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FERGUSON v. LION HOLDING

March 30, 2004.

ROBERT D. FERGUSON and RALPH MILO, Plaintiff, -against- LION HOLDING, INC., Defendants; ROBERT D. FERGUSON and MILO FAMILY LIMITED PARTNERSHIP, Plaintiff, -against- HANNOVER RUCKVERSICHERUNGS-AKTEIENGESELLSCHAFT, Defendants


The opinion of the court was delivered by: PETER LEISURE, District Judge Page 2

OPINION AND ORDER

These actions arise out of the acquisition by Hannover Ruckversicherungs-Aktiengesellschaft ("Hannover Re"), a German reinsurance company, of Lion Holding, Inc. ("Lion"). Plaintiffs were officers, directors, and shareholders of Lion at the time of the acquisition in 1999, and remained as executives of Lion after the acquisition through the end of 2001. Defendants are Hannover Re and Lion. Plaintiffs bring these actions for breach of contract, alleging that defendants failed to pay "Earnouts" due under a Stock Purchase Agreement and Employment Agreements executed when Hannover Re acquired Lion. Plaintiffs contend that defendants owe them the maximum Earnouts as provided in the agreements between the parties, which total $100 million. Defendants counterclaim that any damages caused by defendants' alleged breach of contract must be set off against monies allegedly owed to them by plaintiffs pursuant to an indemnification provision in the Stock Purchase Agreement. Defendants also counterclaim that plaintiffs breached their fiduciary duty to Lion and Hannover Re.

  Plaintiffs now bring a motion for partial summary judgment. Plaintiffs contend that there is no genuine issue of material fact in dispute as to one of four Earnouts at issue, that for the year 1999, and ask the Court to grant summary judgment that defendants owe plaintiffs $25 million. Defendants respond that genuine issues of material fact remain in dispute about whether plaintiffs should receive the 1999 Earnout. Defendants also contend that genuine issues of material fact relating to their counterclaims remain in dispute, and that this should prevent summary judgment. For the reasons set forth below, plaintiffs' motion for partial summary judgment is denied. Page 3

  Background

 I. The Parties

  The current summary judgment motion concerns two actions. In the first action (docket number 02-4258), plaintiffs Robert Ferguson and Ralph Milo assert a breach of contract claim against defendant Lion Holding, Inc. ("Lion"). Lion is an insurance company for which Ferguson and Milo served as executives from at least 1996 to the end of 2001. (Plaintiffs' Local Rule 56.1 Statement of Material Facts, ¶ 2 ("Plaintiffs' 56.1"); Affidavit of Joseph W. Jacobs, ¶ 11 ("Jacobs Aff.").) Plaintiffs also served as officers of Lion's subsidiary, Clarendon.*fn1 (Plaintiffs' 56.1, ¶ 2-4; Answer and Counterclaim of Defendant Lion Holding, ¶ 60-61 ("Lion Answer").) In this first action, the operable agreements between plaintiffs Ferguson and Milo and defendant Lion are those that govern plaintiffs' employment as executives of Lion. Plaintiffs claim that defendant Lion owes them $50 million pursuant to these agreements.

  In the second action (docket number 02-4261), plaintiffs Ferguson and Milo LP*fn2 assert a breach of contract claim against defendant Hannover Re. Hannover Re is a German reinsurance Page 4 company that acquired Lion early in 1999. (Plaintiffs' 56.1, ¶ 1.) Plaintiffs Ferguson and Milo LP bring this second action as the shareholders who sold Lion to Hannover Re. The central agreement between the selling shareholders and Hannover Re in this action is a Stock Purchase Agreement ("Purchase Agreement") dated February 16, 1999. (Jacobs Aff., Exh. E.) Plaintiffs claim that Hannover Re owes them $50 million pursuant to this agreement.

  The substance of plaintiffs' claims, defendants' counterclaims, the applicable contract provisions, and the facts underlying the disputes are essentially the same for both actions. Plaintiffs move for partial summary judgment on both actions for identical reasons, and defendants likewise oppose summary judgment without distinguishing between the actions. Unless otherwise indicated, references below to the parties denote the plaintiffs or defendants in both actions collectively. Likewise, references to agreements and obligations between the parties refer to the actions and contracts between the parties collectively, unless the Court indicates otherwise.

