Partnership Argues Intercompany Loan Was Genuine Debt

By letter dated October 8, 2009, Respondent's Appeals Office mailed Petitioner a Notice of Deficiency for income taxes for the tax years ended March 31, 2001, March 31, 2002 and March 31, 2003. Respondent's Notice of Deficiency asserts that Petitioner is liable for income taxes for the following taxable years in the following amounts, respectively:

      Fiscal Year Ending                 Proposed Tax Deficiency

On January 6, 2010, Petitioner timely filed its petition in this case. Respondent filed its answer on March 9, 2010. After exhaustive informal and formal discovery, the trial of this case was conducted from May 2, 2011 to May 11, 2011 in Washington, DC before the Honorable Judge Diane L. Kroupa. At the conclusion of trial, the Court ordered the parties to file simultaneous opening briefs by July 25, 2011, and simultaneous reply briefs no later than August 24, 2011.

C. Rule 155 Computations

Computations under Rule 155 of the Court's Rules of Practice and Procedure will be required to reflect the resolution of the interest expense issue by the Court and concessions by Respondent, including a July 7, 2009 abatement (and resulting overpayment) of income taxes in the amount of $2,189,930 with respect to Petitioner's March 31, 2003 tax period.

      Fiscal Year Ending                 Interest Expense Claimed

A. Jurisdictional Matters

2. By letter dated October 8, 2009, the Respondent's Appeals Office mailed Petitioner a Notice of Deficiency (Ex. 1-J) for income taxes for the tax years ended March 31, 2001, March 31, 2002 and March 31, 2003. Stip. ¶ 1.

3. On January 6, 2010, Petitioner timely filed its petition in this case. Stip. ¶ 2. At the time of filing the petition, Petitioner's principal place of business was in Portland, Oregon. Ex. 1-J.

B. The Parties

5. Iberdrola Renewables Holdings, Inc. & Subsidiaries, a Delaware corporation, became the successor in interest to NAGP as follows: On December 1, 2003, NAGP merged into PacifiCorp Holdings, Inc. ("PHI"), with PHI as the surviving corporation; on March 21, 2006, PHI changed its name to ScottishPower Holdings, Inc. ("SPHI"); and on April 15, 2008, SPHI changed its name to Iberdrola Renewables Holdings, Inc. ("IRHI" or "Iberdrola"). Stip. ¶ 5.

7. Until April 23, 2007, when ScottishPower was acquired (and became a subsidiary of) by Iberdrola S.A., ScottishPower shares were widely held and publicly traded on both the London Stock Exchange and the New York Stock Exchange (through American Depositary Shares ("ADS")). Iberdrola S.A. is an international energy company based in Spain. Stip. ¶ 13.

9. At year-end 1998, PacifiCorp's revenue and profits were derived primarily from Domestic Electric Operations in the United States. Ex. 245-P (Shaked Expert Report) at p. 9. Domestic Electric Operations was primarily composed of a regulated utility distribution and retail sales business located in Oregon, Utah, Washington, Idaho, Wyoming and California. Ex. 245-P (Shaked Expert Report) at p. 9; Stip. ¶ 15.

10. PacifiCorp also owned indirectly 100% of Powercor Australia, Ltd. ("Powercor"), the largest of the five electric distribution companies in Victoria, Australia, and a 19.9% interest in the 1,600 megawatt brown coal-fired thermal Hazelwood power station and adjacent brown coal mine in Victoria, Australia ("Hazelwood"). Stip. ¶ 16.

11. At the time of the Acquisition, PacifiCorp's common shares were publicly-traded on the New York Stock Exchange. Stip. ¶ 17. During 1994 through 1998, PacifiCorp paid quarterly dividends in the amount of $0.27 ($1.08 annually) per share of common stock. Stip. ¶ 18.

C. Trial Witnesses

13. Andrew MacRitchie: Former Director of ScottishPower's Corporate Strategy Group and subsequently Transition Director and an Executive Vice-President at PacifiCorp testified as to aspects of ScottishPower's due diligence surrounding the acquisition of PacifiCorp, including the development of financial and cost savings projections, site visits, regulatory approvals, transition planning, and the impact of the Western Power Crisis. Tr. 316-354 (MacRitchie).

14. Larry Martin: Former Senior Tax Executive of PacifiCorp (U.S.) testified as to PacifiCorp post-merger, NAGP's service of the Intercompany Debt and the accounting and tax treatment thereof, later analysis of the debt under changed conditions and subsequent review, restructuring and replacement of the debt. Tr. 743-777 (Martin).

15. Charles Merriman: Former Global Service Client Director (M&A) of Ernst & Young's International Tax Practice Group testified as to Ernst & Young's advice to ScottishPower concerning its acquisition of PacifiCorp, including with respect to the Intercompany Debt. Tr. 55-146 (Merriman).

16. Heather Self: Former Director of ScottishPower's Tax Group (International) testified as to ScottishPower and PacifiCorp's treatment of the Loan Notes post-merger and facts surrounding the payment of interest on the debt and the tax treatment thereof, as well as later analysis of the debt under changed conditions and the subsequent review, restructuring and replacement, and repayment of the debt. Tr. 896-943 (Self).

17. Jamie Wilson: Former Senior Financial Analyst of ScottishPower's Corporate Strategy Group testified as to ScottishPower's due diligence process surrounding the acquisition of PacifiCorp, including preparation of the financial and cost savings projections and development of the Valuation Model. Tr. 262-294 (Wilson).

18. Donald Wright: ScottishPower Assistant Treasurer (Group Treasury) testified as to ScottishPower and NAGP's accounting treatment of the Intercompany Debt. Tr. 817-878 (Wright).

20. Charles Chigas: Investment Banker and former Managing Director of Credit Suisse First Boston's Debt Capital Markets Desk (Electric Utility, Energy and Project Finance) provided expert testimony on whether third party investors would have purchased bonds on terms similar to the Loan Notes and how the debt capital markets would have viewed such an offering. Mr. Chigas is an expert in investment banking and the debt capital markets. Ex. 253-P (Chigas Expert Report).

21. Israel Shaked: Professor of Finance and Economics, Boston University's School of Management, provided expert testimony on NAGP's capital adequacy, equity value and whether ScottishPower's projections formed a reasonable basis to assess NAGP's ability to repay the Loan Notes. Professor Shaked is an expert in corporate finance, corporate valuations, and mergers and acquisitions. Ex. 245-P (Shaked Expert Report).

22. James Vander Weide: Research Professor of Finance and Economics, Duke University, the Fuqua School of Business, provided expert testimony on the electric power industry and economic environment pre- and post-merger, the reasonableness of ScottishPower's cost savings and growth rate assumptions and the impact of regulatory restrictions on PacifiCorp's ability to pay dividends to NAGP. Professor Vander Weide is an expert in the fields of corporate finance, the utility industry, and utility regulations. Ex. 249-P (Vander Weide Expert Report).

23. During the mid to late 1990s, the electric power industry was robust, characterized by rapid economic growth and an optimistic future. Ex. 249-P (Vander Weide Expert Report) at pp. 12, 14. During this period, energy companies frequently engaged in mergers and acquisitions that were intended to reduce costs and improve their competitive positions. Ex. 249-P (Vander Weide Expert Report) at p. 2.

24. ScottishPower had a history of successful acquisitions and was experienced at delivering cost savings in order to increase value for both the acquiring and acquired companies' stockholders. Tr. 428:5-9 (Shaked); Ex. 189-J at PHI-DOCS079355 to PHI-DOCS079356; Tr. 209:16-210:19 (Brown).

25. In the early 1990s, ScottishPower made two sizable acquisitions: in October 1995, ScottishPower acquired Manweb, an electricity supplier to more than 1.3 million customers (and $1.3 billion in annual turnover) in Wales, United Kingdom. Stip. ¶ 8. In August 1996, ScottishPower acquired Southern Water, a water supplier to more than 1.7 million customers (and $800 million in annual turnover) in the southern United Kingdom. Stip. ¶ 9.

26. ScottishPower routinely prepared financial projections or forecasts in connection with its negotiations with potential acquisition targets, including the Manweb transaction. Tr. 209:16-19; Tr. 210:6-9 (Brown). These projections were prepared primarily to value the company and to gauge the impact of the combined company on ScottishPower's earnings per share. Tr. 209:20-210:5 (Brown).

27. When ScottishPower acquired Manweb and Southern Water, it prepared cost savings projections that were largely, if not entirely, achieved. Tr. 210:13-19 (Brown).

28. By the mid-1990s, ScottishPower began exploring international acquisitions. Stip. ¶ 7. ScottishPower's primary interest in international business expansion focused on the United States because of trends towards deregulation and the anticipated introduction of competition into utility markets. Stip. ¶ 10; Tr. 213:15-215:6 (Brown). ScottishPower felt that its ability to grow in the U.K. was constrained both by the size of the utility industry, and also by the fact that it already had substantial U.K. interests. Tr. 213:18-23 (Brown).

29. ScottishPower had explored an acquisition in Victoria, Australia, but concluded that the Australian market was too remote and too small to be of great strategic interest. Tr. 215:7-14 (Brown).

30. ScottishPower's strategy group studied the U.S. utility industry and obtained advice from various advisors including investment bankers and U.S. regulatory experts. Tr. 213:2-14 (Brown).

31. ScottishPower began its acquisition efforts in the U.S. by compiling an exhaustive list of potential acquisition targets and then eliminating companies with substantial exposure to nuclear generation. Tr. 215:15-22 (Brown). ScottishPower was also seeking companies in geographical areas with strong growth prospects. Tr. 215:23-216:2 (Brown).

32. In early 1998, ScottishPower actively pursued a number of target companies in the U.S., including extended discussions with Florida Progress, brief talks with Dominion Resources and more extensive discussions with Cinergy. Stip. ¶ 11; Tr. 208:13-209:14 (Brown).

B. ScottishPower's Identification of PacifiCorp as an Acquisition Target

33. In late 1998 PacifiCorp's stock was trading at approximately $19 per share (down sharply from over $27 per share a year earlier). Ex. 2-J at PHI-DOCS097142. During this period, PacifiCorp's stock had declined, in part, due to a failed acquisition attempt of its own and management turnover. Ex. 2-J at PHI-DOCS097144; Tr. 216:11-217:3 (Brown).

34. In 1998, there was a general perception in the financial community that PacifiCorp had "taken their eye off the ball" of its core businesses in pursuit of international expansion activities. Tr. 547:5-9 (Vander Weide); Tr. 216:24-217:3; Tr. 218:24-219:2 (Brown).

35. ScottishPower believed that PacifiCorp had not paid sufficient attention to controlling its costs, which was highlighted in ScottishPower's benchmarking analysis that compared PacifiCorp's costs against comparable utilities. Tr. 219:3-9 (Brown). This belief was later confirmed through ScottishPower's due diligence. Id.

36. Notwithstanding the above-referenced issues, PacifiCorp was otherwise a highly valuable and respected company with an "A" debt rating, a good asset base with solid growth and demand for electricity, a consistent dividend-paying record, and a strong presence in the western U.S. Consequently, ScottishPower viewed PacifiCorp as an ideal acquisition target. Ex. 2-J at PHI-DOCS097146; Tr. 219:13-16 (Brown).

37. In summary, ScottishPower viewed PacifiCorp as a sound company that was going through a bad patch. Tr. 219:13-16 (Brown).

38. ScottishPower believed that a merger would benefit both companies by improving operating performance and providing enhanced service to customers. Stip. ¶ 54; Ex. 13-J at PHI-DOCS 104947.

39. ScottishPower management believed its experience operating in the competitive market in the U.K. would assist PacifiCorp as the electric utility industry in the U.S. moved toward increased competition and deregulation. Ex. 13-J at PHI-DOCS 104947.

40. In early July 1998, Ian Robinson, ScottishPower's chief executive, contacted PacifiCorp's then chief executive, Frederick Buckman. Stip. ¶ 23. Along with Ian Russell, ScottishPower's finance director, Mr. Robinson met with Mr. Buckman on July 16, 1998 in New York to discuss the potential for a strategic combination of ScottishPower and PacifiCorp. Id.

41. Discussions between ScottishPower and PacifiCorp continued throughout the summer, temporarily ceasing when Mr. Buckman was replaced as CEO in August and PacifiCorp undertook a strategic review of its business. Ex. 2-J at PHI-DOCS097144.

42. On August 19, 1998 and October 5, 1998, corporate officers from PacifiCorp and ScottishPower met again to discuss possible merger scenarios. Stip. ¶ 24. ScottishPower representatives at the October 5, 1998 meeting included Julian Brown, Ian Russell, Jamie Wilson and Andrew MacRitchie. Tr. 210:20-211:6 (Brown).

43. The companies entered into a confidentiality and standstill agreement on October 12, 1998, and due diligence began shortly thereafter. Stip. ¶ 25.

C. ScottishPower's Due Diligence

45. Mr. Brown previously performed the analytical work in connection with ScottishPower's acquisition of Southern Water and also led the transition team that integrated ScottishPower and Southern Water. Tr. 207:25-208:6 (Brown).

46. Mr. Brown earned a Bachelor of Science degree from the Australian National University. Subsequent to that, Mr. Brown received a Doctorate of Philosophy from the University of London in Organic Chemistry and a Graduate Diploma of Business Administration from the Swinburne Institute of Technology in Victoria, Australia. Tr. 202:1-8 (Brown). He had previously worked as a consultant at McKinsey. Tr. 202:23-203:13 (Brown).

47. Andrew MacRitchie, of ScottishPower, was primarily responsible for operational due diligence. Specifically, he was responsible for: (i) evaluating the risks associated with the potential transaction; (ii) identifying and quantifying potential cost savings ScottishPower could deliver by applying its expertise and practices; and (iii) supporting the corporate strategy team in defining how the acquisition would fit within ScottishPower's larger strategy of growth. Tr. 325:2-11 (MacRitchie).

48. Mr. MacRitchie earned a degree in electrical and electronic engineering; a B.Sc. from Washington University, an MBA from Strathclyde Graduate Business School, and also attended an executive education program at The Wharton School of the University of Pennsylvania. Tr. 317:5-10 (MacRitchie). He originally joined ScottishPower in the engineering group and worked in various positions throughout the company. Tr. 318:15-322:4 (MacRitchie). At the time of the acquisition, Mr. MacRitchie was working in the corporate strategy team and reported to Messrs. Brown and Russell. Tr. 323:9-14 (MacRitchie).

49. At ScottishPower, Mr. MacRitchie was considered an expert at "benchmarking," which is a means by which companies identify best practices and quantify performance improvement through analysis of like companies. Tr. 320:5-23 (MacRitchie).

50. During the Manweb acquisition, Mr. MacRitchie was responsible for leading a team of ScottishPower senior management in a six-month exercise to integrate Manweb into ScottishPower and to drive efficiency, which resulted in a 30% reduction in operating costs at Manweb. Tr. 321:2-8 (MacRitchie).

51. Jamie Wilson, of ScottishPower, was responsible for developing ScottishPower's Valuation Model, discussed below at Proposed Findings ¶ 78 through ¶ 103; Tr. 267:21-268:3 (Wilson); Stip. ¶ 43. This process involved marshalling the different assumptions that ScottishPower required to enable them to properly develop a view on the acquisition target. Id.

52. Mr. Wilson is a Chartered Accountant in the United Kingdom (similar to a CPA qualification in the U.S.) and had previously worked at Grant Thornton in Scotland in a variety of different roles including finance and advisory consulting, business planning and corporate finance. Tr. 263:17-264:13 (Wilson). He joined ScottishPower's corporate strategy team as a Senior Financial Analyst in 1997. Tr. 264:15-24 (Wilson). At ScottishPower, Mr. Wilson was responsible for developing valuation models in connection with M&A activity as well as preparing internal valuations for different divisions within ScottishPower. Tr. 264:24-265:2 (Wilson).

53. Prior to the PacifiCorp acquisition, Mr. Wilson had worked on a number of different potential acquisitions for ScottishPower. Tr. 266:10-21 (Wilson). His prior responsibilities included analyzing and developing valuation models for different utility targets. Id.

55. PacifiCorp engaged several advisors including Salomon Smith Barney, Inc. ("Salomon Smith Barney") as its financial advisor, Stoel Rives LLP ("Stoel Rives") as its U.S. counsel, Linklaters & Paines as its U.K. counsel, and LeBoeuf Lamb Greene & Macrae as special counsel to the transaction. Stip. ¶ 30.

56. ScottishPower sought U.S. and U.K. tax advice in connection with the merger transaction from E&Y. E&Y had previously provided ScottishPower with tax advice in connection with its unsuccessful merger negotiations with Florida Progress and Cinergy. Ex. 16-J; Stip. ¶ 74.

57. Charles Merriman, E&Y Tax Partner in London, was responsible for managing E&Y's global tax services to ScottishPower in connection with the merger. Tr. 79:2-5 (Merriman). Mr. Merriman supervised teams of E&Y tax professionals in London (ten tax professionals); Washington (3-5 tax professionals); and New York ("a few partners"). Tr. 78:8-79:1 (Merriman).

59. On November 15, 1998, ScottishPower delivered to PacifiCorp an initial draft of a proposed merger agreement. Stip. ¶ 27. Both companies proceeded to open data rooms in New York and commenced detailed due diligence reviews. Stip. ¶ 28. Negotiations over specific merger terms and conditions continued through the due diligence process. Stip. ¶ 33.

60. On November 21 and 22, 1998, the management of ScottishPower and PacifiCorp each made presentations to the other and their respective financial advisors. Stip. ¶ 31.

61. During the period from November 23, 1998 to December 6, 1998, personnel from and advisors for ScottishPower and PacifiCorp engaged in rigorous due diligence. Stip. ¶ 32; Tr. 77:3-6 (Merriman) (level of due diligence was "very rigorous" compared to other significant transactions); Tr. 328:15-17 (MacRitchie) ("extensive diligence, really quite extensive diligence ahead of our formal announcement of the deal").

62. ScottishPower assembled a large team of employees to work on the due diligence. Tr. 219:19-25 (Brown). In November 1998, ScottishPower had 20 employees working in New York alongside numerous (20+) advisors. Tr. 219:19-220:4 (Brown). ScottishPower's due diligence team worked for about three weeks in New York reviewing data provided by PacifiCorp. Tr. 328:17-20; Tr. 356:3-12 (MacRitchie).

63. In connection with its due diligence efforts, teams of ScottishPower employees and advisors interviewed senior PacifiCorp management and inspected certain PacifiCorp assets in the United States and Australia. Stip. ¶ 33; Tr. 328:20-329:6; Tr. 356:13-22 (MacRitchie).

