In re Paragon Trade Brands, Inc.
| Decision Date | 30 October 2002 |
| Docket Number | Bankruptcy No. 98-60390.,Adversary No. 99-6470. |
| Citation | 324 B.R. 797 |
| Parties | In re PARAGON TRADE BRANDS, INC., Debtor. Randall Lambert, Litigation Claims Representative for the Bankruptcy Estate of Paragon Trade Brands, Inc., Plaintiff, v. Weyerhaeuser Company, Defendant. |
| Court | U.S. Bankruptcy Court — Northern District of Georgia |
John A. Lee, W. Scott Locher, Andrews Kurth LLP, Houston, TX, for Plaintiff Randall Lambert, The Litigation Claims Representative.
ORDER GRANTING PLAINTIFF'S MOTION FOR PARTIAL SUMMARY JUDGMENT AND DENYING DEFENDANT'S MOTION TO STRIKE AND MOTION FOR SUMMARY JUDGMENT
This adversary proceeding is a breach of contractual warranty case. Randall Lambert, Plaintiff, was appointed as the Litigation Claims Representative for the Chapter 11 estate (the ") of Paragon Trade Brands, Inc. ("Paragon") pursuant to Paragon's confirmed Second Amended Plan of Reorganization1. Plaintiff filed this action against Weyerhaeuser Company ("Weyerhaeuser") on behalf of Paragon's Estate to recover damages for Weyerhaeuser's alleged breach of four warranties contained in the contracts by which Weyerhaeuser transferred to Paragon the assets relating to Weyerhaeuser's private label diaper business. The transfer of assets to Paragon was a part of Weyerhaeuser's initial public offering of Paragon's stock.
Before the Court are cross motions for summary judgment (the "Motions"). Plaintiff seeks an order granting partial summary judgment that Weyerhaeuser is liable for breaching the four contractual warranties. Defendant seeks dismissal of Plaintiff's Complaint. Defendant also has filed motions to strike certain summary judgment evidence filed by Plaintiff. The Court has reviewed the parties' motions and briefs, as well as all admissible evidence the parties submitted in support of their Motions. Oral argument was held June 24, 2002, on all the motions. At the conclusion of the hearing, the court announced its ruling granting Plaintiff's motion for summary judgment and denying Defendant's motions.
In late 1997, the United States District Court of Delaware (the "Delaware Court") entered judgment against Paragon2, enjoining it from selling its private label "Ultra" diaper, its primary product, because the diaper utilized a key "inner leg gather" ("ILG") feature that infringed patents of Proctor & Gamble ("P & G"). Paragon was also held liable to pay P & G $178 million in damages for infringement3. The judgment prompted Paragon, which then was the largest private label manufacturer of infant diapers in the United States, to file, on January 6, 1998, a petition for reorganization under Chapter 11 of the Bankruptcy Code to protect its assets (the "Chapter 11 Bankruptcy Case").
Weyerhaeuser formed Paragon in 1992 as the vehicle to dispose of the division comprised of its private label infant disposable diaper business through an initial public offering of stock ("IPO"). At closing of the IPO in February 1993, the assets and liabilities associated with Weyerhaeuser's private label diaper division were transferred to Paragon pursuant to an Asset Transfer Agreement ("ATA") and an Intellectual Property Agreement ("IPA"), and Weyerhaeuser concurrently sold 100% of Paragon's stock to new public investors. Weyerhaeuser received $240 million upon closing of the IPO.4
At the time of the IPO, Weyerhaeuser's private label diaper business consisted primarily of selling its "Ultra" private label diaper to large retail establishments that would place their retail name on the package and sell the diaper on their shelves at lower prices than the prices of the branded diapers (Luvs, Pampers, and Huggies) marketed by P & G and Kimberly-Clark Corporation ("K-C"). At the time of the IPO, Weyerhaeuser's Ultra diaper contained the ILG feature, which, in layman's terms, is a second, elasticized inner barrier cuff in the diaper that contains effluent and significantly reduces leakage. Reduced leakage is a key attribute consumers desire in an infant diaper; without it, Weyerhaeuser learned, a disposable diaper was not a successful product. Weyerhaeuser had begun production and marketing the Ultra diaper with the new ILG feature in March 1991.
