TAX INDEMNIFICATION AGREEMENT
This TAX INDEMNIFICATION AGREEMENT (the "Agreement") is
entered into as of December __, 1996 between Credit Management Solutions, Inc.,
a Delaware corporation (the "Company"), and the persons listed on Schedule A
attached hereto (individually a "Stockholder" and collectively the
"Stockholders"). Capitalized terms not otherwise defined have the meanings
ascribed to them in Section 1.1.
WHEREAS, the Company and the Stockholders have entered into
this Agreement as a condition to the Public Offering;
WHEREAS, the Company has been an "S corporation" (as defined
in Section 1361(a)(1) of the Code) for federal tax purposes since its inception
WHEREAS, the Company's election to be treated as an S
corporation terminated upon the reincorporation of the Company in Delaware (the
"Termination Date"), and as a result the Company has been a "C corporation" (as
defined in Section 1361(a)(2) of the Code) since the Termination Date;
WHEREAS, the Company will declare the AAA Dividend, a portion
of which will be payable on the Closing Date and the balance of which will be
payable on or before the Balance Payment Date;
WHEREAS, the Company and the Stockholders wish to provide for
certain tax related payments in connection with the Company's status as an S
corporation and for the adjustment of the amount of the AAA Dividend in certain
WHEREAS, the Company and the Stockholders wish to terminate
this Agreement such that it has no effect should the Pubic Offering not occur.
NOW, THEREFORE, the parties agree as follows:
1.1 Definitions. the following terms, as used herein,
have the following meanings:
"AAA" means the Company's "Accumulated adjustments
account," as defined in Section 1368(e)(1) of the Code, as of the close of
business on the day before the Termination Date.
"AAA Dividend" means the dividend to be declared by
the Company in an amount equal to the Company's undistributed S corporation
earnings to the stockholders of record one day prior to the Termination Date.
"AAA Settlement Date" means the last day of one of
the following periods, whichever is applicable: (i) the "post-termination
transition period," as defined in Section 1377(b) of the Code, of the Company,
in the case where the AAA is determined to be greater than determined on the
Balance Payment Date, or (ii) the calendar year of the Closing Date, in the
case where the AAA is determined to be less than determined on the Balance
"Adjustment Amount" means the net increase in taxable
income of one or more of the Stockholders or the Company based on a Final
Determination and which gives rise to a payment pursuant to Section 3.3 or
Section 3.4 hereof.
"Affected Stockholder" means a stockholder whose tax
returns are adjusted in a manner which gives rise to an obligation of the
Company pursuant to Section 3.3 hereof.
"Balance AAA Dividend" means the portion of the AAA
Dividend payable to the Stockholders of record as of one day prior to the
Termination Date in an amount equal to the balance of the AAA on the
Termination Date minus the Initial AAA Dividend.
"Balance Payment Date" means January 15, 1997.
"Blended Rate" means a percentage which equals the
sum of the maximum marginal federal and state individual income tax rates for
an individual residing in Maryland (after giving effect to the full
deductibility of state income taxes for federal income tax purposes) in effect
for the year of the adjustment to a tax return of the Company or such
Stockholder that gives rise to a correlative adjustment to a tax return of such
Stockholder or the Company, respectively. For example, if an adjustment that
results in an amount due from the Stockholders hereunder, the year of the
Company's return that was adjusted shall determine the Blended Rate to be used
in computing the amount due.
"Closing Date" means the date on which the Public
"Code" means the Internal Revenue Code of 1986, as
"C Short Year" means that portion of the S
Termination Year of the Company beginning on the Termination Date and ending on
the last day of the S Termination Year.
"C Taxable Year" means any taxable year (or portion
thereof) of the Company during which it is a C corporation, including the C
"Final Determination" means the earliest to occur of
(i) the execution of a closing agreement between a Stockholder and a Taxing
Authority or between the Company and a Taxing Authority, (ii) a decision of a
court of law that is either nonappealable or with respect to which no appeal is
taken, or (iii) any other event or agreement which establishes the tax
treatment of an item to the reasonable satisfaction of both parties.
