A company’s failure to meaningfully market its assets led to the dismissal of its attempted chapter 11 reorganization. As a result, a Massachusetts court held in a detailed opinion that an acquiring company was the successor to the company it acquired, and therefore liable for an $8.8 million debt.
Upon cross-motions for summary judgment, the Superior Court in Milliken & Co. v. Duro Textiles, LLC, 19 Mass L. Rptr. 509, 2005 WL 1791562 (Mass. Super. June 14, 2005) held that Duro Textiles (“Textiles”) was the successor to Duro Industries (“Duro”), and therefore liable for the payment of the debt owed by Duro to Milliken. A bench trial followed on the issues of whether Milliken was guilty of “unclean hands” or “lack of innocence.” The trial also assessed the liability of the equity owners of Textiles for Milliken’s debt under veil-piercing theories. Duro was once a significant force in the domestic textile industry. Following a series of transactions that began in December 2000, with Patriarch buying a minority interest in the syndicated secured debt of Duro, Patriarch became the holder of Duro’s secured debt, and an owner of 51 percent of the equity. This occurred by July of 2002, when Duro was in the zone of insolvency. Prior to this time, Patriarch had no power to control the board of directors, officers or management of Duro, and did not attempt to do so. Milliken, a textile giant, was a major and long-term supplier to Duro. In May 2001, Duro owed Milliken $2.2 million, with $100,000 on “bill and hold.” By September 2001, Duro’s debt to Milliken never had gone below $8 million. Between May 2001 and July 2002, Milliken was aware of Duro’s financial issues. During the same period, Milliken began to develop products that could be direct competitors of some of Duro’s products.
During the summer of 2002, an effort was made to effectuate a consensual restructuring, which included a proposal made by Patriarch to cut its secured debt3 and to infuse new capital, provided that it would receive additional equity. The plan also called for the trade creditors to accept a substantial discount. Milliken, put off by a “take it or leave it” meeting with Patriarch’s management that occurred Aug. 6, 2002, chose not to accept the restructuring proposal. Following that meeting, Milliken demanded full payment of its outstanding balance.
On Aug. 9, 2002, given the company’s tight cash, and failing to achieve a consensual restructuring, the Board of Directors of Duro voted to file a chapter 11 petition. The goal was to have Duro continue as a going concern. Patriarch planned on being a stalking horse bidder, and believed that it would acquire Duro by credit bidding its secured debt. Patriarch also planned to offer DIP financing to enable Duro to continue to operate until the sale could be concluded. Patriarch made an offer to pay the unsecured creditors $700,000; the Creditors’ Committee believed that Patriarch should pay $1.7 million to the unsecured creditors.
Because an agreement was not reached, the Committee and the United States Trustee challenged the debtor’s marketing efforts. “Milliken’s counsel advocated for the immediate dismissal of the chapter 11, arguing that the marketing was a sham designed to guarantee a sale to the secured lender and shareholder—Patriarch.” The bankruptcy court found that there was no meaningful marketing of the assets and dismissed the chapter 11 proceeding. Milliken stopped supplying Duro.
Immediately after the chapter 11 dismissal, Patriarch scheduled a foreclosure sale pursuant to Article 9 of the Uniform Commercial Code. A newly formed affiliate of Patriarch was the winning bidder5; the purchase was financed by a secured term loan of $22.5 million extended by the previous Patriarch lenders. Following the sale, management remained the same, as did the operations.
Had the marketing process been adequate and the chapter 11 case not been dismissed, the trade debt could have been eliminated. However, the chapter 11 case was dismissed, and the state court found Textiles to be the successor of Duro.
Following the sale, Textiles needed more cash, and Patriarch lent an additional $20 million in working capital. Patriarch and Duro maintained that Milliken should not be able to successfully assert successor liability because it inequitably created the debt at issue out of an anti-competitive purpose.
The court disagreed, determining instead that Milliken acted for a proper business purpose and not with a dishonest or fraudulent intent to harm Duro.
The defendants also asserted that Milliken acted inequitably in failing to accept the restructuring offer made by Duro in 2002 prior to the chapter 11 filing.
The court found that “Milliken acted in accordance with its own business interests and not out of ill will or a dishonest purpose.” “Similarly, Milliken’s post-bankruptcy refusal to supply Duro with product was based on a legitimate souring of the relationship, no doubt fueled by [Patriarch’s] abrasive conduct as well as what had transpired in the bankruptcy court…. Milliken’s suit was a proper attempt, made in good faith, to collect a trade debt validly owed.
In addition, the court concluded that Milliken was an “innocent creditor,” and entitled to recover from Textile, as the successor to Duro.
Corporate Veil Not Pierced
Despite its support of Milliken’s position, the court refused to pierce the corporate veil and denied Milliken recovery against Patriarch. Importantly, the court found that there was no common ownership between Patriarch and Textiles.
“Patriarch is wholly owned by Tilton, while Textiles is comprised of Ark I and AIP, investment funds owned almost entirely by outside investors,” the court stated.
The court did consider “pervasive control” as a factor that weighed heavily toward piercing the veil, noting that Lynn Tilton was both the principal of Patriarch and the president of Duro Textile Management, Inc. (the general partner of Textiles). Nonetheless, evidence at trial established that Patriarch did not exercise control over the day-to-day operations of Textiles. There was no blurring or intermingling of the business activities, assets or management between Patriarch and Textiles.
As to the “thinly capitalized” prong of piercing, the court concluded Milliken was no worse off after the sale than it was before the sale. The court found no evidence that Patriarch was siphoning away Duro’s or Textiles’ corporate assets. Milliken also argued that the corporate veil should be pierced because “Textiles was formed for the fraudulent purpose of allowing the Ark Lenders to cleanse Duro of its unsecured debt.”
“Although this court has concluded that the status of the Ark Lenders as majority shareholders of Duro Industries warrants the imposition of successor liability on Duro Textiles, such liability was imposed under the de facto merger and mere continuation theories and not on the basis of fraud,” the court stated. “This is not one of those rare cases in which piercing the corporate veil is warranted in order to prevent gross inequity.
“The Article 9 sale which the Ark Lenders, as secured creditors, had every right to conduct created no injurious consequences because Milliken is entitled to judgment against Duro Textiles for the amount owed to it by Duro Industries,” the court further stated. “There is no credible evidence that the Article 9 sale of the assets of Duro Industries to Duro Textiles left Milliken in any worse position than it would have been in had the assets been sold to an entity other than the one owned by the majority shareholders of Duro Industries.”