<PAGE>


                                                                    Exhibit 10.1

                               COVENANT NOT TO SUE
                            AND SETTLEMENT AGREEMENT

     This Covenant Not to Sue and Settlement Agreement ("the Agreement") is
entered into this 16th day of May, 2006 by and between Avondale Mills,
Inc. ("Avondale") and Factory Mutual Insurance Company ("Factory Mutual").
Avondale and Factory Mutual are collectively referred to herein as the "Parties"
and individually as a "Party."

     WHEREAS, Factory Mutual issued to Avondale a policy of insurance for the
period from September 1, 2004 to September 1, 2005, Policy No. JB275 ("the
Policy"), which Policy insured specified property of Avondale at various
locations identified in the Schedule of Locations which forms a part of the
policy (referred to herein as the "insured location"), and also insured
Avondale's business income loss, all under the terms, conditions, definitions,
exclusions and endorsements contained in the Policy; and

     WHEREAS, on or about January 6, 2005, a train operated by Norfolk Southern
Corporation and/or Norfolk Southern Railway Company (hereinafter collectively
"Norfolk Southern") derailed on Avondale's property, releasing chlorine into the
environment and causing damage to Avondale's property at some of the insured
locations referenced in the Policy (referred to herein as the "Norfolk Southern
Derailment"); and

     WHEREAS, Factory Mutual has, as of the date of execution of this Agreement,
paid Avondale one hundred fifteen million and 00/100 dollars ($115,000,000.00)
in advance payments for the insured loss resulting from the Norfolk Southern
Derailment (referred to herein as the "Advance Payments"); and

     WHEREAS, Avondale intends to make and has already made additional claims
under the Policy for damages to Avondale's property and for business income loss
arising from the Norfolk Southern Derailment (referred to herein as "Additional
Claims"); and


<PAGE>

     WHEREAS, Avondale retained counsel immediately after the Norfolk Southern
Derailment, has been represented by counsel throughout the adjustment process
and settlement negotiations, and was represented by counsel at the time of
settlement; and

     WHEREAS, Avondale and Factory Mutual retained and relied upon experts and
consultants throughout the adjustment process and settlement negotiations; and

     WHEREAS, Avondale and Factory Mutual dispute the scope and measure of
insured damages from the Norfolk Southern Derailment; and

     WHEREAS, Factory Mutual requested additional information, documents, and
testing in accordance with the terms of the Policy, but has not yet received all
of said information, documents, and testing; and

     WHEREAS, Avondale maintains that insured and uninsured damage to its
property and Avondale's business income loss is ongoing and has not been fully
measured and quantified as of the date of this settlement and that Avondale has
sustained other uninsured loss; and

     WHEREAS, the Parties have already expended significant time and money in
the investigation and resolution of this matter, and the Parties wish to forego
any additional costs and resolve the disputes among themselves; and

     WHEREAS, Avondale and Factory Mutual reached a negotiated settlement and
executed a Memorandum of Understanding Regarding the Terms of Settlement on May
11, 2006 (referred to herein as the "Memorandum of Understanding"), attached
hereto, the terms of which are incorporated herein by reference; and

     WHEREAS, the Parties acknowledge that the negotiated settlement reflected
in both the Memorandum of Understanding and this Agreement was reached in good
faith and at the conclusion of arms length negotiations; and


                                      -2-

<PAGE>

     WHEREAS, Avondale and Factory Mutual desire to compromise, settle and
resolve the Additional Claims, as well as all claims, demands, disputes, and
obligations pending between them and/or which have been or could have been
asserted by one against the other pursuant to the terms of the Policy or
relating in any way to the Norfolk Southern Derailment, this being the intent
and purpose of the Agreement; and

     WHEREAS, Avondale intends to settle with Factory Mutual only, and Avondale
specifically intends to preserve its rights to continue to pursue its claims
against Norfolk Southern, all related parties and affiliates of Norfolk
Southern, and all other persons or entities, other than Factory Mutual, who may
be legally responsible for damages resulting from the Norfolk Southern
Derailment, and Factory Mutual intends to preserve its rights, to the extent it
has such rights independent of Avondale, to pursue Norfolk Southern, all related
parties and affiliates of Norfolk Southern, and all other persons or entities,
other than Avondale, who may be legally responsible for the damages resulting
from the Norfolk Southern Derailment; and

