Debevoise & Plimpton Private Equity Re p ort

Spring 2013 Volume 13 Number 3

Tender Offers Poised to Become WHAT’S INSIDE Dividend Recaps: an Acquisition Structure of Choice 3 Used With Care, for Private Equity Buyers a Useful Tool Guest Column Every so often the Delaware legislature order to consummate this type of squeeze- 5 ILPA Ten Years On: adopts a change to the Delaware General out merger. Last year, less than 40% of Our Focus in 2013 Corporation Law (DGCL) that has far- large ($500 million +) U.S. LBOs of public reaching consequences in the practice of companies were effected via tender offer. We Delaware Court Decision mergers and acquisitions. Everyone in the expect this number to increase significantly 7 Could Reduce Litigation deal community, and especially those in upon adoption of the amendment. Exposure in Going Private the private equity world, should be tracking The Benefits Transactions an anticipated amendment to the DGCL of Two-Step Tender Offers that will make acquisitions structured as As is commonly known, a tender offer The IRS Has Been Busy tender offers more inviting. The amendment followed by a back-end merger provides 8 will greatly simplify the deal process acquirers of public companies with several Social Twist: Emerging once a bidder acquires more than 50% advantages as compared to one-step, long- 9 ESG Policies Could Present of the outstanding shares of the target by form mergers, accelerated timing being chief More Opportunities Than permitting the use of a short-form, squeeze- among them. The primary reason for the Challenges for Private out merger to acquire the remaining shares, timing advantage is that a bidder does not Equity without a stockholder vote. Under current need to file the disclosure documents with law, a bidder must reach a 90% threshold in CONTINUED ON PAGE 18 How Will the AIFMD 11 Impact Non-E.U. Fund Managers? Answers to Frequently Asked Questions

© 2013 The Cartoon Bank Club Deals Class Action 13 Survives Summary Judgment

Alert 15 New Banking Guidance May Impact Leveraged Lending 17 UK Take Privates: “I’m afraid I have some bad news. The company has been taken over by the little Recent Changes to the kid who sells lemonade down the street.” Takeover Code Letter from the Editors The past few months have seen a flurry of court decisions, acquisitions of UK companies subject to the Code. legislative proposals and administrative pronouncements that Dividend recaps became prevalent once again in 2012 and impact private equity dealmakers. In this issue, we round up the their popularity continues. We review the factors that are driving most noteworthy of these developments. this trend, as well certain ways to mitigate the risks that these Two recent developments in Delaware spell good news for transactions pose for the company, its shareholders and its officers, private equity firms. First, on our cover we explain proposed and directors. Another trend is interest among private equity fund changes to Delaware law, which will level the playing field for investors in a fund’s environmental, sustainability and governance sponsors seeking to utilize the speedier tender offer structure to practices, so-called ESG programs. We review what is driving such acquire public Delaware companies by making this structure easier initiatives and argue how developing a program in advance of your to execute in a leveraged transaction. In addition, a recent decision next fundraising could be advantageous. by the Delaware Chancery Court provides added comfort to private In our Guest Column, Michael Elio, a Managing Director equity buyers who partner with controlling stockholders or other at ILPA, discusses the changing role of the Institutional Limited insiders to acquire publicly-traded Delaware companies by reducing Partners Association over its ten-year history, growing from their exposure in the now nearly inevitable shareholder litigation an informal sounding board for institutional investors into a that accompanies public to privates. sophisticated advocate for its LP members in promoting best Elsewhere in this issue, we review the spate of recent rulings practices, developing research and benchmarks and creating and announcements by the IRS on topics ranging from spin-offs industry leading education programs. to management fee waivers to the medicare tax, and report on the In other news, as part of our ongoing effort to make the Private status of the long-running class action litigation challenging club Equity Report the most relevant and useful resource for up-to-date deals and other practices on antitrust grounds. We also update information and analysis for private equity professionals, we are you on two ongoing European legislative initiatives impacting revamping the electronic version of the Report to make it more user private equity funds. First, we follow up on our extensive previous friendly, whether viewed online, on your tablet or on your other reporting on the European Alternative Investment Fund Managers mobile devices. We hope to launch this new product with the next Directive (AIFMD), which is to be implemented by July 22, 2013, issue and look forward to your feedback. with a more detailed discussion of its impact specifically on fund Kevin A. Rinker managers based outside the EU and on the marketing within the on behalf of the Editorial Board EU of funds organized outside the EU. We also update you on some recent changes to the UK Takeover Code that will affect

Private Equity Partner /Counsel Practice Group Members The Debevoise & Plimpton Franci J. Blassberg The Private Equity David J. Schwartz Alan V. Kartashkin – Moscow Private Equity Report is a Michael P. Harrell Practice Group Rebecca F. Silberstein Antoine F. Kirry – Paris publication of Stephen R. Hertz All lawyers based in New Dmitriy A. Tartakovskiy Jonathan E. Levitsky Kevin A. Rinker York, except where noted. Guy Lewin-Smith – London Debevoise & Plimpton LLP Hedge Funds Jeffrey E. Ross Dmitri V. Nikiforov – Moscow 919 Third Avenue Private Equity Funds Byungkwon Lim Editorial Board William D. Regner New York, New York 10022 Marwan Al-Turki – London Gary E. Murphy Kevin A. Rinker 1 212 909 6000 Ann Heilman Murphy Gavin Anderson – Hong Kong ­ Mergers & Acquisitions Jeffrey J. Rosen www.debevoise.com Managing Editor Kenneth J. Berman – Washington, D.C. Andrew L. Bab Kevin M. Schmidt Washington, D.C. Erica Berthou David H. Schnabel E. Raman Bet-Mansour – London Thomas Schürrle – Frankfurt 1 202 383 8000 Jennifer J. Burleigh Cartoon Editor Paul S. Bird John M. Vasily London Woodrow W. Campbell, Jr. Franci J. Blassberg Please address inquiries Peter Wand – Frankfurt 44 20 7786 9000 Sherri G. Caplan Colin Bogie – London regarding topics covered in Jane Engelhardt Leveraged Finance Paris Richard D. Bohm this publication to the authors Sally Gibson – London Katherine Ashton – London 33 1 40 73 12 12 Thomas M. Britt III – Hong Kong or any other member of the William B. Beekman Matthew James Griffin – London Geoffrey P. Burgess – London Frankfurt Practice Group. David A. Brittenham Michael P. Harrell Margaret A. Davenport 49 69 2097 5000 Geoffrey Kittredge – London Paul D. Brusiloff All contents © 2013 Debevoise Michael A. Diz Moscow Timothy S. Long Pierre Clermontel – Paris & Plimpton LLP. All rights E. Drew Dutton – Hong Kong 7 495 956 3858 Marcia L. MacHarg – Frankfurt Alan J. Davies – London reserved. Michael J. Gillespie Peter Hockless – London Hong Kong Anthony McWhirter – London Gregory V. Gooding Pierre Maugüé 852 2160 9800 Jordan C. Murray Stephen R. Hertz Margaret M. O’Neill Shanghai Andrew M. Ostrognai – Hong Kong­ David Innes – London 86 21 5047 1800 Richard D. Robinson, Jr. Nathan Parker – London Dividend Recaps: Used With Care, a Useful Tool

Dividend recaps are all the rage. 2012 saw memory, there is a near-continuous flow re-emergent PIK toggle features in dividend a record volume of recap transactions (over of such deals in the U.S., and the activity recap financing (in which interest may, at $60 billion, according to data provider S&P has been spreading worldwide. In Europe, the borrower’s option, be paid in the form of Capital IQ LCD), and 2013 is shaping up to despite a traditional reluctance toward additional debt instead of in cash). be another big year in the U.S. and abroad. dividend recaps, the market in 2013 has …But There Are Still A recent report from Thomson Reuters noted already witnessed several major transactions, Associated Risks that the dividend recap volume in 2Q 2013 including loan-funded dividends for Pets-at- While a dividend recap can provide clear ($18.4 billion completed and $5.4 billion Home and Mivisa. And PE fund Investcorp benefits for shareholders and financial currently in the market as of the June 17 recently announced that it would scrap sale sponsors, there are still risks for the company, report) may exceed the previous market high plans for its portfolio company, Armacell, in its shareholders, and its officers and of $19.3 billion seen in the last quarter of favor of a dividend recap. Even Asia, where directors. If the debt-funded dividends are 2012. This frenzy of activity isn’t surprising, this financing mechanism had been almost too large relative to the company’s earnings as dividend recaps have turned out to be a unheard of, has recently seen a handful of and available capital, the company will be powerful tool for private equity firms focused dividend recap transactions, led by the recent vulnerable after the transaction to downturns, on returning capital. offerings of Nord Anglia Education that were as it may be left without the ability to As with all power tools, however, there used, in part, to channel funds to sponsor adequately fund day-to-day working capital are certain precautions that anyone involved Baring Private Equity Asia. needs. The company also risks devoting in a recap transaction will want to take to There are good reasons for these so much of its working capital to debt help reduce the inherent risks. developments. With prevailing interest rates service that future growth opportunities are at near-historic lows, dividend recaps offer Dividend Recaps Are Prevalent impaired. an attractive opportunity for funds to obtain for Good Reasons… Ultimately, if the company is unable to a return of – or even a profit on – invested Many attributed the record number of recaps comply with its covenants, meet its interest capital, without giving up the potential for in 2012 to looming changes in the U.S. obligations or repay its debt at maturity, it future equity upside. Thus, this tool allows tax code that caused private equity firms may find itself in a workout or bankruptcy a fund to accelerate returns to a point early to want to realize profits before the end of scenario. In that case, creditors who are in the business cycle, at a point when a full the tax year. But even as 2012 recedes into not being paid in full may, with the benefit exit might not be attractive because business of 20/20 hindsight, blame the dividend growth or improvements have not recap for having caused the problem and yet been fully realized. may sue directors, officers and shareholders The recently robust credit Alan V. Kartashkin – Moscow Christopher Rosekrans Employee Compensation in an attempt to recoup some of their lost Antoine F. Kirry – Paris Jeffrey E. Ross & Benefits market has allowed borrowers to Lawrence K. Cagney investment. Jonathan E. Levitsky Philipp von Holst – Frankfurt access more money at lower interest Guy Lewin-Smith – London Jonathan F. Lewis This creates distinct risks for the various Tax Alicia C. McCarthy rates and with lighter covenants Dmitri V. Nikiforov – Moscow constituents: William D. Regner John Forbes Anderson – London Elizabeth Pagel Serebransky than is typical in tighter credit Kevin A. Rinker Eric Bérengier – Paris Charles E. Wachsstock • Directors and officers are at risk if environments. This means that Jeffrey J. Rosen Andrew N. Berg The articles appearing in this disgruntled creditors argue they breached Kevin M. Schmidt Cécile Beurrier – London publication provide summary many portfolio companies have Thomas Schürrle – Frankfurt Pamela Boorman their fiduciary duty by over-levering information only and are not been able to increase their leverage John M. Vasily Pierre-Pascal Bruneau – Paris intended as legal advice. Readers the company – thereby rendering it Peter Wand – Frankfurt Gary M. Friedman should seek specific legal advice and pay a dividend even as, in Peter A. Furci insolvent – in order to pay an unlawful Leveraged Finance before taking any action with Yehuda Y. Halpert some cases, they have improved Katherine Ashton – London respect to the matters discussed in dividend to shareholders. These claims Friedrich Hey – Frankfurt William B. Beekman these articles. Any discussion of their covenant position and kept Adele M. Karig U.S. Federal tax law contained in can raise the specter of personal liability David A. Brittenham their debt service costs constant. Rafael Kariyev these articles was not intended or Paul D. Brusiloff for directors and officers: even if they Vadim Mahmoudov written to be used, and it cannot Companies have also been able to Pierre Clermontel – Paris ultimately are unsuccessful, they are an Matthew D. Saronson – London be used by any taxpayer, for the Alan J. Davies – London insulate against unexpected cash David H. Schnabel purpose of avoiding penalties that unpleasant and expensive distraction. Peter Hockless – London Peter F. G. Schuur may be imposed on the taxpayer flow hiccups by taking advantage of Pierre Maugüé Richard Ward – London under U.S. Federal tax law. CONTINUED ON PAGE 4 Margaret M. O’Neill Nathan Parker – London Spring 2013 l Debevoise & Plimpton Private Equity Report l page 3 Dividend Recaps: Used With Care, a Useful Tool (cont. from page 3)

