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Alpha Cepheus LLC v. Chu

United States District Court, D. New Jersey

December 20, 2019

ALPHA CEPHEUS, LLC, et al., Plaintiffs,
v.
CHINH CHU, et al., Defendants.

          OPINION

          HON. MADELINE COX ARLEO UNITED STATES DISTRICT JUDGE

         THIS MATTER comes before the Court on Defendants Chinh Chu's (“Chu”), Douglas Newton's (“Newton”) and Truc To's (“To”) (collectively “Defendants”) Motions to Dismiss, ECF Nos. 70 & 71, Plaintiffs Paul Parmar (“Parmar”) and Alpha Cepheus, LLC's, First United Health, LLC's, Constellation Health, LLC's, Naya Constellation Health, LLC's, Constellation Health Investment, LLC's (“CHI, ” and together with Alpha Cepheus, LLC, First United Health, LLC, Constellation Health, LLC, Naya Constellation Health, LLC, the “LLC Plaintiffs”)[1] Amended Complaint, ECF No. 65. For the reasons stated herein, the motions are granted.

         I. Background

         A. Factual Background

         This action arises from a transaction to take a medical billing company private, uncovering an alleged fraud by its the senior officers and shareholders.

         1. Parmar, CHT and the “Empty Shell” LLCs

         In 2012, Parmar and others acquired Orion Healthcorp, Inc., a medical billing, collections and physician practice management company. Am. Compl. ¶ 57. They merged the company into Constellation Healthcare Technologies, Inc. (“CHT”), which they later took public, listing CHT's shares on the London Stock Exchange's Alternative Investment Market (“AIM”). Id. ¶ 60. CHT grew its business by acquiring existing medical billing and practice management companies, to use their existing customer lists and relationships. Id. ¶ 59. CHT followed a “common pattern” for its acquisitions, first forming a “shell” subsidiary limited liability company (“LLC”), with the intention of merging the proposed target into the shell. Id. ¶ 61. “[E]very acquisition of CHT” followed this pattern, and “the majority of these shell [LLCs] were filled, but two remained unfilled: Phoenix Health LLC (‘Phoenix') and MDRX Medical Billing, LLC (‘MDRX').” Id. ¶¶ 61-62. A third shell LLC, Northstar First Health, LLC (“Northstar”) “was filled, but with a smaller subsidiary than expected.” Id. ¶ 62.

         While CHT was a public company, it regularly sought financing in the form of secondary share offerings and announced its activities via press releases. Id. ¶¶ 63-64. CHT issued press releases concerning Phoenix, MDRX, and Northstar, which they concede were inaccurate. Id. These included: (1) an announcement that CHT acquired Northstar on September 16, 2015, when Northstar was actually a shell LLC filled by Vachette Business Services, LLC; (2) an announcement that CHT acquired Phoenix on September 18, 2015, when Phoenix was a shell LLC created by CHT; and (3) an announcement on February 10, 2016 that CHT acquired MDRX, when MDRX was also a shell LLC created by CHT. Id. ¶¶ 65-66, 68.

         2. CC Capital's Interest in CHT

         In September 2015, Parmar met Chu. Am. Compl. ¶ 70. Chu is the Senior Managing Director and Founder of nonparty CC Capital, LLC (“CC Capital”), a private equity firm. Id. ¶ 37. Defendant Newton is a CC Capital Senior Managing Director. Id. ¶ 39. In January 2016, Chu began to show interest in acquiring CHT, de-listing its stock and taking it private. Id. ¶¶ 70-71.

         CC Capital's first set of bids were unsuccessful. After an initial disagreement, Parmar and Chu agreed that Parmar would hold a minority position after the deal “and give limited voting rights to CC Capital on the equity [he and the LLC Plaintiffs] continue to hold.” Id. ¶ 74. In order to raise the price offered for CHT, Parmar agreed to contribute $10 million to the purchase. Id. ¶ 77. As a result of his position as a buyer, CHT's board required Parmar to recuse himself from bid evaluations and formed a special committee to evaluate the offer. Id. ¶¶ 77-78. Chu directed CC Capital to hire defendant To, then a KPMG partner, to conduct due diligence. Id. ¶ 80. After receiving a fairness opinion from Duff & Phelps, CHT's special committee rejected Chu and Parmar's bid on August 23, 2016. Id. ¶ 86.

