Private Equity 2020

A practical cross-border insight into private equity law

Sixth Edition

Featuring contributions from:

Aabø-Evensen & Co HBK Partners Attorneys at Law Morais Leitão, Galvão Teles, Soares da Silva & Atanaskovic Hartnell Kennedys Bermuda Associados Bär & Karrer Ltd. Lee and Li, Attorneys-at-Law Schindler Attorneys Dechert LLP Legance – Avvocati Associati Sidley Austin LLP Eversheds Sutherland (Luxembourg) LLP McCann FitzGerald Udo Udoma & Belo-Osagie Garrigues McMillan LLP Zhong Lun Law Firm ISBN 978-1-83918-068-2 ISSN 2058-1823

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59 Tanner Street London SE1 3PL United Kingdom Private Equity 2020 +44 207 367 0720 [email protected] www.iclg.com Sixth Edition

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Senior Editor Contributing Editors: Sam Friend Christopher Field & Dr. Markus P. Bolsinger Head of Production Suzie Levy Dechert LLP

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Disclaimer This publication is for general information purposes only. It does not purport to provide comprehensive full legal or other advice. Global Legal Group Ltd. and the contributors accept no responsibility for losses that may arise from reliance upon information contained in this publication. This publication is intended to give an indication of legal issues upon which you may need advice. Full legal advice should be taken from a qualified professional when dealing with specific situations. Table of Contents

Expert Chapters

2020 and Beyond: Private Equity Outlook for 2021 1 Robert Darwin, Siew Kam Boon & Adam Rosenthal, Dechert LLP

Defensive Strategies for Sponsors during Periods of Financial Difficulty 4 Eleanor Shanks, Bryan Robson, Mark Knight & Matt Anson, Sidley Austin LLP

Q&A Chapters

Australia Nigeria 8 Atanaskovic Hartnell: Lawson Jepps 95 Udo Udoma & Belo-Osagie: Folake Elias-Adebowale & Christine Sijuwade Austria 19 Schindler Attorneys: Florian Philipp Cvak & Norway Clemens Philipp Schindler 103 Aabø-Evensen & Co: Ole Kristian Aabø-Evensen

Bermuda Portugal 29 Kennedys Bermuda: Nick Miles & Ciara Brady 125 Morais Leitão, Galvão Teles, Soares da Silva & Associados: Ricardo Andrade Amaro & Canada Pedro Capitão Barbosa 38 McMillan LLP: Michael P. Whitcombe & Brett Stewart Spain 133 Garrigues: Ferran Escayola & China María Fernández-Picazo 47 Zhong Lun Law Firm: Lefan Gong & David Xu (Xu Shiduo) Switzerland 142 Bär & Karrer Ltd.: Dr. Christoph Neeracher & Hungary Dr. Luca Jagmetti 58 HBK Partners Attorneys at Law: Dr. Márton Kovács & Dr. Gábor Puskás Taiwan 150 Lee and Li, Attorneys-at-Law: James C. C. Huang & Ireland Eddie Hsiung 67 McCann FitzGerald: Rory O’Malley, Ben Gaffikin, John Neeson & Elizabeth Maye United Kingdom 157 Dechert LLP: Ross Allardice & Robert Darwin Italy 77 Legance – Avvocati Associati: Marco Gubitosi USA 168 Dechert LLP: John LaRocca, Dr. Markus P. Bolsinger Luxembourg & Allie M. Misner 87 Eversheds Sutherland (Luxembourg) LLP: Holger Holle & José Pascual Welcome

Preface

We are privileged to have been invited to introduce the 2020 edition of ICLG – Private Equity, one of the most comprehensive comparative guides to the legal aspects of private equity transactions available today. The Guide is in its sixth edition, which is itself a testament to its value to practitioners and clients alike. Dechert LLP is delighted to continue to serve as the Guide’s editor. With today’s rapidly changing macroeconomic, social and political developments in private equity, it is critical to maintain an accurate and up-to-date guide regarding relevant practices and legislation in a variety of jurisdictions. The 2020 edition of this Guide accomplishes that objective by providing global businesses leaders, in-house counsel, and international legal practitioners with ready access to important information regarding the legislative framework for private equity transactions in 16 different jurisdictions. This edition also includes two general chapters, which discuss pertinent issues affecting the private equity industry, transactions and legislation. The sixth edition of the Guide serves as a valuable, authoritative source of reference material for lawyers in industry and private practice seeking information regarding the procedural laws and legal aspects of private equity transactions, provided by experienced practitioners from around the world.

Christopher Field & Dr. Markus P. Bolsinger Dechert LLP Welcome Chapter 1 1

2020 and Beyond: Private Equity Outlook for 2021 Robert Darwin

Siew Kam Boon

Dechert LLP Adam Rosenthal

I.2 Introduction non-controlling positions further down the capital structure is also likely to continue and potentially accelerate, as PE sponsors 2019 was another active year for the global private equity (PE) are driven by challenging market conditions to seek innovative industry. Transaction volumes and values continued at levels investment structures that allow the deployment of capital at only slightly lower than those of 2018, despite some anticipation attractive valuations while permitting a greater degree of down- of a global economic slowdown in the near term. Deal multiples side protection (such as preferred equity or convertible debt) remained historically high in the US and Europe, driven by the than is afforded by more typical control investment transactions. same intense competition for assets that has characterised the market in recent years, itself caused by the presence of significant Deal termination and disputes levels of dry powder and a relative scarcity of targets on which to deploy it. Holding periods slightly decreased in 2019, as sponsors sought to avail themselves of more favourable exit condi- One trend that emerged quickly in the weeks following the tions before the expected onset of recession. Take-private trans- outbreak of the COVID-19 pandemic was that of buyers actions remained a significant component of market activity, attempting to terminate or renegotiate transactions entered especially in the technology and healthcare industries. Much of into prior to the pandemic but that had yet to close. Initially, this buoyancy continued into Q1 of 2020. However, for most buyers focused on arguments that material adverse change of the globe, the abrupt arrival of the COVID-19 pandemic clauses contained in their purchase agreements had been trig- was accompanied by a sharp recession, which included the end gered. This was followed by a number of claims being brought of long bull markets in US and European equities and sharp by buyers who argued that actions taken by targets in response falls across a number of Asian markets. COVID-19 has been a to the pandemic (e.g. the furloughing of staff or drawing down defining influence in the trends affecting the PE market in 2020 on loans to support capital needs) constituted a breach of the and will also affect the outlook for the next year. common interim operating covenant that requires the seller to operate the target in the ordinary course of business consistent II.2 Trends in the PE Market with past practice or for the seller not to incur additional indebtedness. Even where such a breach would not give rise to a termination right exercisable by the buyer, litigation in respect of an Deal terms to bridge the valuation gap alleged breach has been used as a strategy to renegotiate deal terms and defer closing of the transaction to gain more time for Ongoing uncertainty caused by the turbulent economic outlook the buyer to assess unfolding events. We expect this to be a rela- and a lack of “business as usual” trading information from targets tively short-term phenomenon, which only affects transactions has damaged the confidence levels of both buyers and sellers. that had signed but not closed at the time the pandemic started, To bridge the difference in valuation expectations caused by this as newly signed transactions tend to reflect COVID-19-related uncertainty, we expect to see a return of deal terms more usually business risks. seen in recessionary environments, such as deferred consideration mechanisms that have been more rarely used in the period COVID-19 diligence issues of growth between the 2008–2009 global financial crisis and the start of the COVID-19 outbreak. We are also seeing the emergence of various COVID-specific financial measures, e.g. COVID-19 has required increased attention to be given to “EBITDAC” – where the “C” stands for coronavirus. certain legal due diligence topics. In particular, due diligence has focused on those terms of a target’s commercial contracts that may impact revenue certainty, the impact of any imple- Minority investment mented or available governmental measures on the target’s business (e.g. in respect of furloughing staff or providing emergency The recent trend of deploying capital in minority and state funding) and the target’s access to additional funding under

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its existing financing arrangements and any potential breaches infrastructure (as was typically the case historically), but in of borrower debt covenants that may have arisen as a result of many cases extend to finance, healthcare, infrastructure, trans- COVID-19. Buyers are behaving cautiously in assessing targets port, media, agriculture and technology industries, too. The that have been (or are likely to be) negatively affected by the increasing number and strength of these regimes will necessarily pandemic and we are seeing investment and credit commit- become a feature of analysing whether a transaction is feasible tees increasing the duration and depth of their review of buyout and will certainly feature in transaction documentation as condi- transactions accordingly. tions to closing where mandatory governmental approvals apply. This represents a step back from globalisation and a resurgence of the importance of national borders that has also been particu- Buy-out finance larly apparent in governmental responses to the immediate challenges posed by COVID-19 to national healthcare infrastruc- Credit markets tightened in response to COVID-19 and ture, the supply of medical equipment and the right to obtain obtaining high degrees of leverage for buyout transactions may vaccines, when available. become increasingly challenging. This may result in buyers contributing more equity to fund transactions or accepting less favourable debt terms than have been common in recent years. Opportunity for those with sector expertise

Our closing comment in last year’s edition of this chapter, that W&I market global events may also provide significant opportunities for investors to acquire distressed assets at advantageous valuations, Due to the decline in transaction volume, the W&I insurance has proved true in ways few of us predicted. Deal teams with market became very competitive in the weeks following the the deep sector expertise required to understand the effects of COVID-19 outbreak, especially as to premium rates. After an the pandemic on their target industry, and the ability to execute initial period during which insurers applied broad COVID-19 transactions in distressed environments, will be best placed to exclusions to policy coverage, many insurers are now taking a take advantage of the opportunities presented by corporates more nuanced view and are moving away from broad COVID-19 divesting non-core businesses to bolster their own balance exclusions to more tailored exclusions that focus on the aspects sheets in response to revenues damaged by lockdown. This is of the target’s business that may be particularly affected by the particularly true in the life sciences and healthcare industries, pandemic, such as supply chain issues, material contracts and where those with the expertise to navigate the complex interplay employee issues. Several of the W&I brokers we deal with are of factors that are relevant to targets in these industries (which expecting the competitive W&I market to continue for the have, in many cases, been at the forefront of the response to remainder of the year. COVID-19) will be able to compete most effectively for those high-quality assets that become available. Secondaries transactions III.2 Outlook 2019 was another highly active year for transactions in the After a promising start to 2020, the outbreak of the COVID-19 secondaries market. In the context of the worsening macroe- pandemic caused a significant pause in deal-making and a sharp conomic climate, we expect to see growth in the secondaries decline in transaction volumes in Europe and the US, as many market continue, as distressed investors look for liquidity, and deals went on hold. Although there are signs that market activity LPs seek to rebalance their portfolios and free up capital to meet is picking up again, we expect the PE industry’s return to deal- revised investment theses. PE sponsors are likely to continue making to be cautious, as the effects of the pandemic continue to set up continuation or specific asset funds to allow them to to ripple through a global economy that was already poised to continue to hold particularly successful investments that were enter a period of contraction. We have seen most resilience in originally acquired by funds that are approaching their liquida- those industries least affected by the pandemic, such as tech- tion period. We expect this trend to continue throughout 2020, nology, financial services and e-commerce. Fundraising in the especially if less seller-favourable exit conditions become more first half of 2020 marginally outstripped the equivalent period in common. 2019, and levels of dry powder remain very high. The challenge for the PE industry in 2020 will be how to deploy this capital The increase in Foreign Direct Investment (FDI) controls effectively in an uncertain market.

A number of jurisdictions have introduced FDI controls for Acknowledgment the first time in 2020, and several more, including the US, Thomas Clarke, an associate based in Dechert’s London office, have enhanced those FDI regimes that were already in place. also contributed to this chapter. These investment controls are not limited to national defence

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Robert Darwin has a broad international practice focused on private equity and M&A. He executes the most strategic and critical private transactions for global corporates, funds and other private investors. Mr. Darwin advises clients across a wide range of industries including industrials, technology and retail. He is particularly known for his work with global life sciences and healthcare corporations and investors. He has led deals of all types in these industries, including strategic collaborations, acquisitions, private equity buyouts and venture deals.

Dechert LLP Tel: +44 20 7184 7603 160 Queen Victoria Street Email: [email protected] London, EC4V 4QQ URL: www.dechert.com United Kingdom

Siew Kam Boon practises in the areas of mergers and acquisitions, private equity and emerging growth and venture capital, with significant experience in the technology, healthcare and life sciences, outsourcing, media, telecommunications, FMCG, energy, infrastructure and resources industries.

Dechert (Singapore) Pte. Ltd. Tel: +65 6730 6980 One George Street, #16-03 Fax: +65 6730 6979 Singapore 049145 Email: [email protected] URL: www.dechert.com

Adam Rosenthal advises clients on mergers and acquisitions, joint ventures, private equity transactions and general corporate and business matters. His clients include private equity sponsors and their portfolio companies, asset managers and a variety of public and private companies across a wide range of industries.

Dechert LLP Tel: +1 215 994 2623 / +1 212 641 5612 Cira Centre, 2929 Arch Street Fax: +1 215 994 2222 / +1 212 698 3599 Philadelphia, PA, 19104-2808, USA / Email: [email protected] Three Bryant Park, 1095 Avenue of the Americas URL: www.dechert.com New York, NY, 10036-6797, USA

Dechert is a global law firm focused on sectors with the greatest complexities and highest regulatory demands. We deliver practical commercial insight and judgment to our clients’ most important matters. Nothing stands in the way of giving clients the best of the firm’s entrepreneurial energy and seamless collaboration in a way that is distinctively Dechert. Dechert has been an active advisor to the private equity industry for more than 30 years – long before it was called “private equity”. As a result of our longstanding roots and diverse client base, we have a deep understanding of the latest market terms and trends and provide creative solutions to the most complex issues in evaluating, structuring and negotiating PE transactions. Ranked among the top law firms for PE by prominent league tables and legal directories, Dechert’s global team has been recognised for its commercial judgment and client focus. www.dechert.com

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Defensive Strategies for Sponsors during Periods of Financial Difficulty Eleanor Shanks Bryan Robson

Sidley Austin LLP Mark Knight Matt Anson

“Having a large amount of leverage is like driving a car with a dagger on headroom and generous add-backs and look-forward pro forma the steering wheel pointed at your heart. If you do that, you will be a better adjustments for internal operational restructurings and cost- driver. There will be fewer accidents but, when they happen, they will be saving projects (amongst other things) giving Sponsors signif- fatal.” Warren Buffett icant release valves in times of distress. As a result, lenders are being brought to the table later and Introduction Sponsors and their portfolio companies are likely to have significantly more preparation time to appraise and improve their The events of 2020 have seen massive reductions in both negotiating position before engaging with lenders. Good revenue and cashflow for many businesses. As a result, financial early analysis and strategic advice pay dividends in executing a sponsors (“Sponsors”) have watched with growing concern, successful defensive strategy. fearing certain of their struggling and highly-leveraged portfolio companies are heading inexorably into the sort of ‘acci- In the absence of substantive performance triggers, cash dent’ Warren Buffett described. flow and liquidity are likely to be the key drivers in assessing the imminence of default. In particular, the Sponsor and the However, the proliferation of covenant light (“cov-lite”) debt board of the portfolio company will need to consider (among packages and the absence of ongoing performance metrics in other matters): (i) whether interest payments can be made on credit documentation, may mean that Sponsors have a stronger time; (ii) how accurately cash flow can be mapped against hand when dealing with lenders in distress scenarios than near-term liabilities; and (iii) whether there are any short-term current headlines regarding market conditions might suggest. financing options permitted under the credit documentation The continued wall of money across the deep high-yield capital (e.g., factoring arrangements, sale and leaseback schemes or the markets and syndicated and alternative lending markets favours execution of an asset sale). equity Sponsors who have become increasingly adept at running competitive debt processes. Duties and Conflicts This chapter will explore some of the options available to Sponsors that are considering the adoption of defensive strate- Where insolvency is a real possibility, both the Sponsor and the gies in the face of lender-led distressed approaches. board of the portfolio company will also need to be mindful of the shift in directors’ duties toward value preservation for creditors. Identifying the Distress This can place Sponsor-appointed directors in a particularly difficult position when it comes to conflicts of interest. While it is Typically, restructuring discussions will begin shortly after a usually permissible for a director to vote on matters in respect of waiver is requested from a portfolio company’s lenders in rela- which they have an interest if it is declared, the dynamic opens tion to a default under that company’s credit documentation. up an unhelpful avenue of attack for lenders. This risk can be Although there can be material benefit to starting those discus- partially mitigated by the Sponsor through the adoption of strin- sions earlier, depending on circumstances and the relationships gent governance protocols and, when appropriate, arranging for involved. Indeed, discussions often begin as soon as a cove- the Sponsor and the portfolio company to retain separate and nant or other default is anticipated owing to macro events or a independent counsel. softening of performance. In a similar vein, the Sponsor will need to be mindful of the According to S&P Market Intelligence, as at 31 January risks of shadow directorship and the possibility that transactions 2019 approximately 82% of all outstanding leveraged credits in entered into during the applicable look-back period are review- Europe were cov-lite. Given the massive growth in the use of able, and potentially voidable, in the event of an insolvency. cov-lite documents, there has been a general erosion of the ‘early warning systems’ traditional debt documentation included. By What Are the Sponsor’s Aims? way of illustration, pre-2008 syndicated debt would typically include four performance triggers (which would customarily Assuming that distress has been identified and a liquidity or include covenants on leverage ratio, interest cover, debt service solvency default is expected to be triggered under the credit cover and capex). By contrast, a cov-lite facility would include documentation, a Sponsor must first ask itself what it ulti- only a springer covenant applicable to the revolving credit mately intends to achieve before seeking to implement a defen- facility and which operates more as a clean down than a tradi- sive strategy. The answer will be dependent on a number of tional financial covenant. Alternative lending deals usually factors, including: (i) the performance of the portfolio company have a single leverage covenant, but increasingly with significant to date; (ii) whether it is realistic to expect future returns from

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the investment if it is retained; and (iii) the life cycle of a fund forward – for example: (i) will certain lenders have a different that holds the company and, in particular, whether that fund perspective due to cross holdings in different classes of capital is able to provide additional liquidity and where in the capital in the structure; and (ii) are all lenders capable of holding equity structure such funding can be advanced. Whether there have instruments if that is agreed as part of a broader restructuring been previous injections of further funding by the Sponsor is solution? particularly relevant in this context, as limited partners in the Other (non-exhaustive) examples of structural advantages funds will be concerned as to whether following their money which may be enjoyed by Sponsors include: is still the right thing to do, or whether it is time to cut losses. (i) the absence of a single point of enforcement for lenders, Questions will inevitably arise around the overall sector perfor- with the attendant complexity of enforcement that this mance and its future, particularly in this era of paradigm shift, entails; as well as the management team and whether changes need to be (ii) the requirement that the lenders enforce in ‘creditor- made to weather the storm and get back on track. unfriendly’ jurisdictions; and One other significant consideration will be whether the (iii) the identity of the security agent. Sponsor is currently fundraising. If the Sponsor is forced to realise an impairment during a fundraising cycle this will have a detrimental impact on returns and, potentially, the Sponsor’s Active levers reputation. For Sponsors that are perennially fundraising, this concern may be particularly acute. In these circumstances, the Active levers are the means through which Sponsors and port- Sponsor may decide to look hard at ways of retaining an asset to folio companies can directly influence the negotiating dynamic. avoid disrupting the fundraising process. General reputational While some of these tactics could be considered aggressive, it and track record considerations will always apply. will often not be necessary to actually ‘use’ an active lever; the This assessment may be done in parallel with the review of mere fact that it is available as an option to the Sponsor can the Sponsor’s negotiating position under the credit documenta- significantly bolster its negotiating position. tion or otherwise (see Passive and Active Levers, below) so that the Examples of ‘active’ levers include (non-exhaustively): Sponsor arrives at an informed view of risk and reward. It is not (i) actively preventing the occurrence of an event of default uncommon for Sponsors that learn they have more negotiating (through EBITDA add-backs, pro forma adjustments or leverage, or hold-out value, than previously thought to suddenly equity cures); see a distressed asset in a more favourable light. Similarly, where (ii) the policing of transfers into and out of the lending syndi- a Sponsor lacks strategic levers to prevent a lender-led restruc- cate; and turing, it may decide that a swift and fully consensual exit is the (iii) transfers of value away from existing lenders where this is best way forward, even for assets which might otherwise remain permitted due to any gaps in the credit documentation and attractive. If the fund or funds are otherwise performing well raising financing against those assets. and have completed a high number of successful exits, an orderly Sponsors should be mindful of reputational risk when consid- handover of the keys or an exit to a distressed specialist investor ering active levers: lenders may be engaged across the Sponsor’s may be a more logical and better outcome than a ‘Hail Mary’ portfolio and an overly aggressive approach may make it chal- play to save the business in current ownership. lenging, or more expensive, to borrow money in future. That said, the Sponsor will also wish to avoid signalling to loan- Passive and Active Levers to-own investors that their portfolio is an ‘easy target’. At the same time as considering how attractive the retention Having established its view of the distressed portfolio of the relevant portfolio company is in the abstract, a Sponsor company and the tools at its disposal (both active and passive), should consider what leverage it has by virtue of the facts and a Sponsor should now be well-equipped to turn its attention to circumstances intrinsic to the situation (passive levers), and the engaging with the lender group. ways in which they can proactively influence the dynamic in their favour (active levers). Conclusion The ubiquity of cov-lite debt packages may present Sponsors Passive levers with the opportunity to retain assets that they might previously have been expected to consensually exit in distress scenarios. Examples of structural or ‘passive’ advantages the Sponsor In other words, the general position of Sponsors looks at least might enjoy include whether or not the lender syndicate is highly as good, if not better, than it did in the financial crisis after concentrated (which yields efficiencies in terms of the number the debt binge which preceded that episode. Perhaps foremost of counterparties with whom active engagement is needed, while among the benefits yielded by the cov-lite regime in this context, ceding some negotiating power), how much of the debt stack is the time afforded to the Sponsor to prepare for its engagement is under water and whether the lenders have divergent objec- with the lender group. Early preparation with specialist restruc- tives (e.g., distressed investors who have invested at well below turing counsel is crucial in assisting with the development of par will have different imperatives to traditional bank lenders a coherent strategy which provides the best possible chance of who have held the debt from the outset). Fully understanding securing a positive outcome. which lenders hold what instruments is crucial in finding a way

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Acknowledgments James Wood James Wood is a partner in Sidley’s Corporate Department and The authors would like to thank Jifree Cader, James Crooks and member of the firm’s Private Equity Practice Group. He has James Wood for their invaluable assistance and contribution in significant public and private cross-border M&A experience the production of this chapter. across many sectors, providing advice to senior client stakeholders on significant, complex and transformative transactions. Jifree Cader Teams led by James have helped clients successfully complete Jifree Cader co-heads Sidley’s Restructuring Group in London multi-jurisdictional transactions involving up to 70 countries, and is a partner in the firm’s Private Equity Practice Group. He and he has advised clients on transactions in Africa, Western has a wealth of experience in advising clients on all facets of and Eastern Europe and, in particular, Asia, having lived and European insolvencies and restructurings. Jifree works closely worked for four years in Tokyo. He has particular experience with corporate clients as well as private equity firms, hedge advising investors and corporate clients on international trans- funds, investment banks and other distressed debt and par actions and other strategic initiatives in the financial services, investors, providing advice on their investment portfolios. He life sciences, telecoms and technology sectors. He is recognised has also advised insolvency practitioners. by The Legal 500 for M&A and he has been listed in Best Lawyers Jifree and Mark Knight have just led a large Sidley multi- 2021 for Mergers and Acquisitions Law and Private Equity Law. disciplinary team who successfully completed the Travelex James was a key member of the team that successfully closed the restructuring, achieving a successful rescue for the business and Travelex restructuring. solutions for the investors.

James Crooks James Crooks co-leads Sidley’s London leveraged finance practice, advising LBO sponsors, their portfolio companies and credit funds on debt financing transactions, including leveraged acquisitions, syndicated lending, asset-backed financings, debt restructurings and general banking arrangements. He is distinguished for playing a crucial role in establishing the thriving practice in Sidley’s London office including advising such industry heavyweights in 2019 as Apollo, Blackstone, Compass, HIG, KKR, Northleaf, Soros and TowerBrook. The Lawyer named James to the 2020 edition of its “Hot 100” list. The annual list recognises the United Kingdom’s most daring, innovative and creative lawyers from in-house, private practice and the Bar. James was praised for helping shape the legal profession.

Private Equity 2020 © Published and reproduced with kind permission by Global Legal Group Ltd, London Sidley Austin LLP 7

Eleanor Shanks is a leading partner in Sidley’s Corporate Department and the firm’s Private Equity Practice Group. She advises on mergers and acquisitions, joint ventures, co-investments and other equity investments, including those in distress or into distressed situations. She has advised leading private equity Sponsors, other investors and funds (including family offices and sovereign wealth-funds), financial institutions, corporates and management teams. Amongst the investors she has acted for are The Blackstone Group, Cerberus European Capital, Colony Capital, CVC, EQT, First Reserve, GIC, Goldman Sachs, Hamilton Lane, Investcorp, KSL Capital, LetterOne, L1 Energy, L1 Health, Oaktree Capital, Round Hill Capital, Partners Group, Pamplona Capital, Schroders REIT and Third Point. Eleanor is recognised by leading rankings including The Legal 500. In 2016, she was named in the Financial News Top 40 Under 40 Rising Stars in Legal Services. She was also named the Most Distinguished Winner of 2015 and awarded Best Private Equity Lawyer in the Women in Private Equity Awards.

Tel: +44 20 7360 2555 | Email: [email protected]

Bryan Robson is a leading partner in Sidley’s Global Finance Department and the firm’s Private Equity Practice Group and co-leads Sidley’s London leveraged finance practice. He is highly skilled in matters related to banking and debt finance, including in distressed situations, syndicated lending, leveraged acquisitions and issues related to general banking. He advises clients in mergers and acquisitions, joint ventures and financial restructurings. Bryan most recently acted for TowerBrook Capital Partners on the distressed acquisitions of the Azzurri Group and the CarTrawler Group. Legal Week named Bryan Robson to its 40 Under 40: Rising Stars in Private Equity list, which recognises the United Kingdom’s “finest private equity legal practitioners”.

Tel: +44 20 7360 3717 | Email: [email protected]

Mark Knight co-heads Sidley’s Restructuring Group in London and is a partner in the firm’s Private Equity Practice Group. He is a seasoned restructuring lawyer with deep experience in multi-jurisdictional workouts and restructurings, and has successfully led many complex restructurings, acting for both creditors and debtors. Mark works closely with private equity houses, hedge funds and other investors in relation to the acquisition and reorganisation of stressed and distressed businesses. His practice is focused on all stages of the restructuring life cycle, including investment structuring, contingency planning and strategy, negotiations, implementation, post-restructuring, optimisation of existing investments and exit. Prior to joining the firm, Mark served as general counsel and partner of Pillarstone, a KKR turnaround platform which partners with European banks to manage their exposure to NPLs and non-core assets. He was named one of the top-25 “Rising Stars of Private Equity” of 2018 by Private Equity News. Mark has recently acted for TowerBrook Capital Partners with Bryan on the distressed acquisition of the Azzurri Group.

Tel: +44 20 7360 3740 | Email: [email protected]

Matt Anson is a senior associate in the Corporate Department and member of the firm’s Private Equity Practice Group. Matt has wide-ranging experience advising private equity Sponsors on acquisitions, disposals, restructurings, incentive schemes and has acted for a number of sovereign wealth funds on co-investment matters. He spent just over a year working in the warranty and indemnity insurance market and has extensive knowledge of customary policy terms and the competitive landscape in the transactional risk insurance market. Matt acted for the bondholders in connection with their bail-in of The Co-operative Bank plc (the first-ever creditor bail-in of a bank in the UK). Matt has also represented clients in respect of a number of public takeovers and take-private transactions.

Tel: +44 20 7360 3690 | Email: [email protected]

Sidley has an extensive Private Equity practice with lawyers around the decades. [Sidley] saw its revenue from this private equity work hit roughly $300 world focused on advising our private equity clients, including general million this past year, a leap from just $50 million in 2011.” buyout funds, specialist funds in sectors like infrastructure, real estate, Sidley has more than 2,000 lawyers in 20 offices in key business and finan- energy, financial services, insurance and healthcare, sovereign wealth- cial centres around the globe and is proud to serve clients across the entire funds, pension funds, family offices and other limited partners. spectrum of legal services. Sidley lawyers pride themselves on being Our private equity lawyers possess deep experience across the broad spec- the trusted counsel of choice for their clients most complex and crucial trum of private equity transactions, from multibillion-dollar leveraged buyouts matters and on talent, teamwork and results for over 150 years. (LBOs), platform buy-and-builds, consortium deals and co-investments, large- Our team has worked successfully with a number of its Private Equity scale restructurings and distressed investing, to growth equity investments clients on the early preparations described in this chapter and we have in premium middle markets companies. The firm has built a practice with consistently helped them defend and retain key assets where they would a committed multi-disciplinary approach as one team with one objective – have otherwise been vulnerable to loan-to-control investors. to help the client meet theirs. Corporate, debt, restructuring, tax and other www.sidley.com private equity specialists work seamlessly with a deep bench of specialist employment, wide variety of regulatory, compliance and industry operational legal specialists. Bloomberg covered the rise of Sidley’s Private Equity practice earlier this year, saying that: “Sidley Austin has shaken up the private equity space, in part using a string of lateral hires from more established PE players to make rapid progress in a market where the top law firms have had practices spanning several

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Atanaskovic Hartnell Lawson Jepps

12 Overview A$2.2 billion in 2019. With respect to fintech, venture capital deals had an aggregate value of A$867 million in 2019, which is an increase of 190% from 2015. 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? 1.2 What are the most significant factors currently encouraging or inhibiting private equity transactions in your jurisdiction? The current state of the market for private equity transactions in Australia has obviously been fundamentally altered by the economic impact of the COVID-19 pandemic, in common with Significant factors encouraging Australian private equity trans- other jurisdictions. actions in normal circumstances include: There was some evidence of resilience in the early stages of the ■ domestic bank interest rates staying at historic lows; and crisis, e.g. in late March, Xinja announced it had secured A$433 ■ attractions of Australia for inbound investment through: million in equity capital from Emirates’ World Investments, and ■ lower Australian dollar forex rate compared to SafetyCulture announced a A$60.5 million capital raising from previous years; new and follow-on investors in early April, but conventional ■ perceptions of Australia as a “safe haven” destination wisdom suggests it can take up to 12 months before the full compared to volatility overseas; and economic impact of a severe shock is felt. ■ impact of government initiatives like the Biomedical Evidence of detrimental impact to date has been largely anec- Translation Fund and the National Innovation and dotal, but we would expect a generally greater incidence of Science Agenda (NISA). invocation of material adverse change/material adverse effect Significant factors inhibiting specifically Australian private clauses by newly nervous investors and financiers. At the same equity transactions include: time, some investment firms that have raised funds prior to the ■ thinner market for deals and domestic capital; and present crisis will see depressed valuations as an opportunity to ■ less favourable taxation regime for private equity compared deploy their stores of dry powder. to markets such as the US and UK. Prior to the present crisis, according to the Australian Investment Council (AIC), there was a general soft decline in 1.3 What are going to be the long-term effects for investment across the financial year 2019 (FY19). Private equity private equity in your jurisdiction as a result of the fundraising in Australia dipped to A$778 million while private COVID-19 pandemic? equity investments markedly increased to A$25 billion. On the investment side, while average deal value increased to A$620 In respect of existing investments, there might clearly be a million, up from A$444 million the year before, the number longer timescale to exit than had been envisaged prior to the of private equity-backed buy-out deals dropped from 106 to pandemic. It has become a commonplace observation that 85 deals completed. Aggregate deal value also dropped from Australian private equity funds are sitting upon a mountain A$17.3 billion to A$16.1 billion. Consumer discretionary and of “dry powder” (i.e. capital yet to be deployed by investment healthcare were key sectors of investment. in portfolio companies), reported by the AIC to be over A$13 Of the private equity transactions that completed, take-private billion in 2019; therefore, there will be capital available for new transactions featured prominently again during the course of investment by funds confident enough to act. It would seem the past year. In particular, the privatisation of Healthscope highly likely that new opportunities will transpire in the health- Limited for A$5.7 billion in January 2019 and Navitas Limited care sector, for instance. for A$2.087 billion in March 2019 made the top five list of However, there are new regulatory factors that will provide a largest private equity backed buy-out deals in Australia in 2019. chilling effect on potential investment, in particular the present At a macro level, overall public-to-private transactions repre- temporary A$0 monetary threshold for the Foreign Investment sented 53% of total Australian buy-out deal value in 2019. Review Board (FIRB) review for inward investment (as to Australian start-ups, particularly fintech, is an emerging area which, see the answer to question 4.1) and future changes to in Australia, having had a substantial upward growth trend over the FIRB regime (as to which, see the answer to question 10.2). the past five years. For instance, aggregate venture capital deal values in Australia have increased from A$0.8 billion in 2015 to

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1.4 Are you seeing any types of investors other 2.3 How is the equity commonly structured in private than traditional private equity firms executing private equity transactions in your jurisdiction (including equity-style transactions in your jurisdiction? If so, institutional, management and carried interests)? please explain which investors, and briefly identify any significant points of difference between the deal terms offered, or approach taken, by this type of investor and Institutional investors might typically participate by acquiring that of traditional private equity firms. bid 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 Private equity is a comparatively undeveloped segment in the to question 2.5) with transfer restrictions/drag-along rights for Australian mergers and acquisitions market relative to the UK and institutional investors on exit. US, for instance, so we would not expect to see private equity-style transactions generally gaining traction with a broader range of investors and markedly different deal terms being offered than for 2.4 If a private equity investor is taking a minority those firms practising across other jurisdictions. That being said, position, are there different structuring considerations? there have been some early signs of investments which might be said to have some private equity-style characteristics being made The lack of control involved in a minority investment means by superannuation funds, such as AustralianSuper’s investment in that structuring must be very carefully considered to ensure Prospa’s A$43.3 million private funding round in October 2018. either that the private equity investor has sufficient veto rights and other protections as regards how the investee is managed, 2 2 Structuring Matters and also to ensure that the private equity investor can both avoid value destroying dilution of its ownership and be able to obtain a 2.1 What are the most common acquisition structures swift exit from the investment on fair terms, should the investor adopted for private equity transactions in your be unhappy with the direction of the investee company. Good jurisdiction? legal advice at the “heads of agreement/terms sheet” stage is usually critical to ensuring that the appropriate structures can Private equity funds can take a combination of equity and debt be agreed in detail at an early stage, as introducing such protec- interests in targets, structured by any combination of: tions later in the process will usually be met with stiff resistance. ■ convertible subordinated loans. Unsecured loans subordinated to senior and mezzanine debt (e.g. acquisition debt) 2.5 In relation to management equity, what is the potentially convertible into equity immediately prior to typical range of equity allocated to the management, and exit; what are the typical vesting and compulsory acquisition ■ preference equity. Preference shares offering a coupon provisions? during the term of investment but potentially pari passu with ordinary shares upon exit; and/or The typical range of equity allocated is between 5% and 15%. ■ ordinary shares. Potentially pari passu with management Vesting can depend on the anticipated time of exit, whether a interests. non-recourse loan has funded the subscription’s proceeds and Warrants can also be taken by private equity funds, i.e. options the structure of the management’s equity. over unissued shares, potentially for greater control on realisa- Vesting and compulsory acquisition provisions depend on the tion of downside risks, e.g. unsatisfactory management perfor- management interest’s legal structure. Where management take mance/covenant breaches in special/distressed situations. actual shares, vesting and compulsory acquisition provisions will be familiar from other jurisdictions, including: 2.2 What are the main drivers for these acquisition ■ vesting provisions whereby management’s equity interest structures? is adjusted by “ratchet” referable to factors such as length of service and the company’s financial performance relative to milestones/targets; and Relative composition of debt/equity interests depends on factors ■ compulsory acquisition provisions upon management including: departure, alternating between: ■ requirements of third-party financiers, e.g. for subordina- ■ bad-leaver – management interest acquired at cost/book tion of private equity fund debt interests; value upon departure: ■ requirements of private equity fund investors, e.g. as to ■ at own volition, e.g. prior to fixed date; or balance of interim income (favouring debt/preference ■ on termination for cause/not meeting agreed shares) and final capital returns (favouring equity); performance; and ■ tax planning for: (a) private equity investors; (b) port- ■ good-leaver – management interest acquired at fair folio company, e.g. deductibility of debt interest payments; market value upon departure: and (c) management, e.g. meeting criteria for equity tax ■ at own volition, e.g. prior to fixed date; or incentives; ■ on faultless incapacity, e.g. long-term illness/ ■ prospective cash-flows, i.e. the company’s ability to service termination without cause. existing and additional debt interest; and Alternatives to actual shares include: ■ deals with incumbent/incoming management, e.g. real ■ options over unissued shares at nominal/no strike price, equity incentives. vesting in actual shares on service/performance-based events (potentially according to “ratchet”); exit events; and/or “good leaver” departures; or ■ phantom schemes – management receive a cash bonus of the amount their equity interest would have realised, subject to “ratchet”, upon exit event or “good leaver”/“bad

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leaver” departure, being easier to operate as a simple debt constitutions are not ordinarily a public document, so there is obligation of the company, but possibly unpopular with not normally confidentiality lost in duplicating shareholders’ management seeking a voting interest or equity tax incen- agreement provisions in the constitution, where appropriate. tive criteria being met. 3.2 Do private equity investors and/or their director 2.6 For what reasons is a management equity holder nominees typically enjoy veto rights over major usually treated as a good leaver or a bad leaver in your corporate actions (such as acquisitions and disposals, jurisdiction? business plans, related party transactions, etc.)? If a private equity investor takes a minority position, what veto rights would they typically enjoy? Given the comparative smallness of the private equity market in Australia relative to the UK or the US, leaver provisions are less standardised than they are elsewhere. Yes. It is not unusual to include in shareholders’ agreements veto In Australia, we would typically see “good leaver” treatment rights against any of the following: material M&A; commencing/ for an executive who leaves because of death, permanent disa- defending litigation; related party transactions; incurring (addi- bility or incapacity, or is otherwise agreed to be a good leaver. tional) debt; changing the nature of the business; and/or adopting The typical consequence is the ability to sell shares at fair market or changing business plans/strategy. value. We would typically see “bad leaver” designation for any Private equity investors holding minority interests (but with executive that is not a “good leaver” (commonly one who leaves over 25% voting rights) ordinarily have veto rights under the to take a better offer of employment before exit). The typical Corporations Act 2001 (Cth) (Corporations Act) over: consequence is the compulsory acquisition of their shares at ■ modification/repeal of constitution; cost, unless the fair market value is lower. ■ change to company name; ■ change to legal classification, e.g. proprietary company 3 2 Governance Matters becoming public; ■ selective reduction of capital or buy-back of shares; ■ giving financial assistance; and 3.1 What are the typical governance arrangements ■ members’ scheme of arrangement. for private equity portfolio companies? Are such Statutory veto rights can be: arrangements required to be made publicly available in your jurisdiction? ■ negated by increased voting rights attached to majority shares in respect of any/some/all relevant votes; or ■ increased by additional shareholders’ agreement veto Private equity investors and management will often enter into rights (see the response to question 3.3). a shareholders’ agreement governing their relationship and commonly dealing with: ■ management constitutional issues: 3.3 Are there any limitations on the effectiveness of ■ quora for directors’ and shareholders’ meetings; veto arrangements: (i) at the shareholder level; and (ii) at the director nominee level? If so, how are these typically ■ director removal/nomination rights for private equity addressed? investors; and ■ potential referral rights for votes from board to shareholders where not otherwise required by statute; (i) If the company is party, shareholders’ agreement veto ■ management operational issues: rights might not be effective in fettering the company’s stat- ■ performance targets/milestones and impact on utory powers if employed against the company rather than its management incentive, e.g. equity “ratchet”; shareholders, if the English House of Lords’ decision in ■ information rights over financial reports/performance Russell v Northern Bank Development Corporation Ltd is applied against lending covenants; and in Australia – the same applies if such veto rights appear in ■ veto rights where not otherwise available under corpo- the constitution. ration law for: Russell v Northern Bank may be mitigated in any event by ■ dilutive issues of equity (alternatively pre-emption weighted voting rights (potentially varying by subject- rights); matter) facilitating statutory majorities not being obtain- ■ incurring (further) debts (depending upon existing able where minorities object, even without statutory veto negative pledges); rights. ■ approving budgets/business plans; (ii) Nominated directors are subject to the same statutory ■ approving M&A; and and common law fiduciary duties as other directors. At ■ approving dividends/distributions; and least while the company is solvent, they have to take into ■ exits: account its best interests, being the interests of all share- ■ equity lock-ups prohibiting transfers by management/ holders, not just those who nominate them. other investors outside: The exercise of a board veto willed by a shareholder might ■ permitted transfers (e.g. intra-group/declarations not be in the interests of all shareholders and therefore of trust); in breach of that nominated director’s fiduciary duties. ■ transfers subject to good-leaver/bad-leaver This could be dealt with by provision in the shareholders’ mechanics; and agreement/constitution permitting directors to refer veto ■ pre-emption rights/drag-along/tag-along exit rights. matters to a shareholder meeting, where fiduciary duties Shareholders’ agreements for proprietary (e.g. private) do not apply. Nevertheless, such a right should be consid- companies are private contracts and, unlike in the UK, their ered carefully to not become routine, and may entail potential shadow director liability for nominating shareholders.

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3.4 Are there any duties owed by a private equity (ii) Although investors would generally be protected by corpo- investor to minority shareholders such as management rate limited liability and the “corporate veil”, key poten- shareholders (or vice versa)? If so, how are these tial risks/liabilities for investors that nominate directors typically addressed? to boards include “shadow director” responsibility for the liabilities described in (i) above, if the investor is deemed Legal duties are not owed as a general matter by private equity (amongst other things) to be a person “in accordance with investors to minority shareholders merely by virtue of all being whose instructions or wishes the directors of the corpora- shareholders (fiduciary duties do not apply). The same applies tion are accustomed to act”. There are also exceptions to vice versa, save to the extent of fiduciary duties owed by manage- the “corporate veil”, e.g. fraud. ment shareholders in their separate capacity as directors/ officers. Investors may nonetheless be mindful of: 3.7 How do directors nominated by private equity ■ contractual duties under shareholders’ agreements, e.g. investors deal with actual and potential conflicts of provision of financial information; and interest arising from (i) their relationship with the party ■ general legal protections for minority shareholders, e.g. nominating them, and (ii) positions as directors of other orders in respect of [majority] conduct deemed: portfolio companies? ■ contrary to the interests of shareholders as a whole; or ■ oppressive to, unfairly prejudicial to, or unfairly Nominated directors are prima facie required by statute (and poten- discriminatory against, a shareholder or shareholders tially also by the constitution/shareholders’ agreement) to notify whether in that capacity or in any other capacity. other directors of material personal interests in matters relating to the affairs of companies due to either their: (i) relationship 3.5 Are there any limitations or restrictions on the with their appointor; or (ii) position as directors of other port- contents or enforceability of shareholder agreements folio companies, subject to exceptions. Notice does not, of itself, (including (i) governing law and jurisdiction, and (ii) discharge the statutory duty to exercise powers in good faith in the non-compete and non-solicit provisions)? best interests of the corporation and common law fiduciary duties. However, statutory disclosure for proprietary companies (i) There is no general prohibition on shareholder agreements permits (subject to constitution): (a) voting on matters relating to including non-domestic governing law and jurisdiction the interest; (b) approving transactions that relate to the interest; provisions. and (c) retaining transaction benefits. The company may not (ii) Non-compete/non-solicitation provisions are subject to the (subject to constitution) avoid transactions merely because of same limitations as in ordinary commercial contracts, being a disclosed director’s interest or an interest within the statutory potential invalid under common law restraint of trade. To exception to disclosure. be enforceable, relevant provisions have to protect a legit- Statutory/common law duties might also be mitigated by consti- imate business interest (e.g. private equity investor against tutional/shareholders’ agreement provisions accepting conflicts of departing management) with reasonable scope in terms of interests represented by appointor shareholders/appointments to duration and geographical/business reach. other portfolio company boards, provided directors’ actions are otherwise consistent with company law. Non-statutory/constitutional internal management protocols can also regulate conflicts. 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 4 2 Transaction Terms: General portfolio companies? What are the key potential risks and liabilities for (i) directors nominated by private 4.1 What are the major issues impacting the timetable equity investors to portfolio company boards, and (ii) for transactions in your jurisdiction, including antitrust, private equity investors that nominate directors to foreign direct investment and other regulatory approval boards of portfolio companies? requirements, disclosure obligations and financing issues? Overseas investors should note that proprietary companies need at least one director who is ordinarily residing in Australia. Regulatory timing constraints include: (i) Key potential risks/liabilities for nominee directors ■ Foreign investment approval. A description of all circum- include: stances in which notification might be made under ■ breach of statutory duties and common law fiduciary the Foreign Acquisitions and Takeovers Act 1975 (Cth) (as duties, with a wide variety of civil/criminal penalties amended) and the Foreign Acquisitions and Takeovers Regulation and/or an obligation to compensate the company; and 2015 (Cth) is beyond the scope of this response, but as a ■ insolvent trading for board members when: the result of the Foreign Acquisitions and Takeovers Amendment company incurs a debt and there are reasonable (Threshold Test) Regulations 2020 introduced by the grounds for suspecting that the company is or would Australian Government in the context of the COVID-19 become insolvent; and the company is insolvent, or pandemic, monetary thresholds for many actions subject becomes insolvent by incurring that debt. to Australia’s foreign investment regime have been set at Statutory provisions also void mitigation of these risks by nil. The Australian Government’s FIRB’s accompanying companies: guidance (Guidance Note 53) suggests the board will work ■ exempting liabilities incurred by persons as officers; with existing and new applicants to extend statutory time- ■ indemnifying persons for most liabilities incurred as frames for reviewing applications from 30 days to up to six officers; and months. ■ payment of premiums for contracts insuring officers ■ Competition approval. A description of all circumstances against many liabilities for wilful breach of duty or in which approval might be sought from the Australian breach of some statutory duties. Competition and Consumer Commission (ACCC) under

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the Competition and Consumer Act 2010 (Cth) (CCA) is simi- 4.2 Have there been any discernible trends in larly beyond the scope of this response. transaction terms over recent years? Pre-transaction notification is often advisable but not mandatory. At present, most notifications request informal Given the more limited volume of Australian private equity merger approval, with no formal timetable. If notified transactions when compared with other jurisdictions, it is diffi- transactions are cleared, the ACCC provides a non-binding cult to verify generalised trends in commercial terms. “letter of comfort” stating no present intention to oppose. The informal ACCC process has two stages. Initial review/“pre-assessment” considers whether transactions 52 Transaction Terms: Public Acquisitions prima facie raise competition concerns and they are cleared where risk of competition issues is considered low. A 5.1 What particular features and/or challenges apply significant proportion of notifications is pre-assessed to private equity investors involved in public-to-private quickly, often within two weeks of notification. transactions (and their financing) and how are these commonly dealt with? A second in-depth public review follows for more contentious mergers, comprising: ■ o two t five weeks of market inquiries with active scrutiny Public-to-private transactions comprise: of information from competitors, suppliers and customers, ■ Off-market takeover. Most takeovers are off-market, being an and other interested persons; offer to all security holders in a bid class (whether or not listed) ■ usually within six to 12 weeks, a decision not to oppose, or for all those securities or a proportion of them, implemented a statement of issues; and either by contractual takeover offer/bid or court-approved ■ if there is a statement of issues, another round of market scheme of arrangement: inquiries which can take an additional six to 12 weeks, or ■ takeover bid/offer: a bidder’s compulsory acquisition is potentially longer. ultimately permitted if the bidder and associates, by the More recently, since 20 March 2020, the ACCC has granted end of the offer period, have: 16 authorisations across a range of industries, allowing busi- ■ relevant interests in at least 90% (by number) of bid nesses to collaborate in response to the COVID-19 pandemic in class securities (whether or not acquired under the circumstances that might previously have been subject to their bid); and regulatory supervision. ■ acquired at least 75% (by number) of securities that Australian Securities Exchange (ASX) listed companies are the bidder offered to acquire under the bid. subject to continuous disclosure obligations and have an imme- The requirement for (broadly speaking) committed diate prima facie obligation to disclose information (such as invest- financing coupled with the uncertainty of meeting these ment or acquisition by private equity investors) that a reason- thresholds and ultimately obtaining approval of finan- able person would expect to have a material effect on the price cial assistance given by the target company in security for or value of their securities. The Corporations Act was modified acquisition leverage tends to mitigate against contractual by the exercise of the Treasurer’s emergency powers to estab- takeover offers/bids by private equity funds; or lish a temporary test that raises the bar on when certain informa- ■ schemes of arrangement: acquisitions with consent of tion will have a material effect on the price or value of securities target security holders according to a court-approved for the purposes of that Act’s civil penalty provisions and there- procedure under Part 5.1 of the Corporations Act. The fore should be disclosed. The unmodified test required entities to scheme must be approved by: disclose non-public information that a reasonable person would expect ■ 75% by value; and (generally) to have a material effect on the price or value of the entity’s securities. Under ■ a bare majority in number of holders, of offer class the temporary test, which applies for six months for the purposes securities present and voting in the scheme meeting. of civil proceedings only, non-public information need only be Unlike in the UK, the court has discretion to disclosed if the entity knows or is reckless or negligent with respect to dispense with a majority headcount. whether that information would, if it were generally available, have Votes of the offeror and associates are usually excluded, a material effect on the price or value of the entity’s securities. which makes it difficult to execute schemes where private Disclosure can be deferred for information concerning “an equity offerors already have target stakes. Schemes incomplete proposal or negotiation” where it’s confidential; the ASX provide “all-or-nothing” certainty that, if approved, the has not formed the view that it has ceased to be confidential offeror acquires all scheme class securities, but if not, and a reasonable person would not expect the information to acquires nothing at all, so external leverage need not be be disclosed. Where a public-to-private bidder has made a firm drawn. decision to proceed, this is communicated to the target and ■ Market takeover bid: comprising acquisition of listed securi- announced to ASX immediately with offer terms. The public-to- ties by contractual offer through the stock exchange, which private bidder must make the offer within two months. It typi- must be for all bid class securities, unconditional and in cash. cally takes three to four months to conclude the offer and imple- They are less flexible and less common than off-market take- ment compulsory acquisition. overs, particularly for private equity offerors, but can prove Commercial timing constraints can impact timetables, significantly faster where possible. including acquisition (and possibly syndication) of debt financing Australia is less stringent than the UK in expectations of bid and commercial consents either to novation of, or change financing when offers are made, not requiring the equivalent of of control under, key commercial contracts. If target group UK “cash confirmations”. Nevertheless, both the Australian members will be providing security in respect of acquisition-re- Takeovers Panel (Takeovers Panel) and the ASIC advocate that lated loans then this may require notification to the Australian bidders have reasonable expectations at announcement that Securities and Investments Commission (ASIC) and approval funding (even if subject to drawdown conditions or not formally by shareholders under the “financial assistance” rules of the documented) will be available once an offer becomes uncondi- Corporations Act. tional, otherwise the Takeovers Panel can declare “unacceptable circumstances”.

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However, the Federal Court recently departed from an 6.2 What is the typical package of warranties / objective test for bidders to avoid being “reckless” in breach of indemnities offered by (i) a private equity seller, and (ii) the Corporations Act and suggested bidders’ boards are only the management team to a buyer? “reckless” if: ■ they are subjectively aware of a substantial risk that they Private equity sellers typically try to minimise warranties/ will not meet funding obligations if a substantial propor- indemnities on secondary buy-outs to pursue “clean exits” tion of offers are accepted; and distributing sale proceeds quickly to investors. Sellers often ■ having regard to known circumstances, they were not claim to be “passive investors” not sufficiently informed in justified in taking it. day-to-day operation of the target to give business warran- Legislative reform is likely to be required to harmonise the ties, trying to restrict coverage to title to shares, capacity and legal position with expectations of the ASIC, the Takeovers authority. Buyers in secondary buy-outs typically seek to resist Panel and market participants. such an approach, unless factored in to the consideration paid, and the final outcome will ultimately depend upon a range of 5.2 What deal protections are available to private factors and the competitive forces at work. equity investors in your jurisdiction in relation to public The seller’s management team’s position depends on whether acquisitions? they remain with the company. It will not necessarily make sense for the buyer to seek aggressive legal recourse against incumbent Lock-up devices including “no shop”, “no due diligence” or “no management of their new portfolio company, which mitigates the matching rights” obligations allow private equity investors to value of their warranties/indemnities. Management will often seek exclusivity protection in public acquisitions. Targets often claim an inability in any event to resource substantial liability, pay break fees in recommended bids on transaction failure in trying to limit exposure to a low multiple of annual salary. circumstances such as withdrawal of target board recommen- Buyers seeking substantive recourse from such sellers and dation. However, such protections are frequently subject to a management might initially be told to “bridge the gap” with “fiduciary-out” for the directors of the target. This relieves the warranty and indemnity insurance (see the response to question directors of lock-up obligations (or aspects of them) which may 6.4). be required in their directors’ duties. The Takeovers Panel can declare unacceptable circumstances 6.3 What is the typical scope of other covenants, if the size or structure of break fees pose a disproportionate undertakings and indemnities provided by a private disincentive to competitive bids or unduly coerce target security equity seller and its management team to a buyer? holders. It considers break fees of 1% or less of target equity value “generally not unacceptable” unless payment is subject to Private equity sellers typically agree on covenants/undertakings excessive/coercive triggers. “Naked no vote” break fees (i.e. from signing to completion for maintenance of present conduct payable where a bid is rejected by security holders even in the of target business (whether or not to support “locked-box” absence of competing proposals) can fall into this category. consideration) and assistance with regulatory filings. Covenants It is possible, but less common, for targets to seek reverse could be extended to management, depending upon whether break fees upon transaction failure in circumstances such they remain with the target (i.e. some buyers might not consider as a bidder not obtaining regulatory consent for which it was them necessary for management transferring to them). Sellers responsible, or breaching pre-bid agreements. The Takeovers might also have to stand behind taxation/environmental Panel’s 1% “rule of thumb” does not apply to reverse break fees, indemnities. giving more flexibility in pricing. Non-compete/non-solicitation covenants might also be sought from both sellers and management, particularly seller 62 Transaction Terms: Private Acquisitions non-solicitation where management remain with the target.

6.1 What consideration structures are typically 6.4 To what extent is representation & warranty preferred by private equity investors (i) on the sell-side, insurance used in your jurisdiction? If so, what are the and (ii) on the buy-side, in your jurisdiction? typical (i) excesses / policy limits, and (ii) carve-outs / exclusions from such insurance policies, and what is the Private equity sellers in secondary buy-outs might ideally prefer typical cost of such insurance? “locked box” structures where a fixed price is agreed over the target’s historic or special purpose financial statements. The Warranty and indemnity insurance is certainly available on seller then covenants against value leakage from the statement both the buyer-side (against the buyer’s losses upon acquisition) date to completion. This mechanism’s acceptability has declined and seller-side (against the seller’s liabilities to the buyer under in a less buoyant market for secondary buy-outs. contractual warranties and indemnities, which can leave the buyer Private equity buyers might prefer (and come under pres- taking credit risk on both the seller and insurer). It is not unusual sure from external financiers to require) traditional acquisition for sellers, who wish to limit their exposure or avoid retentions in consideration structures such as “cash-free/debt-free” enterprise escrow, to suggest it. valuations subject to adjustment by completion accounts for a As (generally) a bespoke non-standardised product, it is diffi- target’s completion: (i) cash; (ii) net debt; and/or (iii) working cult to generalise as to typical policy terms, but: (i) excesses/ capital (against expectation). policy limits (and therefore an element of co-insurance from seller) are typical but quantum responds to transaction size/ premium pricing. Typically, excesses are approximately 1% of the enterprise value and policy limits, which are tailored to each transaction, range from 20%–70% of the enterprise value; and (ii) carve-outs/exclusions typically include:

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■ seller’s fraud (excluded from buyer-side policies); commitment letter and term sheet, replaceable with defin- ■ matters known to the buyer at completion; itive financing documents if the private equity bid is ■ consequential losses (e.g. lost profits); and successful. ■ environmental liabilities, unless specifically negotiated for (ii) Buyers’ equity funding commitments are also often set out inclusion. in commitment letters addressed to target, which repre- Warranty and indemnity insurance in Australia typically costs sent that the buyer has sufficient equity to meet purchase 1%–1.5% of the policy limit (including brokerage). GST and document obligations and commit to drawing down equity stamp duty also apply. finance, subject to transaction conditions precedent. It is not unheard of in Australia for sellers to obtain specifically enforceable rights against buyers for an “equity cure” should 6.5 What limitations will typically apply to the liability of a private equity seller and management team under debt financing not transpire, which are potentially subject to warranties, covenants, indemnities and undertakings? clean-up grace periods for buyers otherwise in default.

To the extent that sellers are successful in limiting warranties/ 6.8 Are reverse break fees prevalent in private equity indemnities to title/capacity/authority (see response to ques- transactions to limit private equity buyers’ exposure? If tion 6.2), secondary buy-out acquirers should expect them to so, what terms are typical? be uncapped or subject to a cap equal to the aggregate purchase price. The management team might try to cap their liability at Reverse break fees are certainly possible (but not necessarily the deductible/excess of applicable insurance or at a relatively low prevalent) in public-to-private transactions (see the response to multiple of aggregate salaries. question 5.2), but less prevalent in private transactions. Where a more expansive limitation regime applies, tax warranties and “fundamental warranties” are typically not subject to de 72 Transaction Terms: IPOs minimis, may not be disclosed against, and have a limitation period between five and seven years. 7.1 What particular features and/or challenges should For more general business warranties, limitations will be a private equity seller be aware of in considering an IPO familiar from general corporate transactions, e.g.: exit? ■ de minimis thresholds on an individual and/or aggregate “basket” basis below which claims are inadmissible and Once a private equity investor wishes to conduct an IPO in above which claims are permitted either on a whole liability respect of a portfolio company, the existing shareholders’ agree- or excess-only basis; and ment will be terminated. Neither ASX Listing Rules nor market ■ time limitations normally being: practice generally permit typical provisions in shareholder agree- ■ one audit cycle for general business warranties (e.g. ments including weighted voting rights and drag-along rights. An 12–18 months from completion); and IPO would likely require lock-ups and escrow obligations on the ■ longer for long-tail liabilities, e.g. environmental claims. sellers in respect of their retained shares in the listed company.

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 the management team)? Historically, Australian sellers were not restrained from disposing their shareholding on IPO, but, recently, the (i) Sellers typically resist customary requests on secondary Australian market has caught up with the US – in order to obtain buy-outs for purchase price retention in escrow pending the best price, exiting sellers will often yield to demands from term expiry of (most) warranties/indemnities, as escrow new investors that they retain a substantial target stake in the impedes distribution of sale proceeds from the seller fund newly listed business at least until release of the first full-year to investors. Ultimately, presence/absence of escrow financial results post-listing. Apollo Global Management LLC should therefore factor into valuation discussions. and Oaktree Capital Management L.P. entered into voluntary (ii) Buyers in secondary buy-outs ideally seek escrow support escrow in respect of shares held by their funds upon IPO of for warranties/liabilities from both seller and manage- Nine Entertainment Co. Holdings Limited until publication ment. Departing management can find it more difficult of the company’s full-year results. In a common exception to to argue against because they are not generally under the “lock-up”, they could sell down 25% of their shares in escrow if same pressure for rapid distribution of proceeds. In either first half-yearly results had been published and the share price case, secondary buy-out acquirers face suggestions that over 20 days was at least 20% higher than the IPO price. insurance is an appropriate substitute for escrow (see the Mandatory lock-up obligations may be imposed by the ASX response to question 6.4). in certain circumstances, typically where the entity to be listed does not have a history of profits or is otherwise a speculative investment. 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 do sellers 7.3 Do private equity sellers generally pursue a dual- typically obtain in the absence of compliance by the track exit process? If so, (i) how late in the process are buyer (e.g. equity underwrite of debt funding, right to private equity sellers continuing to run the dual-track, specific performance of obligations under an equity and (ii) were more dual-track deals ultimately realised commitment letter, damages, etc.)? through a sale or IPO?

(i) The debt financing package is often set out in a debt Although less common than trade sale exits in practice, dual-track

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exit processes are often cited as a means to try to drive compet- of returns (i.e. potentially a deductible interest expense or itive tension. A continuing decline in the amount of IPOs and potentially a frankable dividend, respectively). Determination private placements as a proportion of total buy-out exits has is made by Division 974 of the Income Tax Assessment Act 1997 been reported by the Association of Investment Companies; (Cth). Broadly speaking, it operates to treat all holders of: ordi- IPOs represented 53% of all exits in 2015, 30% in 2016, 20% in nary shares; preference shares; convertible securities; and secu- 2017, and 6% in 2018. rities, the returns of which are a function of target performance, as holders of equity interests provided that they do not also satisfy 82 Financing the requirements of a debt interest. Usually, an arrangement will satisfy the requirements of a debt interest if the entity subject to it 8.1 Please outline the most common sources of debt has an effectively non-contingent obligation under the arrange- finance used to fund private equity transactions in your ment to provide a benefit in the future (e.g. the repayment of a jurisdiction and provide an overview of the current state loan) and it is substantially more likely than not that the value of the finance market in your jurisdiction for such debt provided will at least be equal to the value received. (particularly the market for high yield bonds). Off-shore tax structures are common in the Australian private equity landscape. Traditionally, the legal vehicle most commonly Senior secured debt and mezzanine (or subordinated) debt are used has been the limited partnership domiciled in a jurisdiction the most common sources of funding for private equity trans- offering tax neutrality, such as Delaware, the Cayman Islands or actions in Australia, initial buy-out financing traditionally being the British Virgin Islands. Australia has been proposing a new limited to a few institutional bank lenders. High-yield bonds corporate collective investment vehicle (CCIV) regime since and securitisation structures have not generally been taken up, 2017, without implementation to date. The proposed CCIV but bridge loans have occasionally been used to fund acquisi- regime will provide investors with the ability to obtain deemed tions, which might then be replaced by high-yield debt or retail capital gains tax (CGT) treatment and a reduced rate of with- debt securities, but this has not been typical. holding tax when investing from a country that has entered into an exchange of information agreement with Australia. It is also worth noting that the Australian Taxation Office 8.2 Are there any relevant legal requirements or (ATO), in its efforts to combat multinational tax avoidance, restrictions impacting the nature or structure of the debt continues to review the structures created and held off-shore financing (or any particular type of debt financing) of private equity transactions? by multinational corporate groups to which Australia’s cross- border and general anti-avoidance rules may apply.

Like the UK but unlike much of the US, Australia has a statutory prohibition upon financial assistance given by a company 9.2 What are the key tax-efficient arrangements that to a person to acquire shares in that company or in its holding are typically considered by management teams in private equity acquisitions (such as growth shares, incentive company. The prohibition typically pertains to the giving of shares, deferred / vesting arrangements)? security for acquisition debt without direct consideration. “Whitewash” shareholder approval either by a unanimous shareholder resolution or by a special resolution (75%) passed by Shares and options granted for less than market value may be shareholders other than the buyer and its associates, is required subject to employee share scheme (ESS) provisions resulting in to the extent financial assistance is materially prejudicial to the gain being taxed as income rather than capital. The taxing point interests of the company or its shareholders or its ability to pay under those provisions is either upon grant or on a deferred basis its creditors. If required, shareholder approval must be obtained (i.e. until vesting or exercise). Tax may generally be deferred for and the ASIC notified thereof at least 14 days before the giving qualifying options until exercise, rather than vesting. To qualify of the financial assistance. for deferral, an employee can hold up to 10% of the ownership interests of the employer for up to 15 years from grant.

8.3 What recent trends have there been in the debt financing market in your jurisdiction? 9.3 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? The bank market still represents a significant portion of the overall funding market in Australia, primarily utilising traditional syndicated loans. However, recent times have seen Australia imposes a somewhat complicated CGT regime on a convergence of terms from Europe and the US with the many investments, which may apply to individuals within any increasing prevalence of international sponsors and the local management team. The ability to access CGT concessions increasing prevalence of unitranche and term loan B (TLB) and be able to roll over any capital investment into a new invest- financing, and the associated first lien and second lien struc- ment without triggering an immediate CGT liability may be tures, in addition to the traditional mezzanine financing that important to management teams when considering a new acqui- remains commonplace. sition structure.

92 Tax Matters 9.4 Have there been any significant changes in tax legislation or the practices of tax authorities (including in relation to tax rulings or clearances) impacting private 9.1 What are the key tax considerations for private equity investors, management teams or private equity equity investors and transactions in your jurisdiction? transactions and are any anticipated? Are off-shore structures common?

Amendments to Australia’s hybrid mismatch rules that were A key tax consideration for investors is classification of their foreshadowed in the 2019–2020 Budget were introduced to investment as debt or equity to determine corporate tax treatment

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Parliament on 13 May 2020 in Treasury Laws Amendment (2020 businesses has yet to be defined but it is understood that it could Measures No. 2) Bill 2020. As at the date of writing, the Bill has include assets in technology, energy, communications, water, not been passed by the Parliament into law. ports, data and other sectors considered crucial to Australian national security. If implemented, this could conceivably have 102 Legal and Regulatory Matters a material impact of the identification of potential portfolio companies. 10.1 Have there been any significant legal and/or regulatory developments over recent years impacting 10.3 How detailed is the legal due diligence (including private equity investors or transactions and are any compliance) conducted by private equity investors prior anticipated? to any acquisitions (e.g. typical timeframes, materiality, scope, etc.)? ARFP The Asia Region Funds Passport (ARFP) is an initiative led Investees should expect a level of detailed due diligence from by the Asia-Pacific Economic Cooperation (APEC) with the private equity investors in Australia that is comparable to that objective of attracting and keeping finance within the region undertaken in similar jurisdictions, e.g. the UK and US, custom- to foster its economic growth, and strengthen the invest- arily principally driven by financial due diligence on reve- ment management industry. Five countries (Australia, Japan, nues and assets, but also extending to regulatory compliance Korea ,New Zealand, and Thailand) signed a Memorandum of depending on the industry (especially in financial services). Understanding to participate in the ARFP. Financiers and warranty and indemnity insurers can demand The ARFP has been live since 1 February 2019. Australia, their own detailed diligence processes with their own external Japan and Thailand are ready to receive registration applications counsel and should not necessarily be expected to merely be from local prospective Passport funds and entry applications content to “piggy-back” investor due diligence. from foreign Passport funds. Korea and New Zealand continue to make progress with the legal and regulatory requirements for 10.4 Has anti-bribery or anti-corruption legislation implementation required in their respective jurisdictions. The impacted private equity investment and/or investors’ APEC is continuously promoting the ARFP scheme to other approach to private equity transactions (e.g. diligence, member countries for consideration. Potential new joiners contractual protection, etc.)? could include India, Indonesia, the Philippines, Singapore and Vietnam (currently observers in the ARFP working group). Private equity investors will clearly seek protection in the The ARFP allows units of funds authorised in a participating context of avoiding acquisitions of Australian businesses that country (home jurisdiction) to be offered in other partici- conduct business in sanctioned jurisdictions or have relation- pating countries (host jurisdictions) upon approval as an ARFP ships with sanctioned or politically exposed persons. Applicable fund and host jurisdiction authorisation. The ARFP empha- risks are typically excluded from warranty and indemnity insur- sises investor protection by ensuring that participating coun- ance coverage, such that an investor would commonly seek tries meet the standards of the International Organisation of contractual protections by way of specific indemnity. Securities Commissions (IOSCO). Key requirements of an ARFP fund are that it must: ■ Be constituted or established as a regulated Collective 10.5 Are there any circumstances in which: (i) a private Investment Scheme (CIS) or a sub-fund of a regulated CIS equity investor may be held liable for the liabilities of in one of the participating ARFP jurisdictions. the underlying portfolio companies (including due to ■ Be distributed in its home jurisdiction. breach of applicable laws by the portfolio companies); and (ii) one portfolio company may be held liable for the ■ Have a net asset value of at least US$500 million. liabilities of another portfolio company? ■ Only invest in specific asset classes: transferable securities; money market instruments; deposits; depositary receipts over gold; derivatives; and units of other funds. Further The corporate veil can be pierced such that a private equity investor details can be found in the ARFP rules document. may suffer liabilities as a result of the actions of an investee port- The fund’s operator must have a minimum capital of US$1 folio company through fraud or in limited circumstances through million, plus 0.1% of Assets under Management (AuM) above the operation of particular legislation, such as acting as a shadow US$500 million of AuM, up to US$20 million. director or under section 545 of the Fair Work Act 2009 (Cth), which empowers a court to order that an accessory (which can include shareholders) be liable to back-pay employee entitlements. 10.2 Are private equity investors or particular It should be very rare that a portfolio company be held liable transactions subject to enhanced regulatory scrutiny in for the liabilities of another portfolio company outside of contrac- your jurisdiction (e.g. on national security grounds)? tual cross-guarantees, but it could conceivably occur if group arrangements are deemed to be a fraud/sham and the corporate It would be unfair to suggest that the regulatory scrutiny of veil pierced. investors or transactions in Australia at present, by bodies such as FIRB or the ACCC (as to which, see the answer to question 112 Other Useful Facts 4.1), is necessarily any more intensive in respect of private equity investors or the transactions that they normally contemplate, 11.1 What other factors commonly give rise to concerns than for other investors. It should, however, be noted that, on 5 for private equity investors in your jurisdiction or should June 2020, the Australian Treasurer proposed major changes to such investors otherwise be aware of in considering an the foreign investment regime with effect from 1 January 2021, investment in your jurisdiction? which would impose a permanent A$0 investment notification and approval threshold for investments in sensitive national Australia is a relatively open economy with a freely floating security businesses. The definition of sensitive national security

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currency and no foreign exchange controls. It has well-developed financial markets and a sophisticated professional services sector, with a strong and impartial legal and judicial system that remains very similar to that of the UK. It is thus a jurisdiction posing relatively few concerns to private equity investors. These responses describe the law and policies in force as at 12 August 2020. The above is intended for general information purposes only and is not intended to constitute the giving of any legal advice (which should always be specific to individual circumstances) and, therefore, the above should not be relied upon as advice by any person for any purpose.

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Lawson Jepps Professional qualifications: New South Wales, Australia, solicitor; England and Wales, solicitor. Areas of practice: public mergers and acquisitions; private mergers and acquisitions; business sales; joint ventures; capital markets; securities; private equity; corporate governance; and corporate advisory. Non-professional qualifications: B.A. (Hons), Oxford University.

Atanaskovic Hartnell Tel: +61 2 9224 7091 Atanaskovic Hartnell House Email: [email protected] 75–85 Elizabeth Street URL: www.ah.com.au Sydney NSW 2000 Australia

Formed in 1994, Atanaskovic Hartnell’s lawyers are recognised for International; WIN Corporation and Bruce Gordon; Consolidated Press and their legal expertise. A number of the firm’s lawyers are internationally Publishing and Broadcasting companies; Messrs James Packer and Peter acknowledged as leaders in their fields, and are all highly regarded for their Yates; and four former non-executive directors of James Hardie Industries. commerciality, astuteness and tenacity. In contrast with some of the firm’s www.ah.com.au 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 that 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

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Austria Austria

Florian Philipp Cvak

Schindler Attorneys Clemens Philipp Schindler

12 Overview 1.3 What are going to be the long-term effects for private equity in your jurisdiction as a result of the COVID-19 pandemic? 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? We anticipate that the COVID-19 pandemic will result in several opportunities for special situations funds and gener- alist funds with a broader investment mandate over the next Austria has seen the full spectrum of private equity transactions. couple of years. That could be because a seller in distress must In the large-cap (buyout) segment (deals values of EUR 100 divest non-core businesses because of pressure from the banks million and above) the main trend over the last years was the or a target company itself is in distress. Transactions could increased use of vendor due diligence and warranty and indem- take various forms, including straight buyouts to hybrid equity nity insurance as well as the increased interest of debt funds and could take place in all segments and sectors; we do antici- to finance the term loan facilities in leveraged buyout trans- pate retail and travel to be affected the most by the pandemic. actions (“LBO”). In terms of sectors, there was no discern- Dedicated distressed situations funds and debt funds active in ible trend. This is mainly due to the limited number of trans- stressed financing will also see a lot of deal opportunities. actions within that segment. In the mid-cap (buyout) segment (comprising deals with values between EUR 10 million and EUR 100 million, which make up the vast majority of Austrian 1.4 Are you seeing any types of investors other deals) and typically target family- or founder-owned businesses than traditional private equity firms executing private tax-optimised roll-over structures were often used which allow equity-style transactions in your jurisdiction? If so, founders or other sellers to reinvest part of the sale proceeds. In please explain which investors, and briefly identify any significant points of difference between the deal terms terms of sectors, technology, healthcare, industrials and business offered, or approach taken, by this type of investor and services accounted for most of the deal flow in this segment. that of traditional private equity firms. Another trend that continued is increased activity in the growth capital segment and the venture capital segment where corporate accelerator and venture capital funds are becoming increas- We see a significant increase of investment holding activity over ingly active and are causing significant competition for tradi- the last two to three years, which mainly comes from Germany. tional venture capital funds. Investors from Asia (in particular, Investment holdings tend to have an entrepreneurial back- China and India) are also regularly playing significant roles. ground and their capital is usually sourced from entrepreneur On the debt side, specialist debt funds have become increas- families only. The main difference to traditional private equity ingly active over the last years, not only in the large-cap (buyout) is their evergreen structure which allows them to invest longer segment. These days debt funds offer all sorts of instruments, term and put less focus on exit provisions. Their entrepre- ranging from growth capital, stressed financing, acquisition neurial background often gives them a competitive advantage in financing to bridge loans and DIP loans. auctions where family-owned businesses are up for sale. 22 Structuring Matters 1.2 What are the most significant factors currently encouraging or inhibiting private equity transactions in your jurisdiction? 2.1 What are the most common acquisition structures adopted for private equity transactions in your jurisdiction? Please see question 1.1. Austrian companies often have substantial CEE exposure The typical onshore acquisition structure involves one or more which is perceived as an opportunity by some private equity holding companies (“HoldCos”) and an acquisition vehicle funds, but it is an issue for other funds who must not invest (“BidCo”), which then enters into the purchase agreement and in targets in the CEE, or with considerable CEE exposure, ultimately acquires the shares. From a tax perspective, this pursuant to their investment mandate. With CEE developing, multi-layer holding structure is no longer necessary (see ques- we have seen this becoming a lesser issue over the last couple tion 2.2). In leveraged transactions, interim holding companies of years. are, however, often still needed as senior lenders typically insist that junior lenders lend a level higher in the structure to achieve

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not only contractual subordination (which is achieved through 2.4 If a private equity investor is taking a minority an inter-creditor or subordination agreement), but also struc- position, are there different structuring considerations? tural subordination of junior debt. Private equity funds will usually try to maximise debt in the Private equity investors taking a minority position typically insist financing structure for a transaction. The difference between on new governance documents (for a description, see question available bank debt and the purchase price is financed by the 3.1). Where that request is rejected, the investor must carefully fund through a combination of debt (so-called “institutional analyse what rights are available to him following completion debt”) and equity. How much institutional debt can be employed under the existing governance documents and, where necessary, is determined by “thin cap” rules. While there are no statutory request amendments. In that process, it is important to become rules in place, debt-to-equity ratios of 3:1 to 4:1 are generally familiar with the minority protections already available under the accepted by the Austrian tax authorities. law, which of them are mandatory, which of them can be amended Where bank debt is employed, the target company is usually to the benefit of minority shareholders only, and which of them required to accede to the financing documents on an exclu- can be amended without restriction. Which protections are avail- sive lender basis (to avoid structural subordination to existing able differs but, generally, protection includes information rights, lenders) and to grant guarantees and security interests securing rights to call a shareholders’ meeting, quorum, and voting require- acquisition debt as well as the refinanced target company debt on ments for major corporate actions (such as corporate restructur- or shortly after completion. To the extent guarantees and secu- ings, a change of the company’s purpose, changes to the articles rity interests secure acquisition debt, capital maintenance and, of association, dealings involving all or substantially all of the where a joint stock company (“JSC”) is involved, financial assis- business or assets, and squeeze-outs of shareholders). tance rules are a concern. Transactions violating capital maintenance rules are null and void between the parties as well as any third party (e.g. the financing bank) if that third party knew, or 2.5 In relation to management equity, what is the should have known, of the violation. In addition, the members typical range of equity allocated to the management, and of the management and supervisory board who approved the what are the typical vesting and compulsory acquisition provisions? transaction may be subject to liability for damages. Transactions violating financial assistance rules, on the other hand, are not void but may result in liability of the members of the manage- Management equity is typically subject to vesting over a period of ment and supervisory board who approved the transaction. three to five years. Compulsory transfer provisions apply upon Both issues are usually addressed in the financing documents by termination of the manager, with consideration varying depending “limitation language” which limits the obligations of Austrian on the reason for termination (a “good” or a “bad” leaver), obligors to an amount and terms compliant with capital mainte- although structures have become less aggressive in that regard due nance and financial assistance rules. to recent developments in Austrian labour law. In addition, the private equity fund will require a right to drag-along the management shares upon an exit and will often insist on pooling of the 2.2 What are the main drivers for these acquisition management shares in a pooling vehicle (often a partnership). structures?

The main drivers for the acquisition structures described under 2.6 For what reasons is a management equity holder usually treated as a good leaver or a bad leaver in your question 2.1 are tax and subordination. jurisdiction? With regard to taxes, the main argument for Austrian multi- layer HoldCo and BidCo structures was the availability of goodwill amortisation on share deals and that capital tax on capital In their simplest form, good and bad leaver provisions make contributions could be avoided through indirect parent contri- reference to employment law and treat a manager as a bad leaver butions; neither have any relevance anymore. Austrian HoldCos if he is dismissed (entlassen) by the company for good cause or if he and BidCos can, however, still enter into a tax group with the resigns on his own initiative without cause (ohne wichtigen Grund ). target company. This allows for a set-off of interest expenses at More sophisticated provisions specifically define good leaver and HoldCo and BidCo level with the taxable profits of the target bad leaver cases (this includes dismissal for pre-defined “causes” company (for a more detailed discussion, please see question 9.1). with covers things like felonies against the company such as fraud or embezzlement and breaches of material obligations). Resignation without cause is typically seen as a bad leaver case 2.3 How is the equity commonly structured in private unless the manager has “good reasons” for his resignation (e.g. equity transactions in your jurisdiction (including health). Attaining retirement age, death or permanent incapacity institutional, management and carried interests)? or disability are typically seen as good leaver case.

Institutional equity is usually given offshore and passed onto the 3 2 Governance Matters Austrian HoldCo and BidCo structure through (direct or indirect) capital contributions or shareholder loans. Management equity is often given in the form of actual shares, 3.1 What are the typical governance arrangements for private equity portfolio companies? Are such either in the target company itself (or the entity in which the exit arrangements required to be made publicly available in is expected to occur) or shares in entities further above. From your jurisdiction? a tax perspective, actual shares (and certain other equity interests) may have benefits relative to phantom stock and contractual bonus scheme arrangements, as gains realised upon an exit The governance documents typically include: may be eligible for capital gains taxation. ■ a shareholders’ agreement; ■ new articles of association; and ■ by-laws for the management board and supervisory board (if any).

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The main areas of concern in the governance documents are 3.4 Are there any duties owed by a private equity the private equity fund’s rights to appoint sponsor representa- investor to minority shareholders such as management tives (and/or observers) to the supervisory board (if any) or advi- shareholders (or vice versa)? If so, how are these sory board (if any), sponsor representative liability and conflicts typically addressed? of interest, veto rights of the fund (and/or the sponsor representative) (see question 3.2), dilution protection for the fund, Austrian courts have consistently held that shareholders owe a a liquidation preference for the fund, restrictions on dealings duty of loyalty (Treuepflicht) towards one another, requiring them with shares (typically including a lock-up, rights of first refusal, to consider the interests of their fellow shareholders in good tag-along, and drag-along rights), exit rights for the fund (via a faith (Treu und Glauben) and in line with bonos mores (gute Sitten). trade sale, an IPO or a shotgun mechanism) as well as reporting, That duty is more pronounced for closely held companies than information and access rights. for widely held companies and differs from shareholder to share- In the majority of cases, the fund will also insist that senior holder, depending on their ability to cause a certain action to be management signs up to an (equity) incentive scheme (see ques- taken or not to be taken. A majority shareholder may there- tion 2.3) and that all of the management team (and sometimes also certain other key personnel) enters into new employment fore be exposed to liability in circumstances where a minority agreements on terms agreed with the fund. shareholder is not (because his appearance or vote would not To the extent the above arrangements are included in the arti- have mattered in the circumstances anyway). A violation of the cles of association (which has some benefits for some (but not duty of loyalty may result in claims for damages, cease and desist all) of them from an enforcement perspective (see question 3.3)), orders, or a challenge (Anfechtung) of shareholder resolutions. they are publicly accessible through the companies register. In addition, certain arrangements may have to be disclosed under 3.5 Are there any limitations or restrictions on the Securities Law disclosure requirements. contents or enforceability of shareholder agreements (including (i) governing law and jurisdiction, and (ii) non-compete and non-solicit provisions)? 3.2 Do private equity investors and/or their director nominees typically enjoy veto rights over major corporate actions (such as acquisitions and disposals, Shareholders’ agreements are typically governed by Austrian business plans, related party transactions, etc.)? If a law and the competent courts at the seat of the company typi- private equity investor takes a minority position, what cally have jurisdiction. This is mainly because disputes related veto rights would they typically enjoy? to shareholders’ agreements are usually supported by arguments based on Austrian corporate law and corporate law disputes The governance documents will typically include veto rights must be brought before the courts at the seat of the company. of the private equity fund (and/or a sponsor representative on However, where Austrian court judgments are not enforce- a supervisory board) over major corporate actions and stra- able in the jurisdiction of a particular shareholder, arbitration is tegic decisions (such as acquisitions and disposals, major litiga- sometimes agreed as an option. tion, indebtedness, changing the nature of the business, busi- Non-compete and non-solicitation provisions are generally ness plans and strategy) although the specific requirements vary enforceable for the period of the shareholding (for that period, widely from fund to fund and deal to deal. Usually, such veto contractual restrictions compete with the corporate law-based rights are structured to fall away if the relevant fund’s interest duty of loyalty (see question 3.4)) and for up to two (in excep- is reduced below a certain threshold. Where multiple private tional cases, three) years thereafter. Where a shareholder was equity funds invest, they will generally insist that all investors also an employee (which could be the case for management agree and vote on some set of veto matters, with quorum and shareholders), the restriction will also be scrutinised under majority voting requirements varying widely from deal to deal. employment law and is generally only valid for a period of up to one year and to the extent that the restriction does not unduly 3.3 Are there any limitations on the effectiveness of limit the employee’s future prospects. If backed up by a contrac- veto arrangements: (i) at the shareholder level; and (ii) at tual penalty only its payment can be requested (but not the the director nominee level? If so, how are these typically employee’s compliance). addressed? It should be noted that where a shareholders’ agreement includes an obligation to transfer shares of a limited liability If a veto (or majority) requirement is included in the articles of company (such as an option or a drag-along right), it must be association (and/or by-laws), resolutions violating the arrange- drawn up in the form of an Austrian notarial deed if the obli- ment can be challenged. In contrast, if a veto right (or majority gation to transfer is to be enforceable (note: a German notarial requirement) set forth in the shareholders’ agreement is violated, deed is considered equivalent). only actions for damages and cease and desist orders are available. It should be noted, however, that in one decision the Austrian Supreme Court also accepted a challenge of a share- 3.6 Are there any legal restrictions or other holders’ resolution in breach of a majority requirement set forth requirements that a private equity investor should in a shareholders’ agreement where all shareholders were a be aware of in appointing its nominees to boards of portfolio companies? What are the key potential risks party to the agreement. This will usually be the case in private and liabilities for (i) directors nominated by private equity transactions where the shareholders’ agreement typically equity investors to portfolio company boards, and (ii) provides for a mandatory accession clause. Regarding manage- private equity investors that nominate directors to ment board member actions, it must be noted that, towards third boards of portfolio companies? parties, the power of representation cannot be limited in the shareholders’ agreement, the articles of association, the by-laws or elsewhere in such a way that the company is not bound if a General member transacts in violation of a contractually agreed veto (or Austria has a two-tier board structure. The management board majority) requirement. is responsible for the day-to-day management of the company, while the supervisory board is responsible for monitoring and

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resolving the matters brought before the supervisory board for a investor. However, whenever there is involvement beyond vote (which is a matter for the governing documents). Sponsors that, the investor could face criminal law penalties and civil usually request rights to nominate one (or more) members of the law liability for damages (e.g. where the investor has collabo- supervisory board (Aufsichtsrat) or observers to the supervisory rated with the member on a transaction intended to mislead board, but hardly ever get involved in management. For that another or which is adverse to the interests of shareholders reason, the answers under questions 3.6 and 3.7 will focus on (see above)). In addition, in circumstances where a sponsor supervisory board nominees. nominee who, at the same time is a decision-maker of the investor within the meaning of the Association Responsibility Restrictions Act (Verbandsverantwortlichkeitsgesetz – “VbVG”), commits a crim- Restrictions with respect to the aggregate number of super- inal offence for the benefit of the investor, the private equity visory board positions and provisions aimed at preventing investor may face criminal law penalties and civil law liability conflicts of interest exist: supervisory board members must not for damages. Further, the private equity investor could face be managing directors of the portfolio company or of a subsid- civil law liability based on corporate law for trying to influence iary, or employees of the portfolio company (employee repre- members of the management or supervisory board to his own sentatives are exempt from that restriction). They must not hold benefit or the benefit of another (e.g. requiring the company’s more than 10 (eight for a listed JSC) supervisory board posi- management to pay the fund’s transaction costs, or influencing management so that a business opportunity is not pursued and tions (with chairman positions counting double and exceptions remains available for another portfolio company of the investor). for group positions), or be appointed a managing director of a subsidiary or of another company to whose supervisory board a member of the management board of the portfolio company is 3.7 How do directors nominated by private equity appointed (unless that company belongs to a group (Konzern)). investors deal with actual and potential conflicts of interest arising from (i) their relationship with the party nominating them, and (ii) positions as directors of other Requirements portfolio companies? Corporate law does not require a specific qualification or experience for supervisory board members. Such requirements can be introduced in the articles of association. However, every Where a sponsor nominee director has a conflict of interest with supervisory board member must be able to meet its duty of care respect to any matter, he must inform the chairman of the super- (Sorgfalspflicht) requiring the relevant member to exercise the visory board accordingly. It is then the responsibility of the level of care of a proper and diligent supervisory board member chairman of the supervisory board to make sure that the sponsor nominee director does not vote with respect to the matter in of the particular company (that is, a supervisory board member question and does not participate in any related meetings. of a biotech company will have to have different knowledge and skills from a supervisory board member of a company that is in the retail business). In general terms, a supervisory board 4 2 Transaction Terms: General member must have at least a basic understanding of the business brought before the supervisory board, understand finan- 4.1 What are the major issues impacting the timetable cial statements and be able to assess when an expert opinion is for transactions in your jurisdiction, including antitrust, required and to devote sufficient time. foreign direct investment and other regulatory approval requirements, disclosure obligations and financing issues? Risks and liability Members of the supervisory board owe to the portfolio company (and not to the private equity investor appointing them or to any The following clearance requirements are typically a factor for other constituents): a duty of care (Sorgfaltspflicht) (see above – the timetable: ■ antitrust clearance (which takes four weeks if cleared in which includes an obligation to be reasonably informed and to phase one proceedings (if no exemption is granted) and up articulate any concerns he may have); a duty of loyalty (Treuepflicht) to five months if cleared in phase two proceedings); (requiring the member to act in the best interest of the company ■ regulatory clearance (e.g. the acquisition of a qualified and its shareholders and not in his own interest); and a duty of or controlling interest in the banking, insurance, utili- confidentiality. A supervisory board member is not prohibited ties, gambling, telecoms or aviation sector is subject to to compete with the business of the portfolio company, as long advance notification or approval of the competent regula- as there is no breach of the duty of loyalty. Absent a breach of tory authority); their corporate duty of care, supervisory board members can ■ real estate transfer clearance (the acquisition of title and generally not be held liable for a portfolio company’s breach certain other interests in real estate by non-EEA nationals, of administrative law or criminal law. A supervisory board or control over companies holding such interests, is subject member may, however, become liable for his own conduct, to advance notification or approval (depending on state including, without limitation: for fraud (Betrug) (e.g. by entering law)); and or approving a transaction intended to mislead another); for ■ clearance pursuant to the Investment Control Act breach of trust (Untreue) (e.g. by entering or approving a transac- (Investitionskontrollgesetz – “InvKG”) (the direct or indirect tion that is adverse to the interests of shareholders); for misrep- acquisition of voting rights (thresholds vary depending on resentation (e.g. with regard to the portfolio company’s assets, the sensitivity of the sector) or an (otherwise) controlling financial or earning position or related information in the finan- interest or of material assets of a business involved in certain cial statements or in a public invitation to acquire shares, state- protected industries by a non-EEA or non-Swiss national is ments in a shareholders’ meeting, statements to the company’s subject to approval of the Federal Ministry for Digitalization auditors, in companies register filings); or for violations of anti- and Business Location. Micro-enterprises with less than 10 bribery legislation (see question 10.4 below). employees and an annual turnover or balance sheet total of A private equity investor will generally not be held respon- less than 2 million are in any case exempt). sible for an act or a failure to act as a member of the super- With regard to timing aspects related to public-to-private visory board just because that member was nominated by that transactions, see question 5.1.

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4.2 Have there been any discernible trends in 62 Transaction Terms: Private Acquisitions transaction terms over recent years?

6.1 What consideration structures are typically Vendor due diligence is becoming more and more common preferred by private equity investors (i) on the sell-side, in auctions of bigger targets (sometimes coupled with reliance and (ii) on the buy-side, in your jurisdiction? and/or warranties given by the seller or the management on the vendor due diligence report, sometimes without). Similarly, Private equity investors tend to prefer locked box structures, warranty and indemnity insurance is more frequently used, in particularly when they are on the sell-side. Where the gap between particular where private equity investors are sellers. signing and the anticipated date of closing is long (e.g. because of Specialist dept funds (see question 1.1) have become increas- antitrust or other clearance requirements), closing adjustments are ingly relevant, not only for LBO transactions. the norm. Which parameters are included in a closing adjustment depends on the target business, with the most common combina- 52 Transaction Terms: Public Acquisitions tion being adjustments for net debt, working capital, and (sometimes) capex. Equity adjustments are the exception. 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 6.2 What is the typical package of warranties / commonly dealt with? indemnities offered by (i) a private equity seller, and (ii) the management team to a buyer?

A typical going-private transaction involves a voluntary takeover Experienced private equity sellers will try to avoid business offer aimed at control ( freiwilliges Angebot zur Kontrollerlangung), warranties and indemnities (and instead just provide warranties subject to the condition that 90% of the outstanding shares are on title and capacity). In addition, experienced private equity tendered, followed by a squeeze-out pursuant to the Shareholders sellers will be very keen to limit recourse for warranty claims Exclusion Act (Gesellschafterausschluss-Gesetz ) and the delisting. A (e.g. to an amount paid into escrow) as well as any other post- regular delisting pursuant to the Stock Exchange Act (BörseG) closing liability. requires that the securities were listed for at least three years, Where private equity sellers must give business warranties, that a takeover bid was published no earlier than six months they often seek back-to-back warranties from management and ahead of the request and a shareholder resolution with at least underwrite seller’s warranty and indemnity insurance or offer 75% majority or a request of a qualified shareholder majority. the buyer management warranties instead (then usually linked In the context of the takeover offer, the private equity to buyer’s warranty and indemnity insurance). The latter option investor must ensure that the necessary funds are secured prior has the benefit that the private equity fund need not concern to the announcement of the takeover offer. The latter must be himself with post-closing warranty litigation. confirmed by an independent expert pursuant to the Austrian Takeover Code (Übernahmegesetz ). The expert will typically require (i) a copy of the equity commitment letter from the fund, 6.3 What is the typical scope of other covenants, and (ii) copies of the definitive finance agreements together undertakings and indemnities provided by a private with documents evidencing that all conditions precedent (other equity seller and its management team to a buyer? than those within the private equity investor’s sole control) have been satisfied, to satisfy itself that the necessary funds require- Private equity sellers will try to limit post-closing covenants to ment has been complied with. access to books and records and sometimes assistance in relation to pre-closing affairs. Usually buyers will insist on non-com- 5.2 What deal protections are available to private pete and non-solicitation covenants (which private equity sellers equity investors in your jurisdiction in relation to public will typically try to resist). Other post-closing covenants will acquisitions? depend on the particular case and may include covenants on de-branding, migration, transitional services and group security interests and guarantees. Break-up fees and cost cover arrangements are quite common in private transactions (that is, transactions not involving a public takeover bid). 6.4 To what extent is representation & warranty In public acquisitions (that is, transactions involving a public insurance used in your jurisdiction? If so, what are the takeover bid) where the target company would have to pay, they typical (i) excesses / policy limits, and (ii) carve-outs / are sometimes discussed but they are not common as there is exclusions from such insurance policies, and what is the typical cost of such insurance? little guidance to what extent they would be valid. Common opinion is that this should primarily depend on two factors: (i) the amount of the fee (a break-up fee in an amount that will keep Private equity sellers sometimes use warranty and indemnity management from considering competing bids or deter others insurance to “bridge the gap”. Seller policies (which protect from considering a competing bid will probably not be valid); the seller from its own innocent misrepresentation) are some- and (ii) the circumstances in which it is triggered (a break-up fee times used but it is not that common. More often, buy-side poli- that is solely triggered upon active solicitation of competing bids cies (which protect the buyer from the seller’s misrepresentation should be valid, whereas a break-up fee triggered because a bid (innocent or otherwise)) are taken out by the buyer, in particular is not supported for good reason, or because a better competing where a private equity seller is not willing to back up business bid is supported, is probably not valid). warranties (see question 6.2). In well-prepared auctions, flip- ping policies (that is a policy organised by the seller as part of the auction process which flips into a buyer’s policy) are sometimes put in place early on in the process.