"Initial AAA Dividend" means the portion of the AAA
Dividend to be paid to the Stockholders of record as of one on or immediately
after the Closing Date.
"Public Offering" means the initial public offering
of the Company's Common Stock pursuant to the Registration Statement on Form
S-1 originally filed by the Company with the Securities and Exchange Commission
on October 11, 1996.
"S Short Year" means the portion of the S Termination
Year beginning on the first day of such taxable year and ending on the day
immediately preceding the Termination Date.
"S Taxable Year" means any taxable year (or portion
thereof) of the Company during which the Company was an S corporation for the
entire year, including the S Short Year.
"S Termination Year" shall mean the fiscal year of
the Company that includes the Termination Date.
"Taxing Authority" means the United States Internal
Revenue Service and any comparable state or foreign taxing authority.
TERMINATION OF S CORPORATION STATUS, ALLOCATION
OF INCOME AND ADJUSTMENT OF AAA DIVIDEND
2.1 Termination of S Corporation Status. Termination of
the Company's S corporation status occurred upon the reincorporation of the
Company in Delaware.
2.2 Declaration of AAA Dividend. On December 1, 1996 the
Company shall declare the AAA Dividend. The AAA Dividend (including the
Initial AAA Dividend and the Balance AAA Dividend and any adjustments thereto)
shall be payable based upon the Stockholders ownership of common stock as of
one day prior to the Termination Date.
2.3 Allocation Election. The Company shall be required
to elect to allocate the items described in Section 1362(e) (2) (A) of the Code
pursuant to Section 1362(e) (3) of the Code under "normal tax accounting
rules," and the Stockholders agree to consent to such
election and to provide the Company with the statement of consent of all
Stockholders described in Section 1.1362-6(b) of the Treasury Regulations.
2.4 Adjustment to AAA Dividend.
(a) The parties acknowledge that the amount of the
Initial AAA Dividend and the Balance AAA Dividend will be based on good faith
determinations by the Company of the amount of AAA.
(b) The parties agree that if the Company determines
after the Termination Date and on or before the AAA Settlement Date that the
amount of the AAA as of December 15, 1996 does not equal the amount of the sum
of the Initial AAA Dividend and the Balance AAA Dividend, then:
(i) if the amount of the sum of the Initial AAA
Dividend and the Balance AAA Dividend exceeds the amount of
the AAA as of December 15, 1996, the Stockholders who received
the Initial AAA Dividend and the Balance AAA Dividend shall
immediately thereafter remit to the Company their pro-rata
share of such excess; and
(ii) if the amount of the AAA as of December 15,
1996 exceeds the amount of the sum of the Initial AAA Dividend
and the Balance AAA Dividend, the Company shall immediately
thereafter distribute to the Stockholders of record as of one
day prior to the Termination Date their pro-rata share of such
(c) The Company shall notify the Stockholders no later
than five (5) days prior to the AAA Settlement Date in the event the
Stockholders are required to remit any amount to the Company pursuant to this
(d) No payment shall be due, and no party shall have a
claim against the other party, under this Agreement if the relevant
determination of the AAA occurs after the applicable AAA Settlement Date.
3.1 Liability for Taxes Incurred During S Short Year.
Each Stockholder covenants and agrees that: (i) the Stockholder will duly
include, in his own federal and state income tax returns, all items of income,
gain, loss, deduction, or credit attributable to the S Short Year in a manner
consistent with the Form 1120S and the schedules thereto (and the corresponding
state income tax forms and schedules) to be filed by the Company with respect
to such period; (ii) such returns shall be filed no later than the due date
if any) for filing such returns; and (iii) each Stockholder shall pay any and
all taxes required to be paid for its taxable year that includes the S Short
3.2 Liability for Taxes Incurred During S Short Year and
C Short Year. The Company covenants and agrees that: (i) the Company shall be
responsible for and shall effect the filing of all federal and state income tax
returns for the Company with respect to the S Short Year and the C Short Year;
(ii) such Company returns shall be accurately prepared and timely filed; and
(iii) the Company shall pay any and all taxes required to be paid by the
Company for the periods covered by such returns as required by applicable law.
