Our first article, by John Taylor and Laura Stuckey, offers some practical tips for optimising the chances of achieving a successful transaction with Chinese buyers on inbound European acquisitions. This is an area of increasing activity and one which looks set to grow further over the coming year. However, European sellers can be sometimes daunted by the unfamiliar regulatory regime and differences in approach to doing deals. This article aims to demystify some of the approvals which may be required and highlight some of the key issues European sellers may wish to consider when embarking on such a transaction.
Our second article discusses various new tax measures arising out of the legitimate tax-optimisation schemes used by multinational companies which have come under increasing media scrutiny in recent years. Isaac Zailer considers the background to this topical issue, before analysing the potential impact of some of these new measures on the private equity industry.
The third article is a guest article by our best friend law firm, WKB Wierciski Kwieciski Baehr which provides an overview of the private equity market in Poland. Ben Davey and Jakub Jdrzejak of WKB discuss certain issues which may be relevant for foreign investors in the Polish market, including the regulatory regime and the particular need for thorough due diligence, before outlining market practice with regard to deal terms and financing. Finally, the article considers some opportunities for private equity investors in Poland throughout 2017 and beyond.
The final article, by Will Nevin and Gonzalo Martin de Nicolas, analyses the leveraged finance market in Spain, setting out the key trends relevant to international private equity investors. Will and Gonzalo go on to discuss the documentary and execution requirements which are particular to leveraged buy-outs in Spain.
Although many questions about how Brexit will take shape still remain, some clarity has been brought to the issue of how the UK proposes to leave the EU in recent months.
With the benefit of this improving visibility, the fourth edition of our legal guide, looking at the implications of Brexit in light of recent actions by the UK Government, Parliament and the courts, can be found on our website at:
Considered in John Taylor and Laura Stuckey's article, Chinese outbound M&A investment into Europe is set to be a continuing trend for 2017. The HSF private equity team intend to hold a webinar in Q2 2017 which will discuss some of the themes outlined in the article and practical tips for achieving success with Chinese buyers.
Further details on the webinar and how to register for the event will be released shortly. For further information, please contact Gulya Gulieva at firstname.lastname@example.org.
02 ACHIEVING SUCCESS WITH CHINESE BUYERS
HERBERT SMITH FREEHILLS
ACHIEVING SUCCESS WITH CHINESE BUYERS
Buyers from the People's Republic of China (PRC) continue to demonstrate a healthy enthusiasm for outbound M&A investments into Europe.
According to a recent Mergermarket report, 142 deals featuring PRC buyers and European targets were announced in 2016, worth approximately 70.7bn, compared to 83 deals worth approximately 23.5bn in the previous year an increase in deal value of over 200%. 2016 also saw the announcement of ChemChina's US$43.8bn acquisition of Syngenta, the largest ever outbound Chinese M&A deal to date, which demonstrates the increasing scale of PRC deals in Europe and the US (see box 'Recent Large Scale Outbound M&A Transactions by PRC Buyers').
FROM TOP John Taylor Partner, London
Laura Stuckey Associate, London
Market commentators anticipate that Chinese appetite for acquisitions in Europe is set to continue throughout the year of the Rooster (2017) despite recent developments in the PRC regulatory landscape which indicate tightening control on flight of capital (see box 'Recent developments in regulation of outbound M&A in the PRC') and increased protectionism by governments in seller jurisdictions. The latter has been a particularly prevalent factor in the US, where the Committee on Foreign Investment in the United States (CFIUS) blocked the US$2.8bn sale by Philips of its Lumileds business to a consortium led by China's GO Scale Capital on the basis of possible national security concerns, and there are similar calls in Europe, by countries such as Germany, France and Italy, to increase the ability of governments to block takeovers by Chinese investors in key industries.
Increasing attraction of PRC buyers
In light of this, European PE sellers are likely to receive increasing interest in investment targets from PRC buyers which is no bad thing, particularly on the basis that:
the spectrum of PRC buyers and the breadth of sector investment has increased significantly over the last few years. Although state-owned enterprises (SOEs) still tend to participate in the largest transactions in the market, private-owned entities (POEs), listed companies and high net worth individuals are also very active in the European M&A space in a wide range of industries, including technology, energy, mining, utilities, industrials, chemicals, healthcare, consumer goods, real estate and infrastructure, financial services and leisure;
Recent large scale outbound M&A transactions by PRC buyers
ChemChina announced its intention to acquire Swiss a grochemical and seeds company Syngenta via a tender offer for US$43.8bn EU and US antitrust approval for this transaction was secured in early April 2017
PRC buyers participating in outbound investment are typically cash rich and have been known to apply high valuation multiples when assessing targets, which can make bids appealing; and
the increasing number of successful Chinese outbound M&A transactions demonstrates a sharpened understanding of European M&A deal dynamics and structuring among PRC buyers and an ability to participate competitively in auctions and other sales processes. It is also increasingly common for consortia, made up of PRC strategic buyers as well as private equity investors (both Western and Chinese) to participate in auction bids. Such parties complement each other in terms of what they can each bring to the table. In particular in highly competitive auctions, where speed and credibility are critical, PRC buyers often partner with seasoned PE buyers to benefit from the latter's experience in deal structuring, negotiation, valuation, financing and execution, and the credibility a PE partner offers in fronting the negotiations with sophisticated sellers and their financial advisers.
Qingdao Haier, a Shanghai stock exchange listed company that is 41% owned by Haier Group, completed its US$5.4bn acquisition of GE Appliances from General Electric
SEPT/O CT 2016
Blackstone completed its US$6.5bn disposal of Strategic Hotels and Resorts to Anbang Insurance and shortly after announced its intention to sell a 25% stake in Hilton Worldwide Holdings Inc to Chen Feng's HNA Group for US$6.49 billion
However, European PE sellers are often concerned about the sometimes lengthy list of PRC approvals and filings that may be required in order to complete transactions and gaps in market practice between the PRC and Europe, which can contribute to a perception of heightened execution risk.
This article aims to guide PE sellers through some of the key areas which can cause delay and difficulties on a sale to a PRC buyer, with
HERBERT SMITH FREEHILLS
ACHIEVING SUCCESS WITH CHINESE BUYERS
practical tips for tackling potential obstacles and ensuring the successful completion of a transaction.
Navigating the PRC regulatory landscape
There are various elements of PRC outbound M&A which may trigger pre-notifications, approvals or filings with bodies in the PRC such as:
the National Development and Reform Commission (NDRC) and the Ministry of Commerce of the People's Republic of China (MOFCOM) in respect of PRC outbound investment;
State Administration of Foreign Exchange (SAFE) in respect of the remittance of foreign exchange and the provision of cross-border guarantees by PRC-incorporated entities;
the State-owned Assets Supervision and Administration Commission (SASAC) in respect of investments by SOEs;
the Chinese Insurance Regulatory Commission (CIRC), the China Securities Regulatory Commission (CSRC) and the China Banking Regulatory Commission (CBRC) in respect of investments by financial institutions;
CSRC and shareholder approvals in respect of PRC listed entities; and
MOFCOM in respect of merger control filings.
