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

• Decision Date: 02 August 2006
• Docket Number: Bankruptcy No. 02-88570.,Bankruptcy No. 02-88568.,Bankruptcy No. 02-88572.,Adversary No. 04-08680.,Bankruptcy No. 02-88573.,Bankruptcy No. 02-88564.
• Citation: 346 B.R. 621
• 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

346 B.R. 621

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.

August 2, 2006.

COPYRIGHT MATERIAL OMITTED

COPYRIGHT MATERIAL OMITTED

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.

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, for the Defendants.

MEMORANDUM OF DECISION AND ORDER

STAN BERNSTEIN, Bankruptcy Judge.

Introduction

In a prior decision¹, the Court disqualified the defendants' witness, Scott P. Peltz, C.P.A., from submitting a report and testifying as an expert on (1) the total enterprise value of the defendant Addus Health Care, Inc. (Addus), a privately held company, as of January 8, 2002, and (2) the exchange value of an alleged six and a half month option and/or extension agreement between Addus, as seller, and the debtor, Med Diversified, Inc. (Med D) as purchaser, for which Med D paid $7.5 million to purchase 100% of Addus' shares, as framed by an unsigned First Amendment to the Stock Purchase Agreement (First Amendment).

A. Contentions of the Parties

If the $7.5 million were treated as the purchase price for an option, the "strike" or "exercise price" for the shares under the Stock Purchase Agreement would have been not less than $119.9 million.² The plaintiffs sought to prove that the fair market value Of the shares as of January 8, 2002, the date of the execution of the Stock Purchase Agreement, was $21 million, based solely upon the enterprise valuation according to its proposed expert, Robert J. Cimasi (Cimasi). If this valuation of the shares were adopted by the Court, the plaintiffs argue that this Court would then necessarily have to find and conclude that the $7.5 million payment for the option and/or extension agreement was not for reasonably equivalent or fair value.³ Alternatively, the plaintiffs argue that since the First Amendment was never authorized by Med D's board of directors and never signed by Med D's CEO, then the $7.5 million is recoverable as an ultra vires payment, and it does not matter what the value of the option and/or extension may have been worth if the payment had been authorized.

The defendants counter by averring that the First Amendment was substantially performed and that the $7.5 million payment is not recoverable. Moreover, the defendants further aver that Med D's board did authorize the CEO to enter into any further agreements to implement the Stock Purchase Agreement before the $7.5 payment was made, or ratified it immediately thereafter. Finally, the defendants aver that the value of the shares, according to its expert, was at least $89 million as of February 14, 2002, and that an option price of $7.5 for a six and a half month period was for reasonably equivalent or fair value.⁴

B. A Summary of the Discussion

The Court now turns to the defendants' cross-motion in limine to deny admission of the expert report and testimony of Cimasi on the ground that in applying the standard methodologies for an enterprise valuation of Addus, he exhibited such a deliberate, manifest, pervasive, and systematic bias in selecting his data points, in adjusting the data points, and in assigning weights to the data points in order to drive his valuation opinion toward its lowest levels that his report and testimony have to be excluded as fundamentally unreliable.

After reviewing all of the evidence, the Court has determined to grant the defendants' cross-motion in limine and exclude Cimasi's expert testimony and report. As this memorandum amply attests, the deliberate, manifest, pervasive and systematic bias on Cimasi's part in applying the standard methodologies for estimating the total enterprise value of Addus warrants disqualifying him and his report on the principal ground of unreliability. The Court has taken considerable pains to point out the myriad ways in which Cimasi deliberately drove his adjustments of the discount rate and other variables toward the lowest order of value in order to accomplish his client's implicit bidding, notwithstanding his protestations of objectivity. Perhaps this memorandum of decision may assist other bankruptcy courts in framing their decisions on motions in limine under the evolving standards of disqualification of purported non-scientific expert witnesses under the United States Supreme Court's Kumho decision with respect to financial matters.

Background and Procedural History

The background to this adversary proceeding was discussed at length in the Court's prior Memorandum and Decision,⁵ and this Memorandum of Decision "presupposes familiarity" with the prior Memorandum, part of which is reproduced here as a matter for the reader's convenience. The relevant transactional history is this: 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 privately held shares of stock of Addus. On January 24, 2002, the parties executed a Modification to the SPA under which the sales price was set at approximately $119.9 million. Under the Modification, the closing date for the transaction was scheduled for February 14, 2002.

What happened next is in material dispute.⁶ The parties agree that sometime before February 14, 2002, Med D and Addus began negotiating a further "amendment" to the modified agreement. 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 approximately $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 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 the defendant W. Andrew Wright (Wright). In fact, all of the $7.5 million was immediately transferred to Wright. Within a very short period of time, he advanced $4 million of these proceeds to Addus for its urgent working capital needs, 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 the defendants retained the $7.5 million.

Within a month after the joint escrow was distributed to the parties, Med D filed an action, based upon common law or state law claims, 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.⁷ That action was quickly dismissed by the plaintiffs and then refiled as an amended complaint. That amended action was removed to the Federal District Court for the Central District of California, Western Division, sitting in Los Angeles.⁸ That action was removed once again to the Federal District for the Northern District of Illinois (the Chicago Action).⁹ Med D and several, but not all, of its affiliates filed petitions for relief with this Court in late November of 2002, 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, alleging claims arising under the Bankruptcy Code as well as related state law claims. 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. The defendants have also raised counterclaims alleging actual and consequential damages from an alleged breach of contract under the SPA, as modified.

In their pretrial statement, the plaintiffs listed Cimasi as their expert on business valuation, and filed a motion in limine to exclude all of the testimony of defendants' expert on business valuation, Scott P. Feltz (Peltz), on the ground that he does not qualify as an expert on valuation of all of the shares...