Newsletter Private Equity - 3/2009 EN

Foreword

In this issue of our Private Equity Newsletter, we provide a brief overview of the latest changes to the Italian rules regarding the so-called “passivity rule”, acting in concert and shareholders’ agreements, particularly as they relate to investments in listed companies. We proceed to offer some observations regarding investments made by consortiums of multiple investors in the same target company and complete or partial exit strategies from the investment.
Of particular relevance is the third article that addresses the duties and responsibilities of the directors appointed by financial sponsors in the target when they are faced with a restructuring. With respect to alternative financing, we have commented briefly on vendor financing and related key terms, such as ranking, subordination and repayment.
On taxation matters, you will find a preliminary discussion that addresses the changes introduced in the event that control is obtained of a company located in a tax privileged country. A second article highlights a recent resolution relating to the potential impact of a pledge granted by a holding company to third parties on shares of its subsidiary with respect to establishing the requisite basis for the commencing and execution of a consolidated tax treatment.
With respect to regulatory matters, our first article addresses the issues related to PE investments in, within the context of the Markets in Financial Instruments Directive (MiFID). The article that follows offers a brief overview of the recent “ILPA” principles, which comprise best practice recommended by international limited partners, and raises issues concerning their application with respect to Italian private equity funds.
We conclude this edition of our Newsletter with some snapshots regarding the legal procedures of the European Directive concerning “Alternative Fund Managers” – which we all hope is amended to best respond to the reality facing private equity players – and finish with an overview of the most recent EU legislation or case law related to banks and financing services.
As always, we hope that our Newsletter might be of interest to you. We of course are available to take up with you in greater detail on any of the topics we have discussed thus far or explore any themes of interest to you in future newsletters.

Franco Agopyan
(Chief Editor)
 

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Passivity Rule, Acting In Concert And Shareholders’ Agreements: New Changes To The Rules

Several months after the so-called “Anti-crisis” Legislative Decree, containing rules aimed to facilitate third party tender offers, the Council of Ministers convened in September 2009 has approved certain amendments to the Legislative Decree 229/2007 for the purpose of implementing the EU directive on tender offers. The main changes made by the Legislative Decree address the “passivity rule” (which now includes a form of “opt-out” mechanism), acting in concert, and shareholders’ agreements.
These actions, in effect, represent an about turn. The “passivity rule” (i.e., the rule that forces companies not to take defensive measures after the launch of a third party tender offer on its shares) had been made optional by the Legislative Decree 185/2008 (as passed with law 2/2009), thereby leaving to the discretionary decision of each company whether or not to adopt such a rule by inserting an appropriate provision into its articles.
The “passivity rule” has been re-introduced as a provision that would apply to listed companies by operation of law. The Legislative Decree provides that, unless approved through either an ordinary or extraordinary shareholders’ meeting, which, in turn, depends on the nature of the resolution that needs to be approved, listed companies whose securities are subject to a tender offer must abstain from taking actions or conducting transactions that might offset the achievement of the aims of the offer. This obligation to abstain applies from the date of the notice pursuant to Article 102, subsection 1, of the Consolidated Law on Finance (“TUF”), relating to the decision, or from the occurrence of the relevant obligation, to launch the tender offer, until the closure of the offer or its expiry.
The Legislative Decree did not change the other provisions set forth in Article 104 of the TUF, which make clear that the mere research into other offers does not constitute an act or transaction in conflict with the aims of the tender offer, and that the approval from the shareholders is also to be required in order to implement any decision taken before the start of the above-mentioned period which has not yet been implemented, to the extent that such a decision does not fall within the ordinary course of business of the company and its implementation could counteract the achievement of the aims of the offer. Nor has the Legislative Decree itself changed Article 104-bis of the TUF stating that the “breakthrough rule” shall apply only to companies that elect to introduce such a rule in their articles.
The Legislative Decree, however, allows each listed company to opt for the “passivity rule” by inserting an appropriate provision into its articles that would imply the application of such a rule with respect to any launch of a tender offeri involving its shares. The directors of the company shall then be required to draft a report aimed at illustrating to the shareholders’ meeting the reason for passing the resolution which deals with the “passivity rule”, taking into account that the provisions of law which enable a qualified minority of shareholders to halt the passing of such a resolution apply.
Moreover, the issues inherent in the exit rights of the shareholders triggered by the changes to the articles in connection with inserting the “passivity rule” will need to be carefully evaluated.
In this respect, the new provisions under the Article 104, paragraph 1-ter, of the TUF, directs the companies to notify Consob and the supervisory authorities for takeover bids in member countries in which their securities are admitted to listing on a regulated market or in which admission to listing has been requested of any optional deviation from the law approved pursuant to the above-mentioned provisions. Any such a deviation must also be promptly disclosed to the public in accordance with the provisions under the Article 114 of the TUF.
The provisions introduced by the Legislative Decree with respect to the “passivity rule” will come into force on 1 July 2010. Until this date, Italian listed companies will need to assess their own market control and take any appropriate decision with respect to their own shareholding and strategic ends. The companies that envisage conducting acquisitions by launching takeover bids on companies that have a seat in other EU member countries will also need to take into account that any choice to take advantage of the “passivity rule” would entitle the target company to claim, as a defensive measure, the application of the so-called “reciprocity rule”.
The Legislative Decree also attempts to clarify the concept of “acting in concert” - which is relevant to the applicability of the rules on tender offers - by phrasing the concept in general terms and by using a language that would deem acting in concert to include persons that are cooperating by virtue of any agreement (whether express or implied, verbal or in writing, even if the agreement is invalid or ineffective) intended to acquire, maintain or consolidate the control over a listed company or counteract the achievement of the aims of the offer
It is worth noting that the concept of “concert”, as phrased in the new Article 101-bis, paragraph 4, of the TUF, must be read in conjunction with the following provisions aimed at categorizing the circumstances in which certain persons and entities are deemed to be in “concert” as an absolute presumption unsusceptible to contrary evidence: (i) the parties to a shareholders’ agreement (even if null and void); (ii) a company, its parent company and its subsidiaries; (iii) the companies subject to joint control; (iv) a company and its directors, members of the management board, or supervisory board or general managers. Consistent with the new provisions of law, the Legislative Decree entrusts Consob with substantive regulatory powers which allow it to identify the cases in which (unless any contrary evidence is given) the involved persons and entities are presumed by operation of law to be in concert, as well as to identify the forms of cooperation which do not constitute an action in concert (Article 101-bis, paragraph 4-ter, of the TUF).
Furthermore, the decree empowers Consob to establish any exemption from the regulation, thereby tempering the recurring demand to minimize the burdens for companies planning to launch a tender offer with the need to frame an adequate degree of protection of the investors’ interests. The regulatory instrument granted to Consob includes the power to establish the cases in which derivative securities are computed for the purpose of determining the threshold relevant to the launch of a mandatory tender offer.
Consob, in accordance with the amended Article 102, paragraph 4-bis, of the TUF, is also entitled, on a case-by-case basis, to accept a request from a bidder to have tender offer involving bonds or other debt securities be subject to the less burdensome regulation of public offerings for sale and subscription.
Finally, the Legislative Decree has made certain material changes to the rules applicable to shareholders’ agreements, to the extent that a one-off 5-day term has been introduced under which the shareholders’ agreements must be notified to Consob, published in abstract form in the Italian daily press, filed with the Register of Companies in which the company office is registered, and (by virtue of an “ad-hoc” provision introduced by the Legislative Decree) notified to the company that is the subject matter of the agreement. Other rules on this matter provide for certain exemption from the notification requirements, provided that the agreement involves number of shares which do not represent more than 2% of the issued voting share capital of the company, thus seemingly using the same percentage set forth in the Article 120, paragraph 2, of the TUF, dealing with the notification requirements of major holdings.

