US Investment in Australian Real Estate

US Investment in Australian Real Estate(and other bits) : 

US Investment in Australian Real Estate(and other bits) February 9, 2009 The views, opinions, statements, analysis and information contained in these materials are those of the individual presenters and do not necessarily reflect the views of Kirkland & Ellis LLP or any of its past, present and future clients. These materials (1) do not constitute legal advice; (2) do not form the basis for the creation of the attorney/client relationship; and (3) should not be relied upon without seeking specific legal advice with respect to the particular facts and current state of the law applicable to any situation requiring legal advice. These materials may only be reproduced with the prior written consent of Kirkland & Ellis LLP. These materials are provided with the understanding that the individual presenters and Kirkland & Ellis LLP are not rendering legal, accounting, or other professional advice or opinions on specific facts or matters, and, accordingly, such entities assume no liability whatsoever in connection with their use. Pursuant to applicable rules of professional conduct, this material may constitute Attorney Advertising. Prior results do not guarantee a similar outcome. © 2009 Kirkland & Ellis LLP. All rights reserved. Robert Buday Kirkland & Ellis LLP 200 East Randolph Drive Chicago, IL 60601 312.861.2095 rbuday@kirkland.com Thomas Geraghty Kirkland & Ellis LLP 200 East Randolph Drive Chicago, IL 60601 312.861.2317 tgeraghty@kirkland.com Bruce Gelman Kirkland & Ellis LLP 200 East Randolph Drive Chicago, IL 60601 312.861.2370 bgelman@kirkland.com with special guest Josh Cardwell Greenwoods & Freehills

The Move to Kirkland - Here’s Why : 

The Move to Kirkland - Here’s Why Global Firm. Kirkland is a global law firm with more than 1,500 lawyers practicing from offices in the US, Europe, and Asia Firmwide Recognition. Chambers & Partners, a respected international rating firm, named Kirkland the “2006 USA Law Firm of the Year,” and in 2007, Kirkland was selected as “International Law Firm of the Year” by The Lawyer. Private Equity. In 2008, Chambers Global ranked Kirkland in the top tier of all U.S. law firms in Private Equity - Buyout & Venture Capital Investment as well as top tier of all U.S. law firms in Fund Formation. - Ranked first among law firms in Global Buyouts and USA Buyouts by deal volume in Mergermarket’s Global M&A Round-Up for Year End 2008. - Ranked first among law firms for borrower financings in both M&A transactions and leveraged transactions by number of deals in Reuters Loan Pricing Corporation’s 2008 League Tables Private Funds . Kirkland has represented 127 funds that are closed or are in process in the last year targeting approximately $120 billion. Chambers Global 2008 ranked Kirkland in the top tier of all US law firms in private equity fund formation, calling the group a “major threat [to competitors] in the fund formation arena.” Chambers UK 2009 called the Fund Formation group an “absolutely top-quality and highly-visible group of lawyers,” and noted that the “the firm is really making a mark on the industry.” - More than 150 partners and associates globally work on fund formations - A well developed precedent system enhances Kirklands’ efficiency and responsiveness Tax. Chambers Global 2008 listed Kirkland as a first-tier law firm for tax for the 3rd year in a row. Kirkland’s Tax Practice Group was recognized with the Chicago Tax Firm of the Year award by International Tax Review at the Americas Tax Awards in October 2008. And, all this before Bruce and Tom arrived. Restructuring and Insolvency. In the 2008/2009 editions of International Financial Law Review 1000: The Guide to the World’s Leading Financial Law Firms, Kirkland was ranked in Tier 1, the highest ranking, for Insolvency and Restructuring in the U.S. In the 2008 edition of Chambers USA, Kirkland’s Restructuring Group was ranked in the first tier among law firms for bankruptcy/restructuring.

Discussion points : 

Discussion points Overview US investment in AU real estate - tax issues and strategies Exiting and restructuring investments in US real estate Investments in US debt Distressed real estate and debt: non-tax issues Appendix - US tax rules for outbound investment

Overview : 

Overview For some (?) reason, investment in US real estate has ebbed OK, OK - so, the US made a botch of the real estate market US investors are looking for other opportunities, including Australia AU$ has fallen against the US$ from nearly $0.98 in July 2008 to about $0.66 today Less competition from local players

US investment in Australian real estate:tax issues and strategies : 

US investment in Australian real estate:tax issues and strategies

Goals : 

Goals US investors (both taxable and tax-exempt) want to minimize foreign taxes US taxable investors are subject to various foreign tax credit limitations US tax-exempt investors often cannot claim credit for foreign tax credits Interest payments subject to low withholding taxes can reduce high-taxed business income Treaties often reduce withholding taxes on interest (as well as dividends) The US has a comprehensive income tax treaty with Australia Also, want to avoid filing foreign tax returns where possible

Goals : 

Goals Minimize US taxes Taxable investors do this by investing directly or through pass-through entities Flow-through of capital gains, depreciation and amortization Avoid application of anti-deferral regimes, which apply to blockers only controlled foreign corporation (CFC) passive foreign investment company (PFIC) - includes LPTs Far fewer limitations on crediting foreign taxes Tax-exempt investors do this by investing through blockers Tax-exempt investors investing directly or through pass-through entities taxed on business income unrelated to their tax-exempt purposes “unrelated business taxable income,” or UBTI Dividends and interest paid by blockers usually are tax-exempt Tradeoff – blockers may pay full income tax on their earnings (unless organized in low-tax jurisdictions or as pass-through entities under local law) Important note: state pension plans, e.g. CALPERS, take the position that they are “sovereign” investors, and not subject to tax on UBTI, so they may act more like taxable investors

Typical investment structure : 

