MedSource, LLC v. Katschanow et al

Filing 98

OPINION AND ORDER granting in part and denying in part 67 Motion to Dismiss; granting in part and denying in part 68 Motion to Dismiss; granting 70 Motion to Dismiss. Signed by District Judge John Corbett O'Meara. (WBar)

UNITED STATES DISTRICT COURT
EASTERN DISTRICT OF MICHIGAN
SOUTHERN DIVISION
MEDSOURCE, LLC,
Plaintiff,

Case No. 12-11946

v.
Hon. John Corbett O’Meara
DEROYAL INDUSTRIES, INC., et al.,
Defendants.
_________________________________/
OPINION AND ORDER GRANTING IN PART
AND DENYING IN PART MOTIONS TO DISMISS
Before the court are three motions to dismiss filed by DeRoyal Industries, Inc., Ken
Jones, and the Physician Defendants. The court heard oral argument on November 15, 2012, and
took the matter under advisement.
BACKGROUND FACTS
Plaintiff MedSource LLC has sued DeRoyal Industries, Inc., Kevin Katschanow, Ortho
Workz, Inc., Ortho Workz South, LLC, Mendelson Kornblum Orthopedics, P.C., Dr. Stephen
Mendelson, Dr. David Mendelson, Dr. Jeffrey Mendelson, Dr. Martin Kornblum, Dr. Andrew
Monk, and Ken Jones. DeRoyal is suing Kevin Katschanow and Timothy Kalbfleisch; and
Katschanow, Ortho Workz, Inc., and Ortho Workz South are suing Kalbfleisch. DeRoyal,
Katschanow, and Ortho Workz, Inc., have also filed a counterclaims against MedSource.
The motions before the court focus on MedSource’s complaint: (1) DeRoyal Industries’
motion to dismiss; (2) Ken Jones’s motion to dismiss; and (3) the motion to dismiss filed by the
“Physician Defendants” (Mendelson Kornblum Orthopedics, P.C. and the five individual
physicians). Katschanow, Ortho Workz, Inc., and Ortho Workz South filed a joinder in the

motions to dismiss; however, they answered the complaint and therefore cannot seek dismissal
pursuant to Rule 12(b)(6). See Fed. R. Civ. P. 12(b).
In its complaint, MedSource alleges a scheme by Defendants to use MedSource’s trade
secrets, resources, and employees to unfairly compete against it and cut it out of the Michigan
market. Medsource is a supplier of durable medical equipment (“DME”) that also offers thirdparty billing services to physician offices. DeRoyal is a manufacturer of DME products. Kevin
Katschanow was a sales representative for MedSource and DeRoyal. Katschanow also owns
Ortho Works, Inc. (“OWI”). MedSource alleges that from 2007 to 2010, MedSource, DeRoyal,
and Katschanow worked together in the Michigan market. OWI, through Katschanow, would
maintain business relationships with physicians; the physicians would order DME product
through MedSource; MedSource would purchase DME product from DeRoyal and others; and
then MedSource would bill the third-party payor, such as Medicare. MedSource alleges that
neither DeRoyal nor Katschanow/OWI had experience in third-party billing, and therefore relied
on MedSource for this service.
MedSource alleges that, sometime in 2010, Katschanow and DeRoyal joined together
with several Michigan physicians (the Physician Defendants) and Ken Jones (a DeRoyal vice
president) in a scheme to push MedSource out of the relationship. Katschanow, Jones, and the
Physician Defendants formed Ortho Workz South LLC (“OWS”). MedSource alleges that, in
order to push MedSource out, OWS or OWI would need to engage in third-party billing and
would need approval to bill Medicare. Obtaining such approval requires accreditation from an
authorized accreditor, such as The Joint Commission. MedSource alleges that obtaining
accreditation from The Joint Commission is an extensive process that involves significant capital

