MEMORANDUM
PRIVILEGED AND CONFIDENTIAL ATTORNEY WORK PRODUCT
TO: File — Matter No. HRW-SPIN-001 (Engagement No. 1003-00005)
FROM: Garrett Simmons, Senior Associate, Tax Department, Calderwood & Harkness LLP
REVIEWED BY: Leonard Cross, Partner, Tax Department, Calderwood & Harkness LLP
DATE: June 15, 2022
RE: Continuity of Interest and § 368(a)(1)(D) Reorganization Analysis — Proposed Spin-Off of Meridian Flow Technologies, Inc. from Veldran Industries Holdings, Inc.
CLIENT: Harrowgate Private Equity Fund IV, L.P.
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I. Executive Summary
The purpose of this memorandum is to analyze whether the proposed contribution by Veldran Industries Holdings, Inc. ("Veldran" or "Distributing") of all assets and liabilities associated with its Precision Flow Solutions Division to Meridian Flow Technologies, Inc. ("Meridian," "Controlled," or "SpinCo") — in exchange for one hundred percent (100%) of the outstanding common stock of Meridian and Meridian's assumption of certain allocated liabilities (the "Contribution") — qualifies as a reorganization under Section 368(a)(1)(D) of the Internal Revenue Code of 1986, as amended (the "Code" or "IRC"). This memorandum separately analyzes whether the continuity of interest ("COI") requirement, a judicial and regulatory prerequisite to reorganization treatment, is satisfied in the context of this divisive D reorganization when coupled with a pro rata distribution of Meridian stock to Veldran's shareholders under IRC § 355 (the "Distribution").
Based on the proposed transaction structure as currently described to us, we conclude that the Contribution should qualify as a reorganization under IRC § 368(a)(1)(D), and the COI requirement should be satisfied, provided that the transaction is structured as currently contemplated — that is, a pro rata 1:1 distribution of Meridian common stock to all Veldran shareholders, with no cash boot, no notes or other non-equity consideration, and no change in the proportionate ownership interests of Veldran shareholders. The qualification of the Contribution as a D reorganization is, however, contingent upon the Distribution qualifying under IRC § 355. As discussed in greater detail in Section VII below, several significant § 355 issues remain open as of the date of this memorandum.
This memorandum should be read in conjunction with the following companion memoranda, which together constitute the comprehensive tax analysis of the proposed spin-off transaction:
• Comprehensive § 355 Analysis Memorandum (first draft dated May 20, 2022);
• § 355(b) Active Trade or Business Analysis Memorandum (dated June 1, 2022);
• § 355(e) Plan Analysis Memorandum (first draft anticipated late June 2022);
• Device Test Analysis Memorandum (to be drafted);
• Business Purpose Memorandum (to be drafted); and
• § 355(d) Disqualified Distribution Analysis Memorandum (in progress).
Each of the foregoing memoranda addresses discrete requirements of the § 355 qualification that, in turn, directly bear on the viability of the D reorganization analysis set forth herein.
II. Background and Transaction Overview
A. The Parties
1. Veldran Industries Holdings, Inc. (Distributing)
Veldran Industries Holdings, Inc. ("Veldran") is a corporation organized under the laws of the State of Delaware, having been incorporated on March 14, 2019 (Employer Identification Number 86-1920347). Veldran maintains its principal executive office at 2400 Commerce Park Drive, Suite 500, Charlotte, North Carolina 28217, and its registered agent and registered address in the State of Delaware is located at 1209 Orange Street, Wilmington, Delaware 19801.
Veldran is a diversified industrial products and engineered materials company operating through two principal business segments. For the fiscal year ended December 31, 2021 ("FY2021"), Veldran reported consolidated revenue of approximately $2.34 billion and consolidated EBITDA of approximately $418 million. As of the most recent headcount data available, Veldran employs approximately 8,200 persons across its domestic and international operations.
The two principal business segments are as follows:
(i) Engineered Coatings Division. This segment is engaged in the development, manufacture, and sale of advanced coatings and surface treatment technologies for aerospace, automotive, and general industrial applications. For FY2021, the Engineered Coatings Division reported revenue of approximately $1.52 billion and EBITDA of approximately $285 million.
(ii) Precision Flow Solutions Division. This segment is engaged in the design, manufacture, and sale of precision fluid-control systems for industrial, petrochemical, and water-infrastructure end markets. For FY2021, the Precision Flow Solutions Division reported revenue of approximately $820 million and EBITDA of approximately $133 million. The Precision Flow Solutions Division constitutes the business to be contributed to Meridian in the Contribution.
Veldran's current management team includes Jonathan Caldecott (Chief Executive Officer), Rita Subramanian (Chief Financial Officer), and Philip Crundell (General Counsel and Corporate Secretary).
2. Meridian Flow Technologies, Inc. (Controlled / SpinCo)
Meridian Flow Technologies, Inc. ("Meridian") is a planned Delaware corporation that has not yet been incorporated as of the date of this memorandum. Upon incorporation, Meridian's registered agent and registered address will be located at 1209 Orange Street, Wilmington, Delaware 19801, and its principal executive office will be located at 7100 Northlake Parkway, Suite 300, Tucker, Georgia 30084.
Meridian is being formed for the purpose of housing and operating the Precision Flow Solutions Division following the Contribution. As noted above, the Precision Flow Solutions Division is engaged in the design, manufacture, and sale of precision fluid-control systems for industrial, petrochemical, and water-infrastructure end markets. On a pro forma basis for FY2021, Meridian would have reported revenue of approximately $820 million and EBITDA of approximately $133 million.
The planned senior management team for Meridian includes Sandra Waverly, who currently serves as President of the Precision Flow Solutions Division and will serve as Meridian's Chief Executive Officer, and Derek Okonkwo, who currently serves as Vice President of Finance for the Precision Flow Solutions Division and will serve as Meridian's Chief Financial Officer.