         At this time, Parmar did not want to proceed with the transaction, and told Chu and Newton as much. ¶¶ 87-88, 90. Parmar “was honest with Newton, ” telling him that he wanted “more time to resolve the CHT issues, ” while Newton responded that “Chu did not want to drop the deal and that they would be happy to work out any of CHT's issues with Parmar once they became partners.” Id. ¶ 92. Despite wanting to proceed with the transaction, on September 12, 2016 CC Capital withdrew its offer, allegedly in order to have Chu select advisors for a new CHT special committee. Id. ¶ 99. Chu then had his associates introduce Parmar to SunTrust Robinson Humphrey (“SunTrust”) and McGuireWoods LLP as potential financial and legal advisors for CHT. Id. ¶¶ 102-03.

         Before CC Capital withdrew its first bid, To and KPMG began performing due diligence. Id. ¶ 108. CC Capital had access to CHT's proprietary internal database that accurately represented all “data, collections and fees” concerning CHT, and thus Plaintiffs allege that Chu and To “had actual knowledge” that MDRX, Northstar and Phoenix were not as represented by CHT, and that “the empty shells had no assets, revenue or employees, ” Id. ¶¶108-09. Plaintiffs also claim that other audit data provided to To and Chu indicate that they “knew that the empty shells were indeed empty.” Id. ¶¶ 109-13.[2]

         3. The Deal Closes

         CC Capital submitted another bid for CHT on September 14, 2016. Id. ¶ 119. CHT formed a new independent committee and rejected the offer, without the benefit of a new fairness opinion.[3]Id. ¶¶ 124, 129. CC Capital then raised its bid again, which the committee again rejected, after which all board members offered to resign. Id. ¶ 131. CC Capital then increased its bid “by 2 cents/share, ” and at the request of the special committee's legal counsel, included an offer of indemnity for the committee's counsel and all board members, along with increased compensation for board members. Id. ¶ 133. The board approved this offer on November 29, 2016, with defendant CHT Holdco LLC, an entity part owned by CC Capital and Plaintiffs, to purchase CHT. Id. ¶¶ 133-34. At the CHT board's request, Chu agreed to add a 30-day “go shop” period, during which CHT could solicit competing bids. Id. ¶¶ 134-42. Plaintiffs allege that Chu set up this go shop period “to ensure that no other buyer could outbid him” and that he “improperly and corruptly influenc[ed] the bidding process” to ensure that his bid was successful. Id. ¶ 141, 145. Despite receiving at least one other bid, CHT accepted CC Capital's offer. Id. ¶ 145.

         As part of the transaction, certain Plaintiffs[4] executed a “Voting and Support Agreement and Release of Claims” (the “Proxy Agreement”), agreeing to vote in support of the proposed merger and to release certain claims. Id. ¶ 146. Plaintiffs allege that the Proxy Agreement “was fraudulent in several respects and unenforceable in others, ” specifically that the document failed to disclose that Duff & Phelps's fairness opinion concluded CHT was worth more than CC Captial's offer, SunTrust's resignation (see supra n. 3), that CHT's board had approved the offer without a fairness opinion, that CHT had delayed a scheduled acquisition at the request of CC Capital, that CHT disregarded superior bids during the go shop period, that CHT's special committee refused to approve the CC Capital offer without indemnification, or that the special committee were given additional compensation to approve CC Capital's offer. Id. ¶ 148(a)(i)-(vii). The Proxy Agreement was also allegedly unenforceable as it purported to release future claims, in violation of Delaware law. Id. ¶ 148(b)(i)-(ii).

         Additionally, on January 26, 2017, the Financial Times published a story on the empty shell LLCs, “exposing” them four days before the transaction closed on January 30, 2017. Id. ¶¶ 174, 177. Plaintiffs allege that “at closing, the final funds flow document showed a very different flow of funds than was anticipated in the prior documents.” Id. ¶ 180. This document allegedly reflected that CC Capital contributed approximately $6 million less to the transaction than “originally anticipated” and included fees of “questionable legitimacy.” Id. ¶ 180.