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investment and can take several years, often requiring the services of an expert consultant.
MedSource claims that Defendants planned to obtain accreditation for OWI and use
OWI’s billing number for OWS, relying on their similar names to confuse the two. MedSource
alleges that OWI did not have sufficient resources to obtain accreditation, so Defendants chose
to defraud MedSource by using MedSource’s employees, trade secrets, and resources to obtain
accreditation for OWI. MedSource contends that Katschanow directed his friend and
MedSource’s manager in its Michigan office, Timothy Kalbfleisch, as well as at least eight other
MedSource employees, to work on matters for the benefit of OWI and OWS. MedSource
contends that its employees were used to solicit customers and other employees away from
MedSource and to prepare OWI’s accreditation application. According to MedSource, when
The Joint Commission conducted an on-site visit in February 2011, OWI represented that certain
MedSource employees were its own.
In addition, MedSource claims that OWI presented MedSource’s written policies,
procedures, and patient files as its own to The Joint Commission. According to MedSource,
DeRoyal’s President and General Counsel knew that OWI was using MedSource’s resources to
obtain accreditation. MedSource asserts that, because of these misrepresentations, OWI received
accreditation and third-party billing privileges with Medicare in April 2011. MedSource
contends that OWI would not have been able to do so if it had not improperly used MedSource’s
resources. MedSource alleges that DeRoyal intended to use OWI/OWS instead of MedSource to
offer third-party billing services to its customers.
MedSource contends that when it discovered the scheme, it immediately closed its
Michigan office in May 2011. MedSource filed its complaint on April 30, 2012, and its

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amended complaint in September 5, 2012. MedSource alleges the following causes of action:
Count I, violation of RICO, 18 U.S.C. § 1962(c); Count II, RICO, 18 U.S.C. § 1962(d)
(conspiracy); Count III, tortious interference with contract; Count IV, conspiracy to commit
tortious interference with contract; Count V, tortious interference with business expectancy;
Count VI, conspiracy to commit tortious interference with business expectancy; Count VII,
breach of fiduciary duty; Count VIII, conversion; Count IX, conspiracy to convert; Count X,
unjust enrichment; Count XI, Michigan Trade Secrets Act; Count XII, unfair competition; and
Count XIII, conspiracy to unfairly compete. Defendants seek dismissal of all of MedSource’s
claims.
LAW AND ANALYSIS
I.

Standard of Review
Defendants seek dismissal pursuant to Rule 12(b)(6). To survive a motion to dismiss, the

plaintiff must allege facts that, if accepted as true, are sufficient “to raise a right to relief above
the speculative level” and to “state a claim to relief that is plausible on its face.” Ashcroft v.
Iqbal, 556 U.S. 662, 678 (2009). “A claim has facial plausibility when the plaintiff pleads
factual content that allows the court to draw the reasonable inference that the defendant is liable
for the misconduct alleged.” Id. See also Hensley Manuf. v. Propride, Inc., 579 F.3d 603, 609
(6th Cir. 2009). “A pleading that offers ‘labels and conclusions’ or “a formulaic recitation of the
elements of a cause of action will not do.’ Nor does a complaint suffice if it tenders ‘naked
assertion[s]’ devoid of ‘further factual enhancement.’” Iqbal, 556 U.S. at 677-78 (citing Bell
Atlantic Inc. v. Twombley, 550 U.S. 544, 555, 557 (2007)).
II.

Physician Defendants’ Motion

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MedSource’s amended complaint is devoid of concrete factual allegations against the
Physician Defendants, although it states the following claims against them: Count II, RICO
conspiracy; Count V, tortious interference with business expectancy; Count VI, conspiracy to
commit tortious interference with business expectancy; Count IX, conspiracy to convert; Count
X, unjust enrichment; Count XI, Michigan Trade Secrets Act; and Count XIII, conspiracy to
unfairly compete. MedSource fails to allege that the individual Physician Defendants
participated in the alleged scheme, other than to contend that the Physician Defendants stood to
benefit from their ownership of OWS, and that they agreed to exclusively use OWS/OWI and
DeRoyal. Given the lack of factual allegations suggesting liability on the part of the individual
Physician Defendants, Plaintiff’s Amended Complaint is insufficient under Iqbal and Twombley
with respect to each of MedSource’s causes of action.
MedSource argues that the Physician Defendants are liable for the wrongdoing of
Kalbfleisch, who it contends is their “agent.” MedSource does not allege facts regarding this
alleged agency relationship in its Amended Complaint; nor does MedSource allege in the
Amended Complaint that Kalbfleisch was acting as the agent of the individual physicians in
conducting the alleged scheme.
MedSource also suggests that the Physician Defendants are liable as “managing
members” of the OWS LLC, an allegation that was also not pleaded in the Amended Complaint.
OWS was organized as a LLC in Florida. Under Florida law, in general, members are not liable
for torts of the LLC. See Fla. Stat. 608.4227 (“[T]he members, managers, and managing
members of a limited liability company are not liable, solely by reason of being a member or
serving as a manager or managing member, under a judgment, decree, or order of a court, or in

