Sama v. Mullaney (In re Wonderwork, Inc.)

• Citation: 611 B.R. 169
• Decision Date: 17 January 2020
• Docket Number: Case No. 16-13607 (SMB),Adv. Pro. No. 18-01873 (SMB)
• Parties: IN RE: WONDERWORK, INC., Debtor Vincent A. Sama, as Litigation Trustee of the WW Litigation Trust, Plaintiff, v. Brian Mullaney, Hana Fuchs, Theodore Dysart, Ravi Kant, John J. Coneys, Steven Levitt, Clark Kokich, Steven Rappaport, Richard Price, and Mark Atkinson, Defendants.
• Court: United States Bankruptcy Courts. Second Circuit. U.S. Bankruptcy Court — Southern District of New York

611 B.R. 169

IN RE: WONDERWORK, INC., Debtor

Vincent A. Sama, as Litigation Trustee of the WW Litigation Trust, Plaintiff,

v.Brian Mullaney, Hana Fuchs, Theodore Dysart, Ravi Kant, John J. Coneys, Steven Levitt, Clark Kokich, Steven Rappaport, Richard Price, and Mark Atkinson, Defendants.

Case No. 16-13607 (SMB)

Adv. Pro. No. 18-01873 (SMB)

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

Signed January 17, 2020

ARNOLD & PORTER KAYE SCHOLLER LLP, 250 West 55th Street, New York, New York 10019, Benjamin Mintz, Esq., Peta Gordon, Esq., Of Counsel Attorneys for Plaintiff Vincent A. Sama, as Trustee of the WW Litigation Trust.

STORCH AMINI PC, 140 East 45th Street, 25th Floor, New York, New York 10017, Bijan Amini, Esq., Edward P. Dolido, Esq., Jeffrey Chubak, Esq., Of Counsel Attorneys for Defendant Brian Mullaney.

DRINKER BIDDLE & REATH LLP, 1177 Avenue of the Americas, 41st Floor, New York, New York 10036-2714, Frank F. Velocci, Esq., Of Counsel Attorneys for Defendant Theodore Dysart.

CERTILMAN BALIN ADLER & HYMAN, LLP, 90 Merrick Avenue – 9th Floor, East Meadow, New York 11554, Paul B. Sweeney, Esq., Nicole L. Milone, Esq., Of Counsel Attorneys for Defendant John J. Coneys.

SMITH, GAMBRELL & RUSSELL, LLP, 1301 Avenue of the Americas, 21st Floor, New York, New York 10019, John G. McCarthy, Esq., Victor M. Metsch, Esq., Edward J. Heppt, Esq., Of Counsel Attorneys for Defendants Steven Levitt, Clark Kokich, Steven Rappaport and Richard Price

LAW OFFICE OF ROBERT R. VIDUCICH, 40 Wall Street, 28th Floor, New York, New York 10005, Robert R. Viducich, Esq., Of Counsel Attorneys for Defendant Hana Fuchs.

MEMORANDUM DECISION GRANTING IN PART AND DENYING IN PART DEFENDANTS' MOTIONS TO DISMISS

STUART M. BERNSTEIN, United States Bankruptcy Judge

The plaintiff, Vincent A. Sama, as trustee of the WW Litigation Trust ("Plaintiff"), asserts thirteen causes of action against nine remaining defendants (Kant was never served), all former officers and directors of the debtor WonderWork, Inc. ("Debtor" or "WW"). (Complaint , dated Dec. 28, 2018 (ECF Doc. # 1).)¹ They include Brian Mullaney, the Debtor's founder and former chief executive officer, Hana Fuchs, its former chief financial officer and Theodore Dysart, John J. Coneys, Steven Levitt, Clark Kokich, Steven Rappaport, Richard Price, and Mark Atkinson, all former directors ("Director Defendants" and collectively with Mullaney and Fuchs, the "Defendants"). Each of the Defendants moved to dismiss the Complaint .² For the reasons that follow, the Defendants' motions to dismiss are granted in part and denied in part, and the Plaintiff is granted leave to replead.

BACKGROUND³

The Debtor was formed by Mullaney as a not-for-profit corporation under Delaware law on or about March 7, 2011. (¶ 5.) According to its amended certificate of incorporation:

The purposes for which the Corporation is formed are to provide treatment, surgery, and related assistance to children in developing countries suffering from disease, illness, or malady, including but not necessarily limited to blindness, cleft palate

, club foot, hydrocephalus, and burns; and to further support and educate doctors and the public on potential treatments and surgical techniques, as well as creating general awareness of these maladies and available treatments.

(¶ 46; Notice of Filing of Volume 1 of Redacted Document Exhibits to Final Report of Jason R. Lilien, Examiner ("Volume 1 of Exhibits "), Ex. 3, at WON-EX 0019 (Case No. 16-13607, ECF Doc. # 336).) WW was further authorized to "engage in other charitable and educational activities" consistent with its federal tax-exempt status under I.R.C. § 501(c)(3) and to "engage in all lawful activities for which nonprofit corporations may be organized" under Delaware law. (Volume 1 of Exhibits , Ex. 3, at WON-EX 0019.)

WW obtained tax-exempt status from the Internal Revenue Service on September 1, 2011 and was registered to solicit charitable contributions under Article 7-A of the New York Executive Law in May 2012. (¶ 41.) Under Article 7-A, WW was required to comply with registration and solicitation laws and make certain annual public financial reporting. (¶ 42.) These reports were certified as correct each year by Mullaney and Fuchs. (¶ 43.)