64. ScottishPower's due diligence was a "very disciplined" process of examining each piece of the business, which culminated in an extensive body of reports, including reporting of the state and prospects for PacifiCorp's various businesses and potential improvements to the Valuation Model. Tr. 220:5-24 (Brown); Tr. 430:12-431:12 (Shaked); Ex. 5-J; Ex. 8-J; Ex. 11-J; Ex. 12-J; Ex. 14-J; Ex. 18-J; see also Stips. ¶ 34, ¶ 49, ¶ 50.

66. ScottishPower similarly believed there was significant potential to reduce costs at PacifiCorp though a systemic program of cost reductions, which ScottishPower referred to as a "transition plan." Tr. 227:18-25 (Brown). These cost savings projections were part of the rationale for the merger. Tr. 228:8-14 (Brown).

67. In late 1998, PacifiCorp was under-earning compared with its allowed regulatory return on equity ("ROE") in most of the states in which it operated. Stip. ¶ 57. ScottishPower management believed that there was "considerable headroom" to increase returns by reducing costs without triggering rate reviews. Stip. ¶ 57; Ex. 2-J at PHI-DOCS097146; Tr. 251:12-252:2 (Brown).

68. Each member of ScottishPower's due diligence team was asked to identify opportunities for reducing operating cost (OPEX) and capital expenditures (CAPEX) over a five year period. Tr. 329:13-22 (MacRitchie).

69. ScottishPower's due diligence team did not prepare a cost savings plan for Australia because ScottishPower intended to divest Powercor after the Acquisition, although one member of the due diligence team traveled to Australia to evaluate the operations. Tr. 330:5-18 (MacRitchie).

70. In MacRitchie's view, at the time of the Acquisition, PacifiCorp did not have challenging cost savings goals in its business plan. Tr. 332:24-25 (MacRitchie). Instead, PacifiCorp planned to rely primarily on rate cases to improve its financial performance. Tr. 333:1-7 (MacRitchie). ScottishPower believed that pursuing deliverable cost savings and using rate cases as filler was a better approach to improving PacifiCorp's return on equity. Tr. 333:7-12 (MacRitchie).

71. ScottishPower anticipated that through its expertise in management and implementation of best business practices, PacifiCorp would achieve $306 million annual cost savings by 2004, the fifth year of ScottishPower's anticipated ownership. Ex. 2-J at PHI-DOCS097158; Tr. 227:9-228:7 (Brown); Stip. ¶ 58. ScottishPower was confident on the basis of its previous experience that it had the skills to deliver these cost savings projections. Tr. 228:12-14 (Brown).

72. ScottishPower's approach to developing projections was consistent with how it viewed and targeted improvements in its own business. Tr. 331:2-5 (MacRitchie). Although the projected cost savings were challenging, MacRitchie believed they were achievable. MacRitchie perceived ScottishPower's approach and culture as one where its executives were expected to "under-promise and over-deliver." Tr. 331:7-12 (MacRitchie).

73. ScottishPower had consistently overachieved its public forecasts, including with Manweb, Southern Water, its own core business, and ultimately for PacifiCorp. Id. MacRitchie understood that not only was he expected to deliver the cost savings measures he was projecting, but to "over-deliver" on them. Tr. 331:12-15 (MacRitchie).

74. ScottishPower engaged in an intense effort to validate its projected cost savings. Tr. 229:13-230:2 (Brown). ScottishPower assigned approximately a dozen people, including individuals with specific functional expertise drawn from ScottishPower's business, to spend a couple months examining in detail the state of various PacifiCorp businesses. Id.

75. Each of the cost savings assumptions was subjected to significant scrutiny including: (i) comparing the cost savings assumptions to ScottishPower's own cost cutting experiences, which were considerable; (ii) testing the projections through the outcomes of the due diligence process; (iii) and comparing PacifiCorp's cost structure to comparable companies and a vast amount of publicly available information (i.e., benchmarking). Tr. 228:15-229:9 (Brown).

76. Based on a benchmarking analysis using data from other companies, ScottishPower's cost savings assumptions might have been conservative. Tr. 571:1-9 (Vander Weide).

77. After the Acquisition was announced in December 1998, MacRitchie assembled a team of U.S. advisors and U.K. employees of ScottishPower in Portland to develop and implement a regulatory strategy that would deliver the necessary approvals, both at the state and federal level, and also to continue to work with PacifiCorp on further diligence and validation of ScottishPower's assumptions in terms of the business. Tr. 336:3-19 (MacRitchie).

79. The Valuation Model utilized the projected cash flow figures to calculate a discounted cash flow value for PacifiCorp. Tr. 275:15-22 (Wilson).

80. The purpose of the Valuation Model was to provide a view on the value of PacifiCorp, such that ScottishPower management and the Board could reach a decision whether or not the company was a suitable acquisition target. Tr. 266:22-267:7 (Wilson).

81. From ScottishPower's perspective, the transaction was "hugely important not just from reputation, but from an investment perspective." Tr. 292:22-293:18 (Wilson).

82. Consequently, in developing its Valuation Model, ScottishPower's management attempted to not introduce any bias one way or another into the Valuation Model. Tr. 238:10-14 (Brown).

83. The Valuation Model was the culmination of the work of a whole team of ScottishPower executives and advisors who were all very knowledgeable persons who knew the business. Tr. 292:22-293:18 (Wilson).

84. Based on this Valuation Model, ScottishPower's corporate strategy team concluded that PacifiCorp had an inherent value of $28.17 per share, with an overall equity value of $8.4 billion. Ex.2-J at PHI-DOCS097154.

85. ScottishPower's approach to valuing PacifiCorp was "detailed, rigorous, and neutral." Tr. 237:4-7 (Brown); see also Tr. 271:21-272:5 (Wilson).

86. ScottishPower's acquisition of PacifiCorp was a "very big deal" for ScottishPower -- more than twice the size of ScottishPower's previous largest deal. Tr. 237:4-17 (Brown). ScottishPower's management viewed ScottishPower's Board as "painfully prudent" and "much more interested in knowing about the downside of any proposal than they were about upsides." Tr. 238:4-14 (Brown).

87. Julian Brown was ultimately responsible for determining what assumptions were incorporated into the Valuation Model, as well as ensuring that the model was reasonable and structurally correct and sound, although there were other checks and balances. Tr. 222:3-10 (Brown); Stip. ¶ 42.

88. Mr. Wilson worked with a number of individuals in connection with the development of the Valuation Model including: his colleagues on the corporate strategy team; a separate team of business experts at ScottishPower, whose job it was to analyze their areas of expertise and determine appropriate assumptions; as well as a number of different professional advisors engaged by ScottishPower including Morgan Stanley, E&Y and PwC. Tr. 268:4-24 (Wilson); Tr. 223:17-224:19 (Brown); Stip. ¶ 46.

89. Of ScottishPower's advisors that provided input into the Valuation Model, Morgan Stanley had the most day-to-day involvement. Tr. 268:17-24 (Wilson). Morgan Stanley reviewed several versions of the Valuation Model, advised ScottishPower on financial data and assumptions and provided input into the Valuation Model. Stip. ¶ 46.

90. Mr. Wilson worked very closely with Iain Smedley from Morgan Stanley, with whom he had worked on other acquisition targets. Tr. 223:20-224:1 (Brown); Tr. 269:10-19 (Wilson); Stip. ¶ 45. Mr. Smedley began assisting PacifiCorp with the development of the Valuation Model in mid-1998 and at times was working with Mr. Wilson on a daily basis. Tr. 269:10-19 (Wilson).

91. Morgan Stanley simultaneously developed its own valuation model, which was focused on projecting earnings and depreciation. Tr. 223:20-24 (Brown). Morgan Stanley and ScottishPower collaborated to ensure they were using the same information and that the model results were logically consistent. Tr. 224:2-6 (Brown).

92. The structure of the Valuation Model was more or less identical to models ScottishPower had utilized in previous acquisitions. In essence, it was "just another chapter in a series of financial models that [ScottishPower] built for various companies, and it was an apparatus that [ScottishPower] were well familiar with." Tr. 223:4-10 (Brown).

93. The Valuation Model was a "sum of the parts model," with each part being a conventional discounted cash flow model. Tr. 221:19-222:2 (Brown).

94. The Valuation Model included separate discounted cash flow valuations for PacifiCorp's core utility business, Powercor, its energy trading business, and "other operations." Stip. ¶ 44. Within each of the business' models, there were a number of different inputs and analyses. Tr. 275:23-277:7 (Wilson). Although each year was a continuation of the prior year, ScottishPower developed unique assumptions for each of the years in the forecasts. Id.

95. The model was very detailed and driven by numerous fiscal assumptions relative to PacifiCorp. Tr. 275:23-277:7 (Wilson). Although the Valuation Model took account of "some peculiarities with PacifiCorp," it was fairly conventional in all other respects. Tr. 223:4-16 (Brown).

96. The Valuation Model included a 10-year cash flow forecast (1997 through 2007), which was typically the period ScottishPower used for its own forecasts. Tr. 274:24-275:9 (Wilson).

97. ScottishPower's 1997 cash flow projection was based on the most current actual figures available at that time. Tr. 275:1-9 (Wilson). ScottishPower then projected cash flows forward over a 10-year period for each of PacifiCorp's four businesses to arrive at consolidated cash flow figures for PacifiCorp. Tr. 255:5-14 (Wilson).

98. Sources of the data for the Valuation Model originally included publicly available information, the Pegasus October 16 Plan and the Pegasus October Financial Statements. Stip. ¶ 40. The financial data was analyzed and adjusted by ScottishPower's corporate strategy team to take account of exceptional items, discontinued operations and other items. Id. Projections of future cash flows were then developed using ScottishPower's assumptions regarding future capital expenditures, revenues and costs. Id.

99. ScottishPower examined all the information it and Morgan Stanley could possibly find about PacifiCorp, including annual reports, regulatory data, analysts' reports, as well as its own business experts' views on forward assumptions and comments from Morgan Stanley. Tr. 270:21-271:20 (Wilson). This information was incorporated into the Valuation Model. Id.

100. The Valuation Model also included cost-savings assumptions. Tr. 226:20-22 (Brown). During the due diligence process, ScottishPower's due diligence teams worked to validate and update the data and assumptions in the Valuation Model. Stip. ¶ 41.

101. Data from the December 6, 1998 version of the Valuation Model ("1998 Projections") was presented to the ScottishPower board of directors on December 6, 1998 and included in Appendix Two to the Project Jet Board Paper. Stip. ¶ 37; Ex. 6-J; Ex. 7-J.

102. Following the announcement of the Merger in December 1998, Mr. Wilson received regular requests for updates from ScottishPower management and continued to maintain and update the Valuation Model to ensure that ScottishPower's view of PacifiCorp had not changed. Tr. 287:8-288:24 (Wilson). Earlier assumptions were reviewed and reformulated as ScottishPower's due diligence teams continued their work in Portland and the developments occurred in the various state regulatory processes. Id.

103. Shortly before the Acquisition was completed on November 29, 1999, ScottishPower's corporate strategy team prepared an updated Valuation Model for PacifiCorp and the combined group ("1999 Projections"). Stip. ¶ 38; Ex. 9-J; Ex. 10-J. Mr. Wilson also updated the Valuation Model immediately prior to the Acquisition to ensure that there had not been a material adverse change in the valuation of PacifiCorp. Tr. 288:25-289:14 (Wilson).

D. E&Y's Tax Advice

104. ScottishPower intended to structure the transaction as an all stock transaction because it believed that ScottishPower stock was fully valued and PacifiCorp's stock was probably undervalued. Tr. 217:13-18 (Brown).

105. E&Y recommended that the proposed merger be structured to qualify as an Internal Revenue Code § 368(a)(1)(B) reorganization, which would result in tax free treatment to PacifiCorp's shareholders who received ScottishPower stock as consideration for their shares of PacifiCorp. Stip. ¶ 75.

107. The "Step Plan" contemplated that PacifiCorp would be indirectly held by ScottishPower through a U.S. general partnership (i.e., NAGP) and that the general partnership would commit, as part of the merger, to issue ScottishPower a loan note of an amount equal to 75% of the total consideration given by ScottishPower to PacifiCorp shareholders. Ex. 17-J.

108. At that time, it was contemplated that ScottishPower would convey a percentage of its shares to PacifiCorp's shareholders as consideration. Tr. 63:25-64:4 (Merriman). Consequently, the exact amount of the loan note could only be determined once the final share price was known. Tr. 82:20-83:2 (Merriman).

110. For U.S. tax purposes, the structure was intended by E&Y to provide a single interest deduction by NAGP equal to the amount of interest it paid to ScottishPower. Tr. 69:23-70:13 (Merriman).

111. From a U.K. tax perspective, E&Y advised ScottishPower that ScottishPower NA1 Limited ("NA1") and ScottishPower NA2 Limited ("NA2"), could deduct an equal amount of interest expense, which effectively would offset a corresponding amount of interest income recognized by ScottishPower in the U.K. Tr. 69:23-70:13 (Merriman). E&Y further advised ScottishPower that when PacifiCorp paid dividends to NAGP, ScottishPower would recognize dividend income in the U.K.; however, that income could potentially be offset with U.K. foreign tax credits (arising from income taxes paid in the U.S.), if such credits were available. Tr. 72:7-19 (Merriman).

112. E&Y advised ScottishPower in the Step Plan that the U.K. tax benefits of the "double dip" were dependent on: (i) PacifiCorp having sufficient underlying U.S. tax credits in the U.K. (in other words, paying sufficient U.S. income tax to generate foreign tax credits in the U.K.); (ii) PacifiCorp and ScottishPower both generating sufficient taxable profit; (iii) interest on the note issued by the U.S. general partnership actually being paid to ScottishPower and being considered valid debt for both U.S. and U.K. tax purposes. Ex. 17-J; Tr. 73:11-19 (Merriman).

113. The interest deduction and source of repayment would have operated for U.S. tax purposes in the same manner regardless of whether the underlying debt was issued to a related party (ScottishPower) or to an unrelated third party lender. Tr. 70:17-21; Tr. 71:1-7 (Merriman).

E. PacifiCorp's Australian Operations

114. In November 1998, ScottishPower management anticipated selling PacifiCorp's Australian operations, which included Powercor and Hazelwood. Stip. ¶ 65; Tr. 225:5-15 (Brown). PacifiCorp acquired Powercor in 1995 for approximately $1.6 billion in cash. Stip. ¶ 65.

115. ScottishPower was not financially compelled to sell PacifiCorp's Australian assets. Tr. 225:16-226:7 (Brown). ScottishPower's rationale for selling PacifiCorp's Australian assets included its long-held view that Australia was too remote and that the assets were highly valued. Stip. ¶ 65; Tr. 215:9-14; 224:19-225:4; 225:5-12 (Brown).

116. ScottishPower initially valued Powercor at $1.9 billion, excluding approximately $860 million of debt. Stip. ¶ 66. Taking into account the Powercor debt, the net equity value of Powercor would have been $1.04 billion ($1.9 billion - $860 million). Id. In November of 1999, ScottishPower valued Powercor at approximately $1.6 billion before taking into account Powercor debt. Id. Taking into account the approximately $860 million of Powercor debt, the net equity value of Powercor would have been approximately $858 million. Id.

117. ScottishPower further assumed that Hazelwood would be sold in 1999 for $130 million. Stip. ¶ 67.

118. Powercor was eventually sold to CKI-Hong Kong Electric on September 6, 2000, for a purchase price of approximately $1.3 billion. Stip. ¶ 68. CKI-Hong Kong Electric assumed Powercor debt of approximately $625 million, and PacifiCorp's subsidiary, PacifiCorp Group Holding Company ("PGHC"), received net cash proceeds from the sale of Powercor of approximately $675 million. Id. Hazelwood was sold on November 17, 2000 for approximately $45.77 million ($88 million AUD). Id.

119. PacifiCorp realized lower proceeds from the sale of its Australian Operations than it had expected at the time of the Merger due in large part to adverse movements in the exchange rate between the U.S. dollar and Australian dollar. Ex. 245-P (Shaked Expert Report) at pp. 48-49.

F. ScottishPower's December 6, 1998 Board of Directors Meeting

120. At the conclusion of the due diligence process, ScottishPower's due diligence teams prepared detailed reports for ScottishPower's board of directors concerning: generation, mining, transmission & distribution, customer service, corporate service, information services, power marketing & trading, Australian operations and a territory review ("Business Evaluation Workstream Report"). Stip. ¶ 34; Ex. 5-J; see also Stips. ¶ 49, ¶ 50.

121. Financial data and cash flow projections from the 1998 Projections were also presented to the ScottishPower Board and included in Appendix Two to the Project Jet Board Paper. Stip. ¶ 37; Ex. 6-J; Ex. 7-J; see also Stips. ¶ 49, ¶ 50.

122. ScottishPower's senior executives prepared a written presentation to ScottishPower's board of directors (the Project Jet Board Paper), that summarized the results of their financial analysis, cost savings projections and due diligence reviews of PacifiCorp, and set forth their recommendation to proceed with the merger. Stip. ¶ 49; Ex. 2-J.

123. The Project Jet Board Paper provided that ScottishPower's expertise in management and best business practices could result in $306 million of annual cost savings by 2004. Stip. ¶ 58; Ex. 2-J at PHI-DOCS097158; Tr. 334:13-17 (MacRitchie). The projected cost savings included:

126. Morgan Stanley delivered a written fairness opinion letter ("Fairness Opinion Letter") (Ex. 14-J) and presentation (Ex. 15-J). Stip. ¶ 69. In its Fairness Opinion Letter, Morgan Stanley concluded that the consideration to be paid to PacifiCorp shareholders was fair from a financial point of view to ScottishPower. Id.

127. For purposes of valuing PacifiCorp, Morgan Stanley reviewed and relied upon the 1998 Projections and assumed that the 1998 Projections were reasonably prepared on bases reflecting the best currently available estimates and judgments of the future financial performance of ScottishPower and PacifiCorp. Stip. ¶ 70.

128. E&Y prepared a board paper ("E&Y Board Paper" -- Ex. 19-J), discussed in the following subsection, which contained E&Y's "threshold view" with respect to certain U.S. corporate income tax and U.K. corporate income tax consequences associated with the proposed merger. Stip. ¶ 79; Tr. 80:2-11 (Merriman).

129. On December 6, 1998, ScottishPower's board of directors met to consider the proposed merger with PacifiCorp. Stip. ¶ 49. Based on ScottishPower management's analyses and recommendation, as well as recommendation and advice of its numerous advisors, ScottishPower's board unanimously voted to authorize the merger. Stip. ¶ 81; Ex. 212-J.

130. Likewise, after presentations by PacifiCorp management, Stoel Rives and Salomon Smith Barney, the PacifiCorp board of directors unanimously approved the proposed merger and the proposed terms of the merger agreement on December 6, 1998. Stip. ¶ 82.

G. E&Y's December 4, 1998 Board Paper

131. The purpose of the E&Y Board Paper was to provide ScottishPower's board with a description of how the transaction would work in principle, with "some threshold numbers" for the board to consider before they made a decision to approve the merger transaction. Tr. 80:6-11 (Merriman).

