The Bermuda fund industry sees investment predominantly from North America and Europe, and therefore trends in the Bermuda fund finance market track the major onshore markets. Although there is no overall data reporting service for the local fund finance market, anecdotal reports from many of the major facility lenders, as well as Appleby practitioners, anticipate that there will continue to be a high demand for capital call or subscription line facilities. That is not to say, of course, that other structures such as NAV facilities will not be utilised.
BERMUDA FUND OVERVIEW
Bermuda as a jurisdiction is highly responsive to evolving market demands and benefits from years of experience providing services to a number of high-profile asset management companies, cementing Bermuda’s position as one of the premier offshore jurisdictions for private equity funds in addition to those investing in insurance-linked securities.
FUND FORMATION AND FINANCE
INVESTMENT FUNDS – OVERVIEW
The IFA governs the registration and authorisation of investment funds and contains certain requirements for the formation of investment funds, their operation, and the offering of shares or interests of investment funds, the key point being that investment funds are prohibited from operating in or from Bermuda unless they are authorised or registered under the IFA.
An “investment fund” is broadly defined under the IFA and means any arrangement with respect to property of any description, including money, the purpose or effect of which is to enable persons taking part in the arrangements to participate in or receive profits or income arising from the acquisition, holding, management or disposal of the property or sums paid out of such profits and income.
In addition, investors must not have day-to-day control over the management of the fund’s property, whether or not they have the right to be consulted or to give direction. There also needs to be a pooling of investor contributions together with the profits or income out of which payments are to be made to them and/or the property is managed as a whole by or on behalf of the operator of the fund.
Whilst this may appear to be a relatively broad definition at first, there is a supplemental piece of secondary legislation that narrows down the scope to exclude those arrangements, such as joint ventures, that may not truly be considered funds.
REGULATORY APPROVAL AND REQUIREMENTS
The formation of companies, partnerships and limited liability companies (LLCs) is subject to the approval of the Registrar of Companies (Registrar) and the Bermuda Monetary Authority (BMA) (the Registrar and BMA being the principal regulatory bodies). The BMA is the principal body responsible for the regulation of investment funds, including those listed on the Bermuda Stock Exchange (BSX). The Registrar is responsible for the registration of companies, partnerships and LLCs and has powers pursuant to, inter alia, the Companies Act 1981 (Companies Act), the Partnership Act 1902, the Limited Partnership Act 1883, the Exempted Partnerships Act 1992, the Segregated Accounts Companies Act 2000, the Limited Liability Company Act 2016 and the Incorporated Segregated Accounts Companies Act 2019 (ISACA). Whilst the Registrar and BMA do not regulate the formation of unit trust funds, a unit trust fund is required to apply to the BMA for authorisation or exemption under the IFA, and must also seek the permission of the BMA under the exchange control regulations (Exchange Regulations) to issue units.
ANTI-MONEY LAUNDERING AND ANTI-TERRORIST FINANCING AND ECONOMIC SUBSTANCE
The Bermuda government and BMA are committed to ensuring that Bermuda’s anti-money laundering and anti-terrorist financing (AML/ATF) requirements are aligned with the highest international standards.
The Bermuda AML/ATF framework requires that certain persons, including AML/ATF regulated financial institutions such as investment funds, establish policies and procedures to forestall and prevent money laundering and terrorist financing. Such policies and procedures must cover:
- customer due diligence measures and ongoing monitoring;
- reporting;
- record keeping;
- internal control;
- risk assessment and management; and
- the monitoring and management of compliance with and the internal communication of such policies and procedures in order to prevent activities related to money laundering and terrorist financing.
The policies and procedures should be developed using a risk-based approach. The nature and extent of such policies and procedures will depend on a variety of factors, including: the nature, scale and complexity of the business; the diversity of its operations, including geographical diversity; and its customer, product and activity profile.
In keeping with other onshore and offshore jurisdictions, economic substance requirements were introduced in Bermuda. Assuming that an investment fund does not conduct any activity that would be a relevant activity (operating an investment fund is not such an activity),
economic substance requirements should not apply to the fund itself. If the fund has a Bermuda investment manager, then that vehicle would most likely be in scope and specific advice should be sought to ensure that manager complies with the applicable requirements.
BENEFICIAL OWNERSHIP REGIME
Bermuda has also adopted legislation to implement international standards in order to enhance transparency whilst combatting money laundering and terrorist financing. The standards that the legislation implements were initially adopted by the Financial Action Task Force (FATF), with the Organisation for Economic Co-operation and Development incorporating key FATF requirements into their proposals. The Bermuda beneficial ownership regime has certain exemptions where considered appropriate, including with respect to investment funds.
