w ICLG The International Comparative Legal Guide to: Private Equity 2017 3rd Edition
A practical cross-border insight into private equity
Published by Global Legal Group, with contributions from:
Aabø-Evensen & Co Matheson Advokatfirman Törngren Magnell McMillan LLP Ali Budiardjo, Nugroho, Reksodiputro Memminger LLP Allen & Gledhill LLP Morais Leitão, Galvão Teles, Soares da Silva Angola Capital Partners & Associados Ashurst Hong Kong Pinheiro Neto Advogados Atanaskovic Hartnell Samvād: Partners Bär & Karrer Ltd. Schindler Attorneys Borenius Attorneys Ltd Schulte Roth & Zabel LLP British Private Equity & Venture Capital Association Skadden, Arps, Slate, Meagher & Flom LLP Cox Hallett Wilkinson Limited Tomashevskaya & Partners Dentons Triay & Triay Fried, Frank, Harris, Shriver & Jacobson LLP Udo Udoma & Belo-Osagie GTs Advocates LLP VdA Vieira de Almeida Houthoff Buruma Webber Wentzel Lloreda Camacho & Co. Zhong Lun Law Firm The International Comparative Legal Guide to: Private Equity 2017
General Chapters:
1 What’s in Store for PE in 2017, Trends and Practices – Sandro de Bernardini & Stephen Sims, Skadden, Arps, Slate, Meagher & Flom LLP 1
2 Private Equity Transactions in the UK: the Essential Differences from the U.S. Market – Nicholas Plant, Dentons 3 Contributing Editors Lorenzo Corte & Lutz 3 Reallocating Risk: An Introduction to Warranty and Indemnity Insurance in UK Private Equity Zimmer, Skadden, Arps, Transactions – Dan Oates & Hannah Luqmani, Fried, Frank, Harris, Shriver & Jacobson LLP 6 Slate, Meagher & Flom LLP Sales Director 4 International Standard Setting Bodies and the Global Regulatory Agenda – Michael Johnson, Florjan Osmani British Private Equity & Venture Capital Association (BVCA) 12 Account Director Oliver Smith Country Question and Answer Chapters: Sales Support Manager Paul Mochalski 5 Angola VdA Vieira de Almeida and Angola Capital Partners: Hugo Moredo Santos & Rui Madeira 18 Sub Editor Oliver Chang 6 Australia Atanaskovic Hartnell: Lawson Jepps & Jon Skene 25 Senior Editors 7 Austria Schindler Attorneys: Florian Philipp Cvak & Clemens Philipp Schindler 34 Suzie Levy, Rachel Williams Chief Operating Officer 8 Bermuda Cox Hallett Wilkinson Limited: Natalie Neto 43 Dror Levy 9 Brazil Pinheiro Neto Advogados: Eduardo H. Paoliello Jr. 49 Group Consulting Editor Alan Falach 10 Canada McMillan LLP: Michael P. Whitcombe & Brett Stewart 56 Publisher Rory Smith 11 China Zhong Lun Law Firm: Lefan Gong & David Xu (Xu Shiduo) 63
Published by 12 Colombia Lloreda Camacho & Co.: Santiago Gutiérrez & Juan Sebastián Peredo 72 Global Legal Group Ltd. 13 Finland Borenius Attorneys Ltd: Johannes Piha & Johan Roman 79 59 Tanner Street London SE1 3PL, UK 14 Germany Memminger LLP: Peter Memminger & Tobias Reiser 86 Tel: +44 20 7367 0720 Fax: +44 20 7407 5255 15 Gibraltar Triay & Triay: F. Javier Triay & Jay Gomez 93 Email: [email protected] URL: www.glgroup.co.uk 16 Hong Kong Ashurst Hong Kong: Joshua Cole 100
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Copyright © 2017 22 Nigeria Udo Udoma & Belo-Osagie: Folake Elias-Adebowale & Christine Sijuwade 147 Global Legal Group Ltd. All rights reserved 23 Norway Aabø-Evensen & Co: Ole Kristian Aabø-Evensen & Harald Blaauw 154 No photocopying 24 Portugal Morais Leitão, Galvão Teles, Soares da Silva & Associados: ISBN 978-1-911367-54-3 Ricardo Andrade Amaro & Pedro Capitão Barbosa 174 ISSN 2058-1823 25 Russia Tomashevskaya & Partners: Zhanna Tomashevskaya & Roman Nikolaev 181 Strategic Partners 26 Singapore Allen & Gledhill LLP: Christian Chin & Lee Kee Yeng 191
27 South Africa Webber Wentzel: Nicole Paige & Andrew Westwood 198
28 Sweden Advokatfirman Törngren Magnell: Anett Lilliehöök & Sten Hedbäck 207
29 Switzerland Bär & Karrer Ltd.: Dr. Christoph Neeracher & Dr. Luca Jagmetti 215
30 United Kingdom Skadden, Arps, Slate, Meagher & Flom LLP: Lorenzo Corte & Sandro de Bernardini 223
31 USA Schulte Roth & Zabel LLP: Peter Jonathan Halasz & Richard A. Presutti 232
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WWW.ICLG.COM Chapter 1
What’s in Store for PE in 2017, Trends and Sandro de Bernardini Practices
Skadden, Arps, Slate, Meagher & Flom LLP Stephen Sims
After a deal-rich 2015, 2016 saw a decline in PE activity. Both PE billion for a long-term fund with a lower risk profile.4 This shift deal volume and deal count fell approximately 20% year on year. will require an investor base willing to invest patient capital, such as Target valuations remained high. Relatively high purchase price pension or sovereign wealth funds, and a different fee schedule as multiples, combined with increased competition from strategic the return (IRR) would be lower. This change will allow PE firms to buyers rife with cash and seeking external growth, made for a target businesses that need long-term capital and do not intend to go challenging environment. PE exits also declined by approximately public in a 3–5 year period. A longer time horizon will also allow 25% as capital markets continued to struggle and PE firms PE to address the ever increasing cost of sourcing deals in a market postponed sales to avoid price cuts that would erode overall returns. that becomes more competitive every day. On the bright side, fund raising only dropped marginally and for As PE firms readjust to new market conditions, family offices have the fourth consecutive year, private capital raised globally exceeded emerged as a player to reckon with. Single-family offices manage $300 billion. about $1.2 trillion in assets, and multi-family offices manage Deals have become more difficult to source and more expensive approximately $550 billion.5 Family offices have come about as to complete since financial buyers may be forced to invest a an alternative way to put private capital/wealth at work, but have greater proportion of equity to avoid overleveraging investments. gained momentum as a valid means to address some of the perceived Moreover, holding periods have become longer as PE firms have PE pitfalls. Direct investment allows family offices to avoid PE chased suitable but often fleeting exit windows to maximise returns. fees, obtain greater control over the investment and determine the These factors are coming together to drive changes in the duration holding period themselves, in the hope of realising higher returns. of funds and their return profile, as well as a greater number of On the other hand, family offices are also an equity ally to PE firms deals where PE firms team up with family offices to make up the that seek additional capital at a time when the traditional investors additional equity required. At the same time, family offices are base may not be as willing to open their coffers. emerging as yet another alternative to, and therefore competition Family offices have been poaching private equity experts to manage for, PE investments. their direct investments, and we see this as a trend that will continue. The amount of time PE firms hold on to buyout investments has On the investment side, they have until recently mostly purchased increased steadily − from 4.1 years in 2008 to almost 6 years in minority interests in target companies, but as they grow more confident 2014.1 Europe had the longest average holding period, having in their direct investing abilities and their structure develops, we see increased from 4.1 years in 2008 to 6.2 years in 2014. This increase them beginning to purchase controlling interests, which will pitch was most pronounced in deals worth $1 billion or more, where them against, and in direct competition with, PE firms. On the fund the average holding period increased from just 3 years in 2008 to raising side, the larger family offices have begun to attract funds from 7 years in 2014.2 The average holding period decreased in 2015 investors that are external to members of the family. As the wall of to approximately 5.5 years, likely as a result of the record number secrecy surrounding family offices subsides somewhat, they have also (1,700) and value ($442 billion) of private equity-backed exits in started teaming up to compete with other players by pooling capital the relevant period. Investment holding period is a crucial factor together to generate scale as well as sourcing deals. to PE firms as it is generally more challenging to generate a high Family offices can be attractive bidders because of their willingness return over a longer investment holding periods. While longer to invest patient capital and be flexible. On the other hand, family holding periods may affect PE firms’ ability to meet investors’ offices are unlikely to engage in bidding wars and are waryof return expectations, faced with the alternative of selling within a high valuations, mainly as a result of their using 50% or less debt given timeframe, but making little profit (or even a loss) or holding capital when funding deals. Low bids are the most common reason onto the investment with a view to selling at a better time, PE firms investment bankers cite when family offices fail to win auctions. naturally lean towards the latter. On the other hand, PE investors The increase in direct investments, however, has not been matched may grow impatient if they perceive investments are being held on by a decrease in investment in PE funds. Large majorities of single- to for longer than anticipated while continuing to pay high fees. family offices believe both private equity and direct investments This dynamic is driving a structural change. outperform traditional portfolios. The majority of single-family PE firms such as Blackstone and Carlyle are developing funds offices invest in PE funds and are likely to increase their allocation with longer investment hold periods, potentially twice as long as a to PE funds in the next few years. Numerous sponsors/GPs indicate traditional fund. Carlyle has already raised $3 billion and invested that family offices have an increasing desire to invest in PE, which is $500 million in one of these funds, which will invest in technology supported by the fact that family offices increased from 7% to 11% 3 start-ups, and Blackstone has raised $670 million of their target $5 of LPs in PE funds between 2010- 2015.6
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PE firms are today more willing to offer co-investment rights, and we see that family offices that are LPs are eager to take up the offer. Endnotes Co-investment is attractive in many ways, it can improve the LP’s 1. Private Equity Spotlight, Preqin, p. 7 (May 2015). return profile on the one hand (by improving the net (after fees) returns), and keeps a potential competitor close on the other hand. 2. Id. at 8–9. One survey of GPs found that 69% offered co-investment rights to 3. Carlyle Said to Raise More Than $3 Billion for Long-Term investors, with an additional 18% considering doing so in the future. Fund, Bloomberg Technology (Feb. 9, 2016), available at http://www.bloomberg.com/news/articles/2016-02-09/ These advantages measure against the impact to the relationships carlyle-said-to-raise-more-than-3-billion-for-long-term- between GPs and LPs. In return for additional capital, LPs may gain fund. preferential/elite rights that sometimes create friction with the GP 4. Blackstone Core Equity Partners Raises Almost $670M, itself or other LPs that enjoy no such rights. Pitchbook (Apr. 25, 2016), available at http://pitchbook.com/ We think PE will continue to evolve and change to address these newsletter/blackstone-core-equity-partners-raises-almost- challenges. Industry-specific funds with tailored holding periods 670m. and fee schedules will become more common. At the same time, 5. Family Offices Team Up Taking Page from Private Equity, we see the potential for large family offices to develop into quasi Bloomberg (May 28, 2014), available at http://www. PE structures, adding to the arena of competitors. Increasing bloomberg.com/news/articles/2014-05-28/family-offices- competition is likely to drive more positive changes (more efficient team-up-taking-page-from-private-equity. management, greater cost control), but will also continue to fuel 6. Private Equity Fund Manager Outlook for 2016, Preqin, p. 5, high valuations at a time when it is not unthinkable economic 12 (February 2016). growth may slow down and the opportunities for investment shrink.
Sandro de Bernardini Stephen Sims Skadden, Arps, Slate, Meagher & Flom LLP Skadden, Arps, Slate, Meagher & Flom LLP 40 Bank Street 40 Bank Street Canary Wharf Canary Wharf London, E14 5DS London, E14 5DS United Kingdom United Kingdom
Tel: +44 20 7519 7108 Tel: +44 20 7519 7127 Fax: +44 20 7072 7108 Email: [email protected] Email: [email protected] URL: www.skadden.com URL: www.skadden.com
Sandro de Bernardini is a partner based in Skadden’s London office. Stephen Sims is the practice leader of Skadden’s European He focuses on cross-border mergers and acquisitions, private equity, Investment Management Group. Mr. Sims has experience in real estate and corporate finance transactions. He has represented investment management and funds formation, advising fund managers a variety of companies in several industries in connection with cross- and investors on the structuring, establishment and operation of border acquisitions and disposals, auction sales and multijurisdictional investment funds, especially private equity and real estate funds. His restructurings. Mr. de Bernardini also has worked for private equity work involves: fund formation and capital raising; fund-related mergers firms, attending to all aspects of their business, from formation to and acquisitions at manager/group level and ongoing ‘house’ work; portfolio acquisition and management to refinancing and exit. In and secondary transactions in fund interests. 2015, he was named by the Financial News as one of its 40 Under 40 Mr. Sims is recommended as a leading lawyer in Who’s Who Legal Rising Stars in Legal Services. Mr. de Bernardini also is a member of and Chambers UK and he was also recommended as one of the top Skadden’s award-winning Italian desk, which has been recognised as 40 lawyers under 40 in Financial News in 2013. He is the Senior Vice Law Firm of the Year/Italy Desk for 2015 by Premio Le Fonti, Law Firm Chair of the IBA’s Private Funds Subcommittee. of the Year — Italian Commitment for 2015 by Legalcommunity, and Italy Desk of the Year by TopLegal for both 2014 and 2015.
Skadden is one of the world’s leading law firms, serving clients in every major financial centre with over 1,700 lawyers in 22 locations. Our strategically positioned offices across Europe, the US and Asia allow us proximity to our clients and their operations. For almost 60 years, Skadden has provided a wide array of legal services to the corporate, industrial, financial and governmental communities around the world. Wehave represented numerous governments, many of the largest banks, including virtually all of the leading investment banks, and the major insurance and financial services companies. Skadden has one of the leading M&A practices in the world and has developed a first-rank mergers and acquisitions capability in Europe over 20 years with a focus on complex, cross-border transactions.
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Private Equity Transactions in the UK: the Essential Differences from the U.S. Market
Dentons Nicholas Plant
3. Financing: UK deals are usually done on a “certain funds” Introduction basis with no financing condition or financing out. But some private equity and strategic deals in the U.S. contain A U.S. private equity fund seeking to acquire a business in the UK financing conditions. In the UK, we would argue that makes will soon notice a number of differences from the U.S. market. It the acquisition agreement little more than a call option. If is important to be aware of these differences if you are competing there is no financing condition, as is the case in virtually all against UK private equity houses. U.S. large cap private equity deals, there will typically be a reverse termination fee which requires the buyer to pay a fixed The key features are that in the UK we have a far more seller-friendly amount if the financing is not available and the other closing approach and management incentives are structured differently conditions are met. This reverse termination fee is usually (however, they achieve much the same economic result). the seller’s exclusive monetary remedy against the buyer. Although reverse termination fees are seen in the UK, they are relatively rare, certainly by comparison with U.S. practice. Seller-friendly
Below are 11 ways in which the UK approach (and English law) is Transfer of Risk more seller-friendly. The common theme among the next three distinctions is the timing of when the risk (and benefit) of ownership transfers. Deal Certainty 4. Price certainty: It is has been common for a number of years in English law acquisition agreements, particularly in auctions, The common theme among the first three distinctions is deal for the acquisition price to be structured on a “locked box” certainty. A typical UK agreement assumes that, even where there basis. That is, the price payable for the target company is is a gap between signing and closing, deal certainty is required from agreed upon in advance of signing based on a balance sheet signing and so, from that point on, risk passes to the buyer. drawn up to an agreed locked box date. The buyer then 1. Conditions: Typically, UK agreements contain only those bears the risk and rewards of the target’s performance from closing conditions required by law or regulation e.g. anti- the locked box date through signing to closing. In return, trust clearances or other regulatory approvals. These are the seller undertakes that there will be no “leakage” of value generally specified together with detailed provisions on from the “locked box” to the sellers in that period in the form timings for filings and consequences based upon the response of dividends or otherwise. This is entirely in keeping with the from the relevant regulatory body. By contrast, U.S. deals are philosophy that risk passes to the buyer from signing. The more likely to have greater conditionality and to provide for a advantages for the seller in using a “locked box” include the meaningful period of time before closing, known in the U.S. ease with which bids can be compared and price certainty (as as the “marketing period”, for the buyer to have a fair shot at there is no post-closing adjustment). securing acquisition financing. Although the use of the locked box mechanism is increasing 2. Material Adverse Change: It is unusual for UK deals to be in the U.S., it is still common to have a purchase price subject to a MAC condition. Even if a MAC condition is adjustment based on the working capital or net worth of the included, it is likely to be relevant only if an “armageddon” company as of the closing date (which is typically estimated event occurs in respect of the target business itself which is at closing and trued up post-closing), and the seller is free not the result of macro-economic factors. It is also frequently to make ordinary course distributions out of the company constructed so that it is only triggered by a change that has during the interim period. Unlike the locked box mechanism, a specified financial consequence on the target group. The and depending on the precise formula used in any particular aim of this approach is to bring certainty by clearly defining adjustment, the seller retains the commercial risk and reward the trigger for the MAC (rather than leaving it to a court or until closing. Furthermore, the seller has less control over the arbitrator to decide whether the impact of a future event is final amount of the purchase price, and the price is likely to “material”). By contrast, MAC clauses are far more common be subject to a post-closing adjustment and potential dispute in the U.S., although they are also interpreted very narrowly. based on the closing accounts. Conceptually, that makes sense because in the U.S, risk is not 5. Control between signing and closing: The covenants to considered to pass to the buyer until closing (see below). which the target business and seller are subject in the period between signing and closing are likely to be significantly more prescriptive and extensive in the UK than in the U.S.
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6. Repetition or “bring down” of warranties and acquisition agreement, the seller’s disclosures are typically representations: In the UK, it is unusual for warranties contained in a separate disclosure letter, rather than the to be repeated (or “brought down”) at closing, although, schedules to the sale agreement itself, which is often the as a compromise, sellers may agree that a small number case in the U.S. A UK disclosure letter will contain a mix of fundamental warranties, such as those regarding title, of general and specific disclosures against the warranties. insolvency and material litigation, are repeated at closing. In Even the specific disclosures are normally deemed to qualify the U.S., the practice is generally to require representations all warranties and not just the specific warranties to which and warranties to be repeated on closing or, at the very least, they relate. More significantly, in auctions it would be usual include a closing condition that gives the buyer the ability to for the entire contents of the data room and of any vendor terminate the transaction for a material breach of warranty due diligence reports to be deemed to be generally disclosed and representation prior to closing. against the warranties. In the U.S., the buyer will usually allow specific disclosures against specific warranties, and any other warranties as to which it is readily apparent that such Seller’s Liability disclosures might relate. General disclosures, or imputations to buyers of the entire contents of the data room, are far The position on seller’s liability when comparing the UK and U.S. less common in the U.S. and not typically accepted by U.S. is more balanced. On the one hand, a UK private equity seller is buyers. unlikely to give any warranties and other warrantors are unlikely to 9. Specific Performance and Liquidated Damages: While the repeat them on closing. Also disclosure will more be comprehensive. test for granting specific performance is the same between On the other hand, the scope of warranties and caps and time limits the U.S. and the UK (i.e. monetary damages would not be on liability are likely to be broader, higher and longer in the UK an adequate remedy), an order for specific performance is than the U.S. generally easier to obtain in the U.S. than the UK. Liquidated damages are also easier to obtain in the U.S., since in the UK 7. Limits on Liability: Private equity sellers in the UK never the onus is on the enforcer to prove that the amount claimed give business warranties in an acquisition agreement. is a reasonable estimate of its loss i.e. UK courts do not award Instead, a buyer relies upon warranties received from the penalties. management team. That, combined with a management team rolling over 50% or more of its post-tax sale proceeds, 10. Buying from an Administrator: In the UK our equivalent of gives the buyer some comfort in what it is acquiring. If a buying a business out of Chapter 11 is acquiring it from an buyer requires a higher level of recovery against the purchase “Administrator”. Buyers of businesses from an Administrator price in the event of a breach of warranty, then it can also will, typically, receive no warranties or representations on acquire warranty and indemnity insurance. Warranty and the target business from the sellers, and have no post-closing indemnity insurance is now very common in the UK private recourse against the sellers. At best, they will receive a equity market. Typically, the premium costs around 1.5% of warranty from the Administrator confirming the validity the amount covered and the deductible (also known as the of his appointment. It is possible for the buyer to have an “retention” or “excess”) is around 1% of the enterprise value. escrow arrangement or deferred consideration, but if there are competing bids the Administrator will favour the bid In the U.S., the construct is different. A selling private that provides the maximum cash payment on closing. The equity fund is unlikely to give business warranties and solution is for the buyer to price in the risks. any management liability of this kind seen in the UK is extremely rare (perhaps reflecting the reality that a lawsuit against one’s new management team is an unattractive Finally proposition). However, both the selling private equity fund and management team may fund, proportionate to their 11. Process: Vendor legal due diligence (where key legal due shareholdings, an escrow in an amount equal to 5–10% of diligence materials are prepared in advance of the sale the equity value. The escrow is typically paid over to the process and designed to be relied on by the successful bidder) seller once the representations and warranties expire, subject is common in the UK. It may be particularly helpful if the to reserved amounts for any pending claims. The corollary business to be sold has “issues”, requires explanation, and/ of this is that in the U.S. the seller’s representations and or if the auction is expected to be highly competitive and the warranties can survive for as little as the first anniversary of timetable aggressive. the closing or, alternatively, the completion of the first audit cycle under the buyer’s ownership. By contrast, in the UK, By contrast, in the U.S. it is rarely used, largely because of time limits tend to be longer – typically two years for non- litigation risk and scepticism on the part of U.S. buyers as to tax warranties and seven years for tax warranties. Although, the level of comfort offered. the warranty and indemnity insurance is invariably structured so that the warrantors themselves cease to be liable for the Conclusion deductible after the first anniversary of closing. Also in the UK, express contractual indemnification is far These differences demonstrate why U.S. sellers might prefer that less common than in the U.S, except in relation to tax or other their international deals are done under UK law. However, in specifically identified risks (e.g. environmental exposure). making tactical decisions about the choice of law, sellers should be The buyer’s remedy for breach of a warranty in a UK acquisition agreement will instead usually be a contractual mindful of the geographic location of the likely pool of buyers. It claim for damages, with a duty to mitigate losses and a would make no sense to have English law if both the pool of bidders requirement for any damage to be reasonably foreseeable. and target itself are based outside of the UK. Some U.S. deals actually end up with a similar result, notwithstanding the express contractual indemnification due to waivers by buyers of consequential damages and a Management Incentives contractually imposed duty to mitigate. 8. Disclosure: The style and substance of the disclosure process In the UK we structure management incentives a little differently differs between UK and U.S. documents. Under a UK from the U.S., but with much the same economic result.
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In the UK, all share incentives are awarded to the management team on closing, but all are subject to forfeiture if the manager leaves Nicholas Plant before the exit. The reason is entirely tax-driven i.e. if shares are Dentons awarded at less than their market value at the time of award, then One Fleet Place London, EC4M 7WS the recipient will suffer income tax on the difference between the United Kingdom price he pays (if lower) and the market value. The employer will also suffer a tax bill on the difference (employer national insurance Tel: +44 20 7246 7081 Email: [email protected] which is currently charged at 13.8% on the difference). Because it URL: www.dentons.com is assumed the market value of the shares will increase during the lifespan of the investment, it therefore makes sense to award all the incentives at the outset of the investment period. That is why the Nicholas is global co-head of private equity at Dentons. He has nearly issue of shares during the investment period pursuant to staggered 20 years of experience working on both domestic and cross-border vesting under an option plan makes no sense in the UK. leveraged buyouts and has led over £7 billion of LBOs in the last five years. If a manager leaves before the exit, then all the shares will be forfeitable. The question is at what price. A bad leaver will be Nicholas has worked extensively for some of the leading private equity houses, including: Advent International; Apax; Blackstone; CVC required to offer his shares for sale at the lower of market value and Capital Partners; Duke Street Capital; European Capital; Graphite the subscription price. The price for a good leaver will, typically, be Capital; and Investcorp. market value (since the higher of market value and the subscription Nicholas receives exceptional praise from market sources. He is price would, perversely, incentivise a manager to leave if the named as a “leading individual” by Chambers & Partners. It quotes company is underperforming). A third category has developed in clients who describe him as “technical” and “very client-focused” – the UK market – the intermediate leaver, who is essentially someone Chambers UK 2016 (Private Equity). It also says Nicholas “is a well- known private equity lawyer whose clients include leading players” – dismissed without cause on full notice. He will receive the lower of Chambers UK 2017 (Private Equity). market value and the subscription price for a portion of his shares and market value for the balance. The portion that must be offered Nicholas also has a specialism in African private equity. He advised on the largest private equity transactions in Africa in 2013 and 2014 (the for market value will increase in line with how long the relevant Petrobras JV and IHS Holdings). He is listed in The Lawyer: Africa manager has been in the business. This is what we call “value Elite 2015 as one of the 10 leading international lawyers advising on vesting”. Four years is a typical period for the manager’s entire African private equity. holding to “value vest” i.e. be forfeitable entirely for market value. This last category achieves the same economic outcome as the “actual vesting” that one sees in the U.S. Two countries divided by a common language – indeed!
Dentons is the world’s first polycentric global law firm. A top 20 firm on the Acritas 2015 Global Elite Brand Index, the Firm is committed to challenging the status quo in delivering consistent and uncompromising quality and value in new and inventive ways. We are driven to provide our clients with a competitive edge, and are connected to the communities where our clients want to do business. Now the world’s largest law firm, Dentons’ global team builds agile, tailored solutions to meet the local, national and global needs of private and public clients of any size in more than 125 plus locations, serving 50 plus countries. Dentons is at the core of international private equity. We have one of the largest integrated global teams, with over 200 specialist lawyers advising on private equity transactions. We offer the full range of private equity services including Buyouts, Secondaries, Spin-outs, Venture Capital and Fund Formation, together with specialist advisers in our Leveraged and Acquisition Finance, Competition, Tax and Regulatory practices.
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Reallocating Risk: An Introduction to Warranty and Indemnity Insurance in Dan Oates UK Private Equity Transactions
Fried, Frank, Harris, Shriver & Jacobson LLP Hannah Luqmani
Introduction and background Objective
Warranty and indemnity or “transactional risk” insurance (“W&I This article considers how the availability of W&I insurance has insurance”) is a tool to facilitate acquisition transactions by having changed the transacting process and the dynamic between buyer an insurer take on risks otherwise borne by a buyer or seller. and seller in acquisitions involving a private equity sponsor, and Such insurance has been available for a number of years, but whether there is any basis to the common perception that having has not been widely used until the last few, during which time it such insurance can present a “moral hazard” in that sellers take less has experienced rapid growth in popularity, particularly in M&A care with disclosure and buyers become less rigorous with the due transactions involving private equity sponsors.1 The bulk of the diligence process. policies now written are “buyer side,” and these represent some We explore whether insurers may require that they have a more four-fifths of policies issued – the remainder being “seller side”. active role in the transacting process, given that they essentially They differ in that a buyer-side policy is between the buyer and only have two levers to pull – the premium they require to provide the insurer, which provides the buyer with recourse directly to the the insurance and their ability to decline to underwrite altogether. insurer, in the event that a warranty is breached or an indemnity Lastly we consider the type of matters such insurance will not triggered. In a seller-side policy, the seller has recourse to the insurer typically cover, why this is the case, and whether this is an area of to reimburse what it has had to pay the buyer for a successful claim. potential flexibility, along with the types of matters where insurance Since seller-side insurance is comparatively rare in UK transactions can, in some circumstances, afford greater comfort to a buyer than involving a private equity sponsor, the focus of this article is on what would typically be obtained in a sale agreement. buyer-side insurance only. To properly explore each of these issues, we need to consider the Buyer-side insurance arose to address situations where, for instance: context and legal framework in which such transactions sit, and to (i) a sponsor seller was unwilling to provide the desired level of do this we need to start with first principles. financial coverage for breaches of warranty because it wanted a “clean exit” (in order that it be able to quickly return funds to its investors which in turn meant accepting only minimal residual risk Why does a buyer seek warranties from a after closing of the transaction); or (ii) the buyer was concerned that seller or warrantor? the sellers or “warrantors” (see below) might not (or, in the case of warrantors, would not) have the necessary financial resources A seller or warrantor is under no general duty to make a buyer to provide adequate compensation for a warranty breach; and/or aware of issues or shortcomings associated with a target business, (iii) the buyer wished to enhance what it could offer in a competitive and the principle of “caveat emptor” or “buyer beware” applies. bid situation by reducing or eliminating the sellers’/warrantors’ The buyer will therefore wish to obtain disclosure of documents warranty exposure. and information3 that could impact: (i) its valuation of the target business – with a view to price adjustment either pre-signing by W&I insurance particularly lends itself to acquisition transactions an up-front reduction in the headline consideration or post-signing involving private equity sponsors where management shareholders through the operation of specific indemnities; and (ii) whether it (often referred to as the “warrantors”) give the “operational”2 does the deal at all – disclosure of certain information may be so warranties to the buyer, but receive only a small fraction of the problematic for the buyer that it simply walks away. consideration, and hence, can only reasonably be expected to provide limited financial coverage to a buyer in the event that a warranty is To obtain the types of documents and information it requires, the breached. Insurance used in such transactions is almost invariably buyer will push for the sale agreement to include detailed statements buyer-side, albeit that in an auction sale, a draft buyer-side policy from the warrantors relating to the condition of the target business will sometimes be part of the transaction package proposed by the and its liabilities – “warranties” on matters about which it requires seller, in which case the seller will have already shared the draft specific comfort. To this end, the buyer will want the scope and sale documentation with an insurance broker, who in turn will have content of the warranties provided to be as broad as possible, but obtained a range of coverage positions and corresponding quotations realistically, the sensible approach is that their scope be tailored to from various underwriters, which are then presented to the buyer at what the buyer actually needs, given the nature of the acquisition. the outset of the transaction. The matters warranted in relation to a target business typically include, as a minimum, the status of: ownership, compliance with law, litigation, material contracts, accounts, real property and assets,
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intellectual property, employees, pensions and insurance, though (b) makes a statement which is false or misleading in a depending on the nature of the target business, certain warranties material respect, being reckless as to whether it is or not; may be significantly more detailed, and further specific warranties or may be appropriate. (c) dishonestly conceals any material facts, whether in The seller or warrantor however ideally wants the warranties it connection with a statement it makes or otherwise, provides to be as limited as possible, and its range of responses to the such seller or warrantor commits a criminal offence under buyer’s proposed warranties are essentially to (i) accept a warranty, section 89 of the Financial Services Act 2012. (ii) narrow or qualify its scope, by awareness, materiality, etc., or (iii) Note that whilst the penalties for such offences are severe,5 there is reject inclusion of the warranty in its entirety. The last option can be no associated civil remedy apart from whatever can be received in a counterproductive for a seller or warrantor, since it inevitably has the potential action for misrepresentation under general law. effect of making the buyer suspicious that the seller or warrantor has Moreover, any liability limitations and exclusions agreed upon/to something to hide in that area – unless the seller or warrantor is able between the buyer and the seller or warrantor do not apply in the to convince the buyer that disclosure under such a warranty would event of the seller’s or warrantor’s fraud, in which case the seller’s provide limited actual benefit either because the matter is entirely or warrantor’s liability will be effectively without limitation or irrelevant to the transaction or it would require a disproportionate exclusion. amount of work to produce the disclosure required to ensure that the In light of the above, the seller or warrantor has a strong incentive warranty is appropriately qualified (more on disclosure below). to not deliberately withhold disclosure of relevant matters of which it is aware. This is, of course, not the same thing as ensuring that What is the risk to a warrantor or seller if it enquiries are made and all potentially relevant information and does not disclose against a warranty? documents are ascertained and disclosed. The incentive to ensure that this occurs is the prospect of the buyer making a breach of Non-disclosure of information and documents relating to a known warranty claim against the seller or warrantor after completion. The issue does not in itself constitute misrepresentation because there is degree of concern this provokes on the part of the seller or warrantor no general common law or statutory duty on a warrantor to disclose will inevitably depend on the extent of the liability the seller or information relevant to what it is selling. However, note: warrantor may face for such breaches. (1) where the warrantor has given a warranty which requires Such matters are usually agreed upon/to between the buyer and qualification by disclosure of information or documents in seller or warrantor in the sale agreement, and will typically be the order to be accurate, the warrantor’s failure to disclose may whole of the consideration for warranties on certain fundamental constitute a: matters (such as ownership of what is being sold and the seller’s (a) misrepresentation, which may be innocent, negligent or warrantor’s capacity to effect the sale), but limited to some part or fraudulent depending on the reason for such non- of the consideration for breach of warranties relating to operational disclosure, though it is typically accepted between the matters, usually between 10% and 30% of the seller’s or warrantor’s buyer and seller or warrantor that the warranties are not net proceeds. also representations as such, and that the remedies for misrepresentation are excluded by the effect of the entire agreement clause, except where the misrepresentation is What will insurers expect from a disclosure 4 fraudulent; or process? (b) breach of warranty, since the matters warranted are not supported by the facts, and the sale agreement is therefore Where the buyer has obtained W&I insurance, the seller’s or breached (the actual reason for the non-disclosure is warrantor’s liability cap will typically be set at the “excess” under irrelevant) – so it is in the seller’s or warrantor’s interest the policy, and may be as low as 1% of the consideration, or even as to disclose to the buyer documents and information that low as £1. In such cases, the obvious concern is that this is too low qualify the warranties in order that they be accurate and not misleading, and thus preclude a claim for breach, to incentivise the seller or warrantor to conduct a proper disclosure since no claim will arise if facts giving rise to the breach exercise. of warranty were disclosed; Putting the lack of incentive to disclose aside, a seller or warrantor (2) where a seller or warrantor, with the intention of making a will, in any event, typically be unfamiliar with the disclosure gain or causing the buyer a loss: process, so they will need to engage legal counsel to ensure that (a) dishonestly makes a representation or gives a warranty all potentially relevant information and documents are ascertained that is false, and does not qualify it by making the and disclosed, and that the process is managed and completed to a appropriate disclosure – this may constitute fraud by false reasonable standard.6 This entails ensuring that proper enquires are representation under the Fraud Act 2006; or made to the appropriate persons and that appropriate resources are (b) does not disclose a warranty breach between exchange allocated to extract relevant documents and to review and organise and completion, and is therefore in breach of a contractual the information in a coherent way, identifying any gaps. duty in the sale agreement to disclose (perhaps because Providers of W&I insurance have the necessary expertise to the seller or warrantor feels this may put the transaction at risk were the buyer to know such information) – such determine whether the seller’s counsel has ensured that the breaches may constitute fraud by failing to disclose under disclosure process has been conducted to appropriate standards, and the Fraud Act 2006 (such failure may also be fraud by will take comfort where it has been handled in the way it would false representation); have been had the seller faced exposure to the traditional level of (3) where the seller or warrantor is selling shares (as opposed to potential liability. Alternatively, a complete absence of disclosure or assets), and in order to induce the buyer to enter into the sale a badly managed process will be a “red flag” to an insurer because agreement it: it will presume there are matters that should be disclosed, and the (a) makes a statement that the seller or warrantor knows to be fact that they have not been disclosed may well be the basis for a false or misleading in a material respect; breach of warranty claim. This in turn may lead to a greater number
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of exclusions from coverage and/or a higher premium, as the insurer disclosures like any other disclosures and review them with a view seeks to balance what it sees to be increased risk. to understanding whether a price reduction or additional specific It is important to note here that from an insurer’s perspective, an indemnity is appropriate. acquisition transaction entails a dynamic risk profile. The initial Not only is it better to address disclosed matters prior to signing “indicative” quotation will typically be given at an early stage in (rather than make a warranty claim after completion), but there is also the transaction process and be based on (i) assumptions that may a risk that a buyer may be found to have been fixed with knowledge be apparent at the point of signing but can no longer be supported, of a last minute disclosure, despite its purported “rejection”, and this and/ or (ii) information that has turned out to be incorrect or partially both compromises any related warranty claim and invalidates the incorrect. The insurer will reserve its position on the coverage it is buyer’s W&I insurance, since the buyer has signed the representation ultimately able to provide until the later stages of a transaction. letter stating that it has no knowledge of such matters. Typically the insurance broker will organise a teleconference for the underwriter, buyer and buyer’s legal advisors, during which the How can W&I insurance protect the buyer underwriter is likely to ask about specific factual issues that have arisen during diligence investigations in order to gain comfort on against disclosed or known potential its proposal for a binding quotation. A high-level agenda might liabilities? be circulated by the underwriter prior to the call, although the underwriter is unlikely to indicate exactly which factual issues on Where the warranties have provoked disclosure of a potential liability which it will probe. It is essential that all individuals with in-depth that is contingent or not sufficiently defined so as to realistically knowledge of the diligence investigations attend these calls, in translate into a price reduction, the buyer might not be prepared to order to be able to field the underwriter’s questions and make the take it on. Moreover, since the disclosure precludes any warranty underwriter comfortable with underwriting the policy. claim in the event the liability crystallises, the buyer may instead require that the seller undertakes to indemnify it for that liability, It is worth mentioning that, given that private equity sponsors are irrespective of whether the buyer suffered loss from that liability. “financial” rather than “trade” buyers, and do not typically have the same intimate understanding of a target business’ industries, it is Such indemnity operates as a retrospective price adjustment now common for sponsors to take the additional step of obtaining mechanism in relation to specifically identified known liabilities which specialist reports on legal, financial, tax, market, insurance and are not qualified or neutralised by disclosure or buyer knowledge. environmental matters. All of these would be made available to The focus of such indemnities is usually liabilities potentially arising the insurer as a matter of course, and be of material assistance to its from ongoing litigation, the transfer of employees and/or tax issues, assessment of the risk profile. however it may also cover a variety of other matters where the risk likelihood is low, but the impact on the value of the target business is material. They are usually included in the sale agreement, but How does the buyer’s knowledge impact a the tax indemnity is typically a separate deed which in essence warranty claim and insurance coverage? proves that the seller will reimburse the buyer for any tax liability not otherwise provided for in disclosure that may arise in the target The buyer will seek that the sale agreement states that warranties business, together with associated penalties and costs. therein are qualified only by matters “fully, fairly and specifically” A standard W&I insurance policy will provide coverage under the divulged in the disclosure letter “with sufficient detail to identify the general tax indemnity, but for unknown and undisclosed matters nature and scope of the matter disclosed” and by no other information only; specific tax indemnities relating to known contingent liabilities of which the buyer had actual or constructive knowledge. would not be covered and would require a separate bespoke tax The last part of such requirement with respect to constructive insurance policy. Similarly, specific indemnities for other known knowledge is typically rejected by the seller or warrantor for the liabilities would not typically be covered; the insurer would need reason that it seeks to impose a disclosure standard on the seller to get comfortable with the risk involved, and, if it does obtain such or warrantor higher than that imposed by law. It is also probable comfort, the W&I policy would be either extended to cover the that such clause is ineffective where the buyer already had actual liability, or a separate additional bespoke policy would be provided. knowledge of matters not revealed in the disclosure letter, and only constructive knowledge that may be excluded (knowledge that the buyer ought to have had, but did not in fact have, even if known to What happens to the sellers or warrantors its agents). when a warranty is breached and an Since the law could be better settled in this area, the prudent insurance claim brought? course is for a buyer to work on the basis that it will not be able to recover for warranty breaches it knew of before it entered into No matter how good a buyer’s due diligence, it will only truly know the sale agreement. Moreover, where the buyer has obtained W&I the assets, liabilities and performance of the target business after insurance, the policy will both expressly exclude claims in such that business has been acquired and operated, typically for a full circumstances as well as require that the buyer sign a representation audit cycle. So, in addition to driving disclosure, warranties also letter declaring that at the inception of the policy, specified provide a means of retrospective price adjustment, since in a breach members of the buyer’s deal team are not aware of any claims (or of warranty claim the buyer will be entitled to recover the reduction circumstances) which may lead to a claim under the policy. in value of the target business as a result of the warranty not being true, irrespective of whether it relied on the warranty in question. What about “last minute” disclosures? Where the target business is held by a private equity sponsor, all sellers will give fundamental warranties as to ownership and Whilst simply resisting last minute disclosures can be a tempting capacity, but typically only the management team members who response for the buyer, it is not ultimately an attractive option. hold equity (i.e., the warrantors) will give operational warranties, The preferable course in such circumstances is to handle the and consequently they will be the most likely recipients of a breach
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of warranty claim. In cases where that team has continued with the Insurers will also pay particular attention to the scope of warranties business post-completion of the deal, and comprises the very people given in relation to (i) unfunded or underfunded pension plans, the buyer has backed to make the acquisition a success (usually the (ii) regulatory compliance, and (iii) environmental matters, such co-owners), making a claim against such individuals is inevitably as asbestos or the release of hazardous substances. Insurance can counterproductive, since it compromises the working relationship be obtained for warranties repeated at completion, but only where and is extremely demotivating for them. they are qualified by an updated disclosure letter at completion What is recovered for breach of warranty is typically something less with respect to matters which arise in the period between exchange than the whole of the loss, since it is customary for the buyer and and completion (i.e., not matters which arose before exchange, but seller to agree that (i) losses will not be recoverable until they reach which were discovered only afterwards). a certain amount, (ii) certain types of loss will be excluded from In most policies, the approach is to replicate the warranties from recovery entirely, (iii) there will be a cap on the amount recoverable the sale agreement in a table and specify the extent to which the from the seller, and (iv) there will be a time limit within which a insurer is prepared to provide coverage for each – full, partial or not claim must be made. at all. The more information the insurers can obtain on a matter, Being able to claim against an insurer not only preserves the the wider the coverage position they can offer. The duration of the working relationship with management (and reduces their potential insurance will generally track the duration of the warranties in the exposure), but also enables parameters other than purchase price to sale agreement. be tweaked without risk to the buyer, including: a reduction in the In a buyer-side policy, the insurer will require that the buyer accepts amount of the purchase price held in escrow (if any); a reduction in a certain portion of the risk, which is referred to as the “excess” (or scope of the types of loss recoverable; and a reduction in the cap on sometimes as the “retention” or “deductible”) – typically between liability for warrantors. 0.5% and 1% of the purchase price. However, even if a loss is theoretically recoverable, the buyer may be concerned about its ability to collect damages from the seller, What does the insurer need to know – and this concern is usually addressed by putting some part of the purchase price into an escrow account for the duration of the period and when – in order to provide a binding the buyer has to make a claim. This is not typically problematic quotation? except where the seller is a private equity sponsor that wishes to distribute sale proceeds to investors shortly after receiving them and The insurer is effectively being asked to undertake liabilities is reluctant to accept an escrow of any meaningful amount. Here, that would otherwise be borne by the seller or warrantors, so at a buyer-side W&I insurance provides a means to do away with the minimum it will require: need for an escrow, and to substitute a financially-rated insurer as a (1) an understanding of the transaction, an opportunity to speak recipient of any warranty claim. to the seller and buyer and their respective professional advisors, and access to current drafts of the relevant transaction documents being negotiated; What will an insurer typically cover and (2) visibility of the seller’s disclosure process and the buyer’s exclude? due diligence process, including the buyer’s due diligence reports (for a buyer-side policy); and W&I insurance will largely track the warranties in the sale (3) a signed representation letter (see above) on completion of agreement, but will usually expressly not cover: the sale transaction. (1) fraud on the part of the buyer (fraud on the part of the seller or Note that it is not the insurer’s desire to conduct a parallel due warrantor is normally covered, although the general waiver diligence process, and it would not look to engage on this front or of the insurer’s right of subrogation against the seller or make requests. A material change in the scope of warranties will warrantor will expressly carve out such circumstance); however have an inevitable impact for the insurer, who will need to (2) matters of which the insured buyer was aware on inception of work through any implications before it is able to confirm coverage. the policy (see above); This should be anticipated and built into the transaction timetable, as (3) changes to the underlying transaction documents without the should the time required to negotiate the policy (which is prepared consent of the insurer; concurrently with the underwriting process, and usually takes two (4) warranties relating to: to three weeks). (i) projections or forward-looking statements – e.g., the ability to collect debts or accounts receivable post signing; What are the main factors that determine (ii) bribery/anti-corruption – unless the insurer is persuaded that comprehensive diligence has been done; the premium? (iii) fines and penalties – insurers consider there to bea The premium for W&I insurance is typically between 1% and 1.5% moral duty not to provide cover for such, though this is of the amount insured, or “coverage”, which typically ranges from sometimes limited to criminal fines and penalties, which are uninsurable by law; and 10% to 50% of the transaction value. It is usually payable in full for the whole of the policy period upon inception of the policy itself. (iv) certain tax matters such as transfer pricing; (5) indemnities relating to: The key factors that determine the level of the premium are: (i) purchase price adjustments – which would normally be (1) warranty scope and degree of qualification – e.g., by effected through completion account mechanics, rather awareness, materiality, etc.; than warranty claims; and (2) the amount of insurance coverage sought and the excess (ii) leakage under a locked-box mechanism; and proposed; (6) consequential loss. (3) whether insurance coverage is required for specific indemnities;
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(4) the industry sector of the target business, identity of the buyer ■ Avoids potential reputational risk for a sponsor if a claim and seller, geographical location, and governing law of the becomes public, which may adversely impact on a sponsor’s sale agreement; reputation and ability to enter into future transactions. (5) the identity of the buyer’s and seller’s professional advisors, Negative features: as well as the extent of disclosure made by the seller and the ■ Volume of W&I insurance claims is still in its infancy. It is level of due diligence conducted by the buyer; and therefore difficult to evaluate the prospects offered to buyers (6) whether the members of management giving the warranties by W&I insurance using any meaningful metrics. are retaining an interest in the business and continuing with ■ If a binding W&I insurance policy is a deal completion the buyer (in a private equity secondary buyout, the private deliverable, the transaction timetable can be scuppered by the equity sponsor buyer has comfort that the business is already insurer at any point, including at short notice and/ or at the subject to disciplines of the prior sponsor owner). last minute, which may be especially crucial for sponsors. In a buyer-side policy, the insurer has no direct leverage over the ■ The coverage position offered will inevitably contain many seller, but exerts leverage indirectly via the buyer using the premium exclusions and limitations overlaying those in the sale or by its ability to decline to underwrite altogether. documentation. Insurers will also be more circumspect when the target business is ■ Buyers may find that the premium demanded is in certain industries, including those where the valuation has a large disproportionate, especially given the relatively low goodwill component and those subject to a high degree of regulation likelihood of the warranty claim being successfully brought. or litigation, e.g., financial services or healthcare. ■ The process of securing W&I insurance is rather involved, requiring quite some time and resource to be dedicated A buyer-side policy will usually provide that the insurer’s equitable to it – e.g., regularly and promptly updating the insurer on right of subrogation against the seller has been waived, except in every transactional development and satisfying the insurer’s the case of seller fraud – the seller will have asked for this and such numerous requests for additional information in relation to request is usually accommodated by the insurer. diligence and disclosure issues.
Might the insurer be able to offer something Endnotes more than the warranty package? 1. Between 2011 and 2015, the use of W&I insurance in M&A For an increased premium, the insurer may be prepared to (i) remove grew by 240% globally, rising from around 500 policies qualifiers as to knowledge or materiality, (ii) lower liability caps and written annually to a figure closer to 1,700. In 2015, 22% of remove the exclusion of certain types of liability, or (iii) extend the all UK M&A deals used W&I insurance. Source: Paragon International Insurance Brokers Ltd. – “M&A Insurance duration of coverage beyond the survival of the sale agreement. Solutions Factsheet” https://wsandco.com/southern-california- perspectives/reps-warranties-insurance-ma/. Does W&I insurance pay out? 2. The “Operational” warranties are warranties relating to the business and/or operations of the target company. Based on global data for W&I insurance from 2011 to 2014, one 3. Typically into an electronic data room made available to the in seven policies reported a claim, and the most common subject buyer and its advisors. matter in the instances where alleged breaches of warranty were 4. For a misrepresentation to be fraudulent, the seller or warrantor reported were financial statements (28%), tax information (13%) must have made the false representation knowingly, or without and contracts (10%).7 However, whilst it is clear that policyholders belief in its truth, or recklessly as to its truth, with the intention frequently attempt to rely on protection offered by their W&I that the buyer rely on it, which the buyer must have done and insurance policies, there is limited data available in relation to the suffered loss as a result of. success rates of such claims, which is likely the result of a limited 5. Under the Fraud Act, the maximum penalty is 10 years’ volume of claims from which data can be gathered (given the present imprisonment and a potential fine. Under the Financial Services novelty of W&I insurance) and, of course, certain confidentiality Act, the maximum penalty is seven years’ imprisonment and an unlimited fine. constraints, but also insurer reluctance to publically share such data. 6. Information and documents must be “fairly disclosed” and “with sufficient detail to identify the nature and scope of the matter Is it just schmuck insurance? disclosed” – the required standard under English law, see New Hearts v Cosmopolitan Investments [1997] 2 BCLC 249 – but W&I insurance seems to be a useful tool, although it is not without note that the question of whether or not disclosure effectively qualifies the warranties in any acquisition agreement will depend potential pitfalls. Note some of the key positive and negative upon the level of disclosure that the buyer has agreed to accept features: – Infiniteland Limited v Artisan Contracting Limited ([2005] Positive features: EWCA Civ 758) and MAN Nutzfarhrzeuge AG and others v ■ Useful for buyers, and especially sponsors, seeking to build Freightliner Limited [2005] EWHC 2347 (Comm). a positive and constructive relationship with management 7. Source: American International Group, Inc. – “What Happens warrantors following completion of the transaction. After the Deal Closes? Warranty and Indemnity Insurance ■ Avoids awkwardness and potential negative knock-on effects Global Claims Study” https://www.aig.ch/content/dam/aig/ for the entire business of bringing a warranty claim against emea/switzerland/documents/brochure/ma_trend_claims_ management warrantors. study_2016_engl.pdf.
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Dan Oates Hannah Luqmani Fried, Frank, Harris, Shriver & Jacobson LLP Fried, Frank, Harris, Shriver & Jacobson LLP 41 Lothbury 41 Lothbury London London EC2R 7HF EC2R 7HF United Kingdom United Kingdom
Tel: +44 20 7972 9168 Tel: +44 20 7972 9193 Fax: +44 20 7972 9602 Fax: +44 20 7972 9602 Email: [email protected] Email: [email protected] URL: www.friedfrank.com URL: www.friedfrank.com
Dan Oates is a partner in Fried Frank’s Corporate Department and Hannah Luqmani is an associate in Fried Frank’s Corporate Private Equity Practice, resident in the London office. He advises Department and Private Equity Practice, resident in the London office. private equity and corporate clients on a wide range of multi- Ms. Luqmani has particular experience in advising private equity and jurisdictional transactions, including equity investments, acquisitions corporate clients on a range of cross-border corporate transactions and leveraged buyouts, disposals, public-to-private transactions and including mergers, acquisitions and disposals. initial public offerings. Ms. Luqmani has acted for a range of clients including sponsors Mr. Oates has completed a significant number of transactions on and their portfolio companies, corporates, financial institutions and behalf of clients including 3i, Accel KKR, AEA Investors, Apollo management teams. Amongst these are 3i, AEA Investors, CVC Group, Apax Partners, Audax Group, Bain Capital, Barclays Capital, Capital Partners, Francisco Partners, Genesys, Goldman Sachs, KKR, Blackstone, Candover, CCMP Capital, CVC Capital Partners, Dyal and the management teams of Cath Kidston, New Look and Mayborn. Capital, Francisco Partners, Golden Gate Capital, Goldman Sachs, KKR, Marathon Asset Management, Metalmark Capital, Oaktree Capital Management, Paul Capital, Silver Lake Sumeru, Welsh, Carson, Anderson & Stowe and Yellow Wood Partners. Mr. Oates is recognised as a leading practitioner in M&A and private equity by The Legal 500 UK and The Lawyer magazine.
Fried, Frank, Harris, Shriver & Jacobson LLP advises the world’s leading corporations, investment funds and financial institutions on their most critical legal needs and business opportunities. The Firm’s approximately 500 lawyers are based in North America and Europe. More information can be found at www.friedfrank.com.
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International Standard Setting Bodies and the Global Regulatory Agenda
British Private Equity & Venture Capital Michael Johnson Association (BVCA)
Introduction The Standard Setters – Who are they? What do they do? An argument made frequently on the losing side of last year’s referendum on the United Kingdom’s membership of the European The development of international standards for financial regulation Union put international standard setting bodies at the heart of is a relatively recent innovation. Although the Bank for International financial regulation. Leaving the EU would not lead to a bonfire Settlements was initially established in 1930, its primary function of financial regulation, as suggested by some proponents of Brexit, at that point in time was to oversee German reparations payments the Remainers contended, because the source of most financial arising from the First World War. The role of BIS in setting regulation was not the European Union, but rather international international regulatory standards did not begin to take shape bodies that set global standards that the UK would have to conform until over 40 years later when the Basel Committee on Banking to inside or outside the EU. Supervision was established under its auspices to serve as a forum By way of example, an article penned by a leading Remain campaigner for regular cooperation between regulators. in City AM in the run-up to the vote, claimed “as far as financial As one might expect, the Basel Committee was born of an instance of regulation is concerned, there is no expectation in the industry regulatory failure – the collapse of Bankhaus Herstatt in West Germany. that leaving the EU will lead to any reduction in the regulatory Since then, as financial markets have developed, international standard burden… Many of the new prudential requirements stem from global setters have grown in both number and importance, usually catalysed agreements in which Britain has been an active supporter and most of by financial crises or prominent instances of regulatory failure – the conduct of business regulation is purely home grown”. particularly where such events have demonstrated the increasingly Similarly, another prominent advocate of Remain, the Economist global and interconnected nature of financial markets. magazine, made the same argument in its 7th May 2016 edition: Today, financial regulation is increasingly driven by international “Brussels can be annoying, especially when it sets limits on bankers’ bodies. Although none is focused directly on the private equity bonuses. But most of today’s regulations stem from international industry, there are dedicated regulators for securities, and investors accords like the Basel rules on bank capital or domestic proposals in and providers of finance to the private equity industry. The shadow the Vickers report into bank structure.” banking work stream initiated by the G20 also threatens to bring Given the frequency with which this argument surfaced during the asset managers within its purview. referendum campaign, it may seem paradoxical that more industry The key international standard setting bodies that are likely to have resources are not focused on the international standard setting relevance to the private equity industry are outlined below. bodies. Most firms and industry bodies in the financial services sector are intimately familiar with national and European institutions – many have dedicated offices in Brussels. Yet very few have set The G20 up dedicated public affairs functions in Basel, Madrid or Paris – the homes, respectively, of the Bank for International Settlements At the top of the tree sits the G20. The G20 is the central forum for (BIS), the International Organization of Securities Commissions international cooperation on financial and economic issues, made up and the Organisation for Economic Co-operation and Development of 19 of the largest industrialised and developing countries and the (OECD). European Union. The G20’s primary focus is global economic and financial governance, though it has broached other topics such as In view of the arguments put forward during the referendum climate change and migration. Much of the global tax transparency campaign, what explains this disparity of attention? Is there a case agenda and post-financial crisis regulatory framework originated in for the industry enhancing its capacity to influence at an international discussions between finance ministers, central bankers and heads of level? government at a G20 level. This article will examine the broader international architecture through The G20 was formed in the wake of the Asian financial crisis of which financial regulation is developed and promulgated. The first 1997–99 as it became clear that existing fora, such as the G7, made section gives an overview of the different bodies, their respective up largely of rich countries, did not adequately include emerging roles and how they function. The second section discusses how these economies. For most of the first decade of its existence, the G20 bodies, and the rules and recommendations that they produce, stand primarily worked through regular meetings of finance ministers and in relation to national governments and regulators, and draws some central bank governors. The 2008 global financial crisis changed conclusions about how to influence the standard setters.
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this, however, and meetings were raised to the level of heads of and advising on regulatory policies and international best practice, and government. promoting the implementation standards and policy recommendations. Now the G20 meets regularly at summits, typically every year; It is chaired by Bank of England Governor, Mark Carney. however, it met more regularly during the financial crisis. While the Like the G20, the FSB cannot make decisions that translate directly heads of government summit typically attracts the most attention, into law, or compel its members to implement its findings and much of the detailed work is done through ministerial meetings and recommendations. As the FSB puts it, “the organisation operates working groups on particular policy areas held in the run-up to the by moral suasion and peer pressure”. To achieve this, the FSB summits. conducts periodic peer reviews of the participating countries’ The first heads of state summit was convened in Washington, D.C. adherence to international standards, publishing the results. These in 2008 and a follow-up summit in London in 2009, resulted in a include thematic reviews on the implementation and effectiveness of dramatic reform agenda for the regulation of financial services, international standards across participating countries, and reviews including a 47-point plan to prevent future crises. The work streams of the adoption of international standards in individual countries. and rules that have their origins in these meetings cover four broad The FSB’s main decision-making body is its Plenary, which themes: oversees the work of the FSB, decides on membership, sets its work ■ Building more resilient financial institutions – This area, programme, and adopts policies, principles, recommendations and focused on the banking system, manifested itself in the guidance. It comprises of senior central bankers, finance ministry development of the Basel III capital and liquidity standards. officials and representatives from other standard setting bodies. ■ Ending too-big-to-fail – This work stream has initiated A Steering Committee undertakes operational work between work to identify global systematically important financial meetings, and oversees and coordinates the work of three Standing institutions, and introduce stronger supervisory and prudential Committees, comprising of senior central bankers and finance regimes for these firms. ministry officials from the G20 countries, which undertake more ■ Making derivatives markets safer – Significant reforms to detailed work: derivative markets have been made as a result of G20 efforts ■ The Standing Committee on Assessment of Vulnerabilities, in this area, including rules on trade reporting, margin posting which identifies and assesses risks to the global financial and central clearing. system. ■ Shadow banking – The G20 work stream on shadow banking ■ The Standing Committee on Supervisory and Regulatory has led to new rules on money market funds, securitisation Cooperation, which analyses and develops regulatory and the development of a global monitoring framework under responses to identified threats. the auspices of the Financial Stability Board to assess global trends and risks in the shadow banking system. ■ The Standing Committee on Standards Implementation, which monitors the implementation of policies agreed at the In subsequent summits, agreements were struck on tax transparency, FSB level and other international standards. leading to significant reforms to blacklist uncooperative states and measures to shed light on the beneficial ownership of corporate The FSB has a small secretariat, based at the Bank of International entities. A summit in Antalya in 2015 adopted the OECD’s 15-point Settlements in Basel. At G20 summits in 2011 and 2012, it was plan on Base Erosion and Profit Shifting. agreed to strengthen the FSB’s resources further, as well as to amend its mandate to emphasise the role it plays in setting international The main elements of these reform agendas have largely been standards. Despite this, as of the FSB’s most recent annual report, agreed and implemented to varying degrees, though work on its secretariat was made up of just 32 staff. shadow banking is still at a relatively early stage. Mark Carney recently outlined the FSB’s four priorities for 2017 in Typically, the role of the G20 in these areas is setting the high-level a letter to G20 finance ministers. They include: strategic direction and agreeing broad principles on which rules ■ transforming shadow banking into resilient market-based should be based. However, the G20’s capacity to take actions is finance and addressing structural vulnerabilities in asset limited. It does not have a secretariat or an administrative staff – management; summits are organised by the country that occupies the rotating ■ making derivatives markets safer by progressing the post- presidency – nor do the rules it agrees upon have direct legal effect. crisis reforms to over the counter (OTC) derivative markets The development and implementation of the more detailed rules that and delivering coordinated guidance on central counterparty ultimately bite on firms therefore falls to other international bodies, (CCP) resilience, recovery and resolution; working under the direction of the G20. ■ supporting full and consistent implementation of post-crisis reforms, while developing a structured framework for post- Financial Stability Board implementation evaluation of the effects of reforms; and ■ addressing new and emerging vulnerabilities, including The Financial Stability Board (FSB) is the international body misconduct risks, as well as those stemming from the decline responsible for promoting financial stability. It was established in in correspondent banking and from climate-related financial risks. 2009 following that year’s G20 summit in London as a successor to the Financial Stability Forum, which included a more limited set of countries. The FSB by contrast includes all of the G20 nations, plus International Organization of Securities Commissions four others and the European Commission, which are represented by their finance ministries, central banks and supervisors. The FSB The International Organization of Securities Commissions (IOSCO) membership also includes international financial institutions such is the international body that brings together national securities as the World Bank and the IMF, and other international standard regulators and develops, implements and promotes adherence setting bodies. to international standards for securities regulation. Established Its mandate, which was set out by the G20, includes monitoring global in 1983, its membership includes the securities regulators of 115 systemic risks, promoting coordination and information exchange jurisdictions. It works closely with the G20 and the FSB on the among regulators and international standard setting bodies, developing international regulatory agenda.
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IOSCO has published a high-level set of ‘Objectives and Principles The OECD has a wide-ranging remit including trade and of Securities Regulation’ that guide IOSCO’s development of more investment, economic growth, employment, health, education and granular standards. They have been endorsed by both the G20 and tax. In these areas, its work extends from producing research and the FSB, and form the basis for the evaluation of the securities statistics, examining best practice and developing and coordinating regulation by other international bodies. international solutions to common problems. Most notably for the The IOSCO board is the primary governing and standard-setting private equity industry, the OECD plays an important role in setting body of IOSCO, and is made up of 34 securities regulators. It international standards for tax rules, and in recent years, it has conducts its policy work through eight committees, made up of worked closely with the G20 on the global tax transparency agenda. senior regulators from participating nations, each dedicated to a The OECD’s tax work, undertaken by the Centre for Tax Policy and particular policy area. Those of greatest relevance to private equity Administration – one of the OECD Secretariat’s 12 departments – are: has included work on: ■ Committee 1: Issuer Accounting, Audit and Disclosure – ■ Enhancing Tax Transparency – This has included the Attempts to improve the development of accounting and establishment of the Global Forum on Tax Transparency audit standards, as well as reporting standards for listed and Exchange of Information for Tax Purposes, which companies. monitors the implementation of international standards ■ Committee 2: Regulation of Secondary Markets – Covers on tax transparency and exchange of information between developments in the structure of global capital markets and jurisdictions. financial market infrastructure, and how they are affected by, ■ Addressing Tax Avoidance – Under this heading, the OECD and contributed to, the financial crisis. has conducted the Base Erosion and Profit Shifting (BEPS) ■ Committee 3: Regulation of Market Intermediaries – project, with the endorsement of the G20. Covers investor protection and market efficiency of market ■ International standards – The OECD’s standard-setting intermediaries. Its recent work includes the publication work is based on two key standards. The first, the OECD of suitability requirements for the distribution of complex Model Tax Convention, is the basis for the negotiation and financial products and criteria for the categorisation of interpretation of tax treaties. The second, the OECD Transfer different kinds of investors. Pricing Guidelines, provide guidance on valuing cross-border ■ Committee 5: Investment Management – Covers issues transactions within multinational groups. They are designed relating to investment management. This includes hedge to help national governments prevent profits and revenues funds, private equity, and venture capital funds, and their being artificially transferred out of jurisdictions where value advisers. Recent work by this committee has focused on has been created and, from the perspective of taxpayers, to issues raised by the financial crisis, including the development limit the risk of double taxation. of a global template to gather data from hedge funds and The OECD is also the home of the Financial Action Task Force. policy recommendations for money market funds. A number of pieces of IOSCO’s work in recent years have been The Financial Action Task Force relevant to the private equity industry. For example, work on the distribution of complex products outlines criteria for separating The Financial Action Task Force (FATF) is an inter-governmental retail and professional investors, which is highly relevant to body established to set global standards for combating money jurisdictions that prohibit the marketing of private equity funds to laundering, terrorist financing and related threats to the integrity of retail investors. Similarly, IOSCO’s recent work on loan origination the international financial system. Established in 1989 by the G7 funds will be relevant to managers that also operate direct lending countries, FATF is headquartered at the OECD in Paris, but is an funds or make use of these lenders as part of transactions. independent body. It now includes as members 35 nations, plus the IOSCO has a small secretariat, based in Madrid, of 29 staff, some European Commission and the Gulf Co-operation Council. of whom are seconded from national regulators, which supports the FATF’s Recommendations, first issued in 1990 and updated several work of the Board and the policy committees. times since, most recently in 2012, are widely recognised as the international standard for combating of money laundering and the Organisation for Economic Co-operation and Development financing of terrorism, and form the basis of national and European law in these areas. The most recent revision included strengthened The Organisation for Economic Co-operation and Development requirements on transparency that have led to the establishment of (OECD) is an intergovernmental economic organisation founded in registers of beneficial ownership in a number of jurisdictions. FATF 1960 to promote policies that are designed to improve economic and also monitors the progress of its members in implementing the social well-being. It has 35 member countries, with membership measures it recommends, and maintains a list of high-risk and non- focusing on developed democracies with advanced market cooperative jurisdictions. economies. FATF’s current work falls into five broad areas: The OECD’s primary decision-making body is the OECD Council, ■ Identifying and analysing threats to the integrity of the which oversees the organisation and sets its strategic direction. The financial system – this primarily relates to identifying Council comprises representatives of the member countries and vulnerabilities and weaknesses that might be exploited by the European Commission. The OECD has a sizeable secretariat – criminals. particularly in comparison to other international bodies – of 2,500 ■ Developing and refining international standards for staff, based in Paris. combatting money laundering and the financing of terrorism. Specialist committees are responsible for most of the OECD’s policy ■ Assessing and monitoring its members’ implementation of work. Their role is to oversee, direct and contribute to work by FATF standards. the OECD secretariat. There are around 250 committees, working ■ Promoting global implementation of FATF standards beyond groups and expert groups at present, comprising relevant officials FATF’s member countries. from national administrations. ■ Identifying and engaging with high-risk and non-cooperative jurisdictions.
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FATF’s primary decision-making body is the FATF plenary, which markets, and thereby contribute to global financial stability. To this meets three times a year, and makes decisions by consensus. It has end, it has produced a set of ‘Core Principles’ for insurance supervision, a small secretariat of 26 staff members that support the work of the which include recommendations on how supervisors should require plenary and its working groups. insurers to address private equity investments in their risk management policies. In recent years, the IAIS has also been involved in the development of global capital requirements for insurers. The Bank for International Settlements and the Basel Committee The senior decision-making body of the IAIS is its annual General Meeting of members, but a smaller Executive Committee comprising As discussed in the introduction to this section, the Bank for of representatives from national regulators meets throughout the year International Settlements (BIS), and the Basel Committee on to take decisions. The IAIS also has a small secretariat of around 30 Banking Supervision that it hosts and supports, is the original and staff based at the Bank for International Settlements in Basel. the most well known of the international standard setting bodies. BIS, based in Basel, is an international organisation intended to How the International Bodies Work Together promote global monetary and financial stability. Its members are 60 central banks, to which it provides a range of banking services as well The bodies described above frequently have overlapping areas of as research and policy analysis on matters relevant to central banking expertise and overlapping membership. There is therefore a need and financial stability. It has just over 600 staff. BIS hosts and for overall co-ordination of their efforts. supports the work of a number of committees engaged in international The G20 plays the central role in setting the work streams and standard setting, the most important of which is the Basel Committee. priorities for the international standard setters. On matters of The Basel Committee is the primary global standard setter for the financial regulation, the FSB plays the key role in driving forwards prudential regulation of banks and provides a forum for regulators policy making and building consensus on key areas of reform, with to cooperate on banking supervisory matters. Its mandate is to much of the granular work undertaken by the more specialised strengthen the regulation, supervision and practices of banks bodies – IOSCO, the Basel Committee, FATF. These efforts result worldwide with the purpose of enhancing financial stability. in high-level international standards that must then be adopted by Notably, it is responsible for the Basel Accords, which set prudential lawmakers at a national (or EU) level before taking effect. standards for banks. The Committee includes as members 45 institutions from 28 jurisdictions, including central banks and banking supervisors. Influencing the Standard Setting Bodies The Committee also has nine observers including central banks, supervisory groups, international organisations and other bodies. While on the face of it, it might seem paradoxical that less attention is paid to the international standard setters given their overarching The Basel Committee summarises its primary work and functions scope and reach, especially since the 2008 financial crisis, it is clear thusly: why this should be the case. ■ exchanging information on developments in the banking sector and financial markets to help identify current or First, the international standards produced by these bodies constitute emerging risks for the global financial system; ‘soft law’ – they are ultimately discretionary in nature unless enacted into law by national authorities. Without the power to make law that ■ sharing supervisory issues, approaches and techniques to promote common understanding and cross-border has direct effect, much of the impact of the work conducted by the cooperation; international standard setting bodies will come down to how those standards are transposed into national laws. The devil is in the detail. ■ establishing and promoting global standards, guidelines and best practice for the regulation and supervision of banks; Second, although many of the bodies described above have within ■ addressing regulatory and supervisory gaps that pose risks to their remits an objective to encourage consistent implementation of financial stability; standards by their members, their ability to do so is severely limited ■ monitoring the implementation of BCBS standards in by two factors. They have no powers to compel jurisdictions to adopt member countries and beyond to encourage their timely and their proposals or implement them in a particular way – typically, consistent implementation; their powers are limited to naming and shaming. Moreover, most of ■ consulting with central banks and bank supervisory authorities these organisations have miniscule secretariats – typically of around that are not members of the BCBS to benefit from their input 30 staff – with which their modest carrots and sticks can be wielded. on policy formulation and to promote the implementation Despite this lack of firepower, it is clear that the trend in recent of BCBS standards, guidelines and sound practices beyond decades has been for an ever-enhanced role for international standard BCBS member countries; and setters. With this in mind, two simple conclusions for influencing ■ cooperating with other financial sector standard setters and them are worth bearing in mind for industry bodies. international bodies, particularly those involved in promoting Firstly, relationships with national authorities remain key. As is clear financial stability. from the above descriptions of the international standard setting bodies, their key decision-making bodies are typically constituted International Association of Insurance Supervisors (IOSCO) by officials from national regulators, central banks and finance ministries. The existing relationships industry representatives Like IOSCO, the International Association of Insurance Supervisors have with their own national regulators and finance ministries (IAIS) is made up of a broad set of industry regulators, though in therefore remain the primary route into the international standard the IAIS’s case, from the insurance sector. Its membership includes setting bodies, providing an early warning system on their work and supervisors from almost 140 countries. enabling the final products to be shaped. The IAIS’s aim is to promote globally consistent supervision of the Secondly, cross-country working will become increasingly insurance industry in order to maintain safe and stable insurance important. The international standard setting bodies were set up
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with a view to solving a coordination problem for regulators – The PAE makes policy submissions on behalf of the European how do primarily nation-state regulators address policies at an private equity and venture capital industry to the European increasingly globalised industry? However, their establishment and Institutions and international bodies. The BVCA engages directly increasingly prominent role creates a corresponding coordination with policymakers in the UK and international bodies outside of problem for nationally and regionally-based industry bodies, such the European Union. However, our close relationship with our as those that exist to represent the private equity industry. colleagues in Europe ensures that our positions are joined up, and While each body will have a strong relationship with the regulators the European industry speaks with a unified voice. in its home jurisdiction, the decision-making fora at the international The BVCA also maintains regular contact with the American standard setting bodies are made up of the regulators from Investment Council, which represents the Private Equity Industry in multiple jurisdictions. Taken collectively, all the national industry the United States. Sometimes this collaboration is looser, designed representatives may have strong relationships with policymakers to ensure that our messaging and arguments are consistent when we from all jurisdictions, there is no single industry body for which approach international bodies. In other cases, our joint working is this is true. This implies the need for efforts to be made by the tighter and we have submitted a number of jointly badged responses industry to link-up across borders to ensure that the industry speaks to consultation exercises conducted by international bodies. with a unified voice, so that when decisions are made at the standard setting bodies, everybody around the table has been hearing the same arguments. Conclusion At a European level, this already works well in the private equity The role of international standard setters has become more prominent industry. The private equity industry’s primary decision-making as the global financial system has become more international and body for political engagement at a European level is the Public interconnected. This trend has been catalysed by practically every Affairs Executive (PAE), which brings together practitioners major financial shock in the last 50 years, most recently bythe from across Europe, representatives from national venture capital 2008 financial crisis. Despite this trend, most international bodies associations and Invest Europe – the pan-European industry body. have very small secretariats and limited powers to enforce the rules The BVCA, AFIC (the French trade association) and the BVK (the and standards they develop and promote. Therefore, work on the German trade association) have permanent seats on the PAE, and transposition of their standards into directly binding law at national Invest Europe provides the secretariat. and regional levels remains of prime importance. Other national trade associations have a rotating seat filled by the Relationships at a national level are also of primary importance when country holding the EU presidency, and also feed into decision- it comes to influencing the international standard setting bodies. making through the European Representative Group – a deliberating This is on account of most of the key decision-making bodies at body composed of representatives of all the national private equity international standard setting bodies being staffed by officials from and venture capital associations and Invest Europe. national regulators and finance ministries. However, the enhanced role of international standard setters does require greater cross- border cooperation on the part of industry representatives to ensure their messages are aligned, and the industry speaks with a unified consistent voice.
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Michael Johnson British Private Equity & Venture Capital Association (BVCA) 5th Floor East, Chancery House 53-64 Chancery Lane London WC2A 1QS United Kingdom
Tel: +44 20 7492 0400 Email: [email protected] URL: www.bvca.co.uk
Michael Johnson is Policy Manager at the British Private Equity & Venture Capital Association (BVCA), where he is responsible for policy work on European regulatory issues and venture capital. He joined the BVCA in 2016 from the City of London Corporation. Michael read Philosophy, Politics and Economics at Somerville College, Oxford.
The British Private Equity & Venture Capital Association (BVCA) is the industry body and public policy advocate for the private equity and venture capital industry in the UK. Since our founding in 1983, we have represented the industry and delivered authoritative research and analysis, proprietary publications, specialist training, topical conferences and best practice standards. Our membership comprises more than 670 influential firms, including over 250 private equity and venture capital houses, over 100 institutional investors and funds-of-funds, as well as professional advisers, service providers and international associations. We work together to provide capital and expertise to growing businesses, to unlock potential and to deliver enhanced returns to the millions who directly and indirectly invest in our industry.
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Angola Hugo Moredo Santos
VdA Vieira de Almeida and Angola Capital Partners Rui Madeira
1 Overview 1.2 What are the most significant factors or developments encouraging or inhibiting private equity transactions in your jurisdiction? 1.1 What are the most common types of private equity transactions in your jurisdiction? What is the current state of the market for these transactions? Have 2015 was a year of change for private equity in Angola. The you seen any changes in the types of private equity country’s legal framework had lacked specific legislation on transactions being implemented in the last two to private equity; however, following the submission of a draft three years? to public consultation in 2014 by the Angolan Securities Market Commission (Comissão do Mercado de Capitais) and The Private Equity (PE) market in Angola was non-existent until the disclosure of the relevant feedback report to the public, 2009, when Angola Capital Partners launched FIPA – the first Presidential Legislative Decree no. 4/15, dated 16 September, country-dedicated investment fund focused on small and medium- approved the Legal Framework for Private Equity Collective sized enterprises. Having raised US$ 39 million from the country’s Investment Schemes. largest private banks and international Development Finance Institutions, FIPA is now fully invested across a wide range of industry sectors (e.g. agriculture, fishing, building materials, media 2 Structuring Matters and waste management treatment), becoming the pioneer of a nascent market with enormous growth potential. 2.1 What are the most common acquisition structures New investment funds emerged. In 2011, the Angolan sovereign adopted for private equity transactions in your wealth fund, or Fundo Soberano de Angola, became the largest jurisdiction? Have new structures increasingly investment fund, with US$ 5 billion dedicated to large-scale regional developed (e.g. minority investments)? projects and infrastructures. In 2012, the Fundo Activo de Capital de Risco Angolano was created via presidential decree with US$ A typical acquisition structure consists of the PE investment fund 250 million to support venture capital projects. In 2016, Angola becoming the beneficial owner of intermediate Special Purpose Capital Partners raised US$ 45 million from existing investors to Vehicles (SPVs), domiciled in Angola or abroad, which in turn launch its follow-on PE fund, FIPA II, devoted to small and medium- acquire equity stakes directly in specific target companies, or sized enterprises. International PE houses have also been present in otherwise subscribe to new shares issued by such target companies. Angola, particularly as co-investors of Angolan-focused PE funds. The PE investment fund may co-invest together with other Growth capital has represented the most common type of PE deal over individuals, namely top managers, under a single newco ring- the last two to three years and it is expected to remain a major deal fenced structure solely dedicated to each target company, ensuring type in the future. After a devastating civil war, which ended only incentive alignment and commitment. in 2002, this resource-rich former Portuguese colony has been one PE investment fund structures are subscribed by limited partners of the world’s fastest-growing economies over the past decade. The and are usually domiciled in investor-friendly jurisdictions (e.g. significant rise of its middle class, when compared to its regional peers, Europe or the U.S.), and hence subject to the competent regulatory in sync with a decline in the number of people living on or below the authorities. PE investment fund manager variable compensation is poverty line, in addition to a relatively young and technology-savvy structured to depend on the returns it delivers to limited partners (i.e. population, have acted as catalysts to a boom in the demand for carried interest). The right to be paid such variable compensation products and services provided by partnerships set up between foreign will only be vested after limited partners receive their drawdown investors with know-how and Angolan partners with local expertise. capital accrued from a preferred return. In contrast to the reputation of PE funds in developed markets, FIPA and FIPA II are welcomed by Angolan market stakeholders. 2.2 What are the main drivers for these acquisition In frontier markets, PE funds are seen as an important alternative structures? to local finance institutions for their longer maturity financing and for their contribution to the local business development strategy and The adoption of the above-described acquisition structures aims share of their far-reaching networks which facilitate growth, access at (i) incentive alignment, (ii) compliance, and (iii) tax treatment. to external pools of capital and potential co-exits. Incentive alignment between investors and managers drives carried
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interest remuneration type, as do newco ring-fenced structures, which composition of the board of directors, indicating one or more persons provide risk-sharing and human talent retention mechanisms during to form part of a list to be elected to the board, although directors the lifetime of the fund’s vehicle or investment, which is particularly will not actually represent the relevant shareholders. Committees vital in Angola. Compliance is a key reason why PE funds are dealing with investment policy, remuneration or conflicts of domiciled in conventional investment jurisdictions (e.g. Europe interest may also be put in place. There is no requirement for such or the U.S.), fulfilling institutional investors’ legal, governance arrangements to be made public in a private equity structure. and transparency requirements. Tax treatment of international PE structures is another important consideration when selecting a mature 3.2 Do private equity investors and/or their director market as the domicile for such alternative asset class investments. nominees typically enjoy significant veto rights over major corporate actions (such as acquisitions and Angola disposals, litigation, indebtedness, changing the 2.3 How is the equity commonly structured in private nature of the business, business plans and strategy, equity transactions in your jurisdiction (including etc.)? If a private equity investor takes a minority institutional, management and carried interests)? position, what veto rights would they typically enjoy?
In the typical PE transactions described above, equity is structured Veto rights may be created to the benefit of private equity investors, through limited partnership models, which incorporate waterfall notably under shareholder agreements. Such arrangements may remuneration and carried interest mechanisms. Investors hold limited refer to the exercise of voting rights, but not to the actual exercise partnership interests in the fund’s vehicle, while the fund manager’s of management or auditing functions. Matters in respect of which team holds an interest in the General Partner. The common profit such veto rights may be created include, among others, significant allocation scheme is usually distributed in the amount of 80% to acquisitions and disposals, material litigation, incurrence of material limited partners, pro rata to their capital contributions, and 20% to indebtedness, changes in the nature of the business, business plans, the General Partner, i.e. carried interest, the latter conditional upon budgets and strategic plans. There are no standard veto rights the limited partners having first received their preferred return, i.e. awarded to private equity investors that take a minority position. hurdle rate. Limited partners sometimes request to directly invest in target companies along with the PE fund to increment their exposure to a specific industry sector or to adjust their risk profile target. 3.3 Are there any limitations on the effectiveness of veto arrangements: (i) at the shareholder level; and (ii) at the director nominee level? If so, how are these 2.4 What are the main drivers for these equity structures? typically addressed?
Equity structures are primarily designed to align incentives and to Veto arrangements are not permitted to result in a scenario whereby induce risk-sharing mechanisms between investors and managers. a given shareholder is always required to exercise his/her voting In Angola, retaining and aligning human capital is particularly rights in line with the instructions of the relevant company, or any of important due to the scarcity of PE/managerial expertise. its corporate bodies, or to always approve the proposals presented by the relevant company or any of its corporate bodies. Veto 2.5 In relation to management equity, what are the typical arrangements are also not permitted to be set-up as compensation vesting and compulsory acquisition provisions? for obtaining special benefits.
Stock option schemes are increasingly used in Angola. The vesting 3.4 Are there any duties owed by a private equity investor trigger is typically driven by performance, while vesting periods are to minority shareholders such as management usually linked to the specific PE fund’s time schedule. Customary shareholders (or vice versa)? If so, how are these leaver provisions triggering call options for investors (good vs. bad typically addressed? leaver provisions) may sometimes be required. No. However, particularly in respect of limited liability companies by shares (sociedades anónimas), the relevant bylaws may stipulate 2.6 If a private equity investor is taking a minority specific rules aimed at ensuring that minority shareholders are entitled position, are there different structuring considerations? to appoint a representative to the board of directors. In relation to public limited liability companies by shares (sociedades por quotas), the inclusion of such mechanisms in the bylaws is mandatory. Customary minority rights protections are negotiated by the PE fund in its investment agreements, including but not limited to non-executive directorship, and contractual and organisational 3.5 Are there any limitations or restrictions on the safeguards, closely monitored by the risk manager controller to contents or enforceability of shareholder agreements ensure that these rights protections and safeguards are enforced. (including (i) governing law and jurisdiction, and (ii) non-compete and non-solicit provisions)?
3 Governance Matters Shareholder agreements may be executed among two or more shareholders, and may have as their subject any action which is not prevented by operation of law. Shareholder agreements are 3.1 What are the typical governance arrangements binding upon the parties thereto, and no acts or facts performed by for private equity portfolio companies? Are such the company or by any of its shareholders vis-à-vis the company arrangements required to be made publicly available in your jurisdiction? may be challenged on the basis of such agreements. Shareholder agreements may refer to the exercise of voting rights, but not to the exercise of management or auditing functions, and therefore may Although experience is quite limited, one should not exclude the not imply that a given shareholder is always required to exercise possibility of private equity investors being willing to influence the
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his/her voting rights in line with the instructions of the relevant Investment Law aimed at reducing bureaucracy, streamlining company or any of its corporate bodies, or to approve the proposals the decision-making process and facilitating capital repatriation; presented by any of its corporate bodies, or as compensation for in short, aiming at a more investor-friendly legal framework. obtaining special benefits. Non-compete and non-solicit provisions Highlights of the new Private Investment Law include: may be inserted, within certain limits. ■ The minimum private investment amount required from Angolan sponsors was reduced from US$ 1 million to US$ 500,000 per project. The minimum private investment 3.6 Are there any legal restrictions or other requirements required from foreign sponsors remains at US$ 1 million per that a private equity investor should be aware of project. It will be possible to make investments under these in appointing its nominees to boards of portfolio companies? What are the key potential risks and thresholds under the new law, provided that investors will Angola liabilities for (i) directors nominated by private equity not apply for tax incentives. In any case, investors will be investors to portfolio company boards, and (ii) private entitled to repatriate their profits or dividends. equity investors that nominate directors to boards ■ Ministry(ies) in charge of the relevant investment sector of portfolio companies under corporate law and also will be responsible for evaluating and approving private more generally under other applicable laws (see investment projects of up to US$ 10 million, above which section 10 below)? amount approval falls under the authority of the President of the Republic. Members of the board of directors are not directly appointed by ■ The Angolan National Private Investment Agency (ANIP) shareholders acting individually, but rather by means of a resolution will no longer be involved in the evaluation, negotiation or passed by the shareholders’ meeting. Accordingly, directors approval of investment projects. ANIP will now mainly be do not represent a given shareholder (even if proposed by such engaged in promoting Angola as an attractive destination for shareholder) and are required to act in the company’s best interests, private investment, and in monitoring the implementation of the Government’s private investment policies. employing the same level of diligence a prudent manager would use, without prejudice to the interests of the shareholders and the ■ Tourism, hospitality, telecommunications and information workers (diligence duty – dever de diligência). technologies, transport and logistics, energy and water, and construction were elected as priority investment areas. Members of the board of directors may be held liable towards the Foreign investors in these sectors are required to partner with creditors of the company whenever they wilfully disregard legal or local investors with a minimum equity interest of 35%. contractual obligations aimed at protecting such creditors, or if the ■ Investors remain eligible to apply for tax incentives, company’s estate becomes insufficient to discharge the company’s including corporate income tax, property conveyance tax and obligations. On the other hand, any shareholder, acting alone or investment income tax, ranging from 5% to 100%, depending together with another shareholder under a shareholder agreement, on specific criteria which include the number of jobs created may appoint managers or members of the auditing body (without the for Angolan nationals. remaining shareholders being entitled to participate in such election) The foreign private investments timeline tends to last, on average, six and may also be jointly and severally liable with the appointed to nine months from the preparation and submission to the processing person in cases where there is wilful default in the selection of such of investments. The new law aims to streamline this timeline. person and the same has a duty to indemnify.
4.2 Have there been any discernible trends in transaction 3.7 How do directors nominated by private equity terms over recent years? investors deal with actual and potential conflicts of interest arising from (i) their relationship with the In addition to the significant regulatory changes in Angolan private party nominating them, and (ii) positions as directors of other portfolio companies? investment law throughout the past decade, a trend towards more liquid equity and debt instruments is expected to emerge now that the Angolan Stock Exchange has been launched (in 2017). The Conflict of interest rules exist both at the level of the shareholders’ Angolan Debt Exchange has already opened, although it is still meeting and of the board of directors. For instance, a shareholder mostly dedicated to Government bond trading among banks. As may not take part in: any decision pertaining to the discharge of self- for the applicable legislation, the Angolan Securities Market obligation, either as a shareholder or as a member of a corporate body; Commission (Comissão do Mercado de Capitais) has approved a any dispute between such shareholder and the company; its dismissal number of consolidating regulations regarding the trading of private with cause as a member of the board of directors; or any relationship, equity on the stock exchange. current or future, between such shareholder and the company, which falls outside the scope of the corporate subject. On the other hand, any transactions between the company and its board members are 5 Transaction Terms: Public Acquisitions null and void except if previously authorised by the board of directors pursuant to a decision in which the relevant board member may not participate, and provided that the auditing body has voted favourably. 5.1 What particular features and/or challenges apply to private equity investors involved in public-to-private transactions (and their financing) and how are these 4 Transaction Terms: General commonly dealt with?
The Angolan market has no significant experience in this respect due 4.1 What are the major issues impacting the timetable for to the fact that capital markets and private equity are still at a very transactions in your jurisdiction, including competition early stage in the country. However, Angola has approved a new and other regulatory approval requirements, disclosure obligations and financing issues? Securities Code, published in August 2015, which is aimed at dealing in more detail, in a European-inspired manner, with public-to-private transactions. In May 2015, the Angolan Government approved a revised Private
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5.2 Are break-up fees available in your jurisdiction in 6.7 How do private equity buyers typically provide relation to public acquisitions? If not, what other comfort as to the availability of (i) debt finance, arrangements are available, e.g. to cover aborted deal and (ii) equity finance? What rights of enforcement costs? If so, are such arrangements frequently agreed do sellers typically obtain if commitments to, or and what is the general range of such break-up fees? obtained by, an SPV are not complied with (e.g. equity underwrite of debt funding, right to specific Please see the preceding answer. performance of obligations under an equity commitment letter, damages, etc.)?
6 Transaction Terms: Private Acquisitions Guarantees (from banks or investors) or equity commitment letters Angola are typically used.
6.1 What consideration structures are typically preferred by private equity investors (i) on the sell-side, and (ii) 6.8 Are reverse break fees prevalent in private equity on the buy-side, in your jurisdiction? transactions to limit private equity buyers’ exposure? If so, what terms are typical? Consideration structures will normally exclude short- and long-term interest-bearing debt, net of any excess cash or cash equivalents, and Reverse break fees are not common. will possibly accrue net working capital. 7 Transaction Terms: IPOs 6.2 What is the typical package of warranties/indemnities offered by a private equity seller and its management team to a buyer? 7.1 What particular features and/or challenges should a private equity seller be aware of in considering an IPO exit? Standard representations and warranties apply – mostly the target company’s underlying assets. Currently, there are no equity capital markets in Angola and thus there is no IPO experience to speak of. 6.3 What is the typical scope of other covenants, undertakings and indemnities provided by a private equity seller and its management team to a buyer? 7.2 What customary lock-ups would be imposed on private equity sellers on an IPO exit? Other covenants and undertakings will usually include non-compete provisions. Please see question 7.1.
6.4 Is warranty and indemnity insurance used to “bridge 7.3 Do private equity sellers generally pursue a dual-track the gap” where only limited warranties are given by exit process? If so, (i) how late in the process are the private equity seller and is it common for this private equity sellers continuing to run the dual-track, to be offered by private equity sellers as part of the and (ii) were more dual-track deals ultimately realised sales process? If so, what are the typical (i) excesses through a sale or IPO? / policy limits, and (ii) carve-outs / exclusions from such warranty and indemnity insurance policies? Please see question 7.1.
Typically, warranty and indemnity insurance is not used in Angola. 8 Financing
6.5 What limitations will typically apply to the liability of a private equity seller and management team under 8.1 Please outline the most common sources of debt warranties, covenants, indemnities and undertakings? finance used to fund private equity transactions in your jurisdiction and provide an overview of the current Caps and baskets are the standard limitations. state of the finance market in your jurisdiction for such debt (particularly the market for high yield bonds).
6.6 Do (i) private equity sellers provide security (e.g. The Angolan Banking System is comprised of 20+ banks, escrow accounts) for any warranties / liabilities, and although there is room for consolidation movements. In October (ii) private equity buyers insist on any security for 2015, Banco Privado Atlantico and Banco Millennium Angola, warranties / liabilities (including any obtained from the management team)? respectively the fifth- and sixth-largest banks in Angola by net loans market share, announced their merger. The merged entity became the second-largest privately held lender in Angola after Banco Standard security and safeguards are usually required from both Angolano de Investimentos. Angolan banks have quickly expanded buyers and sellers and mostly rely on hard assets. their nationwide branch networks. Their offering of products and services has developed significantly for both retail and institutional clients. However, there is significant potential for the development of more friendly debt structures for mergers and acquisitions, e.g. PE transactions. Debt availability is largely limited to short-term facilities, and market interest rates are in the region of 12% to 14%, dependent upon each bank’s internal credit rating analysis.
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In November 2015, the Angolan Government tapped international investors, raising US$ 1.5 billion in its debut Eurobond issue with a 9.3 What are the key tax-efficient arrangements that are yield of 9.5% and a 10-year maturity. The appetite of international typically considered by management teams in private investors showed resilience despite significant adverse market equity portfolio companies (such as growth shares, deferred / vesting arrangements, “entrepreneurs’ conditions, enabling Angolan authorities to consider follow-on relief” or “employee shareholder status” in the UK)? issues in the future, to further (i) diversify the country’s external sources of financing, (ii) establish sources of long-term financing, No tax exemptions are available. There is some incertitude and lack (iii) improve evaluation by rating agencies, (iv) build its yield curve, of clarity as to whether capital gains arising from the sale of shares and (v) possibly increase its international reserves. in an Angolan-based company between non-resident shareholders
Angola are also subject to Investment Income Tax. Besides transfer pricing 8.2 Are there any relevant legal requirements or legislation, Angola has no anti-abuse provisions. restrictions impacting the nature or structure of There is a special tax regime for Collective Investment Vehicles. the debt financing (or any particular type of debt financing) of private equity transactions? 9.4 Have there been any significant changes in tax The existing legal framework hinders Angola’s bank lending legislation or the practices of tax authorities activities for secured lending; namely impediments to the (including in relation to tax rulings or clearances) enforcement of property ownership and the foreclosing of collateral impacting private equity investors, management – properties in particular. The relatively small number of Angolan teams or private equity transactions and are any anticipated? firms with annual financial statements verified by external auditors (approx. 20% in Angola vs. approx. 40% in other African countries) also contributes to the lender’s limited ability to accurately gauge Significant changes in tax legislation were enacted in November the creditworthiness of its prospective borrowers. PE funds 2014, with most of the tax codes having been amended. The scrutiny have contributed to a culture of financial discipline and greater of the Angolan Tax Authorities has increased over the last few years transparency by enforcing external annual auditing of their portfolio and a significant number of tax inspectors have been appointed to companies. deal specifically with tax leakage issues. Due to this fact, in the past months tax inspections and enforced collection procedures were improved. 9 Tax Matters 10 Legal and Regulatory Matters 9.1 What are the key tax considerations for private equity investors and transactions in your jurisdiction? Are off-shore structures common? 10.1 What are the key laws and regulations affecting private equity investors and transactions in your Typically, income derived from private equity investments may jurisdiction, including those that impact private equity transactions differently to other types of transaction? qualify as capital gains, interest or dividends. As such, this income should be subject to Investment Income Tax (Imposto sobre a Aplicação de Capitais) under a withholding mechanism. Rates may Angola has recently approved a specific legal framework applicable vary from 5% up to 15% and taxation shall always be due provided to private equity: Presidential Legislative Decree no. 4/15, dated that the income is deemed to be from an Angolan source (i.e. income 16 September. Angola also recently approved a new Securities is paid from Angola, shareholders are resident in Angola or the Code. Any acquisition or disposal of an equity stake, or the rights paying entity is resident therein). and obligations inherent thereto, are governed by the Angolan Corporate Code (Lei das Sociedades Comerciais – Law no. 1/2004, Capital gains obtained by resident shareholders may be subject to dated 13 February) and, if traded in the Angolan Stock Exchange Corporate Income Tax (Imposto Industrial) or Personal Income Tax market, by the Regulations issued by the Angolan Securities Market (Imposto sobre o Rendimento do Trabalho). Commission (Comissão do Mercado de Capitais) that are already in Dividends paid between resident companies in Angola may be force – despite certain matters still pending further regulation. exempt from Investment Income Tax provided that a 25% stake is held for a minimum holding period of one year. 10.2 Have there been any significant legal and/or There are no anti-abuse provisions regarding transactions involving regulatory developments over recent years impacting off-shore structures. private equity investors or transactions and are any anticipated? 9.2 What are the key tax considerations for management teams that are selling and/or rolling-over part of their Publication of Presidential Legislative Decree no. 4/15, dated 16 investment into a new acquisition structure? September, which approved a specific legal framework applicable to private equity, is the most relevant recent legal development. Angola’s tax legislation is at an early stage in dealing with finance Despite the recent developments, certain matters are still pending structured investments, thus no specific exemptions are available. further regulation to be issued by the Angolan Securities Market Gains obtained from the sale and/or rollover of investments are Commission (Comissão do Mercado de Capitais). subject to taxation pursuant to the Investment Tax Code. Any capital gains arising from such operations will be subject to a 10% fixed tax rate. The enforcement of tax provisions is inconsistent. Tax benefits may be available under an investment project.
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10.3 How detailed is the legal due diligence (including 10.5 Are there any circumstances in which: (i) a private compliance) conducted by private equity investors equity investor may be held liable for the liabilities of prior to any acquisitions (e.g. typical timeframes, the underlying portfolio companies (including due to materiality, scope etc.)? Do private equity investors breach of applicable laws by the portfolio companies); engage outside counsel / professionals to conduct all and (ii) one portfolio company may be held liable for legal / compliance due diligence or is any conducted the liabilities of another portfolio company? in-house? Angolan corporate law sets forth that any company that controls Due diligence is a particularly detailed, and vital, pre-investment another company is liable for the obligations undertaken by the phase in Angola. PE funds engage with external professionals latter, before or after the control relationship was established and Angola to perform the customary due diligence analysis, particularly until the same ceases. In addition, the controlled company has the in the legal, financial and tax areas. In addition, some PE funds right to require that the controlling company compensate it for any may be required to actively consider Environmental, Social and annual losses that the former may experience during the control Governance due diligence. This is the case of FIPA due to its relationship, provided that such losses are not compensated by the international investor base – Development Finance Institutions – reserves accumulated during such period. which promote such values and the core of their mission. PE funds will also conduct in-house due diligence analysis to complement that provided by external advisors and aim to complete their discussions 11 Other Useful Facts at the investment committee level. Depending on the investment complexity, the due diligence phase may take one to three months. 11.1 What other factors commonly give rise to concerns for private equity investors in your jurisdiction or 10.4 Has anti-bribery or anti-corruption legislation should such investors otherwise be aware of in impacted private equity investment and/or investors’ considering an investment in your jurisdiction? approach to private equity transactions (e.g. diligence, contractual protection, etc.)? Angola’s economic, social and cultural environment presents PE players with significant challenges, particularly those focused on Angola has legislation aimed at avoiding anti-money laundering or liquid and mature markets without a permanent presence on the the financing of terrorism. This legislation triggers a wider range ground. Building a strong local team is very important, not only to of duties, which include the duty to identify, perform due diligence, pursue proprietary deal flow, but also to be able to enforce close and refuse or abstain from certain actions, cooperate, maintain secrecy, frequent portfolio monitoring mechanisms. control, train and communicate.
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Hugo Moredo Santos Rui Madeira VdA Vieira de Almeida Angola Capital Partners Edifício Dália Plaza Academia BAI, Edifício C Av. de Portugal 31 - 35, 9.º A Avenida Pedro de Castro Van-Dunem Loy Ingombota, Luanda 1º Andar, Morro Bento, Luanda Angola Angola
Tel: +244 933 627 701 Tel: +244 227 281 000 (ext. 4019) Email: [email protected] Email: [email protected] URL: www.vda.pt URL: www.angolacapitalpartners.com Angola Hugo holds a law degree from the University of Lisbon, Faculty of Law, Rui is a Partner at Angola Capital Partners focused on private equity and a Master’s in Law from the University of Lisbon, Faculty of Law investments and divestments in Angolan small and medium-sized (“Transparência, OPA obrigatória e imputação de direitos de voto” – enterprises. “Transparency, Mandatory Bid and Attribution of Voting Rights”). He previously worked for the Government of Portugal, as an advisor Hugo joined Vda in 2001 and is currently a partner in the Banking & to the Secretary of State for Finance/Ministry for Finance, focusing Finance and Capital Markets practice areas. He provides advice in on privatisations and on the creation of a Portuguese development the context of takeovers and public offerings, as well as in respect of finance institution, as part of the €78 billion financial assistance the issuance of securities and structured finance products, including programme negotiated with the European Commission, the European securitisation and covered bonds, advising issuers, offerors, financial Central Bank and the International Monetary Fund. He also worked intermediaries or investors. He also provides ongoing advice on for Deutsche Bank in London, advising large private equity funds and regulatory matters in the areas of banking law and capital markets. corporates in mergers and acquisitions, leverage buyouts and debt and equity issuances, mostly in European markets, as part of the German investment bank’s leverage finance and corporate finance divisions. Rui also worked for Espírito Santo Investment Bank in its corporate finance divisions in Portugal, Brazil and Poland. Rui holds an MBA degree from London Business School, UK (exchange programme with Columbia Business School, US). He also has an M.Sc. in business administration from Catholic University, Portugal.
VdA Vieira de Almeida VdA is an independent Portuguese law firm with 350 plus staff and a strong experience in various industries. Over the past 40 years, VdA has been involved in a significant number of pioneering transactions in Portugal and abroad, in some cases together with the most relevant international law firms, with whom we have a strong working relationship. The recognition of VdA’s work is shared with our team and clients, and is reflected in the awards achieved, such as: the “Financial Times 2015 Game Changing Law Firm in Continental Europe”, the “Financial Times Innovative Lawyers in Continental Europe 2013 and 2016”, the “Most Active Law Firm” awarded to VdA by Euronext for five consecutive years, the “Portuguese Law Firm of the Year 2015 and 2016” awarded by the IFLR, the “Portuguese Law Firm of the Year 2016” and “Client Service Law Firm of the Year 2017” awarded by Chambers & Partners, the “Iberian Firm of the Year 2017” awarded by The Lawyer and the “International Firm of the Year 2017” by Legal Business. VdA through its VdA Legal Partners (which encompasses all lawyers and independent law firms associated with VdA Vieira de Almeida for the provision of integrated legal services) is actively present in 11 jurisdictions that include all African members of the Community of Portuguese- Speaking Countries (CPLP), as well as Timor-Leste and some of the Francophone African Countries. Angola – Cape Verde – Congo – Democratic Republic of the Congo – Equatorial Guinea – Gabon – Guinea-Bissau – Mozambique – Portugal – Sao Tome and Principe – Timor-Leste Angola Capital Partners Angola Capital Partners was founded as a joint venture between Banco Angolano de Investimentos (BAI) and the Norwegian Investment Fund for Developing Countries (Norfund) to create a leading independent Private Equity firm in Angola. BAI is Angola’s largest private bank with an extensive local network, while Norfund, owned by the Norwegian state, is a leading investment company with a long track record in developing countries. In 2009, Angola Capital Partners launched the first Angolan dedicated investment fund, Fundo de Investimento Privado – Angola (FIPA), domiciled in Luxembourg and supervised by the Commission de Surveillance du Secteur Financier (CSSF) with US$ 39 million of capital commitments to invest in equity, and other long-term instruments, in private small and medium-sized enterprises in Angola across a wide range of industries. In 2016, Angola Capital Partners launched its second Private Equity fund (FIPA II) with US$ 45 million from existing investors aiming at pursuing a similar investment strategy across Angolan small and medium-sized enterprises, uncovering value by facilitating new business initiatives and upgrading existing technologies in partnership with strong management teams that enhance performance and deliver superior returns to investors, as well as to Angola’s economic and social development.
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Australia Lawson Jepps
Atanaskovic Hartnell Jon Skene
1 Overview 1.2 What are the most significant factors or developments encouraging or inhibiting private equity transactions in your jurisdiction? 1.1 What are the most common types of private equity transactions in your jurisdiction? What is the current state of the market for these transactions? Have Significant factors encouraging Australian private equity you seen any changes in the types of private equity transactions include: transactions being implemented in the last two to ■ domestic bank interest rates staying at historic lows; and three years? ■ attractions of Australia for inbound investment through: ■ lower Australian dollar forex rate compared to previous Private equity represents a smaller proportion of the Australian years; mergers and acquisitions market compared to other markets ■ a free trade agreement with the United States with a worldwide. According to the Australian Private Equity & Venture threshold for US private investment in Australia which Capital Association Limited (AVCAL), private equity contributed would usually not require statutory review; and 8% of overall deal volumes for the 2015 financial year compared to ■ perceptions of Australia as a “safe haven” destination 22% for the UK and 26% for the US. compared to volatility overseas, (e.g. Denham Capital’s As a consequence, it is more difficult to generalise about most commitments up to US$200m in Pembroke Resources common private equity transaction types in Australia than it is and Auctus Minerals). elsewhere. Nevertheless, the principal transaction types familiar in Significant factors inhibiting Australian private equity transactions those jurisdictions are also present in Australia, with deals among include: more prominent recent transactions including: ■ below-trend GDP growth (although still respectable ■ consortium bid: e.g. A$8.2 billion acquisition of GE Capital compared to other developed economies) and exposure to Finance Australasia Pty Ltd’s Australian and New Zealand slowing Chinese growth; and consumer lending business by a consortium of KKR, Varde ■ thinner market for deals and domestic capital. Partners and Deutsche Bank; ■ leveraged buy-out: e.g. A$750m acquisition of Orica Limited’s chemicals business to funds advised by Blackstone; 2 Structuring Matters and ■ joint venture by partial management buy-in/buy-out: e.g. 2.1 What are the most common acquisition structures A$336m investment by Affinity Equity Partners in 35% of adopted for private equity transactions in your Virgin Australia’s Velocity loyalty programme. jurisdiction? Have new structures increasingly The market for Australian private equity transactions has recently developed (e.g. minority investments)? been consistent with overall corporate mergers and acquisitions activity, with those deals representing a marginally increased Private equity funds can take a combination of equity and debt proportion by volume of overall transactions in the 2015 compared interests in targets, structured by any combination of: to the 2014 financial year, according to AVCAL. ■ convertible subordinated loans. Unsecured loans Activity has recently been supported by interest rates remaining at subordinated to senior and mezzanine debt (e.g. acquisition historic lows, together with the attraction for inbound investment debt) potentially convertible into equity immediately prior to exit; of a lower Australian dollar foreign exchange rate than in previous years. ■ preference equity. Preference shares offering a coupon during the term of investment but potentially pari passu with Because of the relatively constrained volume of Australian ordinary shares upon exit; and/or private equity transactions, it is more difficult to verify a marked ■ ordinary shares. Potentially pari passu with management change in overall transaction types than it is in other jurisdictions. interests. Nevertheless, there is a clear pattern of reliance on foreign capital as with overall M&A activity in Australia, with all transactions cited Warrants can also be taken by private equity funds i.e. options above sourcing non-domestic capital and domestic superannuation over unissued shares, potentially for greater control on realisation of downside risks e.g. unsatisfactory management performance/ funds reported to be winding back allocations to private equity. covenant breaches in special/ distressed situations.
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events (potentially according to “ratchet”); exit events; and/ 2.2 What are the main drivers for these acquisition or “good leaver” departures; or structures? ■ phantom schemes – management receive cash bonus of the amount their equity interest would have realised, subject to Relative composition of debt/ equity interests depends on factors “ratchet”, upon exit event or “good leaver”/ “bad leaver” including: departure, being easier to operate as a simple debt obligation ■ requirements of third party financiers, e.g. for of the company, but possibly unpopular with management subordination of private equity fund debt interests; seeking a voting interest or equity tax incentive criteria being met. ■ requirements of private equity fund investors, e.g. as to balance of interim income (favouring debt/ preference
Australia shares) and final capital returns (favouring equity); 2.6 If a private equity investor is taking a minority ■ tax planning for: (a) private equity investors; (b) portfolio position, are there different structuring company, e.g. deductibility of debt interest payments; and (c) considerations? management, e.g. meeting criteria for equity tax incentives; ■ prospective cash-flows, i.e. the company’s ability to service Management voting shares, whether from the outset or subject to existing and additional debt interest; and options that vest, would obviously tend to dilute the private equity ■ deal with incumbent/ incoming management, e.g. real investor’s voting interest. Dilution can be mitigated by the investor’s equity incentives. voting rights per share being increased, or by management’s voting rights per share being impaired, in the company’s constitution, (potentially on a matter-by-matter basis) or by provisions in the 2.3 How is the equity commonly structured in private shareholders’ agreement, subject to limitations described in response equity transactions in your jurisdiction (including institutional, management and carried interests)? to question 3.3.
Institutional investors might typically participate by acquiring bid 3 Governance Matters vehicle ordinary voting shares. Management might typically be offered ordinary, but non-voting, bid vehicle shares, subject to amplification of returns by “ratchet” (see the response to question 2.5) with transfer 3.1 What are the typical governance arrangements restrictions/ drag-along rights for institutional investors on exit. for private equity portfolio companies? Are such arrangements required to be made publicly available in your jurisdiction? 2.4 What are the main drivers for these equity structures? Private equity investors and management will often enter into a Typical drivers would include the overriding need of private equity shareholders’ agreement governing their relationship and commonly investors for an orderly exit in controlling disposal of management dealing with: equity, balanced against management seeking tax incentive criteria ■ management constitutional issues: for their equity being met. ■ quora for directors’ and shareholders’ meetings; ■ director removal/ nomination rights for private equity 2.5 In relation to management equity, what are the typical investors; and vesting and compulsory acquisition provisions? ■ potentially referral rights for votes from board to shareholders where not otherwise required by statute; Vesting and compulsory acquisition provisions depend on the ■ management operational issues: management interest’s legal structure. Where management take ■ performance targets/ milestones and impact on actual shares, vesting and compulsory acquisition provisions will be management incentive e.g. equity “ratchet”; familiar from other jurisdictions, including: ■ information rights over financial reports/ performance ■ vesting provisions whereby management’s equity interest against lending covenants; and is adjusted by “ratchet” referable to factors such as length of service/ the company’s financial performance relative to ■ veto rights where not otherwise available under milestones/ targets; and corporations law for: ■ compulsory acquisition provisions upon management ■ dilutive issues of equity (alternatively pre-emption departure, alternating between: rights); ■ bad-leaver – management interest acquired at cost/book ■ incurring (further) debts (depending upon existing value upon departure: negative pledges); ■ at own volition, e.g. prior to fixed date; or ■ approving budgets/ business plans; ■ on termination for cause/ not meeting agreed ■ approving M&A; and performance; and ■ approving dividends/ distributions; and ■ good-leaver – management interest acquired at fair ■ exits: market value upon departure: ■ equity lock-ups prohibiting transfers by management/ ■ at own volition, e.g. prior to fixed date; or other investors outside: ■ on faultless incapacity e.g. long-term illness/ ■ permitted transfers (e.g. intra-group/ declarations of termination without cause. trust); or Alternatives to actual shares include: ■ transfers subject to good-leaver/ bad-leaver mechanics; ■ options over unissued shares at nominal/ no strike price, and vesting in actual shares on service/ performance-based ■ pre-emption rights/ drag-along/ tag-along exit rights.
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Shareholders’ agreements for proprietary (e.g. private) companies are private contracts and, unlike in the UK, their constitutions are not 3.4 Are there any duties owed by a private equity investor ordinarily a public document, so there is not normally confidentiality to minority shareholders such as management shareholders (or vice versa)? If so, how are these lost in duplicating shareholders’ agreement provisions in the typically addressed? constitution, where appropriate. Legal duties are not owed as a general matter by private equity 3.2 Do private equity investors and/or their director investors to minority shareholders merely by virtue of all being nominees typically enjoy significant veto rights over shareholders (fiduciary duties do not apply). The same applies vice major corporate actions (such as acquisitions and versa save to the extent of fiduciary duties owed by management disposals, litigation, indebtedness, changing the shareholders in their separate capacity as directors/ officers. nature of the business, business plans and strategy, Australia etc.)? If a private equity investor takes a minority Investors may nonetheless be mindful of: position, what veto rights would they typically enjoy? ■ contractual duties under shareholders’ agreements, e.g. provision of financial information; and Yes. It is not unusual to include in shareholders’ agreements veto ■ general legal protections for minority shareholders e.g. orders rights against any of: material M&A; commencing/ defending in respect of [majority] conduct deemed: litigation; incurring (additional) debt; changing the nature of the ■ contrary to the interests of shareholders as a whole; or business; and/ or adopting business plans/ strategy. ■ oppressive to, unfairly prejudicial to, or unfairly Private equity investors holding minority interests (but with over discriminatory against, a shareholder or shareholders 25% voting rights) ordinarily have veto rights under Corporations whether in that capacity or in any other capacity. Act 2001 (Cth) (Corporations Act) over: ■ modification/ repeal of constitution; 3.5 Are there any limitations or restrictions on the ■ change to company name; contents or enforceability of shareholder agreements (including (i) governing law and jurisdiction, and (ii) ■ change to legal classification e.g. proprietary company non-compete and non-solicit provisions)? becoming public; ■ selective reduction of capital or buy-back of shares; (i) There is no general prohibition on shareholder agreements ■ giving financial assistance; and including non-domestic governing law and jurisdiction provisions. ■ members’ scheme of arrangement. (ii) Non-compete/ non-solicitation provisions are subject to Statutory veto rights can be: the same limitations as in ordinary commercial contracts, ■ negated by increased voting rights attached to majority shares being potential invalidity under common law restraint of in respect of any/ some/ all relevant votes; or trade. To be enforceable, relevant provisions have to protect ■ increased by additional shareholders’ agreement veto rights a legitimate business interest (e.g. private equity investor (see the response to question 3.3). against departing management) with reasonable scope in terms of duration; and geographical/ business reach.
3.3 Are there any limitations on the effectiveness of veto arrangements: (i) at the shareholder level; and (ii) 3.6 Are there any legal restrictions or other requirements at the director nominee level? If so, how are these that a private equity investor should be aware of typically addressed? in appointing its nominees to boards of portfolio companies? What are the key potential risks and liabilities for (i) directors nominated by private equity (i) If the company is party, shareholders’ agreement veto rights investors to portfolio company boards, and (ii) private might not be effective in fettering the company’s statutory equity investors that nominate directors to boards powers if employed against the company rather than its of portfolio companies under corporate law and also shareholders, if the English House of Lords decision in more generally under other applicable laws (see Russell v Northern Bank Development Corporation Ltd is section 10 below)? applied in Australia – the same applies if such veto rights appear in the constitution. Overseas investors should note proprietary companies need at least Russell v Northern Bank may be mitigated in any event one director ordinarily resident in Australia. by weighted voting rights (potentially varying by subject- matter) facilitating statutory majorities not being obtainable Key potential risks/ liabilities for: (i) nominee directors include: where minorities object, even without statutory veto rights. ■ breach of statutory duties and common law fiduciary duties, (ii) Nominated directors are subject to the same statutory and with a wide variety of civil/ criminal penalties and/or an common law fiduciary duties as other directors. At least obligation to compensate the company; and while the company is solvent, they have to take into account ■ insolvent trading for board members when the company its best interests, being the interests of all shareholders, not incurs a debt, there are reasonable grounds for suspecting that just those who nominate them. the company is or would become insolvent; and the company The exercise of a board veto willed by a shareholder might not is insolvent, or becomes insolvent by incurring that debt. be in the interests of all shareholders and therefore in breach Statutory provisions also void mitigation of these risks by of that nominated director’s fiduciary duties. This could companies: be dealt with by provision in the shareholders’ agreement/ ■ exempting liabilities incurred by persons as officers; constitution permitting directors to refer veto matters to a shareholder meeting, where fiduciary duties do not apply. ■ indemnifying persons for most liabilities incurred as officers; Nevertheless, such a right should be considered carefully, not and to become routine and may entail potential shadow director ■ payment of premiums for contracts insuring officers against liability for nominating shareholders. many liabilities for wilful breach of duty or breach of some statutory duties.
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Although investors would generally be protected by corporate Pre-transaction notification is often advisable but not limited liability and the “corporate veil”, key potential risks/ mandatory. At present most notifications request informal liabilities for: (ii) investors that nominate directors to boards include merger approval, with no formal timetable. If notified “shadow director” responsibility for liabilities described in (i), if transactions are cleared, the ACCC provides a non-binding the investor is deemed (amongst other things) to be a person “in “letter of comfort” stating no present intention to oppose. accordance with whose instructions or wishes the directors of the The informal ACCC process has two stages. Initial review/ corporation are accustomed to act”. There are also exceptions to the “pre-assessment” considers whether transactions prima “corporate veil”, e.g. fraud. facie raise competition concerns and they are cleared where risk of competition issues is considered low. A significant proportion of notifications is pre-assessed quickly, often 3.7 How do directors nominated by private equity within two weeks of notification. Australia investors deal with actual and potential conflicts of A second in-depth public review follows for more contentious interest arising from (i) their relationship with the mergers, comprising: party nominating them, and (ii) positions as directors of other portfolio companies? ■ two to five weeks of market inquiries with active scrutiny of information from competitors, suppliers and customers, and other interested persons; Nominated directors are prima facie required by statute (and potentially also by the constitution/ shareholders’ agreement) to ■ usually within six to 12 weeks, a decision not to oppose, or a statement of issues; and notify other directors of material personal interests in matters relating to the affairs of companies due either to their: (i) relationship ■ if there is a statement of issues, another round of market with their appointor; or (ii) position as directors of other portfolio inquiries which can take an additional six to 12 weeks, or potentially longer. companies, subject to exceptions. Notice does not, of itself, discharge the statutory duty to exercise powers in good faith in the The regime is due for reform (described in response to question best interests of the corporation and common law fiduciary duties. 10.2). However, statutory disclosure for proprietary companies permits Australian Securities Exchange (ASX) listed companies are (subject to constitution): (a) voting on matters relating to the subject to continuous disclosure obligations and have a prima facie interest; (b) approving transactions that relate to the interest; and obligation immediately to disclose information (such as investment (c) retaining transaction benefits. The company may not (subject or acquisition by private equity investors) that a reasonable person to constitution) avoid transactions merely because of a disclosed would expect to have a material effect on the price or value of their director’s interest or an interest within the statutory exception to securities. Disclosure can be deferred for information concerning disclosure. “an incomplete proposal or negotiation” where it’s confidential; the ASX has not formed the view that it has ceased to be confidential Statutory/ common law duties might also be mitigated by and a reasonable person would not expect the information to be constitutional/ shareholders’ agreement provisions accepting conflicts disclosed. Where a public-to-private bidder has made a firm decision of interests represented by appointor shareholders/ appointments to proceed, this is communicated to the target and announced to ASX to other portfolio company boards, provided directors’ actions are immediately with offer terms. The public-to-private bidder must otherwise consistent with company law. Non-statutory/ constitutional make the offer within two months. It typically takes three to four internal management protocols can also regulate conflicts. months to conclude the offer and implement compulsory acquisition. Commercial timing constraints can impact timetable including 4 Transaction Terms: General acquisition (and possibly syndication) of debt financing and commercial consents either to novation of, or change of control under, key commercial contracts. 4.1 What are the major issues impacting the timetable for transactions in your jurisdiction, including competition and other regulatory approval 4.2 Have there been any discernible trends in transaction requirements, disclosure obligations and financing terms over recent years? issues? Given the more limited volume of Australian private equity Regulatory timing constraints include: transactions referred to in response to question 1.1, it is difficult to ■ Foreign investment approval. A description of all verify generalised trends in commercial terms. circumstances in which notification might be made under the Foreign Acquisitions and Takeovers Act 1975 (Cth) (as amended) and the Foreign Acquisitions and Takeovers 5 Transaction Terms: Public Acquisitions Regulation 2015 (Cth) is beyond the scope of this response, but they include investors from jurisdictions without free trade agreements with Australia acquiring businesses worth 5.1 What particular features and/or challenges apply to over A$252m. private equity investors involved in public-to-private Where notification is made, the Federal Treasurer, acting transactions (and their financing) and how are these on the advice of the Australian Foreign Investment Review commonly dealt with? Board, has 30 calendar days to make a decision. This period is only subject to extension at the request of the investor or Public-to-private transactions comprise: upon statutory request for further information. ■ Off-market takeover. Most takeovers are off-market, being ■ Competition approval. A description of all circumstances an offer to all security holders in a bid class (whether or in which approval might be sought from the Australian not listed) for all those securities or a proportion of them, Competition and Consumer Commission (ACCC) under implemented either by contractual takeover offer/ bid or the Competition and Consumer Act 2010 (Cth) (CCA) is court-approved scheme of arrangement: similarly beyond the scope of this response.
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■ takeover bid/ offer: a bidder’s compulsory acquisition is recommendation, potentially subject to “fiduciary-outs” for superior ultimately permitted if the bidder and associates, by the competitive proposals. end of the offer period, have: The Takeovers Panel can declare unacceptable circumstances if the ■ relevant interests in at least 90% (by number) of bid size or structure of break fees pose a disproportionate disincentive class securities (whether or not acquired under the to competitive bids or unduly coerce target security holders. It bid); and considers break fees of 1% or less of target equity value “generally ■ acquired at least 75% (by number) of securities that not unacceptable” unless payment is subject to excessive/ coercive the bidder offered to acquire under the bid. triggers. “Naked no vote” break fees (i.e. payable where a bid The requirement for (broadly speaking) committed is rejected by security holders even in the absence of competing financing coupled with the uncertainty of meeting these proposals) can fall into this category.
thresholds and ultimately obtaining approval of financial Australia It is possible, but less common, for targets to seek reverse break fees assistance given by the target company in security for acquisition leverage tends to mitigate against contractual upon transaction failure in circumstances such as a bidder not obtaining takeover offers/ bids by private equity funds; or regulatory consent for which it was responsible, or breaching pre-bid agreements. The Takeovers Panel’s 1% “rule of thumb” does not ■ schemes of arrangement: acquisitions with consent of apply to reverse break fees, giving more flexibility in pricing. target security holders according to a court-approved procedure under Part 5.1 of the Corporations Act. The scheme must be approved by: 6 Transaction Terms: Private Acquisitions ■ 75% by value; and (generally) ■ a bare majority in number of holders, of offer class securities present and voting in the scheme meeting. 6.1 What consideration structures are typically preferred Unlike in the UK, the court has discretion to dispense by private equity investors (i) on the sell-side, and (ii) with a majority headcount. on the buy-side, in your jurisdiction? Votes of the offeror and associates are usually excluded, which makes it difficult to execute schemes where private Private equity sellers in secondary buy-outs might ideally prefer equity offerors already have target stakes. Schemes “locked box” structures where a fixed price is agreed over the provide “all-or-nothing” certainty that, if approved, the target’s historic or special purpose financial statements. The offeror acquires all scheme class securities, but if not, seller then covenants against value leakage from statement date to acquires nothing at all, so external leverage need not be completion. This mechanism’s acceptability has declined in a less drawn; or (rarely). buoyant market for secondary buy-outs. ■ Market takeover bid: comprising acquisition of listed Private equity buyers might prefer (and come under pressure from securities by contractual offer through the stock exchange, external financiers to require) traditional acquisition consideration which must be for all bid class securities, unconditional and structures such as “cash-free/ debt-free” enterprise valuation subject in cash. They are less flexible and less common than off- to adjustment by completion accounts for a target’s completion: (i) market takeovers, particularly for private equity offerors, but can prove significantly faster where possible. cash; (ii) net debt; and/or (iii) working capital (against expectation). Australia is less stringent than the UK in expectations of bid financing when offers are made, not requiring the equivalent 6.2 What is the typical package of warranties/indemnities of UK “cash confirmations”. Nevertheless, both the Australian offered by a private equity seller and its management team to a buyer? Takeovers Panel (Takeovers Panel) and the Australian Securities and Investments Commission (ASIC) advocate that bidders have Private equity sellers typically try to minimise warranties/ indemnities reasonable expectations at announcement that funding (even if on secondary buy-outs to pursue “clean exits” distributing sale subject to drawdown conditions or not formally documented) will proceeds quickly to investors. Sellers often claim to be “passive be available once an offer becomes unconditional, otherwise the investors” not sufficiently informed in day-to-day operation of the Takeovers Panel can declare “unacceptable circumstances”. target to give business warranties, trying to restrict coverage to title However, the Federal Court recently departed from an objective test to shares, capacity and authority. Buyers in secondary buy-outs for bidders to avoid being “reckless” in breach of the Corporations typically seek to resist such an approach, unless factored in to the Act and suggested bidders’ boards are only “reckless” if: consideration paid, and the final outcome will ultimately depend ■ subjectively aware of a substantial risk that they will not meet upon a range of factors and the competitive forces at work. funding obligations if a substantial proportion of offers are The Seller’s management team’s position depends on whether accepted; and they remain with the company. It will not necessarily make sense ■ having regard to known circumstances, they were not justified for the buyer to seek aggressive legal recourse against incumbent in taking it. management of their new portfolio company, which mitigates the Legislative reform is likely to be required to harmonise the legal value of their warranties/ indemnities. Management will often position with expectations of ASIC, the Takeovers Panel and market claim an inability in any event to resource substantial liability, trying participants. to limit exposure to a low multiple of annual salary. Buyers seeking substantive recourse from such sellers and management might initially be told to “bridge the gap” with warranty 5.2 Are break-up fees available in your jurisdiction in relation to public acquisitions? If not, what other and indemnity insurance (see the response to question 6.4). arrangements are available, e.g. to cover aborted deal costs? If so, are such arrangements frequently agreed 6.3 What is the typical scope of other covenants, and what is the general range of such break-up fees? undertakings and indemnities provided by a private equity seller and its management team to a buyer? Targets often pay break fees in recommended bids on transaction failure in circumstances such as withdrawal of target board Private equity sellers typically agree covenants/ undertakings from
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signing to completion for maintenance of present conduct of target outs for purchase price retention in escrow pending term business (whether or not to support “locked-box” consideration) and expiry of (most) warranties/ indemnities, as escrow impedes assistance with regulatory filings. Covenants could be extended to distribution of sale proceeds from the seller fund to investors. management, depending upon whether they remain with target (i.e. Ultimately presence/ absence of escrow should therefore some buyers might not consider them necessary for management factor in valuation discussions. transferring to them). Sellers might also have to stand behind (ii) Buyers in secondary buy-outs ideally seek escrow support taxation/ environmental indemnities. for warranties/ liabilities from both seller and management. Departing management can find it more difficult to argue Non-compete/ non-solicitation covenants might also be sought from against because they are not generally under the same both sellers and management, particularly seller non-solicitation pressure for rapid distribution of proceeds. In either case, where management remain with the target. secondary buy-out acquirers face suggestions insurance Australia is an appropriate substitute for escrow (see the response to 6.4 Is warranty and indemnity insurance used to “bridge question 6.4). the gap” where only limited warranties are given by the private equity seller and is it common for this 6.7 How do private equity buyers typically provide to be offered by private equity sellers as part of the comfort as to the availability of (i) debt finance, sales process? If so, what are the typical (i) excesses and (ii) equity finance? What rights of enforcement / policy limits, and (ii) carve-outs / exclusions from do sellers typically obtain if commitments to, or such warranty and indemnity insurance policies? obtained by, an SPV are not complied with (e.g. equity underwrite of debt funding, right to specific Warranty and indemnity insurance is certainly available both buyer- performance of obligations under an equity side (against the buyer’s losses upon acquisition) and seller-side commitment letter, damages, etc.)? (against the seller’s liabilities to the buyer under contractual warranties and indemnities, which can leave the buyer taking credit risk on both (i) The debt financing package is often set out in a debt the seller and insurer). It is not unusual for sellers, who wish to limit commitment letter and term sheet, replaceable with definitive their exposure or avoid retentions in escrow, to suggest it. financing documents if the private equity bid is successful. As (generally) a bespoke non-standardised product, it is difficult to (ii) Buyers’ equity funding commitments are also often set out generalise as to typical policy terms, but: (i) excesses/ policy limits in commitment letters addressed to target, which represent (and therefore an element of co-insurance from seller) are typical that buyer has sufficient equity to meet purchase document but quantum responds to transaction size/ premium pricing; and (ii) obligations and commit to drawing down equity finance subject to transaction conditions precedent. It is not unheard carve-outs/ exclusions typically include: of in Australia for sellers to obtain specifically enforceable ■ seller’s fraud (excluded from buyer-side policies); rights against buyers for an “equity cure” should debt ■ matters known to the buyer at completion; financing not transpire, potentially subject to clean-up grace ■ consequential losses (e.g. lost profits); and periods for buyers otherwise in default. ■ environmental liabilities, unless specifically negotiated for inclusion. 6.8 Are reverse break fees prevalent in private equity transactions to limit private equity buyers’ exposure? If so, what terms are typical? 6.5 What limitations will typically apply to the liability of a private equity seller and management team under warranties, covenants, indemnities and undertakings? Reverse break fees are certainly possible (but not necessarily prevalent) in public-to-private transactions (see the response to question 5.2), but less prevalent in private transactions. To the extent sellers are successful in limiting warranties/ indemnities to title/ capacity/ authority (see response to question 6.2), secondary buy-out acquirers should expect them to be uncapped or subject to 7 Transaction Terms: IPOs cap equal to aggregate purchase price. Management team might try to cap their liability at the deductible/ excess of applicable insurance or at a relatively low multiple of aggregate salaries. 7.1 What particular features and/or challenges should a Other limitations will be familiar from general corporate private equity seller be aware of in considering an IPO exit? transactions, e.g.: ■ de minimis thresholds on an individual and/or aggregate Once a private equity investor wishes to conduct an IPO in respect “basket” basis below which claims are inadmissible and of a portfolio company, the existing shareholders’ agreement will above which claims are permitted either on a whole liability or excess-only basis; be terminated. Neither ASX Listing Rules nor market practice generally permit typical provisions in shareholder agreements ■ time limitations normally being: including weighted voting rights and drag-along rights. ■ one audit cycle for general business warranties (e.g. 12– 18 months from completion); and ■ longer for long-tail liabilities, e.g. tax/ environmental claims. 7.2 What customary lock-ups would be imposed on private equity sellers on an IPO exit?
