Prepackaged Bankruptcy Offers Investors a Quick Return to Liquidity Chapter 11 bankruptcy cases are typically lengthy and expensive, potentially lasting years and costing millions of dollars in fees and expenses. One valuable technique to minimize a debtor’s time in Chapter 11, reduce cost and disruption, and still secure the benefits of a Chapter 11 plan is a prepackaged bankruptcy (also called a “prepack”). In a prepack, a debtor negotiates the terms of a chapter 11 plan and solicits votes prior to the bankruptcy filing. One of the greatest benefits of a prepack is that it allows a company to quickly implement a balance sheet restructuring without the consent of 100% of its creditors. While restructuring debt outside bankruptcy often requires unanimous consent from financial creditors, a prepack requires the support of creditors that hold two-thirds in amount and more than onehalf in number of claims voting in a class under the bankruptcy plan. As a result, where full consensus cannot be obtained, a prepack may provide an attractive option for funds seeking to implement a balance sheet restructuring. An analysis of the 12 largest prepacks in the U.S. Bankruptcy Court for the Southern District of New York (“SDNY”) from 2012 to 2014 demonstrates that prepacks are relatively quick proceedings. Prepacks in the SDNY can be confirmed as soon as 30 days from the bankruptcy filing and generally do not take longer than approximately 80 days to complete (with many finishing much sooner). To this end, the local rules for the SDNY provide that the disclosure statement and confirmation hearings should be combined “whenever practicable,” which eliminates the need to have (and prepare for) two hearings, the requisite notice period for each (28 days), and the accompanying cost. The local rules for the SDNY Attorney Advertising In This Issue Prepackaged Bankruptcy Offers Investors a Quick Return to Liquidity.......................................................................... 1 ILPA Seeking Input on Proposed Private Equity Fee Reporting Template ............................................................. 2 Funds That Employ Foreign Nationals Should Begin Preparing for Highly Competitive H-1B Visa Program............ 4 SEC Takes Positive Steps Toward Crowdfunding Rules and Clarifying General Solicitation....................................... 5 Florida Open for Clean Energy Financing After Court Removes Barrier to PACE Programs..................................... 6 Getting a Deal Done in Delaware Without Revlon ................ 7 Editorial Team December 2015 Kramer Levin’s Funds Talk provides legal commentary on the news and events that matter most to alternative asset managers and funds. www.kramerlevin.com Funds Talk The contents of this publication are intended for general informational purposes only, and individualized advice should be obtained to address any specific situation. Robert N. Holtzman firstname.lastname@example.org | 212.715.9513 Gilbert K.S. Liu email@example.com | 212.715.9460 Ernest S. Wechsler firstname.lastname@example.org | 212.715.9211 Mergers and Acquisitions Securitization Bankruptcy Thomas T. Janover email@example.com | 212.715.9186 Derivatives and Structured Products Fabien Carruzzo firstname.lastname@example.org | 212.715.9203 Insurance and Reinsurance Daniel A. Rabinowitz email@example.com | 212.715.9378 Employment Barry Herzog firstname.lastname@example.org | 212.715.9130 Tax Robin Wilcox email@example.com | 212.715.3224 White Collar Defense and Investigations Mark F. Parise firstname.lastname@example.org | 212.715.9276 Regulatory Kevin P. Scanlan email@example.com | 212.715.9374 Fund Formation www.kramerlevin.com Funds Talk 2 also permit the waiver of the requirements to (1) file schedules and statements of financial affairs and (2) hold a meeting of creditors pursuant to Section 341 of the Bankruptcy Code — all of which save the debtor time and money. Moreover, in a prepack much of the work required to document the restructuring (including the drafting and solicitation of a chapter 11 plan) is completed before the bankruptcy filing so that as of the filing, the primary unresolved issue is confirmation of the chapter 11 plan. By minimizing a debtor’s time in bankruptcy, a prepack limits the administrative costs that a debtor would otherwise incur during the bankruptcy case. Furthermore, in prepackaged cases, the United States trustee often declines to appoint a statutory committee, leading to significant cost savings. Where, as is common in prepacks, all unsecured creditors are either unimpaired or have otherwise voted in favor of the plan, an unsecured creditors’ committee is not necessary. Indeed, local rules for the SDNY contemplate that a creditors’ committee should not typically be appointed in a prepack “where the unsecured creditors are unimpaired.” In addition, an equity committee will not be appointed in cases where equity holders are clearly out of money. As a result, out of 12 cases analyzed, only two had a statutory committee. Prepacks also help preserve vendor and customer confidence and employee morale. Since a chapter 11 plan is negotiated before a bankruptcy filing, the debtor can better provide these constituents with clarity on how they will be treated in the restructuring, thereby obtaining their cooperation and support upon the filing. Also, the accelerated bankruptcy timeline greatly simplifies vendor and creditor communications concerning the bankruptcy. Finally, negotiating a plan prior to the bankruptcy filing