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Eldridge v. Gordon Brothers Group, L.L.C.

United States Court of Appeals, First Circuit

July 13, 2017

DAVID KAY ELDRIDGE; RAY ELDRIDGE, JR.; D. CHRIS ELDRIDGE, as trustee, not individually, of the C. Eldridge GST Trust; PATRICIA K. SAMMONS, as trustee, not individually, of the P.K. Sammons 1994 Trust; K'S MERCHANDISE MART, INC., Plaintiffs, Appellants,


          Thomas E. Patterson, with whom Kristi L. Browne and The Patterson Law Firm, LLC were on brief, for appellants.

          Theresa A. Foudy, with whom Turner P. Smith, Curtis, Mallet-Prevost, Colt & Mosle LLP, Richard M. Zielinski, Peter D. Bilowz, and Goulston & Storrs PC were on brief, for appellees.

          Before Torruella, Thompson, and Kayatta, Circuit Judges.

          THOMPSON, Circuit Judge.


         Today's case involves a moderately complex business dispute, rich with issues. On one side is plaintiff K's Merchandise Mart, Inc., which we call "Old K's" (for reasons that will soon become clear).[1] On the other side is defendant Gordon Brothers Group, L.L.C., which we call "Gordon, " along with two of its executives, defendants William Weinstein and Frank Morton. Old K's challenges orders by the district judge granting defendants summary judgment and requiring it to pay them $35, 000 in sanctions. After studying the briefs, the record, and the applicable law, we affirm the summary-judgment rulings but vacate the sanctions order and remand for reconsideration of the sanctions matter, assuming defendants still wish to pursue it.


         Consistent with the summary-judgment standard, we set out the essential facts in the light most complimentary to Old K's position, see Collazo-Rosado v. Univ. of P.R., 765 F.3d 86, 89, 92 (1st Cir. 2014) - even though the "facts, " as accepted for summary-judgment purposes, may not be the actual facts if the case went to trial.

         Old K's Precarious Financial Position

         Founded by David Kay Eldridge in 1957, Old K's sold clothing, appliances, sporting goods, jewelry, furniture, and other merchandise from retail stores in Illinois, Indiana, Iowa, Florida, Kansas, Kentucky, and Missouri. And Old K's saw many years of success. But by the early to mid-2000s, competition with ginormous retailers like Target, Wal-Mart, Best Buy, and Toys "R" Us caused Old K's financial distress - the company, for example, suffered a net loss of $1.8 million in 2004.

         Faced with mounting losses, Old K's hired the investment firm William Blair & Co ("Blair") sometime in 2005 to help sell the company before the end of the year. Blair explained that because Old K's was "unlikely" to find a buyer, "liquidation" was the "most logical" way to go.[2] Blair later hooked Old K's up with Gordon, a company known nationwide for its expertise in retail liquidations. Old K's hired Gordon in July 2005 to "provide preliminary advice and consultation to [Old K's] in connection with a possible orderly liquidation of [Old K's] 'big box' format stores" and to "develop a plan for the disposition of all inventory in the [s]tores with reference to the optimal timing of a 'store closing' or similar themed sale." Eldridge, Old K's president, would later testify that the reason Old K's retained Gordon was to get "different viewpoints and evaluate" Old K's "options" in case Old K's "decide[d] . . . to liquidate."

         Asked to analyze the liquidation value of Old K's merchandise and real estate, Gordon offered to buy Old K's in August 2005 for about $25 million. Convinced that Old K's was worth much more, Old K's rejected the offer and asked Gordon to finish its "[r]eal [e]state appraisal and inventory liquidation" analysis - adding that if liquidation ended up being the way to go, Old K's would do the liquidation itself before accepting an offer like the one Gordon had floated. But unfortunately for Old K's, its business continued hemorrhaging money in the months following Gordon's offer, posting losses of between $3.2 and $6.7 million for the fiscal year ending January 2006.

         And things turned from bad to worse for Old K's when its principal lender, LaSalle National Bank ("LaSalle"), sent it a notice of default for violating financial-performance covenants, slashed its credit line, and dishonored checks to its vendors. LaSalle's Robert Barnhard, a former Gordon employee, then met with folks from Old K's in February 2006. During this confab, Barnhard flatly disagreed with Old K's proposed plan to improve profitability by reducing inventory and asked Old K's to prepare a 13-week cash-flow projection and business plan. Barnhard also hired consulting firm Alliance Management, Inc. ("Alliance") to gauge Old K's performance. Issuing a report in late February 2006, Alliance noted that Old K's (a) had "[a]ccumulated losses . . . exceed[ing] $8 million dollars [over] a 3 year period, " (b) "fac[ed] significant liquidity challenges that are material to the continuing business operations, " and (c) had a "business model" that was outdated and "not sustainable." After getting Alliance's report, LaSalle demanded that Old K's liquidate by about mid-April 2006.

