Local daily newspaper faces $3.6M lawsuit

Former Texas Grill owners sue the Rockford Register Star for alleged defamation concerning ‘switch and flush scam’ article and illustration

Alleging parts of a Rockford Register Star article were “patently false,” Todd Gage and Phil Priola, former owners of U Grill It Inc., who did business in Machesney Park Mall as Texas Grill Steakhouse and Lounge, filed a lawsuit July 30 against the newspaper. They are seeking at least $3.6 million in damages.

The lawsuit names three defendants: the Rockford Register Star, reporter Isaac Guerrero, and the owners of the Register Star, Gannett Satellite Information Network, Inc. Gannett is a multi-national, multi-billion dollar company with 2003 operating revenues of $6.7 billion. Gannett Corporation, chartered in Delaware, has its headquarters in Arlington, Va.

Priola and Gage also owned Best Rockford Group Inc., which did business from 2000 to 2002 as Texas Grill at the same location at 8750 N. Second St.

According to the complaint, Gage and Priola allege portions of an Oct. 6, 2003, article and accompanying illustration, “written by Guerrero and published by the Rockford Register Star, were patently false.” The article and illustration refer to a “switch and flush scam.”

The term “switch” refers to illegally transferring assets from a previous business to a new business. “Flush” refers to illegally disposing of the previous business’ debt to avoid paying creditors.

Bankruptcy trustee’s attorney Kenneth F. Ritz of Ritz and Laughlin Ltd., was a source for Guerrero’s Oct. 6, 2003, article. In that article, Ritz is described as a “bankruptcy expert” who authored a book on methods people employ during bankruptcy proceedings.

One of Gage and Priola’s attorneys, George P. Hampilos of Schirger, Monteleone and Hampilos, P.C., said, in the article, Ritz does not appear to comment specifically about the bankruptcy case concerning Gage and Priola.

Ritz learned of the lawsuit during an interview with The Rock River Times Aug. 9. He refused to answer questions of whether Guerrero asked him to comment specifically about the Gage and Priola case. Ritz said: “I’m not going to answer any questions because of pending litigation. I’ll leave it to the courts to decide. I’m not trying to be rude. It just wouldn’t be appropriate.”

Linda Grist Cunningham, executive editor of the Rockford Register Star, said: “Our story was accurate. All the material was on the record. We didn’t use anonymous sources. We stand by the story, and we will prevail in the suit.” Cunningham didn’t want to comment on details of the article or illustration.

Guerrero referred questions to Cunningham and Rockford attorney Thomas D. Luchetti.

The lawsuit cites the Oct. 6 article in which Guerrero asserts: “Gage’s testimony August 25 [,2003] at a bankruptcy meeting reveals how he and his partners transferred Texas Grill’s assets before the company [Best Rockford Group] filed bankruptcy. Six months before Texas Grill filed for bankruptcy, its owners formed another company [U Grill It] and transferred the assets of Texas Grill to the new entity [Texas Grill Steakhouse and Lounge],” the article read.

Hampilos said the meeting was actually Aug. 23, not Aug. 25, even though his complaint against the Register Star indicates an Aug. 25 date for the meeting. He said the Aug. 25 meeting date on the complaint was probably a typographical error.

As to the alleged switch and flush transfer, Hampilos said it never occurred, which is why federal bankruptcy Judge Manuel Barbosa sided with Gage, Priola, and Tom Johnson (another Texas Grill owner) to dismiss Ritz’s Dec. 5, 2003, adversary complaint against the former restaurant owners.

Some time after the Oct. 6 article was published, Ritz was hired as the attorney to represent bankruptcy Trustee Joseph D. Olsen in the case against Gage, Priola, and Johnson. According to Guerrero’s Dec. 27, 2003, follow-up article, Ritz was hired in November 2003.

Ritz filed his complaint and alleged there was a “transfer” of assets from Best Rockford Group to U Grill It that “made it impossible for the Debtor [Best Rockford Group] to pay its debts. …the conduct of the defendants was aggravated and fraudulent, and was the violation of a fiduciary duty.”

Hampilos responded to Ritz in a Jan 8, 2004, motion to dismiss Ritz’s complaint by

stating: “the fraudulent transfer alleged in the trustee’s complaint [Ritz on behalf of Olsen] never took place.” Exhibit C of Hampilos’ motion is 14 pages from the Register Star’s Web site.

The exhibit is the Register Star’s transcript of Gage’s testimony at the creditors’ meeting that lists the date of the meeting as Aug. 23, 2003. A breakout box next to Guerrero’s article refers readers to the Register Star’s Web site to read transcripts and listen to the audio version of the meeting. However, in contradiction to the Web site exhibit, but consistent with the article, the breakout box also lists the date of the meeting as Aug. 25.

At the creditors’ meeting, Gage was questioned by Jason Rock, attorney for Machesney Park. According to Hampilos and the meeting transcript, the village loaned $75,000 to Best Rockford Group in 2000.

The following is from the Register Star’s transcript of the creditors’ meeting, which is also one of the exhibits in Hampilos’ Jan. 8 response to Ritz’s complaint:

“Rock: ‘Was there any bill of sale that transferred the assets that I showed to you on the exhibit from the original debtor [Best Rockford] to the new entity [U Grill It]?’

“Gage: ‘No. …’

“Rock: ‘Is there any type of asset sale or lease between the two companies?’

“Gage: ‘No.’

“Rock: ‘OK, so are you essentially saying that U Grill It Inc. owns those assets or leases those assets from the debtor [Best Rockford Group]?’

“Gage: ‘Umm…’

“Dan Donahue (Gage’s attorney): ‘No, I mean the assets are still the debtor’s. …There’s personal guarantees involved on the loan as you know, and the guarantors want to work out a deal with the Village of Machesney to transfer ownership of the equipment after the trustee [Olsen] has a chance to review the situation.’”

