NAV Facilities: A Promising Vaccine for Funds in the Era of Covid-19?

1. Are there any regulatory issues which need to be considered when a fund is borrowing pursuant to a NAV facility?

Certain changes were made to the fund regime in Bermuda towards the end of 2019 and the beginning of 2020. The changes refined some definitions used to identify what constitutes an “investment fund” including bringing closed-ended funds within scope of the Investment Funds Act 2006 (IFA). In addition, certain clarifications were introduced to ensure that arrangements that should not properly be considered to constitute an investment fund were not unintentionally then brought within scope.

We do not consider that the oversight by the Bermuda Monetary Authority (BMA) with respect to open or closed-ended funds requires compliance with any regulatory issues that are specific to a fund looking to enter into a NAV facility. Consistent with advice given to clients in earlier stage fund finance where capital call rights and the like are more the focus, attention should be given to ensure that the offering materials and related constitutional documents adequately disclose and provide for entering into the type of lending (and related grant of security) contemplated.

Where the existing fund offering materials and constitutional documentation arguably does not give scope to accommodate a NAV facility, consideration must be given as to whether notification to or consent from the BMA must be sought in order to make the requisite changes. This may also engage investor consent requirement considerations that may also need to be addressed.

2.      Are there any other impediments or considerations to any restructurings that may be required to implement a NAV facility? 

If a restructuring is required to implement a NAV facility, one must first review the applicable Bermuda legislation and the underlying constitutional documents of the fund to ensure the proper consents (if any) are obtained and the correct procedures are followed.

For closed-ended private equity funds such as exempted limited partnerships – which are commonly utilised in Bermuda for fund structures – for example, a change to the general partner may require the consent of the BMA; however, in certain circumstances a notification to the BMA may suffice. Further, the limited partnership agreement will likely set forth the required steps for the admission or withdrawal of partners, transfers of partnership interests and partner consent thresholds. If the provisions in the partnership agreement would make it overly burdensome for the general partner to carry out the terms of the NAV facility, then the partners should consider making amendments to the partnership agreement prior to implementing the NAV facility, in order to reduce such potential challenges.

Other than in respect of assets which constitute Bermuda real estate (including leasehold interests) and voting equity rights in Bermuda entities, there are no material impediments to restructurings in Bermuda required to implement a NAV facility. That said, while the former may not be a viable option for the purposes of the provision of security by Bermuda funds, the latter is possible subject to satisfying certain BMA consent or notification requirements.

3.         What security in respect of portfolio entities is commonly taken and how is this taken?

The most common security taken over Bermuda investment funds include the equity interests in the fund itself (e.g., shares in an exempted company or partnership interests in an exempted limited partnership), and fixed and floating charges over the assets held by such entity. For both companies and partnerships such security typically extends to the equity interests of the material subsidiaries of such entity. For partnerships, lenders would also take a charge over the partnership’s unfunded capital calls and the account in which such commitments are contributed. While standard, standalone security agreements are commonly used for in the company context, it is becoming more common in the context of a fund which is a partnership to build the security provisions directly into the fund’s partnership agreement.

Security granted by a Bermuda company or partnership should, where possible, be registered at Bermuda’s publicly searchable registries to ensure the legal priority of such charge vis-à-vis other creditors of the fund where priority falls to be determined by Bermuda law. Note however, that charge registration in Bermuda does not impact creation, attachment, validity or perfection of such charge.

1.         Are there any regulatory issues which need to be considered when a fund is borrowing pursuant to a NAV facility?

On 31 December 2019, the BVI amended the Securities and Investment Business Act 2010 (SIBA) to bring closed-ended private investment funds within the scope of the regulatory regime. Previously only open-ended funds were subject to licensing or registration requirements in the BVI. SIBA defines private investment funds as companies, partnerships, unit trusts or any other BVI bodies that (i) collect and pool investor funds for the purpose of collective investment and diversification of portfolio risk; and (ii) issue fund interests, which entitle the holder to receive an amount computed by reference to the value of a proportionate interest in the whole or part of the assets of the entity. In addition to the newly regulated closed-ended funds, the BVI has a range of open-ended fund products, each regulated pursuant to SIBA and its associated regulations.