Typical investment structure Goal of “parallel” structure is to address US tax issues for both US taxable and US tax-exempt and governmental investors Taxable US investor issues: Flow-through of losses and foreign taxes in order to obtain credit in US Avoiding anti-deferral rules (i.e., the CFC and PFIC rules) These factors must be weighed against issues such as income deferral, character differences on exit, and possible “qualified dividend” treatment for individuals US tax-exempt investor issues: Avoiding UBTI Reducing foreign taxes, since such investors generally cannot credit foreign taxes Important note: AU tax issues may require modifying this basic structure E.g., using a taxable AU company would result in 30% entity level tax Parallelfunds for other investors Parallel fund for US tax- exempt investors PoolingVehicle local assets Venture US and others Non-US Debt Debt Blocker Vehicle Parallel fund for US taxable investors

Typical AU structures - direct investment : 

Typical AU structures - direct investment US Australia Investors AU Assets MIT Managed investment trust (MIT) owns AU real estate MITs essentially are flow-through for AU tax purposes Withholding imposed on gross amount of distributions from MIT of AU source income (other than dividends, interest, or royalties) 22.5% until July 1, 2009 15% from July 1, 2009 through June 30, 2010 7.5% thereafter Note: these rates available only when paid to investor located in country that has exchange of information agreement (EOI) with AU Income from dividends/interest subject to ordinary withholding (30/10%, respectively) unless reduced by treaty US pension/retirement plans may be exempt from such withholding with a ruling from the ATO Gain on sale of MIT units not subject to CGT, unless 10% or greater holder If 10% holder, 30% AU tax and AU tax return After June 30, 2009, MIT withholding will be the final return, with non-AU investors no longer required to file an AU tax return Responsible entity

Typical AU structures - direct investment : 

Typical AU structures - direct investment US Australia State plan AU Assets MIT Absent a check the box election, we would expect an MIT to be treated as a partnership for US tax purposes However, after June 30, 2009, the final return treatment of the MIT withholding regime may cast some doubt on this conclusion Based on this, no anti-deferral regime concerns for HNW or US Co FTCs should be available With no return requirements after June 30, 2009, this is an ideal result Foundation’s blocker entity is needed to prevent UBTI; located in jurisdiction with EOI Bermuda and Isle of Man have EOI agreements with Australia Responsible entity HNW Foundation US Co Blocker entity

Typical AU structures - direct investment : 

Typical AU structures - direct investment US Australia CALPERS AU Assets MIT This example would apply for 2011 tax year MIT has $300 distributable cash before tax ($400-$100) After depreciation of $60, MIT has taxable base of $240 Withholding tax is calculated on the $240 taxable base, so 7.5% withholding tax imposed would equal $18 MIT can distribute $282 dollars (distributable cash less tax) to investors Overall tax rate on $300 is 6% If the MIT had earned any dividend or interest income, CALPERS could obtain a ruling to reduce the rate of AU withholding on such income to 0% This ruling would not apply to rental income earned on the AU assets Rulings available to pension plans and certain other T-Es Responsible entity Rent ($400) Interest ($100) Depreciation ($60) Net cash ($141) HNW Net cash ($141)

: 

US Australia Investors AU Assets MIT Use of debt can convert distributions subject to MIT withholding to interest subject to ordinary AU withholding After June 30, 2010, when MIT withholding rate is lowered to 7.5%, use of debt does not make sense for any US investor other than tax-exempt plan that obtains ATO ruling to obtain 0% withholding on interest Rate of withholding on interest paid from Australia is 10% to US investors Tax-exempt US investors who get a ruling for 0% withholding on interest still should want to gear the structure AU tax issues thin capitalization rules if the MIT is foreign-controlled, 3:1 debt-equity ratio, including 3rd party debt transfer pricing use of participating debt may raise some issues Responsible entity debt Typical AU structures - debt and equity

: 

US Australia Investors AU Assets MIT Use of unit trust makes sense for an existing MIT where debt cannot be put on Debt to unit trust potentially converts distributions to interest, thereby reducing withholding tax Unit trust must lodge AU returns, although these are fairly simple returns Capital gains on exit still exempt from CGT where investor owns less than 10% of unit trust Where the unit trust sells MIT units, gains would be subject to the MIT withholding regime Where the unit trust is closely held, gain on sale of units subject to 30% AU CGT and AU tax return required Treatment of the unit trust would need to be examined in order to determine whether US anti-deferral regimes would apply or whether a tax-exempt US investor would require an additional “blocker” AU tax issues thin capitalization rules transfer pricing use of participating debt may raise some issues Responsible entity debt Unit trust Typical AU structures - debt and equity

Typical AU structures - offshore entity : 

Typical AU structures - offshore entity US Australia Investors AU Assets MIT Same tax results as for direct investment should obtain, provided interposed entity is in a jurisdiction that has an EOI agreement with AU Important - there is no need to determine residency of recipient or whether the recipient is acting as an agent for foreign resident Benefits of this structure, however, largely undone by the new MIT withholding regime Prior to the new MIT withholding regime, the interposed entity would have filed an AU tax return in order to avail itself of its share of the MIT’s deductions, in order to reclaim a portion of amounts withheld Now, since the MIT withholding is the final return, it makes more sense for investors to simply invest in the MIT directly Of course, non-sovereign tax-exempt US investors will still require a blocker entity to avoid UBTI Interposed entity Responsible entity debt

Typical AU structures - property linked note : 

Typical AU structures - property linked note US Australia Investors AU Assets MIT PLN provides a return economically equivalent (in cash terms) to an investment in one or more MIT assets - similar to a swap Unit linked note - provides return equivalent to that of an investment in units of MIT; issued by unitholder, not MIT PLN terms: Interest equal to the total annual cash distribution on an equivalent investment in MIT units Term generally less than 10 years PLN redeemed for cash in an amount equal to the value of the relevant interest in the MIT Redemption premium treated as interest for w/h tax Voting rights generally PLN likely equity for US tax purposes Interest subject to 10% withholding; may not make sense vis-à-vis direct investment in MIT (other than for certain tax-exempt entities) New regime for taxing financial arrangements should make clear that MIT gets deduction for interest Australian stamp duty and CGT benefits, since PLN does not crystallize a gain for the legal owner of units or property Responsible entity PLN interest Unitholders Investors PLN interest

