In July 2013, Luxembourg legislation came into force specifically tailored to the needs of private equity / real estate investment managers providing for (a) significant amendments to the existing Luxembourg simple limited partnership (société en commandite simple) (the Standard Limited Partnership) and (b) the introduction of a new limited partnership (société en commandite spéciale) (the Special Limited Partnership).
WHY DOES THIS MATTER TO EUROPEAN PRIVATE EQUITY?
Luxembourg limited partnerships derive from the same ultimate source as limited partnerships of the Anglo-American, common law type. However, until now a number of tax and corporate matters have made the Luxembourg models materially less attractive for private equity / real estate investment managers than the models available in other jurisdictions.
The purpose of this modernizing Luxembourg legislation is to specifically remedy each of these individual points of corporate or tax law disadvantage, deliberately seeking to adopt a best-in-class solution in each case from the other models available internationally. Comparative review confirms that this has been successfully achieved.
This modernisation was deliberately included in the same law as that which incorporated the EU Alternative Investment Fund Managers Directive (AIFMD) into Luxembourg Law. Whilst AIFMD clearly brings a number of additional compliance obligations for European private equity, it may also develop material distribution advantages in relation to certain core European institutional investors. Whilst the most obvious distribution advantage may be the marketing passport, in practice it is likely that at least as much importance may be found in preferential treatment in internal asset allocation requirements for such core European institutional investors.
Combining these distribution advantages in a single law with the modernisation of limited partnerships tailored to private equity / real estate investment is intended to underline Luxembourg's attributes as a leading fund domicile for European private equity and real estate funds.
TRACK RECORD - ALREADY ESTABLISHED
Ogier Luxembourg established one of the first Special Limited Partnerships on 19 July 2013. Acting for a European real estate fund manager, this Luxembourg Special Limited Partnership forms part of a multi-jurisdictional, Luxembourg-Channel Islands structure. Ogier is the only law firm with the jurisdictional reach to implement such structures for clients, working closely with principal Counsel in managers' home jurisdictions.
WHY TWO LIMITED PARTNERSHIP VEHICLES?
Following these reforms, the Standard Limited Partnership and the Special Limited Partnership both have the required features for such investment vehicles. The key difference is that the Special Limited Partnership is an unincorporated association of persons without separate corporate legal personality (similar to the English and standard Channel Islands limited partnerships). In contrast the Standard Limited Partnership has a separate legal personality (similar to the Jersey Separate Limited Partnership, the Guernsey Limited Partnership Inc. and the Scottish model).
CONSTITUTING THE PARTNERSHIP
As for the Channel Islands and UK private equity models, both of these Luxembourg partnerships require one or more general partners and one or more limited partners. General partners have joint, unlimited liability for partnership obligations. Limited partners' liability for partnership obligations is limited to the amount of their agreed partnership contribution, provided they do not act in their capacity as limited partners, in the management of the partnership towards third parties or hold themselves out as being general partners. Please see further below in relation to non-management safe harbours.
In accordance with international structuring norms the general partner's liability risk in this area is neutralised by use of a limited liability corporate vehicle to act as general partner.
NO NOTARIAL REQUIREMENT
One aspect of Luxembourg's civil law tradition is that constituting and amending the constitutional documents of Luxembourg sociétés (ie companies and pre-reform limited partnerships) is required to be done by notarial deed, made in the physical presence of a Luxembourg notary. This additional, transaction management requirement (and the associated fees) has been disapplied in relation to the Special Limited Partnership and Standard Limited Partnership, as has the requirement that a translation of the partnership agreement be available in one of French, German or Luxembourgish in addition to the business language most suited to the individual managers and investors.
Thus, the partnership agreement can now be solely in English (if appropriate) and can be entered into as a private agreement executed simply by signature. Also, in contrast to other sociétés, there is no minimum capital requirement.
The partnership with limited liability for limited partners exists immediately from signature and exchange, notwithstanding the fact that the partnership will then need to be registered with the Luxembourg Trade and Companies Register.
HIGH FLEXIBILITY - CONTRACTUAL FREEDOM
One of the most important characteristics of both the Special Limited Partnership and the Standard Limited Partnership is a very high degree of flexibility.