Franco Agopyan (franco.agopyan@chiomenti.net)
Michele Cera (michele.cera@chiomenti.net)
 

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Multiple-Fund Investments, Change-Of-Control And Redeemable Shares

It often happens that several funds participate jointly in a consortium, either directly or indirectly, in an investment in the same target company. Let us suppose, for example, that funds A, B and C, each through its respective subsidiary company (that we will call subsidiary company A, B and C, respectively) create a limited liability company (Newco), wholly owned by them, and, through Newco, acquire 100% of the share capital of target (Target). Let us further imagine that the three funds, A, B, and C, through their subsidiaries A, B, and C, enter into a shareholders’ agreement in relation to Newco and to Target, containing, among other things, limits on the transfer of shares of Newco and of Target.
A problem can arise when one of the funds, such as, e.g., fund A, wishes to transfer the control of its own subsidiary A because, in this manner, the shares of Newco, and therefore of Target, would be indirectly transferred. As a result, funds B and C would continue in their investment with a party that is formally equal to that of the original party (subsidiary A), but which is substantially different (to the extent that it is no longer held by fund A).
In order to overcome this problem, it is possible to insert in the shareholders’ agreement a lock-up on the transfer of shares of the subsidiaries A, B and C, requiring funds A, B and C directly to undertake such an obligation upon executing the shareholders’ agreement. However, problems can arise when, in the example above, subsidiary A holds not only shares in Newco, but other investments as well. In such event, A would also be bound in relation to divestments of holdings different from those in Newco and in Target.
It is therefore possible to provide, in the shareholders’ agreement , an option mechanism, through which subsidiaries B and C, of the B and C funds, respectively, have the right to acquire the shares in Newco held by Subsidiary B, if the A fund were to lose control over its subsidiary A.
However, neither is this second solution ideal to the extent that it runs into two kinds of limits: on the one hand, the shareholders’ agreement is limited by time (since it must have a duration, which length depends upon applicable law), and, on the other hand, if it is breached by one of the parties, the protections granted to the other parties are exclusively “in personam” (i.e., restitution for damages or, if provided for, liquidation damages, the amount of which can, however, be reduced in equity by the deciding judge or arbitrators).
In order to benefit of a protection that is not limited in time and is “in rem” (thus rendering invalid any transfer of shares), it is necessary to introduce provisions in the bylaws of Newco. However, the inclusion in Newco’s bylaws of “traditional” rights of first refusal (i.e. the right to be preferred, on equal terms, if there is a transfer of Newco shares) or approval rights (i.e., the right of the corporate bodies to approve the purchaser of Newco shares), do not provide sufficient protection where transfers, like those referred to above, occur “upstream” and involve Newco’s direct or indirect partners.
Article 2437 sexies of the Italian Civil Code (the “Civil Code”), adopted pursuant to Legislative Decree 5/2003, allows to establish, within the bylaws, the power for the company or its shareholders to redeem the shares of the company upon the occurrence of various events. Taking advantage of the possibilities available under Article 2437 sexies of the Civil Code’s it appears possible to provide in Newco’s bylaws that, upon a change of control of one of the shareholders’, the other shareholders can exercise their right to purchase shares in the company, on a pro rata basis, at the same terms offered by the third party. This right of first refusal can also be granted to the company, which can exercise it if, and to the extent permitted by law
The value of the shares subject to the right of first refusal is determined by the board of directors, on the basis of an opinion of its internal auditors and external auditors. It is possible to provide in the bylaws different criteria for the determination of the shares’ liquidation value. If there is a dispute by the shareholders regarding the purchase value, the liquidation value is determined by an expert auditor appointed by the competent court.

