INTERNAL WORK PRODUCT — PRIVILEGED AND CONFIDENTIAL ATTORNEY-CLIENT PRIVILEGE / WORK PRODUCT DOCTRINE
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CALDERWOOD & HARKNESS LLP 1301 Avenue of the Americas, 40th Floor New York, New York 10019
August 10, 2022
MEMORANDUM
Subject: Comments Compilation on First Draft Tax Opinion Letter — Proposed Spin-Off of Meridian Flow Technologies, Inc. from Veldran Industries Holdings, Inc.
Matter Code: HRW-SPIN-001
Engagement Number: 1003-00005
Client: Harrowgate Private Equity Fund IV, L.P. (EIN: 84-3291067)
Prepared by: Garrett Simmons (Lead Associate) and Leila Nazari (Working Associate) — compiling comments
Comments by: Leonard Cross (Responsible Partner) and Sylvia Hartwell (Billing Partner)
Reference Document: Draft Tax Opinion Letter dated August 5, 2022 (first draft), circulated to Christine Yeung (General Counsel, Harrowgate Capital Advisors LLC) and Priya Chandrasekar (Partner, Whitfield & Gage LLP)
Purpose of This Compilation: This memorandum compiles and organizes all marginal notes, tracked comments, discussion items, and oral instructions from Cross and Hartwell arising from their respective reviews of the first draft of the Tax Opinion Letter dated August 5, 2022. The compilation is intended to serve as the primary reference document for the internal team review session and to guide the preparation of the revised second draft of the opinion. All comments have been organized by subject matter, with specific drafting instructions and action items flagged for Simmons and Nazari. Cross-references to supporting work papers, internal memoranda, diligence materials, and correspondence are provided where relevant.
This document is intended for discussion between Cross, Hartwell, Simmons, and Nazari only. It should not be shared with the client, outside counsel, or any third party under any circumstances. This document reflects the mental impressions, opinions, legal theories, and strategic deliberations of Calderwood & Harkness attorneys and is protected as attorney work product.
I. OVERVIEW AND GENERAL OBSERVATIONS
A. Cross — General Comments on Draft Structure and Confidence Level
Cross has reviewed the first draft of the Tax Opinion Letter in its entirety and provides the following general observations regarding the structure, confidence level, and overall framing of the opinion.
1. Current Opinion Level. The draft opinion currently opines that the proposed pro rata distribution by Veldran Industries Holdings, Inc. ("Distributing" or "Veldran") of 100% of the common stock of Meridian Flow Technologies, Inc. ("Controlled," "SpinCo," or "Meridian") to Veldran shareholders "should" qualify as a tax-free distribution under Section 355(a) of the Internal Revenue Code of 1986, as amended (the "Code"), and that the Contribution (i.e., the transfer by Veldran of the assets and liabilities constituting the Precision Flow Solutions Division to Meridian in exchange for Meridian stock) "should" qualify as a reorganization under Section 368(a)(1)(D) of the Code.
2. Appropriateness of "Should" Level. Cross notes that the "should" level of comfort — the second-highest level in our firm's customary hierarchy, below "will" and above "more likely than not" — is appropriate given the open factual and legal issues identified throughout this compilation. However, Cross has a significant concern regarding how the draft deploys the "should" qualifier: the current draft applies "should" uniformly across all requirements and conclusions without differentiating between those areas where a higher level of confidence is warranted and those where the "should" qualifier is doing meaningful analytical work.
3. Recommended Restructuring. Cross recommends that the opinion be restructured to provide a "will" level conclusion on certain discrete, mechanical requirements of Sections 355 and 368(a)(1)(D) where the facts are clear and there is no meaningful uncertainty. Specifically, a "will" level conclusion is supportable for the following elements:
(a) The "control" requirement under Section 368(c) of the Code — Veldran will own 100% of the stock of Meridian immediately before the distribution, which plainly satisfies the 80% control threshold;
(b) The distribution-of-control requirement under Section 355(a)(1)(D) — Veldran will distribute 100% of the Meridian stock, satisfying the requirement that the distributing corporation distribute stock constituting control of the controlled corporation;
(c) The "solely stock or securities" distribution requirement — the distribution will consist entirely of Meridian common stock, with no boot or other consideration; and
(d) The continuity-of-interest requirement — the 1:1 pro rata distribution to all Veldran shareholders inherently preserves continuity.
By contrast, the "should" qualifier is performing substantive work — and should be highlighted as such — in the following areas:
(a) The Section 355(e) "plan" analysis — whether the distribution is treated as part of a plan or series of related transactions including the September 2019 acquisition by HPE Fund IV;
(b) The business purpose requirement under Treasury Regulations Section 1.355-2(b) — the articulation and substantiation of real and substantial corporate-level business purposes for the spin-off; and
(c) The "not a device" requirement under Section 355(a)(1)(B) and Treasury Regulations Section 1.355-2(d) — the draft's device analysis, while generally adequate, involves judgment calls regarding the absence of device indicators.
Cross notes that this bifurcated approach — "will" for mechanical requirements, "should" for substantive judgment calls — is more informative to the client, more precisely communicates the nature of the remaining uncertainties, and mirrors current market practice for divisive reorganization opinions issued by peer firms. Cross has seen this approach employed in recent comparable transactions, including opinions issued in connection with the Atherton / Virelay separation (2021) and the Runcible Holdings spin-off (2022).
4. Representation Letter Caveat. Cross further flags that the draft must include a more prominent caveat regarding the Representation Letter. The current draft references the Representation Letter in a general "assumptions and qualifications" section near the end of the opinion, but does not make sufficiently clear on the face of the opinion that (a) the Representation Letter has not been finalized — the second draft dated July 11, 2022 remains under negotiation with Christine Yeung (General Counsel, Harrowgate Capital Advisors LLC) and Philip Crundell (General Counsel, Veldran), (b) no Internal Revenue Service private letter ruling has been sought or obtained in connection with the proposed transaction, and (c) the opinion is therefore subject to finalization of the factual record as set forth in the executed Representation Letter. These caveats should appear prominently in the opening paragraphs of the opinion, not buried in the limitations section. This is particularly important given the matters discussed in Section II below regarding the § 355(e) analysis, where the factual representations are the linchpin of our conclusion.
