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General Nutrition Corp. v. Gardere Wynne Sewell

July 21, 2010

GENERAL NUTRITION CORPORATION, PLAINTIFF,
v.
GARDERE WYNNE SEWELL, LLP., DEFENDANT.



The opinion of the court was delivered by: Terrence F. McVerry United States District Court Judge

MEMORANDUM OPINION AND ORDER

Pending before the Court are the MOTION FOR SUMMARY JUDGMENT (Document No. 83) filed by Defendant Gardere Wynne Sewell, LLP ("Gardere") and the MOTION FOR PARTIAL SUMMARY JUDGMENT (Document No. 87) filed by Plaintiff General Nutrition Corporation.*fn1 The motions have been thoroughly briefed (Document Nos. 85, 88, 90, 98, 104, 106, 108, 109, 112), and extensive appendices have been provided.*fn2 The Court heard oral argument on May 27, 2010 and the motions are ripe for disposition.

Factual Background

This is a legal malpractice case. The "GNC" business consists of a family of numerous companies that operate retail stores, and sell vitamins, nutritional supplements and diet products. Plaintiff General Nutrition Corporation is the "operating" company in the family, owns the retail stores, has approximately 14,000 employees, and is the signatory on the retail leases. However, Plaintiff General Nutrition Corporation does not pay any bills or have its own checking account. Deposition of Lisa Davis, Vice President and Corporate Controller ("Davis Deposition") at 39. A separate corporate entity, General Nutrition Incorporated, serves as the "banker" in the GNC family. Two ultimate parent companies, GNC Corporation and General Nutrition Centers, Inc. (collectively, the "Parent Companies"), existed in the GNC family during the 2004-2005 time frame at issue in this lawsuit.*fn3

In September 2001, Plaintiff General Nutrition Corporation and Basic Media/Franklin Publications, Inc. ("Franklin") entered into contracts (the "Franklin Contracts") for the production, advertising and targeted delivery of two magazines, Let's Live and Physical. These publications comprised a large part of GNC's marketing strategy and budget.

In 2003, a private equity investment fund, Apollo Management LP ("Apollo"), acquired 100% of the GNC family of companies for approximately $750 million. Peter Copses, a senior partner at Apollo, was the individual primarily responsible for the acquisition of the GNC family of companies. At the time, sales and profits of GNC were declining, and Apollo's objective was to turn the business around. After the acquisition, Copses was a member of the Boards of Directors of each of the Parent Companies, initially serving as chairman of the Boards.

In June 2004, Louis Mancini, then Chief Executive Officer ("CEO") of the GNC family of companies, signed agreements to extend the Franklin Contracts through December 2009, at an annual cost of $10-11 million. In November 2004, Mancini was terminated from his position as CEO. Robert DiNicola, whom Copses initially had engaged as a consultant due to his experience in the retail industry and marketing expertise, became interim CEO, Chairman of the Board and Executive Chairman of the Parent Companies. DiNicola did not believe that the Franklin Contracts were the best use of GNC's marketing budget and was concerned that in extending the contracts, Mancini had a potential conflict of interest due to payments his wife had been receiving from the magazines. Accordingly, DiNicola wanted to terminate the Franklin Contracts and pursue an alternate marketing strategy.

Joe Fortunato has been employed by the GNC family of companies for nineteen years and is the current CEO of Plaintiff. During the 2004-2005 time frame, Fortunato was the Chief Operating Officer of Plaintiff. In the fall of 2005, Fortunato became Acting CEO of the GNC Companies and he was officially appointed to that position on November 10, 2005. Fortunato had a prior business relationship with Scott Johnson, the principal officer of Franklin, and he was personally involved in the consideration of whether the Franklin Contracts should be terminated, the efforts to renegotiate those contracts, the actual termination of the contracts, and the ultimate settlement of the Ohio litigation.