While D&O insurance will generally • PE funds and other shareholders are at against both shareholders that received a cover such claims, private equity firms risk if creditors attempt to claw back the dividend and any follow-on recipients, and individual directors are well-advised dividend payment on the theory that raising the possibility that PE funds, to ensure that they can overcome it was “constructive fraud” that left the their LPs, and individual shareholders exclusions in the policies (including for business insolvent. With a lookback such as management teams may be willful misconduct or improper personal period that can extend to ten years or pursued for return of a dividend years benefit from the transaction). more, clawback actions can be filed CONTINUED ON PAGE 20 U.S. Tax Considerations Relating to Leveraged Recaps Basic Rules. The tax consequences specific to a leveraged fund to buy a target corporation can impact whether the target’s recapitalization can have a significant impact on how much of the historic E&P survives, it is important to consider the possibility proceeds the investors (including the sponsor) are able to keep. of a future leveraged recap in structuring a portfolio company Where the recap is structured as a distribution from a corporation, acquisition. an ordering rule in the tax code determines how the distribution Redemptions and Share Buybacks. In some leveraged is taxed for U.S. purposes. Specifically, the distribution is taxed recaps, the portfolio company buys back stock from all (or a as a “dividend” to the extent of the corporation’s current or group) of the investors instead of making a distribution. Since accumulated earnings & profits (“E&P”). (E&P is somewhat like the transaction is in form a sale of stock, one might think that retained earnings but computed on a tax basis.) To the extent the tax consequences would follow and the selling stockholders the distribution exceeds the E&P, it can be received tax free up to would have gain (or loss) equal to the difference between the sale the tax basis in the share. Finally, to the extent the distribution proceeds and the tax basis in the stock. However, the tax code exceeds both the E&P and the tax basis, it is taxed as capital gain. includes a special rule that recharacterizes a sale of stock to the U.S. individuals. Where the distribution is from a Delaware (or issuer corporation as a distribution (subject to the rules described other U.S.) corporation, the dividend portion is generally treated above), unless the selling shareholder’s percentage interest in the as “qualified dividend income” (“QDI”) and therefore eligible company (by vote and value) goes down by a significant amount. for the favorable 20% tax rate in the hands of a U.S. individual. Leveraged Recaps by LLCs Taxed as Partnerships. A Where the distribution is from a non-U.S. corporation, the completely different set of rules applies to leveraged recaps dividend portion is generally treated as QDI only if the class by portfolio companies (such as LLCs) that are treated as of stock is publicly traded or the corporation is eligible for the partnerships for tax purposes. In many such cases, it is possible benefits of a tax treaty with the U.S. If the dividend portion is to structure a leveraged recap so that there is no current tax at not treated as QDI, it is generally taxed at a 39.6% tax rate in the all. (Of course, where an investor holds an interest in such an hands of a U.S. individual. investment through a blocker corporation, the distribution by the Non-U.S. Investors. In the case of non-U.S. investors, the U.S. blocker corporation is subject to the rules described above and generally does not tax distributions paid by U.S. companies may be subject to current tax). that exceed E&P and distributions paid by non-U.S. companies Fund and GP Level. In any leveraged recap, it is important to regardless of E&P. However, the U.S. imposes a 30% understand how the proceeds will be shared (and be allocated for withholding tax (which may be reduced by a treaty) on a non- tax purposes) under the terms of the fund agreement. Moreover, U.S. investor’s share of any dividend income received from a where the proceeds of a leveraged recap do not give rise to current Delaware (or other U.S.) corporation. tax to the fund (e.g., because the portfolio company did not have Importance of E&P (or the lack thereof). Given the E&P), the distribution of the proceeds by the fund to a partner or significance of E&P to the tax treatment, it is important for by the general partner to its individual partners may give rise to sponsors to understand the amount of a corporation’s E&P current tax if the proceeds exceed the partner’s tax basis in the before effecting a leveraged recap. In many cases, deductions for fund (or the general partner). interest (even PIK interest) and other items will eliminate a target company’s current E&P. Moreover, since the structure used by a David H. Schnabel [email protected]

page 4 l Debevoise & Plimpton Private Equity Report l Spring 2013 Dividend Recaps: Used With Care, a Useful Tool (cont. from page 3) guest column ILPA Ten Years On: Our Focus in 2013

Investing in any institutional market • Benchmarking: The release of an Tools is perplexing. Investing in the global institutional benchmark relevant to To assist members in applying the private equity arena – with limited private equity investors; and ILPA’s Best Practices to their workflow, transparency, benchmarking and • Outreach: The continuation of our we have developed an online rating guidance – is downright challenging. education initiatives to external model that members can use to note the The Institutional Limited Partners constituents that impact our industry presence (or absence), on a weighted Association (the “ILPA”) just celebrated basis, of key partnership agreement terms ten years of working to make private Standards and provisions. equity investing less mystifying. The release of the ILPA Principles and With over 70 questions highlighting Originally an informal gathering of their resulting Best Practices in reporting 13 key areas within the alignment and senior investors, the organization has continue to find their way into the governance areas of the ILPA Principles, become an even more sophisticated mindset of General Partners. We are the model not only provides members association that continues to provide pleased with the response received to the means to rate the compliance of the a global platform for its members to these new standards and now have over partnership agreements of the funds in collaborate and access institutional 283 official endorsers with additional a member’s portfolio against the ILPA quality education and research. endorsements coming weekly. Principles, but also a tool to highlight Today the ILPA is the only global, We have heard from across our areas of concern for future monitoring. member-driven organization dedicated membership, which has embraced the This tool is not a substitute for due solely to advancing the interests of adoption of the ILPA Principles and diligence and document negotiation, private equity Limited Partners through Best Practices, and also from many in but does provide a flexible model for industry-leading education programs, the industry, including General Partners, the varying needs of a global and diverse independent research, best practices, service providers, consultants and others. membership. networking opportunities and global We will continue to be a resource for collaborations. The ILPA has over 280 those looking to strive for Best Practice Benchmarking Properly benchmarking private equity institutional member organizations that in their own organizations. investments has been a challenge since collectively manage over $1 trillion of The next step in the evolution of the first successful portfolio company private equity assets. the ILPA’s best practices initiatives exit. Though recent years have shown a In the remaining months of 2013, was to minimize the administrative slow transition to absolute and public- the ILPA will be focusing on four main burden and increase efficiencies in market-equivalent benchmarks within areas: the due diligence process. The ILPA the private equity community, there • Standards: Further evolution of reached out to General Partners, will always remain the need for relevant the ILPA’s industry best practices Limited Partners, placement agents benchmarking. The ILPA announced initiative to include development and other interested parties to develop last year that it had partnered with of a Standardized Due Diligence the recently released Standardized Due Cambridge Associates to create a measure Questionnaire; Diligence Questionnaire. The DDQ was released for a trial period to improve that more accurately benchmarks the • Tools: Further adoption of tools to its efficiency and coverage, and it is performance of institutional funds in assist the ILPA’s members in applying available for download and review at ilpa. the marketplace. Over the last year, the ILPA Private Equity Principles 2.0 — org/standardized-ddq/. We welcome content and scope of this benchmark in the areas of alignment of interests, comments and revisions, because we has been refined and several quarters governance and transparency — to believe that feedback from interested have been produced to further assess the their own investment strategies; parties can only produce a better results. product. CONTINUED ON PAGE 6

Spring 2013 l Debevoise & Plimpton Private Equity Report l page 5 ILPA Ten Years On: Our Focus in 2013 (cont. from page 5)

The ILPA recently released the Q4 Washington, we meet on an ongoing was a Managing Director and Partner 2012 results to its members and in the basis with regulators, members of the at a private equity advisory firm where balance of this year, with the help of media and key government officials. he served as the lead consultant to North our members and the participation of Our expectation is to continue this American and European institutional the institutional fund community, we education in the best interest of our investors committing in excess of $5 billion will focus on broadening coverage of members and the asset class at large. annually. For more information please the benchmark from the 2,000+ funds * * * visit ilpa.org or email Mr. Elio at melio@ currently included to the over 5,000 Private equity is built on partnerships ilpa.org. funds in the portfolios of our members. and strong relationships between General Outreach Partners and Limited Partners. The ILPA will continue to focus its efforts on Education has always been a cornerstone education, benchmarking and advocating of the ILPA’s mission. Over the last the importance of private equity within a few years, the discourse on private diversified portfolio. We encourage the equity has expanded from our small continued participation of General sphere to common dialogue in financial Partners and Limited Partners in the and political circles. This greater industry’s march to standardization and conversation highlighted the need for widely accepted best practices. expanding the education platform to combat the negative press and Mike Elio misinformation about private equity Managing Director, Industry Affairs circulating among global news desks. ILPA We have been to Beijing several times to deliver customized seminars on Michael Elio joined the ILPA in 2012 as private equity to local LPs and insurance its Managing Director, Industry Affairs. companies and to meet with regulators Mr. Elio leads the ILPA’s programs around in order to understand the nuances of research, standards and industry strategic investing in China for our members. In priorities. Prior to joining the ILPA he

A complete article index, along with Looking all past issues of the Debevoise for a past & Plimpton Private Equity Report, is available in the “publications” article? section of the firm’s website, www.debevoise.com.

page 6 l Debevoise & Plimpton Private Equity Report l Spring 2013 Delaware Court Decision Could Reduce Litigation ILPA Ten Years On: Our Focus in 2013 (cont. from page 5) Exposure in Going Private Transactions