132. The E&Y Board Paper described the following features of the proposed merger: (i) the receipt by PacifiCorp shareholders of solely ScottishPower voting shares as consideration for the merger; (ii) ScottishPower's use of a U.S. General Partnership (i.e., NAGP) to effect the merger; and (iii) the issuance of a loan note by [NAGP] to ScottishPower as partial consideration for ScottishPower's issuance of its shares to PacifiCorp shareholders with interest payments on the loan note being funded by dividends from PacifiCorp to [NAGP]. Stip. ¶ 64(a).

133. E&Y advised ScottishPower that the loan note should include the following terms, inter alia (Ex. 19-J at PHI-DOCS083951-52):

135. E&Y further advised ScottishPower that under the U.K. group relief rules, to the extent that the dividends paid by PacifiCorp to [NAGP] carried with them underlying tax credits for U.S. taxes paid by PacifiCorp, ScottishPower subsidiaries (and indirectly ScottishPower) will not be subject to tax on those dividends. Stip. ¶ 64(c).

136. The E&Y Board Paper included a threshold analysis of the amount of principal, payment terms and interest rate for [NAGP's] contemplated loan note to ScottishPower. Tr. 81:25-82:15 (Merriman).

137. The purpose of the analysis in the Board Paper was not to set a final amount of the intercompany debt or interest rate, because the amount of the anticipated loan note would be based on the final share price (i.e., the acquisition price) for PacifiCorp, which would be determined at closing. Tr. 82:20-83:16 (Merriman).

138. For purposes of this threshold analysis, the Board Paper assumed a $5.6 billion intercompany debt. Tr. 85:20-24 (Merriman). E&Y based the $5.6 billion loan amount on the value of consideration that was expected to be conveyed to the PacifiCorp shareholders as of December 1998. Tr. 82:20-83:2; Tr. 86:2-7 (Merriman).

139. In order to determine a "threshold" interest rate, E&Y considered U.S. transfer pricing regulations for interrelated party indebtedness. Tr. 107:3-9 (Merriman). E&Y advised ScottishPower that there was a safe harbor "arms length rate" for interest rates within a certain range, specifically 100% to 130% of the Applicable Federal Rate ("AFR Safe Harbor Method"). Id.; see also Ex. 220-J.

140. E&Y advised ScottishPower that as an alternative to the AFR Safe Harbor Method, the interest rate on the loan note could be set using a market-based approach ("Capital Markets Analysis Method"); however that approach would not be considered a "safe harbor." Tr. 108:2-9; Tr. 111:3-10 (Merriman). E&Y believed that ScottishPower could use either the AFR Safe Harbor Method or the Capital Market Analysis Method. Tr. 111:11-16 (Merriman).

141. Under the Capital Markets Analysis Method, E&Y evaluated the financial ratios, credit rating and interest rates that were being paid by comparable companies in the utility area. Tr. 110:11-20; Tr. 109:3-11 (Merriman). Although E&Y is not a credit rating agency, it estimated that NAGP would likely be assigned a BB credit rating. Tr. 109:17-18 (Merriman). Based on a BB credit rating, E&Y concluded that an arms-length "threshold" interest rate for the intercompany debt would be 7.67%. Tr. 110:6-10 (Merriman).

142. Once the interest rate and amount of debt was determined, E&Y reviewed ScottishPower's financial projections for PacifiCorp and concluded that NAGP could support $5.6 billion of debt at 7.67%. Tr. 87:15-20 (Merriman). Specifically, E&Y was given access to ScottishPower's Valuation Model, as well as Morgan Stanley's cash flow model. Tr. 270:18-20 (Wilson); Tr. 89:6-11; Tr. 88:12-18; Tr. 99:24-100:6 (Merriman). Based on these cash flow analyses, E&Y concluded that there was sufficient cash to support $5.6 billion of debt. Tr. 89:6-11; Tr. 88:12-18; Tr. 99:24-100:6 (Merriman).

143. E&Y also analyzed consolidated financial projections prepared by PacifiCorp. Tr. 101:14-17 (Merriman); Ex. 19-J at PHI-DOCS084025. Specifically, E&Y's transfer pricing team evaluated the projections for efficacy of the interest rate, to determine whether NAGP could pay the interest, and also to see whether or not the overall free cash flow could support a repayment of the indebtedness. Tr. 101:1-6; Tr. 168:19-25 (Merriman). E&Y projected that NAGP would have the following excess cash flows after payment of interest on the new debt obligations (which, at the time was assumed to be $5.6 billion): $591 million in 1999; $567 million in 2000; $526 million in 2001; $550 million in 2002; $526 million in 2003; $636 million in 2004; $656 million in 2005; $686 million in 2006; and $719 million in 2007. Tr. 103:22-25; Tr. 195:6-17 (Merriman); Ex. 19-J at PHI-DOCS084026;. In other words, Ernst & Young projected that, after payment of the interest expense, through 2007 (at least 2 years prior to maturity) NAGP would have $5.457 billion in excess cash flows to pay down principal. Ex. 19-J at PHI-DOCS084026; Tr. 195:6-17 (Merriman).

144. In advance of the E&Y Board Paper, ScottishPower and PacifiCorp's advisors vigorously debated the proposed amount of the loan note (i.e., 75% of the value of PacifiCorp). Ex. 18-J; Tr. 86:21-87:11 (Merriman). E&Y examined the financial analysis and projections that were developed by PacifiCorp, ScottishPower and Morgan Stanley and concluded that there would be sufficient cash flow to support $5.6 billion of debt. Tr. 89:6-89:11 (Merriman); Ex. 18-J; Ex. 210-J; see also Tr. 87:15-20 (Merriman).

145. Based on these cash flow, repayment, capitalization and interest rate analyses, E&Y advised ScottishPower's Board of Directors that interest paid by [NAGP] on a $5.6 billion loan between ScottishPower and [NAGP] should be deductible for U.S. Federal income tax purposes. Tr. 86:21-87:20 (Merriman); Stip. ¶ 80. This was not intended to be E&Y's final analysis. Tr. 112:10-11 (Merriman). E&Y anticipated that the financial ratios would be refined, that numbers would change in terms of purchase price and other metrics, and that projections would be updated closer to Closing. Tr. 112:1-7 (Merriman).

146. In the weeks prior to closing, E&Y reviewed the latest projections to confirm that they were consistent with prior projections reviewed by E&Y. Tr. 93:9-16 (Merriman).

H. Merger Approval Process

147. A definitive Agreement and Plan of Merger (Ex. 20-J) was signed on December 6, 1998 and the Acquisition was announced the following morning ("Announcement Date"). Stip. ¶ 83.

148. Pursuant to the terms of the Agreement and Plan of Merger, ScottishPower would acquire 100% of PacifiCorp issued and outstanding common stock, giving ScottishPower shareholders approximately 64% and PacifiCorp shareholders approximately 36% ownership in the combined group. Stip. ¶ 85.

149. PacifiCorp common stock shareholders would receive 0.58 American Depositary Shares (ADS) of ScottishPower, each ADS representing 4 ordinary shares. Alternatively, PacifiCorp common stock shareholders could elect to receive 2.32 ordinary shares of ScottishPower. Stip. ¶ 86.

150. Applying this 2.32 fixed ratio to ScottishPower's average closing price (over the two week period ending December 2, 1998) of 651 pence, each share of PacifiCorp stock was anticipated to be purchased at $25.06, or at a 28.9% premium to market (based on a PacifiCorp closing price of $19.4375 as of December 3, 1998). Stip. ¶ 87.

151. The Agreement and Plan of Merger was later amended on January 29, 1999 and February 9, 1999, resulting in the parties' Amended and Restated Agreement and Plan of Merger ("Merger Agreement") (Ex. 23-J), dated February 23, 1999. Stip. ¶ 92.

152. A meeting of PacifiCorp's shareholders was held and the transaction was approved on June 17,1999. Stips. ¶ 95, ¶ 96.

153. Certain state regulatory approvals were required in connection with the merger including the California Public Utilities Commission ("CPUC"), Oregon Public Utility Commission ("OPUC"), Washington Utilities and Transportation Commission ("WUTC"), Idaho Public Utilities Commission ("IPUC"), Utah Public Service Commission ("UPSC"), and Wyoming Public Service Commission ("WPSC"). Stips. ¶ 101 through ¶ 103; Stips. ¶ 106 through ¶ 108; Stip. ¶ 110.

154. The state utility commissions had no jurisdiction over NAGP or ScottishPower and, therefore, did not approve or disapprove the issuance of debt by NAGP to ScottishPower. Stip. ¶ 111.

I. Loan Notes

156. On January 19, 1999, E&Y provided ScottishPower with a letter opinion ("Letter Opinion") that set forth the recommended terms and conditions of the loan note. Ex. 151-J.

157. Consistent with the Board Paper, E&Y stated that the amount of the loan note (which E&Y contemplated might ultimately consist of two or more separate instruments) would not exceed 75% of the value of PacifiCorp shares held by NAGP immediately after Closing (i.e., NAGP would have an initial debt-to-equity ratio not exceeding 3:1). Ex. 151-J at PHI-DOCS082508; Tr. 120:2-7 (Merriman).

158. E&Y further advised ScottishPower in its Letter Opinion that the loan note would constitute a recourse obligation of NAGP and would be secured by a pledge of PacifiCorp's shares. Ex. 151-J at PHI-DOCS082509; Tr. 120:12-21 (Merriman).

159. E&Y also stated that the interest payments would be funded from distributions paid by PacifiCorp. Ex. 151-J; Tr. 120:23-121:1 (Merriman).

161. On October 14, 1999, Freshfields circulated a first draft of the Loan Notes to ScottishPower and PacifiCorp's advisors including E&Y, Milbank and Stoel Rives. Ex. 152-J. The draft was adapted from loan notes issued by ScottishPower in relation to the Southern Water bond offering, which was a debt capital market transaction. Ex. 152-J; Tr. 123:17-22; Tr. 124:3-8; Tr. 177:7-10; Tr. 177:16-25 (Merriman).

162. On October 20, 1999, E&Y circulated comments to Freshfield's first draft of the Loan Notes. At that point, E&Y was expecting a much simpler document than Freshfields had prepared. Tr. 125:19-126:2; Tr. 185:14-186:22 (Merriman). E&Y also offered comments on the method for determining an appropriate interest rate, the due dates for interest payments, and separating the note into $1 billion tranches. Ex. 152-J; Tr. 128:16-129:5.

163. Freshfields circulated a revised draft of the Loan Notes to ScottishPower and PacifiCorp's advisors on November 8, 1999, which incorporated comments from various advisors. Ex. 154-J; Tr. 129:6-20 (Merriman). With respect to E&Y's comments regarding commerciality, Freshfields responded that the instrument it drafted "is much more closely analogous with a loan note issued in connection with an acquisition" than a revolving credit facility. Ex. 154-J. With regard to interest rate, Freshfields stated that E&Y's approach of using a "safe harbour" interest rate equivalent to 130% of the IRS's Applicable Federal Rate "seems sensible." Id.

164. E&Y circulated further comments to Freshfields revised draft Loan Notes on November 16, 1999, approximately two weeks prior to Closing. Ex. 41-J; Tr. 131:15-132:3 (Merriman). E&Y commented that the Loan Notes "as drafted does accurately reflect an offering of debt to a wide range of unrelated investors, possible for the purpose of the issuer making an acquisition." Ex. 41-J. E&Y concluded that "the Loan Note is nonetheless representative of a debt instrument for US tax purposes and, as such, if all other parties are otherwise satisfied with its contents, then it should be satisfactory for the intended purposes if the features required can be accommodated." Ex. 41-J at PHI-DOCS089400; Tr. 132:14-24 (Merriman).

165. On November 23, 1999, approximately one week prior to Closing, ScottishPower and its advisors agreed on key terms of the Loan Notes, including:

167. On November 25, 1999, E&Y completed its review of the revised Loan Notes drafted by Freshfields and advised Freshfields that E&Y had "reviewed the amendments made and are comfortable that they are consistent with those discussed." Ex. 156-J; Tr. 137:11-24 (Merriman).

168. E&Y also reviewed a draft Pledge Agreement, which was executed at Closing. Tr. 140:3-9 (Merriman); Stip. ¶ 166; Ex. 59-J. E&Y recommended a pledge agreement at the outset of the Acquisition because it wanted ScottishPower to have a further security interest to help ensure repayment. Tr. 140:20-141:1 (Merriman).

170. On November 25, 1999, E&Y advised ScottishPower and Freshfields that under the AFR Safe Harbor Method, the maximum AFR safe harbor interest rate (130% of the Applicable Federal Rate) for ten-year and fourteen-year loans with quarterly compounding issued in November 1999 was 8.1%.² Ex. 156-J.

171. Therefore, E&Y believed that an interest rate between 6.24% and 8.1% would be considered an appropriate arm's length rate of interest (i.e., within the AFR Safe Harbor range). Tr. 114:1-3 (Merriman).

172. E&Y also advised ScottishPower that, as another check, it should consult with an independent investment bank to determine a market rate of interest for the Loan Notes. Tr. 114:14-23 (Merriman).

173. ScottishPower engaged Warburg, Dillon, Read ("Warburg"), the investment banking division of UBS AG, to provide advice with respect to a market interest rate for the Fixed Rate Notes and the Floating Rate Notes. Ex. 58-J; Stip. ¶ 162.

174. Warburg determined a BBB1 credit rating for NAGP, which was slightly more favorable than E&Ys BB rating in December 1998, and analyzed market indices provided by Bloomberg. Ex. 58-J; Tr. 117:17-22 (Merriman).

175. Warburg concluded that appropriate arms-length interest rates for the Fixed Rate Notes and Floating Rate Notes were 7.3% and 55 basis points over LIBOR, respectively. Ex. 58-J; Tr. 114:14-23 (Merriman). Warburg's recommendation fell squarely within the AFR Safe Harbor range of 6.24% through 8.1%. Tr. 114:24-115:1 (Merriman). These were the final interest rates used in the Loan Notes. Tr. 118:4-10 (Merriman); Stip. ¶ 163(d); Stip. ¶ 164(d).

177. On November 16, 1999, two weeks before Closing, E&Y advised ScottishPower that they remained satisfied that the proposed 3:1 debt-equity ratio was sustainable for tax purposes. Tr. 90:23-24; Tr. 91-1 (Merriman). At that time, E&Y had examined the cash flow projections and felt that they were adequate to support the anticipated indebtedness (interest and principal). Tr. 99:11-21 (Merriman); Ex. 148-J.

178. E&Y's advice was subject to it receiving updated drafts of the Loan Notes and reviewing ScottishPower's latest financial projections for PacifiCorp. Ex. 148-J; Tr. 92:15-23 (Merriman); Tr. 93:2-11 (Merriman).

179. ScottishPower's advisors determined that NAGP would issue $4 billion of Fixed Rate Notes and the remaining debt as Floating Rate Notes. Tr. 98:4-21 (Merriman). Although ScottishPower's advisors anticipated that the purchase price for PacifiCorp's shares would fall within a certain range, the precise amount of the Floating Rate Notes could not be computed until PacifiCorp's share price was set at Closing. Tr. 98:22-25 (Merriman).

180. E&Y performed further financial analysis immediately prior to Closing. Tr. 93:12-16 (Merriman). Based on this analysis, E&Y concluded that the final amount of the Loan Notes could be supported. Tr. 93:22-25 (Merriman).

181. On November 25, 1999, Freshfields provided ScottishPower with engrossed copies of each loan note instrument and a certificate for each tranche of the notes. Ex. 157-J. The amount of each Floating Rate Note Certificate was intentionally left blank because that amount would be determined at Closing. Id.

J. Closing and Key Merger Terms

182. On November 26, 1999, the Directors of NA1 and NA2 met to consider and approve items related to the merger, including issuance of the Loan Notes. Stip. ¶ 151; Stip. ¶ 152; Ex.43-J; Ex.44-J.

183. On November 29, 1999, ScottishPower and PacifiCorp completed their proposed merger under which PacifiCorp became a direct subsidiary of NAGP and an indirect subsidiary of ScottishPower. Stip. ¶ 112. The Closing took place at the offices of Milbank in New York. Stip. ¶ 117.

184. At Closing, ScottishPower, PacifiCorp and their advisers executed hundreds of transactions documents including the Loan Notes and Pledge Agreement. Ex. 189 through 194; Ex. 45-J through 49-J; Ex. 56-J; 59-J.

185. Based on the closing price of PacifiCorp stock at Closing, PacifiCorp's equity was valued at approximately $6.5 billion. Stip. ¶ 116. Under the terms of the deal, ScottishPower assumed PacifiCorp's existing debt totaling approximately $4.4 billion. Id.

186. In order to effectuate the merger transaction, ScottishPower formed two wholly-owned U.K. subsidiaries with an aggregate capital contribution of £100,000, NA1 and NA2, which were to be treated as disregarded entities for U.S. Federal income tax purposes. Stip. ¶ 124.

187. NA1 and NA2 contributed £100,000 to NAGP in exchange for 10% and 90% of the interests in NAGP, respectively, and NAGP made an election pursuant to Treasury Regulation §301.7701-3(a) ("Treas. Reg.") to be treated as a corporation for U.S. Federal income tax purposes. Stip. ¶ 125.

188. At Closing, NA1 and NA2 issued a total of 1,016,638,626 shares to ScottishPower, or twenty-five percent of the value of the ScottishPower ADSs and ScottishPower shares provided to the PacifiCorp shareholders at the Closing. Stip. ¶ 149. Each issued and outstanding share of PacifiCorp common stock was cancelled and converted into the right to receive either 0.58 New ScottishPower plc ADSs or 2.32 shares of ScottishPower. Stip. ¶ 127. PacifiCorp then issued 297,324,604 new shares of common capital stock (Ex. 32-J) to NAGP. Stip. ¶ 128.

K. Execution of the Loan Notes

189. On November 29,1999, Nick Evans at Freshfields faxed to David Nish and various executives at ScottishPower a computation of the amount of the Loan Notes to be issued by NAGP to ScottishPower, and the number of shares to be issued by NA1 and NA2 to ScottishPower. Ex. 42-J; Stip. ¶ 150. The amount of the Loan Notes was based on the number of PacifiCorp shares that were acquired by ScottishPower (through NAGP) and the price of each share. Ex. 42-J: Tr. 95:23-96:6 (Merriman).

190. At Closing, NAGP issued Loan Notes to ScottishPower in an amount equal to seventy-five percent of the value of the ScottishPower ADSs and ScottishPower shares provided to the PacifiCorp shareholders at the Closing. Stip. ¶ 148.

191. NAGP executed a loan note instrument ("Fixed Rate Loan Note Instrument") (Ex. 45-J) for $4 billion Fixed Rate Notes. The Fixed Rate Note Loan Instrument provided for the issuance of loan note certificates to the noteholders. Stip. ¶ 153.