B. Hartwell — General Comments on Audience and Fund-Level Considerations
Hartwell has completed her review of the first draft and provides the following general observations, with particular attention to the audience, addressee conventions, and fund-level considerations relevant to the opinion.
1. Opinion Addressees. The draft opinion is currently addressed to the Board of Directors of Veldran Industries Holdings, Inc. and Harrowgate Private Equity Fund IV, L.P. ("HPE Fund IV"). Hartwell notes that HPE Fund IV is a Delaware limited partnership, not a corporation, and the opinion should clarify whether any of its conclusions extend to the partners of HPE Fund IV — in particular, the limited partners who will bear the ultimate economic and tax consequences of the spin-off. As currently drafted, the opinion could be read as opining on the tax consequences to HPE Fund IV as a shareholder of Veldran, without addressing the downstream consequences to HPE Fund IV's partners. The opinion should include an express disclaimer stating that it does not address the partnership-level consequences to HPE Fund IV or any of its partners, as further discussed in Section VI below.
2. Federal-Only Scope. Hartwell recommends adding a paragraph in the "Limitations" section of the opinion clarifying that the opinion addresses only the federal income tax consequences of the proposed spin-off and distribution. The opinion should expressly state that it does not address any state, local, or foreign tax consequences arising from the transaction, including but not limited to state income taxes, franchise taxes, transfer taxes, or any analogous taxes imposed by any non-U.S. jurisdiction. Hartwell notes that a separate state and local tax ("SALT") memorandum dated July 20, 2022 was prepared by Nazari and reviewed by Hartwell, covering the potential state income tax consequences of the spin-off in Delaware, North Carolina, and Georgia — the three jurisdictions most relevant to Veldran's and Meridian's operations and organizational structure. The existence of this separate SALT memorandum should not be referenced in the opinion letter itself, as it is an internal work product, but the scope limitation paragraph should make clear that SALT consequences are not covered.
3. Third-Party Reliance Disclaimer. Hartwell observes that the draft opinion does not address the tax consequences to any Veldran shareholder other than the named addressees — in particular, the opinion is silent regarding Prescott Capital Management LP, which holds approximately 14.8% of Veldran's outstanding common stock (11,026,000 shares) and is a significant co-investor alongside HPE Fund IV. Prescott's tax advisor, Dunmore Havens & Associates LLC (principal: Irene Salcedo), may be conducting its own analysis of the spin-off, and it is conceivable that Prescott or Dunmore Havens could seek to rely on or reference our opinion in the absence of a clear disclaimer. Accordingly, Hartwell recommends that the opinion include an express statement in the "Reliance" section that the opinion is rendered solely for the benefit of the named addressees and may not be relied upon by, furnished to, or referred to by any other person or entity — including Prescott Capital Management LP, Dunmore Havens & Associates LLC, and their respective partners, members, affiliates, and advisors — without the prior written consent of Calderwood & Harkness LLP. This is standard practice and should be prominently stated.
II. COMMENTS ON § 355(e) "PLAN" ANALYSIS — STRENGTHENING THE "SHOULD" OPINION LANGUAGE
A. Cross — Comment on Section IV.B of Draft (§ 355(e) Anti-Morris Trust Analysis)
Cross has reviewed Section IV.B of the draft opinion, which addresses the application of Section 355(e) of the Code (the so-called "Anti-Morris Trust" provision) to the proposed spin-off in light of HPE Fund IV's prior acquisition of a controlling interest in Veldran. Cross identifies this as one of the two areas of greatest concern in the opinion (the other being business purpose, discussed in Section IV below) and provides detailed comments.
1. Current Draft Treatment. The draft's treatment of Section 355(e) currently occupies approximately three pages of the opinion letter and concludes that the proposed distribution of Meridian stock by Veldran to its shareholders "should not" be treated as part of a plan or series of related transactions that includes the September 20, 2019 acquisition by HPE Fund IV of approximately 62.4% of Veldran's outstanding common stock (46,488,000 shares at $40.00 per share, for aggregate consideration of $1,859,520,000), which acquisition constituted a change of control of Veldran within the meaning of Section 355(e)(2)(A)(ii) of the Code.
2. Temporal Gap Analysis. Cross acknowledges that the draft correctly identifies the approximately three-year temporal gap between the September 20, 2019 acquisition and the anticipated Q4 2022 distribution date, and that this temporal gap is favorable for the client's position. However, Cross notes that the draft fails to engage with the specific safe harbors and presumptions set forth in the Treasury Regulations under Section 355(e) — specifically Treasury Regulations Section 1.355-7 — in sufficient detail to support the opinion's conclusion. The current discussion reads as conclusory: it states the favorable temporal gap and announces the conclusion without walking through the applicable regulatory framework. This is inadequate for an opinion of this significance and must be rectified.
3. Specific Requested Revisions. Cross requests the following specific revisions to the § 355(e) discussion in the draft opinion:
(a) Treasury Regulations Section 1.355-7(b)(2) Safe Harbor. The revised draft must include an explicit discussion of the safe harbor provided under Treasury Regulations Section 1.355-7(b)(2), which provides that a distribution and an acquisition are not part of a "plan" if the distribution occurs more than two years after the acquisition, provided that, at the time of the acquisition, there was no "agreement, understanding, arrangement, or substantial negotiations" regarding the distribution or a similar transaction. Cross notes the following:
(i) The approximately three-year gap between the September 20, 2019 acquisition and the anticipated Q4 2022 distribution exceeds the two-year safe harbor period, which is a favorable fact that should be highlighted in the opinion.
(ii) However, the safe harbor is not automatic — it applies only if the condition regarding the absence of pre-acquisition discussions, agreements, understandings, or arrangements is satisfied. The opinion must squarely address this condition and state the basis for concluding that it is met.
