1018-00009 · Client 1018 · Related Matters

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MEMORANDUM

PRIVILEGED AND CONFIDENTIAL — ATTORNEY-CLIENT COMMUNICATION / ATTORNEY WORK PRODUCT

TO: Leonard Cross, Responsible Partner Sylvia Hartwell, Billing Partner

FROM: Leila Nazari, Associate

DATE: November 15, 2023

RE: Analysis of Tax Covenants in Penterra Pharmaceuticals Corp. Revolving Credit Facility with Hargrove National Bank, N.A. — Impact of IRS Proposed Adjustments ($380.4M)

MATTER NO.: 1018-00009

I. Executive Summary

This memorandum analyzes whether the Notice of Proposed Adjustment ("NOPA") issued by the Internal Revenue Service on October 12, 2023, proposing net adjustments of $380,400,000 across tax years 2017 through 2020, triggers any reporting obligations, event-of-default provisions, or other covenant implications under Penterra Pharmaceuticals Corp.'s ("PPC") $1.5 billion revolving credit facility (the "Credit Facility") with Hargrove National Bank, N.A. ("Hargrove") as administrative agent and a syndicate of participating lenders (the "Credit Agreement").

Based on the analysis set forth in detail below, the principal conclusions of this memorandum are as follows:

(a) The NOPA likely triggers the "Material Tax Event" reporting and notification requirement contained in the Credit Agreement. Given the magnitude of the proposed adjustments — $380.4 million in net income adjustments, generating potential additional federal income tax liability of approximately $79.88 million before penalties and interest — the NOPA almost certainly exceeds any reasonable materiality threshold that the Credit Agreement would impose. PPC should provide written notice to Hargrove promptly.

(b) The NOPA does not, standing alone, constitute an Event of Default under the Credit Agreement. As a proposed adjustment rather than a final, non-appealable assessment, the NOPA represents the IRS's opening position and is subject to administrative protest, IRS Appeals consideration, and potential judicial challenge. PPC is actively contesting the adjustments, and the preliminary hazards-of-litigation analysis conducted by Calderwood & Harkness LLP ("C&H") suggests that the proposed adjustments are significantly overstated. However, the NOPA could ripen into an Event of Default — particularly under the Material Adverse Change or Material Adverse Effect provisions — if PPC fails to contest the adjustments or if the adjustments are sustained at or near the full proposed amount without adequate reserves or liquidity to absorb the resulting liability.

(c) Immediate analysis of the tax-indemnity provisions in the Credit Agreement is warranted to determine whether the NOPA creates any potential indemnification exposure vis-à-vis the syndicate lenders. Although the standard Tax Indemnity and Tax Gross-Up provisions in revolving credit facilities are generally designed to address withholding taxes on interest payments and FATCA compliance rather than borrower income tax liabilities, the specific definitions in PPC's Credit Agreement should be reviewed to confirm this conclusion.

(d) We recommend prompt notification to Hargrove's relationship manager, Christine Bellucci, Senior Vice President, to preserve PPC's good-faith compliance posture under the Credit Agreement. Given that the NOPA was received on or about October 12, 2023, and that Credit Agreements typically require notification within a specified number of business days of becoming aware of a triggering event, PPC should act without further delay to provide the required notice. Any notification should be reviewed by C&H before delivery to ensure no inadvertent waiver of attorney-client privilege or work-product protection.

By way of context, the NOPA was issued by the IRS Large Business & International Division ("LB&I"), Northeast Transfer Pricing Practice, Exam Team LB&I-NE-TP-2022-00641. The NOPA challenges the transfer pricing methodology used in PPC's Irish intellectual-property-holding structure, which involves intercompany transactions between PPC and its indirect subsidiary, Penterra Biopharma International DAC ("PBI"), an Irish designated activity company. C&H is defending PPC through all phases of the examination, and a Formal Protest is being prepared for filing by December 22, 2023, in response to the 30-Day Letter issued on November 8, 2023. The preliminary hazards-of-litigation analysis conducted by C&H, in consultation with Whitmore Valuation Group LLC ("Whitmore"), indicates that a reasonable settlement range is 10–15% of the proposed adjustment, or approximately $38 million to $57 million in adjusted income, corresponding to approximately $8.0 million to $12.0 million in additional tax liability.

II. Background

A. The Credit Facility

PPC is the borrower under a $1.5 billion senior unsecured revolving credit facility entered into with Hargrove National Bank, N.A. as administrative agent and a syndicate of lenders (the "Credit Facility"). Hargrove National Bank, N.A. is headquartered at 100 Federal Street, Boston, Massachusetts 02110. The designated relationship manager for the PPC account is Christine Bellucci, Senior Vice President.

PPC — Penterra Pharmaceuticals Corp. — is a Delaware corporation headquartered at 2200 Independence Boulevard, Princeton Junction, New Jersey 08550. PPC is publicly traded on the Nasdaq Stock Market under the ticker symbol PPCA, and its employer identification number is 22-3741856. PPC is a specialty pharmaceutical company with significant global operations, including research and development, manufacturing, and commercial activities across more than thirty countries.

For context regarding PPC's financial scale and creditworthiness, the following key financial data are relevant to this analysis:

• PPC's fiscal year 2020 annual revenue was approximately $6.82 billion.

• PPC's fiscal year 2020 pre-tax income was approximately $1.47 billion.

• PPC maintains investment-grade credit ratings from the major rating agencies.

• PPC's current outstanding borrowings under the Credit Facility are understood to be substantially below the $1.5 billion commitment level, though the exact draw amount should be confirmed with PPC's treasury team.

The Credit Agreement contains customary representations, warranties, affirmative and negative covenants, financial covenants, and events of default, including tax-specific provisions that are the primary focus of this memorandum. As discussed in Section V.B below, we have not yet received a complete copy of the Credit Agreement (including all amendments and side letters) for detailed review of the specific defined terms and applicable thresholds. The analysis in this memorandum is accordingly based on our understanding of the general structure of such provisions as they are typically found in investment-grade revolving credit facilities, informed by discussions with PPC's General Counsel, Deborah Staines, regarding the general contours of the Credit Agreement's tax provisions.

B. The IRS Examination and NOPA

The IRS opened an examination of PPC's federal income tax returns on May 16, 2022, covering tax years 2017, 2018, 2019, and 2020. The examination was assigned to the LB&I Division's Northeast Transfer Pricing Practice and designated as Exam Team LB&I-NE-TP-2022-00641. The examination has focused primarily on the transfer pricing of intercompany transactions between PPC and PBI, including cost-sharing payments under a qualified cost-sharing arrangement ("CSA") effective July 1, 2012, and royalty payments under a legacy intellectual property licensing arrangement at a 4.5% rate of net sales.

On October 12, 2023, the IRS issued a Notice of Proposed Adjustment covering all four examined tax years. Subsequently, on November 8, 2023, the IRS issued a 30-Day Letter providing PPC with the opportunity to file a Formal Protest and request consideration by the IRS Office of Appeals.

The total proposed adjustments set forth in the NOPA are $380,400,000 net, consisting of the following components:

CSA Cost-Sharing Ratio Adjustments: $235,010,000. The IRS proposes to increase PBI's cost-share percentages under the CSA by 8 to 12 percentage points across each tax year, asserting that PBI's share of intangible development costs should have been substantially higher than the amounts reflected on PPC's returns. The year-by-year breakdown is as follows:

• Tax Year 2017: Increase of 10.0 percentage points applied to a $487.3 million cost-sharing base, resulting in a proposed adjustment of $48,730,000.

• Tax Year 2018: Increase of 11.0 percentage points applied to a $523.8 million cost-sharing base, resulting in a proposed adjustment of $57,610,000.

• Tax Year 2019: Increase of 11.2 percentage points applied to a $561.2 million cost-sharing base, resulting in a proposed adjustment of $62,850,000.

• Tax Year 2020: Increase of 11.0 percentage points applied to a $598.4 million cost-sharing base, resulting in a proposed adjustment of $65,820,000.

Legacy IP Royalty Rate Adjustments: $188,040,000. The IRS proposes to increase the arm's-length royalty rate applicable to PBI's use of pre-CSA intellectual property from PPC's reported rate of 4.5% to 11.0% of net sales. The year-by-year breakdown is as follows:

• Tax Year 2017: Proposed adjustment of $52,950,000.

• Tax Year 2018: Proposed adjustment of $49,550,000.

• Tax Year 2019: Proposed adjustment of $44,970,000.

• Tax Year 2020: Proposed adjustment of $40,570,000.

Correlative Offset: ($42,650,000). The IRS has allowed a correlative offset of $42,650,000 across the four tax years, reflecting the partial reduction in U.S. taxable income attributable to the increased cost-sharing payments that would flow from the proposed CSA adjustments.

In addition to the income adjustments, the NOPA proposes the imposition of an accuracy-related penalty under IRC § 6662(e) (substantial valuation misstatement in the context of transfer pricing) of approximately $15,980,000, calculated as 20% of the underpayment of tax attributable to the proposed adjustment ($380.4 million × 21% statutory rate = approximately $79,884,000 × 20% = approximately $15,977,000, rounded to $15,980,000).

If the proposed adjustments were fully sustained, the total additional federal income tax liability would be approximately $79,880,000 (at the 21% corporate rate applicable to the post-2017 tax years, with adjustments for TY 2017 at the applicable blended rate), plus the § 6662(e) penalty of approximately $15,980,000, for a total exposure of approximately $95,860,000 before the accrual of interest.

It should be noted that PPC currently maintains an ASC 740-10 (formerly FIN 48) uncertain tax position reserve of $62,400,000 related to the Irish intellectual property structure. This reserve was established by PPC's independent auditor in consultation with PPC's in-house tax department and reflects the anticipated additional tax exposure attributable to the transfer pricing positions at issue. The reserve provides a partial — but not complete — cushion against the proposed adjustments, and would need to be reassessed in light of the NOPA.

C&H is preparing a Formal Protest for filing by December 22, 2023, the deadline established by the 30-Day Letter. The preliminary hazards-of-litigation analysis conducted by C&H, in coordination with Whitmore Valuation Group LLC (the economic consulting firm retained to support PPC's transfer pricing defense), suggests that the proposed adjustments are significantly overstated. In particular, with respect to the royalty rate issue, PPC's 4.5% rate falls within the interquartile range of 3.1% to 6.8% (median 4.4%) identified by Whitmore based on an analysis of 14 comparable uncontrolled transaction ("CUT") agreements. C&H's preliminary settlement target is 10–15% of the proposed adjustment, or approximately $38 million to $57 million in adjusted income, corresponding to approximately $8.0 million to $12.0 million in additional tax liability.

C. Relevant PPC Group Entities

The transfer pricing dispute at issue in the NOPA concerns intercompany transactions within PPC's international corporate structure. The relevant entities in the chain of ownership are as follows:

Penterra Pharmaceuticals Corp. ("PPC") — the ultimate U.S. parent company and borrower under the Credit Facility; a Delaware corporation headquartered at 2200 Independence Boulevard, Princeton Junction, NJ 08550.

