Reproduced with permission from World Securities

Law Report, World Securities Law Report Vol. 18 No.

8, 08/10/2012. Copyright 2012 by The Bureau of Na-
tional Affairs, Inc. (800-372-1033) http://www.bna.com
Delaware As A Location For Private Funds:
The Why And The What
By Robert Schwartz, of Allen & Overy LLP, London.
Introduction
Although people speak of U.S. funds, this general
term acts solely as a genus, with individual species to be
found only at the level of a U.S. state. Individual states
create almost all U.S. corporate and partnership law,
and U.S.-based or U.S.-oriented fund sponsors can
therefore pick which states corporate (or partnership)
law system will govern their dealings. While in prin-
ciple this could mean that U.S. private funds are dis-
tributed widely throughout the 50 U.S. states, Dela-
ware, for the reasons explored here, serves as domicile
to the vast bulk of large U.S.-based private funds, and,
as a result, will be the focus of this Special Report.
In choosing an appropriate entity as a fund vehicle, a
sponsor must consider a range of legal, regulatory and
tax issues in relation to both the entity itself and the
proposed investor base. This Special Report will pro-
vide a brief overview of some of the key features of the
Delaware limited partnership and the Delaware limited
liability company (LLC), two vehicles frequently used
for both private equity and hedge funds established in
the United States. The limited partnership and the
LLC exhibit strong parallels, not least in the contrac-
tual exibility afforded to fund owners and managers
to structure legal and economic relationships.
This Special Report aims to:
s explain why Delaware exerts such pull as a location
for private investment funds within the United
States, assessing available data to understand
whether the private equity and hedge fund indus-
tries differ in their attraction to Delaware;
s briey introduce the Delaware limited partnership
and the Delaware LLC;
s compare the key differences between the Delaware
limited partnership and the Delaware LLC; and
s give a brief overview of the consequences under
U.S. federal law of choosing Delaware as a private
fund jurisdiction.
Why Delaware?
Entrenched Advantages
Businesses in the United States have sought to incorpo-
rate in Delaware since the early 1900s.
1
At present,
more than 50% of all U.S. public companies are incor-
BNA International Inc., a subsidiary of The Bureau of National Affairs, Inc., U.S.A.
Volume 18, Number 8 August 2012
porated in Delaware, with almost 60% of the Fortune
500 incorporated there (and this despite Delaware hav-
ing less than one-third of 1 percent of the U.S. popula-
tion).
2
Harvard law professor Lucian Bebchuk points
out that if one looks past the general gures (putting to
one side businesses that incorporate in their home states
and are not looking for a jurisdiction) to focus on those
companies that shop for out-of-state incorporation,
Delaware grabs 85% of all incorporations.
3
The situa-
tion is analogous for investment fund incorporation,
with one recent study noting that 75% of U.S.-based
hedge funds are formed in Delaware, the next-closest
states being California at 5% and New York and Florida
at 4% each.
4
The primary drivers behind this dominant position are:
1) the exibility, clarity and efciency of Delawares cor-
porate and partnership laws and the Court of Chancery;
and 2) the economics of market dominance. Both of the
primary statutory instruments that govern funds in Dela-
ware the Delaware Revised Uniform Limited Partner-
ship Act, as amended (DRULPA), and the Delaware
Limited Liability Company Act, as amended (LLCA)
expressly provide that it is their policy to give maximum
effect to the principle of freedom of contract and the
enforceability of the limited partnership agreement or
limited liability company agreement.
5
Reecting this enterprising philosophy, the Court of
Chancery explained that DRULPA allows limited part-
ners and general partners to operate their businesses as
they choose so long as their actions do not conict with
the demands of public policy.
6
This principle is embed-
ded throughout the statutes, for example, in the ability
of a partner of a limited partnership or a member or
manager of an LLC to expand, restrict or eliminate -
duciary duties by contract (with the exception of the im-
plied covenant of good faith and fair dealing, both of
which go to public policy concerns)
7
or to determine
the precise scope of any indemnication in their agree-
ments.