(iii) The factual record supporting the absence of pre-acquisition discussions about a potential spin-off is thin. The Representation Letter (second draft, July 11, 2022) contains a representation on this point — specifically, a representation that, as of the date of the September 2019 acquisition, neither Harrowgate Capital Advisors LLC nor any of its affiliates (including HPE Fund IV) had engaged in any discussions, entered into any agreement, or reached any understanding with Veldran's management, Board of Directors, or any other party regarding a potential spin-off, split-off, or other separation transaction involving any division or business of Veldran. However, Cross notes that this representation was flagged as an open item in his email to Christine Yeung (General Counsel, Harrowgate Capital Advisors LLC) dated July 11, 2022, because Yeung indicated that the representation required further internal review by Harrowgate.
(iv) Specifically, the representation needs additional factual support from the following individuals at Harrowgate: Marcus Adler (Founding Partner and Chairman), Diana Fenn (Managing Partner and Chief Investment Officer), and Tobias Rourke (Partner, Head of Portfolio Operations). These individuals were involved in the underwriting and evaluation of the Veldran investment in 2019 and would have knowledge of any pre-acquisition discussions about separation or monetization strategies. Simmons or Nazari should follow up with Christine Yeung to determine the status of this internal review and to request, if not already provided, any investment committee memoranda, term sheets, board presentations, or internal communications from the 2018–2019 period that may shed light on whether a spin-off was discussed prior to or at the time of the acquisition.
(b) Facts-and-Circumstances Test Under Treasury Regulations Section 1.355-7(b)(3). The revised draft must also discuss the facts-and-circumstances test set forth in Treasury Regulations Section 1.355-7(b)(3) and address the specific factors enumerated in the regulations that weigh in favor of and against a finding that the distribution and the acquisition are part of a "plan." The current draft simply states the conclusion without walking through the factors, which renders the analysis unsupported and potentially vulnerable if scrutinized by the IRS on audit or in litigation. Cross recommends that the revised draft address at least the following factors:
(i) Temporal proximity. As noted, the approximately three-year gap favors the conclusion that the distribution is not part of a plan. This is the single strongest factor in the client's favor.
(ii) Discussions or negotiations. To the extent the factual record supports the absence of pre-acquisition discussions about a spin-off, this factor favors the client. However, the weight of this factor is contingent on the factual representations, which remain open (see above).
(iii) Business reasons for the acquisition and the distribution. The acquisition by HPE Fund IV was a leveraged buyout of Veldran as a going concern, not a step in a pre-planned separation strategy. The distribution is motivated (at least as articulated) by corporate-level business purposes relating to management focus and capital allocation. To the extent these business purposes are independent and genuine, this factor favors the client.
(iv) Relationship between the acquisition and the distribution. There is no structural or contractual link between the September 2019 acquisition and the proposed spin-off — the acquisition was a stock purchase, and the spin-off involves a different corporate action (contribution and distribution of a subsidiary). The absence of such a structural link is favorable.
(v) Identity of parties. HPE Fund IV is both the acquirer in the September 2019 transaction and a significant shareholder that will receive Meridian stock in the distribution. While this overlap does not by itself create a plan, the IRS could argue that the economic substance of the overall transaction sequence — acquisition of control, followed by separation of a business unit — suggests a pre-existing plan to monetize individual business lines.
The revised draft should present these factors in a balanced manner, acknowledging the factors that favor the client's position while noting the areas of potential vulnerability, and should explain why, on balance, the favorable factors outweigh the unfavorable factors.
(c) Quantification of Tax at Risk. The revised draft must include a quantification of the potential federal income tax liability that would arise if Section 355(e) were determined to apply to the distribution. This quantification is critical to informing the client — including the Board of Directors of Veldran, which bears fiduciary responsibility for the decision to proceed — of the magnitude of the risk. Based on information currently available, the quantification is as follows:
(i) If Section 355(e) applies, Veldran would be required to recognize gain on the distribution of Meridian stock as if such stock had been sold at fair market value on the distribution date.
(ii) The estimated fair market value of Meridian (i.e., the Precision Flow Solutions Division) is in the range of $1,396.5 million to $1,702.4 million, based on the preliminary valuation prepared by Brackenridge & Co. (received June 10, 2022, prepared by Samuel Ng, Managing Director, Industrials Group), which applied an enterprise value to EBITDA multiple range of 10.5× to 12.8× to Meridian's trailing twelve-month EBITDA of approximately $133 million.
(iii) Veldran's estimated adjusted tax basis in the assets constituting the Precision Flow Solutions Division is approximately $800 million (based on information provided by Pemberton Rathbone LLP and Veldran management, subject to verification; see Section VII.D below).
(iv) Accordingly, the estimated gain recognized by Veldran under Section 355(e) would be in the range of approximately $596.5 million to $902.4 million ($1,396.5M–$1,702.4M FMV minus $800M adjusted tax basis).
(v) At the statutory federal corporate income tax rate of 21%, the resulting federal income tax liability would be in the range of approximately $125.3 million to $189.5 million.
This quantification should appear in the opinion to ensure that the Board and HPE Fund IV are informed of the financial exposure. Cross notes that this is not merely a matter of good practice — it is a matter of professional responsibility, as an opinion that addresses a significant tax risk without quantifying the potential exposure may be inadequate for the purpose of informing the client's decision-making.
(d) Supporting Language for "Should Not" Formulation. The "should not" formulation regarding Section 355(e) in the draft opinion should be supported by a sentence noting that while no statutory safe harbor applies at exactly the three-year mark (the statutory language of Section 355(e) itself does not contain a specific temporal safe harbor — the safe harbors are in the regulations), the regulatory framework set forth in Treasury Regulations Section 1.355-7 provides meaningful comfort once the two-year period specified in the safe harbor has elapsed, provided the factual representations regarding the absence of pre-acquisition discussions, agreements, and understandings are accurate and complete.
B. Hartwell — Comment on § 355(e) Interaction with § 355(d)
Hartwell notes that the draft treats the Section 355(e) analysis and the Section 355(d) analysis in separate sections of the opinion without adequately addressing the interaction between these two provisions. While the provisions are technically distinct — Section 355(d) addresses "disqualified distributions" resulting from certain purchases within the five-year period, while Section 355(e) addresses distributions that are part of a "plan" involving an acquisition of control — they overlap significantly on the facts of this transaction, because HPE Fund IV's acquisition of its 62.4% stake on September 20, 2019 falls within the five-year window for both provisions.
