Mallinckrodt and Endo Announce Merger, Possible Spin

By: Stuart E. Leblang, Michael J. Kliegman, and Amy S. Elliott 

On March 13, pharmaceutical manufacturers Mallinckrodt plc (Mallinckrodt), an Irish corporation, and Endo, Inc. (OTCQX: NDOI) (Endo), a Delaware corporation, announced that they entered into an agreement to combine in a stock-and-cash transaction expected to close in the second half of 2025.¹ By way of a merger of a special purpose U.S. subsidiary, Mallinckrodt will acquire 100 percent of the stock of Endo, and the Endo shareholders will receive consideration consisting of $80 million in cash and 49.9 percent of the outstanding post-merger stock in Mallinckrodt, with the combined company headquartered in Ireland.² 

Among other things, the merger will return Mallinckrodt to public trading, which it lost in 2023.³ The announcement also indicated that the companies would combine their generic pharmaceuticals businesses and Endo’s sterile injectables business following the merger and intend to separate that combined business at an undetermined later date in a distribution or sale transaction (Generics Separation).

Despite the overwhelmingly large amount of stock consideration in the transaction, the Transaction Agreement makes clear the intention to treat the entire consideration as taxable capital gain or loss to the Endo shareholders. The “mechanism” for ensuring that the merger does not qualify as a tax-free reorganization seems to be that at least some cash consideration is sourced from Mallinckrodt, disqualifying the acquisition of Endo stock from “B” reorganization treatment due to its strict “solely for voting stock” requirement.⁴ The reverse subsidiary merger format would lend itself to potentially qualifying under a somewhat more lenient set of requirements. Further, according to the Transaction Agreement, the merger subsidiary is a limited liability company (LLC) that is treated as a disregarded entity for tax purposes, thus negating the transaction as potentially qualifying under the reverse subsidiary merger provisions.⁵ 

We are not sure about the precise amounts but think that the bulk of the cash will be sourced from Endo, either cash on hand or borrowed amounts. The Transaction Agreement lays out in unusually abundant detail how the parties intend the cash to be treated.⁶ The Endo-sourced cash will be treated as distributed in redemption of a portion of each shareholder’s Endo stock, which, taking into account the sale of the company in the merger, is to be treated as a complete termination of the shareholder’s interest in the corporation qualifying for capital gain or loss treatment.⁷   

As noted above, all consideration, including stock and some amount of cash sourced from Mallinckrodt, is treated as taxable consideration for the sale of Endo stock. The parties anticipated, however, that the Mallinckrodt cash could potentially be subject to the redemption rules by way of Section 304 of the Internal Revenue Code. Where the shareholders of a target corporation will own 50 percent or more of the acquiror after the acquisition, any non-stock consideration is treated as redemption proceeds, with the possibility of dividend treatment if the redemption tests are not satisfied.

With Endo shareholders as a group owning 49.9 percent of post-merger Mallinckrodt and the likelihood of overlapping shareholders, it is clear that the parties anticipated that Section 304 would be more than just a risk, but a near-certainty. The Transaction Agreement explicitly calls on the parties to use best efforts to ensure that the Exchange Agent accepts certificates from Endo shareholders that the deemed redemption resulting from Section 304 will qualify as a substantially disproportionate redemption ensuring capital gain treatment.⁸  

Any time we have a non-U.S. corporation issuing its stock to acquire a U.S. corporation, the U.S. anti-inversion rules can potentially cause significant adverse consequences. Mainly, if the transaction causes the U.S. corporation to be an “expatriated entity,” then the most severe consequence may be that the non-U.S. acquiror will be treated as a U.S. corporation for U.S. tax purposes.⁹ Subject to details developed in regulations, such an acquisition does not attract adverse consequences provided the shareholders of the acquired U.S. corporation will acquire  less than 60 percent of the non-U.S. acquiror’s stock. The severe treatment of the non-U.S. corporation as a U.S. taxpayer kicks in if the U.S. corporation’s shareholders acquire 80 percent or more of the acquiror. The Transaction Agreement makes clear the parties’ intention that these rules will not come into play, and given the post-merger ownership percentages, this makes sense.

The Transaction Agreement explicitly anticipates that, pre-combination, the parties will begin to prepare for the prompt separation of the combined Specialty Generics Business from the post-merger company “by spin-off, split-off sale or otherwise.”¹⁰ This raises a few technical questions as to their ability to execute a tax-free spin-off or split-off relatively soon after the merger.