3. Harrowgate Private Equity Fund IV, L.P. (Controlling Shareholder)
Harrowgate Private Equity Fund IV, L.P. ("HPE Fund IV") is a limited partnership organized under the laws of the State of Delaware (Employer Identification Number 84-3291067). HPE Fund IV is a private equity fund with a fund size of approximately $6.8 billion (vintage 2018). The general partner of HPE Fund IV is Harrowgate Capital Partners IV GP LLC (EIN 84-3291104), and the investment advisor to HPE Fund IV is Harrowgate Capital Advisors LLC (EIN 83-2756891). HPE Fund IV maintains its principal office at 600 Lexington Avenue, 38th Floor, New York, New York 10022.
HPE Fund IV holds approximately 62.4% of the outstanding common stock of Veldran — representing 46,488,000 shares — through its wholly owned subsidiary Harrowgate Veldran Holdings LLC, a Delaware limited liability company (EIN 86-1483920). HPE Fund IV acquired its controlling stake in Veldran on September 20, 2019, pursuant to a negotiated tender offer and merger squeeze-out of the prior controlling shareholder, Greystone Partners Fund III LP (EIN 81-2683910), at a price of $40.00 per share, representing a total acquisition cost of approximately $1,859,520,000. The key principals of HPE Fund IV include Marcus Adler (Founding Partner & Chairman), Diana Fenn (Managing Partner & Chief Investment Officer, and current Chair of the Board of Directors of Veldran), Tobias Rourke (Partner, Head of Portfolio Operations), and Christine Yeung (General Counsel).
4. Other Significant Shareholders
In addition to HPE Fund IV, the following significant shareholders of Veldran have been identified:
(a) Prescott Capital Management LP (EIN 13-4928371) holds approximately 14.8% of the outstanding common stock of Veldran, representing 11,026,000 shares. Prescott Capital Management LP is an institutional investment manager with its principal office at 277 Park Avenue, 42nd Floor, New York, New York 10172. Its Managing Partner is Andrew Kessler.
(b) Veldran Management Stockholders collectively hold approximately 5.3% of the outstanding common stock of Veldran, representing 3,948,500 shares. These shares are held by Veldran officers, directors, and other employees pursuant to Veldran's equity incentive plans.
(c) Public and Institutional Float. The remaining approximately 17.5% of Veldran's outstanding common stock — representing 13,037,500 shares — is held by public and institutional shareholders.
As of the date of this memorandum, Veldran has 74,500,000 shares of common stock outstanding.
B. Proposed Transaction Structure
The proposed spin-off transaction will be implemented in two steps, as described below.
Step 1 — The Contribution
Veldran will transfer to Meridian all assets and liabilities associated with the Precision Flow Solutions Division (the "Contributed Business"). The Contributed Business encompasses the entirety of the Precision Flow Solutions Division's operations, including, among other things, all operating assets (property, plant and equipment, inventory, intellectual property, contracts, and accounts receivable), the stock or assets of Kestrel Precision Controls, Inc. (as described below), and associated liabilities.
The Contributed Business includes the operations of Kestrel Precision Controls, Inc. ("Kestrel"), a Georgia corporation (EIN 58-2847193) founded on February 12, 2003. Kestrel was acquired by Veldran on June 7, 2019, from Rennick Industrial Partners Fund II LP in a taxable transaction for $295 million in cash. Kestrel designs and manufactures precision control valves and actuation systems and has been operated as a business unit within the Precision Flow Solutions Division since its acquisition.
In consideration for the Contribution, Meridian will issue to Veldran all of its outstanding common stock, and Meridian will assume certain allocated liabilities of the Precision Flow Solutions Division (the "Assumed Liabilities"). The scope of the Assumed Liabilities has not been finalized as of the date of this memorandum and is subject to the debt allocation analysis discussed in Section II.C below and the § 357(c) analysis discussed in Section V.E below.
Step 2 — The Distribution
Immediately following the Contribution, Veldran will distribute pro rata to its shareholders of record as of the record date 100% of the outstanding common stock of Meridian (the "Distribution"). The distribution ratio will be 1:1, meaning that each holder of one share of Veldran common stock on the record date will receive one share of Meridian common stock. Based on the 74,500,000 shares of Veldran common stock currently outstanding, Meridian will issue 74,500,000 shares of common stock in connection with the Contribution, all of which will be distributed to Veldran shareholders in the Distribution.
Post-Spin Ownership. Following the consummation of the Distribution, each pre-spin Veldran shareholder will hold one share of Veldran common stock and one share of Meridian common stock for each share of Veldran common stock held immediately prior to the Distribution. There will be no change in the proportionate economic interests of any Veldran shareholder. Specifically, HPE Fund IV (through Harrowgate Veldran Holdings LLC) will hold 62.4% of each of Veldran and Meridian; Prescott Capital Management LP will hold 14.8% of each; Veldran management stockholders will hold 5.3% of each; and the public and institutional float will comprise 17.5% of each.
Additional Transaction Parameters
The targeted timing for the Distribution is the fourth quarter of 2022, subject to the satisfaction of all legal, regulatory, and transactional conditions. The record date and distribution date have not yet been fixed.
No IRS private letter ruling will be sought in connection with the proposed transaction. Instead, Calderwood & Harkness LLP will deliver a tax opinion at the "should" level (i.e., a "should" opinion) as the sole form of tax assurance for the transaction. The decision not to seek a ruling reflects the current IRS policy of generally not issuing rulings on § 355 transactions and the engagement team's assessment that a ruling request would introduce unacceptable delays.
Critically, the Contribution involves solely the issuance of Meridian common stock to Veldran — no cash, notes, warrants, or other boot consideration is contemplated. Similarly, the Distribution consists solely of Meridian common stock — no cash in lieu of fractional shares is currently contemplated, although this point remains subject to confirmation. The absence of any non-equity consideration is an important structural feature of the transaction that bears directly on both the § 368(a)(1)(D) and COI analyses below.