The scope of PRC approvals and filings will depend on a number of factors, including the business and location of the target, the total investment amount, the place of incorporation of the acquisition vehicle, the source of funding for the acquisition (including whether the funds are sourced from inside or outside the PRC), whether any guarantees to foreign lenders will be required, and the identity of the PRC buyer (SOE, POE, listed entity or consortium). In respect of the latter, the formation of a consortium itself may constitute "concentration" under the PRC Anti-Monopoly Law, thereby triggering a merger control filing requirement in the PRC. However, as noted above, in other respects the identity of consortia bidders can also complement each other and constitute a more attractive prospect to a European seller. For example, having a Hong Kong based private equity fund as buy-side consortium partner can mean that the funding comes from outside of the PRC (for regulatory purposes) and therefore avoids some of the SAFE/NDRC consents which can complicate deals with mainland PRC buyers.
Early identification of approvals is key Ascertaining an accurate list of required approvals and filings at an early stage should be a key seller objective on a sale to a PRC buyer, given that the approvals will form the backbone of the conditions precedent (CPs) to signing the transaction documents or completing the transaction, as well as driving the deal timetable.
We have found that the most efficient way to tackle identifying required approvals is for
sellers to engage PRC counsel at the outset. Sell-side PRC counsel should work closely with the buyer's PRC counsel to determine which governmental and non-governmental approvals will be required. As with any legislation, there is an element of interpretation to the PRC regulatory requirements so any buy-side PRC counsel assumptions should be tested by the seller's PRC counsel at an early stage. This will not only provide greater oversight of, and clarity on, the likely approvals process, but will also give sellers a vital insight into the potential support that a transaction may receive from the relevant PRC approving authorities (at central or local level) based on sell-side counsel's previous experience.
Sellers should also consider at an early stage the types of protection that may be required in the transaction documents in order to mitigate execution risk and drive the deal to completion. Protection may take the form of robust procurement obligations on the buyer to satisfy CPs, reporting obligations on the buyer to keep the seller abreast of progress with PRC regulatory bodies, and incentives, such as buy-side escrow arrangements, non-refundable deposits or break fees, to motivate the buyer to procure swift and successful satisfaction of CPs and to give the seller recourse in the event that the transaction fails. Any such requirements should be communicated to the buyer in early drafts of transaction documents to avoid lengthy negotiations on protections sought in the run up to signing.
04 ACHIEVING SUCCESS WITH CHINESE BUYERS
HERBERT SMITH FREEHILLS
Other events which may cause delay Whilst PRC approvals processes are often seen as the key gating item in achieving quick execution of a transaction, it is important to be aware of other events which may cause delay so that expectations can be managed and the deal planned accordingly. This is particularly relevant where the buyer is listed on a PRC stock exchange and shareholder approval of either the transaction or any capital increase to fund the acquisition is required.
The Shanghai/Shenzhen listing requirements are not as readily transparent as equivalent EU/US regimes and may involve unforeseen workstreams if not diligenced upfront: for example, where shareholder approval must be sought, there may be a requirement to reconcile the target's accounts to Chinese GAAP or to prepare and include an asset valuation report on the target in the shareholder circular (in particular where the transaction constitutes a "Material Assets Reorganisation"), which can be a significant and time consuming exercise. Further, the announcement of the transaction may constitute price sensitive information which requires an immediate suspension of trading in the buyer's shares as well as regular updates on such suspension and progress of the transaction to, and liaison with, the relevant exchange.
As part of the early engagement with buy-side PRC counsel, sell-side PRC counsel should carefully test (i) what information will be needed from the sellers and the target, and (ii) what the buyer's advisers (such as their financial sponsors) will require in order
to satisfy the buyer's filing or listing rule requirements (this includes any commitments or statements required from directors of the target or their advisers). Such discussions ensure that any such requirements are known from the outset and relevant information gathering can begin promptly with minimal impact to the deal timetable. This should prevent the need for the parties to reopen diligence-like workstreams following signing.
Preparing for success
Identifying external approvals early will be a significant step in realising a successful sale to a PRC buyer. However, there are other areas in a transaction which can be a source of challenge for parties, particularly where market practice in Europe and the PRC differs.
Internal approvals It is important to identify who in the PRC buy-side team has authority to make final decisions on key issues and to execute transaction documents it may not always be the team negotiating the transaction. For POEs, for example, ultimate responsibility may reside with a founder or chairman with a large equity stake. Understanding the lines of communication with the ultimate decision-maker and ensuring that key issues are escalated appropriately and in good time can be crucial in accelerating decision-making on a deal. However, it is also important to recognise that certain buy-side positions may not be reversed once a view has been taken by an ultimate decision-maker (with deal teams being reluctant to re-escalate issues).
RECENT DEVELOPMENTS IN REGULATION OF OUTBOUND M&A IN THE PRC
Increased control by the State-owned Assets Supervision and Administration Commission, on outbound investment by state-owned enterprises
Remittance of foreign exchange in the amount of US$5 million or more to be reported to the State Administration of Foreign Exchange for approval
MOFCOM AND NDRC
Increased scrutiny by the Ministry of Commerce of the PRC/the National Development and Reform Commission on certain types of outbound investment transactions, including (among others):
o utbound real estate acquisitions or d evelopments by SOEs valued at US$1bn or more;
acquisitions or investments by Chinese c ompanies in non-core business areas valued at US$1bn or more;
extra-large outbound investments by Chinese companies valued at US$10bn or more; and
minority investments of 10% or less in overseas listed companies
HERBERT SMITH FREEHILLS
Sellers should also seek to understand any prescribed internal approval processes that the PRC buyer must undertake in order to proceed with the transaction. The buy-side deal team may, for example, be required to report to, and obtain sign-off, from their internal legal team before any documents are put forward for execution. This may require a 'wait period' between documents being in agreed form and signing. Any such processes and associated requirements (such as document translations, document summaries and legal opinions from buy-side advisers) should be identified quickly and factored into the deal timetable. Due diligence In our experience, PRC buyers tend to undertake a full due diligence exercise on European targets. As such, sell-side management teams should be prepared for multiple site visits from, and face-to-face meetings with, the buyer as well as the traditional documentary disclosure and Q&A exercise. Certain areas of due diligence are likely to attract greater scrutiny from a PRC buyer, particularly where local law or allocation of risk differs from the typical PRC position (e.g. sanctions, environmental liabilities and labour relations) or where the target operates in a sector that has a particular socio-political focus in the PRC. When planning a diligence exercise, advice should be sought on which areas may be of particular interest to a PRC buyer based on the target's sector so that a buyer's critical queries can be addressed early.
ACHIEVING SUCCESS WITH CHINESE BUYERS
Herbert Smith Freehills has extensive experience of private equity sell-side processes and advising both PE sellers and PRC SOEs and POEs on significant outbound cross-border M&A transactions. Transactions are typically led by our specialist teams across London, the PRC and Hong Kong, offering full coverage across time zones, with on-the-ground Mandarin capability in each of Beijing, Hong Kong and London.
Our recent experience includes:
The Ping An 3i Group
Acting for Ping An on its acquisition of the Mayborn Group, a manufacturer of infant and parenting products including the popular "Tommee Tippee" brand. The Mayborn Group was acquired by the Ping An Group from former PE owner 3i. The acquisition, which involved HSF teams in London, the PRC and Hong Kong, is one of the first examples of a Chinese bidder successfully winning and completing a competitive auction process in the UK.
Shaanxi Ligeance Mineral Resources
Acting for Shaanxi Ligeance Mineral Resources (SLMR), which is listed on the Shenzhen stock exchange, on its 326m acquisition of Gardner Aerospace from PE owner Better Capital. HSF teams in London and France helped SLMR successfully participate in a competitive sale process for Gardner, together with SLMR's preferred local counsel in the PRC and Hong Kong.
