CALDERWOOD & HARKNESS LLP Attorneys at Law
1301 Avenue of the Americas, 40th Floor New York, New York 10019
Telephone: (212) 554-7000 Facsimile: (212) 554-7001 www.calderwoodharkness.com
August 5, 2022
DRAFT — FOR DISCUSSION PURPOSES ONLY — NOT FOR RELIANCE
Engagement Number: 1003-00005 Matter Code: HRW-SPIN-001
The Board of Directors Veldran Industries Holdings, Inc. 2400 Commerce Park Drive, Suite 500 Charlotte, North Carolina 28217
Harrowgate Private Equity Fund IV, L.P. c/o Harrowgate Capital Advisors LLC 600 Lexington Avenue, 38th Floor New York, New York 10022
Attention: Christine Yeung, Esq., General Counsel, Harrowgate Capital Advisors LLC Philip Crundell, Esq., General Counsel, Veldran Industries Holdings, Inc.
Re: Draft Tax Opinion — Proposed Spin-Off of Meridian Flow Technologies, Inc. by Veldran Industries Holdings, Inc.
Dear Members of the Board of Directors and Partners:
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I. Introduction and Engagement
Calderwood & Harkness LLP ("Calderwood & Harkness," "we," "our," or "us") has been engaged by Harrowgate Private Equity Fund IV, L.P. ("Harrowgate" or "HPE Fund IV"), a Delaware limited partnership, and Veldran Industries Holdings, Inc. ("Veldran" or the "Company"), a Delaware corporation, to render this opinion (the "Opinion") regarding certain United States federal income tax consequences of the proposed spin-off transaction described herein (the "Spin-Off" or the "Transaction"). Specifically, we have been asked to opine on whether the proposed contribution of the Precision Flow Solutions Division to Meridian Flow Technologies, Inc. ("Meridian" or "SpinCo"), a Delaware corporation to be formed, followed by a pro rata distribution of all outstanding Meridian common stock to Veldran shareholders, qualifies for tax-free treatment under Sections 355 and 368(a)(1)(D) of the Internal Revenue Code of 1986, as amended (the "Code").
The engagement was opened on April 11, 2022, pursuant to an engagement letter of the same date executed by Leonard Cross, Partner, on behalf of Calderwood & Harkness, and Christine Yeung, General Counsel, on behalf of Harrowgate Capital Advisors LLC, as investment advisor to HPE Fund IV, and Philip Crundell, General Counsel, on behalf of Veldran Industries Holdings, Inc. The scope of our engagement, as set forth in the engagement letter, is limited to the rendering of an opinion concerning the United States federal income tax consequences of the Spin-Off as described herein. Our engagement does not encompass any state, local, or foreign tax analysis, the provision of any business, financial, or accounting advice, or the rendering of any opinion with respect to the securities law implications of the Transaction.
This draft Opinion is being circulated for discussion purposes only and should not be relied upon by any party. This draft has been prepared to facilitate discussion and to identify open issues that must be resolved prior to the delivery of a final Opinion. The Opinion remains subject to (i) finalization and execution of the Representation Letter (as defined below), (ii) resolution of certain open issues identified in Section IX hereof, (iii) review and finalization of definitive transaction documents, and (iv) internal review and approval by the responsible and billing partners of Calderwood & Harkness. No party should take any action in reliance on this draft Opinion.
This Opinion is rendered at a "should" level of confidence. A "should" opinion represents the second-highest level of tax assurance that may be rendered by a law firm, below a "will" or "more likely than not" opinion but above a "may" or "substantial authority" opinion. A "should" opinion means that, based on the analysis herein and subject to the assumptions, qualifications, and limitations set forth below, we believe that the Transaction "should" qualify for the tax treatment described herein, although we are unable to opine that such treatment is "more likely than not" at this time. Our inability to deliver a higher level of assurance is attributable to certain unresolved issues described in Section IX of this Opinion, principally the adequacy of the business purpose articulation and the completeness of the factual record regarding the Section 355(e) plan analysis.
Unless otherwise defined herein, capitalized terms have the meanings set forth in this Opinion.
II. Summary of the Proposed Transaction
A. Overview of the Parties
Veldran Industries Holdings, Inc. ("Distributing"): Veldran is a Delaware corporation incorporated on March 14, 2019, Employer Identification Number 86-1920347, with its principal executive offices located at 2400 Commerce Park Drive, Suite 500, Charlotte, North Carolina 28217. Veldran is a diversified industrial products and engineered materials company that operates through two principal business segments: the Engineered Coatings Division and the Precision Flow Solutions Division. For its 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 date hereof, Veldran employs approximately 8,200 full-time employees across its operations in the United States, Canada, Mexico, and Western Europe. Veldran's Chief Executive Officer is Jonathan Caldecott, its Chief Financial Officer is Rita Subramanian, and its General Counsel is Philip Crundell.
Meridian Flow Technologies, Inc. ("Controlled" or "SpinCo"): Meridian is a Delaware corporation to be formed prior to the consummation of the Transaction. Meridian's planned principal executive office will be located at 7100 Northlake Parkway, Suite 300, Tucker, Georgia 30084. Upon consummation of the Transaction, Meridian will operate the Precision Flow Solutions Division, which is engaged in the design, manufacture, and sale of precision fluid-control systems, components, and related engineered solutions for industrial, petrochemical, and water-infrastructure end markets. On a pro forma basis for FY2021, the Precision Flow Solutions Division reported revenue of approximately $820 million and EBITDA of approximately $133 million. Sandra Waverly has been designated as the planned Chief Executive Officer of Meridian, and Derek Okonkwo has been designated as the planned Chief Financial Officer.