PRIVATE EQUITY FUNDS
Closed-ended private equity funds are typically formed as limited partnerships or companies incorporated with liability limited by shares; although, in our experience, the former is the more popular.
Following the developments discussed further below, whilst such funds were historically often outside the scope of the IFA, we would now typically expect such funds to be registered as professional closed-ended funds.
INVESTMENT FUNDS
Historically, investment funds have typically been formed as mutual fund companies or limited partnerships, the optimal structure depending on a number of factors, including where and to whom the investment opportunity is to be marketed, the nature of the investor base, and the identified portfolio of investment assets.
MUTUAL FUND COMPANIES
A mutual fund company is a company incorporated with limited liability that is incorporated for the purpose of investing the monies of its members for their mutual benefit, having the power to redeem or purchase for cancellation its shares without reducing its authorised share capital, and stating in its memorandum of association that it is a mutual fund. In the case of a mutual fund company, the shares of which are to be sold in overseas markets, an exempted company is the appropriate vehicle. However, shares of a Bermuda mutual fund company, which is an exempted company, may also be offered inside Bermuda to both local and international investors.
Typically, a mutual fund company is incorporated with two share classes: ordinary voting shares (non-participating) held by the investment manager; and non-voting, participating, redeemable shares held by the investors.
The timeline for incorporation of a mutual fund company, after submission of the application to the BMA, is usually three to five business days. A mutual fund company may only commence business and issue shares after it has been organised and the consents under Bermuda’s Exchange Regulations, the IFA (if required) and the AML/ATF framework (if required) have been obtained.
Following certain amendments to the legislative framework, it is no longer a requirement that a Bermuda company meet the definition of a “mutual fund company” in order be considered an investment fund.
However, given that certain provisions of the Companies Act do not apply, or apply in an amended form that is conducive to the operation of a fund, it would be unusual to proceed with a company structure without it being a mutual fund company.
LIMITED PARTNERSHIPS
Investment funds may also be formed as exempted limited partnerships. A limited partnership consists of one or more general partners (which may be bodies corporate, or general or limited partnerships, formed under the laws of Bermuda or another jurisdiction) and one or more limited partners (namely investors) whose relationship is governed by a partnership agreement.
In Bermuda, partnerships (both general and limited partnerships) are not legal entities separate from their partners unless a specific election has been made by the partnership to have separate legal personality.
Nevertheless, a partnership may in any event function as an “entity”, and may sue and be sued and carry on business in its own name. In the event that a partnership does not elect to have separate legal personality, any actions brought against the partnership shall be, in the
first instance, brought against the general partner of said partnership. If an election is made by the partnership to have separate legal personality, such election is irrevocable and the partnership will continue regardless of whether all the partners die or are declared bankrupt or if there is a change in its constitution.
General partners are fully liable for partnership debts and obligations. In the case of limited partnerships, the general partners will have such general liability to third parties, whilst, generally speaking, the liability of the limited partners is limited to the value of the money
and any property that they contribute (or agree to contribute) to the limited partnership. It should be noted that the limited partners may forfeit their limited liability status in certain circumstances if they participate in the management of the partnership.
LIMITED LIABILITY COMPANIES
LLCs were introduced to the Bermuda regulatory landscape in 2016 as a result of the Limited Liability Company Act 2016, as amended (LLC Act). An LLC is a hybrid legal structure allowing the contractual and operational flexibility of a partnership to be housed within a corporate entity.
Like a Bermuda exempted company, an LLC has separate legal personality and the liability of its members is limited. Whilst members of a Bermuda company receive shares, members of a Bermuda LLC will each have an interest in a capital account in a similar way to partners in a partnership. Under the LLC Act, parties can create bespoke vehicles, having the contractual freedom to set out in the LLC agreement the terms of operation and management of the LLC as well as expressly agreeing the allocation of profits and timing of distributions amongst its members. A Bermuda LLC may be managed by one or more members (a managing member), or a manager may be appointed who may or may not be entitled to share in the profits of the LLC.
Whilst the LLC vehicle may be utilised by clients in a broad range of sectors, the Bermuda LLC is an attractive structuring option for operators of investment funds and, in particular, closed-ended private equity funds, as the flexible corporate governance structure allows
“managing members” to manage the fund (in a similar way to a general partner) but without unlimited liability for such members in respect of the fund’s losses. At the moment, it is not yet clear what the lender collateral package will look like in respect of LLC funds, although arguably the use of LLCs, as opposed to partnerships, may serve to simplify the security package, as security would only have to be granted by the LLC itself and not its manager.
