Taking notice – notice of security to investors in a Cayman Islands fund
October 2013 | PROFESSIONAL INSIGHT | PRIVATE EQUITY
Financier Worldwide Magazine
Much has been written on private equity fund subscription bridge financings involving Cayman Islands exempted limited partnerships, and the type of security to be granted to secure the loan obligations is fairly settled.
In practice, however, it is not the security package that sends investment managers and the banks into a flurry during negotiations, but rather whether to notify the investors in the fund and, if so, how to go about it. The simple answer: it depends upon the fund in question.
This article examines the reasons for notice and the various approaches taken in the current market.
Must notice be given? If so, to whom?
The standard collateral package for subscription bridge financings consists of an assignment by way of security of the right of the general partner to call for capital contributions from the limited partners of the partnership (generally referred to as the ‘call rights’) and the proceeds of the called capital and a charge over the account into which the called capital is paid.
As the call rights arise by virtue of a Cayman Islands law governed partnership agreement, the priority and perfection of security over the call rights will be decided by Cayman Islands law. Under Cayman Islands law, and subject to certain exceptions, priority between successive assignees is decided according to the order notice is given to the relevant debtor or obligor (the so called ‘rule inDearle v Hall’). Under the rule in Dearle v Hall, a later encumbrancer taking without notice of the earlier assignment and giving notice first would obtain priority.
In practice, therefore, in order to obtain priority over any subsequent creditor of the fund, as a condition subsequent to closing the financing, notice of the assignment of the call rights is given by the general partner and the assignee bank to each of the limited partners of the partnership.
What should the notice say?
There are no requirements concerning the form of notice or person who must give it. What is key is that the recipient has in some way been made sufficiently aware of the nature of the security so that a reasonable person would act upon the information and regulate their conduct accordingly.
Given the subjectivity of sufficiency of notice the counterparties often start from opposing ends of the spectrum as to how detailed the notice should be.
At a minimum the notice should contain a short statement confirming the name of the security document, its date, the parties to the document and that the security comprises an assignment of the call rights and the proceeds. The notice should also explain to whom the obligations are owed, especially once there is an event of default.
Although not advisable, in rare cases the security document is attached to a covering letter to the limited partners. The more common compromise position is that the entire charging clause is incorporated into the notice.
When and how should the notice be delivered? Should evidence of delivery be obtained?
Notice to the limited partners may be effected directly or indirectly. It is sufficient to show each limited partner has notice of the assignment irrespective of the source of the notice.
The relationship between and relative bargaining power of the counterparties to the transaction as well as practicalities (particularly the number and sophistication of the limited partners in the fund) will often influence how delivery is effected. The investment manager of the fund will always be mindful of less sophisticated investors unfamiliar with market processes and may be reluctant to send specific notice through fear of being overburdened with questions and investors seeking comfort as to the content of the notice and any risks to the fund. Such concerns have to be balanced against the bank’s legitimate need to protect against the risk of intervening creditors.
Options for delivery range from, at one end of the scale, requiring notice to be sent by internationally recognised courier or overland registered mail and obtaining date and time tracking receipts to confirm notice has been served, to, at the other end of the scale, including a footnote in a quarterly investment bulletin posted on the website for the fund (although this will only be likely to be acceptable to the bank where investors are notified that new content has been added). To reduce both legal and administrative costs, if there are numerous investors to be notified, an email to the investors copying in the bank may well be an agreeable compromise.
Timing for delivery of the notice is also generally subject to negotiation and can range from a requirement for notice to be served immediately upon closing of the financing to an agreement that notice will only be served if an event of default has occurred and is continuing on the loan obligations. It is not unusual for a compromise to be reached providing for delivery of notice to be made with the next regular investor communication.
Need the investors acknowledge the notice?
Acknowledgement of notice is something all banks want, is nice to have but not essential to regulate their ranking point in priority. Unless there is a single investor, practical considerations such as the administrative burden to collate acknowledgments and check all investors have acknowledged generally serve to ensure costs outweigh any potential benefit in obtaining acknowledgements.
A pragmatic approach should be adopted by the parties and their legal advisers as to the form of notice of assignment and when it should be given to the investors of a fund so as to ensure what is effected is appropriate for the number and sophistication of the funds’ investors, while protecting the lenders’ interests.
Alexandra Woodcock is senior counsel at Walkers. She can be contacted on +1 (345) 814 4588 or by email: firstname.lastname@example.org.
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