Privatizing LPTs : 

Privatizing LPTs US REIT Investors JV MPR ProLogis Investors Cash Units of MPR In MPR, ProLogis acquired units of MPR with intention to liquidate (to own US REIT directly) While sale by MPR unitholders in itself not subject to US tax, liquidation would have subjected MPR to tax on all of the inherent gain in its shares of US REIT MPR made an election to be treated as a US corporation for FIRPTA purposes only (Section 897(i)) Many requirements Toll charge payable In current environment, were there little or no gain on the shares of the US REIT, MPR would not have needed to make this election (if the tax due would be lower than the toll charge noted above) Assets

Exiting and restructuring investments in US real estate : 

Exiting and restructuring investments in US real estate

Selling US investments : 

Selling US investments Gain on sale of interests in foreign entity treated as a corporation for US tax purposes not subject to FIRPTA inherent tax in underlying US assets remains Gain on sale of interests in US entities (REIT, US corp, partnership) subject to tax in the US under FIRPTA current valuations may not generate as much taxable gain avoid FIRPTA withholding by providing certificate attesting to no tax due AU tax issues CGT discount Flow-through vehicles US REIT Investors LPT Assets Australia US Sale of LPT interests: no FIRPTA Sale of US REIT or blocker: FIRPTA, unless (in the REIT case) the REIT is domestically controlled Sale of Fund interests: FIRPTA, unless fund is non-US and elects corporate status for US tax purposes US REIT/blocker Investors Assets Investors Assets Fund

Creating domestic control : 

Creating domestic control Domestic control No FIRPTA tax on sale by non-US persons of shares in a domestically controlled REIT, which is a REIT in which at all times during the testing period less than 50% in value of the stock of the REIT was held directly or indirectly by foreign persons. The testing period is the shorter of (i) the five year period ending on the date of disposition or (ii) the period during which the REIT was in existence Waiting five years after proposed structure implemented to sell interests in the REIT would avoid FIRPTA FIRPTA not as large a concern in current market REIT Australia US Assets US investors >50% LPT Current structure REIT Assets LPT Proposed structure

: 

Advantages Once assets are sold, blocker can be liquidated, and retained earnings may be distributed without U.S. withholding tax Obviously, easier in case of single-asset blocker Investor need not file a U.S. tax return No branch profits tax Branch profits tax puts a non-US investor investing directly in the US as a non-US investor investing through a US subsidiary that would pay withholding tax on distributions Investor pays this tax in connection with its US tax return Disadvantages Up to 35% tax on Blocker income (including gain on sale of assets) Any dividend distributions made before liquidation of blocker reduce the benefit of the cleansing rule US Blocker Australia US Asset(s) AU investor Buyer cash liquidating distribution Cleansing Rule

Liquidating a REIT : 

Liquidating a REIT Evaluate prior investment strategies to see if they make sense today In the past, an LPT would not consider liquidating a REIT, as it would pay tax in the United States directly on built-in gains when assets were sold In the current environment, however, even once unthinkable options may be viable If the REIT had net operating losses (NOLs), the LPT inherits the NOLs and can use them to offset gains recognized on dispositions of US assets formerly held by the REIT The LPT can also use any losses generated in the future to offset other US income Of course, the LPT would (if it is not already doing so) be required to file US tax returns in the future REIT Australia US Asset(s) LPT liquidating distribution Step one Step two Asset(s) LPT

Monetizing investments : 

Monetizing investments Australia US A properly structured total return swap could monetize an AU investor’s investment Whether such a swap would trigger FIRPTA would depend on whether ownership for tax purposes is treated as transferred Facts and circumstances test, with little authority Furthermore, the market for such instruments is not robust, with the result that pricing is difficult US Asset AU investor all economics from asset FMV of asset Counterparty

Investments in US debt : 

Investments in US debt

Unrelated party purchases debt : 

Unrelated party purchases debt No tax consequences to the REIT Buyer has market discount of $150M changes character of amounts received at maturity (or on gain from sale) to ordinary income to extent of market discount can make election to accrue market discount over time REIT Australia US Asset(s) LPT Lender(s) $1B debt Buyer $350M $500M face of debt

Related party purchases debt : 

Related party purchases debt Where debt is acquired by person related to the issuer from an unrelated person at discount: Acquisition discount = cancellation of debt income (CODI) to issuer which is taxable Treated as new debt being issued with issue price equal to purchase price of debt, resulting in original issue discount (OID) Deductions of OID for issuer, phantom income for buyer Additional deductions may be limited, though, under earnings stripping rules or HYDO rules Key question - what is related? In this case, easy, while in others, complex attribution rules may surprise you Becoming related later on also may trigger CODI CODI not relevant for 75% and 95% income tests (a good thing), but would increase taxable income, although it would not materially increase required REIT distribution Where a REIT buys debt, issues are (i) whether the debt is a qualifying REIT asset and the interest income qualifies under the 75% and 95% income tests, and (ii) how the debt affects the REIT’s required distribution REIT Australia US Asset(s) LPT Lender(s) $1B debt $350M $500M face of debt

Related party purchases debt : 

