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Kilcullen v. Spectro Scientific, Inc.

Court of Chancery of Delaware

July 15, 2019

KEVIN M. KILCULLEN, in his capacity as individual trustee of the George S. Mennen Irrevocable Trust FBO John H. Mennen UAD November 25, 1970, Plaintiff/Counterclaim Defendant,
v.
SPECTRO SCIENTIFIC, INC., Defendant/Counterclaim Plaintiff.

          Date Submitted: April 16, 2019

          Kevin G. Abrams, J. Peter Shindel, Jr., Matthew L. Miller, ABRAMS & BAYLISS LLP, Wilmington, Delaware; Herbert J. Stern, Brian J. DeBoer, STERN KILCULLEN & RUFOLO LLC, Florham Park, New Jersey; Counsel for Plaintiff and Counterclaim Defendant Kevin M. Kilcullen, in his capacity as Trustee of the John H. Mennen Trust.

          Raymond J. DiCamillo, Kevin M. Gallagher, RICHARDS, LAYTON & FINGER, P.A., Wilmington, Delaware; John J. Tumilty, Amanda R. Phillips, MORSE, BARNES-BROWN & PENDLETON, P.C., Waltham, Massachusetts; Counsel for Defendant and Counterclaim Plaintiff Spectro Scientific, Inc.

          MEMORANDUM OPINION

          McCORMICK, V.C.

          This is a dispute over a half a million dollars held in escrow in connection with a stock purchase agreement. Under the agreement, Spectro Scientific, Inc. ("Spectro") purchased all of the issued and outstanding shares of On-Site Analysis, Inc. ("On-Site"). The escrow served as security for the indemnification obligations the seller owed to Spectro. After the stock purchase closed, Spectro discovered that contrary to representations made in the stock purchase agreement, On-Site had sold and shipped to end users products containing unlicensed software. To resolve this licensing problem, Spectro entered into a settlement with the software's licensor. Through the settlement, the licensor agreed to release claims against Spectro and On-Site, but not against the end users of Spectro's products, leaving Spectro exposed to potential claims and cross claims by those end users.

         In light of these settled and potential claims, Spectro sought indemnification from the seller against the escrow and instructed the escrow agent to hold all escrowed funds until Spectro's indemnification claims were resolved. The seller commenced this litigation to resolve Spectro's indemnification claims and secure a release of the escrowed funds. Spectro counterclaimed. The seller moved for judgment on the pleadings on its claims and to dismiss Spectro's mirror-image counterclaims.

         This decision grants and denies the seller's motion in part. Spectro is time-barred from claiming indemnification for first-party claims against the seller for alleged breaches of representations and warranties in the stock purchase agreement. Spectro is likewise time-barred from claiming fraud against the seller based upon the seller's allegedly false representations and warranties. Spectro's counterclaims seeking indemnification for potential, unasserted third-party claims by end users are dismissed without prejudice as unripe. Spectro's counterclaims seeking indemnification for third-party claims by the licensor, however, survive the pleadings stage.

         I. FACTUAL BACKGROUND

         The facts are drawn from Spectro's Verified Counterclaims (the "Counterclaims"), the documents incorporated by reference therein, and matters not subject to reasonable dispute, including allegations admitted in Spectro's answer ("Answer") to the Verified Complaint ("Complaint").[1]

         On November 19, 2014, Spectro, On-Site, and plaintiff and counterclaim defendant George S. Mennen Irrevocable Trust established for the benefit of John H. Mennen under agreement dated November 25, 1970 ("Seller") entered into a stock purchase agreement ("Stock Purchase Agreement").[2] Under that Agreement, Spectro purchased all of the issued and outstanding shares of On-Site from Seller. The transaction closed on November 28, 2014. Contemporaneous with the closing, Spectro and Seller executed an escrow agreement ("Escrow Agreement")[3] placing $500, 000 of the purchase price in escrow. The escrowed funds served as security for indemnification obligations owed by Seller to Spectro under the Stock Purchase Agreement.[4]

         On-Site designs and manufactures oil analyzers, which it sells and ships to customers. Before the stock purchase closed, On-Site shipped approximately 640 analyzers containing unlicensed software owned by Microsoft Corporation ("Microsoft"). Neither On-Site nor Seller disclosed these facts to Spectro prior to the closing. To the contrary, On-Site and Seller represented and warranted in the Stock Purchase Agreement that On-Site was authorized to use the software, had obtained all necessary licenses, and was in compliance with all laws.[5] Spectro discovered the issue and investigated its scope after the stock purchase closed. Spectro determined that of the 640 shipped analyzers containing unlicensed software, approximately 330 (the "legacy units") remained in worldwide use after the closing.