B. Ownership Structure of Veldran (Pre-Spin)
The authorized capital stock of Veldran consists of 100,000,000 shares of common stock, par value $0.01 per share. As of the date hereof, there are 74,500,000 shares of Veldran common stock issued and outstanding. The ownership of Veldran common stock immediately prior to the Transaction is as follows:
¹ Harrowgate Veldran Holdings LLC ("HVH") is a Delaware limited liability company (EIN 86-1483920) and is a wholly owned subsidiary of Harrowgate Private Equity Fund IV, L.P. ("HPE Fund IV"), a Delaware limited partnership (EIN 84-3291067). HPE Fund IV is managed by Harrowgate Capital Advisors LLC, a Delaware limited liability company (EIN 83-2756891), which serves as the fund's investment advisor, and Harrowgate Capital Partners IV GP LLC, a Delaware limited liability company (EIN 84-3291104), which serves as the fund's general partner. HPE Fund IV is a 2018-vintage private equity fund with total committed capital of $6.8 billion. HPE Fund IV acquired its 62.4% controlling interest in Veldran on September 20, 2019.
² Prescott Capital Management LP is a Delaware limited partnership. Prescott originally co-invested alongside HPE Fund IV in September 2019, purchasing 15,500,000 shares of Veldran common stock at $40.00 per share (aggregate purchase price of $620 million). Prescott subsequently sold 4,474,000 shares in a registered secondary offering, reducing its holdings to 11,026,000 shares (14.8%).
³ Management stockholders hold shares under equity incentive plans maintained by Veldran. These holdings are distributed among approximately 24 members of senior management.
C. Veldran Business Segments
Veldran operates through two principal business segments:
Engineered Coatings Division (to remain with Veldran post-spin). The Engineered Coatings Division is engaged in the development, manufacture, and sale of high-performance industrial coatings, surface treatment solutions, and engineered materials for the aerospace, automotive, energy, and general industrial end markets. For FY2021, the Engineered Coatings Division reported revenue of approximately $1.52 billion and EBITDA of approximately $285 million, reflecting an EBITDA margin of approximately 18.75%. The Engineered Coatings Division operates 14 manufacturing facilities in the United States and three international facilities.
Precision Flow Solutions Division (to be contributed to Meridian). The Precision Flow Solutions Division is engaged in the design, manufacture, and sale of precision fluid-control systems, valves, actuators, sensors, and related components and assemblies 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, reflecting an EBITDA margin of approximately 16.22%. The Precision Flow Solutions Division operates nine manufacturing facilities in the United States and two international facilities.
The Precision Flow Solutions Division includes the business of Kestrel Precision Controls, Inc. ("Kestrel"), a Georgia corporation (EIN 58-2847193) founded on February 12, 2003, which Veldran acquired on June 7, 2019 from Rennick Industrial Partners Fund II LP, a Delaware limited partnership (EIN 82-3017564), for aggregate cash consideration of $295 million in an all-cash, taxable stock acquisition (the "Kestrel Acquisition"). The Kestrel Acquisition was structured as a purchase of 100% of the outstanding capital stock of Kestrel and was fully taxable to the selling shareholders. Kestrel is a leading manufacturer of precision flow-control valves and electronic actuators for the petrochemical and water-treatment industries and comprised approximately 35% of the Precision Flow Solutions Division's FY2021 revenue (approximately $287 million). The Kestrel Acquisition is significant for purposes of the active trade or business analysis under Section 355(b) and is discussed in detail in Section V.B.2 below.
D. Capital Structure
Veldran's existing indebtedness includes the following material instruments:
First Lien Term Loan B. Veldran is the borrower under a First Lien Term Loan B in the aggregate principal amount of $1.1 billion, entered into on or about September 20, 2019, in connection with the acquisition of Veldran by HPE Fund IV. The Term Loan B is administered by Ashfield National Bank, N.A. (administrative agent), located at 100 Federal Street, Boston, Massachusetts 02110, and is syndicated among a group of institutional lenders. The Term Loan B is secured by substantially all of the assets of Veldran and its domestic subsidiaries and contains customary covenants, including a prohibition on asset dispositions and changes of control, that may be implicated by the Spin-Off.
6.250% Senior Unsecured Notes due 2027. Veldran has $450 million in aggregate principal amount of 6.250% Senior Unsecured Notes due 2027, issued under an indenture dated September 20, 2019, with Colton Trust Company as trustee, located at 10 South LaSalle Street, Chicago, Illinois 60603. The indenture contains customary covenants and events of default, including certain restrictions on mergers, consolidations, and asset sales.
The consummation of the Spin-Off may require the consent of the lenders under the Term Loan B and/or the noteholders (or trustee) under the Senior Unsecured Notes indenture, or may require the refinancing or modification of one or both instruments. We have been advised that negotiations with the lending syndicate and the indenture trustee are ongoing. Our analysis assumes that any required consents will be obtained on terms that do not alter the tax analysis set forth herein.
E. The Contribution
In the first step of the Transaction, Veldran will contribute to Meridian all of the assets and liabilities associated with the Precision Flow Solutions Division (the "Contributed Business"), including, without limitation, (i) all of the equity interests in Kestrel Precision Controls, Inc., (ii) all tangible and intangible operating assets of the Precision Flow Solutions Division, including real property, equipment, inventory, intellectual property, contracts, and customer relationships, and (iii) the assumption by Meridian of certain allocated liabilities associated with the Contributed Business (collectively, the "Contribution"). In exchange for the Contribution, Veldran will receive all of the outstanding shares of Meridian common stock. The specific assets and liabilities to be contributed and assumed will be identified in the Separation Agreement, which has not yet been finalized.
Based on information provided by Veldran and its independent auditors, Pemberton Rathbone LLP, Veldran's estimated aggregate adjusted tax basis in the assets constituting the Contributed Business is approximately $800 million.
F. The Distribution
Immediately following the Contribution, Veldran will distribute pro rata to its shareholders of record all of the outstanding shares of Meridian common stock (the "Distribution" and, together with the Contribution, the "Spin-Off"). The Distribution will be made on the basis of one share of Meridian common stock for each share of Veldran common stock held by a Veldran shareholder as of the record date established by the Veldran Board of Directors (the "Record Date"). Based on the 74,500,000 shares of Veldran common stock currently outstanding, 74,500,000 shares of Meridian common stock will be distributed in the Distribution.
Following the consummation of the Distribution, each existing 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 by such shareholder on the Record Date. Veldran will retain no shares of Meridian common stock following the Distribution.
The originally targeted Record Date and Distribution date is the fourth quarter of calendar year 2022. The precise dates have not been established as of the date hereof.
