Conspiracy Theory of Personal Jurisdiction Over Director Survives Motion to Dismiss

Hospitalists Of Delaware, LLC v. Lutz, C.A. No. 6221-VCP (Aug. 28, 2012)

In this derivative and direct action, the plaintiffs, two judgment creditors of defendant Cubit Medical Practice Solutions, Inc., a dissolved Delaware corporation, accused Cubit’s three directors, its controlling stockholder, and three other entities within the same corporate family of participating in an “elaborate scheme” to take the company’s assets and then dissolve the company.  While the company’s directors and controlling stockholder consented to personal jurisdiction in Delaware, the three non-Delaware corporate defendants, BCV, BC2 and Integra (collectively the “Moving Defendants”) moved to dismiss this action under Court of Chancery Rule 12(b)(2) for lack of personal jurisdiction.  Additionally, Integra moved to dismiss under Rule 12(b)(6).

BACKGROUND

Plaintiffs, Hospitalists of Delaware, LLC and Morgan Kalman Clinic, P.A. (“MKC”) are well-known professional medical services providers in Delaware.  Cubit was a Delaware corporation operating as a medical billing company with a principal place of business in Ohio before it was dissolved effective on October 8, 2010.  Director defendants Lutz, McIlwraith, and Rosenberg (the “Director Defendants”) comprised Cubit’s board of directors. Defendant Blue Chip IV Limited Partnership (“BC4″), an Ohio limited partnership, was Cubit’s controlling shareholder.  Defendant Blue Chip Venture company, Ltd. (“BCV”), an Ohio limited liability company, was the general partner of both BC4 and Defendant Blue Chip Capital Fund II Limited Partnership (“BC2″), an Ohio limited partnership.

Defendants Change Company Name and Take Down Website to Evade Plaintiffs’ Claims

In 2005, BC4 was the majority owner and a significant note holder of NextMed Systems, Inc., a failing medical billing company.  BC4 formed Cubit in November 2005 as Integra Professional Services, Inc. and then caused Cubit to foreclose on NextMed’s assets.  Plaintiffs argued that in essence, Cubit and Integra were being operated as the same company – they shared certain common directors, officers, employees, office, technology infrastructure and at least one credit card. 

Eventually, both plaintiffs became dissatisfied with the medical billing services that Cubit was providing and in July 2009, Hospitalists threatened suit.  In response, plaintiffs alleged that the defendants “began to devise a plan by which they would either sell or dissolve [Cubit] and, at the same time, extract their investment from [Integra] for the purpose of avoiding [Cubit's] creditors.”  As part of that plan, Cubit changed its name from Integra Professional Services, Inc. to Cubit.  In addition, the day after MKC filed its complaint, “Rosenberg instructed Cubit and [Integra] to ‘take down’ the Cubit website so that it would be as hard as possible for folks to track any of us down, make connections to [Integra], etc.”  Rosenberg then directed Integra to document the management fees it was receiving from Cubit as secured payments so that Integra could claim priority over Cubit’s other creditors in case Integra could be held liable for judgments against Cubit.  Then BC2 effected a redemption of its Integra stock for $2.5 million.

Parties’ Contentions

Plaintiffs argued that the Court may exercise personal jurisdiction over the Moving Defendants because (1) the Director Defendants caused Cubit to file a certificate of dissolution with the Delaware Secretary of State, which constitutes the transaction of business for purposes of long arm jurisdiction, and (2) that filing can be attributed to BCV, BC2, and Integra under the so-called “conspiracy theory” of personal jurisdiction recognized by the Delaware Supreme Court in Istituto Bancario Italiano SpA v. Hunter Engineering Co. 

The Moving Defendants argue that: (i) there is no evidence that they conspired or participated in a scheme to dissolve Cubit; and (ii) Plaintiffs cannot identify any conduct by  BCV, BC2, or Integra as legally distinct entities, showing agreement or participation in a conspiracy separate and apart from the actions the Director Defendants took on behalf of Cubit alone.