3.3 Company's Indemnification for Tax Liabilities. In
the event of an adjustment to one or more tax returns of the Company for an S
Taxable Year based on a Final Determination which results in a net increase in
taxable income of a Stockholder and a corresponding adjustment to one or more
tax returns of the Company for a C Taxable Year based on a Final Determination
which results in a net decrease in taxable income of the Company, the Company
shall pay to the Affected Stockholder an amount equal to the Adjustment Amount
multiplied by the Blended Rate. In the event the Adjustment Amount differs
from the adjustment to the income of the Company for a C Taxable Year, the
Company shall be required to pay an amount to the Affected Stockholder equal to
the lesser of the Adjusted Amount or the net decrease in the income of the
Company for the C Taxable Year, multiplied by the Blended Rate. In addition,
provided the Affected Stockholder originally reported its distributive share of
income and other items of the Company from an S Taxable Year consistently with
the Schedule K-1 provided to him by the Company, the Company shall pay to the
Affected Stockholder any penalties or interest actually paid by the Affected
Stockholder as a result of the adjustment to such items giving rise to the
Company's liability hereunder. The Company shall pay the amount due to the
Affected Stockholder within ten (10) business days of the later of (i) the
later of the two Final Determinations referred to in this Section 3.3 or (ii)
the date on which the Affected Stockholder provides proof reasonably
satisfactory to the Company that it has paid the taxes arising from the
3.4 Stockholders Indemnification for Tax Liabilities.
(a) In the event of an adjustment to one or more tax
returns of the Company for a C taxable year based on a Final Determination
which results in a net increase in taxable income of the Company for a C
Taxable Year and a corresponding adjustment to one or more tax returns of the
Company for an S Taxable Year based on a Final Determination which results in a
net decrease in taxable income of the Company for the S Taxable Year, the
Stockholders agree to contribute to the capital of the Company an amount equal
to the Adjustment Amount multiplied by the Blended Rate. In the event the
Adjustment Amount differs from the adjustments to the income of the Company for
the S Taxable year, the Stockholder shall be required to contribute to the
capital of the Company an amount equal to the lesser of the Adjustment Amount
or net decrease in the income of the Stockholder, multiplied by the Blended
Rate. In addition, each Stockholder shall contribute to the capital of the
Company an amount
equal to interest actually paid by the Company as a result of the adjustment
giving rise to the Stockholder's liability hereunder.
(b) If based on a Final Determination the Company is
deemed to have been a C corporation for federal, state or local income tax
purposes during any period in which it reported (or intends to report) its
taxable income as S corporation or is subject to the tax imposed by Section
1374 of the Code, each Stockholder agrees to contribute to the capital of the
Company an amount necessary to hold the Company harmless from any taxes and
interest arising from such Final Determination. The obligations of the
Stockholders under this subsection (b) shall include all taxes and interest
incurred by the Company as a C Corporation for periods ending before the
Termination Date, other than any obligation arising from an adjustment to the
Company's tax return for a period ending before the Termination Date which, if
the Company had been an S corporation for such period, would have given rise to
an obligation of the Company to the stockholders under Section 3.3 hereof.
Each Stockholder's obligation under this Section 3.4(b) shall be limited to
that percentage of the tax and interest due by the Company equal to the
fraction, expressed as a percentage, the numerator of which is the total
distributions to such Stockholder made by the Company from July 1, 1987 through
and including December 15, 1996, plus the AAA Dividend and any adjustment
thereto pursuant to this Agreement, and the denominator of which is the total
distributions made by the Company to all Stockholders from July 1, 1987 through
and including December 15, 1996, plus the AAA Dividend and any adjustment
thereto pursuant to this Agreement.