Hartwell recommends that the draft include a discussion of the overlap and, in particular, the rule under Section 355(d)(3) and Section 355(e)(4)(A) of the Code that prevents double counting of gain where both provisions could otherwise apply to the same distribution. This overlap rule ensures that Veldran would not be required to recognize gain twice on the same distribution — once under Section 355(d) and again under Section 355(e) — if both provisions were determined to apply. The draft should reference this rule explicitly and explain its application to the facts of the proposed transaction.
Hartwell further recommends that the revised draft include a cross-reference to the separate Section 355(d) Disqualified Distribution Analysis Memorandum (discussed in Section III below), without incorporating the memorandum by reference into the opinion itself. The cross-reference should appear as an internal notation for the benefit of the drafting team and should not be visible in the version of the opinion delivered to the client.
C. Cross — Revision to Opinion Paragraph
Cross proposes the following revised language for the key Section 355(e) opinion paragraph in the draft. The current draft states:
"Based on the foregoing, we are of the opinion that the Distribution should not be treated as part of a plan (or series of related transactions) within the meaning of Section 355(e) of the Code."
Cross finds this language insufficient because it does not make clear the extent to which the conclusion is dependent on the factual representations set forth in the Representation Letter — particularly the representation regarding the absence of pre-acquisition discussions. Cross proposes the following revised formulation:
"Based on our review of the facts described in the Representation Letter, and assuming the accuracy and completeness of such representations, particularly those relating to the absence of discussions, agreements, or understandings regarding a distribution or similar transaction prior to or at the time of the September 20, 2019 Acquisition, we are of the opinion that the Distribution should not be treated as part of a plan (or series of related transactions) within the meaning of Section 355(e) of the Code that includes the Acquisition."
Cross emphasizes the critical need for the qualifying language regarding accuracy of representations in this revised formulation. The Section 355(e) issue represents the area of greatest tax risk in the transaction, with potential federal income tax liability in the range of $125.3 million to $189.5 million as quantified above. The opinion must make clear — both to the Board of Directors of Veldran and to HPE Fund IV — that the "should not" conclusion is representation-dependent and that the accuracy and completeness of the factual representations regarding pre-acquisition discussions are material to the conclusion. If these representations prove to be inaccurate or incomplete, the conclusion could change, and the tax exposure could be substantial. The integrity of our opinion depends on this being stated clearly and prominently.
III. COMMENTS ON § 355(d) DISQUALIFIED DISTRIBUTION — ADDING A SEPARATE DISCLAIMER PARAGRAPH
A. Cross — Comment on Current § 355(d) Treatment in Draft
Cross has reviewed the draft's treatment of Section 355(d) of the Code — the "disqualified distribution" provision — and finds it materially deficient in its current form. The draft currently limits its discussion of Section 355(d) to two paragraphs in Section IV.C of the opinion and effectively treats Section 355(d) as subsumed within, or subsidiary to, the Section 355(e) analysis. This approach is analytically incorrect and exposes the firm to potential criticism from the client, co-counsel, and (in the worst case) the IRS if the opinion is later reviewed.
1. Separate Treatment Required. Cross notes that Section 355(d) is technically a separate provision from Section 355(e), with distinct requirements, different triggering events, and independent consequences. Section 355(d) applies where stock of the distributing or controlled corporation was "purchased" (within the meaning of Section 355(d)(5)) within the five-year period ending on the date of the distribution, and the purchaser holds (or is deemed to hold) a "disqualified" amount of stock (generally, 50% or greater by vote or value). Section 355(e), by contrast, requires that the distribution be part of a "plan" or "series of related transactions" that includes an acquisition of a 50% or greater interest. The two provisions serve different policy purposes — Section 355(d) targets distributions to recent purchasers, while Section 355(e) targets distributions that are part of a planned change of control — and the opinion should treat them as distinct analytical exercises, each with its own section, rather than conflating them.
2. Key Facts. The key facts for the Section 355(d) analysis are as follows:
(a) HPE Fund IV acquired its 62.4% stake in Veldran (46,488,000 shares) on September 20, 2019, for cash consideration of $1,859,520,000. This acquisition is within the five-year period preceding the anticipated Q4 2022 distribution date.
(b) The acquisition by HPE Fund IV constitutes a "purchase" within the meaning of Section 355(d)(5) of the Code, because the shares were acquired in a transaction in which the basis of the stock in the hands of HPE Fund IV was not determined in whole or in part by reference to the transferor's basis, and the acquisition was not a transaction described in Section 355(d)(5)(B) (i.e., it was not a Section 351 exchange, a gift, or an inheritance).
(c) HPE Fund IV holds its 62.4% Veldran stake through Harrowgate Veldran Holdings LLC (EIN: 86-1483920), a wholly owned Delaware limited liability company that is treated as a disregarded entity for federal income tax purposes. For purposes of Section 355(d), the Veldran stock is treated as held by HPE Fund IV.
(d) Because HPE Fund IV holds more than 50% of the outstanding Veldran stock by vote and value, and such stock was "purchased" within the five-year period, the distribution of Meridian stock to HPE Fund IV (through Harrowgate Veldran Holdings LLC) could trigger Section 355(d) gain recognition by Veldran — i.e., Veldran would be required to recognize gain on the distribution as if the Meridian stock distributed to HPE Fund IV (through the disregarded entity) were sold at fair market value on the distribution date.
3. Internal Memorandum. The Section 355(d) analysis memorandum, prepared by Nazari, reviewed by Simmons, and dated July 8, 2022, concluded that Section 355(d) is implicated on these facts and that gain would be recognized by Veldran at the corporate level unless an exception applies. Cross notes that the draft opinion does not adequately reflect this conclusion. The opinion should not ignore or minimize the Section 355(d) issue; rather, it should address the issue directly and provide appropriate disclaimers.
B. Cross — Proposed Separate Disclaimer Paragraph
Cross recommends adding a separate, standalone paragraph in the opinion letter addressing the Section 355(d) issue. This paragraph should be located in the section of the opinion addressing corporate-level tax consequences and should state the following:
(a) The Distribution may constitute a "disqualified distribution" within the meaning of Section 355(d) of the Code by reason of HPE Fund IV's acquisition of approximately 62.4% of the outstanding common stock of Veldran within the five-year period preceding the date of the Distribution. HPE Fund IV acquired such stock for cash in a transaction that constitutes a "purchase" within the meaning of Section 355(d)(5) of the Code.
