Legal & Regulatory Bulletin

Legal & Regulatory Bulletin 26

CONTENTS

4 EU General Data Protection Regulation: A Primer for Funds and Portfolio Companies

8 Permanent Capital Vehicles: Dealing with the Liquidity Quandary

11 Trends in Structuring India Focused Funds and LP-GP Negotiations

14 Disputes in Relation to Private Equity FALL 2018

Issue no. 26 | 26 no. Issue EMPEA Legal & Regulatory Bulletin | FALL 2018 1 About EMPEA EMPEA Legal & Regulatory Council

EMPEA is the global industry association Mark Kenderdine-Davies (Chair) Gordon Myers for private capital in emerging markets. An CDC Group plc IFC independent, non-profit organization, the Carolyn Campbell Peter O’Driscoll association’s membership comprises 300+ Emerging Capital Partners Orrick, Herrington & Sutcliffe LLP firms representing institutional investors, fund Antonio Felix de Araujo Cintra Chike Obianwu managers and industry advisors who together TozziniFreire Advogados Templars manage more than US$5 trillion in assets across John Daghlian Bayo Odubeko 130 countries. Our members share EMPEA’s belief O’Melveny & Myers Norton Rose Fulbright that private capital is a highly suited investment Mark Davies Paul Owers strategy in emerging markets, delivering attractive King & Spalding Actis long-term investment returns and promoting the sustainable growth of companies and Folake Elias-Adebowale George Springsteen Udo Udoma & Belo-Osagie IFC Asset Management Company economies. We support our members through global authoritative intelligence, conferences, Laura Friedrich Mara Topping Shearman & Sterling LLP White & Case LLP networking, education and advocacy. Geoffrey Kittredge Cindy Valentine For more information, visit empea.org. Debevoise & Plimpton Simmons & Simmons

Prakash Mehta Nigel Wellings Akin Gump Strauss Hauer & Feld LLP Clifford Chance

Publication Editorial Team Zia Mody Harald Zeiter AZB & Partners Capital Dynamics Ann Marie Plubell Vice President, Regulatory Affairs

Production Assistance

Ben Pierce Pierce Designers

© 2018 EMPEA. All rights reserved. The EMPEA Legal & Regulatory Bulletin is an EMPEA publication. Neither this publication nor any part of it may be reproduced, stored in a retrieval system, or transmitted in any form or by any means—electronic, mechanical, photocopying, recording or otherwise—without the prior permission of EMPEA.

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DISCLAIMER: This material should not be construed as professional legal advice and is intended To learn more about EMPEA or to request solely as commentary on legal and regulatory developments affecting the private equity a membership application, please send an community in emerging markets. The views expressed in this bulletin are those of the authors email to [email protected]. and not necessarily those of their firms. If you would like to republish this bulletin or link to it from your website, please contact Holly Radel at [email protected].

The regulatory environment Topics Covered in this Bulletin: continues to move at a fast EU General Data Protection Regulation—A Primer for Funds and pace. What was previously Portfolio Companies: Data protection is a fundamental right in the EU. This article addresses how private equity funds are addressing the considered market practice new regulations and what are the extraterritorial applications as well as has moved rapidly to become other implications and consequences of compliance failures. negotiable, an array of issues Permanent Capital Vehicles: This article deals with the liquidity are likely to give rise to disputes quandary. Evergreen funds aren’t a new concept, but absent a fixed termination date, what are some innovative approaches investors take in relation to private equity to address liquidity issues these funds raise? investments. Many entities Structuring India Focused Funds: This article highlights rising trends in doing business in the European negotiations among investors and fund managers in India. With overall investments in India gaining, the dialogue around traditionally “market Union have not only updated practice” terms are increasingly open to negotiation. What are some key their procedures in light of fund terms and trends? the General Data Protection Disputes in Relation to Private Equity: With deal activity on the Regulation, but are taking the rise so is the risk of disputes. What are some areas of dispute and recent examples? opportunity to improve the In addition to providing industry resources like the Bulletin, EMPEA way they manage personal data has filled the upcoming calendar with events of particular value to our generally. Increasing interest readers. I look forward to meeting many of you in London on 23 October 2018 at the Sustainable Investing in Emerging Markets Summit and on in evergreen funds invites the 25th at the EMPEA Private Equity Masterclass. novel questions. The current I welcome your thoughts at any time and invite you to share them with me, Legal and Regulatory Bulletin Mark Kenderdine-Davies ([email protected]) and with offers thoughtful discussion Ann Marie Plubell, Vice President, Regulatory Affairs at [email protected]. of aspects of each of these Best wishes, developments. Mark Kenderdine-Davies General Counsel, CDC Group plc Chair, EMPEA, Legal & Regulatory Council

EMPEA Legal & Regulatory Bulletin | FALL 2018 3 EU General Data Protection Regulation: A Primer for Funds and Portfolio Companies By Friedrich Popp, Associate, Debevoise & Plimpton LLP