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The typical excess is around 1% of the consideration. Policy Other limitations are a matter of negotiation. If other indem- limits vary between seller policies (usually they match the nities (e.g. for contamination and environmental compliance overall cap under the purchase agreement) and buyer poli- or specific due diligence findings) are accepted, limitations are cies (usually they start at around 20% of the enterprise value usually heavily negotiated. but can also cover the full enterprise value). The premium will depend on the transaction but tends to be in the range of 6.6 Do (i) private equity sellers provide security (e.g. 1%–3% of the cover purchased. Typical carve-outs and exclu- escrow accounts) for any warranties / liabilities, and sions include fraud, matters disclosed, matters the insured was (ii) private equity buyers insist on any security for aware of, pension underfunding and forward-looking warranties warranties / liabilities (including any obtained from the (e.g. the ability to collect accounts receivables). Indemnities for management team)? risks identified in the course of the due diligence can usually be insured as well, provided that materialisation risk and quantum Private equity sellers are generally prepared to provide security can be assessed. but will, in turn, often require that the buyer’s recourse is limited to such security (see question 6.2). Whether or not private equity buyers insist on security depends on various factors, including 6.5 What limitations will typically apply to the liability of a private equity seller and management team under the set of agreed warranties and the credit of the seller (that is, warranties, covenants, indemnities and undertakings? where the seller is a listed corporate there is less need for security than in the case of a secondary transaction where the seller is a SPV or where business warranties come from management only). Common limitations on warranties include: ■ Time limitation for bringing claims: ■ title and capacity warranties usually survive 10 years at 6.7 How do private equity buyers typically provide a minimum; comfort as to the availability of (i) debt finance, and (ii) equity finance? What rights of enforcement do sellers ■ business warranties between 12 and 24 months; typically obtain in the absence of compliance by the ■ tax warranties typically around seven years; and buyer (e.g. equity underwrite of debt funding, right to ■ environmental warranties five to 10 years. specific performance of obligations under an equity ■ Financial limits, including: commitment letter, damages, etc.)? ■ a cap on the total liability (where there are multiple sellers, each may seek to limit its liability to the shares Private equity buyers will typically be willing to provide a copy sold and otherwise pro rata); of the executed equity commitment letter from the fund and ■ a minimum aggregate claims threshold (“basket” or copies of the definitive financing agreements together with “deductible”); and documents evidencing that all conditions precedent (other than ■ an exclusion of de minimis claims. those within the private equity investor’s sole control) have ■ Limitation to direct loss (as opposed to indirect and conse- been satisfied on or around the signing date, to provide comfort quential loss (including lost profit)). that the necessary funds will be available at closing. If those ■ Exclusion of claims to the extent caused by: financing commitments are not complied with, sellers are typi- ■ agreed matters; cally limited to claims for damages. An equity underwrite of the ■ f acts o the purchaser (outside of the ordinary course of debt component of the purchase price is rather the exception business); but, where definitive financing agreements are not in place at ■ change of law or interpretation of law; or signing, experienced sellers will insist on an equity underwrite, ■ change of tax or accounting policies. particularly in auctions. ■ No liability for contingent liabilities. ■ No liability if the purchaser knew or could have known. 6.8 Are reverse break fees prevalent in private equity ■ No liability for mere timing differences (Phasenverschiebung). transactions to limit private equity buyers’ exposure? If ■ No liability if covered by insurance. so, what terms are typical? ■ Obligation to mitigate loss. ■ No double recovery under warranties, indemnities and Reverse break fees as a means to limit a private equity buyer’s insurance policies. exposure in case the necessary financing is not available at closing are not very common in Austria. If they are agreed, they Qualifying warranties by disclosure are typically linked to a financing condition (that is where the Warranties are usually qualified by matters that have been financing is not available at closing, the private equity buyer can disclosed (in a certain manner) or are deemed disclosed by withdraw from the contract but has to pay the reverse break fee operation of the provisions of the acquisition agreement or the to the seller). If structured that way (i.e. a condition linked to a disclosure letter (e.g. information which can be obtained from withdrawal right), the amount of the fee should not be subject to publicly accessible registers). The seller will always push for judicial review. Conversely, if the reverse break fee is structured general disclosure (i.e. everything disclosed to the purchaser as a contractual penalty for failure to close, the amount of the and its advisors at whatever occasion qualifies all warranties) fee would be subject to judicial review. while the purchaser will push for specific disclosure (i.e. separate disclosure for each warranty) and try to introduce a disclo- 72 Transaction Terms: IPOs sure threshold requiring that a matter must be “fully and fairly” disclosed. This is usually heavily negotiated. 7.1 What particular features and/or challenges should a private equity seller be aware of in considering an IPO Limitations on indemnities exit? Indemnities are generally not qualified by disclosure or knowledge. The tax indemnity is usually only subject to a specific tax An IPO exit requires that the articles of association and by-laws conduct provision, a direct loss limitation and the overall cap. be adjusted, due diligence performed and a prospectus prepared.

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In addition, the company will have to enter into an underwriting which requires a lender to have an Austrian or passported EU agreement and management will have to participate in road licence if lending takes place (or is deemed to take place) in shows. All of that requires the cooperation of the company and Austria. Specialist debt funds managed by a licensed AIFM (see (at least) where no new shares are issued and the management the discussion under question 10.1) do not require such a licence will typically ask the private equity seller to bear most of the as long as the lending business is covered by their AIFM licence. associated costs (based on an argument related to capital maintenance rules). Any new shares issued in the IPO will naturally limit the number of shares the private equity seller can sell into 8.3 What recent trends have there been in the debt financing market in your jurisdiction? the IPO. In addition, the underwriting agreement will usually provide for lock-up restrictions (see question 7.2) which limit the private equity seller’s ability to sell any shares it has retained Please see the discussion on the increased activity of specialist following the IPO. Finally, the private equity seller will usually debt funds in question 1.1. be asked to give warranties in the underwriting agreement. In most cases the private equity seller will be able to limit those 92 Tax Matters warranties to matters relating to the private equity fund and the shares it sells into the IPO. Sometimes director nominees are 9.1 What are the key tax considerations for private also required to give warranties in the underwriting agreement. 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? Usually, the private equity fund will seek to implement a tax offset structure to offset interest expense at Austrian BidCo The underwriting banks will usually expect some of the private level with profit generated at the target company level. In prin- equity seller’s shares to be locked up for a period of about 180 ciple, there are two methods to achieve this: days after the IPO. In addition, lock-up requirements may (1) The first method is to establish a tax group between an already be included in the shareholders’ agreement, but this is Austrian BidCo and the target company. In such tax rather the exception. group, the fiscal result of BidCo and the target company is consolidated at BidCo level. If the aggregated fiscal result 7.3 Do private equity sellers generally pursue a dual- of the BidCo and the target company is negative, the loss track exit process? If so, (i) how late in the process are can be carried forward by the BidCo to future periods. private equity sellers continuing to run the dual-track, The formation of such tax group requires a tax allocation and (ii) were more dual-track deals ultimately realised agreement and an application to the tax office. If the tax through a sale or IPO? group is collapsed prior to the lapse of three years (which is the minimum period), the group members are retroac- Dual-track processes are rare in Austria. As far as we are aware, tively taxed on a standalone basis. there have only been a few attempts in the last couple of years, (2) A second method, which is sometimes discussed but rarely all of which ultimately resulted in a trade sale. implemented because of the significant risk it involves, is an upstream merger of the target company into BidCo. Based 82 Financing on past decisions of the Austrian Supreme Court, it is pretty clear that where the BidCo carries the acquisition debt for 8.1 Please outline the most common sources of debt the purchase of the shares of the target company, a down- finance used to fund private equity transactions in your stream merger of the BidCo into the target company will jurisdiction and provide an overview of the current state not be registered. In certain exceptional cases, an upstream of the finance market in your jurisdiction for such debt merger of the target company into BidCo may, however, (particularly the market for high yield bonds). be feasible. The result of such upstream merger would be that the shares in the target company pass to the BidCo Sources of debt finance for private equity transactions differ parent, interest expense on the acquisition debt can be substantially for domestic private equity funds (which usually offset against profit, and guarantees and security interests finance all equity or seek debt finance from domestic banks), granted by the merged entity (holding the cash-generating and international private equity funds, which are able to tap the assets) are not subject to the limitations under the Austrian international markets. Debt-to-equity levels also vary depending capital maintenance rules (see above) and thus will be of on the size of the deal and are around 50% for large-cap transac- greater value to the financing banks. In particular, the last tions (involving international private equity funds) and 40% for point is of great interest to the financing banks, which is mid-cap transactions. why this route is sometimes explored when a particular case On mid- and small-cap transactions there is usually just senior supports the necessary arguments. and institutional debt. On large-cap transactions, it is a matter In addition, please note that, as a general rule, tax authorities of pricing whether mezzanine is applied. High yield is typically may request the disclosure of the eventual recipient (whether only considered for post-completion refinancing but not for the related or non-related) of any expenses deducted and that such financing of the transaction. Generally, recent deals show a rule also applies to interest expenses. In particular in relation noticeable increase in financing provided by debt funds. to funds acting as lender, such disclosure rule may be burdensome to comply with. 8.2 Are there any relevant legal requirements or Regarding a future exit, it should be taken into account that restrictions impacting the nature or structure of the debt double taxation treaties usually assign the right to tax capital financing (or any particular type of debt financing) of gains to the state of residence of the exiting shareholder. If the private equity transactions? seller is an Austrian tax resident, capital gains taxation applies (i.e. no participation exemption is available for Austrian tax resi- Lending is regulated by the Austrian Banking Act (“BWG”) dents in relation to Austrian target companies).

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Avoidance of withholding taxes on dividends is usually less Anti-hybrid rules of an issue, since pre-exit distributions are very rare. Still, to The Tax Reform Act 2020 foresees anti-avoidance rules targeting address that issue, EU entities are usually preferred over non-EU hybrid cross-border structures. Specific structures leading to a entities and, among the latter, entities from non-EU countries tax deduction in one state without any corresponding taxable with which Austria has concluded a double taxation treaty over income in the other state (Deduction/No Inclusion) as well entities from other non-EU countries. In such structures, we as structures enabling a double tax deduction in two different also see an increased level of substance (in terms of own prem- states (Double Deduction) shall be prevented. The new provi- ises and personnel) in the foreign entities which then usually sions shall apply to specific structures defined by law (e.g. hybrid provide internal services to related entities. financial instrument, hybrid transfer, hybrid entities, hybrid PE and unconsidered PE) and shall lead to tax deduction of expenses failed and/or taxable income in Austria as well as to 9.2 What are the key tax-efficient arrangements that tax deduction of expenses failed in Austria. The new rules for are typically considered by management teams in private hybrid cross-border structures apply as of 1 January 2020. equity acquisitions (such as growth shares, incentive shares, deferred / vesting arrangements)? Transfer tax There have been certain changes in relation to real estate transfer There is no specific regime that provides for tax reliefs or other taxation (that is, a lower share consolidation threshold (now 95% tax benefits of substantial nature to management teams. It is compared to 100% previously) and full attribution of shares held therefore important to ensure that capital gains taxation (27.5%) in trust to the trustor) which should be considered where real applies as opposed to taxation as employment income (up to estate is involved. 55%) (see question 2.3 above). Reporting regime 9.3 What are the key tax considerations for On 1 July 2020, the EU Reporting Obligation Act came into management teams that are selling and/or rolling-over effect, which requires the reporting of certain cross-border tax part of their investment into a new acquisition structure? arrangements. This act implements an EU directive (DAC 6) that must also be applied in the other 26 EU Member States. A cross-border arrangement is subject to reporting if it An exchange of shares is treated in the same way as a sale of involves a potential risk of tax avoidance or of circumvention of shares and thus triggers capital gains taxation. In a typical the reporting obligation under the Common Reporting Standard case, where the management only holds a small stake in the or of preventing the identification of the beneficial owner and (i) target company, the only option to roll-over into a new struc- its first step was implemented between June 25, 2018 and June ture without triggering capital gains taxation is a contribution 30, 2020 (so-called “old cases”), or (ii) its first step is imple- ( ) under the Reorganisation Tax Act (“UmgrStG”) Einbringung mented from July 1, 2020 or it is designed, marketed, organ- of their shares into a holding which thereby acquires or enlarges ised, made available for implementation, or managed from July an already existing majority holding in the target company. 1, 2020. A distinction is made between arrangements that are Recently, the rules for individuals applicable to such transac- subject to mandatory reporting and those that are subject to tions in a cross-border context have been adopted to expand the conditional reporting. In any case, arrangements that are subject options for managers to avoid taxation upon the roll-over. to a mandatory reporting obligation must be reported, regardless of whether a potential tax advantage has been obtained. The 9.4 Have there been any significant changes in tax obligation to report a cross-border tax arrangement is generally legislation or the practices of tax authorities (including imposed on the so-called intermediary. An intermediary is any in relation to tax rulings or clearances) impacting private person who designs, markets, organises, makes available for equity investors, management teams or private equity implementation, or manages the implementation of an arrange- transactions and are any anticipated? ment subject to reporting requirements. Accordingly, in each transaction is has to be analysed whether such new reporting CFC legislation regime applies or not. Since 1 January 2019, CFC rules for “controlled foreign companies” and permanent establishments have been implemented 102 Legal and Regulatory Matters which provide that passive and low-taxed income (e.g. interest payments, royalty payments, taxable dividend payments and 10.1 Have there been any significant legal and/or income from the sale of shares, financial leasing income, and regulatory developments over recent years impacting activities of insurances and banks) of controlled foreign subsidi- private equity investors or transactions and are any aries can be attributed to, and included in, the corporate tax base anticipated? of an Austrian parent. The most significant recent development impacting the private Tax rulings equity industry was the implementation of the AIFMD (EU Tax rulings are becoming more common, after a new ruling Directive 2011/61/EU) by the Austrian Alternative Investment regime providing for binding tax rulings in the areas of reor- Manager Act (Alternatives Investmentfonds Manager-Gesetz – ganisations, group taxation and transfer pricing was introduced “AIFMG”). Private equity funds typically qualify as alterna- a couple of years ago. Binding tax rulings are meanwhile also tive investment funds (“AIF”). Managers of an AIF (“AIFM”) available in the areas of international taxation and for questions require a licence from the Austrian Financial Market Authority in connection with abuse (since 1 January 2019) and value-added (Finanzmarktaufsichtsbehörde – “FMA”), unless the AIF qualifies tax (since 1 January 2020). In practice we increasingly see ruling for the de minimis exception (which applies to managers of small requests in relation to pre-exit reorganisations, but also in rela- AIFs with assets of less than EUR 100 million (where leverage is tion to transfer pricing issues. used) or less than EUR 500 million (where no leverage is used)), in which case such AIFs only need to register with the FMA.

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10.2 Are private equity investors or particular 10.5 Are there any circumstances in which: (i) a private transactions subject to enhanced regulatory scrutiny in equity investor may be held liable for the liabilities of your jurisdiction (e.g. on national security grounds)? 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 the With regard to regulatory scrutiny over private equity funds, liabilities of another portfolio company? please see question 10.1 above. With regard to transactions, there is no private equity specific scrutiny. Private equity funds In principle, a private equity investor is not liable for the liabili- should, however, be aware of the general clearance requirements ties of an underlying portfolio company. Exceptions apply, inter (see question 4.1 above). alia, under concepts of piercing the corporate veil, including (i) where the private equity investor factually manages, or substan- 10.3 How detailed is the legal due diligence (including tially controls the management of, the underlying portfolio compliance) conducted by private equity investors prior company ( faktische Geschäftsführung), (ii) in cases of undercapital- to any acquisitions (e.g. typical timeframes, materiality, isation (only where there is an obvious imbalance between the scope, etc.)? risks of the business and the equity which is likely to result in a default), (iii) where based on the accounting records, the assets of Private equity buyers often split due diligence in different phases the company cannot be separated from the assets of the private (particularly in auctions), with the first phase only covering a equity investor (Sphärenvermischung), and (iv) in cases of share- few value-driving items and the latter phases then covering holder action putting the portfolio company at risk (existenzver- the rest of the scope. The timeframe depends very much on nichtender Eingriff ) (where the investor takes action causing insol- whether it is a proprietary situation (in which case the due dili- vency (Insolvenzverursachung), e.g. acceleration of a loan in distress). gence can take eight to 10 weeks) or an auction (in which case the In addition, a private equity investor may become liable to timing is driven by the auction process). Private equity buyers a creditor up to the amount secured where the private equity usually engage outside counsel to conduct all legal due diligence. investor granted a guarantee or security interest securing a loan Compliance due diligence is sometimes done in-house. of a portfolio company in “crisis” (defined in the Company Reorganisation Act (“URG”)). In such circumstances, the portfolio company can request the creditor to claim against the 10.4 Has anti-bribery or anti-corruption legislation private equity investor first (in which case the recourse claim impacted private equity investment and/or investors’ of the private equity investor against the portfolio company approach to private equity transactions (e.g. diligence, is suspended until the crisis is over); in addition, if the port- contractual protection, etc.)? folio company pays the creditor, the portfolio company can take recourse against the private equity investor. Anti-bribery and anti-corruption legislation had a significant The above principles apply mutatis mutandis in relation to the impact on private equity transactions in Austria. Since their risk of potential liability of one portfolio company for the liabil- enactment, more emphasis has been placed on those areas in ities of another portfolio company. the due diligence process as well as in the purchase or investment agreement. Also, private equity funds (in particular bigger 112 Other Useful Facts international investors) will make sure that a compliance system is put in place following closing if not already existing at the time 11.1 What other factors commonly give rise to concerns of the transaction. Provided such system is appropriately moni- for private equity investors in your jurisdiction or should tored, it can serve as a defence for management and portfolio such investors otherwise be aware of in considering an company liability in case there is an administrative or criminal investment in your jurisdiction? offence by any representatives of the portfolio company under Austrian law. In addition, international private equity investors Most private equity investors find it difficult to access Austrian will be concerned with any additional requirements under the businesses, in particular where the business is family owned. UK Bribery Act and the US Foreign Corrupt Practices Act, as For that reason, they often team up with a local partner or both of them claim extra-territorial jurisdiction. initiate contact through trusted advisors. Post-COVID-19, an increased level of appetite to sell is however expected. In relation to listed target companies, investors should be aware that there is often limited free float and one or two major block shareholders, which even though they might not own a majority control the company.

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Florian Philipp Cvak’s practice is focused on corporate and finance law, in particular whenever private equity is involved. Florian is admitted to the Austrian, New York and Polish Bars. Before establishing the firm as a co-founder, Florian was a partner at Schoenherr, where he co-headed the private equity practice and was involved in some of the firm’s most prestigious private equity transactions in Austria as well as the wider CEE region.

Schindler Attorneys Tel: +43 1 512 2613 500 Kohlmarkt 8-10 Email: [email protected] 1010 Vienna URL: www.schindlerattorneys.com Austria

Clemens Philipp Schindler’s transactional practice is focused on corporate and tax. He is admitted as both a lawyer and a certified public tax advisor in Austria. Before establishing the firm as a co-founder, Clemens spent six years as a partner at Wolf Theiss, where he led some of the firm’s most prestigious transactions. Prior to that, he practised with Haarmann Hemmelrath in Munich and Vienna, as well as with Wachtell Lipton Rosen & Katz in New York. Clemens’ practice focuses on corporate and tax advice in relation to public and private M&A, private equity and corporate reorganisations (such as mergers, spin-offs and migrations), most of which have a cross-border element.

Schindler Attorneys Tel: +43 1 512 2613 205 Kohlmarkt 8-10 Email: [email protected] 1010 Vienna URL: www.schindlerattorneys.com 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 private equity track record 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. The firm usually acts for financial sponsors, but also advises banks on leverage buyout transactions. www.schindlerattorneys.com

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Bermuda Bermuda

Nick Miles

Kennedys Bermuda Ciara Brady

12 Overview 1.3 What are going to be the long-term effects for private equity in your jurisdiction as a result of the COVID-19 pandemic? 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? While the long-term impact of COVID-19 on private equity in Bermuda will require more time to assess, we have seen an immediate impact of tightening of credit availability, completion Private equity investment in Bermuda largely originates from dates being pushed out and break fees renegotiated. Having said the United States, Canada and Europe and, as fund managers that, the market turbulence resulting from COVID-19, along are typically located in these jurisdictions, Bermuda’s private with hardening of rates in the insurance sector as a result of equity transactions will follow the investment trends of major the estimated $100 billion of additional insured losses arising onshore markets. Bermuda is seeing an increasing trend in from the pandemic, have also presented opportunities in an private equity investors taking stakes in Bermuda insurers and area where private equity, understood to have a large volume of reinsurers, whether in new ventures or in participation in the “dry powder”, has recently shown much interest (see our answer insurance business consolidation and runoff. This trend is to question 1.4 below). For example, a number of Bermuda not surprising given Bermuda’s position as the world’s premier insurers have engaged in significant capital-raising exercises offshore insurance and reinsurance jurisdiction. to fund new acquisitions, presenting considerable opportunities, with Fidelis raising $800 million and RenaissanceRe $900 1.2 What are the most significant factors currently million, to name but two. encouraging or inhibiting private equity transactions in your jurisdiction? 1.4 Are you seeing any types of investors other than traditional private equity firms executing private Bermuda is recognised as a premier offshore jurisdiction for equity-style transactions in your jurisdiction? If so, domiciling private equity groups. Bermuda’s robust and dynamic please explain which investors, and briefly identify any legislative and regulatory framework, common law legal system significant points of difference between the deal terms offering familiarity to UK and US investors, political stability, offered, or approach taken, by this type of investor and tax neutrality, OECD white list designation, choice of flexible that of traditional private equity firms. structures which are easily set up, experienced service providers, proximity to major financial centres and favourable time zone Bermuda has witnessed a significant uptick in business involving together make Bermuda an attractive domicile of choice. private equity fund managers with a presence in the United The Bermuda Monetary Authority (BMA), the regulatory body States, Canada and Europe doing significant business in, or from, responsible for Bermuda’s financial services sector, proactively Bermuda, with Bermuda insurance and reinsurance companies. A consults with industry regarding its needs and the development large number of substantial private equity fund managers with a of new laws and regulation. This has proven critical in estab- presence in the United States, Canada and Europe do significant lishing and maintaining a healthy relationship between business, business in, or from, Bermuda, such as Apollo Global Management government and the regulator and in fostering the continued and Onex Partners, which participate in the Bermuda insurance development of robust industries, including private equity. and reinsurance industry through companies like Athene Holding, Collaboration between the BMA and the industry has been most Aspen Insurance and Convex Re. Athene Life Re’s sidecar vehicle recently evidenced by the enactment of legislation providing for for life and retirement investment opportunities, Athene Co-Invest the incorporation of incorporated segregated accounts compa- Reinsurance Affiliate, has recently raised $3 billion of capital. The nies (facilitating the establishment of separate cells or sub-funds Carlyle Group and Japan’s T&D Holdings recently increased their with separate legal personality), and legislation supporting the holding of ex-AIG legacy reinsurance entity, Fortitude Re, to incorporation and regulation of fintech-related businesses. Such 76.6%. Runoff reinsurance also continues to be an area of interest legislative changes are addressed, along with others, in greater for private equity, with Bermuda seen as an attractive domi- detail in response to question 10.1 below. cile. 2019 saw Aquiline Capital Partners partner with others in a $500 million capital raise for Armour Group Ltd., a Bermuda- based property and casualty runoff acquirer, and Carlyle’s stake in Fortitude Re as examples, not to mention investments in closed books of life business.

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22 Structuring Matters Where the structure employs LPs, private equity investors will subscribe for partnership interests and, though less common, management may participate through a carried interest. 2.1 What are the most common acquisition structures adopted for private equity transactions in your jurisdiction? 2.4 If a private equity investor is taking a minority position, are there different structuring considerations? There is a broad choice of private equity vehicles in Bermuda, namely exempted companies limited by shares, exempted limited Taking a minority position will often necessitate the private partnerships (LPs), limited liability companies (LLCs), segre- equity investor to focus on protections that can be established gated accounts companies, incorporated segregated accounts in the bye-laws and shareholders agreements. Typical minority companies and unit trusts. shareholder protections include voting rights (whether through Private equity acquisition structures vary depending on unanimous, weighted, veto or voting thresholds or require- whether the target entity is a privately or publicly held entity and ments), anti-dilution rights, drag-along and tag-along rights, whether the acquisition involves the whole, or only a minority director nominations or appointments, information rights, and position, of the target. For privately held Bermuda entities, change of control provisions. acquisition may be by direct or indirect investment. Direct investment involves the issue of new shares (or partnership or 2.5 In relation to management equity, what is the membership interests or units) or the transfer of shares (or part- typical range of equity allocated to the management, and nership or membership interests or units) to the private equity what are the typical vesting and compulsory acquisition investors. Indirect investment structures typically involve the provisions? incorporation of an acquisition vehicle to acquire the target by way of share purchase, merger, amalgamation or share exchange. The typical allocation of equity to management would be in The acquisition vehicle may be the borrower under related debt the range of 5–20%, but generally follows the trend of onshore facilities or other intermediary entities may be incorporated for markets. such purpose or to accommodate other structuring needs of the Management’s options would typically be subject to condi- acquirer, such as security arrangements and tax considerations. tions tied in with performance and length of tenure, with options Where the target is a listed entity, the acquisition structure being exercisable on reaching targets and/or vesting on sale of may involve a merger or amalgamation, an offer to purchase the target within parameters. It would be expected that manage- the shares of the target, a compulsory acquisition, or a scheme ment shares would be subject to repurchase on termination of of arrangement. The requirements for a merger or amalgama- employment, with options being exercisable after employment tion are the same for private and public targets – generally, the termination depending on good and bad leaver scenarios. boards of the respective companies must approve the merger or amalgamation agreement, and their respective shareholders must approve the merger or amalgamation agreement; such 2.6 For what reasons is a management equity holder approval, for any Bermuda entities, being 75% of the share- usually treated as a good leaver or a bad leaver in your jurisdiction? holders present and voting at a special general meeting at which two or more persons are present in person or by proxy, unless the bye-laws provide otherwise. All shares have the right to vote What constitutes a good or a bad leaver will be agreed contrac- in an amalgamation, including non-voting shares, and classes tually rather than by reference to Bermuda employment laws. may be entitled to a separate vote if the merger or amalgamation Bad leavers would include those who voluntarily resigned, agreement contains a provision that would constitute a variation breached non-competition or other covenants or were other- of the rights attaching to any such class of share. Shareholders wise terminated for cause. Good leavers would include those who do not vote in favour of the merger or amalgamation and leaving employment due to death, injury or retirement or any who are not satisfied that they have been offered fair value for other reason that does not fall under the category of a bad leaver. their shares may, within one month of the notice of the special general meeting, apply to court to have the fair value of their 3 2 Governance Matters shares appraised. 3.1 What are the typical governance arrangements 2.2 What are the main drivers for these acquisition for private equity portfolio companies? Are such structures? arrangements required to be made publicly available in your jurisdiction?

Acquisitions structures are driven largely by onshore tax and commercial considerations, including requirements of lenders. A Bermuda private equity portfolio company would be governed by its board of directors, typically composed of executive directors, investor-appointed directors and independent direc- 2.3 How is the equity commonly structured in private tors. In private equity transactions, a shareholders agreement equity transactions in your jurisdiction (including (or investor rights agreement) would set out the rights of the institutional, management and carried interests)? investors and other shareholders (or a group of them) vis-à-vis each other and the company as regards, among other things, The structuring of equity in a private equity transaction varies the appointment of directors and voting rights and thresh- but would typically involve private equity investors subscribing olds. Neither the bye-laws nor the shareholders agreement are for shares (common and/or preference) and possibly being publicly available documents. However, due to changes to the issued loan notes, and key management similarly subscribing Companies Act 1981 in 2018, certain provisions of the bye-laws for shares (common or another class) and possibly being issued are required to be filed with the Registrar of Companies (ROC), performance-triggered share options. namely provisions on share transfer and registration of estate

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representatives, duties of the secretary and quorum require- 3.4 Are there any duties owed by a private equity ments for general meetings. However, these filed bye-law provi- investor to minority shareholders such as management sions are not publicly available. shareholders (or vice versa)? If so, how are these An LP is managed by its general partner (which need not be typically addressed? a Bermuda entity or resident) and the rights and obligations of the partners are largely agreed in the limited partnership agree- Fiduciary duties are not owed by a private equity investor to ment (LPA), rather than statutorily mandated. The LPA is not minority shareholders under Bermuda law or vice versa (unless publicly available and is not required to be filed with the BMA contractually agreed). Members have absolute discretion to or the ROC. exercise voting rights in their own sectoral interests, subject to Bermuda’s limited liability legislation was modelled on that of limited exceptions relating to resolutions to approve and adopt Delaware and, as such, a Bermuda LLC will share many of the modification and/or restatement of bye-laws, where resolutions same attributes, including the significant degree of flexibility when to make such modifications or restatements can be attacked it comes to management and shareholder arrangements, that are if shown to be of a type that no rational member could have agreed in the LLC agreement. A private equity portfolio company approved. that is an LLC is afforded great latitude in its governance structure – it may be member-managed or non-member-managed. As with an LPA, the LLC agreement is not a public document, nor it is filed 3.5 Are there any limitations or restrictions on the contents or enforceability of shareholder agreements with the BMA or ROC. (including (i) governing law and jurisdiction, and (ii) non-compete and non-solicit provisions)? 3.2 Do private equity investors and/or their director nominees typically enjoy veto rights over major There are no limitations or restrictions on the contents or corporate actions (such as acquisitions and disposals, enforceability of shareholders agreements, save if contrary to business plans, related party transactions, etc.)? If a private equity investor takes a minority position, what public policy (noting, as provided above, it would not be permis- veto rights would they typically enjoy? sible for a shareholders agreement to fetter the powers of the company beyond that expressly permitted in the Companies Act 1981). Shareholders agreements governed by the laws of other Whether and what veto rights a private equity investor will enjoy jurisdictions are similarly enforceable to the extent they are not is a matter for negotiation in each transaction. It would not illegal or contrary to Bermuda public policy. Non-competition be usual to see veto powers (whether requiring the director or and non-solicitation provisions are enforceable under Bermuda shareholder vote or requiring an agreed voting threshold be met law provided the restraint is reasonable and necessary to protect whilst a benchmark shareholding is met) at a shareholder or the legitimate business interests of the private equity investor director level regarding changes to share capital, debt, constitu- and reasonable as to other factors. tional documents, the composition of the board or management, the nature of business and as regards anti-dilution (whether by the issue of new issues or share transfers), major acquisitions or 3.6 Are there any legal restrictions or other dispositions and change of control. requirements that a private equity investor should Veto rights of limited partners are not typically seen where the be aware of in appointing its nominees to boards of portfolio companies? What are the key potential risks private equity entity is an LP. In such cases, the general partner and liabilities for (i) directors nominated by private exercises its powers within the confines of the negotiated LPA. equity investors to portfolio company boards, and (ii) private equity investors that nominate directors to 3.3 Are there any limitations on the effectiveness of boards of portfolio companies? veto arrangements: (i) at the shareholder level; and (ii) at the director nominee level? If so, how are these typically While directors of a Bermuda company may be appointed or addressed? elected by a particular shareholder or shareholder group, they each owe a fiduciary to act in good faith (including a duty to The Companies Act 1981 expressly provides that certain powers avoid conflicts of interest) in dealing with or on behalf of the of the company reserved to shareholders can be fettered company, and a statutory duty to act honestly and in good faith (including name changes, alteration of the constitutional docu- with a view to the best interests of the company. Such duties are ments, alteration of share capital and removal of directors). owed to the company as a whole, which includes all its share- Fettering of the powers of the company reserved to shareholders holders. As such, directors cannot put the interests of the share- in a shareholder agreement or investors rights agreement that holder who appointed or elected them in priority to the interest go beyond those expressly permitted would not be upheld by a of the company and need to be particularly mindful that their Bermuda court. duties are owed to the company as a whole and not to the share- As noted in response to question 3.6 below, directors owe holders who nominated or appointed them. Similarly, where a fiduciary and statutory duties to the company. Any purported director is a director for multiple companies of the same group, fettering of the discretion of the directors and their ability to while a group benefit may be considered, he must nonetheless act in the best interests of the company in the bye-laws or a act in the best interests of each company he serves individually shareholders/investor rights agreement may not be upheld by a and not sacrifice any one such company’s interests to those of Bermuda court. To avoid such issues, voting and veto powers the group as a whole. should, to the extent possible, be at the shareholder level in the The bye-laws of a Bermuda company would typically provide shareholders agreement. Similarly, the general partner of an LP (i) for the indemnification and exculpation of its directors and owes a duty of good faith and must act in the interests of the LP offices acting in relation to the affairs of the company and its and not in the interests of one limited partner. subsidiaries, except in respect of any fraud or dishonesty, and (ii) that the company may purchase, for the benefit of its directors and officers, insurance in respect of losses arising out of a breach

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of their duty of care, diligence and skill or insurance indemni- For private equity funds that are closed-ended investment fying for losses in respect of negligence, default, breach of duty or funds, please see the response to question 10.1 which addresses trust. See also question 3.7 below regarding conflicts of interest. recent amendments to the Investment Funds Act 2006 of The general partner of a Bermuda LP is responsible for Bermuda (IFA) bringing within its scope closed-ended invest- managing the business of the LP and has a statutory duty to act ment funds and overseas investment funds, requiring regis- in good faith and, subject to the express provisions of the LPA, trations or designation. Where the private equity vehicle is a in the interest of the LP. With amendments made to Bermuda’s closed-ended investment fund, the registration process can be partnership legislation in 2015, members of boards and commit- prompt, although consideration should be given to the time tees of an LP will have the benefit of indemnity and exculpa- required to prepare the application which includes, among other tion clauses in the LPA (unless such agreement states otherwise). things, a copy of the offering document complying with the IFA As the express intent of Bermuda LLC legislation is to give and details of the fund’s service providers to satisfy the BMA maximum effect to the principle of freedom of contract, consid- that they are fit and proper persons. erable flexibility is permitted as regards managers’ duties to the There are no antitrust or foreign direct investment approvals LLC. Such duties are agreed in the LLC agreement and to the to be obtained or filings to be made in Bermuda. The timetable extent, at law or in equity, a member, manager or other person for transaction could be impacted if the target is a regulated has duties (including fiduciary duties) to an LLC or member, entity, such as a financial institution, investment business, regu- manager or other party to the LLC agreement, the LLC agree- lated fund or insurance company where regulatory approvals or ment may expand, restrict or eliminate such duties (except that notification and confirmation of no objection may be required. the LLC agreement may not permit fraud or dishonesty). The Unless a general permission of the BMA applies, all transac- LLC agreement may also provide for indemnity and exculpation tions involving the transfer or issue of shares to non-residents provisions for it members and managers (except in respect of will first require the customary customer due diligence and their fraud or dishonesty) and provide for the purchase of insur- vetting of the new ultimate beneficial owners. Once provided ance for the benefit of its officers, members and managers for with satisfactory information, approval for the issue or transfer liabilities incurred in acting in such capacities. See question 3.7 is typically a perfunctory matter. regarding conflicts of interest. Offers of securities to the public are subject to prospectus See also the response to question 10.5 regarding situations rules under the Companies Act 1981. However, it is often giving rise to shareholders, member and limited partner liabilities. possible to disapply these on the basis that the offer can be certified on behalf of the board of directors as not calculated to result, directly or indirectly, in the shares becoming avail- 3.7 How do directors nominated by private equity investors deal with actual and potential conflicts of able to more than 35 people and, if greater, they are likely to interest arising from (i) their relationship with the party have an offering document as a matter of course. Prospectus nominating them, and (ii) positions as directors of other rules are also disapplied where the securities are to be listed on portfolio companies? an “appointed stock exchange” (being a foreign stock exchange approved by the ROC). Directors are required by the Companies Act 1981 to disclose, at the first opportunity, at a meeting of the directors (or by writing 4.2 Have there been any discernible trends in to the directors), his interests in any material or proposed mate- transaction terms over recent years? rial contract with the company or its subsidiaries and in any person a party thereto. Failure to disclose a conflict of interest Private equity transactions in Bermuda follow the trends in can render the director liable to a fine of $1,000. Subject to the North America and Europe. bye-laws, a director is not prohibited from voting on any matter in relation to which he has disclosed an interest. 52 Transaction Terms: Public Acquisitions The Bermuda LLC Act expressly permits members and managers to vote in their own self-interest even if not in the best interests of the LLC, unless otherwise provided in the LLC 5.1 What particular features and/or challenges apply agreement. Where the private equity fund is an LP, an advisory to private equity investors involved in public-to-private transactions (and their financing) and how are these committee may be established for the purposes of approving/ commonly dealt with? disallowing conflicts.

4 2 Transaction Terms: General For the most part, Bermuda companies in privatisation transactions are likely to be listed on exchanges outside of Bermuda, so one would need to look to the particular exchange to ascer- 4.1 What are the major issues impacting the timetable tain the relevant features and/or challenges to the privatisation. for transactions in your jurisdiction, including antitrust, Bermuda does not have a takeover code. The rules of the foreign direct investment and other regulatory approval requirements, disclosure obligations and financing applicable exchange (being the Bermuda Stock Exchange listing issues? rules if the target is listed in Bermuda), the Companies Act 1981, any other applicable legislation (which will be dependent on the business of target company) and the constitutional documents Bermuda offers an efficient, streamlined approach to incorpora- of the target will all be relevant in a privatisation. Where the tion, formation and organisation of private equity vehicles. The target is a public company, the transaction will be structured in ROC and the BMA are the two regulatory bodies that approve one of the manners outlined in response to question 2.1 above. incorporation or formation of private equity vehicles. Once submission of the required beneficial ownership information is complete, a company can be incorporated or a partnership formed in a matter of days.

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5.2 What deal protections are available to private 6.6 Do (i) private equity sellers provide security (e.g. equity investors in your jurisdiction in relation to public escrow accounts) for any warranties / liabilities, and acquisitions? (ii) private equity buyers insist on any security for warranties / liabilities (including any obtained from the management team)? Break fees and “no shop” provisions are available, provided the break fee is based on a genuine pre-estimate of compensation for losses and not a penalty, and with the “no shop” being subject No, it is not usual for sellers to provide security for warran- to an exemption where necessary to permit directors to comply ties or liabilities. While warranty and representation insurance with their fiduciary duties in relation to a competing offer. may be used in transactions, it remains a common approach for Break fees tend to be in the range of 2–4% of the deal value. a portion of total consideration to be withheld and subject to adjustment based on post-completion adjustments to the value 62 Transaction Terms: Private Acquisitions of the target, capturing losses resulting from breaches of certain warranties and/or covenants.

6.1 What consideration structures are typically preferred by private equity investors (i) on the sell-side, 6.7 How do private equity buyers typically provide and (ii) on the buy-side, in your jurisdiction? comfort as to the availability of (i) debt finance, and (ii) equity finance? What rights of enforcement do sellers typically obtain in the absence of compliance by the Consideration is most commonly subject to a holdback for adjust- buyer (e.g. equity underwrite of debt funding, right to ments based on post-closing valuations of the target. The use of specific performance of obligations under an equity locked box consideration structures is increasing. commitment letter, damages, etc.)?

6.2 What is the typical package of warranties / Sellers obtain comfort as to equity or debt financing in the trans- indemnities offered by (i) a private equity seller, and (ii) action agreement, be it a purchase or implementation agree- the management team to a buyer? ment, whose obligations would become enforceable on the satisfaction of agreed conditions. Representations and warranties as It would be expected that management provide the usual to financing and/or comfort letters would also be customary. commercial warranties, and sellers push to limit their representations to title, capacity and authority, with knowledge and materi- 6.8 Are reverse break fees prevalent in private equity ality qualifiers and short survival periods. Indemnification for transactions to limit private equity buyers’ exposure? If losses resulting from breaches of representations and warran- so, what terms are typical? ties are customary (to the extent not otherwise captured in post- closing adjustments), with trigger and cap thresholds. While reverse break fees are seen in Bermuda transactions, their prevalence is deal-driven, with an increased prevalence in deals 6.3 What is the typical scope of other covenants, involving US investors. undertakings and indemnities provided by a private equity seller and its management team to a buyer? 72 Transaction Terms: IPOs

Sellers would be expected to provide pre-completion covenants 7.1 What particular features and/or challenges should to assist with any regulatory filings or approvals, and exiting a private equity seller be aware of in considering an IPO management may be required to provide non-solicitation and exit? non-compete covenants (see response to question 3.5 for further considerations on non-compete and non-solicitation clauses). IPOs on the Bermuda Stock Exchange are not a common exit strategy for private equity transactions. If an IPO is the 6.4 To what extent is representation & warranty chosen exit strategy, it is more likely that the entity would be insurance used in your jurisdiction? If so, what are the conducting an IPO on an onshore exchange and, as such, the typical (i) excesses / policy limits, and (ii) carve-outs / rules of such exchange would be relevant. The BMA has given exclusions from such insurance policies, and what is the its permission for the issue and transfer of “equity securities” typical cost of such insurance? of Bermuda-exempted companies to and from non-residents of Bermuda where such company’s equity securities are listed on Warranty and representation insurance is seldom purchased in an “appointed stock exchange”. (An equity security is a share connection with Bermuda private equity transactions. conferring the right to vote for or appoint a director (or security convertible into such a share) and there are 59 appointed stock exchanges, including NASDAQ, NYSE, the LSE and HKSE.) 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? While negotiating terms, a seller may limit its liabilities under warranties, covenants and its indemnity by limiting their scope, The terms of lock-ups would be negotiated by onshore parties employing knowledge qualifiers, restricting the period for and, in particular, the underwriters, to the IPO. Private equity claims, employing threshold amounts for triggering payment sellers should expect a lock-up on all or some of their shares for (whether for individual items or in the aggregate), and seeking a period of approximately six months post-IPO. an individual or aggregate cap.

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7.3 Do private equity sellers generally pursue a dual- a clearer understanding of their residents’ financial assets and track exit process? If so, (i) how late in the process are income outside of their jurisdiction. Bermuda has further imple- private equity sellers continuing to run the dual-track, mented the OECD Country-by-Country reporting, which permits and (ii) were more dual-track deals ultimately realised tax administrations to perform high-level transfer pricing risk through a sale or IPO? assessments and to evaluate other BEPS-related risks.

Private equity sellers seeking the highest return on their invest- 9.2 What are the key tax-efficient arrangements that ment will generally pursue a dual-track exit. are typically considered by management teams in private equity acquisitions (such as growth shares, incentive 82 Financing shares, deferred / vesting arrangements)?

8.1 Please outline the most common sources of debt Please see the response to question 9.1 above. Structuring to finance used to fund private equity transactions in your achieve tax efficiencies is driven by onshore considerations. 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 bonds). 9.3 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? Private equity investors are typically based outside Bermuda, as are their sources of financing transactions; it is necessary to look to onshore markets to understand the debt sources and state of Please see the response to question 9.1 above. Structuring to finance in those markets. achieve tax efficiencies is driven by onshore considerations.

9.4 Have there been any significant changes in tax 8.2 Are there any relevant legal requirements or legislation or the practices of tax authorities (including restrictions impacting the nature or structure of the debt in relation to tax rulings or clearances) impacting private financing (or any particular type of debt financing) of equity investors, management teams or private equity private equity transactions? transactions and are any anticipated?

No, there are no legal requirements or restrictions impacting the Please see the response to question 9.1 above. nature or structure of debt financing in Bermuda. 102 Legal and Regulatory Matters 8.3 What recent trends have there been in the debt financing market in your jurisdiction? 10.1 Have there been any significant legal and/or regulatory developments over recent years impacting As debt financing for private equity transactions is not typically private equity investors or transactions and are any obtained in Bermuda, there are no discernible trends to speak of. anticipated?

92 Tax Matters More recently, key stakeholders, including the Government of Bermuda, the BMA, industry and professionals have collabo- 9.1 What are the key tax considerations for private rated to make legislative changes aimed at improving Bermuda’s equity investors and transactions in your jurisdiction? private equity product that serves to further bolster its position Are off-shore structures common? as a premier offshore jurisdiction for private equity fund transactions. Among the recent legislative changes is the introduction Private equity vehicles and their investors, shareholders, part- of the Incorporated Segregated Accounts Companies Act 2019, ners or unit holders, as the case may be, that are non-residents of which adds to the range of vehicles available for private equity Bermuda, are not subject to any tax computed on profits, income, structuring. An incorporated segregated account is an attrac- capital assets, gains or appreciation or any tax in the nature of tive vehicle as it blends the benefits of a company with those of estate duty or inheritance tax. For a nominal fee, an assurance a segregated accounts company. They are cost-efficient as they from the Minister of Finance may be obtained confirming that, avoid the expense of incorporating several separate companies in the event any legislation is enacted imposing any of the afore- and can be used for multi-strategy platforms. mentioned taxes in Bermuda, such taxes will not be applicable As an enhancement to Bermuda’s new Economic Substance to a private equity vehicle, its operations or to its shares or inter- regime, in January 2020, the IFA was amended to bring within ests, debentures or other obligations (except insofar as such tax its scope closed-ended investment funds (being Bermuda funds applies to persons ordinarily resident in Bermuda or is payable in in which the participants are not, at their election, entitled respect of real property owned or leased in Bermuda). Currently, to have their units redeemed) and overseas investment funds such an assurance may be obtained for a period until 31 March (being funds established outside of Bermuda but are managed 2035. Exempted undertakings are exempt from Bermuda stamp or carry on promotion in or from within Bermuda). A number duty. of private equity vehicles may fall within the new IFA definition Bermuda has entered into Model 2 intergovernmental agree- of “investment fund”, namely, any arrangement with respect to ments with the United States and the United Kingdom, requiring property of any description, including money, the purpose or Bermuda financial institutions to report to the US IRS or UK effect of which is to enable a person taking part in the arrange- HMRC on accounts held by US or UK citizens, respectively. ment to participate in or receive profits or income arising from Bermuda has implemented the OECD’s Common Reporting the acquisition, holding, management or disposal of the property Standard, permitting the automatic exchange of information or sums paid out of such profits or income. Such arrangements among numerous countries to assist tax authorities in developing must meet the following characteristics: (i) the participants do

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not have day-to-day control over the management of the prop- 10.2 Are private equity investors or particular erty (whether or not they have the right to be consulted or give transactions subject to enhanced regulatory scrutiny in directions); and (ii) the contributions of the participants and the your jurisdiction (e.g. on national security grounds)? profits or income out of which payments are to be made to them are pooled and/or the property is managed as a whole by or on Investors and transactions are not, solely by reason of being behalf of the operator of the fund. private equity investors or private equity transactions, subject The amendments to the IFA require overseas investments to enhanced regulatory scrutiny. Such investors and transac- funds to, among other things, be designated by the BMA, tions, however, may attract enhanced regulatory scrutiny where and closed-ended investment funds to be registered with the the target is an insurance company, a bank, a telecommunica- BMA (unless an exclusion applies). Of the available categories tions or utility company, investment business or other regulated in which a closed-ended investment fund may register, many entity and if the private equity vehicle is an investment fund. private equity vehicles will likely register as “Professional Closed In such circumstances, the enhanced regulatory scrutiny would Funds”. The notable requirements of Professional Closed Funds typically require transactional approval of the BMA, including include that: its securities are only to be made available to “qual- the vetting of proposed shareholder controllers, officers and ified participants”; it must appoint an auditor and a Bermuda- operators and service providers as fit and proper persons. See resident, licensed service provider (e.g. a fund administrator or the response to question 4.1 regarding closed-ended funds. The corporate service provider) or officer, trustee or resident repre- BMA also requires officers, operators and service providers sentative having access to the books and records of the fund; to carry on business in a prudent manner and, in making such it must provide an investment warning in a form satisfactory determination, the BMA may take into account any failure to to the BMA to participants prior to the sale of units; and it comply with the IFA and other laws, codes of conduct and inter- must prepare audited financial statements in accordance with national sanctions. International Financial Reporting Standards (IFRS) or recognised generally accepted accounting principles (GAAP). The definition of “qualified participants” has changed such that 10.3 How detailed is the legal due diligence (including the value of the individual’s residence and benefits or rights compliance) conducted by private equity investors prior to any acquisitions (e.g. typical timeframes, materiality, under contracts of insurance are excluded from the calculation. scope, etc.)? Professional Closed Funds must annually certify that they meet the BMA registration requirements and provide the BMA with information on net asset value (NAV) and underlying assets, the Private equity investors will engage in detailed legal due dili- latest audited financial statements and a statement of any mate- gence, including material business contracts, key employee rial changes to the fund’s terms of offering. contracts, confirming corporate compliance and searching In keeping with Bermuda’s aim to align with the global trend charges and litigation filings. The timeframe, materiality and towards transparency, the Companies Act 1981 was amended scope will differ depending on the target and the investors’ risk to require a register of directors be publicly available and filed tolerance, with smaller transactions typically involving less due with the ROC. Such register is available on the Government diligence and larger transactions requiring more investor scru- of Bermuda website and contains the company name and regis- tiny with higher materiality thresholds. Legal due diligence can tration number and the names and addresses of its directors (or be expected to take several weeks, with the time depending, in company name and registered address for corporate directors). large part, on the size of the transaction and the nature of the Similarly, the memorandum of association (and all amendments target. thereto), which sets out the powers and objects of the company, is publicly available. Additionally, Bermuda companies and 10.4 Has anti-bribery or anti-corruption legislation partnerships must use reasonable efforts to identify their “bene- impacted private equity investment and/or investors’ ficial owners” (and the beneficial owners of relevant entities) and approach to private equity transactions (e.g. diligence, maintain an up-to-date register thereof at their registered office. contractual protection, etc.)? A beneficial owner is a natural person who directly or indirectly owns or controls more than 25% of the shares, voting rights or Bermuda enacted new anti-bribery and anti-corruption legisla- interest in a company or who controls a company by other means tion in 2016 which is modelled on the UK Bribery Act 2010. or, failing the existence of such persons, the company’s senior The Bribery Act 2016 criminalises private-sector bribery and managers. Certain of the beneficial owner information must be makes it an offence to bribe a public official and a corporate filed with the BMA (namely, name, address, date of birth, and criminal offence of failing to prevent bribery by an associ- nature and extent of interest in the company or partnership); ated person. The scope of the Bribery Act 2016 is such that however, such information is not publicly available. companies and partnerships incorporated or created outside of The Government of Bermuda has long been committed to Bermuda are caught if they carry on business (or part of a busi- ensuring Bermuda anti-money laundering (AML) and anti- ness) in Bermuda. The only defence to the new corporate crim- terrorist financing (ATF) requirements are aligned with the inal offence of failing to prevent bribery is that the entity had international standards, and has implemented recent legislative “adequate procedures” to prevent persons associated with it changes to further strengthen this regulatory regime. The from undertaking acts of bribery. scope of entities that fall within the definition of an AML/ATF Given the seriousness of the offences and the potential for Regulated Financial Institution, and therefore fall under the economic and reputations repercussions, private equity inves- AML/ATF regulation and supervision umbrella of the BMA, tors are apt to require seller warranties as to compliance with has been expanded to include corporate service providers and Bermuda’s Bribery Act 2016 and all other applicable anti-bribery fund administrators. and anti-corruption laws.

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10.5 Are there any circumstances in which: (i) a private If the directors are accustomed to acting in accordance equity investor may be held liable for the liabilities of with their directions or instructions of certain investors, such the underlying portfolio companies (including due to investors would fall within the definition of “officers” for breach of applicable laws by the portfolio companies); the purposes of the Companies Act 1981 provision regarding and (ii) one portfolio company may be held liable for the offences by officers of companies in liquidation. liabilities of another portfolio company? 112 Other Useful Facts The doctrines of the separate legal personality of Bermuda companies, and the limitation of liability of the shareholders of 11.1 What other factors commonly give rise to concerns companies limited by shares to the unpaid amounts in respect for private equity investors in your jurisdiction or should of their shares, are foundational principles of Bermuda company such investors otherwise be aware of in considering an law that are invariably upheld by Bermuda courts. It is incon- investment in your jurisdiction? ceivable that they would not be upheld by Bermuda courts except in very rare instances where it can be shown that the company Bermuda remains an attractive jurisdiction for investors as a was improperly interposed by a controller to evade, conceal well-regulated, politically stable and business-orientated juris- or frustrate enforcement of a liability. Investors should take diction. With market and regulatory uncertainties continuing note that if the directors are accustomed to acting in accord- to unfold globally – and in the United Kingdom, Europe and ance with their directions or instructions of certain investors, Hong Kong in particular – Bermuda remains well positioned such investors would fall within the definition of “officers” for to promote and to take advantage of its comparative state of the purposes of the Companies Act 1981 provision regarding certainty, stability, ﬂexibility, creativity and responsiveness. The offences by officers of companies in liquidation. recent implementation of the Economic Substance regime in A limited partner is only liable for the unpaid amounts agreed Bermuda means that Bermuda is enjoying a strategic advantage to be contributed to the partnership. A limited partner must be that this and its recent “white-listed” status give it over certain mindful not to engage in management activities as it would risk of its competitors. losing its limited liability and could become liable for the debts Bermuda also has entities that offer corporate concierge and obligations of the partnership. However, subject to the LPA, services to international business, assisting new start-ups to a limited partner’s membership on a board or committee of the find premises, helping staff with relocation arrangements, and LP will not in and of itself result in such limited partner owing providing introductions to local law firms and corporate service a fiduciary duty to the partnership or other partners therein. providers and offering serviced offices. This limitation on liability typically remains in place even if LLC members actively participate in the management of an LLC. In fact, the ability of the members to both manage the day-to-day operations of an LLC while retaining their limited liability are two cornerstones of this structure and are particularly attractive to business owners.

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Nick Miles is a Partner and Head of Corporate at Kennedys Bermuda. He is admitted as a Barrister and Attorney of the Supreme Court of Bermuda and is admitted as a Solicitor of the Senior Courts of England and Wales. He has practised law for 20 years, 10 in Bermuda. He has advised on mergers, amalgamations and debt and equity financings in a wide range of industry sectors, including the insurance, banking, and funds sectors. He has particular experience in insurance-linked securities transactions.

Kennedys Bermuda Tel: +1 441 278 7164 20 Brunswick Street Email: [email protected] Hamilton HM 10 URL: www.kennedyslaw.com Bermuda

Ciara Brady is a Senior Associate at Kennedys Bermuda. She advises public and private international and local companies, partnerships and joint ventures as well as leading financial institutions and funds on a range of corporate, corporate finance, banking, debt and equity offerings, structured finance, secured lending, mergers and acquisitions and reorganisations. Ciara is admitted as a Barrister and Attorney in the Supreme Court of Bermuda, is qualified (not practising) as a Solicitor in England and Wales and is a former member of the Law Society of British Columbia, Canada. She represents clients from a variety of sectors, including banking, insurance, mining, commodities, pharmaceuticals and financial information and analytics.

Kennedys Bermuda Tel: +1 441 278 7169 20 Brunswick Street Email: [email protected] Hamilton HM 10 URL: www.kennedyslaw.com Bermuda

Kennedys advises participants in private equity transactions, including funds, managers, target entities, banks and other financial institutions, on all aspects of the structuring and funding of acquisitions and investments. We also advise on equity and debt finance, restructuring and refinancing, joint ventures and governance and compliance matters. We have particular expertise in relation to transactions involving Bermuda insurance companies and insurance intermediaries, most notably commercial insurers and limited purpose insurers used in insurance-linked securities transactions. * * * Kennedys and Kennedys Bermuda are the trading names in Bermuda of Kennedys Chudleigh Ltd., an independent Bermuda law firm. Kennedys Chudleigh Ltd. is a limited liability company incorporated in Bermuda under the Companies Act 1981, which is regulated under the provisions of the Bermuda Bar Act 1974, and approved and recognised under the Bermuda Bar (Professional Companies) Rules 2009. www.kennedyslaw.com

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Michael P. Whitcombe

McMillan LLP Brett Stewart

12 Overview new credit. Private equity buyers need to balance the availability of existing credit with the requirements of existing portfolio companies against using existing credit availability as leverage 1.1 What are the most common types of private equity in new acquisitions. The Canadian government announced a transactions in your jurisdiction? What is the current policy that it would increase its scrutiny of transactions subject state of the market for these transactions? to review under the Investment Canada Act with respect to investments in health-related sectors as well as sectors involved A number of trends continued through 2019 and into the first in the supply of critical goods and services. On a positive note, quarter of 2020. Canadian private equity deal activity remained the lower Canadian dollar continues to make Canadian targets high through 2019, reaching over $60 billion in capital invested attractive and since May 2020, we have started to see a number and making it the most active year in over a decade. This high of transactions that were “paused” by the pandemic, proceed to level of activity continued into the first quarter of 2020, with completion. total deal value more than doubling over Q1 2019 according to Mergermarket and the Canadian Venture Capital Association. Larger deals (over $1 billion) continued to be a significant driver 1.3 What are going to be the long-term effects for private equity in your jurisdiction as a result of the in terms of total value invested, though sub-$100 million deals COVID-19 pandemic? accounted for the majority of all activity. As in 2018, the industrial and manufacturing sector and the information communications technology sector continue to capture the largest share While many professionals have looked to previous financial of activity measured by both the number of deals (approxi- crises to help predict possible scenarios for the near future, the mately 40% combined) and total value. Complete data is not yet reality is that we have never had to deal with a lockdown of available for the second quarter of 2020, but all signs indicate a a majority of the domestic and global economies before. It is significant slowdown in deal activity following the emergence expected that the pandemic will eventually create significant of the COVID-19 pandemic and the imposition of significant opportunities to invest in the most distressed sectors, such as oil restrictions on economic activity across Canada and the globe. and gas, travel, and hospitality. We also expect that the theme Despite record levels of dry powder on hand, market uncertainty of globalisation, which has dictated the deal dance of the last has made buyers hesitant to invest when valuations have yet to decade or so, will slowly fade as more private equity funds look significantly drop. to build and invest in supply chains which carry little geographic risk and greater redundancies in an effort to minimise vendor and supplier risk. Less traditional investments may also become 1.2 What are the most significant factors currently increasingly common, such as private investment in public equi- encouraging or inhibiting private equity transactions in ties (“PIPE”) transactions. We are also seeing an increased your jurisdiction? level of interest by private equity in take-private transactions of Canadian public companies. Continuing economic uncertainty from the COVID-19 pandemic is the greatest single factor currently inhibiting deals, especially traditional buyout activity, as many sectors of have taken huge 1.4 Are you seeing any types of investors other than traditional private equity firms executing private revenue hits. In addition, unprecedented governmental support, equity-style transactions in your jurisdiction? If so, at both the provincial and federal level, and related economic stim- please explain which investors, and briefly identify any ulus packages have helped to prop up many Canadian companies, significant points of difference between the deal terms allowing them to survive in the immediate short term and avoid a offered, or approach taken, by this type of investor and distressed sale process. From the private equity buyer’s perspec- that of traditional private equity firms. tive, seller’s valuation expectations remain high. Valuations are increasing difficult to conduct, as operations and supply chain Family offices and institutional investors, such as pension disruption are a key focus of risk assessment and investors must funds, are becoming more active and independent participants understand the financial risks associated with a target’s trading in the private M&A space. If these investors are competing partners, suppliers and customers caused by the pandemic. against private equity firms in an auction setting, then they tend Diligence and integration activities are complicated by the to offer private equity-like transaction terms, including the use Canadian border being closed to all non-essential travel. Canadian of representation and warranty insurance. If it is not a compet- banks have, from early March 2020 to until very recently, frozen itive process, then their approach and timelines are often more

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closely aligned to that of a strategic purchaser. Since these inves- equity interests offered to, or required of, continuing manage- tors generally have the ability to hold an investment indefinitely, ment are often a major point of negotiation in transactions. they will be more willing to acquire businesses that include Typical structures include multiple classes of equity with one real estate assets and will be more willing to consider acquiring class designed to pay out investors, such as the fund and any manufacturing operations that have “legacy issues”. co-investors (including management), in priority over a second class designed to pay out continuing management only if the 22 Structuring Matters business is eventually sold for more than a certain threshold value (incentive equity). Stock options (more tax-effective) or 2.1 What are the most common acquisition structures phantom stock options (less tax-effective) are also commonly adopted for private equity transactions in your granted. jurisdiction? 2.4 If a private equity investor is taking a minority Privately held Canadian businesses are generally acquired by position, are there different structuring considerations? private equity buyers either through a purchase of assets or a purchase of shares. Private equity investors will typically incor- Minority positions require private equity firms to consider porate a Canadian acquisition corporation and fund it by way different structuring issues due to the lack of control. The of interest-bearing debt and equity on a 1.5:1 basis in order to minority rights stipulated in the shareholders’ agreement comply with Canadian thin-capitalisation rules. This acquisi- become of primary concern to ensure private equity firms have tion entity then acquires all of the shares/assets of the Canadian veto power (or at least significant influence) over critical deci- target and, in the case of a share acquisition, the acquisition sions. Likewise, put and drag-along provisions are key to ensure corporation and target are then “amalgamated” under the rele- the private equity investor has flexibility with regard to their vant corporate statute to align the leverage with the operating exit strategy. A minority interest is often taken in the form of company. Often, these buyout structures include key manage- convertible preferred shares or a convertible debt instrument. ment rolling their interest and maintaining their equity stake. The then amalgamated operating company will then typically make add-on transactions by way of direct acquisition whereby 2.5 In relation to management equity, what is the typical range of equity allocated to the management, and the operating company will acquire the share or assets of an what are the typical vesting and compulsory acquisition add-on target directly. Buyouts remain the preferred form of provisions? investment but minority investments, once only common in smaller growth equity deals, are a continuing and increasingly popular trend. Allocation to management will vary on a deal-by-deal basis but typically ranges from 10–20%. Aligning the equity interests granted to continuing managers with the continued growth 2.2 What are the main drivers for these acquisition and success of the company is essential. In order to align inter- structures? ests, most stock option plans call for options to vest and become exercisable upon the achievement of certain conditions. Those Whether a Canadian acquisition should be completed by conditions are typically tied to either continued employment purchasing assets or shares is driven by tax and non-tax consid- and the passage of time, and/or certain performance/success erations. The weight given to these factors will depend on requirements, such as the achievement of stated financial the circumstances of the transaction and the parties’ ability to returns. Generally, management equity is structured to allow leverage their respective positions. From the point of view of for repurchase by the company upon a termination of employ- a potential purchaser, the greatest benefits of an asset sale are ment. Options granted to management may vary on whether tax advantages and the ability to pick and choose the assets and they are exercisable following termination of employment based liabilities that will be acquired. The majority of “legacy liabil- on whether the termination was a “good exit” or a “bad exit” or ities” can be left with the seller. However, asset sales tend to on where the management ultimately lands following the exit. be significantly more complex in larger transactions and can The options granted to management typically vest automati- require more third-party consents for material contracts. In cally in the event of a sale of the company by the private equity contrast, a share sale is relatively simple from a conveyancing investor. perspective and less likely to trigger third-party consent requirements. From the seller’s perspective, tax considerations gener- 2.6 For what reasons is a management equity holder ally favour share transactions as individual sellers may be able usually treated as a good leaver or a bad leaver in your to utilise their $883,384 (as of 2020) lifetime personal capital jurisdiction? gains exemptions to shelter a portion of the proceeds. “Hybrid” transactions, which involve the acquisition of both shares and Under Canadian law, the threshold for firing an employee “for assets of a target entity, providing tax advantages to both buyer cause” is very high and hard to establish. For that reason, and seller, also continue to be popular. circumstances amounting to an exiting management equity holder leaving as a “bad leaver” are not tied to a causal dismissal 2.3 How is the equity commonly structured in private but rather to more general grounds of dismissal. Any circum- equity transactions in your jurisdiction (including stance where an exiting equity holder is terminated or is acting in institutional, management and carried interests)? competition with the business will be treated as a “bad leaver”. Good leavers are usually those leaving due to death, disability Sellers of businesses, including key management, will often roll- or retirement. over equity into a corporate purchaser. The precise terms of the

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3 2 Governance Matters 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 3.1 What are the typical governance arrangements typically addressed? for private equity portfolio companies? Are such arrangements required to be made publicly available in your jurisdiction? In contrast to some American jurisdictions, controlling shareholders in Canada do not owe a fiduciary duty to minority shareholders. Private equity firms utilise their equity positions, or negotiated minority rights, to assign seats on the board of directors to their principals and nominees. As such, they typically have 3.5 Are there any limitations or restrictions on the the authority to run the portfolio company for the period of contents or enforceability of shareholder agreements their investment. In Canada, the names and addresses of private (including (i) governing law and jurisdiction, and (ii) companies’ boards of directors are publicly available informa- non-compete and non-solicit provisions)? tion. However, the names of shareholders of private companies are not currently publicly available. There is pressure being A shareholder agreement that is not signed by all of the share- brought by foreign interests on Canadian regulators to bring the holders of a company is treated as a regular commercial contract. disclosure of ownership of Canadian corporations into align- It is subject to the articles and by-laws of the corporation and the ment with other major countries. A recent amendment to the provisions of the relevant corporate statute. In contrast, a USA Canada Business Corporations Act now requires federally incor- is a creature of statute and must be signed by all shareholders. porated businesses to maintain a record of beneficial owners in Corporate legislation expressly recognises the ability of share- their corporate records. Amendments to British Columbia’s holders to contract out of certain statutory requirements and Business Corporations Act will also require private companies fetter certain powers of directors. To the extent a USA restricts to maintain a register of individuals with certain kinds of control the powers of directors to manage the business and affairs of the over the company. Manitoba, Saskatchewan, Nova Scotia, and corporation, shareholders who are given that power inherit the Prince Edward Island have introduced similar amendments to rights, powers, duties and liabilities of a director under corpo- their corporate legislation as well. While this information will rate statutes or otherwise. Canadian courts will generally not not be public (under currently enacted legislation), it is indicative enforce restrictive covenants that unnecessarily restrict an indi- of a growing trend towards more transparency. vidual’s freedom to earn a livelihood. What is reasonably necessary depends on the nature of the business, its geographic reach, and the individual’s former role in that business. Canadian 3.2 Do private equity investors and/or their director nominees typically enjoy veto rights over major courts will not enforce a restrictive covenant that does not corporate actions (such as acquisitions and disposals, contain any time limit. business plans, related party transactions, etc.)? If a private equity investor takes a minority position, what 3.6 Are there any legal restrictions or other veto rights would they typically enjoy? requirements that a private equity investor should be aware of in appointing its nominees to boards of The default dissent rights provided under corporate legislations portfolio companies? What are the key potential risks are typically supplemented through unanimous shareholder and liabilities for (i) directors nominated by private agreements (“USA”) that ensure the private equity investor has equity investors to portfolio company boards, and (ii) private equity investors that nominate directors to ultimate control over the portfolio company. Often, such veto boards of portfolio companies? rights cease to apply where a private equity investor’s equity interest is reduced below a given benchmark. Where a private equity investor holds a minority position, veto rights are still Depending on the jurisdiction of incorporation, the board of typically enjoyed over critical business matters such as acquisi- directors of a Canadian corporation may be subject to certain tions, changes to the board and management team, the issuance minimum residency requirements. Notably, boards of directors of new equity or debt and the disposition of key assets. for companies incorporated under either the federal or Ontario statute must consist of at least 25% resident Canadian directors or include at least one resident of Canada if the board has 3.3 Are there any limitations on the effectiveness of fewer than four members. In Canada, all directors owe fidu- veto arrangements: (i) at the shareholder level; and (ii) at ciary duties to the corporation, including a duty to act in the best the director nominee level? If so, how are these typically addressed? interest of the corporation. The potential statutory liabilities directors are exposed to can be extensive and the basis for this potential liability varies. Directors may be personally liable for In order for a shareholder agreement that sets forth veto their own wrongdoing or failure, such as breaching the duties of arrangements to be enforceable against a subsequent share- loyalty and of care, or, in other instances, held personally liable holder, to fetter the discretion of the directors or to supplant the for wrongdoing by the corporation. The statutes that impose default provisions of corporate legislation where permitted, it liability on directors include those governing: corporate matters; must be unanimous in nature. At the director level, only certain securities compliance; employment and labour protection; taxa- powers of directors can be fettered by a unanimous share- tion; pensions; and bankruptcy and insolvency. holders’ agreement and, most notably, the fiduciary duty owed by the director of a portfolio company to the company itself cannot be restrained.

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3.7 How do directors nominated by private equity 4.2 Have there been any discernible trends in investors deal with actual and potential conflicts of transaction terms over recent years? interest arising from (i) their relationship with the party nominating them, and (ii) positions as directors of other portfolio companies? The increase in foreign investment, typically from the U.S., has influenced transaction terms which have gradually shifted to become increasingly similar to those in the American market. Directors of a corporation who are nominees of a particular For example, the size of indemnity caps, while still significantly shareholder are subject to fiduciary duties to act in the best higher in Canada than in the U.S., continues to trend down- interest of the corporation, not the shareholder who nominated wards. The Canadian market has also increasingly seen “public them. Canadian corporate statutes require directors to disclose style” deals as in the U.S. market. Also, the use of representation in writing the nature and extent of their interest in a proposed and warranty insurance is increasingly being seen as standard in material contract or transaction with the corporation. This the Canadian private equity market and impacts what terms are provision applies whether the director is a party to the contract “market” in deals using that product. For instance, double mate- or transaction personally or is a director or officer of, or has a riality scrapes are now very typical in representation-and-war- material interest in, a party to the contract or transaction. As ranty insured Canadian transactions. such, all conflicts or potential conflicts the director has, as a result of their relationship with the nominating party and/or 52 Transaction Terms: Public Acquisitions other portfolio companies, must be disclosed. In situations of conflict, the statutes require the director to refrain from voting on any resolution to approve the contract or transaction except 5.1 What particular features and/or challenges apply in narrow circumstances. to private equity investors involved in public-to-private transactions (and their financing) and how are these commonly dealt with? 4 2 Transaction Terms: General Canadian takeover bids require that adequate arrangements 4.1 What are the major issues impacting the timetable (an interpreted statement) must be made, with the effect that for transactions in your jurisdiction, including antitrust, a bid cannot be conditional on financing. Statutory plans of foreign direct investment and other regulatory approval requirements, disclosure obligations and financing arrangement on the other hand can be conditional in nature and issues? allow more flexibility to provide collateral benefits to managements, etc. Due to this flexibility, most uncontested Canadian privatisation transactions involving private equity investors are As a result of the COVID-19 pandemic, the due diligence completed by a plan of arrangement. process is playing an increasing role in delaying transactions as restrictions on travel, meetings, and other activities have made it more difficult to perform the investigations necessary to 5.2 What deal protections are available to private complete appropriate diligence in a timely manner. Aside from equity investors in your jurisdiction in relation to public the typical due diligence process, the timetable for transactions acquisitions? is often governed by the regulatory approval required under the Competition Act and the Investment Canada Act, where appli- In friendly acquisitions, break fees are often seen in connection cable. In Canada, certain large transactions trigger advance with “no-shop” provisions. The “no-shop clause” is typically notice requirements under the Competition Act. Such trans- subject to a fiduciary out, upon which the break fee becomes actions cannot be completed until the end of a review period. payable. The break fee, traditionally in the range of 2–4% of the Pre-merger notification filings are required in connection with transaction’s value, is now typically based on enterprise value. a proposed acquisition of assets or shares or an amalgamation or other combination to establish a business in Canada where 62 Transaction Terms: Private Acquisitions thresholds relating to the “size of the parties”, the “size of the transaction” and “shareholding” are exceeded. 6.1 What consideration structures are typically Recent amendments to the Competition Act may result in preferred by private equity investors (i) on the sell-side, more transactions being subject to pre-merger notification as and (ii) on the buy-side, in your jurisdiction? all corporate and non-corporate entities under common direct or indirect control are now treated as “affiliates” and will thus Private equity buyers typically require purchase price adjust- be included in the threshold analysis. This will be especially ments to reflect the financial condition of the target. Typically, impactful on traditional private equity funds that are struc- these are based on a net working capital adjustment. Earn-out tured as limited partnerships. In addition to competition regu- provisions are also often contemplated by private equity buyers lations, under the Investment Canada Act, foreign investments in order to link the seller’s ultimate consideration to the finan- that exceed prescribed values or that relate to a cultural busi- cial success of the target entity post-closing. Earn-out provi- ness or involve national security issues are subject to Investment sions have become especially popular during the COVID-19 Canada Act approval. This allows the federal government to pandemic, as a way for transaction parties to account for uncer- screen proposed investments to determine whether they will be tain future performance without discounting a company’s of “net benefit” to Canada. purchase price. The use of “locked box” structures, common In response to the COVID-19 pandemic, the Canadian in the UK, is also a common structure in Canada as a means to federal government released a policy statement in April 2020 limit post-closing price adjustments. Private equity firms gener- stating that, using existing powers, it will apply enhanced scru- ally arrange their own credit facility and invest on a cash-free, tiny under the Investment Canada Act to certain foreign invest- debt-free basis. On the sell-side, private equity investors typi- ments, notably foreign direct investment relating to public cally prefer simple consideration structures with less variability, health or critical goods or services. and that minimise the size and scope of post-closing obligations.

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6.2 What is the typical package of warranties / 12−18 months (with fundamental representations and warranties indemnities offered by (i) a private equity seller, lasting longer) and negotiated indemnity cap (for non-fundamental and (ii) the management team to a buyer? representations) often in the range of 5–30% of the sale price. Involvement of foreign participants, especially U.S.-based participants, is often correlated to the lower end of these ranges applying, Private equity sellers and management teams will try to minimise whereas we see the upper ends of the ranges more commonly on the representations and warranties and insist on a short survival truly domestic Canadian transactions. period for representations given. Private equity sellers will further try to limit their exposure by ensuring they do not include a full disclosure, 10b-5 type representation by liberally using materi- 6.6 Do (i) private equity sellers provide security (e.g. ality qualifiers and by including an anti-sandbagging provision. escrow accounts) for any warranties / liabilities, and Private sellers are also increasingly insisting on public-style exits. (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 While representation and warranty insurance is becoming private equity seller and its management team to a more popular, the traditional approach of a seller indemnity buyer? coupled with a purchase price holdback or escrow is also still common for both private equity buyers and sellers in Canada. Private equity sellers generally insist on limiting post-closing In the event of an earn-out provision, set-off rights against the exposure as much as possible. As referenced above, they typi- earn-out payment are also typical. cally limit the length and scope of indemnity provisions as much as possible, as well as other post-closing covenants and 6.7 How do private equity buyers typically provide undertakings. Public-style exits, in which a private seller’s post- comfort as to the availability of (i) debt finance, and (ii) closing exposure is limited exclusively to instances of fraud, are equity finance? What rights of enforcement do sellers becoming increasingly common. typically obtain in the absence of compliance by the buyer (e.g. equity underwrite of debt funding, right to specific performance of obligations under an equity 6.4 To what extent is representation & warranty commitment letter, damages, etc.)? insurance used in your jurisdiction? If so, what are the typical (i) excesses / policy limits, and Private equity transactions typically involve equity financing (ii) carve-outs / exclusions from such insurance from the private equity investor and debt financing from a third- policies, and what is the typical cost of such party lender. Comfort, with respect to the equity financing, is insurance? often provided in the acquisition agreement, which generally contains a commitment for the private equity investor to fund Representation and warranty insurance use is not universal, but, and complete the acquisition upon the satisfaction of certain as noted above, has become commonplace and is increasingly conditions. The acquisition agreement generally also contains a popular in Canadian private equity transactions. Policy limits representation and warranty that the private equity investor has typically cap out at 10–20% of the purchase price of a transac- sufficient funds to provide the funding. Comfort letters from tion. Available coverage has gotten broader and, over recent the third-party lender or bank are typically tabled to provide years, the number of typical carve-outs and exclusions from comfort with respect to the debt financing. such policies has decreased quite significantly. However, they remain for pre-closing taxes, pension funding, certain environ- 6.8 Are reverse break fees prevalent in private equity mental matters and other high-risk deal specific terms. Policy transactions to limit private equity buyers’ exposure? If premiums for representation and warranty insurance have been so, what terms are typical? steadily declining in recent years and now may range between 2.5–4% of the policy limit. The retention amounts required Reverse break fees are becoming more common in Canadian under these policies have similarly declined. It is now common private equity transactions. These fees are typically negotiated as a to see this figure as low as 1% of enterprise value. fixed dollar amount or a percentage of enterprise value. Due to the increased exposure of the target entity to potential damage from a 6.5 What limitations will typically apply to the failed deal, reverse break fees are often higher than the negotiated liability of a private equity seller and management break fee on a transaction, ranging up to 10% of enterprise value. team under warranties, covenants, indemnities and undertakings? 72 Transaction Terms: IPOs

It is advisable for private equity investors to build restrictions 7.1 What particular features and/or challenges should on the scope of representations and warranties that fund inves- a private equity seller be aware of in considering an IPO tors are required to give on a sale transaction. Representations exit? and covenants as to the portfolio company’s operations are more properly given by management shareholders who will While traditionally seen as the gold-standard, ideal exit for a have in-depth knowledge in this regard. Private equity investors private equity seller, IPO exits are not common and interest in required to indemnify a purchaser in respect of a breach should such exits waned in 2019 after an uptick in 2018. When consid- do so on a several basis and limitations should be placed on ering an IPO exit, private equity sellers should be aware of the the dollar amount for which private equity investors are respon- costs of preparing for and marketing the IPO, which includes the sible. Typically, post-closing indemnification on the sale lasts preparation of a prospectus and a road show. It is also important

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for the private equity seller to be aware that an IPO will not part of the financing for their Canadian transactions; however, allow for an immediate exit of its entire position and that the the emergence of the COVID-19 pandemic has strained the private equity’s final exit will be subject to lock-up provisions debt financing market. With debt financing less available, it is which will limit the investor’s abilities to sell their shares for a possible that buyers will turn to atypical financing plans and be period of time following the IPO. less reliant on debt financing in the near-term to effect deals.

7.2 What customary lock-ups would be imposed on 92 Tax Matters private equity sellers on an IPO exit? 9.1 What are the key tax considerations for private Underwriters in an IPO will require these shareholders to enter equity investors and transactions in your jurisdiction? Are off-shore structures common? into a lock-up agreement as a condition to the underwriting to ensure their shares do not enter the public market too soon after the IPO. While the terms of lock-up agreements are subject to Many of the common tax considerations in transactions with negotiation, they typically last 180 days. private equity funds apply equally to transactions with strategic buyers. However, there are several considerations that may take on added importance when transacting with foreign 7.3 Do private equity sellers generally pursue a dual- private equity investors in particular. Dividend payments made track exit process? If so, (i) how late in the process are private equity sellers continuing to run the dual-track, by Canadian portfolio companies to foreign private equity inves- and (ii) were more dual-track deals ultimately realised tors are generally subject to a 25% withholding tax, although this through a sale or IPO? rate is substantially reduced under tax treaties in most instances. Non-resident investors should also familiarise themselves with Canada’s thin-cap rules that prohibit Canadian companies from Dual-track processes have not typically been popular in Canada. deducting interest on a portion of interest-bearing loans from However, given the state of the market before the pandemic specified non-residents that exceed one-and-a-half times the tax and the increased use of these processes in the United States, equity of the “specified non-residents” in the Canadian company. we expect to see them becoming more common in Canada, as Historically, intermediary entities in tax-favourable jurisdictions buyers continue to seek ways to hedge the risk of a failed attempt such as Luxembourg and the Netherlands have often been utilised to go public while at the same time increasing valuations. by foreign-based private equity funds investing into Canada. However, the Organisation for Economic Cooperation and 82 Financing Development’s Base Erosion and Profit Shifting (“BEPS”) initiative have significantly affected the usage of such intermediaries. 8.1 Please outline the most common sources of debt finance used to fund private equity transactions in your jurisdiction and provide an overview of the current state 9.2 What are the key tax-efficient arrangements that of the finance market in your jurisdiction for such debt are typically considered by management teams in private (particularly the market for high yield bonds). equity acquisitions (such as growth shares, incentive shares, deferred / vesting arrangements)?

Foreign investors, largely U.S.-based, account for a substantial portion of private equity investment in Canada. U.S. investors Stock options remain the most popular stock-based compensa- often bring their American debt financing with them or obtain tion tool, due to their favourable treatment (no taxation until Canadian debt financing. Private equity investors utilising U.S. exercise and general eligibility for a capital-gains equivalent rate debt sources for Canadian private equity transactions need to of tax). Other popular stock-based compensation arrangements develop FX hedging strategies, which are typically only provided for management include stock appreciation rights and deferred by traditional banks and can be costly. Traditional senior stock units. secured debt obtained from a domestic Canadian bank, often in the form of a revolving credit facility or term loan, remains 9.3 What are the key tax considerations for the most common source of debt financing in Canadian private management teams that are selling and/or rolling-over equity transactions. At times, senior secured debt is also supple- part of their investment into a new acquisition structure? mented by mezzanine financing (usually by way of subordinated debt) through banks or other financial institutions. Investors in a Canadian company are generally permitted a tax-free rollover when exchanging their shares in the company 8.2 Are there any relevant legal requirements or for shares of another Canadian company, but not when such restrictions impacting the nature or structure of the debt shares are exchanged for shares of a non-Canadian company. financing (or any particular type of debt financing) of An effective workaround may be available in the latter circum- private equity transactions? stances through the use of “exchangeable shares” (i.e., shares of a Canadian company that are exchangeable for, and are econom- There are no relevant legal requirements or restrictions that ically equivalent in all material respects with, shares in the rele- affect the choice of structure used for debt financing in Canadian vant foreign company). private equity transactions.

8.3 What recent trends have there been in the debt financing market in your jurisdiction?

Most private equity firms would typically use private lending as

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9.4 Have there been any significant changes in tax Economic Development or the Minister of Canadian Heritage, legislation or the practices of tax authorities (including depending on the nature of the Canadian business being in relation to tax rulings or clearances) impacting private acquired. equity investors, management teams or private equity transactions and are any anticipated? 10.3 How detailed is the legal due diligence (including compliance) conducted by private equity investors prior As noted above, the Organisation for Economic Cooperation to any acquisitions (e.g. typical timeframes, materiality, and Development’s BEPS initiative, insofar as anti-treaty- scope, etc.)? shopping measures are concerned, has significantly decreased foreign-based private equity funds’ usage of intermediary The majority of private equity investors conduct thorough legal entities in favourable jurisdictions (such as Luxembourg and the due diligence, reviewing all material legal documents including Netherlands) for their Canadian investments. Amendments to the target entity’s corporate records, materials contracts and the Excise Tax Act (Canada), enacted in 2018, impose goods employment records. In addition, publicly available searches and services tax obligations on investment limited partnerships. are also typically conducted in order to identify any regis- These changes imposed goods and services tax on management tered encumbrances, active legislation, bankruptcy filings and and administrative services provided by the general partner of other similar matters. Most legal due diligence is conducted by an investment limited partnership. If the partnership meets external counsel and other professionals, such as environmental the definition of “investment limited partnership”, the general consultants. The length of the diligence review and materiality partner will be obligated to charge and remit goods and services threshold applied differs greatly and is often dependent on the tax on the fair market value of any management/administrative nature of the sale process, the risk tolerance of the private equity services provided. In 2019, the federal government proposed a investor and the industry the target is in. $200,000 annual limit on the eligibility of employees of certain businesses to claim a 50% tax deduction for stock option grants. This could affect the compensation packages required to retain 10.4 Has anti-bribery or anti-corruption legislation and incentivise management. While the implementation of impacted private equity investment and/or investors’ approach to private equity transactions (e.g. diligence, this new limit has been delayed following public comment, the contractual protection, etc.)? government has not said it has abandoned the idea.

102 Legal and Regulatory Matters Canada’s Corruption of Foreign Public Officials Act (“CFPOA”) was enacted in 1998 to ensure commercial fair dealing, government integrity and accountability, and the efficient and equitable 10.1 Have there been any significant legal and/or distribution of limited economic resources. CFPOA prohibits regulatory developments over recent years impacting private equity investors or transactions and are any the promise, payment or giving of money or anything of value anticipated? to any foreign official for the purpose of obtaining or retaining business or gaining an improper advantage and concealing bribery in an entity’s books and records. Private equity transac- Amendments to the Competition Act (Canada) expanded what tions, especially in sensitive industries or which involve a target is considered “an affiliate” for the purposes of applying the with material government contracts, typically specify diligence Competition Act thresholds. As amended, the Competition contracts as well as corporate records and policies for compli- Act now includes non-corporate entities as affiliates. Under ance with this legislation. In addition, representations and these amendments, funds structured as partnerships will now warranties are often obtained from the seller confirming the be considered affiliates of both portfolio companies under their entity’s compliance with the same. While the Foreign Corrupt control and any other similarly structured sister funds controlled Practices Act (“FCPA”) is an American law, U.S. private equity by the same entity. This increases the number of entities that investors often seek assurances that Canadian target entities are may count towards the “size of the parties” threshold and is complying with FCPA. If the Canadian target is not currently expected to result in a greater number of private equity transac- owned by an American interest, this can be problematic. tions triggering the notice requirements.

10.5 Are there any circumstances in which: (i) a private 10.2 Are private equity investors or particular equity investor may be held liable for the liabilities of transactions subject to enhanced regulatory scrutiny in the underlying portfolio companies (including due to your jurisdiction (e.g. on national security grounds)? breach of applicable laws by the portfolio companies); and (ii) one portfolio company may be held liable for the Private equity investors are not subject to specific regulatory liabilities of another portfolio company? scrutiny; however, the amendments to the Competition Act noted above are likely to increase the number of private equity Typically, Canadian courts are hesitant to pierce the corpo- transactions that trigger advance notice requirements under the rate veil and hold shareholders liable for their portfolio compa- Competition Act. Foreign investments that constitute an acqui- nies. However, Canadian courts will pierce the corporate veil sition of “control” of a Canadian business will require approval where a corporate entity is controlled and used for fraudulent or under the Investment Canada Act if the investment exceeds improper conduct. Likewise, to the extent a shareholder usurps certain monetary thresholds, involves a cultural business, or the discretion of a director to manage the business, that share- has national security implications. Such investments are subject holder will expose itself to the liabilities of a director of the to approval by the federal Ministry of Innovation, Science and entity.

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112 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?

Other factors that commonly raise concerns for private equity investors, especially foreign investors, include: that foreign ownership in specified industries such as financial services, broadcasting and telecommunications is limited by certain federal statutes; management and administration fees paid by a Canadian resident to a non-arm’s length non-resident are subject to a 25% withholding tax; and that Canadian employment laws differ fairly significantly from American laws and impose more obligations and potential liabilities on a target corporation.

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Michael P. Whitcombe has been recognised as one of Canada’s leading business lawyers in Lexpert®’s Guide to the Leading 500 Lawyers in Canada. He principally practises in the areas of negotiated merger and acquisition transactions (domestic and cross-border), private equity investments, strategic alliances, complex commercial arrangements and corporate governance. Michael regularly advises private equity firms along with other medium and large corporations (both domestic and international) and their boards of directors in connection with their operations throughout Canada. He has significant industry experience in the pharmaceutical, automotive, manufacturing, distribution, service, entertainment, hospitality and tourism sectors. He is a Director of a number of Canadian corporations including Porsche Cars Canada Ltd. Michael obtained a degree in Business Administration (“BBA”) in addition to his LL.B. and LL.M. and was called to the Ontario Bar in 1987.

McMillan LLP Tel: +1 416 865 7126 181 Bay Street, Suite 4400 Email: [email protected] Toronto ON, M5J 2T3 URL: www.mcmillan.ca Canada

Brett Stewart is recognised in the IFLR1000 Financial and Corporate Guide 2016 and 2018 as a rising star in the areas of Investment Funds and Banking, ranked in Lexpert®’s Guide to the Leading U.S./Canada Cross-Border Corporate Lawyers in Canada 2015 as a Corporate Lawyer to Watch in the area of Corporate Commercial Law, and was selected as a Lexpert® Rising Star: Leading Lawyer Under 40 for 2014 by Lexpert® Magazine. Brett is Co-Chair of McMillan’s Private Equity Group. With a focus on assisting domestic and foreign clients with negotiated transactions including mergers and acquisitions, private equity financings, venture capital financings and management buyouts, Brett has represented clients in a number of sectors including agri-food, food manufacturing, aerospace and defence, engineering, pharmaceuticals, tech and clean- tech, manufacturing and transportation. Brett is Vice-Chair of the Private Equity and Venture Capital Committee of the American Bar Association and the Co-Chair Canadian Women in Private Equity. 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 LLP Tel: +1 416 865 7115 181 Bay Street, Suite 4400 Email: [email protected] Toronto ON, M5J 2T3 URL: www.mcmillan.ca Canada

McMillan is a leading 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. www.mcmillan.ca

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China China

Lefan Gong

Zhong Lun Law Firm David Xu (Xu Shiduo)

12 Overview to have control of the target and may as well then rule against club deals as an option.

1.1 What are the most common types of private equity transactions in your jurisdiction? What is the current 1.2 What are the most significant factors currently state of the market for these transactions? encouraging or inhibiting private equity transactions in your jurisdiction? Private equity (PE) transactions in China include both growth capital investments and buyout transactions. One unique aspect Since the Ministry of Commerce (MOFCOM) promulgated the worth mentioning is the fact that transactions, depending on Provisions on Foreign Investors Acquiring Domestic Enterprises the future exit, may be structured as an onshore transaction or (Circular 10) back in 2006 (as amended in 2009), it has become offshore transaction. If the future exit is likely to be an IPO difficult to convert an onshore domestic PRC company struc- in a non-PRC stock market (e.g., a stock exchange in the US or ture into an offshore structure, making it difficult for the foreign Hong Kong), then the listing vehicle will likely take the form of PE investors to opt for the option of establishing an offshore a company incorporated in an offshore jurisdiction such as the structure for investment and future exit through an overseas Cayman Islands (i.e., an offshore holding company). With such IPO. Founders of domestic companies will have to rely on expe- plan in mind, the PE investors will invest into such offshore rienced counsels to go through sophisticated, and often costly, holding company and exit after the IPO of such offshore restructuring processes to migrate the domestic structure into an vehicle. If the target company is a PRC domestic entity, then the offshore one. If this is not successful, then the foreign inves- PE investors would often require that a company restructuring tors will have to invest directly into the PRC domestic target, be completed as a closing condition, such that the PE investors resulting in a Sino-foreign joint venture, which, after converting will become the shareholders of the offshore holding company. into a joint stock company (a.k.a. a company limited by shares), In contrast, if the target company is to be listed within the PRC may be considered for listing in one of the PRC stock exchanges on one of the domestic stock exchanges, then the listing vehicle (i.e., an “onshore IPO or listing” in China). It should be noted must be a PRC incorporated joint stock company. PE investors that IPOs in China are subject to review and approval by the will invest into such domestic company which is governed by the China Securities Regulatory Commission (CSRC) and the process PRC law, including company law, securities rules and, if appli- usually takes many months and even years, and companies often cable, regulations on foreign investment in China. have to wait in a long queue for such approval. As a result, despite The market used to be dominated by growth capital-style the fact that the PRC stock markets can sometimes offer higher investments where the PE investors tend to hold minority PE ratios for companies listed on the A-share stock exchanges, stakes; however, there has been an increase in the popularity the longer waiting period does create more uncertainty than those and number of buyout transactions in China thanks to a variety overseas stock exchanges. of factors, including increased competition among investors The issue of the long waiting period for domestic IPO approval who are chasing fewer growth capital deals, the emergence of may now ease with the introduction of the new “Science and privatisation deals, the government’s regulatory liberalisation Technology Innovation Board” (STIB or Sci-tech innovation allowing loans (subject to conditions and limitations) to finance board), in March 2019 at the Shanghai Stock Exchange. With the M&A and buyout transactions, and the increasing willingness newly adopted registration-based listing system, the conventional of founding shareholders of companies, while reaching retire- CSRC approval-based IPO regime will be replaced with a filing ment age, to sell controlling stakes to third-party buyers, such and registration regime for the purpose of listing at STIB, which as buyout funds. would significantly speed up the process which could otherwise For regular transactions, club deals may not be as prevalent; be months and years for going through the approval and review especially when each of the PE investors faces deal-sourcing process. STIB will especially give priority to companies in high- pressure and intends to keep the deals to themselves as long as tech and strategically emerging sectors such as new generation the investment size is within their own pricing range. However, information technology, advanced equipment, new energy, new for larger transactions, including privatisation deals, those materials and biomedicine. The new policies and regulations funded partly by debt financing, or those requiring certain reflect the government’s intent to fuel growth and development special expertise or value offered by one or more of the “club for tech companies, which is also encouraging for PE and venture members”, club deals can be appealing. Also, in the context of a capital (VC) investors for such added new exit channel. buyout, investors also have to consider factors such as who gets On January 1, 2020, the New Foreign Investment Law and its Implementation Rules (the “New Foreign Investment Law”)

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came into effect. The new law replaces the current laws and Conventional PE and VC funds have a seven- to 10-year term, regulations governing three types of foreign-invested enter- so they must plan for exit before expiry and have disciplines in prises, including equity joint ventures, cooperative joint ventures screening investment opportunities aiming for a high return of and wholly foreign-owned enterprises. It means the above investment. It is common for the investment funds to require mentioned FIEs are now being governed by the PRC Company clauses such as minority shareholder protection, redemption Law, in the same manner as those domestic companies owned rights, liquidation preference, tag-along and drag-along rights, by PRC nationals and/or entities. Meanwhile, the establishment indemnification, etc. while an industrial investor may prefer to procedures have also been simplified and streamlined. acquire controlling stakes, seek longer-term value out of the For the existing foreign invested joint ventures, there is a five- transaction and build synergy among the joint venture partners. year transition period (up until 1 January 2025) that would allow Among other players, insurance companies and other finan- joint ventures to conform to the Company Law, and the joint cial institutions have regulatory restrictions. For instance, for venture partners would potentially need to renegotiate the terms direct investment, they are only allowed to invest in the sector of of the joint venture agreement, the Articles and Associations insurance, non-insurance financial institutions and companies and corporate governance . in those sectors relevant to insurance, such as pension, health- For minority shareholder(s) in a joint venture, it is worth care, and auto services. noting that the former Sino-Foreign Joint Venture Law requires unanimous board resolutions for certain key issues for the 22 Structuring Matters company, such as amendment to the Articles of Association, mergers and acquisitions and dissolution of the company. In 2.1 What are the most common acquisition structures the Company Law, there is no statutory requirement for unan- adopted for private equity transactions in your imous board resolutions, leaving room for the shareholders to jurisdiction? decide what terms to include in the shareholders agreement and the Articles of Association. There are onshore and offshore structures available for PE This means that counsel to the minority shareholder(s) must transactions. Under the onshore investment model, the PE be more cautious, vigilant and assertive asking for protection fund, through an offshore special purpose vehicle (SPV), invests clauses when negotiating the terms of the joint venture contract, into the onshore PRC domestic corporate entity directly and such as its “veto power” at levels of both the shareholders becomes a shareholder of the onshore company. assembly and board of directors. Under the offshore investment model, the PE investor or its SPV invests into or acquires shares of the offshore 1.3 What are going to be the long-term effects for holding company of the target company, and such offshore private equity in your jurisdiction as a result of the holding company often holds 100% interests in a HK interme- COVID-19 pandemic? diary company, which then holds 100% interests in a subsidiary in the PRC, in the form of a “wholly foreign owned enter- The global coronavirus crisis has caused greater instability and prise” (WFOE). Such offshore holding company is most often the threat of a recession could become “palpable” in the coming intended to become a listing vehicle in the future overseas IPO year. As indicated by statistics, the deal volume and amount of and, due to the nature that it holds assets directly or indirectly capital raised in China during the first six weeks of 2020 fell by in China, such offshore holding company is often referred to as more than 60% compared with the same period in 2019. Most a “red chip” company. PE firms have been cautious in making investment decisions amidst the current downward shift in global growth outlook. 2.2 What are the main drivers for these acquisition Against such backdrop, certain sectors such as health- structures? care, biotech and e-commerce, however, have proven their worth and expanded market share during the crisis. As the capital markets in both mainland China and Hong Kong allow PE investors often set up one or more SPVs and use the SPVs not-yet-profitable healthcare companies to be listed, more to hold interests in the target company. The drivers for such PE funds have been willing to increase their investment in acquisition structure can be related to tax planning and avoid- this sector, and the upshot is that the valuation of healthcare ance of onshore PRC approval in case of share transfer. If the companies has substantially increased and become increas- equity transfer involves the equity interests or shares of a PRC ingly appealing to many investors. company, government approval is required if there is any involvement of foreign investment. Although such approval is not hard to get and has largely become a formality, it does usually take 20 1.4 Are you seeing any types of investors other working days for the approval authority to process and then grant than traditional private equity firms executing private the approval. So, if there is an offshore intermediary company equity-style transactions in your jurisdiction? If so, (such as the HK company), the PE investor can simply sell or please explain which investors, and briefly identify any significant points of difference between the deal terms transfer the HK company to a buyer bypassing the onshore offered, or approach taken, by this type of investor and approval, while still achieving the same result of exiting. that of traditional private equity firms. As to tax, in light of the rules issued by PRC State Administration of Tax (SAT) including Bulletin 7, offshore changing-hands of equity interests or shares that indirectly sell or There is increasing number of ultra-high-net-worth individuals transfer the onshore company could be subject to PRC tax filing and families active in the PE and VC space. They may form and potential taxes as if the parties made such sale or transfer funds by acting as GP and/or LP, and make direct investments onshore. In light of this development, the PRC tax benefits of into target companies. As compared to professionally-run setting up such offshore SPVs as intermediary companies have conventional PE and VC firms, individual and family investors now become limited. are more flexible with the exit and the deal terms.

