Memorial Hospital, Roxborough v. Home Health Care Corporation of America, Inc.

Although MHR originally contended that this proceeding was a core matter to1
which I could enter final judgment, I previously concluded that it did not involve a turnover
claim under 11 U.S.C. § 542, and was a simple breach of contract action under state law and thus
non-core. See generally Beard v. Braunstein, 914 F.2d 434, 444 (3d Cir. 1990). Therefore,
(continued...)
UNITED STATES BANKRUPTCY COURT
FOR THE EASTERN DISTRICT OF PENNSYLVANIA
In re 	: 	Chapter 11
MEMORIAL HOSPITAL, 	:
ROXBOROUGH
Debtor 	: 	Bankruptcy No. 04-18933bif
____________________________________
MEMORIAL HOSPITAL, 	:
ROXBOROUGH
Plaintiff 	:
v.
:
HOME HEALTH CORPORATION OF 	Adversary No. 04-1059
AMERICA, INC. 	:
Defendant
____________________________________
.................................................
OPINION
.................................................
The debtor, Memorial Hospital, Roxborough (“MHR”), has filed a
complaint alleging that Home Health Corporation of America, Inc. (“HHCA”) breached
an asset purchase agreement by failing to pay the final $850,000 installment of the
purchase price. As will be discussed, HHCA purchased MHR’s home health care
business, known as Roxborough Home Care Division (“RHC”), in January 2004. HHCA
paid MHR only $1 million of the promised $1.85 million, and does not deny that it did
not pay its remaining $850,000 installment. HHCA, however, asserts that it is excused
from further performance due to MHR’s breach of certain contract provisions. 1
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(...continued)1
although MHR agreed to the entry of a final judgment in this forum, the defendant would also
have to consent or I would be limited to issuing a recommendation to the District Court.
HHCA in its answer to plaintiff’s complaint initially declined to consent to the
entry of a final judgment in this bankruptcy court. See generally 28 U.S.C. § 157(c)(1).
Thereafter, HHCA modified its position and did expressly consent to the entry of a final
judgment pursuant to section 157(c)(2) and Fed. R. Bankr. P. 7012(b). See N.T. 5/18/06 at 3;
Defendant’s Unopposed Motion, filed June 17, 2005, at 5 n.1.
2
The parties have engaged in a lengthy trial covering five separate days,
involving numerous exhibits and witnesses. Thereafter, each party submitted two detailed
post-trial memoranda of law. Upon review of these submissions, it is apparent that, at
bottom, HHCA contends that it obtained a much smaller business than it contracted for,
and that MHR is legally responsible for that business reduction. MHR disagrees; the
plaintiff maintains that it fulfilled all of its contractual obligations to HHCA and is
entitled to full payment, with interest.
I now decide this contractual dispute against the following factual
backdrop. In reciting the relevant facts, I observe that relatively few are truly disputed.
Rather, the parties differ over the proper interpretation of those facts. Moreover, they
disagree about the contractual allocation of risk, the appropriate application of the
“adverse change” provisions of the contract, as well as the scope of the plaintiff’s
representations and warranties; moreover, to the extent that MHR did not fully comply
with the terms of the contract, which MHR denies, the parties disagree about the measure
of damages and the allocation of the burden of proof on that issue.
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The parties’ joint pretrial statement contained, inter alia, 71 statements of2
uncontested facts. Those stipulated facts shall be cited as “JPS, ¶ _.”
3
I.
I make the following findings of fact that are material to my resolution of
this contract dispute. In so doing, it was not necessary to address all of the factual issues
posed by the parties.
1. MHR is a Pennsylvania corporation that was, until December 2002,
engaged in the operation of an acute care hospital in Philadelphia, as well as a home
healthcare business. Joint Pre-trial Statement (“JPS”), ¶ 1. 	In December 2002, MHR2
sold its hospital, Roxborough Memorial Hospital, to Tenet Healthcare Systems. JPS, ¶
20. In early 2003, MHR engaged Mr. Mark Feldman as its president and/or chief
executive officer for the purpose of selling the separate home health care business, known
as the Roxborough Home Care Division (“RHC”). He anticipated a liquidation value for
this business between $750,000 and $1,500,000. JPS, ¶ 21; see Ex. D-5; N.T. 5/25/06 at
105-08.
2. In June 2003, Mr. Feldman sent HHCA’s chief executive officer, Mr.
David Geller, a letter enclosing certain financial and other information concerning RHC
and solicited a purchase offer. JPS, ¶ 24; see Ex. D-6. In July 2003, HHCA’s chief
financial officer, Mr. Richard E. Furtek, advised Mr. Feldman that HHCA had sufficient
assets to complete a sale transaction quickly and requested additional information to assist
HHCA in assessing the potential acquisition of MHR’s business. JPS, ¶ 25; see Ex. D-7.
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The letter, sent by MHR, is dated September 9, 2003, and HHCA signed it on3
September 11, 2003.
4
3. In August 2003, based upon the information provided by MHR, HHCA
made a non-binding expression of interest in purchasing RHC at a preliminary valuation
of $2 million to $2.5 million, less any amounts owed for Medicare or Medicaid
overpayments or obligations owing to other federal or state agencies; moreover, the
proposal was subject to change after due diligence. JPS, ¶ 27; see Exs. P-13; D-9; N.T.
5/18/06 at 214.
4. MHR had received four other expressions of interest for RHC, with
those proposals ranging from approximately $700,000 to $1,000,000. JPS, ¶ 28; see Ex.
D-10. Sometime between August 21, 2003 and September 9, 2003, Mr. Feldman advised
Mr. Geller that HHCA’s preliminary non-binding expression of interest was the highest
proposal MHR had received and that MHR wished to proceed to a firm offer and sale.
JPS, ¶ 29.
5. On September 11, 2003, MHR and HHCA signed a nonbinding
“Exclusivity Letter” relating to the acquisition of RHC, pursuant to which HHCA made a
good faith deposit in the amount of $100,000. JPS, ¶ 31; see Ex. D-11. 	This letter3
agreement, inter alia, gave HHCA the right to conduct due diligence. Specifically, it
stated: “Promptly following the date of your execution and delivery of this letter . . . and
payment of the Good Faith Deposit . . . MHR will, at reasonable times and locations,
provide HHCA . . . with access to all information in MHR’s possession, or reasonably
available to MHR, respecting the Business and the Home Health Assets and will make
senior management of the Business available to HHCA.” Ex. D-11.
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5
6. Beginning not later than September 4, 2003, HHCA conducted due
diligence of RHC’s business and financial condition in accordance with an outline
HHCA’s senior management had prepared. Exs. P-8, P-9; N.T. 5/15/06 at 62-63.
7. Mr. Geller is a certified public accountant who had been employed at a
large accounting firm for many years prior to becoming chief financial officer of another
healthcare business. N.T. 5/18/06 at 210. He became chief financial officer of HHCA in
July 1998, and became its chief executive officer in February 1999. Id. As CEO, Mr.
Geller is responsible for “all strategic planning, all financial performance, all operating
performance and all facets of the operations of HHCA.” Id.
8. Mr. Furtek also is a certified public accountant. N.T. 5/15/06 at 29. He
came to HHCA in 1997 as director of mergers and acquisitions, and became HHCA’s
chief financial officer in January 2002. Id. Prior to joining HHCA, Mr. Furtek worked at
Coopers & Lybrand where he worked on various acquisitions and transactions. N.T.
5/15/06 at 30. As CFO, Mr. Furtek is responsible for “the overall financial operations
and administration at the company. Additionally, [he] take[s] part in transactions, such as
[the] Roxborough transaction[,] overseeing and working through such transactions.” N.T.
5/15/06 at 29-30.
9. Mr. John Brunner has worked for HHCA since 1995 and currently
serves as the director of finance for HHCA. N.T. 5/22/06 at 8. He, among others,
assisted Mr. Furtek in the due diligence effort involving RHC by collecting “the financial
statements, underlying statistics and visits and referrals that would support the financial
statements and then build a forecast, a proforma forecast of what we would have
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6
anticipated that acquisition [of RHC] to produce.” N.T. 5/22/06 at 9. He reported
directly to Mr. Furtek.
10. Ms. Colleen Lederer is HHCA’s senior vice president of professional
services. N.T. 5/18/06 at 6. She oversees clinical operations and marketing, supervises
Medicare compliance, and has budgetary responsibility. Id. at 6-7.
11. HHCA’s due diligence of RHC was undertaken at the direction of Mr.
Furtek, N.T. 5/15/06 at 30, 34, 62, utilizing the efforts of employees such as Mr. Brunner,
Ms. Lederer and Ms. Pine, executive director of HHCA. One of the purposes of HHCA’s
due diligence was to verify the financial information that MHR had provided. N.T.
5/15/06 at 62. HHCA acknowledged at trial that it was not aware of any material
information it requested that MHR did not provide, although Mr. Geller believes that
HHCA did not request new patient referral information concerning the months of
November 2003 and December 2003 until after the asset purchase sale had closed. N.T.
5/15/06 at 63; N.T. 5/22/06 at 23, 51. HHCA did not discover anything during its due
diligence investigation that caused it to believe that there were any “major problems” with
RHC’s business. N.T. 5/15/06 at 52; N.T. 5/18/06 at 215.
12. On November 21, 2003, after HHCA had investigated the financial
affairs of RHC, and after continued negotiations between Mr. Geller and Mr. Feldman,
MHR and HHCA entered into an Asset Purchase Agreement (“APA”) for the sale of
RHC. JPS, ¶ 4; see Ex. D-1. Under this agreement, HHCA promised to pay MHR
$1,850,000; with $1,500,000 to be paid at closing and $350,000 to be paid 180 days later.
Ex. D-1, ¶ 2.5.
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Mr. Geller testified:4
We had picked—we had agreed to the two million dollar figure,
and then shortly before we were going to sign the agreement, it was
in the newspaper that there was a strike, a nurses strike at MCP.
I was a little bit concerned about the nursing strike, but I didn’t
really believe it would have any long-term value—any effect on the
long-term value of the Roxborough home care division.
However, I also used it [as] a bargaining chip and I applied some
negotiating pressure to Mark Feldman, and I indicated I felt there
was a problem and I was successfully able to lower the purchase
price and negotiate it from two million down to a million eight-
fifty.
N.T. 5/18/06, at 221-22.
7
13. Although HHCA’s preliminary non-binding expression of interest had
stated that it valued the business at $2-2.5 million “less any amounts owed to the Centers
for Medicare and Medicaid Services . . . or other federal or state government agencies to
whom the Business owes money and whose liabilities must be assumed in conjunction
with this proposed transaction[,]” Ex. D-9, HHCA did not assume any of MHR’s
Medicare or Medicaid services liabilities under the APA. See Ex. D-1, ¶ 2.4 and
Schedule 2.1(c). Furthermore, HHCA utilized a nurses’ strike at Medical College of
Pennsylvania (MCP) as a “bargaining chip” to reduce the purchase price paid for RHC
below the amount originally expressed in its offer of interest. 4
14. An attachment to the APA disclosed RHC’s actual monthly revenue
from January 2003 to September 2003, and projected net revenue for 2003 by averaging
the January-September revenue. Ex. D-1 (Schedule 4.5). Average monthly net revenue
was projected to be $272,662. This attachment also included audited financial statements
for the years ended June 30, 2000, 2001 and 2002. Id. RHC’s actual monthly net revenue
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Exhibit P-98 records the last month of revenue as measured from December 3,5
2003 to January 5, 2004.
It is possible that other parties that had expressed an interest in purchasing RHC6
had overlapping referral sources or territories that made the business less attractive than it was to
HHCA.
EBITDA is an acronym for “earnings before interest, taxes, depreciation and7
amortization.”
8
for October 2003, November 2003, and December 2003 	turned out to be $304,576,5
$255,888, and $257,147 respectively. Ex. P-98. Thus, the average monthly net income
for the final quarter was $272,537.
15. Mr. Furtek, who was involved in determining HHCA’s final purchase
offer, explained that HHCA valued the business by considering where RHC was located
in relation to HHCA’s existing business, its revenue stream, its patient census, and its
sources of payment. N.T. 5/15/06 at 35-36. Other factors considered by HHCA in its
evaluation of RHC’s worth were that the entity was a going concern, that its past
operations could serve as a “guide of future prospects,” that certain of its expenses could
be reduced by HHCA after purchase, and that there was not a significant overlap of
referral sources. Id. at 70, 77. 6
16. The final purchase price, as well as other contract terms, were
negotiated by Messrs. Geller and Feldman. Although HHCA calculated RHC’s
EBITDA, it used that number solely as a check on its independent evaluation of worth.7
Id. at 71-72. In formulating its preliminary expression of interest to MHR, HHCA
appears to have used an EBITDA of $430,000 and a multipler range of 4.65 to 5.81. Ex.
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As will be discussed, in December 2003 events at MCP caused Mr. Geller to be8
concerned about the agreed-upon purchase price. At Mr. Geller’s direction, Mr. Brunner
prepared a proforma analyzing a value for RHC based upon an EBITDA multiplier of 3.63,
assuming the imminent closure of MCP and its cessation as a patient referral source to RHC, and
assuming MCP constituted 15% of all referrals and then 25% of all referrals. Ex. D-14. This
exhibit was offered in support of HHCA’s contention that the closure of MCP materially affected
the revenues of RHC and reduced its census.
As will be later addressed, the evidence does not reflect that MCP’s impending
closure had an adverse effect upon RHC’s overall referrals. (MCP referrals began to decline
prior to the announced closure and other referral sources increased so that overall referrals
remained fairly constant.) Not explained at trial, though, are the reasons that this HHCA
proforma includes a higher annualized net revenue projection for RHC than is disclosed in
MHR’s attachment to the APA, see also Ex. D-13, a higher EBITDA, and a lower EBITDA
multiplier.
9
P-17. Its accepted purchase offer of $1,850,000 would have yielded an EBITDA
multiplier of 4.30, assuming the same EBITDA calculation. 8
17. In valuing RHC, HHCA anticipated that it could reduce or eliminate
certain RHC expenses. For example, RHC outsourced its billing and accounting and
employee benefits plans, but HHCA did not. N.T. 5/22/06 at 16-17, 39-40. The salary
paid to RHC’s chief executive officer would be eliminated after the sale as duplicative.
N.T. 5/22/06 at 40. HHCA also anticipated reducing RHC’s cost of providing home
healthcare services: “[W]e believed that under our management we could improve upon
that in a couple ways, with better utilization of their full-time care givers, which would
generate more visits being done by full-time fixed staff and fewer visits done by a
variable staff . . . .” N.T. 5/22/06 at 17.
18. Based upon HHCA’a analysis of RHC’s financial records, personnel,
and referral sources, given RHC’s location and minimal overlap with HHCA’s own home
healthcare operations, and also anticipating improved efficiencies in operating RHC’s
business, HHCA negotiated the APA in November 2003 with the intention of closing the
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10
sale before December 25, 2003. JPS, ¶ 6; N.T. 5/18/06 at 222. However, HHCA did not
wish to close during the Christmas and New Year’s holiday season. JPS, ¶ 7; N.T.
