Merger Provision Unclear on Tax Obligations, Court Finds

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By Michael Greene

April 26 — A federal appeals court April 26 declined to determine how much the sellers of KOR Electronics are required to pay Mercury Systems Inc., which bought KOR in 2011, for a “purely hypothetical tax loss”.

Judge Kermit V. Lipez from the U.S. Court of Appeals for the First Circuit said the merger agreement provision at issue entitling Mercury to tax liabilities was ambiguous.

Under the parties' agreement, the sellers were required to indemnify Mercury for tax liabilities as calculated without certain merger-related tax deductions—even though Mercury would pay KOR's actual taxes with the deductions taken into account.

“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,” the judge wrote.

Novel Contract Provision

Mercury purchased KOR for $70 million, in a deal that closed on the last day of KOR's federal tax year. After taking the deductions into account, KOR operated at a loss for tax purposes and was refunded $1.76 million in federal and state taxes.

The parties disputed whether KOR's $1.76 million in prepayments and credits should offset the seller's indemnification obligation.

In vacating the lower court's judgment on the matter, the First Circuit concluded that the indemnification provision was unclear on this point and that the dispute couldn't be resolved without further factual findings.

“This ambiguity is remarkable given the sophistication of the parties,” Lipez wrote. “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 would impact the indemnification provision, he said.

To contact the reporter on this story: Michael Greene in Washington at

To contact the editor responsible for this story: Yin Wilczek at

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