192. NAGP also executed four $1 billion Fixed Rate Note Certificates (numbered one through four -- Ex. 46-J through 49-J) evidencing $4 billion of fixed rate indebtedness. Stip. ¶ 154.

193. Also at Closing, NAGP executed a floating loan note instrument ("Floating Rate Loan Note Instrument" -- Ex. 55-J) for up to $1 billion of Floating Rate Notes and two certificates ("Floating Rate Loan Certificates -- Ex. 56-J). Stips. ¶ 158, 159.

L. Amendments to the Floating Rate Notes

194. On December 3, 1999, shortly after Closing, ScottishPower's advisors determined that 16,400 PacifiCorp shares had been forfeited prior to closing. Stip ¶ 160; Ex. 159-J; Tr. 144:4-19 (Merriman). Freshfields concluded that the amount of the Loan Notes was "slightly too high" (under $100,000) and prepared a deed of amendment that slightly reduced the value of the Floating Rate Notes. Ex. 160-J; Ex. 161-J; Ex. 162-J; Tr. 144:4-19; Tr. 145:5-11 (Merriman).

195. On or about December 17, 1999, two additional Floating Rate Note Certificates were executed dated November 29, 1999, each in the amount of $448,139,922, and numbered No. 002 and No. 003, respectively (Ex. 57-J). Stip. ¶ 160.

196. The principal amount of each Floating Rate Note was reduced from $448,319,972 to $448,139,922. Stip. ¶ 160.

197. On November 6, 2000, the Fixed Rate Loan Note Instrument and Floating Rate Loan Note Instrument were each amended to provide that interest on the debt would be due on the succeeding (rather than the preceding) business day if the quarterly date was not a business day in either London or New York (rather than just London). Stip. ¶ 161.

A. The Terms of the Fixed Rate Notes

199. The Fixed Rate Loan Note Instrument and Fixed Rate Notes included the following terms establishing the amount of principal due and a fixed due date, an interest rate, fixed interest payment dates, and creditors' rights (Stip. ¶ 163):

201. On a hypothetical basis, other than a "slight" modification to the interest rate, the terms of the Loan Notes would have been fully acceptable to debt capital market investors. Id.; Tr. 690:16-19 (Chigas).

B. The Terms of the Floating Rate Notes

202. The Floating Rate Loan Note Instrument and Floating Rate Notes included the following terms establishing the amount of principal due and a fixed due date, an interest rate, fixed interest payment dates, and creditors' rights (Stip. ¶ 164):

203. Throughout the process of drafting and amending the Loan Notes, ScottishPower and its advisors unequivocally intended that the Loan Notes would be treated as debt and would ultimately be repaid. Tr. 145:21-25 (Merriman).

204. ScottishPower and NAGP consciously and purposefully performed the legal acts that establish a debt. See Proposed Findings ¶ 189 through ¶ 193; Stips. ¶ 151, ¶ 152; Ex. 43-J; Ex. 44-J; Ex. 212-J. For example, NA1, NA2 and ScottishPower's boards of directors all adopted resolutions that specifically authorized and directed the issuance of the Loan Notes. Id.

205. ScottishPower and NAGP sought advice on the principal amount and interest rate. See Proposed Findings ¶ 176 through ¶ 179, ¶ 185.

206. ScottishPower's advisors meticulously revised and commented on a series of draft loan notes with the purpose of establishing that the Loan Notes were debt instruments. See Proposed Findings ¶ 160 through ¶ 168.

207. In December 1999, ScottishPower and its advisors took care to amend the Floating Rate Notes to ensure that the total amount of the Loan Notes satisfied the intended 3:1 debt-to-equity ratio. See Proposed Findings ¶ 194 through ¶ 197.

208. The existence of the Loan Notes was expressed as debt on the books and records of both NAGP and ScottishPower. See, e.g., Stips. ¶ 188, ¶ 189, ¶ 190, ¶ 193, ¶ 194, ¶ 197, ¶ 202, ¶ 203, ¶ 208, ¶ 210, ¶ 211, ¶ 213, ¶ 230, ¶ 231, ¶ 232, ¶ 233, ¶ 237, ¶ 239, ¶ 241, Ex. 35-J; Ex. 66-J.

209. ScottishPower's filings with the SEC described the Loan Notes as debt. See e.g., Ex. 75-J at SUPP003507; Ex. 34-J at SUPP001542-43 (loan amount included in Fixed Investments); Ex. 79-J at PHI-DOCS130055; Ex. 91-J at SUPP001674-75 (loan amount included in Fixed Investments); Ex. 92-J at SUPP001800-01 (loan amount included in Fixed Investments); and Ex. 93-J at SUPP001946-47 (loan amount included in Fixed Investments).

210. Correspondence between officers and employees representing each party consistently recognized the Loan Notes as debt and respected the terms thereunder. See e.g., Ex. 133-J; Ex. 135-J through Ex. 139-J.

A. ScottishPower's Financial Projections

212. ScottishPower prepared detailed projections for PacifiCorp immediately prior to the Announcement Date ("1998 Projections") and the Closing Date ("1999 Projections"). These projections were the product of extensive due diligence performed by both ScottishPower (an experienced acquirer) and multiple third-party advisors. Ex. 245-P (Shaked Expert Report) at pp. 20-21; Tr. 430:14-431:12 (Shaked); see also Proposed Findings ¶ 84 through ¶ 90.

213. PacifiCorp's outlook and financial performance were materially the same between the Announcement Date and the Closing Date. Ex. 245-P (Shaked Expert Report) at p. 12. No significant events took place to invalidate the due diligence activities engaged in prior to the Announcement Date. Id.

214. Both the 1998 Projections and the 1999 Projections provide a reasonable basis for assessing whether ScottishPower's reasonably expected that NAGP could service the debt and repay principal based on the following factors:

216. Individual assumptions in the 1998 and 1999 Projections were reasonable. Ex. 249-P (Vander Weide Expert Report) at pp. 10, 18. For example, the projected growth rate was reasonable with respect to historic growth rates and the operating environment. Id.

B. Repayment Capacity

217. At the time the Loan Notes were issued, ScottishPower could reasonably project that interest and principal payments on the Loan Notes could be made out of NAGP's assets and reasonably anticipated cash flow. Ex. 245-P (Shaked Expert Report) at p. 26; see also Proposed Findings ¶ 218 through ¶ 223, infra.

219. Utilizing the 1998 Projections, NAGP was reasonably expected to make regular interest and principal payments and likely could repay both the Fixed Rate Notes and Floating Rate Notes on or before their maturities in 2009 and 2014, respectively. Ex. 245-P (Shaked Expert Report) at pp. 26-27.

221. Utilizing the 1999 Projections, NAGP was reasonably expected to make regular interest and principal payments and likely could repay both the Fixed Rate Notes and Floating Rate Notes on or before their maturities in 2009 and 2014, respectively. Ex. 245-P (Shaked Expert Report) at p. 27.

222. The break-even interest rate for NAGP's Fixed Rate Notes was 23.8% utilizing the 1998 Projections and 23.1% utilizing the 1999 Projections. Ex. 245-P (Shaked Expert Report) at p. 28; Tr. 442:18 through 444:10. Inclusion of the Floating Rate Notes brings these figures to 19.5% and 18.9%, respectively. Id. These figures are significantly higher than the actual interest rate on NAGP's debt, and demonstrate NAGP's strong cash flow relative to its debt service requirements. Id.

223. A high-level regulatory rate of return analysis performed by Dr. Shaked further indicates that at the time the Loan Notes were issued, it was reasonably projected that NAGP should, over the long-term, have sufficient funds to pay interest and principal amounts on the Intercompany Debt. Ex. 245-P (Shaked Expert Report) at pp. 28-29.

C. Adequate Capitalization

224. Adequate capital is often equated with a company's ability to pay its debts as they become due. Ex. 245-P (Shaked Expert Report) at p. 30. There is no "bright-line rule" for assessing whether a utility holding company such as NAGP is adequately capitalized. Id. While a cash flow analysis is internal to the company, capital adequacy may also be analyzed by looking to the marketplace to determine what investors at the time considered to be appropriate leverage and risk/return characteristics, as well as considering qualitative factors underpinning a lending or investing decision. Id.

225. NAGP was adequately capitalized as of the Announcement Date and the Closing Date. This fact is demonstrated by the following analyses (Ex. 245-P (Shaked Expert Report) at pp. 30-31):

227. NAGP had significant positive equity value as of Announcement Date and the Closing Date. Ex. 245-P (Shaked Expert Report) at pp. 36-38; Tr. 445:5 through 446:5 (Shaked). This is true regardless of whether NAGP had $4.0 billion or $4.9 billion of intercompany debt. Id.

228. As of December 7, 1998, the value of NAGP's assets was at least $3.0 billion greater than the Fixed Rate Notes. Ex. 245-P (Shaked Expert Report) at pp. 36-38. Thus, NAGP had a positive equity value of at least $3.0 billion.³Id. This equity cushion would be seen as a significant margin of safety for lenders and other potential investors in NAGP. Id. This conclusion is supported by the following analyses:

230. Mr. Mudge offered no references or analyses to show why ScottishPower's Valuation Model was either reasonable or unreasonable. Tr. 460:20-462:6 (Shaked) (Shaked testified: "Mr. Mudge has none, and when I say none, I mean zero, references to show that the projections are reasonable or unreasonable. . . . I mean, I just couldn't -- frankly, I was shocked not to see it."); Tr. 464:9-465:15 (Shaked further testified: "No standards, and he decides that they are aggressive because that's what he decided. I know that it sounds unreal. . . . it's not an expert report in my opinion").

232. In the 1999 Projections, the dividend was projected to grow at 7.5% annually. Tr. 290:24-291:1 (Wilson). This growth rate was not intended to reflect ScottishPower's management's view of the anticipated growth of PacifiCorp's dividend. Tr. 291:14-17 (Wilson). Rather, the purpose of the 7.5% dividend growth rate assumption was to illustrate financial projections with a debt-equity ratio that was more typical of a US utility, which was 50% debt, 50% equity. Tr. 291:18-23 (Wilson).

233. In order to calculate the amount of cash that ScottishPower anticipated would be generated by PacifiCorp, various cash flow lines in the 1999 Projections would need to be added together. Tr. 292:2-9 (Wilson).

238. Based on NAGP's strong business position in the western United States and Australia, its financial performance and the risk inherent in its degree of financial leverage, if, hypothetically, NAGP had issued $4 billion of debt to third parties under similar terms as the Fixed Rate Notes, NAGP would have been assigned a stand-alone credit rating of at least "BBB-" (investment grade) on the S&P rating scale or equivalent from other independent credit rating agencies such as Moody's. Ex. 251-P (Chambers Expert Report) at p. 4. There is the possibility that a slightly higher "BBB" rating could have been assigned to NAGP at that time. Ex. 251-P (Chambers Expert Report) at p. 4. The planned disposition of certain PacifiCorp assets could have potentially further strengthened NAGP's financial position. Ex. 251-P (Chambers Expert Report) at p. 4; Tr. 598:2-5 (Chambers).

239. NAGP's hypothetical investment grade credit rating would have been attributable to a number of factors specific to the utility industry, and certain other regulated industries, and PacifiCorp in particular, including:

241. A credit rating agency would have reasonably anticipated that the solid economic performance in PacifiCorp's market areas would create a solid underpinning for future demand for energy and the company's results. Ex. 251-P (Chambers Expert Report) at p. 17.

242. A credit rating agency would have observed that there was the traditional oversight on PacifiCorp to justify its costs and rate of return on investment in periodic rate cases and that PacifiCorp remained more protected against competition than utilities in some other states. Ex. 251-P (Chambers Expert Report) at p. 17.

243. A credit rating agency would have considered the 1998 Model as the most reasonable basis to evaluate NAGP's anticipated financial performance and the risk inherent in its degree of financial leverage for several reasons including (Tr. 608:22-610:19 (Chambers)):

245. All three categories of financial risk that are typically examined by a credit rating agency in evaluating a firm's creditworthiness -- debt leverage,⁵ cash flow adequacy⁶ and profitability⁷ -- would have supported at least a low investment-grade rating of "BBB-" in 1999. Ex. 251-P (Chambers Expert Report) at p. 31. That rating assignment might also have received a "positive outlook" reflecting the potential for an upgrading of the rating. Id. Alternatively, a more optimistic view of the situation might have resulted in the higher "BBB" rating being assigned in 1999. Id.

247. NAGP's strong business position remains the same regardless of the treatment of the Floating Rate Notes. Ex. 251-P (Chambers Expert Report) at p. 56.

248. If the Floating Rate Notes had been issued in the open market to third-party investors, it is most likely that the debt would have been issued as subordinated debt, so as not to impair the creditworthiness of the remainder of NAGP's or PacifiCorp's other debt obligations. Ex. 251-P (Chambers Expert Report) at p. 55.

249. If, hypothetically, the Floating Rate Notes were issued to external investors as subordinated debt (i.e., subordinated to the Fixed Rate Notes), there is a greater likelihood that NAGP's senior debt (i.e., the Fixed Rate Notes) and that of PacifiCorp would continue to be rated in the investment grade category at the "BBB-" level. Ex. 251-P (Chambers Expert Report) at p. 56.

250. If, rather than issuing $4 billion of public debt, the Floating Rate Notes had also been issued as external senior debt (i.e., pari passu with the Fixed Rate Notes), the financial position of NAGP would have been only slightly weaker. Ex. 251-P (Chambers Expert Report) at p. 56. While there is still a possibility that an investment grade rating of "BBB-" would have been assigned to NAGP, it is more likely that a lower credit rating of "BB+" would have been assigned to NAGP in 1999, the highest possible rating in the speculative grade. Id.

251. A credit rating in the "speculative" or "non-investment grade" ranges, such as a rating in the "BB" category or even lower, does not imply imminent distress or bankruptcy for the company. Ex. 251-P (Chambers Expert Report) at p. 15. Nor does a non-investment grade rating imply that investors will not purchase such debt instruments when offered. Id. As of 1999, 37% of corporate bond issuers rated by S&P were in the non-investment grade categories. Id; Tr. 598:21-599:24 (Chambers).

254. The debt capital markets would have been the optimal market for placing a hypothetical NAGP financing because PacifiCorp was a well known issuer and the markets were excellent in 1999. Tr. 661:21-662:10 (Chigas).

255. A hypothetical NAGP $4 billion fixed rate investment grade rated debt capital market bond transaction offered on November 29, 1999 would have been purchased by third-party income investors on similar terms as the Loan Notes. Ex. 253-P (Chigas Expert Report) at p. 5; Tr. 658:7-19 (Chigas).

256. The reasons that a hypothetical NAGP $4 billion fixed rate investment grade rated debt capital market bond transaction offered on November 29, 1999 would have been purchased by third-party income investors on similar terms as the Loan Notes include the following:

258. The $897 million Floating Rate Notes would not have materially affected the issuance of a hypothetical NAGP debt capital markets transaction. Ex. 253-P (Chigas Expert Report) at p. 5; Tr. 665:6-18 (Chigas).

259. An investment bank would have viewed a hypothetical debt underwriting of $4 billion as a significant commercial business opportunity and would have competed intently to win the mandate. Ex. 253-P (Chigas Expert Report) at p. 5.

260. An investment bank would have vigorously competed to be chosen as the lead underwriter for a hypothetical $4 billion transaction for the following reasons: (i) prestige for the bank's utility franchise; (ii) distinction associated with the largest utility financing and one of the largest bond deals of 1999; (iii) earn a large fee to the bank; and (iv) capture market share, one of the primary metrics investment banks compete on. Ex. 253-P (Chigas Expert Report) at p. 14.

261. Incorporation of the Floating Rate Notes into the analysis would not have changed the conclusions regarding the ability to market the debt. Ex. 253-P (Chigas Expert Report) at p. 27.

263. The interest rate on the Fixed Rate Notes was 7.3%. An indicative credit spread range for a hypothetical debt capital markets transaction would have been the 10-yr Treasury yield of 6.20%, plus 200 bps (basis points) plus or minus 12.5 bps. Consequently, the initial spread in a debt capital markets transaction for the Loan Notes indicates in an initial yield range of 8.075% - 8.325%. Ex. 253-P (Chigas Expert Report) at pp. 26-27.

265. The terms of the Loan Notes were substantially similar to standard investment grade bond terms at the time. Ex. 253-P (Chigas Expert Report) at p.5.

267. After Closing, Mr. MacRitchie was appointed Transition Director and assembled a team of 60 managers, which were a combination of ScottishPower and PacifiCorp employees, to develop a transition plan to deliver performance improvements at PacifiCorp by May 2000 ("Transition Plan"). Tr. 336:20-337:6 (MacRitchie); Ex. 60-J.

268. In April of 2000, PacifiCorp management prepared a Transition Plan. The Transition Plan provided projected savings in PacifiCorp's operating costs base and capital expenditures over a five year period. Ex. 60-J; Stip. ¶ 167. The Transition Plan was a document that was intended to be ScottishPower's road map and plan for detail of how it would achieve performance improvements. Tr. 337:7-338:2 (MacRitchie). The Transition Plan was also a public document that ScottishPower had committed to share with its new U.S. regulators within six months of Closing. Tr. 337:11-338:2 (MacRitchie).

269. The Transition Plan included a "Base Case," an "Optimistic Case," and a "Highly Optimistic Case" annual cost savings figures. Ex. 60-J at PHI-DOCS065776. ScottishPower and PacifiCorp intended to "over-deliver" on the cost savings figures characterized as "Highly Optimistic." Tr. 380:22-381:12 (MacRitchie).

270. The cost savings in the "Highly Optimistic Case," which were made publicly available, were also the same figures that were presented to ScottishPower's Board of Directors in the Project Jet Board Paper and also incorporated into the 1998 Model. Tr. 341:24-342:5; Tr. 343:12-18 (MacRitchie). The "Highly Optimistic Case" cost savings were also entirely consistent with the cost savings projections ScottishPower communicated to the investor community when the proposed Merger was announced in December 1998. Tr. 343:12-18 (MacRitchie).

271. For fiscal year ending March 31, 2001, ScottishPower projected cost savings of $48 million. Tr. 346:8-10 (MacRitchie); Ex. 5-J at PHI-DOCS097339. In fact, Mr. MacRitchie's team delivered first year cost savings of $85 million, a significant increase above what ScottishPower originally planned. Tr. 346:5-19 (MacRitchie); Ex. 91-J at SUPP001564. These cost savings were achieved through a number of different initiatives in different business units. Tr. 346:20-347:11 (MacRichie).