         Under Section 7.2 of the Stock Purchase Agreement, Seller agreed to indemnify Spectro for certain "Losses." The Escrow Agreement set forth requirements for seeking indemnification against the escrowed funds and disputing such indemnification claims.[6] The Escrow Agreement further provided that the balance of any escrowed funds not subject to an indemnification claim-whether pending or disputed-would be released within three business days of November 28, 2015.[7]

         On November 16, 2015, Spectro sent a letter to Seller and the escrow agent claiming indemnification under Section 7.2 of the Stock Purchase Agreement. The claim notice cited On-Site's "failure to procure and maintain appropriate software licenses" for its analyzers as the basis for Spectro's claim.[8] On November 18, 2015, the Seller responded with a letter disputing Spectro's indemnification claims.

         On May 25, 2016, Spectro entered into a settlement with Microsoft. In exchange for a payment of $66, 000, Microsoft released both Spectro and On-Site from claims relating to the unlicensed software used in the legacy units. Microsoft, however, did not release the end users of the 330 legacy units. According to Spectro, this leaves Spectro and On-Site exposed to licensing related claims by the end users of the legacy units, particularly those end users who Microsoft may contact or sue. Spectro made the $66, 000 payment to Microsoft on July 7, 2016.

         On July 28, 2016, Spectro notified Seller of Spectro's settlement with Microsoft. Spectro demanded that Seller immediately authorize the escrow agent to pay from the escrowed funds the amount of the settlement consideration, plus attorneys' fees and costs, totaling $134, 370.55. Spectro also reserved its right to seek indemnification against the balance of the escrowed funds for future Losses. The Seller responded on August 2, 2016, stating that Spectro had provided no supporting documentation to date and requesting that Spectro provide certain supporting documentation. Seller also stated that Spectro's failure to obtain Seller's approval of the Microsoft settlement violated the Stock Purchase Agreement.

         Communications between Spectro and Seller ceased for nearly two years. Then, on May 10, 2018, Spectro informed the escrow agent and Seller that Spectro's indemnification claims remained pending and that the escrowed funds may not be distributed.

         Seller commenced this litigation on June 12, 2018. Spectro answered and counterclaimed on July 23, 2018. Seller moved for judgment on the pleadings as to the Complaint and to dismiss Spectro's Counterclaims on August 13, 2018. The parties fully briefed that motion[9] and then presented oral arguments on April 16, 2019.[10]

         II. LEGAL ANALYSIS

         Seller's Complaint pleads four counts against Spectro to enforce the Stock Purchase Agreement and Escrow Agreement. Spectro's Counterclaims plead five counts that essential mirroring Seller's counts, as well as a sixth count for fraud. At the heart of the parties' respective contract-based counts is a single question: Is Spectro is entitled to indemnification and if so, to what extent? Beyond this question, Spectro further seeks a determination as to whether Seller committed fraud in connection with its entry into the Stock Purchase Agreement.

         Seller has moved to dismiss the Counterclaims under Court of Chancery Rule 12(b)(6). The Court may grant a motion to dismiss under Rule 12(b)(6) for failure to state a claim if a complaint does not allege sufficient facts that, if proven, would entitle the plaintiff to relief.[11] "[T]he governing pleading standard in Delaware to survive a motion to dismiss is reasonable 'conceivability.'"[12] When considering such a motion, the Court must "accept all well-pleaded factual allegations in the Complaint as true, accept even vague allegations in the Complaint as 'well-pleaded' if they provide the defendant notice of the claim, [and] draw[] all reasonable inferences in favor of the plaintiff[.]"[13] The Court is not required to "accept as true conclusory allegations 'without specific supporting factual allegations'" or "'accept every strained interpretation of the allegations proposed by the plaintiff.'"[14] And the Court may consider the timeliness of claims on a motion to dismiss "if the facts pled in the complaint, and the documents incorporated within the complaint, demonstrate that the claims are untimely."[15]

         Seller has also moved for judgment on the pleadings on each of its claims. In deciding a motion for judgment on the pleadings under Court of Chancery Rule 12(c), the Court "view[s] the facts pleaded and the inferences to be drawn from such facts in a light most favorable to the non-moving party."[16] "A motion for judgment on the pleadings may be granted only when no material issue of fact exists and the movant is entitled to judgment as a matter of law."[17]

         This decision first focuses exclusively on Seller's Rule 12(b)(6) motion and then turns to Seller's Rule 12(c) motion.

