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April 20, 1992

JOHN MORRELL & CO. Defendant.

The opinion of the court was delivered by: ROBERT P. PATTERSON, JR.


 This is an action for damages alleging breach of contract. Having completed discovery, Plaintiff moves pursuant to Rule 56 of the Federal Rules of Civil Procedure for summary judgment on its first claim. For the reasons set forth below, Plaintiff's motion is granted.



 The key figures in this action are Plaintiff Congress Financial Corporation ("Congress") a factoring and financing company; Defendant John Morrell & Co. ("Morrell"), a meat packer; and non-party Dinner Bell Foods, Inc. ("Dinner Bell"), *fn1" a meat packer with principal operations in Defiance and Troy, Ohio.

 In June 1988, a corporation controlled by Joshua Leibovitz, with financial support from Citicorp Venture Capital, Ltd. ("Citicorp"), acquired control of Dinner Bell in a leveraged buyout. Institutional financing for Dinner Bell was provided by a term loan from Glenfed Financial Corporation ("Glenfed") and by a three year revolving credit facility supplied by Congress. Glenfed's term loan was secured by a first lien on Dinner Bell's fixed assets, including its equipment, machinery, real estate, patents, and trademarks. Congress' revolving credit facility was secured by a first lien on Dinner Bell's accounts receivable, inventory, work in process, and other miscellaneous assets. Congress and Glenfed each received a junior lien on the collateral pledged by Dinner Bell to the other.

 The Congress revolving credit facility commenced on June 3, 1988 with a "credit line," or upward limit, set at $ 15 million. *fn2" The actual funding available to Dinner Bell at any given time was calculated by a formula which factored in certain collateral on hand at Dinner Bell (the "Advance Formula"). The Advance Formula permitted loans to Dinner Bell equal to the sum of 85% of its eligible accounts receivable, 65% of its eligible product inventory, and 30% of its eligible supplies. To assist Congress in its calculation of funds available under the Advance Formula, Dinner Bell provided Congress with daily "Loan Collateral Reports," which set forth Dinner Bell's outstanding loan balance, its accounts receivable, its product inventory, and its supplies inventory. Because these amounts varied from day to day, Dinner Bell's financing eligibility varied on a daily basis. *fn3" The Advance Formula remained in effect and unchanged until Dinner Bell filed for bankruptcy on October 17, 1990.


 After the leveraged buy-out, Dinner Bell's business declined substantially, and financial difficulties resulted. In the Spring of 1990, Morrell began seeking a purchaser for certain of its assets, and Citicorp, Dinner Bell, and Morrell began negotiations toward such a sale. Pursuant to those negotiations, on July 25, 1990, Morrell issued Dinner Bell a "Letter of Intent" for the purchase of Dinner Bell's plant in Wilson, North Carolina and all of the intellectual property used in connection with Dinner Bell's business. On August 1, 1990, a team of Morrell representatives commenced an on-site review of Dinner Bell's business and operations. Although this review was denominated in a Morrell document as "Due Diligence," *fn4" Morrell disputes whether this review was sufficiently thorough to constitute "due diligence."

 The transaction formally closed on October 2, 1990, at which time the following agreements were signed by Dinner Bell, Morrell, and Congress.

 A. Asset Acquisition Agreement

 Dinner Bell and Morrell entered into an "Asset Acquisition Agreement" wherein Morrell purchased Dinner Bell's Wilson, North Carolina plant, all of the intellectual property used in connection with Dinner Bell's business, and certain other assets. The purchase price consisted of $ 3,990,000 in cash to be delivered on closing; $ 500,000 to be paid on the first anniversary of the closing date, less any amounts owing from Dinner Bell to Morrell resulting from Dinner Bell's breach of any agreement with Morrell; and a five cent ($ .05) per pound royalty on all processed meat sales subsequently made by Morrell under the Dinner Bell name up to a maximum of $ 12 million.

 B. Co-Pack Agreements

 Morrell and Dinner Bell entered into two separate "Co-Pack Agreements" involving the post-closing purchase by Morrell of Dinner Bell products. The Co-Pack Agreements were to remain in effect while Morrell transferred Dinner Bell's packing operations to its own plants. One Co-Pack agreement was to terminate in 60 days; the other was to remain in effect indefinitely, but could be terminated with notice after 120 days.

 C. Congress/Morrell Agreement

 Congress, Dinner Bell, and Morrell entered into the "Congress/Morrell Agreement." In consideration for the release by Congress of its security interests in and liens upon the Dinner Bell intellectual property and related assets sold by Dinner Bell to Morrell, Morrell acknowledged that Congress had a perfected security interest in and liens upon Dinner Bell's collateral for the revolving credit facility, including Dinner Bell's accounts receivable and inventory. Morrell agreed, inter alia, to pay to Congress within four days of receipt all invoices rendered by Dinner Bell for products purchased, received, and re-sold by Morrell, without offset, claim, counterclaim, or deduction.