5/18/06 at 222. During December 2003, HHCA realized that the closing could not occur
prior to the Christmas season, and it decided to target January 5, 2004—the first business
day after the holiday season—for the RHC asset sale to conclude. N.T. 5/18/06 at 222.
19. On December 31, 2003, the parties amended the APA. JPS, ¶ 8; see
Ex. D-2. This amendment, sought by HHCA, reduced the cash payment due at closing to
$1,000,000 and increased the amount due 180 days after to $850,000. Id. HHCA sought
a change in the payment terms so that it could withhold more of the purchase price if the
announced closing of MCP Hospital proved to have a long-term effect on RHC’s home
healthcare business. N.T. 5/18/06 at 225-26.
20. On January 21, 2004, the parties further amended the APA. JPS ¶ 9;
see Ex. D-3. This amendment altered certain provisions of the agreement to allow the
closing to occur that day. See Ex. D-3 (recitals); JPS, ¶ 13. The closing had been delayed
from January 5, 2004 because MHR had not prepared all of the documentation necessary
to complete the closing. JPS, ¶ 11.
21. The Second Amendment to the APA included a statement that:
Seller acknowledges and agrees that, in consideration of
Buyer’s willingness to complete the Closing on January 21,
2004, notwithstanding that certain conditions to its obligations
to do so have not been satisfied or waived, Buyer shall retain
all of its rights and remedies under the Agreement, including
hereunder, notwithstanding its determination to effect the
Closing on January 21, 2004, and that such determination is
not intended, nor shall be construed, to constitute a waiver,
whether express or implied, of any such right or remedy of
Buyer.
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11
Ex. D-3, ¶ 4. Paragraph 2 of the Second Amendment postponed certain documentary
obligations of MHR until after the closing. During the trial, HHCA offered no testimony
that on January 21, 2004 it knew of any other obligations of the seller that had not been
satisfied. However, as will be discussed, HHCA did have concerns about the patient
census.
22. At the January 21st closing, HHCA paid the $1,000,000 installment
(less the $100,000 down payment). JPS, ¶¶ 13, 31. The remaining $850,000 installment
was due on or before July 19, 2004, and has not been paid. JPS, ¶¶ 14, 15.
23. At the closing, Mr. Feldman certified that MHR had complied with all
of the representations, warranties, covenants and conditions in the Agreement. JPS, ¶ 12.
He signed an Officers’ Certificate, ex. D-4, which stated, in part:
In accordance with Paragraph 7.1 of the Asset Purchase
Agreement . . . the undersigned President of MHR, hereby
certifies to HHCA for and on behalf of MHR that:
1. all representations and warranties of MHR are true and
correct when made and remain true and correct on the date set
forth below (“Closing Date”) with the same force and effect
as though made on and as of the Closing Date.
24. Paragraph 7.1 of the APA concerns conditions precedent to the buyer’s
obligations to complete the closing. See Ex. D-1. To the extent that HHCA alleges that
MHR did not comply with all conditions precedent, HHCA nonetheless elected to
proceed with the closing. Thus, since January 21, 2004, it has owned and operated
MHR’s home healthcare business.
25. HHCA has refused to tender its remaining payment under the APA,
contending that RHC was not worth the $1.85 million purchase price. Specifically, only
about 103 patients were transferred to HHCA in January 2004, Ex. P-49, rather than the
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It is not clear why non-Medicare patients needed to be discharged also, if the9
impetus was solely the different Medicare provider agreements.
12
200 or more patients that HHCA anticipated. N.T. 5/18/06 at 237. On April 20, 2004,
HHCA sent to MHR a letter asserting that the latter violated or breached the following
paragraphs of the APA: ¶¶ 4.5, 4.6, 4.12, 4.24, 6.1, 6.2, 7.1, 7.2, 11.1 and 11.6. Ex. D-19.
26. In mid-December 2003, probably December 17th, N.T. 5/25/06 at 89,
HHCA management held a meeting with RHC staff to review the anticipated transition of
ownership and control to HHCA in January 2004. JPS, ¶ 46. RHC and HHCA had
different Medicare provider numbers and provider agreements. HHCA determined that it
either would not or could not simply purchase all of RHC’s assets, including assumption
of RHC’s Medicare provider agreement, and assume operation of RHC’s home healthcare
business while retaining all of RHC’s patients. See N.T. 5/15/06 at 44-45. HHCA
decided that all of RHC’s patients had to be discharged from RHC and informed of the
option to be readmitted as an HHCA patient. 	RHC staff were so informed and, in9
accordance with HHCA’s directive, patient discharges began forthwith. N.T. 5/25/06, at
73, 88.
27. Once RHC discharged a patient, the patient’s physician would be
involved in any decision to be readmitted to HHCA or any other home healthcare
provider. N.T. 5/25/06 at 49. After RHC began discharging all of its patients, it is
possible that some doctors elected not to refer their patients to HHCA.
28. In order to avoid employee vacation issues around the holiday season,
HHCA decided that its transition to ownership of the RHC business would begin on
December 17, 2003 and end on January 5, 2004, the day after all MHR employees would
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The parties made a commendable attempt to agree to certain patient census data10
prior to trial in the form of stipulated facts. Some of the stipulations are easily reconcilable with
the exhibits introduced at trial and some less so.
JPS ¶ 48 reflects patient discharges in December 2003 and January 2004. The
parties stipulated that MHR (acting through RHC) discharged 228 patients in December 2003
and 39 in January 2004. Among those patients discharged by RHC in December 2003, 149 were
discharged as needing no further treatment; 59 patients were to receive further treatment by other
home healthcare providers, hospitals, or skilled nursing facilities; 18 patients refused further
treatment or were not open to further treatment. Id.
They also stipulated that MHR had 231 patients at the beginning of December
(continued...)
13
be terminated by RHC and rehired by HHCA. JPS, ¶ 50; N.T. 5/15/06 at 43, 47-48. The
transition of RHC to HHCA’s control was completed on January 5, 2004. N.T. 5/22/06 at
85.
29. Three possible patient outcomes were identified by HHCA as a result
of the discharge of all RHC patients beginning on or about December 17, 2003: (1)
patients did not need or no longer qualified for continued care, and thus would be
discharged by RHC without any further care; (2) patients needed and qualified for
continued care, and would be admitted to HHCA after discharge from RHC; or (3) the
patient needed and qualified for continued care, but would elect a home healthcare
provider other than HHCA, or choose not to receive further care. JPS, ¶ 47.
30. On December 1, 2003, RHC had 231 patients. JPS, ¶ 49. On
December 15, 2003, it had 226 patients. Ex. P-49. On January 5, 2004, HHCA had 103
patients obtained from RHC during the transition. Id. There were 27 new patients
admitted to HHCA via RHC during this period. Id. Thus, there were 150 RHC patients
that were discharged after December 15, 2003, and did not need further home healthcare,
or needed it but elected to be treated by a provider other than HHCA, or needed further
care but did not obtain it from any provider. 10
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(...continued)10
2003 and 71 patients at the end of that month. JPS, ¶ 49. The testimony at trial made clear that
around December 17, 2003, RHC began the process of discharging all of its patients and not
admitting any new ones. New patient referrals went to HHCA. Thus, RHC’s low ending census
for December 2003 in JPS ¶ 49 would be consistent with this evidence. Presumably, it had
begun but not concluded the discharge process for all of its patients. Less clear though is how
RHC could cease operating on January 5, 2004, have 71 patients on December 31, 2003, and
only discharge 39 patients in January 2004.
The parties also stipulated that 93 patients were “transferred or referred to HHCA
at that time according to HHCA’s records.” JPS, ¶ 51. The phrase “at that time” may refer to
January 4, 2004, since that date is mentioned in JPS ¶ 50. However, the total of 93 consists of 41
patients “referred to HHCA prior to transition” and 52 patients “discharged and transferred to
HHCA.” JPS, ¶51. There was no evidence that RHC referred any of its patients to HHCA prior
to the mid-December transition process. And it is unclear precisely how and when the 52
patients were transferred to HHCA.
Therefore, since Exhibit P-49 was admitted in evidence, and since part of
HHCA’s defense in this proceeding involves the census when it assumed control of RHC’s
business in early January 2004, I have referred to the figures in that trial exhibit. See also N.T.
5/22/06 at 97 (Mr. Geller stated: “What I know is, the census was 226 on December 15th and the
day that we took over that company it was 103.”).
Exhibit P-38 states that it is a record of HHCA referrals from January 1, 198011
until January 12, 2004. As Mr. Brunner testified that this document “actually relates to the
referrals to the Roxborough branch in early January 2004,” N.T. 5/22/06 at 33, it is likely that
this exhibit concerns referrals between January 1, 2004 and January 12, 2004.
14
31. Because HHCA did not accept Aetna health insurance, nine RHC
patients covered by Aetna in December 2003 could not be transferred to HHCA. N.T.
5/15/06 at 49-50.
32. Also during the RHC ownership transition, telephone calls to RHC
were routed to HHCA so that HHCA would directly receive new patient referrals. N.T.
5/15/06 at 75, 89; N.T. 5/18/06 at 40. As a result, 115 patients were referred to HHCA as
of January 12, 2004. Ex. P-38. 11
33. During the first 11 months of calendar year 2003, RHC’s average initial
monthly patient census exceeded 200. JPS, ¶ 49. HHCA engaged many former RHC
employees on the assumption that, beginning in January 2004, it would service roughly
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Ms. Lamarra, who oversaw RHC’s home healthcare operations, N.T. 5/25/06 at12
33-34, testified that she foresaw that the census would drop significantly due to the transition,
and that she communicated this observation to Ms. Ellen Pine, who at that time was an executive
director of HHCA and involved in the asset purchase. N.T. 5/25/06 at 22-23, 73-77. Ms. Pine
was involved with the December 17th meeting at which RHC staff, including Ms. Lamarra, were
informed about the need to discharge all patients. Id., at 27. Ms. Lamarra stated that she voiced
this census decline concern to Ms. Pine after the meeting. Id., at 73-74, 83-84. Ms. Pine denied
hearing that concern from Ms. Lamarra, and had no similar concern herself. Id., at 92-93. As
there was no corroborative evidence, I do not find it more likely than not that HHCA was made
aware of Ms. Lamarra’s expectation prior to closing. However, as will be discussed later, there
was no evidence to demonstrate that the census decline was not actually connected to RHC’s
discharge of all of its patients.
15
the same number of patients on census as RHC had previously averaged. N.T. 5/18/06 at
237. 12
34. RHC employed both full-time, salaried staff and per diem employees.
N.T. 5/25/06 at 40-41. Prior to the sale to HHCA, RHC operated with the policy that if
its census decreased in a particular month, RHC reduced the home healthcare patient
assignments of per diem employees. Id., at 41, 77.
35. As a result of having more staff than needed in January and February
2004, HHCA operated RHC at a loss during those months. N.T. 5/15/06 at 59; N.T.
5/18/06 at 238. In the first six months of 2004, HHCA had net revenue of $1,363,000
from its new Roxborough Homecare Division, for an average monthly revenue of
$227,167. Ex. P-93. This is about $45,000 less in monthly net revenues than RHC
averaged in 2003.
36. To ameliorate the unanticipated lower census, in March 2004 HHCA
transferred some patients from its King of Prussia branch to the new Roxborough branch.
N.T. 5/22/06 at 20-21. The King of Prussia branch was “pretty – tightly staffed and we
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16
determined that it would make sense since they . . . overlapped territories to transfer some
of the patients to balance out the workload.” Id. at 20.
37. HHCA was aware as of the January 21st closing that the number of
RHC patients transferring over to it “were significantly less than had been expected, but
didn’t know the full number . . . [or] the full extent of the problem.” N.T. 5/18/06 at 229;
see also N.T. 5/22/06 at 107.
38. Although HHCA knew on January 21, 2004 that its patient census for
its Roxborough division was less than anticipated, it concluded that refusing to complete
the sale transaction with MHR was not a viable option because RHC had discharged all of
its patients and its staff were employed by HHCA; thus HHCA’s patients could not be
transferred back to RHC without unwinding the entire transition. N.T. 5/18/06 at 231. In
addition, HHCA decided against postponing the closing, because “we pride ourselves at
HHCA on being reasonable people and fair people, and we had a contract in place, they
had finally complied with the closing conditions and gotten all of the documents that they
said that they needed. We had already gotten a concession from them on the payment
terms . . . . So we had a reputational risk . . . in the community . . . and I felt that the
potential negative publicity and negative [e]ffect on our reputations of not closing when
we had a contract in place . . . was . . . a worse problem than not closing, period.” N.T.
5/18/06 at 232-33.
39. HHCA, through Mr. Geller, believed that even with the lower starting
census than anticipated, RHC was worth at least $1 million to HHCA. N.T. 5/22/06 at
105-06. Furthermore, HHCA anticipated that, if circumstances warranted, it could refuse
to pay the balance of the purchase price, thus minimizing its risk. N.T. 5/18/06 at 226;
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Although Mr. Geller testified that there was a 5.9% error rate in “referrals,” that13
error rate actually concerned treatment of Medicare patients.
17
see also N.T. 5/15/06 at 108. HHCA believed that its reservation of rights contained in
the second amendment to the APA permitted renegotiation of the purchase price after
closing. N.T. 5/18/06 at 226.
40. HHCA bargained for the adverse change warranty in paragraph 4.6 of
the APA to protect itself from negative changes to RHC’s business between the time of
signing the APA until closing. N.T. 5/18/06 at 216-17.
41. HHCA suggested at trial that the lower than anticipated number of
patients it obtained after assuming control of RHC on January 5, 2004 was due to three
factors. First, RHC had a 5.9% error rate in admitting or continuing to treat Medicare
patients, although this was not a “major part” of the problem. N.T. 5/18/06 at 228. 13
Second, the patient census “was artificially propped up through the month of December
[2003] by . . . discharges being delayed.” Id. And, third, the referrals in November and
December 2003 “were dramatically lower than they had been historically.” Id., at 228-29.
The decline in referrals was the “main driver” for the decline in the census on January 5,
2004. Id., at 234.
42. After it closed on the sale of RHC, and concerned about the low census
of patients, HHCA hired IMA Consulting to review MHR’s medicare patient records for
2003. JPS, ¶¶ 53, 54. “The parties agree[d] that [RHC’s] error rate related to Medicare
patient certification for home health services during the period of January through
November 2003 as it related to ‘medical necessity’ was 5.9 percent . . . .” Ex. J-1, ¶ 5.
By contrast, HHCA contends that its error rate was “zero or next to zero” because of its
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18
effective quality assurance program. N.T. 5/18/06 at 219-20. The parties stipulated that
the national error rate on this issue is 1%. Ex. J-1, ¶ 4.
43. There are no exhibits that disclose the percentage of RHC patients on
Medicare throughout the entire year of 2003. However, the following exhibits allow an
inference to be made. Exhibits P-12 and P-31 disclose that 31% of patient referrals from
June 2003 through August 2003 were Medicare patients, while 33% were Medicare
patients in the three months beginning April 1st and ending June 2003. The September
and October 2003 referral logs, Ex. P-32, reveal that 30% of September’s referrals and
29% of October’s referrals were Medicare patients. Exhibit P-34 reports that 33% of
referrals from October 1st through December 18, 2003 were Medicare patients. And
Exhibit D-8 discloses that 36% of referrals were Medicare-insured in the “last quarter of
2003,” which, because RHC’s fiscal year ended in June, would refer to the months of
April through June 2003. Since referrals are the main source of patients, it is likely that
approximately one-third of RHC’s patients in 2003 were Medicare patients. See also Ex.
