Forms of vehicle
What legal form of vehicle is typically used for private equity funds formed in your jurisdiction? Does such a vehicle have a separate legal personality or existence under the law of your jurisdiction? In either case, what are the legal consequences for investors and the manager?
The most common legal form is a closed-ended fund organised as a German limited partnership (KG) as it is taxtransparent, allows flexible structuring and provides limited liability to investors. KGs have separate legal personality. The general partner (GP) of the KG is personally liable for the debts of the KG. To reduce liability risks, typically a company with limited liability (GmbH) serves as GP (GmbH & Co KG). The investors join as limited partners. The fund manager is typically acting as managing limited partner of the KG. Besides the KG, several other legal forms are available for German private equity funds (eg, investment KG, investment AG, UBG). However, the KG is the market standard (in particular for registered, ie, ‘sub-threshold’, fund managers).
Forming a private equity fund vehicle
What is the process for forming a private equity fund vehicle in your jurisdiction?
The formation of a KG is simple. The KG comes into legal existence with the signing of the limited partnership agreement (LPA) by the GP and the limited partners. To ensure limited liability for investors, the KG and its partners will be registered in the German commercial register. Also, the beneficial owners must be reported to the transparency register. Notarisation of the LPA is not required, but the filing with the commercial register must be effected by a notary. Signatures of investors must be notarised by a notary public (if taking place outside Germany, generally an apostille in accordance with the Hague Convention has to be provided by the notary public). Limited partners in the form of an entity must provide proof of their valid existence and due representation by the signatories. The fees and expenses for the notarisation of filing with the commercial register and the registration fees are fairly small and generally do not exceed €2,000. Filings can usually be effected within two to four weeks. The KG itself has no minimum capital requirements. A minimum registered capital of €25,000 applies to a GmbH serving as GP.
Is a private equity fund vehicle formed in your jurisdiction required to maintain locally a custodian or administrator, a registered office, books and records, or a corporate secretary, and how is that requirement typically satisfied?
A separate custodian is necessary if the fund is managed by a fully licensed manager under the KAGB (the German implementation of the Alternative Investment Fund Managers Directive (AIFMD)). A custodian is not necessary in the case of a registered (sub-threshold) manager. A fund in the form of a KG requires a domicile in Germany and must comply with the commercial law requirements regarding book-keeping. The fund manager typically serves as managing limited partner of the fund and also performs corporate secretarial and administrative tasks. A separate administrator is rather uncommon (as opposed to other jurisdictions).
Access to information
What access to information about a private equity fund formed in your jurisdiction is the public granted by law? How is it accessed? If applicable, what are the consequences of failing to make such information available?
The records maintained at the commercial registry are public via the internet. This includes the identity of the investors as limited partners and their liability amounts (typically expressed as a small percentage of the capital commitment). Such disclosure can be avoided by interposing a nominee as direct limited partner, to hold and manage its limited partner interest for and on behalf of the investors as beneficiaries. Filing of the partnership agreement is not required, thus the fund terms remain confidential. The partnership is required to file its annual financial statements with the commercial register and to publish them in the electronic Federal Gazette. The articles of association of the GP are filed with the commercial register and are available to the general public. Fines and other enforcement measures can be imposed for failure to make required filings. In 2018, Germany introduced the transparency register under the EU anti-money laundering (AML) law. The transparency register must include all beneficial owners unless the beneficial owners are already shown in public documents in the commercial register.
Limited liability for third-party investors
In what circumstances would the limited liability of third-party investors in a private equity fund formed in your jurisdiction not be respected as a matter of local law?
The investor’s liability as limited partner in relation to the partnership is limited to such investor’s capital commitment. Liability in relation to third-party creditors of the fund is limited to the liability amount registered with the commercial registry, typically a small percentage of the actual capital commitment. If this amount has been paid into the partnership, then there is no additional liability of such limited partner to third parties. Potentially, there is a risk that a limited partner is treated as GP (ie, fully liable to third parties) for the period of time between its admittance to the partnership and registration of such limited partner with the commercial register (whether when subscribing to a fund in the fundraising process or in the case of a transfer). However, technical solutions are available and common to avoid such risk (eg, making the registration with commercial register a condition precedent for the formal admission to the partnership). Otherwise, there are generally no circumstances in which the limited liability of limited partners would not be respected as a matter of German law.