China Resources and Macquarie
Acting for Genesis Care Limited on the sale of KKR's 45% equity stake in the company to a consortium comprising China Resources and Macquarie Group, which valued GensisCare at AU$1.7bn. GenesisCare is Australia's largest provider of radiation oncology, cardiology and sleep treatments which also has extensive operations in the UK (where it is the largest private radiotherapy provider) and Spain. The structure of this deal was complex and the documentation mostly bespoke (arrangements involved doctors and management selling down alongside KKR).
China Investment Corporation
The Blackstone Group
Acting for The Blackstone Group in relation to its 780m sale of Chiswick Park (a 1.3 million m2 development in West London) to China Investment Corporation.
06 ACHIEVING SUCCESS WITH CHINESE BUYERS
HERBERT SMITH FREEHILLS
Generally, we have found that PRC buyers are less willing to rely on vendor due diligence reports and often insist on their own 'top up' due diligence, which can extend the timetable. Buyers may also have bespoke due diligence requirements which should be taken into account by both parties: for example, if a buyer is PRC listed and the transaction requires shareholder approval, the buyer may need to (i) undertake a prescribed form of diligence on the target and (ii) obtain legal opinions on the diligence from local law firms for use in the preparation of its circular (the format and breadth of which can differ greatly from customary due incorporation, execution and enforceability legal opinions which European PE sellers may be used to seeing). It is important for both buyers and sellers to identify any such requirements promptly, before the due diligence workstreams are closed down at signing, to avoid repeating aspects of the exercise at a later date, which would encroach on sell-side management's time.
to the data room draft sale and purchase agreement), as well as ensuring that there is sufficient time in the timetable to negotiate the policy, to complete necessary diligence and to hold the underwriting call (see our Autumn 2016 edition for an indicative timeline for a seller-led buyer-side W&I insurance process).
Management incentivisation As in any M&A transaction, retention of management will often be crucial to securing the future success of the business the buyer will expect the management team to play a vital role in integrating the target into the new group, particularly where the buyer lacks experience in the European market or does not have ready access to senior executives who can step into the role of existing management where required. That said, we have experienced preference at times for PRC buyers to maintain a 100% ownership structure of acquired targets; as such, buyers may be unwilling to offer management any equity in the new group.
Warranty protection PRC buyers who are unfamiliar with acting as a counterparty to a European PE seller may not anticipate that their key source of warranty protection in relation to the business of the target will be the management team rather than the PE seller itself (given PE sellers classically provide title and capacity warranties only) and the consequent reduction in the level of recourse which this affords the buyer. Sell-side principals and advisers should communicate the likely shape of the protection package being offered to the buyer early, so that expectations are appropriately managed in this regard.
Whilst warranty and indemnity ("W&I") insurance solutions are used increasingly to bridge the gap between sellers and buyers in European M&A, the product is not widely used in the PRC and can be perceived as expensive (where the buyer is responsible for paying the premium) given it does not, by virtue of exclusions, provide back-to-back protection with the sale and purchase agreement. Where W&I insurance is proposed, advisers to the buyer will need to explain the purpose and merits of the policy, the likely exclusions and the process for placing W&I insurance upfront (sellers can assist with this by, for example, stapling a key W&I insurance terms paper
In order to retain management, other forms of incentives may need to be considered (for example retention of sale proceeds, long-term cash incentives, profit sharing and phantom share schemes) and sellers should give thought to what an acceptable alternative to equity may look like in order to manage the management team's expectations and avoid delays in negotiations.
There is sometimes a perception that the regulatory environment in the PRC and business culture differences between Europe and the PRC can make selling to a Chinese buyer an arduous process, particularly in light of the sometimes lengthy list of the PRC approvals and filings that may be required in order to complete the transaction. However, advance awareness of the potential obstacles and the assistance of an experienced advisory team that is well versed in identifying and tackling potential deal tensions can diminish the majority of these concerns for a seller and allow the sell-side team to achieve a successful sale to a PRC buyer.
OUR TOP TIPS A SUMMARY
1. Identify external approvals early including what information will be required (e.g. audit/reconciliation of accounts)
2. A gree an achievable timetable, allowing time for buyer's internal approvals processes
3. C onsider including robust procurement obligations and appropriate incentives in the transaction documents to mitigate conditionality
4. P repare for greater due diligence scrutiny, including site visits and face-to-face meetings with management
5. Highlight any `unusual' seller expectations at the outset (e.g. W&I insurance and management incentive arrangements)
HERBERT SMITH FREEHILLS
PRIVATE EQUITY AND THE "FAIR SHARE OF TAX" DEBATE: AN UPDATE
PRIVATE EQUITY AND THE "FAIR SHARE OF TAX" DEBATE: AN UPDATE
The taxation of multinational companies (MNCs) has attracted considerable media and political attention in the last few years. Readers will have no doubt had at least some exposure to critical news items concerning the taxation of MNCs such as Starbucks, Amazon, Google, McDonald's and Apple. At the heart of the debate has been the ability of MNCs to structure their affairs such that profits for tax purposes are recognised in low tax jurisdictions, irrespective that the activities generating such profits may take place in high tax jurisdictions.
Isaac Zailer Partner, London
No allegations have been made in this context that MNCs are breaking the law in setting up such structures. Instead, the criticism has been levelled at the ability of MNCs to operate fully within the law but nonetheless end up paying less than "their fair share" of the tax due on their activities. This is achieved largely by creating a disconnect between the countries where the commercial profit generating activities of the MNC are undertaken and the countries where taxable profits are reported. By way of a simple example, an interest-bearing loan made by a holding company (holdco) in a low tax jurisdiction, to its operating subsidiary (opco) in a high tax jurisdiction, has the effect of shifting profits from opco to holdco and therefore lowering the effective rate of tax of the group, through the payment of interest.
Because such profit shifting is achieved while operating fully within the law, the debate had focussed initially on the "immorality" associated with the tax mitigation techniques used by MNCs. But it has shifted relatively quickly into recognition by almost all countries that a coordinated effort in changing the law, and in particular the manner in which certain cross border transactions are taxed, will be required.
The new tax environment
In response, many countries have been modifying their domestic legislation, and in some cases have introduced new tax legislation (sometimes referred to as "Google
tax", or "Amazon tax") to counter some of the practices employed by MNCs for the purposes of shifting profits outside their jurisdiction.
In addition, the OECD has embarked on its base erosion and profit shifting (or BEPS) project: a wide-ranging study of the practices used by MNCs to optimise tax, followed by the making of recommendations for domestic tax law changes as well as changes to double tax treaties. The adoption of the OECD BEPS recommendations by the G20 in October 2015 has provided a significant boost to the BEPS project: while the process is still ongoing, a significant number of developed and developing world jurisdictions have been gradually implementing the recommendations by passing new domestic legislation.
Impact on private equity Legislation is by nature general in its application and the new tax rules to which reference is made above are therefore not limited to MNCs only. Therefore, irrespective that the focus of the new rules has been MNCs, some of the measures have the potential to impact on private equity funds and their investors.
Separately, the private equity industry has for many years faced criticism that some "tax breaks" which are available to it, in particular in the context of the personal taxation of managers, operate to provide an unfair advantage. Perhaps in the context of the overall debate on levelling the playing field as regards taxation, countries have taken
the opportunity to introduce a number of tax law changes which impact on private equity managers in particular.