C. Capital Structure Context
Veldran's current capital structure is as follows:
Common Stock. Veldran has authorized 100,000,000 shares of common stock, of which 74,500,000 shares are currently issued and outstanding. Veldran has no preferred stock outstanding.
First Lien Term Loan B. Veldran is the borrower under a First Lien Term Loan B facility in the original principal amount of $1.1 billion. The lending syndicate is led by Ashfield National Bank, N.A. (administrative agent), located at 100 Federal Street, Boston, Massachusetts 02110 (key contact: Margaret Tsao, Managing Director, Leveraged Finance).
6.250% Senior Unsecured Notes due 2027. Veldran has outstanding $450 million aggregate principal amount of 6.250% Senior Unsecured Notes due 2027, issued pursuant to an indenture dated as of a date to be confirmed, with Colton Trust Company acting as indenture trustee, located at 10 South LaSalle Street, Chicago, Illinois 60603.
The allocation of Veldran's existing debt between Veldran (post-spin) and Meridian is a key open item in the structuring of the transaction. The debt allocation will be documented in the Separation Agreement and related financing documents and will have significant implications for both the § 357(c) analysis (discussed in Section V.E below) and the credit agreement and indenture covenant compliance analyses being prepared separately by the corporate finance team. Preliminary discussions with Veldran's management and financial advisors suggest that a portion of the existing debt will be allocated to or refinanced by Meridian, but the specific allocation has not been determined.
D. Valuation Context
Brackenridge & Co., an independent financial advisory firm engaged by Veldran (with offices at 383 Madison Avenue, New York, New York 10179; lead contact: Samuel Ng, Managing Director), has prepared a preliminary valuation analysis of Meridian (SpinCo) on a standalone basis. The preliminary valuation range for Meridian is $1,396.5 million to $1,702.4 million, derived by applying an enterprise value-to-EBITDA multiple range of 10.5× to 12.8× to Meridian's pro forma FY2021 EBITDA of $133 million.
Veldran's estimated adjusted tax basis in the assets of the Precision Flow Solutions Division is approximately $800 million. Based on the preliminary valuation range, the estimated built-in gain in the Meridian stock is approximately $596.5 million to $902.4 million ($1,396.5M − $800M = $596.5M at the low end; $1,702.4M − $800M = $902.4M at the high end).
These valuation figures are principally relevant to the § 355(e) analysis (which addresses the corporate-level tax consequences if the Distribution is part of a "plan" involving a 50% change of control of Distributing or Controlled), but they also provide important context for the magnitude of the built-in gain that would be protected from recognition by reorganization treatment under §§ 368(a)(1)(D), 361, and 355. At a 21% corporate tax rate, the corporate-level tax at risk ranges from approximately $125.3 million to approximately $189.5 million — a substantial exposure that underscores the importance of qualifying the transaction as a D reorganization coupled with a tax-free § 355 distribution.
III. Statutory Framework — § 368(a)(1)(D) Reorganization
A. Text of § 368(a)(1)(D)
Section 368(a)(1)(D) of the Code defines as a "reorganization" the following transaction:
A transfer by a corporation of all or a part of its assets to another corporation if immediately after the transfer the transferor, or one or more of its shareholders (including persons who were shareholders immediately before the transfer), or any combination thereof, is in control of the corporation to which the assets are transferred; but only if, in pursuance of the plan, stock or securities of the corporation to which the assets are transferred are distributed in a transaction which qualifies under section 354, 355, or 356.
As the statutory text makes clear, a D reorganization requires the satisfaction of two essential elements:
(1) The Control Requirement. Immediately after the transfer, the transferor corporation, or one or more of its shareholders (including persons who were shareholders immediately before the transfer), or any combination thereof, must be "in control" of the transferee corporation. The term "control" is defined by cross-reference to IRC § 368(c), as discussed in Section III.C below.
(2) The Distribution Requirement. The stock or securities of the transferee corporation must be distributed, in pursuance of the plan of reorganization, in a transaction that qualifies under IRC § 354 (relating to exchanges of stock and securities in certain reorganizations), IRC § 355 (relating to distributions of stock and securities of a controlled corporation), or IRC § 356 (relating to the receipt of additional consideration, i.e., "boot," in connection with certain reorganizations).
Both elements must be satisfied for the transaction to qualify as a reorganization under § 368(a)(1)(D). In addition, as discussed in Section V below, the judicially developed doctrine of continuity of interest must be satisfied.
B. Divisive D Reorganization Distinguished from Acquisitive D Reorganization
Section 368(a)(1)(D) encompasses two fundamentally different types of reorganizations, commonly referred to as "acquisitive" D reorganizations and "divisive" D reorganizations. The distinction between the two is critical to the proper analytical framework.
In an acquisitive D reorganization, the transferor corporation transfers substantially all of its assets to another corporation controlled by the transferor or its shareholders, and the transferor subsequently liquidates, with its shareholders receiving stock or securities of the transferee corporation in exchange for their stock in the transferor. The distribution in an acquisitive D reorganization qualifies under § 354 (or § 356 if boot is received). The acquisitive D reorganization is functionally similar to a C reorganization under § 368(a)(1)(C), and the two provisions operate in tandem to prevent the circumvention of the "substantially all" requirement applicable to C reorganizations.
In a divisive D reorganization — which is the type of transaction at issue in this memorandum — the transferor corporation transfers a part of its assets to a controlled corporation and distributes the stock of the controlled corporation to its shareholders under § 355. The transferor corporation survives the transaction and continues to operate the assets that were not transferred. The distribution in a divisive D reorganization qualifies under § 355 (or § 356 if boot is received).