The applicable legal framework is deliberately enabling, not limiting. Examples of this approach are as follows:
- a limited partner may also be a general partner (provided there are at least two different partners overall);
- partners' contributions are made against the issue of "partnership interests" (parts d'intérêt) which may be unitised (ie represented by shares - titres) if appropriate;
- partners' contributions in services (apports en industrie) are now accepted, in addition to contributions in cash or of tangible assets. Thus contribution of management, advisory or general partner services are specifically recognised with the valuation of such contributions being entirely a matter for the private, partnership agreement. In contrast to contribution of assets to other forms of Luxembourg sociétés, there is no external valuation requirement for such contribution to these partnerships;
- there is no requirement to divide partnership interests (whether unitised or not) into nominal value and premium and freedom of contract prevails in relation to creating different classes of partnership interests with different rights;
- the conditions of issuance of partnership interests can be freely determined in the partnership agreement;
- the mechanism to evidence ownership of partnership interests is a matter for the partnership agreement;
- in addition to partnership interests, the issue of debt securities is authorised;
- the question of what decisions need to be made (or, if made by the general partner or manager, need to be approved by the partnership as a whole), the required voting thresholds and applicable procedural requirements are substantially private matters for the partnership agreement. The only matters required by law to be resolved by the partnership as a whole are changes to the partnership's purpose, nationality, vehicle type or its dissolution;
- freedom of contract in the partnership agreement prevails in relation to both voting rights and profit sharing. Disapplying pre-reform restrictions in these areas, partnership interests may now carry weighted voting rights or be non-voting and may contractually be excluded from profits or protected from losses, if expedient. Profit share may be allocated without constraint and there is no partnership law requirement for a general partner profit share (although such a share may be appropriate for other reasons);
- there is no requirement to allocate profits to any legal reserve;
- there is no minimum fixed capital requirement, either on formation or on-going;
- whether (or not) any investment, diversification or leverage rules or constraints apply will be determined by any applicable regulatory regime, no such requirements arise in relation to the limited partnerships themselves;
- the rules as to the admission and exclusion of partners are entirely determined by the partnership agreement.
MANAGEMENT AND GOVERNANCE
Two key, modernising reforms have been made in this area.
First, one or more managers may be appointed in the partnership agreement. Whilst, if appropriate, the same person or vehicle may undertake both the manager role and the general partner role, the roles themselves are separate and may be undertaken by different vehicles.
There is no requirement that the manager be domiciled in Luxembourg. Thus, for example, a Luxembourg limited partnership may have a Luxembourg private company as its general partner and a Channel Islands company as its manager.
The manager itself may also delegate its management powers to another party acting as the manager's delegate or agent. A manager is authorised to act in the name of the limited partnership and to carry out any act necessary or useful pursuant to the limited partnership's objects, subject to any contrary provision in the partnership agreement.
Managers who are not also general partners will not be liable to third parties for obligations of the limited partnership. Managers owe duties to the partnership itself which are similar to directors' duties in relation to a company.
Limited partners may also either be appointed as a manager or as the delegate or agent of a manager to carry out the manager's powers. Such delegation or agency may also be granted by a manager who is also a general partner, to a limited partner. In both of these cases, the limited partner acting as manager (or as a manager's delegate or agent) does not forfeit its limited liability (as limited partner) to third party creditors of the partnership, provided that the representative capacity in which it is acting is clearly stated in all circumstances.
General partners therefore may, but are not required to, provide management services to the limited partnership. Management services may therefore be provided by (and management fees paid to) a management company domiciled in the most appropriate jurisdiction.
These provisions enable many structuring outcomes whilst protecting investor limited liability, including the appointment of "managing limited partners" in relation to funds investing into the DACH (ie German language) region.
In other cases (ie other than where formally acting as "manager" of the limited partnership or any delegate or agent), the traditional position, that a limited partner (acting in that capacity) carrying out acts of management in dealings by the partnership with third parties risked loss of limited liability, has also been modernised.
To provide assurance to limited partners undertaking activities in relation to the partnership, safe harbours of specifically non-management activities have been created to protect such limited partners. Non-exhaustive examples of such safe harbours include as follows:
- the provision of advice, including investment advice, to the partnership, its affiliates or its managers;
- the oversight, monitoring and supervision of acts of the partnership;
- the granting of loans, guarantees and security interests to the partnership (or its affiliates); and
- the authorising of the managers' actions outside the specific authority granted by the partnership agreement.
Limited public filings
Prior to the current reform, the Standard Limited Partnership framework carried disclosure requirements on the Luxembourg public registry in relation to partners and their contributions that could be controversial.
The modernised position now applying is that such disclosure of limited partner details and partnership interests is no longer required. Up-to-date details of the general partner only (but not any general partner fee or interest) need to be maintained on the register.
There is no requirement to file and publish the partnership agreement. Filing is limited to an extract of the following matters:
- the general partner(s') name(s);
- the name, corporate objects and registered office of the limited partnership;
- the manager(s) name(s) and signatory powers; and
- the formation date and duration of the limited partnership.
Standard Limited Partnerships are required to prepare annual accounts. In relation to Special Limited Partnerships, whether formal annual accounts are required is a matter for any applicable regulatory regime or, if unregulated, a private matter for the partnership agreement. The information disclosed both as between partners and by way of publically accessible filing also differs between them.
