In re Regional Diagnostics, LLC

• Decision Date: 01 June 2007
• Docket Number: Adversary Proceeding No. 06-1957.,Bankruptcy No. 05-15262.
• Citation: 372 B.R. 3
• Parties: In re REGIONAL DIAGNOSTICS, LLC., et al., Debtors. Robert A. Morris, Creditors' Trustee of DKRC, LLC, f/k/a Regional Diagnostics, LLC, et al., Plaintiff, v. James V. Zelch, et al., Defendants.
• Court: U.S. Bankruptcy Court — Northern District of Ohio

372 B.R. 3

In re REGIONAL DIAGNOSTICS, LLC., et al., Debtors.

Robert A. Morris, Creditors' Trustee of DKRC, LLC, f/k/a Regional Diagnostics, LLC, et al., Plaintiff, v. James V. Zelch, et al., Defendants.

Bankruptcy No. 05-15262.

Adversary Proceeding No. 06-1957.

United States Bankruptcy Court, N.D. Ohio, Eastern Division.

June 1, 2007.

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Frank R. DeSantis, Thompson Hine LLP, Thomas P. Marotta, Andrew L. Turscak, Jr., Cleveland, OH, John D. Eaton, Paul Steven Singerman, Berger Singerman, P.A., Ft. Lauderdale, FL, Barbra Rachel Parlin, New York, NY, for Defendants.

Michael S. Fox, Fredrick J. Levy, Olshan Grundman Frome Rosenzweig & Wolosky, New York, NY, for Plaintiff.

MEMORANDUM OF OPINION

PAT E. MORGENSTERN-CLARREN, Bankruptcy Judge.

In this action, the chapter 11 creditors' trustee seeks to recover funds from multiple defendants following confirmation of the debtors' plan of reorganization.¹ Two sets of defendants bring separate motions to dismiss.² For the reasons stated below, both motions are denied, and the plaintiff is ordered to amend count I of the complaint to comply with federal rule of civil procedure 9 (made applicable by federal rule of bankruptcy procedure 7009).

JURISDICTION

Jurisdiction exists under 28 U.S.C. § 1334 and General Order No. 84 entered by the United States District Court for the Northern District of Ohio. At this point in the proceedings, it is unnecessary to distinguish between core and non-core claims. See Thickstun Bros. Equip. Co., Inc. v. Encompass Servs. Corp. (In re Thickstun Bros. Equip. Co., Inc.), 344 B.R. 515, 520 (6th Cir. BAP 2006) (noting that it is only necessary to determine whether the matter is "related to" the bankruptcy to decide whether the matter is within the bankruptcy court's jurisdiction). The court finds that counts I, II, IV, V, VI, and VII are at least related to the bankruptcy, as the successful or unsuccessful adjudication of those claims (either before or after confirmation) could have altered the debtors' rights, liabilities, or options, and thereby impacted the handling and administration of the bankrupt estate. See Lindsey v. O'Brien, Tanski, Tanzer & Young Health Care Providers of Conn. (In re Dow Corning Corp.), 86 F.3d 482, 489 (6th Cir.1996). Of the seven counts in the complaint, the parties only dispute the court's jurisdiction over count III. As discussed below in connection with the motion to dismiss brought by Mark A. Abbott, Barry J. Uphoff, and Robert W. Koehn, the court finds that it has jurisdiction over that claim.

FACTS

Procedural History

Regional Diagnostics L.L.C. (RDI), Regional Diagnostics Holdings, L.L.C. (RDH), and TR Radiology, Inc. (TRR) (collectively, the debtors) filed voluntary chapter 11 petitions on April 20, 2005.³ On February 8, 2006, the court approved the debtors' Second Amended Disclosure Statement (the disclosure statement).⁴ Then, on April 7, 2006, the court entered an order (the confirmation order)⁵ confirming The Second Amended Joint Plan of Liquidation (the plan).⁶ Pursuant to the confirmation order, plaintiff Robert A. Morris was appointed as creditors' trustee.

Following confirmation, the plaintiff filed a complaint against James V. Zelch, M.D., Mark Zelch, Nancy Lynn Westrich, M.D., Regional Health Services, Inc. (RHS), JVZ Partners Limited (JVZ), and JZ Investment Corp. (JZ) (collectively, the Zelch Defendants), and Mark A. Abbott, Barry J. Uphoff, and Robert W. Koehn (collectively, the Trivest Manager Defendants).⁷ The complaint states these seven causes of action:

(1) Fraudulent Transfers Based Upon Actual Fraud (Count I) against all of the Zelch Defendants;

(2) Fraudulent Transfers Based Upon Constructive Fraud (Count II) against all of the Zelch Defendants;

(3) Breach of Fiduciary Duty (Count III) against Dr. Zelch, Mark Zelch, and the Trivest Manager Defendants;

(4) Unjust Enrichment (Count IV) against all of the Zelch Defendants;

(5) Conversion (Count V) against Dr. Zelch and Mark Zelch (6) Equitable Subordination of Seller Entities' Claims (Count VI) against RHS, JVZ, and JZ; and

(7) Objection to Claim of Seller Entities Pursuant to 11 U.S.C. § 502 (Count VII) against RHS, JVZ, and JZ.⁸

