ARC Lifemed v. AMC-Tennessee, Inc. ( 2005 )

IN THE COURT OF APPEALS OF TENNESSEE
AT NASHVILLE
January 5, 2005 Session
ARC LIFEMED, INC., ET AL. v. AMC-TENNESSEE, INC.
Appeal from the Chancery Court for Davidson County
No. 01-3163-II Carol McCoy, Chancellor
No. M2003-02640-COA-R3-CV - Filed August 2, 2005
This is an action for breach of contract by a limited liability company against its managing member.
The other members of the LLC joined as plaintiffs seeking recovery for breach of fiduciary duty and
negligent misrepresentation. The managing member counterclaimed against the LLC for breach of
contract and, in the alternative, sought recovery in quantum meruit for unjust enrichment. The trial
court held the managing member to be liable to all plaintiffs on all issues and dismissed the
counterclaim. The action of the trial court is reversed as to breach of fiduciary duty and negligent
misrepresentation. The judgment of the trial court is affirmed as to breach of contract and as to
dismissal of the counterclaim. The findings of the trial court as to damages payable to the LLC is
affirmed as is the distribution of the assets of the LLC. Prejudgment interest is disallowed, and costs
are assessed to the managing member.
Tenn. R. App. P. 3 Appeal as of Right; Judgment of the Chancery Court Affirmed in part,
Reversed in part and Remanded
WILLIAM B. CAIN , J., delivered the opinion of the court, in which WILLIAM C.KOCH , JR., P.J., M.S.,
and FRANK G. CLEMENT , JR., J., joined.
Barbara Hawley Smith, Nashville, Tennessee, Robert P. Johnson, Pro Hac Vice, Cincinnati, Ohio,
for the appellant, AMC-Tennessee, Inc.
Charles W. Cook, III, James E. Gaylord, Nashville, Tennessee, for the appellees, ARC LifeMed, Inc.,
LifeTrust America. Inc. and LifeMed, LLC.
OPINION
This case involves the supply of pharmaceutical products to persons residing in assisted
living facilities and the collection of payments for such products. ARC Lifemed, Inc. (“ARC”) is
a large corporation with many years of experience in the nursing home business. LifeTrust America,
Inc. is a corporation formed in 1996 during the infancy of assisted living facilities (“ALF”)
constructed to house residents who are in need of assistance but are not physically or mentally
disabled to the point that they require nursing home care. AMC-Tennessee, Inc. (“AMC-TN”) is a
sizeable retail pharmacy.
I. HISTORY OF LIFEMED, LLC.
ARC was a long-standing leader in the construction and operation of nursing home facilities,
principally in the eastern and southeastern United States, prior to the advent of ALF in the mid
1990s. Desiring to enter the ALF field, ARC, in 1997, embarked upon a plan to develop 40 assisted
living facilities. By the fall of 1998, ARC had 20 such facilities in operation. LifeTrust, Inc.,
organized in 1996, had no prior experience in the ALF market but, by the end of 1998, was operating
30 such facilities. LifeTrust began exploring ways to develop revenue from sources other than the
typical provision of room and board. It recognized that the pharmacy business might provide
additional income. LifeTrust began discussing the formation of a joint venture with “The
Pharmacy,” an institutional pharmacy serving skilled nursing facilities and assisted living facilities
primarily in Tennessee. “The Pharmacy,” owned and managed by Buddy Stephens, had a good
reputation and had profitably concentrated its business in the long-term care market. LifeTrust
learned that “The Pharmacy” would soon be acquired by American Medserve Corporation.
Following this acquisition, “The Pharmacy” was named AMC-TN. Later, American Medserve
would itself be acquired by Omnicare, Inc., the leading institutional pharmacy in the nation, but
AMC-TN would retain its separate identity.
During negotiations between LifeTrust and AMC-TN, the concept of “the pharmacy within
a pharmacy” (“PIP”) was discussed under which a joint venture would operate on AMC-TN’s
physical premises to supply pharmaceutical service and products to LifeTrust and its ALFs. The PIP
arrangement would allow the joint venture to share the overhead of an established provider and
utilize those services without having to overcapitalize the project. LifeTrust and AMC-TN
formalized their joint venture with the creation of LifeMed, LLC in 1997. LifeTrust contributed
$200,000 in exchange for a 40% ownership in the joint venture. AMC-TN contributed $300,000 for
the remaining 60% ownership interest. A Limited Liability Company Agreement established a board
of managers for LifeMed, LLC.
In 1997, ARC learned of the LifeMed, LLC joint venture while searching for ways to increase
its revenues. Unlike LifeTrust, ARC had some prior experience with the pharmacy business, having
operated an institutional pharmacy in Richmond, Virginia. ARC learned that the LifeMed joint
venture had been operating at a breakeven point financially. In 1998, ARC contributed $300,000
to the venture with AMC-TN receiving a $150,000 distribution of capital from the joint venture at
such time. An Amended and Restated LLC Agreement executed by the three parties allocated
ownership equally among the members.
Two agreements governed the joint venture following the admission of ARC as a joint
venturer. These were the Amended and Restated Limited Liability Company Agreement (the
Operating Agreement) dated October 29, 1998, and the Management Agreement previously executed
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on June 11, 1997,between LifeTrust, Inc. and AMC-TN under which AMC-TN was to manage the
joint venture. This agreement remained effective after the Amended and Restated LLC Agreement.
By the Amended and Restated LLC Agreement, a one-third ownership interest was assigned
to each member with each member appointing two representatives to the Board of Directors of
LifeMed. This Agreement provided that no portion of the capital funds of LifeMed could be
withdrawn at any time without the approval of all members and that upon termination, dissolution,
and liquidation of LifeMed, each member’s capital account was to be distributed. Each member
could withdraw from LifeMed at any time and receive a return of its positive capital account balance.
According to the Management Agreement, AMC-TN was engaged to manage LifeMed’s
business. In return, AMC-TN was entitled to a management fee which it would earn by performing
certain duties for the Owner, LifeMed. Among these duties, the Agreement prescribed the following:
1. Retention of Manager. Owner hereby retains Manager to provide
management services in connection with the Pharmacy under the terms and
conditions set forth herein. The Operating Agreement describes various additional
duties for which Manager is also responsible including, without limitation, Budgets
(Operating Agreement, Section 4.4) and various responsibilities for books, records
and accounting matters (Operating Agreement, Article 5). The Owner and Manager
intend that the management fee described in this Agreement shall be full and
complete compensation for the Manager for the provision of its services described
in this Agreement as well as the provision of those additional services required of the
Manager pursuant to the Operating Agreement.
2. Responsibilities of Manager. During the Term, as defined below,
Manager shall provide the following management, consulting and advisory services
to Owner in connection with the operation of the Pharmacy, and shall devote such
time, expertise, and resources as may be appropriate to properly manage the
Pharmacy as provided herein:
...
B. Bank Accounts; Payment of Business Expenses. Manager
shall direct the opening and closing of bank accounts in the name of Owner for the
benefit and account of Owner in a bank of Manager’s selection, which shall be
approved by the Board of Managers, and shall direct the deposit therein of all money
received in the course of the operation of the Pharmacy. Manager shall cause all
expenses incurred in the operation of the Pharmacy, including, but not limited to,
payment of Manager’s fees and expenses hereunder, debt services, payroll, benefits
and related employee expenses, to be paid, at the Owner’s expense, by check drawn
on such accounts and signed by such party or parties as may be designated by
Manager and approved by the Board of Managers.
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...
H. Bookkeeping and Accounting; Taxes. Manager shall direct
the bookkeeping and accounting procedures necessary for the operation of the
Pharmacy and the preparation of proper financial statements and records.
Bookkeeping and accounting procedures and systems shall be in accordance with the
operating capital and cash programs developed by Manager, which programs shall
conform to generally accepted accounting principles. Managers shall maintain the
general ledger for the Pharmacy, cause payment of the accounts payable pursuant to
Section 2.B. and prepare periodic financial statements as required by Article V of the
Operating Agreement. Under Manager’s direction, Owner shall maintain the
accounts receivable for the Pharmacy, and receive, deposit and report on cash
receipts on forms provided by Manager. Subject to the provisions of Section 5.7 of
the Operating Agreement, Manager shall prepare and file all tax returns with respect
to the Pharmacy.
3. Responsibilities of Owner. During the Term, as defined below,
Owner’s responsibilities shall include, but not be limited to, the following:
A. Operational Policies. The Board of Managers of the Owner
shall develop and implement all operational policies and procedures necessary to
establish and maintain the standard of pharmacy services appropriate for the nature
of the Pharmacy.
B. Charges. The Board of Managers of the Owner shall establish
the schedules of recommended charges for pharmaceutical products and services
provided by the Pharmacy.
...
