By: Scott B. Riddle, Esq.

What happens when a company wants to divest itself of a division or product that is not only performing poorly, it also carries potentially significant liability for trademark or patent infringement?  One option is to spin off the division, and its assets and liabilities, into another company.  What if the assumed liability for infringement ultimately takes the new entity into Bankruptcy?  Those were the issues before the United States District Court for the Northern District of Georgia in the case of  Weyerhaeuser Co. v. Lambert, as Litigation Claims Representative for Paragon Trade Brands, Inc., Civil Action No. 1:05-CV-1144-JEC (N.D. Ga. September 26, 2007) (click here for the opinion).

The basic facts are as follows: Weyerhaeuser was in the business of selling unbranded (or store branded) diapers that competed with the more well-known brands of Kimberly-Clark and Proctor & Gamble.  The product did well in the 1980’s, as Weyerhaeuser engaged in a "brand matching" strategy of incorporating features such as the elastic legs (see Pampers Cruisers and Huggies Snug & Dry).   However, P&G, not impressed with the "brand matching," obtained an injunction and $2.3 million infringement award against Weyerhaeuser in 1985. Weyerhaeuser’s sales and profits suffered considerably.

In the 1990’s, Weyerhaeuser tried to revive sales by adding a feature known as the "inner leg gather" that reduced "leakage" (no mention is made of "shrinkage").  P&G and Kimberly-Clark were not so impressed, as they had been marketing this feature since 1990 and claimed patents covering the feature.    Nevertheless, Weyerhaeuser’s sales went up. 

In 1991, in spite of the claims of patent infringement, Weyerhaeuser decided to divest itself of the diaper business and ultimately decided to form a new subsidiary, Paragon Trade Brands, transfer the diaper business to Paragon, then sell 100% of Paragon’s stock in an Initial Public Offering.  The IPO closed in February 1993.  At closing, Weyerhaeuser transferred the diaper business to Paragon via an Asset Transfer Agreement ("ATA"), and the individuals responsible for the brand at Weyerhaeuser became the new managers of Paragon. 

Pursuant to the ATA, Paragon assumed virtually all of the liabilities of Weyerhaeuser relating to the diaper business, including patent liabilities.  The potential liability was also disclosed in the prospectus.  Ultimately, negotiations with Kimberly-Clark and P&G failed, and P&G filed suit in Delaware District Court against Paragon.  In late 1997, P&G received a $178 million judgment, leading to Paragon’s Chapter 11 filing in January 1998.  Lambert was subsequently appointed as Litigation Trustee, and filed suit against Weyerhaeuser for breach of warranties contained in the Asset Purchase Agreement and an Intellectual Property Agreement ("IPA") when it transferred the diaper business to Paragon in 1993. 

After a trial, the Bankruptcy Court agreed and in a 141 page Order (click here for the Bankruptcy Court Order), granted summary judgment in favor of Paragon/Lambert. The Bankruptcy Court then entered judgment against Weyerhaeuser for $457.8 million, plus fees and expenses, after a damages trial.  Weyerhaeuser appealed and the District Court reversed and entered summary judgment in favor of Weyerhaeuser. 

More after the jump …  

The District Court, in reversing and entering Judgment in favor of Weyerhaeuser, held as follows:

1.  It was the express intent of the parties to assume the liability.  The Court founds that the contractual provisions were not ambiguous and at trial, Paragon’s attorneys conceded that Paragon expressly agreed to assume the liability –

In the IPA, Paragon specifically agreed to assume any liability arising from patent infringement claims . In IPA § 4 .01 the parties agreed that Paragon:

shall be obligated for and hereby agrees to indemnify, defend and hold harmless Weyerhauser for, from and against any and all liability, expense and costs asserted against, imposed on, or incurred by Weyerhaeuser, directly or indirectly, for patent infringement or  other similar claims involving products, processes, materials and/or equipment relating to the [diaper] Business or Products made, used or sold prior to, on or after the Closing Date.

