Investment funds in Singapore are typically constituted as companies, unit trusts or limited partnerships. This is set to change with the advent of a new fund vehicle, the Variable Capital Company ("VCC"). The VCC is now an alternative, after the commencement of the Variable Capital Companies Act 2018 ("VCC Act") on 14 January 2020. This update focuses on the considerations a financier may wish to take note of when financing a VCC.
What is a VCC?
The VCC is a new legal structure, which may be incorporated as: (a) a standalone VCC; or (b) an umbrella VCC with multiple sub-funds. The VCC, akin to a company, is a legal entity in its own right, separate from its shareholders. When incorporated as an umbrella VCC, the umbrella VCC together with its sub-funds constitutes one legal entity. The assets and liabilities of each sub-fund are statutorily required to be segregated.
The umbrella VCC is a useful structure for fund managers to employ varying strategies across different investment portfolios. Sub-funds of an umbrella VCC enjoy economies of scale by sharing a board of directors and having common service providers such as the same fund manager, custodian, auditor and administrative agent.
A VCC is required to include "VCC" as part of, and at the end of its name.
Segregation of assets and liabilities of sub-funds
The central tenet of an umbrella VCC is that the assets and liabilities of each of its sub-funds are separate from each other. Under section 29 of the VCC Act, the liabilities of a sub-fund of an umbrella VCC may only be discharged from its assets, and not out of the assets of another sub-fund. Any agreement to apply one sub-fund's assets in discharge of another sub-fund's liabilities is void. If an umbrella VCC without reasonable excuse contravenes the segregation requirement, every officer of the VCC in default will be guilty of an offence. There are a number of implications arising from such segregation.
Firstly, from a structuring standpoint, co-borrower (with joint and several liability provisions), cross-guarantee and cross-collateralisation financing structures across different sub-funds in an umbrella VCC are not permitted under the VCC Act. Any guarantee or provision of security by a sub-fund in an umbrella VCC to secure another sub-fund's loan will be void under the VCC Act. Consequently, any financier financing a particular sub-fund of an umbrella VCC will not be able to obtain credit support from, or have recourse to the assets of other sub-funds.
Secondly, from a credit standpoint, there is a risk that courts in foreign jurisdictions may not uphold and give effect to the segregation of assets and liabilities mandated for under the VCC Act. Foreign law contracts entered into by a VCC, or assets of a VCC located in foreign jurisdictions may be subject to proceedings in foreign courts. There is a risk that foreign jurisdictions (particularly those without a similar fund structure) may order one sub-fund's liabilities to be discharged out of the assets of another sub-fund. Consequently, a financier financing a particular sub-fund may find itself having to prove in competition with creditors of other sub-funds.
On this front, the draft amendments to the Code on Collective Investment Schemes ("CIS Code") indicate that the Monetary Authority of Singapore will require VCCs offered to retail investors to take reasonable measures to mitigate cross-cell contagion risk, when such VCCs invest in assets located in a jurisdiction that does not have a cellular structure. However, it is worth noting that the CIS Code is non-statutory in nature, and failure to comply with the CIS Code does not itself render that person liable to criminal proceedings.
Notwithstanding such safeguards to the cross-cell contagion risk, it may still be prudent for financiers, on a caseby-case basis, to conduct due diligence on the liabilities of each sub-fund, and the material contracts entered into by the VCC on behalf of each sub-fund. Financiers may wish to, on a case-by-case basis, obtain independent legal advice on such cross-cell contagion risks and be satisfied that practical procedures and steps have been put in place to keep the assets and liabilities of each sub-fund separate. In this regard, a leaf may be taken from the Cayman Islands' segregated portfolio companies (the Cayman Islands equivalent of a VCC) customarily either: (a) subject such contracts to the exclusive jurisdiction of the courts of the Cayman Islands, or (b) insert specific provisions in the relevant material contracts to limit the counterparty's recourse to the assets of a particular subfund.
For completeness, from a documentation standpoint, sub-funds of an umbrella VCC do not have legal capacity to enter into agreements; the VCC itself would be the party entering into the finance documents. In addition, the VCC would need to disclose in such agreements where it is acting for the purpose of a sub-fund: (a) the name and registration number of the relevant sub-fund; (b) the fact that the assets and liabilities of the relevant sub-fund are segregated; and (c) that the VCC is acting for the purpose of the relevant sub-fund.
Separate legal personality
As stated above, a VCC has a separate legal personality. When incorporated as an umbrella VCC, the umbrella VCC together with its sub-funds constitute one legal entity. However, the VCC Act provides for some instances where each sub-fund is to be treated as a separate legal entity. For instance, a VCC may sue or be sued in respect of a sub-fund and may exercise rights of set-off between sub-funds as if each sub-fund were a legal person. Sub-funds are also allowed to acquire by subscription or transfer for consideration, shares of any class or classes issued in respect of other sub-funds.
