United States Court of Appeals
For the First Circuit
No. 14-2156
MERCURY SYSTEMS, INC.,
Plaintiff, Appellant,
v.
SHAREHOLDER REPRESENTATIVE SERVICES, LLC,
Defendant, Appellee.
APPEAL FROM THE UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF MASSACHUSETTS
[Hon. Richard G. Stearns, U.S. District Judge]
Before
Thompson, Lipez, and Barron,
Circuit Judges.
Christopher H.M. Carter, with whom Hinckley, Allen & Snyder
LLP was on brief, for appellant.
Roger A. Lane, with whom Courtney Worcester and Foley &
Lardner LLP were on brief, for appellee.
April 26, 2016
LIPEZ, Circuit Judge. We must interpret a merger
agreement in which one party agreed to indemnify the other against
a purely hypothetical tax loss. The sellers agreed to indemnify
the buyer for the tax liabilities of the company being sold, except
that the tax bills for indemnification purposes were to be
calculated as if certain deductions would not be taken, when both
parties knew they would be. Given that these deductions, perhaps
in combination with other deductions, reduced the company's tax
liability to zero, the company's tax prepayments and credits were
refunded in their entirety, benefitting the buyer as the company's
new owner. Yet, because the calculation of the indemnity
obligation was based on a counterfactual measure of tax liability,
that calculation resulted in the sellers' nonetheless owing the
buyer a substantial amount of money. The issue that divides the
parties is whether the prepayments and credits, and resulting tax
refunds, affect the tax indemnification obligation of the sellers.
The district court concluded that the indemnification
provision, by its terms, unambiguously required that the indemnity
obligation be offset by the amount of the refunded prepayments and
credits. It therefore entered judgment on the pleadings in favor
of the seller.
We conclude that the indemnification provision is
ambiguous as to how the tax refunds affect the indemnification
obligation of the sellers. Though these sophisticated parties
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knew of the tax prepayments and credits, and expected substantial
tax refunds, they failed to specify how those refunds should be
treated. This critical omission renders their contract ambiguous
on the issue before us. The plain language arguments of the
parties are not fully convincing; reasonable interpretations of
the text support both positions. Their arguments about the purpose
and negotiating history of the provision cannot be resolved without
the aid of a fact-finder. Indeed, the parties dispute key facts
about the company's tax refunds. Hence, we vacate the judgment of
the district court and remand for further proceedings.
I.
A. Background
The indemnity provision at issue is part of a 2011 merger
agreement by which Mercury Systems, Inc.1 ("Mercury") purchased
KOR Electronics ("KOR") from KOR's stockholders and optionholders
("securityholders," represented on appeal by Shareholder
Representative Services, Inc., "SRS"). Consistent with the terms
of the agreement, Mercury created a merger subsidiary (King Merger
Inc.) and merged it with and into KOR, which thus became a wholly-
owned subsidiary of Mercury.
Mercury agreed to pay KOR's securityholders $70 million
for the company, with adjustments for, inter alia, merger-related
1 At the time of the transaction, Mercury was called "Mercury
Computer Systems, Inc."
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expenses and the amount of cash and debt on KOR's books as of the
closing date. Merger Agreement ["MA"] § 3.02. These adjustments
would be based on a balance sheet reflecting estimates of KOR's
2011 assets and liabilities, which KOR promised to provide. MA
§ 3.05(a). Of the purchase amount of $70 million, $10.65 million
would be paid into an escrow account to cover various obligations
of the securityholders. MA § 3.03(b).
The indemnity arrangement relevant to this appeal is set
forth in detail in Article X, section 10.02(a), and referenced in
sections 10.01 and 10.05(a) and (b). Section 10.02(a) provides
that SRS will prepare KOR's 2011 federal and state tax returns.
Then, SRS, on behalf of the former securityholders, must release
money from the escrow account to pay Mercury "the amount of the
aggregate Tax liabilities due, if any." App. 31-32.2 The unusual
feature of the arrangement is how the obligation to pay Mercury
was to be measured. When preparing KOR's 2011 tax returns, SRS
was required to claim two types of merger-related expenses as tax
deductions. This requirement is stated in section 10.02(a) and
echoed in sections 10.05(a) and (b). App. 41-42 (requiring SRS to
"giv[e] effect to any deductions described in Section 10.[0]5");
id. at 54-55 (specifying that the merger-related deductions "shall
2 The relevant text of the merger agreement, including section
10.02, is set out in the Appendix ("App."). Citations to the
appendix refer to particular line numbers therein.