SECURITY PACKAGE IN FUND FINANCINGS
A key consideration in any fund financing transaction (whether it be a capital call facility, subscription facility or equity bridge facility) is the collateral package that the lender can secure. Typically, security will be granted over the rights to call for contributions from investors, with the security interest in uncalled capital commitments perfected by the delivery of a notice of the assignment of such capital commitments to the investors, where the document granting the security is governed by Bermuda law. Where the security document is not governed by Bermuda law, local counsel should be engaged to determine any perfection requirements. Additionally, the lender will want security over the account into which investors’ capital contributions are funded.
There is no Bermuda law requirement that the collateral account be a local one (although, of course, the local banks are very familiar with such requirements, should it be preferable to secure a local account). Bermuda law does not stipulate that the security package must be governed by Bermuda law, and most often we see the security agreements mirroring the governing law of the applicable credit facility. Bermuda as a jurisdiction is very familiar with New York law as the preferred governing law for US facilities, and English law for European facilities. Of primary concern, therefore, from an offshore perspective, is to review the validity and priority of the offshore-based security.
Bermuda recognises the concept of a security agent and there are no restrictions under Bermuda law on the enforcement of rights or security interests solely because those rights or security interests are held by an agent. An agent is treated in the same way as any other
secured party and is subject to any applicable Bermuda law. It should also be noted that there are no Bermuda law restrictions on granting security to foreign lenders and that it is not necessary under Bermuda law for a security agent to be registered, licensed or otherwise qualified in Bermuda in order to enforce any of its rights.
There are no restrictions under Bermuda law on a company or partnership making payments to a foreign lender under a security document, guarantee or loan agreement, and exempted companies and partnerships are designated by the BMA as “non-resident” for exchange control purposes, which means that they are free to deal in any currency of their choosing, other than “resident” Bermuda dollars.
The Stamp Duties (International Businesses Relief ) Act 1990 abolished stamp duty on most documents executed by exempted undertakings (including exempted companies and partnerships, and this also applies to LLCs).
Following execution of the security document, lenders will want to ensure that their security package is appropriately registered. Charges over the assets of Bermuda companies in Bermuda (except charges over real property in Bermuda or ships or aircraft registered in Bermuda), which are granted by or to companies incorporated outside of Bermuda, are capable of being registered in Bermuda in the office of the Registrar, pursuant to the provisions of Part V of the Companies Act. Registration under the Companies Act is not compulsory and does not affect the validity or enforceability of a charge, and there is no time limit within which registration of a charge must be effected. However, in the event that questions of priority fall to be determined by reference to Bermuda law, any charge registered pursuant to the Companies Act will take priority over any other charge that is registered subsequently in regard to the same assets, and over all other charges created over such assets after 1 July 1983 and which are not registered. The provisions of Part V of the Companies Act are also extended by section 61 of the Act to charges on property in Bermuda that are created, and to charges on property in Bermuda that are acquired, by a company incorporated outside Bermuda.
Partnerships that have elected to have separate legal personality can also register with the Registrar and thereby ensure priority in a similar way to the regime for companies. In the event that a Bermuda partnership has not elected to have separate legal personality but has a Bermuda company as its general partner, the charge can be registered against the general partner acting in its capacity as general partner of the partnership. Additionally, in instances where the partnership has not elected to have separate legal personality, charges are capable of being registered in Bermuda against the partnership, in the office of the Registrar General pursuant to the provisions of the Mortgage Registration Act 1786 and Regulations enacted pursuant thereto.
KEY DEVELOPMENTS
CHANGES TO INVESTMENT BUSINESS LEGISLATION
In July 2023, the Investment Business Amendment Act 2022 (the Amendment Act) became operative, bringing about changes to the investment business landscape in Bermuda.
One key change of particular relevance to investment managers was the removal of the previous exemption regime. A person is no longer exempted under the 2004 Order; instead, anyone who intends to conduct investment business (as defined in the first schedule of the Amendment Act) must apply to the BMA to be licensed or registered unless they are within a limited group of non-registrable persons.
Registrable persons are of two classes, with:
- Class A registrable persons, being any person that was formed or incorporated in
Bermuda and who carries on investment business in circumstances where they are
licensed, authorised or registered by a recognised regulator but does not maintain a
place of business in Bermuda; and
- Class B registrable persons, typically being someone that would have been able to benefit
from the self-certification exemption either as a result of providing investment services
to (i) particular classes of client, and/or (ii) a limited number of clients (20 or fewer).
The BMA considers a “recognised regulator” to be a regulatory authority in a jurisdiction recognised by the BMA as imposing equivalent standards to those in Bermuda and having the power to supervise entities conducting investment business.
From a fund finance perspective, this is an additional diligence item that should be taken into account when lender counsel is reviewing the structure and sees that it includes one or more investment management vehicles incorporated or otherwise formed in Bermuda.