272. Continued cost savings occurred in the fiscal years ending March 31, 2002 and March 31, 2003, with the continued plan of reaching annual savings of $300 million by 2004-2005. Ex. 92-J at SUPP001696; Ex. 93-J at SUPP001823. Through the fiscal year ending March 31, 2003, Mr. MacRitchie was confident that he delivered the cost savings that were projected in the Transition Plan. Tr. 354:16-21 (MacRitchie).

B. Western Power Crisis

273. Following the Merger, PacifiCorp found itself in a "perfect storm" of declining industry fundamentals, regional economic turbulence, and company specific issues. Ex. 245-P (Shaked Expert Report) at p. 49. These events were not anticipated by ScottishPower and could not have reasonably been anticipated at the time of the Merger. Id.; Ex. 249-P (Vander Weide Expert Report) at pp. 17-18; Tr. 557:17-22 (Vander Weide).

275. The Western Power Crisis had its roots in California Bill AB 1890 passed in 1996, which encouraged California electric utilities to sell their fossil-fueled power plants and required California electric utilities to: (i) purchase power from the California Power Exchange at market-clearing prices; (ii) lower retail rates by ten percent; and (iii) not raise retail rates for a period of three years, or until the utilities had recovered their stranded costs, whichever came first, together with other contributing factors that included (Stip. ¶ 169):

277. In the winter of 2000-2001, wholesale prices spiked as high as $3,800/MWh. 245-P (Shaked Expert Report) at p. 44. By the spring of 2001, all three major California utilities were in financial distress, with Pacific Gas & Electric filing for bankruptcy on April 6, 2001. 245-P (Shaked Expert Report) at p. 44.

278. As a result of these events, inter alia, the combined market capitalization of investor owned utilities fell from $433 billion at the end of 1998 to $249 billion at the end of 2002. Ex. 245-P (Shaked Expert Report) at p. 44.

280. For a portion of 2000, PacifiCorp could generally meet demand by using power from its own facilities. Stip. ¶ 171; Tr. 347:15-23 (MacRitchie); Tr. 568:9-569:6 (Vander Weide).

281. On November 24, 2000, at a time when power supplies were extremely tight and prices were at their highest, PacifiCorp's 430 megawatt Hunter Plant experienced a catastrophic failure and did not return to service until April 30, 2001. Stip. ¶ 172.

282. The catastrophic failure at Hunter Power Station was a result of a short in the electrical core of the generator. Tr. 384:4-24 (MacRitchie).

283. With the Hunter Power Station idled and demand high, PacifiCorp was unable to meet its customers' power requirements from dedicated sources, and was instead forced to purchase power on the open market at high prices. Stip. ¶ 172; Tr. 347:24-348:10 (MacRitchie).

284. When prices did return to lower levels in 2002, PacifiCorp did not benefit immediately because it had entered into forward contracts to protect itself from further exposure to the fluctuations which had characterized 2000 and 2001. Stip. ¶ 172. These forward contracts committed PacifiCorp to continue purchasing power at higher prices even after the market had returned to historic levels. Id.

285. The costs associated with this wholesale electric power volatility could not be directly passed on by companies like PacifiCorp to consumers due to the fact that customer rates were fixed by regulators. Ex. 245-P (Shaked Expert Report) at p.45; Ex. 99-J. While electric utilities could apply for increased rates to cover additional costs, there is a regulatory lag in this process. Id.

286. In the wake of the loss of the Hunter Power Station, Mr. MacRitchie and his team accelerated the delivery of projected cost savings and by June 2001 were still on target to deliver $300 million of annual cost savings. Tr. 348:11-349:6; Tr. 350:6-351:6 (MacRitchie). Throughout the Western Power Crisis, ScottishPower didn't let up on its efforts to achieve the cost savings it had projected, and the cost savings were in fact achieved. Tr. 351:17-352:12 (MacRitchie); Ex. 92-J at SUPP001696; Ex. 93-J at SUPP001823; Tr. 355:5-6 (MacRitchie) ("I know for a fact that we delivered these cost savings").

287. Notwithstanding the achievement of projected cost savings in 2000 through 2002, PacifiCorp underperformed relative to the projections developed by Morgan Stanley, PacifiCorp management and ScottishPower. Ex. 245-P (Shaked Expert Report) at p. 48.

288. As a result of the Hunter Power Station failure and the Western Power Crisis, PacifiCorp lost about a billion dollars of cash. Tr. 352:13-19 (MacRitchie); Tr. 569:7-20 (Vander Weide). This underperformance was deeply impacted by industry and regional factors external to PacifiCorp and unforeseen at the time of the Merger. These events negatively affected many companies in the U.S. electric utility industry, not just PacifiCorp. Ex. 245-P (Shaked Expert Report) at p. 48.

C. Insertion of PacifiCorp Holdings, Inc. ("PHI")

289. Prior to and following the merger, ScottishPower and NAGP contemplated that PacifiCorp's non-regulated subsidiaries should be separated from PacifiCorp and its regulated subsidiaries and placed under a newly formed holding company. Stip. ¶ 173; Ex. 61-J; Tr. 853:18-25 (Wright).

290. Although a part of the original merger plan (Project Jet), it was later decided that separating out PacifiCorp's regulated and non-regulated entities was not an essential pre-acquisition step and could be completed after the merger. Tr. 901:20-25 (Self).

291. ScottishPower believed that by separating PacifiCorp's regulated and non-regulated businesses, it would have more freedom of operation for the non-regulated activities, in terms of their financing and operations. Tr. 902:8-18 (Self); Tr. 771:6-14 (Martin); Ex. 225-J.

292. In December 2000, a formal decision was made to proceed with the insertion of PacifiCorp Holdings, Inc. ("PHI") as a holding company for PacifiCorp, PacifiCorp Group Holdings Company ("PGHC") and PacifiCorp Power Marketing ("PPM"). Stip. ¶ 175; Tr. 901:25-902:9 (Self).

293. PHI was formed, and ScottishPower and PacifiCorp began the process to obtain consent from the U.K. Treasury for the insertion of PHI and separation of regulated business from non-regulated businesses, as well as consent from U.S. state regulators. Stip. ¶ 175; Ex. 63-J.

294. NAGP transferred its PacifiCorp stock to PHI, effective December 31, 2001. Stip. ¶ 178; Tr. 901:12-13 (Self); Ex. 257-P.

295. On February 4, 2002, PacifiCorp distributed PGHC to PHI, making PGHC and PacifiCorp brother-sister subsidiaries of PHI. Stip. ¶ 179.

D. Capitalization of the Floating Rate Notes

296. In the Fall of 2001, Larry Martin, Tax Director of PacifiCorp, retained PwC to prepare a study ("PwC Study" -- Ex. 65-J) regarding the reasonableness of the amount of the Loan Notes as of Closing. Tr. 763:18-22; Tr. 765:17-21 (Martin); Stip. ¶ 182.

297. By December 2001 PwC gave PacifiCorp its preliminary indication that it would be able to support the $4 billion of fixed rate debt and, before the end of the tax year ended March 31, 2002, PwC informed PacifiCorp that it could reach a more likely than not opinion on repayment of $4 billion of the Intercompany Debt. Tr. 762:13-18; Tr. 766:3-5 (Martin). PwC's evaluation was not based on ScottishPower's or PacifiCorp's premerger projections (e.g., the Valuation Model), but instead PwC and PacifiCorp's accounting and treasury personnel developed new projections in 2001. Tr. 764:18-24; Tr. 765:22-24 (Martin).

298. In March 2002, NAGP and ScottishPower decided to capitalize the two Floating Rate Notes into equity. Stip. ¶ 180; Tr. 766:14-19 (Martin); Tr. 869:21-25 (Wright); Tr. 918:6-13 (Self). ScottishPower made contributions to NA1 and NA2. NA1 and NA2 made contributions to NAGP. Id. NAGP used the contributions to fully retire the $896,279,844 in Floating Rate Debt. Id. NAGP recorded the elimination of the Floating Rate Debt on its books as additional paid in capital of NA1 and NA2. Id.

299. The timing of capitalization of the Floating Rate Notes was in part so that NAGP's tax return for the tax year ended March 31, 2002 would accurately report interest deductions consistent with PwC's analysis. Tr. 766:22-767:1 (Martin); Tr. 917:19-918:3 (Self). Additionally, NAGP waited for the insertion of PHI before capitalizing the Floating Rate Notes. Tr. 767:1-3 (Martin).

300. On March 27, 2002, the partners of NAGP resolved to use contributions from NA1 and NA2 to fully retire the Floating Rate Notes (Ex. 64-J). Stip. ¶ 181; Ex. 232-J.

E. Repayment

302. ScottishPower and NAGP contemplated that the primary source of cash flow for NAGP's interest payments to ScottishPower on the Loan Notes would be dividends paid by PacifiCorp on a quarterly basis to coincide with the interest due dates. Tr. 888:21-24 (Wright); Tr. 904:13-14 (Self). In addition, ScottishPower and NAGP anticipated funding the interest payments with the proceeds from the sale of certain non-core assets, including its Australian operations. Stip. ¶ 186; Tr. 756:16-19 (Martin); Tr. 922:16-21 (Self).

303. ScottishPower recorded and tracked the financial effects of the Loan Notes in its Treasury Management System (i.e., company transactions, foreign exchange derivatives, etc.). Tr. 818:13-19 (Wright).

304. ScottishPower computed interest on the Loan Notes on a quarterly basis, applying a 360-day accounting period convention that switched to an actual 365-day convention in the final accrual period of each fiscal year. Stips. ¶ 183 and ¶ 184; Tr. 822:9-13; Tr. 825:3-7 (Wright). NAGP accounted for interest accruals on the Loan Notes on a monthly basis, applying a 360-day accounting period convention. Tr. 822:9-13; Tr. 825:8-11 (Wright). This resulted in differences between ScottishPower's interest computations and NAGP's interest accruals. Stips. ¶ 183, ¶ 184; Tr. 825:13-16 (Wright). These differences were identified and reconciled by ScottishPower and NAGP. Tr. 822:17-21 (Wright).

305. Mr. Wright had prepared a spreadsheet that shows accruals and payments of interest with respect to the Fixed Rate Notes and Floating Rate Notes from the issuance date of November 29, 1999 to December 9, 2002. Ex. 66-J; Stip. ¶ 189; Ex. 66-J; Tr. 823:3-11, Tr. 824:17-19 (Wright). In particular, the spreadsheet shows the following:

307. PacifiCorp did not declare a dividend on its common stock in the tax year ending March 31, 2000. Stip. ¶ 191. As a result, NAGP delayed its first interest payment due on February 11th until the late dividend was paid in June 2000. Stips. ¶ 192; ¶ 198; Tr. 852:9-21 (Wright); Tr. 751:3-4 (Martin).

308. Previously, on November 29, 1999, in anticipation of receiving its February 2000 interest payment from NAGP, ScottishPower entered into a cross-currency swap with NA1 and NA2 in order eliminate its foreign exchange exposure with respect to NAGP's payment of interest in dollars on both the Fixed Rate Notes and Floating Rate Notes with respect to the first interest payment date of February 11, 2000. Ex. 198-J; Tr. 843:18-844:15; 846:6-10 (Wright). NA 1 and NA2, in turn, sold the dollars-based interest payment to a third party banks in order to eliminate their foreign exchange exposure. Ex. 204; Tr. 847:25-848:20; 850:8-851:1; Tr. 889:11-890:5 (Wright).

309. Similar swaps and currency sales were engaged in by ScottishPower, NA1, NA2 and third-party banks with respect to interest payments of NAGP due on May 11, August 11 and November 11 of 2000. Tr. 851:2-9 (Wright).

312. The amount of $333,171,736.90 interest that was paid and deducted by NAGP in the tax year ended March 31, 2001 was less than the interest that was accrued on the Fixed Rate Notes through March 31, 2001. Tr. 762:19-23 (Martin).

313. When Mr. Martin signed and filed the 2001 return in December 2001, he had been given a preliminary indication from PwC that they would support only the $4.0 billion of Fixed Rate Debt for tax purposes. Tr. 762:13-763:15 (Martin). Mr. Martin held a similar view. Id. However, because the interest being deducted was less than the accrued interest on the Fixed Rate Notes, Mr. Martin was sufficiently comfortable claiming the deduction. Id. Mr. Martin viewed the Fixed Rate Notes as absorbing interest payments before any payments were allocated to the Floating Rate Notes. Tr. 763:25-764:4 (Martin).

314. NAGP made its interest payments to ScottishPower with the proceeds from the following PacifiCorp dividend payments, which total $332,267,579.40 (Stip. ¶ 199):

316. Dividend payments were suspended pending the insertion of PHI because, inter alia, the dividend payments would have triggered U.K. income tax for ScottishPower since ScottishPower had exhausted its foreign tax credits. Stip. ¶ 200; Tr. 905:8-16 (Self); Tr. 772:11-18; Tr. 782:18-24 (Martin).

317. The decision to delay full payment of the February 2001 dividend also occurred in the midst of the Western Power Crisis and during the same period that the Hunter Power Station was offline.⁸ Stip. ¶ 172.

319. On September 25, 2001, NAGP entered into a $360 million credit facility with Royal Bank of Scotland ("RBS"), with a maturity date of March 31, 2002. Stip. ¶ 216; Ex. 68-J. NAGP incurred the indebtedness with RBS in order to fund its interest obligations to ScottishPower on the Loan Notes in light of the suspension of PacifiCorp dividends. Stip. ¶ 218; Tr. 908:11-24 (Self).

320. NAGP intended that the RBS credit facility would be repaid as soon as PHI was approved by the regulators and put in place. Tr. 908:11-24 (Self). "We wanted to ensure we could demonstrate that NAGP had its own funds available to pay the interest that was due up to March 31, 2002." Tr. 915:8-10 (Self).

321. On or about September 27, 2001, NAGP borrowed $273,373,300 from RBS. Stip. ¶ 227.

322. On or about November 13, 2001, NAGP borrowed $84,116,315.50 from RBS. Stip. ¶ 228.

323. NAGP repaid the two advances from RBS in the taxable year ended March 31, 2002 from cash distributions NAGP received from PHI (its subsidiary). Stip. ¶ 218.

324. According to Mr. Wright, the two advances were drawn down to pay the interest that was due from NAGP but had not been paid. Tr. 859:7-9 (Wright). On September 27, 2001, NAGP received $274 million, paid RBS a fee of $720,000 and transferred $273 million to ScottishPower to pay the interest due and previously unpaid. Tr. 860:20-21; Ex. 132-J.

325. On November 13, 2001, NAGP similarly received $84.1 million and on the same day transferred the funds to ScottishPower as a payment of interest. Tr. 860:25-861:10 (Wright).

326. The source of the funds for NAGP's $273 million interest payments was a revolving credit facility that NAGP obtained from RBS. NAGP borrowed funds from RBS because of the decision to suspend PacifiCorp dividends pending the insertion of PHI. Tr. 859:4-15; Tr. 860:9-21 (Wright); Ex. 132-J.

327. The journal entry referenced in Stip. ¶ 229 was a temporary measure taken until the PHI restructuring could take place, as both ScottishPower and NAGP knew that the interest on the Loan Notes had to be paid from NAGP's sources of cash. Tr. 862:9-20 (Wright). The entries for accruals of $101,848,787.68 and $84,432,841 were viewed as mere book entries and were not intended to reflect an actual payment of interest and certainly were not intended to produce a tax deduction. Tr. 863:2-12 (Wright); Tr. 781:20-782:12; 784:3-6 (Martin).

328. During the tax year ended March 31, 2002, PacifiCorp declared dividends on its common shares in the total amount of $240,832,929.24, comprised of the following (Stip. ¶ 214):

330. PGHC was distributed by PacifiCorp to PHI in February 2002. Stip. ¶ 179; Tr. 909:11-13 (Self).

331. In March 2002, PGHC distributed $300 million to PHI. Stip. ¶ 220. PHI in turn distributed $598 million to NAGP, which paid $360 million to RBS to pay off the loan and deposited the remaining $238 million with ScottishPower U.K. ("SPUK"), a ScottishPower subsidiary. Stips. ¶ 221 to ¶ 223; Tr. 868:1-12 (Wright); Tr. 910:22-911:3 (Self); Ex. 135-J.

332. In February 2002, Mr. Martin prepared a spreadsheet that reflected ScottishPower's and NAGP's view that the interest paid to date was allocated exclusively to the Fixed Rate Notes. Ex. 238-J; Tr. 871:24-874:1-14 (Wright). After such allocation, the interest on the Fixed Rate Notes was fully paid up, except for $1,483,068. See Stip. ¶ 232; Tr. 768:25 (Martin); Tr. 838:3-16 (Wright); Ex. 238-J; Tr. 874:5-10 (Wright); Tr. 916:6-9 (Self). Ms. Self testified the decision was made: "to get NAGP's interest payments all caught up to March 31, 2002 and to give us a clean position going into the following fiscal year." Tr. 915:17-19 (Self).

333. When she was hired in January 2002, Heather Self, ScottishPower's Group Tax Director, took a detailed interest in reviewing the tax implications of the Intercompany Debt. Ms. Self described the Intercompany Debt as "a very significant feature of the group's tax profile," and so she had numerous discussions with U.S. tax colleagues and external advisors to ensure that she fully understood the features of the Intercompany Debt and the tax implications. Tr. 899:21-900:2 (Self).

335. No dividends were declared or paid by PacifiCorp or PGHC to PHI, and in turn no dividends were paid by PHI to NAGP, during the tax year ending March 31, 2003. Stip. ¶ 240.

336. In the tax year ended March 31, 2003, NAGP used funds it had deposited with SPUK to make interest payments on the Fixed Rate Notes. NAGP accounted for the payments on its books by recording an offset against the balance of its receivable from SPUK attributable to its deposit. Stip. ¶ 241.

337. SPUK had the external bank facilities and acted as the banker for ScottishPower and its affiliates, including PacifiCorp and NAGP. The ScottishPower affiliates would deposit cash with SPUK as if they were depositing the cash with a bank. Tr. 869:7-15 (Wright).

338. NAGP paid interest to ScottishPower in the tax year ending March 31, 2003 by transferring to ScottishPower the ownership of monies it held with SPUK. Tr. 875:2-876:21 (Wright); Tr. 923:19-23 (Self). This was done by NAGP directing SPUK to transfer the monies from NAGP's account to ScottishPower's account, similar to how one directs a bank to pay a mortgage payment. Id.

339. For the fiscal year ended March 31, 2003, ScottishPower's books reflected total interest owed on the Loan Notes by NAGP in the amount of $239,684,821.44. Stip. ¶ 239.

340. NAGP paid ScottishPower total interest of $206,127,512.66 during the tax year ending March 31, 2003, and an additional $35,040,377 of penalty interest and premium in connection with the refinancing of the Intercompany Debt. Stip. ¶ 242. Included in this amount was the $1,483,068 that was accrued but unpaid by the end of the tax year ended March 31, 2002. Tr. 919:22-920:1 (Self).

