Newsletter Private Equity - 4/2010 EN

Preface
Following a long winter of discontent in the private equity industry, there are positive signs on the horizon. Investors have finally returned to looking at new deals and investment opportunities. In this issue of our Newsletter we begin with a brief overview of the state of health of the private equity industry, providing our insights, data and comments on major market trends in Italy and internationally.
We open our discussions with an interesting look at the FIG sector and in particular at investments in banks and financial services companies which are no longer subject to the same strict quantitative limits on holdings imposed under previous legislation.
We follow with a discussion on classes of shares and how they are used in the Italian practice by PE funds. Here, we pay particular attention to deals involving the acquisition of minority interests.
The revival of the market for corporate bonds experienced in the latter part of 2009 and in early 2010 is the subject of the note that follows. We discuss in general terms the structure of high yield bonds and the principle legal issues that arise where the issuer is an entity subject to Italian law.
We have also thought to share some of our insights with our readers regarding safe harbours for direct foreign investments provided under the Treaty of Lisbon which recently entered into force on 1 December 2009.


We go on to explain the main changes introduced by the Legislative Decree of 27 January 2010 No. 27 implementing Directive 2007/36/EC of 11 July 2007 (the “Shareholder Rights Directive”) regarding the exercise of certain rights of shareholders in listed companies.
We bring this issue to a close with two articles on tax matters. The first one deals with the changes to CFC’s, which also apply to audits of companies located in “White List” countries. The second note summarizes the main provisions of the new tax treaty on double taxation between the United States and Italy which entered into force on 16 December 2009.
As always we hope that our Newsletter is of interest to you and provides some food for thought. We are of course available for further consultation on the issues we touch upon and remind you that we welcome any suggestions on topics you would like us to address in future issues.

Franco Agopyan (Editor) (franco.agopyan@chiomenti.net)

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Editorial: A brief overview of the state of health of Private Equity
Here follows a quick overview of market trends and some related thoughts:

1.Fund Raising; Investors: Following the 2005-2007 boom (marked by a 380% increase in fund raising) and a 2008 that was substantially in line with previous years, 2009 represented the worst year for new fund raising activity since 2004 (approximately USD 245 billion worth of funds were raised worldwide, a 50% drop from 2008). The dominant fund types raised in 2009 included specialized funds (especially energy and secondary funds) and buyout funds. In terms of sources of capital, the types of investors (LPs) weighing in the most heavily included pension funds, foundations, banks, insurance companies and funds of funds. The U.S. and Europe were the prevailing geographical regions for the origination of funds. Despite the complex conditions surrounding the state of the current market, many GPs are currently raising funds and many of them have already reached their initial targets. A positive sign to note with respect to the immediate future seems to be a renewed willingness of LPs to invest in asset classes as the chief impediments to such investing in 2008 and 2009 (the generally known problems of liquidity, etc.) have been largely resolved. For 2010, GPs expect that LPs will return to make new commitments and that some of them will increase their portfolio allocations dedicated to PE and in particular to mid-market funds, turnaround funds, secondary funds and emerging markets funds. It is interesting to note the great caution exercised by LPs with respect to the selection of GPs and to the performance of investment due diligence, as well as their greater bargaining power regarding fees and fund terms.

2.Secondary Market: Owing in part to the gradual improvement of the global equity and debt capital markets and the limited number of capital calls made by GPs in 2009 (with, as a consequence, a general reduction of tension with respect to the business and/or financial conditions of investors), in 2009 the market for the sale of fund units among investors has experienced lower volumes than expected, except for the recording of rises in volumes and prices during 4Q09 (when the average price seems to have been around 33% of NAV in comparison with an average of 55% at the end of 2008). For 2010, the secondary market is likely to expand with volumes expected to exceed those of 2009. Key factors to take into consideration include: (i) the increasing number of secondary funds and their capital available for new investments (“dry powder”), which is currently estimated at around USD 40-50 billion (including secondary funds currently raised); (ii) the imbalance between supply and demand (the total value of assets potentially up for sale has been estimated in over USD 75 billion); (iii) the likely increase of capital calls by GPs in 2010 following the resumption of investment activity by funds; (iv) the possible introduction of legislation that may prohibit banks from holding shares in private equity or hedge funds; and (v) the possible re-emergence of distressed sellers if any slippage in the market occurs during 2010. However, it is expected that there is still a disparity between dry powder and the volumes that are actually traded.

3.M&A Activity: Following a negative trend in 2009 (a 60% reduction in the value of deals since 2008, which in turn reflected a steep decline with respect to 2007, the total value of closed deals in 2009 reaching approximately USD 75 billion), GPs seem generally confident that 2010 will show signs of a recovery. With respect to private equity, in particular, the recovery could be driven, on the one hand, by the need for some funds to execute new investments (either to meet fund deadlines or for the purpose of making new distributions to its own investors) and, on the other hand, by the availability of unutilized capital commitments estimated at one trillion USD (of which approximately USD 280 billion seems destined for the European market).

4.Leverage Financing: With regard to leverage finance, we note a renewed willingness by banks and financial institutions to finance deals, especially in the mid-market segment, with respect to companies with strong fundamental values. The widely held belief among GPs is that new LBOs will be characterized by: (i) lower degrees of leverage; (ii) greater use of equity (40-50%) and the use of more simplified capital structures than in recent years; and (iii) tighter covenants and conditions with respect to the past. Especially in larger deals, it is, however, likely that leveraged financing may be made available only by a pool of lenders. Alternative financing options to first-lien loans (or additional funding sources, especially for larger deals), may be mezzanine loans and high-yield bonds. We believe that there will continue to be room for vendor financing, earn outs, equity rollovers and other similar structures, especially where there are valuation gaps in target assets.

