United States District Court, S.D. New York
SEKISUI AMERICA CORPORATION and SEKISUI MEDICAL CO., LTD., Plaintiffs,
RICHARD HART and MARIE LOUISE TRUDEL-HART, Defendants
For Sekisui: Karen L. Hagberg, Esq., Craig B. Whitney, Esq., Natalie A. Fleming Nolen, Esq., Leda A. Moloff, Esq., Morrison & Foerster LLP, New York, NY.
For the Harts: Franklin B. Velie, Esq., Jonathan G. Kortmansky, Esq., Siobhan Briley, Esq., Sullivan & Worcester LLP, New York, NY.
OPINION AND ORDER
Shira A. Scheindlin, U.S.D.J.
Sekisui America Corporation (" SAC" ) and Sekisui Medical Co., Ltd. (" SMD" ) (collectively, " Sekisui" ) bring this action for breach of contract against Richard Hart and Marie Louise Trudel-Hart (the " Harts" ). Sekisui alleges that the Harts
breached representations and warranties set forth in Sections 4.12, 4.14(a), 4.14(c), and 4.14(d) of the parties' Stock Purchase Agreement (" SPA" ). The Harts' alleged breaches fall into two categories: (1) breaches related to the failure of America Diagnostica, Inc. (" ADI" ) to comply with FDA regulations, known as Quality System Regulations (" QSRs" ); and (2) breaches related to Femtelle, ADI's breast cancer prognosis assay. The Harts deny that they breached any provision of the SPA and counterclaim that Sekisui breached Section 2.6(d) by failing to use commercially reasonable efforts to market Femtelle and omitting to take actions to obtain FDA approval for Femtelle, thereby preventing ADI from maximizing Femtelle revenues. Both parties seek damages.
I held a bench trial from January 13 to January 17, 2014. The parties made post-trial submissions on January 31, 2014. Pursuant to Rule 52(a) of the Federal Rules of Civil Procedure, I make the following findings of fact and conclusions of law. In reaching these findings and conclusions, I heard the testimony, examined the documentary evidence, observed the demeanor of the witnesses, and considered the arguments and submissions of counsel.
II. FINDINGS OF FACT
1. The Parties
In 1982, the Harts founded ADI, a Connecticut corporation engaged in the discovery, manufacture, and marketing of medical diagnostic products. ADI manufactured and marketed products that were designated " Research Use Only" and products that could be used as in vitro diagnostics (" IVD" ). ADI was the parent company of a Canadian subsidiary, a German subsidiary, and a French subsidiary. ADI with its subsidiaries had a maximum of thirty-five employees.
The Harts are citizens and residents of Connecticut. Until Sekisui acquired ADI, the Harts owned 95.94% of the existing and outstanding shares of common stock of ADI. Richard Hart served as the President and Chief Executive Officer (" CEO" ) of ADI and oversaw the company's operations. Hart left ADI in April 2010 for medical reasons.
SAC and SMD are wholly owned subsidiaries of Sekisui Chemical Co., Ltd. SAC is a corporation organized under Delaware law with its principal place of business in New Jersey. SMD is a Japanese corporation with its principal place of business
in Tokyo. Sekisui engages in the research, development, manufacture, sale, import, and export of plastic medical products.
2. FDA Regulations and Procedures
Section 520(f) of the Food Drug & Cosmetic Act (the " Act" ) gives the FDA authority to prescribe regulations requiring that the methods, facilities, and controls used for the manufacture, packing, storage, and installation of medical devices conform to good manufacturing practices. In 1997, the FDA promulgated the QSRs. Under the QSRs, medical device manufacturers should " establish and maintain a quality system that is appropriate for the specific medical device(s) designed or manufactured, and that meets the requirements of" the QSRs. Failure to comply with the QSRs renders a device " adulterated" under the Act.
The QSRs are flexible regulations. According to the FDA, the QSRs are " an umbrella . . . that specifies general objectives rather than methods."  Because the QSRs " must apply to so many different types of devices, the regulation does not prescribe in detail how a manufacturer must produce a specific device."  Instead, " the regulation provides the framework that all manufacturers must follow by requiring that manufacturers develop and follow procedures and fill in the details that are appropriate to a given device . . . ." 
The FDA advises its inspectors to " use good judgment in determining compliance with the [QSRs], keeping in mind that it is an umbrella . . . and all requirements may not apply or be necessary."  Furthermore, inspectors should " not insist that a manufacturer meet non-applicable requirements."  Inspectors should recognize that at small firms " division of work is at a minimum, with one person often assembling and testing the finished device."  As such, " blueprints or engineering drawings could be adequate procedures," and " several requirements can be met with a single procedure." 
To determine compliance with the QSRs, the FDA conducts an Establishment Inspection (" EI" ). An EI is an inspection of a medical device manufacturing firm's facilities and records. During an EI, the inspector interviews the firm's management responsible for the QMS. Inspectors
use a " top-down" approach to evaluate a firm's system for addressing quality in four main areas: Management Control, Corrective and Preventive Actions (" CAPA" ), Design Controls, and Production and Process Controls. Nonconformities must be addressed through the CAPA process. CAPAs come from a company's own monitoring process, regulatory inspections, customer audits, and internal audits.