341. Payments were made in May, August and November, as well as on December 9, 2002, the same day the Fixed Rate Notes were replaced with $2.375 billion of indebtedness in the form of a deferred subscription agreement between PHI and PacifiCorp UK Ltd. ("PUKL"), a ScottishPower affiliate. See Stip. ¶ 242; Stip. ¶ 247.

342. The amount of the debt was properly reduced from $4.0 billion to $2.375 billion based on a prospective financial analysis of NAGP by PwC in 2002. Tr. 935:21-936:15 (Self); Ex. 65-J.

343. Of the four $1 billion Fixed Rate Notes, $1.625 billion was capitalized in light of the reassessment of PacifiCorp's financial capacity as of December 9, 2002 (known as "Project Venus"). Stip. ¶ 247. NAGP subsequently merged into PHI as a part of Project Venus. Stip. ¶ 247.

F. Tax Return Preparation and Return Positions

344. NAGP timely filed its U.S. Federal income tax return for the tax year ended March 31, 2001 on December 17, 2001. Stip. ¶ 204; Ex. 67-J. NAGP claimed an interest deduction in the amount of $333,171,736, equal to the amount of interest actually paid to ScottishPower on the Fixed Rate Notes. Stip. ¶ 201, Stip. ¶ 207; Ex. 67-J.

345. NAGP timely filed its U.S. Federal income tax return for the tax year ended March 31, 2002, on December 19, 2002. Stip. ¶ 234. NAGP claimed an interest deduction in the amount of $357,489,615, equal to the amount of interest actually paid to ScottishPower on the Fixed Rate Notes. Stips. ¶ 207, ¶ 224; Ex. 72-J.

346. NAGP timely filed its U.S. Federal income tax return for the tax year ended March 31, 2003 on December 15, 2003. Stip. ¶ 243. NAGP claimed an interest deduction in the amount of $241,167,889, equal to the amount of interest and penalty interest actually paid to ScottishPower on the Fixed Rate Notes. Stip. ¶ 242, Stip. ¶ 245; Ex. 73-J.

347. Mr. Martin signed NAGP's U.S. Federal income tax return for each of the tax years ended March 31, 2001, 2002 and 2003. Tr. 750:5-10; Tr. 754:5-11 (Martin). Each of these returns was prepared by PwC. Tr. 749:13-19 (Martin).

348. Before signing NAGP's returns, Mr. Martin performed his own due diligence and satisfied himself that the interest expense claimed on the return with respect to the Intercompany Debt was correct, documented and valid under professional (CPA) and statutory standards. Tr. 758:5-20 (Martin).

349. In Mr. Martin's view, no portion of the interest deductions NAGP claimed in Tax Year 2001 was attributable to interest payments on the Floating Rate Loan Notes; rather, the deductions were attributable entirely to interest payments on the Fixed Rate Notes. Tr. 793:21-794:2; Tr. 799:10-800:14 (Martin); Tr. 919:12-15 (Self).

350. In Tax Year 2002, the interest payments that were made by NAGP to ScottishPower were slightly less than the total interest accrued on the Fixed Rate Notes. Tr. 768:15-20 (Martin); Tr. 871:10-14 (Wright); Ex. 238-J.

351. No portion of the interest deductions NAGP claimed on its U.S. Federal tax return for the tax years ended March 31, 2001, 2002, or 2003 was attributable to interest payments to ScottishPower, the source of which was a loan from ScottishPower. Tr. 757:12-21; Tr. 782:1-12 (Martin).

352. No portion of the interest payments that were deducted by NAGP in Tax Year 2002 was funded by monies borrowed from ScottishPower or any ScottishPower affiliate through a "circular cash flow" arrangement or otherwise. Tr. 782:1-12 (Martin).

G. Project Venus

353. At the time that PwC recommended capitalizing the Floating Rate Notes, PwC also recommended that NAGP should restructure the Intercompany Debt based on new, forward-looking financial projections. Tr. 925:2-10 (Self); Ex. 65-J at PHI-EDOCS008656.

354. The restructuring recommendation was based on proposed changes to U.S. tax regulations, which, if enacted, would result in increased U.S. withholding taxes for NAGP. Tr. 926:6-13 (Self). Additionally, ScottishPower had nearly exhausted its U.S. foreign tax credits, which would result in U.K. income taxes on dividend payments to ScottishPower. Tr. 926:13-17 (Self).

355. Detailed planning for the restructuring took place during 2002 and was referred to by NAGP and ScottishPower personnel as "Project Venus." Tr. 926:22-927:6 (Self); Ex.-233-J.

356. Ms. Self had primary responsibility for Project Venus. Tr. 927:8-12 (Self).

357. The Project Venus Plan called for the following steps:

359. On the day of the Project Venus refinancing, ScottishPower, NAGP and PHI arranged for a daylight borrowing facility with RBS. Tr. 939:11-13 (Self). The purpose of the daylight borrowing facility was for audit trail purposes, to evidence that the numerous steps and cash flow movements required by the Project Venus transaction actually occurred in the proposed order. Tr. 939:13-24 (Self).

360. By the end of December 9, 2002, PHI owed $2.375 billion in intercompany debt to ScottishPower, $2.375 billion of the principal of NAGP's Fixed Rate Loan was repaid to ScottishPower, and $1.625 billion of the principal of NAGP's Fixed Rate Loan was capitalized. Tr. 941:6-23 (Self).

361. Under the deferred subscription obligation structure, the intercompany debt was regarded as a debt instrument for U.S. tax purposes and as an equity instrument for U.K. tax purposes. Tr. 929:16-19 (Self). When asked to explain, Ms. Self testified, "It's a structure where the form of the structure is that a U.S. company makes subscriptions to share capital in a U.K. company. For U.K. purposes, we don't tax that because we don't tax subscriptions for capital, but the way the amounts are calculated is economically equivalent to vanilla debt." Tr. 929:21-930:1 (Self).

362. ScottishPower, relying on PwC's forward-looking cash flow projections as of December 2002, determined that $2.375 billion of restructured debt could be supported for U.S. tax purposes. Tr. 935:17-22; Tr. 936:15-17 (Self); Ex. 234-J.

363. The resulting aggregate principal amount of debt claimed by Petitioner after December 9, 2002 was $2.375 billion, comprised of six separate notes (the "Project Venus Debt"). Pursuant to Project Venus, the fixed interest rate on the intercompany debt was lowered from 7.3% to 6.75%, with the first interest payment on the restructured debt becoming due on March 31, 2003. Stip. ¶ 247. Each of the Project Venus Notes had different principal amounts and maturity dates, all within a range of maturities that were broadly consistent with external ScottishPower debt terms. Tr. 937:13-23 (Self).

364. ScottishPower and PacifiCorp separately retained PwC to provide tax opinions on the reasonableness of Project Venus for U.S. tax purposes. Tr. 936:8-22 (Self); Ex. 234-J; Ex. 176-J.

365. NAGP subsequently merged into PHI as a part of Project Venus. Stip. ¶ 247.

H. Retirement of the Intercompany Debt in 2006

366. In May 2005, ScottishPower announced a sale of PacifiCorp to MidAmerican Energy Holdings, Inc. ("MidAmerican") for $5.109 billion. Stip. ¶ 248.

367. The $2.375 billion of Project Venus debt was restructured in September 2005 due to proposed U.K. legislation that may have caused the interest payments to be taxable in the U.K. Stip. ¶ 249.

368. On March 21, 2006, PHI closed its sale of PacifiCorp to MidAmerican Energy Holdings Company. Stip. ¶ 250.

369. On July 31, 2006, more than three years before the stated maturity date of November 11, 2009, the entire outstanding principal and accrued interest on PHI's indebtedness to ScottishPower's affiliate was repaid in full by Scottish Power Holdings, Inc. ("SPHI"), successor in interest to PHI. Stip. ¶ 251; Tr. 942:8-16 (Self).

370. PacifiCorp was sold to MidAmerican at a net equity value of approximately $5.1 billion. Ex. 95-J at SUPP002136.

Because ScottishPower and NAGP are related parties, careful scrutiny is appropriate, but their status as parent and wholly-owned subsidiary does not preclude the existence of valid debt, and application a strict third-party arm's length standard is unwarranted. Due regard must be given to the business realities and the normal course of doing business in parent-subsidiary relationships. See Litton Business Systems, Inc. v. Comm'r, 61 T.C. 367, 379 (1973) (applying the law of the Ninth Circuit); Nestle, 70 T.C.M. (CCH) at 705 (citations omitted); see also Kraft, 232 F.2d at 123-26.

The evidence shows that ScottishPower and NAGP intended to create valid indebtedness, with a reasonable expectation of repayment, and that this intention comported with the economic reality of creating a debtor-creditor relationship. See Litton, 61 T.C. at 377.

The planning and formalities surrounding the Loan Notes, the considerable professional advice and input obtained by the parties in advance of the Merger, the pledge agreement and foreign currency hedging contracts, the representations on both NAGP's and ScottishPower's books and records of the obligations as debt, the accrual and payment of interest, and consistent external representations, such as to the SEC and other regulators, that the Loan Notes were debt, inter alia, evidence the parties' intent to create valid indebtedness.

ScottishPower's reasonable expectation of repayment at the time of the Merger was based on its successful prior acquisition and cost-savings implementation experience, as well as its extensive understanding of the industry and its outlook, and of PacifiCorp's historical and anticipated performance. ScottishPower's reasonable expectation of repayment was supported by meticulously and conservatively prepared cash flow projections, developed with the input of ScottishPower's and PacifiCorp's experienced internal experts as well as the input of outside advisors, which models clearly demonstrated sufficient cash flows to pay interest and principal on the Loan Notes. Thorough and informed analysis by Petitioner's well-qualified finance and industry experts further confirmed the reasonableness of ScottishPower's expectation of repayment.

NAGP could have borrowed from a hypothetical third-party lender in a debt capital markets transaction under substantially similar terms to the Loan Notes. The appropriate measure, which Petitioner has met, is not whether a third-party borrowing would have occurred on identical terms to the Loan Notes, but rather whether the terms of the Loan Notes are "reasonably comparable" to, and not, a "patent distortion" of what would normally have been available in an arm's length financing. See Nestle, 70 T.C.M. at 703, citing Litton, 61 T.C. at 379. According to Petitioner's well-qualified credit rating and investment banking experts, a debt capital markets offering on substantially similar terms to the Loan Notes would have been an attractive investment vehicle that banks would have competed for the opportunity to offer.

The evidence further shows that NAGP was adequately capitalized at the time of the Merger.

NAGP and ScottishPower's conduct following the Merger remained consistent with the economic reality of a debtor-creditor relationship, including ultimate payment of all interest accrued on the Fixed Rate Notes up until the time those notes were restructured in December 2002. All interest payments made and deducted for U.S. tax purposes were sourced from PacifiCorp dividends and the proceeds of sale of Australian assets, as contemplated at the time of the Merger.

PacifiCorp's expected financial performance post-Merger was significantly negatively affected beginning in mid-2000 by the two unanticipated events: the Western Power Crisis and the simultaneous catastrophic failure of the Hunter Power Station. This ultimately led to a reassessment, based on changed economic conditions and new external analyses of debt capacity, which supported capitalization of the Floating Rate Notes in March 2002 and the later capitalization of a portion of the Fixed Rate Notes in December 2002. Capitalization of a portion of a debt obligation does not indicate an intention to treat the remaining debt as equity, either at inception or from that time forward, particularly where the capitalization is dictated by changed business circumstances. Deseret News Publication v. Comm'r, 34 T.C.M. (CCH) 714, 718 (1975).

The Fixed and Floating Rate Notes should be evaluated on an instrument by instrument basis. See The Motel Company v. Comm'r, 22 T.C.M. (CCH) 825 (1963); John Wrather v. Comm'r, 14 T.C.M. (CCH) 345 (1955); Plastic Toys, Inc. v. Comm'r, 27 T.C.M. (CCH) 707 (1968); Priv. Ltr. Rul. 7906001 (Sept. 30, 1977). The evidence shows the parties intended to allocate all interest payments and deductions to the Fixed Rate Notes. Interest payments may be allocated based on the parties' intent. See, e.g., Restatement (Second) of Contracts §§ 259, 260; Williston on Contracts § 72:17; Lincoln Storage Warehouses v. Comm'r, 13 T.C. 33 (1949). Since Petitioner derived no tax benefits from the Floating Rate Notes, the Court need not, if it so chooses, evaluate the debt or equity character of the Floating Rate Notes.

The restructured indebtedness was fully repaid in advance of maturity in 2006.

As a preliminary matter, Petitioner submits that Respondent's position in this case seems driven by an unwarranted focus on what it incorrectly deems to be impermissible tax arbitrage. Respondent has repeatedly referred to the $4.9 billion in Intercompany Debt between NAGP and ScottishPower as a "scheme" to obtain "double dip" tax benefits. E.g., Tr. 1129:23 (Thurston). It is not entirely clear whether Respondent is bothered more by the U.S. interest deduction or the U.K. interest deduction; Petitioner submits that a motivation to achieve either one should not govern the analysis in this case.

Despite the complicated cross-border nature of the transaction in which the Intercompany Debt arose, at the heart of the debt issuance is simply a decision by ScottishPower as to how to capitalize its subsidiary. Here, the subsidiary, NAGP, acquired $6.5 billion of PacifiCorp stock from the shareholders. The subsidiary's parent, ScottishPower, paid the PacifiCorp shareholders $6.5 billion in ScottishPower stock. Effectively, NAGP was capitalized with a $6.5 billion asset. NAGP issued ScottishPower $1.6 billion in stock and $4.9 billion in debt in exchange for that asset.

Respondent appears to be questioning a parent's right to capitalize a subsidiary partially with debt and partially with equity -- a right confirmed long ago in Kraft Food Co. v. Comm'r, 232 F.2d 118 (2d Cir.), rev 'g 21 T.C. 513 (1954). Respondent argued in his closing statement that the Intercompany Debt was a "scheme to achieve tax benefits by converting non-deductible dividends into deductible interest." Tr. 1102:25-1103:2 (Thurston). Respondent unsuccessfully advanced this identical argument 16 years ago in Nestle Holdings, Inc. v. Comm'r, -- that is, that "putative 'debt' repayments [were] substituted for dividend payments -- and this Court responded that this is merely another way of stating the debt-equity issue and "adds nothing to the analysis." Nestle, 70 T.C.M. at 705. Citing Kraft, this Court said "petitioner's desire to minimize taxes is not conclusive of characterization of the advances." Nestle, 70 T.C.M. at 701; see also Nassau Lens Co. v. Comm'r, 308 F.2d 39, 46 (2d Cir. 1962) (in upholding intercompany debt against a business purpose challenge by the government, the Second Circuit stated that '"[t]here is no rule which permits the Commissioner to dictate what portion of a corporation's operations shall be provided for by equity financing rather than debt,' so long as the latter can be said to be debt in terms of substantial economic reality").

To the extent that Respondent is concerned by an interest deduction being claimed in both the U.S. and the U.K., such a concern does not translate into a legal position. The traditional position of the Department of Treasury and the IRS has been that the U.S. federal income tax consequences and characterization of transactions should be determined by applying the provisions and principles of U.S. federal income tax law without regard to the treatment of rights or obligations under foreign tax law unless specifically required by the pertinent U.S. federal income tax provisions.⁹

Moreover, the term "double-dip" is a bit of a misnomer. Yes, because of the differences between U.S. law and U.K. law, the interest payments made by NAGP to ScottishPower were claimed as deductions by NAGP in the U.S. and by NAGP's owners, NA1 and NA2, in the U.K. However, the U.K. group of ScottishPower, NA1 and NA2 also had two streams of income: income from receipt of the interest payments and income from the dividends paid by PacifiCorp to NAGP. Stip. ¶ 64; Tr. 72:7-19 (Merriman). Even if the U.K. interest income washed with the interest deduction, the U.K. group still has taxable dividend income. So this is not really an "arbitrage" or a "double dip" in a technical sense. There is a deduction in the U.S., but there is also corresponding income in the U.K. Thus, the real tax benefit of the so-called "double dip" structure was a U.K. tax benefit, and it was, ironically, dependent upon PacifiCorp being profitable enough to pay sufficient U.S. income taxes to generate credits in the U.K. that would offset U.K. tax on the dividends received by NA1 and NA2. Tr. 73:11-19 (Merriman). The value ascribed by ScottishPower from this so-called "double dip" came entirely from the ability of the U.K. group to claim these tax credits. That is a tax planning strategy coming from the U.K., not the U.S.

The real inquiry in this case is whether Petitioner has demonstrated that ScottishPower and NAGP intended to create valid indebtedness with a reasonable expectation of repayment, and whether that intention comports with the economic reality of creating a debtor-creditor relationship. Petitioner submits that it has met its burden of proof.

The Ninth Circuit, where any appeal of this case would ultimately lie, applies eleven factors when evaluating whether an advance is debt or equity for federal income tax purposes (hereinafter, "the Hardman factors"). See Hardman v. United States, 827 F.2d 1409 (9th Cir. 1987); Bauer v. Comm'r, 748 F.2d 1365 (9th Cir. 1984); and A.R. Lantz Co. v. United States, 424 F.2d 1330 (9th Cir. 1970). "The determination of whether an advance is debt or equity depends on the distinction between a creditor who seeks a definite obligation that is payable in any event, and a shareholder who seeks to make an investment and to share in the profits and risks of loss in the venture." Bauer, 748 F.2d at 1367. When evaluating the eleven factors, no single factor controls the analysis. Rather, all factors must be considered and given appropriate weight under the circumstances. See Hardman, 827 F.2d at 1412; and Bauer, 748 F.2d at 1370. "The object of the inquiry is not to count factors, but to evaluate them." Bauer, 748 F.2d at 1368. The Hardman factors are:

After quickly finding that the contract had no name but looked more like a debt instrument than a stock certificate, the Ninth Circuit concluded that, while the contract had no fixed maturity date, it nevertheless "contains more of the traditional indicia of a debt instrument than that of an equity certificate." Hardman, 827 F.2d at 1413. The Court then proceeded through the remaining nine factors, finding all of them to support its holding that the contract was debt. In doing so, the Ninth Circuit was guided by principles cited from the Fifth Circuit:

B. The Parties Agree that a Litton Analysis is Appropriate

In Litton Business Systems, Inc. v. Comm'r, the Tax Court applied Ninth Circuit law in a fact pattern strikingly similar to the facts of this case. After citing A.R. Lantz Co., 424 F.2d 1330, as the applicable debt-equity standard in the Ninth Circuit (Litton was decided before Bauer and Hardman), the Tax Court announced it would apply a more targeted approach in deciding between debt and equity in the related party context:

Litton's approach was followed by the Tax Court in the next major debt-equity case, Nestle Holdings, Inc. v. Comm'r, in which Second Circuit law was applied and Litton was relied on heavily. In the very next debt-equity decision of the Tax Court, Laidlaw Transportation, Inc. v. Comm'r, 75 T.C.M. (CCH) 2598 (1998), in which Fifth Circuit law was applied, the Court went through a rigid application of the thirteen factors from the Fifth Circuit decision in Estate of Mixon v. United States, 464 F.2d 394, 402 (5th Cir. 1972), and then added three more factors to analyze. Notably, with this approach, many of the factors are simply irrelevant and often awkward to apply in the related party context, resulting in ambiguity over what factors really tipped the scale in favor of equity over debt, or vice versa. Petitioner urges this Court to adopt the more sensible, and more targeted, form of legal analysis used in Litton and Nestle, particularly since the Litton approach was designed to incorporate the law of the Ninth Circuit. Respondent also agrees that the standard that should be used by this Court is the one used in Litton. Tr. 37:2-8 (Thurston).