Fund manager’s fiduciary duties
What are the fiduciary duties owed to a private equity fund formed in your jurisdiction and its thirdparty investors by that fund’s manager (or other similar control party or fiduciary) under the laws of your jurisdiction, and to what extent can those fiduciary duties be modified by agreement of the parties?
A fund manager’s fiduciary duties are mainly based on the rules of conduct imposed by the AIFMD. This means a fund manager must act honestly, fairly and with due skill, act in the best interests of the fund and its investors and treat all investors fairly. Furthermore, the fund manager must take all reasonable steps to avoid conflicts of interest where possible. These fiduciary duties cannot be altered by agreement. However, the fund manager and the investor can agree on higher threshold for the fund manager’s liability.
Does your jurisdiction recognise a ‘gross negligence’ (as opposed to ‘ordinary negligence’) standard of liability applicable to the management of a private equity fund?
The management of the fund (ie, the GP, the managing limited partner, or both) must by law apply the standard of care of a prudent business person. In particular, the management must follow the legal requirements for book-keeping, preparing of statutory accounts and filing of tax returns of the fund. In practice, however, partnership agreements typically restrict the liability of the GP and the managing limited partner to gross negligence and wilful misconduct. Some commentators in legal publications dispute, however, whether such a restricted standard of liability can be enforced in court as between the partners of a partnership.
Other special issues or requirements
Are there any other special issues or requirements particular to private equity fund vehicles formed in your jurisdiction? Is conversion or redomiciling to vehicles in your jurisdiction permitted? If so, in converting or redomiciling limited partnerships formed in other jurisdictions into limited partnerships in your jurisdiction, what are the most material terms that typically must be modified?
Fund sponsors need to be aware of the special rules on the taxation of a private equity fund. German regulated investors, such as insurance companies, require a free transferability of their interest in the fund. If the sponsor uses the limited partnership (GmbH & Co KG) as the most common private equity fund vehicle in Germany, investors need to be registered with the commercial register of the KG in order to be shielded from unlimited liability.
There are no specific rules for a conversion of a non-domestic vehicle into a domestic vehicle. Possible from a legal perspective is redo miciling of a non-domestic vehicle to Germany. This would result in the case of a limited partnership to a conversion of the vehicle into a German limited partnership (GmbH & Co KG). The most material change of such redomiciling will be the fact that the KG and its investors need to be registered with the local commercial register in order to benefit from limited liability. Potential negative tax effects of such conversion or redomiciling have to be analysed in advance on a case-by-case basis.
Fund sponsor bankruptcy or change of control
With respect to institutional sponsors of private equity funds organised in your jurisdiction, what are some of the primary legal and regulatory consequences and other key issues for the private equity fund and its general partner and investment adviser arising out of a bankruptcy, insolvency, change of control, restructuring or similar transaction of the private equity fund’s sponsor?
There are no legal or regulatory rules directly connecting an event at the fund sponsor level with the private equity fund and its GP and investment adviser. It is possible, though – depending on the group structure – that events such as bankruptcy, insolvency, change of control or restructuring at the sponsor level will lead to regulatory consequences at the manager level or at the level of the investment adviser. For instance, change of control events in the top holding company of a group will require a notification process to the regulator. Furthermore, a bankruptcy or insolvency of the GP leads to an automatic removal of the GP from the fund and the fund being switched into ‘run-down mode’.
In practice, it is common that the fund LPA contains at least change of control provisions with regard to the GP and the fund manager. It is then left to the negotiations with the investors how extensive these provisions are with regard to other events and other entities of the manager group.
This article is part of the German Chapter of “Private Equity – Fund Formation”, first published in: Private Equity – Fund Formation, Getting the Deal through, Lexology, Law Business Research, 2020