The purpose of this article is to provide a high-level update on some of these new tax rules and their possible impact on the private equity industry.
KEY "FAIR SHARE" TAX CHANGES
Restrictions on interest deductibility
Preventing deductions for hybrid mismatch payments
Tougher benefit rules to prevent treaty shopping
UK rules affecting the taxation of carried interest and management incentives
Interest deductibility The OECD BEPS action point 4 has focussed on interest deductibility. Amongst other matters, the focus has been on structures, such as that described briefly in the simple example earlier in this article, whereby profits can be shifted from an opco located in a high tax jurisdiction to a holdco in a lower tax jurisdiction, through the payment of interest on shareholder debt. The OECD proposed rule introduces a restriction in the amount of interest which would be deductible for
08 PRIVATE EQUITY AND THE "FAIR SHARE OF TAX" DEBATE: AN UPDATE
HERBERT SMITH FREEHILLS
tax purposes, expressed as a percentage (recommended not to be higher than 30%) of EBITDA. At least conceptually the rule is modelled after legislation which has already been adopted by Germany and Italy.
A typical private equity holding structure involves third party (bank) gearing, as well as shareholder debt. Both will be affected by the interest deduction rules. Given the relatively high level of gearing to which private equity usually resorts, it is expected in particular that in many cases, at the very least, interest on shareholder debt will become restricted for tax purposes. This will result in a greater charge to tax in the country where profits are generated (the "opco" countries), and lesser returns to investors via the extraction of interest and other finance costs through the holding structure and into the fund.
At least in principle it is possible that in very high gearing situations the impact of the new rules would be to eliminate all profit, or even impact on the ability to service third party debt, although it is noted that such high levels of gearing are perhaps less likely to arise in reality given other more traditional restrictions such as thin capitalisation.
In addition to countries which have already legislated or are in the process of legislating for the new interest deduction rules (including Germany, Portugal, Denmark and the UK), the proposed EU anti-tax avoidance directive seeks to introduce the rule into all member states.
Hybrid rules A separate BEPS action point focusses on hybrid mismatches, or in other words situations where a deductible payment is made in one country, but because of the "hybrid" nature of the instrument or entity involved, the matching receipt is not taxed in any other country. Such hybrid mismatch payments can be found in some US-based private equity investment into Europe, as well as in the context of some Luxembourg holding structures. The new BEPS inspired rules which are designed to stop the use of hybrids will do so by disallowing deductions in respect of payments made on the relevant instrument.
The impact from a private equity perspective is similar to the interest deductibility rules. Put differently, whereas under current rules most payments made by operating companies to holding companies are deductible, the hybrid rules will result in more limited deductions, greater taxation on operating companies and smaller returns to the fund and its managers.
Hybrid rules are already in place or are in the process of implementation into legislation in Italy, Spain, the UK and France. Very recently
it has been announced that the hybrid rules will form part of the proposed EU anti-tax avoidance directive. It follows that all EU member states are expected to fall within the new rules by 2020 if the anti-tax avoidance directive is implemented in accordance with the currently proposed timetable.
LEGISLATION KEY DATES
1 January 2017 UK hybrid mismatch rules apply to all payments made after this date
1 April 2017 UK interest deductibility rules come into force
June 2017 OECD's Multilateral Convention expected to come into force
June 2017 Member states required to comply with the EU anti-tax avoidance directive
Treaty benefits Private equity structures are almost inherently cross border in nature. This reflects the fact that private equity brings together investors, and investment opportunities, in multiple jurisdictions.
Fund flows in a typical private equity structure therefore cross borders, usually more than once (i.e. at the stage where profits are repatriated from operating companies through a holding structure to the fund, and further when the fund distributes profits to investors).
At its heart a private equity fund seeks to be tax neutral (such that as much as possible all taxation takes place at the level of the operating companies on the one hand, and at the level of investors on the other hand). In the cross border set up this means that it is
necessary to mitigate withholding taxes, often through the application of reliefs available in double tax treaties in respect of the payment of interest, dividends and other amounts. It should be recalled in this context that double tax treaties contain such reliefs for the purpose of encouraging cross border investment.
The continued ability of private equity to rely on double tax treaty reliefs, in the same way as has been the usual practice for many years, is coming under pressure as a result of the adoption by the majority of countries of new measures, which will modify the provisions of double tax treaties to which such countries are parties. These measures, set out in a multilateral convention proposed by the OECD and adopted by over 100 countries so far, are intended to come into force later this year (June 2017). The scope of this article does not allow a detailed discussion of the relevant provisions, but briefly, the multilateral convention imposes tougher restrictions on benefits in an attempt to curb the practice of treaty shopping (or, in other words, the interposition or introduction of an entity into a holding structure solely for the purpose of obtaining treaty benefits).
By way of example, the specific tests introduced can deny treaty benefits in the case of an entity established in jurisdiction X, whose owners are predominantly found in jurisdictions other than jurisdiction X as would be the case in a typical private equity set up. While the detailed test is more complex, and to some extent perhaps uncertain in its application, it is not at this stage clear that private equity investment will continue to be able to benefit from treaty relief in the same way once the multilateral convention takes effect.
Executives' and management incentives The carried interest entitlement has traditionally been structured as a right to share in the proceeds of disposals of shares in underlying portfolio companies, and has therefore provided to private equity executives the ability to realise compensation in the form of capital receipts. The significantly more favourable regime which applies many times to capital gains, relative to income taxation, means that, alongside the commercial attractiveness of providing a carried interest to private equity executives, there has been a significant additional tax incentive for doing so.
Management incentives can be similarly structured as share based, allowing access to capital gains treatment.
Criticism of the taxation of carried interest and management incentives is not new: it has figured in election campaigns and manifestos
HERBERT SMITH FREEHILLS
PRIVATE EQUITY AND THE "FAIR SHARE OF TAX" DEBATE: AN UPDATE
for some two decades now, and has from time to time given rise to media attention as a form of regressive taxation (reference for example the observation by a key UK private equity individual that his cleaner's tax rate is higher than his own).
Perhaps against the background of a trend to level the tax playing field more generally, a combination of new legislation and seemingly greater attention to enforcement in recent years seems to have limited executives' ability to benefit from the more favourable tax regime.
Thus in the UK new rules introduced some two years ago to apply to "disguised investment management fees", a widely defined term, result in payments other than a now statutorily defined "carried interest" received by investment managers being treated as income in almost all cases where they would not be so treated in any event. While the statutory definition of carried interest for these purposes is sufficient to allow standard carry structures to continue to benefit from the favourable capital regime, a number of less usual structures are no longer protected and management incentive schemes are even more exposed.
Other recently revised UK rules have resulted in eliminating the ability of UK managers who are domiciled outside the UK to escape UK taxation in respect of carried interest on the basis that
the underlying shares represent non-UK situated assets. And more recently, capital gains treatment has become conditional on realisation of the carried interest after an average holding period of at least four years: earlier realisation will result in income or part income and part capital taxation. Other European jurisdictions appear to be following a similar trend, if not necessarily through law change then through more limited interpretation of existing rules. Notable cases in France, Italy and Germany have sought to challenge as abusive more or less commonplace management incentive schemes designed to provide capital returns, on the basis that in substance these represent employment or self-employment remuneration.