5.Restructuring: We expect that refinancing and debt restructuring, which kept the majority of funds and their advisors busy in 2009, will continue throughout 2010. Given that the market for CLOs is stagnant, we note the great concern that exists amongst GPs regarding the financing of mega-deals closed at the height of the market in 2006-2007, which should approach maturity in 2012, and in all likelihood will require refinancing. This clearly implicates the erosion of the value of the sponsors’ equity, which are competing with lenders and potential third-party purchasers to defend their investments.

6.GPs’ Focus: A commonly held belief amongst GPs, and one which we share, is that private equity must abandon the investment model adopted in recent years, one that relies too heavily upon the use of leverage aimed at increasing the return on investment, to return to a more traditional model whose goal is to create value through the growth of fundamentals (increase in productivity, revenue growth, improvement of margins, consolidation of market position, etc.) of portfolio companies, with the awareness that such a model might generate lower IRRs than in the past and/or require longer holding periods. We are therefore that for the foreseeable future the key to the success of a fund will be based on its capacity to demonstrate that it can deliver such value to its LPs.

7.New Deals: With respect to the deals, we expect that in the course of 2010 the market will continue to focus on: (i) mid-market deals; (ii) acquisitions of divisions or non-core assets of multinationals (carveouts); (iii) minority holdings (growth capital); (iv) add-on acquisitions; (v) equity replacement for distressed companies – the hottest sectors could include financial services, energy, technology, consumer goods and medical application.

8.Exits: After a negative 2009 (55% drop off from 2008), everyone expects an increase of fund divestments in 2010. The preferred exit route will probably continue to be the trade sale and, in certain cases, especially where there is large-scale holding with strong fundamentals, the IPO. As a consequence, a dual track approach might very well be seen.

9.Regulatory and Tax Issues: European private equity operators are increasingly concerned with the possible market impact resulting from the proposed European directive regarding Alternative Investment Fund Managers (AIFM). Private-equity industry associations, including the European Private Equity and Venture Capital Association (EVCA), have long been active in working to sensitize the European Commission regarding the negative impact that such legislation would have on the competitiveness of European funds worldwide. The costs (direct and indirect) resulting from the introduction of the AIFM Directive could lead to a progressive abandonment of European domicile of certain global PE players, resulting in the penalization of European investors and a general reduction of resources available for investments in the European marketplace. Proposals to amend the tax treatment of bonuses and carried interest that has recently moved forward in certain countries, such as Great Britain and the United States, has become another key issue for private equity operators.

Franco Agopyan (franco.agopyan@chiomenti.net)

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New rules and evaluation criteria for changes in the amount of holdings in entities operating in Italian banking, insurance, reinsurance and securities investment sectors
International private equity funds have closed more than thirty transactions in Europe in the financial sector totalling Euro 2.68 billion in disclosed deal amounts (source Mergermarket). A particularly noteworthy deal included the acquisition by a consortium of private equity funds of 57% of the share capital of the French listed company Paris RE Holdings Ltd. (a multi-line reinsurance company). Leading deals in Italy within the financing sector included Clessidra’s acquisition of 67% of the share capital of Prima SGR S.p.A. (into which Monte Paschi Asset Management SGR S.p.A. and ABN Amro Asset Management Italy SGR S.p.A. had previously merged) as well as Sator’s purchase of 51% of the share capital of Banca Profilo S.p.A.
Italian Legislative Decree 27 January 2010, No. 21, entered into force on 10 March 2010, together with the rejection of the principle of separation between banks and industry introduced by Article 14 of the Italian Law Decree 29 November 2008, No. 185 (converted into Law 28 January 2009, No. 2) (for further discussion, see our Newsletter No. 2 of Spring 2009) opens up new prospects for private equity fund investment in the insurance and financial sectors.
Italy has in fact gone forward with implementing Directive 2007/44/EC by setting forth a new set of rules and criteria for the prudential assessment of acquisitions and increases of holdings in banks, insurance companies and investment companies.
The regulatory framework relating to acquisitions and increases of holdings in the financial sector has been harmonised with the EC Directive and enacted into Italian law. The regulatory guidelines were first set forth in detailed Communications to the market published (a) by the Bank of Italy on 12 May 2009 with respect to holdings in the banks and (b) by the Italian Private Insurance Regulator (“ISVAP”) on 2 July 2009 with respect to holdings in insurance and reinsurance companies. These Communications were issued in response to the deadline for implementation imposed by the Directive, whose clear and precise provisions allowed for its direct application.
The new rules partially modify the Banking Code (Legislative Decree 385/1993), the Financial Code (Legislative Decree 58/1998) and the Insurance Code (Legislative Decree 209/2005) with respect to the procedures necessary to acquire (or to increase) stockholdings in the financial sector.
The first noteworthy change requires any person who proposes to acquire, directly or indirectly, a holding of greater than 10% (n.b.: an increase from the previous 5%) in voting rights or share capital in an Italian bank, insurance or reinsurance company, securities management company, or other financial sector operator, to seek for and receive authorization, prior to the acquisition, from the relevant Italian authority, i.e., from the Bank of Italy for holdings in banking institutions or from ISVAP for holdings in insurance and reinsurance companies. Authorization is also required if the voting rights or capital held reach, exceed or fall below 20%, 30% or 50%. These same thresholds apply to acquisitions (or increases) of holdings in the share capital of other types of financial sector companies, including investment management companies (SIMs), asset management companies (SGRs) and investment companies with variable capital (Sicavs).
The new legislation grants regulatory authority to the Bank of Italy over banks and investment management companies and to ISVAP over insurance and reinsurance companies to assess whether the applicant meets criteria that ensures the sound and prudent management of the target regulated entity. The criteria to be considered by the competent authorities includes assessing the reputation of the proposed acquiror, such as the professionalism, reputation and independence of those who will perform managerial and auditing tasks within the company following the acquisition. The assessment criteria also includes evaluation of the financial soundness of the proposed acquiror; the ability of the target company post-acquisition to comply with the prudential requirements; examination of whether the group of which it will become a part has a structure in place to enable effective supervision.
The procedural aspects relating to the assessment period include the following: (i) the Bank of Italy or ISVAP has 60 days from the date of the written acknowledgement of receipt of the notification to carry out its assessment (such acknowledgement must be mailed to the petitioner within 2 working days following the filing by the potential acquirer, specifying the deadline for the issuance of the approval or disapproval), (ii) the relevant authority may extend, once only, the assessment period by 20 or 30 working days (depending on the type of regulated entity); and (iii) if by the end of such period the competent authority has not notified its disapproval, the transaction is deemed approved.
Any initiatives undertaken within the financial sector obviously may not be taken without prior interaction with the relevant regulatory authorities, especially where a greater degree of the authorities’ technical discretion is involved (as, for example, in the evaluation of the professionalism of the “industrial” investor, or the aptness of the group of the potential purchasers, to ensure an effective prudential regulation), so as to ensure that prior to the application the petitioner understands the nature of the applicable criteria, limitations and requirements.