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any other manner, for a debt, obligation, or liability of the limited liability company.”). Under
limited circumstances, a manager or managing member of a LLC could be liable for the LLC’s
torts by engaging in malfeasance. MedSource has alleged that Katschanow is OWS’s managing
member. Compl. at ¶ 16. MedSource has not pleaded facts indicating that the individual
Physician Defendants were managers or managing members of OWS who engaged in
malfeasance, such that liability could plausibly attach.
MedSource has not pleaded facts that would allow the court to reasonably infer that the
Physician Defendants are liable for a conspiracy to violate RICO, tortious interference with
business expectancy, conspiracy to commit tortious interference, conspiracy to convert, unjust
enrichment, violations of the Michigan Uniform Trade Secrets Act, or conspiracy to unfairly
compete. Accordingly, the court will dismiss all of MedSource’s claims against the Physician
Defendants.
III.

DeRoyal’s Motion
DeRoyal is a defendant in each of the counts alleged in the Amended Complaint, except

Count VII, which alleges a breach of fiduciary duty against Katschanow, only. DeRoyal seeks
dismissal of all of the counts against it.
A.

RICO

MedSource alleges that Defendants have violated 18 U.S.C. § 1962(c) of RICO, which
provides:
It shall be unlawful for any person employed by or associated with
any enterprise engaged in, or the activities of which affect,
interstate or foreign commerce, to conduct or participate, directly
or indirectly, in the conduct of such enterprise’s affairs through a
patter of racketeering activity or collection of unlawful debt.

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18 U.S.C. § 1962(c). To state a RICO claim under this section, MedSource must plead the
following elements: “(1) conduct (2) of an enterprise (3) through a pattern (4) of racketeering
activity.” Moon v. Harrison Piping Supply, 465 F.3d 719, 723 (6th Cir. 2006) (quoting Sedima,
S.P.R.L. v. Imrex Co., Inc., 473 U.S. 479, 496 (1985)).
DeRoyal seeks dismissal of the RICO claim on several grounds; however, because
MedSource has clearly failed to plead a pattern of racketeering activity, the court need only
address that element. See id. A “pattern of racketeering activity” consists of at least two
predicate acts of racketeering activity occurring within a ten-year period. 18 U.S.C. § 1961(5).
The alleged predicate acts may consist of offenses “which are indictable” under any of a number
of federal statutes, including the mail and wire fraud statutes. 18 U.S.C. § 1961(1).
Here, MedSource alleges predicate acts involving wire and mail fraud, specifically that
the OWI and OWS Medicare surety applications contained false information and were
transmitted by fax. See Compl. at ¶¶ 58, 65-72, 75-76, 86-98, 101-103, 104. The Supreme
Court has explained that “the term pattern itself requires the showing of a relationship between
the predicates and of the threat of continuing activity. It is this factor of continuity plus
relationship which combines to produce a pattern.” H.J. Inc. v. Northwestern Bell Tel. Co., 492
U.S. 229, 239 (1989). “Continuity and relationship constitute two analytically distinct prongs of
the pattern requirement.” Moon, 465 F.3d at 724 (citation omitted).
“‘Continuity’ is both a closed- and open-ended concept, referring either to a closed
period of repeated conduct, or to past conduct that by its nature projects into the future with a
threat of repetition.” H.J., 492 U.S. at 241. The continuity requirement “ensures that RICO is
limited to addressing Congress’s primary concern in enacting the statute, i.e. long-term criminal