Another part of the Oct. 6 article cited in the lawsuit reads: “A popular steak restaurant at Machesney Park Mall is claiming bankruptcy while its owners, according to court records, orchestrated a complicated ‘switch and flush’ scam to walk away from debts of nearly $350,000.”

Hampilos said he believes that at the time of publication, there were no “court records” referring to an alleged “switch and flush scam.” He added the only record was the creditors’ meeting transcript, which he said did not refer to any such alleged transfer.

Hampilos’ Jan. 8 response to Ritz’s complaint continued: “Since the fair market value of the property at the time of the alleged transfer was insufficient to cover the amount of the outstanding debt to the village [Machesney Park], a secured creditor, there can be no damages suffered by the trustee with respect to that property.”

As to unsecured creditors, Hampilos wrote: “even assuming, arguendo, that the [bankruptcy] court should find that a transfer did take place, the unsecured creditors have not, and cannot, suffer any damages, because the property in question had no value.’…

“In further support of the defendants’ [Gage, Priola, and Johnson] assertion that the alleged transfer never took place, and that the property in question remains in the estate of the debtor [Best Rockford Group], is the attached affidavit of Phil Priola.”

In his Jan. 7 affidavit, Priola stated: “At no time since acquiring this restaurant equipment and goodwill has the debtor ever transferred, sold, or conveyed it to any other entity, including U Grill It Inc. There has never been a bill of sale or contract involving the sale, transfer, or conveyance of the equipment or goodwill.”

Hampilos concluded: “The Trustee’s [Ritz on behalf of Olsen, the bankruptcy trustee] entire complaint rests upon the assumption that a fraudulent transfer took place. The petition has utterly failed to allege, in
detail, how this alleged transfer was supposed to have taken place.”

Ritz responded to Hampilos’ motion by writing: “The reason the complaint does not state these details is because they are unknown to the Plaintiff [Ritz on behalf of Olsen]. The plaintiff will learn these details through discovery proceedings. The plaintiff will not attempt to guess the details of the transfer.”

Ritz continued his argument in a reply brief: “The defendants seem to have the same problem that a former chief executive of our nation [President Bill Clinton] had defining rather simple terms. The defendants say there was no transfer of assets to the new corporation they formed. But contradicting this interpretation, we note that the former owner of the assets, the debtor, no longer has possession or control of the assets. …

“The trustee’s complaint is unconcerned with the transfer of the restaurant equipment. There was, however, a valuable asset that was transferred. This asset is the going concern value,” Ritz wrote.

Hampilos described “going concern” as “an attempt to quantify future income” of a business.

Ritz continued: “Included in that going concern value is the financing by the Village of Machesney Park. If there was no going concern value, why did the defendants develop this unsavory scheme, often labeled as a ‘switch and flush’?”

Hampilos reacted March 30 by writing: “The trustee has responded with references to past Presidents and toilets, which although makes for interesting reading, is not sufficient to defeat summary judgment [in favor of Gage, Priola and Johnson by Barbosa].”

The Oct. 6 illustration in the Register Star titled “Anatomy of a switch and flush scam” that accompanied Guerrero’s article included a Salvador Dali-type drawing of a toilet. The “concept” of the illustration is credited to Guerrero. The “illustration” is credited to Eloisa Oceguera of the Register Star, who is not listed individually as a defendant in the alleged defamation lawsuit against the newspaper.

Hampilos continued: “Shutting down a business to cap losses, and to stop further accumulation of debts is not a breach of fiduciary duty to unsecured creditors. …The debtor’s choice to cease doing business did not put money in the pockets of its unsecured creditors, but neither did it place them in a worse position. The trustee is simply not willing to acknowledge that the debtor did not, and would not, have the means to pay secured creditors.”

Hampilos concluded: “The trustee has attempted to pigeon-hole a fraudulent transfer claim into a breach of fiduciary claim. However, the breach of fiduciary duty claim is based entirely upon the allegation that something was transferred, be it going concern value or equipment. And while the trustee claims to be unconcerned with any actual transfer, he is extremely concerned with the effect of such transfer. Without employing this circular type of logic, the trustee cannot legally state a claim for relief,” he wrote.

Barbosa’s June 1 order agrees with Hampilos’ motion to dismiss Ritz’s complaint.

Priola said during an interview Aug. 9 that Ritz did not appear in court to hear Barbosa’s decision.

During an interview last week, Hampilos explained the reason U Grill It took over operation from Best Rockford Group was to “keep building the business to make it profitable.” In addition, Hampilos said the restaurant owners were loyal to their staff in an effort to keep them employed as long as possible. Priola said they employed about 46 people, who are now out of work.

According to the alleged defamation lawsuit, Texas Grill Steakhouse and Lounge permanently closed Aug. 1, 2004.

The lawsuit also alleged that since the article was published, “Texas Grill’s monthly gross revenue has declined an average of approximately $40,000 per month,” and the owners allegedly suffered “more than $400,000 total in lost revenues.”

The remainder of the at least $3.2 million sought is for other alleged damages, attorney fees, costs and “relief” the court deems appropriate.

Hampilos said the opening of the new Chili’s restaurant near the intersections of Illinois 251 and 173, which opened shortly after the article was published, may have contributed to increased competition for patrons, but said he was prepared to prove the alleged damages described in the lawsuit can be attributed to the article.

A case management conference concerning the lawsuit is scheduled for Nov. 3, 2004, at 9 a.m., before 17th Judicial Circuit Judge Janet R. Holmgren in the Winnebago County Courthouse.

Enjoy The Rock River Times? Help spread the word!