Investments in the Solar Industry Anticipating a Bright Future — Securitization Fueled in part by government efforts to increase renewable energy generation assets in the U.S., solar is a growing investment market. Solar capacity in the U.S. grew by 3,966 megawatts in the first three quarters of 2014, an approximately 50% jump from the 2,647 megawatts installed during the same period in 2013. This rapid growth is understandably drawing the attention of investors, and solar companies are seeking to capitalize on this unprecedented level of interest. The surge is also prompting them to explore innovative methods of financing to keep up with expansion plans. Solar companies have traditionally obtained financing through the tax equity market, partnering with investors that can make use of the tax credits, accelerated depreciation and other benefits provided for owners of solar projects. As the federal investment tax credit (ITC) is set to step down from 30% to 10% at the beginning of 2017, the industry is working hard to find additional and alternative sources of capital and to diversify its investor base. One method of financing that solar developers have diligently pursued is securitization. In 2013, SolarCity Corp. was the pioneer in solar securitization when it raised $54 million in the industry’s first securitization transaction. The nation’s largest solar company subsequently launched two more asset-backed securitizations in 2014, worth $70 million and $201.5 million. Most significantly, the third transaction leveraged an existing tax equity transaction, proving that solar developers could combine their traditional method of Attorney Advertising In This Issue 1 Investments in the Solar Industry Anticipating a Bright Future 2 IRC Section 956 — Striking a Balance in Negotiating a Credit Agreement 3 Regulators Increase Focus on PE Firms’ Broken Deal Expenses and ISDAfix 4 Recent Developments Require Employers to Redraft Employee Confidentiality Agreements to Explicitly Permit Reporting to Governmental Agencies and FINRA Editorial Team August 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 Fabien Carruzzo firstname.lastname@example.org | 212.715.9203 Insurance 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 www.kramerlevin.com Funds Talk 2 financing with new options. Kramer Levin acted as underwriter’s counsel on all three SolarCity transactions. Sunrun Inc., the second largest solar developer in the U.S., completed an $111 million solar securitization in July 2015 — the first ever by a company other than SolarCity. Sunrun’s transaction also involved existing tax equity transactions and became the first to include more than one tax equity transaction. Kramer Levin represented the underwriter in Sunrun’s transaction as well. Commercial banks and other investors are also providing solar developers with loans and syndicated facilities that leverage existing tax equity transactions by financing the residual cash flow due to the sponsor from the underlying project companies holding the solar assets. These types of facilities allow solar companies to aggregate solar assets on a more efficient basis. Yieldcos are another form of financing gaining momentum in the solar industry. An alternative to master limited partnerships or REITs, yieldcos are taxable entities but aim to achieve passthrough treatment by using tax benefits such as depreciation to offset taxable income. Yieldcos need to maintain a balanced portfolio of investments in order to satisfy this objective. As long as yieldcos can regularly invest in new early-stage projects with tax benefits, they can pass on their revenues with little or no entity-level tax. These growth-oriented public companies package renewable energy assets to generate predictable cash flows and dividends for shareholders. This structure is attractive to renewable energy firms, which face high upfront costs but steady revenue flows once assets are operational. SunEdison’s TerraForm Power has been an active yieldco in the solar market, starting 2015 off by raising $350 million for further acquisitions, such as its June purchase of 23 megawatts of solar generating assets from Integrys Energy Group for $45 million. Other renewable energy companies, such as NextEra Energy Resources, TransAlta, Pattern Energy, NRG Energy and Abengoa, have also established yieldcos. The federal government reinforced the current emphasis on renewable energy in the 2015 State of the Union address, when President Obama set a goal of doubling the country’s renewable energy generation by 2020. Nine days later, the Department of Energy announced funding of more than $59 million to support solar energy innovation, including $45 million to help bring new solar manufacturing technologies to market and more than $14 million to fund 15 projects that will help develop multi-year plans to install solar electricity in homes, businesses and communities. Combined, these long-term investments from both the public and private sectors suggest the shift to solar and other renewables is more than just a short-term trend. n For more information on this topic, please contact: Gilbert K.S. Liu firstname.lastname@example.org | 212.715.9460 IRC Section 956 - Striking a Balance in Negotiating a Credit Agreement — Tax Navigating the complexities of the Internal Revenue Code can be a daunting task when negotiating a credit agreement where the lender seeks credit support from the borrower’s foreign subsidiaries (“controlled foreign corporations” or “CFCs”). Commercial banks and other investors are also providing solar developers with loans and syndicated facilities that leverage existing tax equity transactions by financing the