8
Echoing these principles for Delaware compa-
nies generally, the Delaware Court of Chancery stated in
1997 that the Delaware General Corporation Law is an
enabling statute i.e., it gives an organizations design-
ers exibility to establish management and governance
terms that suit their needs in a cost-efcient manner.
9
Adding to the ethos of exibility, Delaware allows for a
low-cost operational environment: a streamlined, inex-
pensive and simple formation processes; low annual
franchise taxes ($250);
10
generally low registered agent
fees; no requirement to le annual reports; no public
disclosure of LLC agreement or partnership agreement;
and no need to maintain and ofce or personnel in
Delaware.
In short, the Delaware approach has created a virtuous
cycle: Companies and funds incorporate there for ex-
ibility and clarity, which over time spurs the legislature
and the Court of Chancery to create a sophisticated
body of law that enshrines exibility and further en-
hances clarity, giving companies and funds ever more in-
centive to form there. Explaining the net result of this
cycle, Stanford law professor and economist Robert
Daines demonstrated in a landmark 2001 study that
rms governed by Delaware law are worth more than
businesses subject to the legal rules of other U.S. states.
Daines reected that: Delawares courts and political
economy are valuable and impossible to replicate if a
rm incorporates in another state. . . . [This is not to say
that] Delaware law is better than a hypothetical federal
code or that all of Delawares laws are optimal. . . . How-
ever, the data do suggest that Delaware law is a relatively
intangible asset and that shareholders pay more for as-
sets governed by Delaware law [as compared with the
laws of other U.S. states].
11
Manager Location and Investor Location
In addition to Delaware having a seasoned body of law
that is both clear and prizes exibility, a majority of in-
vestment fund managers globally make their home in
the United States. Among the top 100 hedge and private
equity fund managers in the world (measured by assets
under management (AUM) for hedge funds and ve-
year fundraising totals for private equity funds), 80% of
hedge fund managers and 63% of private equity fund
managers are based in the United States.
12
Furthering
this general trend, total global hedge fund assets man-
aged from the United States in 2012 are estimated at
nearly 70%, and in 2010 53% of the private equity funds
raised globally in the ve preceding years were raised in
the United States.
13
Because U.S. managers will in many
cases naturally have a strong domestic investor base, the
familiarity of U.S. investors with Delaware further ex-
plains its popularity as a funds jurisdiction as against
other U.S. states.
Investment Location
In 2011, the Oliver Wyman consultancy ran a survey to
look at the domicile of alternative investment funds in
what they termed offshore and international onshore
jurisdictions, including Bermuda, the British Virgin Is-
lands, the Cayman Islands, Delaware, Guernsey, Ireland,
the Isle of Man, Jersey, Luxembourg and Malta.
14
From
this broad international group, they found that only
20% of hedge funds (22% by AUM) were based in Dela-
ware.
15
By contrast, from the same group, 64% of pri-
vate equity funds were based in Delaware, a gure that
rose to 72% when measured by AUM.
16
These gures highlight a pattern that at rst glance
seems to go against intuition: Although four out of ve
of the worlds largest hedge fund managers are based in
the United States, only approximately one in ve hedge
funds is located there (when comparing against likely al-
ternatives). By contrast, the two-thirds proportion of
large private equity fund managers located in the
United States is matched by the proportion of funds
based in Delaware (and, again, when measured by AUM,
this gure rises to almost three-fourths). Why would the
number of private equity funds set up in Delaware be
much larger proportionally than the group of hedge
funds established there (with a healthy skew toward the
larger funds being located there)?