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conduct.” Vemco, Inc. v. Camardella, 23 F.3d 129, 133-34 (6th Cir. 1994). A plaintiff may
satisfy the continuity requirement by pleading either closed- or open-ended racketeering activity.
A closed period of continuity may be demonstrated “by proving a series of related predicates
extending over a substantial period of time.” H.J., 492 U.S. at 242. “Although there are no rigid
rules regarding what amounts to ‘a substantial period of time,’ racketeering activity lasting only
‘a few weeks or months and threatening no future criminal conduct’ is insufficient.” Moon, 465
F.3d at 724-25 (citing H.J., 492 U.S. at 242). An open-ended period of continuity refers to past
conduct “which by its nature projects into the future with a threat of repetition.” Vemco, 23 F.3d
at 134 (citing H.J., 492 U.S. at 241-42). Open-ended continuity may be shown through pleading
“a distinct threat of long-term racketeering activity,” or by showing “that the predicate acts or
offenses are part of an ongoing entity’s regular way of doing business.” Moon, 465 F.3d at 72627 (citation omitted). The Supreme Court stated that a hoodlum who extorts money from shop
owners and threatens to return each month to collect “protection” money is an example of
racketeering activity with a threat of continuity. See H.J., 492 U.S. at 242.
Here, MedSource contends that it has sufficiently pleaded open-ended continuity.
However, what MedSource alleges is a single fraudulent scheme with a single victim and
objective over a relatively short period of time: to cut MedSource out of the Michigan market by
fraudulently obtaining Medicare billing privileges. Under similar circumstances, the Sixth
Circuit has declined to find that continuity was properly pleaded. See Vemco, 23 F.3d at 135
(allegations “involving a single victim and a single scheme for a single purpose over seventeen
months [do not] constitute the type of ‘long-term criminal conduct’ Congress sought to prohibit
with RICO”); Moon, 465 F.3d at 725 (no continuity where “[a]ll of the predicate acts . . . were

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keyed to Defendants’ single objective of depriving Moon of his benefits. . . and there are no facts
suggesting that the scheme would continue beyond the Defendants accomplishing their goal of
terminating Moon’s benefits”); Thompson v. Paasche, 950 F.2d 306, 311 (6th Cir. 1991)
(fraudulent scheme to sell nineteen lots “an inherently short-term affair” that did not satisfy
continuity requirement); Gotham Print, Inc. v. American Speedy Printing Ctr. Inc., 863 F. Supp.
447, 460 (E.D. Mich. 1994) (“When the Supreme Court spoke of the threat of repetition, it was
referring to the threat of repeated victimization . . . not merely the retention of the ill-gotten fruits
of previous crimes.”). Accordingly, the court will dismiss the RICO § 1962(c) claim against
DeRoyal.
The court will also dismiss MedSource’s RICO conspiracy claim under § 1962(d).
Because MedSource has failed to state a RICO claim under § 1962(c), its conspiracy claim fails
as a matter of law. Craighead v. E. F. Hutton & Co., 899 F.2d 485, 495 (6th Cir. 1989).
B.

State Tort Claims
1.

Unfair Competition

With respect to its unfair competition claim, MedSource alleges that “Defendants
willfully and maliciously passed off MedSource’s employees, patient files, and policies and
procedures as their own to the general public, The Joint Commission and Medicare, with the
intent to confuse such entities.” Compl. at ¶ 169. Under Michigan law,
Unfair competition ordinarily consists in the simulation by one
person, for the purpose of deceiving the public, of the name,
symbols, or devices employed by a business rival, or the
substitution of the goods or wares of one person for those of
another, thus falsely inducing the purchase of his wares and
thereby obtaining for himself the benefits properly belonging to his
competitor.

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Letica Corp. v. Sweetheart Cup Co., Inc., 790 F. Supp. 702, 706 (E.D. Mich. 1992). Here,
MedSource is not alleging that DeRoyal is “passing off” MedSource’s products as its own.
Rather, as stated in its brief, MedSource’s unfair competition claim is based on the
allegation that “the information and resources wrongly taken from MedSource were used by
DeRoyal to gain a competitive edge from MedSource.” See Pl.’s Resp. at 20. In its reply brief,
DeRoyal contends that an unfair competition claim based upon the alleged misappropriation of
trade secrets is displaced by the Michigan Uniform Trade Secrets Act (“MUTSA”), which
provides:
(1) Except as provided in subsection (2), this act displaces conflicting tort,
restitutionary, and other law of this state providing civil remedies for
misappropriation of a trade secret.
(2) This act does not affect any of the following:
(a) Contractual remedies, whether or not based upon
misappropriation of a trade secret.
(b) Other civil remedies that are not based upon misappropriation
of a trade secret.
(c) Criminal remedies, whether or not based upon misappropriation
of a trade secret.
M.C.L. § 445.1908. To the extent that MedSource’s unfair competition claim is based upon an
alleged misappropriation of trade secrets, it is displaced by the MUTSA. See Bliss Clearing
Niagra, Inc. v. Midwest Brake Bond Co., 270 F. Supp.2d 943, 946-47 (W.D. Mich. 2003) (“In
determining whether a claim is displaced, courts generally examine whether the claim is based
solely upon the misappropriation of a trade secret. If so, the claim must be dismissed.”)
(collecting cases). To the extent MedSource’s unfair competition claim is based upon
Defendants’ alleged use of its employees and resources, however, it may survive, assuming such

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allegations state a claim for unfair competition. Because DeRoyal only raised the MUTSA
displacement issue in its reply brief, it has not been fully briefed by the parties. Accordingly, the
court will deny DeRoyal’s motion to dismiss on this issue without prejudice.
2.