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be claimed"); id. 61-62 (same). However, the securityholders'
obligation to pay Mercury was to be calculated without claiming
those deductions. MA § 10.02(a). The arrangement is set forth as
follows:
[F]or 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.[0]53
below) shall promptly be paid by [Mercury] to the
appropriate Governmental Authority.
Id. (App. 34-46) (emphasis in original). In other words, Mercury
would receive, in payment of the indemnity obligation, an amount
from escrow equal to KOR's tax liabilities as calculated without
the deductions, but pay KOR's actual taxes (if any were still owed)
computed with the deductions. Because KOR was required to claim
the section 10.05 deductions on its 2011 tax return, the
calculation of taxes without those deductions was necessarily
greater than KOR's actual taxes owed. SRS conceded in the district
court that this arrangement could require it to pay Mercury for "a
3 The text refers to "Section 10.5 below," though no such
section exists. The parties clearly intended to reference section
10.05.
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phantom 'liability' for indemnification purposes that is not
actually due to the government."
Section 10.02(a) creates an obligation specific to one
tax year, the year to which the merger-related tax deductions
apply: 2011. Further, by its terms, section 10.02(a) applies only
to taxes related to returns "due after the Closing Date." App.
25. The parties identify no tax period, other than 2011, for which
returns had yet to be filed as of December 30, 2011. This
obligation -- specific to 2011 -- is distinct from the conventional
tax indemnification provision in section 10.01, which applies more
generally to all pre-closing time periods:
[E]ach Securityholder shall . . . indemnify and
hold harmless [Mercury] from, against and in
respect of any and all Losses4 that constitute or
that result from, arise out of or relate to,
directly or indirectly [] Taxes (or the non-payment
thereof) of [KOR] for all Pre-Closing Tax Periods
. . . .5
4 "Losses" are defined to include, among other things,
"assessments, fines, penalties, [and] Taxes." MA § 9.01(a).
"Taxes," in turn, includes "any and all federal, state, local, or
foreign taxes . . . including any interest, penalty, or addition
thereto." MA § 1.01.
5 "Pre-Closing Tax Periods" is defined to include the 2011
tax year, although the merger closed on the last day of that tax
year. MA § 1.01.
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MA § 10.01 (App. 6-11.). Section 10.01 clarifies, however, that
this general tax indemnification provision does not override the
specific arrangement for 2011:
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.
MA § 10.01 (App. 12-15). In other words, section 10.01 recognizes
that the former securityholders are required to indemnify Mercury
for more than its actual tax losses for 2011, consistent with
section 10.02(a).
Despite the detailed treatment of tax matters in Article
X, and though the parties anticipated that KOR would receive tax
refunds for 2011, the merger agreement does not explicitly address
KOR's expected tax refunds or mention any offset.
Mercury, its subsidiary King Merger, KOR, and SRS (for
KOR's securityholders) signed the merger agreement on December 22,
2011. In connection with the agreement, KOR furnished Mercury
with a Company Disclosure Schedule, including its consolidated
financial statements.6 The statements contained tax data for prior
6 These statements are fairly incorporated into the First
Amended Complaint. See Beddall v. State St. Bank and Tr. Co., 137
F.3d 12, 17 (1st Cir. 1998).
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years and year-to-date tax figures for 2011. The merger closed on
December 30, the last day of KOR's federal tax year.
To determine KOR's actual 2011 tax obligations, SRS took
advantage of the merger-related deductions specified in section
10.05, as section 10.02 required. With those deductions taken
into account, KOR operated at a loss for federal tax purposes and,
consequently, had no federal tax liability. Having prepaid $1.42
million in federal taxes and owing no federal income tax, KOR was
refunded all $1.42 million.7 Similarly, after deducting the
merger-related expenses, KOR was left with no income taxable by
various states.8 As a result, KOR's state tax prepayments and
credits exceeded what it actually owed, and it accordingly received
$340,000 in state tax refunds. SRS asserts that the federal and
state refunds were the result of the merger-related tax deductions.
Mercury disagrees, claiming that the parties "expected" that $1.76
million "in Tax pre-payments and over-payments would be refunded
to KOR for the benefit of Mercury, irrespective of the Section
7 For the convenience of the reader, we round these figures to
the nearest $10,000.