While investor preference and tax structuring play a key
role, the answer to this conundrum lies partly in the na-
ture of the assets managed by private equity funds and
2
08/12 COPYRIGHT 2012 BY THE BUREAU OF NATIONAL AFFAIRS, INC., WASHINGTON, D.C. WSLR ISSN 1357-0889
hedge funds. Hedge funds very often hold their assets
(which differ in their nature and liquidity, including eq-
uity and debt securities, derivatives and other nancial
instruments) on custody with one or more prime bro-
kers, custodians or other service providers. Because the
assets held by a hedge fund can vary so widely, and a
prime broker or custodian might be located in any num-
ber of likely jurisdictions (such as New York, London,
Dublin, Luxembourg, Paris or Hong Kong), hedge fund
sponsors often establish their funds in offshore jurisdic-
tions that are neutral from a tax perspective and which
(like Delaware) have exible, clear regimes for invest-
ment funds. As a case in point, the Cayman Islands, the
British Virgin Islands and Bermuda between them ac-
count for over two-thirds of hedge funds by assets under
management.
17
In short, it does not seem to matter so
much where a hedge fund is located (from the perspec-
tive of its target investments) so long as the jurisdictions
tax regime is neutral and its legal regime is stable and
clear.
Private equity funds, by contrast, target a relatively nar-
rower class of assets. The target assets for a large or mid-
market buyout fund will be public companies that can
be made private prior to restructuring or other relevant
work. For American private equity rms pursuing Ameri-
can companies, the jurisdiction where most targets re-
side will, as discussed above, be Delaware. Shedding
light on this trend, Daines reveals that Delaware law gov-
erns over 60% of publicly held assets in the United
States and, unsurprisingly, most takeover battles.
18
Delaware supports takeover bids in a number of ways:
raising fewer obstacles to takeovers than other U.S.
states; erecting only minor barriers to hostile acquisi-
tions (Delaware has the shortest delay on hostile bids of
any U.S. state) in a way that has not reduced share-
holder wealth; and lowering acquisition costs by estab-
lishing clear precedents and occasionally prohibiting ex-
treme defensive tactics by targets that would allow man-
agement to entrench themselves.
19
Compounding this
pro-bidder position, almost every public rm incorpo-
rated in Delaware does not operate there (recalling Be-
bchuks observation that Delaware grabs 85% of all out-
of-state incorporations) and, as a result, there is no lo-
cal constituency to push back against bidder-friendly
trends in a way that would reduce bidder prots.
20
Thus, in addition to housing a majority of rms, Dela-
ware increases rm value, and attracts a substantial ma-
jority of private equity funds, by facilitating the sale of
public rms.
21
The Delaware Limited Partnership and the
Delaware LLC: An Introduction
Equipped with a better understanding of why fund spon-
sors look to Delaware in setting up their vehicles, one is
left to examine more closely the two primary Delaware
vehicles for fund investment: the limited partnership
and the LLC. Although limited partnerships generally
date back to the 19th century, and the U.S. National
Conference of Commissioners on Uniform State Laws
approved a model limited partnership act in 1916 (a
move that one author hailed as one of Americas early
European imports),
22
Delaware did not adopt a lim-
ited partnership statute until 1973.
23
After the National
Conference of Commissioners on Uniform State Laws
enacted a revised model limited partnership act in 1976,
Delaware revised its limited partnership statute, enact-
ing DRULPA in 1983 (subsequently adopting material
amendments to it in 1985 and later years).
24
In the earliest days of Delaware investment fund struc-
turing, the limited partnership was the only vehicle avail-
able and suited to the job. Until 1992, when the LLCA
was enacted, Delaware law (like the law of most states)
provided for only three primary forms of business model
(not counting, for these purposes, the sole proprietor-
ship): the general partnership, the limited partnership
and the corporation. Although it provided limited liabil-
ity for shareholders, the corporation was not generally
suitable for funds due to its two tiers of taxation (one at
the level of the corporation itself and one at the level of
individual shareholders). All partnerships, by contrast,
enjoyed tax transparency dating as far back as 1939
when the U.S. Congress enacted the rst modern incar-
nation of the U.S. Internal Revenue Code (which at Sec-
tion 181 provided: Individuals carrying on business in
partnership shall be liable for income tax only in their
individual capacity).
25
As between general partner-
ships and limited partnerships, only limited partnerships
provided the necessary combination of tax transparency
and limited liability for investors, and the majority of
U.S. private equity funds and hedge funds were (and
are) structured as Delaware limited partnerships.