6.6 Do (i) private equity sellers provide security (e.g. Historically, Australian sellers were not restrained from disposing escrow accounts) for any warranties / liabilities, and their shareholding on IPO, but recently the Australian market has (ii) private equity buyers insist on any security for warranties / liabilities (including any obtained from caught up with the US – exiting sellers are often required to retain a the management team)? substantial target stake at least until release of first full-year financial results post-listing. Apollo Global Management LLC and Oaktree (i) Sellers typically resist customary requests on secondary buy- Capital Management L.P. entered into voluntary escrow in respect
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of shares held by their funds upon IPO of Nine Entertainment Co. investment as debt or equity to determine corporate tax treatment of Holdings Limited until publication of the company’s full-year returns (i.e. potentially a deductible interest expense or potentially results. In a common exception to “lock-up”, they could sell-down a frankable dividend, respectively). Determination is made by 25% of their shares in escrow if first half-yearly results had been Division 974 of the Income Tax Assessment Act 1997 (Cth). published and the share price over 20 days was at least 20% higher Broadly speaking, it operates to treat all holders of: ordinary shares; than the IPO price. preference shares; convertible securities; and securities, the returns of which are a function of target performance, as holders of equity interests provided they do not also satisfy the requirements of a 7.3 Do private equity sellers generally pursue a dual-track exit process? If so, (i) how late in the process are debt interest. Usually, an arrangement will satisfy the requirements private equity sellers continuing to run the dual-track, of a debt interest if the entity subject to it has an effectively non-
and (ii) were more dual-track deals ultimately realised contingent obligation under the arrangement to provide a benefit in Australia through a sale or IPO? the future (e.g. the repayment of a loan) and it is substantially more likely than not that the value provided will at least be equal to the Private equity-backed IPOs are not especially common, with value received. AVCAL identifying 30 such IPOs on the ASX for calendar years Off-shore tax structures are common in the Australian private equity 2013, 2014 and 2015 with an offer size of at least A$100m, many of landscape. Traditionally, the legal vehicle most commonly used which were not run as an alternative to trade sales, which would not has been the limited partnership domiciled in a jurisdiction offering suggest a general preference for dual-tracks. tax neutrality, such as Delaware, the Cayman Islands or the British Virgin Islands. However, Australia proposes to introduce a new collective investment vehicle (CIV) regime to be implemented 8 Financing in two phases via amendments to the existing tax legislation: the introduction of a corporate CIV from July 2017, to be followed 8.1 Please outline the most common sources of debt by the introduction of a limited partnership CIV from July 2018. finance used to fund private equity transactions in your The proposed CIV regime will provide investors with the ability jurisdiction and provide an overview of the current to obtain deemed capital gains tax treatment and a reduced rate of state of the finance market in your jurisdiction for such withholding tax when investing from a country that has entered into debt (particularly the market for high yield bonds). an exchange of information agreement with Australia. It is worthwhile to also note that the Australian Taxation Office Senior secured debt and mezzanine (or subordinated) debt are the (ATO), in its efforts to combat multinational tax avoidance, is most common sources of funding for private equity transactions in reviewing the structures created and held off-shore by multinational Australia, initial buy-out financing traditionally being limited to a corporate groups to which Australia’s cross-border and general few institutional bank lenders. After the global financial crisis, it anti-avoidance rules may apply. Where applicable, the Part IVA became more expensive for buyers to obtain such bank funding for leveraged buy-outs and some sponsors therefore brokered their own Anti Avoidance Rule and the newly established Multinational Anti- syndicated financing. High-yield bonds and securitisation structures Avoidance Law (MAAL), which came to effect on 1 January 2016, have not generally been taken up, but bridge loans have occasionally may result in Australian or off-shore companies being liable to pay been used to fund acquisitions, which might then be replaced by significant Australian tax. high-yield debt or retail debt securities, but this has not been typical. 9.2 What are the key tax considerations for management teams that are selling and/or rolling-over part of their 8.2 Are there any relevant legal requirements or investment into a new acquisition structure? restrictions impacting the nature or structure of the debt financing (or any particular type of debt financing) of private equity transactions? If management hold target equity, they are commonly given bidding vehicle shares in exchange, structured typically to obtain capital Like the UK but unlike much of the US, Australia has a statutory gains tax (CGT) rollover relief (deferring taxes otherwise imposed prohibition upon financial assistance given by a company toa on exchange). Conditions to relief include a requirement for an person to acquire shares in that company or in its holding company. entity becoming the owner of 80% or more of target voting shares The prohibition typically pertains to the giving of security for by virtue of the rollover transaction. acquisition debt without direct consideration. “Whitewash” shareholder approval either by a unanimous shareholder resolution 9.3 What are the key tax-efficient arrangements that are or by a special resolution (75%) passed by shareholders other than typically considered by management teams in private the buyer and its associates, is required to the extent financial equity portfolio companies (such as growth shares, assistance is materially prejudicial to the interests of the company deferred / vesting arrangements, “entrepreneurs’ or its shareholders or its ability to pay its creditors. If required, relief” or “employee shareholder status” in the UK)? shareholder approval must be obtained and ASIC notified thereof at least 14 days before the giving of the financial assistance. Shares and options granted for less than market value may be subject to employee share scheme (ESS) provisions resulting in 9 Tax Matters gain being taxed as income rather than capital. The taxing point under those provisions is either upon grant or on a deferred basis (i.e. until vesting or exercise). Tax may generally be deferred for 9.1 What are the key tax considerations for private equity qualifying options until exercise, rather than vesting. To qualify for investors and transactions in your jurisdiction? Are deferral an employee can hold up to 10% of the ownership interests off-shore structures common? of the employer for up to 15 years from grant.
A key tax consideration for investors is classification of their
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The private equity industry in Australia is likely to remain under 9.4 Have there been any significant changes in tax increased regulatory scrutiny in the medium term as a result of legislation or the practices of tax authorities widely publicised instances where private equity investors have (including in relation to tax rulings or clearances) been accused of profiting concurrently with significant destruction impacting private equity investors, management teams or private equity transactions and are any of long-term value, such as the demise of the Dick Smith Electronics anticipated? group which Anchorage Capital Partners acquired for a total consideration of $115m in 2012, floated at a total capitalisation Domestic funds are often structured as unit trusts that qualify for of $520m on the ASX in 2013, then exited before it went into the Managed Investment Trust (MIT) regime, generally permitting administration in 2016. flow-through tax treatment of income and profits to the investor Australia for qualifying trusts. On 4 May 2016, a package of four bills was 10.3 How detailed is the legal due diligence (including passed into law by Parliament which created a new elective regime compliance) conducted by private equity investors for Attribution Managed Investment Trusts (AMITs). At its core is prior to any acquisitions (e.g. typical timeframes, the ability of qualifying AMITs to “flow through” taxable income materiality, scope etc.)? Do private equity investors to their unitholders on an “attribution basis” and for that income to engage outside counsel / professionals to conduct all legal / compliance due diligence or is any conducted retain its character for tax purposes as it flows through the trust at in-house? trustees’ election, giving them the flexibility to choose the ultimate tax treatment of portfolio gains. Prudent private equity investors conduct intensive legal due diligence with the benefit of outside counsel. Timeframes, 10 Legal and Regulatory Matters materiality and scope should always be tailored to the circumstances of the transaction (practicable due diligence being more constrained in an auction sale compared to purely bilateral arrangements and in 10.1 What are the key laws and regulations affecting respect of public-to-private transactions compared to private sales). private equity investors and transactions in your jurisdiction, including those that impact private equity transactions differently to other types of transaction? 10.4 Has anti-bribery or anti-corruption legislation impacted private equity investment and/or investors’ Outside taxation, private equity investors and transactions are subject approach to private equity transactions (e.g. diligence, contractual protection, etc.)? to the same corporate laws as apply to any other corporate investors and transactions. They are therefore subject to the Corporations Prudent private equity investors should be concerned about target Act, foreign investment rules under the Foreign Acquisitions and compliance with anti-bribery and anti-corruption legislation, Takeovers Act 1975 (Cth) (as amended), competition rules under the particularly given that bribery of domestic public officials, and Competition and Consumer Act 2010 (Cth) and, in respect of public- foreign public officials in some circumstances, is a criminal offence to-private transactions, the ASX Listing Rules and the guidance under the Criminal Code Act 1995 (Cth), which could lead to multi- notes of the Takeovers Panel. million dollar fines for corporates. This has been reflected bya general extension of contractual protection for buyers against a 10.2 Have there been any significant legal and/or target’s non-compliance. regulatory developments over recent years impacting private equity investors or transactions and are any anticipated? 10.5 Are there any circumstances in which: (i) a private equity investor may be held liable for the liabilities of The foreign investment regime was overhauled with effect from 1 the underlying portfolio companies (including due to breach of applicable laws by the portfolio companies); December 2015, with some likely impact to non-domestic investors and (ii) one portfolio company may be held liable for particularly in respect of: the liabilities of another portfolio company? ■ raising the “substantive interest” threshold in portfolio companies at the monetary threshold subject to potential Per the response to question 3.6, (i) private equity investors may notification from 15% to 20%; and in exceptional circumstances be liable for liabilities of underlying ■ new application fees for notifications. portfolio companies, including due to breach of applicable laws, The Coalition that presently forms the Australian Government notwithstanding general application of limited liability and the promised early in 2013 that it would deliver the first root and branch “corporate veil”, e.g. “shadow director” liability where the investor review of Australia’s competition laws in over 20 years. The final is deemed to be a person “in accordance with whose instructions review report, led by Professor Ian Harper, was published on 31 or wishes the directors of the corporation are accustomed to act”. March 2015 (Harper Report). The Federal Government published It is difficult to conceive circumstances where, (ii) one portfolio its response in November 2015 adopting a recommendation for company may be held liable for the liabilities of another outside further consultation between the ACCC and business representatives of contractual cross-guarantees, but it might still occur under with the objective of delivering more timely decisions in the informal exceptions to the “corporate veil” e.g. group arrangements are merger review process, together with changes to the (less-utilised) deemed to be a fraud/ sham. formal process. A bill was ultimately introduced to Parliament on 30 March 2017 to implement most of the recommendations of the Harper Report. It is unclear at this stage whether changes to the ACCC’s informal process will make a substantive difference to outcomes once legislation is implemented.
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11 Other Useful Facts
11.1 What other factors commonly give rise to concerns for private equity investors in your jurisdiction or should such investors otherwise be aware of in considering an investment in your jurisdiction?
Australia is a relatively open economy with a freely floating currency and no foreign exchange controls. It has well-developed financial markets and a sophisticated professional services sector, Australia with a strong and impartial legal and judicial system that remains very similar to that of the United Kingdom. It is thus a jurisdiction posing relatively few concerns to private equity investors. These responses describe the law in force as at 26 April 2017.
Lawson Jepps Jon Skene Atanaskovic Hartnell Atanaskovic Hartnell Atanaskovic Hartnell House Birchin Court 75–85 Elizabeth Street 20 Birchin Lane Sydney NSW 2000 London EC3V 9DU Australia United Kingdom
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Professional qualifications. England and Wales, solicitor. Professional qualifications. New South Wales, solicitor; England and Wales, solicitor. Areas of practice. Public mergers and acquisitions; private mergers and acquisitions; business sales; joint ventures; capital markets; Areas of practice. Public and private mergers and acquisitions in securities; private equity; corporate governance; and corporate advisory. both the UK and Australia; business sale and purchase; joint ventures; capital markets and securities (including advice on the Listing Rules Non-professional qualifications. B.A. (Hons), Oxford University. of the LSE, AIM and ASX); private equity; corporate governance; general corporate advisory matters; and competition and antitrust law generally (including relating to the foregoing). Non-professional qualifications. B.A. (Hons), University of New South Wales; LL.B. (Hons) University of Sydney.
Formed in 1994, Atanaskovic Hartnell’s lawyers are recognised for their legal expertise. A number of the firm’s lawyers are internationally acknowledged as leaders in their fields, and are all highly regarded for their commerciality, astuteness and tenacity. In contrast with some of the firm’s national competitors, Atanaskovic Hartnell’s partners are directly involved in all matters, working closely with clients in small focused teams of experienced lawyers. The firm takes pride in delivering cutting edge legal advice, and in taking a key role in matters which have shaped Australia’s corporate and legal landscape. Atanaskovic Hartnell’s reputation for excellence is reflected in the identity of the firm’s clients. Clients for whom the firm has acted include LSE premium listed Asia Resource Minerals plc; Glencore plc (and Ivan Glasenberg); Glencore International; WIN Corporation and Bruce Gordon; Consolidated Press and Publishing and Broadcasting companies; Messrs James Packer and Peter Yates and four former non-executive directors of James Hardie Industries.
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Austria Florian Philipp Cvak
Schindler Attorneys Clemens Philipp Schindler
1 Overview 2 Structuring Matters
1.1 What are the most common types of private equity 2.1 What are the most common acquisition structures transactions in your jurisdiction? What is the current adopted for private equity transactions in your state of the market for these transactions? Have jurisdiction? Have new structures increasingly you seen any changes in the types of private equity developed (e.g. minority investments)? transactions being implemented in the last two to three years? The typical on-shore acquisition structure involves one or more holding companies (“HoldCos”) and an acquisition vehicle (“BidCo”) Austria has seen the full spectrum of private equity transactions, which then enters into the purchase agreement and ultimately acquires from seed to growth capital transaction, to all sorts of buyout and the shares. From a tax perspective, this multi-layer holding structure (non-performing) loan (-to-own) transactions. is no longer necessary (see question 2.2). In leveraged transactions With the Austrian economy slowly recovering, non-performing interim holding companies are, however, often still needed as senior loan transactions (that is, the purchase of secured or unsecured non- lenders typically insist that junior lenders lend a level higher in the performing loans or portfolios of loans from a commercial bank) structure to achieve not only contractual subordination (which is and “loan-to-own” transactions (that is, where a private equity fund achieved through an inter-creditor agreement) but also structural acquires (often shareholder) debt or grants a loan with the ultimate subordination of junior debt to senior debt. aim to convert that debt into equity still played a role in 2016 but to Funds will usually try to maximise debt in the financing structure for a much lesser extent than in recent years where most of the deal flow a transaction. The difference between available bank debt and the had some distressed background. Conversely, 2016 saw a couple of purchase price is financed by the fund through a combination of debt major exits by private equity sellers and divestments by corporates (so called, “institutional debt”) and equity. How much institutional for strategic reasons. debt can be employed, is determined by “thin cap” rules. Whereas One trend that continued from 2015 is increased activity in the there are no statutory rules in place, debt to equity ratios of 3:1 to 4:1 growth capital segment or management buyouts (and buy-ins) are generally accepted by the Austrian tax authorities. which are fuelled by the increasing number of promising Austrian Where bank debt is employed, banks usually require the target startups which have been able to transform into (mostly tech and IT) company to accede to the financing documents on an exclusive lender growth businesses attracting a lot of interest not only from regional, basis (to avoid structural subordination to incumbent borrowers) and but also more recently from global venture and growth capital funds to grant guarantees and security interests securing acquisition debt and investors from Asia and the Far East. We expect that trend to as well as the refinanced target company debt (see, exclusive lender continue and to contribute to the bigger part of the deal count over basis) on or shortly after completion of the purchase. To the extent the next years. guarantees and security interests secure acquisition debt, capital maintenance and, where a joint stock company (“JSC”) is involved, 1.2 What are the most significant factors or developments financial assistance rules, are a concern. Transactions violating encouraging or inhibiting private equity transactions capital maintenance rules are null and void as between the parties as in your jurisdiction? well as any involved third party (e.g. the financing bank) if that third party knew, or should have known, of the violation. In addition, the See question 1.1. Another factor for Austrian transactions is that members of the management and supervisory board who approved many companies have substantial CEE exposure which is perceived the transaction may be subject to liability for damages. Transactions as an opportunity by some investors but it is an issue for others who violating financial assistance rules, on the other hand, are not void must not invest in targets in the CEE, or with considerable CEE but may result in liability of the members of the management and exposure, pursuant to the terms of their investment mandate. supervisory board who approved the transaction. This issue is addressed in the financing documents by “limitation language” which limits the obligations of Austrian obligors to an amount and terms compliant with capital maintenance and financial assistance rules.
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differs depending on the type of company but, generally, minority 2.2 What are the main drivers for these acquisition shareholder protection includes information rights, rights to call a structures? shareholders’ meeting, quorum, and voting requirements for major corporate actions (such as corporate restructurings, a change of the The availability of goodwill amortisation on share deals and capital company’s purpose, changes to the articles of association, dealings tax considerations were the main drivers for on-shore structures as involving all or substantially all of the business or assets, and described under question 2.1 above. Goodwill amortisation on share squeeze-outs of shareholders). deals is no longer available and capital tax on direct parent capital contributions was abolished effective 1 January 2016. The Austrian HoldCos and the BidCo can, however, still enter into a tax group 3 Governance Matters with the target. This allows off-setting interest expenses with the Austria taxable profits of the target. Where Austrian-based companies are 3.1 What are the typical governance arrangements not required for other reasons, the acquisition structure described in for private equity portfolio companies? Are such question 2.1 is often implemented offshore. arrangements required to be made publicly available in your jurisdiction? 2.3 How is the equity commonly structured in private equity transactions in your jurisdiction (including The governance documents typically include: institutional, management and carried interests)? ■ a shareholders’ agreement; ■ new articles of association; and Institutional equity is usually given off-shore and passed on to the ■ by-laws for the management board and supervisory board (if Austrian structure by way of capital contributions. Management any). equity is often given in the form of actual shares, either in the target company (or the entity in which the exit is expected to occur) or The main areas of concern in the governance documents are the shares in entities above. private equity fund’s rights to appoint sponsor representatives (and/ or observers) to the supervisory board (if any) or advisory board (if From a tax perspective, actual shares (and certain other equity any), sponsor representative liability, veto rights of the fund (and/ interests) may have benefits relative to phantom stock and other or the sponsor representative) (see question 3.2), dilution protection contractual bonus scheme arrangements, as gains realised upon for the fund, a liquidation preference for the fund, restrictions on an exit may be eligible for capital gains taxation as opposed to dealings with shares (typically including a lock-up, rights of first employment income. refusal, tag-along, and drag-along rights), exit rights for the fund (via a trade sale, an IPO or a shotgun mechanism) as well as 2.4 What are the main drivers for these equity structures? reporting, information and access rights. In most cases, the fund will also insist that senior management Please see the answer to question 2.3 above. signs up to an incentive scheme (see question 2.3) and that all of the management team (and sometimes also certain other key personnel) enter into new employment agreements at terms agreed with the 2.5 In relation to management equity, what are the typical vesting and compulsory acquisition provisions? fund. To the extent the above arrangements are included in the articles Management equity is typically subject to vesting over a period of association (which has some benefits for some (but not all) of of three to five years. Compulsory transfer provisions apply upon them from an enforcement perspective (see question 3.3)), they are termination of the management function, with the consideration publicly accessible through the companies register. In addition, varying depending on the reason for termination (a “good” or a certain arrangements may have to be disclosed if the target is a listed “bad” leaver) – although structures have become less aggressive in JSC and Securities Law disclosure requirements are triggered. that regard due to recent developments in Austrian labour law. In addition, the private equity fund will require a right to drag along 3.2 Do private equity investors and/or their director the management upon an exit and typically will insist on the pooling nominees typically enjoy significant veto rights over of the management equity in a pooling vehicle (often a partnership). major corporate actions (such as acquisitions and disposals, litigation, indebtedness, changing the nature of the business, business plans and strategy, 2.6 If a private equity investor is taking a minority etc.)? If a private equity investor takes a minority position, are there different structuring position, what veto rights would they typically enjoy? considerations? The governance documents will typically include veto rights of the Private equity investors taking a minority position, typically insist fund (and/or a sponsor representative in a supervisory board) over on new governance documents (for a description, see question 3.1). major corporate actions and strategic decisions (such as acquisitions Where that request is rejected, the investor must carefully analyse and disposals, major litigation, indebtedness, changing the nature what rights are available to him following completion under the of the business, business plans and strategy) although the specific existing governance documents and, where necessary, request requirements vary widely from fund to fund and deal to deal. amendments. In that process, it is important to familiarise oneself Usually such veto rights are structured to fall away if the relevant with which minority protections are already available under the law, fund’s interest is reduced below a certain quota. Where multiple which of them are mandatory, which of them can be amended to funds invest, they will generally insist that all investors vote on the benefit of minority shareholders only, and which of them can the veto matters, with quorum and majority voting requirements be amended without restriction. What protections are available varying widely from deal to deal.
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generally only valid for a period of up to one year and to the extent 3.3 Are there any limitations on the effectiveness of veto that the restriction does not unduly affect the employee’s future arrangements: (i) at the shareholder level; and (ii) prospects. at the director nominee level? If so, how are these typically addressed? It should be noted that where a shareholders’ agreement includes an obligation to transfer shares of a limited liability company (such If a veto (or majority) requirement is included in the articles of as an option or a drag along right), it must be drawn up in the form association (and/or by-laws), resolutions violating the arrangement of an Austrian notarial deed if the obligation to transfer is to be can be challenged. In contrast, if a veto right (or majority requirement) enforceable (note: a German notarial deed is considered equivalent). set forth in the shareholders’ agreement is violated, only an action
Austria for damages and cease and desist orders are available. It should 3.6 Are there any legal restrictions or other requirements be noted though, that in one decision the Austrian Supreme Court that a private equity investor should be aware of also accepted a challenge of a shareholders’ resolution in breach of in appointing its nominees to boards of portfolio a majority requirement set forth in a shareholders’ agreement. In companies? What are the key potential risks and that case all shareholders were a party to the agreement which will liabilities for (i) directors nominated by private equity investors to portfolio company boards, and (ii) private often be the case in private equity deals as well, at least where the equity investors that nominate directors to boards shareholders’ agreement provides for mandatory accession. of portfolio companies under corporate law and also Regarding management board member action, it must be noted that more generally under other applicable laws (see towards third parties the power of representation of management section 10 below)? board members cannot be limited in the shareholder’s agreement, articles of association and/or by-laws in such a way that the General company would not be bound if a member transacts in violation of Austria has a two-tier board structure. The management board is any such limitations. responsible for the day-to-day management of the company, while the supervisory board is responsible for monitoring and resolving on 3.4 Are there any duties owed by a private equity investor the matters brought before the supervisory board for a vote (which to minority shareholders such as management is a matter for the governing documents). Sponsors usually request shareholders (or vice versa)? If so, how are these rights to nominate one (or more) members of the supervisory board typically addressed? (Aufsichtsrat) or observers to the supervisory board, but hardly ever get involved in management. For that reason, the answers under Austrian courts have consistently held that shareholders owe a questions 3.6 and 3.7 will focus on supervisory board nominees. duty of loyalty (Treuepflicht) towards one another requiring them Restrictions to consider the interests of their fellow shareholders in good faith Restrictions with respect to the aggregate number of supervisory (Treu und Glauben) and in line with bonos mores (gute Sitten). board positions and provisions aimed to prevent conflicts of interest That duty is more pronounced for closely held companies than for exist: supervisory board members must not be managing directors widely held companies and differs from shareholder to shareholder of the portfolio company or of a subsidiary, or employees of the depending on the ability of the shareholder to cause a certain action portfolio company (employee representatives are exempt from that to be taken or not to be taken. A majority shareholder may therefore restriction). They must not hold more than 10 (eight for a listed be exposed to liability for failure to appear and vote on a matter JSC) supervisory board positions (with chairman positions counting in circumstances where a minority shareholder is not (because his double and exemptions for group positions), or be appointed a appearance or vote would not have mattered in the circumstances managing director of a subsidiary or of another company to whose anyways). A violation of the duty of loyalty may result in claims for supervisory board a member of the management board of the damages, cease and desist orders, or a challenge action (Anfechtung) portfolio company is appointed (unless that company belongs to a of shareholder resolutions in violation. corporate group (Konzern)). Requirements 3.5 Are there any limitations or restrictions on the contents or enforceability of shareholder agreements Corporate law does not require a specific qualification or experience (including (i) governing law and jurisdiction, and (ii) for supervisory board members. Such requirements can be introduced non-compete and non-solicit provisions)? in the articles of association. As a general matter, however, every supervisory board member must ensure that it can meet its duty of Shareholders’ agreements are typically governed by Austrian law care (Sorgfaltspflicht) requiring the relevant member to exercise the and the competent courts at the seat of the company typically have level of care of a proper and diligent supervisory board member of jurisdiction. This is mainly because disputes related to shareholders’ the particular company to which’s supervisory board he is appointed agreements are usually supported by arguments based on Austrian (that is, a supervisory board member of a biotech company will corporate law and corporate law disputes must be brought before the have to have different knowledge and skills from a supervisory courts at the seat of the company. However, where Austrian court board member of a company that is in the shoe retail business). In judgments are not enforceable in the jurisdiction of a particular general terms, a supervisory board member must have at least a basic shareholder, arbitration is an option. understanding of the business brought before the supervisory board, have an understanding of annual accounts, and be able to assess Non-compete and non-solicitation provisions are generally when expert opinions are required and devote sufficient time. enforceable for the period of the shareholding (for that period contractual restrictions compete with the corporate law based duty Risks and liability of loyalty (see question 3.4)) and for up to two (in exceptional cases, Members of the supervisory board owe to the portfolio company three) years thereafter. Where a shareholder was at the same time an (and not to the private equity investor appointing them or to any employee (which could be the case for management shareholders), other constituents), a duty of care (Sorgfaltspflicht) (see above the restriction will also be scrutinised under employment law and is – which includes an obligation to be reasonably informed and
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articulate any concerns he may have), a duty of loyalty (Treuepflicht) ■ regulatory clearance (e.g. the acquisition of a qualified (requiring the member to act in the best interest of the company or controlling interest in the banking, insurance, utilities, and its shareholders and not in his own interest); and a duty of gambling, telecoms or aviation sector is subject to advance confidentiality. A supervisory board member is not prevented to notification or approval of the competent regulatory compete with the business of the portfolio company, as long as authority); there is no breach of the duty of loyalty. Absent a breach of their ■ real estate transfer clearance (the acquisition of title and corporate duty of care, supervisory board members can generally certain other interests in real estate by non-EEA nationals, or not be held liable for a portfolio company’s breach of administrative control over companies holding such interests, is subject to advance notification or approval (depending on the relevant law or criminal law. A supervisory board member, may, however, state law); and become liable for own conduct, including, without limitation, ■ clearance pursuant to the Foreign Trade Act Austria for fraud (Betrug) (e.g. by entering or approving a transaction (Außenwirtschaftsgesetz) (the acquisition of 25% or more intended to mislead another), for breach of trust (Untreue) (e.g. by or of a controlling interest in an Austrian business involved entering or approving a transaction that is adverse to the interests in certain protected industries, such as defence, security of shareholders) or for misrepresentation (e.g. with regard to the services, hospitals, emergency and rescue services, energy portfolio company’s assets, financial or earning position or related and water supply, telecoms, traffic or universities by a non- information in the financial accounts or in a public invitation to EEA or non-Swiss national is subject to advance approval purchase shares, statements in a shareholders’ meeting, statements of the Austrian Minister of Economic Affairs (before the to the company’s auditors, in companies register filings) or for transaction is signed). violations of anti-bribery legislation (see section 10 below). With regard to timing aspects related to public-to-private A private equity investor will generally not be held responsible for transactions, see question 5.1. an act or a failure to act of a member of the supervisory board just because that member was nominated by the investor. However, 4.2 Have there been any discernible trends in transaction whenever there is involvement beyond that, the investor could face terms over recent years? criminal law penalties and civil law liability for damages (e.g. where the investor has collaborated with the member on a transaction Vendor due diligence is becoming more and more common in intended to mislead another or which is adverse to the interests of auctions of bigger targets (sometimes coupled with reliance and/ shareholders (see above)). In addition, in circumstances, where or warranties given by the seller or the management on the vendor a sponsor nominee who at the same time is a decision taker of the due diligence report, sometimes without). Similarly, warranty and investor within the meaning of the Association Responsibility Act indemnity insurance is more frequently discussed, in particular (Verbandsverantwortlichkeitsgesetz − VbVG) commits a criminal where private equity investors are sellers. offence for the benefit of the investor, the private equity investor may face criminal law penalties and civil law liability for damages. Further, the private equity investor could face civil law liability based 5 Transaction Terms: Public Acquisitions on corporate law for trying to influence members of the management or supervisory board to his own benefit or the benefit of another (e.g. requiring management to pay the fund’s transaction costs or 5.1 What particular features and/or challenges apply to private equity investors involved in public-to-private influencing management so that a business opportunity is not pursued transactions (and their financing) and how are these and remains available for another portfolio company of the investor). commonly dealt with?
3.7 How do directors nominated by private equity A typical going-private transaction involves a voluntary takeover investors deal with actual and potential conflicts of offer aimed at control (freiwilliges Angebot zur Kontrollerlangung), interest arising from (i) their relationship with the subject to the condition that 90% of the outstanding shares are party nominating them, and (ii) positions as directors tendered, followed by a squeeze-out pursuant to the Shareholders of other portfolio companies? Exclusion Act (Gesellschafterausschluss-Gesetz). The squeeze-out then automatically results in a delisting. In the context of the takeover Where a sponsor nominee director has a conflict of interest with offer, the private equity investor must ensure that the necessary funds respect to any matter, he has to advise the chairman of the supervisory are secured prior to the announcement of the offer which must be board accordingly; the chairman of the supervisory board is then confirmed by an independent expert pursuant to the Austrian Takeover asked to make sure that the sponsor nominee director does not vote Code (Übernahmegesetz). The expert will typically require (i) a copy with respect to the matter and does not participate in related meetings. of the equity commitment letter from the fund, and (ii) copies of the definitive finance agreements together with documents evidencing 4 Transaction Terms: General that all conditions precedent (other than those within the private equity investor’s sole control) have been satisfied, to satisfy itself that the necessary funds requirement has been satisfied. 4.1 What are the major issues impacting the timetable for transactions in your jurisdiction, including competition and other regulatory approval requirements, 5.2 Are break-up fees available in your jurisdiction in disclosure obligations and financing issues? relation to public acquisitions? If not, what other arrangements are available, e.g. to cover aborted deal costs? If so, are such arrangements frequently agreed The following clearance requirements are typically a factor for the and what is the general range of such break-up fees? timetable: ■ antitrust clearance (which takes up to four weeks if cleared in Break-up fees obligating the target company to pay a fee to phase 1 proceedings and up to five months if cleared in phase the bidder if the bid fails in a public acquisition are in principle 2 proceedings in Austria); available, but they are not common. There is little guidance, but
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whether a break-up fee is valid or not should primarily depend on two factors: (i) the amount of the fee (a break-up fee in an amount 6.4 Is warranty and indemnity insurance used to “bridge that will keep management from considering competing bids or the gap” where only limited warranties are given by the private equity seller and is it common for this deter others from considering a competing bid will probably not be to be offered by private equity sellers as part of the valid); and (ii) the circumstances in which it is triggered (a break-up sales process? If so, what are the typical (i) excesses fee that is solely triggered upon active solicitation of competing bids / policy limits, and (ii) carve-outs / exclusions from should be valid, whereas a break-up fee triggered because a bid is such warranty and indemnity insurance policies? not supported for good reason, or because a better competing bid is supported, is probably not valid). Private equity sellers sometimes use warranty and indemnity insurance to “bridge the gap”. Seller policies are usually not Austria discussed in the course of the sales process unless the buyer 6 Transaction Terms: Private Acquisitions is expected to bear all or part of the costs. Conversely, flipping policies (that is a policy organised by a seller as part of an auction 6.1 What consideration structures are typically preferred process which flips into a buyer’s policy) are usually an incremental by private equity investors (i) on the sell-side, and (ii) part of the auction documentation. The typical excess is around on the buy-side, in your jurisdiction? 1% of the consideration. Policy limits vary between seller policies (usually they match the agreed maximum liability under the Private equity investors tend to prefer locked box structures, purchase agreement) and buyer policies (usually they start at around particularly when they are on the sell-side. Where the gap between 20% of the enterprise value but can also cover the full enterprise signing and the anticipated date of closing is long (e.g. because of value). Typical carve-outs and exclusions include fraud, matters the antitrust or other clearance requirements) closing adjustments are insured was aware of at the time of taking insurance, and forward the norm. Which parameters are included in a closing adjustment looking warranties (e.g. the ability to collect accounts receivables). depends on the target business, with the most common combination Indemnities for risks identified in the course of the due diligence can being adjustments for net debt, working capital, and (sometimes) sometimes be insured as part of the policy, if the contingent risk is capex. Equity adjustments are relatively rare. identifiable and quantum and likelihood assessable.
6.2 What is the typical package of warranties/indemnities 6.5 What limitations will typically apply to the liability of offered by a private equity seller and its management a private equity seller and management team under team to a buyer? warranties, covenants, indemnities and undertakings?
Experienced private equity sellers will try to avoid business Limitations on warranties warranties and indemnities (and instead just provide warranties on Common limitations on warranties include: title and capacity). In addition, experienced private equity sellers ■ Time limitation for bringing claims: will be very keen to limit recourse for warranty claims (e.g. to an ■ title and capacity warranties usually survive 10 years at amount paid into escrow) as well as any other post-closing liability. the minimum; Where private equity sellers are forced to give business warranties, ■ business warranties between 12 and 24 months; they will seek back-to-back warranties from management and ■ tax warranties typically around seven years; and underwrite a seller’s warranty and indemnity insurance policy (see the discussion in question 6.4 below) or offer the buyer management ■ environmental warranties five to 10 years. warranties instead (which are usually linked to a buyer’s warranty ■ Financial limits, including: and indemnity insurance policy). The latter structure has the benefit ■ a cap on the total liability (where there are multiple sellers, that the private equity seller will not have to concern himself with each may seek to limit its liability pro rata); post-closing warranty litigation. ■ a minimum aggregate claims threshold (“basket”); and ■ an exclusion of de-minimis claims. 6.3 What is the typical scope of other covenants, ■ Limitation to direct loss (as opposed to indirect and undertakings and indemnities provided by a private consequential loss). equity seller and its management team to a buyer? ■ Exclusion of claims to the extent caused by: ■ agreed matters; Private equity sellers will try to limit post-completion covenants to ■ acts of the purchaser (outside of the ordinary course of access to books and records and sometimes assistance in relation to business); pre-completion affairs. Usually buyers will insist on non-compete ■ change of law or interpretation of law; or and non-solicitation covenants (which private equity sellers will typically try to resist). Other post-completion covenants will ■ change of tax or accounting policies. depend on the particular case and may include covenants on de- ■ No liability for contingent liabilities. branding, migration, transitional services, and dealings regarding ■ No liability if the purchaser knew or could have known. group security interests and guarantees. ■ No liability for mere timing differences (e.g. if tax authorities request longer tax depreciation periods). ■ Obligation to mitigate loss. ■ No double recovery under warranties, indemnities and insurance policies. ■ A conduct of claims provision.
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Qualifying warranties by disclosure is not available at closing, the private equity buyer can withdraw Warranties are usually qualified by matters that have been disclosed from the contract but has to pay the reverse break fee to the seller). (in a certain manner) or are deemed disclosed by operation of the If structured that way (i.e. a condition linked to a withdrawal right), provisions of the acquisition agreement or the disclosure letter the amount of the fee should not be subject to judicial review. (e.g. information which can be obtained from publicly accessible Conversely, if the reverse break fee is structured as a contractual registers). The seller will always push for general disclosure (i.e. penalty for failure to close, the amount of the fee would be subject everything disclosed to the purchaser and its advisors at whatever to judicial review. occasion qualifies all warranties) while the purchaser will push for specific disclosure (i.e. separate disclosure for each warranty) and 7 Transaction Terms: IPOs try to introduce a disclosure threshold requiring that a matter must Austria be “fully and fairly” disclosed. This is usually heavily negotiated. Limitations on indemnities 7.1 What particular features and/or challenges should a private equity seller be aware of in considering an IPO Indemnities are generally not qualified by disclosure or knowledge. exit? The tax indemnity is usually only subject to a specific tax conduct provision, a direct loss limitation and the overall cap. Other An IPO exit requires that the articles of association and bylaws are limitations are a matter of negotiation. If other indemnities (e.g. adjusted, a due diligence is performed and a prospectus is prepared. for contamination and environmental compliance or specific due In addition, the company will have to enter into an underwriting diligence findings) are accepted, limitations are usually heavily agreement and management will have to participate in road shows. negotiated. All of that requires the cooperation of the company and (at least) where no new shares are issued, the management will typically 6.6 Do (i) private equity sellers provide security (e.g. ask the private equity seller to bear most of the associated costs escrow accounts) for any warranties / liabilities, and (based on an argument related to capital maintenance rules). Any (ii) private equity buyers insist on any security for new shares issued in the IPO, will naturally limit the number of warranties / liabilities (including any obtained from shares the private equity seller can sell into the IPO. In addition, the the management team)? underwriting agreement will usually provide for lock-up restrictions (see question 7.2) which limit the private equity seller’s ability Private equity sellers are generally prepared to provide security but to sell any shares it has retained following the IPO. Finally, the will, in turn, often require that the buyer’s recourse is limited to such private equity seller will usually be asked to give warranties in the security (see question 6.2). Whether or not private equity buyers underwriting agreement. In most cases the private equity seller will insist on security depends on various factors, including the set of be able to limit those warranties to matters relating to the private agreed warranties and the credit of the seller (that is where the seller equity fund and the shares it sells into the IPO. Sometimes director is a listed corporate there is less need for security than in case of a nominees are also required to give warranties. secondary transaction where the seller is a SPV or where business warranties come from management only). 7.2 What customary lock-ups would be imposed on private equity sellers on an IPO exit? 6.7 How do private equity buyers typically provide comfort as to the availability of (i) debt finance, and (ii) equity finance? What rights of enforcement The underwriting banks will usually expect some of the private do sellers typically obtain if commitments to, or equity seller’s shares to be locked-up for a period of about 180 days. obtained by, an SPV are not complied with (e.g. In addition, lock-up requirements may already be included in the equity underwrite of debt funding, right to specific shareholders’ agreement, but this is rather the exception. performance of obligations under an equity commitment letter, damages, etc.)? 7.3 Do private equity sellers generally pursue a dual-track exit process? If so, (i) how late in the process are Private equity buyers will typically be willing to provide a copy of private equity sellers continuing to run the dual-track, the executed equity commitment letter from the fund and copies and (ii) were more dual-track deals ultimately realised of the definitive financing agreements together with documents through a sale or IPO? evidencing that all conditions precedent (other than those within the private equity investor’s sole control) have been satisfied, to provide Dual-track processes are rare in Austria. As far as we are aware comfort that the necessary funds will be available at closing. If those there have only been a few attempts in the last couple of years, all of financing commitments are not complied with, sellers are typically which ultimately resulted in a trade sale. limited to claims for damages. Equity underwriting of debt funding is the exception but, in situations where definitive financing agreements are not in place at signing, experienced sellers will insist on an equity 8 Financing underwrite, particularly in auctions (to limit execution risks).
8.1 Please outline the most common sources of debt 6.8 Are reverse break fees prevalent in private equity finance used to fund private equity transactions in your transactions to limit private equity buyers’ exposure? jurisdiction and provide an overview of the current If so, what terms are typical? state of the finance market in your jurisdiction for such debt (particularly the market for high yield bonds). Reverse break fees as a means to limit a private equity buyer’s exposure in case the necessary financing is not available at closing Sources of debt finance for private equity transactions differ are not very common in Austria. If they are agreed, they are substantially for domestic private equity buyers, who typically seek typically linked to a financing condition (that is where the financing
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debt finance from domestic banks, and international private equity Regarding a future exit it should be taken into account that double buyers, who are able to tap international markets. taxation treaties usually assign the right to tax capital gains to the Leverage levels for large-cap buyouts have gone up in 2016 to around state of residence of the shareholder. For that reason, a foreign five to six times EBITDA and relative debt to equity ratios of 50% seller will usually not be taxed on the capital gains in Austria. If, to 70%. Mid- and small-cap transactions are sometimes financed however, the seller is an Austrian tax resident, capital gains taxation through equity only. Leverage levels and debt to equity ratios for mid- applies (i.e. no participation exemption is available for Austrian tax and small-cap transactions tend to be lower than for large-cap buyouts. residents in relation to Austrian targets). On mid- and small-cap transactions there is usually just senior and Avoidance of withholding taxes on dividends is usually less of an institutional debt as the additional transaction costs associated with issue, since pre-exit distributions are very rare. Still, to address that
Austria mezzanine debt are often not supported by the limited transaction issue, EU entities are usually preferred over non-EU entities and, size. On large-cap transactions it is a matter of pricing whether among the latter, entities from countries with which Austria has mezzanine debt is applied. High-yield is usually only considered concluded a double taxation treaty. for post-completion refinancing but not for the financing of the (original) purchase price. 9.2 What are the key tax considerations for management teams that are selling and/or rolling-over part of their investment into a new acquisition structure? 8.2 Are there any relevant legal requirements or restrictions impacting the nature or structure of the debt financing (or any particular type of debt Generally, an exchange of shares is treated in the same way as a financing) of private equity transactions? sale of shares and will thus trigger capital gains taxation. Assuming that management holds only a small percentage in the target, the Please see the answer to question 2.1. only option to roll-over their shares without triggering capital gains taxation is to contribute their shares into a company that, through such additional shares, either establishes or enlarges a majority 9 Tax Matters position in the target.
9.1 What are the key tax considerations for private equity 9.3 What are the key tax-efficient arrangements that are investors and transactions in your jurisdiction? Are typically considered by management teams in private off-shore structures common? equity portfolio companies (such as growth shares, deferred / vesting arrangements, “entrepreneurs’ relief” or “employee shareholder status” in the UK)? Usually, the private equity fund will seek to implement a tax offset structure, which is aimed at offsetting interest expense at the BidCo level with profit generated at the target company level. In principle, There is no specific regime that provides for tax reliefs or other tax there are two methods for achieving this: benefits of substantial nature to management teams. It is therefore important to ensure that capital gains taxation (27.5%) applies as (1) The first method is to establish a tax group between the BidCo and the target company. In such tax group, the fiscal result of opposed to taxation as employment income under general tax rules the BidCo and the target company is consolidated at BidCo (up to 55%) (see question 2.3 above). level, and thus the fiscal results of the BidCo and the target are offset. If the aggregated fiscal result of the BidCo and the 9.4 Have there been any significant changes in tax target company is negative, the loss can be carried forward by legislation or the practices of tax authorities the BidCo to future periods. The formation of such tax group (including in relation to tax rulings or clearances) requires a tax allocation agreement and an application to the tax impacting private equity investors, management office. The required minimum period of a tax group is fulfilled teams or private equity transactions and are any when three full fiscal years have expired. If the tax group is anticipated? collapsed prior to the lapse of the three-year period, the group members are retroactively taxed on a standalone basis. Until recently, the equity was typically channelled down to Austria (2) A second method, which is sometimes discussed but rarely by way of indirect grandparent capital contributions to avoid capital ever implemented because of the significant implementation duty (which would have been triggered in the case of a direct parent risk it involves, is an upstream merger of the target company capital contribution). Capital duty on direct capital contributions into the BidCo. Based on past decisions of the Austrian Supreme Court, it is pretty clear that where the BidCo was, however, abolished, effective as of 1 January 2016, which carries the acquisition debt for the purchase of the shares means acquisition structures will become simpler as interim of the target company, a downstream merger of the BidCo HoldCos, previously needed for capital duty reasons, will no longer into the target company will not be registered. In certain be required. Already since 2014, goodwill amortisation is no longer exceptional cases, an upstream merger of the target company available on share deals (which required the establishment of a tax into the BidCo may, however, be feasible. The result of group). The latter will likely lead to more foreign BidCos, unless such upstream merger would be that the shares in the target offsetting interest expenses incurred in financing the acquisition company pass to the BidCo parent, interest expense on the from the profits of the target is a major concern. acquisition debt can be offset against profit, and guarantees and security interests granted by the merged entity (holding Tax rulings are becoming more common, after a new ruling regime the cash-generating assets) are not subject to the limitations providing for binding tax rulings in the areas of reorganisations, under the Austrian capital maintenance rules (see above) and the group taxation regime, and transfer pricing was introduced thus will be of greater commercial value to the financing a few years ago. On the buy-side tax rulings are less common. banks. In particular, the last point is often of great interest However, we increasingly see rulings, e.g., in relation to pre-exit to the financing banks, which is why this route is sometimes reorganisations, such as a carve-out of a certain division which shall explored when a particular case supports the necessary be sold separately. arguments.
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By the Tax Amendment Act 2014, the deductibility of interest emphasis is placed on those areas in the due diligence process as expenses paid abroad is limited if the interest is paid to a related party well as in the purchase or investment agreement. In addition, private and not taxed at a minimum of 10%. Since that amendment of the equity firms will typically insist that a tight compliance system is put law, we see less shareholder loans from tax havens than in the past. in place following closing. Provided it is appropriately monitored, The parties should also consider changes in relation to real estate such system can serve as a defence for potential management and transfer tax (that is, a lower share consolidation threshold (now, 95% portfolio company liability in case of an administrative and criminal compared to 100% previously) and full attribution of shares held in offence by representatives of the portfolio company under Austrian trust to the trustor) whenever real estate is involved in a transaction. law. In addition, international private equity investors should also be concerned with any additional requirements under the UK Bribery Act and the US Foreign Corrupt Practices Act as both of 10 Legal and Regulatory Matters them claim extra-territorial jurisdiction. Austria
10.1 What are the key laws and regulations affecting 10.5 Are there any circumstances in which: (i) a private private equity investors and transactions in your equity investor may be held liable for the liabilities of jurisdiction, including those that impact private equity the underlying portfolio companies (including due to transactions differently to other types of transaction? breach of applicable laws by the portfolio companies); and (ii) one portfolio company may be held liable for the liabilities of another portfolio company? With regard to recent legislation affecting managers of private equity funds, see the discussion in question 10.2 below. With regard to In principle, a private equity investor is not liable for the liabilities transactions, private equity investors should be aware of the general of an underlying portfolio company. Exceptions apply, inter alia, clearance requirements (see question 4.1). under concepts of piercing the corporate veil, including (i) where the private equity investor factually manages, or substantially 10.2 Have there been any significant legal and/or controls the management of, the underlying portfolio company regulatory developments over recent years impacting (faktische Geschäftsführung), (ii) in cases of undercapitalisation private equity investors or transactions and are any (only where there is an obvious unbalance between the risks of anticipated? the business and the equity which is likely to result in a default), (iii) where based on the accounting records, the assets of the The most significant recent development impacting the private equity company cannot be separated from the assets of the private equity industry was the implementation of the AIFMD (EU Directive 2011/61/ investor (Sphärenvermischung), and (iv) in cases of shareholder EU) by the Austrian Alternative Investment Manager Act (Alternatives action putting the portfolio company at risk (existenzvernichtender Investmentfonds Manager-Gesetz − AIFMG). Private equity funds Eingriff) (where the investor takes action causing insolvency typically qualify as alternative investment funds (AIF). Managers of (Insolvenzverursachung), e.g. acceleration of a loan in distress). an AIF (AIFM) require a licence from the Austrian Financial Market Authority (Finanzmarktaufsichtsbehörde – FMA), unless the AIF In addition, a private equity investor may become liable to a creditor qualifies for the de minimis exception (which applies to managers of up to the amount secured where the private equity investor granted a small AIFs with assets of less than EUR100 million (where leverage guarantee or security interest securing a loan of a portfolio company is used) or less than EUR500 million (where no leverage is used), in in a “crisis” (as such term is defined in the Company Reorganisation which case they only need to register with the FMA. Act (URG)). In such circumstances the portfolio company can request the creditor to claim against the private equity investor first (in which case the recourse claim of the private equity investor 10.3 How detailed is the legal due diligence (including against the portfolio company is suspended until the crisis is over); compliance) conducted by private equity investors in addition, if the portfolio company pays the creditor, the portfolio prior to any acquisitions (e.g. typical timeframes, company can take recourse against the private equity investor. materiality, scope etc.)? Do private equity investors engage outside counsel / professionals to conduct all The above principles apply mutatis mutandis in relation to the risk legal / compliance due diligence or is any conducted of potential liability of one portfolio company for the liabilities of in-house? another portfolio company.
Private equity buyers tend to run a rather detailed issue focused due diligence with relatively high materiality thresholds, which 11 Other Useful Facts often concentrate on a very detailed analysis of a few value driving items. The timeframe depends very much whether it is a proprietary 11.1 What other factors commonly give rise to concerns situation (in which case the due diligence can take eight to 10 weeks for private equity investors in your jurisdiction or or even more) or an auction (in which case the timing is driven by should such investors otherwise be aware of in the auction process). With a few exceptions, private equity buyers considering an investment in your jurisdiction? active in Austria do not have the resources to run all legal and compliance due diligence in-house. Foreign private equity investors frequently find it difficult to access Austrian businesses, in particular family owned businesses. For that 10.4 Has anti-bribery or anti-corruption legislation reason they often find it useful to team up with a local partner or impacted private equity investment and/or investors’ initiate the contact through trusted advisors. approach to private equity transactions (e.g. diligence, contractual protection, etc.)?
Anti-bribery and anti-corruption legislation had a significant impact on private equity transactions in Austria. Since their enactment, more
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Florian Philipp Cvak Clemens Philipp Schindler Schindler Attorneys Schindler Attorneys Tuchlauben 13 Tuchlauben 13 1010 Vienna 1010 Vienna Austria Austria
Tel: +43 1 512 2613 Tel: +43 1 512 2613 Email: [email protected] Email: [email protected] URL: www.schindlerattorneys.com URL: www.schindlerattorneys.com Austria Florian’s practice is focused on corporate and finance law, in particular Clemens’ transactional practice is focussed on corporate and tax. He for private equity clients. Florian is admitted to the Austrian, New is admitted both as a lawyer and a certified public tax advisor in Austria. York and Polish Bar. Before establishing the firm as a co-founder, Before establishing the firm as a co-founder, Clemens spent six years Florian was a partner at Schoenherr, where he co-headed the private as partner at Wolf Theiss, where he led some of the firm’s most equity practice and was involved in some of the firm’s most prestigious prestigious transactions. Prior to that, he practised with Haarmann private equity transactions in Austria as well as the wider CEE region. Hemmelrath in Munich and Vienna, as well as with Wachtell Lipton Florian received the following awards and is ranked in: Rosen & Katz in New York. Clemens’ practice focuses on corporate and tax advice in relation to public and private M&A, private equity and ■ Chambers Europe. corporate reorganisations (such as mergers, spin-offs and migrations), ■ Chambers Global. most of which have a cross-border element. Clemens is ranked in: ■ The Legal 500. ■ Chambers Europe. ■ IFLR1000. ■ Chambers Global. ■ Best Lawyers in Austria – (Best Lawyers). ■ The Legal 500. ■ Private Equity Lawyer of the year – Austria (ACQ) – 2013 to ■ IFLR1000. 2015. ■ The International Who’s Who of Corporate/M&A Lawyers. ■ Format (as one of the top 10 CEE lawyers in Austria). ■ The International Who’s Who of Corporate Tax Lawyers. ■ Best Lawyers in Austria – (Best Lawyers). ■ JUVE (as one of the top 20 Corporate/M&A lawyers in Austria). ■ TREND (as one of the top 10 corporate lawyers in Austria).
Schindler Attorneys is a leading Austrian law firm focused on transactional work, with a strong focus on private equity. The members have an impressive track record in private equity and an excellent understanding of the needs of financial sponsors. The firm’s integrated tax practice is a key differentiator from other firms on the Austrian market and is particularly appreciated by financial sponsors for acquisition structuring, incentive schemes can be handled in-house. The firm usually acts for financial sponsors, but sometimes advises banks on the financing of buyout transactions as well.
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Bermuda
Cox Hallett Wilkinson Limited Natalie Neto
are detailed further in the response to question 10.1 below) modernise 1 Overview Bermuda’s asset management sector and improve its product offering for both private equity and closed-ended investment funds. 1.1 What are the most common types of private equity The BMA is positioning Bermuda to receive a recommendation by transactions in your jurisdiction? What is the current the European Securities and Markets Authority to enable Bermuda state of the market for these transactions? Have to operate as an Alternative Investment Fund Managers Directive you seen any changes in the types of private equity equivalent jurisdiction, which would allow Bermuda fund managers transactions being implemented in the last two to three years? to opt in to the AIFMD Passport regime once it is extended to third countries. Once granted, it is anticipated that the availability of this regime will stimulate deal activity. Trends in the private equity market in Bermuda tend to track the markets in the major onshore jurisdictions, particularly in the USA, Europe and Asia. 2 Structuring Matters Political uncertainty in both the US and Europe may bring challenges for the private equity sector, as the impact of Brexit in Europe and the proposals for tax reform in the US are a focus of investors and 2.1 What are the most common acquisition structures adopted for private equity transactions in your sponsors on both sides of the Atlantic. However, proposals for jurisdiction? Have new structures increasingly increased investment in infrastructure in the US signal opportunities developed (e.g. minority investments)? for Bermuda in terms of structuring private equity investments, including, in particular, the first new corporate vehicle introduced in Private equity acquisition structures vary widely and may involve Bermuda in over 100 years, the limited liability company (“LLC”), majority or minority investments or M&A transactions. Acquisition which is based on the Delaware model. structures involving private Bermuda companies may involve direct investment into the target company (by the issue of new shares to 1.2 What are the most significant factors or developments the private equity investor, or by secondary issues) or the formation encouraging or inhibiting private equity transactions of a holding company (“Topco”) into which the private equity in your jurisdiction? investor will invest alongside management and other shareholders. Intermediate holding companies between Topco and the ultimate Bermuda continues to offer a broad array of venture capital and target may be inserted to facilitate debt financing, security structures private equity opportunities and is very attractive to investors due or for tax or other commercial reasons. If so, the relevant holding to the safe, well-regulated, business-oriented environment and the company would acquire the shares in the target company typically by deep bench of industry and professional expertise available locally. way of a share purchase, share for share exchange or by a merger or Bermuda has been an OECD ‘whitelist’ country since 2009 and has amalgamation with the target company (although other acquisition robust anti-money laundering regulations. structures may be used including those mentioned below). The Bermuda Monetary Authority (“BMA”), which is responsible For acquisition structures involving public companies, these are for regulating the financial services sector in Bermuda, takes a risk- typically structured by way of one or more of the following: based approach to the regulation and supervision of the entities for ■ a general offer to purchase the shares (or class of shares) of which it is responsible. Closed-ended private equity funds do not fall the target, which must generally be accepted by the holders within the definition of an ‘investment fund’ under the Investment of at least 90% of the shares that are the subject of the offer Funds Act, 2006 and are not regulated for the purpose of that Act to enable the offeror to compulsorily acquire the remaining being subject only to the basic legal requirements applicable to the shares; particular private equity vehicle used. ■ compulsory acquisition of the shares of the remaining The BMA actively engages the private sector and industry specialists shareholders where the acquirer obtains 95% or more of the in respect of any proposed legislative change. Recent legislative shares; changes which have arisen as a result of a collaboration between ■ a court sanctioned scheme of arrangement pursuant to section the BMA, the Bermuda Government and the private sector, have 99 of the Companies Act, 1981 (as amended) (the “Companies Act”). A scheme requires board approval (as the board enhanced the choices available to companies looking to structure a typically proposes and controls the scheme process) and the private equity deal or fund in Bermuda. These amendments (which approval of a majority in number of scheme shareholders (or
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classes thereof) representing three-fourths in nominal value against dilution) on new issues as well as share transfers; drag/tag- voting at the special general meeting convened by the court along rights; and other change of control provisions. The investor to approve the scheme; and would usually seek veto rights over certain matters, including any ■ amalgamations or mergers pursuant to the Companies Act. An changes to the share capital, debt position, constitutional documents amalgamation involves two or more companies amalgamating and a change of control of the company or of the nature of the and continuing as one company and a merger involves one business conducted by it. company merging into another with only one company surviving. The board of the amalgamating or merging companies would approve the terms of the amalgamation or 3 Governance Matters merger (including an implementation or similar transaction agreement) and the statutory amalgamation or merger Bermuda agreement (as applicable), which would be subject to the 3.1 What are the typical governance arrangements approval of the shareholders of each of the amalgamating or for private equity portfolio companies? Are such merging companies. Subject to the bye-laws, the approval arrangements required to be made publicly available of 75% of the shareholders present and voting at a special in your jurisdiction? general meeting at which two or more persons are present in person or by proxy is required. All shareholders of a company A Bermuda-domiciled private equity portfolio company would be (even those holding non-voting shares) are entitled to vote on managed by a board of directors including executive directors, investor an amalgamation or merger. Dissenting shareholders have directors and independent directors. The composition of boards of the right to apply to the court to have the fair value of their shares appraised by the court within one month of the notice portfolio companies varies widely depending on the deal structure. convening the meeting. The board’s authority is derived from the shareholders and is subject to any restrictions set out in the constitutional documents and in any shareholders’ agreement. 2.2 What are the main drivers for these acquisition structures? The constitutional documents comprise the memorandum of association, which sets out the objects and powers of the company The structure will depend on the nature of the proposed acquisition and the bye-laws which govern the relationship between the and the nature of the target (public/private) as well as tax, commercial company and its shareholders and contain the corporate governance and regulatory considerations. provisions. The memorandum of association is filed at the Registrar of Companies in Bermuda and is publicly available. The bye-laws may also be subject to a separate shareholders’ or 2.3 How is the equity commonly structured in private equity transactions in your jurisdiction (including investor rights agreement between the company and its shareholders institutional, management and carried interests)? (or some of them), which are often required by private equity investors, in part due to concerns over confidentiality. However, Structures vary widely but will often involve the private equity neither the bye-laws or any shareholders’ or investor rights investors taking ordinary shares, preference shares and/or loan notes. agreement are required to be filed or registered in Bermuda. Management would usually hold ordinary shares and/or employee share options or restricted shares. Carried interests are less common. 3.2 Do private equity investors and/or their director nominees typically enjoy significant veto rights over major corporate actions (such as acquisitions and 2.4 What are the main drivers for these equity structures? disposals, litigation, indebtedness, changing the nature of the business, business plans and strategy, This will largely be determined by the location of the private equity etc.)? If a private equity investor takes a minority investor and tax and commercial requirements for the structuring of position, what veto rights would they typically enjoy? investments and any debt related financing. Yes. See the response to question 2.6 above. 2.5 In relation to management equity, what are the typical vesting and compulsory acquisition provisions? 3.3 Are there any limitations on the effectiveness of veto arrangements: (i) at the shareholder level; and (ii) Management shares or options would typically be subject to at the director nominee level? If so, how are these compulsory acquisition provisions which normally include ‘good typically addressed? leaver/bad leaver’ provisions. Depending on the bargaining strength of the parties, either good or bad leaver would usually be defined, (i) Generally veto rights would be upheld by the Bermuda courts unless they were considered to be an unlawful fetter with all other circumstances being deemed to be good or bad, as on the statutory powers of the company. The Companies Act the case may be. Typical good leaver provisions include death, expressly permits a company to fetter its powers in certain disability or long-term illness or after a certain length of employment circumstances, including changes to the constitutional (effectively vesting the value of the shares after an agreed period). documents, changes to share capital, removal of directors, Typically a good leaver would receive the higher of cost and fair approval of amalgamations and mergers and voluntary value for his shares and a bad leaver can expect to receive the lower liquidations. of fair value and cost. (ii) An investor or nominee director is subject to overriding fiduciary and statutory duties which are owed to the company and its shareholders as a whole and would need to ensure that 2.6 If a private equity investor is taking a minority position, at all times decisions were being made with a view to the best are there different structuring considerations? interests of the company.
Considerations would include: pre-emption rights (protecting
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3.4 Are there any duties owed by a private equity investor 4 Transaction Terms: General to minority shareholders such as management shareholders (or vice versa)? If so, how are these typically addressed? 4.1 What are the major issues impacting the timetable for transactions in your jurisdiction, including competition and other regulatory approval requirements, A private equity investor would not generally owe any fiduciary disclosure obligations and financing issues? or other duties to a minority shareholder (unless it had agreed to assume them). The shareholders’ agreement will commonly contain Timetables are usually dictated by any regulatory approvals provisions that expressly exclude any such duties on the part of the required in the jurisdictions in which the private equity investor or investor. the target’s assets is located. There are no competition or anti-trust Bermuda filings in Bermuda. Entities that are regulated by the BMA would 3.5 Are there any limitations or restrictions on the need to observe regulatory notification requirements and obtain any contents or enforceability of shareholder agreements necessary BMA consents. (including (i) governing law and jurisdiction, and (ii) All issues or transfers of shares in Bermuda companies require the non-compete and non-solicit provisions)? prior permission of the BMA, unless a general permission has been granted. A general permission is available for the issue or transfer (i) Shareholder agreements that are subject to a governing law other than the laws of Bermuda would generally be of shares in a company whose shares are listed on a recognised stock enforceable in Bermuda (provided they do not contravene exchange. The BMA will require disclosure of the intermediate and statute or public policy). Third-party rights may now be ultimate beneficial ownership of any person wishing to acquire conferred by contractual provisions but not by a company’s more than 10% of a Bermuda company. Beneficial ownership of bye-laws and any such provisions should be set forth in the private equity funds that are limited partnerships would be traced shareholders’ agreement. through the general partners not the limited partners. (ii) Non-compete and non-solicitation provisions would be Public offers of shares of a Bermuda company may require a prospectus upheld to the extent that they are necessary to protect the to be published and filed in Bermuda unless an exemption is available. legitimate business interests of the private equity investor.
4.2 Have there been any discernible trends in transaction 3.6 Are there any legal restrictions or other requirements terms over recent years? that a private equity investor should be aware of in appointing its nominees to boards of portfolio companies? What are the key potential risks and Trends in transaction terms tend to follow the trends in whatever liabilities for (i) directors nominated by private equity jurisdiction the private equity investor and/or the target company investors to portfolio company boards, and (ii) private is located. equity investors that nominate directors to boards of portfolio companies under corporate law and also more generally under other applicable laws (see 5 Transaction Terms: Public Acquisitions section 10 below)?
(i) Directors of Bermuda companies owe their duties generally 5.1 What particular features and/or challenges apply to to the company itself and not to the party that nominated private equity investors involved in public-to-private them. Nominee directors need to be particularly mindful of transactions (and their financing) and how are these their duties to act in the best interests of the company and to commonly dealt with? avoid conflicts of interests. (ii) Although the concept of a ‘shadow director’ is not formally Bermuda does not have a Takeover Code. The principal regulations recognised in Bermuda, for the purposes of section 243 governing take- privates involving Bermuda companies are derived of the Companies Act (dealing with offences by past or from: present officers of companies in liquidation), the definition ■ the Companies Act, 1981 and other applicable legislation; of ‘officer’ includes a person ‘in accordance with whose ■ if the shares of the target entity are listed on the Bermuda directions or instructions the directors of a company have Stock Exchange (“BSX”), the BSX Listing Regulations; been accustomed to act’. ■ if the shares of the target entity are listed and/or traded on a foreign stock exchange, the Takeover Code and applicable 3.7 How do directors nominated by private equity Listing Rules and regulations concerning disclosure, insider investors deal with actual and potential conflicts of dealing and market manipulation in the relevant jurisdiction; interest arising from (i) their relationship with the and party nominating them, and (ii) positions as directors ■ the constitutional documents (namely, the memorandum of of other portfolio companies? association and bye-laws).
Directors would be required to comply with provisions of the See also the response to question 2.1 for structuring considerations. Companies Act and the bye-laws in relation to any conflicts arising. 5.2 Are break-up fees available in your jurisdiction in relation to public acquisitions? If not, what other arrangements are available, e.g. to cover aborted deal costs? If so, are such arrangements frequently agreed and what is the general range of such break-up fees?
Break fees are permitted in Bermuda on the basis that they provide
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compensation for losses incurred during the course of negotiating the failed transaction (and do not constitute a penalty), and are 6.5 What limitations will typically apply to the liability of usually between 2–4%. Other common provisions are exclusivity, a private equity seller and management team under warranties, covenants, indemnities and undertakings? ‘no shop’ and ‘go shop’. Boards of Bermuda companies need to be cognisant of statutory and See the answer to question 6.2 above. common law duties applicable to directors, including to act honestly and in good faith in the best interests of the company. It is common for directors to seek ‘fiduciary out’ clauses (particularly with respect 6.6 Do (i) private equity sellers provide security (e.g. to ‘no shop’ restrictions and exclusivity undertakings). escrow accounts) for any warranties / liabilities, and (ii) private equity buyers insist on any security for
Bermuda warranties / liabilities (including any obtained from 6 Transaction Terms: Private Acquisitions the management team)?
See the answer to question 6.1 above. On the buy-side, it is common 6.1 What consideration structures are typically preferred for parent guarantees to be sought from corporate sellers (less so by private equity investors (i) on the sell-side, and (ii) from management unless it is a secondary buyout). on the buy-side, in your jurisdiction?
Common consideration structures involve working capital or debt 6.7 How do private equity buyers typically provide comfort as to the availability of (i) debt finance, free/cash free adjustments and earn-outs on the buy-side. Escrow and (ii) equity finance? What rights of enforcement and holdback provisions are routinely included in support of any do sellers typically obtain if commitments to, or consideration adjustment mechanisms, as well as in respect of obtained by, an SPV are not complied with (e.g. claims under the warranties and indemnities. On the sell-side, equity underwrite of debt funding, right to specific investors often seek to limit the amount of any such claims to the performance of obligations under an equity escrow/holdback funds. commitment letter, damages, etc.)?
Comfort is typically provided in the form of a comfort letter upon which 6.2 What is the typical package of warranties/indemnities offered by a private equity seller and its management the target company can rely, which would be subject to satisfaction of team to a buyer? all deal conditions including debt/equity financing availability.
Private equity investors typically only give warranties as to title to 6.8 Are reverse break fees prevalent in private equity shares, capacity and authority. Such warranties are usually unlimited transactions to limit private equity buyers’ exposure? in time and amount although that will be subject to negotiation. If so, what terms are typical? Management usually provide the business warranties and any indemnities. Warranties may be provided generally on an indemnity Reverse break fees are permissible and are seen but are not very basis but more usually we would expect warranties to give rise to common. claims in damages only and specific indemnities to cover only known issues arising through the due diligence/disclosure process. 7 Transaction Terms: IPOs Limitations on the warranties and indemnities would usually be heavily negotiated and would include time limits (typically one to three years) and limits on amounts as well as individual and 7.1 What particular features and/or challenges should a aggregate basket provisions. private equity seller be aware of in considering an IPO exit?
6.3 What is the typical scope of other covenants, IPOs are a very common exit strategy in Bermuda. During the undertakings and indemnities provided by a private first three-quarters of 2015, private equity exits totalled $19.68 equity seller and its management team to a buyer? billion. Challenges would usually arise due to the regulatory rules and market conditions in the jurisdiction in which the IPO is being Typically, only exiting management would provide restrictive launched. IPOs on the BSX would require compliance with the covenants, the scope of which should only extend to what is BSX Listing Regulations. necessary to protect the legitimate business interests of the buyer. Any Bermuda company offering shares to the public would need to comply with the prospectus requirements of the Companies 6.4 Is warranty and indemnity insurance used to “bridge Act. Where the company is seeking a listing on an appointed stock the gap” where only limited warranties are given by exchange other than the BSX and a prospectus has been submitted the private equity seller and is it common for this to be offered by private equity sellers as part of the to the relevant stock exchange, it is not also necessary to publish and sales process? If so, what are the typical (i) excesses file a prospectus in Bermuda. / policy limits, and (ii) carve-outs / exclusions from such warranty and indemnity insurance policies? 7.2 What customary lock-ups would be imposed on private equity sellers on an IPO exit? Insurance is available and attractive to private equity sellers looking to ‘bridge the gap’, but our experience has been that its use can be limited This would depend on the rules of the relevant stock exchange. depending on the nature of carve-outs and policy limits (of which there is a wide range) and the scope of coverage. Insurers would typically require all other recovery sources (e.g. escrow and holdback funds) to be exhausted before recovering under any such policies.
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7.3 Do private equity sellers generally pursue a dual-track 9.4 Have there been any significant changes in tax exit process? If so, (i) how late in the process are legislation or the practices of tax authorities private equity sellers continuing to run the dual-track, (including in relation to tax rulings or clearances) and (ii) were more dual-track deals ultimately realised impacting private equity investors, management through a sale or IPO? teams or private equity transactions and are any anticipated? Private equity sellers increasingly pursue more than one exit strategy simultaneously, including IPOs, trade sales and/or secondary Please see the answer to question 9.1 above. buyouts, with a view to achieving the most favourable outcome in the circumstances. The timing and ultimate realisation of such processes will be dictated by the available routes to exit. 10 Legal and Regulatory Matters Bermuda
8 Financing 10.1 What are the key laws and regulations affecting private equity investors and transactions in your jurisdiction, including those that impact private equity 8.1 Please outline the most common sources of debt transactions differently to other types of transaction? finance used to fund private equity transactions in your jurisdiction and provide an overview of the current Recent legislative changes have significantly enhanced Bermuda’s state of the finance market in your jurisdiction for such product offering in relation to private equity investments. The debt (particularly the market for high yield bonds). following three are the most commonly used vehicles for structuring investment funds and private equity investments in portfolio The most common source is term loan or revolving credit financing companies: from a traditional bank (which may or may not incorporate a junior or mezzanine layer). Increasingly, deal structures may involve (i) Exempted limited partnerships commonly used for investment funds and subject to the Exempted Partnership alternative financing arrangements from funds and other institutional Act, 1995 and the Limited Partnership Act, 1883. A Bermuda investors. High yield bond financing transactions are very popular, partnership may elect to have separate personality and the especially in Bermuda companies that are listed in Asia. general partner is not required to be Bermuda resident. Limited partnership agreements can be customised from 8.2 Are there any relevant legal requirements or Delaware models easily and are flexible. While limited restrictions impacting the nature or structure of partners must not take part in management, the ‘safe harbour’ the debt financing (or any particular type of debt provisions (which will not constitute management by a financing) of private equity transactions? limited partner) have recently been extended and include nominating and serving on management boards. Limited There are no such requirements or restrictions arising under partners do not owe any fiduciary duties to any other partner or the partnership itself. Bermuda law. (ii) Exempted companies are governed by the Companies Act. Exempted companies are companies limited by shares and 9 Tax Matters shareholders’ liability is limited to the amounts unpaid on their shares. Exempted companies can create a registered segregated accounts structure under the Segregated Accounts 9.1 What are the key tax considerations for private equity Act, 2000 (whereby each segregated account is not liable for investors and transactions in your jurisdiction? Are the debts and obligations of the other segregated accounts), off-shore structures common? which is particularly beneficial to deal-by-deal and hybrid investment strategies. Non-Bermuda residents are not subject to any profits tax, withholding (iii) LLCs introduced by The Limited Liability Company Act and tax, capital gains tax, capital transfer tax, estate duty or inheritance tax based on the Delaware model. The LLC is a hybrid between in Bermuda. Private equity vehicles and portfolio companies that are a limited partnership and a company and offer a great deal Bermuda exempted companies, partnerships or LLCs, may obtain a tax of flexibility to investors. LLCs are a separate legal entity assurance from the Minister of Finance for a nominal fee confirming and may be managed by members, and the operating that, until 31 March 2035, in the event that legislation is enacted in agreement allows for maximum contractual flexibility and Bermuda that would impose such taxes, it will not apply to the entity may expressly exclude fiduciary duties owed to the members or the partnership. LLCs may convert to companies or concerned or its operations, shares, interests, debentures or obligations. partnerships and vice versa.
9.2 What are the key tax considerations for management teams that are selling and/or rolling-over part of their 10.2 Have there been any significant legal and/or investment into a new acquisition structure? regulatory developments over recent years impacting private equity investors or transactions and are any anticipated? Please see the answer to question 9.1 above. The BMA is currently engaged in a consultation process with respect 9.3 What are the key tax-efficient arrangements that are to proposed improvements to the Investment Funds Act, 2006 and typically considered by management teams in private the Investment Business Act, 2003. Legislation permitting the equity portfolio companies (such as growth shares, incorporation of segregated accounts is also anticipated. deferred / vesting arrangements, “entrepreneurs’ relief” or “employee shareholder status” in the UK)?
Please see the answer to question 9.1 above.
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Under section 246 of the Companies Act, if during the course of 10.3 How detailed is the legal due diligence (including the winding up of a company it appears that any business of the compliance) conducted by private equity investors company has been carried on with the intention to defraud creditors prior to any acquisitions (e.g. typical timeframes, of the company or creditors of any other person or for any fraudulent materiality, scope etc.)? Do private equity investors engage outside counsel / professionals to conduct all purpose, any person who was knowingly a party to the carrying legal / compliance due diligence or is any conducted on of the business in such manner may be held personally liable in-house? without any limitation of liability, for all or any of the debts or other liabilities of a company. See also the response to question 3.6 above. Bermuda counsel would typically be engaged to review the corporate structure, regulatory compliance and annual filings as
Bermuda well as to confirm that there is no outstanding litigation or registered 11 Other Useful Facts charges in Bermuda. Typically, the assets of a Bermuda company would be located outside of the jurisdiction. We are often involved 11.1 What other factors commonly give rise to concerns in cross-border legal due diligence projects. for private equity investors in your jurisdiction or should such investors otherwise be aware of in considering an investment in your jurisdiction? 10.4 Has anti-bribery or anti-corruption legislation impacted private equity investment and/or investors’ approach to private equity transactions (e.g. If a foreign private equity investor is seeking a physical presence diligence, contractual protection, etc.)? in Bermuda, the Bermuda Business Development Agency (www. bda.com) offers information and support in the form of a ‘concierge Bermuda has recently passed the Bribery Act, 2016 which creates service’ and will assist with making the appropriate connections in new offences of bribery, including offences committed by associated terms of the regulators and service providers in Bermuda. persons (including directors, officers, employees) for which a commercial undertaking may be held liable. As this is recent, its impact on transactions has not been greatly felt. However, transaction documents will need to include contractual protections for potential liability under this Act.
10.5 Are there any circumstances in which: (i) a private equity investor may be held liable for the liabilities of Natalie Neto the underlying portfolio companies (including due to Cox Hallett Wilkinson Limited th breach of applicable laws by the portfolio companies); Cumberland House, 9 Floor 1 Victoria Street and (ii) one portfolio company may be held liable for Hamilton HM 11 the liabilities of another portfolio company? Bermuda
The liability of a shareholder in a Bermuda company limited by Tel: +1 441 294 1512 Email: [email protected] shares is limited to the unpaid amounts (if any) in respect of their URL: www.chw.com shares. This is the corollary to the principle of separate corporate
personality established in Salomon v A Salomon & Co Ltd [1897] Natalie Neto, Head of Corporate AC 22. Natalie has over 18 years’ experience advising on a range of corporate As a consequence, a company’s actions are its own for which it is and regulatory matters including corporate governance issues; IPOs; responsible. A company’s liability is also its own and does not pass banking and private equity transactions; mergers and acquisitions through to its shareholders. The circumstances in which the court (with particular expertise in regulated entities); joint venture and special purpose vehicles; and offshore corporate, partnership and will ignore the principle of a company’s separate liability and hold limited liability company structures (with particular expertise in relation the shareholders accountable for a company’s actions (known as to complex global restructuring projects involving Bermuda entities). ‘piercing the corporate veil’) are therefore very exceptional. Such Natalie is a certified director of the Institute of Directors andis cases would generally involve the legal personality of the company Executive Committee Member and Chairman of the Regulatory Sub- being used for the purpose of wrongdoing where no other remedy Committee of the Institute of Directors – Bermuda Branch. is available.
Cox Hallett Wilkinson Limited is one of Bermuda’s leading commercial law firms. The firm serves a diverse clientele and provides a full range of legal and other professional services. Through its affiliated companies, it provides corporate administration and licensed trustee and administration services. The firm and its attorneys are recommended in a number of global law firm guides. CHW is consistently recognised as one ofthetopthree commercial law firms in Bermuda by Chambers Global, IFLR1000 and The Legal 500.
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Brazil
Pinheiro Neto Advogados Eduardo H. Paoliello Jr.
partnerships), the FIP is a non-personified condominium of assets 1 Overview managed and represented by an administrator registered with the CVM. 1.1 What are the most common types of private equity The FIPs then invest in target companies directly, or through a transactions in your jurisdiction? What is the current corporation. FIPs are authorised to invest in shares, convertible state of the market for these transactions? Have and non-convertible debentures, subscription warrants (bônus de you seen any changes in the types of private equity subscrição) and other convertibles. The FIPs must play an active transactions being implemented in the last two to three years? role in the company’s management. PE investors usually invest in growth strategies (by acquiring The types of transactions we see are acquisitions of either relevant relevant stakes from founding shareholders or making capital minority stakes, or a controlling interest by private equity investors. injections). Although less common because of the high interest In both structures, the private equity fund usually puts a strong rates in Brazil, some PE investors also structure LBO transactions shareholders’ agreement in place, which takes into account by either taking loans from financial institutions or financing the corporate governance rules, registration rights and exit mechanisms, acquisition through a seller’s note. and founding shareholders usually have a key role in the company’s management. The private equity industry has been very active in 2.2 What are the main drivers for these acquisition the last few years, as most players raised new funds for the region. structures? Because of recent local currency devaluation, the size of deals is likely to grow in this new capital deployment round. We may also Tax efficiency and other legal issues are usually the main drivers. experience an increase in the number of private equity investors The FIP structure streamlines the funding process and optimises supporting take-private and PIPE deals. investment returns through its friendly tax regime. The FIP can make the investment directly or through a holding company, 1.2 What are the most significant factors or developments depending on the protection and goals an investor wants to achieve. encouraging or inhibiting private equity transactions In case of LBOs, for instance, it is mandatory in the creation of a in your jurisdiction? holding company, as FIPs cannot take loans.
The tax benefit enjoyed by private equity funds in Brazil is certainly 2.3 How is the equity commonly structured in private the main factor, alongside macroeconomic factors (such as currency equity transactions in your jurisdiction (including devaluation, increase in consumer spending, etc.). Current political institutional, management and carried interests)? and economic crises have inhibited investors from deploying large amounts of capital in 2016. PE firms also focused their efforts in Usually, foreign institutional investors invest in the FIPs, which sectors that have a negative correlation with the country’s economic then invest in shares (most likely) or convertibles of the target growth. companies. Founding shareholders/management generally remain in the company and are not required to invest alongside with the 2 Structuring Matters equity fund. Whenever a long-term incentive plan is designed for a deal, management invests directly in the target company. The structure of carried interests varies from fund to fund, and takes into 2.1 What are the most common acquisition structures account the jurisdiction of investors, whether the equity fund invests adopted for private equity transactions in your only in Brazil or has a broader mandate, and in which jurisdiction jurisdiction? Have new structures increasingly the investment team is located. developed (e.g. minority investments)?
Private equity investments are usually made through Fundos de 2.4 What are the main drivers for these equity structures? Investimento em Participações (“FIPs”). The FIPs are investment funds regulated by the local Securities and Exchange Commission Equity structures are usually driven by a mix of tax efficiency and (“CVM”). As in other forms of Brazilian funds (and as opposed legal protection. to other jurisdictions where investment funds are organised as
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2.5 In relation to management equity, what are the typical 3.3 Are there any limitations on the effectiveness of veto vesting and compulsory acquisition provisions? arrangements: (i) at the shareholder level; and (ii) at the director nominee level? If so, how are these typically addressed? Management equity plans are usually structured as typical stock option plans or phantom stock plans. It is also common to have plans in which vesting is partially time-based and partially return- Veto arrangements are effective in Brazil. Under Brazilian law, the based, tied to a minimum return on the investment made by the obligations set out in a shareholders’ agreement at both shareholder private equity fund. Some companies also use management equity and BoD levels are subject to specific performance. Additionally, plans which require members of management to invest part of their the Chairman of the relevant meeting may disregard the votes cast Brazil bonus in shares of the company. The plans also provide for rules in conflict with the existing shareholders’ agreement. on compulsory acquisition if the beneficiary leaves the company, at different pricing for situations of “good” or “bad” leavers. 3.4 Are there any duties owed by a private equity investor to minority shareholders such as management shareholders (or vice versa)? If so, how are these 2.6 If a private equity investor is taking a minority typically addressed? position, are there different structuring considerations? No special duties arise from the fact that the shareholder is a private equity investor. Brazilian corporate law establishes the duties There is no difference in terms of equity investment structure. Some imposed on a controlling shareholder towards the company and other funds prefer to invest in different types of securities (preferred shareholders. As a rule, shareholders must exercise their voting shares/convertibles) when taking a minority position, though. rights in the company’s best interest. Controlling shareholders are liable for the damage resulting from acts taken in abuse of power. 3 Governance Matters 3.5 Are there any limitations or restrictions on the contents or enforceability of shareholder agreements 3.1 What are the typical governance arrangements (including (i) governing law and jurisdiction, and (ii) for private equity portfolio companies? Are such non-compete and non-solicit provisions)? arrangements required to be made publicly available in your jurisdiction? Shareholders’ agreements must be kept on file at the company to be enforceable on the company itself and on its management. This FIP rules set out certain governance requirements that investees is an important but simple formality, usually met by having the must abide by, such as a unified two-year term of office for the company as an intervening party to the agreement. entire board of directors of the investee, an obligation to disclose related-party agreements, adherence to an arbitration chamber for The laws of a different jurisdiction may be elected to govern settlement of corporate disputes, or compulsory annual auditing into agreements involving Brazilian parties or companies established financial statements. in Brazil. If a foreign jurisdiction governs the shareholders’ agreement, enforcement of any foreign court decision is subject to The FIPs also negotiate shareholders’ agreements which usually an exequatur, which is a potentially complex and time-consuming contain more specific governance arrangements, such as veto rights, recognition procedure before the Brazilian Superior Court of Justice. disclosure rights, the right to appoint executive office members As most effects from the agreement take place in Brazil, and given (usually at least the CFO), compulsory instatement of special the difficulties in enforcing a foreign court decision, virtually all committees to support the board of directors, etc. shareholders’ agreements involving Brazilian companies contain the Shareholders’ agreements for private companies are non-public. choice of jurisdiction of Brazilian courts. Listed companies are required to make any shareholders’ agreements Non-compete obligations are enforceable if some requirements public. At any rate, the bylaws are a public document, and most have been met, namely: (i) proper compensation is paid for it governance rules are usually duplicated there. (i.e. a portion of the purchase price); (ii) there is a limitation on the territory, which cannot be greater than the entire country (i.e. 3.2 Do private equity investors and/or their director clauses limiting competition to Latin America as a whole are not nominees typically enjoy significant veto rights over enforceable); and (iii) the term cannot be longer than five years. major corporate actions (such as acquisitions and For ease of enforceability, it is also advisable to have a well-crafted disposals, litigation, indebtedness, changing the language describing the prohibited activities. The rationale is the nature of the business, business plans and strategy, same for non-solicit obligations, which are also enforceable. etc.)? If a private equity investor takes a minority position, what veto rights would they typically enjoy? 3.6 Are there any legal restrictions or other requirements Yes; PE investments in Brazil usually involve the execution of a that a private equity investor should be aware of shareholders’ agreement containing corporate governance rules. in appointing its nominees to boards of portfolio Veto rights usually depend on the size of the stake held by the companies? What are the key potential risks and liabilities for (i) directors nominated by private equity PE investor. Discussions usually revolve around major corporate investors to portfolio company boards, and (ii) private actions, such as: (i) approval for the business plan and annual budget; equity investors that nominate directors to boards (ii) indebtedness above a certain threshold; (iii) M&A; (iv) CAPEX of portfolio companies under corporate law and also investment; (v) corporate reorganisation; (vi) capital increase and more generally under other applicable laws (see issuance of convertible securities; (vii) stock buyback programmes; section 10 below)? and (viii) approval for related-party agreements. Private equity investors holding a minority stake are usually successful in getting Appointing a director is subject to confirmation that such designee most of the typical veto rights. is not impaired by special law, or sentenced for bankruptcy crime,
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fraud, bribery or corruption, misappropriation of public funds or especially with respect to merger control, in particular through the embezzlement, crimes against the economic system, good morals adoption of a pre-merger review system where antitrust approval is or third-party property, or else subject to any criminal sanction that a condition precedent for the closing or consummation of the deal. precludes, even temporarily, access to public offices. Additionally, Transactions that meet the filing thresholds must go through antitrust unless otherwise waived by the general meeting, persons who hold clearance. The thresholds are: (i) one of the economic groups positions in companies that may be regarded as market competitors or involved in the deal has recorded an annual gross turnover above R$ who have a conflict of interestsvis-à-vis those of the company cannot be 750 million; and (ii) at least another group involved in the deal has appointed as directors. In certain regulated sectors (banking, insurance recorded an annual gross turnover in Brazil above R$ 75 million. and others), the appointment of any member of management is subject
to the regulator’s approval and other experience requirements. Brazil 4.2 Have there been any discernible trends in transaction Directors/officers can be held jointly liable for the company’s terms over recent years? obligations in some stress situations. If a company is unable to pay its liabilities, labour courts usually allow a creditor to hold a LBOs had gained momentum on account of the relaxed credit member of management and shareholders jointly liable for the environment in recent years. This situation has changed more recently claim. Tax and social security courts are not as aggressive as labour because of the increase in interest rates and credit tightening policies, courts. The involvement of members of management in a claim is but may come back in the near future as a result of the decrease of usually limited to situations where such managers acted in abuse of the interest rates. Anticorruption due diligence has also become a hot power or in breach of the law or bylaws. topic since enactment of Brazilian anticorruption legislation. As a form of mitigating this potential liability of management, PE investors usually have the investees take out D&O insurance for all members of management. 5 Transaction Terms: Public Acquisitions
3.7 How do directors nominated by private equity 5.1 What particular features and/or challenges apply to investors deal with actual and potential conflicts of private equity investors involved in public-to-private interest arising from (i) their relationship with the transactions (and their financing) and how are these party nominating them, and (ii) positions as directors commonly dealt with? of other portfolio companies? There are two typical alternatives for acquiring control of a public Firstly, a director must comply with eligibility criteria set out in company: (i) a private agreement executed with the controlling Brazilian law and cannot occupy any position within a competitor shareholders of the public company, followed by a mandatory or else have any conflicts of interest with the company. Secondly, tender offer (tag-along); or (ii) a voluntary tender offer is launched the directors appointed by one group of shareholders have the same to acquire the company’s control. The first alternative is favoured duties towards the company as any other member of management, because of the low level of public companies with dispersed so they should always act in the company’s best interests (regardless ownership in Brazil. The mandatory tender offer allows minority of the interests of shareholders nominating them). The fact that shareholders to receive 80% of the price paid to controlling shares a person takes other management positions in other portfolio (if the company is listed on the traditional segment) or the same companies does not per se affect his ability to exercise his position price paid to controlling shares (if the company is listed on the or duties at the company. A director is prevented from voting in any segments with enhanced governance rules). matter involving an objective conflict of interest. Companies that went public during the IPO boom in the last decade often adopt punitive poison pill provisions in the bylaws, which 4 Transaction Terms: General impose on those acquiring control, in some cases, an obligation to launch a tender offer for a price per share greater than the company’s equity value, thus reducing the appetite of investors to pursue public 4.1 What are the major issues impacting the timetable for deals. transactions in your jurisdiction, including competition Until 2015, the CVM regulations considered the push-down of debt and other regulatory approval requirements, used to finance the acquisition of a public company as an abuse disclosure obligations and financing issues? of controlling power. Thus, leveraged buyouts involving public companies that would then remain public were not usual. With new FIPs formation and funding. The formation of FIPs is subject to regulations in place, we may see, in the near future, this type of CVM’s approval, and this must be taken into consideration when transaction structure also being considered for public company’s structuring the deal. Moreover, assuming the investment will deals, followed by ensuing discussions over valuation. come from abroad, non-resident investors in the FIPs must, at least, nominate: (i) one or more representatives in Brazil (for purposes of Resolution 4,373 of 2014), which must be either financial institutions 5.2 Are break-up fees available in your jurisdiction in or any other institution authorised by the Brazilian Central Bank to act relation to public acquisitions? If not, what other arrangements are available, e.g. to cover aborted deal in such capacity; (ii) a representative for local tax purposes; and (iii) costs? If so, are such arrangements frequently agreed a securities custody services agent (custodian/depositary) in Brazil. and what is the general range of such break-up fees? Regulatory. There are several regulated sectors in the Brazilian economy (banking, insurance, healthcare plans, public utilities, Break-up fees may be negotiated, but this is not a common market etc.). Most types of investment in these sectors are likely to require practice in public deals when the target company is required to pay prior authorisation from the relevant authority. it (given the adverse impacts to management). Antitrust. Effective since May 2012, the new Brazilian Competition Law (Law 12,529 of 2011) introduced several significant changes,
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competition to the asset, etc. It is also typical to negotiate certain 6 Transaction Terms: Private Acquisitions mitigation clauses, such as de minimis, baskets, etc. In special cases, carve-outs to limitations apply. 6.1 What consideration structures are typically preferred by private equity investors (i) on the sell-side, and (ii) 6.6 Do (i) private equity sellers provide security (e.g. on the buy-side, in your jurisdiction? escrow accounts) for any warranties / liabilities, and (ii) private equity buyers insist on any security for Usually, PE buyers structure deals with maximum legal protection, warranties / liabilities (including any obtained from including a package of warranties/indemnities that is meant to the management team)?
Brazil protect investors from pre-closing liabilities, even those disclosed during due diligence. Security is defined on a case-by-case basis. To the extent PE On the sell-side, PE investors usually push for a locked-box structure investors have their limitations to indemnify after distributing the or, at least, set a limit on indemnification (given the difficulties in cash to investors, escrow accounts are good alternatives for them. making payments after the sale proceeds have been distributed to When on the buyer-side, PE investors usually get security from investors). founding shareholders, such as liens on remaining shares or other assets and/or escrow/holdback.
6.2 What is the typical package of warranties/indemnities offered by a private equity seller and its management 6.7 How do private equity buyers typically provide comfort team to a buyer? as to the availability of (i) debt finance, and (ii) equity finance? What rights of enforcement do sellers typically obtain if commitments to, or obtained by, an SPV The package of warranties/indemnities depends on the PE investor’s are not complied with (e.g. equity underwrite of debt involvement in the company’s management and on the size of its funding, right to specific performance of obligations stake. Assuming that the PE fund is a non-controlling passive under an equity commitment letter, damages, etc.)? shareholder, it will try to limit its package of warranties/indemnities to the basic representations. Conversely, if the PE fund has a controlling Private equity buyers are usually reluctant in offering any kind of position, it will be hard to negotiate anything different from the other comfort as to the availability of debt/equity financing. They are shareholders in terms of warranties, and discussions will primarily usually successful in arguing that the PE fund has enough capital gravitate around the cap on indemnification and time limits. commitment to face its obligations under the SPA. In some cases, the PE fund manager may undertake to make a capital call if all 6.3 What is the typical scope of other covenants, conditions precedent are satisfied, and sellers could enforce such undertakings and indemnities provided by a private obligation if the capital call is not made. Whenever available prior equity seller and its management team to a buyer? to signing, a commitment letter to the bank is also presented to the seller, but it is more usual to have the PE investor bearing the risk to As in any M&A deal, the private equity investor and the management obtain the loan, with an open door if banks do not disburse the loan. team usually undertake to run the business, from signing through closing, in the ordinary course of business. Private equity investors 6.8 Are reverse break fees prevalent in private equity also try to avoid undertaking any non-compete/non-solicit transactions to limit private equity buyers’ exposure? provisions, as this could have a negative bearing on their future If so, what terms are typical? investments. It is also standard to set confidentiality provisions. Reverse break fees are unusual. 6.4 Is warranty and indemnity insurance used to “bridge the gap” where only limited warranties are given by the private equity seller and is it common for this 7 Transaction Terms: IPOs to be offered by private equity sellers as part of the sales process? If so, what are the typical (i) excesses / policy limits, and (ii) carve-outs / exclusions from 7.1 What particular features and/or challenges should a such warranty and indemnity insurance policies? private equity seller be aware of in considering an IPO exit? Indemnity insurance is a new product in Brazil and is still unusual, so there is no standard market practice yet. On the few cases this During the last decade, Brazil has achieved substantial development product has been used, it covered hidden liabilities, but not the in capital markets. The menu of available financial instruments has materialisation of the disclosed or identified contingent liabilities. expanded, market infrastructure has been reformed and strengthened, and a diversified investor base has been built. However, Brazil has historically suffered from woeful fiscal and monetary policy 6.5 What limitations will typically apply to the liability of management, which leads to one the highest interest rates in the a private equity seller and management team under world, affecting the progress of such developments and ultimately warranties, covenants, indemnities and undertakings? causing a low liquidity in the secondary market. In view of that, private equity sellers should be aware that an IPO exit at this In terms of indemnification, two important factors should be moment may not be the best alternative. considered: (i) time limits; and (ii) the indemnification cap. As to time limits, market practice is to tie them to the statute of limitation for tax claims (5–6 years). As for the indemnification cap, a limit is 7.2 What customary lock-ups would be imposed on usually set, but there is no standard on that. Negotiations will take private equity sellers on an IPO exit? into account the level of organisation a company is able to show, and the comfort a buyer is able to obtain during due diligence, the If PE investors are exiting or continuing as a minority stake,
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it would not be expected from them to execute a lock-up. If PE investors continue as a relevant shareholder, a six-month lock-up is 9.2 What are the key tax considerations for management to be expected. In the case PE investors continue as the controlling teams that are selling and/or rolling-over part of their investment into a new acquisition structure? shareholder, a six-month lock-up is expected, as is an additional six- month lock-up for 60% of the remaining position. Assuming the management team is located in Brazil and fully composed of individuals, they are probably already enjoying the 7.3 Do private equity sellers generally pursue a dual-track friendliest tax regime one could get in Brazil with respect to capital exit process? If so, (i) how late in the process are gain taxes. If the idea is to roll over the investment into new private equity sellers continuing to run the dual-track, acquisition structures, the key tax consideration is to structure it in
and (ii) were more dual-track deals ultimately realised Brazil through a sale or IPO? a way that it is not treated as a disposal of equity, but rather as a contribution of assets into a new vehicle, which should be tax neutral. Yes, this is a common strategy: (i) PE firms continue to run dual- track strategies until just before launching the deal (i.e. after an initial 9.3 What are the key tax-efficient arrangements that are filing with the CVM, but before the disclosing of the red herring typically considered by management teams in private prospectus); and (ii) it is difficult to assess, but in our experience equity portfolio companies (such as growth shares, PE exits on dual-track deals are more often realised through IPOs. deferred / vesting arrangements, “entrepreneurs’ relief” or “employee shareholder status” in the UK)?
8 Financing Brazilian law does not provide clear guidance regarding the tax effects applicable to long-term incentive/compensation plans, such as stock options or phantom shares plans. The main potential 8.1 Please outline the most common sources of debt tax benefits arising from this structure are: recognition by the finance used to fund private equity transactions in your beneficiaries of capital gains on positive results (generally taxed at jurisdiction and provide an overview of the current state of the finance market in your jurisdiction for such progressive rates from 15% up to 22.5%), as opposed to being taxed debt (particularly the market for high yield bonds). as ordinary income (up to a 27.5% rate); and non-assessment of social security contributions (around 20% for the paying company, The most common sources are term loans or debentures, which and up to 11% for the beneficiary, but capped at around BRL are usually underwritten by local banks. The public debt capital 4,100). However, in order to obtain the desired tax effects without markets in Brazil for this type of issuance are still incipient at the bearing material tax risks, it is important that the plan includes: (i) acquisition stage, although buyers could access such markets when the need of beneficiaries making an effective investment, by means refinancing the debt after the deal is closed. of disbursement of own funds; and (ii) the existence of risks to beneficiaries on the investment made.
8.2 Are there any relevant legal requirements or restrictions impacting the nature or structure of 9.4 Have there been any significant changes in tax the debt financing (or any particular type of debt legislation or the practices of tax authorities (including financing) of private equity transactions? in relation to tax rulings or clearances) impacting private equity investors, management teams or private equity transactions and are any anticipated? Under Brazilian law, FIPs cannot incur debt. Thus, whenever a private equity investor decides to fund its acquisition with debt, it We are not aware of any relevant developments in Brazilian court must do so through a company that will be funded with equity from precedents involving private equity transactions, or of questioning the FIP and debt from the creditor. in respect to the adoption of FIPs with the purpose of enjoying tax benefits in the context of such investments. 9 Tax Matters 10 Legal and Regulatory Matters 9.1 What are the key tax considerations for private equity investors and transactions in your jurisdiction? Are off-shore structures common? 10.1 What are the key laws and regulations affecting private equity investors and transactions in your jurisdiction, including those that impact private equity The main key tax consideration associated with private equity transactions differently to other types of transaction? investments in Brazil is the tax benefit available to FIPs. The most relevant tax advantages in connection with FIPs are the following: CVM sets out the rules applicable to FIPs. Besides, general corporate (i) the tax-exempt status of their portfolio on income and gains from law governs the relationship with management shareholders and investments, as taxation is deferred to redemption of shares by the shareholders’ agreements, whereas general contractual obligation FIP investor; and (ii) provided certain requirements laid down in tax principles apply when negotiating the purchase agreements themselves. regulations are met, non-resident investors holding shares in FIPs may also be exempt from income tax upon redemption of FIP shares (generally levied at a 15% rate, in this case). Off-shore structures may 10.2 Have there been any significant legal and/or have tax advantages (i.e., potential exit strategies carried out at the regulatory developments over recent years impacting level of the foreign entities which, in principle, would not be subject private equity investors or transactions and are any anticipated? to Brazilian WHT) as long as one can provide substance to the foreign vehicles (i.e., investing in other jurisdictions besides Brazil, etc.). A new FIP regulation has been enacted in 2016. The main changes are: (i) FIPs are now able to invest up to 20% of its committed capital
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of Brazil; (ii) FIPs can acquire non-convertible debt securities up to a certain level; and (iii) FIPs can also invest in Brazilian limited 10.5 Are there any circumstances in which: (i) a private liability companies (sociedade limitada) and not only in joint stock equity investor may be held liable for the liabilities of the underlying portfolio companies (including due to companies (sociedades por ações). breach of applicable laws by the portfolio companies); and (ii) one portfolio company may be held liable for 10.3 How detailed is the legal due diligence (including the liabilities of another portfolio company? compliance) conducted by private equity investors prior to any acquisitions (e.g. typical timeframes, In theory, no. As explained above, under some circumstances materiality, scope etc.)? Do private equity investors Brazilian courts apply the disregard doctrine and shareholders end
Brazil engage outside counsel / professionals to conduct all up being held liable for the portfolio companies’ liabilities. Piercing legal / compliance due diligence or is any conducted the corporate veil is more common in favour of labour creditors, as in-house? Brazilian labour courts understand that anyone from the economic group should be held liable for a company’s labour liabilities. This Private equity investors commonly carry out a full and detailed could also go for consumer and environmental liabilities. diligence exercise, engaging local counsel, auditors, and business consultants. Compliance has also became an area of attention, as PE investors are increasing the scope of their exercise in this area 11 Other Useful Facts by engaging firms to not only do a background check, but also to conduct interviews with senior management and sometimes to carry out some limited forensic exercise. 11.1 What other factors commonly give rise to concerns for private equity investors in your jurisdiction or should such investors otherwise be aware of in 10.4 Has anti-bribery or anti-corruption legislation considering an investment in your jurisdiction? impacted private equity investment and/or investors’ approach to private equity transactions (e.g. The amount of litigation involving a Brazilian company tends to diligence, contractual protection, etc.)? be higher than in other jurisdictions. Therefore, the due diligence exercise must be conducted thoroughly to identify the items of The Brazilian anticorruption law, which became effective on concern for the expected returns. PE investors usually target mid- 29 January 2014, has brought about heightened anticorruption size family run businesses. One should bear in mind that these standards, including the introduction of concepts from the Foreign companies are unaudited and often have weak controls, so (i) PE Corrupt Practices Act and the UK Bribery Act. PE investors are investors’ models should factor this in when projecting returns and taking that into account, not only in the diligence exercise but also predicting how the company would operate after the investment in the post-acquisition phase, pushing the companies to implement is made, and (ii) a strong management team should be able to compliance policies. immediately start working alongside the founding shareholders to implement the business plan.
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Eduardo H. Paoliello Jr. Pinheiro Neto Advogados Rua Hungria, No. 1100 01455-906, São Paulo/SP Brazil
Tel: +55 11 3247 8790 Email: [email protected] URL: www.pinheironeto.com.br Brazil
Eduardo H. Paoliello Jr. has been a corporate partner in the São Paulo office of Pinheiro Neto Advogados since 2016. He practises corporate law, with focus on private equity and M&A transactions. Eduardo holds an LLB from UNIP (2002) and a postgraduate degree in business administration (CEAG) from Getúlio Vargas Foundation (2007). He also holds an LLM from Queen Mary College, University of London (2009). Eduardo worked as a foreign associate at Davis Polk, New York, from 2009 through 2010. He was admitted to the Brazilian Bar in 2003. He is fluent in Portuguese and English.
Pinheiro Neto Advogados is a Brazilian, independent, full-service firm specialising in multi-disciplinary deals and in translating the Brazilian legal environment for the benefit of local and foreign clients. Founded in 1942, Pinheiro Neto Advogados was one of the first Brazilian law firms to serve foreign clients as well as the first firm to specialise in corporate clients. With clients in almost 60 countries, Pinheiro Neto was recognised in 2014 by the Brazilian government as the country’s number one exporter of legal services. The firm advises and represents both local and international clients in a broad range of sectors, including automotive, banking and financial services, construction and materials, energy and natural resources, environment and waste management, healthcare, oil and gas, real estate and technology. Pinheiro Neto Advogados has legal correspondents throughout Brazil and developed close and time-tested relationships with first-tier law firms around the world.
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Canada Michael P. Whitcombe
McMillan LLP Brett Stewart
The strong valuations of Canadian companies in 2016 has also 1 Overview influenced the market encouraging a number of exits by financial investors. The majority of Canadian private equity transactions 1.1 What are the most common types of private equity (60%) in 2016 had financial investors on the sell-side with sales by transactions in your jurisdiction? What is the current financial investors to strategic buyer representing the most common state of the market for these transactions? Have exit scenario. you seen any changes in the types of private equity transactions being implemented in the last two to three years? 2 Structuring Matters
In 2016, Canadian private equity deal activity decreased 40% from 2015 levels continuing a downward trend from the market peak of 2.1 What are the most common acquisition structures adopted for private equity transactions in your 2013. While the market was somewhat less active as compared jurisdiction? Have new structures increasingly to prior years, the year ended with positive indicia of increasing developed (e.g. minority investments)? activity. According to the Canada Venture Capital & Private Equity Association, Q4 was the best quarter for Canadian private equity in Privately held Canadian businesses are generally acquired by private 2016 with the $4.1B being invested, representing a 36% increase equity buyers either through a purchase of assets or a purchase over the $3B invested in Q3. The trend of larger deals continued of shares. Private equity investors will typically incorporate a in 2016, with 32 deals with a value of over $50M, for an aggregate Canadian acquisition corporation and fund it by way of interest- deal value of $11B. bearing debt and equity on a 1.5:1 basis in order to comply with In terms of industries, while oil and gas continued to receive a Canadian thin-capitalisation rules. This acquisition entity then significant portion of private equity investment in Canada in 2016 acquires all of the shares/assets of the Canadian target and, in the (32%), this level was substantially down (49%) from the prior year. case of a share acquisition, the acquisition corporation and target are Clean tech on the other hand enjoyed a 200% increase in the amount “amalgamated” under the relevant corporate statute. of funds invested. While buyouts remain the preferred form of investment, private In addition to co-investments by private equity funds, and direct equity investors taking minority positions, once only common in investments by Canadian pension funds both locally and abroad, smaller growth equity deals, has become an increasingly popular both of which are increasingly prevalent, recently, family offices and trend in larger transactions. sovereign wealth funds have also been participating in the sector. It is notable that the significant financial resources of a number of Canadian pension plans and their focus on foreign infrastructure projects has 2.2 What are the main drivers for these acquisition structures? resulted in Canada being a net exporter of investment capital.
Whether a Canadian acquisition should be completed by purchasing 1.2 What are the most significant factors or developments assets or shares is driven by tax and non-tax considerations. The encouraging or inhibiting private equity transactions weight given to these factors will depend on the circumstances of in your jurisdiction? the transaction and the parties’ ability to leverage their respective positions. From the point of view of a potential acquiror, the Private equity firms are flush with capital to be deployed and Canada greatest benefits of an asset sale are tax advantages and the ability is highly ranked by a number of sources as an attractive country for to pick and choose the assets and liabilities that will be acquired. foreign companies to invest in. The Canadian political scene is stable However, asset sales tend to be significantly more complex in larger and the legal system is fully developed and similar, in many respects, to transactions and can require voluminous third-party consents. In the American system. Those factors, coupled with the declined value contrast, a share sale is relatively simple from a conveyancing of the Canadian dollar, have created favourable conditions for private perspective. From the seller’s perspective, tax considerations equity activity in Canada, in particular, by non-Canadian investors. In generally favour share transactions as individual sellers may be able 2016, 41% of Canadian private equity deals involved investments in to utilise their personal capital gains exemptions to shelter a portion Canadian corporations by non-Canadian financial buyers. of the proceeds. We are seeing an increase in the number of ‘hybrid’
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transactions which involve the acquisition of both shares and assets of a target entity, providing tax advantages to both buyer and seller. 3 Governance Matters
2.3 How is the equity commonly structured in private 3.1 What are the typical governance arrangements equity transactions in your jurisdiction (including for private equity portfolio companies? Are such institutional, management and carried interests)? arrangements required to be made publicly available in your jurisdiction? Sellers of businesses will, on occasion, take back equity in a corporate purchaser. The precise terms of the equity interests offered Private equity firms utilise their equity positions, or negotiated minority rights, to assign seats on the board of directors to their
to, or required of, continuing management are often a major point Canada of negotiation in transactions. Typical structures include multiple principals and nominees. As such, they typically have the authority classes of equity with one class designed to pay out investors, such to run the portfolio company for the period of their investment. In as the fund and any co-investors, in priority over a second class Canada, the names and addresses of private companies’ boards of designed to pay out continuing management only if the business directors are publicly available information. However, the names of is eventually sold for more than a certain threshold value. Stock shareholders of private companies are not publicly available. options or phantom stock options are also commonly granted. 3.2 Do private equity investors and/or their director nominees typically enjoy significant veto rights over 2.4 What are the main drivers for these equity structures? major corporate actions (such as acquisitions and disposals, litigation, indebtedness, changing the A number of considerations drive these equity structures including nature of the business, business plans and strategy, the negotiating power of the management team and their personal etc.)? If a private equity investor takes a minority tax considerations, as well as the openness of the private equity position, what veto rights would they typically enjoy? fund to use structures other than their typical or preferred structure. Aligning the equity interests granted to continuing managers with The default dissent rights provided under corporate legislations are the continued growth and success of the company is also essential. typically supplemented through unanimous shareholder agreements Whether equity incentives were held by management prior to that ensure the private equity investor has ultimate control over the the private equity acquisition and, if so, in what form, as well as portfolio company. Often, such veto rights cease to apply where a the overall size of the management team, also impact the equity private equity investor’s equity interest is reduced below a given structure. benchmark. Where a private equity investor holds a minority position, veto 2.5 In relation to management equity, what are the typical rights are still typically enjoyed over critical business matters such vesting and compulsory acquisition provisions? as acquisitions, changes to the board and management team, the issuance of new equity or debt and the disposition of key assets. In order to align interests most stock option plans call for options to vest and become exercisable upon the achievement of certain 3.3 Are there any limitations on the effectiveness of veto conditions. Those conditions are typically tied to either continued arrangements: (i) at the shareholder level; and (ii) employment and the passage of time, and/or certain performance/ at the director nominee level? If so, how are these success requirements, such as the achievement of stated financial typically addressed? returns. In order for a shareholder agreement that sets forth veto arrangements Generally, management equity is structured to allow for repurchase to be enforceable against a subsequent shareholder, to fetter the by the company upon a termination of employment. Options granted discretion of the directors or to supplant the default provisions of to management may vary on whether they are exercisable following corporate legislation where permitted, it must be unanimous in termination of employment based on whether the termination was a nature. At the director level, only certain director discretion can be “good exit” or a “bad exit”. All, or substantially all, of the options fettered by a unanimous shareholders agreement and most notably, granted to management typically vest automatically in the event of a the fiduciary duty directors of portfolio companies owe to the sale of the company by the private equity investor. company cannot be restrained.
2.6 If a private equity investor is taking a minority position, are there different structuring 3.4 Are there any duties owed by a private equity investor considerations? to minority shareholders such as management shareholders (or vice versa)? If so, how are these typically addressed? Minority positions require private equity firms to consider different structuring issues due to the lack of control. The minority rights In contrast to some American jurisdictions, controlling shareholders stipulated in the shareholders agreement become of primary in Canada do not owe a fiduciary duty to minority shareholders. concern to ensure private equity firms have veto power (or at least significant influence) over critical decisions. Likewise, putand drag-along provisions are key to ensure the private equity investor 3.5 Are there any limitations or restrictions on the has flexibility with regards to its exit strategy. A minority interest contents or enforceability of shareholder agreements may also be taken in the form of a convertible debt instrument. (including (i) governing law and jurisdiction, and (ii) non-compete and non-solicit provisions)?
A shareholder agreement that is not signed by all of the shareholders of a company is treated as a regular commercial contract. It is subject
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to the articles and by-laws of the corporation and the provisions of the relevant corporate statute. In contrast, a unanimous shareholder 4 Transaction Terms: General agreement (“USA”) is a creature of statute and must be signed by all shareholders. Corporate legislation expressly recognises the ability 4.1 What are the major issues impacting the timetable of shareholders to contract out of certain statutory requirements and for transactions in your jurisdiction, including fetter certain powers of directors. competition and other regulatory approval requirements, disclosure obligations and financing To the extent a USA restricts the powers of directors to manage issues? the business and affairs of the corporation, shareholders who are given that power inherit the rights, powers, duties and liabilities of a Aside from the typical due diligence process, the timetable for director under corporate statutes or otherwise. Canada transactions is often governed by the regulatory approval required Canadian courts will not enforce restrictive covenants that under the Competition Act and the Investment Canada Act, where unnecessarily restrict an individual’s freedom to earn a livelihood. applicable. What is reasonably necessary depends on the nature of the business, In Canada, certain large transactions trigger advance notice its geographic reach, and the individual’s former role in that requirements under the Competition Act. Such transactions cannot be business. Canadian courts will not enforce a restrictive covenant completed until the end of a review period. Pre-merger notification that does not contain any time limit. filings are required in connection with a proposed acquisition of assets or shares or an amalgamation or other combination to establish 3.6 Are there any legal restrictions or other requirements a business in Canada where thresholds relating to the “size of the that a private equity investor should be aware of parties,” the “size of the transaction” and “shareholding” are exceeded. in appointing its nominees to boards of portfolio companies? What are the key potential risks and In addition to competition regulations, under the Investment Canada liabilities for (i) directors nominated by private equity Act, foreign investments that exceed a prescribed value or that relate investors to portfolio company boards, and (ii) private to cultural business or national security are subject to Investment equity investors that nominate directors to boards Canada Act approval. This allows the federal government to screen of portfolio companies under corporate law and also proposed investments to determine whether they will be of “net more generally under other applicable laws (see benefit” to Canada. section 10 below)?
Depending on the jurisdiction of incorporation, the board of 4.2 Have there been any discernible trends in transaction directors of a Canadian corporation may be subject to certain terms over recent years? minimum residency requirements. Notably, boards of directors for companies incorporated under either the federal or Ontario statute, The increase in foreign investment, typically from the United States, must consist of at least 25% resident Canadian directors. has influenced transaction terms which have gradually shifted to become increasingly similar to those in the American market. In Canada, all directors owe fiduciary duties to the corporation, For instance, the use of pro-sandbagging provisions, common in including a duty to act in the best interest of the corporation. the United States, is increasingly found in Canadian transactions. The potential statutory liabilities directors are exposed to can be Similarly, the size of indemnity caps, while still significantly higher extensive and the basis for this potential liability varies. Directors in Canada than in the United States, have trended downwards in may be personally liable for their own wrongdoing or failure, such recent years. As discussed later, the use of representation and as breaching the duties of loyalty and of care, or, in other instances, warranty insurance has also become increasingly common in the held personally liable for wrongdoing by the corporation. The Canadian private equity market. statutes that impose director liability include those governing corporate matters, securities compliance, employment and labour protection, taxation, pensions and bankruptcy and insolvency. 5 Transaction Terms: Public Acquisitions
3.7 How do directors nominated by private equity 5.1 What particular features and/or challenges apply to investors deal with actual and potential conflicts of private equity investors involved in public-to-private interest arising from (i) their relationship with the transactions (and their financing) and how are these party nominating them, and (ii) positions as directors commonly dealt with? of other portfolio companies?
Directors of a corporation who are nominees of a particular Canadian takeover bids require that adequate arrangements (an shareholder are subject to fiduciary duties to act in the best interest interpreted statement) must be made, with the effect that a bid of the corporation, not the shareholder who nominated them. cannot be conditional on financing. Statutory plans of arrangement on the other hand can be conditional in nature and allow for more Canadian corporate statutes require directors to disclose in writing flexibility to provide collateral benefits to managements, etc. Due to the nature and extent of their interest in a proposed material contract this flexibility, most Canadian privatisation transactions involving or transaction with the corporation. This provision applies whether private equity investors are completed by a plan of arrangement. the director is a party to the contract or transaction personally or is a director or officer of, or has a material interest in, a party to the contract or transaction. As such, all conflicts or potential conflicts 5.2 Are break-up fees available in your jurisdiction in the director has, as a result of their relationship with the nominating relation to public acquisitions? If not, what other arrangements are available, e.g. to cover aborted deal party and/or other portfolio companies, must be disclosed. In costs? If so, are such arrangements frequently agreed situations of conflict, the statutes require the director to refrain and what is the general range of such break-up fees? from voting on any resolution to approve the contract or transaction except in narrow circumstances. In friendly acquisitions, break fees are often seen in connection with
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‘no-shop’ provisions. The ‘no-shop clause’ is typically subject to a the scope of representations and warranties that fund investors are fiduciary out, upon which the break fee becomes payable. The break required to give on a sale transaction. Representations and covenants fee is generally in the range of 2%–4% of the transaction’s value. as to the portfolio company’s operations are more properly given by management shareholders who will have in-depth knowledge in this regard. Private equity investors required to indemnify a purchaser 6 Transaction Terms: Private Acquisitions in respect of a breach should do so on a several basis and limitations should be placed on the dollar amount for which private equity investors are responsible. Typically, post-closing indemnification 6.1 What consideration structures are typically preferred by private equity investors (i) on the sell-side, and (ii) on the sale lasts 12−24 months (with fundamental representations on the buy-side, in your jurisdiction? and warranties lasting longer) and negotiated indemnity caps are often in the range of 20–40% of the sale price. Canada Private equity buyers typically require purchase price adjustments to reflect the financial condition of the target. Typically, these are 6.6 Do (i) private equity sellers provide security (e.g. based on a net working capital adjustment. Earn-out provisions are escrow accounts) for any warranties / liabilities, and also often contemplated by private equity buyers in order to link the (ii) private equity buyers insist on any security for seller’s ultimate consideration to the financial success of the target warranties / liabilities (including any obtained from entity post-closing. the management team)? Private equity firms generally arrange their own credit facility and While representation and warranty insurance is becoming more invest on a cash-free, debt-free basis. On the sell-side, private popular, the traditional approach of a seller indemnity coupled with equity investors typically prefer simple consideration structures a purchase price holdback or escrow is still very common for both with less variability, and that minimise the size and scope of post- private equity buyers and sellers in Canada. In the event of an earn-out closing obligations. provision, set-off rights against the earn-out payment are also typical.
6.2 What is the typical package of warranties/indemnities offered by a private equity seller and its management 6.7 How do private equity buyers typically provide team to a buyer? comfort as to the availability of (i) debt finance, and (ii) equity finance? What rights of enforcement do sellers typically obtain if commitments to, or Private equity sellers and management teams will try to minimise obtained by, an SPV are not complied with (e.g. the representations and warranties and insist on a short survival equity underwrite of debt funding, right to specific period for representations given. Private equity sellers will further performance of obligations under an equity try to limit their exposure by ensuring they do not include a full commitment letter, damages, etc.)? disclosure, 10b-5 type, representation, by liberally using materiality qualifiers and by including an anti-sandbagging provision. Private equity transactions typically involve equity financing from the private equity investor and debt financing from a third-party lender. Comfort, with respect to the equity financing, is often provided in the 6.3 What is the typical scope of other covenants, acquisition agreement which generally contains a commitment for undertakings and indemnities provided by a private equity seller and its management team to a buyer? the private equity investor to fund and complete the acquisition upon the satisfaction of certain conditions. The acquisition agreement generally also contains a representation and warranty that the private Private equity sellers generally insist on limiting post-closing equity investor has sufficient funds to provide the funding. Comfort exposure as much as possible. As referenced above, they typically letters from the third-party lender or bank are typically tabled to limit the length and scope of indemnity provisions as much as provide comfort with respect to the debt financing. possible, as well as other post-closing covenants and undertakings.
6.8 Are reverse break fees prevalent in private equity 6.4 Is warranty and indemnity insurance used to “bridge transactions to limit private equity buyers’ exposure? the gap” where only limited warranties are given by If so, what terms are typical? the private equity seller and is it common for this to be offered by private equity sellers as part of the sales process? If so, what are the typical (i) excesses While still not the norm, reverse break fees are beginning to appear / policy limits, and (ii) carve-outs / exclusions from more often in private equity transactions. These fees are typically such warranty and indemnity insurance policies? negotiated as a fixed dollar amount. Due to the increased exposure of the target entity to potential damage from a failed deal, reverse Representation and warranty insurance is increasingly utilised as a break fees are often higher than the negotiated break fee on a competitive tool in the bid process and deal negotiation by private transaction. equity firms. Typical carve-outs to these policies include pending litigation, environmental liabilities, future adverse tax rulings, criminal matters, fraud, underfunded benefit plans and bribery and 7 Transaction Terms: IPOs anti-corruption matters.
7.1 What particular features and/or challenges should a 6.5 What limitations will typically apply to the liability of private equity seller be aware of in considering an IPO a private equity seller and management team under exit? warranties, covenants, indemnities and undertakings? An IPO is generally seen as the ideal exit for a private equity seller It is advisable for private equity investors to build restrictions on although, in current market conditions, it is certainly not the most
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common. When considering an IPO exit, private equity sellers should be aware of the costs of preparing for and marketing the IPO, 9 Tax Matters which includes the preparation of a prospectus and a road show. It is also important for the private equity seller to be aware that an IPO 9.1 What are the key tax considerations for private equity may not allow for an immediate exit of its entire position and that investors and transactions in your jurisdiction? Are the private equity’s final exit will be subject to lock-up provisions off-shore structures common? which will limit the investors abilities to sell their shares for a period of time following the IPO. Many of the common tax considerations in transactions with private equity funds apply equally to transactions with strategic buyers. However, there are several considerations that may take on added Canada 7.2 What customary lock-ups would be imposed on private equity sellers on an IPO exit? importance when transacting with foreign private equity investors in particular. Underwriters in an IPO will require these shareholders to enter into Dividend payments made by Canadian portfolio companies to a lock-up agreement as a condition to the underwriting to ensure foreign private equity investors are generally subject to a 25% their shares do not enter the public market too soon after the IPO. withholding tax, although this rate is substantially reduced under While the terms of lock-up agreements are subject to negotiation, tax treaties in most instances. they typically last 180 days. Non-resident investors should also familiarise themselves with Canada’s thin-cap rules that prohibit Canadian companies from 7.3 Do private equity sellers generally pursue a dual-track deducting interest on a portion of interest bearing loans from exit process? If so, (i) how late in the process are specified non-residents that exceed 1.5x the tax equity ofthe private equity sellers continuing to run the dual-track, “specified non-residents” in the Canadian company. and (ii) were more dual-track deals ultimately realised Historically, intermediary entities in tax favourable jurisdictions through a sale or IPO? such as Luxembourg and the Netherlands have often been utilised by foreign-based private equity funds investing into Canada. However, Given the generally slow IPO market in Canada, dual-track processes the Organisation for Economic Cooperation and Development’s have not been the norm. However, there has been intermittent Base Erosion and Profit Shifting (“BEPS”) initiative may have a activity in the Canadian IPO market and this has allowed for dual- significant impact on the usage of such intermediaries. track processes to be run on occasion. If the IPO market continues to grow we expect to see dual-track processes become more commonplace, as they have in other jurisdictions. 9.2 What are the key tax considerations for management teams that are selling and/or rolling-over part of their investment into a new acquisition structure? 8 Financing Investors in a Canadian company are permitted a tax-free rollover when the company’s shares are exchanged for the shares of another 8.1 Please outline the most common sources of debt Canadian company, but not when they are exchanged for shares of a finance used to fund private equity transactions in non-Canadian company. your jurisdiction and provide an overview of the current state of the finance market in your jurisdiction for such debt (particularly the market for high yield 9.3 What are the key tax-efficient arrangements that are bonds). typically considered by management teams in private equity portfolio companies (such as growth shares, Foreign investors, largely U.S. based, account for a substantial deferred / vesting arrangements, “entrepreneurs’ portion of private equity investment in Canada. U.S. investors may relief” or “employee shareholder status” in the UK)? bring their American debt financing with them or obtain Canadian debt financing. Private equity investors utilising U.S. debt sources Stock options remain the most popular stock-based compensation for Canadian private equity transactions need to develop FX hedging tool, due to their favourable treatment (no taxation until exercise strategies which are typically only provided by traditional banks and and general eligibility for a capital-gains equivalent rate of tax). can be costly. Contrary to expectations, the recent federal budget made no changes to these rules. Other popular stock-based compensation Traditional senior secured debt obtained from a domestic Canadian arrangements for management include stock appreciation rights and bank, often in the form of a revolving credit facility or term loan, deferred stock units. remains the most common source of debt financing in Canadian private equity transactions. 9.4 Have there been any significant changes in tax legislation or the practices of tax authorities (including 8.2 Are there any relevant legal requirements or in relation to tax rulings or clearances) impacting restrictions impacting the nature or structure of private equity investors, management teams or private the debt financing (or any particular type of debt equity transactions and are any anticipated? financing) of private equity transactions?
The Organisation for Economic Cooperation and Development’s There are no relevant legal requirements or restrictions that impact recently completed BEPS initiative, insofar as anti-treaty-shopping the choice of structure used for debt financing in Canadian private measures are concerned, may have a significant impact on foreign- equity transactions. based private equity funds’ usage of intermediary entities in favourable jurisdictions (such as Luxembourg and Netherlands) for their Canadian investments.
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that allows public stock market investors to participate in private 10 Legal and Regulatory Matters equity-like transactions. While too few SPAC deals have closed to determine what long-term impact SPACs will have on the Canadian 10.1 What are the key laws and regulations affecting market place, with large amounts of capital ready to be invested private equity investors and transactions in your without the need to put financing into place, SPACs are likely to jurisdiction, including those that impact private equity have an impact on the private equity landscape. transactions differently to other types of transaction?
10.3 How detailed is the legal due diligence (including The principal sources of law affecting private equity investors and compliance) conducted by private equity investors transactions in Canada are as follows: prior to any acquisitions (e.g. typical timeframes, Canada 1. Corporate Statutes. Canadian corporations may be formed materiality, scope etc.)? Do private equity investors and governed under a federal or provincial corporate statute engage outside counsel / professionals to conduct all which regulate certain corporate transactions including legal / compliance due diligence or is any conducted statutory amalgamations and plans of arrangement and in-house? extraordinary transactions including the sale, lease, or exchange of all, or substantially all, of the property of a The majority of private equity investors conduct thorough legal corporation. due diligence, reviewing all material legal documents including the 2. Securities Regulation. Canadian publicly traded companies target entity’s corporate records, materials contracts and employment are also regulated under provincial securities laws which records. In addition, publicly available searches are also typically regulate, among other things, public securities offerings, conducted in order to identify any registered encumbrances, active continuous disclosure requirements, insider trading, and legislation, bankruptcy filings and other similar maters. Most tender offer transactions. Certain provinces have additional legal due diligence is conducted by external counsel and other fair dealing rules designed to ensure the fair treatment of minority shareholders of publicly-traded companies in certain professionals, such as environmental consultants. The length of the types of transactions involving controlling shareholders or diligence review and materiality threshold applied differs greatly and “related parties”. is often dependent on the nature of the sale process, the risk tolerance 3. Investment Canada Act (“ICA”). The acquisition of of the private equity investor and the industry the target is in. “control” of a Canadian business which exceeds certain prescribed monetary thresholds by a non-Canadian is 10.4 Has anti-bribery or anti-corruption legislation reviewable under the ICA and subject to approval by the impacted private equity investment and/or investors’ federal Minister of Industry or the Minister of Heritage approach to private equity transactions (e.g. (depending on the nature of the business of the Canadian diligence, contractual protection, etc.)? company). Canada’s Corruption of Foreign Public Officials Act (“CFPOA”) 10.2 Have there been any significant legal and/or was enacted in 1998 to ensure commercial fair dealing, government regulatory developments over recent years impacting integrity and accountability, and the efficient and equitable private equity investors or transactions and are any distribution of limited economic resources. CFPOA prohibits the anticipated? promise, payment or giving of money or anything of value to any foreign official for the purpose of obtaining or retaining business As of July 1, 2016, the modernised investment rules resulting from or gaining an improper advantage and concealing bribery in an the amendments to the Pension Benefits Standards Regulations, entity’s books and records. Private equity transactions, especially 1985 (Canada) published by the federal government on March in sensitive industries or which involve a target with material 25, 2015 came into force. Among other changes, at a high level, government contracts, typically specify diligence contracts as well these rules now clarify the rule that prohibits a pension plan from as corporate records and policies for compliance with this legislation. investing or lending more than 10% of the value of the plan’s assets In addition, representations and warranties are often obtained from in or to a single entity. The 10% Rule was modernised in two ways, the seller confirming the entity’s compliance with same. first to reflect that the 10% is now based on the ‘net market value’ While the Foreign Corrupt Practices Act (“FCPA”) is an American rather than the ‘net book value’ of the plan’s assets, and secondly, to law, U.S. private equity investors often seek assurances that Canadian clarify that the 10% limit is to be respected at the time a transaction target entities are complying with FCPA. If the Canadian target is not is completed and is not subject to subsequent fluctuations in value currently owned by an American interest, this can be problematic. meaning that pension plans governed by these rules are not required to divest of investments if the 10% threshold is crossed subsequent to the completion of a transaction. Generally speaking these changes 10.5 Are there any circumstances in which: (i) a private provide greater investment opportunities to Canadian Pension Plans, equity investor may be held liable for the liabilities of thereby increasing competition for private equity investors. the underlying portfolio companies (including due to breach of applicable laws by the portfolio companies); Although special purposes acquisition companies (“SPACs”) have and (ii) one portfolio company may be held liable for been allowed under Toronto Stock Exchange rules since 2008, no the liabilities of another portfolio company? Canadian IPOs for SPACs occurred until 2015, following which, over the course of approximately 18 months, six SPACs raised over Typically, Canadian courts are hesitant to pierce the corporate $1B. To date Canadian SPACs have experienced some difficulty veil and hold shareholders liable for their portfolio companies. deploying those funds. While 2016 saw the first Canadian SPAC However, Canadian courts will pierce the corporate veil where a deals announced, none managed to close. However, more recently corporate entity is controlled and used for fraudulent or improper SPACs appear to be having more success. So far, Q1 of 2017 has conduct. Likewise, to the extent a shareholder usurps the discretion witnessed the closing of both the first and second acquisitions by of a director to manage the business, that shareholder will expose Canadian SPACs and a third one has been approved and appears to itself to the liabilities of a director of the entity. be on the horizon. SPACs provide a collective investment structure
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ownership in specified industries such as financial services, 11 Other Useful Facts broadcasting and telecommunications is limited by certain federal statutes; management and administration fees paid by a Canadian 11.1 What other factors commonly give rise to concerns resident to a non-arm’s length non-resident are subject to a 25% for private equity investors in your jurisdiction or withholding tax; and that Canadian employment laws differ fairly should such investors otherwise be aware of in significantly from American laws and impose more obligations and considering an investment in your jurisdiction? potential liabilities on a target corporation.