Related party purchases debt REIT Australia US Asset(s) Lender(s) $1B debt $350M $500M face of debt Fund Debt Fund Non-overlapping partners Non-overlapping partners Overlapping partners Actual common ownership of REIT and debt fund <50% But, if one or more of the overlapping partners is an individual, the partner would be treated as owning any stock of the REIT owned by any partner of the individual An individual overlapping partner would treated as constructively owing 100% of the REIT owned by the fund As a result, the overlapping partners would own 55% of the debt fund and would be treated as constructively owning 100% of the REIT Purchase of the debt by the debt fund would result in CODI Structures are available to avoid this (e.g., using a tax haven company) and portfolio interest rules Law may change soon on this point 70% 30% 55% 45%

Debt exchanges : 

Debt exchanges Debt exchanges can also give rise to CODI CODI on equity-for-debt exchange equal to excess of issue price of exchanged debt over FMV of debtor equity received in exchange If the receipt of equity in the equity-for-debt-exchange triggers “ownership change” (50% shift in ownership) of the debtor, the rules of section 382 would apply to limit the debtor’s ability to utilize existing NOLs and built-in losses Exchange of new debt for old debt also may trigger CODI Upon an exchange of old debt for new debt with “significantly modified” terms, the old debt is treated as satisfied for amount equal to “issue price” of the new debt CODI results where the issue price of the new debt is less than the outstanding amount of the old debt Important note: a “significant modification” of the terms of a debt instrument treated as a deemed exchange for tax purposes which could result in CODI

Debt exchange issues : 

Debt exchange issues A “significant modification” of a debt instrument includes: Increase in the interest rate on a debt instrument greater than a de minimis safe harbor Payment of a fee to a lender to cure a covenant default or obtain a waiver or consent is treated as an increase in the interest rate Extension of the term of a debt instrument beyond safe harbor levels Issue price - extremely complex If neither old debt nor new debt are treated as “market traded,” “issue price” equals the principal amount of the new debt, unless interest rate less than applicable federal rate (“AFR”) If either old debt or new debt are treated as “market traded,” issue price of new debt generally equals the FMV of the new debt at the time of the exchange No guidance on what market traded means

Debt exchange - example : 

Debt exchange - example Solvent debtor in technical default on $1B facility, and needs to restructure its debt Lender will agree to covenant waiver/amendment only if Debtor pays for the waiver/amendment by agreeing to a higher rate of interest Debtor’s debt currently trades at 60 cents on the dollar. If the new debt is not publicly traded, debtor treated as satisfying old debt with new debt having an issue price of $1B, thus no CODI If the new debt is publicly traded, debtor treated as satisfying old debt with new debt having an issue price of $600 million (its FMV) Debtor realizes $400 million of CODI, and lenders realize $400 million loss (which is most likely deferred) New debt instrument has $400 million of OID OID income for lenders and OID deductions for debtor, but these may be limited An incredible result, especially since the debtor owes exactly the same amount after the modification as it did before (indeed, at a higher rate of interest!!) Important note - the tax law, not the tax lawyer, is to blame

Debt funds : 

Debt funds A foreign person is subject to net US income tax on income “effectively connected” with a US trade or business (“ECI”) conducted by the foreign person Foreign corp also subject to US branch profits tax A foreign partner of a partnership engaged in a US trade or business is treated as directly engaged in that business Foreign partner taxed on its allocable share of ECI from partnership Under trading safe harbor, trading in stock or securities for taxpayer’s own account does not give rise to ECI, even if all of the activities take place in US The trading safe harbor does not apply to “banking, financing, or similar” business (“financing business”) Financing business deemed to be conducted where loan origination is regular and continuous No bright line rules; little direct authority in this area

Debt funds - ECI and its implications : 

Debt funds - ECI and its implications For mezz/CDO funds, factors indicating conduct of financing business include: Extensive participation in loan origination activities (especially negotiating terms) Receipt of commitment, letter of credit, guarantee, or similar fees Reselling, subdividing, or packaging loans No equity participation For distressed debt funds, there is also a risk DIP financing and active participation in workouts could be viewed as a US trade or business If fund requires legal opinion that activities “will” not generate ECI (e.g., CDO funds), fund document contains strict prohibitions on financing activities (e.g., negotiation of terms, receipt of commitment fees, etc.) If fund investment strategy necessitates negotiation of debt terms (e.g., mezz funds or distressed debt), rely on position that fund is engaged in “investment” activities rather than “financing” activities

Debt funds - structuring : 

Debt funds - structuring Three primary structures Guidelines to restrict debt fund’s investments to those that should qualify for the trading safe harbor Limit ability of the fund to negotiate loan terms, receive origination fees, and purchase before “seasoning” period is over, etc. Two fund vehicles to separate the investments into those that do (and do not) qualify for the safe harbor ECI risk in non-qualifying fund investments does not “taint” income of qualifying funds investments Parallel funds where US fund buys the debt, and later sells the debt to the non-US fund Goal is to make the non-US fund look like a trader and not an originator, sale terms create economic issues for fund constituents

Distressed real estate and debt:non-tax issues : 

Distressed real estate and debt:non-tax issues

CMBS market collapse and projected maturities : 

U.S. CMBS Issuance and Volume 1997-2008 $Bn Projected CMBS Maturities2008-2012$Bn US CMBS Issuance Source: Morgan Stanley; Real Capital Analytics data through October 2008, Morgan Stanley calculations, Thomson One Source: Moody's Structured Finance research dated 25 February 2008; based on initial maturity dates, Trepp CMBS CMBS market collapse and projected maturities

CMBS structure and parties : 

CMBS structure and parties Borrower Lender / Originator Depositor Trust (REMIC) Master Servicer Special Servicer Certificateholders Proceeds Certificates Trustee Proceeds Loans Proceeds Loans Proceeds Loans Pooling and Servicing Agreement

Pooled loans held by REMIC trust : 

Pooled loans held by REMIC trust REMIC - real estate mortgage investment conduit Not subject to US income tax so long as investment criteria are satisfied At inception and during life of REMIC, asset pool must constitute either: “Permitted Investments” Cash flow Reserves Foreclosure property “Qualified Mortgages” Loan to Value Ratio of 80% or less Transferred to REMIC on first day securities are issued Significant modification can be treated as impermissible exchange Exception for modifications occasioned by a default