Filippo Corsini (filippo.corsini@chiomenti.net)


Director’s Duty During A Corporate Restructuring

As a result of the crisis that has recently hit the economy, various companies have had to resort to the restructuring of its debt, also drawing upon various instruments made available subsequent to the recent reform to the bankruptcy law. During a restructuring, prior to taking any such measures, directors will have to carry out a series of actions whose main principles are set forth below.

Brief points of discussion regarding director liability
The obligations that the law places on directors can be generally divided into two main categories: (i) the specific obligations required under specific statutory rules (including, for example, the obligation to convene a shareholder meeting if there are losses and to verify and file with the registry of companies the occurrence of a mandatory liquidation event) or through the by-laws, and (ii) obligations related to the general duty of care and duty of loyalty.

Director’s liabilities to the company
Directors owe two fundamental duties to the company: (i) to perform with the degree of care required in relation to the nature of their mandate, in an informed manner and according to their expertise, and (ii) to pursue the company’s interest without conflict of interests. The duty of care is an abstract performance standard and must be evaluated on a case-by-case basis.

Director liability toward creditors of the company
The directors are liable to the company’s creditors where they have not abided by their obligations to preserve the company’s assets, and as a result of such failure the company has insufficient assets to satisfy its creditors. In the event of a bankruptcy, the cause of action is brought forth by the bankruptcy administrator.

Additional sources of director liability
In addition, directors are potentially liable to individual shareholders or to third parties if they are directly damaged by the directors’ action.

State of crisis and directors’ duties; Actions taken in anticipation of the restructuring
There are no provisions in the Civil Code that impose specific or more stringent duties of care on directors in the event that the company is in a state of insolvency or crisis (except where the financial problems result in effecting the integrity of the share capital, reducing it by more than a third or below the legal minimum). However, it is undeniable that the state of financial tension or the potential insolvency of the company require that the directors act with due caution in undertaking any managerial act, also in light of a possible restructuring of the company.
Generally, it is useful that, prior to undertaking negotiations with creditors, directors place into effect certain preliminary measures that include, among other things, identifying:
• if the company may be subject to bankruptcy, workout agreement with creditors or extraordinary administration proceedings;
• the reasons for the insolvency or the crisis;
• the current and prospective economic status, assets and financial conditions of the company;
• the appropriate measures upon which to base any restructuring.
It is necessary that any directors’ evaluation regarding initiatives to adopt (eventually for the restructuring of the company’s assets and for the choice of the best means to adopt for such restructuring) is taken only upon the completion of an in-depth analysis of the company’s status, including its prospects, which should ideally be carried out with the assistance of outside consultants, including, among other things:
• the accuracy and reliability of the company’s account;
• the financial indebtedness and related contracts (paying particular regard to any termination provisions that are expressly based upon a state of insolvency;
• controls regarding the company’s net equity;
• verifications of intercompany transactions;
• verification of the availability of shareholders to inject new capital.
Until the establishing of a restructuring plan, it is generally advisable for the directors to abstain from carrying out extraordinary transactions. In addition, in this phase, where the state of financial distress become translated into a lack of liquidity the result of which means that not all of the creditors can be satisfied, the company must adopt particular safeguards for the payments to be carried out to creditors to avoid disparate repayment under the principle of “par condicio creditorum”. To accomplish this it is in principle best not to make any payment or distribution to shareholders (including payments for services or under shareholder loans, to related parties, or, possibly, to creditors.
In such a phase, moreover, it tends on principle not to be advisable to incur new debt to the extent that such new debt could deepen insolvency.
It is in all instances generally advisable that the above-mentioned transactions are put into effect only upon the execution of a restructuring plan whose reasonableness is verifiable pursuant to Article 67, Paragraph 3 letter d) of the Bankruptcy Law, or in execution of a restructuring plan under Article 182 bis of the Bankruptcy Law or of a workout agreement with creditors.