When Weyerhaeuser launched the Ultra diaper using the ILG, profits increased as the connection predicted between utilizing the ILG and sales of Weyerhaeuser's diapers proved true. Tempering the Ultra's success, however, was the prospect of patent infringement lawsuits by the two branded-diaper market leaders, P & G and K-C, for infringement of their ILG patents. These two companies were known to be aggressive in enforcing their patents: Weyerhaeuser had already suffered a severe loss in the mid-1980s when P & G successfully sued Weyerhaeuser and obtained an injunction preventing Weyerhaeuser from using technology on its private label diaper that infringed another P & G patent. The significant shock to the financial condition of Weyerhaeuser's diaper business resulting from that injunction had reached a critical point in mid 1990.
By the time of the Paragon IPO in early 1993, P & G and K-C had completed litigation between themselves over their respective ILG patents, in which the Federal Circuit ruled that P & G's Lawson patent retained claims to ILG features. In confidential internal memoranda, Weyerhaeuser's patent counsel had acknowledged that those ILG features were used in Weyerhaeuser's Ultra diaper. Thus, Weyerhaeuser was left in the position of indisputably infringing the P & G ILG patents. Moreover, the priority-in-invention findings of Federal Circuit decision, as well as an interference action before the United States Patent & Trademark Office ("PTO") that also was decided before closing of the IPO, meant that K-C's ILG patent would soon be broadened by amendment to encompass all ILGs, including the ILGs used in Weyerhaeuser's Ultra diaper.
Following the Federal Circuit decision, P & G and K-C each demanded that Weyerhaeuser pay royalties of between 2% and 3% of sales for a license to use the ILG feature on Weyerhaeuser's diapers. P & G had made a 3% royalty demand on Weyerhaeuser well before the ILG diaper was launched in March 1991. Prior to closing of the IPO, Weyerhaeuser's patent counsel informed high ranking Weyerhaeuser executive officers that P & G would likely obtain an injunction against Weyerhaeuser for using the ILG feature, and Weyerhaeuser internally discussed how to limit its liability for infringement damages, including possibly creating a subsidiary company in which to place the diaper business. Weyerhaeuser's General Counsel told the company's auditor, Arthur Andersen, that damages from the threatened P & G infringement action could be "enormous" for Weyerhaeuser.
P & G renewed its demands on Weyerhaeuser in the months before the IPO closing in February 1993. K-C also made demands on Weyerhaeuser in the months before the IPO closed. At the time, the private label diaper business that Weyerhaeuser intended to sell to the public through the IPO had a profit margin of 7%. Paying even a single royalty in the 2%-3% range that P & G and K-C each were demanding would have severely cut the future company's anticipated cash flow, on which the IPO was premised. The Prospectus for the IPO, however, represented to public investors that "the Company [Paragon] believes that any outcome with respect to these matters will have no material adverse effect on its financial position or its results of operations."
Despite the ominous threats from P & G and K-C that Weyerhaeuser did not disclose, the IPO proceeded to close. In the ATA and IPA, Weyerhaeuser gave warranties about the assets and business it was transferring to the newly formed company, Paragon. Post-IPO events, including the injunction prohibiting Paragon from producing its Ultra diaper, demonstrate as a matter of law that Weyerhaeuser breached four of those warranties.
Two of the four warranties are set forth in the ATA. They were made with no qualifications as to Weyerhaeuser's knowledge. They provide, in relevant part:
3.01(d): The Transferred Assets and the services and materials to be provided pursuant to the Related Agreements [includes the IPA] are sufficient to conduct the Business as now being conducted.
3.01(c): [Weyerhaeuser] has, and will transfer to [Paragon] at the Closing, good title to all of the other Assets [all assets other than Real Property] ... free and clear of any and all mortgages, security interests, liens, claims, charges, options and encumbrances of any nature whatsoever, except for minor defects and irregularities in title or encumbrances that do not materially impair the use of any such Assets for the purposes for which they are held.
The other two warranties are contained in the IPA. They were each qualified "to the best of Weyerhaeuser's knowledge":
3.11(ii): Schedules 3.01(a) and 3.01(b) are accurate and complete lists of all Patent Rights and Trademarks, as used in connection with the Business or the Products.
3.11(vii): the Primary Intellectual Property plus Trademarks and Secondary Intellectual Property are adequate for the continuation of the Business as currently conducted.
The motions for summary judgment require this Court to determine whether, under applicable Washington law, which the parties agree governs, each of the warranties should be construed as a matter of law to have only one reasonable meaning; whether a genuine issue of material fact exists that the warranties, as properly construed, were breached; and whether an indemnity clause in the IPA (Section 4.01) precludes Paragon's breach of warranty claims.
A warranty is "an absolute undertaking in praesenti as well as in futuro, against the defect, or for the quantity or quality contemplated by the parties in the subject...
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