Other factors which commonly raise concerns for private equity investors, especially foreign investors, include: that foreign Canada
Michael P. Whitcombe Brett Stewart McMillan LLP McMillan LLP 181 Bay Street, Suite 4400 181 Bay Street, Suite 4400 Toronto ON M5J 2T3 Toronto ON, M5J 2T3 Canada Canada
Tel: +1 416 865 7126 Tel: +1 416 865 7115 Email: [email protected] Email: [email protected] URL: www.mcmillan.ca URL: www.mcmillan.ca
Since 2006, Michael has been recognised as one of Canada’s leading Brett is recognised in the IFLR1000 Financial and Corporate Guide Business Lawyers in Lexpert’s Guide to the Leading 500 Lawyers in 2016 as a rising star in the areas of Investment Funds and Banking, Canada. ranked in Lexpert Guide to the Leading US/Canada Cross-Border Corporate Lawyers in Canada 2015 as a Corporate Lawyer to Watch He principally practises in the areas of negotiated merger and in the area of Corporate Commercial Law, and was selected as a acquisition transactions (domestic and cross-border), private equity Lexpert® Rising Star: Leading Lawyer Under 40 for 2014 by Lexpert® investments, strategic alliances, complex commercial arrangements Magazine. and corporate governance. Michael regularly advises Private Equity firms along with other medium and large corporations (both domestic Brett is Co-Chair of McMillan’s Private Equity Group. With a focus and international) and their boards of directors in connection with their on assisting domestic and foreign clients with negotiated transactions operations throughout Canada. He has significant industry experience including mergers and acquisitions, private equity financings, venture in the pharmaceutical, automotive, manufacturing, distribution, service, capital financings and management buyouts, Brett has represented entertainment, hospitality and tourism sectors. He is a Director of a clients in a number of sectors including agri-food, food manufacturing, number of Canadian corporations including Porsche Cars Canada aerospace and defence, engineering, pharmaceuticals, tech and Ltd. Michael obtained a degree in Business Administration (BBA) in clean-tech; manufacturing and transportation. addition to his LL.B. and LL.M. and was called to the Ontario Bar in Brett is a member of the Canadian Venture Capital & Private Equity 1987. Association and a member of the Executive Committee of Canadian Women in Private Equity. Brett is an active member of the American Bar Association Business Law Section and is on the leadership of the Private Equity and Venture Capital Committee. Brett obtained her J.D. from the University of Toronto and has held the position of Adjunct Faculty Member at Osgoode Hall, York University.
McMillan is a business law firm serving public, private and not-for-profit clients across key industries in Canada, the United States and internationally. With recognised expertise and acknowledged leadership in major business sectors, we provide solutions-oriented legal advice through our offices in Vancouver, Calgary, Toronto, Ottawa, Montréal and Hong Kong. Our firm values – respect, teamwork, commitment, client service and professional excellence – are at the heart of McMillan’s commitment to serve our clients, our local communities and the legal profession.
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China Lefan Gong
Zhong Lun Law Firm David Xu (Xu Shiduo)
partly by debt financing, or those requiring certain special expertise 1 Overview or value offered by one or more of the “club members”, club deals can be appealing. Also, in the context of a buyout, investors also 1.1 What are the most common types of private equity have to consider factors such as who gets to have the control of the transactions in your jurisdiction? What is the current target and may as well then rule against club deals as an option. state of the market for these transactions? Have you seen any changes in the types of private equity transactions being implemented in the last two to 1.2 What are the most significant factors or developments three years? encouraging or inhibiting private equity transactions in your jurisdiction? Private equity transactions in China include both growth capital investments and buyout transactions. One unique aspect worth Since the Ministry of Commerce (MOFCOM) promulgated the mentioning is the fact that transactions, depending on the future exit, Provisions on Foreign Investors Acquiring Domestic Enterprises may be structured as an onshore transaction or off-shore transaction. (Circular 10) back in 2006 (as amended in 2009), it has become If the future exit is likely to be an IPO in a non-PRC stock market difficult to convert an onshore domestic PRC company structure (e.g., a stock exchange in the US or Hong Kong), then the listing into an off-shore structure, making it difficult for the foreign PE vehicle will likely take the form of a company incorporated in an investors to opt for the option of establishing an off-shore structure off-shore jurisdiction such as the Cayman Islands (i.e., an off-shore for investment and future exit through an overseas IPO. Founders holding company). With such plan in mind, the private equity of domestic companies will have to rely on experienced counsels to investors will invest into such off-shore holding company and exit go through sophisticated, and often costly, restructuring processes after the IPO of such off-shore vehicle. If the target company is a to migrate the domestic structure into an off-shore one. If this is not PRC domestic entity, then the private equity investors would often successful, then the foreign investors will have to invest directly into require that a company restructuring be completed as a closing the PRC domestic target, resulting in a Sino-foreign joint venture, condition, such that the private equity investors will become the which, after converting into a joint stock company (a.k.a. a company shareholders of the off-shore holding company. limited by shares), may be considered for listing in one of the PRC stock exchanges (i.e., an “onshore IPO or listing” in China). Bear In contrast, if the target company is to be listed within the PRC on in mind that an IPO in China, pending a potential reform, is subject one of the domestic stock exchanges, then the listing vehicle must be to review and approval by the CSRC (China Securities Regulatory a PRC incorporated joint stock company. Private equity investors Commission), and the process usually takes many months and even will invest into such domestic company which is governed by the years, and companies often have to wait in a long queue for the PRC law, including company law, securities rules and, if applicable, approval. As a result, despite the fact that the PRC stock markets regulations on foreign investment in China. sometimes can offer higher PE ratios for companies listed on the A The market used to be dominated by growth capital-style investments share stock exchanges, the longer waiting period does create more where the private equity investors tend to hold minority stakes; uncertainty than those overseas stock exchanges. however, there has been an increase in the popularity and number of buyout transactions in China thanks to a variety of factors, including increased competition among investors who are chasing fewer growth 2 Structuring Matters capital deals, the emergence of privatisation deals, the government’s regulatory liberalisation, allowing loans (subject to conditions 2.1 What are the most common acquisition structures and limitations) to finance M&A and buyout transactions, and the adopted for private equity transactions in your increasing willingness of founding shareholders of companies, while jurisdiction? Have new structures increasingly reaching retirement age, to sell controlling stakes to third-party developed (e.g. minority investments)? buyers, such as buyout funds. For regular transactions, club deals may not be as prevalent; There are onshore and off-shore structures available for private especially when each of the private equity investors faces deal- equity transactions. Under the onshore investment model, the sourcing pressure and intends to keep the deals to themselves as private equity fund, through an off-shore special purpose vehicle long as the investment size is within their own pricing range. While (SPV), invests into the onshore PRC domestic corporate entity for larger transactions, including privatisation deals, those funded directly and becomes a shareholder of the onshore company.
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Under the off-shore investment model, the private equity investor or nominal price if the management shareholder ceases employment or its SPV invests into or acquires shares of the off-shore holding or service with the company. Vested shares can also be subject to company of the target company, and such off-shore holding company company repurchase if the management shareholder commits a often holds 100% interests in a HK intermediary company, which default. then holds 100% interests in a subsidiary in the PRC, in the form of a “wholly foreign owned enterprise” (WFOE). Such off-shore 2.6 If a private equity investor is taking a minority holding company is most often intended to become a listing vehicle position, are there different structuring in the future overseas IPO and, due to the nature that it holds assets considerations? directly or indirectly in China, such off-shore holding company is
China often referred to as a “red chip” company. Normally, if a private equity investor acts as a minority shareholder, it will require protective provisions in the governance documents 2.2 What are the main drivers for these acquisition of the target, e.g. the shareholders agreement and Articles of structures? Association of the target. Meanwhile, the investor might also insist on special exit right terms, such as drag-along, redemption, etc. to PE investors often set up one or more SPVs and use the SPVs ensure a proper exit. to hold interests in the target company. The drivers for such acquisition structure can be related to tax planning and avoidance of onshore PRC approval in case of share transfer. If the equity 3 Governance Matters transfer involves the equity interests or shares of a PRC company, government approval is required if there is any involvement of 3.1 What are the typical governance arrangements foreign investment. Although such approval is not hard to get and for private equity portfolio companies? Are such has largely become a formality, it does usually take 20 working days arrangements required to be made publicly available for the approval authority to process and then grant the approval. in your jurisdiction? So, if there is an off-shore intermediary company (such as the HK company), the private equity investor can simply sell or transfer the There are several mechanisms to ensure proper governance HK company to a buyer bypassing the onshore approval, while still arrangements with the portfolio companies in private equity achieving the same result of exiting. investments. First, in respect of the board of directors, usually As to tax, in light of the recent rules issued by PRC State the private equity investor, regardless of its minority stake in the Administration of Tax (SAT) including Circular 698 as recently portfolio company, would request a director seat on the board, amended by Bulletin 7, off-shore changing-hands of equity interests which has veto rights over a host of material matters relating to the or shares that indirectly sell or transfer the onshore company could management and operations of the company. If there is a holding be subject to PRC tax filing and potential taxes as if the parties company structure involving multi-tiers of corporate entities, made such sale or transfer onshore. In light of this development, the then such PE-appointed director will appear on the board of each PRC tax benefits of setting up such off-shore SPVs as intermediary of the entities. In other words, if the PE fund invests in the off- companies have now become limited. shore holding company level, which owns 100% of the onshore operating subsidiary (i.e., WFOE), then the dual-board structures will normally be put in place with mirrored board members. 2.3 How is the equity commonly structured in private equity transactions in your jurisdiction (including Second, if the PE investor only invests a minority stake in the institutional, management and carried interests)? portfolio company, it is advisable for the PE investor to install an operation VP and/or a financial controller in the founder-controlled Both “sweet” equity and management reinvestment into the operating company, so that it can monitor the operations and institutional strip have been seen in private equity transactions in company expenditures and control any spending in excess of any China. For the sweet equity shares, they are normally issued to agreed amount. the management teams at a lower price to provide extra incentive Third, it is worth mentioning that under the PRC law and practice, for the management, subject to restrictions, or at the same price usually it is the legal representative of the onshore operating company as the PE investor with the same class of share rights with such (e.g., the WFOE) that has the power to sign documents binding on investor. Carried interest arrangement is often structured as an the company. Such legal representative role is normally assumed by earn-out or ratchet adjustment. In certain deals, carried interest can the chairman of the board, usually the founding shareholder of the also be structured as a part of the consideration for management’s portfolio company. For convenience, such legal representative also subscription of additional shares. holds the company chop/stamp. Under the PRC law, any documents that bear the company chop are binding on the company even if such documents do not have any signatures from the legal representative 2.4 What are the main drivers for these equity structures? or other authorised representative of the company. With the company chop, anyone can go to the bank to change the authorised Such structures regarding management and/or the founder are signatory for releasing funds from the company’s accounts. Thus, mainly designed to incentivise and align interests with management caution suggests designing a proper mechanism to jointly-control and the founder. the company chop or otherwise formulate a chop-use protocol for the portfolio companies. 2.5 In relation to management equity, what are the typical If such governance arrangements of portfolio companies are reflected vesting and compulsory acquisition provisions? in their Articles of Association, given that constitutional document is always required to be filed with the government authority, such A typical vesting schedule usually links with the term of the governance arrangements will be publicly available. employment, IPO timeline and other exit schedules. In usual cases unvested shares will be subject to company repurchase at par value
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If the transaction takes place off-shore, then shareholder agreements 3.2 Do private equity investors and/or their director are normally subject to the law of the jurisdiction of the off-shore nominees typically enjoy significant veto rights over company (such as the Cayman Islands), while the share subscription major corporate actions (such as acquisitions and agreement may be governed by a different law. disposals, litigation, indebtedness, changing the nature of the business, business plans and strategy, International arbitration is commonly selected over court etc.)? If a private equity investor takes a minority adjudication for dispute resolution clauses in those agreements. position, what veto rights would they typically enjoy? Founding shareholders or sellers from China commonly request to choose a China-based arbitration tribunal, while the foreign PE Yes. There is usually an extensive list of reserved matters negotiated investors tend to select international arbitration in venues like Hong between the PE investors and the controlling shareholder(s) of the Kong, Singapore and London. China portfolio company. The reserved matters will be subject to the veto There is no express provision under the PRC law in respect of right of the PE investor(s); they typically include: any amendments the limitations or restrictions on the contents or enforceability to the Articles of Association; any change of the business scope, of shareholder agreements relating to non-compete and non- or the name of the company; any change of the company’s solicitation. capitalisation; signing any material contracts with value in excess of certain specified threshold(s); any matters relating to merger, split, initial public offering, change of legal form, liquidation or 3.6 Are there any legal restrictions or other requirements dissolution of the company; making loans to any parties; providing that a private equity investor should be aware of in appointing its nominees to boards of portfolio any security or guarantee to any parties; and any matters that may companies? What are the key potential risks and have any material impact on the company’s management, operations liabilities for (i) directors nominated by private equity or financial performance. As to a PE investor taking a minority investors to portfolio company boards, and (ii) private position, it will at least enjoy, by statute, the following four veto equity investors that nominate directors to boards rights as these decisions must be subject to a unanimous consent of of portfolio companies under corporate law and also all the directors present at the board meeting under the PRC law: more generally under other applicable laws (see any amendments to the Articles of Association; termination and section 10 below)? dissolution of the company; increase or reduction of the registered capital of the company; and merger or division of the company. If the private equity investor has a controlling stake or otherwise gets However, the PE investor would usually request a much longer list to appoint the chairman of the board of directors, and such chairman of reserved matters based on their negotiation with the controlling also acts as the legal representative of the company, the investor shareholder(s) of the portfolio company. and the appointed person should beware that, under the PRC law, the legal representative by default has certain obligations, such as appearing in court on behalf of the company, accommodating 3.3 Are there any limitations on the effectiveness of veto investigations activities undertaken by the government authorities arrangements: (i) at the shareholder level; and (ii) relating to the company, and to the extent the company is unable to at the director nominee level? If so, how are these typically addressed? pay debt as required by court, the plaintiff can apply to the court to issue order or injunctive relief to restrict such legal representative from leaving the country. Those are the practical risks a person If the shareholder meeting can reach resolution, bypassing the acting as legal representative should be aware of, in particular when board, then the PE investor must make sure it has the veto power at the company’s operations are under control by another shareholder both the board level and shareholder meeting level in respect of the or someone that the PE investor cannot fully trust. particular reserved matter of its concern.
3.7 How do directors nominated by private equity 3.4 Are there any duties owed by a private equity investor investors deal with actual and potential conflicts of to minority shareholders such as management interest arising from (i) their relationship with the shareholders (or vice versa)? If so, how are these party nominating them, and (ii) positions as directors typically addressed? of other portfolio companies?
This question seems to suggest the context where a PE investor acts Under the PRC Company Law, none of the directors, controlling as majority shareholder after a buyout transaction. If it is an onshore shareholders, members of the senior management and supervisors transaction, under the PRC law there are certain statutory provisions may use his or her relationships with the company to impair the on minority shareholders’ rights, including super majority voting interests of the latter. Specifically for listed companies, if a member requirement, but there is no express provision specifying duties of the board is “related to” (i.e., having interest in or conflicts of owed by a majority shareholder to a minority shareholder. interest with) the subject matter to be voted in the proposed board meeting, then such board member must recuse himself or herself 3.5 Are there any limitations or restrictions on the and shall not cast a vote on resolutions over this matter, and shall not contents or enforceability of shareholder agreements act as proxy of any other directors either. As regards to the taking (including (i) governing law and jurisdiction, and (ii) of a directorship position in another company, the law does not non-compete and non-solicit provisions)? prohibit or restrict such act per se, but it should be cautiously noted that a director of a company, without prior consent of the company’s If it is an onshore transaction where the foreign PE investor shareholders’ meeting or shareholders’ assembly, may not engage invests into or acquires equity interests in a PRC company, then in activities for, take positions at or work for any firms that may be the transaction will be subject to government approval. The share competing with the business of such company. purchase agreement (or equity subscription agreement) along with the shareholders’ agreement (or joint venture contract) must be governed by the PRC law.
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4 Transaction Terms: General 5 Transaction Terms: Public Acquisitions
4.1 What are the major issues impacting the timetable 5.1 What particular features and/or challenges apply to for transactions in your jurisdiction, including private equity investors involved in public-to-private competition and other regulatory approval transactions (and their financing) and how are these requirements, disclosure obligations and financing commonly dealt with? issues? The commonly seen public-to-private transactions in the market are As mentioned above, all onshore transactions involving any foreign
China those overseas listed companies (such as those Chinese companies investors require MOFCOM or its local counterparts’ approval and listed on stock exchanges in the US, Hong Kong and Singapore) then registration with the local AIC (Administration for Industry that are taken private with the help of PE investors with the intent and Commerce). For off-shore transactions, such approvals will to go public again at another stock exchange in the future, for better not normally be required, with exceptions such as merger filings for valuation and/or liquidity. The challenges include the requirements antitrust reasons and tax (Circular 698) filings. In addition, when of the stock exchange and the uncertainty arising from the public converting a PRC domestic structure into an off-shore structure, shareholders. The PRC counsel also plays a significant role in, if any of the shareholders of the off-shore holding company (i.e., among others, restructuring the privatised company into an onshore the future “ListCo.”) are PRC residents, SAFE (Circular 37) domestic company suitable for A share listing in the PRC, if the registrations will be required. These regulatory procedures will controlling shareholders and the PE investors intend to have the normally delay the transaction process, and could create uncertainty company go public in China in the future. If a PE investor is from over closing if they are not managed properly in advance. China and uses RMB to acquire the shares listed in Hong Kong or Cultural differences during communications and negotiations the US, or other stock exchanges outside China, it will need to go between Chinese and foreign parties can also be an important through the foreign exchange approval procedure, which is a big element that needs to be factored into for deal planning and project challenge in terms of managing the timing and coordination with the management purposes. For example, Chinese parties sometimes stock exchanges and regulatory authorities outside China. prefer more face-to-face meetings and real-time discussions of the terms and striking deals on principles rather than the nitty-gritties, 5.2 Are break-up fees available in your jurisdiction in while westerners tend to have the detailed terms and conditions laid relation to public acquisitions? If not, what other out on paper, and expect more back-and-forth document mark-ups arrangements are available, e.g. to cover aborted deal and exchange of negotiation points via email. costs? If so, are such arrangements frequently agreed and what is the general range of such break-up fees? Different understanding of terms and having meanings lost in translation may also create misunderstandings and twists. Break-up fees are acceptable under the PRC law and can be seen in PE deals, including acquisition of public companies. The usual 4.2 Have there been any discernible trends in transaction break-up fee would normally be the actual expenses incurred by terms over recent years? the investor or the target, e.g. legal due diligence and financial due diligence related costs, and sometimes it can be set at about For both onshore and off-shore transactions, PE firms have started 1–1.5% of the equity value (Chinese pitch big M&A break-up fees, to realise that sound deal structures and fool-proof transaction small stakes to allay US regulatory fears, finance.yahoo.com/news/ terms must be carefully formulated in light of the unique business chinese-pitch-big-m-break-fees-small-stakes-042333782--finance. environment and legal infrastructure in China. In addition to htm). However, if the liquidated damages far exceed the amount of extensive due diligence, earn-out mechanisms and management the losses and damages actually incurred, the PRC law allows the incentives are increasingly popular in PE transactions, with binding paying party to petition the court to adjust such liquidated damages terms of founders (i.e., founders are committed not to exit until IPO to an appropriate level. or a certain trigger event, e.g. acquisition by industrial players). When crafting the deal terms, PE investors often have to focus on the roles and responsibilities of the founders and management 6 Transaction Terms: Private Acquisitions and how to incentivise them as they can be a primary factor for determining the success of a particular portfolio company given 6.1 What consideration structures are typically preferred the dynamic market situation in China. Also, given the increased by private equity investors (i) on the sell-side, and (ii) competition among PE investors chasing for deals, founders tend to on the buy-side, in your jurisdiction? have more bargaining power in negotiating the valuation and other transaction terms. PE investors would usually reference the latest financial statements Exits through listing in China or acquisition by a listed company of the target company in the transaction agreements, along with in China are also becoming an emerging trend. IPOs through the consideration adjustments and indemnity clauses favourable to the Chinese stock market, and listing on NEEQ (National Equities PE investors. The time period between the financial statement date Exchange and Quotations) are becoming increasingly appealing and the closing will be an interim period during which the company given the recent boom in the Chinese stock market, and the price/ side may not conduct certain activities without prior consent by the earnings ratios can be much higher than those available in the PE investor. Ratchet and earn-out mechanisms are also popular in developed countries’ stock markets. For specific terms and clauses, structuring the considerations. founder indemnity, targeted sales volume and ratchet arrangement If a PE investor is on the sell-side, it will tend to limit representations are commonly seen, while warranty and indemnity insurance and and warranties to a very short list and the survival period thereof and stapled financing are considered rare in the market. any holdback to the minimum. If a PE investor is on the buy-side, it will require the controlling shareholder to have an extensive list
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of representations and warranties and, ideally, a personal liability or seller in annual instalments, subject to adjustments and fulfilment guarantee in case of any breach and, again ideally, with no survival of any indemnification obligations and authorized claims”. (www. period. If the buyer and seller are both private equity investors, then corumgroup.com/Escrow-Provisions-in-MA-Transactions-Part-1).) both sides will tend to drive hard bargains on all those terms of the transaction. 6.7 How do private equity buyers typically provide comfort as to the availability of (i) debt finance, 6.2 What is the typical package of warranties/indemnities and (ii) equity finance? What rights of enforcement offered by a private equity seller and its management do sellers typically obtain if commitments to, or team to a buyer? obtained by, an SPV are not complied with (e.g. equity underwrite of debt funding, right to specific performance of obligations under an equity China Seller-side warranties and indemnities are commonly seen in PE commitment letter, damages, etc.)? transactions to protect against the downsides, including any hidden and contingent liabilities that may pop up in the future. Escrow and If the commitments are provided by SPVs, the seller side will holdback arrangements can be seen more often in buyout deals, and usually request a guarantee of the actual investor(s) or buyer(s). PE investors sometimes request personal guarantee or joint liability Sellers may request buyers to provide parent guarantee and/or bank of the founding shareholders for indemnity-related claims. reference letter.
6.3 What is the typical scope of other covenants, undertakings and indemnities provided by a private 6.8 Are reverse break fees prevalent in private equity equity seller and its management team to a buyer? transactions to limit private equity buyers’ exposure? If so, what terms are typical? Non-compete and non-solicitation are absolutely crucial and are typically seen in PE transactions. It is being seen more and more PE investors usually request an exclusivity clause in the term often that sellers and/or management are requested to provide sheet and in the purchase agreement. In the case of the selling ongoing support to the business with the commitment to stay with the shareholders’ breach of exclusivity, the buyer or investor can then company for an agreed term and reach certain performance targets. assert claims for damages amounting to the fees and expenses it has incurred such as the fees for legal and financial due diligence.
6.4 Is warranty and indemnity insurance used to “bridge the gap” where only limited warranties are given by 7 Transaction Terms: IPOs the private equity seller and is it common for this to be offered by private equity sellers as part of the sales process? If so, what are the typical (i) excesses 7.1 What particular features and/or challenges should a / policy limits, and (ii) carve-outs / exclusions from private equity seller be aware of in considering an IPO such warranty and indemnity insurance policies? exit?
Warranty and indemnity insurance is rarely seen in China, but we There are a variety of factors that need to be considered for an have started seeing insurers offering such insurance products for IPO exit, such as the company’s financial performance, size and cross-border PE and M&A transactions. scalability, industrial sector and growth potential, and ultimately, from the legal perspective, compliance related issues and the 6.5 What limitations will typically apply to the liability of minimum requirements for an IPO in a given jurisdiction and listing a private equity seller and management team under on a particular stock exchange, along with the time required for the warranties, covenants, indemnities and undertakings? preparation and approval of the IPO. PE investors often struggle together with the company to find the most suitable place for the IPO The seller’s counsel will often request a cap on the amount for and listing, and sometimes decide to unwind an off-shore structure indemnification, which can be set at a percentage of the share to go for the Chinese domestic A share listing if that option can offer transfer price, along with a survival period of the representations significantly higher multiples as compared to the overseas capital and warranties, such as six months or one year following the closing. markets. Restructuring the company will take time, and is subject to scrutiny by the CSRC (China Securities Regulatory Commission).
6.6 Do (i) private equity sellers provide security (e.g. escrow accounts) for any warranties / liabilities, and 7.2 What customary lock-ups would be imposed on (ii) private equity buyers insist on any security for private equity sellers on an IPO exit? warranties / liabilities (including any obtained from the management team)? Customary lock-ups imposed on private equity sellers, as a result of a China onshore IPO, will normally be one year and can be shorter In case of any serious or material defects or potential damages that if the IPO takes place overseas. This depends on the different stock may arise therefrom, a private equity buyer may insist on an escrow exchanges. amount to be put in place as recourse for any losses and damages. (Escrow Provisions in M&A Transactions, Part 1: “Contain escrow provisions to address buyer concerns over the seller’s financial 7.3 Do private equity sellers generally pursue a dual-track ability to satisfy indemnification provisions contained in the exit process? If so, (i) how late in the process are definitive agreement. Escrow Coverage: To guard against any post- private equity sellers continuing to run the dual- track, and (ii) were more dual-track deals ultimately realised closing financial loss, buyers insist on placing approximately 10 to through a sale or IPO? 15 per cent of the total purchase price in escrow accounts managed by third-party firms. These funds are generally held for a period of Savvy private equity investors always keep all the options open, one to two years in interest bearing accounts, and are released to the
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although they may not necessarily strictly pursue a dual-track exit make acquisitions. There are some recent developments that allow process from the beginning through to the end. This may gain banks to provide financing to private equity funds registered in the increasing popularity as listed companies and industrial giants may Shanghai Pilot Free Trade Zone, and we expect in the foreseeable be willing to pay more as it takes a long period of time for an IPO future the CBRC will likely refine its policy to allow more debt to take place due to the lengthy regulatory procedure and waiting financing for private equity funds. period. Equally, the idea may increase in popularity when the For the off-shore debt financing, the banks involved are usually capital market is not strong enough to warrant the greater returns. financial institutions outside of the jurisdiction of the PRC, and the terms are therefore not subject to the PRC law or jurisdiction; 8 Financing but when the banks require collateral or security to be provided by China any onshore entities within the PRC, the PRC regulatory restriction will come into play again. In particular, the SAFE restricts onshore 8.1 Please outline the most common sources of debt entities from providing guarantees or security interests to non-PRC finance used to fund private equity transactions in persons. This would make the lenders heavily rely on the pledge your jurisdiction and provide an overview of the of shares or equity interests in the off-shore and onshore operating current state of the finance market in your jurisdiction entities, adding risk to the banks in case of default. for such debt (particularly the market for high yield bonds). Debt financing can only be offered by individuals or financial institutions under the PRC law. Therefore, if an inter-company loan Although PE investors find debt financing desirable for helping is needed in China, to be in full compliance with the law, a PRC generate higher IRR, and in particular for large off-shore buyout and licensed bank or trust company will have to act as trustee to bridge privatisation deals, PE investors are more likely to obtain loans from the loan, i.e. the lender to deposit the loan sums into the trustee bank’s banks to finance the transaction, there are restrictions making debt account, requesting the bank to forward the loan to the borrower. finance more difficult to obtain or structure for China-related private equity transactions. In the context of off-shore transactions, there 9 Tax Matters are certain regulatory conditions required for an onshore PRC entity to provide guarantee or security to any off-shore lender or lender’s affiliate. For instance, the SAFE prohibits an onshore guarantee to 9.1 What are the key tax considerations for private equity an off-shore entity where the loan or debt finance is used to acquire investors and transactions in your jurisdiction? Are another off-shore company’s equity interests and 50% or more of off-shore structures common? the assets of such target off-shore company located within the PRC. For onshore transactions, it was not until 2008 that the China Bank For an off-shore transaction, where a non-PRC private equity Regulatory Commission (CBRC) issued Administrative Provisions investor acquires shares of an off-shore holding company which on Acquisition Loans of Commercial Banks and started allowing owns interests in an onshore entity with operating assets, when such banks to make loans to finance acquisitions by companies that meet onshore entity repatriates dividend up to its off-shore parent, such certain qualifications, such as bank credit rating A or above, but, dividend will be subject to withholding tax at the rate of 10%, unless in general, such acquisition loans are not open to private equity there is a tax treaty or equivalent providing a lower withholding tax investors (to be further discussed below). rate. To the extent the private equity investor sells any of its shares In the PRC, in addition to bank syndicated loans, there are other in the off-shore holding company, such transfer will be deemed as channels for debt finance, e.g. a Chinese unit trust plan can be raised an indirect transfer of equity interests in the onshore subsidiary by a Chinese licensed trust investment company, and then such in the PRC, and thus will be subject to filing with the PRC tax trust investment company will loan the sums to PE investors. Also, authority, pursuant to the Circular 698 (as amended by Bulletin 7 of asset management companies with a proper regulatory licence in SAT issued in 2015), and likely subject to capital gains tax (at the China can also raise funds or use their own funds (e.g. the asset rate of 10%). If the off-shore holding company owns subsidiaries management arm of an insurance company) to loan to PE investors. in multiple jurisdictions, and China only represents one of the In the PRC, the debt market for PE is still emerging and yet to be jurisdictions, then, in theory, the tax authority will only charge tax fully developed. on the capital gains corresponding to the value attributable to the China subsidiary or subsidiaries. High yield bonds in China still have high barriers to entry and higher costs, and as a result, they are not considered as a common source of For an onshore transaction, where a non-PRC private equity investor debt financing for private equity transactions. acquires equity interests in an onshore company in China, then any dividend to be repatriated from such onshore company to the foreign investor will be subject to a 10% withholding tax unless a tax treaty 8.2 Are there any relevant legal requirements or or equivalent provides a lower rate. For the capital gains arising restrictions impacting the nature or structure of from the transfer of such foreign PE investor’s sale of its interests the debt financing (or any particular type of debt in the onshore entity, it will be subject to capital gains tax of 10%. financing) of private equity transactions? For off-shore private equity funds active in China, actions and steps For growth capital deals, if the investment only results in a minority must be taken to prevent such entities from being treated as a PRC stake in the portfolio company, banks, for commercial reasons, will tax resident. If not, all its global income of the fund(s) could be not consider debt financing for such investment anyway. Under the subject to PRC corporate income tax. General Rules for Loans promulgated by the CBRC in 1996, loans In respect of the carried interests, if they are being paid by an off- shall not be used for the purposes of “equity investments” unless shore private equity fund to an off-shore GP, provided that such off- otherwise permitted by law. Although the Administrative Provisions shore fund does not become a PRC tax resident, the carried interests on Acquisition Loans of Commercial Banks do not expressly received by the off-shore GP will not be subject to PRC tax except prohibit loans from being made for private equity funds, the loans where, at the individual level, a GP member may need to pay PRC are usually provided for industrial companies or conglomerates to income tax if he or she is a PRC tax resident.
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In contrast, in the context of an onshore private equity fund (a.k.a. “RMB fund”), the law is not clear as to the tax treatment or tax 10 Legal and Regulatory Matters nature of the carried interests – whether it should be deemed as a dividend and therefore subject to 20% income tax rate, or be deemed 10.1 What are the key laws and regulations affecting as remuneration (i.e., compensation for services) and therefore private equity investors and transactions in your subject to the 5%–35% progressive rates plus 6% VAT applicable to jurisdiction, including those that impact private equity any payment of such remuneration. transactions differently to other types of transaction? As mentioned in question 1.1 above, if the future exit is likely to be an IPO in a non-PRC stock market, investors usually would request For onshore transactions where a private equity investor, whether the controlling shareholders to form an off-shore company as the foreign or domestic, invests into a PRC company, the investment, China future vehicle for financing and listing, commonly known as a “red the corporate governance and future exit through an IPO or sale are chip” structure. Recently, some of those red-chip companies listed subject to the PRC Company Law and, to the extent applicable, the on overseas stock exchanges have decided to go private and then PRC securities regulations. If the investor is a non-PRC investor, seek to get listed on the domestic A-share stock market, in light of the transaction will be subject to approval of the MOFCOM or the much better brand recognition on home turf and higher PE ratios its local counterpart, and a set of foreign investment-related laws and valuations offered by domestic investors, and PE funds tend will apply, including, among others, the Circular 10 issued by to participate in those privatisation transactions. Meanwhile, they MOFCOM governing foreign investor’s acquisition of interests in have become increasingly receptive to making direct investments PRC domestic entities, the Sino-Foreign Joint Venture Enterprise into PRC entities with the hope of an exit through an A-share Law and its implementation rules and regulations on national listing or otherwise through sales to A-share listed companies. And security review. As mentioned above, Circular 10 makes it more onshore RMB funds have grown bigger in size and have gradually difficult and costly for a PRC shareholder to restructure his or her dominated the market. Having said that, an off-shore structure still company into an off-shore “red chip” structure – also known as the has its appeal for TMT companies and some entrepreneurs, which “round-trip investment” – and without such off-shore structure non- may prefer an off-shore structure for estate planning reasons, as they PRC PE or VC investors will have to make investments directly into may find it difficult or prohibitively costly (often for tax reasons) to the onshore company and can no longer opt for an overseas IPO but transfer onshore companies into an off-shore family trust, while a hope for a China domestic IPO to happen in the near future. red-chip structure can be easily put under an off-shore trust. From the tax perspective, although the PRC Enterprise Income Tax Law is one of the basic tax laws, as mentioned above, SAT Circular 698 and Bulletin 7 set out the rules on indirect transfer of interests 9.2 What are the key tax considerations for management in any PRC (onshore) entity through an off-shore transfer requiring teams that are selling and/or rolling-over part of their investment into a new acquisition structure? tax filings by the selling shareholder(s) in certain circumstances, despite the fact that the transaction is conducted off-shore, but it has If the private equity investor sells any of its shares in the off-shore an effect of indirect transfer of onshore assets. holding company, such transfer will be deemed as an indirect As regards to the foreign exchange control, the SAFE has a host of transfer of equity interests in the onshore subsidiary in the PRC, and regulations monitoring the flow-in and flow-out of foreign capital. thus will be subject to filing with the PRC tax authority, and likely There are two requirements or restrictions that often impact private subject to capital gains tax (at the rate of 10%) as mentioned above. equity investors. First, as mentioned above, unless with a special For the capital gains arising from the transfer of such foreign PE approval from SAFE, an onshore entity often cannot offer guarantee investor’s sale of its interests in the onshore entity, it will be subject or security interests to an off-shore entity to secure any financing of to capital gains tax of 10%. any of its direct or indirect investment in China, such as an off-shore What are the key tax-efficient arrangements that are typically bank’s debt finance to an onshore entity’s parent, affiliate or an off- considered by management teams in private equity portfolio shore buyer. That largely limits the options for the buyout funds companies (such as growth shares, deferred/vesting arrangements, that would otherwise want to be active in using debt financing for “entrepreneurs’ relief” or “employee shareholder status” in the UK)? buyout transactions. This largely does not apply to China, and as to incentives for the Second, from the fund formation perspective, due to SAFE’s management team of a portfolio company, the tax treatment will restriction on conversion of infused foreign exchange capital into depend on whether the plan is considered a stock option plan, a RMB for onshore equity investments, it is not easy to structure a restricted stock plan or something else. foreign-invested limited partnership as a PRC registered RMB fund to make onshore portfolio investments. Finally, large private equity funds shall also beware of the potential 9.4 Have there been any significant changes in tax requirement of the merger filing with the MOFCOM having to go legislation or the practices of tax authorities (including in relation to tax rulings or clearances) impacting through an antitrust review for the proposed transaction, regardless private equity investors, management teams or private of the transaction being onshore or off-shore. There are two tests to equity transactions and are any anticipated? ascertain whether the merger filing will be required. First, the two participating entities, whether a PE investor or not, will control or The most recent change made by the tax authority is the issuance of have joint control of a target company in China. Second, in addition Bulletin 7 by the SAT in early 2015 as an amendment to the Circular to the “control test”, there is also a “turnover test”, which is either: 698. Bulletin 7 has made a change making the Circular 698 filing (i) the worldwide combined turnover of the two participating entities from compulsory into voluntary, but increases penalties for failure exceeds RMB10 billion (approximately USD1.64 billion), and each to make the required tax payment and adds burden of reporting on of their PRC turnovers exceeds RMB400 million (approximately the buyer as well. It also clarifies and adds detailed tests for what USD65.6 million), respectively; or (ii) the PRC combined turnover constitutes “reasonable commercial purposes” for a transaction of the participating entities exceeds RMB2 billion (approximately structure. Failure to meet such test could result in tax adjustment USD327 million) and each of their PRC turnovers exceeds RMB400 and even penalties. million, respectively.
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10.2 Have there been any significant legal and/or 10.4 Has anti-bribery or anti-corruption legislation regulatory developments over recent years impacting impacted private equity investment and/or investors’ private equity investors or transactions and are any approach to private equity transactions (e.g. anticipated? diligence, contractual protection, etc.)?
A major regulatory development impacting private equity investors Dictated by its home country anti-corruption related laws, funds is the promulgation of the Interim Measures of the Supervision and with members from countries such as the US, Singapore and the UK Administration of Private Investment Funds, by CSRC on August will often include anti-bribery covenants and indemnity clauses in 21, 2014. Such Interim Measures require filing and registration the transaction documents, and often require anti-corruption-related China of any and all forms of private equity investment funds formed in due diligence before signing the deal. China. Such filing and registration shall be made with the Asset Management Association of China, which is affiliated with CSRC. 10.5 Are there any circumstances in which: (i) a private In respect of foreign players’ involvement in fund formation in equity investor may be held liable for the liabilities of China, in light of the SAFE restrictions on conversion of foreign the underlying portfolio companies (including due to exchange capital into RMB for onshore equity investments, breach of applicable laws by the portfolio companies); some select municipalities (such as Shanghai, Tianjin, Beijing and (ii) one portfolio company may be held liable for the liabilities of another portfolio company? and Shenzhen) have issued “QFLP” measures to grant special approvals to certain qualified foreign PE players to set up “qualified foreign [invested] limited partnership(s)” (QFLPs) in their local Natural persons that are directors, officers or employees, could jurisdictions. Those QFLP funds normally take the form of onshore be held liable for losses and damages he or she has caused to limited partnership, and they can convert up to an approved quota the company if he or she acted against the law, regulation or the of foreign capital into RMB for onshore investments. company’s Articles of Association when performing duties for the company. But for entities such as a private equity fund acting as a shareholder of a portfolio company, there is no express provision 10.3 How detailed is the legal due diligence (including that imposes any liabilities on an entity (acting only as a shareholder) compliance) conducted by private equity investors except under the PRC Criminal Law where such entity has engaged prior to any acquisitions (e.g. typical timeframes, in any criminal activities which constitutes a “crime by an entity”. materiality, scope etc.)? Do private equity investors engage outside counsel / professionals to conduct all This also applies to a portfolio company which can be subject to legal / compliance due diligence or is any conducted criminal liability only if it, in itself, has engaged in criminal activities in-house? in violation of the Criminal Law, otherwise it can only be subject to civil liability for losses or damages it has caused to a third-party on Due diligence is often a critical part of a transaction and it serves tortious or contractual basis or otherwise in violation of the law. many purposes. In an acquisition of a domestic Chinese company, the investor may use due diligence to, among other things, help identify issues that: 11 Other Useful Facts ■ Affect the decision of whether to do the deal or abandon it. ■ Bear on purchase price or risk allocation. 11.1 What other factors commonly give rise to concerns ■ Impact post-closing operations or integration. for private equity investors in your jurisdiction or should such investors otherwise be aware of in ■ Require conditions to closing. considering an investment in your jurisdiction? ■ Require other special treatment. Private equity investors normally engage law firms to conduct legal A common misconception of some foreign private equity investors is due diligence. The law firm will generally review documents provided the inclination not to choose the PRC law as governing law and not by the target as well as publicly available information and materials to use the PRC court and arbitration tribunals in case of any disputes obtained from other sources, and will then provide a summary of its with the PRC portfolio company or any of its Chinese shareholders. findings to its client in the form of one or more legal due diligence In reality, a foreign arbitration tribunal can take much longer to reports. Legal due diligence is generally one aspect of a larger due complete the arbitration proceeding, and has a major disadvantage, diligence process that may include inquiries into the following matters: which is not being able to apply for pre-judgment relief such as ■ Accounting. freezing the defendant’s bank account to ensure it has enough secured fund to pay for the award if any. Such privilege is only available for ■ Financial. arbitration committees or tribunals within the PRC. ■ Internal controls. Thus, for foreign arbitration tribunals, the parties will have to wait ■ Tax. for the local court to review the foreign arbitration award and then ■ Technical. proceed with the enforcement, this process could take months on top ■ IP. of the arbitration proceedings. By such time, the defendant could ■ Operations. already have moved or hidden funds elsewhere or even become ■ Labour. bankrupt, leaving little for the plaintiff to recover for its losses and ■ Product. damages. ■ Customer. Another practical tip for foreign PE investors to manage PE transactions in China is to focus the attention on the management’s/ ■ Supplier. founder’s roles in the target company. In the dynamic market with ■ Environmental. ■ Other.
70 WWW.ICLG.COM ICLG TO: PRIVATE EQUITY 2017 © Published and reproduced with kind permission by Global Legal Group Ltd, London Zhong Lun Law Firm China unique Chinese culture that values relationships, the founder and Acknowledgment management team often play an essential role that “makes it or breaks it” for the success of a company. Therefore, a sound PE The authors would also like to thank Mark Gao (Gao Rufeng), investment structure must fully align the interests with the founder Joanna Jiang (Jiang Lulu), Wang Zhonghai and Aurora Zhang and the management team and install a proper mechanism that ties (Zhang Zhuochen) for their invaluable help in providing support the founder/management with the growth of the company. on the tax-related sections, and for the overall research and editing work.
Lefan Gong David Xu (Xu Shiduo) Zhong Lun Law Firm Zhong Lun Law Firm China 10-11/F, Two IFC, 8 Century Avenue 36-37/F, SK Tower Pudong New Area 6A Jianguomenwai Avenue Shanghai 200120 Chaoyang District, Beijing 100022 P. R. China P. R. China
Tel: +86 21 6061 3608 Tel: +86 10 5957 2288 Fax: +86 21 6061 3555 Fax: +86 10 6568 1022 Email: [email protected] Email: [email protected] URL: www.zhonglun.com URL: www.zhonglun.com
Dr. Lefan Gong is a partner in Zhong Lun’s Shanghai office. He is David Xu focuses on private equity and venture capital practice. recognised by Chambers as a recommended lawyer for private equity He has done numerous PE/VC transactions during his 10 years of fund practice and a “Leading Individual Lawyer” in the PRC for M&A experience. David is particularly knowledgable with respect to those by The Legal 500. aspects of deals that require additional experience and know-how on financial, accounting, business and management. He is particularly Dr. Gong is qualified to practise law in both China and New York. He interested and profoundly established in structuring the equity holding has represented private equity clients, family offices, Fortune 500 structure as well as ESOP structures for company clients, ranging from companies, investment banks and major state-owned enterprises in seed stage up until to pre-IPO stage. private equity transactions, corporate financing, cross-border mergers and acquisitions, overseas IPO, joint ventures, and other complex international investment and commercial transactions. He also advises clients on fund formation, establishing red-chip structure, VIE, corporate restructuring and wealth management related matters.
Zhong Lun has been ranked as one of the leading law firms in China by Chambers Asia, the IFLR, ALB and others in many practice areas. With more than 200 partners and 1000 legal professionals, our strategically positioned offices enable our lawyers to work together on a fully integrated cross-office, cross-disciplinary basis to provide commercially-oriented advice and effective real-world legal solutions. The firm’s pre-eminence in the field of PE and VC investments and capital markets means it regularly handles the largest, mostcomplexand demanding transactions in China and works with clients and other law firms all over the world. We have represented numerous domestic and foreign GPs and institutional investors in the formation of all types of PE funds, including buyout funds, real estate funds, mezzanine funds, VC funds and FOF. For PE investment and PE financing, our services run the full spectrum of stages from start-ups to IPOs and post-IPO mergers and acquisitions. Zhong Lun is also renowned for handling the most complex and challenging dispute resolution matters for private equity clients.
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Colombia Santiago Gutiérrez
Lloreda Camacho & Co. Juan Sebastián Peredo
There has not been a significant development of new structures and 1 Overview it is not a common practice for PE funds to take minority positions.
1.1 What are the most common types of private equity 2.2 What are the main drivers for these acquisition transactions in your jurisdiction? What is the current structures? state of the market for these transactions? Have you seen any changes in the types of private equity transactions being implemented in the last two to A number of factors determine the acquisition structure including, three years? among others, tax considerations (tax efficient repatriation of dividends), governance structure, limitation of liability, business For the last few years, the Colombian private equity (“PE”) continuity, regulatory requirements and protection of assets. market has experienced significant growth. Most of the traditional Nevertheless, the primary driver for selecting the structure is tax- strategies to acquire portfolio companies are used in Colombia. driven. The PE fund must consider upstream and downstream Mainly, the market has seen significant moves in terms of venture issues when structuring the transaction and deciding on an onshore capital investments, growth capital investments, buyout transactions or offshore structure. and turnaround transactions. The Colombian PE market has also grown in the amount of transactions involving turnarounds. 2.3 How is the equity commonly structured in private In contrast, given the nature of the PE market in Colombia, club equity transactions in your jurisdiction (including deals have not been a traditional type of transaction. institutional, management and carried interests)?
Traditionally, the equity composition of the Colombian NewCo will 1.2 What are the most significant factors or developments encouraging or inhibiting private equity transactions only have one class of shares, as the NewCo will only be a vehicle in your jurisdiction? with a majority shareholding for the PE fund. Carried interest and other remuneration schemes are usually found PE transactions have been continuously growing in Colombia within international standards. Such carried interest is paid as a PE as a consequence of a sound and healthy economy. Colombia fund cost and, therefore, usually not a part of the NewCo structure. has been committed to stimulating investment into the country through investment protection treaties, free trade agreements and 2.4 What are the main drivers for these equity structures? double taxation agreements, among other measures. Moreover, the particular tax regime applicable to PE funds is appealing for Typically, the drivers in the selection of the equity structure investor interest in the PE market. will be structural subordination, ease of return of funds and tax Nevertheless, among the transaction structures, IPO exits are still rare, considerations. Nevertheless, the structure will also have to considering that the Colombian capital market is still developing. consider the balance of aligning the interest of the shareholders and stimulating management. 2 Structuring Matters As with structuring acquisition transactions, the primary driver is tax efficiency and an effective exit strategy.
2.1 What are the most common acquisition structures adopted for private equity transactions in your 2.5 In relation to management equity, what are the typical jurisdiction? Have new structures increasingly vesting and compulsory acquisition provisions? developed (e.g. minority investments)? In Colombia, such type of provisions may be found, in different Usually, PE funds investing or acquiring Colombian portfolio versions, in the investment protocol of the PE fund. Likewise, at companies set up a special purpose vehicle (“NewCo”) in Colombia the level of the portfolio company there is room for vesting and to effect the investment or acquisition. For this purpose, onshore compulsory acquisition provisions (e.g. acquiring shares at par and offshore structures are available and have been used for PE value); however, these are rare. transactions.
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2.6 If a private equity investor is taking a minority 3.3 Are there any limitations on the effectiveness of veto position, are there different structuring arrangements: (i) at the shareholder level; and (ii) considerations? at the director nominee level? If so, how are these typically addressed? In Colombia, a minority position would not substantially change the structure of the transaction, taking into account that the primary Veto arrangements may be introduced in different manners, among driver for selecting such structure is tax-driven. Moreover, it is which can be found: an obligation to vote in a determined manner; not common for PE funds to take minority positions in portfolio higher quorums for decision making; among others. companies. Therefore, the structure would be generally similar Nevertheless, veto rights cannot be exercised in relation with the and, probably, with some precisions in terms of the negotiation of a distribution of dividends. Colombia shareholder agreement at the portfolio company level, mainly aimed at protecting minority rights. 3.4 Are there any duties owed by a private equity investor to minority shareholders such as management 3 Governance Matters shareholders (or vice versa)? If so, how are these typically addressed?
3.1 What are the typical governance arrangements Minority shareholders are not entitled to special prerogatives for private equity portfolio companies? Are such different from those established for majority shareholders; unless the arrangements required to be made publicly available majority shareholders use its decision power to jeopardise the rights in your jurisdiction? of the minority shareholders (e.g. their right to receive dividends). As a general rule, each shareholder/owner of ordinary shares will be There are various mechanisms that can be used for the purposes of entitled to: attend the shareholders meetings; receive profits in the arranging proper corporate governance in the portfolio companies. proportion of its holding in the aggregate; and review the corporate However, typically, corporate governance will be addressed information within the 15 working days previous to the shareholders through the shareholders’ agreement, which will contain provisions ordinary meeting. regarding corporate governance. Likewise, corporate governance is addressed through amendments to the articles of association of the The protection of minority shareholders has been developed in portfolio company. Colombia through the binding decisions of judicial courts – mainly the Superintendence of Companies acting as a judicial authority, as Shareholders’ agreements are not required to be made publicly a development of the good faith principle. In accordance with the available. Nevertheless, if corporate governance issues are faced judicial precedents regarding this matter, the majority shareholder through the introduction of amendments to the articles of association shall act and decide in the best interests of the company and its of the portfolio company, such amendments will be made publicly stockholders, and not base those decisions on personal interests. available by means of formalising the amendment through a public In case a court considers that the decision was taken abusing the deed (not required for all types of vehicles) and registering the minority shareholders’ rights, the minority shareholders will be public deed with the chamber of commerce. entitled to claim damages, regardless of the fact that the decision may be upheld by the court. 3.2 Do private equity investors and/or their director However, under Colombian law minorities also have to act in good nominees typically enjoy significant veto rights over faith and face limitations in order to prevent the abuse of their rights. major corporate actions (such as acquisitions and disposals, litigation, indebtedness, changing the nature of the business, business plans and strategy, 3.5 Are there any limitations or restrictions on the etc.)? If a private equity investor takes a minority contents or enforceability of shareholder agreements position, what veto rights would they typically enjoy? (including (i) governing law and jurisdiction, and (ii) non-compete and non-solicit provisions)? PE funds customarily include a list of reserved matters in the shareholders’ agreement of portfolio companies. Such reserved Shareholders’ agreements are typically governed by Colombian matters are also addressed through the introduction of amendments law. The parties are free to determine the extent and scope of the to the articles of association of the portfolio companies which, in shareholders’ agreement. In principle, shareholders’ agreements turn, will include specific rules regarding decision-making at a are enforceable and binding only between the contracting parties. shareholders’ level and board of directors’ level. However, pursuant to Colombian corporate law, shareholders’ Veto rights introduced in the shareholders’ agreements usually agreements with respect to simplified corporations (sociedades por address issues regarding, inter alia, changes in the nature of the acciones simplificadas) – a type of corporation commonly used for business, amendments to the articles of association, changes of these transactions – will be valid without limitations if the agreement legal form, mergers and acquisitions, changes in the capitalisation of is deposited with the portfolio company. the portfolio company, signing of material contracts, indebtedness, Pursuant to recent resolutions issued by the Superintendence of liens or charges, liquidation and dissolution, and related parties’ Industry and Commerce – the Colombian competition authority – non- transactions. compete provisions and non-solicit provisions in M&A transactions These veto rights will provide the PE fund with control over the are not, per se, prohibited or considered as restrictive of competition. portfolio company’s major commercial, corporate, investment and The provision must be reviewed on a case-by-case basis. legal decisions. Moreover, any provision of the shareholders’ agreement that is contrary to the articles of association in relation with preference rights in the allocation and sale of shares, would be deemed null and void.
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portfolio company pertains to a specific sector that requires prior 3.6 Are there any legal restrictions or other requirements consent from the relevant authority (e.g. financial institutions). that a private equity investor should be aware of in appointing its nominees to boards of portfolio In both cases, consent from authorities could take several months companies? What are the key potential risks and and would be a factor to weigh-in when determining the structure liabilities for (i) directors nominated by private equity of the transaction. investors to portfolio company boards, and (ii) private equity investors that nominate directors to boards of portfolio companies under corporate law and also 4.2 Have there been any discernible trends in transaction more generally under other applicable laws (see terms over recent years? section 10 below)? As the PE market has been evolving in Colombia over recent years, Colombia Under Colombian law, nominees to the board of portfolio companies certain trends have also emerged, such as: extensive sellers’ due are jointly and severally liable (along with other directors) vis-à-vis diligence and vendors’ due diligence; the inclusion of different the portfolio company, its shareholders and third parties, for damages compensation mechanisms for management; and the inclusion of caused due to their wilful misconduct or gross negligence. In such more complex earn-out mechanisms being more commonly used. cases, there is no limitation as to the damages that can be claimed. Escrow structures for protection in relation with claims in respect Moreover, PE investors of portfolio companies may be held liable of representations and warranties are also more commonly used in for the same reasons explained above (wilful misconduct and gross PE transactions. negligence in their decision-making capacity), in the event that their In terms of exit structures, it is still not common to find exits through decision-making actions cause damages to the portfolio company, listing in Colombia. other shareholders or third parties. Likewise, under Colombian corporate law, entities that have a control of Colombian portfolio companies may be held liable in the event the Colombian portfolio 5 Transaction Terms: Public Acquisitions company is declared insolvent. As a restriction, PE investors nominating directors to the board of 5.1 What particular features and/or challenges apply to listed portfolio companies, have to take into account that at least private equity investors involved in public-to-private 25% of the directors must be independent. transactions (and their financing) and how are these commonly dealt with? 3.7 How do directors nominated by private equity investors deal with actual and potential conflicts of Public-to-private transactions are not common in Colombia. interest arising from (i) their relationship with the Nevertheless, a takeover of a listed company and its delisting is party nominating them, and (ii) positions as directors highly regulated in Colombia. A public-to-private transaction of other portfolio companies? would involve, in the first place, a tender offer aimed at obtaining control of the portfolio company. Such tender offer would have Colombian corporate law establish that directors shall act in good to comply with certain requirements and conditions, which in turn faith, loyalty and with the diligence of a good businessperson. would affect the timeframe of the transaction, as follows: (i) prior Directors are obliged to refrain from participating, directly or authorisation from the Colombian Superintendence of Finance; (ii) indirectly, either for their personal interest or for that of third publication of the offer; and (iii) a period to receive the acceptance parties, in any activities that may imply unlawful competition with to the offer (a minimum of 10 and a maximum of 30 business days). the portfolio company or that may give rise to a conflict of interest, In terms of financing, it is mandatory to obtain the committed unless there is a prior authorisation of the shareholder. funding before launching the tender offer (the bidder must also provide a guarantee to cover a percentage of the transaction). 4 Transaction Terms: General After obtaining control of the company through the tender offer, the bidder (now shareholder) would be able to request the delisting of the company by means of obtaining the favourable vote of 4.1 What are the major issues impacting the timetable for the majority of shareholders. For purposes of protecting the transactions in your jurisdiction, including competition and other regulatory approval requirements, shareholders who voted against delisting and those who did not disclosure obligations and financing issues? attend the shareholders’ meeting, the shareholders that voted in favour of delisting the company are obliged to launch a tender offer One of the major issues that impact the timetable for transactions addressed to these shareholders. is antitrust clearance. As a general rule, only the companies that meet the regulatory thresholds (jointly or individually obtained 5.2 Are break-up fees available in your jurisdiction in an operational revenue and/or assets in excess of about USD 14M relation to public acquisitions? If not, what other during 2017) and engage in the same economic activity or participate arrangements are available, e.g. to cover aborted deal in the same value chain, are required to notify the Superintendence costs? If so, are such arrangements frequently agreed of Industry and Commerce about the intended operation in the event and what is the general range of such break-up fees? of merger, consolidation, acquisition of control or integration. Any kind of transaction where the jurisdictional thresholds are met, and In general, break-up fees would not be permitted in Colombia, if where the undertakings will cease to compete in the market and will the agreement or provision obstructs the right of the shareholders to be controlled permanently by the same parent entity, will be caught accept competing tender offers by third parties. Nevertheless, the under merger control regulations. Superintendence of Finance in Colombia, when consulted on the matter, has not been reluctant to accepting break-up fees when the Apart from antitrust clearance, PE transactions in Colombia are shareholders are permitted to sell, and end up selling their shares, to not subject, in principle, to regulatory approvals from Colombian a competing bidder. authorities. Specific approvals may have to be obtained when the
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Likewise, PE sellers will include time limitations on the survival of 6 Transaction Terms: Private Acquisitions the indemnification, ranging from one to three years and in certain cases (usually labour and tax-related claims) the statute of limitation 6.1 What consideration structures are typically preferred is accepted. by private equity investors (i) on the sell-side, and (ii) Finally, PE sellers will often try to exclude certain claims and to on the buy-side, in your jurisdiction? limit the indemnification to direct losses.
Typically, “locked-box” structures are preferred for PE sellers, taking into account that the seller will have certainty as to the 6.6 Do (i) private equity sellers provide security (e.g. escrow accounts) for any warranties / liabilities, and purchase price. However, on the buy-side “completion accounts” (ii) private equity buyers insist on any security for structures are preferred as they provide adjustment mechanisms warranties / liabilities (including any obtained from Colombia when the execution date and closing date are expected to be far the management team)? apart. Adjustments under this structure are usually referred to the net cash debt/ position and working capital. As a general rule, PE sellers do not provide security for any The consideration structure often involves earn-out mechanisms to warranties and liabilities. However, PE buyers often require some stimulate management. sort of security to collateralise warranties and liabilities from sellers (not often from the management team). This security is often granted in the form of escrow arrangements. 6.2 What is the typical package of warranties/indemnities offered by a private equity seller and its management team to a buyer? 6.7 How do private equity buyers typically provide comfort as to the availability of (i) debt finance, PE sellers in Colombia do not regularly provide extensive warranties and (ii) equity finance? What rights of enforcement and indemnities. Frequently, these are limited to fundamental do sellers typically obtain if commitments to, or warranties (title to its own shares, capacity and authority). Business obtained by, an SPV are not complied with (e.g. equity underwrite of debt funding, right to specific warranties are not common and, if included, are provided by the performance of obligations under an equity management and not the PE seller. In this sense, buyers have to rely commitment letter, damages, etc.)? on their due diligence. Nevertheless, additional warranties and indemnities can be seen, Usually financing is guaranteed by the PE fund and no further depending on the bargaining power of the buyer. However, this documentation is required from the sellers. In case the PE fund would reflect on contingent liabilities that are commonly addressed is the seller, some sort of comfort is required from the potential through escrow arrangements. beneficial owners of the buyer (i.e. representations as to securing the funds or a guarantee). 6.3 What is the typical scope of other covenants, If financing is to be provided by third parties (e.g. banks), the undertakings and indemnities provided by a private representations and warranties will often include the terms and equity seller and its management team to a buyer? status of the arrangements.
Parties typically agree on non-compete and non-solicitation 6.8 Are reverse break fees prevalent in private equity obligations. The survival period for these obligations may vary but transactions to limit private equity buyers’ exposure? usually range between three and five years. However, PE sellers are If so, what terms are typical? usually reluctant to provide such covenants and, if agreed upon, are part of the negotiation. Reverse break fees are not prevalent in PE transactions in Colombia and are relatively unusual. However, exclusivity clauses in the 6.4 Is warranty and indemnity insurance used to “bridge memorandum of understanding are usual (including clauses the gap” where only limited warranties are given by providing for damages if exclusivity is breached). the private equity seller and is it common for this to be offered by private equity sellers as part of the sales process? If so, what are the typical (i) excesses 7 Transaction Terms: IPOs / policy limits, and (ii) carve-outs / exclusions from such warranty and indemnity insurance policies? 7.1 What particular features and/or challenges should a To our knowledge, Colombian insurance companies are not offering private equity seller be aware of in considering an IPO warranty and indemnity insurance. exit?
The main challenge that a PE seller will face when considering 6.5 What limitations will typically apply to the liability of an IPO exit is related with cost and timing. Costs of an IPO exit a private equity seller and management team under are higher than the cost of a traditional sale to other investors or warranties, covenants, indemnities and undertakings? other PE funds. Moreover, the timing to list the portfolio company (including regulatory approvals) is significantly higher. Typically, PE sellers will include several limitations from its potential liability arising from warranties and indemnities. Such Likewise, an IPO exit will entail subjecting the portfolio company limitations often include: (i) a de minimis threshold (excluding to the regulation applicable to listed companies. As with most claims below the limit); (ii) a basket (for aggregate claims); and (iii) jurisdictions, this regulation includes obligations regarding ad hoc a cap on the total liability. reporting, financial reporting and corporate governance, among others.
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Finally, the Colombian market for listed companies is still developing and, therefore, PE sellers could face the market risk of 9 Tax Matters offering the shares through an IPO. This would entail significant efforts in terms of road shows and market analysis. 9.1 What are the key tax considerations for private equity investors and transactions in your jurisdiction? Are off-shore structures common? 7.2 What customary lock-ups would be imposed on private equity sellers on an IPO exit? Key tax considerations in Colombia include: As mentioned, IPO exit strategies are not common in the Colombian (i) PE funds are not considered tax payers for income tax PE market as the market is still developing. Therefore, there are no purposes; however, the remuneration received by the fund
Colombia manager, constitute taxable income for the administrator customary lock-up periods that have been developed for IPO exits. subject to withholding tax. (ii) Under the so-called “transparency principle”, the income 7.3 Do private equity sellers generally pursue a dual-track received by the PE fund is distributed to the PE investors as if exit process? If so, (i) how late in the process are received directly by them. private equity sellers continuing to run the dual-track, (iii) Tax dividend distributions will be taxed if the PE investor and (ii) were more dual-track deals ultimately realised is a resident individual, a foreign entity or a nonresident through a sale or IPO? individual. (iv) Double taxation treaties are used for purposes of off-shore PE sellers do not generally pursue a dual-track exit process. IPO structures. Currently there are treaties in force aimed at exit strategies are unusual in Colombia. Exit strategies in Colombia avoiding double taxation with Spain, Switzerland, Chile, are usually the sale to new investors or to PE funds. Canada, Mexico, Portugal, India, South Korea and the Czech Republic. Additionally, there is a Decision of the Andean Community (CAN) that can be used as a mechanism to avoid 8 Financing that applying to payments made to Ecuador, Peru and Bolivia. (v) The fund manager must act as withholding agent when 8.1 Please outline the most common sources of debt distributing the profits of the PE fund to the PE investors. finance used to fund private equity transactions in Off-shore structures are common in PE transactions in Colombia. your jurisdiction and provide an overview of the current state of the finance market in your jurisdiction for such debt (particularly the market for high yield 9.2 What are the key tax considerations for management bonds). teams that are selling and/or rolling-over part of their investment into a new acquisition structure? Typically, in leveraged buyouts, traditional bank-led loan financing is used in mid and large PE transactions. Loans may take the form Income tax or capital gain tax is levied over the gains in share and of term loans, in its majority, or revolving credit facilities. Likewise, asset transfers. These gains would be equivalent to the difference leveraged buyouts will traditionally contain several layers of debt. between the fiscal cost of the shares or assets and the transfer price. For mid and large PE transactions, syndicated loans, both with local For tax purposes, the transfer price between unrelated parties cannot and international banks are common. differ by more than 25% from the market value, and in the case of shares of non-listed companies, the commercial value corresponds High-yield bond financing has not taken an important role in to at least to 115% of the intrinsic value of the shares. PE transactions and, therefore, bank loans continue to be the predominant source of funds. We expect an increase in the use of If the shares were held for more than two years, capital gains tax high-yield bond financing for large PE transactions. over its profits will be 10%. Otherwise, (if shares were held for less than two years) the profits are taxed with income tax at the We have not seen significant transactions funded through non-bank rate determined on a yearly basis, which for 2017 is 40% (the 34% alternatives. income tax rate plus a 6% surcharge).
8.2 Are there any relevant legal requirements or restrictions impacting the nature or structure of 9.3 What are the key tax-efficient arrangements that are the debt financing (or any particular type of debt typically considered by management teams in private financing) of private equity transactions? equity portfolio companies (such as growth shares, deferred / vesting arrangements, “entrepreneurs’ relief” or “employee shareholder status” in the UK)? In general, we do not have particular limitations that affect the structure of debt financing of PE transactions in Colombia. The most common arrangements for tax-efficient purposes in Colombian banks are permitted to grant facilities for PE transactions, Colombia are stock purchase plans (stock options) deferred in time. so long as the transaction does not involve taking control of entities under the surveillance of the Colombian Superintendence of Finance. This general rule is subject to certain exceptions. 9.4 Have there been any significant changes in tax legislation or the practices of tax authorities Some limitations may be applicable in relation to the tax treatment (including in relation to tax rulings or clearances) of the financing, taking into account thin capitalisation rules and impacting private equity investors, management transfer pricing rules. teams or private equity transactions and are any anticipated?
Colombia adopted a tax reform in December 2016 that has an indirect impact in PE transactions. Fundamental matters, such as the
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transparency principle” have not been modified. However, tax on dividends entails new challenges when structuring PE transactions. 10.4 Has anti-bribery or anti-corruption legislation impacted private equity investment and/or investors’ approach to private equity transactions (e.g. 10 Legal and Regulatory Matters diligence, contractual protection, etc.)?
As mentioned above, anti-bribery and anti-corruption has become 10.1 What are the key laws and regulations affecting an increasing concern in PE transactions and, therefore, PE investors private equity investors and transactions in your carry compliance due diligence and incorporate strict provisions in jurisdiction, including those that impact private equity contracts (share purchase agreements and shareholders’ agreements). transactions differently to other types of transaction? Colombia In general, PE transactions are governed by the provisions of the 10.5 Are there any circumstances in which: (i) a private Colombian Code of Commerce, with regard to the governance and equity investor may be held liable for the liabilities of operation of portfolio companies and the general legal framework the underlying portfolio companies (including due to breach of applicable laws by the portfolio companies); for equity and acquisition transactions. and (ii) one portfolio company may be held liable for Law 964 of 2005 and Decree 2555 of 2010 shall apply with regard the liabilities of another portfolio company? to the incorporation and operation of PE funds (fondos de capital privado), for tender offers and, in general, for the governance and PE investors are, in general, protected by the rules of limitation of the operation of listed portfolio companies. liability for shareholders in corporations (sociedades anónimas) and The key regulation that impacts PE transactions differently than simplified corporations (sociedades por acciones simplificadas). other types of transactions is Decree 2555 of 2010, as it establishes Such protection and limitation of liability may be questioned in the legal regime for the incorporation and operation of PE funds case the portfolio company was used for fraud purposes or with the (fondos de capital privado) in Colombia. This is a special type of intention of damaging third parties. vehicle created for raising funds for the purposes of PE transactions, and it especially permits raising funds from pension funds that otherwise would not be permitted to carry PE transactions. 11 Other Useful Facts
10.2 Have there been any significant legal and/or 11.1 What other factors commonly give rise to concerns regulatory developments over recent years impacting for private equity investors in your jurisdiction or private equity investors or transactions and are any should such investors otherwise be aware of in anticipated? considering an investment in your jurisdiction?
Legal developments have taken the form of amendments to the PE investors must be familiar with the regulatory framework for PE regulatory framework applicable to PE funds (fondos de capital funds (fondos de capital privado) incorporated in Colombia. privado) in Colombia. The regulatory framework has been specially PE funds in Colombia are under the control of the Superintendence amended to respond to international standards with regard to the of Finance. Prior to the beginning of operations, the PE fund administration and management of PE funds. administrator must submit to the Superintendence of Finance Transaction-wise, the recently adopted tax reform in Colombia certain information (e.g. draft of the by-laws, profile of the persons impacts the structure of PE transactions and, particularly, the that will be designated to the investor committee, among others). structure of PE transactions with foreign investors and offshore If the Superintendence of Finance, after receiving complete vehicles. documentation, does not object to the incorporation of the PE fund within the following 10 days, the PE fund will be automatically The PE market is expecting that the regulatory authorities expand authorised to operate. PE funds have an statutory structure that has: the scope of permitted investments and participation in investments (i) a PE fund administrator (exclusively a Colombian broker-dealer, for institutional investors in PE funds. a trust company or an investment management entity); (ii) a PE fund manager (individual or entity that can be appointed by the PE 10.3 How detailed is the legal due diligence (including fund administrator); (iii) an investment committee; (iv) an oversight compliance) conducted by private equity investors committee; (v) a general assembly of investors; (vi) a custodian; and prior to any acquisitions (e.g. typical timeframes, (vii) (at least two) investors. materiality, scope etc.)? Do private equity investors engage outside counsel / professionals to conduct all legal / compliance due diligence or is any conducted in-house?
Typically, PE transactions involve exhaustive legal due diligence prior to any equity investment or acquisition. Over the last few years, compliance has been taken a more significant role in legal due diligence, as a consequence of anti-money laundering and counter-terrorism financing rules and anti-corruption regulation. Foreign regulation regarding these matters (e.g. the Foreign Corrupt Practices Act) has taken a predominant concern in PE transactions. Usually PE investors rely on outside counsel for the purposes of the legal due diligence.
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Santiago Gutiérrez Juan Sebastián Peredo Lloreda Camacho & Co. Lloreda Camacho & Co. Calle 72 No. 5-83 Calle 72 No. 5-83 Piso 5 Piso 5 Colombia Colombia
Tel: +57 1 326 4270 Tel: +57 1 326 4270 Email: [email protected] Email: [email protected] URL: www.lloredacamacho.com URL: www.lloredacamacho.com
Colombia Santiago is Partner at Lloreda Camacho & Co. He joined the firm in Juan Sebastián is a senior associate of the Financial and Capital 1992 and heads the Corporate and Finance practice areas, and also Markets Law Practice at Lloreda Camacho & Co. co-heads the M&A practice group. Juan Sebastián has extensive experience structuring financial He has a law degree from Universidad Javeriana in Bogotá and transactions, including project finance, syndicated loans, derivatives, completed postgraduate studies in Financial Management at the repos, and securitisations. Juan Sebastián has advised national School of Marketing and Management (ESMA) in Barcelona, Spain. and international banks, multilateral creditors, investment firms and private equity funds in syndicated loan transactions, private equity Santiago also won the “Deal Maker of the Year Award – 2015 Edition” in transactions, transactions for the financing of infrastructure in Colombia Colombia granted by Finance Monthly Magazine (UK) with our partner and several of the most relevant capital markets transactions. Andrés Hidalgo. He is a member of the International Bar Association and of Lawyers Associated Worldwide. Santiago is currently President Juan Sebastián earned his JD from Universidad del Rosario and of the Chamber of Legal Services of the National Association of obtained specialisation degrees from Universitat Pompeu Fabra in Industries (ANDI). Santiago is co-author of the Colombia chapter of Barcelona, Spain (2011), and a specialisation degree in financial and Getting the Deal Through – Mergers and Acquisitions, edited by Law capital markets law from Universidad Externado de Colombia (2015). Business Research, London, 2015. In addition, Juan Sebastián obtained in 2016 a Master’s degree (LL.M.) in Banking Law and Financial Regulation from The London School of Economics and Political Science.
Lloreda Camacho & Co., with an experience of more than 75 years, is widely recognised as a Colombian leading law firm that provides integral legal services especially to foreign companies and funds doing business in Colombia. Our Financial Services and M&A Practices are recognised for their active involvement with the private equity industry in Colombia. Partners and associates of the firm have been involved in some of Colombia’s most relevant private equity transactions. Likewise, partners and associates participate, or have participated in the past, as members of the board of directors of listed companies, institutions of the capital markets and entities under the surveillance of the Superintendence of Finance of Colombia. Our members are well regarded for their in-depth knowledge of Colombian and cross-border regulation that impacts private equity transactions.
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Finland Johannes Piha
Borenius Attorneys Ltd Johan Roman
1 Overview 2 Structuring Matters
1.1 What are the most common types of private equity 2.1 What are the most common acquisition structures transactions in your jurisdiction? What is the current adopted for private equity transactions in your state of the market for these transactions? Have jurisdiction? Have new structures increasingly you seen any changes in the types of private equity developed (e.g. minority investments)? transactions being implemented in the last two to three years? Finnish private equity investors typically use only Finnish acquisition vehicles. Market practice varies between using only Generally the Finnish market does not differ from other Nordic a BidCo or a BidCo together with a TopCo, which is the vehicle jurisdictions as to transaction types. The most common private for the fund and management investor investments and which is equity transaction type in Finland is generally a traditional LBO, governed by the shareholders’ agreement. In larger deals additional although there has also been some activity among private equity Holdco layers may be added, e.g. for mezzanine. The Finnish investors focusing on minority (growth) investments as some new limited liability company (“Oy”) is, in practice, the only company players have entered the market. The sectors getting attention from form used for these. The used structures have not changed bigger private equity investors are predominantly health care and materially over recent years. energy. In the mid-cap segment there has been a growing attention on the building and construction technology sector as well as the industrial maintenance sector and different IT-services. 2.2 What are the main drivers for these acquisition structures? The gaming industry has traditionally very strong roots in Finland, with companies such as Rovio (Angry Birds) and Supercell (Clash Taxation and requirements of the senior lenders. of Clans and other mobile gaming hits on their record), and there is a lot of activity in the Finnish start-up scene and in other technology driven sectors, e.g. Fintech. 2.3 How is the equity commonly structured in private equity transactions in your jurisdiction (including institutional, management and carried interests)? 1.2 What are the most significant factors or developments encouraging or inhibiting private equity transactions Traditionally, direct shareholding combined with shareholder loans in your jurisdiction? have been used to create sweet equity structures for the management. Increasingly, these have been turning into the use of different share Finland has many small to mid-size companies, with great classes due to tax considerations and shareholder loans having technology and know-how, looking for strategic partners or private been replaced by the use of preference shares, a change which is equity investors to take them to the next level and make operations mainly driven by changes in the tax regime. It is rather rare for the more international. Finnish private equity investors are traditionally management to have their own vehicle; usually the private equity very active also in the small-cap segment, constantly seeking and investors and management are directly investing in the same entity developing small companies into great targets for industrial buyers (TopCo). or private equity investors focusing on more sizable targets. The Finnish market has seen several good years in terms of the number of IPOs, and it is evident that IPOs have become a viable exit 2.4 What are the main drivers for these equity structures? alternative for private equity investors. Taxation and requirements of the senior lenders.
2.5 In relation to management equity, what are the typical vesting and compulsory acquisition provisions?
Vesting for the management usually lands somewhere in the range of two to seven years. In small-cap deals there might not be any
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vesting at all as shareholding is tied to the manager’s service and leaver provisions require the manager to sell the shareholding prior 3.4 Are there any duties owed by a private equity investor to exit if the manager leaves the target company. to minority shareholders such as management shareholders (or vice versa)? If so, how are these typically addressed? 2.6 If a private equity investor is taking a minority position, are there different structuring Finnish company law recognises a number of elements aimed at considerations? protecting minority shareholders. Generally, these may be waived in the shareholders’ agreement depending on the structure of the In these situations the private equity investor is often using only one investment and deal-specific arrangements. The private equity investment vehicle (BidCo) without an additional TopCo. Finland investor having a majority shareholding in a Finnish company may, however, not cause the company to take actions intended at 3 Governance Matters discriminating against the management shareholders having a minority shareholding.
3.1 What are the typical governance arrangements 3.5 Are there any limitations or restrictions on the for private equity portfolio companies? Are such contents or enforceability of shareholder agreements arrangements required to be made publicly available (including (i) governing law and jurisdiction, and (ii) in your jurisdiction? non-compete and non-solicit provisions)?
There is no requirement to publish governance arrangements in Finnish law generally recognises a principle of mitigating contractual Finland and, e.g., employees in Finland do not have the right to be obligations that are considered fundamentally unreasonable. That represented in the decision-making bodies of Finnish companies. having been said, generally shareholders’ agreements are fully valid However, private equity investors in the Finnish market usually and enforceable in other Nordic countries as well. heavily invest in the corporate governance aspects of their targets. As an EU country, Finland applies the relevant EU conventions Recently sustainability and CSR reporting has found its way to on governing law and forum rules. Too extensive non-compete almost all portfolios of Finnish private equity investors. undertakings are not generally considered enforceable under EU commission guidelines or to the extent a minority shareholder 3.2 Do private equity investors and/or their director could be considered to be more of an employee rather than a real nominees typically enjoy significant veto rights over management investor. major corporate actions (such as acquisitions and disposals, litigation, indebtedness, changing the nature of the business, business plans and strategy, 3.6 Are there any legal restrictions or other requirements etc.)? If a private equity investor takes a minority that a private equity investor should be aware of position, what veto rights would they typically enjoy? in appointing its nominees to boards of portfolio companies? What are the key potential risks and liabilities for (i) directors nominated by private equity Private equity investors in Finnish targets typically enjoy a very investors to portfolio company boards, and (ii) private wide range of veto rights in case they are in a minority position. equity investors that nominate directors to boards It would be unusual for the private equity investor not to control of portfolio companies under corporate law and also major investments, divestments, corporate restructurings, changes more generally under other applicable laws (see to business plan, etc. In case the private equity has a qualified section 10 below)? majority, the veto rights are of less importance. Please see the answer to question 3.3 above. There is generally no risk for a private equity investor nominating board members, but 3.3 Are there any limitations on the effectiveness of veto since board members may be held personally liable for any breaches arrangements: (i) at the shareholder level; and (ii) at the director nominee level? If so, how are these of company law, board members must ensure that they act in the typically addressed? best interest of the company regardless of any deviating instructions from a private equity investor. Usually, private equity investors On the contractual level shareholder veto arrangements are binding in Finland subscribe for board members liability insurance for the obligations that courts may generally enforce. However, if the board. management shareholders act against the shareholders’ agreement and the agreed veto rights, such actions would not be invalid 3.7 How do directors nominated by private equity corporate resolutions as such, but the private equity investor needs investors deal with actual and potential conflicts of to take the matter into court/arbitration tribunal. interest arising from (i) their relationship with the party nominating them, and (ii) positions as directors In Finnish companies the board members are not considered of other portfolio companies? representatives of shareholders, but rather persons who primarily need to act for the benefit of the target company in all circumstances As to the relationship with the party nominating them, please see (which benefit may differ from that of a specific shareholder). To our answers to questions 3.6 and 3.3 above. Board members in the extent the board is required under law to take a certain resolution Finland may not act in the favour of a particular shareholder if (e.g. due to insolvency concerns), no contractual arrangement may this is contrary to the corporate benefit of the target company and force the board to act differently. As in other jurisdictions, veto all shareholders. If the same persons are board members in other rights in Finnish companies typically concern decision-making at portfolio companies, private equity investors usually have their own the board level, but the parties under a contractual obligation to guidelines on how to deal with these situations. Finnish company arrange this are usually the shareholders, not the individual board law does not prevent a board member of a company from deciding members.
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on arrangements between such company and another company in which he or she is a board member as well. 6 Transaction Terms: Private Acquisitions
6.1 What consideration structures are typically preferred 4 Transaction Terms: General by private equity investors (i) on the sell-side, and (ii) on the buy-side, in your jurisdiction? 4.1 What are the major issues impacting the timetable for transactions in your jurisdiction, including Locked box has remained the preferred choice for sell-side, whereas competition and other regulatory approval the buy-side prefers completion accounts. requirements, disclosure obligations and financing If completion accounts are used, the purchase price is usually based issues? Finland on debt-free, cash-free enterprise value with the agreed level of net working capital. Except for approvals from competition authorities (if needed), Although earn-out has its benefits in closing the pricing gap between no other regulatory approvals are usually required. Thus, other the seller and the buyer, it is seldom used due to the difficulties issues impacting the timetable are normal commercial issues relating to the post-closing running of the business. such as preparation of financials, possible prior change of control approval(s) from major contracting party, etc. 6.2 What is the typical package of warranties/indemnities offered by a private equity seller and its management 4.2 Have there been any discernible trends in transaction team to a buyer? terms over recent years?
This varies heavily from transaction to transaction depending on Recent trends include: (i) warranty and indemnity insurance, which the attractiveness of the target and the process. Furthermore, the have become very common; (ii) terms of management investment, emergence of W&I insurance has changed the landscape to some which have been evolving due to changes in taxation (especially extent. Therefore, it is almost impossible to say that there would be influenced by the developments in Sweden); (iii) increasingly less a “typical package”. Of course, the starting point of the seller in an time between the final bid and the signing of the deal in competitive auction process is to offer a fairly limited set of warranties. processes, which leaves less room for negotiations for the selected bidder; and (iv) attention to compliance matters in the due diligence process as well as in the representation and warranties. 6.3 What is the typical scope of other covenants, undertakings and indemnities provided by a private equity seller and its management team to a buyer? 5 Transaction Terms: Public Acquisitions The transaction covenants and undertakings for a private equity seller usually do not differ from those of an industrial seller 5.1 What particular features and/or challenges apply to (conduct between signing and closing, confidentiality, assistance private equity investors involved in public-to-private transactions (and their financing) and how are these with competition filing, etc.) with the exception that private equity commonly dealt with? sellers seldom provide non-compete covenants. Although in Finnish transactions the terms of the management sellers usually Private equity-led tender offers for listed companies are usually follow those of the private equity sponsors, the above-mentioned friendly, negotiated deals with an attractive premium where the non-compete covenant is usually an exception. majority stakeholders are committed to the deal. The key issues in a public tender offer in Finland for a private equity fund are not 6.4 Is warranty and indemnity insurance used to “bridge different from other markets. Financing is clearly a concern, as the gap” where only limited warranties are given by well as getting firm commitments from the main shareholders and the private equity seller and is it common for this negotiating the terms of the deal (including pricing, premium and to be offered by private equity sellers as part of the closing conditions, among other things) with the target’s board. sales process? If so, what are the typical (i) excesses / policy limits, and (ii) carve-outs / exclusions from such warranty and indemnity insurance policies? 5.2 Are break-up fees available in your jurisdiction in relation to public acquisitions? If not, what other Warranty and indemnity insurance has become very common in arrangements are available, e.g. to cover aborted deal transactions in Finland as well, notably in transactions involving costs? If so, are such arrangements frequently agreed private equity. Although sell-side-initiated insurance with a buy- and what is the general range of such break-up fees? side-flip are sometimes used, it is more common that the buy-side takes care of the insurance. The policy limits follow the normal The Helsinki Takeover Code is cautious towards break-up fees. market practice quite well with regard to the limitations of the Emphasis is placed on the careful evaluation by the board, and as a seller’s liability and are rarely creating any problems. rule, the board should not commit to arrangements that prevent the shareholders from freely considering whether to accept the proposed Carve-outs and exclusions are often industry-specific and depend bid. However, a break-up fee may be a justifiable pre-condition in on the thoroughness of the due diligence process. Exclusions often case: (i) the acceptance of the arrangement is, in the opinion of the include forward-looking warranties, criminal fines and penalties, board, in the interests of the shareholders; and (ii) the amount of the transfer pricing, anti-bribery and corruption. Additionally, separate break-up fee is reasonable. The latter criteria also puts weight on insurance is often required for environmental issues. the costs incurred by the bidder.
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■ Representations and warranties in the placing agreement 6.5 What limitations will typically apply to the liability of should be paid attention to. a private equity seller and management team under warranties, covenants, indemnities and undertakings? 7.2 What customary lock-ups would be imposed on private equity sellers on an IPO exit? Time: The limitation period for the warranties usually varies between 12 to 24 months, with the exception of tax warranties and environmental warranties where the limitation period is longer. The customary lock-up period is six months. Monetary: Depending somewhat on the deal size, the maximum liability cap for warranty breaches usually varies between 10–30% 7.3 Do private equity sellers generally pursue a dual-track Finland of the purchase price received by the sellers. Basket (often around exit process? If so, (i) how late in the process are 1%) and de minimis (often around 0.1%) are also applied. private equity sellers continuing to run the dual-track, and (ii) were more dual-track deals ultimately realised Breaches of covenants and undertakings are usually uncapped. through a sale or IPO?
6.6 Do (i) private equity sellers provide security (e.g. The dual-track processes have become more popular due to the escrow accounts) for any warranties / liabilities, and active IPO market. The question about timing (i.e. how late in the (ii) private equity buyers insist on any security for process) varies from transaction to transaction based on the market’s warranties / liabilities (including any obtained from appetite and interest. There have been a few dual-track processes, the management team)? which in the end have led to trade sales.
Escrow arrangements are sometimes agreed but the emergence of warranty and indemnity insurance, in particular, has reduced the 8 Financing need for these. In Finnish transactions, management sellers often enjoy the same deal terms as the private equity seller (not taking into 8.1 Please outline the most common sources of debt account the terms of a possible rollover), which means that escrow finance used to fund private equity transactions in arrangements for management teams are only rare. your jurisdiction and provide an overview of the current state of the finance market in your jurisdiction for such debt (particularly the market for high yield 6.7 How do private equity buyers typically provide bonds). comfort as to the availability of (i) debt finance, and (ii) equity finance? What rights of enforcement do sellers typically obtain if commitments to, or A traditional senior-secured term loan facility made available by a obtained by, an SPV are not complied with (e.g. bank or a club/syndicate of banks is the most common source of debt equity underwrite of debt funding, right to specific financing in the Finnish private equity market. Credit funds and performance of obligations under an equity other non-traditional lenders have not been active in Finland so far. commitment letter, damages, etc.)? Smaller high-yield bonds have emerged as a financing alternative and the Finnish market has seen its first few cases where private Private equity buyers (i) usually provide executed term sheets equity-backed deals have been financed by high-yield bonds. There and commitment letters from senior financiers (often including are also some mezzanine funds actively operating in the market, but a certainty of funds commitment), and (ii) sometimes provide an given the relatively small deal sizes and good availability of senior equity guarantee issued to the buying entity. The latter is less often financing, mezzanine is quite seldom used. required from local private equity investors.
8.2 Are there any relevant legal requirements or 6.8 Are reverse break fees prevalent in private equity restrictions impacting the nature or structure of transactions to limit private equity buyers’ exposure? the debt financing (or any particular type of debt If so, what terms are typical? financing) of private equity transactions?
Reverse break fees are very seldom used in the Finnish market. Debt structuring is mostly affected by tax legislation (interest deductibility) and the Finnish Companies Act. The Companies Act 7 Transaction Terms: IPOs sets restrictions and requirements on the granting of security, of which the financial assistance prohibition and the requirement for corporate benefit are the most important ones. In addition, regulations 7.1 What particular features and/or challenges should a regarding recovery in bankruptcy and fraudulent preference may private equity seller be aware of in considering an IPO restrict the granting of security. For tax, please see Section 9. exit?
■ An IPO will typically require the private equity seller to 9 Tax Matters maintain a stake in the company for a period of time following the IPO, and in some cases the amount of shares actually sold (=exit) by the PE seller has been fairly modest. 9.1 What are the key tax considerations for private equity investors and transactions in your jurisdiction? Are ■ Repayment of shareholder loans in connection with an IPO off-shore structures common? exit (i.e. use of IPO proceeds for the repayment) is not always well-received by the market. Tax considerations for private equity investors ■ Timing and a clear process roadmap coupled with disciplined execution are absolutely essential to a successful IPO process. In Finland, private equity funds are normally established in the form of limited partnerships (“kommandiittiyhtiö”). A Finnish
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limited partnership is treated as a flow-through entity in Finnish general safe haven of €500,000 is applied; if net interest expenses taxation, which means that the partnership as such is not a separate (including third-party and related-party interests) exceed €500,000 tax subject. However, a partnership is treated as an accounting the interest limitation will nevertheless be applied to the entire and tax calculation unit, and is normally obliged to file a corporate amount. Interest may become non-deductible if such net interest income tax return. The calculative taxable profit of the partnership expenses exceed 25% of the company’s tax EBITDA and such non- flows through the partnership to be taxed directly in the hands deductible interest expenses can be carried forward indefinitely. of the partners in accordance with their pre-agreed shares in the Interest payments for third-party loans should not be affected, partnership’s income. Losses of the partnership can be carried however, the concept of third-party loans and especially intra- forward by the partnership and are not deductible to investors. group pledge arrangements amending the character of such loans Actual distributions made by the partnership to its partners are not to intra-group loans have been subject to discussion. In addition, taxable since the profit distributions in question have been or will be the applicability of group equity ratio-based relief has been subject Finland taxed on the basis of the calculated profit share. to discussion. The uncertainties regarding applicability of interest The final tax treatment of the computational shares of profit deduction limitation regulation may have slightly increased the allocated to the partners depends on the individual tax positions of popularity of preference shares instead of intra-group financing. It the partners. For Finnish-resident limited liability companies acting is possible that the scope and structure of Finnish interest deduction as investors, the share of income is normally taxed as part of its limitation regulation may be widened during the forthcoming years, taxable business profit at the normal corporate tax rate (currently partially due to OECD’s BEPS project. 20%). Exemptions may apply in practice to certain institutional Other key tax considerations during the past years have been investors. Dividends received through a limited partnership are transfer pricing and planning of intra-group goods and service flows treated separately from other profits, as the limited partners had in the arm’s length manner and documenting that accurately enough, received the dividend income directly from the distributing entity, treatment of interest of PIK loans provided by individuals (e.g. the and can thus be subject to lower effective tax rates. management of PE portfolio firms), and correct VAT treatment of Special rules apply to foreign private equity investors in a Finnish transaction and financing expenses including duly documentation partnership. The relevant question is often whether the investor thereof. fulfils the relevant criteria set out in Finnish Income Tax Act. Off-shore structures Consequently, the share of income received by a limited partner Off-shore structures are not commonly used in the Finnish market. from a Finnish limited partnership is taxable in Finland, only to Utilisation of off-shore structures may lead to the applicability of the extent such income would have been taxable in Finland had the Finnish tax provisions attributed to controlling foreign companies. limited partner received it directly, provided that: In addition to that, dividends from off-shore countries received by ■ The relevant limited partnership engages solely in private Finnish entities may be subject to a higher tax burden in Finland equity business. than similar dividends from EEC countries and/or countries having ■ The recipient of relevant income is a limited partner having a a tax treaty in force with Finland. limited tax liability in Finland. ■ The limited partner is deemed to be resident in a country that 9.2 What are the key tax considerations for management has a tax treaty in force with Finland. teams that are selling and/or rolling-over part of their ■ That tax treaty applies to that limited partner. investment into a new acquisition structure? If the foreign limited partner does not meet the referred criteria, holding a partnership interest in a Finnish partnership constitutes a Target company management permanent establishment in Finland, as a result of which the investor It is often possible to achieve tax neutral rollover of the is, i.a., liable to file a tax return in Finland. management’s investment into the new structure in M&A In practice, if the partner fulfils the criteria, Finnish tax will be transactions. Key tax considerations include the use of tax neutral payable on dividends paid by Finnish portfolio companies, and structuring alternatives, such as exchange of shares or mergers. capital gains from the sale of real estate property, or real estate Transfer tax costs should be observed. companies, or rental income. In practice, this provision may Private equity professionals be problematic for a foreign fund of funds (or possibly other tax Currently the taxation of management teams and carried interest transparent entities) being investors in Finnish private equity or income is subject to great uncertainty. The Finnish tax authorities venture capital funds. In most cases, non-resident investors are not seem to generally classify carried interest income as earned income taxed in Finland if the proceeds are distributed in the form of capital subject to progressive earned income rates (up to 55%) and certain gains from the sale of shares in target companies, or in the form of compulsory employer contributions payments. However, there interest. are currently no published case law on the matter and it is the Normally, the subscription or transfer of an interest in the partnership understanding of the authors that carried interest income should is not subject to Finnish transfer tax, the rate being generally 1.6% at least in certain circumstances be classified as capital income or 2% of the transfer price in the transfer of other Finnish securities. (subject to tax rate of 30% or 34%). However, the interpretation is, in fact, based on tax practice and not Provisions regarding dividends based on work on written law. When designing incentive structures, provisions regarding dividends Tax considerations for private equity transactions based on work contributed shall also be taken into account. Under Currently, there are several evolving and developing tax-related said provisions, dividends should be treated as the recipient’s earned issues which may affect the Finnish private equity-related income for taxation purposes, if the distribution of the dividend is transactions. Possibly the most important is the Finnish interest based on work contributed by the recipient or a person belonging to deduction limitation regulation, which was implemented as of the a related interest group. However, a dividend is not considered to fiscal year 2014. The limitations are applied only if the interest be based on the contribution of work just because the distributing expenses exceed the interest income received by the company. A company’s profit has accrued perhaps almost entirely due tothe
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work contribution of the recipient or a person belonging to a related With regard to the management teams of a PE portfolio company, interest group. A dividend based on work contribution may also be the division of treatment of compensation as earned income or distributed to a holding company if its owner has provided the work capital income remains quite likely problematic. Problems have contribution. arisen when the management teams receive income other than earned income from the company, and whether or not said income should be taxed as capital income and/or whether potential losses 9.3 What are the key tax-efficient arrangements that are typically considered by management teams in private from arrangements are tax-deductible from earned income, capital equity portfolio companies (such as growth shares, income, capital gain or at all. In addition, the increasing trend deferred / vesting arrangements, “entrepreneurs’ of employment-side costs may stress the importance of accurate relief” or “employee shareholder status” in the UK)? planning of incentive schemes. The Finnish tax authorities have had Finland an aggressive stance on this, resulting in a lot of income received To start with, in Finnish PE portfolio structures management teams by management teams from different kinds of instruments being can consider the subscription of preference shares instead of the regarded as earned income. provision of shareholder loans. The holder of a preference share The Finnish Ministry of Finance published, in February 2017, a can be entitled to a pre-determined fixed dividend which can, e.g., suggestion concerning amendments to the Finnish dividend taxation be paid at exit. Under the Finnish Companies Act, the share classes regulation mostly affecting individuals receiving dividends from having different rights or obligations are possible but the differences unlisted companies. The amendments would generally increase shall normally be reflected in the public articles of association of the tax burden of such individual shareholders and bring closer the the company. Further, the distribution of the dividend to preferred taxation of earned income and capital income. However, no formal shares, as well as to any other shares, requires that the company proposals concerning the amendment of the dividend tax system distributing the dividend has enough distributable assets. The have been introduced yet. dividend should not be tax-deductible to the distributing company and taxed as a dividend at the hand of the receiver. Another potentially tax-efficient arrangement may be the utilisation 10 Legal and Regulatory Matters of sweet equity structures in incentive schemes of PE portfolio company management. In practice, the portfolio company 10.1 What are the key laws and regulations affecting management could subscribe the sweet equity shares in the early private equity investors and transactions in your stage of the holding period by using the arm’s length value of shares. jurisdiction, including those that impact private equity Possibly, the purchase price of the PE investor can serve as the transactions differently to other types of transaction? benchmark for the valuation. The entitlement of annual dividend or right to vote with sweet equity shares can be limited. At the exit, the In practice, only tax statues are of relevance, especially interest private equity fund can redeem back sweet equity shares with pre- deduction limits, which are usually more critical for private equity determined conditions, the redeemed relative amount depending on investors than others. the revenues gained in the exit.
When management teams are considering using any of the 10.2 Have there been any significant legal and/or aforementioned arrangements, it is always imperative to consider the regulatory developments over recent years impacting risk of derived income being classified as earned income. Therefore, private equity investors or transactions and are any special attention must be paid when preparing and documenting anticipated? arrangements (including, but not limited to, arm’s length investments and other conditions utilised by the management team). Please see our answers to the Tax Section; apart from taxation, there Thirdly, the Finnish Government has officially declared that it is have been no major regulatory developments. examining the possibility of a PE-backed unlisted firm to grant shares or options to its key employees without tax consequences by 10.3 How detailed is the legal due diligence (including using a valuation below the arm’s length value. However, no formal compliance) conducted by private equity investors suggestions on such amendments have been made by April 2017. prior to any acquisitions (e.g. typical timeframes, materiality, scope etc.)? Do private equity investors engage outside counsel / professionals to conduct all 9.4 Have there been any significant changes in tax legal / compliance due diligence or is any conducted legislation or the practices of tax authorities in-house? (including in relation to tax rulings or clearances) impacting private equity investors, management Financial, business, tax and legal due diligence are usually teams or private equity transactions and are any anticipated? conducted in small-cap deals by private equity investors. Legal due diligence is customary reported on a findings-only basis. In practice, all private equity investors engage an external counsel to OECD’s BEPS project may naturally affect the tax environment conduct all such reviews. of private equity fund structures and portfolio companies in the long run, especially as Finland has generally been active in putting certain transfer-pricing-related BEPS actions into practice. 10.4 Has anti-bribery or anti-corruption legislation Tax treatment of carried interest arrangements in private equity funds impacted private equity investment and/or investors’ approach to private equity transactions (e.g. structures has been an issue subject to major discussion during past diligence, contractual protection, etc.)? years. The Finnish Central Tax Board and Supreme Administrative Court have in late 2016 and early 2017 issued published case law Yes. ESG/CSR issues are reviewed more often. Further, the concerning the matter. Both published resolutions indicate that recent changes in global politics have brought growing attention to carried interest should be taxed coherently with its legal form. The sanctions compliance of targets having export business. decisions have decreased the past uncertainty.
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10.5 Are there any circumstances in which: (i) a private 11 Other Useful Facts equity investor may be held liable for the liabilities of the underlying portfolio companies (including due to breach of applicable laws by the portfolio companies); 11.1 What other factors commonly give rise to concerns and (ii) one portfolio company may be held liable for for private equity investors in your jurisdiction or the liabilities of another portfolio company? should such investors otherwise be aware of in considering an investment in your jurisdiction? The shareholders of Finnish limited liability companies are, as a main rule, not liable for the obligations of the company There is nothing relevant to add to the above. The Finnish market itself. An exception to this would be piercing the corporate-veil is generally fairly similar to other Nordic jurisdictions for private Finland judgments which are rare and have only been made in very special equity investors. circumstances. This does not mean that there could never be any liability. A shareholder having breached the Finnish Companies Act or the Articles of Association of a Finnish limited liability company may be held liable for the damage caused to the company or third parties through such actions. In practice, such liability is very rare. Shareholders are of course generally entitled to act in their own interest in any decision-making.
Johannes Piha Johan Roman Borenius Attorneys Ltd Borenius Attorneys Ltd Eteläesplanadi 2 Eteläesplanadi 2 00130 Helsinki 00130 Helsinki Finland Finland
Tel: +358 20 713 3225 Tel: +358 20 713 3489 Email: [email protected] Email: [email protected] URL: www.borenius.com URL: www.borenius.com
Johannes is a transaction lawyer focusing on M&A and private equity Johan practises in the field of mergers and acquisitions advising clients transactions and has been involved in numerous domestic and on both domestic and cross-border transactions. He has more than cross-border transactions acting for both private equity sponsors and 10 years of experience in advising leading private equity sponsors, industrial clients. Lately, he has had special focus on China-related industrial clients and financial institutions. transactions. Clients appreciate his ability to seek hands-on solutions Johan also frequently advises clients on questions relating to private to complicated problems. “He understands the deal-making dynamics equity funds and fund formation, various ownership and equity and has the ability to find solutions instead of problems,” as quoted by structures as well as wind power projects. Johan has also served as one of our clients. He regularly lectures on topics relating to mergers an arbitrator. and acquisitions and private equity.
Borenius Attorneys Ltd is one of the largest leading law firms in Finland. We provide an easy access to full-scale business law solutions in Finland, Russia (Borenius Attorneys Russia Ltd) and in New York in the U.S. (Borenius Attorneys LLP). Our strategic initiatives that derive from the 1990s private equity environment in Finland have helped us to secure a leading position both in fund formation and deal making. Our market share in fund formation and secondaries has for many years been over 50%, giving the firm unprecedented access both to private equity funds and their investors. We have represented a deep list of private equity and venture capital houses in making investments and exits, as well as target companies’ management in these transactions. Additionally, our tax practice, which is the largest of any Finnish law firm, puts us in an excellent position where we can provide “the whole deal” to our PE customers.
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Germany Peter Memminger
Memminger LLP Tobias Reiser
1 Overview 2 Structuring Matters
1.1 What are the most common types of private equity 2.1 What are the most common acquisition structures transactions in your jurisdiction? What is the current adopted for private equity transactions in your state of the market for these transactions? Have jurisdiction? Have new structures increasingly you seen any changes in the types of private equity developed (e.g. minority investments)? transactions being implemented in the last two to three years? The acquisition structure is influenced by tax considerations of the investor(s), financing requirements, the potential exit scenario, As Germany is a well-developed and sophisticated private equity liability considerations and other aspects. Most typically, one sees market, one sees all the kinds of transaction types that are typically a non-German TopCo (often Luxembourg-based), which holds a found in other mature markets. While the straight-forward sale or German AcquiCo, which, in turn, then acquires the German target, acquisition of all, or a majority of, the share capital or assets of a mostly being a German HoldCo. company is the predominant transaction type, minority investments These structures are well-developed and can mostly be seen in the in (publicly listed) companies, private equity-backed takeovers of market. Minority or joint investments are rather exceptional structures publicly listed companies, joint ventures, distressed acquisitions and are mostly contingent on the characteristics of the respective target. as well debt-to-equity swaps, often in some part debt financed, can also be regularly seen in the market place. As the general market conditions have not only improved over the last few years but 2.2 What are the main drivers for these acquisition structures? even outperformed peak times in 2006/2007, there is currently a clear dominance of classical (often debt financed) buy-out deals, See the answer to question 2.1 above. particularly in the tech space. Also, minority transactions in growth- oriented companies can currently be seen quite often. 2.3 How is the equity commonly structured in private equity transactions in your jurisdiction (including 1.2 What are the most significant factors or developments institutional, management and carried interests)? encouraging or inhibiting private equity transactions in your jurisdiction? The structuring of the equity depends on the chosen acquisition structure. In a typical scenario with a non-German HoldCo and a Germany has a large pool of mature, medium-sized companies German AcquiCo, the equity of the German AcquiCo consists of that are often (worldwide) market leaders in their area, plus a vivid ordinary equity, sometimes coupled with a shareholder loan given by start-up scene, i.e., the number of potential targets for private equity the non-German HoldCo or preferred shares in the German AcquiCo is larger than in any other European market. Combine this with to mirror equivalent instruments at the non-German HoldCo level. a reliable and educated legal system, the availability of debt for Typically, at the non-German HoldCo you will then find ordinary leverage buy-outs and a capital market that may build the bridge for shares, hybrid instruments such as preferred shares or shareholder an exit scenario and you have what makes Germany an attractive loans, as well as preferred distribution rights in certain scenarios. market place. The general perception towards private equity, especially among the owners of medium-sized companies, is what held the market back in comparison to, e.g., the UK market. But 2.4 What are the main drivers for these equity structures? that has improved over the last years as well and nowadays even the shareholders of medium-sized (family) companies have set aside The main drivers are tax and corporate governance considerations, their reservations. as well as the requirements of the financing banks to achieve structural subordination.
2.5 In relation to management equity, what are the typical vesting and compulsory acquisition provisions?
One sees good leaver, bad leaver and vesting provisions most
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typically structured in such a way that a certain part of the equity the fund into the relevant boards, and which operating decisions vests over a certain period of time and with an option of the ultimately require investor (or shareholder/board) consent. company/investor to purchase the equity of the manager in case of Furthermore, in cases where certain employee thresholds are surpassed, departure at a certain price, which depends on whether the manager co-determination rights of employees need to be observed. In practice is a good or bad leaver. this is much less of an issue as it first may sound to a non-German Good leaver scenarios are usually the termination of the service investor and there are ways to address and mitigate these concerns. relationship by the company without cause, the expiration of a Where and to what extent such structures need to be disclosed service agreement without the company offering an extension on depends on how they have been implemented (e.g., articles of at least equivalent terms to the manager, and illness of a manager. association vs. by-laws) and on some target specific facts. As a rule, All other reasons would then typically (depending on the bargaining it is achievable that no detailed disclosure needs to occur. power of the parties) qualify as bad leaver events. Germany One has to keep in mind, however, that the economically desired 3.2 Do private equity investors and/or their director result may conflict with the actual taxation of the managers, nominees typically enjoy significant veto rights over in particular given the fact that the German tax authorities had major corporate actions (such as acquisitions and taken a more rigid stance concerning some particular features in disposals, litigation, indebtedness, changing the management equity programmes (“MEPs”). The good thing is, nature of the business, business plans and strategy, however, that the German Federal Fiscal Court (the highest tax court etc.)? If a private equity investor takes a minority in Germany) has just recently ruled against the more rigid stance position, what veto rights would they typically enjoy? of the tax authorities and has thus provided some certainty on the beneficial tax treatment of certain features of MEPs. Yes they do; however, not by virtue of law but by the implementation of the measures described above. Usually the list of veto rights is rather detailed, but one has to keep in mind that the investor neither 2.6 If a private equity investor is taking a minority wants to assume the role of a factual-manager (e.g., with regard position, are there different structuring to liability in insolvency scenarios), nor create a tax presence in considerations? Germany by virtue of its too narrowly defined consent rights. In such a scenario, the investor is usually not able to leverage In case of a minority position, the veto rights are weaker and usually its investment and hence debt-driven structuring aspects can only provide protection as it concerns key aspects such as structural be neglected. If the minority investments form part of a joint measures that affect the target group as a whole, exit scenarios investment strategy with other investors, debt driven structuring (details are usually very specific), capital increases, and related aspects may gain importance again. party transactions.
3.3 Are there any limitations on the effectiveness of veto 3 Governance Matters arrangements: (i) at the shareholder level; and (ii) at the director nominee level? If so, how are these typically addressed? 3.1 What are the typical governance arrangements for private equity portfolio companies? Are such arrangements required to be made publicly available Besides the risks referred to above, veto arrangements are, in general in your jurisdiction? terms, only relevant as it concerns the relationship between manager and investor, but do not invalidate actions which the manager may The governance arrangements depend in part on the legal form of take vis-à-vis third parties in violation of such veto arrangements the target and of the other companies in the acquisition structure. (save for certain exceptions). Hence the hurdle for qualifying veto Assuming the most typical case of a German AcquiCo and the arrangements between the investor and managers as invalid is German target both having the legal form of a limited liability rather high and mostly relate to circumstances which invalidate any company (GmbH) and less than 500 employees, one will typically other contractual arrangements as well (e.g., violation of general find that some or all of the top target management assume the principles of law). role of a managing director of the target, advised and overseen by This is, however, a rather theoretical discussion, as investors will a voluntary advisory board, with the management of the German usually ask for fewer veto rights than what would be legally possible AcquiCo then usually consisting of appointees of the investor and in in order to avoid the risk of being treated as a “factual-manager” and some cases the CEO of the target. any potential negative tax consequences. The management of the target company (and any company below it) would need to follow a pre-defined set of rules of procedure, which 3.4 Are there any duties owed by a private equity investor typically require that the management seeks the prior consent of the to minority shareholders such as management shareholders or of the advisory board in case important measures shareholders (or vice versa)? If so, how are these are concerned (the list of important measures is implemented on typically addressed? a case-by-case basis and largely depends on the characteristics of the target (group)). These rules of procedure, and the stipulation The rights and obligations of shareholders among each other are of (voluntary) advisory boards in the structure, which have not extensive and courts have generally followed the concept information and consent rights and the right to remove and appoint that is expressed by law, i.e. that shareholders are free to agree the management, are the most relevant governance rights for the on the rights and obligations that govern their relationship in the investor to exercise “control” also on the operating level. respective corporate documents. The nuances depend on the legal Again, tax and other considerations (e.g., ERISA) of the specific form in question and whether the target company has a small, more investor need to be observed, in particular as it concerns which personalised investor base versus a diverse, large investor base in rights are ultimately granted, who shall be sent as appointee of case of a publicly listed company.
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As a general rule of thumb, German law requires that structural measures such as mergers and capital increases require a majority 3.7 How do directors nominated by private equity of 75% of the votes. If the investor achieves these thresholds on investors deal with actual and potential conflicts of interest arising from (i) their relationship with the its own, then the investor owes no further duties to the minority/ party nominating them, and (ii) positions as directors management shareholders, unless stipulated in the articles of other portfolio companies? differently or the minority/management shareholders would be able to show that the respective decision was taken to intentionally harm Although it may sound surprising, reality shows that this is rather them – a rather high standard. But again, variances exist depending a theoretical problem and is, in practice, much less of an issue than on the legal form in question. expected. Firstly, because nominees of private equity investors would usually not assume a manager position (where one has the Germany 3.5 Are there any limitations or restrictions on the issue of a statutory non-compete obligation for managers) for contents or enforceability of shareholder agreements the reasons described above, but rather becomes a member of a (including (i) governing law and jurisdiction, and (ii) supervisory or advisory board, where they are usually not under non-compete and non-solicit provisions)? a non-compete obligation and exercise only negative control and are hence much less exposed to liability risks. Secondly, all that Germany accepts that contractual agreements between two or more German law usually (variances depend again on the legal form in parties are governed by laws of jurisdictions other than Germany as question and what the corporate documents say about it) demands long as these do not conflict with the ordre public, which is a pretty from a member of an advisory board or supervisory board is that high threshold. The same applies to the applicable venue. However, he acts in the best interest of the company on whose board he is one has to observe certain formalities in order to have a valid venue serving, and hence the interests are usually aligned with that of the and choice of law provision. While non-competes and non-solicit private equity investor. Lastly, the burden of proof of a violation are generally permissible and enforceable, one has to be very careful of the duties of the board member lies with the company and such in their drafting, as an over-excessive provision can make the entire burden of proof is usually hard to meet in practice. provision invalid.
4 Transaction Terms: General 3.6 Are there any legal restrictions or other requirements that a private equity investor should be aware of in appointing its nominees to boards of portfolio 4.1 What are the major issues impacting the timetable companies? What are the key potential risks and for transactions in your jurisdiction, including liabilities for (i) directors nominated by private equity competition and other regulatory approval investors to portfolio company boards, and (ii) private requirements, disclosure obligations and financing equity investors that nominate directors to boards issues? of portfolio companies under corporate law and also more generally under other applicable laws (see section 10 below)? Regulatory approvals may be required if the transaction and the involved parties are of a certain size so that antitrust clearance is Besides the tax considerations referred to above, there are limitations required, or the target operates in certain industries of particular on the maximum number of board positions someone can hold in a importance to Germany, such as media or defence (in which case German stock corporation. Furthermore, German stock corporations special clearance in addition to antitrust clearance is required). have a two-tier board system and one and the same person cannot Except for extraordinary cases, the regulatory approval process be part of the management board as well as of the supervisory usually only takes around one month and can be conducted between board (the latter is supposed to oversee and control the management signing and closing. board). The same principle applies to voluntarily established boards More time consuming are certain aspects which diligent buyers that exercise a control function over management. find in other jurisdictions as well, i.e., the due diligence process, More importantly, assuming a position as a manager or supervisory/ negotiation of appropriate transaction documents and, if needed, the advisory board member entails the risks of violating the fiduciary arrangement of financing. Germany is, however, a sophisticated duties that come along with such a position, and while Germany market with experienced players and hence these topics can usually has also enacted a business judgment rule, a concept protecting be dealt with in a timeframe of two to four months (and one also still managers and board members while exercising their duties, German sees transactions that are done within two weeks only, although this courts tend to review board actions more and more critically and is rather exceptional). demand that companies, in fact, pursue former or current board members and managers for alleged misbehaviour. 4.2 Have there been any discernible trends in transaction If a misbehaviour (which can vary from an uninformed business terms over recent years? decision to personal entrenchment) is found, the respective manager and board member is then personally liable for all damages caused Within the last few years, one could observe that the transaction by it. However, the (often difficult) burden of proof lies with the terms became more and more seller- and borrower-friendly. This company. development is driven by the shortage of targets on the market and In order to mitigate these potential risks, D&O insurances are the availability of bank financings at very favourable conditions. usually sought for managers, board members and (other) nominees. At present, few targets are facing a tremendous demand from Further, private equity investors try to avoid that nominees assume investors and are, hence, in a very strong bargaining position. In manager positions, but rather take on advisory board functions. addition, many funds are currently very rich on cash and are facing a substantial pressure to invest.
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In case of a publicly listed target, the consideration is usually a 5 Transaction Terms: Public Acquisitions straight-forward cash purchase price; a consideration in the form of an exchange offer is rather exceptional. 5.1 What particular features and/or challenges apply to private equity investors involved in public-to-private 6.2 What is the typical package of warranties/indemnities transactions (and their financing) and how are these offered by a private equity seller and its management commonly dealt with? team to a buyer?
Public-to-private transactions require a different tool-set than The general rule is that private equity sellers offer almost no privately negotiated transactions and investors need to be aware of warranties/indemnities, as they otherwise cannot show a clear exit to that. I have advised on one of the very few public-to-privates that their investors. This general rule has, however, been more and more Germany occurred in the German market in the last years and observed first- contested and nowadays one sees structures where either a warranty hand how surprising the legal set up for this kind of transaction in insurance bridges the gap between the offered and sought protection Germany is for investors, particular for Anglo-American investors. of buyers, or private equity sellers accept to grant a greater warranty/ The challenges can be broadly defined into the following categories: (1) indemnity package to the buyer if recourse for potential claims can availability of information for due diligence; (2) seeking support by the only be sought by raising claims to an escrow account that is funded management of the target and certain shareholders; (3) the acquisition by a relatively small portion of the purchase price. process of shares including the tender offer; (4) ensuring the financing, As management is concerned, one sees that they either participate in in particular in light of the strict financial assistance system that applies the same warranty/indemnity package granted by the selling private to a German stock corporation; (5) ensuring the exercise of control equity investor, or give warranties and indemnity to a greater extent, and access to the cash flow of the target via domination and profit and in particular in cases where they re-invest their funds into a new loss pooling agreements; and (6) conducting a squeeze-out of minority structure set up by the buyer. shareholders to the extent the requirements are met. As each of these steps require an in-depth analysis of the applicable 6.3 What is the typical scope of other covenants, legal regime in Germany, broad and general statements do cause undertakings and indemnities provided by a private harm here and interested investors are better advised to seek early equity seller and its management team to a buyer? legal guidance (before the first share in the target is acquired) if they intend to do a public-to-private transaction. Finally, just one The standard package consists of no leakage covenants and more general remark: despite the peculiar legal setting in Germany, guaranties (in very general terms, guaranties are the German public-to-privates are possible if investors are willing to educate equivalent to warranties), a title and authority guarantee and a themselves and are patient. standard financial statement guarantee. In case it is absolutely required to make a deal happen and the liability of the seller is 5.2 Are break-up fees available in your jurisdiction in capped at a small portion of the purchase price and with recourse relation to public acquisitions? If not, what other for potential claims being limited to an escrow or similar account, arrangements are available, e.g. to cover aborted deal then one also sees a more standard approach, with detailed ordinary costs? If so, are such arrangements frequently agreed business conduct covenants, standard guarantees for matters such as and what is the general range of such break-up fees? employment, litigation, compliance with law, real estate and finance and a tax indemnity for past tax periods. The concept of break-up fees is available in Germany, but attention has to be paid to how it is structured, the amount of the break-up fee in relation to the transaction size and the cost actually incurred by 6.4 Is warranty and indemnity insurance used to “bridge the respective bidder. Furthermore, the triggering events of when the gap” where only limited warranties are given by the private equity seller and is it common for this the break-up fee becomes payable have to be defined carefully. to be offered by private equity sellers as part of the One can find break-up fees regularly in cases of a public take-over, sales process? If so, what are the typical (i) excesses usually drafted as a cost reimbursement clause. The amount of the fee / policy limits, and (ii) carve-outs / exclusions from depends on the actual frustrated costs the bidder asks to be compensated such warranty and indemnity insurance policies? for (this can be explained by the legal justification for such clauses in Germany) and hence usually do not exceed 1–3% of the transaction Yes, one sees warranty and indemnity insurances more and more in value (depending on the transaction value). In a private transaction, the German market, but by far not to the extent as visible as in, e.g., one does not usually find such clauses, as the seller is generally obliged the UK market. The current approach to bridge such gap is still by to deliver the sold shares/assets on closing and if he does not stick to means of funding an escrow account with a relatively small portion this obligation, the buyer is entitled to demand damages. of the purchase price and allow for recourse in the case of breach of the additionally granted warranties and indemnities then only to such escrow. As warranty and indemnity insurance is not yet so 6 Transaction Terms: Private Acquisitions common (but the trend goes in this direction), it is hard to describe “typical” terms. 6.1 What consideration structures are typically preferred by private equity investors (i) on the sell-side, and (ii) 6.5 What limitations will typically apply to the liability of on the buy-side, in your jurisdiction? a private equity seller and management team under warranties, covenants, indemnities and undertakings? In the case of an acquisition of a privately-held company, it is typically either a locked-box-based or a closing accounts-based The liability concept is usually narrowed both in terms of time and purchase price, sometimes coupled with earn-out provisions and money. The parties usually foresee that standard breach of covenant vendor loans. Also, reinvestments by sellers are seen regularly. or guarantee or indemnity claims can only be raised for a relatively
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short period of time after closing, whereas claims for title or no leakage have a longer statute of limitation. It is then also provided 7.2 What customary lock-ups would be imposed on that the liability of the seller for these standard claims is capped private equity sellers on an IPO exit? at a relatively low percentage of the purchase price (often with de minimis and threshold/basket concepts reducing the exposure of the It depends on the respective case at hand, but lock-ups for a period seller further), with recourse often only being available to a certain of around six months are not uncommon. escrow or similar account funded out of the purchase price (and the terms of which usually match the statute of limitations and liability 7.3 Do private equity sellers generally pursue a dual-track thresholds). More fundamental claims, such as claims for a breach exit process? If so, (i) how late in the process are of the title or no leakage guarantee or covenant, are then usually private equity sellers continuing to run the dual-track, and (ii) were more dual-track deals ultimately realised Germany capped at the purchase price. through a sale or IPO? By operation of law, the entire liability concept becomes null and void in case of an intentional misconduct by the seller, and this is often Dual-track proceedings can be seen in Germany, particularly for repeated (while not necessary) in the transaction documents as well. large-cap transactions and when the IPO environment is favourable. Usually companies are exited, however, via a sale and the IPO road 6.6 Do (i) private equity sellers provide security (e.g. is abolished rather late in the process. escrow accounts) for any warranties / liabilities, and (ii) private equity buyers insist on any security for warranties / liabilities (including any obtained from 8 Financing the management team)?
Yes, escrow accounts are usually provided for, in particular, if no 8.1 Please outline the most common sources of debt warranty insurance is concluded. finance used to fund private equity transactions in your jurisdiction and provide an overview of the current state of the finance market in your jurisdiction for such 6.7 How do private equity buyers typically provide debt (particularly the market for high yield bonds). comfort as to the availability of (i) debt finance, and (ii) equity finance? What rights of enforcement Debt financing is predominantly provided by financial institutions in do sellers typically obtain if commitments to, or the form of acquisition finance, sometimes combined with mezzanine obtained by, an SPV are not complied with (e.g. financing provided by special mezzanine capital providers. In larger equity underwrite of debt funding, right to specific performance of obligations under an equity transactions, one also sees bond financing, but usually then governed commitment letter, damages, etc.)? by English law. The appetite for acquisition-related financing is currently healthy in the German market. However, due to the easy It depends on what is demanded by the seller, but the most common availability of debt financing by financial institutions the need for instrument is the so-called equity commitment letter issued by the mezzanine capital is currently very limited and the market for bond fund itself or a similar entity. The details of such letters then vary on financings has dried up to large extent. a case-by-case basis, depending on what the seller demands and what the standard practice of the fund is. Usually, sellers are being granted 8.2 Are there any relevant legal requirements or a right to claim funding from the fund into the acquisition structure. restrictions impacting the nature or structure of Where the availability of debt financing is concerned, the buyer typically the debt financing (or any particular type of debt financing) of private equity transactions? has to show to the seller some form of debt commitment letters, which may provide for a hard debt commitment by the financing banks. In order to provide for a debt-push down, one typically needs to seek a profit and loss pooling and domination agreement between 6.8 Are reverse break fees prevalent in private equity the borrower and the OpCos (or a chain of such agreements in the transactions to limit private equity buyers’ exposure? structure). While this is a rather standard agreement and easy to get If so, what terms are typical? in case of an acquisition of all shares outstanding of the target, it may become really challenging if outside shareholders with a stake of more No, these clauses are rather uncommon in the German market, as than 25% are involved. Without such an agreement, the granting of transaction security is a very high parameter for sellers in the German upstream loans and guarantees may become a real challenge. market and such reverse break fees, coupled with the walk-away right As already addressed in question 5.1 above, the legal restrictions on of the buyer, results in weakened transaction security for the seller. financial assistance by a German stock corporation have a significant impact on the structure of debt financing. 7 Transaction Terms: IPOs 9 Tax Matters 7.1 What particular features and/or challenges should a private equity seller be aware of in considering an IPO exit? 9.1 What are the key tax considerations for private equity investors and transactions in your jurisdiction? Are off-shore structures common? IPOs usually do not allow for a full, immediate exit by the private equity seller, as lock-up commitments may need to be given by Germany has enacted, like many European countries, interest existing shareholders. Even after lapse of these commitments, a sale barrier rules which limit the amount of interest that can be offset of a substantial amount of shares will negatively impact the share in the profit and loss statement for tax purposes. Another key topic price and will raise questions about the prospects of the company.
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is to structure the transaction in such a way that the private equity fund and its personnel does not become tax resident in Germany, 10.2 Have there been any significant legal and/or simply by the way how consent rights are structured or board rights regulatory developments over recent years impacting private equity investors or transactions and are any are exercised. anticipated? Off-shore structures are not uncommon; however, these are implemented in the structure of a private equity fund way above a Certainly the interest barrier rules had an impact on private equity German AcquiCo or HoldCo and do hence not pose a feature of the transactions, in particular on the level of debt that has been used German private equity market. in transactions. Further, as in every other European country, the implementation of the AIFMD into German law had an impact on 9.2 What are the key tax considerations for management the fund formation side (but not so much on the deal side). Germany teams that are selling and/or rolling-over part of their investment into a new acquisition structure? 10.3 How detailed is the legal due diligence (including compliance) conducted by private equity investors An important factor is to avoid having the roll-over treated as a prior to any acquisitions (e.g. typical timeframes, taxable event without having, at the same time, a liquidity event for materiality, scope etc.)? Do private equity investors the manager that allows him to pay taxes that may result from it. engage outside counsel / professionals to conduct all legal / compliance due diligence or is any conducted in-house? 9.3 What are the key tax-efficient arrangements that are typically considered by management teams in private Due diligence is, in almost every case, conducted by outside counsel equity portfolio companies (such as growth shares, deferred / vesting arrangements, “entrepreneurs’ and is usually rather detailed, covering all relevant legal aspects relief” or “employee shareholder status” in the UK)? of the target including contracts, compliance with law, corporate measures, real estate, employment, etc. It usually is done in a The most tax-efficient arrangement is still investment via a special four to six-week time frame, depending on how well prepared and partnership formed for the purpose of bundling the investment of committed the seller is and how many resources the buyer devotes all managers which then invests into the equity of the acquisition to it. In cases of high urgency it can also be done within a two-week vehicle. In such partnership, one would find the relevant leaver and time frame, but then certain areas are usually carved out or very high vesting terms agreed. The tax treatment of investments made by materiality thresholds are applied. managers (indirectly) in their own company was subject to significant changes in the past few years. The tax authorities had pursued a 10.4 Has anti-bribery or anti-corruption legislation strict approach and tended to qualify the gains resulting from such impacted private equity investment and/or investors’ investments as taxable employment income. However, the German approach to private equity transactions (e.g. Federal Fiscal Court just recently ruled that such gains are, if certain diligence, contractual protection, etc.)? conditions are met, to be treated as capital gains. In the case referred to in the foregoing, the German Federal Fiscal Court qualified the Yes, nowadays compliance is part of the usual due diligence exercise gains not only as capital gains but even as non-taxable capital gains. of a private equity investor. Due to these recent changes, management participation structures regained more certainty from a tax law perspective. 10.5 Are there any circumstances in which: (i) a private equity investor may be held liable for the liabilities of 9.4 Have there been any significant changes in tax the underlying portfolio companies (including due to legislation or the practices of tax authorities (including breach of applicable laws by the portfolio companies); in relation to tax rulings or clearances) impacting and (ii) one portfolio company may be held liable for private equity investors, management teams or private the liabilities of another portfolio company? equity transactions and are any anticipated? While such a liability may in theory be possible, in practice this does The tax treatment of management participation structures underwent not become an issue, as it can be avoided by the correct structuring significant changes in the recent past. As described in question 9.3 of the transaction. The same applies for cross-liability among above, the German Federal Fiscal Court ruled that gains resulting portfolio companies. from a management participation are, subject to certain conditions being met, to be qualified as capital gains and eventually even as 11 Other Useful Facts non-taxable capital gains. See also above.
11.1 What other factors commonly give rise to concerns 10 Legal and Regulatory Matters for private equity investors in your jurisdiction or should such investors otherwise be aware of in considering an investment in your jurisdiction? 10.1 What are the key laws and regulations affecting private equity investors and transactions in your jurisdiction, including those that impact private equity Most of the relevant factors have already been addressed in the transactions differently to other types of transaction? foregoing.
In general, one can say that there are no laws that specifically address, or discriminate, private equity transactions, and this is one of the reasons why Germany offers a rather safe legal system for these kinds of transactions.
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Acknowledgment foreign securitisations. Emma Kersch has also lived and worked in the People’s Republic of China (Shanghai), as well as in Belgium The authors would like to acknowledge the third author of this (Brussels), where she worked for companies and institutions such chapter, Emma Kersch. as Bayer, the European Commission and Freshfields Bruckhaus Emma Kersch is a counsel at Memminger LLP and studied law at Deringer. the University of Western Australia, in Perth, Australia. Before Emma Kersch is admitted as a Solicitor in England and Wales, as joining Memminger LLP, she worked in Melbourne, Australia well as in Victoria, Australia. She advises clients on transactions for Mallesons Stephen Jaques in the Debt Capital Markets and with British and Australian law aspects, in the areas of Corporate Finance teams and in the Frankfurt office of Clifford Chance in the Law, M&A, Private Equity and Compliance. securitisation department, where her focus was upon advising banks Tel: +49 69 66778 1500. Email: [email protected].
Germany and financial institutions as dealer and issuer in both domestic and
Peter Memminger Tobias Reiser Memminger LLP Memminger LLP Bleichstrasse 64-66 Bleichstrasse 64-66 60313 Frankfurt am Main 60313 Frankfurt am Main Germany Germany
Tel: +49 69 66778 1500 Tel: +49 69 66778 1500 Email: [email protected] Email: [email protected] URL: www.memmingerllp.com URL: www.memmingerllp.com
Peter Memminger is the founding partner of Memminger LLP and was Tobias Reiser is a counsel at the firm. Prior to joining the firm, Tobias previously a member of the international firm Milbank, Tweed, Hadley was a senior associate in the Banking/Finance department of the & McCloy LLP in Frankfurt. He successfully founded and developed international law firm Skadden, Arps, Slate, Meagher & Flom LLP in its Corporate practice as an Equity Partner. Frankfurt/Main. He focuses on mergers & acquisitions and public takeovers with a Tobias advises in the fields of corporate and finance law with a particular particular emphasis on private equity transactions and is also involved focus on M&A and Private Equity transactions, and with regard to in corporate governance topics. He frequently advises on corporate financing and restructuring aspects. He regularly represents clients in reorganisations, litigations and arbitrations. He serves as Regional court proceedings and also advises on Corporate Governance. Ambassador of the International Directors Program of INSEAD in Tobias studied law at the University of Bayreuth and at the Johannes Germany. Gutenberg-University Mainz. He is admitted to the bar in Germany Current rankings in directories as JUVE, Chambers, The Legal 500, and speaks German and English. IFLR and Best Lawyers recognise Peter Memminger as a top lawyer for M&A and Private Equity. He studied law at the University of Freiburg, the Faculté Internationale de Droit Comparé in Strasbourg (FIDL), holds a post-graduate degree from the University of Miami (LL.M.) and a Ph.D. from the University of Freiburg.