(b) To the extent Section 355(d) applies, Veldran would be required to recognize gain on the distribution of Meridian stock as if such stock were sold to the distributees at fair market value on the date of the Distribution. Based on the preliminary valuation range provided by Brackenridge & Co. and Veldran's estimated adjusted tax basis in the Precision Flow Solutions Division assets, the gain recognized could be in the range of approximately $596.5 million to $902.4 million, resulting in federal income tax liability of approximately $125.3 million to $189.5 million.
(c) However, to the extent that Section 355(e) of the Code also applies to the same Distribution — i.e., if the Distribution is treated as part of a plan or series of related transactions that includes the September 2019 Acquisition — the overlap rule set forth in Section 355(d)(3) and Section 355(e)(4)(A) of the Code should prevent double recognition of gain by Veldran. In such event, the gain recognized under Section 355(e) would take into account the gain that would otherwise be recognized under Section 355(d), such that Veldran would not be subject to a duplicative tax.
(d) This opinion does not opine that Section 355(d) will not apply to the Distribution. Rather, this opinion addresses (i) the tax-free treatment of the Distribution at the shareholder level under Section 355(a) of the Code and (ii) the qualification of the Contribution as a reorganization under Section 368(a)(1)(D) of the Code, and separately addresses whether gain recognition would occur at the corporate (Veldran) level under Section 355(e).
Cross emphasizes that this disclaimer is critically important because the current draft, as written, could be read as opining that no corporate-level gain recognition occurs under any provision of the Code — which is not the intended scope or conclusion of the opinion. The opinion must make clear that the Section 355(d) issue remains outstanding and that the opinion does not provide comfort that Section 355(d) will not apply.
C. Hartwell — Note on § 355(d) Scope
Hartwell agrees with Cross's recommended approach to the Section 355(d) disclaimer and adds the following observations regarding the scope of the Section 355(d) analysis.
1. Prescott Capital Management LP. Hartwell notes that the Section 355(d) disclaimer should also reference the fact that Prescott Capital Management LP (approximately 14.8% of Veldran's outstanding common stock, 11,026,000 shares, Managing Partner: Andrew Kessler) co-invested alongside HPE Fund IV in the September 2019 acquisition, acquiring Veldran shares at $40.00 per share. Prescott's shares may also have been acquired by "purchase" within the meaning of Section 355(d)(5), potentially increasing the percentage of Veldran stock that is "disqualified" for Section 355(d) purposes to approximately 77.2% (62.4% HPE Fund IV + 14.8% Prescott). If the disqualified percentage is 77.2% rather than 62.4%, the amount of gain recognized by Veldran under Section 355(d) would be proportionally larger, because the gain recognition applies to the distribution of Meridian stock to holders of disqualified stock.
2. Prescott Secondary Offering. However, Hartwell notes a complicating factor: Prescott later sold 4,474,000 shares of Veldran common stock in a secondary offering, reducing its stake from approximately 15,500,000 shares to 11,026,000 shares. The Section 355(d) analysis should consider whether the shares sold by Prescott in the secondary offering are still counted for purposes of Section 355(d) vis-à-vis the current holders who purchased them. Specifically, the question is whether the purchasers in the secondary offering acquired their shares by "purchase" within the meaning of Section 355(d)(5) — which they likely did, as they acquired the shares for cash in the secondary market — and, if so, whether those shares would be counted as disqualified stock in the hands of the new holders. The resolution of this question could further increase the total percentage of disqualified stock, depending on the facts. Simmons and Nazari should analyze this issue and include appropriate discussion in the revised draft, or, if the analysis proves complex, prepare a separate supplemental memorandum.
IV. COMMENTS ON BUSINESS PURPOSE DISCUSSION — RECASTING TO AVOID PE SPONSOR MONETIZATION RATIONALE
A. Cross — Comment on Section III.A of Draft (Business Purpose)
Cross identifies the business purpose discussion in Section III.A of the draft opinion as the most significant substantive concern with the current draft. The business purpose requirement under Section 355(a) of the Code and Treasury Regulations Section 1.355-2(b) is a fundamental prerequisite to tax-free treatment, and the IRS and the courts have historically given it significant weight in evaluating whether a distribution qualifies under Section 355. If the business purpose articulation is inadequate, the entire opinion is undermined.
1. Current Articulation. The draft currently identifies two business purposes for the proposed spin-off:
(i) Enabling each business — the Engineered Coatings Division (to be retained by Veldran) and the Precision Flow Solutions Division (to be transferred to Meridian) — to pursue independent capital-allocation strategies; and
(ii) Enhancing management focus and operational efficiency by allowing each division to operate as an independent company with dedicated management and a distinct strategic direction.
2. Concern Regarding Purpose (i): PE Sponsor Monetization Rationale. Cross has a serious concern with the first articulated business purpose. As currently drafted, the statement that the spin-off will enable each business to "pursue independent capital-allocation strategies" reads as a thinly veiled restatement of HPE Fund IV's fund-level objectives. In the context of this transaction — where HPE Fund IV is a 2018 vintage fund holding a 62.4% controlling stake in a diversified industrial company — "independent capital-allocation strategies" is understood to mean that HPE Fund IV can monetize its position in the Precision Flow business independently of the Engineered Coatings business, either through a sale of Meridian stock, a secondary offering, or an eventual exit transaction involving Meridian. This is a shareholder-level liquidity and investment-return objective, not a corporate-level business purpose of Veldran.
Under Treasury Regulations Section 1.355-2(b)(2), the business purpose for a Section 355 distribution 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." Critically, a purpose that is "germane only to the shareholders" does not satisfy this requirement. The IRS has consistently taken the position that a spin-off motivated primarily by the desire of a controlling shareholder to monetize or exit an investment does not satisfy the business purpose requirement, even if the transaction also happens to provide some incidental benefit to the corporations involved.
