Mercury Systems, Inc. v. Shareholder Representative Services LLC et al

Filing 56

Judge Richard G. Stearns: MEMORANDUM & ORDER entered granting 38 Defendant's Motion for Partial Judgment on the Pleadings; denying 42 Plaintiff's Cross-Motion for Partial Judgment on the Pleadings. (RGS, law1)

UNITED STATES DISTRICT COURT
DISTRICT OF MASSACHUSETTS
CIVIL ACTION NO. 13-11962 -RGS
MERCURY SYSTEMS, INC.
v.
SHAREHOLDER REPRESENTATIVE SERVICES LLC
MEMORANDUM AND ORDER ON CROSS MOTIONS FOR PARTIAL
JUDGMENT ON THE PLEADINGS
August 22, 2014
STEARNS, J.
This case involves a dispute over the interpretation of a tax
indemnification clause in an Agreement and Plan of Merger (Merger
Agreement or Agreement) through which plaintiff Mercury Systems, Inc.
(Mercury) acquired KOR Electronics (KOR).

Defendant Shareholder

Representative Services LLC (SRS) is the agent and proxy for the KOR
Securityholders from whom KOR was acquired. Both parties now move for
partial judgment on the pleadings as to Counts I and IV of the First
Amended Complaint, which are related to federal and state tax
indemnification claims for the 2011 tax year.
BACKGROUND
On December 22, 2011, the Merger Agreement was executed, and
KOR became a wholly-owned subsidiary of Mercury, while the

Securityholders of KOR’s outstanding shares and vested options exchanged
their shares and options for payments from Mercury totaling $70 million.1
Pursuant to the Agreement, $10.65 million of the $70 million that Mercury
paid for KOR was placed into an escrow account established at closing to
indemnify Mercury. Merger Agreement §§ 1.01(a), 9.05. The Agreement
contained a tax indemnification section wherein SRS agreed to indemnify
Mercury for pre-closing tax period liabilities and any related losses.
On January 28, 2013, Mercury filed an indemnity claim for
$1,829,112, comprised of $1,473,294 claimed as 2011 federal tax liabilities,
and $355,818 claimed as 2011 state tax liabilities. SRS maintains that it
does not owe this amount because almost all of it has already been paid to
Mercury through tax credits and refunds attributable to KOR’s pre-closing
tax payments and credits that were in excess of the eventual amounts owed
for tax year 2011.2
The Merger Agreement

The Merger Agreement was executed by Mercury Systems, Inc.; King
Merger, Inc. (a Mercury subsidiary); KOR; and SRS.
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SRS has represented that it is willing to pay the difference between
the 2011 tax refunds Mercury received and the amount Mercury currently
seeks, and that SRS is prepared, in the interests of resolving this dispute, to
release this amount ($68,499) to Mercury upon authorization of the court.
See Def.’s Mem. at 4.
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Both parties agree that relevant language covering the disputed
claims is found in Article X of the Merger Agreement, entitled “Tax
Matters,” which begins on page 70 of the Agreement.3 Section 10.01, Tax
Indemnification, requires the Securityholders (who are represented by
SRS) to:
indemnify and hold harmless each Buyer Indemnified Person
from, against and in respect of any and all Losses that
constitute or that result from, arise out of or relate to, directly
or indirectly (a) Taxes (or the non-payment thereof) of the
Company and its Subsidiaries for all Pre-Closing Tax Periods, . .
. (c) any and all Taxes incurred by the Company directly related
to the distribution of proceeds for the Contemplated
Transactions . . . .
Merger Agreement § 10.01. The section concludes with the statement that,
[a]ny indemnification made pursuant to this Section 10.01 shall
be made in accordance with the provisions of Section 9.05.
Notwithstanding any other provision of this Agreement, the
determination of the Taxes with respect to this Section 10.01
will be calculated without taking into account any deductions
described in Section 10.05 below.
Id.
Section 10.05, Allocation of Certain Expenses, dictates that “Company
Transaction Expenses . . . shall be claimed as deductions for the Pre-Closing
Tax Period ending on the Closing Date” and that “any income tax