Memminger LLP is a leading German Corporate Boutique Law Firm based in Frankfurt/Main with an international scope. Our firm was founded by partners and lawyers from renowned international firms, to combine quality legal services and a long history of transactional experience with commercial expertise in the provision of advisory services and thereby to efficiently achieve our clients’ goals. We are more than just your legal advisors. We are your strategic partners, who make it possible for you to concentrate on the really important things. Our long-standing client relationships, built upon trust, pay testimony to this. As “Trusted Advisors”, we put the interests of our clients, pragmatism and integrity first. For this reason, the best-known and most successful German entrepreneurs, international investors and companies, family offices and company founders trust us for our comprehensive legal advice on their commercial issues and transactions. We advise in small teams of top-class specialists, according to our motto: “We talk the talk and we walk the walk”. Our lawyers are aware first-hand of the challenges and expectations of successful international companies and investors, as they themselves are or have been active in leading international investment banks, private equity funds, as the founders of successful companies or as members of a board.
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Gibraltar F. Javier Triay
Triay & Triay Jay Gomez
Gibraltar is part of the European Union (“EU”) by virtue of the 1 Overview United Kingdom’s membership. Therefore when the UK leaves the EU, Gibraltar will follow suit. Whether or not Gibraltar will continue 1.1 What are the most common types of private equity to have access to the EU’s common market will depend on the deal transactions in your jurisdiction? What is the current negotiated by the UK for itself and Gibraltar. Notwithstanding, state of the market for these transactions? Have the UK Government has confirmed that Gibraltar will continue to you seen any changes in the types of private equity have access to the UK market and will therefore continue being a transactions being implemented in the last two to financial services hub and gateway to the UK. three years?
As a UK overseas territory located on the European continent, 2 Structuring Matters Gibraltar offers tax, operational and lifestyle advantages which are second to none for those looking to undertake financial services and gaming business. These advantages are coupled with the security of 2.1 What are the most common acquisition structures adopted for private equity transactions in your high regulatory standards which meet EU requirements, a common jurisdiction? Have new structures increasingly law legal system largely derived from England and Wales and a developed (e.g. minority investments)? jurisdiction that seeks to encourage and facilitate business. Gibraltar’s gaming and financial services sectors are constantly Given Gibraltar’s attractive tax environment, PE transactions are developing and this has resulted in several PE transactions such as usually structured using a GibCo. GibCo’s are frequently used as mergers, refinancing, buy-outs, sales and flotations. Typically, when the holding company (“TopCo”) and also as the BidCo (the entity a Gibraltar entity (“GibCo”) is subject to a buy-out, refinancing, acquiring and holding the target’s shares). There are rarely any and an IPO, the GibCo’s business is undertaken from Gibraltar, but Gibraltar tax implications in utilising a GibCo. services are provided in many other jurisdictions. This has been the At times, it may be necessary to utilise a BidCo in a jurisdiction trend for some time now. which has a double taxation treaty with the target’s jurisdiction. In addition to this, Gibraltar, as a fund jurisdiction, has seen several investment funds established with the sole investment mandate of investing in PE investments. These investment funds are usually 2.2 What are the main drivers for these acquisition structures? established in the form of closed-ended funds but we have recently also seen the emergence of open-ended PE funds which manage liquidity but invest in short-term PE type projects. (i) Purchaser requirements; (ii) tax efficiencies; and (iii) financing entities requirements.
1.2 What are the most significant factors or developments encouraging or inhibiting private equity transactions 2.3 How is the equity commonly structured in private in your jurisdiction? equity transactions in your jurisdiction (including institutional, management and carried interests)? Gibraltar is a UK overseas territory and as a consequence has deep- rooted ties with the UK. The English language, common law legal A PE investor’s holding is commonly structured through the system, speed to market and low costs form part of the reasons purchase of preference shares and/or ordinary shares. Where encouraging PE investors to Gibraltar. Gibraltar’s relatively low management is involved, there shares will usually include certain corporation tax rate (10%) and the capped income tax rate for deferred rights to ensure that they continue to be incentivised. High Executives Possessing Specialist Skills (“HEPSS”) (capped at GBP30,000 income tax per annum) continues to attract business 2.4 What are the main drivers for these equity structures? to Gibraltar. Additional factors include no VAT, capital gains tax, inheritance tax or withholding tax, which also contribute to Ease of return to the investors, repayment of the financing, tax Gibraltar’s attractiveness. efficiency and management incentivisation.
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2.5 In relation to management equity, what are the typical 3.4 Are there any duties owed by a private equity investor vesting and compulsory acquisition provisions? to minority shareholders such as management shareholders (or vice versa)? If so, how are these Most transactions will include provisions to allow the acquisition of typically addressed? shares held by senior management and those having been acquired as a result of his/her employment. The transaction documentation The PE investor is not subject to fiduciary or other duties under typically requires the input of our employment team who will ensure Gibraltar law to the minority shareholders unless these are agreed that good leaver/bad leaver provisions are enforceable. as contractual obligations between the parties in a shareholders’ agreement.
Gibraltar 2.6 If a private equity investor is taking a minority position, are there different structuring 3.5 Are there any limitations or restrictions on the considerations? contents or enforceability of shareholder agreements (including (i) governing law and jurisdiction, and (ii) non-compete and non-solicit provisions)? In Gibraltar it is rare for investors to take minority stakes. However, the structuring considerations remain broadly similar for minority shareholders. Minority investors should consider whether it is The non-compete and non-solicitation clauses will be subject to the appropriately protected from any action the controlling investor test of reasonableness and any provision that may be deemed to be may wish to take. unreasonable may be declared void by the Gibraltar courts. Where the parties to the shareholder agreements are companies from other jurisdictions, the parties will also need to consider any implications 3 Governance Matters that may have on the shareholders’ agreement.
3.1 What are the typical governance arrangements 3.6 Are there any legal restrictions or other requirements for private equity portfolio companies? Are such that a private equity investor should be aware of arrangements required to be made publicly available in appointing its nominees to boards of portfolio in your jurisdiction? companies? What are the key potential risks and liabilities for (i) directors nominated by private equity investors to portfolio company boards, and (ii) private PE providers and management will usually enter into a shareholders’ equity investors that nominate directors to boards agreement to govern their relationship. The articles of association of portfolio companies under corporate law and also are publicly available and therefore sensitive information is more generally under other applicable laws (see typically only contained within the shareholders’ agreement. This section 10 below)? may include: management obligations; obligations on the transfer of shares; issuance of new shares (bonus structure); any applicable Nominee directors are permitted to act as directors and there are no veto; and exit provisions, etc. restrictions on nationality or country of residence. It should be noted that these “providers” will still owe the same common law duties to the company established in the courts of England and Wales. By 3.2 Do private equity investors and/or their director way of example, an act of negligence or non-payment of tax by the nominees typically enjoy significant veto rights over major corporate actions (such as acquisitions and company may result in the directors being personally liable. disposals, litigation, indebtedness, changing the A PE investor who appoints a nominee director but then discharges nature of the business, business plans and strategy, the function himself/herself will also need to consider the etc.)? If a private equity investor takes a minority implications of being construed to be acting as “shadow directors”. position, what veto rights would they typically enjoy? Shadow directors are treated as a director of the portfolio company and the same director’s duties would apply. PE investors generally do enjoy veto rights. These are transaction- specific and can be tailored to the needs of the PE investors. For example, these may include vetos on change of strategy, change 3.7 How do directors nominated by private equity of management, proposal of the issuance of shares, etc. It is also investors deal with actual and potential conflicts of interest arising from (i) their relationship with the common to include certain thresholds. party nominating them, and (ii) positions as directors of other portfolio companies? 3.3 Are there any limitations on the effectiveness of veto arrangements: (i) at the shareholder level; and (ii) The Companies Act 2014 imposes a duty on all directors who are at the director nominee level? If so, how are these directly or indirectly interested in a contract or proposed contract typically addressed? with the company to declare the nature of their interest at a meeting of directors. It should be noted that this does not restrict There are no limitations on the effectiveness of a veto providing it the company from entering into that contract providing it has been has been agreed by the shareholders, usually documented and agreed disclosed. Whilst nominee directors may be appointed by the PE in a shareholders’ agreement provided that they are not contrary investors, their duty is to the company per se not the PE Investors. to Gibraltar law or contrary to public policy. The shareholders’ When a conflict arises it is the duty of the nominee directors to avoid agreement may also contain provisions requiring the shareholders to the conflict and if it is unavoidable ensure that the other directors procure that certain actions are taken (or not) by the relevant target. are aware of the conflict and that the conflict be mitigated to ensure that it does not unfairly prejudice the company. In order to mitigate conflicts the nominee director should have internal conflict process that may include obtaining relevant corporate authorisations.
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4 Transaction Terms: General 6.2 What is the typical package of warranties/indemnities offered by a private equity seller and its management team to a buyer? 4.1 What are the major issues impacting the timetable for transactions in your jurisdiction, including competition and other regulatory approval The seller will, generally, only give warranties on their ability and requirements, disclosure obligations and financing capacity to enter into the SPA and the title to the shares. Sellers issues? occasionally will also provide a tax indemnity.
When a licensed entity is involved the necessary regulatory 6.3 What is the typical scope of other covenants, approvals will be required in order to allow the transaction to undertakings and indemnities provided by a private Gibraltar complete. With regards to gaming companies, due to their size they equity seller and its management team to a buyer? are usually subject to competition approval prior to a transaction taking place. However, given the size of the jurisdiction and the The sellers will be reluctant to provide covenants, undertakings regulators close relationship with licencees, Gibraltar prides itself and indemnities; however, these can sometimes not be avoided. on speed in obtaining decisions from the regulators. Typically a seller will have to provide certain indemnities in relation to tax, regulatory filings and the conduct of the business 4.2 Have there been any discernible trends in transaction (pre-completion). Covenants and undertakings may include non- terms over recent years? compete and non-solicitation clauses and conduct of business (pre- completion); however, sellers are usually reluctant to provide these. None. But the advent of Brexit may result in new trends that impact They are more relevant where management are also exiting the on the jurisdiction generally. Obviously these cannot be determined target business. until there is more certainty as to the final outcome. 6.4 Is warranty and indemnity insurance used to “bridge the gap” where only limited warranties are given by 5 Transaction Terms: Public Acquisitions the private equity seller and is it common for this to be offered by private equity sellers as part of the sales process? If so, what are the typical (i) excesses 5.1 What particular features and/or challenges apply to / policy limits, and (ii) carve-outs / exclusions from private equity investors involved in public-to-private such warranty and indemnity insurance policies? transactions (and their financing) and how are these commonly dealt with? Whilst not being used in every transaction, this is typically obtained (and generally advisable) when the sellers do not want to be subject The Financial Services (Takeover Bids) Act will apply where the to a retention of proceeds of sale clause or escrow agreement. transaction involves an entity which is listed on the Gibraltar Stock Exchange. However, most PE transactions will involve a GibCo which is listed in the UK. As such, the City Code on Takeovers and 6.5 What limitations will typically apply to the liability of Mergers would apply (please see the UK chapter). a private equity seller and management team under warranties, covenants, indemnities and undertakings?
5.2 Are break-up fees available in your jurisdiction in Further to question 6.2 above, warranties are given in relation to the relation to public acquisitions? If not, what other ability and capacity to enter into the SPA, and title to the shares are arrangements are available, e.g. to cover aborted deal costs? If so, are such arrangements frequently agreed generally subject to a maximum cap being the purchase price. and what is the general range of such break-up fees? The management team will also seek to cap their liability under warranties, covenants, indemnities and undertakings. Occasionally Most PE transactions will involve a GibCo which is listed in the these are linked to the excess of any insurance or a multiple of UK. As such, the City Code on Takeovers and Mergers would apply aggregate salaries. (please see the UK chapter). 6.6 Do (i) private equity sellers provide security (e.g. escrow accounts) for any warranties / liabilities, and 6 Transaction Terms: Private Acquisitions (ii) private equity buyers insist on any security for warranties / liabilities (including any obtained from the management team)? 6.1 What consideration structures are typically preferred by private equity investors (i) on the sell-side, and (ii) on the buy-side, in your jurisdiction? Sellers will try and resist the need to provide security. However in limited circumstances the sellers will provide for a percentage of the Most transactions in Gibraltar are based on a multiple of EBITDA proceeds of the sale to be held in an escrow account for a limited or a discounted cash-flow valuation, minus net debt, adjusted for period of time. working capital and other factors, and based on the balance sheet at Buyers will typically seek escrow arrangements and/or insurance to completion. However, this does present certain challenges such as cover the liability. a potential change in value between forecast and actual net debt and working capital.
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6.7 How do private equity buyers typically provide 8 Financing comfort as to the availability of (i) debt finance, and (ii) equity finance? What rights of enforcement do sellers typically obtain if commitments to, or 8.1 Please outline the most common sources of debt obtained by, an SPV are not complied with (e.g. finance used to fund private equity transactions in equity underwrite of debt funding, right to specific your jurisdiction and provide an overview of the performance of obligations under an equity current state of the finance market in your jurisdiction commitment letter, damages, etc.)? for such debt (particularly the market for high yield bonds). It is common for the PE sponsor to provide the seller with a direct
Gibraltar commitment to fund the transaction subject to the satisfaction of the The majority of debt financing is provided by the traditional conditions in the share purchase agreement. This commitment will financial institutions. However, since 2008 as those entities have typically include certain commitments to ensure draw-down for the been subject to greater regulatory scrutiny, financing has been completion of the transaction. provided by alternative entities such as investment funds providing PE debt financing facilities. High-yield bond financing has also become attractive. 6.8 Are reverse break fees prevalent in private equity transactions to limit private equity buyers’ exposure? If so, what terms are typical? 8.2 Are there any relevant legal requirements or restrictions impacting the nature or structure of the debt financing (or any particular type of debt Break fees are permissible under Gibraltar law. However, they are financing) of private equity transactions? not common. There are no legal requirements or restrictions impacting the nature 7 Transaction Terms: IPOs or structure of the debt financing save for the registration of any security with the relevant register in Gibraltar.
7.1 What particular features and/or challenges should a private equity seller be aware of in considering an IPO 9 Tax Matters exit?
There are several features and challenges that a private equity seller 9.1 What are the key tax considerations for private equity investors and transactions in your jurisdiction? Are should be aware of when considering an IPO exit. Despite having off-shore structures common? a European standard stock exchange registered and operating in Gibraltar, GSX currently only permits the listing of certain collective One of the factors that make Gibraltar an attractive jurisdiction is investment schemes and debt products. its low corporate and personal tax regimes. On 1 January 2011, Accordingly, Gibraltar companies that are seeking to list will the Income Tax Act 2010 (the IT Act) came into force. The IT Act generally list on a stock exchange established in the UK. A ended the distinction between offshore and onshore business. On 24 key consideration would therefore be the cost and timescale June 2013, it was announced that the European Council of Economic associated with such a listing. Additionally the seller would need and Finance Ministers of the 27 EU Members States (“ECOFIN”) to obtain comfort that there is sufficient appetite for such a listing. endorsed Gibraltar’s Income Tax Act 2010 as being compliant with Furthermore, there may be contractual obligations and or selling the EU Code of Conduct for business taxation. This is the first time restrictions that may be imposed by UK law. The listing risks are that Gibraltar’s tax system has been fully endorsed by both ECOFIN therefore very much UK-focused. Please see the UK chapter. and the Code of Conduct Group (which is a group formed of the tax authorities of the 27 EU member states and chaired by the EU 7.2 What customary lock-ups would be imposed on commission). private equity sellers on an IPO exit? On 29 October 2014, the global Forum of the OECD categorised Gibraltar as largely compliant: the same as the United Kingdom This will be a matter of UK law or the law of where the listing and Germany. These approvals mark a major milestone in the is going to take place. Based on our understanding of previous transformation of Gibraltar as a mainstream and compliant tax transactions, it is typically around six months. jurisdiction. There is no capital gains tax, wealth tax, inheritance tax, VAT or 7.3 Do private equity sellers generally pursue a dual-track estate duty in Gibraltar. The only relevant tax – income tax – is exit process? If so, (i) how late in the process are levied on a territorial source basis under the “accrued in” or “derived private equity sellers continuing to run the dual-track, from” Gibraltar principle. and (ii) were more dual-track deals ultimately realised through a sale or IPO? While Gibraltar does not at the moment have any bilateral double tax treaties in place with other countries, Her Majesty’s Government of Gibraltar has recently confirmed that it is actively looking to enter Yes it is common to pursue a dual-track exit process. In our into double taxation treaties. Equivalent provisions are however, experience, the majority of transactions result in a sale as opposed available under EU law. In general, all companies are taxed on to an IPO because they wish to avoid the risks set out in the answer profits accruing in or derived from Gibraltar, thereby preserving the to question 6.1 above. territorial basis of taxation. In the case of companies licensed and
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regulated under Gibraltar law, the activities which give rise to profits Gibraltar Commissioner of Income Tax, it has been increasingly are deemed to take place in Gibraltar (with the exception of profits difficult to do so following the EU Commission’s decision which generated by overseas branches or permanent establishments). raised doubts on the compatibility of Gibraltar’s tax rulings with Furthermore, a company is considered to be ordinarily resident in EU state aid rules. Whilst the decision did not contain any final Gibraltar if the management and control of the company is exercised findings and merely opened a formal investigation, Her Majesty’s from Gibraltar. From 1 January 2011, companies are generally Government of Gibraltar is challenging the decision on the basis that chargeable on taxable profits at the rate of 10%. an incorrect procedure was followed, it lacks adequate reasoning There is no charge to tax on the receipt by a Gibraltar company and contains a number of serious errors of fact and of law. Her of dividends from any other company regardless of its place of Majesty’s Government of Gibraltar has issued a public statement incorporation. It is also important to note that Gibraltar companies stating that it “remains convinced that the practice of tax rulings in can benefit from the Parent Subsidiary Directive (“PSD”). The Gibraltar does not constitute state aid”. Gibraltar PSD provides for no withholding tax on dividends payable by a subsidiary in an EU member state to a Gibraltar parent company. 10 Legal and Regulatory Matters This is particularly advantageous when used in the context of EU investments or when an EU special purpose vehicle is utilised. Personal taxation is also low compared to other EU jurisdictions. 10.1 What are the key laws and regulations affecting Individuals are taxed on income accrued in or derived from or private equity investors and transactions in your received in Gibraltar. Gibraltar has a dual tax system under which a jurisdiction, including those that impact private equity taxpayer is free to elect between an allowances based system and a transactions differently to other types of transaction? gross income-based system. There is a broad range of legislation which could apply to a PE transaction. It will depend on the entities in question but these 9.2 What are the key tax considerations for management could include the Financial Services (Banking) Act, Financial teams that are selling and/or rolling-over part of their investment into a new acquisition structure? Services (Insurance Companies) Act, Financial Services (Markets in Financial Instruments Act), Financial Services (Investment & Fiduciary Services) Act, Financial Services (Alternative Investment The Commissioner of Income Tax will automatically tax the Fund Managers) Regulations (“AIFMD”), Financial Services individual on the basis of the system that produces the most (Collective Investment Schemes) Act and the Financial Services beneficial rate for the taxpayer. Rates under the gross income-based (Takeover Bids) Act. system are split between gross income of less than GBP25,000 and gross income exceeding that amount. The rate on income under the GBP25,000 is 6% on the first GBP10,000, 20% between 10.2 Have there been any significant legal and/or GBP10,001 to GBP17,000 and 28% on the balance. The rates on regulatory developments over recent years impacting gross income exceeding GBP25,000 start at 16% and peak at 28%. private equity investors or transactions and are any The rates start to reduce for gross income exceeding GBP105,000 anticipated? up to a minimum of 5% for income exceeding GBP700,000. On the other hand, the allowance-based system has a reduced rate of 14% AIFMD was transposed into Gibraltar law on the 22 July 2013 under for the first GBP4,000, a rate of 17% for the next GBP12,000 and the Financial Services (Alternative Investment Fund Managers) the remainder of the taxable income at 39%. Under the allowance- Regulations and applies to most PE funds established in Gibraltar. based system the rates are charged on income after deduction of Gibraltar is part of the EU by virtue of the UK’s membership. Thus allowances. High executives possessing specialist skills (or when the UK leaves the EU, so will Gibraltar. Whether or not “HEPSS”) is a status designed for individuals who will promote Gibraltar will continue to have access to the EU’s common market and sustain economic activity of particular value to Gibraltar. It is will depend on the deal negotiated by the UK for itself and Gibraltar. therefore available, upon application to the Gibraltar Finance Centre Notwithstanding, the UK Government has confirmed that Gibraltar Director, to employees of fund managers, who will earn more than will continue to have access to the UK. Gibraltar is therefore likely GBP120,000 per year. The effect of HEPSS status is to limit the tax to continue being a financial services hub for and gateway to the payable by such employees to approximately GBP30,000 per year. UK. Gibraltar is currently considering the creation of a dual-regime for 9.3 What are the key tax-efficient arrangements that are funds. The dual-regime will provide a non-AIFMD solution for typically considered by management teams in private those funds domiciled in Gibraltar which are not within the scope of equity portfolio companies (such as growth shares, AIFMD and which do not require EU access; whilst also providing deferred / vesting arrangements, “entrepreneurs’ an AIFMD solutions for those funds domiciled in Gibraltar which relief” or “employee shareholder status” in the UK)? require EU access.
Given Gibraltar’s attractive tax regime, there is typically no requirement to consider a tax-efficient arrangement. 10.3 How detailed is the legal due diligence (including compliance) conducted by private equity investors prior to any acquisitions (e.g. typical timeframes, 9.4 Have there been any significant changes in tax materiality, scope etc.)? Do private equity investors legislation or the practices of tax authorities engage outside counsel / professionals to conduct all (including in relation to tax rulings or clearances) legal / compliance due diligence or is any conducted impacting private equity investors, management in-house? teams or private equity transactions and are any anticipated? The legal due diligence conducted is typically quite comprehensive and focuses on potential legal issues including commercial contracts, Whilst it was common practice to obtain tax rulings from the corporate governance, property, IP, etc. Legal due diligence is
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typically outsourced as opposed to being undertaken by in-house legal counsel. 11 Other Useful Facts
10.4 Has anti-bribery or anti-corruption legislation 11.1 What other factors commonly give rise to concerns impacted private equity investment and/or investors’ for private equity investors in your jurisdiction or approach to private equity transactions (e.g. should such investors otherwise be aware of in diligence, contractual protection, etc.)? considering an investment in your jurisdiction?
Yes, the parties are increasingly concerned with ensuring that Primarily as a result of its good regulation, transparency, an procedures comply with anti-corruption/bribery legislation. It is approachable regulator and high-quality service providers, Gibraltar Gibraltar now common to include relevant provisions within the transaction has been very well recognised as a global finance centre since the documents. 1990s. Gibraltar has worked very hard to position itself as the jurisdiction of choice. To further complement Gibraltar’s offering, the Gibraltar Stock Exchange (GSX) opened its doors in late 2014 10.5 Are there any circumstances in which: (i) a private and now plays a pivotal role in further developing Gibraltar as a equity investor may be held liable for the liabilities of leading finance centre. the underlying portfolio companies (including due to breach of applicable laws by the portfolio companies); Whether or not Gibraltar will continue to have access to the EU’s and (ii) one portfolio company may be held liable for common market will depend on the deal negotiated by the UK for the liabilities of another portfolio company? itself and Gibraltar. Notwithstanding, the UK Government has confirmed that Gibraltar will continue to have access to the UK. As is the case in the United Kingdom, the Gibraltar courts are not Gibraltar is therefore likely to continue being a financial services generally willing to “pierce the corporate veil” so as to impose hub for and gateway to the UK. liability on the shareholders beyond any share capital (unless any Gibraltar is currently considering the creation a dual-regime for common law conditions allow/require the court to do so). However, funds. The dual-regime will provide a non-AIFMD solution for a parent company could be liable under the EU “parental liability” those funds domiciled in Gibraltar which are not within the scope of doctrine and be required to pay substantial fines for antitrust AIFMD and which do not require EU access. Whilst also providing infringements committed by their subsidiaries. A parent company AIFMD solutions for those funds domiciled in Gibraltar which will also need to implement adequate anti-bribery and corruption require EU access. procedures for the purposes of the Crimes Act 2011.
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F. Javier Triay Jay Gomez Triay & Triay Triay & Triay 28 Irish Town 28 Irish Town Gibraltar Gibraltar
Tel: +350 200 72020 Tel: +350 200 72020 Email: [email protected] Email: [email protected] URL: www.triay.com URL: www.triay.com
Javier is a member of the Middle Temple and was called to the Bar in An LLB (Hons) Graduate from Kingston University London, Jay was both Gibraltar and England in 1984. He is a leading member of the called to the Bar in England and Wales and Gibraltar in 2010. He is Corporate & Commercial, Financial Services and Private Client teams. a member of the Middle Temple. Jay is a member of the Corporate & Commercial and Financial Services teams. Javier has considerable experience and expertise in advising on corporate and commercial matters including takeovers, company Jay has developed a strong reputation as an expert in the funds Gibraltar acquisitions, corporate finance, commercial property matters including area and regularly advises prospective funds, investment managers, new developments as well as business startups and is internationally insurance companies and banks on licensing requirements and recognised as a leading lawyer in this area. regulatory, operational, passporting and distribution matters. Jay is a former member of the Financial Services Commission’s Funds Panel, Described as a “true expert” for his work within the banking and finance which was a body created for the purpose of acting as a first point sector, Javier regularly advises clients in this sector including major of consultation with the industry. He was elected by his peers to the banks, successive Gibraltar Governments and insurance companies executive body of the Gibraltar Funds and Investment Association and also sat on the board as a non-executive director of a locally (GFIA). Jay played an integral role in drafting the National Private licensed insurance company. Placement Rules and Small AIFM Rules in Gibraltar following the Javier undertakes private client work on behalf of a wide range of implementation of the AIFM Directive. He was instrumental in drafting clients worldwide. He has been endorsed as a “true expert”. He has the revised Experienced Investor Fund Regulations, the creation advised numerous high-net-worth individuals and families in relation to of Gibraltar’s alternative investment fund (AIF) regime and the all aspects affecting their wealth, taxation or estate planning. He also amendments to Gibraltar’s private fund legislation. advises in relation to the setting up of trusts and associated matters. Jay also forms part of the Corporate & Commercial team. His practice Javier was also the former chairman of the Board of Governors of the has a strong focus on regulatory matters and as a result he has International School Sotogrande and is currently the vice chairman. advised on the establishment of licensed entities, including the drafting of articles of association and shareholders’ agreements; mergers and www.triay.com/staff/javier-triay acquisitions of licensed entities; corporate restructuring; and the negotiation and drafting of commercial contracts for such entities. www.triay.com/staff/jay-gomez
Triay & Triay is a full service Gibraltar law firm with offices in Gibraltar and Spain. The firm was established in 1905 by the late Arthur C. Carrara CMG, KC and has practised Gibraltar Law continuously since then. Our clients range from international businesses to private companies, governments, charities and private individuals. Gibraltar offers tax, operational and lifestyle advantages which are second to none for those looking to undertake financial services and investment business. These advantages are coupled with the security of high regulatory standards which meet EU requirements, a common law legal system largely derived from England and Wales and a jurisdiction that seeks to encourage and facilitate business. Our expertise provides the perfect platform for your introduction to Gibraltar and its advantages and we would be delighted to assist and advise you further in helping you to meet your business objectives.
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Hong Kong
Ashurst Hong Kong Joshua Cole
1 Overview 2.2 What are the main drivers for these acquisition structures?
1.1 What are the most common types of private equity transactions in your jurisdiction? What is the current Tax efficiency and flexibility are the main drives for the use of off- state of the market for these transactions? Have shore holding companies and limited liability partnerships. you seen any changes in the types of private equity The use of an off-shore BidCo for Mainland PRC businesses is transactions being implemented in the last two to driven by the ease of listing those vehicles and the greater perceived three years? certainty of management control that off-shore structures may have.
The focus of most private equity transactions involving Hong Kong are investments into Mainland China businesses. There is a 2.3 How is the equity commonly structured in private particular, but not exclusive, focus on tech (including FinTech). PE equity transactions in your jurisdiction (including institutional, management and carried interests)? houses in Hong Kong also use Hong Kong as a base for transactions throughout the Asia Pacific region (including South East Asia and Australia). Investors may invest through a combination of equity (including preferred equity) and debt. Investments into Mainland China have slowed recently, following recent reforms in China, which include tighter restrictions on capital Management equity would usually vest over a period (three to five (potentially impacting the ability to realise the investment on exit) years, depending on the business) or on an exit, subject to “good and changes to the foreign ownership regime. leaver/bad leaver” provisions and may have limited voting rights. Institutional investors would typically acquire ordinary shares, but may be subject to transfer restrictions or drag-along provisions. 1.2 What are the most significant factors or developments Carried interest is often structured as an earnout or as a contribution encouraging or inhibiting private equity transactions to the consideration for additional shares. in your jurisdiction?
Innovation and sheer entrepreneurialship in Mainland China 2.4 What are the main drivers for these equity structures? continue to provide PE opportunities. However, the recent changes in China (see question 1.1 above), together with the reduction in Ensuring orderly exits (especially by management). growth of the Mainland China economy, have had a noticeable impact on the volume of PE activity. 2.5 In relation to management equity, what are the typical vesting and compulsory acquisition provisions? 2 Structuring Matters Management equity would usually vest over a period of three to five years (depending on the nature and maturity of the business). 2.1 What are the most common acquisition structures Management equity would typically be subject to compulsory adopted for private equity transactions in your acquisition at costs/book value in a bad leaver scenario, but at fair jurisdiction? Have new structures increasingly market value in a good leaver scenario. developed (e.g. minority investments)?
Private Equity investments generally utilise an off-shore holding 2.6 If a private equity investor is taking a minority company whose shares are held by the PE investor and management, position, are there different structuring considerations? or an off-shore limited liability partnership.
Investments in Mainland China which are anticipating an IPO exit A minority private equity investor would usually seek minority will often use an off-shore (e.g. Cayman) bid vehicle which can then shareholder protections, including anti-dilution rights. They may be listed in Hong Kong or another financial centre. Such listings also seek special exit rights (e.g. a right to tag along or a right to put usually take place in Hong Kong or New York. their shares) as well as rights to ensure access to information about the business.
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Broad-based competition law was introduced into Hong Kong 3 Governance Matters in 2014. As a result, non-compete provisions in shareholder agreements must meet the same standards as in other commercial 3.1 What are the typical governance arrangements contracts and are only valid to the extent that they are reasonably for private equity portfolio companies? Are such necessary to protect the legitimate business interests of the party arrangements required to be made publicly available imposing the restraint. in your jurisdiction?
3.6 Are there any legal restrictions or other requirements Where there is more than one shareholder, the governance that a private equity investor should be aware of arrangements will typically be set out in a shareholders’ agreement in appointing its nominees to boards of portfolio (or partnership agreement if an LLP structure is used). These will companies? What are the key potential risks and include minority protections and veto rights as well as provisions in liabilities for (i) directors nominated by private equity Hong Kong respect of board representation and reserved matters. investors to portfolio company boards, and (ii) private equity investors that nominate directors to boards They would typically not be publicly available. of portfolio companies under corporate law and also more generally under other applicable laws (see 3.2 Do private equity investors and/or their director section 10 below)? nominees typically enjoy significant veto rights over major corporate actions (such as acquisitions and There are few restrictions on a person being a director of a disposals, litigation, indebtedness, changing the Hong Kong company. The person must be 18 and cannot be an nature of the business, business plans and strategy, undischarged bankrupt or subject to a disqualification order. etc.)? If a private equity investor takes a minority position, what veto rights would they typically enjoy? The key risks for nominee directors include: liability for a breach of their duty as a director or liability for insolvent trading. There Yes, they do typically enjoy significant veto protections, including is also potential liability for false or misleading statements for issuance of further equity or incurring significant debt and changes directors involved in authorising a prospectus (i.e. on exit). to the nature of the business. More significant minority shareholders Investors who nominate directors would typically have no liability may also seek veto rights in relation to business plans and budgets exposure (assuming they do so in accordance with the agreed and expenditures over a specified threshold. requirements). However, investors need to be wary of acting as “shadow directors” (where the board or the company is accustomed to acting in accordance with the investor’s instructions). Shadow 3.3 Are there any limitations on the effectiveness of veto directors will be considered to be directors and, therefore, are arrangements: (i) at the shareholder level; and (ii) at the director nominee level? If so, how are these exposed to the same liabilities as directors. typically addressed? 3.7 How do directors nominated by private equity Directors owe a fiduciary duty to exercise their rights as directors investors deal with actual and potential conflicts of (including voting) in the interests of the company. This duty may interest arising from (i) their relationship with the limit their ability to exercise veto rights solely in the interests of party nominating them, and (ii) positions as directors their nominating shareholder. of other portfolio companies? No such duties exist for shareholders, who are free to exercise their They must disclose any such conflicts and cannot participate in veto rights as they choose. decisions in relation to conflicts unless the Articles of Association For this reason, certain veto rights may be allocated to shareholders permit them to do so. (rather than directors). Where the Articles permit a director to participate in a vote, notwithstanding the conflict, the director is not discharged from his 3.4 Are there any duties owed by a private equity investor or her obligation to act in the interests of the company. to minority shareholders such as management shareholders (or vice versa)? If so, how are these typically addressed? 4 Transaction Terms: General
As a general position, there are no such duties owed by or to the private equity investor, although nominee directors must exercise their powers 4.1 What are the major issues impacting the timetable in the interests of the company (and not merely their nominator). for transactions in your jurisdiction, including competition and other regulatory approval requirements, disclosure obligations and financing 3.5 Are there any limitations or restrictions on the issues? contents or enforceability of shareholder agreements (including (i) governing law and jurisdiction, and (ii) There are few non-sector-specific issues which have an impact on non-compete and non-solicit provisions)? transaction timing in Hong Kong. There is generally no need for competition or other regulatory approval, unless required by sector There is no general limitation or restriction on shareholder specific regulation (e.g. financial services or telecoms sectors). agreements and they are widely utilised in Hong Kong. However, transactions involving targets in Mainland China may There are no particular governing law requirements in Hong Kong. face significant regulatory approval requirements, relating to both However, where all (or substantially all) of the subject matter of the foreign ownership and competition issues. agreement (including the parties) are based in Mainland China, it may be a requirement that the agreement be governed by PRC law.
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warranties are fully backed by warranty and indemnity insurance (in 4.2 Have there been any discernible trends in transaction which case a much fuller set of warranties may be given). terms over recent years? Management with a significant stake will be expected to give extensive warranties. The use of warranty and indemnity insurance is increasingly popular in private equity transactions (which is a continuing trend). 6.3 What is the typical scope of other covenants, undertakings and indemnities provided by a private 5 Transaction Terms: Public Acquisitions equity seller and its management team to a buyer?
There will typically be a set of pre-completion restraints to ensure 5.1 What particular features and/or challenges apply to Hong Kong that there are no material changes to the business and no leakage of private equity investors involved in public-to-private transactions (and their financing) and how are these value prior to completion. commonly dealt with? Members of the management team may give non-compete undertakings for a period after completion. Such transactions will be subject to the Hong Kong Takeovers Code.
Hong Kong listed companies are frequently held by a single 6.4 Is warranty and indemnity insurance used to “bridge controlling shareholder or family. This means that it is imperative the gap” where only limited warranties are given by to have the support of that shareholder. Typically, a transaction the private equity seller and is it common for this will commence with an agreement with the controlling shareholder to be offered by private equity sellers as part of the which will immediately trigger an obligation to make a follow-on sales process? If so, what are the typical (i) excesses offer. The Code requires all shareholders to be treated equally and / policy limits, and (ii) carve-outs / exclusions from such warranty and indemnity insurance policies? the offer must be on the same or better terms than the terms of the private transaction with the controlling shareholder. Warranty and indemnity insurance is very popular in Hong Kong Takeover offers cannot be subject to finance and therefore finance private equity transactions. needs to be in place (if required) prior to commencing the offer. The excess and policy limits will vary depending on the transaction (including the nature of the business and the perceived risk). 5.2 Are break-up fees available in your jurisdiction in relation to public acquisitions? If not, what other Environmental claims and claims in respect of certain PRC arrangements are available, e.g. to cover aborted deal (Mainland China) taxes are typically carved out. costs? If so, are such arrangements frequently agreed and what is the general range of such break-up fees? 6.5 What limitations will typically apply to the liability of a private equity seller and management team under Break fees (and inducement fees) are permitted in Hong Kong. warranties, covenants, indemnities and undertakings? However, the Takeovers Code requires that it be de minimis (which the Code suggests is normally no more than 1% of the offer value) Where limited warranties are given (title, capacity and authority) and the target company’s Board and its financial adviser must liability will often be capped at the purchase price. confirm to the Takeovers Executive that the fee is in the best interests of the shareholders. It must be fully disclosed. Where broader warranties are given private equity sellers’ liabilities will be a matter for negotiation and may range from 10% to 100% (although that would be unusual). It is common for the private equity 6 Transaction Terms: Private Acquisitions seller to use warranty and indemnity insurance to manage this risk.
6.1 What consideration structures are typically preferred 6.6 Do (i) private equity sellers provide security (e.g. by private equity investors (i) on the sell-side, and (ii) escrow accounts) for any warranties / liabilities, and on the buy-side, in your jurisdiction? (ii) private equity buyers insist on any security for warranties / liabilities (including any obtained from the management team)? Private equity investors on the sell-side prefer a cash consideration transaction and tend to use both completion account post-completion adjustment mechanisms and locked box mechanisms. The choice This is most commonly dealt with via warranty and indemnity tends to be driven by the general preference of the PE house. They insurance. typically look to mechanisms such as warranty and indemnity insurance, rather than retained payments or escrow accounts, to 6.7 How do private equity buyers typically provide provide comfort to purchasers in respect of future claims. comfort as to the availability of (i) debt finance, Private equity investors on the sell-side tend to prefer cash and (ii) equity finance? What rights of enforcement considerations. They will frequently agree to warranty indemnity do sellers typically obtain if commitments to, or obtained by, an SPV are not complied with (e.g. insurance, rather than escrow arrangements to provide comfort in equity underwrite of debt funding, right to specific respect of future warranty claims. performance of obligations under an equity commitment letter, damages, etc.)? 6.2 What is the typical package of warranties/indemnities offered by a private equity seller and its management Bid letters will typically contain a representation that the bidder has team to a buyer? sufficient financial resources. Where there is uncertainty, the bidder may be required to provide a bank commitment letter. Warranty packages offered by private equity sellers are usually Bank commitment letters are usually not legally enforceable. extremely limited (e.g. title, capacity and authority only), unless the
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6.8 Are reverse break fees prevalent in private equity 9 Tax Matters transactions to limit private equity buyers’ exposure? If so, what terms are typical? 9.1 What are the key tax considerations for private equity investors and transactions in your jurisdiction? Are No. These are not common. off-shore structures common?
7 Transaction Terms: IPOs There are very limited Hong Kong tax considerations for private equity investors. However, Hong Kong frequently sees off-shore structures being used, due to the other jurisdiction involved in the transactions. 7.1 What particular features and/or challenges should a private equity seller be aware of in considering an IPO Hong Kong exit? 9.2 What are the key tax considerations for management teams that are selling and/or rolling-over part of their investment into a new acquisition structure? A private equity seller and the target company’s directors may face significant liability for misstatements in the prospectus. There are no capital gains or similar tax considerations in Hong The process can be lengthy and tedious and the company will likely Kong. However, non-Hong Kong investors are frequently concerned be asked a series of questions by the listing committee and the with these issues in the jurisdictions in which they are tax resident. regulator which can have a significant impact on the timetable.
9.3 What are the key tax-efficient arrangements that are 7.2 What customary lock-ups would be imposed on typically considered by management teams in private private equity sellers on an IPO exit? equity portfolio companies (such as growth shares, deferred / vesting arrangements, “entrepreneurs’ A controlling shareholder must maintain the shareholding stated to relief” or “employee shareholder status” in the UK)? be held by it in the prospectus for six months after listing (except to the extent that the prospectus stated that the shares were offered for These mechanisms are rarely used in Hong Kong. sale in the prospectus). That controlling shareholder must not sell shares for a further six months if the sale would result in it failing to 9.4 Have there been any significant changes in tax be a controlling shareholder. legislation or the practices of tax authorities (including in relation to tax rulings or clearances) impacting private equity investors, management 7.3 Do private equity sellers generally pursue a dual-track teams or private equity transactions and are any exit process? If so, (i) how late in the process are anticipated? private equity sellers continuing to run the dual-track, and (ii) were more dual-track deals ultimately realised through a sale or IPO? There have not been any significant changes.
Dual-track processes are not common in Hong Kong (although they 10 Legal and Regulatory Matters do occur). This is likely because of the costs involved and the fact that sellers appear to determine clearly, and early, what approach is likely to result in the better price outcome. 10.1 What are the key laws and regulations affecting private equity investors and transactions in your jurisdiction, including those that impact private equity 8 Financing transactions differently to other types of transaction?
The new Companies Ordinance came into force in early 2014. Whilst 8.1 Please outline the most common sources of debt it was largely intended to be a clarification and simplification of finance used to fund private equity transactions in your jurisdiction and provide an overview of the current existing corporate law, it significantly streamlined and simplified the state of the finance market in your jurisdiction for such arrangements for capital reductions. This has created a mechanism debt (particularly the market for high yield bonds). for returning capital to shareholders. In addition, Hong Kong’s first non-sector-specific competition law Traditional bank (leveraged) debt is the most common source of came into force in late 2014. This imposes similar restrictions to debt finance. Europe, but the merger regime only applies to the telecommunications sector. 8.2 Are there any relevant legal requirements or restrictions impacting the nature or structure of 10.2 Have there been any significant legal and/or the debt financing (or any particular type of debt regulatory developments over recent years impacting financing) of private equity transactions? private equity investors or transactions and are any anticipated? There is a prohibition on a company giving “financial assistance” and this can impact on the use of imaginative financial arrangements There have not been any significant developments. (including the use of the target company’s assets to secure borrowings to be used to acquire shares). There is a “whitewash” procedure available.
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portfolio companies or hold one portfolio company liable for the 10.3 How detailed is the legal due diligence (including acts of another. compliance) conducted by private equity investors prior to any acquisitions (e.g. typical timeframes, materiality, scope etc.)? Do private equity investors 11 Other Useful Facts engage outside counsel / professionals to conduct all legal / compliance due diligence or is any conducted in-house? 11.1 What other factors commonly give rise to concerns for private equity investors in your jurisdiction or Outside counsel are usually engaged to conduct all legal due should such investors otherwise be aware of in diligence. Timeframes are typically shorter than they are for trade considering an investment in your jurisdiction? sales (say between one and three months). There is no “standard” Hong Kong materiality threshold or scope, as this will be determined by the Hong Kong is a jurisdiction which seeks to encourage investment, nature of the business and the perceived risks. including from off-shore. It has a highly-developed common law Typically, private equity investors will require an “exceptions only” legal system and sophisticated financial sector. due diligence report.
10.4 Has anti-bribery or anti-corruption legislation impacted private equity investment and/or investors’ approach to private equity transactions (e.g. diligence, contractual protection, etc.)? Joshua Cole Ashurst Hong Kong 11/F Jardine House Yes. Whilst there are usually significant contractual warranties 1 Connaught Place around compliance in this area, it is increasingly a significant area of Hong Kong diligence and parties will not be satisfied relying only on contractual protections. Where issues are identified they can have a material Tel: +852 2846 8989 Email: [email protected] impact on the transaction timetable. URL: www.ashurst.com
10.5 Are there any circumstances in which: (i) a private equity investor may be held liable for the liabilities of Joshua is a partner based in Hong Kong who specialises in mergers the underlying portfolio companies (including due to and acquisitions, joint ventures and private equity transactions throughout Asia. breach of applicable laws by the portfolio companies); and (ii) one portfolio company may be held liable for Joshua has advised on a number of high-profile international the liabilities of another portfolio company? acquisitions, disposals and joint ventures throughout the region and across a range of industry sectors, including financial services, telecommunications, pharmaceuticals, energy and resources and Hong Kong courts will typically respect the “corporate veil” and it retail. is unlikely that they would hold investors liable for the acts of the
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India Vineetha M.G.
Samvād: Partners Ashwini Vittalachar
of the Finance Minister to phase out the Foreign Investment 1 Overview Promotion Board (“FIPB”) is a significant move. One will need to wait and watch on this proposal, especially whether any other 1.1 What are the most common types of private equity mechanism would effectively replace this body. These changes, transactions in your jurisdiction? What is the current along with a strong and stable political environment and economy, state of the market for these transactions? Have has encouraged PE transactions. you seen any changes in the types of private equity Taxation has been another bottleneck. The uncertainty relating to transactions being implemented in the last two to three years? the General Anti-Avoidance Rule (“GAAR”) is a stumbling block for the PE/venture capital (“VC”) community. The implications of the Place of Effective Management (“POEM”) guidelines, issued in In 2016, private equity (“PE”) transactions in India amounted to January 2017, are also uncertain at this stage and how it plays out approximately USD 16.3 billion across 652 deals. Last year, the will have profound implications on the PE/VC players. investment was dominated in the information technology (“IT”) and IT-enabled services (“ITeS”) sector, as compared to the e-commerce sector. There were also a number of investments in the banking, 2 Structuring Matters financial services and insurance sector. Acquisitions continued to be the popular exit route for most PE firms and 2016 saw close to 200 exits worth approximately USD 7.2 billion. 2.1 What are the most common acquisition structures adopted for private equity transactions in your While the number of PE deals was less in 2016 as compared to 2015, jurisdiction? Have new structures increasingly the “dry powder” earmarked for India is still fairly substantial; India developed (e.g. minority investments)? will continue to attract significant PE investments in the coming years. Given the size of the deals, a lot of deals have been structured as The “Digital India” programme and the ongoing efforts on: “Smart co-investments between General Partners and Limited Partners. In Cities”; ITeS; FinTech companies; banking and financial services, recent times there has been a significant growth in co-investment including P2P lending platforms; retail; telecom; and logistics, structures. As co-investment structures offer access to funds, better may provide more opportunities to investors for investment. assets, increased degree of control over investment portfolios and The liberalisation of the FDI regulations in the financial services increased returns from capital, PE houses have increasingly adopted space is a step towards that direction. Health services (including this medium of investment. diagnostics), the renewable energy sector (which has a strong focus We have also seen a significant increase in control/buyout deals. under the “Make in India” campaign), infrastructure services, PE investors are able to bring in professional management to run education and certain consumer derivative sectors may also attract the business. There is also a significant change in the mindset of considerable foreign investment. promoters who are more open to divesting control. The minority The rising volume of non-performing assets in the banking system, deals continue to exist. could result in a large number of deals in the stressed assets space PE investments are typically infused by way of a combination of as well (both strategic and financial), aided by the strategic debt equity and convertible instruments, such as convertible preference restructuring and the S4A norms including the bankruptcy code. shares or convertible debentures (compulsorily convertible in case of offshore investors). The investor also typically acquires 1.2 What are the most significant factors or developments a nominal number of equity shares to exercise voting rights. The encouraging or inhibiting private equity transactions control/buyout deals are structured more as a secondary acquisition in your jurisdiction? transaction.
The Government of India (“GoI”) has been taking an active role 2.2 What are the main drivers for these acquisition in ensuring a conducive environment for entrepreneurship and structures? investments. On the foreign investment front, the GoI has already undertaken substantive reforms in the Foreign Direct Investment The tax regime, the foreign exchange law, antitrust laws and (“FDI”) policy in the last two years. More than 90% of the total FDI the sectoral guidelines play a dominant role in determining the inflows are now through the automatic route. The recent proposal
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investment/acquisition structures. Important factors such as who can be eligible investors, where and how the investing entity would 3 Governance Matters be set up, the nature of the instrument being subscribed to/acquired, investment limits based on the sectoral caps, timelines for payment 3.1 What are the typical governance arrangements of consideration, feasibility of escrow arrangements are determined for private equity portfolio companies? Are such on the basis of these laws. arrangements required to be made publicly available in your jurisdiction?
2.3 How is the equity commonly structured in private Shareholders’ agreements govern the rights and obligations of the equity transactions in your jurisdiction (including India institutional, management and carried interests)? shareholders. Among other things, the agreement sets out the rights of the shareholders and provides for the manner of conduct of the A PE investor will generally acquire between 10%–25% of the business, governance, share transfer rights and restrictions. Typical equity share capital of the company (assuming conversion in case governance arrangements in such agreements include: of convertible instrument). The controlling equity stake is held by ■ Appointment of the nominee director on the board: PE the promoter/promoter group. In family-owned companies, equity investors typically have one or more representatives on the board depending on the stake held in the portfolio company, shareholding is generally scattered across multiple family members. with his/her presence being mandatory for the purposes of In such cases, the promoter group appoints a lead member to exercise quorum. Similarly, decisions as regards certain identified rights on their behalf. Companies also implement an Employee matters require the prior consent of the investor. Given the Stock Option Plan (“ESOP”) where key officials and employees codification of director obligations under the Indian corporate of the company are entitled to receive equity shares based on their laws, many PE investors prefer to exercise their veto rights performance. Where the PE investor is desirous of acquiring a by way of a shareholder consent/investor consent, rather than controlling stake, the promoters retain anywhere between 10%– through a nominee director. PE investors also seek a board 25% and are entitled to an upside based on the performance of the observer to be appointed to track the progress of the business, company. In certain cases, the existing shareholders have fully as opposed to insisting on a nominee director. exited and the PE investors have acquired 100% pursuant to a co- ■ Anti-dilution protection: To prevent value depletion, PE investment structure. funds seek anti-dilution protection. Any dilutive round would entitle a PE fund to exercise anti-dilution rights, either on a weighted average basis or on a full ratchet basis, depending 2.4 What are the main drivers for these equity structures? on the agreed position. ■ Transfer restrictions on securities and exit mechanism: The primary drivers for equity structures are: (i) business carried on Since PE investors are not in charge of the company’s day- by the target company and the restrictions imposed by law on such to-day management, a PE fund relies substantially on the business (if any); (ii) foreign exchange law restrictions including capabilities of the promoter to run the business. Therefore, sectoral caps and conditions; (iii) the target company being a private lock-in obligations are imposed on the promoters. Common limited company or public company; (iv) approvals that may be forms of share transfer restrictions applicable to promoters required; (v) the sector specific guidelines and approvals; (vi) anti- (and at times, other significant shareholders), are lock-in, right of first refusal or offer, drag-along rights and tag-along trust considerations and approvals; and (vii) tax considerations. rights. Exit mechanisms are usually negotiated upfront at the time of investment, and details of the same are set forth in the 2.5 In relation to management equity, what are the typical transaction documents. vesting and compulsory acquisition provisions? The company is also made a party to such agreements so as to make it binding on the company. In addition to the shareholders’ ESOPs are the most common form of management equity incentives agreement, the articles of association (“AoA”) are the bye-laws of in a PE transaction. In light of certain restrictions on the issuance the company and sets forth the governance rights and share transfer of ESOPs to promoters, it is also typical to have equity incentives mechanisms. Non-conformance to the AoA would render the action structured through warrants and ratchets including phantom ultra vires, and will not be enforceable. Hence the provisions of the options. The equity would vest over a period of four to five years, shareholders’ agreement are included in the AoA for better protection with compulsory vesting under certain circumstances. If there is of a PE investor’s rights. It is a statutory mandate to file the AoA termination for cause, then there are mechanisms for forfeiture of with the jurisdictional registrar of companies. To that extent, the these options. provisions of the shareholders’ agreement become publicly available. In the case of listed entities, the acquisition of some of these rights 2.6 If a private equity investor is taking a minority could also trigger an open offer and these rights are required to be position, are there different structuring disclosed in the open offer documents. considerations?
3.2 Do private equity investors and/or their director Customary protection rights such as elaborate veto rights, board nominees typically enjoy significant veto rights over nominee rights, quorum rights, information rights, exit rights, tag major corporate actions (such as acquisitions and along rights, (as elucidated in Section 3 below), accelerated drag, to disposals, litigation, indebtedness, changing the name a few, play a key role in ensuring that the PE fund’s governance nature of the business, business plans and strategy, and management rights are protected notwithstanding the minority etc.)? If a private equity investor takes a minority role. Sometimes, PEs also prefer acquiring between 10%–25% in position, what veto rights would they typically enjoy? the company to enjoy the benefit of certain statutory protections as discussed in the response to question 3.4 below. Yes. Veto rights are extended to PE investors on matters concerning the target entity’s business and operations, such as acquisitions,
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disposals, litigation, indebtedness, changing the nature of the business, business plans and strategy. 3.5 Are there any limitations or restrictions on the contents or enforceability of shareholder agreements In case of a minority stake investment, the scope of veto rights gets (including (i) governing law and jurisdiction, and (ii) broadened to include other operational aspects of the business, such non-compete and non-solicit provisions)? as changing the name of the business, opening of branch offices, termination of key employees, grant of and amendments to any There are no restrictions generally on the enforceability of equity incentives (especially for key employees), and related party shareholder agreements. Previously, there were enforceability transactions. These veto rights are exercised either by the investor concerns around option contracts and transfer restrictions in public or its nominee director. Although, given the codification of director companies. However, with the recent changes in Indian laws India obligations under the Indian corporate laws, many PE investors (namely, the Companies Act, 2013, the foreign exchange laws and prefer to exercise their veto rights by way of a shareholder consent/ Securities Contract Regulation Act, 1956), it is now possible to have investor consent, rather than through a nominee director. such arrangements subject to certain conditions. Incorporating the provisions of such shareholder agreements in the 3.3 Are there any limitations on the effectiveness of veto AoA of the company enables dual protection vis-à-vis enforcement, arrangements: (i) at the shareholder level; and (ii) in case of a breach. It is advisable for shareholder agreements to be at the director nominee level? If so, how are these governed by Indian laws to enable better enforcement, as in any case, typically addressed? the operation of the company will need to comply with Indian laws. A shareholders’ agreement also contains restrictive covenants such There are no limitations on the effectiveness of veto arrangements as non-compete and non-solicitation restrictions and confidentiality at shareholder level. Since a director of a company is required to obligations. Such restrictive covenants have limited enforceability discharge fiduciary obligations towards the company, which may not under Indian laws. While it is possible to enforce non-competition always be aligned with the interest of the nominating PE investor, restrictions under Indian law in the context of a sale of goodwill, arguably, there could be some limitation around the effectiveness of such restrictions are usually not enforceable purely in the context of a veto arrangement at the nominee director level. This is typically employment, especially post termination of such employment. It is to addressed by ensuring that the veto rights are also available at the be noted that reasonability of a non-competition restriction does play shareholder level. In certain cases, such veto rights are exercised by a vital role in determining the scope and extent of its enforceability. way of investor consent even prior to the matter being taken up at the board/shareholder level. It is possible to enforce breach of a confidentiality obligation as well as a non-solicitation restriction.
3.4 Are there any duties owed by a private equity investor to minority shareholders such as management 3.6 Are there any legal restrictions or other requirements shareholders (or vice versa)? If so, how are these that a private equity investor should be aware of typically addressed? in appointing its nominees to boards of portfolio companies? What are the key potential risks and There are no statutory duties owed by PE investors towards liabilities for (i) directors nominated by private equity investors to portfolio company boards, and (ii) private management shareholders. However, if a PE investor holds a equity investors that nominate directors to boards majority stake in the company, it is important that the investor of portfolio companies under corporate law and also does not act in an unfair, fraudulent or oppressive manner against more generally under other applicable laws (see the interest of any minority shareholders (including management section 10 below)? shareholders, if applicable). A shareholder must have at least 10% in the company so as to be considered as a minority shareholder PE investors appointing nominee directors are required to comply for the purposes of enforcing such protective rights. Some of the with the provision of the Companies Act, 2013. The Companies Act, protections granted to minority shareholders are: 2013 provides for a list of disqualifications for the appointment of ■ Right to file an application with the jurisdictional court, in directors, which includes failure to procure a director identification the event the affairs of the company are being conducted number, a person being an undischarged insolvent, a person being in a manner prejudicial to the interest of the company or its convicted by a court for any offence involving moral turpitude or members, especially the minority shareholder in question. others, to name a few. ■ In a listed company, minority shareholders can appoint a In India, the directors of the company are responsible for the day-to- director for special representation. day affairs and management of the company. They have a fiduciary ■ Consent rights with respect to merger and amalgamations. duty towards the company to act in the interest of the company. ■ Right to file an application with the tribunal (class action The responsibility, risk and liability of any director, including a PE suit) against the company, directors, auditors in the event fund’s nominee director, has gone up manifold. The Companies the affairs of the company are being conducted in a manner Act, 2013 specifically provides for the duties of a director and prejudicial to the interest of the company, its members or the consequences of a breach of such duty. Stringent penalties depositors. have been prescribed, such as a minimum fine of Rs. 25,000 and Since most PE transactions in India are structured as a minority maximum fine of Rs. 25 crores, in the event of contravention of stake investment, and since the control of management is seldom the provisions of the Companies Act, 2013. Apart from monetary overtaken by the PE investor in question, typically these issues are penalties, certain offences even attract imprisonment. While a not predominant in the normal course of business. However, it is nominee director will hold a non-executive position on the board, possible for a promoter holding a minority stake, to allege oppression he nonetheless must discharge and fulfil his fiduciary obligations. in the event of the exercise of control rights by a PE investor. These fiduciary obligations are now prescribed under the statute, and are no longer common law requirements.
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Consequently, if such a nominee director becomes an “officer (“RBI”), Securities Exchange Board of India (“SEBI”) or FIPB. If in default”, i.e., an officer of the company who contravenes any a PE investment is envisaged by an offshore PE fund, in a company provisions of the Companies Act, 2013, he will be subject to the whose business falls within a regulated sector (such as defence, same penalties as an executive director of the company. insurance, to name a few), or if such foreign investment is in excess Previously, a nominee director could recuse his liability on account of the prescribed sectoral caps, then such an investment would of a lack of knowledge of the contravention and express consent require approvals. Also, if the portfolio company is a listed entity, over such contravening act. However, the Companies Act, 2013 has timelines for seeking necessary corporate approvals to facilitate the raised the bar in terms of a nominee director’s obligations and such investment will need to be factored, and could have an impact on the a defence is available in a restricted manner. A nominee director overall transaction timetable. India is deemed to have knowledge by virtue of receipt by him of any Consent from the Indian antitrust regulator, the Competition proceedings of the board. Similarly, a nominee director who has Commission of India (“CCI”) is also becoming very critical in PE consented or connived in the facilitation of a contravening act will deals, especially given the nature and size of the deals. While the be liable as an officer in default. In this regard, he is deemed to have competition regulations do provide for certain exemptions from consented if he has not objected to the contravening act during his notifying the CCI, the CCI’s decisions in the past have tended participation in such board proceedings. towards narrowing down of these exemptions. Obtaining this In light of the above, a nominee director can no longer escape liability approval is also impacting the timelines. purely on the basis of his appointment as a nominee/non-executive director. This regime has made PE investors cautious about the extent 4.2 Have there been any discernible trends in transaction of the governance and oversight being exercised over the portfolio terms over recent years? companies, and certain PE investors in fact are choosing to appoint a non-voting ‘observer’ on the board, instead of appointing a director Typically, PE investments are structured by way of a subscription to (who then has various fiduciary obligations towards the company). convertible preference shares or convertible debentures, apart from Since a PE fund would be a shareholder in the portfolio company, the equity. In case of an offshore PE investor entity, such instruments PE investor’s liability is restricted only to the extent of any unpaid must be mandatorily convertible, in light of the foreign exchange capital as regards the shares held by such PE fund. Such liability regulations in India. In the recent past, the RBI has permitted would normally be enforced only in the context of a winding up. issuance of warrants to offshore PE funds, subject to the pricing of such warrants and conversion formula being determined upfront at the time of issuance, and at least 25% of the total consideration 3.7 How do directors nominated by private equity investors deal with actual and potential conflicts of for the issuance of such warrants being paid upfront. The balance interest arising from (i) their relationship with the consideration must be paid fully within a period of 18 months from party nominating them, and (ii) positions as directors the date of investment. of other portfolio companies? Tax indemnities are being negotiated in detail in the context of an exit by a PE fund, due to an increased tax burden under Indian laws As discussed in question 3.6, directors have a fiduciary duty towards (even where the buyer and seller entities are offshore companies, the company to act in its best interest. To this extent, there could be a but dealing with Indian securities). Where the sale is being made potential conflict of interest, if the interest of the PE fund is not aligned by one offshore PE fund to another offshore entity, tax exposures with the interest of the company. However, the possibility of a PE and tax indemnities are being looked at more closely with a view investor’s interest being distinct and separate from the interest of the to provide necessary comfort to the buyer entity but at the same company is fairly remote, as the value of a PE investor’s investment time minimising indemnity exposures for the seller PE entity. can grow only on the basis of the company’s growth and performance. Consequently, tax indemnity insurances are gaining popularity to Similarly there could be a potential conflict of interest if a common help mitigate this risk. nominee director is appointed by a PE fund, as regards two portfolio Given the tax and foreign exchange restrictions, there have been no companies that are engaged in a business transaction, where such discernible trends affecting transaction terms, per se, in recent years. transaction is not being carried out on an arm’s-length basis, in the ordinary course of business, and that such a transaction is motivated by self-dealing by the common nominee director in question, and not 5 Transaction Terms: Public Acquisitions on the basis of commercial prudence. Further, there could also be conflict situations where the portfolio companies could be competing with each other. Typically, in such cases, the director recuses 5.1 What particular features and/or challenges apply to private equity investors involved in public-to-private himself/herself from one of the boards, if any sensitive matters/bids transactions (and their financing) and how are these are being discussed. Nowadays, the promoters are also insisting that commonly dealt with? the person appointed as the nominee director in the company, should not be appointed on the board of a competing entity. In India, PE investors are seldom parties to public-to-private transactions. 25% of the share capital of a listed company is required 4 Transaction Terms: General to be publicly held (i.e. to be held by persons other than promoters). Depending on the rights available to the PE fund, the PE fund may be classified as a part of the public shareholding. 4.1 What are the major issues impacting the timetable for The SEBI (Delisting of Equity Shares) Regulations, 2009 transactions in your jurisdiction, including competition (“Delisting Regulations”) governs the delisting of equity shares of and other regulatory approval requirements, disclosure obligations and financing issues? listed companies. Under the Delisting Regulations, no company can make an application for delisting and no recognised stock exchange shall permit delisting of shares of a company in the following Timelines of a transaction would be affected in the event an circumstances: approval is required, especially from the Reserve Bank of India
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■ pursuant to a buy-back of equity shares of the company; and were thus not preferred. However, recently, the RBI has allowed ■ pursuant to preferential allotment made by the company; deferred consideration structures under the automatic route, so long ■ unless a period of three years has lapsed since the listing of as not more than 25% of the total consideration is being paid by the that class of equity shares on any recognised stock exchange; buyer on a deferred basis. The deferment has been recognised for or a period up to 18 months from the date of the transfer agreement. ■ if any instruments issued by the company, which are convertible into the same class of equity shares that are 6.2 What is the typical package of warranties/indemnities sought to be delisted, are outstanding. offered by a private equity seller and its management There are several other restrictions that apply to a listed company team to a buyer? proposing to delist, including the minimal shareholding that a India promoter needs to hold pursuant to the delisting, price determination A PE seller usually provides basic warranties on title and authority. for the delisting, etc. Delisting is therefore not a preferred mode of The scope of warranties would also extend to enforceability and exit for PE investors, who typically consider an IPO as a method tax liabilities. A PE seller rarely provides detailed warranties or for exit and prefer the liquidity offered by way of listed shares. indemnities, especially on the operation of the company. It is Consequently, PE investors invest at a stage that is three to five years possible to receive such warranties in case the control is being before the target company is proposing to list, and exit the target exercised entirely by the PE seller, which is typically rare in India. company at the time of listing or shortly thereafter. Alternatively, A buyer, however, is given ample comfort by the promoters who PE funds invest in companies post delisting. normally provide exhaustive warranties to the buyer both on the Delisting as an exit option is only considered in listed companies business and operations of the company as well as enforceability, where the shares are infrequently traded or where such a company title, etc. Typically, the liability of a promoter to indemnify is is in distress. equally exhaustive, subject to certain standard limitations on such liability such as time limitation and cap on the liability. While the indemnities of a PE seller are typically limited for breach 5.2 Are break-up fees available in your jurisdiction in of warranties, as discussed in the first paragraph of the response relation to public acquisitions? If not, what other arrangements are available, e.g. to cover aborted deal to question 6.2, tax indemnities are becoming fairly comprehensive costs? If so, are such arrangements frequently agreed in the context of a sale by a PE investor, and is being negotiated and what is the general range of such break-up fees? closely, in the recent years. In certain PE deals, PEs are seeking insurance for indemnities, especially tax indemnities. Break fees are not typically seen in listed transactions, since parties do not enter into a binding contract unless all commercial terms are 6.3 What is the typical scope of other covenants, finalised. Upon execution of a binding contract, exiting a proposed undertakings and indemnities provided by a private transaction/terminating a transaction involves a fair number of equity seller and its management team to a buyer? regulatory challenges and is seldom seen in practice. Parties may, however, have cost apportionment arrangements for deals that do PE sellers do not undertake any covenants, except for completing not go through. sale of shares within the timelines envisaged. The management team is bound by confidentiality obligations, non-compete and non- solicitations restrictions. 6 Transaction Terms: Private Acquisitions Additionally, the management team is usually retained in the acquired company post such acquisition. This period varies from 6.1 What consideration structures are typically preferred one to three years depending on the stage of the investment cycle. by private equity investors (i) on the sell-side, and (ii) This is to help facilitate integration and ensure better synergy and on the buy-side, in your jurisdiction? growth post acquisitions. Accordingly, the management team usually enters into necessary contracts setting out the terms of such In the context of an investment, PE investors adopt both single employment/consultation, as the case may be. as well as tranche wise investment structures in equal measure. The scope of indemnities provided by a PE seller and the Although, on the sell-side, PE investors as well as promoters/ management team is set out in the response to question 6.2 above. management prefer investments to come through in a single tranche. This helps in implementing growth targets better, and also gives a great impression about the robustness of the business and the 6.4 Is warranty and indemnity insurance used to “bridge company’s performance in the market. the gap” where only limited warranties are given by the private equity seller and is it common for this In the context of an exit/acquisition, it is fairly common to to be offered by private equity sellers as part of the have a tranche wise acquisition, with the majority stake being sales process? If so, what are the typical (i) excesses acquired upfront and payments for such acquisition being made / policy limits, and (ii) carve-outs / exclusions from simultaneously. In the case of a buyout the deal is structured as a such warranty and indemnity insurance policies? complete acquisition with retention mechanisms, especially for the management team. This helps in ring fencing the acquirer from any As discussed in the response to question 6.2 above, the “gap” in the potential claims in the coming years, as well as gives an incentive to warranties/indemnities provided by the PE seller is usually covered the erstwhile promoters (who are typically retained in the target in a by the warranties and indemnities of the promoter group. Hence from consultant/employee role), to ensure better alignment of the business a buyer’s perspective, ring fenced protection is sufficiently extended. and increased growth/opportunities for the target, post-acquisition. However, in recent years, PE sellers are exploring insurance options Previously, deferred consideration structures were not permitted for covering liabilities in the context of tax indemnities. under the automatic route under the Indian foreign exchange laws,
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6.5 What limitations will typically apply to the liability of 7 Transaction Terms: IPOs a private equity seller and management team under warranties, covenants, indemnities and undertakings? 7.1 What particular features and/or challenges should a private equity seller be aware of in considering an IPO Since the scope of a PE seller’s indemnity is limited (on account exit? of the nature of the warranties being given), additional limitations typically are minimal. It is possible to seek limitation of liability on An IPO process in India is typically run by the company and the basis of time and a cap on the overall liability (which can be up to the promoters. The SEBI (Issue of Capital and Disclosure 100% of the consideration received). Since the scope of warranties India Requirements) Regulations, 2009 (“ICDR Regulations”) impose extended by the promoters are exhaustive, detailed limitations to a various pre-conditions, including minimum net tangible assets, promoter’s liability are negotiated. It is fairly standard to have a track record of distributable profits, and minimum net worth, among time limitation and a cap on the overall liability of the promoters others. An issuer company not satisfying any of the conditions may (which again is usually up to 100% of the consideration received). still be able to carry out an IPO if it undertakes to allocate at least Breach of fundamental warranties, specific indemnities and fraud are 50% of the net offer to qualified institutional buyers and to refund all usually uncapped. Additionally, it is also possible to negotiate time subscription monies if it fails to make such allocations to qualified limitations, de minimis and a basket, in addition to exclusions such institutional buyers. Some of the other key challenges that an IPO as non-liability for indirect and consequential losses, exclusions in exit poses for a PE investor are as follows: (a) pre-IPO shareholding case of an insurance cover, etc. is typically locked in for a period of one year (other than for foreign venture capital investors (“FVCI”)); (b) PE investors run the risk 6.6 Do (i) private equity sellers provide security (e.g. of being characterised as promoters where they hold more than escrow accounts) for any warranties / liabilities, and 20% shareholding, and consequently they could become subject (ii) private equity buyers insist on any security for to promoter related obligations (including disclosure obligations), warranties / liabilities (including any obtained from under the ICDR Regulations; (c) market conditions typically require the management team)? an IPO to comprise a primary as well as a secondary component and therefore a complete exit by way of an IPO is not generally It is not usual for PE sellers to provide security for any warranties/ possible; (d) where PEs are exiting by way of an offer for sale, liabilities. However, in the case of specific identified liabilities, the certain indemnities and warranties may have to be provided by parties could agree to hold back mechanisms, which is then kept in PEs in the prospectus in relation to those shares; (e) prior to the the escrow for a certain time period and thereafter released. filing of the red herring prospectus, all special rights (such as veto Again, it is not usual to provide security in the context of an rights/transfer rights) of the PE investor need to be dropped from investment by a PE investor. At best, there could be hold back the constitution of the company and, in certain cases, SEBI has mechanisms or conversion adjustments provided in the documents required that the agreements be terminated, and hence enforceability to address any liabilities. concerns arise in cases where the IPO does not go through; and (f) post listing, all sale transactions will also need to comply with the onerous conditions of the SEBI (Substantial Acquisition of Shares 6.7 How do private equity buyers typically provide comfort as to the availability of (i) debt finance, and Takeovers) Regulations, 2011 and the SEBI (Prohibition of and (ii) equity finance? What rights of enforcement Insider Trading) Regulations, 2015. do sellers typically obtain if commitments to, or Furthermore, failed IPOs could adversely impact the valuation obtained by, an SPV are not complied with (e.g. for the PEs. Therefore, IPO exits are only attempted where the equity underwrite of debt funding, right to specific performance of obligations under an equity company is confident of completing the IPO. Also, the Indian commitment letter, damages, etc.)? law now imposes an obligation on the company to provide an exit to dissenting shareholders in the context of an IPO, hence the Typically, representations are obtained from the PE investor with additional exit burden could have an impact overall for IPO exits respect to their funding ability. Sometimes escrow mechanisms are for a PE seller. also put in place. In light of the regulatory processes and uncertainties on the return In the case of listed companies, where an open offer is made, the involved, an IPO is not a preferred exit mechanism for PE funds in law requires that the open offer consideration be kept in escrow. In India. certain buyout deals we have seen comfort letters being provided. 7.2 What customary lock-ups would be imposed on private equity sellers on an IPO exit? 6.8 Are reverse break fees prevalent in private equity transactions to limit private equity buyers’ exposure? If so, what terms are typical? ICDR Regulations mandate that the minimum promoter’s contribution be locked in for a period of three years from the date A reverse break fee is provided in certain cases and is usually limited of commercial production or date of allotment in the public issue, to a pre-estimate of the costs incurred up to the negotiation stage. whichever is later. Promoters holding in excess of the minimum This helps to ensure that neither party engages in unreasonable promoter’s contribution, are locked in for one year. In this regard, negotiation nor breaches any exclusivity without having to suffer the term ‘minimum promoters’ contribution’ for an IPO has a penalty. been defined as not less than 20% of the post-issue capital. On the other hand, the entire pre-issue capital held by persons other than promoters shall be locked in for a period of one year. FVCI registered with the SEBI are, however, exempt from such lock- in restrictions, provided they have held securities of the issuer company for at least one year.
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option to be taxed as per the provisions of the tax treaty or the 7.3 Do private equity sellers generally pursue a dual-track ITA, whichever is more beneficial. Thus, FVCI investing through exit process? If so, (i) how late in the process are a tax treaty jurisdiction can avail benefits under the tax treaty. It private equity sellers continuing to run the dual-track, is relevant to mention here that India has amended its double tax and (ii) were more dual-track deals ultimately realised through a sale or IPO? avoidance treaties with Mauritius taking away such tax benefits on and after April 1, 2017. This could have a domino effect also in terms of investments from Singapore, as the double tax avoidance A dual-track exit process is quite common, as PE investors tend treaty between India and Singapore adopts the position under the to pursue several exit channels in parallel, continuing to ready an treaty with Mauritius. All investments through entities in Mauritius, IPO even as they negotiate terms for a direct sale to a third party.
made on or before April 1, 2017, are grandfathered. The GoI has India The IPO process is fairly lengthy and often contingent on market also introduced the GAAR which shall come into effect from April conditions, and given the limited life of funds, PE funds typically 1, 2017. GAAR seeks to provide transparency in tax matters and explore multiple exit options simultaneously. helps curb tax evasion. Under this, if a transaction is structured with the principal purpose of obtaining a tax benefit, then such a 8 Financing transaction will be deemed impermissible for the purposes of such tax benefit. Consequently, these rules will not apply if the jurisdiction of a foreign investor (including a FVCI) is finalised 8.1 Please outline the most common sources of debt based on non-tax commercial considerations and the main purpose finance used to fund private equity transactions in of the arrangement is not to obtain tax benefit. your jurisdiction and provide an overview of the current state of the finance market in your jurisdiction Offshore structures were quite common in the past. Previously, for such debt (particularly the market for high yield investments through jurisdictions like Mauritius and Singapore bonds). were very common in light of the taxation considerations. The amendments to the tax treaty coupled with the introduction of Indian laws do not permit banks to extend loans for funding an GAAR will have a significant role in fund structuring decisions, in investment/acquisition of shares in India. Hence it is not possible the coming years. for PE funds to raise debt finance from banks for their investments Also, as discussed in the response to question 1.2 above, the in India, although some promoters approach non-banking finance implications of the POEM guidelines issued in January 2017, are companies for acquisition financing. The RBI is currently also uncertain at this stage and how it plays out will have profound considering relaxation of these regulations especially to enable implications on the PE/VC players. leveraged buyouts of distressed assets.
9.2 What are the key tax considerations for management 8.2 Are there any relevant legal requirements or teams that are selling and/or rolling-over part of their restrictions impacting the nature or structure of investment into a new acquisition structure? the debt financing (or any particular type of debt financing) of private equity transactions? Capital gains tax would be the most important consideration while exploring sale/roll over of investments into newer acquisition As discussed in the response to question 8.1 above, banks cannot structures. Short-term capital gains (“STCG”) accrues if the asset extend loans for financing acquisitions. Additionally, public has been held for less than three years (or in the case of listed companies are also prevented from providing financial assistance securities, less than one year) before being transferred; and gains for the purchase of its own shares. arising from the transfer of assets having a longer holding period would be treated as long-term capital gains (“LTCG”). The 9 Tax Matters income earned by foreign institutional investors or foreign portfolio investors are also treated as capital gains income. LTCG earned by non-residents on the sale of unlisted securities may be taxed at the 9.1 What are the key tax considerations for private equity rate of 10% or 20% depending on certain considerations. LTCG investors and transactions in your jurisdiction? Are on the sale of listed securities on a stock exchange are exempt and off-shore structures common? subject to a securities transaction tax (“STT”). STCG earned by a non-resident on the sale of listed securities, subject to STT, are Under the Income Tax Act, 1961 (“ITA”), income earned by a taxable at the rate of 15%, or at ordinary corporate tax rate with domestic fund registered with SEBI as a venture capital fund respect to other securities. This may, however, not apply in case the (“VCF”) or as category I and category II alternative investment fund seller is an offshore entity that is entitled to benefits under a double (“AIF”), are exempt from tax under section 10 (23FB) and section taxation avoidance treaty. 10 (23FBA) of the ITA. Such VCF and AIF have been granted pass through status. The tax pass through status granted to AIF 9.3 What are the key tax-efficient arrangements that are under section 115(U) is with respect to incomes other than business typically considered by management teams in private income. Business income of an AIF is taxable at the fund level, equity portfolio companies (such as growth shares, at applicable rates, and is exempt in the hands of the unit holder. deferred / vesting arrangements, “entrepreneurs’ However, no tax pass through status is applicable to category-III relief” or “employee shareholder status” in the UK)? AIFs. Section 56(2) of the ITA, exempts a VCF receiving a share premium amount from a portfolio company from being taxed under Equity incentives granted to an employee (including a promoter), the head ‘income from other sources’. has tax implications, and the vesting and exercise period of such There are no specific tax exemptions available to FVCIs. However, incentives are typically structured so as to ensure minimal tax as per section 90(2) of the ITA, a non-resident investor investing burden for such employees. from a country with which India has a tax treaty, would have an
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investment limit for FII/FPI/QFI investment is capped at 24% 9.4 Have there been any significant changes in tax of the share capital of a company. The composite caps are, legislation or the practices of tax authorities however, not applicable to the defence and banking sector. (including in relation to tax rulings or clearances) ■ Foreign investments into various sectors including insurance, impacting private equity investors, management financial services and manufacturing, has been liberalised. teams or private equity transactions and are any anticipated? ■ The RBI has allowed deferred consideration structures to be adopted in cross border transactions, under the automatic route, so long as not more than 25% of the total consideration In February 2016, the Central Board of Direct Taxes (“CBDT”) is being paid by the buyer on a deferred basis. The deferment issued a circular clarifying that income arising from the transfer of has been recognised for a period up to 18 months from the India listed shares and securities, which are held for more than 12 months date of the transfer agreement. would be taxed under the head ‘Capital Gain’ unless the tax-payer SEBI itself treats these as its stock in-trade and transfer thereof as its business income, thus reducing the incidence of tax on transfer of ■ Guidance Note dated August 24, 2015 on SEBI (Prohibition shares of listed companies. In May 2016, the CBDT issued a circular of Insider Trading) Regulations, 2015 (“PIT Regulations”) has been amended with effect from February 17, 2016 to clarifying that income arising from the transfer of unlisted shares clarify that the exit offer is also exempted from the restriction would be considered under the head ‘Capital Gain’ irrespective of on contra trade under the PIT Regulations. the period of holding, unless: (a) the genuineness of transactions in unlisted shares itself is questionable; (b) the transfer of unlisted Recent changes to the taxation regime has already been discussed in shares is related to an issue pertaining to lifting of corporate veil; or response to the questions in Section 9 above. (c) the transfer of unlisted shares is made along with the control and management of underlying business. 10.3 How detailed is the legal due diligence (including Additionally, as discussed in the response to question 9.1 above, the compliance) conducted by private equity investors prior to any acquisitions (e.g. typical timeframes, changes to the tax treaties with Mauritius, and the implementation materiality, scope etc.)? Do private equity investors of GAAR and POEM are other significant developments in the engage outside counsel / professionals to conduct all taxation regime. legal / compliance due diligence or is any conducted in-house? 10 Legal and Regulatory Matters Legal due diligence complexity depends on the tenure of operations of the company. The legal due diligence exercise typically covers 10.1 What are the key laws and regulations affecting review of statutory records, examining the licences and material private equity investors and transactions in your contracts of the company, examining compliance vis-à-vis various jurisdiction, including those that impact private equity laws affecting the business, including employment laws, intellectual transactions differently to other types of transaction? property laws, real estate laws and tax laws. Legal due diligence is most often conducted by external counsels and is completed within The key laws and regulations affecting PE transactions in India are: three to five weeks. ■ Foreign Exchange Management Act, 1999 and Regulations thereunder. 10.4 Has anti-bribery or anti-corruption legislation ■ SEBI Act, 1992 and the Regulations thereunder. impacted private equity investment and/or investors’ ■ The Companies Act, 2013. approach to private equity transactions (e.g. diligence, contractual protection, etc.)? ■ The Income Tax Act, 1961.
Anti-corruption laws and compliances thereunder, are certainly 10.2 Have there been any significant legal and/or playing an important role in PE transactions in the recent years. regulatory developments over recent years impacting The existing Indian anti-corruption law, i.e., the Prevention of private equity investors or transactions and are any Corruption Act, 1988, criminalises receipt of illegal gratification by anticipated? public servants. However, the legislation currently does not cover private sector bribery. An amendment to the Act criminalising Foreign Exchange Laws: private sector bribery is pending approval by the Indian Parliament. ■ FVCIs registered with SEBI are now permitted to invest in: Given the gap in the scope of applicability of anti-corruption laws (i) Indian companies engaged in any of the 10 sectors listed in India vis-à-vis private bribery in offshore jurisdictions, offshore in Schedule 6 of Foreign Exchange Management (Transfer PE investors specifically seek compliance with the more stringent/ or issue of security by a person resident outside India) Regulations, 2000 (“FEMA 20”), including the newly added encompassing anti-bribery laws as applicable in their jurisdiction, infrastructure sector; (ii) startups irrespective of the sector by way of contractual undertakings. in which the startup is engaged; and (iii) units of a VCF or PE investors typically seek warranties as well as covenants from of a Category I Alternate Investment Fund (Cat I AIF) or the management team confirming compliance with anti-bribery laws units of a scheme or a fund set up by a VCF or by a Cat I including Foreign Corrupt Practices Act, 1977 and the UK Bribery AIF, without the need for prior approval of the government. Act, 2010. Breach of such warranties/covenants typically entitles Furthermore, the residency status of the sponsor of such the PE investor to seek an immediate exit, in addition to indemnity/ AIFs, and downstream investments of such AIFs, may be subject to certain conditions. damages as applicable. ■ Composite sectoral cap on foreign investment now takes into account all types of foreign investment such as FDI, FPI, FII, NRI, FVCI, QFI, etc. Individual FII/FPI/QFI can invest up to 10% of the share capital of a company and the aggregate
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mechanisms such as arbitrations to be incorporated in agreements 10.5 Are there any circumstances in which: (i) a private proposed to be executed by PE funds with their portfolio companies. equity investor may be held liable for the liabilities of India is evolving in terms of having a robust legal framework the underlying portfolio companies (including due to around arbitrations and institutional arbitration centres are being breach of applicable laws by the portfolio companies); and (ii) one portfolio company may be held liable for established. However, as of today, overseas institutional arbitrators the liabilities of another portfolio company? such as the Singapore International Arbitration Centre, or the like, are preferred for resolving disputes effectively and in a commercially As discussed in response to question 3.6 above, as a shareholder, savvy manner. a PE fund has negligible liability vis-à-vis a breach by a company, An area of increasing concerns for PE funds and LPs is the threat although a director nominated by the PE fund in the portfolio of enforcement actions under the FCPA and the UK Bribery Act, India company may be subject to various liabilities, especially in case of 2010. These laws essentially expose PE funds to liabilities in the a breach/dereliction of duties. A PE fund may, however, become event that their associates in foreign countries engage in corrupt liable in case of oppression or mismanagement in the event the PE practices. Despite a vast legislative framework, India ranks 79 fund is a majority investor exercising management control over the out of 176 countries in Transparency International’s Corruption portfolio company. There are very limited circumstances where the Perception Index, reiterating that corruption compromises corporate corporate veil of the company is pierced by Indian courts. This has governance, heightens reputational risks and increases costs of doing been further explained in response to question 3.4 above. business in India. It is of pivotal importance that PE funds conduct adequate anti-corruption due diligence in connection with their investments and conform to adequate safeguards against corruption 11 Other Useful Facts throughout. Failure to do so exposes the funds to potential successor liabilities, which can result in huge fines and penalties, often for months or years after a deal is closed. 11.1 What other factors commonly give rise to concerns for private equity investors in your jurisdiction or As discussed in this chapter, tax and regulatory bottlenecks do pose should such investors otherwise be aware of in a few challenges to PE investors, especially those offshore. To considering an investment in your jurisdiction? this extent, the government has taken note of these concerns and is implementing steps to mitigate such concerns. Dispute resolution mechanisms in India pose certain challenges. To this extent, we strongly advice institutional dispute resolution
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Vineetha M.G. Ashwini Vittalachar Samvād: Partners Samvād: Partners Free Press House, 4th Floor, Office no. 41 & 42 D9, Third Floor, Nizamuddin West Free Press Journal Marg New Delhi 110013 215 Nariman Point India Mumbai 400021 India Tel: +91 11 4172 6205 Email: [email protected] Tel: +91 22 6104 4001 URL: www.samvadpartners.com Email: [email protected]
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Vineetha M.G. has extensive experience in advising clients on private Ashwini Vittalachar has close to 10 years of experience, and works equity investments, cross-border and domestic M&A, and banking and extensively on mergers and acquisitions, joint ventures, private equity financing transactions. and venture capital investments advisory matters. Vineetha is widely experienced in advising onshore and offshore Ashwini has a wide range of experience advising various stakeholders funds which invest in several sectors. Vineetha represents and in the funding ecosystem, including early stage companies, growth advises, various private equity investors including Government of stage companies, promoters, early stage investors as well as large Singapore Investment Corporation, New Silk Route, Morgan Stanley corporate groups/PE funds, both in the context of investments as Infrastructure Fund, Cerestra Advisors, Sequoia Capital, and IDFC well as acquisitions. She also advises companies regularly on issues Investments in relation to investments in India, in both listed and of employment and general corporate compliances. Ashwini has unlisted companies, as well as on exits from such investments. co-authored the Indian chapters on private equity published by the Vineetha has also represented and advised Warburg Pincus, IDFC Practical Law Company (a question and answer guide to the Indian Private Equity, ICICI Ventures and SBI Macquarie in relation to laws applicable to private equity; forms part of a multi-jurisdictional their investments and exits in India. She also represents corporate guide) as well as a chapter on ‘Employment laws in India’ in Getting houses such as the Times Group, CMS Computers, Sintex Industries, the Deal Through (a publication of Law Business Research Limited, Parksons Packaging, UTICO and L&T IDPL in their M&A transactions London). in India. Ashwini is admitted to practise law in India. Ashwini Vittalachar is a On the investment funds side, some of the funds Vineetha has recommended practitioner for Labour & Employment. (The Legal 500 assisted in setting up include Cerestra Edu-Infra Fund, IDFC Private 2016.) Equity Fund II and IDFC Private Equity Fund III, Nalanda Capital Fund Ashwini Vittalachar has played a key supporting role in many of the I, Nalanda Capital Fund II and Kae Capital. firm’s recent M&A deals. This has included acting on cross-border Vineetha has also assisted clients on a broad range of financing M&A deals in the life sciences and automotive sectors. (Chambers matters including project finance, corporate finance, microfinance, 2015.) securitisation, structured products and pre-litigation strategies. Some Ashwini is singled out by clients for her “communication skills, quick of the clients advised by her include ICICI Bank Limited, YES Bank, understanding of key business issues, and negotiating ability.” She IDFC, L&T Finance, Indostar, J.P. Morgan, Grameen Foundation, has acted on several mandates for clients in the automotive and Swadhaar, Samunnati, Cashpor, Blue Orchard and DWM. pharmaceutical sectors of late. (Chambers 2014.) Vineetha regularly advises clients on issues arising out of corporate governance, domestic anti-corruption laws as well as foreign anti- corruption laws such as the US Foreign Corrupt Practices Act, 1977 and the UK Bribery Act, 2010 in connection with mergers and acquisitions, private equity and financing transactions. Prior to the formation of the Firm, Vineetha had founded V Chambers of Law which then merged with NDR, to form the Firm. Before that Vineetha was a Partner for over a decade at AZB & Partners, where she handled their private equity, infrastructure, banking & finance and funds’ practice. Vineetha began her career at ICICI Bank Limited, Mumbai, in 1998 before joining AZB & Partners in 2001.
Samvād: Partners is a partner-led, solution-oriented law firm. The Firm is committed to providing smart and quality legal advice to our clients; maintaining the highest levels of professional integrity; and nurturing our lawyers in a work environment that motivates them to achieve and maintain the highest standards. The Partners and other lawyers are leaders in their respective fields of practice. The majority of our Partners have a rich mix of domestic and international experience, having worked in several legal and financial capitals around the world, including London, Hong Kong, Singapore, Mumbai, New Delhi, and The Hague. Our lawyers are truly international, with several being admitted to practise law in India, England & Wales and New York, bringing with them a deep and diverse international perspective. With offices in Bengaluru, Chennai, Hyderabad, Mumbai and New Delhi – the Firm’s partners have regularly received the highest accolades and ranking from our peers, including recognition in Chambers & Partners and The Legal 500, over the past few years.
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Indonesia Freddy Karyadi
Ali Budiardjo, Nugroho, Reksodiputro Anastasia Irawati
1 Overview 2 Structuring Matters
1.1 What are the most common types of private equity 2.1 What are the most common acquisition structures transactions in your jurisdiction? What is the current adopted for private equity transactions in your state of the market for these transactions? Have jurisdiction? Have new structures increasingly you seen any changes in the types of private equity developed (e.g. minority investments)? transactions being implemented in the last two to three years? As previously stated, private equity investors would prefer to invest in equity directly to the target unless the negative lists or certain The most common types of private equity transactions in Indonesia regulations prevent them from doing so. They normally would are private equity transactions through direct equity participation, have a holding company in a jurisdiction with a good tax treaty with mezzanine loans, and convertible notes or bonds where the loan can Indonesia. They also would provide mezzanine loans to the target be converted into shares in the call of the private equity investor to not only boost the financial support to the target, but also to the upon certain events (e.g. IPO, change of laws, etc.). For certain tax mechanism to control the target as lender. purposes, the loan plus warrant would replace the convertible notes/ There is a new structure/trend that is developing for targets that are bonds structure. start-up tech/digital companies. In this case, the investors usually The current state of the market for private equity transactions in require the founders of the start-up company to establish a foreign Indonesia is stable at the moment, but will start focusing on the holding company (in a country that they consider friendly for their unicorn of tech digital companies on top of healthcare, financial investment, usually in Singapore). The investors will invest directly institutions and mining sectors. in the newly set up foreign holding company and then this entity will There has been no significant change in the types of private equity acquire 100% shares of the Indonesian target company. transactions being implemented in the last two to three years. However, we note that there are more private equity investors who 2.2 What are the main drivers for these acquisition invest directly through equity instead of loans right now due to the structures? change in regulation which now allows some types of business activities, which were previously closed for foreign investment, to The main drivers for these acquisition structures are: (a) the exit be owned directly by a foreign investor. possibility; (b) the negative list issued by the authorities where some business activities are closed or restricted for foreign investment; 1.2 What are the most significant factors or developments and (c) the dividend repatriation and tax consideration. encouraging or inhibiting private equity transactions Factors (a) and (c) are the two factors that drive the new trend of in your jurisdiction? setting up a foreign entity for investment purposes (as mentioned in question 2.1 above). The investors request the founders of the target Despite experiencing slowing growth, Indonesia’s economy keeps company to establish a new entity in a country which they consider growing. Indonesia also has a large domestic consumption base to be investment friendly for them (in regards to the tax treatment and natural resources. These factors make investment in Indonesia and exit possibility) so that they can achieve their main goal – i.e. interesting. exit from the investment with optimum upside. Even though Indonesia is an interesting market for private equity For factor (b), if the line of business is closed or restricted for investments, some of the investors still doubt investing their foreign investment, then the private equity investor cannot easily money in Indonesia due to its complicated bureaucracy, lack of invest through equity in the Indonesian target company. Therefore, infrastructure, high corruption rate and the uncertainty of the laws they will use convertible bonds where they will require the same and regulations. rights as if they are shareholders in the target company, or use other Nevertheless, Indonesia’s investment climate remains conducive and sophisticated structures such as back door listing, utilisation of attractive for private equity investors. The government also realises venture capital or mutual funds as a holding company, etc. the potential of private equity investment for economic growth. In this regard, the government has tried to simplify the investment process to make it easier for investors to invest in Indonesia.
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■ Right of first refusal and tag-along right. 2.3 How is the equity commonly structured in private ■ Certain information and audit rights. equity transactions in your jurisdiction (including institutional, management and carried interests)? ■ Exclusivity to key personnel. ■ Non-compete and non-solicitation provisions (if applicable The equity structure of the target company may be in the form to the business of the target company). of: (i) common/ordinary shares; and/or (ii) other classes of shares ■ Deadlock mechanism. having different rights (voting right, dividend right, liquidation right The Company Law does not require that the abovementioned or right to nominate directors/commissioners) and/or a different governance agreement must be made publicly available in the nominal value compared to the common shares. Law No. 40 of articles of association of the company. They can stay in the 2007 regarding Limited Liability Companies (Company Law) shareholders’ agreement between the parties. However, usually Indonesia permits the issuance of these different categories of shares and it is the private equity investors will pursue that right to be included in quite common in private equity transactions. the articles of association of the target company so that it will be It is also possible and quite common for an Indonesian company to publicly available to the other third parties. have a management or employee stock option plan. For this type of stock option plan, there are two common ways being used by the company, i.e. (a) the stock option plan has been issued and held by 3.2 Do private equity investors and/or their director nominees typically enjoy significant veto rights over the founders to be later given to the eligible employee/management; major corporate actions (such as acquisitions and or (b) the stock option plan will only be regulated in the shareholders disposals, litigation, indebtedness, changing the agreement and will be issued later on once the rights has arisen. nature of the business, business plans and strategy, etc.)? If a private equity investor takes a minority position, what veto rights would they typically enjoy? 2.4 What are the main drivers for these equity structures?
As discussed in question 3.1 above, the private equity investors and Private equity would have a special right in the target company the other shareholders of the target company may agree on a list either via a shareholders’ agreement or other instrument. of reserved matters, outlining the key decisions which require the The different classes of shares provide the equity investor with the investors’ approval, either at the shareholders level or at the board ability to: (i) accelerate the return of its investment via the dividend level (through the directors and/or commissioners nominated by preference and/or mandatory IPO; and (ii) avoid higher risk by them). This effective veto ensures that no key decisions are entered having liquidation preference and anti-dilution protection. into without the consent or approval of the investors. For a private equity investor who takes a position as a minority 2.5 In relation to management equity, what are the typical shareholder, they usually require the following reserved matters vesting and compulsory acquisition provisions? to protect their rights: (a) issuance of new shares or convertible instrument coupled with anti-dilution rights; (b) transfer of shares Members of key management or key employees of the target of the other shareholders’ combined with tag-along; (c) change of company are typically included in the management incentive plan. articles of association and management team; (d) entry into affiliated The vesting period for this management stock option plan varies parties or material transaction; (e) dividend distribution and buyback from one private equity investor to the other. A two to three year shares; (f) proposed merger, acquisition, liquidation and litigation of vesting period is often seen (subject to any lock-up provisions under the target company; (g) approval of the business plan; and (h) put the relevant laws and regulations). option.
2.6 If a private equity investor is taking a minority 3.3 Are there any limitations on the effectiveness of veto position, are there different structuring arrangements: (i) at the shareholder level; and (ii) considerations? at the director nominee level? If so, how are these typically addressed? There would not be many different structuring considerations other than having stricter reserved matter, options to increase ownership There should be no limitations on the effectiveness of the veto percentage and a certain put option for the exit. Please refer to our arrangements at either the shareholder level or the director nominee explanation in question 2.4 above. level. The only problem is if this arrangement is not stated in the articles of association of the target company. In that case, if the board of directors of the company take some reserved matter actions 3 Governance Matters without the approval of the private equity investors, the action still binds the company and protects the third party in good faith. In order to minimise that kind of problem, the private equity 3.1 What are the typical governance arrangements for private equity portfolio companies? Are such investors should make sure that the veto arrangements are perfectly arrangements required to be made publicly available written in the articles of association of the company so that the third in your jurisdiction? party understands the veto arrangement as well.
The following features are frequently included in the governance 3.4 Are there any duties owed by a private equity investor agreement of private equity investments in Indonesia: to minority shareholders such as management ■ Investor’s representation in the board of directors and board shareholders (or vice versa)? If so, how are these of commissioners. typically addressed? ■ Certain protective rights to the investor (reserved matter) which require that certain actions cannot be taken without the Indonesian law does not recognise the concept of fiduciary duty of affirmative approval of the investor. majority shareholders to the minority shareholders as recognised
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in the U.S. jurisdiction system. However, for special transactions In particular, Indonesian law clearly stipulates that a director of such as merger and acquisition transactions, the Company Law human resources must be an Indonesian citizen. requires the company to pay attention to the right of the minority Members of the BOD or the BOC may be held to account personally shareholders and to buy back the minority shares to a certain extent. for “losses” suffered by the company pursuant to the Company Law. In addition, the Company Law also regulates the rights that the However, no liabilities would attach in this context if the members minority shareholders having a minimum of 10% of the shares in the of the BOD can prove that: (i) the losses did not arise due to their company have rights to: (i) commence a court proceeding against negligence or fault; (ii) they have performed their duties in good the board of directors and board of commissioners of the company; faith and prudence for the benefit of the company; (iii) no conflict (ii) request the court to commence an investigation against the of interest existed; and (iv) they have taken actions to prevent such company; and (iii) seek the dissolution of the company. losses. For members of the BOC, no liabilities would attach in this
context if the members of the BOC can prove that: (i) they have Indonesia conducted the supervision duty in good faith and with prudence for 3.5 Are there any limitations or restrictions on the contents or enforceability of shareholder agreements the benefit of the company and in accordance with the objectives and (including (i) governing law and jurisdiction, and (ii) purposes of the company; (ii) they do not have a personal interest in non-compete and non-solicit provisions)? the action of the BOD that is causing the losses; and (iii) they have given advice to the BOD to prevent the losses or the continuance of Although shareholders’ agreements often contains a provision stating the losses. that its terms would prevail over the articles of association of the The Company Law does not regulate the responsibility of the company if there is any discrepancy between them, Indonesian courts nominator of the BOD or BOC held accountable for actions in the would generally give credence to the articles rather than the terms of company. the shareholders’ agreement, since the articles of association is a public document whereas the shareholders’ agreement is merely a contractual 3.7 How do directors nominated by private equity obligation amongst the parties to the agreement. As such, in the case investors deal with actual and potential conflicts of of a dispute (and there is discrepancy), the investor’s rights under the interest arising from (i) their relationship with the shareholders’ agreement would be enforced under contract law. party nominating them, and (ii) positions as directors There is no clear restriction that the shareholders’ agreement cannot of other portfolio companies? be governed under foreign law. However, considering that the object of the shareholders’ agreement is the target company which In the case of an actual conflict, the Company Law is unequivocal is located in Indonesia, it is better to govern the shareholders’ that such director may not act on behalf of the company. In the agreement under Indonesian law. In addition, kindly be advised that case of a potential conflict, such director should exercise its business foreign court judgments cannot be enforced directly in Indonesia. judgment to assess if he/she should participate in a decision that Therefore it is going to be difficult if the governing law of the would likely lead to an actual conflict. Otherwise, they may be held shareholders’ agreement is foreign law. accountable if something is going wrong and causes losses to the For this reason as well, the preferred dispute resolution mechanism company due to their actions (as explained in question 3.6 above). in a contract involving a foreign investor is to utilise arbitration in In practice, it may be difficult as a nominated director has to balance an internationally recognised arbitration venue. In the event that a its actions for the best interest of his/her nominator and for the best foreign investor successfully obtains an arbitral award off-shore, the interest of the company (who has more than one shareholder). enforcement against the Indonesian party requires registration and enforcement of the award through the Indonesian courts. 4 Transaction Terms: General Indonesian law does not have a clear limitation and restriction on the content of the non-competition and non-solicitation provisions in a shareholders’ agreement. 4.1 What are the major issues impacting the timetable for transactions in your jurisdiction, including competition and other regulatory approval 3.6 Are there any legal restrictions or other requirements requirements, disclosure obligations and financing that a private equity investor should be aware of issues? in appointing its nominees to boards of portfolio companies? What are the key potential risks and liabilities for (i) directors nominated by private equity Since most private equity transactions involve a foreign investor, investors to portfolio company boards, and (ii) private an approval from the Investment Coordinating Board (BKPM) is equity investors that nominate directors to boards required before the investor can invest as a shareholder in the target of portfolio companies under corporate law and also company. This usually takes the most time because it involves more generally under other applicable laws (see discussion with the BKPM to decide the most appropriate Business section 10 below)? Classification Code Number for the activities of the company as well as the minimum amount of the investment. In certain cases, In general, the member of the Board of Commissioners (BOC) and consent from a creditor would also take some time. Board of Directors (BOD) must comply with the requirements set Furthermore, there are a number of notifications that need to be out under the Company Law, i.e.: made to creditors, employees and other public disclosures in the ■ has never been declared bankrupt; event of a takeover or merger. ■ has never been appointed as a member of a board of directors These notices include: a. The company’s creditors would need or board of commissioners of a company and declared guilty to be notified at least 30 days before the notice of the general for causing the company being declared bankrupt; and meeting of shareholders (GMS). Any objections the creditors ■ has never been convicted for any criminal actions that have must be submitted at least seven days before the notice of the damaged the finance of the state and/or the relevant financial GMS. The merger may not proceed until all objections have been sector.
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resolved. b. The employees of the companies must be notified at least 14 days before the notice of the GMS. Investment in certain 6.2 What is the typical package of warranties/indemnities industries (for example, telecommunications and transportation) offered by a private equity seller and its management team to a buyer? may require additional licensing and notification requirements to the relevant governmental agencies. In a direct investment by a foreign investor, approval from the Investment Coordination Board The warranties/indemnities offered usually relates to the ownership would also be required. Finally, KPPU reporting may be required of the shares and no threats or pending obligations that they owe in in certain takeover situations. relation to such ownership. In the case that the target is a public company, Indonesia’s capital In addition, the private equity seller would normally ask for a market regulator, the Financial Service Authority (OJK) may limitation of liability for the seller. For factual matters relating to
Indonesia request additional information and the investor who would be the the company, the management of the company would be able to give new controlling shareholder would be required to do a tender offer only for the period where they are in office and standard clauses post-closing transaction. such as the due incorporation, constitutional documents and no threats or pending obligations. The other warranties would normally be subject to the best of their 4.2 Have there been any discernible trends in transaction knowledge. terms over recent years?
The round down trend quite often happens in transactions involving 6.3 What is the typical scope of other covenants, tech companies. The red hot industries of the target of private equity undertakings and indemnities provided by a private would include fintech, unicorn tech companies, healthcare, financial equity seller and its management team to a buyer? services, mining and retail. The other covenants, undertakings and indemnities usually relate to the ownership of the shares or the conditions precedent or subsequent 5 Transaction Terms: Public Acquisitions relating to the transaction documents. The management team would covenant limited matters relating to the lack of compliance of the target company. 5.1 What particular features and/or challenges apply to private equity investors involved in public-to-private transactions (and their financing) and how are these 6.4 Is warranty and indemnity insurance used to “bridge commonly dealt with? the gap” where only limited warranties are given by the private equity seller and is it common for this In order to be able to “go private” the target company must obtain an to be offered by private equity sellers as part of the sales process? If so, what are the typical (i) excesses approval from the independent shareholders, be ready to purchase / policy limits, and (ii) carve-outs / exclusions from all shares from dissenting shareholders, in addition to extensive such warranty and indemnity insurance policies? disclosure requirements and tender offer of the remaining shares. In this regard, the company must comply with the minimum capital This is not common in Indonesia, although several insurance carriers requirement set out by the Company Law. do provide this service nowadays.
5.2 Are break-up fees available in your jurisdiction in 6.5 What limitations will typically apply to the liability of relation to public acquisitions? If not, what other a private equity seller and management team under arrangements are available, e.g. to cover aborted deal warranties, covenants, indemnities and undertakings? costs? If so, are such arrangements frequently agreed and what is the general range of such break-up fees? Typical limitations include: (a) time limitation; (b) de minimis; (c) claim threshold; or (d) cap for the liability amount. Although there is no restriction on the break-up fee arrangements, it is not a common practice in Indonesia. 6.6 Do (i) private equity sellers provide security (e.g. escrow accounts) for any warranties / liabilities, and 6 Transaction Terms: Private Acquisitions (ii) private equity buyers insist on any security for warranties / liabilities (including any obtained from the management team)? 6.1 What consideration structures are typically preferred by private equity investors (i) on the sell-side, and (ii) It is not common. However, the buyers may obtain a bank comfort on the buy-side, in your jurisdiction? letter or other proof of fund documentations.
Consideration structures which are typically preferred by private equity investors (on the sell-side) would be an IPO and trade sales 6.7 How do private equity buyers typically provide of shares in a holding company residing in a tax haven country. comfort as to the availability of (i) debt finance, and (ii) equity finance? What rights of enforcement While on the buy-side, direct investment to the equity in the target do sellers typically obtain if commitments to, or company via its own vehicle in a low tax jurisdiction. obtained by, an SPV are not complied with (e.g. equity underwrite of debt funding, right to specific performance of obligations under an equity commitment letter, damages, etc.)?
The private equity buyers may show a bank comfort letter to show the finance ability of the private equity buyers. In the agreement, the
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sellers usually set out some kind of liquidated damages to cover the non-payment of the commitments by the buyers. 8.2 Are there any relevant legal requirements or restrictions impacting the nature or structure of the debt financing (or any particular type of debt 6.8 Are reverse break fees prevalent in private equity financing) of private equity transactions? transactions to limit private equity buyers’ exposure? If so, what terms are typical? The laws and regulations prohibit the use of debt for injection of capital for some line of businesses, such as multi finance companies and It is not common in Indonesia. venture capital companies. In addition, banks are also prohibited from granting loans to an individual or to a company other than securities companies if the loan is used for the purpose of shares trading.
7 Transaction Terms: IPOs Indonesia
9 Tax Matters 7.1 What particular features and/or challenges should a private equity seller be aware of in considering an IPO exit? 9.1 What are the key tax considerations for private equity investors and transactions in your jurisdiction? Are The Indonesian government provides quite strict regulation for a off-shore structures common? company to be able to conduct an IPO. The main challenges to do an IPO would include the long process of the registration statement, The key consideration for private equity investors and transactions thorough verification by the authority, minimum floating, lock- would be the most efficient tax exposure when the private equity up for founder shares and shares resulting from the debt equity exits from its investment and when the return from the investee is conversion. repatriated to it. The private equity would normally concern the tax treatment for the dividend, interest and royalty payment and the 7.2 What customary lock-ups would be imposed on exit scheme. private equity sellers on an IPO exit? Off-shore structures are also common (as we explained in question 2.1 above). If the private equity sellers obtain the shares (within the period of six months prior to the submission of the registration statement 9.2 What are the key tax considerations for management to OJK) with a lower price than the IPO’s price, then such shares teams that are selling and/or rolling-over part of their will be locked up until eight months after the effectiveness of the investment into a new acquisition structure? registration statement to the OJK. Further, if the private equity sellers obtain the shares during the The key tax consideration must be the capital gain tax for the transfer IPO by converting its convertible bonds issued by the target, the of the shares in the jurisdiction of investee and investor. Further, the shares could not be traded in the stock exchange for one year after management teams would seek that the new acquisition structure has a the conversion. better tax treaty benefit for the private equity investor. The management team should also consider the minimum amount of shares percentage 7.3 Do private equity sellers generally pursue a dual-track in the investee that they need to maintain in order to have the lowest exit process? If so, (i) how late in the process are amount of withholding tax rate for the dividend payment. private equity sellers continuing to run the dual-track, and (ii) were more dual-track deals ultimately realised 9.3 What are the key tax-efficient arrangements that are through a sale or IPO? typically considered by management teams in private equity portfolio companies (such as growth shares, Based on our understanding, the dual-track exit process here means deferred / vesting arrangements, “entrepreneurs’ that the private equity company plans to exit by conducting an IPO relief” or “employee shareholder status” in the UK)? while also pursuing a possible M&A exit at the same time. In that case, this method is common in Indonesia. Management teams should consider the maximum tax treaty benefit that they will receive so that they can exit the investment with the lowest tax exposure. In between the investment and the exit, 8 Financing they should wisely choose the jurisdiction of the investee and the beneficial owner, so that they can get the lowest corporate tax rate 8.1 Please outline the most common sources of debt pursuant to the tax treaty. finance used to fund private equity transactions in your jurisdiction and provide an overview of the 9.4 Have there been any significant changes in tax current state of the finance market in your jurisdiction legislation or the practices of tax authorities for such debt (particularly the market for high yield (including in relation to tax rulings or clearances) bonds). impacting private equity investors, management teams or private equity transactions and are any Utilisation of debt to fund private equity transactions is not common anticipated? in Indonesia. Here are the changes in tax legislation which might impact private equity investments: ■ The Minister of Finance set out the debt to equity ratio that will be considered in the calculation of income tax in 2015.
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Pursuant to this regulation, the maximum allowed debt to lenders, suppliers and customers, assets, insurances, environmental equity ratio is 4:1. compliance, litigation and court searches. On the other hand, if the ■ The Minister of Finance set out a new transfer pricing value of the transaction is not material, the investor usually requires regulation and country by country report (CbCR) to combat only a limited due diligence that covers only corporate documents, tax avoidance and BEPS practices in Indonesia. Pursuant to licences, assets, and material agreements. this regulation, a taxpayer who conducts a transaction with The investor usually engages an Indonesian counsel to conduct the affiliated parties must maintain some kind of documentation and information to be reported to the authority. due diligence process. ■ The Minister of Finance has signed a Multilateral Competent Authority Agreement on 3 June 2015. Following the signing 10.4 Has anti-bribery or anti-corruption legislation of this agreement, Automatic Exchange of Information with impacted private equity investment and/or investors’ Indonesia 94 other jurisdictions will automatically apply in September approach to private equity transactions (e.g. 2018. diligence, contractual protection, etc.)? ■ Regulation of the Minister of Finance No. 258/PMK.03/2008 regarding Withholding of Income Tax regulates that a transfer Normally, yes. The jurisdiction of the investor would determine the of shares of a company which was established in a tax haven risk appetite of the investor in this regard. Investors coming from a country and has a special relationship with an Indonesian country with very strict anti-bribery protection like the U.K., U.S. or company or permanent establishment in Indonesia is subject Japan, will be very concerned about this. to 20% of the estimated net sales amount. ■ Regulation of Directorate General Taxation No. PER-62/ PJ./2009 (as lastly amended by Regulation of Directorate 10.5 Are there any circumstances in which: (i) a private General Taxation No. PER-25/PJ/2010) regarding the equity investor may be held liable for the liabilities of Prevention on the Abuse of Double Taxation Avoidance the underlying portfolio companies (including due to regulates that one kind of abuse is that the recipient of the breach of applicable laws by the portfolio companies); and (ii) one portfolio company may be held liable for income is not the beneficial owner. In this case, the tax treaty the liabilities of another portfolio company? arrangement will not be applied and the Indonesian Income Tax Law will apply. Generally, shareholders of an Indonesian company would not be held liable for the company’s losses beyond the value of the shares 10 Legal and Regulatory Matters they held. In theory, a “piercing” of the limited liability veil may take place in the event that it can be proven that certain shareholders unlawfully 10.1 What are the key laws and regulations affecting private equity investors and transactions in your squandered the company’s assets such that the company is unable jurisdiction, including those that impact private equity to meet its obligation. The risk to the private equity investor is, transactions differently to other types of transaction? however, quite low. The risk to other portfolio companies is even more unlikely because, The Investment Regulations, the Company Law and tax regulations normally, the investor would create a separate SPV to hold shares or are the two key regulations for a private equity transaction in interests in each of the portfolio companies, reducing the risk of lateral Indonesia. There is no specific regulation that differentiates the type exposure of debts from other portfolio companies to remote at best. of private equity transaction from other types of transaction though.
11 Other Useful Facts 10.2 Have there been any significant legal and/or regulatory developments over recent years impacting private equity investors or transactions and are any 11.1 What other factors commonly give rise to concerns anticipated? for private equity investors in your jurisdiction or should such investors otherwise be aware of in The government just released a new negative list in 2016 which considering an investment in your jurisdiction? changes some line of businesses which were previously closed for foreign investment to be open for foreign investment with some There is nothing major other than the one that we have stipulated limitations, i.e. retail activities which were previously closed for above. Some minor concerns that the investors might need to foreign investment are now open for the online selling of specific consider are: goods, as long as the sellers cooperate with small and medium ■ Any agreement with an Indonesian party would need to enterprises. be translated pursuant to Article 31 of the Law on Flag, Language, Emblem and National Anthem. 10.3 How detailed is the legal due diligence (including ■ Law No. 13 Year 2003 (the “Labour Law”) contains compliance) conducted by private equity investors several provisions that may adversely impact private equity prior to any acquisitions (e.g. typical timeframes, investment in a company, including: materiality, scope etc.)? Do private equity investors ■ In the event of a change of a company’s status, merger, engage outside counsel / professionals to conduct all consolidation or a “change of ownership” (frequently legal / compliance due diligence or is any conducted associated with a change of the controlling shareholder, in-house? but a change in the management’s policies regarding employees’ rights and entitlements may also qualify for a The scope of due diligence usually depends on the value of the change of ownership), its employees would have the right to transaction and the industry of the target. If the value is high, choose whether to remain or to terminate their employment the investor usually requires a full-blown due diligence covering with the company (Article 163(1) of the Indonesian corporate documents, licences, manpower, agreements with Labour Law). In which case, severance entitlement could
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be payable. However, recently there is a Judicial Review stipulated in Article 163 is vague, the mediator and Industrial Decision from the Constitutional Court under Decision Relations Court may have different interpretations on this Number 117/PUU-X/2012 deciding that the right of clause. termination is in the hands of the employer, meaning that ■ Under Article 163(2) of the Labour Law, the employer the employer is the one to decide whether to terminate or has the right to dismiss employees only in the event of a not. The right of the employee to decide not to continue change of the company’s status, merger and consolidation, the employment relationship in the event of a change of but not in the event of a “change of ownership”. ownership is conditional only if there is a restructurisation, ■ Some joint ventures may be subject to mandatory merger rotation, reposition, inter-department transfer (mutasi), control requirements (Article 28 of Law No. 5 of Year 1999 promotion, demotion, and change of working conditions of (the “Anti-Monopoly Law”)). the employee. If there is no such condition, the employer
may reject the request of termination and the employee will ■ Rupiah must be used in certain cash and non-cash transactions Indonesia be deemed to have voluntarily resigned from the company. occurring in the territory of Indonesia (Bank Indonesia However, our research to the Ministry of Manpower to Regulation No. 17/3/PBI/2015). discuss this issue indicates that given that the term “may” as
Freddy Karyadi Anastasia Irawati Ali Budiardjo, Nugroho, Reksodiputro Ali Budiardjo, Nugroho, Reksodiputro Graha CIMB Niaga 24th Floor Graha CIMB Niaga 24th Floor Jl. Jend. Sudirman Kav. 58 Jl. Jend. Sudirman Kav. 58 Jakarta 12190 Jakarta 12190 Indonesia Indonesia
Tel: +62 21 250 5125 Tel: +6221 250 5125 Email: [email protected] Email: [email protected] URL: www.abnrlaw.com URL: www.abnrlaw.com
Mr. Freddy Karyadi joined ABNR as a senior associate in July 2007 and Ms. Anastasia Irawati joined ABNR as an associate in January 2012. became a Partner on 1 January 2012. He read law at the University She graduated with honours in 2011 from the Faculty of Law of the of Indonesia (1998) and earned an LL.M. in International Tax at Leiden Parahyangan Catholic University. In 2016, she earned a Master of Laws University (2002). He also graduated cum laude in 1997 from the (LL.M.) degree from New York University (NYU) School of Law, majoring Faculty of Economics of Trisakti University in Jakarta and obtained in corporations law. During her studies at NYU, she gained exposure a MBA degree from Peking University (2015). He has participated to U.S. legal practice by participating in the mediation of real disputes in various trainings and seminars in Indonesia and abroad. Prior to in a variety of cases within the New York State court system (including joining ABNR, he worked for a number of years in other prominent landlord-tenant disputes, loan disputes, auto accidents, work contracts law firms in Jakarta. In 2010, he was seconded to a leading Dutch and unpaid bills) alongside coaches and mediation supervisors. law and tax firm. His special practice areas are capital markets, M&A, At ABNR, she has been part of the teams of lawyers that assist clients in power project, project finance, investment, bankruptcy, corporate and general corporate, antitrust, intellectual property rights, pharmaceutical debt restructurings, litigation, property, natural resources, tax, banking and food industry matters as well as in commercial litigation. She and project finance matters. He has represented international financial has ample experience in handling start-up entrepreneur cases and institutions, banks, private equity, venture capital, tech/digital, mining has been involved in projects relating to restructuring, suspension of and publicly listed companies. payment, investment and acquisition. She also contributes articles to He is a member of the editorial board of the Derivatives and Financial Getting the Deal Through, Lexis Nexis and Thomson Reuters. Instrument Journal, the International Bureau of Fiscal Documentation, the Netherlands and is the regional correspondent for the Indonesia jurisdiction for Tax Notes International of Virginia, United States. Freddy also contributes articles to International Financial Law Review (IFLR), International Tax Review, ICLG, Getting The Deal Through and acts as a speaker for the IBA, the IPBA and the various forums of the IFLR. He is also a tax attorney, chartered accountant and licensed tax consultant. He has received awards from the IFLR1000, Asialaw Profiles and The Asia Pacific Legal 500.
Ali Budiardjo, Nugroho, Reksodiputro, usually abbreviated to ABNR, was established in Jakarta in 1967 as a partnership of legal consultants in Indonesian business law. The firm is one of Indonesia’s largest independent full-service law firms. The commitment we make to clients is to provide broad-based, personalised service from top-quality teams of lawyers with international experience that includes groundbreaking deals and projects. ABNR’s reputation has been recognised around the world by independent industry surveys and law firm guides. ABNR was selected, based on its high level of integrity and professionalism, to be the sole Indonesian member of the world’s largest law firm association, Lex Mundi, and of the prestigious Pacific Rim Advisory Council (“PRAC”).
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Ireland Éanna Mellett
Matheson Aidan Fahy
1 Overview 2 Structuring Matters
1.1 What are the most common types of private equity 2.1 What are the most common acquisition structures transactions in your jurisdiction? What is the current adopted for private equity transactions in your state of the market for these transactions? Have jurisdiction? Have new structures increasingly you seen any changes in the types of private equity developed (e.g. minority investments)? transactions being implemented in the last two to three years? PE transactions are usually structured using a holding company (“Holdco”) and an indirect wholly-owned subsidiary of Holdco A broad range of private equity (“PE”) transactions are carried (“Bidco”). Holdco is commonly owned by the PE fund and out in Ireland, the most common including leveraged buyouts, management, as majority and minority shareholders, respectively. refinancings, trade sales, secondary buyouts, bolt-on deals and Holdco can take the form of an offshore vehicle, although it is secondary transactions. usually Irish or UK tax resident. Macroeconomic issues such as uncertainty over “Brexit” impacted Bidco’s primary role is to acquire and hold the target’s shares and Irish corporate activity generally in 2016 including PE activity. it may also act as borrower under the debt facilities. For tax- and/ However the Irish PE market grew in 2016. The last two to three or financing-related purposes, it is common to have intermediate years have seen some new PE entrants to the Irish market with holding companies inserted between Holdco and Bidco. traditional bank acquisition financing being more difficult to obtain, For inbound investments, Bidco is typically a private limited liability particularly for small to medium sized businesses. company resident, for tax purposes, in Ireland. The jurisdiction of incorporation of Bidco can vary and may be onshore or offshore. 1.2 What are the most significant factors or developments Minority investments have become more common. See question encouraging or inhibiting private equity transactions 2.6 below. in your jurisdiction?
Ireland delivers: 2.2 What are the main drivers for these acquisition ■ a low corporate tax rate – corporation tax on trading profits is structures? 12.5% and the regime does not breach EU or OECD harmful tax competition criteria; There are a number of factors which affect the acquisition ■ the regulatory, economic and people infrastructure of a structure adopted in PE transactions. These drivers include: (i) highly-developed OECD jurisdiction; the tax requirements, capacity and sensitivities of the PE house, ■ the benefits of EU membership and of being the only English- management and target; (ii) the finance providers’ requirements; and speaking jurisdiction in the eurozone; (iii) the expected profile of investor returns. ■ a common law jurisdiction, with a legal system that is broadly similar to the US and the UK systems; 2.3 How is the equity commonly structured in private ■ refundable tax credit for research and development activity equity transactions in your jurisdiction (including and other incentives; and institutional, management and carried interests)? ■ an extensive and expanding double tax treaty network, which includes over 70 countries, including the US, UK, China and PE investors typically use small proportions of equity finance to Japan. subscribe for ordinary or preferred ordinary shares in Holdco. The balance is generally invested as a shareholder loan (often structured as loan notes issued by Holdco), or preference shares.
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Management will generally subscribe for ordinary shares in Holdco company. This will likely include, among other provisions: (i) representing between 5% and 15%, commonly referred to as “sweet covenants from management with regard to the conduct of the equity”. On some buyouts, key senior management with sufficient business of the portfolio company; (ii) extensive veto rights for funds to do so may also be permitted (and/or required) to invest in the PE house; (iii) restrictions on the transfer of securities in the the institutional strip. portfolio company; and (iv) provisions regarding further issuances Senior management are usually expected to make sufficient financial of shareholder equity/debt. investment in the target group to ensure their interests remain In addition, the constitutional documents may include governance aligned with the PE investor and that they remain incentivised to arrangements, particularly with regard to the transfer of shares. create further value. They will also typically sign up to contractual
restrictions (see question 2.5 below). Ireland 3.2 Do private equity investors and/or their director Other key personnel may be invited to participate in management nominees typically enjoy significant veto rights over incentive plans or to become additional employee shareholders. major corporate actions (such as acquisitions and disposals, litigation, indebtedness, changing the nature of the business, business plans and strategy, 2.4 What are the main drivers for these equity structures? etc.)? If a private equity investor takes a minority position, what veto rights would they typically enjoy? Management incentivisation, structural subordination of equity and investor financing, ease of return of funds to investors, and tax PE investors normally enjoy significant veto rights over major considerations generally feature as main drivers for these structures. corporate, commercial and financial matters, although thresholds are commonly set to ensure that day-to-day decisions can be taken by management. 2.5 In relation to management equity, what are the typical vesting and compulsory acquisition provisions? These veto rights will typically be split between director veto rights and shareholder veto rights. Transaction documents will invariably include provisions In a minority PE investment, given the PE house is unlikely to have enabling the PE fund to compulsorily acquire a manager’s shares board control, the PE house is typically much more focused on veto on termination of his/her employment with the relevant portfolio controls to the extent that, in certain cases, a minority investment company. may result in more veto control than might be the case in a majority Documentation will usually include good leaver/bad leaver investment. provisions, which will determine the amount payable to the departing manager. These provisions come in many forms but will frequently 3.3 Are there any limitations on the effectiveness of veto define the term “good leaver” by reference to specific circumstances arrangements: (i) at the shareholder level; and (ii) (death, retirement over statutory retirement age, long-term illness, at the director nominee level? If so, how are these etc.) with all other circumstances constituting a “bad leaver”. typically addressed? A “good leaver” will commonly obtain the higher of cost and fair market value for his/her shares while a “bad leaver” may expect to Veto rights will generally be respected by Irish courts, but may be receive the lower of fair market value and cost. found to be void if they constitute an unlawful fetter on any statutory powers of an Irish company or are contrary to public policy. The relevant documentation may also include vesting provisions Generally, appropriate structures can be put in place to ensure that that will regulate the proportion of shares for which the departing customary veto rights are effective. employee will be entitled to the “good leaver” price (i.e. higher of cost and fair market value) by reference to the length of the period A shareholders’ agreement is likely to be entered into to ensure that from buyout to termination. Vesting may be straight-line or stepped agreed veto arrangements would be upheld at the shareholder level. and full vesting may typically occur after a period of between three Such an agreement may also obligate the shareholders to procure and five years. that certain actions are taken (or not taken) by the relevant target group companies. Directors’ veto rights need to be balanced with the directors’ duty to 2.6 If a private equity investor is taking a minority position, are there different structuring act in the best interests of the portfolio company. Hence, it is wise considerations? to retain shareholder level veto rights.
A minority PE investor will typically be more focused on veto 3.4 Are there any duties owed by a private equity investor rights, given it is unlikely to have board control. Depending on to minority shareholders such as management the size of the stake, vesting periods for management shares, good shareholders (or vice versa)? If so, how are these leaver/bad leaver provisions may be somewhat relaxed. typically addressed?
The PE investor itself is not subject to fiduciary or other duties 3 Governance Matters under Irish company law to the minority shareholders (but see question 3.6 below for potential liability as shadow director). Board nominees generally owe duties to the company, but may, in limited 3.1 What are the typical governance arrangements circumstances, owe duties to shareholders (for example, regarding for private equity portfolio companies? Are such arrangements required to be made publicly available information disclosure). in your jurisdiction? Certain duties may also be owed if: (i) the portfolio company is insolvent or verging on insolvency; or (ii) if a specific special PE houses and management will typically enter into a shareholders’ relationship (for example, principal and agent) is established agreement to govern their relations as shareholders in the portfolio between the nominee directors and the shareholders.