(c) The Stockholders shall contribute to the capital of
the Company amounts set forth in this Section 3.4 within twenty-five (25)
business days of the later of (i) the later of the two final Determinations
referred to in Section 3.4(a) or the Final Determination referred to in Section
3.4(b), whichever is applicable, or (ii) the date on which the Company provides
proof reasonably satisfactory to the Stockholder that it has paid the amounts
given rise to such liability.
3.5 Limitation on Amended Returns and Claims for Refund.
The parties acknowledge that the intent of this Agreement is to allocate the
approximate cost of adjustments to the tax returns of the parties based on one
or more examinations by a Taxing Authority and penalties and interest relating
thereto. As a result, this Agreement will not apply to adjustments resulting
from an amended tax return, claim for refund or similar action ("Unilateral
Action") that is not reasonably necessary in order to effectuate an adjustment
based on a Final Determination and resulting directly from an examination by a
Taxing Authority, unless and to the extent both parties consent to such
Unilateral Action. All calculations hereunder shall be made as if such
Unilateral Action had not occurred, unless and to the extent both parties
consented to the Unilateral Action.
3.6 Computational Rules.
(a) The following rules shall apply in making the
computations set forth in Section 3.3, and 3.4, and 3.8:
(i) In determining a net increase in the income
of a Stockholder or the Company pursuant to Sections 3.3 and 3.4, effect shall
be given to any reduction in taxable income of such party resulting from a
Final Determination with respect to prior or future years arising from or
directly relating to the item giving rise to the increase, provided that such
increase or reduction can reasonably be anticipated to be realized within three
taxable years of the corresponding adjustment.
(ii) Capital gains and losses shall be treated the
same as ordinary income. An increase or decrease in tax basis of any property
owned by a party or an increase or decrease in a net operating or capital loss
carryforward of a party shall be treated as an expense or income, respectively,
of such party in the amount of such increase or decrease in the taxable year of
such increase or decrease.
(iii) There will be no increase or decrease in any
payment based on time value of money or similar concepts, and no effect shall
be given to the timing of the decrease in a party's taxable income in
determining the amount of such decrease.
(b) Notwithstanding subsection (a), the parties shall
endeavor to agree to payments under Sections 3.3 and 3.4(a) that, to the extent
reasonable in light of the complexities involved, place the parties in the same
position that they would have been in had there been no Adjustment Amount, with
a view toward minimizing the overall tax burden of the parties and minimizing,
to the extent of a tax cost to another party, the amount of any benefit
realized by a party as a result of an Adjustment Amount.
(a) Contests. Each of the Company and the
Stockholders agree that (i) in the event that any of them receives notice,
whether orally or in writing, of any federal, state, local or foreign tax
examinations, claims, settlements, proposed adjustments or related matters that
may affect in any way the liability of a party under this Agreement, it shall
within ten days notify the other parties in writing thereof (provided that any
failure to give such notice shall not reduce a party's right to indemnification
under this Agreement except to the extent of actual damage incurred by the
other parties as a result of such failure), and (ii) the party or parties (the
"Indemnifying Party") who would be required to indemnify the other party or
parties (the "Indemnified Party") shall be entitled at its reasonable
discretion and sole expense to handle, control and compromise or settle the
defense of any matter which may give rise to a liability under this Agreement,
provided that the Indemnifying Party from time to time provides assurances
reasonably satisfactory to the Indemnified Party that (1) the Indemnifying
Party is financially capable of pursuing such defense to its conclusion, and
(2) such defense is actually being pursued in a reasonable manner.