As a result of a recent decision of the Strine, finding that the special committee compared to the modest benefit resulting Delaware Chancery Court, private equity was independent and functioned properly from merely shifting the burden of proof buyers who partner with controlling and that the unaffiliated stockholders were under the entire fairness standard. But it is stockholders may now be entitled to fully informed, granted defendants’ motion not clear whether it will be embraced by the important new protections when acquiring for summary judgment, applying business Delaware Supreme Court if the decision is publicly traded Delaware companies. If judgment review. appealed. As recently as last summer, that not overturned on appeal, the Delaware Although Chancellor Strine found that court, in its Southern Peru decision, called Chancery Court’s May 29 decision would the case presented an unresolved question entire fairness “the only proper standard of permit such transactions to be reviewed of Delaware law, it is a question that the review” for an interested cash-out merger under the business judgment rule so long deal community has discussed for many and stated that because fair process usually as certain procedural safeguards are used. years: namely, whether all going private results in fair price, it has “no doubt” that Obtaining the benefit of the business mergers with controlling stockholders must the use of special committees and majority- judgment rule can substantially reduce the be subject to the test of entire fairness of-the-minority conditions will continue risk that the transaction will be subject (which reviews fairness of process and to be “integral parts of the best practices to a pre-closing injunction, and lower fairness of price, and is a much tougher test that are used to establish a fair dealing the cost (in terms of both legal expenses for defendants to satisfy), or whether some process.” However, as Chancellor Strine and settlement value) of the shareholder combination of procedural protections acknowledged, “rational minds can disagree litigation that now accompanies nearly could cause such a merger to be subject about this question.” every going private deal. to business judgment review (which While the MFW decision constitutes a The recent decision, by Chancellor would respect a decision of independent potentially ground-breaking development in Strine in a case entitled In re MFW and informed directors unless it was Delaware law relating to take-private Shareholders Litigation, held that a irrational). The Delaware Supreme Court transactions, given the tension between the going private merger with a controlling had previously held that going private Court of Chancery’s holding and prior stockholder will be subject to the mergers with controlling stockholders were rulings of the Delaware Supreme Court, business judgment rule, rather than the subject to entire fairness review, but that private equity practitioners and controlling far more rigorous test of entire fairness, the burden would shift to the plaintiff to stockholders will need to consider carefully if the transaction is conditioned from its show that the merger was not entirely fair whether the potential for improved legal inception on approval by (1) a special if the transaction was approved either by a protection outweighs the additional committee of independent directors and special committee of independent directors conditionality that results from having both (2) a majority of the shares held by persons or a majority-of-the-minority stockholder a special committee process and a majority- unaffiliated with the controlling stockholder vote. That holding has invited the question of-the-minority vote. (a so-called majority-of-the-minority vote). of whether entire fairness should be the Gregory V. Gooding The case arose from a transaction in which test where both procedural protections [email protected] MacAndrews & Forbes, owner of 43% of are present. Chancellor Strine found William D. Regner M&F Worldwide (“MFW”), offered to that despite broad language contained in [email protected] buy the rest of MFW’s equity for $24 per previous Delaware Supreme Court rulings share. In its initial proposal, MacAndrews the issue had not been previously decided & Forbes said it would not proceed with by the Delaware Supreme Court, because any going private transaction that was not both protections were not present in those approved by a special committee and by a situations. majority-of-the-minority vote. The special The logic underlying the Chancellor’s committee negotiated a $1 per share price decision is persuasive, particularly the increase, and the merger was approved by court’s focus on incentivizing transaction holders of 65% of the shares not owned planners to include both protections by by MacAndrews & Forbes. Chancellor applying the business judgment standard,

Spring 2013 l Debevoise & Plimpton Private Equity Report l page 7 The IRS Has Been Busy

Since the beginning of the year, there letter rulings it would issue going forward We believe that this liberalization in has been a steady stream of notable and in the spin-off context. Under the revised the requirements will make these elections somewhat unanticipated announcements IRS procedure, the IRS will stop issuing available in a number of additional and new rules coming out of the IRS that private letter rulings as to the overall tax-free transactions and will therefore increase impact the private equity community, and nature of a spin-off and will generally limit structuring flexibility in the M&A context. not all of them relate to the current scandals its rulings to so-called “significant issues.” Partial 338(h)(10) Elections that have gotten so much attention in the Since the tax consequences of a spin-off Limited press. Below is a brief round-up of these could be catastrophic if it failed to achieve Earlier this year, an IRS private letter ruling developments. tax-free treatment, taxpayers effecting a spin- blessed what has been described as a “partial” off have generally sought the halo effect of a Spin-Off Announcement #1 Section 338(h)(10) election. The transaction private letter ruling that covered the entire The IRS surprised the tax community effectively allowed the buyer to receive a step transaction. The new IRS procedure applies on January 3rd by suspending the up in the basis of some (but not all) of the to private ruling requests made after August issuance of private letter rulings that bless assets of a target corporation in a manner 23rd. The new procedure also applies to three transaction structures frequently that did not create any incremental tax to the certain other corporate transactions. implemented in connection with tax- target corporation or the seller, resulting in free spin-offs while it studies the issues New Election to Treat a Stock an unusual “tax bargain.” (This type of involved. The three so-called “no rules” Purchase as an Asset Purchase transaction is described in greater detail in cover (1) some intercompany transactions IRC Section 338(h)(10) has long enabled the Summer/Fall 2012 issue of the Debevoise that are commonly undertaken in order to taxpayers to elect to treat a stock purchase & Plimpton Private Equity Report.) prepare a company for a spin-off, (2) some as an asset purchase for tax purposes, so that Surprisingly, the new section 336(e) transactions used by a distributing company the tax basis of the assets of the purchased regulations prospectively change the result to extract cash from the business being company is stepped up to fair market value. of the private letter ruling for taxpayers spun-off, and (3) the creation of high-vote/ A variety of requirements must be satisfied engaging in similar transactions going low-vote governance structures in connection in order to make a valid Section 338(h)(10) forward. While there are a few alternative with a spin-off. election, including a requirement that at least methods of effecting a so-called partial While some tax-free spin-offs are 80% of the stock of the target corporation be Section 338(h)(10) election to which the consummated without a private letter ruling, “purchased” and that the buyer be taxed as a new section 336(e) regulations do not apply, the types of transactions covered by the new “corporation.” the alternative transaction may be somewhat “no-rules “ have generally been done only IRC Section 336(e), which was enacted more difficult to execute and/or provide for a with an IRS ruling because of uncertainty as way back in 1986, authorizes the IRS to somewhat reduced tax benefit. to how the relevant tax rules apply. In some issue regulations that would create a similar Management Fee Waivers cases, the transaction is central to the spin- election in other contexts. A few weeks ago, In the last month, the tax press has off being considered (e.g., an intercompany the IRS issued regulations under Section reported on statements made by IRS transaction undertaken in order to get the 336(e) that allow the equivalent of a Section personnel indicating that they are looking assets and liabilities in the right place). In 338(h)(10) election, but with slightly at the so-called “management fee waiver” other cases, the transaction makes the spin- liberalized requirements. Specifically, an mechanisms used by some private equity off more attractive (e.g., the extraction of election is permissible under Section 336(e) funds (there have, of course, been separate cash from the spun-off business). As a result, where the acquirer is a partnership (or reports that the New York attorney general the new no rules are likely to discourage other non-corporate entity) and where the is also analyzing these arrangements). These some companies from pursuing a spin-off acquisition was not effected by “purchase.” statements indicate that the IRS understands and make it essentially impossible for some (The term “purchase” is narrowly defined in that management fee waiver mechanisms businesses to be spun-off. the Section 338(h)(10) context to exclude come in a variety of forms, that the IRS is certain taxable distributions and exchanges, Spin-Off Announcement #2 more troubled by some of the forms than such as transactions involving multiple On June 25th, the IRS announced an even others and that the IRS is planning to acquirers or non-corporate acquirers.) more significant curtailment of the private CONTINUED ON PAGE 14 page 8 l Debevoise & Plimpton Private Equity Report l Spring 2013 Social Twist: Emerging ESG Policies Could Present More Opportunities Than Challenges for Private Equity

Background Guidelines”), provide very broad and, Giving Meaning to ESG More Red Tape? in some cases given the early stage of The specific contours of an ESG For those who do not know or, like many many of these considerations, necessarily investment policy will likely vary based of the rest of us, who know but can’t incomplete guidance on ESG. While on the geography, sectors and asset classes consistently retain each of the individual fund managers can begin to demonstrate the funds target, and other investment components of the acronym, ESG refers in commitment to ESG integration by strategy features. Most governance and a very general way to the environmental, adopting the PEGCC Guidelines or social criteria may arguably be relevant social and governance practices of sponsors similar standards at this time, concerns to all funds to some extent, while and their portfolio companies. These linger in many corners of the private environmental issues are more likely factors are increasingly being discussed by equity community about a “pandora’s to vary with the investment strategy. investors, including labor unions, political box” -type dynamic with respect to the General operational sustainability practices pundits, regulators, management teams evolution of ever more stringent and (water/energy management and recycling and other observers, as a potential means return inhibiting standards governing a practices) will, however, apply to most of both developing a reasonably uniform broad array of non-economic matters. companies; it is, for example, the funds set of best practices for the industry and investing in real estate, infrastructure or Silver Lining? otherwise evaluating more generally the taking control positions in commodities Still, many PE professionals are coming global economic and societal profile of or manufacturing companies that will to believe that, at least on balance, the private equity firms and their portfolio need to consider a much wider variety private equity community may ultimately companies. of environmental issues. Social criteria have more to gain than to lose by the ESG A few years ago, when ESG policies ( , attention to diversity and equal initiative, particularly to the extent it can e.g. were even more nebulous than they are opportunity in employment practices, play an active role in cooperating with now, many PE professionals and other government and community relations, others in developing policies acceptable free market advocates, may have viewed labor conditions and relations, product to it and the various other interested these kinds of policies as an example of safety management and other human constituents. These advantages include overly aggressive global regulation. In rights issues) will come into play in (1) the proactive PR and practical the current geo-political environment; benefits associated with the industry’s CONTINUED ON PAGE 10 however, particularly following the active cooperation in the development prominence of private equity in the 2012 of the ultimate comprehensive standards U.S. Presidential election, and other Institutional fund in this area, as opposed to the seemingly related developments, most private equity greater risks associated with adopting a investors are … firms understand instinctively that the more passive role; (2) maintaining access kinds of considerations embodied in the increasingly adopting to those investors who may ultimately development of ESG are likely to intensify demand ESG compliance as a condition of socially responsible and potentially lead to standards that, if investment, to one degree or another, as not met, could have broader implications investment philosophies, these standards continue to evolve and, all for the industry. cynicism aside; and (3) obviating the lost …[and] there appears to A leading private equity advocacy, opportunities associated with being late be an expectation among research and resource organization has adopters of the greener, more sustainable adopted a sector framework for ESG to and more profitable operating practices fund managers and the assist industry participants in this regard. associated with ESG programs (at least industry more generally The standards adopted by the Private according to their advocates). Equity Growth Counsel, known as the that fund investor Private Equity Growth Guidance for attention to ESG issues Responsible Investments (the “PEGCC will continue to increase over the next five years. Spring 2013 l Debevoise & Plimpton Private Equity Report l page 9 Social Twist: Emerging ESG Policies (cont. from page 9) most investments. From a governance incorporate such “SRI” principles. As and create business opportunities, perspective, virtually all fund managers noted above, there appears to be an potentially leading to higher returns for would also consider portfolio company expectation among fund managers and fund managers and fund investors alike. accounting practices, attention to bribery the industry, more generally that fund and corruption risks, lobbying practices, investor attention to ESG issues will Examples of Value political contributions, anti-competitive continue to increase over the next five Enhancement behavior and executive compensation to years. Proponents of ESG policies point to mention but a few aspects. a number of recent examples of what • Reputational Considerations. they believe to be value enhancements U.S. state pension plans and other Drivers facilitated by ESG policies. These governmental investors also tend As noted above, a number of reasons include the adoption by a major U.S. to be especially focused on ESG are driving the development of ESG private equity sponsor of a green integration in their investments to standards across the industry. These investment program, introducing manage “headline risk” and to avoid include: environmental initiatives and facility potential public embarrassment for • Investor Requirements; Fund Raising and operational improvements that government officials. Fund managers, Edge. Institutional fund investors are have allowed its portfolio companies to fund investors and the portfolio themselves, as part of their investment collectively achieve an estimated $365 companies themselves would seem to policy mandates, increasingly adopting million in savings. They also include (1) be largely aligned in their interests socially responsible investment a portfolio food service company saving to appropriately manage various philosophies, such as the UN a cumulative $70 million and almost reputational ESG exposures. Principles for Responsible Investment 60,000 tons of greenhouse gas emissions (“UNPRI”), which are geared towards • Political Focus. The private equity over two years by improving routing global sustainability and believed to be industry and its various participants technology, increasing the amount consistent with the duties they have have come under increased political of product carried per truckload, and to their stakeholders and the public. scrutiny during the last few years. training drivers on more efficient Such fund investors are encouraging, Implementing ESG policies, adhering driving techniques, such as when to and in some cases requiring, fund to SRI guidelines and generally acting shift gears or how to break in traffic, managers to adopt ESG policies that as good corporate citizens could help (2) an on-line retailer saving $40 million the private equity industry improve its and avoiding 300,000 garbage trucks- public image. worth of waste over a two year period by The private equity • Value Enhancement. While some streamlining and centralizing its recycling efforts and (3) a communication industry and its various cynicism remains on the value proposition in certain corners of the infrastructure company reducing its participants have come PE community, there is a growing energy consumption by 2.5% and under increased political awareness that optimizing ESG saving over $650,000 in annual costs by operational aspects may protect and reducing high-pressure sodium lighting scrutiny during the last increase the value of investments, in manufacturing facilities. few years. Implementing for example through detecting and Integration of ESG Policies ESG policies, adhering preventing operational disruptions If and when ESG policies are eventually due to negative ESG factors, reducing adopted by a particular sponsor, these to SRI guidelines and legal ESG risks and managing ESG policies will need to be integrated at all generally acting as good publicity exposures that may otherwise levels of fund and portfolio management, impair a portfolio company’s brand. including in the due diligence of corporate citizens could Building better business practices and investment targets, through active help the private equity strengthening management may more generally enhance profitability industry improve its CONTINUED ON PAGE 16 public image. page 10 l Debevoise & Plimpton Private Equity Report l Spring 2013 Social Twist: Emerging ESG Policies (cont. from page 9) How Will the AIFMD Impact Non-E.U. Fund Managers? Answers to Frequently Asked Questions