         Hoping to get LaSalle "off [its] back, " Old K's hired consulting firm Buccino & Associates ("Buccino") in March 2006, with the aim of convincing LaSalle to extend the liquidation deadline - Buccino's founder and LaSalle's president were "personal friend[s], " apparently. But Buccino struck out, meaning - according to Buccino - that Old K's "would be out of cash by October [2006], possibly as early as July [2006], " given its then-current financial and operational situation. A Buccino official later recounted how LaSalle was pretty ticked off with the state of affairs, and "they [meaning LaSalle] required quick action to either replace their loan to take them out or they would foreclose." That same official added that, given how over-collateralized the loan was, he "believe[d]" that Buccino "would have found a bank" to provide take-out financing - though he also said that despite having "talked to several lenders, " Buccino found "no interested parties" because of "the conditions that existed" and so Buccino's feeling was that Old K's "would probably have to file for bankruptcy." And in fact, Buccino prepared several liquidation analyses for Old K's.

         With no financial savior in sight, Old K's entered into a forbearance agreement with LaSalle in which Old K's (among other things) admitted to certain defaults, expressed an intent to hold a liquidation sale, and agreed to file a voluntary bankruptcy petition "on or about April 17, 2006." To help it navigate the complexities of the bankruptcy process, Old K's hired a powerhouse law firm, Mayer Brown LLP, and a communications consultant, Sitrick and Company. Old K's also solicited bids to liquidate its assets from several liquidation companies - Gordon (which had never given up the idea of acquiring Old K's, it seems), Hilco, American Group, and Tiger Capital.

         Gordon's Representations

         With the bankruptcy deadline fast approaching, Old K's reconnected with Gordon. And Gordon still had interest in acquiring Old K's. In an email to Gordon employees, Weinstein outlined his strategy:

Guys, we felt like there was $20 ml of equity in the deal 6 months ago. It did not erode that quickly. . . . This could be a classic out of court deal. We guarantee the bank to shut them up. We go to a creditor rights lawyer and hire them to represent the trade in an out of court. We either propose a pot plan or percentage plan distribution at less than 100% and more than a bankruptcy would pay them. We pick up the "equity" in the discount. We run through x-mas out of court.

         And during meetings in early April, Gordon made several representations to Old K's that are at the heart of this case: .

● After achieving a "composition" with Old K's creditors - a"composition" is "[a]n agreement to settle a dispute or debt whereby one party abates part of what is due or claimed, " see Composition, Black's Law Dictionary at 346 - Gordon planned to run the company as a going concern at least through the Christmas selling season before deciding on whether to continue operations, sell the company, or liquidate the company.
● Gordon had the expertise and experience to turn the company around and to keep it running.
● Gordon would get inventory flowing again by guaranteeing payment for future shipments from suppliers within a week.
● And Gordon would consult with the company's management before making any major decision affecting business operations.

         By the way, everyone knew at the time that if no creditor composition happened, Gordon would liquidate the company straight away.

         Rise and Fall of New K's

         After these comments, Old K's - represented by in-house and outside counsel - developed and executed a multi-step plan with Gordon:

         Step 1. Old K's signed a letter of intent - a document "detailing the preliminary understanding of parties who plan to enter into a contract or some other agreement." Letter of Intent, Black's Law Dictionary at 1044. As pertinent here, the letter of intent provided that Gordon would become the "exclusive agent" for Old K's "in connection with the continued operation and/or liquidation of the Company's business operations and disposition of assets of the Company, . . . all in [Gordon's] sole discretion" - though Gordon promised to "use best efforts to keep the Company's officers reasonably informed of [its] decision-making process."[3]Old K's attorneys at Mayer Brown added the words "and/or liquidation of" during the drafting process.[4] Two weeks after signing the letter of intent, Gordon's Morton emailed a colleague that he thought Gordon could "do 2 or 3 store wide events during the next 6 months without taking the juice out of the liquidation."

         Step 2. Gordon paid about $40 million to pay off Old K's debt to LaSalle, relieving Old K's from the imminent loss of its financing and from the LaSalle-demanded bankruptcy filing. Around this same time, Gordon decided to settle with Old K's creditor-suppliers, thereby avoiding an involuntary-bankruptcy petition by them. As part of that effort, Gordon's Weinstein worked with Old K's and its attorneys to draft letters to creditor-suppliers describing the plans for the new company. In one email, Weinstein suggested that Old K's tone down the draft:

Where it says [Gordon] desires to run this as a going concern, I would rather soften this to say that we will do so as we evaluate whether a restructuring of the company is feasible. Something like this. I do not want to sound like we are committing to this.

