Quorum Board Rejects Legal Action Against Community In Connection With Spin Off

Quorum Health's (QHC) board will not assert legal claims against Community Health Systems  (CYH) officials and Quorum's management team in connection with Quorum's spin-off from Community last year.

Brentwood, Tenn.-based Quorum operates and manages general acute care hospitals and outpatient services.

Quorum after the market close on Wednesday, April 5, said its board, through three independent directors, has wrapped up its investigation of matters that were brought up by R2 Investments LDC in an October letter. R2 is part of Texas hedge fund Q Investments LP.

Quorum shares were up 4 cents to $5.05 as noon approached on Thursday. Community shares were down 17 cents to $8.84.

Q Investments had alleged in a letter on Oct. 12 that Community management juiced up Quorum's numbers while concealing costs ahead of the spinoff in an effort to raise as much financing as possible, ultimately causing the latter's bond prices and stock price to tumble. The hedge fund had demanded Quorum's board undertake an independent investigation of the conduct of the management teams of Community and Quorum.

In a March 31 letter to R2, Quorum said that based on the investigation, which was conducted with the assistance of independent outside counsel Orrick Herrington & Sutcliffe LLP, and consideration of the applicable law, Quorum's independent directors had concluded that it would not be in the best interest of the company and its shareholders to asset legal claims against Community or its officers or directors.

Orrick's Robert Varian, William Foley and Christine Hanley served as independent counsel to Quorum's board.

Quorum's independent directors - William M. Gracey, James T. Breedlove and R. Lawrence Van Horn - concluded that, "apart from analyses of the pertinent facts, and consideration of costs, management distraction and other factors, the assertion of claims against  CHS or its management in connection with the matters referred to in the letter would not be in the best interest of the corporation and its shareholders because such claims would lack a viable legal basis," Quorum said. "Under settled law, a parent company does not owe duties to a wholly-owned subsidiary, even if a spin-off of the subsidiary has been structured and announced."

Quorum went on to say that R2's letter "raises certain questions regarding CHS's possible motivations, and the sequence of events surrounding the spin-off provides grounds for suspicion, particularly when viewed in hindsight. Although facts that might otherwise support legal claims against CHS and its management related to events prior to the spin-off would not change the conclusion regarding the nonviability of such claims in light of the governing legal standards... the assertion of such claims would  also be hampered by the fact that the investigation did not produce conclusive evidence of intentional misconduct or fraud by CHS."

"Rather, the facts arising from the investigation suggest (at a minimum) several bases for questioning CHS's operational competence in connection with the planning and execution of the spin-off, and the formulation of financial projections," Quorum added.

Quorum's independent directors also decided it would not be in the best interest of the company and its shareholders to assert claims against Quorum's management team, saying the investigation uncovered no evidence that would back up the assertion of claims.

"Although the lack of an adequate legal or factual basis for the assertion of claims was decisive, the Participating Directors also considered the cost associated with pursuing litigation and the adverse impact such litigation would have on the operation of QHC's business,"  Quorum said.

Sought for comment on Thursday, a Q Investments representative wrote in an email that there was a "glaring lack of factual findings" in Quorum's letter.

"We believe that through this overly lawyered letter the board is relying upon narrow legal arguments instead of relying upon factual evidence uncovered during their investigation," the representative wrote. "A full demonstration of the facts could have refuted any potential allegations of fraud and given shareholders peace of mind, but the glaring lack of factual findings in this letter showing what occurred during the spin-off is, we believe, indicative of the grave issues that this investigation may have uncovered related to the guidance provided to investors by Quorum and Community Health."

Quorum's spin-off was completed on April 29, 2016.

Representatives for Quorum and Community were not immediately available for comment on Thursday.

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