Nes Fin. Corp. v. JPMorgan Chase Bank, No. 11 Civ. 3437(VM).

CourtUnited States Courts of Appeals. United States Court of Appeals (5th Circuit)
Writing for the CourtVICTOR MARRERO
Citation907 F.Supp.2d 448
Docket NumberNo. 11 Civ. 3437(VM).
Decision Date28 November 2012

907 F.Supp.2d 448


No. 11 Civ. 3437(VM).

United States District Court,
S.D. New York.

Nov. 28, 2012.

[907 F.Supp.2d 449]

David Philip Jang, Joel Maximino Melendez, Justin Michael Ellis, Robert Kelsey Kry, Steven Francis Molo, MoloLamken, LLP, New York, NY, for Plaintiff.

[907 F.Supp.2d 450]

John Morgan Callagy, Damon William Suden, David I. Zalman, Melissa Errine Byroade, Kelley Drye & Warren, LLP, New York, NY, for Defendant.


VICTOR MARRERO, District Judge.

Plaintiff NES Financial Corp. (“NESF”) brought this action against defendant JPMorgan Chase Bank, National Association (“JPMorgan”) alleging a variety of claims stemming from the acquisition by NESF of J.P. Morgan Property Exchange Inc. (“JPEX”)—JPMorgan's Section 1031 like-kind exchange business. The Court conducted a bench trial on September 19, 20, 24–25, 27–28, October 1, and November 8, 2012 to adjudicate NESF's claims.

The Court now sets forth its findings of fact and conclusions of law pursuant to Rule 52(a) of the Federal Rules of Civil Procedure.


Under Section 1031 of the Internal Revenue Code (“IRC”), 26 U.S.C. § 1031 (“Section 1031”), a taxpayer may defer recognition of a gain from the sale of investment property by engaging in a “like-kind exchange,” a transaction in which a taxpayer uses the proceeds from a present sale to subsequently purchase other property that is similar or “like-kind” in nature. In order to qualify for tax deferral under Section 1031, the taxpayer must meet certain requirements. Among other things, these requirements include: (1) the taxpayer must identify the replacement property within 45 days of the sale of the existing property; (2) the replacement property must actually be acquired within 180 days from the transfer of the relinquished property; (3) the taxpayer cannot have actual or constructive receipt of the proceeds from the relinquished property during the exchange period; and (4) the person transferring the relinquished property cannot be an agent of the taxpayer. See26 U.S.C. § 1031.

The Treasury Regulations promulgated under Section 1031 include a “safe harbor” provision according to which a taxpayer may use a “qualified intermediary” (“QI”) to facilitate a like-kind exchange in order to ensure tax deferral and avoid complications, including issues of actual and constructive receipt. SeeTreas. Reg. § 1.1031(k)–1(g)(4). In order to use this safe harbor, (1) the taxpayer must enter into a written agreement with the proposed QI; (2) the intermediary must not be a “disqualified person,” which is a defined term in the regulations; (3) the intermediary, pursuant to the exchange agreement, must acquire the relinquished property from the taxpayer and subsequently transfer it to a third party purchaser, and acquire replacement property from a third party seller and transfer it to the taxpayer; and (4) the exchange agreement must provide that the taxpayer “has no rights to receive, pledge, borrow, or otherwise obtain the benefits of money or other property [generated by the sale of property] before the end of the exchange period.” Id.


NESF was founded in 2005 by Michael Halloran (“Halloran”), its president and chief executive officer, to provide technology solutions to financial services companies,

[907 F.Supp.2d 451]

including QI services for Section 1031 tax-deferred like-kind exchanges. In 2008, NESF decided to expand its presence in the QI market through the acquisition of JPEX from JPMorgan. JPMorgan had acquired the company—formerly known as APEX Property Exchange, Inc. (“APEX”)—from Michael and David Marcus in April 2002.

1. Due Diligence Process

In May 2008, JPMorgan and NESF met in New York and began discussions regarding a potential acquisition of JPEX by NESF. During the bidding process, NESF conducted due diligence into JPEX. On or about May 29, 2008, NESF sent its first request for due diligence materials to JPMorgan. (Pl.'s Ex. 13.) Among other things, NESF requested a list of “significant losses/mistakes JPEX has made on an exchange.” (Pl.'s Ex. 13.) JPMorgan responded that there were “no significant losses or mistakes to report.” (Pl.'s Ex. 305.) NESF also requested a list of “significant outstanding/potential litigation.” (Pl.'s Ex. 13.) JPMorgan responded that it was “not aware of any other litigation” aside from two lawsuits with the former owners of APEX that were settled in 2007. (Pl.'s Ex. 306.)