Care should therefore be exercised by private equity firms, in particular those involving internationally mobile employees who may be subject to taxation in more than one jurisdiction, when structuring for carried interest and for management incentives.
Private equity funds provide a platform for collective investment, most commonly by institutions, and may expect that tax authorities recognise the principle that the fund itself should be tax neutral, or (in other words) that taxation is collected at operating company level, and from investors, but not at fund and holding structure level.
The new tax rules, following on from the aftermath of the focus on the tax optimisation methods used most commonly by MNCs, are, however, casting doubt on the extent to which private equity investment may continue to assume tax neutrality at fund level. In addition, the same new rules are imposing a greater burden of tax on highly geared structures, which in turn may impact more significantly on private equity funds than on other operations, given the typically high ratios associated with private equity investment. Further, greater focus on the taxation of the income of individuals is beginning to eat into the tax benefits which have been traditionally associated with private equity remuneration structures, including carried interest and management incentives.
It is too early to assess the full impact of the new tax rules, which have only recently started to come into force. But it is clear already that private equity firms, and fund structures, are already beginning to anticipate and adapt to the new rules, in order to remain competitive relative to other forms of equity ownership.
10 PRIVATE EQUITY IN POLAND
HERBERT SMITH FREEHILLS
PRIVATE EQUITY IN POLAND
Among the countries which have joined the European Union since the turn of the century, Poland has the largest economy and is one of the most popular for foreign private equity investment. In recent times, including during the period from 2008 to 2012 when European economies faced the headwinds of, first the global financial crisis, and then, the euro currency crisis, the Polish economy has continued to grow. Like the other former communist countries, the economic fundamentals are supported by ongoing convergence, but Poland is an attractive investment destination for other reasons too, including reasonably strong corporate balance sheets, a highly educated but relatively cheap labour market, relatively low corporate tax rates and a growing consumer culture. Foreign private equity investors are also drawn by the abundance of entrepreneurial spirit and talent.
FROM TOP Ben Davey Partner, international counsel at WKB
Jakub Jdrzejak Partner, co-head of WKB's M&A team
POLAND FACTS AT A GLANCE1 Population: 38,500,000 approx.
Government: Parliamentary republic
Capital city and financial centre: Warsaw
Memberships: EU, NATO and OECD
Zloty to 1 ; : 4.23; 4.96 as at 10 April 2017
GDP growth (2016): 2.9%
Forecast GDP growth (2017): 3.2%
EU funds 2014-2020: 82.5bn
Number of PE investments > 100 in 2015
Value of PE investments > 800m in 2015
PE investment as proportion of GDP 0.19% in 2015
Warsaw Stock Exchange (WIG) 1, 3 and 5 year performance 9.8%, -0.1% and 24.3%
1. PE investment statistics in this box are taken from KPMG's report "Private Equity in Poland 2016 Trends and Opportunities"
The Polish private equity market is mature, in the sense that there are many well-established local private equity managers (covering a broad cross-section of investment types), supported by experienced professional advisors and lenders, as well as an active private equity association. However, there is still plenty of room for improvement and growth. Currently, private equity investment as a proportion of GDP remains low compared to the European average, and well below many other emerging markets.
Typically, the deals are much smaller in size compared to the more well-developed private equity markets in the larger economies, with the investment for a typical buy out deal being in the range of 15m to 30m. Having said that, in January this year, Cinven, Permira and Mid Europa bought Allegro (the so-called Polish eBay) from Naspers for US$3.25bn, which puts the deal among the largest ever acquisitions of a Polish asset. Also, in February, Mid Europa announced that it had agreed to sell Zabka Polska (a network of convenience stores) to CVC Capital Partners, giving Mid Europa investors a purported return of around 1.1bn. The deal remains subject to clearance from the European Commission but, once completed, will be the largest private equity exit in Poland.
quite intense and, in recent years, there has been considerable interest in Polish assets from Chinese buyers, both trade players and private equity funds, particularly in the electrical engineering and automotive sectors.
NOTABLE DEALS IN POLAND LAST YEAR:
The acquisition by Emest Investments of Getback (a debt collection agency) from Idea Bank for approximately 190m The sale of Smyk (a chain of stores selling children's apparel, toys and accessories) by Empik Media & Fashion to Bridgepoint and Cornerstone for a total price of approximately 247m
Poland is very much open for business. However, compared to the previous Polish government, the current Polish government is more interventionist, more eurosceptic and generally more protective of Polish enterprises, whether in terms of competition from abroad, international pressure (e.g. climate change targets) or, to some extent, foreign ownership.
The most popular sectors for private equity investment in Poland include TMT, industrial manufacturing, business services, medicine and pharmaceuticals and retail, trade and consumer goods. Competition for assets is
Energy and infrastructure assets The Act on Control of Certain Investments (ACCI) (which came into force on 1 October 2015) imposes a requirement to notify the Minister of State Treasury about a planned
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PRIVATE EQUITY IN POLAND
acquisition of control over (or a "significant participation" in i.e. the ability to impact activities by way of holding at least 20% of the votes in a decision-making body, including at a shareholders' meeting, of) a company operating in certain specified strategic business areas, if such company is included on the list contained in a particular regulation of the Council of Ministers. The Minister of State Treasury may prevent the acquisition if it would threaten, among other things, the independence of Poland, the integrity of its territory, the freedoms or rights of people in or citizens of Poland, national security or public order. A transaction which is not notified when required, or which is undertaken despite an objection from the Minister, is invalid.
The relevant business areas are generally in the energy, oil and gas, chemical and telecommunications sectors and, since the law is relatively new, only a small number of companies have been specified in the list to date. However, the list can be amended or extended at any time. Notably, after being acquired by CVC Capital Partners in 2015, PKP Energetyka (the electricity distributor to the Polish railway network) was placed on the list in July 2016. This may seriously limit the scope of exit opportunities for CVC given the expectation that the government wishes to see the asset returned to Polish state-owned hands. Similarly, EDF and Engie's Polish assets were put on the list after press reports indicating that they may have initiated processes to sell their Polish assets and, in December 2016, the Polish government used
the ACCI to block a restructuring ahead of the potential sale of EDF's district heating assets to IFM Investors and its Rybnik power plant to Czech utility EPH.
The ACCI is not limited to foreign investments, but given its nature, clearly it is more likely that objections would be raised in respect of foreign investments and, in particular, investments by foreign state-owned enterprises or from countries with which Poland has strained relations.
Given its focus on the energy, oil and gas, chemical and telecommunications sectors, the ACCI is particularly relevant for energy or infrastructure funds, as well as private equity funds with investment policies covering such assets. However, another new law has implications for all types of investor, sometimes in unexpected situations.
Agricultural land unexpected implications Since 1920, Poland has had some form of law restricting the acquisition of land by foreigners. Aspects of these laws were incompatible with European Union requirements. In May 2004, when Poland joined the European Union, it was afforded a twelve-year period during which the direct or indirect purchase of agricultural or forest land by foreigners, even from within the European Union, would require a special permit from the Ministry of Internal Affairs. This protection expired on 1 May 2016. However, before the expiry took effect, the government amended the Act on Shaping of
the Agricultural System (ASAS) to introduce a different restriction aimed at limiting the direct or indirect acquisition of agricultural land. For these purposes, agricultural land is land that is designated as such, even if such land is within a city or otherwise not being used for agricultural purposes.
