Private equity firms have enjoyed success in a range of investment activities and value creation strategies. But success has also made private equity the subject of scrutiny as transparency becomes an issue, meaning it may not be long before the industry is regulated.
Buyout vehicles must be flexible to facilitate the structuring required to meet investors’ needs and that is what the British Virgin Island (BVI) vehicle provides.
The BVI company will normally enter into the typical debt finance documents (loan agreement, inter-creditor agreement and security documents) and with the equity investment will finance the acquisition of the shares/assets. While financial assistance is not an issue, there can be complications in taking security involving a BVI company and lenders would be well advised to seek appropriate advice. The structuring of the equity investment is perhaps the most relevant aspect.
The main documents are the shareholders’ agreement (SA) and the memorandum and articles of association (M&AA). The SA can be governed by a law other than BVI law, but it is necessary that, in all salient respects, the SA and the M&AA do not conflict. As a result, the requirements of BVI law in relation to notice of meetings of directors and members, voting, quorum, transfer restrictions and the like must be considered when drafting.
BVI law provides that a director of a company (if expressly permitted to do so by the M&AA) that is carrying out a joint venture may, when exercising powers or performing duties as a director, act in a manner that they believe is in the best interests of a shareholder, even though it may not be in the best interests of the company. This is a departure from the common law, and to take the benefit of this provision the facts must fall squarely within the statutory parameters and directors must remain subject to all other common law and statutory duties.
In New Zealand there is similar legislation, and in Australia, where there is also similar legislation, case law recognises that a ‘nominee’ director may promote the interests of their appointor so long as they bona fide believe it is consistent with the interests of the company and that belief is not totally unreasonable.
The fact that directors of a BVI company may be appointed (i) by the members by resolution, or (ii) if the M&AA permits, by the directors, or (iii) by some other person if the M&AA so provide, or (iv) otherwise than by resolution of members, means that the M&AA may be drafted to permit board appointments by a single shareholder or by a major creditor without the need for complicated appointment mechanics or without approval of the members or the existing board at all.
The BVI draftsman has, it seems, been influenced by the New Zealand Companies Act 1993, where it is reported to be common, in relation to such appointments, for the members to be bypassed.
Public to private
For decades BVI companies have been listed on the world’s major exchanges and some will be taken private for various reasons, including market slowdown, changes in the laws, the increased cost of remaining listed, or directors who are perceived as an increase in liability. It may also be as simple as a view by a private equity house that the company is undervalued. Whatever the reason, there are mechanisms under BVI law to enable a company to be taken private in a relatively straightforward manner, subject of course to dissenters’ rights.
By way of statutory merger and thus by operation of law, ‘constituent’ companies (two or more existing BVI companies or one BVI-incorporated and one not, provided that foreign law permits the merger) may merge into one of the constituent companies. In the case of consolidation, the constituent companies combine to form a new company. Also permitted is a merger between a parent and a subsidiary. The statute permits shares to be cancelled, reclassified or converted into money or other assets, or into shares, debt obligations or other securities in the surviving or consolidated company. Shares of the same class may be treated differently – that is, some members may be given shares in the surviving or consolidated company while others of the same class can receive cash instead.
A ‘squeeze-out’ procedure may be implemented if members holding 90 per cent of the votes of the outstanding shares entitled to a vote and 90 per cent of the votes of the outstanding shares of each class of shares entitled to a vote as a class instruct the company in writing, directing it to redeem the shares held by the remaining members. Upon receipt of the instruction the company must redeem those shares.
Finally, it is possible that a BVI court-approved merger or demerger may provide benefits of a financial or regulatory nature in other jurisdictions, and BVI law provides for Plans of Arrangement and Schemes of Arrangement. The distinction lies in the fact that the former is a process to effect a very wide range of restructurings by way of court approval and must be instigated by the board. The latter involves an application by, among others, the company, a creditor, a member or a voluntary liquidator and provides a statutory framework for the company and some or all of its creditors or members to compromise or change their rights against the company subject to court supervision.
The need for hedge funds to increase investment returns, attract investors and reduce risk means that hedge funds with excess moneys have taken an interest in private equity, thus blurring the boundaries. A consequence is that the illiquidity of private equity and issues such as calculations of net asset value of the investment, in light of its nature, has given rise to ‘side pockets’. This mechanism permits illiquid investments, such as in private equity, to be placed in a side pocket (apart from more liquid investments in the fund) and only those members that were members on or before the creation of the side pocket may participate in such investment. Approximately 4,000 hedge funds have been registered in the BVI and it is anticipated that convergence will continue to impact on this number.
–Leonard Birmingham is a partner at Harneys