Let’s start with whether Mallinckrodt’s taxable acquisition of Endo would preclude a Specialty Generics spin-off from satisfying the active trade or business (ATB) requirement under Section 355(b). Generally, the ATB test requires that the Remainco and Spinco each be engaged in an ATB that has been continuously carried on during the preceding five years. If the ATB was acquired during the past five years, it must have been in a transaction in which no gain or loss was recognized. This would be a problem if the entirety of the Specialty Generics Business were acquired in the Endo transaction. However, a portion of the Specialty Generics Business is coming from Mallinckrodt, and therefore, there should not be an ATB problem, at least if Mallinckrodt has carried on the business for at least five years.¹¹ 

There are two distinct provisions of Section 355 that could give rise to corporate-level gain recognition in an otherwise qualifying Section 355 distribution. The more familiar one is Section 355(e), the so-called anti-Morris Trust provision, which generally comes into play where a Section 355 distribution occurs as part of a plan with one or more other transactions resulting in the parent company shareholders not retaining majority ownership in both post-spin companies. This concern arises most commonly where an M&A transaction occurs following a spin-off, but it can also occur where the M&A transaction precedes the spin-off. The other provision, Section 355(d), can apply when one or more shareholders acquire a 50-percent-or-greater interest in either the Remainco or Spinco as a result of having purchased their stock in one or the other during the preceding five years.   

In either case, before expending further effort to analyze the application of these gain recognition rules, we should ask whether we care. Since the company making the Section 355 distribution to shareholders will be Irish-incorporated Mallinckrodt, as a general matter, we should be indifferent as to whether or not it enjoys corporate-level nonrecognition treatment under U.S. tax rules. The reason we do care is that a potentially large portion of the Specialty Generics business presently sits within Endo and possibly a U.S. subsidiary of Mallinckrodt. As such, a tax-free distribution by the Irish public company must be preceded by distributions and an internal reorganization involving these U.S. subsidiaries.

With respect to Section 355(e), it is clear that the spin-off and merger are part of a plan, and we do not see an applicable safe harbor under the regulations.¹²However, it seems to be the case that the pre-merger shareholders of both companies will continue to own a majority of Mallinckrodt and the Specialty Generics Spinco following the separation. This is obviously the case on the Mallinckrodt side, and for the Endo shareholders, it seems to be the case that the parties expect there to be enough overlapping shareholders between the two companies to put the Endo group over the 50-percent mark.¹³ 

Regarding Section 355(d), the Endo shareholders as a group will be regarded as acquiring their Mallinckrodt stock by purchase, since they are receiving it in a taxable exchange for their Endo stock. Provided they receive no more than 49.9 percent of the Generics Spinco or Splitco corresponding to their 49.9 percent interest in Mallinckrodt, it seems they could be on the “good” side of Section 355(d). The situation gets more complicated, however, to the extent that there needs to be an internal Section 355 distribution from Endo to Mallinckrodt. The reason is that Mallinckrodt will have purchased 100 percent of Endo and thereby obtained a purchased basis in Endo. This gets us into an area of extraordinary complexity, but we see a basis in the regulations to conclude that the fact that an internal spin-off from Endo will be followed by the public spin-off by Mallinckrodt may take the distribution out of Section 355(d) and avoid gain recognition.¹⁴ 

To sum up a whirlwind run-through of an extraordinarily complex and well-planned transaction: we have merger-of-equals between an Irish and U.S. company that will take the U.S. company offshore; a mostly stock transaction in which the Endo shareholders recognize capital gain or loss; no U.S. withholding tax on the cash component; and an announced intention to separate a portion of the combined businesses, which may take the form of a tax-free distribution (unclear whether there may be some corporate tax cost) or possibly a sale. Subject, of course, to antitrust and other regulatory hurdles, we do not expect tax issues to impede the successful consummation of the transaction.

^{[1] Joint Press Release, Mallinckrodt and Endo, Mallinckrodt and Endo to Combine to Create a Global, Scaled, Diversified Pharmaceuticals Leader (March 13, 2025) (https://www.sec.gov/Archives/edgar/data/1567892/000110465925023217/tm259039d1_ex99-1.htm).}

^{[2] The combination will also require amendments to Mallinckrodt’s Constitution by way of a Scheme of Arrangement judicial proceeding. For the Transaction Agreement by and among Mallinckrodt, Endo and Salvare Merger Sub LLC dated as of}

^{March 13, 2025, see: https://www.sec.gov/Archives/edgar/data/1567892/000110465925023351/tm259102d1_ex2-1.htm}