Master servicer : 

Master servicer Duties Day-to-day administration of performing loans Make advances of delinquent payments, subject to recoverability standard Inspect mortgaged properties Ensure insurance coverage is maintained Servicing Standard Same care, skill, prudence and diligence as if servicing its own loans Customary and usual standards of practice of prudent commercial lenders Maximize net present value of mortgage loans Disregard conflicts of interest May Not Materially Amend Loan Agreements May only modify to cure ambiguities or mistakes Until Servicing Transfer Event, borrowers have little ability to work with servicers on required modifications

Servicing transfer event : 

Servicing responsibility transferred from Master Servicer to Special Servicer as a result of: Failure to make balloon payment at maturity Failure to make monthly debt service payment and not cured within 60 days Occurrence of a non-monetary default which materially and adversely affects the Certificateholders Bankruptcy event involving the borrower Master Servicer determination that a payment default is imminent and is unlikely to be cured within 60 days Borrower may need to cause a Servicing Transfer Event in order to discuss needed modifications with Special Servicer Servicing transfer event

Special servicer : 

Special servicer Limited flexibility to modify terms of loan, only if A default has occurred or is reasonably foreseeable Modification will increase on net present value basis the recovery to Certificateholders Compare to recovery available from foreclosure and resale Modification will not endanger REMIC status Potential tax liability tied to modification – foreclosure is safe option Potential Conflicts of Interest Required to disregard conflicts under servicing standard Restructuring or liquidation fees Recovery of servicing advances Positions held in junior, first-loss tranches Potential removal by first-loss directing class

Special purpose, bankruptcy remote entities : 

Special purpose, bankruptcy remote entities Designed to prevent Borrower from becoming entangled in affiliates’ bankruptcy and to make it difficult for Borrower to file under Chapter 11 “Special Purpose” is limited to owning and managing the mortgaged property, borrowing the loan, performing obligations of loan, and activities incidental thereto Borrower must be a newly-formed entity to insulate collateral from pre-existing liabilities Borrower may not incur additional debt or create liens on collateral Borrower must not become a guarantor or surety for the debts of others Non-consolidation opinion - borrower must deliver opinion that an affiliate’s filing will not cause the substantive consolidation of Borrower’s assets with any parent or affiliate entities

Separateness covenants : 

Separateness covenants Purpose: to reduce the risk that the bankruptcy remote structure is defeated by substantive consolidation The borrower must: maintain its own separate accounts, books, records, resolutions, and agreements and file its own separate tax returns pay its own liabilities and expenses, including the salaries of its own employees, out of its own funds and assets hold its assets in its own name and not commingle its funds correct any known misunderstandings regarding its separate identity

Independent directors : 

To qualify, an independent director must not: have a direct or indirect legal or beneficial interest in the borrower or any of its related entities, be a substantial creditor, customer, supplier, employee, or other person that derives any of its purchaser or revenues from the borrower or related entities, be a member of the immediate family of any member, manager, creditor, customer, supplier, employee or other person that derives any of its purchases or revenues from the borrower or its related entities, or be a person or entity controlling or under common control of any of the above Fiduciary duties of care and loyalty Solvent - owe duty to company and its shareholders only Insolvent - owe duty to shareholders & creditors “Zone of insolvency” - company is at risk of becoming insolvent Traditionally, duty shifted to shareholders & creditors Recent Delaware case law suggests that duty should remain to company and its shareholders only, with no duty to creditors until actual insolvency LLC members may contractually alter fiduciary duties and impose duty to creditors on Independent Directors when deciding to file for bankruptcy Independent directors

Single asset real estate bankruptcy : 

Intended to prevent bankruptcy filing as delay tactic where owner of single asset has no viable ability to restructure Closely related to CMBS SPE requirements $4 million cap removed by U.S. Congress in 2005 SARE Criteria: Single property or project Substantially all of a debtor’s gross income No substantial business other than operation of the property or activities incidental thereto Special Protection for Secured Creditors: Relief from automatic stay after the 90th day of the debtor’s bankruptcy case unless debtor either files a plan of reorganization with a reasonable chance of confirmation, or makes monthly payments at the non-default contract rate of interest Single asset real estate bankruptcy

Non-recourse carve out liability : 

Non-recourse carve out liability CMBS loans are typically non-recourse to the borrower and its members, except for specified “carveouts” Absent “bad boy” acts, lender’s remedy for default limited to foreclosure of real property Borrower and any guarantor may be liable for actual damages arising from fraud willful misconduct intentional misrepresentation misapplication of rents or insurance proceeds waste Full recourse to borrower and guarantor for certain bankruptcy events or prohibited transfer by the borrower

Automatic stay restrictions : 

Automatic stay operates to prohibit interference with property of the debtor. May Preclude Non-Debtor Partners or LLC Members from Removing General Partners or Other Members Partnership interests and LLC interests, including contractual rights to manage the limited partnership or LLC, are generally considered property of the estate. Accordingly, the automatic stay would likely prohibit a non-debtor partner or member from declaring a default under the applicable partnership or LLC agreement and exercising default remedies thereunder, including removal of the general partner or other member. Automatic stay restrictions

Limited partnerships and LLC’s : 

Limited partnerships and LLC’s Effect of Bankruptcy Filing Under Delaware law governing limited partnerships and LLC’s, unless otherwise modified by the partnership agreement, a person or entity ceases to have management rights upon a voluntary bankruptcy filing and such party shall only have an economic interest in the entity. Limited partnership agreements or LLC agreements may also provide for similar remedies when a partner or member files for bankruptcy.