In response, the Zelch Defendants and the Trivest Manager Defendants filed separate motions to dismiss. The Zelch Defendants request dismissal under federal rules of civil procedure 9, 12, and 19 (made applicable by federal rules of bankruptcy procedure 7009, 7012, and 7019) and the principle of res judicata.⁹ The Trivest Manager Defendants move to dismiss under federal rules of civil procedure 12(b)(1) and (6) (made applicable by federal rule of bankruptcy procedure 7012(b)).¹⁰ The parties filed briefs in support of and in opposition to these motions.¹¹

Factual Allegations in the Complaint

The factual allegations that underlie the complaint center around a leveraged buyout (LBO) of Dr. Zelch's company, RDI.¹² Dr. Zelch founded RDI, a medical services company that performed MRIs, CT scans, ultrasounds, X-rays, and other services.¹³ Dr. Zelch and his family owned RDI until March of 2003, when they sold a 60% interest in the company to Trivest Partners, L.P. for approximately $52.5 million ($42.5 million in cash and $10 million in the form of a seller's note).¹⁴ To finance this purchase, RDI obtained approximately $26 million in senior secured loans from Merrill Lynch and Royal Bank of Canada.¹⁵ RDI obtained an additional $13.5 million in senior subordinated loans from Gleacher Mezzanine and Banc Boston Investments, Inc.¹⁶ These additional loans took the form of so-called "mezzanine financing," a hybrid of debt and equity financing.¹⁷

The plaintiff alleges that this arrangement amounted to wrongdoing on the part of the defendants because, at the time of the sale, RDI was grossly overvalued.¹⁸ According to the plaintiff, the large shareholder payments were justified by an initial value of RDI at approximately $73.2 million.¹⁹ The parties to the sale negotiated a price based on a complex formula using RDI's 2002 earnings before interest, tax, depreciation and amortization (EBITDA) as a significant variable.²⁰ Because of the EBITDA's importance, the parties to the sale retained the accounting firm of Crowe Chizek and Company LLC to calculate RDI's EBITDA for 2002.²¹ The plaintiff alleges that Dr. Zelch and Mark Zelch impeded the ability of Crowe Chizek and RDI's interim CFO, Michael Brodeur, to perform this audit in order to maintain an inflated price for the company.²² Where the sellers initially estimated the EBITDA at about $12.5 million, Crowe Chizek calculated that amount as $10.9 million.²³ However, according to the complaint, Crowe Chizek now acknowledges that RDI's 2002 EBITDA was significantly less than $10.9 million, with one estimate placing this value as low as $8.6 million.²⁴

The problems with the LBO continued. At the time of the sale, RDI was in a precarious financial condition, a fact allegedly known by all or some of the defendants.²⁵ According to the complaint, all or some of the defendants pushed the LBO through despite this knowledge.²⁶ Additionally, all or some of the defendants allegedly engaged in intentional fraud and breaches of fiduciary duty, including maintaining abysmal accounting and financial operations,²⁷ using obsolete and aged equipment,²⁸ withholding information from buyers that could affect the future of the business,²⁹ failing to comply with regulatory standards,³⁰ installing "incompetent" friends and family members in key RDI positions to maintain control of the company following the LBO,³¹ diverting expenses to fraudulently inflate RDI's EBITDA,³² acting to undermine and compete with RDI's business,³³ and failing to establish management services operation agreements with other Zelch-controlled entities, effectively allowing all or some of the Zelch Defendants to divert RDI funds to non-RDI operations.³⁴

In the end, the allegations continue, because of the dire financial state of RDI and the acts of the defendants, the company was so highly leveraged that it defaulted on its loan payments mere months after the parties completed the LBO³⁵ In other words, the debtors' bankruptcy was an inevitable result of the defendants' wrongdoing. Accordingly, the plaintiff brought this action: (1) "to recover for gross breaches of fiduciary duties" both before and after the LBO, (2) "to recover the cash payments received by the Zelch family under the theories of conversion and unjust enrichment," and (3) to object to, and seek equitable subordination of, claims of the defendants against the debtors' estates.³⁶

DISCUSSION

I. The Zelch Defendants' Motion to Dismiss

The Zelch Defendants argue that counts I through VI must be dismissed because they are barred by res judicata.³⁷ Additionally, they argue count I, Fraudulent Transfers Based Upon Actual Fraud, should be dismissed because the plaintiff failed to plead fraud with particularity as required by rule 9(b).³⁸ Further, they argue that the complaint fails to name a number of necessary parties in violation of rule 19, and that the allegations contained in count III, Breach of Fiduciary Duty, require at a minimum a more definite statement under rule 12(e).³⁹ For the reasons stated below, the Zelch Defendants' motion to dismiss is denied; however, the plaintiff is to amend count I to conform to the requirements of rule 9.

A. Dismissal Based on Res Judicata

The Zelch Defendants argue that the principle of res judicata applies to counts I through VI.⁴⁰ Those counts, along with count VII, which is premised upon the allegations in counts I through VI, must be dismissed, the Zelch Defendants continue, because the plaintiff is barred from bringing claims that should have been addressed before the plan was confirmed. The plaintiff does not dispute the well-recognized principle that chapter 11 plans have res judicata effect with respect to claims that became assets of the ...