Fund managers, investment advisers The Regulation replaces the existing Not only do and portfolio companies doing patchwork of EU data protection rules business in the European Union have with (almost) uniform law across the EU individuals have recently been required to adjust their and restricts member state discretion to several new rights procedures for data handling in light certain limited areas such as employment to put them into of Europe’s new privacy law, the law. Not only do individuals have several control of their General Data Protection Regulation new rights to put them in control of their “ (“GDPR“). While this process has personal data, but the new rules are also personal data, required the investment of significant backed by strong enforcement, including but the new rules resources, many businesses have civil liability. are also backed by taken the opportunity to improve the way they manage personal data Processing of personal data strong enforcement, more generally. The GDPR will apply whenever personal including civil data is processed. Funds process a variety liability. Data protection: a wide of personal information, including data ranging fundamental right relating to its partners, employees, portfolio company management teams The broad definition of personal data Data protection is a fundamental and investors. Portfolio companies also includes any information relating to right in the EU and from May 2018, hold data relating to their customers, an identified or identifiable individual, the GDPR protects the personal employees and other individuals. including their name, address, but also information of individuals in the Some of that data may also come into bank account details or investments EU irrespective of their citizenship. the possession of the fund, including made. Special categories of data, for Importantly, the new rules do not during due diligence on prospective example, health data, enjoy an even protect data relating to legal entities investments, as well as during the life of higher standard of protection. While like corporations or funds. the investment itself. anonymization of data can bring the

4 © 2018 EMPEA processing outside the scope of the law, Data controllers and data consent. Data that is no longer needed breaking the link between the individual must be deleted and data protection and their personal information is in processors authorities expect businesses to have practice not easy. Processing, the second The GDPR imposes obligations on a policy detailing the time limits for element of the trigger, is virtually any both the data controller, the person erasure of different categories of data. use of data, including the collection, responsible for the method and storing, sharing, transfer and erasure. purposes of the data processing Do I need consent? and the data processor, the person The GDPR provides several legal bases In other words, private equity fund who processes data on behalf of the for data processing, including consent sponsors will routinely “process” a wide controller (which would include, for of the individual concerned. However, variety of personal data and, as a first example, the provider of a virtual data consent has to be freely given, specific step, now need to understand what room or a payroll service provider). The and informed by a statement or a they hold and where. controller must enter into a written contract with the processor, specifying clear affirmative action (no pre-ticked boxes) and must not be hidden in While the GDPR was primarily intended certain minimum privacy and security lengthy terms and conditions. Consent to address concerns arising from data requirements. The controller also has can be withdrawn at any time and handling by large internet companies, joint and several liability with the the individual has to be informed the law does not distinguish between processor if the processor infringes of their right to withdraw consent industries or take much account of the the GDPR. Therefore, the selection before giving it. Consent obtained size of the business. European data of reliable service providers is key prior to the GDPR can only be used protection authorities have made it and companies should look again at if it demonstrably meets the new clear that they expect all businesses to the data protection terms in existing requirements. That means that, in address data protection. contracts to check that they comply practice, many businesses have had with the regulation. to seek fresh consent – explaining the volume of “opt-in” emails received in Extra-territorial application Guiding principles the run-up to 25 May 2018. The new rules do not only apply Several principles guide the GDPR, to businesses established in the including the overarching principle Processing is also lawful if it is European Union. Businesses with no of accountability: the new law necessary for the performance of a physical presence in the EU are bound not only requires compliance with contract with the individual, which by the rules when they offer goods the rules, but also the ability to may, for example, include the use of or services to individuals in the EU demonstrate compliance, for example, contact details for correspondence (even if no payment is required), or by documented procedures. Personal with an individual investor. monitor their behavior, for example, data must be processed in a manner Processing is permitted if necessary by using webtracking tools for that is transparent to the individual for compliance with European legal profiling purposes. In particular, using and privacy notices should inform obligations, to which the controller a website that is available in German, individuals specifically about the way is subject, which causes some French and English and providing in which their data will be handled. headaches for firms that have to for payments in an EU currency may Further, the principle of purpose comply with non-EU obligations. The be characterized as reaching out to limitation requires the controller to use of “legitimate interest” as lawful individual investors in the EU. If the use data only for specified, explicit base may be most appropriate if the GDPR applies to the non-EU business, and legitimate purposes and does processing is not required by law but it has to appoint a representative in not permit further processing that of clear benefit to the business and the EU as a contact point for data is incompatible with the original there is only a limited privacy impact protection authorities and individuals, purpose. This principle makes it on the individual, in particular, in unless the processing is only unlawful to collect customer data case the individual should reasonably occasional and does not affect special and then pass it to third parties for expect the use of its data in that way. categories of data. marketing purposes without prior

B usinesses with no physical presence in the EU are bound by the rules when they offer goods or services to individuals in the EU (even if no payment is required), or monitor their behavior, for example, by using webtracking tools “ for profiling purposes.