8 Mercury claims that KOR had no taxable income for state tax
purposes, and, accordingly, its $340,000 in state tax prepayments
were entirely refunded. SRS claims that KOR did owe some state
taxes even after the deductions were taken into account. SRS
claims that KOR prepaid $410,000 in state taxes, of which only
$340,000 was refunded. Given our holding that the agreement is
ambiguous, we need not determine whether SRS is correct that KOR's
state tax prepayments must be offset, and, hence, need not consider
whether those prepayments amount to $410,000 or $340,000.
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10.05 Deductions." Whether or not the merger-related deductions
were the cause, it is undisputed that KOR was refunded a total of
$1.76 million by federal and state tax authorities for 2011,
benefitting Mercury as KOR's new owner.
To determine the securityholders' tax indemnity
obligation, Mercury recalculated KOR's tax liabilities without the
deductions. In that calculation, KOR had a taxable income of over
$6 million in 2011, resulting in substantial (though hypothetical)
state and federal tax obligations. Mercury asserts that the
correct measure of KOR's 2011 tax liabilities for indemnification
purposes is $2.4 million. Because SRS already has paid $570,000
of the indemnity obligation,9 Mercury now seeks $1.83 million from
SRS. SRS agrees that $2.4 million is the correct measure of KOR's
2011 tax indemnification obligation, not counting prepayments and
credits, but asserts that after the offset for the $1.76 million
in prepayments and credits, only $640,000 was owed. Since SRS
9 On August 31, 2012, Mercury claimed $620,000 for
indemnification of KOR's (hypothetical) 2011 federal tax
liability, calculated pursuant to section 10.02 of the merger
agreement, including an offset for tax refunds. Mercury's claim
certificate did not purport to discharge its tax indemnity claims
entirely. SRS consented to release $570,000 from escrow, but
contested $50,000 of the claimed amount. SRS did not state that
it considered its tax indemnity obligations to be fully discharged.
Then, on January 28, 2013, Mercury claimed the right to additional
indemnification payments. Mercury had recalculated what it was
owed under section 10.02(a), this time without offsetting the tax
refunds. Mercury ultimately asked for $1.83 million ($2.4 million
less the earlier payment of $570,000.)
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previously paid $570,000, it argues that Mercury is now owed only
$70,000.
B. Procedural History
The operative complaint here is the First Amended
Complaint, which Mercury filed against SRS and various former
securityholders on October 21, 2013. In it, Mercury asserted
claims for, inter alia, declaratory relief and breach of contract.
In Count I, Mercury sought a declaration that it was entitled to
$1.83 million from the escrow account pursuant to section
10.02(a)'s indemnification calculation. In Count IV, Mercury
asserted that SRS had breached the merger agreement by failing to
release those funds from escrow, and sought damages.
SRS moved for partial judgment on the pleadings on Counts
I and IV. Mercury opposed the motion and filed a cross motion for
partial judgment on the pleadings. The district court granted
SRS's motion for judgment on the pleadings, denied Mercury's
motion, and entered judgment for SRS. Mercury timely filed this
appeal.10
10 The parties reached a partial settlement that resolved the
remaining issues in the case, though preserving Mercury's claim
under Count III for indemnification of attorney's fees and costs
related to this action concerning Counts I and IV.
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II.
A. Standard of Review
We review cross-motions for judgment on the pleadings de
novo, viewing the pleadings in the light most favorable to the
party opposing the motion. Curran v. Cousins, 509 F.3d 36, 43
(1st Cir. 2007). "Cross motions simply require us to determine
whether either of the parties deserves judgment as a matter of law
on facts that are not disputed." Barnes v. Fleet Nat'l Bank, N.A.,
370 F.3d 164, 170 (1st Cir. 2004) (quoting Wightman v. Springfield
Terminal Ry., 100 F.3d 228, 230 (1st Cir. 1996)). This analysis
is similar to that used for cross-motions for summary judgment,
Curran, 509 F.3d at 44, though for the purposes of judgment on the
pleadings the court ordinarily may consider only facts contained
in the pleadings and documents fairly incorporated therein, and
those susceptible to judicial notice, R.G. Fin. Corp. v. Vergara-
Nuñez, 446 F.3d 178, 182 (1st Cir. 2006).
B. Massachusetts Law
Under Massachusetts law, contract terms are ambiguous
when they are "inconsistent on their face or where the phraseology
can support reasonable difference of opinion as to the meaning of
the words employed and obligations undertaken." Fashion House,
Inc. v. K Mart Corp., 892 F.2d 1076, 1083 (1st Cir. 1989)).