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Shareholders may be entitled to bring derivative actions on behalf A specific release passed in general meeting or included within the of the company against the nominee directors (often as a last portfolio company’s constitution in relation to any matter of concern resort), although it may be difficult to establish the eligibility of the would reduce this list. shareholders to bring such an action under company law. 4 Transaction Terms: General 3.5 Are there any limitations or restrictions on the contents or enforceability of shareholder agreements (including (i) governing law and jurisdiction, and (ii) 4.1 What are the major issues impacting the timetable non-compete and non-solicit provisions)? for transactions in your jurisdiction, including competition and other regulatory approval Ireland Save to the extent that they contravene statute or are contrary to requirements, disclosure obligations and financing public policy, there are no such limitations or restrictions that would issues? apply with respect to an Irish company as regards enforceability. However, if the group structure includes companies from other The timing for transactions is largely affected by regulatory jurisdictions, the impact of the laws of those jurisdictions will need approvals (mainly competition and sector-specific approvals) and to be considered. Non-complete restrictions will only be enforced the preparation of financials (particularly given the prevalence of to the extent reasonable in terms of geographical, temporal and locked-box-pricing mechanisms in PE transactions). sectoral scope. Governing law clauses which set non-Irish law as the law of choice will typically be respected by the Irish Courts. 4.2 Have there been any discernible trends in transaction terms over recent years? 3.6 Are there any legal restrictions or other requirements that a private equity investor should be aware of The M&A landscape remains generally favourable to PE sellers in appointing its nominees to boards of portfolio in Ireland. Recent trends include: (i) continuing prevalence of companies? What are the key potential risks and the “locked-box” consideration structure; (ii) increase in deals liabilities for (i) directors nominated by private equity involving warranty and indemnity insurance; (iii) continuing limited investors to portfolio company boards, and (ii) private representation and warranty protection from PE sellers; and (iv) equity investors that nominate directors to boards of portfolio companies under corporate law and also reducing limitation of liability periods. more generally under other applicable laws (see section 10 below)? 5 Transaction Terms: Public Acquisitions PE investors must ensure that nominee directors are eligible to act as directors, including, in particular, that they are not disqualified by 5.1 What particular features and/or challenges apply to statute or restricted from so acting under Irish company law. private equity investors involved in public-to-private In the context of being entitled to nominate directors, PE investors transactions (and their financing) and how are these commonly dealt with? ought to be aware that in certain circumstances they may be construed as “shadow directors” under s. 221 of the Companies Act 2014, if the nominee directors are accustomed to act according In public-to-private transactions involving Irish companies, the to the directions and instructions of the PE fund. If construed as Irish Takeover Rules (“Takeover Rules”) will usually apply. The shadow directors, the PE investor would be treated as a director of Takeover Rules regulate the conduct of takeovers of, and certain the portfolio company and directors’ duties would apply to it. other transactions affecting, Irish companies listed on certain stock exchanges, and contain detailed provisions covering matters Nominated directors risk incurring liabilities if they breach their such as confidentiality, announcement obligations, deal timetable, directors’ duties (including their statutory duties under ss. 223–228 capped break fees and public disclosure. The Takeover Rules are CA) and may face the risk of clawback action for certain decisions administered by the Irish Takeover Panel (the “Panel”), which has made during certain periods of time if the company is insolvent or supervisory jurisdiction over such transactions. verging on insolvency. While the application of the Takeover Rules means that such PE investors will typically seek to mitigate the impact of the above transactions are generally subject to a more restrictive framework risks through directors’ and officers’ insurance policies. than a typical private company transaction, there are three particular Irish Takeover Rules features of note: 3.7 How do directors nominated by private equity ■ A transaction must be independently cash confirmed before investors deal with actual and potential conflicts of a bidder can announce a firm intention to make an offer. interest arising from (i) their relationship with the For a private equity investor, this means that, at the time of party nominating them, and (ii) positions as directors announcement, its funding will need to be unconditionally of other portfolio companies? available to the bidder (including possibly being placed in escrow). Such directors must be mindful that although they are nominee ■ Once a firm intention to make an offer is announced, a directors, their duties are generally owed to the company itself and bidder will generally be bound to proceed with the offer. not to the party nominating them or other shareholders. Furthermore, save for the acceptance condition or any The CA (s. 228(i)(f)) imposes a duty on a director to “avoid any competition/anti-trust condition, once an offer is made, the bidder will have limited scope to invoke any other condition conflict between the directors’ duties and… other interests unless the to lapse or withdraw the offer. This increases the importance director is released from his or her duty to the company…”. Such an of due diligence for the private equity investor. actual or potential conflict of interest may arise, for example, with ■ Special arrangements with any category of target shareholder, respect to (i) the nominating PE house, or (ii) the directors’ other including management incentivisation proposals, will generally directorial positions. require Panel consent. Such consent may be given subject
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to independent shareholder approval at a general meeting. assistance with regulatory filings and, in some cases, undertakings This necessitates the importance of early formulation of such regarding the conduct of the target business pre-completion arrangements or proposals and engagement with the Panel. (although frequently limited to exercise of voting in a manner aimed at achieving such outcome rather than an absolute procure covenant). 5.2 Are break-up fees available in your jurisdiction in relation to public acquisitions? If not, what other A PE seller is very unlikely to provide non-compete covenants, arrangements are available, e.g. to cover aborted deal but these may be provided by members of management who are costs? If so, are such arrangements frequently agreed exiting the target business. Typically non-solicitation of employees and what is the general range of such break-up fees? covenants will be acceptable to a PE seller.
Management will also generally provide pre-completion Ireland Break fees are allowed in relation to public acquisitions with undertakings regarding the conduct of the target business pre- Panel consent. The Panel will typically only consent to break-fee completion. arrangements of up to 1% of the value of an offer, with limited trigger events, including: (i) the withdrawal of an offer recommendation by the target board resulting in the offer being withdrawn or lapsing; or 6.4 Is warranty and indemnity insurance used to “bridge (ii) the success of a competing offer. The mere failure to achieve the gap” where only limited warranties are given by a minimum acceptance level in the absence of (i) or (ii) would not the private equity seller and is it common for this typically be an acceptable trigger for payment of a break-fee. to be offered by private equity sellers as part of the sales process? If so, what are the typical (i) excesses / policy limits, and (ii) carve-outs / exclusions from 6 Transaction Terms: Private Acquisitions such warranty and indemnity insurance policies?
Yes, buyer warranty and indemnity insurance policies are an 6.1 What consideration structures are typically preferred increasingly common tool for “bridging the gap”, and preliminary by private equity investors (i) on the sell-side, and (ii) terms for buy-side insurance are commonly included by PE sellers on the buy-side, in your jurisdiction? as part of the initial sell-side transaction documentation, for buyer and insurer to agree during negotiation of the sale and purchase “Locked-box” structures are generally preferred by PE sellers as documentation. they offer certainty in the purchase price from the outset, greater These will typically be given on the basis of a set of business control over financial information, potentially reduced contractual warranties given by management, but subject to limitations designed liability, cost savings and prompt distribution of sale proceeds to to ensure that personal liability of management is limited. investors/sellers after completion. The buyer will be compensated for any “leakage” of value from the target group following the “locked-box date” (save to the extent the parties agree such leakage 6.5 What limitations will typically apply to the liability of is to be treated as “permitted” (and so not to form the basis of any a private equity seller and management team under warranties, covenants, indemnities and undertakings? adjustment)). Other consideration structures commonly used may involve On the basis that a PE seller’s warranties will generally be limited adjustments by reference to working capital and net debt. These to title, capacity and authority, a PE seller’s warranties are usually structures rely on a statement or set of accounts drawn up shortly either subject to a cap equal to the aggregate purchase price or after completion and adjustments are made to the purchase price uncapped. based on deviations from reference balance sheets/accounts, drawn up prior to execution of the share purchase agreement (and on which Liability under any “no-leakage” covenant will likely be limited to a the pricing has, in theory, been based). relatively small amount which is commonly escrowed. Managers can limit their liability under the warranties by: (i) giving them severally (each manager is only liable for its proportionate 6.2 What is the typical package of warranties/indemnities share of liability for any claim and/or its own breach) and subject offered by a private equity seller and its management team to a buyer? to awareness; and (ii) capping maximum liability for any warranty claims. A PE seller usually only provides warranties regarding title to its In a transaction including warranty and indemnity insurance, the cap own shares, capacity and authority. on management liability for warranties will often be set at the level The target’s management will often (subject to their percentage of the insurance deductible/excess. ownership and on the basis they are usually better placed to) General limitations include time limits within which claims may be provide business warranties, under a separate management warranty brought, and de minimis and basket thresholds. deed. The key rationale for the warranties is generally to elicit full disclosure regarding the target during the due diligence process, 6.6 Do (i) private equity sellers provide security (e.g. although the negotiated warranty package may form the basis for escrow accounts) for any warranties / liabilities, and warranty and indemnity insurance protection. (ii) private equity buyers insist on any security for warranties / liabilities (including any obtained from the management team)? 6.3 What is the typical scope of other covenants, undertakings and indemnities provided by a private equity seller and its management team to a buyer? Escrow retention accounts do feature in some transactions but PE sellers typically look to resist such arrangements. PE buyers will, A PE seller will usually provide pre-completion undertakings as an alternative to a retention, look to include warranty breaches in relation to no-leakage (in a locked-box pricing structure) and within the compulsory purchase/good leaver/bad leaver provisions.
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representation and other matters prior to the IPO, these are 6.7 How do private equity buyers typically provide likely to be significantly constrained on completion of the comfort as to the availability of (i) debt finance, IPO (please see further the response to question 7.3 below). and (ii) equity finance? What rights of enforcement do sellers typically obtain if commitments to, or obtained by, an SPV are not complied with (e.g. 7.2 What customary lock-ups would be imposed on equity underwrite of debt funding, right to specific private equity sellers on an IPO exit? performance of obligations under an equity commitment letter, damages, etc.)? The duration of the lock-up provided by the PE seller will vary from transaction to transaction, but is typically for a period of six months The PE fund usually gives a direct commitment to the seller to fund
Ireland following the IPO. As a result, the PE seller will be exposed to Bidco with the equity capital committed to the transaction, subject market risk for the duration of the lock-up period in respect of any only to the satisfaction of the conditions in the share purchase stock it retains, with no ability to sell if the market begins to turn or agreement and financing being available. The seller can generally the company’s performance declines. enforce this commitment directly against the PE fund to the extent it becomes unconditional and the PE fund fails to fund Bidco. 7.3 Do private equity sellers generally pursue a dual-track exit process? If so, (i) how late in the process are 6.8 Are reverse break fees prevalent in private equity private equity sellers continuing to run the dual-track, transactions to limit private equity buyers’ exposure? and (ii) were more dual-track deals ultimately realised If so, what terms are typical? through a sale or IPO?
Reverse break fees are relatively unusual in private equity Almost all Irish transactions in recent years have concluded through transactions in Ireland but may be used in certain circumstances. a sale rather than an IPO. Typically, a PE seller looking to exit by way of an IPO will look to an IPO by way of a dual-listing in Ireland and either the US or UK. 7 Transaction Terms: IPOs
8 Financing 7.1 What particular features and/or challenges should a private equity seller be aware of in considering an IPO exit? 8.1 Please outline the most common sources of debt finance used to fund private equity transactions in Typically an Irish IPO will be part of a dual-listing with either a your jurisdiction and provide an overview of the UK or US listing. There are a number of key issues which need to current state of the finance market in your jurisdiction be considered by PE sellers considering an IPO exit, including the for such debt (particularly the market for high yield bonds). following: ■ Market risk: unlike certain other PE exit routes, PE sellers are Traditional bank-led leveraged loan financing remains the most exposed to market risk when looking to access institutional common source of debt finance used to fund both mid-market and investor capital through an IPO process. Sellers can look to mitigate this risk by commencing a pre-marketing campaign large private equity transactions in Ireland. earlier in the deal timeline to try and secure a successful However, in recent years there has been increasing competition outcome (equally, however, this means that if there is a need between traditional bank lenders and non-bank (or “alternative”) to postpone the transaction for whatever reason, it can be lenders and funds, which has resulted in a wide array of other debt seen as a more significant failure by the investor community). products being offered to market participants to replace and/or ■ Lock-ups/selling restrictions: PE sellers may not be able supplement traditional senior secured bank loans. These include to dispose of their stake in the business completely at the term loan B (“TLB”) facilities, mezzanine and unitranche loans and time of the IPO. The PE sellers may be subject to a lock- second lien loan products. For certain transactions, some market up period during which they would be unable to sell some, participants have also been able to turn to direct lending funds. or all, of their stake in the business to prevent detrimental effects on the valuation of the company immediately after the IPO. As such, there would be a delay between the time of the 8.2 Are there any relevant legal requirements or IPO and the time at which the PE fund would fully realise restrictions impacting the nature or structure of its investment. Please see the response to question 7.2 for the debt financing (or any particular type of debt further commentary on the duration of lock-ups. financing) of private equity transactions? ■ Contractual obligations relating to the IPO: the PE seller will be required to be a party to the underwriting agreement There are no particular legal requirements or restrictions that would entered into with the investment banks underwriting the affect the choice or structure of debt financing of private equity IPO. The PE seller will be expected to give a suite of transactions in Ireland generally. However, market participants should representations and warranties to the banks as to a range of be aware of, and ensure compliance with, any industry specific laws matters relating to itself and the shares it owns and, to a more and regulations, as well as the broader regulatory regime affecting limited extent, the company being floated and its business. It will also be expected to give the underwriting banks a broad private equity transactions. transaction indemnity covering any losses they may incur in For example, market participants need to be especially careful in connection with the transaction. regards to compliance with anti-bribery, corruption and sanctions laws. ■ Corporate governance: on the IPO, depending on the listing Aside from local laws, borrowers and sponsors should also be aware venue, companies are often required to adopt a particular of the expansive nature and potential extraterritorial reach of such laws corporate governance framework. Therefore, whilst the and regulations in the United States, which can necessitate compliance PE seller may have enjoyed contractual rights to board by many non-US entities (or entities that have only limited US ties).
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regime as set out above, Irish structures often feature. However, 9 Tax Matters that said, we do see off-shore structures used from time-to-time, the choice of structure depending on the factors set out in the first 9.1 What are the key tax considerations for private equity paragraph above. investors and transactions in your jurisdiction? Are off-shore structures common? 9.2 What are the key tax considerations for management teams that are selling and/or rolling-over part of their When investing in an Irish target, key tax considerations for private investment into a new acquisition structure? equity investors will include the choice of holding structure, transaction tax costs, debt financing considerations, and the management of tax
A key tax consideration for management teams based in Ireland Ireland costs on the flows of cash from the portfolio companies. will be to ensure that any shares acquired as part of a roll-over will In terms of Ireland as a holding company jurisdiction, Ireland consist of an investment acquired in their capacity as a shareholder offers an attractive tax regime for holding companies. Irish holding in the target or acquisition structure, and not in their capacity as an companies can receive dividends from their Irish subsidiaries tax- employee (and be documented as such), in order (as appropriate) free and from foreign subsidiaries on an effective Irish tax-free basis to avail of capital gains tax (“CGT”) rates on the return on the (or with a very low effective rate of Irish tax). This is due to a investment (and not the marginal rates of income tax, universal combination of Ireland’s low corporation tax rate and the availability social charge and social security). of Irish credit relief for foreign taxes. Management teams will also be keen to ensure that “share-for- Ireland’s “substantial shareholders” exemption relieves Irish share” CGT relief will be available (where preferable) in order to holding companies from Irish capital gains taxation on the disposals defer any potential CGT in respect of the disposal of their holding of subsidiaries. Two main conditions apply: (a) the subsidiaries in the target. must be resident in the EU or in a country with which Ireland has a Stamp duty roll-over relief may also be relevant in the context of tax treaty, and (b) a minimum 5% shareholding must have been held Irish target companies. for a continuous period of at least 12 months within the previous On an ongoing basis, the potential to avail of employee incentives 24 months. such as SARP (the special assignee relief programme), and FED There are broad exemptions from Irish withholding taxes on (the foreign earnings deduction), and any tax reliefs in the context dividends, interest and royalties, including exemptions for payments of share awards will also be relevant. to persons resident in tax treaty countries (and additionally, in the case of dividend payments, to companies controlled by persons resident in tax treaty countries). 9.3 What are the key tax-efficient arrangements that are typically considered by management teams in private Ireland has no controlled foreign company (“CFC”) rules and no equity portfolio companies (such as growth shares, general thin capitalisation rules. deferred / vesting arrangements, “entrepreneurs’ In terms of transaction tax costs, this can depend on how the relief” or “employee shareholder status” in the UK)? investment is structured. Where the target is an Irish incorporated company, an Irish stamp duty cost will generally arise upon the In general, whilst share incentivisation is common in Ireland, acquisition, at a rate of 1% on the consideration paid (or market the tax treatment of most forms of share incentivisation is not value, if higher), depending on how the investment is structured. particularly advantageous for employees/directors based in Ireland, with (broadly) marginal rates of income tax, universal social charge In terms of share acquisitions generally, appropriately structured, an and social security applying on any benefits obtained. However, if interest deduction should be available for interest paid by an Irish the shares that the employees receive qualify as “restricted shares” holding company in connection with an acquisition of shares (subject (under Irish tax rules), there could be a material abatement of up to to certain conditions being satisfied). Provided certain conditions 60% of the taxable value of the shares for Irish tax purposes (subject are met, this tax deduction can be offset against the profits of the to certain qualifying conditions being met). This is, potentially, very Irish target group. Appropriately structured, Irish withholding tax favourable for employees/directors. on the payment of interest can be reduced or eliminated. Ireland has a specific tax regime for the return (known as “carried As alluded to above, Ireland is also an attractive holding company interest”) received by venture capital managers for managing location for private equity investments outside Ireland. investments in certain venture capital funds. The regime operates Finally, Ireland has a beneficial tax regime applying to Irish by treating certain carried interest received by a partnership or a domiciled investment funds (which can provide an attractive company as being subject to chargeable gains and applying a holding structure for private equity investors). reduced rate to such carried interest. The share of profits which Ireland is widely recognised as one of the world’s most advantageous benefit from the reduced rate must relate to an investment ina jurisdictions in which to establish investment funds. Our investment trading company, which remains in place for at least six years and funds offering was bolstered in 2015 by the introduction of the Irish carries on qualifying “research and development” or “innovation Collective Asset-management Vehicle (“ICAV”). The ICAV is activities”, and satisfies certain additional conditions. a corporate entity that is able to elect its classification under the US “check the box” tax rules. Irish domiciled funds have a variety 9.4 Have there been any significant changes in tax of attractive tax attributes, in particular that income and gains can legislation or the practices of tax authorities accumulate free of Irish tax within the fund and that returns can (including in relation to tax rulings or clearances) be paid to non-Irish investors free of Irish tax provided certain impacting private equity investors, management declarations are in place. The ICAV has great potential in the teams or private equity transactions and are any context of private equity transactions. anticipated? As regards whether off-shore structures are common, in short, it depends. Given the attractive features of Ireland’s holding company There are currently no tax changes expected, which would affect
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private equity investments in or from Ireland. However, the European Commission has presented a package of tax transparency 10.4 Has anti-bribery or anti-corruption legislation measures, the main component of which is a proposed European impacted private equity investment and/or investors’ approach to private equity transactions (e.g. Directive that has required Member States to exchange tax diligence, contractual protection, etc.)? rulings issued in respect of certain “cross-border transactions” on a quarterly basis with effect from 1 January 2017. In addition, PE sellers are increasingly concerned with compliance with Irish Revenue have issued new guidance on the validity period of anti-corruption/bribery legislation principles, particularly given opinions/confirmations issued by Irish Revenue, which are stated increasing regulatory scrutiny of corporate conduct and potentially to be subject to a maximum validity period of five years, or such significant financial penalties and reputational damage resulting shorter period as may have been specified by Irish Revenue when Ireland from non-compliance. Typically this concern is addressed by providing the opinion/confirmation. warranty protection regarding compliance with such laws.
10 Legal and Regulatory Matters 10.5 Are there any circumstances in which: (i) a private equity investor may be held liable for the liabilities of the underlying portfolio companies (including due to 10.1 What are the key laws and regulations affecting breach of applicable laws by the portfolio companies); private equity investors and transactions in your and (ii) one portfolio company may be held liable for jurisdiction, including those that impact private equity the liabilities of another portfolio company? transactions differently to other types of transaction? Generally, an Irish court will not “pierce the corporate veil” so as PE investors and transactions are subject to a broad array of Irish to impose liability on a shareholder for the underlying activities/ statutes applicable in the context of corporate transactions. Key liabilities of its subsidiary/investee company, provided the portfolio legislation includes the Companies Act 2014, the Takeover Rules (in company is a limited liability company. If an unlimited company the context of public-to-private transactions) MIFID, the Investment or partnership is used, its shareholders/partners can be liable for the Intermediaries Act, AIFMD and various taxation statutes. entity’s debts.
10.2 Have there been any significant legal and/or regulatory developments over recent years impacting 11 Other Useful Facts private equity investors or transactions and are any anticipated? 11.1 What other factors commonly give rise to concerns for private equity investors in your jurisdiction or The AIFMD has resulted in private equity funds which operate should such investors otherwise be aware of in in the EU becoming subject to additional regulation. In relation considering an investment in your jurisdiction? to private equity transactions, the new regulation imposes new disclosure requirements in relation to portfolio companies and new Ireland provides an economically attractive venue for private equity restrictions on the ability of private equity fund buyers to release investment and the private equity industry. There are attractive tax assets from portfolio companies (the so-called “asset-stripping” structuring options for non-Irish PE investors (e.g. ICAV structure). rules). These obligations apply to all private equity funds that are See section 9 above. managed within the EU and also any private equity funds that are marketed to investors in EU Member States pursuant to the AIFMD private placement regimes. Acknowledgment The authors would like to thank Brian McCloskey for his invaluable 10.3 How detailed is the legal due diligence (including contribution towards this chapter. compliance) conducted by private equity investors Brian is a partner in the Corporate Department at Matheson where prior to any acquisitions (e.g. typical timeframes, he focuses primarily on mergers and acquisitions and corporate materiality, scope etc.)? Do private equity investors engage outside counsel / professionals to conduct all governance matters. Brian has spent more than 10 years advising legal / compliance due diligence or is any conducted international companies, in both the UK and Ireland, on corporate in-house? law matters including public and private company M&A, private equity transactions, equity fundraisings, reorganisations, joint The level of legal due diligence will vary from transaction to ventures, refinancings and general commercial matters. Having transaction. Typically, diligence will be conducted over a three- to previously worked in a large international law firm in London, Brian six-week period. Materiality thresholds will vary from sector to has particular expertise in cross-border M&A and private equity. sector but in a business with a small number of key contracts, a Brian has experience across a range of sectors acting for both buyers PE buyer may set no materiality threshold on those key contracts. and sellers. Typically outside counsel are engaged to conduct diligence.
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Éanna Mellett Aidan Fahy Matheson Matheson 1 Love Lane 70 Sir John Rogerson’s Quay London EC2V 7JN Dublin 2 United Kingdom Ireland
Tel: +44 207 614 5677 Tel: +353 1 232 2000 Email: [email protected] Email: [email protected] URL: www.matheson.com URL: www.matheson.com Ireland Éanna Mellett is a partner in the Corporate Department at Matheson Aidan Fahy is a partner in the firm’s Tax Department and advises on and is Matheson’s London-Resident Counsel. He advises on mergers all aspects of corporate taxation including the structuring of domestic and acquisitions and private equity transactions. Éanna has advised and international reorganisations, mergers and acquisitions, and the the Irish State and many leading Irish and international companies, tax consequences of doing business in and from Ireland. Aidan has a institutions and private equity houses. Éanna is a member of the Irish particular focus on the tax elements of private equity transactions. He Law Society and a member of the Council of the British Irish Chamber also advises on cross-border financial planning, property transactions, of Commerce. employment related taxes, and insolvency related issues. Aidan also advises on personal taxation and represents high-net-worth individuals and owner-managed businesses.
Matheson’s primary focus is on serving the Irish legal needs of internationally focused companies and financial institutions doing business in and from Ireland. Our clients include the majority of the Fortune 100 companies. We also advise 7 of the top 10 global technology brands and over half of the world’s 50 largest banks. We are headquartered in Dublin and also have offices in London, New York and Palo Alto. More than 600 people work across our four offices, including 80 partners and tax principals and over 350 legal and tax professionals.
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Mongolia Zoljargal Dashnyam
GTs Advocates LLP Enkhsaruul Jargalsaikhan
considered as an inhibiting factor for the development of PE 1 Overview investments in Mongolia.
1.1 What are the most common types of private equity transactions in your jurisdiction? What is the current 2 Structuring Matters state of the market for these transactions? Have you seen any changes in the types of private equity transactions being implemented in the last two to 2.1 What are the most common acquisition structures three years? adopted for private equity transactions in your jurisdiction? Have new structures increasingly developed (e.g. minority investments)? The current democratic Constitution was adopted in 1992, transitioning Mongolia from a socialist country into a democratic The acquisition structure for PE transactions is usually relatively nation with a market economy. Since the right of “private ownership” straightforward in Mongolia. The most commonly used transaction was first recognised and secured by the Constitution in 1992, most structure is PE sponsors establishing a holding company which of the laws that govern private transactions adopted thereafter were acquires or subscribes shares and/or other convertible instruments based on the new constitutional ideologies. Accordingly, private in the portfolio companies. In some cases, PE sponsors establish equity (“PE”) is a relatively new concept in Mongolia. In May 2013, a holding company for the purpose of holding shares in only one the Revised Securities Market Law was enacted and introduced particular portfolio company or one investment sector. The holding certain regulations in relation to investment fund activities. Further company must not necessarily be incorporated under the laws of in October 2013, the Investment Fund Law which provides the legal Mongolia, although that is a possible option. A large number of framework for the establishment and operation of investment funds holding companies tend to be offshore entities for various reasons, in Mongolia, including PE funds (private investment funds), was including a favourable tax purpose. Furthermore, we have also enacted by Parliament. witnessed that a minority investment strategy has been increasingly We believe that the growth capital, mezzanine investments, as well adopted for PE transactions in recent times. as leveraged buyouts account for the most common types of PE transactions that are carried out in Mongolia. Mining, banking and financial services and real estate are the main sectors that attract PE 2.2 What are the main drivers for these acquisition structures? investments in particular. However, due to the economic downturn in recent years associated with the fall of global commodity prices, the current state of the PE market in Mongolia has been relatively Tax consideration is, in our view, the key driver to determine the inactive for the past two to three years and therefore no significant acquisition structure, e.g. using an offshore holding entity or changes have been observed. onshore entity, etc. Further, we believe there are a number of factors that affect the growing popularity of minority investment. For example, under the 1.2 What are the most significant factors or developments Land Law, companies with foreign investment (25% or more of the encouraging or inhibiting private equity transactions in your jurisdiction? total issued shares of which are held by foreign investor(s)) can only have a land use right which cannot be pledged to a third party, as it is the most limited type of land right. Many PE sponsors decide to Mongolia is a country with rich natural resources and great limit their shareholding up to 24% in order to prevent the portfolio potential for growth. We view that this growth potential coupled company from being considered as having foreign investment. with business owners’ need for additional investment encourage PE transactions in Mongolia. Furthermore, the enactment of the Investment Fund Law in 2013, which clarifies the regulatory issues 2.3 How is the equity commonly structured in private in relation to activities of investment funds, certainly promotes PE equity transactions in your jurisdiction (including investments and the establishment of domestic PE funds. institutional, management and carried interests)? However, business owners and management teams still tend to lack sufficient knowledge and experience in PE transactions due In a typical transaction structure, institutional PE investors subscribe to the scarce previous practice. This knowledge-gap is sometimes for shares in the holding company which acquires or further subscribes for shares in the portfolio company or companies. The
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holding company usually also provides, with shareholder loans or subscriptions, preference shares of the portfolio company. Except 3 Governance Matters in the leveraged buyout scenario, the initial shareholder(s), i.e. the business owners, are usually required to retain their equity interest in 3.1 What are the typical governance arrangements the portfolio company, as success of the business significantly relies for private equity portfolio companies? Are such from their presence. Management equity is usually implemented arrangements required to be made publicly available through an employee stock option plan rather than through direct in your jurisdiction? shareholding from the outset. PE sponsors, initial shareholders and management (if applicable) The particulars of the carried interest arrangement vary on a case- enter into a shareholders’ agreement which regulates the internal by-case basis. However, as for PE funds established under the
relations with regards to the governance of the portfolio company. Mongolia Investment Fund Law of Mongolia, annual carried interest must not The shareholders’ agreement clarifies, among other things, the exceed 30% of the total profit generated by the PE fund in that year. undertakings of each shareholder, e.g. PE sponsors and the initial shareholders, and the special rights reserved to PE investors, 2.4 What are the main drivers for these equity structures? restrictions on the transfer of shares, as well as the principles to appoint the management of the company. Many issues agreed under This equity structure, in our opinion, typically relates to the the shareholders’ agreement can be incorporated into the charter of investment industry and the size of the portfolio company. As the company and thereby ensured by the company’s constitutional mentioned above, PE transactions usually take place as a growth document. The charter, as well as the shareholders’ agreement (if investment where the shareholders of the portfolio companies are there are two or more shareholders in the company) must be registered looking for an additional equity investment, but are not interested in with the Legal Entity Registration Office of the General Authority of leaving the company. From the private investors’ perspective, these State Registration (the “LERO”). However, these documents are not initial shareholders are considered as key personnel of the company, required to be made publicly available under Mongolian laws. as they are usually responsible for maintaining the necessary licences Furthermore, certain governance issues of joint stock companies and ensure compliance with the local regulatory requirements. are regulated by the Company Law and the Mongolian Corporate Governance Codex, which are mandatorily applicable for 2.5 In relation to management equity, what are the typical companies that are listed with first category status on the Mongolian vesting and compulsory acquisition provisions? Stock Exchange (the “MSE”). For example, joint stock companies must have a board of directors comprising of nine or more directors Compulsory acquisition by a PE fund/holding company is always and one-third of them must be independent directors. The board addressed in the relevant documentation and typically tied to the of directors have extensive authority under the Company Law, termination of employment of the key managers. In our observation, including determining the business lines of the company, issuing a typical vesting period tends to be around five years. shares within authorised amounts, appointing and resigning the executive director and auditor, etc.
2.6 If a private equity investor is taking a minority position, are there different structuring considerations? 3.2 Do private equity investors and/or their director nominees typically enjoy significant veto rights over We believe that the transaction structure does not differ much in major corporate actions (such as acquisitions and disposals, litigation, indebtedness, changing the relation to PE investors taking a minority position. However, there nature of the business, business plans and strategy, are certain regulatory concerns of which PE investors should be etc.)? If a private equity investor takes a minority aware. For example, if PE investors are interested in taking a minority position, what veto rights would they typically enjoy? position in a joint stock company, they are usually advised to hold less than a controlling block (one-third of the total issued shares) of the Under the Company Law, major corporate actions are reserved to the portfolio company in order to prevent the mandatory bid requirement shareholders. Therefore, if PE investors already hold a majority stake under the Company Law and the Securities Market Law. in the portfolio company, they have the power to shape decisions on Moreover, as provided under the Banking Law, if an investor intends a range of major issues, including corporate reorganisation, change to acquire independently or together, with its affiliated person, 5% of business, change of corporate form, issuance of new shares, or more shares of a Mongolian bank, and thereby becoming an exchange of debt into equity, restructuring and liquidation, etc. influential shareholder of the bank, such bank must obtain approval However, the following issues must be resolved by the overwhelming from the Bank of Mongolia, the central bank of Mongolia, prior to majority of shareholders attending the shareholders’ meeting, unless the transfer or issuance of shares. Furthermore, the Banking Law a higher percentage is set by the charter: prohibits an influential shareholder with a voting right of one bank ■ Amendments to the company’s charter and approval of the from being a shareholder with a voting right of another bank. amended and revised charter. In addition, under the Investment Law, a foreign state-owned legal ■ Corporate reorganisation. entity (50% or more of its shares are owned directly or indirectly by ■ Debt to equity swap and issuance of additional shares. a foreign state) that seeks to obtain 33% or more of the total shares ■ Change of the corporate form of the company. of a Mongolian legal entity operating in certain strategic sectors, i.e. ■ Liquidation of the company and appointment of the mining, banking and finance or media and telecommunication, is liquidation committee. required to obtain approval from the National Development Agency (the “NDA”), a relevant government agency in charge of investment ■ Split or merge of shares. affairs. Accordingly, PE funds that are further invested by foreign PE investors in a minority position, which is not protected by the states, e.g. sovereign wealth funds intending to invest in strategic overwhelming majority requirement, usually enable their veto rights sectors in Mongolia, must obtain the abovementioned approval from by requiring a unanimous or significantly higher threshold of votes in the NDA. relation to certain issues over which they wish to have veto rights over.
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The veto rights of the directors representing the PE investors can also be implemented through a unanimous or significantly higher requirement 3.6 Are there any legal restrictions or other requirements of votes. Under the Company Law, the board of directors attending that a private equity investor should be aware of in appointing its nominees to boards of portfolio the board meeting must resolve a matter by its overwhelming majority, companies? What are the key potential risks and unless a higher percentage is set in the charter or the Company Law. liabilities for (i) directors nominated by private equity For example, under the Company Law, material transactions must be investors to portfolio company boards, and (ii) private resolved by a unanimous decision of the board of directors; hence, equity investors that nominate directors to boards protecting the minority shareholders’ position. of portfolio companies under corporate law and also more generally under other applicable laws (see section 10 below)? 3.3 Are there any limitations on the effectiveness of veto Mongolia arrangements: (i) at the shareholder level; and (ii) There are no legal restrictions in appointing the regular directors at the director nominee level? If so, how are these of the portfolio company’s board. The only requirement is that the typically addressed? board members must complete training on corporate governance and obtain a certificate. However, it is recommended by the Corporate At the shareholder level, since the Company Law provides that the Governance Codex to appoint directors that are specialised in auditing issues listed above must be resolved by the overwhelming majority or accounting, finance, law and the investment field. Furthermore, of the shareholders attending the respective shareholders’ meeting, as mentioned above, at least one-third of the board members in a any contractual arrangement setting a lower voting requirement joint stock company must be independent directors. The Company (limiting the minority shareholders’ voting power) could be found Law and Mongolian Corporate Governance Codex provide certain to be ineffective. The same is true for the directors, as the Company requirements regarding the independent directors, including, inter alia: Law mandatorily requires at least an overwhelming majority vote ■ not holding more than 5% of the shares in the company, either to resolve a matter, unless a higher requirement is set in the charter. independently or together with his/her affiliated persons; ■ not holding a senior position in the company or the group in 3.4 Are there any duties owed by a private equity investor which the company is a participant; to minority shareholders such as management ■ not holding a public office other than public services; shareholders (or vice versa)? If so, how are these typically addressed? ■ having no business relations with the company; ■ having no affiliation to a member of the board or executive management team or internal auditor; and Neither PE sponsors nor management shareholders have duties owed towards each other, unless such is voluntarily agreed under ■ not a relative of a shareholder or shareholder’s affiliated person. the shareholders’ agreement. However, the Company Law provides In accordance with Article 84.1 of the Company Law, directors of certain regulations intended to protect the interest of the minority the board are considered as authorised persons of the company. shareholders. In accordance with Article 86.2 of the Company Law, Accordingly, they must act for the best interest of the company a holder of 1% or more shares of a limited liability company can within the legal framework. As provided under the Company Law, sue the shareholder owning 20% or more shares independently or the directors of the board, as authorised persons, must reimburse together with its affiliated persons in relation to indemnification of the company with their own assets in the case that their actions and losses and damages incurred by such shareholder to the company. breach of obligations caused losses to the company. Moreover, in Furthermore, the Company Law also allows minority shareholders the following cases, the authorised persons, including the board to require the company to repurchase their shares if they either directors, are held liable to the company, as well as its shareholders voted against or refused to vote on certain matters, including and the creditors: corporate reorganisation, approval of material transactions, and any ■ if they used the company’s name for his or her private interest; amendment to the charter limiting the shareholders’ rights. The ■ if they wilfully provided the shareholders or the creditors minority shareholders can also require the company to repurchase with false information; and/or their shares if 75% or more of the shares of the company have been ■ if they breached his or her obligation to inform the acquired by a single shareholder or its affiliated persons. shareholders and creditors on matters of the company. As for the PE investors’ liability, under the Company Law, a 3.5 Are there any limitations or restrictions on the shareholder owning 20% or more shares of a limited liability contents or enforceability of shareholder agreements company must assume the same liabilities as an authorised person (including (i) governing law and jurisdiction, and (ii) of the company. Therefore, if PE investors hold 20% or more non-compete and non-solicit provisions)? shares in the portfolio company with limited liability, they can be held liable for their wrongful actions that caused losses to the The Company Law does not contain any limitations or restrictions company. However, it is usually unlikely to hold PE investors and with regards to the contents or enforceability of shareholders’ shareholders liable in relation to their nomination of board directors. agreements. However, in general, a shareholders’ agreement must be in compliance with the Civil Code in terms of its content and form. In respect of its content, the shareholders’ agreement must 3.7 How do directors nominated by private equity investors deal with actual and potential conflicts of not contravene laws and publicly recognised moral standards. interest arising from (i) their relationship with the Non-compete and non-solicit provisions should be respected by party nominating them, and (ii) positions as directors Mongolian courts unless they are contrary to laws and publicly of other portfolio companies? recognised moral standards, although such provisions are not common in PE transactions. Furthermore, it is allowed by the As provided under Article 84.4.3 of the Company Law, directors of Civil Code for the parties to the shareholders’ agreement to freely the board, as being authorised persons, must act in the best interest determine the governing law and jurisdiction. of the company. Accordingly, a potential conflict of interest can arise for a director between the best interest of the company and that
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of the shareholder that appointed such director. The Company Law required by the Company Law, a decision to change the legal form provides that directors of the board must avoid a conflict of interest of a company (e.g. from public to private) must be resolved by an and report the conflict of interest situation if it has arisen. Therefore, overwhelming majority of the shareholders attending the respective the directors of the board can handle such situation by notifying the shareholders’ meeting. Therefore, acquiring such a high level of other directors and by obtaining approval from them, if possible, stake is certainly a challenge for PE investors, especially if the shares thereby preventing or mitigating the risk or liability that may arise of the target company are widely dispersed among a large number from acting in conflict of interest. of minority shareholders. Furthermore, we have known a few cases where it was hardly achievable to locate the minority shareholders of certain public companies that were privatised recently after the 4 Transaction Terms: General democratic revolution of 1990 and to ensure their right to participate
and vote in the shareholders’ meeting. Accordingly, this can be a Mongolia 4.1 What are the major issues impacting the timetable for challenge for PE investors targeting such public companies with transactions in your jurisdiction, including competition diffused ownership. and other regulatory approval requirements, Compliance of regulatory matters during the share acquisition disclosure obligations and financing issues? of a public company can be another challenge. The Securities Market Law, the Company Law and the Regulation on Tender The transaction timeline is greatly affected by the applicable Offer and Acquisition of Shares (the “Acquisition Regulation”) regulatory approval requirements. If PE investors take a certain stake provide rules concerning the acquisition of shares in public in a company in regulated sectors, such as banking and insurance, companies. In accordance with the Company Law, the acquisition etc., they are required to obtain approval from the competent authority of a controlling block of shares of a public company by an investor prior to the acquisition. In addition, a PE fund that is funded by at either independently or together with its affiliated persons must least 50% by a foreign state (or a sovereign wealth fund) which be conducted through a public tender offer in accordance with the intends to acquire 33% or more of a company in strategic sectors, Securities Market Law and the Acquisition Regulation. The FRC requires approval from the NDA; as described in question 2.6 above. Furthermore, approval from the competition authority may oversees the compliance issue throughout the acquisition process. be required if PE sponsors i) have previously acquired at least a 20% The Acquisition Regulation provides detailed requirements stake or controlling rights of a company that is recognised as having a for making a tender offer, such as pricing and inclusion of bank “dominant position in a given market”, and ii) intends to acquire 20% guarantee, etc. or more of another company that produces or sells the same goods. Once PE sponsors acquire a controlling block of shares, they These approval procedures can take up to two months varying from must make a mandatory tender offer to the shareholders within 60 case to case and thereby prolong the overall transaction timetable. days after such acquisition to purchase the remaining shares. The Moreover, in case PE investment is effected through an issuance Securities Market Law and the Acquisition Regulation impose of new shares by the portfolio company, capital increase must be certain requirements on the pricing and other procedural issues of first reflected in its financial statement and must be verified by the the mandatory tender offer process. It could be a challenge for PE relevant finance authority. Lastly, the acquisition of shares by PE investors to arrange the necessary financing for such mandatory sponsors and/or the capital increase of the portfolio company must tender offer. be registered with the LERO in a timely manner. As for the disclosure requirement, if PE investors acquire a 5.2 Are break-up fees available in your jurisdiction in controlling stake (one-third of the total issued shares) of a joint stock relation to public acquisitions? If not, what other company independently or together with their affiliated persons, arrangements are available, e.g. to cover aborted deal they must disclose such acquisition and the list of their affiliated costs? If so, are such arrangements frequently agreed persons to the Financial Regulatory Commission (the “FRC”) and what is the general range of such break-up fees? within 10 days. However, this disclosure obligation usually does not have an impact on the overall transaction timetable as it takes Break-up fees are available in principle, although it is not regulated. place after the transaction closing. Under a general principle of contractual freedom, negotiating parties of a public acquisition transaction can enter into a letter of intent or similar agreement under which they agree to pay a break- 4.2 Have there been any discernible trends in transaction up fee or reverse break-up fee. In the absence of such contractual terms over recent years? arrangement in advance, the Civil Code and the securities-related laws may not allow the acquirer to claim for indemnification of As we noted above, the overall PE market has slowed down in costs, unless the parties could not reach an agreement due to a recent times, due to the economic downturn coupled with certain neglectful action of the seller. The range of such break-up fees other political and legal factors. Accordingly, there have not been varies on a case-by-case basis. any discernible trends with respect to the transaction terms in the past few years. 6 Transaction Terms: Private Acquisitions 5 Transaction Terms: Public Acquisitions 6.1 What consideration structures are typically preferred by private equity investors (i) on the sell-side, and (ii) 5.1 What particular features and/or challenges apply to on the buy-side, in your jurisdiction? private equity investors involved in public-to-private transactions (and their financing) and how are these commonly dealt with? In the context of public acquisitions, consideration is usually structured using an escrow account, regardless if the PE investors In order to implement a public-to-private transaction, PE investors are on the sell-side or buy-side. Since the acquisition of shares is first need to acquire a sufficient stake of the target company. As effected through a registration of the share transfer at LERO; after
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signing the acquisition agreement, the buyer intends to defer the payment until the completion of the registration process, whereas 6.7 How do private equity buyers typically provide the seller wishes to receive the consideration sooner than that. comfort as to the availability of (i) debt finance, and (ii) equity finance? What rights of enforcement Therefore, the use of an escrow account has been the most preferred do sellers typically obtain if commitments to, or solution which both parties can settle with. obtained by, an SPV are not complied with (e.g. equity underwrite of debt funding, right to specific performance of obligations under an equity 6.2 What is the typical package of warranties/indemnities commitment letter, damages, etc.)? offered by a private equity seller and its management team to a buyer? In the context of public acquisitions, the bidders are required, under the
Mongolia Since warranties and indemnities are concepts not well-established Acquisition Regulation, to attach into the tender offer a bank guarantee and recognised under the Civil Code, these are not typical in obtained in relation to the offer, as a proof of its financial capacity Mongolian law-governed agreements. As for agreements governed to fulfil the consideration obligation. Since the bank guarantee must by laws other than Mongolian laws, PE investors usually provide a cover the whole consideration obligation of the bidder, not just debt limited range of warranties covering its capacity, authority, the legal financing availability, PE bidders need to prove the availability of their title of shares and the inexistence of any pledge or liens or other equity contribution to the bank, not to the shareholders. property rights of a third party over the shares. In some cases, the In private acquisitions, it is not common practice to provide comfort management of the portfolio company provides a set of warranties as to the availability of financing. However, if PE investors are in respect of good standing of the company. acquiring shares of companies in regulated sectors, e.g. banking and insurance, they are required to disclose the source of their financing.
6.3 What is the typical scope of other covenants, undertakings and indemnities provided by a private 6.8 Are reverse break fees prevalent in private equity equity seller and its management team to a buyer? transactions to limit private equity buyers’ exposure? If so, what terms are typical? The typical package of covenants and undertakings of a PE seller and the management team is rather limited and would include In our experience, reverse break fees are not prevalent in PE ensuring a normal operation of business until the completion date. transactions, although it is in principle possible, as discussed in The scope of indemnities provided by PE sellers are limited to the question 5.2 above. warranties, covenants and undertakings given by them. 7 Transaction Terms: IPOs 6.4 Is warranty and indemnity insurance used to “bridge the gap” where only limited warranties are given by the private equity seller and is it common for this 7.1 What particular features and/or challenges should a to be offered by private equity sellers as part of the private equity seller be aware of in considering an IPO sales process? If so, what are the typical (i) excesses exit? / policy limits, and (ii) carve-outs / exclusions from such warranty and indemnity insurance policies? We believe that market risk is the biggest challenge for PE investors contemplating an IPO exit. The Mongolian capital market is not very In our experience, warranty and indemnity insurance has not yet large in terms of the size and volume of transactions. Accordingly, become a common tool in PE transactions occurring in Mongolia. it might be challenging for PE investors to raise the necessary funds that they intend to reach through an IPO exit in Mongolia. 6.5 What limitations will typically apply to the liability of a private equity seller and management team under warranties, covenants, indemnities and undertakings? 7.2 What customary lock-ups would be imposed on private equity sellers on an IPO exit?
Typical methods aimed at the limitation of liabilities of the PE seller As provided under the Securities Listing Rule of the MSE, the and the management team include time and capping limits. MSE can submit its recommendation to lock up the shares held by the holder of the controlling block of a company to the FRC. The 6.6 Do (i) private equity sellers provide security (e.g. Securities Registration Rule provides that the FRC can resolve to escrow accounts) for any warranties / liabilities, and lock up the shares held by the holder of the controlling block for (ii) private equity buyers insist on any security for a certain period of time. Accordingly, if PE investors hold more warranties / liabilities (including any obtained from than the controlling block of shares of the company, their shares the management team)? can be locked up for a period up to 12 months. In accordance with the Securities Registration Rule, the lock up period can be extended Although it is not common for PE sellers to provide a security comfort once, if the FRC finds it necessary. to the buyer in relation to its warranties and liabilities; in rare cases, a range of security mechanisms can be used, including the use of an escrow account, retention of a certain portion of the purchase price (in 7.3 Do private equity sellers generally pursue a dual-track very rare cases) and providing a guarantee from its parent entity, etc. exit process? If so, (i) how late in the process are private equity sellers continuing to run the dual-track, On the other hand, PE buyers almost always require sellers to and (ii) were more dual-track deals ultimately realised provide security through the abovementioned mechanisms, most through a sale or IPO? preferably an escrow account and/or retention of a certain portion of the purchase price. It is usual for PE sellers to pursue a dual-track exit process until
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i) they enter into a letter of engagement with the potential private The thin capitalisation rule which limits the interest bearing purchaser, or ii) the registration of the company as a public company shareholder loan to three times of the equity investment made by the (but not listed). In our experience, the majority of the dual-track shareholder should also be considered for PE investors. deals were realised through private sales in the past.
9.2 What are the key tax considerations for management 8 Financing teams that are selling and/or rolling-over part of their investment into a new acquisition structure?
8.1 Please outline the most common sources of debt The Personal Income Tax Law of Mongolia does not provide an finance used to fund private equity transactions in your exemption on income realised through the sale of shares, regardless jurisdiction and provide an overview of the current of whether the shares are employment shares, or acquired and sold Mongolia state of the finance market in your jurisdiction for such within a short period or reinvested as rollovers, etc. Therefore, the debt (particularly the market for high yield bonds). management team should be aware of the tax implication of their exit event from the outset. Income earned through the sale of shares is The most common source of debt finance for PE transactions in taxed at 10% for individuals after deducting the initial purchase price. Mongolia is a traditional loan obtained from commercial banks. Loans are provided by both local and foreign banks depending on the size of the deal. Since the Mongolian debt capital market for 9.3 What are the key tax-efficient arrangements that are corporate financing is at its very initial stage of development, corporate typically considered by management teams in private equity portfolio companies (such as growth shares, financing through debt securities instruments has always been a rare deferred / vesting arrangements, “entrepreneurs’ case in the past. However, we have witnessed a few cases where relief” or “employee shareholder status” in the UK)? companies raised funds through debt instruments in foreign capital markets. Nevertheless, in recent years, we have observed the growing Mongolian tax legislation does not differentiate between the normal interest of companies and domestic investors to raise capital through sale of shares and the sale of employee shares, vesting arrangement or issuance of debt securities instruments in the domestic market. entrepreneur’s profit, etc. Therefore, a tax-efficient structure might be hardly available for the management team in PE transactions. 8.2 Are there any relevant legal requirements or restrictions impacting the nature or structure of the debt financing (or any particular type of debt 9.4 Have there been any significant changes in tax financing) of private equity transactions? legislation or the practices of tax authorities (including in relation to tax rulings or clearances) impacting private equity investors, management teams or private Under Mongolian laws, there are no specific legal restrictions equity transactions and are any anticipated? or requirements that affect the structure of debt financing in PE transactions. As discussed in question 8.1 above, debt financing We believe that the tax exemption on the income of investment for PE transactions is mostly funded through loans received funds, described in question 9.1 above, is the most significant from offshore banks. However, if acquisition financing is development for encouraging PE investment in Mongolia. This provided by a Mongolian bank, such bank must comply with the exemption certainly impacts PE investors as it decreases their banking regulations, e.g. single borrower limit, regulatory capital eventual tax expenses. requirement, etc. We think that the underdevelopment of the debt capital market in Mongolia is the reason for loan financing being the primary source 10 Legal and Regulatory Matters of debt finance. 10.1 What are the key laws and regulations affecting private equity investors and transactions in your 9 Tax Matters jurisdiction, including those that impact private equity transactions differently to other types of transaction? 9.1 What are the key tax considerations for private equity investors and transactions in your jurisdiction? Are The key laws and regulation governing PE activities in Mongolia off-shore structures common? are as follows: 1. The Investment Funds Law of 2013. With the enactment of the Investment Fund Law in 2013, the 2. The Regulation on Operation of Private Investment Funds Corporate Income Tax Law was simultaneously amended, pursuant enacted in 2014. to which income of the investment fund is exempted from corporate 3. The Securities Market Law of 2011. tax, in order to encourage investment fund activity in Mongolia. 4. The Company Law of 2011. However, the sale of shares in portfolio companies by PE investors triggers a taxable event under the Corporate Income Tax Law. 5. Investment Law of 2013. Income earned through the sale of shares by a resident taxpayer is taxed at 10% after deducting the initial acquisition price. 10.2 Have there been any significant legal and/or Off-shore structures that, in some cases, enable a favourable tax regulatory developments over recent years impacting private equity investors or transactions and are any regime due to the existence of a double tax treaty are also common anticipated? for PE investments. In particular, certain double tax treaties provide a lower withholding tax rate on dividend or interest income for As mentioned in question 1.1 above, PE investment is a relatively residents of the contracting states. Currently, Mongolia has signed new phenomenon in Mongolia. Until the enactment of the a double tax treaty with about 30 countries.
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Investment Funds Law of 2011, there has not been any specific legislation on the establishment and operation of investments funds. 10.5 Are there any circumstances in which: (i) a private Given the gradual development of this kind of transaction, we equity investor may be held liable for the liabilities of the underlying portfolio companies (including due to believe no significant legal and regulatory developments, specifically breach of applicable laws by the portfolio companies); impacting PE transactions and investors, are expected in the next and (ii) one portfolio company may be held liable for one to two years. However, the draft proposal of the Investment the liabilities of another portfolio company? Banking Law has been submitted to Parliament recently, and we view that the potential enactment of this law would contribute to Under the general rules of the Company Law, a company is not the development of PE investments in Mongolia to a certain extent. liable for the liabilities of its shareholders, while its shareholders are liable for the liabilities of the company, only to the extent of Mongolia 10.3 How detailed is the legal due diligence (including their shares in the company. However, a shareholder of more compliance) conducted by private equity investors than 50% of a company (the parent company) can be jointly held prior to any acquisitions (e.g. typical timeframes, liable for the liabilities of its subsidiary, in case the subsidiary has materiality, scope etc.)? Do private equity investors become insolvent due to the decision made by its parent company. engage outside counsel / professionals to conduct all Furthermore, Article 9.4 of the Company Law also provides that a legal / compliance due diligence or is any conducted person/persons that individually or jointly, with its affiliated persons in-house? holding 10% or more shares of a company, must be liable to the company with its own assets for losses and damages incurred to the A comprehensive and detailed legal due diligence is usually company due to the wrongful actions of such persons. Therefore, conducted by PE investors prior to making the final investment the PE investors may be held liable to the portfolio company for any decision. A typical legal due diligence report covers compliance of loss and damage incurred due to the PE investors’ wrongful actions. the main rules and regulations relating to the business, the material debts and financial obligations and industry specific requirements. It is unprecedented to hold one portfolio company liable for The requirement of such broad and extensive due diligence is in another portfolio company, as they are separate legal entities with part related to the fact that PE investors usually do not have much independent legal personalities. knowledge as to the Mongolian business and legal environment. PE investors usually hire local legal counsels to conduct the due 11 Other Useful Facts diligence process.
10.4 Has anti-bribery or anti-corruption legislation 11.1 What other factors commonly give rise to concerns impacted private equity investment and/or investors’ for private equity investors in your jurisdiction or approach to private equity transactions (e.g. should such investors otherwise be aware of in diligence, contractual protection, etc.)? considering an investment in your jurisdiction?
PE investors are increasingly concerned about compliance of the In our view, PE investors should be aware of the legal framework portfolio company with anti-corruption legislations, especially for doing business in Mongolia in general, as the laws are constantly if the company’s business is subject to regulatory oversight and/ developing. New legislations are introduced frequently and “change or licences or with state involvement. In some cases, the seller’s in law” events tend to occur commonly in Mongolia. Enactment representation, as to the compliance of anti-corruption-related of new legislations and amendments to the existing laws can have legislation by the target, was included in the acquisition agreements both a positive and negative impact on the investment made by PE as contractual protection. investors.
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Zoljargal Dashnyam Enkhsaruul Jargalsaikhan GTs Advocates LLP GTs Advocates LLP Suite #705, Park Place Suite #705, Park Place Sukhbaatar District, 1st khoroo Sukhbaatar District, 1st khoroo Chinggis Avenue 24 Chinggis Avenue 24 Ulaanbaatar 14253 Ulaanbaatar 14253 Mongolia Mongolia
Tel: +976 7013 1020 Tel: +976 7013 1020 Email: [email protected] Email: [email protected] URL: www.gtsadvocates.mn URL: www.gtsadvocates.mn
Zoljargal is a leading finance and capital market expert. She has Enkhsaruul is an associate at GTs Advocates LLP. She is frequently Mongolia extensive experience in capital markets; corporate law, including involved in transactions relating to banking and finance, project finance mergers and acquisitions; private equity; and foreign direct and indirect and capital markets. Her practice also includes advising clients on investments. Zoljargal’s portfolio is extensive, and her experience various aspects of investing in Mongolia, including regulatory and in cross-border finance transactions is unparalleled. The Legal 500 compliance matters. She earned her Bachelor’s degree in law from describes Zoljargal as highly recommended, while Chambers and the School of Law, National University of Mongolia. In 2016, she Partners Asia Pacific designates her as a leading lawyer in 2010-2017 received her LL.M. in Finance from Goethe University of Frankfurt, in the client’s guide to Asia Pacific’s Leading Lawyers for Business. Germany. Zoljargal has a Bachelor of Arts degree in International Law from the Prior to joining GTs Advocates, she worked as an associate for another School of Law of the National University of Mongolia (2001). She also commercial law firm in Mongolia where she practised corporate law, has a Master’s degree in Business Administration in Finance from foreign investment law, insolvency law and corporate litigation. During Oklahoma City University, USA (2004). In addition, she has completed her master’s studies in Frankfurt, she completed an internship with the various professional training courses on advanced loan documentation banking and capital markets team at the Frankfurt office of Linklaters and PPP concepts and contracts at reputable international legal Germany LLP. training institutions.
GTs is recognised internationally and domestically as one of the leading law firms in Ulaanbaatar. What distinguishes GTs is the hard working team of lawyers who are always on the offence for knowledge and greater experience. The firm has risen in the rankings to a Band One firm for Mongolia focused in General Business Law in 2015, 2016 and 2017. GTs provides a full range of legal advisory services focalised in five key areas including corporate and M&A, finance and capital markets, all stages of project finance (encompassing mining, infrastructure and energy), commerce and real estate, and lastly, litigation and arbitration. As a law firm with wide-ranging experience with far reaching clients, GTs has cultivated a consistent and instinctive pragmatism that is sensitive of cultural, social and legal differences.
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Netherlands Alexander J. Kaarls
Houthoff Buruma Vivian A. L. van de Haterd
Finally, as a general matter, there appears to be an upward trend 1 Overview in venture capital investments in start-ups. Separately, non-Dutch investors are increasingly active in the Dutch private equity market, 1.1 What are the most common types of private equity which has been growing spectacularly over the years 2012–2015, transactions in your jurisdiction? What is the current while at the same time, Dutch funds are found investing abroad state of the market for these transactions? Have more frequently. you seen any changes in the types of private equity transactions being implemented in the last two to three years? 1.2 What are the most significant factors or developments encouraging or inhibiting private equity transactions in your jurisdiction? The Dutch private equity market is covered by local Dutch private equity players as well as London-based and other international houses. According to information collected by the Dutch private While potential acquisitions of Dutch publicly traded companies by equity association NVP, 146 Dutch companies received buyout (73 non-domestic buyers have recently been met, in the Netherlands, by companies) or growth capital (73 companies) for a combined total higher levels of public scepticism than used to be the case in earlier of over EUR 3.1 billion over the year 2015. EUR 2.6 billion was years, it appears that private equity buyers and private equity deals invested to facilitate buyouts and EUR 482 million was invested as now in fact face less public scrutiny; PE deal-making has gained growth capital. Non-Dutch private equity houses were responsible a (desirable) level of respect in the public eye. In the meantime, for 30 primarily larger buyouts, for a combined total of EUR 1.05 PE firms have, successfully, been on the forefront when it comes billion. In 2015, private equity firms held 1,400 Dutch portfolio to developing and utilising newer deal techniques, including, for companies, employing 380,000 people in the Netherlands. instance, the use of dual-track exit processes. Also, in 2015, EUR 163 million was received by 202 Dutch start- ups through venture capital investments. This is a decrease in 2 Structuring Matters comparison to preceding years, in which the average investment per year was EUR 190 million. The reason for this decrease can be found in the increase in non-Dutch investments by Dutch venture 2.1 What are the most common acquisition structures capitalists. Dutch venture capital firms raised EUR 260 million in adopted for private equity transactions in your jurisdiction? Have new structures increasingly new funds in 2015. Other than an outlier in 2014, this is a significant developed (e.g. minority investments)? increase compared to previous years. NVP also published a preliminary report on private equity and Typically, a Dutch bid vehicle (which may or may not be held by venture capital activity in the Netherlands for the first half of 2016. a non-Dutch fund structure) will purchase a Dutch target entity. This report shows a strong fundraising climate: three life sciences Generally, management will, through its own vehicle, participate at venture capital funds raised a total of EUR 261 million (against the bid vehicle – or higher – level. The bid vehicle will ordinarily merely EUR 111 million in 2015). The overall fundraising for acquire 100 per cent of the capital of the target entity. Although private equity strategies (growth, buyout, generalist) amounted to asset deals are, of course, possible, they are less customary. EUR 1.1 billion raised by seven funds, against EUR 1.4 billion that Although there can be the obvious potential drawbacks to minority was raised in the first half of 2015. However, growth funds reported investments, we have seen PE investors be willing to take a good fundraising of EUR 403 million in the first half of 2016, proactive and creative approach in a competitive market in recent compared to EUR 207 million raised in the whole year of 2015. years, including the structuring of minority investment deals that 54 Dutch companies received a total of EUR 66 million in include targeted protections and upside sharing mechanisms. investments from domestic or non-Dutch venture capital firms in the first half year of 2016, while an aggregate EUR 750 million was 2.2 What are the main drivers for these acquisition invested in 36 buyouts in the first half of 2016, which was below the structures? trends recorded in recent periods. The second half of 2016 looked strong though (after market participants appeared to put aside Brexit Typical drivers in the selection of the transaction structure are tax concerns and largely ignored the US elections). considerations, business continuity and the protection of assets. Such assessment is usually made based on the results of the due
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diligence investigation, such as contractual change of control issues, provided on a non-recourse basis) to finance the acquisition of such transferability of licences, IP protection and ability to effect debt equity stake is not uncommon. pushdowns. In an effort to ensure that the private equity investor(s) do not need to deal with a broad group of co-shareholders, company management’s 2.3 How is the equity commonly structured in private investment is typically channelled through a single vehicle (which equity transactions in your jurisdiction (including could be managed by nominees of the PE house(s), but is typically institutional, management and carried interests)? managed by the portfolio company’s senior management itself). Such a vehicle can be a Dutch (orphan) foundation (stichting), Dutch private equity funds (as well as non-Dutch funds marketed in which would hold and vote the entire equity stake on behalf of the Netherlands) typically behave – broadly – in line with UK practice. company management, against the issuance by the foundation to This means that in the Netherlands, investor liability is limited to its
individual participating company managers and key employees of Netherlands investment, an approximate eight per cent hurdle rate applies, a carried depositary receipts (which depositary receipts embody all of the interest allocation of 20 per cent applies, and that a management fee on economic entitlements to the underlying shares). The foundation the commitment between one and two per cent is common, with a step- board would typically be entitled to vote and dispose of the shares down following the investment period. Transaction fees will typically held by the foundation, but would be required to directly pass on be offset, in whole or in part, against the management fee. A typical to the holders of depositary receipts any and all economic benefits investment period may be three to five years, with an overall term of on the equity (including any dividends, other distributions and – eight to 12 years during which redemptions are not permissible. There prospective – sale proceeds). The foundation structure will typically will typically be at least a one per cent co-investment by the manager. be transparent from a tax point of view. Application of the IFRS and EVCA valuation principles is customary. Alternatively, company management participants and other key A Dutch fund is typically structured as a Dutch limited partnership employees may hold their (collective) stake through stock ownership (commanditaire vennootschap, or “CV”), a Dutch private in a senior management-controlled BV or other corporate that would limited liability company (besloten vennootschap met beperkte hold such stake. aansprakelijkheid, or “BV”), a Dutch public limited liability We note that, sometimes, management participants may also directly company (naamloze vennootschap, or “NV”), a Dutch cooperative hold non-voting shares in the (bidco or) portfolio (BV) company (coöperatief), a Dutch fund for mutual account (fonds voor gemene itself. However, as non-voting shares, under Dutch law, still rekening), or a combination thereof. (mandatorily) carry the right to be called for and attend shareholder At the portfolio level, institutional investors will typically invest meetings, the presence of non-voting stock may complicate through the fund. The fund and carried interests will typically invest shareholder decision-making (i.e., block shareholder action by indirectly and the structure may, in addition to (ordinary) shares, written consent in the absence of cooperation by the holders of the typically include (PIK) notes and other debt. Frequently, company non-voting stock in each specific instance). As a result, depositary management will participate in its portfolio company, through its receipt structures (as described above) tend to be preferred over own vehicle, at the bid vehicle – or higher – level. non-voting stock structures. Typically, a Dutch bid vehicle (which may or may not be held by Apart from outright (senior) management equity participation on an a non-Dutch fund structure) will purchase a Dutch target entity. unrestricted basis from day-one, key employees/management may Although alternatives might be preferable in particular cases, the bid be granted (either) restricted stock, subject to a call option that – for vehicle typically will be a BV. A BV has full independent corporate instance – expires in tranches of 20 per cent each over a five-year personality while allowing great flexibility in terms of governance period, or stock options subject to a similar vesting period. Stock and equity structuring (more so than, for instance, in an NV). The options and restricted stock grant agreements will typically contain bid vehicle can borrow part of the acquisition financing, which can (internationally customary) good leaver/bad leaver provisions. lead to interest deductibility when such BV becomes part of the target Also, the management participation vehicle or direct participants, as group’s fiscal unity. However, particularly in international structures, the case may be, will typically be party to a shareholders’ agreement frequently a Dutch cooperative is interposed, which offers similar entered into with the private equity firm(s), providing – among other governance and equity structuring flexibility, but, among other things, things – for customary drag and tag along provisions, as well as is generally not subject to a 15 per cent dividend withholding tax. non-encumbrance commitments, aimed at ensuring a smooth PE-led exit process. 2.4 What are the main drivers for these equity structures? 2.6 If a private equity investor is taking a minority position, Typical drivers in the selection of the equity structure are facilitation are there different structuring considerations? of effective management, alignment of interests with those of the fund investors (both at the fund management and portfolio company Customary minority protection will typically be negotiated, key employee level), and return on capital and exit in an efficient including proportionate board representation and veto rights in manner from a governance, management tools and tax point of view. respect of selected, material corporate actions.
2.5 In relation to management equity, what are the typical vesting and compulsory acquisition provisions? 3 Governance Matters
Frequently, company management will participate in its portfolio 3.1 What are the typical governance arrangements company, through management’s own vehicle, at the bid vehicle – for private equity portfolio companies? Are such or higher – level. The equity held by management will typically arrangements required to be made publicly available constitute (a direct or indirect interest in) part of the portfolio in your jurisdiction? company’s ordinary stock, ensuring an appropriate mix of risk and reward. The provision of a loan to management (which may be Dutch law allows for the creation of either a single-tiered board
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governance structure, or a two-tiered board structure. In the case of a basic standards of reasonableness and fairness that should be single-tiered board structure, the board could consist of either solely observed vis-à-vis other stakeholders in the company, private equity executive directors, or both executive and non-executive directors. investors are free to vote in their own particular (shareholder) In the case of a two-tiered board system, the company’s articles interests. When voting at the board level, a nominee director – like of association will provide for the creation of both a management any other director – must, in the fulfilment of his or her duty, act in board (solely comprised of executive directors) and a supervisory the interest of the company and its business as a whole (as opposed board (solely comprised of non-executive directors). to the interest of a particular shareholder). The corporate interests Apart from supervising the business through the exercise of that the director must seek to safeguard consist of the interests of all shareholder rights, private equity firms typically seek non-executive stakeholders in the company (including all shareholders, but also board ‘representation’. Historically, this was frequently done employees, creditors, etc.). In practice, board members may seek through the appointment of one or more trusted individuals on legal guidance in particularly sensitive situations, but mostly this Netherlands the supervisory board, in a two-tiered structure. Such two-tiered tends not to be a real issue in typical portfolio company situations. structure was particularly popular (and, in fact, in the past was mandatory for certain larger companies) as the explicit possibility to 3.4 Are there any duties owed by a private equity investor appoint non-executives in a single-tiered board structure was only to minority shareholders such as management reflected in the Dutch civil code relatively recently. shareholders (or vice versa)? If so, how are these Prospective director liability exposure is (still) typically perceived typically addressed? as more limited for a supervisory director in a two-tiered board structure in comparison to a non-executive director in a single-tiered Under Dutch law, a majority shareholder (such as a PE house board structure (as a supervisory board member would – as opposed in a portfolio company) should observe basic standards of to a non-executive in a single-tier board structure – not form part reasonableness and fairness towards other shareholders and their of the company’s sole ‘managing’ board). However, we believe bona fide interests. This, essentially, means that the majority that the single-tiered board structure is gaining in popularity in PE shareholder should not exercise its rights in an abusive manner. transactions, because (i) it allows the PE house’s ‘representatives’ Having said that, the overriding rule is that a shareholder is free to direct access to all management/board information and a more direct act in its own interests and it does not owe any fiduciary or similar handle on day-to-day business developments, and (ii) the structure duty to any other shareholder. tends to be more familiar to US, UK and other international investors. The general governance arrangements are typically laid down in the articles of association. There is a statutory obligation to file the 3.5 Are there any limitations or restrictions on the contents or enforceability of shareholder agreements articles of association with the trade register of the Dutch chamber (including (i) governing law and jurisdiction, and (ii) of commerce and as a result the general governance arrangements non-compete and non-solicit provisions)? laid down in the articles of association are publicly available. There is no statutory requirement to file any – more detailed – governance Dutch company shareholders agreements are relatively flexible arrangements laid down in, for example, board rules or shareholders in terms of content. In order to make certain commitments fully/ agreements. directly enforceable (as opposed to potentially creating ‘just a breach of contract’), it may be preferable to lay down certain 3.2 Do private equity investors and/or their director commitments in the portfolio company’s articles of association as nominees typically enjoy significant veto rights over well. Dutch company articles of association are more restrictive, major corporate actions (such as acquisitions and though, both in form and in substance. In addition, the full content disposals, litigation, indebtedness, changing the nature of the business, business plans and strategy, of Dutch companies’ articles of association are publicly on file with etc.)? If a private equity investor takes a minority the trade register, while shareholders’ agreements can be kept fully position, what veto rights would they typically enjoy? confidential. A shareholders’ agreement with respect to a Dutch portfolio Incorporation of a list of reserved matters in the shareholders’ company may be governed by a law other than Dutch law and agreement, the articles of association of the portfolio company and/ jurisdiction in the Netherlands is not required. We note that the or the portfolio company board rules is customary. As a general articles of association of a Dutch company (which will in any case matter, such rules do not directly affect the rights of third parties. also contain a substantial number of the company’s governance Accordingly, if one or more executive board member(s) would exceed provisions) will mandatorily be governed by Dutch law, and their (internal) authority by binding the company to a commitment disputes involving corporate duties under the law or the articles without first obtaining the required internal approval (be it at the non- can be brought in the Dutch courts, irrespective of the governing executive or at the shareholder level), the company will generally law and jurisdiction provided for in the shareholders’ agreement. be bound. However, if an executive would have done so in breach In connection therewith, and recognising the record of the Dutch of the company’s articles of association, it may be relatively easy to courts, many Dutch as well as non-Dutch private equity investors establish director liability vis-à-vis the company in relation thereto. have been happy to provide for Dutch law and jurisdiction in their Accordingly, reserved matters lists tend to be effective tools. In shareholders’ agreements. However, we frequently see alternative cases of minority investments, customary minority protection will arrangements as well. typically be negotiated, including proportionate board representation and veto rights in respect of selected, material corporate actions. One of the more restrictive covenants in the shareholders’ agreement is the non-compete. The restrictions are driven by EU rules and regulations and are mainly related to the duration of the non- 3.3 Are there any limitations on the effectiveness of veto compete after the termination of the shareholders’ agreement and arrangements: (i) at the shareholder level; and (ii) at the director nominee level? If so, how are these the geographical and product scope of the non-compete. typically addressed?
At the shareholder level, as long as shareholders do not infringe
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Apart from the above-described formal compliance with the Dutch 3.6 Are there any legal restrictions or other requirements conflict of interests rules, each director should continuously ensure that a private equity investor should be aware of that he or she acts independently and in the interest of the relevant in appointing its nominees to boards of portfolio portfolio company and all of its stakeholders. Private equity firms companies? What are the key potential risks and liabilities for (i) directors nominated by private equity may want to ensure that they do not nominate individuals for board investors to portfolio company boards, and (ii) private positions with respect to whom conflicts of interest are overly equity investors that nominate directors to boards likely to arise. Moreover, parties should ensure that any particular of portfolio companies under corporate law and also directors’ board positions at other (portfolio) companies do not more generally under other applicable laws (see give rise to confidentiality or competition concerns. In addition, section 10 below)? private equity firms are well advised to monitor that they either have sufficient and appropriate nominees on the board to ensure that they Non-executive directors (whether in a two-tiered structure or in continue to feel comfortable with decision-making when one or Netherlands a single-tier structure) are barred from taking executive action more of their nominees abstain from a decision-making process as and supervisory board members cannot sit on the company’s a result of a conflict of interests, or ensure that the matter concerned management board. When a supervisory board member takes any will be raised to the shareholder level. It is not atypical to require executive action, he or she exposes him or herself to increased that any particular resolution will in any case require the affirmative levels of potential liability, as if such person is a management board vote of a PE firm-nominee, in the absence of which it must be raised member. to the shareholder level. At the level of each board, the duties of the board members are collective in nature, which means that if the board consists of more than one member, the members of the board should exercise their 4 Transaction Terms: General decision-making powers collectively. As a general rule, collective responsibility of the board may result in joint and several liability. A 4.1 What are the major issues impacting the timetable board member may avoid liability by proving that he or she was not for transactions in your jurisdiction, including culpable for the shortcoming(s) of the board and that he or she was competition and other regulatory approval not negligent in taking action to avert the negative consequences of requirements, disclosure obligations and financing the shortcoming(s). issues? Directors may be held personally liable – by the company, but not by its shareholders on behalf of the company (i.e., no U.S. style The major issues impacting the timetable for private transactions derivative suits) – for serious violations of their specific statutory in the Netherlands mainly relate to the involvement of the works duties and general good faith obligations (as developed in case law). council in the transaction and competition clearance. Formally, the The standard to which directors are held is that of a reasonably works council of a company should be provided with the opportunity acting “business person”. to form an opinion on the envisaged transaction at a stage in the transaction process at which the opinion could potentially have an When director duties are fulfilled with reasonable diligence, and impact on the outcome of the transaction. For IPOs to be listed appropriate D&O coverage has been taken out, we believe it is fair to on a regulated market, an additional issue impacting the timetable say that the potential risks and liabilities for a director nominated by consists of prospectus preparation and dealings with the regulator, private equity investors to the board of a Dutch portfolio company whose approval of the prospectus typically dictates the entire should be deemed reasonable and manageable by international timetable. Fortunately, The Netherlands Authority for the Financial standards. Markets (AFM) has proven to be willing to be quite cooperative and For a brief description of certain (limited but) potential risks and takes a constructive approach, making it relatively easy for parties liabilities for private equity investors that have nominated directors to set a clear and manageable timetable. For public-to-private to boards of Dutch portfolio companies, please refer to our answer transactions, the public bid rules, together with the competition to question 10.5 below. process, will typically dictate the timetable.
3.7 How do directors nominated by private equity 4.2 Have there been any discernible trends in transaction investors deal with actual and potential conflicts of terms over recent years? interest arising from (i) their relationship with the party nominating them, and (ii) positions as directors of other portfolio companies? Following the financial crisis, the market turned from a sellers’ market into a buyers’ market, and has now largely turned into a sellers’ market again. Accordingly, deals tend to get done in shorter The Dutch director conflicts of interest rules are relatively time frames again and, sometimes, with ‘lighter’ documentation. restrictive. In principle, a conflict of interests only arises ifa director has a personal financial interest in the matter concerned. Accordingly, a conflict of interests is not necessarily deemed 5 Transaction Terms: Public Acquisitions to arise if a director does not have a personal (and substantial) financial stake in the outcome of the matter. In cases where there is a conflict of interests, the relevant board member cannot take 5.1 What particular features and/or challenges apply to part in the board decision-making process on the matter concerned. private equity investors involved in public-to-private transactions (and their financing) and how are these It follows from the above that under Dutch law, a director is not commonly dealt with? necessarily disqualified from the board decision-making process in case of a (potential) conflict with either the party that nominated the PE firms tend to face no greater challenges in public bid situations director or another portfolio company where the director serves on than strategic bidders. In fact, although typically the entire portfolio the board as well. needs to be considered for antitrust review purposes, issues in this
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respect tend to be more serious (potentially leading to an extended bid period) for strategic buyers. In the case of a cash bid (of course, 6.2 What is the typical package of warranties/indemnities likely in the case of a public-to-private deal), the bidder must offered by a private equity seller and its management team to a buyer? confirm ‘certain funds’ when it files its bid document with the AFM for approval. This is not necessarily more onerous to a PE house than to a strategic bidder offering cash. In line with the prevalent practice in other jurisdictions, private equity sellers in the Netherlands tend to insist on offering very limited We refer to Houthoff Buruma’s contribution in Global Legal warranties and indemnities, and frequently limiting exposure to any Group’s The International Comparative Legal Guide to: Mergers business warranties to an amount equal to an escrowed amount. and Acquisitions 2017 for more extensive detail on the Dutch public However, in recent years, from time to time private equity sellers have bid rules and timetable. offered warranties and indemnities beyond the standard authority and
Netherlands title warranties, etc., in an effort to get a deal done. In that event, we 5.2 Are break-up fees available in your jurisdiction in have seen that warranty and indemnity insurance (with a preference relation to public acquisitions? If not, what other for buyers’ insurance, whereby the premium is sometimes deducted arrangements are available, e.g. to cover aborted deal from the purchase price) is increasingly becoming popular and can fill costs? If so, are such arrangements frequently agreed the gap between the comfort sought by the buyer and the exposure the and what is the general range of such break-up fees? private equity seller is willing to accept.
Break fees are allowed and are frequently agreed (including reverse break fees, although less typical). There are no specific rules in 6.3 What is the typical scope of other covenants, place, nor is there definitive case law on the matter. However, it undertakings and indemnities provided by a private equity seller and its management team to a buyer? is generally believed that (i) there should be some relationship between size of the break fee and deal costs, and (ii) excessive break fees may conflict with the target board’s fiduciary duties (and could They are in line with UK practice. qualify as a disproportional anti-takeover defence) if they would frustrate potential competing bids. A break fee of one to two per 6.4 Is warranty and indemnity insurance used to “bridge cent would not be atypical. the gap” where only limited warranties are given by There is extensive case law in the Netherlands on the subject of the private equity seller and is it common for this to be offered by private equity sellers as part of the aborted deal negotiations. In general, the Dutch Supreme Court has sales process? If so, what are the typical (i) excesses held that a party has contractual freedom, and, as such, is free to / policy limits, and (ii) carve-outs / exclusions from abort negotiations at any point during the process, unless aborting such warranty and indemnity insurance policies? negotiations is unacceptable given the legitimate expectations of the counter party that a deal would be signed, which makes the aborting The warranty and indemnity insurance market is increasing in party liable for damages of the other party. size and importance in the Netherlands and, as such, warranty and indemnity insurances are not necessarily (yet) commonplace 6 Transaction Terms: Private Acquisitions in the Netherlands. However, given the fact that the number of warranty and indemnity insurance policies concluded on a yearly basis worldwide have increased in recent year as a result of 6.1 What consideration structures are typically preferred more sophisticated and tailor-made insurance products (now also by private equity investors (i) on the sell-side, and (ii) covering, for instance, tax matters) and lower insurance premiums, on the buy-side, in your jurisdiction? insurance brokers expect that such insurances will also continue to become more attractive to the Dutch M&A market. Insurance The predominant structure for private equity transactions in the brokers are actively approaching deal-makers in the Netherlands, Netherlands is similar to the structure prevalent in other jurisdictions and we notice increased acceptance of the tool in the Dutch market. such as the UK and the U.S. The transactions (typically straight We expect that, in the future, more and more buyers will make use of buyouts) are commonly funded partially by one or more banks and warranty and indemnity insurance products, especially in controlled partially by private equity funds together with the management auction situations, in which case the insurance might be seen as of the target company. The leverage ratio is dependent on the covering certain risks and could – as a result – potentially have a current market conditions and the projected cash flows of the target positive impact on valuation, giving a bidder a competitive edge. company. Due to the market conditions following the financial crisis, a clear trend of lower leverage ratios in private equity 6.5 What limitations will typically apply to the liability of transactions has clearly been visible, but in more recent years the a private equity seller and management team under tide appears to have turned. warranties, covenants, indemnities and undertakings? In terms of consideration, cash deals tend to be preferred. Reinvestment by management and certain other sellers (including, See question 6.2. for instance, influential local investors) may be (strongly) encouraged (or demanded). With regard to determining the 6.6 Do (i) private equity sellers provide security (e.g. purchase price, private equity funds in the Netherlands traditionally escrow accounts) for any warranties / liabilities, and prefer locked-box mechanisms (focused on working capital) over (ii) private equity buyers insist on any security for closing accounts, although the latter became more popular during warranties / liabilities (including any obtained from the downturn due to the resulting increase in risk aversion of market the management team)? participants (whereby, also in this respect, the tide appears to be turning again). Although private equity sellers tend to push back on providing security for any warranties/liabilities, (limited) escrow arrangements are agreed from time to time. When buying, private equity houses tend to
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take a willing look at warranty and indemnity insurance as a partial by a dual-track process. We expect that this exit strategy will alternative to seller provided security. Comfort/security from the continue to be popular in the years to come. In some cases, the management team is frequently not seen as desirable (‘you don’t want dual-track exit processes were prepared in great detail, and were to sue your new partners’), and in fact comfort can be sought from run pretty much until the end. In other cases, we have seen the IPO sellers that they won’t seek recourse from continuing management as leading option while the seller remained willing to sell privately. team members. Still, in case of a strategic seller, depending on the Although the processes went either way in recent years, ultimately, sale dynamic and competitiveness of the sale process, it is not entirely most of the dual-track exit processes are concluded with a sale uncommon for a private equity buyer to seek a more extensive set of rather than through an IPO. warranties and corresponding security for those warranties.
6.7 How do private equity buyers typically provide 8 Financing comfort as to the availability of (i) debt finance, Netherlands and (ii) equity finance? What rights of enforcement do sellers typically obtain if commitments to, or 8.1 Please outline the most common sources of debt obtained by, an SPV are not complied with (e.g. finance used to fund private equity transactions in equity underwrite of debt funding, right to specific your jurisdiction and provide an overview of the performance of obligations under an equity current state of the finance market in your jurisdiction commitment letter, damages, etc.)? for such debt (particularly the market for high yield bonds). Private equity buyers typically provide comfort by means of an (internationally) customary comfort letter. Debt finance for Dutch private equity deals is largely made available in the form of senior debt and to a lesser extent mezzanine finance, with funding/valuation gaps commonly being filled with vendor 6.8 Are reverse break fees prevalent in private equity loans and/or earn-out arrangements. transactions to limit private equity buyers’ exposure? If so, what terms are typical? The senior debt is largely sourced from Dutch banks and (to a lesser extent) from US/UK banks or German banks. Mezzanine finance is As mentioned above, reverse break fees are less typical in the Dutch to a large extent sourced from specialised mezzanine-debt funds and private equity market, both in public and private transactions. to a lesser extent by Dutch or US/UK banks. Stapled financing (i.e. where the seller pre-arranges an acquisition loan for the benefit of the buyer) may also occur depending on the transaction, but seems 7 Transaction Terms: IPOs to be less common.
7.1 What particular features and/or challenges should a 8.2 Are there any relevant legal requirements or private equity seller be aware of in considering an IPO restrictions impacting the nature or structure of exit? the debt financing (or any particular type of debt financing) of private equity transactions? IPO exits are still relatively rare in the Dutch private equity market (albeit, markedly more popular in recent years as a result of the With respect to private companies with limited liability (besloten IPO window being open for an extended period of time and a well- vennootschappen met beperkte aansprakelijkheid), the financial performing Euronext Amsterdam). Also, recently we have noted a assistance restrictions have been abolished as of 1 October 2012. marked uptick in dual-track exit process deals. An obvious major This means that there is no longer any specific legal provision that drawback of the IPO exit is the fact that the customary lock-up renders void financial assistance transactions by a Dutch private arrangements, prevalent in any IPO, as well as market dynamics, company with limited liability for acquisition loans, and no specific deprive the private equity firm of the opportunity to sell its stake in deal structuring is necessary in this regard. The financial assistance its entirety on the date of listing. Apart from market and disclosure rules with respect to public companies (naamloze vennootschappen) risks, from a legal perspective, the main challenge remains preparing remain in force. Succinctly put, the consequence of these rules is the target company to become a public company. In deals where a PE that a public company or its subsidiaries (i) is not allowed to provide house may not have sole control, we have seen that it may be key to security or guarantees for financing that is used to acquire the shares ensure – in the early stages of the PE investment, far before an IPO in such public company, and (ii) is restricted in providing loans to transaction should actually be implemented – that the shareholders’ third parties to acquire shares in such public company. Common agreement (and other contractual framework) truly allows the PE ways of addressing the financial assistance rules include ensuring house to get done what needs to get done to complete the public that the acquisition financing: (i) is provided to the target public offering and listing. company which can, along with its subsidiaries, provide security for such loan after which the proceeds of the loan are upstreamed 7.2 What customary lock-ups would be imposed on by the public company to the buyer, which then purchases the private equity sellers on an IPO exit? shares in the public company; or (ii) is provided to the buyer and the buyer enters into a statutory merger (juridische fusie) with the This is in line with UK practice. target public company after the shares thereof have been acquired, following which the merged entity can provide security for the loan. 7.3 Do private equity sellers generally pursue a dual-track Please note, however, that the number of private companies with exit process? If so, (i) how late in the process are limited liability existing in the Netherlands far exceeds the number private equity sellers continuing to run the dual-track, of public companies. The practical consequence for private equity and (ii) were more dual-track deals ultimately realised transactions of the continued existence of financial assistance rules through a sale or IPO? with respect to public companies is therefore not great. Although the importance of financial assistance rules under Dutch law is In 2016, the majority of the IPO’s in the Netherlands were preceded
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therefore limited, it should be noted that general principles of Dutch (ii) the equity instrument consist of preference shares bearing an law such as corporate benefit, fraudulent conveyance and board annual yield of at least 15 per cent. duties towards the company and its stakeholders remain important Loan receivables bearing a yield that is dependent on, for example, to consider when resolving on whether or not to enter into financial the profits or turnover of the business or other managerial or assistance transactions. financial targets can also qualify as an equity instrument qualifying as a lucrative interest. 9 Tax Matters 9.3 What are the key tax-efficient arrangements that are typically considered by management teams in private 9.1 What are the key tax considerations for private equity equity portfolio companies (such as growth shares, investors and transactions in your jurisdiction? Are deferred / vesting arrangements, “entrepreneurs’ Netherlands off-shore structures common? relief” or “employee shareholder status” in the UK)?
As noted above, generally Dutch Coop/BV or CV structures are used A manager who has a certain carried interest in the acquisition for transactions where private equity firms invest in and outside the structure qualifying as a lucrative interest as mentioned in question Netherlands. This enables private equity investors to invest in a tax- 9.2. above, may structure its interest through an intermediate entity efficient manner if the structure suits the main business purpose of in such manner that its capital gains and income qualify for specific the private equity investors. taxation in Box 2 (at a flat rate of 25 per cent). Such treatment will One of the key features of a Dutch structure is that it can benefit from be available if the following conditions are met: the participation exemption. This Dutch participation exemption (i) the lucrative interest is held indirectly through a (Dutch or provides for a full exemption of corporate income tax in relation to non-Dutch) holding company in which the taxpayer holds a income (dividend and capital gains) derived from (Dutch and non- substantial interest (i.e. an interest of at least five per cent of Dutch) qualifying subsidiaries. a certain class of shares); and (ii) at least 95 per cent of the annual lucrative interest income In the Netherlands, dividend payments are subject to 15 per cent (i.e. dividends and capital gains) derived by the (Dutch or dividend withholding tax. However, in many cases the dividend non-Dutch) holding company is distributed to the taxpayer withholding tax rate is reduced or cancelled due to applicable within the calendar year of realisation (the “distribution tax treaty rates. In addition, if structured properly and certain requirement”), unless this is not possible due to legal requirements are met, distributions of profits by a Coop are generally restrictions. In that event, distribution has to take place not subject to withholding tax. immediately upon the moment that the restrictions no longer Capital gains realised on the sale of an interest in a Coop/BV by apply. either a Dutch or foreign entity are generally not subject to corporate For foreign managers, it is important to observe the applicability of income tax unless certain anti-abuse provisions are triggered (see a double tax treaty which may prevent or limit the Netherlands from under question 9.4). levying Dutch tax on a carried interest. Although Dutch law does not have thin cap rules, specific limitations on interest deductions may apply on leveraged acquisitions, for 9.4 Have there been any significant changes in tax example in respect of an inclusion of a debt funded Dutch BidCo in legislation or the practices of tax authorities a fiscal unity with an underlying Dutch target entity. (including in relation to tax rulings or clearances) impacting private equity investors, management teams or private equity transactions and are any 9.2 What are the key tax considerations for management anticipated? teams that are selling and/or rolling-over part of their investment into a new acquisition structure? As part of the implementation of a European Directive, the Dutch tax rules in relation to taxation of non-Dutch resident entities were Managers who obtain a qualifying carried interest in the acquisition amended slightly as of 1 January 2016. Taking into account this structure in relation to their Netherlands-based work activities will latest change, non-Dutch resident entities are generally only subject fall within the scope of the so-called “lucrative interest” rules for to corporate income tax on income and capital gains realised in Dutch income tax purposes. Income and capital gains derived respect of shareholding in a Dutch BV or membership interest in from a lucrative interest are taxed at progressive rates up to 52 per a Coop if: cent, unless such a lucrative interest is held indirectly through an ■ such shareholding or interest is attributable to an enterprise intermediate holding vehicle and some other conditions are met (see or permanent representative of the shareholder in the under question 9.3). Netherlands and the Dutch participation exemption does not The lucrative interest rules apply if (i) a taxpayer owns an equity apply to such shareholding or interest; or instrument, (ii) such equity instrument is held with the purpose to ■ a shareholder holds a substantial interest in the Dutch entity be remuneration for the activities performed, while (iii) the equity (generally a direct or indirect five per cent shareholding instrument requires no (or only a limited) capital investment that due or interest), such substantial interest is held with the main to gearing may result in a potential return that is disproportionate to purpose or one of the main purposes to avoid Dutch income the capital invested. tax or dividend withholding tax of another person, and such substantial interest is the result of a (series of) artificial Equity instruments generally speaking qualify as a lucrative interest arrangement(s) that (are) not genuine (e.g. not based on if: sound business principles). (i) the equity instrument is a class of shares that is subordinated to other classes of shares and the paid-in capital of the subordinated class is less than 10 per cent of the total paid-in capital of the company concerned; and
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Compliance has become an increasing focus over recent years. 10 Legal and Regulatory Matters The legal due diligence process is commonly conducted by outside counsel. In controlled auctions, it is not uncommon that an extensive 10.1 What are the key laws and regulations affecting legal vendor due diligence report is prepared, on which reliance can private equity investors and transactions in your be given (in addition to the bidder/buyer’s own – confirmatory – due jurisdiction, including those that impact private equity diligence). Many private equity buyers prefer a focused, high level transactions differently to other types of transaction? legal due diligence exercise resulting in issues-based reporting. Legal due diligence efforts are typically undertaken within weeks, whereby The key legal regime that normally applies to private equity – when needed – substantial efforts can be undertaken and finished is the Dutch regime implementing the Alternative Investment in short timeframes, whether in an effort to contain costs (e.g. in Fund Managers Directive (2011/61/EU), or AIFMD. Pursuant to competitive auction processes), to allow for pre-emptive bidding or this regime, management companies of private equity funds are to allow for bidding in emergency processes (e.g., insolvent seller). Netherlands normally subject to regulation. Private equity investors themselves are not directly impacted by this regime, as the regime only regulates 10.4 Has anti-bribery or anti-corruption legislation management companies (so-called alternative investment fund impacted private equity investment and/or investors’ managers or AIFMs) and funds (or alternative investment funds or approach to private equity transactions (e.g. AIFs). Certain exemptions apply, the most important exemption diligence, contractual protection, etc.)? being true family offices and sheer corporate holding structures. Pursuant to the AIFMD, management companies are subject to Apart from Dutch law compliance checks, when investing in the registration or licensing depending on the size of all funds managed. Netherlands, private equity houses tend to be very much aware of the If this is less than EUR 500 million on an aggregate basis, and U.S. and UK anti-bribery and anti-corruption rules, and sensitivity assuming that the funds are closed-end for at least five years and to potential issues in this respect tends to form an integral part of the no leverage at fund level applies, a Dutch management company diligence process. Contractual comfort sought in this respect tends is subject to registration with the AFM only. When registered, to be in line with international practice. certain reporting requirements need to be met. A large part of the Dutch private equity fund management companies is subject to this 10.5 Are there any circumstances in which: (i) a private registration. If the aforementioned threshold is exceeded, however, equity investor may be held liable for the liabilities of a management company is subject to licensing and compliance with the underlying portfolio companies (including due to certain ongoing requirements. Among such ongoing requirements breach of applicable laws by the portfolio companies); is the requirement to publish a prospectus, meeting the requirements and (ii) one portfolio company may be held liable for set by the AIFMD (and, in case of retail marketing, the Dutch regime the liabilities of another portfolio company? on retail marketing) and rules relating to holdings and control of non- listed companies. These rules include a duty to disclose acquisitions If there is intense involvement by the private equity house (for of interest to the AFM when surpassing certain thresholds, and a instance, through a combination of information and consent rights prohibition on asset stripping during the first 24 months following laid down in the governance documentation, and de facto intense acquisition of control (>50 per cent of the votes) of targets of a involvement in the company’s management, strategy and controls) particular size by means of dividend payments, capital reduction, causing the PE house to exercise decisive influence over the strategy repayment on shares and repurchase of shares. As a result, PE and/or operations of a portfolio company, such involvement may transactions may be impacted if this licensing regime applies. lead to a duty of care vis-à-vis the company’s creditors if the PE house knew or should have known that – without its appropriate action – the portfolio company would end up in insolvency. 10.2 Have there been any significant legal and/or Accordingly, it may be helpful to aim for an appropriate balance regulatory developments over recent years impacting private equity investors or transactions and are any between active involvement and reliance on senior management. anticipated? Apart from the above, we refer to the EC power cable cartel case (EC, IP/14/358, 2 April 2014) in which a large investment bank No, the AIFMD regime entered into force on 22 July 2013. Small was held jointly and severally liable by the European Commission amendments have been made since and further updates are expected, in relation to that investment bank’s former ownership of a power as the regime did not yet enter into force completely. However, cable manufacturer, which, obviously, may have ramifications for the general requirements for private equity firms active in the PE houses active in the Netherlands as well. Netherlands have remained the same since. We do note that certain Assuming no other ties (except for the fact that they are ultimately held exemptions are still available to non-EU management companies by the same PE fund), and, accordingly, assuming among others that no and non-EU funds. contractual comfort is provided for each other’s debt or the like, there is no particular basis under Dutch law that would make a portfolio 10.3 How detailed is the legal due diligence (including company liable for the liabilities of another portfolio company. compliance) conducted by private equity investors prior to any acquisitions (e.g. typical timeframes, materiality, scope etc.)? Do private equity investors 11 Other Useful Facts engage outside counsel / professionals to conduct all legal / compliance due diligence or is any conducted in-house? 11.1 What other factors commonly give rise to concerns for private equity investors in your jurisdiction or should such investors otherwise be aware of in Depending on the complexity of the business or the importance of considering an investment in your jurisdiction? a certain legal field to the business (e.g. environmental, intellectual property, securities/regulatory), levels of legal due diligence vary. In a controversial 2010 ruling, the enterprise chamber at the
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Amsterdam court of appeals held that a private equity firm, when corporate interest prior to approving a PE deal. Not doing so might entering the capital of a target company, should consider the constitute mismanagement. corporate interests of the target prior to becoming a shareholder (i.e., should consider what level of leverage might adversely affect the target’s corporate interest and therefore be non-acceptable, etc.). Acknowledgment The Supreme Court has not confirmed this view (in the absence The authors are grateful to their colleagues Jean Paul Dresen (tax), of appeal); there was ultimately no specific PE party liability, and Jan-Paul van der Hoek and Michiel Pannekoek (PE transactions), this view remains controversial. Less controversial was the court’s Oscar van Angeren (fund formation), Jeroen Vossenberg (debt finding that the target board should duly consider the company’s finance) and Bastiaan Siemers (regulatory) for their valuable input. Netherlands Alexander J. Kaarls Vivian A. L. van de Haterd Houthoff Buruma Houthoff Buruma Gustav Mahlerplein 50 Gustav Mahlerplein 50 1082 MA Amsterdam 1082 MA Amsterdam Netherlands Netherlands
Tel: +31 20 605 6110 Tel: +31 20 605 6580 Email: [email protected] Email: [email protected] URL: www.houthoff.com URL: www.houthoff.com
Alexander Kaarls focuses on (cross-border) private & public M&A Vivian van de Haterd specialises in (cross-border) private M&A and capital markets transactions. He also regularly advises on joint transactions. She mainly represents private equity firms. Vivian venture, securities laws compliance and governance matters. Before graduated from the Faculty of Law of the University of Amsterdam in joining Houthoff, Alexander practised law with Skadden, Arps, Slate, 2015. Vivian joined Houthoff Buruma in 2015 and was admitted to the Meagher & Flom LLP from 1994 until 2004. He is recognised as a Bar in the Netherlands in that same year. leading M&A practitioner in The Netherlands by The Legal 500, Chambers Global, Chambers Europe, Who’s Who Legal – Mergers and Acquisitions, and IFLR1000. Alexander studied at Leiden University (School of Law) and Sciences Po (Paris). Alexander is a member of the Bars in Amsterdam and California.
Houthoff Buruma is a leading Netherlands-based law firm with over 290 lawyers worldwide. Focusing on complex transactions and dispute resolution matters, the firm typically advises domestic and international corporations, private equity houses, financial institutions and governments on a broad variety of matters, including those that may have a key strategic impact on or present the most significant challenges to the organisation. In addition to its offices in Amsterdam and Rotterdam, Houthoff Buruma has offices in London, Brussels and New York. On cross-border matters, the firm frequently works jointly with leading New York and London based-firms, as well as major firms in other global economic centres. Houthoff Buruma is the exclusive member for the Netherlands of Lex Mundi. Houthoff Buruma is continuously listed as a top tier firm by international client guides, including Chambers, IFLR1000 and The Legal 500. In the current edition of Chambers Europe (2017), 36 of our 49 partners are recommended, covering 14 practice areas. The firm is consistently listed as a top firm in the Netherlands in terms of M&A deal flow, and is recognised for its strong private equity practice.
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Nigeria Folake Elias-Adebowale
Udo Udoma & Belo-Osagie Christine Sijuwade
minority interests (singly and as co-investment), in Nigerian 1 Overview portfolio companies registered as limited liability companies under the Companies and Allied Matters Act (Chapter C20) Laws of the 1.1 What are the most common types of private equity Federation of Nigeria (LFN), 2004 (CAMA). The current economic transactions in your jurisdiction? What is the current challenges and risk management concerns appear to contribute to state of the market for these transactions? Have evolving trends of adopting debt and convertible instruments and, you seen any changes in the types of private equity generally, alternative capital structures instead of, or concomitantly transactions being implemented in the last two to with, traditional acquisition structures. three years?
The most common types of private equity (PE) transactions in 2.2 What are the main drivers for these acquisition Nigeria are the acquisition of shares (via subscription or transfer), structures? quasi-equity instruments and, partly in response to recent FX liquidity challenges, debt. Despite such challenges and other Maximisation of returns, control, flexibility, relative ease of exit, macroeconomic factors including declining global oil prices, the risk mitigation or diversification, investor objectives, the economy, market is relatively resilient and increasingly diversified, with the regulatory framework, and tax efficiency. Nigeria’s companies’ notable PE investor interest continuing in the financial services legislation requires foreign companies to “do business” through (including financial technology), insurance, FMCGs, food and Nigerian-registered entities. BuyCo’s liability is limited to its beverages, real estate, technology, media and telecommunications, shareholding and it can readily divest via capital gains tax (CGT)- energy, agribusiness, retail and health sectors. exempted share transfers, either in the portfolio company or by a sale of its own shares.
1.2 What are the most significant factors or developments encouraging or inhibiting private equity transactions 2.3 How is the equity commonly structured in private in your jurisdiction? equity transactions in your jurisdiction (including institutional, management and carried interests)? Democracy, population size, growth and change in demographics of the consumer class, investment policies, greater market depth The target’s equity structure will usually reflect capital contributions. and the restructuring of strategic sectors have helped to boost Shareholders and management may participate through the investment. investment company, with management interest being, typically, in the region of 5%. Carried interest is usually structured through a Oil and commodity price volatility, forex liquidity challenges and the separate vehicle; typically, an offshore limited partnership vehicle absence of a developed PE-specific regulatory and fiscal framework that also owns equity in a BuyCo subject to agreed percentage splits. currently delay or may require greater creativity in structuring PE transactions and the utilising of alternative capital structures. Cyclical challenges do not appear to permanently inhibit PE transaction 2.4 What are the main drivers for these equity structures? activity in Nigeria, particularly in the medium to long term. Regulatory, tax, governance, market and management performance considerations are the main drivers. 2 Structuring Matters
2.5 In relation to management equity, what are the typical 2.1 What are the most common acquisition structures vesting and compulsory acquisition provisions? adopted for private equity transactions in your jurisdiction? Have new structures increasingly Transaction documents will typically include “good leaver” developed (e.g. minority investments)? (employment terminated by retirement, death or disability) and “bad leaver” (e.g. employment terminated for fraud) provisions which Traditionally, structures utilised for Nigerian PE investment determine acquisition pricing for the employee’s shares. Vesting transactions include equity acquisitions by offshore registered provisions may determine conditional equity allocations, e.g. based special purpose vehicles (BuyCos) of majority and significant on length of service or achievement of performance milestones.
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portfolio companies and may not fetter their discretion to vote in 2.6 If a private equity investor is taking a minority any manner. Directors may, therefore, not be personally bound by position, are there different structuring or have to follow the veto arrangements. considerations?
Additional contractual (including shareholder and voting) 3.4 Are there any duties owed by a private equity investor arrangements to protect and particularly to augment minority rights to minority shareholders such as management shareholders (or vice versa)? If so, how are these and interests may be required for acquisitions of minority interests typically addressed? that do not achieve the investor’s required level of protection and control. Please also see questions 2.1 and 2.2. The PE investor will be bound by mandatory provisions of laws Nigeria such as the CAMA, the Investments and Securities Act 2007 (ISA) 3 Governance Matters and constitutional documents in relation to minority shareholders. Under the ISA, for instance, investments in public companies above the 30% threshold may trigger the requirement to make a tender 3.1 What are the typical governance arrangements offer to minority shareholders. There are no statutory obligations for private equity portfolio companies? Are such imposed on PE investors in relation to a target’s management arrangements required to be made publicly available shareholders. Management shareholders who act as directors in in your jurisdiction? portfolio companies owe fiduciary duties to the target company and are bound by mandatory laws and regulations including the PE investors typically insist on governance arrangements that confer requirement not to contractually fetter their discretion to vote protection or augment control such as quorum inclusion, board contractually or otherwise. participation, affirmative voting and veto rights on specified key matters with respect to certain corporate actions and key decisions (where companies’ legislation permits flexibility), organisational 3.5 Are there any limitations or restrictions on the structure, investor exit and related issues, to be put in place in contents or enforceability of shareholder agreements portfolio companies. These arrangements are usually documented (including (i) governing law and jurisdiction, and (ii) non-compete and non-solicit provisions)? in shareholders’ agreements, which are usually confidential, which may be entrenched by replication in target constitutional documents Shareholders’ agreements (and the target itself and its constitutional which are required to be publicly filed at the Corporate Affairs documents) will be subject to mandatory provisions of law including Commission (CAC). Notably, in listed portfolio companies and the CAMA and constitutional documents, however drafted, of other target companies, any information that could materially affect the target, even if the company and its shareholders are made the target’s share price (including provisions of a shareholders’ counterparties to such agreements. agreement signed by the target) may be required to be disclosed. Nigerian courts will generally uphold a choice of foreign law. The Supreme Court has affirmed that a “real, genuine, bona fide 3.2 Do private equity investors and/or their director and reasonable” choice of law (other than Nigerian law) that has nominees typically enjoy significant veto rights over major corporate actions (such as acquisitions and “some relationship to and (is) […] connected with the realities of disposals, litigation, indebtedness, changing the the contract considered as a whole” will generally be upheld, subject nature of the business, business plans and strategy, to certain exceptions. Non-compete clauses and non-solicitation etc.)? If a private equity investor takes a minority clauses are subject to negotiation but must be reasonable in order position, what veto rights would they typically enjoy? to be enforced.
PE investors that acquire majority interest in targets typically 3.6 Are there any legal restrictions or other requirements negotiate supermajority and veto rights for specified reserved that a private equity investor should be aware of corporate, financial, and commercial matters at the shareholder in appointing its nominees to boards of portfolio and board levels, subject to companies’ legislation. PE minority companies? What are the key potential risks and shareholders commonly seek to participate in and/or to influence liabilities for (i) directors nominated by private equity material issues such as exit decisions including the basis for investors to portfolio company boards, and (ii) private valuation, share capital changes impacting on share value, board equity investors that nominate directors to boards composition, target business, approval thresholds for certain target of portfolio companies under corporate law and also more generally under other applicable laws (see expenditure etc., all subject to the CAMA. section 10 below)?
3.3 Are there any limitations on the effectiveness of veto The CAMA requires that directors meet certain qualifications, arrangements: (i) at the shareholder level; and (ii) including that they must not be fraudulent, convicted by a High at the director nominee level? If so, how are these Court of any offence connected with the promotion, formation or typically addressed? management of a company, or be bankrupt or mentally unsound. Sectoral qualifications may also apply (for instance, the Central Certain mandatory provisions of the CAMA, such as prescriptions Bank of Nigeria (CBN) imposes additional qualifications for bank to the kinds of resolutions required for the approval, for instance, of directors). All directors have fiduciary obligations to the targets and amendments to constitutional documents, will override conflicting may not fetter their discretion to vote in any manner. They may, arrangements in contracts and constitutional documents including therefore, not be bound by any agreements that they sign which are in relation to veto rights at all levels, rendering such arrangements inconsistent with this. Notably the termination of employment of unenforceable. Director nominees have fiduciary obligations to executive directors will not automatically remove them as directors, and statutory procedures need to be implemented to validly remove directors unless they resign or retire.
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Directors may incur personal liability, such as for any loss or damage seek to include cancellation and early termination terms, which are sustained by a third party as a result of any untrue statements or rigorously negotiated and may be challenging to implement due to misstatements in a public company prospectus, under the ISA. The governing legislation and regulations. termination of employment of an executive director does not result in automatic removal from the board; removal (as distinct from the procurement of resignation) of directors is subject to a prescribed 5 Transaction Terms: Public Acquisitions statutory meeting and process. Disclosure of (unpublished, price- sensitive information) information by nominee directors to their 5.1 What particular features and/or challenges apply to appointing PE investors may breach fiduciary and sectoral duties private equity investors involved in public-to-private and regulations as well as insider dealing provisions under the ISA transactions (and their financing) and how are these Nigeria and the Securities and Exchange Commission (SEC) rules and commonly dealt with? regulations (SEC Rules). The ISA, SEC Rules, and (for listed targets) the NSE’s Listing Rules 3.7 How do directors nominated by private equity and the SEC’s mandatory Code of Corporate Governance apply to investors deal with actual and potential conflicts of transactions involving public companies and impose disclosure and interest arising from (i) their relationship with the reporting requirements where such transactions exceed prescribed party nominating them, and (ii) positions as directors thresholds or, in listed companies, involve changes that could affect of other portfolio companies? the price of the target’s shares. PE investors usually retain skilled advisers to ensure compliance. Section 280 of the CAMA provides that the personal interest of a director shall not conflict with any of his duties as a director. 5.2 Are break-up fees available in your jurisdiction in A director may not, in the course of managing the affairs of the relation to public acquisitions? If not, what other company, misuse corporate information in order to derive a benefit arrangements are available, e.g. to cover aborted deal and is accountable to the company for any benefit so derived, even costs? If so, are such arrangements frequently agreed after he resigns from the company. Sitting on the board of more and what is the general range of such break-up fees? than one company concurrently does not excuse a director from his fiduciary duties to each company, including a duty not to (mis)use It has not been common for a Nigerian target that is a public property, opportunity or information. Actual or potential conflicts company to agree to pay break fees. In relation to takeover bids of interest are required to be disclosed to the boards of investee involving the shares of a public listed company, the listing rules of companies for consideration. Subject to these considerations, the NSE provide that no offer may be conditional on the payment nominee directors may opt to recuse themselves from participation of compensation for the loss of an offer. Where such payment is in certain decisions at board meetings although this may not be proposed, it must be disclosed in the relevant bid or offer document. mandatory. 6 Transaction Terms: Private Acquisitions 4 Transaction Terms: General
6.1 What consideration structures are typically preferred 4.1 What are the major issues impacting the timetable by private equity investors (i) on the sell-side, and (ii) for transactions in your jurisdiction, including on the buy-side, in your jurisdiction? competition and other regulatory approval requirements, disclosure obligations and financing Cash structures are usually preferred, although share swaps issues? involving portfolio companies and BuyCos are also not unusual.
Transactions can be completed fairly quickly if the transaction is not complex, the parties are experienced (or use experienced advisers), 6.2 What is the typical package of warranties/indemnities and where no regulatory approvals are required. Delays may, offered by a private equity seller and its management team to a buyer? however, arise in the process of obtaining pre- and post-acquisition regulatory approvals from the SEC and other sector-specific regulators such as the CBN, the National Insurance Commission, the This is subject to negotiation. Exiting PE sponsors will typically SEC and the Nigerian Stock Exchange (NSE) (where applicable). seek to give minimal undertakings regarding title and capacity Delays may also arise in the process of raising investment finance except where they have been directly involved in the management and in conducting due diligence, where targets (and sometimes their of the business. Where the PE sponsor and the target’s founders advisers) are inexperienced, have inadequate or incomplete or badly exit at the same time, a more comprehensive set of warranties and organised records. indemnities may be required by the subsequent or incoming investor.
4.2 Have there been any discernible trends in transaction 6.3 What is the typical scope of other covenants, terms over recent years? undertakings and indemnities provided by a private equity seller and its management team to a buyer?
We are seeing the introduction of increasingly creative equity and While this is subject to negotiation, PE sellers do not typically offer debt and alternative capital structure terms, partly in response to a comprehensive suite of undertakings beyond those indicated at microeconomic challenges in Nigeria, as well as the adoption of question 6.2, and will often seek to resist restrictions on their offshore transaction structures aimed at providing PE investors with capacity to freely invest in competing businesses. additional powers and flexibility in governance and management matters. Certain investors, in a bid to reduce FX volatility exposure,
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6.4 Is warranty and indemnity insurance used to “bridge 7 Transaction Terms: IPOs the gap” where only limited warranties are given by the private equity seller and is it common for this to be offered by private equity sellers as part of the 7.1 What particular features and/or challenges should a sales process? If so, what are the typical (i) excesses private equity seller be aware of in considering an IPO / policy limits, and (ii) carve-outs / exclusions from exit? such warranty and indemnity insurance policies? Issues to be considered include the cost of effecting the IPO, the Such insurance is not unusual, but at the preference of the PE value of the seller’s shares after an increase in the share capital sellers, who may resist attempts to make their procurement of such has been effected and issued and the underwriting of shares not Nigeria insurance to mitigate the exposure of counterparties to an express taken up/issued to third parties. Investment and related agreements covenant in transaction documents. including the company as a counterpart that contains provisions that are material to the share price may be required to be disclosed.
6.5 What limitations will typically apply to the liability of a private equity seller and management team under 7.2 What customary lock-ups would be imposed on warranties, covenants, indemnities and undertakings? private equity sellers on an IPO exit?
This is subject to negotiation between the relevant parties. There This is subject to negotiation on a case-by-case basis, and PE sellers is no standard practice other than as prescribed by generic statutory will usually seek to avoid or minimise such requirements. limitations of contractual liability.
7.3 Do private equity sellers generally pursue a dual-track 6.6 Do (i) private equity sellers provide security (e.g. exit process? If so, (i) how late in the process are escrow accounts) for any warranties / liabilities, and private equity sellers continuing to run the dual-track, (ii) private equity buyers insist on any security for and (ii) were more dual-track deals ultimately realised warranties / liabilities (including any obtained from through a sale or IPO? the management team)? It is not uncommon for PE sellers to pursue dual-track exit strategies, Please see question 6.2. PE sellers do not often provide security as capital market liquidity, availability of trade buyers, liquidity for warranties, etc. in an exit scenario particularly where the exit is challenges, share valuation on exit and other factors including concomitant with the expiration of the fund through which a BuyCo timing and viability of undertaking and implementing regulated invested in a local target. Escrow arrangements for limited terms processes and the economy may necessarily require that there be (typically up to two years) are not necessarily unusual. Security flexibility in relation to the path to exit to enable the investor to or escrow support if required for the target’s founders and key achieve its objectives; flexibility is key. shareholders may also be provided in a scenario where the payment of consideration for equity is disbursed in tranches, and subject to the target or its founders meeting conditions and performance 8 Financing milestones set by the PE investors. 8.1 Please outline the most common sources of debt 6.7 How do private equity buyers typically provide finance used to fund private equity transactions in comfort as to the availability of (i) debt finance, your jurisdiction and provide an overview of the and (ii) equity finance? What rights of enforcement current state of the finance market in your jurisdiction do sellers typically obtain if commitments to, or for such debt (particularly the market for high yield obtained by, an SPV are not complied with (e.g. bonds). equity underwrite of debt funding, right to specific performance of obligations under an equity Convertible and non-convertible loans and debt instruments commitment letter, damages, etc.)? are not uncommon. Forex liquidity challenges and the current technical recession in Nigeria are boosting interest in alternative Evidence of funding in the PE investor’s designated account, and debt structures and investments in relative high-yield instruments the deposit of funds in an escrow account that are disbursed to including treasury bills and bonds (particularly Eurobonds). the target or its founders subject to specific conditions being met, are means via which such comfort may be provided. Please see question 6.6 above. Such comfort may not be required where the 8.2 Are there any relevant legal requirements or restrictions impacting the nature or structure of buyer has a good reputation and standing, in which case an equity the debt financing (or any particular type of debt commitment letter addressed to both the target company and the financing) of private equity transactions? seller may suffice, backed up with an appropriate financial capacity warranty. Notwithstanding recent economic challenges, Nigerian law continues to permit and to guarantee free remissibility of dividends, 6.8 Are reverse break fees prevalent in private equity profits, capital on disinvestment and of repayments of principal transactions to limit private equity buyers’ exposure? and interest on foreign loans utilising forex from official CBN If so, what terms are typical? (sources), subject only to a certificate of capital importation having been obtained from a CBN-authorised dealer bank through which Reverse break fees are not generally market practice, and would be forex was inflowed at the point that the original investment or loan negotiated on a case-by-case basis. capital was first brought into Nigeria. As an alternative, PE and other investors are also permitted access to the interbank market
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for eligible transactions such as these. A notable benefit is that PE LFN 2004 even where the proceeds are used to acquire shares in and other investors are now able to convert capital brought into another entity. If the disposal is in the form of assets, however, gains Nigeria for investments into Naira at a (mostly) market-determined realised from the disposal will not be exempt from tax if the buyer exchange rate, since applicable rates are no longer necessarily tied is not related. Where investors sell assets and use the proceeds to to being CBN-determined, as was the case prior to June 2016. The purchase other assets for the business, they would be entitled to roll practical challenge is that delays arising from the availability of over relief, i.e. no CGT. If such rollover of assets is from one related forex in the official market remain, although the CBN continues entity to another, it is possible for investors to avoid the payment to introduce measures to mitigate such challenges as well as to the of CGT if they obtain clearance and direction from tax authorities Naira. which will, however, require that such transfer must be at tax written down value of the assets.
This may account for the increasing investor interest in alternatives Nigeria such as debt and credit support instruments. Notably, foreign PE sector participants may provide lending and 9.3 What are the key tax-efficient arrangements that are credit support to a Nigerian target and are not required to be banks typically considered by management teams in private or to hold banking licences to do so. Financial assistance by targets equity portfolio companies (such as growth shares, deferred / vesting arrangements, “entrepreneurs’ is generally prohibited where there would be a resulting impact on relief” or “employee shareholder status” in the UK)? the net asset value of the target above prescribed thresholds. There are also, currently, no thin capitalisation rules in Nigeria; targets are Management teams may invest through vehicles incorporated in not generally restricted by any debt to equity ratio unless specifically jurisdictions with which Nigeria has DTAs to reduce withholding provided in their constitutional documents. Parties also generally tax on dividends. They may also grant long tenured loans of have the freedom to determine interest rates (usually LIBOR plus up to seven years and above to achieve 0% withholding tax on a margin), fees and other charges except where they are related, in interest payments through which share sales will benefit from CGT which event transfer pricing restrictions will apply and interest, fees exemption on gains made on disposal. Investments in companies etc. must be arm’s length. operating in sectors of the economy attract certain tax advantages e.g. investments in gas utilisation companies enjoy exemptions from 9 Tax Matters corporate and withholding tax on dividends for up to five years.
9.4 Have there been any significant changes in tax 9.1 What are the key tax considerations for private equity legislation or the practices of tax authorities investors and transactions in your jurisdiction? Are (including in relation to tax rulings or clearances) off-shore structures common? impacting private equity investors, management teams or private equity transactions and are any The key tax considerations for private equity investors and anticipated? transactions in Nigeria include: (a) an analysis of the nature of the investment and the vehicle There have been no significant changes in tax legislation or the through which the investment will be made; practices of the Nigerian tax authorities which specifically affect PE (b) applicable taxes at the time of making the investment and on investment in Nigeria in the last year. exit (including stamp duty and filing fees on transaction and security documents where applicable); (c) applicable taxes on income derived from the investment 10 Legal and Regulatory Matters (e.g. withholding tax on dividends, interest on loan and management fees, etc.); 10.1 What are the key laws and regulations affecting (d) applicable rate of corporate tax and other related taxes; private equity investors and transactions in your (e) applicable transfer pricing regulations (for shareholder loans/ jurisdiction, including those that impact private equity related party transactions) and thin capitalisation rules (which transactions differently to other types of transaction? may affect the debt to equity ratio) relating to the funding of the target company; and PE investors and transactions are regulated primarily by the ISA and (f) tax incentives (e.g. 2.5% deduction on withholding tax on the SEC Rules as well as various general and sectoral, investment, dividends, interest and royalties for investors resident in corporate, partnership and tax laws. Corporate targets are subject to countries with which Nigeria has a double tax agreement the CAMA and, where listed, to the ISA, SEC Rules and NSE rules. (DTA)), and exemptions (e.g. on foreign loans up to 100% depending on the tenor of the loan, including a moratorium and grace period). It is becoming increasingly common for 10.2 Have there been any significant legal and/or BuyCos resident in countries with which Nigeria has Double regulatory developments over recent years impacting Tax Treaties to be utilised for Nigerian PE investments and private equity investors or transactions and are any debt finance transactions. anticipated?
Recent amendments to the NSE’s rules to provide for closed periods 9.2 What are the key tax considerations for management teams that are selling and/or rolling-over part of their for trading by insiders (which include a shareholder holding 5% or investment into a new acquisition structure? more of a listed company’s shares) have had an impact on the timing for executing trades. A major tax consideration for management teams willing to divest is whether CGT will apply upon divestment. Under Nigerian law, gains realised from a disposal of shares are exempt from CGT by virtue of Section 31(1) of the Capital Gains Tax Act (Chapter C1)
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10.3 How detailed is the legal due diligence (including 10.5 Are there any circumstances in which: (i) a private compliance) conducted by private equity investors equity investor may be held liable for the liabilities of prior to any acquisitions (e.g. typical timeframes, the underlying portfolio companies (including due to materiality, scope etc.)? Do private equity investors breach of applicable laws by the portfolio companies); engage outside counsel / professionals to conduct all and (ii) one portfolio company may be held liable for legal / compliance due diligence or is any conducted the liabilities of another portfolio company? in-house? As a shareholder, investor liability, is generally limited to the This is subject to negotiation and may be determined by the investors’ amount (if any) unpaid in respect of any shares held by the objectives and timelines. The scope of the inquiry, materiality and
Nigeria investor in a Nigerian limited liability company. Directors may timelines for due diligence are subject to: negotiation between the be personally liable under the CAMA and Common Law. Various parties; the availability of information and documents; feedback laws including the ISA and SEC Rules, certain pensions, employee received from, and the record keeping practices of, the target; the and environmental laws, among others, seek to impose liability on responsiveness of regulators to compliance verification enquiries; the directors and officers of the companies in relation to certain and the record keeping and compliance practices, experience and corporate breaches by the target. Please see question 3.5. competence of the review and deal teams, among other factors, may be relevant. The typical timeframe for a detailed review can be four to six weeks. Investors usually engage professional external 11 Other Useful Facts counsel to conduct legal due diligence and advise on transactions.
11.1 What other factors commonly give rise to concerns 10.4 Has anti-bribery or anti-corruption legislation for private equity investors in your jurisdiction or impacted private equity investment and/or investors’ should such investors otherwise be aware of in approach to private equity transactions (e.g. considering an investment in your jurisdiction? diligence, contractual protection, etc.)? Other factors that should be taken into account include ethical and Such legislation and regulations govern fund structuring as well as strategic alignment with the founders and sellers who continue to transactional arrangements as well as the activities of the Nigerian hold equity in the target, compliance and ESG arrangements, and target and any relevant BuyCos, funds and fund managers. The regulator timelines for obtaining transaction approvals. most common applications to investors and transactions in Nigeria are: the provisions of the UK Bribery Act 2010; the U.S. Foreign Corrupt Practices Act; and various Nigerian laws, including: the Acknowledgment Corrupt Practices and other Related Offences Act, (Chapter C31) The authors would like to acknowledge the third and fourth authors LFN 2004; the Criminal Code Act, (Chapter C38), LFN 2004; and of this chapter, Edidem Basiekanem and Olaedo Osoka. the Economic and Financial Crimes Commission (Establishment etc.) Act (Chapter E1) LFN 2004.
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Folake Elias-Adebowale Christine Sijuwade Udo Udoma & Belo-Osagie Udo Udoma & Belo-Osagie St. Nicholas House, 10th Floor St Nicholas House, 10th Floor Catholic Mission Street Catholic Mission Street Lagos Lagos Nigeria Nigeria
Tel: +234 1 462 2307 10 Tel: +234 1 462 2307 10 Email: [email protected] Email: [email protected] URL: www.uubo.org URL: www.uubo.org Nigeria Folake Elias-Adebowale is a Corporate Partner and head of the firm’s Christine Sijuwade is a Senior Associate and a core member of private equity and oil and gas teams. Her specialisations include the team that advises several local and international private equity cross-border and domestic equity and asset acquisitions, disposals, firms in connection with their equity investments in various Nigerian joint ventures, strategic alliances, restructuring, investments, financing companies including companies in the telecommunications, food for energy, manufacturing and industrial projects and employment and beverage and manufacturing sectors. She has also advised matters. She headed the legal and regulatory sub-committee of on international lending transactions including syndicated loans and the Federal Minister for Industry Trade and Investment’s Nigerian has been involved in a diverse range of financial and capital markets Private Equity and Venture Capital Development project established transactions including private placements and, as part of her asset to make recommendations for boosting private equity and venture Management and Collective Investment practice, the establishment capital activity in Nigeria. She represents the firm on the legal and of mutual funds. She also advises on issues relating to the Nigerian regulatory council of the Emerging Markets Private Equity Association bond market. As part of her corporate advisory practice, Christine (EMPEA) and the African Venture Capital Association (for which she participates in due diligence reviews, in the course of which she is co-chairman). evaluates regulatory compliance practices and credit portfolios to assess the viability of targeted businesses for merger, investment and financing transactions.
Udo Udoma & Belo-Osagie is a full service commercial law firm headquartered in Lagos, Nigeria. Its private equity team advises funds, managers, institutional investors, financiers and targets on structuring, tax, investment and compliance and is committed to regulatory advocacy initiatives for private equity. The firm participates on the legal and regulatory committees of the African Venture Capital Association and the Emerging Markets Private Equity Association and is a founding member of the Private Equity and Venture Capital Association of Nigeria. All three private equity partners are recognised in international independent rankings publications and The Lawyer’s Africa Elite Private Equity Report.
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Norway Ole Kristian Aabø-Evensen
Aabø-Evensen & Co Harald Blaauw
1 Overview 1.2 What are the most significant factors or developments encouraging or inhibiting private equity transactions in your jurisdiction? 1.1 What are the most common types of private equity transactions in your jurisdiction? What is the current state of the market for these transactions? Have The most significant features encouraging PE actors to transact you seen any changes in the types of private equity in Norway is access to relatively inexpensive capital as well as a transactions being implemented in the last two to highly educated workforce, innovative technology, natural resources three years? and a well-established legal framework for M&A transactions. In respect of the latter (see further in section 3), those familiar with Although the Norwegian private equity (“PE”) market ranges from M&A transactions and methodology in most other parts of Europe seed and growth investments by angel and venture capital funds, will find the Norwegian landscape quite familiar, both in respect to leveraged buyouts (“LBO”) and secondary transactions by PE of private and public acquisitions. Most EU-regulations pertaining funds (herewith public-to-private acquisitions and IPO exits); in to M&A transactions have also been implemented in Norwegian 2016, leveraged buyout transactions of private targets dominated the law through membership in the European Free Trade Association transaction volume, representing 52.8% of the total PE transactional (“EFTA”) and the European Economic Area (“EEA”). volume for that year. Historically, an important factor, viewed by many investors as In 2016, the total Norwegian M&A-market experienced a significant sheltering Norway against international financial turmoil, has been improvement in volume and total reported deal value compared a high oil price. The decline in oil prices witnessed at the end of with 2015, while the Norwegian PE market showed a 1.9% decline 2014 and throughout 2016 is in this aspect serious, but it has yet in reported volume compared with 2015. However, for deals to dissuade PE actors from transacting in Norway. Declining oil involving private equity sponsors in 2016, (either on the buy- or prices in combination with a somewhat aggressive approach by sell-side) the average reported deal sizes improved significantly Norwegian tax authorities against LBOs (herewith principals of from €265m in 2015 to €368m in 2016. The market continued to PE funds domiciled in Norway) could in the long term potentially be driven by new investments and add-ons, but in 2016 we also frustrate international PE funds appetite for Norwegian targets, but witnessed a substantial increase in the number of exits. given all the positive counterweights, we do not see this as a likely As mentioned above, the Norwegian PE market spans the width of scenario for the future. all transaction types found in any mature market, but the typical club deals have, save for a few exceptions, for all practical purposes been 2 Structuring Matters outside the realm of the Norwegian PE market. The main reason for this is that most Norwegian transactions are of a size that normally does not require a major international PE fund to spread its equity 2.1 What are the most common acquisition structures risk in order to avoid exceeding investment concentration limits in adopted for private equity transactions in your its fund. The foregoing notwithstanding, sell-downs or syndication jurisdiction? Have new structures increasingly of minority equity portions subsequent to buyouts also occur in the developed (e.g. minority investments)? Norwegian market. Virtually all national and international PE funds are today organised Deals related to the oil, gas and supply industry have traditionally as some type of limited partnership, wherein the institutional dominated the Norwegian PE market. Despite a difficult market investors participate as direct or (normally) indirect limited partners, in the oil and gas segment continuing throughout 2016, PE funds and wherein the fund manager (in the following the “Manager” or continued to show interest in this sector for a large part of 2016. the “Sponsor”) acts as the general partner, normally owned through However, by share number of PE transactions, TMT, Services and a private limited liability company specifically organised for this the Industrial & Manufacturing sectors dominated the Norwegian purpose. The domicile, tax status and internal structure of the market in 2016, each of these sectors with 19% of the buyout Manager sponsoring the fund will very often drive the choice of the investment volume, followed by the Consumer sector and the Energy general partner. Sector, each with respectively 9.4% and 5.7% of the total deal count.