Section 365(e) of Bankruptcy Code : 

May Prevent Involuntary Dissociation of General Partner or Member Ipso facto provisions - clauses that purport to alter a person or entity’s rights because of that party’s insolvency or bankruptcy - are generally unenforceable in a chapter 11 filing pursuant to section 365(e) of the Bankruptcy Code. Application of section 365 of the Bankruptcy Code requires a determination that the applicable limited partnership agreement or LLC agreement is executory (i.e., both parties to the agreement have material unperformed duties). There is limited case law on limited partnerships and LLC’s. With respect to limited partnership and LLC agreements, some courts have found such agreements to be executory contracts, while other have not. The determination is fact specific. Section 365(e) of Bankruptcy Code

Section 365(e) of Bankruptcy Code : 

To the extent that a particular partnership or LLC agreement is determined to be executory, courts have found that section 365(e) of the Bankruptcy Code may be used to invalidate ipso-facto provisions related to dissociation of the general partner or member upon a bankruptcy filing, making such provisions unenforceable. However, certain other courts have held that partnership interests, regardless of whether the agreements related thereto are executory, are not protected by the prohibition against enforcement of ipso-facto provisions under the Bankruptcy Code because such agreements cannot be assumed under section 365(c) of the Bankruptcy Code without the consent of the other party and therefore application of section 365(e) is prohibited. Section 365(e) of Bankruptcy Code

Section 365(e) of Bankruptcy Code : 

In addition, some courts have found that ipso-facto provisions in state law (including limited liability partnership law) that act to dissolve a partnership upon a bankruptcy filing conflict with, among other things, section 365(e) of the Bankruptcy Code, and are thus unenforceable. In conclusion, case law is unsettled in this area. Section 365(e) of Bankruptcy Code

“363” sales : 

“363” sales Under Section 363(b), a debtor’s ability to “use, sell, or lease” property requires approval of the bankruptcy court. Sales conducted under section 363 can provide a purchaser with exceptionally clean title. Hence, the disposition of a debtor’s assets, including real property, are typically referred to as “363 Sales.” Bankruptcy courts will generally defer to a debtor’s business judgment in approving a sale. However, bankruptcy courts will typically require an auction process to maximize value. The contours of different 363 Sale processes may significantly affect value for both the debtor and potential bidders. Retention of experienced bankruptcy counsel and financial advisors may be a practical necessity.

Strategic consideration in 363 sales : 

Strategic consideration in 363 sales Debtors will typically set minimum bids through an agreement for the sale of one or all assets to a “Stalking Horse” bidder. Conversely, the Stalking Horse bidder will need to protect its downside risk in the event a higher bidder emerges. A Stalking Horse bidder may protect itself through a breakup fee. The breakup fee incentivizes the Stalking Horse to conduct due diligence and submit the highest possible bid. Breakup fees are typically up to 3 percent of the ultimate sale price. An interested buyer may also act as a “plan sponsor,” subsidizing a plan for control of the debtor, or its assets, on a reorganized basis.

363 auction sale : 

363 auction sale Notice of auction should be given to all secured creditors. Debtor given broad discretion in setting bidding procedures and sales of assets individually or as a group. Debtor reviews bids at auction to determine highest and best offer. Sale Order - after auction, court must approve results of auction by issuing sale order. Section 363(f) generally allows sale free and clear of any liens, etc. All liens attach to the sale proceeds in same priority. Buyer want finding that it is a good faith purchaser. Waiver of 10-day appeal period.

Appendix:In-depth description of US outbound rules : 

Appendix:In-depth description of US outbound rules

US investors - direct investment : 

US investors - direct investment US taxpayers are taxed on their worldwide income Foreign source income taxed identically to US source Consider effect on foreign tax credits US taxpayers who directly conduct business in foreign countries are usually eligible for a foreign tax credit (FTC) for foreign income taxes paid in the foreign country This includes investments owned through entities treated as pass-through for US tax purposes Jurisdiction where pass-through entity is organized is irrelevant Losses and deductions generally flow through as well US Investor B US Investor A Local Assets Pass Through Entity Income + taxes Income + taxes US Australia US Investor C Income + taxes Pass Through Entity All US investors taxed identically on income generated by foreign assets

Use of “blocker” : 

Use of “blocker” As noted earlier, a blocker is an entity taxed as a corporation for US tax purposes that shields the investor from being treated as the taxpayer for US income tax purposes Investor receives only dividend income (or interest, if blocker funded with debt) If blocker organized in US, income taxed at maximum rate of 35%, plus applicable state taxes, If blocker organized outside US, no US tax on blocker’s income Income taxed on repatriation, or under anti-deferral regimes Foreign tax credits - US corporations owning 10% or more of the foreign corporation can obtain an indirect credit for foreign taxes paid by the foreign corporation Entity classification – making a blocker Most business entities are treated as partnerships or corporations for tax purposes Except for those entities that are always treated as corporations (the “per se” list of corporations), the treatment of foreign entities as partnerships or corporations is at the election of the taxpayer Australian public limited companies are “per se” corporations Investor B Investor A Assets Blocker Pass Through Entity As noted earlier, income “passes through” to investor, which results in a direct return filing obligation Income Income

US investors - passive income : 

US investors - passive income Both US anti-deferral regimes (CFC and PFIC) tax US investors currently on passive income earned by foreign corporations What is passive income for this purpose? Includes dividends, interest and rents and gain from sale of assets that produce such income Important Exception: rents derived in an active business In order to be an active business, activities must be conducted by the foreign corporation’s own officers and employees This issue arises for US investors in US and non-US funds that invest in foreign real estate and infrastructure

US investors - passive income : 