     WHEREAS, Avondale and Factory Mutual recognize and agree that the terms of
this Agreement and any payments called for hereunder shall not constitute an
admission by Avondale or Factory Mutual of Avondale's insured or uninsured loss;
and

     NOW, THEREFORE, in consideration of the mutual covenants herein, the
recitals set forth above and for other good and valuable consideration, the
sufficiency and adequacy of which is acknowledged by all Parties and with the
intent to be legally bound, the Parties to this Agreement agree as follows:

1.   INCORPORATION OF RECITALS AND DEFINITIONS.

     The Parties to this Agreement represent, warrant, and agree that the
recitals appearing above are true and correct to the best of each Party's
knowledge and such recitals are


                                      -3-

<PAGE>

incorporated herein by this reference. For purposes of this Agreement, all
references to Avondale and Factory Mutual shall also include their respective
predecessors, successors, assigns, affiliates, subsidiaries, re-insurers,
adjusters, agents, parents, creditors, bondholders, directors, officers,
trustees in bankruptcy, receivers, employees, representatives, stockholders,
general and limited partners, partners, sister corporations, and/or divisions.

2.   CAPACITY TO EXECUTE.

     Each Party to this Agreement represents and warrants that it is legally
viable and competent to enter into this Agreement, is not currently under the
protection of the bankruptcy courts of the United States, is relying on
independent judgment and has not been influenced, pressured or coerced to any
extent in making this Agreement by any representation or statement made by any
other Party, and that the individuals executing this Agreement on its behalf are
authorized to do so.

3.   CONSIDERATION AND PAYMENT.

     In accordance with the Memorandum of Understanding, Avondale and Factory
Mutual agree to the total sum of two hundred and fifteen million and 00/100
dollars ($215,000,000.00) to completely and finally resolve all Avondale claims
against only Factory Mutual arising from or related in any way to the Norfolk
Southern Derailment, including all claims under the Policy and any other claims
against Factory Mutual; to end the adjustment investigation and process; and
discharge Avondale from further response to the Policy adjustment, proof and
appraisal requirements.

     In consideration of the Covenant Not to Sue and following promises, Factory
Mutual agrees to pay Avondale a total of two hundred and fifteen million and
00/100 dollars ($215,000,000.00). Of this amount, one hundred and fifteen
million and 00/100 dollars


                                      -4-

<PAGE>

($115,000,000.00) was previously paid to Avondale as Advance Payments. The
remaining one hundred million and 00/100 dollars ($100,000,000.00) shall be paid
to Avondale by wire transfer as were the Advance Payments on or before May 25,
2006, provided that the Parties execute this Agreement in accordance with the
Memorandum of Understanding.

     As additional consideration, Factory Mutual agrees to forego its rights
under the Policy concerning the investigation and measure of the Additional
Claims, including its rights to require Avondale to submit a Proof of Loss; seek
appraisal of any differences regarding the measure or amount of loss; obtain
additional documents and information pursuant to the "Requirements In Case of
Loss" provision of the Policy; conduct examinations under oath; and require
Avondale to comply with the requirements in the "Valuation" provision of the
Policy. Avondale is permitted to expend or apply the proceeds of this settlement
as Avondale determines is appropriate in its sole discretion.

     It is expressly agreed, intended, and understood by the Parties that the
above-referenced consideration is received in full settlement, accord, and
satisfaction of any and all claims, damages (known and unknown), losses (known
and unknown), expenses (known and unknown), rights, demands, actions, suits, and
causes of action (including, but not limited to, bad faith or punitive or
extra-contractual damages claims) that Avondale has, may have had, or may claim
in the future to have against Factory Mutual arising out of the Norfolk Southern
Derailment and the Policy. It is specifically agreed that the above-referenced
consideration paid by Factory Mutual to Avondale is an accord and satisfaction
as to the obligations of Factory Mutual only, and Avondale reserves all rights
to continue to pursue its claims against Norfolk Southern, all related parties
and affiliates of Norfolk Southern, and all other persons or entities who may be
legally responsible for damages resulting from the Norfolk Southern Derailment.
Upon the execution of


                                      -5-

<PAGE>

this Agreement, Avondale will submit subrogation receipts in a form mutually
agreed upon by the parties for all payments made by Factory Mutual.