         A few days later, Weinstein returned to this theme, telling Old K's and its lawyers that the draft should not puff up Gordon's intentions:

It is clearly our intention to run the company for a period of time while we determine what the right configuration/make-up of the business is. We just want to be clear that this is a broken business that we see some underlying value in. However, there are no sure things here and we don't want to over promise.

         The letter did not get "softened in response to Weinstein's" comments (a quote lifted from the brief Old K's filed with us).

         Step 3. Gordon and Old K's entered into a Limited Liability Company Agreement ("LLC Agreement") in May 2006, with lawyers for Old K's taking part in the negotiations. The LLC Agreement created New K's Merchandise LLC ("New K's"), a Delaware company that inherited the business operations of Old K's. Old K's got a 22.5% membership interest in New K's, and Gordon got a 77.5% membership interest. The LLC Agreement designated Gordon as the "sole manager" of New K's. As manager, Gordon had the power to "exercise all the powers and privileges granted to a limited liability company" - including the right to liquidate the entity. But Gordon had to "use its best efforts to consult with [Old K's] regarding [Gordon's] conduct of the affairs of [New K's], " "keep [Old K's] fully informed of any material decisions and activities of [Gordon] with respect to [New K's], " and make documents available upon "reasonabl[e] request." The LLC Agreement also set up a "Liquidating Distribution" scheme, allowing Old K's to recover a minimum distribution of $3 million (subject to certain deductions) if the creditors were composed without a bankruptcy filing. The LLC Agreement had a choice-of-law clause specifying that Delaware law governs the parties' contract - as well as an integration clause, saying that the "Agreement . . . embodies the entire agreement and understanding among the parties hereto with respect to the subject matter hereof and supersedes all prior agreements and understandings relating to such subject matter."

         Gordon started running New K's business operations as of May 1, 2006 but kept key personnel from Old K's in place - including Richard Powers, Old K's chief financial officer, who stayed on as New K's chief financial officer. Powers later acknowledged that had Old K's not entered into the LLC Agreement, the most likely scenario would have been bankruptcy liquidation. And he also acknowledged that three weeks later, he got a "financial model" from Buccino (now working for New K's) that contemplated the company's running normally through October 2006 and then operating in "liquidation mode."

         After taking the reins of New K's, Gordon succeeded in composing the creditors outside of bankruptcy, getting them to take 50% of the amount owed and to release the shareholders of Old K's from potential claims. The creditors' advisor had told them that Gordon "has indicated that it intends to operate [New K's] at least through the coming Christmas season." And he later testified in his deposition that if Gordon "had already concluded as of May 1" that it was "going to liquidate this company, " then he was lied to. Anyway, a few weeks after the LLC Agreement's signing, Gordon started sending out financial guarantees to suppliers to restock the company. But it took a while to get the suppliers to start shipping again because - to quote a letter from Powers - "many of our vendors" wanted to wait "until the composition [of creditors] was approved and implemented, " which did not happen until mid-July 2006. Apparently some suppliers were still miffed that Old K's had stiffed them weeks earlier. And even with a "100 percent rock solid guarantee" from Gordon, some vendors "wouldn't ship" inventory to New K's, according to Gordon's Weinstein.

         Whether Gordon had tried its best to improve New K's operations, merchandising, advertising, etc., is a bone of contention between the parties. But in October 2006, having deemed the turn-around efforts a failure, Gordon publicly announced it was liquidating New K's and closing all stores by year's end. And when Gordon made that announcement, none of the plaintiffs complained to Gordon or took any action to stop the liquidation. New K's business operations eventually stopped in January 2007. And its wind-down phase started after that.

         At the beginning of the liquidation phase, Old K's tried to get financial and performance info from Gordon, but to no avail. Old K's did get $1, 748, 217 from Gordon sometime in March 2008 - a figure Gordon claimed represented the minimum $3 million distribution promised in the LLC Agreement, minus certain adjustments. Old K's eventually got some documents but asked for more because some appeared to be missing. And a bit later, Old K's received two CDs containing info that caused Old K's to suspect that Gordon had never intended to run New K's as a going concern.

         Off to Federal Court

         Old K's responded with this suit in federal court under diversity jurisdiction. Count I alleged defendants had fraudulently induced Old K's to enter into the LLC Agreement by (among other things) misrepresenting that defendants intended to turn the company around and that they had the know-how and the experience to do just that. Count II sought an accounting of New K's financial condition and operations, plus the handing over of documents Old K's had requested but had not gotten. And finally, Count III alleged defendants breached the LLC Agreement - a claim focused principally on a bunch of accounting, "best efforts, " and payment breaches, though the count included a sentence alleging defendants breached an implied duty of good faith and fair dealing inherent in the LLC agreement when they committed "the aforementioned fraud and mismanagement."