26
When Delaware enacted the LLCA in 1992, making the
LLC a potential rival to the limited partnership, tax re-
ality had not kept pace with legislative change. Wyoming
had adopted an LLC statute in 1977 and Florida had fol-
lowed suit in 1982, but the U.S. Internal Revenue Ser-
vice (the IRS) did not begin to treat LLCs as tax-
transparent, ow-through entities until 1988.
27
Even
once IRS interpretive guidance allowed LLCs to be tax-
transparent, the result was a tightrope process where
an LLC had to meet at least two out of four possible fac-
tors to be tax-transparent, including limited liability,
centralised management, continuity of life and free
transferability of the LLC interest.
28
Although Delaware LLCs could in principle enjoy tax
transparency from their inception in 1992, widespread
LLC use only truly dawned in 1997 when the IRS intro-
duced its check-the-box election, allowing any LLC to
simply opt in to the benets of ow-through tax treat-
ment.
29
The check-the-box regime has been described
as having a profound, unprecedented, and perhaps un-
predictable impact on the future development of unin-
corporated business organizations.
30
In 1999, two years
after the check-the-box election came into force, the
Delaware Supreme Court commented in respect of
LLCs that the phenomenon of business arrangements
using alternative entities has been developing rapidly
over the past several years. Long gone are the days when
business planners were conned to corporate or part-
nership structures.
31
With clarity as to LLC tax treat-
ment and a statutory framework to support it, fund
3
WORLD SECURITIES LAW REPORT ISSN 1357-0889 BNA 08/12
sponsors have accepted the Delaware LLC as a viable al-
ternative to the limited partnership.
32
Whereas LLC structures had long represented a norm
for funds in offshore jurisdictions, fund sponsors began
to use the Delaware LLC once the U.S. tax code caught
up with the market.
33
More recently, the development
of the series LLC in Delaware has reected this same
trend of U.S. tax provisions lagging behind existing cor-
porate forms and market practice. In offshore jurisdic-
tions such as the Cayman Islands, the British Virgin Is-
lands and Guernsey, fund sponsors have used segregated
portfolio companies and protected cell companies for
some time to house multiple investment strategies
within one corporate body on a segregated basis.
34
While Delaware has a developed series LLC statute (rst
enacted in 1996), two primary obstacles impede accep-
tance of the series LLC as a widespread vehicle for
funds: 1) The IRS has yet to settle and normalise its tax
treatment, though recently proposed Treasury Regula-
tions indicate an intention to treat segregated series as
separate entities for U.S. tax purposes;
35
and 2) al-
though Delaware law respects the partition and segrega-
tion of assets between series within a series LLC, it is less
clear that the courts of a U.S. state or other nation with-
out the series LLC (or with a different series LLC re-
gime) would extend the same privilege.
36
So, while the series LLC could in the future become an
important fund structuring tool, the Delaware limited
partnership and the Delaware LLC remain the two pri-
mary vehicles for U.S. investments, and it now falls to
compare the differences between the two.
The Delaware Limited Partnership and the
Delaware LLC: A Comparison
Introduction and Comparison Table
As noted, Delawares regime for limited partnerships
precedes its LLC regime by almost two decades. Because
it came later and was designed to meet similar ends, the
LLCA was clearly modelled on DRULPA in most of its
particulars, and its provisions mirror those of DRULPA
very closely both in form and in substance.
The following table summarises certain key similarities
and differences between the two regimes that are par-
ticularly relevant where fund management is concerned.
Limited Partnerships (DRULPA) LLCs (LLCA)
Participants General partner, 17-101(5); limited part-
ner, 17-101(8); general partner and limited
partner may be a natural person, entity or
association, whether domestic or foreign
Manager, 18-101(10); member, 18-
101(11); manager and member may be may
be a natural person, entity or association,
whether domestic or foreign
.......................................... ............................................................ ......................... ...................................
Minimum number of necessary
participants
Two or more, with at least one general part-
ner and one limited partner, 17-101(9)
One member, 18-101(6)
.......................................... ............................................................ ......................... ...................................