After the EI, the inspector may issue a Form 483, which may include " inspectional observations."  Inspectional observations are not " final [FDA] determination[s] regarding [a firm's] compliance."  Moreover, inspectors must not report opinions, conclusions, or conditions as " violative" because " [t]he determination of whether any condition is violative is an agency decision made after considering all circumstances, facts and evidence, involving discussions with management . . . ."  The inspector then discusses the Form 483 with the manufacturer's senior management. The firm may respond at that time or send a corrective action plan to the FDA shortly thereafter.
The Director of the relevant field office considers the Form 483 observations, the inspector's narrative of the inspection -- the Establishment Inspection Report (" EIR" ) -- and the firm's responses to the Form 483 observations. The Director then classifies the inspection as no action indicated (" NAI" ), voluntary action indicated (" VAI" ), or official action indicated (" OAI" ).
An NAI is appropriate " when no objectionable conditions were found during the inspection or the significance of the documented objectionable conditions found does not justify further action."  A VAI is given " when objectionable conditions or practices were found that do not meet the threshold of regulatory significance."  An OAI occurs when " significant objectionable conditions or practices were found and regulatory action is warranted to address the establishment's lack of compliance."  After issuing an OAI, the FDA may send a Warning Letter. Because a Warning Letter is " informal and advisory," it communicates " the agency's position on a matter, but does not commit the FDA to taking enforcement action." 
An inspection is " closed" when " a final decision has been made not to take [administrative] action or such action has been
taken and the matter has been concluded."  Thus, when the FDA closes an action, it is satisfied with the results of the inspection and the firm's responses.
B. Pre-Acquisition Events
1. 2004 and 2005 FDA Inspections
Since at least 2004, ADI has manufactured and sold products regulated by the FDA and has therefore been subject to the QSRs. In 2004, the FDA inspected ADI's facilities. After the inspection, the FDA sent ADI a Warning Letter, stating that " [t]he inspection revealed that [ADI's] devices are adulterated under [the Act], in that the methods used in, or the facilities or controls used for, their manufacture, packing, storage, or installation are not in conformity with the [QSRs]."  The letter noted that it " is not intended to be an all-inclusive list of the deficiencies at [ADI]," and that it is ADI's " responsibility to ensure adherence to each applicable requirement of the Act and FDA regulations." 
In June 2005, FDA returned to ADI for a follow-up inspection. The FDA found that " [ADI] has completed corrections on several previous observations and is in the process of completing all others."  Specifically, the FDA noted improvement in ADI's training program, standard operating procedures (" SOPs" ), device master records (" DMRs" ), device history files (" DHFs" ), validation processes, and more.
Nevertheless, the FDA observed that (1) " [p]rocedures to ensure that equipment is routinely checked are not established, documented, and implemented; " (2) " procedures that describe the review and disposition process for nonconforming products were not complete; " and (3) " calibration procedures do not include provisions for remedial actions."  However, the FDA noted that " all three of these observations were being addressed by [ADI] and draft SOPs were in the process as  observed."  In October 2005, the FDA released the EIR to ADI, closing the inspection. Thus, I find that the FDA considered ADI to be in material compliance with the QSRs at that time.
2. Intertek Audits
Interek is a private inspection, product testing, and certification company that operates internationally. Interek audits
firms for compliance with the International Organization of Standardization (" ISO" ). Intertek auditors conduct a comprehensive review of quality management system documentation and then an on-site review. An ISO on-site inspection is similar to an FDA inspection. Like an FDA inspector, the ISO auditor examines the firm's QMS, management responsibility, training, product design and development process, internal audits, CAPAs, and procedures for recalling non-conforming products.
If the auditor finds the firm compliant with ISO standards, Intertek grants ISO certification. ISO 13485:2003 sets forth the international standard for medical device manufacturers' quality management systems, and is similar to the QSRs. In fact, the FDA specifically sought to make the QSRs " consistent, to the extent possible" with ISO 13485:2003. In addition, the FDA has instituted a pilot program that acknowledges ISO certification as evidence of compliance with the QSRs.
Intertek audited ADI six times during the relevant period. The first audits took place in March and April 2006. On March 23 and 24, 2006, Intertek reviewed all of ADI's QMS documentation. After finding ADI's documents ISO compliant, Intertek returned to ADI for an on-site inspection. ADI was certified as ISO 13485:2003 compliant. Intertek noted that it had " verified [the] quality of [ADI's] internal audits."  It found that ADI had " [g]ood use of customer complaints, internal audits, [and] corrective and preventative actions [CAPAs], and [that] management review  continually improve[d]." 
On February 5, 2007, Intertek conducted a review of ADI documents to determine whether ADI also complied with the Canadian Medical Devices Conformity Assessment System (" CMDCAS" ). On March 21, 2007, Intertek conducted an on-site surveillance audit for continued ISO 13485:2003 certification and a CMDCAS upgrade. ADI was re-certified and upgraded.
On April 8 and 9, 2008, Intertek conducted a surveillance audit and extended ADI's ISO certification. On April 14, 15,
and 16, 2009 -- four days before Sekisui acquired ADI -- Intertek audited ADI and granted ISO recertification. Intertek noted that (1) " [t]he Management System was found to be effectively implemented in spite of the minor nonconformities cited; " (2) " [the QMS continues to improve; " (3) " six sets of batch records were audited [and] found to be complete; " (4) " all [manufacturing] records reviewed were found to be complete; " (5) " [calibration] records of eight devices were sampled and found acceptable."  Given the similarity between ISO 13485:2003 and the QSRs, I find the Intertek ...