Director’s Breach of Contract Lawsuit Found to Violate the Underlying Contract’s Confidentiality Clause

Jan 02 2018

In Cappella Holdings, LLC v. Anderson, C.A. No. 9809-VCS (Del. Ch. Nov. 29, 2017), the Chancery Court dismissed a director’s breach of contract claims against his former employer relating to alleged violations of an anti-dilution provision in his employment agreement. The Court instead found that the director’s initial complaint, which included highly sensitive information about the company, violated the confidentiality provision of the underlying contract on which his claims were based.

James Anderson was a director and officer of Capella Holdings, LLC and co-founder of Capella Healthcare, LLC (together, “Capella” or the “Company”). In 2005, as an officer and director, he entered into a Senior Management Agreement (“SMA”) with the Company that governed various aspects of their relationship. In the period prior to 2014, the Company accumulated over $500 million in debt, and a private equity investor held preferred shares and payment in-kind interest valued at about $349 million. In an attempt to avoid a downgrade by ratings agencies, the Company approved a recapitalization whereby the Company would issue over 1.1 billion common shares and the private equity investor’s preferred shares would be converted into common shares. All of the Company’s executives were permitted to participate in the recapitalization; however, Anderson declined to do so. When the Company’s board approved the recapitalization, Anderson was the only director who dissented.

Following the approval of the recapitalization by Capella’s board, Anderson filed a lawsuit against the Company and several of its directors in Tennessee. Anderson alleged that the recapitalization violated a provision of the SMA because it diluted his ownership interests. In his initial complaint, Anderson included highly sensitive information, including legal advice provided to Capella’s board and details of a non-public bidding process regarding a potential sale of the Company. Anderson did not seal his filings or seek to obtain a confidentiality order from the Tennessee court. In response, the Company terminated Anderson for cause and filed a lawsuit against Anderson in Delaware alleging that Anderson’s complaint violated the confidentiality provision of the SMA. Because the SMA had a Delaware choice of law provision, Anderson agreed to voluntarily dismiss his Tennessee complaint, and bring his original claims as counterclaims in the Delaware action. The Delaware Court then dismissed Anderson’s breach of fiduciary duty claims for failure to state a claim, and the Company later filed for summary judgment.

According to the Court of Chancery, Capella’s motion for summary judgment turned on whether the provision of the SMA relating to the Purchase and Sale of Executive Securities contained an anti-dilution provision. If it did not, Capella did not violate the SMA, and Anderson clearly violated the confidentiality provision of the SMA by revealing sensitive information in his Tennessee complaint. The SMA provision in question stated in relevant part:

The Company [Capella] shall reserve 2,211,688 additional shares of Common Stock (the “Additional Common Stock”) for issuance (whether through restricted stock, upon exercise of options or otherwise) to other executives and employees of the Company and its Subsidiaries after the date hereof (including executives and employees of acquired companies); provided that in the event that any portion of such Additional Common Stock are not issued prior to the earliest to occur of (x) the redemption of all issued and outstanding Preferred Stock, (y) a Sale of the Company or (z) an initial Public Offering, the Board in its sole discretion may issue any or all of the remaining shares of Additional Common Stock to the executives of the Company or its Subsidiaries (including [Anderson]) in the amounts determined by the Board. Any shares of Additional Common Stock not allocated by the Board to executives and employees of the Company and its Subsidiaries pursuant to the immediately preceding sentence shall remain unissued.

The Court of Chancery found that rather than containing any anti-dilution language, the provision merely confirmed that the Company could not issue stock from the reserved pool unless it did so for executive compensation – it did not limit the Company’s ability to issue shares outside of the reserved pool. Further, the provision demonstrated that the parties contemplated that Capella might issue additional common shares beyond the “Additional Common Stock” referenced in the provision.

As a result, the Court of Chancery granted summary judgment in favor of Capella and dismissed Anderson’s breach of contract counterclaims, finding that Capella offered the only reasonable interpretation of the Purchase and Sale of Executive Securities provision. After deciding that Capella did not breach the SMA, the Court of Chancery granted summary judgment in favor of the Company on its breach of contract claims relating to Anderson’s violation of the SMA’s confidentiality clause because Anderson gave sworn testimony acknowledging his release of the Company’s confidential information in his Tennessee complaint without permission. However, the Court of Chancery denied Capella’s motion for summary judgment on its breach of fiduciary duty claims against Anderson, because they were wholly duplicative of its breach of contract claims.

Capella Holdings LLC v. Anderson v. Capella Healthcare LLC memorand.._