Cross references his email to Christine Yeung dated July 22, 2022, in which he flagged this concern in detail, and the conference call of August 15, 2022, in which Jonathan Caldecott (Chief Executive Officer, Veldran) acknowledged difficulty in articulating business purposes for the spin-off that are independent of Harrowgate's strategic investment objectives. This is a troubling development, and the drafting team should be aware that the factual support for the business purpose requirement is weaker than Cross would prefer.
3. Requested Revisions. Cross requests the following specific revisions to the business purpose discussion in the draft opinion:
(a) Remove or Substantially Rewrite Purpose (i). The "independent capital-allocation strategies" purpose must be removed or substantially rewritten to eliminate any reference to or implication of PE sponsor monetization. The current draft's supporting paragraph for this purpose references "enabling Meridian to access the public equity and debt capital markets independently to fund its growth initiatives" and "allowing Veldran to redeploy capital toward its core coatings business without cross-subsidization." These statements are closer to genuine corporate-level business purposes — they describe benefits to the corporations, not to the shareholders — but the supporting paragraph then proceeds to reference HPE Fund IV's fund-level considerations, including language about "alignment of strategic priorities between the fund and each portfolio business." This language directly undermines the corporate-level characterization and must be deleted. The revised draft should frame this purpose exclusively in terms of the corporate-level benefits: Meridian's ability to access capital markets tailored to the fluid-control industry's growth profile, Veldran's ability to allocate capital toward coatings without dilution of investment in flow technologies, and the reduction of conglomerate discount that impedes each business from obtaining optimal financing terms.
(b) Strengthen Purpose (ii): Management Focus and Operational Efficiency. The draft's treatment of the "management focus and operational efficiency" purpose is conclusory. It states the conclusion — that the spin-off will enhance management focus — without providing the specific factual support that would make the purpose "real and substantial" rather than formulaic. The revised draft should include the following factual details:
(i) The Precision Flow Solutions Division generated approximately $820 million of revenue and approximately $133 million of EBITDA for fiscal year 2021. It serves distinct end markets — including petrochemical, water infrastructure, and industrial process applications — that are fundamentally different from the end markets served by the Engineered Coatings Division.
(ii) The Engineered Coatings Division generated approximately $1.52 billion of revenue and approximately $285 million of EBITDA for fiscal year 2021. It serves the automotive, aerospace, and architectural end markets.
(iii) The two divisions have materially different capital expenditure profiles, customer bases, competitive dynamics, and growth trajectories. The Precision Flow Solutions Division is capital-intensive with long-cycle project-based revenue, while the Engineered Coatings Division has a higher proportion of short-cycle, volume-driven revenue.
(iv) Following the spin-off, Sandra Waverly, the current division president of the Precision Flow Solutions Division, would become Chief Executive Officer of Meridian, providing dedicated executive leadership for the fluid-control business. This represents a meaningful improvement in management focus relative to the current structure, in which the Precision Flow Solutions Division competes for attention and resources with the larger and more established Engineered Coatings Division within Veldran's corporate structure.
(v) The separation would allow Meridian's management to establish compensation, incentive, and equity programs that are directly tied to the performance of the fluid-control business, which would improve alignment between management incentives and business performance.
(c) Explore Third Business Purpose. Cross suggests exploring whether there is a third potential business purpose that could be identified and included in the opinion. Specifically, Cross recommends investigating whether regulatory, customer, or supplier dynamics favor the separation of the two businesses. For example, certain government procurement contracts — particularly in the water infrastructure and petrochemical sectors — may favor or require contracting with pure-play companies that are focused on the relevant industry rather than diversified conglomerates. If such dynamics exist, they could provide an additional, independent corporate-level business purpose for the spin-off that would strengthen the opinion. However, Cross notes that this requires input from Veldran management, specifically from Jonathan Caldecott (CEO) and Sandra Waverly (Division President, Precision Flow Solutions), and that such input has not been forthcoming to date despite requests. Simmons should follow up with Philip Crundell (General Counsel, Veldran) to request information on this point.
B. Cross — Note on Impact on Opinion Level
Cross flags a critical concern regarding the potential impact of the business purpose issue on the overall opinion level. If the business purpose articulation cannot be strengthened along the lines described above — specifically, if Calderwood & Harkness is unable to identify real and substantial corporate-level business purposes for the spin-off that are independent of HPE Fund IV's investment and monetization objectives — the firm may not be able to deliver even a "should" level opinion. The business purpose requirement is a fundamental prerequisite to tax-free treatment under Section 355, and a conclusion that the business purpose requirement is satisfied is embedded in, and essential to, the overall "should qualify" opinion. If the factual support for business purpose is inadequate, a "should" opinion becomes a "more likely than not" opinion — or, in the worst case, the firm may need to decline to issue any opinion at all.
Cross acknowledges that this is a difficult message to deliver to the client, but notes that the professional standards governing the issuance of tax opinions require Calderwood & Harkness to have a reasonable basis for its conclusions, and the firm cannot issue an opinion that it does not believe in good faith to be supportable.
As an interim measure, Cross proposes that the draft opinion include a more explicit qualification in the business purpose section. Cross suggests the following language:
"Our opinion regarding the satisfaction of the business purpose requirement under Section 355(a) of the Code and Treasury Regulations Section 1.355-2(b) is based on the representations set forth in the Representation Letter and assumes that the business purposes described therein are real, substantial, and motivated by genuine corporate-level operational and strategic considerations of the Distributing Corporation and the Controlled Corporation, and not primarily by the investment or liquidity objectives of any particular shareholder. We note that the determination of whether a business purpose is 'real and substantial' and 'germane to the business of the distributing corporation, the controlled corporation, or the affiliated group' within the meaning of the applicable Treasury Regulations is inherently factual, and our opinion is limited to the facts as represented to us."
This language serves a dual function: it protects the firm by making clear that the business purpose conclusion is representation-dependent, and it signals to the client that the strength of the opinion rests on the quality of the factual representations regarding business purpose. Cross notes that this approach shifts risk to the client via the representation mechanism, which is appropriate given the state of the factual record, but it is not a substitute for strengthening the underlying analysis. Ideally, both the analysis and the representation language should be robust.