(IPA § 4 .01, ER2-9 .)
In the Assumption Agreement, executed at closing, Paragon specifically agreed to assume the P&G and KC claims . Under the Assumption Agreement, Paragon assumed :

the Liabilities and obligations relating to all Actions related to or arising out of the operations of the [diaper] Business[] including, without limitation, all actions listed on Schedule 3 hereto ;

(Assumption Agreement at 2(g), ER3 – 2 .) Schedule 3 is titled "Actions ." (Id. at Schedule .) It includes the following description of the P&G claims :

The Company was notified in December, 1991 of the result of Proctor & Gamble’s analysis of the Company’s Ultra product and concerns about the infringement of U .S . Patents 4,695,278 (Lawson) and 4,795,454 (Dragon). Modifications of the Company’s product are being studied .  The Lawson patent was subject to an appeal resulting from a Kimberly-Clark Seattle suit . The appeal decision was generally in favor of Kimberly-Clark, Leaving the Lawson patent with narrow claims. Settlement discussions are continuing.

2.  The "Good Title Warranty" is not implicated. The potential liability was not an "encumbrance" that would implicate the warranty that Weyerhaeuser had good title to the transferred assets, and shifting the liability back to Weyerhaeuser is in direct conflict with the other provisions whereby Paragon expressly assumed the liability.  To the extent there was a conflict, the more specific provisions expressly transferring the liability controlled.

3. Weyerhaeuser did not breach the listed patents warranty.  The Bankruptcy Court found that Weyerhaeuser breached the listed patents warranty by failing to list or convey licenses for the Kimberly Clark patent.  However, the patents were not included on the patent schedule of the IPA because Weyerhaeuser did not own any right, title or interest in those patents. To the contrary, it would have been fraudulent for Weyerhaeuser to include the patents on the schedule.

4. Weyerhaeuser did not breach the warranty that the transferred assets were "sufficient to conduct the Business as now being conducted."  The Court paused somewhat on this one –

According to Paragon, these warranties guaranteed that Paragon "would be able to conduct the same baby diaper business in the future that Weyerhaeuser had been conducting," which predominantly consisted of selling the Ultra ILG diaper … Consequently, Paragon argues, Weyerhaeuser breached the warranties when " P&G’s judgment crushed Paragon and again when Paragon could not emerge from bankruptcy to continue its business without obtaining a license from KC."

… According to Weyerhaeuser, the warranties simply ensured that no asset used by Weyerhaeuser in the diaper business would be inadvertently omitted from the transfer… Thus, Weyerhaeuser argues, the warranties were intended to assure that Paragon, following the transfer, would be in the same position as Weyerhaeuser with respect to the operation of the business–no better and no worse. …

The adequacy and sufficiency warranties are part of a larger agreement
transferring Weyerhaeuser’s diaper business to Paragon. That agreement unambiguously indicates the parties’ intent for Paragon to accept the risk of patent infringement claims generally, and of the P&G and KC claims specifically… Paragon’s interpretation shifts liability for the same claims to Weyerhaeuser, negating a central feature of the parties’ agreement.’ … In fact, Paragon’s interpretation of the adequacy and sufficiency warranties is untenable in light of the parties’ specific warranty addressing patent infringement claims, which Weyerhaeuser indisputably did not breach.

 5. The extrinsic evidence favors Weyerhaeuser.   To the extent extrinsic evidence was appropriate to ascertain the parties’ intent and construe the writing, it supported Weyerhaeuser.  The prospectus conspicuously identified Paragon’s potential liability.*

* The court noted that this was not a securities case, so the adequacy of the disclosures in the prospectus were not at issue. 

Every person involved in the drafting of the agreements testified that the parties intended for Paragon to assume the risk of the infringement claims. 

 6.  The parties’ subsequent conduct supports Weyerhaeuser’s position.  Consistent with its acceptance of the patent liabilities, Paragon defended the litigation and never sought indemnification from Weyerhaeuser.

