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Sparton Corporation v. O'Neil

Court of Chancery of Delaware

June 18, 2018

Sparton Corporation
Joseph F. O'Neil et al.

         Dear Counsel:

         This letter opinion addresses Defendants' motion for partial judgment on the pleadings and Defendants' motion for interim attorneys' fees. For the reasons stated below, both motions are granted. This letter opinion assumes familiarity with the facts outlined in the Court's August 9, 2017 memorandum opinion. The current dispute arises from Plaintiff's refusal to release funds held in escrow pursuant to the parties' agreements.

         I. BACKGROUND

         Plaintiff Sparton Corporation ("Sparton") acquired Hunter Technology Corporation ("Hunter") through a reverse triangular merger on April 14, 2015, with Hunter surviving as a wholly-owned subsidiary of Sparton. Defendants were stockholders and optionholders of Hunter before the merger.

         A. The prior opinion

         Sparton alleged in its Complaint that Defendant Joseph F. O'Neil, Hunter's stockholder representative, and other Defendants fraudulently induced Sparton to enter into the merger agreement through which Sparton acquired Hunter (the "Merger Agreement") by presenting false financial statements during negotiations. Sparton also asserted breach of contract claims relating to the Merger Agreement for (1) breach of warranties relating to Hunter's calculation of its working capital (the "Working Capital Claim"); (2) O'Neil's alleged failure to use commercially reasonable efforts to resolve certain liabilities that Hunter incurred before the merger (the "O'Neil Claim"); and (3) Defendants' purported failure to pay certain invoices Hunter incurred before the merger (the "Expenses Claim"). As a result of the purported fraud and contractual breaches, Sparton alleged it had suffered (1) $1, 829, 455 in damages representing the difference between the inflated working capital it paid for and the working capital that actually existed at closing; (2) unliquidated damages in the amount of fees and costs necessary to resolve the liabilities that O'Neil promised to resolve; and (3) $100, 498.70 in damages for the invoices incurred by Hunter for which Sparton now is responsible. Defendants moved to dismiss all claims except the Expenses Claim. On August 9, 2017, this Court dismissed the Working Capital Claim, O'Neil Claim, and fraud claim for failure to state a claim under Court of Chancery Rule 12(b)(6).[1]

         B. The current dispute

         The current dispute arises from Sparton's refusal to release $838, 000 held in escrow pursuant to the Merger Agreement and a contemporaneously executed escrow agreement (the "Escrow Agreement") between Sparton and Hunter. On October 14, 2016, Defendants filed counterclaims alleging that the parties' agreements require Sparton to release the escrow funds.[2] On November 7, 2016, Sparton filed its answer to Defendants' counterclaims denying Defendants' claim that the parties' agreements entitle Defendants to release of the escrow funds.[3] On September 22, 2017, Defendants moved for partial judgment on the pleadings under Court of Chancery Rule 12(c) seeking release of the escrow funds and interim attorneys' fees and expenses in the amount of $447, 564.03. The Court heard oral arguments on the motion for partial judgment and motion for interim attorneys' fees on March 20, 2018.

         II. ANALYSIS

         "This court will grant a motion for judgment on the pleadings pursuant to Court of Chancery Rule 12(c) when there are no material issues of fact and the movant is entitled to judgment as a matter of law."[4] "When considering a Rule 12(c) motion, the court must assume the truthfulness of all well-pled allegations of fact in the complaint and draw all reasonable inferences in favor of the plaintiff."[5] "The Court must therefore accord plaintiffs opposing a Rule 12(c) motion the same benefits as a plaintiff defending a motion under Rule 12(b)(6). As on a Rule 12(b)(6) motion, however, a court considering a Rule 12(c) motion will not rely upon conclusory allegations of wrongdoing or bad motive unsupported by pled facts."[6]"Although 'all facts of the pleadings and reasonable inferences to be drawn therefrom are accepted as true . . . neither inferences nor conclusions of fact unsupported by allegations of specific facts . . . are accepted as true.'"[7] Thus, "[a] trial court need not blindly accept as true all allegations, nor must it draw all inferences from them in plaintiffs' favor unless they are reasonable inferences.'"[8]"In analyzing a motion to dismiss, the court may consider, for carefully limited purposes, documents integral to or incorporated into the complaint by reference. This same standard logically applies on a Rule 12(c) motion as well."[9]

         The current dispute between the parties centers on the Court's interpretation of the Merger and Escrow Agreements. "Delaware law adheres to the objective theory of contracts, i.e., a contract's construction should be that which would be understood by an objective, reasonable third party."[10] "When interpreting a contract, this Court 'will give priority to the parties' intentions as reflected in the four corners of the agreement, ' construing the agreement as a whole and giving effect to all its provisions."[11] The terms of the contract control "when they establish the parties' common meaning so that a reasonable person in the position of either party would have no expectations inconsistent with the contract language."[12] Standard rules of contract interpretation state that "a court must determine the intent of the parties from the language of the contract."[13] "In giving sensible life to a real-world contract, courts must read the specific provisions of the contract in light of the entire contract. This is true in all commercial contexts, but especially so when the contract at issue involves . . . [the] sale of an entire business."[14]