D-18 (reflecting 33% of referrals were Medicare patients from “October - December 19,
2003”).
44. Medicare patients contributed a larger share of revenue to RHC than
other patients. An attachment to the APA provided by MHR reflects that in the first nine
months of 2003, Medicare patients contributed 61% of net revenue. Ex. D-1, Schedule
4.5. HHCA seems to have anticipated that Medicare would generate about 57% of net
revenue. Ex. D-14.
45. If RHC had transferred 200 patients to HHCA on January 5, 2004, as
the latter anticipated, a 5.9% Medicare patient error rate would overstate the “true” census
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This assumption was made by Mr. Steven D. Garber, HHCA’s damage expert.14
MHR challenges this assumption, arguing that Medicare reimburses home healthcare agencies at
different rates for different types of treatment, and that the bulk of the errors made by RHC may
have occurred for patients with less remunerative types of treatment. See MHR’s Post-trial
Memorandum, at 26-30.
Ms. Lamarra testified that Mr. Massino was laid off, N.T. 5/25/06 at 57-59, 86,15
but later explained that HHCA already had a person who performed Mr. Massino’s
responsibilities, so there would not be a place for him at HHCA. Id. at 81, 86.
19
by only 4 patients, given that roughly 33% of the patients were receiving Medicare
reimbursement. Furthermore, assuming average monthly net revenues of $272,000, and
further assuming that a 5.9% error rate would overstate monthly Medicare net revenues
by the same percentage, 	then if 61% of net revenues were attributable to Medicare14
patients, RHC’s monthly net revenues would have included less than $10,000 (or about
3.5%) subject to potential reimbursement by Medicare. Thus, Mr. Geller’s statement at
trial—that RHC’s Medicare error rate was not a significant factor in causing HHCA’s
lower than anticipated census in January 2004, and lower than anticipated net revenues in
early 2004—is correct.
46. RHC employed Mr. Kevin Massino as assistant director, and among his
duties were responsibility for Medicare compliance issues. N.T. 5/25/06 at 34-36, 57.
Mr. Massino began with RHC in January 2003 and left sometime in November or
December 2003. Id., at 57-59, 81. 15
47. MHR offered testimony that from November 2002—when Ms.
Lamarra was director of RHC—until the January 5, 2004 transition to HHCA control, that
no claims were denied by Medicare due to medical necessity or homebound status in
2003. Id., at 35, 38. HHCA offered no evidence to the contrary.
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20
48. RHC was subject to Pennsylvania state surveys. Id. at 34-35. There
were no state surveys conducted during Ms. Lamarra’s tenure at RHC, but the previous
survey a year before had not found any deficiencies in Medicare guidelines. Id. at 36. A
mock survey was performed at RHC in the summer of 2003 to prepare for the Joint
Commission of Accreditation of Home Health Organizations. Id. at 35, 37. No problems
were reported to Ms. Lamarra involving medical necessity or homebound status as a
result of this mock survey. Id. at 38.
49. In the course of conducting its due diligence, HHCA became aware that
there were some issues concerning the need of some RHC patients for home health
services. Ex. P-9. It concluded, however, that those issues were “not material to the . . .
transaction, or material to the business.” N.T. 5/15/06 at 64; see also N.T. 5/22/06 at 52.
50. RHC’s Operating Statement for January through September 2003,
attached to the APA, includes a bad debt reserve reflecting approximately 5% of the total
budget. Ex. D-1 (Schedule 4.5). HHCA’s bad debt reserve was approximately 1.8%.
N.T. 5/22/06 at 85. In its proforma assessment of RHC for valuation purposes, HHCA
included a 5% bad debt reserve when computing RHC’s EBITDA. Exs. D-14; P-17.
51. Virtually all of RHC’s patients in 2003 had some form of insurance
coverage to reimburse RHC for its services. Between December 2002 and June 2003,
“commercial” and “private pay” patient receipts were only 2.7% of total receipts. Ex. D-
8. Thus, it is unlikely that RHC’s 5% bad debt reserve was established in anticipation
that receivables only from uninsured patients would be uncollectable. It is likely that this
reserve was established in the event that insurers were to conclude that the services
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See also Ex. D-5 (MHR’s own liquidation analysis for all of its operations,16
including RHC, and reflecting a potential Medicare recoupment) and Ex. P-92 (HHCA’s analysis
of RHC’s financial statements through September 30, 2003, which apportions $99,000 of the 5%
debt reserve to Medicare revenues).
21
rendered by RHC were not reimbursable. Medicare accounted for about 60% of RHC’s
receivables. Ex. D-1, Schedule 4.5. 16
52. It is more likely than not that RHC’s quality control efforts and
Medicare error rate were consistent throughout 2003, and that RHC did not realize that
this rate was significantly higher than the industry average. HHCA likely was unaware of
the precise error rate for RHC at the time of the sale, but was likely aware from its due
diligence that RHC’s Medicare compliance rate was not as high as HHCA’s, see also
N.T. 5/18/06 at 23-24 (RHC’s recertification rate for patients was higher than HHCA’s),
and viewed this difference either as not materially affecting the value of RHC’s business
or already reflected in the purchase offer of $1.85 million.
53. Although HHCA contends that the December 2003 RHC census was
inflated, it conceded that the December 15, 2003 census of 226 patients was accurate.
N.T. 5/15/06 at 100; N.T. 5/18/06 at 234. That is, there actually were 226 RHC home
care patients, as RHC’s records reflected.
54. Furthermore, HHCA was unable to identify any particular patients who
were kept on the census too long, despite engaging experts to analyze patient records for
support for this proposition. N.T. 5/18/06 at 53-54; N.T. 5/22/06 at 121. All of the
patient discharges appeared to have been appropriate. N.T. 5/15/06 at 101.
55. HHCA’s contention that RHC employees kept their patients on census
too long because referrals were slowing and the employees wanted to keep busy and be
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In its post-trial memoranda, HHCA relies upon JPS ¶ 48 to support its17
contention that an unusually high number of RHC patients were discharged in December 2003
and January 2004 as needing no further treatment. For example, it argues:
Specifically, paragraph 48 of Exhibit J-2 summarizes the actual
discharges of MHR’s patients between December 2003 and
January 2004. During this time, 167 out of 267 total patients were
discharged to the community as having their goals met and
requiring no further care. It is this disproportionate amount of
patients being discharged and as requiring no further care coupled
with the fact that the referral base was dwindling after September
2003, that resulted in the change in the census.
Defendant’s Post-Trial Reply Memorandum, at 16.
As noted earlier, this fact stipulation states that 149 out of 228 patients were so
discharged in December 2003 and 18 out of 39 patients were so discharged in January 2004.
However, no similar data from other months were offered in evidence, thus precluding any
comparison or conclusion of “disproportionality.”
Moreover, home healthcare treatment episodes are generally brief, averaging
between one and two months. See Finding # 56. As will be discussed, RHC averaged more than
200 new patient referrals each month and had an average monthly census of somewhat more than
200 patients. Thus, one would anticipate extensive patient turnover from month to month. If so,
then the statistics in JPS ¶ 48 would not be extraordinary.
22
rehired by HHCA, N.T. 5/22/06 at 99-102, is a “theory” based on the result that only 103
RHC patients transferred to HHCA on January 5, 2004. Id., at 101, 103; see also N.T.
5/18/06 at 55 (describing this belief as a “gut” feeling). The defendant offered no data
demonstrating a change in RHC discharge rates during the last quarter of 2003 prior to
HHCA’s mid-December directive that all patients had to be discharged as part of the sale
process. See 5/22/06 at 103. As HHCA’s CEO acknowledged at trial: “If one could find
[discharge] patterns like that, possibly one could prove my theory. But, one could very
possibly not prove my theory.” Id., at 103. 17
56. The parties stipulated that in the home healthcare industry, “[r]eferral
sources for patients are critical to the ability to generate future revenue.” JPS, ¶ 63. As
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Ex. P-32 states that October 2003 had a total of 221 referrals.18
See note 11 supra.19
23
Medicare patients are typically discharged in a matter of one to two months, see N.T.
5/15/06 at 73-74, referrals are needed to replenish the patient census. Id., at 76.
57. These referrals principally come from doctors, hospital administrators,
nursing homes, and assisted living facilities upon releasing patients. N.T. 5/15/06 at 77.
Absent any exclusive contracts with a referral source, which neither RHC or HHCA had,
RHC’s referral sources were free to refer patients to any home healthcare provider. JPS,
¶¶ 64, 65.
58. Throughout 2003 RHC did not have a formal marketing program,
overseen by its director, to maintain and increase referrals. N.T. 5/25/06 at 43, 62-64, 67.
59. The evidence demonstrates that RHC received 216 (or possibly 221)
and 204 referrals during the months of October 2003 and November 2003 respectively.
Exs. P-34, D-18. 	Referrals averaged 6.97 per day in October and 6.80 in November. Id.18
From December 1st through “midday” on December 19, 2003, there were 132 patient
referrals for a daily average of 6.95. Id. In April, May and June 2003, there were 651
patient referrals, averaging 217 per month. Ex. P-31. In September 2003, there were 257
patient referrals (averaging 8.57 per day). Ex. P-32. Between January 1, 2004 and
January 12, 2004, there were 115 referrals (averaging 9.6 per day). Ex. P-38. 	Finally,19
from the beginning of September 2003 to the end of November 2003, RHC averaged 71
Medicare referrals per month and in February 2004, HHCA estimated that it would
receive only 40 such referrals. Ex. P-54.
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This chart concerns RHC’s “4th Qtr. 2003.” Because RHC’s fiscal year ended20
in June 2003, see, e.g., Ex. D-1 (Schedule 4.5 showing cash flows for years ended June 30, 2001
and 2002), the fourth quarter of 2003 for RHC was not the calendar quarter.
24
60. Analysis of referrals and the sources of referrals were components of
HHCA’s due diligence efforts. See Exs. P-7; P-8; P-9, P-12. HHCA analyzed RHC’s
primary referral sources during due diligence and did not find any significant overlap with
its own. N.T. 5/22/06 at 28-29; Ex. P-12. Therefore, HHCA anticipated that acquiring
RHC would increase its referral sources. N.T. 5/22/06 at 64.
61. MHR provided HHCA with considerable information regarding its
referrals and sources. Early in HHCA’s due diligence process, it was given a pie chart
disclosing RHC’s major referral sources from April 2003 to June 2003. Ex. D-8. 	This20
chart revealed that, in that three month time period, seven referral sources were identified
as follows: Albert Einstein Medical Center (AEMC) 38%; Medical College of
Pennsylvania (MCP) 25%; Roxborough Memorial Hospital (RMH) 20%; physicians
10%; Northeastern Hospital (NEH) 3%; nursing homes 2%; and “other” 2%. Id. See also
Ex. P-31. With 651 referrals in that quarter, MCP would have been the source of 163
referrals or an average of 54 per month.
62. Based in part upon the referral information for the quarter ending June
2003, and using an annual net revenue estimate of $3.2 million, plus estimates of
operating expenses (including a bad debt reserve that was about 5% of net revenue)
totaling $2,778,000 and an EBITDA multiplier ranging from 4.65 to 5.81, HHCA
calculated an estimated range of value for RHC of $2 million to $2.5 million—the
estimate used in its original August 2003 expression of interest. Ex. P-17.
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25
63. For the time period June 1, 2003 to August 31, 2003, only four
categories of referral sources were identified by MHR: RMH (called ROX), AEMC
(called EMC), Germantown (called GTN) and “other.” Ex. P-6. Exhibit P-12, which was
prepared by HHCA during due diligence, N.T. 5/22/05 at 30-31, identified the 25 doctors
who provided the most referrals to RHC. Those 25 physicians provided 35% of all
referrals during this three month period. These doctors were affiliated with AEMC,
RMH, Northeastern, Germantown Hospital, and “other.” MCP is not mentioned. Id.
64. HHCA prepared a referral summary for September 2003. Ex. P-15.
This summary disclosed that 31.1% of referrals that month came from AEMC, 16.7%
from MCP, 16.3% from RMH, 10.1% from Sunrise/Other ALF’s, 14.4% from doctors,
and 11.3% from others. Id. With 257 referrals that month, MCP was the source of 43
referrals.
65. In October 2003, AEMC provided 33% of RHC’s referrals, RMH
provided 21.7% and MCP only 13.6%. Ex. P-32. Of the 221 referrals in October, MCP
provided 30.
66. From November 11, 2003 (before the APA was executed) until
December 18, 2003, the nurses at MCP were on strike. JPS, ¶ 39. Then, on December
18, 2003, the owner of MCP (and of MHR), Tenet, announced its intention to close MCP.
JPS, ¶ 41. This hospital was located within two miles of RHC. N.T. 5/15/06 at 38.
67. HHCA did not consider the strike likely to have “any effect on the
long-term value of [RHC].” N.T. 5/18/06 at 221-22. However, HHCA was concerned
that, when MCP closed, RHC might lose a significant referral source of patients. Id., at
223. Based upon this concern, Mr. Geller telephoned Mr. Feldman seeking information
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26
regarding MCP referrals and the potential impact the hospital’s closure might have upon
RHC revenue. JPS, ¶ 42; N.T. 5/18/06 at 223.
68. After analyzing RHC referral data up through mid-day of December 19,
2003, Mr. Feldman advised on December 19th that in his opinion the loss of MCP as a
referral source would not greatly affect the business, as “MCP’s referrals were not as big
a piece of the mix as [he] had thought, and that there ha[d] been hardly a blip in the total
Roxborough Home Care volume since the MCP strike began in mid-November.” JPS, ¶
43; Ex. D-15. Mr. Feldman also opined that, given the relative locations of Roxborough
Memorial Hospital (RMH) and MCP, given their common Tenet ownership, and given
the percentage of doctors who were on the staffs of both hospitals, RMH had “a very high
likelihood of picking up the patients who had been going to MCP.” Ex. D-15. He noted
that RMH’s “census increased significantly as soon as the MCP nurses went on strike and
has continued at that higher level.” Ex. D-15. Thus, Mr. Feldman was suggesting that
the closure of MCP was unlikely to significantly affect RHC referrals because MCP itself
was a relatively small referral source, and because RMH would likely obtain additional
patients that would otherwise have been admitted to MCP but for its closure, and some of
those additional RMH patients could be referred to RHC.
69. In addition, Mr. Feldman provided HHCA with certain data concerning
MCP referrals to RHC to support his opinions. See Ex. D-15. He provided to HHCA a
breakdown of the referrals received from MCP, RMH, Einstein and “other” sources in
October, November, and thru mid-day December 19, 2003. This data, tabled below,
reflects a decline in referrals from MCP prior to any announced future hospital closing.
See id.
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Exhibit P-32 shows 30 referrals from MCP in October 2003, constituting 13.621
percent of a 221 total. These numbers are not appreciably different from those utilized by Mr.
Feldman in his December 19, 2003 e-mail message to HHCA.
