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August 8, 1989

Armco Inc. and Armco Financial Holdings Corporation
Glenfed Financial Corporation

The opinion of the court was delivered by: LECHNER



 This matter involves three separate motions (two of which include cross-motions) for partial summary judgment in a substantial contract dispute arising in the two years after the closing of an acquisition transaction. *fn1" Because of the size and complexity of this case, the parties have agreed to present, to the extent possible, various discrete issues for disposition by way of summary judgments and limited evidentiary hearings. The disposition of the present motions will not end this lawsuit.

 By way of further introduction to the disputes occasioning the present motions, in late 1984, plaintiff Armco, Inc. ("Armco") *fn2" agreed to sell its financial services subsidiary, Armco Financial Corporation ("AFC"), to Glendale Federal Savings and Loan Association ("Glendale"). The sale was completed by way of a forward merger of AFC into a newly created subsidiary of Glendale, defendant Glenfed Financial Corporation ("Glenfed"), pursuant to the terms of an Agreement and Plan of Merger and Liquidation (the "Merger Agreement") executed by the parties to this litigation, among others, on April 10, 1985. The purchase price for the acquisition was $ 77 million, $ 20 million of which was to be paid in the form of a Subordinated Promissory Note (the "Note").

 Plaintiffs contend the purchase price was intended to be based on the approximate "book value" (assets minus liabilities) of AFC. Plaintiffs' Third Brief, p. 2. The main business of AFC was secured commercial lending to small to mid-size companies. Glenfed conducts the same type of lending as its predecessor, AFC -- having assumed control of AFC's loan portfolio, staff and offices as of April, 1985.

 The most significant motion and cross-motion, from a dollar point of view, involve an interpretation of the words "realized tax benefits" contained in the Merger Agreement. In short, this motion (the "Tax Motion") requires a determination of whether certain events gave rise to "realized tax benefits" in favor of the defendant within the meaning of the Merger Agreement. For the reasons set forth below, partial summary judgment on the Tax Motion is granted in favor of Glenfed.

 A second substantial motion and cross-motion (the "Deferred Income Motion") seek a determination of the amount of certain revenues, derived from various aircraft loan, lease and other accounts acquired by Glenfed, which Glenfed must share with the plaintiffs pursuant to a sharing formula set forth in a collateral agreement (the "Aircraft Agreement"). Because an exhibit to the Aircraft Agreement contains a material ambiguity -- indeed a discrepancy concerning a key dollar figure to be "plugged into" the sharing formula -- and because an adequate determination of the appropriate figure to be included in the calculation would require a resolution of disputed material facts, the Aircraft Motion for summary disposition is denied.

 The third motion for partial summary judgment is brought by plaintiffs and concerns their asserted entitlement, under the Aircraft Agreement, to have the amount of sharable proceeds from the aircraft portfolio reduced only by commissions which were actually paid (in the sense of a disbursement) by Glenfed to National Union (defined below) (the "Commissions Motion"). The Commissions Motion is denied for the reasons set forth below.


 Summary Judgment Standard

 To prevail on a motion for summary judgment, the moving party must establish "there is no genuine issue as to any material fact and that [it] is entitled to judgment as a matter of law." Fed.R.Civ.P. 56(c). The district court's task is to determine whether disputed issues of fact exist, but the court cannot resolve factual disputes in a motion for summary judgment. Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 249-50, 91 L. Ed. 2d 202, 106 S. Ct. 2505 (1986). All evidence submitted must be viewed in a light most favorable to the party opposing the motion. See Matsushita Elec. Industrial Co., Ltd. v. Zenith Radio Corp., 475 U.S. 574, 587, 89 L. Ed. 2d 538, 106 S. Ct. 1348 (1986).

its opponent must do more than simply show that there is some metaphysical doubt as to the material facts. . . . In the language of the Rule, the non-moving party must come forward with 'specific facts showing that there is a genuine issue for trial.' . . . Where the record taken as a whole could not lead a rational trier of fact to find for the non-moving party, there is no 'genuine issue for trial.'

 Matsushita, 475 U.S. at 586-87 (emphasis in original, citations and footnotes omitted).

