Jensen v. Thompson
| Decision Date | 22 March 2018 |
| Docket Number | Case No: 17-CV-4014-LLP |
| Parties | WADE K. JENSEN, as trustee of the DeAnna W. Jensen Living Trust dated January 26, 2012, and any amendments thereto; DAN KENSINGER; RAYMOND SHERMAN, trustee of the Raymond Sherman Trust, and any amendments thereto; STEVEN STOKESBARY; STEVE MEYER; GRANT SHUMAKER; THOMAS KENNY; TOM JACOB SON; ELISABETH NOEL, as trustee of the Elisabeth J. Noel Trust, and any amendments thereto; SARAH POWELL; RYAN MEIS; and MATTHEW JOHNSON, Plaintiffs, v. WAYNE THOMPSON; MICHAEL HURLBURT; DANIEL RISSING; DANIEL NEWELL, Defendants. |
| Court | U.S. District Court — District of South Dakota |
Pending before the Court is Defendants Wayne Thompson, Michael Hurlburt, and Daniel Rissing's (Management Defendants) Motion to Dismiss, Doc. 26, pursuant to Rules 12(b)(1) and 12(b)(6) of the Federal Rules of Civil Procedure. In their motion, Management Defendants ask that the federal security claims be dismissed for several reasons, including: 1) the claims are barred by the statute of limitations; 2) the complaint fails to meet the heightened pleading standards required under the Private Securities Litigation Reform Act (PSLRA) and Rule 9(b) of the Federal Rules of Civil Procedure; and 3) the complaint fails to raise a strong inference of scienter, show materiality of the alleged misrepresentations or omissions, or adequately allege reliance or loss causation. Additionally, Management Defendants ask that the state law claims be dismissed as they 1) necessarily rely on supplemental jurisdiction, which would be lacking should the motion to dismiss the federal securities claims be granted, and 2) are also inadequately pled as they do not meet the standards of Rule 9(b). Management Defendants also assert that South Dakota law does recognize claims for "Fraud in Relation to a Contract" and that they did not contract with the Plaintiffs, a necessary requirement of the cause of action for Fraud in Relation to Contract under S.D. Code § 53-4-5. Finally, Management Defendants argue that the claim for Breach of State-Law Fiduciary Duty is a derivative action and the necessary procedural prerequisites for bringing a derivative action in federal court have not been met. For the following reasons, Management Defendants' motion is granted in part and denied in part.
Also pending before the Court is Defendant Daniel Newell's Motion to Dismiss, Doc. 28. With the exception of Count I, Plaintiffs complaint alleges all of the same causes of action against Defendant Newell. Similarly, for the reasons below, Defendant Newell's motion is granted in part and denied in part.
BACKGROUND
Accepting Plaintiffs' allegations as true and giving Plaintiffs the benefit of all reasonable inferences, the Court lays out the following facts in accordance with the pleadings. See Frey v. City of Herculaneum, 44 F.3d 667, 671 (8th Cir. 1995) (). Plaintiffs—eleven physicians and one widow of a deceased physician—allege they were defrauded by Defendants, who are managers and/or directors of non-party Progressive Acute Care, LLC (PAC), when Defendants solicited the Physicians' investment in PAC by misrepresenting or omitting material information regarding historical and projected financial performance of the investment. PAC was founded in 2008 under the laws of the state of South Carolina and engages in the for-profit acquisition and management of rural hospitals. PAC is managed by three individuals, the Management Defendants—Thompson as Chief Financial Officer, Hurlburt as Chief Operating Officer, and Rissing as Chief Executive Officer. Each of the Management Defendants also sits on PAC's Board of Directors along with Defendant Newell. Newell is a licensed CPA and was a member of PAC's Audit Committee at all times during the relevant period.