The new rules are broadly intended to ensure that agricultural land is bought only by persons with relevant qualifications who will actually farm it, and will not be available for sale to entities or natural persons for investment purposes. However, the breadth of the rules and the scope of actions that may be taken by the authorities create serious potential traps for investors.
Apart from the limitations on transfers of agricultural land, the new rules give powers to the Agricultural Property Agency (APA) which may complicate many different types of transaction, not only in the real property market. In particular, the new provisions will impact transactions involving shares in commercial companies which just happen to own agricultural land.
The APA will have a pre-emptive right in respect of shares in such companies (except listed companies). The right will apply if the relevant company owns at least 0.3 hectares of agricultural land, irrespective of the ratio of the value of agricultural land owned by the company to the value of all its assets. The pre-emptive right may be enforced even if the
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company is engaged in a business other than agriculture and has few properties designated as agricultural land. Moreover, it will apply to any size share deal, and will not be limited to transfers of majority stakes or transactions that otherwise result in a change of control over the company. The pre-emptive right will even apply to transfers between related parties i.e. there is no exception for mere restructurings.
Further, if agricultural land is directly or indirectly acquired as a result of a transaction such as a division, transformation or merger of a company, the APA has the right to acquire the land or the shares in the relevant company after the event at market value (unless the APA had given its consent, which could only be given if the agricultural land is being acquired by persons with relevant qualifications who will actually farm it).
On their face, these new rules would seem not to impact on most private equity transactions. However, it is quite common in Poland that real properties which are, in principle, industrial, will have certain small parts that remain designated as agricultural. For example, it would not be unusual for the operator of a warehouse or logistics centre, a service centre or a manufacturing facility built on the outskirts of a city, to own a small parcel of land adjacent to the main facility that is still designated as agricultural land.
Potentially, in cases where agricultural land is an incidental or minor asset, it would be worthwhile considering its sale ahead of any broader transaction that would otherwise be affected by its direct or indirect inclusion. Alternatively, in cases where agricultural land is not actually being used for agriculture, it may be appropriate to seek a change of the designation of the land before a direct or indirect sale occurs. Either of these approaches could affect the timetable for the transaction.
In circumstances where the operation of the ASAS cannot be avoided, this will also impact the timetable. Moreover, the APA could end up holding land that is, for one reason or another, important to the party which held or intended to hold it, or the APA could have a seat at the table among otherwise private shareholders. On the other hand, if the rules are breached, even inadvertently, the relevant transaction may be invalid. In many cases, the invalidity of the transaction may not be immediately apparent at the time of a transaction. Historical transactions that may have been subject to these rules will need to be scrutinised closely as part of due diligence on a prospective target, even if the relevant company no longer holds the affected assets.
Corporate due diligence
In addition to the ACCI and the ASAS, Polish law contains a myriad of provisions a breach
of which may invalidate a transaction, or at least render it ineffective against one or more parties. This includes issues or transfers of shares not made in accordance with the proper formalities and the taking of actions without approval required under or otherwise in breach of the articles of association of the company.
Some significant transactions, including transfers of land, or certain issues of shares by limited liability companies, require the participation of a notary. A notary will typically check that the requisite formalities have been met, which offers a safety net in addition to the attentiveness of the parties and their legal advisors. However, notaries are not involved in many transactions which are at risk of being invalid or ineffective and, in any event, notaries are not infallible.
Moreover, Polish law does not have a concept of "a bona fide purchaser for value without notice" that applies to the acquisition of rights (including, notably, shares in companies) which might otherwise protect the interests of an innocent party to an otherwise tainted transaction.
In light of this, it is critical to conduct thorough due diligence on all the historical dealings in shares, including all share transfers or share issues, as well as major asset or real property sales or acquisitions. This can be a time consuming exercise, and sellers rarely
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make available all the historical documents necessary to satisfactorily complete the task, especially in an auction process. Fortunately, the history of most companies in Poland dates back no further than the end of the communist era, which confines the scope of the exercise to some extent. However, obviously, as each year passes, the period which needs to be examined only grows.
Given the above, in Polish M&A, the package of warranties that covers these historical issues is vital. Also, currently, there are very few options to white-wash many of the historical issues that may be identified. As a result, it is quite common for indemnities to be sought by a buyer with respect to known risks. As in any jurisdiction, private equity sellers are especially reluctant to give indemnities. As an alternative or to supplement indemnity protection, title and/or warranty and indemnity insurance may be needed, but only to the extent there remains some room for doubt, since known, clear-cut cases of invalidity or ineffectiveness are generally not insurable.
Deal terms and financing
The key terms on which private equity transactions are made in Poland are broadly consistent with international norms as regards both the acquisition from the seller, and the arrangements with the management team or co-investors, including with respect to management incentives and exits.
As regards acquisition debt financing, if obtained locally, it would typically be in the form of a traditional secured term loan facility from a bank. Given the size of some of the deals now being undertaken in Poland, syndicated financings have become more common. Also, in recent years, bond financing has become more popular. For smaller local deals, corporate bonds issued under Polish law are quite common. In the case of larger deals, bonds issued under foreign law (mainly New York law) may be a means of financing (or possibly refinancing of interim bridge financing provided by banks).
Polish targets are typically either a limited liability company or a joint stock company. A limited liability company is more common, simpler in terms of the required internal governance arrangements, but less flexible in terms of share capital. A joint stock company is the only type of company that can be listed (which more readily facilitates an exit by way of IPO) and offers more flexibility with respect to the issue of share capital, including the flexibility to issue different classes of shares and instruments convertible into shares (which may be helpful in structuring
management incentive schemes). However, unlike a limited liability company, a joint stock company is subject to restrictions on the provision of financial assistance.
Apart from limited exceptions, including the financing of employee share plans, a joint stock company may only directly or indirectly finance the acquisition of its own shares (including by way of loan, making advance payments or granting security) subject to a cumbersome and time-consuming white-wash procedure. The white-wash is rarely applied in practice. Rather, if the target is a joint stock company, security in favour of the acquisition debt financiers is initially usually given only over the shares being acquired, with an undertaking from the buyer or a controlling entity that the target and the buyer (most often a limited liability company) will be merged (with the buyer as the surviving entity) or that the target will be transformed into a limited liability company within a specified timeframe. Following such merger or transformation, the restrictions on provision of financial assistance will no longer apply, and further security in respect of the acquisition debt finance can be given over the assets of the target.
A lot of mature businesses in Poland were established in the early 1990s and are still owned and managed by the entrepreneur who founded them. Often, there is no obvious successor in the family. These businesses may be ideal candidates for management buy-ins as the founder approaches retirement.
Also, some types of business are undergoing or are ripe for consolidation, especially within the TMT, healthcare, financial services, fast-moving consumer goods and retail sectors. This creates opportunities for roll-ups and bolt-ons.
There has also been a development that may be of particular interest to distressed asset and turnaround funds. Until recently, Polish law provided only limited options for dealing with distressed businesses. Often, such businesses would undergo lengthy bankruptcy proceedings during which a court appointed receiver would manage the assets. The receivers typically had little relevant operational or sector-specific experience, which put creditors at risk of significant further erosion of value. However, at the beginning of 2016, a significant amendment to the insolvency law and a whole new restructuring law came into effect. Among other new tools, the insolvency law now provides for the bankruptcy court to approve (together with the opening of the bankruptcy proceedings)
the terms of a pre-pack sale of the bankrupt enterprise (or an organised or significant part of it).