Penterra Holdings Luxembourg S.à r.l. ("PHL") — a Luxembourg private limited liability company (société à responsabilité limitée) that is treated as a disregarded entity for U.S. federal income tax purposes. PHL is located at 14, rue Aldringen, L-1118 Luxembourg, and is registered with the Luxembourg Registre de Commerce et des Sociétés under No. B 168452. PHL serves as an intermediate holding company in PPC's international structure.

Penterra Biopharma International DAC ("PBI") — an Irish designated activity company, located at 4th Floor, Claremont House, Sandyford Business Park, Dublin D18 K7T4, Ireland, and registered with the Irish Revenue Commissioners under Tax Reference No. 3218764T. PBI is the counterparty to the CSA and the licensee of the legacy intellectual property under the royalty arrangement. PBI holds the rights to exploit PPC's pharmaceutical intellectual property outside the United States and is the principal Irish entity through which PPC's non-U.S. revenues flow.

Penterra Manufacturing Ireland Ltd. ("PMI") — an Irish limited company, located at Unit 7, Ringaskiddy Industrial Estate, Co. Cork T12 PX29, Ireland, and registered with the Companies Registration Office under CRO No. 512347. PMI is PBI's wholly owned manufacturing subsidiary and operates PPC's Irish API manufacturing facility.

The ownership chain runs from PPC to PHL (100% ownership) to PBI (100% ownership by PHL) to PMI (100% ownership by PBI). The transfer pricing dispute centers on the intercompany transactions between PPC and PBI under (i) the CSA, effective July 1, 2012, pursuant to which PPC and PBI share the costs of developing intangible property in proportion to their reasonably anticipated benefits, and (ii) a pre-CSA legacy intellectual property royalty arrangement under which PBI pays PPC a royalty of 4.5% of net sales for the right to exploit intellectual property developed prior to the CSA's effective date.

III. Analysis of Credit Agreement Tax Covenants

The following analysis examines the principal categories of tax-related provisions typically found in a senior unsecured revolving credit facility of the type maintained by PPC, and assesses the implications of the NOPA for each category. As noted above, this analysis is based on our understanding of the general structure and content of such provisions; specific conclusions should be confirmed against the actual Credit Agreement once a complete copy has been provided to C&H for review.

A. Material Tax Event Notification Covenant

Typical Provision. Investment-grade revolving credit agreements customarily require the borrower to promptly notify the administrative agent of any "Material Tax Event." This term is generally defined to encompass the receipt of a notice of deficiency, a notice of proposed adjustment, a revenue agent's report, or any similar written communication from a federal, state, local, or foreign taxing authority proposing adjustments to the borrower's reported tax liability in excess of a specified dollar threshold. The materiality threshold varies by agreement but is typically tied to either a fixed dollar amount (commonly $25 million or $50 million in potential additional tax liability) or a percentage of the borrower's consolidated net income or consolidated net worth. In some facilities, particularly those with sophisticated syndicate lenders, the threshold may be set at a level that captures any adjustment that could reasonably be expected to have a "material adverse effect" on the borrower, effectively incorporating the MAC/MAE standard by reference.

The notification requirement is designed to ensure that the administrative agent and the lending syndicate receive timely information about significant tax exposures that could affect the borrower's financial condition, liquidity, or creditworthiness. Failure to comply with the notification covenant is itself typically an Event of Default (or becomes one after the expiration of an applicable cure period), which underscores the importance of prompt compliance.

Analysis. The NOPA proposes net adjustments of $380,400,000, generating potential additional federal income tax liability of approximately $79,880,000, plus an accuracy-related penalty under IRC § 6662(e) of approximately $15,980,000, for a total pre-interest exposure of approximately $95,860,000. This amount is well in excess of the typical notification thresholds found in investment-grade credit facilities. Even if the Credit Agreement employs a $50 million threshold — which would be at the higher end of typical materiality thresholds — the potential additional tax liability of approximately $79.88 million (before penalties) comfortably exceeds that level.

Moreover, even if PPC's ASC 740-10 uncertain tax position reserve of $62.4 million were taken into account — on the theory that the "net" exposure above existing reserves is the appropriate measure — the incremental exposure above the reserve ($95.86 million minus $62.4 million = approximately $33.46 million) would still exceed a $25 million threshold, and the gross proposed adjustment amount of $380.4 million would exceed any reasonable threshold by a substantial margin.

Conclusion. The NOPA almost certainly triggers the Material Tax Event notification requirement under the Credit Agreement, regardless of where the specific materiality threshold is set. PPC should provide written notice to Hargrove promptly.

Timing Considerations. Credit Agreements typically require notification within a specified number of business days — commonly 5 to 10 business days — after the borrower becomes aware of a Material Tax Event. The NOPA was received by PPC on or about October 12, 2023. If PPC has not yet provided notice to Hargrove, the notification period has likely lapsed, and PPC should provide notice immediately to mitigate any argument that it has failed to comply with the notification covenant. Late notice, while undesirable, is substantially preferable to no notice at all, and PPC's good-faith compliance posture can be preserved if PPC acts promptly and provides full and transparent disclosure to Hargrove.

It should also be noted that the 30-Day Letter, issued on November 8, 2023, reinforces the urgency of notification. Even if PPC could argue that the NOPA itself did not trigger the notification requirement (a difficult argument given the amounts involved), the 30-Day Letter — which formally initiates the protest period and signals the IRS's intention to proceed with the proposed adjustments absent a formal challenge — would independently trigger the notification obligation under most formulations of the Material Tax Event definition.

Internal Coordination. PPC's General Counsel, Deborah Staines, and Chief Financial Officer, Rajesh Iyer, should coordinate with the Vice President of Global Tax, Marcus Whitfield, regarding the specific notification mechanics required by the Credit Agreement, including the form of notice (whether letter or certificate), the designated recipient (whether Christine Bellucci in her capacity as relationship manager or a separate notice address specified in the Credit Agreement), and any required certifications or supporting documentation.

B. Representations and Warranties — Tax Compliance

Typical Provision. The Credit Agreement customarily contains representations and warranties relating to PPC's tax compliance, including representations that:

(i) PPC and its subsidiaries have timely filed all required federal, state, local, and foreign tax returns;

(ii) PPC and its subsidiaries have paid all taxes shown as due on such returns and all taxes assessed against them, except where contested in good faith by appropriate proceedings and for which adequate reserves have been established in accordance with GAAP;

(iii) no material tax claims, assessments, or deficiencies are pending or, to the knowledge of PPC, threatened against PPC or any of its subsidiaries, except as disclosed in writing to the administrative agent; and

(iv) PPC has established reserves adequate to cover all tax liabilities that are reasonably likely to arise from pending or threatened tax matters.

These representations are typically subject to a "bring-down" mechanism under which they are deemed to be re-made as of each borrowing date or each delivery of a compliance certificate, ensuring that the administrative agent and the lending syndicate have current information about PPC's tax posture throughout the life of the facility.

Analysis. PPC timely filed IRS Forms 1120 for tax years 2017 through 2020. These returns were prepared by PPC's independent accounting firm, Crestfield & Associates LLP, under the direction of engagement partner Martin Ogilvy and transfer pricing partner Susan Lam. PPC maintained contemporaneous transfer pricing documentation for all four years in compliance with the documentation requirements of Treasury Regulations §§ 1.482-7 and 1.482-4, prepared under the penalty-protection standards of IRC § 6662(e). The existence of contemporaneous documentation is relevant not only to PPC's transfer pricing defense but also to its representation of compliance with applicable tax filing and reporting requirements.

The IRS examination was opened on May 16, 2022. The threshold question is whether PPC disclosed the existence of the examination to Hargrove at or around the time of its opening. If PPC did disclose the examination — either as part of its periodic compliance certificate delivery or as a separate notification of a pending tax proceeding — then the NOPA represents an escalation of a previously disclosed matter. In that case, PPC's obligation would be to update the prior disclosure to include the specific proposed adjustments and the associated dollar amounts.

If, on the other hand, PPC did not disclose the examination at opening, there is a potential gap in PPC's compliance with the representation and warranty provisions. An undisclosed IRS examination of this scope and magnitude could be viewed as inconsistent with the representation that no material tax claims or assessments are "pending or threatened" against PPC. However, the opening of an examination is not, in and of itself, a "claim" or "assessment" — it is an information-gathering process — and many borrowers take the position that disclosure is not required until the IRS proposes specific adjustments. The strength of this position depends on the specific language of the Credit Agreement.

Conclusion. PPC should confirm with its in-house legal and tax teams whether the initial examination was disclosed to Hargrove at or around the time of its opening in May 2022. Regardless of the answer, PPC should now update its disclosure to include the NOPA, the aggregate proposed adjustment of $380.4 million, and the associated potential tax and penalty exposure of approximately $95.86 million. The updated disclosure should also describe PPC's intention to file a Formal Protest by December 22, 2023, and the engagement of C&H and Whitmore to defend against the proposed adjustments.

C. Tax Indemnity Provisions

Typical Provision. Investment-grade revolving credit agreements typically contain a Tax Indemnity or Tax Gross-Up provision under which the borrower agrees to indemnify the administrative agent and the syndicate lenders for certain taxes imposed on or with respect to payments made by the borrower under the Credit Agreement. These provisions are designed primarily to address:

(i) Withholding taxes imposed on interest payments to non-U.S. lenders or U.S. lenders that fail to provide required tax documentation;

(ii) FATCA (Foreign Account Tax Compliance Act) withholding under IRC §§ 1471–1474;

(iii) Backup withholding under IRC § 3406; and

(iv) In some cases, stamp taxes, documentary taxes, or similar transactional taxes imposed on the execution, delivery, or enforcement of the Credit Agreement or related loan documents.

The Tax Indemnity provision may define "Indemnified Taxes" broadly or narrowly, depending on the negotiating leverage of the parties and the sophistication of counsel involved in the drafting. Some facilities also contain broader indemnity provisions — separate from the Tax Indemnity — under which the borrower indemnifies the lenders for losses arising from a wide range of events, potentially including material tax events that impair the borrower's ability to service the facility.

Analysis. The transfer pricing adjustment proposed in the NOPA primarily affects PPC's federal income tax liability. The adjustment reallocates income from PBI (an Irish entity) to PPC (a U.S. entity), increasing PPC's U.S. taxable income and correspondingly reducing PBI's income. This adjustment does not, on its face, affect any withholding taxes on payments made by PPC to Hargrove or the syndicate lenders under the Credit Facility. Nor does it implicate FATCA withholding, backup withholding, or documentary taxes.

The Tax Indemnity provision in a typical revolving credit facility is not designed to shift the borrower's own income tax exposure to the lenders. It is designed to protect the lenders against being economically burdened by taxes imposed on the flow of funds under the credit facility — i.e., to ensure that the lenders receive the full contractual amount of interest and other payments without reduction for taxes. The NOPA does not affect the lenders' receipt of payments under the Credit Facility.