The proposed Veldran/Meridian transaction is a divisive D reorganization. Veldran will transfer only the assets and liabilities of the Precision Flow Solutions Division — representing approximately 35% of consolidated revenue and approximately 31.8% of consolidated EBITDA — to Meridian. Veldran will retain the Engineered Coatings Division and will continue to operate as a going concern after the Distribution. The Distribution of 100% of Meridian common stock to Veldran shareholders is intended to qualify under § 355. Veldran will not liquidate.
The divisive D reorganization structure has significant implications for the control analysis (as discussed in Section IV.B below), the COI analysis (as discussed in Section V below), and the interplay between § 368(a)(1)(D) and § 355 (as discussed in Section VI below).
C. Control Requirement — § 368(c)
Section 368(a)(1)(D) requires that, "immediately after the transfer," the transferor or its shareholders (or any combination thereof) be "in control" of the transferee corporation. The term "control" is defined by cross-reference to IRC § 368(c), which provides:
The term "control" means the ownership of stock possessing at least 80 percent of the total combined voting power of all classes of stock entitled to vote and at least 80 percent of the total number of shares of all other classes of stock of the corporation.
This is the standard 80% control threshold that applies throughout Subchapter C in range contexts, including § 351 transfers, § 332 liquidations, and the definition of affiliated groups under § 1504(a) (though with a different percentage threshold).
It should be noted that in certain contexts involving divisive D reorganizations, commentators and the IRS have considered whether the relaxed control standard of § 304(c) — which defines control as ownership of at least 50% of the total combined voting power or at least 50% of the total value of all classes of stock — might apply in lieu of the 80% threshold of § 368(c). This question arises because § 368(a)(1)(D) refers broadly to "control" without specifying a particular definition in all contexts, and the legislative history suggests that Congress intended the D reorganization provision to have broad reach in the divisive context. However, the 80% threshold of § 368(c) remains the standard requirement for D reorganizations, and, as discussed in Section IV.B below, the control requirement is unambiguously satisfied in the proposed transaction because Veldran will own 100% of Meridian immediately after the Contribution.
D. Distribution Requirement — Nexus with § 355
The second prong of § 368(a)(1)(D) requires that, "in pursuance of the plan," stock or securities of the transferee corporation be "distributed in a transaction which qualifies under section 354, 355, or 356." In the context of a divisive D reorganization, the relevant qualifying provision is § 355, which governs the distribution of stock and securities of a controlled corporation.
Here, the Distribution — Veldran's pro rata distribution of 100% of the outstanding Meridian common stock to Veldran shareholders — is intended to qualify under § 355. The comprehensive analysis of the § 355 requirements is set forth in the separate Comprehensive § 355 Analysis Memorandum (first draft dated May 20, 2022) and related issue-specific memoranda, including the § 355(b) Active Trade or Business Analysis Memorandum (dated June 1, 2022), and the forthcoming memoranda addressing the device test, business purpose, § 355(e) plan analysis, and § 355(d) disqualified distribution analysis.
For purposes of the § 368(a)(1)(D) analysis set forth in this memorandum, we assume that the Distribution qualifies under § 355. If the Distribution does not qualify under § 355, the Contribution would not satisfy the distribution requirement of § 368(a)(1)(D), and the Contribution would fail to qualify as a D reorganization. The consequences of such failure are described in Section VI.C below.
The nexus between the D reorganization and the § 355 distribution underscores the integrated nature of the analysis. A failure under § 355 would cascade into a failure under § 368(a)(1)(D), with the result that both the corporate-level and shareholder-level tax consequences of the transaction would be fully taxable.
IV. Application of § 368(a)(1)(D) to the Proposed Transaction
A. The Contribution Satisfies the Transfer Requirement
The first requirement of § 368(a)(1)(D) is that there be "a transfer by a corporation of all or a part of its assets to another corporation." The statute is satisfied by the transfer of "all" or "a part" of the transferor's assets — there is no minimum threshold, although in the divisive context the transfer must be of sufficient assets to constitute an active trade or business for purposes of § 355(b).
In the proposed transaction, Veldran will transfer to Meridian all of the assets and liabilities associated with the Precision Flow Solutions Division, constituting a transfer of "a part of" Veldran's assets within the meaning of § 368(a)(1)(D). The Contributed Business encompasses a substantial and operationally distinct portion of Veldran's overall enterprise, including:
(i) all operating assets of the Precision Flow Solutions Division, including real property, leasehold interests, manufacturing facilities, machinery and equipment, raw materials and finished goods inventory, intellectual property (patents, trademarks, trade names, trade secrets, and know-how), customer contracts, supplier agreements, accounts receivable, and other current assets;
(ii) the stock or assets of Kestrel Precision Controls, Inc., a wholly owned subsidiary of Veldran engaged in the design and manufacture of precision control valves and actuation systems, which has operated as a business unit within the Precision Flow Solutions Division since its acquisition by Veldran on June 7, 2019; and
(iii) certain associated liabilities of the Precision Flow Solutions Division to be assumed by Meridian (the scope and amount of which are to be finalized).
The Contributed Business represents a material portion of Veldran's consolidated operations, accounting for approximately 35% of consolidated revenue ($820 million of $2.34 billion) and approximately 31.8% of consolidated EBITDA ($133 million of $418 million) for FY2021. The magnitude and operational significance of the Contributed Business confirm that the transfer of "a part of" Veldran's assets is not a de minimis or pro forma transfer, but rather a genuine divisive transaction involving a substantial and independently viable business.
Accordingly, the transfer requirement of § 368(a)(1)(D) is satisfied.
B. The Control Requirement Is Satisfied
1. Testing Immediately After the Contribution
The control requirement of § 368(a)(1)(D) is satisfied if, "immediately after the transfer," the transferor (Veldran) or one or more of its shareholders (or any combination thereof) is "in control" of the transferee (Meridian), where "control" is defined by § 368(c) as ownership of stock possessing at least 80% of the total combined voting power of all classes of stock entitled to vote and at least 80% of the total number of shares of all other classes of stock.