As between partners, for Standard Limited Partnerships, the annual accounts, management and auditor's report (if required) are to be made available to partners at the registered office at least 15 days prior to the annual partners' meeting due to consider the accounts. In contrast, for Special Limited Partnerships, freedom of contract prevails and the information to be made available to partners is limited to what is provided for in the partnership agreement.
In relation to publically available filings, the annual accounts for a Standard Limited Partnership will be filed and available at the Luxembourg public registry. In contrast, annual accounts for an unregulated Special Limited Partnership (if required) will not be.
Both Standard Limited Partnerships and Special Limited Partnerships need to maintain a partners' register. The starting point that any partner may access this register is subject to any limiting provisions that may be applied by the partnership agreement.
DISTRIBUTIONS - NO INSOLVENCY CLAWBACK
The allocation of profits/losses between partners, any required conditions for distributions to be made and the circumstances (if any) in which distributions of profit, (re-)payments in respect of any loan contributions or the return of partnership capital are matters solely to be regulated by the partnership agreement.
Thus, whilst it would be entirely prudent for the partnership agreement to require an assessment of cashflow solvency by the manager or general partner prior to making any such payment, as a matter of law there is no longer any insolvency clawback risk in respect of such payments if such assessment subsequently proves to have be incorrect (absent fraud).
Both forms of limited partnership can be funded either purely by way of equity commitments or by a mixture of equity and partner loan contributions, as appropriate.
REDUCTIONS, BUY-BACK AND TRANSFERS OF PARTNERSHIP INTERESTS
The conditions for and authorisation to reduce or buy-back any partnership interest may be set out in the partnership agreement, they are not prescribed by statute.
Any requirements for the approval of the admission of new limited partners on a transfer or sub-division of limited partner interests or on the enforcement of a pledge over such interests are also a matter for the partnership agreement and are not prescribed by statute.
Similarly statute does not prescribe any particular requirement as to approval thresholds for transfers of partnership interests, either in relation to general partners or limited partners.
INTERNATIONAL MARKET NORMS
This significant contractual freedom to regulate internal partnership matters enables these Luxembourg limited partnerships to adopt international norms relating to private equity / real estate investment vehicles with absolutely minimal localisation requirements. These vehicles can be used for funds, onshore feeder vehicles and carry, either in structures which are entirely Luxembourg-domiciled or as part of multi-jurisdictional structures.
Where, for example, a Luxembourg-Channel Islands structure is appropriate, this contractual freedom enables the use of substantially common documents across the different jurisdictions with consequential transaction management and ongoing operational advantages.
TAX - TRANSPARENCY AND NEUTRALITY
Prior to the current reforms having come into effect, the Standard Limited Partnership was treated as tax transparent and tax neutral for Luxembourg income tax and net wealth tax purposes. However, where (as would often be desirable) a Luxembourg capital company were to act as its general partner and its registered office was located in Luxembourg City, municipal business tax would be charged at a rate of 6.75% on the partnership's taxable income as it was deemed to perform commercial activities (Geprägetheorie). In many cases this would clearly result in an uncompetitive position compared to other internationally available fund domiciles.
The post-reform position, now applying, provides full tax transparency and neutrality in respect of Luxembourg direct tax, ie income tax, net wealth tax and municipal business tax, provided that the partnership interest of a corporate general partner stands at less than 5% of aggregate partnership interests. As will be apparent, this can be achieved in full compliance with commonly encountered structuring norms.
However, legal uncertainty remained as to whether investment activities could be considered as commercial activities per se. To solve that matter, on 9 January 2015, the Luxembourg tax administration issued the long-expected circular letter LIR n°14/4 (the Circular). The Circular clarifies that a Luxembourg Limited Partnership (either Standard or Special) which qualifies as an alternative investment fund (AIF) within the meaning of the Luxembourg law on alternative investment fund managers dated 12 July 2013 (AIFM Law) shall not be considered to carry out a business activity triggering municipal business tax. The latter is underpinned by the fact that an investment activity has not a commercial purpose and obeys to an investment policy compliant with the AIFM Law and with the guidelines issued by the European Securities and Markets Authority (ESMA). Hence, Standard and Special Limited Partnerships qualifying as an AIF and having a general partner holding less than 5% of interest will not be subject to municipal business tax.
This briefing focuses on the attributes of these Luxembourg limited partnerships in themselves. For information as to regulatory requirements that may separately apply in relation to particular circumstances, please refer to our regulatory product briefings in the Luxembourg Legal client briefings on www.ogier.com.
Daniel Richards, Partner, Luxembourg
Laurent Thailly, Partner, Luxembourg