In previous issues of the Debevoise & Plimpton Private Equity Report, we have reported extensively on the European Alternative Investment Fund Managers Directive (the “AIFMD”).1 The AIFMD will regulate, in stages, the managers (“fund managers”)2 of European and non-European private equity funds, hedge funds and other alternative investment funds (simply referred to below as “funds”), whether those fund managers are based in one of the Member States of the European Economic Area (the “EU”) or outside the EU.3 The AIFMD is required to be implemented into national law by EU Member States by July 22, 2013 (the “Effective Date”).4

In this article we discuss the impact of the Member States of the EU.5 that may be marketing a non-EU fund in one AIFMD on one subset of industry players The bottom line for non-EU fund or more of the EU Member States after the that will be impacted by the AIFMD: managers wishing to market non-EU funds Effective Date must: fund managers that are based outside the to professional investors in the EU is that, (1) identify those funds that it may be EU (even if they have sub-advisors in the for the period from the Effective Date until marketing in the EU after the Effective EU) and that will be marketing funds at least the fourth quarter of 2015 (subject to Date; organized outside the EU (such as funds any transitional relief that may be adopted by (2) identify those EU Member States in organized as Cayman Islands or Delaware EU Member States), the AIMFD will require which the manager may be marketing limited partnerships) in one or more of the those managers (1) to comply with new funds after the Effective Date (the disclosure rules (including extensive reporting “relevant EU Member States”); 1 See “EU Directive on Alternative Investment Fund to regulators) and “no asset stripping” Managers: Good News at Last” in our Fall 2010 issue requirements and (2) to continue to market (3) determine whether the private placement and “Alert: UK/EU Developments: More Disclosure, their funds by complying with national regimes in the relevant EU Member More Regulation and a Potentially Shrinking Pool of States will be retained (or modified) Investors” in the Winter 2012 issue. private placement regimes in the relevant EU Member States, as those regimes may be after the Effective Date and, for each 2 The AIFMD defines the “manager” as the entity modified from time to time. The impact of relevant EU Member State where the performing at least portfolio management or risk current private placement regime will be management in respect of an alternative investment the AIFMD’s on these non-EU managers is eliminated or modified, determine the fund, or “AIF”. The concept of “AIF” is very broadly discussed in further detail in the frequently defined and includes almost any investment fund, asked questions (“FAQs”) and answers below. requirements of the new fund marketing whether closed or open ended and however structured, rules; other than regulated retail funds. A. What are the key steps that non-EU (4) monitor how the AIFMD is fund managers must take now to prepare 3 The Member States of the European Economic Area for the implementation of the AIFMD? implemented in the relevant EU are: the 27 Member States of the European Union Member States (including whether a (Austria, Belgium, Bulgaria, Cyprus, Czech Republic, Non-EU fund managers that may be Denmark, Estonia, Finland, France, Germany, relevant EU Member State provides for a Greece, Hungary, Ireland, Italy, Latvia, Lithuania, marketing non-EU funds in the EU in the “transitional” regime); and near future must take five key steps right Luxembourg, Malta, Netherlands, Poland, Portugal, (5) prepare the necessary compliance Romania, Slovakia, Slovenia, Spain, Sweden and the away, if they have not already done so. The procedures, which in most cases (unless United Kingdom), together with Iceland, Liechtenstein Effective Date of the AIFMD is July 22, and Norway. Croatia will become the 28th Member a transitional regime applies) will involve 2013. State of the European Union on July 1, 2013. satisfaction of new disclosure obligations Specifically, a non-EU fund manager References in these FAQs to “EU Member States” (or the and compliance with new “no asset equivalent) are references to the Member States of the stripping” rules. European Economic Area, from time to time. 5 The application of the AIFMD to EU-based alternative investment fund managers, and to non-EU 4 As many as 16 EU Member States have not yet managers managing funds organized under the laws published draft AIFMD implementing legislation. Some of an EU Member State (e.g., a private equity fund or EU Member States (including Italy and Norway) are hedge fund organized as an English limited partnership) unlikely to implement the AIFMD into national law by in the EU, differ from those outlined in this article. We the Effective Date. would be happy to discuss those rules with interested CONTINUED ON PAGE 12 clients.

Spring 2013 l Debevoise & Plimpton Private Equity Report l page 11 How Will the AIFMD Impact Non-E.U. Fund Managers? (cont. from page 11)

B. Does the AIFMD apply to non-EU Each EU Member State is required States. If, however, a country changes its fund managers that only manage non-EU to adopt legislation incorporating the private placement regime (which Germany funds? AIFMD’s requirements in that country by has done), the non-EU fund manager will Yes, the AIFMD applies to non-EU fund the Effective Date. Although the AIFMD be required to comply with the new regime 7 managers marketing non-EU funds to sets forth certain basic, uniform principles, in that country. See question E below. “professional investors” in the EU. the details of implementation are left to the In addition, a non-EU fund manager The AIFMD applies to fund managers Member States. These details can differ marketing a non-EU fund in the EU will based in the EU, to non-EU fund managers from country to country. The Member be required to comply with the AIFMD’s managing EU funds, and to non-EU States and their regulators have adopted–or new disclosure and “no asset stripping” funds marketing its funds in the EU. are expected to adopt, because at the time requirements. See questions F and G These FAQs discuss the application of the this article is being published not all EU below. Even these new AIFMD rules may AIFMD to non-EU managers marketing Member States have adopted AIFMD not apply in limited circumstances where a non-EU funds to professional investors in implementing legislation–somewhat transitional regime applies. See question H the EU Member States. different approaches to implementation. below. Professional investors include large This means that the impact of the AIFMD Stages two and three of the pension plans (and other undertakings) and will not necessarily be consistent across the implementation of the AIFMD are institutional investors. A natural person EU. discussed at question I below. will only be considered a “professional D. Initially, how will the AIFMD apply to E. Will non-EU fund managers be able investor” in limited circumstances. non-EU fund managers marketing non- to market non-EU funds in the EU in Different regulatory regimes apply to non- EU funds in the EU? the same way after the Effective Date as professional (retail) investors. before the Effective Date? From the Effective Date until at least the C. Does the AIFMD impose consistent fourth quarter of 2015, non-EU fund Not necessarily. Under the AIFMD, non- marketing rules across the EU for non-EU managers generally will be able to (continue EU fund managers may continue to market fund managers marketing non-EU funds? to) market their non-EU funds in the their non-EU funds in reliance on national No, because each EU Member State has EU in reliance on local private placement private placement regimes after the Effective its own private placement regime and its regimes, subject to new AIFMD disclosure Date. However, it is possible for an EU regulator may take a different approach to requirements and “no asset stripping” rules. Member State to change its laws to add implementing the AIFMD. However, some EU Member States may new and more onerous requirements that change their national private placement regimes. CONTINUED ON PAGE 21 The first stage of the (three-stage) The bottom line for non-EU AIFMD regime begins on the Effective 7 In addition, the AIFMD requires that appropriate fund managers wishing to Date. In general, from July 22, 2013 until cooperation agreements, intended to help regulators market non-EU funds… in the fourth quarter of 2015 (and possibly oversee potential systemic risk, be in place between regulators in the relevant EU Member States and the EU is that, for the period until a later date),6 a non-EU alternative regulators in the jurisdictions in which the fund and from the Effective Date until investment fund manager may (continue the fund manager are established. On May 22, 2013, at least the fourth quarter of to) market non-EU funds to professional forms of cooperation agreements were agreed to by 2015, the AIMFD will require investors in the EU so long as it complies ESMA and regulators in over 30 non-EU countries, with the various private placement regimes including the United States and the Cayman Islands. those managers (1) to comply While ESMA negotiated the forms of cooperation in effect in each of the relevant EU Member with new disclosure rules agreements centrally, the cooperation agreements are bilateral agreements that must be signed between (including extensive reporting 6 The dates for implementation of stages two and the regulator in the relevant EU Member State to regulators) and “no asset three are not yet known and are dependent on the and the regulator in the relevant non-EU country. stripping” requirements and European Securities and Markets Authority (“ESMA”) Theoretically, the regulator of an EU Member State making a positive recommendation that these stages may decide not to enter into a bilateral agreement (2) to continue to market should be implemented. The earliest that stage two with a particular non-EU jurisdiction. There is no their funds by complying with will be implemented is the fourth quarter of 2015. set date on which the bilateral cooperation agreements The earliest that stage three will be implemented is the will be signed. national private placement fourth quarter of 2018. regimes in the relevant EU Member States.… page 12 l Debevoise & Plimpton Private Equity Report l Spring 2013 Club Deal Class Action Survives Summary Judgment