residual cash flow due to the sponsor from the underlying project. www.kramerlevin.com Funds Talk 3 In such situations, the parties must strike a balance between two competing tensions: the lender’s desire to optimize its collateral package by obtaining guarantees of valuable foreign subsidiaries with the borrower’s desire to avoid a deemed repatriation for U.S. income tax purposes of its foreign subsidiaries’ earnings. Certainly, the stakes are high. Failure to properly structure a credit facility can significantly add to the parent’s U.S. tax liability under Section 956 of the Internal Revenue Code, potentially costing a company hundreds of millions of dollars. Treasury Regulations under section 956 of the Internal Revenue Code provide that if a CFC guarantees a loan to its U.S. parent corporation or pledges its assets to secure such a loan, or if the U.S. parent pledges two-thirds or more of the CFC’s voting stock in support of the loan, then the borrower in general would be required to include in income the lesser of the amount of the loan and the CFC’s unrepatriated earnings and profits. Thus, the additional credit support given to the lender can result in a material tax liability to the U.S. parent, unless (i) the CFC has little or no unrepatriated earnings and profits (and doesn’t anticipate having material earnings and profits during the term of the loan) or (ii) the U.S. parent has sufficient net operating losses or available foreign tax credits to offset the deemed dividend. This tension between the tax management of the borrower and the credit support desired by the lender has traditionally been resolved in favor of the former, except in unusual circumstances or where a borrower unknowingly commits a foot fault. However, that is not always the case, and the landscape is beginning to shift. Increasingly, lenders are showing a willingness to push for more favorable terms from borrowers despite the adverse tax consequences to the borrower. This is especially true in distressed situations, where lenders have even greater influence in securing their demands. Distressed borrowers with reduced or minimal leverage and significant offshore assets should be prepared to encounter lenders that will seek to extract additional security notwithstanding the adverse tax consequences to the borrower. Borrowers and lenders will need to weigh the tax cost of the foreign subsidiary credit support against the benefit of the increased security to the lenders in reaching a resolution to this issue. n For more information on this topic, please contact: Barry Herzog email@example.com | 212.715.9130 Regulators Increase Focus on PE Firms’ Broken Deal Expenses and ISDAfix — Litigation A pair of recent developments have revealed noteworthy shifts in financial regulators’ focus and will be of interest to banks, alternative funds and others within the industry. The first came when KKR agreed to pay nearly $30 million to settle SEC charges that it breached its fiduciary duty to investors in its flagship private equity funds between 2006 and 2011. The firm, which neither admitted nor denied the allegations, agreed to pay a $10 million penalty, $14 million in disgorgement and more than $4.5 million in prejudgment interest. At issue were allegations that the firm charged so-called broken deal expenses to limited partners, primarily institutional investors, but not to Distressed borrowers with reduced or minimal leverage and significant offshore assets should be prepared to encounter lenders that will seek to extract additional security notwithstanding the adverse tax consequences to the borrower. www.kramerlevin.com Funds Talk 4 co-investors, including KKR executives. As a result, LPs would have assumed all of the expense burden for failed transactions, which the firm was alleged to have failed to disclose to these investors. When the SEC was given expanded authority to investigate and enforce compliance under the Dodd-Frank Act in 2010, it warned specifically it would increase scrutiny of private equity fee structures and expenses. However, Andrew Ceresney, director of the SEC’s Enforcement Division, pointed out that “this is the first SEC case to charge a private equity adviser with misallocating broken deal expenses.” The matter should serve as a reminder for private equity and other financial firms to revisit their compliance and disclosure policies. Secondly, the New York Department of Financial Services requested information from major banks as part of an investigation into the suspected manipulation of ISDAfix, the global derivatives benchmark that banks, corporate treasurers and money managers use to help settle trades in the $381 trillion interest rate swaps market and $44 trillion market for swaps options. The information request came on the heels of the CFTC’s decision in May to impose a $115 million penalty on Barclay’s for attempted manipulation of and false reporting of U.S. dollar ISDAfix benchmark swap rates. Together, these events illustrate increasing regulator scrutiny in this area. n For more information on this topic, please contact: Robin Wilcox firstname.lastname@example.org | 212.715.3224 Recent Developments Require Employers to Redraft Employee Confidentiality Agreements to Explicitly Permit Reporting to Governmental Agencies and FINRA — Employment Employers typically are vigilant about protecting their confidential information. Indeed, employees often are required, as a condition of employment, to execute a broad confidentiality agreement prior to or on the first day of employment. In the financial services industry, confidential information often is the competitive advantage that differentiates one firm from