Remaining Tort Claims

DeRoyal also seeks dismissal of MedSource’s claims of tortious interference with
contract, tortious interference with business expectancy, conversion, unjust enrichment, and
misappropriation of trade secrets. These claims have been sufficiently pleaded in the Amended
Complaint to survive a Rule 12(b)(6) motion. MedSource alleges that DeRoyal, through
Katschanow and Jones, knew of MedSource’s non-solicitation agreements with its employees
and induced those employees to breach those agreements by using MedSource’s resources and
confidential information for the benefit of OWI, thus stating a claim for tortious interference
with contract. See Health Call of Detroit v. Atrium Home & Health Care Serv., 268 Mich. App.
83, 89-90 (2005) (elements of tortious interference with contract and business expectancy
claims). MedSource also alleges that DeRoyal interfered with MedSource’s business expectency
with existing clients by using MedSource’s employees, trade secrets, and resources to compete
with MedSource. See id. MedSource further alleges that DeRoyal, through Katschanow,
wrongfully assumed control over MedSource’s property, including files, employees, policies and
procedures, thus stating a claim for conversion. See Foremost Ins. Co. v. Allstate Ins. Co., 439
Mich. 378, 391 (1992) (“In the civil context, conversion is defined as any distinct act of domain
wrongfully exerted over another's personal property in denial of or inconsistent with the rights
therein.”).
MedSource also alleges that DeRoyal unfairly benefitted from the scheme and misappropriated
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MedSource’s trade secrets. See Sweet Air Inv., Inc. v. Kenney, 275 Mich. App. 492, 504 (2007)
(unjust enrichment); Ajuba Int’l, LLC v. Saharia Prods., LLC, __ F. Supp.2d __, 2012 WL
1672713 at *15-16 (E.D. Mich. 2012) (elements of a MUTSA claim).
With respect to each of these causes of action, MedSource has alleged plausible claims
for relief. Although DeRoyal contests, for example, whether Katschanow and Jones were acting
within the scope of their employment and whether MedSource’s confidential information
constitutes a trade secret, such arguments are best assessed after further factual development in
discovery. The court will deny DeRoyal’s motion to dismiss with respect to these state tort
claims.1
IV.

Ken Jones’s Motion
Defendant Ken Jones, a DeRoyal vice president, also seeks dismissal of the claims

against him: RICO, tortious interference with contract, tortious interference with business
expectancy, unjust enrichment, and misappropriation of trade secrets. The court finds that
MedSource has failed to plead RICO claims against Jones for the same reasons stated above –
MedSource has failed to plead a pattern of racketeering activity. The court will dismiss the
RICO claims under §§ 1962(c) and (d) against Jones.
The remaining state tort claims have been sufficiently pleaded by MedSource in order to
survive a motion to dismiss. MedSource has pleaded sufficient personal involvement by Jones to
allow these claims to proceed to discovery. The court will deny Jones’s motion with respect to
MedSource’s tortious interference with contract, tortious interference with business expectancy,

1

At the hearing, DeRoyal argued that all of MedSource’s tort claims are preempted by
the MUTSA. Because this issue has not been briefed, the court will not consider it at this time.
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unjust enrichment, and misappropriation of trade secrets claims.
ORDER
IT IS HEREBY ORDERED that the Physician Defendants’ September 25, 2012 motion
to dismiss is GRANTED.
IT IS FURTHER ORDERED that DeRoyal Industries, Inc.’s September 19, 2012 motion
to dismiss is GRANTED IN PART and DENIED IN PART, consistent with this opinion and
order.
IT IS FURTHER ORDERED that Jones’s September 19, 2012 motion to dismiss is
GRANTED IN PART and DENIED IN PART, consistent with this opinion and order.

s/John Corbett O'Meara
United States District Judge
Date: November 20, 2012

I hereby certify that a copy of the foregoing document was served upon counsel of record
on this date, November 20, 2012, using the ECF system.

s/William Barkholz
Case Manager

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