US investors - passive income Active trade or business - foreign corporation’s own officers or staff or employees must regularly perform active and substantial management and operational functions Related person activities do not count Independent contractor activities do not count, unless corporation’s own activities rise to the level described above, without regard to the IC activities Where the corporation owns property through a partnership, only the activities of the partnership, not the separate activities of the foreign corporation, count Fund Non-US Corporation Property Non-US Operator Management Agreement Investors Lessees Fund Non-US Corporation Property Investors JV Other Investors Management Agreement Fund Non-US Corporation Property Independent Operator Investors Management Agreement All examples of rents that would be treated as passive Rents Rents Rents

US investors - passive income : 

US investors - passive income Gains from sales of dealer property not passive income Dealer property is stock in trade or inventory (if on hand), or property held for sale in the ordinary course Inherently factual determination Number, frequency, and continuity of sales Purpose for acquisition and reason property is held Length of ownership Development activities Efforts to sell property For passive income determination, property may be dealer property if it is not held for investment or speculation, and the foreign corporation regularly and actively offers to, and in fact does, enter into transactions with customers that are unrelated in the ordinary course Pure development projects usually OK No “own officers or employees” requirement for sales If otherwise dealer property generates rental income in advance of sale, passive asset treatment may attach (for PFIC purposes)

US investors – subpart F/CFC regime : 

US investors – subpart F/CFC regime A CFC is any foreign corporation if US persons own (directly, indirectly, or constructively) more than 50% of the corporation’s stock (by vote or value), but taking into account only US persons owning 10% or more of such stock (measured by vote only) In a diverse fund, risk of CFC treatment is low, given the ownership thresholds involved Of course, as demonstrated in the middle scenario, a US fund vehicle (even where the fund is diverse) can lead to CFC treatment Nevertheless, the foreign corporation may still be treated as a PFIC (see the discussion below) Single US investor US Australia Fund Corporation Assets ≥50% Single US investor Fund Corporation Assets ≥50% 1% Non-US investors 99% Corporation is a CFC Corporation is a CFC Single US investor Fund Corporation Assets 1% Non-US investors 99% Corporation is NOT a CFC

US investors - subpart F/CFC regime : 

US investors - subpart F/CFC regime US person owning 10% or more of a CFC taxed on its pro rata share of certain income earned by CFC (so-called “subpart F income”), regardless of whether such income is distributed Subpart F income generally will be passive income (as described above) In effect, US 10% shareholders treated as receiving deemed distribution from CFC CFC planning No earnings and profits – subpart F income “pickup” limited to current E&P Recapture may be required in later years if E&P is generated High tax exemption – no pickup if CFC’s subpart F income subject to at least 90% of US tax rate (i.e., at least 31.5% tax) Since AU rate is 30%, this exemption would not apply De minimis exemption – no pickup if subpart F income less than $1M or 5% of CFC’s gross income Check the box elections – treat certain entities as pass-through entities to blend income and losses from entities May not be desirable for tax-exempt investors, if it gives rise to UBTI Sale of stock in a CFC usually requires pickup of subpart F income not previously included in income as a dividend (i.e. ordinary treatment instead of capital gain treatment, subject to qualified dividend rules for individual investors)

US investors - PFIC : 

US investors - PFIC A passive foreign investment company (“PFIC”) is any foreign corporation if either: 75% or more of its gross Income is passive income 50% or More of its assets are passive assets That is, they produce or held for the production of passive income Based on average percentage of assets, based on each quarter of taxable year Generally – based on FMV If the corporation is not publicly traded, is a CFC, or makes an election, adjusted basis of assets may be used Look through rules apply for making these determinations Foreign corporation treated as owning proportionate share of assets/income of 25% or greater owned subsidiary Foreign corporation treated as owning proportionate share of assets/income held through a partnership Dividends/interest/rents received from related parties not treated as passive, to the extent attributable to non-passive activities of related person Trap for unwary – rules could easily apply to companies that recently raised significant capital, company with depressed stock price (negative goodwill can cause company to fail asset test), and start-up companies that are PFICs beyond their first taxable year

PFIC – Keeping US tax books : 

PFIC – Keeping US tax books Many questions about this in the past year from US investors This issue only affects LPTs with US investors PFIC (passive foreign investment company): a foreign corporation if either (i) ≥75% of gross income for the taxable year is passive income (such as dividends, interest, rents) or (ii ) ≥50% of the value of its assets produce passive income PFIC rules are an issue for US investors regardless of the level of US ownership Without a QEF election, a US shareholder of a PFIC that receives an “excess distribution” from the PFIC or transfers its PFIC stock pays US tax at the top ordinary income tax rate (not capital gains rate), plus an interest charge to reflect the value of deferral With a QEF election, a US shareholder includes in income a pro rata share of the PFIC’s earnings (whether or not distributed) The foreign corporation, in turn, must agree to provide information regarding its earnings, calculated under US income tax principles Keeping a separate set of books for a foreign corporation under US income tax principles will be expensive and difficult in any event It may be possible to seek a regulatory change or a ruling to obtain relief from this requirement, thereby allowing US investors to make a QEF election more easily

US investors - PFIC : 

US investors - PFIC Subsidiary look through example Because each Australian company owns >25% of stock in Holdco, the AusCos may look through to Target’s trade or business activities If exit is an IPO of Holdco, each AusCo’s ownership in Holdco could fall below 25%, thereby causing each AusCo to be treated as a PFIC, as their only asset would be stock in Holdco insufficient to permit look-through A check the box election on AusCo would allow test to be done (more favorably) at Holdco/Target level Of course, this example does not take into account the potential downsides of using Australia-domiciled companies Investors US Australia Non-US Fund AusCo Non-US Fund AusCo Investors US investors Fund AusCo 34% Holdco Target 33% 33%

US investors - PFIC : 