         A. The Merger and Escrow Agreements do not allow Sparton to withhold the escrow funds

         Sparton is withholding $838, 000 in escrow funds arguing that it is owed this amount for the O'Neil Claim.[15] Defendants argue that the parties' agreements require Sparton to release the escrow funds because Sparton never had a contractual basis to withhold the funds as Sparton admittedly did not incur any out-of-pocket expenses by October 14, 2016 as required under the parties' agreements.[16]

         The parties do not dispute the material terms of the Merger or Escrow Agreements. As I stated in my prior opinion, the Merger Agreement provides that Sparton is entitled to indemnification for claims related to fraud or "any of the matters set forth on the Specific Indemnity Schedule" ("Specific Indemnity Escrow Claims"), which includes the O'Neil Claim.[17] But Sparton's right to indemnification for Specific Indemnity Escrow Claims is limited to losses "that [were] actually incurred prior to October 14, 2016."[18] Sparton had no contractual right to indemnification for losses from Specific Indemnity Escrow Claims "that [were] pending or otherwise [had] not been resolved prior to October 14, 2016."[19]Moreover, "the obligation to indemnify Sparton for [Specific Indemnity Escrow Claims] terminate[d] on October 14, 2016 . . . regardless if any [Specific Indemnity Escrow Claims] remain pending and have not been settled or otherwise resolved.'"[20]The Merger Agreement also provides that "[t]he Specific Indemnity [Escrow] Claims are Sparton's sole and exclusive remedy for losses related to matters listed on the Specific Indemnity Schedule, except in the case of fraud."[21] The Escrow Agreement provides that Sparton "may not submit a Specific Indemnity Escrow Claim until it actually incurs out-of-pocket Losses indemnifiable under Section 11.01(iii) of the Merger Agreement or there is a judgment or settlement . . . of any matter covered by Section 11.01(iii)."[22] On October 14, 2016, the Escrow Agreement required the escrow agent to release the remaining escrow funds "less the aggregate amount, if any, of funds requested for distribution" in all pending Specific Indemnity Escrow Claims.[23]

         These provisions of the Escrow and Merger Agreements are unambiguous. To withhold the escrow funds for losses arising out of any Specific Indemnity Escrow Claims, Sparton must have incurred out-of-pocket expenses related to such claim or obtained a judgment or settlement of such claim prior to October 14, 2016. Sparton does not seriously contend otherwise. Sparton has not alleged that it incurred any such out-of-pocket expenses. To the contrary, Sparton stated in response to Defendants' motion to dismiss that "[n]o judgment or settlement has been entered with respect to the Specific Indemnity Matters because Defendant O'Neil has refused to do so."[24] And, in my prior opinion dismissing the O'Neil Claim, I held that "[t]he conclusory allegation that O'Neil did not use commercially reasonable efforts to resolve the matters because the matters remain unresolved is not enough to state a claim under Rule 12(b)(6)."[25] Thus, because Sparton never had any contractual right to withhold the escrow funds, Defendants are entitled to release of the funds under the terms of the parties' agreements.

         B. A mandatory injunction provides the appropriate form of relief for the release counterclaim

         Defendants seek a mandatory injunction ordering Sparton to instruct the escrow agent to release the escrow funds.[26] I find that a mandatory injunction is the appropriate form of relief. "To issue a mandatory injunction requiring a party to take affirmative action . . . the Court of Chancery must either hold a trial and make findings of fact, or base an injunction solely on undisputed facts."[27] In order for a movant to be entitled to a mandatory injunction, the movant must show "(1) actual success on the merits; (2) irreparable harm; and (3) the harm resulting from failure to issue an injunction outweighs the harm befalling the opposing party if the injunction is issued."[28]

         1. Success on the merits

         As discussed above, Defendants have proven actual success on the merits because it has shown that it is entitled to release of the escrow funds under the parties' agreements.

         2. Irreparable harm

         Section 13.17 of the Merger Agreement provides that "irreparable damage would occur in the event that any of the provisions" of the Merger Agreement "were not performed in accordance with their specific terms or were otherwise breached[.]"[29] Further, "each party shall be entitled to enforce specifically the terms and provisions of" the Merger Agreement, "and appropriate injunctive relief shall be granted in connection therewith."[30] "In Delaware, parties can agree contractually on the existence of requisite elements of a compulsory remedy, such as the existence of irreparable harm in the event of a party's breach, and, in keeping with the contractarian nature of Delaware corporate law this court has held that such a stipulation is typically sufficient to demonstrate irreparable harm."[31] Further, Delaware courts have held that an order requiring immediate release of escrow funds is the most certain, prompt, complete, and efficient form of relief, such that any legal remedies would be inadequate.[32] The escrow funds belong to Defendants, and under the circumstances, damages would not adequately compensate Defendants for their losses.