C. Hartwell — Comment on Business Purpose from Partnership Perspective
Hartwell adds an important observation regarding the business purpose issue as it relates to the fund structure of HPE Fund IV.
HPE Fund IV is a 2018 vintage private equity fund with aggregate capital commitments of $6.8 billion. As of the proposed Q4 2022 distribution date, the fund is approximately four years old, which places it squarely within the typical investment period or early harvest period for a private equity fund. The timing of the spin-off — occurring during the period when a PE fund would typically be seeking to monetize its portfolio investments and return capital to limited partners — creates a circumstantial inference that the spin-off is motivated, at least in significant part, by HPE Fund IV's fund-level objectives. The IRS could argue that the spin-off is timed to facilitate distributions to limited partners and to enable HPE Fund IV to exit one or both of the separated businesses on a timeline consistent with its fund lifecycle, rather than being motivated by genuine corporate-level business purposes.
Hartwell recommends that the opinion not reference fund-vintage, fund-cycle, fund-level return objectives, or limited partner distribution considerations at all — whether in the business purpose discussion or anywhere else in the opinion. Any such references would create a documentary record that could be used against the client in an IRS examination or in litigation, and there is no obligation to include such information in a corporate tax opinion addressed to the Board of Directors of Veldran. The opinion should be entirely silent on the fund structure's investment cycle and should focus exclusively on the corporate-level business purposes as articulated by Veldran management.
V. COMMENTS ON KESTREL § 355(b)(2)(C)/(D) ANALYSIS — REVISING TREATMENT
A. Cross — Comment on Section III.C of Draft (Active Trade or Business)
Cross has reviewed the draft's treatment of the Section 355(b) active trade or business ("ATB") requirement and finds it generally sound, with one significant exception: the handling of the Kestrel Precision Controls acquisition requires substantial revision. The ATB requirement is one of the core prerequisites for tax-free treatment under Section 355(a), and the Kestrel acquisition raises technical issues under Sections 355(b)(2)(C) and 355(b)(2)(D) that must be addressed precisely and thoroughly in the opinion.
1. Background Facts. The following background facts should be more precisely stated in the opinion's factual summary and in the ATB analysis section:
(a) Kestrel Precision Controls, Inc. is a Georgia corporation (EIN: 58-2847193) that was acquired by Veldran on June 7, 2019 from Rennick Industrial Partners Fund II LP (EIN: 82-3017564) for aggregate consideration of $295 million in an all-cash taxable stock acquisition.
(b) Kestrel was founded on February 12, 2003, as evidenced by its certificate of incorporation filed with the Georgia Secretary of State on that date. Kestrel has continuously operated its precision fluid-control systems business since its founding in 2003.
(c) Following the acquisition, Kestrel became a wholly owned subsidiary of Veldran and was integrated into the Precision Flow Solutions Division. As of fiscal year 2021, Kestrel contributed approximately 35% of the Precision Flow Solutions Division's total revenue — approximately $287 million of the division's $820 million total — making it a significant component of the business to be conducted by Meridian post-spin.
(d) The five-year look-back period for purposes of Section 355(b)(2)(A) runs from the date of the distribution. Assuming a Q4 2022 distribution date, the five-year look-back would reach back to Q4 2017. The Kestrel acquisition on June 7, 2019 falls within this five-year window.
2. Section 355(b)(2)(C) Issue. Section 355(b)(2)(C) of the Code provides that a trade or business shall not be treated as meeting the ATB requirement if it was acquired by the distributing or controlled corporation in a transaction in which gain or loss was recognized in whole or in part within the five-year period ending on the date of the distribution. Because Kestrel was acquired by Veldran for cash in a fully taxable stock acquisition — not a tax-free reorganization or other nonrecognition transaction — Section 355(b)(2)(C) is directly implicated. The Kestrel trade or business, standing alone, would not meet the ATB requirement under Section 355(b)(2)(A) (which requires that the trade or business have been actively conducted throughout the five-year period by the distributing or controlled corporation) because it was acquired by Veldran only approximately three-and-a-half years before the anticipated distribution date.
3. Section 355(b)(2)(D) Safe Harbor. However, Section 355(b)(2)(D) provides a safe harbor. Under this provision, a trade or business acquired in a taxable transaction within the five-year period is nevertheless treated as meeting the ATB requirement if the trade or business was actively conducted throughout the five-year period ending on the date of the distribution by the entity from which it was acquired (i.e., Kestrel itself, prior to its acquisition by Veldran). Because Kestrel was founded on February 12, 2003 and has operated its precision fluid-control systems business continuously since that date — a period of approximately 19 years — the safe harbor under Section 355(b)(2)(D) should be satisfied with respect to the Kestrel business.
B. Cross — Specific Drafting Comments
Cross provides the following specific drafting comments regarding the ATB analysis in the opinion:
1. Standalone Subsection. The draft currently conflates the Section 355(b)(2)(C)/(D) issue with the broader ATB analysis, mentioning the Kestrel acquisition in passing within a general discussion of the Precision Flow Solutions Division's business history. Cross recommends creating a standalone subsection within the ATB discussion dedicated specifically to the Kestrel issue. This subsection should set forth the relevant facts, identify the Section 355(b)(2)(C) concern, and explain why the Section 355(b)(2)(D) safe harbor is satisfied. A standalone treatment is appropriate given the significance of the Kestrel business to Meridian's overall operations (approximately 35% of division revenue) and the technical specificity of the issue.
2. Distinguishing Kestrel from Non-Kestrel Business. The draft does not adequately distinguish between the Kestrel business and the non-Kestrel portion of the Precision Flow Solutions Division. This distinction is analytically important. The opinion should make clear that:
(a) The ATB analysis applies to the Precision Flow Solutions Division as a whole — i.e., as the trade or business to be conducted by Meridian following the spin-off;
(b) The Kestrel portion of the division (approximately 35% of division revenue) satisfies the ATB requirement by virtue of the Section 355(b)(2)(D) safe harbor, as described above; and
(c) The non-Kestrel portion of the division (approximately 65% of division revenue, or approximately $533 million) satisfies the ATB requirement under Section 355(b)(2)(A) on its own terms, because this business was conducted by Veldran (or its predecessor entities) for more than five years prior to the anticipated distribution date.
