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A federal bankruptcy judge in Atlanta has levied a $457.8 million judgment against one of the world’s largest forest products companies. In a 138-page ruling, U.S. Bankruptcy Judge Margaret H. Murphy levied the nearly half-billion dollar judgment, plus millions more in attorney fees and interest, against Weyerhaeuser Co., based in Washington state, for violating contract warranties when it spun off its disposable diaper division as a “liability-laden subsidiary.” The division, Paragon Trade Brands Inc., was taken public in a 1993 initial public offering. In her ruling, Murphy left little doubt that, in her opinion, Weyerhaeuser had breached warranties in its sales agreement for the diaper division by failing to have licenses for patents. Throughout the ruling, which Murphy took more than a year to issue, the judge chastised Weyerhaeuser for producing a generic disposable diaper that infringed on diaper design patents held by competitors Procter & Gamble and Kimberly-Clark. (P&G manufactures Pampers and Luvs disposable diapers, and Kimberly-Clark makes Huggies.) Not having the patents “constituted a stark gap in Paragon’s intellectual property, known to Weyerhaeuser and undisclosed in the IPO,” Murphy wrote. “The gravamen of Weyerhaeuser’s liability,” Murphy continued, “is that, in addition to the funds that Weyerhaeuser received in connection with the IPO, the primary benefit of the bargain to Weyerhaeuser was divorcing itself from what it knew to be an enormous potential patent infringement liability that was substantially certain to occur. Additionally, Weyerhaeuser was able to reap the benefit of an unpredictably successful IPO. To reward Weyerhaeuser’s strategic divestment by limiting damages … would encourage other large corporations to evade liabilities by transferring assets to a subsidiary and divesting themselves of their liability-laden subsidiaries.” IT COULD HAVE BEEN WORSE Last week’s ruling was the result of an adversary proceeding initiated as part of Norcross, Ga.-based Paragon’s Chapter 11 bankruptcy reorganization. After going public in 1993, Paragon, within a year, found itself the target of a patent infringement suit by Procter & Gamble. A Delaware judge levied a $178 million judgment against Paragon on Jan. 6, 1998. Paragon filed for bankruptcy in Georgia the same day. The breach-of-warranty adversary proceeding against Weyerhaeuser was pursued by Randall Lambert, a court-appointed litigation claims representative on behalf of the equity committee in Paragon’s bankruptcy. Atlanta attorney Charles E. Campbell, a McKenna Long & Aldridge partner, served as Lambert’s local counsel. He worked with attorneys from Houston-based Andrews Kurth and Seattle-based Susman Godfrey. “I’m sure Weyerhaeuser doesn’t consider it good news,” Campbell said of the judgment. “But the damages could have been higher than they were. We were asking for somewhere north of $700 million.” Campbell said that Paragon’s creditors and stockholders will benefit from the judgment. He cautioned that “a suit yielding a judgment of this magnitude might very well go on for number of years. The issues are quite complicated.” COMPANY PLANNING APPEAL The company reported 2004 net earnings of $1.3 billion on sales of $22.7 billion. Although the judgment represents a substantial portion of its earnings, Weyerhaeuser said it will not record a charge against earnings because it believes the decision will be reversed on appeal. The company noted that generally accepted accounting rules don’t require a reserve to be established if there is a high likelihood that the damages won’t have to be paid. Weyerhaeuser’s local counsel, Richard B. Herzog Jr. of Atlanta’s Nelson Mullins Riley & Scarborough, said Wednesday that the company will appeal to the U.S. District Court in Atlanta. He referred other questions to Bruce Amundson, a Weyerhaeuser spokesman in the company’s Seattle headquarters. Amundson called Murphy’s ruling “a flawed view.” “We think what is happening here is this case is being treated like securities law rather than a contract case,” he said. “What the judge is saying here is that somehow the shareholders were not aware of the potential for litigation or that Weyerhaeuser was trying to, somehow, shirk its responsibility, which is not the case.” Amundson said, “We fully disclosed to the Paragon shareholders in the [IPO] prospectus the potential for these patent infringement lawsuits. If you were a Paragon shareholder, you purchased a share knowing full well such litigation could exist.” Murphy clearly disagreed. In her order, the Atlanta bankruptcy judge noted that the patent infringement ruling that forced Paragon into bankruptcy was preceded by a 1981 patent infringement suit against Weyerhaeuser by Procter & Gamble. Weyerhaeuser lost that case in 1986, and was enjoined from using Procter & Gamble’s diaper design. As a result, Weyerhaeuser’s disposable diaper profits had plunged from $31 million before the 1986 judgment to $3 million afterward. By 1990, Weyerhaeuser had abandoned efforts to develop its own patented disposable diaper. But, in response to a clamor from retail customers seeking a store-brand, less expensive disposable diaper, Weyerhaeuser began producing a diaper using design features patented both by Procter & Gamble and Kimberly-Clark, according to Murphy’s order. In the fall of 1991, Weyerhaeuser’s in-house patent counsel advised the company’s general counsel that Weyerhaeuser’s chances of winning a patent infringement suit were “no better than 50/50,” according to the order. Weyerhaeuser’s management initiated discussions to sell the diaper subdivision “to protect Weyerhaeuser from what was then stated to be a substantial and growing infringement liability,” Murphy wrote. But at least one corporate investment bank had advised that the division “might not be saleable at anything better than a �fire sale’ price.” In December 1991, P&G notified Weyerhaeuser that its diaper infringed on P&G disposable diaper patents. At that time, Weyerhaeuser General Counsel Bob Lane advised company auditor Arthur Andersen that the damages arising from such a claim could be “enormous,” according to the order. Three months later, Weyerhaeuser decided to dispose of the division by creating a subsidiary, headed by diaper division employees, and then spinning it off with an IPO. Weyerhaeuser sold 11.5 million shares of Paragon to the public at $19 a share, netting more than $215 million. The case is Lambert v. Weyerhaeuser Co., No. 99-6470.

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