However, there are two potential areas of concern that warrant closer examination of the specific provisions in PPC's Credit Agreement:

First, if the Credit Agreement contains an unusually broad definition of "Indemnified Taxes" that extends beyond withholding taxes and transactional taxes to encompass any tax liability arising from or related to the borrower's business operations, the NOPA could conceivably fall within the scope of the indemnity. This would be an atypical drafting approach, but it is not unheard of in facilities with non-standard terms.

Second, if the Credit Agreement contains a general indemnity provision (separate from the Tax Indemnity) under which PPC indemnifies the lenders for "losses, claims, damages, liabilities, and expenses" arising from a breach of PPC's representations, warranties, or covenants, then a failure to timely notify Hargrove of the NOPA as a Material Tax Event could give rise to an indemnification claim by the lenders if they suffer losses as a result of the notification failure.

Conclusion. The standard Tax Indemnity provision likely does not impose direct indemnification obligations on PPC vis-à-vis the lenders as a result of the NOPA. The proposed adjustment relates to PPC's own income tax liability and does not affect the lenders' receipt of payments under the Credit Facility. However, PPC should review the specific definitions of "Indemnified Taxes," "Tax Event," and "Excluded Taxes" in the Credit Agreement to confirm this conclusion, and should separately assess whether the general indemnity provisions could create exposure in the event of a failure to comply with the notification covenant.

D. Financial Covenants — Impact Assessment

Typical Provisions. Senior unsecured revolving credit facilities for investment-grade borrowers such as PPC typically contain financial covenants requiring the borrower to maintain specified financial ratios on a consolidated basis, tested as of the end of each fiscal quarter. The most common financial covenants include:

(i) A maximum leverage ratio (typically defined as the ratio of consolidated funded indebtedness to consolidated EBITDA), often set at 3.5x or 4.0x for investment-grade pharmaceutical companies;

(ii) A minimum interest coverage ratio (typically defined as the ratio of consolidated EBITDA to consolidated interest expense), often set at 3.0x or 3.5x; and

(iii) In some cases, a minimum net worth or minimum tangible net worth covenant, requiring PPC to maintain consolidated net worth or tangible net worth above a specified floor.

Analysis of Potential Impact of the Proposed Adjustment. If the NOPA were fully sustained — resulting in a total additional tax and penalty liability of approximately $95.86 million before interest — the impact on PPC's financial condition should be assessed in the context of PPC's overall scale:

• PPC's fiscal year 2020 pre-tax income was approximately $1.47 billion. The total proposed tax and penalty liability of approximately $95.86 million represents approximately 6.5% of a single year's pre-tax income. While this amount is by no means insignificant, it is unlikely to cause PPC to breach typical leverage or interest coverage covenants for a company of PPC's size and profitability.

• PPC's ASC 740-10 uncertain tax position reserve of $62.4 million already accounts for a substantial portion of the potential exposure. If the NOPA were fully sustained, the incremental cash impact above existing reserves would be approximately $33.46 million ($95.86 million less $62.4 million), a comparatively modest amount relative to PPC's overall financial position.

• The proposed adjustment, if sustained, would represent a one-time payment (or installment payments, depending on payment arrangements) rather than an ongoing reduction in earnings capacity. The adjustment would not affect PPC's EBITDA on a going-forward basis (except to the extent that a settlement or assessment requires a restatement of historical financial results), and therefore should not materially affect the leverage ratio or interest coverage ratio calculations going forward.

• At the expected settlement range — which C&H currently targets at 10–15% of the proposed adjustment, or approximately $38 million to $57 million in adjusted income, corresponding to approximately $8.0 million to $12.0 million in additional tax liability — the financial impact would be modest by any measure and well within the parameters of PPC's existing reserves.

Conclusion. The proposed adjustment, even if fully sustained at the $380.4 million level, is unlikely to cause a breach of the standard financial covenants in the Credit Agreement, given PPC's substantial revenue base ($6.82 billion), strong pre-tax income ($1.47 billion), and existing reserves ($62.4 million). However, PPC should model the worst-case scenario against the specific covenant calculations in the Credit Agreement to confirm this conclusion, taking into account any applicable covenant levels, cure periods, and definitions of the financial metrics used in the covenant calculations. Rajesh Iyer's treasury team should prepare detailed compliance certificate calculations under the worst-case, expected-case, and best-case scenarios for presentation to PPC's General Counsel and outside counsel.

E. Event of Default — Material Adverse Change / Material Adverse Effect

Typical Provision. The Credit Agreement is expected to contain a provision under which an Event of Default is triggered by the occurrence of a "Material Adverse Change" or "Material Adverse Effect" (collectively, "MAC/MAE"). The MAC/MAE clause is typically defined to encompass any event, development, circumstance, condition, or occurrence that, individually or in the aggregate, has had or could reasonably be expected to have a material adverse effect on:

(i) the business, operations, assets, liabilities, financial condition, or results of operations of the borrower and its subsidiaries, taken as a whole;

(ii) the ability of the borrower to perform its obligations under the Credit Agreement and the other loan documents; or

(iii) the rights and remedies of the administrative agent and the lenders under the Credit Agreement and the other loan documents.

The MAC/MAE clause is one of the most heavily negotiated provisions in credit agreements, and its scope and application depend critically on the specific language employed. Some formulations include express carve-outs for events that are disclosed to the lenders, events that are the subject of ongoing litigation or proceedings, or events that are adequately reserved against in the borrower's financial statements.

Analysis. Several factors are relevant to the assessment of whether the NOPA, standing alone, constitutes a MAC/MAE Event of Default:

First, the NOPA is a proposed adjustment, not a final determination. PPC retains the right to contest the proposed adjustments through administrative protest (which PPC is actively pursuing, with a Formal Protest due December 22, 2023), IRS Appeals consideration, and potential judicial challenge in the United States Tax Court or a federal district court (upon payment of the asserted deficiency). The NOPA represents the IRS's opening position in what is expected to be a multi-year resolution process. Credit agreements typically recognize the distinction between pending or threatened claims and final, non-appealable assessments, and the mere receipt of a NOPA — without more — should not rise to the level of a MAC/MAE.

Second, C&H's preliminary hazards-of-litigation analysis indicates that the IRS's proposed adjustments are significantly overstated. In particular:

• On the royalty rate issue, PPC's reported rate of 4.5% falls within the interquartile range of 3.1% to 6.8% (median 4.4%) identified by Whitmore Valuation Group LLC based on an analysis of 14 comparable uncontrolled transaction agreements. The IRS's proposed rate of 11.0% is well above the upper quartile and is not supported by the comparable data.

• On the CSA cost-sharing ratio issue, PPC's methodology is consistent with the framework prescribed by Treasury Regulations § 1.482-7 and is supported by contemporaneous documentation.

• PBI maintains economic substance in Ireland, with a substantial workforce, physical presence, and operational activities at the Dublin and Cork locations. The IRS has not challenged PBI's economic substance as a separate basis for adjustment.

Third, PPC's existing ASC 740-10 reserve of $62.4 million demonstrates that PPC has recognized and reserved for a significant portion of the potential exposure. The existence of this reserve, established in accordance with GAAP and disclosed in PPC's audited financial statements, is an important factor in any MAC/MAE analysis because it shows that the transfer pricing risk was already reflected in PPC's financial condition as presented to the lenders.

Fourth, PPC has adequate liquidity to absorb the potential exposure, even at the full proposed level. A total tax and penalty liability of approximately $95.86 million (before interest), while significant in absolute terms, represents a manageable obligation for a company with $6.82 billion in annual revenue and $1.47 billion in pre-tax income. PPC's ability to service the Credit Facility would not be materially impaired by a payment of this magnitude.

Conclusion. The NOPA does not, by itself, constitute a MAC/MAE Event of Default under the Credit Agreement. The proposed adjustments are preliminary, actively contested, and subject to significant reduction at the administrative and judicial levels. PPC has adequate reserves and liquidity to manage the exposure, and C&H's preliminary analysis indicates that a reasonable settlement would be at a fraction of the proposed amount. However, this conclusion is contingent on PPC's active defense of the positions and on the ultimate resolution of the examination. If PPC were to fail to file a Formal Protest, if the adjustments were sustained at or near the full proposed amount on a final, non-appealable basis, or if PPC's financial condition were to deteriorate materially for other reasons during the pendency of the examination, the MAC/MAE analysis could change.

F. Negative Covenants — Restrictions on Tax Settlements

Typical Provision. Some credit agreements contain negative covenants that restrict the borrower from entering into material tax settlements, compromises, or closing agreements with taxing authorities without providing prior notice to the administrative agent or, in some cases, obtaining the consent of the required lenders. These provisions are designed to prevent the borrower from voluntarily accepting substantial tax liabilities that could impair its creditworthiness or its ability to service the credit facility.

Analysis. As PPC proceeds through the Formal Protest (filing deadline December 22, 2023), potential IRS Appeals consideration (anticipated to commence in early 2024), and any settlement discussions that may arise during the Appeals process, any proposed settlement terms will need to be evaluated against any such negative covenant in the Credit Agreement.

PPC's current settlement strategy, as developed in coordination with C&H and Whitmore, targets resolution at 10–15% of the proposed adjustment, corresponding to approximately $38 million to $57 million in adjusted income and approximately $8.0 million to $12.0 million in additional tax liability. A settlement in this range should be well within PPC's operating capacity and is unlikely to trigger any restrictions under standard negative covenants, which typically set the threshold for required lender notification or consent at a level substantially above PPC's anticipated settlement range.

However, if the settlement discussions were to result in a substantially higher resolution — for example, if the IRS Appeals office were to sustain the proposed adjustments at 50% or more of the proposed amount — the analysis could change, and PPC may need to provide additional notification to Hargrove or seek lender input before accepting the settlement.

Recommendation. PPC should review the Credit Agreement for any express restrictions on tax settlements exceeding a specified dollar threshold and, if applicable, should build lender notification into the settlement timeline. C&H should be consulted before PPC accepts any settlement offer from the IRS to ensure compliance with both the Credit Agreement's covenants and PPC's broader legal and fiduciary obligations.

IV. Interaction with SEC Disclosure Obligations

While a comprehensive analysis of PPC's disclosure obligations under the federal securities laws is beyond the scope of this memorandum and is addressed in a separate SEC Disclosure Analysis Memorandum being prepared concurrently, a brief cross-reference is warranted here because of the potential overlap between PPC's SEC disclosure obligations and its notification obligations under the Credit Agreement.

As a publicly traded company listed on the Nasdaq Stock Market, PPC is required to disclose material contingent liabilities and uncertain tax positions in its periodic reports filed with the Securities and Exchange Commission, including its annual reports on Form 10-K and quarterly reports on Form 10-Q. The NOPA, with its proposed adjustments of $380.4 million, may require disclosure in PPC's upcoming 10-K filing (for the fiscal year ending December 31, 2023) as a material subsequent event, and may also require enhanced disclosure in the ASC 740-10 footnote to PPC's audited financial statements.