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PE funds typically create a special purpose shell acquisition vehicle In both instances, PE funds must consider upstream issues (taxation (“SPV”) to effect an investment or acquisition, and commit to of monies extracted from the top Norwegian holding company fund a specified amount of equity to the SPV at closing. The final (“TopCo”) to the foreign holding-structure) and downstream issues acquisition structure adopted by these PE funds in the Norwegian (taxation of monies extracted from BidCo up to TopCo, herewith market will normally depend on whether the respective fund is monies flowing up from the target and its various subsidiaries). organised under Norwegian law or under foreign jurisdictions. Before deciding the final acquisition structure, Sponsors must Funds organised under Norwegian law will, when investing into consider numerous additional issues, typically including tax issues Norwegian target companies, normally adopt a one-tier structure by relating to management and employee compensation; the target’s investing through a set of Norwegian holding companies. and its group companies’ debt service capability; regulatory Funds organised under a foreign jurisdiction investing into requirements/restrictions (i.e. prohibition against financial Norway Norwegian target companies will usually structure the acquisition assistance and debt-pushdowns, and the new anti-asset stripping by adopting a two-tier structure, irrespective of whether the Manager rules, cf. question 10.2); rules on thin-capitalisation and deductibility is foreign or domestic. Firstly, the PE fund establishes an offshore of interests; withholding tax on shareholder debt and distributions; holding structure of one or more private limited liability companies VAT; and corporate liability and disclosure issues, etc. incorporated and tax resident outside of Norway – typically in Luxembourg, the Netherlands or (occasionally) Cyprus. Secondly, 2.3 How is the equity commonly structured in private the acquisition of the shares in the Norwegian target company will equity transactions in your jurisdiction (including be made by the foreign holding structure through a Norwegian institutional, management and carried interests)? incorporated and tax resident special purpose vehicle (an SPV or “BidCo”) that eventually acquires the target company. Additional The equity structure in any PE transaction usually provides an Norwegian holding companies could be added into the structure opportunity and/or a requirement for the target’s management to between the foreign holding structure and the Norwegian BidCo to co-invest (“Investing Management”) together with the PE fund in allow for flexibility in obtaining subordinated debt financing and the acquiring group. The co-investment typically takes place at the other commercial reasons. Norwegian TopCo-level, or at the foreign holding company level. Occasionally, we also over the last three years see examples of The equity strip for the Investing Management depends on the size Sponsors carrying out minority investments in listed companies, but of the transaction, but it is normally relatively small with a share these Funds’ limited partners have often criticised such strategies. price at an affordable level. If the Investing Management mainly consists of Norwegian citizens, 2.2 What are the main drivers for these acquisition these may prefer to structure their co-investment into the Norwegian structures? TopCo instead of into the foreign holding company structure. However, the PE fund may insist that the Investing Management Various deal-specific considerations dictate the type and organisation must invest in the foreign holding-structure. From a valuation of the SPV, including, among others, tax structuring issues, desired perspective, it is imperative for both the PE fund and the Investing governance structure, number of equity holders, equity holders’ Management that the Investing Management’s equity participation (and the Sponsor’s) exposure to liability by use of the applicable is acquired at “full and fair market value”, as participation under vehicles, general ease of administration and required regulatory Norwegian law otherwise may be subject to income tax (rather requirements including the financing bank’s demand for structural than tax on capital gains). In order to achieve that the Investing subordination (see below). Management invests at the same price per shares as the institutional Typically, the entry-route used by PE funds for their investments investors, the Sponsor will typically invest in a combination of depends upon which structure provides the greatest flexibility shareholder loans, preferred shares and ordinary shares, while the for efficiently repatriating funds back to the fund’s investor-base Investing Management mainly invests in ordinary shares (i.e. shares in connection with either an exit or a partial exit, with as little tax with no preferential rights). The Investing Management’s senior leakage as possible (i.e. minimising the effective tax rate for all members may occasionally also be allowed to invest in the same relevant stakeholders upon exit). The choice of entry-jurisdiction into instruments (or “institutional strip”) as the Sponsor. The detailed Europe, therefore, normally depends on the identity and geography structuring of the management incentive package will depend on the of the fund’s investors, the tax treaty between the proposed European tax treatment of any benefit. If the Investing Management pays less entry-jurisdiction and the home jurisdiction for the majority of the than the market value of the shares, this could under Norwegian law fund’s investor-base and the tax treaties between the various other give rise to an employment tax charge (46.9% marginal rate for the jurisdictions involved, including Norway. It is not uncommon that individual and 14.1% payroll tax for the employer). Sponsors structure the investment through various forms of sub- In secondary buyouts, it commonly is a condition that the Investing partnerships (or feeder-funds) set up in different jurisdictions in order Management must reinvest a proportion of their sale proceeds to achieve the most optimal structure for their respective investors, (rollover). Any gains on such rollover will in principle trigger capital all depending upon such investors’ geographical location. gains tax for the Investing Management, unless the members of the Another main driver when choosing relevant acquisition structures management team invested through separate holding companies and (and particularly the number of holding companies involved), is these are the one rolling over their investments. In recent years structuring of the financing (i.e. the bank’s demand for control of it has also become more common that the Investing Management cash flow and debt subordination), sections 8 and 9. Particularly invest into a separate pooling vehicle to simplify administration, in large transactions, it can be necessary to use various layers of which otherwise could be complicated by having a large number of financing from different stakeholders in order to be able to carry shareholders (e.g. meeting attendance and exercising voting rights). out the acquisition. The need for flexible financing structures The carried interest arrangements (the “Carry”) for Managers is a commercial reason that often drives the number of holding domiciled in Norway will more or less be the same irrespective of companies between the foreign holding-structure and the Norwegian where the PE fund is located, although variations exist with regards BidCo. to other key factors for how the profit from the fund’s investments
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is split between the Manager and the Institutional Investors (such as such person resigns without good reasons, the person is classified as annual fee, hurdle rate, catch-up, etc.). The Manager’s right to Carry a “bad leaver” and must sell the shares for less than market price. is most always accompanied by an obligation to risk alongside the Although subject to individual variations, neither time- nor Institutional Investors, where the Manager as a precondition must performance-based vesting has been very common for Investing risk its own money and invest into the fund’s limited partnership. Management’s participation in Norwegian PE transactions, at least if Today, such Carry arrangements may be structured using a separate the buyer is a domestic or Nordic PE fund. However, in transactions limited partnership (“SLP”) or offshore company, held directly or where international Sponsors are involved, vesting is more common. indirectly by the relevant investment professionals of the Manager, When introduced, a three to five year time-based vesting model is which in either case becomes a partner in the fund’s limited often used, with accelerated vesting on exit. Such a vesting model partnership. Each participant’s share of the Carry is delivered means that only the vested part of the equity is redeemable at Norway through an interest in the SLP, or in the fund itself by way of partial “fair value” at each anniversary ensuing investment, whereas the assignment of the offshore company’s interest in the fund’s limited part of the equity that has not vested may only be redeemable at partnership. In principle, distribution delivered this way should be a lower value. Given the recent years’ rather aggressive approach the same for the Institutional Investors in the fund, namely a share of from the Norwegian tax authorities on Carry, some advisors fear the income and gains derived from the underlying investments of the that vesting provisions may be used as an argument for classifying fund’s limited partnership. As such, Carry has traditionally under profits from Investing Management’s co-investments as personal Norwegian law been perceived as a regular return on investment income (in whole or in part) rather than capital gains. The obvious and taxed as capital gains. Taxation of Carry has, however, become argument against such an assertion is that if the equity has been a much debated topic in Norway in the last few years, where the acquired or subscribed for at “fair market value” and at the same Norwegian tax authorities have argued that the Carry should be price per shares as the Institutional Investors (cf. question 2.3), then taxed as income rather than capital gains. For taxation of Carry, revenues therefrom should, strictly speaking, be treated and taxed in see question 9.4. the same way as revenues derived from the institutional equity (i.e. classified as capital gains). Nevertheless, as there is no firm legal 2.4 What are the main drivers for these equity structures? precedent on the matter, domestic PE funds seem to choose the path of least resistance by foregoing vesting. There is, of course, also a For interested parties alike, the predominant driver is finding the question in each transaction of how much ‘leverage’ the PE fund has right balance to align the various stakeholders’ interests in creating in relation to the Investing Management, and, correspondingly, how value for its investors. The drivers behind equity terms and the much push-back introducing vesting provisions will receive. equity structures are, therefore, always the desire to control and incentivise. 2.6 If a private equity investor is taking a minority The control aspect is partly manifested through the chosen equity position, are there different structuring structure (in particular rights attaching to shares or other ownership considerations? interest held by the PE fund), and partly through contractual control like veto rights on operational matters and the ability to obtain In such situations, a PE investor will focus on exactly the same information. issues as mentioned in questions 2.2 and 2.4 above (particularly if they are using leverage to acquire their minority stake), but will As equity stakeholders in the relevant target they manage, the likely obtain a lower level of protection than taking a controlling Investing Management are incentivised to drive growth and stake. In addition, there will be particular focus on securing an exit profitability, and Managers are incentivised as equity stakeholders in route/timing of exit, and securing anti-dilution rights/pre-emption the fund’s portfolio companies. Put differently, given the particular rights on any issue of new shares. nature of the PE business model, it is important that both the Institutional Investors, the Manager and the Investing Management all have an aligned interest to create value for the Institutional 3 Governance Matters Investors, both in the incentive and risk-sharing perspective. It is therefore necessary to ensure that the Manager and the Investing Management each has sufficient “skin in the game”. Tax treatment 3.1 What are the typical governance arrangements on capital, tax for managers, availability of reliefs for managers, for private equity portfolio companies? Are such rollover considerations, and incentive/risk sharing are always arrangements required to be made publicly available in your jurisdiction? vital factors for the Institutional Investors’ investment decisions. Consequently, it is impossible to understand the structure of equity The governance arrangements commonly used by PE funds to terms without also understanding the underlying tax drivers. Debt gain management control over their portfolio companies tend to be financing also has a substantial impact on equity terms. relatively detailed, but there could be substantial variations between domestic funds compared to the governance structure deployed by 2.5 In relation to management equity, what are the typical European or global PE funds. vesting and compulsory acquisition provisions? The shareholders’ agreement will normally contain provisions regarding corporate governance issues. The ability to appoint Management offering to subscribe for shares in the acquiring group directors, and to control the board if necessary, is the key tool will typically be required to accept compulsory transfer of such that the Sponsor will ensure is put in place in such agreements, shares if his/her employment terminates. The financial terms of including a right to appoint additional directors in order to flood such compulsory transfer depends on the reason for termination the board in the event of disagreement with the executives and (“good” or “bad” leaver). If termination is due to acceptable any employee representatives. Although some international reasons, typically death, disability or involuntary termination funds also implement a separate management board, Norwegian without cause, the person is a “good leaver” and will receive market portfolio companies normally only have a single board of directors value for the shares. If employment is terminated with cause, or if on which the Sponsors are represented. It is not uncommon that
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some PE funds want to appoint an independent chairman to provide strategic oversight and to create an independent bridge between the 3.3 Are there any limitations on the effectiveness of veto Sponsor and the Investing Management Through veto rights and/or arrangements: (i) at the shareholder level; and (ii) at the director nominee level? If so, how are these preferential voting rights afforded in the shareholders’ agreement, typically addressed? the Sponsor-appointed directors will usually have control over important decisions like new acquisitions and disposals, approval As a starting-point, shareholders can agree that one or more of business plans and annual budgets, new investments outside of designated representatives shall have veto rights over certain the business plan, etc. Besides appointment/dismissal of directors decisions at the general meeting. Nevertheless, the traditional view (always subject to consent from the general meeting, meaning the is that a decision from the general meeting is valid regardless of Sponsor), the shareholders’ agreement may further contain rules
whether some shareholders have voted in breach of contractual Norway about audit and remuneration, business plans and budgets, transfer/ obligations under a shareholders’ agreement. Consequently, to issue of shares and financial instruments, confidentiality and other ensure that shareholders respect such veto rights, it is important restrictive covenants, management of exit, and customary drag-, that the shareholders’ agreement contains appropriate enforcement tag- and shot-out provisions. From a strict governance perspective, mechanisms (see question 3.5). the important requirement for the Sponsor is to ensure that the shareholders’ agreement provides the Sponsor with appropriate Veto rights in a shareholders’ agreement binds neither the board access to information about the company. There is no requirement (as a governing body) nor the CEO. This means that even if a for making such shareholders’ agreements publicly available. shareholders’ agreement grants Sponsor-appointed directors veto over certain important board resolutions, there is always the risk Unlike what is common in other jurisdictions (e.g. the UK or the US), that the board disregards this and resolves the matter in question it is not common to include a detailed set of protective provisions as the majority find appropriate. In order to cater for the “risks of in Norwegian portfolio companies’ articles of associations. disobedience”, each director could be required to sign some form Traditionally, most domestic PE funds have also preferred to keep of adherence agreement to the shareholders’ agreements, but if these types of provisions only in the shareholders’ agreements for such adherence agreement is considered to bind the directors in confidentiality and flexibility reasons. For the last few years, it has their capacity as such (and not shareholders), there is a legal risk nonetheless become more common to also include certain protective that the agreement, under Norwegian law, will be deemed invalid provisions in the articles, especially if the portfolio company as constituting a fettering of their discretion (other valid portions is controlled by an international PE fund. Such articles must be of such agreements may remain in force). This risk cannot registered in the Norwegian Register of Business Enterprises, and be eliminated by making the relevant company a party to the are thus publicly available. shareholders’ agreement. The reason being that the board owes fiduciary duties to the company trumping those owed to a director’s 3.2 Do private equity investors and/or their director appointing shareholders. Therefore, the company cannot dictate nominees typically enjoy significant veto rights over how the board in the future shall exercise duties, discretions and major corporate actions (such as acquisitions and judgments relating to individual matters put in front of them, unless disposals, litigation, indebtedness, changing the otherwise set out in the company’s articles. As a result, some funds nature of the business, business plans and strategy, etc.)? If a private equity investor takes a minority seek to alleviate risk by implementing provisions in the portfolio position, what veto rights would they typically enjoy? companies’ articles, stating that the shareholders and the company have entered into a shareholders’ agreement regulating, inter alia, The shareholders’ agreement is normally drafted so that PE funds restrictions on transfer of shares, veto rights, etc. Such clauses will and their director nominees (through board majority or mandatory then state that the board may, as a condition for its consent to transfer consent requirements) have control over the portfolio company and shares, require that new shareholders accede to such shareholders’ any important corporate action. This includes, inter alia, material agreement. There is no clear court decision on the topic as to what changes in the nature of the business or disposal of any substantial extent such a reference in the articles will solve the problem, or if part thereof; changes to issued share capital; major acquisitions; it is necessary to include the relevant text itself in the articles. In adoption of annual business plan/budget and recommendations in academic circles, the view is also divided. respect of dividend distributions; entering into any partnerships If the directors are also shareholders in the company, it must be or creating any obligations, liens or charges; major employment assumed that they are free to bind their powers in their capacity as matters like pensions and bonus schemes; and, naturally, entering shareholders. Consequently, Sponsors controlling sufficient votes into litigation or liquidation proceedings. Some Sponsors may in the general meeting can in principle seek comfort in its right to divide the list of vetoes between those requiring director consent convene an extraordinary general meeting and remove disobedient and those requiring Sponsor consent at shareholders’ level. directors from the board. Still, the right to remove board members A PE investor holding a minority position is likely to hold less cannot completely eliminate the risk that the portfolio company, protection than on taking a controlling stake. The priority areas will as a result of the board’s resolution, has already entered into a be ensuring that they have visibility of the day-to-day conduct of binding arrangement with a third party before a new board is the business (i.e. board or observer seat), and ensuring that certain elected. Normally, an appropriate and well-tailored enforcement fundamental transactions which protects their ownership interest mechanism in the shareholders’ agreement itself will therefore, in cannot be taken without their consent. Examples of such veto rights most situations, be considered sufficient to ensure that no party (in are: changes to the company’s constitutional documents; disposal of particular the directors holding shares) has any incentive to breach key assets; borrowing of monies; and any form of debt restructuring the terms of the shareholders’ agreement, and therefore that it will transactions, etc. not be necessary with any further enforcement. In practice, most Norwegian funds seem to rely on such enforcement mechanisms in the shareholders’ agreements instead of implementing lengthy articles. Having said this, over the last few years there seems
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to have been a move for implementing more detailed articles, in than injunctions agreed in such an agreement can be claimed before particular when UK or global funds are investing in Norwegian the courts. portfolio companies. In the event that a shareholders’ agreement contains provisions that are conflicting with statutory minority protection rules or provisions 3.4 Are there any duties owed by a private equity investor in the company’s articles of association, this could also result in to minority shareholders such as management the agreement not being enforceable, at least with regard to such shareholders (or vice versa)? If so, how are these provision (see question 3.4 above). typically addressed? Further, note that if the shareholders’ agreement attempts to bind the directors in their capacity as a director, there is a risk that this The general principle under Norwegian law is that a controlling
Norway part of the agreement is invalid and cannot be enforced towards the shareholder does not have any duty towards minority shareholders company itself nor the director in question (see question 3.3). Also, and is free to act in his or her own best interest unless otherwise is note that it is not possible to extend the binding force of certain explicitly set out in law, the company’s articles or in an agreement. provisions of such an agreement by making the company itself a Under the Norwegian Limited Liability Companies Acts party to it (see question 3.3). Nevertheless, if the director is also a (“Companies Acts”), however, a controlling influence cannot be shareholder, and as such is a party to the shareholders’ agreement, exercised at board level, management level or at the general meeting it must be assumed that such shareholders are free to bind their in a manner likely to cause unjust enrichment to a shareholder or powers in the capacity of shareholders (see question 3.3). Provided a third party at the cost of the company or another person. For appropriate remedies and enforcement mechanisms are agreed in the PE investments in particular, the Sponsor will in addition have agreement itself, such mechanisms will therefore, in most situations, undertaken a set of detailed (but limited) undertakings towards be considered effective towards such party. minority shareholders (such as management shareholders), the Typically, shareholder agreements cannot be enforced towards third main purpose being to align the minority shareholders’ interest not parties, but can be enforced against the party in breach. However, through annual compensation, but through growing the business and this may sometimes be of little help, unless the agreement itself receiving equity returns as shareholders. contains appropriate and effective remedies and enforcement Shareholders also have certain statutory minority protections mechanisms (see question 3.3). through a detailed set of rules in the Companies Acts, including In terms of dispute resolution, the preferred avenue of approach the right to attend and speak at general meetings, certain disclosure for PE funds has, over the last decade, shifted from regular court rights, rights to bring legal actions to void a corporate resolution hearings to arbitration, and it should be noted that alternative on the basis of it being unlawfully adopted or otherwise in conflict dispute resolution in general (including both arbitration and court- with statute or the company’s articles, etc. Some of these rights are sponsored mediation) is now decidedly more common in Norway granted to each individual shareholder irrespective of voting rights, than in the rest of the Nordics. International influence combined and the Companies Acts also provides specific rights to minority with the perceived upsides (i.e. non-publicity, efficiency, expertise shareholders representing a certain percentage of the share capital and costs) may be credited for this shift. Pursuant to the New York and/or votes. Convention, arbitral awards are enforceable in Norway. As from Sometimes, Sponsors, particularly foreign Sponsors, may 1 January 2016, Norway implemented certain statutory limitations address certain of these statutory minority protection rules in the on enforceability of non-compete clauses in employment contracts. shareholders’ agreement by introducing provisions that aim (directly Under certain special circumstances, the new rules may also have or indirectly) to limit them. To what extent this is possible, and if so, an impact on the enforceability of non-compete provisions of how far and for how long it is possible to limit (or at least minimise) shareholder agreements. them, is subject to substantial legal uncertainty under Norwegian law. Many of the rules cannot be deviated from, and an overzealous shareholders’ agreement could affect the validity of either the entire 3.6 Are there any legal restrictions or other requirements agreement or the particular provision in question (see question 3.5). that a private equity investor should be aware of in appointing its nominees to boards of portfolio By implementing several share classes with different financial and companies? What are the key potential risks and voting rights, and by introducing good leaver/bad leaver provisions, liabilities for (i) directors nominated by private equity etc., a Sponsor may to some extent at least limit the financial impact investors to portfolio company boards, and (ii) private of some of these minority protection rules so that the principles of equity investors that nominate directors to boards the shareholders’ agreement in general will apply. The same can of portfolio companies under corporate law and also be achieved by pooling the minority investors’ investment in the more generally under other applicable laws (see portfolio company through a separate investment vehicle in which section 10 below)? the Sponsor holds the controlling vote. Legal restrictions on nominating boards of portfolio companies The CEO and at least half of the directors in Norwegian private 3.5 Are there any limitations or restrictions on the contents or enforceability of shareholder agreements and public limited liability companies (“LLC”) must either be (including (i) governing law and jurisdiction, and (ii) residents of Norway or EEA nationals who reside in an EEA state. non-compete and non-solicit provisions)? With respect to this, at least half of the ordinary directors must fulfil the residential requirement; it will not suffice that solely deputy Insofar as the shareholders’ agreement does not contravene statutory directors fulfil it, irrespective of how many of them are Norwegian laws (e.g. the Companies Acts) or the relevant company’s articles, residents or EEA nationals. The Norwegian Ministry of Trade and such agreements are considered valid under Norwegian law, and can Industry may grant exemptions on a case-by-case basis. Also note in principle be enforced among the parties thereto (but not against that for public LLCs (irrespective of such companies being listed or third parties). Even if the shareholders’ agreement is binding, there not), Norwegian law dictates that each gender shall be represented are still some uncertainties as to what extent it can be enforced by on the board by (as a main rule) at least 40%. Consequently, on a injunctions. Nevertheless, it must be assumed that remedies other board of five directors there cannot be fewer than two members of
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each gender. Exceptions apply to directors elected by and among price and other terms that are customary for such agreements. Also the employees (if any). note that several amendments for simplifying the Companies Acts PE funds must also take into consideration the requirements for have now, inter alia, been proposed with regard to general meeting employee representatives on Norwegian boards. According to approval of such related-party transactions (see question 11.1). law, employees are entitled to board representation, both in private Directors violating any of the formal requirements described above and in public LLCs, provided the number of full-time employees may, in worst case, expose him- or herself to personal responsibility/ in such a company exceeds 30. Under such circumstances, the liability for ensuring that any funds/assets distributed in violation of employees are entitled to elect between one and up to one-third of such rules are returned to the company. Note that the new anti-asset the board members from among the employees. The exact number stripping rules implemented by the new AIFMD Act (see question of employee board representatives varies with the number of 10.2) is also likely to result in personal liability for directors – in Norway employees in the company, but all employee representatives have particular those appointed by the Sponsor if they contribute to the the same voting rights as regular board members. Employee board Sponsor’s breaching of such anti-asset stripping provisions. representation is not mandatory under Norwegian law, but cannot be Further, note that in the event that a portfolio company is in financial rejected if requested by the employees and the conditions for such distress, its directors will at some stage come under obligation to representation are fulfilled. cease trading and file for court composition proceedings or to Risks and potential liabilities for the directors appointed liquidate the company. Such distress situations very often involve Like other directors, a Sponsor-appointed director of a portfolio some type of prior attempts of restructuring or reorganising the company owes fiduciary duties to the company that takes precedence business to salvage the various stakeholders’ financial interests. over duties owed to the shareholders appointing him. Directors owe These type of attempts could involve selling off assets or parts their duties to all the shareholders, not only the individual shareholder of the business to a stakeholder against such stakeholder being or group of shareholders nominating him/her. Upon assuming willing to contribute additional cash or converting debt into equity, office, the nominated directors will be subject the same potential etc. It is not uncommon that such transactions, in the event that personal director liability as any other member. Under Norwegian these attempts later fail, may be challenged by other creditors, the law, directors or executive officers may become liable for damages receiver or trustee on behalf of the creditors, and they therefore suffered by the company, shareholders or third parties caused by entail substantial risks of liability for the various directors. negligence or wilful acts or omissions. In addition, directors can Risks and potential liabilities for the Sponsors be held criminally liable as a result of intentional or negligent In terms of liability, the general point is that a Sponsor itself will not contravention of the Companies Acts and/or ancillary regulations. assume or be exposed to any additional liability simply by virtue of As a general principle, all directors (including employee-elected nominating/appointing directors to a portfolio company. However, directors) are subject to the same standard of care or fault standard a parent company or a controlling shareholder may be held and, although the board acts collectively, a director’s liability is independently liable for its subsidiary’s liability if it has contributed personal. Joint and several liability only applies to such actions or to a wrongful act through a controlling interest in the company. omissions attributable to more than one board member. Consequently, if the Sponsor has reserved so may vetoes over the Examples of potential risks and liabilities that Sponsor-appointed portfolio company that the management team is no longer able to directors should be particularly aware of relate to the board’s carry out its day-to-day business in the ordinary course without first heightened scrutiny in controlling that all related-party transactions consulting the Sponsor, this could, at least theoretically, mean that (if any) between a portfolio company, its shareholders and/or its the Sponsor might be considered a “shadow director” or manager of directors are concluded at arm’s-length basis. In a PE investment, the business. Under these circumstances, consequent liability issues such transactions may typically relate to fixing the interest rates on can arise for the Sponsor if something goes wrong. Having said this, shareholder loans, and/or intra-group loans between the acquiring to pierce the corporate veil under Norwegian law is not considered companies and the target group, or payment of various forms to be a particularly easy task. of management fees, etc. between such parties. Other forms of transactions falling within the same category may be transactions 3.7 How do directors nominated by private equity that directly or indirectly aim at distributing funds out of a portfolio investors deal with actual and potential conflicts of company to the Sponsors or to third parties. Also, directors should interest arising from (i) their relationship with the be particularly aware of the general rule prohibiting a target company party nominating them, and (ii) positions as directors from providing upstream financial assistance in connection with the of other portfolio companies? acquisition of shares in the target company (or its parent company). This prohibition against financial assistance has previously As mentioned in question 3.6, Sponsor-appointed directors are, upon prevented Norwegian target companies from participating as co- assuming office, subject to the same corporate fiduciary duties as borrower or guarantor of any acquisition financing facilities. Even any other director on the board, and these rules (principles) cannot though Norway has now implemented a new set of rules that be departed from through shareholder agreements or constitutional somewhat eases the previous strict ban of financial assistance (by documents. introducing a type of ‘whitewash’ procedure), this is still an area that According to law, a director in a Norwegian portfolio company is needs careful consideration and compliance with strict formalities if disqualified from participating in discussions or decisions on any the respective directors shall stay out of peril. On a general note, issues that are of such personal importance to him, or any of his it is also important to be aware that in order to be valid, related related parties, that the director is deemed to have a strong personal party transactions must be approved by the general meeting if the or special financial interest in the matter. The same will apply consideration from the company represents a real value exceeding for a company’s CEO. Whether or not this provision comes into 10% (private companies) and 5% (public companies) of the share play, demanding a director to step down while the remaining board capital of the company. Note that additional formal requirements resolves the matter, depends on an individual evaluation at any will apply for the approval process of such agreements. Certain given crossroad. However, it must be assumed that most particular exemptions from these requirements apply, typically agreements circumstances must be present – i.e. a director will not automatically entered into as part of the company’s normal business at market
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be disqualified just because he is also director in another portfolio supporting documents will have to be made available to the company that is the company’s contractual counterpart. In a sense, shareholders no later than two weeks prior to the general it could be viewed as providing a safety valve for PE nominees that meeting at which such merger will have to be decided upon. If have a personal financial interest (by virtue of being a partner of the public LLCs are involved in such a merger, the notice period Manager and thereby entitled to parts of the Carry, cf. question 2.3) is one month prior to the general meeting, and the merger plan must also be filed with the Register of Business Enterprises to withdraw from handling board matters (and thus avoiding any (“RBE”) a month before the meeting. If approved by the conflicts of interest) relating to other portfolio companies. general meeting, the merger must thereafter be filed with To avoid potential conflicts of interest arising between nominators the RBE for public announcement; this applies to private and nominees, increasingly more PE-backed companies have and public LLCs alike. Once the announcement has been introduced quite comprehensive instructions and procedural rules published by the RBE, a six-week creditor period begins, Norway for both management (daily operations and administration) and the upon the expiry of which the merger may be effectuated. board of directors (board work and decision-making processes). ■ Also note that if the target company is operating within certain industries, there are sector-specific requirements to consider
(such as requirements for public permits and approvals). These 4 Transaction Terms: General industries are banking, insurance, petroleum, hydropower and fisheries, etc., and the need for obtaining such public permits and approvals could heavily influence the transaction 4.1 What are the major issues impacting the timetable for timetable. transactions in your jurisdiction, including competition Issues influencing the timetable for take-private transactions in and other regulatory approval requirements, Norway will in general be more or less the same. For such target disclosure obligations and financing issues? companies, however, the following additional issues must be accounted for: As a starting point, private corporate transactions do not require consent from Norwegian authorities, which means that regular ■ The time necessary for the target’s board to evaluate the initial proposal for the transaction and any alternatives. share purchases can be completed in accordance with the timeframe agreed upon by the parties – i.e. there is no set timetable. Standard ■ In a voluntary tender offer, the offer period must be no less waiting periods pursuant to relevant competition legislation will than two weeks and no more than ten weeks. apply, however. The major issues impacting the timetable for ■ In a subsequent mandatory offer, the period must be at least private transactions in Norway are: four weeks and no more than six weeks. ■ The initial diligence exercise that the buyer intends to ■ The time necessary to conduct squeeze-out of the minority undertake. shareholders. ■ Time necessary for financing discussions. The time required ■ The application process for delisting the target in the event for such discussions will normally be heavily dependent upon that the bidder has not managed to acquire more than 90% the size of the deal and type of preferred financing options of the shares and some of the remaining shareholders file an available. If it is necessary with bank financing syndication, objection against delisting the target company. mezzanine debt, issuing debt instruments, etc. ■ In the event that it is necessary to file the transaction with 4.2 Have there been any discernible trends in transaction domestic or foreign competition authorities, the time required terms over recent years? to prepare the necessary disclosures to be submitted to such authorities. In the event of a change of control transaction, Structured sales (auction) processes continue to be the preferred provided that the combined group turnover of the acquirer option for PE exits in the Norwegian market – at least for transactions and the target in Norway is NOK 1 billion or more, and at least two of the undertakings concerned each have an exceeding EUR 100 million. Also in smaller transactions the annual turnover in Norway exceeding NOK 100 million, the seller’s financial advisors will often attempt to invite different transaction must be filed with the Norwegian Competition prospective bidders to compete against each other. Conversely, a Authorities (“NCA”), unless filing takes place under the EU PE fund looking for an exit will never go for a bilateral sales process Merger Control Regime instead. as a preferred exit route unless: (i) the fund has a very clear sense of ■ If filing with competition authorities is necessary, the time who the most logical buyer is; (ii) an auction involves a high risk of necessary for such authorities’ regulatory reviews, including damage from business disruption; and (iii) the PE fund feels it has a requests for additional information from such authorities, and very strong negotiating position. to wait for the expiry of standard waiting periods under such Throughout 2013 and at the beginning of 2014, the confidence regulatory approval schemes. There is no deadline for filing returned to the international equity capital markets. This again led a notification with the NCA, but a standstill obligation applies until the NCA has cleared the transaction. After receipt of the to an upswing in the number of initial public offerings, both in the filing under the new rules, the NCA now has up to 25 working Norwegian market and the rest of Scandinavia. Due to this market days to make its initial assessment of the proposed transaction. sentiment, IPOs and “dual-track” processes became increasingly ■ The necessity to comply with obligations to inform the popular among PE funds looking to exit their portfolio investments, employee union representatives and/or the employees of the in particular for some of their largest portfolio companies where the transaction and its potential effects in accordance with law buyer-universe might be limited and the relevant company needed to and relevant collective bargaining agreements. raise equity in order to pursue future growth strategies. In Norway, this ■ The time necessary for implementing relevant co-investment trend continued through 2016 although transaction volume fell due to arrangements with Investing Management. volatility in the market resulting from a declining oil and gas sector. ■ The time necessary to establish the desired investment Stapled financing offers have again started to re-emerge inthe vehicles and special purpose vehicles in order to execute and Norwegian market, in particular for the larger deals in which the complete the transaction. sellers are pursuing an exit via dual-track processes. ■ If the transaction is conducted through a statutory merger, where only private LLCs are involved, the merger plan with
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We have also seen increasing examples of sellers that, in order makes diligence access one of the bidder’s main hurdles in a public to accommodate a greater bidder universe, have been willing to takeover. The target is not restricted from facilitating a due diligence offer certain attractive bidders some form of cost-coverage for investigation by a bidder, but the scope and structure of such reviews money spent in an unsuccessful auction. These arrangements are in the context of a listed target will vary significantly. Provided that subject to great variations, but, on a note of caution, they regularly the target’s board is prepared to recommend the offer, the bidder will include provisions that stealthily alleviate much of the apparent normally be admitted to a confirmatory due diligence. It is therefore seller liability by prescribing that the buyer will not be entitled to not surprising that a prospective acquirer (particularly PE funds) any coverage if it is no longer willing to uphold a purchase price practically always will seek upfront recommendation from the corresponding to the adjusted enterprise value of its initial offer. target’s board. In a control context, the prospective acquirer’s first Escrow structures as basis for making contractual claims in contact with the target is customarily a verbal, informal sounding- Norway respect of warranties and purchase price adjustments are normally out (by the chairman or a senior executive of the acquirer or by not popular among sellers, but depending on the parties’ relative the acquirer’s external financial adviser) of the target’s appetite bargaining positions it is not uncommon for buyers to request for a take-private transaction. Depending on the outcome of that escrow structures. In terms of new trends in the Norwegian PE discussion, the fund will submit to the target a written, confidential, market, there has been a significant uptick in the usage of M&A indicative and non-binding proposal and seek due diligence. insurance (i.e. commercial insurance of warranties and indemnities When the board of a listed company reviews a take-private in the sale and purchase agreement (“SPA”)), which is also used to proposal, it must uphold its fiduciary duties, which include two get rid of the aforementioned escrow mechanisms. elements: a duty of care and a duty of loyalty. The duty of care includes a duty for the board to inform itself, prior to making a business decision, of all material information that is reasonably 5 Transaction Terms: Public Acquisitions available. Consequently, the directors must evaluate a proposed offer or business combination in the light of risks and benefits of the proposed transaction compared to other alternatives reasonably 5.1 What particular features and/or challenges apply to private equity investors involved in public-to-private available to the corporation, including the alternative of continuing transactions (and their financing) and how are these as an independent entity. It is currently not clear under Norwegian commonly dealt with? law to what extent this duty of care requires the board to reasonably inform itself of alternatives or actively seek alternative bidders in Takeover of a publicly listed company is subject to more regulation connection with a business combination transaction. Each director under Norwegian law than takeovers of private companies. Both of a listed company considering a take-private transaction also has the prospective buyer and the targets’ boards must observe a detailed to assess if, and to what extent, they can or should assist in the set of rules and regulations, which among others comprises insider transaction, or if they have a conflict of interest. If a director in the dealings rules, mandatory offer thresholds, disclosure obligations target has a specific interest in a potential bidder, or in a bidder in (regarding ownership of shares and other financial instruments), competition of a first bidder, such director is incompetent and must content limitations for offer documents, filing and regulatory not participate in the handling of issues relating to the bid. approval of offer documents, length of offer periods, employee Take-private transactions in Norway are subject to the same consultations, limitations on type of consideration offered, etc. disclosure issues and requirements as other takeover offers The main challenge in any acquisition, albeit more relevant to take- involving a publicly listed company. The board of a listed target is, private of listed companies, is for the PE fund to secure a sufficient on an ad hoc basis and on its own initiative, required to disclose any level of shareholder support (i.e. 90% or more of the target’s shares information on new facts or occurrences of a precise nature that are and voting rights) in order to carry out a subsequent squeeze-out likely to have a notable effect on the price of the target’s shares or of any remaining minority shareholders. This 90% threshold is of related financial instruments (so-called insider information). This also important since it will be a straightforward process to have is an issue of particular concern for any bidder, as well as for a PE the target delisted from the Oslo Stock Exchange (“OSE”) or Oslo fund. The decision to engage in discussions with a PE fund relating Axess. If not, the process for delisting the target could be far more to a potential take-private transaction and to divulge information complex. In principle, there are several avenues of approach for PE is thus made at the discretion of the target’s board. Confidential houses desirous to taking a publicly listed company private under negotiations with the target’s board at an initial stage are possible, Norwegian law – one of which is to launch a voluntary tender offer with certain constraints, prior to the announcement of the bidder’s to the shareholders. The principal legislation and rules regulating intention to launch a bid, provided the parties are able to maintain takeovers of publicly listed companies is found in Chapter 6 of the confidentiality. However, the fact that a listed company is discussing Norwegian Securities Trading Act (“STA”). One of the beneficial a takeover or a merger (and the content of such negotiations) will at features with a voluntary offer is that, in general, there are no some point constitute inside information that must be disclosed to limitations in law as to what conditions such an offer may contain; the market. The OSE’s Appeals Committee has previously ruled that this affords the PE fund a great deal of flexibility, e.g. with respect confidential negotiations between a potential bidder and the target’s to price, type of consideration and required conditions precedents. board could trigger disclosure requirements, even before there is A voluntary tender offer may be launched at the bidder’s discretion, a high probability of an offer being launched, provided that such and the bidder can also choose to make the offer to only some of conversations ‘must be assumed not to have an immaterial impact the shareholders. A voluntary offer can also be made subject to a on the target’s share price’. Consequently, a potential bidder (like financing condition, although this is rare. a PE fund) and the target’s board must be prepared for a situation A potential bidder will quite often find it challenging to successfully where the OSE takes the view that the requirement for disclosure is conclude a take-private transaction by launching a public bid without triggered at an early stage, possibly from the time the target enters the co-operation and favourable recommendation of the target’s into a non-disclosure agreement allowing due diligence access. The board at some point in the process. The reason being that, as a rule, forgoing notwithstanding, if a target is approached regarding the a bidder who launches a public tender offer for a listed Norwegian potential intentions of launching a bid, this will in itself not trigger target does not have a right to be admitted to due diligence. This any disclosure requirements.
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Under Norwegian law, a publicly listed target can take a more or (following a stake-building process or one or more voluntary offers) less co-operative approach in a takeover situation. Confidentiality has acquired more than ⅓ of the votes in the target, it is (save for agreements between the bidder and the target, allowing the bidder certain limited exceptions) obligated to make a mandatory offer access to due diligence or additional information about the target, for the remaining outstanding shares. After passing the initial ⅓ will often include a ‘standstill’ clause preventing the bidder for threshold, the fund’s obligation to make a mandatory offer for the a specified period from acquiring stocks in the target without remaining shares is repeated when it passes (first) 40% and (then) the target’s consent. If the bidder obtains the target’s support to 50% of the voting rights (consolidation rules apply). Please note recommend a ‘negotiated’ tender offer, it is normal practice for that certain derivative arrangements (e.g. total return swaps) may the parties to enter into a detailed transaction agreement, which be considered as controlling votes in relation to the mandatory (typically) sets out the terms for the target’s support and the offer rules. Of particular concern to PE funds is that the share price Norway main terms for the bidder’s offer. Such transaction agreements offered in a mandatory offer cannot be lower than the highest price also often include a non-solicitation clause granting the bidder paid, or agreed to be paid, by the fund for shares (or rights to shares) some type of limited exclusivity, including a right to amend its in the target during the last six months. In special circumstances, offer and to announce a revised offer to match any alternative or the relevant takeover supervisory authority (i.e. the exchange where superior competing offers that are put forward. The foregoing the securities are listed) may also demand that market price is paid notwithstanding, the Norwegian Code of Practice for Corporate for the shares (if this was higher at the time the mandatory offer Governance (“Code of Practice”) recommends that a target’s obligation was triggered). A mandatory offer must be unconditional board exercise great caution in agreeing to any form of exclusivity. and must encompass all shares of the target. The consideration may The Code of Practice further requires the board to exercise be offered in cash or by alternative means, provided that complete particular care to comply with the requirements of equal treatment and no less favourable payment in cash is always available upon of shareholders, thus ensuring that it achieves the best possible bid demand. The consideration offered under a mandatory offer must terms for all the shareholders. be unconditionally guaranteed by either a bank or an insurance A PE fund may want to use several different tactics to ensure a undertaking (in each case authorised to conduct business in Norway). successful take-private transaction, one of which is stake-building. Getting the necessary finance arrangement in place may also Stake-building is the process of gradually purchasing shares in represent a major hurdle for a bid dependent on significant leverage; a public target in order to gain leverage and thereby increase the in particular when it comes to mandatory offers, since any debt chances of a successful subsequent bid for the entire company financing the bidder relies on in these situations must, in practice, (i.e. the remaining outstanding shares). Purchasing shares outside be agreed on a “certain funds” basis, so that it does not include any an offer may be prohibited if the bidder is in possession of insider conditions that are not effectively within the bidder’s control. information. In addition to the insider dealing rules, a bidder must A PE fund desirous to take private a public target should also seek pay particular attention to disclosure requirements during the stake- support from the target’s management team as early as possible since building process. The disclosure requirements is triggered by any these persons often are required to co-invest together with the fund person owning shares in a company whose securities are listed on a (see question 2.3 above). In connection with structuring of relevant Norwegian regulated market (OSE or Oslo Axess), if their proportion management co-investment arrangements, the principle that all of shares or rights to shares in such company reaches, exceeds or shareholders must be treated equally in a voluntary and mandatory falls below any of the following thresholds: 5%, 10%, 15%, 20%, offer situation imposes some constraints on the terms that can be 25%, ⅓, 50%, ⅔ or 90% of the share capital, or a corresponding agreed with employees that hold (or have options to hold) shares proportion of the votes, as a result of acquisition, disposal or other in the target. At the outset, the PE fund may, without limitations, circumstances. If so, such person must immediately notify the approach an employee of the target and agree upon whatever terms company and the OSE. Breach of the disclosure rules are fined, and desired, provided, of course, that such terms are not contrary to good such fines have grown larger over the years. business practice and conduct, or in violation of rules and regulations Except for the insider dealing rules, disclosure rules, and mandatory pertaining to what considerations a member of a company may or bid rules (see below) there are generally few restrictions governing may not accept in connection with such member’s position in the stake-building. However, confidentiality agreements entered into company. As there are no explicit legal constraints on what can be between a potential bidder and the target can impose standstill agreed regarding severance terms for directors or senior executives obligations on a bidder, preventing acquisition of target shares in the target, entitlements provided under such arrangements are outside the bidding process. Subject to such limitations, the fund likely to be permitted and upheld insofar as the arrangements do not can also attempt to enter into agreements with key shareholders to give such employees unreasonable benefits at the expense of other seek support for a possible upcoming bid. Such agreements can take shareholders in the target. The foregoing is naturally assuming various forms, from an SPA, a conditional purchase agreement, some that no limitations follow from the possible board declarations on form of letter of intent, MoU, etc., or a form of pre-acceptance of a fixing of salaries or other remuneration schemes approved by the potential bid. Pre-acceptances are typically drafted as either a “soft” target’s general meeting. Although not specifically pertaining to or “hard” irrevocable (“Irrevocable”) – the former normally only the aforementioned, please take particular note that Norwegian law commits the shareholder who gives the Irrevocable to accept the restricts the employees’ and directors’ right to accept remuneration offer if no higher competing bid is made, whereas the latter commits from anyone outside the target in connection with their performance the shareholder to accept the offer regardless of whether a subsequent of assignments on behalf of the target. higher competing bid is put forward. It is assumed in Norwegian In relation to the foregoing, it should also be noted that a bidder legal theory that a properly drafted “soft” Irrevocable will not must disclose in the offer document what contact he has had with the trigger the disclosure requirements. When dealing with shareholders management or governing bodies of the target before the offer was directly in take-private transactions, a PE fund will also experience made, herewith including any special benefits conferred or agreed to that shareholders are reluctant to grant extensive representations and be conferred upon any such individuals. Furthermore, when dealing warranties besides title to shares and the shares being unencumbered. with employees who are also shareholders in the target, a bidder should Another challenge in take-private transactions is that if a PE be aware that agreed upon terms and benefits that are not exclusively fund directly, indirectly or through consolidation of ownership related to the employment of such shareholder may, in accordance
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with the principle of equal treatment, be considered as part of the the target is engaged in, i.e. whether it is particularly susceptible to offered share price, thus exposing the bidder to the risk of having the seasonal variations or other cash-flow fluctuations throughout the offer price in the offer document adjusted to such higher amount. year, and the timing of the transaction, i.e. expected closing date. If a Norwegian listed company becomes subject of a take-private Completion accounts remain a common feature if: (i) there is an proposal that materialises in a voluntary or mandatory offer to the expected delay between signing and completion of the transaction; shareholders, the board is obliged to evaluate the terms of the offer (ii) the business being sold is to be carved out from a larger group; and issue a statement to its shareholders describing the board’s (iii) substantial seasonal fluctuation in the target’s need for working view on the advantages and disadvantages of the offer. Should capital is expected; and (iv) a large part of the target’s balance sheet the board consider itself unable to make a recommendation to the refers to “work-in-progress” items. shareholders on whether they should or should not accept the bid, If completion accounts are proposed by a PE fund, it is common to Norway it is to account for the reasons. According to the Code of Practice, base the calculation of the purchase price on the target’s enterprise it is recommended, that the board arranges a valuation for each value adjusted to reflect both (i) the net cash/debt position of bid by an independent expert, and that the board on such basis the target group at completion, and (ii) any deviation from the forms its recommendation on whether or not to accept the offer. normalised working capital level at completion. A seller may also Exemptions apply in situations where a competing bid is made. The propose different variations of this methodology, e.g. by fixing the recommendations of the Norwegian Code of Practice go beyond the purchase price in the SPA but at the same time assuming a “target requirements of the STA. level” of debt and working capital. On rare occasions, other adjustment mechanisms are proposed depending on the target’s industry, e.g. adjustments based on the target group’s net financial 5.2 Are break-up fees available in your jurisdiction in relation to public acquisitions? If not, what other assets, etc. arrangements are available, e.g. to cover aborted deal costs? If so, are such arrangements frequently agreed 6.2 What is the typical package of warranties/indemnities and what is the general range of such break-up fees? offered by a private equity seller and its management team to a buyer? As a starting point, break fees are available in the sense that Norwegian takeover legislation does not contain particular The catalogue of vendor representations, warranties and indemnities provisions prohibiting it. However, due to strict rules regarding offered to prospective buyers varies significantly from transaction to corporate governance and fiduciary responsibilities, the use of transaction, where it more or less comes down to bargaining power break fees is decisively less common in Norwegian public-to- and leverage; if there is great competition for a target, only limited private transactions compared to other jurisdictions. Break fees warranties will be given, and if the target is less sought-after, then a payable by the target can raise issues in relation to compliance with more extensive warranty catalogue may be obtained. the target’s corporate interests and may, in the worst case, trigger The typical packages of warranties and indemnities offered by liability for misuse of the target’s assets. Break fee agreements a PE seller in the Norwegian market can, to some extent, also be limiting the ability of a target’s board to fulfil its fiduciary duties, or influenced from market practices in the fund’s home jurisdiction. It that may put the target in financial distress if the break fees become is, for example, a well-known fact that many UK Sponsors rarely effective, are likely to be deemed unenforceable and, consequently, want to provide business representations and warranties, which may result in personal liability for the board members. Potential means that the PE fund will try to limit the warranty package to financial assistance aspects of a break fee arrangement must also be so-called fundamental warranties (i.e. ownership to shares, valid considered carefully. execution of documentation, etc.). Instead, these sellers will attempt In relation to the above, it should be noted that the Code of Practice to make the buyer rely on its own due diligence and, if possible, by recommends that a target’s board must exercise great caution warranties provided by the target’s management team. This means in agreeing to any commitment that makes it more difficult for that when such Sponsors are attempting an exit of a Norwegian competing bids to be made from third party bidders or may hinder portfolio company, they may attempt to apply the same practice any such bids. Such commitments, including break fees, should be depending on what they expect is the most likely “buyer-universe” clearly and evidently based on the shared interests of the target and for the relevant assets. This being so, such an approach is rarely its shareholders. According to the recommendations, any agreement seen in the Norwegian market, at least if the seller is a Norwegian for break fees payable to the bidder should, in principle, be limited or Nordic PE fund. to compensation for costs incurred by the bidder in making the bid. Throughout 2013 and 2014, sellers in general had to accept a fairly Break-up fees occur, often in a range of 0.8% to 2.0% of the target’s broad set of representations and warranties if they wanted a deal market-cap. Of eight public M&A offers launched in 2016, such to succeed in the Norwegian market, and the warranty catalogue fees were agreed in 12% of the bids. remained at least as extensive in 2015. During this period, buyers often succeeded in broadening the scope of the warranty coverage; 6 Transaction Terms: Private Acquisitions for example, by including some type of information warranties in the contracts. However, exceptions did apply, especially in particular sectors, depending on the parties’ bargaining position. For some 6.1 What consideration structures are typically preferred extremely attractive assets sold through dual-tracks, we also witnessed by private equity investors (i) on the sell-side, and (ii) that PE vendors in some situations managed to get away with a very on the buy-side, in your jurisdiction? limited set of fundamental warranties (only), and where the buyer had to rely completely on a warranty and indemnity insurance. As a general observation, it seems that PE funds on the buy-side In general, the representations and warranties packages offered by often prefer transactions based on completion accounts. When on a typical PE vendor in the Norwegian market will be fairly limited, the sell-side, however, the same funds tend to propose a locked-box but may, at first glance, not look too different from what a strategic mechanism. Having said this, the choice of preferred completion seller may propose in its first draft. mechanics is normally decided on basis of what kind of business
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Foreign Sponsors should note that, historically, it has not been by a buyer in order to achieve a competitive advantage in a bidding very common that Norwegian or Nordic sponsors insist on process). The W&I insurance product has become particularly the Investing Management providing separate management popular among PE funds seeking a clean exit. Such funds have warranties in connection with their co-investments or rollovers. now started to arrange “stapled” buy-side W&I insurance to be If the management team provides such management warranties, made available to selected bidders in structured sales processes. the warranties are often limited in scope. International Sponsors Such insurances have also been used as a tool for the PE fund in unfamiliar with the Norwegian market often find such a practice order to get rid of the escrow clause in the SPA. Typical carve-outs/ strange, and may therefore insist that the Investing Management exclusions under such policies will comprise: pension underfunding; provide such warranties in line with what is common in other projections; transfer pricing issues; anti-bribery; secondary tax jurisdictions. obligations; and uninsurable civil fines or penalties. For more on Norway excess/policy limits, see question 6.5 below.
6.3 What is the typical scope of other covenants, undertakings and indemnities provided by a private 6.5 What limitations will typically apply to the liability of equity seller and its management team to a buyer? a private equity seller and management team under warranties, covenants, indemnities and undertakings? As in most other jurisdictions, a PE fund’s starting point will often be that they do not provide any restrictive covenants. The same Save in respect of vendor liability for locked-box leakage or breach applies for wide confidentiality provisions; the reason being that of specific restrictive covenants, which normally are subject to such clauses may restrict the ability to use knowledge acquired special liability regulations (please see question 6.3), a PE vendor during the lifetime of the investment for future investments. will normally attempt to include several limitations on its potential However, depending on market conditions, and the respective liability for breach of the SPA and its obligations, covenants, party’s bargaining position, most funds are willing to adapt their warranties and indemnities thereunder. Significant variations will “policy” in order to secure the exit, and non-compete and non- apply depending on the market conditions, the parties’ bargaining solicitation clauses between 12 to 24 months are seen. position, the target’s industry sector and individual circumstances. In a Norwegian transaction, it is not customary for a buyer to require Historically, if a PE fund was on the sell-side, it would very often warranties on “an indemnity basis” like in the US, and a seller will start off with proposing a six to 12-month limitation period for the normally resist such an approach and instead provide indemnities for general warranties, and a period of between 12 to 24 months for the specific identified risks. However, indemnities are common in share tax warranties. However, the introduction of the W&I insurance purchase agreements and asset purchase agreements. Indemnities product has led some of the Norwegian funds to become slightly mainly cover potential claims, losses or liabilities that the buyer has more generous with the length of the limitation periods offered in revealed during due diligence and that have not been addressed as their first draft of the SPA. The main reason is that the insurance a “to be fixed” issue or by a price reduction. In general, allPE market is able to offer a 24-month limitation period for the general funds are looking for a complete exit with cash on completion, warranties, and between five to seven years on tax warranties at a and depending on at what stage of the fund’s lifetime the exit takes very little price differences compared to shorter limitation periods. place, such funds will normally seek to resist or limit any form of A PE vendor will typically (but depending on the market conditions) indemnification clauses in the SPA. also start-off with proposing a relatively high “de minimis” (single Nevertheless, as long as the PE fund selling is Norwegian or loss) threshold combined with a basket amount in the upper range Nordic, it has not been common to insist that a buyer relies solely of what traditionally has been considered “market” in Norway for on indemnities provided by the management team. Instead, the PE such limitation provisions. PE funds exiting their investments today funds have tried to accommodate buyer’s requests for indemnities, may also attempt to align the basket amount with the policy “excess but at the same time introduce special caps and deadlines for such amount” under W&I insurance. This typically means an amount potential liability. To the extent possible, the PE vendor might also from 0.5% to 1% of the target’s enterprise value, depending on the attempt to insure all potential liability claims, but some diligence insurance market and which insurance provider is underwriting findings may often be of such nature that insuring it is rather the policy. The standard policy excess amounts offered by the difficult. In some cases the insurance premium is also so high that insurance industry is normally 1% of enterprise value, which is it is better to negotiate an appropriate price reduction. Warranty above historical level of what has been considered market value for and indemnity insurances, including special claims insurances, have the basket-amounts in Norway. While the majority of the deals in however started to become increasingly popular in the Norwegian the Norwegian market traditionally are done with a “tipping basket” market (see question 6.4 below). (whereby the seller is responsible for all losses and not just those exceeding the basket amount), an exiting PE fund may propose a “deductible basket” (whereby the seller is only responsible for 6.4 Is warranty and indemnity insurance used to “bridge the gap” where only limited warranties are given by losses in excess of the basket amount). The result in the final SPA the private equity seller and is it common for this depends on market conditions and the bargaining position of the to be offered by private equity sellers as part of the parties involved. A PE vendor will also normally propose to cap sales process? If so, what are the typical (i) excesses its total liability at the lower end of what is market, for example / policy limits, and (ii) carve-outs / exclusions from by proposing an overall liability cap of 10% of the purchase price. such warranty and indemnity insurance policies? Finally, note that it has thus far not been tradition among Norwegian PE funds, as sometimes seen when international PE Warranty and indemnity (“W&I”) insurance has historically not funds exit investments, to propose a different set of warranties and been a common feature in the Norwegian deal landscape. However, indemnities for the PE fund and the target’s management team (see during 2013, 2014 and 2015, the Norwegian market witnessed a question 6.3) and thereby also a different set of limitation rules substantial growth in the number of transactions in which the seller for the management. However, in the event that the buyer is an or the buyer attempted to use W&I insurance as a way to reach international PE fund and the management team have to rollover agreement on liability under the SPA (or, alternatively, introduced parts of its investments, such international funds may want to
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request that the Investing Management in the co-investment that furnished a seller exclusively by BidCo (by way of copies of agreement/shareholders’ agreement provides the fund with separate a commitment letter or other form of promissory notes issued to representations and warranties (see question 6.3). BidCo) will only be enforceable against BidCo, which normally does not have any funds besides its share capital (in Norway the minimum share capital for a LLC is NOK 30,000). Consequently, a 6.6 Do (i) private equity sellers provide security (e.g. escrow accounts) for any warranties / liabilities, and careful seller will often require a limited right to enforce the equity (ii) private equity buyers insist on any security for commitment letter directly against the PE fund itself. warranties / liabilities (including any obtained from the management team)? 6.8 Are reverse break fees prevalent in private equity transactions to limit private equity buyers’ exposure? Norway As mentioned in questions 4.2 and 6.4, PE vendors will, by virtue If so, what terms are typical? of seeking a clean exit without any clawback or similar post-closing issues, rarely accept security arrangements like escrow accounts Reverse break/termination fees have historically not been prevalent unless absolutely necessary. Depending on the circumstances, in Norwegian PE transactions, and PE funds have rather sought to PE buyers may insist to include escrow provisions into the SPA make their obligation to consummate the transaction conditional as security for sellers’ warranties/liabilities. As with most other upon receiving required financing, without having to pay any elements in a given transaction, however, this comes down to form of fees to the sellers. To what extent sellers are willing to prevailing market conditions and the parties’ relative bargaining accept such conditions normally depends on the market situation positions. It has not been common practice among Norwegian PE and the respective parties’ bargaining positions. Such financing funds to request that the target’s Investing Management in the co- out conditions/clauses have not disappeared in today’s market, but investment agreement/shareholders’ agreement provides the fund sellers tend to resist these types of conditions. with separate representations and warranties (see question 6.3). As Over the last few years, we have observed that the use of reverse alluded to in question 6.5 such arrangements are, however, seen if break fees is on the rise (albeit very slowly), and whereas virtually the buyer is an international PE fund and the management team have no M&A transactions in the Norwegian market included reverse to rollover parts of its investments. break fees a few years ago, our PE clients have regularly, during the last few years, enquired about its feasibility. 6.7 How do private equity buyers typically provide The amount of a reverse break fees is largely a matter for negotiation comfort as to the availability of (i) debt finance, and will therefore vary in each individual transaction. Typically, and (ii) equity finance? What rights of enforcement do sellers typically obtain if commitments to, or however, the fees are agreed at a fixed amount in the range of 1% to obtained by, an SPV are not complied with (e.g. 2.5% of transaction value. equity underwrite of debt funding, right to specific performance of obligations under an equity commitment letter, damages, etc.)? 7 Transaction Terms: IPOs
The sellers’ process letters to PE buyers will normally instruct that 7.1 What particular features and/or challenges should a a buyer’s final bid must be fully financed (i.e. expressly state that private equity seller be aware of in considering an IPO it is not subject to financing), and that the sources thereof must be exit? reasonably identified. If financing is to be provided by external sources, the final bid must also provide the terms and status of all From a PE perspective, three main considerations guide the such financing arrangements (including any commitment letters), determination of whether an IPO exit is the right choice. The first, as well as the contact details of the relevant institutions providing which goes to the very nature of the PE model, is whether the PE financing (the buyer is often requested to inform the institutions that fund through an IPO exit achieves the best possible price for its a seller’s representative may contact them). shares, while at the same time reducing its exposure (shareholding) It has become common that sellers insist that the SPA contains buyer to an acceptable level. A successful IPO often requires that warranties regarding the equity financing commitment (if applicable investing shareholders receive a discount of between 10% and 15% to the transaction). A PE fund is often required to provide an equity on the regular trading price, and the PE fund seldom manages to commitment letter to backstop its obligation to fund the purchasing offload 100% of its shareholding. A clear strategy for continued vehicle (“BidCo”) immediately prior to completion. However, such ownership is thus imperative, especially considering that a larger equity commitment letters will often be addressed to the TopCo in the shareholder’s planned/impending sale (typically upon expiry of string of holding companies that owns BidCo (or to a subordinated relevant lock-up periods) will put substantial negative pressure on HoldCo further down in the string of holding companies). The the share price. Another key element in terms of achieving the best enforceability of such equity commitment letters is most often sales price will be the formulation of a powerful equity story, which, qualified upon a set of conditions, and the PE fund’s liability under in essence, is the sales-pitch and reasoning why investors should the letter is, in all events, capped at a designated committed amount. pick up the share. For PE funds, the equity story highlights the In respect of the above, a seller should note that Norwegian corporate strong sides of the target in a growth perspective, with focus on law adheres to the concept of corporate personhood, whereby a a high appreciation potential – the value perspective, accentuating company is treated as a separate legal person, solely responsible for expectations of low appreciation and high dividends is normally its own debts and promises, and the sole beneficiary of credits it is not relevant for PE-backed portfolio companies. Timing is also of owed. Related parties will thus not incur liability for a company’s essence, and sometimes the window of opportunity is simply closed due to prevailing market conditions. If that is the case, an alternative promises/guarantees, and a Norwegian court of competent approach can be to carry out a private placement in advance – either jurisdiction will only in exceptional circumstances (e.g. in connection in order to raise both new equity and new shareholders, or just for with legal charges of fraud or tax evasion) pierce the corporate veil raising new equity and to take the spread upon the listing itself. through application of the alter ego doctrine. As such, guarantees
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The second main deliberation a PE fund contemplating an IPO exit equity markets but these deals have, during the last few years, often must make is of whether the target is ready, willing and able to go materialised in a sale. public. Irrespective of excellence, the public investor market for the relevant industry sector may simply be saturated, and, in such a situation, a newcomer will most likely struggle severely to get 8 Financing both traction and attention. From an internal point of view, there is also the household tasks of getting procedures and regulations up 8.1 Please outline the most common sources of debt to STA standards and listing requirements, preparing financial and finance used to fund private equity transactions in other pertinent investor documentation, and training management your jurisdiction and provide an overview of the and key personnel, whom frequently have very limited insight into current state of the finance market in your jurisdiction Norway the dynamics and requirements of a public company in terms of for such debt (particularly the market for high yield governance, reporting, policy implementation, etc. bonds). Thirdly, and assuming the target is deemed suitable for listing and Norwegian LBOs generally involve bank debts as the main source that all elements above have undergone careful scrutiny, the PE for financing in the form of term loans and a revolving credit fund must consider whether it is prudent to place all eggs in the facility. In large transactions, the senior loan will be governed IPO basket, or whether it is smarter to initiate a dual track process – either by Norwegian or English law, with one bank acting as an combining the IPO exit with either a structured or a private (bilateral) agent for a lending syndicate. In such syndicated transactions, the sales process. Such a process may either be a “true parallel” (where senior loan agreements used are normally influenced by the forms both routes run parallel and ultimate decision is deferred to final used internationally, in particular the standard forms developed by stages), “staggered” (where the M&A process front-run the IPO the Loan Market Association. A typical leveraged PE structure may, process and ultimate decision is made after receipt of second round depending on the size of the target, contain several layers of debt. bids), or an “IPO-led hybrid” (where both routes’ preparation and Historically, it was quite common to use a combination of senior progress is dictated by the IPO timeline). The process of preference facilities and mezzanine facilities, whereby security is granted to a notwithstanding, the obvious advantages of initiating a dual-track security agent. In certain circumstances, the mezzanine debt was process is a better understanding of market value and investor/ also issued in combination with warrants to purchase equity in the buyer universe, increased flexibility, and reduction of transactional target. However, due to the severe hit mezzanine investors faced risk – each track is effectively the fail-safe of the other. On the during and after the credit crunch, it became difficult to obtain reverse comes added and often concurrent work streams, prolonged such financing at reasonable prices, and many Sponsors started timelines, the inherent risk of prematurely deviating from the dual- to consider mezzanine financing too expensive. Over the last 48 track (which may cause internal friction and stoppages) and, of months, mezzanine financing has rarely been seen in the Norwegian course, the additional advisor costs. market for new transactions. One of the more important reasons for this development has been the development of a very buoyant 7.2 What customary lock-ups would be imposed on Norwegian high-yield bond market, which largely substituted the private equity sellers on an IPO exit? traditional mezzanine facilities. Such transactions would typically involve “bridge-financing commitments” pursuant to which either Although significant variations may apply, Managers are normally a bank or a mezzanine provider agrees to provide “bridge” loans in subject to a 180-day lock-up period from listing (the last couple of the event that the bond debt cannot be sold prior to completion. Due years we have seen examples as high as 360 days). Lock-up periods to a rapid decline in oil prices during 2014 and 2015, the Norwegian for co-investing management are somewhat less common, but, if high-yield bond market took a severe hit from October 2014 and imposed, tend to range in the region of 360 days. onwards throughout most of 2016. However, at the beginning of 2017, the Norwegian high-yield bond market started to improve 7.3 Do private equity sellers generally pursue a dual-track significantly, at least within certain selected industries. exit process? If so, (i) how late in the process are For the last year, we have also started to see increased activity private equity sellers continuing to run the dual-track, from non-bank (alternative) lenders and funds which are offering and (ii) were more dual-track deals ultimately realised to replace or supplement traditional senior secured bank loans. The through a sale or IPO? products these lenders are offering typically include term loan B facilities, unitranche loans, etc. Private equity sellers’ preferences for dual-track processes is generally subject to equity market momentum (i.e. that the capital market may offer superior valuation to M&A alternatives) but where 8.2 Are there any relevant legal requirements or an IPO valuation could be close to LBO valuations, and where the restrictions impacting the nature or structure of the debt financing (or any particular type of debt lead buyer(s) is less clear. Under such circumstances, dual-track exit financing) of private equity transactions? processes are used to maintain flexibility, to help maximise valuation and for de-risking a potential IPO. Dual-track exit processes allow Until 1 July 2013, when the Norwegian Parliament approved the sellers maximum visibility, and the decision on the M&A track amending the previous strict ban on financial assistance, Norwegian should be resolved a short time ahead of launching the company’s targets (public and private alike) were generally prohibited from intention to float (“ITF”) since investors do not focus during pre- providing upstream financial assistance in connection with the deal investor education sessions until clarity on the winning track acquisition of themselves or their parents. From the outset, is announced. Consequently, a second round M&A process will this prohibition prevented such targets from participating as co- normally run parallel to research drafting under the IPO-track. The borrowers or guarantors under any acquisition-financing facilities, decision on the winning track is often taken shortly before roadshow but, in practice, there were a number of ways (not considered as launch under the IPO-track. Whether dual-track deals are ultimately breach of the prohibition) to achieve at least a partial debt pushdown realised through a sale or IPO depends on the momentum in the post-takeover through refinancing of the target’s existing debt.
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Under the rules of 2013, which introduced a type of ‘whitewash’ sufficient when issuing an intra-group guarantee, even if there is no procedure, both private and public targets can now (subject to certain direct benefit to the individual group company issuing the guarantee. conditions) provide funds, offer loan/credit arrangements and grant Finally, PE funds’ use of various forms of shareholder loans and inter- security in connection with an acquisition of shares (or share rights) company debt, supported by various intra-group guarantees in LBO in themselves of their parents, but only within the limits of what transactions, could also trigger a need for shareholder approval in such target otherwise legally could have distributed as dividends. the various group companies in order to be valid. This could turn If granted, financial assistance must be provided on commercial out to be necessary unless such loans are entered into as part of the terms and conditions, and a buyer must deposit “adequate security” relevant subsidiaries’ ordinary course of business activity and contain for its obligation to repay such assistance received. Furthermore, prices and other terms that are normal for such agreements. In legal the assistance must be approved at the target’s general meeting by theory, it has, however, been argued that intra-group loan agreements Norway a special resolution, which requires the same majority as needed entered into in connection with M&A transactions very often must to amend the articles of association (i.e. ⅔ of the shares and votes be considered to fall outside the normal business activity of the represented, unless the articles of association contains stricter voting respective company receiving such financing and, therefore, under requirements). In addition, the target’s board must prepare a special all circumstances must be approved by such company’s shareholders. report that contains information on: (i) the proposal for financial assistance; (ii) whether or not the assistance will be to the target’s corporate benefit; (iii) conditions that relate to the completion of the 9 Tax Matters transaction; (iv) the impact of the assistance on the target’s liquidity and solvency; and (v) the buyer’s price for the shares (or rights to shares) in the target. This report shall be attached to the summons 9.1 What are the key tax considerations for private equity investors and transactions in your jurisdiction? Are for the general meeting and for public LLCs, the report must also off-shore structures common? be registered with the Norwegian Register of Business Enterprises (RBE) before the assistance is provided. For governance purposes, Key tax considerations relating to Norwegian PE acquisitions the target’s board is finally required to obtain a credit rating report typically include: (i) quantification of the tax costs associated with on the party receiving the assistance. the acquisition; (ii) management of tax charges of the target group; The rule’s requirement for depositing ‘adequate security’ for the (iii) exit planning (including a partial exit); and (iv) tax-efficient target’s borrower’s obligation to repay any upstream financial compensation to the management of the target group. Most Sponsors assistance provided by a target in connection with M&A operating in the Norwegian market quite commonly use off-shore transactions, means that it is quite impractical to obtain direct structures for achieving a tax-efficient acquisition structure. financial assistance from the target in most LBO transactions, due Costs of acquisition to the senior financing banks’ collateral requirements in connection with such deals. Consequently, in practice, the rules have had No stamp duties, share transfer taxes or other governmental fees little impact on how LBO financing is structured under Norwegian apply in connection with a share sale under Norwegian law. The law, at least in PE LBO transactions. Therefore, in most cases, tax treatment of transaction costs depends on whether these are the parties continue to pursue debt pushdowns by refinancing the classified as costs for acquisitions/disposals, operating costs, or debt target’s existing debt, the same way as previously adopted. Note financing costs. that in early 2016, the Ministry of Trade, Industry and Fisheries As a general principle, all transaction costs incurred directly in proposed to amend the current requirement for adequate security. connection with an acquisition of shares should be capitalised for If the Ministry’s proposal is finally adopted by Parliament as both accounting and tax purposes with the acquired shares. This originally proposed, it means that it will also for LBO-transactions means that the costs are non-deductible for corporation tax purposes. become possible for a buyer to receive financial assistance from the Instead, transaction costs related to the acquisition should be added target in the form of security for that buyer’s acquisition financing. to the tax base cost of the shares, and may therefore reduce any From 1 July 2014, Sponsors must also ensure that they observe capital gain arising upon a subsequent disposal (to the extent the the anti-asset stripping regime that is set out in the new Act on disposal is not covered by the Norwegian participation exemption Alternative Investment Fund Managers (see question 10.2). These rules). Note that according to the Norwegian participation exemption rules may limit the sponsor’s ability to conduct debt pushdowns, rule, Norwegian shareholders being limited companies and certain depending on the status of the target (listed or non-listed), the similar entities (corporate shareholders) are generally exempt from number of employees in the target and the size of the target’s tax on dividends received from, and capital gains on the realisation revenues or balance sheet. of, shares in domestic or foreign companies domiciled in EU and EEA member states. Losses related to such realisation are not tax- Further note that the power of a Norwegian entity to grant security deductible. Since normally both the target and BidCo used by the or guarantees may, in some situations, also be limited by the doctrine PE fund will be LLCs domiciled in Norway, the acquisition costs in of corporate benefit. Under Norwegian law, it is uncertain if a group connection with a share-deal will not effectively be deductible under benefit is sufficient when there is no benefit to the individual group the current Norwegian tax regime. company; for example, in connection with such individual group company granting a guarantee or providing a security. Previously, Notwithstanding the above, certain expenses incurred by a company it has been assumed that Norwegian companies are able to provide in connection with the ownership of shares/subsidiaries (i.e. costs upstream and cross-stream guarantees, provided that: (i) this will for corporate management and administration, strategy work and not jeopardise its continuing existence; (ii) its corporate objects are planning, marketing costs, financing costs, restructuring costs, etc.) not transgressed by such transactions; (iii) it can be argued that such may be deductible on a current basis for corporate tax purposes cross guarantees benefiting the Norwegian company exist or that the under Norwegian law. Taking effect from 1 January 2016, a rule relevant group company receives any type of guarantee fees; and was implemented clarifying that broken-deal expenses incurred in (iv) such guarantees and securities are not in breach of the financial connection with failed acquisitions of shares in another company assistance propitiation. However, an amendment to the Companies (typical expenses relating to due diligence) is no longer deductible Acts from 2013 now seems to indicate that a group benefit may be for tax purposes.
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In principle, costs of arranging the financing (i.e. fees in connection borrowing company, or (ii) a pledge or charge over that related- with obtaining and maintaining debt, bank charges and associated party’s outstanding claims towards the borrowing company. For advisory/legal fees) will be deductible, but must be spread over security in the form of claims towards the borrower, it is not the period of the loan as an interest expense (i.e. amortised). The required that such claim is owned by a parent company. Negative deductibility of such costs may, however, become subject to the pledges provided by a related-party in favour of a third-party lender Norwegian interest-deduction limitation regime (see below). are not deemed as security within the scope of the interest limitation The acquisition vehicle will, in addition, seek to maximise its rule. Consequently, in a situation where the acquisition vehicle is recovery of VAT incurred in acquiring the target (particularly in excessively leveraged from a tax point of view, any interest over relation to advisory fees). This is a difficult area that has started and above the limitation rules will be non-deductible. Further to attract increased scrutiny from the Norwegian tax authorities. restrictions to the interest deduction are expected to be implemented Norway The tax authorities will now argue that input VAT on advisory fees in the coming years. In this regard also note that the EFTA in relation to acquisition of shares in general is not recoverable/ Surveillance Authority has resolved to challenge the Norwegian deductible for VAT purposes. interest limitation rules (see below under question 9.4). Target group tax management Also note that the acquisition vehicle itself is unlikely to have profits against which to offset its interest deductions. Therefore, it is critical In order to reduce the buyer’s effective tax rate, PE funds are for the Norwegian holding companies in the acquisition structure desirous to offset the interest costs on the acquisition debt against to be able to offset its interest expenses against the possible profits the operating target group’s taxable profit. Consequently, the generated by the target’s operations. Norwegian companies cannot acquisition structure is normally established to maximise the file consolidated tax returns or form fiscal unities, but a transfer of amount of financing costs that can be offset against the operating taxable income within an affiliated group of Norwegian entities is profit of the target group. Where the target group is multinational, possible through group contributions in order to offset taxable profits the fund will also desire that such costs can be “pushed down” into against tax losses in another Norwegian entity. It is possible to grant the jurisdiction that has profitable activities without imposition more group contribution than taxable income, but the grantor company of additional tax costs such as withholding taxes. Additional tax will not be able to deduct the excess amount. This excess amount, minimisation techniques may also be used to manage the target which is not deductible for the grantor, would equally not be taxable group’s tax charge. Parts of the PE fund’s investment may also for the recipient. The distributable reserves form the limit for total be made in the form of shareholder loans, which may generate group contribution and dividend distribution. In order to enable group additional tax deductions, provided this can be structured in a way contributions, the contributing and receiving entities must be corporate that current tax liabilities are not imposed on the fund’s investors entities taxable in Norway, an ultimate parent company must hold more and sponsors in some form of phantom income. than 90% of the shares and voting rights of the subsidiaries (either Historically, under Norwegian law, interest arising on related party directly or indirectly) at the end of the parent’s and the subsidiaries’ debt was considered deductible for tax purposes to the extent that the fiscal year, and the companies must make full disclosure of the quantum and terms of the debt was arm’s length in nature. Over the contribution in their tax returns for the same fiscal year. last years, the Norwegian tax authorities have taken an increasingly Norway does not levy withholding tax on interest payments to aggressive approach in challenging leveraged structures, in foreign lenders, nor on liquidation dividends to foreign shareholders. particular by challenging the substance of non-Norwegian holding Nevertheless, see below under question 9.4 with regard to expected company structures, distributions out of liquidation and the tax changes to the current tax regime. Normally, in a typical LBO it will deductibility of interest on shareholder debt. From the income year not be envisaged that any dividends will be made by the Norwegian 2014, a new rule limiting the deduction of net interest paid to related holding company structures during a PE fund’s investment period parties also entered into force. Additional restrictions to this rule except in respect of potential partial exits. However, in the event were later implemented. From 1 January 2016, the limitation rule that any distributions from the Norwegian holding company broadly caps the interest deductions on loans from related parties structure are required prior to exit, Norwegian withholding tax to 25% of the borrower’s “taxable earnings before interest, tax, on dividends will need to be considered. The potential applicable depreciation, and amortisations”. The rule aims to eliminate, or withholding tax rate depends on the respective tax treaties and reduce the risk of, the Norwegian base being excavated as a result (typically) on the foreign shareholder’s ownership percentage in of tax planning within international groups where the debt has been the Norwegian holding companies. No withholding tax is imposed allocated to the Norwegian group companies. The term “related- on dividends or liquidation dividends paid by a Norwegian LLC party” covers both direct and indirect ownership or control, and the to an EEA-resident corporate shareholder, provided the shareholder minimum ownership or control required is 50% (at any time during is genuinely established and conducts real business activity in the the fiscal year) of the debtor or creditor. Please note that a loan from relevant jurisdiction. Furthermore, the EEA-resident corporate an unrelated party (typically a bank) that is nevertheless secured by shareholder must be comparable to a Norwegian LLC. In this a guarantee from another group company (i.e. a parent company context, an assessment must be performed to determine whether the guarantee) will also be considered as an intra-group loan coming company is genuinely established pursuant to a business motive and under these rules. Companies with total interest expenses (both that the establishment is not purely tax-motivated. The assessment internal and external) of NOK 5 million or less are not affected by will differ according to the nature of the company in question, and it these limitation rules. is assumed that the assessment of a trading company and a holding According to a regulation adopted by the Ministry of Finance, company will not be the same. If such criteria are not met, then the interests paid under a loan secured by a related-party is not subject withholding tax rate in the applicable double-taxation treaty for the to the interest limitation rule if the security is a guarantee from the relevant jurisdictions involved will apply. Also note, if such a foreign related-party of the borrowing company, and such related-party holding company is considered an agent or nominee for another real is a subsidiary owned or controlled by the borrowing company. shareholder (not a legal and economic owner of the dividends) or a The same exemption applies on loans from a third party secured pure conduit company without any autonomy to decide what to do by a related-party of the borrowing company if such related-party with its income, the Norwegian tax authorities may apply the default security is either (i) a pledge over that related-party’s shares in the 25% withholding tax rate (i.e. not accept treaty protection). Foreign
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buyers of Norwegian assets should thus be cautious when setting up acquisition structures and include tax reviews of any prior holding 9.2 What are the key tax considerations for management structures when conducting due diligence. teams that are selling and/or rolling-over part of their investment into a new acquisition structure? Also note that dividends received by a Norwegian company on business-related shares in group subsidiaries within the EEA held The key tax considerations for Investing Management selling and/or directly or indirectly with more than 90% inside the EEA are also rolling over part of their investment into a new acquisition structure, exempted from Norwegian corporate tax on the part of the receiving includes: corporate shareholders. However, a 3% claw-back rule will apply ■ Rollover relief: to dividends received by corporate shareholders holding less than 90% of the shares as well as to foreign corporate shareholders ■ For individual shareholders, as a starting point no statutory Norway having a permanent establishment in Norway that receive dividends rollover relief exists that allow shares to be exchanged for shares without crystallisation of a capital tax charge. from Norwegian companies, subject to such foreign corporate shareholders participating or carrying out business in Norway to ■ If Investing Management has invested through a separate which such shareholdings are allocated. Under such circumstances, holding company or pooling vehicle, the Norwegian participation exemption rule will allow rolling over 3% of such dividends are subject to Norwegian taxation as ordinary part of such investment into a new acquisition structure income at a tax rate of 24% (reduced from 25% as per 1 January without triggering capital tax charges. 2017) (giving an effective tax rate of 0.72%). ■ Subject to certain conditions being fulfilled, a rollover- Exit planning relief could be achieved in cross-border transactions also In general, it is of vital importance to PE funds that all potential exit for individual shareholders. scenarios are anticipated and planned for when formulating the final ■ Exchanging shares for loan notes: acquisition structure. This means that the advisors needs to consider ■ For individual shareholders, this will not qualify for a full exit, partial exit, IPO, etc. rollover relief, and will attach a tax charge. As described above, the ultimate parent company in the acquisition ■ If the selling management team’s investment is structured structure will quite often be a non-Norway resident entity. Non- through separate holding companies or a pooling vehicle, Norway domiciled carried interest holders are thus able to benefit exchanging shares for loan notes will under the Norwegian from the remittance basis of taxation in respect of carried interest participation exemption rule, as a starting point not trigger distributions arising from an exit. Having said this, it is nevertheless any tax charges. critical that any exit can be structured in such way that it does not Other key issues that need to be considered are: to what extent trigger any withholding tax or other tax leakages and, where possible, any members of the team will be subject to tax if the target or the that any exit proceeds can be taxed as capital gains for investors, carry PE-fund makes a loan to members of the team to facilitate the holders and management. As described earlier, Luxembourg holding purchase of equity. Will tax and social security contributions be companies (LuxCo) are often used to achieve such objectives. due if such loans are written off or waived by the lender? Note Executive compensation that from 1 January 2016, loans from a Norwegian company to any of its direct or indirect shareholders being private individuals (or In addition to receiving salaries, which under Norwegian law to such shareholders’ related parties) will be taxed as dividends on is subject to income tax and national insurance contributions in the part of such individual shareholder (see question 9.4 below). the normal way, members of the target’s management team (the Investing Management must also consider if any restrictions to Investing Management) will normally also be offered an opportunity the transferability and other terms at which new shares/financial to subscribe for shares in BidCo. To the extent that the Investing instruments will be acquired may affect the income tax treatment of Management pays less than the market value of such shares, this such instruments. Too close links to the employment can lead to the could give rise to an employment tax charge (see above under re-characterisation of the income/gains from such instruments. For question 2.3). As employers’ contributions to the social security tax more issues, please see questions 2.3 and 9.1 above. are deductible, the effective rate for the employer should be lower. Normally, the PE fund will split its investment between ordinary equity and preferred equity or debt, while the Investing Management 9.3 What are the key tax-efficient arrangements that are invests in ordinary shares. As a result of this, the ordinary shares typically considered by management teams in private equity portfolio companies (such as growth shares, will normally have a low initial market value, but with the potential deferred / vesting arrangements, “entrepreneurs’ to appreciate significantly if the acquired business generates the PE relief” or “employee shareholder status” in the UK)? fund’s desired IRR. In order to avoid accusations that the Investing Management were allowed to subscribe their shares at a price lower The most common tax-efficient arrangement considered by than market-price, it is fairly normal that the value of the Investing management teams in private equity portfolio companies is to Management’s shares is confirmed by a valuation carried out post- structure the managements’ equity participation via private holding acquisition. It is further not uncommon that particular foreign PE companies to benefit from the Norwegian participation exemption funds require that members of the Investing Management accept rule. Under Norwegian law, arrangements such as growth shares an appropriate indemnity in the shareholders’ agreement to cover and deferred/vesting arrangements may entail a risk that parts of any any potential employment tax obligations arising as a result of the capital gains will be subject to employment income tax and social Investing Management’s equity investment. security, although this liability will only arise when such shares Any employment taxes arising because of Investing Management are sold, provided such shares when acquired were acquired or obtaining shares at a discount must be reported to the Norwegian subscribed at their fair market value. If, however, such securities are tax authorities immediately after the transaction in the relevant tax considered discounted, such discount will be chargeable to income period. tax at the relevant employee’s marginal tax rate and will be subject to social security tax.
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No similar rules to the UK “entrepreneurs’ relief” exist under by ensuring that companies established in Norway will under no Norwegian law. International PE-funds may still want to structure circumstances be “stateless”. their management investment programs in Norwegian portfolio Further note that from 1 January 2016, a new rule was implemented companies to meet the conditions for such reliefs in case existing into Norwegian law which attempts to neutralise the effects of or future members of the investing management team would qualify hybrid mismatch arrangements by denying corporate shareholders for such relief due to their current tax domicile. to apply the Norwegian participation exemption rule on distributions received from an entity which has been, or will be, granted tax 9.4 Have there been any significant changes in tax deduction on such distributions. legislation or the practices of tax authorities Members of management teams should also note that from 7 October (including in relation to tax rulings or clearances)
Norway 2015, loans granted from a Norwegian company to any of its direct impacting private equity investors, management or indirect shareholders being private individuals (or to such teams or private equity transactions and are any anticipated? shareholders’ related parties) shall be taxed as dividends on the part of such individual shareholder. This rule will also apply on loans granted from third-party lenders to such individual shareholders, There are no explicit Norwegian tax regulations regarding provided the company in which such borrower owns shares and/ distribution of Carry to the managers in exchange for their services, or another company within the same group of companies, provides and the prevailing view was until recently that insofar such managers invest capital into the funds, the Carry must be considered security for such third-party loans. capital gains and taxed at capital gains rates, and if the Managers are organised as LLCs, such corporate shareholders’ income in 10 Legal and Regulatory Matters form of dividends and gains on shares/ownership interest in other companies would also be exempt from taxation in accordance with the Norwegian exemption method. 10.1 What are the key laws and regulations affecting In the past few years, Norwegian tax authorities started to challenge private equity investors and transactions in your the above view by seeking to treat Carry as ordinary income and jurisdiction, including those that impact private equity transactions differently to other types of transaction? thus subject to income taxation (which is higher than taxation rates for capital gains). This culminated in a legal process between the tax authorities, a Manager called Herkules Capital and the The main statutory framework regulating PE transactions and Manager’s three key executives and ultimate shareholders (the “Key M&A in Norway consists of the Private Limited Liability Executives”), which in November 2015 found its conclusion when Companies Act, the Public Limited Liability Companies Act, and the Norwegian Supreme Court rejected the tax authorities’ attempt the Partnership Act. Tender offers and other transactions involving to reclassify Carry from capital gains to personal income for the Key public companies whose securities are listed on a regulated market Executives. place (i.e. the Oslo Stock Exchange and the Oslo Axess list) are furthermore subject to the Securities Trading Act and the Securities In 2013, the District Court rejected the tax authorities’ primary Trading Regulation. The foregoing corporate-specific framework is claim that Carry must be considered as income from labour subject on a case-by-case basis supplemented by various and more general to income taxation. The court also rejected the tax authorities’ regulations found, inter alia, in the Contracts Act and the Sales argument that distributions from a PE fund to the Key Executives of Goods Act (both applicable to most contracts), the Income Tax must be subject to payroll tax (14.1%). The District Court Act and the Accounting Act (both pertaining to transactional tax concurred, however, with the tax authorities’ alternative claim that Carry is subject to Norwegian taxation as ordinary corporate income considerations), the Competition Act (which also covers antitrust), for the Manager at the then prevailing tax rate of 28% (now 24%). and the Employment Act. On appeal, the decision was overturned and the Norwegian Court As Norway is a member of the EFTA and the EEA, most EU- of Appeal upheld the tax authorities’ original tax assessment, i.e. regulations pertaining to M&A transactions have also been that Carry must be considered as corporate income for the Manager, implemented in Norwegian law, thus subjecting cross-border salary income for the Key Executives, and that that the distribution to transactions within the EU (involving publicly listed companies) to the Key Executives accordingly was subject to payroll tax. Finally, strict antitrust regulations promulgated and enforced by the European the court ordered the Key Executives to pay 30% penalty tax on Commission (“EC”) and the EFTA Surveillance Authority. With top. In November 2015, the Norwegian Supreme Court overturned respect to the foregoing, the Competition Act has corresponding the Court of Appeals and invalidated the tax authorities’ assessment. merger control provisions that authorise the Norwegian Competition The Supreme Court concluded that Carry (in this case) should be Authority to intervene against anti-competitive concentrations; considered as ordinary corporate income at the then prevailing therefore, from a practical perspective, the ‘one-stop shop’ principle tax rate of 28% (now 24%), but that such an income could not be formulated in Council Regulation No. 139/2004 effectively considered as salary income for the Key Executives. As such, there averts unnecessary cross-review. Other relevant EU-regulations could neither be a question of payroll taxes. implemented in Norwegian law include the Prospectus Directive, the In October 2015, the Ministry of Finance proposed a tax reform Takeover Directive, the Transparency Directive, the Market Abuse to address tax evasion, see below under question 11.1. In this Directive, and the Markets in Financial Instruments Directive. document it is, among others, proposed to implement a rule allowing the government to introduce withholding tax on interest and royalty 10.2 Have there been any significant legal and/or payments. The government also intends to implement further regulatory developments over recent years impacting restrictions on the interest deduction limitation regime (see below). private equity investors or transactions and are any In addition, the government proposed to implement a rule stating anticipated? that all entities established and registered in Norway, according to Norwegian law, shall be considered to have Norwegian tax domicile, As indicated in question 3.1, the regulations stipulated in question unless a tax treaty with the other state leads to a different result. The 10.1 are supplemented by the Alternative Investment Fund Managers purpose of this rule is to reduce the possibility for treaty shopping Directive (“AIFMD”).
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The AIFMD was implemented in Norwegian law on 1 July 2014 (the “Act”), and applies to managers of all collective investment 10.3 How detailed is the legal due diligence (including vehicles (irrespective of legal structure, albeit not UCITS funds) compliance) conducted by private equity investors prior to any acquisitions (e.g. typical timeframes, that call capital from a number of investors pursuant to a defined materiality, scope etc.)? Do private equity investors investment strategy (alternative investment funds (“AIF”)). engage outside counsel / professionals to conduct all There are two levels of adherence under the Act. The first is a general legal / compliance due diligence or is any conducted obligation to register the AIF-manager with the Norwegian FSA and in-house? provide the agency with information, on a regular basis, regarding: the fund’s investment strategy; the main category of instruments it In a structured process, PE investors tend to limit diligence scope and invests in; and the largest engagements and concentrations under its timeframe (i.e. only key issues/areas of interest) and only request a Norway management. Failure to comply with these reporting requirements very limited and preliminary “red-flag” legal due diligence report may induce the Norwegian FSA to demand immediate rectification, on the target. This is simply an economic (cash-saving) approach, or to impose a temporary ban on the manager’s and the fund’s allowing the fund to show interest and get to know the target more activities. The foregoing applies to all AIFs, whereas the second intimately without ‘burning cash’ on what may turn out to be an level of adherence (see below) only applies to funds that have either uninteresting or too costly object. If the fund is invited into the final (a) a leveraged investment capacity exceeding €100 million, or (b) an bid round of an ‘auction’ process, and provided only few bidders unleveraged investment capacity exceeding €500 million, and where remain in contest, the diligence field is opened up, and PE funds its investors do not have redemption rights for the first five years of normally ask its advisors to prepare a more complete diligence investment. Where an AIF exceeds these thresholds, the manager report on legal, financial, commercial and compliance matters. must, in addition to the reporting requirements above, obtain Further, on compliance diligence, see question 10.4. The level of authorisation from the Norwegian FSA to manage and market the scope, materiality, etc. will depend on certain associated factors, fund’s portfolio, herewith conducting its own risk assessments, etc. like whether the fund has obtained exclusivity, whether the target From a transactional point of view, and particularly with respect to is reputable or otherwise familiar to the investors, the equity, debt (new) obligations for PE actors operating in the Norwegian market, and liability history of the target, the prevailing M&A market (to the Act stipulates the following points of particular interest: the first is some extent, the warranty catalogue reflects the diligence process), disclosure of control in non-listed companies, and stipulates that if a and so forth. fund, alone or together with another AIF, acquires control (more than PE funds normally always engage outside expertise to conduct 50% of votes) in a non-listed company with 250 or more employees and diligence in connection with LBO-transactions. This will normally either revenues exceeding €50 million or a balance sheet exceeding also be a requirement from the senior banks in order to finance €43 million, the manager must, within 10 business days, inform such transactions. Even if the fund has in-house counsel, outside the Norwegian SFA. Exempt from the forgoing are acquisitions expertise is engaged so that the fund’s investment committee can of companies whose sole purpose is ownership or administration make informed decisions on the basis of impartial, qualified and or real property. The notification must include information about independent advice. when and how control was acquired, shareholdings and voting rights of the target, any planned undertakings to avoid potential conflicts of interest and planned communication strategy vis-à-vis 10.4 Has anti-bribery or anti-corruption legislation impacted private equity investment and/or investors’ investors and employees. The target and its residual shareholders approach to private equity transactions (e.g. shall also be informed about the fund’s strategic plans and how the diligence, contractual protection, etc.)? acquisition potentially may affect employees. Please note that the same disclosure requirements, according to the rules, also apply if In our experience, particular Pan-European and global funds an AIF acquires control of a listed target company, irrespective of, have, in the last few years, increased their focus on and concerns inter alia, such target company’s number of employees, revenues about regulatory and compliance risk in their diligence exercises. and balance sheet. Secondly, and ensuing an acquisition described For some of these funds, it has become standard to request legal above, the manager is under duty to inform the Norwegian SFA advisors to prepare separate anti-bribery reports to supplement within 10 business days if and when the fund’s shareholdings in a the regular diligence report, often also accompanied by a separate target either reaches, exceeds or falls below 10%, 20%, 30%, 50% environmental, social and governance (“ESG”) report. Some of the or 75%. The third point of interest, legislated through the Act, is funds also require that the sellers provide separate anti-corruption that a manager, during the 24-month period following acquisition, and anti-bribery warranties in the SPA. more or less is prohibited from facilitating, supporting or instructing any distribution, capital reduction, share redemption or acquisition Previously, Norwegian funds were more relaxed and it was not of own shares of the target (portfolio company) (the so-called “anti- market practice to request such special reports. Now, this seems to asset-stripping” rules). The foregoing applies if either: (a) target’s slowly change, and on the diligence side we see a continuing focus net assets, pursuant to the last annual accounts are, or following such on legal compliance because regulators in general have become distribution would become, lower than the amount of subscribed more aggressive in pursuing enforcement of bribery, corruption and capital plus reserves that cannot be distributed subject to statutory money laundering laws. regulation; or (b) such distribution exceeds the target’s profit for From a contractual (SPA) point of view, it should also be noted the previous fiscal year plus any subsequent earnings/amounts that providers of W&I insurance normally, probably by virtue of allocated to the fund, less any losses/amounts that must be allocated great damage potential and the inherent difficulty (impossibility) of to restricted funds subject to statutory regulation. Also, note that examining facts through its own underwriting process, will, with the above anti-asset stripping provision will apply to such fund’s some exemptions, refuse coverage for any seller warranties assuring acquisitions of listed target companies irrespective of the number of compliance with and absence of anti-corruptive behaviours. As employees, size of revenue or balance sheet for such listed targets. can be expected, this creates a disharmony in PE due diligence The so-called anti asset stripping provisions could, to an extent, (cf. above) and the concurrent or ensuing SPA negotiations, where affect a PE fund’s ability to conduct debt-pushdowns in connection both parties (in principle) are open for relevant representations and with LBOs going forward. warranties in relation to anti-bribery/anti-corruption being included,
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but where the vendor cannot abide for the sake of a clean exit (which proposed tax reform to address tax evasion originally published the buyer reluctantly can appreciate). back in October 2015 (cf. question 9.4 above). In the fiscal budget, the government proposed a further lowering of the corporate tax rate from today’s 25% down to 24% to take effect from 1 January 2017. 10.5 Are there any circumstances in which: (i) a private equity investor may be held liable for the liabilities of At the same time, the government proposed to increase the tax the underlying portfolio companies (including due to burden on dividends received from, or capital gains derived from, breach of applicable laws by the portfolio companies); the realisation of shares held by Norwegian private individuals and (ii) one portfolio company may be held liable for from today’s 28.75% to 29.76%. The corporate tax rate for 2018 the liabilities of another portfolio company? is expected to be reduced further down to 23% (instead of 22% as originally proposed). Norway The general rule under Norwegian law is corporate personhood, Back in 2015, the government also stated that it intended to follow up whereby a portfolio company alone is held accountable/liable for and introduce further amendments based on recommendations made its own acts and omissions – i.e. a Norwegian court of competent by OECD’s project relating to ‘Base Erosion and Profit Shifting’, jurisdiction will only pierce the corporate veil in exceptional in particular with regard to the arm’s-length principle, anti-hybrid circumstances. rules, and the definition of permanent establishment, etc. As part From this general point of basis flows certain limited, but important of this, in March 2016, a professor appointed by the Ministry to exceptions, namely that a parent company or a controlling shareholder propose a general anti-tax avoidance rule issued his text for such a may be held independently liable for its subsidiary’s liability if it has rule, which is currently under evaluation by the Ministry of Finance. contributed to a wrongful act through a controlling interest in the Furthermore, the government has also stated that it intends to submit company (see question 3.6). For practical purposes, such liability a consultation paper for amending the Norwegian controlled-foreign- can be divided into ‘criminal liabilities’ and ‘civil liabilities’. companies (“CFC”) rules. Such consultation paper will, however, In the criminal liabilities category falls anything that a portfolio most likely not be issued until the beginning of 2017. company may do or refrain from doing, which carries the potential Further note that in its original proposal for a tax reform addressing risk of criminal prosecution. In respect of publicly listed companies, certain tax evasion techniques, issued in October 2015, the and thus relevant in relation to IPO exits or public-to-private government stated that it intended to implement further restrictions transactions, such ‘criminal liability’ may arise in connection with on the interest deduction limitation regime and to adopt a rule market manipulation (undertaken in order to artificially inflate or allowing the government to introduce withholding tax on interest deflate trading price of listed shares),insider dealing or violation of and royalty payments. In this regard, the government also stated relevant security trading regulations (e.g. wilful misrepresentation that that it wanted to consider if all external debt should be included or omission of certain information in offer documents). If a portfolio in the interest-limitation rule, i.e. disallowing tax deductibility on company violates such regulations, and its PE investor (either on its interest payments on external bank financing too. Nevertheless, own, through the violating portfolio company or through another in the proposal for the 2017 fiscal budget, the government did portfolio company) transacts in securities affected thereby, there is not follow up on these previous proposals. The government may, tangible risk that the PE investor will be identified with its portfolio however, at a later stage, resolve to reintroduce such proposals. company (i.e. the shareholder should have known), and thus held Norwegian interest limitation regime challenged by the EFTA liable for the same transgression(s). Surveillance Authority In the category of ‘civil liability’ (meaning that liability usually On 25 October 2016, the EFTA Surveillance Authority issued a is limited to fines or private lawsuits), the same consolidation reasoned opinion, stating that the Norwegian interest limitation (identification) rules may come to play if a portfolio company rules of 2014 in its current form violates the freedom of violates, e.g. applicable antitrust or environmental legislation. establishment, and thereby Article 31 in the EEA Agreement. The Over recent years, we have seen very few, but disturbing, EFTA Surveillance Authority is of the opinion that the Norwegian examples of decisions by Norwegian courts in which it was ruled interest limitation rules are deterring Norwegian companies from that environmental liability of a subsidiary (unable to remedy the establishing a cross-border group relief scheme under which a situation on its own) was moved upwards in the holding structure company may make a “group contribution” with affiliated group until rectification was satisfied. members in other EEA States (or, conversely, deterring companies The foregoing notwithstanding, the general concept of corporate from such States from establishing similar groups with affiliated personhood and individual (contained) liability is still the all- group members in Norway). The reason for this is that the interest encompassing rule of practice, and we have yet to see any case limitation rules, in their current form, are very unlikely to apply where a PE investor or another portfolio company has been held to wholly Norwegian groups of companies in practice, and will liable for its portfolio company acts or omissions in Norway. never apply to groups that are entitled to grant each other group contributions. This gives rise, in economic terms, to a higher tax charge for groups of companies with a cross-border structure than 11 Other Useful Facts for wholly Norwegian groups of companies. Therefore, cross- border intra-group interest contributions will de facto be subject 11.1 What other factors commonly give rise to concerns to the interest cap rules to a greater extent (since the exception for private equity investors in your jurisdiction or provided under group contribution rules is not available to them). should such investors otherwise be aware of in The EFTA Surveillance Authority requested Norway to take considering an investment in your jurisdiction? necessary measures to comply with the opinion. The outcome of this controversy remains to be seen. Expected amendment to the corporate tax system VAT In October 2016, the government issued its fiscal budget for 2017, On 16 May 2013, the Norwegian tax authorities issued a much- proposing certain amendments to the Norwegian corporate tax criticised memo in which the authorities argued that in the event a system. These proposals were following-up on the government’s Sponsor provides advisory and consultancy services to its portfolio
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companies, such services should be subject to 25% VAT. This that currently states that certain transactions between a company raises difficult classification issues between the Sponsor’s ordinary and its shareholders, etc. are only valid if the general meeting management of its portfolio companies which, in general, is VAT of the company has approved such transactions (cf. question 3.6 exempt, and other consultancy/advisory services that may be subject above). Instead, a new disclosure requirement for such agreements to VAT. The authorities have indicated that individual circumstances is proposed, introduced, at the same time, amending the rules in a tax inspection may determine that parts of the management applicable for such agreements in line with current EU legislation. services provided by a Sponsor must be reclassified as consultancy The Ministry is currently working to prepare a bill to be enacted by services and therefore will become subject to VAT under Norwegian Parliament, most likely to enter into force either on 1 July 2017 or law. There has also been an increased aggressiveness from the 1 January 2018. authorities on this area and we expect that this will continue in the EU initiatives coming year. Norway Over the last few years, the EU has issued several new Directives, Expected amendment to the corporate law system regulations and/or clarification statements regarding the capital On 21 October 2016, the Norwegian Ministry of Industry, Trade markets. These initiatives from the EU, will most likely, directly and Fishery published an Official Norwegian Report (“NOU”) or indirectly, have an impact on the regulatory framework for public in which the government proposed to simplify and adapt the M&A transactions in Norway in the years to come. As a result of rules of the Norwegian Companies Acts. The purpose of these these initiatives, several amendments to the STA are expected to proposed amendments is to simplify the burden on trade and take place over the next 12-month period. industry, especially for small and medium-sized companies. In this regard it is, inter alia, proposed to remove the invalidity rule
Ole Kristian Aabø-Evensen Harald Blaauw Aabø-Evensen & Co Aabø-Evensen & Co Karl Johans gate 27, P.O. Box 1789 Vika Karl Johans gate 27, P.O. Box 1789 Vika N-0122 Oslo N-0122 Oslo Norway Norway
Tel: +47 2415 9010 Tel: +47 2415 9050 Email: [email protected] Email: [email protected] URL: www.aaboevensen.com URL: www.aaboevensen.com
Ole K. Aabø-Evensen is one of the founding partners of Aabø- Harald Blaauw, co-head of M&A litigation, primarily advises clients Evensen & Co, a Norwegian boutique M&A law firm. Ole assists on general corporate and commercial law, M&A, stock exchange industrial investors, financial advisors, private equity funds, as well as and securities, and all transactional-related matters. Mr. Blaauw has other corporations in friendly and hostile take-overs, public and private extensive experience with strategic takeovers, structured sales & mergers and acquisitions, corporate finance and other corporate acquisitions (herewith cross-border) and corporate litigation, and has matters. He has extensive practice from all relevant aspects of been recognised as a leading advisor for his involvement in many of transactions, both nationally and internationally, and is widely used the most prominent private equity transactions in the Nordic region as a legal and strategic advisor in connection with the follow-up of his during the last years. Prior to joining the firm, Mr. Blaauw worked as clients’ investments. Mr. Aabø-Evensen is also the author of a 1,500- an attorney at Curtis, Mallet-Prevost, Colt & Mosle LLP (New York) page Norwegian textbook on M&A. He is recognised by international and Wiersholm Advokatfirma AS (Oslo) after clerking at the Supreme rating agencies such as The Legal 500 and European Legal Experts, Court of Norway (Oslo). Mr Blaauw has also acted as an authorised and during the last eight years he has been rated among the top three arbitrator in a number of civil and criminal disputes before the M&A lawyers in Norway by his peers in the annual surveys conducted Philadelphia Municipal Court and the Philadelphia Arbitration Center, by the Norwegian Financial Daily (Finansavisen). Both in the 2012, and is admitted to the Bar of New York and the Bar of Norway. Mr. 2013 and 2017 editions of this survey, the Norwegian Financial Daily Blaauw received his education from the University of Pennsylvania named Mr. Aabø-Evensen as Norway’s No. 1 M&A lawyer. He is Law School and the Wharton School of Business. also the former head of M&A and corporate legal services of KPMG Norway. Mr. Aabø-Evensen is the co-head of Aabø-Evensen & Co’s M&A team.
Aabø-Evensen & Co is a leading M&A boutique law firm in the Nordic region, operating out of Oslo, Norway. The firm is not, nor does it strive to be, the largest law firm measured by number of offices or lawyers – instead it endeavours to find the best solutions for its clients’ legal and commercial challenges, and securing their business transactions. Our M&A and equity capital practitioners are recognised for their high level of expertise and experience. We advise bidders, targets and financial advisers on all aspects of public and private M&A deals. Our work covers the gamut of M&A and corporate finance, including tender offers and take- private transactions, mergers, demergers (spin-off), share exchange, asset acquisitions, share acquisitions, group restructuring, joint ventures, LBO, MBO, MBI, IBO, private equity acquisitions and exits therewith, due diligence, take-over defence, shareholders activism, M&A tax, securities and securities offerings including credit and equity derivatives, acquisition financing, anti-trust and TUPE-issues. A large amount of our work relates to cross-border transactions and our approach to international work is driven by the principle that complex transactions require first-class independent legal expertise, rooted in local practice, procedures and culture.
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Portugal Ricardo Andrade Amaro
Morais Leitão, Galvão Teles, Soares da Silva & Associados Pedro Capitão Barbosa
passport rules, enabling the marketing of large private equity funds, 1 Overview have also been approved by the aforementioned diplomas.
1.1 What are the most common types of private equity transactions in your jurisdiction? What is the current 2 Structuring Matters state of the market for these transactions? Have you seen any changes in the types of private equity transactions being implemented in the last two to 2.1 What are the most common acquisition structures three years? adopted for private equity transactions in your jurisdiction? Have new structures increasingly developed (e.g. minority investments)? Private equity in Portugal has experienced significant growth despite the financial crisis and sovereign debt crisis which have loomed in The typical private equity transaction in Portugal is made through a the country over the last few years. According to the latest data private equity fund. Pursuant to this structure, the fund participants available, value under management by private equity players has or LPs (as well as the managing entity, which retains some “skin in been steadily rising since 2003, reaching €4.0 billion at year-end the game”) subscribe and pay-up units in the fund, after the latter is 2015. registered before the relevant regulatory authority in Portugal (the Turnaround or distressed transactions have been the most relevant Portuguese Securities Market Commission – “CMVM”). types of private equity deals in Portugal in the last few years, The aforementioned investment vehicles then either: (i) acquire followed by growth capital investment. It is worth noting that the equity participations directly or subscribe newly issued shares by the amount invested in management buyouts and management buy-ins target company (in a typical buyout, growth or venture capital deal); is small and that venture capital investment (start-up, seed capital, or (ii) acquire debt instruments or securities (notably senior bank early stage investment) is dwarfed by more “traditional” private loans) and convert such instruments into equity, thereby gaining equity (distressed and growth) (19.3% against 80.7%, respectively). control of the target (in distressed or turnaround transactions). Other trends in the sector arising in the last few years include the If the private equity investor does not ultimately come to hold occurrence of several high-profile “exits” and the increasing use of the entirety of the company’s equity, a shareholder agreement is non-equity investments (mostly subordinated debt) in lieu of equity generally entered into with the surviving shareholders. capital to fund portfolio companies. “Corporate” venture capital players are becoming relevant in private equity structures, as these newcomers in the market usually start 1.2 What are the most significant factors or developments out by investing through “proprietary” structures, notably via encouraging or inhibiting private equity transactions holding companies. Typically, it is only when such entrants to the in your jurisdiction? market seek to attract outside investment that they advance to the “regulated” structures. The main trend in private equity dealmaking at this stage is probably Another interesting trend which has surfaced recently is the launching the occurrence of several high-profile “exits”. This is due to the fact of public tenders by State-owned entities to capitalise companies, that many of the largest Portuguese private equity funds are now such as tenders to award European Union funds (such as QREN) to reaching maturity (i.e. are close to being unwound) and also because entities organised as private equity fund managers. In these structures in 2015 and 2016 Portugal experienced increasing levels of private investments are conditioned by European state aid regulations and the investment and economic growth, both of which have encouraged presence of public entities with very significant unit holdings. asset sales by private equity funds. The sector is still undergoing a regulatory overhaul with the enactment of Law no. 16/2015, of February 24 (“Law 16/2015”) and 2.2 What are the main drivers for these acquisition of Law no. 18/2015, of March 4 (“Law 18/2015”), both of which structures? transpose EU Directive no. 2011/61/EU, of the European Parliament and the Council (the “AIFM Directive”) to Portugal. The statutes The main drivers for these structures relate to incentive alignment introduce relevant changes to the legal framework of private equity and tax reasons. investment in Portugal in areas as diverse as remuneration, regulatory Investment using private equity funds is an efficient way for various disclosures, risk and liquidity management and outsourcing. EU institutional investors to pool money into alternative asset classes
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which potentially offer higher yields than public equities or bonds, differ. For instance, minority private equity investors will have while avoiding operational risks and regulatory hurdles which (contractual) rights to designate directors, veto rights and drag- would arise from investing directly in non-listed companies. In along or rights for their participations to be mandatorily acquired by private equity funds, the managing entity retains a residual equity the majority shareholders. participation in the fund to signal that it is committed to act in the best interests of the LPs. The carried interest remuneration structure (detailed below) also helps align incentives. 3 Governance Matters Tax-wise, private equity funds incorporated in Portugal are exempt from corporate income tax and any gains made are directly attributed 3.1 What are the typical governance arrangements to its LPs, at a favourable rate. for private equity portfolio companies? Are such arrangements required to be made publicly available Portugal in your jurisdiction? 2.3 How is the equity commonly structured in private equity transactions in your jurisdiction (including institutional, management and carried interests)? Private equity investors will commonly have one or more representatives on the board of directors of portfolio companies to serve as non-executive directors. Another typical feature of As explained above, equity in private equity transactions is supplied governance structures of portfolio companies is the set-up of a via private equity funds. remuneration committee and/or related party transactions committee Remuneration of such equity is typically made through a simple used for the private equity investor to monitor the company. waterfall and carried interest payment structure, whereby any These governance arrangements are typically regulated in a distributions made by the fund would be done in the following shareholder agreement. Such agreements, unless they relate to order: (i) all unit holders recoup their nominal investment; (ii) the public (i.e. which shares are exchanged in a regulated market) or LPs are paid a minimum hurdle rate; and (iii) any amounts left shall financial companies, need not be made public and will almost surely be distributed 80–85% to the LPs and 15–20% to the GP/managing contain confidentiality provisions. entity. Entry into force of the provisions transposing the AIFM Directive (i.e. Law 18/2015) may have a significant impact on the 3.2 Do private equity investors and/or their director abovementioned equity remuneration structure for large private nominees typically enjoy significant veto rights over major corporate actions (such as acquisitions and equity funds (i.e. which have over €500,000,000 of assets under disposals, litigation, indebtedness, changing the management, if not leveraged, or €100,000,000 of assets under nature of the business, business plans and strategy, management, if leveraged). Notably, requirements that at least 40% etc.)? If a private equity investor takes a minority of the variable remuneration of fund manager’s officers is deferred position, what veto rights would they typically enjoy? over a period of at least three to five years and that at least 50% of any variable remuneration must consist in units of the fund has the Yes. Usually shareholder agreements entered into between private potential to have an impact in many of the existing remuneration equity investors and management/surviving shareholders/partnering arrangements set out in Portugal. shareholders will have “restricted board matters” (via supermajorities or share classes) involving material aspects of the business regarding which the private equity investor enjoys a veto right. 2.4 What are the main drivers for these equity structures? Veto rights enjoyed by private equity investors in portfolio These equity structures are used primarily for inducing risk sharing companies typically include fundamental corporate matters such as between investors and management, thus aligning their incentives. amendments to articles of association, mergers, demergers, approval of annual accounts and distributions.
2.5 In relation to management equity, what are the typical vesting and compulsory acquisition provisions? 3.3 Are there any limitations on the effectiveness of veto arrangements: (i) at the shareholder level; and (ii) at the director nominee level? If so, how are these Stock option plans or “phantom stock” option plans are increasingly typically addressed? being used in venture capital transactions in Portugal. Vesting of the schemes is usually associated with the achievement of certain No limitations usually exist. Restricted board matters are almost operating figures (e.g. the company having an EBITDA over a without exception transposed into the company’s by-laws, making certain figure). them enforceable towards third parties. Good leaver/bad leaver provisions are also common, and a bad Similarly, on matters where shareholders have the last say (which leaver will often trigger call/put options for investors/managers’ would depend on the type of company in question) the shareholders’ equity participation in the target company in order to dissolve the agreement and by-laws create a set of restricted matters (again “partnership” established between the manager and the private supermajorities or share classes) for shareholders’ resolutions as equity investor. well, granting a veto right to the private equity investor.
2.6 If a private equity investor is taking a minority position, are there different structuring 3.4 Are there any duties owed by a private equity investor considerations? to minority shareholders such as management shareholders (or vice versa)? If so, how are these typically addressed? The acquisition structure is essentially the same regardless of whether the position being acquired is a majority or minority No special statutory duties exist regarding private equity investors position. Nevertheless, the terms and conditions of the investment in relation to minority shareholders or otherwise.
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It is, however, worth noting that Portuguese law provides for several At portfolio company level, a related party transaction committee special rights of minority shareholders, such as the right to appoint is often set up to deal with vertical (company-fund) and horizontal directors from a separate list (if such mechanism is included in the (portfolio company-portfolio company) conflicts of interest. by-laws) or the right to annul resolutions approved by the majority More generally, statutory corporate law provisions contain shareholders, if proved to be to their detriment (e.g. on self-dealing mandatory provisions whereby shareholders and board members transactions). In addition, the law provides for “opt-out” rights for are impeded to vote in the relevant meetings if they are deemed to minority shareholders in case of (i) mergers and demergers (when be in a conflict of interest. minority shareholders vote against such transactions), and (ii) in case there is a majority shareholder holding more than 90% of the share capital in the company. 4 Transaction Terms: General Portugal
3.5 Are there any limitations or restrictions on the 4.1 What are the major issues impacting the timetable contents or enforceability of shareholder agreements for transactions in your jurisdiction, including (including (i) governing law and jurisdiction, and (ii) competition and other regulatory approval non-compete and non-solicit provisions)? requirements, disclosure obligations and financing issues? Under Portuguese law, it is generally understood that the provisions of shareholder agreements are binding only upon the parties and, Timetable constraints and other formalities for transactions in thus, are not enforceable towards third parties, nor towards the Portugal involve, generally, the following: company itself. a) waivers from financing banks, in direct or, sometimes, Other restrictions set out in the law regarding the contents of indirect changes of control; shareholder agreements include: (i) no provisions may be included b) securing financing for the transaction; restricting the actions of members of the company’s management c) in asset deals (e.g. transfer of business via agreement or or audit bodies; (ii) no shareholder may commit to always vote in prior statutory demerger) formalities related to employment accordance with the instructions or proposals given/made by the matters, notably town hall meetings and opinions from company or its management or audit bodies; and (iii) no shareholder employees representative structures; may exercise or not exercise its voting right in exchange for “special d) in large deals, waivers from competition authorities; and advantages” (i.e. prohibition of vote selling). e) deals in some regulated sectors (especially banks, insurance In what concerns non-compete provisions, these should be weighed companies and other financial institutions) require prior against mandatory labour and competition law provisions to assess approval from the respective regulatory authorities. their validity. Following the implementation of the AIFM Directive in Portugal, Law no. 16/2015, of February 24, has imposed disclosure requirements for managing entities of alternative investment 3.6 Are there any legal restrictions or other requirements that a private equity investor should be aware of funds (which include private equity funds) when acquiring private in appointing its nominees to boards of portfolio companies. Pursuant to the newly approved rules, private equity companies? What are the key potential risks and fund managers must now disclose to CMVM: (i) the acquisition liabilities for (i) directors nominated by private equity or divestment of a significant shareholding in the company; (ii) investors to portfolio company boards, and (ii) private acquisition of control over the company; and (iii) if acquiring a equity investors that nominate directors to boards position of control in a company, intentions regarding the future of portfolio companies under corporate law and also more generally under other applicable laws (see activity of the company and the probable repercussions in the section 10 below)? company’s headcount.
Directors appointed by private equity investors should be aware 4.2 Have there been any discernible trends in transaction that, under Portuguese law, they owe fiduciary duties (care and terms over recent years? loyalty) to all shareholders of the portfolio company, and may not cater only to the interests of the private equity investor. No trends in transaction terms have arisen over the past few years. On the other hand, private equity investors, if they exercise a significant influence in the company to allow it to be qualified as a de facto board member, may be held liable should the company be 5 Transaction Terms: Public Acquisitions declared insolvent, if it is proven that the insolvency was the result of culpable action by the investor. 5.1 What particular features and/or challenges apply to private equity investors involved in public-to-private transactions (and their financing) and how are these 3.7 How do directors nominated by private equity commonly dealt with? investors deal with actual and potential conflicts of interest arising from (i) their relationship with the party nominating them, and (ii) positions as directors Only one private equity type public-to-private transaction has ever of other portfolio companies? been recorded in Portugal (i.e. the acquisition of Brisa, a highway toll operator, in 2012, by a joint venture formed by a Portuguese At fund level, conflicts of interest are typically addressed through family office holding company and a European infrastructure fund). an Advisory Council, which attributions typically entail issuing Since there is but one example of this type of transaction in Portugal, opinions on certain transactions undertaken by the fund, notably it is not possible to assess patterns or trends. related party transactions, and other conflicts of interest.
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maturity, shy away from providing securities for breach of 5.2 Are break-up fees available in your jurisdiction in representations and warranties. relation to public acquisitions? If not, what other arrangements are available, e.g. to cover aborted deal Private equity buyers, on the other hand, are keen on having escrow costs? If so, are such arrangements frequently agreed accounts credited with a percentage of the purchase price, as a and what is the general range of such break-up fees? security for breach of representations and warranties and other obligations by the sellers. Please see the answer above. 6.7 How do private equity buyers typically provide comfort as to the availability of (i) debt finance, 6 Transaction Terms: Private Acquisitions and (ii) equity finance? What rights of enforcement do sellers typically obtain if commitments to, or Portugal obtained by, an SPV are not complied with (e.g. 6.1 What consideration structures are typically preferred equity underwrite of debt funding, right to specific by private equity investors (i) on the sell-side, and (ii) performance of obligations under an equity on the buy-side, in your jurisdiction? commitment letter, damages, etc.)?
Common variations to the price payable by private equity investors Corporate guarantees/comfort letters are common. To a limited in Portugal to shareholders of portfolio companies include: (i) extent, bank guarantees are also provided. deduction of the amount corresponding to non-current net debt; (ii) In case of non-performance of funding obligations, the seller’s when relevant, accrual of net working capital; and (iii) sometimes, typical remedy is to claim for damages. when management is expected to stay on board, earn-outs in accordance with commonly used financial indicators (e.g. EBITDA). “Locked-box” consideration structures are also, albeit to a less 6.8 Are reverse break fees prevalent in private equity transactions to limit private equity buyers’ exposure? extent, being used. If so, what terms are typical?
6.2 What is the typical package of warranties/indemnities Reverse break fees are not common. offered by a private equity seller and its management team to a buyer? 7 Transaction Terms: IPOs Standard representations and warranties involving mostly the underlying assets of the portfolio companies (as opposed to management) are offered. 7.1 What particular features and/or challenges should a private equity seller be aware of in considering an IPO exit? 6.3 What is the typical scope of other covenants, undertakings and indemnities provided by a private No IPO exit from a private equity investment has ever been made equity seller and its management team to a buyer? in Portugal.
Covenants and other undertakings usually include non-compete provisions. Asset-specific covenants are also provided, when 7.2 What customary lock-ups would be imposed on applicable. private equity sellers on an IPO exit?
As mentioned above, there is no factual basis to answer the question 6.4 Is warranty and indemnity insurance used to “bridge as no IPO exit from a private equity investment has ever been made. the gap” where only limited warranties are given by the private equity seller and is it common for this to be offered by private equity sellers as part of the 7.3 Do private equity sellers generally pursue a dual-track sales process? If so, what are the typical (i) excesses exit process? If so, (i) how late in the process are / policy limits, and (ii) carve-outs / exclusions from private equity sellers continuing to run the dual-track, such warranty and indemnity insurance policies? and (ii) were more dual-track deals ultimately realised through a sale or IPO? Warranty and indemnity insurance is scarcely used. We are not aware of any dual-track process for the sale of a private 6.5 What limitations will typically apply to the liability of equity portfolio company ever being initiated in Portugal. a private equity seller and management team under warranties, covenants, indemnities and undertakings? 8 Financing Caps and baskets are the most usual limitations to liability in private equity exit transactions. 8.1 Please outline the most common sources of debt finance used to fund private equity transactions in your 6.6 Do (i) private equity sellers provide security (e.g. jurisdiction and provide an overview of the current escrow accounts) for any warranties / liabilities, and state of the finance market in your jurisdiction for such (ii) private equity buyers insist on any security for debt (particularly the market for high yield bonds). warranties / liabilities (including any obtained from the management team)? Due to the fact that the average value of private equity transactions in Portugal is small, deals involving private equity investors are Private equity sellers, especially ones backed by funds reaching made almost exclusively through the funds’ equity, raised from its
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participants. Debt financing of transactions is thus rare and even Alas, the treatment of income derived from carried interest and other more so the issuance of high yield bonds. variable private equity managers’ compensation is not clear from tax When it does occur (in larger transactions), debt financing of legislation. As such, due to the fact that, from a tax perspective, private equity transactions is usually made through senior secured treatment of such income is not clear, there have been several loan facilities (usually composed of an acquisition facility and a calls to, like in many other jurisdictions, clearly state that variable revolving facility). management compensation is taxed as capital gains.
8.2 Are there any relevant legal requirements or 9.2 What are the key tax considerations for management restrictions impacting the nature or structure of teams that are selling and/or rolling-over part of their the debt financing (or any particular type of debt investment into a new acquisition structure? Portugal financing) of private equity transactions? A tax neutrality regime on the corporate reorganisations is also Notwithstanding the abovementioned response, it is worth noting available, allowing for cases of merger, de-merger, and/or asset that financial assistance (i.e. contracting loans or providing securities contribution, in order that no step up in value is realised, but at the same for the acquisition of the company’s own shares) is restricted under time preserving the original date of acquisition of the participations. Portuguese law, thus limiting the possibility of pursuing leveraged Additionally, there are two key tax considerations: the participation buyouts. exemption regime and the tax treatment of dividends distributed by a Portuguese company. 9 Tax Matters The Portuguese Participation Exemption regime currently in force foresees that dividends distributed by a company resident in Portugal (and not subject to the tax transparency regime) to its 9.1 What are the key tax considerations for private equity corporate shareholder are tax exempt, provided some requirements investors and transactions in your jurisdiction? Are are met, such as a continuous 24-month holding period of at least off-shore structures common? 5% of the shares or voting rights. Under the out-bound regime, to benefit from the 0% withholding Private equity funds are considered neutral vehicles, for tax purposes, tax rate on the dividends paid by a company in Portugal, besides and as such are exempt from corporate income tax. Income derived the fact that the beneficiary of the income has to be subject inits by the unit holders in the private equity funds, on the other hand, residence State to a CIT nominal tax rate of at least 12.6%, it has is subject to a 10% withholding tax (whether personal or corporate to hold, directly or indirectly, at least a 10% stake in the company income tax), provided the unit holder is a non-resident entity (without resident in Portugal uninterruptedly held in the 12 months prior to the Permanent Establishment in Portugal), or an individual resident in distribution of dividends. Portugal (that derives this income out of a business activity). If the unit holder in the private equity fund (i.e. when the beneficiaries of such income) is an entity exempted from tax on capital gains 9.3 What are the key tax-efficient arrangements that are typically considered by management teams in private (resident or non-resident) or if it is an entity with no permanent equity portfolio companies (such as growth shares, establishment in Portugal to which the income is attributable the deferred / vesting arrangements, “entrepreneurs’ derived income may be exempted from tax in Portugal. relief” or “employee shareholder status” in the UK)? Neither the 10% or the exemption rule are applicable when: (i) the beneficiary is an entity which is resident in a blacklisted jurisdiction; Due to the high tax burden on employment income in Portugal, there and (ii) when the beneficiaries are non-resident entities held, directly has been a recent phenomenon of the implementation of Employment or indirectly (more than 25%), by resident entities. The general Reward Plans, such as phantom “Stock Option Plans”. Through these withholding tax is 35% in the case of blacklisted entities; in other plans, taxation is deferred until the exercisable moment of the option. It cases, there is 25% CIT withholding tax. has been determined that tax should be paid on the difference between Offshore structures are not common owing mostly to the the price paid (if any) and the market value upon the exercisable disadvantageous tax repercussions of setting up transactions in moment as this qualifies as employment income. An interesting note blacklisted entities (see paragraph above). Nevertheless, international is that the “vesting” concept, as it is commonly referred to, is not fund managers usually invest through Luxembourg vehicles (typically expressly foreseen on any Portuguese Tax Code or legislation, which then incorporating a Portuguese BidCo to execute the transaction). may lead to tax litigation with the Portuguese Tax Authorities. Private equity companies (sociedades de capital de risco) also benefit from a tax allowance of a sum corresponding to the limit of the sum 9.4 Have there been any significant changes in tax of the tax base of the five preceding years, as long as such deduction is legislation or the practices of tax authorities (including used to invest in companies with high growth potential. On the other in relation to tax rulings or clearances) impacting private equity investors, management teams or private hand, dividends payable by private equity companies to its shareholders equity transactions and are any anticipated? do not receive any special treatment (i.e. 28% final rate for individuals and the current corporate income tax rates for companies). We are not aware of any recent change in tax legislation or in the Capital gains derived by the sale of units in the private equity funds practice of the tax authorities regarding issues that may specifically are subject to 10% corporate and personal income tax if the resident impact private equity investors, since the focus has been on creating entity derives the income out of a business activity and, regarding an optimal context of investment, with a substantial effort on the non-resident entity, if it is not exempted under the general implementing an investment friendly environment. exemption on capital gains obtained by non-residents.
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10 Legal and Regulatory Matters 10.3 How detailed is the legal due diligence (including compliance) conducted by private equity investors prior to any acquisitions (e.g. typical timeframes, 10.1 What are the key laws and regulations affecting materiality, scope etc.)? Do private equity investors private equity investors and transactions in your engage outside counsel / professionals to conduct all jurisdiction, including those that impact private equity legal / compliance due diligence or is any conducted transactions differently to other types of transaction? in-house?
Currently, the main provisions regulating private equity investment Private equity investors usually undertake legal due diligence before in Portugal were Law 16/2015 and Law 18/2015, mentioned earlier, investing in a company. Timeframes for conducting due diligence which were enacted following the regulatory overhaul of the range from one to three months and will typically have materiality Portugal alternative investment fund sector by the AIFM Directive. thresholds for litigation and material agreements under review. Often, insurance, competition and tax matters will be excluded from 10.2 Have there been any significant legal and/or due diligence (sometimes because other advisors will be engaged to regulatory developments over recent years impacting perform the review in such matters). private equity investors or transactions and are any Due diligence is typically conducted by outside counsel. anticipated?
Law 16/2015 and Law 18/2015 provided several major changes to 10.4 Has anti-bribery or anti-corruption legislation the regulation of private equity in Portugal. Highlights include: impacted private equity investment and/or investors’ approach to private equity transactions (e.g. a) Investment compartments – the management regulations of diligence, contractual protection, etc.)? private equity or venture capital funds may now establish that the fund may be divided into several investment Law no. 25/2008, of June 5, established several obligations on, compartments, named “subfunds”. among others, “know your customer” and due diligence procedures b) Management may change certain aspects of the management and disclosure of monetary flows for purposes of preventing money regulations (e.g. details of the manager; and reduction in laundering transactions and the financing of terrorism. These management fees) in private equity funds without the consent of unit holders. obligations are applicable to private equity funds (as well as to banks and other financial institutions). c) Own funds requirements – private equity and venture capital companies must have their own funds corresponding to 0.02% The aforementioned reporting duties have an impact on due of the amount of the net value of assets under management diligence procedures taken during fund structuring, as the private exceeding €250,000,000. equity investor shall, for instance, be obliged to know what is the However, the main innovation put in place by the enactment of Law controlling structure of its clients (the fund LPs) and who is the 18/2015 is imposing a more demanding regulatory framework to ultimate beneficial owner of such LPs. Consequently, the major management entities of collective undertakings which have assets private equity players in Portugal have instated official “know under management with a value exceeding: (i) €100,000,000, when your customer” procedures in an effort to not fall foul of the law’s the respective portfolios include assets acquired with leverage; or provisions. (ii) €500,000,000, when the respective portfolios do not include assets acquired through leverage and regarding which there are no 10.5 Are there any circumstances in which: (i) a private reimbursement rights which may be exercised during a five-year equity investor may be held liable for the liabilities of period counting from the date of initial investment. the underlying portfolio companies (including due to Such funds are now subject to, inter alia, the following obligations: breach of applicable laws by the portfolio companies); and (ii) one portfolio company may be held liable for a) their incorporation is subject to the prior authorisation of the the liabilities of another portfolio company? Portuguese Securities Market Commission (CMVM); b) risk management should be functionally and hierarchically Private equity funds enjoy full limited liability and asset partitioning separated from the operating units, including the portfolio in relation to its portfolio companies and participants, respectively. management function; In this sense, the fund may not be liable for debts and other liabilities c) measures should be taken to identify situations of possible of the portfolio companies, unless it has provided guarantees for the conflicts of interest as well as to prevent, manage and monitor benefit of such companies. conflicts of interest; As for private equity companies, if the latter holds 100% of the share d) CMVM shall be informed of the intention to delegate services to third parties for carrying out functions in the name of the capital of a portfolio company incorporated in Portugal, mandatory abovementioned managing entities; corporate law provisions assume a “co-mingling of assets” of sorts and state that they are liable before the creditors of said portfolio e) managing entities shall employ an appropriate liquidity management system; and companies. f) applicability of “EU passport rules” (i.e. the ability to market In the case of portfolio companies being liable before one another, units of private equity funds in other EU countries or third assuming that they are both directly held by the same private equity countries). investor (i.e. horizontal group relationship) no subsidiary liability Also worth noting is the new crowdfunding legislation, yet to be may arise. regulated, which provides a framework for the creation of equity crowdfunding platforms in Portugal, which is becoming increasingly relevant for venture capital investment in the Portuguese market.
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11 Other Useful Facts
11.1 What other factors commonly give rise to concerns for private equity investors in your jurisdiction or should such investors otherwise be aware of in considering an investment in your jurisdiction?
Nowadays, private equity investment in Portugal faces the issue of a lack of opportunities to invest in relation to the money being
Portugal raised. Due to the economic frailties that the country still faces, not many investment opportunities are arising (notwithstanding the prevalence of distressed or turn-around acquisitions) in relation to the funds being raised.
