13. Commitments and Contingencies

(a) Lease commitments

The Company leases office space, data processing equipment and software licenses under operating leases that expire on various dates through 2024. The lease agreements provide for rent escalations. Lease expense, exclusive of sublease income, for the year ended December 31, 2015, 2014 and 2013 was $5.4 million, $6.9 million and $7.6 million, respectively. Sublease income was $25,000, $42,000 and $0.3 million for the years ended December 31, 2015, 2014 and 2013, respectively.

Minimum annual lease payments to be made both under capital leases and operating leases, net of nominal sublease payments to be received for each of the next five years ending December 31 and thereafter are as follows (

in thousands

	Capital Lease Payments		Operating Lease Payments
2016	$	47	$	12,957
2017		4		10,133
2018		-		5,917
2019		-		3,544
2020		-		3,263
Thereafter		-		7,599
		51	$	43,413
Less: Interest		-
	$	51

(b) Litigation

Kern Health Systems

: In August 2011, in the Superior Court of the State of California, County of Los Angeles, Kern Health Systems (“KHS”) sought to recover in excess of $7.0 million exclusive of interest, attorneys’ fees and costs, against HMS’s wholly owned subsidiary Allied Management Group Special Investigation Unit, Inc. (“AMG”) and two of AMG’s former owners Dennis Demetre and Lori Lewis (collectively, the “Defendants”), jointly and severally, on causes of action for breach of contract, professional negligence, intentional misrepresentation, negligent misrepresentation and unfair business practices under the California Business and Professions Code. In June 2014, the jury issued its verdict in favor of all the Defendants, and against KHS, on all causes of action except negligent misrepresentation. On that cause of action, the jury issued a verdict against all the Defendants, jointly and severally, in the sum of $1.38 million. The negligent misrepresentation verdict was based on representations to KHS allegedly made by AMG and Demetre in the spring of 2008, prior to the Company’s acquisition of AMG. HMS believes that the jury erroneously awarded damages based on an error inasmuch as the jury unanimously found that the Defendants (through Demetre) made the negligent misrepresentation to KHS while having reasonable grounds for believing the representation to be true. Based on the jury’s verdict, HMS believes AMG is properly characterized as the prevailing party on the breach of contract claim. AMG has filed an appeal of the verdict and is seeking to recover its attorneys’ fees and costs in the sum of approximately $2.3 million. HMS has not recorded an obligation at this time, as the Company continues to believe that it is probable that AMG will prevail on the appeal of this matter, although there are risks and uncertainties related to any litigation, including appeals, and neither the Company nor its counsel can assure litigation results. Pending the appeal process, HMS was required to obtain a surety bond in the amount of 150% of the final judgment amount, or approximately $2.2 million, which was collateralized by a cash deposit and is reflected in other current assets on the Company’s Consolidated Balance Sheet as of December 31, 2015.

Dennis Demetre and Lori Lewis

: In July 2012, Dennis Demetre and Lori Lewis (the “Plaintiffs”), filed an action in the Supreme Court of the State of New York against HMS Holdings Corp., claiming an undetermined amount of damages alleging that various actions unlawfully deprived the Plaintiffs of the acquisition earn-out portion of the purchase price of AMG under the applicable Stock Purchase Agreement (the “SPA”) and that HMS had breached certain contractual provisions under the SPA. The Plaintiffs filed a second amended complaint with two causes of action for breach of contract and one cause of action for breach of implied covenant of good faith and fair dealing. Although the Plaintiffs also alleged an action based on fraud, the court dismissed that claim and further denied their subsequent appeal to resurrect the dismissed claim. HMS filed a counterclaim for breach of contract arising out of the Plaintiffs’ failure to indemnify the Company for costs, including attorneys’ fees arising out of the Company’s defense of the

Kern Health Systems

matter described above and for fraud and negligent misrepresentation arising out of the Plaintiffs’ misrepresentations concerning capabilities of their software platform. In July 2015, the court granted in part and denied in part the Plaintiffs’ motion to dismiss HMS’s counterclaims, allowing its counterclaim for breach of contract to proceed but dismissing the counterclaims for fraud and negligent misrepresentation. On January 4, 2016, HMS moved for summary judgment on (i) its remaining counterclaim for breach of contract against the Plaintiffs and (ii) the Plaintiffs’ breach of contract causes of action against HMS. A pretrial conference has been set for April 2016 but no trial date has been set. HMS believes it has a meritorious defense and will continue to defend this matter vigorously, although there are risks and uncertainties related to any litigation. As such, HMS has not accrued for any loss contingencies related to this matter because no assessment can been made as to the likely outcome of this lawsuit or whether the outcome will be material to the Company.