In the Agreement, Mercury is called the “Parent,” and KOR is the
“Company.” “Pre-Closing Tax Period” is defined as “taxable periods ending
on or before the Closing Date and the portion through the end of the
Closing Date for any Taxable period that includes (but does not end on) the
Closing Date.” Merger Agreement § 1.01.
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deductions attributable to payments due at Closing to holders of Vested
Options shall be claimed as deductions for the Pre-Closing Tax Period
ending on the Closing Date.” Id. § 10.05.
Section 10.02, Tax Return Preparation, requires that a distribution be
made to Mercury from the escrow account three days prior to the filing of
tax returns relating to any pre-closing tax period and explains the
calculation for this distribution as follows:
With respect to any such Tax Return filed after the Closing Date
that relates to any Pre-Closing Tax Period and upon the request
of the Securityholders’ Representative, the Escrow Agent shall
make a distribution from the Escrow Amount (sic) to the Parent
three (3) days prior to the filing of such Tax Returns the amount
of the aggregate Tax liabilities due, if any, with respect to such
Pre-Closing Tax Periods; provided however, that for purposes of
determining the Tax liability due with respect to such Tax
Return for purposes of calculating the Securityholders’
indemnification obligations, the determination of the
Tax liability for any such Pre-Closing Tax Period will
be calculated and determined excluding any
deductions described in Section 10.05 below. The
amounts actually due on the Tax Return (after giving effect to
any deductions described in Section 10.05 below) shall
promptly be paid by Parent to the appropriate Governmental
Authority.
Id. § 10.02 (bolded emphasis added).
2011 Tax Claims
On its 2011 federal tax return, KOR reported federal taxable income
as a negative $380,441. Because of estimated tax payments for 2011 that
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KOR made prior to the closing, and because of an overpayment carried over
from the previous year, KOR ultimately overpaid its 2011 federal tax
liability by $1,423,294. KOR also made estimated state tax payments prior
to the closing totaling $407,515, resulting in a state tax overpayment of
$337,319 for 2011.

In sum, it is undisputed that KOR (before it was

acquired by Mercury), overpaid both its federal and state 2011 tax liabilities
in the aggregate amount of $1,760,613.4
DISCCUSSION
The interpretation of the Merger Agreement and the rights of the
parties under it are governed by Massachusetts law, in accordance with
Section 12.08 of the Agreement. In Massachusetts, contract interpretation
questions “are ordinarily questions of law for a court,” as “contract law,
unlike tort law, [] favors judicial resolution of disputes.” Nadherny v.
Roseland Prop. Co., Inc., 390 F.3d 44, 48 (1st Cir. 2004).
Unambiguous terms in a contract “must be construed in their usual
and ordinary sense,” Ober v. Nat’l Cas. Co., 318 Mass. 27, 29 (1945), and a
term is not rendered ambiguous “merely because an imaginative reader
devises a way to split hairs.” Lexington Ins. Co. v. Gen. Accident Ins. Co. of

As previously noted, the difference between these overpayments and
the amount Mercury seeks pursuant to its alleged “pro-forma” calculation is
$68,499.
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Am., 338 F.3d 42, 47 (1st Cir. 2003). “[S]ubjective and unexpressed
expectations cannot refute an agreement which emerges from the objective
facts; contracts rest on objectively expressed manifestations of intent.”
Beatty v. NP Corp., 31 Mass. App. Ct. 606, 612 (1991). Nevertheless, when
a court is construing a commercial contract, “[c]ommon sense is as much a
part of contract interpretation as is the dictionary or the arsenal of canons.”
Fishman v. LaSalle Nat’l Bank, 247 F.3d 300, 302 (1st Cir. 2001); see also
id. (“The presumption in commercial contracts is that the parties were
trying to accomplish something rational.”).
Mercury asserts that it is entitled to the sum of $1,829,112 in
accordance with its “pro forma” calculation of KOR’s 2011 federal and state
tax liability, as detailed in Sections 10.01 and 10.02 of the Merger
Agreement.