This SEC disclosure dimension is relevant to the Credit Agreement analysis for two reasons. First, PPC's SEC filings are publicly available and are monitored by sophisticated institutional investors and creditors. Ridgeview Capital Management LP, which holds an 8.3% equity stake in PPC (managed by Douglas Everett, Managing Partner), is known to closely monitor PPC's ASC 740-10 disclosures and uncertain tax position reserves. Any public disclosure of the NOPA in PPC's SEC filings will be visible to Hargrove and the syndicate lenders, whether or not PPC provides direct notification under the Credit Agreement.

Second, and more critically, if Hargrove and the syndicate lenders were to learn of the NOPA through PPC's public SEC filings rather than through direct notification under the Credit Agreement, PPC could face allegations that it failed to comply with the Material Tax Event notification covenant and that it attempted to conceal material information from its lenders. Such allegations, even if ultimately determined to be unfounded, could damage PPC's relationship with its lending syndicate and could create unnecessary risk at a time when PPC needs to maintain the confidence and cooperation of its creditors.

For these reasons, proactive and prompt notification to Hargrove under the Credit Agreement is essential — both to satisfy PPC's contractual obligations and to preserve PPC's credibility and good-faith compliance posture vis-à-vis its lending syndicate.

V. Recommended Actions

Based on the analysis set forth above, I recommend the following actions:

A. Immediate Notification to Hargrove

PPC should provide written notice to Christine Bellucci, Senior Vice President and Relationship Manager, Hargrove National Bank, N.A., at 100 Federal Street, Boston, Massachusetts 02110, of the NOPA as a Material Tax Event under the Credit Agreement. The notice should be delivered in writing, in the form and manner specified by the Credit Agreement (which typically requires notice by certified mail, overnight courier, or hand delivery, with a copy by email), and should include the following information:

(a) The date of the NOPA (October 12, 2023) and the nature of the IRS's proposed adjustments, including a description of the transfer pricing issues at stake (CSA cost-sharing ratios and legacy IP royalty rate);

(b) The aggregate proposed net adjustment ($380,400,000) and the approximate potential additional federal income tax and penalty exposure (approximately $95,860,000 at the full proposed amount, before interest);

(c) A statement that PPC disputes the proposed adjustments in their entirety, both on the merits and as to the proposed penalty, and that PPC intends to file a Formal Protest with the IRS by December 22, 2023, to initiate consideration by the IRS Office of Appeals;

(d) A statement that PPC's outside counsel, Calderwood & Harkness LLP, and PPC's economic consultants, Whitmore Valuation Group LLC, are actively engaged in the defense of PPC's transfer pricing positions and are preparing the Formal Protest;

(e) A statement that PPC has maintained an ASC 740-10 uncertain tax position reserve of $62,400,000 related to the Irish intellectual property structure, established in accordance with GAAP, which partially addresses the potential exposure; and

(f) An offer to provide additional information or to discuss the matter with Hargrove's legal or credit teams at Hargrove's convenience, subject to applicable privileges and confidentiality considerations.

The draft notification letter should be reviewed by C&H — specifically by Leonard Cross and Leila Nazari — before delivery to ensure that the letter does not contain any statements that could constitute an inadvertent waiver of attorney-client privilege or work-product protection. In particular, the letter should describe the NOPA and PPC's response in factual terms without disclosing C&H's legal analysis, settlement strategy, or hazards-of-litigation assessment. The letter should also include an express reservation of PPC's rights and privileges.

B. Credit Agreement Review

PPC's in-house legal team, under the direction of General Counsel Deborah Staines, should provide C&H with a complete copy of the Credit Agreement, including all amendments, supplements, waiver letters, side letters, and ancillary documents, for detailed review of the specific defined terms, thresholds, and provisions relevant to this analysis. Key provisions that should be examined include:

• The definition of "Material Tax Event," including the applicable materiality threshold (whether a fixed dollar amount, a percentage of net income, or a MAC/MAE-based standard);

• The notification timing requirements (i.e., the number of business days within which PPC must provide notice after becoming aware of a Material Tax Event);

• The definition of "Material Adverse Effect" or "Material Adverse Change," including any applicable carve-outs, qualifiers, or safe harbors;

• The definition of "Indemnified Taxes" and "Excluded Taxes" in the Tax Indemnity and Tax Gross-Up provisions;

• The bring-down certificate language, including the scope of representations and warranties that are re-made on each borrowing date;

• The definitions of "Indebtedness" and "Contingent Obligations," to determine whether the NOPA creates a contingent obligation that must be separately reported or that affects the calculation of financial covenant ratios;

• Any negative covenants restricting the entry into material tax settlements, compromises, or closing agreements; and

• The cure periods and grace periods applicable to any covenant breach or Event of Default arising from the NOPA or related matters.

C&H will prepare a supplemental memorandum analyzing the specific Credit Agreement provisions upon receipt of the agreement.

C. Coordination with CFO

Rajesh Iyer, PPC's Chief Financial Officer, should be advised of the covenant analysis set forth in this memorandum and should coordinate with PPC's treasury team regarding the following matters:

• Any potential impact of the NOPA on the Credit Facility's availability, including whether the NOPA affects PPC's ability to draw on the revolving credit facility or triggers any condition precedent to borrowing;

• The compliance certificate calculations for the current and upcoming fiscal quarters, including a sensitivity analysis showing the impact of the proposed adjustment under the worst-case, expected-case, and best-case scenarios;

• Any upcoming borrowing-base or financial-covenant compliance dates, and whether the NOPA could affect PPC's ability to deliver a clean compliance certificate on those dates; and

• The potential need to update PPC's ASC 740-10 uncertain tax position reserve in light of the NOPA, in consultation with Crestfield & Associates LLP and PPC's Audit Committee.

D. Ongoing Monitoring

As the IRS examination and contest process progresses through the following stages — Formal Protest filing (December 22, 2023), assignment to IRS Appeals (anticipated early 2024), Appeals conferences and settlement discussions, and potential Tax Court litigation — PPC should take the following ongoing steps:

• Update Hargrove and the syndicate lenders as appropriate regarding material developments in the examination process, including the filing of the Formal Protest, the assignment of the case to Appeals, and any settlement offers or counterproposals;

• Evaluate the covenant implications of any settlement terms before acceptance, including consultation with C&H regarding compliance with any negative covenants restricting material tax settlements;

• Monitor PPC's financial covenant compliance on an ongoing basis, taking into account the potential financial impact of the examination under various resolution scenarios; and

• Coordinate SEC disclosure obligations with Credit Agreement notification obligations to ensure consistency and to avoid any appearance of selective or inconsistent disclosure.

VI. Conclusion

The IRS's NOPA, proposing net adjustments of $380,400,000 across tax years 2017 through 2020, triggers a notification obligation to Hargrove National Bank, N.A. under the Material Tax Event provision of the Credit Agreement. PPC should provide prompt written notice to Christine Bellucci, Hargrove's relationship manager, describing the NOPA and PPC's response, and should offer to provide additional information at Hargrove's request.

The NOPA does not, standing alone, constitute an Event of Default under the Credit Agreement. The proposed adjustments are preliminary, actively contested, and subject to significant reduction through the administrative protest and Appeals process. C&H's preliminary hazards-of-litigation analysis indicates that a reasonable settlement is likely to be achieved at 10–15% of the proposed adjustment, corresponding to approximately $8.0 million to $12.0 million in additional tax liability — an amount that is well within PPC's financial capacity and existing reserves.

The proposed adjustment, even if fully sustained at the $380.4 million level (resulting in approximately $95.86 million in tax and penalties before interest), is unlikely to cause a breach of the financial covenants in the Credit Agreement given PPC's substantial scale, with fiscal year 2020 revenue of $6.82 billion, pre-tax income of $1.47 billion, and an existing ASC 740-10 uncertain tax position reserve of $62.4 million.

PPC should provide prompt notice to Hargrove, should furnish C&H with a complete copy of the Credit Agreement for detailed review of the specific tax-related provisions, and should keep Hargrove informed as the examination proceeds toward resolution.

Calderwood & Harkness LLP stands ready to assist PPC with drafting the notification letter to Hargrove, reviewing the specific provisions of the Credit Agreement, and advising PPC on the covenant implications of any settlement or resolution of the IRS examination.

Please do not hesitate to contact me with any questions regarding this analysis.

Leila Nazari, Associate Calderwood & Harkness LLP Direct: (212) 555-0147 lnazari@calderwoodharkness.com

VII. Appendices (Referenced)

The following appendices are referenced in this memorandum and will be circulated under separate cover:

Appendix A: Summary of IRS Proposed Adjustments — $380.4M Breakdown by Issue and Tax Year

Appendix B: Proposed Worst-Case and Expected-Case Financial Impact Scenarios

Appendix C: Key Credit Agreement Provisions to Be Reviewed

Specific section references will be inserted upon receipt of the Credit Agreement from PPC's General Counsel. The following categories of provisions have been identified for detailed review:

• Material Tax Event definition and notification requirements

• Material Adverse Effect / Material Adverse Change definition

• Representations and warranties — tax compliance

• Bring-down certificate requirements

• Tax Indemnity / Tax Gross-Up provisions

• Definitions of "Indemnified Taxes" and "Excluded Taxes"

• Financial covenant definitions and calculations

• Definitions of "Indebtedness" and "Contingent Obligations"

• Negative covenants restricting material tax settlements

• Event of Default provisions (including cure periods)

• Notice provisions (form, manner, and designated recipients)

PRIVILEGED AND CONFIDENTIAL — ATTORNEY-CLIENT COMMUNICATION / ATTORNEY WORK PRODUCT. This memorandum has been prepared by Calderwood & Harkness LLP at the request of Penterra Pharmaceuticals Corp. and is protected by the attorney-client privilege and the work-product doctrine. This memorandum is intended solely for the use of the named recipients and should not be disclosed to any third party without the prior written consent of Calderwood & Harkness LLP.