G. Estimated Valuation and Built-In Gain
A preliminary valuation analysis prepared by Brackenridge & Co., financial advisor to Veldran, received on June 10, 2022, estimates the aggregate fair market value of Meridian (on an enterprise value basis) in the range of approximately $1.4 billion to $1.7 billion. This range is derived from an EV/EBITDA multiple analysis, applying multiples of 10.5× to 12.8× to the Precision Flow Solutions Division's FY2021 EBITDA of approximately $133 million:
The estimated built-in gain on the Meridian stock to be distributed is calculated as follows:
If Section 355(e) were to apply to the Distribution, or if Section 355(d) were to require gain recognition, the estimated federal corporate income tax liability at the statutory rate of 21% would be:
The foregoing valuation ranges are preliminary and based on the Brackenridge & Co. analysis. A final valuation will be required to quantify the precise amount of gain and the resulting tax liability, if any.
III. Scope, Basis of Opinion, and Documents Reviewed
A. Scope
This Opinion addresses solely the United States federal income tax consequences of the Spin-Off under Sections 355 and 368(a)(1)(D) of the Code and certain related Code provisions. Specifically, this Opinion addresses whether (i) the Contribution and the Distribution, taken together, qualify as a reorganization under Section 368(a)(1)(D) of the Code, (ii) the Distribution qualifies as a distribution to which Section 355(a) of the Code applies, and (iii) the principal federal income tax consequences to Veldran, Meridian, and Veldran shareholders arising from the Spin-Off. This Opinion also addresses the potential application of Sections 355(d), 355(e), and 355(g) of the Code.
This Opinion does not address any state, local, or foreign tax consequences of the Spin-Off. A separate State and Local Tax Considerations Summary Memorandum, addressing certain state and local tax implications of the Transaction, was prepared by Calderwood & Harkness and circulated on July 20, 2022. We refer the addressees to that memorandum for discussion of state and local tax matters.
This Opinion does not address the individual federal income tax consequences to any particular shareholder of Veldran, including HPE Fund IV, Prescott Capital Management LP, or management stockholders. Each such shareholder should consult its own tax advisors regarding the tax consequences of the Spin-Off to such shareholder.
This Opinion does not constitute a guarantee, representation, or prediction of how the Internal Revenue Service (the "IRS") or any court would rule on the matters addressed herein. The tax treatment of the Transaction depends upon the application of complex provisions of the Code, Treasury Regulations, and case law to particular facts, and no assurance can be given that the IRS would agree with the analysis or conclusions set forth in this Opinion or that a court would sustain such conclusions if challenged.
No private letter ruling has been sought or will be sought from the IRS in connection with the Spin-Off. This Opinion is intended to serve as the sole source of tax assurance for the Transaction, and the addressees have informed us that they do not intend to obtain a private letter ruling.
B. Documents and Materials Reviewed
In rendering this Opinion, we have reviewed and relied upon the following documents and materials:
1. Draft Representation Letter from Veldran Industries Holdings, Inc. and Harrowgate Private Equity Fund IV, L.P. (second draft dated July 11, 2022) (the "Representation Letter"). Note: The Representation Letter has not been finalized or executed as of the date hereof. Finalization and execution are prerequisites to the delivery of a final Opinion.
2. Certificate of Incorporation of Veldran Industries Holdings, Inc., as currently in effect, including all amendments thereto.
3. Amended and Restated Bylaws of Veldran Industries Holdings, Inc., as currently in effect.
4. Limited Liability Company Agreement of Harrowgate Veldran Holdings LLC, dated as of September 20, 2019, as currently in effect.
5. Amended and Restated Limited Partnership Agreement of Harrowgate Private Equity Fund IV, L.P., dated as of June 15, 2018, as currently in effect.
6. Stock Purchase Agreement, dated as of June 7, 2019, by and among Rennick Industrial Partners Fund II LP, as seller, and Veldran Industries Holdings, Inc., as buyer, relating to the acquisition of 100% of the outstanding capital stock of Kestrel Precision Controls, Inc. (the "Kestrel SPA").
7. Historical federal income tax returns of Veldran Industries Holdings, Inc. (EIN 86-1920347) for tax years 2019, 2020, and 2021, and historical federal income tax returns of Kestrel Precision Controls, Inc. (EIN 58-2847193) for tax years 2017, 2018, 2019, 2020, and 2021, in each case as prepared by Pemberton Rathbone LLP, Veldran's independent auditors and tax-return preparers.
8. First Lien Term Loan B Credit Agreement, dated as of September 20, 2019, by and among Veldran Industries Holdings, Inc., as borrower, the lenders party thereto, and Ashfield National Bank, N.A., as administrative agent, including all amendments, waivers, and supplements thereto.
9. Indenture, dated as of September 20, 2019, by and between Veldran Industries Holdings, Inc. and Colton Trust Company, as trustee, governing the 6.250% Senior Unsecured Notes due 2027, including all supplements thereto.
10. Preliminary valuation analysis prepared by Brackenridge & Co. (dated June 10, 2022), estimating the fair market value of the Precision Flow Solutions Division and the contemplated Meridian entity.
11. Veldran Industries Holdings, Inc. 2019 Equity Incentive Plan, as amended and restated, together with forms of award agreements.
12. Additional documents and information obtained through Calderwood & Harkness's due diligence process, as reflected in our diligence tracker and information request lists dated April 25, 2022 and May 16, 2022, including responses thereto received from Veldran, Harrowgate Capital Advisors LLC, and their respective advisors.
13. Applicable provisions of the Internal Revenue Code of 1986, as amended (the "Code"), Treasury Regulations promulgated thereunder, published IRS revenue rulings and revenue procedures, and relevant judicial authority, all as in effect on the date hereof. References herein to Sections of the "Code" or "IRC" are to sections of the Internal Revenue Code of 1986, as amended, and references to "Treasury Regulations" or "Treas. Reg." are to the Treasury Regulations promulgated under the Code.