Ambiguity exists where "reasonably intelligent persons would
differ as to which meaning is the proper one." Id. (quoting
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Citation Ins. Co. v. Gomez, 688 N.E.2d 951, 953 (Mass. 1998)); see
also Caldwell Tanks, Inc. v. Haley & Ward, Inc., 471 F.3d 210, 215
(1st Cir. 2006). Where more than one interpretation fits the
literal meaning of the text and is compatible with common sense
and practical economic reality, a court may find a provision to be
ambiguous as a matter of law. See Den Norske Bank AS v. First
Nat'l Bank of Boston, 75 F.3d 49, 54-55 (1st Cir. 1996).
Where "the contract language is ambiguous, on its face
or as applied," contract interpretation normally becomes a
question of fact to be decided with reference to extrinsic
evidence. Den Norske Bank, 75 F.3d at 52 (citing Freelander v. G.
& K. Realty Corp., 258 N.E.2d 786, 788 (Mass. 1970); Robert Indus.,
Inc. v. Spence, 291 N.E.2d 407, 410 (Mass. 1973)). Extrinsic
evidence may include the parties' negotiations during contracting,
their course of performance under the contract, their course of
dealing prior to the contract, and trade usage in the relevant
industry. Id. at 52-53.
III.
As described above, this case involves three provisions
of the merger agreement: sections 10.01, 10.02(a), and 10.05. The
last of those, 10.05, simply obliges Mercury to take the applicable
merger-related deductions when filing returns for "the Pre-Closing
Tax Period," and it is not in dispute. The controversy centers
primarily on section 10.02(a) and the indemnification amount it
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requires SRS to pay Mercury. Although the parties agree that the
provision's purpose was to pay Mercury the value of the merger-
related tax deductions, they disagree on the magnitude of that
benefit. The relationship between section 10.01, the general
indemnification provision, and section 10.02(a) is one of the
questions that must be considered in construing the latter
provision.
SRS accepts that Mercury was owed the $2.4 million
attributable to the merger-related deductions, but it insists that
the parties understood that part of that amount -- $1.76 million
-- had already been paid in the form of KOR's tax refunds. SRS
draws support for its interpretation from the text of section
10.01, which imposes an indemnification burden on the
securityholders for "losses," while instructing that the 10.05
deductions must be treated differently. Mercury, on the other
hand, contends that SRS must pay the full $2.4 million from the
escrow account. Mercury argues that, because KOR was in a tax
loss position for 2011 and thus had no tax debt, KOR would have
received full refunds of its tax prepayments even without the
merger-related deductions. Hence, the refunds were unrelated to
the payment required by section 10.02(a), and, under Mercury's
reading, section 10.02(a) in effect amounted to a price adjustment.
We first review the pertinent terms of the agreement and
then briefly consider the parties' additional contentions
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regarding its construction. See Den Norske Bank, 75 F.3d at 52-
53.
A. Plain Language
We begin our examination of the agreement's language with
section 10.02(a), the provision that details the indemnification
benefit to Mercury, and then consider whether the general
indemnification provision, section 10.01, sheds light on how that
benefit is to be calculated.
1. Section 10.02(a)
This section, labeled "Tax Return Preparation," appears to
have three primary purposes. First, it states SRS's obligation to
prepare, and Mercury's obligation to file, any KOR tax returns
covering pre-closing time periods that are due after the merger's
closing date. App. 19-25. That obligation, of course,
incorporates the requirement of section 10.05 that Mercury take
advantage of available merger-related deductions. App. 40-44.
Second, section 10.02(a) provides for a transfer of funds from the
escrow account to Mercury to cover payment of the taxes due for
the pre-closing period, but with the amount calculated as if the
merger-related deductions had not been taken. App. 33-40. Third,
section 10.02(a) requires Mercury to promptly pay "[t]he amounts
actually due on the Tax Return." App. 40-41. Thus, the text
plainly requires payment to Mercury of an amount in excess of the
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actual tax debt, leaving Mercury with a cash payment that appears
to be, in effect, a purchase price adjustment.