5. Management Fees. For services performed hereunder, Owner shall
pay to Manager a management fee equal to Manager’s actual costs incurred in
providing the services to be performed by Manager hereunder, plus ten percent
(10%). As such costs of Manager will only be determined semi-annually (as
hereinafter provided), until such costs have been determined, Owner shall pay
Manager on an interim basis an interim fee of Four Dollars ($4.00) for each
prescription processed and filled by Owner. Owner shall pay such interim fees
monthly, in arrears, no later than the last day of the month following the month
during which such management fees were earned. Manager shall be entitled to cause
all such amounts to be disbursed to itself out of the accounts provided for in Section
2.B. hereof. Within forty-five (45) days after the completion of each six-month
period of July 1-December 31 and January 1-June 30 hereunder (provided, that the
first period shall be June 11-December 31), Manager shall deliver to Owner and
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LifeTrust an itemized statement of Manager’s direct and indirect costs of providing
the services to be performed by Manager hereunder. Manager shall cooperate with
LifeTrust and Owner in answering any questions and addressing any objections
relative to Manager’s costs as set forth on such itemized statement, and shall permit
Owner and LifeTrust to audit the books and records of Manager relating to such
costs. Owner and LifeTrust hereby agree not to disclose any information provided
by Manager which constitutes confidential business information of Manager, and not
to use such information other than for purposes of determining the fees to be paid to
Manager hereunder, in each case except as otherwise required by applicable law or
court process. Based upon Manager’s actual costs of providing the services to be
performed by Manager hereunder (costs plus 10%) against the interim fees previously
paid to Manager on an interim basis (initially, $4.00 per prescription), and Manager
or Owner, as the case may be, shall pay any overpayment or deficiency of the interim
payments as compared to the cost-based management fee to be paid hereunder, as
applicable. Based upon such itemized costs, Owner and Manager (with the consent
of LifeTrust, which shall not be unreasonably withheld, delayed or conditioned) shall
establish a new interim fee to be paid hereunder for the next semi-annual period,
which shall approximate as closely as practicable the projected costs of Manager for
the next semi-annual period, plus ten percent (10%). Such reconciliation of costs to
interim fees and re-setting of the interim fees to be paid shall be made after each
semi-annual period.
...
7. No Guaranty of Profitability. Owner acknowledges that Manager
does not guarantee that the Pharmacy will be profitable.
II. LIFEMED, LLC IN OPERATION
Prior to the beginning of the LifeMed, LLC joint venture, Buddy Stephens, The Pharmacy,
American MedServiceCorporation, and AMC-TN had extensive experience in the nursing home
pharmacy supply business. ARC had some experience having, for some period of time, owned an
institutional pharmacy serving its nursing home facilities. Newly-formed LifeTrust, Inc. had no
experience in supplying pharmaceuticals to nursing homes. Assisted living facilities did not come
into being until the mid-1990s, and none of the parties had any experience in supplying the pharmacy
needs of assisted living facilities. While one might think that the transition from nursing home
supply to assisted living facility supply would involve a simple conversion, the parties learned that
such an assumption was far from the truth. The operations manager for AMC-TN, Ms. Julie Frazier,
explained the differences between the underlying problems of serving the pharmacy needs of nursing
homes as compared to supplying the same needs in assisted living facilities.
Q. Could you give us a little more detail and background on the mix of
the customer base of The Pharmacy prior to the formation of the joint venture?
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A Sure. Prior to the joint venture, our customer base was primarily
nursing home. It’s a different population than assisted living, in that probably 80
percent of that business is TennCare related, another, you know 10 to 15 percent of
it is Medicare related, in which either the payor of the bill is TennCare or Medicare.
You have about a 5 percent population that’s private payor, private insurance.
The assisted living side is practically just the opposite. You don’t
have any Medicare because Medicare still doesn’t have drug benefit program. You
don’t have a lot of TennCare because that population in an ALF typically has a son
or daughter that’s paying the tab for them.
So the majority of that population was private pay, private insurance,
had the ability to, you know, do the things that they wanted to do and was a little bit
freer population than what we were used to seeing in a nursing home setting.
Q. Did the different mix, the TennCare and Medicare on the nursing
home side versus more of a private pay insurance mix on the assisted living facility
side, have any effect on collections?
A Absolutely, for multiple reasons. One of them which I’ve already
talked about is that if you don’t get the correct information on a timely basis, then
there are limits as to when you can file insurance claims. And the other thing is you
have a more – – a population of people that have a bill that they’ve got to pay, and
lots of times the last payor (sic) that they think about is the pharmacy or a vendor.
You know, they’re going to pay their room and board first, and from that point they’ll
pay whoever’s left over.
You’ve got a sicker population of people. You wouldn’t think that,
but what happens in the nursing home setting is where we have such regulations that
we have to comply by, we have a tendency to do things a little bit different. We have
consultants in their building once a month who go through a drug regimen review
process where we try to make recommendations to the doctor to reduce their
medications, whereas in an assisted living populations, you have don’t have that.
You know, they complain about their foot hurting and they give them something for
it, and that’s the easiest way to keep them from complaining.
The average prescription rate – – and I know in our business that – –
and during the LifeMed joint venture – – was right around ten prescriptions per
resident, whereas in our nursing home setting it’s more like seven or eight. So their
drug bills were higher. They may have had private insurance that sometimes would
pay for it, but they still had co-pays. And so their drug bills typically ran higher than
what you’d see in a nursing home population.
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Q. When the joint venture started in 1997, operationally what was
involved in getting that set up?
A. We had to go out in the homes – – or the communities, I should say,
and you had to gather information. You gathered information, as much as you could,
about their drug therapy, about insurance information. You had to set up
responsibility documents, in other words, who was going to be responsible for the
bill.
Internally we had to go through the process of getting prescriptions,
because it is considered a retail environment. So we had to contact the doctors and
get prescriptions. We had to verify all that insurance and make sure that we were a
provider for that insurance, and if we weren’t, start the process for getting on their
list of preferred providers. We had to set them up in the machine. You know, we
had a brand-new piece of equipment that we’d been trained on that we hadn’t used
a lot of.
Q. Is that the Baxter machine?
A. That’s the Baxter machine. It was a learning curve for anybody. And
we used that machine, we tried it, and it worked pretty well. But as we added more
business and it started having to produce more, that’s when we starred (sic) seeing
our problems.
At the time the joint venture was launched under the Management Agreement June 11, 1997,
the “pharmacy-within-a-pharmacy” concept was implemented. Joint venturer and managing
venturer, AMC-TN, was in fact a pharmacy, and only a pharmacy (though a very large pharmacy)
and was supplying its own clientele separate and apart from the assisted living facilities it was
supplying in its capacity as manager of LifeMed, LLC.
LifeMed, LLC operated only for the limited period between the inception of the Management
Contract in June of 1997 and August 2000, when the decision was made to dissolve the joint venture.
From the beginning, troubles developed relative to separation of inventories between The Pharmacy
and the PIP. Said Julie Frazier:
A There were two things that we needed computer-system-wise. No. 1
was we needed to upgrade our hardware and we needed to upgrade our software. In
order to upgrade our software, we had to upgrade our hardware. The purpose of it
was to hopefully be able to separate, without having to do a lot of extra work, the
A/R [Accounts Receivable] and the billing between the LifeMed joint venture and
AMC-Tennessee.
Q. Was there a problem separating the billing of the two entities?
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A Because we were running off of one inventory and we were running
off the same computer system, it was all being processed under one company. We
did come up with methodology in order to separate the LifeMed A/R from The
Pharmacy’s A/R, and we put that into place.
Q. According to your deposition, you testified that the upgrade was
never – – that you never got the upgrade.
A. We did get the upgrade but not before the joint venture was dissolved.
We had to do a work-around, which we were able to do.
Q. So until after the JV was dissolved, all the A/R was on the same
computer system?
A. That is correct.
Q. And it was not easily separated?
A. Once we did the work-around, the only part of it that we weren’t able
to resolve – – separate, I guess I should say, easily was the third party. As far as the
private, private insurance guarantor type A/r, we separated that. The third party was
a little bit more difficult.
Q. But before the joint venture was dissolved, it was hard to separate the
accounts receivable?
A No, we separated before the – – we separated the guarantor or the
private pay side prior to the joint venture dissolving. We were not able to separate
the third party.
Q. What’s the breakdown between third party and private pay for the
joint venture
A. The private insurance side was probably 65, 70 percent. But you’ve
still got a private pay portion to that. I mean, even if you bill the insurance company,
you’ve still got the co-pays and stuff that fall into the private pay side.
Q. Now, with respect to inventory, there were problems with the cost of
goods generator and so the inventory was separated sometime in late 1999; is that
correct?
A. We separated the inventory in early 2000.
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Q. And physical inventories were done every two to three months?
A. That’s correct.
Q. Now, there was borrowing between – – once you separated the
inventory – – well, can you explain how the inventory was separated for the Court?
A. We physically tried to separate the two pharmacies from the
downstairs of our building. We had a two-story building. And in the downstairs of
our building – – we put our nursing home or The Pharmacy or AMC’s operation in
the downstairs. The upstairs, we put the LifeMed joint venture. So we separated
their inventory upstairs, AMC’s inventory downstairs.
While overestimation of the ALF market and shortcomings in projected participation by ALF
residents played a significant role in the failure and demise of LifeMed, LLC, it was a combination
of difficulties in inventory control and inflated value of collectible accounts receivable that brought
about this litigation among the parties.
The inventory problem from the beginning of LifeMed, LLC, according to AMC-TN’s expert
John Gould, emanated from a combination of the “pharmacy-within-a-pharmacy” concept and the
use of an inaccurate cost generator in the calculation of inventories. Said Mr. Gould:
THE WITNESS: The cost generator is a very educated estimate.
THE COURT: Like an actuary, tell me what it is.
THE WITNESS: I’m sorry?
THE COURT: Like actuaries do, tell me, what is a cost generator.
THE WITNESS: A cost generator is another term used to identify
what your cost of product sold was. In most businesses that move inventory, they are
able to identify, as it goes out the door, the cost of that product to them on an
individual basis. You know, a widget company can tell you that Widget A cost them
$5.
