What Managers of Private Equity Funds must know about the new German Investment Law
Managers of private equity funds will in future be faced with new notification and disclosure requirements. They will also encounter new restrictions when accessing the liquidity of the target companies in order to repatriate acquisition loans. These new rules will apply not only to German domiciled funds, but also to EU and non-EU funds and their EU and non-EU fund managers as long as the fund is marketed in Germany and the target company is domiciled in the EU. Marketing on a private placement basis will no longer be possible under this new regime.
The new German Capital Investment Act
In light of the financial crisis, the G-20 leaders resolved at their 2009 summits in London and Pittsburgh that in future all financial market actors shall be regulated. The G-20 resolution targeted in particular hedge funds and private equity funds. On 21 July 2011, the European Directive 2011/61/EC on Alternative Investment Fund Managers ("AIFMD" or the "Directive") entered into force which introduced the first comprehensive regulatory framework for managers of alternative investment funds ("AIF") in Europe. The Directive does not only affect European managers but also third country managers (e.g. managers domiciled in the United States, the Cayman Islands or Jersey and Guernsey) if they manage or market alternative investment funds in the European Economic Area ("EEA").
All EU Member States must implement the Directive no later than 22 July 2013. The German legislator will implement the Directive by creating an entirely new statute, the Capital Investment Act (Kapitalanlagegesetzbuch – "KAGB") which will not only implement the Directive, but will also transpose the Regulation on European Venture Capital Funds1 and the Regulation on European Social Entrepreneurship Funds (EuSEF)2 into German law. In addition, the KAGB will replace the former Investment Act which implemented the UCITS IV-Directive3. The German Federal Parliament (Bundestag) approved the KAGB on 16 May 2013. Germany’s second parliamentary chamber, the German Federal Council (Bundesrat), approved the KAGB on 7 June 2013. The KAGB will become effective on 22 July 2013.
While the KAGB focuses on the regulation of German fund managers, in particular their licensing and passporting into other Member States, as well as on the passporting for non-German fund managers and their funds, it also contains some frequently overlooked provisions for foreign private equity funds which are marketed in Germany by way of public or, more commonly, private placement.4
Specific Requirements for Managers of Private Equity Funds
Private equity funds domiciled in Germany or, in the case of non-German funds, marketed in Germany (more), whose investment objective is to gain control of an unlisted company or an issuer (more), must fulfil certain notification requirements (more), must meet certain disclosure requirements (more) and are subject to certain rules prohibiting so-called "asset stripping" (more).
Which private equity funds are affected by the new rules?
The following rules apply to alternative investment funds whose objective it is to acquire control over unlisted companies or certain issuers5. Alternative investment funds are defined as collective investment schemes which raise capital from investors in order to invest such capital according to a defined investment policy for the benefit of the investors and which are not UCITS6. The following rules do not apply where a fund manager domiciled in Germany and its group companies only manage alternative investment funds with an aggregate volume of no more than EUR 100 million or, in the case of unleveraged alternative investment funds with no redemption rights during the first 5 years, with an aggregate volume of no more than EUR 500 million.
These rules do not only apply to private equity funds domiciled in Germany but also apply to private equity funds domiciled outside of Germany if one or more of the following conditions are met:
- the fund manager is domiciled in Germany7,
- the fund manager is domiciled outside the EEA but has Germany as a reference state8 or manages a private equity fund which is marketed in Germany9.
"Marketing" is any sales activity of the fund manager or of third parties on the fund manager’s behalf, including private placement, except where the sale of a fund unit occurs upon the exclusive initiative of the investor. Please note that there is no private placement regime under the KAGB.
As far as the target investments of the aforementioned private equity funds are concerned, the following rules apply only with respect to unlisted companies10 having their registered seat in the European Union with the exception of SMEs, i.e. small and medium-sized enterprises which employ fewer than 250 persons and which have an annual turnover not exceeding EUR 50 million, and/or an annual balance sheet total not exceeding EUR 43 million11. Special purpose vehicles for the acquisition, the holding and the management of real estate do not qualify as unlisted company in this context. Certain of the following rules also apply with respect to issuers of securities admitted to trading on a regulated market provided the issuer has a registered seat in the European Union (in the following the "Issuer").