         4. Post-Closing and CHT's Bankruptcy

         As part of the merger, Parmar and Chu agreed to keep Parmar as CHT's CEO after closing. Id. ¶ 186. Chu also requested that To be hired as chief financial officer of CHT. Id. ¶ 185. Plaintiffs allege that Chu had Parmar fired as CEO in July 2017, shortly after the transaction closed. Id. ¶ 189. After Parmar was fired, “multiple employees” told him that To had approached them, stating that “they were aware that Parmar and Zaharis had been stealing money and faking the books, and asking for any information that they might have.” Id. ¶ 191.

         CHT filed for bankruptcy on March 16, 2018, in the United States Bankruptcy Court for the Eastern District of New York. Id. ¶ 220. Plaintiffs allege that the bankruptcy petitions on behalf of CHT were fraudulent as they failed to disclose that plaintiff Alpha Cepheus, LLC's consent to filing was required under an operating agreement executed as part of the merger, that the Eastern District of New York had “minimal” jurisdiction over CHT and was chosen to steer the bankruptcy to a specific trustee, and failed to properly list all creditors of CHT. Id. ¶ 224. Chu allegedly engaged in other misconduct related to the bankruptcy, including inter alia, an attempt to rig a bankruptcy auction to ensure that Chu's preferred entity won some of CHT's assets, Id. ¶¶ 225-35, and making fraudulent representations as to the value of CHT. Id. ¶¶ 236-42.

         5. Parmar's Arrest and Criminal Charges

         On May 15, 2018, the United States Attorney for the District of New Jersey (the “Government”) filed a two-count criminal complaint against Parmar and two of his associates, Sotirios Zaharis and Ravi Chivukula. See Compl., United States v. Parmar, No. 18-cr-735 (D.N.J. May 15, 2018) (the “Criminal Complaint”). The Criminal Complaint charges Parmar, Zaharis and Chivukula with one count of securities fraud in violation of Section 10(b) of the Exchange Act of 1934, 15 U.S.C. § 78j(b) and Rule 10b-5, 17 C.F.R. § 240.10b-5, and one count of conspiracy to defraud the United States in violation of 18 U.S.C. § 371, based on misstatements in the press releases concerning the empty shells. Id.

         Specifically, the Government claims that the false press releases were part of a scheme to “grossly inflate the value” of CHT. Criminal Compl. ¶ 2. The press release concerning Northstar represented that CHT had acquired it for $18 million, and that it was an operating company with 77 retained clients, more than 200 employees, and approximately $7.9 million in revenue. Id. ¶¶ 33-34. In reality, Northstar was formed only a few months before its acquisition, and only two weeks before the press release had purchased a business asset for approximately $2.78 million. Id. The Government also contends that Parmar and his codefendants misrepresented that they used $15 million from secondary offerings to purchase Northstar, while the company's bank records do not reflect any such use of those funds. Id. Two days after the Northstar announcement, Parmar, Zaharis and Chivukula announced that CHT had acquired Phoenix for $14 million, “which it described as a company employing 138 people with revenue of $9.8 million as of the end of 2014.” Id. ¶ 35. In reality, Phoenix was formed only a week before the release, and had no employer tax number. Id. ¶ 36.

         Finally, the Government also alleges that Parmar and his codefendants used information they received from an unrelated third-party company to make it appear that MDRX was an operating company, when in fact it was not. Parmar, Zaharis and Chivukula allegedly “used the description” of the unrelated company “in many cases lifting the description word for word.” Id. ¶ 18. They allegedly created an extensive set of false documentation concerning MDRX, including a detailed merger agreement, false financial documents, and bank transfers to make it appear as though MDRX was an operating company. Id. ¶¶ 23-32. The Government indicted Parmar, Zaharis and Chivukula on December 13, 2018, and that indictment is still pending. See Indictment, ECF No. 32, United States v. Parmar, No. 18-cr-735 (D.N.J. December 13, 2018)

         Parmar was arrested by the Federal Bureau of Investigation (“FBI”) on May 16, 2018. Id. ¶ 251.[5] Plaintiffs allege Parmar was arrested at the direction of CC Capital, which made “false representations to the DOJ” after Parmar refused Chu's demands to transfer his interest in CHT to him and to give Chu $10 million. Id. ¶¶ 248, 256, 201-02, 324(b). Plaintiffs also allege that “Defendants prepared and transmitted an anonymous tip to the FBI” that falsely ...


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