Mercury maintains that this “calculation” must be made

without reference to any actual tax liability Mercury incurred for KOR’s
2011 tax debts. This is a plausible reading of the Agreement because certain
deductions that were taken on KOR’s 2011 tax returns are explicitly
excluded from the tax indemnity calculation.5

SRS has conditionally

See Merger Agreement § 10.01 (“[T]he determination of the Taxes
with respect to this Section 10.01 will be calculated without taking into
account any deductions described in Section 10.05 below.”); id. § 10.02
(“[F]or purposes of determining the Tax liability due with respect to such
Tax Return for purposes of calculating the Securityholders’ indemnification
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assented to this plain reading and is willing to pay Mercury the difference
between the refund it received from KOR’s overpayments and the amount
of KOR’s theoretical tax liability.
Where Mercury goes beyond the plain meaning of the contract is in
its assertion that this “pro forma” calculation is to be applied without
reference to the tax overpayments and credits that KOR had already paid
toward the indemnified tax liabilities (which amounts Mercury indisputably
received post-merger). Mercury argues that the exclusion of the referenced
deductions from the tax indemnification calculation in Sections 10.01 and
10.02 is a specific “bargained-for benefit,” which is independent of
Mercury’s entitlement to any refunds or credits that KOR was to receive
(that would inure to Mercury as KOR’s new owner).

Thus Mercury’s

position is that this “benefit” must be calculated without being offset by
amounts Mercury actually received as refunds from the Internal Revenue
Service for the 2011 tax year.
The best that can be said is that this construction seems to be no
more than a recently contrived theory intended to recoup what SRS
accurately terms “double recovery.” Mercury admits that it has already

obligations, the determination of the Tax liability for any such Pre-Closing
Tax Period will be calculated and determined excluding any deductions
described in Section 10.05 below.”).
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received the economic benefit it bargained for – which is the “benefit of the
10.05 deductions.” While Mercury claims the “benefit” of the tax refunds
resulting from 10.05 deductions is distinct from what it terms the
“economic benefit of the 10.05 deductions,” these two are, in financial
reality, overlapping, and there is no language in the Agreement suggesting
that this practical reality was intended to be altered by the parties; a
condition specifying that the calculation of tax indemnification would be
performed without reference to certain deductions cannot be read to also
mean that the tax indemnification calculation should be performed without
reference to amounts already paid toward taxes, unless it is so specified in
the contract.
Aside from the fact that such double recovery is not supported by the
plain language of the contract, the fact that this provision was placed in a
section entitled “Tax Indemnification” is only further indication that the
provision was intended to reimburse Mercury for any gap between the taxes
already paid by KOR for the 2011 tax year before the closing and tax owed
ultimately owed by KOR for 2011 (without having to calculate this in
advance of the closing thereby reducing the purchase price to the SRS
Securityholders). See Black’s Law Dictionary 886 (10t ed. 2009) (defining
“indemnification” as “[t]he action of compensating for loss or damage
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sustained”); see also id. at 887 (defining “indemnity clause” as “[a]
contractual provision in which one party agrees to answer for any specified
or unspecified liability or harm that the other party might incur”).
Mercury’s last-gasp argument is that, because it was already entitled
to receive the tax overpayments (Mercury submits a balance sheet
exchanged between the parties during negotiations that reflects the
overpayments as an asset), the tax indemnification section must be deemed
at least ambiguous with regard to whether it should be offset by these
amounts. But nothing in the actual contract suggests such an ambiguity.
The idea that the tax indemnification provision was intended to provide
some wholly separate “economic benefit” of the merger-related deductions
distinct from a tax refund entitlement that appeared on a particular balance
sheet exchanged between the parties is found nowhere in the plain
language of the agreement.
ORDER
For the foregoing reasons, defendant’s motion for partial judgment
on the pleadings is ALLOWED, and plaintiff’s motion for partial judgment
on the pleadings is DENIED. The court orders SRS to make a payment of
$68,499, representing the difference between the calculation of 2011 tax
liability without reference to the specified deductions, and the amounts
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Mercury has received by virtue of KOR’s pre-closing 2011 tax overpayments
and credits.
SO ORDERED.
/s/ Richard G. Stearns
UNITED STATES DISTRICT JUDGE

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