4.   COVENANT NOT TO SUE.

     In exchange for the consideration paid hereunder and referred to herein,
Avondale hereby covenants and agrees not to file or initiate any type of action
or proceeding at law or in equity, or any proceeding of any description,
including but not limited to appraisal or arbitration, against Factory Mutual
related to any claims, demands, causes of action (including, but not limited to,
bad faith or punitive or extra-contractual damages claims), suits, damages
(known and unknown), losses (known and unknown), and expenses (known and
unknown), arising from the Norfolk Southern Derailment or the Policy. In
addition, Avondale will not ask any other person or entity to initiate such a
proceeding or suit on its behalf. It is the intent of this covenant not to sue
to preserve the right of Avondale to pursue its claims against Norfolk Southern,
its related parties and affiliates, and all other persons or entities who may be
legally responsible for damages resulting from the Norfolk Southern Derailment
(other than Factory Mutual).

5.   RECOVERY ACTION.

     The Parties hereby agree that this Agreement shall not impact or otherwise
affect in any way any claims that have been or could be asserted by Avondale or
Factory Mutual in the action against Norfolk Southern and all others who may be
responsible for the damages resulting from the Norfolk Southern Derailment or
any future action against any person that may be responsible for damages
resulting from the Norfolk Southern Derailment except as provided in the
sections numbered three (3) and four (4) of this Agreement. The Parties further
agree to abide by the terms of the Memorandum of Understanding ("MOU") executed
on May 11, 2006, specifically including, but not limited to, the terms and
provisions of the Recovery Action section of the


                                      -6-

<PAGE>

MOU pertaining to the apportionment of recoveries, which MOU is incorporated
herein by reference.

6.   WARRANTY REGARDING UNKNOWN CLAIMS, INJURIES, AND DAMAGES.

     Avondale warrants and represents that the extent of damages sustained by
Avondale may be unknown, as Avondale maintains that insured and uninsured
damages to its property and Avondale's business income loss is ongoing and that
Avondale has sustained other uninsured loss, and Avondale understands, agrees,
and warrants that the Covenant Not to Sue contained herein extends to all
unknown or unanticipated claims and damages Avondale could assert against
Factory Mutual pursuant to the terms of the Policy and as a result of the
Norfolk Southern Derailment, as well as to those claims and damages that are now
known or disclosed, apprehended, or anticipated.

7.   SETTLEMENT AUTHORITY.

     The Parties represent and warrant that they have taken all necessary
corporate, legislative, legal, and other action to duly approve the making and
performance of this Agreement and that no further action or approval is
necessary. Upon execution of this Agreement, Avondale will provide to Factory
Mutual a copy of the resolution of its Board of Directors approving the amount
and terms of the settlement, as well as the relevant portions of minutes of the
meeting in which the Agreement is adopted.

8.   INDEMNIFICATION.

     Avondale represents and warrants that no lien holder has any rights with
respect to any of the payments made hereunder. Avondale agrees to defend at its
cost, indemnify, and hold harmless Factory Mutual against any claim from any
other person or entity seeking all or any portion of the proceeds to be paid by
Factory Mutual as contemplated by this settlement. Except


                                      -7-

<PAGE>

for this limited indemnity obligation, Avondale shall have no obligation to
defend at its cost, indemnify, or hold harmless Factory Mutual against any
claim, damages, or costs from any other person or entity for any act or omission
by Factory Mutual. Factory Mutual shall have no obligation to defend at its
cost, indemnify, or hold harmless Avondale against any claim, damages, or costs
from any other person or entity for any act or omission by Avondale.

9.   NO ADMISSION OF LIABILITY.

     This Agreement evidences a compromise settlement of disputed claims entered
into in order to avoid further dispute and litigation. It is expressly
understood and agreed by the Parties hereto that neither the making of this
Agreement, the making of any payment by any Party, nor any other action taken by
any Party pursuant to this Agreement shall be construed as an admission by any
Party of responsibility or liability to any other Party.