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2.3 How is the equity commonly structured in private regardless of its minority stake in the portfolio company, would equity transactions in your jurisdiction (including request a director seat on the board, which has veto rights over institutional, management and carried interests)? a host of material matters relating to the management and operations of the company. If there is a holding company struc- Both “sweet” equity and management reinvestment into the ture involving multiple tiers of corporate entities, then such institutional strip have been seen in PE transactions in China. PE-appointed director will appear on the board of each of the For the sweet equity shares, they are normally issued to the entities. In other words, if the PE fund invests in the offshore management teams at a lower price to provide extra incentive holding company level, which owns 100% of the onshore oper- for the management, subject to restrictions, or at the same price ating subsidiary (i.e., WFOE), then the dual board structures as the PE investor with the same class of share rights with such will normally be put in place with mirrored board members. investor. Carried interest arrangement is often structured as an Second, if the PE investor only invests a minority stake in earn-out or ratchet adjustment. In certain deals, carried interest the portfolio company, it is advisable for the PE investor to can also be structured as a part of the consideration for the install an operation VP and/or a financial controller in the management’s subscription of additional shares. founder-controlled operating company, so that it can monitor the operations and company expenditures and control any spending in excess of any agreed amount. 2.4 If a private equity investor is taking a minority Third, it is worth mentioning that under the PRC law and position, are there different structuring considerations? practice, usually it is the legal representative of the onshore operating company (e.g., the WFOE) that has the power to Normally, if a PE investor acts as a minority shareholder, it sign documents binding on the company. Such legal represent- will require protective provisions in the governance documents ative role is normally assumed by the chairman of the board, of the target, e.g., the shareholders agreement and Articles of usually the founding shareholder of the portfolio company. For Association of the target. Meanwhile, the investor might also convenience, such legal representative also holds the company insist on special exit right terms, such as drag-along, redemp- chop/stamp. Under the PRC law, any documents that bear the tion, etc. to ensure a proper exit. company chop are binding on the company even if such documents do not have any signatures from the legal representative or other authorised representative of the company. With 2.5 In relation to management equity, what is the typical range of equity allocated to the management, and the company chop, anyone can go to the bank to change the what are the typical vesting and compulsory acquisition authorised signatory for releasing funds from the company’s provisions? accounts. Thus, caution suggests designing a proper mechanism to jointly-control the company chop or otherwise formu- late a chop-use protocol for the portfolio companies. A typical vesting schedule usually links with the term of the If such governance arrangements of portfolio companies are employment, IPO timeline and other exit schedules. In usual reflected in their Articles of Association, given that constitu- cases, unvested shares will be subject to company repurchase at tional document is always required to be filed with the govern- par value or nominal price if the management shareholder ceases ment authority, such governance arrangements will be publicly employment or service with the company. Vested shares can available. also be subject to company repurchase if the management shareholder commits a default. 3.2 Do private equity investors and/or their director nominees typically enjoy veto rights over major 2.6 For what reasons is a management equity holder corporate actions (such as acquisitions and disposals, usually treated as a good leaver or a bad leaver in your business plans, related party transactions, etc.)? If a jurisdiction? private equity investor takes a minority position, what veto rights would they typically enjoy? In the event that a management equity holder leaves a company, depending on the contractual arrangement, the company may Yes. There is usually an extensive list of reserved matters nego- exercise a call option over his or her equity interests at an agreed tiated between the PE investors and the controlling share- price. The typical definition of “good leaver” would include holder(s) of the portfolio company. The reserved matters will the following circumstances, i.e., the death or incapacity of the be subject to the veto right of the PE investor(s), which typi- owner or manager, or sometimes resignation or retirement on cally include: any amendments to the Articles of Association; good terms. If a manager commits breach of contract, fraud, any change of the business scope, or the name of the company; wilful misconduct, or engages in other unethical activities, he any change of the company’s capitalisation; signing any material may be deemed as a “bad leaver”. But those often are subject to contracts with value in excess of certain specified threshold(s); the contract terms and negotiation between the parties. any matters relating to merger, split, IPO, change of legal form, liquidation or dissolution of the company; making loans to any 32 Governance Matters parties; providing any security or guarantee to any parties; and any matters that may have any material impact on the compa- 3.1 What are the typical governance arrangements ny’s management, operations or financial performance. As to a for private equity portfolio companies? Are such PE investor taking a minority position, it will at least enjoy, by arrangements required to be made publicly available in statute, the following four veto rights as these decisions must your jurisdiction? be subject to a unanimous consent of all the directors present at the board meeting under the PRC law: any amendments to There are several mechanisms to ensure proper governance the Articles of Association; termination and dissolution of the arrangements with the portfolio companies in PE investments. company; increase or reduction of the registered capital of the First, in respect of the board of directors, usually the PE investor, company; and merger or division of the company. However, the

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PE investor would usually request a much longer list of reserved chairman also acts as the legal representative of the company, matters based on their negotiation with the controlling share- the investor and the appointed person should be aware that, holder(s) of the portfolio company. under the PRC law, the legal representative has certain obligations by default, such as appearing in court on behalf of the company, accommodating investigations activities undertaken 3.3 Are there any limitations on the effectiveness of veto arrangements: (i) at the shareholder level; and (ii) at by the government authorities relating to the company, and the director nominee level? If so, how are these typically to the extent the company is unable to pay debt as required by addressed? court, the plaintiff can apply to the court to issue an order or injunctive relief to restrict such legal representative from leaving the country. Those are the practical risks a person acting as If the shareholder meeting can reach resolution, bypassing the legal representative should be aware of, particularly when the board, then the PE investor must make sure it has the veto company’s operations are under control by another shareholder power at both the board level and shareholder meeting level in or someone that the PE investor cannot fully trust. respect of the 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 investors deal with actual and potential conflicts of investor to minority shareholders such as management interest arising from (i) their relationship with the party shareholders (or vice versa)? If so, how are these nominating them, and (ii) positions as directors of other typically addressed? portfolio companies?

This question seems to suggest the context where a PE investor Under the PRC Company Law, none of the directors, controlling acts as majority shareholder after a buyout transaction. If it is shareholders, members of the senior management and supervi- an onshore transaction, under the PRC law there are certain sors may use his or her relationships with the company to impair statutory provisions on minority shareholder’s rights, including the interests of the latter. Specifically for listed companies, if a super majority voting requirement, but there is no express a member of the board is “related to” (i.e., having interest in provision specifying duties owed by a majority shareholder to a or conflicts of interest with) the subject matter to be voted in minority shareholder. the proposed board meeting, then such board member must recuse himself or herself and shall not cast a vote on resolu- 3.5 Are there any limitations or restrictions on the tions over this matter, and shall not act as proxy of any other contents or enforceability of shareholder agreements directors either. As regards to the taking of a directorship posi- (including (i) governing law and jurisdiction, and (ii) tion in another company, the law does not prohibit or restrict non-compete and non-solicit provisions)? such act per se, but it should be cautiously noted that a director of a company, without prior consent of the company’s share- If it is an onshore transaction where the foreign PE investor holders’ meeting or shareholders’ assembly, may not engage in invests into or acquires equity interests in a PRC company, activities for, take positions at or work for any firms that may be then the transaction will be subject to government approval. competing with the business of such company. The share purchase agreement (or equity subscription agreement) along with the shareholders’ agreement (or joint venture 42 Transaction Terms: General contract) must be governed by the PRC law. If the transaction takes place offshore, then shareholder agree- 4.1 What are the major issues impacting the timetable ments are normally subject to the law of the jurisdiction of the for transactions in your jurisdiction, including antitrust, offshore company (such as the Cayman Islands), while the share foreign direct investment and other regulatory approval subscription agreement may be governed by a different law. requirements, disclosure obligations and financing International arbitration is commonly selected over court issues? adjudication for dispute resolution clauses in those agreements. Founding shareholders or sellers from China commonly request As mentioned above, all onshore transactions involving any to choose a China-based arbitration tribunal, while the foreign foreign investors require MOFCOM or its local counterparts’ PE investors tend to select international arbitration in venues approval and then registration with the local Administration for like Hong Kong, Singapore, and London. Industry and Commerce (AIC). For offshore transactions, such There is no express provision under the PRC law in respect approvals will not normally be required, with exceptions such as of the limitations or restrictions on the contents or enforcea- merger filings for antitrust reasons and tax (Bulletin 7) filings. bility of shareholder agreements relating to non-compete and In addition, when converting a PRC domestic structure into non-solicitation. an offshore structure, if any of the shareholders of the offshore holding company (i.e., the future “ListCo.”) are PRC residents, 3.6 Are there any legal restrictions or other SAFE (Circular 37) registrations will be required. These regula- requirements that a private equity investor should tory procedures will normally delay the transaction process and be aware of in appointing its nominees to boards of could create uncertainty over closing if they are not managed portfolio companies? What are the key potential risks properly in advance. and liabilities for (i) directors nominated by private Cultural differences during communications and negotia- equity investors to portfolio company boards, and (ii) tions between Chinese and foreign parties can also be an impor- private equity investors that nominate directors to boards of portfolio companies? tant element that need to be factored into for deal planning and project management purposes. For example, Chinese parties sometimes prefer more face-to-face meetings and real-time If the PE investor has a controlling stake or otherwise gets discussions of the terms and striking deals on principles rather to appoint the chairman of the board of directors, and such than the nitty-gritty, while westerners tend to have the detailed

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terms and conditions laid out on paper, and expect more back- 5.2 What deal protections are available to private and-forth document mark-ups and exchange of negotiation equity investors in your jurisdiction in relation to public points via email. acquisitions? Different understandings of terms and having meanings lost in translation may also create misunderstandings and twists. Break-up fees and exclusivity clauses are acceptable under the PRC law and can be seen in PE deals, including acquisition of 4.2 Have there been any discernible trends in public companies. The usual break-up fees would normally be transaction terms over recent years? the actual expenses incurred by the investor or the target, e.g., legal due diligence and financial due diligence-related costs, and For both onshore and offshore transactions, PE firms have sometimes it can be set at about 1%–1.5% of the equity value. started to realise that sound deal structures and foolproof trans- However, if the liquidated damages far exceed the amount of action terms must be carefully formulated in light of the unique the losses and damages actually incurred, the PRC law allows business environment and legal infrastructure in China. In the paying party to petition the court to adjust such liquidated addition to extensive due diligence, earn-out mechanisms and damages to an appropriate level. The exclusivity clause prevents management incentives are increasingly popular in PE trans- the seller from pursuing an offer from another potential buyer for actions, with binding terms of founders (i.e., founders are a specified period of time after signing the indicative offer/letter committed not to exit until IPOs or a certain trigger event, e.g., of intent (LOI) with the current potential buyer. The takeover of acquisition by industrial players). listed companies in China usually takes the form of a negotiated When crafting the deal terms, PE investors often have to focus agreement between the bidder and the principal shareholder(s), on the roles and responsibilities of the founders and manage- which often grant(s) an exclusivity clause to the effect. ment and how to incentivise them, as they can be a primary factor for determining the success of a particular portfolio 62 Transaction Terms: Private Acquisitions company given the dynamic market situation in China. Also, given the increased competition among PE investors chasing for 6.1 What consideration structures are typically deals, founders tend to have more bargaining power in negoti- preferred by private equity investors (i) on the sell-side, ating the valuation and other transaction terms. and (ii) on the buy-side, in your jurisdiction? Exits through listing in China or acquisition by a listed company in China are also becoming an emerging trend. IPOs PE investors would usually reference the latest financial state- through the Chinese stock market, and listing on the National ments of the target company in the transaction agreements, Equities Exchange and Quotations (NEEQ) are becoming along with consideration adjustments and indemnity clauses increasingly appealing given the recent boom in the Chinese favourable to the PE investors. The time period between the stock market, and the price/earnings ratios can be much higher financial statement date and the closing will be an interim than those available in the developed countries’ stock markets. period during which the company side may not conduct certain For specific terms and clauses, founder indemnity, targeted sales activities without prior consent by the PE investor. Ratchet volume, and ratchet arrangement are commonly seen, while and earn-out mechanisms are also popular in structuring the warranty and indemnity insurance and stapled financing are considerations. considered rare in the market. If a PE investor is on the sell-side, it will tend to limit representations and warranties to a very short list and the 52 Transaction Terms: Public Acquisitions survival period thereof and any holdback to the minimum. If a PE investor is on the buy-side, it will require the controlling 5.1 What particular features and/or challenges apply shareholder to have an extensive list of representations and to private equity investors involved in public-to-private warranties and, ideally, a personal liability or guarantee in case transactions (and their financing) and how are these of any breach and, again ideally, with no survival period. If the commonly dealt with? buyer and seller are both PE investors, then both sides will tend to drive hard bargains on all those terms of the transaction. The commonly seen public-to-private transactions in the market are overseas listed companies (such as those Chinese compa- 6.2 What is the typical package of warranties / nies listed on stock exchanges in the US, Hong Kong, and indemnities offered by (i) a private equity seller, and (ii) Singapore) that are taken private with the help of PE investors the management team to a buyer? with the intent to go public again at another stock exchange in the future, for better valuation and/or liquidity. The challenges Seller-side warranties and indemnities are commonly seen in include the requirements of the stock exchange and the uncer- PE transactions to protect against the downsides, including any tainty arising from the public shareholders. The PRC counsel hidden and contingent liabilities that may pop up in the future. also plays a significant role in, among others, restructuring the Escrow and holdback arrangements can be seen more often privatised company into an onshore domestic company suitable in buyout deals, and PE investors sometimes request personal for A-share listing in the PRC, if the controlling shareholders guarantee or joint liability of the founding shareholders for and the PE investors intend to have the company go public in indemnity-related claims. China in the future. If a PE investor is from China and uses RMB to acquire the shares listed in Hong Kong or the US, or other stock exchanges outside China, it will need to go through 6.3 What is the typical scope of other covenants, the foreign exchange approval procedure, which is a big chal- undertakings and indemnities provided by a private equity seller and its management team to a buyer? lenge in terms of managing the timing and coordination with the stock exchanges and regulatory authorities outside China. Non-compete and non-solicitation are absolutely crucial and are typically seen in PE transactions. It is being seen more and

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more often that sellers and/or management are requested to 6.8 Are reverse break fees prevalent in private equity provide ongoing support to the business with the commitment transactions to limit private equity buyers’ exposure? If to stay with the company for an agreed term and reach certain so, what terms are typical? performance targets. PE investors usually request an exclusivity clause in the term sheet 6.4 To what extent is representation & warranty and in the purchase agreement. In the case of the selling of the insurance used in your jurisdiction? If so, what are the shareholders’ breach of exclusivity, the buyer or investor can then typical (i) excesses / policy limits, and (ii) carve-outs / assert claims for damages amounting to the fees and expenses it exclusions from such insurance policies, and what is the has incurred, such as the fees for legal and financial due diligence. typical cost of such insurance? 72 Transaction Terms: IPOs Representation and warranty insurance is not often seen in China, but we have started seeing insurers offering such insur- 7.1 What particular features and/or challenges should ance products for cross-border PE and M&A transactions. a private equity seller be aware of in considering an IPO Usually, the typical premium of such insurance is 1%–3% of the exit? insured amount, which depends largely upon the jurisdiction, industry type and structure of the transaction. There are a variety of factors that need to be considered for an IPO exit, such as the company’s financial performance, size and scala- 6.5 What limitations will typically apply to the liability bility, industrial sector and growth potential, and ultimately, from of a private equity seller and management team under a legal perspective, compliance-related issues and the minimum warranties, covenants, indemnities and undertakings? requirements for an IPO in a given jurisdiction and listing on a particular stock exchange, along with the time required for the The seller’s counsel will often request a cap on the amount for preparation and approval of the IPO. PE investors often struggle indemnification, which can be set at a percentage of the share together with the company to find the most suitable place for the transfer price, along with a survival period of the representa- IPO and listing, and sometimes decide to unwind an offshore tions and warranties, such as six months or one year following structure to go for the Chinese domestic A-share listing if that the closing. option can offer significantly higher multiples compared with the overseas capital markets. Restructuring the company will take time and is subject to scrutiny by the CSRC. 6.6 Do (i) private equity sellers provide security (e.g. escrow accounts) for any warranties / liabilities, and (ii) private equity buyers insist on any security for 7.2 What customary lock-ups would be imposed on warranties / liabilities (including any obtained from the private equity sellers on an IPO exit? management team)? Customary lock-ups imposed on PE sellers, as a result of a China In case of any serious or material defects or potential damages onshore IPO, will normally take one year and can be shorter if that may arise therefrom, a PE buyer may insist on an escrow the IPO takes place overseas. This depends on the different amount to be put in place as recourse for any losses and damages. stock exchanges. (Escrow Provisions in M&A Transactions, Part 1: “Contain escrow provisions to address buyer concerns over the seller’s financial ability to satisfy indemnification provisions contained in 7.3 Do private equity sellers generally pursue a dual- the definitive agreement. Escrow Coverage: To guard against any track exit process? If so, (i) how late in the process are private equity sellers continuing to run the dual- track, post-closing financial loss, buyers insist on placing approximately and (ii) were more dual-track deals ultimately realised 10 to 15% of the total purchase price in escrow accounts managed through a sale or IPO? by third-party firms. These funds are generally held for a period of one to two years in interest bearing accounts, and are released to the seller in annual instalments, subject to adjustments and fulfil- Savvy PE investors always keep all the options open, although ment of any indemnification obligations and authorised claims.”) they may not necessarily strictly pursue a dual-track exit process from the beginning through to the end. This may gain increasing popularity as listed companies and industrial giants 6.7 How do private equity buyers typically provide may be willing to pay more as it takes a long period of time comfort as to the availability of (i) debt finance, and (ii) for an IPO to take place due to the lengthy regulatory proce- equity finance? What rights of enforcement do sellers dure and waiting period. Equally, the idea may increase in popu- typically obtain in the absence of compliance by the buyer (e.g. equity underwrite of debt funding, right to larity when the capital market is not strong enough to warrant specific performance of obligations under an equity the greater returns. commitment letter, damages, etc.)? 82 Financing If the commitments are provided by SPVs, the seller side will usually request a guarantee of the actual investor(s) or buyer(s). 8.1 Please outline the most common sources of debt Sellers may request buyers to provide a parent guarantee, and/ finance used to fund private equity transactions in your or bank reference letter. 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 bonds).

Although PE investors find debt financing desirable for helping

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generate higher IRR, and in particular for large offshore buyout loan is needed in China, to be in full compliance with the law, a and privatisation deals, PE investors are more likely to obtain PRC-licensed bank or trust company will have to act as trustee loans from banks to finance the transaction; there are restric- to bridge the loan, i.e., the lender to deposit the loan sums into tions making debt finance more difficult to obtain or structure the trustee bank’s account, requesting the bank to forward the for China-related PE transactions. In the context of offshore loan to the borrower. transactions, there are certain regulatory conditions required for an onshore PRC entity to provide guarantee or security to 8.3 What recent trends have there been in the debt any offshore lender or lender’s affiliate. For instance, the SAFE financing market in your jurisdiction? prohibits an onshore guarantee to an offshore entity where the loan or debt finance is used to acquire another offshore company’s equity interests and 50% or more of the assets Banks in the PRC, due to regulatory restrictions, are normally not of such target offshore company are located within the PRC. allowed to provide loans to companies for equity investment. More For onshore transactions, it was not until 2008 that the China recently, on January 5, 2018, the CBRC issued the Administration Bank Regulatory Commission (CBRC) issued Administrative Measures on the Entrustment Loans of Commercial Banks (the Provisions on Acquisition Loans of Commercial Banks and “Measures”), which came into effect on the same date. Such started allowing banks to make loans to finance acquisitions by Measures expressly prohibit the use of entrustment loans on equity companies that meet certain qualifications, such as bank credit investment. To our knowledge, most of the PE funds in the PRC rating A or above, but, in general, such acquisition loans are not rely on their own capital for investments and rarely use leverage or open to PE investors (to be further discussed below). debt financing. In the PRC, in addition to bank syndicated loans, there are other channels for debt finance, e.g., a Chinese unit trust plan 92 Tax Matters can be raised by a Chinese-licensed trust investment company, and then such trust investment company will loan the sums to 9.1 What are the key tax considerations for private PE investors. Also, asset management companies with a proper equity investors and transactions in your jurisdiction? regulatory licence in China can also raise funds or use their own Are off-shore structures common? funds (e.g., the asset management arm of an insurance company) to loan to PE investors. In the PRC, the debt market for PE is For an offshore transaction, where a non-PRC PE investor still emerging and yet to be fully developed. acquires shares of an offshore holding company which owns High-yield bonds in China still have high barriers for entry interests in an onshore entity with operating assets, when such and higher costs, and as a result, they are not considered a onshore entity repatriates dividends up to its offshore parent, common source of debt financing for PE transactions. such dividend will be subject to withholding tax at the rate of 10%, unless there is a tax treaty or equivalent providing a lower 8.2 Are there any relevant legal requirements or withholding tax rate. To the extent the PE investor sells any of restrictions impacting the nature or structure of the debt its shares in the offshore holding company, such transfer will be financing (or any particular type of debt financing) of deemed as an indirect transfer of equity interests in the onshore private equity transactions? subsidiary in the PRC, and will thus be subject to filing with the PRC tax authority, pursuant to Bulletin 7 of the SAT issued in For growth capital deals, if the investment only results in a 2015, and likely subject to capital gains tax (at the rate of 10%). minority stake in the portfolio company, banks, for commer- If the offshore holding company owns subsidiaries in multiple cial reasons, will not consider debt financing for such invest- jurisdictions, and China only represents one of the jurisdic- ment anyway. Under the General Rules for Loans promulgated tions, then, in theory, the tax authority will only charge tax on by the People’s Bank of China (PBOC) in 1996, loans shall not the capital gains corresponding to the value attributable to the be used for purposes of “equity investments” unless other- China subsidiary or subsidiaries. wise permitted by law. Although the Administrative Provisions For an onshore transaction, where a non-PRC PE investor on Acquisition Loans of Commercial Banks do not expressly acquires equity interests in an onshore company in China, then prohibit loans from being made for PE funds, the loans are any dividend to be repatriated from such onshore company to usually provided for industrial companies or conglomerates to the foreign investor will be subject to a 10% withholding tax make acquisitions. There are some recent developments that unless a tax treaty or equivalent provides a lower rate. For the allow banks to provide financing to PE funds registered in the capital gains arising from the transfer of such foreign PE inves- Shanghai Pilot Free Trade Zone, and we expect that in the fore- tor’s sale of its interests in the onshore entity, it will be subject to seeable future the CBRC will likely refine its policy to allow a capital gains tax of 10%. more debt financing for PE funds. For offshore PE funds active in China, actions and steps must For the offshore debt financing, the banks involved are be taken to prevent such entities from being treated as a PRC usually financial institutions outside of the jurisdiction of the tax resident. If not, all its global income of the fund(s) could be PRC, and the terms are therefore not subject to the PRC law or subject to PRC corporate income tax. jurisdiction; but when the banks require collateral or security to In respect of the carried interests, if they are being paid by an be provided by any onshore entities within the PRC, the PRC offshore PE fund to an offshore GP, provided that such offshore regulatory restriction will come into play again. In particular, fund does not become a PRC tax resident, the carried inter- the SAFE restricts onshore entities from providing guarantees ests received by the offshore GP will not be subject to PRC tax or security interests to non-PRC persons. This would make the except where at the individual level, a GP member may need to lenders heavily rely on the pledge of shares or equity interests in pay PRC income tax if he or she is a PRC tax resident. the offshore and onshore operating entities, adding risk to the In contrast, in the context of an onshore PE fund (a.k.a. banks in case of default. “RMB fund”), the law is not clear as to the tax treatment or tax Debt financing can only be offered by individuals or financial nature of the carried interests – whether it should be deemed as institutions under the PRC law. Therefore, if an inter-company a dividend and therefore subject to a 20% income tax rate, or

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be deemed as remuneration (i.e., compensation for services) and the foreign company is not yet distributed to the individual. The therefore subject to the 5%–35% progressive rates plus 6% VAT introduction of CFC rules is one of the general-anti avoidance applicable to any payment of such remuneration. rules (GAAR) that is being implemented in China. As mentioned above, at question 1.1, if the future exit is As mentioned above, a PE investors’ trade sale at offshore likely to be an IPO in a non-PRC stock market, investors level would trigger the PRC indirect transfer tax issue. In early would usually request the controlling shareholders to form 2015, the SAT issued Bulletin 7 as an amendment to the Circular an offshore company as the future vehicle for financing and 698. Bulletin 7 changed the Circular 698 filing from compul- listing, commonly known as a “red chip” structure. Recently, sory to voluntary, but increased penalties for failure to make some of those red-chip companies listed in overseas stock the required tax payment and added the burden of reporting exchanges have decided to go private and then seek to be listed on the buyer as well. It also clarifies and adds detailed tests on a domestic A-share stock market, in light of the much better for what constitutes “reasonable commercial purposes” for a brand recognition on home turf and higher PE ratios and valu- transaction structure. Failure to meet such test could result in ations offered by domestic investors; PE funds tend to partici- tax adjustment and even penalties. On October 17, 2017, the pate in such privatisation transactions. Meanwhile, they become SAT issued new guidance (Announcement [2017] No.37, the increasingly receptive to making direct investments into PRC “Announcement 37”) on withholding tax on PRC-originated entities with the hope of exit through A-share listing or other- income, along with official interpretations, superseding Circular wise through sale to A-share listed companies. Onshore RMB 698. The Announcement 37 came into force on December 1, funds have grown bigger in size and gradually dominated the 2017. In addition to those amendments on tax filing procedures, market. That being said, offshore structure still has its appeal it is worth noting a new change that allows such withholding tax for TMT companies and some entrepreneurs, which may prefer to be deferred until the paid purchase price has exceeded the an offshore structure for estate planning reasons, as they may cost base of the corresponding equity interests so transferred. find it difficult or prohibitively costly (often for tax reasons) to This is intended to ease the tax burden of the sellers and reduce transfer onshore companies into an offshore family trust, while the liquidity pressure on both sides. a red-chip structure can be easily put under an offshore trust. 102 Legal and Regulatory Matters 9.2 What are the key tax-efficient arrangements that are typically considered by management teams in private 10.1 Have there been any significant legal and/or equity acquisitions (such as growth shares, incentive regulatory developments over recent years impacting shares, deferred / vesting arrangements)? private equity investors or transactions and are any anticipated? This largely does not apply to China, and as to incentives for the management team of a portfolio company, the tax treatment will A major regulatory development impacting PE investors is depend on whether the plan is considered a stock option plan, a the promulgation of the Interim Measures of the Supervision restricted stock plan, or something else. and Administration of Private Investment Funds, by CSRC on August 21, 2014. Such Interim Measures require filing and registration of any and all forms of PE investment funds formed 9.3 What are the key tax considerations for management teams that are selling and/or rolling-over in China. Such filing and registration shall be made with the part of their investment into a new acquisition structure? Asset Management Association of China (AMAC), which is affiliated with CSRC. On August 30, 2017, the Legal Affairs Office of the State Council If the PE investor sells any of its shares in the offshore holding issued a draft regulation seeking public comments, the Interim company, such transfer will be deemed as an indirect transfer of Regulation of the Administration of Private Investment Funds, equity interests in the onshore subsidiary in the PRC, and thus which intends to beef up the protection of investor rights in fund- will be subject to filing with the PRC tax authority, and likely raising and investment activities. It also sets out a list of circum- subject to capital gains tax (at the rate 10%) as mentioned above. stances where an individual/entity would be forbidden to act as a For the capital gains arising from the transfer of such foreign fund manager or a principal shareholder or partner thereof, e.g., PE investor’s sale of its interests in the onshore entity, it will be creditworthiness problems such as failure to repay past due indebt- subject to a capital gains tax of 10%. edness. In respect of foreign players’ involvement in fund formation in China, in light of the SAFE restrictions on conversion of 9.4 Have there been any significant changes in tax foreign exchange capital into RMB for onshore equity investments, legislation or the practices of tax authorities (including some select municipalities (such as Shanghai, Tianjin, Beijing, in relation to tax rulings or clearances) impacting private and Shenzhen) have issued “QFLP” measures to grant special equity investors, management teams or private equity approvals to certain qualified foreign PE players to set up “qual- transactions and are any anticipated? ified foreign [invested] limited partnership(s)” (QFLPs) in their local jurisdictions. Those QFLP funds normally take the form of The most recent change made by the tax authority is the issu- an onshore limited partnership and can convert an approved quota ance of the amendment to the Individual Income Tax Law of the of foreign capital into RMB for onshore investments. People’s Republic of China in 2018 (the “Individual Income Tax Law”), which introduces the Controlled Foreign Corporation 10.2 Are private equity investors or particular rules (the “CFC rules”). Under the CFC rules, a PRC tax resi- transactions subject to enhanced regulatory scrutiny in dent shareholder is subject to tax on undeclared profits kept your jurisdiction (e.g. on national security grounds)? without reasonable business reasons by a controlled foreign company incorporated in a jurisdiction with an effective tax rate obviously lower than that of the PRC. That is, a 20% dividend Under China’s current regulatory regime on foreign invest- tax may immediately apply even if the dividend received from ment, the national security review applies only to mergers and acquisitions involving Chinese companies and foreign investors

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under certain circumstances. If the invested domestic enter- 10.4 Has anti-bribery or anti-corruption legislation prises involve military or military-related products or services, impacted private equity investment and/or investors’ national defence-related products or services, agricultural prod- approach to private equity transactions (e.g. diligence, ucts, energy, resources, infrastructure, significant transportation contractual protection, etc.)? services, key technology and heavy equipment manufacturing, a national security review will be triggered. In 2015, interim Dictated by their home-country anti-corruption related laws, procedures for a national security review of foreign investment funds with members from countries such as the US, Singapore, in all free trade zones in Shanghai, Tianjin, and the provinces of and UK will often include anti-bribery covenants and indem- Guangdong and Fujian, were published by the State Council’s nity clauses in the transaction documents, and often require anti general office on April 20. The Circular clarifies standards for corruption-related due diligence before signing the deal. conducting security reviews of foreign investment that may affect national security or involve sensitive investors, acquisition targets, industries and technology, as well as other areas. 10.5 Are there any circumstances in which: (i) a private equity investor may be held liable for the liabilities of In addition to M&A transactions, a greenfield investment may the underlying portfolio companies (including due to also trigger national security review. However, currently there breach of applicable laws by the portfolio companies); is no such unified national security law at central level to regu- and (ii) one portfolio company may be held liable for the late foreign investment. liabilities of another portfolio company? The new Foreign Investment Law in 2019 also provides that “a foreign investment security review system will be estab- Natural persons that are directors, officers or employees, could lished” and further specifies that “decisions made on those be held liable for losses and damages he or she has caused to National Security Review cases shall be final”. However, the the company if he or she acted against the law, regulation or Foreign Investment Law only provides general principles, the company’s articles of association when performing duties leaving more details for the future implementation rules. It is for the company. But for entities such as a PE fund acting as a also unclear how this shall reconcile with the existing national shareholder of a portfolio company, there is no express provi- security review regime in place. sion that imposes any liabilities on an entity (acting only as a shareholder) except under the PRC Criminal Law where such 10.3 How detailed is the legal due diligence (including entity has engaged in any criminal activities which constitutes a compliance) conducted by private equity investors prior “crime by an entity”. This also applies to a portfolio company to any acquisitions (e.g. typical timeframes, materiality, which can be subject to criminal liability only if it, in itself, has scope, etc.)? engaged in criminal activities in violation of the Criminal Law, otherwise it can only be subject to civil liability for losses or Due diligence is often a critical part of a transaction, and it damages it has caused to a third party on a tortious or contrac- serves many purposes. In an acquisition of a domestic Chinese tual basis or otherwise in violation of the law. company, the investor may use due diligence to, among other things, help identify issues that: 112 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 ■ Require conditions to closing. such investors otherwise be aware of in considering an ■ Require other special treatment. investment in your jurisdiction? PE investors normally engage law firms to conduct legal due diligence. The law firm will generally review documents A common misconception of some foreign PE investors is provided by the target as well as publicly available information the inclination not to choose the PRC law as governing law and materials obtained from other sources and will then provide and not to use the PRC court and arbitration tribunals in case a summary of its findings to its client in the form of one or of any disputes with the PRC portfolio company or any of its more legal due diligence reports. Legal due diligence is gener- Chinese shareholders. In reality, a foreign arbitration tribunal ally one aspect of a larger due diligence process that may include can take much longer to complete the arbitration proceeding, inquiries into the following matters: and has a major disadvantage, which is not being able to apply ■ Accounting. for pre-judgment relief such as freezing the defendant’s bank ■ Financial. account to ensure it has enough secured funds to pay for the ■ Internal controls. award if any. Such privilege is only available for arbitration ■ Tax. committees or tribunals within the PRC. ■ Technical. Thus, for foreign arbitration tribunals, the parties will have to ■ IP. wait for the local court to review the foreign arbitration award ■ Operations. and then proceed with the enforcement; this process could take ■ Labour. months on top of the arbitration proceeding. By such time, ■ Product. the defendant could have already moved or hidden funds else- ■ Customer. where or even become bankrupt, leaving little for the plaintiff to ■ Supplier. recover for its losses and damages. ■ Environmental. As mentioned earlier, the New Foreign Investment Law came ■ Other. into effect on January 1, 2020. Separately, a new foreign investment information reporting system has also been implemented. All the FIEs are required to submit investment information to the above-mentioned system, including the information of the ultimate controlling person of the FIE, and the information

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of the ultimate controlling person of each of the investors. As PE investment structure must fully align the interests with the mentioned above, if the ultimate controlling shareholder(s) are founder and the management team and install a proper mecha- PRC nationals, a foreign exchange registration is required (i.e. nism that ties the founder/management with the growth of the Circular 37 registration) and the failure to complete Circular 37 company. registration will result in penalties and the inability to repatriate profits to offshore shareholders including any PE investors. Acknowledgments A practical tip for foreign PE investors to manage PE transactions in China is to focus attention on the management/found- The authors would also like to thank Joanna Jiang (Jiang Lulu), er’s roles in the target company. In the dynamic market with Yancy Chen (Chen Jiayan) and Mark Gao (Gao Rufeng), for their a unique Chinese culture that values relationships, the founder invaluable help in providing support on tax-related sections, and and management team often play an essential role that “makes it overall research and editing work. or breaks it” for the success of a company. Therefore, a sound

Private Equity 2020 © Published and reproduced with kind permission by Global Legal Group Ltd, London Zhong Lun Law Firm 57

Dr. Lefan Gong is a partner in Zhong Lun’s Shanghai office. He has been recognised by Chambers Asia and The Legal 500 as a “Leading Individual Lawyer” for many years. Dr. Gong is qualified to practise law in both China and New York. He has represented PE clients, family offices, Fortune 500 companies, investment banks and major state-owned enterprises in PE 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 structures, VIE, corporate restructuring, and wealth management-related matters.

Zhong Lun Law Firm Tel: +86 21 6061 3608 10–11/F, Two IFC, 8 Century Avenue Email: [email protected] Pudong New Area URL: www.zhonglun.com Shanghai 200120 China

David Xu (Xu Shiduo) focuses on PE and VC practice. He has completed numerous PE/VC transactions during his 10 years of experience. David is particularly knowledgeable with respect to those aspects of deals that require additional experience and know-how on finance, accounting, business and management. He is particularly interested and profoundly established in structuring the equity holding structure as well as ESOP structures for company clients, ranging from seed stage up until pre-IPO stage.

Zhong Lun Law Firm Tel: +86 10 5957 2288 36–37/F, SK Tower Email: [email protected] 6A Jianguomenwai Avenue URL: www.zhonglun.com Chaoyang District, Beijing 100022 China

Zhong Lun has been ranked as one of the leading law firms in China by funds and FOF. For PE investment and PE financing, our services run the Chambers Asia, IFLR, ALB and others in many practice areas. With more full spectrum of stages from start-ups to IPOs and post-IPO mergers and than 200 partners and 1,000 legal professionals, our strategically posi- acquisitions. Zhong Lun is also renowned for handling the most complex tioned offices enable our lawyers to work together on a fully integrated and challenging dispute resolution matters for PE clients. cross-office, cross-disciplinary basis to provide commercially-oriented www.zhonglun.com 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, most complex and 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

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Dr. Márton Kovács

HBK Partners Attorneys at Law Dr. Gábor Puskás

12 Overview is also re-allocating funds to aid companies in the most affected sectors (for example, tax and social contribution incentives have been introduced temporarily in the tourism and aviation sector 1.1 What are the most common types of private and new rules have been enacted to alleviate the operation of equity transactions in your jurisdiction? What is the current state of the market for these transactions? Have corporate entities). On the other hand, the restrictive meas- you seen any changes in the types of private equity ures, described in detail under question 1.4 below, enacted by transactions being implemented in the last two to three the Government, create a new situation for everyone where both years? target companies and investors are still adapting to these new circumstances. The business environment for private equity (PE) transac- Without the virus outbreak, the balance would be quite tions in Hungary have been favourable in recent years though positive for Hungary which has already proven to be a cred- this has been stricken down a bit by the COVID-19 pandemic. ible and growing market for international and domestic players. Nevertheless, Central and Eastern Europe (CEE) is still trending The growth potential is still great in CEE and Hungary ranks upwards, the domestic economy is growing and financing among the top four countries in PE activity. Hungary, unlike is cheap and readily available. Thus, Hungary is a well-liked more mature Western European markets, offers opportunities target of international PE investment companies interested in for off-market deals and reasonable pricing with an economy share and asset deals. Hungary closely follows Poland, Latvia growing at an average of more than 3%. In addition, the rising and Romania as the most-frequented jurisdiction for PE invest- domestic consumption allows investors to maximise their ments in the region. profits within the region. Venture capital (VC) markets, in particular, are emerging The availability of EU and domestic funds and their attrac- and there are a host of domestic funds specialised in small- tiveness to PE, the low interest rates and cheap financing possi- scale investments that are financed from EU resources (funds bilities, the booming start-up scene as well as the Hungarian of funds) and by PE investors. Such public funding is generally Government, have many times accentuated the drive to draw in available on the condition of receiving private funding which capital to fuel the domestic economy which keeps the interest attracts PE investors. of experienced PE investors from Europe and, especially, the Riding the wave of EU funds and the Hungarian Government United States, alive. initiatives providing strong support for VC investments, the Hungary is becoming more attractive for investors from past few years saw the rise of seed and start-up investments new regions, such as China, the Middle East and South Africa. providing capital for the early phases of product development For these third country investors, besides the general business and distribution. According to the market statistics of Invest advantages, Hungary offers free access to the EU market. Europe, in 2018, EUR 346 million was invested into Hungarian Also, PE transactions are sometimes inhibited by the rela- companies through 191 transactions. Total invested value repre- tively small market itself. Dealmakers in Hungary are also sents a 141% increase compared to EUR 144 million in 2017 keeping an eye on geopolitics focusing on the occurring strains and total number of transactions increased by 84%. As for the with the EU, a crucial trading partner and investor in the region. domestic and foreign transactions made by Hungarian investors (industry statistics) in 2018, 189 investments were executed by Hungarian investors either in Hungary or abroad (95% higher 1.3 What are going to be the long-term effects for than in 2017) for a total value of EUR 66 million, which repre- private equity in your jurisdiction as a result of the sents a 23% growth versus 2017. COVID-19 pandemic?

1.2 What are the most significant factors currently During the first wave of the pandemic, the Government grad- encouraging or inhibiting private equity transactions in ually introduced a series of emergency rules relating to various your jurisdiction? sectors of the economy. These rules scattered across various government decrees were later consolidated into a single act The strongest factor which is encouraging while also inhibiting (Act LVIII of 2020 on transitional rules) which shall be in force PE transactions is the COVID-19 situation. On the one hand, until December 31, 2020 even after the state of emergency was the virus encourages investors to look for new investment possi- lifted mid-June. The most important set of rules affecting PE bilities and perhaps be less picky as to the expected standards investments in Hungary is the so-called foreign direct invest- and returns due to the struggling economy and the Government ments (FDI) screening regulation which is a more ambitious and broader version of the 2018 FDI screening regime which had a

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relatively narrow scope. The new regime’s declared goal is to 1.4 Are you seeing any types of investors other protect the public interest related to the security and operability than traditional private equity firms executing private of networks and equipment, and to the continuity of supply by equity-style transactions in your jurisdiction? If so, restricting foreign investments made in relation to Hungarian please explain which investors, and briefly identify any ‘strategic companies’. The Act provides that such transactions significant points of difference between the deal terms offered, or approach taken, by this type of investor and can only take effect if they are notified to and acknowledged by that of traditional private equity firms. the Minister of Innovation and Technology beforehand. For the purposes of the Act, foreign investors are private persons and legal entities domiciled outside the EU, EEA (European Other than the usual PE and VC investors, no other specific type of investor has emerged. The Government pours state Economic Area) and Switzerland and other entities where a funds into the economy but this is strictly an emergency-type of third-country shareholder holds majority. Strategic companies aid and not an investment by any means. are all limited liability companies, private companies limited by shares or public companies limited by shares seated in Hungary if they are operating in sectors of strategic importance. The 22 Structuring Matters affected 22 sectors of strategic importance are established in a separate Decree (Gov. Decree 289/2020(VI.17.)) and include, 2.1 What are the most common acquisition structures among others, many sectors preferred by PE investors such as adopted for private equity transactions in your jurisdiction? energy, transport, tourism, trade, construction, IT, telecommunications and healthcare. Transaction falling within the scope of the Act are (i) any The most common acquisition structure for PE transactions is transfer or acquisition of an ownership share in a strategic naturally the acquisition of 100% or the majority of the target’s company, (ii) capital increase in a strategic company, (iii) the shareholding. transformation, merger or division of a strategic company, (iv) In the VC market, portfolio companies are usually set-up issuing convertible bonds, bonds with subscription rights or jointly by the founders and the investors to serve as a special converting bonds by a strategic company, and (v) establishing purpose vehicle for future investment rounds but in case of more mature companies with ongoing product development and a right of usufruct over a share or business share of a strategic market presence, the investor may opt for a share purchase or company provided that: capital increase in order to keep the brand going. a) the foreign investor or an EU/EEA or Switzerland-based investor acquires a controlling majority; b) the foreign investor acquires 10% ownership and the 2.2 What are the main drivers for these acquisition investment value exceeds HUF 350 million; structures? c) the foreign investor acquires 15%, 20% or 50% ownership; or The main driver for the acquisition structures is to have corpo- d) the foreign investor’s ownership in the strategic company rate control over the target and preservation of the investors’ exceeds 25% as a result of the transaction. rights. In some cases, other considerations, such as tax, have The Minister shall provide reasons for a prohibiting decision substantial effect on structuring matters. and the foreign investor may challenge such prohibiting decision in a non-contentious administrative proceeding based on 2.3 How is the equity commonly structured in private the alleged violation of the substantive rules of the procedure. equity transactions in your jurisdiction (including The acquiring party can apply for registration of its owner- institutional, management and carried interests)? ship in a strategic company only after acquiring the confirmation of the acknowledgment from the Minister. In the absence The most popular form for PE and VC investments are limited of a confirmation of the acknowledgment of the notification, or liability companies, namely “zrts”, i.e. companies limited by if the Minister passed a prohibiting decision, the acquiring party shares, or “kfts”, a company form which issues business quota shall not be registered in the register of shareholders or members instead of shares. Business quotas have their share of limitations and may not exercise any rights in the strategic company related in terms of flexibility compared to shares, but they are still able to the shareholding interest in question. to meet the investors’ needs with regard to preferential rights The Minister adopts its decision within 30 working days (or associated to the investors’ equity interest. 45 if the deadline is extended) on the transaction by taking into account whether: 2.4 If a private equity investor is taking a minority a) the notification meets the conditions set out in the Act; position, are there different structuring considerations? b) a violation or compromise of state interest, public security or public policy of Hungary, or the possibility thereof, arises from the transaction; An investor with minority shareholding interest in general requires c) the notifier is controlled, directly or indirectly, by an much stronger rights attached to its shares or business quota. Such administrative organ of a non-EU state including also state rights embedded into the corporate structure and the underlying contractual arrangements usually take the form of a wide range organs and armed forces, either due to its ownership struc- of preferential rights relating to exit, decision-making, dividends, ture or as a result of significant funding; liquidation, control over the management and key employees. d) the notifier was already involved in an activity concerning security or public policy in EU Member State; and e) there is a serious risk that the notifier will perform an illegal 2.5 In relation to management equity, what is the activity or an activity constituting a criminal offence. typical range of equity allocated to the management, and The failure to notify a transaction under the Act may result what are the typical vesting and compulsory acquisition provisions? in a fine up to two times the value of the relevant transaction.

Transactions vary in this regard, but a typical pool of shares

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allocated to management members and key employees (hence Corporate documents that are submitted to the court of regis- the term ESOP, or “Employer Stock Ownership Programme”), tration are publicly accessible for anyone but there can be internal ranges from 5%–10%. Vesting under Hungarian law can some- regulations and SHAs that remain hidden from the public. The times be problematic and, especially for VCs, the preferred solu- drawback of such private law agreements and non-statutory tion for ensuring management retention is the so-called reverse regulations is that in case of a dispute, they can only be enforced vesting where the management must divest all or part of their in civil court, which may take significant time. shares if they leave the company or violate the shareholders’ agreement (SHA). This is usually ensured by a call option established for the benefit of the investor. 3.2 Do private equity investors and/or their director nominees typically enjoy veto rights over major corporate actions (such as acquisitions and disposals, 2.6 For what reasons is a management equity holder business plans, related party transactions, etc.)? If a usually treated as a good leaver or a bad leaver in your private equity investor takes a minority position, what jurisdiction? veto rights would they typically enjoy?

Good/bad leaver conditions are usually negotiated on a case- Veto rights at both shareholder and management level are a very by-case basis but, in general, a management member is typically common tool for investors, especially investors with minority considered to be a good leaver if the employment relationship is shareholding, to maintain reasonable control over the oper- terminated by mutual consent or unilaterally by the company, ation of the portfolio company. In recent years, de facto veto unless it is based on reasons attributable to the management rights started to be replaced by a high quorum required to decide member. Good leaver conditions sometimes include long-term critical issues. For example, if the investor holds a 4% share health or family issues. in the portfolio company, then setting a minimum quorum of Circumstances under which a management member is consid- 96.01% means that no material issues can be decided without the ered and sanctioned as a bad leaver are obviously much broader, consent of the investor. This is because the Hungarian compe- e.g. management members terminating their employment tition law and the Hungarian Competition Authority (HCA) contract during the early years of the investment or without considers strong veto rights to qualify as a controlling right. If a reasons neither attributable to the portfolio company nor the controlling relationship exists between two or more companies, investor, or committing material breaches of the SHA or their this may call for the application of the strict EU and domestic terms of employment. competition law and result in mandatory pre-notification or even approval to be sought by the parties. In order to avoid 32 Governance Matters these costly and time-consuming procedures, both founders and investors are becoming more careful with incorporating 3.1 What are the typical governance arrangements investor rights into the corporate documents. for private equity portfolio companies? Are such Veto rights and topics requiring high quorum at the most arrangements required to be made publicly available in important decision-making levels, the shareholders’ meeting, your jurisdiction? are usually restricted to material issues affecting the core operation of the portfolio company that can range from the most Most of the portfolio companies operate as private limited important corporate decisions (merger, transformation, liquida- companies (or stock companies, abbreviated as “zrt.” in tion, annual report) to business operation issues such as entering Hungarian) and especially in the VC sector, limited partner- into high-value contracts, taking out loans and licensing intel- ships. Hungarian law enables a great deal of flexibility in terms lectual property rights. There is no exhaustive list of veto rights of corporate governance for both. The three most important as they are usually subject to negotiation by the investor and the governance bodies of Hungarian companies are: founders or other shareholders. ■ the shareholders’ meeting operating as the fundamental Similar veto rights exist on a management level (usually a decision-making body (ownership level); board of directors) where the board member delegated by the ■ board of directors or a single director heading the investor has the final say in crucial management decisions day-to-day business operation (management level); and (ESOP, vesting, key employees, management bonus, etc.). ■ the supervisory board serving as the controller of legitimate operation. On the ownership level, the investor, especially if in minority, 3.3 Are there any limitations on the effectiveness of generally retains the most important veto rights in material veto arrangements: (i) at the shareholder level; and (ii) at issues to ensure that fundamental decisions affecting the life of the director nominee level? If so, how are these typically the portfolio company are adopted with due regard to the inves- addressed? tor’s interests. On the management level, investors generally require the The drawback of veto rights or high quorum provisions incor- set-up of a board of directors, if the portfolio company does not porated into the corporate documents of portfolio compa- have one already, where the investor delegates at least one board nies stems from the relative nature of such internal regulations member. The board decides in every issue not specifically allo- compared to proprietary rights that are absolute. Although cated to the scope of authority of the shareholders’ meeting but corporate documents are publicly accessible, veto rights are not even then, the board member delegated by the investor usually listed in the corporate registry that third parties rely on and third exercises veto rights in material issues. The board of directors’ parties may presume, in good faith, that a decision adopted by functions may be allocated to a single management member who the shareholders or the management is valid and effective even replaces the board, but this usually does not serve either parties’ if they have been adopted contrary to the corporate documents interests well and thus it is a rare sight. including veto rights. On the third level, a supervisory board operates in most of the Further limitation on the effectiveness of such veto arrange- portfolio companies which oversee compliance with the rele- ments, on either level, is the fact that any decision adopted in vant laws and internal by-laws of the company. violation with the investor’s rights must be challenged in court

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and such court procedures may take a long time, ranging from 3.6 Are there any legal restrictions or other a couple of months to several years, even if the law provides for requirements that a private equity investor should an expedited procedure. be aware of in appointing its nominees to boards of These limitations cannot be effectively addressed, and inves- portfolio companies? What are the key potential risks tors simply must accept the associated risks and negotiate other and liabilities for (i) directors nominated by private types of insurances, for example, flip-over, call-and-put-options equity investors to portfolio company boards, and (ii) private equity investors that nominate directors to and other rights exercisable in case of serious violation of the boards of portfolio companies? SHA and/or the corporate documents. Also, veto rights in the Articles of Association are hardcore limitations as to the business operation of portfolio compa- There are standard conditions applicable for all board members nies and as already mentioned above, the HCA sees them (and management in general, altogether called as “executive as controlling rights under competition law which makes the officers”) across all companies regardless of nationality and the market players cautious and more inclined to resort to a softer fact of whether they are delegated by an investor or not. These tool (high quorum) to ensure investor rights. general requirements include being of legal age, having full legal capacity, having no criminal record and not being prohibited by court from being a management member. Special condi- 3.4 Are there any duties owed by a private equity tions may apply to portfolio companies operating in the finan- investor to minority shareholders such as management cial sector or any other sector that requires professional exper- shareholders (or vice versa)? If so, how are these typically addressed? tise in certain fields. Risks and liabilities of board members delegated by an investor are the same as any other board member’s: they must Under Hungarian law, shareholders have a duty towards the perform their management functions representing the compa- portfolio company and not the other shareholders and even ny’s interests; and they must comply with the internal by-laws then, only to the extent of providing their respective capital as to procuration, decision-making and other regulated areas. contributions. Shareholders’ have rights that they can exercise But, in fact, investor-delegated members usually have less rights vis-à-vis the company itself or the management. and information related to the portfolio company’s actual oper- Minority shareholders enjoy special rights pursuant to the ation compared to the other board members. The information corporate laws with regard to convening the shareholders’ asymmetry affects the position and capability of these board meeting or appointing an auditor for the investigation of certain members which, in turn, results in higher business risk for the business decisions. Furthermore, all shareholders have the right investor. This is usually addressed in the SHAs through provi- to contest the validity of a resolution of the supreme body, the sions granting the investor-delegated board member immu- management or the supervisory board of a company, if the reso- nity to set off the lack of information and actual control over lution violates legal regulations or the articles of incorporation day-to-day operation. of the company (with the condition that the shareholder did not The investors (or any other shareholders or third parties) approve the given resolution with its vote). themselves have no legal risk or liability related to their delegated board members as “delegation” is not a legally regulated 3.5 Are there any limitations or restrictions on the issue under Hungarian law. Board members are ultimately contents or enforceability of shareholder agreements appointed by the shareholders regardless of any background (including (i) governing law and jurisdiction, and (ii) deals and the shareholders are not legally liable for the appoint- non-compete and non-solicit provisions)? ment except under extreme circumstances where, for instance, the appointment was in bad faith or qualifies as a crime. The enforceability of SHAs may become problematic and very time-consuming in the case of parties with different nationalities, 3.7 How do directors nominated by private equity especially outside the EU. That is why, in practice, SHAs stipulate investors deal with actual and potential conflicts of the governing law and jurisdiction of the country where the port- interest arising from (i) their relationship with the party folio company is seated and it is rather rare that a SHA related to nominating them, and (ii) positions as directors of other a Hungarian company stipulates foreign law. Commercial arbitra- portfolio companies? tion, however, is much more acceptable in high-value deals and it is not uncommon that the parties submit themselves to the juris- Depending on the actual transaction, a PE investor may have diction of an international arbitration court (ICC, UNCITRAL, majority or minority voting rights in the portfolio company. In etc.) for disputes stemming from the SHA. either case, the directors must act at all times by force of law in The risk of unenforceability is usually addressed in the SHAs the best interest of the portfolio company which is also in line by additional insurances for the investors in case of violations, with the PE investors’ interests in the successful and profitable such as triggering exit rights at a given return on the investment, operation of the company so, in practice, potential conflicts of flip-over of management or put/call option on shares. interests of this nature are rare and they are not different from Enforcing non-compete and non-solicitation obligations is general conflict of interest issues potentially arising between especially tricky without a reasonable limitation on the affected shareholders and management members. geographic region and scope of activity. Investors run a high Directors nominated by the same PE investor are usually not risk of being unable to enforce such provision against parties delegated to portfolio companies with competing activities, or activities on another continent, therefore these undertakings especially with regard to the small Hungarian market, and it is are usually underlined by penalty payment obligations of the quite rare for a PE investor to invest in companies competing infringing party. with each other.

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42 Transaction Terms: General Breakthrough provisions may be incorporated into the corporate documents of the listed company to lift certain restrictions applicable the share transfers. 4.1 What are the major issues impacting the timetable for transactions in your jurisdiction, including antitrust, foreign direct investment and other regulatory approval 5.2 What deal protections are available to private requirements, disclosure obligations and financing equity investors in your jurisdiction in relation to public issues? acquisitions?

These issues will very much depend on the industry in which Public takeover bids are strictly regulated and there is little room the investment is taking place. In industries like banking, insur- for manoeuvring for PE investors. In their takeover bid, a buyer ance and energy, the transfer of control over a regulated entity is may reserve the right to withdraw the takeover bid if, pursuant subject to prior regulatory clearance. These clearance proceed- to the declarations of acceptance, the shares to be acquired are ings can easily take up from one to three months. less than 50% of the total shares of the listed company. Financing is cheap and easily available in Hungary for various Other contractual arrangements (such as a break fee or PE transactions but data protection issues, especially GDPR, reverse break fee) between the seller and buyer may be appli- present frequent headaches for sellers, buyers and investors alike. cable and enforceable but any arrangement affecting the price Portfolio deals involving large databases of personal data, espe- must be published along with the takeover bid. cially if multiple jurisdictions are involved with various regulatory practices, may affect the scheduling or even the feasibility 62 Transaction Terms: Private Acquisitions of deals. Unfortunately, such issues may well emerge during the due diligence process by the time the parties have already 6.1 What consideration structures are typically invested serious resources into preparing the transaction. preferred by private equity investors (i) on the sell-side, and (ii) on the buy-side, in your jurisdiction? 4.2 Have there been any discernible trends in transaction terms over recent years? PE sellers in Hungary prefer the locked box mechanism which enables the fixing of the purchase price at the date of signing Transaction terms vary greatly depending on the parties, negoti- of the SHA. This pricing method gives more control to the ating skills, sector and the type of transaction (share or asset deal, seller over the elaboration of the price and requires an in-depth VC investment, etc.), but one noticeable trend is the more frequent due diligence on the buyer’s side to make proper adjustments appearance of foreign start-ups in international pitches and as before signing the SHA with the fixed price. The advantage for targets for Hungarian VC funds, which may be the result of the both parties is that the price is fixed and known in advance and start-up friendly environment and the cheap funding available. the sale process can be much quicker as no closing accounts are It is a minor observation but worth noting that drag-along and necessary. tag-along provisions still form part of the regular set of rights in Following the international trends, the locked-box price SHAs despite the fact that, according to the common experience setting methodology is slowly replacing the post-closing price and understanding of market players, no drag-along or tag-along adjustment method as the most commonly used tool in M&A right has actually been exercised in Hungary in the past decade. transactions. On the buyers’ side, PE investors still prefer the classic buyer- 52 Transaction Terms: Public Acquisitions friendly method of price adjustment based on the working capital, debt and cash data of the company. This makes the acquisition process longer and requires more effort from both 5.1 What particular features and/or challenges apply parties but gives room for the parties to adjust the price based on to private equity investors involved in public-to-private transactions (and their financing) and how are these events that occurred between the signing and the closing date. commonly dealt with? 6.2 What is the typical package of warranties / Public-to-private transitions are not common in Hungary due indemnities offered by (i) a private equity seller, and (ii) to the relatively low number of listed companies. Pursuant to the management team to a buyer? the Hungarian Capital Market Act, any third party intending to acquire more than 33% (or 25% if no other shareholder has The list of seller warranties and indemnifications is typically the more than 10% in the company) shares in a listed company, most heavily negotiated set of terms in M&A transactions, and a mandatory public takeover bid must be submitted to the PE investors always try to narrow down the scope of warranties Hungarian Central Bank as supervisory authority. At the same to the most prevalent warranties related to legal title and capacity. time, the takeover must be published and sent to the company Met with the buyers’ intentions to widen the sellers’ scope of as well. Any shareholder may decide to opt-in and sell their liability, an average W&I list usually includes warranties related shares within a 30–65-day period. Similar rules apply to volun- to good standing, capitalisation, shareholder structure, financial tary takeover bids except for the minimum threshold which statements, intellectual property, material contracts, taxes and means any third party may submit a takeover bid regardless of compliance with the applicable laws and regulations. the volume of affected shares. Post-closing indemnity is often limited to a reasonable period Special rules apply to a takeover bid exceeding 90% or share- of time (two to five years depending on the associated risks, for holders ending up with more than 90% of shares following a example, indemnity for environmental issues usually covers a public takeover bid process. In such cases, the majority share- longer period while tax indemnities are sometimes excluded). holder can squeeze out the minority shareholders at the price Basket thresholds, which mean a certain aggregated amount quoted in the takeover bid or the amount of equity capital per must be reached before any indemnity is enforced, and caps are share, whichever is higher. also regularly applied.

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Seller indemnity is often backed by an escrow typically around The liability of management teams is either dealt with under 5%–15% of the purchase price from which the buyer may claim the general rules applicable for management liability or capped the amounts related to any specific breach of the seller’s W&I pro rata their shareholding interest. obligations. In the mega-deals, this classic deal structure is currently being transformed slightly by the increasing trend of 6.6 Do (i) private equity sellers provide security (e.g. taking out W&I insurance for the comfort of all parties. escrow accounts) for any warranties / liabilities, and (ii) private equity buyers insist on any security for 6.3 What is the typical scope of other covenants, warranties / liabilities (including any obtained from the undertakings and indemnities provided by a private management team)? equity seller and its management team to a buyer? PE buyers usually provide bank guarantee, parent guaranty, or an Typical undertakings of a PE seller and its management team escrow amount for a pre-determined part of the purchase price. include non-competition and non-solicitation obligation for a The retention of a certain part of the purchase price on part of the limited period of time, usually one to three years. buyers is still seen as the best option for buyers but this is becoming less and less frequent due to the current seller-friendly market. Obtaining securities by PE investors for management liability 6.4 To what extent is representation & warranty is not common in Hungary. insurance used in your jurisdiction? If so, what are the typical (i) excesses / policy limits, and (ii) carve-outs / exclusions from such insurance policies, and what is the 6.7 How do private equity buyers typically provide typical cost of such insurance? comfort as to the availability of (i) debt finance, and (ii) equity finance? What rights of enforcement do sellers Hungarian PE transactions including W&I insurance are still typically obtain in the absence of compliance by the uncommon, although they are slowly but steadily spreading in buyer (e.g. equity underwrite of debt funding, right to specific performance of obligations under an equity practice. W&I insurance is usually applied in high-value (above commitment letter, damages, etc.)? EUR 10 million) commercial real estate deals where the insurance premium moves in the range of 0.8%–1.3%, but the market players and the insurance companies are becoming more and Depending on the value of the transaction, the negotiated deal more prepared for reducing the sell-side transaction risks by and the proportion of equity/debt financing, PE buyers usually taking out a W&I policy. provide a comfort letter or a commitment letter on the available The Hungarian market is starting to realise the valuable advan- equity financing that is usually sufficient for buyers on the rela- tages of limiting sell-side risks and having a buy-side policy where tively small Hungarian market. the buyer and the insurance company may directly deal with each As to debt financing, a confirmation letter or mandatory, but other without the necessary involvement of the seller committing conditional, financing offer from banks on the availability of a a warranty breach. Buyers also spare the costs and time related loan or line of credit, is usually required. to the retention of the purchase price or an escrow agent as well as post-closing litigation and instead charge their costs on the 6.8 Are reverse break fees prevalent in private equity sellers who are still better off with the low premium rates. transactions to limit private equity buyers’ exposure? If W&I insurance also makes risky transactions more attractive so, what terms are typical? and provide another tool for both sellers and buyers to negotiate the deal. Reverse break fees on the buy-side (and break fees on the sell- Usual policy limits include a minimum premium set by most side) usually do not appear in Hungarian M&A PE deals. insurers, a de minimis or basket threshold and a cap on the risks covered by the insurer as well as the exclusion of such forward- looking and post-closing warranties as reaching a certain turn- 72 Transaction Terms: IPOs over or profit level. Existing risks known by the parties, regulatory fines, fraud, corruption, environmental issues and 7.1 What particular features and/or challenges should conditions of real estate are also usually excluded. a private equity seller be aware of in considering an IPO Premiums are affected by many conditions including depth exit? of due diligence, seller transparency, list and type of warranties, advisor competency, geographic location, etc. As a rule of IPO exits may provide higher returns for PE investors than thumb, premiums usually move between 1%–1.5% of the trans- other exit routes (for example, public equity markets may valuate action value but coverage for specific or non-regular risks can the company higher than regular buyers) but they also involve be more expensive. several limitations relating to the exit. IPO processes are also costly and time-consuming efforts and investors looking for 6.5 What limitations will typically apply to the liability quick cash may eventually pursue other exits rather than waiting of a private equity seller and management team under and even then the outcome may be uncertain. warranties, covenants, indemnities and undertakings? Also, it must be noted that IPO exits are not a common occurrence in Hungary. PE sellers usually negotiate a minimum and maximum threshold for their liability between 10%–20% depending on the type 7.2 What customary lock-ups would be imposed on and specific conditions of the given deal and especially the private equity sellers on an IPO exit? outcome of the due diligence and a time limit of three to five years. Buyers generally try to exclude legal title, capacity and tax There is no mandatory lock-up period in Hungary for an investor warranties from such limitations due to their high importance before going public. Also, although IPO exits are not a common and the associated risks.

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occurrence in Hungary, in theory, PE shareholders, including 9.2 What are the key tax-efficient arrangements that angel investors, venture capitalists and other entities investing are typically considered by management teams in private in the company pre-IPO, would be required to comply with a equity acquisitions (such as growth shares, incentive lock-up period of three to six months after going public to keep shares, deferred / vesting arrangements)? the stock prices high. Management participation is not that common in Hungary, but 7.3 Do private equity sellers generally pursue a dual- whether the sale of shares under a management participation track exit process? If so, (i) how late in the process are qualifies for a tax-exempt capital gain is a case-by-case decision. private equity sellers continuing to run the dual-track, and (ii) were more dual-track deals ultimately realised through a sale or IPO? 9.3 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? As noted above, such exit strategies, where the PE seller is pursuing both an initial public offering and a potential M&A Since the dividend and capital gains tax form an integral part of exit, are not as common in Hungary as in other European coun- the personal income tax regime, such kinds of income paid to a tries or in the US. non-resident individual may be subject to personal income tax at 15%, unless the rate is reduced under the applicable tax treaty. 82 Financing Private person founders or management teams resident in Hungary selling their investment should be aware of the current 8.1 Please outline the most common sources of debt 15% income tax and 19.5% social contribution (szociális hozzá- finance used to fund private equity transactions in your járulási adó) applicable to natural persons realising any income jurisdiction and provide an overview of the current state based on the actual profit they make. of the finance market in your jurisdiction for such debt In case of foreign investors, the relevant Double Tax Treaty (particularly the market for high yield bonds). (DTT) can determine tax exemptions or tax relief opportunities. Rolling over the investment into a new company structure Small-cap transactions which make out most of the PE trans- does not involve tax considerations if the volume of shares actions on the Hungarian market are usually financed through remains the same. equity but for mid-cap and large-cap transactions, cheap debt financing is available due to the Hungarian Central Bank’s policy of keeping interest rates low for the past several years. 9.4 Have there been any significant changes in tax legislation or the practices of tax authorities (including Hungary’s bond market is dominated by government bonds in relation to tax rulings or clearances) impacting private and corporate bond issuance is scarce. equity investors, management teams or private equity transactions and are any anticipated? 8.2 Are there any relevant legal requirements or restrictions impacting the nature or structure of the debt A new Act on Social Contribution Tax entered into force in financing (or any particular type of debt financing) of 2019. From 2019, healthcare contribution is replaced by social private equity transactions? contribution. Under the previous regulation, a 14% rate was applied for private individuals on their capital gains and divi- No special legal requirements or restrictions apply to debt dend income which was increased to 19.5%. The HUF 450,000 financing of PE transactions. tax cap on contribution payment was also increased to HUF 697,320 for 2019. 8.3 What recent trends have there been in the debt financing market in your jurisdiction? 102 Legal and Regulatory Matters

Banks operating in Hungary are still offering attractive financing 10.1 Have there been any significant legal and/or opportunities for PE transactions due to the low interest rates regulatory developments over recent years impacting private equity investors or transactions and are any and potential buyers having access to cheap financing for anticipated? various deals.

92 Tax Matters In December 2016, the legislator introduced a new regulatory package for the establishment of PE funds which enables an easier set-up of funds and fund managers. Unfortunately, 9.1 What are the key tax considerations for private the laws relating to PE and VC funds are still not unequiv- equity investors and transactions in your jurisdiction? ocal in certain aspects, the application thereof is not clear and Are off-shore structures common? the Hungarian regulator’s ever-shifting practice makes the Hungarian market sometimes hard for market operators and Offshore structures are becoming less preferred due to the strict advisors to work in. anti-money laundering rules of the EU. Ultimate Beneficial Owners (UBOs) of contracting parties must be identified in various phases of transactions by the parties’ legal and financial 10.2 Are private equity investors or particular advisors which makes offshore companies with non-transparent transactions subject to enhanced regulatory scrutiny in your jurisdiction (e.g. on national security grounds)? owners less attractive.

National security consideration as well as anti-fraud, anti-money laundering and anti-corruption laws do not distinguish between

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PE investments but certain sectors, especially the financial company forms (kft. and zrt.) in PE transactions, the share- sector, are under strict scrutiny by the competent authorities. holders are, in general, liable for the obligations of the portfolio company only to the extent of their own capital contribution. Under extreme circumstances, for example, when a shareholder 10.3 How detailed is the legal due diligence (including compliance) conducted by private equity investors prior deliberately abuses its limited liability, the limited liability is not to any acquisitions (e.g. typical timeframes, materiality, applicable but in practice such investor behaviour is basically scope, etc.)? unprecedented. Under Hungarian law, a portfolio company will be liable for the liabilities of another portfolio company only if there is a Legal due diligence is confined mostly to a red flag type of direct link between the unlawful conduct of these companies review in smaller transactions which concentrates on the iden- either through a contract or market behaviour, for example, in tification of the most prevalent legal issues (corporate structure, the case of an illegal merger. Under normal circumstances all lawful operation, capacity of management, significant contracts, portfolio companies, even with overlapping shareholders, will employment issues, intellectual property and real estate prop- have a stand-alone liability for their own obligations. erty). Such DDs usually take between two to four weeks depending on the availability and quality of the data room and the maturity phase of the portfolio company. 112 Other Useful Facts

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 should impacted private equity investment and/or investors’ such investors otherwise be aware of in considering an approach to private equity transactions (e.g. diligence, investment in your jurisdiction? contractual protection, etc.)?

PE investors should be aware of Act LVII of 2018 on, which In line with international and EU trends, the Hungarian anti- entered into force on January 1, 2019 and introduced a national bribery and anti-corruption laws have been becoming stricter in security review for foreign investments in Hungary. For the recent years, but we are not aware of any shift in the investors purposes of the act, any natural person or legal entity registered approach to PE transactions. in a country outside of the EU, EEA or Switzerland is consid- Anti-bribery and anti-corruption regulations are stricter in ered a foreign investor. Investors should also be aware of indi- various sectors (finance, government) so market players oper- rect investments of foreign entities, where the foreign entity is ating within these fields are more affected if involved in PE the majority controller of a non-foreign investor entity. transactions and compliance is usually checked during the legal Pursuant to the act, a foreign investor may acquire more than and financial due diligence process. 25% (or 10% in case of a listed company) shares in a company registered in Hungary and operating in certain strategic indus- 10.5 Are there any circumstances in which: (i) a private tries if a prenotification is filed to the minister subsequently equity investor may be held liable for the liabilities of appointed by the Government regarding the planned trans- the underlying portfolio companies (including due to action. Strategic industries include the military, financial and breach of applicable laws by the portfolio companies); public utility and public information security sectors and will and (ii) one portfolio company may be held liable for the liabilities of another portfolio company? be specified later by the Hungarian Government in separate decrees. The minister issues a written resolution about the acceptance or the prohibition of the transaction, the latter only The Hungarian law does not distinguish between a PE investor if the transaction violates Hungary’s national security interests. shareholder and any other shareholder, which means every The minister’s decision can be challenged before court in an shareholder is liable for their activities as a shareholder to the expedited procedure. same extent. The extent of liability is predominantly established Non-compliance with the law may result in a fine of HUF by the company form in which the portfolio company oper- 1–10 million depending on whether the infringing party is a ates. Due to the limited liability nature of the most common legal entity or a natural person.

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Dr. Márton Kovács has, since 2003, worked in the real estate and litigation practice group of the Budapest office of Baker & McKenzie. In 2006, he founded his own firm and from January 2017, he became one of the founding partners of HBK Partners. Although his professional experience covers mainly real estate and M&A, he is also proficient in capital markets transactions, having led HBK Partners’ capital markets team in all three public takeovers at the Budapest Stock Exchange in 2017 and the listing of Hungary’s fourth largest commercial bank in 2019. Further, he has gained unique experience in hotel law, representing various investors vis-à-vis global and local hotel operator companies. Márton is also a lecturer in M&A courses of the Budapest Institute of Banking (BIB) and holds workshops for various VC funds and start-up companies.

HBK Partners Attorneys at Law Tel: +36 1 610 4440 Kálvin Square Offices Email: [email protected] 1085 Budapest, Kálvin tér 12. URL: www.hbk-partners.com Hungary

Dr. Gábor Puskás established his own law firm in 2009 and joined KMBK Legal Partnership where he accumulated experience through working for various government agencies and leading Hungarian banks. Gábor teamed up with colleagues from global law firms to represent Hungary against multinational investors before various international arbitration fora, like ICSID in Washington and the PCA in the Hague, in procedures related to energy and telco issues. He provided legal advice on a regular basis to Hungarian agencies and companies in large- scale railroad and waterways development projects in state aid issues. Gábor joined HBK Partners in September 2018, where he gives legal advice to EU and private equity financed VC funds in respect of their investments. Besides his expertise in M&A and corporate law, Gábor has extensive experience in international investment protection law, EU state aid law and Hungarian media law.

HBK Partners Attorneys at Law Tel: +36 1 610 4440 Kálvin Square Offices Email: [email protected] 1085 Budapest, Kálvin tér 12. URL: www.hbk-partners.com Hungary

HBK Partners is an independent leading Hungarian boutique law firm focusing on Banking & Finance, M&A and Capital Markets. Founders of our law firm previously worked for prestigious international law firms, Big Four consultancies and highly successful local law firms, as partners. Our professional experience and commitment enabled us to compile a young, talented and customer-friendly team that fully understands the business and legal expectations of both local and multinational clients. In our work, we strive to find solutions complying with international standards yet tailor- made to the peculiarities of the Hungarian legal and business environment. For years, several of our colleagues have featured as ranked practitioners and recommended lawyers by the leading legal ranking organisations. www.hbk-partners.com

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Ireland Ireland

Rory O’Malley Ben Gaffikin

McCann FitzGerald John Neeson Elizabeth Maye

12 Overview has experienced as a result of the outbreak of COVID-19, and the measures implemented by the Irish government in order to contain its spread. The effect of these factors has seen a dramatic 1.1 What are the most common types of private slow-down in commercial activity in Ireland since March 2020. equity transactions in your jurisdiction? What is the Although the full extent of the economic impact in Ireland is current state of the market for these transactions? Have you seen any changes in the types of private equity not yet known, global deal-making has slowed down signifi- transactions being implemented in the last two to three cantly and this will likely negatively impact on PE activity for years? the remainder of 2020 and possibly beyond. However, strongly capitalised PE funds are well placed to take advantage of any investment opportunities that may arise from the uncertainty. The most commonly executed private equity (“PE”) transactions are buyouts (including management buyouts, institutional buyouts and public-to-private transactions), growth capital trans- 1.3 What are going to be the long-term effects for actions, exits (including trade sales, secondary buyouts and, to a private equity in your jurisdiction as a result of the lesser extent, IPOs) and recapitalisations and restructurings. COVID-19 pandemic? 2019 was a strong year for Irish PE activity. During Q3 of 2019, Mergermarket reported that Irish PE buyouts stood at As mentioned at question 1.2 above, the full extent of the their second highest year-to-date (“YTD”) volume on record economic impact of the COVID-19 pandemic is not yet known. (worth €1.9 billion) and accounted for 19.8% of Irish M&A However, the impact has been negative thus far, with PE activity deals, representing the highest percentage since the 2008 finan- slowing down both in Ireland and internationally. It is likely cial crisis. This increased activity is partly attributable to the that this will continue throughout 2020; however, strongly capi- huge amounts of “dry powder” available to PE firms following talised PE funds are well placed to take advantage of any invest- a number of years of strong fundraising and to the health of ment opportunities that may arise from the uncertainty. the Irish economy, which provided the necessary conditions for robust deal-flow throughout the year. However, market condi- 1.4 Are you seeing any types of investors other tions have now changed significantly following the outbreak of than traditional private equity firms executing private COVID-19. See further details in question 1.2. equity-style transactions in your jurisdiction? If so, As regards developing trends, recent years have witnessed an please explain which investors, and briefly identify any increasing number of PE exits, as funds continue to success- significant points of difference between the deal terms fully monetise their earlier investments, as well as an increasing offered, or approach taken, by this type of investor and number of secondary buyout transactions. There has also been that of traditional private equity firms. an increase in buy-and-build transactions, as PE firms focus on growing and diversifying their portfolios. PE-style transactions backed directly by high-net-worth individuals have long been a feature of the Irish M&A market, in particular 1.2 What are the most significant factors currently from 2000 to 2007. These have continued to be a feature of the encouraging or inhibiting private equity transactions in market, albeit on a smaller scale than during that period. your jurisdiction? More recently, family offices (from Ireland, other European countries, or the US) have executed PE-style transactions in Significant encouraging factors include: an attractive tax regime Ireland, albeit often in transactions employing little or no direct which incorporates a low corporate tax rate of 12.5%, favour- leverage. able tax structures/schemes and access to an extensive tax treaty network; membership of the EU; a young and well-educated, 22 Structuring Matters English-speaking workforce; and a highly developed communications and technology infrastructure. 2.1 What are the most common acquisition structures While the relatively small number of assets and businesses adopted for private equity transactions in your available for acquisition (when compared with larger markets jurisdiction? such as the UK) does tend to limit PE deal activity somewhat, the most significant factors currently inhibiting PE transactions Typically, PE acquisitions are structured using a double or in Ireland are the severe economic shock that the Irish economy triple NewCo structure. The PE sponsor and management

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will generally hold shares in the holding company at the top of is that a minority investor will often only have the right to appoint the acquisition chain (“TopCo”) and an intermediate company one or two directors, rather than the right to control the board. (“MidCo”) may be used as the issuer of loan notes to the sponsor (and any management who are participating in the institutional 2.5 In relation to management equity, what is the strip), while the company at the bottom (“BidCo”) will acquire typical range of equity allocated to the management, and the shares in the target company and may also act as a borrower what are the typical vesting and compulsory acquisition under any debt facilities. provisions? Where the target company is Irish, BidCo would typically be an Irish tax resident limited company. However, the jurisdiction The portion of equity allocated to management will vary as of incorporation of the companies in the acquisition chain will between transactions, though it would typically be in the region vary depending on tax and capital structuring considerations. of between 5% and 15%. Management equity that is issued pursuant to an incentive 2.2 What are the main drivers for these acquisition plan is typically subject to time-based vesting, so that that a structures? manager’s equity will likely vest in increments over a specified period of time, typically between three and five years. Vesting The key drivers for this structure are ensuring structural subor- can be straight-line or cliff vesting, and is usually accelerated in dination of sponsor’s equity and shareholder debt to any third- full on a successful exit. party debt, facilitating the structuring of third-party lenders’ In the vast majority of cases, a manager’s sweet equity shares security and tax considerations. In addition, the structures are will be subject to compulsory acquisition in the event that he designed to allow any future sale proceeds on exit to be returned or she ceases to be employed in the business. Typically, a good to the PE sponsor (and its investors) on exit with minimal delay, leaver will receive fair market value for their vested shares, and tax liabilities and other friction costs. cost for their unvested shares. A bad leaver will receive cost for all of their shares. See question 2.6 for further details on the applicable good 2.3 How is the equity commonly structured in private leaver/bad leaver criteria. equity transactions in your jurisdiction (including institutional, management and carried interests)? 2.6 For what reasons is a management equity holder usually treated as a good leaver or a bad leaver in your A small proportion of the funding committed by the PE investor jurisdiction? to the transaction will be by way of subscription for ordinary shares in TopCo. The remainder is typically invested by way of preference shares or shareholder debt in the form of loan notes. The criteria for good leavers and bad leavers are always a matter This total mixed investment is known as the “institutional strip”. for negotiation in the specific deal, and the circumstances of Typically, management will subscribe for a portion of the ordi- the deal, together with the “house style” of the PE sponsor, will nary shares in TopCo, known as “sweet equity”. These structures impact on this. For example, in a highly contested auction of are designed to ensure that management remain incentivised to a PE-backed company, management will usually be in a strong increase value in the business and that their interests are aligned position to negotiate favourable leaver definitions. with those of the PE investor. Sweet equity structures are often Death and permanent incapacity are almost invariably good combined with management ratchets, which allow management leaver events, and voluntary resignation and dismissal for gross to make larger returns in the event of a successful exit. misconduct are typically bad leaver events. All other circum- In some cases, particularly in secondary buyouts where manage- stances are a matter for negotiation. It is increasingly common ment are rolling over some of their sale proceeds, management for “dismissal for cause” to constitute a bad leaver event, may invest in the institutional strip. Often, further equity may although the meaning of this phrase in an Irish law context can also be offered to management or other key employees by way of be a matter for debate. equity-based incentive plans. Generally, the board will also have discretion to treat a Carried interests are more commonly relevant at the PE fund level manager as a good leaver notwithstanding that he/she does not than at the level of the target company and its equity structuring. fall within the definition of the same. 3 2 Governance Matters 2.4 If a private equity investor is taking a minority position, are there different structuring considerations? 3.1 What are the typical governance arrangements for private equity portfolio companies? Are such In transactions where the PE investor is taking a minority stake, arrangements required to be made publicly available in particularly if there is no third-party debt involved, the structure your jurisdiction? of the deal may be simpler, with no triple NewCo stake and an investment directly into the target holding company. However, The governance arrangements for PE portfolio companies are this is not necessarily the case and minority investments can use typically documented in a shareholders’ agreement. This agree- the structure referred to in the response to question 2.2. ment will cover matters including the agreed conduct of business A PE investor taking a minority position will usually seek the of the company, board representation rights, information rights same contractual protections that a PE investor typically requires and wide-ranging controls for the PE investor through the form in a control transaction, including tag-along rights, (drag-along of vetoes over material issues (as outlined in questions 2.4 and rights and a right to board representation), as well as veto rights 3.2). The shareholders’ agreement is a private contract between over material non-ordinary course issues including major changes the shareholders of the portfolio company and the company itself to the business plan and strategy, the issuance of new equity or and does not generally need to be made publicly available. debt, share redemptions, acquisitions and disposals of assets, and changes to the constitutional documents. One possible difference

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Governance matters will also be included in the constitu- and instructions of the PE investor. If such a determination is tional documents of the company. However, the constitution made, the PE investor will be treated as a director of the port- is a publicly filed document and a shareholders’ agreement is folio company and all directors’ duties would apply to it. therefore a more suitable vehicle to address sensitive or internal company issues that are not intended for public consumption. 3.5 Are there any limitations or restrictions on the contents or enforceability of shareholder agreements 3.2 Do private equity investors and/or their director (including (i) governing law and jurisdiction, and (ii) nominees typically enjoy veto rights over major non-compete and non-solicit provisions)? corporate actions (such as acquisitions and disposals, business plans, related party transactions, etc.)? If a Shareholders’ agreements concerning an Irish company will private equity investor takes a minority position, what typically be upheld in full by the Irish courts provided that their veto rights would they typically enjoy? provisions do not fall under any of the proscribed headings outlined in the response to question 3.3 above. PE investors normally enjoy extensive veto rights over major While shareholders’ agreements relating to an Irish company corporate actions and strategic decisions (including acquisitions are generally governed by the laws of Ireland, so as to ensure and disposals, major litigation, incurring indebtedness, controls consistency with the laws applicable to the company, it is open to over the business plan, strategy and budget) through share- the parties to choose another governing law and jurisdiction for holder veto rights and/or director veto rights exercisable by their resolving disputes should they wish, and such choice will usually nominee directors. These vetoes are usually structured in such be respected by the Irish courts. a way that management’s ability to make day-to-day decisions is Non-compete and non-solicit provisions will be enforced to not unduly hindered. the extent they are limited to what is reasonably necessary to In a minority investment position, the list of veto rights protect the investment of the PE sponsor. Any such provisions afforded to the PE investor will be similar to a control transac- that go beyond this and are overly broad as regards geograph- tion, although this will be influenced by the respective bargaining ical, temporal or sectoral scope, may be found to be unenforce- strength of the parties. able by the Irish courts as an unfair restraint of trade.

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directors’ duties to the company and the directors’ other The use of locked-box consideration mechanisms has also (including personal) interests. However, this duty is not abso- gained momentum in recent years and is particularly favoured lute and a director may be released from it either by the constitu- in PE deals. tion of the relevant company or by a resolution of the company in a general meeting. Typically, any such prospective release or 52 Transaction Terms: Public Acquisitions waiver contained in the constitution will require the director to make disclosure of the circumstances of the conflict to the 5.1 What particular features and/or challenges apply board of the company and may also prescribe further proce- to private equity investors involved in public-to-private dures to be followed. The constitution will usually also stip- transactions (and their financing) and how are these ulate whether a director is entitled to participate in the deci- commonly dealt with? sion-making process having made such disclosure to the board. As a practical matter, nominee directors should ensure to Public-to-private transactions of Irish companies are gener- actively monitor any potential or actual conflict situation that ally governed by a statutory scheme of takeover regulation arises by virtue of their relationship with the PE sponsor or their comprising a set of rules (the “Takeover Rules”) that have the directorship of other portfolio companies. They should also force of law and are administered by the Irish Takeover Panel. ensure to act in accordance with any provisions of the consti- The Takeover Rules apply to takeovers or substantial acquisi- tution dealing with conflicts, and where none are in place, they tions of securities of Irish-incorporated companies whose secu- should inform the other board members of any conflict situ- rities are quoted on certain “recognised” stock exchanges and ation that does arise and recuse themselves from the relevant are principally for the purpose of protecting shareholders of the decision-making process unless released by a resolution of the target by ensuring they receive equal treatment in the conduct of company in a general meeting. any relevant transaction. The framework imposed by the Takeover Rules is signifi- 4 2 Transaction Terms: General cantly more prescriptive than that which applies to private transactions, and advice of counsel should always be sought in order 4.1 What are the major issues impacting the timetable to navigate it successfully. However, the following features of for transactions in your jurisdiction, including antitrust, the Takeover Rules might be of particular note to PE investors: foreign direct investment and other regulatory approval ■ the timetable applicable to a takeover (tender) offer is requirements, disclosure obligations and financing strictly regulated; issues? ■ where the offer is for cash or includes an element of cash, a cash confirmation (usually made by the bidder’s finan- The factor most likely to impact on transaction timetables in cial adviser) that the bidder has sufficient resources avail- Ireland is the requirement to obtain regulatory approval or able to it to satisfy full acceptance of the offer must be consent for certain transactions. Approval is generally sought included in any announcement of a firm intention to make between signing and closing and the approvals that are most an offer and any offer document. Practically speaking, this commonly required are merger control clearance from the will mean that any acquisition financing will need to be in Competition and Consumer Protection Commission (the place on a committed basis on or before the date of the “CCPC”) and industry-specific approvals or consents (e.g. offer announcement; and approval from the Central Bank of Ireland (“CBI”) in relation to ■ once a firm intention to make an offer is announced, a certain investments in regulated financial services businesses). bidder will generally be bound to proceed with the offer. The imposition of conditionality in relation to the acquisition Conditions to the transaction will be negotiated between the of debt financing is not common in Irish PE transactions. bidder’s and target’s advisers but there is an accepted minimum market standard. The conditions will typically include positive 4.2 Have there been any discernible trends in conditions relating to matters that must occur before the condi- transaction terms over recent years? tions are fulfilled (such as target shareholder approval, specified regulatory clearances, and any listing of consideration shares becoming effective), and negative conditions that will relate to Recent years have seen a trend towards increasingly seller-friendly certain circumstances not having occurred, including a material transaction terms (such as shorter limitation of liability periods adverse change condition relating to the target business. In the and the limiting of conditionality) as the market has shifted case of these negative conditions, the Irish Takeover Panel will towards a seller’s market due to strong valuations, widespread not allow a condition to be invoked unless: availability of financing, and healthy competition from interna- ■ the circumstances that give rise to the right to invoke the tional and local, financial and strategic buyers. condition are of material significance to the bidder in the There has also been a continuing upward trend in the use of context of the bid; and warranty and indemnity (“W&I”) insurance in M&A transac- ■ it would be reasonable in the circumstances for the bidder tions generally and particularly in those that involve a PE seller, to invoke the condition. who may be unable to take on liability under its fund rules and/ The Irish Takeover Panel sets a very high standard for mate- or who needs to make immediate distributions of sale proceeds. rial adverse change in these circumstances and scope to with- Furthermore, increased competition between W&I insurers in draw by involving these conditions is very limited. the Irish market has driven innovation with more bespoke insurance solutions and policy enhancements now available for previously uninsurable matters.

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5.2 What deal protections are available to private 6.3 What is the typical scope of other covenants, equity investors in your jurisdiction in relation to public undertakings and indemnities provided by a private acquisitions? equity seller and its management team to a buyer?