Immediately after the Contribution (and before the Distribution), Veldran will own 100% of the outstanding common stock of Meridian — 74,500,000 shares, representing 100% of the total combined voting power and 100% of the total number of shares of the sole class of stock. Meridian will have no other classes of stock outstanding. Accordingly, Veldran's ownership of 100% of Meridian's stock clearly and unambiguously exceeds the 80% threshold of § 368(c), and the control requirement is satisfied by a substantial margin.
2. Effect of the Distribution on the Control Analysis
After the Distribution, Veldran will own zero shares of Meridian stock, having distributed all 74,500,000 shares to its shareholders on a pro rata basis. This raises the question of whether the control requirement should be tested before or after the Distribution.
In the context of a divisive D reorganization effected through a § 355 distribution, the well-established principle — reflected in the Treasury Regulations and IRS administrative guidance — is that the control requirement is tested immediately after the Contribution (i.e., the asset transfer) and before the Distribution. The Contribution and the Distribution are treated as separate steps for purposes of the control analysis, notwithstanding the step-transaction doctrine, which might otherwise collapse the two steps into a single integrated transaction.
This principle is supported by the following authorities:
(a) Treasury Regulation § 1.368-2(l). This regulation addresses the application of the control requirement in divisive D reorganizations and confirms that, in a transaction in which the transferor distributes the stock of the transferee in a § 355 distribution, the control requirement of § 368(a)(1)(D) is tested immediately after the transfer and before the distribution.
(b) Rev. Rul. 2003-79 and analogous guidance. The IRS has consistently treated the control requirement in divisive D reorganizations as satisfied where the transferor owns 100% of the transferee immediately after the asset transfer, even though the transferor divests all of its stock in the transferee through the subsequent § 355 distribution.
(c) Legislative and structural considerations. If the control requirement were tested after the Distribution, no divisive D reorganization could ever satisfy § 368(c), because the very definition of a § 355 distribution requires the distributing corporation to distribute stock of the controlled corporation to its shareholders, thereby divesting itself of control. The control requirement in § 368(a)(1)(D) would be rendered a nullity in the divisive context. Congress plainly did not intend such a result when it provided that D reorganizations encompass transfers of "a part of" the transferor's assets followed by § 355 distributions.
3. Conclusion on Control
The control requirement of § 368(a)(1)(D), as defined by § 368(c), is satisfied because Veldran will own 100% of the outstanding common stock of Meridian immediately after the Contribution and before the Distribution.
C. The Distribution Requirement Is Satisfied (Subject to § 355 Qualification)
The second prong of § 368(a)(1)(D) requires that, in pursuance of the plan of reorganization, stock or securities of the transferee corporation (Meridian) be distributed in a transaction qualifying under § 354, § 355, or § 356.
In the proposed transaction, Veldran will distribute 100% of the outstanding Meridian common stock to Veldran's shareholders on a pro rata basis immediately following the Contribution. This Distribution is intended to qualify under IRC § 355. If the Distribution qualifies under § 355 — as analyzed in the separate § 355 memoranda referenced above — the distribution requirement of § 368(a)(1)(D) is satisfied.
It is worth noting that the Distribution must also satisfy § 355(a)(1)(D), which requires that the distributing corporation distribute stock of the controlled corporation constituting "control" within the meaning of § 368(c). Because Veldran will distribute 100% of the outstanding Meridian common stock — far exceeding the 80% threshold — this requirement is clearly satisfied.
As of the date of this memorandum, several key § 355 issues remain open and are being analyzed in separate memoranda. These issues are summarized in Section VII.A below. The resolution of these issues will determine whether the Distribution qualifies under § 355 and, by extension, whether the Contribution qualifies as a D reorganization. The critical open issues include:
(i) the articulation and sufficiency of the business purpose for the Distribution;
(ii) the device test analysis, particularly in light of the pro rata nature of the Distribution and HPE Fund IV's controlling 62.4% stake;
(iii) the § 355(b) active trade or business requirement, including the analysis of the Kestrel Precision Controls acquisition within the five-year look-back period;
(iv) the § 355(e) plan analysis, given HPE Fund IV's September 2019 acquisition of its controlling stake; and
(v) the § 355(d) disqualified distribution analysis.
Subject to the satisfactory resolution of these § 355 issues, the distribution requirement of § 368(a)(1)(D) is satisfied.
D. Plan of Reorganization
A D reorganization requires that the transfer and distribution occur "in pursuance of the plan" of reorganization. This requirement ensures that the Contribution and the Distribution are part of a single, integrated transaction undertaken pursuant to a deliberate plan, rather than unrelated events.
Veldran's board of directors will adopt a formal plan of reorganization that encompasses both the Contribution and the Distribution. The plan of reorganization will be documented principally in the Separation Agreement, which is being drafted by Whitfield & Gage LLP (lead corporate/capital markets partner: Priya Chandrasekar) in collaboration with Thornapple McCord LLP (lead corporate/securities partner for Veldran: David Ochoa). The tax provisions of the Separation Agreement, including the representations and covenants relating to the § 368(a)(1)(D) and § 355 qualification, are being prepared by Calderwood & Harkness LLP.
The plan of reorganization will specify, among other things, (i) the assets and liabilities to be contributed to Meridian, (ii) the consideration to be received by Veldran (i.e., Meridian common stock), (iii) the pro rata distribution of Meridian stock to Veldran shareholders, (iv) the distribution ratio (1:1), (v) the record date and distribution date, and (vi) the covenants and conditions to the consummation of the transaction.
No issues are anticipated with respect to the plan-of-reorganization requirement. The Contribution and the Distribution are clearly part of a single, integrated transactional plan, and the plan will be formally adopted and documented in accordance with applicable corporate law and tax requirements.