US investors - PFIC Absent a “QEF election” or “mark to market election,” US persons who beneficially own shares in a PFIC are subject to a severe tax regime The PFIC rules apply potentially to any US person that owns shares in a foreign entity treated as a corporation for US income tax purposes Attribution rules apply for this purpose Tax-exempt investors should be indifferent, provided their investment in the foreign entity is not debt financed LPTs generally would be treated as PFICs PFIC status can be avoided in a number of ways Electing to be treated as a partnership or disregarded entities May not be desirable for tax-exempt investors Being a CFC – PFIC rules not applicable to 10% US shareholders of a CFC Structuring activities to qualify activities as “active,” perhaps by using officers and employees

US investors - PFIC : 

US investors - PFIC The “severe” tax regime Gain on the sale of stock in a PFIC or the receipt of an “excess distribution” (a distribution in excess of 125% of the average distribution over the prior three years) is treated as earned ratably over the shareholder’s entire holding period in the stock The gain or excess distribution allocable to any year is taxed at the highest rate for that year Interest is due on the amount of tax that would have been due on the income allocated to the earlier period as if it had been earned in that year The rate of interest is the short-term federal rate plus 3.0% Interest begins accruing from the due date of the return for the relevant year Example Assume a US investor purchased PFIC stock (such as an LPT) on 1/1/2008 for $100 and sold the stock on 12/31/2012 for $600. Assuming the interest rate is 7%, the $500 in gain would be taxed as follows: Year Gain allocated Tax (35%) Interest due 2008 $100 $35 4 years of 7% on $35, or $9.80 2009 $100 $35 3 years of 7% on $35, or $7.35 2010 $100 $35 2 years of 7% on $35, or $4.90 2011 $100 $35 1 year of 7% on $35, or $2.45 2012 $100 $35 none Total $500 $175 $24.50 Total tax/interest - $199.50

US investors - avoiding PFIC regime : 

US investors - avoiding PFIC regime The “severe” PFIC tax regime can be avoided through the use of either a “qualified electing fund” election (“QEF election”) or a “mark to market” election (“MTM election”) By making a QEF election, the US shareholder elects to be taxed currently on profits of the foreign corporation (income, but not losses, flow through) Amount included would be shareholder’s pro rata share of income and net capital gain, whether or not distributed Investor, not the corporation, makes the election by filing Form 8621 with the IRS US partnership holding shares could make election for all US investors Corporation must provide statement to investor showing its share of income and gains (or other information that would permit the investor to calculate these amounts), and must be calculated using US income tax principles International GAAP or IFRS not acceptable By making a MTM election, the investor includes as ordinary income in each taxable year the excess of the FMV of the PFIC stock over adjusted basis May deduct losses to the extent of prior MTM inclusions Election made on Form 8621 Applies only to PFICs that are traded on certain US and foreign stock exchanges

US investors - UBTI : 

US investors - UBTI UBTI is “unrelated business taxable income,” or gross income earned by an otherwise tax-exempt entity from a trade or business not substantially related to the tax-exempt entity’s exempt purpose Tax-exempt entities may receive passive-type income free of tax, but not UBTI. Earning UBTI generally does not affect the tax-exempt status of most tax-exempt entities. Instead, earning UBTI will require a tax-exempt investor to file a US federal income tax return and pay tax on the UBTI (maximum rate of 35%) UBTI recognized by a pass-through entity is allocated to the tax-exempt investors and retains its character as UBTI in the hands of the tax-exempt investor. Pass-through entities also must report UBTI to its partners or members. A tax-exempt entity generally is ineligible for the foreign tax credit. However, a credit may be taken for foreign taxes imposed on UBTI. A tax-exempt corporation may claim both direct and indirect foreign tax credits, but only the direct credit may be taken by tax-exempt trusts.

US investors - UBTI : 

US investors - UBTI UBTI does not include many types of passive investment income : Dividends Interest Rents from real property (with certain exceptions) Gains or losses from sale of property (other than dealer property) Passive investment income can be treated as UBTI if the property generating the income is debt-financed (e.g., borrowing to buy LPT stock) This includes any income received by the tax-exempt investor to the extent such income is attributable to debt incurred by a fund in which a tax-exempt entity invests to acquire or improve the property However, certain debt incurred to acquire real property may not cause a tax-exempt investor to incur UBTI UBTI rules apply equally to foreign income as to US income CFC and PFIC rules generally do not affect tax exempts Foreign tax credit regime only useful if used to reduce taxes on UBTI

US investors – use of blocker to avoid UBTI : 

US investors – use of blocker to avoid UBTI Taxation of a blocker Blocker shields the tax-exempt investor from being treated as the taxpayer for US income tax purposes – no UBTI for the tax-exempt investor Blocker can either be below fund vehicle or tax-exempt entity can establish its own blocker entity Interest received from a controlled blocker (i.e., more than a 50% ownership) will be UBTI to the extent the payment reduces the net income of the blocker (or increases an NOL) Investment in blocker cannot be debt financed As noted earlier, a state pension plan (i.e., a quasi-US “sovereign” plan) may invest through the pass-through entity in any event Tax-exempt Investor B Tax-exempt Investor A RE/infrastructure Investments Blocker Pass Through Entity As noted earlier, income “passes through” to investor, which results in a direct return filing obligation Income Income US Non-US

US investors - review : 

US investors - review Taxable US investors avoid CFC/PFIC rules by investing in pass-through (i.e., non-corporate) entity Able to use losses Able to credit foreign taxes paid by venture with greater ease Debt not necessary from taxable US investor Tax-exempt investors invest in blocker, thereby avoiding UBTI Debt reduces tax at blocker level (for which tax-exempt investor would not have received any credit) Ideally, interest subject to little or no withholding tax (again, since tax-exempt investor would not get credit) Parallelfunds for other investors Parallel fund for US tax- exempt investors PoolingVehicle local assets Venture US and others Australia Debt Debt Blocker Vehicle Parallel fund for US taxable investors and US “sovereigns”