Legal personality separate
from participants?
Yes, 17-201(b) Yes, 18-201(b)
Constituting document Limited partnership agreement, 17-101(12) Limited liability company agreement, 18-
101(7)
.......................................... ............................................................ ......................... ...................................
Freedom of contract? Yes, fundamental principle throughout; see,
e.g., 17-106(d), 17-107, 17-204(b), 17-
211(b), 17-216(d), 17-219, 17-301(d), 17-
401(a), 17-502(a), 17-605, 17-702(a), 17-
801(2)
Yes, fundamental principle throughout; see,
e.g., 18-106(d), 18.107, 18-204(b), 18-
209(b), 18-213(d), 18-216, 18-301(d), 18-
302(d), 18-304(a), 18-402, 18-502(a), 18-605,
18-702(a) and 18-801(a)
.......................................... ............................................................ ......................... ...................................
Nature of permitted business Any lawful business, purpose or activity other
than banking, 17-106(a)
Any lawful business, purpose or activity other
than banking, 18-106(a)
Liability and role
.......................................... ............................................................ ......................... ...................................
Does a managing participant
have general liability?
Yes, a general partner has general liability for
the obligations of the limited partnership,
17-303(a), 17-403(b); a creditor may not
levy execution against a general partner to
satisfy a judgment based on a claim against
the limited partnership unless: 1) the assets
of the limited partnership are insufcient to
satisfy the claim; 2) the limited partnership is
insolvent; 3) the general partner agrees; 4) a
court grants execution against the general
partner in its equitable discretion; or 5) the
general partner bears liability by law or con-
tract independent of the limited partnership;
17-403(d)
No (absent agreement to the contrary), a
manager or other managing person does not
have general liability for the obligations of
the LLC, the LLC itself bears liability; 18-
105, 18-109, 18-305, 18-401, 18-40305, 18-
602, 18-803
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Limited Partnerships (DRULPA) LLCs (LLCA)
.......................................... ............................................................ ......................... ...................................
Does a passive participant
have limited liability?
Yes (absent agreement to the contrary and
subject to the consideration below), liability
for each limited partner is limited to the
amount of capital contributed to the partner-
ship for interests; 17-303(b), 17-502
Yes (absent agreement to the contrary), li-
ability for each member (and, as relevant,
manager) is limited to the amount contrib-
uted to the LLC for interests; 18-215, 18-
303, 18-502
.......................................... ............................................................ ......................... ...................................
Is the role of a passive partici-
pant limited in any way by
statute?
Yes, a limited partner cannot participate in
the control of the business or it will become
liable for the obligations of the partnership,
17-303(a); however, the statute provides for
a long list of activities that do not, as a mat-
ter of law, constitute participating in the con-
trol of the business, 17-303(b)
No (absent agreement to the contrary),
18-302, 18-303
Management Each partnership must have at least one gen-
eral partner, which will have the rights, pow-
ers and obligations of a partner as set out in
the Delaware Uniform Partnership Act, as
amended, any of which may be delegated to
one or more persons (NB: unless otherwise
noted in the limited partnership agreement,
delegation by the general partner does not
cause the general partner to cease being or
acting as general partner); 17-403(a), (b)
Unless the limited liability company agree-
ment provides otherwise, the management
of an LLC shall be vested in the members
in proportion to the then current percent-
age or other interest of members in the prof-
its of the LLC, with a simple majority con-
trolling; the limited liability company agree-
ment may provide for the appointment of
one or more managers (noting that a man-
ager does not have to be a member of the
LLC); each member and manager has the
authority to bind the LLC unless the lim-
ited liability company agreement provides
otherwise; 18-402
Fiduciary duties All duties including duciary duties can be
expanded, diminished or wholly eliminated
by agreement, provided that the partner-
ship agreement may not eliminate the im-
plied contractual covenant of good faith and
fair dealing, 17-1101(d)
All duties including duciary duties can be
expanded, diminished or wholly eliminated
by agreement, provided that the limited
liability partnership agreement may not
eliminate the implied contractual covenant
of good faith and fair dealing, 18-1101(c)
Tax treatment Can elect to be treated as a corporation or a
partnership for U.S. federal tax purposes
Can elect to be treated as a corporation or a
partnership/disregarded entity for US fed-
eral tax purposes
Non-judicial dissolution Among consensual, contractual and judicial
reasons for dissolution, the withdrawal of a
general partner (if there is no replacement
general partner) or of all limited partners
will cause the fund to dissolve and be wound
up, 17-801
Among consensual, contractual and judicial
reasons for dissolution, the LLC will be dis-
solved and wound up if it has no members,
18-801(a)(4)
In addition to the categories mentioned above, both
DRULPA and LLCA contain a large number of provi-
sions that overlap with one another almost entirely, in-
cluding in respect of admission of participants, remedies
for breach, contributions, prot and loss allocations, dis-
tributions, assignment and transfer of interests, govern-
ing law and other related matters. In almost every in-
stance under the statutes, except as noted above, the ap-
proach is to set out a general rule but to make the rule
subject to the desire of the participants as they may
specify by contract.