Issue	TY 2017	TY 2018	TY 2019	TY 2020	Total
CSA Cost-Sharing Ratio Adjustments	$48,730,000	$57,610,000	$62,850,000	$65,820,000	$235,010,000
Legacy IP Royalty Rate Adjustments	$52,950,000	$49,550,000	$44,970,000	$40,570,000	$188,040,000
Correlative Offset	—	—	—	—	($42,650,000)
Net Proposed Adjustment	$380,400,000
Scenario	Adjusted Income	Tax (21%)	§ 6662(e) Penalty (20%)	Total (Pre-Interest)
Worst Case (100% sustained)	$380,400,000	~$79,880,000	~$15,980,000	~$95,860,000
Expected Settlement (10–15%)	$38,000,000–$57,000,000	~$8,000,000–$12,000,000	Waived	~$8,000,000–$12,000,000

MEMORANDUM
PRIVILEGED AND CONFIDENTIAL — ATTORNEY-CLIENT COMMUNICATION / ATTORNEY WORK PRODUCT
TO: Leonard Cross, Responsible Partner Sylvia Hartwell, Billing Partner
FROM: Leila Nazari, Associate
DATE: November 15, 2023
RE: Analysis of Tax Covenants in Penterra Pharmaceuticals Corp. Revolving Credit Facility with Hargrove National Bank, N.A. — Impact of IRS Proposed Adjustments ($380.4M)
MATTER NO.: 1018-00009
I. Executive Summary
This memorandum analyzes whether the Notice of Proposed Adjustment ("NOPA") issued by the Internal Revenue Service on October 12, 2023, proposing net adjustments of $380,400,000 across tax years 2017 through 2020, triggers any reporting obligations, event-of-default provisions, or other covenant implications under Penterra Pharmaceuticals Corp.'s ("PPC") $1.5 billion revolving credit facility (the "Credit Facility") with Hargrove National Bank, N.A. ("Hargrove") as administrative agent and a syndicate of participating lenders (the "Credit Agreement").
Based on the analysis set forth in detail below, the principal conclusions of this memorandum are as follows:
(a) The NOPA likely triggers the "Material Tax Event" reporting and notification requirement contained in the Credit Agreement. Given the magnitude of the proposed adjustments — $380.4 million in net income adjustments, generating potential additional federal income tax liability of approximately $79.88 million before penalties and interest — the NOPA almost certainly exceeds any reasonable materiality threshold that the Credit Agreement would impose. PPC should provide written notice to Hargrove promptly.
(b) The NOPA does not, standing alone, constitute an Event of Default under the Credit Agreement. As a proposed adjustment rather than a final, non-appealable assessment, the NOPA represents the IRS's opening position and is subject to administrative protest, IRS Appeals consideration, and potential judicial challenge. PPC is actively contesting the adjustments, and the preliminary hazards-of-litigation analysis conducted by Calderwood & Harkness LLP ("C&H") suggests that the proposed adjustments are significantly overstated. However, the NOPA could ripen into an Event of Default — particularly under the Material Adverse Change or Material Adverse Effect provisions — if PPC fails to contest the adjustments or if the adjustments are sustained at or near the full proposed amount without adequate reserves or liquidity to absorb the resulting liability.
(c) Immediate analysis of the tax-indemnity provisions in the Credit Agreement is warranted to determine whether the NOPA creates any potential indemnification exposure vis-à-vis the syndicate lenders. Although the standard Tax Indemnity and Tax Gross-Up provisions in revolving credit facilities are generally designed to address withholding taxes on interest payments and FATCA compliance rather than borrower income tax liabilities, the specific definitions in PPC's Credit Agreement should be reviewed to confirm this conclusion.
(d) We recommend prompt notification to Hargrove's relationship manager, Christine Bellucci, Senior Vice President, to preserve PPC's good-faith compliance posture under the Credit Agreement. Given that the NOPA was received on or about October 12, 2023, and that Credit Agreements typically require notification within a specified number of business days of becoming aware of a triggering event, PPC should act without further delay to provide the required notice. Any notification should be reviewed by C&H before delivery to ensure no inadvertent waiver of attorney-client privilege or work-product protection.
By way of context, the NOPA was issued by the IRS Large Business & International Division ("LB&I"), Northeast Transfer Pricing Practice, Exam Team LB&I-NE-TP-2022-00641. The NOPA challenges the transfer pricing methodology used in PPC's Irish intellectual-property-holding structure, which involves intercompany transactions between PPC and its indirect subsidiary, Penterra Biopharma International DAC ("PBI"), an Irish designated activity company. C&H is defending PPC through all phases of the examination, and a Formal Protest is being prepared for filing by December 22, 2023, in response to the 30-Day Letter issued on November 8, 2023. The preliminary hazards-of-litigation analysis conducted by C&H, in consultation with Whitmore Valuation Group LLC ("Whitmore"), indicates that a reasonable settlement range is 10–15% of the proposed adjustment, or approximately $38 million to $57 million in adjusted income, corresponding to approximately $8.0 million to $12.0 million in additional tax liability.
II. Background
A. The Credit Facility
PPC is the borrower under a $1.5 billion senior unsecured revolving credit facility entered into with Hargrove National Bank, N.A. as administrative agent and a syndicate of lenders (the "Credit Facility"). Hargrove National Bank, N.A. is headquartered at 100 Federal Street, Boston, Massachusetts 02110. The designated relationship manager for the PPC account is Christine Bellucci, Senior Vice President.
PPC — Penterra Pharmaceuticals Corp. — is a Delaware corporation headquartered at 2200 Independence Boulevard, Princeton Junction, New Jersey 08550. PPC is publicly traded on the Nasdaq Stock Market under the ticker symbol PPCA, and its employer identification number is 22-3741856. PPC is a specialty pharmaceutical company with significant global operations, including research and development, manufacturing, and commercial activities across more than thirty countries.
For context regarding PPC's financial scale and creditworthiness, the following key financial data are relevant to this analysis:
• PPC's fiscal year 2020 annual revenue was approximately $6.82 billion.
• PPC's fiscal year 2020 pre-tax income was approximately $1.47 billion.
• PPC maintains investment-grade credit ratings from the major rating agencies.
• PPC's current outstanding borrowings under the Credit Facility are understood to be substantially below the $1.5 billion commitment level, though the exact draw amount should be confirmed with PPC's treasury team.
The Credit Agreement contains customary representations, warranties, affirmative and negative covenants, financial covenants, and events of default, including tax-specific provisions that are the primary focus of this memorandum. As discussed in Section V.B below, we have not yet received a complete copy of the Credit Agreement (including all amendments and side letters) for detailed review of the specific defined terms and applicable thresholds. The analysis in this memorandum is accordingly based on our understanding of the general structure of such provisions as they are typically found in investment-grade revolving credit facilities, informed by discussions with PPC's General Counsel, Deborah Staines, regarding the general contours of the Credit Agreement's tax provisions.
B. The IRS Examination and NOPA
The IRS opened an examination of PPC's federal income tax returns on May 16, 2022, covering tax years 2017, 2018, 2019, and 2020. The examination was assigned to the LB&I Division's Northeast Transfer Pricing Practice and designated as Exam Team LB&I-NE-TP-2022-00641. The examination has focused primarily on the transfer pricing of intercompany transactions between PPC and PBI, including cost-sharing payments under a qualified cost-sharing arrangement ("CSA") effective July 1, 2012, and royalty payments under a legacy intellectual property licensing arrangement at a 4.5% rate of net sales.
On October 12, 2023, the IRS issued a Notice of Proposed Adjustment covering all four examined tax years. Subsequently, on November 8, 2023, the IRS issued a 30-Day Letter providing PPC with the opportunity to file a Formal Protest and request consideration by the IRS Office of Appeals.
The total proposed adjustments set forth in the NOPA are $380,400,000 net, consisting of the following components:
CSA Cost-Sharing Ratio Adjustments: $235,010,000. The IRS proposes to increase PBI's cost-share percentages under the CSA by 8 to 12 percentage points across each tax year, asserting that PBI's share of intangible development costs should have been substantially higher than the amounts reflected on PPC's returns. The year-by-year breakdown is as follows:
• Tax Year 2017: Increase of 10.0 percentage points applied to a $487.3 million cost-sharing base, resulting in a proposed adjustment of $48,730,000.
• Tax Year 2018: Increase of 11.0 percentage points applied to a $523.8 million cost-sharing base, resulting in a proposed adjustment of $57,610,000.
• Tax Year 2019: Increase of 11.2 percentage points applied to a $561.2 million cost-sharing base, resulting in a proposed adjustment of $62,850,000.
• Tax Year 2020: Increase of 11.0 percentage points applied to a $598.4 million cost-sharing base, resulting in a proposed adjustment of $65,820,000.
Legacy IP Royalty Rate Adjustments: $188,040,000. The IRS proposes to increase the arm's-length royalty rate applicable to PBI's use of pre-CSA intellectual property from PPC's reported rate of 4.5% to 11.0% of net sales. The year-by-year breakdown is as follows:
• Tax Year 2017: Proposed adjustment of $52,950,000.
• Tax Year 2018: Proposed adjustment of $49,550,000.
• Tax Year 2019: Proposed adjustment of $44,970,000.
• Tax Year 2020: Proposed adjustment of $40,570,000.
Correlative Offset: ($42,650,000). The IRS has allowed a correlative offset of $42,650,000 across the four tax years, reflecting the partial reduction in U.S. taxable income attributable to the increased cost-sharing payments that would flow from the proposed CSA adjustments.
In addition to the income adjustments, the NOPA proposes the imposition of an accuracy-related penalty under IRC § 6662(e) (substantial valuation misstatement in the context of transfer pricing) of approximately $15,980,000, calculated as 20% of the underpayment of tax attributable to the proposed adjustment ($380.4 million × 21% statutory rate = approximately $79,884,000 × 20% = approximately $15,977,000, rounded to $15,980,000).
If the proposed adjustments were fully sustained, the total additional federal income tax liability would be approximately $79,880,000 (at the 21% corporate rate applicable to the post-2017 tax years, with adjustments for TY 2017 at the applicable blended rate), plus the § 6662(e) penalty of approximately $15,980,000, for a total exposure of approximately $95,860,000 before the accrual of interest.
It should be noted that PPC currently maintains an ASC 740-10 (formerly FIN 48) uncertain tax position reserve of $62,400,000 related to the Irish intellectual property structure. This reserve was established by PPC's independent auditor in consultation with PPC's in-house tax department and reflects the anticipated additional tax exposure attributable to the transfer pricing positions at issue. The reserve provides a partial — but not complete — cushion against the proposed adjustments, and would need to be reassessed in light of the NOPA.
C&H is preparing a Formal Protest for filing by December 22, 2023, the deadline established by the 30-Day Letter. The preliminary hazards-of-litigation analysis conducted by C&H, in coordination with Whitmore Valuation Group LLC (the economic consulting firm retained to support PPC's transfer pricing defense), suggests that the proposed adjustments are significantly overstated. In particular, with respect to the royalty rate issue, PPC's 4.5% rate falls within the interquartile range of 3.1% to 6.8% (median 4.4%) identified by Whitmore based on an analysis of 14 comparable uncontrolled transaction ("CUT") agreements. C&H's preliminary settlement target is 10–15% of the proposed adjustment, or approximately $38 million to $57 million in adjusted income, corresponding to approximately $8.0 million to $12.0 million in additional tax liability.
C. Relevant PPC Group Entities
The transfer pricing dispute at issue in the NOPA concerns intercompany transactions within PPC's international corporate structure. The relevant entities in the chain of ownership are as follows:
Penterra Pharmaceuticals Corp. ("PPC") — the ultimate U.S. parent company and borrower under the Credit Facility; a Delaware corporation headquartered at 2200 Independence Boulevard, Princeton Junction, NJ 08550.