The long-running antitrust class action ten private equity firms and JPMorgan to are “established and appropriate business litigation challenging club deals and certain allocate the purported market for large LBOs practices in the industry” and are beneficial other practices was recently downsized, but among themselves. to bidders “for a number of reasons that is still alive. A Boston federal judge’s March Plaintiffs contended, in opposing are unrelated to any alleged overarching decision in Dahl v. Bain Capital Partners, summary judgment, that the alleged conspiracy, including the fact that such LLC, et al. (on summary judgment motions) conspiracy affected transactions in which the partnerships minimize the cost and risk for allows plaintiffs to proceed to trial against target’s board solicited bids in an auction, each partner.” The judge also found that most defendants but narrows the grounds as well as other “proprietary” deals in which the “occasional inclusion of a losing bidder on which they may attempt to prove their the target negotiated with a single buyer or in a final deal” may have the same benefits “overarching conspiracy” theory, allegedly consortium of buyers, after which better and, “on its own, does not support an involving twenty-seven separate transactions. offers were solicited in a go-shop period. overarching conspiracy.” Similarly, frequent While allowing that claim to go forward, Plaintiffs alleged that the anticompetitive communications and the existence of quid the court made clear that it did not find agreement was carried out through a variety pro quo arrangements in terms of bringing anything inherently unlawful in joint of mechanisms: (1) “club deals,” in which a firm into a deal in return for later being bidding by different private equity groups. a pre-arranged group of firms bid together invited into one of its deals “does not tend Background in a group; (2) “quid pro quos,” in which to exclude the possibility that they are private equity firms purportedly agreed to acting independently across the relevant Club deals became a relatively common allocate acquisition opportunities among market” (the evidentiary standard needed phenomenon during the period from themselves to limit competition and ensure for a conspiracy claim to survive summary 2003 through 2007. While private equity that each firm was able to participate in judgment). firms justified them as a necessary element its share of the bids; (3) improper auction The court further found that “[e]ven of increasingly large transactions, which conduct, including communicating with where the evidence suggests misconduct were often beyond the capacity of most each other in breach of confidentiality related to a single transaction; there is private equity sponsors to pursue on their agreements and sharing price information; largely no indication that all the transactions own, some observers questioned whether and (4) refusing to “jump” each other’s the joint bids were being used to restrict CONTINUED ON PAGE 14 proprietary deals. During the second day of competition and thus reduce the prices hearings on the summary judgment motions, paid in acquisitions of public companies. after Judge Harrington expressed skepticism In late 2006, media reports indicated that The decision provides concerning the sufficiency of the evidence the Department of Justice was investigating a renewed warning that offered, the plaintiffs largely abandoned all whether joint bids violated the antitrust laws. of their arguments in support of the alleged private equity firms Although that investigation never led to any overarching conspiracy other than the claim must take great care in criminal or civil government proceedings, of an agreement not to jump a signed deal or the Dahl lawsuit was filed by private all communications, a deal where the price reached a pre-agreed plaintiffs in Boston federal court. The initial including emails, not to level. complaint was brought on behalf of former make statements that may public shareholders of nine corporations The Ruling create the impression that were the subject of joint bids. After The court’s ruling on the motions confirmed several years of discovery, plaintiffs’ current the wisdom of plaintiffs’ decision to focus (whether or not accurate) complaint challenges twenty-seven proposed on the alleged agreement not to jump that they have agreed acquisitions and seeks damages on behalf deals. Judge Harrington rejected plaintiffs’ with competitors not to of former shareholders of seventeen of the other proffered evidence of an overarching compete or otherwise acquired companies. The complaint alleges conspiracy, ruling that “joint bidding to restrict competition a single overarching conspiracy among and the formation of consortiums” [sic] beyond a particular transaction. Spring 2013 l Debevoise & Plimpton Private Equity Report l page 13 Club Deal Class Action Survives Summary Judgment (cont. from page 13) were, in turn, connected to a market- agreement not to jump announced deals Conclusion wide agreement.” Because the court had could be inferred. Judge Harrington Judge Harrington’s decision is consistent held, on a previous motion, that plaintiffs held that this evidence “tends to exclude with the limited number of other decisions were bound by their repeated allegations the possibility of independent action” addressing this issue, which have held that (through five amended complaints) of a and thus enabled plaintiffs to proceed to joint bids for public companies do not, in single overarching conspiracy, they were trial, but “solely on this more narrowly themselves, violate the antitrust laws. Such not permitted to go to trial on a changed defined overarching conspiracy.” He bids can have the procompetitive effect theory of separate conspiracies relating to therefore denied all defendants’ motions of allowing or encouraging more bidders individual deals. The one exception is a for summary judgment, except the motion to participate. However, coordinated claim against some defendants concerning of JPMorgan, as to which the evidence activity between competitors, especially the acquisition of HCA, which plaintiffs did not show that it was in the business agreements not to compete, may also have had alleged in a separate count. of bidding for target companies or had anticompetitive effects that render them Despite holding for defendants on all otherwise participated in the narrowed unlawful. The decision provides a renewed of these issues, the court found sufficient conspiracy. warning that private equity firms must evidence to let plaintiffs proceed to trial Because the plaintiffs narrowed their take great care in all communications, based on several pieces of evidence: theory following the briefing of the including emails, not to make statements (1) a statement by a TPG executive that motions, and the court accepted only this that may create the impression (whether “KKR has agreed not to jump our deal narrowed theory, the judge ruled that each or not accurate) that they have agreed with [to acquire Freescale Semiconductor] remaining defendant could file a separate competitors not to compete or otherwise since no one in private equity ever jumps renewed motion for summary judgment to restrict competition beyond a particular an announced deal” (emphasis added); “contending that the evidence does transaction. (2) the fact that none of the announced, not create a genuine dispute as to their Gary W. Kubek proprietary deals involved in the litigation participation in the more narrowly-defined [email protected] were ever “jumped” during the go-shop overarching conspiracy.” Those renewed period; (3) a Goldman Sachs executive’s motions are still in the process of being statement that “club etiquette prevail[ed]” briefed, so it remains to be seen whether in the Freescale transaction; and (4) several any of the claims will proceed to trial and, other similar statements from which an if so, whether the plaintiffs will prevail.

The IRS Has Been Busy (cont. from page 8)

address the use of the mechanism through (which typically flows through as capital of issues in certain contexts – such as the the audit process rather than published gain, dividends and interest) but will application of the tax to income flowing guidance. generally not apply to amounts received from non-U.S. corporations and treatment New 3.8% Medicare Tax from the “manager” (typically ordinary of various deductions and loss carryovers in compensation income or an allocation computing the net investment income As has been widely reported, a new 3.8% of management fees). In some cases the subject to the tax. As a result, there should “Medicare tax” went into effect on January proposed regulations may encourage hedge be plenty for your tax lawyer to talk to you 1 of this year. The tax applies to certain funds that do not generate significant about. types of investment income recognized by amounts of long-term capital gain to U.S. individuals and certain trusts and, in David H. Schnabel restructure their carried interest as a “fee” effect, increases their cumulative tax rate [email protected] rather than a partnership “profits interest.” on such income. For most private equity Vadim Mahmoudov While simple in theory, the proposed professionals, the tax will apply to the [email protected] regulations exceed 40 pages and raise a host professional’s share of the carried interest

page 14 l Debevoise & Plimpton Private Equity Report l Spring 2013 ALERT New Banking Guidance May Impact Leveraged Lending

In March 2013, the Federal Reserve following elements: capacity as part of the lender’s risk rating Board, the Federal Deposit Insurance • the proceeds are to be used for buyouts, analysis, including whether the borrower Corporation and the Office of the acquisitions or capital distributions; has the ability to fully amortize its senior Comptroller of the Currency (the secured debt, or repay a significant • total Debt to EBITDA would exceed “Agencies”) issued the final version portion (e.g., 50%) of its total debt, over 4x, or Senior Debt to EBITDA would of their new supervisory Interagency the medium term (i.e., 5-7 years) using exceed 3x, in each case without netting Guidance on Leveraged Lending free cash flow. The Guidance also takes cash against debt, or other defined (the “Guidance”). To the extent that the position that an acceptable leverage levels appropriate to the industry or the Guidance causes a tightening in level is 6x total debt to EBITDA or sector; underwriting policies at regulated banks, less, saying that a higher level “raises it could ultimately lead to a relatively • the borrower is recognized in the debt concerns” for borrowers in “most smaller role in the leveraged finance markets as a highly leveraged firm, industries.” Loans that do not meet these market for loans by regulated banks and characterized by a high debt-to-net criteria would be subject to additional a larger role for less regulated products worth ratio; and scrutiny and potential criticism by the and providers, including private funds. • the borrower’s post-financing leverage, applicable regulating Agency and, thus, To Whom Does as measured by its leverage ratios (for lending banks are apt to treat these the Guidance Apply? example, debt-to-assets, debt-to-net standards as bright line rules going forward. The Guidance is applicable to banks worth, debt-to-cash flow, or other In contrast to the Agencies’ proposed and other financial institutions that are similar standards common to particular guidance, the final Guidance clarifies regulated by the Agencies and engage industries or sectors), significantly that diligence and evaluation of in leveraged financing activities, and exceeds industry norms or historical financial sponsors is not mandated in is intended to update the Agencies’ levels. all instances but instead only when standards in light of the financial crisis The Guidance covers asset-based loans sponsors actually provide financial and the many changes in the leveraged that “are part of the entire debt structure support for a transaction (a relatively rare loan market in recent years. It replaces of a leveraged obligor.” occurrence). If a sponsor does provide the Agencies’ prior guidance in this While obviously relevant for banking such support, the Guidance requires area, which had been issued in 2001, institutions (which will need to review lending banks to analyze and monitor and is the final version of proposed and update their risk management policies the financial condition and historical guidance first released a year ago, having and underwriting standards in light of the performance of the particular sponsor been revised in response to numerous criteria established in the Guidance), the in transactions where the sponsor has comments submitted by industry Guidance also is likely to have broader provided a guarantee of a leveraged loan participants. implications for the leveraged lending that is relied on as a secondary source of The definition of “leveraged lending” market, and for financial sponsors and payment. under the Guidance would pick up their portfolio companies, which should most acquisition financing provided in note a few aspects of the Guidance in Conclusion connection with private equity buyouts. particular. The date for banks and other regulated Specifically, the Guidance indicates financial institutions to be in compliance What Does that a leveraged loan would commonly with the Guidance was May 21, 2013, the Guidance Require? contain some combination of the although we expect that there are Notably, the Guidance requires lenders to consider a borrower’s de-leveraging CONTINUED ON PAGE 16

Spring 2013 l Debevoise & Plimpton Private Equity Report l page 15 Alert: New Banking Guidance May Impact Leveraged Lending (cont. from page 15)

ongoing discussions with the Agencies providers of financing, such as private Guidance. regarding the exact timing of funds, as well as for less regulated David A. Brittenham implementation to allow for the financing products, such as high yield [email protected] necessary changes to internal processes, bonds. Such providers and products may Satish M. Kini such as revising credit and underwriting become a relatively more attractive [email protected] standards. While the full implications of alternative to bank-provided leveraged the Guidance and the resulting changes loans in future leveraged financing Christopher Rosekrans that will be made by regulated lending transactions, both in new transactions, [email protected] banks in response remain to be seen, it is and in refinancings of existing possible that the Guidance could lead to transactions, particularly those existing an increased role in the leveraged lending transactions that do not meet the market for unregulated (or less regulated) financial criteria outlined in the

