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MiMedx Group, Inc. v. Fox

United States District Court, N.D. Illinois, Eastern Division

January 24, 2018

MiMedx Group, Inc., Plaintiff/Counter-Defendant,
Michael Fox, Defendant/Counter-Plaintiff.


          Manish S. Shah United States District Judge

         MiMedx filed this lawsuit against a former employee, Michael Fox. Fox responded by asserting various counterclaims against MiMedx. MiMedx now seeks to dismiss Fox's counterclaims for breach of contract, defamation, and declaratory judgment. Fox also requests leave to amend his counterclaim to add claims under the Dodd-Frank Wall Street Reform and Consumer Protection Act, 15 U.S.C. § 78u-6(h), and the Illinois Whistleblower Protection Act, 740 ILCS 174/1 et seq. For the reasons discussed below, both the motion to dismiss and the motion for leave to amend are granted in part, denied in part.

         I. Legal Standards

         To survive a motion to dismiss under Federal Rule of Civil Procedure 12(b)(6), a complaint (or here, a counterclaim) must contain factual allegations that plausibly suggest a right to relief. Ashcroft v. Iqbal, 556 U.S. 662, 677-78 (2009); Firestone Fin. Corp. v. Meyer, 796 F.3d 822, 826-27 (applying the Rule 12(b)(6) standard to the defendants' counterclaim). The court must construe all factual allegations as true and draw all reasonable inferences in the plaintiff's favor, but the court need not accept legal conclusions or conclusory allegations. Iqbal, at 678- 79. The court should grant leave to amend pleadings freely “when justice so requires.” Fed.R.Civ.P. 15(a)(2). “Leave to amend need not be granted, however, if it is clear that any amendment would be futile.” Bogie v. Rosenberg, 705 F.3d 603, 608 (7th Cir. 2013).

         II. Background

         Michael Fox was employed at MiMedx, first as a Regional Sales Director and later as an Area Vice President. [67] at 29, ¶ 8, 10.[1] MiMedx developed and marketed products for wound care, utilizing a particular method to manipulate placental tissue to create skin grafts for surgical applications. [112] at 8, ¶ 11. MiMedx awarded Fox stock options each quarter of his employment. [67] at 30, ¶ 12-16; id. at 31, ¶ 17-18; [112] at 10, ¶ 19-24; id. at 11, ¶ 25. The company's stock incentive plan provided that employees terminated for cause could not exercise options that had been granted to them under the plan. [67] at 37, ¶ 58. The plan defined “cause” as dishonesty, refusal or continued failure to perform duties for the company, fraudulent conduct, or any conduct that could be materially damaging to the company without reasonable good faith that such conduct was in the best interest of the company. Id. at 38, ¶ 59. MiMedx's board of directors determined whether an employee would be fired for cause; such determination would be final and conclusive. Id. at 38, ¶ 60; id. at 49.

         Aside from the acts alleged to be retaliatory in his proposed amended counterclaim, Fox was never disciplined or informed by anyone at MiMedx that his performance was unsatisfactory. [112] at 9, ¶ 17. And though Fox performed strongly throughout his employment-in his fourth year of employment, for example, he was a top performing sales manager-MiMedx demoted him in December 2015, for his refusal to participate in a channel-stuffing scheme in which MiMedx fraudulently recognized revenue in its certified financial statements before the revenue had been realized or realizable and earned. [112] at 7, ¶ 2; id. at 11, ¶ 26. To effectuate the scheme, MiMedx entered into a distribution agreement with AvKARE, Inc., which allowed MiMedx to sell directly to the U.S. Department of Veterans Affairs. Id. at 11, ¶ 27. MiMedx sales representatives ordered products under AvKARE's account through MiMedx's software, meaning MiMedx controlled AvKARE's demand for MiMedx products. Id. ¶ 28. The orders would be billed to AvKARE's account, but shipped directly to VA hospitals, and MiMedx would recognize revenue for the orders at the time of shipment. Id. These orders, which the VA had not requested, were often in quantities well in excess of what the VA needed. Id. at 12, ¶ 38. MiMedx sales representatives were then responsible for ensuring the resale of the products to end customers and did not receive commission for an AvKARE sale until the product was resold. Id. at 12, ¶ 29, 31; id. at 14, ¶ 40. MiMedx intended to slowly issue returns for these products over time, concealing its actions by balancing the returns against actual revenue in future reporting periods. Id. at 13, ¶ 36.