^{[3] Press Release, Intercontinental Exchange, Inc., NYSE American to Commence Delisting Proceedings Against Mallinckrodt plc (MNK) (Aug. 28, 2023) (https://ir.theice.com/press/news-details/2023/NYSE-American-to-Commence-Delisting-Proceedings-Against-Mallinckrodt-plc-MNK/default.aspx).}

^{[4] IRC §368(a)(1)(B).}

^{[5] IRC §368(a)(2)(E). We also note that where each share of Target stock is acquired for a combination of stock and cash, the requirements of the statute will not be met.}

^{[6] There is more detail elsewhere in the Transaction Agreement, but paragraph (G) of the recitals (page 2) is worth quoting in full: “(G) For U.S. federal (and to the extent applicable, state and local) income tax purposes, it is the intent of the Parties (A) that with respect to the Merger, (i) the receipt by the Eagle Shareholders of the Per Share Tax Eagle Funded Cash Consideration shall be treated as a redemption by Eagle of a portion of each share of Eagle Common Stock, with a value equal to such Per Share Tax Eagle Funded Cash Consideration (the “Redemption”) that is integrated with the disposition of the remaining portion of each share of Eagle Common Stock in the Merger pursuant to Zenz v. Quinlivan, 213 F.2d 917 (6th Cir. 1954), resulting in a complete termination of each Eagle Shareholder’s interest in the aggregate equity interests in Eagle owned by such Eagle Shareholder before the Merger within the meaning of Section 302(b)(3) of the Code (other than with respect to any Eagle Shareholder that, after the Merger, owns, directly or constructively under Section 318 of the Code, 50% or more of the stock of Macaw and thus is treated as owning, under Section 318(a)(2)(C) of the Code, stock of Eagle after the Merger), (ii) the receipt by the Eagle Shareholders of the Per Share Stock Consideration (other than any Fractional Entitlements) shall be treated as a taxable exchange of a portion of each share of Eagle Common Stock, with a value equal to the value of such Per Share Stock Consideration, governed by Section 1001 of the Code, and (iii) subject to the last sentence of Clause 7.5(f), the receipt by the Eagle Shareholders of the Per Share Tax Base Cash Consideration (together with any cash in lieu of Fractional Entitlements) shall be treated as taxable exchange of a portion of each share of Eagle Common Stock, with a value equal to such Per Share Tax Base Cash Consideration (and the amount of any cash in lieu of Fractional Entitlements), governed by Section 1001 of the Code unless Section 304 of the Code applies to the Merger, and, if, as anticipated by the Parties, Section 304 of the Code applies to the Merger, a distribution of property in a transaction described in Section 304(a)(1) of the Code (the “Section 304 Transaction” and clauses (i), (ii) and (iii), the “Intended Merger Consideration Tax Treatment”) and (B) Macaw shall not become, as a result of the Merger, an Inverted Company (the “Intended Section 7874 Treatment,” and, together with the Intended Merger Consideration Tax Treatment, the “Intended US Tax Treatment”).”}

^{[7] IRC §302(b)(3), relying on the well-established doctrine of Zenz v. Quinlivan, 213 F.2d 917 (6th Cir. 1954). Section 7.05(e) of the Transaction Agreement provides that the parties will use best efforts to ensure that the Exchange Agent accepts certification from Endo shareholders that they satisfy this redemption test.}

^{[8] Section 7.05(f) of the Transaction Agreement. Under IRC §304(b)(1), a shareholder’s post-merger indirect ownership in Endo (as a subsidiary of Mallinckrodt) is compared to its pre-merger percentage ownership in Endo. A greater-than-20% reduction is generally sufficient to satisfy the statute.}

^{[9] IRC §7874.}

^{[10] Section 7.14 of the Transaction Agreement. We suspect that there is a missing comma here: there is no such a thing as a split-off sale, but rather three alternatives are presented: spin-off, split-off, or sale.}

^{[11] If there were a question as to whether the specific resources being spun off from the combined entity had been carried on for five years, there would still likely be a strong argument that the Specialty Generics Business was an outgrowth, or expansion, of longer-term historical businesses of Mallinckrodt.}

^{[12] See Treas. Reg. §1.355-7(d).}

^{[13] We infer this from the fact that the parties expect §304 to apply to the merger, which would require them to believe that there are enough overlapping shareholders to put the Endo shareholders over 50%. See Recital G, quoted in footnote 5 above.}

^{[14] See Treas. Reg. §1.355-6(b)(3)(vi), Example 10.}

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