United States District Court, Southern District of New York
July 18, 2000
CARMEL N. DONOVAN, ERICH EIDENSCHENK, DAVID FOLLETT, AND ESTATE OF FRANK M. PURNELL, INDIVIDUALLY AND AS SHAREHOLDERS OF LH RADIOLOGISTS, P.C., PLAINTIFFS,
LEWIS ROTHMAN, STEPHEN SCHARF, R.S. BILLING SYSTEMS, INC., LENOX HILL HOSPITAL, AND LH RADIOLOGISTS, P.C., DEFENDANTS.
The opinion of the court was delivered by: Stein, District Judge.
OPINION & ORDER
Four shareholders of LH Radiologists, P.C. brought this
shareholders' derivative action in New York Supreme Court
against defendants Lewis Rothman, Stephen Scharf, R.S. Billing
Systems, Inc., Lenox Hill Hospital (the "Hospital"), and LH
Radiologists, P.C. The amended complaint set forth seven causes
of action, including allegations that Rothman breached his
fiduciary duty as President of LH Radiologists by entering into
a fee arrangement with the Hospital that violated the federal
Medicare anti-kickback statute, 42 U.S.C. § 1320a-7b(b).
The Hospital subsequently removed this action to this Court
pursuant to 28 U.S.C. § 1441(a) on the grounds that the
application of the anti-kickback statute presents a substantial
federal question. Plaintiffs have now moved to remand this
action to New York Supreme Court pursuant to 28 U.S.C. § 1447(c)
on the grounds that no substantial federal question has been
presented. Because the complaint does not present a substantial
federal question, plaintiffs' motion to remand this action is
According to the amended complaint, plaintiffs as well as two
of the defendants — Lewis Rothman and Stephen Scharf — were
radiologists on the staff of Lenox Hill Hospital in the early
1980s. See Am. Compl. ¶¶ 13-14. Those individuals ultimately
incorporated LH Radiologists, P.C. as a separate professional
corporation through which they provided radiological services
pursuant to a fee-for-service arrangement with the Hospital.
See id. ¶¶ 16, 26, 28. Each of the radiologists was a
shareholder. See id. Rothman was director of the Department of
Radiology at the Hospital as well as President of LH
Radiologists. See id. ¶¶ 28-29.
Specifically, in December 1987, Rothman, acting on behalf of
LH Radiologists, entered into a "Fee For Service Agreement" as
well as a separate "Supplemental Agreement" with the Hospital,
whereby LH Radiologists would bill patients directly and then
forward a portion of the proceeds to the Hospital in accordance
with the following terms:
It is hereby agreed that [LH Radiologists'] net
annual collections in excess of an amount equal to
its actual, usual, ordinary and necessary expenses
of operation . . . shall be distributed as follows:
66-2/3% to [LH Radiologists]; 25% to a department
of Radiology Fund ("the Fund") to be utilized for
capital improvements, equipment, and other
expenditures for the Department . . .; and 8-1/3%
to the Hospital for its general purposes. Said
amounts shall be estimated and payable quarterly,
with adjustments at the end of each annual term.
Id. ¶ 30 (quoting Supplemental Agreement ¶ 1). Pursuant to
this provision, LH Radiologists paid or credited the Hospital
approximately $3.75 million through October 31, 1998. See id.
In 1988, Rothman allegedly caused a certificate to issue to
himself for all shares of LH Radiologists, thus purporting to
make himself the sole shareholder of the corporation. See id.
¶ 34. Subsequently, according to the complaint, Rothman operated
LH Radiologists as a sole proprietorship, unilaterally fixed
salaries, and engaged in other illegal, improper, and
self-dealing transactions, including the transfer of the
corporation's billing services business to R.S. Billing Systems,
Inc., a separate entity wholly owned by Rothman and Scharf. See
id. ¶¶ 35, 42-44, 53-55.
