Subscription Finance: Rated Note Feeder Funds and Debt Capital Commitments | Perspectives & Events | Mayer Brown

Insurance coverage firm traders are more and more seeking to spend money on non-public fairness and related non-public funding funds by way of debt capital commitments (versus conventional fairness capital commitments) to reap the benefits of improved regulatory capital therapy, together with below the risk-based capital system established by the US Nationwide Affiliation of Insurance coverage Commissioners (the “NAIC”). Fund sponsors have responded to this request by utilizing a rated observe feeder construction, the place a feeder fund points notes below a observe buy settlement to an investor (as an alternative of requiring a conventional fairness capital dedication) and obtains a powerful credit standing on such notes that ends in a way more favorable NAIC risk-based capital therapy.

As famous in our prior Authorized Updates, debt capital commitments have traditionally been categorised as ineligible for borrowing base inclusion in subscription amenities. That is as a result of uncertainty of whether or not such debt capital commitments could be enforceable below Part 365(c)(2) of the US Chapter Code if the relevant fund was ever topic to a chapter continuing.¹ The priority facilities on whether or not the debt capital dedication could be decided to be an “executory contract” to “make a mortgage, or lengthen different debt financing or monetary lodging to or for the good thing about the debtor.” In that case, the duty could possibly be rendered non-assumable by the fund or its chapter trustee (and thus non-enforceable by the fund, its chapter trustee, or the fund’s lenders).

In an try to deal with this concern whereas responding to the market want for debt commitments offered by insurance coverage firms, some sponsors have began utilizing hybrid debt/fairness capital commitments that begin as a debt capital dedication however “convert” to an fairness capital dedication upon the prevalence of an occasion of default or related triggering occasion below the subscription facility (corresponding to a chapter or insolvency of the fund). Whereas this sort of conversion function is untested in litigation, there’s a concern {that a} chapter court docket might view it to be unenforceable below part 365(e) of the US Chapter Code, which gives a contractual settlement that terminates or modifies an executory contract conditioned or triggered by the prevalence of an insolvency, the graduation of a chapter case or related occasion isn’t enforceable in a chapter continuing (this idea is sometimes called an “Ipso Facto Prohibition”). Accordingly, many subscription lenders have objected to the “conversion strategy” for a hybrid debt/fairness capital dedication. There are, nevertheless, two approaches which can be gaining traction available in the market that don’t increase the identical Ipso Facto Prohibition points: First, a “day-one” fairness capital dedication strategy and, second, a chapter distant feeder fund strategy. We discover each of those approaches under.

“Day-One” Fairness Capital Dedication

At a excessive degree, the day-one fairness capital dedication strategy gives that the investor subscribe to a shared fairness/debt capital dedication on “day-one.” This shared capital dedication may be referred to as within the type of debt by way of a observe buy settlement or fairness by way of a conventional capital name on the possibility of the fund or subscription lender, and any debt or fairness funding will cut back the shared capital dedication on a dollar-for-dollar foundation. For the reason that capital dedication consists of an fairness element on “day-one”—and doesn’t convert from one type of capital dedication to a different type of capital dedication primarily based off of a bankruptcy-type occasion – this day-one fairness capital dedication strategy isn’t more likely to increase the identical degree of potential Ipso Facto Prohibition considerations because the conversion strategy described above.

The day-one fairness capital dedication strategy works for insurance coverage firm traders as a result of the NAIC’s risk-based capital therapy is decided by precise funded investments. Thus, the mere chance of the capital dedication being funded in fairness wouldn’t negatively have an effect on the investor’s regulatory capital therapy except the investor really makes an fairness capital contribution. To supply the investor consolation that, within the regular working course, the preferable regulatory capital therapy shall be achieved by calling debt, the organizational paperwork of the rated feeder fund may even be structured with situations precedent for making an fairness capital name. For instance, an fairness capital name could possibly be conditioned upon (1) the prevalence of an occasion of default below the subscription facility, (2) an investor failing to truly fund the debt capital dedication and/or the fund being unable to name the debt capital dedication, or (3) the fund being bancrupt and/or topic to a chapter continuing.

Chapter-Distant Rated Debt Feeder Funds

Whereas the day-one fairness capital dedication strategy focuses on structuring the capital dedication to be enforceable in a chapter continuing, the second strategy focuses on minimizing the danger that the feeder fund shall be topic to a chapter within the first place by structuring the feeder fund as a bankruptcy-remote particular goal car (an “SPV”). In different phrases, an SPV construction doesn’t search to deal with the authorized bankruptcy-related dangers related to debt capital commitments however as an alternative is meant to decrease the chance of the prevalence of a chapter continuing of the feeder fund impacting the debt capital dedication of the traders. Vital options of an SPV embrace, amongst different objects, provisions in its organizational paperwork that (1) require an impartial director or impartial supervisor of the feeder fund to explicitly approve any chapter submitting on the a part of the feeder fund or different materials actions that might give rise to an insolvency continuing, (2) restrict the feeder fund’s company actions (together with incurrence of indebtedness apart from obligations to the lender) and require it to keep up company separateness from the underlying grasp fund, and (3) prohibit modifications to the organizational paperwork with out the impartial director/supervisor’s consent and the consent of subscription lenders whereas any subscription facility obligations are excellent. Subscription lenders may even need to search an specific acknowledgement that the traders of the feeder fund and different lenders (if any) won’t search to start, or in any other case help, any chapter or insolvency continuing of the feeder fund. Though these kinds of customary SPV provisions might add some incremental price to the institution of the SPV (together with authorized structuring prices and bills associated to opinions required to be delivered as a part of the subscription facility closing from fund formation counsel to the feeder fund) and the upkeep of the chapter distant construction (together with the annual charges of the impartial director/supervisor), such SPV protections are well-established within the structured finance area and often relied on in structured financing transactions. To the extent that it is ready to get hold of these protections, a subscription lender could also be keen to incorporate debt capital commitments within the borrowing base on account of the diminished chance of a chapter of the feeder fund.²

Conclusion

As extra traders look to take a position by way of debt capital commitments, we anticipate the market will embrace the “day-one” fairness capital dedication strategy as the popular strategy to borrowing base inclusion. So too, on condition that many subscription lenders are well-versed in chapter distant autos given their familiarity with structured finance transactions, we anticipate extra subscription lenders will begin giving loanable worth to debt capital commitments as long as the feeder fund is structured as a chapter distant car. Accordingly, sponsors ought to strongly take into account using one or, ideally, each of those strategies with a view to unlock extra loanable worth on their subscription amenities.

Please contact us if we will present any extra info or help associated to this matter.

Kiel A. Bowen
kbowen@mayerbrown.com
+1 704 444 3692

Todd N. Bundrant
tbundrant@mayerbrown.com
+1 312 701 8081

Mark C. Demspey
mdempsey@mayerbrown.com
+1 312 701 7484

Ann Richardson Knox
aknox@mayerbrown.com
+1 212 506 2682

¹ For dialogue of enforceability of Fairness Capital Commitments, please see Enforceability of Capital Commitments in a Subscription Credit score Facility | Views & Occasions | Mayer Brown, and for dialogue of enforceability of Debt Capital Commitments, please see Microsoft Phrase – Mayer Brown_Enforceability of (Debt) Commitments Spring 2016.docx.

² Word that the SPV construction assumes that the capital dedication of the SPV to the underlying grasp fund is an fairness capital dedication and there’s no debt capital dedication element that must be addressed at that degree of the construction.