 II. The Agreements

  Four agreements between the parties, governing extensive, competing obligations for each side, give rise to plaintiffs' breach of contract claims and plaintiffs' current motion for summary judgment. First, Hannover Re acquired Lion from the selling shareholders pursuant to a Purchase Agreement dated February 16, 1999. Second, plaintiff Ferguson remained employed as an executive of Lion and Clarendon after Hannover Re acquired Lion, pursuant to an amended employment agreement. (Jacobs Aff., Exh. F.) Third, plaintiff Milo also remained employed as an executive of Lion and Clarendon after Hannover Re acquired Lion, pursuant to an amended employment agreement. (Jacobs Aff. Exh. G.) The terms of Ferguson's and Milo's amended Page 5 employment agreements are the same for the purposes of this motion, and are referred to in this opinion collectively as the "Employment Agreements." Fourth, the parties reached a letter agreement, dated February 24, 2000 (the "February Letter"), that addresses some of the parties' obligations that arise out of the Purchase Agreement and the Employment Agreements. (Jacobs Aff. Exh. I.) The first three agreements largely provide the basis for the contractual relationship between the parties, and thus largely provide the basis for plaintiffs' breach of contract claims. It is upon the fourth agreement, however, that plaintiffs seek partial summary judgment.

  A. The Purchase Agreement

  Defendant Hannover Re acquired Lion pursuant to a Purchase Agreement dated February 16, 1999. (Plaintiffs' 56.1, ¶ 1; Jacobs Aff. Exh. E.) Article 2 of the Purchase Agreement includes a provision titled "Additional Purchase Price." (Jacobs Aff. Exh. E, ¶ 2.3.) This provision entitles Ferguson and Milo LP, the selling shareholders, to receive additional compensation if Lion's subsidiary, Clarendon, achieves particular profitability levels for any or all of four periods: 1999, 2000, 2001, and the combined period 1999-2001. (Plaintiffs' 56.1, ¶ 3-4; Defendants' Statement of Disputed Material Facts, ¶ 1 ("Defendants' 56.1"); Declaration of Herbert Haas, ¶ 6-7 ("Haas Decl.").) The additional compensation is called an "Earnout." Under the Purchase Agreement, the maximum Earnout payable to Ferguson and Milo LP for any one year period is $12,500,000, of which Milo LP would receive 70% and Ferguson 30%. (Plaintiffs' 56.1, ¶ 8.)

  The criteria used to determine whether Ferguson and Milo LP would receive some or all of the maximum Earnout for any time period is Clarendon's "Combined Ratio." (Jacobs Aff. Page 6 Exh. E, ¶ 2.3.) The Combined Ratio measures Clarendon's profitability.*fn3 If Clarendon attained a Combined Ratio of 75% or less for any one year period then the maximum Earnout became due to Milo LP and Ferguson. (Plaintiffs' 56.1, ¶ 5, 9; Defendants' 56.1, ¶ 1.) Thus, for example, if Clarendon's Combined Ratio for 1999 was 75% or less, then Hannover Re is obligated under the Purchase Agreement to pay a $12,500,000 Earnout to Ferguson and Milo LP. Hannover Re was obligated to pay any Earnout due under the Purchase Agreement by May 15, 2002. (Plaintiffs' 56.1, ¶ 6, 9.)

  Article 7 of the Purchase Agreement, titled "Indemnification," includes separate provisions governing the selling shareholders' obligation to indemnify Hannover Re in certain circumstances. (Jacobs Aff., Exh. E, ¶¶ 7.1-7.6; Plaintiffs' 56.1, ¶ 17; Defendants' 56.1, ¶ 6, 7.) For the purposes of this motion it is useful to note the distinction in Article 7 between two particular indemnity obligations incumbent upon Ferguson and Milo LP. First, Article 7 imposes general indemnification obligations upon the selling shareholders. Article 7 further provides that, should the selling shareholders become obligated to make payments pursuant to the general indemnification provisions, that funds for the payments should be taken from a prioritized list of sources. (Jacobs Aff. Exh. E, ¶ 7.4(B).) Article 7 includes in this list of sources "any amount of Additional Incentive Compensation (as defined under the Employment Agreement Amendments) payable at such time or paid to Milo or Ferguson after the Closing Date," and "any amounts payable at such time or paid to Milo or Ferguson under Section 2.3 of this Agreement [the Page 7 Earnout provision]." In sum, Article 7 of the Purchase Agreement specifies that in the event the selling shareholders become obligated to indemnify Hannover Re, Earnouts payable or paid to Ferguson, Milo LP, and Milo pursuant to Article 2 or the Employment Agreements are an eligible source of funds to pay the indemnity.