In the pharmacy business, because of the volume of products that we
have, we don’t have the system capability to help us track every individual product
leaving the door. We have in upwards of 15,000 different products that could leave
our doors. So we can’t, as those drugs are leaving the door, identify at that particular
point in time what that cost was to us in our systems.
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So from a financial standpoint, very general basic accounting is, if
you’re going to make a sale of inventory, you have to have a cost associated with
that. And in the pharmacy world the way we do that is through this cost generator.
And this generator is simply a percent of sales that has been developed over time
through experience, through reconciliations with your physical inventories and
through just general industry knowledge of certain margins on drugs.
On a monthly basis, that generator or that percent is applied to net
sales to identify what the estimated cost of product sold was as it relates to the
product that was sold in that particular time period.
BY MR. COOK:
Q: So at some point you do physical inventories to sort of readjust your cost
generator?
A: Yes, we do.
Q: And so it’s a moving number, in effect?
A: It can fluctuate. I mean, for the most part it’s static unless you have a lot of
changes going on in your business.
Mr. Gould further testified that a “cost generator” was at best an educated guess and that if
the cost generator used was markedly inadequate, it would result in great discrepancy between the
on-paper inventory used in accounting and the substantive inventory that was actually on hand. As
relates to accounts receivable in pharmacy billing practices, to get from gross to net, two qualifiers
must be considered.
As explained by John Gould:
Q. And in terms of preparing the financial statements, if I look at a typical
financial statement, I’m going to see accounts receivable, correct?
A. Yes.
Q. And I’m talking about a balance sheet.
A. Right.
Q. And I’m going to see – – under that I’m going to see, I guess, two qualifiers,
one is allowance for bad debt, is that correct, and the other one would be
contractual disallowances?
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A. Yes.
Q. And can you explain what those two terms are?
A. Sure. Going back to two of our payor types, which were Medicaid and third-
party insurance, we typically bill – – there’s an allowable amount that they’re
going to pay, and it’s pretty standard. I mean, the state has an allowable
reimbursement rate, insurance companies have allowable reimbursement
rates. It is a practice of ours, and actually in the industry, to bill more than
what they say they’re going to pay for.
And the reason is, if you bill less than what they say they’re
going to pay for. They’re going to pay that. So in order to maximize
– – to make sure you’re maximizing the benefit of what they’re going
to pay for, you typically bill above what you know they will pay for.
The difference between what you bill and what they pay is called a
contractual disallowance. And, again, that’s only for Medicaid and
third-party insurance.
Q. Okay. And how about allowance for bad debt?
A. Allowance for bad debt is a reserve on uncollectible acounts.
Q. And is it a generally accepted accounting principle to reserve against accounts
receivable?
A. Yes.
In order to understand the problem with accounts receivable, which was the subject of
extensive expert testimony, it is necessary to excerpt from the balance sheets prepared under the
management contract by AMC-TN and submitted to LifeMed, LLC. Beginning in July of 1999,
these balance sheets disclose:
Contractual
Disallowance Doubtful Acct. Net Accounts
Date Acct Rec. (Trade) Reserve Reserve Receivable
7-31-99 663,121 (116,379) (25,000) 521,742
8-31-99 742,821 (145,072) (26,000) 571,749
9-30-99 794,862 (164,004) (27,000) 603,858
10-31-99 773,225 (169,374) (28,000) 575,851
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11-30-99 880,579 (180,849) (29,000) 670,730
12-31-99 671,943 (45,663) (30,000) 596,280
1-31-00 836,213 (68,074) (33,500) 734,639
2-28-00 904,980 (101,471) (37,780) 765,729
3-31-00 965,986 (160,159) (43,012) 762,815
4-30-00 997,201 (165,139) (47,681) 784,381
5-31-00 1,037,491 (172,823) (52,374) 812,294
6-30-00 980,947 (158,201) (55,916) 766,830
7-31-00 1,117,839 (208,133) (62,250) 847,456
8-31-00 1,084,112 (198,081) (67,107) 818,924
9-30-00 1,103,525 (185,175) (70,772) 847,578
10-31-00 887,529 (177,028) (70,772) 639,729
11-30-00 829,936 (169,602) (70,772) 589,562
12-31-00 731,886 (139,730) (70,772) 521,384
1-31-01 682,425 (101,099) (89,964) 491,362
As described by both experts, the contractual disallowance and doubtful accounts are crucial
qualifiers of the net accounts receivable and of pivotal importance in the subsequent litigation. Ms.
Frazier’s testimony shows how the new ALF market affected these qualifiers.
III. THE LITIGATION
Following the decision of August 15, 2000, to dissolve LifeMed, LLC, the relationship
between the member entities of the LLC deteriorated to the point that on October 12, 2001, ARC
LifeMed, Inc., LifeTrust America, Inc. and LifeMed, LLC brought suit against AMC-TN, Inc.
alleging breach of contract, breach of fiduciary relationship, negligent representation and fraudulent
misrepresentation. It is alleged in the Complaint:
B. Management
12. ARC-LifeMed and LifeTrust entered into the LifeMed venture with
AMC-TN because AMC-TN and its parent Omnicare claimed to have significant
expertise in the pharmaceutical business, including pricing, packaging, inventory
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management, budgeting and accounting. ARC-LifeMed and LifeTrust did not have
the specialized knowledge regarding the pharmacy business that AMC-TN and
Omnicare claimed to have, and they reasonably relied on AMC-TN’s advice as to
these matters in connection with AMC-TN’s role as a member of LifeMed. AMC-
TN owed LifeTrust, ARC-LifeMed and LifeMed a fiduciary duty as a result of its
membership interest and specialized knowledge.
13. Pursuant to the LLC Agreement, ARC-LifeMed, LifeTrust and AMC-
TN ratified the existing management agreement, dated June 11, 1997 (the
“Management Agreement”) between LifeMed and AMC-TN. Pursuant to the
Management Agreement, AMC-TN was to manage the day-to-day affairs of LifeMed
and provide other services as required therein such as: (a) management of bank
accounts, (b) marketing efforts, (c) preparation of budgets, and (d) bookkeeping and
accounting. The Management Agreement states that it is to be governed by and
construed in accordance with Tennessee law. A copy of the Management Agreement
is attached as Exhibit B.
14. Pursuant to the LLC Agreement, AMC-TN was directly and primarily
responsible for the preparation of budgets, maintaining books and records, and
performing other accounting functions.
C. AMC-TN’s Mismanagement And Its Discovery
15. In August 2000, the LifeMed board voted to cease operations and
dissolve LifeMed. However, as of this date, LifeTrust and ARC-LifeMed have not
received any distributions of their contributions to the Capital Account or an
accounting.
16. At all times between October 29, 1998 to January 30, 2001, AMC-TN
assured LifeTrust and ARC-LifeMed that LifeTrust that their Initial Capital
Contributions were safe.
17. On January 30, 2001, the LifeMed board members met. At that
meeting AMC-TN and/or Omnicare representatives presented updated financials for
LifeMed through January 2001, and ARC-LifeMed’s and LifeTrust’s representatives
questioned why LifeMed was still trying to wind down the accounting five months
after the LifeMed board voted to cease operations.
18. At the January 30, 2001, Meeting ARC-LifeMed and LifeTrust learned
the following information:
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A. AMC-TN never reserved against accounts receivable balances
since inception of the business, while failing to timely,
properly manage receivables.
B. AMC-TN never properly charged cost of goods sold to
LifeMed since its inception. AMC-TN never performed
physical inventories. It appears that inventory was stolen or
misused by the parent pharmacy, not billed for or expired or
was discarded. AMC-TN never alerted LifeTrust or ARC-
LifeMed until January 30, 2001 that the inventory had been
overvalued by $400,000. Incidentally, the manager of the
parent pharmacy also told LifeTrust and ARC-LifeMed at that
January 30 meeting that she experienced an inventory
shrinkage of close to $500,000 separate and apart from the
PIP (pharmacy in pharmacy) shrinkage. Evidently, AMC-TN
staffed the parent pharmacy and the PIP with a grossly
inadequate manager and failed to provide proper accounting
and financial controls to the extreme detriment of the PIP and
LifeMed.
C. AMC-TN regularly produced misleading financial statements
for LifeTrust and ARC-LifeMed. For example, on January
30, 2001, Omnicare’s regional controller provided to ARC
income statements and balance sheets for each month of 2000
and for January 2001, which presents accounts receivable and
inventory figures unadjusted and incorrect.
19. As a result of the above-reference misrepresentations and wrongful
actions and omissions: (a) LifeTrust and ARC-LifeMed received materially
inaccurate financial statements from AMC-TN; (b) LifeMed was unable to properly
price the goods and services provided, resulting in cumulative losses; (c) the PIP was
permitted to own its own inventory, which was detrimental to LifeTrust, ARC-
Lifemed and LifeMed and ultimately hid the poor financial results of LifeMed; and
(d) LifeTrust and ARC-LifeMed were unable to understand the cumulative poor
financial condition which caused ARC-LifeMed and LifeTrust to continue their
participation in the losing business longer than would otherwise have been the case.
...
23. AMC-TN and LifeTrust have asked for (a) a dissolution of LifeMed,
(b) an accounting, and (c) and a return of their funds held in the Capital Account, but
AMC-TN has failed to wind up the affairs of LifeMed, provide an adequate an (sic)
accurate accounting and pay the amounts requested.