27
Time Period 	Number of
Referrals
from MCP
Percentage
of Total
Total
Referrals
from All
Sources
October 2003 	31 	14% 	216 21
November 2003 	9 	4% 	204
December 1-19 2003 	9 	7% 	132
70. Additionally, Mr. Feldman’s December 19th e-mail data disclosed to
HHCA that referrals from RMH constituted 22% of all referrals during that almost-three
month period; from AEMC constituted 32% of all referrals; and from “Other” sources
constituted 37% of all referrals. See id. He also informed HHCA about total referrals for
the period from October 1, 2003 until mid-day December 19, 2003. October had 216
referrals, for a daily rate of 6.96; November had 204 referrals, for a daily rate of 6.80; and
part of December 2003 had 132 referrals for a daily rate of 6.95. See also Ex. P-34.
71. HHCA offered no evidence at trial that Mr. Feldman’s data on
December 19th was incorrect, misleading or inaccurate. Accordingly, prior to closing,
HHCA was aware that during the last calendar quarter of 2003—prior to the signing of
the APA and prior to its transition and RHC’s complete patient discharge—MCP referrals
had diminished significantly as a percentage from the second calendar quarter of 2003,
and that MCP was not considered a major RHC referral source. See also N.T. 5/25/06 at
64-65 (MCP was a referral source, but Roxborough and Einstein were the major referral
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28
sources). Furthermore, HHCA was informed that other referral sources had increased so
that, even with MCP’s lower profile, daily referrals remained fairly consistent. See N.T.
5/22/06 at 122 (these daily averages were “fairly minor fluctuations” in referral patterns).
72. Despite receipt of this information, HHCA continued at closing to
believe that MCP was a major referral source for RHC and viewed it as illogical that
MCP’s closure would not significantly affect RHC’s business. N.T. 5/18/06 at 224-26.
HHCA utilized the events occurring at MCP to negotiate a change in the payment terms
in the APA, mentioned above. Id. at 226. It tried, but was unsuccessful in negotiating a
purchase price for RHC below the $1.85 million in the APA. Id. at 227. HHCA
continues to believe that RHC’s referral stream was significantly slowing prior to the
transition. N.T. 5/15/06 at 105. However, there was no evidence offered that this
occurred.
73. There were 115 referrals from January 1, 2004 through January 12,
2004, for a daily referral rate of 9.58 patients. Ex. P-38. Referral data from November 1,
2003 until February 24, 2004, ex. P-54, shows that there were a total of 174 referrals in
December 2003. Since Exhibits P-34 and D-18 show 132 referrals from December 1
through December 19, 2003, the daily rate of referrals from December 20, 2003 to the end
of December was 5.6 (174 total referrals minus the 132 referrals received up until
December 19, divided by 11 days), down from 6.95 earlier in the month. Id. In January
2004 there were 134 referrals, yielding a daily rate of only 4.32 (or only about 1 per day
after January 12th). Referrals in February 2004 totaled only 94 through February 24th,
for a daily rate of 3.92. Id. Clearly, the number of monthly referrals declined from
October 2003 through February 2004. But the daily referral rate remained reasonably
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HHCA, relying upon Ex. P-54, emphasizes a downward referral trend from22
September 2003 (257) to October 2003 (221) to November 2003 (204) to December 2003 (174)
to January 2004 (134) to February 24, 2004 (94). I find this analysis unpersuasive for two
reasons.
First, it includes December 2003, January and February 2004, months in which
HHCA either began its transition (with the discharge of all RHC patients) or assumed complete
control. As will be discussed, MHR argues that these factors adversely affected the referral rates.
Second, if one concentrates only on monthly referral rates in 2003 and only when
RHC was operating in its usual manner, besides the months of September through December 19
2003, the only other referral data offered in evidence is found in Ex. P-31, addressing the months
of April through June 2003. Those three months yielded a total of 651 referrals, for an average
of 217 per month. (No data was offered in evidence for the months of January through March
200, or July and August 2003.) The referral averages for the second calendar quarter of 2003 are
consistent with the October and November 2003 referral rates, as well as the December 1st-19th
daily rate, and therefore suggests that September 2003 data was unusually high.
There was testimony that referral rates can fluctuate. N.T. 5/18/06 at 55-56; N.T.
5/25/06 at 40-41, 44-45. If one allows for some monthly fluctuations, the limited evidence of
record suggests that daily referral rates were fairly consistent in 2003 up to December 19, 2003.
29
consistent through December 19, 2003, and only began to decline significantly after RHC
began to discharge its patients during the holiday season, as part of the HHCA-led
transition to new ownership. 22
74. As a percentage of patient referrals, MCP as a source constituted 4.4%
in November 2003, 6.3% in December 2003, 8.2% in January 2004 and 3.2% in February
2004. Id. The data is tabled as follows:
Time Period 	Number of
Referrals
from MCP
Percentage
of Total
Total
Referrals
from All
Sources
December 2003 (total) 	11 	6.3% 	174
January 2004 	11 	8.2% 	134
February 2004 (thru
the 24th)
3 	3.2% 	94
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30
75. About one month after closing on the sale, on February 25, 2004,
HHCA determined that after its acquisition of RHC the number of Medicare patient
referrals declined, primarily from RMH, Chestnut Hill Hospital, doctors, Sunrise ALF
and other assisted living facilities. Ex. P-54. MCP is not mentioned in this analysis. Id.
Since RHC, upon its sale to HHCA, no longer had a common ownership with RMH, it is
possible that RMH and the doctors affiliated with it might have chosen another home
healthcare provider to service their patients.
76. HHCA did not communicate with RHC’s referral sources prior to
closing, intending to communicate with them only after acquisition of RHC. JPS, ¶¶ 67,
68. Neither did HHCA create any written marketing plan directed towards referral
sources prior to its acquisition of RHC. JPS, ¶ 66. HHCA anticipated that by retaining
the RHC employees responsible for servicing the latter’s various referral sources, RHC
referrals would remain consistent after the asset sale. N.T. 5/15/06 at 84-85, 114.
77. HHCA offered no evidence that RHC staff acted to lower the referral
rate after the transition and sale to HHCA. N.T. 5/15/06 at 103-05.
78. Steven D. Garber was engaged by HHCA as an expert to determine the
damages allegedly suffered by HHCA in its purchase of RHC. His initial damage
assessment was modified after the parties agreed, just prior to trial, that the evidence
established RHC’s Medicare error rate at 5.9%. His testimony at trial, N.T. 5/18/06 at 78-
79, and his supplemental damage report, Ex. D-20, modified his initial damage report.
Ex. D-17. Mr. Garber opined that HHCA was damaged in the amount of $540,000, based
upon the stipulated Medicare error rate of 5.95% ($300,000) and the lower than expected
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Mr. Garber’s damage opinion may be inconsistent with Mr. Geller’s opinion that23
RHC’s Medicare error rate was a minor part of HHCA’s business difficulties with low patient
census.
31
census ($240,000). MHR challenged Mr. Garber’s assumptions, methodology and
conclusions. 23
II.
I reach the following legal conclusions:
1. The parties’ asset purchase agreement is governed by Pennsylvania law.
2. The parties expressly agreed that this bankruptcy court can enter final
judgment in this proceeding.
3. The plaintiff met its evidentiary burden to demonstrate that the
defendant breached the asset purchase agreement by failing to pay the balance of the
purchase price.
4. The defendant did not meet its evidentiary burden to demonstrate that the
plaintiff breached any warranties or representations.
5. To the extent that there were any breaches by the plaintiff of conditions
precedent in the contract, such breaches were waived by the defendant’s decision to
complete the purchase of plaintiff’s home healthcare division, and its decision not to seek
rescission of the contract.
6. The plaintiff is entitled to pre-judgment interest under Pennsylvania law.
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It also alleged that HHCA should turn over $850,000 as a debt that is property of24
the estate and that is matured, payable on demand, or payable on order, pursuant to 11 U.S.C. §
542. Courts construing section 542(b) have concluded that for turnover of money from a
defendant:
the liability must be undisputed. In re [FLR Co.], Inc., 58 B.R.
632, [634] (Bkrtcy. E.D. Pa. 1985) (“Implicit in the bankruptcy
concept of turnover is the idea that the property being sought is
clearly the property of the Debtor but not in the Debtor’s
possession. Turnover, 11 U.S.C. § 542, is not the provision of the
Code to determine the rights of the parties in legitimate contract
disputes[.]”). Liability is not undisputed unless there is “a final
judgment from a court of competent jurisdiction or a stipulation by
the defendant.” In re Satelco, Inc. v. North American Publishers,
Inc., 58 B.R. 781, 786 (Bkrtcy. N.D. Tex. 1986). See also In re
Theobald Industries, Inc., 53 B.R. 506, 508 (Bkrtcy. D.N.J. 1984)
(“Since the right to payment of the claims [asserted by the estate] is
contingent on a judgment establishing liability, the claims are not
‘matured’).
Ches-Mont Utilities Const. Co. v. Willistown Woods Associates, 1992 WL 96335, at *2 (E.D.
Pa. Apr. 24, 1992). As liability here is disputed, turnover under section 542 is not appropriate.
However, to the extent that MHR asserts a state law breach of contract action, both parties
consented to the entry of a final judgment by me.
32
III.
MHR alleged in its complaint that HHCA breached the Asset Purchase
Agreement by failing to make the $850,000 post-closing payment. 	HHCA generally24
averred as affirmative defenses that it is not obligated to pay any additional amount to
MHR as its obligations are excused as a result of MHR’s material breach of the
agreement.
The parties’ contract, ¶ 13.10 of the APA, provides that enforcement
actions are governed by Pennsylvania law.
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33
Under Pennsylvania law, a plaintiff alleging breach of contract must
establish “‘(1) the existence of a contract, including its essential terms, (2) a breach of a
duty imposed by the contract[,] and (3) resultant damages.’” Ware v. Rodale Press, Inc.,
322 F.3d 218, 225 (3d Cir. 2003) (citing Corestates Bank, N.A. v. Cutillo, 723 A.2d 1053,
1058 (Pa. Super. 1999)); see also Sampathachar v. Federal Kemper Life Assur. Co., 186
Fed. Appx. 227, 230 (3d Cir. 2006). That is, the plaintiff must prove that it substantially
complied with the contract so that the defendant was obligated to perform under the
agreement. See, e.g., Otis Elevator Co. v. Flanders Realty Co., 244 Pa. 186, 190 (1914).
The burden of persuasion thereafter would shift to the defendant to prove its affirmative
defenses. See Evans v. Fegely, 67 Pa. 370 (1871); Iddings v. The Equitable Gas Co., 8
Pa. Super. 244 (1898); see also Girard Bank v. John Hancock Mut. Life Ins. Co., 524 F.
Supp. 884, 892-93 (E.D. Pa. 1981) (defendant had burden to prove breach of contractual
representations or warranties). Each party must meet its evidentiary burden by a
preponderance standard. See, e.g., Ragnar Benson, Inc. v. Bethel Mart Associates, 308
Pa. Super. 405, 413 (1982).
In its complaint, MHR alleged that it and HHCA entered into the Asset
Purchase Agreement “pursuant to which MHR agreed to sell and HHCA agreed to
purchase substantially all of the operating assets owned by MHR relating to its home
healthcare business.” Complaint, ¶ 8. It further alleged that HHCA made the closing-
day payment of $1,000,000, but not the $850,000 due on July 19, 2004. Complaint, ¶¶
12-14. HHCA does not dispute that it entered into the APA and did not make the final
payment according to the terms of the contract. See Answer, ¶¶ 12, 14; JPS, ¶¶ 8, 14-15.
HHCA further does not dispute that MHR did indeed transfer the RHC business assets to
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34
HHCA as required, along with the requisite documents, and that it has owned and
operated the Roxborough division since January 2004. As a result of HHCA’s breach,
MHR asserts that it was damaged in the amount of $850,000, plus costs and attorney fees.
Clearly, MHR has proven that it transferred RHC’s business to HHCA, as
agreed, but the buyer did not comply with the payment terms of the contract. The crux of
this litigation, however, is that HHCA disputes that MHR satisfied all of its contractual
promises. The defendant contends that there was a massive patient census drop as of
January 5, 2004, as well as a decrease in patient referrals, both of which violated the no
adverse change provisions of the contract. HHCA’s Post-trial Memorandum, at 13. In
addition, the defendant contends that MHR breached various warranties because of its
5.9% Medicare patient error rate and its failure to operate the business “diligently” in
2003. Id., at 13, 61.
As to MHR’s operational deficiencies beyond its error rate, HHCA
maintains that patients were retained on RHC’s census too long in December 2003, id., at
57, and that RHC failed to perform adequate marketing. Id., at 61. In addition, HHCA
contends that MHR’s statement regarding the minimal effect that the closing of MCP
Hospital had upon patient referrals was false. Id., at 56.
In its post-trial reply memorandum, HHCA articulates its position that the
APA price was too high, given the true state of RHC’s business and the events that
followed the signing of the agreement; moreover, HHCA argues that MHR agreed to
accept the risk of such overpricing. As a result, the defendant asserts that it never
received the benefit of its contractual bargain and need not pay the full contract price:
. . . HHCA submits that the problems in this transaction were
caused by a number of facts, none of which were the fault of
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35
HHCA. First, the negotiated purchase price was too high
given the fact that the warranted Financial Statements were
overstated by the Medicare Error Rate. Second, MHR failed
to adequately track and monitor the referral sources and take
affirmative steps to correct declines in the referrals. The
problems with the referrals were exacerbated upon the
announced closure of MCP which had previously accounted
for 25% of RHC’s referral base. At the end of the day, these
two general problems manifested themselves in the reduction
of the patient census at the Transition. Simply put, RHC did
not have enough patients that continued to need care or
qualified for Medicare.
In each instance, the Agreement assigned MHR the risk for
these problems. HHCA is entitled to the benefit of its bargain
with regard to these items.
HHCA’s Post-Trial Reply Memorandum at 4.
HHCA did not receive the benefit of its bargain:
a. HHCA bargained for the purchase of a
business with 5.9% more legitimate Medicare
patients than ever actually existed.
b. HHCA bargained for the purchase of a
business with a steady census in excess of 200
patients. HHCA received a business with
approximately half of that figure.
c. HHCA bargained for the purchase of a
business in which MCP accounted for 25% of
the referrals. Because of the closure of MCP,
these referrals never materialized.
The fact that HHCA now owned a business that has a
significantly smaller volume does not mean that HHCA
obtained the benefit of its bargain.
HHCA’s Post-Trial Reply Memorandum at 12.
. . . HHCA submits that the facts show that there was a
tremendous decline in the census because RHC did not have
enough patients that needed further care and did not generate
enough new patients. Specifically, paragraph 48 of Exhibit J-
2 summarizes the actual discharges of MHR’s patients
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36
between December 2003 and January 2004. During this time,
167 out of 267 total patients were discharged to the
community as having their goals met and requiring no further
care. It is this disproportionate amount of patients being
discharged and as requiring no further care coupled with the
fact that the referral base was dwindling after September
2003, that resulted in the change in the census.
Moreover, MHR has not proven that the change in the census
was caused by the mass discharge. MHR’s own records show
what happened to the patients. (Exhibit J-2, paragraph 48).