Neither SIBA nor the regulations which supplement it require a BVI fund to obtain any regulatory approval or to make any regulatory filings when borrowing under a NAV facility or more generally borrowing against portfolio assets of the fund. In addition, there are no legal limits imposed by SIBA or the associated regulations and no restrictions imposed by the regulatory regime in relation to borrowing by a fund.

2.         Are there any other impediments or considerations to any restructurings that may be required to implement a NAV facility? 

The provisions of the fund documentation will determine the impediments or considerations to any restructurings as well as restrictions on borrowing or approvals required from limited partners or shareholders as the case may be. Provided that the secured investments do not include BVI land (or companies that hold interests in BVI land) or BVI regulated entities, there are no material statutory considerations for BVI funds to consider in implementing a NAV facility.

In line with onshore trends, we would expect BVI funds to establish a special purpose vehicle (SPV) to act as the borrower, and to mortgage its shares in a second SPV which acts as a holding company for the underlying investments. The speed and ease of incorporation, together with tax neutrality, positions the BVI well as a jurisdiction for SPV incorporation. For added comfort as to whether the borrower SPV is insolvency remote, a restricted purpose company could be used, which may only lawfully undertake transactions within or incidental to its prescribed purposes.

3.         What security in respect of portfolio entities is commonly taken and how is this taken?

For a NAV Facility, we would expect a fund would look to grant security over the shares in its portfolio companies (or, to simplify enforcement, a holding company for those portfolio entities), assets and, in hybrid structures, its future capital calls and general partnership interests (where applicable).

Security over interests in BVI entities usually takes the form of an equitable mortgage. The chargee should seek to record the security in the register of members or register of partnership interests (as the case may be). The chargee should ensure that they have legal recourse and an ability to require the registered agent to transfer ownership in the event of a default, usually through deliverables such as a letter with the registered agent, stock transfer forms and director resignation letters.

Except where assets of the fund are situated in BVI (for instance, being shares in BVI entities), we would expect any asset charges to be governed by the jurisdiction in which assets are located.

The chargee should ensure that charges granted by BVI companies are registered publicly in the BVI so that the chargee benefits from the provisions of the BVI Business Companies Act relating to priority of charges. Public registration confirms the priority of the charge against future charges whilst also providing notice to interested parties of the charge and enable the identification of a negative pledge (if relevant) to potential future lenders. Under BVI law, a failure to register a charge does not invalidate the charge however an unregistered charge will have priority ahead of other registered charges and a bona fide third party future lender may not be put on notice of the charge and/or any negative pledge.

1.         Are there any regulatory issues which need to be considered when a fund is borrowing pursuant to a NAV facility?

The Private Funds Law, 2020, as amended (PF Law), came into force on 7 February 2020 and has created an entirely new regulatory regime for private investment funds.  It applies to any ‘private fund’ carrying on business in or from the Cayman Islands other than a mutual fund or an EU connected fund regulated under the Mutual Funds Law.  A ‘private fund’ is defined in the PF Law as a company, unit trust or partnership that offers or issues or has issued investment interests, the purpose or effect of which is the pooling of investor funds with the aim of enabling investors to receive profits or gains from such entity’s acquisition, holding, management or disposal of investments, where: (i) the holders of investment interests do not have day-to-day control over the acquisition, holding, management or disposal of the investments; and (ii) the investments are managed as a whole, by or on behalf of the operator of the private fund, directly or indirectly. Certain regulated entities and “non-fund arrangements” are expressly excluded from the ambit of the regime. Open-ended funds are regulated pursuant to the Mutual Funds Law, 2020 (MF Law), including newly registrable limited investor funds.

Neither the MF Law nor the PF Law nor any related regulations require a Cayman Islands fund to obtain any regulatory approval or to make any regulatory filings when borrowing pursuant to a NAV facility or more generally borrowing against portfolio assets of the fund. In addition, there are no legal limits imposed by the MF Law, the PF Law, or related regulations and no restrictions imposed by the regulatory regime in relation to borrowing by a fund. However, the amount of leverage taken on by a Cayman Islands fund may be restricted by its constitutional and/or offering documents.