When Rothman refused a request by Donovan and Purnell to
inspect the books and records of LH Radiologists, they brought a
special proceeding in New York Supreme Court to compel
inspection pursuant to N.Y. Business Corporation Law § 624 and
New York common law. See id. ¶¶ 36-37. The New York Court of
Appeals ultimately affirmed the lower courts' conclusion that
plaintiffs were in fact shareholders of LH Radiologists. See In
Matter of Estate of Purnell v. LH Radiologists, P.C., 90 N.Y.2d 524,
530-32, 686 N.E.2d 1332, 1335-36,
664 N.Y.S.2d 238, 241-42 (1997), aff'g 228 A.D.2d 360, 361-62,
644 N.Y.S.2d 274, 274-75 (1st Dep't 1996).
In 1996, plaintiffs brought this shareholder derivative action
in New York Supreme Court alleging breach of fiduciary duty by
Rothman and Scharf and naming LH Radiologists as a nominal
defendant. Extended motion practice followed. See Donovan v.
Rothman, 256 A.D.2d 184, 184-85, 683 N.Y.S.2d 25, 26 (1st Dep't
1998); Donovan v. Rothman, 253 A.D.2d 627, 629-30,
677 N.Y.S.2d 327, 329-30 (1st Dep't 1998).
In late September 1999, Justice Shainswit of New York Supreme
Court granted plaintiffs' motion to add the Hospital as a
defendant to the claim seeking recovery for breach of fiduciary
duty on the grounds that payments made to the Hospital pursuant
to the fee-for-services agreement amounted to illegal kickbacks
in violation of 42 U.S.C. § 1320a-7b(b).*fn1 In granting the
motion, the Supreme Court reasoned that "[t]he proposed claim
against the Hospital seeks recovery of those same funds"; that
"[t]he issues as to both claims are largely the same"; and that
a separate action against the Hospital would prove unduly
wasteful. Donovan v. Rothman, No. 105335/96-010 & 011, slip.
op. at 2-3 (N.Y.Sup.Ct. Sept. 29, 1999); Aff. of Joseph H.
Einstein, dated Nov. 17, 1999, Ex. B.
The Hospital then removed the entire derivative action to the
Southern District of New York pursuant to 28 U.S.C. § 1441(a) on
the grounds that the allegations against the Hospital turn on
the application of the federal anti-kickback statute and
therefore present a substantial federal question. As noted
above, plaintiffs have now moved to remand the action to New
York Supreme Court pursuant to 28 U.S.C. § 1447(c) on the
grounds that no substantial federal question has been presented.
28 U.S.C. § 1441(a) provides that "any civil action brought in
a State court of which the district courts of the United States
have original jurisdiction, may be removed by the defendant or
the defendants, to the district court of the United States for
the district and division embracing the place where such action
is pending." Pursuant to Section 1447(c), however, "[i]f it
appears before final judgment that a case was not properly
removed, because it was not within the original jurisdiction of
the United States district courts, the district court must
remand it to the state court from which it was removed."
Franchise Tax Bd. v. Construction Laborers Vacation Trust,
463 U.S. 1, 8, 103 S.Ct. 2841, 2845, 77 L.Ed.2d 420 (1983).
Because the parties to this action are not of diverse
citizenship, subject matter jurisdiction is present only if
federal question jurisdiction exists. See Fax
Telecommunicaciones Inc. v. AT & T, 138 F.3d 479, 486 (2d Cir.
1998) (citing Caterpillar Inc. v. Williams, 482 U.S. 386, 392,
107 S.Ct. 2425, 2429-30, 96 L.Ed.2d 318 (1987)). Federal
question jurisdiction is governed by 28 U.S.C. § 1331, which
provides that federal district courts shall have original
jurisdiction of all civil actions "arising under" the laws of
the United States. To determine whether an action "arises under"
federal law, a court must inquire, first, "whether federal law
creates the cause of action," and if not, then second, "whether
that cause of action poses a substantial federal question."
West 14th St. Commercial Corp. v. 5 West 14th Owners Corp.,
815 F.2d 188, 193 (2d Cir. 1987); see Barbara v. New York Stock
Exch., Inc., 99 F.3d 49, 53-54 (2d Cir. 1996).
