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Contingencies
 6 Months Ended
Jun. 30, 2012
Contingencies  
Contingencies

 

 

16.                               Contingencies

 

The Company is a party to outstanding legal proceedings, investigations and claims as described below. The Company believes that it is unlikely that the outcome of each of these matters, including the matters discussed below, will have a material adverse effect on the Company and its subsidiaries as a whole, notwithstanding that the unfavorable resolution of any matter may have a material effect on the Company’s net earnings (if any) in any particular quarter. However, the Company cannot predict with any certainty the final outcome of any legal proceedings, investigations (including any settlement discussions with the government seeking to resolve such investigations) or claims made against it or its subsidiaries described in the paragraphs below, and there can be no assurance that the ultimate resolution of any such matter will not have a material adverse impact on the Company’s consolidated financial position, results of operations, or cash flows.

 

The Company records accruals for certain of its outstanding legal proceedings, investigations or claims when it is probable that a liability will be incurred and the amount of the loss can be reasonably estimated. The Company evaluates, on a quarterly basis, developments in legal proceedings, investigations and claims that could affect the amount of any accrual, as well as any developments that would make a loss contingency both probable and reasonably estimable. When a loss contingency is not both probable and reasonably estimable, the Company does not accrue the loss. However, if the loss (or an additional loss in excess of the accrual) is at least a reasonable possibility and material, then the Company discloses a reasonable estimate of the possible loss or range of loss, if such reasonable estimate can be made. If the Company cannot make a reasonable estimate of the possible loss, or range of loss, then that is disclosed.

 

The assessments of whether a loss is probable or a reasonable possibility, and whether the loss or range of loss is reasonably estimable, often involve a series of complex judgments about future events. Among the factors that the Company considers in this assessment are the nature of existing legal proceedings, investigations and claims, the asserted or possible damages or loss contingency (if reasonably estimable), the progress of the matter, existing law and precedent, the opinions or views of legal counsel and other advisers, the involvement of the U.S. Government and its agencies in such proceedings, the Company’s experience in similar matters and the experience of other companies, the facts available to the Company at the time of assessment, and how the Company intends to respond, or has responded, to the proceeding, investigation or claim. The Company’s assessment of these factors may change over time as individual proceedings, investigations or claims progress. For matters where the Company is not currently able to reasonably estimate a range of reasonably possible loss, the factors that have contributed to this determination include the following: (i) the damages sought are indeterminate, or an investigation has not manifested itself in a filed civil or criminal complaint, (ii) the matters are in the early stages, (iii) the matters involve novel or unsettled legal theories or a large or uncertain number of actual or potential cases or parties, and/or (iv) discussions with the government or other parties in matters that may be expected ultimately to be resolved through negotiation and settlement have not reached the point where the Company believes a reasonable estimate of loss, or range of loss, can be made. In such instances, the Company believes that there is considerable uncertainty regarding the timing or ultimate resolution of such matters, including a possible eventual loss, fine, penalty or business impact, if any.

 

In addition to the matters described in the paragraphs below, in the normal course of our business, the Company is involved in various lawsuits from time to time and may be subject to certain other contingencies. To the extent losses related to these contingencies are both probable and reasonably estimable, the Company accrues appropriate amounts in the accompanying financial statements and provides disclosures as to the possible range of loss in excess of the amount accrued, if such range is reasonably estimable. The Company believes losses are individually and collectively immaterial as to a possible loss and range of loss.

 

Litigation

 

Matters Related To Blackstone Medical, Inc. and Related Escrow Claims

 

On or about July 23, 2007, the Company’s subsidiary, Blackstone Medical, Inc. (“Blackstone”) received a subpoena issued by the Office of Inspector General of the Department of Health and Human Services (“HHS-OIG”), under the authority of the federal healthcare anti-kickback and false claims statutes. The subpoena sought documents for the period January 1, 2000 through July 31, 2006, which is prior to Blackstone’s acquisition by the Company. The Company believes that the subpoena concerned the compensation of physician consultants and related matters. On September 17, 2007, the Company submitted a claim for indemnification from the escrow fund established in connection with the agreement and plan of merger between the Company, New Era Medical Corp. and Blackstone, dated as of August 4, 2006 (the “Blackstone Merger Agreement”), for any losses to the Company resulting from this matter.  The Company was subsequently notified by legal counsel for the former shareholders of Blackstone that the representative of the former shareholders of Blackstone objected to the indemnification claim and intended to contest it in accordance with the terms of the Blackstone Merger Agreement.