The motion seeking approval of the pre-pack has to include details of the price and the proposed buyer. The motion must also include an expert's valuation of the assets, and the price cannot be lower than such value. The court will approve the pre-pack if the price is higher than the amount that could be obtained by way of liquidation of the relevant assets (less the costs of the bankruptcy proceedings). If the motion also attaches the draft sale agreement, the transaction can be completed immediately following the opening of the bankruptcy i.e. the enterprise (or the relevant organised or significant part of it) may be handed over to the buyer on the day of the opening of the bankruptcy proceedings (provided that the entire purchase price has been paid in advance into a court deposit account). No credit bidding is allowed in the context of a pre-pack.
The new Polish pre-pack rules have not yet been tested in practice. Nevertheless, there is hope that, as in other jurisdictions which have such rules, certain enterprises that fall into distress may now be sold more quickly and continue to operate, preserving value for the benefit of various stakeholders.
Overall, notwithstanding the challenges, the private equity market in Poland has been active and the outlook with regard to 2017 remains positive.
FINANCIAL ASSISTANCE WHITE-WASH BY A JOINT STOCK COMPANY
The financial assistance must be provided in exchange for a benefit on market terms
Any acquisition of or subscription for shares in the company must be for fair consideration
Before the financial assistance is provided, the solvency of the beneficiary of the assistance must be checked and the company must create a reserve capital fund from sums which would otherwise be available for distribution as dividends (i.e. profits)
The financial assistance must be approved at a shareholders' meeting having regard to a report from the management board describing the purpose and terms of, the company's interest in providing, and the effect on the company's cash flows of, the financial assistance
14 LEVERAGED FINANCE TRENDS IN SPAIN
HERBERT SMITH FREEHILLS
LEVERAGED FINANCE TRENDS IN SPAIN
2016 saw another year of strong performance for Spain's acquisition debt finance market, with an increase in new money leveraged finance deals. This is generally in line with a return to liquidity levels previously seen before the financial crisis (following which there was a prolonged period of subdued activity levels).
In this article, we consider some of the key features and market trends in the context of Spanish leveraged finance transactions, primarily from the perspective of an international private equity fund.
FROM TOP Armando GarcaMendoza Senior Associate, Madrid
Deborah Dove Senior Associate, Madrid
SOME HIGHLIGHTS OF SPANISH LEVERAGED FINANCE1
Spanish GDP grew by 3.2% in 2016 and is forecast by the International Monetary Fund to grow by 2.3% in 2017 and by 2.1% in 2018 (with growth projections for 2017 being revised upwards in light of stronger than expected performance in the second half of 2016)
Investments made by international private equity funds in Spain increased by 35% in 2016 as against 2015 (up from 1.31 billion in 2015 to an estimated 1.77 billion in 2016)
International funds represented 66% of the total investments in Spain in 2016, comprising 1.99 billion split over 62 investments a 17% increase against equivalent figures for 2015
Total investment value, taking into account all venture capital and private equity deals in Spain, increased by 3% from 2015 (up from 2.92 billion in 2015 to an estimated 2.99 billion in 2016)
Double Luxco structures
Market expectation a few years ago was that the double Luxco structure would become increasingly prevalent on Spanish financings. Whilst this has not been entirely borne out in practice, we are still typically seeing this structure on financings involving international banks or sponsors who have successfully
used those structures in the past. In contrast, it is rarely used on deals involving syndicates of lenders led by Spanish banks as they may be more relaxed in terms of lending into a "Spain only" corporate structure (albeit there may, of course, be obligors located in other jurisdictions).
The double Luxco structure was initially devised by way of response to a French case where a single Luxembourg company migrated its centre of main interests (COMI) to France, enabling French law debtor-friendly restructuring proceedings to be taken advantage of by the borrower. In general
terms, Spain still tends to be considered, along with other southern European countries, as a debtor-friendly jurisdiction in terms of insolvency processes; the perception among international banks is therefore that structures of this kind enable a quicker response within enforcement scenarios.
A typical Spanish Leveraged Buy-Out (LBO) structure involving a double Luxco would have a Spanish bidco and target group, with the bidco sitting below two Luxembourg incorporated companies as shown on the next page.
1. Information obtained from the 2016 annual report of the Asociacin Espaola de Capital, Crecimiento e Inversin (ASCRI) and the International Monetary Fund website.
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LEVERAGED FINANCE TRENDS IN SPAIN
Typical Spanish leveraged buy-out structure involving a double Luxco
Luxembourg Share pledge Spain Share pledge
Sponsor Topco Parent Bidco Target
Subject to tax structuring considerations, it is fairly common in Spanish deals for management to hold shares directly in the Spanish target company (as opposed to an entity higher up the structure outside of the security net) and to rollover by investing in bidco (or the entity just above bidco) in the context of the LBO transaction.
Notwithstanding execution requirements and similar formalities when individuals appear as parties to legal documents used in acquisition financing transactions (mainly granting pledges over the shares held in an obligor), lenders can usually get comfortable with this structure for two key reasons:
first, Spanish notaries (which, as explained below, are used to formalise legal documents as public documents) confirm in a public document the identity and legal capacity of the individuals who act on their own behalf; and
secondly, the shares held by management are usually pledged in favour of the secured parties, with that security becoming enforceable in the same circumstances as the other share security over the target shares.
Spanish law forbids Spanish companies from granting financing, security, or guarantees or from providing any other type of financial assistance to acquire (i) its own shares; (ii) those of its parent company (in the case of sociedades annimas); or (iii) those of any company of its group (in the case of sociedades de responsabilidad limitada).
Among other aspects, this restriction means that the lenders providing financing in a typical LBO structure (bidco receiving the financing for the acquisition of target's shares) would be prevented from taking security over target's assets to secure the facility used to finance the acquisition of target's shares. Lenders would, however, be allowed to take security over bidco's shares and assets (including the shares held in target) to secure the acquisition facility and over target's assets to secure financing for other purposes (e.g., refinancing, general corporate requirements or capex facilities).
An extremely cautious approach must be taken when structuring an acquisition finance transaction as any breach of applicable provisions of Spanish law would render transactions affected by the financial assistance null and void.
THE MAIN ADVANTAGES OF THE DOUBLE LUXCO STRUCTURE FOR SECURED CREDITORS
Increasing the range of potential enforcement options available to the lenders. Enforcement of a Luxembourg law share pledge over the parent should be quicker than enforcing the target level Spanish law share pledge
Controlling the directors of the obligor group in an insolvency situation where compulsory pre-insolvency proceedings are threatened or started or where there may be concerns around COMI migration to the detriment of secured creditors. This control is achieved initially by way of a share pledge where voting rights attached to the shares in the Luxembourg parent, including the right for the secured creditors to replace hostile directors and appoint replacements of their choice, may be contractually vested in the secured creditors prior to any default or enforcement of the share pledge. For a double Luxco structure requiring the COMI of the Luxembourg entities to be and remain located in Luxembourg, it is advisable that (i) a majority of directors should be Luxembourg residents, (ii) board meetings should regularly take place in Luxembourg, (iii) some of the agreements entered into by the Luxcos should be governed by Luxembourg law, and (iv) the articles of association include a prohibition to transfer the registered office abroad
Financial assistance restrictions have historically been structured around in Spain by including an obligation in the facility agreement for bidco and target to merge within a specific period of time after closing. Once the merger had been completed, assets initially affected by the financial assistance restrictions were then owned by the company resulting from the merger, so security could be taken over them freely. However, as a result of the provisions established by a law on corporate structural modifications, as well as a change in the criteria traditionally followed by the Spanish tax authorities (in relation to the tax treatment of mergers of this kind), merger between bidco and target is no longer the best way to avoid financial assistance restrictions.