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Plaintiffs then sought inter alia, the following:
A. Require AMC-TN to provide a thorough accounting of the assets and
liabilities of LifeMed, including (1) a complete explanation of the current assets and
liabilities of LifeMed, (2) a complete history of the receipt of funds and other
property and the disposition of funds and other property, and (3) an explanation as
to the status and whereabouts of the Capital Account and LifeTrust’s and ARC-
LifeMed’s Initial Capital Contributions.
B. Order a dissolution, winding up and distribution of the assets of
LifeMed in accordance with the LLC Agreement and applicable law;
C. Order that AMC-TN shall not be allowed to (1) receive any money from
the distribution of the assets of LifeMed until ARC-LifeMed and LifeTrust are
compensated for their contributions to LifeMed, including interest; or (2) otherwise
receive any distribution from the assets of LifeMed as the result of its wrongful acts
and omissions.
D. To the extent that LifeTrust and ARC-LifeMed are not made whole
from the distribution from LifeMed, award a judgment in favor of LifeTrust and
ARC-LifeMed against AMC-TN for such amounts together with interest to make
them whole from their investments;
E. In addition, award LifeTrust, ARC-LifeMed and/or LifeMed judgments
against AMC-TN for all direct, consequential and punitive damages arising from
AMC-TN’s fraudulent and/or negligent misrepresentations, wrongful conduct, breach
of fiduciary duty and breach of contract, lack of good faith and gross negligence.
F. Award Plaintiffs their attorneys fees and expenses incurred in this action.
G. Grant such additional relief as is appropriate under equity or is
otherwise appropriate.
AMC-TN answered the Complaint with general denials and with a counter claim for payment
by LifeMed, LLC of unpaid management fees allegedly due under the Management Agreement.
It is first necessary to consider the standing and status of LifeMed, LLC as a party to the
litigation. In the Complaint of October 12, 2001, LifeMed, LLC is averred to be a party plaintiff,
and the body of the Complaint contains the following allegations with regard to the status of the
LLC:
3. Plaintiff LifeMed, LLC (“LifeMed”) is a limited liability corporation
organized under the laws of Delaware. At all times relevant to this lawsuit,
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LifeMed’s principal offices were located in Hermitage, Davidson County, Tennessee.
Upon information and belief, LifeMed is no longer transacting business in this state,
and its certificate of authority has been revoked by the Tennessee Secretary of State.
As is more fully-set forth below, LifeMed was formed to provide pharmacy services
in assisted living facilities.
...
6. ARC-LifeMed, LifeTrust and AMC-TN are the members of LifeMed.
ARC-LifeMed and LifeTrust have assented to LifeMed’s filing the claims contained
herein in its own name. In the event that LifeMed cannot bring this action because
of some refusal of AMC-TN to consent or take some other action, LifeTrust and
ARC-TN assert claims on behalf of LifeMed because it is unlikely that AMC-TN
would consent to being sued by LifeMed. Moreover, to the extent that LifeMed’s
corporate existence has ceased or it is otherwise unable to bring this action in its own
name, LifeTrust and ARC-LifeMed assert claims which would otherwise be brought
by LifeMed based on the harm to their membership interests in LifeMed.
...
26. Based on the foregoing, AMC-TN has breached its duties under the
LLC Agreement and/or Management Agreement, including its duty of good faith and
fair dealing. LifeMed, ARC-TN, and LifeTrust were harmed as the proximate result
of such breach.
When the defendant, AMC-TN, Inc., answered the Complaint, it asserted:
3. AMC-TN denies that LifeMed is a limited liability “corporation.”
AMC-TN admits the remaining allegations of paragraph 3 of the Complaint except
that the Tennessee Secretary of State has reinstated the certificate of authority for
LifeMed, LLC.
As an affirmative defense, AMC-TN asserted:
29. AMC-TN states that LifeMed, LLC is not a proper plaintiff in this
action and that Plaintiffs ARC LifeMed, Inc. and LifeTrust America, Inc. are not
authorized to bring this action on behalf of LifeMed, LLC without the consent of all
members and/or an affirmative vote of all Board of Managers of LifeMed, LLC.
In its counterclaim, AMC-TN, Inc. joins ARC-MedLife, Inc., LifeTrust America, Inc. and
LifeMed, LLC as counter defendants. AMC-TN, Inc. then alleges:
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4. Counter-Defendant LifeMed, LLC (“LifeMed”) is a limited liability
company organized and existing pursuant to the laws of the State of Delaware.
LifeMed is qualified to do business in Tennessee and, at all times material to the
allegations in this Counter-Claim, maintained a business office in Davidson County,
Tennessee.
The Counter Complaint then alleges breach of contract by LifeMed, LLC in its failure to pay
management fees allegedly due and owing to AMC-TN. By way of relief, the counter plaintiff seeks:
A. The award of judgments in favor of Counter-Plaintiff AMC-Tennessee,
Inc. against Counter-Defendants ARC LifeMed, Inc., LifeTrust America, Inc. and/or
LifeMed, LLC, for all damages arising from LifeMed’s breach of contract and the
Counter-Defendants’ unjust enrichment and/or quantum meruit;
When the counter-defendants answered the counterclaim, they answered all the paragraphs
in the combined answer and Counterclaim of AMC-TN, Inc. which were set forth numerically first
in the answer and then in the affirmative defenses and the Counterclaim itself. Pertinent to the
standing and status problem in the answer to the Counterclaim, it is asserted:
. . . 3. Counter-defendants Admit the Allegations in Paragraph 3 of the
Counterclaim.
All other relevant allegations of the Counter-complaint are met with a general denial.
Taking the pleadings as a whole, it appears that in the Complaint, the plaintiffs did not know
the status of LifeMed, LLC and asserted in effect a possible termination of the LLC under Tennessee
Code Annotated section 48-245-701 and alternatively sought to pursue the action under Tennessee
Code Annotated section 48-245-1201.1
When the defendants asserted their answer to the Complaint, they affirmatively asserted that
“. . . the Tennessee Secretary of State has reinstated the certificate of authority for LifeMed, LLC.”
In its Counter-complaint, AMC-TN affirmatively asserted that LifeMed, LLC was a limited liability
company organized and existing under the laws of Delaware and qualified to do business in the state
of Tennessee. In the answer of the plaintiffs/counter-defendants to the Counterclaim, they admitted
the allegation of the continued existence of LifeMed, LLC. The pleadings themselves establish the
continued existence of LifeMed, LLC, and both the Complaint and the Counter-complaint draw
issues between LifeMed, LLC and AMC-TN. Even if a termination of LifeMed, LLC had actually
occurred, both the Complaint and Counter-complaint are properly before the Court under Tennessee
Code Annotated section 48-245-1201.
1
Right to sue or defend after termination period – – after an LLC has been terminated, any of its former
managers, governors, or members may assert or defend, in the name of the LLC any claims by or against the LLC. Tenn.
Code Ann. § 48-245-1201.
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This is essentially a breach of contract case. LifeMed, LLC seeks recovery from AMC-TN
for the member manager’s failure to perform its contractual duties with particular emphasis on
AMC-TN’s failure to provide financial reports consistent with generally accepted accounting
principles. In this respect, the case involved a dual of expert witnesses. Both Brian Richardson,
chief financial officer of ARC, and John Gould, chief financial officer for AMC-TN, were “in-
house” experts rather than independent accountants. This dual ended when the trial court accepted
the testimony of Mr. Richardson in preference to that of Mr. Gould. In this kind of a credibility call,
the judgment of the trial court carries with it great weight in the appellate courts. Mitchell v.
Archibald, 971 S.W.2d 25, 29-30 (Tenn.Ct.App.1998). It is well to observe that the position of Mr.
Gould was seriously compromised by the fact that he did not take over the financial affairs of AMC-
TN under the Management Contract until the time that the decision was made in August of 2000 to
dissolve LifeMed, LLC. Most of the management problems had already occurred before he was in
a position of responsibility. John Gould assumed command of this Titanic only after it struck the
iceberg.
Three major areas are involved in the breach of contract: (1) the “cost generator” used in
measuring inventory was grossly in error; (2) AMC-TN did not collect its fee and expenses
contemporaneously with earning such fees and incurring such expenses as required by the
management contract; (3) AMC-TN grossly understated reserves for bad accounts. The trial judge
accepted Mr. Richardson’s testimony, holding that AMC-TN had breached its Management Contract
with respect to deficient control of inventories, failure to timely collect its fees and expenses and
maintaining grossly inadequate reserves for bad debts, and the evidence supports these findings.
After realizing the bookkeeping and accounting problems of LifeMed, Gould commiserated
with Pat Keefe of Omnicare by memo of January 11, 2001. In considering this memo, certain
observations are necessary.
1. What is referred to as “Stephen’s J.V.” is in fact LifeMed, LLC. What is referred to as
“Stephens” is AMC-TN (The Pharmacy) in its status independent of the LifeMed, LLC venture.
2. The criticisms by Gould, deal primarily with matters predating his arrival on the scene.
3. AMC-TN is, and has been since the joint venture began, a single entity. It cannot divide
itself into component parts and disavow the pre-Gould era.
4. The memo is dated five months after the decision to dissolve the joint venture, four
months after the projected date of the dissolution and 19 days prior to the January 30, 2001, meeting
of the joint venture board.
