One of the most important aspects in arranging any fund finance transaction is structuring the security package.
Even a "simple" private fund structure chart often includes several entity types, such as limited partnerships and limited liability companies, organised in multiple jurisdictions like the Cayman Islands, the United States, and Europe , for example. The type of facility, whether it is a subscription facility, a NAV facility, or a hybrid facility, determines the collateral pledged. This collateral may be provided by one or more of these entities to secure the repayment obligation to the lenders or a security agent on their behalf.
For the purposes of this article, we will discuss fund finance securities for private equity funds in the Cayman Islands under The Private Funds Act (As Revised) (PF Act).
Structuring Considerations
While many types of Cayman entities (such as exempted companies and limited liability companies (LLCs)) are occasionally used as fund vehicles, the exempted limited partnership (ELP) is the most common type of entity used for closed-ended private equity funds. The exempted company and limited liability company each have legal personality as opposed to the ELP which does have legal personality and is instead, a contractual agreement between the partners.
A Cayman Islands exempted company is a type of company with limited liability and is sometimes used as the borrower rather than an ELP in subscription facilities. This structural change adds additional considerations particularly for a lender. The governing agreement of an ELP is its limited partnership agreement (with rights capable of assignment by the ELP). An exempted company is governed by constitutional documents being its memorandum and articles of association (Articles). The Articles are not capable of assignment by a company. As such, in a corporate subscription facility, the lender will usually take security over the investor subscription agreements rather than over the Articles themselves. The subscription agreements are subject to the terms of the Articles. Further, the obligations which are created in a corporate facility are different than those created in a ELP facility and enforcements issues may arise in the company context that would not arise in the ELP context.
Types of Security Packages
Subscription Facilities
Security packages for subscription facilities, which we typically see are the most common types of facilities, are formed by firstly, the contractual obligation of a limited partner to fund capital, to the extent that it has not already been called (Uncalled Capital), and secondly, the corresponding rights of the ELP to call for that Uncalled Capital (Capital Call Rights). The most appropriate type of security under Cayman Islands law over such rights is an assignment by way of security.
The security over Capital Call Rights can be granted under a Cayman Islands law document, such as a Limited Partnership Agreement (LPA). Provided that the grant of security is permitted under the LPA, or other document, the Cayman Islands courts will generally recognise the grant of security even if such security were granted under a foreign law-governed security agreement.
Other common features of security packages for subscription facilities include the grant of a security interest over a designated bank account under the control of the lender to which capital commitments are deposited, as well as an express irrevocable power of attorney in favour of the lender to exercise effectively the Capital Call Rights following the occurrence of an event of default.
It is important for lenders to note that it is crucial that any Cayman Islands private fund that is party to a subscription facility be registered with the Cayman Islands Monetary Authority (CIMA) ahead of the initial closing or if applicable, its joinder to an existing facility. This is due to the fact that the PF Act requires private funds to be registered with CIMA within 21 days after accepting capital commitments from investors and this is especially important for subscription facilities given that capital contributions from investors are key to their typical security packages.
NAV Facilities
NAV facilities for older, well-established funds which are heavily invested and have a relatively large portfolio NAV typically utilise a security structure whereby the lenders to the fund take security over the shares in one or more holding companies of the fund that directly or indirectly owns the portfolio's investments. One of the consequences of such a security structure is that by providing financing to a fund and securing this against the holding company's shares, rather than the assets of the underlying portfolio companies, means that the lender has less control over the assets of the fund's portfolio, and that the pricing of these loans is typically higher.
A clear advantage of NAV facilities is that it can avoid change of control triggers in shareholders' agreements and leveraged finance facility agreements, as well as possibly avoiding the need to seek regulatory consent in relation to the regulated assets of the fund. By taking security over shares, the lender can effectively pick which assets they have control over and therefore strategically pledge security over the holding companies where change of control or regulatory consents do not exist.
Hybrid Facilities
Whilst uncommon, hybrid facilities vary greatly between lenders when they are provided. Security packages for hybrid facilities range from subscription facilities with NAV covenants to taking security over any intercompany loans or other receivables by the holding companies of the fund. It is difficult to advise upon the general advantages and disadvantages of hybrid facilities, but typically, the more complex the fund, the more benefit there is in exploring hybrid facilities with potential lenders to execute the optimum security package for the private fund.
Perfecting Security Interests
The Cayman Islands has no public security registration regime, nor does it have any publicly searchable registers.
Where a security interest is created by a company and regardless of where the asset is located, it is necessary under section 54 of the Cayman Companies Act to enter any security interest created by the company in the register of mortgages and charges of the company (maintained by the company at its registered office in the Cayman Islands). Failure to enter such particulars will not invalidate the security; however, Cayman Islands are expected to comply with the requirement, and failure to do so will expose such companies to a statutory penalty.
Other than to enter particulars of any agreements entered into by a company creating security interests in its register of mortgages and charges, it is not necessary that any transaction documents creating a security interest be filed, recorded or enrolled with any governmental, regulatory or judicial authority in the Cayman Islands in order to ensure the validity of the security interest.
Where a security interest is created by an ELP, such as a security interest granted over Capital Call Rights pursuant to a Cayman Islands law governed LPA, the priority and perfection of any security interests will be determined by Cayman Islands common law. Perfection and priority over Capital Call Rights are achieved through the delivery of written notice of the grant of security to the ELP's limited partners. Additionally, if the bank account into which capital commitments are deposited is located in the Cayman Islands, priority of the security over such bank account is achieved by giving notice of the creation of the security interest to the applicable account bank.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.