         In 2014, MiMedx senior managers began directing senior sales managers, including Fox, to significantly increase the amount of inventory placed in VA hospitals through AvKARE. Id. at 14, ¶ 39. From then on, at the end of every quarter, senior management pressured the regional sales directors to place additional orders on behalf of AvKARE for products neither AvKARE nor the customer had ordered or needed. Id. ¶ 40. Fox became worried that this practice would compromise relationships with the customers, and in 2015 he began to push back against management directives. Id. ¶ 41. Fox refused to participate in the scheme and directed his sales force not to order AvKARE products unless they felt the products were needed. Id. Fox repeatedly raised objections that the company's AvKARE revenue was a “false performance number” used only to affect the stock price, and MiMedx senior management officials acknowledged that the number did not accurately reflect actual sales. Id. at 15, ¶ 42-43. Fox's refusal to participate caused him to miss an artificially inflated revenue quota-the first quota Fox had ever missed during his career with MiMedx. Id. ¶ 44.

         In October 2015, after MiMedx's Chairman of the Board and CEO, Parker Petit, learned about Fox's objections to MiMedx's scheme, Petit verbally reprimanded Fox at a meeting. Id. ¶ 46. Two months later, Fox was demoted- resulting in a large reduction in Fox's managerial responsibilities and annual compensation. Id. at 16, ¶ 48-49. MiMedx could not implement its scheme without the cooperation of its area vice presidents, like Fox. Id. at 15-16, ¶ 47. Later in December, a MiMedx senior director spoke on the phone with a member of the sales team saying, “I need to know not what you're putting on for yourself but what additional could you put on to help us hit the number for the quarter because we're short overall. And so do you have any additional space?” Id. at 16-17, ¶ 51. The following year, in March 2016, a phone call between the same salesperson and Fox's eventual replacement, Steve Blocker, took place. Id. at 18, ¶ 55. On that call, Blocker expressed frustration at having to meet a “false number” and concern that customers that didn't “have carte blanche at their facilities [were] starting to get, you know, questions” and that floor managers were “looking at how many grafts [were] spilling out of every cabinet available.” Id. at 19, ¶ 55. Blocker also stated that “[t]here's just an insinuation that there will be hell to pay. And, you know, [Petit] says: Well, you don't want to be on the wrong end and not hit your number, you know.” Id. at 20, ¶ 56.

         Around the same time, Fox was on a conference call with various MiMedx executives discussing a new initiative through which MiMedx would ship shoebox-sized boxes containing small graft products to targeted VA hospitals. Id. at 22, ¶ 58. Fox expressed his concerns, saying everyone knew those boxes would be returned. Id. A MiMedx official noted that he understood Fox's concerns, but that they were going through with the project nonetheless. Id. In March 2016, MiMedx sent out the grafts discussed on the conference call to VA hospitals that had no use for them. Id. at 23, ¶ 61-62. Most of those grafts remained unused and were returned or concealed by sales representatives until MiMedx authorized their return. Id. ¶ 65. MiMedx failed to disclose, among other things, the contingent nature of the sales to AvKARE, its complete control over AvKARE's subsequent sales, MiMedx's ongoing involvement in ensuring resale of the products sold to AvKARE, that AvKARE was not obligated to pay MiMedx until the product was resold, and that MiMedx maintained liability for AvKARE tissues that went missing while being stored at VA facilities. Id. at 28, ¶ 74; id. at 29, ¶ 74-76.