JUDICIAL CONSIDERATION OF SEGREGATED ACCOUNTS
For quite some time, Bermuda has been able to offer to the market the use of segregated accounts companies. Under the provisions of the Segregated Accounts Companies Act 2000, a mutual fund company may be registered as a segregated accounts company, enabling it to create different share classes, each representing a segregated portfolio of assets. Accordingly, where a multi-class structure is desired with a separation of liability between classes, it is not necessary to incorporate multiple companies in an umbrella form. Instead, a single
segregated accounts company may be incorporated, with segregated accounts representing each share class. Such accounts enjoy a statutory division of liability, effectively ringfencing each segregated account from the general liabilities of the company, and from other
segregated accounts. Bermuda segregated accounts can invest in other segregated accounts in the same company, creating a master/feeder structure, making it possible to invest and redeem without the capital leaving the company and creating a capital transfer.
Whilst the existence of the segregated accounts company is not a key development in and of itself, following a directions hearing lasting five days, Hargun CJ delivered an important judgment concerning, and upholding, the integrity of the statutory regime governing the creation and operation of segregated accounts companies in Bermuda – Re Northstar Financial Services (Bermuda) Ltd and Omnia Ltd [2023] SC (Bda) 57 Civ.
The Chief Justice reaffirmed that the linkage of assets and liabilities to particular accounts is a fundamental feature of the statutory regime under the Segregated Accounts Companies Act 2000. He found that the touchstone for “linkage” is the ability to identify in the company’s accounting records an asset or liability with a given segregated account (by writing or other conclusive indication). It is not necessary, therefore, to show segregation by way of actual segregation of funds (for example, by separate bank accounts). The Court also went as far as to confirm that it is not necessary that the assets “linked” to an account can be demonstrably derived from an original investment. All that is required for sufficient segregation is that the segregated assets can be identified. The consequences of demonstrating linkage are as set out in section 17 of the Segregated Accounts Companies Act 2000, namely that where the liability of a segregated account arises from a transaction related or linked to that particular account, the only recourse for that liability is against the assets of the segregated account and not the assets of any other account.
MARKET TRENDS
We are seeing an increase in the Bermuda market in the use of NAV facilities and hybrid facilities on cross-border fund finance transactions. As in other jurisdictions, where traditional subscription facility agreements are secured by undrawn investor commitments, a NAV facility agreement is typically made available on the basis of the net asset value of the fund’s portfolio of investments, with the assets of the fund securing the facility. A hybrid facility, on the other hand, utilises a blend of both, with such facility being made available on the basis of both the uncalled capital commitments of the investors as well as the net asset value of the fund’s assets.
A NAV or hybrid facility can be useful in situations where the investment period for a fund is nearing or has reached maturity. Typically, funds have exhausted the lion share of their uncalled capital at this point and are therefore no longer eligible to obtain subscription facilities. The NAV and hybrid facilities offer a useful source of liquidity and allow private equity managers to take out loans against the underlying assets in their portfolio, rather than resorting to other means of unlocking liquidity, such as public offerings.
Additionally, NAV facilities often attract a wider array of lenders than traditional subscription facilities. Leverage providers, such as insurance companies, can be more willing to be make commitments available under these facilities, as they can be structured as term loans with longer tenors than subscription facilities.
THE YEAR AHEAD
We have also started to see a greater use within structures over the last year or so of the Bermuda LLC. Following its introduction in 2016, there was a period of time where persons preferred to retain the time-tested existing structures. However, as the existence of the LLC becomes more widely known and people have become more comfortable with the features and expected treatment of LLCs as part of their wider structuring concerns, we are now starting to see more transactions that utilise them not least to take advantage of the flexibility offered and the ability to have greater parity with the constitutional documentation used by a platform in other jurisdictions (e.g., Delaware).
Whilst Bermuda has offered the use of segregated accounts in this way for quite some time, such segregation does not create separate bodies corporate. The ISACA has now introduced the incorporated segregated accounts company (ISAC) to provide another option whereby segregation is provided within a structure that does create a new body corporate. It will be interesting to see whether this structure sees increasing utilisation going forward as parties evaluate how it may compliment or provide an alternative to existing structures.
Bermuda will continue its commitment to developing new and innovative products, and we will continue to see a “collaborative effort” by regulators, government and industry professionals to ensure that Bermuda continues to provide innovative fund products and maintains its position as a leader in the offshore funds world.
First published by Global Legal Group as the Bermuda chapter for Global Legal Insights – Fund Finance 2024, January 2024
For further information, please contact:
Matthew Ebbs-Brewer, Partner, Appleby
mebrewer@applebyglobal.com