C. Reliance on Representations
This Opinion is based on and subject to the factual representations set forth in the draft Representation Letter, and we have assumed the accuracy, completeness, and truthfulness of all such representations. We have not undertaken any independent investigation or verification of the factual matters represented in the Representation Letter, and our Opinion is expressly conditioned on the accuracy of such representations. To the extent any representation contained in the Representation Letter is inaccurate, incomplete, or changes in any material respect, our analysis and conclusions may be affected, and this Opinion should not be relied upon.
We emphasize that the Representation Letter remains in second draft form, dated July 11, 2022, and has not been executed by the parties. Finalization and execution of the Representation Letter by authorized officers of Veldran and a principal of Harrowgate are absolute prerequisites to the delivery of a final Opinion. The draft Representation Letter is attached hereto as Exhibit A in the form of the second draft; however, certain representations therein remain subject to modification and supplementation in light of the open issues identified in Section IX of this Opinion.
IV. Assumptions
In rendering this Opinion, we have made the following assumptions, each of which is material to our analysis and conclusions:
1. Transaction Execution. We assume that the Transaction will be consummated in all material respects in the manner described in Section II of this Opinion and in accordance with the terms of the definitive transaction documents, which have not yet been finalized. We assume that no material deviations from the transaction structure as described herein will occur.
2. Representation Letter. We assume that the Representation Letter will be executed in substantially the form of the second draft dated July 11, 2022, and that all representations contained therein will be true, correct, and complete in all material respects both at the time of execution and at the time of the Distribution.
3. Contributed Business. We assume that the Contributed Business will constitute all of the assets and liabilities of the Precision Flow Solutions Division, as such assets and liabilities will be defined and delineated in the Separation Agreement, and that no material assets or liabilities of the Precision Flow Solutions Division will be retained by Veldran following the Contribution.
4. Formation of Meridian. We assume that Meridian will be duly incorporated under the laws of the State of Delaware prior to the Distribution, and that at the time of the Contribution and Distribution, Meridian will have no assets, liabilities, or operations other than those acquired in the Contribution (and any de minimis organizational matters incident to its formation).
5. Pro Rata Distribution. We assume that the Distribution will be effected on a pro rata basis to all holders of Veldran common stock on the Record Date, in the ratio of one share of Meridian common stock for each share of Veldran common stock held, and that no shareholder will receive any consideration in the Distribution other than Meridian common stock.
6. No Change in Law. We assume that no changes in applicable law, Treasury Regulations, IRS published rulings, or judicial authority will occur between the date hereof and the date of the Distribution that would materially affect the analysis set forth herein.
7. Financial Data. We assume the accuracy and completeness of all financial data provided to us, including the FY2021 segment financial data for the Engineered Coatings Division and the Precision Flow Solutions Division, the estimated adjusted tax basis of the Contributed Business assets, and the preliminary valuation prepared by Brackenridge & Co.
8. Debt Consents. We assume that any required consents, waivers, or amendments under the First Lien Term Loan B Credit Agreement and the 6.250% Senior Unsecured Notes indenture will be obtained on terms that do not alter the structure, terms, or tax analysis of the Transaction as described herein.
9. No Other Transactions. We assume that, other than the Contribution and the Distribution as described herein (and any internal reorganization steps that may be necessary to effectuate the transfer of the Contributed Business to Meridian), no other transaction, event, or series of transactions or events will occur that would, alone or in combination with the Spin-Off, cause the Distribution to fail to qualify for tax-free treatment under Sections 355 and 368(a)(1)(D) of the Code.
V. Discussion and Analysis
A. Qualification as a Reorganization Under IRC § 368(a)(1)(D)
Section 368(a)(1)(D) of the Code provides that a transfer by a corporation of part or all of its assets to another corporation qualifies as a "reorganization" if, immediately after the transfer, the transferor corporation (or one or more of its shareholders, including shareholders who were shareholders immediately before the transfer) is in "control" of the transferee corporation within the meaning of Section 368(c) of the Code, and the stock or securities of the transferee corporation are distributed in a transaction that qualifies under Section 354, 355, or 356 of the Code. Section 368(c) defines "control" 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 of the corporation.
The proposed Transaction involves a transfer by Veldran of the Contributed Business — constituting all of the assets and liabilities of the Precision Flow Solutions Division — to Meridian in exchange for all of the outstanding shares of Meridian common stock and Meridian's assumption of certain allocated liabilities. Immediately following the Contribution, and prior to the Distribution, Veldran will own 100% of the outstanding shares of Meridian common stock, which exceeds the 80% threshold required under Section 368(c). The control requirement of Section 368(a)(1)(D) is therefore satisfied.
The Distribution of Meridian common stock to Veldran shareholders will be made pursuant to the plan of reorganization in connection with the Section 368(a)(1)(D) reorganization, and we analyze in Section V.B below whether the Distribution qualifies under Section 355 of the Code.
Continuity of Interest. The continuity of interest requirement, as articulated in Treasury Regulations Section 1.368-1(b), is inherently satisfied in a divisive D reorganization. In the proposed Transaction, the same shareholders — namely, all holders of Veldran common stock on the Record Date — will hold equity interests in both Distributing (Veldran) and Controlled (Meridian) following the consummation of the pro rata Distribution. The pro rata 1:1 distribution structure ensures that continuity of proprietary interest is preserved, as each Veldran shareholder's proportionate interest in the combined enterprise is maintained (albeit held through two separate corporate entities rather than one).
Continuity of Business Enterprise. The continuity of business enterprise requirement under Treasury Regulations Section 1.368-1(d) requires that the issuing corporation (Meridian) either continue a significant historic business of the acquired entity or use a significant portion of its historic business assets in a business. Following the Spin-Off, Meridian is expected to continue the active conduct of the Precision Flow Solutions business in substantially the same manner as it has been conducted by Veldran. Veldran, for its part, is expected to continue the active conduct of the Engineered Coatings business. These expectations, if realized, will satisfy the continuity of business enterprise requirement.
Conclusion: Based on the foregoing analysis and subject to the assumptions set forth in Section IV, the Contribution, when combined with the Distribution, should qualify as a reorganization within the meaning of Section 368(a)(1)(D) of the Code, and Veldran and Meridian each should be "a party to a reorganization" within the meaning of Section 368(b).