Social Twist: Emerging ESG Policies (cont. from page 10)

ownership and engagement of portfolio currently directed at the industry, compliance with their policy upon the companies on ESG issues, by monitoring including SEC registration, SEC fund manager. Such policies would not the implementation of the ESG policy presence examinations and on-going be tailored to the specifics of the both at the fund level and with portfolio challenges associated with implementing particular fund investment program. In companies, and via reporting to fund Dodd-Frank, FCPA and UK anti-bribery addition, as a fiduciary to a fund with investors and maybe even the public on requirements, a relatively small number many investors that may have differing ESG initiatives, accomplishments and of fund managers, outside of a few views on ESG matters, a fund manager compliance. market leading private equity houses, may find itself in a conflict position Still, successful ESG integration is have devoted a lot of resources to date to trying to comply with different investor unlikely to be achieved if no further ESG considerations. Still, while not policies. Plus, broadly speaking, we have work is done beyond just the formal necessarily at the very top of the found fund investors to be amenable to adoption of a policy and the taking of industry’s “to do” list at the moment, the reviewing a fund manager’s existing ESG the concrete steps noted above. Rather, current status of the evolution of ESG policy and taking comfort from the the highest substantive impact of ESG standards seems to us to create a unique manager’s undertaking to use integration will likely be achieved by opportunity for the industry to burnish commercially reasonable efforts to senior management with a fund manager its image by working cooperatively in the comply with such policy. tailoring an ESG policy appropriate for development of sensible and palatable Erica Berthou the relevant funds and ensuring that standards in this sensitive area. Indeed, [email protected] such policy is adhered to at all stages we are increasingly seeing fund managers Peter M. Vaglio of the investment process. Some fund starting to think about these issues in [email protected] managers that are at the forefront of connection with upcoming fundraisings. these matters designate a special ESG We suspect it may become increasingly committee or an ESG compliance advantageous in the future for fund officer to oversee implementation of the managers to adopt a formal ESG policy ESG policy and train their investment in advance of entering into negotiations professionals in ESG evaluation. with fund investors on terms, because in Looking Forward the absence of a pre-existing policy (and perhaps even when a policy exists), While perhaps not surprising given all certain fund investors may try to impose the regulatory and political attention page 16 l Debevoise & Plimpton Private Equity Report l Spring 2013 UK Take Privates: Recent Changes to the Takeover Code

The UK Takeover Panel (the “Panel”) has that a bidder is now required to disclose its London Stock Exchange) or on any stock recently announced two sets of changes to plans for employer contributions to the target’s exchange in the Chanel Islands or the Isle be made to the City Code on Takeovers defined benefit pension schemes, including the of Man. The Takeover Code currently also and Mergers (the “Takeover Code”) (which current arrangements for funding any scheme applies to any offer for a public company that is the principal source of regulation for UK deficit. A bidder also has to state its intentions has its registered office in the UK, the Channel take private transactions). The first change, for the accrual of benefits for existing members Islands or the Isle of Man (but does not have which came into force on May 20, 2013, and the admission of new members. Where a its securities admitted to trading on a regulated requires a bidder to provide more disclosure bidder does not intend to make any changes in market in the UK, Channels Islands or Isle of of the impact of a proposed offer on the target relation to the schemes, it is required to make Man) where the company is considered by the company’s defined benefit pension schemes, a statement to that effect. The Panel may hold Panel to have its place of central management and allows the trustees to take a public position a bidder to these statements for at least a year and control in the UK, the Channel Islands or on the offer and obliges the bidder to follow after the end of the offer period. the Isle of Man. This central management and through with its statements of intent. These Any agreement between a bidder and control test is often referred to as the “residency will be followed on September 30, 2013 by the pension scheme trustees on future test.” Of particular importance to private an extension of the jurisdiction of the Panel to scheme funding arrangements will need to be equity bidders was that many public companies cover a broader range of public companies i.e., summarized in the firm offer announcement listed on AIM fell outside the jurisdiction of companies that are incorporated in the UK, the and in the offer document. The agreement will the Takeover Code because they did not satisfy Channel Islands or the Isle of Man and whose not need to be published on a website unless it the residency test. securities trade on a UK trading facility (such falls within the definition of a material contract The Panel has now announced that as AIM), in addition to such companies whose of the bidder under the Takeover Code, in changes to the Takeover Code, to come into securities trade on a regulated market.1 which case publication will be required. force on September 30, 2013, will remove the Changes to Pension Scheme The bidder and the target are required to residency test in respect of companies with Trustee Rights: Key Points make all documents that have to be provided their registered office in the UK, the Channel to the target’s employee representatives also Islands or the Isle of Man whose securities are These changes to the Takeover Code apply available to the pension scheme trustees, and admitted to trading on a multilateral trading only to defined-benefit schemes (not to money pension scheme trustees have the right to have facility in the UK (such as AIM or the ISDX purchase or defined contribution schemes) their opinion on the impact of the offer on the Growth Market). Companies which meet and are designed to provide a target company’s pension schemes published. the registered office requirement but whose pension scheme trustees with similar rights It is worth noting that these changes do securities are not admitted to trading on any to those of the target company’s employee not give the pension scheme trustees or the market in the UK will continue to use the representatives. The Panel intends the changes Pensions Regulator (the UK statutory body residency test to determine whether or not the to create a framework in which the effects of with responsibility for all work-based pension Takeover Code applies. an offer on a target’s defined benefit pension schemes) the right to approve or disapprove This will also mean that private equity schemes can become a negotiated point during of the offer. These and various other changes funds listed on AIM, which have in some cases the course of an offer. that would have strengthened the negotiating been able to take the view that they are not The key impact of the changes to the position of the pension scheme trustees were subject to the Takeover Code, will no longer be Takeover Code for private equity bidders is considered but not implemented. able to do so once these changes come into Changes in the Companies force. 1 A regulated market is one that has been designated David Innes as such under certain European legislation and Subject to the Takeover Code – included on a list maintained by the FCA. These Key Points [email protected] include, amongst others, the Main List of The London The Takeover Code applies to any offer for a Geoffrey P. Burgess Stock Exchange, Main Board of the ICAP Securities public company that has its registered office and Derivatives Exchange (“ISDX”) and the London [email protected] in the UK, the Channel Islands or the Isle Metal Exchange. Other UK-based markets or trading Guy Lewin-Smith facilities, such as AIM or the ISDX Growth Market, of Man, if any of its securities are traded on [email protected] which are not on this list, are not “a regulated market.” a regulated market in the UK (such as the Spring 2013 l Debevoise & Plimpton Private Equity Report l page 17 Tender Offers Poised to Become an Acquisition Structure of Choice (cont. from page 1)

the SEC prior to launch of a tender offer, Another benefit of the tender offer strategic acquirers, have often been whereas the acquirer in a one-step merger structure is that the disclosure documents reluctant to pursue two-step financed must pre-file a proxy statement, often wait are generally less burdensome to prepare acquisitions of public companies due to 30 days or more for SEC comments, then than a proxy statement. For instance, concerns relating to the federal margin provide responses and sometimes rinse full audited financial statements of the rules, which prohibit loans to a shell and repeat several times. Once the review target are required in a proxy statement, acquisition vehicle if directly or indirectly process is over, a merger proxy must be but are not typically required in a tender secured by margin stock with a value in mailed to stockholders at least one month offer where the consideration is all cash. excess of 50% of the amount of the loan. If in advance of the stockholder meeting. Not surprisingly, this faster and more the sponsor was able to close the back-end By comparison, once launched, a tender streamlined process also tends to result in merger simultaneously with the closing offer is required to remain open for just lower transaction costs. of the tender offer by reaching the 90% twenty business days, and the waiting So What’s the Rub? threshold, the loan would not be deemed period under the Hart-Scott-Rodino secured by margin stock, but rather by the You may now be asking yourself why Antitrust Improvement Act of 1976, which assets of the surviving company. But if anyone would ever choose the one-step is generally thirty days, is shortened to it did not reach the 90% threshold, and merger structure. Well, the answer only 15 days. Thus, a successful bidder thus had to pursue a long-form back-end is that, historically, there was a real in a tender offer can usually acquire merger, the sponsor would run a real risk stumbling block with the tender offer control of a target in a little over a month, of violating the margin rules, because approach, which was the need to acquire whereas a typical one-step merger can the margin stock would be the only at least 90% of the outstanding shares in take three or four months, during which available collateral for the loan. Although order to effect a second-step, short-form time the pending transaction is exposed some workarounds have been developed merger to squeeze out the remaining to competing bidders who can disrupt or over time, they present a number of stockholders of the target. This can be derail the deal. Other risks, such as those complications and are not available in all a difficult threshold to reach even in a associated with financing and MAE, can be circumstances. deal with broad stockholder support due eliminated in the two-step structure if the While tools such as top-up options and to the fact that it is often hard to get the back-end merger can be closed at the same dual track structures have been developed attention of retail stockholders, never time as the tender offer. to mitigate some of the issues presented mind that achieving such a high threshold by the tender offer approach, they are can be quite challenging where there is clunky and imperfect. A top-up option any stockholder ambivalence about the allows the bidder to buy shares directly Section 251(h) would deal. If a bidder does not reach the 90% from the target in an effort to “top up” threshold, it then has to proceed with all the bidder’s post-tender offer ownership allow a sponsor to launch of the steps that would have been needed to 90%. However, because of the way to effect a long-form merger, including a financed tender offer the math works, the target may not have filing a full proxy statement and calling a enough shares authorized under its charter conditioned on valid stockholder vote, which of course results to move the needle significantly. For in an even longer transaction timeline than example, if a bidder in a tender offer tenders of only a majority if the parties had simply begun with a obtains 70% of the outstanding shares long-form merger. And it is all somewhat of the target’s stock at the completion of the offer, the target meaningless because the bidder will have would need to issue to the bidder twice already obtained control of the target (and without worrying that as many shares as the total outstanding thus the stockholder vote) through the in order for the bidder to reach the 90% the margin rules would tender offer, so the outcome of the second- threshold. See “The Tender Offer Returns: step merger is a foregone conclusion. What Does It Mean for Private Equity” in prevent it from closing Despite the benefits of speed and our Winter/Spring 2007 issue and “Speed the offer if it cannot lower costs, private equity buyers, unlike CONTINUED ON PAGE 19 reach the 90% threshold. page 18 l Debevoise & Plimpton Private Equity Report l Spring 2013 Tender Offers Poised to Become an Acquisition Structure of Choice (cont. from page 18) is King: Pointers and Pitfalls on Sponsor- already own 15% or more of the target’s withdraw their shares at any time, allowing Led Tender Offers” in the Spring 2011 stock. more time for interlopers or activists to issue for background on the use of tender Thus, Section 251(h) would allow a appear. By contrast, there is no such need offers by sponsors. sponsor to launch a financed tender offer to wait to conduct a stockholder vote, In a so-called dual track structure, the conditioned on valid tenders of only a which, if successful, would effectively bidder runs a tender offer and a one-step majority of the target’s stock without cut off any further opportunity for a merger process in parallel, so that if the worrying that the margin rules would third party to upset the deal or for the 90% threshold is not reached, it can drop prevent it from closing the offer if it cannot stockholders to change their minds, as the the tender offer in favor of a one-step reach the 90% threshold. The new rule “fiduciary out” would fall away at that merger process that is already well along. would therefore help level the playing field point. The deal could then close as soon as However, there are, of course, incremental for sponsors competing for assets with regulatory approval is obtained. costs to this approach, and it is not clear strategic buyers and make tender offers Another timing concern relates to that the SEC is fully comfortable with it. a more attractive acquisition structure the acquisition financing itself. It may Moreover, this structure will obviously not generally. simply not be feasible to complete the allow the bidder to gain control of a target contemplated financing process within the as quickly as a tender offer followed by a Have We Seen the Last twenty business-day period that the tender short-form merger in the event that the of One-Step Mergers? offer remains open, particularly where the 90% threshold is not reached. Adoption of the new rule does not mean, financing is marketed. However, it may however, that tender offers will all of a Section 251(h) to the Rescue well be possible to complete the process sudden become the weapon of choice within a period that is shorter than the Many of these issues would be swept for sponsors in all circumstances. For 2-3 months required for a one-step merger away by proposed Section 251(h) of the one thing, by its terms, Section 251(h) process. In this case, the parties might Delaware General Corporation Law, would not be available to buyers who pursue a tender offer, but negotiate the which is expected to be adopted and made own, together with their affiliates, 15% or circumstances under which the offer is effective as of August 1st of this year. If more of the target. This limitation could automatically or voluntarily extended to adopted, a bidder for a public Delaware have consequences in particular in the accommodate the financing. While an corporation would be able to consummate context of a management buyout where abbreviated transaction timeline may limit a short-form merger without a stockholder management and the bidder together hold the buyer’s ability to manage entry into the vote if the following criteria are met: more than 15% of the target’s stock. In financing markets, even with a long-form • the bidder completes a tender offer addition, where lengthy periods of time merger there is often a limited window in for any and all outstanding stock, and may be required to obtain regulatory which to conclude the marketing period following completion, holds at least the approvals, tender offers do not provide (unless the financing is closed into escrow, number of shares required to approve a much, if any, benefit to the bidder, since which presents its own complications and merger (a majority of the outstanding the deal cannot close within the twenty costs). shares, unless the target’s charter specifies business-day period in any event. * * * a higher threshold); Indeed, in a deal where a long period Ultimately, Section 251(h) will go a long between signing and closing is expected • the merger agreement expressly provides way in making tender offers a more (either due to regulatory reasons, holiday that the merger will be governed by the attractive deal structure for private equity financing blackouts or otherwise), a one- new rule and that the back-end merger buyers of public Delaware companies. step merger may be preferable to a tender will be effected as soon as practicable However, sponsors should not discard offer. A tender offer would need to be following the completion of the tender long-form mergers from the toolkit extended again and again until regulatory offer; and altogether as regulatory approvals and approval was finally obtained permitting financing considerations may make that • the bidder is not an “interested the bidder to close the offer. During old standby preferable in certain cases. stockholder” under Delaware law, which that extended period, stockholders who Andrew L. Bab generally means that the bidder does not tender would continue to have the right to [email protected]