V. Continuity of Interest Analysis
A. The COI Requirement in General
The continuity of interest ("COI") doctrine is a judicially developed requirement for tax-free reorganization treatment that has been codified in the Treasury Regulations. The COI doctrine provides that a transaction will not qualify as a reorganization unless the historic shareholders of the target (or, in a divisive reorganization, the transferor corporation) receive a sufficient equity stake in the surviving or acquiring corporation to preserve a continuing proprietary interest in the reorganized enterprise.
The COI doctrine is set forth in Treasury Regulation § 1.368-1(b), which provides, in relevant part:
Requisite to a reorganization under the Code are a continuity of the business enterprise under the modified corporate form . . . and a continuity of interest therein on the part of those persons who, directly or indirectly, were the owners of the enterprise prior to the reorganization.
Treasury Regulation § 1.368-1(e) elaborates on the COI requirement in the context of acquisitive reorganizations, providing that the COI requirement is satisfied if a "substantial part" of the value of the proprietary interests in the target is preserved in the reorganization. For purposes of the quantitative COI standard, the IRS has historically required that at least 40% of the total consideration received by the target's shareholders consist of equity in the acquiring corporation, although the regulations do not specify a fixed percentage.
The underlying policy of the COI doctrine is to ensure that a reorganization represents a genuine continuation of the business enterprise in modified corporate form — not a disguised sale. Where the historic equity owners of the transferor corporation receive primarily cash or other non-equity consideration, the transaction is economically indistinguishable from a sale and should not receive tax-free treatment. Conversely, where the historic equity owners retain a substantial equity stake in the reorganized enterprise, the transaction preserves a continuity of investment that justifies the deferral of gain recognition.
The Supreme Court's decisions in Pinellas Ice & Cold Storage Co. v. Commissioner, 287 U.S. 462 (1933), Helvering v. Minnesota Tea Co., 296 U.S. 378 (1935), and their progeny establish the foundational principle that a reorganization requires a continuing interest in the reorganized enterprise through stock ownership, not merely a financial return. These principles have been refined and codified in the current regulatory framework.
B. Application of COI to Divisive D Reorganizations
The application of the COI requirement to divisive D reorganizations involving § 355 distributions differs in important respects from its application to acquisitive reorganizations. In an acquisitive reorganization, the focus is on the nature of the consideration received by the target's shareholders — specifically, whether a sufficient proportion of the consideration consists of equity in the acquiring corporation. In a divisive D reorganization, the analysis focuses on whether the historic shareholders of the distributing corporation retain a continuing equity interest in both the distributing corporation and the controlled corporation after the distribution.
In the proposed transaction, the COI analysis is straightforward for the following reasons:
(i) The Contribution Step. In the Contribution, Veldran (the transferor) will receive 100% Meridian common stock — and no cash, notes, warrants, or other non-equity consideration — in exchange for the Contributed Business assets. The consideration is 100% equity, which unambiguously satisfies any quantitative COI threshold. Unlike an acquisitive reorganization in which the consideration mix may include cash or notes that could jeopardize COI, the Contribution involves purely stock consideration.
(ii) The Distribution Step. In the Distribution, Veldran will distribute 100% of the Meridian common stock pro rata to its shareholders. After the Distribution, the same persons who were Veldran shareholders before the spin-off will hold stock in both Veldran and Meridian. There is no change in the identity of the ultimate equity owners, and there is no change in the proportionate interests of those owners. Each shareholder's proportionate interest in the reorganized enterprise (now consisting of two separate corporations rather than one) is preserved identically.
(iii) No Cashing Out. No shareholder will receive cash, notes, or other non-equity consideration in the Distribution. No shareholder's interest will be "cashed out" or otherwise converted into a non-equity interest.
The COI requirement is inherently satisfied in a pro rata spin-off transaction because the very structure of a pro rata distribution preserves the continuity of the shareholders' proprietary interests. The shareholders' aggregate economic interest in the transferred business (the Precision Flow Solutions Division) continues in the form of their Meridian stock, and their aggregate economic interest in the retained business (the Engineered Coatings Division) continues in the form of their Veldran stock. The reorganization is, in substance, a mere change in the corporate form through which the shareholders hold their investments — precisely the type of transaction that the COI doctrine is designed to accommodate.
C. Detailed Shareholder-Level COI Analysis
To confirm the COI analysis, we set forth below the pre-spin and post-spin ownership of each identified category of Veldran shareholders.
Pre-Spin Ownership of Veldran
As of the date of this memorandum, there are 74,500,000 shares of Veldran common stock outstanding, held as follows:
Post-Spin Ownership (After 1:1 Pro Rata Distribution)
Under the proposed 1:1 distribution ratio, each Veldran shareholder will receive one share of Meridian common stock for each share of Veldran common stock held on the record date. After the Distribution, each Veldran shareholder will hold both Veldran and Meridian common stock as follows:
As the foregoing table demonstrates, every pre-spin Veldran shareholder retains a continuing equity interest in the reorganized enterprise — both in Veldran (which retains the Engineered Coatings Division) and in Meridian (which receives the Precision Flow Solutions Division). There is zero "cashing out" of any shareholder's interest. The proportionate ownership of each shareholder is preserved identically in both Veldran and Meridian.
This shareholder-level analysis confirms that the COI requirement is fully and unambiguously satisfied.
D. No Cash Boot or Other Non-Equity Consideration
The proposed transaction involves no cash or other non-equity consideration at either the Contribution level or the Distribution level. Specifically:
(i) In the Contribution, Meridian will issue to Veldran 74,500,000 shares of Meridian common stock — and no cash, promissory notes, warrants, or other boot — in exchange for the Contributed Business assets.