Stefano Mazzotti (stefano.mazzotti@chiomenti.net)
Francesco Maria Graziani (francescomaria.graziani@chiomenti.net)

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Expansion capital and succession issues: the opportunities offered by share classes
It is often the case that funds consider making investments in companies that face, for various reasons, critical issues relating to their development. Take for instance the very delicate and complex issues relating to succession. According to a recent survey conducted by the University of Milan, 50% of all Italian entrepreneurs are between sixty and seventy years old.
Succession issues can be a traumatic moment for a family business that threatens to undermine its survival if the company does not have sufficient financial or managerial resources to enable it to plan and manage change in the face of challenges posed by global markets. Tension, then, is likely to increase also due to internal factors within the company, if one considers that the financial structure of small- and medium-size companies in Italy are not very sophisticated in terms of capital structure because of the limited availability of financial instruments.
Although share classes have been recognized for years in the Italian legal framework, the use of such instruments is not yet widespread in the Italian market, in contrast to more mature markets, such as the United Kingdom and United States. We provide below a few observations relating to these instruments and the possibility of their use in practice.

Share Classes
Company law reforms have revitalized the issue of share classes by offering new possibilities for their use by providing for greater flexibility in drafting by-laws provisions with respect to share classes, by introducing: (1) “standard” categories of shares (e.g. tracking stock, shares without voting rights, shares with limited or conditional voting rights, shares carrying a limited percentage of voting shares, and redeemable shares) and (2) the “negotiability” of the special share classes, which allow parties to negotiate on their own the rights of each share class.
The points that are mostly negotiated among the parties with are: (1) participation to profits; (2) participation to losses; and (3) rights upon liquidation.

Priority shares and preferred shares
Priority shares provide holders with preferential rights to dividends. These rights may be limited to a maximum percentage according to specified parameters (e.g. nominal value of the shares, amount of the paid up share capital or other criteria) and/or a specified absolute amount. The right of priority can then be exclusive, in which case the shares will have no further right of participation in profits (i.e. non-participating shares), or include the right of participation in residual profits (i.e. participating shares).
Preferred shares, by contrast, provide holders an unqualified and specific right to profits participation to the extent that, in diverging from the principle of proportionality, they provide a right to a percentage of distributed profits that is always higher than that of ordinary shares.
It is clear that based on the actual percentage of profits that are reserved to preferred shares, priority shares might also turn out to be like preferred shares where distributable profits are declared in an amount just sufficient to ensure the minimum dividend priority.
In any case any issuance of priority shares results in the deferment of the ordinary shares in participating in distributed profits.
In addition, there is no reason to prevent a company from issuing special shares whose right of priority or, alternatively, whose right of preference is made conditional upon the elapsing of a certain number of fiscal years, the occurrence of certain events, or achieving certain threshold amounts of profits declared or distributed in each fiscal year.
The parties are free to devise progressive distribution mechanisms (i.e. the progressive increase of the attributable percentages of profits), regression (i.e. the progressive reduction of such percentages), staggering (depending on the actual amount of profits which is declared and distributed) or amount limits (pursuant to which the right to profits which are in excess of a certain amount would be forfeited) with respect to the rights, or measure the rights on the basis of indices which are not keyed to the performance of the company.

Reference parameters and profits
The method for calculating the rights can be tied to a fixed value (e.g. the nominal or face value of the shares), a variable value (e.g. the amount of the distributable profits or the net equity), or a function of specific components of income generated by the management of the companies (e.g. the profits associated with a business unit, or the portion of profits deriving from the disposal of certain assets or business units).
The component underlying the right of priority or preference can be represented by the operating net profits only (on an exclusive basis) or extend to retained earnings or other distributable reserves (subject to an ad hoc provision of the by-laws).
One should exercise extreme caution in drafting the by-laws or the shareholders’ agreement in order to guard against conflicts arising among the various interests, but also to avoid incurring the risk that the rights of priority and preference can be eluded by a dividend policy that does not meet initial expectations (i.e., the board deliberately fails to distribute profits in the years even when such profits would be sufficient to remunerate the preferred shares). It is therefore advisable for the investor to mitigate this kind of risk by setting out in the by-laws appropriate mechanisms (e.g. cumulative dividend clauses) to ensure that the right of priority or preference which remains unpaid from previous years (because of the failure to achieve profits or the creation of reserves from such profits) is paid cumulatively prior to any distribution to other shareholders.