Antonio Tavella (antonio.tavella@chiomenti.net)
 

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Vendor Financing

The recent status of the market of acquisition finance has resulted in investors increasingly turning to alternative financing structures and sources. Among the alternative financing sources, we note the ever increasing use of vendor financing or vendor loans.
Vendor financing is characterized by the granting of a financing by the seller (or an affiliate or of the seller) to the purchaser for an amount equal to a portion, to varying degrees, of the acquisition price of the asset being sold and takes the form of a deferred payment of part of the acquisition price.
The vendor loan is distinct from the mechanics and structure of “earn outs” and “rollover equity”. In an earn out, which is often used where the parties are not able to reach agreement on the value of a company, that part of the deferred price is conditioned on the achievement of pre-determined economic-financial objectives by the target company. In a rollover equity structure, by contrast, part of the consideration for the vendor is represented by shares or other securities issued by the acquirer.
Vendor financing is generally interest-bearing. The repayment of principal and interest does not provide for an amortization plan but usually occurs according to targeted deadlines (i.e., “bullet payments”).
As to ranking, vendor financing does not fall into a particular, typical place in the capital structure, since this depends on negotiations. Often it is repayable prior to the core acquisition finance if certain performance targets are met. On the other hand, it is generally subordinated to acquisition finance on an insolvency.
Vendor financing can be subject to subordination agreement. In this instance one ordinarily speaks of contractual subordination. In other cases the subordination is, instead, obtained through the granting of the financing by the vendor not to the acquirer but to a parent company of the acquirer, and then downstreamed to the acquirer (generally in the form of equity). In this instance one commonly speaks of structural subordination.
The partial or total repayment of the vendor loan before its maturity is generally prohibited except in certain instances such as, for example, a change of control in the target company. It is also necessary to point out that the ability of the vendor to request an advance repayment of the vendor loan is usually subordinated to the prior request for advance repayment by the other creditors who have priority for the repayment of their credits.
Interest on vendor loans, in line with market practice, are often high and many times near the usury threshold. We note, moreover, a major use of PIK interest structures.
Although the vendor loans are generally unsecured, theoretically they could benefit from a pledge over the shares of the purchaser or second-tier security interests.
With regard to taxation, vender loans, to the extent they are granted by parties other than financial institutions, do not benefit from a separate substitute taxation scheme. It follows that any security granted by the acquirer to the vendor will discount the application of any applicable taxes. Finally, it is worth bearing in mind that in those cases where the vendor loan is made by non resident parties, the interest payments made to the vendor will discount the usual taxes on the interest.

Carola Antonini (carola.antonini@chiomenti.net)
Franco Agopyan (franco.agopyan@chiomenti.net)
Alessandro Cagnato (alessandro.cagnato@chiomenti.net)
 

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Amendments To The CFC Legislation

Article 13 of Legislative Directive of 1 July 2009, No. 78 (the “Decree”) introduced several amendments to article 167 of Decree No. 917 dated 22 December 1986 (the Income Tax Act, hereinafter, “ITA”), setting out the so-called Controlled Foreign Companies legislation, the anti abuse provision applicable to companies located in countries enjoying a privileged tax treatment (“CFC Companies”). In particular, the scope of application of such provisions has been broadened under several aspects, so to encompass – in some circumstances – also companies not established in tax haven jurisdictions (“Black List Countries”).

Changes to the exemption motives (business test)
Pursuant to the Italian CFC regime laid down by Article 167 ITA, if an Italian resident directly or indirectly controls a foreign entity located in a Black List Country, any income derived by the CFC company is taxed on an accrual basis (by transparency) in the hands of the resident taxpayer, in proportion to the participation held.
The transparent taxation regime laid down under the preceding CFC legislation was not applicable in case the Italian resident demonstrated that either:
(i) the CFC mainly carries out an actual commercial activity in the state where it is located (business test exemption); or
(ii) the participation in the CFC does not have the effect of locating its income in a low tax state (income test exemption).
In line with the latest approach taken by the Italian tax authorities relating to the business test exemption and with ECJ case law (case C-196/04 Cadbury Schweppes), the Decree amended the previously applicable business test exemption. As a result, under the amended provisions, the exemption applies (and therefore the CFC regime does not apply) only upon condition that the Italian taxpayer demonstrates that the foreign company carries out an industrial or commercial business, as its main activity, within its market of establishment.

Special provisions for banking, financial and insurance activities
The Decree also introduced a special regime for CFC Companies that carry out a banking, financial or insurance business. With respect to such activities, the business test is considered as fulfilled when the majority of the “sources, investments or revenues” originates in the state or territory where such activities were established. It is worth noting that these new provisions are not unambiguous, since the expression “sources, investments and revenues” is open to interpretation.

Further changes to the business test
The Decree also introduced further provisions aimed at broadening the scope of application of the CFC regime. In particular, under these new provisions the business test exemption cannot be invoked if more than 50% of the CFC’s income is made of passive income. More in detail, passive income comprises any income from the management, holding or investment in securities, participations, receivables or other financial activities, as well as from the transfer – or the granting – of intellectual property rights) and from intra-group services (i.e., income from the supply of services, including financial services, in favour of group companies). In these circumstances, the only possible safe harbour available to exclude the application of the CFC regime would be the income test exemption, under which it is to be proven that the participation in the CFC does not have the effect of locating its income in a low-tax state.