limits an adverse party’s ability to use the bankruptcy process as leverage in its negotiations with the debtor. Specifically, once the debtor is in bankruptcy, an adverse party can cause dislocation for the debtor through motion practice (including motions to appoint an examiner, lift the automatic stay and/or terminate exclusivity), whereas outside bankruptcy, an adverse party’s ability to cause disruption is more limited. In sum, the prepack structure provides a viable alternative to a traditional chapter 11 filing if the goal of the restructuring is to implement a balance sheet restructuring. A prepack offers a comparatively quick and efficient way to restructure a company’s debt obligations with minimal operational disruptions and, even with unanticipated delays, allows a company to emerge from bankruptcy in a fraction of the time necessary for a traditional chapter 11 filing. n For more information, please contact: Stephen D. Zide firstname.lastname@example.org | 212.715.9492 ILPA Seeking Input on Proposed Private Equity Fee Reporting Template The Institutional Limited Partners Association (“ILPA”), a global organization representing private equity fund limited partners (“LPs”), released a draft template setting forth recommended reporting practices with respect to the disclosure by private equity fund managers A prepack offers a comparatively quick and efficient way to restructure a company’s debt obligations with minimal operational disruptions and, even with unanticipated delays, allows a company to emerge from bankruptcy in a fraction of the time necessary for a traditional chapter 11 filing. www.kramerlevin.com Funds Talk 3 (“GPs”) of the fees and expenses borne by the private equity funds managed by the GPs. The proposal is the first product of ILPA’s Fee Transparency Initiative, a broad-based effort involving senior investment and reporting professionals from a cross section of investor institutions and advisers that seeks to establish stronger and more consistent standards for fee and expense reporting and compliance disclosures among investors, fund managers and their advisers. Feedback on the proposed template is being accepted until Dec. 11, and final guidance is expected to be published by Jan. 29, 2016, along with broader recommendations on fee reporting and compliance disclosure best practices. The consultation period is an opportunity for GPs and LPs alike to get involved in a collaborative dialogue regarding disclosure and transparency within the private equity fund industry. A greater level of involvement by all affected parties should help ensure a more balanced and practicable outcome, as LPs are likely to use the final product in their discussions with GPs in the future. As currently written, the proposed template would require GPs to disclose specific fees received from portfolio companies. It would also require fund managers to clearly report how much of those fees they have passed on to investors via reduced management fees. GPs would be obligated to report these figures in three categories: (1) on a quarterly basis, (2) for the trailing 12-month period and (3) since the fund’s inception. The template is part of a larger movement focused on enhancing the level of transparency private equity fund managers offer their investors. Fee and expense practices have been subject to increased scrutiny since May 2014, when Andrew J. Bowden, a director of the SEC’s Office of Compliance Inspections and Examinations, indicated that the SEC had identified high rates of fee- and expense-related violations in investment adviser examinations. More recently, public pension funds have called for better reporting practices from the private equity fund managers with which they invest. In August, the California Public Employees’ Retirement System said it would require private equity fund managers to disclose the fees they receive from portfolio companies if they want to receive future investments from the $300 billion fund. Subsequently, the New York City Retirement System wrote to 200 investment firms to demand “full transparency” on a range of fees, both on a historical basis and on a quarterly basis going forward. Funds that decline could be cut off from the nation’s fourth-largest pension fund. ILPA has moved the market through some of its previous efforts, most notably through its Private Equity Principles Version 1.0, released in 2009, and the revised Version 2.0, released in 2011. Designed as best-practice documents, they outline “a means to restore and strengthen the basic ‘alignment of interests’ value proposition in private equity.” Both were devised through an extensive consultation process that included both GPs and LPs. The group’s call for feedback on its proposed template is the latest step in this process, and it represents another opportunity for discussion between LPs and GPs regarding the terms of private equity fund investments. n For more information, please contact: Kevin P. Scanlan email@example.com | 212.715.9374 The proposed template would require GPs to disclose specific fees received from portfolio companies. www.kramerlevin.com Funds Talk 4 Funds That Employ Foreign Nationals Should Begin Preparing for Highly Competitive H-1B Visa Program Financial institutions and private investment funds should determine now whether any professional employee will require the filing of an H-1B petition. By way of background, the H-1B specialty occupation status permits professionals (including, for example, financial analysts, quantitative