(ii) In the Distribution, Veldran will distribute to its shareholders 74,500,000 shares of Meridian common stock — and no cash, promissory notes, or other property — on a pro rata 1:1 basis.
(iii) No cash in lieu of fractional shares is currently contemplated. The 1:1 distribution ratio, applied to the 74,500,000 whole shares of Veldran common stock outstanding, produces an equal number of whole shares of Meridian common stock. Each outstanding share of Veldran generates exactly one whole share of Meridian, eliminating the potential for fractional share entitlements.
The complete absence of cash boot or other non-equity consideration eliminates any issue under IRC § 356 (which governs the recognition of gain upon the receipt of boot in connection with a reorganization) and reinforces the COI conclusion. In transactions where boot is present, the COI analysis requires a determination of whether the equity component of the consideration is "substantial" — typically at least 40% of the total consideration. Here, 100% of the consideration is equity, and no COI issue arises.
Additionally, the absence of boot simplifies the shareholder-level tax analysis. Under § 355(a)(1), no gain or loss is recognized by Veldran shareholders on the receipt of Meridian stock, provided all § 355 requirements are satisfied. There is no § 356 gain-recognition analysis to perform at the shareholder level.
E. Interaction with Assumption of Liabilities
1. General Rule — § 357(a)
In the Contribution, Meridian will assume certain liabilities of the Precision Flow Solutions Division (the "Assumed Liabilities"). Under IRC § 357(a), the assumption of liabilities by the transferee corporation in a reorganization is generally not treated as "money" or "other property" received by the transferor — that is, the assumption of liabilities is not treated as boot. Accordingly, the assumption of liabilities by Meridian in the Contribution should not give rise to gain recognition by Veldran under the general rule.
2. Exception — § 357(c) Excess Liabilities
Section 357(c) provides an important exception to the general rule. Under § 357(c)(1), if the total amount of the liabilities assumed by the transferee exceeds the total adjusted basis of the properties transferred by the transferor, the excess is treated as gain from the sale or exchange of a capital asset (or, if the transferred property is not a capital asset, as ordinary income). This gain is recognized by the transferor (Veldran) in the year of the transfer.
Application of § 357(c) to the proposed transaction requires a comparison of:
(a) The total adjusted basis of the Contributed Business assets, estimated at approximately $800 million; and
(b) The total amount of liabilities to be assumed by Meridian in the Contribution.
As of the date of this memorandum, the amount of liabilities to be assumed by Meridian has not been finalized. The allocation of Veldran's existing debt — including the $1.1 billion First Lien Term Loan B and the $450 million aggregate principal amount of 6.250% Senior Unsecured Notes due 2027 — between the two post-spin entities is a key open item that will be determined in the course of the structuring discussions and documented in the Separation Agreement and related financing documents.
Our preliminary expectation, based on discussions with the transaction team, is that the liabilities assumed by Meridian will not exceed the adjusted basis of the Contributed Business assets. However, this expectation requires confirmation once the debt allocation is finalized. If the Assumed Liabilities were to exceed the approximately $800 million adjusted basis of the Contributed Business assets, § 357(c) would trigger gain recognition by Veldran on the excess, notwithstanding the reorganization treatment.
We recommend that the debt allocation be structured to ensure that the Assumed Liabilities do not exceed the adjusted basis of the Contributed Business assets. This recommendation is discussed further in Section VIII.B below.
3. Tax-Avoidance Purpose — § 357(b)
Section 357(b) provides another exception to the general rule of § 357(a). Under § 357(b), if the principal purpose of the assumption of liabilities is the avoidance of Federal income tax, or if there is not a bona fide business purpose for the assumption, the entire amount of the assumed liabilities is treated as boot received by the transferor. Section 357(b) shifts the burden of proof to the transferor (Veldran) to establish that the assumption of liabilities was motivated by a bona fide business purpose.
In the proposed transaction, no tax-avoidance purpose for the assumption of liabilities is apparent. The Assumed Liabilities are expected to consist of trade payables, accrued expenses, contractual obligations, and allocated portions of Veldran's funded indebtedness that are directly associated with the Precision Flow Solutions Division. The assumption of these liabilities by Meridian is a natural and commercially necessary consequence of the separation of the Precision Flow Solutions Division from Veldran's other operations. The assumption serves legitimate business purposes, including (i) ensuring that Meridian has an appropriate capital structure to operate as an independent public company, (ii) allocating economic obligations between the two post-spin entities in a manner that reflects the underlying business operations, and (iii) enabling Meridian to access the capital markets on a standalone basis.
Accordingly, we do not anticipate that § 357(b) will be implicated. However, the Representation Letter (discussed in Section VII.C below) should include appropriate representations confirming the absence of any tax-avoidance purpose for the assumption of liabilities.
4. Cross-Reference to Related Analyses
The credit agreement governing the First Lien Term Loan B and the indenture governing the 6.250% Senior Unsecured Notes due 2027 contain restrictive covenants that may bear on the permissibility and mechanics of the debt allocation. Separate analyses of the credit agreement and indenture covenant implications are being prepared by the corporate finance team. We recommend coordination between the tax and corporate finance workstreams to ensure that the debt allocation satisfies both the § 357(c) constraints and the contractual requirements of the existing debt instruments.
VI. Interplay Between § 368(a)(1)(D) and § 355
A. Integrated Analysis Required
A divisive D reorganization and a § 355 distribution are inextricably linked, forming a single integrated transaction structure that must satisfy the requirements of both provisions simultaneously. The qualification under one provision is contingent upon the qualification under the other:
(i) The Distribution must qualify under § 355 for the Contribution to qualify as a D reorganization under § 368(a)(1)(D). This is because § 368(a)(1)(D) requires that the stock of the transferee be distributed "in a transaction which qualifies under section 354, 355, or 356." If the Distribution fails to qualify under § 355 (and does not qualify under § 354 or § 356 on a standalone basis, which it would not in the divisive context), the distribution requirement of § 368(a)(1)(D) is not satisfied, and the Contribution does not qualify as a D reorganization.