On June 26, 2008, NESF and JPMorgan held a due diligence meeting in Boston. ( See Def.'s Ex. 91.) JPEX's senior personnel were present at the meeting, including its in-house counsel, Bill Lopriore (“Lopriore”), its client service manager, Dawn Shuster (“Shuster”), its controller, Kristen West, and the head of sales, Patrick McCloskey (“McCloskey”). Kate Gallivan (“Gallivan”), who had previously worked at JPEX, and had become an employee of JPMorgan, also attended the meeting. JPMorgan employee Jason Orben, who had previously served as JPEX's president, also attended. Halloran and Dan Yoder attended the management meeting for NESF. Kelly Alton (“Alton”), the general counsel of NESF, did not attend the meeting.

Among other issues discussed at that meeting, NESF asked McCloskey about JPEX's client base and the source of business. The parties disagree over the precise language used and the nature of the response in this connection. NESF claims that Gallivan responded to a question about the source of business by stating that most JPEX clients were either external non-bank referrals or APEX legacy clients, and that JPEX did not derive much business from JPMorgan bank referrals. At trial, Gallivan testified that she was asked about JPEX's largest clients and whether NESF “would have any trouble without the JPMorgan brand name selling business.” (Trial Tr. 1083.) Gallivan further testified that a number of the largest JPEX clients were heritage APEX clients prior to JPMorgan's acquisition of the business and she informed NESF that, for these large clients, this was “ongoing business that [NESF] could expect to continue.” ( Id.) Furthermore, Gallivan thought the JPEX employees had client relationships she believed would continue and that NESF would be able to sell its services without the JPMorgan brand name. (Trial Tr. 1084.)

Regardless of Gallivan's exact response at the meeting, it is undisputed that following this meeting Gallivan collected and posted the source of new business statistics for 2008 to an electronic data room which was available for NESF to review. ( See Def.'s Ex. 97; Trial Tr. 1086–88.) The statistics displayed that JPMorgan banker referrals had been the source of 52 percent of JPEX's transactions that had closed by that point in 2008. Therefore, NESF was at least on notice prior to the acquisition of JPEX that a large quantity of business referrals came from internal JPMorgan bankers.

[907 F.Supp.2d 452]

At no point during this meeting did the parties discuss JPEX's compliance with IRS regulations, the issue of potential disqualification of any JPEX transaction, or alleged instances of actual and constructive receipt of Section 1031 exchange funds by JPEX clients.

2. Share Purchase Agreement

On October 31, 2008, NESF entered into a share purchase agreement (the “Share Purchase Agreement”) with JPMorgan to acquire all of the shares of JPEX and related entities for the contract price of $8 million minus certain adjustments. (Pl.'s Ex. 543.) The sale of JPEX closed on or about November 5, 2008. As part of the Share Purchase Agreement, JPMorgan made various representations and warranties regarding JPEX that are at issue in this case. Article 8 of the Share Purchase Agreement provides that JPMorgan will indemnify NESF for any liabilities arising out of, among other things, “[a]ny material breach of the representation or warranties made by JPMorgan” in the Share Purchase Agreement. ( Id.) Article 8 further provides that these indemnification procedures are the “sole and exclusive” remedy and provides a $3 million cap for breach of contract damages. ( Id.)

Under Section 3.7 of the Share Purchase Agreement, JPMorgan represented that JPEX has no undisclosed “[l]iabilities or obligations of any nature, whether absolute, accrued, contingent or other and whether due or to become due that would be required to be reflected or reserved against on a balance sheet or related footnotes of [JPEX] prepared in accordance with GAAP.” ( Id.)

Under Section 3.9 of the Share Purchase Agreement, JPMorgan represented that, to its knowledge, “no event has occurred or facts exist that may reasonably give rise to, or would serve as a basis for, commencement of any Action by or against any of the Companies or JPMorgan.” ( Id.) In the disclosure schedule to Section 3.9, JPMorgan represented that “[t]here is no pending or threatened material litigation against any of the Companies.” ( Id.)

Under Section 3.10(a) of the Share Purchase Agreement, JPMorgan represented that “[e]ach of the Companies and JPMorgan ... have each complied and are in compliance in all material respects with all Laws applicable to them and the Business, and to JPMorgan's knowledge no material violations of Law exists.” ( Id.) JPMorgan also represented under Section 3.10(a) that “no reasonable basis or bases exists for any threatened investigation or disciplinary proceeding against any of the Companies relating to the Business that could lead to an order or action suspending, restricting, or disqualifying the continued performance of the Business in any material respect.” ( Id.)

NESF claims that JPMorgan breached these representations and warranties by failing to disclose the alleged actual receipt, constructive receipt, and potential disqualification incidents at issue in this case. Although NESF did propose specific representations, such as Section 3.10(d) relating...

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