Ricardo Andrade Amaro Pedro Capitão Barbosa Morais Leitão, Galvão Teles, Morais Leitão, Galvão Teles, Soares da Silva & Associados Soares da Silva & Associados Rua Castilho, 165 Rua Castilho, 165 1070-050 Lisbon 1070-050 Lisbon Portugal Portugal
Tel: +351 21 38174 00 Tel: +351 21 38174 00 Email: [email protected] Email: [email protected] URL: www.mlgts.pt URL: www.mlgts.pt
Ricardo Andrade Amaro is a partner in MLGTS and is part of the Pedro Capitão Barbosa is an associate with MLGTS and is part of the corporate, M&A, capital markets team and energy law team. corporate, M&A and capital markets team. Pedro joined the firm in 2011, and previously worked with the real estate team. He is a lawyer with great experience in corporate and commercial law, securities law, as well as in energy law. Ricardo has, inter alia, acted as Pedro has relevant experience in corporate transactions (restructurings, legal advisor in the setting up of the first private equity fund in Portugal joint ventures) and mergers and acquisitions in several industries (with exclusively dedicated to the recovery of companies (turnaround fund), a particular focus in renewable energies) and additionally regularly which is currently the largest Portuguese private equity fund. partakes in legal advice concerning investment fund structuring and regulation. In the area of corporate and commercial law, he has acted as legal advisor in several mergers, restructuring, acquisitions and sales of Pedro Capitão Barbosa has a degree from the New University of companies, on behalf of domestic and foreign clients. Lisbon (2010) and has obtained a LL.M. in Finance & Law from the Duisenberg School of Finance (in partnership with the University He has also acted as legal advisor in the setting up of several initial of Amsterdam). He has been a member of the Portuguese Bar public offerings, including the largest initial public offering ever made Association since 2014. in Portugal and the largest in Europe during 2008, and also in the structuring of several public share takeover bids. Ricardo was also engaged as a junior assistant at the Law faculty of the University of Lisbon from 2005 to 2009. Ricardo Andrade Amaro has a law degree from the University of Lisbon (2002) and a postgraduate degree from the Catholic University in Corporate Law (2004). He has been a member of the Portuguese bar association since 2004 and of the Securities Institute (also since 2004).
Independent and internationally recognised as a leading law firm in Portugal, Morais Leitão, Galvão Teles, Soares da Silva & Associados’s (MLGTS) reputation is based on the excellence of its legal services, the professionalism and the innovative solutions of our team. With more than 180 lawyers at a client’s disposal, MLGTS has three offices in Portugal. As a result of our network of associations with local firms and the creation of the MLGTS Legal Circle, MLGTS also operates through offices in Angola, Macau (China) and Mozambique. MLGTS offers specialised services in the main areas of law, having been involved in many of the largest and most important deals in Portugal, as well as in high-value cross-border transactions and disputes. Its client list includes some of the largest Portuguese and international companies and business groups as well as public and private entities, giving the firm deep insight into the national and international business environment from a legal perspective.
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Russia Zhanna Tomashevskaya
Tomashevskaya & Partners Roman Nikolaev
instruments) which are detailed in the later sections of this chapter. 1 Overview These amendments are clearly a positive sign of progress and an ambition to create a more predictable and flexible legal environment 1.1 What are the most common types of private equity for all concerned. transactions in your jurisdiction? What is the current state of the market for these transactions? Have you seen any changes in the types of private equity 2 Structuring Matters transactions being implemented in the last two to three years? 2.1 What are the most common acquisition structures adopted for private equity transactions in your The most common types of private equity (PE) transactions in jurisdiction? Have new structures increasingly Russia are angel investing, venture capital and minority investments developed (e.g. minority investments)? in portfolio companies. Private equity investors also continue to have a strong interest in distressed investments, which are still The Russian PE market has adopted several standard structures that popular to an extent. are used by most of the market players. Typically, it is one or more Notwithstanding the uncertain economic conditions over the last years, off-shore SPVs incorporated in a tax-friendly jurisdiction which act a reasonable level of PE activity remains, as investors with substantial as a parent/holding company through which investors contribute and amounts of undeployed capital continue to seek opportunities in the control their investments into Russian operating companies. This region. The PE market remained, however, the same. structure varies depending on the industry (FMCG, TMT, Oil & Gas), The pattern of how investors structure PE transactions has not level of maturity of the target and its expansion plans, type of investor changed significantly over the last few years. Investments are and its status as tax and currency resident in Russia. For most of the typically made through a special purpose vehicles (SPV) established transaction documents English law is still used rather than Russian law. by the market players in a tax-friendly jurisdiction with the purpose Investments which relate to projects with state participation in the of providing unleveraged private equity financing in exchange for a equity or under public-private partnership seem to have a greater minority- or majority-controlled stake. However, the “anti-offshore” involvement of onshore arrangements (Russian law applied to the law that aims to retrieve Russian capital back from offshore zones, transactions). In these cases, it is typical to structure the investment the development of Russian corporate and contract law and other through an onshore joint venture vehicle (usually in the form of a stimulus measures of the state have been changing the structuring joint stock company or limited liability company) or an investment landscape to a certain extent. partnership. Since 2012, Russian law has underestimated vehicles for 1.2 What are the most significant factors or developments investments. The investment partnership – which can be used encouraging or inhibiting private equity transactions in PE more actively – is a good vehicle because it minimises the in your jurisdiction? defects of the most popular domestic schemes of investments, including Russian mutual funds (паевой инвестиционный фонд) There is still a considerable uncertainty around the Russian and ordinary or trust partnerships (простое товарищество или economy. The main reasons being: the total revaluation of assets товарищество на вере), and attracts more investors (major and caused by the devaluation of the rouble; and international tensions minor) into the market. and sanctions. Many PE funds are more engaged today with the The investment partnership (IP) establishes the legal grounds for active management of portfolio companies, than in the search of joint corporate investments by introducing a new business structure new sources of investment. created through an investment partnership agreement (IPA). This At the same time, during the last few years the Russian Parliament vehicle is similar to an English limited partnership and represents has put a lot of effort to improve the legal tools which are used a marked improvement over the existing structure for fund vehicles in PE transactions, making them more flexible and accorded with in Russia. Investors, both foreign and Russian, who wish to use a international best practice. It is worth mentioning the Civil Code Russian investment structure can move their off-shore vehicles into of the Russian Federation (the “Russian Civil Code”) amendments, (or create investment vehicles under) the jurisdiction of the Russian some of which are quite revolutionary (e.g., an implied obligation courts. An IP is not a separate legal entity and thus does not require to act in good faith; conceptually new indemnity analogous any registration or any licence. This vehicle also allows for the
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introduction of specific provisions in the IPA which are available becoming more popular. Time-based and performance-based in no other structure, such as the size and type of the contributions, vesting are both commonly used for Russian management equity- capital call procedures, default contribution rules, conduct of the linked programmes. Equity-linked programmes are usually subject IP’s business (management and decision-making procedures, or to good and bad leaver concepts under which such equity may be establishment of an investment committee), distribution of profit acquired at either fair value or at a cost, and a drag in the event rules, assignment of rights and obligations rules, and exit rules. of an exit by the private equity investor. Since most equity-linked compensation regimes for Russian portfolio companies do not result in actual shares being issued to management, there is not typically 2.2 What are the main drivers for these acquisition a compulsory acquisition requirement. The only exception would structures? be if management held stock in a public company which is under Russia a compulsory acquisition regime (the Joint-Stock Company Law The fundamental drivers for the above acquisition structures are provides a buyout right for minority interest holders when a person tax efficiency, cost performance, the regulatory regime, corporate has acquired an interest in all or most of the securities in a class). governance and shareholder protection, including enforceability of This right allows the remaining holders of shares to require the contractual and corporate rights. major interest holder to purchase their securities.
2.3 How is the equity commonly structured in private 2.6 If a private equity investor is taking a minority equity transactions in your jurisdiction (including position, are there different structuring institutional, management and carried interests)? considerations?
PE investors typically invest through a combination of ordinary Minority investments usually take the form of convertible debt and preference equity along with shadow equity participation in the or/and shares carrying preferential rights over the class of shares form of bonus payments calculated with reference to the share price held by the founder and other shareholders. The key minority or other financial indicators. The final structure of the instruments investor considerations would be governance and the need to ensure depends largely on the nature of the investor, value drivers for the preferred returns. As mentioned previously, preference shares may target company and the level (jurisdiction) of structuring. be issued with fixed or variable liquidation preferences, preferences It is also often the case that the standard instruments of investments in respect to dividends, and preferences with ratchets that modify as are combined with liquidation preferences, ratchets, down round the financial health of the company changes. protections and pre-negotiated exit terms in the form of redemption Minority investors also often negotiate representation on the board rights, put options, drag-along rights or rights to force an IPO or (this ensures that entities in the group do not take actions that are strategic sale following a prescribed holding period. Carried interest reserved matter actions in contravention to the minority investor’s is a rarely-used tool in relation to Russian targets structures. Only reserved matter veto rights); pre-emption rights in respect to new 2–5% of PE transaction structures apply this approach. issuances of shares; lock-ups and prohibitions against changes of Equity participation for management may be structured through control at the majority shareholder level; reporting and inspection share options, performance/restricted shares, option to SPV shares, rights giving the minority shareholder regular access to the financial phantom option and shares, and equity-linked bonuses (deferred). accounts of the company. Another effective tool for minority investor interests are reserved 2.4 What are the main drivers for these equity structures? matter approval/veto rights.
The principal drivers for these equity structures are: tax efficiency; 3 Governance Matters the need to secure the priority of return of the private equity investor’s capital, and to facilitate the ability to return capital to shareholders; and the desire to incentivise management. 3.1 What are the typical governance arrangements With respect to management, it should be noted that there is no for private equity portfolio companies? Are such existing Russian legislation which clearly regulates management arrangements required to be made publicly available programmes, thus giving sufficient freedom when developing in your jurisdiction? the conditions of the programme. The mechanisms for the implementation of such management programme must therefore be The corporate governance regime has become considerably more carefully chosen. flexible and accorded with international best practice following amendments to the Russian Civil Code, Joint-Stock Company Successful introduction of the management programme depends Law and Limited Liability Company Law introduced over the last not only on its correctly constructed motivational component, but three years. These new rules have given PE investors an ability also on how the legal mechanism, which is its cornerstone, can fully to structure their interest over participation in the composition and realise the programme’s conditions. Moreover, it is also necessary functioning of the board of directors, along with the shareholders’ to resolve the tax issues concerning the realisation of the programme meeting. Typically, governance arrangements include an off- beforehand. These questions arise not only for the company, but also shore holding company, its board of directors or shareholder for the participant(s) of the programme. Thus, in developing a model advisory board, which takes all principal decisions pursuant to the of long-term remuneration of management, the company inevitably company’s articles of association and/or shareholders agreement, faces a question of the legal and tax mechanisms of its realisation. which typically set out reserved matters through which PE investors exercise control and veto rights. This governance regime then 2.5 In relation to management equity, what are the typical gets pushed down to the Russian operating company level through vesting and compulsory acquisition provisions? mirrored provisions in the operating company’s charter/constituent documents or as a limitation or grant of authority on the operating In recent years, different approaches have been tested by the PE company’s general director. market players. Vesting linked to a company operating metric is
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Usually the governance arrangements with more than one benefit of the target company in all circumstances (the priorities of shareholder are usually set out in a shareholders’ agreement. Such which may differ from that of a specific shareholder). To the extent agreements are not required to be filed with the state bodies and the board is required under law to take a certain resolution (e.g. due are generally not required to be made publicly available. Other to insolvency concerns), no contractual arrangement may force the arrangements will also be set out in the constitution documents of board to act differently. Where there is a concern that the directors’ portfolio companies, which are made available to an extent to the ability to exercise their veto rights may be limited by their fiduciary public upon filing with the Uniform State Register of Legal Entities. duty owed to the company, such concern is often addressed by giving such veto rights to the shareholders instead of the directors.
3.2 Do private equity investors and/or their director
nominees typically enjoy significant veto rights over 3.4 Are there any duties owed by a private equity investor Russia major corporate actions (such as acquisitions and to minority shareholders such as management disposals, litigation, indebtedness, changing the shareholders (or vice versa)? If so, how are these nature of the business, business plans and strategy, typically addressed? etc.)? If a private equity investor takes a minority position, what veto rights would they typically enjoy? Under Russian law, there are no specific duties owed by a PE investor as a management shareholder to minority shareholders. A veto right is one of the main and most effective tools which PE However, there are minority protection rules under which, inter investors acquire over the governance arrangements. alia, the shareholders must be treated equally and shareholders or In Russia, a veto over fundamental acts in the corporate structure directors may not undertake any measures that would give an undue can easily be accomplished. Current Russian law provides for advantage to a shareholder or other person to the disadvantage of the shareholder participation in fundamental corporate acts, such as company or another shareholder. Shareholders in Russia also can be acquisitions and disposals, litigation, indebtedness, changing the held liable for any damage caused to the company by their actions nature of the business, business plans and strategy, etc. beyond the ordinary course of business. This scope of liability cannot be eliminated by a contract. A charter provision requiring unanimity for all shareholder action or for those particular acts will provide for each shareholder an Also, a PE investor that acquires more than 30%, 50% or 75% effective veto over certain corporate changes. Similarly, a provision in a public company is obliged to make a mandatory offer to the requiring approval of holders of a high percentage of the shares for a remaining shareholders. An acquisition of more than 95% of the shareholder’s action can be used to provide a veto over fundamental shares also triggers mandatory buyout requirements. acts. High voting requirements for shareholders’ action, however, usually 3.5 Are there any limitations or restrictions on the do not give the power to veto important policy matters such as contents or enforceability of shareholder agreements operational issues or the day-to-day conduct of business. To provide (including (i) governing law and jurisdiction, and (ii) a veto over those kinds of decisions, unanimity or a high vote must non-compete and non-solicit provisions)? be required for director action, and the shareholders for whom a veto is sought must be assured representation on the board of directors. Russian law accepts that contractual arrangements between two or Further, it may be necessary to define narrowly in the charter the more shareholders may be governed by laws other than Russian law authority and duties of corporate officers; otherwise corporate officers as long as they are not against the mandatory rules or the moral may be given the authority to perform, without director approval, acts standard of the general public and involve a so-called “foreign against which a veto is desired. Whenever a shareholder has sufficient element” (i.e. when one of the parties is non-Russian). The same voting strength to keep a representative on the board, a requirement applies to the applicable courts and the relative clauses. A striking of unanimity for board action, of course, gives that shareholder the example is an issue related to a unilateral (optional, alternative, effective power to veto action within the province of the board. hybrid) arbitration clause. The approach to these clauses varies from jurisdiction to jurisdiction. In 2012, the Supreme Arbitration Another possible method of assuring that a PE shareholder will Court of Russia (a state court), in Russian Telephone Company v. control the fundamental acts in the company is the nomination of two Sony Ericsson, declared a unilateral arbitration clause invalid. The general directors (analogous to the CEO). This arrangement results decision attracted the attention of arbitration participants both in in the concerted acts of the original and second CEO (nominated by Russia and abroad. the shareholders) in the day-to-day conduct of business. While non-compete and non-solicit clauses are used and generally The volume of veto rights depends on the pre-deal negotiations. permissible, one has to be very careful in their drafting, as an over- Generally, the size of the stake in the company will not change the excessive provision can make the whole provision invalid or hardly situation around veto rights dramatically. enforceable. PE investors have to, therefore, observe certain formalities in order 3.3 Are there any limitations on the effectiveness of veto to have a valid jurisdiction and choice of law provision. arrangements: (i) at the shareholder level; and (ii) at the director nominee level? If so, how are these typically addressed? 3.6 Are there any legal restrictions or other requirements that a private equity investor should be aware of in appointing its nominees to boards of portfolio Generally, there are no limitations on these rights. On the contractual companies? What are the key potential risks and level, shareholder veto arrangements are binding obligations that liabilities for (i) directors nominated by private equity courts may generally enforce. However, if management act against investors to portfolio company boards, and (ii) private the shareholders’ agreement and the agreed veto rights, such actions equity investors that nominate directors to boards would not be invalid corporate resolutions as such and only contractual of portfolio companies under corporate law and also more generally under other applicable laws (see damages can be sought from the defaulting shareholder(s). section 10 below)? In Russia, board members are not considered representatives of shareholders, but rather persons who primarily need to act for the Some companies specify requirements for nominees like education
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and professional experience. However, the practice of enforceability of these clauses is rather controversial. The law also provides 4 Transaction Terms: General binding qualification requirements for the members of the board in particular business areas like insurance, banking and securities. 4.1 What are the major issues impacting the timetable The Russian code of corporate governance (a source of soft law) for transactions in Russia, including competition and states that companies should have a few independent directors. other regulatory approval requirements, disclosure This rule is usually recognised as binding in corporations with state obligations and financing issues? participation, private equity funds and public companies listed at the Moscow exchange. The major issues affecting the timetable for Russia PE transactions include: (i) the extent to which any restructuring of the target group Russia Members of the board of directors owe the duties of care and loyalty (Russian Civil Code, article 53.1). They also can be held liable is required (which is very often the case); (ii) the level of due for any damage caused to the company by their actions beyond diligence to be carried out; (iii) the complexity of the transaction the ordinary course of business. This scope of liability cannot be structure and terms; and (iv) the extent to which the transaction will eliminated by a contract. The same liability is provided for a person require notification or approval by the Russian government. or a legal entity who de facto has influence on the legal entity or Acquisitions may be subject to anti-monopoly control by the board members. Russian Federal Antimonopoly Service (FAS) when certain control Though Russian law prohibits a company from indemnifying a thresholds are reached. This also applies to indirect acquisitions director for actions that result in the company’s breach of its legal through off-shore holding companies. Obtaining preliminary FAS obligations, it is quite common for PE investors to indemnify their consent to a transaction normally takes 30 days. nominated director or to insist that the portfolio company obtain Approval will be required where the transaction structure includes: directors and officers liability insurance to protect against risks (a) a foreign acquisition of more than 50% in a protected sector associated with director decision-making liability. (natural resources, defence, nuclear energy, certain transportation businesses, certain telecommunications and media, certain power businesses, aviation, fishing and metals processing) or more than 3.7 How do directors nominated by private equity 25% in the mineral resources sector; or (b) where the acquirer is investors deal with actual and potential conflicts of interest arising from (i) their relationship with the a foreign state or international organisation and such acquirer will party nominating them, and (ii) positions as directors control more than 25% of a business in one of the protected sectors of other portfolio companies? mentioned in (a) above, or 5% in the mineral resources sector. Russian public deals structured as direct acquisition of shares Company statutes supplement the general duty for directors and the may be subject to voluntary or mandatory buyout offers when the CEO to act in the company’s best interest with the concept of an acquired stake exceeds 30%, 50% or 75% of the voting shares and, interested-party transaction. The board or the shareholders must subject to meeting certain statutory requirements, possible squeeze- approve interested-party transactions. out of minorities if a shareholder acquires more than 95% of the A company is obliged to inform on the transaction in which there is company’s shares. an interest from board members (the supervisory board) of society, Starting from 1 January 2016, foreigners are not allowed to acquire, members of the collegiate executive body of society, and in case all directly or indirectly (including through controlled persons or board members (of the supervisory board) of society are interested entities where foreign ownership exceeds 20%), more than 20% of in the commission of such transaction, or in case this formation is shares in a shareholder of a media founder, media editorial office or not provided by the law or the charter of society. Shareholders in broadcasting company. the order provided for by holding a general shareholder meeting, if Disclosure of information on material facts is applicable to public an order is not provided by the charter of society, are also obliged companies. to be informed. By the charter of society, the duty of notice of the shareholders along with board members (of the supervisory board) There are also special pre-completion requirements applicable to of society can be provided. transactions in the banking industry. The people specified in paragraph 1 of article 81 of the JSC law, within two months from the date when they learned or had to 4.2 Have there been any discernible trends in transaction learn about the approach of circumstances owing to which they terms over recent years? recognised interest in the commission of transactions by society, are obliged to notify society: Many of the recent PE transactions are being carried out in sectors ■ about legal entities concerning which they, their spouses, where the business strategy of the portfolio company involves parents, children, full and not full brothers and sisters, some form of global expansion and is not solely Russian-facing adoptive parents and the adopted and (or) their under control or dependent on Russian consumers or the growth of the Russian organisations are the controlling persons or have the right to economy. But in the last few years we have witnessed an overall give obligatory instructions; trend of the decline in the volume of PE transactions, due in part to a ■ about legal entities in which governing bodies they, their combination of sanctions, asset freezes, perceived limited economic spouses, parents, children, full and not full brothers and growth prospects, low oil prices, rouble depreciation, capital flight, sisters, adoptive parents and the adopted and (or) their under deoffshorisation policies and other factors. control persons hold positions; and ■ about the made or estimated transactions known by him in which they can be recognised as interested persons.
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with management representation made to the private equity sellers. 5 Transaction Terms: Public Acquisitions Indemnities are rarely given by PE sellers. When they are given, they are normally limited to specific risks identified in the buyer’s due 5.1 What particular features and/or challenges apply to diligence or they relate to corporate structuring and tax compliance private equity investors involved in public-to-private issues that cannot be easily remedied by the company. transactions (and their financing) and how are these commonly dealt with? 6.3 What is the typical scope of other covenants, undertakings and indemnities provided by a private This type of transaction is not common for the Russian market. In any equity seller and its management team to a buyer? case, there are general takeover rules binding on all investors acquiring Russia public companies in Russia. The public-to-private transactions In an acquisition agreement governed by foreign law, private equity are mostly conducted through: (i) a first step tender offer; and (ii) a sellers typically agree to a set of undertakings as to the conduct of squeeze-out of the remaining minority shareholders. In addition, prior business pre-completion in order to ensure the business is carried on to making a tender offer, investors often acquire the stock from the in the ordinary course and to minimise any value leakage. A PE seller company’s majority shareholders under a privately negotiated deal. might also be asked for non-compete covenants, the enforceability of which is, however, questionable from the Russian law perspective. 5.2 Are break-up fees available in your jurisdiction in Often the same may be asked from the top-management team. In relation to public acquisitions? If not, what other addition to that, the acquisition agreement typically includes the arrangements are available, e.g. to cover aborted deal full range of conditions precedent expected in any other jurisdiction costs? If so, are such arrangements frequently agreed (e.g., third-party consents, antitrust and other government approvals, and what is the general range of such break-up fees? accuracy of representations and warranties (subject to materiality tests), and performance of pre-completion undertakings). Russian law does not prohibit break-up fees or similar payments. At the same time, there is no particular regulation. In practice, 6.4 Is warranty and indemnity insurance used to “bridge public company transactions in Russia do not include break-up fees, the gap” where only limited warranties are given by particularly since this might give rise to a conflict of interest between the private equity seller and is it common for this the personal interests of the major selling shareholders (who might to be offered by private equity sellers as part of the also be the company’s board members) and the interests of the target sales process? If so, what are the typical (i) excesses company. Alternatively, it is more common for an acquirer to pre- / policy limits, and (ii) carve-outs / exclusions from negotiate terms and required approvals with shareholders holding such warranty and indemnity insurance policies? significant stakes in the public company to ensure that its bid will be successful. The warranty and indemnity insurance tools structured under Russian law are still almost untested. The most common way to bridge any warranty gap used in Russian deals is to reduce the 6 Transaction Terms: Private Acquisitions purchase price to address a specific potential liability.
6.1 What consideration structures are typically preferred 6.5 What limitations will typically apply to the liability of by private equity investors (i) on the sell-side, and (ii) a private equity seller and management team under on the buy-side, in your jurisdiction? warranties, covenants, indemnities and undertakings?
All the main forms of payment structures are used by PE investors Foreign law-governed acquisition agreements prevail in Russian PE in Russia. Private equity investors on the sell-side tend to prefer all deals. We can see that no limits usually apply for title warranties, cash consideration structures that are subject to adjustments based claims for business warranties are usually time-barred after one on completion accounts to be prepared post-completion. year, tax warranty limitations often follow the statutory period for Buy-side private equity investors also tend to prefer all cash tax authorities to bring claims in that jurisdiction, and caps range consideration structures, and typically require an escrow amount from 10% to 100% of the purchase price. The threshold for bringing to be set aside for warranty claims. Earn-out payments or profit claims is generally between 1% and 5% of the purchase price or guarantees are also preferred mechanisms to bridge valuation gaps. from $100,000 to $1,000,000 depending on the transaction. Assumption or repayment of debt is also common in PE deals, Limitations on the seller’s liability in Russian law-governed acquisition convertible debt and stock. agreements are quite narrow and usually only concern the type of damages that may be claimed by the buyer (as a rule, indirect damages, 6.2 What is the typical package of warranties/indemnities such as loss of profit, are excluded from Russian deals). Caps and offered by a private equity seller and its management baskets could be structured under Russian law but these have not yet team to a buyer? been properly tested in the courts. The limitation period for bringing claims for breach of contract (which is generally three years) cannot The package of warranties/representations is contractually negotiated be increased or decreased by an agreement governed by Russian law. and varies from transaction to transaction, heavily depending on stake size, but usually includes customary warranties (and, 6.6 Do (i) private equity sellers provide security (e.g. very rarely, representations) regarding title (to shares and assets), escrow accounts) for any warranties / liabilities, and liabilities, and regulatory as well as typical transactional warranties – (ii) private equity buyers insist on any security for such as capacity. Private equity sellers would typically seek to limit warranties / liabilities (including any obtained from their warranties and/or indemnities to warranties on title, capacity the management team)? and authority. Where management holds a significant stake, they are expected to give comprehensive warranties to the buyer, together Generally, PE sellers do not provide security for warranty claims.
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However, the final structure of security depends on the parties are tied to currency devaluations and other geopolitical factors respective bargaining strengths. which may influence timing horizons for a possible IPO, making Escrow arrangements are common for PE transactions, particularly them longer than in other jurisdictions. This is perhaps the most where pricing is subject to adjustments and/or is linked to the future important consideration in the Russian market at the moment. financial results of the portfolio company or some other variable that As a basic rule for all PE transactions, inclusion of appropriate rights is not possible to determine at the time of closing. and protections in shareholders’ agreements is critical to facilitating Since the last amendments to the Russian Civil Code, domestic a clean exit under an IPO, since the interests of PE investors are not escrow instruments have become involved in the security schemes. always aligned. In particular, in order to ensure that the shareholders’ New provisions on escrow accounts allow parties to open a special agreement allows for an exit plan, detailed obligations would normally
Russia bank account to hold money in escrow until obligations are need to be imposed on minority shareholders in respect of an IPO. performed. Specific conditions may be set out in a contract, upon Those often include the minorities’ obligations to swap their shares satisfaction of which the bank is authorised to release payment, for shares in an IPO special purpose vehicle, the obligation to give all i.e. the change is primarily oriented towards contractual rather consents and pass all resolutions required to effect the IPO, as well as than statutory regulation. Escrow agents’ obligations may be set the obligation to escrow a portion of their shares in an IPO exit. out in a separate escrow agreement or in other agreements. Unless Thorough consideration needs to be given by a private equity stated otherwise in the respective contract, until such time as the investor to factors that may complicate the exit, such as a non-cash specific contractual conditions are fulfilled, neither party (depositor consideration or complex capital structures. or beneficiary) is allowed to dispose of the funds in the escrow account. The bank’s fees also cannot be deducted from the escrow account unless specifically provided otherwise in the contract. 7.2 What customary lock-ups would be imposed on private equity sellers on an IPO exit? 6.7 How do private equity buyers typically provide comfort as to the availability of (i) debt finance, When Russian companies place their stock on overseas stock and (ii) equity finance? What rights of enforcement markets, it is customary for PE sellers to lock-up or escrow all or do sellers typically obtain if commitments to, or part of their stock in the listing vehicles for a period of 180 or 90 obtained by, an SPV are not complied with (e.g. days post-listing. For IPOs on the Russian stock exchange, the lock- equity underwrite of debt funding, right to specific up period is normally the same. performance of obligations under an equity commitment letter, damages, etc.)? Under one of the latest deals on the MICEX – IPO Russneft – one of the major shareholders and its subsidiary selling shares of Russneft Transaction documents typically include a commitment or warranty have assumed obligations not to sell shares for 180 days after the from the PE investor that it has sufficient financial resource to complete offer. Another shareholder of the company – Glencore plc – also the transaction. A bank commitment letter may also be provided in agreed to the 180-day ban on the sale of shares. certain cases. Such commitments are generally enforceable by the seller against the private equity fund, but bank commitment letters 7.3 Do private equity sellers generally pursue a dual-track are only intended to provide soft comfort to sellers and are usually exit process? If so, (i) how late in the process are not enforceable against the bank. In addition to that, it is common to private equity sellers continuing to run the dual-track, check the ultimate beneficial owners and decision-makers to define and (ii) were more dual-track deals ultimately realised the risks associated with doing business with them. Therefore, PE through a sale or IPO? investors are usually asked to provide information about their group structure and persons who have decision-making powers. Where Within dual-tracking, the seller of a company pursues IPO and M&A only Russian buyers are involved, sometimes parent company/PE deals simultaneously. The dual-track exit process was a feature of fund guarantees the seller by suretyship. the Russian market a number of years ago. As noted, IPO deals are currently limited in Russia by several factors (costs, sanctions). 6.8 Are reverse break fees prevalent in private equity Optimism for a return of IPO activity, including dual-track exits has transactions to limit private equity buyers’ exposure? since subsided. Recently, most dual-track deals have been realised If so, what terms are typical? through a sale and not an IPO.
This type of compensation is illustrative for a transaction that involves a strategic investor or where, given the nature of the transaction, it 8 Financing may be impossible to determine the quantum of damages that would be suffered if the target company backed out of the deal. Usually, reverse break fees are payable when the deal is not completed, e.g., 8.1 Please outline the most common sources of debt owing to the buyer’s failure to obtain financing and/or corporate or finance used to fund private equity transactions in your jurisdiction and provide an overview of the regulatory approval for the deal; however, they are not common within current state of the finance market in your jurisdiction the Russian market. When it comes to the deal, the size of the fee is for such debt (particularly the market for high yield negotiable and usually varies between 3–5% of the transaction value. bonds).
7 Transaction Terms: IPOs Traditional bank financing remained the most common source of debt finance for private equity transactions in Russia prior to the imposition of economic sanctions, which curtailed their investment 7.1 What particular features and/or challenges should a activities. Convertible loans and mezzanine finance have been used private equity seller be aware of in considering an IPO regularly, especially by foreign banks with a presence in Russia. exit? Nowadays, financing tends to be attracted from other sources to fund the acquisition and sometimes the working capital needs of the PE investors should be aware that the current market conditions
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target. We are seeing more Russian investment funds and strategic ■ Regional and industry tax incentives. players actively competing with foreign investment funds in the Various types of tax incentives are available in Russia. For financing area. example, a reduction in the profits tax rate (to 0%, in certain cases), along with other benefits, is available for investment projects in many regions. Certain tax preferences (e.g., a 8.2 Are there any relevant legal requirements or reduction of the federal profits tax rate) are granted to residents restrictions impacting the nature or structure of of territories of advanced social and economic growth. the debt financing (or any particular type of debt Companies that participate in the Skolkovo Innovation Center financing) of private equity transactions? may benefit from a 10-year tax holiday. Technology and software companies may benefit from reduced social security
Generally, debt financing of PE projects is not limited by any special rates. A 0% profits tax rate applies to a range of educational and Russia legal requirements or restrictions. Thin capitalisation rules apply medical services. A 150% deduction for profits tax purposes is where a Russian borrower seeks debt financing from its owners available to all companies with qualifying R&D expenditure. based in another jurisdiction. Foreign investors invest in Russia through a company established There are also no special rules preventing a PE investor from giving in a country that has a double tax treaty with Russia (Cyprus, financial assistance to a target. However, under Russian civil law Luxembourg, the Netherlands) often having a holding in an off- financial assistance cannot be made in the form of a gift by one profit- shore jurisdiction. making company to another (article 575 of the Russian Civil Code). Russian tax law allows for financial assistance if either the company 9.2 What are the key tax considerations for management providing financing owns over 50% of the shares or participatory teams that are selling and/or rolling-over part of their interests of the company being financed or vice versa (article 251 investment into a new acquisition structure? of the Russian Tax Code). Thus, a transfer free of charge may be transferred for the purpose of being redistributed within a group of ■ Taxation of dividends: companies in pursuance of the group’s common economic objectives. Dividends received by a Russian entity from Russian and foreign entities generally are subject to tax at a rate of 13%. 9 Tax Matters ■ Capital gains: Capital gains are taxed as ordinary income at the normal corporate rate of 20%. 9.1 What are the key tax considerations for private equity ■ Participation exemption: investors and transactions in your jurisdiction? Are off-shore structures common? To qualify for the participation exemption with regard to dividend income, a Russian company must hold a participation of at least 50% for at least 365 days in a calendar Key tax considerations for private equity investors and transactions year. A foreign investee must not be a resident in a “black in Russia include: list” jurisdiction. A participation exemption is available ■ Anti-avoidance rules. for capital gains realised on the sale of unlisted shares and ■ CFC rules. participations in Russian companies, and listed shares in high-technology Russian companies acquired after 1 January ■ Transfer pricing rules. 2011 and held for more than five years. ■ Comprehensive transfer pricing provisions, which are substantially in line with OECD principles, apply. ■ Thin capitalisation rules. 9.3 What are the key tax-efficient arrangements that are typically considered by management teams in private ■ Currency control regulations. equity portfolio companies (such as growth shares, Residents and non-residents can hold bank accounts in any deferred / vesting arrangements, “entrepreneurs’ currency. Russian residents (as defined under the Russian relief” or “employee shareholder status” in the UK)? currency control legislation) are required to notify the tax authorities upon opening, changing or closing personal Equity participation for management is typically structured through accounts with banks located outside of Russia. Residents are phantom share, share appreciation rights, or equity linked bonus also required to notify the tax authorities about the movement regimes due to a quirk in Russian securities law regulations, and of funds in their foreign bank accounts (e.g., deposits). unclear tax law treatment. ■ Exchange of Financial Account Information executed by the Management teams typically do not hold their interests in shares RF Tax authorities (CRS). of the portfolio company and prefer to receive phantom shares or ■ General tax burden (Russian profit tax (20%), payment of equity-linked bonuses to mitigate risk being taxed upon the granting Russian VAT (18%/10%), social security contributions). of such rights. ■ Withholding tax. ■ Granting of phantom shares: ■ Dividends paid to a foreign entity or to a non-resident individual are subject to a 15% withholding tax, unless Phantom stock should be non-taxable until the cash is paid, the rate is reduced under a tax treaty. generating ordinary income for the employee and a deduction for the company. Phantom stock is a way to share a stake in ■ Interest paid to a non-resident is subject to a 20% a business while avoiding the need for the new “owner” to withholding tax, unless the rate is reduced under a tax invest cash or suffer taxable income. treaty. ■ Share appreciation rights (SARs): ■ Royalties paid to a non-resident are subject to a 20% withholding tax, unless the rate is reduced under a tax treaty SARs offer the right to the cash equivalent of value increases of a certain number of stocks over a predetermined time ■ Application of DTTs and allowance for repatriation of profit period. This bonus is almost always paid in cash; however, (particularly where the PE investor has invested through an the company may pay the employee bonus in shares. In most off-shore holding entity). cases, SARs can be exercised after they vest; when SARs
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vest, it simply means that they become available to exercise. source of regulation of such activities in Russia is the Russian SARs are generally issued in conjunction with stock options Civil Code and laws on joint stock companies and limited in order to assist in funding the purchase of options or to pay liabilities companies, which regulate all main forms of Russian off taxes due at the time the SARs are exercised. commercial legal entities and their business operations. After ■ Equity-linked bonuses: certain amendments, the Russian Civil Code contains norms The analysis of the tax consequences for employees in which are frequently used in PE transactions, such as commercial relation to employee share plans is based on a reasonable representations and warranties, the principal of good faith interpretation of how the provisions of Russian Securities negotiations. It also introduces a number of legal instruments, Market Law may apply. The Ministry of Finance has issued such as irrevocable powers of attorney and escrow accounts, which several private rulings on this issue, providing clarification bring Russia’s legal environment more in line with continental Russia that stock options are not taxable at grant (only at exercise) European jurisdictions. as long as they are not deemed as financial instruments under the Russian Securities Market Law. The employment income of highly-qualified foreign 10.2 Have there been any significant legal and/or professionals is taxable at a rate of 13% (even during periods regulatory developments over recent years impacting of non-residence for tax purposes), rather than the 30% rate private equity investors or transactions and are any that otherwise would apply). anticipated?
Over the last three to five years, Russian legal regulation of business 9.4 Have there been any significant changes in tax operations has undergone a number of massive and substantial legislation or the practices of tax authorities (including in relation to tax rulings or clearances) revisions. This resulted in most laws and regulations being in impacting private equity investors, management line with international best practices and has made the Russian PE teams or private equity transactions and are any market more attractive to foreign and local investors. anticipated? The Russian Civil Code has been revised to include concepts used in PE deals on other markets but previously arguable under The most significant tax changes affecting the PE industry have Russian law. The significant changes that have already come into been in relation to recent deoffshorisation policies set out in Federal force include the concepts of irrevocable powers of attorney and Law No. 376-FZ, 24 November 2014 which introduced substantial escrow arrangements. Russia introduced shareholder agreements changes to the rules governing the reporting and taxation of and the court’s capacity to lift of corporate veil. Shareholders are participation interests held by Russian tax residents in controlled able to choose the governing law of their shareholders’ agreements foreign companies (CFCs). Following the adoption of the law, in respect of Russian companies. profits generated by a CFC will be imputed as taxable profit of As for contractual instruments, the Russian Civil Code introduced Russian tax residents who control the CFC at a rate of 20% for legal indemnities, warranties, potestative clauses, option, waiver, etc. persons and 13% for natural persons, which has made the treaty There are also new types of securities: security deposit; and an benefits previously enjoyed by Russian investors who structured independent guarantee issued by a bank or corporation. their investments off-shore no longer possible. The other thing that changed the landscape of law enforcement was the The Federal Law No. 376-FZ of 24 November 2014 law introduced landmark directive issued by the High Arbitration Court. It states that a number of key principles new to Russian tax law, including CFC any rule contained in law is non-mandatory if otherwise is provided. rules, beneficiary ownership, as well as tax residency for legal entities. On 12 May 2016, Russia signed the multilateral competent authority agreement on the exchange of financial account information, thereby 10.3 How detailed is the legal due diligence (including compliance) conducted by private equity investors joining the Standard for Automatic Exchange of Financial Account prior to any acquisitions (e.g. typical timeframes, Information (Common Reporting Standard, the CRS). materiality, scope etc.)? Do private equity investors Joining the CRS will enable Russian tax authorities to obtain engage outside counsel / professionals to conduct all information on financial accounts held by Russian tax-resident legal / compliance due diligence or is any conducted individuals and legal entities abroad (in jurisdictions which have in-house? also signed up to the CRS, i.e. “partner jurisdictions”) from the tax authorities of the relevant countries. The Russian tax authorities will Due diligence processes and the relevant requirements in Russia also be obliged to provide similar information to the tax authorities of are largely dependent on the size, type and location of the relevant partner jurisdictions regarding financial accounts held by tax residents company. Private companies are generally even more skittish about of those jurisdictions with Russian financial institutions. The exchange sharing information and may need a fair degree of prodding before of information will occur automatically on an annual basis. The first they will do so. exchange of information with partner jurisdictions will occur in 2018. Generally, Russian targets present a number of specific challenges that may significantly complicate the due diligence process. This goes partially from the fact that the legal framework relating to the 10 Legal and Regulatory Matters ownership and use of land and other real property, and the proper recording of title to shares and participatory interests in Russian companies, are not yet sufficiently developed. 10.1 What are the key laws and regulations affecting private equity investors and transactions in your Foreign investments in certain sectors are also subject to multiple jurisdiction, including those that impact private equity and often ambiguous prohibitions and restrictions. And finally, transactions differently to other types of transaction? Russian legal and accounting regimes are developing at a very rapid pace, so just keeping up with the changes and figuring out how they There is no special state authority or professional self-regulatory might impact an investment is itself a challenging task. organisation supervising off-shore PE funds’ activities. The main
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Most PE funds outsource this function to modern Russian law firms or international law firms that jointly carries out financial, 10.5 Are there any circumstances in which: (i) a private business and legal due diligence with auditors, since guidance from equity investor may be held liable for the liabilities of the underlying portfolio companies (including due to experienced, knowledgeable advisors is crucial to success at the breach of applicable laws by the portfolio companies); stage of PE investment. and (ii) one portfolio company may be held liable for the liabilities of another portfolio company? 10.4 Has anti-bribery or anti-corruption legislation impacted private equity investment and/or investors’ In Russia, the doctrine of “piercing the corporate of veil” started approach to private equity transactions (e.g. to be widely discussed in connection with the famous ruling of the
diligence, contractual protection, etc.)? Supreme Arbitration Court in relation to “Parex Bank” (Latvia), Russia where this doctrine was directly mentioned by the court for the first Russia is still considered a “high-risk” country from an anti-bribery time. For many years, the Russian courts were, however, reluctant and anti-corruption perspective, despite the fact the Russian anti- to “pierce the corporate veil” and generally refused to hold a parent corruption legislation has gone some way to creating an ostensibly or controlling company liable for the debts of its subsidiaries or comprehensive framework of anti-corruption rules. The main affiliates. law regulating corruption issues in Russia is the Federal law “On Nowadays, an investor can be held liable if he de facto has influence Combating Corruption” dated December 25 2008, which provides on a legal entity or board members for any damage caused to the the definition of corruption. Anti-corruption is also regulated by a company by his actions. This scope of liability cannot be eliminated number of specific laws, such as the prohibition of state officials to by a contract (article 53.1 of the Russian Federation Civil Code). accept gifts with a value exceeding RUB3,000, and the Federal Law This measure also applies to cases of bankruptcy. An investor may “On the State Civil Service”, which establishes rules for accepting be held severally and jointly liable for the liabilities if he caused the presents by state civil servants. Money laundering is separately status of insolvency. regulated by the Federal Law “On Combating the Legalisation of the As a general rule, different portfolio companies are not liable for the Proceeds of Crime (Money Laundering) and Terrorist Financing” wrongdoings of another portfolio company unless they meet certain dated August 7 2001. The Russian Code concerning administrative criteria mentioned above. Therefore, PE investors in Russia should violations and the Russian Criminal Code set out administrative and diversify their investments so as to exclude crossing liabilities. criminal liability respectively for failure to comply with anti-bribery and anti-money laundering rules, with sanctions ranging from fines to imprisonment. As a result, the price of non-compliance with anti- 11 Other Useful Facts bribery and corruption legislation in Russia can be high, both in monetary terms and reputation. Directors of Russian companies may be subject to criminal and civil liability for breach of anti- 11.1 What other factors commonly give rise to concerns corruption legislation. for private equity investors in your jurisdiction or should such investors otherwise be aware of in Therefore, PE investors should usually perform anti-corruption considering an investment in your jurisdiction? due diligence, introduce anti-corruption related warranties and indemnities, and most routinely require the portfolio company to Russia is a large and still growing investor-friendly market, full implement an anti-corruption policy as a condition precedent to of potential opportunities. Most laws and regulations are in line its investment if it does not already have one. Representations, with international best practices, and should not cause too much warranties and covenants dealing with anti-corruption, anti-bribery concern on the part of experienced private equity investors. Last and other compliance matters are more and more common in deals year, Russia significantly improved the process of setting up new involving foreign PE buyers due to this legal regime. enterprises and the customs regulation. The next “growth zone” for Russia is reform of international trade rules and construction licence regulations. These movements over the last year allowed Russia to appear in 40th place in the Doing Business Rating. Achieving a higher position in the rating is still the main task in President Decrees. Russia has the aim of moving to 20th place in 2018, despite sanctions by the US and Europe and countervailing sanctions by Russia. But PE investors must be wary of potential pitfalls and be extra vigilant during the due diligence process in order to minimise risks to the greatest extent possible. Guidance from experienced, knowledgeable advisors is crucial to success in this land of still relative uncertainty.
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Zhanna Tomashevskaya Roman Nikolaev Tomashevskaya & Partners Tomashevskaya & Partners 51 floor, Imperia Tower 51 floor, Imperia Tower Moscow City Moscow City Presnenskaya Naberezhnaya 6/2 Presnenskaya Naberezhnaya 6/2 Moscow, 123117 Moscow, 123117 Russia Russia
Tel: +7 495 134 1444 Tel: +7 495 134 1444 Email: [email protected] Email: [email protected] URL: www.tp-law.com URL: www.tp-law.com Russia Zhanna Tomashevskaya, Managing Partner Roman Nikolaev, Senior Vice President Since 2006, Zhanna has been providing legal counsel to corporations Roman specialises in International Banking and Finance, Mergers in both Russia and those based internationally as they engage in M&A and Acquisitions, Capital Markets and Cross-border litigation. He negotiations and transactions. has got years of direct in-house experience as the lawyer for multiple banking institutions. Roman was previously the General Counsel Zhanna has strong expertise in English and Russian law and extensive of the Member Credit and Restructuring Committee of MDM Bank experience in leading technological and innovative projects. In 2012– (rebranded as Binbank, a Russian commercial bank in the top-20 2016, Zhanna served as the partner and head of the Moscow office of Russian banks with $18,000,000,000+ assets), where he led a team O2 Consulting, a law firm with a focus on M&A. of more than 70 lawyers across a diverse set of business units and Zhanna was a lead partner in deals with the two most popular and locations. exciting apps, in 2016: Prisma and MSQRD. She is the general Prior to that, Roman was the head of MDM Bank’s international law counsel to Gagarin Capital Partners, a major investor into technologies, division, where he advised the institution in matters related to cross- holding negotiations and making business-related decisions. border litigation, private equity, capital markets, and mergers and Both Best Lawyers and Chambers and Partners have named Zhanna acquisitions. as a top corporate and M&A lawyer. Zhanna routinely speaks at major Russian legal conferences and lectures at Moscow State University and the prestigious National Research University Higher School of Economics.
Tomashevskaya & Partners is an award winning Russian law firm with a focus on complex corporate restructuring projects and comprehensive legal advice to tech companies, and private equity and venture capital funds. Tomashevskaya & Partners consists of a team of legal specialists with proven track records and extensive experience in M&A deals, corporate, finance, and investment law. The firm has been involved in major IP projects, such as investments to IT start-ups Sixa and Wallarm; the sale of 30% of Yota’s shares, a major Russian mobile Internet operator; the purchase of a Moscow region-based Internet service provider to a Kazakh telecom company, which ensured their entrance into a new market; securing a major investment for CleverDATA, a Russian company specialising in CRM and data management solutions.
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Singapore Christian Chin
Allen & Gledhill LLP Lee Kee Yeng
There are plans to introduce a new corporate structure for collective 1 Overview investment schemes, known as the Singapore Variable Capital Company (S-VACC), which will provide greater flexibility for the 1.1 What are the most common types of private equity return of capital to shareholders to facilitate redemption rights of transactions in your jurisdiction? What is the current investors and allow the creation of sub-funds with segregated assets state of the market for these transactions? Have and liabilities within a single S-VACC. It remains to be seen how this you seen any changes in the types of private equity new structure (if introduced) will be used in private equity transactions. transactions being implemented in the last two to three years? 2.2 What are the main drivers for these acquisition structures? The most common types of private equity transactions in Singapore are venture capital and buyout transactions, and minority investments in portfolio companies. The main drivers for these acquisition structures are tax efficiency and financing requirements. The volume of private equity activity in Singapore continued to gain momentum in 2016, though the total deal value was less than in 2015. The real estate and technology sectors continue to generate 2.3 How is the equity commonly structured in private keen interest, examples being the recent bid by a consortium led equity transactions in your jurisdiction (including institutional, management and carried interests)? by Warburg Pincus to privatise real estate fund manager ARA Asset Management, and significant funding rounds by ride-hailing platform Grab and consumer internet platform provider Garena. Private equity investors typically invest through a combination of ordinary and preference equity and convertible debt, with the latter The region has also seen a growing trend of large institutional two forming the bulk of the investment. investors and/or sovereign wealth funds seeking co-investment opportunities with private equity funds. Key management may be granted equity sweeteners whose structures can vary substantially – from ordinary shares with a vesting schedule, profit participating options exercisable on exit, to subordinated equity. 1.2 What are the most significant factors or developments encouraging or inhibiting private equity transactions in your jurisdiction? 2.4 What are the main drivers for these equity structures?
Singapore is the most developed market in Southeast Asia, with a The main drivers for these equity structures are tax efficiency, the stable political-economic environment, a strong infrastructure, an need to secure the priority of return of the private equity investor’s investor-friendly tax regime and a skilled workforce with a strong capital and to facilitate the ability to return capital to shareholders, pool of professional talent. These factors continue to draw private and the desire to incentivise management. equity investors, as Singapore provides a good base from which to make investments in the region. 2.5 In relation to management equity, what are the typical vesting and compulsory acquisition provisions? 2 Structuring Matters Management equity would typically vest over three to five years, or upon an exit. Management equity is usually subject to (a) ‘good 2.1 What are the most common acquisition structures leaver’ and ‘bad leaver’ provisions under which such equity (which adopted for private equity transactions in your usually take the form of shares or options) may be acquired at either jurisdiction? Have new structures increasingly fair value or at cost, and (b) a drag in the event of an exit by the developed (e.g. minority investments)? private equity investor.
Private equity investments are typically structured with an offshore holding company whose shares are held by the private equity investor 2.6 If a private equity investor is taking a minority position, are there different structuring considerations? and management. A BidCo is sometimes used under the holding company to hold the target’s shares and/or to take on acquisition debt. The key considerations would be governance (as specified in
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Section 3 below) and the need to ensure preferred returns. Minority However, minority shareholders can seek recourse under Section stake investments by private equity investors usually take the form 216 of the Companies Act if the affairs of a Singapore company are of convertible debt (to maintain priority) or preferred shares. conducted in a manner which is oppressive to one or more minority shareholders. If a finding of oppression is made, the court may order such remedies as it deems fit, including orders regulating the future 3 Governance Matters conduct of the company or a winding up.
3.1 What are the typical governance arrangements 3.5 Are there any limitations or restrictions on the for private equity portfolio companies? Are such contents or enforceability of shareholder agreements arrangements required to be made publicly available (including (i) governing law and jurisdiction, and (ii)
Singapore in your jurisdiction? non-compete and non-solicit provisions)?
The governance arrangements of private equity portfolio companies Singapore courts generally uphold the provisions of a shareholder with more than one shareholder are usually set out in a shareholders’ agreement in relation to a Singapore company, except for those agreement. Typical arrangements include veto rights, restrictions provisions which are unlawful or otherwise regarded as contrary to on the transfer of securities, covenants on the continued operation public policy. of the business, non-compete undertakings, and deadlock resolution Non-compete and non-solicit provisions are regarded as a restraint procedures. on trade and against public policy. These are unenforceable Some of these arrangements will also be set out in the portfolio unless the party seeking enforcement can show that the restraint is company’s constitution, which is made available to the public upon reasonable and seeks to protect a legitimate proprietary interest. filing with the Accounting and Corporate Regulatory Authority Provisions that are regarded as penal in nature will also be struck (ACRA). Shareholders’ agreements are, however, not required to be down. filed with ACRA and are generally not required to be made publicly available unless they contain arrangements entered into as part of a take-private transaction governed by the Singapore Takeover Code. 3.6 Are there any legal restrictions or other requirements that a private equity investor should be aware of in appointing its nominees to boards of portfolio 3.2 Do private equity investors and/or their director companies? What are the key potential risks and nominees typically enjoy significant veto rights over liabilities for (i) directors nominated by private equity major corporate actions (such as acquisitions and investors to portfolio company boards, and (ii) private disposals, litigation, indebtedness, changing the equity investors that nominate directors to boards nature of the business, business plans and strategy, of portfolio companies under corporate law and also etc.)? If a private equity investor takes a minority more generally under other applicable laws (see position, what veto rights would they typically enjoy? section 10 below)?
Yes, private equity investors typically enjoy significant veto rights Singapore companies require at least one Singapore-resident over material corporate actions. Typical veto rights enjoyed by director. Certain persons (e.g., an undischarged bankrupt or a person private equity investors include restrictions on further issuances of who has been convicted for offences relating to fraud or dishonesty) debt/equity, change of business and winding up. Depending on the are not eligible to be directors of a Singapore company. size of the minority stake, the private equity investor may also have Directors of Singapore companies have duties under the Companies veto rights over operational matters such as the annual budget and Act vis-à-vis the Singapore company. These include obligations to business plan, capital expenditures above a certain threshold and disclose their interests in transactions with the company (Section material acquisitions and disposals. 156 of the Companies Act), an obligation to seek authorisation from the company prior to disclosing information received in their 3.3 Are there any limitations on the effectiveness of veto capacity as directors (Section 158 of the Companies Act) and a duty arrangements: (i) at the shareholder level; and (ii) to act at all times honestly and with reasonable diligence in the at the director nominee level? If so, how are these discharge of its duties (Section 157 of the Companies Act). Such typically addressed? directors also have a common law fiduciary duty to the company. These obligations apply not only to persons formally appointed as Singapore courts will generally enforce veto arrangements at both directors of the company, but also to any person whom the court the shareholder level and the board level. However, veto rights considers a ‘shadow director’ (usually a person whose directions or exercised by directors are subject to their overriding fiduciary duty instructions an appointed director is accustomed to act upon). to the company on whose board they sit. Where there is a concern that the directors’ ability to exercise their veto rights may be limited 3.7 How do directors nominated by private equity by their fiduciary duty owed to the company, such concern is often investors deal with actual and potential conflicts of addressed by giving such veto rights to the shareholders instead of interest arising from (i) their relationship with the the directors. party nominating them, and (ii) positions as directors of other portfolio companies?
3.4 Are there any duties owed by a private equity investor to minority shareholders such as management Directors who face a conflict of interests (whether actual or potential) shareholders (or vice versa)? If so, how are these should disclose the nature of the conflict to the board and abstain typically addressed? from voting on the resolution. Private equity investors should craft their veto rights accordingly so that the investor as a shareholder has A private equity investor does not owe any duty to minority the ability to ensure that certain decisions cannot be taken with their shareholders such as management shareholders (or vice versa). consent even if their directors have to abstain from voting.
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4 Transaction Terms: General 5.2 Are break-up fees available in your jurisdiction in relation to public acquisitions? If not, what other arrangements are available, e.g. to cover aborted deal 4.1 What are the major issues impacting the timetable costs? If so, are such arrangements frequently agreed for transactions in your jurisdiction, including and what is the general range of such break-up fees? competition and other regulatory approval requirements, disclosure obligations and financing Break fees, though permitted under the Singapore Takeover Code, issues? are not common. Where a break fee is imposed, the Singapore Takeover Code requires that it be no more than 1% of the value of For public-to-private transactions, the key drivers of the timetable are the offeree company and confirmations must be made by the board the mandatory timelines imposed by the Singapore Takeover Code of the offeree company and its financial adviser that the break fee is Singapore and the clearances required from the Securities Industry Council prior in the best interests of shareholders. to announcing the transaction. Privatisation transactions subject to the Singapore Takeover Code generally take between two to three months to complete, assuming no other regulatory clearances are 6 Transaction Terms: Private Acquisitions required. Where the privatisation is subject to shareholders’ approval, the timetable will be stretched by an additional five to seven weeks to include the time needed for clearance by the Singapore Exchange 6.1 What consideration structures are typically preferred by private equity investors (i) on the sell-side, and (ii) and the notice period for the shareholders’ meeting. As public to on the buy-side, in your jurisdiction? private transactions are subject to certain funds requirements prior to launching the transaction, the time needed to satisfy this requirement Private equity investors on the sell-side tend to prefer all cash should also be taken into account. consideration structures that are subject to adjustments based on Other factors that may affect the timetable for transactions include completion accounts to be prepared post-completion (typically the scope of due diligence (including the preparation of financials to adjust for working capital levels). Locked box structures are for the purposes of locked box deals) and other regulatory sometimes used, but are less common. approvals. Key regulatory approvals that may materially affect the Buy-side private equity investors also tend to prefer all cash timeline include industry-specific approvals in relation to holdings consideration structures, and typically require an escrow amount in regulated industries (e.g., investments in the banking, insurance, to be set aside for warranty claims. Earn-out payments or profit or telecommunications industries) and competition approvals. The guarantees are also preferred mechanisms to bridge valuation gaps. timeframe for competition approvals is approximately 30 working days (in respect of a Phase 1 review) and 120 working days (in respect of a Phase 2 review). 6.2 What is the typical package of warranties/indemnities offered by a private equity seller and its management team to a buyer? 4.2 Have there been any discernible trends in transaction terms over recent years? Private equity sellers would typically seek to limit their warranties and/or indemnities to warranties on title, capacity and authority. Recent trends in private equity transactions include the use of Where management holds a significant stake, they are expected warranty and indemnity insurance and the introduction of locked to give comprehensive warranties to the buyer, together with a box structures in lieu of the purchase price adjustment mechanisms. management representation made to the private equity sellers. Where the management stake is not significant, the private equity 5 Transaction Terms: Public Acquisitions sellers may be prepared to increase the scope of warranties subject to limited liability caps of between 10% to 25% of the consideration. Warranty and indemnity insurance is also gaining popularity as a 5.1 What particular features and/or challenges apply to way to bridge the liability gaps (see question 6.4 below). private equity investors involved in public-to-private transactions (and their financing) and how are these commonly dealt with? 6.3 What is the typical scope of other covenants, undertakings and indemnities provided by a private equity seller and its management team to a buyer? Public-to-private transactions are governed by the Singapore Takeover Code, which imposes certain rules and restrictions on deal structuring. Public takeovers in Singapore, once announced, cannot Private equity sellers typically agree to a set of undertakings as to the be subject to, or conditional upon, financing being obtained. This conduct of business pre-completion in order to ensure the business is carried on in the ordinary course and to minimise any value leakage. certain funds requirement means that deal financing must be in place Non-competes or non-solicits are generally not given by the private at the time of announcement, with limited covenants under which equity seller, though these would be given by the management team. the financing can be withdrawn. The Singapore Takeover Code requirement for all shareholders to be treated equally also limits the ability of private equity investors to 6.4 Is warranty and indemnity insurance used to “bridge the gap” where only limited warranties are given by offer sweeteners to key shareholders, and this often results in higher the private equity seller and is it common for this acquisition costs for public-to-private transactions. to be offered by private equity sellers as part of the sales process? If so, what are the typical (i) excesses / policy limits, and (ii) carve-outs / exclusions from such warranty and indemnity insurance policies?
Warranty and indemnity insurance is gaining popularity among
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private equity investors. It is used on the sell-side to bridge the gap on liability caps and on the buy-side to improve the attractiveness of 7 Transaction Terms: IPOs the private equity investor’s bid in competitive bid situations. Typical excesses range from 0.5% to 1% of the insured amount, and 7.1 What particular features and/or challenges should a typical policy limits range from 20% to 30% of the insured amount. private equity seller be aware of in considering an IPO Customary carve outs/exclusions include known/disclosed matters, exit? forward looking warranties, civil or criminal fines, consequential losses, purchase price adjustments, secondary tax liabilities, transfer ■ Prospectus Liability. A private equity seller participating pricing risks, environmental and anti-bribery/corruption liabilities. as a vendor in an IPO is responsible for the accuracy of the prospectus to be issued as part of the public offering of securities under the IPO. Singapore law imposes criminal Singapore 6.5 What limitations will typically apply to the liability of and civil penalties for false or misleading statements or a private equity seller and management team under omissions in the prospectus. warranties, covenants, indemnities and undertakings? ■ Prospectus Disclosure. An IPO prospectus is required to disclose all material information, including background Where the warranties are limited to title, capacity and authority, information on all vendors in the IPO. the private equity seller’s liability is either uncapped or capped at ■ Lock-ups. A private equity seller may be subject to lock- the amount of consideration paid. The private equity seller and up requirements under the listing rules of the Singapore management team’s liabilities for other warranties are usually capped, Exchange – please see the discussion in question 7.2 below. and the amount of the cap may range from 10% to 100% of the ■ Interested Person Transactions. If the private equity seller consideration paid, depending on the type of warranty and the strength retains a shareholding of 15% or more post-listing, it will be of each party’s bargaining position. Liability under covenants, an “interested person” for the purposes of the listing rules indemnities and undertakings may not be subject to such caps. of the Singapore Exchange and any transactions between the private equity seller (or any of its associates) and the listed Where known risks are identified, an escrow amount may be set company (or any of its subsidiaries or unlisted associated aside from the consideration to satisfy such claims. companies) will be “interested person transactions”. General limitations such as time limits within which claims must Depending on the materiality of the value of the transaction, be made and a de minimis threshold before claims can be made are the listing rules may require announcements to be made and/ also customary. or prior shareholder approval to be obtained. ■ Take-overs. The conversion of the portfolio company into a public company will subject its shareholders to the take-over 6.6 Do (i) private equity sellers provide security (e.g. regime under Singapore law, which requires a general offer to escrow accounts) for any warranties / liabilities, and be made by any person who, together with its concert parties, (ii) private equity buyers insist on any security for either: (a) acquires 30% or more of the voting rights of the warranties / liabilities (including any obtained from company; or (b) holds at least 30% but not more than 50% the management team)? of the voting rights of the company, and acquires additional shares carrying more than 1% of the voting rights within any Generally, private equity sellers do not provide security for warranty six-month period. A private equity seller considering an IPO claims. exit should bear these thresholds in mind when structuring its While private equity buyers will try to insist on such security being anticipated level of post-listing shareholding interest. provided by sellers, the agreement reached between buyer and seller ultimately depends on their respective bargaining strengths. 7.2 What customary lock-ups would be imposed on private equity sellers on an IPO exit? 6.7 How do private equity buyers typically provide comfort as to the availability of (i) debt finance, and (ii) equity If the private equity seller retains a shareholding of 15% or more at finance? What rights of enforcement do sellers typically the time of listing, the listing rules of the Singapore Exchange will obtain if commitments to, or obtained by, an SPV require a lock-up to be given by the seller over all of their shares are not complied with (e.g. equity underwrite of debt for a period of either six or 12 months after listing, depending on funding, right to specific performance of obligations the admission criteria upon which the company is listed. If the under an equity commitment letter, damages, etc.)? private equity seller retains a shareholding of less than 15% at the time of listing, the listing rules of the Singapore Exchange will The purchase agreements or bid letters typically include a also require a six-month lock-up to be given over a proportion of commitment or warranty from the private equity fund that it has the shares acquired within a period of 12 months preceding the sufficient financial resource to complete the transaction. Abank date; the proportion of shares subject to the lock-up reflecting the commitment letter may also be provided in certain cases to provide proportionate price discount enjoyed by the private equity seller in comfort on the availability of financing where certain funds are acquiring such shares, compared to the IPO price for the shares. required. Such commitments are generally enforceable by the seller against the private equity fund, but bank commitment letters are only intended to provide soft comfort to sellers and are usually not 7.3 Do private equity sellers generally pursue a dual-track enforceable against the bank. exit process? If so, (i) how late in the process are private equity sellers continuing to run the dual-track, and (ii) were more dual-track deals ultimately realised 6.8 Are reverse break fees prevalent in private equity through a sale or IPO? transactions to limit private equity buyers’ exposure? If so, what terms are typical? Because they are costly, dual-track exit processes are only undertaken when private equity sellers are unsure which option is Reverse break fees are not common in Singapore. more likely to be consummated. It follows that private equity sellers
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are also keen to end the dual-track as soon as it becomes apparent the hands of a shareholder (regardless whether the recipients of such that consummation of the preferred option is imminent. dividends are individuals or corporate entities) and no Singapore Recently, most dual-track deals have been realised through a sale withholding tax will be imposed on such dividends. and not an IPO. Where private equity acquisitions are financed (wholly or partly) through debt, any payments in the nature of interest which are borne by a person or permanent establishment in Singapore and paid to a 8 Financing person not resident in Singapore would be subject to withholding tax in Singapore. However, the withholding tax rates may be reduced by tax treaties, and certain exceptions from withholding tax may 8.1 Please outline the most common sources of debt finance used to fund private equity transactions in also be applicable. For instance, a withholding tax exemption may your jurisdiction and provide an overview of the be available for qualifying debt securities where certain conditions Singapore current state of the finance market in your jurisdiction are met, and where Singapore financial institutions with the relevant for such debt (particularly the market for high yield incentives have arranged such issuance. bonds). Certain tax incentive schemes may also be available for qualifying Singapore or non-Singapore tax resident funds which are managed Traditional bank financing through loans remains the most common by Singapore-based fund managers. Specified income of qualifying source of debt finance for private equity transactions in Singapore. funds derived from a prescribed list of designated investments may The financing market remains fairly stable and banks continue to be exempt from tax under the fund management incentive schemes. show a willingness to support leveraged finance transactions, taking Various conditions must be met by both the fund and the fund into consideration factors such as the quality of target assets, the manager. track record of the sponsor, the debt quantum, pricing and security package. Off-shore structures are quite commonly used – please see the discussion in question 2.1 above.
8.2 Are there any relevant legal requirements or restrictions impacting the nature or structure of 9.2 What are the key tax considerations for management the debt financing (or any particular type of debt teams that are selling and/or rolling-over part of their financing) of private equity transactions? investment into a new acquisition structure?
Leveraged buyouts typically involve a debt pushdown following Unlike the UK, “rollover relief” is not available in Singapore. completion where the target company takes over the acquisition As there is no capital gains tax in Singapore, one of the key debt and gives a security package over its assets to the lender. considerations for private equity transactions is whether the gains Such an arrangement constitutes financial assistance on the part of from such transactions constitute capital gains or trading income, the the target company, and has to be whitewashed by its shareholders latter of which is subject to Singapore income tax. For example, the if it is a public company or a subsidiary of a public company. The gains from a sale of shares may be regarded as trading income and prohibition against giving such financial assistance no longer applies subject to income tax if the entity disposing the shares is regarded by to private companies, unless their parent is a public company. the IRAS to be trading in such shares or having acquired such shares for subsequent disposal for a profit (as opposed to acquiring such shares for long-term investment holding purposes). 9 Tax Matters Certain “safe harbour” rules have been enacted in Singapore whereby gains derived by a divesting company from its disposal 9.1 What are the key tax considerations for private equity of ordinary shares in an investee company are not taxable if certain investors and transactions in your jurisdiction? Are conditions are met (the “Certainty of Non-Taxation Rule”). This off-shore structures common? rule provides that gains derived by a qualifying divesting company from its disposal of ordinary shares in an investee company during Any income accruing in or derived from Singapore (i.e., sourced the period from 1 June 2012 to 31 May 2022 are not taxable if: in Singapore) or accruing or derived from outside Singapore (i.e., (a) immediately prior to the date of the disposal, the divesting sourced outside Singapore) which is received or deemed received in company has held at least 20% of the ordinary shares in the investee Singapore, is subject to income tax in Singapore. There is no capital company for a continuous period of at least 24 months; and (b) gains tax in Singapore. the shares disposed of are ordinary shares, and not preference, redeemable or convertible shares. This rule does not apply to: Foreign-sourced income in the form of dividends, branch profits (i) a divesting company whose gains or profits from the disposal and service income received or deemed to be received in Singapore of shares are included as part of its income as an insurer; and (ii) by a Singapore-resident company are exempt from tax if certain an unlisted investee company that is in the business of trading or conditions are met, including: (i) such income is subject to tax of holding Singapore immoveable properties (other than the business a similar character to income tax under the law of the jurisdiction of property development). from which such income is received; and (ii) at the time the income is received in Singapore, the highest rate of tax of a similar character to income tax levied under the law of the territory from which 9.3 What are the key tax-efficient arrangements that are the income is received, on any gains or profits from any trade or typically considered by management teams in private business carried on by any company in that territory at that time, is equity portfolio companies (such as growth shares, not less than 15%. deferred / vesting arrangements, “entrepreneurs’ relief” or “employee shareholder status” in the UK)? All Singapore-resident companies are under the one-tier corporate tax system. Under this system, the tax on corporate profits is final and There are no key tax-efficient arrangements (such as “entrepreneurs’ dividends paid by a Singapore-resident company are tax-exempt in relief” or “employee shareholder status” in the UK) available in
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Singapore. Share-based equity plans may be implemented, and awards pursuant to such plans are generally taxable, depending on 10.3 How detailed is the legal due diligence (including when they vest (or are exercised, in the case of options) and whether compliance) conducted by private equity investors prior to any acquisitions (e.g. typical timeframes, disposal restrictions apply to the shares awarded. materiality, scope etc.)? Do private equity investors engage outside counsel / professionals to conduct all 9.4 Have there been any significant changes in tax legal / compliance due diligence or is any conducted legislation or the practices of tax authorities in-house? (including in relation to tax rulings or clearances) impacting private equity investors, management Private equity investors typically engage outside counsel to conduct teams or private equity transactions and are any legal due diligence on the target prior to any acquisition. Timeframes anticipated? Singapore for conducting legal due diligence vary, and usually take between one to three months. Such legal due diligence is usually conducted On 11 March 2017, amendments to the Stamp Duties Act were on an “exceptions only” basis, and the materiality and scope will passed imposing additional conveyance duties on the acquisition depend on the private equity investor’s internal compliance and and disposal of certain equity interests in property holding entities financing requirements, the complexity of the target’s business, and that have an interest (directly or indirectly through other entities) in the timeframe for the particular acquisition. Singapore residential properties, as if such acquisition or disposal were a conveyance of the underlying interest in the residential properties. The changes were introduced to ensure parity of 10.4 Has anti-bribery or anti-corruption legislation impacted private equity investment and/or investors’ treatment in the stamp duty to be paid when a person acquires or approach to private equity transactions (e.g. disposes Singapore residential property directly, versus acquiring or diligence, contractual protection, etc.)? disposing the equity interests of the property holding entity which has an interest in the Singapore residential property. Save as stated, Compliance with applicable anti-bribery and anti-corruption laws no significant changes have been introduced, nor are any anticipated is a prerequisite to most, if not all, private equity transactions in that would impact private equity investors, management teams or Singapore. If non-compliance is a concern, private equity investors private equity transactions. will usually seek to restructure the transaction to isolate the risk (e.g., by acquiring assets instead of shares). 10 Legal and Regulatory Matters 10.5 Are there any circumstances in which: (i) a private equity investor may be held liable for the liabilities of 10.1 What are the key laws and regulations affecting the underlying portfolio companies (including due to private equity investors and transactions in your breach of applicable laws by the portfolio companies); jurisdiction, including those that impact private equity and (ii) one portfolio company may be held liable for transactions differently to other types of transaction? the liabilities of another portfolio company?
A broad range of regulations affect private equity transactions in Singapore courts would generally not pierce the corporate veil the Singapore market. These include the Singapore Takeover Code and/or hold a private equity investor liable for the liabilities of (which governs public-to-private transactions), the Competition underlying portfolio companies or hold one portfolio company Act, industry specific legislation regulating holdings in regulated liable for the liabilities of another portfolio company in the absence industries, and anti-corruption/anti-money laundering legislation. of fraud or bad faith.
10.2 Have there been any significant legal and/or regulatory developments over recent years impacting 11 Other Useful Facts private equity investors or transactions and are any anticipated? 11.1 What other factors commonly give rise to concerns for private equity investors in your jurisdiction or The Singapore Companies Act was updated in 2015 to abolish should such investors otherwise be aware of in the concept of financial assistance for private companies and the considering an investment in your jurisdiction? introduction of new exemptions to financial assistance for public companies. This facilitates leveraged buyouts by making it easier Singapore is an investor-friendly jurisdiction and is consistently to effect debt push-downs by purchasers post-completion. The ranked as one of the easiest countries in which to do business. Most procedures for the amalgamation of companies have also been laws and regulations are in line with international best practices, simplified, and directors of amalgamating companies will no longer and should not cause too much concern on the part of experienced be required to attest to the amalgamated entity’s solvency on a private equity investors. forward-looking basis. In the first quarter of 2017, the Singapore Companies Act was further amended to introduce requirements for Singapore companies to maintain registers of controllers and nominees in respect of their appointed directors. These changes have been introduced to improve transparency and are consistent with the standards applied in the UK and the EU.
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Christian Chin Lee Kee Yeng Allen & Gledhill LLP Allen & Gledhill LLP One Marina Boulevard #28-00 One Marina Boulevard #28-00 Singapore 018989 Singapore 018989 Singapore Singapore
Tel: +65 6890 7616 Tel: +65 6890 7783 Email: [email protected] Email: [email protected] URL: www.allenandgledhill.com URL: www.allenandgledhill.com
Christian Chin is a Partner in the Corporate Mergers & Acquisitions Lee Kee Yeng is a Partner in the Corporate Mergers & Acquisitions Singapore practice. His areas of practice include mergers and acquisitions, practice. Her areas of practice encompass mergers and acquisitions corporate restructuring, joint ventures, employment law and general (for both public and private companies), equity capital markets and commercial contracts. corporate advisory work for financial institutions and public companies listed on the Singapore Exchange. He represents investment and commercial banks, private equity and sovereign funds and strategic corporate clients on domestic and She has advised on sovereign wealth funds, private equity firms and cross-border mergers and acquisitions, joint ventures and private multinational corporates in an extensive range of domestic and cross- equity transactions, and frequently speaks and conducts training on border transactions including public takeovers, private acquisitions his areas of practice. Christian has been cited as a notable individual and joint ventures. She is also actively involved in the listing of in Corporate and M&A by The Legal 500 Asia Pacific (2016). structured warrant programmes on the Singapore Exchange. Christian has been a Legal Case Studies Instructor at the NUS Law Kee Yeng has been recognised for her work in Corporate/M&A in School and has also been a lecturer and instructor for the Corporate Chambers Global, Chambers Asia-Pacific and IFLR1000. & Commercial Practice module of the Singapore Bar Examinations. Kee Yeng graduated from the National University of Singapore in 2001 Christian graduated from the National University of Singapore with an with an LLB (Hons) degree and holds a BCL from the University of LLB (Hons) degree, and holds an MBA from the F.W. Olin Graduate Oxford. She was called to the Singapore Bar in 2006. Prior to joining School of Business at Babson College, where he was awarded the the firm, she served as a Justices’ Law Clerk and as an Assistant Babson Fellowship. He was also awarded the Ethics Award by the Registrar with the Supreme Court of Singapore. Singapore Medical Association, and the Tun Salleh Award by the American Universities Alumni of Malaysia. He was called to the Singapore Bar in 2000.
Allen & Gledhill LLP, established in 1902, is one of the largest law firms in Singapore and South-east Asia. We provide legal services to a wide range of premier clients, including local and multinational corporations and financial institutions. An award-winning full-service commercial law firm, we are consistently ranked as a market leader in Singapore for every major practice area, having been involved in numerous challenging, complex and significant deals. Our Partners are specialists in their areas of practice and many are widely recognised as leading legal experts by clients and peers. Our network comprises Rahmat Lim & Partners, our Malaysian associate firm in Kuala Lumpur, and our local office in Yangon, Myanmar. The firms are staffed by local lawyers familiar with the distinctive business environment, laws, regulations and practices in the respective jurisdictions. With more than 400 lawyers across South-east Asia and our close collaboration with leading law firms regionally and internationally, we are able to ensure our clients with multi-jurisdictional interests are provided with an integrated and seamless legal service. Our experience allows us to take on an effective lead counsel or project manager role in cross-border transactions.
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South Africa Nicole Paige
Webber Wentzel Andrew Westwood
1 Overview 2 Structuring Matters
1.1 What are the most common types of private equity 2.1 What are the most common acquisition structures transactions in your jurisdiction? What is the current adopted for private equity transactions in your state of the market for these transactions? Have jurisdiction? Have new structures increasingly you seen any changes in the types of private equity developed (e.g. minority investments)? transactions being implemented in the last two to three years? In most leveraged buyout transactions, a ‘debt push down structure’ would be used in order to facilitate the introduction of acquisition debt The South African market continues to see a substantial number on an efficient basis. This involves a two-stage transaction whereby, of private equity (“PE”) transactions by local and foreign private in the first stage, the purchaser (“Bidco”) acquires the shares in the equity houses, including leveraged buyouts, follow-on acquisitions, target company using equity funding and a bridge loan. Immediately exits and Broad-Based Black Economic Empowerment transactions thereafter, the assets of the target company are acquired by a new (see question 11.1 below). Recent years have seen an established company (“Newco”), typically a subsidiary of Bidco, using term trend in exits by way of auction/managed disposal processes and an debt. The proceeds of the business acquisition are then distributed to increasing number of secondary PE transactions (demonstrating that Bidco and Bidco applies the proceeds to settle the bridge loan. the PE market in South Africa is maturing). In recent years, subscription and buy-back structures have often Transactional activity, both on the acquisition and the realisations been used as an alternative to traditional share sale transactions. side, was firm over the past year, across the deal-size spectrum and We have recently also started seeing a rise in buy-in structures, in a range of industry sectors. The quarterly data tables prepared by where PE investors that were traditionally only interested in the Southern African Venture Capital and Private Equity Association taking majority stakes in buyout transactions are now increasingly (“SAVCA”), in collaboration with Webber Wentzel, indicate that open to exploring minority stakes with strong veto rights. These there were 203 reported acquisitions and 41 exits in Africa during transactions would often be coupled with a refinancing implemented 2016. There were 99 reported deals and 14 exits in Southern Africa by the target. over this period. Of the acquisitions, a third were in South Africa, with Nigeria, Kenya and Namibia also featuring prominently. There has been a shift towards a broader regional perspective with 2.2 What are the main drivers for these acquisition structures? many African PE acquisitions being of companies operating across multiple African jurisdictions. PE investors are also backing the expansion of South African businesses into the rest of Africa. The use of a debt push-down structure allows the funding bank to take direct asset security from Newco, as well as a pledge over Bidco’s shares in Newco. It also allows the target company to be liquidated 1.2 What are the most significant factors or developments in order to mitigate any historical liabilities, and is efficient from encouraging or inhibiting private equity transactions a tax perspective (subject to certain interest deduction limitations). in your jurisdiction? Subscription and buy-back structures potentially provide a tax In an African context, South Africa is seen as a jurisdiction efficient exit for disposing shareholders (especially South African with strong and efficient banking and regulatory institutions, tax resident corporate shareholders). However, changes announced an established legal system as well as access to debt and capital in South Africa’s 2017 budget are likely to limit the efficiency of markets including the Johannesburg Stock Exchange (“JSE”) which this structure in the future. is highly regarded. The main driver for the growth in minority investment/buy-in The South African Rand is relatively volatile, which can be to transactions seems to be a desire by the founders or management the advantage or disadvantage of an investment depending on the of primarily South African businesses to realise value and diversify timing, although this is not necessarily an unusual attribute for their investments, whilst retaining control and continuing to drive investors looking to invest in emerging markets. the growth of the business. Another driver is expansion into the African continent where having a PE partner with capital and a well- developed continental network is seen as an advantage.
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2.3 How is the equity commonly structured in private 3 Governance Matters equity transactions in your jurisdiction (including institutional, management and carried interests)? 3.1 What are the typical governance arrangements for private equity portfolio companies? Are such The equity capital structure typically consists of a combination of arrangements required to be made publicly available shareholder loans, preference shares and ordinary share capital. in your jurisdiction? Typically the pure equity (ordinary share) component is relatively small after taking into account third-party acquisition debt and The governance arrangements in respect of a portfolio company are shareholder funding in the form of shareholder loans and preference contained in its constitutional document, namely its memorandum shares. of incorporation, and the shareholders’ agreement, which would
Management will generally reinvest alongside the PE investor for a usually set out, at a minimum: (i) the composition of the board South Africa minority stake of between 10% and 40% of the equity investment, (which is dependent on the shareholding structure); (ii) the conduct often on a subsidised basis. Their investment would usually be held of board and shareholder meetings; (iii) specially protected matters through a management trust or other investment vehicle. (veto rights) in favour of the PE investor or other shareholders; (iv) provisions regarding the future funding requirements of the portfolio Carried interests are typically dealt with as part of the fund company and the further issuance of shares and/or the advancement formation and structuring, and do not typically form part of the of shareholder loans; and (v) restrictions of the transferability of equity structuring at individual deal level. However, ‘ratchet’ type shares and shareholder loans, as well as tag-along, drag-along and structures are often used to drive exit alignment and incentivise exit provisions. management if a particular return hurdle is met by the PE investor at exit. The day-to-day management of the portfolio company is the responsibility of the board over which a majority PE investor will usually have control. Where the PE investor only acquired a minority 2.4 What are the main drivers for these equity structures? stake and does not control the board, it would expect to have veto rights in respect of certain specially protected matters at shareholder level. The main drivers for the structuring of equity capital are usually: (i) Whilst the shareholders’ agreement is a private contract between the ease of returning funds to shareholders; (ii) tax efficiency, including shareholders inter se, and between the shareholders and the portfolio for the ultimate investors; (iii) subsidisation of management, where company, any inconsistency between the shareholders’ agreement applicable; and (iv) correct ranking of instruments, including and the memorandum of incorporation will result in the memorandum relative to third-party debt. of incorporation superseding the shareholders’ agreement. The memorandum of incorporation must therefore be aligned with the 2.5 In relation to management equity, what are the typical shareholders’ agreement. The memorandum of incorporation is vesting and compulsory acquisition provisions? required to be lodged with the Companies and Intellectual Property Commission and is, in principle, a public document. The extent to which management shares may vest over time will usually depend on whether such management shares were subsidised 3.2 Do private equity investors and/or their director and, if so, to what extent (i.e. if management paid full value for their nominees typically enjoy significant veto rights over shares, they would acquire their shares outright and there would be major corporate actions (such as acquisitions and no vesting). Vesting would typically occur over a period of between disposals, litigation, indebtedness, changing the nature of the business, business plans and strategy, three and five years. etc.)? If a private equity investor takes a minority Shareholder agreements will usually contain compulsory offer position, what veto rights would they typically enjoy? provisions which would be triggered if a management member’s employment with the company comes to an end. A distinction is In terms of the Companies Act 71 of 2008, as amended (“Companies sometimes (but not always) drawn between good leavers (e.g. Act”), ordinary resolutions can be passed with majority support, and due to death, disability or retirement) and bad leavers (e.g. due to special resolutions with the support of at least 75% of the ordinary dismissal), but this may affect the value received for the shares voting rights. These thresholds can, however, be altered in the rather than whether an offer is triggered. A good leaver will memorandum of incorporation. generally receive the fair market value for his/her shares (subject A shareholder holding a majority stake would (by default) be able to to any vesting provisions) while a bad leaver will be penalised in elect the board of directors, and a shareholder holding 25% or more some way. would be able to block special resolutions. Any vesting and/or compulsory offer provisions in relation to In addition to corporate actions requiring a special resolution, the management shares should be analysed from a tax perspective. memorandum of incorporation and shareholders’ agreement may set out additional specially protected matters or veto rights. The extent of these protections would vary depending on the size of the PE 2.6 If a private equity investor is taking a minority position, are there different structuring investor’s stake, but would typically be extensive if the PE investor considerations? holds more than 25%. Generally, veto rights apply at a shareholder level. Where a PE investor is taking a minority position, it is unlikely that a debt push-down structure would be implemented as the PE 3.3 Are there any limitations on the effectiveness of veto investor would usually just invest into the existing group structure. arrangements: (i) at the shareholder level; and (ii) Often a refinancing or restructuring would take place at the same at the director nominee level? If so, how are these time as the investment. typically addressed?
Any veto arrangements contained in the portfolio company’s
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memorandum of incorporation and/or shareholders’ agreement will be void to the extent that they contravene or are inconsistent with 3.6 Are there any legal restrictions or other requirements the Companies Act. This does not generally present any practical that a private equity investor should be aware of in appointing its nominees to boards of portfolio difficulty, however. companies? What are the key potential risks and Directors are subject to fiduciary duties in favour of the company, liabilities for (i) directors nominated by private equity which may potentially conflict with the interests of a particular investors to portfolio company boards, and (ii) private shareholder. Accordingly, it is best if veto rights are exercised at equity investors that nominate directors to boards of portfolio companies under corporate law and also shareholder level, but a PE investor’s veto rights can be structured more generally under other applicable laws (see so as to be effective at either level. section 10 below)?
Before appointing its nominees as directors to the board of a portfolio South Africa 3.4 Are there any duties owed by a private equity investor to minority shareholders such as management company, a PE investor should ensure that such nominee is not shareholders (or vice versa)? If so, how are these ineligible or disqualified (e.g. because he/she is an unrehabilitated typically addressed? insolvent) to be a director as set out in section 69 of the Companies Act. Whilst shareholders do not generally owe any duties to each other, The common law duties of directors have been partially codified in section 163 of the Companies Act does provide a shareholder with sections 75 and 76 of the Companies Act. These consist of fiduciary relief from oppressive or unfairly prejudicial conduct on the part duties and duties of care, skill and diligence. To the extent that such of another shareholder. This section allows a court to come to the duties have not been codified, the common law continues to apply. assistance of a shareholder if the shareholder satisfies the court that Directors are required to exercise their powers and perform their an act or omission of the company or another shareholder, or the functions in good faith, for a proper purpose and in the best interests manner in which it has conducted its affairs, is unfairly prejudicial, of the company. Furthermore, a director cannot use his position on unjust or inequitable, or unfairly disregards the interests of the the board or information obtained by virtue of his position to gain applicant. an advantage for anyone other than the company or a wholly owned In reaching its decision, a court would take account of the subsidiary, nor to do harm to the company or any subsidiary (whether underlying motives of the majority in deciding whether particular wholly owned or not) of the company. Directors are also required to conduct requires relief, and our courts uphold the general principle disclose all information they believe to be relevant to the company that by becoming a shareholder a person undertakes to be bound unless they are subject to a legal or ethical obligation not to disclose it. by the decisions of the prescribed majority of shareholders A director is required to exercise the care, skill and diligence that provided that these are in accordance with the law. Accordingly, may reasonably be expected of a person carrying out the same mere dissatisfaction with the conduct of the company’s affairs or functions as that director and having the general knowledge, skill the majority shareholders will not of itself constitute grounds of and experience of that director. prejudice, injustice or inequity within the meaning of the section. In terms of section 77 of the Companies Act, a breach of these duties may attract liability for a director in his or her personal capacity. 3.5 Are there any limitations or restrictions on the Furthermore, although directors’ duties and liabilities in the contents or enforceability of shareholder agreements Companies Act are owed (in line with the common law) to the (including (i) governing law and jurisdiction, and (ii) company and not to the shareholder appointing the director, where non-compete and non-solicit provisions)? applicable, section 218(2) of the Companies Act effectively extends the remedies available for a breach of any duty contained in the A shareholders’ agreement must be consistent with the Companies Companies Act to anyone who has suffered loss due to the breach. Act and the relevant portfolio company’s memorandum of incorporation, and any provision of a shareholders’ agreement that is Typically, PE investors would require that a portfolio company take inconsistent with the Companies Act or the company’s memorandum out D&O insurance to provide protection to its nominee directors. of incorporation is void to the extent of the inconsistency. It is permissible for the shareholders’ agreement relating to a South 3.7 How do directors nominated by private equity African portfolio company to be governed by foreign law and for investors deal with actual and potential conflicts of interest arising from (i) their relationship with the the parties to submit themselves to the jurisdiction of foreign courts, party nominating them, and (ii) positions as directors provided that this does not give rise to any conflicts between the of other portfolio companies? shareholders’ agreement and the Companies Act or a contravention of the Companies Act. As set out above, directors owe their fiduciary duties to the company To the extent that the shareholders’ agreement contains any non- and not to the PE investor appointing him/her. compete and/or non-solicitation provisions, they must be reasonable In terms of section 75 of the Companies Act, a director is required as to, inter alia, (i) geographic area and (ii) time period, and should to avoid any conflict of interest and accordingly, if he has a material be limited to what is reasonably required in order to protect the personal financial interest in a matter before the board, he is required legitimate interests of the PE investor and its investment in the to recuse himself from all discussion on that matter. However, a portfolio company. The courts tend to scrutinise restraint provisions decision by the board will be valid despite any personal financial more closely when applied to individuals, given public concerns interest of a director or a person related to the director if it has been regarding employment and the right to a trade. ratified by an ordinary resolution of the shareholders. Due to the risk of nominee directors or the PE investors appointing them being regarded as having a personal financial interest in any decisions of the board, it has become practice for board resolutions in respect of major corporate, commercial and/or financial decisions to be ratified by shareholder resolutions.
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In an effort to limit any potential conflicts of interests, it is shareholder who acquires more than 90% of the voting securities of recommended that veto rights and the like fall to the shareholders a regulated company). and not be exercised at board level. For purposes of the Takeover Provisions and the Takeover A conflict would typically only arise between portfolio companies Regulations, all public companies and certain state owned where they are in competition or transact with one another. The companies are “regulated companies”. A private company will also director would need to make the appropriate disclosure to the be a “regulated company” if more than 10% of the issued shares of respective boards and recuse himself where necessary. Where that company have been transferred, other than by transfer between portfolio companies are in competition or in similar sectors, or among related or inter-related persons, within the period of 24 competition law may prevent there being common directorships. months immediately before the day of a particular transaction or offer. In addition, a private company may, in its memorandum of incorporation, elect to be a “regulated company”. 4 Transaction Terms: General South Africa Public to private transactions in South Africa are invariably implemented by way of a scheme of arrangement proposed by the 4.1 What are the major issues impacting the timetable for board of the target to its shareholders, as the scheme of arrangement, transactions in your jurisdiction, including competition if approved, allows the PE investor to acquire 100% of the target and other regulatory approval requirements, (and thus delist it). disclosure obligations and financing issues? The main challenges faced by PE investors would include: (i) obtaining board approval for the transaction (as the board would PE transactions in South Africa typically take about 12 weeks from need to propose the scheme of arrangement); (ii) getting certainty signature of the transaction agreements until completion. This is regarding the deal, as the approval of 75% of the shareholders would largely due to regulatory approvals, including competition approvals be required, and there are restrictions on approaching shareholders (in South Africa and, if applicable, other Sub-Saharan African prior to a firm intention announcement; (iii) financing must be secure jurisdictions) and exchange control approval from the Financial at an early stage, as bank guarantee or cash confirmation is required Surveillance Department of the South African Reserve Bank. at firm intention stage; and (iv) restrictions on the conditionality Additional regulatory approvals may also be required in respect of the deal, as the scheme of arrangement may be subject only to of certain specific industries/sectors (e.g. the mining, banking, objective conditions. insurance, security, media and broadcasting industries). Public-to-private transactions have not been a feature of the South African market in the last few years. 4.2 Have there been any discernible trends in transaction terms over recent years? 5.2 Are break-up fees available in your jurisdiction in relation to public acquisitions? If not, what other Over the last couple of years, there has been a clear trend towards arrangements are available, e.g. to cover aborted deal (i) the “locked-box” purchase price mechanism, and (ii) the use of costs? If so, are such arrangements frequently agreed warranty and indemnity insurance. and what is the general range of such break-up fees?
5 Transaction Terms: Public Acquisitions Yes, break fees are permissible and are commonly agreed. However, the Takeover Regulation Panel requires that break fees be limited to 1% of the offer value and the details thereof must be fully disclosed. 5.1 What particular features and/or challenges apply to private equity investors involved in public-to-private transactions (and their financing) and how are these 6 Transaction Terms: Private Acquisitions commonly dealt with?
6.1 What consideration structures are typically preferred The main features of a public-to-private transaction relate to the by private equity investors (i) on the sell-side, and (ii) application of the takeover provisions contained in sections 117 to on the buy-side, in your jurisdiction? 120 of the Companies Act (“Takeover Provisions”), the Takeover Regulations and the JSE Listings Requirements, which impose PE sellers prefer the “locked-box” pricing structure; whilst on stricter rules and disclosure requirements (as opposed to those the buy-side, completion accounts are generally preferable. It is applicable to private acquisitions) and a greater amount of publicity. more common for sellers and buyers to settle on a “locked-box” The Takeover Provisions and Takeover Regulations are aimed at structure; however, often these have hybrid elements, for example, ensuring transparency and fairness to shareholders in regulated by including verification/adjustments for deviations in, for example, companies in the conduct of specific transactions known as “affected net working capital, net asset value and/or net debt. transactions”. These transactions, which will require notification It is also not uncommon to see earn-out structures/agterskot to and a clearance certificate from the Takeover Regulation Panel, payments where a portion of the purchase price is paid on include: (a) a disposal of all or the greater part of the undertaking of completion with a second portion only payable on a later date and a regulated company; (b) an amalgamation or merger involving at upon the target meeting certain performance thresholds. least one regulated company; (c) a scheme of arrangement between a regulated company and its shareholders; (d) the announced intention to acquire a beneficial interest in the remaining voting securities of 6.2 What is the typical package of warranties/indemnities a regulated company not already held by a person or persons acting offered by a private equity seller and its management in concert; (e) mandatory offers (triggered by an acquisition of team to a buyer? more than 35% of the voting securities of a regulated company); and (f) “squeeze-out” transactions (which may be exercised by a In South Africa, both the PE seller and the management team are typically expected to provide a full suite of business warranties,
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pro rata to their shareholding percentages in the target company. However, as mentioned below, warranty and indemnity insurance is 6.6 Do (i) private equity sellers provide security (e.g. commonly taken out to cover the negotiated warranty and indemnity escrow accounts) for any warranties / liabilities, and (ii) private equity buyers insist on any security for package and provide a clean exit to the PE seller. warranties / liabilities (including any obtained from the management team)? 6.3 What is the typical scope of other covenants, undertakings and indemnities provided by a private PE sellers will typically insist on warranty and indemnity insurance equity seller and its management team to a buyer? so as not to be subject to an escrow or deferred consideration mechanism. Interim period undertakings in relation to: (i) the conduct of the PE buyers will look for security to the extent that the seller (for business between the signature date and the completion date; (ii)
South Africa example, an individual, trust or SPV entity) is not considered no leakage (in a “locked-box” compensation structure); and (iii) creditworthy. They may also look for security over shares held cooperation and assistance with regulatory filings, are standard. by management to the extent that warranties are obtained from Indemnities are not typical, but may be agreed where specific risks management. have been identified as part of the due diligence (in which case the indemnity may be insured). 6.7 How do private equity buyers typically provide comfort as to the availability of (i) debt finance, 6.4 Is warranty and indemnity insurance used to “bridge and (ii) equity finance? What rights of enforcement the gap” where only limited warranties are given by do sellers typically obtain if commitments to, or the private equity seller and is it common for this obtained by, an SPV are not complied with (e.g. to be offered by private equity sellers as part of the equity underwrite of debt funding, right to specific sales process? If so, what are the typical (i) excesses performance of obligations under an equity / policy limits, and (ii) carve-outs / exclusions from commitment letter, damages, etc.)? such warranty and indemnity insurance policies? Buyers typically rely on bank term sheets, as well as their track Whilst in the South African market it is expected that PE sellers will record in securing debt for other transactions, to provide comfort provide business warranties, it has become the norm (particularly that debt financing will be available. It is, however, common for in larger transactions) to obtain a warranty and indemnity insurance the deal to be conditional on the debt being raised, although in policy. In auction/managed disposal processes, this is usually a some circumstances a buyer may be willing to underwrite the full requirement of the seller, and the preliminary terms for a buyer acquisition price. warranty and indemnity insurance policy would often be provided Comfort regarding the equity component may be provided through in the data room as part of the proposed transaction documentation. an equity commitment letter or similar form of confirmation/ A warranty and indemnity insurance policy will typically have a undertaking, particularly where an SPV is used. de minimis threshold equal to 0.1%, and a floor equal to 1%, of the target’s enterprise value. The cap for warranty and/or indemnity 6.8 Are reverse break fees prevalent in private equity claims will be negotiated in line with the transaction agreements transactions to limit private equity buyers’ exposure? (and will typically range between 10% and 30% of the target’s If so, what terms are typical? enterprise value). Environmental, anti-corruption, transfer pricing and product Reverse break fees are not typical in PE transactions in South Africa. recall warranties are uninsurable and excluded from warranty and However, cost-sharing arrangements are often agreed, in order indemnity insurance policies. to mitigate costs incurred in respect of, for example, competition filings, in the event of a failed transaction. 6.5 What limitations will typically apply to the liability of a private equity seller and management team under 7 Transaction Terms: IPOs warranties, covenants, indemnities and undertakings?
Warranty claims against the PE seller and management team are 7.1 What particular features and/or challenges should a usually qualified by information disclosed to the purchaser prior to private equity seller be aware of in considering an IPO signature as part of the due diligence and/or in a disclosure schedule exit? attached to the acquisition agreement. Liability is further limited by providing the warranties on a pro rata An IPO exit may provide an attractive valuation, particularly basis which means that, whilst the PE investor will be liable for the as private equity multiples would typically be lower than listed largest proportion of any warranty claim, the management team is multiples. However, the valuation would only be known once the also exposed and encouraged to make full disclosure as part of the IPO takes place and cannot be locked in advance. due diligence and in the disclosure schedule. In considering an exit by IPO, PE sellers should ensure that they Warranty claims would be subject to de minimis, floor, cap and time have alignment with management and other stakeholders and are period limitations. Where warranty and indemnity insurance is well aware of the process required to prepare the portfolio company taken out, these will be aligned to the policy. for IPO (particularly a smaller/younger portfolio company which has not previously been listed). The possibility of an IPO and the process to achieve an IPO should be addressed in the shareholders’ agreement.
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invest through a vehicle or structure that is tax transparent, i.e. any 7.2 What customary lock-ups would be imposed on income (including capital gains, dividend distributions and interest private equity sellers on an IPO exit? payments) derived should be taxed in the investors’ hands (in their tax jurisdictions) in accordance with the underlying nature of such The PE seller and the management team will ordinarily be subject to income. a lock-up period of between six and 12 months. Off-shore structures are common for foreign investors that seek exchange control friendly jurisdictions. Due to the increasing trend 7.3 Do private equity sellers generally pursue a dual-track of foreign investors investing into South African-managed funds, exit process? If so, (i) how late in the process are it is common practice to provide for a “dual fund” structure. The private equity sellers continuing to run the dual-track, dual fund structure provides a second mirrored partnership that and (ii) were more dual-track deals ultimately realised through a sale or IPO? is established outside of South Africa, with the same investment strategy and structure of its South African counterpart – this is the South Africa Dual-track exit processes are not generally pursued in the South vehicle through which foreign investors will invest. African market, and there is no established practice in this regard. There have, however, been instances of this and it may become 9.2 What are the key tax considerations for management more common for portfolio companies which are suited to an IPO. teams that are selling and/or rolling-over part of their investment into a new acquisition structure?
8 Financing Management teams that are not exiting (wholly or in part) will seek to roll-over their investment into a new acquisition structure in a 8.1 Please outline the most common sources of debt tax neutral manner. There are various tax roll-over concessions finance used to fund private equity transactions in your contained in the South African Income Tax Act, which may assist in jurisdiction and provide an overview of the current achieving this desired outcome for management. state of the finance market in your jurisdiction for such debt (particularly the market for high yield bonds). 9.3 What are the key tax-efficient arrangements that are typically considered by management teams in private Debt finance for PE transactions is most commonly sourced in the equity portfolio companies (such as growth shares, form of secured term loans from the major South African banks. The deferred / vesting arrangements, “entrepreneurs’ finance market is generally receptive to funding these transactions, relief” or “employee shareholder status” in the UK)? particularly those undertaken by established sponsors, at healthy levels based on the profitability of the underlying businesses. Given the extent of the tax legislation in South Africa governing Mezzanine financing is not often used in larger transactions, but employees’ remuneration and the taxing thereof, it is important to may be seen in smaller deals involving growth businesses. distinguish income for services rendered from participation in the Bonds, notes and the like are not commonly used to finance PE growth of the underlying PE portfolio companies. transactions, although there is an appetite for bonds issued to As a result of the wide scope of the tax legislation, it is becoming portfolio companies to refinance existing bank funding. Whilst increasingly challenging to structure participation schemes secured bonds in the South African market have some elements (i.e. participation in the growth of the underlying PE portfolio of the high-yield space off-shore (e.g. more covenant light than companies) that are not fully taxed at marginal rates. investment grade bonds and incurrence rather than maintenance covenants), the local bond investors have been more conservative and have been able to negotiate terms more akin to bank funding 9.4 Have there been any significant changes in tax than high-yield bond funding. legislation or the practices of tax authorities (including in relation to tax rulings or clearances) impacting private equity investors, management 8.2 Are there any relevant legal requirements or teams or private equity transactions and are any restrictions impacting the nature or structure of anticipated? the debt financing (or any particular type of debt financing) of private equity transactions? The tax rules (primarily section 8C) that regulate the taxation of employees in respect of share incentive schemes is constantly As mentioned in the answer to question 2.1 above, debt push- modernised to cater for the perceived abuse of such incentive down structures are used to facilitate the security package and a tax schemes. Section 8C seeks to include in (or subtract from) an efficient structure for acquisition debt. employees’ income the gain (or loss) arising upon the vesting of an When structuring the security package as part of a senior debt equity instrument, where such equity instrument was acquired by financing, tax events that may be triggered upon exercise ofthe that taxpayer by virtue of his/her employment or from any person security (especially as a result of the original acquisition structure) by arrangement with that person’s employer. should also be taken into account. With effect from 1 March 2017, an amendment to the section 8C rules will provide that gains and non-exempt dividends vested 9 Tax Matters by employee share trusts are taxed as income in the hands of the beneficiaries. This amendment, together with amendments from 2016, have created the real potential for double taxation in employee 9.1 What are the key tax considerations for private equity share trusts where the trust vests shares or share gains in employees, investors and transactions in your jurisdiction? Are who will also pay income tax on the share or gain as remuneration. off-shore structures common? As noted in the answer to question 9.1 above, the “dual fund” structure has become common practise in South Africa for The most material tax consideration for investors would be to
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investments that need to be made outside South Africa (i.e. into the rest of Africa). Although the “dual fund” structure is highly 10.3 How detailed is the legal due diligence (including effective, the formation process is quite burdensome and is becoming compliance) conducted by private equity investors prior to any acquisitions (e.g. typical timeframes, increasingly difficult to manage by South African funds. In order to materiality, scope etc.)? Do private equity investors compete with exchange control friendly jurisdictions, South Africa engage outside counsel / professionals to conduct all has introduced the “Headquarter Company” regime that essentially legal / compliance due diligence or is any conducted mirrors the benefits of exchange control friendly jurisdictions. Due in-house? to the common law transparent nature of the South African fund, the fund will not qualify for the “Headquarter Company” regime PE investors usually conduct comprehensive legal due diligence and the attendant benefits. As a result, the “dual fund” structure on the target prior to an acquisition. The scope and materiality is the only viable alternative. An amendment to the “Headquarter threshold will typically depend on the nature and size of the target’s South Africa Company” regime that allows for South African funds to qualify business, and will be determined by the PE investor in consultation would negate the necessity for the “dual fund” structure. with its investment committee and advisers. PE investors will usually engage outside legal counsel to conduct the legal due diligence (including, inter alia, corporate, commercial, employment 10 Legal and Regulatory Matters and intellectual property arrangements) which would typically be completed in between three and six weeks (depending on the size 10.1 What are the key laws and regulations affecting and complexity of the target). Compliance due diligence (including private equity investors and transactions in your anti-corruption/bribery compliance and know-your-client (“KYC”) jurisdiction, including those that impact private equity checks) may be done in-house with support from outside counsel. transactions differently to other types of transaction?
10.4 Has anti-bribery or anti-corruption legislation PE investors and transactions are subject to a broad range of South impacted private equity investment and/or investors’ African laws and regulations, including (but not limited to) the approach to private equity transactions (e.g. Companies Act, the Competition Act 89 of 1998, the Takeover diligence, contractual protection, etc.)? Regulations and the JSE Listing Requirements (in the context of a public-to-private transaction or IPO exit), and various taxation statutes. Yes, particularly in respect of international PE investors subject to In addition, fund managers or advisers who render services from South foreign laws (including the US Foreign Corrupt Practices Act and Africa are generally required to register as financial services providers the UK Bribery Act). Locally, the Financial Intelligence Centre Act under the Financial Advisory and Intermediary Services (“FAIS”) Act. (“FICA”) imposes KYC requirements on ‘reporting institutions’ to identify clients and report transactions to the Financial Intelligence 10.2 Have there been any significant legal and/or Centre. Amendments to FICA to bring it in line with international regulatory developments over recent years impacting standards, including introducing requirements in relation to private equity investors or transactions and are any ‘politically exposed persons’ have been adopted by Parliament anticipated? but not yet signed into law. The Prevention and Combatting of Corrupt Activities Act also allows for international reach in that The prudential investment limits for local pension funds were it criminalises corrupt actions undertaken outside South Africa amended in 2011 to expressly permit pension funds to invest up by any South African citizen, anyone domiciled in South Africa, to 10% of their assets in PE funds (with sub-limits of 2.5% per PE or any foreigner, if: (i) the act concerned is an offence under that fund and 5% per fund of funds). The relevant regulations stipulate country’s law; (ii) the foreigner is present in South Africa; or (iii) various requirements that a PE fund needs to comply with in order the foreigner is not extradited. It also criminalises the act of not to qualify for investment purposes – these apply equally to local and reporting attempted or actual corrupt transactions. foreign PE funds. The most significant requirements contained in Conducting a compliance due diligence (including anti-corruption/ the conditions are the following: bribery compliance and KYC checks) is expected and PE investors are ■ fund managers must be members of SAVCA, the local increasingly looking for contractual protection against possible non- industry body, and licensed under FAIS (foreign investment compliance by way of anti-corruption/bribery warranties (which are managers fall within a less onerous licence category); typically excluded from any warranty and indemnity insurance policy). ■ the auditors of the PE fund must verify the assets of the PE fund on a biannual basis and the PE fund must produce audited financial statements complying with international 10.5 Are there any circumstances in which: (i) a private financial reporting standards within 120 days of the end of its equity investor may be held liable for the liabilities of financial year; the underlying portfolio companies (including due to breach of applicable laws by the portfolio companies); ■ the PE fund must have clear policies and procedures for and (ii) one portfolio company may be held liable for determining the fair value of its assets in compliance with the the liabilities of another portfolio company? International Private Equity Valuation Guidelines, and any valuations must be verified at least annually by a third party; and The general principle is that shareholders (including PE investors investing in South African companies) have limited liability and ■ the pension fund must consider a list of prescribed due will not be held liable for the liabilities or obligations of underlying diligence matters before investing in a PE fund, including the fee structure of the PE fund and the risk and compliance portfolio companies. Accordingly, a PE investor could not be held policies and procedures of the PE fund. liable unless the PE investor provides direct warranties, indemnities and/or guarantees in respect of the actions or obligations of the We also understand that the South African regulator is considering portfolio company. the creation of a new category of FAIS licence for PE fund managers, but this has been in the pipeline for several years now without much There are instances where a court may be willing to “pierce the progress. corporate veil” in very specific circumstances. In addition, particular
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pieces of legislation, for example environmental legislation and Broad-Based Black Economic Empowerment (“BBBEE”) is a policy tax legislation, would impose liability on shareholders in certain of the South African government intended to empower and promote instances. the participation in the economy of historically disadvantaged South It is unlikely that one portfolio company would be liable for the Africans. The policy is given effect to primarily by the Broad-Based liabilities of another portfolio company unless they, for example, Black Economic Empowerment Act (“BBBEE Act”) and the Codes provide cross guarantees for each other’s debts. of Good Practice on BBBEE which create a system by which entities are measured for BBBEE purposes in accordance with stipulated scorecards. Importantly, no sanction or prohibition on trading arises 11 Other Useful Facts from a low measurement or failure to comply, however as BBBEE will be a key factor in the government and public entities’ decision to do business with an entity and also a factor for other South African
11.1 What other factors commonly give rise to concerns businesses doing business with an entity (procurement being one of South Africa for private equity investors in your jurisdiction or the measurements on their respective BBBEE scorecards), BBBEE should such investors otherwise be aware of in considering an investment in your jurisdiction? is a business imperative for most companies doing business in South Africa. The South African Reserve Bank (“SARB”) operates a system of Accordingly, it is often necessary for PE investors to introduce exchange controls governing the import and export of capital into BBBEE ownership into portfolio companies to ensure an appropriate and from South Africa. Foreign PE investors would need to comply BBBEE ownership rating. Proposed amendments to the BBBEE Act with the exchange control regime and seek approval for transactions would introduce a requirement to report to a newly created BBBEE where applicable. Certain powers have been delegated to authorised Commission the details of major BBBEE ownership transactions, dealers (the major South African banks), who can grant approval and this is something PE investors would need to be aware of and for certain transactions and submit applications to the SARB where comply with in structuring transactions. required.
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Nicole Paige Andrew Westwood Webber Wentzel Webber Wentzel 90 Rivonia Road 15th Floor, Convention Tower Sandton Heerengracht, Foreshore Johannesburg, 2196 Cape Town, 8001 South Africa South Africa
Tel: +27 11 530 5857 Tel: +27 21 431 7235 Email: [email protected] Email: [email protected] URL: www.webberwentzel.com URL: www.webberwentzel.com
Nicole Paige, a partner and co-head of the Private Equity Sector at Andrew Westwood, a senior associate in the Corporate Practice at South Africa Webber Wentzel specialises in the formation of alternative investment Webber Wentzel, specialises in private equity transactions, including funds. Nicole has advised and acted for local and international leveraged buyouts, structuring of management arrangements, bolt- private equity and venture capital houses looking to raise funds for on and follow-on transactions, refinancings, restructurings and deployment in South Africa as well as in Africa generally and also disposal transactions. He also has experience in general mergers for limited partners looking to invest in those funds. Her experience and acquisitions, both public and private, as well as black economic in fund formation includes the full spectrum of generalist and sector empowerment transactions and incentive schemes, and advises funds, including buyout, real estate, debt, housing, healthcare, clients on other corporate and commercial law matters. infrastructure and renewable energy funds. She also advises on all Andrew has advised on a number of leveraged buyouts and exits regulatory aspects of investment funds. by local and international private equity houses, as well as related Her expertise has been recognised by various international research transactions including follow-on investments, acquisitions by portfolio organisations including Chambers Global and The Legal 500. companies, refinancings, black economic empowerment transactions and exits.
Webber Wentzel is one of Africa’s leading law firms with a total staff of over 800, including more than 450 lawyers with offices in Johannesburg and Cape Town. The firm’s core strategy is to support its clients wherever they do business. A deep understanding of its clients’ needs and Webber Wentzel’s tailored approach has led to numerous independent awards, both in South Africa and on the continent. These include being named Africa Law Firm of the Year at the African Legal Awards, Sub-Saharan Africa Legal Advisers of the Year at the European M&A Awards hosted by the Financial Times and Mergermarket, and Who’s Who Legal South African Law Firm of the Year for five consecutive years. Webber Wentzel provides specialised legal and tax services to the private equity industry in Africa, including in relation to fund formation, acquisitions and disposals and management arrangements. We have been consistently involved in the highest profile private equity transactions in South Africa. Our experienced platform is enhanced by our collaborative alliance with Linklaters, our associate membership of ALN (Africa Legal Network) and our network of best friend law firms across the African continent.
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Sweden Anett Lilliehöök
Advokatfirman Törngren Magnell Sten Hedbäck
an un-bureaucratic legal system, allowing foreign and domestic 1 Overview investments, has allowed for a strong transaction market. The private equity industry is, furthermore, quite mature and well- 1.1 What are the most common types of private equity known and in many ways trusted in Sweden. During the last years, transactions in your jurisdiction? What is the current the public opinion concerning tax structuring, carried interest and state of the market for these transactions? Have the private equity involvement in publicly-funded sectors such as you seen any changes in the types of private equity healthcare and education has, however, created some uncertainty as transactions being implemented in the last two to three years? to whether further regulation targeting private equity activities in certain sectors can be expected. The Swedish Private Equity (PE) market remains active and the amount of PE transactions involving Swedish targets and/or 2 Structuring Matters Swedish PE fund managers continues to be high, although we have seen a slight decrease in volume during 2015 and 2016, compared to the all-time high in 2014. 2.1 What are the most common acquisition structures adopted for private equity transactions in your Infrastructure and engineering/manufacturing-related deals have jurisdiction? Have new structures increasingly traditionally been frequent on the Swedish transaction market. In developed (e.g. minority investments)? respect of the number of PE transactions, the wholesale and retail, consumer goods (herewith consumables), professional services, Today, virtually all national and international private equity funds financial institutions and technology (internet-based services, with Swedish activity are organised as some type of limited liability fintech, medtech, biotech and gaming) sectors have also dominated company, wherein the institutional investors participate as direct or the Swedish market. Due to a threat of an increased regulatory (normally) indirect limited partners, and wherein the fund manager burden on target companies in the publicly-funded healthcare and acts as the general partner, normally owned through a private limited educational sectors, the private equity players have in recent years liability company specifically organised for this purpose. not made new platform investments in these sectors. Instead they have focused on exiting their current holdings by IPO or selling Funds organised under Swedish law will, when investing into their shares to long-term institutional investors. Swedish target companies, normally adopt a one-tier structure by investing through a set of Swedish holding companies. However, A majority of the Swedish PE players focus on mid-cap target funds organised under a foreign jurisdiction investing in Swedish companies. In general, the target companies are exited through target companies will usually structure the acquisition by adopting trade sales, secondary buyouts and IPOs. Controlled auctions are a two-tier structure, irrespective of whether the manager is foreign still quite commonly used in PE transactions involving non-public or domestic. target companies. In recent times, however, most of the established Swedish PE funds have quite mature portfolios, which are currently Normally, the acquisition of the shares in the Swedish target company on many occasions exited through IPOs owing to the high valuations will be made by the foreign or domestic holding structure through present on the Swedish stock exchanges during 2015 and 2016. a Swedish-incorporated and tax-resident special purpose vehicle Quite contradictory, in 2016, the going-private transactions have (SPV) that eventually acquires the target company. Additional increased. (Swedish and foreign) holding companies could be added into the structure to allow for flexibility in obtaining subordinated debt financing and for other tax and commercial reasons. 1.2 What are the most significant factors or developments Under 2016, due to public pressure and new tax legislation, several encouraging or inhibiting private equity transactions in your jurisdiction? large Swedish private equity fund managers have announced that they contemplate setting up their new funds on-shore. Further, due to the increased regulatory burden, the smaller Swedish private The Swedish transaction market in general remains active. The equity players focusing on mid-cap and small-cap targets are financial crisis did not hit Sweden as hard as many other European starting to arrange alternative investment structures in the form of countries. This has led to a continued high demand and fuelled pure investment companies. growth. The good market conditions in combination with a stable financial system, providing relatively inexpensive financing, and
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companies is the shareholders’ agreement entered into by the sponsor 2.2 What are the main drivers for these acquisition and management (containing provisions regarding governance, structures? information undertakings and share transfer restrictions) and the company’s articles of association (containing capital structure, The main drivers relate mainly to tax purposes and the debt corporate governance and share transfer restrictions). The providers’ requirements on the debt and equity structure of the shareholders’ agreement is not public and only the parties to the acquisition holding company structure. agreement are bound by its provisions. The company’s articles of association are publicly available and binding also to third parties 2.3 How is the equity commonly structured in private (and the company itself). equity transactions in your jurisdiction (including Sweden institutional, management and carried interests)? 3.2 Do private equity investors and/or their director nominees typically enjoy significant veto rights over The equity is generally structured by way of ordinary shares and major corporate actions (such as acquisitions and preference shares. The envy ratio is normally linked to the expected disposals, litigation, indebtedness, changing the return (set out in the business plan/investment case) and the expected nature of the business, business plans and strategy, value creation generated by the general partner and management etc.)? If a private equity investor takes a minority position, what veto rights would they typically enjoy? respectively. The carried interest is typically managed on fund level and calculated The private equity investor often holds the majority of the shares on basis of the whole fund. However, there are funds calculating in the portfolio company, and is therefore able to control important the carried interest on the basis of separate deals, or a mix thereof. corporate decisions in the company through its voting rights. If The carried interest entitlement arises normally after investors have the private equity investor does not hold a controlling stake, it will received return above a predetermined hurdle rate. implement a veto (or reserved matters) list in the shareholders’ agreement concerning the appointment of the CEO, new acquisitions 2.4 What are the main drivers for these equity structures? and disposals, anti-dilutive measures, approval of the business plan and annual budgets, new investments outside of the business plan, The main drivers for these structures are related to tax, alignment etc. of interests, incentivising of management and structuring the return of investment. 3.3 Are there any limitations on the effectiveness of veto arrangements: (i) at the shareholder level; and (ii) at the director nominee level? If so, how are these 2.5 In relation to management equity, what are the typical typically addressed? vesting and compulsory acquisition provisions?
Only the parties to the shareholders’ agreement are bound by Compensation arrangements provided by private equity investors its provisions. The shareholders’ agreement is not enforceable typically include management incentives shares in the SPV used against the company itself, its representatives or third parties. The to make the offer (or a holding company directly or indirectly company, its representatives and third parties are however bound by owning the SPV). Usually strong transfer restrictions apply to the the provisions in the articles of association. incentive shares through an accession to a shareholders’ agreement. Management typically need to sell back their shares to the majority The company representatives (e.g. the board and CEO) owes investor for a purchase price corresponding to the market value, if fiduciary duties to the company (and all shareholders jointly) that they are good leavers, or at a discount if they are considered bad supersede the instructions provided by the shareholder appointing leavers (e.g. if they commit a material breach of the shareholders’ the director. A director might therefore disregard the veto rights and agreement, are dismissed for cause or choose to leave the company). instructions provided by the shareholder appointing him. Drag-along and tag-along provisions are normally present to enable As a result, some funds seek to cater for such risk by implementing a smooth exit process. detailed governance provisions in the companies’ articles of association and entering into separate consultancy agreements 2.6 If a private equity investor is taking a minority position, with the directors appointed by them (containing sanctions if the are there different structuring considerations? board representative does not vote in accordance with the investor’s instructions). In general, private equity investors rarely take minority positions. If they do, the shareholders’ agreement will typically include governance 3.4 Are there any duties owed by a private equity investor provisions, right of board participation, information rights, veto to minority shareholders such as management rights, anti-dilution provisions, share transfer restrictions (binding the shareholders (or vice versa)? If so, how are these founders) and exit provisions such as drag-along and tag-along rights. typically addressed?
Under Swedish law, a controlling shareholder is free to act in its best 3 Governance Matters interest and does not have any duties as such towards a minority shareholder. However, the Swedish Companies Act contains various minority protection provisions. As a general principle, all shareholders 3.1 What are the typical governance arrangements should be treated equally, meaning that the majority investor may for private equity portfolio companies? Are such arrangements required to be made publicly available not implement decisions for its own benefit to the detriment of in your jurisdiction? other shareholders, and new share issues that are not offered pro rata to the current shareholders require the support of a qualified The typical governance arrangements for private equity portfolio majority, etc. There are also certain specific minority protection
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clauses, e.g., entitling the minority to appoint an additional auditor and implementing a special scrutiny of the board’s administration 3.7 How do directors nominated by private equity of the company. The parties typically agree in advance on how to investors deal with actual and potential conflicts of interest arising from (i) their relationship with the handle, e.g., value transfers and share issues through the shareholders’ party nominating them, and (ii) positions as directors agreement. However, provisions generally disallowing the minority of other portfolio companies? investors to use their mandatory minority protection through provisions in the shareholders’ agreement are not enforceable. As mentioned in previous questions, the directors have a fiduciary duty to act in the best interest of and care for the company. A 3.5 Are there any limitations or restrictions on the member of the board may therefore not participate in a specific matter contents or enforceability of shareholder agreements
regarding an agreement between the board member and the company, Sweden (including (i) governing law and jurisdiction, and (ii) an agreement between the company and a third party, where the board non-compete and non-solicit provisions)? member in question has material interest which may conflict the interest of the company, or an agreement between the company and a Shareholders’ agreements are enforceable under Swedish law but, as legal person which the board member is entitled to represent, whether mentioned in question 3.3, the agreement is only binding between alone or together with another person. Often, an independent director the parties and not enforceable against the company or third is also appointed so that the board as a whole will not be disqualified parties. If a shareholder commits a breach under the shareholders’ in matters relating to the relevant shareholders. agreement, the non-breaching party may seek contractual damages from the breaching party, but the breach will not affect the validity of corporate resolutions adopted in breach of the shareholders’ 4 Transaction Terms: General agreement. Provisions that are contradictory to mandatory law, e.g. minority protection rules, are not enforceable under Swedish law. 4.1 What are the major issues impacting the timetable for Both non-compete and non-solicit provisions are common in transactions in your jurisdiction, including competition shareholders’ agreement. The provisions need to be reasonable and and other regulatory approval requirements, fair, meaning the provisions may not be extended for an unreasonable disclosure obligations and financing issues? period of time after a party is no longer a shareholder (typically a period of up to two years is deemed reasonable – but it can be up to Except for competition clearance, corporate transactions in general five years if there are special circumstances) and/or without reasonable do not require consent from Swedish authorities, hence regular share compensation. purchases can be completed in accordance with the time schedule agreed upon by the parties. 3.6 Are there any legal restrictions or other requirements If the target company operates within certain regulated industries, that a private equity investor should be aware of there may be specific requirements to consider (such as requirements in appointing its nominees to boards of portfolio for public permits and approvals). Such industries are, e.g., financial companies? What are the key potential risks and institutions, infrastructure, media and defence. liabilities for (i) directors nominated by private equity investors to portfolio company boards, and (ii) private Timing and speed of the work-stream for financing discussions also equity investors that nominate directors to boards impact the timetable. The time required for such discussions will of portfolio companies under corporate law and also normally be heavily dependent upon the complexity and size of the more generally under other applicable laws (see deal, as does the time necessary to establish the desired investment section 10 below)? vehicles and to prepare the exit of the target company. The issues influencing the timetable for going-private transactions The investor should be aware that at least half of the board members in Sweden will, in general, be similar to those above. However, the in a Swedish limited liability company should be residents of the EU/ time necessary to prepare and receive approval of the offer document, EEA. Furthermore, the directors are not bound by the shareholders’ the target’s board to evaluate the offer and any alternatives the offer agreement. Instead, the directors of a Swedish company have a period, conduct squeeze-out of the minority shareholders, etc. also fiduciary duty to act in the best interest and care of the company, needs to be considered. and are responsible for the organisation and the management of the company’s affairs, including its financial position. A director or managing director, who, in the performance of his or her duties, 4.2 Have there been any discernible trends in transaction intentionally or negligently causes damage to the company, fails to terms over recent years? pay due taxes or assists in respect of e.g. unlawful value transfers shall compensate such damages. This liability is personal for the Recent trends in Sweden are the increase in deals involving Warranties director and will not be transferred to the private equity investor & Indemnities (W&I) insurance and the “locked box” purchase price merely for appointing the director. If the investor, however, has mechanism being the prevailing purchase price mechanism. instructed a director (or other shareholders) to execute unlawful value transfers, such transfers may be recovered by the company under customary claw-back provisions in accordance with the 5 Transaction Terms: Public Acquisitions Companies Act. Customary D&O Insurance will normally be provided to directors appointed by private equity investors. 5.1 What particular features and/or challenges apply to private equity investors involved in public-to-private transactions (and their financing) and how are these commonly dealt with?
There are no particular features or challenges applied specifically to private equity investors.
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In a going-private transaction involving companies listed on a Swedish regulated market, the Takeover Act and the particular 6.2 What is the typical package of warranties/indemnities exchange’s Takeover Rules may apply, imposing restrictions and offered by a private equity seller and its management team to a buyer? rules that must be complied with throughout the transaction. To address the risks associated with shareholder dissent, the acquirer Since the private equity sellers usually wish to distribute the prepares and structures the transaction accordingly. Firstly, the transaction proceeds as soon as possible and with high foreseeability, acquirer may seek the pre-approval by the target’s board of directors they typically only provide fundamental warranties such as title, for their recommendation to its shareholders and further secure capacity and authority and absence of certain events (prior to closing) conditional or unconditional acceptances from major shareholders warranties. In recent years, the introduction of cost-efficient W&I of the target company. Sweden insurance policies has however allowed private equity sellers to Secondly, due preparations with respect to due diligence of the provide a wider range of warranties. target company and preparations with respect to financing and other Management might provide more extensive warranties than the key conditions are conducted to mitigate the risk of revaluating or private equity seller but usually all sellers are treated equally in the declining the offer. purchase agreement, mainly due to customary drag-along provisions In a going-private transaction, the bidder may include a financing under the sellers’ shareholders’ agreement where equal treatment condition in its offer. However, such condition may not relate to normally is a general rule. equity financing and could effectively only be invoked should the financing banks fail to fulfil their obligations under the relevant loan agreement. The debt financing for a takeover bid therefore typically 6.3 What is the typical scope of other covenants, undertakings and indemnities provided by a private includes “certain funds” language, meaning that the lenders may not equity seller and its management team to a buyer? refuse to make available acquisition facilities unless a default occurs due to circumstances within the bidder’s control. Restrictive covenants including how the business is run between signing and closing and non-competition/non-solicitations covenants 5.2 Are break-up fees available in your jurisdiction in up to two to three years following the transaction are common. relation to public acquisitions? If not, what other Private equity sellers can be restrictive in giving non-competition/ arrangements are available, e.g. to cover aborted deal non-solicitation covenants depending on the fund structure and costs? If so, are such arrangements frequently agreed holding of portfolio companies; however, management sellers may and what is the general range of such break-up fees? provide such covenants to the buyer. Further, the private equity seller often undertakes not to liquidate the SPV during the warranty period. There are no general restrictions under Swedish law regarding the use of break-up fees or reverse break-up fees (imposed on e.g. a majority shareholder of the target company or the acquirer). The 6.4 Is warranty and indemnity insurance used to “bridge target company itself may, however, not enter into agreements with the gap” where only limited warranties are given by the acquirer, involving restrictions on competing bids or break-up the private equity seller and is it common for this to be offered by private equity sellers as part of the fees, without a prior approval from the Swedish Securities Council. sales process? If so, what are the typical (i) excesses The approval has to be applied for in a certain course of action and / policy limits, and (ii) carve-outs / exclusions from may only be obtained under certain conditions, of which one is that such warranty and indemnity insurance policies? the prospects of a bid is of benefit for the shareholders. The board of the target company shall pay attention to the interests of all As mentioned in question 4.2, there has been an increase in deals shareholders and should not (without a justified reason) intervene or involving W&I insurances in Sweden, providing clean exits and make commitments that limit the shareholders’ ability to evaluate and minimising time spent on negotiating warranties, bridging the gap make a decision on the bid or to call for measures to counter the bid. between the seller and the buyer and enabling the private equity sponsor to distribute the proceeds to its investors immediately after 6 Transaction Terms: Private Acquisitions closing. However, certain areas which have not been included in the due diligence, known risks and disclosed matters are excluded from the insurance policy. Further, areas such as environmental and tax 6.1 What consideration structures are typically preferred often need a special insurance policy to be fully covered. by private equity investors (i) on the sell-side, and (ii) on the buy-side, in your jurisdiction? 6.5 What limitations will typically apply to the liability of a private equity seller and management team under For both private equity buyers and sellers, a “locked box” purchase warranties, covenants, indemnities and undertakings? price mechanism is preferred, often based on an enterprise value less net debt calculation on the basis of audited or non-audited monthly There are several standard limitations to the warranties, including or quarterly reports. The “locked box” mechanism offers certainty limitations in time, baskets and caps, exclusion of deductible items and in the purchase price, avoids post-closing adjustments and potential exclusions for information provided during the due diligence process. disputes in relation thereto, and enables prompt distribution of sale Fundamental warranties such as title capacity and authority, absence proceeds to investors and sellers after closing. When a “locked of certain events (ordinary course) and no leakage covenants are box” mechanism is used, it is common that an interest component excluded from de minimis and basket thresholds and typically is introduced, compensating the seller for the expected cash flow subject to a cap corresponding to the purchase price. Business generated by the business between the “locked box” date and warranties and other covenants are often capped at around 10–30 closing. Depending on the seller, it is not uncommon that part of the per cent of the purchase price. purchase price is paid by issuing consideration shares in the SPV, or that a part of the purchase price is financed by the seller through a vendor loan note.