EMPEA Legal & Regulatory Bulletin | FALL 2018 5 Individual rights the data controller must also tell authority-approved binding corporate Individuals have a number of rights, the individual without undue delay. rules, a GDPR-mechanism binding all including a right to detailed information Companies subject to the GDPR need group members to EU data protection about the data processing and access to have a cyber incident response plan compliance, are meant to facilitate to their data. Businesses have to comply in place. transfers to group members outside with these requests without undue the EU. In practice, many transfers delay and in any event within one High risk processing rely on an exception, for example, on the individual’s explicit and informed month. The same timing applies to If a type of processing is likely to result consent. If there are proceedings before requests for rectification of inaccurate in a high risk to data protection rights, a non-EU regulator or in other litigation, data, the right to erasure and the right for example, customer profiling, the data may be transferred outside the to data portability, which permits an controller must, prior to the processing, European Union to the extent necessary individual to receive their data in a carry out an assessment of the impact to defend legal claims. format that allows them to transfer it of the proposed processing on the to another business. Compliance with protection of personal data. This these sometimes tedious requests data protection impact assessment Supervision and penalties within relatively short timeframes should describe the processing that Independent supervisory authorities requires an established procedure. is envisaged, assess its necessity and in every EU member state monitor proportionality and explain how risks data protection compliance within to the rights and freedoms of natural their territory. If a case affects several Compliance with persons will be managed. The controller EU member states, a lead supervisory is required to consult with the authority coordinates the other these sometimes supervisory authority before processing supervisory authorities. However, tedious requests if the assessment suggests that the businesses established outside the within relatively processing is high risk. EU cannot rely on this one-stop-shop mechanism and have to deal with the short timeframes Controllers or processors that engage regulator in every member state in “ as their core activity in “regular and requires an which they are doing business. established systematic monitoring of individuals The supervisory authorities enforce in the EU,” or large-scale processing of the Regulation, handle complaints procedure. special categories of data, must appoint lodged by an individual and conduct a data protection officer reporting to investigations. Such investigations the most senior level of management. can take place in the form of data Internal processes and EU member states may lower the protection audits and supervisors data security threshold and Germany, as an example, can obtain access to any premises of requires the appointment of a data Every data controller is required to the controller or the processor. The protection officer if there are at least maintain a record of processing activities authority issues warnings, orders ten employees dealing with automated with certain minimum content, including compliance and can also impose a data processing. the purposes of the processing and the temporary or definitive limitation, categories of data and the European including a ban on processing or supervisory authorities have emphasised Transfers of data transferring of data. that they expect compliance from all A transfer of personal data to non-EU businesses, even very small ones. countries is only permitted if the Third The GDPR specifically provides for the The GDPR requires the implementation Country either provides for an adequate cooperation of supervisory authorities, of state of the art technical and level of data protection. The EU-US including mutual assistance and joint organizational measures to address data Privacy Shield enables transfer to the operations, to address panEuropean security, including tested procedures United States (subject to conditions) risks. The Regulation seeks to to ensure the integrity of personal and transfers to Switzerland and ensure the consistent application data. This duty is underscored by a certain other non-EU countries are also of the Regulation throughout the strict regime in case of a data breach: permitted under an adequacy decision. EU and abolish the forum shopping the controller must inform the data If there is no such decision, the parties of more relaxed regimes. Further, protection authority without undue can use the EU Commission’s Standard representatives of supervisory delay, but at the latest within 72 hours Contractual Clauses or other approved authorities of all EU member states of becoming aware of the breach. mechanisms to facilitate lawful transfers. convene in the independent European Furthermore, if the breach results in a Unfortunately, there is no exemption Data Protection Board to ensure high risk for the affected individuals, for intra-group data transfers and the consistent application of the

6 © 2018 EMPEA GDPR; while the guidelines and In accordance with the principle of About the Author recommendations issued by this body accountability, it is the controller or are not binding for local authorities processor who has to demonstrate that or courts, practitioners closely follow it is not responsible for the event giving Friedrich Popp is guidance given by this forum. rise to the damage. Associate at Debevoise & Plimpton LLP An individual has the right to raise The supervisory authorities can impose a complaint with a supervisory sanctions in accordance with criteria authority and challenge its decision set out in the Regulation, which include before a court. Importantly, he or the nature, gravity and duration of the she can bring a civil lawsuit not only infringement, as well as whether it was before the courts of the controller or intentional or negligent. The maximum processor, but also before the court fines are very significant: the higher of in the member state in which it has 2% of the total group turnover or EUR its habitual residence. While there 10 million. In addition, more serious is a tendency in the EU to facilitate offences, such as data processing on the collective redress, there are no US-style basis of invalid consents, or violations class actions yet. of the data transfer rules, could result in fines of up to 4% of the total group An individual who has suffered physical turnover or EUR 20 million. Criminal or financial damage as a result of an liability may also attach to violations infringement of the Regulation has the if stipulated by the local law of the EU right to receive compensation from the member state. controller or the processor.

So, what should I do? Going forward, it is clear that the GDPR will have a dramatic effect on the way organisations handle their data. While it may seem like a daunting task, businesses can establish competitive advantage through rigorous and effective compliance. So, what should be done now?