10.  COMPLETE AGREEMENT.

     The Parties hereto understand and agree that this Agreement, and the
Memorandum of Understanding incorporated by reference herein, contains their
entire understanding concerning the matters herein contained and that there are
no other agreements, whether oral or written, regarding the same. The Parties to
this Agreement acknowledge and agree that this Agreement shall not be subject to
any claim of mistake of fact or any claim of fraud. The terms of this Agreement
are contractual and not a mere recital and merge all prior discussions,
agreements and transactions of all kinds pertaining to the matters discussed in
this Agreement. All of the undersigned have had ample opportunity to investigate
all of the matters covered in this Agreement and to receive the advice of
counsel. This Agreement is made without any reliance on any statement, promise,
inducement or consideration not recited herein. This Agreement may not be
waived, changed, modified, discharged or terminated except as provided herein or
except


                                      -8-

<PAGE>

by a writing signed by the Party against whom such waiver, change, modification,
discharge or termination is sought to be enforced. If any section of this
Agreement shall for any reason be or become invalid or unenforceable, it shall
not affect the remaining provisions of this Agreement which shall remain in full
force and effect.

11.  REPRESENTATION OF COMPREHENSION OF DOCUMENT.

     In entering this Agreement, the Parties represent that they have relied
upon the advice of their attorneys, who are the attorneys of their own choosing,
concerning the legal consequences of this Agreement; that the terms of this
Agreement have been completely read and explained to the Parties by their
attorneys; that the terms of this Agreement are fully understood and voluntarily
accepted by the Parties; and the Parties unconditionally accept this Agreement
and acknowledge that this Agreement is mutual and binding upon all Parties
hereto regardless of the extent of damages allegedly suffered by any of the
Parties.

12.  SUCCESSORS IN INTEREST.

     This Agreement shall be binding upon and inure to the benefit of the
Parties hereto, jointly and severally, as well as to the past, present and
future executors, administrators, agents, employees, adjusters, directors,
officers, stockholders, servants, attorneys, affiliated persons and entities,
predecessors in interest, successors in interest, assigns regardless of form,
creditors, bondholders, trustees in bankruptcy or otherwise, receivers, general
and limited partners, partners, sister corporations, divisions, subsidiaries,
parents, re-insurers, and any other representative or entity acting on behalf
of, pursuant to or by virtue of the rights of each.

13.  CONSTRUCTION OF THIS AGREEMENT.

     The Parties agree that they have each participated in the drafting of this
Agreement, and that, as a result, this Agreement shall not be construed in favor
of or against any party hereto.


                                      -9-

<PAGE>

14.  GOVERNING LAWS.

     This Agreement shall be construed and interpreted in accordance with the
laws of the State of Georgia.

15.  EFFECTIVENESS.

     This Agreement shall become effective immediately upon execution by the
Parties.

16.  EXECUTION IN COUNTERPARTS.

     This Agreement may be executed in several counterparts, separate signature
pages for each Party, each which shall be deemed an original, but all of which
taken together shall be deemed to constitute one and the same instrument.

17.  HEADINGS AND CAPTIONS.

     The headings and captions used in this Agreement are for convenience of
reference only, and shall in no way define, limit, expand or otherwise affect
the meaning or construction of any provision of this Agreement.

     IN WITNESS WHEREOF, the parties to this Agreement have caused this document
to be signed in their respective names by their duly authorized representative
and approved by their attorneys.

                                        AVONDALE MILLS, INC.


                                        By:    /s/ Stephen Felker
                                            ------------------------------------
                                        Title: Chief Executive Officer &
                                               Chairman of the Board
                                               ---------------------------------

                                        Print Name: Stephen Felker, Sr.
                                        Title: Chief Executive Officer,
                                               Chairman of Board of Directors

ATTESTATION:


                                      -10-

<PAGE>
     On the 16th day of May, 2006, before me came Stephen Felker, to me known,
who, being by me duly sworn, did depose and say that he resides in High Shoals,
Georgia, that he is the Chairman and CEO of Avondale Mills, Inc., the
corporation described in, and which executed, the foregoing instrument, that he
knows the seal of the said corporation; that the seal affixed to said instrument
is the Corporate Seal, that it was so affixed by authority from the Board of
Directors of said corporation; and that he signed his name thereto with like
authority.