 

On or about January 7, 2008, the Company received a federal grand jury subpoena from the U.S. Attorney’s Office for the District of Massachusetts (“Boston USAO”). The subpoena sought documents from the Company for the period January 1, 2000 through July 15, 2007. The Company believes that the subpoena concerned the compensation of physician consultants and related matters, and further believes that it was associated with HHS-OIG’s investigation of such matters. On September 18, 2008, the Company submitted a claim for indemnification from the escrow fund established in connection with the Blackstone Merger Agreement for any losses to the Company resulting from this matter. On or about April 29, 2009, counsel received a HIPAA subpoena issued by the U.S. Department of Justice (“DOJ”). The subpoena sought documents from the Company for the period January 1, 2000 through July 15, 2007. The Company believes that the subpoena concerned the compensation of physician consultants and related matters, and further believes that it was associated with HHS-OIG’s investigation of such matters, as well as the January 7, 2008 federal grand jury subpoena. On or about August 26, 2010, counsel for Orthofix Inc. and Blackstone executed a tolling agreement with the Boston USAO (the “Tolling Agreement”) that extended an agreement tolling the statute of limitations applicable to any criminal, civil, or administrative proceedings that the government might later initiate to include the period from December 1, 2008 through and including October 31, 2010. On or about February 1, 2011, the parties further extended the tolling of the statute of limitations through and including May 31, 2011 with respect to any criminal proceedings that the government might later initiate.

 

On or about December 5, 2008, the Company obtained a copy of a qui tam complaint filed by Susan Hutcheson and Philip Brown against Blackstone and the Company in the U.S. District Court for the District of Massachusetts. A qui tam action is a civil lawsuit brought by an individual for an alleged violation of a federal statute, in which DOJ has the right to intervene and take over the prosecution of the lawsuit at its option. On September 18, 2008, after being informed of the existence of the lawsuit by representatives of DOJ and prior to the unsealing of the complaint (which was unsealed by the court on or about November 24, 2008), the Company submitted a claim for indemnification from the escrow fund established in connection with the Blackstone Merger Agreement for any losses to the Company resulting from this matter. On November 21, 2008, the U.S. Department of Justice filed a notice of non-intervention in the case. The complaint was served on Blackstone on or about March 24, 2009. Counsel for the plaintiffs filed an amended complaint on June 4, 2009. The amended complaint sets forth a cause of action against Blackstone under the False Claims Act for alleged inappropriate payments and other items of value conferred on physician consultants; Orthofix is not named as a defendant in the amended complaint. The Company understands that this lawsuit was related to the matters described above involving the HHS-OIG, the Boston USAO, and DOJ. On or about March 12, 2010, the United States District Court for the District of Massachusetts granted Blackstone’s motion to dismiss and, on March 15, 2010, entered judgment in favor of Blackstone. On June 1, 2011, the United States Court of Appeals for the First Circuit reversed the motion to dismiss and remanded to the district court for further proceedings. In response to a joint motion to stay the action, on August 22, 2011, the United States District Court for the District of Massachusetts entered an order administratively closing the lawsuit for a period of no more than ninety (90) days. On August 30, 2011, Blackstone filed with the United States Supreme Court a Petition for a Writ of Certiorari to review the June 1, 2011 judgment of the United States Court of Appeals for the First Circuit, which was denied on December 5, 2011.

 

In January 2012, after a series of ongoing discussions and negotiations with the Boston USAO, the Company’s board of directors approved an agreement in principle to pay $32 million to resolve the matters described in the immediately preceding paragraphs. The Company is currently in discussions with the Boston USAO, the DOJ, and HHS-OIG, as to the terms of definitive written agreements to finally resolve these matters. As part of the resolution of this matter (and matters described below related to the Company’s regenerative stimulation business), on June 6, 2012, Orthofix International N.V., Orthofix Inc. and Blackstone Medical, Inc. entered into a five-year Corporate Integrity Agreement with HHS-OIG.  (The Corporate Integrity Agreement is further described below under the subheading “Corporate Integrity Agreement with HHS-OIG”.)  Based on information currently available, the Company believes that it is probable that a final written definitive settlement agreement with the U.S. Government will be entered into on these economic terms, which, as described below, would be fully funded from the escrow fund established in connection with the Blackstone Merger Agreement. There can be no assurance that the Company will enter into a consensual resolution of these matters, or what the final terms of any such resolution might be; however, the Company believes that the likelihood of any such additional material loss in excess of this amount is remote.