 The Court elaborated in Anderson v. Liberty Lobby, Inc., 477 U.S. at 249-50 (citations omitted): "If the evidence [submitted by a party opposing summary judgment] is merely colorable . . . or is not significantly probative . . . summary judgment may be granted." The Supreme Court went on to note in Celotex Corp. v. Catrett, 477 U.S. 317, 323-24, 91 L. Ed. 2d 265, 106 S. Ct. 2548 (1986) (footnote omitted): "One of the principal purposes of the summary judgment rule is to isolate and dispose of factually unsupported claims or defenses, and we think it should be interpreted in a way that allows it to accomplish this purpose." Thus, once a case has been made in support of summary judgment, the party opposing the motion has the affirmative burden of coming forward with specific facts evidencing a need for trial. See Fed.R.Civ.P. 56(e).

 The parties appear to agree that California law applies to this dispute. Indeed, Section 9 of the Aircraft Agreement states:

9. Disputes. This agreement shall be construed and enforced in accordance with the laws of the State of California. *fn3"

 Id. The parties have cited to New Jersey authorities as well, in case it was concluded that New Jersey has a significant interest in having its law applied to this matter, notwithstanding the language of the Aircraft Agreement. Because of Section 9 of the Aircraft Agreement, this matter will be decided under the law of California. As the parties point out, however, the key legal principles appear to be largely the same under the law in New Jersey and California.

 I. The Tax Motion

 Both parties agree the dispute raised in the Tax Motion is purely legal and that summary judgment on this issue is appropriate. In summary, when Armco sold AFC to the parent company of Glenfed, it agreed under the terms of the Merger Agreement to indemnify Glenfed for certain losses on non-performing loans (the "Credit Losses") net of " all realized tax benefits. . . ." Merger Agreement para. 6.7(b) (emphasis added). This indemnity was to occur by reducing the balance of the Note.

 In July 1987, the Note became due and payable. By the terms of the Merger Agreement, Glenfed was permitted to reduce the principal amount of the Note to the extent it was unable to collect money advanced on loan accounts purchased in the merger after "diligently pursuing collection in accordance with industry standards." Merger Agreement at para. 1.17. As of July, 1987, Glenfed had reduced the amount of the Note, as shown on its financial statements, to zero. At the same time, pursuant to another provision of the Merger Agreement, Armco was conducting an audit of Glenfed's collection practices and attempting to analyze the claimed reductions to the Note. Merger Agreement at § 8.4. Armco substantially completed the audit in November 1987 and concluded that Glenfed had been negligent in its collection procedures and had improperly accounted for amounts owed on the Note in a number of respects. On December 22, 1987, when Armco presented the Note to Glenfed for payment, Glenfed refused to pay any part of it; this lawsuit was subsequently filed.

 Setting aside the issue of the adequacy of Glenfed's effort to collect on the several loan accounts -- an issue which Armco will continue to litigate in this matter -- Armco presently argues in the Tax Motion that Glenfed failed to account for the "realized or realizable tax benefit" it could have achieved from the Credit Losses in determining the indemnification due from Armco. Complaint at para. 24(K). In order to adequately present the scope of the issue involved in the Tax Motion, it is necessary to review various provisions contained in the Merger Agreement and to set forth a number of defined terms referred to therein.

 As noted, Armco agreed in Section 6.2 of the Merger Agreement to indemnify Glenfed for certain losses, including the Credit Losses *fn4" on purchased Loan Accounts which were uncollectible to the extent that the aggregate of such Credit Losses exceeded $ 5 million. *fn5" Armco's Credit Loss indemnification was limited to the balance due from Glenfed on the Note. The Merger Agreement provides:

Limitations of Indemnities. . . . (d) To the extent that any indemnification shall be payable pursuant to Section 6.2(e), such payment shall be made, and shall only be made, by the reduction, on a dollar-for-dollar basis, in the principal amount of the Subordinated Promissory Note.

 Id. at § 6.7 (emphasis added). The Note was due on April 9, 1987. If certain conditions occurred, however, the Note was payable only in part on April 9, 1987, with the balance, including accrued interest, payable on July 9, 1987. *fn6" Section 6.2 of the Merger Agreement must be read in conjunction with Section 6.7(b) of the Merger Agreement, which provides that:

(b) Notwithstanding anything to the contrary contained in Sections 6.1 through 6.4 and this Section 6.7, the Indemnitee shall be entitled to indemnification hereunder for any loss, damage, or expense which it suffered only after giving effect to, and taking the net amount after, all realized tax benefits, realized insurance proceeds, and other realized recoveries relating thereto.