1. Determine to what extent your organization is subject to the GDPR

2. Consider hiring a data protection officer (although it is generally not advisable to have a formal DPO unless it is required by the Regulation because it imposes further responsibilities)

3. Update fair processing and privacy notes

4. Assess (ongoing) validity of consents previously obtained

5. Consider conducting a data protection impact assessment

6. Implement a data breach response plan

7. Review and update data processing agreements

8. Be prepared to comply with new and enhanced individual rights, including subject access requests and the right of erasure

9. Identify your supervisory authority

10. Train staff

EMPEA Legal & Regulatory Bulletin | FALL 2018 7 Permanent Capital Vehicles: Dealing with the Liquidity Quandary By Cindy Valentine, Partner and George Metcalfe, Supervising Associate, Simmons & Simmons LLP

Although not a new concept, What structure is used is very much The key concern around the use of permanent capital vehicles (PCVs) dependent on the nature of the evergreen funds is certainty of liquidity. underlying investments, the type of Absent any fixed termination date, remain a relatively underused investors and the exit plan. Drivers for investors need to ensure that they will be vehicle for private equity funds setting up an evergreen vehicle include able to exit at a suitable point in time. Put in emerging markets. Investor the ability to: more simply – investors need liquidity. demand for conventional • implement longer strategies and We have seen a variety of innovative structures, where commitments are ‘ride-out’ short and medium-term approaches taken to address the issue of invested and proceeds distributed market volatility; liquidity, which we discuss briefly here. within a defined period of time • continue fundraising without the (ordinarily invested over 5 years need to structure and raise successor Liquidity Basics – A Brief and a 10-12 year fund life), remains funds; Reminder strong. However, interest in PCVs • keep a steady capital base to invest Primary liquidity through redemption has increased significantly in recent without needing to return it back to of interests involves investors realizing investors; their investment by redeeming their years in the African market in interest in a fund by way of buyback, certain sectors. • offer investors variations on the conventional 2 and 20 fee model which is generally financed by the which can be better suited to longer manager in three ways: (i) realizing term investments; and underlying investments, (ii) borrowing from a third party, or (iii) taking in new • utilize alternative exit strategies such subscriptions – or a combination of as listings and redemptions. the above. The manager uses the cash proceeds to fund the redemptions (or at least maintain the fund’s NAV).

8 © 2018 EMPEA The key concern runs, all of which reflect the inherent Hybrids illiquidity of private equity assets. More As neither primary nor secondary around the use of widely, managers suffering erosion of liquidity alone offers a clear, workable evergreen funds the asset base have less capital to put to solution to investors’ needs for a work in investments, and for less time, is certainty of reliable exit option, a variety of making hurdle rates and performance approaches are being taken in PCV liquidity. Absent any fees more difficult to attain. “ structures to offer investors liquidity. fixed termination Some are relatively simple, some are Secondary liquidity involves investors date, investors need more complicated and often involve a selling their interests, either to another combination of liquidity options. to ensure that they investor in the fund or a third party. will be able to exit Sales to third parties can be achieved In emerging markets, notably Africa, in several ways, for example (i) through at a suitable point there is a significant trend towards the private secondaries market, (ii) an ultimate objective of listing as a in time. Put more listing the fund on a public securities natural exit. Investors, however, still simply – investors exchange or (iii) ‘tokenizing’ the fund require certainty of exit. Accordingly, interests. However, like the primary need liquidity. although a PCV may be evergreen, if liquidity options, secondaries also have its investment mandate is to exit by their shortcomings. These financing options raise their listing then investors will likely require that the manager must seek to achieve own issues. Selling underlying fund • The secondaries market, whilst an initial public offering (IPO) once assets to raise funds for redemptions long established, does not function the fund’s NAV has reached a certain is problematic as the underlying assets particularly efficiently for market (predetermined) point (or if that NAV is are usually not readily disposable – it participants looking for a quick not reached by a certain point in time, may take an extended period of exit. The process can be slow and when a fixed time period has passed). If time to find the best buyer or exit cumbersome, often fails to provide an IPO is not achieved within the time/ option. In addition, tension can arise selling investors a ‘clean break’ value constraints, investors will likely when deciding which assets are to and is, ultimately, dependent on require the fund to be wound down. be disposed of – selling the ‘best’ a manager being willing to take or ‘easiest-to-sell’ assets could be credit risk (and other risks) on a Listing the shares in this way gives prejudicial to investors remaining in the new investor. fund and this conflict of interest must investors some comfort that they • Listing a fund is notoriously be well managed. should, if the fund is successful, be expensive, so it is normally only able to sell some or all their shares a viable option for larger funds. Borrowing by the fund exposes in the fund on the open market. If It will also need to be part of the non-redeeming investors to greater unsuccessful, they will have whatever investment proposal from the leverage risks. Moreover, borrowing capital is available, returned to them. fund’s launch. Also, disclosure and in private equity funds is usually very Equally, on an IPO, investors can keep transparency rules can hinder a tightly controlled and normally only their investment, or even increase their private equity or venture capital bridge finance or relatively small stake by buying shares from investors manager in conducting business. working capital facilities are permitted. which are selling shares. This is a Incoming investors often prefer • Tokenizing a fund, by initial coin simpler option than re-upping into a their commitments to be put in new offering or otherwise, is a new successor fund of a conventional fixed investments, rather than buying into an process—effectively a hybrid of term real estate or private equity fund. existing, static portfolio and watching the private secondaries market their cash walk out the door with a and the public securities market. We have also seen funds use a redeeming investor. Banks, fund service providers and, combination of liquidity solutions importantly, investors are generally operating in tandem, in hybrid vehicles. In order to protect the fund and cautious about dealing with fund Such structures aim to occupy the space investors, investors’ ability to redeem, interests (or tokens) on a digital between pure open and closed ended if it exists, is often limited by gates currency/blockchain platform. structures, through methods such as (i.e. restrictions on amounts which Regulators are also catching up redemption windows or liquidity events. may be redeemed at a given time with this new technology, which and the frequency at which investors creates considerable uncertainty An example of this is providing investors can redeem), lengthy notice periods, for managers operating in with the ability to approve a listing after payment deferrals and suspension an unpredictable regulatory a certain time period (i.e. there is a lock powers in case of market stress or environment. up), or inserting a requirement that a