Strikingly, section 10.02(a) does not in explicit terms
address the fact -- known to both parties -- that KOR had made
substantial prepayments of its tax obligations and, accordingly,
expected refunds.11 Mercury argues that this omission itself
reveals that the parties did not intend to offset SRS's indemnity
obligation by the amount of the anticipated refunds. It insists
that a deduction of that magnitude from the tax liability
calculation cannot be presumed from silence, and it asserts that
implying an offset into the agreement is tantamount to rewriting
the contract. See Paterson-Leitch Co. v. Mass. Mun. Wholesale
Elec. Co., 840 F.2d 985, 991 (1st Cir. 1988) (warning that courts
should not "rewrite contracts freely entered into between
sophisticated business entities" (quoting RCI Ne. Servs. Div. v.
Bos. Edison Co., 822 F.2d 199, 205 (1st Cir. 1987))).
SRS, however, draws meaning from the fact that section
10.02(a) addresses both preparation of tax returns and the
calculation of the indemnity obligation. It sees a plain
recognition of the tax-refund offset in the relationship between
11 KOR's tax prepayments and credits were among KOR's assets, as
reflected on the balance sheet exchanged by the parties during
negotiations. In addition, KOR's pre-closing financial
disclosures informed the parties that the prepayments and credits
would result in refunds.
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the provision's requirements, emphasizing that SRS's obligation to
make indemnification payments from the escrow account is expressly
linked to the preparation of tax returns through the phrases
"[w]ith respect to any such Tax Return," App. 25-26, and "with
respect to such Tax Return." App. 34-35. Thus, SRS argues, the
indemnification must be calculated "on the same basis as the 'real'
tax calculation -- that is, on the basis of KOR's tax return --
with the only departure . . . being the exclusion of two deductions
specified in Section 10.05." The "real" tax calculation would
include deducting the amount of any prepayments and refundable
credits to arrive at the amount owed at the time the return is
filed. SRS thus reads section 10.02(a), in context, to include an
offset for the amount of prepayments and refundable credits.
We conclude that the language of section 10.02(a) is
reasonably susceptible to both of these interpretations. On the
one hand, as Mercury argues, it is difficult to imagine the parties
intending, but not expressly addressing, the substantial reduction
in the indemnification obligation that would occur through an
offset for the tax prepayments. Contrary to SRS's view, the
language linking the indemnification amount to "such Tax Return"
does not inevitably refer to the routine mechanics of calculating
taxes -- with an offset for prepayments and credits -- but may be
a simple reference back to the provision's subject-matter, i.e.,
a tax return due after the closing date for a pre-closing period.
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If, as Mercury argues, the tax calculation was intended to define
an appropriate "rebate" for Mercury -- rather than a classic
"indemnification" -- it would be reasonable to conclude, absent
explicit instruction to the contrary, that the agreement does not
call for deducting the prepayments and credits. On the other hand,
as described above, the focus in section 10.02(a) on both tax
return preparation and indemnification makes plausible SRS's view
that the required payment was intended to be a net amount.
Hence, the language of section 10.02(a), on its own,
leaves us uncertain about what the parties intended.
Notwithstanding its view that the section's plain language
requires an offset for the tax refunds, SRS asserts that the text
of section 10.01 clarifies any possible ambiguity and reinforces
its contention that the amount owed to Mercury is the difference
between the total merger-related tax savings and the refund amount.
We thus consider whether the ambiguity we discern in section 10.02
is resolved by section 10.01's plain language.
2. Section 10.01
The conventional tax indemnification language of section
10.01 protects Mercury against, inter alia, "any and all
Losses . . . relate[d] to . . . Taxes (or the non-payment thereof)
. . . for all Pre-Closing Tax Periods." App. 8-10. SRS avers
that this language, notwithstanding its generality, is susceptible
to only one meaning. It asserts that the term "Losses," App. 8,
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read in its "usual and ordinary sense," S. Union Co., 941 N.E.2d
at 640, requires an offset for tax prepayments to be read into the
agreement. In SRS's words, there can be no indemnifiable "Losses"
arising from KOR's taxes if KOR has already "actually paid, and
thereby discharged, all or part of any such Taxes."12
SRS may be correct that, once KOR's fictional tax
liability for 2011 is determined, the fictional part of the
calculation is complete and the amount owed to Mercury is intended
to be determined as it would be in a typical indemnification
scenario. Ordinarily, KOR's tax debt and, in turn, Mercury's out-
of-pocket "loss," would be reduced by the amount of the prepayments
and credits. However, it may be that the parties did not intend
the word to be read in this way. In fact, supporting the conclusion
that they intended the word to be read without regard to offsetting
prepayments, the language in section 10.01 on which SRS relies is
followed by the "Notwithstanding" proviso, which instructs that,
regardless of "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
12 The district court generally agreed with this construction,
though it emphasized the plain meaning of the word
"indemnification." In the court's view, the dictionary definition
of the term shows that indemnification requires a pre-existing
loss. Because it believed Mercury's loss was reduced by the amount
of the tax refunds, the court reasoned that $1.76 million must be
offset.