 Id. (emphasis added).

 The Merger Agreement does not define the term "realized tax benefit" for purposes of this section or for purposes of any other section of the Merger Agreement. *fn7" As importantly, the Merger Agreement in no way indicates the term "realized tax benefits" should have any specialized meaning assigned to it.

No deductions were claimed for the portion of the aggregate losses which were indemnified since, as stated above, indemnification resulted in a downward basis adjustment that eliminated any deduction to the extent of such indemnification. Of course, there would be no downward basis adjustment as to losses which were not indemnified, specifically the $ 5 million threshold as well as the excess over the $ 20 million in indemnified losses.

 Id. As to the non-indemnity amounts, deductions appear to have been taken under Section 166. The meaning to the above representation becomes more clear after considering Glenfed's purported reasons for not taking Section 166 deductions with respect to the indemnified portion of Credit Losses, discussed below.

 The opposing views of the parties on the Tax Motion are succinctly stated in Glenfed's brief. It is Glenfed's position it did not realize any tax benefits with regard to the Credit Losses, and that it therefore is entitled to indemnification with respect to all Credit Loss amounts in excess of the $ 5 million cushion and up to the amount of the Note, $ 20 million. Furthermore, Glenfed takes the position that it would not have realized tax benefits during the relevant period (i.e., the term of the Note) even if it had taken deductions for Credit Losses, because the affiliated group of which Glenfed was a member had access to pre-existing net operating loss carryovers ("NOLs") for the relevant taxable years.

 Armco, on the other hand, contends all of the Credit Losses were required to be deducted by Glenfed under Section 166 of the Code, that such losses, had they been deducted, would have increased the amount of NOLs available to Glenfed, and that such an increase in NOLs, in and of itself, constitutes a "realized" tax benefit. Having presented the larger picture of the Tax Motion, attention now shifts to the resolution of the several subsidiary issues raised by the parties.

 Sections 166 and 108(e) (5) of the Code

 In response to Armco's argument that Glenfed should have claimed bad debt deductions for the Credit Losses, Glenfed argues as a threshold matter that it was precluded under federal income tax law from taking such deductions. It is not necessary to conclusively resolve this issue against plaintiffs because it is ultimately concluded Glenfed would not have enjoyed "realized tax benefits" in any event, as discussed infra.

 Section 166(a) of the Code provides for a deduction for any debt which becomes wholly or partially worthless within the taxable year. In determining whether a debt is worthless *fn8" in whole or in part, all facts and circumstances regarding the debt will be considered. Treas.Reg. § 1.66-2(a). Where the surrounding circumstances indicate a debt is worthless and uncollectible, and the legal action to enforce payment in all probability would not result in satisfaction on execution of a judgment, a showing of these facts will be sufficient evidence of the worthlessness of the debt and thereby entitle the taxpayer to a bad debt deduction without actually taking legal action. Treas. Reg. § 1.66-2(b).

 A wholly worthless bad debt is deductible in the taxable year it becomes worthless. I.R.C. § 166(a)(1). A partially worthless bad debt is deductible in the taxable year it becomes partially worthless and is charged off by the taxpayer. I.R.C. § 166(a)(2); Treas.Reg. § 1.66-3(a)(2). The amount of a bad debt deduction for a wholly worthless loan is equal to the taxpayer's adjusted basis in the debt. I.R.C. § 166(b); Treas.Reg. § 1.66-1(d)(1). The basis of a purchased debt is its cost. I.R.C. § 1012; Treas.Reg. § 1.66-1(d)(2)(i).

 Glenfed has not taken the position it is prohibited from taking Section 166 deductions under any of the foregoing rules. Notwithstanding the standards for claiming bad debt deductions under Section 166, however, Glenfed argues such deductions, which would require reductions in "basis," would have been precluded by other tax treatment called for under the Merger Agreement and applicable tax rules.

 As indicated, the purchase price paid for assets was divided into two components: a cash payment of $ 57 million and the execution of the Note in the amount of $ 20 million. Glenfed's argument that bad debt deductions (and corresponding reductions in basis) could not be effected under Section 166 relates to the fact that part of the purchase price constituted "purchase money debt" which was to be reduced pursuant to the indemnity provision. As described above, to the extent Glenfed suffered Credit Losses, it was entitled, pursuant to the indemnity provision in the Merger Agreement, to reduce the amount of the Note.