Varying allocation of losses
Losses can be adjusted to be allocated in varying degrees to different share classes through mechanisms similar to those that can be adopted for the allocation of the participation in profits, such as: (i) by establishing criteria for the allocation of losses, (ii) by setting up parameters for calculating the allocation of the losses and (iii) through the definition of loss.
As a result, in a manner similar to that seen for the participation in profits, one can design subordination rights (such that losses would affect first other classes of shares – up to a predetermined limit – prior to those shares that have incorporated priority rights) or preference rights (such that losses would affect certain shares to a greater extent than shares that have incorporated preference rights).

Liquidation rights
The rights to liquidation proceeds is another cornerstone of the rights incorporated in special shares that can be structured in a way that varies from the principle of proportionality by recognizing liquidation rights to a certain class of shares, for instance: (i) a priority in terms of repayment of the nominal value represented by a class of shares, (ii) a preference in terms of increased participation in residual assets, or (iii) the right to a certain percentage of the liquidation net proceeds that is higher than that applicable to other shares.

Shareholders’ agreement or by-laws?
Market practice has so far demonstrated a tendency to establish the rights, preferences and privileges discussed above through stipulations in the shareholders’ agreement. But what is the relationship between a shareholders’ agreement and special share classes?
It is evident that the creation of special classes of shares rises to the level of a “de facto” shareholders’ arrangement set forth in the by-laws. However, the new rules now make it possible to structure a different kind of relationship between shareholder arrangements and by-laws as the parties enjoy a higher degree of negotiating flexibility in devising mechanisms within the by-laws to establish the preferences and privileges of special share classes. Arguably, private equity funds will not, as a result of the new laws, encounter significant limitations in pursuing such objectives and, moreover, they will have the option of making changes directly to the by-laws which, in contrast to the provisions of shareholders’ agreements, may be agreed to for the entire duration of the company and are effective with respect to both the company and third parties in general.

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

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High yield bonds and Private Equity
Introduction
The global financial crisis beginning in 2008 caused the bailout of several banks in Europe and in the United States, the injection of public funds into the capital markets and a significant decrease in interest rates, all of which, in turn, have led to a revival of the corporate bond market in the latter part of 2009 and early 2010. As reported by Bloomberg, the issuance of corporate bonds in the US reached USD 162 billion in 2009, exceeding the previous peak of USD 149 billion in 2006. Recourse to bond issues has occurred for traditional capital financing or refinancing reasons, as they are currently being offered at more competitive rates, and also in the context of acquisition financing transactions. These transactions have been carried out by companies operating in various business sectors -- from automotive and energy, to the food, pharmaceutical and telecommunications industries. The latter of these sectors in particular have included a number of high yield bond issues for the refinancing of existing debt incurred for acquisition purposes.
These trends have obviously involved the private equity market in which a number of bond issues have been carried out, many of which were for the refinancing of existing indebtedness.
Set out below is a summary of the structure and terms generally applicable to high-yield bonds issuances as well as the main issues to be considered if the issuer is an Italian entity.

Structure of the transaction and main terms and conditions
In the European acquisition finance market, transactions normally involve the issuance of high yield bonds by a company which in turn owns 100% of the Newco used for the acquisition of the target, which is financed with senior bank debt. Generally, high yield bonds are secured by a guarantee by Newco and occasionally, in accord with financial assistance rules, by the target company as well.
Such bonds are normally unrated or assigned ratings below investment grade. Issued instruments, in any case, ensure returns to investors that are above the average rates applied to corporate bond transactions of similar standing in the markets.
The contractual terms of high yield bonds typically provide for: (i) payment of principal in one single instalment (bullet payment), generally with a seven- or ten-year maturity; (ii) semi-annual interest payments (or, alternatively, PIK mechanisms); (iii) mandatory or voluntary prepayment provisions (the voluntary prepayment is generally provided only after the expiration of a "non-call period", also connected with tax treatment of the payments under the notes); (iv) less rigorous financial covenants compared to the senior debt, tested on an incurrence rather than maintenance basis; and (v) tighter covenants than those commonly found in a traditional corporate bond issuance.
In Europe, these kinds of issued securities are generally listed on the Luxembourg or Irish Stock Exchanges, by way of a prospectus prepared in accordance with European legislation. Bearing in mind the involvement of listing authorities to approve the offer documents, the transaction typically completes within a period of not less than two to three months.

Certain legal restrictions where the issuer is an Italian entity
Quantitative limits on listing
Reforms to the Italian company law have introduced changes to the provisions of the Italian Civil Code relating to bonds. Such changes are designed to encourage the issuance of bonds by Italian companies.
The issue of bonds may now be approved by the board of directors (unless otherwise set forth in the company's by-laws) and is typically subject to a quantitative limit equal to twice the sum of (i) the share capital, (ii) the legal reserve and (iii) the available reserve resulting from the last approved financial statements of the issuer. The amounts guaranteed by the company for the bonds issued by other companies, including non-Italian companies, must be taken into account for the purpose of the calculation of the aforementioned limit.
The general limit may be exceeded if the issuance of securities in excess of such limit is offered to qualified professional investors. Such limit can also be exceeded if the repayment of the bonds is guaranteed by a first-ranking mortgage over the company's assets up to two-thirds of their value. Finally, it is worth mentioning that the ratio of capital and reserves, on one hand, and the amount of the loan, on the other hand, must remain unchanged throughout the term of the bond: the company may not write down the share capital or distribute reserves if, compared to the aggregate of bonds, that initial ratio is no longer respected.

