Special thanks to Kevin Lynch, partner at Arthur Cox, for contributing this article to the 2017 Spring Fund Finance Market Review. The views expressed are the author’s own and do not necessarily represent the views of Mayer Brown.
Overview of the Irish Funds Industry
Ireland is regarded as a key strategic location by the world’s investment funds industry. Investment funds established in Ireland are sold in over 70 countries across Europe, the Americas, Asia, Africa and the Middle East. As of July 2016 there were 6,284 Irish domiciled funds with net assets of over €1.9trn. While the majority of these fund assets are held in UCITS2 funds, Irish-domiciled AIFs had in excess of €460bn in net assets as of July 2016 (representing significant growth in the size of alternative investment funds since the introduction of AIFMD3 in 2013). The majority of the investments in these regulated investment funds comes from non-Irish institutional investors.
Fund Financing and Security
Lending to Irish funds is typically structured as either a bilateral or syndicated facility, a note issuance agreement whereby the issuer (the fund) issues a note in favour of the note holder or a derivative contract, typically documented through an ISDA Master Agreement. Lending by AIFs4 is restricted, although it is possible to establish an AIF which is focused on loan origination, including investing in loans. In the last number of years capital call, subscription and equity bridge facilities have become much more commonplace. Irish fund structures, particularly Investment Companies, ICAVs5 and ILPs6 , are also commonly used as property investment vehicles.
THE LENDERS AND GOVERNING LAW
At present the majority of deals in the Irish market are being financed by international financial institutions. Reflecting the international nature of the financiers, the relevant loan agreements for such transactions are commonly governed by the laws of New York or England and Wales, although there is no legal reason why they could not be governed by Irish law. The terms of the loan agreement will very much depend on the type of facility being advanced.
A key consideration in every fund financing is the security package. This will vary depending on the type of financing involved. For example, on many financings, the security package will consist of a fixed charge over the funds rights, title and interest in and to the securities and/or cash account recorded in the books and records of the Depositary (or Trustee in the case of a Unit Trust; as such, any references hereafter to a Depositary should be read to include Trustee in the context of a Unit Trust) and an assignment of the funds rights in the Depositary Agreement (or Trust Deed, in the case of a Unit Trust). Such a security package is also commonly coupled with a control agreement which will give the lender or its security agent control over relevant rights or assets either on a “day-one” or more commonly “springing lien” basis on the occurrence of a future enforcement event.
A properly drafted and structured Irish law security document should also be able to obtain the benefits of being considered a “financial collateral arrangement” pursuant to the European Communities (Financial Collateral Arrangements) Regulations 2010 (as amended). Relevant bank mandates should be reviewed and ,where necessary, amended to be consistent with the terms of the control agreement. It is very important in this context to also verify where the account is located and under whose name the account is opened. In many cases, the account holder may be a Depositary or sub-custodian and the cash account for an Irish fund may not be located in Ireland, particularly where cash is held by a subcustodian. Equally in structures where the connection with Ireland is only that the Depositary is Irishincorporated, it is not uncommon that one or more cash accounts may also be held by sub-custodians outside Ireland.
As with any financing, there is no “one size fits all”. In this regard, the typical security package for a capital call/subscription facility is quite different, commonly consisting of security over the right to call on investors for further contributions, security over the account into which such subscriptions monies are lodged and coupled with a robust power of attorney either prepared on a stand-alone basis or forming part of the relevant security document. The fund’s constitutional documents and prospectus, as well as the administrative services agreement and the subscription agreement, need to be carefully reviewed to verify who actually makes the subscription call; for example, in the context of a corporate fund such as an Investment Company or ICAV, most commonly it is the directors of the fund that make the call, but sometimes the constitutional documents also give the manager (where the corporate fund is externally managed) the power to make the call. It is important in this regard that stakeholders understand what impact a suspension of NAV7 8 or a termination or suspension of the Investment Period could have. Irish regulated funds are generally very tax-efficient, but the legal and regulatory framework can be very complex, and accordingly, proper local counsel should be engaged.
The Administrator also plays an important role in processing subscriptions, and recording and registering the subscriptions; commonly, a side letter addressed to the Lender/Agent is obtained from the Administrator in relation to the performance of their duties under the administrative services agreement insofar as they relate to subscriptions.
Over the last number of years we have also seen a steady growth in financings involving Feeder Fund structures. From an Irish law regulatory perspective, this can require careful structuring of the security package. One of the issues which requires consideration in this regard is that an Irish regulated fund cannot give “guarantees” to support the obligations of a third party (which may include another sub-fund within the same umbrella fund structure). Unfortunately, the term “guarantees” is not defined and it would be prudent to take it that this term also captures “security” to support the obligations of a third party. In Feeder Fund structures where, for example, the Feeder Fund is the borrower and the Master Fund is an Irish fund and expected to guarantee the obligations of the Feeder Fund, the rule against giving third-party guarantees is very relevant and the structure and security package will need to be carefully considered and tailored to ensure that this rule is not infringed. The use of “cascading pledges” can also, depending on the structure, be a useful tool in the security package.