Set out below are brief further thoughts on the few key
points where the statutes differ.
General Partner/Manager Liability
One key point of divergence between DRULPA and
LLCA is in the necessity for and liability of general part-
ners and managers. Under DRULPA, a limited partner-
ship must have at least one general partner, and that
general partner is generally liable for the obligations of
the limited partnership. By contrast, an LLC does not
have to have a manager; it is possible for the manage-
ment of the LLC to be carried out by one or more mem-
bers in proportion to their relative shares in the LLC. If
the LLC does appoint a manager, the manager does not
have to be a member of the LLC and, unless the limited
liability partnership agreement specically assigns liabil-
ity to the manager, the manager will not have general li-
ability because the debts, obligations and liabilities of a
limited liability company, whether arising in contract,
tort or otherwise, shall be solely the debts, obligations
and liabilities of the limited liability company, and no
member or manager shall be obligated personally for
any such debt ( 18-303(a)).
This divergence has various practical consequences. In
private equity funds structured as limited partnerships,
5
WORLD SECURITIES LAW REPORT ISSN 1357-0889 BNA 08/12
the general partner and its managers, ofcers and direc-
tors almost invariably negotiate to receive indemnica-
tion from the limited partners for any debts, obliga-
tions and liabilities that they incur in acting as general
partner for the limited partnership (subject to acting
reasonably and in good faith). In addition, private eq-
uity funds rarely house signicant management teams
within general partner entities because of the inherent
unlimited liability, instead delegating responsibilities un-
der the limited partnership agreement from the general
partner to an adviser or manager that then performs
day-to-day activities that require signicant working capi-
tal.
Just as the unlimited liability of general partners can cre-
ate difculties in a limited partnership, so too the poten-
tial limited liability for all parties in an LLC makes it at-
tractive not only as a fund vehicle but also as a vehicle
for housing managers.
37
For example, in a hedge fund
structured as a limited partnership, a sponsor will often
structure the general partner as an LLC. Arranging
things in this manner allows the management team to
be housed in a exible LLC entity where management
and performance fee ows can be passed through to
each member in accordance with a set agreement, du-
ties can be delegated to third persons and members can
leave and join at will, but which also provides limited li-
ability protection that is necessary given the LLCs role
as general partner.
Where liability for a managing participant is concerned,
the LLC structure provides more exibility and protec-
tion than the older, more traditional limited partnership
structure.
Limited Partner/Member Liability and Investor
Involvement in Day-to-Day Management
For LLCs, the role that any one member or manager
plays in the overall management scheme is uid and
subject to agreement between the relevant parties. Mem-
bers can appoint a manager or reserve management for
themselves. A manager can delegate or keep discretion
for itself. A manager might or might not be a member
of the LLC. The parties have complete exibility.
In the limited partnership structure, a general partner
has responsibility to care for the control of the busi-
ness and a limited partner cannot take part in control
of the business if it wants to keep its limited liability.