  In February 2001, defendant Hannover Re made a claim for indemnification from the selling shareholders pursuant to these general indemnification provisions. (Plaintiffs' 56.1, ¶ 18; Defendants' 56.1, ¶ 6; Jacobs Aff. Exh. J.) Hannover Re claims that the selling shareholders owe hundreds of millions of dollars in payments for indemnification pursuant to Article 7 of the Purchase Agreement. The selling shareholders dispute this claim for indemnification. (Plaintiffs' 56.1, ¶ 18; Defendants' 56.1, ¶ 7; Jacobs Aff. Exh. K.) The parties are currently engaged in litigation in the Supreme Court of New York to resolve this dispute. (Defendants' 56.1, ¶ 7.)

  The second indemnity obligation incumbent upon the selling shareholders is described in paragraphs 7.1(C) and 7.4(D) of the Purchase Agreement, which govern Ferguson and Milo LP's indemnification obligations with respect to the "LMX Business." (Jacobs Aff. Exh. E, ¶¶ 7.1(C), 7.4(D); see Defendants' Opposition, at 5 n.4.) The parties have not developed the substance of this obligation on the current record, as its substance is largely irrelevant at this stage. It is important to note, however, that the parties came to dispute the extent of the selling shareholders' indemnity obligations with respect to the LMX Business. The February letter, discussed below, reflects an effort by the parties to address this dispute.

  B. The Employment Agreements

  Prior to Hannover Re's acquisition of Lion, plaintiffs Ferguson and Milo served as executives of Lion pursuant to Employment Agreements. (Plaintiffs' 56.1, ¶ 2; Jacobs Aff. Exh. Page 8 F (Ferguson Agreement), Exh. G (Milo Agreement).) When Hannover Re acquired Lion, it agreed with Ferguson and Milo to keep them employed as executives of Lion, and agreed to execute amendments to the Employment Agreements. (Id.) The Employment Agreements between plaintiffs and Hannover Re, as amended, include provisions titled "Payment of the Additional Incentive Compensation." These provisions require the payment of Earnouts to Ferguson and Milo, largely on the same terms as under the Purchase Agreement. If Clarendon attained a Combined Ratio of 75% or less for any one year period, then, under the Employment Agreements, Hannover Re would owe Milo and Ferguson a $12,500,000 Earnout payment. (Plaintiffs' 56.1, ¶ 5; Defendants' 56.1, ¶ 1.) As with the Purchase Agreement, under the Employment Agreements Milo would receive 70% of the Earnout and Ferguson would receive 30%, and any Earnout must be paid by May 15, 2002. The only material difference between the conditions for the Earnout under the Employment Agreements and the Purchase Agreement is that the Employment Agreements also required that Ferguson and Milo still be employed by Lion as of December 30, 2001. (Plaintiffs 56.1, ¶ 7.) The parties do not dispute that Ferguson and Milo remained employed by Lion through the end of 2001. (Plaintiffs 56.1, ¶ 7.)

  The compensation provisions in the Employment Agreements were included to keep Ferguson and Milo on as executives of Lion after its acquisition by Hannover Re. (Jacobs Aff. ¶ 6; Haas Decl., ¶ 6.) As Ferguson and Milo were involved in operating Lion's subsidiary, Clarendon, the Earnout provisions in both the Employment Agreements and Purchase Agreement provided an incentive for plaintiffs to manage Clarendon at a profitable level. (Id.) Having acquired Lion, Hannover Re of course would itself profit by plaintiffs' profitable management of Clarendon. If, for example, Ferguson and Milo managed Clarendon to a Combined Ratio of less than 75% in 1999, then Hannover Re would profit, and in turn would pay Ferguson, Milo, and Page 9 Milo LP a combined $25 million in Earnouts pursuant to the Purchase Agreement and Employment Agreements.