The Takeover Rules limit a target company’s ability to agree PE sellers and management will ordinarily provide a suite of deal protection measures. The Takeover Rules would, however, pre-completion undertakings including: (i) covenants regarding permit a relatively customary non-solicit provision to be built the conduct of the business between signing and closing; (ii) into the transaction agreement (this is in contrast to the posi- undertakings to assist with regulatory filings or satisfy other tion under the UK’s Takeover Code which prohibits such provi- closing conditions; and (iii) a no-leakage covenant (in the case sions). A break fee arrangement may also be agreed by the target of a “locked-box” pricing structure). company. However, the Takeover Rules limit the target break The management team will also typically provide non-compete fee amount to 1% of the deal value to cover costs reimbursement and non-solicit covenants where they are exiting the target business. only (i.e. whichever is lower) payable only where the target board It would be extremely rare for a PE investor to give any non-compete withdraws or modifies its recommendation of the transaction, covenants and rare for it to give any non-solicit covenants. or where a competing offer is successful. Subject to limits in the Takeover Rules on the bidder’s ability to invoke conditions, the 6.4 To what extent is representation & warranty rules are not concerned with reverse break fee arrangements, insurance used in your jurisdiction? If so, what are the which will therefore be a matter for negotiation between the typical (i) excesses / policy limits, and (ii) carve-outs / parties. exclusions from such insurance policies, and what is the The transaction documentation would also typically include typical cost of such insurance? a confidentiality agreement and a commitment to cooperate to obtain regulatory clearances. W&I insurance is becoming more prevalent in the Irish M&A landscape as a means of bridging the gap between the buyer’s need 62 Transaction Terms: Private Acquisitions for strong deal protection and a seller’s desire for a clean exit free of residual liabilities. Indeed, PE sellers will often insist as part of 6.1 What consideration structures are typically the transaction terms that the buyer take out buy-side insurance to preferred by private equity investors (i) on the sell-side, cover the business warranties provided by management. and (ii) on the buy-side, in your jurisdiction? Most W&I insurance policies will be subject to an excess which will ideally be set to match the aggregate liability cap of the sellers, Sell-side PE investors tend to prefer a “locked-box” consider- so that as soon as the sellers’ liability is exhausted, the policy will ation structure as it provides purchase price certainty, affords respond. However, to the extent there is a gap, management may greater seller control over the process and represents a cost be asked to bridge some or all of that gap. Excess limits tend to saving as there is no requirement to review and agree comple- be between 0.5% and 1% of the enterprise value of the target, tion accounts post-closing, which in turn facilitates the imme- although recently this limit has been trending downwards with diate distribution of sales proceeds following closing. caps of €1 becoming increasingly common. Completion account structures are also commonly used, Typical exclusions from such policies include coverage for which involve a post-completion adjustment to the purchase product liability, liability arising as a result of bribery, corruption price by reference to the working capital and/or net debt posi- or fraud, pollution/contamination, criminal fines and penalties, tion of the target at completion as compared with an agreed and pension underfunding. Known liabilities or risks are also target position on which the purchase price was based. excluded from coverage. On the buy-side, it would be common for PE investors to The cost of insurance would typically be between 1% and 1.5% look for a portion of the consideration to be deferred by way of of the policy limit. earn-out or other contingent payments linked to the successful performance of the target or to be held in escrow as security for 6.5 What limitations will typically apply to the liability warranty and/or indemnity claims. of a private equity seller and management team under warranties, covenants, indemnities and undertakings? 6.2 What is the typical package of warranties / indemnities offered by (i) a private equity seller, and (ii) As noted previously, a PE seller will usually only provide certain the management team to a buyer? fundamental warranties and, as such, its liability will typically be unlimited or capped at the purchase price and perhaps subject to a Typically, a PE seller will only provide fundamental warran- claims period of three to six years from closing. ties relating to its title and its authority and capacity to sell. Liability for leakage claims should be several and limited to Business and operational warranties will usually be given by the leakage received by the PE seller itself and is typically uncapped. senior management team as they are involved in the day-to-day Usually the applicable claims period is six to 12 months post-closing. running of the business and therefore better placed to do so. The management team’s liability for business warranties is The management team would also usually provide the customary normally limited by applying an aggregate liability cap (which indemnity for pre-completion tax liabilities of the target. These will depend on the transaction value and the availability of W&I warranties and indemnities are generally subject to relatively low insurance) and de minimis and basket thresholds (ordinarily set at liability caps (depending on the percentage ownership of the 0.1% and 1% of the purchase price, respectively), below which management warrantors). As such, the warranty package may no claim can be made. Such warranties typically survive for form the basis for W&I insurance protection as the buyer will 12−24 months post-closing. Management may further limit want to ensure coverage above this liability cap. Increasingly, their liability by giving the warranties on a several/propor- where W&I insurance is available, the liability of the manage- tionate basis and subject to their actual awareness. ment warrantors will be capped at €1.

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6.6 Do (i) private equity sellers provide security (e.g. exposed to price fluctuations during this lock-up period escrow accounts) for any warranties / liabilities, and which may impact on the final return to the PE seller’s (ii) private equity buyers insist on any security for investors. warranties / liabilities (including any obtained from the ■ Costs – an IPO exit is likely to be significantly more management team)? expensive than a private sale due to the number of advisers and parties involved in, and the length (approximately six While escrow accounts are sometimes used and often sought months) of, the process required to execute an IPO. by a PE buyer in respect of management warranties, they are ■ Risk – an IPO exposes PE sellers to significant market becoming less common due to the increase in the use of W&I risk compared to the comparative certainty of a private insurance. Escrow accounts will usually be strongly resisted by sale and, if the IPO is not successful, there is the added PE sellers on the basis that the risk of breach for the funda- risk of potential reputational damage. Furthermore, a PE mental warranties given by PE sellers is very low and security seller will likely be required to provide the underwriters is not therefore required. This also means that PE sellers can with certain warranties relating to the title to its shares distribute the full sale proceeds to their investors as soon as and, in some cases, the underlying business as well as an possible post-closing. indemnity covering any losses the underwriters may incur in connection with the transaction. Under Irish law, there is potential prospectus liability for selling shareholders 6.7 How do private equity buyers typically provide involved in an IPO of an Irish company which PE sellers comfort as to the availability of (i) debt finance, and (ii) equity finance? What rights of enforcement do sellers may not be in a position to assume. typically obtain in the absence of compliance by the ■ Control – as a result of adaptations required to be made buyer (e.g. equity underwrite of debt funding, right to to the company’s corporate governance regime in order specific performance of obligations under an equity to render it fit for an IPO, a PE seller will likely lose the commitment letter, damages, etc.)? benefit of certain control or minority protection rights.

PE buyers will typically issue an equity commitment letter 7.2 What customary lock-ups would be imposed on to the seller from the PE sponsor undertaking to fund BidCo private equity sellers on an IPO exit? with sufficient equity capital to cover the relevant portion of the purchase price, subject only to satisfaction of the conditions in The length of any lock-up period imposed on a PE seller the acquisition agreement and “certain funds” debt financing post-IPO will be determined by regulation and market prac- being available. tice applicable to the chosen listing venue and may be negoti- The debt finance portion may be confirmed by binding ated, but would customarily be for a period of six months from financing term sheets, and commitments may also be given listing. Following expiration of the lock-up period, PE sellers in the commitment letter by the PE fund in relation to BidCo will sometimes agree with the issuer and underwriters of the drawing down the requisite funds under the “certain funds” IPO to continue to be subject to “orderly market” limitations on debt financing. The seller can then enforce its rights to specific the timing, volume and manner of the disposal of their shares. performance of this commitment letter directly against the PE fund if it fails to comply with its terms. 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? If and (ii) were more dual-track deals ultimately realised so, what terms are typical? through a sale or IPO?

Reverse break fees are not a common feature of PE transactions Exits by PE sellers by way of IPO have not been a feature of the in Ireland. Irish market in recent years and almost all exits have been implemented by way of sale process. As such, there is no established 72 Transaction Terms: IPOs market practice or pattern as regards the pursuit of a dual-track process. In our experience, PE sellers would run a dual-track 7.1 What particular features and/or challenges should process up until the point at which an investor “road show” a private equity seller be aware of in considering an IPO in relation to the IPO process would be due to start and then exit? decide which path to take. It would be unusual to continue to run a sale process in conjunction with publicly sharing extensive Typically, a PE seller looking to exit by way of an IPO of an information on the business in a “road show” process. Irish company will look to listing venues in Ireland and either the US or UK. 82 Financing Although an IPO exit can present the most lucrative form of exit for a PE seller, there are a number of issues that should be 8.1 Please outline the most common sources of debt considered, including: finance used to fund private equity transactions in your ■ Delayed/Incomplete Exit – a PE seller may not be able jurisdiction and provide an overview of the current state to effect a full and immediate exit upon IPO as, in order of the finance market in your jurisdiction for such debt to support the IPO and post-IPO price, the sponsor or (particularly the market for high yield bonds). underwriter will typically require PE sellers both to retain a holding in the issuer post-IPO and to enter into lock-up While there has been a noticeable increase over the past number agreements that restrict the disposal of the retained of years in the use of non-traditional sources of financing for holding for a set period post-IPO. The PE seller will be corporate transactions in Ireland, the most common source of

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debt finance used to fund PE transactions in Ireland continues exempt from tax. A generous and flexible foreign tax credit to be traditional bank-led loan financing. system usually eliminates or reduces any Irish tax liability on the The rise in alternative lenders, such as direct lending funds receipt of dividends from foreign subsidiaries. and other institutional investors, has created a more competi- There is no capital gains tax on the disposal of ordinary shares tive lending landscape in Ireland which, prior to the outbreak of in a trading subsidiary, resident in the EU or a country with COVID-19, had resulted in the widespread availability of credit which Ireland has a tax treaty, where the Irish holding company being offered on attractive terms and in increasingly innova- has (directly or indirectly) a minimum of 5% shareholding for tive and flexible formats. These include term loan B facilities, 12 months or more, within the previous two years where certain mezzanine and unitranche loans and the use of payment-in-kind conditions are met. (“PIK”) or convertible debt. CFC rules, which attribute undistributed profits of a CFC Bond issuances are rare in PE acquisition finance in Ireland. arising from non-genuine arrangements for the purposes of avoiding tax to the controlling company in Ireland, apply for accounting periods beginning on or after 1 January 2019. The 8.2 Are there any relevant legal requirements or restrictions impacting the nature or structure of the debt introduction of CFC rules is unlikely to have a significant impact financing (or any particular type of debt financing) of on Irish holding companies due to the low rates of corporation private equity transactions? tax and availability of various exemptions and reliefs. In respect of transaction tax costs, stamp duty at 1% on the consideration paid (or market value, if higher) will generally Generally speaking, there are no particular Irish law require- arise upon the acquisition of an Irish incorporated company. ments or restrictions that would dictate or otherwise impact the Subject to certain conditions, associated companies and recon- nature or structuring of the debt financing of PE transactions, struction reliefs may apply. A higher rate of stamp duty applies and such considerations will depend on the particular circum- when acquiring shares in certain real estate companies. stances of the transaction in question. Irish holding companies may be financed principally by means In this regard, it might be noted that there could be industry- of debt. Trading companies can generally take a deduction for specific requirements or regulations that may apply to a particular interest incurred wholly and exclusively for the purposes of transaction, and PE investors should ensure they are cognisant the trade. Subject to certain conditions, a deduction should be of, and comply with, these as well as the broader regulatory available (on a paid basis) for interest paid by an Irish holding regime affecting PE transactions. company in connection with the acquisition of shares. While there are no thin capitalisation rules in Ireland, interest may be 8.3 What recent trends have there been in the debt re-characterised as a distribution and therefore as non-deductible financing market in your jurisdiction? in certain circumstances. There are wide exemptions from withholding tax on divi- As noted in response to question 8.1, there has been increased dends, interest and royalties. competition in the Irish lending market in recent years due to Ireland also offers a beneficial tax regime for a range of the growing presence of non-traditional lenders which has led fund vehicles which are exempt from tax on income and gains to the greater availability of credit and a wider array of innova- irrespective of where their investors are resident. The Irish tive debt products. Collective Asset Management Vehicle (the “ICAV”) is a popular However, more recently the outbreak of COVID-19 has fund vehicle for PE investors as it can elect (i.e. “check the caused severe disruption to this previously buoyant market. In box”) to be treated as a flow-through or partnership for US tax an effort to mitigate the impact of the financial turmoil caused purposes. by this health crisis, a significant number of wide-ranging regu- PE investors will be focused on achieving capital gains tax latory measures have been announced by the CBI, the European treatment on an exit (see question 9.3). Central Bank and other relevant supervisory authorities in While offshore structures feature occasionally, Irish transac- respect of the banking sector, which range from flexibility in tions tend to utilise Irish incorporated and tax resident entities. meeting minimum regulatory ratio requirements to the postponement of certain reporting requirements. 9.2 What are the key tax-efficient arrangements that Given the extent of the unknowns still surrounding this are typically considered by management teams in private pandemic, it is not yet possible to predict exactly how the loan equity acquisitions (such as growth shares, incentive market in Ireland will be affected by COVID-19 or the meas- shares, deferred / vesting arrangements)? ures that have been introduced to address the economic challenges posed by it. A restricted share scheme can offer an abatement of up to 60% on the taxable value of the shares, where certain conditions are 92 Tax Matters satisfied. Growth share schemes are implemented with an expectation 9.1 What are the key tax considerations for private of a nominal liability to income tax on acquisition and capital equity investors and transactions in your jurisdiction? gains treatment on a disposal of shares. Careful structuring is Are off-shore structures common? required to avoid falling foul of anti-avoidance for income tax purposes. The key considerations include the holding company regime, tax The Key Employee Engagement Programme (“KEEP”) is a costs on transactions, debt-financing matters, the management/ tax-efficient, share-based remuneration scheme for small- and mitigation of tax on cash flows from portfolio companies to the medium-sized enterprises only. Where conditions are satis- investors and management of tax liabilities on an exit. fied, qualifying share options can be granted to and exercised Ireland offers an attractive holding company regime due to by employees free from income tax, universal social charge and its low corporation tax rate of 12.5% on trading profits and 25% Pay Related Social Insurance (“PRSI”). A subsequent disposal of on non-trading profits. Dividends from Irish subsidiaries are shares will generally be subject to capital gains tax.

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The tax treatment of many common share incentive schemes competition concerns in Ireland, commenced on 1 July are not particularly advantageous for Irish tax resident employees 2020. The aim of the simplified procedure is to decrease or directors as marginal rates of income tax, universal social review periods and reduce the burden on notifying parties charge and PRSI generally apply on any benefits obtained. to non-controversial transactions. Certain income tax reliefs for employees such as the Special ■ The Alternative Investment Fund Managers Directive Assignee Relief Programme (“SARP”) may be relevant. (“AIFMD”) applies to most PE capital funds that operate in the EU. On 10 June 2020, the European Commission published a report on its findings from its review of the 9.3 What are the key tax considerations for management teams that are selling and/or rolling-over scope and application of the AIFMD and whether it is part of their investment into a new acquisition structure? achieving its stated objectives. The report notes that PE fund managers encounter significant barriers to marketing their funds in other Member States and that there is an While a disposal of shares will generally be subject to capital argument that the AIFMD could be amended to better gains tax, management will also be keen to ensure capital gains accommodate the PE sector by removing unneces- treatment on a roll-over so that reorganisation relief (“share-for- sary charges and seeking more effective ways to protect share”) may apply to defer any potential liability relating to the non-listed companies or issuers. disposal of the original shareholding. Relief from stamp duty for the acquiring company in the context of a roll-over may also be relevant. 10.2 Are private equity investors or particular transactions subject to enhanced regulatory scrutiny in your jurisdiction (e.g. on national security grounds)? 9.4 Have there been any significant changes in tax legislation or the practices of tax authorities (including in relation to tax rulings or clearances) impacting private PE investors are not generally subject to enhanced regulatory equity investors, management teams or private equity scrutiny in Ireland. However, transactions involving businesses transactions and are any anticipated? operating in certain regulated sectors will be subject to additional regulatory consents or approvals. These include, amongst The Irish tax landscape has been subject to various changes others, acquisitions of a qualifying holding (10% or more of the in recent years as a result of Ireland’s obligations under the capital or voting rights or the ability to otherwise exercise signif- OECD’s Base Erosion and Profit Shifting Project (“BEPS”) and icant influence over management) in firms regulated by the CBI, the Anti-Tax Avoidance Directive (“ATAD”). mergers of Irish media businesses, and acquisitions of stakes New anti-hybrid rules, which aim to deny tax benefits in Irish airlines that are subject to European foreign control resulting from mismatches between different jurisdictions, restrictions. Public-to-private transactions also need to comply apply to payments made or arising after 1 January 2020. with the Takeover Rules as discussed in section 5. Transfer pricing rules have been extended to include non-trading transactions so intra-group, cross-border, non-trading transac- 10.3 How detailed is the legal due diligence (including tions should be considered in light of the arm’s length principle. compliance) conducted by private equity investors prior The EU mandatory disclosure regime (“DAC6”) for certain to any acquisitions (e.g. typical timeframes, materiality, cross-border transactions is effective from 1 July 2020. scope, etc.)?

102 Legal and Regulatory Matters The level of legal due diligence conducted will vary from transaction to transaction and depends on factors such as the nature 10.1 Have there been any significant legal and/or and size of the target business and whether the sale is bilat- regulatory developments over recent years impacting eral or by way of auction – which may also influence the appli- private equity investors or transactions and are any cable timeframe. Typically, external legal counsel is engaged to anticipated? conduct legal diligence on a “red flag issues”-basis with materiality thresholds reflecting the size of the deal. The following are some of the most significant developments introduced or announced in Ireland in the last year that may 10.4 Has anti-bribery or anti-corruption legislation impact on PE investors or transactions: impacted private equity investment and/or investors’ ■ 0 On 2 June 2019, the Investment Limited Partnership approach to private equity transactions (e.g. diligence, (Amendment) Bill 2019 was published which proposes a contractual protection, etc.)? number of changes to the existing Irish legislative framework regulating investment limited partnerships, with The enactment in Ireland of the Criminal Justice (Corruption the aim of modernising this framework so as to better Offences) Act 2018, which introduced potential criminal reflect changes in the global PE market. Once enacted, liability for corporate bodies for the acts of directors, managers, the reformed legislation should greatly enhance the attrac- employees, agents or subsidiaries who commit an offence under tiveness of Ireland as a jurisdiction of choice for the domi- the Act for the company’s benefit, and the extraterritorial reach ciling and servicing of PE funds. of the UK Bribery Act and the US Foreign Corrupt Practices ■ A new, simplified notification procedure for mergers that Act, have led to increased concern and focus from PE investors meet the relevant Irish mandatory merger control noti- in Ireland on compliance with such legislation. As a result, more fication thresholds (where the acquirer and target each emphasis is placed on the warranty protections in this regard in generate €10 million (or more) and together generate €60 the sale/investment agreement. million (or more) of turnover in Ireland), but do not raise

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10.5 Are there any circumstances in which: (i) a private 112 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 the for private equity investors in your jurisdiction or should liabilities of another portfolio company? such investors otherwise be aware of in considering an investment in your jurisdiction? Where the portfolio companies are incorporated as limited liability companies, Irish courts will typically respect the sepa- There are limited additional issues to be considered when plan- rate legal personality of each entity and will not impose liability ning a PE investment in Ireland that are not already addressed on their shareholders or on other companies in the group for above. Ireland represents a very stable and economically their activities save in very exceptional circumstances, such as appealing location for PE investors with a sophisticated finan- where it is being used for a fraudulent purpose or to evade legal cial sector and a common law legal system similar to that in obligations. If an unlimited company or partnership is used, the US and the UK. There are also attractive tax structuring its shareholders or partners can be liable for the entity’s debts. options for non-Irish PE investors (see section 9 above).

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Rory O’Malley advises on a broad range of corporate matters, including mergers and acquisitions, private equity, venture capital and joint ventures. He is especially experienced with M&A and equity fundraisings in the renewable sector. He also works on all forms of private equity and venture capital financing, from the funding of start-ups to the equity and debt financing of buyouts and all stages in between. Rory is the co-head of the Start-Up team in McCann FitzGerald and has been a driving force in developing the Start Strong programme.

McCann FitzGerald Tel: +353 1 607 1359 Riverside One Email: [email protected] Sir John Rogerson’s Quay URL: www.mccannfitzgerald.com Dublin 2 Ireland

Ben Gaffikin is a partner in our Corporate Group and his practice includes mergers and acquisitions, private equity, venture capital, joint ventures and restructurings. Ben is head of the firm’s Private Equity and Venture Capital Group where he regularly advises private equity sponsors, management teams and financial institutions in relation acquisitions, disposals and restructurings. He has deep experience in the pharmaceutical, technology and retail sectors, where he has acted on several fundraisings, disposals, acquisitions, restructurings and corporate migrations.

McCann FitzGerald Tel: +353 1 611 9101 Riverside One Email: [email protected] Sir John Rogerson’s Quay URL: www.mccannfitzgerald.com Dublin 2 Ireland

John Neeson is a corporate lawyer who specialises in mergers & acquisitions, joint ventures, restructurings and, in particular, private equity and venture capital transactions. He has worked extensively on both investor and investee roles over a range of sectors, with a particular focus on the renewable energy, technology, medical devices and pharmaceutical sectors.

McCann FitzGerald Tel: +353 1 511 1554 Riverside One Email: [email protected] Sir John Rogerson’s Quay URL: www.mccannfitzgerald.com Dublin 2 Ireland

Elizabeth Maye is an associate in the Corporate Transactions Group and has experience working on a wide range of corporate practice areas including mergers and acquisitions, corporate reorganisations, joint ventures, and private equity and venture capital transactions. She also advises on general corporate law issues.

McCann FitzGerald Tel: +353 1 511 1570 Riverside One Email: [email protected] Sir John Rogerson’s Quay URL: www.mccannfitzgerald.com Dublin 2 Ireland

With c. 650 people, including over 450 lawyers and professional staff, years by the Financial Times as one of the Top 50 Innovative Lawyers in its McCann FitzGerald is Ireland’s premier law firm. most recent Innovative Lawyers Report. They have also been recognised McCann FitzGerald offers expert, forward-thinking legal counsel to clients by International Financial Law Review and Chambers Europe as Irish “Law and practices Irish law from offices in Dublin, London, New York and Firm of the Year” and Irish “Client Service Law Firm of the Year”. Brussels. The firm’s deep knowledge spans a range of industry sectors, www.mccannfitzgerald.com tailoring solutions to fit your specific needs. McCann FitzGerald’s clients are principally in the corporate, financial and business sectors and it also advises government entities and many state bodies. The firm is divided broadly into four main groupings of corporate, finance, dispute resolution and litigation and real estate (including construction). They also operate industry sector and specialist practice groups which comprise professionals from different groupings. In recognition of their market leading position, McCann FitzGerald was awarded Irish “Law Firm of the Year 2018” at The Lawyer European Awards and named for successive

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Italy Italy

Legance – Avvocati Associati Marco Gubitosi

12 Overview Moreover, during such period of time, approximately 63 private equity firms carried out about 132 divestments, mainly made through trade sale mechanisms (59), followed by founders and 1.1 What are the most common types of private equity sellers buy-back (28), secondary (27), and to a limited extent by transactions in your jurisdiction? What is the current IPOs (nine), with the remaining divestments carried out through state of the market for these transactions? sale to other investors, entities or family offices, or write-off. During 2019, there were no major changes in the implementa- The Italian private equity market is well structured and it encom- tion of the structure of private equity transactions in the Italian passes a significant number of global, European and domestic private equity arena and firms continued to use in the structuring private equity firms, carrying out most of the types of trans- of their investments a combination of equity, quasi-equity and actions, and relevant processes and contractual documentation, debt. However, some trends and features can be highlighted: (i) envisaged in the other sophisticated European and US private a relative increase of sale auction processes with fierce competi- equity markets, as well as – at the end of 2019 – more than 1,200 tion between financial sponsors and strategic/corporate investors; private equity-backed companies. (ii) co-investments or “consortia” between private equity firms or The above is the result of 10 years of steady growth of private between private equity firms and strategic investors are becoming equity activity in Italy – which recorded its peak in 2018 – that more common in Italy, in particular with regard to large or mega slowed down in 2019 in terms of values (whilst still registering buy-out deals; (iii) a remarkable increase in the execution of warran- robust transaction volumes) due to lack of large and mega deals ties and indemnities policies within the context of buy-out transac- as well as increasing market worries and uncertainties arising tions; (iv) increasing re-investment(s) by the seller/founder(s) of the from political and macro-economic global issues. The slow- target alongside the private equity investors in the special purpose down was also caused by a long-lasting, seller-friendly market vehicle; and (v) a relative increase in private investment in public with an increasing market mismatching in asset valuation and companies (“PIPE”) transactions, while take-private transactions prices between sellers and investors. Italian private equity activity are still infrequent in the Italian market also due to the characteris- further dropped both in value and volumes at the end of the 1Q tics and number of Italian listed companies. 2020 due to the COVID-19 outbreak. Indeed, in the 2Q 2020, private equity firms primarily devoted their efforts to recovering their portfolio companies while scouting for potential transac- 1.2 What are the most significant factors currently encouraging or inhibiting private equity transactions in tions, mainly connected to add-on and consolidations needs. your jurisdiction? Private equity represents a fundamental part of the Italian economy, linking the globally recognised Italian family-owned entrepreneurship with the global and national financial markets. The Italian private equity landscape is generally considered by Notwithstanding the present international and national chal- global, European and domestic private equity firms an attrac- lenges, Italian private equity should remain robust and active. tive market characterised by a large number of potential primary More specifically and in relation to quantitative data, according transactions, relatively few sale auction processes and a vast to data provided by AIFI, the Italian Private Capital Association spectrum of appealing targets at more advantageous valuations founded in 1986, during 2019, approximately 370 transactions than other, more mature private equity markets. were executed of which 123 belonged to the buy-out segment, More specifically, the Italian corporate and economic market, 48 to the expansion/growth segment, and a remarkable number considered the second European manufacturing powerhouse, of 168 to the early stage segment. Those transactions were includes a multitude of small, mid and large globally successful performed by approximately 128 private equity firms – 67 of family-owned companies (few listed ones) with a particular which were international – mostly in the buy-out cluster (65), focus on exports and international markets and active in highly and in the early stage segment (40) while the number of firms specialised sectors, with skilled and highly trained personnel. belonging to the expansion/growth cluster was relatively limited The “Made in Italy” brand plays a pivotal role, too. in number (24). In making their investments in Italy, private Therefore, the Italian market represents a fertile land for equity firms preferred to acquire the control of a company rather global and European financial sponsors that focus their invest- than a minority stake either through (i) the subscription of a ment appetite mainly on mid and large private companies as well reserved share capital increase – mainly when the target needs as some listed companies. By contrast, Italian private equity new equity to repay its debts or feed its development goals, or (ii) firms usually focus their investments on the mid-market sector. straight acquisitions of the controlling shareholding. Both clusters of investors are more active in the regions of North and Central Italy.

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On the other hand, the unpredictable Italian political scenario, structures, which can include a foreign (typically EU) so-called along with uncertainties in the efficiency of some Italian courts HoldCo, and sometimes also a so-called MidCo, but the actual and public administration red tape, are considered by most number of entities and their layers depends mainly on financing, investors as the main factors currently limiting the amount of tax and governance needs. The direct acquiring company, foreign direct investment in Italy, including private equity. however, is generally an Italian newly incorporated Italian company (“NewCo”) in the form of a joint stock company limited by shares (“ ”) or a limited liability company (“ ”). 1.3 What are going to be the long-term effects for S.p.A. S.r.l. private equity in your jurisdiction as a result of the In the event that managers want to participate in the envis- COVID-19 pandemic? aged investment, they may acquire a minority stake in NewCo or its parent company, directly or through another corporate entity. Management investment is particularly encouraged by private From March to May, the Private Equity deal-making activity in equity firms in Italy since it guarantees continuity of the busi- Italy declined sharply (from around 40 transactions executed ness and full commitment of key persons. in the period between January and May 2020, compared with For additional thoughts and details, please refer to sections 8 almost 80 transactions executed in 1H 2019) due to the recession (Financing) and 9 (Tax Matters). arisen from the COVID-19 outbreak. However, it seems that the Italian private equity market is resilient and it is adapting to the new post-COVID scenario. 2.2 What are the main drivers for these acquisition In June and July, the initial phases of the deal-making activity structures? increased (scouting, due diligence, setting up of auction procedures, etc.), regaining momentum in the traditional and resil- Significant drivers for private equity acquisition structures ient Italian mid-market (healthcare, sciences, manufacturing are represented by tax and financing reasons as well as some and industrial) and being complemented by some large invest- ownership issues. For further details, please refer to sections 8 ments in the infrastructure and financial sectors. There is some (Financing) and 9 (Tax Matters). positive realism about the private equity activity in Italy in 2H 2020 and private equity players are back in, actively scouting 2.3 How is the equity commonly structured in private the market for new opportunities (add-on, distress acquisitions, equity transactions in your jurisdiction (including opportunistic transactions), notwithstanding the fact that sector institutional, management and carried interests)? forecasts and market analysis are continuously changing and subject to high volatility and unpredictability. As anticipated, private equity transactions are usually implemented by a NewCo whose corporate capital is owned – directly 1.4 Are you seeing any types of investors other or indirectly through a MidCo – by a HoldCo. When the private than traditional private equity firms executing private equity fund allows management investment, usually managers equity-style transactions in your jurisdiction? If so, participate with a small stake either in the target company or in please explain which investors, and briefly identify any significant points of difference between the deal terms a NewCo (or in a MidCo). offered, or approach taken, by this type of investor and The carry is an important instrument to incentivise managers that of traditional private equity firms. to perform, and aligns their interests with those of the investors. The carried interests represent a share of the profits of the investment – embodied into a financial instrument – that Recently we have experienced the entrance of global private managers receive as compensation if a targeted “threshold” equity conglomerates (formerly pure hedge funds) into the Italian return of the investment is achieved (the “hurdle rate”). Usually market, which usually have a more short-term approach and less the relevant instrument also provides for little or no govern- interest in direct governance powers or rights than the typical ance rights and limitations to transfers. For further considera- private equity investor active in the Italian market. tions on carried interests, please refer to section 9 (Tax Matters). In addition, the Italian market also experienced the rise and activism of small private equity investors (club deals and other informal investors) as well as of venture capital players thanks to 2.4 If a private equity investor is taking a minority a favourable new legislation. position, are there different structuring considerations? Within the current market landscape, the so-called Special Purpose Acquisition Company (“SPAC”) represents a relatively In case of minority investments, private equity firms – like all new type of investment “tool” in Italy. Such vehicle, incorporated investors – typically seek (a) protections, such as veto right/super by a team of experienced sponsors, collects risk capital through majority provisions on certain matters (e.g., extraordinary trans- an IPO with the purpose to acquire – and, ultimately, aggregate actions, transactions with related parties, strategic decisions, through the so-called “business combination” – an operative etc.), the possibility to have “watching dogs” in the board of the target which will be then listed. Upon completion of the business target – or sometimes, to designate one/two director(s), (b) pref- combination (which will generally occur within 16/18 months erence rights on distributions and liquidation, and (c) specific from the incorporation of the SPAC), the vehicle disappears. information rights on the activity of the management body of the company (with detailed quarterly or semi-annual reports). 22 Structuring Matters Furthermore, minority investments generally entail trust in the seller which, usually, continues to manage – directly or thought 2.1 What are the most common acquisition structures its managers – the company’s business and, as a consequence, adopted for private equity transactions in your they require his/her commitment to the company for a certain jurisdiction? time period. Therefore, it is common to see minority investors also negotiating share transfer limitations (such as lock-ups or Private equity investors traditionally operate through ad hoc tag- and drag-along clauses). To that end, shareholders’ agreements (and by-law provisions) play a fundamental role.

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2.5 In relation to management equity, what is the vis-à-vis third parties (efficacia reale); such difference plays an obvi- typical range of equity allocated to the management, and ously important role in cases of violations. what are the typical vesting and compulsory acquisition provisions? 3.2 Do private equity investors and/or their director nominees typically enjoy veto rights over major The typical range of equity allocated to the management is corporate actions (such as acquisitions and disposals, generally a small minority of the corporate capital of the target business plans, related party transactions, etc.)? If a or NewCo (around 5–10% of the ordinary shares). However, private equity investor takes a minority position, what should the target be a “family-managed” company, the equity veto rights would they typically enjoy? allocated to the management could be higher. It is not unusual to negotiate a call option on the remaining shares in favour of Unless the by-laws of a private company contain supermajority the investor or a put option in favour of the management, which provisions at shareholders’ level and/or board level, resolutions can be triggered upon occurrence of certain agreed events are taken by simple majority. (including good or bad leaver events). Generally, a private equity investor (directly or through the Management’s ownership is also usually subject to lock-ups and designated director(s)) acquiring a minority stake would seek other share transfer restrictions and non-compete undertakings. veto rights/supermajorities on all major corporate decisions of the target either at the shareholders’ level (such as extraordinary transactions, liquidation, amendments of the by-laws, capital 2.6 For what reasons is a management equity holder usually treated as a good leaver or a bad leaver in your increases, etc.) or at the board of directors’ level (strategic deci- jurisdiction? sions, related party transactions, important financial matters such as approval of the business plan, etc.). Should a private equity investor acquire a controlling stake, the Good and bad leaver concepts are generally taken into account veto/supermajorities above are usually sought by the minorities. to calculate the price of the management shares in case of departure of the manager. The most common events of good leaver are death, mental/ 3.3 Are there any limitations on the effectiveness of physical incapacity preventing the manager from continuing his veto arrangements: (i) at the shareholder level; and (ii) at office, retirement, and revocation without cause. the director nominee level? If so, how are these typically addressed? On the other hand, any case of revocation with just cause (giusta causa) usually represents a bad lever event (in addition to other specific events negotiated by the parties). Bad leaver There are no specific rules limiting the effectiveness of veto events usually determine a discount on the market price of the rights. Veto rights are usually provided in shareholders’ agree- management shares. ments, enforceable as contractual obligations binding upon the contractual parties, unless they are also reflected in the by-laws 32 Governance Matters – to the extent permitted by the law. However, in order to avoid serious and continuous deadlock situations (which could lead to the impossibility for the company to operate and continue 3.1 What are the typical governance arrangements for private equity portfolio companies? Are such pursuing its corporate purpose and, in certain extreme cases, arrangements required to be made publicly available in to its dissolution), escalation procedures may be agreed by the your jurisdiction? parties. The ultimate deadlock resolution mechanism is the so-called “Russian roulette” or “shotgun” clause. This clause, which forces a shareholder to either sell its participation or The governance arrangements for private equity portfolio acquire the participation of the other shareholder, in both cases companies depend on the type of investment. For instance: at the price determined by the proposing shareholder, has been (i) in case of minority investments, refer to the answer under widely debated among Italian scholars and, recently, its validity question 2.4 above; and has been confirmed by the decisions of two important Italian (ii) in case of majority investments, governance arrangements courts. It is worth mentioning that although such clause was not mostly relate to the full operational management of the new in the Italian legal framework, its validity was specifically target. By contrast, minority shareholders would usually analysed by the Italian case law for the first time only in 2017, seek veto/super majorities for material decisions, including when the Court of Rome was called to decide upon the validity the possibility to designate at least one director of the of a Russian roulette clause inserted in a shareholders’ agree- board. ment. The Court of Rome declared the legitimacy and validity In Italy there is no obligation to disclose and/or make available of the clause. Such decision has been recently upheld by the shareholders’ agreements, save for listed companies. However, Court of Appeal of Rome (decision dated February 3, 2020). in case corporate arrangements are also reflected in the by-laws of the target, those arrangements will be publicly available (since by-laws of companies are publicly available in Italy and can be 3.4 Are there any duties owed by a private equity easily extracted from the Italian Register of Enterprises). investor to minority shareholders such as management It is worth mentioning that, especially for joint stock compa- shareholders (or vice versa)? If so, how are these nies (whose regulation is less flexible than the regulation typically addressed? provided for limited liability companies), certain governance provisions agreed by the parties in a shareholders’ agreement Equity investors have no particular obligations towards minority cannot be mirrored into the by-laws of the company. Also, shareholders. However, in taking any corporate resolutions, the the main difference is that while shareholders’ agreements are majority shareholder shall always act in good faith and pursue the enforceable only towards shareholders party to the agreement corporate benefit. The majority shareholder shall not take advan- (efficacia obbligatoria), by-laws provisions are also enforceable tage of its position (abuso di maggioranza). Therefore, a resolution

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directed only to the benefit of the majority shareholder (and to acting in conflict of interests with the company. On the other the detriment of the minority shareholder) with no corporate hand, directors are protected by the “business judgment rule” benefit for the company could be challenged in court for annul- principle. ment (in certain cases, the minority shareholder is also entitled Directors may be liable towards (a) the company, (b) the to receive liquidated damages). company’s creditors, and (c) the company’s shareholders or third It is worth mentioning that minority shareholders shall not parties. abuse their position (for instance, in case the by-laws of the Furthermore, it is worth mentioning that a shareholder could company provide for a veto right/supermajority in favour of the potentially be held liable for the underlying portfolio compa- minority shareholders) or act to their sole benefit or in prejudice nies if its exercise of the “direction and coordination” activity of the interest of the company (abuso di minoranza). over the controlled companies causes damages or losses to such companies. The “direction and coordination” activity over the controlled companies is presumed upon occurrence of certain 3.5 Are there any limitations or restrictions on the contents or enforceability of shareholder agreements conditions, such as the presence of the same members of the (including (i) governing law and jurisdiction, and (ii) management bodies in both the directing company and of the non-compete and non-solicit provisions)? controlled company, the steady stream of instructions that the directing company gives to the controlled company’s directors. Please also refer to the answer to question 10.5 below. Under Italian law, the duration of shareholders’ agreements is subject to certain time limits. In particular: ■ with respect to joint stock companies (società per azioni ), 3.7 How do directors nominated by private equity save in case of joint ventures, the duration of a shareholders’ investors deal with actual and potential conflicts of agreement shall not exceed a five-year term; and interest arising from (i) their relationship with the party ■ with respect to limited liability companies (società a responsa- nominating them, and (ii) positions as directors of other portfolio companies? bilità limitata), contrary to joint stock companies, there is no such time limit; however, the shareholders enjoy a termination right at will. Under Italian law, there is no conflict of interest per se if a Furthermore, according to Italian law, holders of the same director is designated by a shareholder or in case a director sits type (category) of shares should enjoy similar rights, therefore on the board of different portfolio companies. it is common for joint stock companies to provide for different The above being said, a director shall always act in the interest categories of shares that vest different rights. This principle of the company he/she serves, in order to pursue its corporate does not apply for limited liability companies, whose corporate purpose and in compliance with the corporate benefits prin- capital is represented by quotas (and not by shares) and whose ciple. As a matter of fact, unless specifically authorised by the regulation is more flexible. shareholders’ meeting, directors cannot (i) be shareholders of With regard to non-competition provisions contained in a competing companies with no liability limitation, (ii) operate a shareholders’ agreement, such provisions shall be limited both competing business, or (iii) hold the office of director or general in terms of time and geographic area or activities. manager in competing companies. When a director is in a conflict of interest (on his/her or a third party’s behalf) with respect to the adoption of a certain 3.6 Are there any legal restrictions or other corporate resolution, he/she shall declare and explain such requirements that a private equity investor should be aware of in appointing its nominees to boards of conflict before the vote. A resolution passed with the deci- portfolio companies? What are the key potential risks sive vote of a conflicted director can be challenged by the other and liabilities for (i) directors nominated by private directors or statutory auditors if such resolution causes damage equity investors to portfolio company boards, and (ii) to the company. In certain cases, the conflicted director should private equity investors that nominate directors to refrain from voting (for instance, in case the resolution concerns boards of portfolio companies? the director’s liability).

First of all, directors must be entitled to serve and not fall into 42 Transaction Terms: General one of the prohibited categories set out by the law. Directors of Italian joint stock companies can be appointed for a maximum 4.1 What are the major issues impacting the timetable three-year term, while no such limit applies to limited liability for transactions in your jurisdiction, including antitrust, companies. foreign direct investment and other regulatory approval The by-laws of the portfolio companies could also provide requirements, disclosure obligations and financing for specific requirements to be met by directors. Moreover, issues? for certain types of companies (those subject to regulatory control, such as banks and insurance companies), directors The major issues impacting the timetable for transactions in and top managers shall meet further requirements provided Italy are those regarding antitrust and/or regulatory authorisa- by applicable law (in terms of reputation, professionalism and tions/approvals/clearances, as well as the completion of unions’ independence). procedures. In addition to the foregoing, Law Decree no. The risks and liabilities of directors designated by a private 23/2020 (the “Decree”) introduced new rules that significantly equity investor are exactly the same of directors designated by strengthened the foreign direct investment (“FDI”) screening any other shareholder. Directors shall carry out their offices (i) regulation (so-called “golden power” regulation), including a in accordance with applicable law and the company’s by-laws, provisional regime for the COVID-19 emergency. In particular, to pursue the company’s corporate purpose and in compli- the Decree introduced the obligation to also file transactions, ance with the corporate benefit principle, (ii) with the diligence by any EU or extra-EU entity, involving companies operating required by the office and based on their respective specific assets falling in the so-called “high-tech sectors”, i.e.: critical skills and knowledge, (iii) in an informed manner, and (iv) not infrastructures (including energy, transportation, water, health,

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communications, media, data processing or storage, aerospace, National Commission for Companies and the Stock Exchange defence, electoral or financial infrastructure, and sensitive facil- (“CONSOB”) (i.e., the Italian authority regulating and super- ities, as well as land and real estate crucial for the use of such vising companies listed in Italy and Italian securities markets, infrastructure); critical technologies (including artificial intel- including public-to-private deals) in order to implement the ligence, robotics, semiconductors, cybersecurity, aerospace, Consolidated Financial Act provisions at a secondary level. defence, energy storage, quantum and nuclear technologies as Furthermore, the EU Regulation no. 596/2014 (the “Market well as nanotechnologies and biotechnologies); supply of critical Abuse Regulation”) and the related EU delegated regulations inputs (including energy or raw materials, as well as food secu- are also applicable. rity); access to sensitive information (including personal data, More specifically, the control of an Italian public company or the ability to control such information); and freedom and can be acquired in several different ways including, without pluralism of the media. limitations, by (i) launching a voluntary tender offer over the In addition, the Decree introduced a temporary regime public company’s shares, (ii) acquiring the “controlling” stake providing that, until December 31, 2020, the following transac- through a share purchase agreement entered into with the tions are subject to foreign investment filing: majority shareholder(s), which implies the launching of a manda- ■ any resolution and transaction adopted/entered into by tory tender offer over all of the public company’s shares, and (iii) any EU or extra-EU entity holding strategic assets in the subscribing to a capital increase of the listed company. Tender energy, transportation and communications sectors, as offers and capital increases are supervised by CONSOB. well as high tech, resulting in change of control or owner- Subject to the Consolidated Financial Act and Market Abuse ship, or of use with respect to the assets/businesses indi- Regulation, a prospective bidder may generally build a stake in cated above; the target public company’s share capital before the acquisition ■ any acquisition of shareholdings, by any EU or extra-EU of its control. However, a careful valuation and an in-depth entity, in companies holding strategic assets in the sectors analysis should be made prior to any stakebuilding activity to of energy, transportation and communications, as well as be made before the launch of a tender offer in case such share- high tech, resulting in a change of control of the target holder has taken the decision (not yet publicly announced to company; and the market) to launch a voluntary tender offer over the target ■ any acquisition of shareholdings, by any extra-EU entity, in in order to make sure that such stakebuilding activity does not companies holding strategic assets in the sectors of energy, raise issues under the Market Abuse Regulation. transportation and communications, as well as high tech, Due diligence exercise carried out over an Italian public resulting in the acquisition of at least 10% of share capital company shall be carried out in compliance with the provisions or voting rights, provided that the total investment value of the Market Abuse Regulation. is equal to or higher than one million euros. Such acquisitions will be also subject to communication whenever 5.2 What deal protections are available to private the holding thresholds of 15%, 20%, 25% and 50% are equity investors in your jurisdiction in relation to public exceeded. acquisitions? The Decree also entitled the Government to commence ex officio the procedure to assess the exercise of the golden power Voluntary tender offers (but not mandatory tender offers) may (in case of failure to report a transaction). be subject to conditions precedent (e.g., minimum threshold On June 7, 2020, the Decree was converted into law (Law no. of acceptance, obtainment of authorisations such as antitrust/ 40/2020). The main amendments introduced by the conversion golden power, material adverse change, etc.), provided that the law to the Decree are the extension of the golden power regu- satisfaction of these conditions precedent does not depend on lation to the agri-food and steel sectors and the introduction of the offeror’s mere will (so-called “condizioni potestative”). new evaluation criteria for the FDI screening in said sectors, as well as some clarifications regarding the scope of application of the FDI screening to the health and financial sectors. 62 Transaction Terms: Private Acquisitions It is also worth mentioning that, for specific business sectors, delays could also be due to the obtainment of prior authorisa- 6.1 What consideration structures are typically tions from third parties (e.g., for certain types of agreements preferred by private equity investors (i) on the sell-side, entered into with the Public Administration). and (ii) on the buy-side, in your jurisdiction?

4.2 Have there been any discernible trends in In the last few years, many private equity transactions have transaction terms over recent years? been carried using the locked box mechanism. The value and use of such consideration structure is dependent upon various elements, such as (i) the time running between the date in which Please refer to the answers to the questions above (in particular, the investor prices the company (usually through a reference section 1). statement, which is also subject to specific and strong warranties delivered by the seller) and the closing of the transaction, 52 Transaction Terms: Public Acquisitions (ii) the type of financial document produced by the company/ seller that the investor uses to price the business (audited finan- 5.1 What particular features and/or challenges apply cial statements vs financial statements vs pro forma balance sheet, to private equity investors involved in public-to-private and so on), (iii) the standing of the subject certifying or auditing transactions (and their financing) and how are these such document, and, of course, (iv) the stability of the business commonly dealt with? involved (which can change materially over a short timeframe). Any difference in the relevant figures between the date in which Italian public-to-private deals are governed by Legislative Decree the buyer “locked the box” (the so-called “reference date”) and no. 58 of February 24, 1998 (the “Consolidated Financial the closing date is usually treated as leakage, with certain excep- Act”) and Regulation no. 11971 of May 14, 1999, issued by the tions to be agreed in the course of the negotiation.

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The above being said, sellers typically prefer an earn-out policies do not offer coverage for certain business representa- structure consideration (which gives value to their continuing tions and warranties, such as environmental, compliance with presence in the company after the sale), while buyers are much law (anti-corruption), secondary tax liability, sanctions, product more comfortable with the closing accounts structure and, with liabilities, balance-sheet projections, etc. the caveat above, the locked box mechanism (which somehow The cost of such policies depends on the indemnification cap, gives certainty to the purchase price and the business acquired). on the coverages sought and on other factors (such as de minimis, basket and so on). It is worth mentioning that while nowadays these policies 6.2 What is the typical package of warranties / indemnities offered by (i) a private equity seller, and (ii) are often adopted in real estate transactions, their use in corpo- the management team to a buyer? rate transactions is still limited, in particular due to (i) the articulated process necessary for their execution – the buyer shall indeed negotiate the representations and warranties not just with All sellers (especially private equity sellers) generally tend to the seller, but also with the insurer, (ii) the (still) considerable offer a very limited package of representations and warranties: costs, also considering that the buyer shall bear the costs of the the commonly accepted representations and warranties are the legal advisors of the insurer, (iii) the relatively limited coverage “legal ones” (those referring to the ownership and title over the offered (see above), and (iv) the very little room that insurers shares of the company subject to transfer) usually accompanied leave to negotiation. by certain limited business warranties, such as tax and labour representations and warranties. The standard duration for business warranties is up to 12–18 months. 6.5 What limitations will typically apply to the liability The representations and warranties of the management tend of a private equity seller and management team under to be aligned. warranties, covenants, indemnities and undertakings? In common practice, private equity sellers deliver less representations and warranties than an “ordinary” seller and tend Sellers’ indemnification obligations are always subject to (a) to negotiate a very small indemnification cap (around 10–20%); limitations: cap (around 10–20% of the consideration agreed); uncapped indemnities are not usually accepted by private equity basket (around 10–20% of the cap); and de minimis (which is typi- sellers. cally expressed by a number, the greater the better for the seller), and (b) exclusions, such as losses resulting from change of laws after the closing, events disclosed in the context of the due dili- 6.3 What is the typical scope of other covenants, undertakings and indemnities provided by a private gence (where not subject to specific indemnities) or caused by an equity seller and its management team to a buyer? action or omission of the potential buyer. Time limitations for general representations and warranties are in a range between 12–18 months. Private equity sellers do not usually deliver When the transaction envisages a separate signing and closing, fundamental representations and warranties (usually requested interim negative covenants are usually provided. Interim cove- by a buyer for environmental, labour and tax matters) or special nants ensure that, during the period running from signing to indemnity provisions. closing (the so-called “interim period”), the target’s business is not subject to material alterations with respect to the one evaluated (and priced) by the potential buyers and it is carried out in 6.6 Do (i) private equity sellers provide security (e.g. a manner consistent with past practice. Anti-leakage provisions escrow accounts) for any warranties / liabilities, and are common too, especially if the parties agree on a locked box (ii) private equity buyers insist on any security for warranties / liabilities (including any obtained from the consideration structure. management team)? In certain cases, private equity sellers may also grant specific indemnities in relation to specific issues identified by a potential buyer during its due diligence activity in order to mitigate any In case of execution of a representation & warranty insurance impact such issues might have on the purchase price previously policy, private equity sellers do not generally provide any addi- agreed by the parties (perhaps in a binding offer). tional security. In the absence of the above policy, generally a corporate guarantee is released by the parent HoldCo (or by another capable company of the private equity seller’s group). 6.4 To what extent is representation & warranty Private equity buyers, on the other hand, usually request bank insurance used in your jurisdiction? If so, what are the guarantees or the execution of escrow agreements to cover (all typical (i) excesses / policy limits, and (ii) carve-outs / exclusions from such insurance policies, and what is the or part of) the indemnity cap with part of the purchase price typical cost of such insurance? pre-adjustment(s). The duration of the escrow usually mirrors the duration of the guarantees. Back in the day, the use of warranty & indemnity insurances (or “W&I insurances”) was very rare in Italy due to the high 6.7 How do private equity buyers typically provide premiums requested and the necessity to carry out a very comfort as to the availability of (i) debt finance, and (ii) detailed (and expensive) due diligence exercise, as required by equity finance? What rights of enforcement do sellers typically obtain in the absence of compliance by the the insurers. However, in recent years, the trend has seen some buyer (e.g. equity underwrite of debt funding, right to changes, and private equity players are now much more inter- specific performance of obligations under an equity ested in – but still not used to – W&I insurances, which are commitment letter, damages, etc.)? offered by many insurers (usually through brokers). W&I insurance policies do not cover issues identified during A private equity buyer typically delivers to the seller an equity the due diligence process or arising from matters that have not commitment letter which commits the guarantor/sponsor (part been properly assessed or inspected in the due diligence and, of the buyer’s group) to provide the necessary funds to close of course, do not cover price adjustments. In addition, such the transaction or fulfil any other buyer’s monetary obligation

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towards the seller. Equity commitment letters usually contain However, in larger transactions, acquisitions are also frequently the right of the seller to trigger the guarantor’s obligation to financed through a combination of senior and mezzanine debt or provide equity, upon occurrence of certain conditions (and senior debt and bonds. Financing can include senior term and failure of the buyer to do so). revolving debt, first and second lien debt in the form of loans or notes, mezzanine term debt, payment-in-kind (“PIK”) loans or notes, and vendor financing. The recourse of unitranche 6.8 Are reverse break fees prevalent in private equity transactions to limit private equity buyers’ exposure? If financing has been growing, although such corporate structure so, what terms are typical? shall now be tested following the negative impact of COVID-19. Furthermore, high-yield market is a viable source of acquisition financing; the related corporate structure, similarly to bank Reverse break fees are not common in the Italian market. financing, may contemplate senior and subordinated debt compo- A break-up fee could be negotiated (but would rarely be nents through the issuance of different types of notes, with accepted by a sophisticated seller) in the preliminary documenta- senior secured notes eventually becoming structurally senior to tion of the transaction. For instance, a break-up fee can be estab- the subordinated notes. Despite this, the number of acquisitions lished for the reimbursement of the due diligence costs suffered entirely funded through a high-yield bond issuance is still limited by the potential purchaser in the event of the seller’s unjustified in the Italian market, but we expect a considerable increase of interruption of the negotiations or wilful misconduct. acquisition bond financing in the near future, in particular by means of a combination of bridge to bond senior financings 72 Transaction Terms: IPOs granted by the arrangers for the purpose of completion of the acquisition closing and their refinancing through bond issuance. 7.1 What particular features and/or challenges should a private equity seller be aware of in considering an IPO exit? 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 financing) of The IPO process requests a sort of “transformation” of the private equity transactions? private company into a public corporation: this usually implies an internal reorganisation, also in terms of corporate govern- The main Italian law restrictions involve financial assistance and ance, in order to allow the company to comply with the rules corporate benefit issues. provided for listed entities. Financial assistance requirements restrict Italian companies from directly or indirectly providing financial support (including 7.2 What customary lock-ups would be imposed on in the form of granting security to acquisition lenders) to buyers private equity sellers on an IPO exit? in the purchase of its shares. Any loan, guarantee or security given or granted in breach of these provisions is null and void. Joint Global Coordinators usually request the sellers to abide by Although in certain cases a whitewash procedure is achiev- a lock-up period ranging from six to 12 months (starting from able for targets to provide immediate support in acquisition the IPO date). financing, generally speaking in the context of leveraged buyout (“LBO”) transactions, any financial assistance restriction would cease to apply upon perfection of a merger between the NewCo/ 7.3 Do private equity sellers generally pursue a dual- BidCo and the target made in compliance with Italian law provi- track exit process? If so, (i) how late in the process are sions related to LBO merger (which also impose to follow a private equity sellers continuing to run the dual-track, and (ii) were more dual-track deals ultimately realised specific procedure contemplating a debt sustainability test at the through a sale or IPO? level of the combined entity). In market practice, to avoid any financial assistance issues, acquisition financing is commonly structured in a combination The dual-track process is usually pursued by private equity of short-term debt granted to the NewCo/BidCo (and having funds. The decision to proceed with a sale or the IPO is usually a maturity in line with the envisaged timing of the merger) taken before the approval by CONSOB of the prospectus and and long-term financing (aimed at refinancing the short-term ultimately depends on the price offered by the potential buyers financing at the level of the combined entity). In turn, in less and capital market conditions. complex deals, long-term financing may also be granted from day one which will provide an early termination in case the 82 Financing merger is not completed by a fixed longstop date (usually set six to 12 months following the closing). 8.1 Please outline the most common sources of debt In the first phase of the financing (until merger), the acqui- finance used to fund private equity transactions in your sition debt is likely to be supported only by means of a share jurisdiction and provide an overview of the current state pledge over the NewCo and the target (as well as by further of the finance market in your jurisdiction for such debt security at the level of NewCo). In the second phase (i.e., upon (particularly the market for high yield bonds). merger), in addition to the share pledge over the merged entity, the financing takes usually benefit from security interests The structure of the financing of private equity acquisitions created over significant assets of the combined entity. in Italy largely depends on the size of the transaction. In the Corporate benefit requirements impose that Italian compa- mid-cap market, deals are generally financed through senior nies, providing upstream and/or cross-stream security interests bank loans provided by a pool of banks or, for higher amounts, and guarantees in the interest of their parent company financing, syndicated loans. The number of transactions financed by means obtain a direct or indirect tangible benefit from the secured trans- of bond issuance (in the form of mini-bond or corporate bond) action. The existence of a corporate benefit for an Italian entity and the recourse to vendor loans are also growing. is ultimately a matter of fact – rather than a legal concept – to be

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carefully evaluated by the management of the relevant Italian 9.2 What are the key tax-efficient arrangements that guarantor, and the guaranteed or secured amount must not are typically considered by management teams in private materially exceed the financial capability of the Italian guar- equity acquisitions (such as growth shares, incentive antor. The market practice has elaborated some solutions for shares, deferred / vesting arrangements)? helping directors in evaluating the existence of corporate benefit and its “translation” in the relevant financing documentation Italy has only recently introduced a sort of safe harbour favourable (such as, for instance, limiting the maximum amount guaran- carried interest regime which, in certain circumstances (among teed by an Italian subsidiary to the amount of intragroup debt which (i) minimum managers’ co-investment equal to 1% of the received by it). Anyway, the existence of the corporate benefit value of the target, and (ii) minimum investment period), may must be evaluated on a case-by-case basis. ensure tax treatment as a financial investment (26%) (as opposed to employment income tax treatment up to 43%) to investment 8.3 What recent trends have there been in the debt instruments (preferred shares or other preferred financial instru- financing market in your jurisdiction? ment) providing “additional remuneration” above a certain hurdle rate compared to ordinary equity investment. If the safe harbour requirements are met, the more beneficial tax treatment will be At the beginning of 2020, the expectation in relation to deal guaranteed even if a clear link exists between the employment activity was robust thanks to the abundance of liquidity provided position and the entitlement to the “preferred remuneration”. by banks and the huge number of alternative lenders that entered the market (also thanks to recent reforms which provided new rules that expressly allowed EU alternative investment funds 9.3 What are the key tax considerations for to “invest” in loans (where “invest” also includes also origina- management teams that are selling and/or rolling-over tion), subject to certain conditions, and a new favourable tax part of their investment into a new acquisition structure? regime for foreign investors), as well as very positive borrowing conditions in terms of leverage, pricing and fees, plus the intro- Much depends on the actual co-investment scheme but in general, duction of a whole range of new structures. Among them, it is when simply selling their co-investment, management teams will worth mentioning, in the context of senior acquisition loans in seek where possible to enjoy a particular tax scheme that allows the Italian market, the unitranche loans. In any case, despite the step-up of the value of the investment by paying an 11% tax the influx of alternative lenders, traditional banks continue on the full fair market value of the instrument. Subsequent sales to play a major role in the Italian market. Indeed, looking at would be carried out without realising any chargeable gain. survey results, senior-only structures will be the most common In the context of a possible reinvestment, to the extent that mid-market debt structures. (i) terms and conditions of the “new” scheme are not materi- The above remarks are now obviously subject to the ally different from the old one, and (ii) the purchaser is ready to COVID-19 effects and impacts that such pandemic will have cooperate, it would be possible (although not common) under over both investors and stakeholders and, generally speaking, certain circumstances to obtain a roll-over of the management over the European and Italian markets. teams’ scheme into a new acquisition structure without realising a chargeable gain. 92 Tax Matters 9.4 Have there been any significant changes in tax 9.1 What are the key tax considerations for private legislation or the practices of tax authorities (including equity investors and transactions in your jurisdiction? in relation to tax rulings or clearances) impacting private Are off-shore structures common? equity investors, management teams or private equity transactions and are any anticipated? Different key tax and structuring considerations may come into play depending on the type of acquisition (minority vs 100% or Historically, acquisition structures have been severely challenged listed company vs private). by the Italian tax administration on the basis of non-deducti- In all circumstances, given the fairly significant amount of bility of interest on acquisition financing. Since 2016, certain taxes still applicable in Italy on interest, dividends and capital clarifications have been released by the tax authority which have gains (generally at 26%), special attention is devoted to efficient provided a much more relaxed (tax) environment for most of tax structuring in order to manage those charges. Intermediate the LBO transactions. It has been clarified that although the foreign (typically EU) holding or finance companies generally financing is not strictly linked to the target but is an acquisition play an important role in this attempt. One key aspect is always financing, it will be deductible upon certain specific conditions. ensuring maximum deductibility of interest expenses in combi- Similarly to other EU jurisdictions, interest will only be deduct- nation with no interest withholding tax on payments to lenders. ible within the 30% EBITDA interest barrier rule. Of course, repatriation of dividends or capital gains on exit free The current hot topics in Italian tax legislation are mostly from withholding tax are also key factors when structuring the connected to the recent changes in the EU tax system and acquisition in order to maximise return from the investments. connected attention to cross-border transactions. In particular, Italy is one of the few countries that introduced measures to restrictions set forth in the implementation of the Anti-Tax incentivise capitalisation of companies vs leverage through the Avoidance Directive (“ATAD”) (including anti-hybrid rules) and granting of a notional interest deduction (“NID”). Maximising the EU Directive on administrative cooperation (“DAC 6”) need the effect of the NID while still maintaining deductibility of the to be carefully addressed when structuring private equity deals. interest on the acquisition financing is key. As to the 2019 so-called “Danish” cases (concerning the Another area of interest is management plans, to make sure beneficial ownership of EU-based holding structures and their incentive schemes are designed to fit within the recently abuse of EU Parent-Subsidiary/Interest and Royalties Directives), introduced beneficial carried interest regime. the European Court of Justice’s approach is mostly consistent with the long-standing aggressive position of the Italian tax

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administration. In other words, such cases cannot be deemed players depends on several factors. Generally, the due diligence as significantly affecting the Italian tax system, but rather as exercise is very detailed, in particular should the parties decide confirming a sound approach as to substance/beneficial owner- to execute a W&I policy (since a very detailed due diligence ship tests of EU intermediate holding companies. report would be requested by the insurer). In other cases, it can be carried out at a higher level. Of course, it varies case by case, 102 Legal and Regulatory Matters also depending on the needs of the purchaser, the size of the target, and the type of investment. 10.1 Have there been any significant legal and/or Should the size of the target be particularly consistent, it is regulatory developments over recent years impacting common that parties agree on materiality thresholds, in order to private equity investors or transactions and are any avoid a long and expensive due diligence activity. The magni- anticipated? tude of the contractual warranties plays a fundamental role in such respect: if many material warranties are previously agreed, The main legislative development impacting private equity inves- the potential buyer might be more relaxed in the due diligence tors in recent years has certainly been the entry into force of exercise. Directive 2011/61/EU of the European Parliament and of the As per the timings, provided that it depends on the amount of Council of June 8, 2011 on alternative investment fund managers documentation to analyse, three or four weeks might suffice to complete the due diligence. (“AIFMD”), as fully implemented in the Italian jurisdiction in 2015. In certain cases, an additional or confirmatory due diligence In particular, the AIFMD, introducing the regulatory provisions between signing and closing may be agreed by the parties and/ or requested by the buyer, especially in the context of competi- for all non-UCITS investment fund managers (“AIFM”), provides for, inter alia: (i) rules prohibiting “asset stripping” by private equity tive procedures. firms in the case of an acquisition of control over a non-listed company having its registered office in the EEA (i.e., the AIFM is 10.4 Has anti-bribery or anti-corruption legislation not allowed, for a period of two years following the acquisition of impacted private equity investment and/or investors’ control, to facilitate, support, instruct, or vote in favour of certain approach to private equity transactions (e.g. diligence, distributions, capital reductions, share redemptions and/or acqui- contractual protection, etc.)? sitions of own shares by the relevant company, and must in fact use its best efforts to prevent any such transactions from taking place); Anti-bribery and anti-corruption legislation have a material (ii) the obligation for the AIFM to make certain information avail- impact on private equity investments in Italy, especially for able to investors before they invest in the fund, including a descrip- certain types of acquisitions (e.g., where the target operates in tion of the investment strategy; and (iii) the obligation for AIFM certain specific sectors or deals with the Public Administration). to disclose, to the competent authorities as well as to shareholders and employees of target companies, information on the acquisi- 10.5 Are there any circumstances in which: (i) a private tion of control and their intentions on the future business of the equity investor may be held liable for the liabilities of company and repercussions on employment. the underlying portfolio companies (including due to Moreover, it is worth mentioning that recent developments in breach of applicable laws by the portfolio companies); the Italian anti-money laundering (“AML”) framework will soon and (ii) one portfolio company may be held liable for the require all Italian companies to disclose to the companies’ register liabilities of another portfolio company? the identity and relevant information on the beneficial owners of the companies. In this respect, it is worth mentioning that AML A private equity investor could potentially be considered liable rules provide for potentially far-reaching definitions of “beneficial for the underlying portfolio companies in case of its exercise of owner”, which may also include investors of private equity funds “direction and coordination” activity. holding significant percentages of fund interests. In particular, to be held liable, a company shall exercise direction and coordination activity and act in its own or another’s 10.2 Are private equity investors or particular business interests in violation of the principles of proper corpo- transactions subject to enhanced regulatory scrutiny in rate and business management of the controlled company. your jurisdiction (e.g. on national security grounds)? The foregoing may expose the directing company to liability for damages towards the shareholders and creditors of the Generally, Italian law does not set out any specific restriction controlled company. on the issue and transfer of equity interests, except for compa- The above liability is excluded when the damage is non-ex- nies active in specific sectors where the authorisation of certain istent in light of the overall result of the direction and coordi- competent authorities may be required. Reference is made, in nation activity, or is entirely eliminated, also further to action particular, to transactions involving banks and (re)insurance taken specifically for such purposes. companies as well as other financial institutions subject to the supervision and rigorous scrutiny of EU and national super- 112 Other Useful Facts visory authorities (i.e., European Central Bank, Bank of Italy, Insurance Supervisory Authority (“IVASS”), CONSOB). 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 10.3 How detailed is the legal due diligence (including investment in your jurisdiction? compliance) conducted by private equity investors prior to any acquisitions (e.g. typical timeframes, materiality, scope, etc.)? All significant factors have been addressed above.

The accuracy of the due diligence conducted by private equity

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Marco Gubitosi is the London Managing Partner and a Corporate Finance Partner (May 2013) at Legance – Avvocati Associati. Marco has been recognised by Leaders League in the “Leading” tier of private equity lawyers – Italy. Marco provides hands-on advice and has been involved in several major transactions carried out in the Italian and international markets. In particular, he has outstanding expertise in corporate finance, LBOs, mergers, acquisitions (private and public), private equity buy-outs, divestitures, real estate transactions, alternative investments and joint ventures. He regularly advises Italian and foreign banks and financial institutions, private equity houses, real estate and sovereign funds, family offices and alternative capital providers, as well as governments and public institutions, corporations and family-owned businesses on a diverse range of transactions. Marco has developed his expertise both in Italy and abroad, particularly whilst working in New York, Beijing and London. He is a regular lecturer at professional associations and academic institutions both in Italy, Europe and the USA, as well as a co-author of books and legal publications on corporate law and on M&A and private equity. Education After graduating from the Università degli Studi di Napoli “Federico II” in Naples, he earned an LL.M. Degree from the Université Libre de Bruxelles, Institut des Hautes Etudes Européennes. He is admitted to the Italian Bar (Consiglio dell’Ordine di Milano) and also represents clients before the Supreme Court (Corte di Cassazione). He has been admitted to the England and Wales Roll of Solicitors, currently as a non-practising solicitor. Further expertise & memberships Marco is a member of the M&A Committee and of the Tax and Legal Committee at AIFI (Italian Private Equity and Venture Capital Association). He is a member of the Board of Directors of the American Chamber of Commerce in Italy and a member of the Council for the relations between Italy and the United States, as well as a member of Chatham House in London. He also held the office as Director General of the ANSPC, National Association for the Credit Studies. Academic experience Marco is a regular lecturer and speaker at several conferences, workshops and seminars at professional associations and academic institutions, in both Italy and the USA, on corporate law, M&A and private equity. Publications Marco is the co-author of several books and legal publications on M&A, private equity and corporate and restructuring matters.

Legance – Avvocati Associati Tel: +39 335 6252 260 / +44 779 519 6209 via Broletto, 20 Email: [email protected] 20121, Milan URL: www.legance.com Italy

Legance is an independent law firm with offices in Milan, Rome, London Legance, thanks to a strong international practice, can support clients and New York. from several different geographical areas, and organise and coordinate Founded in 2007, by a group of acclaimed partners who began their careers multi-jurisdictional teams. in the same law firm, Legance distinguishes itself in the legal market as a www.legance.it point of reference for both clients and institutions. Legance’s rapid growth is undisputed evidence of its strength in legal services, and its achievements are the result of a consistent strategy focused on creating value around the institutional nature of the firm. Legance, thanks to the firm’s constant attention to clients’ needs, and an unconventional approach, has positioned itself at the top of the national and international market. The name Legance evokes unity and excellence: these fundamental principles have been at the foundation of the law firm and have supported its standing.

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Luxembourg Luxembourg

Holger Holle

Eversheds Sutherland (Luxembourg) LLP José Pascual

12 Overview modern and pragmatic legal framework with a wide array of available structures; a multilingual and technically-skilled workforce; and finally the strong governmental commitment towards 1.1 What are the most common types of private equity the private equity sector. However, the current COVID-19 transactions in your jurisdiction? What is the current pandemic is the most significant factor affecting private equity state of the market for these transactions? transactions. All industries across the world have been affected by the economic consequences of the COVID-19 pandemic Luxembourg is one of the most pre-eminent jurisdictions glob- and private equity is not an exception to this; it is inhibiting a ally for the structuring of private equity transactions, both in the number of private equity transactions in Luxembourg. regulated and the unregulated space. Luxembourg has developed an impressive toolbox of structuring solutions to accommodate investments in both spaces. Besides the “all time 1.3 What are going to be the long-term effects for private equity in your jurisdiction as a result of the classic”, the non-regulated SOPARFI (participation holding COVID-19 pandemic? companies in any form available for commercial companies under the Luxembourg law of 10 August 1915 on commercial companies (1915 Law)), the most significant examples are the At this stage in the COVID-19 pandemic, it is difficult to creation of the SICAR in 2004 (regulated investment company ascertain what the future impact will be on private equity in in risk capital), the SIF in 2007 (specialised investment fund, Luxembourg. However, from the stage we are already at, there a regulated alternative investment fund (AIF) vehicle used for are a number of possible long-term effects resulting from any type of investment, including private equity) or the RAIF COVID-19. The pandemic has created an ongoing uncertainty, (reserved alternative investment fund, not subject to supervision which additionally presents the possibility of strategic opportu- by the Luxembourg financial supervisory authority (CSSF), but nity to those firms that have cash available. to be managed by an authorised external alternative investment Private equity deals are still moving, albeit at a marked slower fund manager (AIFM) within the meaning of the AIFMD). On pace. Those deals that were due to close within the lockdown the regulated side, recent years have seen an increasing use of period are now closing, as well as those in the latter part of nego- the RAIF. tiations, continuing to be signed. However, deals in the earlier On the unregulated side, recent years have seen an increasing stages of negotiations appear to be slowing down, with some use of the overhauled S.C.S. and the new S.C.Sp. type of part- being put off until the market begins to stabilise. nerships (LP); the latter was created in 2013 as a flexible struc- While the above is the case for a number of private equity ture without its own legal personality similar to an English LP firms, there are a number of other private equity firms with to accommodate investors from an Anglo-Saxon background. significant levels of cash in hand and so are viewing the current climate as a good opportunity to invest. As we have seen acquisition prices steadily increase over recent years, this has enabled 1.2 What are the most significant factors currently a number of firms to accumulate significant sums of cash. encouraging or inhibiting private equity transactions in Because of this, the industry could see a number of transactions your jurisdiction? by such firms with cash in hand. This is particularly likely to be seen in industries such as travel and entertainment, as they have Luxembourg has been a major hub in the private equity industry been hit hardest by the COVID-19 pandemic. Such transactions for over 20 years and continues to attract an increasing number are likely to be of those where companies are strapped for cash, of private equity firms. Due to recent substance requirements, rather than a takeover. more private equity firm offices are growing in Luxembourg. To summarise, caution is certainly still the order in Luxembourg has positioned itself as one of the jurisdic- Luxembourg. In a survey conducted by the Luxembourg Private tions likely to benefit from Brexit by attracting private equity Equity Association (LPEA) amongst Luxembourg-based GPs houses and asset managers, thanks to its distinctively private and LPs in July 2020, on the back of improved visibility, the equity-friendly environment. The following factors are typi- impact of COVID-19 has not worsened for 85% of respond- cally mentioned as encouraging private equity transactions in ents when compared with March 2020. However, respondents Luxembourg: political and economic stability; an attractive recognised that the most-hit area is new business and expect the tax framework with a large number of double tax treaties; the NAV to land between -5% and -25% at year end.

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1.4 Are you seeing any types of investors other large degree of flexibility. Unregulated LPs are often used for than traditional private equity firms executing private feeder funds, carried interest vehicles or “club deal” types of equity-style transactions in your jurisdiction? If so, co-investment constellations. please explain which investors, and briefly identify any significant points of difference between the deal terms offered, or approach taken, by this type of investor and 2.3 How is the equity commonly structured in private that of traditional private equity firms. equity transactions in your jurisdiction (including institutional, management and carried interests)?

On the regulated side, there is a tendency for the pension funds and insurance companies to become more active in the Acquisition structures typically include one or more Luxembourg Luxembourg PE market; however, the most remarkable recent unregulated SOPARFI companies which in turn acquire and hold development in that respect is the increasingly frequent involve- the target shares or assets. In secondary buy-out situations, the ment of family offices. Pursuant to a recent survey conducted original acquisition structure is typically sold as part of the transac- by the LPEA amongst Luxembourg family offices, on average, tion. In recent years, LP structures have become a preferred choice 35% of the assets in portfolios managed by Luxembourg family of structuring investments in private equity transactions. LPs can offices were alternative investments and 73% of those investing be unregulated SOPARFIs or established as one of the (directly or in this asset class expect private investments to deliver higher indirectly) regulated types (SICAR, SIF or RAIF). In both alter- returns than public investments. Further, also in light of the natives, the LP regime benefits from a large degree of flexibility. recent COVID-19 crisis, family offices appreciate the greater Unregulated LPs are often used for feeder funds, carried interest control and visibility offered by private equity compared with vehicles or “club deal” types of co-investment constellations. public investments. In that sense, deal terms are likely to be no different from those 2.4 If a private equity investor is taking a minority required by a traditional private equity firm taking a minority position, are there different structuring considerations? stake. Differences exist, however, e.g. financing contingency clauses are rarely required by a family office investor and there A minority private equity investor will typically aim to mitigate is less appetite in getting involved on the operational level. the lack of control by other mechanisms protecting it against the Family offices often also have a longer investment horizon and majority investor, e.g. veto rights in major decisions, anti-dilution exit plans may be less prescriptive than for a traditional private provisions, share transfer restrictions, exit provisions, etc. These equity firm. provisions are usually included in shareholders’ agreements or LP agreements. 22 Structuring Matters

2.5 In relation to management equity, what is the 2.1 What are the most common acquisition structures typical range of equity allocated to the management, and adopted for private equity transactions in your what are the typical vesting and compulsory acquisition jurisdiction? provisions?

Acquisition structures typically include one or more Management equity will typically represent a small percentage of Luxembourg unregulated SOPARFI companies which in turn the equity and management equity holders will undertake either acquire and hold the target shares or assets. In secondary not to vote or to vote as the sponsor directs. The typical vesting buy-out situations, the original acquisition structure is typically and compulsory provisions are similar to what can be seen in sold as part of the transaction. In recent years, LP structures other European jurisdictions, and transaction documents usually have become a preferred choice of structuring investments in include (good leaver/bad leaver) provisions allowing the private private equity transactions. LPs can be unregulated SOPARFIs equity sponsor to acquire the management’s equity upon termi- or established as one of the (directly or indirectly) regulated nation of the manager’s employment with the relevant portfolio types (SICAR, SIF or RAIF). In both alternatives, the LP company. The management’s exit upon exit of the sponsor is regime benefits from a large degree of flexibility. Unregulated typically ensured by drag-along provisions, combined with share LPs are often used for feeder funds, carried interest vehicles or pledges or call options in the sponsor’s favour. Alternatively, “club deal” type of co-investment constellations. management equity is structured in a separate vehicle investing alongside the main acquisition vehicle, often in the form of an 2.2 What are the main drivers for these acquisition LP managed by the sponsor. structures? 2.6 For what reasons is a management equity holder Acquisition structures typically include one or more Luxembourg usually treated as a good leaver or a bad leaver in your unregulated SOPARFI companies which in turn acquire and jurisdiction? hold the target shares or assets. In secondary buy-out situations, typically the original acquisition structure is sold as part A management equity holder would typically be considered a of the transaction. In recent years, LP structures have become good leaver if leaving for reasons of permanent incapacity or a preferred choice of structuring investments in private equity illness or death and, in some instances if dismissed without transactions. LPs can be unregulated SOPARFIs or established cause. A management equity holder dismissed for cause of as one of the (directly or indirectly) regulated types (SICAR, SIF resigning voluntarily would be considered a bad leaver. or RAIF). In both alternatives, the LP regime benefits from a

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3 2 Governance Matters 3.5 Are there any limitations or restrictions on the contents or enforceability of shareholder agreements (including (i) governing law and jurisdiction, and (ii) 3.1 What are the typical governance arrangements non-compete and non-solicit provisions)? for private equity portfolio companies? Are such arrangements required to be made publicly available in your jurisdiction? As an expression of the overarching principle of freedom of contract, the parties may agree what they commercially deem appropriate, with certain restrictions applying under Governance arrangements such as the right to appoint nominee Luxembourg public policy rules, e.g. clauses excluding the risk directors, restrictions of transfer of shares, tag-along and drag- of loss for one party or the right to a share in the profits for along rights, pre-emption rights, matters requiring shareholder another party would be ineffective. The parties are generally consent, distribution of proceeds and exit provisions, are typi- free to choose the governing law and jurisdiction. Historically, cally part of shareholder agreements or LP agreements. Neither English or New York law and courts have been the preferred agreement is required to be made public, but as a way of easing choice; however, more recently there has been a clear shift to enforcement it is common to reflect certain key provisions, e.g. using Luxembourg law and courts or arbitration. Non-compete those governing transfer of shares, in the articles of association and non-solicit provisions are common and not subject to of the company which are public in order to make the provi- specific restrictions (assuming that none of the shareholders are, sions of the shareholders’ agreements enforceable against third at the same time, an employee of the company). parties.

3.6 Are there any legal restrictions or other 3.2 Do private equity investors and/or their director requirements that a private equity investor should nominees typically enjoy veto rights over major be aware of in appointing its nominees to boards of corporate actions (such as acquisitions and disposals, portfolio companies? What are the key potential risks business plans, related party transactions, etc.)? If a and liabilities for (i) directors nominated by private private equity investor takes a minority position, what equity investors to portfolio company boards, and (ii) veto rights would they typically enjoy? private equity investors that nominate directors to boards of portfolio companies? It is common to provide for veto rights for private equity investors in shareholders’ agreements over major corporate actions. A director nominated by a shareholder does not owe any The scope of the veto rights will, to a large extent, depend on the particular duty to that shareholder. To the contrary, the direc- overall influence, i.e. the share percentage held, with minority tors of a Luxembourg company have the duty to fulfil their investors typically enjoying veto rights only over fundamental mandate in good faith and to carry out their duties in the best actions and less over business planning and strategy matters. corporate interest of the company itself, which is not necessarily in line with, or even contrary to, the interest of the private 3.3 Are there any limitations on the effectiveness of equity investor. Moreover, the directors are bound by confiden- veto arrangements: (i) at the shareholder level; and (ii) at tiality duties and cannot easily disclose sensitive and confiden- the director nominee level? If so, how are these typically tial information related to the business of the company to the addressed? shareholders. This somewhat delicate position may, in practice, expose nominee directors to increased liability risks; generally, Veto arrangements both at shareholder level and at board level their obligations do not differ from those of any other director. are generally effective as an expression of the prevailing prin- Private equity investors are generally not liable for the acts and ciple of freedom of contract as long as they are not contrary to omissions of their nominee directors, as long as they do not public policy rules in Luxembourg (e.g. by depriving a share- interfere directly with the company’s management, in which holder entirely of its voting rights or by completely excluding a case they may be held liable as de facto directors. director from board deliberations). Voting arrangements typically address these limitations by including the appropriate 3.7 How do directors nominated by private equity exceptions. investors deal with actual and potential conflicts of interest arising from (i) their relationship with the party nominating them, and (ii) positions as directors of other 3.4 Are there any duties owed by a private equity portfolio companies? investor to minority shareholders such as management shareholders (or vice versa)? If so, how are these typically addressed? Under Luxembourg corporate law, a director who has, directly or indirectly, a monetary interest which is opposed to the company’s Private equity investors do not have any specific fiduciary duties interest, is under the obligation to notify the existence of such toward the minority shareholders. As a general rule, however, conflict of interest to the board of directors, have it recorded a majority shareholder shall, at all times, refrain from abusing in the minutes of the board meeting and refrain from partici- its majority rights by favouring its own interests against the pating in the deliberation with respect to the transaction in which corporate interest of the company. Luxembourg law also clearly the impacted director has a conflicting interest. Finally, the next distinguishes between interests of the shareholder(s) and interest general meeting of shareholders must be informed by the board of the company; a director, albeit a nominee of a shareholder, of directors of the existence of such conflicts of interest. The needs to act in the company’s interest and not in that of the fact that a nominee director is, at the same time, director of nominating shareholder. another portfolio company does not create a conflict per se, but the director needs to be mindful that the notion of group interest is applied very restrictively in Luxembourg and, as a general principle, only the interest of the individual company itself is relevant.

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4 2 Transaction Terms: General to Luxembourg law as the governing law, while, historically, English law or New York law would have been the preferred choice. To a certain extent, this tendency also applies to the 4.1 What are the major issues impacting the timetable choice of Luxembourg as the place of jurisdiction (often for transactions in your jurisdiction, including antitrust, coupled, however, with the submission to an arbitral tribunal foreign direct investment and other regulatory approval requirements, disclosure obligations and financing instead of state courts), with the arbitration procedure being issues? held in Luxembourg.

Traditionally, private equity transactions in Luxembourg do 52 Transaction Terms: Public Acquisitions not usually require any antitrust or regulatory clearances in Luxembourg itself. However, if the transaction concerns a target 5.1 What particular features and/or challenges apply in a regulated sector such as the financial sector, the approval of to private equity investors involved in public-to-private the regulatory authorities such as the Commission de Surveillance du transactions (and their financing) and how are these commonly dealt with? Secteur Financier (CSSF) will be required. Such approval requirements may also apply to the funding of the acquisitions of a regulated business. Due to the very small number of Luxembourg companies However, in line with recent trends in other European juris- publicly listed in Luxembourg itself that may be potential dictions, a bill of law (No. 7578) aiming to regulate foreign direct targets of private-to-public transactions, it is difficult to iden- investments (the Bill) was introduced into the legislation process tify a genuine market standard for this type of transaction. on 11 June 2020. The Bill is still under review by the various From a strictly legal perspective, such transactions are subject to stakeholders and, therefore, subject to change; however, the the Luxembourg securities law, the takeover law implementing current status suggests that a mandatory procedure of prior noti- the EU Takeover Directive and the squeeze-out law provision fication to, and authorisation by, the Ministry of Economy will imposing specific restrictions, a stringent procedural framework be implemented for certain foreign investments. The Ministry and a strict timetable. will be able to scrutinise and evaluate proposed foreign investment in order to determine whether a foreign investment is likely 5.2 What deal protections are available to private to affect public security and public order or essential national equity investors in your jurisdiction in relation to public or European interests. According to the current draft of the acquisitions? Bill, the Ministry will be able to impose conditions or prohibit a proposed transaction altogether if public security and public As a general principle in Luxembourg law, the parties have order or essential national or European interests are affected. contractual freedom to negotiate and to abort the negotiations It is expected that the potential effects on the following at any point during the process unless the negotiation is so elements will be particularly decisive for the Ministry’s advanced that one party can legitimately expect from the coun- assessment: terparty that the deal is about to be done. (a) critical infrastructure, whether physical or virtual, That said, it is possible for the parties to contractually provide including infrastructure relating to energy, transport, for specific deal protections, such as break-up fees provided that water, health, communications, media, data processing or the amount of the break-up is proportionate to the size of the storage, aerospace, defence, electoral or financial infra- deal. structure and sensitive facilities, as well as land and real estate essential for the use of such infrastructure; (b) critical technologies and dual-use items within the meaning 62 Transaction Terms: Private Acquisitions of Article 2(1) of Council Regulation (EC) No. 428/2009 of 5 May 2009; 6.1 What consideration structures are typically (c) the supply of essential inputs, including energy or raw preferred by private equity investors (i) on the sell-side, and (ii) on the buy-side, in your jurisdiction? materials, and food or health safety; (d) access to or the ability to control sensitive information, including personal data; and The vast majority of private equity M&A transactions realised (e) freedom and pluralism of the media. in Luxembourg have a cash-for-shares type of consideration. While still in early stages, it can be expected that the foreign Arrangements including shares-for-shares types of considera- investment regime, once implemented, will be in line with the tion or merger arrangements are possible, but fairly rare. A sell- recent trend of renewed protectionism seen in neighbouring side private equity investor will naturally prefer a full payment countries such as France and Germany. of the cash consideration at closing, while a buy-side private equity investor will attempt to retain a portion of the purchase price as collateral for potential warranty/indemnity claims. 4.2 Have there been any discernible trends in Earn-out components are also seen but less frequent than in transaction terms over recent years? other jurisdictions.

The modernisation of the 1915 Law and the constant thriving of the Luxembourg legislator to expand the “toolbox” of avail- 6.2 What is the typical package of warranties / indemnities offered by (i) a private equity seller, and (ii) able structuring alternatives (including the transposition of the management team to a buyer? Anglo-Saxon style instruments into local law such as the new LP), coupled with the wealth of experience and understanding by courts and other authorities for the particularities of the The package of warranties/indemnities is similar to the ones private equity industry, have led to an increasing readiness by typically given by a private equity seller in other European juris- private equity investors to submit the transaction documents dictions, i.e. a private equity seller will usually provide warranties only with respect to title, capacity and authority and certain

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tax matters. A private equity seller will typically resist against be asked to provide personal security (other than possibly the giving any operational or business warranties. Management vesting of shares in the target if the management team is taken teams may be pressured to give operational warranties if they over and a management incentive programme is put in place at co-sell their shares alongside the private equity seller. the target).

6.3 What is the typical scope of other covenants, 6.7 How do private equity buyers typically provide undertakings and indemnities provided by a private comfort as to the availability of (i) debt finance, and (ii) equity seller and its management team to a buyer? equity finance? What rights of enforcement do sellers typically obtain in the absence of compliance by the buyer (e.g. equity underwrite of debt funding, right to Similar considerations as in other jurisdictions apply to cove- specific performance of obligations under an equity nants regarding the conduct of business in the period between commitment letter, damages, etc.)? signing and closing and would depend on the nature of the business, the length of the pre-closing period and on whether the Equity commitment letters by the private equity fund to the management team will be taken over by the buyer. Non-leakage SPV’s benefit are a frequent means for private equity buyers to provisions will be found in any purchase agreements using provide financial comfort. Less frequently, the private equity a “black box” purchase price model. Restrictive covenants fund itself or an affiliate with proven financial wealth may (non-compete, non-solicit) are common. Indemnities will typi- become party to the transaction documents as a guarantor for cally be given for tax matters relating to periods pre-signing/ the SPV. In either alternative, the liability is limited to contrac- pre-closing. tual damages and no specific performance of the SPV’s obligations may be claimed. 6.4 To what extent is representation & warranty insurance used in your jurisdiction? If so, what are the typical (i) excesses / policy limits, and (ii) carve-outs / 6.8 Are reverse break fees prevalent in private equity exclusions from such insurance policies, and what is the transactions to limit private equity buyers’ exposure? If typical cost of such insurance? so, what terms are typical?

Warranty and indemnity (“W&I”) insurances are increasingly Reverse break fees have not (yet) been observed as a standard common in Luxembourg. However, while it is too early to practice in the Luxembourg market. identify a genuine market standard for Luxembourg, the likely providers of W&I insurances are the same players as in other 72 Transaction Terms: IPOs European jurisdictions and it may be expected that similar limitations, carve-outs and exclusions will become market practice 7.1 What particular features and/or challenges should standards as in other European jurisdictions, but this is always a private equity seller be aware of in considering an IPO subject to negotiation. The premium for W&I insurances for exit? Luxembourg acquisition agreements typically ranges from 0.9% to 1.8% of the insured sum. IPO exits are not frequently seen in Luxembourg as there are very few publicly listed companies in Luxembourg that would 6.5 What limitations will typically apply to the liability be eligible. However, the legal and regulatory framework exists of a private equity seller and management team under and an IPO initiated by a private equity seller would be carried warranties, covenants, indemnities and undertakings? out under supervision of the CSSF and subject to the provisions of the Luxembourg prospectus law. The limitations are similar to the ones applied in other European jurisdictions, i.e. general limitations include time limits within 7.2 What customary lock-ups would be imposed on which the claims can be brought (typically between 12 and private equity sellers on an IPO exit? 24 months) and limitation of financial exposure to a capped amount. With respect to the latter, depending on the bargaining A lock-up period of up to 180 days seems to be a standard period position of the seller, caps of 30% up to 100% of the purchase in an IPO exit in Luxembourg. price can be observed. Indemnities for particular risks identified in the due diligence exercise may, in very exceptional cases, be uncapped. 7.3 Do private equity sellers generally pursue a dual- track exit process? If so, (i) how late in the process are private equity sellers continuing to run the dual-track, 6.6 Do (i) private equity sellers provide security (e.g. and (ii) were more dual-track deals ultimately realised escrow accounts) for any warranties / liabilities, and through a sale or IPO? (ii) private equity buyers insist on any security for warranties / liabilities (including any obtained from the management team)? Dual-track exits combined with an IPO in Luxembourg are not common in Luxembourg due to the reasons set out above. As the overall number of dual-track exits involving Luxembourg Private equity sellers will generally resist providing security entities is very small and the possible timeframe for continuing for any warranties/liabilities due to their interest to distribute the dual track depends largely on the procedural requirements proceeds to their sponsors. Escrow arrangements for a (small) of the IPO pursued in another jurisdiction, a common standard proportion of the purchase price are seen occasionally, but cannot be identified at this time. private equity sellers will rather tend to resolve warranty matters as part of purchase price discussions. Management teams, if at all liable for warranty or indemnity claims, will typically not

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82 Financing SICARs (other than LPs) are subject to normal corporate taxation, but income derived from securities held by a SICAR does not constitute taxable income. Capital gains realised by 8.1 Please outline the most common sources of debt non-resident shareholders are not subject to tax in Luxembourg. finance used to fund private equity transactions in your Dividend and interest payments are exempt from withholding tax. jurisdiction and provide an overview of the current state of the finance market in your jurisdiction for such debt LPs are tax-transparent and not subject to corporate income tax. (particularly the market for high yield bonds). SIFs, irrespective of the legal form, are not subject to taxes on capital gain or income in Luxembourg. The only tax due is a subscription tax of 0.01% based on the quarterly net asset value Traditional bank-led leveraged loan financing remains the of the SIF. most common source of debt finance used. Bank financing is RAIFs are subject to the same tax regime as SIFs, but can opt typically sourced from outside of Luxembourg with UK and for the SICAR regime if the RAIF invests in risk capital. German banks and, to a lesser extent, US and French banks being amongst the most frequent lenders. High-yield bonds which are usually listed on the Luxembourg 9.2 What are the key tax-efficient arrangements that Stock Exchange are another frequent source of financing. are typically considered by management teams in private equity acquisitions (such as growth shares, incentive shares, deferred / vesting arrangements)? 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 financing) of Carried interest: management teams employed by an AIFM may private equity transactions? have income derived from carried interest taxed at 25% of the global tax rate, if certain conditions are fulfilled, e.g. the recipient becoming a Luxembourg tax resident, no advance payments There are no particular legal requirements or restrictions that having been received by the recipient and the carried interest would affect the nature or structure of the debt financing. being conditional upon the prior return to the equity investors There is no specific legislation regarding thin capitalisation but, of their initial investments. generally, a debt-to-equity ratio of 85:15 is accepted by the tax For Luxembourg resident managers it may be tax-efficient to authorities in Luxembourg. From a corporate law perspective, structure the receipt of carried interest as sale of shares or secu- however, in dealing with debt financing, the corporate interest rities issued by the AIF, in which case the exemptions described of the borrowing or guaranteeing company needs to be taken in questions 9.1 and 9.3 below will apply. into account and special attention should be given to the rather restrictive rules governing financial assistance and upstream or cross-stream guarantees. 9.3 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? 8.3 What recent trends have there been in the debt financing market in your jurisdiction? Capital gains realised by non-Luxembourg resident managers on shares issued by a Luxembourg company are only taxable in Luxembourg, through the law of 5 August 2005 on collat- Luxembourg if the capital gains are realised upon the disposal eral arrangements, offers a legal framework that is likely the of a substantial participation (more than 10% over the five years most lender-friendly in any European jurisdiction and interna- prior to the date of the disposal) within six months from the tional lenders increasingly opt to use Luxembourg as a conven- acquisition of the shareholding; Luxembourg resident managers ient jurisdiction to secure the financing, irrespective of the may benefit from similar exemptions and may further benefit governing law of the loan documents and irrespective of the from the exemptions described in question 9.1 above. location of the underlying assets.