                                        /s/ Leigh Ann Mansmann   (Seal)
                                        -------------------------------
                                        Print Name: Leigh Ann Mansmann
                                                    -------------------
                                        Title: Assistant Secretary
                                               ------------------------


Sworn to and Subscribed before me
this 16th day of May, 2006.

/s/ Lynn D. Atha
-------------------------------------
Notary Public


                                      -11-

<PAGE>

                                        FACTORY MUTUAL INSURANCE COMPANY


                                        By: /s/ Dennis M. Corrigan
                                            ------------------------------------
                                        Title:  VP Central Div. Claims Mgr.
                                               ---------------------------------

                                        Print Name: Dennis Corrigan
                                        Title: Vice President, Central Division
                                               Claims Manager

ATTESTATION:

     On the 16 day of May, 2006, before me came Dennis M. Corrigan, to me known,
who, being by me duly sworn, did depose and say that he resides in Illinois,
that he is the Vice President, Central Division Claims Manager of Factory Mutual
Insurance Company, the corporation described in, and which executed, the
foregoing instrument, that he knows the seal of the said corporation; that the
seal affixed to said instrument is the Corporate Seal, that it was so affixed by
authority from the Board of Directors of said corporation; and that he signed
his name thereto with like authority.

                                                                          (Seal)
                                        ----------------------------------
                                        Print Name: Annette Pope
                                                    ----------------------------
                                        Title:
                                               ---------------------------------
Sworn to and Subscribed before me
this 16 day of May, 2006.

/s/ Annette Pope
-------------------------------------
Notary Public


                                      -12-
<PAGE>

                          MEMORANDUM OF UNDERSTANDING
                         REGARDING TERMS OF SETTLEMENT

     This Memorandum of Understanding ("MOU") is made and entered into by and
between Factory Mutual Insurance Company ("Factory Mutual") and Avondale Mills,
Inc. ("Avondale"). Avondale and Factory Mutual agree to the total sum of
$215,000,000 to completely and finally resolve all Avondale claims against
Factory Mutual arising from or related in any way to the January 6, 2005 train
derailment and chlorine release ("the Incident"), including claims under Policy
JB275 ("the Policy") and any other claims and to end the adjustment
investigation and process and discharge Avondale from further response to the
Policy adjustment, proof and appraisal requirements. Of this amount, one hundred
fifteen million and 00/100 dollars ($115,000,000) has already been paid by
Factory Mutual. The full consideration will not be paid until the parties have
drafted, agreed upon, and executed a final Covenant Not to Sue and Settlement
Agreement ("Settlement Agreement"). Subject to the execution of the Settlement
Agreement within 5 days of this MOU, the remaining dollars will be paid by
Factory Mutual in the following manner: $100,000,000 will be paid by May 25
(Factory Mutual will use best efforts to pay by May 22) but after the execution
of the Settlement Agreement. The parties are obligated to execute a Settlement
Agreement within 5 days of this MOU.

     It is expressly agreed, intended, and understood by the parties that the
above-referenced consideration is received in full settlement, accord, and
satisfaction of any and all claims, damages (known and unknown), rights, demands
and causes of action (including, but not limited to, bad faith or punitive or
extra-contractual damages claims) that Avondale has, may have had, or may claim
in the future to have against Factory Mutual its directors, officers, employees,
agents, affiliates, subsidiaries and parents, arising out of the January 6, 2005
train derailment and chlorine release. Avondale will execute subrogation
receipts for all Factory Mutual payments. Avondale warrants that there are no
liens on this recovery or loss payees entitled to be identified for these
payments.

     At the time the Covenant Not to Sue and Settlement Agreement is executed,
Avondale will provide Factory Mutual a copy of the resolution of its Board of
Directors approving this settlement and its terms and the relevant part of the
minutes of the meeting at which it was adopted.

     AFFIRMATIONS OF FACT - In conjunction with this settlement, Factory Mutual
and Avondale hereby acknowledge the following:

     A.   Avondale retained counsel immediately after the Insured event, has
          been represented by counsel throughout the adjustment process and
          settlement negotiations, and was represented by counsel at the time of
          settlement.

