Christine and Priya,
In connection with Calderwood & Harkness's engagement on behalf of Harrowgate Private Equity Fund IV, L.P. and Veldran Industries Holdings, Inc. (Matter No. HRW-SPIN-001) relating to the proposed pro rata spin-off of Meridian Flow Technologies, Inc., please find attached our first draft of the tax opinion letter for your review and comment. The opinion is addressed to the Board of Directors of Veldran Industries Holdings, Inc. and Harrowgate Private Equity Fund IV, L.P. As drafted, the opinion provides a "should" level opinion that (i) the proposed distribution by Veldran of 100% of the outstanding common stock of Meridian to Veldran shareholders should qualify as a tax-free distribution under IRC § 355(a), and (ii) the contribution of the Precision Flow Solutions Division assets and liabilities to Meridian should qualify as a reorganization under IRC § 368(a)(1)(D).
**Draft Status.** I want to emphasize that this is a first draft, marked as such throughout, and should not be relied upon in its current form for any purpose. The opinion remains subject to the finalization of several open items discussed below and to the completion and execution of the Representation Letter. I would ask that distribution of the attached draft be limited to the addressees and parties copied on this email. The draft is protected by the attorney-client privilege and the work product doctrine.
**Key Open Items**
There are three principal open items that must be resolved before we can finalize the opinion:
1. **Business Purpose Articulation.** This remains our primary concern and the principal impediment to delivering the opinion at the "should" level. The current articulation of business purposes for the spin-off is, in our judgment, insufficient to support that standard. The two business purposes identified to date — (i) enabling each business (the Engineered Coatings Division and the Precision Flow Solutions Division) to pursue independent capital-allocation strategies, and (ii) enhancing management focus and operational efficiency — are framed in terms that could be characterized as primarily serving HPE Fund IV's fund-level objectives (specifically, capital return to limited partners and monetization of the Precision Flow investment) rather than genuine corporate-level purposes of Veldran. Under Treas. Reg. § 1.355-2(b), the 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. A purpose driven primarily by the PE sponsor's liquidity needs would be vulnerable to IRS challenge.
We recommend that Veldran management — specifically Jonathan Caldecott and Sandra Waverly — work to develop and articulate additional concrete corporate-level justifications. Examples that may be available on these facts include distinct customer and end-market dynamics between the two divisions, different capital investment profiles, the ability for each standalone entity to use its equity as acquisition currency in its respective sector, and enhanced talent retention through targeted equity compensation programs. As you will recall, we addressed this at some length in the Business Purpose Memorandum circulated on July 18 and in my email to Christine on July 22. The analysis there remains our framework, but the factual predicate needs to be substantially strengthened.
2. **Section 355(e) "Plan" Analysis — Factual Representations.** The § 355(e) analysis addresses whether the proposed spin-off is part of a "plan (or series of related transactions)" that includes HPE Fund IV's September 20, 2019 acquisition of approximately 62.4% of Veldran common stock (46,488,000 shares at $40.00 per share, for approximately $1.86 billion), which constituted a change of control of Veldran. The approximately three-year gap between the September 2019 acquisition and the anticipated Q4 2022 distribution falls within the broader "plan" analysis window under Treas. Reg. § 1.355-7; there is no statutory safe harbor at exactly three years.
Our preliminary analysis (per the June 28 memo) supports a conclusion that the acquisition and spin-off should not be treated as part of a plan, but the factual record as it currently stands is thin. To finalize this analysis, we need additional factual representations in the Representation Letter — specifically, representations confirming that (a) there were no discussions, negotiations, agreements, or understandings regarding a potential spin-off or separation of the Precision Flow Solutions Division prior to HPE Fund IV's acquisition of Veldran in September 2019, and (b) the decision to explore a spin-off arose independently and was not contemplated at the time of the acquisition.
The tax exposure if § 355(e) were found to apply is significant. Based on Brackenridge & Co.'s preliminary valuation range of approximately $1.4 billion to $1.7 billion for Meridian, and against Veldran's estimated adjusted tax basis of approximately $800 million in the Precision Flow Division assets, the estimated built-in gain is in the range of $600 million to $900 million. At the 21% corporate rate, the resulting tax liability would be approximately $125 million to $190 million.
Christine and Priya — I would ask that you coordinate with Diana Fenn, Marcus Adler, and Tobias Rourke to develop the factual record and confirm that these representations can be made.
3. **Representation Letter — Not Yet Finalized.** The draft opinion is premised on the representations set forth in the draft Representation Letter, the second draft of which was circulated on July 11, 2022. That letter has not been finalized or executed. Several representations remain in brackets or are subject to further client input — most critically, the business purpose and § 355(e) plan representations discussed above. The opinion cannot be finalized until the Representation Letter is agreed upon and executed by the appropriate officers of Veldran (Jonathan Caldecott, CEO, and Rita Subramanian, CFO) and Harrowgate Capital Advisors LLC (Diana Fenn, Managing Partner).
**Additional Notes**
A few secondary items for your awareness as you review the draft:
- The draft opinion addresses the § 355(b) active trade or business requirement, including the Kestrel Precision Controls issue. As you know, the June 7, 2019 taxable acquisition of Kestrel from Rennick Industrial Partners Fund II LP for $295 million falls within the five-year look-back window. Our analysis concludes that the § 355(b)(2)(D) safe harbor should be satisfied given Kestrel's continuous operation since its founding on February 12, 2003. This is reflected in the draft as a favorable conclusion, subject to the representations.
- The draft also addresses § 355(d) (disqualified distribution), the device test, and continuity of interest under § 368(a)(1)(D).
- State and local tax considerations are addressed in the separate memorandum circulated on July 20 and are not covered in this federal opinion.
- I would encourage you to review the draft Tax Matters provisions for the Separation Agreement (circulated July 28) and the outline of the Tax Sharing Agreement (circulated August 4) in conjunction with this opinion. The post-spin restrictive covenants in those documents are specifically designed to protect the § 355 qualification, and the three work streams should be considered together.
**Proposed Next Steps**
I would like to schedule a call early the week of August 8 to discuss the open items — in particular, the business purpose articulation. On our end, Sylvia, Garrett, and I would participate. On your side, I would suggest Christine and relevant Harrowgate principals, Priya from Whitfield & Gage, and Philip from Veldran. If Jonathan Caldecott and Sandra Waverly are available to discuss the business purpose directly, that would be very helpful.
In the meantime, I would be grateful if you could circulate any comments on the draft opinion in advance of the call so that we can make productive use of the time. Garrett Simmons will reach out to coordinate scheduling.
Thank you both, and thanks to the broader team, for the continued effort on this matter. Please do not hesitate to reach out over the weekend if any questions arise.
Best regards,
Leonard Cross Partner, Tax Department Calderwood & Harkness LLP 1301 Avenue of the Americas, 40th Floor New York, NY 10019 T: (212) 555-4180 E: lcross@calderwoodharkness.com
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