In Cyber Holding LLC v. CyberCore Holding, Inc. (C.A. No. 7369-VCN), the Delaware Court of Chancery (Noble, J.) ruled on a contract dispute over which party is entitled to tax savings in the amount of $1,557,171, resulting from deductions of various transaction expenses during the stub year. In its opinion, the Court reached its conclusion by applying the objective theory of contract construction combined with the consideration of extrinsic evidence in an effort “to ascertain the shared intentions of the parties.” After considering the limited extrinsic evidence available and conducting its analysis of the Agreement, the Court ruled in favor of the seller and held that the Buyer would have to remit the tax savings plus post-judgment interest. The Court rejected the seller’s request for prejudgment interest as the Agreement’s exclusive remedy provision controlled over the default of awarding prejudgment interest.
CyberCore Corporation (the “Company”) was sold in 2011 through an auction process pursuant to a Redemption and Stock Purchase Agreement (the “Agreement”). The seller, Cyber Holding LLC, an affiliate of Roark Capital Group (the “Seller”), brought a suit against the buyer, CyberCore Holding, Inc., an affiliate of Moelis Capital Partners Opportunity Fund I, L.P. (the “Buyer”), claiming the Buyer breached the Agreement by not paying the full amount of tax savings realized from the transaction deductions to the Seller. The Court rejected the parties’ respective motions for summary judgment in July 2015 and now ruled on the merits of the case.
The Court found that the parties knew before entering into the Agreement that there would be significant change of control payments and professional fees which would reduce the company’s tax liability as “Transaction Deductions.” The Agreement covered treatment of Transaction Deductions, allocating a NOL carryback refund for 2009 and 2010 tax years and a refund of the prepaid estimated taxes for the 2011 stub year and a reduction of the stub year taxes. The dispute centered around treatment of the Transaction Deductions as they applied to the 2011 stub year. Specifically, does the language in Section 6.5(f)(z) of the Agreement limit the amount of tax refund which may be applied to taxes paid in 2009, 2010, and the stub year 2011 or just to the amount paid in the year upon which the credit was received.
The Court found that there were ambiguities in the contract and therefore extrinsic evidence could be reviewed to determine the parties’ intent. The Court reviewed three telephone conversations between counsel for the Seller and Buyer as well as the tax provisions of the Agreement.
The section of the Agreement which governs the allocation of the tax savings in question is Section 6.5(f)(z), specifically the below provision:
To the extent . . . (z) Transaction Deductions claimed in the Tax year ending on or including the Closing Date result in a reduction of Taxes for that Tax year in excess of the amount paid to Sellers pursuant to Sections 6.5(d) and (e), then Buyer shall utilize such deductions . . . as fully and quickly as possible and shall pay to the [Sellers] an amount equal to the amount by which (i) the amount of Taxes that the Buyer, the Company and its Subsidiaries (or their successors) would have been required to pay in the Tax year in question but for the deduction . . . exceeds (ii) the amount of Taxes actually payable by the Buyer, the Company and its Subsidiaries (or their successors) with respect to such Tax years (and in the case of payments pursuant to clause (z) above, solely to the extent such amount is in excess of the amount paid to Sellers pursuant to Sections 6.5(d) and (e)). Buyer shall make such payments within fifteen (15) days of filing the applicable Tax Returns for each such Tax year to the extent of the excess for such Tax year.”
Section 6.5(f)(z) allocates to the Seller the tax savings based on the Transaction Deductions. The amount is limited and cannot exceed the amounts paid under Section 6.5(d) and Section 6.5(e), which are the benefits from the NOL carrybacks to Tax years 2009 and 2010 together with the refund of prepaid estimated taxes for the Stub Year.
The Court determined that even though the limiting clause of Section 6.5(f)(z) does not expressly limit the offset to a particular tax year, the better interpretation was that the parties intended to limit the exclusion provision to the tax year in which the tax savings were applied. Since the tax savings in question applied to the stub tax year, the Court found it was more logical to limit the offset to the amounts paid in that stub year, rather than including the 2009 and 2010 NOLs.
The Buyer was unable to persuade the Court that the 2009 and 2010 carryback refunds should offset 2011 stub year tax savings. Furthermore, the Court determined that Section 6.5(f)(z) would serve “little purpose” with the Buyer’s interpretation and that under the Buyer’s position Section 6.5(f)(z) would never have been triggered.
Based on the contractual ambiguity, the Court also considered three phone calls between the parties’ respective tax attorneys, two of which occurred a few weeks before the closing and a final call the day prior to the closing. During the first call, the Agreement was changed to allocate liability for pre-closing taxes to the Seller. On the second call, the Buyer’s attorney argued that Section 6.5(f)(z) was inconsistent with the revisions to the tax section and should be removed. The proposal was rejected by the Seller. During the call the day before the closing, the Buyer’s tax attorney again argued that Section 6.5(f)(z) should be removed. The Seller’s attorney informed him that it was nonnegotiable. Buyer’s attorney stated he understood the Seller’s position and that if he didn’t call back later that day, Seller’s counsel should consider his request abandoned. The Buyer’s attorney never called back and never proposed language which would change Section 6.5(f)(z)’s limitation on refunds to include the 2009 and 2010 NOLs.
Based on the evidence of the three phone conversations, the parties each argued a contract interpretation principle to advance their position. The Seller invoked the “forthright negotiator principle” which allows the Court to adopt the “subjective understanding of one party that has been objectively manifested and is known, or should be known by the other party.” The Court stated that the Buyer’s tax attorney “could have been clearer or more precise” during his conversation with the Seller’s tax attorney but there was not evidence of disingenuous conduct that is necessary for the application of the forthright negotiator principle, and the Court thus declined to apply such principle here.
The Buyer argued the doctrine of contra proferentem and asked the Court to construe the Agreement against the Seller as the drafting party. The Court rejected this argument because the Agreement contained express language against using this doctrine and both parties were sophisticated with substantially equal bargaining power,. The Court determined that a party can take a firm position, as the Seller did on Section 6.5(f)(z), and it would not be unfair to uphold that position. especially “in light of Buyer’s sophistication and bargaining strength.”
The Court concluded that because of the language of Section 6.5(f)(z), when read in conjunction with Sections 6.5(d) and (e), the tax section of the Agreement, and with the added benefit of the extrinsic evidence around the parties’ discussions over the provision, the Seller’s interpretation prevailed and the Seller was entitled to the tax savings in dispute.