Originally published in WORLDwatch, August 2010
The global financial crisis has had a major impact on private equity investors globally and has put the investment funds industry, in particular, under intense scrutiny. The British Virgin Islands (BVI) is one of the largest offshore fund domiciles which, like its onshore counterparts during the height of the crisis, saw unprecedented fund redemptions, closures and outright collapses. With that in mind, the intent of this overview is to highlight certain elements of the legal and regulatory structure in the BVI, which facilitates private equity transactions through the use of BVI corporate vehicles.
Types of Vehicles, Attraction and Licensing
In the BVI, the most popular vehicle for carrying out private equity transactions is the BVI business company (BVI BC). A BVI BC is a separate legal entity distinct from its members, and continues in existence until its dissolution. For private equity transactions, the BVI BC is generally structured as a limited liability company, which limits the liability of its members to the amounts, if any, unpaid on their shares. In addition to BVI BCs, BVI limited partnerships (BVI LP) are also used as vehicles for private equity transactions. Unlike a BVI BC, a BVI LP does not have separate legal personality and is a partnership formed by two or more persons with one or more general partners and one or more limited partners. Each general partner in a BVI LP is jointly liable with the other general partners for all debts and obligations of the partnership incurred while it is a general partner. A limited partner has the benefit of limited liability, provided he or she is not also a general partner and provided he or she does not participate in the control of the partnership business. Unit trusts are also used for private equity transactions but not as frequently as BVI BCs and BVI LPs.
BVI BCs structured as closed-ended funds (which would tend to include most leverage buyout funds) are outside the scope of funds regulation in the BVI and therefore can be set up as a standard company without any fund licensing requirements. However, if the BVI BC is structured as an open-ended fund, it will be subject to the BVI Securities and Investment Business Act, 2010 (SIBA) and will require licensing by the BVI Financial Services Commission (FSC). Under SIBA, a fund is defined as an entity that collects and pools investor money for the purpose of collective investment, and issues either shares in a company, interests in a limited partnership or units in a unit trust that entitle the holder to receive, on demand, an amount computed by reference to the value of their proportionate interest in the whole or part of the net assets of the fund. SIBA came into effect in May 2010 and as part of the process for the enactment of SIBA, the Mutual Funds Act, 1996 was repealed. SIBA not only enhanced the mutual funds regime in a number of ways but also introduced legislation to regulate other types of investment business, public issues of securities and market abuse.
Private equity fund managers are attracted to the BVI for a number of reasons including: the absence of direct taxes in the BVI, which allows funds to maximise returns to their investors; no income, withholding or capital gains taxes in the BVI with respect to shares, interests or units of the fund owned by investors; no capital or stamp duties levied in the BVI on the issue, transfer or redemption of shares, interests or units of a fund and a stable and well regulated environment.
Under SIBA, there are three categories of licensed BVI funds: (i) private; (ii) professional; and (iii) public funds. The licensing requirements and procedures are more stringent in the case of public funds, which are primarily suitable for retail investors. Private and professional funds are primarily suitable for sophisticated, individual and institutional investors. The distinction between private and professional funds is that private funds have no minimum investment requirement although they are restricted to only 50 members and are also restricted as to the way in which the offering can be marketed. Professional funds have a minimum investment of $100,000 for each investor and they must confirm in the subscription documents that they are professional investors. A BVI BC may also be structured as a segregated portfolio company, which is becoming increasingly popular among private equity investors to enhance the fund structure and related tax benefits. A segregated portfolio company permits a fund to separate its assets into different portfolios with distinct liabilities. This structure can provide some additional flexibility to fund managers by allowing them to pursue different investment strategies for different types of investors and assets, without losses in one portfolio affecting the assets or investors in another. The type of vehicle used for private equity fund investments is usually dependent upon the investors' own domestic fiscal conditions and so although the fund is offshore, investors will need to seek advice from onshore legal and tax advisers. As it relates to BVI funds, European investors are more inclined to use BVI BCs, US investors, limited partnerships and Japanese investors, unit trusts. There is a rebound in the market and although banks are still tight on lending, the stock markets are up and so private equity investors do have capital to make specific and calculated investments.
Recent Legal and Regulatory Developments
Like most fund markets, the BVI has seen its fair share of legal and regulatory developments spurred on by the global financial crisis. The inability of several funds in the BVI to meet all redemption requests during the crisis resulted in litigation in a number of cases. For example, a decision by the BVI High Court of Justice (SV Special Situations Fund Limited v. Headstart Class F Holdings Limited, 2008) has confirmed the ability of a person to petition for the winding-up of a fund based upon an unpaid redemption request. This decision has caused more funds to put in place redemption lock-out periods and gates, which gives fund managers more control over the outflow of money out of the fund on any given redemption day. The establishment of valuation committees and boards, which are more independent of the fund managers, are also becoming more frequent in fund structures.
From a regulatory perspective, the FSC, in addition to its other requirements with respect to licence applications, will apply a 'fit and proper' test to assess the suitability of the principals behind the fund. The 'fit and proper' test is designed to test the principal's character and experience in the financial services industry and this becomes particularly important in relation to the choice of functionaries for the fund. The test has existed for quite some time now but given the recent crisis it may be applied more strictly. The FSC also has a 'four eyes' principle, in which all applicants for licensing are required to have at least two directors. In addition, all private, professional and public funds are obligated to file with the FSC a 'Mutual Funds Annual Return' for the financial period ending 31 December of each year within six months of the end of the financial period, and funds that are incorporated as segregated portfolio companies are required to deliver their audited annual accounts to the FSC within six months of their financial year end.
The BVI is also continuing to maintain its alignment with international standards, while at the same time seeking to remain an attractive jurisdiction. New anti-money laundering legislation that requires financial institutions and service providers to identify the beneficial owners of companies and tax information exchange agreements are part of this international alignment process. Currently, the BVI is on the OECD's white list and is committed to meeting future standards. The BVI places great importance on maintaining high standards and this has enabled it to become the first member of the International Organization of Securities Commissions to be admitted through IOSCO's Multilateral Memorandum of Understanding Concerning Consultation and Co-operation and the Exchange of Information. An extensive review concluded that the BVI's legislative and institutional regimes on international cooperation met IOSCO's standards.
Despite the global economic crisis, the BVI has been able to maintain a modern, user-friendly and well regulated environment for private equity investors. Legislative enactments such as the Insolvency Act, 2003, the BVI Business Companies Act, 2004 and the recently enacted SIBA, 2010 together with adequate regulation will ensure that BVI continues to stay on the cutting edge of the offshore funds industry in the years to come.
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