9.4 Have there been any significant changes in tax 92 Tax Matters legislation or the practices of tax authorities (including in relation to tax rulings or clearances) impacting private 9.1 What are the key tax considerations for private equity investors, management teams or private equity equity investors and transactions in your jurisdiction? transactions and are any anticipated? Are off-shore structures common? By the law of 18 December 2015 transposing the Council The tax framework in Luxembourg is considered among the most Directive (EU) 2014/107 of 9 December 2014, itself imple- stable and business-friendly in Europe for companies, their share- menting the Common Reporting Standard developed by the holders and their employees alike. Luxembourg is not, and does OECD as part of the BEPS action plans at European Union not aim to be, a tax haven, but it offers one of the most flexible level, the Luxembourg legislator has imposed on Luxembourg and attractive tax regimes within the EU. Luxembourg has bilat- financial institutions (including in certain cases SOPARFIs, eral tax treaties with all EU Member States (except Cyprus) and SICARs, SIFs and RAIFs) the obligation to (i) collect certain with a number of other countries (including almost all OECD information about their sponsors that are fiscally resident in a Member States). EU Member State or in a country with a tax information sharing SOPARFIs (other than LPs) are subject to normal corpo- agreement with Luxembourg, and (ii) report such information rate taxation but benefit from Luxembourg’s extensive network to the Luxembourg tax authorities, thus facilitating an automatic of double-taxation treaties and from the EU Parent-Subsidiary information exchange between the participating tax authorities Directive. Despite it being fully taxable, various structuring alter- on an annual basis. natives are available for SOPARFIs, allowing for the exemption of The Council Directive (EU) 2016/1164 of 12 July 2016, setting many income and exit tax charges for private equity investments. forth rules against tax avoidance practices directly affecting the

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functioning of the internal market (ATAD), has been trans- diligence. If the focus in Luxembourg is on the holding struc- posed into domestic law in Luxembourg by the adoption of the ture, this necessarily impacts the scope of the due diligence, i.e. ATAD law of 21 December 2018, comprising certain additional due diligence will typically be limited to title, corporate govern- measures not contained in the ATAD. ance and financing arrangements. The multilateral instrument (MLI) signed on 7 June 2017 by 68 jurisdictions, including Luxembourg, in view of aligning 10.4 Has anti-bribery or anti-corruption legislation existing tax treaties with the different BEPS action plans, will impacted private equity investment and/or investors’ have a significant impact in Luxembourg resulting from article approach to private equity transactions (e.g. diligence, 5 of the MLI, under which Luxembourg has opted for a solu- contractual protection, etc.)? tion, whereby Luxembourg must apply the credit method on dividends received by a Luxembourg company from a foreign Luxembourg scored 80 points out of 100 on the 2017 Corruption company, instead of the exemption method, which is currently Perceptions Index reported by the NGO Transparency the standard method for Luxembourg double tax treaties. International, making it one of the least corrupt countries in Finally, Directive (EU) 2018/822 (DAC 6) has been imple- the world (ranked 9 out of 198). Anti-corruption legislation has mented into Luxembourg domestic law by the law of 25 March been strong for decades and transparency has been fostered by 2020 (the DAC 6 Law). In response to the impact of the a number of reforms over the years. In that respect, it is worth COVID-19 pandemic, on 18 June 2020, the Luxembourg tax noting that Luxembourg has now largely implemented the 4th administration announced that the reporting obligation for AML Directive. A private equity investor shall, throughout the cross-border structures will take effect on 1 January 2021 life cycle of an investment in Luxembourg, comply with appli- instead of 1 July 2020. cable anti-money laundering legislation. While sometimes burdensome for an investor in the context of a fast-moving 102 Legal and Regulatory Matters transaction, the stringent AML legislation has contributed to Luxembourg’s reputation as a transparent and trustworthy juris- 10.1 Have there been any significant legal and/or diction for transactions of any scale. 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 underlying portfolio companies (including due to There are no specific laws or regulations applicable to the breach of applicable laws by the portfolio companies); private equity investors. In structuring their deals, the private and (ii) one portfolio company may be held liable for the equity investors must comply with the provisions applicable liabilities of another portfolio company? in the context of corporate transactions, e.g. company law in Luxembourg, anti-money laundering laws, and the Alternative As a general principle, it is not possible for a third party to pierce Investment Fund Manager Directive. the corporate veil, i.e. the liability of the private equity investors in their capacity as shareholders or limited partners of private/ 10.2 Are private equity investors or particular public limited liability companies or partnerships is limited to transactions subject to enhanced regulatory scrutiny in their contribution to the share capital of the company. However, your jurisdiction (e.g. on national security grounds)? in case of partnerships, if a private equity investor in its capacity as limited partner gets involved in the active management of the Private equity transactions are not subject to any particular partnership, its liability can be sought beyond the amount of its restrictions; as a large part of the transactional activity in share capital contribution. Similarly, a shareholder of a private/ Luxembourg consists of the involvement of Luxembourg public limited liability company becoming personally involved structures ultimately holding assets in other jurisdictions, in the management of the company and committing manage- specific or regulatory scrutiny often originates from such other ment faults, may be held liable as a de facto manager. jurisdictions. 112 Other Useful Facts 10.3 How detailed is the legal due diligence (including compliance) conducted by private equity investors prior 11.1 What other factors commonly give rise to concerns to any acquisitions (e.g. typical timeframes, materiality, for private equity investors in your jurisdiction or should scope, etc.)? such investors otherwise be aware of in considering an investment in your jurisdiction?

Similar to other European jurisdictions, private equity investors typically conduct a relatively detailed legal due diligence. The Luxembourg has created an environment and legal framework timeframe depends on the complexity and the number of docu- showing a clear commitment to promote the private equity ments to be covered within the scope of the due diligence. The sector. Private equity firms should not face any particular issues due diligence process is usually conducted by outside legal and or concerns apart from the ones indicated specifically in this tax advisors alongside the auditors conducting the financial due chapter.

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Holger Holle is a partner in our corporate group. He divides his time between our Luxembourg office where he leads the corporate practice and our Munich office. Holger focuses on business and corporate law and particularly specialises in national and cross-border mergers and acquisitions and private equity transactions. Holger’s experience includes advising: NYSE-listed WestRock Company, on the German and Luxembourg aspects of the $1.025 billion disposal of its home, health and beauty division to Silgan Holdings Inc. and the acquisition by WestRock of Multi Packaging Solutions International Limited. The Teacher Retirement System of Texas on the acquisition of KBC Bank Deutschland, the German banking business of Belgium’s KBC Bank (today Bremer Kreditbank) and the acquisition of Oldenburgische Landesbank by Bremer Kreditbank. A leading New York private equity house on the structuring and financing in relation to several investments in Europe, including the acquisition of the Spanish manufacturer of food cans Mivisa Envases and the investment in the largest German off-shore wind farm. The private equity investors in the sale of Nycomed Group by the Luxembourg holding entity Nycomed SICAR and the subsequent exit from the SICAR.

Eversheds Sutherland (Luxembourg) LLP Tel: +352 278 64696 33, rue Sainte-Zithe Email: [email protected] L-2763 URL: www.eversheds-sutherland.com Luxembourg

José Pascual specialises in investment funds formation work, advising domestic and foreign clients on matters relating to the structuring, setting-up and organisation of AIFs (whether regulated or non-regulated). This includes contracts, company law, regulatory matters and operating arrangements, with a specific focus on private equity funds, real estate funds, infrastructure funds, hedge funds, debt funds and any other type of alternative assets funds, as well as the related acquisition structures. He is also deeply involved in the corporate and transactional aspects relating to such alternative funds and the structures set up for acquisition purposes. José holds a postgraduate degree (Mastère Spécialisé) in international business law and management from the École des Hautes Études Commerciales (HEC), Paris (France) in partnership with the École Supérieure de Commerce de Paris (ESCP) (France), and a Master’s degree in foreign affairs from the Universidad Complutense, Madrid (Spain) in partnership with the Spanish School of Diplomacy, Madrid (Spain).

Eversheds Sutherland (Luxembourg) LLP Tel: +352 278 64695 33, rue Sainte-Zithe Email: [email protected] L-2763 URL: www.eversheds-sutherland.com Luxembourg

Eversheds Sutherland is one of the largest full-service law firms in the Our Investment Funds team is experienced in advising clients on the struc- world acting for the public and private sectors. We have thousands of turing, formation and management of investment funds, corporate trans- people working worldwide and 69 offices in 34 jurisdictions across Europe, actions and regulatory or compliance matters. As part of the Eversheds the United States, the Middle East, Africa and Asia. Our Luxembourg office Sutherland global network, we hold an excellent understanding of local focuses on corporate clients and investment funds. We advise domestic Luxembourg law within a wider commercial context. and international clients (including large corporates, private equity houses www.eversheds-sutherland.com and fund managers) on private equity transactions and M&A as well as the structuring, setting-up and organisation of all types of AIFs, UCITS funds and corporate entities. We also advise on regulatory issues relating to investment funds and portfolio managers. Our corporate lawyers are well-versed, advising across the full spectrum of corporate transactions for leading global and national businesses. Our team in Luxembourg is particularly experienced in advising companies and institutions on complex multijurisdictional transactions.

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Nigeria Nigeria

Folake Elias-Adebowale

Udo Udoma & Belo-Osagie Christine Sijuwade

1.4 Are you seeing any types of investors other Population size, young consumer demographics, a cheap and than traditional private equity firms executing private relatively educated labour force, sectoral restructuring, and equity-style transactions in your jurisdiction? If so, evolving policies aimed at enabling business in Nigeria are please explain which investors, and briefly identify any helping to boost PE activity and Nigeria’s ease of doing business significant points of difference between the deal terms rankings. Although fundraising from institutional and strategic offered, or approach taken, by this type of investor and investors has slowed down due to the pandemic, development that of traditional private equity firms. financial institutions (DFIs) remain committed to supporting businesses, thereby encouraging investments. Repatriation DFIs and high-net-worth individuals (HNIs) are executing of proceeds from investments in Nigeria remains a relatively PE-style transactions due to emerging opportunities created by straightforward process. the pandemic. One key divergence in deal structuring is the The impact of the pandemic on asset valuation, challenges ability of HNIs to take long-term positions in targets, unlike with navigating the existing legal and regulatory framework PE investors who are typically restricted to a five- to seven-year (many of which are not PE-specific), currency depreciation, investment period. FX availability, infrastructure deficit and local content requirements, among other reasons, are identified as PE-activity inhib- 22 Structuring Matters itors. Cyclical macroeconomic challenges do not appear to permanently inhibit PE transaction activity in Nigeria in the 2.1 What are the most common acquisition structures medium to long term, as investors remain willing to take advan- adopted for private equity transactions in your tage of developing opportunities. jurisdiction?

Bilateral majority acquisitions and minority acquisitions of shares in Nigerian target companies remain the most common,

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often implemented by investor-controlled, offshore-registered 3 2 Governance Matters special purpose vehicles (SPVs). Debt, convertible instruments and alternative capital structures are, however, expected to continue evolving. 3.1 What are the typical governance arrangements for private equity portfolio companies? Are such arrangements required to be made publicly available in 2.2 What are the main drivers for these acquisition your jurisdiction? structures? Governance arrangements typically confer protection or Control and direct influence are the main drivers for such augment investor control and may involve quorum prescrip- acquisition structures. Majority acquisition structures confer tions, reserved matters, board and board committee partic- these attributes under applicable legislation, while acquirers of ipation, consultation and participation in executive recruit- minority stakes seek contractual and similar protections such ments, voting agreements and veto rights, organisational and as key executive appointments to provide insight into finan- operational structures and related issues entrenched in target cials and business operations. Other drivers include risk miti- company constitutional documents and/or shareholder agree- gation, flexibility, exit considerations, maximisation of returns ments. Shareholder agreements are generally confidential but and tax efficiency (share transfers are exempt from capital gains may be replicated in target constitutional documents that must tax (CGT)). be publicly filed at the Corporate Affairs Commission (CAC). In listed targets, information that could materially affect a target’s share price (including shareholders’ agreement signed 2.3 How is the equity commonly structured in private equity transactions in your jurisdiction (including by the target) may be required to be publicly disclosed. institutional, management and carried interests)? 3.2 Do private equity investors and/or their director A target’s equity structure will usually reflect capital contribu- nominees typically enjoy veto rights over major tions. Shareholders and management may participate through corporate actions (such as acquisitions and disposals, an investment company, with management interest in the region business plans, related party transactions, etc.)? If a private equity investor takes a minority position, what of 5%. Carried interest is typically structured through a sepa- veto rights would they typically enjoy? rate vehicle: an offshore limited partnership with equity in an offshore holding company (BuyCo) subject to agreed percentage splits. The Companies and Allied Matters Act (CAMA) prescribes minimum thresholds for specified decisions as ordinary resolutions (50%+1 vote) and for special resolutions (75%), and 2.4 If a private equity investor is taking a minority board decisions via majority. Investors acquiring minority position, are there different structuring considerations? stakes typically negotiate supermajority and veto rights for specified “reserved matters” such as acquisitions, restructurings, Minority protection mechanisms will aim to facilitate and disposals, business plans, significant expenditures, related party support voting arrangements, information and access rights, transactions, debt arrangements, executive appointments, share governance, board and board committee participation and nomi- capital changes, board composition, amendments to constitu- nation rights in relation to key executives and board members, tional documents, winding-up, and other matters subject to including board chairpersons, with the ultimate objective of CAMA mandatory prescriptions. attaining control and influence. Minority investors may require such strategies to be entrenched contractually and in constitu- 3.3 Are there any limitations on the effectiveness of tional documents as closing conditions. veto arrangements: (i) at the shareholder level; and (ii) at the director nominee level? If so, how are these typically 2.5 In relation to management equity, what is the addressed? typical range of equity allocated to the management, and what are the typical vesting and compulsory acquisition Mandatory provisions of the CAMA, such as voting thresh- provisions? olds for the removal of a director, will override any conflicting arrangements in shareholder contracts and constitutional docu- This is typically 5%–10%. Transaction documents may include ments, rendering such arrangements unenforceable. Director “good leaver” and “bad leaver” provisions that determine nominees have fiduciary obligations and may not fetter their compulsory acquisition/pricing for employee-held shares. discretion to vote in any manner. Vesting provisions may determine equity allocations, conditional upon length of service and achievement of performance 3.4 Are there any duties owed by a private equity milestones. investor to minority shareholders such as management shareholders (or vice versa)? If so, how are these 2.6 For what reasons is a management equity holder typically addressed? usually treated as a good leaver or a bad leaver in your jurisdiction? PE investors are bound by mandatory provisions of laws such as the CAMA, the Investment and Securities Act (ISA) (as well as Transaction documents typically envisage “good leavers” (e.g. regulations issued by the Securities and Exchange Commission management employees whose employment is terminated by pursuant to the ISA (SEC Rules)) and constitutional documents retirement, death or disability) and “bad leavers” (e.g. manage- protecting minority shareholders. For instance, the ISA and ment employees terminated for fraud). SEC Rules require investors in public companies (or private companies recently converted from public companies in the

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preceding 12 months) above the 30% threshold to make a tender not, in the course of managing the affairs of the company, offer to minorities where the 30% interest (a) is proposed to be misuse corporate information in order to derive a benefit, and acquired in the course of a single transaction, or (b) has been is accountable to the company for any benefit so derived, even acquired in a series of transactions over a period of time, except after he resigns from the company. Sitting on the board of more where exemptions apply. than one company concurrently (discouraged under the NCCG Code in order to avoid conflicts of interest) does not excuse a director from such fiduciary duties to both, including a duty 3.5 Are there any limitations or restrictions on the contents or enforceability of shareholder agreements not to (mis)use property, opportunity or information. Actual (including (i) governing law and jurisdiction, and (ii) or potential conflicts of interest are required to be disclosed to non-compete and non-solicit provisions)? the target’s board for consideration. Subject to this, nominee directors may opt to recuse themselves from participation in certain decisions at board meetings, although this may not be Shareholders’ agreements are subject to mandatory provisions mandatory. of the law including the CAMA, and to a target’s constitutional documents. Nigerian courts will generally uphold a choice of foreign law. 4 2 Transaction Terms: General The Supreme Court has affirmed that a “real, genuine, bona fide and reasonable” choice of law (other than Nigerian law) that 4.1 What are the major issues impacting the timetable has “some relationship to and [is] … connected with the real- for transactions in your jurisdiction, including antitrust, ities of the contract considered as a whole” will generally be foreign direct investment and other regulatory approval upheld, subject to limited exceptions. Non-compete clauses requirements, disclosure obligations and financing issues? and non-solicitation clauses are subject to negotiation but must be reasonable in order to be enforced. Non-compete provisions will also be subject to the Federal Competition and Consumer Transactions can be completed fairly quickly if they are not Act (FCCPA) which prohibits agreements in restraint of compe- complex, involve experienced parties and advisers, and require no tition and agreements with undertakings containing exclu- regulatory approvals. Delays may, however, arise in capital raising, sionary provisions. during due diligence (including external due diligence regulatory verifications where reviews are manual), in procuring regulatory approvals from, e.g. the FCCPC, the SEC and other sector-specific 3.6 Are there any legal restrictions or other regulators, e.g. the CBN, the National Insurance Commission, and requirements that a private equity investor should be aware of in appointing its nominees to boards of the Nigerian Stock Exchange (NSE), as applicable. portfolio companies? What are the key potential risks and liabilities for (i) directors nominated by private 4.2 Have there been any discernible trends in equity investors to portfolio company boards, and (ii) transaction terms over recent years? private equity investors that nominate directors to boards of portfolio companies? Parties are becoming increasingly creative in structuring equity, debt and alternative capital deal terms to diversify and mitigate Director nominees have fiduciary obligations and may not fetter risk exposure in response to foreign currency volatility, macro- their discretion to vote in any manner. The CAMA imposes economic and other challenges. As these challenges become director qualifications and restrictions, including that they must more apparent in the current global pandemic, it is expected that not be fraudulent, bankrupt, mentally unsound, or convicted the key contractual provisions identified above will be carefully by a High Court of any offence connected with the promotion, considered and negotiated. formation or management of a company. The Nigerian Code Although PE investors continue to structure offshore transac- of Corporate Governance 2018 (NCCG Code) prohibits the tions to provide flexibility from a governance and fiscal perspec- simultaneous appointment of an individual as the Chairman and tive, there is an increasing focus on deferred consideration and the Managing Director or Chief Executive Officer of an entity. escrow structures, all geared toward protecting investments from Sectoral qualifications may also apply (for instance, the Central the negative impacts of the pandemic. Certain investors, in a bid Bank of Nigeria (CBN) prescribes specific qualifications for to reduce exposure, seek to include cancellation and early termi- bank directors). Directors may incur personal liability, e.g. for nation terms, which are usually rigorously negotiated. loss or damage sustained by a third party as a result of untrue statements or misstatements in a public company prospectus, under the ISA. The termination of employment of an executive 52 Transaction Terms: Public Acquisitions director does not result in his automatic removal from the board; involuntary removals of directors must follow a prescribed stat- 5.1 What particular features and/or challenges apply utory process. Disclosure of unpublished, price-sensitive infor- to private equity investors involved in public-to-private mation by nominee directors may breach insider dealing provi- transactions (and their financing) and how are these sions under the ISA and the SEC Rules. commonly dealt with?

The ISA, SEC Rules, NSE Rulebook (for listed targets), and 3.7 How do directors nominated by private equity the Code of Corporate Governance for Public Companies in investors deal with actual and potential conflicts of interest arising from (i) their relationship with the party Nigeria 2011 apply to transactions involving public companies nominating them, and (ii) positions as directors of other and impose disclosure and reporting requirements where such portfolio companies? transactions exceed prescribed thresholds or, in listed companies, involve changes that could affect the target’s share price. The CAMA requires that the personal interest of a director FCCPC approval and sector-specific reporting obligations may must not conflict with his duties as a director. A director may

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apply. PE investors and targets usually retain skilled professional 6.6 Do (i) private equity sellers provide security (e.g. advisers to ensure compliance with applicable requirements. escrow accounts) for any warranties / liabilities, and (ii) private equity buyers insist on any security for warranties / liabilities (including any obtained from the 5.2 What deal protections are available to private management team)? equity investors in your jurisdiction in relation to public acquisitions? This is subject to negotiation and may be subject to the expiration of the fund/SPV in an exit scenario. Escrow arrange- Deal protection mechanisms adopted include structures that ments for up to two years are not unusual. Consideration may isolate identified liabilities following detailed due diligence, be disbursed in tranches subject to investor-prescribed perfor- representations and warranties, indemnities, insurance, the use mance milestones. of escrow structures, the adoption of governance arrangements along the lines outlined above, and where negotiated, break fees (although this is not common). 6.7 How do private equity buyers typically provide comfort as to the availability of (i) debt finance, and (ii) 62 Transaction Terms: Private Acquisitions equity finance? What rights of enforcement do sellers typically obtain in the absence of compliance by the buyer (e.g. equity underwrite of debt funding, right to 6.1 What consideration structures are typically specific performance of obligations under an equity preferred by private equity investors (i) on the sell-side, commitment letter, damages, etc.)? and (ii) on the buy-side, in your jurisdiction? Evidence of funding in the PE investor’s designated account, Cash structures are typically preferred, although there have been and of acquisition funds held in an escrow account and concom- a number of share swaps and structures incorporating earn-out itant arrangements for disbursement, subject to specific condi- arrangements. tions being met, are means via which such comfort may be provided. Such evidence may not be required where the buyer is 6.2 What is the typical package of warranties / reputable, in which case an equity commitment letter addressed indemnities offered by (i) a private equity seller, and (ii) to both the target and the seller may suffice, backed by an appro- the management team to a buyer? priate financial capacity warranty. Seller enforcement terms are subject to negation and may confer remedies of specific perfor- This is subject to negotiation. Exiting PE sellers will typically mance and damages for buyer non-compliance. seek to give minimal warranties (restricted to title and capacity). Where a PE investor and the target’s founder(s) exit at the 6.8 Are reverse break fees prevalent in private equity same time, comprehensive warranties and indemnities may be transactions to limit private equity buyers’ exposure? If required by the buyer. so, what terms are typical?

6.3 What is the typical scope of other covenants, Reverse break fees are not prevalent but may be negotiated on a undertakings and indemnities provided by a private case-by-case basis. equity seller and its management team to a buyer? 72 Transaction Terms: IPOs This is subject to negotiation; however, PE sellers do not typically offer a comprehensive suite of undertakings beyond those 7.1 What particular features and/or challenges should indicated at question 6.2 and will typically resist restrictions on a private equity seller be aware of in considering an IPO their activities post-exit. exit?

6.4 To what extent is representation & warranty A PE seller should be aware of the regulatory requirement insurance used in your jurisdiction? If so, what are the and costs of effecting the IPO, the value of the seller’s shares typical (i) excesses / policy limits, and (ii) carve-outs / following changes in share capital, and the underwriting of exclusions from such insurance policies, and what is the shares not taken up by/issued to third parties. Valuations typical cost of such insurance? in certain sectors and exit timelines may be affected by the pandemic. Material agreements with a potential impact on share This is increasingly popular. Investors may resist require- price may have to be disclosed. ments to mandatorily procure such insurance to reduce or exclude counterparty(ies) liability. The cost of such insurance 7.2 What customary lock-ups would be imposed on may depend on risk appetite and the extent of the perceived private equity sellers on an IPO exit? exposure. This is subject to negotiation and there may be a restriction for 6.5 What limitations will typically apply to the liability a prescribed minimum of years post-investment. PE sellers will of a private equity seller and management team under usually seek to avoid or minimise such requirements. warranties, covenants, indemnities and undertakings?

This is subject to negotiation. There is no standard practice other than as may be mandatorily prescribed by statutory and common law limitations on liability.

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7.3 Do private equity sellers generally pursue a dual- to the health sector, and a NGN1 trillion loan to the manufac- track exit process? If so, (i) how late in the process are turing sector, have also been announced. private equity sellers continuing to run the dual-track, Existing loan facilities are being renegotiated and restructured. and (ii) were more dual-track deals ultimately realised Moratoriums have been granted on all federal government-funded through a sale or IPO? loans.

It is not uncommon for PE sellers to pursue multi-track exit 92 Tax Matters strategies. The macroeconomic environment, capital market illiquidity, dearth of trade buyers, share valuation on exit, polit- 9.1 What are the key tax considerations for private ical and foreign exchange risks, timing, and regulated process equity investors and transactions in your jurisdiction? challenges may require flexibility in the path to exit. Exit to Are off-shore structures common? trade buyers and private sales remained more prevalent when compared with the number of IPOs implemented as exit Key tax considerations for PE investors and transactions in mechanisms. Nigeria include: (a) an analysis of the nature of the investment and the vehicle 82 Financing through which the investment will be made; (b) applicable taxes at the time of making the investment and 8.1 Please outline the most common sources of debt on exit (including stamp duty and filing fees on transaction finance used to fund private equity transactions in your and security documents where applicable); jurisdiction and provide an overview of the current state (c) applicable taxes on income derived from the investment of the finance market in your jurisdiction for such debt (e.g. withholding tax on dividends, interest on loan and (particularly the market for high yield bonds). management fees, etc.); (d) applicable rate of corporate tax and other related taxes; Convertible and non-convertible loans and alternative debt struc- (e) applicable transfer pricing regulations (for shareholder tures, credit support instruments, and investments in relatively loans/related party transactions); and high-yield instruments including treasury bills and bonds, are not (f ) tax incentives (e.g. 2.5% deduction on withholding tax uncommon. on dividends, interest and royalties for investors resident in countries with which Nigeria has a double tax agree- 8.2 Are there any relevant legal requirements or ment (DTA)), and exemptions (0%–70% depending on restrictions impacting the nature or structure of the debt the tenor of the loan and grace period (including morato- financing (or any particular type of debt financing) of rium)). It is common for BuyCo’s residents in countries private equity transactions? with which Nigeria has DTAs to be utilised for Nigerian PE investments and debt transactions. Nigeria currently Nigerian law guarantees free remissibility of dividends, profits, has effective DTAs with Belgium, Canada, China, the capital on divestment, and repayments of principal and interest Czech Republic, France, the Netherlands, Pakistan, the on foreign loans utilising the official FX market, subject only Philippines, Romania, Slovakia, South Africa, Spain and to a certificate of capital importation having been obtained the United Kingdom. from a CBN-authorised dealer bank when the original investment or loan capital was inflowed into Nigeria. Investors also 9.2 What are the key tax-efficient arrangements that have access to the interbank market for such eligible transac- are typically considered by management teams in private tions, meaning that PE and other investors can convert capital equity acquisitions (such as growth shares, incentive brought into Nigeria for investments into Naira at a (mostly) shares, deferred / vesting arrangements)? market-determined exchange rate, as applicable rates are no longer fixed by the CBN. The following arrangements are typically considered:’ Financial assistance by Nigerian targets is generally prohib- ■ utilisation of SPVs incorporated in jurisdictions with ited where there would be a resulting impact on the net asset which Nigeria has DTAs to reduce withholding tax on transfer of the target above prescribed thresholds. dividends; Tax-deductible interest earned on loans granted by foreign ■ granting of long tenured loans of up to seven years and connected parties to Nigerian companies is restricted to 30% of above to achieve 70% withholding tax on interest; and EBITDA per accounting period. Expenses incurred by related ■ use of share sale structures that are CGT-exempt. parties within or outside Nigeria will be tax-deductible only if the transaction is consistent with transfer pricing restrictions, 9.3 What are the key tax considerations for which must be at arm’s length. management teams that are selling and/or rolling-over part of their investment into a new acquisition structure? 8.3 What recent trends have there been in the debt financing market in your jurisdiction? Share sales are CGT-exempt even where the proceeds from one sale are rolled over into a new share acquisition. Gains real- There has been a continued increase in debt financing through ised from asset disposals (chargeable at 10%) are not so exempt, DFIs and syndicated loans in which DFIs invest in Nigerian however, where the buyer is not related to the seller. Proceeds sub-nationals to boost growth in emerging companies. from asset sales used to acquire other assets for the same busi- The CBN has recently introduced a NGN50 billion Targeted ness are entitled to roll-over relief, i.e. no CGT. Credit Facility (TCF) with favourable interest rates, as a stimulus For reorganisations or similar transactions involving related package to support households and micro, small and medium entities, the recently enacted Finance Act 2019 has introduced enterprises affected by the pandemic. A NGN100 billion loan a 365-day pre- and post-business reorganisation rule for related

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party business reorganisation transactions, in order for the Nigeria recently signed the African Continental Free Trade assets transferred to be entitled to the applicable tax benefits, Agreement, aimed at creating a single continental market for such as exemption from CGT, value-added tax, transfer of assets goods and services, with free movement of businesses, persons at tax written-down value, etc. and investments. The Agreement, however, will not become effective in Nigeria until it is ratified by the National Assembly. Please also see question 9.4. 9.4 Have there been any significant changes in tax legislation or the practices of tax authorities (including in relation to tax rulings or clearances) impacting private 10.2 Are private equity investors or particular equity investors, management teams or private equity transactions subject to enhanced regulatory scrutiny in transactions and are any anticipated? your jurisdiction (e.g. on national security grounds)?

The Finance Act 2019 has amended key provisions of various Nigerian law permits 100% foreign ownership of Nigerian tax laws relevant to PE transactions. Key amendments include: businesses other than in certain sectors such as shipping, (i) the classification of companies into three categories for tax broadcasting, advertising, private security, aviation, and oil purposes: (a) small companies (i.e. those with an annual gross and gas. Nigerians and foreign nationals cannot invest in turnover of NGN25 million and below); (b) medium-sized the production of: arms and ammunition; narcotic drugs and companies (i.e. those with an annual gross turnover above psychotropic substances; or military and paramilitary wear and NGN25 million, but less than NGN100 million); and (c) accoutrements. large companies (i.e. those with an annual gross turnover above NGN100 million). Although small companies are exempted from paying companies income tax, they are 10.3 How detailed is the legal due diligence (including compliance) conducted by private equity investors prior still required to register with the Federal Inland Revenue to any acquisitions (e.g. typical timeframes, materiality, Service; scope, etc.)? (ii) an increase in the rate of value-added tax from 5%–7.5%; (iii) taxation of digital companies using the “significant economic presence” test; This is subject to negotiation and investors’ objectives, budgets (iv) the introduction of an interest deductibility cap at no more and timelines. The scope of the inquiry, materiality and time- than 30% EBITDA on loans issued to Nigerian companies lines may be subject to counterparty negotiation. Typically, by foreign connected persons; legal due diligence will cover the corporate structure, regulatory (v) the introduction of a 365-day pre- and post-business reor- compliance, employee-related liabilities, material contracts and ganisation rule for related party business reorganisation debt portfolio, intellectual property and the litigation profile of transactions. See question 9.4; the target. It is expected that the scope of due diligence will (vi) the introduction of withholding tax at the rate of 10% become more detailed in certain areas such as a target’s supply on the dividend of investors in upstream oil and gas chain dependency, review of material contracts for termination companies; provisions and force majeure clauses, due to COVID-19. (vii) Nigerian companies with at least 25% foreign equity The timeframe for a detailed review, typically four to six investment which has no taxable profit, or with taxable weeks, has, however, been extended because searches, which profits less than the minimum tax, will now be liable to are largely manual, cannot be conducted in public registries or pay a minimum tax of 0.5% of gross turnover; courts due to government restrictions. (viii) insurance companies will be permitted to carry forward tax losses indefinitely; and 10.4 Has anti-bribery or anti-corruption legislation (ix) documents relating to electronic transactions are now impacted private equity investment and/or investors’ liable to stamp duties. approach to private equity transactions (e.g. diligence, contractual protection, etc.)? 102 Legal and Regulatory Matters Anti-bribery and corruption, and anti-money laundering require- 10.1 Have there been any significant legal and/or ments under legislation and international treaties and agree- regulatory developments over recent years impacting ments, are generally prevalent in PE funds, fund structuring, private equity investors or transactions and are any fund management and transaction arrangements in Nigeria. anticipated? 10.5 Are there any circumstances in which: (i) a private In November 2019, the FCCPC issued guidelines titled equity investor may be held liable for the liabilities of “Guidelines on Simplified Process for Foreign-to-Foreign the underlying portfolio companies (including due to Mergers with Nigerian Component” to regulate offshore acqui- breach of applicable laws by the portfolio companies); sitions of shares or other assets resulting in the change of control and (ii) one portfolio company may be held liable for the of a business, part of a business, or any asset of a business, in liabilities of another portfolio company? Nigeria. The guidelines prescribe an expedited review process of 15 days subject to the submission of a complete application Shareholder liability is generally limited to the amount (if any) and the payment of an expedited review fee. The FCCPC is also unpaid in respect of any shares held by the investor in a Nigerian expected to issue Merger Guidelines and Regulations governing limited liability company. merger control.

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112 Other Useful Facts PE investors will also need to consider adopting different strategies in the coming months to preserve investment. Timelines will need to be realistically considered and adjusted 11.1 What other factors commonly give rise to concerns due to the pandemic. for private equity investors in your jurisdiction or should such investors otherwise be aware of in considering an investment in your jurisdiction? Acknowledgments The authors wish to acknowledge the contributions of Key factors include the strategic importance of choosing part- the following persons in the preparation of this chapter: ners aligned with the PE investor’s outlook and objectives of: Chukwunedum Orabueze; and Chinomso Odega. compliance and environmental, social and governance arrangements; having a pragmatic and realistic approach to regulatory interactions and timelines; and working with experienced local advisers.

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Folake Elias-Adebowale is a partner in the firm’s private equity, corporate/M&A and oil and gas teams. Her specialisations include cross- border and domestic equity and asset acquisitions, disposals, joint ventures, strategic alliances, restructuring, investments, financing for energy, manufacturing and industrial projects and employment matters. She headed the legal and regulatory sub-committee of the Federal Minister for Industry Trade and Investment’s Nigerian Private Equity and Venture Capital Development project, established to make recommendations for boosting private equity and venture capital activity in Nigeria. She represents the firm on the legal and regulatory councils and committees of the EMPEA, the African Venture Capital Association and the Private Equity and Venture Capital Association, Nigeria.

Udo Udoma & Belo-Osagie Tel: +234 1277 4920 St Nicholas House, 10th, 12th & 13th Floors Email: [email protected] Catholic Mission Street URL: www.uubo.org Lagos Nigeria

Christine Sijuwade is a partner in the firm’s private equity and corporate advisory teams. She is a core member of the team that advises several local and international private equity firms in connection with the structuring and establishment of their funds as well as their equity investments in various Nigerian companies including companies in the telecommunications, financial services, food and beverage, healthcare, and manufacturing sectors. She has also advised on international lending transactions including syndicated loans and has been involved in a diverse range of financial and capital markets transactions including private placements and, as part of her Asset Management and Collective Investment practice, the establishment of mutual funds. She also advises on issues relating to the Nigerian bond market. As part of her corporate advisory practice, Christine supervises due diligence reviews, in the course of which she evaluates regulatory compliance practices and credit portfolios to assess the viability of targeted businesses for merger, investment and financing transactions. Christine is the Secretary to the Nigerian Bar Association-Section on Business Law Committee on Competition and Consumer Protection.

Udo Udoma & Belo-Osagie Tel: +234 1277 4920 St Nicholas House, 10th, 12th & 13th Floors Email: [email protected] Catholic Mission Street URL: www.uubo.org Lagos Nigeria

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. The firm participates on the legal and regulatory committees of the African Venture Capital Association and the Emerging Markets Private Equity Association (EMPEA) and is a founding and board member of the Private Equity and Venture Capital Association of Nigeria. Three private equity partners are recognised in international independent rankings publications including Chambers Global, The Legal 500, the IFLR1000 and Who’s Who Legal (Nigeria), and are commended in The Lawyer’s ‘Africa Elite’ Private Equity Report. www.uubo.org

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Norway Norway

Aabø-Evensen & Co Ole Kristian Aabø-Evensen

12 Overview resources and a well-established legal framework for M&A transactions. In respect of the latter (see further in section 3), those familiar with M&A transactions and methodology in most 1.1 What are the most common types of private equity other parts of Europe will find the Norwegian landscape quite transactions in your jurisdiction? What is the current familiar, both in respect of private and public acquisitions. Most state of the market for these transactions? EU regulations pertaining to M&A transactions have also been implemented in Norwegian law through membership in the Although the Norwegian private equity (“PE”) market ranges European Free Trade Association (“EFTA”) and the European from seed and growth investments by angel and venture capital Economic Area (“EEA”). funds, to leveraged buyouts (“LBO”) and secondary transac- Historically, an important factor, viewed by many investors tions by PE funds (herewith public-to-private acquisitions and as sheltering Norway against international financial turmoil, IPO exits), in 2019, LBO transactions of private targets domi- has been a high oil price. The decline in oil prices witnessed nated the transaction volume, representing 57.5% of the total at the end of 2014 and throughout 2016 was, in this aspect, PE transactional volume for that year. serious, but never dissuaded PE actors from transacting in In 2019, the total Norwegian M&A market experienced an Norway. Declining oil prices in combination with a some- increase in volume and total reported deal value compared with what aggressive approach by Norwegian tax authorities against 2018, and so did the Norwegian PE market with a 17.6% increase LBOs (herewith principles of PE funds domiciled in Norway) in reported volume compared with 2018. For deals involving could in the long term potentially frustrate international PE PE Sponsors in 2019, (either on the buy- or sell-side) the average funds’ appetites for Norwegian targets. However, currently, reported deal sizes also increased significantly from €249 in the COVID-19 pandemic is the single most significant factor 2018, to €346 in 2019. The market continued to be driven frustrating PE funds’ appetite for new deals in most countries by new investments and add-ons but, in 2019, we witnessed a (including Norway), at least within certain sectors such as the significant increase in the number of exits and a slight decrease leisure, consumer and retail sectors, etc. in the number of new investments. As mentioned above, the Norwegian PE market spans the width of all transaction types found in any mature market, 1.3 What are going to be the long-term effects for private equity in your jurisdiction as a result of the but the typical have, save for a few exceptions, for all club deals COVID-19 pandemic? practical purposes been 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 Despite the slowdown in deal activity due to the COVID-19 major international PE fund to spread its equity risk in order pandemic, Norwegian M&A could return to higher levels of to avoid exceeding investment concentration limits in its fund. deal volume once there is more certainty around the ramifica- The foregoing notwithstanding, sell-downs or syndication of tions of the virus on businesses and the Norwegian economy. minority equity portions subsequent to buyouts also occur in We expect continuing strong momentum for new PE deals the Norwegian market. within particular sectors, such as TMT, healthcare, pharmaceu- By the number of PE transactions, TMT, services and the ticals, and the industrial and manufacturing sector. There is industrial and manufacturing sectors dominated the Norwegian still much cash waiting to be invested. On the other hand, we market in 2019, each with 31%, 17.2% and 13.8% of the buyout expect that the COVID-19 pandemic most likely will result in investment volume respectively, followed by the energy sector, an increasing number of insolvency cases, particularly within the consumer sector and the medical sector, each with 6.9% of industries such as travel, tourism and the retail sector. At the the total deal count, respectively. same time, this may also create a number of opportunities for investors looking to invest within these industries from a long- term perspective. 1.2 What are the most significant factors currently Irrespective of which position one may take in relation to the encouraging or inhibiting private equity transactions in COVID-19 pandemic, the author believes many investors will your jurisdiction? continue to view Norway as a good place to invest, due to its highly educated workforce, technology, natural resources and well- The most significant features encouraging PE actors to transact established legal framework for M&A transactions. Consequently, in Norway are access to relatively inexpensive capital as well our view is that the long-term effects of COVID-19 on PE in as a highly educated workforce, innovative technology, natural Norway, will most likely be limited once the pandemic is over.

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1.4 Are you seeing any types of investors other companies, but these funds’ limited partners have often criti- than traditional private equity firms executing private cised such strategies. equity-style transactions in your jurisdiction? If so, please explain which investors, and briefly identify any significant points of difference between the deal terms 2.2 What are the main drivers for these acquisition offered, or approach taken, by this type of investor and structures? that of traditional private equity firms. Various deal-specific considerations dictate the type and organ- During the last decade, we have seen a number of family offices, isation of the SPV, including, among others, tax structuring but also smaller investment-firms, and individual investors issues, desired governance structure, number of equity holders, executing PE style transactions in the Norwegian market. The equity holders’ (and the Sponsor’s) exposure to liability by use main difference between the deal terms offered in such transac- of the applicable vehicles, general ease of administration and tions is that some of these investors tend to be slightly more flex- required regulatory requirements including the financing bank’s ible with regard to their sweet-spot for investing, the approach demand for structural subordination (see below). they take with regard to lock-up until exit, vesting structures, Typically, the entry route used by PE funds for their investments accepting investments in minority stakes, and the amount of depends upon which structure provides the greatest flexibility for leverage applied in the deal. Some of these investors tend to efficiently repatriating funds back to the fund’s investor-base in seek out investment opportunities in areas that have not typi- connection with either an exit or a partial exit, with as little tax cally been a focus for traditional PE funds, but where consoli- leakage as possible (i.e. minimising the effective tax rate for all rele- dation opportunities still exist. Examples of such investors are, vant stakeholders upon exit). The choice of entry-jurisdiction into inter alia, Ferd, Credo Partners, Icon and Hawk. Europe, therefore, normally depends on the identity and geog- raphy of the fund’s investors, the tax treaty between the proposed 22 Structuring Matters European entry-jurisdiction and the home jurisdiction for the majority of the fund’s investor base and the tax treaties between the various other jurisdictions involved, including Norway. It is 2.1 What are the most common acquisition structures not uncommon that Sponsors structure the investment through adopted for private equity transactions in your jurisdiction? Have new structures increasingly developed various forms of sub-partnerships (or feeder funds) set up in (e.g. minority investments)? different jurisdictions in order to achieve the most optimal structure for their respective investors, all depending upon such investors’ geographical location. Virtually all national and international PE funds are today organ- Another main driver when choosing relevant acquisition ised as some type of limited partnership, wherein the institu- structures (and particularly the number of holding companies tional investors participate as direct or (normally) indirect limited involved), is the structuring of the financing (i.e. the bank’s partners, and wherein the fund manager (in the following the demand for control of cash flow and debt subordination); see “Manager” or the “Sponsor”) acts as the general partner, sections 8 and 9. Particularly in large transactions, it can be normally owned through a private limited liability company necessary to use various layers of financing from different stake- (“LLC”) specifically organised for this purpose. The domicile, holders in order to be able to carry out the acquisition. The tax status and internal structure of the Manager sponsoring the need for flexible financing structures is a commercial reason fund will very often drive the choice of the general partner. that often drives the number of holding companies between the PE funds typically create a special purpose shell acquisi- foreign holding structure and the Norwegian BidCo. tion vehicle (“SPV”) to effect an investment or acquisition, In both instances, PE funds must consider upstream issues and commit to fund a specified amount of equity to the SPV (taxation of monies extracted from the top Norwegian holding at closing. The final acquisition structure adopted by these company (“TopCo”) to the foreign holding structure) and down- PE funds in the Norwegian market will normally depend on stream issues (taxation of monies extracted from BidCo up to whether the respective fund is organised under Norwegian TopCo, herewith monies flowing up from the target and its law or under foreign jurisdictions. Funds organised under various subsidiaries). Norwegian law will, when investing into Norwegian target Before deciding the final acquisition structure, Sponsors must companies, normally adopt a one-tier structure by investing consider numerous additional issues, typically including: tax through a set of Norwegian holding companies. issues relating to management and employee compensation; the Funds organised under a foreign jurisdiction investing into target’s and its group companies’ debt service capability; regula- Norwegian target companies will usually structure the acqui- tory requirements/restrictions (i.e. prohibition against financial sition by adopting a two-tier structure, irrespective of whether assistance and debt-pushdowns, and the new anti-asset stripping the Manager is foreign or domestic. Firstly, the PE fund estab- rules, cf. question 10.1); rules on thin-capitalisation and deduct- lishes an offshore holding structure of one or more private ibility of interests; withholding tax (“WHT”) on shareholder LLCs incorporated and tax resident outside of Norway – typi- debt and distributions; VAT; and corporate liability and disclo- cally in Luxembourg, the Netherlands or (occasionally) Cyprus. sure issues, etc. Secondly, the acquisition of the shares in the Norwegian target company will be made by the foreign holding structure through a Norwegian incorporated and tax resident special purpose 2.3 How is the equity commonly structured in private vehicle (an SPV or “BidCo”) that eventually acquires the target equity transactions in your jurisdiction (including company. Additional Norwegian holding companies could be institutional, management and carried interests)? added into the structure between the foreign holding structure and the Norwegian BidCo to allow for flexibility in obtaining The equity structure in any PE transaction usually provides an subordinated debt financing and other commercial reasons. opportunity and/or a requirement for the target’s management Occasionally over the last four years, we have also seen exam- to co-invest (“Investing Management”) together with the PE ples of Sponsors carrying out minority investments in listed fund in the acquiring group. The co-investment typically takes

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place at the Norwegian TopCo-level, or at the foreign holding 2.4 If a private equity investor is taking a minority company level. The equity strip for the Investing Management position, are there different structuring considerations? depends on the size of the transaction, but it is normally relatively small with a share price at an affordable level. In such situations, a PE investor will focus on the exact same If the Investing Management mainly consists of Norwegian issues as mentioned in question 2.2 above (particularly if they are citizens, these may prefer to structure their co-investment using leverage to acquire their minority stake) and to find the right into the Norwegian TopCo instead of into the foreign holding balance to align the various stakeholders’ interests in creating value company structure. However, the PE fund may insist that the for its investors. The drivers behind equity terms and the equity Investing Management must invest in the foreign holding struc- structures are, normally the desires to control and incentivise, but ture. From a valuation perspective, it is imperative for both the PE investor will likely obtain a lower level of protection when the PE fund and the Investing Management that the Investing taking a minority position than taking a controlling stake. In addi- Management’s equity participation is acquired at “full and fair tion, there will be particular focus on securing an exit route/timing market value”, as participation under Norwegian law other- of exit and securing anti-dilution rights/pre-emption rights on any wise may be subject to income tax (rather than tax on capital issue of new shares. gains). In order to achieve that the Investing Management invests at the same price per shares as the institutional investors, the Sponsor will typically invest in a combination of share- 2.5 In relation to management equity, what is the holder loans, preferred shares and ordinary shares, while the typical range of equity allocated to the management, and Investing Management mainly invests in ordinary shares (i.e. what are the typical vesting and compulsory acquisition provisions? shares with no preferential rights). The Investing Management’s senior members may occasionally also be allowed to invest in the same instruments (or “institutional strip”) as the Sponsor. Management offering to subscribe for shares in the acquiring The detailed structuring of the management incentive package group will typically be required to accept compulsory transfer of will depend on the tax treatment of any benefit. If the Investing such shares if his/her employment terminates. The financial terms Management pays less than the market value of the shares this of such compulsory transfer depends on the reason for termina- could, under Norwegian law, give rise to an employment tax tion (“good” or “bad” leaver). If termination is due to accept- charge (46.4% marginal rate for the individual and 14.1% payroll able reasons, typically death, disability or involuntary termination tax for the employer). without cause, the person is a “good leaver” and will receive market In secondary buyouts, it is commonly a condition that the value for the shares. If employment is terminated with cause, or if Investing Management must reinvest a proportion of their sale such person resigns without good reasons, the person is classified proceeds (rollover). Any gains on such rollover will, in principle, as a “bad leaver” and must sell the shares for less than market price. trigger capital gains tax for the Investing Management, unless Although subject to individual variations, neither time- nor the members of the management team invested through separate performance-based vesting has been very common for the Investing holding companies and these are those rolling over their invest- Management’s participation in Norwegian PE transactions, at least ments. In recent years it has also become more common that the if the buyer is a domestic or Nordic PE fund. However, in trans- Investing Management invest into a separate pooling vehicle to actions where international Sponsors are involved, vesting is more simplify administration, which otherwise could be complicated common. When introduced, a three to five-year time-based vesting by having a large number of shareholders (e.g. meeting attendance model is often used, with accelerated vesting on exit. Such a vesting and exercising voting rights). model means that only the vested part of the equity is redeemable The carried interest arrangements (the “Carry”) for Managers at “fair value” at each anniversary ensuing investment, whereas the domiciled in Norway will more or less be the same irrespective part of the equity that has not vested may only be redeemable at of where the PE fund is located, although variations exist with a lower value. Given the recent years’ rather aggressive approach regard to other key factors for how the profit from the fund’s from the Norwegian tax authorities on Carry, some advisors fear investments is split between the Manager and the Institutional that vesting provisions may be used as an argument for classifying Investors (such as annual fee, hurdle rate, catch-up, etc.). The profits from Investing Management’s co-investments as personal Manager’s right to Carry is almost always accompanied by an income (in whole or in part) rather than capital gains. The obvious obligation to risk alongside the Institutional Investors, where the argument against such an assertion is that if the equity has been Manager as a precondition must risk its own money and invest acquired or subscribed for at “fair market value” and at the same into the fund’s limited partnership. Today, such Carry arrange- price per shares as the Institutional Investors (cf. question 2.3), then ments may be structured using a separate limited partnership revenues therefrom should, strictly speaking, be treated and taxed (“SLP”) or offshore company, held directly or indirectly by the in the same way as revenues derived from the institutional equity relevant investment professionals of the Manager, which in either (i.e. classified as capital gains). Nevertheless, as there is no firm case becomes a partner in the fund’s limited partnership. Each legal precedent on the matter, domestic PE funds seem to choose participant’s share of the Carry is delivered through an interest the path of least resistance by foregoing vesting. There is, of course, in the SLP, or in the fund itself by way of partial assignment of also a question in each transaction of how much “leverage” the PE the offshore company’s interest in the fund’s limited partner- fund has in relation to the Investing Management, and, correspond- ship. In principle, distribution delivered this way should be the ingly, how much push-back introducing vesting provisions will same for the Institutional Investors in the fund, namely a share receive. of the income and gains derived from the underlying investments of the fund’s limited partnership. As such, Carry has tradition- 2.6 For what reasons is a management equity holder ally, under Norwegian law, been perceived as a regular return on usually treated as a good leaver or a bad leaver in your investment and taxed as capital gains. Taxation of Carry has, jurisdiction? however, become a much-debated topic in Norway in the last few years, where the Norwegian tax authorities have argued that the “Good leaver” will usually mean leaving employment on Carry should be taxed as income rather than capital gains. For grounds of retirement, death, disability or being discharged for taxation of Carry, see question 9.4.

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“cause” not related to the employee him/herself. “Bad leaver” 3.2 Do private equity investors and/or their director will usually mean the employee him/herself terminates his/ nominees typically enjoy veto rights over major her position prior to exit, leaving in circumstances justifying corporate actions (such as acquisitions and disposals, the summary dismissal of the employee (typically misconduct), business plans, related party transactions, etc.)? If a or the employee being discharged for “cause” related to the private equity investor takes a minority position, what employee him/herself. veto rights would they typically enjoy?

3 2 Governance Matters The shareholders’ agreement is normally drafted so that PE funds and their director nominees (through board majority or mandatory consent requirements) have control over the port- 3.1 What are the typical governance arrangements for private equity portfolio companies? Are such folio company and any important corporate action. This arrangements required to be made publicly available in includes, inter alia: material changes in the nature of the business your jurisdiction? or disposal of any substantial part thereof; changes to issued share capital; major acquisitions; adoption of annual business The governance arrangements commonly used by PE funds to plan/budget and recommendations in respect of dividend distri- gain management control over their portfolio companies tend butions; entering into any partnerships or creating any obliga- to be relatively detailed, but there could be substantial variations tions, liens or charges; major employment matters like pensions between domestic funds compared to the governance structure and bonus schemes; and, naturally, entering into litigation or deployed by European or global PE funds. liquidation proceedings. Some Sponsors may divide the list The shareholders’ agreement will normally contain provisions of vetoes between those requiring director consent and those regarding corporate governance issues. The ability to appoint requiring Sponsor consent at shareholders’ level. directors, and to control the board if necessary, is the key tool A PE investor holding a minority position is likely to hold that the Sponsor will ensure is put in place in such agreements, less protection than on taking a controlling stake. The priority including a right to appoint additional directors in order to flood areas will be ensuring that they have visibility of the day-to-day the board in the event of disagreement with the executives and conduct of the business (i.e. board or observer seat), and ensuring any employee representatives. Although some international that certain fundamental transactions which protect their owner- funds also implement a separate management board, Norwegian ship interest cannot be taken without their consent. Examples portfolio companies normally only have a single board of direc- of such veto rights are: changes to the company’s constitutional tors on which the Sponsors are represented. It is not uncommon documents; disposal of key assets; borrowing of monies; and any that some PE funds want to appoint an independent chairman form of debt restructuring transactions, etc. to provide strategic oversight and to create an independent bridge between the Sponsor and the Investing Management. 3.3 Are there any limitations on the effectiveness of Through veto rights and/or preferential voting rights afforded veto arrangements: (i) at the shareholder level; and (ii) at in the shareholders’ agreement, the Sponsor-appointed direc- the director nominee level? If so, how are these typically tors will usually have control over important decisions like addressed? new acquisitions and disposals, approval of business plans and annual budgets, new investments outside of the business plan, As a starting point, shareholders can agree that one or more etc. Besides appointment/dismissal of directors (always subject designated representatives shall have veto rights over certain to consent from the general meeting, meaning the Sponsor), the decisions at the general meeting. Nevertheless, the tradi- shareholders’ agreement may further contain rules about audit tional view is that a decision from the general meeting is valid and remuneration, business plans and budgets, transfer/issue regardless of whether some shareholders have voted in breach of shares and financial instruments, confidentiality and other of contractual obligations under a shareholders’ agreement. restrictive covenants, management of exit, and customary drag, Consequently, to ensure that shareholders respect such veto tag and shot-out provisions. From a strict governance perspec- rights, it is important that the shareholders’ agreement contains tive, the important requirement for the Sponsor is to ensure that appropriate enforcement mechanisms (see question 3.5). the shareholders’ agreement provides the Sponsor with appro- Veto rights in a shareholders’ agreement binds neither the priate access to information about the company. There is no board (as a governing body) nor the CEO. This means that requirement for making such shareholders’ agreements publicly even if a shareholders’ agreement grants Sponsor-appointed available. directors to veto over certain important board resolutions, there Unlike what is common in other jurisdictions (e.g. the UK is always the risk that the board disregards this and resolves or the US), it is not common to include a detailed set of protec- the matter in question as the majority find appropriate. In tive provisions in Norwegian portfolio companies’ articles of order to cater for the “risks of disobedience”, each director associations. Traditionally, most domestic PE funds have also could be required to sign some form of adherence agreement preferred to keep these types of provisions only in the share- to the shareholders’ agreements, but if such adherence agree- holders’ agreements for confidentiality and flexibility reasons. ment is considered to bind the directors in their capacity as such For the last few years, it has nonetheless become more common (and not shareholders), there is a legal risk that the agreement, to also include certain protective provisions in the articles, espe- under Norwegian law, will be deemed invalid as constituting a cially if the portfolio company is controlled by an international fettering of their discretion (other valid portions of such agree- PE fund. Such articles must be registered in the Norwegian ments may remain in force). This risk cannot be eliminated by Register of Business Enterprises and are thus publicly available. making the relevant company a party to the shareholders’ agreement. The reason being that the board owes fiduciary duties to the company trumping those owed to a director’s appointing shareholders. Therefore, the company cannot dictate how the board in the future shall exercise duties, discretions and judgments relating to individual matters put in front of them, unless

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otherwise set out in the company’s articles. As a result, some irrespective of voting rights, and the Companies Acts also funds seek to alleviate risk by implementing provisions in the provides specific rights to minority shareholders representing a portfolio companies’ articles, stating that the shareholders and certain percentage of the share capital and/or votes. the company have entered into a shareholders’ agreement regu- Sometimes, Sponsors, particularly foreign Sponsors, may lating, inter alia, restrictions on transfer of shares, veto rights, etc. address certain of these statutory minority protection rules Such clauses will then state that the board may, as a condition in the shareholders’ agreement by introducing provisions that for its consent to transfer shares, require that new shareholders aim (directly or indirectly) to limit them. To what extent this accede to such shareholders’ agreement. There is no clear court is possible, and if so, how far and for how long it is possible to decision on the topic as to what extent such a reference in the limit (or at least minimise) them, is subject to substantial legal articles will solve the problem, or if it is necessary to include the uncertainty under Norwegian law. Many of the rules cannot relevant text itself in the articles. In academic circles, the view be deviated from, and an overzealous shareholders’ agreement is also divided. could affect the validity of either the entire agreement or the If the directors are also shareholders in the company, it must particular provision in question (see question 3.5). By imple- be assumed that they are free to bind their powers in their menting several share classes with different financial and voting capacity as shareholders. Consequently, Sponsors controlling rights, and by introducing good leaver/bad leaver provisions, sufficient votes in the general meeting can, in principle, seek etc., a Sponsor may to some extent at least limit the financial comfort in their right to convene an extraordinary general impact of some of these minority protection rules so that the meeting and remove disobedient directors from the board. Still, principles of the shareholders’ agreement in general will apply. the right to remove board members cannot completely eliminate The same can be achieved by pooling the minority investors’ the risk that the portfolio company, as a result of the board’s investment in the portfolio company through a separate invest- resolution, has already entered into a binding arrangement with ment vehicle in which the Sponsor holds the controlling vote. a third party before a new board is elected. Normally, an appropriate and well-tailored enforcement mechanism in the share- 3.5 Are there any limitations or restrictions on the holders’ agreement itself will therefore, in most situations, be contents or enforceability of shareholder agreements considered sufficient to ensure that no party (in particular, the (including (i) governing law and jurisdiction, and (ii) directors holding shares) has any incentive to breach the terms non-compete and non-solicit provisions)? of the shareholders’ agreement, and therefore that it will not be necessary with any further enforcement. In practice, most Insofar as the shareholders’ agreement does not contravene stat- Norwegian funds seem to rely on such enforcement mecha- utory laws (e.g. the Companies Acts) or the relevant company’s nisms in the shareholders’ agreements instead of implementing articles, such agreements are considered valid under Norwegian lengthy articles. That said, over the last few years there seems law, and can, in principle, be enforced among the parties thereto to have been a move for implementing more detailed articles, in (but not against third parties). Even if the shareholders’ agree- particular when UK or global funds are investing in Norwegian ment is binding, there are still some uncertainties as to what portfolio companies. extent it can be enforced by injunctions. Nevertheless, it must be assumed that remedies other than injunctions agreed in such 3.4 Are there any duties owed by a private equity an agreement can be claimed before the courts. investor to minority shareholders such as management In the event that a shareholders’ agreement contains provi- shareholders (or vice versa)? If so, how are these sions that are conflicting with statutory minority protection typically addressed? rules or provisions in the company’s articles of association, this could also result in the agreement not being enforceable, at least The general principle under Norwegian law is that a controlling with regard to such provision (see question 3.4 above). shareholder does not have any duty towards minority share- Further, it should be noted that if the shareholders’ agree- holders and is free to act in his or her own best interest unless ment attempts to bind the directors in their capacity as direc- otherwise is explicitly set out in law, the company’s articles tors, there is a risk that this part of the agreement is invalid and or in an agreement. Under the Norwegian Limited Liability cannot be enforced towards the company itself nor the director Companies Acts (“Companies Acts”), however, a controlling in question (see question 3.3). It should also be noted that it is influence cannot be exercised at board level, management level not possible to extend the binding force of certain provisions of or at the general meeting in a manner likely to cause unjust such an agreement by making the company itself a party to it (see enrichment to a shareholder or a third party at the cost of the question 3.3). Nevertheless, if the director is also a shareholder, company or another person. For PE investments in particular, and as such is a party to the shareholders’ agreement, it must be the Sponsor will, in addition, have undertaken a set of detailed assumed that such shareholders are free to bind their powers in (but limited) undertakings towards minority shareholders (such the capacity of shareholders (see question 3.3). Provided appro- as management shareholders), the main purpose being to align priate remedies and enforcement mechanisms are agreed in the the minority shareholders’ interest not through annual compen- agreement itself, such mechanisms will therefore, in most situa- sation, but through growing the business and receiving equity tions, be considered effective towards such party. returns as shareholders. Typically, shareholder agreements cannot be enforced Shareholders also have certain statutory minority protections towards third parties, but can be enforced against the party in through a detailed set of rules in the Companies Acts, including breach. However, this may sometimes be of little help, unless the right to attend and speak at general meetings, certain the agreement itself contains appropriate and effective remedies disclosure rights, rights to bring legal actions to void a corpo- and enforcement mechanisms (see question 3.3). rate resolution on the basis of it being unlawfully adopted or In terms of dispute resolution, the preferred avenue of otherwise in conflict with statute or the company’s articles, etc. approach for PE funds has, over the last decade, shifted from Some of these rights are granted to each individual shareholder regular court hearings to arbitration, and it should be noted

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that alternative dispute resolution in general (including both and/or ancillary regulations. As a general principle, all direc- arbitration and court-sponsored mediation) is now decid- tors (including employee-elected directors) are subject to the edly more common in Norway than in the rest of the Nordics. same standard of care or fault standard and, although the board International influence combined with the perceived upsides acts collectively, a director’s liability is personal. Joint and several (i.e. non-publicity, efficiency, expertise and costs) may be cred- liability only applies to such actions or omissions attributable to ited for this shift. Pursuant to the New York Convention, arbi- more than one board member. tral awards are enforceable in Norway. Norway has further Examples of potential risks and liabilities that Sponsor- implemented certain statutory limitations on the enforceability appointed directors should be particularly aware of relate to the of non-compete clauses in employment contracts. Under certain board’s heightened scrutiny in controlling that all related-party special circumstances, the new rules may also have an impact transactions (if any) between a portfolio company, its share- on the enforceability of non-compete provisions of shareholder holders and/or its directors are concluded at arm’s-length basis. In agreements. a PE investment, such transactions may typically relate to fixing the interest rates on shareholder loans, and/or intra-group loans between the acquiring companies and the target group, or payment 3.6 Are there any legal restrictions or other requirements that a private equity investor should of various forms of management fees, etc. between such parties. be aware of in appointing its nominees to boards of Other forms of transactions falling within the same category may portfolio companies? What are the key potential risks be transactions that directly or indirectly aim at distributing funds and liabilities for (i) directors nominated by private out of a portfolio company to the Sponsors or to third parties. equity investors to portfolio company boards, and (ii) Also, directors should be particularly aware of the rule prohib- private equity investors that nominate directors to iting a target company from providing upstream financial assis- boards of portfolio companies? tance in connection with the acquisition of shares in the target company (or its parent company). This prohibition against finan- Legal restrictions on nominating boards of portfolio cial assistance has previously prevented Norwegian target compa- companies nies from participating as co-borrower or guarantor of any acqui- The CEO and at least half of the directors in Norwegian private sition financing facilities. Although, on 1 January 2020, Norway and public LLCs must either be residents of Norway or EEA implemented a set of rules that further eases the previous strict nationals who reside in an EEA state. With respect to this, at least ban of financial assistance (by amending the existing “whitewash” half of the ordinary directors must fulfil the residential require- procedure), this is still an area that needs careful consideration and ment; it will not suffice that solely deputy directors fulfil it, irre- compliance with strict formalities if the respective directors shall spective of how many of them are Norwegian residents or EEA stay out of peril (see further in section 11 below). On a general note, nationals. The Norwegian Ministry of Trade and Industry may in order to be valid, related-party transactions must be approved grant exemptions on a case-by-case basis. It should also be noted by the board, and if the consideration from the company repre- that, for public LLCs (irrespective of such companies being listed sents a real value exceeding 2.5% of its balance sheet amount for or not), Norwegian law dictates that each gender shall be repre- previous fiscal year, the board must prepare a special report to be sented on the board by (as a main rule) at least 40%. Consequently, distributed to all shareholders with a known address. In addition, on a board of five directors there cannot be fewer than two such report must be filed with the Norwegian Registry of Business members of each gender. Exceptions apply to directors elected by Enterprises. Certain exemptions from these requirements apply; and among the employees (if any). typically agreements entered into as part of the company’s normal PE funds must also take into consideration the requirements business at market price and other terms that are customary for for employee representatives on Norwegian boards. According to such agreements (see question 11.1). If the relevant company’s law, employees are entitled to board representation, both in private shares are listed on a regulated market, additional requirements and in public LLCs, provided the number of full-time employees apply and such agreements must also then be approved by the rele- in such a company exceeds 30. Under such circumstances, the vant company’s shareholders’ meeting in order to be valid. employees are entitled to elect between one and up to one-third Directors violating any of the formal requirements described of the board members from among the employees. The exact above may, at worst, expose him/herself to personal responsibility/ number of employee board representatives varies with the number liability for ensuring that any funds/assets distributed in violation of employees in the company, but all employee representatives of such rules are returned to the company. Note that the anti- have the same voting rights as regular board members. Employee asset stripping rules implemented by the AIFMD Act (see ques- board representation is not mandatory under Norwegian law, but tion 10.2) are also likely to result in personal liability for directors cannot be rejected if requested by the employees and the condi- – in particular those appointed by the Sponsor if they contribute tions for such representation are fulfilled. to the Sponsor’s breaching of such anti-asset stripping provisions. Further, note that in the event that a portfolio company is in Risks and potential liabilities for the directors appointed financial distress, its directors will at some stage come under obli- Like other directors, a Sponsor-appointed director of a port- gation to cease trading and file for court composition proceed- folio company owes fiduciary duties to the company that takes ings or to liquidate the company. Such distress situations very precedence over duties owed to the shareholders appointing often involve some type of prior attempts of restructuring or reor- him. Directors owe their duties to all the shareholders, not only ganising the business to salvage the various stakeholders’ finan- the individual shareholder or group of shareholders nominating cial interests. These types of attempts could involve selling off him/her. Upon assuming office, the nominated directors will be assets or parts of the business to a stakeholder against such stake- subject the same potential personal director liability as any other holder being willing to contribute additional cash or converting member. Under Norwegian law, directors or executive officers debt into equity, etc. It is not uncommon that such transactions, may become liable for damages suffered by the company, share- in the event that these attempts later fail, may be challenged by holders or third parties caused by negligence or wilful acts or omis- other creditors, the receiver or trustee on behalf of the credi- sions. In addition, directors can be held criminally liable as a result tors, and they therefore entail substantial risks of liability for the of intentional or negligent contravention of the Companies Acts various directors.

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Risks and potential liabilities for the Sponsors timeframe agreed upon by the parties – i.e. there is no set time- In terms of liability, the general point is that a Sponsor itself table. Standard waiting periods pursuant to relevant competi- will not assume or be exposed to any additional liability tion legislation will apply, however. The major issues impacting simply by virtue of nominating/appointing directors to a port- the timetable for private transactions in Norway are: folio company. However, a parent company or a controlling ■ The initial diligence exercise that the buyer intends to shareholder may be held independently liable for its subsid- undertake. iary’s liability if it has contributed to a wrongful act through ■ Time necessary for financing discussions. The time a controlling interest in the company. Consequently, if the required for such discussions will normally be heavily Sponsor has reserved so many vetoes over the portfolio dependent upon the size of the deal and type of preferred company that the management team is no longer able to carry financing options available. If it is necessary with bank out its day-to-day business in the ordinary course without first financing syndications, mezzanine debt, issuing debt consulting the Sponsor, this could, at least theoretically, mean instruments, etc. that the Sponsor might be considered a “shadow director” or ■ In the event that it is necessary to file the transaction manager of the business. Under these circumstances, conse- with domestic or foreign competition authorities, the quent liability issues can arise for the Sponsor if something goes time required to prepare the necessary disclosures to be wrong. That said, to pierce the corporate veil under Norwegian submitted to such authorities. In the event of a change law is not considered to be a particularly easy task. of control transaction, provided that the combined group turnover of the acquirer and the target in Norway is NOK 1 billion or more, and at least two of the undertak- 3.7 How do directors nominated by private equity investors deal with actual and potential conflicts of ings concerned each have an annual turnover in Norway interest arising from (i) their relationship with the party exceeding NOK 100 million, the transaction must be filed nominating them, and (ii) positions as directors of other with the Norwegian Competition Authorities (“NCA”), portfolio companies? unless filing takes place under the EU Merger Control Regime instead. As mentioned in question 3.6, Sponsor-appointed directors are, ■ If filing with competition authorities is necessary, the upon assuming office, subject to the same corporate fiduciary time necessary for such authorities’ regulatory reviews, duties as any other director on the board, and these rules (princi- including requests for additional information from such ples) cannot be departed from through shareholder agreements authorities, and to wait for the expiry of standard waiting or constitutional documents. periods under such regulatory approval schemes. There According to law, a director in a Norwegian portfolio company is no deadline for filing a notification with the NCA, but is disqualified from participating in discussions or decisions on a standstill obligation applies until the NCA has cleared any issues that are of such personal importance to him, or any of the transaction. After receipt of the filing under the new his related parties, that the director is deemed to have a strong rules, the NCA now has up to 25 working days to make its personal or special financial interest in the matter. The same initial assessment of the proposed transaction. will apply for a company’s CEO. Whether or not this provision ■ The necessity to comply with obligations to inform the comes into play, demanding a director to step down while the employee union representatives and/or the employees of remaining board resolves the matter, depends on an individual the transaction and its potential effects in accordance with evaluation at any given crossroad. However, it must be assumed law and relevant collective bargaining agreements. that most particular circumstances must be present – i.e. a ■ The time necessary for implementing relevant co-invest- director will not automatically be disqualified just because he ment arrangements with Investing Management. is also director in another portfolio company that is the compa- ■ The time necessary to establish the desired investment ny’s contractual counterpart. In a sense, it could be viewed as vehicles and special purpose vehicles in order to execute providing a safety valve for PE nominees that have a personal and complete the transaction. financial interest (by virtue of being a partner of the Manager ■ If the transaction is conducted through a statutory merger, and thereby entitled to parts of the Carry, cf. question 2.3) to where only private LLCs are involved, the merger plan withdraw from handling board matters (and thus avoiding any with supporting documents will have to be made avail- conflicts of interest) relating to other portfolio companies. able to the shareholders no later than two weeks prior to To avoid potential conflicts of interest arising between nomi- the general meeting at which such merger will have to nators and nominees, increasingly more PE-backed companies be decided upon. If public LLCs are involved in such a have introduced quite comprehensive instructions and proce- merger, the notice period is one month prior to the general dural rules for both management (daily operations and admin- meeting, and the merger plan must also be filed with the istration) and the board of directors (board work and deci- Register of Business Enterprises (“RBE”) a month before sion-making processes). the meeting. If approved by the general meeting, the merger must thereafter be filed with the RBE for public 4 2 Transaction Terms: General announcement; this applies to private and public LLCs alike. Once the announcement has been published by the RBE, a six-week creditor period begins, upon the expiry of 4.1 What are the major issues impacting the timetable which the merger may be effectuated. for transactions in your jurisdiction, including antitrust, ■ It should also be noted that if the target company is oper- foreign direct investment and other regulatory approval requirements, disclosure obligations and financing ating within certain industries, there are sector-specific issues? requirements to consider (such as requirements for public permits and approvals). These industries are banking, insurance, petroleum, hydropower and fisheries, etc., and As a starting point, private corporate transactions do not require the need for obtaining such public permits and approvals consent from Norwegian authorities, which means that regular could heavily influence the transaction timetable. share purchases can be completed in accordance with the

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■ Finally, it should be noted that if a target company oper- the Norwegian PE market, there has been a significant uptick ates in sectors considered vital from a national security in the usage of M&A insurance (i.e. commercial insurance of perspective, the National Security Act now grants the warranties and indemnities in the sale and purchase agreement Government powers to intervene and stop acquisitions of (“SPA”)), which is also used to get rid of the aforementioned shares in such company. escrow mechanisms. Issues influencing the timetable for take-private transactions in Norway will in general be more or less the same. For such 52 Transaction Terms: Public Acquisitions target companies, however, the following additional issues must be accounted for: 5.1 What particular features and/or challenges apply ■ The time necessary for the target’s board to evaluate the to private equity investors involved in public-to-private initial proposal for the transaction and any alternatives. transactions (and their financing) and how are these ■ In a voluntary tender offer, the offer period must be no less commonly dealt with? than two weeks and no more than 10 weeks. ■ In a subsequent mandatory offer, the period must be at Takeover of a publicly listed company is subject to more regula- least four weeks and no more than six weeks. tion under Norwegian law than are takeovers of private compa- ■ The time necessary to conduct the squeeze-out of the nies. Both the prospective buyer and the targets’ boards must minority shareholders. observe a detailed set of rules and regulations, which among ■ The application process for delisting the target in the event others comprises insider dealings rules, mandatory offer thresh- that the bidder has not managed to acquire more than 90% olds, disclosure obligations (regarding ownership of shares and of the shares and some of the remaining shareholders file other financial instruments), content limitations for offer docu- an objection against delisting the target company. ments, filing and regulatory approval of offer documents, length of offer periods, employee consultations, limitations on type of 4.2 Have there been any discernible trends in consideration offered, etc. transaction terms over recent years? The main challenge in any acquisition, albeit more relevant to take-private of listed companies, is for the PE fund to secure a Structured sales (auction) processes continue to be the preferred sufficient level of shareholder support (i.e. 90% or more of the option for PE exits in the Norwegian market – at least for target’s shares and voting rights) in order to carry out a subse- transactions exceeding €100 million. Also, in smaller transac- quent squeeze-out of any remaining minority shareholders. tions the seller’s financial advisors will often attempt to invite This 90% threshold is also important since it will be a straight- different prospective bidders to compete against each other. forward process to have the target delisted from the Oslo Stock Conversely, a PE fund looking for an exit will never go for a Exchange (“OSE”) or Oslo Axess. If not, the process for delis- bilateral sales process as a preferred exit route unless: (i) the ting the target could be far more complex. In principle, there are fund has a very clear sense of who the most logical buyer is; (ii) several avenues of approach for PE houses desirous to taking a an auction involves a high risk of damage from business disrup- publicly listed company private under Norwegian law – one of tion; and (iii) the PE fund feels it has a very strong negotiating which is to launch a voluntary tender offer to the shareholders. position. The principal legislation and rules regulating takeovers of Throughout 2013 and at the beginning of 2014, confidence publicly listed companies is found in chapter 6 of the Norwegian returned to the international equity capital markets. This again Securities Trading Act (“STA”). One of the beneficial features led to an upswing in the number of initial public offerings, both with a voluntary offer is that, in general, there are no limita- in the Norwegian market and the rest of Scandinavia. Due to tions in law as to what conditions such an offer may contain; this this market sentiment, IPOs and “dual-track” processes became affords the PE fund a great deal of flexibility, e.g. with respect to increasingly popular among PE funds looking to exit their port- price, type of consideration and required conditions precedents. folio investments, in particular for some of their largest port- A voluntary tender offer may be launched at the bidder’s discre- folio companies where the buyer-universe might be limited and tion, and the bidder can also choose to make the offer to only the relevant company needed to raise equity in order to pursue some of the shareholders. A voluntary offer can also be made future growth strategies. In Norway, this trend continued subject to a financing condition, although this is rare. through 2019. A potential bidder will quite often find it challenging to Stapled financing offers have again started to re-emerge in the successfully conclude a take-private transaction by launching Norwegian market, in particular for the larger deals in which the a public bid without the co-operation and favourable recom- sellers are pursuing an exit via dual-track processes. mendation of the target’s board at some point in the process. We have also seen increasing examples of sellers that, in order The reason being that, as a rule, a bidder who launches a public to accommodate a greater bidder universe, have been willing to tender offer for a listed Norwegian target does not have a right offer certain attractive bidders some form of cost-coverage for to be admitted to due diligence. This makes diligence access money spent in an unsuccessful auction. These arrangements one of the bidder’s main hurdles in a public takeover. The are subject to great variations, but, on a note of caution, they target is not restricted from facilitating a due diligence investi- regularly include provisions that stealthily alleviate much of the gation by a bidder, but the scope and structure of such reviews apparent seller liability by prescribing that the buyer will not in the context of a listed target will vary significantly. Provided be entitled to any coverage if it is no longer willing to uphold a that the target’s board is prepared to recommend the offer, the purchase price corresponding to the adjusted enterprise value of bidder will normally be admitted to a confirmatory due dili- its initial offer. gence. It is therefore not surprising that a prospective acquirer Escrow structures as the basis for making contractual claims (particularly PE funds) will almost always seek upfront recom- in respect of warranties and purchase price adjustments are mendation from the target’s board. In a control context, the not normally popular among sellers but, depending on the prospective acquirer’s first contact with the target is custom- parties’ relative bargaining positions, it is not uncommon for arily a verbal, informal sounding-out (by the chairman or a buyers to request escrow structures. In terms of new trends in senior executive of the acquirer or by the acquirer’s external

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financial adviser) of the target’s appetite for a take-private trans- the terms for the target’s support and the main terms for the action. Depending on the outcome of that discussion, the fund bidder’s offer. Such transaction agreements also often include a will submit to the target a written, confidential, indicative and non-solicitation clause granting the bidder some type of limited non-binding proposal and seek due diligence. exclusivity, including a right to amend its offer and to announce When the board of a listed company reviews a take-private a revised offer to match any alternative or superior competing proposal, it must uphold its fiduciary duties, which include two offers that are put forward. The foregoing notwithstanding, the elements: a duty of care; and a duty of loyalty. The duty of care Norwegian Code of Practice for Corporate Governance (“Code includes a duty for the board to inform itself, prior to making a of Practice”) recommends that a target’s board exercise great business decision, of all material information that is reasonably caution in agreeing to any form of exclusivity. The Code of available. Consequently, the directors must evaluate a proposed Practice further requires the board to exercise particular care offer or business combination in the light of risks and bene- to comply with the requirements of equal treatment of share- fits of the proposed transaction compared to other alternatives holders, thus ensuring that it achieves the best possible bid terms reasonably available to the corporation, including the alternative for all the shareholders. of continuing as an independent entity. It is currently not clear A PE fund may want to use several different tactics to ensure under Norwegian law to what extent this duty of care requires a successful take-private transaction, one of which is stake- the board to reasonably inform itself of alternatives or actively building. Stake-building is the process of gradually purchasing seek alternative bidders in connection with a business combina- shares in a public target in order to gain leverage and thereby tion transaction. Each director of a listed company considering increase the chances of a successful subsequent bid for the entire a take-private transaction must also assess if, and to what extent, company (i.e. the remaining outstanding shares). Purchasing they can or should assist in the transaction, or if they have a shares outside an offer may be prohibited if the bidder is in conflict of interest. If a director in the target has a specific possession of insider information. In addition to the insider interest in a potential bidder, or in a bidder in competition of a dealing rules, a bidder must pay particular attention to disclo- first bidder, such director is incompetent and must not partici- sure requirements during the stake-building process. The pate in the handling of issues relating to the bid. disclosure requirements are triggered by any person owning Take-private transactions in Norway are subject to the same shares in a company whose securities are listed on a Norwegian disclosure issues and requirements as other takeover offers regulated market (OSE or Oslo Axess), if their proportion of involving a publicly listed company. The board of a listed target shares or rights to shares in such company reaches, exceeds or is, on an ad hoc basis and on its own initiative, required to disclose falls below any of the following thresholds: 5%; 10%; 15%; 20%; any information on new facts or occurrences of a precise nature 25%; ⅓; 50%; ⅔; or 90% of the share capital, or a corresponding that are likely to have a notable effect on the price of the target’s proportion of the votes, as a result of acquisition, disposal or shares or of related financial instruments (so-called insider infor- other circumstances. If so, such person must immediately notify mation). This is an issue of particular concern for any bidder, the company and the OSE. Breaches of the disclosure rules are as well as for a PE fund. The decision to engage in discus- fined, and such fines have grown larger over the years. sions with a PE fund relating to a potential take-private trans- Except for the insider dealing rules, disclosure rules, and action and to divulge information is thus made at the discretion mandatory bid rules (see below) there are generally few restric- of the target’s board. Confidential negotiations with the target’s tions governing stake-building. However, confidentiality agree- board at an initial stage are possible, with certain constraints, ments entered into between a potential bidder and the target prior to the announcement of the bidder’s intention to launch can impose standstill obligations on a bidder, preventing acqui- a bid, provided the parties are able to maintain confidentiality. sition of target shares outside the bidding process. Subject to However, the fact that a listed company is discussing a takeover such limitations, the fund can also attempt to enter into agree- or a merger (and the content of such negotiations) will at some ments with key shareholders to seek support for a possible point constitute inside information that must be disclosed to the upcoming bid. Such agreements can take various forms, from market. The OSE’s Appeals Committee has previously ruled an SPA, a conditional purchase agreement, some form of letter that confidential negotiations between a potential bidder and of intent, MoU, etc., or a form of pre-acceptance of a poten- the target’s board could trigger disclosure requirements, even tial bid. Pre-acceptances are typically drafted as either a “soft” before there is a high probability of an offer being launched, or “hard” irrevocable (“Irrevocable”) – the former normally provided that such conversations “must be assumed not to have only commits the shareholder who gives the Irrevocable to an immaterial impact on the target’s share price”. Consequently, accept the offer if no higher competing bid is made, whereas the a potential bidder (like a PE fund) and the target’s board must latter commits the shareholder to accept the offer regardless of be prepared for a situation where the OSE takes the view that whether a subsequent higher competing bid is put forward. It the requirement for disclosure is triggered at an early stage, is assumed in Norwegian legal theory, that a properly drafted possibly from the time the target enters into a non-disclosure “soft” Irrevocable will not trigger the disclosure requirements. agreement allowing due diligence access. The forgoing notwith- When dealing with shareholders directly in take-private transac- standing, if a target is approached regarding the potential intentions, a PE fund will also experience that shareholders are reluc- tions of launching a bid, this will in itself not trigger any disclo- tant to grant extensive representations and warranties besides sure requirements. title to shares and the shares being unencumbered. Under Norwegian law, a publicly listed target can take Another challenge in take-private transactions is that if a PE a more or less co-operative approach in a takeover situa- fund directly, indirectly or through consolidation of ownership tion. Confidentiality agreements between the bidder and the (following a stake-building process or one or more voluntary target, allowing the bidder access to due diligence or addi- offers) has acquired more than ⅓ of the votes in the target, it is tional information about the target, will often include a “stand- (save for certain limited exceptions) obligated to make a manda- still” clause preventing the bidder for a specified period from tory offer for the remaining outstanding shares. After passing acquiring stocks in the target without the target’s consent. If the initial ⅓ threshold, the fund’s obligation to make a manda- the bidder obtains the target’s support to recommend a “nego- tory offer for the remaining shares is repeated when it passes tiated” tender offer, it is normal practice for the parties to enter (first) 40% and (then) 50% of the voting rights (consolidation into a detailed transaction agreement, which (typically) sets out rules apply). Please note that certain derivative arrangements

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(e.g. total return swaps) may be considered as controlling votes If a Norwegian-listed company becomes subject of a in relation to the mandatory offer rules. Of particular concern take-private proposal that materialises in a voluntary or manda- to PE funds, is that the share price offered in a mandatory offer tory offer to the shareholders, the board is obliged to evaluate cannot be lower than the highest price paid, or agreed to be paid, the terms of the offer and issue a statement to its shareholders by the fund for shares (or rights to shares) in the target during describing the board’s view on the advantages and disadvan- the last six months. In special circumstances, the relevant take- tages of the offer. Should the board consider itself unable to over supervisory authority (i.e. the exchange where the securi- make a recommendation to the shareholders on whether they ties are listed) may also demand that market price is paid for the should or should not accept the bid, it is to account for the shares (if this was higher at the time the mandatory offer obliga- reasons why. According to the Code of Practice, it is recom- tion was triggered). A mandatory offer must be unconditional mended, that the board arranges a valuation for each bid by and must encompass all shares of the target. The consideration an independent expert, and that the board on such basis forms may be offered in cash or by alternative means, provided that its recommendation on whether or not to accept the offer. complete and no less favourable payment in cash is always avail- Exemptions apply in situations where a competing bid is made. able upon demand. The consideration offered under a manda- The recommendations of the Norwegian Code of Practice go tory offer must be unconditionally guaranteed by either a bank beyond the requirements of the STA. or an insurance undertaking (in each case authorised to conduct business in Norway). 5.2 What deal protections are available to private Getting the necessary finance arrangement in place may also equity investors in your jurisdiction in relation to public represent a major hurdle for a bid dependent on significant acquisitions? leverage; in particular when it comes to mandatory offers, since any debt financing the bidder relies on in these situations must, As a starting point, break fees are available in the sense that in practice, be agreed on a “certain funds” basis, so that it does Norwegian takeover legislation does not contain particular not include any conditions that are not effectively within the provisions prohibiting it. However, due to strict rules regarding bidder’s control. corporate governance and fiduciary responsibilities, the use of A PE fund desirous to take private a public target should break fees is decisively less common in Norwegian public-to- also seek support from the target’s management team as early private transactions compared to other jurisdictions. Break fees as possible since these persons are often required to co-invest payable by the target can raise issues in relation to compliance together with the fund (see question 2.3 above). In connec- with the target’s corporate interests and may, in the worst case, tion with structuring of relevant management co-investment trigger liability for misuse of the target’s assets. Break fee agree- arrangements, the principle that all shareholders must be treated ments limiting the ability of a target’s board to fulfil its fidu- equally in a voluntary and mandatory offer situation imposes ciary duties, or that may put the target in financial distress if the some constraints on the terms that can be agreed with employees break fees become effective, are likely to be deemed unenforce- that hold (or have options to hold) shares in the target. At the able and, consequently, may result in personal liability for the outset, the PE fund may, without limitations, approach an board members. Potential financial assistance aspects of a break employee of the target and agree upon whatever terms desired, fee arrangement must also be considered carefully. provided, of course, that such terms are not contrary to good In relation to the above, it should be noted that the Code of business practice and conduct, or in violation of rules and regula- Practice recommends that a target’s board must exercise great tions pertaining to what considerations a member of a company caution in agreeing to any commitment that makes it more diffi- may or may not accept in connection with such member’s posi- cult for competing bids to be made from third-party bidders tion in the company. As there are no explicit legal constraints or may hinder any such bids. Such commitments, including on what can be agreed regarding severance terms for directors break fees, should be clearly and evidently based on the shared or senior executives in the target, entitlements provided under interests of the target and its shareholders. According to the such arrangements are likely to be permitted and upheld insofar recommendations, any agreement for break fees payable to the as the arrangements do not give such employees unreason- bidder should, in principle, be limited to compensation for costs able benefits at the expense of other shareholders in the target. incurred by the bidder in making the bid. Break fees occur, The foregoing is naturally assuming that no limitations follow often in a range of 0.8% to 2% of the target’s market-cap. Of from the possible board declarations on fixing of salaries or the five public M&A offers launched during 2019, a break fee of other remuneration schemes approved by the target’s general around 2% of the offer price was agreed for one of these deals. meeting. Although not specifically pertaining to the aforementioned, please take particular note that Norwegian law restricts the employees’ and directors’ right to accept remuneration from 62 Transaction Terms: Private Acquisitions anyone outside the target in connection with their performance of assignments on behalf of the target. 6.1 What consideration structures are typically In relation to the foregoing, it should also be noted that a preferred by private equity investors (i) on the sell-side, bidder must disclose in the offer document what contact he has and (ii) on the buy-side, in your jurisdiction? had with the management or governing bodies of the target before the offer was made, herewith including any special bene- As a general observation, it seems that PE funds on the buy-side fits conferred or agreed to be conferred upon any such individ- often prefer transactions based on completion accounts. When uals. Furthermore, when dealing with employees who are also on the sell-side, however, the same funds tend to propose a shareholders in the target, a bidder should be aware that agreed locked-box mechanism. That said, the choice of preferred upon terms and benefits that are not exclusively related to the completion mechanics is normally decided on the basis of what employment of such shareholder may, in accordance with the kind of business the target is engaged in, i.e. whether it is particu- principle of equal treatment, be considered part of the offered larly susceptible to seasonal variations or other cash-flow fluctu- share price, thus exposing the bidder to the risk of having ations throughout the year, and the timing of the transaction, i.e. the offer price in the offer document adjusted to such higher expected closing date. Completion accounts remain a common amount. feature if: (i) there is an expected delay between signing and

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completion of the transaction; (ii) the business being sold is to warranties in connection with their co-investments or rollovers. be carved out from a larger group; (iii) substantial seasonal fluc- If the management team provides such management warran- tuation in the target’s need for working capital is expected; and ties, the warranties are often limited in scope. International (iv) a large part of the target’s balance sheet refers to “work-in- Sponsors unfamiliar with the Norwegian market often find such progress” items. a practice strange and may therefore insist that the Investing If completion accounts are proposed by a PE fund, it is Management provide such warranties in line with what is common to base the calculation of the purchase price on the common in other jurisdictions. target’s enterprise value adjusted to reflect both (i) the net cash/ debt position of the target group at completion, and (ii) any devi- 6.3 What is the typical scope of other covenants, ation from the normalised working capital level at completion. undertakings and indemnities provided by a private A seller may also propose different variations of this method- equity seller and its management team to a buyer? ology, e.g. by fixing the purchase price in the SPA but at the same time assuming a “target level” of debt and working capital. As in most other jurisdictions, a PE fund’s starting point will On rare occasions, other adjustment mechanisms are proposed often be that they do not provide any restrictive covenants. The depending on the target’s industry, e.g. adjustments based on the same applies for wide confidentiality provisions; the reason target group’s net financial assets, etc. being that such clauses may restrict the ability to use knowledge acquired during the lifetime of the investment for future 6.2 What is the typical package of warranties / investments. However, depending on market conditions, and the indemnities offered by (i) a private equity seller, and (ii) respective party’s bargaining position, most funds are willing to the management team to a buyer? adapt their “policy” in order to secure the exit, and non-compete and non-solicitation clauses between 12 and 24 months are seen. The catalogue of vendor representations, warranties and indem- In a Norwegian transaction, it is not customary for a buyer to nities offered to prospective buyers varies significantly from require warranties on “an indemnity basis” like in the US, and a transaction to transaction, where it more or less comes down to seller will normally resist such an approach and instead provide bargaining power and leverage; if there is great competition for indemnities for specific identified risks. However, indemnities a target, only limited warranties will be given, and if the target is are common in share purchase agreements and asset purchase less sought after, then a more extensive warranty catalogue may agreements. Indemnities mainly cover potential claims, losses be obtained. or liabilities that the buyer has revealed during due diligence The typical packages of warranties and indemnities offered by and that have not been addressed as a “to be fixed” issue or a PE seller in the Norwegian market can, to some extent, also by a price reduction. In general, all PE funds are looking for be influenced from market practices in the fund’s home juris- a complete exit with cash on completion and, depending on at diction. It is, for example, a well-known fact that many UK what stage of the fund’s lifetime the exit takes place, such funds Sponsors rarely want to provide business representations and will normally seek to resist or limit any form of indemnification warranties, which means that the PE fund will try to limit the clauses in the SPA. warranty package to so-called fundamental warranties (i.e. owner- Nevertheless, as long as the PE fund selling is Norwegian ship to shares, valid execution of documentation, etc.). Instead, or Nordic, it has not been common to insist that a buyer relies these sellers will attempt to make the buyer rely on its own due solely on indemnities provided by the management team. diligence and, if possible, by warranties provided by the target’s Instead, the PE funds have tried to accommodate buyer’s management team. This means that when such Sponsors are requests for indemnities, but at the same time introduce special attempting an exit of a Norwegian portfolio company, they caps and deadlines for such potential liability. To the extent may attempt to apply the same practice depending on what they possible, the PE vendor might also attempt to insure all poten- expect is the most likely “buyer-universe” for the relevant assets. tial liability claims, but some diligence findings may often be of This being so, such an approach is rarely seen in the Norwegian such nature that insuring it is rather difficult. In some cases, the market, at least if the seller is a Norwegian or Nordic PE fund. insurance premium is also so high that it is better to negotiate an Throughout 2016 and 2017, sellers in general had to accept appropriate price reduction. W&I insurances, including special a fairly broad set of representations and warranties if they claims insurances, have, however, started to become increas- wanted a deal to succeed in the Norwegian market, and the ingly popular in the Norwegian market (see question 6.4 below). warranty catalogue remained at least as extensive in 2018 and 2019. During this period, buyers often succeeded in broadening 6.4 To what extent is representation & warranty the scope of the warranty coverage; for example, by including insurance used in your jurisdiction? If so, what are the some type of information warranties in the contracts. However, typical (i) excesses / policy limits, and (ii) carve-outs / exceptions did apply, especially in particular sectors, depending exclusions from such insurance policies, and what is the on the parties’ bargaining position. For some extremely attrac- typical cost of such insurance? tive assets sold through dual-tracks, we also witnessed that PE vendors in some situations managed to get away with a W&I insurance has historically not been a common feature very limited set of fundamental warranties (only), and where in the Norwegian deal landscape. However, during 2013 and the buyer had to rely completely on Warranty and Indemnity throughout 2019, the Norwegian market witnessed a substantial (“W&I”) insurance. growth in the number of transactions in which the seller or the In general, the representations and warranties packages buyer attempted to use W&I insurance as a way to reach agree- offered by a typical PE vendor in the Norwegian market will ment on liability under the SPA (or, alternatively, introduced by be fairly limited, but may, at first glance, not look too different a buyer in order to achieve a competitive advantage in a bidding from what a strategic seller may propose in its first draft. process). For 2019, we estimate that close to 20% of all M&A Foreign Sponsors should note that, historically, it has not deals in Norway used this type of insurance. been very common that Norwegian or Nordic Sponsors insist The W&I insurance product has become particularly popular on the Investing Management providing separate management among PE funds seeking a clean exit. Such funds have now

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started to arrange “stapled” buy-side W&I insurance to be made international PE funds exit investments, to propose a different available to selected bidders in structured sales processes. Such set of warranties and indemnities for the PE fund and the insurances have also been used as a tool for the PE fund in order target’s management team (see question 6.3) and thereby also a to get rid of the escrow clause in the SPA. Typical carve-outs/ different set of limitation rules for the management. However, exclusions under such policies will comprise: pension under- in the event that the buyer is an international PE fund and the funding; projections; transfer pricing issues; anti-bribery; management team has to rollover parts of its investments, such secondary tax obligations; and uninsurable civil fines or penal- international funds may want to request that the Investing ties. For more on excess/policy limits, see question 6.5 below. Management in the co-investment agreement/shareholders’ The cost of such insurance depends on the industry in which the agreement provides the fund with separate representations and target operates, the type of insurance coverage requested, the warranties (see question 6.3). target itself and the parties involved, but will typically be in the range from around 0.8% to 1.8% of the insured amount. 6.6 Do (i) private equity sellers provide security (e.g. escrow accounts) for any warranties / liabilities, and 6.5 What limitations will typically apply to the liability (ii) private equity buyers insist on any security for of a private equity seller and management team under warranties / liabilities (including any obtained from the warranties, covenants, indemnities and undertakings? management team)?