 The parties agree that under Section 108(e)(5) of the Code Glenfed must treat its indemnification by Armco as an adjustment to its purchase price for the assets of AFC, rather than as receipt of taxable income. *fn9" Noting that application of the principle of Section 108(e)(5) is mandatory in this case (Merger Agreement § 6.2), *fn10" Glenfed essentially argues that the additional application of Section 166 (for bad debt deductions) as proposed by plaintiffs would result in an anomolous situation as far as the "adjusted basis" in Glenfed's newly acquired assets is concerned.

 Plaintiffs' approach would involve Glenfed, in the first instance, claiming deductions for the Credit Losses which were suffered. At the time of such deductions, Glenfed would be required to make corresponding reductions in the basis it had in the loan and lease accounts. Next, pursuant to the Merger Agreement, Glenfed would be indemnified by plaintiffs for the Credit Losses sustained. As indicated, indemnification would not come in the form of a cash reimbursement but instead as a reduction in the principal amount of the Note to be paid by Glenfed to Armco.

 This procedure would constitute a reduction in the amount of purchase money debt under Section 108(e)(5). Such a purchase price reduction will not give rise to taxable income to the debtor, but, according to Glenfed, "the debtor is required to reduce its basis in the property for which the debt was consideration." (Emphasis added) Defendant's First Brief at 8.

 Glenfed's particular problem with plaintiffs' approach to the dual application of Sections 166 and 108(e)(5) of the Code is that, once the basis in the bad loan accounts has been reduced to reflect the bad debt expense deduction, there will be no basis remaining in the loan accounts to reflect the subsequent basis reduction pursuant to Section 108(e)(5). Glenfed considers it inappropriate or unusual to reflect the downward adjustment in the purchase price by reducing the basis Glenfed has in assets other than the loans, whose worthlessness initially triggered the purchase price reduction. In the words of Glenfed:

the rule surmised (sic) by Armco's advisers, however, would permit a current deduction under section 166 even though the expenditure underlying that deduction was recovered in the year of the deduction, with such recovery taken into account merely as an adjustment to the adjusted basis of other acquired assets.

 Defendant's First Brief at 10 (emphasis added). Stated alternatively, "the tax cost of an improper current deduction would be a potential tax increase in the indeterminate future (upon the sale of other property the basis of which was adjusted)." *fn11" Id.

 While Glenfed argues that the proposed Section 166 deductions would be "improper current deductions," at most it is suggesting that the result of subsequently reflecting the downward basis adjustment (resulting from the deemed purchase price reduction under Section 108(e)(5)) in other assets seems anomolous. No authority has been presented which indicates that Armco's proposed treatment of the Credit Losses is improper. Glenfed itself has indicated that regulations interpreting the operation of Section 108(e)(5) have not been issued and it has not located any authorities bearing directly on this issue. Defendant's First Brief, p. 10.

 It is noted, moreover, that Glenfed's proposed reconciliation of the application of Sections 166 and 108 (e)(5), in situations such as this one, gives rise to a strange result as well. Under Glenfed's construction of the rules, the owner of loan and lease accounts would be flatly denied a bad debt expense deduction for the Credit Losses, simply because of the fact that the purchase price for AFC was comprised of both cash and purchase money debt (which implicates Section 108(e) (5) of the Code). There appears to be no direct authority for such a result. *fn12"

 Glenfed's position supports a result that, as between the anomolies of (1) effecting the purchase price reduction under Section 108 (e)(5) by reducing the basis in assets other than in the loan accounts which gave rise to the purchase price adjustment and (2) eliminating altogether the availability of a deduction for bad debt expenses (which were in fact incurred), the former anomoly is more important to avoid than the latter. *fn13"

 Because it is concluded that, even if Glenfed had claimed deductions for all of the Credit Losses, it would not have "realized tax benefits" within the meaning of the Merger Agreement, it is not necessary to explicitly reject Glenfed's interpretation of the interrelationship between Sections 166 and 108(e)(5) in this situation. Accordingly, for purposes of the Tax Motion, plaintiffs' construction of the applicable rules is accepted and it is assumed that Glenfed, under applicable tax law, could have claimed Section 166 deductions for the Credit Losses in the year they were sustained. *fn14"