C. Related Parties Are Not Held to a Strict Third-Party Standard

Respondent and Respondent's expert analyze this case almost entirely within a hypothetical third-party lending context, attempting to examine all the facts under an arm's length standard. Ex. 260-R at p. 2; Tr. 1133:1-2; 1135:18-19; 1139:5-7; 1139:22-24; 1142:24-25; 1143:12-14 (Respondent's Closing). While related party cases require careful scrutiny, applying a strict third-party standard is contrary to applicable precedent, both in the Tax Court and the Ninth Circuit, governing related party debt. See Litton, 61 T.C. at 379 and Nestle, 70 T.C.M. at 703.

The subsidiary in Litton issued debt to its parent to acquire the parent's shares, which the subsidiary then used to acquire a target in a triangular "C" reorganization. In respecting the debt for tax purposes, the Tax Court was favorably influenced by (i) the sufficiency of anticipated cash flows to service the principal and interest on the debt, including the fact that the borrower had acquired an "existing enterprise with substantially valuable assets, already established in a dominant position in its market and generating significant operating profits," and (ii) the borrower's ability to borrow partly from commercial banking and private sources, notwithstanding that a third party would have required a guarantee from the parent and a security interest in the subsidiary's assets. Litton, 61 T.C. at 378-379. Most importantly, it was sufficient that the related party debt terms were not a "patent distortion" of the third-party terms. Litton, 61 T.C. at 379. It is significant that the Court determined there was true indebtedness without regard to: (i) the fact that debt was not documented in a written certificate or agreement; (ii) the fact that debt was payable on demand; (iv) the fact that the lender advanced monies so that some of the interest payments could be paid; or (v) the fact that no further payments of principal or interest were made after the IRS dispute arose.

In Nestle the Tax Court upheld debt issued by a U.S. subsidiary to its foreign parent. Applying the Litton approach for deciding between debt and equity, the Court first found the parties intended debt based on the fact that the debt terms were set forth in confirmation letters and other correspondence that confirmed a stated interest rate, a specified repayment schedule and a maturity date. See Nestle, 70 T.C.M. at 701. It did not matter that a $2 billion intercompany loan was not reflected in a formal debt instrument. Other evidence of intent included the fact the debt was recorded in the parties' books and in SEC filings. The "reasonable expectation" requirement was met based on expert testimony as to the anticipated cash flows at the time the debt was issued, including proceeds from the sale of assets. The "hypothetical third party borrowing" requirement was met based on a finding that, although the taxpayer could not have borrowed the entire amount from a single third-party bank without a parent guaranty, the taxpayer could have obtained financing on its own through a combination of private lenders and commercial banks. Citing heavily from Litton, the Tax Court determined that a finding of equity was not mandated due to the long maturity period of 20 years or the unsecured nature of $2 billion in intercompany debt, stating that "the terms of the related party advances here cannot be characterized as a 'patent distortion' of what would normally have been available to [taxpayer] as independent-debt financing." Nestle, 70 T.C.M. at 703. The fact that certain interest payments were paid with advances from the parent also did not preclude a finding of debt. Id.

Litton and Nestle establish that while related party debt arrangements should be carefully scrutinized, the government may not simply use the related party relationship to justify the position that loans are equity rather than debt. While the Tax Court recognized in Litton that it "should view the purported debtor-creditor relationship with closer scrutiny than if the debt obligation was in substantial disproportion to the equity holding . . . it is just as clear that where such scrutiny has been exercised, the fact of proportional identity of interest between stockholders and creditors, particularly where a sole stockholder is involved, does not preclude the existence of a valid debt." Litton, 61 T.C. at 379. In Nestle where the petitioner leveraged itself to acquire a target company, "an established entity with an established cash flow and valuable assets," this Court cautioned, "We think it unwarranted to apply legalistic and mechanical tests, in the area of parent-subsidiary relationships, without regard to the realities of the business world and the manner in which the transactions are handled in the normal and ordinary course of doing business." Nestle, 70 T.C.M. at 705, citing Malone & Hyde, Inc. v. Comm'r, 49 T.C. 575, 578 (1968). See also Kraft, 232 F.2d at 123-26 ("Undoubtedly, there are elements in the present case which invite close scrutiny by the Commissioner, among them the fact that the arrangement was made between a parent corporation and its wholly-owned subsidiary . . . However, it is one thing to say that transactions between affiliates should be carefully scrutinized . . . and quite a different thing to say that a genuine transaction affecting legal relations should be disregarded for tax purposes merely because it is a transaction between related parties. . . .").

Further, the Litton standard does not hold related parties to a strict third-party standard. In fact, the law is quite lenient in its treatment of related party debt. This Court recognized in Nestle that "different creditors invariably undertake different degrees of risk, and, where debtor and creditor are related, the lender might understandably offer more lenient terms than could be secured elsewhere." Nestle, 70 T.C.M. at 703, citing G.M. Gooch Lumber Sales Co. v. Comm'r, 49 T.C. 649, 659 (1968); see also, Litton, 61 T.C. at 379. Litton further observes that "formal debt paraphernalia . . . are not as necessary to insure payment" in the related party context. Litton, 61 T.C. at 377, citing American Processing & Sales Co. v. United States, 371 F.2d 842 (Ct. Cl. 1967). Both Litton and Nestle make absolutely clear that, "in evaluating the terms of related party debt," the Court should not apply "a mechanical test of absolute identity between the related party debt and the hypothetical third party debt." Nestle, 70 T.C.M. at 703, citing Litton, 61 T.C. at 379. Rather, in applying the hypothetical third-party borrowing test, the debtor is treated as being able to borrow the same amount under similar terms so long as the real terms of the borrowing are not a "patent distortion" of the terms that would be required in a third-party borrowing. Litton, 61 T.C. at 379; Nestle, 70 T.C.M. at 703. In short, this Court does not require related parties to act precisely like an arm's length debtor and creditor.

The Tax Court's view on related parties is consistent with that of the Ninth Circuit. In Wilshire & Western Sandwiches v. Comm'r, shareholders of a closely held corporation decided to capitalize the corporation partly with equity and partly with debt. The debt was held by the shareholders in proportion to their equity. The IRS and Tax Court concluded that "original intent of the parties was nullified" on the basis that "the 'loans' were not secured; . . . [and] interest was not paid when due," among other reasons. The Ninth Circuit, id. at 721-722, believed that these "actions complained of seem consistent with a valid debtor creditor relationship," and reversed the Tax Court, stating:

Litton found an "objective" expression of intent in "the formal documentation of a debtor-creditor relationship," which, although there was no formal debt instrument, included: a debtor's board resolution "which specifically authorized and directed the establishment of the advance account as a debt obligation," the existence of the debt obligation on the "books of record" of both subsidiary and parent and "correspondence between officers and employees representing each party which consistently recognized the existence of the advance account as a debt and the establishment of its terms and payments thereon." Litton, 61 T.C. at 377-378. Litton held "that there was adequate evidence, in addition to the formal indicia of debt, that the parties genuinely intended that the advance account create a debt obligation, payable in any event and not merely at the risk of the business, that the parties' actions conformed to that intent, and that the debtor-creditor relationship was economically reasonable." Litton, 61 T.C. at 378.

In Nestle, 70 T.C.M. at 714, the court determined intent by pointing to "substantial objective evidence of an intent to create a debtor-creditor relationship:"

Here, the parties have stipulated many of the facts that support debt treatment of the Loan Notes:

The record is replete with evidence, and Petitioner's experts confirm, that, based on its relevant experience, extensive due diligence and informed analysis, ScottishPower reasonably expected the Loan Notes to be repaid.

Litton found that "based on Old Eureka's past earnings and annual cash flow of approximately $2 million to $3 million, and the anticipated ability of New Eureka to sustain and even increase the performance of the business, at the time the advance was created the parties contemplated that New Eureka would be able to retire the advance within 10 years." Litton, 61 T.C. at 373 (emphasis added).

Nestle also confirmed that projected cash flows may include proceeds from asset sales and are based on what was "anticipated." 70 T.C.M at 701. "Here, Nestle anticipated that the combined petitioner-Carnation entities would have a high level of cash and investments on hand that could be used to pay down debt; that divestiture proceeds would be used to pay down debt; and also the cash-flow from the combined entities would be adequate for debt service." Id.

In contrast, Respondent's expert, Mr. Mudge, was asked to address the following question: "Whether there was a reasonable expectation at the time that the Loan Notes were established that, per their terms (i.e., reliant upon dividends paid by PacifiCorp), NAGP could service the interest on the debt and repay the principal when due had they in fact been obligations to third parties." Ex. 260-R at p. 2 (emphasis added). That factor -- the reasonable expectation of repayment of a hypothetical third-party creditor -- exists nowhere in the law, and Mr. Mudge's opinions on that issue are not relevant to the Court's analysis and should be disregarded. In fact, Mr. Mudge testified that he did not perform any analysis with respect to the correct test -- whether ScottishPower could reasonably expect to be repaid. Tr. 1041:7-13 (Mudge).¹⁰

ScottishPower's 1998 and 1999 Projections were carefully developed and modified, based on relevant prior experience and historical performance and with input resulting from extensive due diligence and the informed contributions of relevant business units. Respondent has asserted that PacifiCorp's 1998 and 1999 Projections do not provide a basis to meet the "reasonable expectation of repayment" factor because ScottishPower did not create these financial projections specifically for the purpose of showing debt repayment. However, the test is whether ScottishPower reasonably anticipated being repaid; there is no requirement for a separate formal debt repayment analysis. It is obvious that the raw data that answered the question as to whether ScottishPower could reasonably be expected to be repaid is in the rigorously prepared and reviewed cash flow projections. As the testimony at trial confirmed, ScottishPower could determine on the face of the models that it was reasonable to anticipate they could be repaid both interest and principal on the Loan Notes. Ex. 245-P (Shaked Expert Report) at p. 26; see also Proposed Findings ¶ 143. The meticulously prepared and necessarily conservative cash flow projections were in fact done for purposes of ScottishPower, the acquirer, valuing the target, PacifiCorp, in the context of this significant cross-border acquisition, a fact which only enhances their reliability. Tr. 426:8-16; Tr. 432:5-12; Tr. 466:12-16 (Shaked); Ex. 245-P (Shaked Expert Report) at pp. 14-15; Shaked Exhibits 11, 12, 14.

Israel Shaked is a Professor of Finance and Economics at Boston University's School of Management. Professor Shaked is a highly qualified finance expert who concluded that, based on the information known at the time of the Merger, NAGP was projected to be able to pay interest and principal on the Loan Notes as it became due, that the value of NAGP's assets at the time of the Acquisition exceeded its debt obligations to ScottishPower and that NAGP was adequately capitalized. Ex. 245-P at p. 8.

Dr. Shaked's expert analysis confirmed the reasonableness of ScottishPower's projections and NAGP's ability to repay interest and principal on the Loan Notes; his report is balanced, thorough and authoritative. Dr. Shaked compared ScottishPower's 1998 and 1999 Projections to each other, to PacifiCorp's historical performance, to PacifiCorp's management's projections, to Morgan Stanley's projections and to independent industry analysts' projections, including consideration of the outlook for PacifiCorp's core business and of ScottishPower's successful track record in achieving its projections in prior acquisitions. He performed a cash flow analysis and several sensitivity analyses in confirming NAGP's ability to repay and also performed two valuation analyses of NAGP concluding that NAGP's assets exceeded its debt to ScottishPower and that NAGP was adequately capitalized. Id.

Professor James Vander Weide, a Research Professor of Finance and Economics at Duke University, has given extensive testimony on the electric utility industry in both legal and regulatory proceedings. Professor Vander Weide put into context ScottishPower's and the industry's positive outlook for PacifiCorp at the time of the acquisition based on the economic environment at the time and the anticipated deregulation in the electric power industry. He also opined that ScottishPower's cost savings and growth rate assumptions for PacifiCorp were reasonable in light of his knowledge of the regulated utility industry and the economic outlook at the time. Ex. 249-P at p. 2.

In that regard, Professor Vander Weide provided this Court with background and context concerning the regulation of power companies, including the concept of "allowed rate of return" whereby regulatory authorities set rates that allow utilities to recover their operating and capital costs, including a fair return on investment. This regulatory context is relevant for purposes of evaluating the reasonableness of ScottishPower's cost-savings expectations. A regulated utility is a very stable business with an above average business profile -- and is in fact a monopoly -- that is protected from the threats of competition or financial distress faced by other businesses. Leading up to the Acquisition, PacifiCorp was under-earning its authorized return on equity in nearly all the states in which it operated and thus, with the projected improved operating efficiencies resulting from the Merger, its financial performance was expected to improve. Id.

Petitioner's experts thus confirmed that, from the perspective of the overall regulated industry, based on the industry's outlook at the time, analysts' views, typical financial analysis, and taking into account the parties' history and experience, ScottishPower could reasonably expect the Loan Notes to be repaid at the time of the Merger.¹¹

C. The Parties' Intention to Create Debt Comported with the Economic Reality of a Debtor-Creditor Relationship

In Nestle Respondent argued that the interest rate on the related party debt should have been higher on the grounds that the petitioner's credit rating would have been non-investment grade. The court rejected the opinion of Respondent's expert in this regard for failure to give adequate consideration to the petitioner's historical borrowings and contemporaneous expectations with respect to interest rates. See Nestle, 70 T.C.M. at 702. Respondent's contention in Nestle that the repayment terms of the related party debt were too lenient and would have required additional covenants in the third-party context were similarly rejected by the court. The court found that a hypothetical outside loan could have been obtained with the addition of a parent guarantee, a higher rate of interest, with additional conditions, or through a combination of commercial banking and private lenders. See id. In this court's view, citing Litton, the actual related party debt terms were found not to be a "patent distortion" of the various terms that could have been required in the context of a hypothetical third-party lender. See id. at 703. In effect, the Tax Court has expressly acknowledged an obvious point that has been overlooked here by Respondent: that the terms of outside financing may have to be "more strict than" the terms of the related party debt and that a related lender might understandably offer more lenient terms.

Respondent has attempted to make the hypothetical third-party lender test impossible for Petitioner to meet by requiring Petitioner to prove that it could have gone to a single commercial lender and obtained a single $4.9 billion loan on the exact same terms as the Loan Notes. But that is clearly not what the law requires. Petitioner was entitled to prove, as it did, how it could have successfully approached the debt capital markets for a substantially similar borrowing. Ex. 253-P at p. 5. It is for this Court to then decide whether the actual terms of the Fixed Rate Notes and the Floating Rate Notes are a patent distortion of what would have been available to Petitioner in a hypothetical third-party debt issuance.

Professor Chambers determined an investment grade credit rating of BBB-for the Fixed Rate Notes. Ex. 252-P at p. 4. Mr. Chigas testified that the debt would have made an attractive offering to third-party investors in the debt capital markets on substantially similar terms to the Fixed Rate Notes (with the exception of a slightly higher interest rate), and that the Floating Rate Notes could have been issued as subordinated debt with a lower but still marketable credit rating. Ex. 253-P at pp. 28-29. Further, Mr. Chigas concluded that investment banks would have viewed this as a "commercial business opportunity and would have competed intently to win the mandate." Id.

In sum, Petitioner's experts concluded that NAGP could have borrowed on substantially similar terms in the debt capital markets. Yes, the interest rate on the Fixed Rate Notes may have had to have been increased by less than 100 basis points. Nevertheless, Petitioner submits that the Court can, as it did in Litton and Nestle, find that the actual terms of the Fixed Rate Notes, when compared to these hypothetical adjustments that might be required in the context of a hypothetical third-party borrowing, do not represent a "patent distortion" and are "reasonably comparable."

Two of Petitioner's experts addressed the Floating Rate Notes separately in the hypothetical context. Dr. Chambers concluded that the $896 million floating rate indebtedness most likely would have been issued as subordinated debt with a lower credit rating of BB+ or BB, without affecting the investment grade category of the NAGP's senior debt. Ex. 251-P at p. 56. Mr. Chigas concluded that the inclusion of the floating rate debt would not have materially affected the hypothetical issuance of fixed rate investment grade debt. Ex. 253-P at p. 5. Petitioner submits, based on the testimony of Dr. Chambers and Mr. Chigas, the Court would also be able to conclude, should it address the debt or equity treatment of the Floating Rate Notes, that the actual terms of the Floating Rate Notes are not a patent distortion of this hypothetical debt capital markets borrowing.

In an effort to prove that Petitioner would have been unable to secure financing from third-parties, Respondent's expert asserted that a third-party financing of $4.9 billon would have contravened an SEC Order issued on December 6, 2000 (Ex. 76-J; Stip. ¶ 253), relating to purported debt restrictions under the Public Utility Holding Company Act of 1935 (15 U.S.C. 79 et seq.) ("PUHCA"). Ex. 260-R at p. 27. Mr. Mudge, recognizing that the 30% equity capitalization requirement was contained in an SEC order issued a year after the Merger, would not address whether the requirement could possibly apply to third-party debt hypothetically incurred by Petitioner in connection with the Merger on the grounds that he was not a PUHCA expert. Tr. 1060:13-1061:5 (Mudge). The SEC Order itself answers the question; Section III of the Order clearly exempts all existing financing arrangements from the Order's reach. Ex. 76-J at SUPP000945. As a result, there is absolutely nothing in the Court's record supporting Mr. Mudge's opinion. Julian Brown, on the other hand, testified that ScottishPower's regulatory lawyers advised that PUHCA was a non-issue and that PUHCA was likely to be significantly modified or repealed. Tr. 258:4-9 (Brown). It turns out that such advice was correct, as PUHCA was later repealed in the Energy Policy Act of 2005. In short, Respondent has established no record of any kind to assist the Court's evaluation of Mr. Mudge's assertion and his report should not be afforded any weight.