There is no private cause of action to redress violations of
the federal antikickback statute, 42 U.S.C. § 1320a-7b(b), the
infraction of which is a crime. See, e.g., West Allis Mem.
Hosp., Inc. v. Bowen, 852 F.2d 251, 254-55 (7th Cir. 1988);
American Health Sys., Inc. v. Visiting Nurse Ass'n, No. Civ.
A. 93-542, 1994 WL 314313, at *4-5 (E.D.Pa. June 29, 1994).
Certainly, the absence of a private right of action in the
statute "counsels against a finding of federal question
jurisdiction," Barbara, 99 F.3d at 54, and its significance
"cannot be overstated," Merrell Dow Pharms. Inc. v. Thompson,
478 U.S. 804, 812, 106 S.Ct. 3229, 3234, 92 L.Ed.2d 650 (1986).
Therefore, this Court must next inquire whether plaintiffs'
cause of action against the Hospital presents a substantial
federal question by looking "to the nature of the federal
interest at stake." West 14th St., 815 F.2d at 193 (citing
Merrell Dow, 478 U.S. at 814 n. 12, 106 S.Ct. at 3236 n. 12);
see Barbara, 99 F.3d at 54-55. Pursuant to the "well-pleaded
complaint" rule, "federal jurisdiction must be found from `what
necessarily appears in the plaintiffs statement of his own
claim'" in the complaint. West 14th St., 815 F.2d at 192
(quoting Taylor v. Anderson, 234 U.S. 74, 75-76, 34 S.Ct. 724,
58 L.Ed. 1218 (1914)). Accordingly, "a plaintiff as `master of
the complaint' may preclude removal by electing to disregard an
available federal dimension of a claim and asserting only a
distinct state law cause of action." Derrico v. Sheehan
Emergency Hosp., 844 F.2d 22, 27 (2d Cir. 1988) (citing
Caterpillar, 482 U.S. at 392-93, 107 S.Ct. at 2430). However,
"a plaintiff cannot avoid removal by artful pleading, ie., by
framing in terms of state law a complaint the `real nature of
[which] is federal, regardless of plaintiffs characterization.'"
Id. (quoting Travelers Indem. Co. v. Sarkisian,
794 F.2d 754, 758 (2d Cir. 1986)).
The amended complaint alleges that Rothman violated his
fiduciary duties to the other shareholders by wasting and
diverting the company's assets by a variety of methods,
including having the company pay $3.75 million to the Hospital
pursuant to the Supplemental Agreement. See Am. Compl. ¶¶
63-64. The complaint names the Hospital as a defendant only with
respect to the sixth cause of action, which alleges that the
payments to the Hospital were "in violation of applicable laws
and regulations" and that the Hospital knew that those payments
were illegal. See id. ¶¶ 75-82. The complaint seeks to have the
Hospital account for and turn over all sums received by it
pursuant to the Supplemental Agreement, to enjoin the Hospital
from receiving similar payments in the future, and to impose
punitive damages. See id.
Pursuant to New York common law, "a shareholders' derivative
action for waste and diversion of corporate assets is a proper
vehicle for relief against not only corporate officials, but
also third parties who were beneficiaries of their misconduct."
15 N.Y. Jur.2d Business Relations § 1174 (2d ed. 1996) (citing
Blank v. Schafrann, 70 N.Y.2d 887, 519 N.E.2d 288,
524 N.Y.S.2d 377 (1987)); see also Superintendent of Ins. v.
Freedman, 443 F. Supp. 628, 638 (S.D.N.Y. 1977), aff'd mem.,
594 F.2d 852 (2d Cir. 1978); Schneider Leasing Plus, Inc. v.
Stallone, 172 A.D.2d 739, 741, 569 N.Y.S.2d 126, 128 (2d Dep't
1991). New York statute similarly authorizes a private
action "[t]o set aside an unlawful conveyance, assignment or
transfer of corporate assets, where the transferee knew of its
unlawfulness." N.Y. Bus. Corp. Law § 720(a)(2) (McKinney 1999).