2.         Are there any other impediments or considerations to any restructurings that may be required to implement a NAV facility? 

Subject to licensing requirements applicable to certain regulated entities in connection with a change of control, issuance of shares or change to its board, there are no authorisations or consents required by law from any governmental bodies or agencies in connection with the implementation of a NAV facility. Security over land, certain intellectual property rights, ships and aircraft, must be registered at public specialist registries related to the relevant asset and there will be certain fees payable to such registries in connection with the registration.

3.         What security in respect of portfolio entities is commonly taken and how is this taken?

Security in respect of portfolio entities will typically take the form of security over shares, limited partnership interests or limited liability company interests. There may also be a related pledge over the fund’s bank account into which cash distributions are deposited.

Insofar as security over shares in a Cayman Islands company is concerned, title to shares in a Cayman Islands company is not transferable by delivery (as share certificates are not determinative of share ownership). As such, the security will usually take the form of a legal or an equitable mortgage depending on whether the mortgagee wishes to take legal title to the shares prior to default (which is rare). Given the lack of any system by which security over shares may be perfected in the Cayman Islands and the fact that an equitable mortgage may be defeated by the interest of a bona fide purchaser of the legal estate without notice of same, lenders will typically seek a suite of supporting aids to enforcement, including blank share transfer forms, director resignation letters and registered office undertakings. A notation of the security over the shares will also typically be made on the register of members of the issuing company. Different considerations may apply if the register of members is maintained outside of the Cayman Islands or if the shares are held in the name of a custodian.

Security over interests in a Cayman Islands exempted limited partnership (ELP) or a Cayman Islands LLC (LLC) will typically take the form of an equitable mortgage or charge and a corresponding assignment of amounts due to the charger under its constituent document. Importantly, written notice of the security interest must be given to the ELP or the LLC at its registered office. Any security interest over a limited partnership interest or a limited liability company interest will take its priority from the time that the written notice of security is validly served at the registered office of the ELP or the LLC. The General Partner/LLC is required to maintain (or cause to be maintained) a register of security interests at the registered office in which each security interest in relation to which a valid notice has been served is required to be registered. Unlike the register of members of a Cayman exempted company, the register of security interests of an ELP is public in the sense that it is open to inspection by any person during all usual business hours at the registered office of the ELP. The register of security interests of an LLC is open for inspection by persons expressly provided for in the LLC agreement; or permitted by the manager.

1.         Are there any regulatory issues which need to be considered when a fund is borrowing pursuant to a NAV facility?

Guernsey private equity funds are typically registered as limited partnerships under the Limited Partnerships (Guernsey) Law, 1995, as amended (the Guernsey LP Law), and those which constitute closed or open-ended collective investment schemes will be subject to the investment fund regulatory regime set out in the Protection of Investors (Bailiwick of Guernsey) Law, 1987 (as amended) (the POI Law) and regulated by the local financial regulatory body – the Guernsey Financial Services Commission (GFSC).

Subject to any commercially agreed limits or restrictions which are disclosed in a fund’s information particulars, there are no legal limits imposed by the Guernsey LP Law, the POI Law or related regulations and no restrictions imposed by the regulatory regime in relation to borrowing by a fund (including by way of NAV facility). If facilities are to be entered into which might exceed such commercially agreed limits, there are statutory obligations to notify the GFSC and investors and revise the information particulars. The fund’s constitutional and/or offering documents should always be carefully reviewed to determine the leverage that can be taken on by the Guernsey fund.

2.         Are there any other impediments or considerations to any restructurings that may be required to implement a NAV facility?

If a shareholder (direct or indirect) of an entity which is regulated by the GFSC under the POI Law is changing due to a restructuring, then it is likely the prior consent of the GFSC will be required (in the form of a letter of no-objection) prior to the restructuring.  The GFSC has a statutory period of 60 within which to provide its no-objection confirmation, although the GFSC will usually work towards the transaction timetable and endeavour to provide the no objection in a shorter time frame than 60 days.

If a portfolio company (or a subsidiary of the same) is subject to GFSC regulation, then whilst notice of such security does not need to be provided to the GFSC upon execution of the finance documents, lenders should be cognisant of this additional ‘hoop’ in enforcing the security, and the effect it can have on the timings of any potential enforcement.