For the most part, they didn’t need further care. Ms. Lamarra
testified that no patients were abandoned by MHR.
Furthermore, MHR has presented no evidence that any of the
patients, other than the nine Aetna patients, chose to go to a
different provider. In short, the evidence presented does not
support a conclusion that the change in census of the Business
was caused by the mass discharge associated with the transfer
of patients.
HHCA’s Post-Trial Reply Memorandum at 16.
In addition to its contention that MHR breached various contractual
provisions, HHCA maintains that such contractual violations were material breaches. As
a result, HHCA argues that it is entitled to retain ownership of the business assets for the
partial contractual price paid, unless MHR can prove that the value of those assets was
greater than the consideration already received. The defendant asserts:
The actual burden of proof in this case is more fully set forth
in HHCA’s main Brief. Specifically, HHCA has the burden
of proving that there was a breach in the Agreement. Once it
is determined that a breach existed, HHCA then has the
burden of proving that the breach was material. If HHCA
sustains its burden of proving that the breach is material, the
Plaintiff may only recover based upon a restitution theory of
damages under Section 374 of the Second Restatement of
Contracts. Under such a scenario, the Plaintiff would have
the burden of proving restitution damages. If HHCA is not
successful in proving that there was a material breach, HHCA
would be entitled to a set-off against MHR’s claims. See
Sevast v. Kakouras, 841 A.2d 1062 (Pa. Super. 200[3]).
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Given my factual and legal conclusions that MHR did not breach the APA, I25
need not address HHCA’s damage contentions. Nonetheless, I feel constrained to note the
counter-intuitiveness of defendant’s position.
The defendant argues that even if I were to accept the opinion of its own expert
(over plaintiff’s vociferous objections) that it was damaged in the amount of $540,000, it still
would not be liable to the plaintiff in the amount of $310,000— viz. $850,000 unpaid purchase
price minus $540,000 in damages. HHCA contends that Pennsylvania law limits its liability at
most to the difference between the value of the assets transferred and the amount already paid.
And as MHR offered no such valuation evidence, HHCA contends that it gets to keep its
purchased assets without any additional payment. Presumably, HHCA’s position would be
unchanged even if it had paid less than $1 million at closing.
Not only does this contention seem contrary to the traditional common law
principle that a party’s liability for a contract breach is limited to provable damages, but
Lancellotti v. Thomas, 341 Pa. Super. 1 (1985), referred to by HHCA, may not support its
position that, under Pennsylvania law, upon a contractual breach by a seller a buyer may retain
assets for less than the purchase price and place the burden upon the seller to demonstrate the
value of the assets retained. Compare U.S.B. Acquisition Company, Inc. v. Stamm, 660 So. 2d
1075 (Fla. Ct. App. 1995) (buyer of business must demonstrate difference between the value paid
and the actual value of the business); Greathouse v. Jones, 158 Colo. 516 (1965) (same).
37
HHCA’s Post-Trial Reply Memorandum at 19. 25
MHR does not agree with any of the defendant’s contentions. First, it
disputes that it violated any contractual terms. As will be discussed, MHR made no
express representations or warranties guaranteeing HHCA a minimum patient census, a
particular referral rate, or a minimal net income level. Second, it contests HHCA’s legal
position that if a seller violated a contract which a buyer does not seek to rescind then the
seller has the evidentiary burden to demonstrate the value of the property sold to the
buyer. Rather, MHR maintains that HHCA has the duty to demonstrate the extent of its
damages; and it further complains that the defendant’s expert damage evidence was so
speculative and unpersuasive that HHCA’s burden was not met.
Although the parties spend much effort on their respective evidentiary
burdens regarding the value of RHC’s business and the strength (or lack thereof) of
HHCA’s damage evidence, I must first address the issue of MHR’s alleged breach of
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38
contract. That is, HHCA concedes that it must demonstrate that MHR violated certain
provisions of the APA, see HHCA’s Post-Trial Reply Memorandumat 19, before it could
be permitted to retain RHC’s assets and offset the contract price. I thus turn to the
question whether MHR breached any contractual provisions. Only if HHCA proves by a
preponderance of the evidence that MHR violated the APA would it be necessary to
consider the issue of damages and the requisite state law burdens of proof on that
question.
IV.
HHCA raises numerous contractual provisions that it claims were violated
by MHR. Specifically, it alleged that MHR breached paragraphs 7.1 and 7.2 of the Asset
Purchase Agreement, which provided as follows:
Article VII
CONDITIONS PRECEDENT
TO THE OBLIGATIONS OF BUYER
The obligation of Buyer to complete the Closing is subject to
the satisfaction of the following conditions (any one or more
may be waived in writing by Buyer to the extent permitted by
applicable Law):
7.1. Agreements, Representations and Warranties. The
representations and warranties of Seller contained in this
Agreement shall have been true and correct when made and
shall be true and correct on and as of the Closing Date with
the same force and effect as though made on and as of the
Closing Date. Seller shall have performed and complied with
all covenants and agreements required by this Agreement to
be performed or complied with by it on or prior to the Closing
Date. Seller shall have delivered to Buyer a certificate dated
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The same evidentiary burden applies to a party asserting a breach of a condition26
subsequent. See Massachusetts Bonding & Ins. Co. v. Johnston & Harder, 340 Pa. 253, 261
(1940).
39
as of the Closing Date and signed by the President of Seller,
certifying that (i) all representations and warranties of Seller
were true and correct when made and remain true and correct
on and as of the Closing Date with the same force and effect
as though made on and as of the Closing Date, (ii) all
covenants and agreements required to have been performed or
complied with by Seller on or prior to the Closing Date have
been performed or complied with, and (iii) all conditions to
Buyer’s obligations to complete the Closing have been
satisfied or, to the extent permitted by applicable Law,
waived.
7.2. No Adverse Change. There shall have been no material
adverse change in the assets or the Business or the prospects
thereof since June 30, 2002. Without limiting the foregoing,
Seller shall not have suffered any Loss to any of the Assets,
whether or not insured, or been subject to any adverse action,
which would, individually or in the aggregate, affect or impair
the ability of Buyer to conduct the Business.
Before attempting to interpret these conditions precedent and then analyze
whether MHR has not complied, as the defendant contends, see generally Mellon Bank,
N.A. v. Aetna Business Credit, Inc., 619 F.2d 1001, 1007 (3d Cir. 1980) (“The generally
accepted rule is that the burden of proof in regard to a condition precedent is on the party
alleging the breach of the conditional promise.”), 	I will consider the enforceability of26
these conditions in this adversary proceeding.
These two contractual terms raised by HHCA are found in Article VII, titled
“Conditions Precedent to the Obligations of the Buyer.” Ex. D-1, at 21. Therefore, they
are clearly intended to be construed as conditions precedent. See Carter v. Edwin J.
Schoettle Co., 390 Pa. 365 (1957) (contract clearly established the seller’s financial status
as condition precedent, not as a warranty or representation); see generally Mellon Bank,
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40
N.A. v. Aetna Business Credit, Inc., 619 F.2d at 1016 (state law requires conditions
precedent to be “expressed by clear language”). Under Pennsylvania law, “a condition
precedent must occur before performance under a contract arises[.]” Village Beer and
Beverage, Inc. v. Vernon D. Cox and Co., Inc., 327 Pa. Super. 99, 109 (1984). Consistent
with this definition, the sales contract stated that “[t]he obligation of Buyer to complete
the Closing is subject to the satisfaction of the following conditions (any one or more of
which may be waived in writing by Buyer to the extent permitted by applicable Law).”
Article VII contained eight separate paragraphs detailing numerous
conditions imposed upon seller MHR. Paragraphs 7.1 and 7.2, quoted above, were but
two; there were also requirements for Orphans’ Court approval, delivery of certain
permits and consents, retention by HHCA of identified RHC employees, and others.
The failure of MHR to comply with these conditions precedent would have
permitted HHCA to refuse to consummate its purchase of RHC. That is the remedy
specified in the preamble to Article VII of the APA, and it is the traditional contractual
remedy for such non-performance. See generally Carter v. Edwin J. Schoettle Co., 390
Pa. at 376-77; In re Sugarhouse Realty, Inc., 192 B.R. 355, 378 (E.D. Pa. 1996); In re
Stroud Ford, Inc., 190 B.R. 785, 787 (Bankr. M.D. Pa. 1995); Restatement (Second)
Contracts, § 224 (2006). As the District Court of Delaware explained, however, the non-
performance of a condition precedent is not technically a breach of contract entitling the
other party to damages:
The assertion that the nonperformance of a condition
precedent constitutes a breach of the agreement is incorrect.
See 3A Corbin on Contracts § 634, at 33. See also Saulcy
Land Co. v. Jones, 983 P.2d. 1200, 1204 n. 2 (Wyo. 1999);
Frost Constr. Co. v. Lobo, Inc., 951 P.2d 390, 397 (Wyo.
1998) (“A condition precedent should not be described as
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41
broken.”). Rather, a condition merely does not exist or does
not occur. See 3A Corbin on Contracts, § 634.
The non-fulfillment of a promise is called a breach of
contract, and creates in the other party a secondary right to
damages; it is the failure to perform that which was required
by a legal duty. The non-occurrence of a condition will
prevent the existence of a duty in the other party; but it may
not create any remedial rights and duties at all, and it will not
unless someone has promised that it shall occur.
Weiss v. Northwest Broadcasting Inc., 140 F. Supp. 2d 336, 345-46 (D. Del. 2001); see
also Carter v. Edwin J. Schoettle Co., 390 Pa. at 377; Edwards Business Machines, Inc. v.
Laughlin, 1995 WL 170128, at *3 (E.D. Pa. 1995):
Similarly, a failure of conditions set forth in an Asset
Purchase Agreement gives rise to the ability of the purchaser
to refuse to proceed to closing. However, if instead the
purchaser proceeds to closing, the condition will be deemed to
have been waived. As the Third Circuit recently noted, under
Section 225 of the Restatement (Second) of Contracts, “while
‘a contracting party’s failure to fulfill a condition excuses
performance by the other party whose performance is so
conditioned, it is not, without an independent promise to
perform the condition, a breach of contract subjecting the
nonfulfilling party to liability for damages[.]’”
(quoting In re Columbia Gas System, Inc., 1995 WL 97407, at *6 (3d Cir. Mar. 10,
1995)).
In this proceeding, the evidence is clear that HHCA elected to complete the
transaction and has retained ownership of RHC. Indeed, years after the closing, it does
not seek to rescind the transaction (and probably could not do so as RHC no longer
operates).
Despite a contractual provision stating that waiver or modification of its
terms must be in writing, Pennsylvania permits a subsequent waiver by conduct or orally.
See, e.g., Universal Builders, Inc. v. Moon Motor Lodge, Inc., 430 Pa. 550, 557 (1968);
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Indeed, as will be discussed below, there was a non-written waiver of a27
contractual provision insisted upon by HHCA. Although RHC promised to operate its business
as it normally did, until closing, HHCA required that RHC discharge all of its patients prior to
closing.
42
Brinich v. Jencka, 2000 Pa. Super. 209, 757 A.2d 388, 399 (2000), app. denied, 565 Pa.
634 (2001); Rosenzweig v. Suburban Orthopedics Associates, Ltd., 1988 WL 65905, at
*5 n.2 (E.D. Pa. 1988); see also Prousi v. Cruisers Div. of KCS Int’l., Inc., 975 F. Supp.
768, 771-72 (E.D. Pa. 1997) (condition precedent can be waived by conduct), recon.
granted on other grounds, 1999 WL 551359 (E.D. Pa. 1999). 	By electing to perform27
under the contract, and by declining to return the property purchased even after learning
of the alleged breach, HHCA has chosen to waive any non-compliance of those
conditions precedent that were included in the APA. See Edwards Business Machines,
Inc. v. Laughlin, 1995 WL 170128, at *3; see also Greenleaf v. Safeway Trails, Inc., 140
F.2d 889, 891 (2d Cir. 1944) (“If the audit can be considered as a condition precedent to
executing the note, the condition was waived both by the statement of account (exhibit 7)
and by continuing to accept the benefits of the contract of October 22, 1940.”); cf.
Watson v. Miller, 164 Ore. App. 309 (1999) (a party can waive a contractual condition by
accepting performance, thus triggering a duty on that party to perform as well).
HHCA argues nonetheless, see Defendant’s Post-Trial Memorandum, at 55
n.19, that the second amendment to the APA contained a non-waiver provision and thus
MHR’s duty to fulfill those conditions precedent remains outstanding.
Paragraph 4 of Amendment No. 2, Ex. D-3, provides in relevant part:
Seller acknowledges and agrees that, in consideration of
Buyer’s willingness to complete the Closing on January 21,
2004, notwithstanding that certain conditions to its obligations
to do so have not been satisfied or waived, Buyer shall retain
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43
all of its rights and remedies under the Agreement, including
hereunder, notwithstanding its determination to effect the
Closing on January 21, 2004, and that such determination is
not intended, nor shall be construed, to constitute a waiver,
whether express or implied, of any such right or remedy of
Buyer.
I find unpersuasive HHCA’s assertion that this provision permits it to raise
in this adversary proceeding MHR’s failure to comply with any condition precedent in the
APA. Any “right and remedy” for a seller’s breach of a condition precedent would be
limited to the buyer’s right to decline to purchase, see Carter v. Edwin J. Schoettle Co.,
390 Pa. at 378-79, a result neither feasible at this time nor desired by HHCA.
Accordingly, I conclude that even if MHR failed to comply with the provisions of ¶¶7.1
or 7.2, such a failure of a condition precedent would not entitle HHCA to reduce the
contract price while retaining RHC’s assets and business. See Carter v. Edwin J.
Schoettle Co. (“The parties carefully and scrupulously delineated between the sellers’
undertakings which were intended to be ‘warranties’ and those which were intended to be
‘conditions.’ It is crystal clear that the undertaking under paragraph 9(a) was simply a
‘condition’ and not a ‘warranty’ and once the buyer elected to accept this agreement the
provisions of paragraph 9(a) ceased to be operative and the buyer had no right to recover
any damages.”); Weiss v. Northwest Broadcasting Inc., 140 F. Supp. 2d at 346; see also
Edwards Business Machines, Inc. v. Laughlin, at *4.
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There is a distinction between contractual representations and warranties. A28
contractual warranty is “[a]n express or implied promise that something in furtherance of the
contract is guaranteed by one of the contracting parties; esp., a seller’s promise that the thing
being sold is as represented or promised.” Black’s Law Dictionary (8th ed. 2004). A contractual
representation is “[a] presentation of fact – either by words or by conduct – made to induce
someone to act, esp. to enter into a contract.” Id.
The difference between the two has been described as follows:
A warranty differs from a representation in four principal ways: (1)
a warranty is an essential part of a contract, while a representation
is usu[ally] only a collateral inducement, (2) an express warranty is
usu[ally] written on the face of the contract, while a representation
may be written or oral, (3) a warranty is conclusively presumed to
be material, while the burden is on the party claiming breach to
show that a representation is material, and (4) a warranty must be
strictly complied with, while substantial truth is the only
requirement for a representation.