     B.   The Parties retained and relied upon experts and consultants.

     C.   The settlement was reached in good faith after arms length
          negotiations by the Parties.

     D.   The Parties dispute the scope and measure of insured damages from the
          Incident;

<PAGE>

     E.   The settlement is intended to compromise and settle disputed claims
          arising out of the Incident. This settlement is a compromise of
          Avondale's claim under the Policy. Factory Mutual's current loss
          measure will be sent to counsel for Avondale. This agreement does not
          constitute an admission by Avondale or Factory Mutual of Avondale's
          insured or uninsured loss.

     F.   In exchange for this settlement, Factory Mutual is foregoing certain
          rights under the Policy concerning its investigation and measure of
          the claims, including, its rights to:

          1.   require Avondale to submit a Proof of Loss;

          2.   seek appraisal of any differences regarding the measure or amount
               of loss;

          3.   obtain documents pursuant to the "Requirements In Case of Loss"
               provision;

          4.   require Avondale to comply with the requirements in the
               "Valuation" provision; and

          5.   conduct examinations under oath.

     G.   Factory Mutual agrees that Avondale has the right to expend or apply
          the proceeds of this settlement as Avondale determines is appropriate
          in its sole discretion.

     H.   Nothing in this MOU shall be deemed a release of any claims asserted
          by Avondale or Factory Mutual against Norfolk Southern or other
          parties to the Recovery action.

     RECOVERY ACTION - Avondale is pursuing a lawsuit against Norfolk Southern
and others for all losses from the Incident and punitive damage claims of the
("Recovery action"). The Parties agree that Avondale can continue to pursue its
claim for uninsured losses, including compensatory damages and punitive damages,
against Norfolk Southern and others in the Recovery action and Factory Mutual
can pursue its subrogation claim against Norfolk Southern and others in the
Recovery action. The Parties will agree to apportion recoveries for any joint
settlement or lump sum recovery as set forth below.

     In the event the court denies Factory Mutual's Motion to Intervene,
Avondale shall agree upon entry of the Order denying Factory Mutual's Motion to
Intervene that Factory Mutual's selected counsel will be added as counsel of
record to represent Factory Mutual's subrogated interest in the Recovery action.
Factory Mutual shall also have the right to control its subrogated interest as
part of the Recovery Action.

     A.   Authority to Settle Recovery Action - Both Avondale and Factory Mutual
          shall have the right to separately settle their respective claims in
          the Recovery action and will do so in a manner that does not
          materially prejudice the ability of the non-settling party to proceed
          with said litigation. In the event of settlement by one Party, the
          settling party will cooperate with the remaining plaintiff or party in
          making files, evidence, experts and other witnesses reasonably
          available to the remaining plaintiff or party to pursue its recovery
          claims at the expense of the nonsettling party. The parties agree that
          the recovery distribution in the event of joint settlement and the
          recovery distribution in the event of jury verdict will not apply if
          either party exercises its right to independently settle its portion
          of the Recovery action.

     B.   Recovery Distribution in the Event of a Joint Settlement - If Avondale
          and Factory Mutual jointly settle their claims in the Recovery action,
          the parties hereby agree that the


                                       -2-
<PAGE>

          first $ 215 million of the settlement shall be considered compensatory
          damages. Subject to this agreement, any funds recovered in a joint
          settlement will be allocated as follows:

          1.   Avondale will receive first dollars to reimburse for its
               deductible and for its uninsured losses up to $ 5 million;

          2.   Factory Mutual will receive the next dollars until it is
               reimbursed $100,000,000 for loss payments under the insurance
               policy;

          3.   Avondale will receive the next dollars for its uninsured loss up
               to an additional $10,000,000.

          4.   Factory Mutual will receive the next dollars until it is
               reimbursed in full for loss payments under the insurance policy
               and pursuant to this MOU.

          5.   After Factory Mutual is compensated per B(4), Avondale will
               receive all additional amounts, including any punitive damages
               recovered by way of settlement.