Penterra Holdings Luxembourg S.à r.l. ("PHL") — a Luxembourg private limited liability company (société à responsabilité limitée) that is treated as a disregarded entity for U.S. federal income tax purposes. PHL is located at 14, rue Aldringen, L-1118 Luxembourg, and is registered with the Luxembourg Registre de Commerce et des Sociétés under No. B 168452. PHL serves as an intermediate holding company in PPC's international structure.
Penterra Biopharma International DAC ("PBI") — an Irish designated activity company, located at 4th Floor, Claremont House, Sandyford Business Park, Dublin D18 K7T4, Ireland, and registered with the Irish Revenue Commissioners under Tax Reference No. 3218764T. PBI is the counterparty to the CSA and the licensee of the legacy intellectual property under the royalty arrangement. PBI holds the rights to exploit PPC's pharmaceutical intellectual property outside the United States and is the principal Irish entity through which PPC's non-U.S. revenues flow.
Penterra Manufacturing Ireland Ltd. ("PMI") — an Irish limited company, located at Unit 7, Ringaskiddy Industrial Estate, Co. Cork T12 PX29, Ireland, and registered with the Companies Registration Office under CRO No. 512347. PMI is PBI's wholly owned manufacturing subsidiary and operates PPC's Irish API manufacturing facility.
The ownership chain runs from PPC to PHL (100% ownership) to PBI (100% ownership by PHL) to PMI (100% ownership by PBI). The transfer pricing dispute centers on the intercompany transactions between PPC and PBI under (i) the CSA, effective July 1, 2012, pursuant to which PPC and PBI share the costs of developing intangible property in proportion to their reasonably anticipated benefits, and (ii) a pre-CSA legacy intellectual property royalty arrangement under which PBI pays PPC a royalty of 4.5% of net sales for the right to exploit intellectual property developed prior to the CSA's effective date.
III. Analysis of Credit Agreement Tax Covenants
The following analysis examines the principal categories of tax-related provisions typically found in a senior unsecured revolving credit facility of the type maintained by PPC, and assesses the implications of the NOPA for each category. As noted above, this analysis is based on our understanding of the general structure and content of such provisions; specific conclusions should be confirmed against the actual Credit Agreement once a complete copy has been provided to C&H for review.
A. Material Tax Event Notification Covenant
Typical Provision. Investment-grade revolving credit agreements customarily require the borrower to promptly notify the administrative agent of any "Material Tax Event." This term is generally defined to encompass the receipt of a notice of deficiency, a notice of proposed adjustment, a revenue agent's report, or any similar written communication from a federal, state, local, or foreign taxing authority proposing adjustments to the borrower's reported tax liability in excess of a specified dollar threshold. The materiality threshold varies by agreement but is typically tied to either a fixed dollar amount (commonly $25 million or $50 million in potential additional tax liability) or a percentage of the borrower's consolidated net income or consolidated net worth. In some facilities, particularly those with sophisticated syndicate lenders, the threshold may be set at a level that captures any adjustment that could reasonably be expected to have a "material adverse effect" on the borrower, effectively incorporating the MAC/MAE standard by reference.
The notification requirement is designed to ensure that the administrative agent and the lending syndicate receive timely information about significant tax exposures that could affect the borrower's financial condition, liquidity, or creditworthiness. Failure to comply with the notification covenant is itself typically an Event of Default (or becomes one after the expiration of an applicable cure period), which underscores the importance of prompt compliance.
Analysis. The NOPA proposes net adjustments of $380,400,000, generating potential additional federal income tax liability of approximately $79,880,000, plus an accuracy-related penalty under IRC § 6662(e) of approximately $15,980,000, for a total pre-interest exposure of approximately $95,860,000. This amount is well in excess of the typical notification thresholds found in investment-grade credit facilities. Even if the Credit Agreement employs a $50 million threshold — which would be at the higher end of typical materiality thresholds — the potential additional tax liability of approximately $79.88 million (before penalties) comfortably exceeds that level.
Moreover, even if PPC's ASC 740-10 uncertain tax position reserve of $62.4 million were taken into account — on the theory that the "net" exposure above existing reserves is the appropriate measure — the incremental exposure above the reserve ($95.86 million minus $62.4 million = approximately $33.46 million) would still exceed a $25 million threshold, and the gross proposed adjustment amount of $380.4 million would exceed any reasonable threshold by a substantial margin.
Conclusion. The NOPA almost certainly triggers the Material Tax Event notification requirement under the Credit Agreement, regardless of where the specific materiality threshold is set. PPC should provide written notice to Hargrove promptly.
Timing Considerations. Credit Agreements typically require notification within a specified number of business days — commonly 5 to 10 business days — after the borrower becomes aware of a Material Tax Event. The NOPA was received by PPC on or about October 12, 2023. If PPC has not yet provided notice to Hargrove, the notification period has likely lapsed, and PPC should provide notice immediately to mitigate any argument that it has failed to comply with the notification covenant. Late notice, while undesirable, is substantially preferable to no notice at all, and PPC's good-faith compliance posture can be preserved if PPC acts promptly and provides full and transparent disclosure to Hargrove.
It should also be noted that the 30-Day Letter, issued on November 8, 2023, reinforces the urgency of notification. Even if PPC could argue that the NOPA itself did not trigger the notification requirement (a difficult argument given the amounts involved), the 30-Day Letter — which formally initiates the protest period and signals the IRS's intention to proceed with the proposed adjustments absent a formal challenge — would independently trigger the notification obligation under most formulations of the Material Tax Event definition.
Internal Coordination. PPC's General Counsel, Deborah Staines, and Chief Financial Officer, Rajesh Iyer, should coordinate with the Vice President of Global Tax, Marcus Whitfield, regarding the specific notification mechanics required by the Credit Agreement, including the form of notice (whether letter or certificate), the designated recipient (whether Christine Bellucci in her capacity as relationship manager or a separate notice address specified in the Credit Agreement), and any required certifications or supporting documentation.
B. Representations and Warranties — Tax Compliance
Typical Provision. The Credit Agreement customarily contains representations and warranties relating to PPC's tax compliance, including representations that:
(i) PPC and its subsidiaries have timely filed all required federal, state, local, and foreign tax returns;
(ii) PPC and its subsidiaries have paid all taxes shown as due on such returns and all taxes assessed against them, except where contested in good faith by appropriate proceedings and for which adequate reserves have been established in accordance with GAAP;
(iii) no material tax claims, assessments, or deficiencies are pending or, to the knowledge of PPC, threatened against PPC or any of its subsidiaries, except as disclosed in writing to the administrative agent; and
(iv) PPC has established reserves adequate to cover all tax liabilities that are reasonably likely to arise from pending or threatened tax matters.
These representations are typically subject to a "bring-down" mechanism under which they are deemed to be re-made as of each borrowing date or each delivery of a compliance certificate, ensuring that the administrative agent and the lending syndicate have current information about PPC's tax posture throughout the life of the facility.
Analysis. PPC timely filed IRS Forms 1120 for tax years 2017 through 2020. These returns were prepared by PPC's independent accounting firm, Crestfield & Associates LLP, under the direction of engagement partner Martin Ogilvy and transfer pricing partner Susan Lam. PPC maintained contemporaneous transfer pricing documentation for all four years in compliance with the documentation requirements of Treasury Regulations §§ 1.482-7 and 1.482-4, prepared under the penalty-protection standards of IRC § 6662(e). The existence of contemporaneous documentation is relevant not only to PPC's transfer pricing defense but also to its representation of compliance with applicable tax filing and reporting requirements.
The IRS examination was opened on May 16, 2022. The threshold question is whether PPC disclosed the existence of the examination to Hargrove at or around the time of its opening. If PPC did disclose the examination — either as part of its periodic compliance certificate delivery or as a separate notification of a pending tax proceeding — then the NOPA represents an escalation of a previously disclosed matter. In that case, PPC's obligation would be to update the prior disclosure to include the specific proposed adjustments and the associated dollar amounts.
If, on the other hand, PPC did not disclose the examination at opening, there is a potential gap in PPC's compliance with the representation and warranty provisions. An undisclosed IRS examination of this scope and magnitude could be viewed as inconsistent with the representation that no material tax claims or assessments are "pending or threatened" against PPC. However, the opening of an examination is not, in and of itself, a "claim" or "assessment" — it is an information-gathering process — and many borrowers take the position that disclosure is not required until the IRS proposes specific adjustments. The strength of this position depends on the specific language of the Credit Agreement.
Conclusion. PPC should confirm with its in-house legal and tax teams whether the initial examination was disclosed to Hargrove at or around the time of its opening in May 2022. Regardless of the answer, PPC should now update its disclosure to include the NOPA, the aggregate proposed adjustment of $380.4 million, and the associated potential tax and penalty exposure of approximately $95.86 million. The updated disclosure should also describe PPC's intention to file a Formal Protest by December 22, 2023, and the engagement of C&H and Whitmore to defend against the proposed adjustments.
C. Tax Indemnity Provisions
Typical Provision. Investment-grade revolving credit agreements typically contain a Tax Indemnity or Tax Gross-Up provision under which the borrower agrees to indemnify the administrative agent and the syndicate lenders for certain taxes imposed on or with respect to payments made by the borrower under the Credit Agreement. These provisions are designed primarily to address:
(i) Withholding taxes imposed on interest payments to non-U.S. lenders or U.S. lenders that fail to provide required tax documentation;
(ii) FATCA (Foreign Account Tax Compliance Act) withholding under IRC §§ 1471–1474;
(iii) Backup withholding under IRC § 3406; and
(iv) In some cases, stamp taxes, documentary taxes, or similar transactional taxes imposed on the execution, delivery, or enforcement of the Credit Agreement or related loan documents.
The Tax Indemnity provision may define "Indemnified Taxes" broadly or narrowly, depending on the negotiating leverage of the parties and the sophistication of counsel involved in the drafting. Some facilities also contain broader indemnity provisions — separate from the Tax Indemnity — under which the borrower indemnifies the lenders for losses arising from a wide range of events, potentially including material tax events that impair the borrower's ability to service the facility.
Analysis. The transfer pricing adjustment proposed in the NOPA primarily affects PPC's federal income tax liability. The adjustment reallocates income from PBI (an Irish entity) to PPC (a U.S. entity), increasing PPC's U.S. taxable income and correspondingly reducing PBI's income. This adjustment does not, on its face, affect any withholding taxes on payments made by PPC to Hargrove or the syndicate lenders under the Credit Facility. Nor does it implicate FATCA withholding, backup withholding, or documentary taxes.
The Tax Indemnity provision in a typical revolving credit facility is not designed to shift the borrower's own income tax exposure to the lenders. It is designed to protect the lenders against being economically burdened by taxes imposed on the flow of funds under the credit facility — i.e., to ensure that the lenders receive the full contractual amount of interest and other payments without reduction for taxes. The NOPA does not affect the lenders' receipt of payments under the Credit Facility.