         After each party inflicted tons of discovery on the other, defendants moved for partial summary judgment. Pertinently, defendants argued that the fraudulent-inducement claim failed because the complained-of comments (a) were not actionable misrepresentations and (b) were too vague or immaterial (or both), so any reliance on the part of Old K's was unreasonable, especially given express contract terms inconsistent with the alleged promises and the integration clause that explicitly disavowed commitments not included in the contract (and by contract, defendants meant the LLC Agreement). Defendants also insisted that the breach-of-contract claim misfired "to the extent it purport[ed] to assert a claim for breach of the implied covenant of good faith and fair dealing arising out of the LLC Agreement." Any such claim, defendants wrote, flopped because Old K's did not identify "which of the allegations of fraud and/or mismanagement" infracted the covenant - and, defendants added, any suggestion that a breach of that covenant occurred because defendants did not set out to turn New K's around fizzled since the LLC Agreement gave Gordon the authority to liquidate New K's. Old K's opposed defendants' partial-summary-judgment motion but did not file its own summary-judgment motion at that time.

         Basically agreeing with defendants' analysis, the judge granted defendants partial summary judgment on the claims of fraudulent inducement and breach of an implied covenant of good faith and fair dealing. The judge then ordered the parties to file a joint-status report explaining what further action was needed to get this case to final judgment.

         Responding, Old K's pertinently said that what remained against defendants were (a) an accounting claim; (b) a breach-of-contract claim for failing "to consult" with Old K's and failing to correctly "calculat[e] Plaintiff's share in the 'Accounting'" that "forms the basis of the distribution made to Plaintiff"; and (c) a claim for breach of the implied covenant of good faith and fair dealing given the way defendants "operat[ed]" New K's. Among other things, defendants insisted that the judge had already dismissed "the breach of the implied covenant claim." And they said that they might ask "for permission to file" another summary-judgment motion - "depending on the exact contours of the elements of Plaintiff's remaining claims."

         At a follow-up conference, the judge said he was "not going to sort through" whether he had dismissed the "breach of the implied covenant claim." "[Y]ou can deal" with that in a summary-judgment motion, the judge added. And then the judge gave defendants the go-ahead to move for summary judgment on the still-existing claims. Turning to counsel for Old K's, the judge said he assumed "from plaintiff['s] musings" that it does not "believe that [it] can file for summary judgment, so [it] will be opposing defendants'" summary-judgment motion. The attorney for Old K's said nothing in response.

         Roughly two weeks after the conference, though, Old K's asked the judge for leave to cross-move for summary judgment on all the "remaining claims" it had identified. Defendants opposed this request, insisting Old K's could not point to uncontested facts establishing its right to judgment as a matter of law - hence dealing with a cross-motion for summary judgment would waste defendants' and the judge's time and energy. The judge ultimately gave Old K's permission to file a summary-judgment motion - but the judge "advised" counsel "to consider the application of Fed.R.Civ.P. 11 to any such motion if the motion has no conceivable likelihood of success."[5]

         In their second summary-judgment motion, defendants - as relevant here - argued as follows: The judge had already tossed out the entire claim for breach of an implied covenant of good faith and fair dealing, meaning - defendants' argument continued - that Old K's was dead wrong to suggest that a claim premised on their "operation" of New K's somehow survived the judge's earlier edict. Defendants also asserted that the accounting claim got mooted by the documents they had produced during the many years of discovery. They also later argued Old K's did not respond to their accounting-claim arguments and so the judge should dismiss that claim. As for the breach-of-contract claim, defendants contended that, as argued by Old K's, this claim basically boiled down to three theories - (a) defendants had wrongly failed to consult with Old K's; (b) they had wrongly denied Old K's its share of the profits because they did not account for $13.9 million in "missing inventory"; and (c) they had wrongly calculated the liquidating distribution. And having framed the breach-of-contract claim this way, defendants said they should prevail because (a) "it is impossible to imagine a measure of damages" for the failure-to-consult "breach that would not be unduly speculative"; (b) Old K's debuted the "missing inventory" damages theory after discovery had closed, a discovery violation that called for the theory to be stricken under Fed.R.Civ.P. 37(c); and (c) the evidence showed defendants had given Old K's the correct liquidating distribution.[6]

         Old K's opposed defendants' motion and cross-moved for summary judgment in its favor. As Old K's saw it, defendants had breached the implied covenant of good faith and fair dealing by mismanaging New K's furniture department and had breached the LLC Agreement by not making the proper distribution payment.

         Defendants, in turn, opposed the motion by Old K's. And convinced that this motion had "no chance" of succeeding, they also moved for Civil-Rule-11 sanctions against the attorneys representing Old K's - a motion opposed by Old K's.

         The judge granted defendants' summary-judgment motion and denied the cross-motion by Old K's. And on top of that, the judge ordered Old K's to pay defendants $35, 000 in sanctions for filing what he ...

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