Spring 2013 l Debevoise & Plimpton Private Equity Report l page 19 Dividend Recaps: Used With Care, a Useful Tool (cont. from page 4)

after it was originally paid. the company was insolvent at the time of, grow as anticipated; the macroeconomic Applicable Legal Standards or rendered insolvent by, the transaction, situation deteriorates; or unexpected . . . Why It All Boils Down to and (b) the transfer in question was made litigation or other claims arise – that the “Solvency” for less than reasonably equivalent value. portfolio company will enter a bankruptcy Because shareholders receiving a dividend or workout, which in turn may spur Challenges to Officer and Director get cash without making an equivalent unsatisfied creditors to pursue litigation. Decision-Making transfer to the company (satisfying the As a matter of law, courts generally To successfully sue directors and officers second element), the only real U.S.-law should evaluate both director decision- over a dividend recap, creditors must defense to a clawback challenge is to prove making and questions related to fraudulent generally show as a threshold matter that that the company was solvent at the time of conveyance from the perspective of what the company was insolvent at the time the dividend. While standards outside the was known or anticipated at the time of the of, or was rendered insolvent by, the U.S. may be more forgiving, it is fair to say transaction. Practically speaking, however, dividend recap. Under the laws of most under most jurisdictions that the ability to it can be difficult for a court to ignore the states, this is a factual predicate for alleging prove solvency at the time of transfer is a very fact of the portfolio company’s failure that a dividend was illegal or improper. key element of defending a dividend. in evaluating whether it was solvent at the For example, Delaware law requires time of a dividend recap. Hindsight bias that corporations pay dividends to their What is the Best Way to is not limited to Monday mornings. For shareholders only from capital “surplus”: in Demonstrate Solvency? example, if projections were not met, that essence, the fair value of assets less liabilities, In evaluating solvency, courts generally may influence a judge’s view as to whether less stated capital (this last item is often a de consider: they were reasonable in the first instance, minimis amount). • Whether the fair value of a company’s or whether they were properly stress-tested. Insolvency or near-insolvency at the assets exceeded its liabilities (including Similarly, if asset values at the time of time of the transaction is also a requirement stated liabilities and identified contingent challenge are below book value, the judge for creditor claims that directors and liabilities); may question whether the fair value was officers breached fiduciary duties. Courts overstated at the time of the transaction. in most U.S. states hold that directors and • Whether the company should be able For this reason, when planning a dividend officers have no duties to creditors, unless to satisfy its debt obligations – related to recap, the parties should be sure to and until the corporation is insolvent or, existing debt as well as to any new debt construct a careful factual record, designed in some states, near-insolvent. Similar incurred as a result of the transaction – as to withstand later litigation scrutiny, solvency-based constructs apply in many those debts mature; and demonstrating that the transaction was jurisdictions outside the United States. • Whether the company should have appropriate at the time it was entered into. To defend against these types of claims a reasonable level of surplus capital after the fact, it is therefore crucial that following a leveraged transaction to Best Practices for Director, directors and officers be able to demonstrate provide downside protection in the case Officer and Shareholder solvency at the time of the transaction. of deteriorating business conditions. Protection While there are no silver bullets in this Clawback/Fraudulent Conveyance An unfortunate reality in defending context, there are a few simple steps that Challenges litigation claims related to dividend recaps directors, officers and shareholders can Creditors may also attempt to unwind is that lawsuits occur only after something take to mitigate the risk of a court second- a dividend recap transaction – thereby has gone unexpectedly wrong. If all goes guessing a dividend recap transaction. clawing back the dividend – by alleging as planned and the portfolio company it was a fraudulent conveyance under the performs as projected, it will repay or Make a Clear, Contemporaneous Record United States Bankruptcy Code, applicable refinance its funded debt and honor other of the Decision-Making Process state laws (i.e., the Uniform Fraudulent creditor claims in the ordinary course, If a dividend recap is challenged in Conveyance Act) or equivalent provisions and the dividend recap will never be hindsight following a restructuring, it will under non-U.S. law. challenged. It is only if there is a problem be invaluable for defensive purposes to Under U.S. law, to claw back a – e.g., the company’s asset value declines have a clear record that the directors and payment, the creditor must show that (a) to below book value; EBITDA fails to CONTINUED ON PAGE 21 page 20 l Debevoise & Plimpton Private Equity Report l Spring 2013 Dividend Recaps: Used With Care, a Useful Tool (cont. from page 20) officers engaged in a careful, deliberative support – with the imprimatur of a well entity, care should be taken to document process before approving the transaction. respected outside expert – the officers’ the relevant facts and board deliberations Board minutes should reflect that directors and directors’ decision to enter into the as to each entity’s solvency, its business considered the company’s solvency both transaction. A contemporaneous solvency purpose in participating in or facilitating before and after the transaction, articulated opinion is a foundation for the directors’ the transaction, and the benefit that it will a clear business purpose for the action, and belief that the dividend was paid from receive for any value (including liens and determined, based on contemporaneously the company’s balance sheet surplus, guarantees) it is transferring as part of the available information including well- thus deflecting illegal-dividend claims. A deal. vetted projections, that there should be a solvency opinion also provides important * * * reasonable level of surplus capital following contemporaneous evidence that the While there is no perfect protection against the dividend recap to provide downside company was solvent at the time of the litigation risk if a portfolio company fails protection in event of a downturn. transaction, thus helping to defeat clawback after a dividend recap transaction, following Directors and officers will be best protected claims and fiduciary duty claims for the best practices at the time of the transaction if the record shows they consulted outside reasons described above. can significantly improve litigation professionals, carefully reviewed the Cover Every Borrower/Guarantor outcomes. As the current open credit cycle available information, asked questions, and Subsidiary (hopefully) continues, private equity firms had plenty of time to consider the issues In most dividend recap transactions, will no doubt continue to view divided (for example, by receiving board materials multiple corporate entities will be involved, recaps as attractive partial-exit well in advance and by holding more than whether as borrowers or as guarantors opportunities, but would be well-advised to one meeting to discuss the transaction). of the new debt obligations or as entities use them with care. Get a Solvency Opinion through which the dividend will pass. M. Natasha Labovitz Although a solvency opinion cannot in Litigation claims may arise with respect [email protected] to not only the primary corporate holding and of itself ensure against future financial Daniel E. Stroik company, but also any other participating distress (or provide a complete litigation [email protected] shield if such distress ensues), it can affiliates. Thus, for every participating

How Will the AIFMD Impact Non-E.U. Fund Managers? (cont. from page 12) must be satisfied before a fund manager placement regimes, in one form or another, German transitional regime applies). The may rely on its national private placement at least until such time as non-EU fund new German regime will make marketing regime, and Germany has already done managers are able to apply for an AIFMD of funds by non-EU fund managers to this. Also, a non-EU Member State could marketing passport (which would be in the professional investors in Germany more withdraw (repeal) its national private fourth quarter of 2015 at the earliest). difficult than is currently the case. placement regime altogether. Subject to It is possible for an EU Member State Because the AIFMD does not require EU any available transitional regimes, non- to change its national private placement Member States to retain their national EU fund managers will also be subject regime, for example by adding new and private placement regimes, it is also possible to the disclosure and “no asset stripping” more onerous requirements, and Germany for an EU Member State to withdraw requirements described in the answer to the is an example of an EU Member State its national private placement regime next question. that has done so. Germany has used completely before the date when non- The AIFMD allows EU Member the implementation of the AIFMD EU fund managers are able to apply for States to keep their existing national private into national law as an opportunity to AIFMD marketing passports (in the fourth placement regimes in place until the significantly re-write its national private quarter of 2015 at the earliest). Were an fourth quarter of 2018 (or possibly later), placement regime. The modified German EU Member State to do this, non-EU fund although it does not require that they do national private placement regime will managers would not be able to market their so. The hope and expectation is that most apply from July 22, 2013 (or July 22, EU Member States will retain their private 2014, for certain fund offerings if the CONTINUED ON PAGE 22