(ii) Conversely, the Contribution must qualify as a D reorganization for the Distribution to receive full tax-free treatment for both Distributing (Veldran) and its shareholders. While § 355 standing alone provides nonrecognition treatment at the shareholder level, the corporate-level nonrecognition for the transferor (Veldran) depends on § 361(a) and (c), which apply only in the context of a reorganization.
The integrated nature of the analysis requires that all of the elements discussed in this memorandum (§ 368(a)(1)(D) requirements, COI) and in the companion memoranda (§ 355 requirements) be satisfied for the transaction to achieve its intended tax-free treatment at both the corporate and shareholder levels.
The key statutory provisions governing the integrated transaction structure are as follows:
• § 355(a)(1): A distribution of stock of a controlled corporation to shareholders of the distributing corporation is not treated as a taxable distribution under § 301 if the requirements of § 355 are satisfied. "Control" for this purpose means the ownership described in § 368(c). Here, Veldran will own 100% of Meridian immediately before the Distribution, satisfying this requirement.
• § 361(a): No gain or loss is recognized by a corporation (here, Veldran) if it transfers property, in pursuance of a plan of reorganization, in exchange solely for stock or securities of another corporation that is a party to the reorganization. The Contribution — Veldran's transfer of the Contributed Business assets to Meridian in exchange solely for Meridian common stock — satisfies this provision if the Contribution qualifies as a D reorganization.
• § 361(c): No gain or loss is recognized by the distributing corporation (Veldran) on the distribution of "qualified property" (defined in § 361(c)(2)(B) as stock in a corporation that is a party to the reorganization) to its shareholders in pursuance of the plan of reorganization. The Distribution of Meridian stock to Veldran's shareholders satisfies this provision.
• § 362(b): The transferee corporation (Meridian) takes a carryover basis in the transferred property — that is, a basis equal to the transferor's (Veldran's) adjusted basis, increased by any gain recognized by the transferor on the transfer (expected to be zero).
B. Tax Consequences If the Transaction Qualifies
If the proposed transaction qualifies as a divisive D reorganization under § 368(a)(1)(D) and the Distribution qualifies under § 355, the tax consequences to each party are as follows:
1. To Veldran (Distributing)
(a) No gain or loss on the Contribution. Under § 361(a), Veldran will recognize no gain or loss on the transfer of the Contributed Business assets to Meridian in exchange for Meridian common stock.
(b) No gain or loss on the Distribution. Under § 361(c), Veldran will recognize no gain or loss on the distribution of Meridian common stock to its shareholders. The Meridian common stock constitutes "qualified property" under § 361(c)(2)(B) because Meridian is a party to the reorganization.
(c) Potential § 355(e) exception. Notwithstanding §§ 361(a) and (c), if the Distribution is part of a "plan" (or series of related transactions) pursuant to which one or more persons acquire, directly or indirectly, stock representing a 50-percent or greater interest in Distributing (Veldran) or Controlled (Meridian), § 355(e) would require Veldran to recognize gain on the distribution of Meridian stock as if such stock had been sold at fair market value on the distribution date. The estimated corporate-level tax at risk under § 355(e) is approximately $125.3 million to $189.5 million, calculated as 21% (the applicable corporate tax rate) multiplied by the estimated built-in gain of $596.5 million to $902.4 million. The § 355(e) plan analysis is being conducted in a separate memorandum (first draft anticipated late June 2022).
(d) Potential § 355(d) exception. If the Distribution constitutes a "disqualified distribution" under § 355(d) — generally, a distribution in which a shareholder holds "disqualified stock" (stock acquired by purchase within five years before the distribution) representing a 50% or greater interest in either Distributing or Controlled — Veldran would recognize gain on the distribution of Meridian stock. This issue is being analyzed in a separate § 355(d) memorandum.
2. To Meridian (Controlled / SpinCo)
(a) Carryover basis. Under § 362(b), Meridian will take a carryover basis in the Contributed Business assets equal to Veldran's adjusted basis in those assets, increased by any gain recognized by Veldran on the transfer. If Veldran recognizes no gain on the Contribution (as expected), Meridian's basis in the Contributed Business assets will equal Veldran's adjusted basis of approximately $800 million.
(b) No gain on stock issuance. Meridian will recognize no gain or loss on the issuance of its common stock in exchange for the Contributed Business assets, consistent with § 1032 (no gain or loss recognized by a corporation on the receipt of money or other property in exchange for its own stock).
3. To Veldran Shareholders
(a) No gain or loss on receipt of Meridian stock. Under § 355(a)(1), Veldran shareholders will recognize no gain or loss on the receipt of Meridian common stock in the Distribution, provided all § 355 requirements are satisfied.
(b) Basis allocation. Under § 358, each shareholder's aggregate adjusted basis in its pre-spin Veldran common stock will be allocated between the Veldran common stock retained and the Meridian common stock received, based on the relative fair market values of the Veldran stock and Meridian stock on the distribution date. For example, if on the distribution date the aggregate fair market value of a shareholder's Veldran stock is $X and the aggregate fair market value of the corresponding Meridian stock is $Y, the shareholder's pre-spin basis would be allocated $X/($X+$Y) to the Veldran stock and $Y/($X+$Y) to the Meridian stock.
(c) Holding period. Under § 1223(1), each Veldran shareholder's holding period for the Meridian common stock received in the Distribution will include the holding period for the Veldran common stock with respect to which the Meridian stock was distributed. This "tacking" of the holding period ensures that a shareholder who held its Veldran stock as a long-term capital asset will also hold its Meridian stock as a long-term capital asset immediately after the Distribution.
C. Tax Consequences If the Transaction Does NOT Qualify