         In November 2016, two other MiMedx employees submitted a joint report asserting their belief that the company was engaging in a fraudulent revenue recognition scheme in violation of the Sarbanes-Oxley Act.[2] Id. at 30, ¶ 78. A month later, Fox attended an emergency meeting with MiMedx leadership during which Petit stated that the employees who had submitted the report would be “hurt professionally and with every possible resource available.” Id. at 31, ¶ 84-85. MiMedx later fired and sued those two employees, who then filed their own suit against MiMedx, along with a whistleblower complaint with the SEC. Id. at 32-33, ¶ 91; id. at 37, ¶ 114. After reading that whistleblower complaint, MiMedx came to believe Fox had provided the whistleblowers with information relating to the company's violations. Id. at 33, ¶ 92. Fox was notified that his employment had been terminated on December 29, 2016, during a phone call with MiMedx's Executive Vice President and Thornton Kuntz, the Senior Vice President of Administration. [67] at 31, ¶ 20; id. at 31-32, ¶ 22; [112] at 34, ¶ 95-96. Kuntz informed Fox that he was terminated for cause and that he would have only until the end of the day to exercise his vested stock options. [67] at 32, ¶ 23-24. When Fox pointed out that the market was already closed for the day, Kuntz replied, “exactly.” Id. at 32, ¶ 24; [112] at 34, ¶ 97. In not allowing Fox to exercise his vested options, MiMedx withheld nearly $250, 000 in Fox's deferred compensation. [112] at 7, ¶ 3. Kuntz confirmed Fox's for-cause termination in a letter. [67] at 32, ¶ 25; id. at 79-80; [112] at 34, ¶ 98.

         The next day, MiMedx issued a press release entitled, MiMedx Files Lawsuits against Two Additional Former Sales Employees for Breach of Contractual Obligations, naming Fox and explaining its decision to terminate his employment. [67] at 82. The release, quoting MiMedx's President and Chief Operating Officer, stated that,

[t]he Company took employment actions with various other employees based on the degree of transgression and the openness and willingness of these employees to cooperate in the Company's investigation. No. legal actions have been taken with individuals who have cooperated and have been truthful with the Company during the investigation.

Id. The press release went on to quote MiMedx CEO, Petit, saying,

when an employee violates the duty of loyalty and contractual obligations by selling competitive products or other products, employment actions must be taken. Although the sales employees who participated in these violations were a very small number of the more than 300 employees in our sales organization, we are always disappointed when individuals choose to follow self-serving financial motives rather than adhere to the high standards of conduct and compliance that we foster and instill at MiMedx.

Id. The press release ended with a safe-harbor statement, which read in part, “[t]his press release includes statements that look forward in time or that express met with the SEC, providing information relating to MiMedx's alleged violations of securities laws. [112] at 7, ¶ 4; id. at 37, ¶ 115.

         One of the sales representatives who had worked under Fox and whose employment was also terminated sent Kuntz, the Senior Vice President of Administration, an email regarding the company's justifications for her termination. [67] at 33, ¶ 33. Kuntz replied, stating that

[t]he leadership of [the] group did not meet expectations related to the investment made by the Company, and as a result, management decided to disband the roles. While we regret that the direct leadership provided to the [group] was ineffective and inadequate; nonetheless, the necessary results were not achieved in aggregate to sustain those positions.

Id. at 86. Later, on a conference call, Petit said,

[w]e think it's well known we terminated four and filed lawsuits against them. We've terminated some others and didn't file lawsuits because we felt that they hadn't reached the point of being problematic. And then we've had some others that came clean with us. We sat people down and said just tell us the truth, and we'll go from there. Most of these others-all of them didn't tell us the truth. It appeared they were-continued to dig deeper with their lies, and the few that came clean with us, they're still here. . . . Mostly disappointing to me is the lack of integrity that we uncovered in the process.

[67] at 34, ¶ 36; [112] at 36-37, ¶ 110. The purpose of the call was to discuss MiMedx's earnings with ...

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