Chancery Court Dismisses Breach of Fiduciary Duty Claims Against Company and Its Board of Directors Relating to 2014 Recapitalization, But Holds That Contract Claims May Proceed

By Annette Becker and Lauren Garraux

In a July 8, 2015 letter opinion, Vice Chancellor John W. Noble granted in part and denied in part the motion of Capella Holdings, Inc. and Capella Healthcare, Inc. (“Capella” or the “Company”) and five Capella directors (the “Director Defendants”) (collectively, “Defendants”) to dismiss breach of fiduciary duty and breach of contract claims asserted against them by James Thomas Anderson (“Anderson”), a founder and former director and officer of Capella, relating to a 2014 recapitalization of the Company.

Anderson’s counterclaims against Defendants all arise from a recapitalization of Capella which the Director Defendants approved in April 2014.  Anderson voted against the recapitalization, which decreased Anderson’s ownership percentage in the Company, as well as that of the minority shareholders, and increased the ownership percentage of affiliates of GTCR Golder Rauner II LLC (“GTCR”), which, upon Capella’s formation, made an equity investment of approximately $206 million in the Company.

Anderson thereafter filed an action in Tennessee state court alleging breaches of contract and fiduciary duty in connection with the recapitalization and seeking rescission of the recapitalization.  Capella responded to the complaint by terminating Anderson “for cause” under a Senior Management Agreement (the “SMA”) on grounds that the Tennessee complaint included confidential information about the recapitalization and a 2013 bid to purchase the Company by Apollo Global Management, LLC (“Apollo”).  Capella also refused to pay Anderson severance under the SMA and filed a complaint against him in Delaware Chancery Court.  Anderson voluntarily dismissed the Tennessee action and filed counterclaims against the Defendants in the Delaware action which mirrored the claims he first asserted in Tennessee.  Defendants moved to dismiss Anderson’s counterclaims under Chancery Rule 12(b)(6).

Anderson’s first three counterclaims asserted claims for breach of the duties of loyalty, care and good faith against Defendants in approving the recapitalization.  Specifically, Anderson characterized the recapitalization as unfair, largely based on Apollo’s proposed per share stock price in connection with its 2013 bid.  The Vice Chancellor, however, rejected Anderson’s characterization of the recapitalization and his reliance on the proposed price as “speculative,” holding that Anderson failed to plead an entire fairness case against Defendants arising from the recapitalization.  As a result, the Vice Chancellor granted Defendants’ motion to dismiss Anderson’s breach of fiduciary duty claims.

Anderson’s remaining counterclaims asserted breaches of the SMA by Defendants in (i) authorizing the issuance of greater than 2 million shares of common stock for issuance to other executives and employees, an action which Anderson contended the SMA prohibited, and (ii) terminating him without cause.  Regarding Anderson’s former claim, the Vice Chancellor explained that the SMA does not include language regarding a floor or ceiling on common stock and only requires the Company to reserve approximately 2.2 million common shares for executives and employees.  Notwithstanding, the Vice Chancellor acknowledged that it was “reasonably conceivable” that Anderson suffered from a violation of his contract rights and rights associated with stock ownership, such as voting power, and, therefore, that the claim should proceed.

The Vice Chancellor similarly permitted Anderson’s latter claim to proceed, explaining that, under the SMA, “termination for cause” requires proof of a breach of the duty of loyalty or a material breach of the SMA, conclusions which require factual determinations which could not be made at the motion to dismiss stage.  Accordingly, Anderson’s breach of contract claim relating to his termination was also permitted to proceed.

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