In 2009, PAC acquired and began operating three rural hospitals in central Louisiana, thanks in part to the investments of Plaintiffs and others. Sometime around late 2012 to early 2013, Management Defendants suggested that PAC purchase a fourth hospital—Dauterive Hospital (Dauterive). Defendants solicited additional capital from the Plaintiffs for this investment through a private placement memorandum (PPM) and in-person meetings. An in-person meeting took place in Dakota Dunes, South Dakota in February of 2013, whereManagement Defendants "walked [Plaintiffs] through key parts of the PPM. Defendant Newell was evidently not present at this meeting. In April 2013, Plaintiffs were presented with the PPM itself, which also contains a Due Diligence Report, dated February 8, 2013, which purportedly discussed the historical performance of Dauterive. The PPM contained a table which purports to "[set] forth the summary historical financial information" of Dauterive for the fiscal years ended December 31, 2011 and 2012. Doc. 32-1 at 75. The PPM states that the information "was derived from Dauterive Hospital's internal unaudited financial statements which were prepared by the seller and are not reflective or in accordance with generally accepted accounting principles (GAAP)". Id. "Therefore," the PPM advised, "this unaudited historical financial information may differ materially and completely from GAAP and may be substantially incomplete for your purposes in evaluating Dauterive Hospital's financial results." Id. According to the provided information, Dauterive's net income with interest, taxes, depreciation, and amortization (EBITDA) was $3.72 million in 2011 and $2.434 million in 2012. Id.
The next section of the PPM is entitled "Projected Pro Forma Financial Information" and contains a summary of a four year projection for fiscal years 2013-2016. Id. at 76. The projections were prepared "based solely upon our analysis and on the assumptions...listed related to revenues, expenses, and other factors." Id. The PPM states that its authors had not "verified or confirmed the reasonableness of the assumptions contained in the projections" and lists a total of eleven assumptions the financial projects are based on. Id. The projected EBITDA for 2013 was $4.131 million, $9.169 million in 2014, $9.625 million in 2015, and $8.122 million in 2016. Id. at 77. Finally, the PPM contains a lengthy description of risk factors associated with the acquisition, including risks that accompany running a business in the healthcare industry, government regulations and taxes that may impact the business, problems with deriving financial projections from unaudited information prepared by the seller, and the fact that PAC's accounting department had yet to operate in a company as large as PAC would become after the potential Dauterive acquisition. Id. at 84-119.
Plaintiffs state in their complaint that Plaintiffs agreed to invest the $3 million in equity required for PAC to complete the Dauterive acquisition following the February 2013 in-person meeting in Dakota Dunes. The final version of the PPM was dated April 8, 2013 and stated that the signed participation agreement and check had to be returned by April 22, 2013. The signed participation agreements that were dated all had dates after April 8, 2013. In return for theirinvestment, they received a number of Series B Preferred Units in proportion to their existing equity ownership of PAC. It is uncontested that these Series B Preferred Units and their exchange fall under the Securities Exchange Act of 1934. Plaintiffs also approved the Management Defendants obtaining financing for the remainder of the $15 million purchase price with bank debt. Plaintiffs were also promised that each of the Management Defendants would enter into a $1 million personal guarantee for the bank loan. Plaintiffs maintain these guarantees were illusory.
PAC formally agreed to purchase Dauterive in May 2013. Following the Dauterive acquisition, the PAC Board of Directors increased the Management Defendants' compensation to $400,000 annually, along with short-term incentive compensation of up to 100% of the base salary. Management Defendants were also entitled to 25% of the cash distributions if the 3-year average EBITDA fell between $0-$3.39 million and could obtain as much as 40% of cash distributions with an EBITDA of $19.1 million or more.
Plaintiffs "received little information regarding PAC's financial health outside of an annual investors update and/or PowerPoint presentation from the Management Defendants" but by early 2014, PAC began defaulting on its bank loans. Dauterive's cash flow from operations sunk to -$4.7 million in 2014 and -$6.1 million in 2015, a far cry from the projected EBITDA of $6 million as provided by the PPM. Though PAC's other three hospitals continued to remain profitable, Plaintiffs received information in the spring of 2016 that PAC would potentially need to file for bankruptcy.
On May 18, 2016, some of the Plaintiffs met with "some or all of the Management Defendants" and PAC's legal counsel in Dakota Dunes. Multiple Plaintiffs were unable to attend the meeting other than by proxy, which was entrusted to Management Defendant Hurlburt. Hurlburt informed the Plaintiffs "that the 'perfect storm' of factors had hit PAC and left the company insolvent." Management Defendants briefly summarized PAC's financial state, advised the Plaintiffs that were present that PAC was defaulting on payments due, and informed them that a group of emergency-room physicians had obtained a $1.2 million judgment against PAC, making time of the essence because PAC could not currently pay that judgment.
Management Defendants called for a vote, with Defendant Hurlburt casting the proxy votes for each absent member. Feeling under pressure and ill-prepared to discuss the company's financial situation due to a lack of prior information, Plaintiffs authorized the filing of thebankruptcy. It was through the Bankruptcy process that Plaintiffs came to discover...
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