The new “White List” CFC Companies
The Decree also extended the CFC regime to any controlled foreign company, even if not established in Black List Countries (therefore, potentially including EU subsidiaries). In particular, the CFC regime in now applicable if the controlled company, at the same time: (i) is subject to an effective taxation less than half of that levied had the company been tax resident in Italy, and (ii) more than 50% of its income either is made of passive income, or it derives from intra-group services as defined in the previous paragraph.
However, this provision does not apply if the Italian taxpayer is able to prove to the tax authorities that the CFC’s establishment was not a merely artificial arrangement aimed at achieving an unfair fiscal advantage. In this respect, it is arguable that reference should be made to the guidelines set out by ECJ in Cadbury Schweppes, a case in which the UK CFC regime was held to be non-compatible with the freedom of establishment principles granted under the EU Treaty.
Pursuant to the reasoning of the ECJ as set out in Cadbury Schweppes, a national anti-abuse measure (such as, in the case at stake, the CFC regime) does represent a restriction on the freedom of establishment, but can be justified where it specifically relates to wholly artificial arrangements aimed at circumventing the application of the national legislation. In this respect, such condition would not be fulfilled in any case in which the incorporation of the foreign company reflects economic reality; any such evaluation must be grounded on objective factors which are ascertainable by third parties and which relate, in particular, to the extent to which the CFC physically exists in terms of, as an example, premises, staff and equipment.

Entry into force
The Decree brought several issues to be dealt with in the forthcoming months, the first one being the date of entry into force of the new provisions. It is unclear, indeed, whether the new provisions had legal effect as from 1 July 2009 (i.e., the date of publication of the Decree in the “Official Gazette”), or if, as a result of the so-called “Statute of Taxpayer” (Statuto del contribuente), these new provisions should apply starting from the tax period following that in which the Decree was enacted (therefore, as from the 2010 tax period).

Massimo Antonini (massimo.antoni@chiomenti.net)
Raul Angelo Papotti (raul.papotti@chiomenti.net)
 

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Resolution Of The Italian Tax Administration Regarding Share Pledges And Tax Consolidation

Background
Within the context of group companies it is rather common that the head company pledges the shares of the subsidiary company as part of a credit facility agreement with the bank creditor. In Resolution No. 240/E dated 27 August 2009 (hereinafter, the “Resolution”) the Italian tax authorities addressed the issue of the possible impact of a pledge agreement on the existence of the conditions for the tax consolidation regime regulated by article 117 and ff. ITA.
In brief, the option for group taxation is exercisable by companies bound by an ownership relationship pursuant to article 2359, paragraph 1), number 1) of the Italian Civil Code, pursuant to which a company is regarded as a subsidiary of another company, if this other company, (i.e., the parent company) holds the majority of the voting rights exercisable in an ordinary shareholders’ meeting. In particular, the option for the group taxation is possible, as set out by article 120 ITA, if the parent company holds, directly or indirectly: (i) a participation in the subsidiary’s share capital higher than 50% and (ii) a participation in the subsidiary’s profits higher than 50%.
This being said, the Resolution addresses the scenario in which the parent company pledges the subsidiary’s shares and, customarily, agrees with the lending bank as to the procedures for allocating (i) the voting rights exercisable in the subsidiary’s ordinary shareholders’ meeting and (ii) the rights to the subsidiary’s distributed dividends. In this respect, the tax authorities have maintained that if, by operation of the pledge agreement, the parent company suffers a reduction in its voting rights by more than 50% of the share capital, the option for – and the continuance of – the group consolidation regime is not possible. On the contrary, the tax authorities have considered as irrelevant, for the purposes of the election and continuance of the group taxation, any granting to the lending bank of the right to the earnings distributed by the subsidiary.

The investment in the share capital
The tax authorities have clarified that the ratio related to the “investment in the share capital” must be calculated by placing (i) in the numerator, the portion of share capital of the subsidiary held by the parent company and (ii) in the denominator, the whole share capital of the subsidiary, consisting in the ordinary shares only. It is worth noting that, for the purpose of performing such a calculation, shares with no voting rights, as well as any similar security, must be excluded from both the numerator and the denominator. This being said, the tax authorities have maintained that, in any case of separation between the ownership of the share capital and the voting rights, such shares should be calculated only in the denominator of the above ratio.
In the light of such principles, the tax authorities have clarified that, where the pledge agreement provides for the allocation to the creditor bank of the voting rights exercisable in the subsidiary’s ordinary shareholders’ meeting, the relevant capital is to be counted for only as part of the denominator.
Moreover, the tax administration specifies that such shares are not relevant also in all the cases in which the voting rights of the parent company are only potentially reduced, or are dependent on an event conditioned entirely by the choice of the pledgor. Instead, the allocation to the creditor of the right to vote in the subsidiary’s extraordinary shareholders’ meeting has been considered irrelevant for the purposes of the fulfilment of the said requirement.
This being said, where the pledge agreement contains provisions regarding the granting of voting rights that strip the parent company, even if only potentially, of the majority of the exercisable voting rights in the subsidiary’s ordinary shareholders’ meeting, the tax consolidation cannot be opted for, and, if already existing, must be interrupted.