another, yet the repositories of such information — that is, the firm’s employees — walk out the door at the end of each day. Thus, broad contractual agreements are necessary to protect employer assets. Due to recent actions by the Securities and Exchange Commission (the ‘‘SEC”) and the Financial Industry Regulatory Authority (‘‘FINRA”), however, those carefully crafted confidentiality agreements may cause employers to violate applicable laws and regulations. The SEC recently filed an enforcement proceeding, and FINRA issued a notice to members, to address concern that broad confidentiality agreements could be construed to prohibit potential whistle-blowers from reporting information to governmental authorities or self-regulatory organizations. At the same time, other governmental agencies such as the Equal Employment Opportunity Commission (the ‘‘EEOC”) have demonstrated increased concern that such restrictions may impair individuals from reporting violations of the laws such agencies enforce. As a result, all employers must take prompt action to revise confidentiality obligations imposed upon When the SEC was given expanded authority to investigate and enforce compliance under the Dodd-Frank Act in 2010, it warned specifically it would increase scrutiny of private equity fee structures and expenses. www.kramerlevin.com Funds Talk 5 employees in order to ensure compliance with this new regime. SEC Files Enforcement Action Regarding Allegedly Overreaching Confidentiality Agreement In In re KBR, Inc., the SEC filed the first enforcement action alleging that the provisions of a confidentiality agreement violated the whistleblower provisions of the Securities Exchange Act (the ‘‘Exchange Act”) that were added by the DoddFrank Wall Street Reform and Consumer Protection Act (‘‘Dodd-Frank”) and associated rules.1 Exchange Act Rule 21F-17(a) provides that ‘‘[n]o person may take any action to impede an individual from communicating directly with the Commission staff about a possible securities law violation, including enforcing, or threatening to enforce, a confidentiality agreement...with respect to such communications.” When KBR interviewed employees in connection with internal investigations, it required them to sign an agreement prohibiting them from discussing the substance of the interview without prior authorization from KBR’s legal department. The agreement indicated that an unauthorized disclosure “may be grounds for disciplinary action up to and including termination of employment.” The SEC found that this agreement clearly impeded potential communications between such employees and the SEC, and thus violated Rule 21F-17. KBR agreed to modify the confidentiality agreement at issue to include the following statement, set out in full here as an example to be used by other employers: Nothing in this Confidentiality Statement prohibits me from reporting possible violations of federal law or regulation to any governmental agency or entity, including but not limited to the Department of Justice, the Securities and Exchange Commission, the Congress, and any agency Inspector General, or making other disclosures that are protected under the whistleblower provisions of federal law or regulation. I do not need the prior authorization of the Law Department to make any such reports or disclosures and I am not required to notify the company that I have made such reports or disclosures. KBR also was assessed a civil monetary penalty of $130,000. Notably, in addition to the enforcement action against KBR, The Wall Street Journal reported that the SEC has sought the production of years of nondisclosure agreements, employment agreements, and other documents from several employers and has indicated that it has initiated a number of ongoing investigations regarding alleged attempts to silence whistle-blowers.2 As such, it appears clear that the SEC’s action in In re KBR, Inc. is part of a broader strategy to prevent restrictions on the conduct of potential whistleblowers. FINRA Reminds Members to Take Care in Drafting Confidentiality Agreements In Regulatory Notice 14-40 (October 2014), FINRA reminded member firms that a confidentiality agreement prohibiting a person from communicating with the SEC, FINRA, or any other state or regulatory authority would violate FINRA Rule 2010 regarding standards of commercial honor and principles of trade. The Notice focuses in particular on confidentiality provisions used in settlement agreements or in connection with the discovery process in arbitration proceedings. FINRA advises that confidentiality provisions of settlement agreements must “expressly authorize” the signatory to provide information to FINRA and regulatory authorities, “without restriction or condition.” The Notice provides an example of an acceptable provision: 1 In re KBR, Inc., SEC Release 34-74619 (Apr. 1, 2015). 