EMPEA Legal & Regulatory Bulletin | FALL 2018 9 listing is completed within a certain Liquidity is a key issue and managers need not time period (other than obtaining of a certain NAV as explained above) Like be tied to any single approach to providing it. the example mentioned above, this However, it is the case that PCVs which offer a gives investors a secondary liquidity clear exit option for investors are more likely to option, allowing them to realize their appeal to a wider group of investors. investment at that point by selling “ their shares on the open market (to the extent that, in practice, there is a ready market). It also gives investors control Alternatively, some long-term funds Of particular note is the issue of to approve a listing in their discretion have been structured to continue investor control. PCVs commonly at the time, rather than being bound by automatically if certain fund grant significant control to investors pre-set conditions put in place during performance thresholds have been to determine the timing of, and means the initial fundraising which may no reached, failing that an investor vote by which, they exit, at the time of longer be in their best interests. In will be determinative. Other funds exit. In so doing they have built in addition, after the lock-up, where there simply have no fixed term and all that considerable flexibility. This is especially is no listing, investors can redeem their is offered by way of secondary liquidity true of PCVs established by smaller, less shares year-on-year up to a certain limit, is an obligation on the manager to use well-established managers. Generally giving investors a second (albeit partial) reasonable endeavors to assist investors speaking, PCVs sponsored by long exit option, using a primary liquidity with finding buyers for their interests. established managers with strong track mechanism. Although not providing However, such terms have often been records (both in terms of managing ‘immediate’ liquidity as might be seen in less popular with investors, who are conventional fixed term funds and PCVs) a conventional hedge fund, given that then subject to wider market liquidity are likely to be able to retain control shares in listed funds often trade at a forces, confidence in the valuation of over the process. discount to NAV, having the choice to the interests being sold and, ultimately, redeem some shares at a price equal to manager engagement. Ultimately, whatever the manager or NAV (less costs) is clearly desirable for investor base and however liquidity investors. Also, limiting redemptions in Market Trends is offered, liquidity is a fundamental this way allows the manager to manage investor concern with PCVs (including The increasing use of PCVs and hybrids any asset sales sensibly, lessening the hybrids) and careful thought should in emerging markets, notably Africa, need for any asset fire-sales or cherry- be given from the outset as to the suggests a growing sophistication of best solution for both the manager picking, or suspension of redemptions, managers and investors operating in and investors. as well as use income generated from that space. Although conventional underlying assets that would otherwise private equity fixed term funds are likely be distributable. to remain predominant, a PCV provides a sensible alternative. About the Authors We have also seen several long-term funds structured with no fixed term, Liquidity is a key issue and managers Cindy Valentine is Partner but which have a continuation vote need not be tied to any single approach at International Funds after an initial period of ten or twelve to providing it. However, it is the case Team years, allowing the fund to continue for that PCVs which offer a clear exit option a further ten or twelve years thereafter. for investors are more likely to appeal Other funds, for example in the to a wider group of investors. PCVs infrastructure space, hold continuation with less focus on investor exit may only George Metcalfe is votes more frequently (every three attract capital from investors which are Supervising Associate at or five years) after the fund has been willing (and able) to lock up capital for International Funds Team running for ten or twelve years. Either the long-term. As such, funds using a way, this approach gives investors combination of liquidity solutions which greater control over their exit and allows operate in tandem can be a workable them to judge the prevailing market solution, as they can cater for a wider conditions and fund performance to range of investor exit requirements. date at the relevant time.

10 © 2018 EMPEA Trends in Structuring India Focused Funds; LP-GP Negotiations By Richie Sancheti (Head, Investment Funds) and Nandini Pathak (Senior Associate, Investment Funds), Nishith Desai Associates

Introduction tax (GST), tax initiatives for Small and As per the Securitisation and In 1H 2018 India focused funds saw Medium Enterprises, policy initiatives Reconstruction of Financial Assets a hectic fundraising and investment for the insurance sector and increased and Enforcement of Securities levels that was 44% higher than 1H focus on technology driven payment Interest Act, 2002 (“SARFAESI”), 2017.1 Several topics came to the mechanisms. We will subsequently an asset reconstruction company fore as fund managers raised their (in this article) discuss some of these (“ARC”) is required to establish subsequent funds. India continues changes, and their impact on the Indian securitization trusts for the to be a significant recipient of DFI investment funds. acquisition of stressed assets and allocation. With one or more DFIs or issuance of Security Receipts (“SRs”) In this article, we share some sovereign investors in the mix, the fund to pass on the economics arising observations on the above trends, terms continue reflecting a more LP therefrom. The securitization trusts followed by specific discussion points tilt in balance even for fund managers acquire the stressed assets from (currently in focus in India) on key fund raising a Series III or a Series IV fund. ‘Selling Banks’. Investment by terms during LP-GP negotiations. non-resident entities into SRs can New investment funds with more be made by overseas entities that 2 focused strategies are seen coming up Distressed assets inspiring are registered as Foreign Portfolio as India introduces favorable policy and new structures Investors (“FPIs”). SRs can also be regulatory changes such as introduction The recently introduced Insolvency and listed on a recognized stock exchange of the Insolvency and Bankruptcy Code, Bankruptcy Code has enhanced the that has enhanced its liquidity and passing of a single goods and services mechanisms to recover from borrowers.3 attractiveness as an asset class.