Legal Analysis

Under 10 Del. C. §3104, the Delaware Long Arm Statute, “a court may exercise personal jurisdiction over any nonresident . . . who in person or through an agent . . . [t]ransacts any business . . . in the State [and] the filing of a corporate instrument in Delaware that facilitated transactions under challenge in litigation in this court . . . [is] sufficient to constitute the transaction of business under § 3104(c)(l).”  There was no disagreement that the Director Defendants caused the company to file a certificate of dissolution with the Secretary of State which represents a transaction of business for purposes of long arm jurisdiction.  The issue however, was whether the Director Defendants’ actions can be attributed to the Moving Defendants consistent with constitutional due process.

Under the five-part test established in Istituto Bancario, a plaintiff seeking to subject a foreign defendant to jurisdiction in Delaware under a conspiracy theory of jurisdiction, must make a factual showing that:

(1)        a conspiracy to defraud existed;

(2)        the defendant was a member of that conspiracy;

(3)        a substantial act or substantial effect in furtherance of the conspiracy occurred in the forum state;

(4)        the defendant knew or had reason to know of the act in the forum state or that acts outside the forum state would have an effect in the forum state; and

(5)        the act in, or effect on, the forum state was a direct and foreseeable result of the conduct in furtherance of the conspiracy. 

 Istituto Bancario Elements Satisfied

Count III of the complaint is a claim against Integra for aiding and abetting the Director Defendants’ alleged breaches of fiduciary duty.  Under Delaware law, “a claim for aiding and abetting a breach of fiduciary duty satisfies the first and second elements of the Istituto Bancario test.”  The elements of aiding and abetting a breach of fiduciary duty are: “(1) a fiduciary relationship; (2) a breach of that relationship; (3) that the alleged aider and abettor knowingly participated in the fiduciary’s breach of duty; and (4) damages proximately caused by the breach.”  There was no dispute as to factors 1 and 4, but with respect to factors 2 and 3, Integra argued that Plaintiffs failed to plead a breach of duty against the Director Defendants or that Integra “knowingly participated” in the directors’ breaches of their fiduciary duties.

 In rejecting Integra’s argument, the Court noted that “[w]hen a company is insolvent, giving preferential treatment to insider creditors constitutes a self-interested transaction that may breach a director’s duty of loyalty.”  The complaint alleged that the Director Defendants “breached their fiduciary duties by unlawfully dissolving Cubit and engaging in a series of self-dealing and interested transactions . . . to the detriment of Cubit’s creditors, including [P]laintiffs.”  The Court found that that was enough to state a claim for breach of fiduciary duty.  With respect to the third factor, “knowing participation”, the Court stated that factor requires “that the third party act with the knowledge that the conduct advocated or assisted constitutes such a breach.”  In rejecting Integra’s argument, the Court noted that:

[t]he alleged breach of duty in this case includes not only the formal and final act of filing a certificate of dissolution, but also ‘unlawfully dissolving Cubit and engaging in a series of self-dealing and interested transactions’…. Although dissolution of the company was a substantial component of the Director Defendants’ alleged scheme to effect self-dealing transactions, the ‘conduct advocated or assisted constitut[ing the] breach’ was the preferential treatment Cubit gave to a subset of its creditors for self-interested reasons at a time when the company was insolvent and, ultimately, planning to dissolve. Hence, Plaintiffs only need to plead facts permitting an inference that Integra knowingly advocated or assisted the Director Defendants in giving Integra the alleged preferential treatment.

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The brash attitude reflected in Rosenberg’s two emails about managing Cubit’s affairs solely and explicitly to undermine Plaintiffs’ ability to recover on their then-still prospective judgments and to advantage its affiliate Integra is sufficiently suspicious — indeed, even egregious — to permit a reasonable inference that Integra knowingly participated in the preferential treatment it was offered and received.  Integra also knew that Cubit was insolvent; both of its directors served on Cubit’s board and Integra provided day-to-day management services to the company.  Thus, Plaintiffs have alleged that Integra acted with the knowledge that the preferential treatment it advocated or assisted would violate the Director Defendants’ fiduciary duties to Cubit under the circumstances. By doing so, and despite the fact that Integra did not recoup all the management fees to which it was due under its contract with Cubit, Plaintiffs adequately have pled a claim for aiding and abetting against Integra.  