2 ‘‘SEC Charge KBR With Violating Whistleblower Protection Rule,’’ The Wall Street Journal, Apr. 1, 2015, http://www.wsj. com/articles/sec-charges-kbr-with-violating-whistleblowerprotection-rule-1427902706. www.kramerlevin.com Funds Talk 6 Any non-disclosure provision in this agreement does not prohibit or restrict you (or your attorney) from initiating communications directly with, or responding to any inquiry from, or providing testimony before, the SEC, FINRA, any other self-regulatory organization or any other state or federal regulatory authority, regarding this settlement or its underlying facts or circumstances. While not identical to the confidentiality provision approved by the SEC in In re KBR, Inc., the FINRA formulation addresses similar concerns and has a comparable effect. FINRA also cautioned that confidentiality agreements used in connection with arbitration proceedings should not restrict or prohibit any person from communicating with FINRA or any other regulatory authority, including with respect to information received pursuant to the confidentiality agreement. Indeed, it stated that “confidentiality provisions relating to document production in the discovery process do not apply to the sharing of the documents with regulatory authorities.” EEOC Challenges Separation Agreements Perceived to Limit an Individual’s Ability to Communicate With the Agency Like the SEC, the EEOC has recently attacked provisions in settlement agreements that, it contended, placed conditions on severance pay and other separation benefits and thus improperly interfered with the agency’s investigative mission. Two particular lawsuits, the EEOC maintained, were intended to further one of the six strategic enforcement priorities of the agency, that of “preserving access to the legal system.”3 Although neither of the two cases filed by the EEOC to date resulted in a decision on the merits, employers are well advised to consider the views of the EEOC in crafting confidentiality and other provisions in separation and settlement agreements. In Equal Employment Opportunity Commission v. CVS Pharmacy, Inc., No. 1:14-cv-00863 (N.D. Ill. Feb. 7, 2014), the EEOC asserted that the company’s separation agreement violated Title VII of the Civil Rights Act of 1964 because certain provisions impeded the employee’s right to file an administrative charge and cooperate in investigations with governmental agencies. The EEOC asserted that a variety of provisions were problematic, including: The agreement’s cooperation clause required the individual to promptly notify the company if he received a subpoena or other inquiry in connection with any legal matter, including an administrative investigation. A nondisparagement clause prohibited the individual from making “any statements” disparaging the business or reputation of the company. The individual was prohibited from disclosing any “confidential information” — broadly defined to include ‘‘information concerning the Corporation’s personnel”— without permission of the company’s Chief Human Resources Officer. The case was dismissed because the agency failed to participate in conciliation procedures required by Title VII prior to filing the lawsuit. As such, there was no ruling on the merits of the EEOC’s claims.4 In a second case, Equal Employment Opportunity Commission v. CollegeAmerica Denver Inc., No. 14-cv- 01232 (D. Colo. Apr. 30, 2014), the EEOC again brought suit to challenge the employer’s separation agreement. There, the agreement specifically prohibited the individual from “contacting any government or regulatory agency with the purpose of filing any complaint or 3 Press Release, EEOC, EEOC Sues CVS to Preserve Employee Access to the Legal System (Feb. 7, 2014), http://www.eeoc. gov/eeoc/newsroom/release/2-7-14.cfm). 4 ‘EEOC v. CVS Pharm., Inc., 2014 BL 306399, No. 1:14-cv- 00863 (N.D. Ill. Oct. 7, 2014). www.kramerlevin.com Funds Talk 7 grievance that shall bring harm to [the employer]” and contained a broad nondisparagement clause.5 Once again, however, the EEOC suffered a setback when the claims regarding the separation agreement were dismissed due to the agency’s failure to conciliate prior to filing the lawsuit, as well as the fact that CollegeAmerica previously had agreed to not enforce these provisions or interfere with employees’ rights to file a claim or participate in other charges of discrimination.6 Despite the EEOC’s losses, these cases reflect a focus on the form of agreements used by employers in settling disputes with current or former employees and a concern that such agreements do not inhibit potential complainants from contacting the agency and pursuing charges of discrimination. Employers Must Revise Existing Policies and Agreements The conclusion to be drawn from recent actions by the SEC, FINRA, and the EEOC is unambiguous: Employers must ensure that their agreements with employees do not suggest that employees are in any way restricted from providing information to governmental authorities or self-regulatory organizations. Indeed, FINRA specifically requires an express carveout, and the actions of the SEC and EEOC suggest that employers are well advised to expressly advise employees that they are permitted to communicate with such entities notwithstanding the terms of any agreement or policy that might otherwise restrict such communication. A broad range of documents may include potentially problematic provisions, including employment agreements, confidentiality and nondisclosure agreements, separation agreements, settlement agreements, employee handbooks, codes of conduct, and instructions provided to employees in connection with internal investigations. Employers should undertake a comprehensive review of all such documents to ensure that such provisions do not run afoul of the dictates of the SEC in In re KBR, Inc., FINRA in Regulatory Notice 14-40, and the EEOC in the CVS Pharmacy and CollegeAmerica Denver cases. With respect to current employees, employers should consider amending existing agreements or advising employees in writing that any restrictions on communications with governmental authorities or self-regulatory organizations no longer are in effect, and expressly clarifying that employees are free to make such reports. n 5 Complaint, EEOC v. CollegeAmerica Denver Inc., No. 14- cv-01232 (D. Colo. Apr. 30, 2014), ¶ 10. 6 EEOC v. CollegeAmerica Denver, Inc., 2014 BL 338471, No. 1:14-cv-01232 (D. Colo. Dec. 2, 2014). 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