Save in respect of vendor liability for locked-box leakage or As mentioned in questions 4.2 and 6.4, PE vendors will, by breach of specific restrictive covenants, which are normally virtue of seeking a clean exit without any clawback or similar subject to special liability regulations (please see question 6.3), a post-closing issues, rarely accept security arrangements like PE vendor will normally attempt to include several limitations escrow accounts unless absolutely necessary. Depending on the on its potential liability for breach of the SPA and its obligations, circumstances, PE buyers may insist to include escrow provi- covenants, warranties and indemnities thereunder. Significant sions into the SPA as security for sellers’ warranties/liabilities. variations will apply depending on the market conditions, the As with most other elements in a given transaction, however, parties’ bargaining position, the target’s industry sector and this comes down to prevailing market conditions and the individual circumstances. parties’ relative bargaining positions. It has not been common Historically, if a PE fund was on the sell-side, it would very practice among Norwegian PE funds to request that the target’s often start with proposing a six to 12-month limitation period Investing Management in the co-investment agreement/share- for the general warranties, and a period of between 12 and 24 holders’ agreement provides the fund with separate representa- months for the tax warranties. However, the introduction of the tions and warranties (see question 6.3). As alluded to in ques- W&I insurance product has led some of the Norwegian funds tion 6.5, such arrangements are, however, seen if the buyer is an to become slightly more generous with the length of the limi- international PE fund and the management team has to rollover tation periods offered in their first draft of the SPA. The main parts of its investments. reason is that the insurance market is able to offer a 24-month limitation period for the general warranties, and between five 6.7 How do private equity buyers typically provide and seven years on tax warranties at a very little price difference comfort as to the availability of (i) debt finance, and (ii) compared to shorter limitation periods. equity finance? What rights of enforcement do sellers A PE vendor will typically (but depending on the market typically obtain in the absence of compliance by the conditions) also start off with proposing a relatively high “de buyer (e.g. equity underwrite of debt funding, right to minimis” (single loss) threshold combined with a basket amount specific performance of obligations under an equity commitment letter, damages, etc.)? in the upper range of what traditionally has been considered “market” in Norway for such limitation provisions. PE funds exiting their investments today may also attempt to align the The sellers’ process letters to PE buyers will normally instruct basket amount with the policy “excess amount” under W&I that a buyer’s final bid must be fully financed (i.e. expressly state insurance. This typically means an amount from 0.5% to 1% that it is not subject to financing), and that the sources thereof of the target’s enterprise value, depending on the insurance must be reasonably identified. If financing is to be provided by market and which insurance provider is underwriting the policy. external sources, the final bid must also provide the terms and The standard policy excess amounts offered by the insurance status of all such financing arrangements (including any commit- industry is normally 1% of enterprise value, which is above ment letters), as well as the contact details of the relevant institu- the historical level of what has been considered market value tions providing financing (the buyer is often requested to inform for the basket amounts in Norway, but currently an increasing the institutions that a seller’s representative may contact them). number of insurers are willing to offer 0.5% of the enterprise It has become common that sellers insist that the SPA contains value as the policy excess amount. While the majority of the buyer warranties regarding the equity financing commitment deals in the Norwegian market traditionally are done with a (if applicable to the transaction). A PE fund is often required “tipping basket” (whereby the seller is responsible for all losses to provide an equity commitment letter to backstop its obliga- and not just those exceeding the basket amount), an exiting PE tion to fund the purchasing vehicle (BidCo) immediately prior fund may propose a “deductible basket” (whereby the seller is to completion. However, such equity commitment letters will only responsible for losses in excess of the basket amount). The often be addressed to the TopCo in the string of holding compa- result in the final SPA depends on market conditions and the nies that owns BidCo (or to a subordinated HoldCo further bargaining position of the parties involved. A PE vendor will down in the string of holding companies). The enforceability of also normally propose to cap its total liability at the lower end of such equity commitment letters is most often qualified upon a what is market, for example by proposing an overall liability cap set of conditions, and the PE fund’s liability under the letter is, of 10% of the purchase price. in all events, capped at a designated committed amount. Finally, it should be noted that it has thus far not been tradi- In respect of the above, a seller should note that Norwegian tion among Norwegian PE funds, as sometimes seen when corporate law adheres to the concept of corporate personhood,

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whereby a company is treated as a separate legal person, solely low appreciation and high dividends is normally not relevant for responsible for its own debts and promises, and the sole bene- PE-backed portfolio companies. Timing is also of the essence, ficiary of credits it is owed. Related parties will thus not incur and sometimes the window of opportunity is simply closed due liability for a company’s promises/guarantees, and a Norwegian to prevailing market conditions. If that is the case, an alterna- court of competent jurisdiction will only in exceptional circum- tive approach can be to carry out a private placement in advance stances (e.g. in connection with legal charges of fraud or tax – either in order to raise both new equity and new shareholders, evasion) pierce the corporate veil through application of the or just for raising new equity and to take the spread upon the alter ego doctrine. As such, guarantees that furnished a seller listing itself. exclusively by BidCo (by way of copies of a commitment letter The second main deliberation a PE fund contemplating an or other form of promissory notes issued to BidCo) will only be IPO exit must make is of whether the target is ready, willing and enforceable against BidCo, which normally does not have any able to go public. Irrespective of excellence, the public investor funds besides its share capital (in Norway, the minimum share market for the relevant industry sector may simply be saturated, capital for a LLC is NOK 30,000). Consequently, a careful seller and, in such a situation, a newcomer will most likely struggle will often require a limited right to enforce the equity commit- severely to get both traction and attention. From an internal ment letter directly against the PE fund itself. point of view, there are also the household tasks of getting procedures and regulations up to STA standards and listing requirements, preparing financial and other pertinent investor 6.8 Are reverse break fees prevalent in private equity transactions to limit private equity buyers’ exposure? If documentation, and training management and key personnel, so, what terms are typical? whom frequently have very limited insight into the dynamics and requirements of a public company in terms of governance, reporting, policy implementation, etc. Reverse break/termination fees have historically not been prev- Thirdly, and assuming the target is deemed suitable for listing alent in Norwegian PE transactions, and PE funds have rather and that all elements above have undergone careful scrutiny, the sought to make their obligation to consummate the transaction PE fund must consider whether it is prudent to place all its eggs conditional upon receiving required financing, without having in the IPO basket, or whether it is smarter to initiate a dual-track to pay any form of fees to the sellers. To what extent sellers process – combining the IPO exit with either a structured or a are willing to accept such conditions normally depends on the private (bilateral) sales process. Such a process may either be a market situation and the respective parties’ bargaining posi- “true parallel” (where both routes run parallel and ultimate deci- tions. Such financing out conditions/clauses have not disap- sion is deferred to final stages), “staggered” (where the M&A peared in today’s market, but sellers tend to resist these types process front-runs the IPO process and the ultimate decision is of conditions. made after receipt of second round bids), or an “IPO-led hybrid” Over the last few years, we have observed that the use of (where both routes’ preparation and progress is dictated by the reverse break fees is on the rise (albeit very slowly), and whereas IPO timeline). The process of preference notwithstanding, the virtually no M&A transactions in the Norwegian market obvious advantages of initiating a dual-track process is a better included reverse break fees a few years ago, our PE clients have understanding of market value and investor/buyer universe, regularly, during the last few years, enquired about its feasibility. increased flexibility, and reduction of transactional risk – each The amount of a reverse break fees is largely a matter for track is effectively the fail-safe of the other. On the reverse negotiation and will therefore vary in each individual transac- comes added and often concurrent work streams, prolonged tion. Typically, however, the fees are agreed at a fixed amount timelines, the inherent risk of prematurely deviating from the in the range of 1% to 2.5% of transaction value. dual-track (which may cause internal friction and stoppages) and, of course, the additional advisor costs. 72 Transaction Terms: IPOs

7.2 What customary lock-ups would be imposed on 7.1 What particular features and/or challenges should private equity sellers on an IPO exit? a private equity seller be aware of in considering an IPO exit? Although significant variations may apply, Managers are From a PE perspective, three main considerations guide the normally subject to a 180-day lock-up period from listing (the determination of whether an IPO exit is the right choice. The last couple of years we have seen examples as high as 360 days). first, which goes to the very nature of the PE model, is whether Lock-up periods for co-investing management are somewhat the PE fund through an IPO exit achieves the best possible less common, but, if imposed, tend to range in the region of price for its shares, while at the same time reducing its expo- 360 days. sure (shareholding) to an acceptable level. A successful IPO often requires that investing shareholders receive a discount of 7.3 Do private equity sellers generally pursue a dual- between 10% and 15% on the regular trading price, and the PE track exit process? If so, (i) how late in the process are fund seldom manages to offload 100% of its shareholding. A private equity sellers continuing to run the dual-track, clear strategy for continued ownership is thus imperative, espe- and (ii) were more dual-track deals ultimately realised cially considering that a larger shareholder’s planned/impending through a sale or IPO? sale (typically upon expiry of relevant lock-up periods) will put substantial negative pressure on the share price. Another key PE sellers’ preferences for dual-track processes are generally element in terms of achieving the best sales price will be the subject to equity market momentum (i.e. that the capital market formulation of a powerful equity story, which, in essence, is the may offer superior valuation to M&A alternatives) but where an sales pitch and reasoning why investors should pick up the share. IPO valuation could be close to LBO valuations, and where the For PE funds, the equity story highlights the strong sides of the lead buyer(s) is less clear. Under such circumstances, dual-track target in a growth perspective, with focus on a high appreciation exit processes are used to maintain flexibility, to help maximise potential – the value perspective, accentuating expectations of valuation and for de-risking a potential IPO. Dual-track exit

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processes allow the sellers maximum visibility, and the deci- of shares in a target company (or its parent company). This sion on the M&A track should be resolved a short time ahead of prohibition prevented Norwegian target companies from partic- launching the company’s intention to float (“ITF”) since inves- ipating as co-borrowers or guarantors of any acquisition-financing tors do not focus during pre-deal investor education sessions facilities. However, in practice, there have always been a number until clarity on the winning track is announced. Consequently, of ways to achieve at least a partial debt pushdown through refi- a second round M&A process will normally run parallel to nancing the target company’s existing debt, which should not be research drafting under the IPO track. The decision on the regarded as a breach of the prohibition against financial assistance. winning track is often taken shortly before roadshow launch Effective from 2013, the Norwegian Parliament introduced a under the IPO track. Whether dual-track deals are ultimately type of “whitewash” procedure, allowing both public and private realised through a sale or IPO depends on the momentum in the target companies to provide financial assistance to a potential equity markets but these deals have, during the last few years, buyer of shares in such target (or its parent company), provided, often materialised in a sale. inter alia, such financial assistance did not exceed the funds available for distribution of dividend. Such financial assistance had 82 Financing to be granted on normal commercial terms and policies, and the buyer also had to deposit adequate security for his obligation to 8.1 Please outline the most common sources of debt repay any financial assistance received from the target. finance used to fund private equity transactions in your The rule’s requirement for depositing “adequate security” for jurisdiction and provide an overview of the current state the borrower’s obligation to repay any upstream financial assis- of the finance market in your jurisdiction for such debt tance provided by a target in connection with M&A transactions (particularly the market for high yield bonds). would, however, mean that it was quite impractical to obtain direct financial assistance from the target company in most LBO trans- Norwegian LBOs generally involve bank debts as the main actions, due to the senior financing banks’ collateral requirements source for financing in the form of term loans and a revolving in connection with such deals. The reason for this was that the credit facility. In large transactions, the senior loan will be banks normally request extensive collateral packages, so that, in governed either by Norwegian or English law, with one bank practice, there would be no “adequate security” left or available acting as an agent for a lending syndicate. In such syndicated from the buying company (or its parent company) for securing any transactions, the senior loan agreements used are normally financial assistance from the target group, at least for the purchase influenced by the forms used internationally, in particular the of the shares. With effect from 1 January 2020, this situation has standard forms developed by the Loan Market Association. A now changed. typical leveraged PE structure may, depending on the size of First, provided the target company is a Norwegian the target, contain several layers of debt. Historically, it was ASA-Company, an exemption from the dividend limitation rule quite common to use a combination of senior facilities and has now been implemented with effect from 1 January 2020. This mezzanine facilities, whereby security is granted to a security exemption rule will, however, only apply if the bidder (as borrower) agent. In certain circumstances, the mezzanine debt was also is domiciled within the EEA area and is part of or, after an acqui- issued in combination with warrants to purchase equity in the sition of shares, will form part of a group with the target company. target. However, due to the severe hit mezzanine investors In such latter situations, the financial assistance may now also faced during and after the credit crunch, it became difficult to exceed the target company’s funds available for distribution of obtain such financing at reasonable prices, and many Sponsors dividend. This group exemption will, however, not apply if the started to consider mezzanine financing too expensive. Over target company is a Norwegian ASA-Company. the last seven years, mezzanine financing has rarely been seen in Second, from the same date, the requirement for the buyer (as the Norwegian market for new transactions. One of the more borrower) to provide “adequate security” for its repayment obli- important reasons for this change has been the development of a gation will no longer be an absolute condition for obtaining such very buoyant Norwegian high-yield bond market, which largely financial assistance from the target company. That said, due to substituted the traditional mezzanine facilities. Such transac- the requirement that such financial assistance has to be granted tions would typically involve “bridge-financing commitments” on normal commercial terms and policies, it cannot be completely pursuant to which either a bank or a mezzanine provider agrees ruled out that a bidder, in the future, may still have to provide to provide “bridge” loans in the event that the bond debt cannot some sort of “security” for being allowed to obtain financial assis- be sold prior to completion. Due to a rapid decline in oil prices tance from a Norwegian target company. Nevertheless, as long as during 2014 and 2015, the Norwegian high-yield bond market it can be argued the acquisition being in the target company’s best took a severe hit from October 2014 and onwards throughout interest and such financial assistance can be justified in absence most of 2016. However, since the beginning of 2017 and of any security, after 1 January 2020, it will now be possible for a throughout 2019, the Norwegian high-yield bond market has target company to grant financial assistance to a bidder without improved significantly, at least within certain selected industries. such security. Any financial assistance must still be approved by the general meeting, resolved by at least two-thirds of the aggregate vote cast 8.2 Are there any relevant legal requirements or and the share capital being represented at the meeting (unless restrictions impacting the nature or structure of the debt otherwise required by the target company’s articles of association). financing (or any particular type of debt financing) of private equity transactions? In addition, the board must ensure that a credit rating report of the party receiving the financial assistance is obtained and, also, that the general meeting’s approval is obtained prior to any financial From 1 January 2020, certain further easing of the Norwegian assistance actually being granted by the board. The board shall financial assistance prohibition rule has now finally been also prepare and execute a statement, which must include: (i) infor- adopted (see below). mation on the background for the proposal of financial assistance; As a general rule, the Norwegian public and private limited (ii) conditions for completing the transaction; (iii) the price payable liability companies have been prohibited from providing by the buyer for the shares (or any rights to the shares) in the upstream financial assistance in connection with the acquisition target; (iv) an evaluation about to what extent it will be in the

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target’s best interest to complete such transaction; and (v) an typically include: (i) quantification of the tax costs associated with assessment of the effect on the target’s liquidity and solvency. the acquisition; (ii) management of tax charges of the target group; From 1 July 2014, Sponsors must also ensure that they (iii) exit planning (including a partial exit); and (iv) tax-efficient observe the anti-asset stripping regime that is set out in the Act compensation to the management of the target group. Sponsors on Alternative Investment Fund Managers (see question 10.2). operating in the Norwegian market quite commonly use offshore These rules may limit the Sponsor’s ability to conduct debt push- structures for achieving a tax-efficient acquisition structure. downs, depending on the status of the target (listed or non-listed), the number of employees in the target and the size of the target’s Costs of acquisition revenues or balance sheet. No stamp duties, share transfer taxes or other governmental fees Further, it should be noted that the power of a Norwegian apply in connection with a share sale under Norwegian law. The entity to grant security or guarantees may, in some situations, also tax treatment of transaction costs depends on whether these are be limited by the doctrine of corporate benefit. Under Norwegian classified as costs for acquisitions/disposals, operating costs, or law, it is uncertain if a group benefit is sufficient when there is no debt financing costs. benefit to the individual group company; for example, in connec- As a general principle, all transaction costs incurred directly tion with such individual group company granting a guarantee in connection with an acquisition of shares should be capital- or providing a security. Previously, it has been assumed that ised for both accounting and tax purposes with the acquired Norwegian companies are able to provide upstream and cross- shares. The costs will be added to the tax base of the shares stream guarantees, provided that: (i) this will not jeopardise its and may therefore reduce any capital gain arising upon a subse- continuing existence; (ii) its corporate objects are not transgressed quent disposal to the extent the disposal is not covered by the by such transactions; (iii) it can be argued that such cross guaran- Norwegian participation exemption rules. Note that, according tees benefitting the Norwegian company exist or that the relevant to the Norwegian participation exemption rule, Norwegian group company receives any type of guarantee fees; and (iv) such shareholders which are limited companies, as well as certain guarantees and securities are not in breach of the financial assis- similar entities (corporate shareholders), are generally exempt tance propitiation. However, an amendment to the Companies from tax on dividends received from, and capital gains on the Acts from 2013 now seems to indicate that a group benefit may realisation of, shares in domestic or foreign companies domi- be sufficient when issuing an intra-group guarantee, even if there ciled in EEA Member States including the EU, Norway, Iceland is no direct benefit to the individual group company issuing the and Liechtenstein. Losses related to such realisations are not guarantee. tax-deductible. Since normally both the target and BidCo used Finally, PE funds’ use of various forms of shareholder loans by the PE fund will be LLCs domiciled in Norway, the acquisi- and inter-company debt, supported by various intra-group guar- tion costs in connection with a share deal will not effectively be antees in LBO transactions, could also trigger a need for the deductible under the current Norwegian tax regime. board to prepare special reports for the various group companies, Notwithstanding the above, certain expenses incurred by a and require such reports to be filed with the RBE in order to be company in connection with the ownership of shares/subsidi- valid. This could turn out to be necessary unless such loans are aries (i.e. costs for corporate management and administration, entered into as part of the relevant subsidiaries’ ordinary course strategy work and planning, marketing costs, financing costs, of business activity and contain prices and other terms that are restructuring costs, etc.) should be deductible on a current basis normal for such agreements. In legal theory, it has, however, been for corporate tax purposes under Norwegian law. Broken-deal argued that intra-group loan agreements entered into in connec- expenses which are incurred in connection with failed acquisition with M&A transactions very often, must be considered to fall tions of shares (typical expenses relating to due diligence) are outside the normal business activity of the respective company not deductible for tax purposes. receiving such financing and, therefore, under all circumstances, In principle, costs of arranging the financing (i.e. fees in falls within the scope of such reporting requirements. connection with obtaining and maintaining debt, bank charges and associated advisory/legal fees) should be deductible on a current basis. It is important to distinguish between financing 8.3 What recent trends have there been in the debt financing market in your jurisdiction? costs, which are considered interest for tax purposes, and other financing costs, as interest costs are subject to the Norwegian interest-deduction limitation regime (see below). For the last few years, we have started to see increased activity The acquisition vehicle will, in addition, seek to maximise its from non-bank (alternative) lenders and funds which are offering recovery of VAT incurred in acquiring the target (particularly in to replace or supplement traditional senior secured bank loans. relation to advisory fees). Generally, input VAT on advisory fees The products these lenders are offering typically include term in relation to acquisition of shares is not recoverable/deductible loan B facilities, unitranche loans, etc. for VAT purposes. In addition, an increasing number of banks also seems willing to offer PE funds so-called “capital call facilities”, “subscrip- Deductibility of interest tion facilities” or “equity bridge facilities” to provide short- In order to reduce the buyer’s effective tax rate, PE funds are term bridge financing for investments, ultimately financed from desirous to offset the interest costs on the acquisition debt against capital contributions from the limited partners of the PE funds. the operating target group’s taxable profit. Consequently, the acquisition structure is normally established to maximise the 92 Tax Matters amount of financing costs that can be offset against the operating profit of the target group. Where the target group is multi- 9.1 What are the key tax considerations for private national, the fund will also desire that interest costs can be equity investors and transactions in your jurisdiction? “pushed down” into the jurisdiction that has profitable activi- Are off-shore structures common? ties without the imposition of additional tax costs such as WHT. Additional tax minimisation techniques may also be used to Key tax considerations relating to Norwegian PE acquisitions manage the target group’s tax charge. Parts of the PE fund’s investment may also be made in the form of shareholder loans,

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which may generate additional tax deductions, provided this can in the group accounts relating to the Norwegian company or be structured in a way that current tax liabilities are not imposed the Norwegian part of the company group, must be allocated on the fund’s investors and Sponsors in some form of phantom to these entities. The local balance sheets must also be adjusted income. for intra-group shares and claims which are consolidated line by Historically, under Norwegian law, interest arising on related- line in the group accounts. Shares in and claims against such party debt was considered deductible for tax purposes to the group companies shall be set off against debt and total assets extent that the quantum and terms of the debt was arm’s length when calculating the group’s equity ratio. The adjusted group in nature. Over recent years, the Norwegian tax authorities accounts and the adjusted local accounts for the Norwegian have taken an increasingly aggressive approach in challenging company or the Norwegian part of the group, must be approved leveraged structures; in particular by challenging the substance by the companies’ auditor. of non-Norwegian holding company structures, distributions The “separate entity rule” only applies if the net interest out of liquidation and the tax deductibility of interest on expenses (both internal and external) exceed NOK 5 million. shareholder debt. This rule caps the interest deductions on loans from related From the income year 2014, rules limiting the deduction of parties to 25% of the borrower’s “taxable earnings before net interest paid to related parties entered into force. The rules interest, tax, depreciation, and amortisations”. The term “related aim to eliminate, or reduce the risk of, the Norwegian tax base party” covers both direct and indirect ownership or control, and being excavated as a result of tax planning within international the minimum ownership or control required is 50% (at any time groups where the debt has been allocated to the Norwegian during the fiscal year) of the debtor or creditor. Also, a loan group companies. Additional restrictions on interest deduc- from an unrelated party (typically a bank) that is secured by a tions have been implemented later. With effect from 1 January guarantee from another group company (i.e. a parent company 2019, interest payable on bank facilities and other external debt guarantee), will also be considered an intra-group loan under have also become subject to a similar interest-deduction limita- this rule. Nevertheless, interests paid under a loan secured by tion regime, as interest paid to “related parties” for companies a related party is not subject to the “separate entity rule” if the within a “group”. The group definition includes all companies security is a guarantee from a subsidiary owned or controlled by which could have been consolidated if IFRS had been applied. the borrowing company. The same exemption applies on loans The original “separate entity rule” will exist in parallel with the from a third party secured by a related party of the borrowing new “group rule”. In situations where a Bidco is used for an company if such related-party security is either (i) a pledge over acquisition, one should assume that the “group rule” will apply that related party’s shares in the borrowing company, or (ii) a for limitation of Bidco’s and its subsidiaries’ interest deduc- pledge or charge over that related party’s outstanding claims tion. Interest cost disallowed under the limitation rules can be towards the borrowing company. For security in the form of carried forward for 10 years, but subsequent deduction is also claims towards the borrower, it is not required that such claim dependent on capacity for interest deduction, inter alia, within is owned by a parent company. Negative pledges provided by a 25% of taxable EBITDA. related party in favour of a third-party lender are not deemed The “group rule” applies if the annual net interest expenses as security within the scope of the interest limitation rule. exceed NOK 25 million in total for all companies domiciled in Consequently, in a situation where the acquisition vehicle is Norway within the same group. Where the threshold amount excessively leveraged from a tax point of view, any interest over is exceeded, deductions are limited to 25% of taxable EBITDA and above the limitation rules will be non-deductible. on a separate company basis. Note that the “separate entity It should also be noted that the acquisition vehicle itself would rule” also applies to a group company when interest is paid to a normally have no taxable profits against which to offset its related party outside of the consolidated group (typically where interest deductions. Therefore, it is critical for the Norwegian the related lender is an individual or a company not belonging to holding companies in the acquisition structure to be able to the consolidated group for accounting purposes). Two escape offset its interest expenses against the possible profits generated rules allowing deduction of interest payments on loans from by the target’s operations. Norwegian companies cannot file third parties not forming part of any tax evasion scheme have consolidated tax returns or form fiscal unities, but a transfer of been implemented. Under the first rule, which applies to each taxable income within an affiliated group of Norwegian enti- Norwegian company in a group separately, the equity ratio in ties is possible through group contributions. Group contribu- the balance sheet of the Norwegian company is compared with tions allow a company to offset taxable profits against tax losses the equity ratio in the consolidated balance sheet of the group. in another Norwegian entity in the same fiscal year by transfer- A group company established in the fiscal year or a surviving ring funds or establishing an account receivable. It is possible company in a merger during the fiscal year cannot apply this to grant more group contribution than taxable income, but the rule to obtain interest deduction. Under the second escape rule, grantor company will not be able to deduct the excess amount. which applies to the Norwegian part of the consolidated group This excess amount, which is not deductible for the grantor, as a whole, the equity ratio for a consolidated balance sheet of would equally not be taxable for the recipient. The distribut- the Norwegian part of the group is compared with the balance able reserves form the limit for total group contribution and sheet of the group. In both cases, the Norwegian equity ratio dividend distribution. In order to enable group contributions, must be no more than two percentage points lower than the the contributing and receiving entities must be corporate enti- equity ratio of the group as a whole. Companies qualifying for ties taxable in Norway, an ultimate parent company must hold the equity escape clauses may deduct net interest expenses in more than 90% of the shares and voting rights of the subsidi- full, except for interest expenses to related parties outside of aries (either directly or indirectly) at the end of the parent’s and the group. Several adjustments have to be made to the balance the subsidiaries’ fiscal year, and the companies must make full sheet of the Norwegian company or the Norwegian part of the disclosure of the contribution in their tax returns for the same group when calculating the equity ratio. If different accounting fiscal year. principles have been applied in the local Norwegian accounts Norway does not currently levy WHT on interest payments to and group accounts, the local accounts must be aligned with foreign lenders, nor on liquidation dividends to foreign share- the principles applied in the group accounts. Further, goodwill holders. Nevertheless, see question 9.4 below with regard to and badwill, as well as other positive or negative excess values expected changes to the current tax regime.

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Distributions of dividends Exit planning Normally, in a typical LBO, it will not be envisaged that any divi- In general, it is of vital importance to PE funds that all poten- dends will be made by the Norwegian holding company struc- tial exit scenarios are anticipated and planned for when formu- tures during a PE fund’s investment period except in respect lating the final acquisition structure. This means that the advi- of potential partial exits. However, in the event that any distri- sors need to consider a full exit, partial exit, IPO, etc. butions from the Norwegian holding company structure are As described above, the ultimate parent company in the acqui- required prior to exit, Norwegian WHT on dividends will need to sition structure will quite often be a foreign entity. Foreign- be considered. The applicable WHT rate depends on the respec- domiciled carried interest holders are thus able to benefit from tive tax treaties and (typically) on the foreign shareholder’s owner- the remittance basis of taxation in respect of carried interest ship percentage in the Norwegian holding companies. Norway distributions arising from an exit. That being said, it is never- has a broad network of tax treaties which reduce the ordinary theless critical that any exit can be structured in such way that WHT rate of 25%. It should be noted that Norway has imple- it does not trigger any WHT or other tax leakages and, where mented the OECD multilateral instrument for avoidance of base possible, that any exit proceeds can be taxed as capital gains for erosion and profit shifting, introducing a principal purpose test in investors, carry holders and management. As described earlier, many treaties. All existing treaties should be considered carefully, Luxembourg holding companies (“LuxCo”) are often used to to analyse their current status when relying on treaty protection. achieve such objectives. Under domestic legislation, no WHT is imposed on dividends or liquidation dividends paid by a Norwegian LLC to an Executive compensation EEA resident corporate shareholder, provided the shareholder In addition to receiving salaries, which under Norwegian law is genuinely established and conducts real business activity in is subject to income tax and national insurance contributions the relevant jurisdiction. Furthermore, the EEA resident corpo- in the normal way, members of the target’s management team rate shareholder must be comparable to a Norwegian LLC. In (the Investing Management) will normally also be offered an this context, an assessment must be performed to determine opportunity to subscribe for shares in BidCo. To the extent whether the company is genuinely established pursuant to a that the Investing Management pays less than the market value business motive and that the establishment is not purely tax of such shares, this could give rise to an employment tax charge motivated. The assessment will differ according to the nature (see above under question 2.3). As employers’ contributions to of the company in question, and it is assumed that the assess- the social security tax are deductible, the effective rate for the ment of a trading company and a holding company will not be employer should be lower than the standard 14.1%. Normally, the same. If such criteria are not met, then the WHT rate in the PE fund will split its investment between ordinary equity the applicable double-taxation treaty for the relevant jurisdic- and preferred equity or debt, while the Investing Management tions involved will apply. Also note, if such a foreign holding invests in ordinary shares. As a result of this, the ordinary shares company is considered an agent or nominee for another real will normally have a low initial market value, but with the poten- shareholder (not a legal and economic owner of the dividends) tial to appreciate significantly if the acquired business generates or a pure conduit company without any autonomy to decide what the PE fund’s desired IRR. In order to avoid accusations that the to do with its income, the Norwegian tax authorities may apply Investing Management were allowed to subscribe their shares at the default 25% WHT rate (i.e. not accept treaty protection). a price lower than market price, it is fairly normal that the value Foreign buyers of Norwegian assets should thus be cautious of the Investing Management’s shares is confirmed by a valua- when setting up acquisition structures and include tax reviews tion carried out post-acquisition. Further, it is not uncommon of any prior holding structures when conducting due diligence. that particular foreign PE funds require that members of the Paid-in capital is an individual tax position for the share- Investing Management accept an appropriate indemnity in the holders. A foreign holding company which has paid in a shareholders’ agreement to cover any potential employment tax premium to an acquisition vehicle can repay such paid-in capital obligations arising as a result of the Investing Management’s with no risk of dividend WHT. In case of a dividend distribu- equity investment. tion where there is a risk for WHT, a shareholder with paid-in Any employment taxes arising because of the Investing capital as a tax position can opt to allocate the distribution to Management obtaining shares at a discount must be reported to its individual paid-in capital account, thereby avoiding divi- the Norwegian tax authorities immediately after the transaction dend WHT. When setting up a Norwegian Bidco, one should in the relevant tax period. thus register a limited amount as nominal share capital and the remaining equity as paid-in premium, to allow for tax-exempt 9.2 What are the key tax-efficient arrangements that distributions during the holding period. are typically considered by management teams in private It should also be noted that dividends received by a Norwegian equity acquisitions (such as growth shares, incentive company on business-related shares in group subsidiaries within shares, deferred / vesting arrangements)? the EEA held directly or indirectly with more than 90% inside the EEA are exempt from Norwegian corporate tax on the part The most common tax-efficient arrangement considered by of the receiving corporate shareholders. However, 3% of the management teams in PE portfolio companies is to struc- received dividends are subject to taxation for corporate share- ture the managements’ equity participation via private holding holders holding not more than 90% of the shares. This entails companies to benefit from the Norwegian participation exemp- an effective tax of 0.66% as from 2019. This rule should level the tion rule. Under Norwegian law, arrangements such as growth benefit that shareholders are allowed tax deduction for owner- shares and deferred/vesting arrangements may entail a risk that ship costs incurred on shares subject to participation exemption. parts of any capital gains will be subject to employment income Under the Norwegian GAAP, dividends received from wholly tax and social security, although this liability will only arise when owned subsidiaries can be recognised in the accounting year the such shares are sold, provided such shares when acquired were dividend is based on, hence making the basis for a distribution acquired or subscribed at their fair market value. If, however, from the parent company in the same accounting year. This may such securities are considered discounted, such discount will be allow for a tax-effective and quick cash flow to handle bridge chargeable to income tax at the relevant employee’s marginal financing in an acquisition.

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tax rate and will be subject to social security tax. Generally, parties) will be taxed as dividends on the part of such individual arrangements initiated by the principal or the employer, which shareholder (see question 9.4 below). Nevertheless, the taxed reduce the risks for the Investing Management, increase the risk amount will increase the shareholder’s individual paid-in capital of reclassifying capital gains to salary for the management. As position, and can be distributed as a dividend subsequently this would both increase the tax burden and social security obli- without taxation. The Investing Management must also consider gations for the management and the employer, diligent planning if any restrictions to the transferability and other terms at which should be in place for any management incentive plans. new shares/financial instruments will be acquired may affect No similar rules to the UK “entrepreneurs’ relief ” exist under the income tax treatment of such instruments. Links which are Norwegian law. International PE-funds may still want to struc- too close to the employment can lead to the re-characterisation ture their management investment programmes in Norwegian of the income/gains from such instruments. For more issues, portfolio companies to meet the conditions for such relief in please see questions 2.3 and 9.1 above. case existing or future members of the Investing Management team would qualify for such relief due to their current tax domi- 9.4 Have there been any significant changes in tax cile. Some limited-tax incentive schemes are available for the legislation or the practices of tax authorities (including discounted acquisition of shares, with options for employees to in relation to tax rulings or clearances) impacting private acquire shares in the employing company. However, the general equity investors, management teams or private equity tax rule allowing a tax-exempt discount for purchasing shares is transactions and are any anticipated? very limited and must include all employees. The general rule of taxation of options in employment only allows for the poten- There are no explicit Norwegian tax regulations regarding tial beneficial timing of the taxation. However, employees in distribution of Carry to the Managers in exchange for their small start-up companies are entitled to a more substantial tax services, and the prevailing view was, until recently, that insofar incentive by way of deferring the taxation of options until the such Managers invest capital into the funds, the Carry must be acquired shares are realised by the employee. Nevertheless, considered capital gains and taxed at capital gains rates, and if the the maximum deferred benefit is NOK 1 million and there is Managers are organised as LLCs, such corporate shareholders’ both a minimum and maximum holding period for the incen- income in form of dividends and gains on shares/ownership tive to apply. The final total tax burden is also potentially higher interest in other companies would also be exempt from taxation compared to an ordinary acquisition of shares without deferred in accordance with the Norwegian exemption method. taxation for both the employer and the employees. In the past few years, Norwegian tax authorities started to challenge the above view by seeking to treat Carry as ordinary 9.3 What are the key tax considerations for income and thus subject it to income taxation (which is higher management teams that are selling and/or rolling-over than taxation rates for capital gains). This culminated in a legal part of their investment into a new acquisition structure? process between the tax authorities, a Manager called Herkules Capital and the Manager’s three key executives and ultimate The key tax considerations for the Investing Management shareholders (the “Key Executives”), which in November selling and/or rolling over part of their investment into a new 2015, found its conclusion when the Norwegian Supreme Court acquisition structure, include: rejected the tax authorities’ attempt to reclassify Carry from ■ Rollover relief: capital gains to personal income for the Key Executives. ■ For individual shareholders, as a starting point no In 2013, the District Court rejected the tax authorities’ primary statutory rollover relief exists that allow shares to claim that Carry must be considered income from labour subject be exchanged for shares without crystallisation of a to income taxation. The court also rejected the tax author- capital tax charge. ities’ argument that distributions from a PE fund to the Key ■ If the Investing Management has invested through Executives must be subject to payroll tax (14.1%). The District a separate holding company or pooling vehicle, the Court concurred, however, with the tax authorities’ alternative Norwegian participation exemption rule will allow claim that Carry is subject to Norwegian taxation as ordinary rolling over part of such investment into a new acqui- corporate income for the Manager at the then prevailing tax rate sition structure without triggering capital tax charges. of 28% (now 22%). On appeal, the decision was overturned and ■ o Subject t certain conditions being fulfilled, a rollover the Norwegian Court of Appeal upheld the tax authorities’ orig- relief could be achieved in cross-border transactions inal tax assessment, i.e. that Carry must be considered corporate also for individual shareholders. income for the Manager, salary income for the Key Executives, ■ Exchanging shares for loan notes: and that that the distribution to the Key Executives accordingly ■ For individual shareholders, this will not qualify for was subject to payroll tax. Finally, the court ordered the Key rollover relief, and will attach a tax charge. Executives to pay 30% penalty tax on top. In November 2015, ■ If the selling management team’s investment is struc- the Norwegian Supreme Court overturned the Court of Appeals tured through separate holding companies or a and invalidated the tax authorities’ assessment. The Supreme pooling vehicle, exchanging shares for loan notes will, Court concluded that Carry (in this case) should be considered under the Norwegian participation exemption rule as ordinary corporate income at the then prevailing tax rate of a starting point, not trigger any tax charges. 28% (now 22%), but that such an income could not be consid- Other key issues that need to be considered are: to what extent ered salary income for the Key Executives. As such, there could will any members of the team be subject to tax if the target or neither be a question of payroll taxes. the PE fund makes a loan to members of the team to facilitate The government also stated that it intended to issue a consul- the purchase of equity? Will tax and social security contribu- tation paper in 2020 for the proposal of adopting a rule allowing tions be due if such loans are written off or waived by the lender? the government to introduce WHT on interest and royalty Loans from a Norwegian company to any of its direct or indirect payments. The consultation letter has been in a public consul- shareholders being private individuals holding more than 5% tation phase, with a deadline for comments in May 2020. It of the shares in the company (or to such shareholders’ related is proposed that WHT is introduced on interest, royalty and

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also certain lease payments effective from 2021. According to million, the Manager must, within 10 business days, inform the the proposal, WHT shall be imposed on interest paid to related Norwegian SFA. Exempt from the forgoing are acquisitions of parties in low-tax jurisdictions. Further, royalty payments and companies whose sole purpose is ownership or administration or rental payments for certain physical assets to related parties are real property. The notification must include information about proposed to be subject to WHT (also outside low-tax jurisdic- when and how control was acquired, shareholdings and voting tions). The proposed rate is 15%. rights of the target, any planned undertakings to avoid potential Effective from 2020, Norway introduced a statutory general conflicts of interest and planned communication strategy vis-à-vis anti-avoidance rule (“GAR”). This was, in many respects, legis- investors and employees. The target and its residual shareholders lation on the previous non-statutory anti-avoidance doctrine. In shall also be informed about the fund’s strategic plans and how the preparatory works, it was stated that a tax-exempt demerger of the acquisition may potentially affect employees. Please note that an asset with an inherent capital gain out of a company, followed the same disclosure requirements, according to the rules, also by a tax-exempt sale of the shares in the demerged company, apply if an AIF acquires control of a listed target company, irre- should not be subject to disallowance and anti-avoidance meas- spective of, inter alia, such target company’s number of employees, ures. The tax authorities have established a practice where other revenues and balance sheet. Secondly, and ensuing an acquisi- assets or parts of a business could similarly be demerged out tion described above, the Manager is under duty to inform the to avoid capital gains tax. However, the revision of the 2020 Norwegian SFA within 10 business days if and when the fund’s National Budget, confirms that such a demerger followed by a shareholdings in a target either reach, exceed or fall below 10%, sale of shares, only applies for real estate. One should thus care- 20%, 30%, 50% or 75%. The third point of interest, legislated fully investigate the status of such partial exits going forward. through the Act, is that a Manager, during the 24-month period Due to the COVID-19 pandemic, the Norwegian Parliament following acquisition, more or less is prohibited from facili- passed a number of temporary adjustments to the tax legislation, tating, supporting or instructing any distribution, capital reduc- in order to ease the consequences of locking down many busi- tion, share redemption or acquisition of own shares of the target ness areas. These adjustments mainly involve postponement of (portfolio company) (the so-called “anti-asset stripping” rules). reporting and payments of tax, but also include some tempo- The foregoing applies if either: (a) the target’s net assets, pursuant rary reductions of rates and the acceleration of tax depreciation. to the last annual accounts are, or following such distribution would become, lower than the amount of subscribed capital plus 102 Legal and Regulatory Matters reserves that cannot be distributed subject to statutory regulation; or (b) such distribution exceeds the target’s profit for the 10.1 Have there been any significant legal and/or previous fiscal year plus any subsequent earnings/amounts allo- regulatory developments over recent years impacting cated to the fund, less any losses/amounts that must be allocated private equity investors or transactions and are any to restricted funds subject to statutory regulation. It should also anticipated? be noted that the above anti-asset stripping provisions will apply to such fund’s acquisitions of listed target companies irrespective of the number of employees, size of revenue or balance sheet for The Alternative Investment Fund Managers Directive (“AIFMD”) such listed targets. Anti-asset stripping provisions could, to an was implemented in Norwegian law on 1 July 2014 (the “Act”), and applies to managers of all collective investment vehicles (irre- extent, affect a PE fund’s ability to conduct debt-pushdowns in spective of legal structure, albeit not UCITS funds) that call capital connection with LBOs going forward. from a number of investors pursuant to a defined investment strategy (alternative investment funds (“AIF”)). 10.2 Are private equity investors or particular There are two levels of adherence under the Act. The first transactions subject to enhanced regulatory scrutiny in is a general obligation to register the AIF Manager with the your jurisdiction (e.g. on national security grounds)? Norwegian FSA and provide the agency with information, on a regular basis, regarding: the fund’s investment strategy; the main Norway has, as in many other countries, tightened its grip on category of instruments it invests in; and the largest engagements national security reviews of foreign direct investments, by and concentrations under its management. Failure to comply with implementing a new National Security Act, granting the govern- these reporting requirements may induce the Norwegian FSA to ment powers to intervene and stop acquisitions of shares in a demand immediate rectification or impose a temporary ban on company holding investments in sectors considered vital from the Manager’s and the fund’s activities. The foregoing applies a Norwegian national security perspective. It is therefore to all AIFs, whereas the second level of adherence (see below) expected that PE investors’ investments within such sectors or only applies to funds that have either (a) a leveraged investment particular transactions within such sectors in the near future capacity exceeding €100 million, or (b) an unleveraged invest- could become subject to enhanced scrutiny by the Norwegian ment capacity exceeding €500 million, and where its investors do government, even if this so far has not been very prevalent in not have redemption rights for the first five years of investment. the Norwegian market. Where an AIF exceeds these thresholds, the Manager must, in addition to the reporting requirements above, obtain authorisation from the Norwegian FSA to manage and market the fund’s 10.3 How detailed is the legal due diligence (including compliance) conducted by private equity investors prior portfolio, herewith conducting its own risk assessments, etc. to any acquisitions (e.g. typical timeframes, materiality, From a transactional point of view, and particularly with scope, etc.)? Do private equity investors engage outside respect to (new) obligations for PE actors operating in the counsel / professionals to conduct all legal / compliance Norwegian market, the Act stipulates the following points of due diligence or is any conducted in-house? particular interest: the first is disclosure of control in non-listed companies, and stipulates that if a fund, alone or together with In a structured process, PE investors tend to limit diligence another AIF, acquires control (more than 50% of votes) in a scope and timeframe (i.e. only key issues/areas of interest) and non-listed company with 250 or more employees and either reve- only request a very limited and preliminary “red-flag” legal nues exceeding €50 million or a balance sheet exceeding €43 due diligence report on the target. This is simply an economic

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(cash-saving) approach, allowing the fund to show interest and whereby a portfolio company alone is held accountable/liable for get to know the target more intimately without “burning cash” its own acts and omissions – i.e. a Norwegian court of compe- on what may turn out to be an uninteresting or too costly object. tent jurisdiction will only pierce the corporate veil in exceptional If the fund is invited into the final bid round of an “auction” circumstances. process, and provided only few bidders remain in contest, the From this general point of basis flows certain limited, but diligence field is opened up, and PE funds normally ask its advi- important exceptions, namely that a parent company or a sors to prepare a more complete diligence report on legal, finan- controlling shareholder may be held independently liable for cial, commercial and compliance matters. Further, on compli- its subsidiary’s liability if it has contributed to a wrongful act ance diligence, see question 10.4. The level of scope, materiality, through a controlling interest in the company (see question 3.6). etc. will depend on certain associated factors, like whether the For practical purposes, such liability can be divided into “crim- fund has obtained exclusivity, whether the target is reputable or inal liabilities” and “civil liabilities”. otherwise familiar to the investors, the equity, debt and liability The criminal liabilities category includes anything that a port- history of the target, the prevailing M&A market (to some extent, folio company may do or refrain from doing, which carries the the warranty catalogue reflects the diligence process), and so potential risk of criminal prosecution. In respect of publicly forth. listed companies, and thus relevant in relation to IPO exits or PE funds normally always engage outside expertise to conduct public-to-private transactions, such “criminal liability” may arise in diligence in connection with LBO transactions. This will connection with market manipulation (undertaken in order to arti- normally also be a requirement from the senior banks in order ficially inflate or deflate the trading price of listed shares), insider to finance such transactions. Even if the fund has in-house dealing or violation of relevant security trading regulations (e.g. wilful counsel, outside expertise is engaged so that the fund’s invest- misrepresentation or omission of certain information in offer ment committee can make informed decisions on the basis of documents). If a portfolio company violates such regulations, impartial, qualified and independent advice. and its PE investor (either on its own, through the violating portfolio company or through another portfolio company) transacts in securities affected thereby, there is a tangible risk that the PE 10.4 Has anti-bribery or anti-corruption legislation impacted private equity investment and/or investors’ investor will be identified with its portfolio company (i.e. the approach to private equity transactions (e.g. diligence, shareholder should have known), and thus held liable for the same contractual protection, etc.)? transgression(s). In the category of “civil liability” (meaning that liability usually is limited to fines or private lawsuits), the same consol- In our experience, particular Pan-European and global funds idation (identification) rules may come to play if a portfolio have, in the last few years, increased their focus on and concerns company violates, e.g. applicable antitrust or environmental about regulatory and compliance risk in their diligence exercises. legislation. Over recent years, we have seen very few, but For some of these funds, it has become standard to request legal disturbing, examples of decisions by Norwegian courts in which advisors to prepare separate anti-bribery reports to supplement it was ruled that environmental liability of a subsidiary (unable the regular diligence report, often also accompanied by a sepa- to remedy the situation on its own) was moved upwards in the rate environmental, social and governance (“ESG”) report. holding structure until rectification was satisfied. Some of the funds also require that the sellers provide separate The foregoing notwithstanding, the general concept of anti-corruption and anti-bribery warranties in the SPA. corporate personhood and individual (contained) liability is still Previously, Norwegian funds were more relaxed and it was not the all-encompassing rule of practice, and we have yet to see market practice to request such special reports. Now, this seems any case where a PE investor or another portfolio company has to slowly change, and on the diligence side we see a continuing been held liable for its portfolio company acts or omissions in focus on legal compliance because regulators in general have Norway. become more aggressive in pursuing enforcement of bribery, corruption and money laundering laws. From a contractual (SPA) point of view, it should also be 112 Other Useful Facts noted that providers of W&I insurance normally, probably by virtue of great damage potential and the inherent difficulty 11.1 What other factors commonly give rise to concerns (impossibility) of examining facts through its own under- for private equity investors in your jurisdiction or should writing process, will, with some exemptions, refuse coverage for such investors otherwise be aware of in considering an any seller warranties assuring compliance with and absence of investment in your jurisdiction? anti-corruptive behaviours. As can be expected, this creates a disharmony in PE due diligence (cf. above) and the concurrent Tax treatment of a management fee paid by a private equity or ensuing SPA negotiations, where both parties (in principle) fund to its Managers are open for relevant representations and warranties in relation In a ruling by the Norwegian Supreme Court from February to anti-bribery/anti-corruption being included, but where the 2018, the court concluded that management fees paid by a PE vendor cannot abide for the sake of a clean exit (which the buyer fund to its Manager/advisor must, for tax purposes, be allocated reluctantly can appreciate). between the different tasks carried out by such Managers on behalf of the fund. In this regard, the Supreme Court concludes that any part of such management fees that could be consid- 10.5 Are there any circumstances in which: (i) a private equity investor may be held liable for the liabilities of ered related to transaction services (i.e. services related to acqui- the underlying portfolio companies (including due to sitions and exits of the funds’ portfolio companies) carried out breach of applicable laws by the portfolio companies); by a fund’s Managers, under Norwegian law, must be capitalised and (ii) one portfolio company may be held liable for the and consequently will not be tax-deductible for such funds. In liabilities of another portfolio company? this particular case, the Norwegian tax authorities had argued that 40% of the management fee was related to such transac- The general rule under Norwegian law is corporate personhood, tion services. However, the court concluded that this was not

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sufficiently considered and justified, thus resolving to set aside 2019, the Parliament adopted a bill implementing the Market the tax assessment. This ruling will mainly have an impact on Abuse Regulation into Norwegian law by amending chapter 3 investors domiciled in Norway investing into PE funds organ- of the STA. On 12 June 2019, the Parliament adopted a bill ised as limited partnerships, since the profit and losses from implementing the Prospectus Regulation into Norwegian law by such limited partnerships under Norwegian law must be allo- amending chapter 7 of the STA. cated among its partners and will be taxed at the hand of such partners. New takeover rules expected In addition, a committee is currently also working on a report VAT concerning the Norwegian rules governing voluntary and On 16 May 2013, the Norwegian tax authorities issued a much mandatory offers, with a particular focus on the STA current criticised memo in which the authorities argued that in the limited regulation of the pre-offer phase. This committee report event a Sponsor provides advisory and consultancy services does not arise out of changes to EU rules but rather the need to to its portfolio companies, such services should be subject to review and update Norwegian takeover rules on the basis of past 25% VAT. This raises difficult classification issues between experience and market developments. On 23 January 2019, the the Sponsor’s ordinary management of its portfolio companies committee submitted a report concerning the Norwegian rules which, in general, is VAT-exempt, and other consultancy/advi- on voluntary and mandatory offers, with particular focus on the sory services that may be subject to VAT. The authorities have current limited regulation of the pre-offer phase. indicated that individual circumstances in a tax inspection may It is unclear when the Parliament will adopt these amend- determine that parts of the management services provided by a ments into Norwegian legislation, although we do not expect Sponsor must be reclassified as consultancy services and there- the proposed changes to be implemented into Norwegian law fore will become subject to VAT under Norwegian law. There until 1 January 2021 at the earliest. However, on 27 March 2020, has also been an increased aggressiveness from the authorities the Ministry issued a bill and a draft resolution to the Parliament on this area and we expect that this will continue in the coming in which the Ministry follows up on the committee’s proposal year. for a regulation setting out rules for calculating the offer price in cases where an exception to the above main rule is required, EU initiatives or where it is not possible or reasonable to use the main rule for Over the last few years, the EU has issued several new calculating the offer price. In its proposed bill and draft reso- Directives, regulations and/or clarification statements regarding lution, the Ministry argues that it anticipates that the ongoing the capital markets. These initiatives from the EU, will most COVID-19 pandemic may create special situations where there likely, directly or indirectly, have an impact on the regulatory may be a need to determine mandatory offer prices which are framework for public M&A transactions in Norway in the based on principles besides those in the existing legislation. The years to come. As a result of these initiatives, the Norwegian Ministry also proposes to abolish the alternative under which government has appointed an expert committee to evaluate and the Takeover Authority may resolve that the mandatory offer propose relevant amendments to the existing Norwegian legis- price should be adjusted to the current “market price”. Instead, lation resulting from EU amending the Transparency Directive, the Ministry proposes to replace the “market pricing” alterna- the MiFID I, and the Market Abuse Directive. This committee tive with a more balanced rule set out in a separate regulation. has now published five reports proposing several amendments Finally, the Ministry states that it will revert to the committee’s to the STA. Some of the proposals so far have also resulted other proposals in a new and separate bill and draft resolution in several amendments to Norwegian legislation. On 12 June issued in due course at a later time.

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Ole Kristian Aabø-Evensen is one of the founding partners of Aabø-Evensen & Co, a Norwegian boutique M&A law firm. Ole assists industrial investors, financial advisors, PE funds, as well as other corporations in friendly and hostile takeovers, public and private mergers and acquisitions, corporate finance and other corporate matters. He has extensive practice from all relevant aspects of transactions, both nationally and internationally, and is widely used as a legal and strategic advisor in connection with the follow-up of his clients’ investments. Mr. Aabø-Evensen is also the author of a 1,500-page Norwegian textbook on M&A. He is recognised as a “leading individual” within M&A by The Legal 500, and during the last eight years he has been rated among the top three M&A lawyers in Norway by his peers in the annual surveys conducted by the Norwegian Financial Daily (Finansavisen). In the 2012, 2013, 2017, 2018 and 2019 editions of this survey, the Norwegian Financial Daily named Mr. Aabø-Evensen as Norway’s No. 1 M&A lawyer. He is 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 Tel: +47 2415 9010 Karl Johans gate 27 Email: [email protected] P.O. Box 1789 Vika URL: www.aaboevensen.com N-0122 Oslo Norway

Aabø-Evensen & Co is a leading M&A boutique law firm in the Nordic region, TUPE-issues. A large amount of our work relates to cross-border trans- operating out of Oslo, Norway. The firm is not, nor does it strive to be, actions and our approach to international work is driven by the principle the largest law firm measured by number of offices or lawyers – instead that complex transactions require first-class independent legal expertise, it endeavours to find the best solutions for its clients’ legal and commer- rooted in local practice, procedures and culture. cial challenges, and securing their business transactions. Our M&A and www.aaboevensen.com 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, PE 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, antitrust and

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Portugal Portugal

Ricardo Andrade Amaro

Morais Leitão, Galvão Teles, Soares da Silva & Associados Pedro Capitão Barbosa

12 Overview be outweighed by the economic demand-side and supply-side effects of the COVID-19 pandemic (see next question).

1.1 What are the most common types of private equity transactions in your jurisdiction? What is the current 1.3 What are going to be the long-term effects for state of the market for these transactions? private equity in your jurisdiction as a result of the COVID-19 pandemic? Private equity in Portugal has experienced significant growth despite the financial crisis and sovereign debt crisis, which Given that the effects of the pandemic are likely to be protracted, loomed over the country until 2014. According to the latest it may be too early to tell exactly what the repercussions will be data available (the Portuguese Securities Market Commission for the private equity industry. – “CMVM”, 2018), value under management by private equity On the one hand, the effects for the industry may be posi- players has been steadily rising since 2003, reaching upwards of tive: various opportunities may arise regarding transactions in €4.8 billion by the end of 2018. companies in financial distress or in need of equity support Turnaround or distressed transactions have still been the to resume growth, particularly if economic activity is able to most relevant types of private equity deals in Portugal in the rebound relatively quickly after the brunt of the crisis. last few years, followed by growth capital investment (approxi- On the other hand, a lengthy recovery could ultimately hurt mately one-third of the value invested). Nevertheless, venture existing portfolio companies and make future fundraising capital (start-up, seed and early stage) investing and management processes more difficult, which could then have a negative buyouts maintained their relevance throughout the year of 2018. effect on the prospects of (particularly local) private equity fund Sector-wise, the main sectors invested by private equity are managers. real estate and construction, manufacturing, and information technologies. 1.4 Are you seeing any types of investors other It is implausible that these market dynamics will continue than traditional private equity firms executing private following the wake of the economic downturn caused by the equity-style transactions in your jurisdiction? If so, COVID-19 pandemic. However, given the lag in the availability please explain which investors, and briefly identify any of the relevant data, it will take a considerable amount of time significant points of difference between the deal terms before we can know for sure the effects the health crisis and offered, or approach taken, by this type of investor and that of traditional private equity firms. lockdown measures will have on the industry.

Yes. In relation to “traditional” private equity transactions, we 1.2 What are the most significant factors currently are seeing “family offices” or wealthy investors also stepping encouraging or inhibiting private equity transactions in your jurisdiction? into the space. Their approach relative to private equity investors is usually more long term. Where venture capital transactions (start-up, seed and early Prior to the COVID-19 pandemic, some of the most relevant stage) are concerned, corporate venture capital units of large trends that were encouraging transactions in Portugal were: (i) companies are also participating. These investors are not only low interest rates and an accommodative monetary policy from focused on pure financial returns, but are also integrating into the European Central Bank; (ii) the launching of public tenders their investment rationale the ability of the invested company by State-owned entities to capitalise companies, such as tenders to contribute to the overall business of the sponsor (innovative to award EU funds to entities organised as private equity fund products or services, technology transfers, etc.). managers; and (iii) the use of private equity funds as conduits for In infrastructures, we are seeing pension funds competing obtaining investment residence permits, which also encourage with traditional private equity investors for assets with long- fundraising and consequently private equity and venture capital term regulated revenues. transactions in Portugal. While each of these trends is set to continue (in particular, given the recently announced stimulus package from the European Union and the resiliency in the appetite for investment residence permit projects), it may be the case that they will

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22 Structuring Matters 2.4 If a private equity investor is taking a minority position, are there different structuring considerations?

2.1 What are the most common acquisition structures adopted for private equity transactions in your Besides the capital structure being markedly different, in jurisdiction? minority investments (notably in venture capital transactions), the private equity investor usually requests veto rights in The typical private equity transaction in Portugal is made shareholder and board decisions, anti-dilution provisions and through a private equity fund. Pursuant to this structure, pre-emption/tag-along rights. the fund participants or limited partners (“LPs”) (as well as the managing entity, which retains some “skin in the game”), 2.5 In relation to management equity, what is the subscribe and pay up units in the fund, after the latter is regis- typical range of equity allocated to the management, and tered before the relevant regulatory authority in Portugal what are the typical vesting and compulsory acquisition (CMVM). provisions? Under Portuguese law, only the management entity can manage/take decisions for the private equity fund and there are Equity attributable to management in majority acquisitions no “general partners” affiliated with management with deci- may vary considerably, from single digits to a sizeable minority sion-making powers. participation. The aforementioned investment vehicles then either: (i) Vesting usually occurs during a three- to four-year period, acquire equity participations directly or through a wholly-owned with the period being structured with a one-year cliff and “BidCo” or subscribe newly-issued shares by the target company “linear” vesting thereafter. (in a typical buyout, growth or venture capital deal); or (ii) Compulsory acquisition provisions depend essentially on the acquire debt instruments or securities (notably senior bank mode of management departure: if management are deemed loans) and convert such instruments into equity, thereby gaining a “bad leaver”, unvested shares are acquired at nominal value; control of the target (in distressed or turnaround transactions). or alternatively, if management are considered a “good leaver”, If the private equity investor does not ultimately come to hold shares are acquired at fair value. the entirety of the company’s equity, a shareholder agreement is generally entered into with the surviving shareholders. 2.6 For what reasons is a management equity holder usually treated as a good leaver or a bad leaver in your 2.2 What are the main drivers for these acquisition jurisdiction? structures? A manager will be treated as a good leaver if private equity The main drivers for these structures relate to incentive align- investors deem it so or, alternatively, if the former is required to ment and tax reasons. leave the company for serious reasons unrelated to professional Investments using private equity funds is an efficient way factors (illness, serious injury, attending to family members). for various institutional investors to pool money into alter- In investor-friendly deals, the “bad leaver” concept is usually native asset classes which potentially offer higher yields than defined by exclusion, meaning that a manager will be deemed a public equities or bonds, while avoiding the operational risks bad leaver towards the company unless it is determined that it and regulatory hurdles that would arise from investing directly has parted ways with the same in a manner that would allow her in non-listed companies. In private equity funds, the managing to be considered a “good leaver”. entity retains a residual equity participation in the fund to signal In more manager/founder-friendly transactions, the bad that it is committed to act in the best interests of the LPs. The leaver definition often contains a “discrete” set of premises carried interest remuneration structure (detailed below) also (for instance, resigning at own volition from board functions helps align incentives. before a certain date, being dismissed with cause from board Tax-wise, private equity funds incorporated in Portugal are functions). exempt from corporate income tax and any gains made are directly attributed to its LPs, at a favourable rate. 3 2 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? Usually the equity is divided in share classes and quasi-equity shareholder contributions, with the private equity investor subscribing Private equity investors will commonly have one or more repre- the latter as well as preferred shares, granting the latter special sentatives on the board of directors of portfolio companies to “political rights” and preference in liquidation. serve as non-executive directors. Another typical feature of Management, on the other hand, will typically own common governance structures of (the larger) portfolio companies is shares and be the recipient of an incentive plan, which may or may the set-up of a remuneration committee and/or a related party not include the attribution of additional “physical” equity instru- transactions committee used for the private equity investor to ments (alternatives include phantom shares or performance-based monitor the company. cash pay-outs). These governance arrangements are typically regulated in a shareholder agreement. Such agreements, unless they relate to public (i.e. whose shares are exchanged in a regulated market) or financial companies, need not be made public and will almost surely contain confidentiality provisions.

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3.2 Do private equity investors and/or their director parties and are therefore not enforceable towards third parties, nominees typically enjoy veto rights over major nor towards the company itself. corporate actions (such as acquisitions and disposals, Other restrictions set out in the law regarding the contents business plans, related party transactions, etc.)? If a of shareholder agreements include: (i) no provisions may be private equity investor takes a minority position, what included that restrict the actions of members of the company’s veto rights would they typically enjoy? management or audit bodies; (ii) no shareholder may commit to always vote in accordance with the instructions or proposals Yes. Usually, shareholder agreements entered into between given/made by the company or its management or audit bodies; private equity investors and management/surviving share- and (iii) no shareholder may exercise or not exercise their voting holders/partnering shareholders will have “restricted matters” right in exchange for “special advantages” (i.e. prohibition of at board of director and shareholder level (via supermajori- vote-selling). ties or share classes) involving material aspects of the business, As regards governing law and jurisdiction of shareholder agree- regarding which the private equity investor enjoys a veto right. ments, no particular restrictions exist (although any shareholder Veto rights enjoyed by private equity investors in portfolio agreements regarding Portuguese companies should respect the companies at shareholder level typically include fundamental restrictions set out in the previous paragraph as well as other corporate matters such as amendments to articles of association, mandatory Portuguese law provisions), while non-compete provi- mergers, demergers, approval of annual accounts, and distribu- sions should be weighed against mandatory labour and competi- tions. “Restricted matters” at board level are more managerial tion law provisions to assess their validity. in nature and include relevant expansions or divestments in the business, approvals of business plans and dealings with related 3.6 Are there any legal restrictions or other parties. requirements that a private equity investor should be aware of in appointing its nominees to boards of 3.3 Are there any limitations on the effectiveness of portfolio companies? What are the key potential risks veto arrangements: (i) at the shareholder level; and (ii) at and liabilities for (i) directors nominated by private the director nominee level? If so, how are these typically equity investors to portfolio company boards, and (ii) addressed? private equity investors that nominate directors to boards of portfolio companies?

No limitations usually exist. Restricted board matters are, almost As a general rule, legal persons are entitled to appoint persons without exception, transposed into the company’s by-laws, to, on their behalf, exercise functions as directors. making them enforceable towards third parties. Concretely, directors appointed by private equity investors Similarly, on matters where shareholders have the last say (which should be aware that, under Portuguese law, they owe fidu- would depend on the type of company in question), the share- ciary duties (care and loyalty) to all shareholders of the portfolio holder agreement and by-laws create a set of restricted matters company, and may not cater only to the interests of the private (again supermajorities or share classes) for shareholders’ resolu- equity investor. tions as well, granting a veto right to the private equity investor. On the other hand, private equity investors, if they exercise a significant influence in the company to allow it to be qualified as 3.4 Are there any duties owed by a private equity a de facto board member, may be held liable should the company investor to minority shareholders such as management be declared insolvent, if it is proven that the insolvency was the shareholders (or vice versa)? If so, how are these result of culpable action by the investor. typically addressed?

3.7 How do directors nominated by private equity No special statutory duties exist regarding private equity inves- investors deal with actual and potential conflicts of tors in relation to minority shareholders or otherwise. It is interest arising from (i) their relationship with the party argued that there are, in any case, general corporate law duties nominating them, and (ii) positions as directors of other that should be observed by shareholders (towards other share- portfolio companies? holders and the company), such as duties of loyalty. It is also worth noting that Portuguese law provides for several At fund level, conflicts of interest are typically addressed special rights of minority shareholders, such as the right to appoint through an Advisory Council, whose attributions typically directors from a separate list (if such mechanism is included in entail issuing opinions on certain transactions undertaken by the by-laws) or the right to annul resolutions approved by the the fund, notably related party transactions, and other conflicts majority shareholders, if proved to be to their detriment (e.g. on of interest. self-dealing transactions). In addition, the law provides for “opt- At portfolio company level, a related party transaction out” rights for minority shareholders in case of (i) mergers and committee is often set up to deal with vertical (company–fund) demergers (when minority shareholders vote against such trans- and horizontal (portfolio company–portfolio company) conflicts actions), and (ii) in case there is a majority shareholder holding of interest. more than 90% of the share capital in the company. More generally, statutory corporate law provisions contain mandatory provisions whereby shareholders and board members 3.5 Are there any limitations or restrictions on the are impeded to vote in the relevant meetings if they are deemed contents or enforceability of shareholder agreements to be in a conflict of interest. (including (i) governing law and jurisdiction, and (ii) Agreements implementing the investment often attempt non-compete and non-solicit provisions)? to regulate conflicts of interests that arise from private equity management having directorships in several portfolio compa- Under Portuguese law, it is generally understood that the provi- nies (usually by providing protections to the private equity sions of shareholder agreements are binding only upon the investor).

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4 2 Transaction Terms: General 62 Transaction Terms: Private Acquisitions

4.1 What are the major issues impacting the timetable 6.1 What consideration structures are typically for transactions in your jurisdiction, including antitrust, preferred by private equity investors (i) on the sell-side, foreign direct investment and other regulatory approval and (ii) on the buy-side, in your jurisdiction? requirements, disclosure obligations and financing issues? Consideration structures in the price payable by private equity investors in Portugal to shareholders of portfolio companies Timetable constraints and other formalities for transactions in often include “closing accounts” mechanisms, whereby the price Portugal generally involve the following: changes according to variations in cash, (net-)debt and working a) waivers from financing banks in direct, or sometimes indi- capital from a reference date to closing date. rect, changes of control; Earn-outs are also common (buy-side) price variations, b) securing financing for the transaction; notably in management buy-out transactions or other deals c) in asset deals (e.g. transfer of business via agreement when the selling shareholders are expected to continue to play a or prior statutory demerger) and formalities related to key role in the business. employment matters, notably town hall meetings and On the other hand, “locked-box” consideration structures are opinions from employee representative structures; increasingly being used (more prevalent on the sell-side). d) waivers from competition authorities; e) deals in some regulated sectors (especially banks, insurance companies and other financial institutions) require 6.2 What is the typical package of warranties / indemnities offered by (i) a private equity seller, and (ii) prior approval from the respective regulatory authorities; the management team to a buyer? and f) in critical infrastructure transactions involving investors outside of the European Economic Area (“EEA”), these Standard representations and warranties involving mostly the are generally required to be reviewed by the government. underlying assets of the portfolio companies (as opposed to management) are offered. Especially in more “buyer-friendly” deals, specific indemnities (notably tax indemnities) are also 4.2 Have there been any discernible trends in included. transaction terms over recent years?

6.3 What is the typical scope of other covenants, In recent years, “locked-box” price adjustment mechanisms undertakings and indemnities provided by a private have become more common in transactions. equity seller and its management team to a buyer? In addition, warranties and indemnities insurance policies are slowly being introduced in the Portuguese market, notably where private equity sellers are involved. Covenants and other undertakings usually include non-compete provisions. Asset-specific covenants are also provided, when 52 Transaction Terms: Public Acquisitions applicable.

5.1 What particular features and/or challenges apply 6.4 To what extent is representation & warranty to private equity investors involved in public-to-private insurance used in your jurisdiction? If so, what are the transactions (and their financing) and how are these typical (i) excesses / policy limits, and (ii) carve-outs / commonly dealt with? exclusions from such insurance policies, and what is the typical cost of such insurance?

Only one private equity-type public-to-private transaction has ever been recorded in Portugal (i.e. the acquisition of Brisa, a Warranty and indemnity insurance was scarcely used but is now highway toll operator, in 2012, by a joint venture formed by more common in transactions involving private equity sellers. a Portuguese family office holding company and a European Typical exclusions include criminal liability, certain tax and infrastructure fund). environmental matters, fraud, and matters known to the buyer Since there is but one example of this type of transaction in during due diligence or not covered by the due diligence at all. Portugal, it is not possible to assess patterns or trends. The insurance premium is usually calculated as a percentage of the liability cap.

5.2 What deal protections are available to private equity investors in your jurisdiction in relation to public 6.5 What limitations will typically apply to the liability acquisitions? of a private equity seller and management team under warranties, covenants, indemnities and undertakings?

See the answer to question 5.1 above. There are, however, recommendations in the Corporate Governance Code appli- Caps and baskets are the most common limitations to liability cable to Portuguese listed companies which effectively limit in private equity exit transactions. Specific disclosures against the protections that can be afforded to private equity investors, warranties (typically included in disclosure letters) are also such as recommendations against the adoption of break fees or commonly used. similar pay-outs in public tender offers.

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6.6 Do (i) private equity sellers provide security (e.g. 82 Financing escrow accounts) for any warranties / liabilities, and (ii) private equity buyers insist on any security for warranties / liabilities (including any obtained from the 8.1 Please outline the most common sources of debt management team)? 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 debt Private equity sellers, especially those backed by funds reaching (particularly the market for high yield bonds). maturity, prefer to shy away from providing securities for breach of representations and warranties, but may occasionally provide Due to the fact that the average value of private equity transac- escrow account/price retention mechanisms to benefit the tions in Portugal is small, deals involving private equity inves- buyers. tors are made almost exclusively through the funds’ equity, Private equity buyers, on the other hand, are more keen (and raised from its unit holders. Debt financing of transactions is it occurs frequently) on having escrow accounts with part of the thus rare and, even more so, the issuance of high-yield bonds. price in deposit. When it does occur (in larger transactions), debt financing of private equity transactions is usually made through senior 6.7 How do private equity buyers typically provide secured loan facilities (usually composed of an acquisition comfort as to the availability of (i) debt finance, and (ii) facility and a revolving facility). Bond issuances are rare in equity finance? What rights of enforcement do sellers private equity acquisition finance and the few issuances that exist typically obtain in the absence of compliance by the are subscribed by banking syndicates (notably for tax reasons). buyer (e.g. equity underwrite of debt funding, right to specific performance of obligations under an equity commitment letter, damages, etc.)? 8.2 Are there any relevant legal requirements or restrictions impacting the nature or structure of the debt Corporate guarantees/comfort letters are common. To a limited financing (or any particular type of debt financing) of private equity transactions? extent, bank guarantees are also provided. In buyer-friendly deals, financing is sometimes even established as a condition precedent to closing. Notwithstanding the above-mentioned response, it is worth In case of non-performance of funding obligations, the sell- noting that financial assistance (i.e. contracting loans or er’s typical remedy is to claim for damages (or terminate the providing securities for the acquisition of the company’s own agreement if the same has not yet “closed”). shares) is restricted under Portuguese law, thus making leveraged buyouts harder to structure (and with limitations, notably in what concerns the terms of the security package). 6.8 Are reverse break fees prevalent in private equity When planning raising debt financing, “interest stripping” transactions to limit private equity buyers’ exposure? If so, what terms are typical? rules under Portuguese law should also be taken into account, which limit the deductibility of financial expenses.

Reverse break fees are not common. 8.3 What recent trends have there been in the debt financing market in your jurisdiction? 72 Transaction Terms: IPOs

Due in part to a blooming real estate market in large Portuguese 7.1 What particular features and/or challenges should a private equity seller be aware of in considering an IPO urban centres, as well as to the continuance of low interest rates, exit? debt financing activity (acquisition finance, project finance) has risen in recent years. This debt is being syndicated increasingly by foreign banks, as No private equity investment has ever generated an exit Portuguese banks are still improving their balance sheets since involving a listing in Portugal. the sovereign debt crisis and ensuing recapitalisation measures. Finally, in recent times there have been various refinancing 7.2 What customary lock-ups would be imposed on transactions as a consequence of diminishing rates and increasing private equity sellers on an IPO exit? borrower credit profiles.

As mentioned above, there is no factual basis to answer the 92 Tax Matters question as no IPO exit from a private equity investment has ever been made. 9.1 What are the key tax considerations for private equity investors and transactions in your jurisdiction? Are off-shore structures common? 7.3 Do private equity sellers generally pursue a dual- track exit process? If so, (i) how late in the process are private equity sellers continuing to run the dual-track, Private equity funds are considered neutral vehicles, for tax and (ii) were more dual-track deals ultimately realised purposes, and, as such, are exempt from corporate income tax. through a sale or IPO? Income derived by the unit holders in private equity funds, on the other hand, is subject to a 10% withholding tax (whether We are not aware of any dual-track process for the sale of a private personal or corporate income tax), provided the unit holder equity portfolio company ever being initiated in Portugal. is a non-resident entity (without permanent establishment in Portugal), or an individual resident in Portugal (that derives this income out of a business activity).

If the unit holder in the private equity fund (i.e. the beneficiary available, allowing for cases of merger, de-merger, and/or asset of such income) is an entity exempted from tax on capital gains contribution, in order that no step-up in value is realised but, at (resident or non-resident) or if they are an entity with no perma- the same time, preserving the original date of acquisition of the nent establishment in Portugal to which the income is attribut- participations. able, the derived income may be exempted from tax in Portugal. Additionally, there are two key tax considerations: the partic- Neither the 10% nor the exemption rule are applicable when: ipation exemption regime; and the tax treatment of dividends (i) the beneficiary is an entity resident in a blacklisted jurisdic- distributed by a Portuguese company. tion; or (ii) when the beneficiaries are non-resident entities held, The Portuguese participation exemption regime currently in directly or indirectly (more than 25%), by resident entities. The force foresees that dividends distributed by a company resident general withholding tax is 35% in the case of blacklisted entities; in Portugal (and not subject to the tax transparency regime) to its in other cases, there is 25% CIT withholding tax. corporate shareholder are tax-exempt, provided some require- Off-shore structures are not common, owing mostly to the ments are met, such as a continuous 12-month holding period of disadvantageous tax repercussions of setting up transactions in at least 10% of the shares or voting rights. blacklisted entities (see paragraph above). Nevertheless, interna- Under the outbound regime, to benefit from the 0% with- tional fund managers usually invest through Luxembourg vehi- holding tax rate on the dividends paid by a company in Portugal, cles (typically then incorporating a Portuguese BidCo to execute besides the fact that the beneficiary of the income has to be the transaction). subject in its residence State to a nominal corporate income tax Private equity companies (sociedades de capital de risco) also rate of at least 12.6%, it has to hold, directly or indirectly, at least benefit from a tax allowance of a sum corresponding to the limit a 10% stake in the company resident in Portugal uninterrupt- of the sum of the tax base of the five preceding years, as long as edly held in the 12 months prior to the distribution of dividends. such deduction is used to invest in companies with high growth potential. On the other hand, dividends payable by private equity 9.4 Have there been any significant changes in tax companies to their shareholders do not receive any special treat- legislation or the practices of tax authorities (including ment (i.e. a 28% final rate for individuals and the current corpo- in relation to tax rulings or clearances) impacting private rate income tax rates for companies). equity investors, management teams or private equity Capital gains derived by the sale of units in the private equity transactions and are any anticipated? funds are subject to 10% corporate and personal income tax if the resident entity derives the income out of a business activity A recent change in the law has caused Portuguese tax authorities and, regarding the non-resident entity, if it is not exempted under to consider management fees charged by management entities to the general exemption on capital gains obtained by non-residents. funds as being subject to stamp duty (imposto do selo). This inter- Alas, the treatment of income derived from carried interest pretation does not, however, appear to be unanimous and it may and other variable private equity managers’ compensation is not face challenges from taxpayers in the future. clear from tax legislation. As such, due to the fact that, from a tax perspective, treatment of such income is not clear, there have 102 Legal and Regulatory Matters been several calls, as in many other jurisdictions, to clearly state that variable management compensation is taxed as capital gains. 10.1 Have there been any significant legal and/or regulatory developments over recent years impacting 9.2 What are the key tax-efficient arrangements that private equity investors or transactions and are any are typically considered by management teams in private anticipated? equity acquisitions (such as growth shares, incentive shares, deferred / vesting arrangements)? Law no. 16/2015 and Law no. 18/2015 provided several major changes to the regulation of private equity in Portugal. Tax considerations invariably play a role in structuring manage- Highlights include: ment compensation packages, whether they are in the form of a) Investment compartments – the management regulations physical shares, “phantom” shares or earn-outs, but there is no of private equity or venture capital funds may now estab- one typical tax-efficient arrangement to remunerate manage- lish that the fund may be divided into several investment ment in private equity transactions. compartments, named “subfunds”. It is worth mentioning, however, that the 2018 State Budget b) Management may change certain aspects of the manage- includes a tax benefit that foresees the exemption for personal ment regulations (e.g. details of the manager, and reduc- income tax (“PIT”) of gains arising from stock option plans up tion in management fees) in private equity funds without to the amount of €40,000 received by the start-ups/emerging the consent of unit holders. companies’ employees. c) Own funds requirements – private equity and venture For this tax exemption to apply: capital companies must have their own funds corre- a) Employers must qualify as micro or small enterprises and sponding to 0.02% of the amount of the net value of assets have developed their activities for a period not longer than under management exceeding €250 million. six years within the technological sector. However, the main innovation put in place by the enactment b) Employees must own the relevant stocks for at least two of Law no. 18/2015 is imposing a more demanding regulatory years, not be a member of any corporate body, and not hold framework to management entities of private equity funds that a participation higher than 5% in the respective company. have assets under management with a value exceeding: (i) €100 million, when the respective portfolios include assets acquired 9.3 What are the key tax considerations for with leverage; or (ii) €500 million, when the respective port- management teams that are selling and/or rolling-over folios do not include assets acquired through leverage and part of their investment into a new acquisition structure? regarding which there are no reimbursement rights that may be exercised during a five-year period counting from the date of A tax neutrality regime on the corporate reorganisations is initial investment.

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Such funds are now subject to, inter alia, the following obliga- 10.4 Has anti-bribery or anti-corruption legislation tions arising from the regime implemented by the Alternative impacted private equity investment and/or investors’ Investment Fund Managers Directive (“AIFMD”): approach to private equity transactions (e.g. diligence, a) their incorporation is subject to the prior authorisation of contractual protection, etc.)? the CMVM; b) risk management should be functionally and hierarchically Law no. 83/2017, of August 18 (which partially transposes the separated from the operating units, including the portfolio Fifth Money Laundering Directive to the Portuguese jurisdic- management function; tion), establishes several obligations on, among others, “know c) measures should be taken to identify situations of possible your customer” and due diligence procedures and disclosure of conflicts of interest as well as to prevent, manage and monetary flows for purposes of preventing money laundering monitor conflicts of interest; transactions and the financing of terrorism. These obligations d) the CMVM shall be informed of the intention to delegate are applicable to private equity fund managers (as well as to services to third parties for carrying out functions in the banks and other financial institutions). name of the above-mentioned managing entities; The aforementioned reporting duties have an impact on due e) managing entities shall employ an appropriate liquidity diligence procedures taken during fund structuring, as the management system; and private equity investor shall, for instance, be obliged to know f) applicability of “EU passport rules” (i.e. the ability to what is the controlling structure of its clients (the fund LPs) and market units of private equity funds in other EU countries who is the ultimate beneficial owner of such LPs. Consequently, or third countries). the major private equity players in Portugal have instated official As of January 1, 2020, Decree-Law no. 144/2019, of “know your customer” procedures in an effort to not fall foul of September 23 came into force. Among other innovations, this the law’s provisions. statute imposes more stringent regulatory requirements for the incorporation of private equity fund managers below the “AIFMD” thresholds (notably regarding the adequacy of quali- 10.5 Are there any circumstances in which: (i) a private equity investor may be held liable for the liabilities of fied shareholders and members of corporate bodies of such fund the underlying portfolio companies (including due to managers). breach of applicable laws by the portfolio companies); Also worth noting is the new crowdfunding legislation, which and (ii) one portfolio company may be held liable for the provides a framework for the creation of equity crowdfunding liabilities of another portfolio company? platforms in Portugal, which is becoming increasingly relevant for venture capital investment in the Portuguese market. Private equity funds enjoy full limited liability and asset parti- tioning in relation to their portfolio companies and participants, 10.2 Are private equity investors or particular respectively. In this sense, the fund may not be liable for debts transactions subject to enhanced regulatory scrutiny in and other liabilities of the portfolio companies, unless it has your jurisdiction (e.g. on national security grounds)? provided guarantees for the benefit of such companies. As for private equity companies, if the latter holds 100% of the There is no enhanced scrutiny of private equity transactions in share capital of a portfolio company incorporated in Portugal, Portugal. In any case, certain rules exist that apply to foreign mandatory corporate law provisions assume a “co-mingling of investment controls in critical infrastructure. assets” of sorts and state that they are jointly and severally liable Under the provisions of Decree-Law no. 138/2014, of before the creditors of said portfolio companies (following a September 15, acquisitions of control of critical infrastruc- 30-day delay in performance of the obligation in question). ture by non-EEA residents may be subject to review by the In the case of portfolio companies being liable before one Portuguese government. Transactions that have not been previ- another, assuming that they are both directly held by the same ously cleared and are subject to opposition by the government private equity investor (i.e. horizontal group relationship), no are null and void. subsidiary liability may arise.

10.3 How detailed is the legal due diligence (including 112 Other Useful Facts compliance) conducted by private equity investors prior to any acquisitions (e.g. typical timeframes, materiality, 11.1 What other factors commonly give rise to concerns scope, etc.)? for private equity investors in your jurisdiction or should such investors otherwise be aware of in considering an investment in your jurisdiction? Private equity investors usually undertake legal due diligence before investing in a company. Timeframes for conducting due diligence range from one to three months and will typically have Portugal has been establishing itself to both inside and outside materiality thresholds for litigation and material agreements investors as a “business”- and “transaction”-friendly jurisdic- under review. Often, insurance, competition and tax matters tion. This also reflects in the private equity sector. will be excluded from due diligence (sometimes because other Alas, some challenges remain, notably in what concerns advisors will be engaged to perform the review in such matters). timings for resolution of disputes in the State courts (which is why transaction agreements usually contain arbitration clauses).

Ricardo Andrade Amaro is a partner at Morais Leitão. He is head of a corporate team and is member of the energy law 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 legal advisor in the setting up of the first private equity fund in Portugal exclusively dedicated to the recovery of companies (turnaround fund), which is currently the largest Portuguese private equity fund. In the area of corporate and commercial law, he has acted as legal advisor in several mergers, restructuring, acquisitions and sales of companies, on behalf of domestic and foreign clients. He has also acted as legal advisor in the setting up of several initial public offerings, including the largest initial public offering ever made in Portugal and the largest in Europe during 2008, and also in the structuring of several public share takeover bids. Ricardo has a law degree from the University of Lisbon (2002) and a postgraduate degree from the Catholic University of Portugal in Corporate Law (2004). He has been a member of the Portuguese Bar Association since 2004 and of the Securities Institute (also since 2004).

Morais Leitão, Galvão Teles, Soares da Silva & Tel: +351 21 38174 00 Associados Email: [email protected] Rua Castilho, 165 URL: www.mlgts.pt 1070-050 Lisboa Portugal

Pedro Capitão Barbosa is an associate with Morais Leitão and is part of the corporate, M&A and capital markets team. His corporate law practice focuses on several cross-border corporate restructuring and acquisition transactions (private equity and venture capital), including trade partnerships and mergers. In respect of capital markets, Pedro has been actively involved in equity capital markets operations, intervening in public acquisition offers and other restructuring operations. He regularly provides legal advice in matters regarding corporate governance. Moreover, he advises on the restructuring, governance and regulatory matters of investment funds, particularly in venture capital. Pedro has a degree from the New University of Lisbon (2010) and has obtained a LL.M. in Finance & Law from the Duisenberg School of Finance (in partnership with the University of Amsterdam). He completed accounting training for lawyers at the University of Lisbon and has been a member of the Portuguese Bar Association since 2014.

Morais Leitão, Galvão Teles, Soares da Silva & Tel: +351 21 38174 00 Associados Email: [email protected] Rua Castilho, 165 URL: www.mlgts.pt 1070-050 Lisboa Portugal

Morais Leitão, Galvão Teles, Soares da Silva & Associados (Morais Leitão) is one of Portugal’s leading, full-service law firms, with more than 80 years of experience. The firm is internationally recognised for high levels of service and cutting-edge solutions. Specialised legal services in the main areas of law and in different sectors of the economy are a benchmark of the firm, leading to its involvement in the most important operations in Portugal, as well as in high-value cross-border transactions and disputes. With a team of more than 200 lawyers, Morais Leitão has its head office in Lisbon and offices in Porto and Funchal (Madeira Island). To support clients’ international strategies, Morais Leitão developed a network of associations with local firms in Angola, Mozambique, Macau and Hong Kong – Morais Leitão Legal Circle – which offers integrated multijurisdictional teams. www.mlgts.pt

Spain Spain

Ferran Escayola

Garrigues María Fernández-Picazo

12 Overview As opposed to COVID-19’s adverse effects, there will be good opportunities for add-ons as uncertainty regarding the evolu- tion of the markets and target screening are better assessed by 1.1 What are the most common types of private equity portfolio companies in the same industry, with companies with transactions in your jurisdiction? What is the current similar structural or finance problems. Low interest rates may state of the market for these transactions? also encourage PE leveraged transactions or transactions implemented using hybrid instruments, such as convertible/mezza- According to the Spanish Venture Capital & Private Equity nine debt provided by specialised funds. Should the adverse Association (“Asociación Española de Capital, Crecimiento e Inversión” effects of COVID-19 and the world’s economies worsen, we will – “ASCRI”), 2019 has beaten, for the third year in a row, a record also see opportunities in the opportunistic and distress markets. in the Spanish private equity (“PE”) sector activity in terms of From a strictly legal standpoint, the freedom of the movement volume, with an increase of 22% compared to 2018. of capitals and foreign investments in Spain has been restricted, International funds continue to be major market players, as has been the case in most EU countries. Certain foreign accounting for 81% of the total investment volume. New funds investments are now subject to the prior scrutiny and approval that have never before invested in Spain entered the market. of Spain’s Council of Ministers. In 2019, domestic PE players’ investment increased by 16% With companies’ valuations going south as per COVID-19, with respect to 2018, distributed in 475 transactions. the Spanish Government decided to anticipate the entry into Several transactions above the EUR 100 million threshold in force of Regulation (EU) 2019/452 of the European Parliament equity were closed in 2019, representing 68% of total investment and the Council, of 19 March 2019, establishing a framework volume. Mid-market transactions (between EUR 10 million and for the screening of foreign direct investments in the EU on the EUR 100 million) marked a new historic record, reaching an grounds of security or public order, which shall apply as from increase of 23% with respect to 2018. 11 October 2020, and passed a new regulation which has effec- On the divestment side, 258 transactions were closed, out tively suspended the deregulation regime for certain foreign of which 46% were secondary buy-outs, followed by owners’ direct investments made: (a) in specific “strategic sectors” of the buy-backs (14%), and share sales after IPO (14%). The vola- Spanish economy affecting national security, public policy and tility of equities in all markets has recently slowed this divest- public health; and (b) by certain foreign investors which meet ment option. certain subjective conditions, as further explained under ques- On fundraising, international investors maintained confi- tion 4.1 below. dence in Spanish PE managers and good market conditions. As This will undoubtedly affect (1) certain investments from a consequence, fundraising remained strong in 2019. foreign controlled private or sovereign equity funds, and (2) exit strategies to certain third-party acquirers, which may need to 1.2 What are the most significant factors currently complete a prior authorisation process. encouraging or inhibiting private equity transactions in your jurisdiction? 1.3 What are going to be the long-term effects for private equity in your jurisdiction as a result of the All around the world, funds are experiencing a period of high COVID-19 pandemic? liquidity; however, several factors are having an adverse effect on PE transactions, mostly driven by the effect of the COVID-19 The COVID-19 pandemic will definitively affect companies’ pandemic on the investee portfolio and the general down-sizing valuations. It is very likely that, with the exception of a few very of target valuations and its collateral effects on divestitures – specific sectors, valuations (and value calculation mechanics most PE funds are on stand-by disposing of their portfolios and such as EBITDA multiples) may fall. Decrease in valuations, awaiting valuations to adjust further for new acquisitions. There excess of dry powder in the PE market, and less acquisition are sectors, however, such as healthcare, essential products, agri- opportunities may lead to greater competition for the same culture, education, and technology, to name a few, that are not deals. This is already visible and larger-sized funds are setting only more immune to the COVID-19 impact, but are also more up funds to compete in the mid-market, while mid-market attractive because of it. funds are accessing much larger transactions than is customary, supported by their limited partners.

1.4 Are you seeing any types of investors other the financial entities; and (ii) tax reasons, not only tax efficiency than traditional private equity firms executing private but also requirements imposed by the country of origin or by equity-style transactions in your jurisdiction? If so, Spanish tax regulations for tax deductibility. please explain which investors, and briefly identify any Other drivers include: (i) the expected returns for the investor; significant points of difference between the deal terms (ii) the role and incentives of the management team and PE offered, or approach taken, by this type of investor and sponsors; (iii) the economic and operational costs related to the that of traditional private equity firms. post-closing restructuring of the Company; and (iv) the fore- seen rules and costs of exit that any given acquisition structure You may find a few players with alternative PE-style transaction may dictate. approaches in the Spanish market, but they are not yet relevant enough to call the market’s attention. There are family offices 2.3 How is the equity commonly structured in private or structures managing the capital of third parties with various equity transactions in your jurisdiction (including mechanisms and investment approaches, which are carrying out institutional, management and carried interests)? PE-type transactions, and other funds that in the past focused more on mezzanine financing or opportunistic transactions, which are now engaging in traditional PE models. Some big As mentioned above, PE transactions can be executed directly industrial corporations are investing in companies that develop in the target Company or routed through a BidCo. technologies linked to their core businesses. Some differences The investment of the management team is sometimes between those kinds of transactions and the traditional PE deals (partially) financed through loans that can be provided by the are (i) more flexibility on the exit horizon, (ii) the investment is, PE sponsors, repayable either as management bonus compensa- in certain occasions, more driven by the access to the information or sometimes at exit. This financing can also be provided tion and/or technology, instead of pure financial return, and (iii) by the target Company, if not restricted by financial assistance more difficulties in terms of corporate governance, remunera- provisions under Spanish or other applicable laws, and re-paid tion/ratchets of the management team, and willingness to retain also with management’s bonuses or at exit. access to the developed technology after exit. It is also customary that management invests only in equity whilst the PE sponsor provides both equity (common shares) 22 Structuring Matters and subordinated financing (through profit participating loans or preferred shares). Management is, in most cases, provided with sweet equity or 2.1 What are the most common acquisition structures a ratchet that vests upon exit, provided that a minimum internal adopted for private equity transactions in your rate of return (“IRR”) is obtained and/or certain investment jurisdiction? multiples are achieved. Usual thresholds would be an IRR of 20% and return multiples in the range of 2× to 3.5× (with inter- Usually PE transactions are executed according to the following mediate levels vesting a portion of the marginal gain obtained structures: (i) acquisition of companies in which a part of the at exit). The managers’ rights under the ratchet arrangements purchase price is financed, that is, leveraged buy-outs (“LBOs”); are usually vested throughout agreed vesting periods (four to (ii) financing of the growth of companies that are certainly consol- five years are usual), and subject to good-leaver and bad-leaver idated or already have benefits; (iii) replacement of part of the events. current shareholding structure (typically for family businesses and Carried interests paid to managers typically include a hurdle in succession situations); and (iv) investment for the restructuring rate or cumulative compounded rate of return (usually 8% p.a.) or Company turnaround. once 100% of the capital invested is distributed to all investors Transactions may be executed by regulated funds named “enti- pro rata to their respective investments. dades de capital riesgo”, through direct investment in the target Thereafter, a full catch-up is usually distributed to manage- companies or through holding vehicles (“BidCos”) whose share- ment until they recover the amounts not received up to that holders are the PE funds, jointly with its shareholders and the fund moment, and then the amounts are distributed equally to both management team, when applicable. BidCos are the acquiring investors and management pro rata until the amounts distributed entities and often assume the role of borrower if any acquisition to investors equal around 20%–25% and/or a certain multiple financing is needed. of aggregate capital invested by them. From that moment on, Transaction structures for foreign PE investments are, in general, there is a split of all distributions, in which amounts received by driven by tax efficiency (mainly tax treatment of dividends and management are substantially higher than those corresponding capital gains at the exit). International PE companies usually cana- to them according to their investment. lise their Latin American investment through a Spanish holding structure named ETVE (“entidad tenedora de valores extranjeros”), taking advantage of the bilateral tax treaties entered into between 2.4 If a private equity investor is taking a minority position, are there different structuring considerations? Spain and several Latin American countries. Alternatively, subject to the tax residency of the investors, another frequently used structure consists of the incorporation of a vehicle in a tax-efficient Majority or minority positions do not usually affect the invest- EU country on top of the ETVE structure (provided that valid ment structuring. economic reasons and sufficient substance, following the OECD’s In Spain, PE funds traditionally acquire majority stakes, base erosion and profit shifting (“BEPS”) regulations, are met). unless when their investment policies require otherwise or they agree to hold non-controlling positions alone or in combination with other partners, either with other strategic investors, PE 2.2 What are the main drivers for these acquisition sponsors, or founding families. In such cases, obtaining addi- structures? tional rights – to those already granted by the corresponding share percentage – such as veto rights and reinforced majori- The main drivers for PE transactions mainly relate to: (i) finan- ties in strategic decisions, seats at the board of directors, exit cial considerations and the ability to grant enough warranties to

provisions (including tag-along rights, put options, etc.), or key a bad-leaver situation, the sale price of the manager’s shares is management retention schemes, among others, is key for PE lower than both the market value and acquisition cost. investors with non-controlling positions. 3 2 Governance Matters 2.5 In relation to management equity, what is the typical range of equity allocated to the management, and 3.1 What are the typical governance arrangements what are the typical vesting and compulsory acquisition for private equity portfolio companies? Are such provisions? arrangements required to be made publicly available in your jurisdiction? The management team usually takes 5%–10% of the share capital of BidCo, or 15%–20% in secondary PE deals. PE investors usually have the right to appoint members in the In addition to question 2.3 above, vesting provisions for board of directors of their portfolio companies, even when ratchets and other types of incentives may be structured, their representation in the board is higher than in the share depending on the relevant PE sponsor, based upon (i) the time capital. In minority investments, PE investors usually have such elapsed from the investment or commencement of the relation- right, usually appointing one director, devoted to control the ship of the manager with the Company to the time of the depar- decision-making process and to be involved in the Company’s ture of the relevant manager, and (ii) the time from the termi- day-to-day business. However, in cases where the PE investor nation of the manager’s relationship with the target and the exit. holds a minority stake, or for any other reason is not allowed In this regard, good-leaver and bad-leaver provisions (see to appoint a director, PE investors usually reserve the right to question 2.6 below) play a relevant role in management incen- appoint one or more observers, who can participate in the board tives, as they encourage the management team to remain in the meetings with voice but with no voting rights. Company and to carry out their duties properly. These provi- As explained in question 3.2 below, PE investors usually sions allow the sponsor (and also usually the other shareholders) impose super-majority voting requirements for the passing to purchase the equity that a manager leaving the Company held of certain key decisions of the Company to ensure that their at a pre-agreed purchase price. Conditions of this (mandatory) favourable vote is required to pass certain relevant decisions, transfer of shares will vary depending on whether they are a both in general shareholders’ meetings and board of directors’ good leaver (occasionally the manager is allowed to keep the meetings, when applicable. shares) or bad leaver. Further, PE investors usually impose requirements to the Call options are usually granted to ensure effectiveness of this Company and managers to provide information to shareholders obligation to transfer, which are frequently reinforced with irrev- to which they otherwise may not be entitled to by law. ocable powers of attorney granted by the managers in favour of Shareholders’ agreements, which are usually private and the PE sponsor (or the representative of the other shareholders, confidential documents, include these provisions, as well as any as applicable). Put options in favour of the managers are some- other governance matters, such as the structure of the manage- times contemplated, but PE sponsors generally try to avoid ment group and the limitation to the powers of attorney to be them to ease the transaction. granted to some directors and managers and so forth.