B. Qualification of the Distribution Under IRC § 355(a)
Section 355(a) of the Code provides that, if certain requirements are met, a distribution by a corporation (the "distributing corporation") to its shareholders of stock of a corporation that the distributing corporation controls (the "controlled corporation") is not treated as a distribution of property to which Section 301 applies, and no gain or loss is recognized by the shareholders on the receipt of such stock. The requirements for qualification under Section 355(a) are discussed below.
1. Control Requirement — § 355(a)(1)(A) and § 368(c)
Section 355(a)(1)(A) of the Code requires that the distributing corporation distribute stock of a controlled corporation. "Control" is defined by reference to Section 368(c), which, as noted above, requires 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.
In the proposed Transaction, Veldran will distribute 100% of the outstanding common stock of Meridian to Veldran shareholders. Because Meridian will have only one class of stock outstanding (common stock), and because Veldran will distribute all of such stock, the control requirement of Section 355(a)(1)(A) is clearly satisfied.
2. Active Trade or Business Requirement — § 355(b)
Section 355(b)(1) of the Code provides that a distribution qualifies under Section 355(a) only if both the distributing corporation (and any applicable "separate affiliated group" member) and the controlled corporation are engaged, immediately after the distribution, in the "active conduct of a trade or business." Section 355(b)(2) further provides that a corporation is treated as engaged in the active conduct of a trade or business only if (A) the corporation is engaged in the active conduct of a trade or business, and (B) such trade or business has been actively conducted throughout the five-year period ending on the date of the distribution, and (C) such trade or business was not acquired in a transaction in which gain or loss was recognized in whole or in part within such five-year period, unless the safe harbor of Section 355(b)(2)(D) applies.
We analyze the active trade or business requirement with respect to each of Distributing and Controlled.
Engineered Coatings Division (Veldran — Distributing). Following the Spin-Off, Veldran will continue to operate the Engineered Coatings Division, which generates FY2021 revenue of approximately $1.52 billion and employs approximately 5,200 of Veldran's 8,200 total employees. The Engineered Coatings Division constitutes a substantial, standalone business involving the development, manufacture, and sale of high-performance industrial coatings and surface treatment solutions. Veldran has been incorporated since March 14, 2019, and has operated the Engineered Coatings Division since that date. Based on representations in the draft Representation Letter, the predecessor operations of the Engineered Coatings Division were conducted for well in excess of five years prior to the anticipated Distribution date. The five-year look-back period from an anticipated Q4 2022 Distribution reaches back to approximately Q4 2017. To the extent the Engineered Coatings Division's predecessor operations have been actively conducted since at least Q4 2017, the five-year active conduct requirement should be satisfied with respect to Veldran.
Precision Flow Solutions Division (Meridian — Controlled). Following the Spin-Off, Meridian will operate the Precision Flow Solutions Division. The Precision Flow Solutions Division has been operated by Veldran since Veldran's incorporation on March 14, 2019. However, as noted in Section II.C above, a significant portion of this division — the Kestrel business — was acquired by Veldran on June 7, 2019 from Rennick Industrial Partners Fund II LP in a taxable stock acquisition for $295 million. The Kestrel business comprised approximately 35% of the Precision Flow Solutions Division's FY2021 revenue. The Kestrel Acquisition closed within the five-year look-back period (which extends from the anticipated Q4 2022 Distribution date back to approximately Q4 2017).
Section 355(b)(2)(C) Issue. Under Section 355(b)(2)(C) of the Code, a trade or business is not treated as meeting the five-year active conduct requirement if, during the five-year period ending on the date of the Distribution, the trade or business was acquired in a transaction in which gain or loss was recognized in whole or in part. The Kestrel Acquisition was a taxable stock acquisition in which the selling shareholders (Rennick Industrial Partners Fund II LP) recognized gain on the sale of their Kestrel stock. Accordingly, Section 355(b)(2)(C) is implicated with respect to the Kestrel business, and absent the application of a safe harbor, the Kestrel business would not satisfy the five-year active conduct requirement on a standalone basis.
Section 355(b)(2)(D) Safe Harbor. Section 355(b)(2)(D) of the Code provides a safe harbor to the prohibition in Section 355(b)(2)(C). Under this safe harbor, a trade or business that was acquired in a taxable transaction within the five-year period will nevertheless be treated as satisfying the five-year active conduct requirement if such trade or business had been conducted by the acquired corporation (or its predecessor) throughout the five-year period ending on the date of the Distribution. The purpose of this safe harbor is to permit a trade or business that has a sufficient historical pedigree — i.e., one that was actively conducted for at least five years at the corporate level of the acquired entity — to satisfy the active business requirement notwithstanding the fact that the acquiring corporation obtained the business in a taxable acquisition within the five-year window.
Kestrel Precision Controls, Inc. was founded on February 12, 2003, and, based on representations in the draft Representation Letter, Kestrel has continuously operated its precision fluid-control business since that date. The five-year look-back period from an anticipated Q4 2022 Distribution date reaches back to approximately Q4 2017. Kestrel's operations well predate Q4 2017, having commenced in 2003. Accordingly, the Kestrel business has been actively conducted by Kestrel (at the corporate level of the acquired entity) throughout the five-year period ending on the anticipated Distribution date. The safe harbor of Section 355(b)(2)(D) should therefore be available with respect to the Kestrel business.
We note that the satisfaction of the Section 355(b)(2)(D) safe harbor is dependent upon the accuracy of the representations in the draft Representation Letter that Kestrel continuously conducted the precision fluid-control business without interruption from at least Q4 2017 through the date of the Distribution. Any interruption, cessation, or material change in the nature of Kestrel's business during such period could jeopardize the availability of the safe harbor.
With respect to the portion of the Precision Flow Solutions Division that does not consist of the Kestrel business, we understand based on the draft Representation Letter that such operations have been actively conducted by Veldran (or its predecessors) for well in excess of five years. Accordingly, the five-year active conduct requirement should be independently satisfied with respect to the non-Kestrel component of the Precision Flow Solutions Division.
