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Evergreen Sports, LLC v. SC Christmas, Inc.

United States District Court, Fourth Circuit

December 20, 2013

SC CHRISTMAS, INC., et al., Defendants.

MEMORANDUM OPINION (Awarding Damages after Bench Trial)

HENRY E. HUDSON, District Judge.

This is a contract dispute involving the purchase of a warehouse in Pocahontas, Arkansas, which is not at issue, and the majority of its contents. The inventory, which consisted of almost three million items, included products with professional and college sports team logos, such as programmable pens, Christmas wreaths, football and helmet pens, super balls, nutcracker musicals, acrylic ornaments, desk sets, and an item referred to as a flying monkey. The inventory, purchased in bulk and intended for resale, was acquired by the Plaintiff under an Asset Purchase Agreement (the "Purchase Agreement"). Plaintiff's core claim is that the products purchased were nonconforming, in that they were damaged, defective, or otherwise unsalable in the normal course of business. Other items were either not licensed for commercial sale or were subject to licenses which had expired. Plaintiff's contract claim turns on Section 11(f)(i) of the Purchase Agreement, which warrants that the inventory purchased from Defendants is "free from defects in materials and workmanship." (Defs.' Mem. Support Mot. Summ. J., Ex. A at 6, ECF No. 35 (hereinafter "Purchase Agreement").)

After reviewing memoranda filed by each party with accompanying exhibits, and hearing oral argument on September 25, 2013, this Court granted Plaintiff's Motion for Summary Judgment as to liability. Finding the record inadequate to assess damages, this Court heard evidence on damages and Plaintiff's claim for indemnification on October 29, 2013. The bulk of Plaintiff's claim for indemnification consists of attorneys' fees and related litigation expenses. Each party was afforded an opportunity to submit additional memoranda addressing those issues.

Before awarding damages, it is important to provide some context for Plaintiff's entitlement to summary judgment on liability, particularly because Plaintiff seeks damages for the entire unsold inventory of items acquired from the Defendants. At both summary judgment and trial, the Defendants contend that Plaintiff is unable to identify what specific items of inventory, if any, were in a damaged condition prior to delivery. Furthermore, Defendants maintain that even if a portion of the inventory was damaged, Plaintiff's evidence fails to demonstrate that it was sufficient to warrant discontinuation of resale of the entire balance of remaining inventory. Plaintiff maintained at summary judgment and at trial that aside from a de minimis number of salable items, the vast majority of the inventory was defective or unlicensed for resale. Based on the number of items returned as defective, and to protect the goodwill of its business, Plaintiff elected to cease all sales of products acquired from the Defendants.

In awarding summary judgment on the issue of liability, this Court found that Plaintiff had proffered evidence supporting its allegation that a significant but unquantified portion of the inventory was damaged prior to delivery. This Court articulated the following conclusion:

Despite Defendants' contention to the contrary, Plaintiff proffers in its Motion for Summary Judgment virtually unrebutted evidence that Defendants were aware of the defective nature of the inventory prior to sale. Two prior managerial employees of Defendants who transitioned to Plaintiff after the warehouse in which they were employed was conveyed under the Purchase Agreement, confirm Plaintiff's claim. Derrick Difani ("Difani"), manager of the Pocahontas Warehouse under S.C. Christmas, and David Futrell ("Futrell"), the former assistant manager, have filed sworn declarations describing Defendants' inability to sell the inoperable, defective and damaged sports inventory prior to entering into the Purchase Agreement with Plaintiff.

(Mem. Op. 9-10, ECF No. 54.)

[I]n July 2013, Futrell, assistant manager of the Pocahontas Warehouse, was tasked by Plaintiff with examining and testing the remaining inventory for defects and functionality. The majority were found by Futrell to be too defective for resale. (Pl.'s Mem. Support Mot. Summ. J. Ex. 4 at 4-10.) Futrell determined that helmet and football pens failed to light even with new batteries ( id. at 4.); the Christmas wreaths were infested with bugs and had berries and garland missing ( id. at 7); musical nutcrackers did not function ( id. at 8); acrylic ornaments had corroded batteries ( id. at 9); and the desk sets were damaged at the base and bore defective paint ( id. at 10). Both Difani and Futrell concluded that due to its condition, the inventory purchased from Defendants could not be sold in the ordinary course of business.