With respect to the third Istituto Bancario element, Cubit’s filing of a certificate of dissolution with the Secretary of State was a substantial act in furtherance of the Director Defendants’ allegedly disloyal scheme to give preferential treatment to Integra. Because the illicit scheme alleged by Plaintiffs involved siphoning Cubit’s assets and then causing the company to dissolve, the filing of the certificate of dissolution was an important action to further the conspiracy.  Moreover, Hospitalists and MKC “are not only Delaware entities, but [also] businesses in Delaware” with “physical bricks-and-mortar businesses in the state.”  To the extent that Plaintiffs accuse Defendants of participating in an “elaborate scheme” to avoid Plaintiffs’ judgments, the alleged scheme itself arguably was designed to have, and did have, a substantial effect in Delaware.

With respect to the fourth and fifth Istituto Bancario elements, the Court found that because Integra was charged with the knowledge of its directors, Lutz and McIlwraith, both of whom authorized Cubit’s dissolution in their alternate capacities as Cubit directors, the act of filing a certificate of dissolution in Delaware was a direct and foreseeable result of conspiring to dissolve a Delaware corporation.  Thus, it was “reasonable to infer that Integra, through Lutz and McIlwraith, knew of the preferential payments to Integra and that, as a result of those payments, Cubit would be unable to afford comparable treatment to Plaintiffs, even though they were (or imminently would be) judgment creditors of the company.”

No Conspiracy Jurisdiction Over BC2 or BCV

Although the Court found that Integra “knowingly participated” in the Director Defendants’ alleged breaches of duty because (1) an interlocking directorate necessarily would have known of the Director Defendants’ breaches of duty, and (2) Integra, an inside creditor, received priority treatment for the explicit purpose of limiting other creditors’ recovery, the Court stated that reasoning is inapposite to Defendant BC2, however.  None of the Director Defendants served in a board-level position at BC2, and there was no non-conclusory allegation or evidence that BC2 actually participated in wrongdoing.  The Court noted that “[e]ven construing the pleadings and record in the light most favorable to Plaintiffs, something more than a single conclusory allegation is necessary to permit a reasonable inference that BC2 affirmatively participated in the Director Defendants’ breaches of duty. Because nothing more was pled, the aiding and abetting claim against BC2 is not sufficient to support exerting personal jurisdiction over BC2 under a conspiracy theory.

The Court went on to note that while “Plaintiffs could satisfy the first two Istituto Bancario elements consistent with the test’s literal terms by pleading a claim for civil conspiracy…the only suspicious aspect of the redemption is its temporal proximity to Cubit’s dissolution, an aspect explained by uncontested evidence that BC2 itself was liquidating for unrelated and legitimate reasons during the same period. Thus, the Court granted the motion to dismiss as to BC2. 

The Court also found that Plaintiffs’ basis for personal jurisdiction over BCV fails due to the absence of nonconclusory allegations or evidence that BCV conspired or knowingly participated in an unlawful scheme to defraud Cubit’s creditors.  The Court found that there was no indication that BCV participated in any of the events that gave rise to Plaintiffs’ various claims.

INTEGRA’S 12(b)(6) MOTION

Integra contended that: (i)  the aiding and abetting and civil conspiracy claims, fail to state a claim for the same reasons that it moved to dismiss for lack of personal jurisdiction; (ii) the civil conspiracy claim should be dismissed as redundant of the aiding and abetting claim; (iii) with respect to fraudulent transfer, Plaintiffs failed to plead the element of intent with the requisite degree of specificity; and (iv) as to the veil-piercing claim, Plaintiffs’ allegations are insufficient to support a reasonable inference that Cubit lacked an independent identity or acted as an agent of Integra, as opposed to Integra’s acting as Cubit’s agent. 

The Court denied Integra’s motion to dismiss the aiding and abetting claim and the civil conspiracy claim (NOTE: the Court provided an excellent explanation of the differences between aiding and abetting and civil conspiracy).  With respect to the declaratory judgment claim regarding alter ego or veil-piercing, the Court also denied Integra’s motion.   Finally, the Court granted  Integra’s motion to dismiss the fraudulent transfer claim under 6 Del. C. § 1304 due largely to the dearth of relevant factual allegations.