1. EMPEA (1H 2018 India Data Insight) 2. https://www.bain.com/insights/india-private-equity-report-2018/ 3. https://www.livemint.com/Opinion/DzvsgPI3OHFQzvpAYxSabM/Distressed-asset-investments-in-India.html

EMPEA Legal & Regulatory Bulletin | FALL 2018 11 Asset Reconstruction Trust Structure approvals are invariably required for flexibility in structuring investments. The use of fundamental fund platform allows investor participation alongside FPIs / AIFs main fund with limited weightlifting on the structure and licenses.

Returns It is required that liabilities are not on SRs Subscription comingled, expense sharing ratio of SRs is maintained at fair levels and the documentation sufficiently caters to Asset ARC the difference in investment as well as Returns on SRs Reconstruction distribution ratios, along with the other Consideration for Trust fund terms, for two different pools loan portfolio Repayment of loans operating within the same platform.

Selling bank Subscription Portfolio Company Secondaries of SRs By and large Indian funds continue to struggle to achieve desired portfolio exits with identified fund terms and Recently, the Reserve Bank of India Co-investments as a LP-approved extended terms. In line classified certain investment vehicles with global practices, this is leading to (i.e. Category II and Category III sub-class of the main fund GP-sponsored LP secondaries and fund Alternative Investment Funds (“AIFs”) Overseas institutional investors are restructuring exercises. There have also registered with the Securities and increasingly looking for co-investment been instances where the fund manager Exchange Board of India (“SEBI”)) opportunities from their fund offered to buyout the LP stake at a haircut. as ‘qualified buyers’ for investing in managers to reduce the agency cost security receipts issued by the trusts of and yet enhance their investment asset reconstruction companies. exposure. Traditionally, co-investment Variations in Structuring opportunities which are accepted by Other structuring avenues for this asset investors are consummated either Key Person Events class include investments in non-banking directly by such investors or through a Existing India funds are seen grappling finance companies. side pocket vehicle being managed by with key person clauses given the the same fund manager. reshuffling of investment management However, AIFs are being preferred as personnel (including spinoffs and an option due to their tax pass-through Investors in the main fund are formation of new ventures)4. Many nature, light touch regulations by SEBI circumspect about co-investment large PE fund managers of India focused and their ability to be treated at par with structuring largely around enhanced funds have recently seen senior level domestic investors (despite having foreign informational rights for select investors officials quit to start their own ventures. investment) as long as they are owned eligible for co-investments, allocation of and controlled by Indian resident citizens. deal expenses between main fund and GPs are exploring ways of identification co-investors, conflicts of interest for the of key persons and related Certain complications continue to exist manager, double-dipping on fees, etc. (proportionate) consequences, as LPs despite choosing AIFs as the investment look to be as inclusive as possible while vehicle, as strategic investors look to get Indian fund managers are looking to determining time commitment of key involved at the portfolio level, the ability structure the main fund vehicle in a persons. While the corporate execution of AIFs to take leverage is restricted. manner which allows co-investments to at the “Chief” level of personnel also be consummated through the main continue to be relevant, LPs also expect Consequently, structures involving fund vehicle but as a separate class. the GP team to take a haircut on its different types of investment vehicles economics if it is unable to retain talent (which include AIFs) are cutting across The upside for the manager is to avoid at the investment management team different regulations and authorities, incurring set up and operating costs level. Concepts of ‘super key person’ and as investors look to tap this asset class for a new vehicle and offer greater ‘standard key person’ are increasingly in India. transparency to investors. Licenses and becoming common.

4. https://economictimes.indiatimes.com/news/company/corporate-trends/why-are-so-many-indian-fund-managers-quitting-private-equity-firms/articleshow/65369255.cms

