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May 15, 2001


The opinion of the court was delivered by: Owen, District Judge:


Before me is Plaintiff Quantum's application for a preliminary injunction pursuant to Fed. R. Civ. P. 65(a) seeking to prevent the Defendant Assist You and Nurse You corporations from disposing of assets pledged to Quantum under two loan and security agreements dated June 23, 2000. On March 29, 2001, this Court directed the defendants to show cause as to why an order enjoining the transfer of assets should not be entered and also put a temporary restraining order in place to maintain the status quo pending a hearing on Quantum's application.*fn1 The parties appeared on April 19, 20 and 25, 2001 for said hearing and presented the following facts.

Quantum is a New York corporation engaged in the business of factoring*fn2 and commercial finance. The corporate defendants, Nurse You and Assist You, and individual defendant Hofler, are citizens of Virginia and providers of health care services. Hofler is manager of the Assist You entities and president and CEO of Nurse You. On June 23, 2000, the parties entered into two virtually identical Loan and Security Agreements, one pertaining to the Assist You corporations and the other to the Nurse You entity, in which Quantum, in its "sole absolute discretion," agreed to make loans and advances (of up to $350,000 to Assist You and $100,000 to Nurse You) against defendant's "Eligible Account" receivables.*fn3 The agreement defined "Eligible Account" receivables at Appendix A, page S-4:

Eligible Account — shall mean Accounts created by Borrower [Defendants] in the ordinary course of its business arising out of its sale of goods or rendition of services, which are and at all times shall continue to be acceptable to Lender [Quantum] in its sole and absolute discretion. Eligible Accounts shall exclude accounts that are over one hundred twenty (120) days from invoice date, contra accounts, foreign, employee and affiliate accounts, accounts with poor credit histories, excessive concentration accounts, accounts subject to cross-aging or any other accounts which do not constitute acceptable collateral to Lender. Standards of eligibility may be fixed and revised from time to time solely by Lender in its exclusive judgment. In determining eligibility, Lender may, but need not, rely on aging, reports and schedules of Accounts furnished by Borrower but reliance by Lender thereon from time to time shall not be deemed to limit its right to revise standards of eligibility at any time without notice as to both Borrower's present and future Accounts.

The Loan and Security Agreements, among other things, require that the corporate defendants pay their obligations when due (§ 10.1.1), remain solvent under a definition of solvency stated in the contract (§§ 7.1.14, 10.1.9), prepare and maintain books, records and financial statements in accordance with Generally Accepted Accounting Principles ("GAAP") (§§ 7.1.12, 8.1.3) and also prohibit the defendants from making loans (§ 8.2.2) or merging or consolidating with any other entity (§ 8.2.2).

The Agreements also established a specific manner in which Quantum could collect on its interest in defendants' account receivables because, as described by the witnesses and attorneys, Medicare regulations prohibit the assignment of claims by providers, like the defendants, to "any other person," 42 C.F.R. § 424.73. Accordingly, the Agreements established that Medicare payments to the defendants would be placed in a "lockbox" at First Union Bank in Charlotte, North Carolina in defendants' name and the contents of the lockbox would be forwarded to Quantum on a daily basis (§§ 6.2.10, 6.2.11).

Frank Madonna, Quantum's senior vice-president and officer responsible for asset-based lending, negotiated the Agreements with Assist You and Nurse You, which were represented by Hofler. He testified and introduced various documents, including the UCC-1 forms evidencing Quantum's secured interest in the defendants' receivables and filed in the Circuit Clerk's Office in Petersburg, Virginia. Prior to execution of the Agreements, Quantum discovered that defendants were in arrears on payroll taxes in the amount of approximately $80,000 and Quantum's loan in or about July 2000 was used to pay this tax debt. Madonna testified that Quantum normally schedules an audit somewhere within the first three months of taking on a new client, however, plaintiff had trouble doing so with Hofler and the corporate defendants. Quantum was finally able to audit the defendants in October 2000 using its financial field examiner Dick Seymour of DF Flores & Associates.

Seymour reported to Quantum in the last week of November 2000 that the Assist You entities had failed to post general ledgers since September 30, 2000, the same for Nurse You since August 31, 2000, payroll taxes through November 13, 2000 were past due and no reconciliation of defendants' accounts receivables (to determine what monies had actually been collected) had been performed on the financial reports submitted to Quantum. Seymour also noted that there was no internal financial controller or outside accountant. Madonna testified that Seymour further informed Quantum that the defendants' aforementioned payroll tax liability was at that point in excess of $400,000.

Quantum was understandably concerned because defendants' payroll tax liability exceeded the amount of Quantum's loan and plaintiff, therefore, reduced defendants' available financing. It informed Hofler that, by Seymour's calculations, defendants were over-advanced on their credit by approximately $44,000. Madonna stated that he contacted Hofler, who conceded that defendants owed the taxes and that payroll would be paid as soon as sufficient funds became available. Madonna stated that approximately $16,000 of the payroll taxes were paid on January 3, 2001, but he never saw any other documents evidencing further payment of defendants' payroll liability. Madonna testified that defendants stopped furnishing Quantum financial information and lockbox payments entirely on February 15, 2001. At this time, the parties exchanged several letters declaring one another to be in breach of the Agreements.

Madonna, addressing a recent set of financials Quantum received from the defendants in connection with this Court's TRO order, concluded that defendants are insolvent as defined by the Agreements and that as of March 23, 2001, Quantum's loan statements reflect that (1) the total amount of the loan outstanding to the Assist You companies was $201,748.58, including interest from February 15 to March 23 and (2) the total amount of the loan outstanding to Nurse You was $27,988.74.