When is a private equity fund deemed to gain control of a target company or an Issuer?
"Control" is defined as the holding of 50 % or more of the voting rights of a target company, either alone or acting in concert with others. Voting rights held by companies controlled by the private equity fund and voting rights held by individuals or legal entities acting on behalf of the private equity fund or on behalf of a company controlled by the private equity fund are attributed for this purpose to the private equity fund.
In the case of Issuers, and exclusively for purposes of the disclosure obligations and prohibitions on asset stripping set out below, control is defined with reference to the Takeover Directive12 as the percentage of voting rights which confers control for purposes of establishing the takeover obligation as determined by the rules of the EU Member State in which the Issuer has its registered office13.
Which notification requirements apply in connection with the acquisition of interests in an unlisted company?
The fund manager must notify the German Federal Financial Services Supervisory Authority ("BaFin") of the proportion of the voting rights held by the private equity fund if the percentage shareholding in an unlisted target company reaches, exceeds or falls below the thresholds of 10 %, 20 %, 30 %, 50 % and 75 %.
Under existing German corporate law, an undertaking holding 25 % or more of a German stock corporation must inform the company accordingly which in turn must publish this information in the company’s statutory publication media14. The further notification requirements listed above are entirely new for unlisted companies; they are, however, reminiscent of the notification requirements to BaFin and the issuers of listed shares under the Transparency Directive with the notable exception that notification must also be made under these last mentioned rules if the thresholds of 3 %, 5 %, 15 % or 25 % are affected. Furthermore, in the case of listed shares, the shareholder would also have to publish and inform the target’s management of the fact of reaching a controlling shareholding, i.e. 30 % of the voting shares under the German Takeover Code and would have to make a public takeover offer15.
Where the private equity fund, alone or jointly, gains control over an unlisted company, the fund manager will have to inform the following of the acquisition of control:
- the unlisted company,
- the target’s shareholders whose identities and addresses
- are available to the fund manager,
- can be made available by the unlisted company or
- are available through a register to which the fund has or can obtain access, and
The aforementioned notification must contain the following additional information:
- the resulting situation in terms of voting rights,
- the conditions under which control was acquired, including information about the identity of the different shareholders involved, any private individual or legal entity authorized to exercise voting rights on their behalf and, where applicable, the chain of undertakings through which voting rights are actually held, and
- the date on which control was obtained.
All of the aforementioned notifications must be made as soon as possible, but no later than 10 working days after the private equity fund has reached or passed the relevant threshold or gained control.
When informing the target company, the fund manager must request the target’s management board to inform the employees’ representatives, or where there is no such employees’ representation, the employees themselves of the acquisition of control by the private equity fund and of the further information listed above. The fund manager must use its best efforts to ensure that the target’s management board properly fulfils the aforementioned information requirements16.
What are the disclosure requirements when a private equity fund acquires control of an unlisted company or an issuer?
Where the private equity fund, alone or jointly with another private equity, has acquired control over an unlisted company or an Issuer, it must provide the recipients listed in here above with the following information:
- the identity of the private equity fund(s) involved,
- the policy for preventing and managing conflicts of interest, in particular between the fund manager, the private equity fund and the target, including information about the specific safeguards established to ensure that any agreement between any of them is concluded at arm’s length and
- the policy for external and internal communication relating to the target in particular as regards employees.
As in the case of the aforementioned notification requirements, the fund manager must use its best efforts to ensure that the employees or their representatives are properly informed of the information listed in above by the target’s management board (cf. here).
The fund manager must ensure that the private equity fund’s intentions concerning the future business of the unlisted company and the likely repercussions on employment, including any material change in the conditions of employment are disclosed to the target and its shareholders17. Furthermore, the fund manager must ensure that the target’s management board will disclose this aforementioned information to the target’s employees or employee representatives, as the case may be. – These obligations are independent of and in addition to the information obligations imposed upon the management of a German target company under German labour laws vis-à-vis the employees’ representatives which are very similar to the regulatory disclosure obligations set out in this sub-chapter18.