CEO DiNicola had worked with the Defendant Gardere law firm since the early 1990s and had a personal and professional relationship with one of its partners, attorney Ronald Gaswirth. In the spring of 2005, DiNicola engaged Gardere to handle certain labor and employment legal matters for the GNC companies. In July 2005, Gaswirth was elected to the corporate officer position of Secretary and hired to serve as Interim General Counsel for all of the GNC family of companies. Gaswirth contemporaneously retained his role as a partner at Gardere.

In the summer of 2005, Gardere was asked to provide legal advice as to whether the Franklin Contracts were enforceable and whether there was a basis for terminating them. Gardere concluded that it was highly likely that GNC would be found liable for breach of contract if they acted to terminate the contracts. Gardere was then asked to provide legal advice as to the potential damages GNC may face for termination of the contracts. Gaswirth assigned attorney Doug Haloftis, a labor and employment partner at Gardere, to research and opine on these issues.

On August 1, 2005, Haloftis delivered a legal memorandum which was premised on his initial conclusion that the Franklin Contracts were contracts for the sale of "goods," and thus, would be governed by the law of the Uniform Commercial Code (UCC). Haloftis opined that under the UCC, Franklin's recoverable damages for the breach of the contracts would be limited to $1-3 million and that Franklin would be precluded from recovering consequential damages for its lost advertising revenue from third-party advertisers, which was estimated to be approximately $34.5 million. On August 3, 2005, Gaswirth forwarded the Haloftis memorandum to DiNicola and Fortunato, with the accompanying statement: "My advice is tell them we are going to the mattresses (which I already told their lawyer) and see if they blink."

In September 2005, Gardere met with Franklin's lawyers in an attempt to resolve their dispute over the contracts. On October 4, 2005, Franklin provided Gardere with an analysis authored by Douglas Whaley, a Law Professor Emeritus, which assumed, arguendo, that the UCC applied but specifically noted: "It may be that the provision of services outweighs the sales aspects of these contracts and, therefore, the UCC may not be applicable." Upon receipt of Professor Whaley's analysis, Copses and Fortunato asked Gardere to re-assess the strength of the parties' competing legal positions.

Gardere assigned Camille Penniman, a second-year associate lawyer, to conduct this additional review. Penniman did not revisit or challenge Haloftis' opinion that the UCC would be the applicable law. In addition, Haloftis prepared a second memorandum to respond to the arguments advanced by Professor Whaley. The memoranda were reviewed by attorney Joe Harrison, Gardere's "most senior (grey haired) trial partner." On October 11, 2005, Gaswirth forwarded the memoranda to Fortunato, Copses and DiNicola, among others, and opined that GNC's likelihood of success was in the 85-90% range. The email also noted: "Both Joe and Doug however warn, as all lawyers must, that the termination is not risk free especially when dealing with Judges and juries." On October 19, 2005, Gardere prepared a memorandum for the Board of Directors regarding GNC's potential exposure from repudiation of the Franklin Contracts, and again opined that Franklin would not be entitled to recover consequential damages relating to third-party advertising contracts under the UCC.

On October 20, 2005, there was a joint meeting of the Boards of Directors of the Parent Companies, at which there were presentations by Gaswirth and Copses and a "detailed discussion" regarding termination of the Franklin contracts. As liability was fairly certain, the real question was the quantum of damages Franklin could be entitled to recover. Gaswirth reviewed the legal research, as outlined above, and explained that the high-end risk was $34.5 million, but GNC had only a 20% chance of losing on the consequential damages issue. Copses provided a probable risk analysis, which reflected a certainty of direct damages of $1-4 million plus a 33% chance of losing on the consequential damages issue, for an expected loss value of $10-12 million. Copses started from Gaswirth's opinion, but discounted it as overly optimistic. The Boards of Directors then unanimously approved the following resolution:

WHEREAS, the former Chief Executive Officer, Louis Mancini, of GNC Corporation ("Parent") and General Nutrition Centers, Inc. (the "Company"and, together with Parent, the "Companies") purported to execute extension agreements in June 2004 with Franklin Publications for the publication of the Physical and Let's Live magazines, purporting to extend the contractual relationship with Franklin Publications until December 2009; and

WHEREAS, the Board has determined that it is not in the best interests of the Companies to continue ...


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