A. WW's Board and Management

Different Director Defendants served on WW's Board of Directors ("Board") at different times. At the first meeting on April 12, 2012, attended by Mullaney and Dysart, Mullaney was selected as president and Dysart as secretary and treasurer. (¶ 45.) Coneys joined the Board in December 2012 and at times served as the "Lead Independent Director." (¶¶ 12, 48.)

The Board formed an audit committee at its February 2013 meeting with Coneys as chair and nominating and compensation committees with Dysart as chair. (¶ 49.) There is no evidence of any formal meetings of these committees. (¶ 50.) Dysart resigned from the Board in or about November 2015 "following disagreements with Mullaney, in particular with respect to Mullaney's compensation and whether employment counsel should be employed in connection with formalizing Mullaney's employment agreement." (¶ 51.)

Defendants Levitt, Kokich, Rappaport, Price and Atkinson ("2015 Directors") joined the Board in December 2015 but did not attend a Board meeting until March 2016. (¶ 52.) At a June 2016 Board Meeting, the Board reconstituted the audit, nominating, and compensation committees, with Coneys, Kant, Kokich, and Levitt serving on the nominating and compensation committee and Coneys and Rappaport serving on the audit committee. In addition, non-defendant Richard Steele, Coneys and Mullaney staffed the finance and investment committee. After the Debtor filed its chapter 11 petition on December 29, 2016 ("Petition Date"), Kant and Steele resigned from the Board leaving Mullaney, Coneys, Kokich, Levitt, Rappaport, Price and Atkinson as the remaining directors. (¶¶ 23, 54.)

Although it is not clear that Mullaney was ever formally named chairman of the Board, he served in that role for all intents and purposes. (¶ 55.) After the Better Business Bureau told WW that its

accreditation required a charity's chairman of the Board to be different from a charity's CEO, Coneys was identified as WW's "Lead Independent Director." (¶ 55.) As Lead Independent Director, Coneys' role was "primarily to finalize Mullaney's employment agreement in late 2015, which had been in negotiation since October 2012 and had taken up a considerable amount of Board time." (¶ 55.)

B. Mullaney's Compensation

The principal claims asserted in the adversary proceeding center on Mullaney's compensation and perquisites. His compensation included an annual base salary of $475,000 and annual bonuses of between $200,000 and $250,000, the same compensation he had received from his prior employer, Smile Train, Inc. ("Smile Train" or "ST"). (¶¶ 57, 59.) However, ST raised $120 million in Mullaney's last year and funded 120,000 surgeries per year. (¶ 59.) By contrast, WW raised $12 million in its best year. (¶ 59.) Mullaney's additional benefits included commuting costs between New York and Boston, first class travel for him and his spouse, personal life insurance, and hundreds of thousands of dollars of expenses. (¶ 57.)

At Dysart's recommendation, and over Mullaney's objection, the Board retained a compensation consultant in May 2013, Pearl Meyer & Partners ("Pearl Meyer"), to evaluate Mullaney's salary. (¶ 60.) Pearl Meyer warned Dysart that it might not be able to conclude that Mullaney's salary was reasonable under section 4958 of the Internal Revenue Code, known as the "Intermediate Sanctions" rule.⁴ (¶ 60.) Pearl Meyer's engagement letter provided an incentive in the form of a $5,000.00 fee increase (over the $18,137.00 it was receiving to evaluate Mullaney's compensation) if it could state that his pay was reasonable under the Intermediate Sanctions rule. (¶ 60.)

Pearl Meyer presented its final report ("Pearl Meyer Report") at a Board meeting on June 13, 2013. (¶ 60; Notice of Filing of Volume 1 of Redacted Interview Transcripts and Exhibits to Final Report of Jason R. Lilien, Examiner ("Volume 1 of Transcripts and Exhibits "), Mullaney Exhibit 43,⁵ (Case No. 16-13607, ECF Doc. # 339).) The Pearl Meyer Report did not state that Mullaney's compensation was reasonable under the "Intermediate Sanctions" rule, (¶ 60), and declined to express an opinion on whether Mullaney's compensation was reasonable. (¶ 66.) It concluded that Mullaney's base salary was at the high end of the competitive range and his bonus was very high for a non-profit. It would only be warranted if Mullaney were able to repeat his success at ST. (¶ 65.) Pearl Meyer recommended that if the Board accepted the peer groupings as reasonable,⁶ it should keep Mullaney's salary at $475,000.00 but offer a bonus in the range of $50,000.00 to $200,000.00 if his performance warranted it. (¶ 66.) The Pearl Meyer Report also recommended, among other things, that the Board quantify his other forms of compensation, such as spousal travel expenses, commuting expenses, etc ., in determining the amount of his bonus and periodically review his compensation package. (¶ 66.)

The Board did not follow Pearl Meyer's recommendations.⁷ (¶ 67.) It never quantified Mullaney's other compensation, never again reviewed Mullaney's compensation and awarded him a $250,000.00 bonus every year except 2015, when it awarded him a $200,000.00 bonus. (¶ 67.)

As a result of an effort led by Coneys after Dysart's resignation, the Board entered into a written employment agreement with Mullaney in December 2015 ("Employment Agreement"). (¶ 68; Mullaney Exhibit 41, at WON1237.) The Employment Agreement provided a yearly salary of $475,000.00, a discretionary bonus of $250,000.00 and payment of various other benefits such as spousal travel and life insurance premiums. (¶ 69.)

As noted, WW also paid for Mullaney's other expenses that were either excessive or personal and the Board failed to follow its...