General Nutrition Corp. v. GARDERE WYNNE SEWELL

Citations: 727 F. Supp. 2d 377; 2010 U.S. Dist. LEXIS 73654; 2010 WL 2891247Docket: 2:08-cv-831

Court: District Court, W.D. Pennsylvania; July 21, 2010; Federal District Court

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The case involves General Nutrition Corporation (GNC), which operates a network of retail stores focused on vitamins and dietary supplements, and claims legal malpractice against Gardere Wynne Sewell, LLP. GNC does not manage its own finances, as a separate entity, General Nutrition Incorporated, handles banking functions. During the relevant period (2004-2005), GNC was owned by two parent companies, GNC Corporation and General Nutrition Centers, Inc., and was acquired by Apollo Management LP in 2003 amid declining sales and profits.

Central to the malpractice claim are the "Franklin Contracts," signed in 2001 with Basic Media/Franklin Publications for marketing purposes, which became a significant expenditure for GNC. In June 2004, CEO Louis Mancini extended these contracts, but after his termination in November 2004, interim CEO Robert DiNicola expressed concerns about the contracts' value and potential conflicts of interest associated with Mancini. DiNicola sought to terminate the contracts for a more effective marketing strategy. Joe Fortunato, who was COO during this time, later became CEO in November 2005. The court has received extensive documentation and arguments regarding both parties' motions for summary judgment, and oral arguments were presented in May 2010.

Fortunato had prior dealings with Scott Johnson, the principal officer of Franklin, and was involved in the decision-making regarding the termination and renegotiation of the Franklin Contracts, as well as the settlement of related Ohio litigation. CEO DiNicola had a longstanding relationship with the Gardere law firm and hired attorney Ronald Gaswirth, who became Secretary and Interim General Counsel for GNC in July 2005. Gardere was tasked with assessing the enforceability of the Franklin Contracts and potential liabilities associated with their termination. 

Attorney Doug Haloftis concluded that terminating the contracts would likely lead to GNC being liable for breach of contract, estimating Franklin's recoverable damages under the Uniform Commercial Code (UCC) to be limited to $1-3 million, while excluding consequential damages related to $34.5 million in lost advertising revenue. On August 3, 2005, Gaswirth advised GNC to take a strong stance in negotiations. 

In September 2005, Gardere engaged in discussions with Franklin's lawyers. Following receipt of a conflicting analysis from Professor Douglas Whaley in October, who suggested that service provisions might outweigh sales aspects, GNC requested that Gardere reassess the situation. Camille Penniman, a second-year associate, reviewed the matter but did not dispute Haloftis's conclusion regarding UCC applicability. Haloftis later produced a second memorandum addressing Whaley's arguments, which was reviewed by senior attorney Joe Harrison. On October 11, 2005, Gaswirth communicated to GNC executives that their chances of success in court were approximately 85-90%, while cautioning that termination of the contracts carried risks. A final memorandum prepared for the Board of Directors reiterated that Franklin would not be entitled to recover consequential damages under the UCC.

On October 20, 2005, the Boards of Directors of GNC Corporation and General Nutrition Centers, Inc. convened to discuss terminating the Franklin Contracts due to certain liability concerns. Legal analyses indicated a high-end risk of $34.5 million in potential damages, with GNC facing only a 20% chance of losing on consequential damages. A more conservative estimate by Copses suggested direct damages of $1-4 million and a 33% chance of losing on consequential damages, leading to an expected loss of $10-12 million. The Boards resolved to terminate the publishing contracts with Franklin Publications, deeming the projected losses acceptable. On October 25, 2005, Gardere, at Fortunato's direction, notified Franklin of the termination, resulting in Franklin suing GNC in Ohio, which was later moved to federal court. Gardere argued that the contracts fell under UCC regulations, limiting Franklin's claims for consequential damages. After cross-motions for summary judgment in May 2006 and a failed mediation in June 2007, the Ohio court ruled that the contracts were primarily for services, allowing for consequential damages. Following this unfavorable ruling, GNC replaced Gardere with new legal counsel and ultimately settled the litigation for $12 million in early 2008. Payments of $9 million and $3 million were made to Franklin in March 2008 and March 2009, respectively, recorded as inter-company accounting entries, with no formal documentation between the related corporations regarding this transaction.