In this context, plaintiffs concede that the "applicable laws"
violated by the agreement include the federal anti-kickback
statute, but they argue that "[t]he obligation to repay these
amounts arises under state common law principles" and that
"[t]he same principles would apply to payments of any kind which
violated applicable law." Pl.'s Mem. Supp. Mot. Remand at 3.
See Eastern States Health & Welfare Fund v. Philip Morris,
Inc., 11 F. Supp.2d 384, 392-93 (S.D.N.Y. 1998). In other words,
plaintiffs assert that the antikickback statute merely gives
content to Rothman's fiduciary duty, which is ultimately a
creature of New York common law, and that any federal interest
in the action is therefore insubstantial. In response,
defendants claim that the federal interest is substantial
because the resolution of the claim necessarily turns on whether
the agreement violates the antikickback statute.
The U.S. Supreme Court has emphasized that "the mere presence
of a federal issue in a state cause of action does not
automatically confer federal-question jurisdiction." Merrell
Dow, 478 U.S. at 813, 106 S.Ct. at 3234; see Barbara, 99 F.3d
at 54. "`Rather, in determining federal question jurisdiction,
courts must make principled, pragmatic distinctions, engaging in
a selective process which picks the substantial causes out of
the web and lays the other ones aside.'" Barbara, 99 F.3d at
54 (quoting Greenblatt v. Delta Plumbing & Heating Corp.,
68 F.3d 561, 570 (2d Cir. 1995)); see Merrell Dow, 478 U.S. at
813-14, 106 S.Ct. at 3235.
Thus, courts have found that removal to federal court is
proper where the state action simply provides the vehicle for
"the vindication of rights and . . . relationships created by
federal law." West 14th St., 815 F.2d at 193; see Fax
Telecommunicaciones, 138 F.3d at 486; Derrico, 844 F.2d at
28; see also Platzer v. Sloan-Kettering Inst. for Cancer
Research, 787 F. Supp. 360, 366-67 (S.D.N.Y.), aff'd mem.,
983 F.2d 1086 (Fed.Cir. 1992).
On the other hand, courts have consistently "held that when
Congress has provided no private right of action under a federal
statute, the borrowing of that federal law as a standard of
conduct in a state created action is not sufficiently
substantial to confer federal question jurisdiction." West 14th
St., 815 F.2d at 193. In Merrell Dow, for example, the U.S.
Supreme Court found that removal was improper where the
plaintiffs brought a state tort action to recover for birth
defects allegedly caused by drugs ingested by the mother,
asserting that the defendant's alleged violation of federal
labeling requirements gave rise to a rebuttable presumption of
negligence. 478 U.S. at 805-06, 817, 106 S.Ct. at 3231, 3237;
see Greenblatt, 68 F.3d at 570-71; see also Eugene Iovine,
Inc. v. City of New York, No. 98 Civ. 2767, 1999 WL 4899, at *5
(S.D.N.Y. Jan. 5, 1999); Box Tree So., Ltd. v. Bitterman,
873 F. Supp. 833, 837-38 (S.D.N.Y. 1995) (no jurisdiction where state
libel claim turned on allegation that plaintiff violated federal
labor laws); J.A. Jones Constr. Co. & Daidone Elec. of N.Y.,
Inc. v. City of New York, 753 F. Supp. 497, 501 (S.D.N.Y. 1990)
(no jurisdiction where breach of public works contract turned on
interpretation of federal "model clauses" inserted to obtain EPA
The present case plainly falls into the latter category of
cases. The alleged violation of the federal anti-kickback
statute simply informs the inquiry whether Rothman breached his
fiduciary duty to LH Radiologists by entering the agreement with
the Hospital, much as the alleged violation of the federal
labeling statute informed the determination of negligence in
Merrell Dow. Moreover, contrary to those cases in which a
federal statute defined the rights of or relationship between
the parties, in this case it is
New York law and not the federal antikickback statute that
defines the fiduciary relationship between Rothman and LH
Radiologists and, by extension, between Rothman and plaintiffs
in their capacity as shareholders of LH Radiologists. To the
extent New York looks to federal law as a guidepost in assessing
a breach of fiduciary duty, therefore, that assessment
ultimately remains a creature of New York law.
