)(1). See Memorandum Opinion, Arrowsmith v. Mallory, et al. (In re Health Diagnostic Laborartory, Inc.), No. 3:17-cv-399-HEH, 3:17-cv-400-HEH, 3:17-cv-409-HEH (E.D. Va. July 19, 2017) ECF No. 8.

The test for determining post-confirmation "related to" jurisdiction is whether a claim has a "close nexus" to the bankruptcy plan or proceeding such that it affects an integral aspect of the bankruptcy process. Valley Historic Ltd. P'ship of N.Y., 486 F.3d 831, 836-37 (quoting In re Resorts Int's Inc., 372 F.3d 154, 167 (3d Cir. 2004)) ("[M]atters that affect the interpretation, implementation, consummation, execution, or administration of the confirmed plan will typically have the requisite close nexus."). Matters that are integrated into a debtor's plan as a means of recovery for the debtor's creditors are such matters, even if they are referenced in the plan generally rather than specifically. See Air Cargo, Inc. Litig. Tr. v. i2 Techs., Inc. (In re Air Cargo, Inc.), 401 B.R. 178 (Bankr. D. Md. 2008) (holding that adjudication of the lawsuit brought by the litigation trustee to recover funds for satisfaction of creditor claims necessarily affects the implementation, consummation, execution and administration of the plan, even though the assignment of the claims to the litigation trust was general rather than specific); In re Railworks Corp., 325 B.R. 709 (Bankr. D. Md. 2005).

All of the claims asserted by the Liquidating Trustee that arise under applicable nonbankruptcy law including those alleged for assumpsit and unjust enrichment,²⁹ for fraud andconstructive fraud against the assigning creditors,³⁰ for tortious interference with contracts and contract expectancy of assigning creditors,³¹ and for common law and statutory conspiracy asserted by assigning creditors³² are an integral part of the Plan. The prosecution of those claims by the Liquidating Trustee affects the implementation, consummation, execution and administration of the Plan.³³ See Lain v. Erickson, No. WDQ-11-3736, 2013 WL 6490263 (D. Md. Dec. 9, 2013) (finding the court had subject matter jurisdiction over liquidating trustee's recovery of a state law claim because the claim was provided for in the plan, was being prosecuted by a trust created by the plan, would bring recovery to the debtors' creditors if successful, and the claim arose pre-petition); see also Bos. Reg'l Med. Ctr., Inc. v. Reynolds (In re Bos. Reg'l Med. Ctr., Inc.), 410 F.3d 100, 106 (1st Cir. 2005) (explaining that the rationale for distinguishing between plans of reorganization and liquidation is that a reorganized debtor maintains a tangential relationship with the bankruptcy proceedings, while a liquidating debtor exists for the singular purpose of executing an order of the bankruptcy court, and any litigation involving such debtor relates much more directly to a proceeding under Title 11). All of the claims asserted in the Complaint under applicable nonbankruptcy law arose pre-petition, are significant assets of the Debtors' estate, and are brought by the Liquidating Trustee. As there exists a close nexus between those claims and the Plan and the Bankruptcy Cases, the Court has "related to" subject matter jurisdiction over the claims.

Venue is appropriate in this Court pursuant to 28 U.S.C. § 1408.

The Parties

The Plaintiff

Plaintiff, Richard Arrowsmith, is the Liquidating Trustee of the HDL Liquidating Trust. In such capacity, he has asserted claims that were held by the Debtors. Those claims became property of the Debtors' bankruptcy estate under 11 U.S.C. § 541 on the Petition Date. The claims now belong to the HDL Liquidating Trust as the Debtors' successor-in-interest under the confirmed Plan. The Liquidating Trustee has also asserted claims that were held by creditors of the Debtors that were assigned to the HDL Liquidating Trust in accordance with the Plan.

The Shareholder Defendants

LaTonya S. Mallory ("Mallory") was a co-founder of HDL. She owned 8.9048% of HDL's stock as of the Petition Date. Mallory served as Chief Executive Officer of HDL from its formation in 2008 through September 2014. She served as chairman of the HDL Board of Directors from HDL's formation in 2008 through the end of 2014. Scott Mallory, the husband of Mallory, owned 6.0021% of HDL's stock as of the Petition Date. The Complaint refers to Mallory and Scott Mallory as the Mallory Defendants (the "Mallory Defendants").

G. Russel Warnick ("Warnick") was a co-founder of HDL. Warnick owned 7.6236% of HDL's stock as of the Petition Date....