The Income Statement of both General Nutrition Incorporated and Plaintiff General Nutrition Corporation was unaffected by inter-company transactions, as only a consolidated balance sheet is reported for the GNC family. A separate monthly balance sheet is prepared for Plaintiff General Nutrition Corporation, which is incorporated into the consolidated balance sheet. Inter-company liabilities and receivables offset each other and do not appear on the consolidated balance sheet. The $12 million inter-company liability and receivable between the two entities remain on their respective books, with no established payment terms or specific due date for repayment. Davis indicated uncertainty regarding the likelihood of this liability being paid and noted that cash settlements of inter-company amounts are rare, with only one such repayment occurring since 1984.

In March 2007, during ongoing litigation in Ohio, the GNC family of companies was sold for approximately $1.65 billion. The $12 million payment to Franklin was included in this purchase price. The Plaintiff filed a legal malpractice complaint against Gardere in May 2008, claiming negligence, breach of contract, and breach of fiduciary duty. Gardere removed the case to federal court and subsequently moved to compel arbitration based on a retention agreement with "GNC." The Plaintiff opposed this motion, asserting its distinct corporate identity from GNC Corporation and clarifying that GNC Corporation did not receive the legal representation in question. A declaration from Kenneth Fox, Senior Vice President and Treasurer, emphasized that the case involved only General Nutrition Corporation. On August 12, 2008, the court ruled in favor of the Plaintiff, denying Gardere's motion to compel arbitration based on the distinctions between the corporate entities.

The Court denied Gardere's Motion to Dismiss Plaintiff's Complaint and the parties proceeded with extensive discovery, with cross-motions for summary judgment currently pending. Gardere seeks summary judgment on all counts, asserting several defenses: GNC terminated the Franklin Contracts for business reasons; Gardere fulfilled its duty to provide legal advice and is protected by the "judgment rule"; GNC was aware of the risks of termination and the $12 million payment was anticipated; Gardere's advice did not directly cause the termination or alleged damages; Plaintiff suffered no economic loss as it did not pay the claimed damages; GNC saved money by repudiating the contracts; the doctrine of in pari delicto bars recovery due to Plaintiff's conscious repudiation; the claims are barred by the statute of limitations; Plaintiff lacks standing as it did not receive legal advice from Gardere; no disloyalty was proven to establish breach of fiduciary duty; the claim is based on tort law rather than contract law; and Plaintiff has incorrectly focused on improper research rather than failure to present critical facts. Gardere argues that Plaintiff attempted to create factual disputes to avoid summary judgment.

Plaintiff seeks partial summary judgment regarding three defenses raised by Gardere: regulatory estoppel, violation of a Federal Trade Commission consent order, and that recovery is barred by a settlement with Franklin. The Court finds a fundamental flaw in Plaintiff's case—specifically, the inability to demonstrate any actual loss or monetary damages. Under Pennsylvania law, as established in Kituskie v. Corbman, proof of actual loss is essential for a legal malpractice claim. The Court notes that General Nutrition Corporation has not suffered any actual monetary loss, as the settlement was paid by a separate entity, General Nutrition Incorporated, and there are no outstanding payments related to Gardere's advice. Any potential future harm is deemed speculative, with inter-company liabilities effectively offsetting each other within the consolidated financial statements.

Plaintiff General Nutrition Corporation claims its loss is straightforward, stemming from a $12 million settlement paid by GNC in a lawsuit. However, the situation is complicated due to multiple entities involved: General Nutrition Corporation interacted with Franklin, was the signatory on the contracts, and was named in the Ohio litigation, while GNC Corporation and General Nutrition Centers, Inc. authorized the termination of the contracts, and General Nutrition Incorporated made the settlement payment. The plaintiff submitted an expert report asserting that inter-company accounting should reflect a loss for General Nutrition Corporation due to the settlement. Nonetheless, this report does not address testimony indicating that the inter-company liability has not been resolved, leading the Court to conclude that any actual loss for General Nutrition Corporation is speculative or nonexistent.

Additionally, the plaintiff seeks to disregard corporate formalities, arguing for recognition of the economic impact of the payment made by General Nutrition Incorporated. The defendant counters that damages cannot be claimed for harm to other entities. Pennsylvania law allows courts to disregard corporate structures only under specific circumstances, such as to prevent fraud or injustice, as highlighted in relevant case law. The courts maintain a strict distinction between injuries to a corporate entity and those to separate individuals or entities, reinforcing the legal separation of corporate identities. Thus, the principles of corporate structure must be respected, as established in prior Pennsylvania Supreme Court rulings.