This notional position aligns, for example, with the po-
sition under Section 6 of the English Limited Partner-
ship Act 1907, which states that a limited partner shall
not take part in the management of the partnership
business, and shall not have power to bind the rm.
Under English law, the notion of management has
never been well dened, and the requirement leads to a
general precariousness where limited partners must fol-
low a conservative line on what could constitute manage-
ment.
Under DRULPA, this notional position of limited part-
ners staying away from control of the business has
been tempered by aggressive steps taken by the Dela-
ware legislature (rst when enacting the predecessor to
DRULPA in 1973 and then when adapting the reformed
model uniform limited partnership act in 1983) to give
limited partners safe harbours that include, among oth-
ers (each listed in 17-303(b)): acting as a contractor
on behalf of the limited partnership; acting as a guaran-
tor of the limited partnership; consulting with or advis-
ing a general partner; selling assets of the limited part-
nership; and making determinations in respect of invest-
ments to be made by the limited partnership.
Commenting on the Delaware approach, the English
Law Commission observed that it was the least restrictive
of any the Law Commission had reviewed, and appeared
to allow almost unrestricted scope, subject to the terms
of the partnership agreement, for the limited partners
to be involved in controlling the business.
38
Both DRULPA and LLCA allow for participants
(whether members, limited partners, managers or gen-
eral partners) to take an active role in the business of
the entity in question, again reecting the Delaware
bent toward exibility and freedom of contract.
Additional Considerations
While it is clear that Delaware serves as the most likely
location for private funds in the United States, and that
its limited partnership and LLC regimes give sponsors a
large degree of contractual exibility, any analysis of
Delaware as a funds jurisdiction must take note at least
briey of the wider implications triggered by locating an
investment fund (and its management functions) in the
United States. Setting up and operating a private fund
of an size in any U.S. state will give rise to an array of
regulatory and legal consequences, requirements and
obligations that almost defy belief.
Here is a cursory overview of the main issues:
s Registrable securities: Under the U.S. Securities Act
of 1933, as amended (the Securities Act), interests in
private funds qualify as securities. Under the Securi-
ties Act, all securities must be either registered with
the U.S. Securities and Exchange Commission (SEC)
or exempt from registration. Selling fund interests in
the United States on a private placement basis, ex-
empt from registration, requires selling in compli-
ance with safe harbour requirements (e.g., no general
advertising or solicitation) only to interested parties
with whom the sponsor or its agent has an existing re-
lationship and who are accredited investors under
Regulation D of the Securities Act.
s Selling to U.S. investors: Anyone who sells securities
in the United States is subject to regulation under the
U.S. Securities Exchange Act of 1934, as amended
(the Exchange Act). The general requirement under
the Exchange Act is that securities must be sold by
SEC-registered broker-dealers, so fund sponsors must
carefully consider how they intend to market fund in-
terests and whether they will have an appropriate
broker-dealer as an intermediary.
s Advising a fund: Any individual or entity that for com-
pensation engages in the business of advising others
. . . as to the value of securities or as to the advisabil-
6
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ity of investing in, purchasing, or selling securities
39
is subject to registration as an investment adviser un-
der the U.S. Investment Advisers Act of 1940, as
amended (the Advisers Act). Congress and the SEC
recently provided de minimis registration relief under
the Advisers Act for non-U.S. advisers (with less than
$25 million AUM from U.S. investors) and advisers to
small funds (less than $150 million, in which case the
adviser must report to the SEC but escapes full regis-
tration), failing which a fund adviser must register
with the SEC. In addition, if the pool of assets man-
aged for a fund with U.S. investors also includes swaps
(other than security-based swaps), options, futures or
other derivatives, then the manager may additionally
be subject to registration with the Commodity Fu-
tures Trading Commission (CFTC) as a commodity
trading adviser and a commodity pool operator. The
CFTC provides no exemptions from registration, but
it does have a registration light regime where the
U.S. investors in question meet prescribed net worth
thresholds.
s Vehicle registration: Under the U.S. Investment
Company Act of 1940, as amended (the Investment
Company Act), an investment fund with U.S. inves-
tors must register with the SEC as an investment com-
pany unless it ts within a relevant exemption. For
funds with U.S. investors, the most often used exemp-
tion arises under Section 3(c)(7) of the Investment
Company Act, which gives relief provided that the in-
vestors in question are all qualied purchasers that
meet net worth hurdles.