At the outset, the memo provides:
The following represents key financial accounts and balances as of November 30,
2000:
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Cash $553,107
Net A/r 596,864
Inventory 557,149
Net P, p&c 72,080
Net Goodwill 238,492
A/p 1,138,847
Member Equity 897,249
The balances above were as of November 30. I am currently in the process of
reconciling several accounts including cash, inventory, accounts payable and
member’s equity. With the exception of inventory, due to the lack of paper trail, I
am having trouble reconciling these accounts. The following is being taken into
consideration before the final balance sheet is calculated.
...
Accounts Payable
Of the $1,138,000 balance, $1,110,000 is owed to Stephens pharmacy for service
performed and inventory purchased. The problem is Stephens has an account
receivable balance for the J.V. of $1,231,904 for a difference of $117,788. As
mentioned above the lack of paper trail for 1997-1999 is making it difficult to
reconcile this balance.
Thus, it appears that as of November 30, 2000, joint venture carried $1,110,000 in accounts
payable to AMC-TN, not only for inventory purchased but for “service performed.” Nothing in the
periodic accountings and balance sheets supplied to LifeMed, LLC discloses that AMC-TN had not
been collecting for its “service performed” as it is required to do under paragraph B of the
Management Agreement. It is also difficult to see how AMC-TN, in its capacity as manager of
LifeMed, LLC, can carry accounts payables to AMC-TN of $1,110,000 while simultaneously
carrying on its own books accounts receivable from the joint venture of $1,231,904.
The memo next addresses inventory and reveals in stark fashion the shortcomings of AMC-
TN’s management of inventory.
Inventory
The J.V. started carrying inventory effective January 1, 2000. Prior to that, an
inventory amount equal to the cost generator percent was transferred from Stephens’
books to the J.V. The J.V. recorded this as cost of goods sold. Under this scenario,
whenever an inventory was taken any gain or loss was recorded on Stephens’ books.
In the last 6 months of 1999, Stephens recorded an inventory loss of $450,000, none
of which was recorded by the J.V.
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Even though inventory was purchased separately by Stephens and the J.V. starting
in 2000, all physical counts were combined and compared to the combined book total
for both companies. The reason for this was there was still a significant amount of
inventory that was shared by both companies that was not properly being tracked.
By combining the two inventories a total gain or loss could be calculated with the
difference usually being shared.
On September 15, a physical inventory was taken and a combined loss of $133,000
was noted. Depending on how the reconciliation of the accounts payable/account
receivable balances are resolved (as noted above) this loss could reach $260,000. As
it stands on the books for each company, Stephens has a gain of $260,000
(or$133,000 gain if the reconciliation of a/r is unfavorable to Stephens) on a physical
count of $784,588 and the J.V. had a loss of $393,000 on a count of $226,270.
The kicker to the September 15 physical is that throughout the month, Stephens
would borrow inventory from the J.V. This inventory was supposed to be tracked so
that an entry could be made to record the transfer. The last transfer recorded was
May 2000. The amount of the unrecorded transfer is approximently [sic] $400,000.
If this transfer were to be recorded, Stephens would have a loss at September 15, of
$140,000 (or $267,000 depending on how the a/r reconciliation is resolved) and the
J.V. would have a gain of approx. $10K.
Another thing to note, the November 30 inventory for Stephens yielded a gain of
$260,000. However, this is before the $400,000 transfer and Stephens purchase of
J.V. inventory (the amount has yet to be determined). If the transfer were to be
recorded the $260,000 gain would become a $140,000 loss. If the transfer were to
be made, the J.V. would have an inventory balance of $220,000 that Stephens would
have to purchase. Therefore the loss at 11/30 on Stephens books would be $360,000.
Mr. Gould next addresses accounts receivable and makes his candid appraisal of the situation
facing the joint venture as of the end of December 2000.
An additional $80,000 was collected in December. Therefore the net a/r balance is
approximently (sic) $517,000. My conservative estimate is that we will be lucky to
see $200,000 more in collections. Because of how the books were kept early on in
the J.V., I am not convinced that there is even $517,000 to collect. Of the $517,000
left to collect, $200,000 is unbilled third party insurance. This is the amount we are
trying to collect.
In testimony at trial, Bryan Richardson discussed the requirements of generally accepted
accounting principles as to reserves against bad accounts:
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[T]here’s two tests as far as when you would set up a reserve: When something is
probable that it will be a loss contingency; and when you can estimate it. And then
there’s some specific guidance on accounts receivable that talks very specifically
about the fact that this is – – you’re literally looking at the receivables as a whole.
In other words, the fact that at any point in time you can’t say, well,
I’m not sure that this persons’ going to pay me or this person’s going to pay me but
that you would look at the whole pool of receivables that you have, you would look
at the historical trends in your business and the fact that, on average, X percentage
of people don’t pay you, that you would be needing to use that kind of guidance as
far as setting up reserves.
So the fact at any point in time you may not be able to point
specifically at which receivable are going to go bad, the guidance is very clear that
that is not a defense, that you need to look at historical trends and look at your
estimates and set up reserves accordingly.
As a matter of fact, one of the things that I – – that’s what I’ve
mentioned in my write-up as far as, you know, the need to continually assess that
based on the trends. One of the items that I received as a response to my report was
some information from John Gould entitled Response to Bryan Richardson’s
Analysis of LifeMed’s Accounts Receivable and Collection Records. And in that
he’s talking about in most cases a receivable balance will not be reserved until it is
positively determined that no other course of action can be taken or that it is highly
probable it will not be collected. Again, in our business this could take up to a year
of more to make that determination.
That’s directly in contradiction to what GAAP [Generally Accepted
Accounting Principles] tells you you need to do. GAAP is saying you can’t wait until
you positively know something is going to be not collectible that you need to make
a reasonable estimate, and it allows you to update that estimate from time to time as
you have more facts and circumstances. But the response that John made to my
memorandum is directly in contradiction to what GAAP tells you you need to do.
And then it further goes on to say – – and, again, this is John’s
response to my memo. It says, “It’s easy to conclude today that two and a half years
ago LifeMed’s reserves were understated, hindsight is 20/20. However, I disagree
that two and a half years ago this conclusion was that evident.” This is, again,
admitting that as you look back, certainly those reserves were understated but not, I
guess, recognizing the responsibility to have set aside an appropriate reserve at that
time.
Mr. Richardson’s report provided:
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6) The total amounts recorded on the LifeMed financial statements as of 9/30/00
were:
Accounts Receivable $1,110,777
Allowance for doubtful accounts (70,772)
Contractual Allowances (185,175)
Net Accounts Receivable $854,830
7) Based on the information provided, it appears that the Allowance for Doubtful
Accounts reserve balance as of 9/30/00 should have been at least $380,000.
Overall Conclusions
In my opinion, based on the information reviewed, the Allowance for Doubtful
Accounts as of 9/30/00, should have been at least $380,000. The significant balances
beyond terms, lack of effective collection activity, billing difficulties, and other
information and trends should have indicated a need for a larger reserve balance than
was shown on the financial statements.
Based on the $380,000, the reserve balance at 9/30/00 of $70,772 was understated
by $309,228. Based on my review, I believe the reserve balance as recorded on the
LifeMed financial statements was materially understated throughout 1999 and 2000.
One cannot help but note the parallel between Mr. Richardson’s analysis of accounts
receivable reserves and the candid observations of John Gould in his memo of January 11, 2001.
Under both analyses, the collectibility of the net accounts receivable reflected on the AMC-TN
prepared balance sheets for the joint venture are clearly and strictly limited.
The trial court held:
As a result of the improper financial statements, the joint venture
probably continued longer than it would have by AMC-Tennessee advancing monies
for expenses and not properly taking them out of the checking account set up for the
joint venture. The members of the joint venture were deprived of how serious the
joint venture was running into the red.
If this process that had been set up in the management agreement had
been followed rather than AMC-Tennessee financing some of the expenses through
their accounts rather than the checking accounts set up and approved by the board of
managers, it would have become very evident earlier on as to what problems were
being incurred in the operation of the joint venture.
I cannot precisely point to what financial problems started when,
whether the billing of the communities’ residents and nonpayment caused a lack of
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cash flow. I don’t know if the purchase of pharmaceuticals by AMC-Tennessee as
the PIP, pharmacy in a pharmacy, operator caused them to have expenses that they
carried which were not reimbursed, but it is apparent from all the testimony that the
$400,000 write-off occurred over a period of time that would have been evident if all
of the bookkeeping and accounting procedures that were set out in the management
agreement had been followed.
It was incumbent upon AMC-Tennessee, Inc., to keep the books and
to prepare proper financial statements and records. That included preparing proper
financial statements in August of 2000 and in January 2001. Those financial
statements were not properly prepared, and AMC-Tennessee, Inc., breached its duties
under the management agreement both with regards to the payment of expenses to
be paid at the joint venture’s expense by checks drawn on the joint venture’s
accounts and by failing to maintain proper bookkeeping and accounting procedures
and proper preparation of financial statements and records.
The evidence sustains these findings of the trial court that AMC-TN materially breached the
Management Agreement to the detriment of LifeMed, LLC. As a result of the materially inaccurate
financial statements issued by AMC-TN to LifeMed, LLC, the joint venture asserts that it was unable
to properly price the goods and services provided, and that this inability resulted in cumulative
losses. By withholding the inventory shortages and failing to disclose that its fees and expenses were
accumulating rather than being contemporaneously paid in the manner required by the Management
Agreement and by overvaluing accounts receivable, AMC-TN provided a false picture of the true
financial condition of the joint venture and the degree to which losses were accumulating. It matters
not whether the motivations of AMC-TN were altruistic or self-servingly deceptive. If the true
financial picture would have caused LifeMed, LLC to price its products out of the market, such is
not a decision to be made by the manager under the Management Agreement. Among the
responsibilities of the owner, as provided by the Management Agreement, are:
A. Operational Policies. The board of managers of the owner shall develop and
implement all operational policies and procedures necessary to establish and maintain
the standard of pharmacy services appropriate for the nature of The Pharmacy.