( Id. at 10-11.)

Therefore, in awarding Plaintiff partial summary judgment as to liability, this Court necessarily found that at least portions of the inventory were in a damaged, nonconforming condition prior to delivery. The Court, however, reserved judgment on what portion of the inventory was in fact "merchantable, usable and salable in the ordinary course of business" and was "free from defects in materials and workmanship" as warranted in Section 11(f)(i) of the Purchase Agreement. (Purchase Agreement at 6.)

The standard of measure for assessing damages in nonconforming goods cases is well settled. The defendant is entitled to the difference between the value of the goods as represented at the time of purchase, and the value of the inventory as delivered.[1] See Neilson Bus. Equip. Ctr., Inc. v. Italo V. Monteleone, M.D., 524 A.2d 1172, 1176 (Del. 1987); McLachlan v. Wilmington Dry Goods Co., 41 Del. 378, 384 (Del. Super. Ct. 1941). "Contract damages are designed to place the injured party in an action for breach of contract in the same place as he would have been if the contract had been performed." Paul v. Deloitte & Touche, LLP, 91A A.2d 140, 146 (Del. 2009) (internal quotation marks omitted).

Although the total number of items purchased from Defendants was 2, 826, 938 at a cost of $5, 060, 926, [2] Plaintiff only seeks reimbursement for approximately 350, 000 defective items. In part, the figure reflects the fact that some items purchased were resold.

John Toler ("Toler") Chief Operating Officer of Evergreen Enterprises, Inc., [3] testified at trial that the approximate wholesale value of the 350, 000 remaining items was about $1, 600, 000. (Hr'g Tr. 84-85.) Toler, who has seventeen years of experience in marketing sports logo goods, testified that distressed inventory typically sells at approximately 50-70 percent of wholesale value. Toler, who was involved in the acquisition of the goods presently at issue, estimated that the remaining inventory had a fair market value of 50 percent of its wholesale worth. Accordingly, Toler testified that Evergreen was seeking $827, 585 for unsalable goods and $439, 499 in associated costs, fees and chargebacks. The latter figure includes the cost of resolving the patent infringement claim involving the flying monkey. Toler conceded that the volume of goods and the marketability of individual items in each category complicated the damage calculation process.[4]

Toler also explained that the defective nature of the goods, in most cases, was not readily detectable from the exterior of the packaging. The scale of defects was not apparent until items were removed from boxes at a trade show several months after the deal closed. Even after discovery, there was no reasonable means to segregate defective products. Detailed inspection required breaking the outer wrapping, rendering the item unsalable. Retailers would not accept taped up packages for resale. (Hr'g Tr. 60-61.) Toler was also aware of the defects revealed during the tests performed by Evergreen's employees, Difani and Futrell. ( Id. at 56.) Toler further opined that repair, such as replacement of batteries and removal of mold from wreaths, was neither practical nor economically feasible.[5] He stated that Evergreen did not have sufficient personnel to perform such repairs. Moreover, in his opinion, it would not be cost effective given the nature of their business and value of the goods. That is why, Toler indicated, Evergreen relied on the representations and warranties contained in Section 11(f)(i) of the Purchase Agreement. The need for such refurbishing was not contemplated in negotiating the deal, according to Toler. ( Id. at 62.) "[I]t's not feasible for us to rework, touch, repair 350, 000 pieces of inventory... given [the] low wholesale value of the product." ( Id. at 67-68.) Furthermore, Toler explained that such remedial steps would "erode" the profit margin anticipated on the deal. ( Id. at 70.)

Prior to discontinuing sales, Toler solicited the assistance of Defendants in repairing some of the items or locating a buyer. Defendants declined to do so and refused to adjust the purchase price, rescind the deal or accept ...

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