Luxembourg is moving to overhaul corporate law and introduce a third form of limited partnership to attract private equity funds, says Dechert's Patrick Goebel.
Luxembourg’s reformed limited partnership regime has the aim of extending structuring options when setting up a private equity, or similar fund, in the domicile, and of attracting more private equity managers.
The most common vehicle for private equity funds in any jurisdiction is the limited partnership, which distinguishes between one or more general partners and limited partners. The general partner bears unlimited liability, manages the fund and represents it towards third parties. Limited partners have liability limited to their contributions and they cannot interfere in daily management.
Luxembourg corporate law uses two types of legal forms: the société en commandite par actions (SCA); and the société en commandite simple (SCS).
As in other civil law countries, Luxembourg law classifies companies into joint-stock companies, where creditors’ claims are, in principle, limited to the company’s capital, and intuitu personae companies, where creditors may extend their claims to all or some of the partners/shareholders.
The SCA is a joint-stock company whose capital is represented by shares. Ordinary shares are transferable except if stated in the articles of association. The SCS is an intuitu personae company issuing partnership interests whose transferability is determined in the partnership agreement and often subject to restrictive conditions. Both are legal persons. This makes the SCS, which shares many features with the limited partnership under English common law, fundamentally different.
Luxembourg is moving to overhaul the SCS and introduce a third form of limited partnership, the société en commandite spéciale (SCSp), into the Luxembourg Companies Act. The SCA, which has been popular among private equity managers, will only be subject to a few technical adjustments.
The SCSp is an intuitu personae company but, unlike the SCS, does not have a legal personality. It is transparent – from a corporate and tax perspective. While investments made by the SCSp are owned by its partners, it will enable ownership recording (and recording of any guarantee, security or pledge) on behalf of the SCSp. It will also clarify that assets recorded on the SCSp can only satisfy claims triggered in relation to the creation, the conduct or the dissolution of the SCSp. A creditor having a personal claim against one of the partners cannot require satisfaction on the assets recorded on the SCSp.
SCS and SCSp have common features. Each is established by a partnership agreement either set by a notary deed or by private instrument between one or more general partners and one or more limited partners. A general partner has unlimited joint and several liability for all the obligations of the partnership – typically the general partner adopts the form of a limited liability company to absorb the unlimited liability. The general partner can participate in any action of internal or external management of the partnership.
A limited partner’s liability is limited to the amount of its contribution to the partnership. It is prohibited to participate in any action of external management – participating may expose the limited partner to an unlimited liability in relation to that action and even to a general unlimited liability if the limited partner repeatedly participates in actions of external management.
The partnership agreement may provide that the partnership is managed by one or more external managers different from the general partner. Such a manager’s liability regime will be based on common rules of agency – that is, the manager will only be liable for misconduct in the management of the partnership’s affairs.
The reform of the limited partnership regime removes, to a certain extent, old-fashioned requirements and therefore enables a more convenient use for alternative investment funds – in particular, specialised investment funds. For example, publication of the identity of limited partners who have not yet fully paid-in their contributions will no longer be required under the Companies Act, which ensures a higher level of confidentiality. Also, while the partnership may be funded by a combination of equity and loan, it is not necessary, as for English limited partnerships, to be funded by a small amount of capital and a large amount of debt.
Other amendments bring further clarifications and help reinforce legal security, such as the restriction of a limited partner to participate in the management being limited to any action in relation to external management. As such, a list of actions which are not deemed participation in external management has been introduced in the Companies Act: advising, supervising, controlling, granting loans, guarantees or security or approving decisions of general partner(s) or manager(s). Participating in an advisory or an investment committee will consequently be deemed a participation in internal management.
SIFs and SICARs can avail the SCSp form. SIF or SICAR adopting the SCS form can be structured as an internally managed alternative investment fund as understood under the Alternative Investment Fund Managers Directive (AIFMD). The lack of legal personality requires a SIF or a SICAR under the form of a SCSp to have either the general partner or a third party to be the alternative investment fund manager.
Alongside the amendments in the Companies Act, the Bill contains certain tax provisions.
To avoid that the activity of a partnership other than a SIF or a SICAR would be deemed a commercial activity triggering the municipal business tax when the general partner is a Luxembourg company, the Bill determines that a limited partnership does not carry out a commercial activity if its Luxembourg-based general partner holds less than 5% of the partnership interests.
The concept of the carried interest will be clarified in the Income Tax Act by distinguishing between carried interest as an incentive right not attached to a partnership interest or a share. This will be considered as miscellaneous income to be taxed in principle at the marginal income tax rate, and carried interest attached to a partnership interest or a share. This qualifies as capital gain for tax purposes (and which is exempted from income tax if it is realised after a minimum holding period of six months and if the participation does not exceed 10% of the issuer’s capital).
Additionally, a favourable tax regime will be created for the employees of the general partner or the management company of a relevant fund subject to certain conditions, among others, if he/she becomes a Luxembourg tax resident within five years after the bill becomes effective and that the carried interest is paid after investors have recovered their initial investment.
Reforming the Luxembourg partnership regime alongside the transposition of the AIFMD provides an attractive option to those managers who look for going onshore in the post-AIFMD world.
Patrick Goebel is Luxembourg partner at Dechert
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