  C. The February Letter

  While the Purchase Agreement and Employment Agreements are the focus of plaintiffs' breach of contract claims and defendants' counterclaims, a letter agreement, dated February 24, 2000 (the "February letter"), is the subject of plaintiffs' current summary judgment motion. (Jacobs Aff. ¶ 17 & Exh. I.) The February letter was written by plaintiff Ferguson and sent to Herbert Haas, then the Chief Financial Officer of Hannover Re. Haas countersigned the February letter on behalf of Hannover Re. (Haas Decl., ¶ 8.) The February letter describes an agreement between the selling shareholders of Lion, Ferguson and Milo in their personal capacities, and Hannover Re. In general, the February letter memorializes an agreement between the parties on two issues: the temporary, or immediate payment for indemnity by the selling shareholders with respect to the LMX business; and the payment of the 1999 Earnout by Hannover Re to Ferguson, Milo, and Milo LP. The parties dispute virtually any and all possible implications of the February letter. As plaintiffs move for partial summary judgment on the February letter, and defendants contend that the letter is unenforceable for lack of consideration and because it was procured by fraud, the Court must assess the February letter's import to resolve the current motion.

  1. Plaintiffs' Description of the February Letter

  Plaintiffs contend that the February letter is an enforceable contract. It reflects an agreement between the selling shareholders and Hannover Re. After entering the Purchase Agreement, the selling shareholders and Hannover Re came to dispute the selling shareholders' indemnity obligation with respect to the LMX Business, and particularly the "LMX Settlement." Page 10

  The parties apparently agreed that the selling shareholders owed some payment for indemnity to Clarendon (Hannover Re's newly acquired subsidiary) in association with the LMX Settlement, but disagreed as to the proper amount of the payment. According to plaintiffs, prior to the entry of the February letter, defendants sought a payment of $17.183 million for the LMX Settlement, whereas the selling shareholders asserted that they owed roughly $4 million less than that. The February letter purports to resolve, at least temporarily, this discrepancy. Under the terms of the February letter, the selling shareholders agreed to pay $17.183 million, but also agreed to continue good faith negotiations with Hannover Re to resolve the dispute over the proper payment, and to arbitrate the dispute if the negotiations failed. As defendants argue that the February letter lacks consideration, plaintiffs stress that the $17.183 million payment essentially includes a $4 million credit or temporary forfeiture, which would be returned to the selling shareholders should negotiations or arbitration eventually vindicate plaintiffs' position. (See Plaintiffs' Reply Memorandum of Law in Support of Their Motions for Partial Summary Judgment, at 5 ("Plaintiffs' Reply").)

  The selling shareholders also agreed in the February letter to exclude the $17.183 million from Clarendon's financial statement for the purpose of calculating Ferguson and Milo's 1999 bonus. Plaintiffs contend that the Employment Agreements provide that Milo and Ferguson were entitled to a bonus, separate from the Earaouts, that would be calculated as a percentage of Clarendon's profits. (Plaintiffs' Reply, at 6; Jacobs Aff. Exhs. F & G.) By agreeing to exclude the $17.183 million payment from Clarendon's profits, plaintiffs thus diminished the funds from which their bonus would be calculated. Page 11

  Plaintiffs contend that in exchange for these considerations, defendants agreed to pay the 1999 Earnout. Section 4 of the February letter written by Ferguson, titled "Earn out," reads as follows:
Section 2.3 of the Stock Purchase Agreement obligates Hannover to pay to Milo L.P. and me Additional Purchase Price as calculated in that provision. Ralph and I are separately entitled to receive Additional Incentive Compensation calculated on the same basis under our Employment Agreement Amendments. Hannover has agreed with Ralph, Milo L.P., and me that (i) Milo L.P. and I have qualified for and are entitled to receive our respective shares of the maximum $12.5 million dollar Additional Purchase Price for 1999 and (ii) Ralph and I have separately qualified for and are entitled to receive (subject only to Section II of Exhibit B of the Existing Employment Agreement, as amended) the maximum $8.75 million and $3.75 million, respectively, of Additional Incentive Compensation for 1999 under our respective Existing Employment Agreement, as amended, in each case payable as provided in such documents.
(Jacobs Aff., Exh. I, § 4.) In other words, Hannover Re agreed in the February letter to pay the 1999 Earnout to plaintiffs. (Haas Decl., ¶ 9.)

  2. Defendants' Description of the February Letter

  Defendants offer a separate account of the February letter and its implications. Defendants contend that sections 7.1(C) and 7.4(D) of the Purchase Agreement required the selling shareholders to indemnify Clarendon for $17.163 million for the LMX Settlement. Thus the February letter simply noted the selling shareholders' pre-existing obligation. Defendants also assert that plaintiffs' agreement to exclude the $17.183 million from the calculation of their bonus "would have had little or no effect on Ferguson and Milo's bonus for 1999." (Defendants' Opposition, at 19-20 n. 11.) The February letter, ...


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