As soon as a private equity fund acquires control over an unlisted company, its manager must provide BaFin and the investors in the private equity fund with information concerning the financing of the acquisition.
The following information must be included in the private equity fund’s financial reports or in the target’s financial reports, which should be timely prepared and made available to the target’s employees or employee representation:
- a fair view of the development of the target’s business,
- any important events since of the end of the financial year,
- the target’s likely future development, and
- the information required in the case of the acquisition of own shares19.
The fund manager must ensure that the private equity fund’s financial information is either (x) timely provided by the target’s management board to the employees or employee representation or (y) timely provided by the fund manager to the investors in the private equity fund20.
What are the rules prohibiting asset stripping where a private equity fund acquires control over an unlisted company or an issuer?
For a period of 24 months following acquisition of control over the target, the fund manager is obliged
(a) not to allow, facilitate, support or instruct any distribution, capital reduction, share redemption and/or acquisition of own shares by the target as set out below,
(b) where the fund manager is authorized to vote on behalf of the private equity fund in the meetings of the target’s governing bodies, not to vote in favour of any of the aforementioned measures,
(c) to use its best efforts to prevent the target from effecting any of the aforementioned measures.
Independent from the specific legal structure of the corporation (e.g. stock corporation or limited liability company), the amounts available for distribution must always be determined on the basis of the annual accounts of the immediately preceding financial year. This wording of the new rule resembles the wording of the existing Second Corporate Directive (Directive 77/91/EEC) which has been implemented in Germany in the Stock Corporation Act, but not in the Limited Liability Company Act. As a consequence, where the target company is a German limited liability company which may at present make interim dividend distribution, the new rules of the KAGB would, arguably, constitute a limitation of the applicable corporate laws. With respect to the determination which amounts are available for distribution, the AIFMD and the KAGB are not quite clear. One interpretation would be that the strict rules applying to stock coporations, in particular as regards the prohibition to resolve and distribute certain reserves, apply to all target companies regardless of their specific legal structure, e.g. also to German limited liability companies. The interpretation more consistent with the purpose and spirit of the AIFMD, however, appears to be that the applicable provisions of the target’s national corporate law statutes determine which amounts are free for distribution, in particular which reserves can be resolved and distributed. Please note that distributions are defined as the payments of dividends or interests relating to shares. The latter includes interest payments convertible bonds and other forms of hybrid instruments but may also extend to acquisition finance loans.
The purchase of own shares is only permissible (a) if it does not lead to an annual loss, (b) where it serves to offset losses or (c) where it serves the purpose to include sums of money in a non-distributable reserve provided that such reserve is not greater than 10% of the reduced subscribed capital. Furthermore, the prohibition to purchase own shares does not apply in certain circumstances set out in Art. 20 (1) lit. (b) – (h) of Directive 77/91/EEC21. The restrictions for the purchase of own shares and the aforementioned general prohibition of capital reductions go beyond the restrictions imposed by German corporate law.
While fund managers managing exclusively German domiciled private equity funds which are fully invested on 21 July 2013 and do not make any further acquisitions after this date do not have to comply with the aforementioned rules22, there is no corresponding grandfathering provision for private equity funds domiciled in other countries, be they EEA Member States or third countries.
The private placement rules for private equity funds established prior to 22 July 2013 continue to apply until 21 July 201423. After this date public or private placement of a private equity fund requires a notification to BaFin as Germany, unlike other European jurisdictions, will not enact private placement rules for alternative investment funds. A European passport for such funds will not be available before 2015.
Regulation of the European Parliament and of the Council on European Venture Capital Funds, 2011/0417 (COD).
Regulation of the European Parliament and of the Council on European Social Entrepreneurship Funds (EuSEF), 2011/0418 (COD).