 Glenfed next argues that, even if it is assumed Section 108(e)(5) does not preclude the applicability of Section 166, it was not required under federal tax principles, or explicitly by the Merger Agreement, to take deductions for the Credit Losses. The Board of Tax Appeals noted in a 1925 case that "a taxpayer may neglect or refuse to make a correct computation of income in a given year and pay a greater tax than he owes -- and nobody will force the excess tax back upon him." Even Realty Co. v. Commissioner, 1 B.T.A. 355, 362 (1925).

 It is pursuant to the Merger Agreement (although not explicitly provided for) *fn15" that Glenfed was duty-bound to take advantage of the Section 166 deductions for the Credit Losses to the extent available. As persuasively explained in plaintiffs' brief, in interpreting a contract, a court must give all of its terms a reasonable and lawful meaning. See Restatement (Second) of Contracts, § 203(a) (1979).

 Section 6.7(b) of the Merger Agreement provides:

Notwithstanding anything to the contrary contained in sections 6.1 through 6.4 and this section 6.7, the Indemnitee shall be entitled to indemnification hereunder for any loss, damage, or expense which it suffered only after giving effect to, and taking the net amount after, all realized tax benefits, realized insurance proceeds, and other realized recoveries relating thereto.

 Id. (emphasis added). The underscored language would be meaningless if Glenfed could simply decide at its whim whether to take available deductions which produce realized tax benefits. Accordingly, the only reasonable interpretation to which this language is susceptible is that Glenfed must conduct itself in such a manner so that all realized tax benefits which are available and to which it is legitimately entitled are in fact enjoyed by it. *fn16"

 Realized Tax Benefits

 The dispositive issue in the Tax Motion involves a question of contract law, not federal income tax principles: whether Glenfed realized tax benefits, within the meaning of the Merger Agreement, as a result of Credit Losses -- or stated another way whether it could have realized such benefits had it taken bad debt deductions to which it was entitled under Section 166. For two chief reasons (which are perhaps interrelated) it is concluded that, even assuming Section 166 deductions had been claimed, Glenfed would not have enjoyed "realized tax benefits" within the meaning of the Merger Agreement. First, the Merger Agreement term "realized tax benefits" contemplates more than mere hypothetical tax benefits which probably, but not necessarily, will result in a dollar reduction of taxes payable at some time. Second, the structure of the Merger Agreement, particularly the indemnity provision, indicates the parties intended their ongoing relationship to be severed in significant ways by the time the Note became due in 1987.

 In this context, that means Glenfed would only be entitled to indemnification for Credit Losses identified within the two year period and plaintiffs would only be entitled to offset the amount of the indemnity in an amount representing realized -- not hypothetical -- tax benefits actually enjoyed during the same period. As discussed in greater detail below, both the narrow language contained in the Merger Agreement and an absence of a special mechanism for treating the measurement of "realized tax benefits" over a specified period of time essentially requires the court to step in and rewrite the Merger Agreement in order for plaintiffs' position to prevail. This will not be done. The patent terms of the Merger Agreement will be given effect. This result obtains from the so-called "objective theory of contract," under which the subjective, undeclared, intentions of the parties are immaterial, because manifestation of intention (as reflected in the language) controls. See, e.g., Heston v. Farmers Insurance Group, 160 Cal. App. 3d 402, 206 Cal. Rptr. 585 (1984).

 In construing a contract which purports on its face to be a complete expression of entire agreement between the parties, courts will not add another item on which the agreement is silent. Wm. E. Doud & Co. v. Smith, 256 Cal. App. 2d 552, 64 Cal. Rptr. 222 (Cal.Ct.App. 1967). The undisclosed intentions of parties to a contract are not material. Id. at 226. See also Rosen v. E.C. Losch, Co., 234 Cal. App. 2d 324, 44 Cal. Rptr. 377 (Cal.Ct.App. 1965) (court is without power, under guise of contruction, to depart from plain meaning of words contained in writing and insert terms or limitations not found therein). In arriving at the intentions of the parties to a written contract, courts cannot be guided by an unexpressed state of mind. Crow v. P.E.G. Construction Co., 156 Cal. ...

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