Interest in the dividends
The pledge agreement can provide for the option of the pledgor to receive any dividends distributed under the shares. In this respect, the tax authorities have specified that the receipt of the dividends by the creditor – the lender – does not technically represent a payment, as the dividends are attributable to the debtor, representing a reduction in the overall financial exposure. The receipt of the dividends only has a financial function, as the cashed amount, despite belonging to the parent company, is directly received by the creditor, as provided for by the provisions of Article 2791 of the Italian Civil Code. Accordingly, the creditor records a reduction of the loan granted, rather than the receipt of dividends. Therefore, for the purposes of the “participation in the earnings” requirement (calculated as the ratio between (i) the number of shares with dividend rights that are held by the parent company and (ii) the total number of shares with dividend rights), no bearing should be attributed to the circumstance that the dividends are cashed directly by the creditor. As a consequence, the related shares will have to be computed in the numerator of the above ratio, with no impact on the consolidation regime.

Concluding remarks
Given the complexity of the issues discussed, the above remarks should serve only as a general overview of such issues.

Massimo Antonini (massimo.antoni@chiomenti.net)
Raul Angelo Papotti (raul.papotti@chiomenti.net)
 

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The Provision Of Investment Advice In Favour Of Portfolio Managers Or Managers Of Mutual Funds

The MiFID directive, as known, has included investment advice in the group of investment services and has reserved it to duly authorized intermediaries. The main elements of the investment advice are: (i) the existence of a personalized recommendation, presented as tailored for the client or based on the client’s specific features; and (ii) the object of the recommendation, which must be a specific financial instrument (more specifically, the transactions being recommended can be reduced to the following: buying, selling, subscribing, exchanging, redeeming, holding a specific financial instrument or assuming a guarantee towards the issuer in relation to such instrument; exercising or not exercising any right granted by a specific financial instrument to buy, sell, subscribe, exchange or redeem a financial instrument).
The scope of the investment advice appears to be broad, bearing in mind the non-executive nature of this service and of the possibility that the same might be provided in absence of any material activity or management service. On the national level, therefore, Consob had a means to furnish – within the context of the implementation in Italy of the MiFID directive – some interpretive guidelines for clarifying the cases in which the investment advice may be deemed to be provided (with or without other investment services) and the cases in which such service is not carried out.
In view of defining the limits of the investment advice, the Committee of European Securities Regulators (“CESR”) –coordinating the Supervisory Authorities and regulating the financial markets in the European Union – has published on its website, on 14 October 2009, a consultation document (the “Consultation Document”) entitled, “Understanding the definition of advice under MIFiD”. The consultation process will concluded at the end of December; therefore, now, it is not possible to foresee whether, upon the conclusion of such process, the interpretative instructions contained in the Consultation Document (referred to below) will be confirmed.
Preliminarily, the Consultation Document clarifies the difference between the investment advice (investment service) and the so-called “non-core service” of advising on “undertakings on capital structure, industrial strategy and related matters and advice and services relating to mergers and the purchase of undertakings” (which, under the Italian Financial Law, constitute an ancillary service and, therefore, is not subject to reserve). On this point, the CESR has affirmed that “advice on “capital structure, industrial strategy and related matters” is not investment advice because such advice will not involve investment in financial instruments”; it is understood, however, that the “firms may need to consider whether they are providing investment advice or corporate finance advice (or a combination of the two) on a case-by-case basis”.
Moreover, it is made clear that an advice provided to a company aimed at determining the issue by such company of securities does not fall within the scope of the investment advice to the extent that “investment advice will be provided only where a recommendation is made to a person in his capacity as an investor or potential investor” or, as will be discussed below - “in his capacity as an agent for an investor or potential investor”.
The Consultation Document contains certain points of interest regarding the hypothesis in which the investment advice is provided to a portfolio manager or to manager of mutual funds, on the basis of the specific investment policies of the interested funds or the investment needs of the clients managed. With regards to this, according to the Consultation Document, the generic indication of an investment opportunity to a manager does not fall within the scope of the investment advice, as it lack the necessary personalization of the recommendation with respect to the needs of the investor in question.
However, where the investment recommendations are furnished to a manager responsible acting on behalf of a client or group of clients, having regard for the specific characteristics and needs of these clients, based on the Consultation Document, both the elements constituting the investment advice may be deemed to exist. In other words, as stated by the CESR, more than the party requesting the investment advice, it is important the party whose investment needs are considered in view of presenting the recommendation as “suitable”.
The above can also have consequences for the private equity sector with respect to those scenarios in which the Italian or foreign manager requests to an advisor to identify possible investment opportunities. In this scenario, for the purpose of understanding if it is or not provided by the advisor the investment advice, it will be necessary to verify whether the recommendations furnished by the advisor to the manager can be qualified as personalized with respect to the specific investment policies of all or some of the collective investment vehicles managed by such manager.
From another perspective, the qualification made by CESR in the Consultation Document, to the extent that it identifies, as the clients, the assets managed by the advisor, can have an impact on verifying whether the investment advice offered to the managers by parties that belong to the same group is or not “infragroup” and, consequently, falls or not within the scope of the relevant exception provided for under article 2 of MiFID and by internal laws and regulation.
The communitarian law, indeed, excludes the application of the rules concerning the investment services in respect of an infra-group provision of investment services (i.e. when the investment services are provided in favour of the parent company, the subsidiaries or the subsidiaries of the parent company). Although the cited provision has not been expressly adopted in Italy, Italian law and regulations provides for an analogous exception (in D.M. 329/1997, still in force) pursuant to which authorization requirements, applicable to the provision of investment services, do not apply to services provided exclusively to parent companies, subsidiaries, or subsidiaries of the parent company.