Directive 2009/65/EC of the European Parliament and of the Council of 13 July 2009 on the coordination of laws, regulations and administrative provisions relating to undertakings for collective investment in transferable securities (UCITS).
The KAGB adopts almost verbatim the language of the AIFMD. While the legislator’s official comments provide very useful guidelines for interpretation on most of the provisions of the KAGB, they are almost silent on the rules for private equity funds.
Consequently, private equity funds which only acquire minority positions and do not aim at acquiring control in concert with others are not affected by these additional rules.
I.e. harmonised investment funds under Directive 2009/65/EC of the European Parliament and of the Council of 13 July 2009 on the coordination of laws, regulations and administrative provisions relating to the undertakings for collective investment in transferable securities.
This applies even if the private equity fund is domiciled and marketed exclusively outside the EEA (cf. § 55 (1) no. 1 KAGB).
A „reference state“ is that EEA Member State which supervises a fund manager having its registered seat in a non-EEA Member State when managing or marketing an alternative investment fund in the EEA, cf. § 57 (2) KAGB).
§ 330 (1) KAGB.
I.e. corporations, including partnerships limited by shares, whose shares are not admitted to trading on a regulated market - but not other partnerships, including limited partnerships.
Cf. Commission Recommendation of 6 May 2003 concerning the definition of micro, small and medium-sized enterprises (2003/361/EC), Annex, Article 2 (1).
Directive 2004/25/EC of the European Parliament and of the Council of 21 April 2004 on takeover bids, Art. 5 (3).
E.g. 30 % or more of the voting rights in a listed company domiciled in Germany or in another EEA Member State (§ 29 of the German Takeover Code).
§ 20 German Stock Corporation Act.
§§ 10 (5), 35 of the German Takeover Code.
Violations of the aforementioned notification requirements may constitute an administrative offence which is punishable with a fine of up to EUR 100,000.
Where the shareholder of a German domiciled listed company reaches or exceeds the threshold of 10 % of the voting rights, the issuer must be informed of the shareholder’s objectives and the source of the financing of the acquisition (§ 27a German Securities Trading Act).
The management of a German company must inform the employees‘ representatives (i.e. the works council or in the case of a company with more than 100 employees, the economic committee) of a change of control, details of the potential purchaser and the purchaser’s intentions regarding the future business, the likely repercussions on employment and potential material changes in the conditions of employment. Where the target has more than 100 employees, additional information obligations exist (cf. § 106, 109a German Works Constitution Act). Where a takeover offer must be published, the target’s management must inform the employees of the takeover offer (§ 10 (5) German Takeover Code).
Namely the reasons for the acquisition, the number and nominal value or, in the absence of a nominal value, the accountable par of the shares acquired and disposed of during the financial year and the proportion of the subscribed capital which they represent; in the case of acquisition or disposal for a value, the consideration for the shares; and the number and nominal value or, in the absence of a nominal value, the accountable par of all the shares acquired and held by the company and the proportion of the subscribed capital which they represent (cf. Second Council Directive of 13 December 1976 (77/91/EEC), Art. 22 (2)).
Violations of the aforementioned disclosure requirements may constitute an administrative offence which is punishable with a fine of up to EUR 100,000.
Namely to (i) shares acquired as a result of a universal transfer, (ii) fully paid-up shares acquired free of charge or by banks and other financial institutions as purchasing commission, (iii) shares acquired by virtue of a legal obligation or resulting from a court ruling for the protection of minority shareholders in the event, particularly, of a merger, a change in the company’s object or form, transfer abroad of the registered office, or the introduction of restrictions on the transfer of shares, (iv) shares acquired from a shareholder in the event of failure to pay them up, (v) shares acquired in order to indemnify minority shareholders of associated companies, (vi) fully paid-up shares acquired under a sale enforced by a court order for the payment of a debt owed to the company by the owner of the shares and (vii) fully paid-up shares issued by an investment company with fixed capital and acquired at the investor’s request by that company or by an associate company
Cf. § 353 (1), (2) KAGB.
Cf. § 353 (6), § 351 (5), § 345 (8) KAGB.