Spring 2013 l Debevoise & Plimpton Private Equity Report l page 21 How Will the AIFMD Impact Non-E.U. Fund Managers? (cont. from page 21)

funds in that country at all (as compared arrangements. comply not only with the disclosure and to AIFMD authorized EU fund managers, Third, the fund manager must regularly “no asset stripping” rules described above, which may obtain marketing passports as report certain matters, such as information but also with additional AIFMD duties and early as the Effective Date). on aggregate assets under management, obligations including the appointment of fund-level leverage and the main categories depositaries meeting specified standards (per F. In addition to possible burdens that might be imposed by changes to national of assets in which its fund is invested, to fund), obtaining independent valuations private placement regimes, what are the the regulators in the relevant EU Member (per fund), meeting regulatory capital most important new requirements that States. These reporting obligations will requirements and implementing certain the AIFMD imposes on non-EU fund require fund managers to gather and report systems and controls (including with respect managers? a significant amount of detailed information to compensation of employees). to EU regulators and, at least initially, Subject to any available transitional regimes, G. Will non-EU fund managers be beginning on the Effective Date non- are likely to be the most onerous of the subject to the remuneration provisions of EU fund managers marketing non-EU AIFMD disclosure requirements. the AIFMD? Fourth, where its fund acquires control funds in the EU will be subject to new Only in part. Non-EU fund managers disclosure requirements and to new “no (greater than 50% of the voting rights) of an EU portfolio company, the fund initially will be required by the AIFMD to asset stripping” requirements applicable disclose certain compensation information to control investments in EU portfolio manager must disclose certain matters (such as information on the financing of the in their annual reports. Fortunately, non- companies. EU fund managers will not be subject, Subject to any transitional regimes (see acquisition of the portfolio company) to the regulators in the relevant EU Member initially, to the AIFMD’s guidelines and question H below) and beginning on the requirements concerning compensation Effective Date, non-EU fund managers will States and to the EU portfolio company (with the request that information be passed (including deferral of a portion of variable be subject to new disclosure obligations if compensation). they market funds in the EU. These new on to the company’s shareholders). In addition to these disclosure Until a non-EU fund manager obtains disclosure obligations are summarized as an AIFMD marketing passport (in the follows. requirements, non-EU fund managers will be subject to certain “no asset stripping” fourth quarter of 2015 at the earliest), the First, the fund manager must prepare only impact of the AIFMD’s remuneration an annual report for each fund that was requirements. In broad terms, when a fund acquires control (greater than 50% of the provisions will be to require the fund marketed in the EU after the Effective Date manager to disclose certain compensation no later than six months following the end voting rights) of an unlisted EU portfolio company, the non-EU fund manager information if it markets a fund in the EU of the fund’s financial year. The annual after the Effective Date. report must be provided to investors on will be required to use its best efforts to prevent distributions, capital reductions, Specifically, a non-EU fund manager request and made available to the regulators will be required to disclose in its annual in the relevant EU Member States. Most share redemptions and/or the acquisition of its own shares by the portfolio company, report (see question F above) the following importantly, the annual report must contain information: certain prescribed information, including unless (1) any resulting payments to disclosure of certain compensation effect a distribution to shareholders will (1) the total remuneration for the financial information. See question G below. be made out of distributable profits and year, split into fixed and variable Second, the fund manager must (2) after giving effect to the distribution, remuneration, paid by the fund 8 provide specified information to prospective the portfolio company’s net assets would manager to its staff, and the number of investors prior to their investment in the remain at or above the level of subscribed staff who received such remuneration; fund, typically in the private placement capital plus non-distributable reserves. memorandum (or a supplement thereto) Note: Once authorized as an CONTINUED ON PAGE 23 of the fund being marketed. A standard “alternative investment fund manager” 8 The concept of “staff” has been broadly construed offering document ordinarily contains most (on July 22, 2013 at the earliest), an EU fund manager that manages one or more by ESMA and is not limited to employees of the fund of the information that will be required manager. The concept extends to those individuals by the AIFMD, although there may need EU-based funds will be subject to greater whose services are made available to the fund manager to be enhanced disclosure around certain regulation than non-EU managers. Such and includes the staff of entities to which portfolio matters, including in respect of side letter EU fund managers will be required to management or risk management activities have been delegated by the fund manager. page 22 l Debevoise & Plimpton Private Equity Report l Spring 2013 How Will the AIFMD Impact Non-E.U. Fund Managers? (cont. from page 22)

(2) to the extent that the information exists guidance is made available, it is likely to I. Looking further down the road, what or is readily available, whether the be quite difficult in practice to apply these should non-EU fund managers know total paid remuneration relates to the remuneration guidelines. about the second and third stages of the entire staff of the fund manager or only AIFMD? H. Have any EU Member States adopted to those staff who are fully or partly transitional regimes that mitigate the The questions and answers above relate to involved in the activities of the fund, impact of the AIFMD? the first stage of the AIFMD. It is not too as well as the total remuneration paid early, however, for alternative investment Yes, the United Kingdom and Germany to the staff of the fund manager that is fund managers to begin to consider with are proposing to adopt transitional regimes attributable to each fund; their advisers the impact of the second and (transition or “grandfathering” rules) that third stages of the implementation of the (3) the total remuneration for the financial provide limited relief from the AIFMD’s AIFMD. year, split into fixed and variable requirements for funds being marketed in In stage two, beginning in the fourth remuneration, paid by the fund certain ways before the Effective Date. quarter of 2015 (or possibly later), the manager to senior management and The United Kingdom is proposing to AIFMD provides that a non-EU fund members of staff of the fund manager adopt a transitional regime that exempts a manager has the option to obtain a whose actions have a material impact on non-EU fund manager from the AIFMD’s “marketing passport.” The AIFMD the risk profile of the fund; disclosure and “no asset stripping” marketing passport would allow the requirements, until July 21, 2014, with (4) where relevant, any incentive allocation fund manager to market its funds to respect to any non-EU fund that the non- or carried interest distributed by the professional investors throughout the EU fund manager has marketed anywhere fund; and EU, without being required to satisfy the in the EU prior to the Effective Date. The (5) a general description of the financial different requirements of the national current position being taken by the UK and non-financial criteria of the fund private placement regimes that apply in regulator is that “marketing” of a fund for manager’s compensation policies and the countries where the funds are being this purpose begins on the distribution of practices for relevant categories of marketed. To hold a marketing passport, a near final forms of the fund’s constitutional staff, so that investors may assess the non-EU fund manager would be required documents (e.g., its limited partnership incentives created. to comply in full with the requirements agreement and subscription agreement) to of the AIFMD. These requirements Aside from disclosure and until such time as any investor in the EU. Distribution of include appointing depositaries meeting it obtains an AIFMD marketing passport, only a private placement memorandum in specified standards (per fund), obtaining a non-EU fund manager is not required to the EU is not considered marketing for this independent valuations (per fund), meeting have any particular compensation policies purpose. regulatory capital requirements and or procedures in place. Germany has its own transitional implementing certain systems and controls Note: EU fund managers will be regime. The proposed German transition (including with respect to compensation of required to comply with the disclosure rules would permit a non-EU manager the fund manager’s staff). Alternatively, a obligations described above, and in addition to market a non-EU fund in Germany in non-EU fund manager that does not wish will be required to comply with all other reliance on the existing German private to satisfy the requirements imposed by AIFMD duties and obligations, including placement regime (not the more onerous the AIFMD as a condition to obtaining a the requirement to adopt remuneration regime that goes into effect on the Effective marketing passport may continue to rely on policies that satisfy the AIFMD guidelines. Date), and without have to comply with the national private placement regimes until These remuneration policies must be the AIFMD’s disclosure and “no asset the fourth quarter of 2018 (or possibly consistent with and promote sound and stripping” rules, until July 21, 2014, if longer), but only to the extent that national effective risk management and, in addition the non-EU manager marketed the fund private placement regimes are retained in of other matters, require at least 50% of in Germany prior to the Effective Date. the EU Member States where the fund variable remuneration to consist of non- In Germany, the current position is that manager will be marketing its funds. cash instruments and at least 40% of marketing of a fund is considered to have In stage three, beginning in the fourth variable remuneration to be deferred over begun as soon as the fund’s final private quarter of 2018 (or possibly later), a non-EU at least a three to five year period. Until placement memorandum is distributed to a fund manager will only be able to market its market practice develops and additional single German investor.

CONTINUED ON PAGE 24

Spring 2013 l Debevoise & Plimpton Private Equity Report l page 23 How Will the AIFMD Impact Non-E.U. Fund Managers? (cont. from page 23)

funds to professional investors in the EU if it may show a bias towards investing in and the other fund being managed by a holds an AIFMD marketing passport. EU-based funds (although these investors new manager (and being marketed to EU are most likely to be the same group investors pursuant to the AIFMD) – seem J. Should non-EU fund managers restructure themselves or their funds in of investors that already raise concerns premature for most non-EU fund light of the AIFMD? about investing in Cayman Islands and managers, given the added complexity and Channel Islands funds). If this pattern cost, and the limited advantage, of For most non-EU fund managers, the emerges (and depending on the types modifying existing structures. Restructuring answer at this stage is likely no, although of investor and the size of their likely may become a more attractive option from the business objectives and structure of investments), consideration may need to be 2015, however, when the acquisition of an a particular fund manager may lead to a given to incorporating an EU-based fund AIFMD marketing passport would have the different answer. Also, restructuring may (potentially managed by an EU-based fund consequence of requiring full compliance become a more attractive option in the manager) into the overall fund structure. with the AIFMD. future when, for example, acquisition of Other forms of restructuring – an AIFMD marketing passport (and full Sally Gibson including, for example, the establishment of compliance with the AIFMD) becomes [email protected] a parallel fund structure, with one fund necessary or desirable (see question I above). being managed by the existing manager Michael P. Harrell It is possible that, after implementation (and not being marketed to EU investors) [email protected] of the AIFMD, some European investors

Recent and Upcoming Speaking Engagements

April 11-12, 2013 May 14, 2013 June 6-7, 2013 Geoffrey Kittredge Nicholas F. Potter Kevin M. Schmidt Matthew D. Saronson “Recent Trends in Offshore M&A” Judith L. Church “Ensure the Right Terms: Making Both Parties 2013 Cross Border M&A Summit Acquiring or Selling the Privately Held Company Happy – Term Sheets and Fund Structuring/ The M&A Advisor 2013 Regulatory Changes Impacting Fundraising Efforts” New York Practising Law Institute GP Masterclass: Fundraising and Best Practices New York African Private Equity and Venture Capital May 16, 2013 Association Raman Bet-Mansour June 11, 2013 Cape Town “Sponsor-backed IPOs: IPO Exits of Portfolio David H. Schnabel Companies” “‘Topside’ Planning for Private Equity and Hedge April 24, 2013 Chambers and Partners General Counsel Seminar Fund Investments” Stephen R. Hertz London Tax Planning for Domestic and Foreign David Innes Partnerships, LLCs, Joint Ventures and Other Choices of Law in Acquisitions Agreements: May 16, 2013 Strategic Alliances 2013 U.S. vs. UK Marwan Al-Turki Practising Law Institute Practising Law Institute Peter A. Furci San Francisco New York Geoffrey Kittredge “Legal Strategies: Balancing GP Interests and July 9, 2013 April 26, 2013 Maintaining Competitive and Marketable Kenneth J. Berman Michael P. Harrell Positioning to LPs” “Monitoring Compliance at Private Equity Firms: “Private Equity Investing and Beyond” EMPEA EM PE Fundraising Masterclass Issues for CCOs” American College of Investment Counsel Washington, DC Fourteenth Annual Private Equity Forum Spring Investment Forum Practising Law Institute Chicago May 20, 2013 New York Lord Goldsmith May 8, 2013 Christopher L. Tahbaz David A. Brittenham, Co-Chair Philip Rohlik “Leveraged Financing Today” “Risk Management in Private Equity Transactions Jeffrey E. Ross in China” “Drafting in Leveraged Finance” China World Summit Wing 2013 PLI Leveraged Finance Conference Beijing Practising Law Institute Debevoise & Plimpton/Fangda Partners New York

page 24 l Debevoise & Plimpton Private Equity Report l Spring 2013