     C.   Recovery Distribution in the Event of a Jury Verdict - Avondale and
          Factory Mutual agree that they will submit and support a jury verdict
          form that permits the jury to issue separate damages awards to
          Avondale and Factory Mutual for their respective claims. Avondale and
          Factory Mutual shall retain any separate damages awarded to them
          respectively. If Avondale and Factory Mutual collect on a verdict in
          the recovery action which does not separately allocate the Parties'
          respective claims, any amounts awarded by the jury, entered as a
          judgment, and collected by the parties on the judgment will be
          allocated as follows:

          1.   Avondale will receive first dollars awarded as compensatory
               damages to reimburse for its deductible and for its uninsured
               losses up to $5 million;

          2.   Factory Mutual will receive the next dollars awarded as
               compensatory damages until it is reimbursed $100,000,000 for loss
               payments under the insurance policy and pursuant to this
               settlement made to Avondale;

          3.   Avondale will receive the next dollars awarded as compensatory
               damages for its uninsured losses up to an additional $10,000,000;

          4.   Factory Mutual will receive the next dollars awarded as
               compensatory damages until it is reimbursed in full for loss
               payments under the insurance policy and pursuant to this MOU;

          5.   After Factory Mutual is compensated per C(4), Avondale will
               receive all additional amounts awarded as compensatory damages
               and Avondale will receive all amounts awarded as punitive
               damages.

     D.   Recovery Action Expenses - Recovery action expenses include all fees
          and costs incurred for consultants and experts retained by either
          Avondale or Factory Mutual in the Recovery action (not any consultant
          or expert fees on the adjustment issues). Recovery action expenses
          also include: costs of court reporters and deposition transcripts,
          costs of computer support services for document production, document
          copying costs, travel


                                       -3-

<PAGE>

          expenses and related fees provided to witnesses, and expert expenses.
          Finally, Recovery action expenses shall not include any expenses,
          costs or fees relating to the submission or adjustment of the claim
          under the insurance policy, the salary or time incurred by an employee
          of the parties to assist in prosecuting the Recovery action, nor shall
          it include any attorneys' fees and related expenses (including direct
          travel costs) incurred by Avondale or Factory Mutual in the Recovery
          action.

          All Recovery action expenses incurred from the date upon which this
          agreement is executed until the conclusion of the litigation by
          Avondale and/or Factory Mutual shall be split between Avondale and
          Factory Mutual on a 50/50 basis and shall be paid upon receipt of a
          statement with necessary supporting back-up from counsel for
          Avondale/Factory Mutual. Upon completion of the Recovery action by
          Avondale and/or Factory Mutual, Avondale and Factory Mutual shall
          adjust these litigation expense obligations on a pro-rata basis based
          upon the allocation of the full recovery (compensatory and
          punitives) to each party. In the event of settlement by either Party,
          the settling party will be obligated to their 50% of the Recovery
          action expenses as defined in this Agreement up to the date of the
          settlement and will have no other obligation for Recovery action
          expenses.

          In the event of dispute as to application of this provision concerning
          Recovery action expenses, the Parties agree to enter binding
          arbitration pursuant to AAA rules.

     SUCCESSORS IN INTEREST - The terms of this settlement shall be binding upon
Avondale and Factory Mutual and each of their respective successors in interest
and assigns.

     APPLICABLE LAW - This Agreement will be construed in accordance with the
law of the State of Georgia in which the Policy was delivered.

     Signatures on following page.


                                       -4-

<PAGE>

     The Parties to this MOU have caused this document to be signed in their
respective names by their duly authorized representative and approved by their
attorneys.

Factory Mutual Insurance Company        Avondale Mills, Inc.


/s/ Dennis Corrigan                     /s/ Stephen Felker
-------------------------------------   ----------------------------------------
Dennis Corrigan                         Stephen Felker, Sr.
Vice President                          Chief Executive Officer
Central Division Claims Manager         Chairman of Board of Directors


Robins, Kaplan, Miller & Ciresi LLP     King & Spalding LLP
Attorneys for Factory Mutual            Attorneys for Avondale Mills, Inc.
Insurance Company


By: /s/ William H. Stanhope             By: /s/ Michael. C. Russ
    ---------------------------------       ------------------------------------

DATE: May 11, 2006


                                      -5-