         A. Seller's Motion to Dismiss the Counterclaims

         Seller seeks dismissal of five of Spectro's six Counterclaims-specifically, those counts for declaratory judgment, breach of contract (two counts), specific performance, and fraud.[18] This decision refers to the declaratory judgment, breach of contract, and specific performance claims as the "Indemnification Counterclaims."

         1. Spectro's Indemnification Counterclaims

         The Indemnification Counterclaims implicate two provisions of the Stock Purchase Agreement. The first, the "representations" provision, entitles Spectro to claim indemnification for Losses "asserted, incurred in connection with, arising out of, resulting from or incident to . . . any breach of any representation or warranty made by [On-Site] or the Seller in or pursuant to this [Stock Purchase] Agreement or in any certificate or other closing document delivered pursuant to this Agreement[.]"[19] Counterclaims I-IV seek indemnification based upon Seller's alleged breaches of representations and warranties and are thus are based in whole or in part on this first provision. The second, the "product shipment" provision, entitles Spectro to claim indemnification for Losses "asserted, incurred in connection with, arising out of, resulting from or incident to . . . any product shipped or manufactured by, or any services provided by, [On-Site], in whole or in part, prior to the Closing Date."[20] Counterclaims I, III, and IV each seek indemnification in connection with Spectro's settlement with Microsoft and residual exposure to liability from the legacy unit end users and are thus based in part on this second provision.[21]

         a. Indemnification Based on the Representations Provision

         Under Delaware law, post-merger claims for breaches of contractual representations and warranties and claims for contractual indemnification for those breaches accrue on the day of closing.[22] The stock purchase closed, and claims for breach of representations and warranties and corresponding claims for contractual indemnification under the Stock Purchase Agreement therefore accrued, on November 28, 2014.

         The default statute of limitations for contractual claims is three years.[23] While "statutes of limitation do not generally apply directly in equity, equity follows the law and will apply a statute of limitations by analogy under appropriate circumstances."[24] Given the mixed legal and equitable nature of the Indemnification Counterclaims, this Court applies the relevant statute of limitations by analogy.[25]Thus, absent tolling, the statute of limitations barred the Indemnification Counterclaims based on the representations provision as of November 28, 2017- three years from the closing.

         In addition to the three-year statute of limitations, the Stock Purchase Agreement imposed a truncated one-year contractual limitations period on representations and warranties related to intellectual property. Section 7.1(a) of the Stock Purchase Agreement provides that "all representations and warranties in this Agreement [other than certain representations and warranties not relevant here] . . . shall terminate on the date that is twelve (12) months following the Closing Date"- i.e., November 28, 2015.[26]

         Spectro argues that its November 16, 2015 indemnification claim notice tolled both statutory and contractual limitations periods. In support of its tolling argument, Spectro relies on Section 7.1(d) of the Stock Purchase Agreement:

[A]ny representation or warranty in respect of which indemnity may be sought under Section 7.2 below, and the indemnity with respect thereto, shall survive the time at which it would otherwise terminate pursuant to this Section 7.1 if notice . . . shall have been given to the party against whom such indemnity may be sought prior to such time.[27]

         According to Spectro, Section 7.1(d) served to toll both limitations periods until resolution of its indemnification claims based upon the representations provision.[28]

         Spectro's reliance on Section 7.1(d) is misguided. Although parties may contractually agree to permit an indemnification notice to toll limitations periods until the underlying claim is resolved, [29] Section 7.1 does not reflect such an agreement. Section 7.1 does not expressly provide for tolling the statutory limitations period until the indemnification claim is resolved.[30] Rather, it provides that any representation or warranty "shall survive the time at which it wouldotherwise terminate pursuant to this Section 7.1[.]"[31] As to the survival of the intellectual property-related representations and warranties, Section 7.1 sets forth the applicable one-year contractual limitations period. Thus, Section 7.1(d) allows tolling of the contractual limitations period only. Put differently, Section 7.1(d) provides for the survival of the ...


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