3. Predecessor Entity History. With respect to the non-Kestrel portion of the division, Cross notes that the draft should clarify the predecessor-entity history. Veldran Industries Holdings, Inc. was incorporated on March 14, 2019 — within the five-year look-back period — in connection with the leveraged buyout by HPE Fund IV. However, the Precision Flow Solutions business operations trace to predecessor entities that conducted the business for a substantially longer period. The opinion should identify the relevant predecessor entities and explain that the business was continuously conducted by such predecessors for more than five years, with the operations being transferred to Veldran in connection with the 2019 buyout. This predecessor-entity history is necessary to satisfy the Section 355(b)(2)(A) requirement with respect to the non-Kestrel business, and the current draft is ambiguous on this point.
4. Section 338 Election. Cross also notes that the draft should address whether a Section 338 election was made in connection with the Kestrel acquisition. A Section 338 election would have treated the Kestrel stock acquisition as an asset acquisition for federal income tax purposes, which could affect Kestrel's tax basis in its assets and could potentially implicate different aspects of the Section 355(b)(2)(C)/(D) analysis. The supplemental diligence request dated May 16, 2022 asked Veldran's counsel for information regarding whether a Section 338 election was made, and the firm's diligence tracker shows this item as received. The opinion should state affirmatively whether a Section 338 election was or was not made and should address the implications (or lack thereof) of the election status for the ATB analysis.
C. Nazari Compilation Note
Per the firm's diligence tracker (last updated August 29, 2022), documents received from Philip Crundell (General Counsel, Veldran) on June 20, 2022 confirm that no Section 338 election was made in connection with the Kestrel Precision Controls acquisition. The acquisition was a straight stock purchase at a price of $295 million, with no election under Section 338(g) or Section 338(h)(10). Accordingly, Kestrel retained its historical tax basis in its assets following the acquisition, and the Section 355(b)(2)(D) safe harbor analysis should not be complicated by any deemed asset acquisition or basis step-up.
Additionally, the Kestrel founding documentation — specifically, the certificate of incorporation issued by the Georgia Secretary of State, dated February 12, 2003 — was received from Veldran's counsel and has been reviewed by Nazari. This document confirms that Kestrel has been in continuous corporate existence since February 12, 2003. Supplemental due diligence materials, including Kestrel's annual report filings with the Georgia Secretary of State and its federal tax returns for the years 2017 through 2021, have been received and are on file. These materials are consistent with the representation that Kestrel has continuously operated its precision fluid-control systems business since its founding.
VI. HARTWELL'S COMMENTS ON PARTNERSHIP-LEVEL TAX CONSEQUENCES FOR HPE FUND IV LIMITED PARTNERS
A. Hartwell — Comment on Scope of Opinion
Hartwell provides the following detailed comments regarding the scope of the opinion as it relates to partnership-level tax consequences for HPE Fund IV and its limited partners.
1. Current Opinion Scope. The draft opinion currently addresses the tax consequences of the proposed spin-off at two levels: (i) the corporate level — specifically, whether Veldran will recognize gain or loss on the distribution of Meridian stock to its shareholders — and (ii) the shareholder level — specifically, whether Veldran shareholders will recognize gain or loss on their receipt of Meridian stock in the distribution. The opinion concludes (at the "should" level) that the distribution should qualify for non-recognition treatment at both levels.
2. Omission of Partnership-Level Analysis. Hartwell notes that the opinion is entirely silent on the pass-through consequences to HPE Fund IV's limited partners. This is a significant omission that should be addressed — not by adding a full partnership-level opinion (which is beyond the scope of the engagement and raises additional complexity), but by adding appropriate disclaimers and scope limitations.
3. Fund Structure. The relevant fund structure is as follows:
(a) HPE Fund IV — Harrowgate Private Equity Fund IV, L.P. (EIN: 84-3291067) — is a Delaware limited partnership formed under the Delaware Revised Uniform Limited Partnership Act. HPE Fund IV is the entity that holds the 62.4% stake in Veldran (through the disregarded entity described below).
(b) HPE Fund IV is managed by Harrowgate Capital Advisors LLC (EIN: 83-2756891), a Delaware limited liability company that serves as the fund's investment advisor and manager.
(c) Harrowgate Capital Partners IV GP LLC (EIN: 84-3291104) is a Delaware limited liability company that serves as the general partner of HPE Fund IV.
(d) HPE Fund IV holds its 62.4% Veldran stake through Harrowgate Veldran Holdings LLC (EIN: 86-1483920), a wholly owned Delaware limited liability company. Harrowgate Veldran Holdings LLC has not elected to be classified as a corporation for federal income tax purposes and is therefore treated as a disregarded entity. For federal income tax purposes, the Veldran stock held by Harrowgate Veldran Holdings LLC is treated as held directly by HPE Fund IV.
(e) HPE Fund IV is itself classified as a partnership for federal income tax purposes. Accordingly, HPE Fund IV does not pay federal income tax on its income; rather, the items of income, gain, loss, deduction, and credit of HPE Fund IV are allocated to and reported by its partners — the limited partners and the general partner — under the rules of subchapter K of the Code.
4. Tax Consequences to Partners. Upon receipt of Meridian stock in the distribution, HPE Fund IV would hold the Meridian stock as a partnership asset. The tax consequences of the distribution to HPE Fund IV's limited partners would depend on several factors, including:
(a) Whether the Section 355(a) non-recognition treatment at the shareholder level "flows through" to the partners of HPE Fund IV — i.e., whether the partners are treated as receiving their pro rata share of the Meridian stock on a tax-free basis;
(b) How the partners' basis in their HPE Fund IV partnership interests is affected by the distribution — specifically, how basis is allocated between the Veldran stock and the Meridian stock at the partner level;
(c) Whether any special allocation provisions in the HPE Fund IV partnership agreement affect the allocation of the Meridian stock or the tax consequences of the distribution among the partners; and
(d) Any state or local tax consequences to the partners, which may vary depending on the partner's domicile and the jurisdictions in which HPE Fund IV conducts business.
5. Recommended Disclaimers. Hartwell recommends adding a paragraph in the op