Accordingly, the federal interest in plaintiffs' claim for
relief against the Hospital is too insubstantial to support
federal question jurisdiction. See Seinfeld v. Austen,
39 F.3d 761, 763-65 (7th Cir. 1994) (removal of shareholder derivative
action was improper where state law breach of fiduciary duty
claim was predicated on defendants' alleged violation of federal
antitrust laws); Estate of Ayres v. Beaver, 48 F. Supp.2d 1335,
1339-40 (M.D.Fla. 1999) (removal of state law breach of
fiduciary duty claim was improper even though payments turned on
state Medicare and Medicaid contracts); Arvin v. Go Go
Investment Club, No. C 96-3264, 1996 WL 708589, at *3-5
(N.D.Cal. Dec. 5, 1996) (dismissing state breach of fiduciary
duty claim for lack of jurisdiction even though claim turned on
violation of Internal Revenue Code); United Health Care Servs.,
Inc. v. Columbia/HCA Healthcare Corp., No. Civ. A. 95-1855,
1995 WL 622915, at *1 (E.D.Pa. Oct. 16, 1995) (dismissing state
fraud and breach of warranty claims for lack of jurisdiction
even though claims turned on interpretation of federal
The cases the Hospital relies upon are not to the contrary.
For example, in Smith v. Kansas City Title & Trust Co.,
255 U.S. 180, 41 S.Ct. 243, 65 L.Ed. 577 (1921), the plaintiff
sought to enjoin corporate officers from investing corporate
funds in bonds issued by federal land banks on the grounds that
the act authorizing their issue was unconstitutional and the
investment was therefore unlawful under Missouri law. See West
14th St., 815 F.2d at 192. Removal was proper because the
constitutional issue had to be decided as an element of the
state law claim, See id. The Supreme Court in Merrell Dow
explained, however, that the attack in Smith on the
constitutionality of a federal statute inevitably magnified the
federal interest at stake, as distinct from the situation where
"the violation of the federal standard as an element of state
tort recovery [does] not change the state tort nature of the
action." 478 U.S. at 814 n. 12, 106 S.Ct. at 3235 n. 12
(reconciling Smith with Moore v. Chesapeake & Ohio R. Co.,
291 U.S. 205, 54 S.Ct. 402, 78 L.Ed. 755 (1934)).
The Hospital also contends that the federal interest in this
dispute is substantial both because application of the
anti-kickback statute under these facts would effect a
significant federal intrusion into "areas historically subject
to state regulation," and because "resolution of this dispute
will impact the federal reimbursement of health care expenses
nationwide." Def.'s Mem. Opp. Mot. Remand at 6. To the extent
the Hospital contends that removal is proper because of the
preemptive effects of the anti-kickback statute or of federal
common law, removal based on federal preemption is available
only where "Congress has clearly manifested an intent to
disallow state law claims in a particular field." Marcus v.
AT&T Corp., 138 F.3d 46, 53-54 (2d Cir. 1998) (citing
Metropolitan Life Ins. Co. v. Taylor, 481 U.S. 58, 65-66, 107
S.Ct. 1542, 1547-48, 95 L.Ed.2d 55 (1987)); see also Box Tree
South, Ltd. v. Bitterman, 873 F. Supp. 833, 837-38 (S.D.N.Y.
1995). However, the Hospital has failed to demonstrate any such
clear congressional intent. See Gilman v. BHC Sees., Inc.,
104 F.3d 1418, 1421 (2d Cir. 1997) (party asserting federal
jurisdiction bears burden of demonstrating case is properly in
Accordingly, because there is no substantial federal question
involved, plaintiffs' motion to remand the action to New
York Supreme Court pursuant to 28 U.S.C. § 1447(c) is hereby