Conclusion: Both the Engineered Coatings Division (to remain with Veldran) and the Precision Flow Solutions Division (to be contributed to Meridian), including the Kestrel business, should satisfy the five-year active trade or business requirement of Section 355(b) of the Code, subject to the accuracy of the representations in the draft Representation Letter regarding the continuous active conduct of the relevant businesses.
3. Device Test — § 355(a)(1)(B)
Section 355(a)(1)(B) of the Code provides that a distribution does not qualify for tax-free treatment under Section 355(a) if the transaction was used principally as a "device" for the distribution of the earnings and profits of the distributing corporation or the controlled corporation, or both. The device test is a facts-and-circumstances analysis, and Treasury Regulations Section 1.355-2(d) identifies certain factors that are evidence of device ("device factors") and certain factors that are evidence of nondevice ("non-device factors"). The regulations make clear that the existence of a device depends upon the strength of the device and non-device factors in the particular case.
Device Factors Identified:
Pro Rata Distribution. The proposed Distribution is pro rata — each Veldran shareholder will receive one share of Meridian common stock for each share of Veldran common stock held. A pro rata distribution is identified in Treasury Regulations Section 1.355-2(d)(2)(ii) as a device factor because, in a pro rata distribution, the shareholders hold the same proportionate interest in both corporations after the distribution, and a subsequent sale of stock of either corporation achieves the same economic result as a non-pro-rata distribution. We note, however, that the pro rata nature of the distribution is an inherent feature of a public-company spin-off and does not, standing alone, establish that the distribution is a device.
Financial Sponsor Controlling Interest. HPE Fund IV holds, through HVH, a 62.4% controlling interest in Veldran. HPE Fund IV is a private equity fund with a defined investment horizon and fund lifecycle, and, as is typical for private equity sponsors, HPE Fund IV's investment objectives include the realization of returns on its investment through an eventual monetization event such as a sale, merger, or initial public offering. While the draft Representation Letter states that no agreement, understanding, or arrangement exists as of the date hereof for a post-Distribution sale or exchange of Distributing or Controlled stock, the inherent nature of HPE Fund IV as a financial sponsor with a time-limited investment horizon creates a concern that the Distribution may be viewed by the IRS as facilitating a subsequent monetization of the Controlled corporation's stock. This factor, while not determinative, adds to the device analysis.
Non-Device Factors Identified:
Absence of Post-Distribution Sale or Exchange. Based on the draft Representation Letter, there is no existing plan, agreement, arrangement, or understanding for a post-Distribution sale or exchange of either Distributing or Controlled stock. The absence of such arrangements is a strong non-device factor under Treasury Regulations Section 1.355-2(d)(3)(iii), which provides that "the absence of a prearranged sale of stock" is evidence that the distribution is not a device. We note that the regulations do not require that no sale ever occur; rather, the inquiry is directed at whether a sale was prearranged at or before the time of the distribution.
Corporate Business Purpose. Under Treasury Regulations Section 1.355-2(d)(3)(ii), the existence of a corporate business purpose for the distribution is evidence that the distribution is not a device. The strength of this factor depends on the strength of the business purpose. As discussed in Section V.B.5 below, two preliminary business purposes have been identified, but the articulation of those purposes remains unresolved and requires further development. To the extent robust corporate business purposes are established, this factor would serve as a significant counterweight to the device factors identified above.
Nature of Distributing and Controlled Businesses. Both Distributing (post-spin) and Controlled are operating companies with substantial active business operations, significant revenues, meaningful employee headcount, and genuine business assets. Neither entity is an investment vehicle or a shell company. This factor weighs against device characterization.
Analysis. The device analysis in the present case presents a nuanced inquiry. The pro rata nature of the Distribution and HPE Fund IV's controlling stake as a financial sponsor create meaningful device concern that the IRS could raise in a challenge to the Transaction. In particular, the IRS could argue that the Spin-Off is designed to facilitate HPE Fund IV's realization of its investment in the Precision Flow Solutions business through a subsequent sale of Meridian stock (or through a post-spin sale or merger of Meridian), effectively converting what would otherwise be a taxable dividend-equivalent distribution into a tax-free separation followed by a capital gains transaction.
However, these device factors must be weighed against the non-device factors, particularly the absence of a prearranged post-spin sale and the establishment of bona fide corporate business purposes. The regulations explicitly recognize that the device test is not a per se rule: even where device factors are present, a distribution may qualify if the non-device factors are sufficiently strong. In the present case, the device test analysis is manageable provided that (i) no agreement, understanding, or arrangement exists, or is entered into prior to the Distribution, regarding a post-spin sale or merger of either Distributing or Controlled, and (ii) robust corporate business purposes are established and articulated in a manner that demonstrates genuine corporate-level (rather than sponsor-level) motivations for the Spin-Off.
Conclusion (preliminary): The Distribution should not be treated as principally a device for the distribution of earnings and profits, assuming the representations in the draft Representation Letter are accurate and complete, and assuming that the business purpose articulation is strengthened as discussed in Section V.B.5 and Section IX of this Opinion. This conclusion, however, remains preliminary and is subject to the caveat that the business purpose articulation has not yet been satisfactorily resolved.
4. Distribution of All Stock — § 355(a)(1)(D)
Section 355(a)(1)(D) of the Code requires that, in a distribution described in Section 355(a), the distributing corporation distribute all of the stock and securities of the controlled corporation held by it immediately before the distribution, or distribute an amount of stock constituting control within the meaning of Section 368(c) and the Secretary is satisfied that the retention of stock by the distributing corporation was not in pursuance of a plan having as one of its principal purposes the avoidance of federal income tax.
In the proposed Transaction, Veldran will distribute 100% of the outstanding common stock of Meridian. Veldran will retain no shares of Meridian stock following the Distribution. Accordingly, the requirement of Section 355(a)(1)(D) is satisfied.