Usury
National usury legislation implicates both civil and criminal law aspects. Under civil law, contractual provisions imposing interest deemed usurious are ineffective and any accrued interest under the provision is not due.
Interest rates are deemed usurious if they are 50% higher than the global average effective rate (tasso effettivo globale medio, TEGM -- which includes commissions, fees and costs, except those relating to taxes) set forth in the most recent evaluation conducted by the Bank of Italy on behalf of the Italian Ministry of Economy and Finance. The evaluation is carried out on a quarterly basis and according to the classification of the type of transaction. The Bank of Italy has recently proposed a partial reclassification of the evaluated transactions.
Given the variety of applicable criteria seen on the market, the usury test for high-yield bond transactions demands a case-by-case analysis of the relevant terms and conditions. Based on our experience, because of the risk and complexity in high-yield bond issuing transactions, the danger that financial terms and conditions are or may become usurious is a very delicate issue. The severity of the consequences under civil law as well as the possibility of criminal sanctions requires moving cautiously.

Interest capitalization (PIK clauses)
In recent transactions, mechanisms have been used to optimize the position of the issuer by capitalizing interest in one single instalment to be paid on maturity of the instrument. Such mechanism provide for the capitalization of interest - the accrual of interest on interest due (compounded interest) - until the repayment date.
Article 1283 of the Italian Civil Code provides that accrued interest, unless otherwise agreed, may bear interest only as of the date when legal proceedings commence or, if agreed by the parties, after interest has become due, provided that such interest is due for at least six months.
In practice, in order to allow the capitalization of interest according to the provisions of the Italian Civil Code, contractual mechanisms have been developed to, for instance, grant an option in favour of the borrower to capitalize interest. This option can be exercised only after a six-month period.

Conclusion
Typically, in European markets, acquisitions are primarily financed by means of bridge loans, which are then taken out through medium-term loans guaranteed by target and its assets and/or through the issuance of high-yield instruments.
In the current scenario of economic contraction of funding by banks and the resulting preference for debt instrument issuances, it could be of interest to consider the viability of issuances to finance acquisitions - or to refinance, in the context of such transactions, existing indebtedness (including for target companies) - without resorting to bridge financing schemes. Save where the acquisition agreement is subject to financing, the structure of the acquisition would be affected by a similar approach, given that, inter alia, a conditional issuance of high-yield instruments does not appear to be possible. In this regard, one could evaluate introducing "financing-out" clauses in acquisition contracts which, based on the US market experience, may conversely imply a "reverse break-up fee" for the purchaser if the issuance fails. Alternatively, one could consider a "vendor financing" solution in order to bridge the gap to the issuance of high-yield bonds.
It is also clear that, in any event, where transactions are carried out by Italian issuers, the legal implications briefly described above must be considered carefully.

Carmelo Raimondo (carmelo.raimondo@chiomenti.net)
Franco Agopyan (franco.agopyan@chiomenti.net)
Marco Paruzzolo (marco.paruzzolo@chiomenti.net)

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The protection of foreign direct investments following the Treaty of Lisbon
The Treaty of Lisbon, which entered into force on 1 December 2009, has granted exclusive competence for foreign direct investment (FDI) to the European Union. Article 206 of the new Treaty on the Functioning of the European Union (TFUE) provides for the inclusion of the “progressive abolition of restrictions […] on foreign direct investment” in the objectives of the Common Commercial Policy (CCP); while Article 207(1) TFUE provides that the CCP is “based on uniform principles, particularly with regard to (…) foreign direct investment”.
The scope of competencies granted to the European Parliament (EP) has increased within the framework of the CCP. In particular, the EP has an enhanced role in ratifying trade agreements and must provide consent prior to the conclusion of international agreements with non-EU countries or international organizations (Art. 218(6) a) TFUE).
The promotion, handling and protection of investments conducted abroad have been the subject of more than 1,000 bilateral investment treaties (BITs) entered into by individual EU Member States. Such treaties guarantee respective signatory State investors, among other things, fair and equitable treatment on terms no less favourable than those afforded to investors within the signatory State and to those of non-EU countries, restitutionary compensation in the event of investment expropriation, the free transfer of payments related to an investment and of the profits of the investment, and the investor’s right to submit any dispute that arises within the host State to arbitration. A BIT typically treats as an “investment” any invested asset relating to economic activities such as movable and real property, shares and debentures, government bonds and other kinds of interest in companies; financial credits and claims to any performance having an economic value, associated with an investment as well as reinvested income and capital gains; intellectual property rights; licences and concessions.

The scope of the new competence
Because the TFUE does not define “foreign direct investment” it is too early to conclude that the Member States have entirely relinquished competence in this area. The scope of the competence transferred to the EU remains in fact open to interpretation and discussion.
The European Commission (Commission) has stated that the term ‘FDI’ does not include portfolio investments - investments realized exclusively for the purpose of speculation.
However, it is not yet clear at this stage whether the EU competence includes, besides the promotion and handling of investments by a foreign State, also the ‘protection’ of investments. Given that the TFUE in no way prejudices the rules in Member States governing the system of property ownership (Art. 345 TFUE), several authors argue that the protection of property, a frequent element in BITs which was traditionally reserved to the Member States, will remain within Member State competence. However, on this issue the Commission believes that competence includes investment protection.