12 © 2018 EMPEA From a governance perspective, SEBI has been actively examining AIF applications, and paying due attention to each of the documents. A manager to an AIF must now tread more carefully with both the “ regulator and the investors. Consequences of key person events are As a result, excusal provisions are About the Authors not expected to be limited to suspension becoming extremely important in the of investment period anymore, but if Indian context for managers to balance uncured, may also trigger consequences all pools of capital within the same fund. Richie Sancheti heads the that are at par with removal for cause Investment Funds practice events. Conclusion at Nishith Desai Associates This article only summarizes a few of Removal of GPs the many discussion items which have Nandini Pathak is a ‘For cause’ removal typically refers to the gradually shifted from being ‘market Senior Associate in premature termination of the manager’s practice’ to ‘negotiable’ in a matter the Investment Funds services to the fund by the LPs, owing to of a couple of years with respect to practice at Nishith Desai events of default – mainly fraud, willful India focused funds. More variations in Associates misconduct, and gross negligence. structures are expected in the coming months as the industry makes more The relevant question in the context of representations to the Government. some of the recent funds has been on who determines whether a ‘cause’ event From a governance perspective, SEBI has has occurred. Global LPs are circumspect been actively examining AIF applications, about the determination standard to and paying due attention to each of the be applied by Indian courts, because of documents. A manager to an AIF must the perception that dispute resolution now tread more carefully with both the by way of litigation in India may take regulator and the investors. unreasonably long to conclude. While inventive terms are being Carried Interest considered to build better investor While the taxation of carried interest relations, given the recent observations remains unclear globally, several Indian by regulators in sophisticated GPs are considering allowing their jurisdictions, Indian managers must not employees (who are entitled to carry) to lose sight on the disclosure as well as track the carry directly from the fund, fiduciary norms. including through structures such as employee welfare trusts. Accordingly, while experimenting with structures, attention should be given Excuse Rights to articulating adequate disclosures Domestic insurers continue to remain in the fund’s marketing documents a significant source of asset allocation. and carefully designing the investment Indian insurers regulated by the policies. Fund documentation should Insurance Regulatory and Development ensure insulation of fund managers Authority of India are required to ensure from unintended exposure to legal, tax that their capital contributions are and regulatory risks, while providing not invested outside India. Likewise, adequate disclosure and information to other statutory / state-aided Indian potential LPs. institutional investors impose similar conditions while making commitment to a fund. Investment programs for several DFIs too require that they be excused from certain deals if the fund were to explore certain opportunities.

EMPEA Legal & Regulatory Bulletin | FALL 2018 13 Disputes in Relation to Private Equity By Ruth Crowley, Partner and Andrew Reeves, Senior Associate, Norton Rose Fulbright LLP

Summary investors, with money being invested by While this growth funds in an increasingly diverse set of Low interest rates and the search for international markets. is good news greater returns have led to increased for the industry, private equity investment: deal activity Buyouts in Europe reached USD159.8 in the US and UK has been at its highest disputes are billion in 2017, a 22 per cent increase in level since 2007. While this growth is value from 2016. US buyouts amounted becoming more good news for the industry, disputes “ to USD190.8 billion (a 12% rise). This frequent as a are becoming more frequent as a increase in investment correlates consequence, particularly given the consequence, surge of investment into emerging with record levels of private equity particularly given acquisitions since the financial crisis, markets and increased regulatory the surge of action. In this article we explore the as investors seek strong returns during types of disputes that typically arise a period of low interest rates. Not only investment into in relation to private equity, set out are we witnessing high levels of overall emerging markets activity, but there has also been a recent examples and explain why recent and increased trends in private equity have led to an return to some mega-acquisitions, for increased risk of disputes. example PAG’s USD1.4 billion purchase regulatory action. of Yingde Gases in March 2017, the Bain- led consortium’s USD18 billion deal for Increased private equity Toshiba’s memory chip unit in September activity 2017, and Carlyle’s USD11.5 billion first half of 2017 – an almost 50% rise Recent years have seen an increasingly acquisition of Akzo Nobel’s specialty from the same period in 2016 according strong private equity market following chemicals business in March 2018. to EMPEA data. Investment has focused the financial crisis. Through the second on Asia and in particular China, India half of 2016 and into 2017, the private An increasing amount of capital is being and South Korea. Latin America, Eastern equity industry has experienced a sharp invested in emerging markets, with a Europe and CIS have also experienced rise in the levels of fundraising from total of USD22 billion invested in the leaps in investment.