B. Charges. The board of managers of the owner shall establish the scheduled or
recommended charges for pharmaceutical products and services provided by The
Pharmacy.
Instead of giving the board of managers of LifeMed, LLC the information upon which it
could make decisions as to the pricing of products, or for that matter, the continued existence of the
joint venture, the managing member withheld such information and appropriated to itself a right to
make unilateral decisions for the joint venture. This was clearly in breach of the Management
Agreement.
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IV. FIDUCIARY DUTY AND NEGLIGENT MISREPRESENTATION
Both breach of fiduciary duty and negligent misrepresentation fail as causes of action under
the facts of this case for reasons set forth in McGee v. Best, 106 S.W.3d 48 (Tenn.Ct.App.2002).
In McGee, a terminated member of the LLC filed suit against the LLC and its other members
charging inter alia, breach of contract, breach of fiduciary duty and misrepresentation. In affirming
the trial court’s rejection of the breach of fiduciary duty claim, this Court held:
The plaintiff argues that the trial court erroneously held that the plaintiff’s
claims based upon an alleged breach of fiduciary duty owed to him individually by
the other members must fail as a matter of law because there is no fiduciary duty
between, or among, individual members of a Limited Liability Corporation. We
disagree. Tenn.Code Ann. § 48-240-102(a)(2002) provides:
(a) FIDUCIARY DUTY OF MEMBERS OF MEMBER
MANAGED LLC. Except as provided in the articles or operating
agreement, every member of a member-managed LLC must account
to the LLC for any benefit, and hold as trustee for it any profits
derived by the member without the consent of the other members
from any transaction connected with the formation, conduct, or
liquidation of the LLC or from any use by the member of its property
including, but not limited to, confidential or proprietary information
of the LLC or other matters entrusted to the member as a result of
such person’s status as a member.
(b) STANDARD OF CONDUCT. A member of a member-
managed LLC shall discharge such member’s duties as a member,
including all duties as a member of a committee:
(1) In good faith;
(2) With the care an ordinarily prudent person in a like
position would exercise under similar circumstances; and
(3) In a manner the member reasonably believes to be in the
best interest of the LLC.
Id.
The rule of statutory construction to which all others must yield is that the
intention of the legislature must prevail. Mangrum v. Owens, 917 S.W.2d 244, 246
(Tenn.Ct.App.1995)(citing Plough, Inc. v. Premier Pneumatics, Inc., 660 S.W.2d
495, 498 (Tenn.Ct.App.1983); City of Humboldt v. Morris, 579 S.W.2d 860, 863
(Tenn.Ct.App.1978)). “[L]egislative intent or purpose is to be ascertained primarily
from the natural and ordinary meaning of the language used, when read in the context
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of the entire statute, without any forced or subtle construction to limit or extend the
import of the language.” Mangrum v. Owens, 917 S.W.2d at 246; (quoting Worrall
v. Kroger Co., 545 S.W.2d 736, 738 (Tenn.1977)). The Court has a duty to construe
a statute so that no part will be inoperative, superfluous, void or insignificant. The
Court must give effect to every word, phrase, clause, and sentence of the Act in order
to achieve the Legislature’s intent, and it must construe a statute so that no section
will destroy another. Id. (citing City of Caryville v. Campbell County, 660 S.W.2d
510, 512 (Tenn.Ct.App.1983); Tidwell v. Collins, 522 S.W.2d 674, 676
(Tenn.1975)).
The statute in question defines the fiduciary duty of members of a member-
managed LLC as one owing to the LLC, not to individual members. We cannot
contravene the intent of the Legislature. Therefore, we find that the trial court
correctly dismissed the plaintiff’s cause of action for breach of fiduciary duty.
McGee v. Best, 106 S.W.3d at 63-64.
In Anderson, et al. v. Wilder, et al., E2003-00460-COA-R3-CV, 2003 WL 22768666(Tenn.Ct.App.), this Court distinguished the rule in McGee and, adapting partnership and closely-
held corporation principles, imposed a fiduciary relationship upon a majority shareholder of an LLC
in his relationship to a minority shareholder. McGee was distinguished by the Court because the case
involved “. . . ‘a rather uncomplicated dispute controlled by the Employment Contract and the
Operating Agreement . . . . The only issue involved is whether termination of the employment was
for cause.’ McGee, 106 S.W.3d at 67.” Anderson, 2003 WL 22768666 at *6. The case at bar
likewise involves uncomplicated contractual duties under an operating agreement and a management
agreement and not a factual situation involving oppression by a majority shareholder of minority
shareholders.
The parties do not dispute the existence of a fiduciary duty owed by the managing member
of the LLC to the LLC. In addition, all of the factual allegations of the Complaint constitute repeated
breaches of the Management Contract between the managing member and the LLC resulting in
damages to the LLC. Thus, the question whether or not a fiduciary duty is owed by the managing
member to the other members is of little consequence under the facts of this case. Plaintiffs have
asserted no damages to themselves personally, but only such damages as necessarily flow from
breach of the Management Contract with LifeMed, LLC.
As to alleged negligent misrepresentation, it is noted that the only misrepresentations asserted
are the same misrepresentations as constitute the breach of contract asserted by LifeMed, LLC. No
assertions of individual damages accruing to ARC or LifeTrust are made independent of damages
recoverable by the LLC other than general allegations asserting compensatory and punitive damages
to the members, which are supported by no proof. Once again, McGee is instructive.
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As the trial court pointed out, “the plaintiff alleges that certain information
was withheld from him-either intentionally or negligently – and that this information
was material in the manner by which he conducted the affairs of the LLC. Plaintiff
does not allege that he conducted his own personal affairs in reliance upon any such
material information or that he obligated himself personally in reliance thereon.”
Plaintiff’s amended complaint provides in pertinent part:
94. The Plaintiff was relying on statements of employees of IEI
to conduct the affairs of MBF & I and these material omissions
caused Plaintiff to act in manner that he otherwise would if he had
known the true state of affairs thereby damaging him and the LLC.
The plaintiff has, in essence, alleged a derivative claim, but at this point has no
standing to bring such a claim. In Bourne v. Williams, 633 S.W.2d 469(Tenn.Ct.App.1981), Judge Tomlin of this Court said:
It has long been recognized that where a wrong to the
corporation was claimed by a stockholder, if the board of directors of
the corporation did not take steps to rectify the wrong, then a
stockholder could bring the action in the name of the corporation, for
the benefit of the corporation. This is the gravamen of a “derivative”
suit. 13 Fletcher, Cyc. Corp. sec. 5908 (perm. ed.1980). See also
Opportunity Christian Church v. Washington Water Power Co., 136
Wash. 116, 238 P. 641 (1925).
Bourne v. Williams, 633 S.W.2d at 471. However, the plaintiff has not proceeded in
this manner. Furthermore, the plaintiff’s amended complaint also alleges a personal
injury as a result of certain information being withheld from him. The plaintiff’s
personal injury is, in essence, the plaintiff’s termination from employment with MBF
& I. However, as the trial court noted, “that claim arises out of the employment
relationship and does not create a cause of action for fraud or misrepresentation.”
McGee v. Best, 106 S.W.3d at 65.
Breach of fiduciary duty is an action sounding in tort. Mike v. Po Group, Inc., 937 S.W.2d
790, 795 (Tenn.1996). An action for negligent misrepresentation sounds in tort. Atkins v.
Kirkpatrick, 823 S.W.2d 547, 552 (Tenn.Ct.App.1991). In actions based on ordinary negligence
rather than willful conduct, proof of damages is an element of the plaintiff’s cause of action and,
without such proof offered by ARC and LifeTrust, Inc., their cause of action fails. Skoretz v.
Cowden, 707 S.W.2d 529, 532 (Tenn.Ct.App.1983); Morris v. State, 21 S.W.3d 196, 203
(Tenn.Ct.App.1999); see also 22 Am Jur 2d, “Damages” § 16.
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The findings of the trial court as to fiduciary duty and negligent misrepresentation are
reversed.
V. COUNTER COMPLAINT
By its counterclaim, AMC-TN seeks recovery of unpaid management fees under the
Management Contract and, in the alternative, recovery from LifeMed, LLC because of unjust
enrichment or for the value of services in quantum meruit.
In this context, as well, the significance of the trial court’s acceptance of the testimony of Mr.