(b) Cooperation. the parties will make available
to one another, as reasonably requested, and to any taxing authority, all
information, records or documents relating to the liability for taxes covered
by this Agreement and will preserve such information, records
or documents until the expiration of any applicable statute of limitations or
extensions thereof. The party requesting such information shall reimburse the
other party for all reasonable out-of-pocket costs incurred in producing
3.8 Indemnification for Taxes on Payments. The parties
agree that amounts paid or contributed hereunder (including pursuant to this
Section 3.8) shall be net of any federal and state income tax imposed on the
receipt of such amounts, but only to the extent of the federal and state income
tax benefit to the Indemnifying Party from the payment to the Indemnified
Party. The parties will determine by mutual agreement whether and the extent
to which any amounts paid or contributed hereunder will be subject to tax, the
amount of benefit received by a party, and the appropriate increase in such
amount required by this Section 3.8. In the event the parties are unable to
agree on any matter described in this Section 3.8, they shall select a firm of
certified public accountants mutually acceptable to both parties to determine
such matters, whose decisions shall be final and binding on the parties.
3.9 Cost. Except to the extent otherwise provided
herein, each party shall bear its own costs in administering this Agreement.
3.10 Interest on Overdue Payments. Any payment pursuant
to this Agreement not made when due under this Agreement shall bear interest at
the rate of 10% per annum until paid.
3.11 Correction of a Final Determination. In the event a
party makes a payment pursuant to this Agreement based on the expected outcome
of a Final Determination which subsequently is determined to have been
incorrect, the parties shall adjust the payments hereunder in order to reflect
the subsequent determination as if it was the Final Determination upon which
the original payment was based.
4.1 Counterparts. This Agreement may be executed in
several counterparts, each of which shall be deemed an original, but all of
which counterparts collectively shall constitute an instrument representing the
Agreement between the parties hereto.
4.2 Construction of Terms. Nothing herein expressed or
implied is intended, or shall be construed, to confer upon or give any person,
firm or corporation, other than the parties hereto or their respective
successors and assigns, any rights or remedies under or by reason of this
4.3 Governing Law. This Agreement and the legal
relations between the parties hereto shall be governed by and construed in
accordance with the substantive laws of the State of Delaware without regard to
Delaware choice of law rules.
4.4 Amendment and Modification. This Agreement may be
amended, modified or supplemented only by a written agreement executed by the
4.5 Assignment. This Agreement and all of the provisions
hereof shall be binding upon and inure to the benefit of the parties hereto and
their respective successors and permitted assigns, but neither this Agreement
nor any of the rights, interests or obligations hereunder shall be assigned by
any of the parties hereto without the prior written consent of the other
parties, nor is this Agreement intended to confer upon any other person except
the parties any rights or remedies hereunder.
4.6 Interpretation. The title, article and section
headings contained in this Agreement are solely for the purpose of reference,
are not part of the agreement of the parties and shall not in any way affect
the meaning or interpretation of this Agreement.
4.7 Severability. In the event that any one or more of
the provisions of this Agreement shall be held to be illegal, invalid or
unenforceable in any respect, the same shall not in any respect affect the
validity, legality or enforceability of the remainder of this Agreement, and
the parties shall use their best efforts to replace such illegal, invalid or
unenforceable provisions with an enforceable provision approximating, to the
extent possible, the original intent of the parties.
4.8 Entire Agreement. This Agreement embodies the entire
agreement and understanding of the parties hereto in respect to the subject
matter contained herein. There are no representations, promises, warranties,
covenants, or undertakings, other than those expressly set forth or referred to
herein. This Agreement supersedes all prior agreements and the understandings
between the parties with respect to such subject matter.
4.9 Fees. In any action or proceeding brought to enforce
or interpret any provision of this Agreement (except with respect to matters
described in Section 3.8 hereof) the successful party shall be entitled to
reasonable fees of attorneys, accountants and other professionals as well as
other costs incurred in connection with such action or proceeding.
4.10 Termination of Agreement. This Agreement shall
terminate and be void, as if it never had been executed, if the Closing Date
shall occur after January 15, 1997.
IN WITNESS WHEREOF, the parties have executed this Agreement
as of the date first written above.
CREDIT MANAGEMENT SOLUTIONS, INC.
James R. DeFrancesco
Scott L. Freiman
James R. DeFrancesco
Scott L. Freiman