‘Mixed’ treaties?
Consequently, some commentators consider that any future treaties that deal with issues that are not included in the transferred competence (e.g. portfolio investments or issues related to the enjoyment of property rights), will have to be ‘mixed’, i.e. signed both by the Union and its individual Members. This confers, effectively, a right of veto to each of the 27 Member States.

What happens to existing treaties?
In order to guarantee legal certainty for investors, the Commission has stated that existing treaties will remain valid for the time being, to the extent they were consistent with Union law before the entry into force of the Lisbon Treaty. It should be noted in this regard that the Court of Justice has previously ruled that treaties entered into by a Member State and a non-EU country are incompatible if they confer to investors the guarantee to transfer, freely and without undue delay, payments connected with an investment and the returns yielded by them. Such transfers could indeed be contrary to any restrictions on movements of capital and payments that have been decided by the Council on the basis of Articles 64, 66 and 75 TFUE (ex art. 57, 59 and 60 TEC) (Judgments of 3 March 2009 in case C-205/06 Commission v. Austria and C-249/06 Commission v. Sweden, and of 19 November 2009 in case C-118/07 Commission v. Finland).
Moreover, the Commission has stated that treaties concluded between EU Member States are invalid, as they are superseded by European Union law as from the date of accession to the EU. Certain Member States have a different opinion on this issue. Therefore, it cannot be excluded that arbitral awards could still be issued on the basis of such intra-EU treaties, as occurred in the dispute between the Dutch company Eastern Sugar B.V. and the Czech Republic.

Conclusion
The EU’s new exclusive competence for foreign direct investment increases the number of questions concerning the scope of institutional competence at the national and European level as well as the validity of the existing treaties. It is not currently possible to respond to these questions with certainty. Investors therefore need to pay close attention to the upcoming developments in this area in order to insure that the level of protection presently achieved remains guaranteed.

Stefania Bariatti (stefano.mazzotti@chiomenti.net)
Simon van Cutsem (simon.vancutsem@chiomenti.net)

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Implementation of listed companies’ shareholder rights directive
Legislative Decree No. 27 of 27 January 2010, published in the Italian Official Gazette on 5 March 2010 (the “Decree”) implements in Italy EU Directive No. 36 of 11 July 2007 EC (the so-called “Shareholder Rights Directive”) regarding the exercise of certain shareholder rights with respect to listed companies.
Pursuant to Article 7 of the Decree, most of the Decree’s provisions will apply only to a notice to call a shareholders’ meeting issued after 31 October 2010.
Below is a summary of the main innovations introduced by the Decree.

New provisions according to which listed companies may be required to amend their by-laws before 31 October 2010
– Call for shareholders’ meeting: under new Article 125-bis of the Italian Consolidate Law on Financial Intermediation (the “IFL”), the shareholders’ meeting is to be called: (i) in most cases, at least 30 days prior to the date of the meeting, (ii) or at least 40 days prior to the date of the meeting called to resolve on the appointment of the members of the company’s management or supervisory body; (iii) at least 21 days prior to the date of the meeting called to resolve upon the reduction of the company’s share capital due to losses or for the appointment of liquidators; (iv) as of the fifteenth day prior to the date of the meeting called to adopt defensive measures against public offers to purchase or exchange financial instruments. The meeting’s call notice must be published on the company’s website and by any other means required by Consob (the Italian authority responsible for regulating the Italian securities market) regulations.
– Call of meeting upon shareholders’ request: Article 1, paragraph 2, of the Decree has amended the percentage provided by Article 2367 of the Italian Civil Code for the call of a meeting upon the shareholders’ request. Article 2367 (as amended by the Decree) now provides that the shareholders’ meeting must be called without delay when requested by shareholders representing at least one-twentieth of the share capital of a listed company (a company’s by-laws may provide for a lower threshold).
– Attendance in shareholders’ meeting and voting rights: under new Article 2370 of the Italian Civil Code, shareholders with voting rights may attend the shareholders’ meeting. According to new Article 83-sexies of the IFL, the rights to attend a meeting and to vote is certified by a notice provided to the issuer by financial intermediaries, in compliance with their accounting records relating to the accounting period ending on the seventh open market day prior to the date in which the meeting is called, on its first or second call (the so-called “record date”). Any additions or subtractions from the registry recorded subsequent to the aforementioned period is not considered for the purposes of determining voting participation in the meeting.
– Proxies: pursuant to Article 2372, listed companies by-laws can no longer exclude voting by proxy at a shareholders meeting. Legal provisions that forbid shareholders from granting proxies to members of the board of directors or the board of statutory auditors, to the issuer’s employees, to employees retained by companies controlled by the issuer or to controlled companies themselves have been repealed. Provisions that place restrictions on the number of proxies that can be granted to the same party have also been repealed. Pursuant to new Article 135-novies, paragraph 6, of the IFL, listed companies’ by-laws must outline at least one way of serving electronic notice of the proxy that shareholders have the option to use.
– Lists of candidates for the election of director and auditing bodies: pursuant to the new paragraph 1-bis of Article 147-ter of the IFL, the list of candidates for the election of the board of directors must be filed at the registered office at least twenty-five days prior to the date of the relevant meeting and must be made available to the public at the company’s registered office, on the company’s website, and also by any other means required by Consob, at least twenty-one days prior to the date of the meeting. Meeting the minimum shareholding required for the submission of the lists of candidates pursuant to Article 147-ter, paragraph 1, of the IFL is based on the shareholdings recorded in the financial intermediaries’ accounts at the date of filing of the list of candidates. Such terms and conditions also apply to the appointment of members of the board of statutory auditors (pursuant to the amended Article 148, paragraph 2 of the IFL).
– Financial statements: the amended Article 154-ter of the IFL provides that within 120 days of the fiscal year’s end, listed companies must publicly display their annual financial reporting, including, among others, their yearly draft financial statements. According to the new provision, issuers can now enjoy greater flexibility in calling a meeting to approve the financial statements, having the power to postpone, where contemplated by companies’ by-laws and/or by the applicable law, the financial statements meeting date to a maximum of 180 days following the fiscal year’s end, provided that the filing of the relevant financial and accounting documents occurs within 120 days of the fiscal year’s end.
– Amendment of the meeting agenda by the minority shareholders: pursuant to new Article 126-bis of the IFL, shareholders who individually or jointly hold at least 2.5% of the company’s share capital may request, within ten days (and no longer within five days as previously required) of the publication of the meeting’s call notice. However, the five day period applies where the call is upon request of the minority shareholders or in connection with the approval of defensive measures in the context of a takeover bid, the amendment of the list of matters to be discussed, indicating the additional topics suggested in their request.