analysts, accountants and computer systems analysts) to work in the U.S. For an individual to qualify for H-1B status, the employer must offer a position that normally requires at least a bachelor’s degree in a specific field, and the foreign national must have earned at least this degree in this or a closely related field. Degree equivalency is permitted under limited circumstances to provide possible H-1B eligibility for persons lacking formal degrees, or for those who have foreign degrees unrelated to the position offered. As a general rule, three years of progressive work experience may be substituted for each year of university that is missing. Individuals may hold H-1B status for a total of six years, and possibly even longer if a permanent residence case has been commenced. The filing period for FY 2017 will begin on April 1, 2016, for requests for H-1B status effective Oct. 1, 2016. The H-1B category is well-suited for financial institutions and investment firms alike, which routinely hire students or recent graduates of U.S. universities for a year of practical training. However, at the end of that year, in most cases, firms are unable to continue employing these recent graduates without having H-1B petitions approved on their behalf. Unfortunately, in the past several years, the demand for the annual allotment of 85,000 H-1B numbers (65,000, plus an additional 20,000 for those who were awarded U.S. master’s or higher degrees) has far exceeded the supply. Last year, U.S. Citizenship and Immigration Services (“USCIS”) received 233,000 petitions for the 85,000 H-1B slots during the first five days of the filing period. If the annual cap is reached in the first five business days, as it was in the past several years, USCIS will conduct a random lottery to select the 85,000 petitions that will be adjudicated. Filings that are not selected are returned with government filing fees. Several factors contribute to the H-1B category being so heavily utilized. It doesn’t require the employing entity to be owned by nationals of a particular country (as is the case with E-1 and E-2 visas), and it doesn’t require previous experience abroad with the employer (as do L-1s); it doesn’t depend on the nationality of the individual (TNs, H-1B1s or E-3s); and it doesn’t (in most cases) depend on a shortage of qualified U.S. workers for the position (the standard for most employmentbased permanent residence categories). Due to the high demand for H-1B numbers, employers should begin planning for the upcoming H-1B filing period now to ensure their petitions are ready to file on March 31, 2016. n For more information, please contact: Mark D. Koestler firstname.lastname@example.org | 212.715.9385 Matthew S. Dunn email@example.com | 212.715.9408 The H-1B category is well-suited for financial institutions and investment firms alike, which routinely hire students or recent graduates of U.S. universities for a year of practical training. www.kramerlevin.com Funds Talk 5 SEC Takes Positive Steps Toward Crowdfunding Rules and Clarifying General Solicitation In a long-awaited decision, the SEC adopted final rules that will allow companies to offer and sell securities through the use of crowdfunding. The final rules represent a reluctant but positive first step by the SEC in allowing companies to take advantage of the potential source of fundraising. The final rule permits non-reporting U.S. companies to raise $1 million in any rolling 12-month period. Potential investors with an annual income or net worth less than $100,000 can invest the higher of $2,000 or 5% of their annual income or net worth, while those with an annual income or net worth exceeding $100,000 can invest up to 10% of their annual income or net worth but never in excess of $100,000 in a 12-month period. Nonprofit groups and individuals have been taking advantage of the Internet to raise funds for years. However, companies have been reluctant to use crowdfunding to sell securities, due to the stringent registration process required by Section 5 of the Securities Act of 1933. In order to lessen those requirements and help small businesses and startups attract investments and create jobs, Congress passed Title III of the JOBS Act of 2012. Since then, adoption of these rules had been held up, in part over the regulator’s concerns that investors could potentially be more easily defrauded online. In setting these limits, the SEC sought to strike a balance between allowing companies access to this new source of capital and creating jobs while also protecting investors. Although adoption of the crowdfunding rule will be well-received by investors and startups alike, both groups will hope the regulator isn’t done yet. Should the adopted rules result in a limited number of fraud cases or failed companies, the SEC could further loosen the restrictions, increase the amount that companies can raise and allow investors to take on greater risk by permitting larger investments. While the crowdfunding rules grabbed the majority of the headlines, a related SEC announcement is also of interest to fund managers. In several Aug. 6 Compliance and Disclosure Interpretations related to Regulation D of the Securities Act, the SEC expanded on existing guidance regarding the use of general solicitation in attracting capital. The SEC provided guidance that general solicitation is acceptable under certain circumstances, specifically where a “pre-existing, substantive relationship” exists with a prospective investor. Essentially, the issuer