 

In 2007 and 2008, the Company received certain other subpoenas from state and federal entities related to Blackstone’s financial relationship with physicians, which the Company has described in prior reports.  The Company has fully responded to each of these subpoenas, and there are currently no pending proceedings related to any of these matters.

 

Under the Blackstone Merger Agreement, the former shareholders of Blackstone agreed to indemnify the Company for breaches of representations and warranties under the agreement as well as certain other specified matters. These post-closing indemnification obligations of the former Blackstone shareholders were limited to a cumulative aggregate amount of $66.6 million. At closing, an escrow fund was established pursuant to the terms of the Blackstone Merger Agreement to fund timely submitted indemnification claims. The initial amount of the escrow fund was $50.0 million. As of December 31, 2011, the escrow fund contained $47.5 million.

 

In February 2012, the Company reached an agreement with the representative of the former shareholders of Blackstone resolving all outstanding escrow and indemnification claims under the Blackstone Merger Agreement.  Under this agreement, approximately $42.5 million was distributed from the escrow fund to the Company (which will be used, among other things, to fund the proposed $32 million settlement in principle described above).  Each of the Company and the former shareholders of Blackstone also mutually released each other from all further claims against each other related to these matters.  As of September 30, 2011, the Company had recognized $15.5 million as an “escrow receivable” on the consolidated balance sheet, reflecting previously incurred expenses that the Company believed were reasonably assured of collection.  The Company received approximately $9.5 million in cash from the escrow fund after application of (i) the $32 million allocated to the settlement in principle described above with the government and (ii) approximately $1 million of other fees incurred with respect to this matter since September 30, 2011. As a result, the Company recorded a charge of approximately $6 million during the fourth quarter of 2011 for previously incurred legal fees that were reflected in this escrow receivable balance as of September 30, 2011. The Company recorded a charge of $0.2 million in the second quarter of 2012 which represents imputed interest on the settlement accrued through June 30, 2012.

 

Matters Related to Regenerative Stimulation Business

 

On or about April 10, 2009, the Company received a HIPAA subpoena (“HIPAA subpoena”) issued by the Boston USAO. The subpoena sought documents concerning, among other things, the Company’s promotion and marketing of its regenerative stimulator devices (which the Company has also described in the past as its “bone growth stimulator devices”). The Boston USAO issued several subsequent document and testimony subpoenas.  The Company cooperated with these requests.

 

On or about April 14, 2009, the Company obtained a copy of a qui tam complaint filed by Jeffrey J. Bierman in the U.S. District Court for the District of Massachusetts against the Company, Orthofix Inc. and other companies that have allegedly manufactured regenerative stimulation devices, including Orthologic Corp., DJO Incorporated, Reable Therapeutics, Inc., the Blackstone Group, L.P., Biomet, Inc., EBI, L.P., EBI Holdings, Inc., EBI Medical Systems, Inc., Bioelectron, Inc., LBV Acquisition, Inc., and Smith & Nephew, Inc. The complaint, as subsequently amended in 2010, alleged various causes of action under the federal False Claims Act and state and city false claims acts premised on the contention that the defendants improperly promoted the sale, as opposed to the rental, of regenerative stimulation devices. The complaint also included claims against the defendants for, among other things, allegedly misleading physicians and purportedly causing them to file false claims and for allegedly violating the Anti-Kickback Act by providing free products to physicians, waiving patients’ insurance co-payments and providing inducements to independent sales agents to generate business.

 

On April 28, 2011, after a series of ongoing discussions and negotiations with the Boston USAO, the Company’s board of directors approved an agreement in principle proposed by the Boston USAO to resolve the criminal and civil matters described in the immediately preceding two paragraphs. On June 6, 2012, the Company entered into a definitive settlement agreement with the United States of America, acting through DOJ and on behalf of HHS-OIG, the TRICARE Management Activity, through its General Counsel, the Office of Personnel Management, in its capacity as administrator of the Federal Employees Health Benefits Program, the United States Department of Veteran Affairs and Mr. Bierman.  This settlement agreement finally resolves these matters.

 

In connection with the settlement agreement, the Company’s wholly-owned subsidiary, Orthofix Inc., entered into a plea agreement with the Boston USAO and DOJ on June 7, 2012 under which Orthofix Inc. agreed to plead guilty to one felony count of obstruction of a June 2008 federal audit (§18 U.S.C. 1516).  This plea agreement currently remains subject to review and approval by the U.S. District Court for the District of Massachusetts, and there can be no assurance that the plea agreement will be approved by the court on the terms proposed.