However, there are two potential areas of concern that warrant closer examination of the specific provisions in PPC's Credit Agreement:
First, if the Credit Agreement contains an unusually broad definition of "Indemnified Taxes" that extends beyond withholding taxes and transactional taxes to encompass any tax liability arising from or related to the borrower's business operations, the NOPA could conceivably fall within the scope of the indemnity. This would be an atypical drafting approach, but it is not unheard of in facilities with non-standard terms.
Second, if the Credit Agreement contains a general indemnity provision (separate from the Tax Indemnity) under which PPC indemnifies the lenders for "losses, claims, damages, liabilities, and expenses" arising from a breach of PPC's representations, warranties, or covenants, then a failure to timely notify Hargrove of the NOPA as a Material Tax Event could give rise to an indemnification claim by the lenders if they suffer losses as a result of the notification failure.
Conclusion. The standard Tax Indemnity provision likely does not impose direct indemnification obligations on PPC vis-à-vis the lenders as a result of the NOPA. The proposed adjustment relates to PPC's own income tax liability and does not affect the lenders' receipt of payments under the Credit Facility. However, PPC should review the specific definitions of "Indemnified Taxes," "Tax Event," and "Excluded Taxes" in the Credit Agreement to confirm this conclusion, and should separately assess whether the general indemnity provisions could create exposure in the event of a failure to comply with the notification covenant.
D. Financial Covenants — Impact Assessment
Typical Provisions. Senior unsecured revolving credit facilities for investment-grade borrowers such as PPC typically contain financial covenants requiring the borrower to maintain specified financial ratios on a consolidated basis, tested as of the end of each fiscal quarter. The most common financial covenants include:
(i) A maximum leverage ratio (typically defined as the ratio of consolidated funded indebtedness to consolidated EBITDA), often set at 3.5x or 4.0x for investment-grade pharmaceutical companies;
(ii) A minimum interest coverage ratio (typically defined as the ratio of consolidated EBITDA to consolidated interest expense), often set at 3.0x or 3.5x; and
(iii) In some cases, a minimum net worth or minimum tangible net worth covenant, requiring PPC to maintain consolidated net worth or tangible net worth above a specified floor.
Analysis of Potential Impact of the Proposed Adjustment. If the NOPA were fully sustained — resulting in a total additional tax and penalty liability of approximately $95.86 million before interest — the impact on PPC's financial condition should be assessed in the context of PPC's overall scale:
• PPC's fiscal year 2020 pre-tax income was approximately $1.47 billion. The total proposed tax and penalty liability of approximately $95.86 million represents approximately 6.5% of a single year's pre-tax income. While this amount is by no means insignificant, it is unlikely to cause PPC to breach typical leverage or interest coverage covenants for a company of PPC's size and profitability.
• PPC's ASC 740-10 uncertain tax position reserve of $62.4 million already accounts for a substantial portion of the potential exposure. If the NOPA were fully sustained, the incremental cash impact above existing reserves would be approximately $33.46 million ($95.86 million less $62.4 million), a comparatively modest amount relative to PPC's overall financial position.
• The proposed adjustment, if sustained, would represent a one-time payment (or installment payments, depending on payment arrangements) rather than an ongoing reduction in earnings capacity. The adjustment would not affect PPC's EBITDA on a going-forward basis (except to the extent that a settlement or assessment requires a restatement of historical financial results), and therefore should not materially affect the leverage ratio or interest coverage ratio calculations going forward.
• At the expected settlement range — which C&H currently targets at 10–15% of the proposed adjustment, or approximately $38 million to $57 million in adjusted income, corresponding to approximately $8.0 million to $12.0 million in additional tax liability — the financial impact would be modest by any measure and well within the parameters of PPC's existing reserves.
Conclusion. The proposed adjustment, even if fully sustained at the $380.4 million level, is unlikely to cause a breach of the standard financial covenants in the Credit Agreement, given PPC's substantial revenue base ($6.82 billion), strong pre-tax income ($1.47 billion), and existing reserves ($62.4 million). However, PPC should model the worst-case scenario against the specific covenant calculations in the Credit Agreement to confirm this conclusion, taking into account any applicable covenant levels, cure periods, and definitions of the financial metrics used in the covenant calculations. Rajesh Iyer's treasury team should prepare detailed compliance certificate calculations under the worst-case, expected-case, and best-case scenarios for presentation to PPC's General Counsel and outside counsel.
E. Event of Default — Material Adverse Change / Material Adverse Effect
Typical Provision. The Credit Agreement is expected to contain a provision under which an Event of Default is triggered by the occurrence of a "Material Adverse Change" or "Material Adverse Effect" (collectively, "MAC/MAE"). The MAC/MAE clause is typically defined to encompass any event, development, circumstance, condition, or occurrence that, individually or in the aggregate, has had or could reasonably be expected to have a material adverse effect on:
(i) the business, operations, assets, liabilities, financial condition, or results of operations of the borrower and its subsidiaries, taken as a whole;
(ii) the ability of the borrower to perform its obligations under the Credit Agreement and the other loan documents; or
(iii) the rights and remedies of the administrative agent and the lenders under the Credit Agreement and the other loan documents.
The MAC/MAE clause is one of the most heavily negotiated provisions in credit agreements, and its scope and application depend critically on the specific language employed. Some formulations include express carve-outs for events that are disclosed to the lenders, events that are the subject of ongoing litigation or proceedings, or events that are adequately reserved against in the borrower's financial statements.
Analysis. Several factors are relevant to the assessment of whether the NOPA, standing alone, constitutes a MAC/MAE Event of Default:
First, the NOPA is a proposed adjustment, not a final determination. PPC retains the right to contest the proposed adjustments through administrative protest (which PPC is actively pursuing, with a Formal Protest due December 22, 2023), IRS Appeals consideration, and potential judicial challenge in the United States Tax Court or a federal district court (upon payment of the asserted deficiency). The NOPA represents the IRS's opening position in what is expected to be a multi-year resolution process. Credit agreements typically recognize the distinction between pending or threatened claims and final, non-appealable assessments, and the mere receipt of a NOPA — without more — should not rise to the level of a MAC/MAE.
Second, C&H's preliminary hazards-of-litigation analysis indicates that the IRS's proposed adjustments are significantly overstated. In particular:
• On the royalty rate issue, PPC's reported rate of 4.5% falls within the interquartile range of 3.1% to 6.8% (median 4.4%) identified by Whitmore Valuation Group LLC based on an analysis of 14 comparable uncontrolled transaction agreements. The IRS's proposed rate of 11.0% is well above the upper quartile and is not supported by the comparable data.
• On the CSA cost-sharing ratio issue, PPC's methodology is consistent with the framework prescribed by Treasury Regulations § 1.482-7 and is supported by contemporaneous documentation.
• PBI maintains economic substance in Ireland, with a substantial workforce, physical presence, and operational activities at the Dublin and Cork locations. The IRS has not challenged PBI's economic substance as a separate basis for adjustment.
Third, PPC's existing ASC 740-10 reserve of $62.4 million demonstrates that PPC has recognized and reserved for a significant portion of the potential exposure. The existence of this reserve, established in accordance with GAAP and disclosed in PPC's audited financial statements, is an important factor in any MAC/MAE analysis because it shows that the transfer pricing risk was already reflected in PPC's financial condition as presented to the lenders.
Fourth, PPC has adequate liquidity to absorb the potential exposure, even at the full proposed level. A total tax and penalty liability of approximately $95.86 million (before interest), while significant in absolute terms, represents a manageable obligation for a company with $6.82 billion in annual revenue and $1.47 billion in pre-tax income. PPC's ability to service the Credit Facility would not be materially impaired by a payment of this magnitude.
Conclusion. The NOPA does not, by itself, constitute a MAC/MAE Event of Default under the Credit Agreement. The proposed adjustments are preliminary, actively contested, and subject to significant reduction at the administrative and judicial levels. PPC has adequate reserves and liquidity to manage the exposure, and C&H's preliminary analysis indicates that a reasonable settlement would be at a fraction of the proposed amount. However, this conclusion is contingent on PPC's active defense of the positions and on the ultimate resolution of the examination. If PPC were to fail to file a Formal Protest, if the adjustments were sustained at or near the full proposed amount on a final, non-appealable basis, or if PPC's financial condition were to deteriorate materially for other reasons during the pendency of the examination, the MAC/MAE analysis could change.
F. Negative Covenants — Restrictions on Tax Settlements
Typical Provision. Some credit agreements contain negative covenants that restrict the borrower from entering into material tax settlements, compromises, or closing agreements with taxing authorities without providing prior notice to the administrative agent or, in some cases, obtaining the consent of the required lenders. These provisions are designed to prevent the borrower from voluntarily accepting substantial tax liabilities that could impair its creditworthiness or its ability to service the credit facility.
Analysis. As PPC proceeds through the Formal Protest (filing deadline December 22, 2023), potential IRS Appeals consideration (anticipated to commence in early 2024), and any settlement discussions that may arise during the Appeals process, any proposed settlement terms will need to be evaluated against any such negative covenant in the Credit Agreement.
PPC's current settlement strategy, as developed in coordination with C&H and Whitmore, targets resolution at 10–15% of the proposed adjustment, corresponding to approximately $38 million to $57 million in adjusted income and approximately $8.0 million to $12.0 million in additional tax liability. A settlement in this range should be well within PPC's operating capacity and is unlikely to trigger any restrictions under standard negative covenants, which typically set the threshold for required lender notification or consent at a level substantially above PPC's anticipated settlement range.
However, if the settlement discussions were to result in a substantially higher resolution — for example, if the IRS Appeals office were to sustain the proposed adjustments at 50% or more of the proposed amount — the analysis could change, and PPC may need to provide additional notification to Hargrove or seek lender input before accepting the settlement.
Recommendation. PPC should review the Credit Agreement for any express restrictions on tax settlements exceeding a specified dollar threshold and, if applicable, should build lender notification into the settlement timeline. C&H should be consulted before PPC accepts any settlement offer from the IRS to ensure compliance with both the Credit Agreement's covenants and PPC's broader legal and fiduciary obligations.
IV. Interaction with SEC Disclosure Obligations
While a comprehensive analysis of PPC's disclosure obligations under the federal securities laws is beyond the scope of this memorandum and is addressed in a separate SEC Disclosure Analysis Memorandum being prepared concurrently, a brief cross-reference is warranted here because of the potential overlap between PPC's SEC disclosure obligations and its notification obligations under the Credit Agreement.