3.         What security in respect of portfolio entities is commonly taken and how is this taken?

Typical security packages for NAV facilities, usually provided when funds are nearing the end of their life cycle, include security over underlying assets of the fund taken pursuant to the Security Interests (Guernsey) Law, 1993, as amended (the Guernsey Security Law).  In Guernsey, these might include shares in Guernsey registered subsidiary companies, Guernsey situs bank accounts, units in Guernsey unit trusts, and/or contract rights arising under Guernsey law contracts (e.g. intra-group loans).  In respect of these asset types, security is taken by way of a Guernsey law security interest agreement and the formalities to finalise the creation of the security are as follows:

• Shares – notice of the assignment is given to the company whose shares are secured, possession is taken of the share certificates (together with blank stock transfer forms) and the register of members is annotated to reflect the security interest.
• Bank accounts – notice of the assignment is given to the account bank with whom the bank account is held.
• Units – notice of the assignment is given to the trustee of the unit trust whose units are secured, possession is taken of the unit certificates (together with blank unit transfer forms) and the register of unit holders is annotated to reflect the security interest.
• Contract rights – notice of the assignment is given to the contract counterparty and acknowledgment obtained.

The Guernsey Security Law also makes available wide ranging enforcement powers which provide lenders with a number of options upon any default in the financing arrangements.

1.         Are there any regulatory issues which need to be considered when a fund is borrowing pursuant to a NAV facility?

If the fund has been established as a ‘Jersey Private Fund’ then there should not be any regulatory concerns.

For slightly more regulated Expert Funds, Listed Funds and Eligible Investor Funds, no legal restrictions are set in stone but the Jersey Financial Services Commission (JFSC) reserves the right to additional scrutiny if the fund is permitted to borrow money in excess of 200% of its net asset value.  A change to the fund that is not in accordance with the guides covering these classes of funds will require prior approval from the JFSC.

For open-ended certified collective investment funds offered to the general public, which are more heavily regulated, the JFSC provides guidance on borrowing restrictions depending on the type of fund.  If these restrictions are to be exceeded, it is likely that consent of the JFSC is required and the JFSC would normally expect either investor consent or that investors are given the opportunity to redeem.

Whilst Jersey is not a part of the EU, it has implemented the EU’s Alternative Investment Fund Managers Directive into domestic law.  The introduction of leverage at fund level may trigger a change in status of a previously sub-threshold fund or fund manager requiring registration for the manager as an AIFM and the fund as an AIF and additional compliance and reporting requirements.

2.         Are there any other impediments or considerations to any restructurings that may be required to implement a NAV facility?

If a shareholder (direct or indirect) of an entity which is regulated by the JFSC under the Financial Services (Jersey) Law 1998 is changing due to a restructuring, then it is likely the prior consent of the JFSC to the restructuring will be required (in the form of a letter of no-objection).  Such no-objection confirmation may take a matter of weeks even for a straight forward internal re-organisation.

If a portfolio company (or a subsidiary of the same) is subject to regulation by the JFSC, then notice of any security should be notified by the fund to the JFSC.  Lenders should be aware that if they seek to enforce such security, the consent of the JFSC as described above will be required which could have an effect on the timings of any potential enforcement.

3.         What security in respect of portfolio entities is commonly taken and how is this taken?

We would expect a lender to require security over the relevant equity interests in the portfolio companies.  Depending on how the portfolio is structured, such security may be over a single holding company (or aggregator vehicle) or a number of different vehicles if the structure cannot be simplified.

The Security Interests (Jersey) Law 2012 (SIL) creates a modern, effective security regime permitting security interests to be created over present and future intangible moveable property in Jersey. Security can be easily taken, by way of a Jersey law security interest agreement, over (amongst other things):

• shares in a Jersey incorporated company;
• units in a Jersey property unit trust;
• interests in a Jersey limited partnership;
• bank accounts maintained in Jersey; and
• contractual obligations owed by a Jersey entity or governed by Jersey law.

SIL also makes available wide ranging enforcement powers which provide lenders with a number of options upon any default in the financing arrangements.