7. Paragon’s interpretation of the contracts is not reasonable.   Paragon’s position is essentially that Weyerhaeuser guaranteed that Paragon would be able to produce the product at a profit for an indefinite time, and thus that Weyerhaeuser did not transfer sufficient assets to do so. This interpretation would lead to uncertainty in the agreements.

In the order, and at trial, it is apparent that the bankruptcy court accepted Paragon’s characterization of Weyerhaeuser as a "bad actor ." (SJO at 42 .) The bankruptcy court apparently believed that Weyerhaeuser intended to use the APO to avoid its "mounting" infringement liability . (Id . at 16 . ) The court stated :

Weyerhaeuser’s game plan, clearly, was to stall, delay and postpone the inevitable financial disaster and assume a naive posture when possible . Weyerhaeuser was neither naive nor innocent . Weyerhaeuser walked Paragon off the plank .

(Id . at 42 .) Yet, the bankruptcy court managed to also find that the parties intended for Weyerhaeuser to maintain liability for the P&G and KC claims (the same claims it was so eagerly trying to avoid by transferring the business to Paragon) by virtue of the adequacy
and sufficiency warranties . (SJO at 39-44 .) The bankruptcy court’s holding fails to give effect even to its own characterization of the parties’ intent .

 8. Weyerhaeuser is entitled to summary judgment.

The ATA and IPA evidence a clear intent for Paragon to assume the risk of patent infringement claims arising from the operation of the diaper business . (ATA § 2 .02, ER1-9 ; IPA § 4 .01, ER2-9-10 .) The Assumption Agreement clarifies the parties’ intent for Paragon to assume all risk of liability related to the P&G and KC claims .  (Assumption Agreement, ER3 .) The warranties in the contract cannot  reasonably be interpreted to shift liability for these claims to  Weyerhaeuser . Under the express terms of the parties’ contract, Paragon is contractually responsible for the P&G and KC claims .

 9. Weyerhaeuser is entitled to indemnity for any liability for the K-C or P&G claims.

IPA § 4 .01 provides:

Patent, Trade Secret or Trademark Claims . Paragon shall be obligated for and hereby agrees to indemnify, defend and hold harmless Weyerhaeuser for, from and against any and all liability, expense and costs asserted against, imposed on, or incurred by Weyerhaeuser, directly or indirectly, for patent, trade secret, copyright or trademark infringement or other similar claims involving products, processes, materials and/or equipment relating to the Business or Products made, used or sold prior to, on or after the Closing Date.

(IPA § 4 .01) . The P&G and KC claims clearly come within this provision, requiring Paragon to indemnify Weyerhaeuser for any  liability arising from these claims .

In rejecting this argument , the bankruptcy court interpreted the IPA’s indemnity provision as limited to third-party claims . Specifically, the court found it "clear that the ‘claims’ for which Paragon agreed to indemnify Weyerhaeuser in Section 4 .01 are claims by third parties against Weyerhaeuser for patent infringement relating to the Business ." (SJO at 48 .)" This Holding is contrary to the express language of IPA § 4 .01, which requires indemnity for "any and all liability, expense [or] cost incurred by Weyerhaeuser, directly or indirectly ." (IPA § 4 .01 .) It also leads to illogical results . Under this interpretation of IPA § 4 .01,, if P&G and KC had sued Weyerhaeuser directly for patent infringement, Paragon would ultimately be responsible for the claims, but because P&G and KC sued Paragon, Weyerhaeuser is ultimately responsible . That P&G and KC decided to sue Paragon directly should not foreclose Weyerhaeuser from its contractual right to indemnity for claims that plainly come within the indemnity clause of IPA § 4 .01 . 

Giving effect to the unambiguous language of IPA § 4 .01, even if  plaintiff were entitled to recover damages from Weyerhaeuser under  any theory , it would also be entitled to indemnification for that same amount from Paragon .