Mr. Mudge's report also cited the equity capitalization requirement imposed by Oregon in its approval of the Merger, and concluded that at a constant dividend growth of 7.5%, PacifiCorp's ratio of equity to capitalization would drop below the 40% threshold imposed by Oregon. Ex. 260-R (Mudge Report) at pp. 12, 33-34. Mr. Mudge testified that his calculation was derived from the consolidated financial statements of PacifiCorp, and was applied to the entirety of PacifiCorp's regulated and nonregulated operations, both in and outside Oregon. That is, Mr. Mudge believes that Oregon has the authority to regulate utility operations in other states. Tr. 1062:19-1063:20 (Mudge). This testimony is in direct contradiction to the testimony of Professor Vander Weide, a regulatory expert who confirmed that Oregon's equity capitalization requirement applies only to PacifiCorp's regulated operations in Oregon, and that it would be impossible to determine whether such requirement was breached by examining the consolidated financial statements of PacifiCorp. Tr. 548:6-18; 553:20-554:9 (Vander Weide). Again, just like the illusory PUHCA restrictions, Mr. Mudge provided no credible analysis of how the Oregon restrictions would possibly have been violated by NAGP's issuance of third-party debt. Petitioner's expert, on the other hand, provided a thorough and substantiated analysis of why this Oregon restriction would not have come into play. Ex. 249-P (Vander Weide Report) pp. 22-23; Tr. 548:16-22; Tr. 555:11-556:2 (Vander Weide).

Finally, in a further effort to prove that Petitioner would have encountered difficulty borrowing from third parties, Respondent pursued a theory that either the equity capitalization requirements or the dividend restrictions in PacifiCorp's credit agreements would have been violated with a hypothetical third-party debt of NAGP. In a special post-trial deposition of Bruce Williams, Vice President and Treasurer of PacifiCorp, testified that PacifiCorp's credit agreements would have had no impact on any debt incurred at the NAGP level. Ex. 264-R at pp. 7-12; Tr. 22:7-12 (Williams). Mr. Williams also testified that PacifiCorp's payment of dividends out of current earnings to NAGP would not have reduced PacifiCorp's equity and, thus, would not have impacted PacifiCorp's ability to comply with the equity capitalization requirement in its credit agreements. Tr. 21:10-21; 23:7-12 (Williams). Again, the record does not support Respondent's theory.

Testimony was provided at trial by three executives of ScottishPower and PacifiCorp who were involved in various post-acquisition actions relating to the Intercompany Debt. Mr. Martin came to PacifiCorp in September 2000 and was the company's senior tax executive for the remainder of the time relevant to this case. Tr. 745:1-5 (Martin). Mr. Wright was ScottishPower's Assistant Treasurer, and Ms. Self joined ScottishPower in early 2002 as its Global Tax Director. Tr. 818:4-7 (Wright); Tr. 897:23-25 (Self).

The parties' post-Merger actions demonstrate that they were cognizant of their obligations under the Loan Notes and took steps to ensure that the funds to pay interest deducted for each year were ultimately sourced from PacifiCorp dividends and the Australian asset proceeds. The two responsible tax executives, Mr. Martin and Ms. Self, each devoted considerable attention to putting NAGP in the strongest position for supporting the debt characterization of the Loan Notes. Stip. ¶ 182; Tr. 763:18-22; Tr. 765:17-21 (Martin); Tr. 899:21-900:2 (Self). They took a conservative approach, in light of changed economic conditions, in asking outside advisors to analyze whether the amount of the debt should be reduced and then implemented that advice, in effect reducing the amount of interest deductions that NAGP and later PHI would be able to claim for U.S. tax purposes. See Proposed Findings ¶ 296 through ¶ 300; Tr. 899:21-900:2 (Self); Tr. 762:13-18; Tr. 763:18-22; Tr. 766:3-5 (Martin).

Respondent has seized on a purported "circular flow of cash" to make NAGP interest payments in the summer of 2001. While awaiting PHI's insertion,¹² as Mr. Wright testified, payments of interest were recorded on the books by having NAGP issue an intercompany payable. Tr. 862:9-863:8; 865:6-12; 866:7-12 (Wright). One entry may have involved actual cash and the other was a mere book entry. Tr. 884:10-20 (Wright). However, the evidence shows, according to both Mr. Wright and Mr. Martin, that these purported payments recorded in the books were not intended to qualify as payments for tax purposes and represented only an interim measure pending the PHI restructuring, at which time NAGP would receive a distribution from PHI to fully satisfy its interest obligations. Tr. 862:9-20 (Wright); Tr. 863:2-12 (Wright); see also Tr. 781:20-782:12 (Martin). Because the PHI restructuring was unexpectedly delayed for state regulatory approval, in September 2001, NAGP arranged to borrow from an outside lender, Royal Bank of Scotland ("RBS"), to actually pay outstanding interest owed to ScottishPower. Stips. ¶ 216, ¶ 218; Tr. 908:11-24 (Self); T. 915:8-10 (Self); see also Tr. 859:7-9 (Wright). The RBS facility was itself fully repaid in March 2002 (within the same tax year and prior to the filing of NAGP's March 31, 2002 tax return) when PacifiCorp dividends and proceeds from the sale of Powercor were distributed up from PHI to NAGP totaling $598 million. Stips. ¶ 218, ¶ 219, ¶ 220, ¶ 221, ¶ 222, ¶ 223; Tr. 868:1-12 (Wright); Tr. 910:22-911:3 (Self).

The testimony of Mr. Martin, Mr. Wright and Ms. Self establish that the payable set up on NAGP's books during fiscal year ending March 31, 2002 was never intended by NAGP to constitute a payment of interest for tax purposes, as it was intended that NAGP would claim a deduction only if it paid interest from either its own funds or from an external borrowing. Tr. 863:2-12 (Wright); Tr. 781:20-782:12; 784:3-6 (Martin); Tr. 908:17-24 (Self). For Respondent to claim that NAGP paid down $186 million in intercompany payables, rather than actual interest, is an elevation of form over substance.

In any event, it is undisputed that, by the end of the March 31, 2002 tax year, NAGP had completely paid off the RBS loan with distributions representing PacifiCorp's operating cash flows and Powercor sales proceeds. Stips. ¶ 218 through ¶ 222. Any suggestion that NAGP deducted interest for that year paid through the device of a circular cash flow arrangement is untenable.

The law of this Court and of the Ninth Circuit supports a finding of debt in spite of these issues surrounding the timing of the interest payments. As to late payment and ScottishPower's failure to declare default, the Ninth Circuit held in Wilshire & Western Sandwiches, 175 F.2d at 721-722 that "no adverse inference should be drawn from the failure of the stockholders to demand payment immediately when due. Id. The same strict insistence on payment on due date, as would be the case if a bank were the creditor, should not be expected." See also Earle v. W.J. Jones & Son, 200 F.2d 846, 850 (9th Cir. 1952). Again, with respect to timely payments of interest between related parties, strict adherence to a third-party standard of conduct is not required.

As to the suspension of interest payments while PacifiCorp continued to declare dividends, it is instructive to note that, in Litton, this Court did not find detrimental to petitioner's case the fact that payments of interest and principal were suspended while the parties continued to accrue interest expense and interest income. This Court found that the continued accruals demonstrated that the parties "respect[ed] the nature" of the debt obligation. Litton, 61 T.C. at 381. Also, in Litton, the taxpayer prevailed in spite of the fact that there were additional intercompany advances via circular cash flow while the loan was pending, during a period when the company's financial performance had met with some difficulty. See Litton, 61 T.C. at 380.

Given the normal course of conduct between related parties and given that ScottishPower and NAGP otherwise consistently conducted themselves in accordance with a debtor-creditor relationship, Petitioner submits that the timing of the interest payments at issue does not warrant a finding that the Loan Notes were equity.

As Mr. Martin and Ms. Self testified, shortly after filing the March 31, 2001 tax return and before the close of the following taxable year on March 31, 2002, Ms. Self, on PwC's advice, directed the official capitalization of the Floating Rate Notes into equity. Tr. 766:22-767:1 (Martin); Tr. 917:19-918:3 (Self). As a result, prior to the close of the fiscal year ending March 31, 2002, the $896 million in Floating Rate Notes was surrendered in exchange for equity. Although the parties had duly accrued interest on the Floating Rate Notes on their books, the total amount of interest paid and deducted by NAGP to ScottishPower as of March 31, 2002 had only been sufficient to cover interest on the four $1 billion Fixed Rate Notes. ScottishPower and NAGP intended that all of the interest paid to date be allocable only to the Fixed Rate Notes, and reflected that intent in their internal books and records. Ex. 238-J; Tr. 871:24 - 874:1-14 (Wright); see also Stip. ¶ 232; Tr. 768:25 (Martin); Tr. 838:3-16 (Wright); Ex. 238-J; Tr. 874:5-10 (Wright); Tr. 916:6-9 (Self).

There is no legal requirement to allocate the interest payments on a pro rata basis to the Floating Rate Notes. Rather, when a debtor owes interest on several debt instruments to a creditor and makes a single payment, the payment is allocated based on the parties' intent. See e.g., Restatement (Second) of Contracts §§ 259, 260; Williston on Contracts § 72:17; Lincoln Storage Warehouses v. Comm'r, 13 T.C. 33 (1949). Here, the parties intended that the payments in both 2001 and 2002 were to be applied exclusively to the Fixed Rate Notes.

In fact, if the Court finds that the interest payments through March 31, 2002 are attributable only to the Fixed Rate Notes as the parties intended, Petitioner submits that the Court need not make a determination as to the debt or equity status of the Floating Rate Notes. The evidence in this case demonstrates that the parties intended at the time of the Merger to treat both the Fixed and Floating Rate Notes as indebtedness. Nevertheless, if the parties' intent is honored, the Court may simply decide whether each of the four $1 billion Fixed Rate Notes constitutes debt for tax purposes. That is, Petitioner believes that this case can be decided in its favor without having to prove that the Floating Rate Notes are debt for tax purposes because Petitioner never derived tax benefits from the Floating Rate Notes. The Floating Rate Notes were cancelled in March 2002 without any interest ever having been paid, and thus deducted, on them. In the March 31, 2003 tax year, all of the interest paid was paid on the Fixed Rate Notes, as they were the only Notes remaining.

Petitioner submits that it has met its burden of proof on the entire Intercompany Debt put in place at the time of the Merger. Nevertheless, the law does not require proof that every tranche of debt qualifies as debt or none qualifies. A contrary view simply cannot be reconciled with the view of both courts and the IRS that the debt-equity factors apply separately to different issuances of debt having different terms. Here, the Fixed Rate Notes and Floating Rate Notes had different interest rates, maturity dates and call rights. Stip. ¶ 163 and Stip. ¶ 164. Further, Petitioner's expert Charles Chigas distinguished the Fixed and Floating Rate Loan Notes as different "classes," which would be viewed as such if issued in the debt capital markets. Tr. 722: 23-25 (Chigas). Further, the Fixed Rate Loan Instrument provides that the Fixed Rate Notes issued under that instrument "form a single series." Stip. ¶ 163(b). The Floating Rate Loan Instrument provides likewise for the Floating Rate Notes. Stip. ¶ 164(b). To treat the two sets of notes as a single debt instrument would be contrary to the parties' intent as evidenced by the legal documents. Further, the courts and the IRS have routinely applied the debt-equity analysis on an instrument-by-instrument basis. See Motel Company v. Comm'r, 22 T.C.M. (CCH) 825 (1963); John Wrather v. Comm'r, 14 T.C.M. (CCH) 345 (1955); Plastic Toys, Inc. v. Comm'r, 27 T.C.M. (CCH) 707 (1968); Priv. Ltr. Rul. 7906001 (Sept. 30, 1977).

Thus, the Court could find in the Petitioner's favor on the Fixed Rate Notes even without determining whether the Floating Rate Notes constituted valid indebtedness.

In the summer of 2000, less than a year after the Intercompany Debt was issued by NAGP, PacifiCorp was dramatically impacted by the Western Power Crisis as well as the concurrent catastrophic failure of PacifiCorp's Hunter Power Station, which was out of service for six months at the height of the crisis, forcing PacifiCorp to purchase power on the open market at exorbitantly high prices. Stip. ¶ 172; Tr. 347:24-348:10 (MacRitchie). These post-acquisition developments had a measurable adverse effect on PacifiCorp's available cash, with the cost of these events to PacifiCorp being in the $1 billion range. Tr. 352:13-19 (MacRitchie); Tr. 569:7-20 (Vander Weide). This led to a re-evaluation in 2002 of the level of intercompany debt that could be supported by NAGP. Neither the Western Power Crisis nor the failure of the Hunter Power Station could reasonably have been foreseen by ScottishPower at the time of the Merger. Tr. 557:17-22 (Vander Weide); Ex. 249-P at p. 2; Ex. 245-P at p. 49.

Heather Self, head of global tax for ScottishPower, undertook Project Venus to have PwC re-evaluate the level of debt during calendar year 2002. Ultimately the Fixed Rate Notes were replaced on December 9, 2002 by capitalizing $1.625 billion into equity and substituting restructured debt in the amount of $2.375 billion. The new debtor was PHI, into which NAGP subsequently merged, as always intended. The new creditor was a disregarded entity which was an affiliate of ScottishPower, so in effect, ScottishPower remained as the creditor. The new restructured $2.375 billion debt obligation was fully repaid in advance of maturity in 2006 when Mid-American Energy Holdings, Inc. bought PacifiCorp. The debtor (then ScottishPower Holdings, Inc. or "SPHI") continued to own the nonregulated energy businesses (e.g., wind farms), which were later acquired by Iberdrola, S.A. Tr. 943:1-5 (Self).

It certainly is not uncommon for a debtor and creditor to restructure the terms of outstanding debt, including a reduction in principal. As this Court stated in Deseret News Publication v. Comm'r, 34 T.C.M. (CCH) 714, 718 (1975), capitalization of a portion of a debt does not indicate an intention to treat the remaining debt as equity, either at inception or from that time forward, particularly where the capitalization is dictated by changed business circumstances. This rule is echoed in various regulations and rulings acknowledging that a restructuring of a debt instrument, including a reduction in principal, does not call into question the debt status of the underlying instrument. See Rev. Rul. 89-122, 1989-2 C.B. 200 (ruling that the reduction in the principal of a debt obligation from $1,000,000 to $650,000 is merely treated as a modification of the debt, not a recharacterization of the obligation to equity); Treas. Reg. § 1.1001-3(g)(example 4) (change in yield resulting from a reduction in principal of a debt obligation is treated as a modification of the debt obligation, not a recharacterization of the obligation as something other than debt); Treas. Reg. § 1.1275-2(f) (the unscheduled retirement of a contingent payment debt instrument does not result in the characterization of the instrument as equity); Treas. Reg. § 1.1502-13(g)(3) (contemplating the possibility that members of a consolidated group may extinguish "all or part" of outstanding debt obligations, which extinguishment is treated as a satisfaction and re-issuance of the debt but the treatment of the debt as such is not questioned as equity). Thus, the restructuring of the Fixed Rate Notes in December 2002, based on unanticipated economic changes and a contemporaneous analysis of debt capacity, does not call into question that the Fixed Rate Notes constituted valid indebtedness.

DATED: July 25, 2011

² At that time, the applicable federal rate was 6.24%. See Rev. Rul. 99-14.

³ If the Court determines the Floating Rate Notes should be included in NAGP's liabilities, the equity value of NAGP becomes at least $2.1 billion as of December 7, 1998. Ex. 245-P (Shaked Expert Report) at p. 37.

⁴ If the Court determines that the Floating Rate Notes should be included in NAGP's liabilities, the equity value of NAGP becomes at least $1.6 billion as of November 29, 1999. Ex. 245-P (Shaked Expert Report) at p. 52.

⁵ Key "debt leverage" ratios include: "Total Debt to Total Capital," "Total Debt to Funds from Operations," and Total Debt to Free Operating Cash Flow." Ex. 251-P (Chambers Expert Report) at p. 24.

⁶ Key "cash flow adequacy" ratios include: "Funds from Operations to Interest Expense," "Free Operating Cash Flow to Interest Expense," "Earnings Before Interest and Taxes to Interest Expense," "Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA) to Interest Expense," and Funds from Operations to Capital Expenditures." Ex. 251-P (Chambers Expert Report) at p. 24.

⁷ Key "profitability" ratios include: Earnings Before Interest and Taxes to Assets," Net Income to Net Sales Revenue (Profit Margin)," "Net Income to Total Assets (Return on Assets)," and "Net Income to Total Equity (Return on Equity)." Ex. 251-P (Chambers Expert Report) at p. 24.

⁸ The Hunter Plant was offline from November 24, 2000 until April 30, 2001. Stip ¶ 172.

⁹See statements by former IRS Chief Counsel B. John Williams, Speech before the International Tax Discussion Group (Mar. 18, 2003), in "Chief Counsel Statement on Transfer Pricing, International Tax Issues," 2003 TNT 54-47 , at para. 22 ("We are confident in the principles and integrity of our tax law and, unless the law requires otherwise, we will determine the appropriate tax treatment of an item based solely on the application of U.S. law."); statements by Nicholas J. DeNovio, Deputy Chief Counsel (Technical), International Revenue Service, Remarks at the Spring meeting of the Section of Taxation, American Bar Association, Washington, D.C. (May 7, 2004), in "ABA Tax Section Meeting: DeNovio Warns about Cross-Border Hybrids," 2004 TNT 90-5 ("We will determine the appropriate tax treatment of an item based solely on the application of U.S. law"); statement by Hal Hicks, International Tax Counsel, in "Former Treasury Official Hicks Talks about Transition, Tax Reform," 2007 TNT 50-8 (Mar. 14, 2007) (Mr. Hicks did not think the United States could be the "international tax police.").

¹⁰ As a result of being asked the wrong question, Mr. Mudge presumably was led to make another critical error of excluding the Australian asset proceeds from his cash flow projections. That is, because Mr. Mudge was viewing projected cash flows from the standpoint of a hypothetical third-party creditor of NAGP, he was able to develop a theory that ScottishPower wanted those proceeds for reasons other than paying down NAGP's indebtedness, and thus would not let the Powercor proceeds be paid over to the hypothetical third-party lender. Respondent's expert's misapplication of this test led to a "billion and a half dollar mistake" in Mr. Mudge's cash flow model. Ex. 247-P (Shaked Expert Rebuttal Report) at p. 10.

¹¹ Respondent has asserted in these proceedings that PacifiCorp could not have paid sufficient dividends to NAGP without violating certain purportedly applicable regulatory restrictions or loan covenants. The record is devoid of any evidence in support of these assertions. Moreover, Professor Vander Weide, as well as other witnesses, testified that any such restrictions or covenants had little or no impact on PacifiCorp's ability to pay dividends to NAGP. See discussion at Section III(C)(ii), infra.

¹² PHI was inserted in December 2000 as a holding company for PacifiCorp, PGHC and PPM for the purpose of separating the regulated and nonregulated businesses. See Proposed Findings ¶ 289 through ¶ 295.