         3. Balance of the equities

         The equities are in Defendants' favor because Sparton never had the right to withhold the escrow funds under the parties' agreements. Allowing Sparton to withhold assets that rightfully belong to Defendants will harm Defendants more than taking those assets that were not Sparton's away from Sparton.[33] Thus, I find that Defendants are entitled to an injunction requiring the parties to enter into a "Joint Release Instruction, " as defined in the Escrow Agreement, to provide for the disbursement of all of the escrow funds to Defendants.[34]

         C. An interim attorneys' fee award is warranted

         Defendants also seek to recover an interim award for attorneys' fees and expenses incurred in connection with the O'Neil Claim and fraud claim that the Court dismissed in its August 9, 2017 opinion.[35] Delaware courts generally apply the American Rule, under which "each party is obligated to pay its own attorneys' fees regardless of the outcome."[36] But "where the parties have determined the allocation of fees by private ordering, " like in a merger agreement, "departure from this general rule and deference to their agreement are warranted. Absent any qualifying language that fees are to be awarded claim-by-claim or on some other partial basis, a contractual provision entitling the prevailing party to fees will usually be applied in an all-or-nothing manner."[37]

         This Court's power to award interim fees "is part of the original authority of the chancellor to do equity in a particular situation."[38] This Court "may grant interim fees for a variety of reasons, including as a consequence for discovery abuse, as a sanction for making frivolous legal arguments or engaging in bad-faith litigation tactics, as a remedy for contempt of an interlocutory court order, or under specific statutory authority."[39] "[I]nterim fee awards may be appropriate where a plaintiff has achieved the benefit sought by the claim that has been mooted or settled and that benefit is not subject to reversal or alteration as the remaining portion of the litigation proceeds."[40] "By contrast, if further litigation could alter the nature or scope of the relief obtained, or if there are reasons why benefits cannot yet be evaluated, then an interim award would be premature."[41] "Regardless of whether a party can satisfy the requirements for an interim fee award, the decision to entertain the application remains at the discretion of the trial court."[42]

         Defendants seek an award of interim attorneys' fees under Section 13.09 of the Merger Agreement, which states:

Prevailing Party. In the event of any litigation arising from a claim for Fraud or the matters set forth on the Specific Indemnity Schedule, the prevailing party shall be entitled to recover from the non-prevailing party all reasonable costs incurred including staff time, court costs, attorneys' fees, and all other related expenses incurred in such litigation. For avoidance of doubt, the Stockholders and the Optionholders shall be third-party beneficiaries of this Section 13.09 and shall have the benefit of this Section 13.09 in connection with any Fraud claim brought against them in connection with the transactions contemplated hereby.[43]

         Section 13.09 requires Sparton to pay Defendants' attorneys' fees related to their defense against the Specific Indemnity Escrow Claims and fraud claims.[44] Sparton cites several cases for the proposition that interim attorneys' fees are not granted absent exigent circumstances, [45] but those cases do not discuss a contractual right to attorneys' fees akin to Section 13.09 that carves out claims that the Court has already dismissed and that are not subject to reversal or alteration by the remaining litigation. This Court dismissed Sparton's fraud claim and O'Neil Claim, which are the only claims brought by Sparton arising from "Fraud" or the "Specific Indemnity Escrow Schedule" as stated in Section 13.09. Sparton's only remaining claim is the Expenses Claim, which is unrelated to the indemnifiable matters set forth in Section 13.09. Thus, because Defendants are the "prevailing party" under Section 13.09 as to the fraud claim and O'Neil Claim, they are entitled to all reasonable attorneys' fees thereunder.

         D. The requested fees are reasonable

         Section 13.09 entitles the prevailing party to recover all "reasonable" attorneys' fees and expenses incurred.[46] This Court has discretion in determining the reasonableness of attorneys' fees.[47] The party seeking the attorneys' fees bears the burden of establishing the reasonableness of the amount sought.[48] "Determining the reasonableness of amounts sought 'does not require that this Court examine individually each time entry and disbursement[.]'"[49] "If a party cannot be certain that it will be able to shift expenses at the time the expenses are incurred, the prospect that the party will bear its own expenses provides 'sufficient incentive to monitor its counsel's work and ensure that counsel [does] not engage in excessive or unnecessary efforts.'"[50]

         Defendants seek $447, 565.03 in attorneys' fees and expenses.[51] Sparton challenges the reasonableness of Defendants' fee request. First, Sparton argues that Defendants' requested fees are unreasonable because "the only activity in this litigation" related to "one substantive motion[.]"[52] This argument ignores the activity in this matter. Sparton "twice [] asserted multiple claims in lengthy complaints against 26 individual defendants, asserted a fraudulent breach claim that was barred by the merger agreement, and insufficiently pled fraud claims" and put Defendants "in a position of having to move to dismiss, to prepare opening briefs in support of two motions to dismiss, to complete briefing, and then to appear and present that motion before this Court."[53] Sparton's own conduct thus required Defendants' counsel to defend multiple claims in enforcing its rights under the parties' agreements.[54]

         Sparton next argues that Defendants only obtained a $838, 000 benefit for the O'Neil Claim; therefore, the fee request is unreasonable.[55] But this argument ignores the fact that Defendants also prevailed on Sparton's fraud claim and Working Capital Claim. "In total, Sparton valued the [claims dismissed by the Court] at over $2.6 million."[5 ...

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