must have formed a relationship with prospective investors prior to any solicitation and be sufficiently familiar with their financial status and investment knowledge in order to determine their suitability for the solicitation. Therefore, a fund manager seeking to raise capital for a new fund can avoid general solicitation by reaching out to current and past investors with which it has a pre-existing, substantive relationship to invest in the new fund, and during the offering can create a relationship with accredited or sophisticated investors after commencement of the offering if there is a reasonable waiting period before making the investment. This represents a loosening of these rules and is consistent with the JOBS Act’s intention of helping firms raise money and encouraging economic growth. n For more information, please contact: Christopher S. Auguste firstname.lastname@example.org | 212.715.9265 The SEC could further loosen the restrictions, increase the amount that companies can raise and allow investors to take on greater risk by permitting larger investments. www.kramerlevin.com Funds Talk 6 Florida Open for Clean Energy Financing After Court Removes Barrier to PACE Programs In an Oct. 15 opinion, the Florida Supreme Court rejected a challenge to property-assessed clean energy (“PACE”) programs, which provide upfront financing to residential and commercial property owners that allows them to use green energy technology to improve their properties. The decision continues the trend of an increasingly friendly environment for clean energy producers and providers — as well as the investment funds that back them. The decision is a victory for both the renewable energy industry and municipalities in Florida, as it should help expand the use of such programs across the state. Residential PACE programs — which surpassed their commercial counterparts in 2014 — represent a tremendous growth opportunity for financing activity. The ruling confirms Florida as the 30th state in the U.S. to authorize PACE programs, and the state could become the second-largest residential PACE market in the country, behind California. While some areas, including MiamiDade County, already allowed PACE programs, Broward County and other jurisdictions had suspended implementation of local programs due to the uncertainty caused by the court challenge. In conjunction with the current political and regulatory focus on increasing the use of renewable energy, opportunities in this area are likely to increase now that the court has removed a barrier. California has led the way on PACE projects to this point. Program administrators retained by counties and other municipal entities have successfully placed a series of rated securitizations of PACE assets. Leading the way has been the HERO program of Renovate America, which has issued five deals in its program. In July, Ygrene Energy Fund also announced a $150 million private securitization transaction to help fund 6,210 energy and water conservation projects in partnership with local municipalities. In its decision, the Florida Supreme Court ruled against the Florida Bankers Association, saying the group did not have standing to fight the program. The bankers’ group — echoing concerns expressed by federal housing regulators — had argued that PACE loans could negatively affect mortgages should they be paid back before mortgages. The Florida decision was significant for the future of residential PACE programs in Florida, where they have previously been used only on a limited basis. Combined with the Obama administration’s Clean Power Plan Rule, announced in August, these decisions further contribute to market conditions that are increasingly hospitable to investments in renewable energy projects. n For more information, please contact: Laurence Pettit email@example.com | 212.715.9458 The decision continues the trend of an increasingly friendly environment for clean energy producers and providers — as well as the investment funds that back them. www.kramerlevin.com Funds Talk 7 Getting a Deal Done in Delaware Without Revlon In its recent decision of Corwin v. KKR Financial Holdings LLC, the Delaware Supreme Court did two things. It affirmed that a court will not apply an entire fairness review to a merger transaction so long as the board is disinterested and the acquirer does not have “effective control,” no matter how closely tied the acquirer is to the operations of the target company. Second, it championed the informed and uncoerced vote of a disinterested majority of shareholders as a cure for many sins of the M&A process, including the failure to follow Revlon. In 2004, KKR & Co. LP, the well-known publicly traded investment company (“KKR”), formed KKR Financial Corp., a Maryland real estate investment trust (“KKR Financial”), which in 2005 engaged in a public offering. Then, in 2007, KKR Financial restructured so that it became a subsidiary of KKR Financial Holdings LLC, a publicly traded Delaware limited partnership (“KFN”). The subsequent going-private transaction in 2013-2014, in which KFN was acquired by KKR, is the subject of the case. Everything about KFN, except its ownership and the majority of its board, was tied to KKR. KFN’s primary asset was a portfolio of subordinated notes in collateralized loan transactions that financed KKR’s leveraged buyout activities. KFN delegated management responsibility for its operations to KKR Financial Advisors LLC (“KFA”). By its own statement, KFN was wholly dependent on KFA. Thus, KFN had