Id.; see also Karp v. Fidelity-Phenix Fire Ins. Co., 134 Pa. Super. 514, 517-18 (1939):
The difference between a warranty and representation is well stated
in Miller v. National Casualty Co., 62 Pa. Super. 417, 420, as
follows: “A warranty must be literally true, without regard to its
materiality to the risk, while a representation must be true only so
far as it is material to the risk.”
As will be seen, HHCA appears to treat all 24 provisions of APA Article IV as
warranties and none as simply representations.
44
V.
In addition to the conditions precedent in the APA, HHCA also contends
that MHR breached certain “representations and warranties 	of seller,” adversely28
affecting the value of the business it purchased. It emphasizes, inter alia, RHC’s
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In April 2004, HHCA sent to MHR a notice of the latter’s breach of the APA.29
Ex. D-19. In it, HHCA asserts numerous breaches of the APA, including fraud, some of which
are not addressed in its post-trial submissions. I shall assume that, based upon discovery and the
evidence adduced at trial, HHCA has now concluded that not all of its assertions made in April
2004 were proven, or even true, and will only address the issues raised post-trial by the
defendant.
45
Medicare error rate, the drop in the patient census in January 2004, the decline in referrals
from MCP, and the alleged failure of RHC personnel to undertake marketing efforts. 29
In analyzing the APA (and its amendments), I note that the contract states
that Pennsylvania law shall govern, see, e.g., APA ¶ 13.10, and also provides that
“[a]mbiguities and uncertainties in the wording of the Agreement shall not be construed
for or against any Party, but shall be construed in the manner that most accurately reflects
the Parties’ intent as of the date of this Agreement.” Ex. D-1, ¶ 13.11. Indeed,
Pennsylvania law directs that “[a] fundamental rule in construing a contract is to ascertain
and give effect to the intent of the contracting parties.” Mace v. Atlantic Refining
Marketing Corp., 567 Pa. 71, 80 (2001); accord Chen v. Chen, 586 Pa. 297, 893 A.2d 87,
93 (2006). A contractual provision is generally interpreted “to have the most reasonable
and beneficial operation that its language permits.” Reilly v. City Deposit Bank & Trust
Co., 322 Pa. 577, 582 (1936).
A.
HHCA asserts (on page 63 of its post-trial memorandum) that MHR
breached paragraphs 4.3 and 4.8 of Article IV, Representations and Warranties of Seller,
which provide as follows:
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“Law” is defined in the APA as “any provision of any law, statute, ordinance,30
order, constitution, charter, treaty, code, rule or regulation enacted, approved or adopted by any
Governmental Agency and applicable common law.”
“Contract” is defined as “any written or oral contract, agreement, instrument,
commitment or binding arrangement, express or implied, of any nature whatsoever.”
“Permit” is defined as “any license, permit, approval, certificate, Consent, right or
privilege of any kind or nature whatsoever granted, issued, approved or allowed by any
Governmental Agency.”
46
Seller hereby represents and warrants to Buyer on and as of
the Agreement Date and on and as of the Closing Date as
follows: . . .
4.3. 	No Breach. Except as set forth on Schedule 4.3, the
consummation of the transactions herein contemplated
including the execution, delivery, performance and
consummation of this Agreement and the Documents required
to effect the transactions herein contemplated, do not and
shall not (a) constitute a violation of or default under (either
immediately or upon notice, lapse of time or both), conflict
with or result in a breach of . . . (iv) any Laws; or . . . (c)
result in the breach of any of the terms and conditions of,
constitute a default under or otherwise cause any impairment
of, any Contract, or Permit[.] 	. . .30
4.8 	Compliance with Laws. Seller’s operations in
connection with the Business and the Assets, Seller’s conduct
of the Business as and where such Business is presently or has
in the past been conducted, and the Assets and their uses
comply with all applicable Laws. . . .
HHCA contends that these two contract provisions were violated by RHC
having a Medicare error rate of 5.9%. HHCA further maintains that even if it knew or
should have known of the seller’s error rate, because of its due diligence, paragraph 10.1
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Paragraph 10.1 of the APA states:31
Notwithstanding any right of Buyer to fully investigate the affairs
of Seller and notwithstanding any knowledge of facts determined
or determinable by Buyer pursuant to such investigation or right of
investigation, Buyer has the right to rely fully upon the
representations, warranties, covenants and agreements contained in
this Agreement or in any Document delivered to Buyer or in any
statement to Buyer made by representatives of Seller in connection
with the transactions contemplated by this Agreement. Each
warranty, representation and covenant contained herein is
independent of all other warranties, representations and covenants
herein (whether or not covering identical or related subject matter)
and must be independently and separately complied with and
satisfied. All representations and warranties shall survive the
Closing for a period of two (2) years following the Closing, except
that the representations and warranties set forth in Sections 4.2,
4.8, 4.13, 4.14, 4.18, 4.20, and 4.22 shall each survive until ninety
(90) days after the expiration of the applicable statutory period of
limitation with respect to any claims arising out of, relating to or
caused by any misrepresentation, breach or failure of any such
representation or warranty. All covenants and agreements shall
survive the Closing in accordance with their respective terms.
Notwithstanding any provision hereof to the contrary, all
representations, warranties, covenants and agreements that are the
subject of one or more claims for indemnification pursuant to
Article XI, notice of which claims has been delivered in
accordance with this Agreement during the survival period set
forth above, shall survive the Closing until all such claims have
been finally settled or finally adjudicated by a court of competent
jurisdiction.
In Giuffrida v. American Family Brands, Inc., 1998 WL 196402, at *4-*5 (E.D.
Pa. 1998), the district court predicted that the Pennsylvania Supreme Court would allow a party
to a contract to enforce a warranty, even if the party did not rely upon the warranty, at least when
the contract expressly provides that the warranty would be preserved. The parties have not cited
and I am unaware of any reported Pennsylvania state court decision that has either agreed or
disagreed with the prediction of Giuffrida. While I will accept arguendo its thoughtful analysis
that a party’s warranty may not be eliminated by the due diligence of the other contracting party,
a distinction relevant to this proceeding should be noted. In construing the parties’s intended
(continued...)
47
of the APA renders the buyer’s knowledge irrelevant for purposes of enforcing certain
representations and warranties. 31
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(...continued)31
scope of their warranties, their joint prior knowledge can be relevant. That is, unless the
contractual language is very clear, it is unlikely that a contract would intentionally contain a
warranty that both parties know, or are likely to know, cannot be true.
48
Clearly, ¶ 4.3, in which MHR warrants the lack of certain effects of the sale
transaction, is not implicated by the seller’s Medicare error rate. Although not identified
expressly by HHCA in its post-trial memorandum (or in its April 2004 notice of breach
letter to MHR), its memorandum reference to paragraph 4.3 of APA is probably
unintended. On page 63, it refers to a contract provision providing that MHR represented
and warranted that it had no “‘Knowledge’ of any circumstances that would call into
question the medical necessity of any services which are the basis of any claim . . . .”
That provision is found in paragraph 4.13 of the APA, not 4.3. Thus, I will consider
whether the evidence demonstrates that MHR violated ¶ 4.13.
The representation and warranty in ¶ 4.13 is titled “Third-Party Payment
Filings.” Ex. D-1. It was designed to address issues of payment from the Medicare and
Medicaid program, and is one of a number of provisions intended to insulate HHCA from
any liability to those governmental programs for services provided by RHC prior to
selling the business to HHCA. Paragraph 4.13 states:
Third Party Payment Filings. Seller has filed on a
timely basis all claims, cost reports and annual
filings required to be filed by it to secure payment under
Medicare and Medicaid programs for the Business. Seller has
no Knowledge of any circumstances which would call into
question the medical necessity which are the basis for any
claim, and all services provided by Seller in the Business have
been provided pursuant to valid physician orders. Seller is not
subject to Medicaid program audits for the Business except as
set forth on Schedule 4.13, and to the extent required by
applicable Law, Seller has filed all Medicare cost reports and
has received settlements for all amounts billed Medicare
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49
Business. The liability for amounts due Medicare reflected on
Seller’s latest balance sheet included in the Financial
Statements is adequate to cover all amounts due from Seller to
Medicare for the Business. All claims, cost reports or annual
filings made by Seller to secure payment under the Medicare
and Medicaid programs for the Business are complete and
correct except to the extent that the Medicare and Medicaid
programs have issued to Seller prior to the Closing Date
notices of program reimbursements making adjustments
thereto. Seller has no liability to Medicaid by reason of
services provided prior to and including the closing date for
the Business.
I assume that HHCA intended to argue in its post-trial memorandum that
RHC’s Medicare error rate in 2003 runs afoul of this provision. I also disagree with
defendant’s contention that this provision was breached.
Paragraph 4.13 consists of seven sentences addressing RHC’s pre-sale
filings with Medicare and Medicaid concerning payments and overpayments. To the
extent HHCA views them as seven discrete warranties, it focuses only upon the second
sentence as allegedly breached: “Seller has no Knowledge of any circumstances which
would call into question the medical necessity which are the basis for any claim, and all
services provided by Seller in the Business have been provided pursuant to valid
physician orders.”
The term “Knowledge” is defined in the APA as: “[W]ith respect to any
Person, that (a) such Person is actually aware of a particular fact or other matter or (b) a
prudent Person could be expected to discover or otherwise become aware of a particular
fact or other matter in the course of conducting a reasonably comprehensive investigation
concerning the existence of such fact or other matter.” Ex. D-1, ¶ 1.1.
The evidence at trial reflects that RHC did not know that its Medicare error
rate was higher than the national average, and believed it had a quality control person in
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50
place to alert it to repayment problems. The evidence further revealed that RHC’s error
rate had not surfaced in any real or mock audit prior to the sale, see generally Chaves
County Home Health Service, Inc. v. Sullivan, 931 F.2d 914 (D.C. Cir. 1991), and that
HHCA, while discovering during due diligence that RHC had some quality control issues,
did not discover the extent of the problem until long after the sale closing, and only after
it hired an expert to analyze carefully chosen samples of RHC’s 2003 patient records.
See Ex. D-16. A sample is used because it is too time-consuming and expensive to look
at every patient file, given patient turnover during a calendar year.
The evidence also revealed that MHR established a bad debt reserve in part
to address any potential Medicare overpayments, and that HHCA was aware of this bad
debt reserve. Moreover, on average every home healthcare agency has some Medicare
error rate.
Given the evidence that all home healthcare agencies are likely to have
some Medicare error rate, one cannot conclude that the parties intended that MHR was
warranting in ¶ 4.13 that it had none or that HHCA was misled into believing that it had
none. Nor does the evidence reflect that RHC hid the true state of affairs from HHCA, or
that RHC should have known that its error rate exceeded the national average.
Furthermore, RHC also represented in paragraph 4.13 that its “[l]iability for
amounts due to Medicare reflected on Seller’s latest balance sheet included in the
Financial Statements is adequate to cover all amounts due from Seller to Medicare for the
Business.” HHCA, which bargained to exclude any liability for Medicare and Medicaid
overpayments made to RHC, does not argue that this provision has been violated by
MHR. There was no evidence that Medicare or Medicaid sought recoupment of any
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51
overpayments from RHC or HHCA. See generally Reliable Home Health Care, Inc. v.
Thompson, 2002 WL 22025 (E.D. La. 2002) (explaining that Medicare makes interim
payments on an estimated basis and audits those payments at a later time for under- or
overpayment). Plus, RHC established a debt reserve which would protect against this
contingency.
Therefore, HHCA has not met its burden of demonstrating that MHR
breached APA ¶ 4.13 concerning “third-party payment filings.”
B.
I reach a similar conclusion concerning paragraph 4.8, which warrants and
represents that MHR conducted its business operations in compliance with relevant laws.
This provision was not violated simply because RHC appears to have improperly
provided services in 2003 to a small fraction of its patients, and in so doing may not have
been entitled to reimbursement from Medicare for treating those patients.
I appreciate that 42 CFR § 484.55 provides that one condition a home
health agency should follow to participate in the Medicare program is a “comprehensive
assessment” of its Medicare patients. Further, the “HHA must verify the patient’s
eligibility for the Medicare home health benefit including homebound status, both at the
time of the initial assessment visit and at the time of the comprehensive assessment.” Id.
The evidence demonstrated that RHC complied with this regulation, but
during 2003 for 5.9% of its Medicare patients its assessments may have not met some
treatment standard or other condition imposed by Medicare for repayment. See generally
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The logic of HHCA’s argument would mean that RHC would violate ¶¶ 4.8 and32
4.13 if it had any Medicare error rate at all, even one less than the national average.
52
Reliable Home Health Care, Inc. v. Thompson. Given HHCA’s concession that it too
may have a small number of Medicare patients for which it may not be entitled to
reimbursement, given that HHCA bargained that it would not be held liable under the
APA for any Medicare overpayments received by RHC, given the lack of evidence that
Medicare has sought recovery of any overpayments from RHC, and given the parties’
stipulation that there is a national average Medicare error rate for home health care
providers, I conclude that it was unlikely that the parties intended in November 2003 that
a general provision concerning RHC’s compliance with laws would serve as a warranty
that RHC had absolutely no Medicare error rate. 32
Thus, I conclude that RHC was operating in compliance with federal, state
and local laws as intended by the parties when they signed the APA.
HHCA also contends that the existence of RHC’s Medicare error rate
violated ¶ 4.5 of the APA. See Defendant’s Proposed Legal Conclusions, ¶ 7(c);
Defendant’s Post-Trial Reply Brief at 11. Paragraph 4.5 states:
Financial Statements: Corporate Records and Reports
(a) Seller’s fiscal year ends on June 30. Schedule 4.5 contains
the financial statements and notes thereto of seller (including
balance sheets and related statements of operations, changes
in net assets and cash flows (at and for the fiscal year ended
June 30, 2002, 2001 and 2000). All such statements including
footnotes thereto were audited and reported upon by Smart &
Associates, LLP, Certified Public Accountants, and an
unqualified auditor’s opinion with an explanatory paragraph.
Schedule 4.5 also sets forth the seller’s financial statements
for the Business (including unaudited balance sheets and
related statements of operations, changes in net assets and
cash flows) at and for the nine (9) months ended September
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53
30, 2003. The foregoing financial statements of seller are
hereinafter collectively referred to as the “Financial
Statements”. The Financial Statements are true and correct
and fairly present the financial position of the Business as at
such dates, and the results of its operations and the changes in
its net assets and its financial position for the periods then
ended in accordance with GAAP, except that the monthly
payroll accruals are not recorded, the amount of which would
not be material. The Financial Statements do not contain any
misstatements or omissions regarding the Business. The
Financial Statements are not affected by transactions or
accounts with affiliated persons, if any, other than as set forth
in Schedule 4.5.
(b) Seller’s books and records relating to the Business are and
have been properly prepared and maintained in form and
substance, and accurately reflect all of the respective items of
income and expenses, and all of its respective assets and
Liabilities, and accruals adequate for preparing Financial
Statements in accordance with GAAP except that monthly
payroll accruals are not recorded, the amount of which would
not be material. Seller has filed all reports required by all
laws to be filed, and has duly paid or accrued on its respective
books on account all applicable duties and charges due or
assessed against or pursuant to such reports.
Ex. D-1, ¶ 4.5.