New legal provisions according to which listed companies may discretionally decide to enact further by-law changes, also after 31 October 2010
– Electronic voting: the new version of the fourth paragraph of Article 2370 of the Italian Civil Code now allows by-laws of all companies limited by shares to introduce an electronic voting mechanism.
– Identification of shareholders: the new Article 83-duodecies of the IFL now allows a listed company to include rules in its by-laws that provide for the identification of the company’s shareholders. Where so provided under the by-laws a company may request at any time and under its own initiative from its financial intermediaries to furnish identification information, through the centralized administration company, from those of its shareholders who have not expressly forbidden such disclosure together with the number of shares registered on their respective shareholder accounts. Where the by-laws so provide, the issuer must request the same identification information as above from that number of shareholders who represent at least half of the amount of share capital required in order to file a list of candidates
– Dividend increase: the new Article 127-quater of the IFL allows listed companies to provide in their by-laws for the right of minor shareholders (those shareholders who individually hold no more than 0.5% of the company share capital) who have held their shares in the company continuously for a year to receive a higher dividend, not, however, to exceed 10% of the dividend distributed in connection with the other shares. The new law also sets forth a number of conditions on the right of the relevant shareholder to receive a higher dividend.
– Shareholders’ representative appointed by the issuers: the new Article 135-undecies of the IFL introduces the figure of the shareholders’ representatives appointed by the company. Listed companies may decide to introduce in their by-laws a clause excluding the application of Article 135-undecies of the IFL and, therefore, the shareholders’ representative figure.

Other provisions introduced by the Decree
In addition to the amendments described above, the Decree has introduced several new changes that may impact corporate requirements and the rules of organization of shareholders’ meetings. With the exception of the change relating to the updating of the shareholders’ ledger, which will enter into force on 20 March 2010, the following changes will enter into force as of the Deadline.
– Right to submit questions prior to the shareholders’ meeting: Article 127-ter of the IFL regulates shareholder rights to submit questions on the issues comprised in the agenda, allowing the shareholders to exercise such right also prior to the meeting. The questions submitted prior to the meeting must be addressed no later than during the meeting. However, the company does not need to provide a response if the answer is already made available in the specific “Q&A” section on the company’s web-site.
– Conflicts of interest of the shareholder’s representative: Article 135-decies of the IFL expressly regulates conflicts of interest between the shareholder’s representative and the delegating shareholder. The delivery of a proxy to a conflicted representative is permitted to the extent that the representative notifies the shareholder in writing of the circumstances out of which such conflict arises and provided that the shareholder furnishes specific voting instructions with respect to each resolution on which the representative will vote on behalf of the shareholder.
– Update of the shareholders’ ledger: pursuant to Article 83-undecies of the IFL, the issuer shall update the shareholders’ ledgers in accordance with the notices provided by intermediaries and within 30 days of receipt of such notices. Failure by the issuer management to comply with the obligations to update the shareholders’ ledger pursuant to Article 83-undecies of the IFL is a punishable offense that results in an administrative monetary sanction of between Euro 2,500 and Euro 250,000, in accordance with Article 190, paragraph 2, letter d-sexies, of the IFL.

Paolo Valensise (paolo.valensise@chiomenti.net)
Irene Bui (irene.bui@chiomenti.net)
Andrea Sacco Ginevri (andrea.saccoginevri@chiomenti.net)

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The new CFC rules for companies located in “white listed” countries
Preface
Article 13 of Law Decree No. 78 dated 1 July 2009 (the so-called “Anti-crisis Decree”) amended the provisions of the controlled foreign companies rules (the “CFC rules”) set forth under Article 167 of the Italian Income Tax Code, extending the scope of its provisions to apply to controlled companies located in “white-listed” countries, including the Member States of the European Union.
Under new paragraph 8-bis, the CFC rules apply if the controlled company is simultaneously: (i) subject to an effective taxation less than half of that imposed had the company been a tax resident in Italy, and (ii) more than 50% of its income is either made of passive income (i.e., dividends, interest, royalties) or derives from intra-group services.
The new provisions do not apply if the Italian parent company demonstrates, through an advance tax ruling to be filed with the tax authorities, that the establishment of the CFC is not a wholly artificial arrangement intended to escape the national tax normally payable.