Structuring around the application of these restrictions in the context of acquisition
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HERBERT SMITH FREEHILLS
finance transactions now depends on the specific circumstances of the target company and whether or not they allow for the implementation of a complex structure that enables the lenders to take security over the target's assets.
A necessary first approach would involve tranching the debt, with the tranches utilised by the target (for refinancing, general corporate needs and capex) including as much of the total debt as possible, and the acquisition tranche being left holding the amount inevitably affected by the financial assistance restrictions. By doing so, security could be taken over target's assets to secure those tranches that are not strictly used for the purposes of financing the acquisition of target's shares. Depending on the nature of the business, quantum of refinancing debt and the risk profile of the target group, this might well suffice.
Certain other scenarios may allow for the implementation of alternative structuring mechanisms. When bidco holds credit rights against the target, a debt push-down mechanism can be implemented by setting them off, with the target assuming part of the acquisition debt. These credit rights are usually found as distributable reserves and intra-group facilities. It may be possible for the push down to be performed on closing or, alternatively, once a specific period of time has elapsed, to be agreed by the parties under the facility agreement.
Another structuring option that is attracting some interest in the market would be to grant financing for the target to pay a dividend to be received either by bidco or the seller, while the payment of the purchase price for the target's shares is made with equity. This option would also depend on whether the accounts of the target allow the distribution of the dividend.
Typical Spanish security package
In terms of execution costs, only the execution of in rem rights of mortgage would have a significant impact on the transaction as it would trigger the application of stamp duty at a rate of between 0.5% and 1.8% over the amount secured by the mortgage (depending on the region where the asset is located). This is why it is fairly common to see promissory security over real estate assets in security packages connected to LBO transactions in Spain. The level of comfort provided under the promissory security is usually strengthened by conferring on the lenders an irrevocable power of attorney empowering them to execute and formalise the mortgage if those trigger events foreseen under the promissory security document occur.
Execution particularities In the case of an English-law financing in Spain, it is market practice for the finance documents to be formalised as Spanish public documents
before a public notary. Whilst not strictly necessary, documents are signed in this way in order to avoid the lenders having to take further judicial steps in the event of acceleration or enforcement.
In practice, this often means that the key finance documents (facility agreement, intercreditor agreement, fee letters) will be signed in counterpart in advance using a standard remote-signing process. All parties would subsequently appear before the notary on the closing day for the documents to be formalised as Spanish public documents as a condition precedent to funding.
It is also necessary for all parties (including non-Spanish citizens or entities) to any document being signed before a Spanish notary to obtain a Spanish tax identification number; furthermore, each signatory should provide the notary with their passport and powers of attorney as evidence that they have authority to sign on behalf of the entity in question.
Documentation It remains the case that some large deals in Spain involving either international banks or sponsors tend to be carried out under English law.
In terms of documentation, English law facility agreements tend to be based on a combination of the Loan Market Association's (LMA) precedents or the relevant sponsor's latest
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LEVERAGED FINANCE TRENDS IN SPAIN
A full security package in the context of an acquisition finance transaction in Spain would include:
Guarantees granted by the guarantor companies (usually material subsidiaries, identified by the parties on the basis of agreed specific criteria)
In rem rights of pledge over:
shares in bidco, target and, if agreed, some of the key subsidiaries of target's group;
credit rights under the share purchase agreement and the due diligence reports;
credit rights under bank accounts;
credit rights under insurance policies and material agreements; and
credit rights under hedging agreements
Promissory in rem rights of mortgage over real estate assets
In rem rights of chattel mortgage over intellectual property and trade marks (only if these are significant in value)
working precedent, updated to the deal in question. We are typically seeing strong sponsors being able to impose the use of their precedent documents, with sponsor's counsel having drafting control of the finance documents.
This approach is in contrast to Spanish law LBO deals whilst there is a Spanish law/ language investment grade LMA credit agreement, there is no leveraged version. Accordingly, Spanish law deals are not documented on the basis of a standard format (albeit they do tend to follow features of the English Law LMA). However, the vast majority of the top local and international law firms in Spain use Spanish and English language precedents and model forms that are, in general terms, standard in the Spanish leveraged market. They are significantly shorter than a typical LMA facility agreement and the terms and conditions included in these facility agreements are completed by provisions under Spanish codes, laws and regulations applicable to transactions of this kind, a characteristic of civil law jurisdictions.
Selection of recent HSF Spanish leveraged finance credentials
Trilantic Partners on the financing of the acquisition of Pach group (on-going)
Magnum Industrial Partners on the 50.3 million financing granted for the acquisition of Grupo Barbel, a group of companies involved in the production of siliconized papers used in adhesive labels and envelopes amongst others
First State Investments on the 187 million financing granted by Caixabank, S.A. for the acquisition of Parkia, a Spanish parking network
Torreal and Mutua Madrilea on the acquisition of Ingesport group, a company of health and fitness clubs, and the 103 million financing granted in that context by a syndicate of financial entities for the refinancing of the group
a syndicate of financial entities led by Socit Gnrale on the 200 million financing granted to The Carlyle Group for the acquisition of Cupire Padesa, a worldwide leading company in natural slate (English law)
Bankinter and Tikehau Direct Lending on the 39 million refinancing granted to Elix Polymers, a leading manufacturer of ABS resins
a syndicate of financial entities led by Bankinter on the financing granted to Bluesun Group, a group owned by Phi Asset Management Partners, for the acquisition of certain brands and assets of Procter & Gamble
Banco Santander, Caixabank and Bankia on the financing granted to Lonsdale Capital Partners for the acquisition of a majority stake in Global Yachting Group (English law)
H.I.G. European Capital Partners on the 23.5 million English law bond financing granted by Pricoa for the Spanish law acquisition of Sistemas e Imagen Publicitaria S.L. and Impursa S.A., two Spanish companies whose main activity is focused on the marketing and advertising sector (English law)
BNP Paribas, CACIB, BBVA, Banco Santander and Bankia on the 135 million financing granted to The Carlyle Group for the acquisition of Grupo Palacios, a leading business group in the Spanish food sector (English law)
Magnum Industrial Partners on financing of the acquisition, and the subsequent 90 million recap, of Grupo Iberchem, a group of companies involved in the production of fragrances and flavours, granted by a syndicate of financial entities led by Natixis
GPF Capital on the financial aspects for the acquisition of a majority stake in Quesera Ibrica S.L., a leading company in the Spanish food manufacturing sector
Banco Santander on the financing for the acquisition of an SPV owner of the contract for the development of the shopping centre "Vialia Estacin de Mara Zambrano" (Mlaga)
Magnum Industrial Partners on the financing aspects for the disposal of Centro Mdico Teknon, a leading hospital in the Spanish healthcare private sector
AXA on the refinancing of the facilities granted to a French infrastructure fund for the acquisition of shares in CLH
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DUBAI Herbert Smith Freehills LLP T +971 4 428 6300 F +971 4 365 3171
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NEW YORK Herbert Smith Freehills New York LLP T +1 917 542 7600 F +1 917 542 7601
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Herbert Smith Freehills LLP 2017 2565S /E1u0ro0p4e1a7n Private Equity