Essentially, HHCA argues that MHR’s financial statements were not “true
and correct” and did not “fairly present [RHC’s] financial position” because the Medicare
revenues were overstated by virtue of the 5.9% error rate. Again, my review of these
statements and the evidence at trial finds the defendant’s position unpersuasive.
The revenues that MHR disclosed were accurately stated and actually
received. There is no evidence that RHC did not receive the amount of revenue noted on
its financial statements. Further, MHR budgeted for a potential Medicare overpayment in
its bad debt reserve—an overpayment which the governmental agency has not sought or
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I am unaware of any governmental overpayment claim having been filed in this33
bankruptcy case.
54
asserted. 	Once again, HHCA is arguing in effect that MHR warranted in ¶ 4.5 that RHC33
had no Medicare error rate whether known to RHC or not. It is unlikely, for the reasons
previously stated concerning ¶¶ 4.8 and 4.13, that the parties so intended.
C.
On page 64 of its post-trial memorandum, HHCA maintains that MHR
violated ¶ 4.24 of the APA. This paragraph provided:
4.24 	Full Disclosure. The information furnished by or on
behalf of Seller to Buyer in connection with this Agreement
and the transactions contemplated hereby does not contain any
untrue statement of material fact and does not fail to state any
material fact necessary to make the statements made, in the
context in which they are made, not false or misleading.
There is no fact which Seller has not disclosed to Buyer in
writing which adversely affects, or so far as Seller can now
foresee, shall adversely affect, the Assets, the Business or
condition (financial or other) of Seller or any of them or the
ability of Seller to perform this Agreement.
HHCA asserts that this provision was breached in the following numerous
ways:
1. The referrals for the business began dropping after
September, 2003;
2. 5.9% of RHC’s Medicare patients did not qualify for
Medicare;
3. RHC’s director failed to perform the marketing function of
her job;
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4. RHC failed to adequately maintain a Medicare compliance
program;
5. RHC terminated a key employee, Mr. Massino, without
written notice to HHCA as required by the Agreement;
6. RHC’s census dropped prior to closing; and
7. RHC failed to disclose the adverse impact of the announced
closure of MCP.
Id.
Furthermore, HHCA argues that Mr. Feldman’s December 2003 e-mail
messages to HHCA, opining that MCP’s intended hospital closure would have a minimal
effect upon RHC’s business, were untrue and are also within the scope of the
representation and warranty of ¶ 4.24. Id.
Other than this reference to December 2003 e-mails and its contentions
about the Medicare error rate, HHCA does not maintain that any of the information
provided by MHR during due diligence was erroneous or falsified. From the evidence
presented, it appears that RHC earned the amounts disclosed in its financial reports, had
the number and categories of patients that were disclosed to HHCA, and had the patient
referrals that it disclosed and from the sources that were disclosed.
It is true that RHC’s director, Ms. Lamarra, was not involved with
marketing efforts. But MHR never represented otherwise. Obviously, RHC must have
undertaken some marketing efforts, for its business over a number of years was successful
enough to attract expressions of interest from more than one prospective buyer. And if,
as HHCA now asserts, RHC’s marketing efforts should have been more extensive, its net
income might have been higher and the purchase price would have been greater. Thus,
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Paragraph 7.8 of the APA contains, as a condition precedent, that certain key34
employees of MHR would agree to become employed by HHCA upon the sale of RHC.
Schedule 7.8 identifies these three employees, and Mr. Massino is not among them.
56
Ms. Lamarra’s lack of marketing involvement was not a material fact hidden from
HHCA, which MHR had a duty to reveal under ¶ 4.24.
It is also true that RHC had a higher than national average Medicare error
rate in 2003, but the seller never implied nor represented otherwise to HHCA. RHC had
an employee, Mr. Massino, among whose duties was to review patient records for
Medicare compliance. His employment was terminated in November or December 2003
when it became clear that his services would not be needed by HHCA. See Finding #46
n.12. There was no evidence offered that HHCA was unaware of this—indeed, since it
hired RHC staff in early January 2004, it must have known who was no longer employed
by RHC—or that MHR sought to hide his termination. Thus, his termination as part of
the transition to HHCA ownership was not a material fact that fell within the scope of ¶
4.24 of the APA. 34
Insofar as MHR’s disclosures regarding patient census and patient referrals
are concerned, HHCA has not pointed to any information provided to it that was not true,
including RHC’s December 2003 e-mail messages, noting the decline in MCP referrals
from June 2003 levels. HHCA conceded at trial that the patient census information was
accurate, as was the referral information. Indeed, as mentioned in the fact finding
section, the limited evidentiary record reflects that the daily referral rate was fairly
constant throughout 2003, until the commencement of the transition period when HHCA
assumed control of RHC’s operations. See Findings ## 59, 73.
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The evidence admitted in this proceeding does not reflect that MHR was a
seller who falsified financial information to deceive HHCA, compare Kool, Mann, Coffee
& Co. v. Coffey, 300 F.3d 340, 358 (3rd Cir. 2002), nor does it involve a seller who
promised some minimum level of future revenue to a buyer. There was no evidence that
the seller attempted to or successfully siphoned business from the buyer, or hid crucial
facts about the business from the buyer.
Having reviewed the testimony, documents and arguments of the parties, I
conclude that defendant HHCA has not proven by a preponderance of the evidence that
seller MHR did not fully and accurately disclose its business, assets and financial
condition as of the time the agreement of sale was signed, and even up to closing, as the
parties intended when the APA was signed in November 2003.
IV.
HHCA’s closing arguments and post-trial submissions make it clear that its
central affirmative defense involves paragraph 4.6 of the APA: the “no adverse change”
provision of the contract.
Article IV of the APA, Ex. D-1 at 11, states that the:
Seller hereby represents and warrants to Buyer on and as of
the Agreement Date and on and as of the Closing Date as
follows: . . .
4.6 	No Adverse Change. From and after December 31,
2002, the business, activities and operations of Seller relating
to the Business have been carried on and conducted in the
ordinary course of business, diligently and in the same manner
as they have been conducted in the past, and there has not
been and there shall not be an adverse change in the Assets or
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The term “Business” is defined as the “home health care business conducted by35
the Seller and the Properties used in such business.” APA, Ex. D-1 at ¶ 1.1. “Property” is
defined to mean “real, personal, or mixed property.” Id. And “Assets” are described as
including scheduled: tangible property, inventory, contract rights, intangible property, customer
lists, claims and causes of action. Id., at ¶¶ 1.1, 2.1. The assets do not include the sellers’
Medicare provider number or agreement, its accounts receivable, or patient medical records. Id.,
at ¶¶ 1.1, 2.2.
58
Business or prospects of Seller relating to the Business. Any
change which has occurred reflects only the ordinary and
regular conduct of the Business or the normal use or operation
of the Assets. Seller has no Knowledge of any such
impending change, and since December 31, 2002, there has
not been any damage, destruction or loss affecting the Assets
or the Business, whether or not covered by insurance.
This clause contains several promises by the seller MHR: to carry on RHC’s
business in the ordinary course; to carry on the business diligently; to warrant that there
was and will not be an adverse change in the assets, business or prospects of seller; and to
represent that seller has no knowledge of any impending change. Notably, the clause
protects the buyer against adverse changes; however, it does not protect a buyer against a
change occurring in the “ordinary and regular conduct of the Business or the normal use
or operation of the Assets.” 35
As I read HHCA’s post-trial submissions, it does not argue that there was
any damage, destruction or loss affecting the “assets” of RHC, a term distinct in ¶ 4.6
from the term “business.” Nor does HHCA address expressly that provision of ¶ 4.6
excluding from its scope those changes which occurred due to the ordinary and regular
conduct by RHC of its home healthcare business.
Instead, HHCA contends that a “striking drop in referrals after September
2003" constitutes an “adverse change” in the business or its prospects. Defendant’s Post-
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Trial Memorandum, at 55. On that issue, it emphasizes a decline in the referral stream
from MCP, which it argues was a “major referral source” formerly “account[ing] for 25%
of RHC’s referrals.” Id., at 56.
In addition, HHCA also maintains that the drop in patient census between
December 2003 and January 2004 constitutes an adverse change in the business. Id. It
contends that this decline arose from an unusual number of patients discharged in
December 2003 and January 2004 as having completed their treatment: the result of
“RHC . . . keeping its patients on census too long.” Id., at 57. The defendant also
complains that the Medicare error rate of 5.9% resulted in an inflated census of patients.
Id., at 58. Furthermore, HHCA maintains that, based upon historic RHC patient data, it
“had reasonable expectations that the census on closing would approximate 200 patients.”
Id.
In considering the evidence, as well as the parties’ intent and language of
the adverse change clause, I cannot agree with HHCA that MHR breached the
representation and warranty found in ¶ 4.6 of the APA.
The purpose behind a broad material adverse change (“MAC’) provision in
an asset purchase agreement was described by one court as follows: “[T]hat provision is
best read as a backstop protecting the acquiror from the occurrence of unknown events
that substantially threaten the overall earnings potential of the target in a durationally-
significant manner. A short-term hiccup in earnings should not suffice; rather the
Material Adverse Effect should be material when viewed from the longer-term
perspective of a reasonable acquiror.” In re IBP, Inc. Shareholders Litigation, 789 A.2d
14, 68 (Del. Ch. 2001) (footnote omitted). Compare KLRA, Inc. v. Long, 6 Ark. App.
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125 (1982) (a 48% drop in radio station profits from contract signing to closing was a
material adverse change) with Borders v. KLRB, Inc., 727 S.W.2d 357, 359 (Ct. App.
Tex. 1987) (Arbitron ratings showing loss of one-half of the audience of a radio station
between signing of sale agreement and closing was not a material adverse change because
the MAC clause was intended by the parties to prevent “deliberate adverse action” by
seller’s management).
A commentator recently offered this conceptual approach to MACs:
From a theoretical perspective, MAC clauses represent a
mechanism to alleviate the “lemon problem”—the problem
faced by a better-informed seller trying to convince a
less-informed buyer that the object of the sale has no hidden
defects. Left unallayed, the buyer’s doubts will lead to a steep
discount in the offered price, perhaps even reducing it below
the seller’s minimum sale price and scuppering a potentially
valuable deal.
By agreeing to bear the cost of any unwelcome post-signing
development, the seller can induce the buyer to apply a
shallower discount and raise the offer price. MAC clauses are
a means of arranging such a cost-shift. Should a material
adverse change materialize, the deal will be broken off or
renegotiated; in either case, the erstwhile seller will be forced
to swallow the costs of coping with the adverse change.
This perspective provides a framework for the interpretation
of MAC clauses in court, in cases where the parties’ language
is not unambiguous. Two principles, in particular, are useful
as background for this paper’s consideration of courts’ actual
practice. First, courts should avoid interpreting an event as a
material adverse change if its occurrence—or the strong
probability of its occurrence—was expected by the buyer or
was obvious, or if the buyer had as much information on the
risk as the seller. The impact of such an event should already
be reflected in the agreed price; granting the buyer an option
to break off the deal would be a reallocation of value contrary
to what the parties originally bargained for. For example, if a
software maintenance company suffers a decline in sales of
70% in the second quarter of 2000, as its Y2K contracts end,
the decrease in revenue ought not be considered a material
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adverse change—it was surely foreseen by the acquiror and
accounted for in the offer price.
Second, courts’ view of materiality ought to depend on the
needs and purposes of the buyer, as it is the buyer’s doubts
and fears that the MAC is intended to allay. For instance, if
an acquiror is interested in a small biotech company solely for
the sake of a patent it holds, a sudden plummeting of the
company’s sales should not be material. While the plummet
is clearly material to the company as a going concern, it does
not impact the purposes of the acquiror in making the deal.
The revelation of a third-party claim of prior art, on the other
hand, might well be considered material.
Galil, MAC Clauses In A Materially Adversely Changed Economy, 2002 Colum. Bus. L.
Rev. 846, 849 (2002).
I appreciate that ¶ 4.6 does not use the modifier “material” in addressing the
absence of adverse changes. But I also note that HHCA explained that its intent in
bargaining for this contract provision was similar to a MAC: to protect itself from
negative changes to RHC’s business between the time of signing the APA until closing.
N.T. 5/18/06 at 216-17. The buyer’s intent is relevant in construing contractual terms.
See Galil, MAC Clauses In A Materially Adversely Changed Economy, 2002 Colum.
Bus. L. Rev. at 853.
I now consider HHCA’s specific contentions regarding ¶ 4.6.
HHCA cites to In re Eastern Continuous Forms, Inc., 302 B.R. 320 (Bankr.
E.D. Pa. 2003), aff’d 2004 WL 2418285 (E.D. Pa. 2004). In that decision, the bankruptcy
court held, and the district court agreed, that the failure of a seller to disclose to its
business purchaser information known to the seller about the financial difficulties and
likely ownership transfer of its major customer—a customer historically responsible for
28% of the seller’s revenues—violated a contractual provision covering material adverse
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changes to “business operations or prospects,” when shortly after the business sale the
customer ceased dealing with the buyer and the buyer’s business became bankrupt. Id. at
302 B.R. 330-31; 2004 WL 2418285, at *3.
HHCA likens the reduction of referrals made to RHC by MCP as analogous
to the loss of a major customer in Eastern Continuous Forms, and argues that the referral
loss represented an adverse change in RHC’s business or prospects, within the scope of ¶
4.6.
The evidence does demonstrate that the number of referrals coming from
MCP declined in 2003. In April thru June 2003, RHC averaged 54 referrals per month
from MCP. See Finding # 61. In September, this number dropped to 43, then to 31 in
October, 9 in November, and 11 in December 2002. See Findings ## 64, 69, 74. In
January 2004, HHCA received 11 referrals from MCP, and in February 2004, just 3. See
Finding # 74.
HHCA’s contention, though, that MCP provided 25% of all RHC referrals
prior to the sale is thus misleading. It did in the first half of 2003; however, MCP did not
provide one-quarter of RHC’s referrals in the second half of 2003 when the sale
agreement was signed. Moreover, HHCA knew or should have known this when it was
negotiating the APA through its due diligence and analysis of RHC’s referral logs. See,
e.g., Exs. P-6, P-12, P-15, P-32. Indeed when Mr. Brunner of HHCA was analyzing, in
February 2004, the decline in Medicare patient referrals after the sale closed, the decline
in MCP referrals is smaller than the decline from other referral sources. Ex. P-54.
Unlike Eastern Continuous Forms, in this adversary proceeding the
evidence shows that there was no sudden cessation of business from a major RHC referral
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While citing to Eastern Continuous Forms as factually analogous, HHCA36
ignores that court’s damage analysis. The court held that the damages allowed to the buyer
would be limited to provable lost profits solely due to the cessation of business from the major
customer. Id., 302 B.R. at 341-43. When the loss of one customer is replaced by another, as
occurred here, so that net revenues for RHC in 2003 were fairly constant, such a methodology
yields no damages.
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source either between the time the APA was signed and closing, or immediately after
closing. Nor was any information known to MHR that was hidden from HHCA. The
MCP hospital closing was publicly announced, and MHR provided HHCA with accurate
referral information. Moreover, the evidence also reflects that as MCP referrals declined
in 2003, which decline pre-dated its announced closing, patient referrals from other
sources increased, and the net number of daily referrals remained fairly constant. See Ex.