Restrictive Covenants, Trade Secret, Contract and other Causes of Action in Texas and New York

: HMS is the plaintiff in lawsuits filed in August 2014, entitled

HMS Holdings Corp., et al. v. Public Consulting Group, Inc., James Gambino and Jason Ramos

, in the District Court of Dallas County, Texas (the “Texas Action”), and

HMS Holdings Corp., et al. v. Matthew Arendt, Sean Curtin and Danielle Lange

, in the New York State Supreme Court, Albany County (the “New York Action”). In July 2015, HMS filed a third related lawsuit, entitled

HMS Holdings Corp., et al. v. Elena Moiseenko and Joseph Flora

, in the New York State Supreme Court, Albany County (the “Second New York Action”). These suits allege that, in violation of their respective contractual, statutory and common law obligations to the Company, defendants PCG, Joseph Flora and former HMS employees Gambino, Ramos, Arendt, Curtin, Lange and Moiseenko unlawfully misappropriated HMS’s confidential, proprietary and trade secret information and committed other wrong doing. The lawsuits seek damages and injunctive relief and assert causes of action including breach of contract, breach of fiduciary duty and misappropriation of trade secrets. HMS has sought injunctions in all three Actions.

In July 2015, the court in the Texas Action found that HMS had proved the existence of unlawful conduct and had demonstrated a probable right to recovery at trial regarding its claims against PCG, Gambino and Ramos and that an injunction was necessary to avoid imminent and irreparable harm to the Company. As such, the Texas court issued an order that granted a temporary injunction against those defendants that was ordered to remain in place through the time of trial in the Texas Action (the “Texas Injunction”). As a condition to obtaining the Texas Injunction, HMS was required to post a surety bond in the amount of $0.5 million. In August 2015, HMS filed an appeal of the Texas Injunction to, among other things, expand upon the relief the trial court had awarded in order to enjoin PCG from providing TPL services to State Medicaid agencies through the time of trial, which PCG, Gambino and Ramos cross-appealed. Oral argument in this matter is set for March 2016. Additionally, in August 2015, PCG filed a counterclaim against the Company in the Texas Action claiming damages for alleged business disparagement and for tortious interference with an existing contract and prospective business relations, which HMS denied. In October 2015, PCG moved for partial summary judgment on HMS’s claims requesting that the court enter a judgment in favor of PCG on the issue of damages suffered in connection with certain PCG TPL proposals. On December 4, 2015, the Texas court denied PCG’s motion for partial summary judgment. On December 14, 2015, PCG filed an application for temporary injunction that would prohibit HMS from referring to certain conclusions made by the court in the Texas Injunction, which relate to the conduct of PCG or PCG’s employees, as “factual findings” in the Company’s future discussions with state authorities charged with awarding TPL contracts. If granted, PCG’s temporary injunction would last through the time of trial in the Texas Action, which is set for April 25, 2016.

In May 2015, the court in the New York action issued an order granting HMS’s motion for spoliation against Curtin and Lange finding that these defendants had engaged in egregious misconduct regarding the wrongful destruction of evidence. The court ordered Curtin and Lange to repay the Company’s associated attorneys’ fees and costs. Pursuant to the court’s order, HMS is seeking reimbursement of approximately $0.45 million from these defendants. In July 2015, following the Texas court’s ruling on the Texas Injunction, the court in the New York Action issued its decision and order on HMS’s motion for a preliminary injunction against Curtin, Lange and Arendt. The New York court found that HMS had successfully established a likelihood of prevailing on its non-solicitation claims against all three defendants and on its trade secret misappropriation claims against Curtin and Lange; however, the court held that injunctive relief in the New York Action was not necessary due to the Texas Injunction. The court’s order also preserved the Company’s right to again seek injunctive relief in the New York Action in the event of a change of status regarding the Texas Injunction. Trial in the New York Action is tentatively set for June 6, 2016.