Richardson over the testimony of Mr. Gould cannot be overemphasized. In addressing this
credibility call, we must give deference to the settled rule:
One of the most time-honored principles of appellate review is that trial
courts are best situated to determine the credibility of the witnesses and to resolve
factual disputes hinging on credibility determinations. See State v. Pruett, 788
S.W.2d 559, 561 (Tenn.1990); Tenn-Tex Properties v. Brownell-Electro, Inc., 778
S.W.2d 423, 425-26 (Tenn.1989). Accordingly, appellate courts routinely decline to
second-guess a trial court’s credibility determinations unless there is concrete, clear,
and convincing evidence to the contrary. See Bingham v. Dyersburg Fabrics Co.,
Inc., 567 S.W.2d 169, 170 (Tenn.1978); Thompson v. Creswell Indus. Supply, Inc.,
936 S.W.2d 955, 957 (Tenn.Ct.App.1996).
The most often cited reason for this principle can be traced to the fact that
trial judges, unlike appellate judges, have an opportunity to observe the manner and
demeanor of the witnesses while they are testifying. See Bowman v. Bowman, 836
S.W.2d 563, 566 (Tenn.Ct.App.1991). There are, however, other reasons for this
principle. As the United States Supreme Court has observed:
The trial judge’s major role is the determination of fact, and with
experience in fulfilling that role comes expertise. Duplication of the
trial judge’s efforts in the court of appeals would very likely
contribute only negligibly to the accuracy of fact determination at a
huge cost in diversion of judicial resources. In addition, the parties
to a case on appeal have already been forced to concentrate their
energies and resources on persuading the trial judge that their account
of the facts is the correct one; requiring them to persuade three more
judges at the appellate level is requiring too much.
Anderson v. City of Bessemer City, 470 U.S. 564, 574-75, 105 S. Ct. 1504, 1512, 84
L. Ed. 2d 518 (1985).
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The advisory committee note to Fed.R.Civ.P. 52(a), which requires that
deference be given to the trial judge’s opportunity to judge the credibility of
witnesses, lists three important policy concerns behind the rule: (1) upholding the
legitimacy of the trial courts to litigants; (2) preventing an avalanche of appeals by
discouraging appellate retrial of factual issues, and (3) maintaining the allocation of
judicial authority. The policy underpinnings of Fed.R.Civ.P. 52(a) advance the
public’s interests in stability and judicial economy, and we view them as equally
important to Tennessee’s citizens and courts.
Mitchell v. Archibald, 971 S.W.2d 25, 29 (Tenn.Ct.App.1998).
The trial court accepted the expert testimony proffered by the plaintiffs. This testimony
established that AMC-TN failed to manage LLC accounts according to generally accepted
accounting principles. This failure constituted a material breach of the Management Agreement.
A party who has materially breached a contract cannot recover on the contract. Nevertheless, under
proper conditions and upon carrying the burden of proof as to the value of services rendered under
the contract, he may recover in quantum meruit. The rule is:
Even though a contract be entire, the party who breaches the same may
recover of the other party, as on a quantum merit, the value of benefits conferred on
such other party by partial performance — these benefits being accepted and retained.
Any damage, of course, which the party not in default suffered by the breach also to
be taken into account. The law is frequently so applied in cases which involve
building contracts and contracts for personal services. Stump v. Estill, 7 Tenn.
(Peck.) 175; Elliott v. Wilkinson, 16 Tenn. (8 Yerg.) 411; Porter v. Woods, 22 Tenn.
(3 Humph.) 56, 39 Am.Dec. 153; Barker v. Reagan, 51 Tenn. (4 Heisk.) 590, 596;
Bush v. Jones, 2 Tenn.Ch. 190; Jones v. Jones, 32 Tenn. (2 Swan) 605; Congregation
of Children of Israel v. Peres, 42 Tenn. (2 Cold.) 620; Massey v. Taylor, Wood &
Co., 45 Tenn. (5 Cold.) 447, 98 Am.Dec. 429; Hunter v. Litterer & Cabler, 60 Tenn.
(1 Baxt.) 168; Bruce v. Baxter, 75 Tenn. (7 Lea) 477.
National Life & Accident Ins. Co. v. Hamilton, 98 S.W.2d 107, 108 (Tenn.1936).
It is well to observe also that the failure of AMC-TN to timely collect its fees and expenses
was itself in material breach of the Management Contract. AMC-TN presents no material evidence
as to the value of its services so as to allow for a recovery in quantum meruit or any evidence of
unjust enrichment. As the trial court held, the counter complaint is without merit.
VI. DAMAGES
If the “pharmacy-within-a-pharmacy” concept was difficult to administer, the separate
remedies sought in this litigation are equally challenging and must be separated in order to be
compatible. When breach of fiduciary duty, negligent misrepresentation and the counterclaim
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asserting quantum meruit and unjust enrichment are removed from the case, we are left with a breach
of contract action by LifeMed, LLC against AMC-TN and a counterclaim for breach of contract by
AMC-TN against LifeMed, LLC. This Court, having affirmed both the trial court’s finding that
AMC-TN breached the Management Contract and its dismissal of the counterclaim, now must first
address the question of damages resulting to LifeMed, LLC because of the breach.
Equitable considerations cannot intervene in a pure breach of contract action.
“Equity follows the law. Where there is no legal liability, equity can create none.”
Henderson v. Overton, 10 Tenn. 394, 397 (1830); Bedwell v. Bedwell, 774 S.W.2d 953, 956
(Tenn.Ct.App.1989); Metropolitan Life Insurance Company v. Owens, 246 S.W.2d 971, 972
(Tenn.1952). “When in doubt equity follows the law.” Tennessee-Carolina Mills v. Mauk, 14
Tenn.App. 517, 519 (1931). What appears to be fair as a matter of equity cannot prevail in the face
of constitutional, statutory or contractual provisions governing the rights of the parties. As the
Supreme Court of Nevada observed,
Our equitable powers do not extend so far as to permit us to disregard
fundamental principles of the law of contracts, or arbitrarily to force upon parties
contractual obligations, terms or conditions which they have not voluntarily assumed.
In this regard, equity respects and upholds the fundamental right of the individual to
complete freedom to contract or decline to do so, as he conceives to be for his best
interests, so long as his contract is not illegal or against public policy. In this respect,
and many others, equity follows the law. Much as we would like to relieve the
appellant from his unfortunate situation, we cannot rightfully do so, as we must
maintain the necessary certainty, stability and integrity of contractual rights and
obligations.
McCall v. Carlson, et al., 172 P2d 171, 187-88 (Nev.1946).
Consequently, where the remedies available to a litigant are circumscribed by the boundaries
drawn at law, such as in a breach of contract case, principles of equity cannot create rights outside
those boundaries. See generally Swartz v. Atkins, 315 S.W.2d 393, 395 (Tenn.1958); Bedwell v.
Bedwell, 774 S.W.2d, at 956. The Missouri Court of Appeals succinctly stated the rule to be applied
in breach of contract cases. “The rights of the parties are to be determined from the contracts into
which they entered and the consequences of those contracts and not from some generalized concepts
of equity.” Norcomo Corp. v. Franchi Construction Co., Inc., 587 S.W.2d 311, 317 (Mo.Ct.App.
1979). This Court has held: “The essential elements of any breach of contract claim include (1) the
existence of an enforceable contract, (2) nonperformance amounting to a breach of the contract, and
(3) damages caused by the breach of the contract.” Custom Built Homes v. G.S. Hinsen Co., Inc.,
1998 WL 960287 (Tenn.Ct.App. Feb. 2, 1998) (citing LifeCare Ctrs. Of Am., Inc. v. Charles Town
Assoc’s. Ltd. Partnership, LPIMC, Inc., 79 F.3d 496, 514 (6th Cir.1996)).
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However, the second remedy sought by the Complaint is for the Court to “. . . order a
dissolution, winding up and distribution of the assets of LifeMed in accordance with the LLC
Agreement and applicable law.” This is therefore a proceeding to dissolve an LLC by judicial
intervention. In such a proceeding, the court “. . . may grant any equitable relief it considers just and
reasonable in the circumstances . . .” Tenn.Code Ann. § 48-245-901.
Determining damages for breach of contract in this case is rendered difficult by the fact that
the managing member controlled the books and records of the LLC, wrote all of the checks, recorded
all of the income, did all of the bookkeeping, and provided all of the accountings under its
Management Contract. Nevertheless, it must abide by the Management Contract.
In addressing the duties of the managing partner of an LLC, it must be recognized that the
LLC is still in its relative infancy. This Court has observed:
The LLC is a relatively new form of business entity, a hybrid which
“incorporates certain beneficial aspects of a partnership with certain beneficial
aspects of a corporation.” Annotation, Construction and Application of Limited
Liability Company Acts, 79 A.L.R. 5th 689. This A.L.R. annotation contains the
following helpful observations:
It is important to keep the history of LLC development in
perspective when working with LLCs and court interpretations of
LLC acts. ... The typical LLC act is usually a hybrid of
provisions culled from the individual state’s partnership statutes and
business corporation law.
***
[W]hen a court is interpreting an LLC act or agreement, the court will
focus on the particular aspect of the LLC that gives rise to the
problem, with emphasis on the foundational business form from
which that characteristic originated. Usually, the particular aspect can
be traced to either the corporate components or the partnership
components of the LLC act or agreement. In such cases where the
characteristic originated from the partnership aspects of the LLC, the
court will use the established princip[le]s and precedent of the
partnership law to resolve the issue . . . In such cases where the
characteristic originated from the corporate aspects of the LLC, the
court will utilize the established princip[le]s and precedent of
corporate law to resolve the issue. 79 A.L.R. 5th at page 698.
Anderson, et al. v. Wilder, et al., 2003 WL 22768666 * 3-4 (Tenn.Ct.App. Nov. 21, 2003).
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Borrowing from partnership law and under the terms of the Management Contract, LifeMed,
LLC was entitled to a proper accounting by its managing partner. Fulcher v. Allen, 2 S.W.3d 207,
218 (Tenn.Ct.App.1999).