 D. Financing Amendment

 Congress and Dinner Bell also signed a letter agreement entitled "Amendment to and Termination of Financing Agreements" (the "Financing Amendment") reflecting the terms pursuant to which Congress would continue to extend financing to Dinner Bell until November 30, 1990.


 On September 29, 1990, just prior to the closing, Dinner Bell conducted its customary fiscal year-end (September 30) inventory at its two Ohio plants. The memorandum setting forth the procedures to be followed during the inventory included procedures specifically requested by Morrell. Dinner Bell representatives did the actual inventory count, and Dinner Bell's accountants, Ernst & Young, were present observing. Both Congress and Morrell also sent representatives to observe the inventory. Morrell sent a four person team headed by its Assistant Corporate Controller to the Defiance plant. A second Morrell team headed by Morrell's Cost Controller went to the Troy plant. Pl. 3(g) Stmt. PP35-36. Because no Congress personnel were available, Congress engaged Richard J. Kaminski, an accountant and former employee of a Congress subsidiary, as its representative. Mr. Kaminski was present at the Defiance plant on September 29, and he went to the Troy plant the following day. Affidavit of Edwin E. Stern, sworn to on November 14, 1991 ("Stern Aff."), P19; Pl. 3(g) Stmt. P36.

 Mr. Kaminski was unable to reconcile his calculation of "priced" inventory as stated on the internal inventory report with the Loan Collateral Report, finding that the figure on the Loan Collateral Report exceeded that on the internal inventory report by $ 501,000. Kaminski Dep. at 108.

 That afternoon, Mr. Kaminski called Edwin Stern, a Senior Vice President of Congress, related that he was unable to reconcile the inventory as priced, and reported that he had asked a Dinner Bell employee, Dave Beck, for a reconciliation. Mr. Kaminski testified that he did not state to Mr. Stern that Dinner Bell had overstated its inventory on the Loan Collateral Report, but rather, "I told him I had inability to reconcile these numbers and we both agreed to give it to Dave Beck to have him reconcile it by the time we got back or I got back." Kaminski Dep. at 108-9.

 Mr. Stern states that after speaking with Mr. Kaminski, he placed a telephone call to Richard Mayberry of Citicorp and advised him of Mr. Kaminski's inability to reconcile the August month-end reports. Stern Aff. With Mr. Stern still on the telephone, Mr. Mayberry placed a telephone call to Stan Frieze, a "crisis manager" who was then running Dinner Bell's operations and who was in Ohio for the closing. Mr. Mayberry instructed Mr. Frieze to follow up on the matter and to provide the reconciliation to Congress. Mr. Stern states that he "did not reach any conclusion about the quantity of the inventory on October 1, 1990 because of the question raised by Kaminski." Stern Rep. Aff. PP19-23.

 Mr. Frieze testified that Mr. Stern did not tell him that there were overstatements of inventory by Dinner Bell on the Loan Collateral Reports, but only that an auditor had noticed a discrepancy between the two reports. He testified that the matter was referred to the Dinner Bell controller to resolve the discrepancy. Nowhere in his deposition does Mr. Frieze indicate that prior to the closing either he or anyone from Morrell concluded that Dinner Bell had been overstating its inventory on the Loan Collateral Reports. Deposition of Stan Frieze of April 22, 1991 ("Frieze Dep.") at 69-71.

 On October 1, 1990, Congress advanced Dinner Bell $ 528,000, and on October 2, 1990, the day of the closing, it advanced Dinner Bell $ 101,000 based on the Loan Collateral Reports sent on those days. On October 3, 1990, the day after the closing, Mr. Frieze sent a memo to Dinner Bell's owners reporting Dinner Bell's discovery that for over a year its former chief financial officer had been systematically overstating Dinner Bell's inventory on the Loan Collateral Reports sent to Congress. Affidavit of Jerome Coleman, sworn to on January 15, 1992, Exh. 6. This information was communicated to Congress and Morrell that same day. When Dinner Bell adjusted the inventory level reported on the Loan Collateral Reports to account for this overstatement, the level of financing for which Dinner Bell was eligible under the Advance Formula was reduced substantially. Dinner Bell received only about $ 18,000 from Congress on the day after the closing. Congress did not, however, modify the Advance Formula, and it continued to advance funds to Dinner Bell. For example, on October 10, 1990, Congress advanced some $ 100,000 to Dinner Bell.

 Morrell paid Dinner Bell $ 3,900,000 on the day of the closing. That money was used by Dinner Bell as follows: $ 2,500,000 was delivered to Glenfed; approximately $ 1.1. million was used to pay selected past due accounts payable and to repay selected other debts; the balance of approximately $ 400,000 was to be used by Dinner Bell as working capital, but was withdrawn by Chemical Bank to cover overdrafts on Dinner Bell's checking account. Pl. 3(g) Stmt. P42. It is not disputed that Congress was not to receive, and did not receive, any portion of the Morrell payments at the closing. Pl. 3(g) Stmt. P41.