Vincenzo Troiano (vincenzo.troiano@chiomenti.net)
Agostino Papa (agostino.papa@chiomenti.net)
Giancarlo Ranucci (giancarlo.ranucci@chiomenti.net)
Andrea Gabrielli (andrea.gabrielli@chiomenti.net)
 

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The ILPA’s Private Equity Principles And Italian funds
On 8 September 2009, the Institutional Limited Partners Association (“ILPA”), a association comprised of over 220 limited partner private equity investors, drew upon the input of limited partner investors and round table discussions among the Association’s members to publish a set of guidelines and standards for private equity limited partnership agreements. The stated principles aim to, among other things: (i) enhance private equity funds’ governance and (ii) align the interests between funds’ managers and investors. Specifically, the principles aim to strike a new balance (on the heals of the systemic crisis) between the interests of the general partners and those of the limited partner investors.
Without prejudice of internal laws and regulations, the above-described principles can provide useful points of reference for the establishing or the analysis of rules governing Italian private equity funds, above all for the enhancing of start up investments by foreign parties or for the evaluation of the feasibility of the transactions related to already existing funds.
According to the ILPA statements, with reference to “waterfall payments” and distribution mechanisms for fund investors of the management proceeds, the standard model is considered to be that of the “all-contributions-preferred-return-back”, which subordinates the distribution of the Fund’s excess earning and of the carried interest to the entire repayment to investors of payments that have been made and of the target earnings.
Where a distribution is conducted on a “deal by deal” basis (in which the waterfall payments are managed separately for each of the investments of the fund), in order to compensate the risk of the investors due to the distribution for repayment of the General partner and of the management (in Italy, of the SGR and of the managers or parties involved in the funds’ management) prior to the entire reimbursement of contributions, it is market standard for at least 30% of the Fund’s excess earning to be placed into an escrow account, accompanied by insertion of a claw-back provision.
Both the distribution mechanisms are compliant with Italian law and are applicable with Italian market practice. In particular, the percentage of surplus earnings that the fund sponsors, the SGR and its managers can expect, which is held in escrow in the deal-by-deal structure, generally depends upon the track record of the manager and the degree of risk of the transaction, with, however, a generally accepted minimum of at least 30%.
As far as the management fees as concerned , the ILPA recommends that the General Partner fee is significantly reduced following the call period and at the start of the second phase of the Fund activity. Italian market practice ordinarily applies commissions, in the first period of the fund’s life, based on the subscriptions of the investors (irrespective of the amount paid) and, following the conclusion of the call period, on the asset value of the fund.
With respect to the “Key Men clauses”, the ILPA recommends the inclusion of clauses requiring the Key Managers to dedicate – at least until the conclusion of the call period or upon the investment of certain percentages threshold of the subscriptions – substantially all of their time and work effort to the fund activity, prohibiting participating in similar initiatives with similar investment policies. Italian practice, also in consideration of the period of set up of the fund and of the approval of the relevant rules generally include provisions that specify the obligations of the Key Managers with respect to managed funds which do not always are accompanied by express provisions preventing the involvement of such Key Managers in analogous initiatives.
With respect to governance, the guidelines of the ILPA recommend avoiding adoption of provisions that: (i) limit the liability of the General Partners; (ii) allow the General Partner to determine those transactions in conflict of interest or with related parties; and (iii) grant the General Partner an indemnity for conduct that constitutes a breach of the partnership agreement and a violation of the General Partner’s fiduciary duties. At the same time, they recommend that the Fund Rules include provisions which (i) allow to remove the General Partner even where there is a non adjudicated judgement; (ii) provide that any amendments to the Rules and to the investment strategy can be enacted exclusively before approval of a qualified majority; and (iii) allow investors to suspend or end the call period, remove the General Partner or liquidate the fund, including without cause, through a simple or qualified majority vote.
Furthermore, with respect to the Advisory Committee, the ILPA identifies uniform provisions regarding the composition, appointment, role and responsibility of the representative body for the investors. In particular, it is provided that this committee is composed of between seven and twelve members, representing separate groups of investors, encouraging the inclusion of provisions that allow the participation to meeting of the Committee of observers, without any voting rights, representing other investors. The obligation to request the prior authorization of the Advisory Committee for the carrying out of conflict of interest or related parties transactions should be included.
Italian laws and regulations expressly provide for the attribution to the fund’s investors meeting the power to resolve on, among other things, changes to the investment policies of the fund and on the substitution of the SGR, reinserting however within the rules the definition of the relevant event. In this sense, the possibility of substituting without just cause the SGR is usually provided for only for a period of 24 or 36 months upon the launch of the fund. Moreover, in practice, the powers of the meeting usually include approval of all the amendments of the fund rules and the anticipated liquidation of the fund. As far as the investors committees, the fund rules provide various mechanisms for appointment, however aimed at ensuring the participation of the main investors. Such committees are normally granted the power to express binding opinions in relation to conflict of interest transactions. We also find a growing use of provisions that attribute to investors the power to suspend or terminate the call period upon the occurrence of specific events specified in the by-laws.