P-34. This is another significant distinction from the facts of Eastern Continuous Forms
and demonstrates that the reduction in referrals from MCP was not adverse to RHC’s
business or its prospects.
Therefore, I conclude MHR was not in breach of paragraph 4.6 of the APA
because MCP reduced its patient referrals after June 2003. 36
The evidence does reflect that after HHCA took control of RHC’s home
healthcare business, the number of patients and patient referrals significantly declined.
And such declines were, indeed, adverse changes in the home healthcare business or its
prospects; however, the APA did not impose the risk of those two declines upon MHR.
Paragraph 4.6 required RHC to conduct its business as it had in the past. It
also excluded changes arising from RHC’s normal operations of its business. The
evidence demonstrates that RHC conducted its home healthcare business consistently
until December 17, 2003. Whatever operational flaws that HHCA now complains
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Indeed, Mr. Feldman testified that, prior to his involvment with MHR, he37
participated in the sale of Visiting Nurse Service System (VNSS) and the buyer of VNSS
assumed the seller’s provider number. Moreover, he was unaware of any significant census
decline occurring in that transaction. N.T. 5/25/06 at 158-59.
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about—i.e., lack of marketing and quality control—existed and persisted throughout
2003. And after studying RHC’s operations, HHCA reached a value of the worth of the
business. RHC’s daily referral rate, quarterly net revenues and methods of conducting
business were fairly consistent throughout 2003.
After December 17, 2003, RHC’s method of operating changed
significantly. All patient referrals were channeled to HHCA. It began to discharge all of
its patients. And it terminated all of its employees. These changes were all made at the
insistence of HHCA, the intended purchaser, prior to closing, because the defendant had a
different Medicare provider number than did RHC and HHCA wanted all patients under
its own provider number. And the evidence suggests that all of the “adverse changes” in
referrals and patient census occurred after December 17th.
There was no evidence offered whether HHCA could have assumed RHC’s
Medicare provider agreement as part of the asset purchase if the buyer so desired. See
United States v. Vernon Home Health, Inc., 21 F.3d 693 (5th Cir. 1994) (provider
agreement was assigned). But the non-assumption of the provider agreement lessened
HHCA’s potential liability for any possible Medicare overpayments made to RHC. See
id. 37
MHR argues that HHCA itself is responsible for the loss of census and
referrals. The plaintiff complains of the defendant’s lack of marketing after the APA was
signed and prior to closing. See generally In re JC’s East, Inc., 1995 WL 555765, at *3
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(S.D.N.Y. 1995) (seller of restaurant did not violate “mac” provision when two
employees left after the sale because “the need to retain key employees . . . was something
which [the buyer] could have anticipated and done something about.”). It also asserts that
HHCA had a poor reputation in the home healthcare industry, thus causing doctors and
referral sources to consider other providers for their patients, including former RHC
patients. And it notes that HHCA was not affiliated with any hospital—RHC had a Tenet
affiliation— and so, without exclusive referral agreements, could not reasonably expect
Tenet physicians to continue referrals at the same level. MHR even speculates that
patients and physicians may have been annoyed or confused by RHC’s mass patient
dismissal.
I need not decide whether any or all of MHR’s proffered explanations and
speculations for the post-transition decline in census and referrals to HHCA are accurate.
The burden fell upon HHCA to demonstrate that it was more probable than not that the
declines did not stem from its decisions and instructions to RHC, but from RHC’s non-
ordinary or irregular conduct. And it failed to do so.
HHCA contends that RHC employees kept patients on its census longer
than was normal in December 2003 to inflate the census and induce HHCA to hire them.
If so, this would be an adverse change. However, as discussed in the fact findings, the
evidence does not support this theory. It does not refute it either. The evidence is simply
insufficient to reach the conclusion asserted.
HHCA also argues that patient referrals declined in the last calendar quarter
of 2003. However, the evidence reflects a fairly consistent daily referral rate except for
month of September. See Exs. P-34; P-54. Instead, the evidence makes it at least as
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likely that the declines in referrals and census, of which HHCA now complains, arose due
to HHCA’s transition to ownership or after its ownership. Indeed, the preponderance of
the evidence shows significant declines in patient referrals after December 19, 2003 when
HHCA was either directing RHC’s actions or operating the business. See Finding # 73.
And MHR did not warrant that its existing referral sources would continue to refer
business to HHCA after the purchase at the same levels as pre-purchase. See generally
Pittsburgh Coke & Chemical Co. v. Bollo, 421 F. Supp. 908, 930 (E.D.N.Y. 1976) (post-
sale decision of vendors to cancel contracts dissolved expectations of the buyer but did
not constitute seller’s breach of warranty).
HHCA argues as though it simply purchased a turn-key home healthcare
business with the same RHC employees performing the same patient functions. Thus, it
reasons, the patient census and referrals should have been unaffected by an ownership
change. Since they were not, the cause must be an inflated RHC census, a decline in
RHC referrals, some significant operational flaw by RHC, or some combination thereof.
This argument, however, overlooks that HHCA controlled RHC for more than one month
prior to closing. This event probably was not anticipated when the APA was signed, and
occurred because HHCA decided that such pre-ownership control was in its interests.
And the evidence discloses it is more likely than not that the adverse changes of which
HHCA complains begin around the time of this ownership transition period.
HHCA could have sought warranties from MHR regarding minimum
census figures at closing, or minimal referral rates at closing, or even minimal net revenue
figures. It did not. It could have assumed RHC’s provider agreement and eliminated any
transition period prior to ownership. It elected not to. Instead, it sought to insulate itself
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The parties did not offer evidence regarding census, referrals or net revenues of38
HHCA beyond a few months after closing. Ex. P-93.
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from any potential overpayment liability while making certain assumptions that RHC’s
business revenues would be unchanged by such efforts. These assumptions proved, at
least in the short term, to be inaccurate. 	Nonetheless, HHCA did not prove that the38
result was caused by adverse changes within the intended scope of ¶ 4.6 of the APA.
VI.
Having determined that HHCA did not prove by a preponderance of the
evidence that MHR breached various warranties in the APA, I need not delve into the
parties’ complicated analysis of the defendant’s damage evidence; nor need I resolve their
difference over Pennsylvania law and the burden of persuasion. MHR is entitled to
judgment for the unpaid portion of the contract purchase price: $850,000. There are,
however, two issues that remain.
A.
First, in its post-trial memorandum, at 5, MHR demands pre-judgment
interest from HHCA, computed from the date the final payment under the APA was due:
180 days from the January 21, 2004 closing (viz. July 19, 2004). See Ex. D-1, ¶ 2.5(c);
Ex. D-2; JPS, ¶ 14.
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Pennsylvania permits prejudgment interest to be awarded for breach of
contract litigation. See Benefit Trust Life Ins. Co. v. Union Nat’l Bank of Pittsburgh, 776
F.2d 1174, 1178 (3d Cir. 1985). As early as 1955, the Pennsylvania Supreme Court
concluded that the payment of prejudgment interest in contract actions was a component
of common law in that state:
Plaintiffs were entitled to interest at the rate of 6% per annum
from the time when they should have been paid for the
services rendered by them. In all cases of contract interest is
allowable at the legal rate from the time payment is withheld
after it has become the duty of the debtor to make such
payment; allowance of such interest does not depend upon
discretion but is a legal right. . . . It is a right which arises
upon breach or discontinuance of the contract provided the
damages are then ascertainable by computation and even
though a bona fide dispute exists as to the amount of the
indebtedness.
Palmgreen v. Palmer’s Garage, Inc., 383 Pa. 105, 108 (1955) (citations omitted).
This entitlement follows acceptance by Pennsylvania courts of the
provisions of the Restatement of Contracts § 337, later Restatement (Second) of Contracts
§ 354 (1979). See, e.g., Penneys v. Pennsylvania R. Co., 408 Pa. 276, 280 (1962);
Somerset Community Hosp. v. Allan B. Mitchell & Associates, Inc., 454 Pa. Super. 188,
202 (1996).
One state appellate court explained the nature of prejudgment interest in
less mandatory terms:
It is well established that in contract cases, prejudgment
interest is awardable as of right. . . . Our courts have
generally regarded the award of prejudgment interest as not
only a legal right, but also as an equitable remedy awarded to
an injured party at the discretion of the trial court. Daset Min.
Corp. v. Industrial Fuels Corp., 326 Pa. Super. 14, 473 A.2d
584 (1984). “In claims that arise out of a contractual right,
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interest has been allowed at the legal rate from the date that
payment was wrongfully withheld, where the damages are
liquidated and certain, and the interest is readily ascertainable
through computation.” Id. at 35, 473 A.2d at 595 (emphasis
added). The basic premise underlying the award of
prejudgment interest to a party centers upon the fact that the
breaching party has deprived the injured party of using
interest accrued on money which was rightfully due and
owing to the injured party.
Somerset Community Hosp. v. Allan B. Mitchell & Associates, Inc., 454 Pa. Super. at
201; accord Fortney v. Tennekoon, 1998 WL 159047, at *15 (E.D. Pa. 1998); see also In
re Blatstein, 260 B.R. 698, 721-22 (E.D. Pa. 2001). Prejudgment interest accrues at the
legal rate, which in Pennsylvania is 6%, simple interest. See 41 P.S. § 202; Fortney v.
Tennekoon, 1998 WL 159047, at *15.
Some state court decisions have left it unclear whether prejudgment interest
under Pennsylvania common law for breach of contract is mandatory or discretionary For
example, in Melley v. Pioneer Bank, N.A., 834 A.2d 1191, 1204 (Pa. Super. 2003), the
Pennsylvania Superior Court stated: “Our courts have generally regarded the award of
prejudgment interest as not only a legal right, but also as an equitable remedy awarded to
an injured party at the discretion of the trial court.” (quoting Kaiser v. Old Republic Ins.
Co., 741 A.2d 748, 755 (Pa. Super. 1999)). Based upon this language, the district court in
Eastern Continuous Forms, Inc., 2004 WL 2418285, at *5, concluded that such an interest
award is discretionary.
In Frank B. Bozzo, Inc. v. Electric Weld Div. of Fort Pitt Div. of Spang
Industries, Inc., 345 Pa. Super. 423 (1985), the Pennsylvania Superior Court observed that
prejudgment interest is awarded as of right in those breach of contract cases where “the
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breach was a failure to pay either a fixed sum or a sum mathematically ascertainable . . . .
[T]his is true even if there was a bona fide dispute as to the amount of the debt.” Id., at
429-30. Where, however, the “contract action is to recover an amount that is neither
liquidated nor ascertainable,” id., at 430, then the award of prejudgment interest is
discretionary, to be allowed as “justice requires.” Id., at 430-33.
Here, the amount due plaintiff MHR by HHCA was a fixed sum of
$850,000 due on July 19, 2004. Since that date, the defendant has retained that sum and
benefitted by such retention. The plaintiff is thus entitled to prejudgment interest at 6%
per annum, simple interest: the per diem rate is $139.73. There are 907 days between July
19, 2004 and the date of judgment in this proceeding: January 12, 2007. Therefore, the
plaintiff is entitled to prejudgment interest in the amount of $126,735.11.
B.
MHR’s final contention is that it is entitled to attorney’s fees pursuant to ¶
11.2 of the APA. That provision states in part:
Buyer’s Obligation to Indemnify. From and after the Closing,
Buyer shall indemnify, defend and hold harmless Seller from
and against any and all Losses arising out of, relating to or
caused by, directly or indirectly, any or all of the following:
***
(b) Any failure or refusal by Buyer to satisfy or perform any
term, covenant or condition of this Agreement required to be
satisfied or performed by Buyer . . . .
MHR notes that Paragraph 2.5 of the APA contains the Buyer’s obligation
to pay the purchase price, including ¶ 2.5(c) (as modified by the first APA amendment)
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which specifies the amount and timing of the Buyer’s payment to the Seller after closing.
And Paragraph 1.1 of the APA defines “Losses” as “any and all Liabilities, costs and
expenses including costs of investigation, actual interest costs, penalties and attorneys’
fees.”
The plaintiff construes these three APA provisions as requiring the
defendant to reimburse it for attorneys’ fees incurred in connection with this adversary
proceeding. Plaintiff’s Post-Trial Memorandum at 4-5; see generally In re Eastern
Continuous Forms, Inc., 302 B.R. at 333.
On the issue of attorney’s fees, the defendant counters, by emphasizing ¶
13.2 of the APA, which states:
Expenses. Whether or not the transaction contemplated by
this Agreement shall be consummated, each Party shall pay its
own expenses incident to preparing for, entering into and
carrying into effect the Agreement and the transactions
contemplated hereby including the fees and expenses of any
advisor, accountant, attorney or other representative retained
by it.
In general, Pennsylvania courts follow the “American rule that there can be
no recovery of attorneys’ fees from an adverse party, absent an express statutory
authorization, a clear agreement by the parties or some other established exception.”
Merlino v. Delaware County, 556 Pa. 422, 425 (1999). HHCA suggests that ¶ 13.2
refutes MHR’s position that the APA establishes a “clear agreement” to depart from the
American rule.
The post-trial memoranda of the parties do not address this issue in depth,
as both were awaiting the outcome of their dispute on contractual liability and damages.
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Therefore, without now deciding whether the plaintiff is entitled to attorneys’ fees, I shall
afford MHR the opportunity to request reimbursement of such fees and to establish their
reasonable amount, and HHCA the opportunity to oppose the plaintiff’s request. See
generally In re Eastern Continuous Forms, Inc., 302 B.R. at 345.
An appropriate order shall be entered.
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UNITED STATES BANKRUPTCY COURT
FOR THE EASTERN DISTRICT OF PENNSYLVANIA
In re 	: 	Chapter 11
MEMORIAL HOSPITAL, 	:
ROXBOROUGH
Debtor 	: 	Bankruptcy No. 04-18933bif
____________________________________
MEMORIAL HOSPITAL, 	:
ROXBOROUGH
Plaintiff 	:
v.
:
HOME HEALTH CORPORATION OF 	Adversary No. 04-1059
AMERICA, INC. 	:
Defendant
____________________________________
.................................................
ORDER
.................................................
AND NOW, this 12th day of January 2006, for the reasons stated in the
accompanying opinion, it is hereby ordered as follows:
1. Judgment is entered in favor of the plaintiff and against the defendant in
the amount of $850,000 plus prejudgment interest in the amount of $126,735.11;
2. Plaintiff shall file and serve upon defendant any motion for
reimbursement of attorney’s fees in connection with this proceeding, along with a
supporting memorandum, on or before February 12, 2007. The defendant shall file and
serve its response, also with supporting memorandum, on or before March 1, 2007.
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3. A hearing on the plaintiff’s entitlement to attorney fees and, if so, the
reasonable amount of such fees, is hereby scheduled for March 28 , 2007, at 2:00 p.m. in
Bankruptcy Courtroom #2.
BRUCE FOX
United States Bankruptcy Judge
copies to:
E. Thomas Henefer, Esquire
Stevens & Lee, P.C.
1818 Market Street, 29th Floor
Philadelphia, PA 19103
Mark D. Pfeiffer, Esquire
Adelman Lavine Gold and Levin
Four Penn Center, Suite 900
Philadelphia, PA 19103-2808
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