5. Business Purpose
Treasury Regulations Section 1.355-2(b)(1) provides that Section 355 applies to a distribution only if the distribution is carried out for one or more corporate business purposes. A "corporate business purpose" is a real and substantial non-federal-tax purpose germane to the business of the distributing corporation, the controlled corporation, or the affiliated group (as defined in Section 1504(a)) to which the distributing corporation belongs. Treasury Regulations Section 1.355-2(b)(2) further provides that a shareholder purpose (such as the personal planning needs of a controlling shareholder) is not a corporate business purpose, and that the principal purpose for the distribution must not be the avoidance of federal income taxes. A purpose of reducing non-income taxes is not a corporate business purpose if the transaction is not otherwise motivated by a real and substantial non-tax purpose.
Two preliminary corporate business purposes have been identified for the proposed Distribution:
(i) Independent Capital-Allocation Strategies. The first identified business purpose is that the separation of the Engineered Coatings and Precision Flow Solutions businesses into two independent public companies will enable each company to pursue independent capital-allocation strategies tailored to the distinct characteristics and growth profiles of its respective business. Specifically, as separate companies, each of Veldran and Meridian would be able to (a) use its own entity-specific equity as acquisition currency in strategic transactions, (b) pursue targeted debt financing appropriate to its specific business risk profile and capital needs, and (c) allocate capital expenditures without the cross-subsidization dynamics that arise when two distinct businesses compete for capital within a single corporate entity.
(ii) Management Focus and Operational Efficiency. The second identified business purpose is that the separation will enhance management focus and operational efficiency by separating two businesses that operate in distinct technical and commercial domains — coatings and materials science (Engineered Coatings) versus mechanical engineering and fluid dynamics (Precision Flow Solutions). Following the Spin-Off, each company would have a dedicated management team, an independent board of directors, and tailored compensation structures aligned with the specific operational and financial metrics of its respective business. This dedicated focus is expected to improve operating performance, accelerate strategic decision-making, and enhance each company's ability to attract and retain specialized talent.
Concern — Sponsor-Level vs. Corporate-Level Purpose. Calderwood & Harkness has flagged a significant concern regarding the articulation of the business purposes. Both of the preliminary business purposes, as currently formulated, may be susceptible to challenge by the IRS on the grounds that they are primarily driven by HPE Fund IV's fund-level investment objectives rather than bona fide corporate-level purposes of Veldran. Specifically, the IRS could argue that the real motivation for the Spin-Off is to facilitate HPE Fund IV's monetization of its investment in the Precision Flow Solutions Division — for example, by positioning Meridian as a standalone company that can be sold or taken public in an IPO — thereby enabling HPE Fund IV to return capital to its limited partners and optimize exit timing within the fund's defined lifecycle.
Treasury Regulations Section 1.355-2(b)(2) makes clear that a corporate business purpose must be a real and substantial non-federal-tax purpose "germane to the business of the distributing corporation, the controlled corporation, or the affiliated group to which the distributing corporation belongs." A purpose that is motivated primarily by the investment objectives of a controlling shareholder — particularly a financial sponsor with a contractual obligation to liquidate investments within a defined timeframe — may not satisfy this requirement. While the involvement of a private equity sponsor does not per se preclude a valid corporate business purpose, the IRS has historically scrutinized spin-offs involving private equity-controlled companies with heightened attention to whether the articulated business purposes are genuinely corporate in nature or are merely restatements of the sponsor's exit strategy.
Status. The business purpose articulation remains unresolved and represents a significant impediment to delivering the final Opinion at a "should" level of confidence. We have recommended that Veldran management — specifically, Jonathan Caldecott (CEO) and Sandra Waverly (President, Precision Flow Solutions Division and designated CEO of Meridian) — articulate concrete operational and strategic benefits of the separation at the corporate level, independent of HPE Fund IV's investment horizon and liquidity needs. Such articulation should address, among other things: specific capital-allocation decisions that have been constrained by the combined corporate structure, identified acquisition targets or strategic opportunities that can only be pursued by a standalone entity, demonstrable inefficiencies in the current management structure attributable to the combination of the two businesses, and concrete plans for Meridian's post-spin operations, capital structure, and growth strategy that are driven by the business's own needs rather than sponsor-level considerations. This issue is discussed further in Section IX.
Conclusion (preliminary): The business purpose requirement of Treasury Regulations Section 1.355-2(b) has not yet been satisfactorily demonstrated. Resolution of this issue is a prerequisite to the finalization of this Opinion.
C. Section 355(d) — Disqualified Distribution
Section 355(d) of the Code provides that, if a distribution to which Section 355 (or so much of Section 356 as relates to Section 355) applies is a "disqualified distribution," the distributing corporation shall be treated as having recognized gain on the distribution equal to the excess of the fair market value of the controlled corporation's stock over the distributing corporation's adjusted basis in such stock. A "disqualified distribution" is any distribution to which Section 355 applies if, immediately after the distribution, any person holds disqualified stock in the distributing corporation or any distributed subsidiary which constitutes a 50-percent or greater interest in such corporation.
"Disqualified stock" is defined in Section 355(d)(3) as any stock in the distributing corporation or any distributed subsidiary that was acquired by "purchase" (within the meaning of Section 355(d)(5)) during the five-year period ending on the date of the distribution. Section 355(d)(5)(A) generally defines a "purchase" as any acquisition of stock where (i) the basis of the property acquired is not determined in whole or in part by reference to the adjusted basis of such property in the hands of the person from whom it was acquired, and (ii) the property is not acquired in a Section 368 reorganization.
Application to the Transaction. HPE Fund IV acquired its 62.4% controlling stake in Veldran on September 20, 2019, through a negotiated tender offer followed by a merger squeeze-out of the prior controlling shareholder, Greystone Partners Fund III LP (EIN 81-2683910). HPE Fund IV (through its wholly owned subsidiary HVH) acquired 46,488,000 shares of Veldran common stock at $40.00 per share, for aggregate cash consideration of $1,859,520,000. This acquisition was a taxable purchase transaction; the basis of the shares in the hands of HVH was determined by the purchase price paid, not by reference to the transferor's basis. The acquisition was not effected pursuant to a Section 368 reorganization. Accordingly, HPE Fund IV's acquisition of its 62.4% Veldran stake constituted a "purchase" within the meaning of Section 355(d)(5).