As held by the Supreme Court of Illinois:
As the managing partner who was admittedly responsible for virtually all of
the financial aspects of the partnership, defendant had a duty, as trustee, to maintain
regular and accurate records and to account for partnership transactions. (Altschuler
v. Altschuler (1951), 410 Ill. 169, 177-78, 196-97, 101 N.E.2d 552; see also Bakalis
v. Bressler (1953), 1 Ill. 2d 72, 78-79, 115 N.E.2d 323. Einsweiler v. Einsweiler
(1945), 390 Ill. 286, 293, 61 N.E.2d 377; Wylie v. Bushnell (1917), 277 Ill. 484, 491,
115 N.E. 618; Ill.Rev.Stat.1981, ch. 106½, pars. 20, 21(1), 22.) All doubts and
obscurities created by his own negligent failure to keep adequate records were
properly resolved against him by the trial court. Altschuler v. Altschuler (1951), 410
Ill. 169, 196-97, 101 N.E.2d 552; Crimp v. First Union Trust & Savings Bank (1933),
352 Ill. 93, 102, 185 N.E. 179; Crane & Bromberg, Partnership sec. 66, at 384
(1968).
Couri v. Couri, 447 N.E.2d 334, 337 (Ill.1983); see also Glazer v. Kurman, 120 A.2d 892, 894
(Penn.1956).
The breach of contract by AMC-TN has been plainly established and the difficulties in
establishing damages are caused by the inaccurate accountings made by AMC-TN, the misstatement
of LifeMed, LLC’s true financial condition, and the failure to manage the LLC’s business in
accordance with the requirements of the Management Contract.
The courts will allow recovery even if it is impossible to prove the exact
amount of damages from the breach of contract. Otherwise, in certain instances, the
courts would be powerless to help some wronged parties. “Exact justice is not
always attained, and the law does not require exactness of computation in suits that
involve questions of damages growing out of contract of tort.” [sic] Provident Life
and Accident Ins. Co. v. Globe Indemnity Co., 156 Tenn. 571, 576, 3 S.W.2d 1057(1928). In Coverdell v. Mid-South Farm Equipment Assoc., Inc., 335 F.2d 9 (6th
Cir.1964), the court applied Tennessee law to determine that an insurance company
agent who was informed by trustees of the defendant corporation that he had been
hired under a personal service contract to organize their group insurance, worked an
entire weekend on the project, and cancelled an appointment in Texas was damaged
when the trustees gave the contract to another agent. Uncertain and speculative
damages are prohibited only when the existence of damage is uncertain, not when the
amount is uncertain. When there is substantial evidence in the record and reasonable
inferences may be drawn from that evidence mathematical certainty is not required.
Id. at 14.
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Cummins v. Brodie, 667 S.W.2d 759, 765 (Tenn.Ct.App.1983).
From a review of the record in this case, it would appear that the shortages in inventory
within the “pharmacy-within-a-pharmacy” may not have resulted in substantial losses to LifeMed,
LLC since AMC-TN, independently of the joint venture, appears to have chosen to absorb these
losses. The real damages occur from the failure of AMC-TN to timely collect its expenses and
management fees in the amount of $538,151, which was clearly in breach of the contract. It further
appears that the overvaluation of accounts receivable was approximately $380,000. These damage
amounts appear to be recoverable by LifeMed, LLC from AMC-TN.
Since the trial court determined the case on the basis of breach of fiduciary duty, negligent
misrepresentation, and breach of contract, and this Court has sustained the action only on breach of
contract in favor of LifeMed, LLC only, review of the trial court’s findings is somewhat complicated.
The final judgment of the trial court provided:
33. Damages are difficult to calculate in this case due to the state of
LifeMed’s books. The Court is guided through the end stages of the limited liability
company’s life somewhat by partnership principles. See Harwitz v. Padden, 581
N.W.2d 359, 362 (Minn. Ct. App. 1998). In particular, all doubts regarding the
division of the firm’s remaining assets well be resolved against the member
responsible for haphazard and misleading accounting practices. See, e.g., Wilson v.
Moline, 38 N.W.2d 201, 207 (Minn. 1949).
34. On this standard, the Court has little difficulty concluding that
LifeTrust and ARC-LifeMed have been damaged to the extent of their initial capital
contributions of $200,000 and $300,000, respectively. The record contains abundant
evidence that these members would have voted to dissolve the limited liability
company upon learning that their equity was in danger.
35. The record reflects that LifeMed presently has available cash of
$686,439.00 and is subject to a third-party property tax claim of $1,135.00. The tax
claim shall be paid from the available cash. Thereafter, the non-managing members
capital contributions shall be returned to them. After return of the non-managing
members’ capital contributions and payment of the taxes, the limited liability
company is left with $185,304.00. The Court holds that AMC-TN is entitled to a
return of its actual capital contribution of $150,000 from this sum. The remaining
$35,304.00 is to be divided pro rata among the parties according to their initial
capital contributions. Although the LLC Agreement provides for the parties to divide
LifeMed assets equally, AMC-TN itself has proposed a pro rata distribution (Ex. 39),
and the Court concludes that such a distribution is more equitable in light of AMC-
TN’s conduct. Thus, the parties shall receive in addition to their capital
contributions:
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LifeTrust: $10,862.77
ARC-LifeMed 16,294.15
AMC-TN 8,147.08
36. It is also represented that there are hard assets consisting primarily of
medical carts which belong to the joint venture. The Court has heard no credible
evidence regarding the value of those carts. In view of the fact that the carts are
depreciating assets, the Court concludes that the time and expense required to
determine their value and ownership would not be warranted from a cost-benefit
standpoint. Accordingly, the carts shall be awarded and remain in the possession of
whichever party currently has them.
37. It is also represented that there is a (sic) outstanding account payable
of approximately $25,000 owed by the plaintiff LifeTrust to the defendant joint
venture LifeMed. The only testimony offered on this subject was the testimony of
Ms. Frazier, unsupported by any documentation. A representative of LifeTrust
disputes the payable. The Court concludes that there is insufficient evidence to
support the existence of the alleged payable and makes no findings as to the merit of
that claim.
38. At the suggestion of the plaintiffs, the uncollected accounts receivable
remaining on LifeMed’s books, estimated by AMC-TN to be approximately
$200,000.00 are awarded to AMC-TN. The defendant shall benefit from any
collection efforts it cares to make.
As can readily be seen, the trial court holds that AMC-TN has materially breached the
contract to the detriment of LifeMed, LLC, but does not make an award of compensatory damages
before proceeding to a judicial distribution of net assets in conformity with the prayer of the
Complaint for judicial dissolution of LifeMed, LLC.
The primary relief sought in the Complaint was “To the extent that LifeTrust and ARC-
LifeMed are not made whole from the distribution from LifeMed, award a judgment in favor of
LifeTrust and ARC-LifeMed against AMC-TN for such amounts together with interest to make them
whole from their investments.”
The holding of the trial court results in fulfillment of the primary relief sought by LifeTrust
and ARC-LifeMed. While the proof as to the failure to collect timely fees and expenses and the
overvaluation of accounts receivable might, upon close analysis, sustain damages more or less in
favor of LifeMed, LLC than the judgment of the trial court ultimately determined in the distribution
made upon dissolution, we are content with the result reached by the trial court, which is in effect
a judgment for LifeMed, LLC in the amount of $538,151. This is the exact amount of the expense
and management fees not timely collected by AMC-TN in breach of the Management Contract and
the amount disallowed as a claim against LifeMed, LLC in the counter complaint of AMC-TN. This
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recovery for breach of contract would leave, in the hands of LifeMed, LLC, the approximate
$675,000 equitably divided by the court in its ultimate distribution to the three joint venturers under
the Decree of Dissolution fashioned by the trial judge. The end result is that LifeMed, LLC is
absolved in the breach of contract claim of $538,151 claimed by AMC-TN as management fees.
Therefore, in the equitable distribution on dissolution of the LLC, each of the LifeMed, LLC
members receives its initial contribution plus a pro rata share of anything left, which is after all the
primary relief sought in this first place. For reasons stated, we affirm the judgment of the trial court
with respect to all issues involving breach of contract and, on the basis stated herein, damages and
dissolution distribution.
VI. PREJUDGMENT INTEREST
All parties in this action were hampered by the paucity of case law providing guidance
relative to limited liability companies which have existed for barely a decade in Tennessee. The trial
court has found no intentional wrongdoing on the part of AMC-TN, and we agree with that finding.
While the breach of contract by AMC-TN resulted in damages to LifeMed, LLC, the record reveals
clearly that such breach of contract was not the only causative factor in the failure of LifeMed, LLC.
All of the members overestimated the participation that they could achieve in the assisted living
facilities which depended not upon the singular judgment of the particular assisted living facility,
but rather the voluntary participation of individual residents. AMC-TN has prevailed on appeal on
all issues except the breach of contract. Applying the principles in Myint v. Allstate Insurance Co.,
970 S.W.2d 920 (Tenn.1998), we have determined that LifeMed, LLC is not entitled to prejudgment
interest.
The judgment of the trial court as to breach of fiduciary duty and negligent misrepresentation
is reversed. The judgment of the trial court as to the award of prejudgment interest is reversed. In
all other respects, the judgment of the trial court as modified herein is affirmed. The case is
remanded to the trial court for such further proceedings as may be necessary.
Costs of appeal are assessed against AMC-TN.
___________________________________
WILLIAM B. CAIN, JUDGE
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