Vincenzo Troiano (vincenzo.troiano@chiomenti.net)
Agostino Papa (agostino.papa@chiomenti.net)
Giancarlo Ranucci (giancarlo.ranucci@chiomenti.net)
Andrea Gabrielli (andrea.gabrielli@chiomenti.net)
 

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Overview Of Recent EU Legislation

The financial crisis has served as a catalyst for the adoption of new initiatives at EU level regarding banking and financial services. These measures share the common goal of correcting weaknesses within the banking and financial system that are at the basis of the current crisis, so as to render the system more stable and less pro-cyclical to the real economy.

Proposal for a Directive regarding “Alternative Fund Managers”
Among the initiatives recently undertaken which directly concern the private equity sector, there is a proposal for a directive relating to “alternative fund managers”, described in the last edition of our Newsletter. Although this proposal was preceded by significant preparation by the Commission, which involved various stakeholders, this proposal for a Directive has been welcomed in a rather critical way both by the industry and also by the Swedish Presidency of the European Union and the European Parliament. One of the most significant issues concerns a topic that is dear to the private equity industry, i.e. the non-differentiation between hedge funds and private equity funds, despite that fact that only the former constitute a source of systemic risk for the market.
Many Members of the Parliament voiced their concern that the adoption of the same rules for these two types of investment funds could result in the distancing of many private equity players from the European Union, because of the disadvantage they would suffer on the basis of their location. In response to these objections, for the time being formulated only orally on the occasion of the debate that took place last October 6, at the Commission for Economic Affairs of the European Parliament, the European Commission reacted by defending its proposal, which avoids having to identify the distinctive features of the various alternative investment instruments, a task deemed “impossible and not desirable”. The Parliament Commission has at the end followed the suggestion of the rapporteur on this proposal, Mr Jean-Paul Gauzès MP, French member of the European Popular Party, on the carrying out of an impact assessment on the various issues deemed to be the most problematic, i.e. the scope of the Directive, the relationship with the investment funds that are not established in the European Union, the liability of the depositary banks and debt leverage. This assessment should be ready by the second half of November and it is expected that it will be duly taken into account by the report of Mr Gauzès, which should be discussed at the Parliament Commission on the session from December 1 to December 2, 2009.
The Council has also begun its own analysis of this proposal for a directive. It is to observe that the Swedish Presidency has been very active by providing a list of issues to be discussed, including the scope of the proposed Directive, the relationship with non-Member States, the new transparency obligations of private equity funds acquiring control over companies and the possible discrimination among funds on the basis of the applicable exemptions. On November 11, 2008, the Swedish Presidency presented a compromise text of the directive, which will be discussed by the Council’s working group over the next several weeks. This compromise text introduces significant changes to the Commission proposal: for example, it would limit the transparency obligations for private equity funds only upon the acquisition of control over non-listed companies, it would introduce provisions on the remuneration policy for employees of asset managers and it would lessen the burdens for funds established in non-Member States that invest in European countries.
In light of the statements made by members of the European Commission, European Parliament and Council, it appears that they intend to reach an agreement and proceed with the approval of this directive in first reading and in any case in a timely manner.

 Changes to capital requirements of banks
Alongside of this proposal, which directly concerns the private equity sector, there is a number of initiatives that can indirectly affect this business. Among these, it is worth mentioning the revision of the Directive regarding the capital requirements of credit institutions (Directive 2006/48/CE and 2006/49/CE). In addition to the amendment proposal of October 2008, which has already been approved by the Parliament and adopted by the Council, on July 13, 2008 the European Commission has published a second amendment proposal that has already been already examined by Council, which adopted on November 10, 2009 its common position, and is currently before Parliament for adoption. It would therefore appear that this second amendment is also soon to be approved.
Among other things, this second amendment will request banks to modify their remuneration policies so that they are not based on the amount of credit granted but rather on the quality of credit risk taken, while at the same time providing for severe sanctions for institutions that do not comply with this rule.
This provision, together with the limits introduced with respect to securitization and the raising of capital requirements with respect to securities recorded on the trading book, will presumably have the effect of significantly limiting any risk-taking attitude on the side of banks as far as the granting of credit is concerned, affecting especially SMEs, which depend a great deal on bank credit and have limited negotiating powers.
The Commission announced that it would publish in October 2009 a third proposal to modify the capital requirements of banks, which most likely will result in the strengthening and tightening of banks capital requirements, thus potentially leading to a further credit crunch. Despite the announcement, however, the Commission has not yet published this proposal and, given the current limit to ordinary business of the Commission due to the expiration its mandate, it seems likely that the issue will be taken into consideration once the new Commission has taken office, presumably in the first months of 2010.

Amendment to the Prospectus Directive
A law provision which, if approved, will carry benefits for the private equity industry is the proposed revision to the Prospectus Directive. Among the various provisions, it is worthwhile to note the simplification of the transparency requirements for limited sized issuers and the elimination of transparency requirements that duplicate those required under the Issuer’s Transparency Directive.
As expressly stated by the Commission, the introduced simplifications have as their goal the simplification of the listing and recourse to the capital markets by the issuers, while reducing the administrative costs connected with the issue.

Stefania Bariatti (stefania.bariatti@chiomenti.net)
Elisa Dell’Anna (elisa.dellanna@chiomenti.net)

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