In August 2015, the court in the Second New York Action entered a temporary restraining order against defendants Moiseenko and Flora pending the court’s final determination of HMS’s application for a preliminary injunction in this matter. Flora generally denied HMS’s motion, and Moiseenko opposed it on its merits and filed a cross-motion to dismiss the complaint on the grounds of improper forum. On November 13, 2015, the court in the Second New York Action issued an order granting a preliminary injunction against Flora after concluding that HMS had demonstrated a probable right to recovery at trial on its claim that Flora had misappropriated and misused the Company’s trade secrets. The court’s order also granted Moiseenko’s motion to dismiss without prejudice to refiling in a proper forum.

As HMS has disclosed in previous filings with the SEC, in July 2015, HMS received notice that reprocurement of its TPL contract with the New Jersey Department of Human Services had been awarded to PCG. On February 12, 2016, HMS filed a protest with the State of New Jersey Division of Purchase and Property challenging the award. After multiple contract extensions, HMS’s current TPL contract with the New Jersey Department of Human Services expires on March 31, 2016. In addition, in August 2015, the New York State Office of Medicaid General Inspector (“OMIG”) awarded HMS the new Medicaid Third Party Liability Match and Recovery Services contract. PCG filed a protest of the award with the New York Office of the State Comptroller, which HMS and OMIG opposed. On January 8, 2016, HMS entered into an amendment to extend its existing TPL contract with OMIG through April 6, 2016. No decision has been rendered regarding the outcome of either protest.

While HMS believes its legal claims are meritorious, there are inherent uncertainties in any litigation, and there can be no assurances that HMS will ultimately prevail at trial or in legal proceedings related to the lawsuits, such as protests, or that the rulings in these proceedings are or will be adequate to protect the Company’s confidential or trade secret information or that the rulings or outcomes in these matters would not have an adverse effect on the Company’s business, financial condition or operating results.

From time to time, HMS may be subject to investigations, legal proceedings and other disputes arising in the ordinary course of the Company’s business, including but not limited to regulatory audits, billing and contractual disputes and employment-related matters. The Company’s contractual relationships, including those with federal and state government entities, subject HMS operations, billing and business practices to scrutiny and audit by those entities and other multiple agencies and levels of government, as well as to frequent transitions and changes in the personnel responsible for oversight of the Company’s contractual performance. Every so often, HMS may have contractual disputes with the Company’s customers arising from differing interpretations of contractual provisions that define the Company’s rights, obligations, scope of work or terms of payment, and with associated claims of liability for inaccurate or improper billing for reimbursement of contract fees, or for sanctions or damages for alleged performance deficiencies. Resolution of such disputes may involve litigation or may require that HMS accept some amount of loss or liability in order to avoid customer abrasion, negative marketplace perceptions and other disadvantageous results that could affect the Company’s business, financial condition, results of operations and cash flows.

HMS records accruals for outstanding legal matters when it believes it is probable that a loss will be incurred and the amount can be reasonably estimated. The Company evaluates, on a quarterly basis, developments in legal matters that could affect the amount of any accrual and developments that would make a loss contingency both probable and reasonably estimable. If a loss contingency is not both probable and estimable, HMS does not establish an accrued liability

As of December 31, 2015, HMS accrued $2.6 million for litigation or other legal proceedings asserted or pending against the Company that could have, in the aggregate, a material adverse effect on its financial condition, results of operations or cash flows, and believe that adequate provision for any probable and estimable losses has been made in its consolidated financial statements. Although HMS believes that none of the Company’s accruals for outstanding legal matters are material to the Company’s financial position, the ultimate result of any current or future litigation or other legal proceedings, audits or disputes is inherently unpredictable and could result in liabilities that are higher than currently predicted.