As a publicly traded company listed on the Nasdaq Stock Market, PPC is required to disclose material contingent liabilities and uncertain tax positions in its periodic reports filed with the Securities and Exchange Commission, including its annual reports on Form 10-K and quarterly reports on Form 10-Q. The NOPA, with its proposed adjustments of $380.4 million, may require disclosure in PPC's upcoming 10-K filing (for the fiscal year ending December 31, 2023) as a material subsequent event, and may also require enhanced disclosure in the ASC 740-10 footnote to PPC's audited financial statements.
This SEC disclosure dimension is relevant to the Credit Agreement analysis for two reasons. First, PPC's SEC filings are publicly available and are monitored by sophisticated institutional investors and creditors. Ridgeview Capital Management LP, which holds an 8.3% equity stake in PPC (managed by Douglas Everett, Managing Partner), is known to closely monitor PPC's ASC 740-10 disclosures and uncertain tax position reserves. Any public disclosure of the NOPA in PPC's SEC filings will be visible to Hargrove and the syndicate lenders, whether or not PPC provides direct notification under the Credit Agreement.
Second, and more critically, if Hargrove and the syndicate lenders were to learn of the NOPA through PPC's public SEC filings rather than through direct notification under the Credit Agreement, PPC could face allegations that it failed to comply with the Material Tax Event notification covenant and that it attempted to conceal material information from its lenders. Such allegations, even if ultimately determined to be unfounded, could damage PPC's relationship with its lending syndicate and could create unnecessary risk at a time when PPC needs to maintain the confidence and cooperation of its creditors.
For these reasons, proactive and prompt notification to Hargrove under the Credit Agreement is essential — both to satisfy PPC's contractual obligations and to preserve PPC's credibility and good-faith compliance posture vis-à-vis its lending syndicate.
V. Recommended Actions
Based on the analysis set forth above, I recommend the following actions:
A. Immediate Notification to Hargrove
PPC should provide written notice to Christine Bellucci, Senior Vice President and Relationship Manager, Hargrove National Bank, N.A., at 100 Federal Street, Boston, Massachusetts 02110, of the NOPA as a Material Tax Event under the Credit Agreement. The notice should be delivered in writing, in the form and manner specified by the Credit Agreement (which typically requires notice by certified mail, overnight courier, or hand delivery, with a copy by email), and should include the following information:
(a) The date of the NOPA (October 12, 2023) and the nature of the IRS's proposed adjustments, including a description of the transfer pricing issues at stake (CSA cost-sharing ratios and legacy IP royalty rate);
(b) The aggregate proposed net adjustment ($380,400,000) and the approximate potential additional federal income tax and penalty exposure (approximately $95,860,000 at the full proposed amount, before interest);
(c) A statement that PPC disputes the proposed adjustments in their entirety, both on the merits and as to the proposed penalty, and that PPC intends to file a Formal Protest with the IRS by December 22, 2023, to initiate consideration by the IRS Office of Appeals;
(d) A statement that PPC's outside counsel, Calderwood & Harkness LLP, and PPC's economic consultants, Whitmore Valuation Group LLC, are actively engaged in the defense of PPC's transfer pricing positions and are preparing the Formal Protest;
(e) A statement that PPC has maintained an ASC 740-10 uncertain tax position reserve of $62,400,000 related to the Irish intellectual property structure, established in accordance with GAAP, which partially addresses the potential exposure; and
(f) An offer to provide additional information or to discuss the matter with Hargrove's legal or credit teams at Hargrove's convenience, subject to applicable privileges and confidentiality considerations.
The draft notification letter should be reviewed by C&H — specifically by Leonard Cross and Leila Nazari — before delivery to ensure that the letter does not contain any statements that could constitute an inadvertent waiver of attorney-client privilege or work-product protection. In particular, the letter should describe the NOPA and PPC's response in factual terms without disclosing C&H's legal analysis, settlement strategy, or hazards-of-litigation assessment. The letter should also include an express reservation of PPC's rights and privileges.
B. Credit Agreement Review
PPC's in-house legal team, under the direction of General Counsel Deborah Staines, should provide C&H with a complete copy of the Credit Agreement, including all amendments, supplements, waiver letters, side letters, and ancillary documents, for detailed review of the specific defined terms, thresholds, and provisions relevant to this analysis. Key provisions that should be examined include:
• The definition of "Material Tax Event," including the applicable materiality threshold (whether a fixed dollar amount, a percentage of net income, or a MAC/MAE-based standard);
• The notification timing requirements (i.e., the number of business days within which PPC must provide notice after becoming aware of a Material Tax Event);
• The definition of "Material Adverse Effect" or "Material Adverse Change," including any applicable carve-outs, qualifiers, or safe harbors;
• The definition of "Indemnified Taxes" and "Excluded Taxes" in the Tax Indemnity and Tax Gross-Up provisions;
• The bring-down certificate language, including the scope of representations and warranties that are re-made on each borrowing date;
• The definitions of "Indebtedness" and "Contingent Obligations," to determine whether the NOPA creates a contingent obligation that must be separately reported or that affects the calculation of financial covenant ratios;
• Any negative covenants restricting the entry into material tax settlements, compromises, or closing agreements; and
• The cure periods and grace periods applicable to any covenant breach or Event of Default arising from the NOPA or related matters.
C&H will prepare a supplemental memorandum analyzing the specific Credit Agreement provisions upon receipt of the agreement.
C. Coordination with CFO
Rajesh Iyer, PPC's Chief Financial Officer, should be advised of the covenant analysis set forth in this memorandum and should coordinate with PPC's treasury team regarding the following matters:
• Any potential impact of the NOPA on the Credit Facility's availability, including whether the NOPA affects PPC's ability to draw on the revolving credit facility or triggers any condition precedent to borrowing;
• The compliance certificate calculations for the current and upcoming fiscal quarters, including a sensitivity analysis showing the impact of the proposed adjustment under the worst-case, expected-case, and best-case scenarios;
• Any upcoming borrowing-base or financial-covenant compliance dates, and whether the NOPA could affect PPC's ability to deliver a clean compliance certificate on those dates; and
• The potential need to update PPC's ASC 740-10 uncertain tax position reserve in light of the NOPA, in consultation with Crestfield & Associates LLP and PPC's Audit Committee.
D. Ongoing Monitoring
As the IRS examination and contest process progresses through the following stages — Formal Protest filing (December 22, 2023), assignment to IRS Appeals (anticipated early 2024), Appeals conferences and settlement discussions, and potential Tax Court litigation — PPC should take the following ongoing steps:
• Update Hargrove and the syndicate lenders as appropriate regarding material developments in the examination process, including the filing of the Formal Protest, the assignment of the case to Appeals, and any settlement offers or counterproposals;
• Evaluate the covenant implications of any settlement terms before acceptance, including consultation with C&H regarding compliance with any negative covenants restricting material tax settlements;
• Monitor PPC's financial covenant compliance on an ongoing basis, taking into account the potential financial impact of the examination under various resolution scenarios; and
• Coordinate SEC disclosure obligations with Credit Agreement notification obligations to ensure consistency and to avoid any appearance of selective or inconsistent disclosure.
VI. Conclusion
The IRS's NOPA, proposing net adjustments of $380,400,000 across tax years 2017 through 2020, triggers a notification obligation to Hargrove National Bank, N.A. under the Material Tax Event provision of the Credit Agreement. PPC should provide prompt written notice to Christine Bellucci, Hargrove's relationship manager, describing the NOPA and PPC's response, and should offer to provide additional information at Hargrove's request.
The NOPA does not, standing alone, constitute an Event of Default under the Credit Agreement. The proposed adjustments are preliminary, actively contested, and subject to significant reduction through the administrative protest and Appeals process. C&H's preliminary hazards-of-litigation analysis indicates that a reasonable settlement is likely to be achieved at 10–15% of the proposed adjustment, corresponding to approximately $8.0 million to $12.0 million in additional tax liability — an amount that is well within PPC's financial capacity and existing reserves.
The proposed adjustment, even if fully sustained at the $380.4 million level (resulting in approximately $95.86 million in tax and penalties before interest), is unlikely to cause a breach of the financial covenants in the Credit Agreement given PPC's substantial scale, with fiscal year 2020 revenue of $6.82 billion, pre-tax income of $1.47 billion, and an existing ASC 740-10 uncertain tax position reserve of $62.4 million.
PPC should provide prompt notice to Hargrove, should furnish C&H with a complete copy of the Credit Agreement for detailed review of the specific tax-related provisions, and should keep Hargrove informed as the examination proceeds toward resolution.
Calderwood & Harkness LLP stands ready to assist PPC with drafting the notification letter to Hargrove, reviewing the specific provisions of the Credit Agreement, and advising PPC on the covenant implications of any settlement or resolution of the IRS examination.
Please do not hesitate to contact me with any questions regarding this analysis.
Leila Nazari, Associate Calderwood & Harkness LLP Direct: (212) 555-0147 lnazari@calderwoodharkness.com
VII. Appendices (Referenced)
The following appendices are referenced in this memorandum and will be circulated under separate cover:
Appendix A: Summary of IRS Proposed Adjustments — $380.4M Breakdown by Issue and Tax Year
Appendix B: Proposed Worst-Case and Expected-Case Financial Impact Scenarios
Appendix C: Key Credit Agreement Provisions to Be Reviewed
Specific section references will be inserted upon receipt of the Credit Agreement from PPC's General Counsel. The following categories of provisions have been identified for detailed review:
• Material Tax Event definition and notification requirements
• Material Adverse Effect / Material Adverse Change definition
• Representations and warranties — tax compliance
• Bring-down certificate requirements
• Tax Indemnity / Tax Gross-Up provisions
• Definitions of "Indemnified Taxes" and "Excluded Taxes"
• Financial covenant definitions and calculations
• Definitions of "Indebtedness" and "Contingent Obligations"
• Negative covenants restricting material tax settlements
• Event of Default provisions (including cure periods)
• Notice provisions (form, manner, and designated recipients)
PRIVILEGED AND CONFIDENTIAL — ATTORNEY-CLIENT COMMUNICATION / ATTORNEY WORK PRODUCT. This memorandum has been prepared by Calderwood & Harkness LLP at the request of Penterra Pharmaceuticals Corp. and is protected by the attorney-client privilege and the work-product doctrine. This memorandum is intended solely for the use of the named recipients and should not be disclosed to any third party without the prior written consent of Calderwood & Harkness LLP.
Issue | TY 2017 | TY 2018 | TY 2019 | TY 2020 | Total
CSA Cost-Sharing Ratio Adjustments | $48,730,000 | $57,610,000 | $62,850,000 | $65,820,000 | $235,010,000
Legacy IP Royalty Rate Adjustments | $52,950,000 | $49,550,000 | $44,970,000 | $40,570,000 | $188,040,000
Correlative Offset | — | — | — | — | ($42,650,000)
Net Proposed Adjustment | $380,400,000
Scenario | Adjusted Income | Tax (21%) | § 6662(e) Penalty (20%) | Total (Pre-Interest)
Worst Case (100% sustained) | $380,400,000 | ~$79,880,000 | ~$15,980,000 | ~$95,860,000
Expected Settlement (10–15%) | $38,000,000–$57,000,000 | ~$8,000,000–$12,000,000 | Waived | ~$8,000,000–$12,000,000

MEMORANDUM

MATTER NO.: 1018-00009

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