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6.6 Do (i) private equity sellers provide security (e.g. 7.2 What customary lock-ups would be imposed on escrow accounts) for any warranties / liabilities, and private equity sellers on an IPO exit? (ii) private equity buyers insist on any security for warranties / liabilities (including any obtained from Lock-up restrictions may apply depending on the transaction and the the management team)? function and demand of the appointed advisers, whether it is book runners, underwriters or the recommendation of any other financial Private equity sellers typically reject to provide an escrow to cover adviser. If the owners are considering a full exit of their holdings, a potential claims due to their interest to distribute the proceeds to the lock-up period will mitigate the price drop of a sudden disposal. If private equity investors as soon as practicable after closing. a financial adviser is acting as an underwriter, they would normally
As mentioned above, private equity buyers and sellers more often not be willing to take on the associated price risk of such sudden Sweden secure themselves by W&I insurances by shifting the risks to a third disposal upon listing. A lock-up period of at least six months or a party. Other ways for private equity buyers to secure themselves against year would be common in such case. counterparty risks is by requesting escrow accounts and guarantees/ undertakings from the sellers in the share purchase agreement. 7.3 Do private equity sellers generally pursue a dual-track exit process? If so, (i) how late in the process are 6.7 How do private equity buyers typically provide comfort private equity sellers continuing to run the dual-track, as to the availability of (i) debt finance, and (ii) equity and (ii) were more dual-track deals ultimately realised finance? What rights of enforcement do sellers typically through a sale or IPO? obtain if commitments to, or obtained by, an SPV are not complied with (e.g. equity underwrite of debt A dual-track process allows the private equity sponsor to keep its funding, right to specific performance of obligations under an equity commitment letter, damages, etc.)? options open and pursue the exit route offering the most attractive return and providing the most favourable terms. The dual-track process is normally run until the end of the sale process and aborted Private equity buyers often have to prove to the seller that financing just prior to execution. of the purchase price is obtained through confirmation from the proposed debt provider prior to entering into a purchase agreement. In recent years the Swedish public market has been subject to high The buyer also normally provides the seller with an equity valuations. Many of the private equity target companies have commitment letter guaranteeing drawdown of sufficient equity from therefore been exited through an IPO. the fund, or the fund’s investors, to cover the remaining part of the purchase price due by the SPV. Enforcement rights for the sellers are 8 Financing typically obtained by way of giving the sellers rights to act on behalf of the buyer subject to the satisfaction of the conditions to closing. 8.1 Please outline the most common sources of debt finance used to fund private equity transactions in 6.8 Are reverse break fees prevalent in private equity your jurisdiction and provide an overview of the transactions to limit private equity buyers’ exposure? current state of the finance market in your jurisdiction If so, what terms are typical? for such debt (particularly the market for high yield bonds). Reverse break fees are not prevalent in Swedish private equity transactions, they do however occur under special circumstances. The typical debt financing of a private equity transaction in the Swedish market combines (two or more of) subordinated 7 Transaction Terms: IPOs shareholder and/or vendor debt which is treated as equity for ranking and covenant purposes, mezzanine or high-yield bond debt and senior bank loans. Mezzanine debt is not as commonly used 7.1 What particular features and/or challenges should a as pre-crises; whereas the market for high-yield bonds has seen a private equity seller be aware of in considering an IPO significant development in the past few years. exit?
8.2 Are there any relevant legal requirements or The starting point related to the shares in a going public transaction is restrictions impacting the nature or structure of to dissolve all rights and restrictions related to the shares, including the debt financing (or any particular type of debt internal restrictions such as within a shareholders’ agreement financing) of private equity transactions? and external restrictions such as within the company’s articles of association. All rights in violation with applicable market rules There are no legal requirements or restrictions that particularly must be dissolved, of which the board appointment rights are one of affect a private equity investor’s choice. However, Swedish law the central subjects of discussion if a majority shareholder retains its contains financial assistant rules which prohibit the making of majority position post the initial offering. loans, or granting of security or guarantees with the purpose of The Swedish Corporate Governance Code sets out rules applicable financing an acquisition of shares in the lender or grantor itself or its to companies listed on a regulated market, under the principle parent or sister company. There is no whitewash procedure under of “comply or explain”. Several of the rules in the Code seek to Swedish law; however, the prohibition on financial assistance is nor improve transparency within public companies, by, e.g., prescribing perpetually linked to a certain loan (differing from, e.g., Norwegian a certain composition of independent directors of the board and the law). Therefore, a target company or its subsidiaries cannot provide requirement to annually publish a corporate governance report. The cash loans, security or guarantees in direct relation to an acquisition measures needed to be taken under the Code, from the moment of of said target. However, the target group may provide security and going public on a regulated market, impose additional costs and guarantees after a period of time. administrative burden on companies and their boards of directors.
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The granting of security and guarantees by a target or a subsidiary purposes (shares, warrants, convertible bonds, profit participation under Swedish law is further subject to restrictions on distributions, loans). In order to lower the initial investment, management may be certain prohibited loans and the purpose of the company’s business. offered to invest in the highly debt financed acquisition company. An Whether and to what extent such restrictions apply, and how they alternative may be to issue warrants or to use different type of share are dealt with, requires analysis on a case-by-case basis. Generally, classes. In order to avoid a tax exposure, it is important to make however, a limitation language to address these issues is inserted in a third-party valuation of the instruments offered to management any relevant security or guarantee document. and to ensure that the instruments are not subject to restriction more severe than has been accepted in case law. 9 Tax Matters In general, all type of salaries and benefits (including acquisition of shares below market value) and incentive instruments not qualified Sweden as securities (but rather as employee share options) provided to 9.1 What are the key tax considerations for private equity an employee is considered an employment income taxed with investors and transactions in your jurisdiction? Are progressive tax rates. Salary and benefit costs are also subject to off-shore structures common? social security contributions for the employer which is, however, a deductible cost for the employer. The vast majority of the transactions on the Swedish private equity market are conducted through share deals since a share deal 9.4 Have there been any significant changes in tax normally is tax-exempt for the seller under the Swedish participation legislation or the practices of tax authorities exemption rules. (including in relation to tax rulings or clearances) A Swedish acquisition company may be established in order to impacting private equity investors, management allow for the taxable income of the Swedish target group to be offset teams or private equity transactions and are any anticipated? against interest payments related to the acquisition, and provided the acquisition company holds more than 90 per cent of the shares in the target company, tax consolidation may be achieved. Under the As regards the private equity fund structures, the main tax issue Swedish participation exemption rules, a Swedish holding company during recent years have been the taxation of carried interest. The may also sell the shares in a Swedish wholly-owned subsidiary tax- Swedish tax agency has previously considered that the carried exempt. interest should be considered as a salary for management in private equity funds. The Swedish tax agency, however, lost these court Off-shore structures are still quite common. Structures involving cases and is now trying to tax the carried interest according to the Swedish target companies typically have a Swedish holding Swedish rules regarding so-called closely held companies. The structure, owned by a foreign holding structure (typically one or effect of applying the rules on closely held companies is that a two Luxembourgian or Channel Islands holding companies) that in portion of the carried interest should be taxed as a salary income (up turn is owned by the fund. In recent years, however, due to the to approximately 58 per cent tax) instead of a capital gain (25–30 decreasing tax benefits, the regulatory burden and a public opinion per cent tax). We expect to see continuous discussions and cases against off-shore structures, many newly founded private equity regarding taxation on carried interest. funds focusing on Swedish target companies have been established employing an on-shore structure. 10 Legal and Regulatory Matters 9.2 What are the key tax considerations for management teams that are selling and/or rolling-over part of their 10.1 What are the key laws and regulations affecting investment into a new acquisition structure? private equity investors and transactions in your jurisdiction, including those that impact private equity Important tax considerations for a Swedish management team in transactions differently to other types of transaction? an exit would be their individual tax treatment in relation to their proceeds, and in relation to their roll-over in order to obtain a tax The Act on Alternative Investment Fund Managers (the AIFM neutral exchange of shares by deferring taxation until exit. Act) affects the funds and fund managers active in Sweden. The Share acquisitions are in general not classified as asset acquisitions Companies Act, Economic Associations Act and the Partnership and for tax purposes. One exception worth mentioning is that Sweden Non-registered Partnership Act provide the fundamental statutory has CFC-rules stating that a foreign company registered in a low tax framework for legal entities and, together with the Contracts Act, jurisdiction owned by a Swedish company or Swedish individual the Sales of Goods Act, the International Sales of Goods Act, the should be disregarded for tax purposes meaning that the Swedish Competition Act and the Securities Market Act, form the legal company or individual for tax purposes are considered holding the grounds governing transactions in Sweden. assets of the foreign company directly. 10.2 Have there been any significant legal and/or 9.3 What are the key tax-efficient arrangements that are regulatory developments over recent years impacting typically considered by management teams in private private equity investors or transactions and are any equity portfolio companies (such as growth shares, anticipated? deferred / vesting arrangements, “entrepreneurs’ relief” or “employee shareholder status” in the UK)? In 2013, Sweden implemented the EU AIFM directive through the AIFM Act. The AIFM Act has made a number of previously Management incentive programmes in Swedish target companies unregulated funds, including private equity funds, subject to are often structured so that management is offered to invest in the regulation. The AIFM Act requires the manager of an alternative fund/target companies through an instrument that will qualify as a investment fund to, among other things, comply with rules related security (typically subject to capital gains taxation) for Swedish tax to conflict of interests, risk management, liquidity management,
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organisational requirements, valuation procedures and rules restricting delegation of functions. In addition, the AIFM Act 10.5 Are there any circumstances in which: (i) a private contains rules for cross-border marketing of alternative investment equity investor may be held liable for the liabilities of the underlying portfolio companies (including due to funds within EEA to professional investors. breach of applicable laws by the portfolio companies); and (ii) one portfolio company may be held liable for 10.3 How detailed is the legal due diligence (including the liabilities of another portfolio company? compliance) conducted by private equity investors prior to any acquisitions (e.g. typical timeframes, Since the portfolio company is a separate limited liability company materiality, scope etc.)? Do private equity investors it is extremely rare that a private equity sponsor is held liable for engage outside counsel / professionals to conduct all the portfolio company’s obligations. The “corporate veil” will only legal / compliance due diligence or is any conducted Sweden be pierced following an unlawful value transfer or due to extremely in-house? hazardous activities in a deliberately under-capitalised portfolio company. The private equity sponsor often wants to conduct a rather thorough due diligence with a focus on the material risk of the target company’s business. Both scope, timeline and materiality 11 Other Useful Facts thresholds depends on the business of the target company. The increase in W&I insurance in Sweden has affected the scope of the due diligence since the private equity buyer will need to examine 11.1 What other factors commonly give rise to concerns all areas included in the insurance policy. External counsels are for private equity investors in your jurisdiction or typically engaged for legal and compliance matters and the report should such investors otherwise be aware of in considering an investment in your jurisdiction? format is often a “red flag” report summarising the material issues and risks with suggestions on how to address such issues. The Swedish PE market, especially concerning mid-cap target companies, is considered strong, and is one of the largest in Europe 10.4 Has anti-bribery or anti-corruption legislation (measured in terms of its share of GDP). Buyers and sellers (and impacted private equity investment and/or investors’ their advisors) are quite accustomed to private equity sponsors approach to private equity transactions (e.g. and their concerns, which facilitate efficient deal execution and diligence, contractual protection, etc.)? structuring. Furthermore, the Swedish legislation is investor- friendly and generally allows foreign as well as domestic investors to The regulatory burden as well as the public opinion has caused the buy and sell Swedish companies without going through unnecessary private equity players to focus on CSR, ESG (Environmental, Social bureaucratic processes. and Governmental) matters, including e.g. anti-corruption. Due diligence is conducted to ensure compliance with applicable laws and to identify potential risks and liabilities relating to the target company. Contractual protection to limit any risks and liabilities relating to ESG matters is becoming standard.
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Anett Lilliehöök Sten Hedbäck Advokatfirman Törngren Magnell Advokatfirman Törngren Magnell Västra Trädgårdsgatan 8 Västra Trädgårdsgatan 8 111 53 Stockholm 111 53 Stockholm Sweden Sweden
Tel: +46 760 028 330 Tel: +46 760 028 305 Email: [email protected] Email: [email protected] URL: www.torngrenmagnell.com URL: www.torngrenmagnell.com Sweden Anett Kristin Lilliehöök works mainly with M&A, advising private Sten Hedbäck’s practice focuses on private M&A transactions, where equity and venture capital clients as well as international corporate he represents private equity funds and other financial investors as well and industrial clients from various industries. She has significant as industrial companies and entrepreneurs in connection with all types experience with regards to cross-border transactions. of acquisitions and divestitures of companies and businesses.
Törngren Magnell is known as a premier transaction law firm in Sweden and was established in 2006. The firm is located in Stockholm and assists in both domestic and cross-border transactions. Our lawyers have previous experience from top-tier law firms, public companies and leading international audit firms. Private equity and venture capital are key industry sectors for Törngren Magnell. Our financial investors team has built a strong reputation in the Swedish marketplace and understands what private equity and other financial investors require for successful deal execution. We have considerable experience advising on all types of transactions, from start-ups and venture capital investments to large and complex cross-border private equity deals, from the initial investment all the way to exit (whether as an IPO or a trade sale). Törngren Magnell’s main areas of expertise cover: Private M&A; Public M&A; Private Equity; Capital Markets; Banking & Finance; Corporate; Dispute Resolution; Employment; and Real Estate.
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Switzerland Dr. Christoph Neeracher
Bär & Karrer Ltd. Dr. Luca Jagmetti
1 Overview 2.2 What are the main drivers for these acquisition structures?
1.1 What are the most common types of private equity transactions in your jurisdiction? What is the current The acquisition structure is mainly tax-driven (tax-efficient state of the market for these transactions? Have repatriation of dividends/double taxation treaties, tax-exempt exit). you seen any changes in the types of private equity Directly investing in the AcquiCo may allow Swiss-domiciled transactions being implemented in the last two to managers to realise a tax-free capital gain on their investment when three years? the AcquiCo is sold at the exit. However, management incentives and regulatory considerations also play important roles. All of the standard transaction strategies to acquire portfolio companies are commonly used in Switzerland. We assume that 2.3 How is the equity commonly structured in private regular leveraged buyouts have accounted for a majority of the equity transactions in your jurisdiction (including transactions in recent years. institutional, management and carried interests)?
1.2 What are the most significant factors or developments A Swiss NewCo often has only one class (or a maximum of two encouraging or inhibiting private equity transactions classes) of shares. Preferential rights, exit waterfall, etc. are in your jurisdiction? implemented on a contractual level in the shareholders’ agreement. NewCos incorporated abroad often have several classes of shares. The most significant event for the Swiss economy was the abandonment of the CHF/EUR minimum exchange rate by the 2.4 What are the main drivers for these equity structures? Swiss National Bank (SNB) in January 2015, which resulted in the appreciation of the CHF against the EUR. However, while 2015 was characterised by rather low M&A levels (compared to 2014, Firstly, Swiss corporate law limits the formation of preferential the amount of transactions decreased by 17%), 2016 has again been shares in certain ways. Secondly, the articles of association are very strong. publicly available. Consequently, the preferred route is to embody preferential rights, etc. in the shareholders’ agreement (which is not publicly available) in which the parties can freely agree on such 2 Structuring Matters features.
2.1 What are the most common acquisition structures 2.5 In relation to management equity, what are the typical adopted for private equity transactions in your vesting and compulsory acquisition provisions? jurisdiction? Have new structures increasingly developed (e.g. minority investments)? Management is often asked to acquire the full stake of their investment at the outset. In mid-sized deals, management Usually, private equity funds investing in Swiss portfolio companies participation usually ranges from around 1% to 3%; however, set up a NewCo/AcquiCo in Switzerland as an acquisition vehicle. certain funds request much higher management investments. As The NewCo is held either directly or via Luxembourg, Netherlands mentioned in question 2.2, usually each of the managers directly or a similar structure. AcquiCos incorporated outside Switzerland invests in the AcquiCo to realise a tax-free capital gain at the exit. are also seen. Often, the equity sponsor or the target company grants loans to the Management usually invests directly in the AcquiCo rather than via a managers so they can finance their investment; the exact structure management participation company. Often, one single shareholders’ is usually sought to be confirmed by a tax ruling in order to avoid agreement (SHA) between the financial investor(s) and management taxation of the exit gain as taxable income. is concluded, which governs all aspects of the investment (governance, The shareholders’ agreements with management typically contain exit procedures, share transfers, good/bad leaver provisions, etc.). In standard good and bad leaver provisions, providing for a call option other cases, a main SHA is concluded between the financial sponsors of the financial sponsor in case of a departure (with a price reduction and a separate, smaller SHA with management. in case of a bad leaver – which may also depend on the duration
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of employment). Sometimes, the management participation is management. The exit rights for private equity investors holding a structured as staggered vesting of the shares. The differences minority position are usually heavily negotiated. between initial investment with good/bad leaver provisions and staggered vesting are of a rather technical nature; the material result 3.3 Are there any limitations on the effectiveness of veto is usually the same. arrangements: (i) at the shareholder level; and (ii) at the director nominee level? If so, how are these typically addressed? 2.6 If a private equity investor is taking a minority position, are there different structuring considerations? On a shareholder level, veto rights may be created by introducing high quorums for certain shareholders’ decisions in the articles of Structuring considerations do not fundamentally differ for minority association and the shareholders’ agreement. Such veto rights are Switzerland stakes. Of course, securing the exit possibilities and minority generally regarded as permissive as long as the arrangement does protection rights in the shareholders’ agreement are of paramount not lead to a blockade of decision-taking in the company per se. importance. On a board level, individual veto rights of certain board members cannot be implemented based on the articles of association or other corporate documents. However, such individual veto rights 3 Governance Matters are regularly incorporated in the shareholders’ agreement; i.e. the parties agree that the board shall not take certain decisions without 3.1 What are the typical governance arrangements the affirmative vote of certain nominees. A board decision taken in for private equity portfolio companies? Are such contradiction to such contractual arrangement would still be valid, arrangements required to be made publicly available but may trigger consequences under the shareholders’ agreement. in your jurisdiction? Furthermore, directors are bound by a duty of care and loyalty vis-à- vis the company. If abiding by instructions given by another person The predominant type for acquisitions of portfolio companies based on contractual provisions leads to a breach of such duties, the in Switzerland is the stock corporation (Aktiengesellschaft). board member may not follow such instructions and will likely not Sometimes, limited liability companies (LLCs, GmbH) are used, be in breach of the shareholders’ agreement (at least if the latter is which have the advantage that they can be treated as transparent for governed by Swiss law). US tax purposes.
The stock corporation is governed by a board of directors which has 3.4 Are there any duties owed by a private equity investor a supervisory function and resolves on strategic and important issues to minority shareholders such as management (appointment of senior management, etc.). A director is elected ad shareholders (or vice versa)? If so, how are these personam; proxies (e.g. in the case of absence at meetings) are not typically addressed? possible. Day-to-day management is normally delegated to management, From its position as a shareholder alone, in principle, a private based on organisational regulations. They often contain a equity investor does not have such duties; shareholders of a Swiss competence matrix defining the competences of each management stock corporation do not have any duty of loyalty. level and which decisions need approval by the board or even However, directors, officers and management have a duty of care shareholders. and loyalty towards the company and, to a certain extent, also to Such division of competence is – together with board composition, the minority shareholders. Under special, limited circumstances, a quorum requirements, etc. – also reflected on a contractual level in private equity investor or an individual acting for it may be regarded the shareholders’ agreement. as de facto/shadow director of the company and, consequently, also be bound by such duties. The claim that a shareholder or one of its Neither the organisational regulations nor the shareholders’ representatives is a shadow director might be made successfully if agreement are required to be made publicly available in Switzerland; such person de facto acts as officer of the company, e.g. by directly only the articles of association. taking decisions that would actually be in the competence of the Our comments in question 3.1 regarding stock corporations apply board, etc. largely for LLCs too.
3.5 Are there any limitations or restrictions on the 3.2 Do private equity investors and/or their director contents or enforceability of shareholder agreements nominees typically enjoy significant veto rights over (including (i) governing law and jurisdiction, and (ii) major corporate actions (such as acquisitions and non-compete and non-solicit provisions)? disposals, litigation, indebtedness, changing the nature of the business, business plans and strategy, Shareholders’ agreements are common in Switzerland and are etc.)? If a private equity investor takes a minority position, what veto rights would they typically enjoy? normally governed by Swiss law. The parties are largely free to determine the rights and duties but there are certain limitations. The most important ones are: If a private equity investor holds a minority of the voting rights, its veto rights usually depend on the stake held, while a small investor ■ a SHA may not be unlimited in time/valid during the entire (up to 20%) normally enjoys only fundamental veto rights aimed lifetime of the company, but may have a maximum term of ca. 20–30 years; and at the protection of its financial interest (dissolution, pro-rata right to capital increases, no fundamental change in business, maximum ■ as per mandatory corporate law, directors must act in the best leverage, etc.); investors holding a more important minority interest of the company (duty of care and loyalty), which may hinder the enforcement of the SHA if its terms would conflict stake (20–49%) usually also have veto/influence rights regarding with such duties. important business decisions and the composition of senior
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A shareholders’ agreement is only enforceable against its parties. There is a debate in Swiss legal doctrine as to what extent the 4 Transaction Terms: General company itself may be party to a SHA and bound by its terms. While a majority acknowledges that the company may fulfil 4.1 What are the major issues impacting the timetable some administrative duties, entering into further obligations is for transactions in your jurisdiction, including questionable. competition and other regulatory approval requirements, disclosure obligations and financing Non-compete obligations of the shareholders in favour of the issues? company are typically enforceable if the respective shareholders are (jointly) controlling the company. Furthermore, non-compete If certain turnover thresholds are met, a Swiss merger filing must be obligations need to be limited to the geographical scope and scope made. Unless the Competition Commission (CC) decides to initiate of activity of the company. a four-month phase II investigation, clearance is granted within one Switzerland To secure share transfer provisions of the SHA, the parties often month (phase I) after filing the complete application. It is strongly deposit their shares with an escrow agent under a separate share recommended to submit a draft filing for review by the Secretariat escrow agreement. Often, SHAs also provide for penalty payments (which usually takes one to two weeks) to make sure that the filing is in case of breach. complete (thereby triggering the one-month period) and not rejected as incomplete 10 days after filing. 3.6 Are there any legal restrictions or other requirements For transactions in certain industries, governmental approvals must that a private equity investor should be aware of be obtained (e.g. banks, telecom, etc.). The impact on the timetable in appointing its nominees to boards of portfolio depends on the respective regulation and on the authorities involved. companies? What are the key potential risks and liabilities for (i) directors nominated by private equity Other than that, practical timing constraints such as setting up a investors to portfolio company boards, and (ii) private NewCo (ca. 10 days) are similar to other European jurisdictions. equity investors that nominate directors to boards of portfolio companies under corporate law and also more generally under other applicable laws (see 4.2 Have there been any discernible trends in transaction section 10 below)? terms over recent years?
On a practical note, at least (i) one person with individual signatory Since debt financing is currently easily available, buyers have power residing in Switzerland, or (ii) two individuals with joint become increasingly willing to enter into binding purchase signatory power both residing in Switzerland must be able to fully agreements prior to having the financing secured. represent the company (entry into the commercial register). It is Further, given the current sellers’ market, share purchase agreements not necessary that such persons are board members (but, e.g., tend to be more seller-friendly (e.g. with regards to R&W, etc.). managers). Additional individual or collective signatory rights may As a general observation, typical Swiss share/asset purchase also be granted for persons residing outside Switzerland. agreements still tend to be significantly shorter than US/UK Directors, officers and managers of the company (including agreements – a consequence of Switzerland’s civil law system. nominees of the private equity investor) have a duty of care and loyalty towards the company and must safeguard the (sole) interest of the portfolio company even if such interest is contrary to the 5 Transaction Terms: Public Acquisitions interest of the appointing private investor. Under special, limited circumstances, a private equity investor or an individual acting for 5.1 What particular features and/or challenges apply to it may be regarded as de facto/shadow director of the company private equity investors involved in public-to-private and, consequently, also be bound by such duties. To prevent such a transactions (and their financing) and how are these scenario, decisions should be taken solely by the competent bodies. commonly dealt with? Further, directors, officers and managers may be held liable in case of non-payment of certain social security contributions and taxes by Anyone who acquires equity securities which, added to equity the company. securities already owned, exceed the threshold of one-third of the voting rights of a Swiss listed company, is obliged to make an offer for all listed equity securities of the company (mandatory tender 3.7 How do directors nominated by private equity offer), barring exemptions granted by the Swiss Takeover Board. investors deal with actual and potential conflicts of interest arising from (i) their relationship with the The target company may, however, have either increased the party nominating them, and (ii) positions as directors threshold to a maximum of 49% of the voting rights (opting-up) or of other portfolio companies? completely excluded the obligation to make an offer (opting-out). Further, anyone who exceeds certain thresholds of the voting rights In case of a conflict of interest, the concerned director must inform in a Swiss listed company (the lowest threshold is 3%) is obliged the other board members and abstain from participating in the to make a notification to the company and the stock exchange respective discussion and decision-making process. In typical (disclosure obligation). Swiss private equity setups with one or few financial sponsor(s) Moreover, to carry out a squeeze-out merger subsequent to a public that are each represented in the board, issues related to conflicts of tender offer, the bidder must hold at least 90% of the share capital interest are of limited relevance in practice. and voting rights of the target company. Voluntary tender offers
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are regularly made subject to a minimum acceptance condition leakage covenants in locked-box deals, (vii) certain categories of which, however, does normally not exceed two-thirds of the target warranties, e.g. environmental warranties or product liability, and company’s shares. Thus, the bidder runs the risk of ending up (viii) liabilities arising as a result of fraud, corruption or bribery. holding less than 90% and, consequently, not being able to squeeze- out the remaining minority shareholders. 6.5 What limitations will typically apply to the liability of a private equity seller and management team under 5.2 Are break-up fees available in your jurisdiction in warranties, covenants, indemnities and undertakings? relation to public acquisitions? If not, what other arrangements are available, e.g. to cover aborted deal The liability for breaches of R&W is typically subject to a de costs? If so, are such arrangements frequently agreed minimis amount (depending on deal size) and a threshold amount and what is the general range of such break-up fees? (often approximately 1% in mid-cap transactions), as well as a cap Switzerland in the range of 10–30%. Title and tax representations are often not Both takeover parties can agree on break fees unless they will result subject to such limitations. in coercing shareholders to accept the offer or deter third parties Managers are only liable in proportion to their shareholding. from submitting an offer. As a rough rule of thumb, break fees should not considerably exceed the costs in connection with the offer. The parties must also disclose such agreements in the offer 6.6 Do (i) private equity sellers provide security (e.g. documents. escrow accounts) for any warranties / liabilities, and (ii) private equity buyers insist on any security for warranties / liabilities (including any obtained from 6 Transaction Terms: Private Acquisitions the management team)?
Escrows to secure R&W are not uncommon; in particular in case 6.1 What consideration structures are typically preferred of multiple sellers (e.g. when a large number of managers are co- by private equity investors (i) on the sell-side, and (ii) sellers). on the buy-side, in your jurisdiction?
The Locked-box mechanism (with anti-leakage protection) 6.7 How do private equity buyers typically provide preferred on the sell-side, and NWC/Net Debt adjustments, based comfort as to the availability of (i) debt finance, and (ii) equity finance? What rights of enforcement on closing accounts, preferred on the buy-side, are equally common do sellers typically obtain if commitments to, or in Switzerland. Earn-outs and vendor loans are less often seen. obtained by, an SPV are not complied with (e.g. equity underwrite of debt funding, right to specific performance of obligations under an equity 6.2 What is the typical package of warranties/indemnities commitment letter, damages, etc.)? offered by a private equity seller and its management team to a buyer? Typically, in relation to the equity portion the private equity fund Usually, a customary set of representations and warranties is granted provides an equity commitment letter which may be enforced by which is not materially different from what strategic sellers offer. the seller (obliging the private equity fund to provide the NewCo Quite often, tax indemnities are seen. with the necessary funds). The debt portion is usually comforted by binding financing term sheets, interim loan agreements or similar. In the context of public transactions, the availability of funds must 6.3 What is the typical scope of other covenants, be confirmed by the review body before the launch of the offering. undertakings and indemnities provided by a private equity seller and its management team to a buyer? 6.8 Are reverse break fees prevalent in private equity Typically, the parties agree on non-compete and non-solicitation transactions to limit private equity buyers’ exposure? If so, what terms are typical? obligations for a period of one to three years.
Reverse break fees are relatively rarely seen in private equity 6.4 Is warranty and indemnity insurance used to “bridge transactions; sellers often insist on actual financing proof (see the gap” where only limited warranties are given by above). the private equity seller and is it common for this to be offered by private equity sellers as part of the sales process? If so, what are the typical (i) excesses / policy limits, and (ii) carve-outs / exclusions from 7 Transaction Terms: IPOs such warranty and indemnity insurance policies? 7.1 What particular features and/or challenges should a So far, W&I insurances have relatively seldom been used. However, private equity seller be aware of in considering an IPO with insurers being more active and given the current sellers’ market, exit? W&I insurances are becoming more common in Switzerland. Generally, a W&I insurance policy will not cover (i) liabilities A private equity seller should be aware of the following features and arising from known facts, matters identified in the due diligence challenges for a company going public: or information otherwise disclosed by the seller, (ii) forward- ■ Lock-up: Typically, existing shareholders holding more looking warranties, (iii) certain tax matters, e.g. transfer pricing than 3% in the share capital prior to the offering, as well and secondary tax liabilities, (iv) pension underfunding, (v) civil or as the members of the board of directors and the executive criminal fines or penalties where insurance cover may not legally management, will be required by the underwriters to sign-up be provided, (vi) post-completion price adjustments and non- for lock-up undertakings during 12 to 18 months after the
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IPO. Therefore, shareholders’ agreements among private equity investors and agreements with directors and managers 8.2 Are there any relevant legal requirements or should provide for respective undertakings. restrictions impacting the nature or structure of the debt financing (or any particular type of debt ■ Drag-along rights: Shareholders’ agreements should also financing) of private equity transactions? include drag rights to ensure that that there are sufficient shares to be sold in the secondary tranche. Under Swiss law, there are no statutory corporate minimum leverage ■ Corporate governance: Private-equity owned companies will have to adapt their corporate governance regimes in order requirements. However, de facto limitations result from the thin to make the company fit for an IPO (including amendments capitalisation rules applied by Swiss tax authorities. Interest paid to the articles of association, board composition, internal on amounts of debt exceeding certain thresholds may be requalified regulations, etc.). as a hidden dividend if paid to a shareholder or a related party
■ Regulation: As in most jurisdictions, Swiss law and the listing of a shareholder. Consequently, such interest would not be tax- Switzerland rules of the SIX Swiss Exchange provide for additional deductible and subject to 35% withholding tax. obligations for a public company (e.g. obligations regarding The same generally applies if debt is provided by a third party but financial reporting, compensation of the board of directors and secured by a shareholder. Furthermore, there are restrictions for the senior management, ad hoc announcement, disclosure of Swiss companies to grant loans or provide security which are of major shareholdings). These obligations require additional an up-stream or cross-stream nature (see question 8.1 above). The resources within the company and the support of an external specialist. Swiss tax authorities publish maximum safe haven interest rates for intercompany loans on an annual basis. Higher interest rates can be justified with a third-party test. 7.2 What customary lock-ups would be imposed on private equity sellers on an IPO exit? 9 Tax Matters Shareholders holding more than 3% in the share capital prior to the offering of the company going public, as well as the members of 9.1 What are the key tax considerations for private equity the board of directors and the executive management, are usually investors and transactions in your jurisdiction? Are requested to sign-up for lock-up undertakings with lock-up periods off-shore structures common? of 12 to 18 months. Switzerland is not known as a very attractive location for the 7.3 Do private equity sellers generally pursue a dual-track establishment of private equity funds, mainly due to the Swiss exit process? If so, (i) how late in the process are withholding tax and securities transfer tax regime. Therefore, private equity sellers continuing to run the dual-track, private equity funds are often established in jurisdictions like Jersey, and (ii) were more dual-track deals ultimately realised Cayman Islands, Luxembourg, Scotland or Guernsey. through a sale or IPO? Private equity acquisitions in Switzerland are mainly performed by This is heavily dependent on the general market conditions. If an an acquisition vehicle (holding company) from jurisdictions with IPO is considered, dual-track processes are often seen. However, if which Switzerland has concluded a double taxation treaty and which an IPO is not the preferred route at the beginning, often just a trade foresee a 0% Swiss withholding tax for a qualifying (minimum 10% sale (auction) process takes place. Dual-track processes have been shareholding) dividend distribution from a Swiss company. pursued until very late in the process, although parties try to make their final decision before the intention to float is published. 9.2 What are the key tax considerations for management teams that are selling and/or rolling-over part of their investment into a new acquisition structure? 8 Financing Swiss-resident managers generally try to achieve a tax-exempt capital gain upon the sale of privately held shares. In order not 8.1 Please outline the most common sources of debt finance used to fund private equity transactions in to qualify as salary (like synthetic bonus schemes), the managers your jurisdiction and provide an overview of the should have full ownership rights (dividend, liquidation, voting current state of the finance market in your jurisdiction rights). A tax neutral roll-over may be structured, e.g. via a for such debt (particularly the market for high yield share-for-share exchange in line with the Swiss reorganisation tax bonds). requirements. Whether the sale of shares under a management participation qualifies for a tax-exempt capital gain is a case-by- Private equity investors usually provide financing in the form of case decision since preferential terms (like sweet equity) or a later mezzanine debt or subordinated loans. In the context of leveraged investment at a formula value could lead to (partial) taxable salary buyouts, investors will typically use senior and junior debt in the for the managers upon sale and social security charges for the Swiss form of credit facilities provided by financial institutions and high employer. Thus, it is recommendable to confirm the consequences yield bonds, although there are some restrictions in connection with of a specific management participation in an advance ruling. bond financing into Switzerland. In the context of acquisitions, debt providers usually require that existing debt is refinanced at the level of 9.3 What are the key tax-efficient arrangements that are the acquisition debt providers. Security released in connection with typically considered by management teams in private the refinancing typically serves as collateral for the new acquisition equity portfolio companies (such as growth shares, financing. The ability of Swiss target group companies to provide deferred / vesting arrangements, “entrepreneurs’ collateral is limited under Swiss law. Upstream security may only be relief” or “employee shareholder status” in the UK)? granted if certain prerequisites are met, and only in the amount of the relevant Swiss company’s freely distributable reserves. There are no specific tax reliefs or tax provisions for management
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share participations, except for blocking period discounts (6% per Schemes Act, CISA). Under the revised CISA, the requirements blocking year) if shares are acquired below fair market value. for the offering and placement of funds mainly depend on whether the fund interests are being “distributed” in the meaning of CISA in or from Switzerland and, if so, whether they are distributed to 9.4 Have there been any significant changes in tax legislation or the practices of tax authorities qualified investors only or to other persons as well. As a result, (including in relation to tax rulings or clearances) the concept of distribution is key to determining the admissibility impacting private equity investors, management of offering interests in private equity funds in or from Switzerland. teams or private equity transactions and are any This new concept replaced the previous distinction between public anticipated? distribution and private placement under the old CISA. As a consequence of the revision of CISA, fundraising has become There are currently no immediate tax changes expected affecting more complex during the last few years. In particular, special Switzerland the investment in Swiss targets and the acquisition by private equity attention has to be paid to the question of what kind of investors can funds. In order to pass the beneficial owner test to qualify for 0% be approached for fundraising. In short, interests in private equity Swiss withholding taxes under the respective double taxation treaty, funds may still be freely offered to regulated financial intermediaries the Swiss Federal Tax Administration generally requires sufficient such as banks, securities dealers, fund management companies and equity (minimum 30%), business reasons and certain substance of insurance companies in Switzerland (the ‘super-qualified investors’). the foreign acquisition holding company. Fundraising from these super-qualified investors does not qualify as The OECD base erosion and profit shifting (BEPS) standards will ‘distribution’ and is, therefore, not subject to the distribution rules of be implemented by Switzerland, e.g. country-by-country reporting, the CISA. The case is different for the offering of interests in private spontaneous exchange of tax rulings, with entry into force as of equity funds to qualified investors, as this may be subject to legal 2017 (with tax ruling exchange to be made as of 1 January 2018) and regulatory requirements (e.g. the requirement of a paying agent respectively expectedly as of 2018 (country-by-country reporting) and representative of the funds). in Switzerland. One of the more recent regulatory developments has been the Further, the anticipated corporate tax reform III (the legislative draft enactment of the Financial Market Infrastructure Act (FinMIA) on was recently rejected in a popular vote; a new draft is currently 1 January 2016, which provides for improvements in the provision being prepared by Swiss Parliament), under which privileged tax of financial services and financial instruments in Switzerland, regimes will be abolished, will have an impact on the effective tax and has been drafted in conformity with the respective European rates of Swiss target companies, since general reductions of tax provisions and international standards. It contains rules regarding rates and measures like patent boxes are expected to be introduced the financial markets infrastructure and the trade in derivatives, such to maintain the attractiveness. as provisions for operators of an organised trading system regarding Tax authorities tend to scrutinise tax-exempt capital gains for selling organisation and transparency of trade. Furthermore, the FinMIA individuals; thus, earn-out arrangements for sellers continuing to contains a set of ‘market rules of conduct’, which regulate the work for the target or non-compete agreements may partly qualify financial market participants’ activities in relation to securities and as taxable income for the seller and should be structured carefully. derivatives trading. These include the provisions on the disclosure of shareholdings, public takeover offers, insider trading and market
manipulation that were formerly included in the Stock Exchange 10 Legal and Regulatory Matters Act, as well as the new regulations for derivatives trading, which are in line with international standards.
10.1 What are the key laws and regulations affecting private equity investors and transactions in your 10.3 How detailed is the legal due diligence (including jurisdiction, including those that impact private equity compliance) conducted by private equity investors transactions differently to other types of transaction? prior to any acquisitions (e.g. typical timeframes, materiality, scope etc.)? Do private equity investors The Swiss Federal Collective Investment Schemes Act (CISA) engage outside counsel / professionals to conduct all legal / compliance due diligence or is any conducted applies to the fund, its activities and distribution. On the transactional in-house? level, private transactions are mainly governed by the Swiss Code of Obligations (CO); no specifics apply. In case of a public tender The legal due diligence (DD) usually covers the following areas: offer, the Federal Stock Exchanges and Securities Trading Act corporate, financing agreements, business agreements, employment, (SESTA) and a number of implementing ordinances apply and, as real property/lease as well as IP/IT and litigation. The handling of the case may be, also the Listing Rules of the SIX Swiss Exchange. compliance and regulatory matters depends on the specific case. Beyond, if a transaction exceeds certain thresholds, the regulations Typically, an external legal counsel is engaged to conduct a red flag of the Federal Act on Cartels and other restraints of competition also legal DD of two to four weeks. need to be considered.
10.4 Has anti-bribery or anti-corruption legislation 10.2 Have there been any significant legal and/or impacted private equity investment and/or investors’ regulatory developments over recent years impacting approach to private equity transactions (e.g. private equity investors or transactions and are any diligence, contractual protection, etc.)? anticipated?
In due diligence, focus on compliance of target companies with After a major revision of the Swiss collective investment schemes anti-bribery, anti-corruption and economic sanctions has increased legislation in 2013, private equity funds may qualify as collective in recent years. investment schemes under Swiss law (Collective Investment
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10.5 Are there any circumstances in which: (i) a private 11 Other Useful Facts equity investor may be held liable for the liabilities of the underlying portfolio companies (including due to breach of applicable laws by the portfolio companies); 11.1 What other factors commonly give rise to concerns and (ii) one portfolio company may be held liable for for private equity investors in your jurisdiction or the liabilities of another portfolio company? should such investors otherwise be aware of in considering an investment in your jurisdiction? Under special, limited circumstances, a private equity investor or an individual acting for it may be regarded as de facto/shadow director In April 2014, the European Commission imposed a €37 million fine of the company and, consequently, be bound by directors’ duties on Goldman Sachs for antitrust breaches committed by a portfolio (see question 3.6). company that was formerly owned by its private equity arm, GS Capital Partners. GS and the portfolio company were held jointly Switzerland A private equity investor that (solely or jointly) controls a portfolio and severally liable for the fine. GS was held liable on the basis that company that has infringed competition law could be made jointly it exercised decisive influence over the portfolio company, although and severally liable for paying the resulting fine. While it is possible GS was not alleged to have participated in, been aware of or that a portfolio company may be made liable for the liabilities of facilitated the alleged cartel in any way. Even though in Switzerland another portfolio company, this is a less likely scenario. See also no such precedents in relation to private equity companies exist so section 11 below. far, it is possible that the Swiss Competition Commission could Under normal circumstances it is highly unlikely that a portfolio follow the European Commission’s line of thinking. In Switzerland, company is liable for another portfolio company. holding companies tend to be found to be jointly and severally liable for the antitrust fines of their subsidiaries. Private equity investors should, therefore, implement a robust compliance programme in their portfolio companies to avoid antitrust law infringements.
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Dr. Christoph Neeracher Dr. Luca Jagmetti Bär & Karrer Ltd. Bär & Karrer Ltd. Brandschenkestrasse 90 Brandschenkestrasse 90 8027 Zürich 8027 Zürich Switzerland Switzerland
Tel: +41 58 261 52 64 Tel: +41 58 261 52 62 Email: [email protected] Email: [email protected] URL: www.baerkarrer.ch URL: www.baerkarrer.ch
Dr. Christoph Neeracher is a partner at Bär & Karrer and co-head of Dr. Luca Jagmetti is a partner at Bär & Karrer in the Practice Group Switzerland the Practice Group Private M&A and Private Equity. He is recognised Private M&A and Private Equity. He has vast experience in domestic as one of the preeminent private M&A and private equity attorneys at and international M&A transactions (share and asset deals) involving law in Switzerland and as a leading lawyer in financial and corporate a broad range of industries, corporate auction processes, venture law. Christoph Neeracher is experienced in a broad range of domestic capital investments and management equity participation schemes. and international transactions, both sell- and buy-side (including Luca Jagmetti further advises clients on intragroup and transaction corporate auction processes), and specialises in private M&A, private financing, corporate restructurings and general contract and equity and venture capital transactions. Furthermore, he advises commercial matters. In his core fields of activity he represents clients clients on general corporate matters, corporate restructurings as well in litigation proceedings. as on transaction finance and general contract matters (e.g. joint ventures, partnerships and shareholders’ agreements), relocation and migration projects, and all directly related areas such as employment matters for key employees (e.g. employee participation and incentive agreements). In his core fields of activity he represents clients in litigation proceedings.
Bär & Karrer is a renowned Swiss law firm with more than 150 lawyers in Zurich, Geneva, Lugano and Zug. The core business is advising clients on innovative and complex transactions and representing them in litigation, arbitration and regulatory proceedings. The clients range from multinational corporations to private individuals in Switzerland and around the world. Bär & Karrer was repeatedly awarded Switzerland Law Firm of the Year by the most important international legal ranking agencies in recent years. Almost all leading private equity funds active in Switzerland form part of our client basis. ■ 2016, 2015 and 2014 Mergermarket European M&A Awards. ■ 2016, 2013 and 2012 Chambers Awards. ■ 2016, 2015 and 2014 The Legal 500 (“most recommended law firm in Switzerland”). ■ 2016 Trophées du Droit. ■ 2015 and 2014 IFLR Awards. ■ 2015, 2014, 2013, 2011, 2010 The Lawyer European Awards. ■ 2015 Citywealth Magic Circle Awards (“Law firm of the Year - EMEA”). ■ 2014 Citywealth International Financial Centre Awards.
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United Kingdom Lorenzo Corte
Skadden, Arps, Slate, Meagher & Flom LLP Sandro de Bernardini
Topco would frequently take the form of an offshore vehicle, 1 Overview commonly UK tax resident. Bidco’s primary role is to acquire and hold the target’s shares and 1.1 What are the most common types of private equity it may also act as borrower under the debt facilities. For tax and/or transactions in your jurisdiction? What is the current financing-related purposes (including avoiding shareholders needing state of the market for these transactions? Have to enter into intercreditor agreements), it is common to have one or you seen any changes in the types of private equity transactions being implemented in the last two to more intermediate holding companies inserted between Topco and three years? Bidco. For inbound investments, Bidco is typically a private limited liability A broad range of private equity (“PE”) transactions are carried company resident for tax purposes in the UK. Non-UK tax resident out in the United Kingdom (“UK”), among the most common are Bidcos have historically been common for certain asset classes leveraged buyouts, refinancings, flotations and follow-on sales, (particularly property related investments) although the market may trade sales, secondary buyouts and bolt-on deals. change in that regard in light of current UK tax authority consultations A degree of uncertainty at a macroeconomic level (compounded by on bringing non-resident companies holding interests in UK political upheaval due to Brexit and the US Elections and ongoing residential real estate into corporation tax and in light of the outcomes structural issues in the Eurozone) have affected the UK PE market and implementation of the OECD’s BEPS project. The jurisdiction in 2016. Deal value and numbers were down from 2015 – levels of incorporation of Bidco can vary based on the desired corporate of exits also went down and, on the buy-side, PE houses suffered flexibility and may be onshore or offshore – many PE investments from lofty purchase price multiples and competition from strategic prefer non-English incorporated companies as there is a 0.5% UK acquirers ripe with cash and seeking growth opportunities. stamp duty on share transfers in English incorporated companies.
1.2 What are the most significant factors or developments 2.2 What are the main drivers for these acquisition encouraging or inhibiting private equity transactions structures? in your jurisdiction? There are a number of factors which affect the acquisition The UK is a free market economy, which is particularly welcoming structure adopted in PE transactions. These drivers include: (i) to businesses. It has a well-established legal system and enduring the tax requirements, capacity and sensitivities of the PE sponsor, political stability offers reliability and comfort to investors. It is management and target (see also section 9 below); (ii) the finance yet unclear how this landscape will be affected, or even reshaped providers’ requirements; and (iii) the expected profile of investor by Brexit. The Government may enact measures to off-set some returns. In recent times, we have seen investors taking a more pro- of the perceived pitfalls of Brexit or implement other measures to active approach in seeking to influence the choice of structure. strengthen London as a business hub. It will be crucial that stability continues and that the UK remains able to attract and retain talent. 2.3 How is the equity commonly structured in private equity transactions in your jurisdiction (including institutional, management and carried interests)? 2 Structuring Matters PE investors typically use small proportions of equity finance to 2.1 What are the most common acquisition structures subscribe for ordinary or preferred ordinary shares in Topco. The adopted for private equity transactions in your balance is generally invested as shareholder loans (often structured jurisdiction? Have new structures increasingly as payment-in-kind loan notes issued by Topco), preference shares or developed (e.g. minority investments)? offshore hybrid instruments (such as Luxembourg-preferred equity certificates). These shares and other instruments are together known PE transactions are usually structured using a holding company as the “institutional strip”. Management will generally subscribe for (“Topco”) and an indirect wholly-owned subsidiary of Topco ordinary shares in Topco representing between 5% and 15% (save (“Bidco”). Topco is commonly owned by the PE fund and for in very large buyouts where this may be less), commonly referred management, as majority and minority shareholders, respectively. to as “sweet equity”. In some buyouts, key senior management
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with sufficient funds to do so may also be permitted (or, in most take minority positions. However, where they have, the structuring instances, required) to invest in the institutional strip. considerations are generally the same – there may just be competing Senior management are usually expected to make sufficient financial structuring interests between the minority private equity investor investment in the target group to ensure their interests remain and the controlling investor. aligned with the PE investor and that they remain incentivised to create further value – the amount of this investment typically varies depending on whether the deal is the first investment by management 3 Governance Matters or a secondary buyout. Other key personnel may be invited to participate in management 3.1 What are the typical governance arrangements incentive plans or to become additional employee shareholders. for private equity portfolio companies? Are such Carried interest (a share of the fund’s overall profits) is typically arrangements required to be made publicly available in your jurisdiction? structured through a limited partnership, with executives or their United Kingdom vehicles as limited partners. The carried interest limited partnership is, in turn, often a special limited partner in the fund limited PE sponsors and management will typically enter into a shareholders’ partnership. It is typically calculated on a whole-of-fund basis (i.e. agreement to govern their relations as shareholders in the portfolio the entitlement arises after investors have received a return of their company. This will likely include, among other provisions: (i) drawn-down capital, plus any preferred return accrued and if certain covenants from management with regard to the conduct of the other pre-agreed hurdles are cleared). business of the portfolio company; (ii) extensive veto rights for the PE sponsor; (iii) restrictions on the transfer of securities in the UK tax resident participants in the carried interest may prefer to portfolio company; and (iv) provisions regarding further issuances receive carried interest through interests falling within the terms of of shareholder equity/debt. a 2003 Memorandum of Understanding between the British Venture Capital Association and the Inland Revenue (now HM Revenue & In addition, the constitutional documents may include governance Customs) relating to carried interest. Participants based or working arrangements, particularly with regard to the transfer of shares. In in the UK will also wish to ensure that the carried interest is respected the UK, constitutional documents of UK incorporated companies as such and is not recharacterised as income-based or otherwise as a are publicly available, so many PE sponsors prefer to keep sensitive disguised investment management fee (see section 9 below). information in the shareholders’ agreement.
2.4 What are the main drivers for these equity structures? 3.2 Do private equity investors and/or their director nominees typically enjoy significant veto rights over major corporate actions (such as acquisitions and Management incentivisation, structural subordination of equity disposals, litigation, indebtedness, changing the and investor financing, ease of return of funds to investors, and tax nature of the business, business plans and strategy, considerations (see question 9.1 below) generally feature as main etc.)? If a private equity investor takes a minority drivers for these structures. position, what veto rights would they typically enjoy?
2.5 In relation to management equity, what are the typical PE investors normally enjoy significant veto rights over major vesting and compulsory acquisition provisions? corporate, commercial and financial matters, although thresholds are commonly set to ensure that day-to-day decisions can be taken Transaction documents will invariably include provisions enabling the by management. PE fund to compulsorily acquire a manager’s shares on termination of These veto rights will typically be split between director veto rights his/her employment with the relevant portfolio company. and shareholder veto rights. Provisions may be included enabling Documentation will usually include good leaver/bad leaver director veto rights to be elevated to shareholder veto rights where, for provisions, which will determine the amount payable to the departing example, concerns arise as to directors’ duties and conflicts of interest. manager. These provisions come in many forms but will frequently If private equity investors take a minority position, whilst having define “good leaver” by reference to specific circumstances (death/ customary “corporate-related” veto rights, they sometimes also disability, retirement over statutory retirement age, long-term negotiate a set of “business-related” protections (so-called “reserved illness, termination without cause, etc.) with all other circumstances matters”), depending on the level of their minority interest. constituting a “bad leaver”. A “good leaver” will commonly obtain the higher of cost and, subject 3.3 Are there any limitations on the effectiveness of veto to vesting provisions, fair market value for his shares while a “bad arrangements: (i) at the shareholder level; and (ii) leaver” may expect to receive the lower of fair market value and cost. at the director nominee level? If so, how are these The relevant documentation may also include vesting provisions typically addressed? that will regulate the proportion of shares for which the departing employee will be entitled to the “good leaver” price (i.e. higher of Veto rights will generally be respected by English courts, but may be cost and fair market value) by reference to the length of the period found to be void if they constitute an unlawful fetter on any statutory from buyout to termination. Vesting may be straight-line or stepped powers of an English company or are contrary to public policy. and full vesting may typically occur after a period of between three Generally, appropriate structures can be put in place to ensure and five years, although the lengthening of investment holding that customary veto rights are effective. More often than not, if a periods is likely to stretch vesting. decision is taken or transaction entered into irrespective of a veto, redress will be in the form of compensation/damages as opposed 2.6 If a private equity investor is taking a minority position, to injunctive relief or specific performance since absent provisions are there different structuring considerations? in the articles and given the principle of ostensible authority, such decision or transaction will stand. Generally in the UK, it is relatively rare for private investors to
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A shareholders’ agreement is likely to be entered into to ensure that as directors, including in particular that they are not disqualified agreed veto arrangements would be upheld at the shareholder level. by statute (e.g. under the Company Directors Disqualification Act Such an agreement may also obligate the shareholders to procure 1986, by being an undischarged bankrupt). that certain actions are taken (or not taken) by the relevant target In the context of being entitled to nominate directors, PE investors group companies. ought to be aware that, in certain circumstances, they may be construed as “shadow directors” under s. 251 Companies Act 2006 3.4 Are there any duties owed by a private equity investor (“CA”), if the nominee directors are accustomed to act according to minority shareholders such as management to the directions and instructions of the PE fund. If construed as shareholders (or vice versa)? If so, how are these shadow directors, the PE investor would be treated as a director of typically addressed? the portfolio company and directors’ duties would apply to it. Nominated directors risk incurring liabilities if they breach their Unless voluntarily assumed by a PE sponsor, the PE investor itself is directors’ duties (including their statutory duties under ss. 170–178 United Kingdom not subject to fiduciary or other duties under English company law to CA) and may face the risk of clawback action for certain decisions the minority shareholders (but see question 3.6 below for potential made during certain periods of time if the company is insolvent or liability as shadow director). Board nominees generally owe duties verging on insolvency. to the company, but may, in limited circumstances, owe duties to PE investors will typically seek to mitigate the impact of the above shareholders (for example, regarding information disclosure). risks through (i) indemnities from the portfolio companies (subject Certain duties may also be owed if: (i) the portfolio company is to certain limitations under the CA), and (ii) directors’ and officers’ insolvent or verging on insolvency; or (ii) if a specific special insurance policies (at both the portfolio company and PE sponsor relationship (for example, principal and agent) is established level). between the nominee directors and the shareholders. Shareholders may be entitled to (i) bring derivative actions on 3.7 How do directors nominated by private equity behalf of the company against the nominee directors (often as a last investors deal with actual and potential conflicts of resort), or (ii) commence an unfair prejudice petition if the affairs interest arising from (i) their relationship with the of a UK company are being, or have been, conducted in a manner party nominating them, and (ii) positions as directors that is unfairly prejudicial to shareholders generally or one or more of other portfolio companies? shareholders – both are relatively rare (especially in a PE context). Such directors must be mindful that, although they are nominee 3.5 Are there any limitations or restrictions on the directors, their duties are generally owed to the company itself and contents or enforceability of shareholder agreements not to the party nominating them or other shareholders. (including (i) governing law and jurisdiction, and (ii) The CA (s. 175) imposes a duty on a director to “avoid a situation in non-compete and non-solicit provisions)? which he has, or can have, a direct or indirect interest that conflicts, or possibly may conflict, with the interests of the company”. This Subject to customary legal reservations and save to the extent that applies to “situations” rather than a conflict of interest arising in they contravene statute or are contrary to public policy, a well relation to a transaction or arrangement with the company (which drafted shareholders’ agreement in relation to a UK company will are governed by separate sections of the CA). Such an actual or generally be respected. However, if the group structure includes potential conflict of interest may arise, for example, with respect to companies from other jurisdictions, the impact of the laws of those (i) the nominating PE sponsor, or (ii) the directors’ other directorial jurisdictions will need to be considered. positions. Certain provisions in the shareholders’ agreement will require careful Where such a conflict exists, the duty to avoid conflicts of interest consideration to ensure that they are enforceable – for example: will not be infringed if the matter has been authorised by the (a) subject to the (i) Rome I Regulation on the law applicable directors, and, accordingly, appropriate authorisations should be put to contractual obligations ((EC) 593/2008), and (ii) Rome in place at the earliest opportunity. The constitutional documents of II Regulation on the law applicable to non-contractual the company should be checked to ensure the directors are able to obligations ((EC) 864/2007), a well-drafted governing law provide such authorisation. and jurisdiction provision will generally be respected; and In addition to the duty under s. 175 CA referred to above, directors (b) driven by public policy, non-compete/non-solicit provisions are required to declare their interests in transactions or arrangements must be reasonable – this will be assessed in the context of all the relevant circumstances and the focus should be ongoing which are proposed but have not yet been entered into by the company no further than is required in order to protect the legitimate (s. 177 CA) and in relation to existing transactions or arrangements interests of the PE sponsor and its investment in the portfolio that the company has already entered into (s. 182 CA). company. The ability for a director to participate in the decision-making process with regard to any transaction in which he has declared an 3.6 Are there any legal restrictions or other requirements interest will be governed by the company’s articles of association. A that a private equity investor should be aware of director will not be in breach of the general duty under s. 177 CA to in appointing its nominees to boards of portfolio declare an interest in a proposed transaction if he acts in accordance companies? What are the key potential risks and with any provisions of the company’s articles dealing with conflicts. liabilities for (i) directors nominated by private equity S. 185 CA permits a general notice to be given in relation to investors to portfolio company boards, and (ii) private equity investors that nominate directors to boards conflicts in certain circumstances, thereby avoiding the need to give of portfolio companies under corporate law and also repeated notices where the conflict arises from the same facts or more generally under other applicable laws (see circumstances. section 10 below)?
PE investors must ensure that nominee directors are eligible to act
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4 Transaction Terms: General 5.2 Are break-up fees available in your jurisdiction in relation to public acquisitions? If not, what other arrangements are available, e.g. to cover aborted deal 4.1 What are the major issues impacting the timetable for costs? If so, are such arrangements frequently agreed transactions in your jurisdiction, including competition and what is the general range of such break-up fees? and other regulatory approval requirements, disclosure obligations and financing issues? As a general rule, “offer-related arrangements”, including break fees, inducement fees or other arrangements having a similar or The timing for transactions is largely affected by regulatory comparable effect are not allowed in relation to public acquisitions approvals (mainly competition and sector-specific approvals) and pursuant to the Takeover Code. Nevertheless, the Panel on the preparation of financials (particularly given the prevalence of Takeovers and Mergers will normally allow break fees in limited locked-box-pricing mechanisms in PE transactions (see question circumstances; including where: (i) a non-recommended offer has United Kingdom 6.1 below)). Another important factor is whether the transaction is been announced and an inducement fee is payable to a white knight run as an auction with multiple potential buyers or on an exclusive as long as it does not exceed 1% of the target’s value; and (ii) the basis. The former tend to be quicker given the tension created by the target announced a formal sale process (and the fee is subject to the auction itself and the seller’s ability to impose terms. 1% cap) or is in financial distress and is seeking a bidder.
4.2 Have there been any discernible trends in transaction terms over recent years? 6 Transaction Terms: Private Acquisitions
The M&A landscape remains generally favourable to PE sellers 6.1 What consideration structures are typically preferred in the UK. Recent trends include: (i) the continuing prevalence of by private equity investors (i) on the sell-side, and (ii) the “locked-box” consideration structure; (ii) an increase in deals on the buy-side, in your jurisdiction? involving warranty and indemnity insurance; (iii) continuing limited warranty protection from PE sellers; and (iv) reducing limitation “Locked-box” structures are generally preferred by PE sellers as of liability periods. That said, PE ability to follow these trends, they offer certainty in the purchase price from the outset (since especially as regards limiting their liability, is becoming more there is no adjustment), greater control over financial information, and more a function of their bargaining power, which in turn is a potentially reduced contractual liability, cost savings and prompt reflection of the asset for sale. distribution of sale proceeds to investors/sellers after completion. The buyer will be compensated for any “leakage” of value from the 5 Transaction Terms: Public target group following the “locked-box date” save to the extent the Acquisitions parties agree such leakage is to be treated as “permitted”. Other consideration structures commonly used may involve adjustments by reference to working capital and net debt. These 5.1 What particular features and/or challenges apply to structures rely on accounts drawn up shortly after completion with private equity investors involved in public-to-private respect to financials at completion and adjustments are then made to transactions (and their financing) and how are these the purchase price based on deviations of working capital and net commonly dealt with? debt at completion from relevant, pre-agreed target figures.
In public-to-private transactions involving UK companies, the City In some instances, there is an escrow account for a short period Code on Takeovers and Mergers (“Takeover Code”) will usually following completion which is available for payment of any apply, imposing restrictions and rules that must be complied with “leakage” or price adjustment claims. throughout the transaction (and which are more restrictive than private transactions). 6.2 What is the typical package of warranties/indemnities Recent changes to the Takeover Code in particular that may impact offered by a private equity seller and its management team to a buyer? PE buyers include: (i) significantly increased obligations with respect to disclosure of financing arrangements (including their publication on websites); (ii) the imposition of a strict timetable for A PE seller usually only provides warranties regarding title to its the announcement of offers under the “PUSU” regime (requiring the own shares, capacity and authority. announcement of a firm offer to make a bid within a 28-day period The target’s management will often (subject to their percentage (unless the Panel on Takeovers and Mergers grants an extension) ownership and on the basis they are usually better placed to) in specified circumstances (e.g. where there has been aleak provide business warranties, under a separate management warranty followed by an announcement identifying the potential bidder)). In deed. The key rationale for the warranties is generally to elicit full the context of a private equity leveraged transaction it may be a disclosure regarding the target during the due diligence process, challenge to arrange financing so as to achieve the necessary “certain although increasingly (as discussed below) the negotiated warranty funds” within such 28-day period; (iii) the abolition of break fees in package may form the basis for warranty and indemnity insurance most cases (see question 5.2 below) reduces PE sponsors’ ability protection. to recover costs (including due diligence costs) of preparing for a bid; and (iv) the inability (in most cases) to achieve “preferred” or 6.3 What is the typical scope of other covenants, “exclusive” bidder status, again exposing PE houses to potential undertakings and indemnities provided by a private costs that cannot be recovered from the target. equity seller and its management team to a buyer? Some of these issues are discussed further in The International Comparative Legal Guide to: Mergers & Acquisitions 2016 in the A PE seller will usually provide pre-completion undertakings chapter entitled “Divergence / A Game of Two Halves?” in relation to no-leakage (in a locked-box pricing structure) and
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assistance with regulatory filings and, in some cases, undertakings regarding the conduct of the target business pre-completion 6.6 Do (i) private equity sellers provide security (e.g. (although frequently limited to exercise of voting in a manner escrow accounts) for any warranties / liabilities, and (ii) private equity buyers insist on any security for aimed at achieving such outcome rather than an absolute procure warranties / liabilities (including any obtained from covenant). Indemnities continue to be a rarity, although not the management team)? unheard of in respect of specific events/circumstances of significant magnitude. Private equity sellers do not generally provide security for any A PE seller is very unlikely to provide non-solicit/non-compete warranties/liabilities – this is generally because (i) they only provide covenants, but these may be provided by members of management title, capacity and authority warranties (where the risk of claim is who are exiting the target business. generally considered low by buyers) and the relatively short-time Management will also generally provide pre-completion undertakings period post-completion for any no-leakage/true-up payments regarding the conduct of the target business pre-completion. (although, in some instances, comfort is given by way of a small United Kingdom escrow for these liabilities), and (ii) they are focused on returning exit proceeds to their investors as soon as possible post-completion 6.4 Is warranty and indemnity insurance used to “bridge and therefore have a negative view of any bids where an escrow or the gap” where only limited warranties are given by the private equity seller and is it common for this deferred consideration mechanism is proposed. to be offered by private equity sellers as part of the On the buy-side, save for on secondary buyouts where private equity sales process? If so, what are the typical (i) excesses houses will agree a package with continuing management that / policy limits, and (ii) carve-outs / exclusions from typically covers (i) a management warranty deed, and (ii) incentive/ such warranty and indemnity insurance policies? equity arrangements moving forward, private equity houses tend to act like any other purchaser in wanting to ensure that there is Yes; buyer warranty and indemnity insurance policies are an meaningful recourse for warranties/covenants given by the sell-side. increasingly common tool for “bridging the gap”, and preliminary terms for buy-side insurance are commonly included by PE sellers as part of the initial sell-side transaction documentation, for buyer 6.7 How do private equity buyers typically provide and insurer to agree during negotiation of the sale and purchase comfort as to the availability of (i) debt finance, and (ii) equity finance? What rights of enforcement documentation. do sellers typically obtain if commitments to, or These will typically be given on the basis of a set of business obtained by, an SPV are not complied with (e.g. warranties given by management, but subject to limitations designed equity underwrite of debt funding, right to specific to ensure that the personal liability of management is limited (e.g. performance of obligations under an equity recourse may be limited to (i) a seller/management-funded escrow commitment letter, damages, etc.)? fund or retention account, or (ii) the amount of a proposed transaction bonus payable post-completion by the portfolio company). The PE sponsor usually gives a direct commitment to the seller that it will (i) call required capital from its investors and that it knows Excess and policy limits vary and is somewhat difficult to indicate of no reason why such capital would not be paid, or (ii) fund Bidco standards. It is not unusual for the excess to reflect the liability of with the equity capital committed to the transaction, either way is management (such that the buyer recovers under the insurance only subject only to the satisfaction of the conditions in the share purchase after the liability of management is exceeded). Cap depends on the agreement and “certain funds” debt financing being available. The size of the transaction and the premium payable. latter for commitment offering greater assurance to a seller and becoming more common in practice. This commitment letter will 6.5 What limitations will typically apply to the liability of also include certain commitments from the PE sponsor aimed a private equity seller and management team under at ensuring that BidCo draws down the requisite funds under the warranties, covenants, indemnities and undertakings? “certain funds” debt financing in order to complete the transaction. The seller can generally enforce this commitment directly against On the basis that a PE seller’s warranties will generally be limited the PE fund to the extent it becomes unconditional and the PE fund to title, capacity and authority, a PE seller’s warranties are usually fails to fund Bidco. If the banks under the “certain funds” debt either subject to a cap equal to the aggregate purchase price, or financing do not fund when they are legally required to, thePE uncapped. sponsor may be required to take certain steps to enforce against the Liability under any “no-leakage” covenant will generally be banks and/or use reasonable endeavours to obtain alternative debt uncapped, given that a leakage claim is restitution in nature (the financing. This does not usually extend to the PE sponsor being recipient is dropping back in what should not have leaked). required to fund such amounts from equity, i.e. there is not typically Managers can limit their liability under the warranties by: (i) giving an equity underwrite of the debt funding. them severally (each manager is only liable for its proportionate share of liability for any claim and/or its own breach) and subject to 6.8 Are reverse break fees prevalent in private equity awareness (as is common); and (ii) capping maximum liability for transactions to limit private equity buyers’ exposure? any warranty claims (it is common for managers to cap at a portion If so, what terms are typical? (significant enough to ensure they have skin in the game) of their take-home proceeds). Reverse break fees are relatively unusual in private equity In a transaction including warranty and indemnity insurance, the cap transactions in the UK, and certainly less prevalent than in certain on management liability for warranties may be set at the level of the other jurisdictions, including the USA. insurance deductible. General limitations include time limits within which claims may be brought, a de minimis threshold and, sometimes, culpability.
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it retains, with no ability to sell if the market begins to turn or the 7 Transaction Terms: IPOs company’s performance declines.
7.1 What particular features and/or challenges should a 7.3 Do private equity sellers generally pursue a dual-track private equity seller be aware of in considering an IPO exit process? If so, (i) how late in the process are exit? private equity sellers continuing to run the dual-track, and (ii) were more dual-track deals ultimately realised There are a number of key issues which need to be considered by PE through a sale or IPO? sellers considering an IPO exit, including the following: Market risk – unlike certain other PE exit routes, PE sellers are In 2016, a number of exits were run as dual-track processes – exposed to market risk when looking to access institutional investor albeit, most ended up being realised via sales (i) for some of the capital through an IPO process. Sellers can look to mitigate this risk reasons noted in question 7.1 regarding the ability to realise value United Kingdom by commencing a pre-marketing campaign earlier in the deal timeline immediately and avoid market risk post-IPO, and (ii) with equity to try and secure a successful outcome (equally, however, this means capital markets being relatively soft. that if there is a need to postpone the transaction for whatever reason, In some instances, the IPO track was aborted very later in the it can be seen as a more significant failure by the investor community). process on or about the time of the issuance of “intention to float” Lock-ups/selling restrictions – PE sellers may not be able to dispose announcements. On top of wanting to keep all options opened, of their stake in the business completely at the time of the IPO (in sometimes the dual-track continues until late as a means to keep fact, in most instances, it will be highly unlikely given the value competitive tension among bidders high. of portfolio companies generally floated). The PE sellers may be subject to a lock-up period of between six to 12 months during which 8 Financing they would be unable to sell some, or all, of their stake in the business without the consent of the company and its investment bank to prevent detrimental effects on the valuation of the company immediately after 8.1 Please outline the most common sources of debt the IPO. As such, there would be a delay between the time of the IPO finance used to fund private equity transactions in and the time at which the PE fund would fully realise its investment, your jurisdiction and provide an overview of the exposing the PE fund to adverse price movements between the IPO current state of the finance market in your jurisdiction and the final cash realisation. PE sellers may also be subject to a for such debt (particularly the market for high yield bonds). further orderly market period of up to 12 months following the end of the lock-up period. Please see the response to question 7.2 below Traditional bank-led leveraged loan financing remains the most for further commentary on the duration of lock-ups. common source of debt finance used to fund both mid-market and Contractual obligations relating to IPO – the PE seller will be large PE transactions in the UK. required to be a party to the underwriting agreement entered into However, in recent years, there has been increasing competition with the investment banks underwriting the IPO. The PE seller will between traditional bank lenders and non-bank (or “alternative”) be expected to give a suite of representations and warranties to the lenders for mid-market PE transactions, with funding increasingly banks as to a range of matters relating to itself and the shares it being sought from alternative sources such as direct lending funds owns and, to a more limited extent, the company being floated and and other institutional investors. Participants in mid-market its business. It will also be expected to give the underwriting banks transactions have also increasingly looked to implement “unitranche” a broad transaction indemnity covering any losses they may incur in financing structures, pursuant to which traditional senior and junior connection with the transaction. debt tranches are replaced by a single tranche term facility carrying a Corporate governance – on IPO, depending on the listing venue, single, blended rate of interest. Other debt instruments, such as PIK companies are often required to adopt a particular corporate (“payment-in-kind”) or convertible debt, remains a small portion of governance framework. Therefore, whilst the PE seller may have the overall financing provided by third-party lenders. enjoyed contractual rights to board representation and other matters For larger PE transactions, leveraged loans are often structured as prior to IPO, these are likely to be significantly constrained on a term loan B (or “TLB”) – a non-amortising, senior secured term completion of the IPO (please see further the response to question loan. Investors in TLB include a mix of traditional bank lenders and 7.3 below). Where a PE seller retains a significant shareholding institutional investors. post-IPO (e.g., more than 30%), the PE seller may also be required to enter into a relationship agreement containing provisions to Aside from leveraged loan financing, high-yield bond financing ensure the independence of the company. remains an important source of funds and is commonly used alongside traditional senior secured bank loans. Cost and timing – the costs of an IPO may be significantly higher than a typical sale, primarily as a result of underwriting fees. In A key theme in the UK leveraged finance market in recent years addition, an IPO typically requires at least six months from inception – and a function of the increased appetite of institutional investors to float, as the company’s group will need to be prepared for the (who traditionally invested in high-yield bonds) for leveraged loans public market. – has been the convergence of the terms of English law leveraged loans with both high-yield bonds and U.S. leveraged loans. This has led to a general loosening of covenants in English law leveraged 7.2 What customary lock-ups would be imposed on loans, with the market becoming more accepting of “covenant- private equity sellers on an IPO exit? loose” structures (that is, where the relevant loan agreement contains only a single on-going or maintenance financial covenant, usually The duration of the lock-up provided by the PE seller will vary from a leverage ratio) and, for certain stronger borrowers, “covenant- transaction to transaction, but is typically for a period of six months lite” structures (that is, where the loan agreement contains no following IPO. As a result, the PE seller will be exposed to market maintenance financial covenants). risk for the duration of the lock-up period in respect of any stock
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Maximising the overall efficiency of cash drawn from investors and 8.2 Are there any relevant legal requirements or external financing providers is generally also a key consideration; restrictions impacting the nature or structure of deductions for finance costs in respect of shareholder debt in particular the debt financing (or any particular type of debt can be vulnerable to challenge under thin capitalisation principles financing) of private equity transactions? or specific anti-erosion measures such as the UK anti-hybrid rules introduced with effect from 1 January 2017 and interest barrier There are no particular legal requirements or restrictions that would limitations expected to take effect from 1 April 2017, that may restrict affect the choice or structure of debt financing of PE transactions in interest deductions to 30% of EBITDA. the UK generally, although practical deal concerns play an obviously important role in dictating the ultimate financing structure. For Management will strongly prefer to plan for low (or no) taxes example, some PE funds have valued the lighter disclosure on acquisition, (including in a secondary transaction by way of requirements of a TLB or leveraged bank loan as compared to a rollover reliefs). This is facilitated in practice for structures falling high-yield bond issuance (which requires the preparation of, within certain Memoranda of Understanding agreed by the UK tax United Kingdom amongst other things, a detailed offering memorandum). Further, authorities. Management will often wish to achieve the lowest in an acquisition context, another advantage of a loan (rather than a available rates on exit, being generally 28% for gains derived from high-yield bond issuance) is that loans can typically be documented carried interest (see question 9.3 below). It is essential to consider and executed on a much shorter timetable that is more aligned with planning exit scenarios from the outset. the timing constraints of the acquisition itself. With its successful Off-shore structures are not uncommon above the Bidco level. execution dependent on ever fluctuating market conditions and increased disclosure requirements, a high-yield bond issuance, on 9.2 What are the key tax considerations for management the other hand, must typically either be bridged by a loan or funded teams that are selling and/or rolling-over part of their into an escrow arrangement if being used to finance an acquisition. investment into a new acquisition structure? Aside from such practical concerns, market participants should be aware of, and ensure compliance with, any industry-specific laws As mentioned above, rollover or reorganisation reliefs are available and regulations, as well as the broader regulatory regime affecting although complex to implement and achieve. As such, rulings may private equity transactions. be required. However, it should be noted that valuation rulings are For example, in the current sensitive political and regulatory no longer available. climate, market participants need to be especially careful in regards to compliance with anti-bribery, corruption and sanctions 9.3 What are the key tax-efficient arrangements that are laws. Aside from local laws, borrowers and sponsors should also typically considered by management teams in private be aware of the expansive nature and potential extraterritorial equity portfolio companies (such as growth shares, reach of such laws and regulations in the United States, which can deferred / vesting arrangements, “entrepreneurs’ necessitate compliance by many non-U.S. entities (or entities that relief” or “employee shareholder status” in the UK)? have only limited U.S. ties). Growth shares and deferred/vesting arrangements remain relevant in In the context of public buyout transactions in the UK involving debt the UK. Growth shares are very popular either through low value grants finance, a key issue will be to ensure compliance with the “certain of shares on Day 1 or “joint share ownership plans”. “Entrepreneurs’ funds” and cash confirmation requirements of the Takeover Code. relief” is no longer accessible in respect of carried interest. These principles require that a bidder have the funds and resources in place to finance a proposed acquisition, prior to the public The introduction of the “disguised investment management fee” announcement of any bid (and the bidder’s financial advisor must (DIMF) rules and associated legislation in relation to the capital confirm the availability of such funds). In practical terms, this means gains tax or income tax treatment of proceeds deriving from carried that the bidder and its lenders will need to finalise and have executed interest during 2015 and 2016 will mean in practice that the lowest the required loan documentation (and satisfy, subject to limited headline tax rate applicable to carried interest is 28%. Higher rates exceptions, the conditions precedent to the loan) at the bid stage. may be relevant (including the various dividend rates and marginal income tax rates) if the carried interest is received in a form that is not The “certain funds” concept has also increasingly permeated and capital on general principles (e.g. dividends or interest) or is deemed become a feature of private buyout transactions. Although not a to be income under the DIMF or income-based carried interest rules. legal requirement in this context, in practical terms, this means that in certain private buyout transactions, lenders will be required to confirm upfront the satisfaction of all of their financing conditions 9.4 Have there been any significant changes in tax and agree to disapply loan drawstop events (other than certain legislation or the practices of tax authorities limited exceptions) until after completion of the acquisition. (including in relation to tax rulings or clearances) impacting private equity investors, management teams or private equity transactions and are any 9 Tax Matters anticipated?
The introduction of the diverted profits tax in Finance Act 2015, 9.1 What are the key tax considerations for private equity of the anti-hybrid rules in Finance Act 2016 and the anticipated investors and transactions in your jurisdiction? Are introduction of the interest barrier rules once Finance Bill 2017 off-shore structures common? becomes law may result in a decrease in the overall ease of use or efficiency of certain portfolio company structures, including certain One of the more material tax considerations from an investor’s OpCo/PropCo arrangements and arrangements reliant on significant perspective is the reduction or elimination of withholding tax costs interest costs or hybrid instruments or entities to reduce the effective on flows of cash back from the portfolio companies to the PE fund, tax rate. whether in the form of dividends (if any), interest and principal payments or on exit.
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Anti-avoidance measures preventing certain economic or value allocations (referred to as disguised investment management fees) 10.4 Has anti-bribery or anti-corruption legislation to investment managers have also been introduced in the form of impacted private equity investment and/or investors’ approach to private equity transactions (e.g. the DIMF rules. These measures are not intended to cover genuine diligence, contractual protection, etc.)? carried interest allocations or returns on co-investment and are not expected to have an impact on arrangements for external investors. PE sellers are increasingly concerned with compliance with However, new rules introduced to complement the DIMF rules have anti-corruption/bribery legislation principles, particularly given also restricted the efficiency of carried interest by limiting non-UK increasing regulatory scrutiny of corporate conduct and potentially situs of the carried interest, removing “base cost shift” planning, and significant financial penalties and reputational damage resulting restricting capital gains treatment to fund carry where (broadly) the from non-compliance. This trend has been reflected in transaction investment horizon or average is greater than 40 months. terms by a general extension of buyers’ contractual protection Recently announced changes on recoverability of VAT by investment against target groups’ non-compliance with laws and regulations. United Kingdom funds and their managers, and the eligibility of holding companies to register as part of a VAT group may also impact the tax profile of 10.5 Are there any circumstances in which: (i) a private both the target group, of investors and of management in the UK equity investor may be held liable for the liabilities of fund management sector. the underlying portfolio companies (including due to breach of applicable laws by the portfolio companies); and (ii) one portfolio company may be held liable for 10 Legal and Regulatory Matters the liabilities of another portfolio company?
Generally, an English court will not “pierce the corporate veil” so 10.1 What are the key laws and regulations affecting private equity investors and transactions in your as to impose liability on a shareholder for the underlying activities/ jurisdiction, including those that impact private equity liabilities of its subsidiary/investee company. However, there are a transactions differently to other types of transaction? number of specific instances in which a PE sponsor and its directors, officers or employees may be held liable for its portfolio company’s PE investors and transactions are subject to a broad array of UK actions or omissions, including: (i) a sponsor could incur liability statutes applicable in the context of corporate transactions. Key under EU “parental liability” doctrine, which presumes liability of legislation includes the Companies Act 2006, the Financial Services the sponsor on a joint and several basis with its portfolio company and Markets Act 2000, the Bribery Act 2010, the Takeover Code for any breach of EU antitrust law by the latter, where the sponsor has (in the context of public-to-private transactions), and various full or decisive influence over the portfolio company’s commercial taxation statutes. In addition, the Alternative Investment Fund conduct; and (ii) a sponsor could incur Bribery Act liability for Managers Directive (the “AIFMD”) has imposed specific additional failing to implement adequate procedures for its portfolio company. regulations on PE investors (see question 10.2 below). 11 Other Useful Facts 10.2 Have there been any significant legal and/or regulatory developments over recent years impacting private equity investors or transactions and are any 11.1 What other factors commonly give rise to concerns anticipated? for private equity investors in your jurisdiction or should such investors otherwise be aware of in Private equity funds that are managed from or marketed within considering an investment in your jurisdiction? EU Member States will generally be subject to some, or all, of the rules and regulations promulgated by the AIFMD. In relation While the UK has historically provided an economically attractive to private equity transactions, these rules impose specific disclosure venue for private equity investment, the private equity industry, requirements in relation to portfolio companies and restrictions on the remuneration and returns for its investors and executives are ability of private equity fund buyers to release assets from portfolio increasingly scrutinised and subject to potentially adverse legislative companies (the so-called “asset-stripping” rules). Clearly this is an change. The implementation in practice of changes to the UK tax area that may be impacted by Brexit, although it is reasonable to regime (see also question 9.4 above) are being monitored by PE predict that pan-European funds may continue to comply regardless. sponsors and may impact the manner in which deals are structured (particularly in relation to interest deductibility).
10.3 How detailed is the legal due diligence (including compliance) conducted by private equity investors Acknowledgment prior to any acquisitions (e.g. typical timeframes, materiality, scope etc.)? Do private equity investors The authors would like to acknowledge the contribution of Skadden engage outside counsel / professionals to conduct all tax partner Alex Jupp to the drafting of this chapter. legal / compliance due diligence or is any conducted in-house?
PE sponsors typically conduct relatively detailed legal due diligence – this includes compliance due diligence. Whilst detailed, as the overall scope must be sufficient to satisfy its debt financiers, they tend to be focused on the key issues and subject to sensible materiality thresholds. Legal due diligence is typically conducted by third-party advisers and reliance on such due diligence reports given to the PE sponsor, BidCo and BidCo’s debt financiers.
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Lorenzo Corte Sandro de Bernardini Skadden, Arps, Slate, Meagher & Flom LLP Skadden, Arps, Slate, Meagher & Flom LLP 40 Bank Street 40 Bank Street Canary Wharf Canary Wharf London, E14 5DS London, E14 5DS United Kingdom United Kingdom
Tel: +44 20 7519 7025 Tel: +44 20 7519 7108 Fax: +44 20 7519 7025 Fax: +44 20 7072 7108 Email: [email protected] Email: [email protected] URL: www.skadden.com URL: www.skadden.com
Lorenzo Corte is a corporate partner in Skadden’s London office. Sandro de Bernardini is a partner based in Skadden’s London office. He regularly acts for private equity investors on their investments He focuses on cross-border mergers and acquisitions, private equity,
and divestments, including LetterOne Holdings S.A., for which he real estate and corporate finance transactions. He has represented United Kingdom has completed a number of transactions in the technology sector a variety of companies in several industries in connection with cross- (including investments in Uber and Freedompop) and the energy border acquisitions and disposals, auction sales and multijurisdictional sector (including the US$7.1 billion acquisition of RWE Dea AG from restructurings. Mr. de Bernardini also has worked for private equity RWE AG, the subsequent sale of Dea UK and the acquisition of E.On firms, attending to all aspects of their business, from formation to Norge); as well as Doughty Hanson and Ares Life Sciences. portfolio acquisition and management to refinancing and exit. In 2015, he was named by the Financial News as one of its 40 Under 40 Mr. Corte lectures and participates in seminars related to his practice Rising Stars in Legal Services. Mr. de Bernardini also is a member of and is an adjunct professor in M&A at Ohio State University School of Skadden’s award-winning Italian desk, which has been recognised as Law. He is recommended as a leading individual in Chambers Global, Law Firm of the Year/Italy Desk for 2015 by Premio Le Fonti, Law Firm Chambers Europe and Chambers UK, which cites sources describing of the Year – Italian Commitment for 2015 by Legalcommunity, and Mr. Corte as “instrumental in devising some incredibly innovative Italy Desk of the Year by TopLegal for both 2014 and 2015. structuring” and stating “I would bet the bank on him”.
Skadden is one of the world’s leading law firms, serving clients in every major financial centre with over 1,700 lawyers in 22 locations. Our strategically positioned offices across Europe, the US and Asia allow us proximity to our clients and their operations. For almost 60 years, Skadden has provided a wide array of legal services to the corporate, industrial, financial and governmental communities around the world. Wehave represented numerous governments, many of the largest banks, including virtually all of the leading investment banks, and the major insurance and financial services companies. Skadden has one of the leading M&A practices in the world and has developed a first-rank mergers and acquisitions capability in Europe over 20 years with a focus on complex, cross-border transactions.
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USA Peter Jonathan Halasz
Schulte Roth & Zabel LLP Richard A. Presutti
Private equity buyers responded to the competitive pricing 1 Overview environment with increased creativity in acquisition structures, investments in assets outside a firm’s traditional geographic market or 1.1 What are the most common types of private equity sector, and continued reliance on longer-term investment strategies. transactions in your jurisdiction? What is the current state of the market for these transactions? Have 2.2 What are the main drivers for these acquisition you seen any changes in the types of private equity structures? transactions being implemented in the last two to three years? Asset purchase structures are often chosen for tax reasons. Buyers 2016 was a robust year for M&A, particularly for high-value often receive more favourable tax treatment in asset purchase transactions. However, a high-multiple pricing environment structures, due to a stepped-up basis in the assets. Subject to contributed to a decrease in private equity deal volume by transaction certain exceptions, the structure also allows a buyer to avoid certain value and deal count year-over-year. Total dollar-denominated deal liabilities. However, this structure often requires obtaining consents volume in U.S. private equity M&A decreased from $737 billion in to assignment of contracts. Stock purchase structures only require 2015 to $649 billion in 2016. consents for contractual change of control provisions and, in certain instances, an election can be made to treat stock purchases as asset purchases for tax purposes. In any event, every deal’s unique 1.2 What are the most significant factors or developments characteristics must be considered when apportioning liabilities encouraging or inhibiting private equity transactions among the parties and for determining a tax-efficient structure. in your jurisdiction?
The largest contributing factors to private equity deal activity in the 2.3 How is the equity commonly structured in private United States include, for buyers, the availability of debt financing equity transactions in your jurisdiction (including at attractive interest rates, and for sellers, the fact that the cash many institutional, management and carried interests)? potential strategic buyers conserved during the economic downturn is now being deployed. The private equity deal market in the United Equity structures for private equity vary, but funds traditionally States has also been supported by a global perception of economic earn a management fee and carried interest with respect to stability. As long as the United States continues to enjoy “safe- their investments. Equity-based compensation is customary in haven” status, near-term deal activity is likely to remain robust. connection with any portfolio company investment and may take the form of stock options, restricted stock, restricted stock units, profit interests and phantom partnership interests. In addition, 2 Structuring Matters private equity investors often permit or require management to re-invest a portion of the proceeds received in connection with an acquisition. Depending on the structure of the transaction, 2.1 What are the most common acquisition structures management’s re-investment or “roll over” of existing equity in a adopted for private equity transactions in your jurisdiction? Have new structures increasingly portfolio company may be accomplished without the members of developed (e.g. minority investments)? management recognising taxable income.
Private equity buyers typically acquire private companies through 2.4 What are the main drivers for these equity structures? a stock/limited liability company (“LLC”) purchase, asset purchase or reverse triangular merger structure; while public company targets While certain private equity investors have a preferred form of equity are typically purchased through either a merger or tender offer. In a awards, classification will depend on various factors, including: reverse triangular merger, the private equity buyer forms a “Newco” ■ whether the portfolio company is organised as a corporation group, which includes a holding company – into which the buyer or LLC; transfers the deal consideration – and a merger subsidiary, which ■ negotiation leverage by management; merges with and into the target, with the target surviving such merger. ■ the form of equity awards held by management in the portfolio company prior to its acquisition;
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■ the expected exit strategy of the investor; and to other investors. Typical structuring considerations likely include ■ the size of the management team receiving equity awards. a combination of: pre-emptive, tag-along and drag-along rights; restrictions or veto rights on amendments to the operating or shareholders agreement; the ability to appoint directors or observers 2.5 In relation to management equity, what are the typical to the board; and other negotiated veto rights (see question 3.2). vesting and compulsory acquisition provisions? Minority investors should seek the opinion of outside counsel to assess their exposure. In general, management will become vested in their equity awards based on continued employment (“Time-Based Awards”),
performance (“Performance-Based Awards”) or a combination of 3 Governance Matters USA both. Time-Based Awards typically become vested over a period of 3.1 What are the typical governance arrangements continuous employment of at least three to four years. Performance- for private equity portfolio companies? Are such Based Awards also become vested over a period of continuous arrangements required to be made publicly available employment, but are subject to the attainment of specified in your jurisdiction? performance goals. In each year or other performance period, a portion of the award will vest based on the achievement of Private equity investors typically own portfolio companies through annual financial goals. Such performance goals may relate to the an intermediate acquisition entity, most often an LLC, through achievement of financial goals of the portfolio company, such as which the private equity investor owns interests in, and governs, the EBITDA, or based on the attainment of specified financial returns portfolio company. Governance structures vary, but the acquisition earned by the private equity investor (e.g., IRR, multiple of capital/ entity is most commonly controlled either by a managing member money or both). Goals based on the performance of the portfolio or a board of managers. In instances where several private may be prescribed at the time of the award grant, or may be based equity investors own interests in the same portfolio company, the on annual goals set by the portfolio company’s board each year. intermediate holding company’s operating agreement may also Goals based on the specified financial returns earned by the private contain provisions governing the rights and obligations of its equity investor are ordinarily prescribed at the time of the award investors with respect to ownership and governance of the portfolio grant. In connection with the private equity investor’s sale of the company. These may include certain economic rights (e.g., rights to portfolio company (e.g., a “change in control” or “liquidity event”), distributions, rights of first refusal, drag-along rights, pre-emptive management employees generally will become vested immediately rights and tag-along rights) and rights to appoint individuals to (i.e., vesting is accelerated) in their Time-Based Awards; however, the board of managers. The portfolio company’s chief executive Performance-Based Awards might provide for accelerated vesting officer (or other officer) may sometimes be appointed to the board only if the applicable performance goals have been achieved prior of managers of the acquisition holding company. In general, to, or in connection with, the sale transaction (particularly where governance arrangements must only be made publicly available if the goals are based on the attainment of specified financial returns the portfolio company is a public reporting company. earned by the private equity investor). Portfolio companies are often incorporated entities governed A portfolio company will typically retain a right to repurchase a by boards of directors. Often, the senior officers of the portfolio management employee’s equity, even if vested, in the event of company also serve on the boards of portfolio companies, but, employment termination. The price generally depends on the reason because the sole shareholder of the portfolio company is typically for the employee’s termination. If the termination is on account of the intermediate holding company, and because the intermediate death, disability, the employee’s involuntary termination without holding company reserves the right to remove and replace the “cause” or voluntary termination for “good reason”, the purchase directors and officers of the portfolio company, effective control price typically will be the fair market value of the equity. If the over the portfolio company is vested at the intermediate holding termination is for “cause” or the employee voluntarily terminated company level. Nonetheless, day-to-day operational decisions employment without “good reason”, the employee’s equity may be are made by the officers of the portfolio company and its board forfeited, without consideration, or repurchased at the lesser of the of directors. Portfolio company directors and officers are often price, if any, paid by the employee or the current fair market value. individuals with relevant industry and management experience, The requirements of Section 409A of the U.S. Internal Revenue rather than private equity investment professionals. Code of 1986, as amended, should be considered in connection with the grant of any form of management equity award. For example, 3.2 Do private equity investors and/or their director Section 409A requires that stock options have an exercise price (or nominees typically enjoy significant veto rights over “strike price”) equal to the “fair market value” of the underlying major corporate actions (such as acquisitions and stock on the date of grant and have certain particular terms. Equity disposals, litigation, indebtedness, changing the awards in the form of “restricted stock units” or “phantom units” nature of the business, business plans and strategy, may also be subject to the requirements of Section 409A, including etc.)? If a private equity investor takes a minority strictly limiting payment or settlement of the award to pre-set position, what veto rights would they typically enjoy? triggers – death, disability, separation from service, change in control or a specified date. Private equity governance structures are generally designed to ensure that the private equity owner has ultimate control over the portfolio company and any major decision with respect thereto. In structures 2.6 If a private equity investor is taking a minority in which multiple private equity funds control interests in the same position, are there different structuring portfolio company, it is common for each private equity owner to considerations? negotiate for the veto rights over certain strategic decisions, such as the incurrence of indebtedness, sale of the company, significant Minority investors will seek to protect their economic interests, asset sales and large capital expenditures, although the specific based on the size of their stake and their bargaining position relative
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rights of private equity investors may vary widely based on deal- specific dynamics. Such veto rights are often structured to fall away 3.6 Are there any legal restrictions or other requirements if the relevant private equity owner’s interests fall below a given that a private equity investor should be aware of in appointing its nominees to boards of portfolio percentage. companies? What are the key potential risks and liabilities for (i) directors nominated by private equity 3.3 Are there any limitations on the effectiveness of veto investors to portfolio company boards, and (ii) private arrangements: (i) at the shareholder level; and (ii) equity investors that nominate directors to boards at the director nominee level? If so, how are these of portfolio companies under corporate law and also typically addressed? more generally under other applicable laws (see
USA section 10 below)? Although the internal affairs doctrine holds that rights of Generally, there are no special requirements for an investor shareholders and directors are governed by the laws of the state of nominating directors. Corporate directors owe the fiduciary duties the company’s formation, in the context of veto rights for private of care and loyalty to all shareholders (including management that equity owners (in the case of an acquisition holding structure with holds equity) of the portfolio company. Since private equity director multiple shareholders) or any individual director, such veto rights nominees are usually members, managers or employees associated are generally contractually granted, and any applicable limitations with the private equity owner, these directors also owe duties to on their effectiveness are determined by the acquisition holding the limited partner investors in the private equity fund. Conflicts company’s shareholder agreement (in the case of a corporation) of interests may arise in the context of transactions between the or operating agreement (in the case of an LLC). While corporate portfolio company and the fund. These considerations are why director fiduciary duties (subject to certain limits) must remain LLCs are typically used in lieu of corporations. unfettered, these concerns do not arise in the case of LLCs.
3.7 How do directors nominated by private equity 3.4 Are there any duties owed by a private equity investor investors deal with actual and potential conflicts of to minority shareholders such as management interest arising from (i) their relationship with the shareholders (or vice versa)? If so, how are these party nominating them, and (ii) positions as directors typically addressed? of other portfolio companies?
In the typical private equity acquisition holding company structure Pursuant to the fiduciary duty of loyalty referenced in question 3.6, discussed above, the LLC operating agreement often includes an directors must disclose conflicts of interest and must not usurp for express waiver of the fiduciary duty of care owed by the majority themselves corporate opportunities that would benefit the corporation owner to members holding minority interests. In the absence of without disclosure to the board. LLC operating agreements can a provision, there are no default fiduciary duties for LLCs in the carve out the fiduciary duty of loyalty to avoid these conflicts. Delaware statute, and the Delaware Court of Chancery will not read in fiduciary duties. In a Delaware corporation, the duties of care and loyalty cannot be 4 Transaction Terms: General waived. In the case of a corporation with multiple private equity investors, there is typically a shareholder agreement containing an 4.1 What are the major issues impacting the timetable express acknowledgment that private equity firms engage in the for transactions in your jurisdiction, including business of investing, and, therefore, consider other opportunities competition and other regulatory approval and have access to proprietary information, and that private requirements, disclosure obligations and financing equity investors have no obligation to the corporation or the other issues? shareholders with respect to such opportunities or information. Duties of private equity investors to other minority shareholders, Subject to certain exceptions and exemptions, transactions in the such as management with incentive equity interests, are typically United States involving more than $80.8 million in transaction waived in connection with the granting of such interests. consideration are subject to filing and review by the Federal Trade Commission (“FTC”) and the Department of Justice (“DOJ”) under 3.5 Are there any limitations or restrictions on the the Hart-Scott-Rodino Act (“HSR”). The standard waiting period contents or enforceability of shareholder agreements for filing parties is 30 days, but parties can request early termination (including (i) governing law and jurisdiction, and (ii) of the waiting period (usually 14 to 21 days). If a transaction raises non-compete and non-solicit provisions)? anticompetitive concerns, it could receive a “second request” for more filing information and extended review time. Generally, shareholder agreements must not contravene the In addition to HSR, transactions in certain sectors may be subject to certificate of incorporation and bylaws of the corporation, and any other regulatory approvals before a transaction can be consummated. restrictions on shareholder agreements lie in the jurisdiction of For example, the Committee on Foreign Investment in the United incorporation. Pursuant to the internal affairs doctrine, corporate States (“CFIUS”) may review transactions in which foreign buyers governance and internal documents must be governed by the laws are to purchase U.S. companies and which may affect national of the state of incorporation, but jurisdiction can lie outside of such security. If a transaction has been consummated prior to CFIUS state. Fiduciary duties cannot be carved out. approval, and if CFIUS then undertakes an investigation, divestment LLCs have greater flexibility than corporations, as the members of of the acquisition may be ordered. In practice, such divestiture LLCs govern their affairs through an operating agreement, which orders are very rare. is a contract negotiated and agreed by the members. In the case In addition to regulatory matters, purchase agreements sometimes of most states, state law is drafted to assure a significant amount contain contractually imposed conditionality to the parties’ of flexibility for LLC members to negotiate the terms of their obligations to consummate a transaction, such as the obtainment of agreement.
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key consents, novations of key contracts or, in some instances, the and collect a break fee. Over the past few years, the mean break fees availability of debt or equity financing. for large market and middle market deals each hover around two- point-five to three-point-five per cent of the equity value. A majority of “go-shop” provisions provide for a smaller break fee than would 4.2 Have there been any discernible trends in transaction terms over recent years? apply during the “no-shop” period. For a specified period of time, a break fee can also be triggered during a “fee tail” that applies if shareholders vote down the original merger agreement due to the As deal value has increased, financing contingencies have become likelihood that a better deal will arise and then, defining a period more rare in private equity deals. This has, in part, led to reverse after termination, the target does actually sign or close another deal. break fees (that is, a payment to the target company if a buyer Alternatives to break fees – though not mutually exclusive – include USA backs out of a deal) becoming increasingly common since the 2008 specific performance provisions and money damages. financial crisis, particularly in deals in which the buyer is a private equity fund. In such deals, the reverse break fee is usually the sole Buyers reduce the risk of a competing offer arising by including remedy if debt financing is not available, and in the vast majority of in the transaction agreement a “no-shop” provision to restrict the deals, the target has a limited specific performance right to force the target company from taking actions that increase the likelihood that buyer to close only if the debt financing is available. another bidder will make a competing offer to acquire the target. Because a public company board of directors has a fiduciary duty While “go-shop” provisions (which allow a target company to seek to get the highest price for the shares of the company, “no-shops” better offers for a prescribed period after it has entered an agreement include a “fiduciary out” escape valve that allows the board to to sell itself) are not standard, they continue to be widely used, terminate an acquisition agreement to accept an unsolicited superior although more target companies are engaging in pre-signing market offer. In this case, the original buyer would receive the break fee. checks instead of relying on such “go-shop” provisions.
5 Transaction Terms: Public Acquisitions 6 Transaction Terms: Private Acquisitions
6.1 What consideration structures are typically preferred 5.1 What particular features and/or challenges apply to by private equity investors (i) on the sell-side, and (ii) private equity investors involved in public-to-private on the buy-side, in your jurisdiction? transactions (and their financing) and how are these commonly dealt with? Consideration structures in private equity transactions vary broadly In addition to the ordinary disclosure requirements under the United and will always depend on deal dynamics and the investor profile States securities laws, some going-private transactions – engaged in by of the private equity investor(s) involved in a transaction. In a the target or the target’s “affiliate” and resulting in either (i) delisting leveraged buyout scenario, the private equity buyer negotiates for, from an exchange, or (ii) a class of the company’s equity securities and arranges, a buyer-side credit facility, and in these transactions, being held by fewer than 300 persons – are subject to Rule 13e-3 the target company is typically acquired on a cash-free and debt- under the U.S. Securities Exchange Act of 1934. Rule 13e-3 requires free basis. In some instances, however, the target company’s more disclosure than is usually required by the federal proxy rules existing credit facility is considered a valuable asset, and the parties or tender offer rules. Among other requirements, the participating may negotiate to keep it in place after closing (although this often parties and the target must attest to the fairness of the transaction and requires the consent of the lender). disclose information about the private equity sponsors and funding Private equity buyers often negotiate for a target working capital of the transaction. Transactions, including those subject to Rule 13e- mechanic, where the consideration to be paid by the buyer at closing 3 that involve a tender offer, are governed by specific tender offer is adjusted up or down depending on the variance between working rules. Transactions that involve shareholder votes are governed by capital at closing and a pre-negotiated target working capital proxy rules. Finally, transactions that involve issuance of securities amount. In addition to working capital adjustments, private equity are governed by the registration and prospectus requirements. transactions can include cash covenants, earnouts, contingent value Disclosure requirements and various other requirements affect the rights and other creative consideration structures. timing of the transaction, including the target board’s evaluation Private equity sellers desire to promptly distribute funds following of the transaction, bank syndication and the sale of debt securities, a sale, and in order to facilitate this, will often negotiate for antitrust and other regulatory review, solicitation of proxies or representation and warranty insurance to be the principal source of tenders, as well as the creation of special purpose vehicles (“SPV”). recovery for breaches of the seller’s representations and warranties. Hiring a competent team of professionals, including lawyers, This construct is increasingly accepted by buyers, since insurance accountants, proxy solicitors, PR professionals and others is often provides longer survival and coverage for more extensive essential to navigating these processes. seller representations and warranties than a buyer would receive from a traditional indemnity.
5.2 Are break-up fees available in your jurisdiction in relation to public acquisitions? If not, what other 6.2 What is the typical package of warranties/indemnities arrangements are available, e.g. to cover aborted deal offered by a private equity seller and its management costs? If so, are such arrangements frequently agreed team to a buyer? and what is the general range of such break-up fees? Post-closing indemnification provisions are often the most heavily In acquisitions of public company targets, break fees are available to negotiated deal terms in private equity acquisitions. In the typical compensate the buyer when the target terminates to accept another arrangement, management is not personally liable for indemnities. deal. Additionally, if the target board decides not to recommend the When a public company is being acquired, there typically is no deal to its shareholders, the buyer can usually immediately terminate post-closing indemnification because all material information about
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the target company has been disclosed to the buyer in the target cleaner exit and distribute funds to investors without significant company’s filings with the Securities and Exchange Commission holdbacks and escrows in respect of the seller indemnity. Insurance (“SEC”), and because seeking recovery against a broadly held policy limits, survival periods and deductibles vary dependent on shareholder base is impractical. the premium the parties are willing to pay; however, coverage can Special indemnities are used to protect the buyer from matters that approximate what a buyer would receive in a traditional indemnity arise in its due diligence review. Special indemnities can also be structure. Insurers universally demand anti-sandbagging provisions used to protect the buyer from shareholders of the target exercising as a condition to coverage and often exclude from coverage breaches appraisal rights. In many deals, the seller agrees to indemnify occurring between signing and closing. Other carve-outs may apply the buyer for pre-closing taxes that are owed by the target. This in particular industries, but are generally deal-specific. USA ensures that the sellers, who received the benefit of past earnings, pay the taxes associated with those past earnings. It also allows 6.5 What limitations will typically apply to the liability of the purchase price to be calculated without having to diligence and a private equity seller and management team under estimate potential tax liabilities. Special indemnities may also cover warranties, covenants, indemnities and undertakings? deal expenses or the cost of obtaining any third-party consents under change-in-control provisions. Generally, indemnification obligations of target company To provide comfort as to payment of indemnity, in private target deals, stockholders for representations and warranties extend for one to part of the deal consideration is often placed in an escrow account. two years post-closing (though extended coverage to three years Such escrow arrangements are used in roughly 90 per cent of private is common in representations and warranty insurance policies). deals, although increasingly, they serve merely to provide a source However, reps and warranties concerning tax, employee benefits of funds for part of the retention on a representations and warranties and environmental matters usually survive until expiration of the insurance policy. The escrow period is typically one to two years and underlying statute of limitations. tends to track the survival of the representations and warranties. Most agreements with traditional indemnity structures include caps As further discussed below, private equity sellers will generally on losses arising from breaches of reps and warranties. Caps for negotiate several limitations on their obligations to pay indemnities. representations relating to the target company’s condition range from These limitations include: time limitations; de minimis exclusions; 10 per cent to 20 per cent or less of the purchase price. Fundamental deductibles or baskets; caps; and categorical exclusions. There can matters are generally capped at the purchase price. Losses from also be carve-outs from these limitations. breaches of covenants are usually not capped. In addition to caps, transaction agreements typically require losses to exceed a “basket” amount before the company must pay 6.3 What is the typical scope of other covenants, undertakings and indemnities provided by a private the indemnification. The amount is usually zero-point-five per equity seller and its management team to a buyer? cent to one per cent of the purchase price. In stock purchase and merger transactions, seller stockholders (which include, in private In addition to the indemnities discussed above, the buyer and seller equity transactions, the one or more private equity sellers party will negotiate to include covenants restricting the sellers’ actions after to the transaction) are usually responsible pro rata for providing closing, including their ability to enter into business in competition indemnification to the buyer. with the target or to solicit the target’s employees and customers. Generally, the seller’s management does not personally make 6.6 Do (i) private equity sellers provide security (e.g. representations, covenants or other undertakings, but often enters escrow accounts) for any warranties / liabilities, and into non-competition and non-solicit covenants as part of the (ii) private equity buyers insist on any security for warranties / liabilities (including any obtained from negotiations in connection with the transaction. the management team)?
6.4 Is warranty and indemnity insurance used to “bridge The level of security a seller provides in a transaction is dependent the gap” where only limited warranties are given by on the negotiating dynamic between the parties. It is not uncommon the private equity seller and is it common for this for sellers to agree to an escrow to backstop representations and to be offered by private equity sellers as part of the warranties and to protect against known risks. sales process? If so, what are the typical (i) excesses / policy limits, and (ii) carve-outs / exclusions from Recently, however, bidding strategies used by buyers have included such warranty and indemnity insurance policies? foregoing certain contractual protections in favour of insurance for such risks. Policies are often used strategically in the United States, including as an alternative where the seller provides little or no indemnification. 6.7 How do private equity buyers typically provide Sellers use insurance as an alternative to tying up money in escrow comfort as to the availability of (i) debt finance, for a long period of time or giving a funding guarantee. While a and (ii) equity finance? What rights of enforcement “public style” deal with no seller indemnity and insurance as the sole do sellers typically obtain if commitments to, or recourse is possible (and increasingly common in the larger mid- obtained by, an SPV are not complied with (e.g. market deals), the most common structure features a limited seller equity underwrite of debt funding, right to specific indemnity (approximately one per cent of enterprise value) with a performance of obligations under an equity commitment letter, damages, etc.)? representations and warranties insurance policy for 10 per cent or more of enterprise value (as a source of secondary recovery behind the seller indemnity). Buyers have historically used this structure to gain Private equity deals usually require at least two sources of financing: an advantage in a competitive auction, but more and more frequently, equity financing from the private equity fund and debt financing from sellers are proactively pitching this structure to the field of potential third-party lenders. Each source of financing is usually supported by bidders as the required indemnity structure in order to achieve a a commitment letter that is signed at the same time the acquisition agreement is entered into. The target, though not a party to the
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equity commitment letter, usually receives enforcement rights under company for up to 180 days following the IPO. While a 180-day the equity commitment letter that come in either of two forms. In lock-up is typical, underwriters have entered into lock-up waivers some deals, the target is named as an express third-party beneficiary in connection with secondary offerings. In addition, since private under the equity commitment letter. In other deals, the target can use equity sellers are insiders, they still may not be able to sell a large its specific enforcement right in the merger agreement against the portion of their shares after the lock-up period expires. parent of the SPV, making the parent of the SPV pursue its remedies against the private equity fund that provided the equity commitment. 7.3 Do private equity sellers generally pursue a dual-track The target often has a similar specific enforcement right against the exit process? If so, (i) how late in the process are committed lender for the debt financing. Any condition in the third- private equity sellers continuing to run the dual-track, party lender’s commitment letter should conform to the equivalent and (ii) were more dual-track deals ultimately realised USA condition in the buyer’s acquisition agreement. through a sale or IPO? Participants in private equity transactions commonly negotiate guarantees from the private equity fund in circumstances where a Private equity buyers commonly engage in dual-track processes, and parent SPV has agreed to pay a reverse break fee. The fund may the commitment point varies dependent on other factors, including also guarantee to pay damages capped at the same amount as the market window, credit availability and the availability of potential reverse break fee. buyers. To facilitate an IPO or other public offering, private equity investors typically put in place registration rights that govern the rights of shareholders in the event of an IPO. 6.8 Are reverse break fees prevalent in private equity transactions to limit private equity buyers’ exposure? If so, what terms are typical? 8 Financing
Though sometimes used in tender offers, financing conditions are increasingly rare in private equity deals. A reverse break fee is the 8.1 Please outline the most common sources of debt most common alternative. Under a reverse break fee, the buyer is finance used to fund private equity transactions in your permitted to terminate the transaction upon payment of a negotiated jurisdiction and provide an overview of the current state of the finance market in your jurisdiction for such fee if it is unable to obtain its debt financing despite having used debt (particularly the market for high yield bonds). sufficient efforts to do so. If the reverse break fee is triggered, it is normally the sole and The most common sources of debt used to fund private equity exclusive remedy. The target cannot sue for specific performance or transactions in the United States are generally classified by their waive the fee and sue for damages. Failed regulatory approvals can tiers or layers, which may include senior secured debt, subordinated trigger a reverse break fee. Usually, this reverse break fee is payable debt (either structurally or contractually) or mezzanine debt (which only if all the conditions to the buyer’s obligations (other than is typically subordinated and contains an equity component for the regulatory approval) have been satisfied. In some deals, the reverse financing sources). Senior secured credit facilities typically include: break fee is triggered by a material breach of a representation, working capital facilities (in the form of asset-based revolving warranty or agreement. Reverse break fees are used in both middle credit facilities or cash flow revolving credit facilities) and term and large market deals with public targets, but are more common in credit facilities in the form of term loan A debt (which typically large market deals. Over the past few years, the mean break fees of include a higher percentage of amortisation payments with a smaller large market and middle market deals each hover between five and bullet payment at maturity); first lien debt or first-out debt (which seven per cent of the equity value. is typically amortised evenly over several years and repaid in equal installments); term loan B debt (which is typically amortised at a 7 Transaction Terms: IPOs rate equal to one per cent per annum); and junior lien debt or last- out debt (which is amortised nominally over several years with a large bullet payment at maturity). In addition to the secured credit 7.1 What particular features and/or challenges should a facilities a portion of the debt financing may be in the form of bonds private equity seller be aware of in considering an IPO that are secured (which may be secured by certain assets on a first, exit? junior or “crossing” liens basis), unsecured or subordinated. Private equity funds may look to the high-yield debt market to provide IPOs are a popular exit strategy among private equity sellers. With long-term debt financing without the financial covenants and other the ideal market conditions, an investor can maximise its ROI restrictions which would normally be found in credit facilities. through higher and predictable valuation, and the portfolio company It is worth noting that, if there are financing sources providing would have greater access to capital than with other forms of exits. commitments in connection with a proposed transaction, such One disadvantage with an IPO is that it is not an actual exit; rather financing sources may require the private equity fund to provide it is the first step, and the private equity seller only truly exits its an equity contribution. The equity contribution would be used to investment when its shares are sold in the market. Consequently, partially fund the transaction. private equity sellers may be exposed to market risks including fluctuations in the price of shares for a given period of time, during and after a lock-up period. 8.2 Are there any relevant legal requirements or restrictions impacting the nature or structure of the debt financing (or any particular type of debt 7.2 What customary lock-ups would be imposed on financing) of private equity transactions? private equity sellers on an IPO exit? Although The Dodd-Frank Wall Street Reform and Consumer IPO underwriters typically require a lock-up agreement to prohibit Protection Act of 2010 (“Dodd-Frank”) introduced a broad a private equity seller from selling its shares in the portfolio swath of new regulation for private equity funds, the landscape
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with respect to structuring private equity debt financing remains “rolled over” into the new acquisition structure without causing largely unregulated by these regulations. There have been recent management to recognise taxable income. However, where the developments in lending guidelines (such as Interagency Guidance equity-based compensation is being paid or settled in connection on Leveraged Lending (the “Guidelines”)) which may impact the with the transaction, the management team members generally will ability to obtain financing from regulated banks and the overall not be able to avoid recognising taxable income. Importantly, the covenant protections in the credit agreements. However, there has requirements of Section 409A of the U.S. Internal Revenue Code been an increase by “shadow” banks (and other lending institutions must be considered in connection with the rollover of any equity that are not subject to the Guidelines) providing the debt financing awards that were designed to be paid or settled upon a sale of the necessary to consummate a transaction. As of the date of this portfolio company (or similar transaction). The rollover of certain
USA publication, it is unclear as to the impact the Guidelines may have on equity awards, such as “restricted stock units” or “phantom units”, the cost of obtaining debt financing (i.e., commitment fees, interest could constitute an impermissible deferral of compensation that rate, amortisation and/or original issue discount/upfront fees). triggers penalty taxes under Section 409A.
9 Tax Matters 9.3 What are the key tax-efficient arrangements that are typically considered by management teams in private equity portfolio companies (such as growth shares, 9.1 What are the key tax considerations for private equity deferred / vesting arrangements, “entrepreneurs’ investors and transactions in your jurisdiction? Are relief” or “employee shareholder status” in the UK)? off-shore structures common? Where a portfolio company (or other entity holding equity of the Non-U.S. investors making private equity investments in the United portfolio company) is formed as a partnership, “profits interests” are States have to carefully analyse the nature of the type of investment generally viewed as the most management-friendly form of equity- assets they are investing in and the investment vehicles that they based compensation. In general, a “profits interest” is an interest will be investing through. The U.S. tax system imposes a myriad in a partnership or limited liability company other than a “capital of different taxes on different types of income and different types interest” – an interest that provides the holder with a share of the of taxpayers. Among these are net income taxes on U.S. income proceeds if the partnership’s assets were sold at fair market value from trades or businesses that are effectively connected with the and then the proceeds were distributed in complete liquidation of United States, gross withholding taxes on interest, dividends, the partnership. While a profits interest is economically similar to a royalties and other types of passive or periodic income, branch stock option by providing the holder with a share of the entity’s future profits taxes earned by non-U.S. corporations and capital gains appreciation, it can be treated as a transfer of property under U.S. taxes imposed on investments in U.S. real property, either directly tax law, even if subject to future vesting (typically, holders of profits or through U.S. property holding corporations. There are numerous interests file elections, called “83(b) elections”, help ensure such exceptions from tax that are available to mitigate the impact of treatment). Under U.S. tax law, a profits interest should have zero these taxes, either under domestic U.S. legislation or pursuant to value upon grant, and therefore, a recipient of a profits interest should the tax treaties in force with the United States. Matching the types not recognise any taxable income upon its receipt. Depending on of income expected to be earned with an investment structure that how long a management team member holds a profits interest before takes advantage of available exceptions is critical to successful a subsequent sale of the portfolio company (or the profits interest), private equity investing in the United States. In addition, many the full value of the proceeds received by the profits interest holder non-U.S. taxpayers should be particularly attuned to structuring could be treated as capital gain or loss by the holder. One perceived their investment in U.S. private equity funds to minimise the need to drawback of profits interests is that the recipient must be treated as file tax returns in the United States. Other non-U.S. taxpayers may a partner of the entity in which the profits interest was granted, and want to maintain confidentiality of their identities through the use therefore, must receive a Schedule K-1 from the partnership. of appropriate investment structures in order to ensure that the U.S. In general, other equity-based compensation awards, such as stock tax system does not establish direct jurisdiction over the investors or options, restricted stock units or “phantom” equity, generally cause enable the United States to exchange information with the investors’ a management team member to recognise ordinary income upon home governments where such entanglement in the U.S. tax system payment or settlement. Accordingly, those equity awards generally could be problematic. are not perceived as being as tax-efficient as profits interests.
9.2 What are the key tax considerations for management 9.4 Have there been any significant changes in tax teams that are selling and/or rolling-over part of their legislation or the practices of tax authorities investment into a new acquisition structure? (including in relation to tax rulings or clearances) impacting private equity investors, management The structure of a transaction generally is determinative of whether teams or private equity transactions and are any anticipated? a management team member will be required under U.S. tax law to recognise any taxable income with respect to the equity (vested equity) of the portfolio company that the management team member Notably, legislation has been proposed on numerous occasions over holds. In general, any such gain will be taxable as short-term or the past six years to eliminate the tax-favourable treatment of carried long-term capital gain depending on how long the management interests earned by sponsors of private equity funds. This legislation team member held such equity. However, whether the management has still not come to a vote. However, other notable tax legislation team can roll over their equity on a “tax-free” basis typically is not has affected U.S. private equity investment. In 2010, for example, a driving consideration in designing the structure of a transaction. the United States enacted the Foreign Account Tax Compliance Act (“FATCA”) and since then the U.S. Treasury Department has In addition, depending on the structure of the transaction (e.g., a promulgated extensive regulations enabling the FATCA regime. tax-free reorganisation), certain equity-based compensation awards, FATCA imposes substantial withholding taxes on, among other such as stock options, held by management could be assumed or
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things, foreign financial institutions and other foreign enterprises The Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley”), receiving payments from U.S. sources unless such organisations which imposed additional corporate governance-related comply with extensive rules to ensure that foreign financial assets requirements on public companies, is part of the Exchange of U.S. taxpayers have been appropriately disclosed. As the U.S. Act. Dodd-Frank added provisions to the Exchange Act implemented the FATCA regime, many other governments around granting regulators broader discretion to regulate corporate governance matters, including executive compensation and the world (and the Organisation for Economic Co-operation and proxy access. Dodd-Frank required certain private equity Development) determined that they should be entitled to determine funds to register under the Investment Advisers Act of 1940 who is behind financial accounts where the beneficial ownership is (the “Advisers Act”), discussed more in question 10.2. not immediately apparent. Accordingly, account holder identification 3. A corporation’s organisational documents. Each corporation and certification requirements have been increasing for private will be governed by a minimum of two documents: a certificate USA equity investors both within and outside of the United States. At the of incorporation, or “charter”, and its bylaws. Either or end of 2015, legislation was enacted which overhauled the income both of these documents will contain important provisions tax audit procedures for U.S. partnerships (including LLCs and other regarding board composition, annual meetings, stockholder entities that are treated as partnerships for U.S. tax purposes). Under rights and other aspects of the entity’s corporate governance. prior rules, known as the TEFRA audit procedures which dated from In addition, reporting companies with listed securities are 1982, audits of partnerships were undertaken at the partnership required to have written charters for various committees of level but the collection of any tax liability arising from such audits the board of directors, and in some cases, companies may was done at the level of the partners in the partnership. In private have additional documents setting out additional rights for various classes of shares or convertible securities. equity partnerships where an income-producing partnership may be owned through tiers of intervening partnerships, the IRS was often 4. Other sources. The New York Stock Exchange (“NYSE”) and other exchanges require listed companies to abide by unable to collect the taxes due without significant additional effort certain corporate governance standards and regulations. to move up the tiers until they reached the ultimate taxpayer. Under Additionally, industry groups, stockholder advisory the new legislation, audits will still be conducted at the partnership services, and in some cases, institutional investors may also level, but any tax liability arising out of such audit will, in the first publish non-binding corporate governance guidelines and instance, be required to be paid by that partnership. While certain recommendations. exemptions exist that may permit the tax to be paid by the partners (or by their partners), such exemptions carry with them obligations that the partners actually pay the tax and certain increases in the 10.2 Have there been any significant legal and/or regulatory developments over recent years impacting computation of the amounts due. For private equity partnerships, private equity investors or transactions and are any these rules will require some realignment of the interests of the anticipated? parties. Tax-exempt investors, for example, will have little interest in seeing a partnership tax liability arise from a partnership they As of August 2013, the new Section 251(h) of the DGCL provides are invested in and will insist that any such taxes that are paid at for parties to enter merger agreements that can “opt in” to the statute the partnership level be allocated to or indemnified by the taxable to eliminate the shareholder vote on the back-end merger following investors in the partnership. In cases where the ownership of the a tender offer. The acquirer must obtain a sufficient amount of votes partnership has changed between the year under audit examination (usually more than 50 per cent) such that its vote alone would be and the year the tax payment is due, parties will have to be careful sufficient to approve the merger. Before the change, acquirers faced to ensure that the right party ultimately bears the economic cost of two options: a higher hurdle of obtaining 90 per cent (or, if not, the additional taxes due. complete a back-end merger) of the vote, or a more expensive, time- consuming “top up” option in which the target issued more shares 10 Legal and Regulatory Matters for the acquirer to reach 90 per cent. Tender offers may become more popular as a result of the new Section 251(h). The new Section 251(h) facilitates financing of a tender offer because the lender no 10.1 What are the key laws and regulations affecting longer has to wait for a back-end merger. private equity investors and transactions in your jurisdiction, including those that impact private equity transactions differently to other types of transaction? 10.3 How detailed is the legal due diligence (including compliance) conducted by private equity investors prior to any acquisitions (e.g. typical timeframes, The principal sources of law affecting private equity investors and materiality, scope etc.)? Do private equity investors transactions in the United States are as follows: engage outside counsel / professionals to conduct all 1. State law of a company’s state of incorporation. U.S. legal / compliance due diligence or is any conducted corporations are incorporated under the laws of the individual in-house? states, and accordingly, every U.S. corporation is governed in the first instance by the laws of its state of incorporation and Dependent on factors such as deal size, complexity and the corresponding cases interpreting these laws. adequacy of corporate controls, a private equity investor may 2. Federal statutes and the rules and regulations adopted engage in very in-depth diligence through outside counsel. Legal pursuant to these statutes by the SEC. All public companies due diligence is conducted with regard to corporate governance and are subject to regulation by the SEC pursuant to at least standing, environmental issues, regulatory considerations, pending two principal statutes: (i) the Securities and Exchange Act or potential litigation, real property and asset holdings, employment of 1934 (the “Exchange Act”); and (ii) the Securities Act policies and procedures, customer-and-supplier contracts, debt of 1933 (the “Securities Act”). The Exchange Act requires annual, quarterly and periodic reporting by public companies, arrangements, intellectual property, and other legal obligations. requires stockholders of such companies to file reports upon Diligence may, depending on the transaction, range anywhere from crossing certain ownership thresholds, and regulates, in several days to several months. Scope and materiality may vary part, the process by which stockholder votes are solicited. based upon those same parameters.
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a partnership) is based on ownership of profits interests or capital 10.4 Has anti-bribery or anti-corruption legislation interests. In the private equity context, it has long been argued that a impacted private equity investment and/or investors’ private equity investor, typically organised as a limited partnership, approach to private equity transactions (e.g. is not a “trade or business” for this purpose, and therefore, not part diligence, contractual protection, etc.)? of a portfolio company’s controlled group – even if the investor owns an 80 per cent or more interest in the portfolio company. In The U.S. Foreign Corrupt Practices Act of 1977 (“FCPA”) merits recent years, however, both the Appeals Board of the PBGC and consideration by private equity investors whenever the target has U.S. courts have ruled that particular private equity investors had foreign government customers or conducts operations overseas. indeed engaged in sufficient activities with respect to their respective It is customary for the acquirer to obtain appropriate contractual USA portfolio companies to constitute a trade or business. Such decisions representations warranting the target’s compliance with the FCPA have heightened the concern that a private equity investor could be and other applicable anti-bribery and anti-corruption laws. It also liable for the pension liability of its portfolio company. is customary for the acquirer to conduct FCPA due diligence on the target’s anti-bribery compliance procedures and controls, the target’s agents and other third-party intermediaries who interact with foreign 11 Other Useful Facts officials on its behalf, and the existence of any current or prior bribery-related allegations or investigations. Not infrequently, the acquirer’s FCPA due diligence will uncover issues that may warrant 11.1 What other factors commonly give rise to concerns further investigation, remedial action by the target, disclosure of for private equity investors in your jurisdiction or should such investors otherwise be aware of in apparent violations to government authorities in the United States considering an investment in your jurisdiction? and other jurisdictions, and/or delays in, or even termination of, the contemplated transaction. The U.S. DOJ and SEC have made clear The purchase of a unionised employer raises collective bargaining that they expect prospective acquirers to conduct pre-acquisition and workplace flexibility issues. Private equity buyers seeking to due diligence and will assess the quality of the acquirer’s due acquire a business having a single employer defined benefit plan, or diligence in determining whether to impose successor liability for contributing to a multiemployer defined benefit plan, must consider pre-acquisition violations and the magnitude of any sanctions that potential liabilities arising from the plans. Experienced employment are imposed. and employee benefits counsel is vital in navigating this area. The United States has an extremely well-developed, sophisticated 10.5 Are there any circumstances in which: (i) a private and highly efficient environment for private equity deal-making. equity investor may be held liable for the liabilities of As a result, investors seeking to participate in the opportunities the underlying portfolio companies (including due to breach of applicable laws by the portfolio companies); provided by the large U.S. private equity market can and should and (ii) one portfolio company may be held liable for take advantage of the professionals experienced in this market and the liabilities of another portfolio company? the regulatory framework that surrounds it, including private equity lawyers and others. Under the U.S. Employee Retirement Income Security Act of 1974, as amended (“ERISA”), all members of a “controlled group” have Acknowledgment joint and several liability for underfunded defined benefit pension plans sponsored by any member of the group (including any The authors would like to acknowledge the assistance, in the “withdrawal liability” from a union multiemployer pension plan). preparation of this chapter, of Andrew J. Fadale and Monica A. In general, a “controlled group” will consist of a corporation or other McKinnon, associates in the M&A and Securities Group at Schulte “trade or business” and any entity in which it (directly or indirectly) Roth & Zabel LLP. holds at least an 80 per cent interest, including parent-subsidiaries The authors would also like to acknowledge Schulte Roth & Zabel and brother-sister entities. In general, control of a corporation is LLP partners Howard O. Godnick, Dan A. Kusnetz, Ian L. Levin, based on stock ownership (both in terms of its voting power and Michael M. Mezzacappa, Ronald E. Richman and Gary Stein for economics), while control of a partnership (and any entity taxed as their contributions to this chapter.
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Peter Jonathan Halasz Richard A. Presutti Schulte Roth & Zabel LLP Schulte Roth & Zabel LLP 919 Third Avenue 919 Third Avenue New York, NY 10022 New York, NY 10022 USA USA
Tel: +1 212 756 2238 Tel: +1 212 756 2063 Email: [email protected] Email: [email protected] URL: www.srz.com URL: www.srz.com USA
Peter Jonathan Halasz is general counsel and a partner in the Richard A. Presutti is co-chair of the M&A and Securities Group and Investment Management and M&A and Securities Groups at chair of the investment management M&A practice at Schulte Roth Schulte Roth & Zabel LLP. Educated in both law and business, & Zabel LLP. He practises primarily in the areas of private equity, his practice includes mergers and acquisitions, securities, private mergers and acquisitions, leveraged buyouts and alternative asset equity, international business and investment funds. In the area of management transactional matters, and he also regularly represents a private equity M&A, he has represented clients in auctions and sales, number of high-profile private equity firms in many transactions across restructurings and leveraged capitalisations, mergers, unsolicited a range of industries. In recognition of his transactional expertise and tender offers, privatisations, international joint ventures, special- commitment to client service, as well as for advising on an award- committee representations and venture capital investments. In the winning transaction for a well-known private equity client, he was finance area, he has represented issuers and underwriters in public named “North America Lawyer of the Year” by Global M&A Network’s offerings of equity and debt, commercial paper and euro medium- Americas M&A Atlas Awards and is among Global M&A Network’s elite term note programmes, Rule 144A offerings, and the organisations group of the top 50 most influential North America M&A Lawyers. He and offerings of alternative investment fund products. After graduating received his B.S. from Bentley University and his J.D., cum laude, from magna cum laude from Harvard College, he was admitted to a dual- Tulane University Law School. degree programme offered jointly by Harvard Law School and Harvard Business School and was awarded a J.D., cum laude, and an M.B.A.
Schulte Roth & Zabel LLP (“SRZ”) is a full-service law firm with offices in New York, Washington, D.C. and London. SRZ attorneys advise on some of the most sophisticated domestic and cross-border private equity transactions ranging from billion dollar-plus to small-cap deals serving clients that include many of the most active and influential private equity firms. The firm is actively involved in every aspect of the private equity investment process, from the formation of leveraged buyout, venture capital, real estate and other private equity and mezzanine funds, to the representation of these funds and other private equity investors in making investments, through realisation events including acquisitions, corporate financings and sales.
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