 Despite this influx of cash, as a result of its deteriorated financial condition Dinner Bell was unable to continue to purchase raw materials needed for production. On October 17, 1990, Dinner Bell declared bankruptcy, ceased operations, and stopped performing its Co-Pack Agreements with Morrell.

 Before declaring bankruptcy, however, Dinner Bell had processed its remaining inventory and delivered finished products to its former customers for the account of Morrell. The 34 invoices for these products totalled $ 2,706,854.36, and Dinner Bell billed Morrell for this amount. Pursuant to the revolving credit facility and the Congress/Morrell Agreement, Dinner Bell assigned the invoices to Congress. Under the Congress/Morrell Agreement, payment was due to Congress from Morrell four days after receipt of the invoices.

 On October 5, 1990, Morrell Senior Vice President Mark Littman notified Mr. Stern that Morrell had verified receipt of $ 450,428.38 in products from Dinner Bell and was wire transferring that amount to Congress. This represented the amount due from one invoice. During the next several days, Mr. Stern spoke to Mr. Littman and inquired about further payments due from Morrell. Mr. Littman responded that Morrell had not yet verified receipt of additional products. By October 15, 1990, when Congress had not received any further payments from Morrell, and Mr. Stern was unable to ascertain from Morrell when payment of the balance was forthcoming, Congress served a demand for payment on Morrell. On October 16, 1990, Morrell responded that it was refusing to pay any of the other invoices. Congress instituted this action imminently thereafter. Whether Morrell continued to receive the benefit and profits of deliveries of Dinner Bell products to Morrell customers, but failed to disclose to Congress its intent not to pay for those products is not established.

 Congress charges that after applying certain credits, there remains a balance due from Morrell of $ 1,876,809.31. Congress now moves for summary judgment against Morrell with respect to this claim. *fn5" Morrell offers no evidence that this balance is incorrect, but instead maintains that it has valid offsets and counterclaims against Congress.


 It its answer, Morrell alleged as affirmative defenses and counterclaims: that prior to the closing, and at least once in September 1990, Congress conducted an examination of Dinner Bell's inventory; that Congress learned that Dinner Bell's inventory was less than Dinner Bell had represented to Morrell; that Congress did not disclose to Morrell that Dinner Bell had overstated its inventory to Morrell; that this failure to disclose caused Morrell to enter into a transaction it would not have entered into had it known the inventory was overstated; and that this failure to disclose constituted negligence, fraud, or breach of the implied covenant of good faith and fair dealing in the Congress/Morrell Agreement.

 Congress moved for summary judgment with respect to the defenses and counterclaims asserted in Morrell's answer. Morrell's answering papers on this motion provide no support for essential elements of the claims asserted in its answer: that Congress conducted an examination of Dinner Bell's inventory, that Congress learned that Dinner Bell's inventory was less than Dinner Bell had represented to Morrell, and that Dinner Bell's inventory was in fact overstated in reports to Morrell. The Dinner Bell-Morrell transaction did not involve the purchase of Dinner Bell's inventory by Morrell, and Thomas Davis, a Morrell Senior Vice President, states that Morrell was "not particularly interested in the [Dinner Bell] inventory levels." Deposition of Thomas Davis of May 16, 1991 ("Davis Dep.") at 22.

 In its motion papers, however, Morrell sets forth a different theory from that asserted in its answer. *fn6" Morrell maintains that Congress' discovery of the discrepancy in the priced inventory reported in the August 31, 1990 Loan Collateral Report was material information in light of an alleged oral agreement between Congress and Morrell that Congress' level of financing of Dinner Bell after the closing would be comparable to its level prior to the closing. Def. Br. at 5-7. Morrell asserts that the continued financing of Dinner Bell by Congress was essential to ensure that Dinner Bell could continue its operations and comply with the terms of the Dinner Bell-Morrell Co-Pack Agreements. Mr. Davis states that:

 A crucial element in the success of the co-pack agreements was Congress' continued financing of Dinner Bell so as to allow Dinner Bell to have sufficient working capital to purchase raw materials for production and sale.

 While Congress did not initially not want to continue providing such financing to Dinner Bell, I - - and other Morrell personnel - - informed Congress and Dinner Bell on several occasions that Morrell would not continue to pursue the deal if Congress' financing of Dinner Bell did not remain intact after the closing on October 2, 1990.

 These discussions were between Mark Littman, Henry Thoman and me, for Morrell, and Edwin Stern and Robert Miller for Congress, and Stanley Frieze, for Dinner Bell.

 * * *

 After intense negotiations on this issue of continued financing by Congress, Congress relented and agreed to provide the continued financing of the type and amounts regularly advanced in ...

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