The September 20, 2019 acquisition date falls within the five-year period preceding the anticipated Q4 2022 Distribution date. Therefore, immediately after the Distribution, HPE Fund IV (through HVH) would hold stock in both Distributing (Veldran) and Controlled (Meridian) that constitutes a 50-percent or greater interest and that is attributable to a "purchase" within the five-year period. Section 355(d) is accordingly implicated.
Potential Gain Recognition. If Section 355(d) applies, Veldran would be treated as having recognized gain on the Distribution of Meridian stock in an amount equal to the excess of the fair market value of the Meridian stock over Veldran's adjusted tax basis in such stock. Based on the preliminary Brackenridge & Co. valuation and the estimated adjusted tax basis discussed in Section II.G, the estimated gain recognition would be in the range of $596.5 million to $902.4 million, resulting in federal income tax of approximately $125.3 million to $189.5 million at the 21% statutory corporate rate.
Interaction with Section 355(e). It is important to note that Sections 355(d) and 355(e) operate independently, even though they may overlap in their application to a given set of facts. Section 355(d) applies based on the existence of a 50-percent or greater interest attributable to a "purchase" within the five-year window, without regard to whether the spin-off is "part of a plan." Section 355(e), by contrast, applies only if the distribution is "part of a plan" (or series of related transactions) pursuant to which one or more persons acquire a 50-percent or greater interest. In this factual context, both provisions are potentially triggered by HPE Fund IV's September 2019 acquisition. However, the analysis under each provision is distinct, and the availability of relief under one provision does not necessarily affect the application of the other.
Analysis of Potential Exceptions. We note that the statutory definition of "purchase" under Section 355(d)(5) generally excludes acquisitions in Section 368 reorganizations and certain other transactions in which the transferee's basis is determined by reference to the transferor's basis. As discussed above, HPE Fund IV's acquisition of Veldran stock was a taxable purchase through a tender offer and subsequent merger squeeze-out, not a Section 368 reorganization. Accordingly, the purchase exclusion does not appear to be available. We are continuing to analyze whether any other exception or relief mechanism may be available under Section 355(d) or its implementing regulations, including an analysis of the application of the attribution rules under Section 355(d)(7) and (8) and the potential applicability of any available regulatory safe harbors.
Status. The Section 355(d) analysis is ongoing and requires further detailed review. This issue is identified as an open item in Section IX.D.
Conclusion (preliminary): Section 355(d) is implicated by HPE Fund IV's September 2019 taxable purchase of a 62.4% interest in Veldran. This represents a material tax risk to the Transaction. The estimated federal income tax liability, if Section 355(d) applies, ranges from $125.3 million to $189.5 million. Further analysis of available exceptions is ongoing and constitutes a prerequisite to the finalization of this Opinion.
D. Section 355(e) — Plan or Series of Related Transactions (Anti-Morris Trust)
Section 355(e) of the Code, commonly referred to as the "anti-Morris Trust" provision, provides that if a distribution to which Section 355 applies 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 (within the meaning of Section 355(d)(4)) in the distributing corporation or any controlled corporation, then the distributing corporation shall recognize gain on the distribution as if the stock of the controlled corporation had been sold for its fair market value on the date of the distribution. Section 355(e) was enacted in 1997 to address transactions in which a spin-off was followed by an acquisition of either the distributing or controlled corporation in a manner that effectively resulted in a disguised sale.
Application to the Transaction. HPE Fund IV's acquisition of a 62.4% controlling interest in Veldran on September 20, 2019 constituted an acquisition of a 50-percent or greater interest in Distributing. The central question under Section 355(e) is whether the proposed Spin-Off (anticipated Q4 2022) is "part of a plan (or series of related transactions)" that includes the September 2019 acquisition. If the acquisition and the Spin-Off are treated as part of a single plan, Section 355(e) would require Veldran to recognize gain on the Distribution.
Temporal Analysis. The gap between the September 20, 2019 acquisition and the anticipated Q4 2022 Distribution is approximately three years. There is no per se statutory safe harbor that immunizes transactions separated by exactly three years. The analysis under Section 355(e) is governed by Treasury Regulations Section 1.355-7, which employs a facts-and-circumstances approach to determine whether a distribution and an acquisition are "part of a plan." The regulations provide certain safe harbors and presumptions, as well as a series of factors to be considered in the facts-and-circumstances analysis.
Treasury Regulations Section 1.355-7 Framework. The regulations address the "plan" inquiry in several relevant respects:
Plans in Existence at the Time of the Acquisition. If a plan to distribute controlled corporation stock existed at the time of the acquisition, the acquisition and the distribution are treated as part of the same plan. Based on the draft Representation Letter, there were no discussions, agreements, negotiations, or understandings regarding a spin-off or separation of the Precision Flow Solutions Division at or before the time of HPE Fund IV's September 2019 acquisition. If this representation is accurate, then no plan existed at the time of the acquisition, and this factor supports a finding that the acquisition and the Spin-Off are not part of a single plan. However, as discussed below, the factual record supporting this representation is currently thin and requires additional corroboration.
Plans Formed After the Acquisition. Even where no plan existed at the time of the acquisition, a plan may be found to exist if the distribution was contemplated, discussed, or explored in connection with the acquisition, or if facts and circumstances indicate that the acquisition and the distribution were steps in an integrated transaction. The draft representations state that the spin-off concept was first raised internally within Harrowgate in early 2022 — approximately two and one-half years after the September 2019 acquisition. If this representation is accurate, the substantial temporal gap between the acquisition and the first discussions of a spin-off supports a finding that the two events were not part of a single plan.
Safe Harbors Under Treasury Regulations Section 1.355-7(d). The regulations provide several safe harbors under which a distribution and an acquisition are deemed not to be part of a plan. Of particular relevance:
(a) Two-Year Safe Harbor — Section 1.355-7(d)(1). Under this safe harbor, a distribution and an acquisition are deemed not to be part of a plan if the distribution occurs more than two years after the acquisition, and the distribution was not discussed or agreed upon at the time of the acquisition, or at any time during the two-year period beginning on the date of the acquisition. The September 2019 acquisition occurred more than two years prior to the anticipated Q4 2022 Distribution, which is favorable. However, the safe harbor also requires that the distribution was not discussed or agreed upon at the time of the ac