I'm afraid I don't know a whole lot about dialogue coding. At what point does the upgrade not work? I assume you have all the items you've listed.
All the items are listed, the merchant can talk and the store works, but the part on where it detects the item to be upgraded (in this case "mlitem11") just does not trigger. I don't know why

Where are you setting the variable mlFelinoAttacked, is it in the CRE script? You might try changing it to a GLOBAL though really, a LOCALS should work here too.
Yes, it is in the CRE script, this is the script:
IF OR(2) AttackedBy([PC],DEFAULT) AttackedBy([GOODCUTOFF],DEFAULT) THEN RESPONSE #100 SetGlobal("mlfelinoAttacked","LOCALS",1) StartDialogNoSet([PC]) END
This I put on the Override Script, is that correct?