no facilities or employees, and KFA was responsible for KFN’s investments, financing, risk management and valuation of its assets. KFN’s management agreement with KFA could be terminated only under certain circumstances and the payment of a substantial termination fee. As alleged by plaintiffs, the amount of the termination fee as of the end of 2012 exceeded the amount of cash and cash equivalents on the balance sheet of KFN at the time. On the other hand, KKR owned only a de minimis amount of the equity of KFN, and only two of the 12 directors on the board of KFN were clearly affiliated with KKR. In late 2013, KKR expressed interest in acquiring KFN in a stock-for-stock merger. In the negotiations that ensued, the KFN transactions committee of independent directors succeeded only in extracting a minimal improvement in KKR’s offer, from 0.50 to 0.51 KKR shares per KFN share. The exchange ratio reflected a 35% premium over the trading value of KFN shares on the date the merger agreement was executed in December 2013. Plaintiffs observed, however, that at the time the KFN shares were trading near their one-year low, while KKR shares were trading near their one-year high. The merger was approved by a vote of the KFN shareholders, and the merger was consummated in April 2014. Plaintiffs claimed that the merger transaction should have been reviewed by the court under the standard of entire fairness rather than the far more lenient standard of the business judgment rule. The entire fairness standard is reserved for transactions with controlling shareholders, essentially because the controlling shareholder is positioned on both sides of the transaction. With KKR’s tentacles wrapped around KFN in numerous directions, plaintiffs urged that KKR was indeed a controller of KFN. The Delaware Supreme Court, agreeing with the court below, gave this argument short shrift. While KKR controlled the operations of KFN, it owned virtually no stock, and the board was largely independent of KKR. KFN’s almost total operational dependency on KKR was of no consequence. KKR did not have what was termed “effective control” over KFN, that is, “a combination of potent voting power and management control.” The court’s decision is consistent with its holding in Kahn v. M&F Worldwide Corp. The court held in that case that given an independent committee of directors and www.kramerlevin.com Funds Talk 8 a majority vote of disinterested shareholders, the business judgment rule will apply even in transactions with an undeniable controlling shareholder. Plaintiffs next argued for relief on the basis that the KFN board failed to conduct a sale process that complied with its duties under the famed case of Revlon v. MacAndrews & Forbes Holdings, Inc. In Revlon, the Delaware Supreme Court held that in a sale of a company, the directors must exercise their fiduciary duties so as to achieve the highest price reasonably available. Plaintiffs were arguing, it seems, that the KFN board conducted neither an auction nor a market check, nor took any other action that would satisfy Revlon. Ignoring whether the plaintiffs properly pleaded a Revlon claim, the Delaware Supreme Court said that it did not matter. First, Revlon was designed primarily for injunctive relief to be applied before closing of a transaction; the plaintiffs here were seeking post-closing relief. Second, and more important, when a merger transaction is approved by a fully informed, uncoerced vote of disinterested shareholders, the default business judgment rule applies even if there are process defects. These defects could include a failure to follow Revlon or the existence of interests of directors in the transaction that might have tainted the board’s decision-making process. So long as there was full and fair disclosure to shareholders and an uncoerced vote, the defects will be overlooked. The opinion implies, but does not expressly state, that the principles of the case could apply even to a challenge brought prior to the vote. There is a caveat, however. The opinion does not apply to a transaction that is subject to an entire fairness review. Corwin v. KKR provides clear recognition that having a substantial operational interest in a company does not necessarily equate to control, with its higher standards for M&A transaction process and procedure. Second, Revlon is not the be-all and end-all condition for immunizing a change-of-control transaction in Delaware. A board may be able to dispense with Revlon provided that it is fully candid with its shareholders about the proposed transaction and does not coerce the vote. Moreover, even conflicts of interest in the boardroom are not fatal, so long as they are carefully explained to shareholders, as implied by Section 144(a)(2) of the Delaware General Corporations Law. This is not to suggest that companies should lightly dispense with a more traditional approach of following Revlon and quarantining conflicts, but it is good to know that there may be a fallback when the exigencies of a transaction do not allow for best practice. n For more information, please contact: Abbe L. Dienstag firstname.lastname@example.org | 212.715.9280 NEW YORK 1177 Avenue of the Americas New York, NY 10036 212.715.9100 PARIS 47 avenue Hoche Paris 75008 +33 (0)1 44 09 46 00 SILICON VALLEY 990 Marsh Road Menlo Park, CA 94025 650.752.1700 www.kramerlevin.com A board may be able to dispense with Revlon provided that it is fully candid with its shareholders about the proposed transaction and does not coerce the vote.