2.6 For what reasons is a management equity holder 3.2 Do private equity investors and/or their director usually treated as a good leaver or a bad leaver in your nominees typically enjoy veto rights over major jurisdiction? corporate actions (such as acquisitions and disposals, business plans, related party transactions, etc.)? If a private equity investor takes a minority position, what “Good leaver” usually refers to the cease of a management veto rights would they typically enjoy? equity holder for a reason out of their control such as: (i) death; (ii) retirement; (iii) permanent illness or physical disability which renders the manager incapable of continuing employment In practice, executives appointed by the management team are in their current position; and (iv) voluntary non-justified termi- in charge of the day-to-day business of the Company by means nation by the Company. of the powers of attorney granted in their favour. However, On the contrary, the main reasons why management equity such powers of attorney are generally limited, so certain deci- holders are treated as “bad leavers” may be: (i) disciplinary sions have to be passed by the board of directors (i.e. acqui- dismissal based on misbehaviour in the workplace; (ii) being sitions and disposals, business plan, related party transactions, found guilty by a court of a criminal offence, jeopardising the etc.), by law, or by the agreement of the shareholders in the Company’s position, results or reputation; (iii) voluntary resig- general shareholders’ meeting. nation of the management equity holder (when not considered In this regard, PE investors with a majority stake may have as “good leaver”); and (iv) termination by the Company with fair influence over the decisions (as they are entitled to appoint the cause based on a material breach. majority or a wide number of members of the board of directors), Good leavers may be granted the right to keep their shares except over those decisions subject to veto rights for minority of the Company. Bad leavers, instead, are usually forced to shareholders. When a minority stake is held and the PE investor transfer their shares at pre-agreed, penalised valuations or at a does not have enough director nominees representing its inter- discount. Manager’s shares may either be distributed propor- ests, then veto rights and reinforced majorities are usually nego- tionally amongst the remaining equity holders or acquired with tiated and granted in their favour. certain limitations by the Company for their later amortisation. Veto rights and reinforced majorities not only apply to deci- It may also be the case that both good and bad leavers are sions to be adopted in board of directors’ meetings but also in obliged to transfer their shares. Thereupon, it is common to general shareholders’ meetings. These provisions are usually include a clause in the bylaws that states the sale price of the included in the bylaws of the Company and/or in the corre- good leaver’s shares shall be greater than both the acquisi- sponding shareholders’ agreements. tion cost and the market value of such shares. Conversely, in

3.3 Are there any limitations on the effectiveness of 3.6 Are there any legal restrictions or other veto arrangements: (i) at the shareholder level; and (ii) at requirements that a private equity investor should the director nominee level? If so, how are these typically be aware of in appointing its nominees to boards of addressed? portfolio companies? What are the key potential risks and liabilities for (i) directors nominated by private equity investors to portfolio company boards, and (ii) There are no contractual limitations on the effectiveness of private equity investors that nominate directors to veto arrangements, and they can be registered in the bylaws and boards of portfolio companies? before the Commercial Registry. However, the Spanish Capital Companies Act (“LSC”) sets A PE investor should be aware of the fiduciary duties it may have forth some binding minimum and maximum majorities to decide as director or as member of the board of directors, or those of its on certain matters (such as the removal of directors, amendment appointed directors. Directors may not be subject to any ground of the bylaws or corporate restructurings, amongst others) or of prohibition or incompatibility to discharge their office and, in on some matters restricting the rights of certain shareholders particular, to any of those established in the Law 3/2015, of 30 with the express consent of the affected shareholder. These March 2015, and other related legislation or any statutory prohi- limitations can be modified or agreed differently between the bition and, in particular, those established in the LSC. parties in the shareholders’ agreement, but cannot be included Directors’ duties are, among others: (i) duty of diligence; (ii) or registered in the bylaws of the Company and, therefore, they duty of loyalty; (iii) obligations to avoid conflicts of interest become private agreements among the shareholders, unenforce- situations; and (iv) duty of secrecy. Directors are held person- able against third parties. ally accountable for any damage caused by their acts performed Finally, the agreement to require the unanimous favourable without diligence or against the law or the Company’s bylaws. vote for the adoption of certain matters at the board level can be Directors are liable to the Company, its shareholders and the included in the shareholders’ agreement but not in the bylaws of creditors of the Company for any damage they may cause through the Company, as these provisions are rendered void and, there- acts (or omissions) contrary to the law or the bylaws, or carried fore, are not enforceable. out in violation of the duties inherent to their office, provided that there has been intentional misconduct or negligence. 3.4 Are there any duties owed by a private equity Additionally, it is also important to bear in mind that these investor to minority shareholders such as management duties of directors and the related liability resulting from a shareholders (or vice versa)? If so, how are these breach of these duties are also extended to those persons or enti- typically addressed? ties acting as “shadow” directors or “de facto” directors. This is the main risk applicable to PE investors that nominate directors PE investors have no specific duties towards minority share- to boards of portfolio companies. holders, unless voluntarily assumed by the PE investor. Most directors of PE-invested companies in Spain usually Nonetheless, pursuant to the LSC, Company resolutions may enter into directors and officers liability insurance to cover their be challenged when they are contrary to the law, bylaws or the civil liability to the possible extent. Company’s meeting regulation, or damage the Company’s interest in the benefit of one or more shareholders or third parties. 3.7 How do directors nominated by private equity Damage to the interest of the Company also occurs when investors deal with actual and potential conflicts of the resolution, although not causing damage to the Company’s interest arising from (i) their relationship with the party assets, is abusively imposed by the majority. The resolution will nominating them, and (ii) positions as directors of other be understood to be imposed in abuse when, without being in portfolio companies? response to a reasonable need of the Company, it is adopted by the majority in its own interest and to the unjustified detriment Directors must refrain from discussing and voting on resolutions of the other members. or passing decisions in which the director or a related person may have a direct or indirect conflict of interest. Excluded from 3.5 Are there any limitations or restrictions on the the foregoing prohibition are the resolutions or decisions that contents or enforceability of shareholder agreements affect the director in its condition as such, such as the director’s (including (i) governing law and jurisdiction, and (ii) appointment or removal from positions on the administration non-compete and non-solicit provisions)? body or others similar. In any event, directors have the duty to adopt the necessary Shareholders’ agreements are private and only enforceable measures to avoid situations in which their personal interests, against the parties who have signed them, while bylaws and or those on behalf of others, can conflict with the Company’s other corporate documents are public and thus enforceable interests and their duties to it. Therefore, directors must also against not only the Company and its shareholders but also by refrain from, among other things, engaging in activities on their third parties. own behalf or on behalf of others that involve effective compe- There are no limitations or restrictions on the contents of tition, whether actual or potential, with the Company or that in shareholders’ agreements other than the observance of law. In any other way place it in permanent conflict with the interests Spanish PE deals, the parties usually agree to subject the share- of the Company. holders’ agreement to Spanish law and to submit any disputes to arbitration, to ensure confidentiality and a fast process as opposed to slower public Spanish courts.

4 2 Transaction Terms: General 5.2 What deal protections are available to private equity investors in your jurisdiction in relation to public acquisitions? 4.1 What are the major issues impacting the timetable for transactions in your jurisdiction, including antitrust, foreign direct investment and other regulatory approval PE investors are usually requested to accept break-up fees when requirements, disclosure obligations and financing entering into auctions or competitive bids. However, such fees issues? do not usually exceed 1% of the total transaction costs. The board of directors of the target Company must have approved The EU Member States have traditionally been seen as some such fee, a favourable report by the target’s financial advisors of the world’s most liberal foreign direct investment territories. must be submitted, and the terms and conditions of the break-up PE transactions do not usually require prior authorisation, fee must be described in the takeover prospectus. except for those undertaken in regulated sectors such as, but not limited to, gaming, financing, telecom, public conces- 62 Transaction Terms: Private Acquisitions sions, energy, air transport, sports, media and tour operators. Authorisations can be at an EU, national or local level depending 6.1 What consideration structures are typically on the applicable regulation. preferred by private equity investors (i) on the sell-side, This notwithstanding, as explained above, a new article 7-bis and (ii) on the buy-side, in your jurisdiction? of Spanish Law 19/2003 of 4 July on legal regime of movements of capital and economic transactions abroad, subjects foreign Irrespective of the transaction side, PE investors usually prefer direct investments in certain strategic sectors (critical, physical locked-box structures due to the certainty they provide (as there or virtual infrastructures, critical technology and dual-use items, are no adjustments) and the simplicity and cost-efficiency in essential commodities, in particular, energy and sectors with setting the price (using the latest approved financial statements). access to sensitive data and media) made by residents (or whose In this regard, for proper protection of the buyer under this struc- beneficial owner is resident) of countries outside the EU and ture, the seller will have to warrant the non-existence of undis- the European Free Trade Association (“EFTA”) to prior admin- closed leakages in the financial statements until the closing date. istrative authorisation by the Spanish Government (Council of Earn-out structures are still used, enabling the buyer to Ministers) if, as a consequence of such investments, the investor maximise the price if the seller keeps control over the Company’s holds a stake equal to or greater than 10% of the capital stock management and allowing the buyer to reduce overpayment Spanish Company, or effectively participates in the management risks. Earn-outs are nevertheless conflictive and may easily lead of the Spanish Company or its control. to litigation. In addition, as from 18 March 2020, foreign direct investment is also restricted (subject to prior authorisation) to foreign investors that are directly or indirectly controlled by a third country 6.2 What is the typical package of warranties / government (including public agencies, the military or armed indemnities offered by (i) a private equity seller, and (ii) the management team to a buyer? forces), amongst others. This subjective condition may impact sovereign wealth and certain pension funds and other institutional investors who are natural investors in PE funds and in PE sellers commonly have to offer a set of representations Spanish infrastructures and big corporates. about the target Company, although limited in scope and time. Authorisations are also required for those acquisitions that Escrow deposits are still amongst the most common warran- result in a business concentration that exceeds certain antitrust ties granted by PE sellers, in which a percentage of the purchase thresholds (supervised by both Spanish and EU competition price is deposited in a bank account for a period of time and authorities). partial releases can be agreed.

4.2 Have there been any discernible trends in 6.3 What is the typical scope of other covenants, transaction terms over recent years? undertakings and indemnities provided by a private equity seller and its management team to a buyer?

In the last two to three years, auctions and IPOs are gaining momentum in bilateral transactions. Recent trends include the Covenants, undertakings and indemnities are avoided as much increasing use of locked-box and earn-out structures in lieu of as possible by PE sellers, to the extent that the PE sellers attempt post-closing adjustments of the purchase price, as well as the use to make the management team bear the burden. The most typi- of representation and warranties insurance. cally requested and controversial covenant is non-compete, which is usually provided by the management team but gener- 52 Transaction Terms: Public Acquisitions ally not by the PE seller.

Spanish takeover regulations establish that PE investors shall detail the full control chain of the funds into the take- The use of representations and warranties insurance is signifi- over prospectus and that all documentation must be submitted cantly increasing in Spain, particularly in auctions or competi- in Spanish as it will be addressed to all potential or actual tive bid acquisition processes. shareholders.

Any parameter of the insurance policies is determined by each confirmatory due diligence; reliance letters; final agreement insurance Company considering the requested coverage, the on contractual terms and conditions; and no material adverse main characteristics of the transaction and the target Company. change occurrence. However, to provide an estimated average of the market, the In the absence of compliance by the buying entity, sellers policy limit ranges between 10% and 20% of the target’s enter- have the right to request specific performance of obligations prise value, the deductible is fixed between 0.5% and 1% and the under the commitment letter and/or to be indemnified for the recovery policy period is generally seven years. damages caused. However, due to the soft nature of the letters Insurance premiums vary depending on the target Company, and since they are commonly subject to certain conditions prec- the insurer’s associated costs, the requested coverage, the edent, it may be difficult to obtain their enforcement. insurer due diligence and the timing of the transaction, among other factors, but usually range between 0.5% and 2% of the 6.8 Are reverse break fees prevalent in private equity policy limit. 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 Reverse break fees are relatively unusual in PE transactions in warranties, covenants, indemnities and undertakings? Spain because they are difficult to negotiate and enforce in case of breach. PE sellers usually cap their liability at a percentage of the price (between 5% and 20%) and for a period of up to two years from 72 Transaction Terms: IPOs closing, except for matters such as tax, labour, social security, personal data protection and eventually environmental matters 7.1 What particular features and/or challenges should which are usually subject to their relevant statute of limitations a private equity seller be aware of in considering an IPO periods (i.e. four to five years). Warranties are usually provided exit? for specifically identified potential liabilities or to cover any potential damages arising from the breach of the representations No particular features and/or challenges shall concern PE and warranties or any covenant agreed in the share and purchase sellers in considering an IPO exit, further than those applicable agreement. The extension of the definition of damages is also by law to any other seller. negotiated and limited to the item provided for in the Spanish Civil Code. 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. escrow accounts) for any warranties / liabilities, and (ii) private equity buyers insist on any security for They are imposed for 180 days with a possibility to be increased warranties / liabilities (including any obtained from the up to 360 days depending on the participation that the PE management team)? investor might still have remaining in the target Company after the IPO exit. As mentioned, escrow accounts are the most common warranties granted by PE sellers. These warranties are usually requested 7.3 Do private equity sellers generally pursue a dual- by buyers to cover certain potential liabilities and ensure reten- track exit process? If so, (i) how late in the process are tion and faster access to the seller’s money, although they are private equity sellers continuing to run the dual-track, monetarily limited to a percentage of the purchase price, limited and (ii) were more dual-track deals ultimately realised to a period of time, and partial releases of the amount deposited through a sale or IPO? need to be agreed between the parties. Except when the management teams are also selling share- Dual-track exit processes are not implemented in all transac- holders, they rarely grant warranties in PE transactions. tions but can be seen in Spain, particularly in large deals and when the IPO market is favourable. 6.7 How do private equity buyers typically provide PE sellers can continue to run the dual-track exit process comfort as to the availability of (i) debt finance, and (ii) until pricing, but it usually depends on the particularities of each equity finance? What rights of enforcement do sellers transaction. In Spain, both sales and IPOs have turned out to typically obtain in the absence of compliance by the be successful, so both structures have the same possibilities to buyer (e.g. equity underwrite of debt funding, right to be ultimately realised. specific performance of obligations under an equity commitment letter, damages, etc.)? 82 Financing

In Spain, the most common scenario is the buyer providing the 8.1 Please outline the most common sources of debt seller with an equity commitment letter that sets forth the avail- finance used to fund private equity transactions in your ability of debt and/or equity finance. jurisdiction and provide an overview of the current state Staple financing or a pre-arranged financing package offered of the finance market in your jurisdiction for such debt to potential bidders for an acquisition and arranged by an invest- (particularly the market for high yield bonds). ment bank is not yet common. Where equity finance is required, the commitment letter Bank financing and direct lending (seller’s loans or direct is usually provided by the PE funds controlling the compa- financing at the target Company) are common sources of nies. Where debt financing is required, such letters (usually of a debt in the Spanish market. Direct lending gained impor- soft nature) are issued by financial entities, although they are in tance during the economic and financial crisis as an alternative general subject to the fulfilment of certain conditions, including:

financing tool when banks were not providing enough liquidity. the target and the tax consolidation regime. The participation Additionally, some mezzanine debt funds are very active in the exemption regime also applies to domestic investments when Spanish market, providing financing facilities where the tradi- the shareholding in the target is higher than 5%, that is, divi- tional financial entities do not reach or cover the needs of the dends obtained by Spanish entities from Spanish subsidiaries are transaction. exempt from Corporate Income Tax (“CIT”). Likewise, capital The combination of both bank financing and alternative gains obtained by Spanish entities from the transfer of Spanish financing has proved interesting since it allows for far more subsidiaries are exempt. complex and flexible structures, with higher returns. This is typically applied in hybrid structures where debt funds not only 9.2 What are the key tax-efficient arrangements that provide equity but also debt. are typically considered by management teams in private Lately, with the recovery of the Spanish economy, the high- equity acquisitions (such as growth shares, incentive yield bond market has returned, with attractive yields and a shares, deferred / vesting arrangements)? low-risk premium. Thus, despite the high dependence on financing from tradi- It is common practice for the management team to receive tional banks, the trend for Spanish corporates is to actively seek incentive packages based on risk-sharing principles and the alternative financing. This trend might be reinforced now in the maximisation of value at exit. Considering tax-efficiency post-COVID-19 deals. reasons, management teams usually focus their attention on: (i) sweet equity or ratchets; (ii) payments of deferred bonus (which 8.2 Are there any relevant legal requirements or may enjoy certain reductions for tax purposes if generated in a restrictions impacting the nature or structure of the debt minimum period of time); or (iii) stock appreciation or similar financing (or any particular type of debt financing) of rights (“SAR”). private equity transactions? As the management team also holds a minority stake in share capital of the target Company, capital gains upon exit would be Financial assistance (that is, to advance funds, extend credits generated in the same way as the financial investors, and would or loans, grant security, or provide financial assistance for the be subject to the 23% Personal Income Tax rate, which is lower acquisition of its own quotas or shares) is the main legal restric- than the taxation of the income received as employment remu- tion under the LSC. neration (even though it might be raised during 2020 based on Additionally, there are some tax limitations imposed to tax the proposals made by the Government). Likewise, ratchet deductibility of interests (as further explained in section 9 payments upon exit up to EUR 300,000 may benefit from a 30% below). tax reduction provided for gains accrued in periods longer than two years. Nevertheless, there is a certain discussion about the taxation 8.3 What recent trends have there been in the debt financing market in your jurisdiction? of these instruments and their risk of re-classification, due to the wide definition of “salary” or “work-related income” for tax purposes, and the already existing anti-avoidance rules (e.g. As mentioned in question 8.1 above, although financial enti- any assets, including securities or derivatives, acquired by an ties and banks are offering liquidity and lower interest rates, in employee below market price are deemed to be “salary” from a the last two years the Spanish market, driven by a macroeco- Personal Income Tax point of view). nomic positive environment and a record of PE transactions in Recently, amendments have been introduced in the relevant the period 2017–2019, observed a significant increase in direct applicable regulations in the territories of the Basque Country lending from funds. and Navarra to clarify and provide certainty to managers in Thus, both bank financing and direct lending coexist, connection with the taxation of the carried interest. The goal providing investors and companies with a diversified menu of of this amendment is to align regulations and to clarify that, debt structures. if certain conditions are met, carried interest will be taxed as a capital gain or income on movable property, rather than as 92 Tax Matters employment income. This also follows a recent trend in other EU jurisdictions. 9.1 What are the key tax considerations for private equity investors and transactions in your jurisdiction? 9.3 What are the key tax considerations for Are off-shore structures common? management teams that are selling and/or rolling-over part of their investment into a new acquisition structure? Unless the investor is resident in a tax haven, income obtained by non-resident investors in Spanish PE-regulated vehicles (both As mentioned in question 9.2, capital gains at exit are generally dividends and capital gains derived from the transfer of shares subject to Personal Income Tax at a 23% marginal tax rate. in the Spanish PE) is not usually subject to taxation in Spain. The main tax consideration in the reinvestment of part of the Subject to the investor tax residency, interest income obtained management team’s investment into a new acquisition structure by non-resident investors could be subject to Withholding Tax is that the exchange is qualified as tax-neutral. However, recent (except if the lender is an EU resident). Other types of vehicles tax audits and court resolutions have denied the application require careful planning to facilitate efficient cash-back chan- of the tax neutrality regime to exchanges of shares in certain nels to investors. cases. To apply for the tax neutrality regime in share-for-share Off-shore structures are also common in Spanish PE deals exchanges, the issuer of the new shares (i) should hold more for international funds. However, it is important to undertake a than 50% of the share capital in the target Company as a result particular analysis of certain tax issues, like the tax deductibility of the shares’ exchange, and (ii) cannot pay more than 10% in of the interest expense incurred by the Spanish entity acquiring cash.

9.4 Have there been any significant changes in tax since the report usually covers an extensive analysis of the poten- legislation or the practices of tax authorities (including tial acquisitions from several perspectives including legal, finan- in relation to tax rulings or clearances) impacting private cial, tax, commercial, technical, regulatory and compliance. equity investors, management teams or private equity However, red-flag reports, sample-based due diligence and transactions and are any anticipated? materiality thresholds are common as well. Due diligence is generally conducted by outside advisors specialised in each area. The last legal reform operated in the tax area with a significant Vendor’s due diligence is also common in auctions or compet- impact in the PE industry and structures was carried out in 2014, itive bid acquisition processes. The usual timeframe covers a with effects as of 1 January 2015 (mainly due to the amendments four-week period, depending on the commitment and resources on interest deductibility and tax consolidation). As explained in devoted by each party and the technology used in the process. question 9.2 above, recently, the territories subject to Foral and Publicly traded companies are normally exempt from due dili- special tax regimes (Basque Country and Navarra) have enacted gence work. certain regulations on carried interest. Taking into account the current environment in Spain, it is likely that 2020 will bring 10.4 Has anti-bribery or anti-corruption legislation certain additional tax reforms that may have an impact on the impacted private equity investment and/or investors’ traditional PE structures, such as news on dividend treatments approach to private equity transactions (e.g. diligence, or corporate reorganisations. contractual protection, etc.)? As to the approach of the tax authorities, interest deduction in PE structures has been the main area of discussion over the PE sellers are increasingly concerned with compliance and with last few years (especially in intra-group indebtedness), together anti-corruption and anti-bribery regulations. PE companies are with the analysis of the rationale and substance of structures as incorporating internal compliance officers primarily focused a whole (following the OECD’s BEPS approach). Tax rulings on undertaking extensive and carefully supervised anti-money aimed at protecting particular situations or transactions may be laundering due diligence every time the entity approaches a more difficult to obtain, as the Directorate General of Taxes is potential investment. focusing on the technical interpretation of the rules, rather than Further, compliance provisions are becoming increasingly on its application to particular transactions. common in investment agreements (particularly as a representation to be provided by the selling shareholders) and/or share- 102 Legal and Regulatory Matters holders’ agreements.

10.1 Have there been any significant legal and/or 10.5 Are there any circumstances in which: (i) a private regulatory developments over recent years impacting equity investor may be held liable for the liabilities of private equity investors or transactions and are any the underlying portfolio companies (including due to anticipated? breach of applicable laws by the portfolio companies); and (ii) one portfolio company may be held liable for the After the intense legislative activity undertaken in 2014 and liabilities of another portfolio company? 2015, no significant new legislation affecting PE investments was enacted or amended in 2019. There are two circumstances under which a PE investor could On 29 September 2018, the Spanish Securities Market Act be held accountable for the liabilities of the underlying port- (“LMV”) was amended to partially transpose the provisions folio companies: (i) if the PE investor is considered a Company of Directive 2014/65/EU of the European Parliament and of “shadow director”; or (ii) if the court lifts the corporate veil of the Council of 15 May 2014 on markets in financial instruments the portfolio Company and, consequently, the action or omis- (“MiFID II”), which impact on the management companies and sion for which a liability has risen is attributed to the PE investor. impose additional requirements, especially in the commerciali- Otherwise, under Spanish law, a portfolio Company (nor its sation of funds. directors, officers or employees) cannot be held accountable for the liabilities of another portfolio Company. 10.2 Are private equity investors or particular transactions subject to enhanced regulatory scrutiny in 112 Other Useful Facts your jurisdiction (e.g. on national security grounds)? 11.1 What other factors commonly give rise to concerns Other than as stated in question 4.1 above, PE transactions for private equity investors in your jurisdiction or should are not subject to any prior authorisation unless the Company such investors otherwise be aware of in considering an is engaged in a strategic or regulated sector, or the transaction investment in your jurisdiction? results in a concentration of companies that exceeds certain antitrust thresholds. Most of the relevant factors that a potential PE investor must Foreign investments and divestments in Spanish companies consider when approaching a Spanish investment have already must, however, be communicated to Spanish authorities but for been addressed in the previous sections. As in any other foreign direct investment statistical purposes only. economy, legal certainty, political stability, foreign exchange rates, labour and union regulations become major considerations to invest in our jurisdiction. 10.3 How detailed is the legal due diligence (including compliance) conducted by private equity investors prior to any acquisitions (e.g. typical timeframes, materiality, scope, etc.)?

Due diligence work is a process to be performed thoroughly,

Ferran Escayola is a corporate, M&A and PE partner based in Spain and co-chairs the firm’s U.S. Desk. Between 2010 and 2016, he headed the firm’s office in New York. His practice focuses on Spanish M&A and PE, with a particular emphasis in cross-border transactions with the U.S. and LatAm and American investments in Spain. Ferran has a significant track record and experience with multijurisdictional acquisitions and foreign investments. Prior to joining Garrigues in 1999, he was an associate in the corporate and business law department of another international firm. He graduated from the Autonomous University of Barcelona where he completed a specialisation in European Community Law. Later, he obtained his LL.M. in International Economic Law (honours) from Howard University School of Law in Washington, D.C. and supplemented his studies by completing a postgraduate programme at Harvard Law School. In 2005–2006, he worked as an associate in the M&A department of Skadden, Arps, Slate, Meagher & Flom LLP in New York.

Garrigues Tel: +34 93 253 37 00 Avinguda Diagonal, 654 Email: [email protected] 08034 Barcelona URL: www.garrigues.com Spain

María Fernández-Picazo is a corporate, M&A and PE partner based in Madrid (Spain). She specialises in M&A, with a special focus on PE (both transactions and fundraising), leveraged financing and MBIs/MBOs, and regulated acquisitions in the financial (insurance companies, banks, stockbrokers, fund managers) and energy (wind, solar, biofuels) industries.

Garrigues Tel: +34 91 514 52 00 Hermosilla, 3 Email: [email protected] 28001 Madrid URL: www.garrigues.com Spain

Garrigues is a leading international law firm with dedicated offices in industry players. Garrigues M&A and PE partners are highly and consist- Beijing, Bogotá, Brussels, Casablanca, Lima, Lisbon, London, Mexico D.F., ently recognised by the most prestigious rankings and international legal New York, Porto, Santiago de Chile, São Paulo, Shanghai, and Warsaw, in directories and by their clients. addition to our 18 offices in Spain. www.garrigues.com Our PE teams sit in the main offices of the firm’s extensive Spanish and international network, thereby finding the right blend between specialist expertise and local market knowledge. The PE group works in close collaboration with other industry specialists, ensuring optimum quality and tailor- based analysis for each acquisition and for each investor. Our PE practice covers areas such as setting up funds, acting on behalf of management teams and investors, advising transactions in seed or venture stages, LBOs or MBOs and fund of funds transactions. Our experience accumulated in the sector has made Garrigues one of the leading providers of legal and tax services to PE firms, LPs, GPs and other

Private Equity 2020 © Published and reproduced with kind permission by Global Legal Group Ltd, London 142 Chapter 16 Switzerland Switzerland

Dr. Christoph Neeracher

Bär & Karrer Ltd. Dr. Luca Jagmetti

12 Overview 22 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? jurisdiction?

All of the standard transaction strategies to acquire portfolio Usually, private equity funds investing in Swiss portfolio compa- companies are commonly used in Switzerland. We assume that nies set up a NewCo/AcquiCo in Switzerland as an acquisition regular leveraged buyouts have accounted for the majority of vehicle. The NewCo is held either directly or via Luxembourg, the transactions in recent years. In 2019, private equity funds the Netherlands or a similar structure. We have also seen were involved in around one-third of M&A transactions in AcquiCos incorporated outside of Switzerland. Switzerland. Management usually invests directly in the AcquiCo rather than via a management participation company. Often, a single shareholders’ agreement (SHA) is concluded between the finan- 1.2 What are the most significant factors currently encouraging or inhibiting private equity transactions in cial investor(s) and management, which governs all aspects of your jurisdiction? the investment (governance, exit procedures, share transfers, good/bad leaver provisions, etc.). In other cases, a main SHA is concluded between the financial sponsors and a separate, While low interest rates for transaction financing, as well as smaller SHA with management. favourable borrowing conditions, still generate an incentive for high levels of private equity activity, the COVID-19 pandemic will have an impact on private equity transactions (see question 1.3). 2.2 What are the main drivers for these acquisition structures?

1.3 What are going to be the long-term effects for private equity in your jurisdiction as a result of the The acquisition structure is mainly tax-driven (tax-efficient COVID-19 pandemic? repatriation of dividends/application of double taxation treaties, tax-exempt exit). Directly investing in the AcquiCo may allow Swiss-domiciled managers to realise a tax-free capital gain on The COVID-19 pandemic is expected to slow down private their investment when the AcquiCo is sold on exit. equity deal-making until summer 2020, at least. The further impact will largely depend on the development of the pandemic and we may see increased activity in distressed sales transactions 2.3 How is the equity commonly structured in private towards the year end. equity transactions in your jurisdiction (including institutional, management and carried interests)?

1.4 Are you seeing any types of investors other than traditional private equity firms executing private A Swiss NewCo often has only one class (or a maximum of two equity-style transactions in your jurisdiction? If so, classes) of shares. Preferential rights, exit waterfall, etc. are please explain which investors, and briefly identify any implemented on a contractual level in the SHA. NewCos incor- significant points of difference between the deal terms porated abroad often have several classes of shares. offered, or approach taken, by this type of investor and that of traditional private equity firms. 2.4 If a private equity investor is taking a minority position, are there different structuring considerations? A number of family offices are playing an active role in Swiss private equity-style transactions, both in co-investments with private equity funds and as sole investors. In particular, in the Structuring is, in principle, not fundamentally different from latter case, their approach can differ from traditional private majority investments. Pre-existing structures are often main- equity firms, e.g. in terms of structuring in connection with tax tained to a certain extent. However, on a contractual level considerations. increased protection is sought (veto rights, right to trigger an exit, etc.).

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2.5 In relation to management equity, what is the If a private equity investor holds a minority of the voting rights, its typical range of equity allocated to the management, and veto rights usually depend on the stake held: while a small investor what are the typical vesting and compulsory acquisition (up to 20%) normally enjoys only fundamental veto rights aimed provisions? at the protection of its financial interest (dissolution, pro rata right to capital increases, no fundamental change in business, Management equity amounts and terms depend very much on maximum leverage, etc.), investors holding a more significant the individual deal. Typically the management stake ranges minority stake (20–49%) usually also have veto/influence rights between 3–10%. In most cases, standard drag-along and regarding important business decisions and the composition of tag-along provisions and good/bad leaver call options for the senior management. The exit rights for private equity investors benefit of the financial sponsor will apply. Put options for the holding a minority position are usually heavily negotiated. benefit of management are less prevalent. 3.3 Are there any limitations on the effectiveness of 2.6 For what reasons is a management equity holder veto arrangements: (i) at the shareholder level; and (ii) at usually treated as a good leaver or a bad leaver in your the director nominee level? If so, how are these typically jurisdiction? addressed?

Good leaver cases typically encompass (i) termination of At shareholder level, veto rights may be created by introducing employment by the company absent cause set by the manager, high quorums for certain shareholders’ decisions in the arti- (ii) termination of employment by the manager with cause set by cles of association and the SHA. Such veto rights are generally the company, and (iii) death, incapability, reaching of retirement regarded as permissive as long as the arrangement does not lead age or mutual termination. to a blockade of decision-taking in the company per se. Bad leaver cases on the other hand usually include (i) termi- At board level, individual veto rights of certain board nation of employment by the company with cause set by the members cannot be implemented based on the articles of associ- manager, (ii) termination of employment by the manager ation or other corporate documents. However, such individual absent cause set by the company, and (iii) material breach by the veto rights are regularly incorporated in the SHA; i.e. the parties manager of the SHA or criminal acts. agree that the board shall not take certain decisions without the affirmative vote of certain nominees. A board decision 32 Governance Matters taken in contradiction to such contractual arrangement would still be valid but may trigger consequences under the SHA. Furthermore, directors are bound by a duty of care and loyalty 3.1 What are the typical governance arrangements vis-à-vis the company. If abiding by instructions given by another for private equity portfolio companies? Are such person based on contractual provisions leads to a breach of such arrangements required to be made publicly available in your jurisdiction? duties, the board member may not follow such instructions and will likely not be in breach of the SHA (at least if the latter is governed by Swiss law). The predominant model for acquisitions of portfolio companies in Switzerland is the stock corporation (Aktiengesellschaft). Sometimes, limited liability companies (LLCs, GmbH) are used, which have the 3.4 Are there any duties owed by a private equity advantage of being treated as transparent for US tax purposes. investor to minority shareholders such as management shareholders (or vice versa)? If so, how are these The stock corporation is governed by a board of directors which typically addressed? has a supervisory function and resolves on strategic and important issues (appointment of senior management, etc.). A director is elected ad personam; proxies (e.g. in the case of absence at meet- Purely from its position as a shareholder, in principle, a private ings) are not possible. equity investor does not have such duties; shareholders of a Day-to-day management is normally delegated to management, Swiss stock corporation do not have any duty of loyalty. based on organisational regulations. They often contain a compe- However, directors, officers and management have a duty of tence matrix defining the competences of each management level care and loyalty towards the company and, to a certain extent, and the decisions which need approval by the board or even also to the minority shareholders. Under special, limited shareholders. circumstances, a private equity investor or an individual acting Such division of competence is – together with board compo- for it may be regarded as de facto/shadow director of the company sition, quorum requirements, etc. – also reflected on a contrac- and, consequently, also be bound by such duties. The claim that tual level in the SHA. a shareholder or one of its representatives is a shadow director Neither the organisational regulations nor the SHA are might be successfully made if such person has de facto acted as required to be made publicly available in Switzerland; only the an officer of the company, e.g. by directly taking decisions that articles of association. would actually be within the competence of the board, etc. Our comments in question 3.1 regarding stock corporations apply largely also to LLCs. 3.5 Are there any limitations or restrictions on the contents or enforceability of shareholder agreements (including (i) governing law and jurisdiction, and (ii) 3.2 Do private equity investors and/or their director non-compete and non-solicit provisions)? nominees typically enjoy veto rights over major corporate actions (such as acquisitions and disposals, business plans, related party transactions, etc.)? If a SHAs are common in Switzerland and are normally governed by private equity investor takes a minority position, what Swiss law. The parties are largely free to determine the rights veto rights would they typically enjoy? and duties but there are certain limitations. The most important ones are:

■ A a SH may not be unlimited in time/valid during the 4 2 Transaction Terms: General entire lifetime of the company, but may have a maximum term of ca. 20–30 years; and ■ as per mandatory corporate law, directors must act in the 4.1 What are the major issues impacting the timetable best interests of the company (duty of care and loyalty), for transactions in your jurisdiction, including antitrust, foreign direct investment and other regulatory approval which may hinder the enforcement of the SHA if its terms requirements, disclosure obligations and financing would conflict with such duties. issues? A SHA is only enforceable against its parties. There is a debate in Swiss legal doctrine as to what extent the company itself may be party to a SHA and be bound by its terms. While a majority If certain turnover thresholds are met, a Swiss merger filing acknowledges that the company may fulfil some administrative must be made. Unless the Competition Commission (CC) duties, entering into further obligations is questionable. decides to initiate a four-month phase II investigation, clearance Non-compete obligations of the shareholders in favour of the is granted within one month (phase I) after filing the complete company are typically enforceable if the respective shareholders application. It is strongly recommended that a draft filing be are (jointly) controlling the company. Furthermore, non-compete submitted for review by the Secretariat (which usually takes one obligations need to be limited to the geographical scope and scope to two weeks) to make sure that the filing is complete (thereby of activity of the company. triggering the one-month period) and not rejected as incomplete To secure share transfer provisions of the SHA, the parties 10 days after filing. often deposit their shares with an escrow agent under a sepa- For transactions regarding certain industries, governmental rate share escrow agreement. Sometimes, SHAs also provide for approvals must be obtained (e.g. banks, telecoms, etc.). The penalty payments in case of breach. impact on the timetable depends on the respective regulation and on the authorities involved. There is no general approval requirement regarding foreign direct investments, however. 3.6 Are there any legal restrictions or other Other than that, practical timing constraints such as setting requirements that a private equity investor should up a NewCo (ca. 10 days) are similar to other European be aware of in appointing its nominees to boards of jurisdictions. portfolio companies? What are the key potential risks and liabilities for (i) directors nominated by private equity investors to portfolio company boards, and (ii) 4.2 Have there been any discernible trends in private equity investors that nominate directors to transaction terms over recent years? boards of portfolio companies? Since debt financing has been easily available, buyers became On a practical note, at least (i) one person with individual signa- more willing to enter into binding purchase agreements prior tory power residing in Switzerland, or (ii) two individuals with to securing financing. It is currently difficult to predict what joint signatory power both residing in Switzerland, must be effect the temporary dislocation of financial markets caused by able to fully represent the company (entry into the commer- the COVID-19 pandemic will have on this trend. cial register). It is not necessary that such persons are board Further, given the recent sellers’ market, share purchase agree- members (but, e.g. managers). Additional individual or collec- ments had tended to be more seller-friendly (e.g. with regard tive signatory rights may also be granted for persons residing to R&W, etc.), albeit not as extreme as in the preceding years. outside Switzerland. As a result of the COVID-19 pandemic, we expect a tendency Directors, officers and managers of the company (including towards less seller-friendly agreements in the near future, in nominees of the private equity investor) have a duty of care particular with regard to conditionality (e.g. MAC clauses). and loyalty towards the company and must safeguard the (sole) As a general observation, typical Swiss share/asset purchase interest of the portfolio company even if such interest is contrary agreements still tend to be significantly shorter in length than to the interest of the appointing private investor. Under special, US/UK agreements – a consequence of Switzerland’s civil law limited circumstances, a private equity investor or an individual system. acting for it may be regarded as a de facto/shadow director of the company and, consequently, also be bound by such duties. To 52 Transaction Terms: Public Acquisitions prevent such a scenario, decisions should solely be taken by the competent bodies. Further, directors, officers and managers may be held liable in 5.1 What particular features and/or challenges apply to private equity investors involved in public-to-private case of non-payment of certain social security contributions and transactions (and their financing) and how are these taxes by the company. commonly dealt with?

3.7 How do directors nominated by private equity Anyone who acquires equity securities which, added to equity investors deal with actual and potential conflicts of securities already owned, exceed the threshold of one-third of interest arising from (i) their relationship with the party the voting rights (irrespective of whether these voting rights nominating them, and (ii) positions as directors of other portfolio companies? are exercisable) of a Swiss listed company, is obliged to make an offer for all listed equity securities of the company (mandatory tender offer), barring exemptions granted by the Swiss Takeover In case of a conflict of interest, the concerned director must Board. The target company may, however, have either increased inform the other board members and abstain from participating such threshold in its articles of association to a maximum of in the respective discussion and decision-making process. In 49% of the voting rights (opting-up), or completely excluded the typical Swiss private equity set-ups with one or few financial obligation to make an offer (opting-out). sponsor(s) that are each represented on the board, issues related Further, anyone who exceeds certain thresholds of the voting to conflicts of interest are of limited relevance in practice. rights in a Swiss listed company (the lowest triggering threshold

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is 3%) is obliged to make a notification to the company and the 6.4 To what extent is representation & warranty stock exchange (disclosure obligation). insurance used in your jurisdiction? If so, what are the Moreover, to carry out a statutory squeeze-out or a squeeze-out typical (i) excesses / policy limits, and (ii) carve-outs / merger subsequent to a public tender offer, the bidder must exclusions from such insurance policies, and what is the hold at least 98% (for a statutory squeeze-out) or 90% (for a typical cost of such insurance? squeeze-out merger), respectively of the voting rights of the target company. Voluntary tender offers are regularly made In the past, W&I insurances were relatively seldom used. However, subject to a minimum acceptance condition which, however, with insurers being more active and given the recent sellers’ market, does normally not exceed two-thirds of the target compa- W&I insurances have become more common in Switzerland. ny’s shares (depending on the circumstances, the Takeover Generally, a W&I insurance policy will usually not cover (i) Board may grant exemptions). Thus, the bidder can typically liabilities arising from known facts, matters identified in the due not structure the offer in a way to exclude the risk of ending diligence (DD) or information otherwise disclosed by the seller, up holding less than 90% and, consequently, not being able to (ii) forward-looking warranties, (iii) certain tax matters, e.g. squeeze-out the remaining minority shareholders. In practice, transfer pricing and secondary tax liabilities, (iv) pension under- however, bidders reach squeeze-out levels in most Swiss public funding, (v) civil or criminal fines or penalties where insurance acquisitions. cover may not legally be provided, (vi) post-completion price adjustments and non-leakage covenants in locked-box deals, 5.2 What deal protections are available to private (vii) certain categories of warranties, e.g. environmental warran- equity investors in your jurisdiction in relation to public ties or product liability, and (viii) liabilities arising as a result of acquisitions? fraud, corruption or bribery.

Both takeover parties can agree on break fees unless the fee 6.5 What limitations will typically apply to the liability payable by the target company will result in coercing share- of a private equity seller and management team under holders to accept the offer or deter third parties from submitting warranties, covenants, indemnities and undertakings? an offer. As a rough rule of thumb, break fees should not considerably exceed the costs in connection with the offer. The parties The liability for breaches of R&W is typically subject to a de must also disclose such agreements in the offer documents. minimis amount (depending on deal size) and a threshold amount In addition, block trades secure an improved starting posi- (often approximately 1% in mid-cap transactions), as well as a tion and decrease the likelihood of a competing bid. An alterna- cap in the range of 10–30%. Title and tax representations are tive would be tender obligations from major shareholders. These often not subject to such limitations. would, however, not be binding in the event of a competing offer. Managers are only liable in proportion to their shareholding.

62 Transaction Terms: Private Acquisitions 6.6 Do (i) private equity sellers provide security (e.g. escrow accounts) for any warranties / liabilities, and 6.1 What consideration structures are typically (ii) private equity buyers insist on any security for preferred by private equity investors (i) on the sell-side, warranties / liabilities (including any obtained from the and (ii) on the buy-side, in your jurisdiction? management team)?

The locked-box mechanism (with anti-leakage protection) Escrows to secure R&W are not uncommon; in particular, in preferred on the sell-side, and NWC/Net Debt adjustments, case of multiple sellers (e.g. when a large number of managers based on closing accounts, preferred on the buy-side, are equally are co-sellers). common in Switzerland. However, the seller-friendly market in recent years has led to an increase in the use of the locked-box 6.7 How do private equity buyers typically provide mechanism. Earn-outs and vendor loans have been seen less comfort as to the availability of (i) debt finance, and (ii) often recently. equity finance? What rights of enforcement do sellers typically obtain in the absence of compliance by the buyer (e.g. equity underwrite of debt funding, right to 6.2 What is the typical package of warranties / specific performance of obligations under an equity indemnities offered by (i) a private equity seller, and (ii) commitment letter, damages, etc.)? the 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 provides an equity commitment letter which may be enforced granted by a private equity seller and co-selling managers, which by the seller (obliging the private equity fund to provide the is not materially different from what strategic sellers offer. Quite NewCo with the necessary funds). The debt portion is usually often, tax indemnities are seen. comforted by binding financing term sheets, interim loan agreements or similar. In the context of public transactions, the avail- 6.3 What is the typical scope of other covenants, ability of funds must be confirmed by the review body before undertakings and indemnities provided by a private the launch of the offering. equity seller and its management team to a buyer?

Typically, the parties agree on non-compete and non-solicitation obligations for a period of one to three years.

6.8 Are reverse break fees prevalent in private equity required by the underwriters to sign up for lock-up undertakings transactions to limit private equity buyers’ exposure? If six to 18 months after the IPO. Therefore, SHAs among private so, what terms are typical? equity investors and agreements with directors and managers should provide for respective undertakings. Reverse break fees are relatively rarely seen in private equity transactions; sellers often insist on actual financing proof (see above). 7.3 Do private equity sellers generally pursue a dual- track exit process? If so, (i) how late in the process are 72 Transaction Terms: IPOs private equity sellers continuing to run the dual-track, and (ii) were more dual-track deals ultimately realised through a sale or IPO? 7.1 What particular features and/or challenges should a private equity seller be aware of in considering an IPO exit? This is heavily dependent on the general market conditions. If an IPO is considered, dual-track processes are often seen. However, if an IPO is not the preferred route at the beginning, a trade sale A private equity seller should be aware of the following features (auction) process will often just take place. Dual-track processes and challenges for a company going public: are being pursued until very late in the process, although parties ■ Lock-up: Typically, existing shareholders holding more try to make their final decision before the intention to float is than 3% of the share capital prior to the offering, as well published. Preferably, the timelines for both tracks are aligned so as the members of the board of directors and the exec- that the analyst reports and investor feedback on the IPO track utive management, will be required by the underwriters are available simultaneously with the binding offers on the trade to sign lock-up undertakings six to 18 months after the sale track. This allows the decision on the track to be made once IPO. Therefore, SHAs among private equity investors and there is a relatively clear view on the valuation. agreements with directors and managers should provide for respective undertakings. ■ Drag-along rights: SHAs should also include drag-along 82 Financing rights to ensure that that there are sufficient shares to be sold in the secondary tranche. 8.1 Please outline the most common sources of debt ■ Corporate governance: Private-equity owned companies finance used to fund private equity transactions in your will have to adapt their corporate governance regimes jurisdiction and provide an overview of the current state of the finance market in your jurisdiction for such debt in order to make the company fit for an IPO (including (particularly the market for high yield bonds). amendments to the articles of association, board composition, internal regulations, executive compensation, etc.). ■ Regulation: As in most jurisdictions, Swiss law and the Private equity investors usually provide financing in the form listing rules of the SIX Swiss Exchange provide for addi- of subordinated loans. In the context of leveraged buyouts, tional obligations of a public company (e.g. obligations investors will typically use senior and junior debt in the form of regarding financial reporting, compensation of the board credit facilities provided by financial institutions and high-yield of directors and the senior management, ad hoc announce- bonds, although there are some restrictions in connection with ments, disclosure of major shareholdings). These obliga- bond financing into Switzerland. In the context of acquisitions, tions require additional resources within the company and debt providers usually require that existing debt is refinanced the support of an external specialist. at the level of the acquisition debt providers. Security released ■ Liability: The liability regime and exposure in connec- in connection with the refinancing typically serves as collateral tion with an IPO is different to a trade sale. While in a for the new acquisition financing. The ability of Swiss target trade sale, the liability of the seller(s) is primarily contrac- group companies to provide collateral is limited under Swiss tual (i.e. under the SPA) and, therefore, subject to negotia- law. Upstream and cross-stream security may only be granted if tion, the main liability risk in an IPO results from the stat- certain prerequisites are met, and only in the amount of the rele- utory prospectus liability. However, since the company vant Swiss company’s freely distributable reserves. going public is primarily responsible for preparing the prospectus, the sellers’ exposure under this statutory 8.2 Are there any relevant legal requirements or regime is limited in most cases. In addition, the under- restrictions impacting the nature or structure of the debt writers typically require the selling shareholder(s) to also financing (or any particular type of debt financing) of make some limited representations in the underwriting private equity transactions? agreement and it is advisable that these are agreed early in the process. Certain limitations on leverage result from the thin capitalisation ■ Full exit: A full exit at the listing, i.e. a sale of all shares rules applied by Swiss tax authorities. Interest paid on amounts of held by the private equity seller, is typically not possible via debt exceeding certain thresholds may be requalified as a hidden an IPO. Therefore, the private equity seller will need to dividend if paid to a shareholder or a related party of a share- sell the remaining shares gradually or in one or more block holder. Consequently, such interest would not be tax-deductible trades after the lock-up expired. and subject to 35% withholding tax. The same applies if debt is provided by a third party but secured 7.2 What customary lock-ups would be imposed on by a shareholder. The Swiss tax authorities publish maximum safe private equity sellers on an IPO exit? haven interest rates for intercompany loans on an annual basis. Higher interest rates can be justified with a third-party test. Furthermore, there are restrictions on Swiss companies Typically, existing shareholders holding more than 3% of the granting loans or providing security which are of an upstream or share capital prior to the offering, as well as the members of cross-stream nature (see question 8.1 above). the board of directors and the executive management, will be

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8.3 What recent trends have there been in the debt participation qualifies as a tax-exempt capital gain is a case-by- financing market in your jurisdiction? case decision since preferential terms (like sweet equity) or a later investment at a formula value could lead to (partial) taxable salary for the managers upon sale and social security charges The Swiss debt financing market stayed robust despite the for the Swiss employer. Thus, it is recommendable to confirm fact that M&A activity appears to be slowing down slightly in the consequences of a specific management participation in an terms of the number of transactions and their total volume. advance ruling. Uncertainties on economic, legal and political levels – both internationally, such as Brexit or more recently the COVID-19 pandemic, and domestically, such as the unresolved relation- 9.4 Have there been any significant changes in tax ship with the EU – raise doubts about an imminent resumption legislation or the practices of tax authorities (including of M&A activity. The negative interest rates introduced by the in relation to tax rulings or clearances) impacting private Swiss National Bank are being maintained. equity investors, management teams or private equity transactions and are any anticipated? Covenant-lite and loose loans (especially with respect to financial covenants) have become more and more common but that may change due to the impact of the COVID-19 pandemic. The substance of foreign acquisition companies and their quali- In order to fight the financial consequences of the COVID-19 fication as beneficial owners of the shares in the Swiss target in pandemic for small and medium-sized businesses, the Swiss order to benefit from a Swiss dividend withholding tax reduc- government decided to provide government guarantees for tion are subject to more scrutiny by the Swiss Federal Tax emergency credit lines provided by Swiss commercial banks to Administration. Thus, a diligent set-up and advance tax ruling Swiss businesses. Due to their restrictive covenants (inter alia, confirmation are recommended, in particular since a future a dividend prohibition on a single entity level) and unless the buyer will generally inherit the current withholding tax situation respective emergency laws are changed, an acquirer will need to under the so-called “old reserve” regime and address such with- refinance these emergency credit lines with priority. holding tax risks in the purchase price determination. Under the OECD’s multilateral instrument, Switzerland has opted to apply 92 Tax Matters a principal purpose test, which should, however, not change the currently applied practice. Further, the corporate tax reform (approved on 19 May 2019) 9.1 What are the key tax considerations for private equity investors and transactions in your jurisdiction? entered into force on 1 January 2020 and provides for an abol- Are off-shore structures common? ishment of the privileged tax regimes. It also has an impact on the effective tax rates of Swiss target companies, as, in order to maintain attractive tax conditions for investors in Switzerland, Switzerland is not known as a very attractive location for the measures such as a reduction of tax rates, patent boxes, an extra establishment of private equity funds, mainly due to the Swiss R&D deduction, a notional interest deduction on surplus equity withholding tax and securities transfer tax regimes. Therefore, (only in the canton of Zurich) and exemptions for capital tax private equity funds are often established in jurisdictions like purposes were introduced. It also provides for an immigration Jersey, Cayman Islands, Luxembourg, Scotland or Guernsey. step-up, i.e. legal corporations may disclose hidden reserves, Private equity acquisitions in Switzerland are mainly including goodwill, in a tax-neutral way and subsequently create performed by NewCo acquisition vehicles (holding company) tax-deductible expenses through amortisation of the stepped-up from jurisdictions with which Switzerland has concluded a value. Further, the lump-sum tax credit system was adjusted and double taxation treaty and which foresee a 0% Swiss withholding now allows lump-sum tax credits for permanent establishments tax for a qualifying (generally a minimum of 10% shareholding) of foreign corporations under certain circumstances. Finally, dividend distribution from a Swiss company. The entitlement adjustments with respect to dividend taxation for individuals for a withholding tax reduction requires sufficient substance were introduced. and beneficial ownership of the shareholder in the Swiss target. Tax authorities tend to scrutinise tax-exempt capital gains for selling individuals; thus, earn-out arrangements for sellers 9.2 What are the key tax-efficient arrangements that continuing to work for the target or non-compete agreements are typically considered by management teams in private may partly qualify as taxable income for the seller and should be equity acquisitions (such as growth shares, incentive structured carefully. It is important to note also that payments shares, deferred / vesting arrangements)? by related parties could qualify as (taxable) salary which is generally subject to social security contributions by the Swiss There are no specific tax reliefs or tax provisions for manage- employer. ment share participations, except for blocking period discounts (6% per blocking year) if shares are acquired below fair market 102 Legal and Regulatory Matters value. 10.1 Have there been any significant legal and/or 9.3 What are the key tax considerations for regulatory developments over recent years impacting management teams that are selling and/or rolling-over private equity investors or transactions and are any part of their investment into a new acquisition structure? anticipated?

Swiss-resident managers generally try to achieve a tax-exempt A notable change in Swiss corporate law was implemented in capital gain upon the sale of privately held shares. In order not November 2019 and concerns the regime for the notification to qualify as salary (like synthetic bonus schemes), the managers of the beneficial owner of shareholders acquiring more than should have full ownership rights (dividend, liquidation, voting 25% in a Swiss company. The amendments removed some of rights). A tax neutral roll-over may be structured in certain the uncertainty surrounding the former rules implemented in circumstances. Whether the sale of shares under a management 2015. At the same time, failure to comply with the obligations

to disclose the beneficial owners is now subject to a fine. The property/lease; and IP/IT, data protection and litigation. The same applies for intentional breaches of directors’ obligations handling of compliance and regulatory matters depends on the relating to the keeping of a share register and register of benefi- specific case. Typically, an external legal counsel is engaged to cial owners. These newly introduced criminal sanctions apply in conduct a red flag legal DD of two to four weeks’ duration. addition to corporate law consequences of non-compliance with disclosure duties, which include the suspension of voting rights 10.4 Has anti-bribery or anti-corruption legislation and the loss of property rights until due notice is given. Another impacted private equity investment and/or investors’ key pillar of the new rules is the de facto abolition of bearer shares. approach to private equity transactions (e.g. diligence, After a transitional period and subject to few exceptions (notably contractual protection, etc.)? companies with shares listed on a stock exchange), Swiss stock corporations will no longer be allowed to issue bearer shares. If In DD as well as transaction agreements, a focus on compli- bearer shares are still outstanding by the end of the transitional ance of target companies with anti-bribery, anti-corruption and period in May 2021, they will be converted by law into regis- economic sanctions has increased in recent years. tered shares. On 1 January 2020, the new Financial Services Act (FinSA) and Financial Institutions Act (FinIA) entered into force, 10.5 Are there any circumstances in which: (i) a private changing the Swiss financial regulatory landscape signifi- equity investor may be held liable for the liabilities of cantly. The FinSA, in particular, introduces new concepts of the underlying portfolio companies (including due to breach of applicable laws by the portfolio companies); financial services regulation, partly modelled on the MiFID, and (ii) one portfolio company may be held liable for the to Switzerland. Furthermore, the new laws include a number liabilities of another portfolio company? of revisions to the Collective Investment Schemes Act (CISA), which affect the regulatory framework for the marketing and offering of interests in private equity funds in or into Under special, limited circumstances, a private equity investor Switzerland. Broadly speaking, the revised regime is subject or an individual acting for it may be regarded as a de facto/shadow to transitional rules under which the new regulatory duties are director of the company and, consequently, be bound by direc- phased in over a period of up to two years. tors’ duties (see question 3.6). In a nutshell, the revision of the CISA abolishes the former A private equity investor that (solely or jointly) controls a port- concept under which both product-related requirements and folio company that has infringed competition law could be made point-of-sale duties in connection with investment funds were jointly and severally liable for paying the resulting fine. While linked to a broad notion of “distribution” with very limited it is possible that a portfolio company may be made liable for exceptions, limiting the possibilities of foreign private equity the liabilities of another portfolio company, this is a less likely funds to raise funds in Switzerland without triggering regula- scenario. See also section 11 below. tory requirements. The new regime is more closely integrated Under normal circumstances it is highly unlikely that a port- into general financial instruments regulation and enables the folio company will be liable for another portfolio company. offering of foreign investment funds to a broader audience of qualified investors (including, for instance, regulated financial 112 Other Useful Facts institutions, but also large corporates, occupational pension schemes and other companies with professional treasury opera- 11.1 What other factors commonly give rise to concerns tions) without having to seek approval of the fund by the Swiss for private equity investors in your jurisdiction or should regulator FINMA and/or having to appoint a Swiss paying such investors otherwise be aware of in considering an agent and representative. Furthermore, the licence/supervision investment in your jurisdiction? requirement for distributors of collective investment schemes was abolished with the revised CISA. However, activities in In April 2014, the European Commission imposed a €37 million or into Switzerland, aimed at the purchase of fund interests by fine on Goldman Sachs for antitrust breaches committed by a Swiss investors, may qualify as a “financial service”, which may portfolio company that was formerly owned by its private equity trigger point-of-sale duties and other requirements under the arm, GS Capital Partners. GS and the portfolio company were FinSA, even if conducted on a cross-border basis from abroad. held jointly and severally liable for the fine. GS was held liable on the basis that it exercised decisive influence over the port- 10.2 Are private equity investors or particular folio company, although GS was not alleged to have partici- transactions subject to enhanced regulatory scrutiny in pated in, been aware of or facilitated the alleged cartel in any your jurisdiction (e.g. on national security grounds)? way. Even though in Switzerland no such precedents in relation to private equity companies exist so far, it is possible that the Swiss Competition Commission could follow the European While a few voices in politics have called for scrutiny on foreign Commission’s line of thinking. In Switzerland, holding compa- investments in the recent past, at this point there are no political nies tend to be found to be jointly and severally liable for the majorities for stricter laws in that respect. antitrust fines of their subsidiaries. Private equity investors should, therefore, implement a robust compliance programme in 10.3 How detailed is the legal due diligence (including their portfolio companies to avoid antitrust law infringements. compliance) conducted by private equity investors prior to any acquisitions (e.g. typical timeframes, materiality, scope, etc.)?

The legal DD usually covers the following areas: corporate; financing agreements; business agreements; employment; real

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Dr. Christoph Neeracher is a partner at Bär & Karrer and co-head of the Private M&A and Private Equity Practice Group. He is recognised as one of the preeminent private M&A and private equity attorneys at law in Switzerland and is a leading lawyer in financial and corporate law. Christoph Neeracher is experienced in a broad range of domestic and international transactions, on both the sell- and buy-side (including corporate auction processes), and specialises in private M&A, private equity and venture capital transactions. Furthermore, he advises clients on general corporate matters, corporate restructurings as well as on transaction finance and general contract matters (e.g. joint ventures, partnerships and SHAs), 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. Chambers Global and Europe rank him as a leader in the field of M&A (since 2010) and IFLR1000 lists him as one of the leading lawyers in Switzerland (since 2012). The International Who’s Who of M&A Lawyers lists Christoph Neeracher as one of the world’s leading M&A lawyers. The Legal 500 (2012) describes him as “extremely experienced in M&A matters and very strong in negotiations” and ranks him among the leading individuals. Christoph Neeracher is ranked first in Mergermarket’s Profile League Table for 2016’s most prolific individual DACH legal advisors.

Bär & Karrer Ltd. Tel: +41 58 261 52 64 Brandschenkestrasse 90 Email: [email protected] 8002 Zurich URL: www.baerkarrer.ch Switzerland

Dr. Luca Jagmetti is a partner at Bär & Karrer in the Private M&A and Private Equity Practice Group. He has vast experience in domestic and international M&A transactions (share and asset deals) involving a broad range of industries, corporate auction processes, venture capital investments and management equity participation schemes. Luca Jagmetti further advises clients on intragroup and transaction financing, corporate restructurings and general contract and commercial matters. In his core fields of activity he represents clients in litigation proceedings. Luca Jagmetti has several speaking engagements on asset transactions, legal DD and other M&A topics (e.g.: Akademie der Treuhand- Kammer; the Seminar on Mergers & Acquisitions for practitioners; and the Course on Commercial Law of the University of St. Gallen). According to The Legal 500 (2016) he is “very knowledgeable and speedy”. IFLR (2018) lists him as a noticeable practitioner. Luca Jagmetti is jointly ranked first in Mergermarket’s Profile League Table for 2016’s most prolific individual DACH legal advisors.

Bär & Karrer Ltd. Tel: +41 58 261 52 62 Brandschenkestrasse 90 Email: [email protected] 8002 Zurich URL: www.baerkarrer.ch Switzerland

Bär & Karrer is a renowned Swiss law firm with more than 170 lawyers in 2018, 2016, 2015 and 2014 Mergermarket M&A Awards. Zurich, Geneva, Lugano and Zug. The core business is advising clients on 2016, 2013 and 2012 Chambers European Awards. innovative and complex transactions and representing them in litigation, 2016, 2015 and 2014 The Legal 500 (“most recommended law firm in arbitration and regulatory proceedings. The clients range from multina- Switzerland”). 2015, 2014, 2013, 2011 and 2010 The Lawyer’s European Awards. tional corporations to private individuals in Switzerland and around the 2015 Citywealth Magic Circle Awards (“International Law Firm of the world. Bär & Karrer was repeatedly awarded Switzerland Law Firm of the Year EMEA”). Year by the most important international legal ranking agencies in recent 2014 Citywealth International Financial Centre Awards. years. Almost all leading private equity funds active in Switzerland form www.baerkarrer.ch part of our client basis. 2019 STEP Award (“International Legal Team of the Year”). 2019 Citywealth Magic Circle Award (“Law Firm of the Year – Switzerland”). 2019, 2015 and 2014 International Financial Law Review (IFLR) Awards. 2019 IFLR “Debt and Equity-linked Deal of the Year” Award. 2019, 2015 and 2014 IFLR Awards. 2018 IFLR “Deal of the Year” Award. 2018, 2017 and 2016 Trophées du Droit Gold or Silver.

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James C. C. Huang

Lee and Li, Attorneys-at-Law Eddie Hsiung

12 Overview it is difficult to gauge the longer-term impact on industry performance. Therefore, we expect that PE firms will be more conservative towards the economic outlook and cherry-pick 1.1 What are the most common types of private equity the underlying companies/industries or even halt transactions. transactions in your jurisdiction? What is the current However, we believe that there will still be PE firms that wish state of the market for these transactions? to proceed with transactions under which the target is under- valued, or even financially distressed, but with large potential to In local practice, recently the most common types of private recover due to, for example, its core technologies or competitive equity (“PE”) transactions are related to technology, media and edge among the industries. telecommunications (“TMT”) industries, while some traditional industries such as the chemical industry and people’s livelihood consumption enterprises are also increasingly favoured by large 1.4 Are you seeing any types of investors other than traditional private equity firms executing private international PE investors. In the past three years, a series of equity-style transactions in your jurisdiction? If so, significant deals led by PE funds were completed, including please explain which investors, and briefly identify any KKR’s take-private acquisition of LCY, Morgan Stanley’s significant points of difference between the deal terms take-private acquisition of Microlife, BlackRock’s acquisition of offered, or approach taken, by this type of investor and a solar portfolio from J&V Energy Technology, and Permira’s that of traditional private equity firms. investment into aquaculture company Grobest. Not to our knowledge. In local practice, traditional PE firms 1.2 What are the most significant factors currently are still the most common investors executing PE-style trans- encouraging or inhibiting private equity transactions in actions in Taiwan. your jurisdiction? 22 Structuring Matters Factors encouraging PE transactions normally include, for example, (i) from the perspective of a portfolio company, the 2.1 What are the most common acquisition structures need to re-structure the company from a financial and/or oper- adopted for private equity transactions in your ational viewpoint with the assistance of PE firms, and (ii) from jurisdiction? the perspective of PE firms, the potential increase of value of the portfolio company if the company is benefitted from the In local practice, it is very common to see a PE firm establishing resources (strategically or otherwise) that can be brought into a local special purpose vehicle (“SPV”) to acquire the shares of the company by PE firms. the portfolio company in Taiwan. With respect to inhibitory factors, the attitude of the govern- Additionally, for a public transaction under which the PE ment would be the main factor affecting PE transactions. For investor wishes to acquire 100% shares of the Taiwan company, example, the government might not necessarily wish to see large the following two approaches are commonly considered and or reputable companies delisted from the exchanges in Taiwan. adopted: Also, the government would be concerned about the protection (i) two-step approach: The PE investor firstly launches a of minority shareholders under a take-private transaction. In tender offer to acquire more shares of the target company, addition, some government officials seem to still hold a rather followed by a share swap to acquire the remaining shares; conservative view towards PE firms and transactions, thinking and that PE firms focus more on relatively short-term investment (ii) one-step approach: The PE investor carries out a share performance and would not necessarily be good for local stake- swap to acquire the shares of the target company directly. holders (e.g., industries, employees, etc.)

2.2 What are the main drivers for these acquisition 1.3 What are going to be the long-term effects for structures? private equity in your jurisdiction as a result of the COVID-19 pandemic? The main reasons for setting up a local SPV for acquisition (as indicated under question 2.1 above) are tax efficiency and Given the uncertainty surrounding the COVID-19 pandemic, simplicity in transaction structure and related actions.

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With respect to approaches (i) and (ii) as described in question 32 Governance Matters 2.1, a PE investor may tend to adopt approach (i) (i.e., launching a tender offer first to acquire more shares of the company) if it cannot be certain whether the proposed M&A will be passed by 3.1 What are the typical governance arrangements the shareholders’ meeting. for private equity portfolio companies? Are such 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 There are no typical governance arrangements for a PE port- institutional, management and carried interests)? folio company if the PE investor acquires 100% of the shares of such portfolio company. In Taiwan, the equity structure for PE transactions should vary from case to case, and there is no typical way of equity structuring in PE transactions. 3.2 Do private equity investors and/or their director nominees typically enjoy veto rights over major While the arrangement of original major shareholder/ corporate actions (such as acquisitions and disposals, management rollover is more and more popular in Taiwan, it business plans, related party transactions, etc.)? If a is commonly arranged that the rollover participants hold the private equity investor takes a minority position, what equity of an offshore entity upon closing of the PE transactions. veto rights would they typically enjoy? Similar to many other jurisdictions, carried interest is the principal part of the compensation to the general partner (“GP”) of If the PE investor acquires 100% of the shares of the portfolio a PE fund. company, the portfolio company will be wholly controlled by the PE investor so there should be no issue regarding veto rights. 2.4 If a private equity investor is taking a minority In case a PE investor takes a minority position, the PE investor position, are there different structuring considerations? may wish to have veto rights over activities that will materially affect the company, such as M&A, issuance of securities, change In local practice, it is rare for a a PE investor to take a minority to the business plan of the company, material transactions and position. If a PE investor is taking a minority position in a port- capital expenditure, etc. The veto rights may be entitled to the folio company, it is anticipated that the minority PE investor PE investor at the level of shareholders’ meeting or, in case the would wish to include clauses that may protect the interest of PE investor nominated any director of the company, the board the minority shareholders, such as tag-along rights, right of first meeting. refusal, and even veto rights for certain matters. A minority PE shareholder may also wish to have one or more board seats, 3.3 Are there any limitations on the effectiveness of depending on the percentage of shareholding, in order to have veto arrangements: (i) at the shareholder level; and (ii) at the information rights that entitle a director. the director nominee level? If so, how are these typically addressed?

2.5 In relation to management equity, what is the typical range of equity allocated to the management, and From a contract point of view, there is no limitation on the what are the typical vesting and compulsory acquisition effectiveness of veto arrangements under Taiwan law, and if a provisions? party is in breach of the veto arrangement, the other party may seek remedies against the breaching party under the contract. If In Taiwan, the range of equity allocated to the management the contract also stipulates that the veto arrangement should be varies from case to case, and there is no typical range in this reflected in the constitutional document (i.e., articles of incor- regard. According to our experience, the management may be poration (“AOI”)) of the company, not all of the thresholds entitled to equity pursuant to an employee stock ownership plan expressly specified in the Taiwan Company Act for the resolu- (“ESOP”) or similar arrangement under which a certain portion tions of shareholders and directors may be raised by the AOI. of equity vests after a certain period of time and/or is based Therefore, any attempt to reflect the veto arrangement in the on performance of the target company. It is also common that AOI that contradicts the statutory voting thresholds may be PE or the target company may have the right to purchase the deemed null and void. equity held by the management at a certain price in case of their Also, the Taiwan Company Act permits shareholders of departure. non-public companies to have contractual voting arrangements. Therefore, the enforceability of voting arrangements among shareholders of a public company might not necessarily 2.6 For what reasons is a management equity holder be recognised by the court. usually treated as a good leaver or a bad leaver in your jurisdiction? 3.4 Are there any duties owed by a private equity investor to minority shareholders such as management Whether a management equity holder is treated as a good leaver shareholders (or vice versa)? If so, how are these or bad leaver varies depending on individual circumstances. typically addressed? Generally speaking, a PE firm would tend to treat a management equity holder as a “good leaver” if the leaver’s conduct is without fault (e.g., death, disability, retirement), and as a “bad Under local law and practice, there are no specific duties owed leaver” if there is, to some extent, fault on behalf of the leaver by a PE investor to minority shareholders except where the PE (e.g., dismissal for cause, breach of the shareholders’ agreement, investor appoints any directors in the company, in which case failure to achieve certain targets or expectations, etc.). such directors shall have fiduciary duties under the Taiwan Company Act.

3.5 Are there any limitations or restrictions on the a result that reflects the principles and voting arrangements contents or enforceability of shareholder agreements agreed by all shareholders in the shareholders’ agreement. (including (i) governing law and jurisdiction, and (ii) non-compete and non-solicit provisions)? 4 2 Transaction Terms: General

From a Taiwan legal perspective, choice of foreign law 4.1 What are the major issues impacting the timetable (governing law) and submission to exclusive jurisdiction of for transactions in your jurisdiction, including antitrust, a foreign country (jurisdiction) will be recognised and given foreign direct investment and other regulatory approval effect by the courts of Taiwan, provided that Taiwan courts requirements, disclosure obligations and financing may refuse to apply the relevant provisions of foreign law to the issues? extent such courts hold that: (i) the application of such provisions would be contrary to the public order or good morals In Taiwan, PE acquisitions are often subject to foreign investment of Taiwan; and (ii) such provisions would have the effect of approvals and an antitrust review process. For those target compa- circumventing mandatory and/or prohibitive provisions of nies that are in a regulated industry, approval from the competent Taiwan law. For submission to an exclusive jurisdiction of a authority would also be required. Therefore, whether and how foreign country, a submission to jurisdiction clause and the regulatory approvals can be smoothly obtained is a critical issue to relevant foreign court judgment would be generally recognised the completion of a PE transaction in Taiwan, which would mate- and enforced by Taiwan courts on a reciprocal basis. rially impact the timetable for PE transactions in Taiwan. The obligations of shareholders under non-compete and Disclosure obligations and financing are normally not major non-solicit provisions are generally recognised by the courts. issues impacting the timetable for transactions in Taiwan. However, if a shareholder is an executive officer of the target company and his shareholding is limited, his non-compete obli- 4.2 Have there been any discernible trends in gations after termination of service agreement may be subject to transaction terms over recent years? the court’s review (and the important factors that may affect the validity of such non-compete obligations include proper consideration and period, etc.). Acquisition by PE investors has risen strongly in recent years. The major reasons include the local regulators’ policies (being neutral to such transactions), the relatively low price-to-earnings ratio of 3.6 Are there any legal restrictions or other Taiwan listed companies, and favourable interest rates in local requirements that a private equity investor should financing markets. Also, use of warranty and indemnity (“W&I”) be aware of in appointing its nominees to boards of portfolio companies? What are the key potential risks insurance has become more common in local M&A transactions, and liabilities for (i) directors nominated by private especially for take-private transactions by PE investors. equity investors to portfolio company boards, and (ii) private equity investors that nominate directors to 52 Transaction Terms: Public Acquisitions boards of portfolio companies?

5.1 What particular features and/or challenges apply There are no specific legal restrictions or other requirements to private equity investors involved in public-to-private with respect to a PE investor’s appointment of any directors in transactions (and their financing) and how are these portfolio companies, except that such directors shall have fidu- commonly dealt with? ciary duties under the Taiwan Company Act, which include the duty of loyalty to the company. Also, from a Taiwan law With respect to a public-to-private transaction where the target perspective, the individual(s) appointed by a PE investor to act company will be delisted, a particular challenge is the regula- as the director(s), and the PE investor itself, would be deemed tory threshold of shareholders’ resolution. Where the target director(s) of the target company for all purposes of the direc- company is to be delisted upon closing, such transaction would tor’s fiduciary duties. Therefore, if any individual appointed by require approval of two-thirds of the total number of the issued a PE investor to act as the director breaches his fiduciary duties shares of the target company. It is noteworthy that the govern- and causes damage to the target company, the individual and the ment has even proposed to raise the threshold from the current PE investor may be jointly and severally liable for such damage. two-thirds to three-quarters, although this proposal is still under discussion. The common way to deal with this challenge 3.7 How do directors nominated by private equity is by (1) first launching a tender offer to acquire more shares investors deal with actual and potential conflicts of before carrying out the M&A requiring such high threshold, interest arising from (i) their relationship with the party and/or (2) entering into an agreement with existing major share- nominating them, and (ii) positions as directors of other holder(s) who could help obtain a sufficient number of votes to portfolio companies? support the proposed transactions. We do not see any particular challenges with respect to the Theoretically speaking, directors nominated by a PE investor financing of PE investors in public-to-private transactions. are subject to their fiduciary duties to the target company. However, in local practice, the risk of conflict of interest may 5.2 What deal protections are available to private be remote. First of all, as PE investors normally acquire 100% equity investors in your jurisdiction in relation to public equity of a target company, the best interest of the company is acquisitions? usually aligned with that of the PE investor. Also, where the target company has more than one shareholder (e.g., PE investor Under public acquisitions, it is common to see a PE investor and rollover participants), the governance of the target company request the seller to accept an exclusivity provision, under which would be carried out in accordance with the shareholders’ agree- the seller may not look for other buyers after the signing of the ment, and the decision made in the board meeting should be definitive agreement.

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62 Transaction Terms: Private Acquisitions 6.5 What limitations will typically apply to the liability of a private equity seller and management team under warranties, covenants, indemnities and undertakings? 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? In addition to the survival period of the representation, it is common that the aggregate liabilities of the sellers would be capped at 100% of the purchase price, and liabilities for breach In local practice, PE investors typically prefer to use cash of non-fundamental representations would be capped at 20–30% consideration for private acquisitions on both the sell-side and of the purchase price. On the other hand, the parties would the buy-side. usually consider the nature of the target company’s business and the deal size when negotiating the amounts of de minimis and 6.2 What is the typical package of warranties / basket thresholds. indemnities offered by (i) a private equity seller, and (ii) the management team to a buyer? 6.6 Do (i) private equity sellers provide security (e.g. escrow accounts) for any warranties / liabilities, and Typically, the package of warranties offered by the PE seller in (ii) private equity buyers insist on any security for a private acquisition is similar to those customarily provided by warranties / liabilities (including any obtained from the the sellers in normal M&A transactions. With respect to indem- management team)? nities, a PE seller would normally tend not to offer a long period during which the buyer may seek for indemnities; otherwise the We have seen escrow or holdback arrangements in some cases PE firms may not be able to have a clear exit or make the distri- but we do not think they are common in local PE deals. bution to its investors soon after the closing of the transactions. We notice that in some cases, W&I insurance was used to bridge the gap. 6.7 How do private equity buyers typically provide In local practice, it is not typical to have warranties/indemni- comfort as to the availability of (i) debt finance, and (ii) equity finance? What rights of enforcement do sellers ties separately offered by the management team to a buyer under typically obtain in the absence of compliance by the private acquisitions. buyer (e.g. equity underwrite of debt funding, right to specific performance of obligations under an equity commitment letter, damages, etc.)? 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? According to our experience, when the seller needs comfort, a PE buyer may present to the seller a commitment letter issued In local practice, other than certain typical pre-closing cove- by it to its SPV (the buyer), indicating its commitment to make nants such as “standstill”, a PE seller normally would not agree equity investment in the SPV for the transaction. With respect to provide post-closing covenants for non-competition, etc. to debt finance, a PE buyer (for its own benefits as well) would With respect to indemnities, as advised under question 6.2, obtain a certain fund commitment from the lenders before normally a PE seller would tend not to offer a long period during signing a definitive agreement with the seller, which may also be which the buyer may seek for indemnities. presented to the seller. In local practice, management teams who are also selling In local practice, the seller (as a third party) usually has no shareholders would be required to either enter into a certain right to enforce such commitment letters pursuant to the terms retention arrangement or undertake not to compete with the and conditions thereof. However, theoretically speaking, if target company for a certain period of time after the closing. the definitive agreement for the transaction and the relevant commitment letters are governed by Taiwan law, the seller may have a right to enforce the relevant commitment letters for and 6.4 To what extent is representation & warranty on behalf of the buyer for the general benefits of all creditors of insurance used in your jurisdiction? If so, what are the typical (i) excesses / policy limits, and (ii) carve-outs / the buyer (instead of in the name of the seller and for its own exclusions from such insurance policies, and what is the benefit). typical cost of such insurance? 6.8 Are reverse break fees prevalent in private equity In local practice, the W&I insurance has recently become transactions to limit private equity buyers’ exposure? If more and more popular. Our observation is that the buyer so, what terms are typical? may consider obtaining a W&I insurance when a seller needs a clear exit (such as a PE seller) or the nature of the transaction According to our experience, “break fee” arrangements are not makes the post-closing indemnity for breach of representations prevalent in local practice. less meaningful (such as a public company deal without a major selling shareholder). 72 Transaction Terms: IPOs The provisions of W&I insurance may vary from case to case, and to our knowledge, in local practice, there are no typical (i) 7.1 What particular features and/or challenges should excesses/policy limits, (ii) carve-outs/exclusions, or (iii) costs a private equity seller be aware of in considering an IPO for such insurance, which would largely depend on the size of exit? transaction, the business of target company and the due diligence exercise of the buyer. A Taiwanese IPO may not be an attractive way of exit due to the relatively low price-to-earnings ratio of the Taiwan stock market, and PE investors usually prefer to carry out IPOs in other

jurisdictions. However, due to the special relationship between 8.3 What recent trends have there been in the debt Taiwan and China, the approval of Taiwanese regulators for a financing market in your jurisdiction? PE investor’s acquisition of a Taiwanese target company may be given on the condition that the PE investors shall undertake There are no particular recent trends in the debt financing not to have the target company list in stock exchanges in China market in Taiwan. Most PE investors still prefer to arrange for or Hong Kong in the future, which may limit the IPO exit by bank loans (as described above in question 8.1) as the source of PE investors. debt finance.

7.2 What customary lock-ups would be imposed on 92 Tax Matters private equity sellers on an IPO exit?

9.1 What are the key tax considerations for private In local practice, for an IPO, the directors and supervisors of equity investors and transactions in your jurisdiction? such company, as well as the shareholder(s) holding more than Are off-shore structures common? 10% of the shares of the company (“10% Shareholder”), are required to place their shares with the Taiwan Depository & In Taiwan, a tax implication normally considered in PE transac- Clearing Corporation (“TDCC”) for central custody. The total tions is, from the perspective of the seller, whether the transac- number of shares placed in custody shall also reach a certain tion would be subject to the securities transaction tax (0.3% of percentage (5–25%, depending on the number of total issued the transfer price) on the sale of the securities and/or the income shares) of the shares of the company. tax (for which the highest tax rate is up to 40% for individuals). The required period for such central custody is one year. After the first half-year of the IPO, the directors, supervisors and 10% Shareholders will be able to retrieve 50% of their shares, and 9.2 What are the key tax-efficient arrangements that the remaining 50% may be retrieved after the second half-year are typically considered by management teams in private equity acquisitions (such as growth shares, incentive of the IPO. shares, deferred / vesting arrangements)?

7.3 Do private equity sellers generally pursue a dual- As indicated above, it is commonly arranged that the manage- track exit process? If so, (i) how late in the process are ment (rollover participants) hold the equity of an offshore private equity sellers continuing to run the dual-track, and (ii) were more dual-track deals ultimately realised entity upon closing of the PE transactions, in which case the through a sale or IPO? focus would be more on the tax law of the jurisdiction where the offshore entity is incorporated. However, a Taiwanese individual’s non-Taiwan-sourced income from his/her equity in the From our observation, the dual-track exit process is not common offshore entity should also be included in the calculation of the in Taiwan. As mentioned above in question 7.1, an IPO does not alternative minimum tax of Taiwan. seem to be considered an exit priority, so there were many more In case the management (rollover participants) holds the cases where PE sellers exited through a sale. equity of an onshore entity upon closing of the PE transactions, the tax implication would depend on the type of equity instru- 82 Financing ments granted to the rollover participant. For example, in case of employee stock options, the Taiwanese individual holder will 8.1 Please outline the most common sources of debt be taxed (income tax) on the difference between (i) the “then- finance used to fund private equity transactions in your fair value” when the option is exercised, and (ii) the exercise jurisdiction and provide an overview of the current state price of the option. of the finance market in your jurisdiction for such debt (particularly the market for high yield bonds). 9.3 What are the key tax considerations for management teams that are selling and/or rolling-over The most common source of debt finance used in PE trans- part of their investment into a new acquisition structure? actions is bank loan – specifically, syndicate loans extended by domestic and/or foreign banks. Other debt financing instruments are rarely seen in local practice. See question 9.2.

8.2 Are there any relevant legal requirements or 9.4 Have there been any significant changes in tax restrictions impacting the nature or structure of the debt legislation or the practices of tax authorities (including financing (or any particular type of debt financing) of in relation to tax rulings or clearances) impacting private private equity transactions? equity investors, management teams or private equity transactions and are any anticipated?

As indicated above under question 8.1, the most common source No, there have not. of debt finance used in PE transactions is bank loan. While there are no legal requirements or restrictions that would specifically impact the nature or structure of the debt financing of a PE transaction, from our experience, Taiwan regulators may have concern if the loan granted by domestic banks exceeds 60% of the consideration for the transaction.

Private Equity 2020 © Published and reproduced with kind permission by Global Legal Group Ltd, London Lee and Li, Attorneys-at-Law 155

102 Legal and Regulatory Matters it is commonly seen that the Legal DD period may take one to two months. The materiality thresholds for a PE transaction should really depend on individual cases, and the size and 10.1 Have there been any significant legal and/or operation of the target company (as measured by, for example, regulatory developments over recent years impacting assets and revenues) as well as the requirements of the insurer private equity investors or transactions and are any anticipated? for W&I insurance, are normally the important factors in determining the thresholds. As to the scope of the Legal DD, PE investors would normally request a comprehensive Legal DD on There have been two significant legal developments since 2018: the target company. (1) In November 2018, the Justices of the Constitutional Court granted a minority shareholder in a cash-out merger in 2007 an appraisal right in Interpretation No. 770, on 10.4 Has anti-bribery or anti-corruption legislation the basis that the then effective M&A Act failed to afford impacted private equity investment and/or investors’ approach to private equity transactions (e.g. diligence, sufficient protection and was therefore unconstitutional. contractual protection, etc.)? The Justices of the Constitutional Court further opined that the current M&A Act (in effect since 2016) is also flawed in terms of shareholder protection, including with Not to our knowledge. However, the relevant issues would regard to disclosure requirements. Public comment on this definitely be a concern of PE investors and would need to be Constitutional Court interpretation is that the validity of checked during the Legal DD. the current M&A Act is not immediately affected. On the other hand, the competent authority is expected to amend 10.5 Are there any circumstances in which: (i) a private the current M&A Act in response to the Constitutional equity investor may be held liable for the liabilities of Court’s concerns, including potentially raising the extraor- the underlying portfolio companies (including due to dinary general meeting (“EGM”) voting threshold for breach of applicable laws by the portfolio companies); delisting, thereby affording minority shareholders more and (ii) one portfolio company may be held liable for the protection. liabilities of another portfolio company? (2) The government has proposed to amend the Statute for Investment by Foreign Nationals, which governs foreign No, except for the following rule regarding “piercing the corpo- investments, by replacing the current prior approval rate veil” under the Taiwan Company Act. According to the system with a post-closing notification system for deals Taiwan Company Act, if a shareholder (i.e., PE investor) abuses under a certain size. The proposed amendment aims to the status of the company (i.e., portfolio company) as a legal shorten the foreign investment review process. By and entity and thus causes the company to bear specific debts and it large, the proposed amendment is expected to be friendlier is apparently difficult for the company to pay such debts, and if to cross-border M&A deals; however, there is no definitive such abuse is of a severe nature, the shareholder shall, if neces- timeline for the legislative process. sary, be liable for the debts. This rule is rather abstract and relatively new under Taiwan law, and its applicability is subject to a court test on a case-by-case basis. 10.2 Are private equity investors or particular transactions subject to enhanced regulatory scrutiny in your jurisdiction (e.g. on national security grounds)? 112 Other Useful Facts

Considering the current government’s conservative attitude 11.1 What other factors commonly give rise to concerns toward China investments, any transactions involving Chinese for private equity investors in your jurisdiction or should funding is under higher scrutiny by Taiwan regulators. Given such investors otherwise be aware of in considering an investment in your jurisdiction? the sensitivity of China investments in Taiwan, buyers and sellers might need to spend more time structuring their transactions to meet local restrictions/requirements. In addition, as Practically speaking, PE investors wishing to invest in Taiwan a result of recent developments in Hong Kong, it is likely that must not overlook the fact that the Taiwanese authorities tend Hong Kong will also be considered China by Taiwan regulators to take a more stringent attitude towards investments by foreign in the future. PE investors and, especially, PRC investors. Therefore, the whole review process by the relevant competent authorities might be time-consuming. Potential PE investors are advised to 10.3 How detailed is the legal due diligence (including seek professional assistance from local advisors to better under- compliance) conducted by private equity investors prior stand the application requirements and process, as well as the to any acquisitions (e.g. typical timeframes, materiality, scope, etc.)? authority’s policy and recent practice, to ensure that PE transactions can be conducted smoothly. The timeline of legal due diligence of PE transactions (“Legal DD”) varies from case to case. According to our experience,

James C. C. Huang is a partner in the banking and capital market department of Lee and Li, with principal practice areas in banking, capital markets and M&A. Mr Huang has represented clients in various high-profile M&A transactions. He also advises local and international banks, securities firms, insurance companies, financial holding companies and other financial institutions on drafting and review of relevant transaction documents, regulatory compliance issues and applications and permits for relevant business. He also has extensive experience in syndicated loans, acquisition finance, project finance, mortgaged loan securitisation, and disposals of non-performing loans by financial institutions.

Lee and Li, Attorneys-at-Law Tel: +886 2 2763 8000 ext. 2157 8F, No. 555, Sec. 4, Zhongxiao E. Rd. Email: [email protected] Taipei 11072 URL: www.leeandli.com Taiwan

Eddie Hsiung is licensed to practise law in Taiwan and New York, and is also a CPA in Washington State, U.S.A. His practice focuses on M&A, securities, banking, finance, asset and fund management, cross-border investments, general corporate and commercial, etc. Mr Hsiung has participated in many private and public corporate transactions (such as M&A, JVs, group restructuring) spanning a broad range of industries (such as tech, manufacturing, media, cable, private equity, financial, biotech, logistics, gaming, tourism). Matters he recently handled include the privatisation/delisting of TPEx-listed HH Leasing & Financial Corporation, Google’s acquisition of HTC, NXP’s sale of its Standard Products business, Japanese DyDo DRINCO’s investment in TPEx-listed TCI, the restructuring of J.P. Morgan Asset Management, and the M&A between MediaTek and MStar.

Lee and Li, Attorneys-at-Law Tel: +886 2 2763 8000 ext. 2162 8F, No. 555, Sec. 4, Zhongxiao E. Rd. Email: [email protected] Taipei 11072 URL: www.leeandli.com Taiwan

Lee and Li is the largest full-service law firm in Taiwan. We understand the need to diversify and specialise. In response to the rapid developments in trade and technology and to satisfy the needs of our clients, we are constantly refining and expanding our practice areas. Over the decades, we have built the largest intellectual property right practices in Taiwan, and have been involved in the phenomenal growth of foreign direct investment since the 1970s. We were a pioneer in developing banking and capital market practice in the 1980s, and played a pivotal role in the formation of technology law practice in the 1990s. We are also active in public construction, government procurement and M&A. We stay relevant by staying current on the latest developments in every industry and apply our legal skills to help clients achieve their business goals. www.leeandli.com

United Kingdom United Kingdom

Ross Allardice

Dechert LLP Robert Darwin

12 Overview While Brexit has dominated the headlines in Europe, the PE industry is hopeful that investors and founders alike will be given new opportunities to use the UK as a platform investing 1.1 What are the most common types of private equity country. The COVID-19 pandemic has more far-reaching transactions in your jurisdiction? What is the current consequences for the UK PE industry and this is discussed at state of the market for these transactions? question 1.3 below.

The most common types of PE transactions in the UK centre around leveraged buyouts (in the form of share and asset acqui- 1.3 What are going to be the long-term effects for private equity in your jurisdiction as a result of the sitions), take-private transactions, refinancings, flotations and COVID-19 pandemic? bolt-on transactions. Based on the BVCA (the British Venture Capital Association), the value of PE investments in the UK from 2016 up to Since the COVID-19 pandemic reached its peak in March/April December 2019 has consistently remained between £21.4 2020, PE firms have been working diligently on ensuring the and £22.3 billion. While this has proved to be a strong and safety of employees and customers and shoring up portfolio consistent deal flow in the UK for the past few years, buyout companies so they can ride out the crisis. The impact on market activity in 2019 generally increased, both on a number-of-deal activity was significant with announced PE exits dropping 70% basis and on a value basis. There were a number of large exits in May 2020 versus May 2019. Now that these first few months in the UK in 2019 with sponsors appearing to crystallise returns have passed, firms are turning to other challenges. ahead of Brexit and the UK General Election in December 2019. Key effects of the COVID-19 pandemic include the following: Numerous considerations for private equity remain with ■ Additional barriers to deal execution: it is difficult to the backdrop of Brexit and the consequential effects of the conduct due diligence face-to-face, attend management COVID-19 pandemic. The UK withdrew from the European presentations or to undertake physical site visits. Union in 2019 and will formally withdraw from its transitional ■ Valuations have adapted: generally, these are lower but arrangements in December 2020 although, at the time of writing, there is also an increase in the use of earn-outs to provide the terms under which the country will leave are unclear. More well-advised PE buyers with additional protection in the prevalent are the lasting effects from the COVID-19 pandemic event of further market downside from the COVID-19 and time will tell how the market will react to the lack of deal pandemic. flow from the second quarter of 2020. There is recent anecdotal ■ Business disruptions have proved overwhelming and evidence at the time of writing that we are seeing an uptick in negotiating them has proved complex and challenging, PE transactions across the healthcare and technology sectors in especially when employee health concerns are required to the UK. Consumer and hospitality industries have continued be weighed up against business continuity. to struggle given the market interference from the COVID-19 ■ Weaknesses have been revealed in many companies while pandemic. other companies have thrived: it is clear that certain healthcare and technology businesses have been able to grow rapidly during the COVID-19 pandemic. 1.2 What are the most significant factors currently Many sponsor-backed companies in the UK that were encouraging or inhibiting private equity transactions in preparing for imminent exit in 2020 will need to continue to wait your jurisdiction? and see how the rest of 2020 plays out with the transition out of lockdown and returning to business as usual. Sponsors will The UK has historically been the largest PE market in Europe need to weigh up the pros and cons of launching an exit process and has a long and proud history in welcoming PE sponsors to in a market where valuations may continue to be depressed, at fundraise and invest there. As such, the UK has a well estab- least in the short term. lished legal system and regulatory footprint to deal with various Longer term, the impacts of the COVID-19 pandemic are not outcomes and challenges which the PE industry may face from yet clear. Clearly the likelihood of a “second wave” is front of time to time. The experience which the PE industry gleaned in mind for PE investors and it is expected that COVID-19-focused the UK in the aftermath of the financial crisis in 2008 has deliv- diligence and stress-testing will be an integral part of all future ered a strong and robust system and created new asset classes buy-side diligence processes. There is an expectation that, in the and credit funds which have adapted to the leveraged buyout long term, the COVID-19 pandemic will lead to lower leverage system. ratios than were required prior to the market downturn.