Hofler testified on behalf of the defendants. Most of his testimony centered on the process by which the corporate defendants get paid under the Medicare and Medicaid regimes. Defendants' clients are referred for community-based care from the Virginia Department of Medical Assistance Services. This government agency pre-screens the patients to ascertain whether they are eligible for Medicare and Medicaid. Upon receipt of the referral, defendants send a nurse to do an initial assessment of the patient to determine the number of hours of care necessary. Once the care hours are determined, defendants send an admissions packet, which includes the pre-screening information from Virginia and the nurse's report from the initial assessment, in order to obtain billing authorization from Medicare and Medicaid. Without such authorization, defendants are not permitted to bill for services rendered. The authorization process takes somewhere between eight to twelve weeks and Hofler stated that he had never had situation where authorization had been denied. However, defendants are obligated under Medicare and Medicaid to provide services within twenty-four hours of accepting the patient, notwithstanding that authorization to bill remains pending. Hofler estimated that Medicare and Medicaid account for approximately 85 to 90 percent of his companies' revenues.

This delay in billing for services made up the bulk of Hofler's testimony and, in his mind, the crux of the dispute. Hofler testified that he became frustrated with Quantum because plaintiff cut back its funding to defendants based, in his opinion, on Quantum's lack of familiarity with Medicare and Medicaid and GAAP principles for the home health care industry. Moreover, Hofler testified that Quantum had previously loaned against accounts receivable that included unbilled services and had done so without complaint. As Hofler and his outside accountant testified, GAAP principles for home health care permit unbilled services rendered to be listed as accountants receivable, which are assets of the company. Since the centerpiece of these Agreements was asset-based lending — that is, lending against defendants' receivables — exactly what is an asset and what is not was an important question to Hofler and Quantum. As Hofler stated, Quantum did not believe unbilled services were appropriate assets against which to provide financing, despite the fact that such were listed on defendants' books as receivables.

All of Hofler's testimony about accounting principles and billing practices is, however, a bit removed from the real issue in this case: the relationship is governed by the written loan and security Agreements. Keeping this in mind, several undisputed facts came out at the hearing. First, the Agreements grant Quantum vast and absolute discretion to determine the amount of its loan and against which assets it would provide advances. Second, Hofler admits that defendants had incurred new (meaning after Quantum advanced money in July 2000 to pay off the $80,000 in arrears) payroll tax liability of approximately $400,000. Third, Hofler stated that defendants had several internal problems in the billing department resulting in receivables that were over 120 days and thus not considered "Eligible Accounts" under the loan Agreements, although Hofler quarreled somewhat with how Quantum computed 120 days. Fourth, defendants' outside accountant, Wayne Lee, testified that he agreed with Seymour's findings regarding defendants' failure to post general ledgers and keep accurate financial records, the arrears on payroll taxes and failure to perform reconciliations. Hofler also conceded, as did his attorney, that the companies have not been keeping accurate and reliable financials for quite some time. Indeed, Hofler blamed an internal accountant, whom Hofler terminated, for the accounting failures of the companies. These facts suggest that defendants are in breach of the loan and security Agreements or, at the very least, present sufficiently serious questions to litigate about the financial condition of the companies and the terms of the Agreements.

Turning to facts which tend to suggest that Quantum may suffer irreparable harm in the absence of an injunction, Hofler testified on cross-examination that he was formerly the president of a company called "Assist You, Inc." This company is not a party in the instant matter. However, Hofler was the largest (60 percent) shareholder in Assist You, Inc. The company was in the same home health care business as the defendants and also shared two business addresses with the corporate defendants. Hofler closed Assist You, Inc. down at some point and the company failed to pay off its creditors. Specifically, it failed to pay off its Internal Revenue Service payroll tax liability, which amounts to approximately $160,550. The IRS has filed levies against Assist You, Inc. and the company, despite the fact that it no longer has any revenue, has been trying to settle the matter since 1995. The State of Virginia also filed tax levies on Assist You, Inc. in 1996 for approximately $37,806. Further, Assist You. Inc. left behind a number of unsatisfied judgments from entities including Richmond Temporaries, West Home Health Care, Inc., MCV Associate Physicians, Care Advantage, Inc., Robert Heff International and Terry Phillips.

Hofler professed to have no knowledge of these judgments and was often evasive when discussing the financials of his currently-owned companies (four of his thirteen companies are defendants in this case) and Assist You, Inc. Hofler is simply not credible on these issues. He was the largest shareholder of Assist You, Inc. and acknowledged that the company was closed, that he knew it had outstanding obligations and, moreover, testified that he was familiar with the legal principle that the largest shareholder in a small corporation may have personal liability for federal payroll taxes and other claims against the corporation. Knowing this, he clearly would have focused some degree of attention on whether he was going to be personally out close to $200,000 for unpaid federal and state taxes, not to mention obligations flowing from any judgments against the corporation for which he might have personal liability. On this record, Hofler appears to have a history of making judgments uncollectible.*fn4

Furthermore, having provided his adversary with a consolidated balance sheet representing total current assets, some portion of which is receivables, in excess of $800,000, Hofler attempted over several painful pages in the transcript to waffle away from that number. The colloquy went as follows:

Q. Now presently you're telling me you have over $800,000 in accounts receivable?

A. I don't know.

Q. I'll refer you to Exhibit 7 [the aforementioned consolidated balance sheet], second page. It lists current assets at $825,457.79?

A. I don't have that in front of me, so I can't respond.

The Court: Give him a copy.

A. Okay. So this line item indicates total current assets. I'm not sure what that is made up of. I'm sure a portion of it is accounts receivables, but I can't tell you exactly what that figure is made up ...

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