 

The Company has agreed to pay $34.2 million (plus interest at a rate of 3% from May 5, 2011 through the day before payment is made) under the terms of the settlement agreement.  Under the plea agreement, Orthofix Inc. has agreed to pay (i) a criminal fine of $7.8 million, and (ii) a mandatory special assessment of $400.  In addition, the Company agreed in July 2012 to pay Mr. Bierman’s counsel $1.0 million in fees.  The Company previously recorded a charge of $43 million during the first quarter of 2011 in anticipation of the settlement.  The Company recorded a charge of $1.2 million in the second quarter of 2012 which represents imputed interest on the settlement accrued through June 30, 2012.

 

The settlement is neither an admission of liability by the Company or its subsidiaries nor a concession by the United States or the civil qui tam relator that their claims are not well founded, except as to such admissions as Orthofix Inc. makes in connection with its guilty plea under the Plea Agreement.

 

Corporate Integrity Agreement with HHS-OIG

 

On June 6, 2012, in connection with the Company’s settlement of the matters described above related to the Company’s regenerative stimulation business, and in anticipation of a final settlement of the government investigation and related qui tam complaint described above related to Blackstone Medical, Inc., the Company also entered into a five-year corporate integrity agreement with HHS-OIG (the “CIA”).  The CIA acknowledges the existence of the Company’s current compliance program, and requires that the Company continue to maintain during the term of the CIA a compliance program designed to promote compliance with federal healthcare and Food and Drug Administration (“FDA”) requirements.  The Company is also required to maintain several elements of the existing program during the term of the CIA, including maintaining a Chief Compliance Officer, a Compliance Committee, and a Code of Conduct.  The CIA requires that the Company conduct certain additional compliance-related activities during the term of the CIA, including various training and monitoring procedures, and maintaining a disciplinary process for compliance obligations.  Pursuant to the CIA, the Company is required to notify the HHS-OIG in writing, among other things, of: (i) any ongoing government investigation or legal proceeding involving an allegation that the Company has committed a crime or has engaged in fraudulent activities; (ii) any other matter that a reasonable person would consider a probable violation of applicable criminal, civil, or administrative laws related to compliance with Federal healthcare programs or FDA requirements; and (iii) any change in location, sale, closing, purchase, or establishment of a new business unit or location related to items or services that may be reimbursed by Federal healthcare programs.  The Company is also subject to periodic reporting and certification requirements attesting that the provisions of the CIA are being implemented and followed, as well as certain document and record retention mandates.  The CIA provides that in the event of an uncured material breach of the CIA, the Company could be excluded from participation in Federal healthcare programs and/or subject to monetary penalties.

 

Matters Related to Promeca

 

During the second quarter of 2010 internal management review of Promeca S.A. de C.V. (“Promeca”), one of the Company’s Mexican subsidiaries, the Company received allegations of improper payments by certain of Promeca’s local employees in Mexico to employees of a Mexican governmental healthcare entity. The Company engaged Hogan Lovells US LLP and Deloitte Financial Advisory Services LLP to conduct an internal investigation (the “Promeca Internal Investigation”) focusing on compliance with the Foreign Corrupt Practices Act (“FCPA”) and voluntarily contacted the Securities and Exchange Commission (the “SEC”) and DOJ to advise both agencies that an internal investigation was underway. Promeca accounted for approximately one percent of the Company’s consolidated net sales and consolidated total assets.

 

The Company completed the Promeca Internal Investigation in April 2011 and commenced settlement discussions with the U.S. Government regarding this matter in May 2011. In January 2012, the Company reached an agreement in principle to settle these matters with the DOJ, and on July 10, 2012, the Company entered into definitive agreements with DOJ and the SEC agreeing to settle this matter.  As part of the settlement, the Company has entered into (i) a consent to final judgment (the “SEC Consent”) with the SEC in a civil matter filed by the SEC on the same date in the U.S. District Court for the Eastern District of Texas and (ii) a deferred prosecution agreement (the “DPA”) with DOJ.  These agreements remain subject to review and approval by the U.S. District Court for the Eastern District of Texas, and there can be no assurance that they will be approved by the court on the terms proposed.

 

Under the terms of the SEC Consent, the Company will settle civil claims related to this matter by voluntarily disgorging profits to the United States government in an amount of $5.2 million, inclusive of pre-judgment interest.  The Company has also agreed to pay a fine of $2.2 million to the U.S. Government pursuant to the terms of the DPA.  The Company previously recorded charges of $3.0 million during the first quarter of 2011 and $4.5 million during the fourth quarter of 2011 to establish an accrual in anticipation of a future final resolution of these matters with both DOJ and the SEC.  The Company made payment of the amounts owed pursuant to the DPA in July 2012, and expects to make payments pursuant to the SEC Consent in the third fiscal quarter of 2012.