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in Section 10.05 below." This sentence appears to say that neither
the general indemnity obligation just stated, nor any other
provision in the agreement, negates the unusual arrangement
specified in section 10.02(a), i.e., that Mercury is owed an amount
to be calculated by reference to a fictional tax liability.
Of course, the "Notwithstanding" sentence does not by
its terms exclude the possibility that the ordinary concept of
loss was intended in section 10.01 and thus was meant to be applied
to the fictional liability, requiring a deduction for the
prepayments and credits. It is also plausible to read the
"Notwithstanding" caveat as recognizing and reinforcing a distinct
method of calculating the "indemnification" obligation for the
not-yet-completed 2011 taxes due, disregarding the usual method of
determining a "loss." Indeed, as we have described, section
10.02(a) creates both a tax liability and thus an indemnification
obligation where none in fact existed because of KOR's financial
circumstances. That explicit fiction belies the inevitability of
the parties' intention to apply a literal concept of "loss" to
calculate the 2011 tax indemnification amount. See Mass. Mun.
Wholesale Elec. Co. v. Town of Danvers, 577 N.E.2d 283, 294-95
(Mass. 1991) (recognizing that plain meaning does not control where
context shows that the parties have assigned an unusual meaning to
a term).
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To the contrary, while section 10.01 as a general matter
imposes responsibility on the securityholders for possible tax
"Losses" resulting from future IRS audits, including for 2011, the
section can reasonably be read to identify SRS's "indemnification"
obligation at the time of the merger as the amount specified in
section 10.02(a) -- without accounting for the prepayments and
credits. The parties' sophistication and the obviousness of the
refund issue makes it unlikely that, given the section 10.02(a)
fiction, they would have hidden the answer to the refund question
between the lines of section 10.01. Again, the absence of explicit
reference to the anticipated refunds leaves the parties' intent
unclear.
In sum, given that section 10.02(a) appears to use the
tax liability context as a way to define a price adjustment -- and
calls for a transfer of funds that ordinarily would not be
described as an "indemnification" -- we have no confidence that
the parties intended the ordinary calculation of "loss" to apply.
We thus find no decisive guidance on the meaning of section
10.02(a) in the plain language of section 10.01.
B. Other Arguments
The parties offer multiple theories to support their
competing contentions that the intent of section 10.02 is
discernible from the provision's plain language. These theories
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are largely fact-dependent and, hence, require judgments based on
fact-finding that we cannot do.
SRS, for example, argues that KOR's tax refund must offset
Mercury's recovery lest Mercury receive what it calls a double
recovery, or a "windfall by recovering some amounts twice." As
noted above, SRS believes that no refunds would have been paid
absent the deductions. Because KOR's 2011 tax refunds are part of
the benefit of the merger-related tax deductions, SRS argues, they
must be counted against the former securityholders' indemnity
obligation. To allow Mercury to claim KOR's 2011 tax refunds
(worth $1.76 million), and the full $2.4 million value of the tax
deductions without an offset, would give Mercury $1.76 million
twice.13 However, whether the refunds are solely attributable to
the merger is a disputed fact that cannot be determined on the
limited record before us. Moreover, this argument has force only
if the parties in fact intended to define the total amount due to
Mercury by the net benefit from the merger-related deductions. As
we have explained, the agreement does not plainly limit the
"indemnification" payment to that amount.
13 The district court found this argument persuasive. It
reasoned that Mercury "received the economic benefit it bargained
for -- which is the 'benefit of the 10.05 deductions.'" It further
observed that "[t]he 'benefit' of the tax refunds resulting from
10.05 deductions" and the "'economic benefit of the 10.05
deductions,' . . . are, in financial reality, overlapping."