14 © 2018 EMPEA Types of disputes that often result in, or arise out of, compounded where, as is common typically arise regulatory scrutiny (see below). in many emerging markets, • Mismanagement and fraud portfolio companies are originally In addition to the generally strong The 2016 collapse of Kenya’s Chase family-owned. Such companies may outlook for the private equity market, Bank resulted in a panic run on be run by related parties without we are seeing an ever-increasing deposits, which led to twelve Kenyan the necessary professional and number of disputes. Private equity banks allegedly failing to comply technical management experience transactions tend to give rise with Kenyan banking regulations, required or that would be expected to certain types of disputes, for and losses to a number of emerging in a typical US or UK company, with example: market private equity firms. The potential issues around conflicts of collapse of both Intercontinental interests, transactions with related • Disputes relating to the Bank and Oceanic Bank in Nigeria in parties, and individuals appointed investments themselves 2009 amidst allegations of fraud have to management positions based on These disputes include breach of led to substantial losses amongst their relationship to the founders warranty or misrepresentation leading private equity backers. or majority shareholder and not on claims, indemnity claims and technical capability or experience. At • Disputes in relation to growth disputes in relation to inflated the time of the billion dollar collapse capital transactions projections and forecasts. In short, of Oceanic Bank in Nigeria, the bank These disputes (as opposed to disputes tend to arise when the was headed by a family member secondary M&A transactions) are investee company turns out to be who was reportedly without any common in particular where the a substantially different or less formal banking education, training founders effectively misappropriate valuable company to the one the or experience (save for her time the growth capital. Private equity fund thought it was investing in. working in the same bank). firms need to consider carefully • Shareholder disputes the protections they put in place In many cases shareholder disputes in relation to their investment Fraud and corruption present simply come down to investors and ensure they have appropriate significant risks in emerging having different objectives and visibility and control over the use of markets, particularly in sectors goals. The risk of disputes tends growth capital. such as oil and gas and to be heightened where founders telecommunications where the key of the company remain significant assets of a business will usually have shareholders. This commonly Reasons for increased been purchased from governments. leads to disputes about short and dispute risk Civil and criminal litigation long term goals and about the In part, the increase in the number and frequently arises in relation to the way in which the company is run, size of private equity acquisitions has historic acquisition of such assets particularly in emerging markets resulted in a corresponding increase in emerging markets, which can (see below). in the number of related disputes and substantially undermine the value • Mismanagement of funds many matters arose from the financial of the business and the time the Mismanagement allegations can crisis. However, particular features of disputes take to resolve can scupper arise even in relation to established the growth in private equity activity over the fund’s exit strategy. private equity houses. recent years have also increased the risk of disputes, in particular: (i) increased The case of Lilliput Kidswear, an • Issues arising from breaches investment in emerging markets; (ii) Indian-based clothing company or termination of material increased investor expectations; and (iii) which was acquired for USD86 contracts increased focus by regulatory authorities million by Bain Capital and TPG in For example, Helios Towers Nigeria on investment advisors. 2011, acts as a warning to other Limited, backed by private equity funds. The discovery of alleged group Helios Investment Partners, (i) Increased investment in emerging financial irregularities in the sued Telkom South Africa in 2011 markets. business post acquisition has led for what it argued was wrongful Investing in emerging markets to civil claims left pending for a termination of a ten-year lease can yield substantial returns but considerable period in the Indian agreement. comes with significant challenges, courts. Bain Capital has pursued the • Claims against fund managers such as geopolitical instability, company’s auditors in an attempt These claims are in relation to non- regulatory issues, compliance risks to recover alleged losses totalling disclosure of expenses, fees and and the slow pace of criminal and approximately USD60 million. conflicts of interest. Such claims civil legal processes. These risks are

EMPEA Legal & Regulatory Bulletin | FALL 2018 15 It is essential that managers have strong communication networks to each of their investors so investor expectation is managed in situations where returns are below those anticipated. “ With around USD500 million of funds, increasing purchase prices to funds generally. This, in turn, private equity investment tied up and expected returns. Due to tends to lead to follow-on civil in legal disputes in India alone, the an uncertain economic climate, litigation against the investment slow pace of the legal process in companies may not always be advisors. Approximately 20% of all many emerging market jurisdictions able to deliver on expectations. enforcement actions pursued by the is a serious consideration for funds Underperforming portfolio Securities and Exchange Commission looking to invest. Conducting companies may lead to disputes (SEC) were levelled at investment thorough due diligence, structuring between managers and investors. advisors. In October 2015 Blackstone transactions to benefit from While underlying losses may form settled an SEC enforcement action protections afforded by bilateral, the basis of such a dispute, it is at USD39 million (without admission multilateral and other investment more likely that investors will of liability), brought in relation to treaties as well as drafting the only make formal claims against alleged failures to disclose benefits transaction documentation so managers where there is a failure to that Blackstone private equity fund as to gain direct recourse to the appropriately address and explain advisers obtained from accelerated investment state (typically via those losses. Managers reacting monitoring fees paid by portfolio arbitration) are likely to be key as promptly to poor performance and companies prior to the companies’ the private equity industry invests being alert to how relationships sale or IPO and which allegedly more heavily in infrastructure, between managers and investors reduced the value of the portfolio mining, energy and other large are managed is likely to help companies. Hedge funds have also projects in emerging markets. to mitigate the risk of formal been a focus for US authorities: civil Corruption issues can in turn lead actions ultimately being pursued. and criminal fraud charges were to money laundering risks relating In an increasingly competitive brought by the US Department of to dividends, to loss of investment environment, it is critical that Justice in December 2016 against value, and to civil disputes (e.g. managers retain the trust of their the founder, president and other claims from investors/shareholders investors such that they feel they executives of Platinum Partners, against the fund, against directors are acting in their best interests; regarding the alleged overvaluation appointed to the portfolio company communicating quickly and acting of its assets and alleged concealment and between the portfolio company decisively in situations where the of a liquidity crisis at the fund; and counterparties/competitors). fund performs below investor and the SEC brought a lawsuit expectations. alleging insider trading against Leon Disputes in relation to emerging Cooperman and hedge fund Omega markets investments usually Equally, increases in capital being Advisors Inc., which was settled for involve complex multi-jurisdictional raised in markets where there is USD4.95 million in May 2017. issues and it is important that the relatively low available leverage conduct of disputes is carefully applies pressure to managers to managed between local and global maintain strong return ratios and counsel. Equally, it is important in turn meet investor expectations. About the Authors that careful thought is given at the It is essential that managers have time of investment to ensuring that strong communication networks to Ruth Crowley is Partner contracts provide for disputes to be each of their investors so investor at Norton Rose Fulbright settled in accordance with the most expectation is managed in situations LLP appropriate governing law and in where returns are below those the right jurisdiction. anticipated.

(ii) Great expectations (iii) Focus by regulatory authorities Andrew Reeves is Senior Low interest rates and record Regulatory authorities, particularly in Associate at Norton Rose levels of available capital have the US, are focused on investigating Fulbright LLP increased competition between the activities of investment advisors