GOVERNING LAW OF SECURITY PACKAGE
Irish law does not strictly require that the security package be governed by Irish law. We commonly see transactions where security is taken under the laws governing the relevant financing agreement, e.g. New York or England & Wales law. However, where the relevant secured assets are in Ireland, e.g. the securities or cash account or, for a subscription call deal, the governing law of the subscription agreement is Irish law, a lender may consider Irish law-governed security be taken in addition to any New York or other U.S.-governed security. Typically, any control agreement would be governed by the laws of the country where the account is located; however, if this not the case, local law guidance and preferably a legal opinion should be obtained to ensure that the use of a different governing law will be enforceable in the relevant jurisdiction.
As a common law jurisdiction, there is no issue as a matter of Irish law with security being granted in favour of a security agent or security trustee and, subject to the bank licensing considerations referred to previously, it is not necessary under Irish law for the security agent to be licensed in Ireland to enforce its rights. A point to note in relation to the enforcement of Irish security is that on enforcement typically it is a receiver appointed by the lender/security agent who will be appointed over the secured assets and realise same on behalf of the secured parties. One advantage of this from a lender/security agent perspective is that the Irish security document will contractually provide that the receiver is the agent of the borrower rather than the lender(s)/security agent, thereby insulating the lender/security agent from potential claims arising from the actions of the receiver as part of any enforcement.
CONSENTS AND STAMP DUTY
No Irish governmental consent or stamp duty is generally required/payable in connection with the execution of security in fund financing. However, where a security assignment is being taken over, the depositary agreement should be carefully reviewed to check that the prior consent of the Depositary and/or the Central Bank is not required. In cases where the assignment is taken by way of security rather than being a true assignment, the consent of the Central Bank will not be required as it permits funds granting such security in connection with its borrowings and for receivers appointed by the lenders enforcing such security.
Once security has been created, lenders will need to ensure that the security, if created by an Irish entity or an entity required to be registered in Ireland as a branch whether governed by Irish law or otherwise, is registered against the correct entity in the appropriate Irish registry. For example, (1) security created by an Investment Company will be registered in the file of the Investment Company in the Irish Companies Registration Office (“CRO”) and (2) security created by a trustee or its nominee as part of a Unit Trust structure will be registered in the file of the trustee/its nominee in the CRO. Importantly, as ICAVs are established under the ICAV Act rather than the Companies Act, registrations for ICAVs are made in the file of the ICAV with the Irish Central Bank rather than the CRO. Particulars of all such security in the form prescribed by the CRO (Form C1) or the Irish Central Bank (Form CH1) must be filed within 21 days of the date of creation of the security and, in the absence of such, filing is void against a liquidator and any creditor.
PROPERTY FUND FINANCING
Irish funds are also popular vehicles for investment in Irish real estate by both Irish and non-Irish investors. In our experience, Investment Companies and ICAVs have been the most popular platforms used by investors, but some investors have also used Unit Trusts due to their familiarity with same in their home jurisdictions. While many investors establish their own fund platforms, it is also possible to establish a sub-fund as part of an existing platform set up by a service provider, a so-called “rent-a-fund”. This can save on the establishment cost. In some deals, ILPs are also set up under the relevant Investment Company or ICAV sub-fund for finance structuring reasons.
The loan agreement in financings for such funds is typically based on the LMA Real Estate Finance form of loan agreement. This is commonly governed by Irish law but, if necessary, could equally be governed by the laws of England & Wales (adapted as required). There are a number of key modifications that need to be made to the LMA form, including, in particular, how to reflect the role and importance of the relevant service providers in such structures, such as the management company, AIFM and the Depositary, the applicable events of default, regulatory compliance matters, the change of control provisions and the security package.
The security package will always consist of security over the relevant property and related assets and in many, but not all, cases, security over the shares/units in the fund/sub-fund. Where the fund/sub-fund has invested in real estate through an ILP, security can also be granted over the sub-fund’s interest in the ILP, and security is also taken over the shares held by the shareholder of the general partner of the ILP. This is important as, in an ILP, it is the general partner who contracts for the ILP and, on an enforcement, having security over those shares means that the lender can exercise control over the general partner and its contracting powers.
As with all fund-financing structures, it is crucial at an early stage of any property fund-financing deal to ascertain who has title to the assets and who has contracting power. An additional point to note in this regard is that the Depositary of the fund investing in real estate is obliged to maintain “control” over the property and related assets, such as rental income. Previously, this was interpreted by Depositaries to mean that title to the property had to be registered in their name. However, as registered owner of the property, this potentially exposes the Depositary to claims; for example, in relation to environmental liability, but also to being named in court proceedings if there is a rent dispute. The practice which has emerged in this regard is that either the Depositary has title registered in the name of a nominee company it establishes or, more commonly, it registers a caution on the relevant property title which restricts future disposals, including on any enforcement. It is crucial in this context to obtain a Control Letter/Deed of Control from the relevant Depositary to regulate the rights and duties of the Depositary on any future enforcement by the lenders but also, for example, to regulate how the Depositary operates the fund’s bank accounts to ensure compliance with the account control and waterfall provisions of the facility agreement. Commonly the rent account in such transactions is opened in the name of the Depositary, and it is Depositary signatories who are named on the bank mandate.
Hotel financing can also be accommodated through a fund structure. Particular issues can arise in relation to this type of structure where a separate OpCo/PropCo structure is used, and advice should be sought at an early stage to optimise the structure and ensure that financing can be put in place.