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Mercury, meanwhile, asserts that it bargained separately for
the tax refunds and the tax indemnification provisions. It
supports this assertion with drafts of the merger agreement and
associated correspondence to and from its counsel during
negotiations. [Mercury Br. 6-7.] However, we may not consider
such evidence in our review of a judgment on the pleadings, as
these materials are not fairly incorporated in the pleadings or
susceptible to judicial notice, see R.G. Fin. Corp., 446 F.3d at
182, and Mercury cites no other basis on which they may be
considered.14
IV.
Although there are elements of reasonableness in both
parties' arguments, neither party succeeds in clarifying the
14 Mercury also makes another argument based on negotiating
history. According to Mercury, KOR had substantial net operating
losses (NOLs) from past years, which it had carried forward in the
hope of reducing its taxable income in a future year. However,
the NOLs could not be carried forward post-merger because section
382 of the Internal Revenue Code ("I.R.C.") does not allow Mercury
as KOR's new owner to take advantage of them. To compensate for
the lost value of KOR's NOLs, according to Mercury, "the parties
negotiated for a cash payment to Mercury in an amount equal to the
Tax benefit Mercury would have received had there been no
limitation on the use of accumulated NOLs." Mercury claims that
this amount is $2.4 million, and that if KOR's prepayments and
credits are offset, it will get less than the tax benefit of the
accumulated NOLs, and thus less than it bargained for. Again,
however, Mercury's claims are not reflected in the text of the
merger agreement. Nor does Mercury explain how it calculates the
tax benefit it would have received if it had been permitted to use
KOR's accumulated NOLs. We are left with no explanation to connect
the NOLs -- allegedly made useless by I.R.C. § 382 -- to the
conclusion that Mercury was owed $2.4 million rather than $640,000.
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meaning of the merger agreement with respect to the offset issue.
On this point, sections 10.01 and 10.02 are inescapably ambiguous;
"reasonably intelligent persons would differ as to which meaning
is the proper one." S. Union Co., 941 N.E.2d at 640 (quoting
Citation Ins. Co., 688 N.E.2d at 953).
This ambiguity is remarkable given the sophistication of
the parties. Mercury and the former owners of KOR agreed to a
seemingly novel contract provision, incorporating elements of an
indemnity and a purchase price adjustment. Although the parties
knew that KOR had tax prepayments and credits and anticipated a
2011 tax refund, they failed to clarify how these prepayments and
credits would affect the indemnification provision. Indeed, the
failure to speak expressly to the issue suggests that the parties,
inexplicably, may have neglected to address how the refunds would
be handled. Having thus agreed to an ambiguous contract, the
parties now must shoulder the costs of additional litigation in
the district court to clarify its meaning, through consideration
of negotiating history and other extrinsic evidence probative of
the intentions of the parties, consistent with Massachusetts law.
See Den Norske Bank AS, 75 F.3d at 52-53.
We vacate judgment in favor of SRS, affirm the denial of
judgment to Mercury, and remand to the district court for further
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proceedings consistent with this opinion.15 Each party shall bear
its own costs.
So ordered.
15 Of course, these additional proceedings could be avoided if
the parties settle this case. We urge them to seriously explore
that possibility. Settlement counsel of the First Circuit stands
ready to assist them in this effort.
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Appendix
Excerpts from the Agreement and Plan of Merger:
Section 10.01. Tax Indemnification. From and after
the Closing Date, each Securityholder shall . . .
indemnify and hold harmless [Mercury] 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 [] Taxes (or the non-payment thereof) of
[KOR] for all Pre-Closing Tax Periods . . . .
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.
Section 10.02. Tax Return Preparation.
(a) [SRS] shall cause to be prepared
(and [Mercury] shall cause to be subsequently
filed) in a timely manner all Tax Returns related
to Pre-Closing Tax Periods (other than Tax Returns
for a Straddle Period) which are required to be
filed by [KOR], to the extent such Tax Returns are
due after the Closing Date. . . . 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 [SRS], the Escrow Agent shall make
a distribution from the Escrow Amount to [Mercury]
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.[0]5 below)
shall promptly be paid by [Mercury] to the
appropriate Governmental Authority. . . .
. . .
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Section 10.05. Allocation of Certain Expenses
(a) Any Company Transaction Expenses,
to the extent not required to be capitalized and
included in [Mercury's] tax basis of the [KOR]
stock and to the extent otherwise permitted by
applicable Legal Requirements . . . shall be
claimed as deductions for the Pre-Closing Tax
Period ending on the Closing Date; and
(b) To the extent permitted by
applicable Legal Requirements . . . any income tax
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.
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