Shareholders cannot selectively disregard the corporate structure when it serves their interests, particularly in legal contexts. They must recognize both the benefits and liabilities associated with incorporation. In Kiehl, the Pennsylvania Supreme Court denied a corporation's attempt to pierce its own veil to evade workers' compensation liabilities, a principle also upheld in related case law involving parent and sister corporations. Courts have consistently ruled against allowing a corporation to assert claims or recover debts owed to related entities simply due to intertwined business interests. For instance, in Mitchell Company v. Campus, it was clarified that a corporation lacks standing to claim on behalf of a closely affiliated corporation. Even if a corporation is primarily a shell controlled by another, it cannot pierce the veil of another corporation it established for its own benefit. Legal precedent underscores that only the corporation engaged in business has the right to recovery for damages, despite potential economic harm to related entities. Cases such as North Carolina ex rel. Long v. Alexander and Nunn v. Chemical Waste Mgt. Inc. reinforce that parent corporations cannot claim losses incurred by subsidiaries. Furthermore, the Pennsylvania Supreme Court in Barium Steel Corp. v. Wiley highlighted that a parent company must demonstrate its own damages to recover for breaches incurred by its subsidiary, maintaining the integrity of separate corporate identities.

The three justices recognized ambiguity in the criteria for piercing the corporate veil but concluded that, based on the case's circumstances, the parent company suffered damage and could pursue recovery. Developments in Pennsylvania law, particularly in Sams and Kiehl, indicate that the dissent in Barium Steel now carries more authority. Under Pennsylvania law, courts are hesitant to disregard corporate formalities, particularly when a corporation seeks to recover losses from a separate entity. The Plaintiff's request to ignore these formalities is undermined by their earlier position that emphasized the distinct corporate identities. The evidentiary record suggests inaccuracies in the Plaintiff's Fox Declaration, revealing that GNC Corporation is the ultimate parent and that its Board received legal advice regarding the termination of the relevant contracts, which were authorized by the Boards of Directors.

The $12 million settlement was recorded in GNC's consolidated financial statements, indicating that the companies operated as a single entity. The Plaintiff's previous successful argument to uphold corporate distinctions now places them at a disadvantage in seeking to disregard those distinctions. The doctrine of judicial estoppel prevents parties from taking contradictory positions, as established in G-I Holdings, Inc. v. Reliance Ins. Co. The Pennsylvania Supreme Court has asserted that a party cannot selectively apply corporate status based on convenience. While the veil-piercing doctrine can lead to seemingly harsh outcomes, as illustrated by Garcia v. Adventure Knits, Inc. and Anesthesiologists Associates of Ogden v. St. Benedict's Hospital, it is intended to prevent fraud or injustice. The complexities of corporate structures, as noted in Joyce, do not merit disregarding corporate protections simply due to unfavorable economic outcomes for the Plaintiff. The court sees no justification for dismantling the corporate barriers that the Defendant established.

The GNC family of companies had full control over its corporate decisions, including the structuring, settlement payments with Franklin, management of inter-corporate liabilities, and litigation pursuits. The court emphasized that it would respect the established corporate structure. General Nutrition Corporation, the plaintiff, did not experience any "actual loss" and therefore cannot pursue a legal malpractice claim based on losses incurred by a separate entity, per Pennsylvania law. Consequently, the court granted Defendant Gardere's Motion for Summary Judgment and denied Plaintiff's Motion for Partial Summary Judgment as moot. 

The court noted that the GNC acronym refers to various entities within the corporate family, and discussions about their structure would follow. It also observed that the parties' Concise Statements of Material Fact lacked value due to numerous disputed issues, leading the court to conduct its own document review. The Board of Directors of General Nutrition Corporation did not convene during the relevant timeframe, with only the parent companies' boards conducting meetings. 

Fortunato, the Acting CEO, indicated that while the Board authorized the termination of the Franklin Contracts, the actual decision to instruct lawyers for termination was his, reflecting a management decision. The settlement agreement was not part of the record, and only a consolidated tax return was filed. The court acknowledged early in the case that the plaintiff had adequately alleged actual harm, contrary to the defendant's arguments of speculative harm. The case cited by the plaintiff was distinguishable as it involved actual payment of expenses, which the plaintiff did not incur. General Nutrition Incorporated was not a plaintiff or liable in the Ohio Litigation, as it was not a party to the relevant contracts. The court clarified that it did not suggest any bad faith on the plaintiff's part and mentioned judicial estoppel only as an example of the courts' reluctance to allow parties to exploit the corporate form for advantages while evading its disadvantages.