1.4 Are you seeing any types of investors other 2.3 How is the equity commonly structured in private than traditional private equity firms executing private equity transactions in your jurisdiction (including equity-style transactions in your jurisdiction? If so, institutional, management and carried interests)? please explain which investors, and briefly identify any significant points of difference between the deal terms offered, or approach taken, by this type of investor and PE investors will typically subscribe for ordinary shares in that of traditional private equity firms. Topco. However, the ordinary shares subscribed by the PE investor typically represent only a small proportion of its funding of the transaction. The majority of the PE investor’s There has been a continuation of the recent shift in non-traditional PE funds such as sovereign wealth funds, pension plans and family commitment is typically funded as shareholder debt, usually in offices moving beyond their primary focus on minority positions the form of “payment in kind” (“PIK”) loan notes, which carry to increasingly serve in a “control” or lead investor-type capacity a right to annual interest which the issuer (Topco) may choose to on direct investments in the PE space. The genesis of this trend satisfy by the issue of further loan notes. Preference shares may has been the desire of these investors for greater control, reduced be used where the shareholder debt would otherwise exceed the fees and greater returns on invested capital, particularly in the levels permitted by transfer pricing rules or corporate interest traditional PE space. This shift in focus has created additional restriction rules. The combination of ordinary share capital, competition for traditional PE funds and is resulting in increased preference shares, and shareholder debt held by the PE investor variation in the deployment of capital by these non-traditional PE is commonly referred to as the “institutional strip”. investors across the capital structure. Many of these non-traditional Management will commonly also take an equity piece in Topco PE funds are unused to a lead investor role and are therefore in order to ensure their interests are aligned with the PE inves- still finding their feet in terms of their preferred approach to tors. This is often referred to as “sweet equity” or “sweat equity”. diligence, transaction terms and governance. Given the profile In some cases, in particular on a secondary buyout where they of the stakeholders in sovereign wealth funds, pension plans and may be required to reinvest realised gains, senior executives family offices, there is an added emphasis on environmentally and may invest in both the institutional strip and the sweet equity. socially responsible investments and this is expected to continue to Management equity incentive plans will often be put in place to be an area of significant focus looking ahead. further incentivise management and other employees. Carried interest (a performance-related share of the fund’s 22 Structuring Matters overall profits) is typically structured through a limited partnership, with executives as limited partners. Often, the carried interest limited partnership will itself be a special limited partner 2.1 What are the most common acquisition structures adopted for private equity transactions in your in the fund limited partnership to allow carried interest to flow jurisdiction? through the structure on a transparent basis such that executives can benefit from capital gains tax treatment on a future exit. Entitlement to carry is typically crystallised after inves- PE transactions in the UK are typically structured using a UK tors have received a return of their drawn-down capital, plus any private limited company limited by shares (“Topco”), commonly preferred return accrued and after any other pre-agreed hurdles owned by the PE fund and management executives, which acts are achieved. As noted in section 9, recent changes to the UK as the holding company for a chain of corporate entities. The tax treatment of carried interest need to be considered. bottom entity in the acquisition chain (“Bidco”), acts as the purchaser of the target shares and may act as borrower under any financing arrangements. A series of entities are typically 2.4 If a private equity investor is taking a minority incorporated between Topco and Bidco for tax and financing position, are there different structuring considerations? purposes, so as to allow for financing by junior lenders to be structurally subordinated to that by senior lenders. The drivers described in question 2.2 will remain relevant but Where transactions involve a UK target, Bidco would typi- the minority position taken by a PE investor may limit the ability cally be a UK-resident limited company. However, Topco (the of the investor to dictate the relative importance of these factors. level at which a future sale by the PE fund of the UK acquisition usually takes place) may be a non-UK incorporated but UK-resident company as a means of mitigating UK stamp 2.5 In relation to management equity, what is the duty which is payable (usually) by a buyer at 0.5% on the future typical range of equity allocated to the management, and transfer or sale of shares in a UK company. It remains to be seen what are the typical vesting and compulsory acquisition if increased substance requirements in typical offshore jurisdic- provisions? tions (such as the Cayman Islands, Bermuda and Jersey, etc.) will impact upon such UK stamp duty planning. Management would typically hold between 5% and 15% of the equity, although this will be very transaction-specific and the proportion may be lower in larger transactions. 2.2 What are the main drivers for these acquisition structures? Transaction documents will invariably include a right for the PE investor to acquire a manager’s equity following the termination of his/her employment with the relevant portfolio Structures are typically driven by a number of factors, including: company. The terms of such compulsory acquisition will usually (i) the tax and other requirements of the PE funds investing in depend on whether the manager is a good leaver or a bad leaver. the transaction; (ii) the requirements of the lenders financing Good leavers will commonly be entitled to receive the higher the transactions (for example, as to any required subordina- of the costs and, subject to vesting provisions, fair market value tion); (iii) the overall tax efficiency of the post-acquisition group for their shares. A “bad leaver” would commonly be entitled to (for example, as to achieving the maximum deductibility of the lower of fair market value and cost. Vesting provisions will interest expense); and (iv) the requirements of management (for often determine the proportion of a good leaver’s shares which example, if they are seeking to qualify for business asset disposal will qualify for good leaver treatment. This will generally be relief (formerly entrepreneurs’ relief)).

based on the expiry of a specified vesting period (usually three manage its investment, drive an exit, and control strategic issues, to five years) following the transaction to the termination of and the ability of management to manage the portfolio company employment. Vesting may take place on a pro rata “straight line” day-to-day. basis over the vesting period or on a “cliff edge” basis only on Where private equity has a minority position, the veto rights completion of the vesting period. tend to be focused on protection of economic interests, and only fundamental strategic matters, i.e. anti-dilution, share transfers, exit below an agreed valuation, and fundamental change 2.6 For what reasons is a management equity holder usually treated as a good leaver or a bad leaver in your of business. jurisdiction? 3.3 Are there any limitations on the effectiveness of Good leavers are typically those who cease to be employed by veto arrangements: (i) at the shareholder level; and (ii) at reason of their death or disability, retirement (although care the director nominee level? If so, how are these typically addressed? should be taken with regard to potential discrimination under UK employment law) or involuntary termination without cause (for example, redundancy). There may be a discretion for At a shareholder level, veto rights are generally respected but can management not falling within such categories to be treated as run into issues if they fall foul of certain English law rules aimed at good leavers nonetheless. Typically, a leaver who is not a good promoting proper corporate behaviour, primarily (a) preventing leaver is a bad leaver. actions which may unfairly prejudice a minority shareholder(s) of the company, (b) not allowing any inappropriate fettering of any 32 Governance Matters statutory powers of the company, or (c) preventing actions being taken which are contrary to UK public policy. At the level of a director nominee, the same issues can arise as 3.1 What are the typical governance arrangements for private equity portfolio companies? Are such outlined above. Additionally, the relevant director will, by virtue arrangements required to be made publicly available in of his or her directorship, also owe a wide range of duties to the your jurisdiction? company, its shareholders (i.e. not just the appointing PE shareholder) and, if a company nears insolvency, its creditors. These duties override and can impede the exercise of certain vetos. The primary contractual document controlling the govern- Vetos which are contrary to law can be challenged and may ance of a PE portfolio company in the UK is generally a share- not be upheld. To ensure that a director’s veto is properly imple- holders’ agreement, setting out the arrangements agreed by the mented as between the company’s shareholders, it will typically PE Sponsor, management, and any other shareholders in the be contained in a shareholders’ agreement and/or the company’s company. The typical matters that this agreement will cover articles and so (subject to the points above) can be implemented extend to day-to-day management appointments and behaviour, effectively among the company’s shareholders. conduct of business of the company (generally expressed through the form of vetos for the PE sponsor), positive covenants for management to follow in their operation of the business, control 3.4 Are there any duties owed by a private equity of share transfers, information rights for the PE sponsor and investor to minority shareholders such as management controls over the raising of further equity and share capital for shareholders (or vice versa)? If so, how are these the company. This governance arrangement may be supported typically addressed? by the presence of a PE sponsor-appointed director or observer on the board of the portfolio company. The shareholders’ agree- A PE sponsor shareholder does not prima facie owe duties to ment is a private contract agreed between the shareholders of the other shareholders in the company. As explained in the answer portfolio and does not generally need to be filed. to question 3.3 above, however, a director appointee of a PE Additionally, the primary constitutional document of an sponsor is subject to fiduciary and statutory duties to the wider English company is its articles of association. Certain govern- company and, in certain cases, its shareholders. Successful ance controls tend to be included in the articles by the PE actions brought against PE-appointed directors on behalf of the sponsor (as a breach of these provisions then becomes an ultra company (a derivative action), or by an aggrieved shareholder on vires act of the company, as opposed to merely a contractual the basis of unfair prejudice are rarely brought, and even more breach), particularly in relation to transfer rights. Articles of rarely successful, but are available in theory. association are a publicly filed document, so PE sponsors should be mindful of this in terms of the information included. 3.5 Are there any limitations or restrictions on the contents or enforceability of shareholder agreements 3.2 Do private equity investors and/or their director (including (i) governing law and jurisdiction, and (ii) nominees typically enjoy veto rights over major non-compete and non-solicit provisions)? corporate actions (such as acquisitions and disposals, business plans, related party transactions, etc.)? If a English law shareholders’ agreements relating to an English private equity investor takes a minority position, what company are generally effective and respected under English veto rights would they typically enjoy? law (which is generally accepted as governing law and the jurisdiction for resolving disputes), provided that they are prop- Yes. These veto rights tend to be expressed via a director’s erly drafted. That said, provisions in shareholders’ agreements veto (in circumstances where the PE Sponsor has a director which purport to offend the principles around proper corpo- appointed to the board) and/or a shareholder veto. Inevitably, rate behaviour, outlined in the answer to question 3.3 above, there is a balance which needs to be struck (in circumstances can be problematic to enforce. In addition, certain European where private equity controls the majority of the investee legislation, for instance the European General Data Protection company) between the need for the PE Sponsor to protect and Regulation (“GDPR”) which governs the transmission and

collection of data in Europe can, for as long as the UK remains Additionally, directors may find themselves in a position of in the European Union, add further challenges to older share- actual conflict in relation to existing or proposed transactions holders’ agreements which may find their existing provisions or arrangements of companies they are appointed to. This is (e.g. in relation to information) ceasing to be compliant with generally known as a “transactional conflict”. Directors are new regulations. generally required to declare their interests in such transactions Non-compete and non-solicit provisions need to be aimed at or arrangements. Having made such a disclosure, the ability providing reasonable protection for the relevant goodwill (i.e. for a director to participate in the decision-making process with the investment of the PE sponsor in the company), for a reason- regard to such transactions will be governed by the articles able period, and within a reasonable area in order to be effec- of association of the relevant company. It is not uncommon, tive under English law. As a basic position, English law dislikes once such interests have been declared, for a director to remain covenants which attempt to unfairly restrain trade or prevent capable under the articles of participating in the relevant deci- an individual from working to support him or herself, so such sions. A director will not be in breach of duties in relation to covenants will need to be carefully drafted in this context, in conflicts to declare an interest in a proposed transaction if he or order to be effective. she acts in accordance with any provisions of the company’s articles dealing with conflicts.

3.6 Are there any legal restrictions or other requirements that a private equity investor should 4 2 Transaction Terms: General be aware of in appointing its nominees to boards of portfolio companies? What are the key potential risks 4.1 What are the major issues impacting the timetable and liabilities for (i) directors nominated by private for transactions in your jurisdiction, including antitrust, equity investors to portfolio company boards, and (ii) foreign direct investment and other regulatory approval private equity investors that nominate directors to requirements, disclosure obligations and financing boards of portfolio companies? issues?

PE investors must ensure that nominee directors are eligible UK transaction closing timetables are largely driven by regu- to act as directors, including, in particular, that they are latory approvals, most commonly mandatory and suspensory not disqualified from acting as a director, e.g. under the UK antitrust filings and industry-specific regulatory approvals Company Directors Disqualification Act 1986. As outlined or consents. There has been a reduction in financing condi- above (particularly in the answer to question 3.3), directors tionality, particularly given the prevalence of sales by way of of an English company (whether considered “executive” or competitive auction processes where sellers are able to push “non-executive”, and irrespective of their appointing share- bidders to obtain financing on a “certain funds” basis at the holder(s)) share the same broad general fiduciary and statutory binding bid stage. The prevalence of auction processes has also duties to the company of which they are a director. This can led to a general increase in the speed at which PE transactions create personal risk and liability for the director concerned, if are executed, with a rising number of auction processes being the director acts only in the best interests of his or her appointer. pre-empted by one bidder. Although a PE sponsor will not incur direct liability for the actions of its appointed director, it could have indirect issues 4.2 Have there been any discernible trends in caused, including (a) a failure of the appointed director to act transaction terms over recent years? as they expect or would prefer (for example, where the relevant director is subject to statutory duties requiring certain behaviour, such as placing a company into insolvency proceed- The UK PE M&A landscape continues to be generally favour- ings where it is insolvent), and (b) consequential issues vis-à-vis able to sellers (both PE and non-PE). Recent trends include: (i) their investors due to their failure to procure that their investee an increase in the number of sale processes being run as compet- company acts as they would prefer. itive auctions on a tight timetable; (ii) increased prevalence of pre-emptive bids in competitive processes; (iii) further growth in the use of warranty and indemnity (“W&I”) insurance, often with 3.7 How do directors nominated by private equity low residual seller liability; and (iv) shorter seller liability time investors deal with actual and potential conflicts of periods, in many cases regardless of whether W&I insurance is interest arising from (i) their relationship with the party being used. However, as with all trends, there are notable excep- nominating them, and (ii) positions as directors of other tions and PE buyers are well placed to negotiate positions more portfolio companies? advantageous than these industry norms, particularly by making use of speed, commerciality and other unique advantages. As explained in the answer to question 3.6 above, directors appointed by PE sponsors do not only owe duties to the sponsor, 52 Transaction Terms: Public Acquisitions but to the companies of which they are directors more generally. The Companies Act 2006 imposes a duty on a director to avoid a “situational conflict”, i.e. a situation in which he or 5.1 What particular features and/or challenges apply to private equity investors involved in public-to-private she has, or can have, a direct or indirect interest that conflicts, transactions (and their financing) and how are these or possibly may conflict, with the interests of the company. commonly dealt with? Clearly, a “situational conflict” could occur where the appointed director also has a directorship with companies with interests Acquisitions of the shares of public companies in the UK are adverse to those of another company to which he or she has generally governed by the UK City Code on Takeovers and been appointed as a director. It should, however, be noted that Mergers (the “Takeover Code”). The Takeover Code imposes a “situational conflict” can be authorised by the non-conflicted various rules on the conduct of such activity, generally aimed directors of the relevant company(ies), and so such authorisations should be obtained where relevant. at ensuring equality of information and treatment for all of the shareholders of the target public company, including its minority

shareholders. This framework is substantially more restrictive to fully diligence the relevant “locked-box accounts” and ensure than the framework applicable to private transactions. they are comfortable doing the deal on the basis of those accounts. Provisions of the Takeover Code that are likely to be particu- Where a completion accounts consideration structure is used, larly relevant to PE sponsors undertaking public to private deals it is common to see a portion of the purchase price placed into are: (i) specific timetables applicable to such deals; (ii) a need escrow with a third-party escrow agent at closing as security for to announce whether or not an offer will be made for a public any post-closing payment which is required to be made by the company within a 28-day period if the likelihood of an offer seller as a result of the completion accounts adjustment. being made becomes publicly known; (iii) restrictions on the Where an acquisition is made by a PE buyer in a “primary” payment of break fees by public company targets on deals; and deal (i.e. not from a PE seller), it is not unusual for a portion of (iv) the Takeover Panel’s (the entity which governs the appli- the consideration to paid on a deferred basis, most commonly cation of the Takeover Code) increasing focus on a bidder’s pursuant to an “earn-out” where the performance or growth intentions regarding the target’s business following acquisi- of the acquired business will be measured against an objection, and the need for any plans for closures and lay-offs to be tive criteria (usually a financial-based criteria during a defined disclosed when a bidder announces its firm intention to make time period) in order to determine what portion of the deferred an offer. One year after completion of an acquisition, a bidder consideration will be payable. must confirm to the Takeover Panel whether or not it has taken the intended course of action, and publish that confirmation. 6.2 What is the typical package of warranties / Inevitable reputational consequences can follow from a failure indemnities offered by (i) a private equity seller, and (ii) to owner specific communicated post-offer intentions. the management team to a buyer?

5.2 What deal protections are available to private A PE seller will in most cases only provide “fundamental” equity investors in your jurisdiction in relation to public warranties, being those regarding title to shares, capacity and acquisitions? authority. A PE seller will only provide business and operational warranties as to the target in limited circumstances and this is Only somewhat limited protections are available. Normal becoming rarer under the current market conditions. measures used on private deals, such as break fees, are gener- Business and operational warranties are usually given by certain ally prohibited under the Takeover Code, because of concerns members of the senior management team of the target and will that such protection mechanisms deter potential bidders from be given subject to relatively low liability caps (dependent on the submitting competing bids and therefore maximise value deal proceeds received by management warrantors). These busi- for shareholders in publicly-listed companies. That said, the ness and operational warranties will be contained in a separate Takeover Panel may allow break fees in very limited circum- management warranty deed and a fulsome disclosure process stances. This can include where the target is in financial distress will be carried out to disclose against these warranties. These and seeking a bidder, or in certain hostile situations. Such break management warranties are more and more being seen as a tool fees are then typically limited to a 1% cap of the target’s value. to elicit accurate and fulsome disclosures regarding the target from the individuals who run the business of the target on a 62 Transaction Terms: Private Acquisitions day-to-day basis. Given the low liability caps that generally apply to these warranties from management, a buyer will typically seek 6.1 What consideration structures are typically to obtain coverage for these warranties above the liability cap of preferred by private equity investors (i) on the sell-side, the management warrantors by putting in place W&I insurance. and (ii) on the buy-side, in your jurisdiction? 6.3 What is the typical scope of other covenants, “Locked-box” consideration structures remain the preferred undertakings and indemnities provided by a private option for PE sellers largely due to the ease of negotiation and the equity seller and its management team to a buyer? certainty they provide with respect to the final consideration paid. Combined with the shorter leakage periods being obtained by PE PE sellers will customarily provide certain pre-completion cove- sellers (some as low as three months post-closing) they present a nants and undertakings to a buyer, including (i) a no-leakage highly attractive proposal when compared to a traditional comple- covenant (in the case of a “locked box” deal) where the buyer tion accounts consideration structure. An additional benefit of a will be able to recover any leakage on a £-for-£ basis, (ii) cove- “locked-box” deal is that because there is no post-closing adjust- nants to provide assistance with, and if relevant, obtain regu- ment, funds can be distributed immediately following closing, latory clearances or satisfaction of other conditions, (iii) oper- allowing a PE seller to optimise investor/LP returns. ational covenants as to how the business of the target may or Given that the current market is a seller’s market, may not be run in the pre-completion period, and (iv) certain “locked-box” consideration structures are commonly accepted limited covenants regarding the provision of information during by buyers except in limited circumstances, including where the the pre-completion period. Indemnification for specific risks is target is a carve-out of a larger business and separate accounts relatively uncommon for PE sellers to give, although it is some- are not maintained, where there have been historical issues with times seen where the PE seller and the buyer have a materially accounts or audits or where some other aspect of the target or different view on the likelihood of a specific risk crystallising. the seller profile makes the deal unsuitable for a “locked-box” More commonly, PE sellers are pushing buyers to “price in” consideration structure. A “locked-box” consideration struc- these types of risks. ture when compared to a completion accounts consideration PE sellers are unlikely to give non-compete covenants, structure will generally be seen as shifting risk from the seller whereas it is common for exiting members of management or to the buyer, as the buyer (together with their advisors) will need founders to give a full suite of restrictive covenants.

6.4 To what extent is representation & warranty a PE seller’s liability for these warranties is typically capped at insurance used in your jurisdiction? If so, what are the the purchase price. Such fundamental warranties are not usually typical (i) excesses / policy limits, and (ii) carve-outs / subject to additional financial limitations, such as a de minimis or exclusions from such insurance policies, and what is the threshold (i.e. excess). The fundamental warranties are typically typical cost of such insurance? given subject to time limitations of between three and seven years from closing. W&I insurance as a product is continuing to increase in popu- Seller liability under the “no-leakage” covenant is usually larity with buyers and sellers seeing the benefit of the product uncapped and recoverable from the seller on the basis of leakage in “bridging the divide” between sellers (including management received or benefitted from, given that compliance with such a warrantors where relevant) and buyers in terms of residual post- covenant is entirely within the control of the seller. closing liability. It is relatively standard in a competitive sell-side The liability of management warrantors for the business and process for the seller to insist on use of W&I insurance by the operational warranties can be subject to various negotiated limita- buyer to cover the business and operational warranties which are tions, including: (i) warranties are usually given on a several basis provided by management. In some transactions, more aggres- only (i.e. each manager is only liable for its proportionate share of sive sellers will also insist that the buyer obtains coverage for liability for any claim and/or its own breach); (ii) warranties can the fundamental warranties as to title to shares, capacity and be given subject to actual awareness of the relevant management authority up to the W&I insurance policy liability cap with the warrantor group; (iii) financial limitations as to (A) aggregate seller standing behind the balance of liability above the W&I liability cap, (B) threshold, below which a warranty claim cannot insurance policy liability cap for the fundamental warranties. be made (which can be on a “tipping” basis or “excess only” Excesses and policy limitations and resulting pricing will basis), and (C) de minimis, being the minimum quantum of liability differ based upon, and be impacted by, insurer, industry sector, which a warranty claim must meet in order to count towards the quality of diligence, thoroughness of disclosure process and threshold; and (iv) time limitations within which claims under the seller/management warrantor liability cap. With respect to busi- warranties must be made which range from between one year and ness and operational warranties, the usual buyer recourse profile three years for claims under the non-tax warranties and between will be first against the seller/management warrantor up to the four and seven years for claims under the tax warranties. relevant excess (which will usually match the attachment point under the W&I insurance policy) and then against the W&I 6.6 Do (i) private equity sellers provide security (e.g. policy up to the relevant liability cap of the policy. The de minimis escrow accounts) for any warranties / liabilities, and financial limitation that applies to claims under the business and (ii) private equity buyers insist on any security for operational warranties will commonly match in the transaction warranties / liabilities (including any obtained from the documentation and the W&I policy and is often driven by the management team)? W&I insurer. It is unusual for sellers/management warrantors to stand behind any additional liability above the relevant W&I Given PE sellers generally only provide fundamental warran- policy liability cap, except where the fundamental warranties are ties as to title, capacity and authority, no security (financial or being insured. In terms of the W&I policy liability caps being otherwise) is provided as the risk of a breach of these warran- obtained in buy-side W&I policies, these range from between ties should be very low. With respect to the no-leakage covenant 5% and 100% of the enterprise value, with the most common provided in “locked-box” deals, it is uncommon for PE sellers to range being between 20% and 40% of the enterprise value of provide any security in relation to this risk as most buyers take the target. the view that the reputational damage caused to a PE seller for More recently, there has been a trend towards lower seller/ a large leakage claim is a material deterrent to the PE sponsor management warrantor excesses (i.e. liability caps in the transac- engaging in activity which constitutes leakage. This position tion documentation) and, in some limited cases, an excess as low also aligns with the PE industry focus of returning proceeds as £1 can be obtained where the business of the target is consid- to LPs/investors as soon as possible post-closing in order to ered particularly “clean” and insurable. Where management maximise economic return metrics. warrantors are required to have material “skin in the game” This position is clearly at odds with the general desire of under the management warranty deed, it is common for the rele- buyers (both PE and non-PE) to obtain meaningful post-closing vant PE seller to offset this potential liability by way of escrow recourse with respect to warranties and covenants. Given the or retention to fund claims against management or by way of fact the current market is largely a seller’s market, this had been transaction bonuses payable on closing. a major driving factor in the rise of W&I insurance. The major downside of W&I insurance is that there are certain exclusions, both general to all W&I insurance policies (i.e. secondary tax liabilities, anti-bribery and corruption) and 6.7 How do private equity buyers typically provide comfort as to the availability of (i) debt finance, and (ii) transaction-specific to address gaps in the scope of diligence equity finance? What rights of enforcement do sellers carried out or particular risks relevant to the industry in which typically obtain in the absence of compliance by the the target operates. In the current market, sellers/management buyer (e.g. equity underwrite of debt funding, right to warrantors do not customarily stand behind warranty claims specific performance of obligations under an equity which fall within the ambit of such policy exclusions and instead commitment letter, damages, etc.)? this potential risk is borne by buyers and ultimately priced in. PE buyers will usually provide an equity underwrite of the 6.5 What limitations will typically apply to the liability total consideration amount to the seller in the form of an of a private equity seller and management team under equity commitment letter from the PE fund itself. Such an warranties, covenants, indemnities and undertakings? equity commitment letter will generally be addressed directly to the seller and includes covenants that the fund will (i) call Given that a PE seller’s warranties will generally be limited to required capital from its investors to fund the purchase price, certain fundamental warranties as to title, capacity and authority, or (ii) fund Bidco with the equity capital required to fund the

relevant portion of the purchase price, which is subject only to ■ Unclean exit: The reluctance of a PE sponsor to provide the satisfaction of the conditions in the share purchase agree- any ongoing W&I protections in relation to the sale of their ment and “certain funds” debt financing being available. This target companies is well-understood. However, in rela- equity commitment letter will customarily also include certain tion to any IPO of a PE-invested business, the PE sponsor commitments from the PE sponsor aimed at ensuring Bidco will find it increasingly challenging to resist providing an draws down the requisite funds under the “certain funds” debt investment bank underwriting the IPO with at least some financing in order to complete the transaction. warranties in relation to its ownership of the shares in the The seller will usually be able to enforce this commit- company being floated, in relation to itself and, in certain ment directly against the PE fund to the extent the transac- circumstances, in relation to an underlying business. tion becomes unconditional and the buyer fails to comply with its obligations to pay the consideration under the transaction 7.2 What customary lock-ups would be imposed on documentation. If the banks under the “certain funds” debt private equity sellers on an IPO exit? financing do not fund when they are legally required to, the PE buyer may be required to take certain steps to enforce against the banks and/or use reasonable endeavours to obtain alterna- As mentioned in the answer to question 7.1 above, the dura- tive debt financing. It would not be typical for a PE buyer to be tion of the “lock-in” provided by the PE sponsor will vary from required to fund such debt financing amounts from equity, i.e. it transaction to transaction but, typically, a period of at least six will not typically equity underwrite the debt financing. months following an IPO will apply. This means that no actual “exit” (in terms of realising value from the investment) will have been effected by the PE sponsor at the completion of the IPO; 6.8 Are reverse break fees prevalent in private equity but only once the lock-up period has expired. In the meantime, transactions to limit private equity buyers’ exposure? If the PE sponsor remains exposed to market risk for the duration so, what terms are typical? of the “lock-in” period and, to a lesser extent, during the orderly market disposal period. Reverse break fees are uncommon in the current UK PE market largely as a result of the fact that in the UK market it is not 7.3 Do private equity sellers generally pursue a dual- typical for a buyer to have a walk-away right between signing track exit process? If so, (i) how late in the process are and closing, e.g. in the event of a “material adverse change” in private equity sellers continuing to run the dual-track, the business or if the debt financing is not obtained (as opposed and (ii) were more dual-track deals ultimately realised to the USA, where both of these rights for buyers are more through a sale or IPO? common and hence so is the use of reverse break fees). During 2019, successful PE exits continued. It was not 72 Transaction Terms: IPOs uncommon to run a dual-track exit process, though a greater number of deals were concluded by way of bilateral or auction- 7.1 What particular features and/or challenges should driven private sales processes, as opposed to successful IPOs. a private equity seller be aware of in considering an IPO This is reflective both of market conditions and also a general exit? preference by funds to conclude private deals where possible, in order to avoid some of the negative aspects of a IPO exits Exiting from an investment by way of an IPO raises a number of (as outlined in the answer to question 7.1 above), provided that issues, including (but not limited to): the valuations achieved on such deals are at an acceptable level. ■ Costs: Pursuing an IPO can be considerably more costly In order to preserve competitive tensions in deals, it is not than an exit by way of a private sale, due to the fees of uncommon on dual-tracks to run such processes in parallel, at least the advisers involved, together with the fees of under- until the likely commencement of an investor “road show” in rela- writing the exit. It is also likely to take longer to execute tion to the IPO process. Immediately prior to the commencement a successful IPO, perhaps up to six months, due to the of the road show, is usually a reasonable inflexion point for the PE various processes involved in presenting a company prop- sponsor to consider whether it has an acceptable (and deliverable) erly to the public markets. private offer for the asset to be disposed; one reason for this being ■ Uncertainty: Exiting from an investment via an IPO can the level of information about the target that will be shared with expose PE sellers to significantly greater market risk than potential investors in the road show process, and a desire to avoid the relative certainty of a private deal. It is not guaranteed this if a private sale seems feasible. Noting that, given the private that sufficient investor capital will be available to support nature of many of these processes, full public information about an exit. In addition, any failures of an IPO are inevi- dual-track processes and their outcomes is not available, it is safe to tably more “public” than the failure of a private disposal say that it is comparatively rare for the IPO track to be abandoned process. This can add wider reputational risk to a disposal. during the period after the roadshows have finished, but prior to ■ Incomplete exit: When an IPO is successful, that still the expected date of listing and admission of the target. does not generally enable an immediate full exit for the PE fund on day one of the IPO. It is typical that the PE 82 Financing sponsor would be subject to a “lock in” period for at least six months following a successful IPO, during which time 8.1 Please outline the most common sources of debt it will not be able to sell its shares in the listed company. finance used to fund private equity transactions in your Following the end of the “lock in” period, it is likely that jurisdiction and provide an overview of the current state an “orderly market” period (perhaps of up to 12 months) of the finance market in your jurisdiction for such debt will follow, during which the sale of the PE sponsor’s (particularly the market for high yield bonds). stake in the business can only be sold in a staggered way, to avoid affecting the price of the target company’s shares Traditional bank-led leveraged loan financing remains the most too significantly as a result of the disposal.

common source of debt finance used to fund both mid-market For example, in the current sensitive political and regula- and large PE transactions in the UK. tory climate, market participants need to be especially careful However, in recent years, there has been increasing competi- in regard to compliance with anti-bribery, corruption and sanc- tion between traditional bank lenders and non-bank (or “alter- tions laws. Aside from local laws, borrowers and sponsors native”) lenders for mid-market PE transactions, with funding should also be aware of the expansive nature and potential extra- increasingly being sought from alternative sources such as direct territorial reach of such laws and regulations in the U.S., which lending funds and other institutional investors. Participants in can necessitate compliance by many non-U.S. entities (or entities mid-market transactions have also increasingly looked to imple- that have only limited U.S. ties). ment “unitranche” financing structures, pursuant to which tradi- In the context of buyout transactions of public (as opposed to tional senior and junior debt tranches are replaced by a single private) companies in the UK involving debt finance, a key issue tranche term facility carrying a single, blended rate of interest, will be to ensure compliance with the “certain funds” and cash usually on a floating rate. Other debt instruments, such as PIK or confirmation requirements of the UK Takeover Code. These convertible debt, remains a small portion of the overall financing principles require that a bidder have the funds and resources in provided by third-party lenders. place on a certain funds basis to finance a proposed acquisition, For larger PE transactions, leveraged loans are often structured prior to the public announcement of any bid (and the bidder’s as a term loan B (or “TLB”) – a non-amortising, senior secured financial advisor must confirm the availability of such funds). term loan usually under NY law. Investors in TLB include a mix In practical terms, this means that the bidder and its lenders will of traditional bank lenders and institutional investors and they are need to finalise and have executed the required loan documen- designed to tap greater availability in the U.S. debt syndication tation (and satisfy, subject to limited exceptions, the conditions markets, relative to the European Markets. precedent to the loan) at the bid stage. Aside from leveraged loan financing, high-yield bond financing The “certain funds” concept has also increasingly permeated remains an important source of funds and is commonly (albeit and become a feature of private buyout transactions. Although subject to fluctuating availability in the market) used alongside not a legal requirement in this context, in practical terms, this traditional senior secured bank loans. means that in certain private buyout transactions, lenders will A key theme in the UK leveraged finance market in recent years be required to confirm upfront the satisfaction of all of their – and a function of the increased appetite of institutional inves- financing conditions and agree to disapply loan drawstop events tors (who traditionally invested in high-yield bonds) for leveraged (other than certain limited exceptions) until after completion of loans – has been the convergence of the terms of English law the acquisition. leveraged loans with both high-yield bonds and U.S. leveraged loans. This has led to a general loosening of covenants in English 8.3 What recent trends have there been in the debt law leveraged loans, with the market becoming more accepting financing market in your jurisdiction? of “covenant-loose” structures (that is, where the relevant loan agreement contains only a single ongoing or maintenance financial covenant, usually a leverage ratio) and, for stronger borrowers, The recent trends were, until the COVID crisis, mainly in favour “covenant-lite” structures (that is, where the loan agreement of the borrower/sponsor side. We are seeing ever more flexibility contains no maintenance financial covenants or only a springing in the additional debt baskets and in the permitted payments leverage covenant for the benefit of the revolving creditors). baskets too. There are one or two areas where the lenders have pushed back, however. For example, there is now usually a cap on the amounts that can be added to EBITDA by way of future 8.2 Are there any relevant legal requirements or synergies on an acquisition or group initiative. As a general restrictions impacting the nature or structure of the debt comment, it is fair to say that the unitranche lenders are a little financing (or any particular type of debt financing) of more conservative than bank lenders, perhaps reflecting the fact private equity transactions? that they are more likely to hold the debt rather than to syndicate it away. It is too early to say how the COVID crisis will affect The UK is, generally speaking, an investor-friendly jurisdiction the market and deal terms, other than to say that, at the time of and there are no particular legal requirements or restrictions publishing, deal volumes were massively down in Q2 2020 and that would affect the choice or structure of debt financing of PE there was a reduced availability (and tightening of terms where transactions in the UK. That said, practical deal concerns play it was made available) of debt financing in the market generally. an obviously important role in dictating the ultimate financing structure. For example, some PE funds have valued the lighter 92 Tax Matters disclosure requirements of a leveraged bank loan as compared to a high-yield bond issuance (which requires the preparation of, amongst other things, a detailed offering memorandum). 9.1 What are the key tax considerations for private equity investors and transactions in your jurisdiction? Further, in an acquisition context, another advantage of a loan Are off-shore structures common? (compared to a high-yield bond issuance) is that loans can typically be documented and executed on a much shorter timetable that is more aligned with the timing constraints of the acquisition At a high level, the primary tax focus is to establish a tax-efficient itself. With its successful execution dependent on ever-fluctuating structure and, in particular, to mitigate tax leakage on payment market conditions and increased disclosure requirements, a high- flows from the underlying portfolio companies through the yield bond issuance, on the other hand, must typically either be acquisition structure to investors. bridged by a loan or funded into an escrow arrangement if being From an investor perspective, withholding tax is often a mate- used to finance an acquisition. rial factor. However, since the UK applies no withholding to divi- Aside from such practical concerns, market participants should dends or capital gains, withholding tax concerns in UK transac- be aware of, and ensure compliance with, any industry-specific tions tend to focus on interest and the ability to reduce the 20% laws and regulations, as well as the broader regulatory regime rate of interest withholding through treaty relief or otherwise affecting PE transactions. (which can be relevant to both external and investor-related debt).

Achieving the maximum deductibility of interest expense changed significantly in recent years in response to the OECD’s on financing remains an important area. In addition to long- Base Erosion and Profit Shifting (“BEPS”) project. Measures standing restrictions on the deductibility of interest (such as likely to impact the PE industry include: under the thin capitalisation rules), relatively recently introduced (a) The anti-hybrid rules which potentially disallow deduc- interest barrier rules (which generally restrict interest deductions tions for interest and other expenses in structures to 30% of EBITDA) and increasingly complex anti-hybrid rules involving hybrid entities or instruments. The rules are provide further limitations, particularly where U.S. investors are commonly a cause of uncertainty in transactions involving concerned. U.S. investors where check-the-box elections have been From a management perspective, the key objective is to mini- made through the acquisition structure. This measure, mise income tax on acquisition of shares and to achieve capital together with (b) below, has led to the increasing use of gains tax treatment on an exit (see questions 9.2 and 9.3 below). preference shares rather than debt as a source of investor UK transactions tend to utilise UK-incorporated and -resident finance. companies in the acquisition structure, although non-UK incor- (b) The interest barrier rules (see question 9.1 above). porated but UK tax-resident companies are sometimes preferred (c) The changes to the availability of double tax treaty for stamp duty efficiency. relief as a consequence of the adoption of the OECD’s multi-lateral instrument (“MLI”) which overlays the application of the UK’s tax treaties with other partici- 9.2 What are the key tax-efficient arrangements that are typically considered by management teams in private pating jurisdictions. This has led to the increasing need equity acquisitions (such as growth shares, incentive for “substance” in entities seeking treaty benefits. shares, deferred / vesting arrangements)? On an international level, the adoption of the second Anti-Tax Avoidance Directive (“ATAD II”) has extended the scope of the hybrid mismatch tax rules to arrangements involving non-EU Although favourable tax treatment for carried interest has become countries and so-called “reverse hybrid” mismatches. This more difficult to achieve, capital gains tax (at 28%) remains available further complicates the anti-hybrid issues discussed above. In on carried interest returns in certain circumstances. Management addition, despite Brexit, the UK has adopted the mandatory will look to ensure that carried interest is not treated as income for disclosure rules introduced by the sixth amendment to the EU tax purposes under the “disguised investment management fee” Directive on Administrative Cooperation (“DAC6”), which (“DIMF”) or income-based carried interest rules. now require the PE industry and its advisers to consider whether For equity investment/co-investment, senior management transactions will be subject to mandatory disclosure to HMRC. may be able to claim business asset disposal relief (formerly On a domestic level, the change from entrepreneurs’ relief to entrepreneurs’ relief) (delivering a 10% rate of capital gains tax business asset disposal relief and corresponding reduction in the on sale) provided certain conditions are satisfied. In particular, available lifetime allowance from £10 million to £1 million may to be eligible, an executive must hold at least 5% of the ordinary have a significant impact on many management teams. share capital for at least two years. With effect from 11 March 2020, a lifetime allowance of £1 million of gains is eligible for business asset disposal relief (a significant reduction from the 102 Legal and Regulatory Matters £10 million of lifetime gains eligible for relief prior to such date). Growth shares and deferred/vesting arrangements remain 10.1 Have there been any significant legal and/or relevant in the UK and are commonly used as a means of deliv- regulatory developments over recent years impacting ering capital gains tax treatment on a future sale with a minimal private equity investors or transactions and are any income tax charge on acquisition. anticipated?

As outlined in the previous answers to the questions in this 9.3 What are the key tax considerations for management teams that are selling and/or rolling-over chapter, a range of UK and European laws affect PE investors part of their investment into a new acquisition structure? and transactions. Among the most important of these is the Companies Act 2006 (which provides the basic framework of company law in England), the Financial Services and Markets Management will generally be keen to ensure that tax is Act 2000 (providing the basic framework of law relating to deferred until any disposal proceeds are received and will want financial services in the UK), the Bribery Act 2010 (legisla- to maximise the availability of business asset disposal relief tion aimed at prohibiting bribery and corruption by UK busi- (although this will be less of a priority following the signifi- nesses and individuals worldwide), GDPR (which governs the cant reduction in the lifetime allowance noted in question 9.2). transmission and collection of data in Europe) and the Takeover Reorganisation reliefs are often available to escape a taxable Code (referred to above). disposal occurring on a rollover. Loan notes are frequently used for these purposes. A tax clearance will generally be required from HM Revenue & Customs (“HMRC”) in connection with 10.2 Are private equity investors or particular any tax-neutral rollover and should be factored into the trans- transactions subject to enhanced regulatory scrutiny in action timing. your jurisdiction (e.g. on national security grounds)?

PE funds (like other funds) that are managed from or marketed 9.4 Have there been any significant changes in tax legislation or the practices of tax authorities (including within EU Member States will generally be subject to some, or in relation to tax rulings or clearances) impacting private all, of the rules of the Alternative Investment Fund Managers equity investors, management teams or private equity Directive (“AIFMD”) (an EU directive that looks to place transactions and are any anticipated? hedge funds, private equity and any other alternative investment firms into a regulated framework, in order to monitor and regu- As is the case in most other jurisdictions, the UK tax rules have late their activity).

10.3 How detailed is the legal due diligence (including sponsor may be held liable for its portfolio company. One such compliance) conducted by private equity investors prior example (with reference to the answer to question 10.4 above), to any acquisitions (e.g. typical timeframes, materiality, is that a PE sponsor could incur liability under the Bribery Act scope, etc.)? 2010 by failing to implement adequate procedures for its portfolio company, and potentially under the UK Proceeds of Crime Especially given that when buying assets from other PE spon- Act 2002 (the relevant “proceeds” of the crime of the bribery sors they may not benefit from substantive warranty protection concerned being the investment proceeds enjoyed by the PE as to the condition of the business being sold to them, PE spon- sponsor from the investee company). sors typically require detailed legal due diligence processes to be undertaken on the assets they are considering buying. These 112 Other Useful Facts investigations will review most legal and business aspects of the target, including (but not limited to) investigations into 11.1 What other factors commonly give rise to concerns title, assets, material contracts, intellectual property, litiga- for private equity investors in your jurisdiction or should tion, real estate, and compliance. These investigations tend to such investors otherwise be aware of in considering an be conducted on an issues-focused “red-flag” basis, and to be investment in your jurisdiction? governed by materiality thresholds aligned to the size of the deal in question. The UK remains a premier place in the world for investment by PE sponsors. It should be noted, however, that the uncertainty 10.4 Has anti-bribery or anti-corruption legislation to the financial environment imposed by the UK’s impending impacted private equity investment and/or investors’ departure (at the time of writing) from the European Union approach to private equity transactions (e.g. diligence, means that, when making PE investments in the UK, inevitable contractual protection, etc.)? uncertainties have now arisen as to the governing legislation and tax rates in the UK which might prevail at the time of a desired Anti-bribery legislation has further increased the focus of PE exit from that investment (although it should be noted that there sponsors on the day-to-day business activities of the targets they would be no particular incentive for the UK government to are acquiring, and their sensitivities to various business prac- worsen the UK’s status as a destination for international invest- tices and corporate conduct. This trend (driven, for instance, ment following a departure from the European Union). Aside by the Bribery Act 2010 in the UK), has impacted the thorough- from Brexit, many other factors remain which can influence ness of due diligence investigations, the strength of related W&I investments by PE sponsors in the UK and there is not room to provisions in purchase documentation, the day-to-day govern- cover them all here. Topics of particular prominence in the UK ance rights insisted upon by PE sponsors and, in some cases, the at the time of writing (2020) are the impacts of the COVID-19 abandonment of proposed transactions due to insurmountable pandemic (addressed elsewhere in this chapter) and also some bribery or corruption issues in the relevant targets. indications that the UK government may tighten restrictions or extend approval timelines in relation to foreign direct investment in industries thought to be of strategic significance (e.g. 10.5 Are there any circumstances in which: (i) a private defence, life sciences and healthcare), in response to concerns equity investor may be held liable for the liabilities of around maintenance of national independence in certain areas, the underlying portfolio companies (including due to breach of applicable laws by the portfolio companies); influenced by greater geopolitical uncertainties. and (ii) one portfolio company may be held liable for the liabilities of another portfolio company? Acknowledgments John Markland, a finance partner at Dechert LLP, Daniel In general, under English law, a shareholder is not liable for the Hawthorne, a tax partner at Dechert LLP, and Tony Brown, underlying activities/liabilities of the company to which the a corporate and securities senior associate at Dechert LLP, all shares relate. There are only very specific instances where a PE contributed to this chapter.

Ross Allardice’s focus on financial sponsor matters means he sees a large number of transactions across the European private equity, portfolio and restructuring space. He is heavily involved with every phase of a transaction and has an excellent understanding of current market terms in the financial sponsor market. He represents parties across multiple industry sectors.

Dechert LLP Tel: +44 20 7184 7362 160 Queen Victoria Street Email: [email protected] London, EC4V 4QQ URL: www.dechert.com United Kingdom

Dechert LLP Tel: +44 20 7184 7603 160 Queen Victoria Street Email: [email protected] London, EC4V 4QQ URL: www.dechert.com United Kingdom

Private Equity 2020 © Published and reproduced with kind permission by Global Legal Group Ltd, London 168 Chapter 19 USA USA

John LaRocca

Dr. Markus P. Bolsinger

Dechert LLP Allie M. Misner

12 Overview PE industry in 2020, but we are beginning to see an uptick in deals as many regions of the country have begun the process of reopening. See question 1.3. 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? 1.2 What are the most significant factors currently encouraging or inhibiting private equity transactions in your jurisdiction? U.S. private equity (“PE”) deal activity remained healthy in 2019, though it decreased slightly in terms of both deal volume and value relative to the record-setting levels of 2018, while Over the last few years prior to the COVID-19 pandemic, the deal activity for the first quarter of 2020 increased in both dearth of suitable targets has resulted in extremely competitive respects relative to the same period in 2019. Deal activity in auctions, which in turn has resulted in historically high selling the first quarter of 2020 benefited from transactions that were multiples and seller-favorable terms. Successful bids often signed prior to the impacts of the COVID-19 pandemic being included “walk-away” terms with few conditions and recourse fully realized in the United States and has slowed in the second limited solely to buyer-obtained representation and warranty quarter or 2020. Commitments in respect of PE fundraising (“R&W”) insurance. With bankers and sellers focused on increased during 2019 to reach record levels but declined during certainty and speed to closing, transactions were often required the first quarter of 2020. to be signed and closed within days or a few weeks. The Over the last 18 months prior to the onset of the COVID-19 COVID-19 pandemic has begun to shift some of those terms pandemic in the United States, PE sponsors continued to be and timelines, as parties increasingly focus on allocating risk, confronted with highly elevated valuations for new platform travel restrictions and other obstacles make in-person meetings companies and seller-friendly terms created by expedited, and visits to a target’s facilities difficult, and decreased access to competitive auctions. These valuations, coupled with record debt financing may result in slower processes and fewer ready levels of dry powder and the lack of suitable targets, continued buyers. See question 1.3. In addition, recent regulatory reforms to create a challenging investment environment for buyers. involving the Committee on Foreign Investment in the United As a result, activity during this period increased for portfolio States (“CFIUS”) could lead to increased timing delays and deal company add-ons and alternative transactions such as carve- uncertainty for transactions involving non-U.S. investors that outs, strategic partnering transactions, minority investments, might raise U.S. national security issues. club deals and take-private transactions. In addition, PE sponsors focused significant attention on readying existing portfolio 1.3 What are going to be the long-term effects for companies for exits. private equity in your jurisdiction as a result of the Since the full onset of the pandemic in the United States, deal COVID-19 pandemic? activity and valuations have been depressed due to a number of impacts from the pandemic, including increased uncertainty, The long-term effects of the COVID-19 pandemic on U.S. PE pricing difficulties, decreased availability of debt financing, chal- are not yet known and will depend on a number of factors, but lenging business circumstances for many businesses and sectors certain trends are likely to emerge. of the economy, and various practical impediments to getting In the shorter term, many funds and potential targets have deals done. Some of the pre-COVID-19 trends described above turned their attention away from active deal-making and may continue for transactions that are successfully completed towards crisis management. For transactions that are being in the balance of 2020 due to the continuing presence of record negotiated during this time, there is an increased focus on allo- levels of dry powder and the need for PE funds to put capital cating risk, in particular relating to the economic impacts of to work, but some deal dynamics may change. The impacts COVID-19, which puts pressure on valuations and deal terms of COVID-19 will undoubtedly be felt throughout the U.S. relating to conditionality and closing certainty and the parties’

obligations between signing and closing, among others. The 2.2 What are the main drivers for these acquisition decreased availability of debt financing is a significant factor in structures? what deals can get done, and the lack of abundant debt financing may result in less competition among buyers. Exits by PE funds The primary drivers include tax considerations, stockholder were down in 2019 and the first quarter of 2020, and that pattern approval, speed and certainty of closing and liability issues. will likely continue as sponsors delay exits and wait for a more Mergers offer simple execution, particularly where the target stable pricing environment, rather than selling portfolio compa- has numerous stockholders, but buyers lack privity with the nies at discounted valuations, or with a significant portion of the target’s stockholders, and the target’s board may expose itself to purchase price subject to an earn-out or deferred purchase price claims by dissatisfied stockholders. Buyers often seek separate with seller financing. agreements with stockholders that include releases, indemnifi- Against that backdrop, sponsors continue to have access cation and restrictive covenants. However, depending on the to record levels of dry powder and will be looking for ways applicable state law, enforceability issues may arise. to deploy capital. That is expected to lead to an increase in Stock purchases require all target stockholders to be party to buyouts of distressed assets, private investments in public equity and support the transaction. These agreements avoid privity (“PIPEs”), carve-outs and minority investments, as well as an and enforcement concerns that arise in a merger but may be increase in smaller deals and add-ons acquisitions for existing impractical depending on the size and character of the target’s portfolio companies that may be easier to finance than large stockholder base. platform acquisitions. In particular, those transactions may be Asset purchases provide favorable tax treatment because buyers easier to finance due to relationships with existing lenders and can obtain a step-up in tax basis in acquired assets. See section 9. their familiarity with the platform’s business. In addition, direct Depending on the negotiated terms, buyers also may leave behind lending by private debt funds, which has increasingly become existing liabilities of the target. However, asset purchases (espe- a source of financing for middle-market PE transactions over cially carve-out transactions) can be difficult and time-consuming the last several years, may have an edge over traditional bank to execute because third-party contract consents may be required. lending in the current environment; private debt funds, like PE For certain regulated businesses, permits and licenses may need funds, have access to significant amounts of dry powder and to be transferred or reissued. In addition, buyers need to carefully may have more willingness and flexibility to lend in a downturn. review the business’ assets and liabilities to ensure that all necessary assets are acquired and that liabilities that flow to buyers as a 1.4 Are you seeing any types of investors other matter of law are not unwittingly inherited. than traditional private equity firms executing private equity-style transactions in your jurisdiction? If so, please explain which investors, and briefly identify any 2.3 How is the equity commonly structured in private significant points of difference between the deal terms equity transactions in your jurisdiction (including offered, or approach taken, by this type of investor and institutional, management and carried interests)? that of traditional private equity firms. U.S. PE returns typically arise from management fees and Over the past several years, the concentration of capital in large, returns on equity investments. Equity structuring varies multi-strategy asset managers has increased, leading to a corre- depending on the PE sponsor involved, the portfolio company sponding increase in the number of deals consummated by such risk profile and the IRR sought. Equity is most often comprised managers. We expect this trend to continue, as large, multi- of preferred and/or common equity interests held by the PE strategy asset managers may be better positioned than some sponsor. Often, some or each type of equity is offered to others to weather the difficult current environment. existing or “rollover” target investors. Preferred equity can be Non-traditional PE funds such as sovereign wealth funds, used to set minimum returns and incentivize common or other pension plans and family offices have been extending beyond junior security holders to drive portfolio company performance. minority positions to increasingly serve as lead investors in PE funds often offer portfolio company management equi- transactions, which has created additional competition for tradi- ty-based incentive compensation in the form of stock options, tional PE funds. restricted stock, phantom or other synthetic equity or profits In addition, pension funds, insurance companies and other interests, each of which is subject to vesting requirements. investors of large pools of capital will likely continue increasing Carried interests are typically found at the fund level and do not their allocation to alternative investments – PE, private debt, directly relate to the structuring of the equity investment at the real estate and infrastructure. portfolio company level. The main drivers for these structures are (i) alignment of 22 Structuring Matters interests among the PE sponsor and any co-investors, rollover investors and management, including targeted equity returns, (ii) tax efficiency for domestic and international fund investors 2.1 What are the most common acquisition structures and other portfolio company investors, including management, adopted for private equity transactions in your jurisdiction? and (iii) incentivizing management.

The most common acquisition structures are mergers, equity 2.4 If a private equity investor is taking a minority purchases and asset purchases in the case of private targets, and position, are there different structuring considerations? one-step and two-step mergers in the case of public targets. Historically, most PE sponsors have prioritized control invest- Minority investments create financial and legal issues not often ments, but the current market has increased focus on alternative encountered in control investments. Unlike control transac- investment structures, including structured equity. tions, where the PE sponsor generally has unilateral control over the portfolio company, minority investors seek to protect their investment through contractual or security-embedded rights.

Rights often include negative covenants or veto rights over liability companies (“LLCs”) or limited partnerships) through major business decisions, including material M&A transactions, which they complete acquisitions and maintain their owner- affiliate transactions, indebtedness above certain thresholds, ship interest in underlying portfolio companies. Governance annual budgets and business plans, strategy, senior management arrangements are typically articulated at the portfolio company hiring/firing and issuance of equity. In addition, PE sponsors level where management holds its investment but may also be will seek customary minority shareholder protections such as found at the buyer level if co-investors or management inves- board and committee representation, information and inspec- tors hold equity interests in the buyer. For control investments, tion rights, tag-along and drag-along rights, registration rights PE sponsors will often control the manager and/or the board of and pre-emptive rights. both the buyer and the portfolio company. For transactions subject to CFIUS review, non-U.S. PE inves- Governance agreements among PE sponsors, co-investors tors taking a minority position might be required to forego and management will most commonly be in the form of a share- certain rights that it otherwise would seek (e.g., board representa- holders’ agreement or LLC agreement. These agreements ordi- tion and access to non-public information) in order to avoid trig- narily contain (i) transfer restrictions, (ii) rights of first refusal or gering CFIUS review or to otherwise facilitate obtaining CFIUS first offer, (iii) tag-along and drag-along rights, (iv) pre-emptive clearance. rights, (v) rights to elect the manager or board of directors, (vi) information rights, (vii) special rights with respect to management equity, including repurchase rights, and (viii) limits on 2.5 In relation to management equity, what is the typical range of equity allocated to the management, and certain duties to the extent permitted by state law. For larger what are the typical vesting and compulsory acquisition portfolio companies contemplating exits through IPOs, registra- provisions? tion rights may also be sought. Governance arrangements are not generally required to be made publicly available unless the portfolio company is a public reporting company. Charters are Management equity is typically subject to time- and/or perfor- required to be filed with the state of organization but generally mance-based vesting. Time-based awards vest in specified incre- do not include meaningful governance provisions. ments over several years (typically four to five years (in the Eastern United States) and sometimes less (in the Western United States)), subject to the holder’s continued employment. Performance- 3.2 Do private equity investors and/or their director based awards vest upon achieving performance goals, often based nominees typically enjoy veto rights over major on the PE sponsor achieving a certain IRR or invested capital corporate actions (such as acquisitions and disposals, multiple upon exit. Time-based awards typically accelerate upon business plans, related party transactions, etc.)? If a private equity investor takes a minority position, what the PE sponsor’s exit. Forfeiture of both vested and unvested veto rights would they typically enjoy? equity in the event of a termination for cause is not uncommon. Compulsory acquisition provisions are not typical, but portfolio companies customarily reserve the right to repurchase an For control investments, PE sponsors will often control the port- employee’s equity in connection with the employee’s termina- folio company through their rights to appoint the manager or a tion at fair market value or the lesser of fair market value and the majority of the directors. As a result, major corporate actions original purchase price, depending on the timing and reason for are ultimately indirectly controlled by the PE sponsor. If a PE termination. sponsor takes a minority position, veto rights will generally not The proportion of equity allocated to management (as well be included in underlying governance arrangements unless the as the allocation among executives) varies by PE fund and the sponsor owns a substantial minority position. See question 2.4. capital structure of the portfolio company, but management equity pools for portfolio companies typically range from 7.5%– 3.3 Are there any limitations on the effectiveness of 15% of equity on a fully-diluted basis, with the higher end of veto arrangements: (i) at the shareholder level; and (ii) at that range being more common with smaller equity investments. the director nominee level? If so, how are these typically addressed?

2.6 For what reasons is a management equity holder usually treated as a good leaver or a bad leaver in your Veto rights are typically contractual rights in favor of specified jurisdiction? shareholders or classes of equity contained in a shareholders’ agreement or LLC agreement if applicable, and are generally Management equity holders are typically treated as good leavers enforceable. For corporations, although less common, nega- if their employment is terminated without cause, they resign tive covenants can also be included in the articles of incorpo- with good reason or after a specified period of time, or their ration, which would render any action taken in violation of one employment terminates due to death or disability. Bad leavers of those restrictions ultra vires. Although shareholder-level veto are commonly those who are terminated for cause or who other- rights are sometimes employed, director-level veto rights are less wise resign without good reason. common, as veto rights exercised by directors will be subject to their overriding fiduciary duty owed to the portfolio company. 3 2 Governance Matters See question 3.6.

3.1 What are the typical governance arrangements 3.4 Are there any duties owed by a private equity for private equity portfolio companies? Are such investor to minority shareholders such as management arrangements required to be made publicly available in shareholders (or vice versa)? If so, how are these your jurisdiction? typically addressed?

PE sponsors generally form new buyer entities (most often Whether a PE investor owes duties to minority shareholders corporations or tax pass-through entities such as limited requires careful analysis and will depend upon several factors,

including the legal form of the entity involved and its jurisdic- 3.6 Are there any legal restrictions or other tion of formation. requirements that a private equity investor should Several jurisdictions hold that all shareholders in closely held be aware of in appointing its nominees to boards of companies owe fiduciary duties to each other and the company. portfolio companies? What are the key potential risks In other jurisdictions, such as Delaware, only controlling share- and liabilities for (i) directors nominated by private holders owe fiduciary duties. In this context, the ability to exer- equity investors to portfolio company boards, and (ii) private equity investors that nominate directors to cise dominion and control over corporate conduct (even if less boards of portfolio companies? than 50% of the equity is owned) will be determinative. Delaware is frequently chosen as the state of organization in PE transactions due to its well-developed business law and There are no meaningful legal restrictions applicable to PE inves- sophisticated judiciary. Under Delaware law, duties arising tors nominating directors to private company boards, other from controlling ownership include fiduciary duties of care and than restrictions under applicable antitrust laws. For example, loyalty and other duties such as those arising under the corpo- the Clayton Act generally prohibits a person from serving as an rate opportunity doctrine. The duty of care requires directors officer or director of two competing corporations. In 2019, the to make informed and deliberate business decisions. The duty U.S. Department of Justice (the “DOJ”) expressed a desire to of loyalty requires that decisions are made in the best interests extend the scope of these restrictions on interlocking director- of the company and its shareholders and not based on personal ships to non-corporate entities and entities that appoint direc- interests or self-dealing. For Delaware corporate entities, these tors to competing entities as representatives or “deputies” of the duties may not be waived. same investor. If the Clayton Act is expanded in such a manner, For PE sponsors organizing their investment vehicles as PE funds may need to reevaluate their existing corporate govern- LLCs in Delaware, the underlying LLC agreement will often ance arrangements with their portfolio companies. PE investors include an express waiver of fiduciary duties owed to minority should also be aware that some U.S. states have been enacting investors. Absent an express waiver, courts will apply tradi- gender diversity requirements for the boards of companies organ- tional corporate-like fiduciary duties. Other duties deemed ized and/or headquartered in the applicable state. included in LLC agreements such as duties of good faith and fair Potential risks and liabilities exist for PE-sponsored directors dealing may not be waived. In addition, shareholders’ and LLC nominated to boards. Directors appointed by PE investors should agreements often include express acknowledgments that the PE be aware that they owe fiduciary duties in their capacity as direc- sponsor actively engages in investing and has no obligation to tors (subject to certain exceptions in the case of an LLC where fiduciary duties of directors are permitted to be, and have been, share information or opportunities with the portfolio company. expressly disclaimed). Directors of corporations cannot delegate LLC agreements also typically provide that portfolio companies their decision-making responsibility to or defer to the wishes of a (and not PE sources) serve as the first source of indemnification controlling shareholder, including their PE sponsor. In addition, for claims against PE sponsor employees serving on the port- conflicts of interest may arise between the PE firm and the portfolio company’s board. folio company. Directors should be aware that they owe a duty of loyalty to the company for the benefit of all of its shareholders 3.5 Are there any limitations or restrictions on the (absent a waiver under the circumstances discussed above) and contents or enforceability of shareholder agreements that conflicts of interest create exposure for breach of duty claims. (including (i) governing law and jurisdiction, and (ii) Finally, while the fiduciary duties to the company remain the same, non-compete and non-solicit provisions)? the ultimate stakeholders might change when a company is insolvent or in the zone of insolvency – as a result, directors may owe Shareholders’ and LLC agreements are generally governed by fiduciary duties to certain creditors of the portfolio company in and must be consistent with the laws of the state of the enti- the event such entity is insolvent or within the zone of insolvency. ty’s formation. LLC agreements, which are contracts among the company and its members, provide greater flexibility than share- 3.7 How do directors nominated by private equity holders’ agreements. Although governing law and submission investors deal with actual and potential conflicts of to jurisdiction provisions may refer to the law of other states, interest arising from (i) their relationship with the party or may apply the law of two or more states through bifurcation nominating them, and (ii) positions as directors of other provisions, this approach is unusual and should be avoided, as portfolio companies? it is unduly complicated and references to state laws outside the state of formation may render certain provisions unenforceable. See question 3.6. Under the duty of loyalty, directors must act in Non-competition and non-solicitation provisions in share- good faith and in a manner reasonably believed to be in the best holders’ and LLC agreements generally restrict management interests of the portfolio company and may not engage in acts and non-PE co-investors, but not PE investors. These provi- of self-dealing. In addition, directors appointed by PE firms sions are subject to the same enforceability limitations as when who are also PE firm officers owe potentially conflicting fidu- contained in other agreements. Enforceability will be governed ciary duties to PE fund investors. Directors need to be cogni- by state law and must be evaluated on a case-by-case basis. The zant of these potential conflicts and seek the advice of counsel. agreements must be constructed to protect the legitimate interests of the portfolio company and not violate public policy. 4 2 Transaction Terms: General Unreasonable temporal and/or geographic scope may render provisions unenforceable or subject to unilateral modification by courts. Other contractual provisions such as transfer restric- 4.1 What are the major issues impacting the timetable tions, particularly for corporate entities, are subject to public for transactions in your jurisdiction, including antitrust, foreign direct investment and other regulatory approval policy limitations. requirements, disclosure obligations and financing issues?

The timetable for a transaction generally depends on the due

diligence process, negotiation of definitive documentation, and 52 Transaction Terms: Public Acquisitions obtaining debt financing, third-party consents and regulatory approvals. Antitrust clearance is the most common regulatory clearance 5.1 What particular features and/or challenges apply faced. Generally, only companies that meet regulatory thresh- to private equity investors involved in public-to-private transactions (and their financing) and how are these olds are required to make filings under the Hart-Scott-Rodino commonly dealt with? Act (“HSR”). The most significant threshold in determining reportability is the minimum size of transaction threshold (2020: US$94 million). In most circumstances, the HSR process takes Public company acquisitions pose a number of challenges for approximately one month and is conducted between signing and PE sponsors. The merger proxy or tender offer documents closing. However, parties can expedite review by filing based on provided to target shareholders will include extensive disclosure executed letters of intent or by requesting early termination of about the transaction, including the buyer and its financing, and the waiting period. a detailed background section summarizing the sale process and Transactions raising anticompetitive concerns may receive a negotiations. These disclosure requirements are enhanced if the “second request” from the reviewing agency, resulting in a more Rule 13e-3 “going private” regime applies to the transaction. extended review period. A public company acquisition will require either consum- In addition, parties to transactions potentially affecting mation of a tender offer combined with a back-end merger or national security may seek regulatory clearance from CFIUS. target shareholder approval at a special shareholder meeting. Given recent political developments and regulatory changes, In either case, there will be a significant delay between signing buyers should expect enhanced scrutiny by the U.S. government and closing that must be reflected in sponsor financing commit- of certain foreign investments in the United States, particu- ments, with a minimum of six weeks for a tender offer (which larly in the technology and defense-related industries. Recent must remain open for 20 business days) and two to three months CFIUS reforms that have been implemented pursuant to the for a merger that requires a special meeting. Foreign Investment Risk Review Modernization Act of 2018 Absent unusual circumstances, there will be no ability to (“FIRRMA”) have expanded CFIUS’ powers and also now seek indemnification or other recourse for breaches of target require mandatory submissions to CFIUS for certain types of representations or covenants, but R&W insurance may be transactions that are more likely to raise U.S. national security obtained. concerns – previously, CFIUS was typically a voluntary process. Prudent buyers seek CFIUS approval to forestall forced dives- 5.2 What deal protections are available to private titure orders. equity investors in your jurisdiction in relation to public Other contractual or government approvals relating to acquisitions? specific sectors or industries (e.g., the Jones Act) may also be necessary or prudent depending on the nature of the business Generally, the acquisition of a U.S. public company is subject being acquired or the importance of underlying contracts. to the ability of the target’s board to exercise a “fiduciary out” to pursue superior offers from third parties until the deal is 4.2 Have there been any discernible trends in approved by the target shareholders or a tender offer is consum- transaction terms over recent years? mated. A PE buyer typically negotiates an array of “no shop” protections that restrict the target from actively soliciting Over the past few years, competitive auctions have become the competing bids, along with matching and information rights if a preferred method for exits by PE sponsors and other sellers in third-party bid arises. If a target board exercises its fiduciary out the United States. As a result of these competitive auctions, to terminate an agreement and enter into an agreement with an the scarcity of viable targets and the abundant availability of unsolicited bidder, or changes its recommendation of the deal to equity financing and, prior to the COVID-19 pandemic, debt shareholders, break-up fees are customary. Fees typically range financing, transaction terms have shifted strongly in favor from 2%−4%. of sellers, including the limiting of conditionality and post- closing indemnification obligations. Transactions are gener- 62 Transaction Terms: Private Acquisitions ally being consummated with “public”-style closing conditions (i.e., representations subject to MAE bring-down), financing 6.1 What consideration structures are typically conditions have virtually disappeared, and reverse break fees preferred by private equity investors (i) on the sell-side, are increasingly common. The use of R&W insurance has been and (ii) on the buy-side, in your jurisdiction? implemented across transactions of all sizes and is now used equally by PE and strategic buyers. Transactions are being struc- U.S. PE buyers typically purchase companies on a cash-free debt- tured more frequently as walk-away deals, with the insurance free basis. As opposed to a locked box approach, U.S. trans- carrier being responsible for most breaches of representations actions typically involve a working capital adjustment where between the retention (which refers to the self-insured deduct- the parties agree to a target amount that reflects a normalized ible) and insured limit under the policy. It also is becoming level of working capital for the business (often a trailing six- or more common to include terms regarding CFIUS in transac- 12-month average) and adjust the purchase price post-closing to tions involving non-U.S. investors. reflect any overage or underage of working capital actually deliv- The COVID-19 pandemic and its impacts on PE will likely ered at closing. Depending on the nature of the business being shift some of these trends in the short term. See question 1.3. acquired and the dynamics of the negotiations, particularly in light of COVID-19 pricing uncertainties, the price may also include earn-outs or other contingent payments that provide creative solutions to disagreements over the target’s valuation.

6.2 What is the typical package of warranties / exclusions based on areas of concern arising during the under- indemnities offered by (i) a private equity seller, and (ii) writing process. In addition, exclusions have recently been the management team to a buyer? expanded to include COVID-specific exclusions. Pricing of policies has grown more favorable in recent years, With the increasing prevalence of R&W insurance, post-closing with premiums commonly around 3% or less of the policy indemnification by sellers, which was once intensely negotiated, limit (although the industry expects rates to increase based on has become less important for allocating risk between buyers recent claims experience) and underwriting due diligence fees and sellers. Historically, sellers would indemnify buyers for of US$25,000–US$50,000. In addition, the premium is subject breaches of representations and warranties, breaches of cove- to taxation under state law, and the insurance broker will also nants and pre-closing tax liabilities, and the parties would care- collect a fee. fully negotiate a series of limitations and exceptions to the indemnification. 6.5 What limitations will typically apply to the liability When buyers obtain R&W insurance, sellers typically provide of a private equity seller and management team under only limited indemnification for a portion of the retention warranties, covenants, indemnities and undertakings? under the policy (e.g., 50% of a retention equal to 1% of enterprise value). Public-style walk-away deals where sellers provide Representations and warranties typically survive for 12−24 no indemnification are increasingly common, and proposing a months post-closing, with 12 months increasingly becoming the walk-away deal provides bidders an advantage in competitive norm, although certain specified representations may survive auctions. longer. For example, tax, employee benefit and fundamental For issues identified during due diligence, buyers may nego- representations often survive until expiration of the applicable tiate for special indemnities, with the terms depending on the statute of limitations. Fundamental representations typically nature and extent of the exposure and the parties’ relative nego- include due organization, enforceability, ownership/capitaliza- tiating power. tion, subsidiaries and brokers. Management team members typically do not provide any special For transactions without R&W insurance, indemnifica- indemnification to buyers in their capacity as management. tion caps typically range from 5%−20% of the purchase price, whereas a significantly lower cap (e.g., 1%) is typically negoti- 6.3 What is the typical scope of other covenants, ated when the buyer is obtaining R&W insurance. Liability for undertakings and indemnities provided by a private breaches of fundamental representations, breaches of covenants equity seller and its management team to a buyer? and fraud is often uncapped. Sellers will often only be responsible for damages above a deductible amount. Historically, U.S. PE sellers typically have not agreed to non-competition covenants, and restrictive covenants were 6.6 Do (i) private equity sellers provide security (e.g. limited to employee non-solicitation covenants. Conversely, escrow accounts) for any warranties / liabilities, and selling management investors and certain co-investors typi- (ii) private equity buyers insist on any security for cally agree to non-competition and other restrictive covenants. warranties / liabilities (including any obtained from the Recently, limited non-competition covenants by PE sellers have management team)? become more common given the high valuations paid by buyers. However, these covenants are typically very narrow and may be With the continuing increase in usage of R&W insurance, limited to restrictions on purchasing enumerated target compa- escrows and holdbacks to cover indemnification for representa- nies. Restrictive covenants by PE sellers tend to be intensely tion breaches are becoming less common. However, for negotiated, and the terms, including the length of the restric- non-walk-away deals, sellers generally place 50% of the retentions, any exceptions and their applicability to PE fund affili- tion under the R&W insurance policy in escrow. Escrows for ates, depend on the parties’ negotiating strength and the nature post-closing purchase price adjustments remain common, as do of the PE seller and the business being sold. special escrows to address issues identified during due diligence. Counsel should ensure that non-selling members of the target’s management team continue to be bound by existing 6.7 How do private equity buyers typically provide restrictive covenants. comfort as to the availability of (i) debt finance, and (ii) equity finance? What rights of enforcement do sellers 6.4 To what extent is representation & warranty typically obtain in the absence of compliance by the insurance used in your jurisdiction? If so, what are the buyer (e.g. equity underwrite of debt funding, right to typical (i) excesses / policy limits, and (ii) carve-outs / specific performance of obligations under an equity exclusions from such insurance policies, and what is the commitment letter, damages, etc.)? typical cost of such insurance? U.S. PE buyers typically fund acquisitions through a combina- PE and other sophisticated sellers routinely request that recourse tion of equity and third-party debt financing. The PE sponsor be limited to R&W insurance obtained by buyers. will deliver an equity commitment letter to the buyer under which Policy terms commonly include coverage limits of 10%−15% it agrees to fund a specified amount of equity at closing, and the of target enterprise value, a 0.75%–1% retention (stepping down seller will be named a third-party beneficiary. In a club deal, each to 0.5% after one year), six years of coverage for breaches of PE sponsor typically delivers its own equity commitment letter. fundamental representations and three years of coverage for Committed lenders will deliver debt commitment letters to breaches of other representations. Exclusions include issues the buyer. Often, PE buyers and their committed lenders will identified during due diligence, certain liabilities known to the limit sellers’ rights to specifically enforce the debt commitment. buyer, benefit plan underfunding and certain environmental See question 6.8. liabilities, and may also include industry and deal specific

6.8 Are reverse break fees prevalent in private equity of the lock-up period, PE sponsors will continue to be subject transactions to limit private equity buyers’ exposure? If to legal limitations on the sale of unregistered shares, including so, what terms are typical? limitations on the timing, volume and manner of sale.

In the current market, closings are rarely, if ever, conditioned on 7.3 Do private equity sellers generally pursue a dual- the availability of a buyer’s financing. In certain circumstances, track exit process? If so, (i) how late in the process are PE buyers may accept the risk that they could be forced to close private equity sellers continuing to run the dual-track, the transaction by funding the full purchase price with equity. and (ii) were more dual-track deals ultimately realised However, buyers seeking to limit such exposure typically nego- through a sale or IPO? tiate for a reverse break fee, which allows termination of the transaction in exchange for payment of a pre-determined fee if Depending on market conditions, PE sponsors may simul- certain conditions are satisfied. Depending on the terms, reverse taneously pursue exit transactions through IPOs and private break fees may also be triggered under other circumstances, such auction sales. Dual-track transactions often maximize the price as a failure to obtain HSR approval. Typical reverse break fees obtained by sellers (through higher IPO multiples or increased range from around 4%−10% of the target’s equity value, with an pricing pressure on buyers), lead to more favorable transaction average of around 6%–7%, and may be tiered based on different terms and provide sellers with greater execution certainty. The triggering events. Where triggered, reverse break fees typically path pursued will depend on the particular circumstances of the serve as a seller’s sole and exclusive remedy against a buyer. Given process, but ultimate exits through private auction sales remain that PE buyers typically have no assets prior to equity funding at the most common. closing, sellers commonly require PE sponsors to provide limited Dual-track strategies have historically depended on the size of guarantees of reverse break fees. the portfolio company and attendant market conditions. Dual- track approaches are less likely for small- to mid-size portfolio 72 Transaction Terms: IPOs companies, where equity values may be insufficient to warrant an IPO. In addition, such companies are less likely to have suffi- 7.1 What particular features and/or challenges should cient resources to concurrently prepare for both an IPO and a private equity seller be aware of in considering an IPO third-party exit. As volatility in IPO markets increases, PE firms exit? generally focus more on sales through private auctions where closing certainty and predictable exit multiples are more likely. Exits through IPOs will often be at higher multiples and more readily apparent market prices than exits through third-party 82 Financing sale transactions. However, exits through IPOs are subject to volatile market conditions and present other significant 8.1 Please outline the most common sources of debt considerations. finance used to fund private equity transactions in your Unlike third-party sales, PE sponsors continue to own signif- jurisdiction and provide an overview of the current state of the finance market in your jurisdiction for such debt icant amounts of portfolio companies’ equity following an IPO. (particularly the market for high yield bonds). As a result, PE sponsors’ ownership interests and rights and the nature of any affiliate transactions with portfolio companies will be subject to public disclosure and scrutiny. PE sponsor The most common debt sources are bank loans, private debt management and monitoring agreements commonly terminate (known as “direct lending”) and high-yield bonds. Debt is cate- in connection with IPOs. gorized by its place in the capital structure and the associated Seeking to retain control over their post-IPO stake and ulti- risk to the lender. Senior debt ranks above all other debt and mate exit, PE sponsors often obtain registration rights and equity of the business and is first in line for repayment. Senior adopt favorable bylaw and charter provisions, including board secured debt includes revolving facilities, with advances made on nomination rights, permitted stockholder action by written the basis of borrowing bases (asset-based loans) or cash flow, and consent and rights to call special stockholder meetings. Because term debt. Second lien or junior lien loans are equal in right of many U.S. public companies elect board members by plurality payment to holders of senior secured debt but rank behind such vote, PE sponsors often retain the right to nominate specific holder’s security in the assets of the business. Mezzanine and numbers of directors standing for reelection following the IPO. other subordinated debt is subordinated in right of payment to Absent submission of nominees by third-party stockholders holders of senior debt, often unsecured and sometimes includes through proxy contests, which are unusual in the United States, equity kickers. Unitranche facilities combine senior and subordi- PE sponsors can ensure election of their nominees. As these nated debt in one facility, typically with a blended rate of interest. favorable PE rights are unusual in U.S. public companies, the Leveraged loans are currently favored over high-yield bonds rights often expire when the sponsor’s ownership falls below due to competitive pricing, similar flexible covenant terms, ease specified thresholds. of amendment and limited prepayment premiums. Unlike private companies, most U.S. public companies are Direct lenders continue to be important market players and subject to governance requirements under stock exchange rules have competitive advantages over traditional bank lenders. such as independent director requirements. Those advantages initially stemmed from constraints on traditional bank lenders by capital requirement guidelines and by regulatory restrictions affecting loans exceeding certain leverage 7.2 What customary lock-ups would be imposed on thresholds. While those guidelines and restrictions have been private equity sellers on an IPO exit? pulled back, borrowing from direct lenders has continued to be a trend in light of the amount of money in the market generally The underwriters in an IPO typically require PE sellers to enter and such lenders’ flexibility in commitment amounts, loan terms into lock-up agreements that prohibit sales, pledges, hedges, etc. and speed in execution. of shares for 180 days following the IPO. After the expiration

8.2 Are there any relevant legal requirements or 92 Tax Matters restrictions impacting the nature or structure of the debt financing (or any particular type of debt financing) of private equity transactions? 9.1 What are the key tax considerations for private equity investors and transactions in your jurisdiction? Are off-shore structures common? The target of an ongoing push for deregulation in the United States is the Dodd-Frank Act, including the Volcker Rule, a regulation that was meant to prohibit banks from making spec- For non-U.S. investors, considerations include structuring the ulative bets with their own capital. The result of this push was fund and investments in a manner that prevents investors from a roll-back of Dodd-Frank regulations late last year, simplifying having direct exposure to U.S. net income taxes (and filing obli- the process for determining which types of proprietary trading gations) and minimizes U.S. tax on dispositions or other events restrictions apply to certain banking entities. This year, the (e.g., withholding taxes). Holding companies (“blockers”) are proposal on the table is to eliminate a 3% cap on ownership of a often used and, in some cases, domestic statutory exceptions or venture capital fund and to allow banks to invest in credit funds tax treaties may shield non-U.S. investors from direct exposure among other changes. to U.S. taxes. For U.S. investors, considerations include minimizing a “double tax” on the income or gains and, in the case of non-corporate U.S. 8.3 What recent trends have there been in the debt investors, qualifying for reduced tax rates or exemptions on certain financing market in your jurisdiction? dividend and long-term gains. There is also a focus in transactions on maximizing tax basis The most important trends in the U.S. loan market relate to in assets and deductibility of costs, expenses and interest on the effect of the COVID-19 pandemic on the credit facilities of borrowings, as well as state and local income tax planning. portfolio companies and include the following: ■ At the start of the lockdowns across the United States, 9.2 What are the key tax-efficient arrangements that many companies chose to draw on their revolvers to ensure are typically considered by management teams in private they would have adequate liquidity to meet the needs of equity acquisitions (such as growth shares, incentive their businesses, including additional cleaning and other shares, deferred / vesting arrangements)? costs relating to COVID-19-specific issues. Recently, in response to the drawdowns, lenders have tried to imple- Tax-efficient arrangements depend on portfolio company tax ment “anti-hoarding” provisions that would require the classification. For partnerships (including LLCs taxed as part- regular repayment of cash over an agreed upon threshold. nerships), profits interests can provide meaningful tax effi- Borrowers have resisted such to ensure access to the full ciencies for management. Profits interests are granted for no amount of their revolver at all times. consideration and entitle holders to participate only in company ■ PE sponsors and management also have carefully reviewed appreciation (not capital), and provide holders with the possi- the definition of “EBITDA” in credit facilities to deter- bility of reduced tax rates on long-term capital gains (but do mine whether any add-backs are available with respect to have certain complexities not present in less tax-efficient alterna- lost earnings attributable to the health crisis and atten- tives). Other types of economically similar arrangements (non- dant costs and expenses that may be incurred in connec- ISO stock options, restricted stock units and phantom equity) tion therewith. If the effects of the crisis are “extraor- do not generally allow for this same capital gain treatment. dinary, unusual or non-recurring,” then an add-back to Profits interests are not available for corporations. In certain EBITDA may well be available for many borrowers for the cases, the use of restricted stock that is subject to future vesting associated expenses, charges, losses and/or items. Also, (together with the filing of an 83(b) election) can enable a holder as part of the EBITDA add-back review, PE sponsors are to benefit from reduced tax rates on long-term capital gains. reviewing the applicability of existing business interruption insurance. The proceeds of such insurance coverage, if paid, would often be permitted to be added back to 9.3 What are the key tax considerations for EBITDA for purposes of covenant compliance. However, management teams that are selling and/or rolling-over whether or not business interruption insurance is available part of their investment into a new acquisition structure? will depend on the language of the particular policy. ■ Some portfolio companies are experiencing breaches Management investors selling their investment focus on qual- arising from COVID-19 related impacts on their busi- ifying for preferential tax rates or tax exemptions on income. ness. If a breach appears inevitable, PE sponsors, manage- Management investors rolling part of their investment seek to ment and lenders have entered into discussions regarding roll in a tax-deferred manner, which may be available depending potential solutions. Some of those solutions include a on the nature of the transaction and management’s invest- payment holiday or an amendment converting upcoming ment. In some cases (such as phantom or restricted stock unit payments into payment-in-kind (“PIK”) payments or the plans), tax deferral is not achievable or may introduce signifi- exercise of an “equity cure” right to either cure the breach cant complexity. or even prevent a technical breach from occurring in the first instance. When government-mandated lockdowns 9.4 Have there been any significant changes in tax are lifted and all parties have greater visibility with respect legislation or the practices of tax authorities (including to future performance, PE sponsors, management and in relation to tax rulings or clearances) impacting private lenders will likely seek to enter into longer-term solutions. equity investors, management teams or private equity transactions and are any anticipated?

There have been a number of significant changes in recent years.

Significant changes to the tax audit process have become effec- 10.3 How detailed is the legal due diligence (including tive, and significant tax reform enacted in 2017, commonly compliance) conducted by private equity investors prior referred to as the Tax Cuts and Jobs, resulted in many signifi- to any acquisitions (e.g. typical timeframes, materiality, cant changes to the U.S. income tax system. Most recently, and scope, etc.)? related to the COVID-19 pandemic, there has been a series of tax legislation and non-legislative changes impacting the U.S. The scope, timing and depth of legal due diligence conducted income tax system. This has included new rules that create or by PE sponsors in connection with acquisitions depends modify tax laws related to deductions for interest expense, use on, among other things, the transaction size, the nature and of carrybacks, and deductions for the expense of certain types complexity of the target’s business and the overall transaction of property, the extension of deadlines for tax payments and timeline. Sponsors may conduct certain diligence in-house, but tax returns, payroll tax incentives including new refundable tax outside counsel typically handles the bulk of legal diligence. credits and payment deferrals. It is possible that further legis- Specialized advisers may be retained to conduct diligence in lation or other initiatives relating to COVID-19 matters could areas that require particular expertise. be enacted. These changes could impact the timing and amount of deductions and tax payments of portfolio companies, and therefore 10.4 Has anti-bribery or anti-corruption legislation impacted private equity investment and/or investors’ will be relevant to PE transactions involving U.S. companies. approach to private equity transactions (e.g. diligence, contractual protection, etc.)? 102 Legal and Regulatory Matters PE buyers and counsel will evaluate the target’s risk profile 10.1 Have there been any significant legal and/or with respect to anti-bribery and anti-corruption legislation, regulatory developments over recent years impacting including the Foreign Corrupt Practices Act (“FCPA”). The private equity investors or transactions and are any risk profile depends on, among other things, whether the target anticipated? conducts foreign business and, if so, whether any of the business is conducted (i) in high-risk regions (e.g., China, India, Significant legislation was adopted in 2017 (the Tax Cuts and Venezuela, Russia and other former Soviet countries and the Jobs Act), and even more recently there has been legislative and Middle East), (ii) with foreign government customers, or (iii) other tax initiatives related to the COVID-19 pandemic. See in industries with increased risk for violations (e.g., defense, section 9. aerospace, energy and healthcare). Diligence will be conducted The enactment of FIRRMA in August 2018 and the imple- based on the risk profile. Possible violations identified need to mentation of related regulations that culminated in early 2020 be thoroughly evaluated and potentially self-reported to the rele- has led to significant reforms to CFIUS. In particular, the scope vant enforcement authorities. of transactions that could be subject to CFIUS review has been The DOJ may impose successor liability and sanctions on PE expanded, certain filings are now mandatory, and there is an buyers for a target’s pre-closing FCPA violations. PE buyers increased focus on particularly sensitive industries. These typically obtain broad contractual representations from sellers changes have led to increased timing delays for transactions that regarding anti-bribery and anti-corruption matters and often require CFIUS review and increased uncertainty as to whether insist on compliance enhancements to be implemented as a CFIUS might seek to impose significant measures to mitigate condition of investment. potential national security concerns in a manner that might materially impact the structure of the transaction. 10.5 Are there any circumstances in which: (i) a private equity investor may be held liable for the liabilities of 10.2 Are private equity investors or particular the underlying portfolio companies (including due to transactions subject to enhanced regulatory scrutiny in breach of applicable laws by the portfolio companies); your jurisdiction (e.g. on national security grounds)? and (ii) one portfolio company may be held liable for the liabilities of another portfolio company? There is enhanced scrutiny by CFIUS of transactions involving non-U.S. investors and U.S. businesses that operate in industries Fundamentally, under U.S. law, businesses operated as legally that are deemed to be sensitive from a national security perspec- recognized entities are separate and distinct from owners. tive. Transactions involving Chinese investors, in particular, Consequently, PE sponsors generally will not be liable for acts of are now subject to intense scrutiny by CFIUS. In addition, portfolio companies. However, there are several theories under FIRRMA expanded CFIUS’ jurisdiction to enable review not which “corporate” form will be disregarded. These include: only of investments in which non-U.S. investors might be (i) Contractual liability arising to the extent the PE sponsor acquiring control over U.S. businesses (which have always been has agreed to guarantee or support the portfolio company. subject to CFIUS review), but also certain investments in which (ii) Common law liability relating to (a) veil piercing, alter non-U.S. persons would gain certain rights involving appoint- ego and similar theories, (b) agency and breach of fidu- ment of directors, access to material non-public technical infor- ciary duty, and (c) insolvency-related theories. Most often, mation, or other substantive decision-making board appoint- this occurs when the corporate form has been misused to ment rights even in the absence of control. Investments by accomplish certain wrongful purposes or a court looks non-U.S. entities that are partially or wholly owned by non-U.S. to achieve a certain equitable result under egregious governments also are subject to heightened scrutiny and might circumstances. trigger mandatory filing requirements. There are exceptions, (iii) Statutory control group liability relating to securities, envi- however, for certain PE investments made through partnerships ronmental, employee benefit and labor laws, the FCPA and in which the general partner is a U.S. entity or is domiciled in consolidated group rules under tax laws. an “excepted state” (which currently includes Australia, Canada, The two most common areas of concern relate to poten- and the United Kingdom). tial liabilities under U.S. environmental laws and employee

benefit laws. The Comprehensive Environmental Response, Transaction parties should expect increased regulation in the Compensation and Liability Act (“CERCLA”) can impose strict United States. In particular, new regulations should be expected liability on owners and/or operators of a facility with respect to in the arenas of cybersecurity and protection of personal data releases of hazardous substances at the facility owned or oper- (both at the federal and state level) that will affect both how ated by the portfolio company. PE sponsors who exercise actual diligence is conducted and how portfolio companies operate. and pervasive control of a portfolio company’s facility by actu- Taxes continue to be a key value driver in PE transactions, with ally involving themselves in the portfolio company’s daily oper- IRRs and potential risks depending on tax considerations. See ations, including environmental activities, may be exposed to section 9. liability as an operator of such facility. Parents can also have Increased attention must be paid to potential CFIUS indirect or derivative liability for the portfolio company’s concerns, particularly given recent reforms and the political liability under CERCLA if there is a basis for veil piercing. climate. Non-U.S. PE investors should be aware that investing Under the Employee Retirement Income Security Act in a U.S. business might trigger mandatory filing requirements. (“ERISA”), when a subsidiary employer terminates a quali- Even if a filing is not mandatory, it nonetheless may be advisable fied defined benefit pension plan, all members of the subsidiary to submit a voluntary filing in order to avoid deal uncertainty, control group become jointly liable. Control groups arise among as CFIUS has the ability to open a review even after closing has affiliates upon “the ownership of stock possessing at least 80% occurred and could even require divestment. CFIUS consider- of total combined voting power of all classes of stock entitled to ations will remain a key issue for PE sponsors regarding foreign vote or at least 80% of the total value of shares of all classes of investments in 2020. See section 10. stock of such corporation.” ERISA imposes joint and several liability on any person who, Acknowledgments upon termination of a plan, is a contributing sponsor of the plan or a member of the person’s controlled group. As a result, all The authors would like to thank Joshua Milgrim, a tax partner affiliated companies (including the PE sponsor and other port- at Dechert LLP, Sarah Gelb, a corporate and securities partner folio companies) may face liability when an inadequately funded at Dechert LLP who focuses her practice on leveraged finance plan terminates, provided that the 80% control test is satisfied. matters, Abbi Cohen, a corporate and securities partner at Dechert LLP who focuses her practice on environmental 112 Other Useful Facts matters, and Darshak Dholokia, an international trade partner at Dechert LLP, for their contributions to this chapter.

Contract law in the United States embraces the freedom to contract. Absent public policy limits, PE sponsors in U.S. transactions are generally able to negotiate and agree upon a wide variety of transaction terms in acquisition documents that satisfy their underlying goals.

John LaRocca practices primarily in the areas of PE, M&A, carve-outs and alternative investments. He has represented a wide range of PE and corporate buyers and sellers in both domestic and cross-border transactions across various industries, including healthcare, manufacturing, chemicals, consumer products and retail. Mr. LaRocca has been ranked among the top PE buyouts lawyers in the United States by Chambers USA, where he is recognized for having “excellent judgment” and “knowing exactly when to be more flexible and when to stand firm”. He has been listed as a top lawyer for PE buyouts in The Legal 500 (U.S.), which noted his “very good business-sense”. Particularly interested in working capital and complicated purchase price and waterfall mechanics and alternatives, Mr. LaRocca served as a certified public accountant and senior accountant with Price Waterhouse prior to joining Dechert.

Dechert LLP Tel: +1 215 994 2778 Cira Centre, 2929 Arch Street Email: [email protected] Philadelphia URL: www.dechert.com PA 19104-2808 USA

Dr. Markus P. Bolsinger, co-head of Dechert’s PE practice, structures and negotiates complex transactions – domestic and transatlantic M&A, leveraged buyouts, recapitalizations and going-private transactions – and advises on general corporate and corporate governance matters. Dr. Bolsinger’s experience extends across industries, including healthcare, industrial, packaging, agribusiness, consumer, food and beverage, and restaurant sectors. His clients have included leading PE firms, such as First Atlantic Capital, ICV Partners, J.H. Whitney & Co., Morgan Stanley Capital Partners and Ridgemont Equity Partners. In addition to his core M&A and PE experience, Dr. Bolsinger has extensive expertise in transactional risk insurance, and frequently speaks and writes on the topic in major media outlets. He has been listed as a recommended lawyer by the U.S., EMEA and Germany editions of The Legal 500, a legal directory based on the opinions of clients and peers. Recognized for M&A and PE buyouts, Dr. Bolsinger has been cited as “a trusted adviser” who “takes the time to understand a client’s business and motivations before undertaking any way”. Since 2010, every year Dr. Bolsinger has been recognized and received a pro bono service award.

Dechert LLP Tel: +1 212 698 3628 / +49 89 2121 6309 Three Bryant Park, 1095 Avenue of the Americas Email: [email protected] New York, NY 10036-6797, USA / URL: www.dechert.com Skygarden, Erika-Mann-Straße 5 Munich 80636, Germany

Allie M. Misner focuses her practice on corporate and securities matters. Ms. Misner represents private equity sponsors and their portfolio companies as well as strategic buyers and sellers in M&A transactions across a wide range of industry sectors. She also has experience representing companies and investment banks in domestic and cross-border securities offerings of equity and debt. In addition, Ms. Misner advises clients on general corporate matters, including corporate governance and public company reporting issues. Ms. Misner currently serves as a member of the Executive Committee of the Business Law Section of the Philadelphia Bar Association and is a past co-chair of the Private Equity & Venture Capital Committee of the Philadelphia Bar Association.

Dechert LLP Tel: +1 215 994 2449 Cira Centre, 2929 Arch Street Email: [email protected] Philadelphia URL: www.dechert.com PA 19104-2808 USA

Dechert is a global law firm focused on sectors with the greatest complexities and highest regulatory demands. We deliver practical commercial insight and judgment to our clients’ most important matters. Nothing stands in the way of giving clients the best of the firm’s entrepreneurial energy and seamless collaboration in a way that is distinctively Dechert. Dechert has been an active advisor to the private equity industry for more than 30 years – long before it was called “private equity”. As a result of our longstanding roots and diverse client base, we have a deep understanding of the latest market terms and trends and provide creative solutions to the most complex issues in evaluating, structuring and negotiating PE transactions. Ranked among the top law firms for PE by prominent league tables and legal directories, Dechert’s global team has been recognized for its commercial judgment and client focus. www.dechert.com

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