Effective taxation of Controlled Foreign Companies
In order to assess if the condition under point (i) above is met, the Italian controlling company must determine the tax burden theoretically applicable to the CFC, as calculated under the Italian tax rules (i.e., the provision set forth by the ITC).
To date, the Italian tax authorities have not provided any guidance with respect to such calculations. It is worth pointing out that several interpretative issues need to be clarified. For example, with regard to the comparison between the Italian taxes and the taxes paid abroad, the Italian tax authorities will need to clarify whether the Italian parent company is required to re-draft the financial statements of the foreign company and then adjust results on the income statement according to the applicable Italian provisions.
Similar doubts surround those cases where a foreign company is included in a foreign consolidated tax group; it has yet to be clarified whether the comparison involves taxation on a consolidated basis, net of permanent consolidation adjustments not recognized by Italian tax law.
Although no clarification has been provided on this point, it is arguable that the Italian Regional Business Tax (“IRAP”) should not be calculated for the purposes of the relevant comparison as the CFC rules pertain to income taxes only.

The concept of “wholly artificial arrangement” under the new CFC rules
The safe harbour provided by paragraph 8-ter refers to the European Court of Justice (ECJ) principle of a wholly artificial arrangement set out in case No. C-196/04 dated 12 September 2006 (Cadbury Schweppes).
In this case, the ECJ did not provide a definition of wholly artificial arrangement, but stated that an arrangement should not be considered wholly artificial where it is proven, on the basis of objective factors ascertainable by third parties, that despite the existence of tax motives the controlled company is in fact established in the host Member State and performs genuine economic activities therein.
The ECJ’s argument is based on the principle that the establishment of a company in a Member State for the purpose of benefiting from more favourable legislation does not in itself constitute an abuse of the freedom of establishment.
Moreover, the European Commission, in Communication No. 785 dated 12 December 2007 relating to anti-abuse measures and the CFC regime, stated that “the objective of minimising one’s tax burden is in itself a valid commercial consideration as long as the arrangements entered into with a view to achieving it do not amount to artificial transfers of profits. In so far as taxpayers have not entered into abusive practices, member’s states cannot hinder the exercise of the rights of freedom of movement simply because of lower levels of taxation in other member’s states. This is the case even in respect of special favourable regimes in the other member’s states’ tax systems”.
Pursuant to the guidelines set out by the ECJ, in order to invoke the exemption clause provided for under paragraph 8-ter of Article 167 of ITC, the Italian parent company must demonstrate that the foreign company is actually established in the host Member State (i.e., the existence of premises, personnel and equipment) and carries on genuine economic activities there.

Massimo Antonini (massimo.antonini@chiomenti.net)
Raul Angelo Papotti (raul.papotti@chiomenti.net)
Luca Vitale (luca.vitale@chiomenti.net)

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The new double taxation treaty between the United States of America and Italy
On 16 December 2009 the new tax treaty between the United States of America and Italy, which was signed on 25 August 1999, entered into force. The new tax treaty and protocol (the “Tax Treaty”) replaces the previous treaty and protocol between the two countries, which was effective as of 20 December 1985.
The Tax Treaty generally follows the format of the 1996 U.S. Model Tax Treaty and incorporates certain provisions found in recent U.S. treaties with other developed countries and agreed to in the OECD Model Tax Treaty.
The new provisions set out in the Tax Treaty have been effective as of 1 February 2010, with respect to withholding taxes, and from 1 January 2010 with respect to all other taxes.
Amongst the new provisions introduced by the Tax Treaty, it is worth noting that:
•withholding tax on dividends has been reduced to 5% on certain “qualified” dividends (where the beneficial owner is a company which has owned at least 25% of the voting stock of the company paying a dividend for a 12-month period ending on the date the dividend was declared), while the existing general 15% withholding tax on all other dividends remains;
•withholding tax on interest generally remains at 10%. No withholding tax is to be applied by the source country on (i) certain interest paid to, guaranteed or insured by qualified governmental entities, and (ii) interest paid or accrued with respect to a sale on credit of goods, merchandise, services as well as of industrial, commercial, or scientific equipment;
•withholding tax on royalties generally remains at 8%. The source country shall not apply withholding tax on royalties for certain literary, artistic or scientific works (excluding computer software, motion pictures, films, tapes or other means of reproduction used for radio or television broadcasting); moreover, a maximum withholding tax of 5% applies to royalties for the use of, or the right to use, computer software or industrial, commercial or scientific equipment.

•the source-country taxing powers are not restricted from applying a branch profits tax on a corporation resident in the other contracting state, subject to certain conditions being met; however, such branch profits tax cannot exceed 5%.
Other noticeable provisions include a “Limitation on Benefits” (LOB) clause, which is more stringent than the one previously in force and now more closely aligned with recent treaties entered into by the U.S:A., as well as the rather peculiar “Amicable Procedure” for dispute resolution. In particular, the Amicable Procedure not only provides for a mechanism for taxpayers to bring to the attention of the States’ competent authorities issues and problems that may arise under the Convention and to resolve cases of double taxation not provided for in the Convention, but also for the use of binding arbitration, even if only in limited cases (i.e., if the competent authorities cannot come to mutual agreement and if consented to by each of the Italian and U.S. competent authorities and the concerned taxpayers).

Massimo Antonini (massimo.antonini@chiomenti.net)
Raul Angelo Papotti (raul.papotti@chiomenti.net)
Luca Vitale (luca.vitale@chiomenti.net)

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