 

As part of the DPA, which has a term of three years, DOJ has agreed not to pursue any criminal charges against the Company in connection with this matter if the Company complies with the terms of the DPA.  The DPA takes note of the Company’s self-reporting of this matter to DOJ and the SEC, and of remedial measures, including the implementation of an enhanced compliance program, previously undertaken by the Company.  The DPA provides that the Company shall continue to cooperate fully with DOJ in any future matters related to corrupt payments, false books and records or inadequate internal controls.  In that regard, the Company has represented that the Company has implemented and will continue to implement a compliance and ethics program designed to prevent and detect violations of the FCPA and other applicable anti-corruption laws.  The Company will periodically report to DOJ during the term of the DPA regarding such remediation and implementation of compliance measures.

 

In addition, under the terms of the SEC Consent, the Company will periodically report to the SEC during a two-year term regarding the status of such remediation and implementation of compliance measures.  The SEC Consent and the DPA do not provide for the appointment of any independent external monitor by DOJ or the SEC.

 

Matters Related to the Company’s Former Breg Subsidiary and Possible Indemnification Obligations

 

On May 24, 2012, the Company sold Breg to an affiliate of Water Street Healthcare Partners II, L.P. (“Water Street”) pursuant to a stock purchase agreement (the “Breg SPA”).  Under the terms of the Breg SPA, upon closing of the sale, the Company and its subsidiary, Orthofix Holdings, Inc., agreed to indemnify Water Street and Breg with respect to certain specified matters, including (i) the government investigation and product liability matters regarding the previously owned infusion pump product line described above, and (ii) pre-closing sales of cold therapy units and certain post-closing sales of cold therapy units, including the product liability cases with respect to such products described above.  The Company has established an accrual of $2.0 million, and had recorded the related charge to discontinued operations,  for its indemnification obligations in connection with the July 2012 verdict described in the preceding paragraph, however, actual liability in this case could be higher or lower than the amount accrued.  The Company has not established any accrual in connection with its other indemnification obligations under the Breg SPA, and currently cannot reasonably estimate the possible loss, or range of loss, in connection with such obligations.

 

The Company’s former subsidiary, Breg, which the Company divested in May 2012, was engaged in the manufacturing and sale of local infusion pumps for pain management from 1999 to 2008. Since 2008, numerous product liability cases have been filed in the United States alleging that the local anesthetic, when dispensed by such infusion pumps inside a joint, causes a rare arthritic condition called “chondrolysis.” The Company believes that meritorious defenses exist to these claims and Breg is vigorously defending these cases. One of the Company’s insurance carriers has asserted to the Company that certain potential losses related to this matter are not covered by its insurance coverage, and the Company currently is in arbitration with this carrier.

 

On or about August 2, 2010, Breg received a HIPAA subpoena issued by the DOJ. The subpoena seeks documents from the Company and its subsidiaries for the period of January 1, 2000 through the date of the subpoena. The Company believes that document production in response to the subpoena is completed as of July 2012. The Company believes that this subpoena relates to an investigation by the DOJ into whether Breg’s sale, marketing and labeling of local infusion pumps for pain management, prior to Breg’s divestiture of this product line in 2008, complied with FDA regulations and federal law.  On January 27, 2012, the Company was orally notified by a U.S. Government official that a civil investigation of Breg was pending in connection with this matter.  The Company is currently cooperating with the U.S. Government in connection with this matter.

 

At the time of its divestiture by the Company, Breg was currently and had been engaged in the manufacturing and sales of motorized cold therapy units used to reduce pain and swelling. Several domestic product liability cases have been filed in recent years, mostly in California state court, alleging that the use of cold therapy causes skin and/or nerve injury and seeking damages on behalf of individual plaintiffs who were allegedly injured by such units. The majority of these cases are at an early stage and no conclusion can be drawn at the present time regarding their potential outcome. However, the Company believes that meritorious defenses exist to these claims.  In July 2012, a jury in one case returned a verdict providing for approximately $2.0 million in compensatory damages to the plaintiff against Breg, and could assess additional exemplary damages in the future.  The Company expects the $2.0 million compensatory award to be covered by existing insurance policies, while any exemplary portion of an award will not be covered by insurance.  The case remains subject to further post-verdict motions and appeals.