Capital maintenance payments to shareholders
Singapore companies are subject to capital maintenance rules, which function to protect creditors. Generally, companies are only able to distribute dividends to its shareholders from its profits. Subject to prescribed limitations and adherence to certain procedures under the Companies Act, a company generally may not:
(a) purchase its own shares or redeem its preference shares;
(b) reduce its own capital; and
(c) (in the case of public companies, or companies whose holding company is a public company) provide financial assistance to a third party to purchase its shares.
In line with the policy of providing flexibility for an investment fund's use of capital, and to allow investors to exit their investments in a fund when they wish to do so, a VCC in contrast, is able to repurchase and redeem its shares at net asset value in accordance with its constitution and pay dividends out of its capital. The prohibition against financial assistance does not appear to apply to VCCs.
Financiers granting loans to a VCC should closely review its constitution and other fund documents to understand how their rights compare with the rights of other investors, given the reduced creditor protection afforded to creditors. Where appropriate, financiers may consider:
(a) imposing contractual restrictions on a VCC in respect of the declaration and payment of dividends, and redemption of capital;
(b) requesting for certain stakeholders to be subordinated to the financier; and
(c) requesting for controlled funds to be deposited in a controlled account maintained with the financier, for purposes of debt and interest servicing.
Registration of charges
A company which creates a charge over prescribed asset classes is required to file a statement containing the prescribed particulars of the charge with the Accounting and Corporate Regulatory Authority within 30 days of the creation of the charge. Failure to comply renders any security on the company's property or undertaking void against the liquidator and any creditor of the company, and each officer of the company in default is guilty of an offence. The same registration requirement applies to VCCs. Additionally, umbrella VCCs will have to indicate the relevant sub-fund's name and registration number in the statement containing prescribed particulars of charge.
Register of members
The register of members of companies is generally available for inspection by the public upon payment of a prescribed fee. However, the register of members of VCCs is not publicly available and may only be requested by limited stakeholders, such as the VCC manager, VCC custodian, a public authority or pursuant to a court order.
The identity of members of a VCC may be critical to financiers, if a VCC is not a mature fund with substantial assets that the financiers may have recourse to, or if the loans are secured against the capital contributions of the members. If necessary, financiers should ensure that the VCC is under a contractual obligation to provide the register of members to the financier upon request, or for the financier to be granted access to the register of members at all times during the tenure of the facilities.
Loans, security and guarantees to related entities
Under section 163 of the Companies Act, subject to certain exceptions, Company A shall not:
(a) make a loan or quasi-loan to Company B; or
(b) enter into any guarantee or provide another security in connection with a loan or quasi-loan made to Company B,
if the directors of Company A is or together are interested in 20% or more of the total voting power in Company B, unless there is prior approval by the company in a general meeting, at which the interested director or directors and their family members abstained from voting. This provision has been imported into the VCC Act, and applies to VCCs.
A company which executes an instrument creating a mortgage over immovable property, stock or shares is required to stamp the instrument in accordance with the Stamp Duties Act. The same requirement applies to a VCC, but the stamp duty treatment in the case of an umbrella VCC, applies at the sub-fund level. When an umbrella VCC executes an instrument for the purpose of a sub-fund, any liability or duty payable on that instrument is considered a liability or duty of the umbrella VCC that is incurred, and to be discharged, for the purpose of the relevant sub-fund.
Winding-up and insolvency
Despite the sub funds of an umbrella VCC having no separate legal personality, sub-funds of an umbrella VCC are to be wound up as if each sub-fund is a legal person. This is a necessary extension of the segregation principle that requires assets and liabilities of sub-funds to be segregated.
The grounds of winding-up of a VCC are similar to those of a company. Additionally, a VCC may be wound-up if: (a) the VCC has conducted business outside the scope of its sole statutory object of being a collective investment scheme(s) in the form of a body corporate; or (b) the VCC has contravened the requirement to have a licensed, registered or exempted VCC manager. Facility documentation should include similar covenants against such noncompliance as well as events of default, to allow financiers to accelerate their loans in cases of non-compliance.
Alternative rehabilitation routes such as judicial management and schemes of arrangement available to companies are generally not applicable to VCCs.
The provisions relating to receivership of companies under the Companies Act are also applicable to VCCs, subject to certain modifications. These provisions will be consolidated under the Insolvency, Restructuring and Dissolution Act, upon its commencement later this year.
The VCC has many attractive features, to fund managers and investors alike. Coupled with the advent of economic substance regulations, we anticipate that fund managers and/or sponsors may choose to re-domicile their funds as VCCs in Singapore. This will provide financing opportunities to financiers.