In addition to the headline items outlined above, U.S.
investment funds (including Delaware funds and their
managers) must pay attention to pay-to-play rules that
can arise in approaching public pension funds, anti-
bribery rules under the U.S. Foreign Corrupt Practices
Act, sanctions rules under the Ofce of Foreign Assets
Control (OFAC) regime administered by the U.S. Trea-
sury Department, anti-money-laundering rules and regu-
lations under U.S. banking laws, banking rules and regu-
lations (including the Volcker Rule) that apply where
a bank acts as an investor or a sponsor, Committee on
Foreign Investment in the United States (CFIUS) regu-
lations that can restrict foreign investment in U.S. assets,
and anti-boycott rules and regulations, not to mention
myriad tax provisions that can give rise to withholding
and other consequences.
In short, Delaware can be exible and inviting, but the
federal government of the United States and its laws are
not!
NOTES
1
Lewis J. Black, Why Corporations Choose Delaware (2007), 1.
2
See, e.g., Black, Why Corporations Choose Delaware, 1; Robert Daines,
Does Delaware Improve Firm Value?, Journal of Financial Economics 62
(2001), 526; Lucian Bebchuk and Assaf Hamdani, Vigorous Race or
Leisurely Walk: Reconsidering the Competition over Corporate Char-
ters, The Yale Law Journal 112 (2002), 553; Paul Mackun and Steven
Wilson, Population Distribution and Change: 2000 to 2010, 2010
Census Briefs (March 2011), 2.
3
Bebchuk and Hamdani, Vigorous Race or Leisurely Walk, 55556.
4
Arindam Bandopadhyaya and James Grant, The Hedge Fund Ex-
plosion: Is the Bang Worth the Buck? (working paper 1010), UMass
Boston College of Management Financial Services Forum (May 2006).
5
6 Del. C. 18-101ff; 6 Del. C. 17-101ff; 17-1101(c), 18-1101(b).
6
Continental Ins. Co. v. Rutledge & Co., 750 A.2d 1219 (Del. Ch. 2000).
7
17-1101(d), 18-1101(c).
8
17-108, 18-108.
9
In re Ford Holdings, Inc. Preferred Stock, 698 A.2d 973 (Del. Ch. 1997).
10
17-1109(a), 18-1107(b).
11
Daines, Does Delaware Improve Firm Value?, 540, 544.
12
The PEI 300, Private Equity International (May 2012), 4041, 45;
The Hedge Fund 100, Institutional Investor (May 2011), 8283.
13
HedgeFund Intelligence, Global Review 2012 (Spring 2012), 9
(HedgeFund Intelligence reports that $1,429 billion of hedge fund as-
sets are managed from the United States against $2,059 in global
hedge fund assets); TheCityUK, Private Equity (August 2011), 23.
14
Stefan Jaecklin, Florian Gamper and Amit Shah, Domiciles of Al-
ternative Investment Funds (Oliver Wyman nancial services report)
(2011).
15
Jaecklin, Gamper and Shah, Domiciles of Alternative Investment
Funds, 3.
16
Jaecklin, Gamper and Shah, Domiciles of Alternative Investment
Funds, 4.
17
Jaecklin, Gamper and Shah, Domiciles of Alternative Investment
Funds, 3. Again, this is measured against the offshore and interna-
tional onshore jurisdictions of Bermuda, the British Virgin Islands,
the Cayman Islands, Delaware, Guernsey, Ireland, the Isle of Man, Jer-
sey, Luxembourg and Malta. Specically, the Cayman Islands represent
52%, the British Virgin Islands represent 11% and Bermuda repre-
sents 4% respectively of hedge fund assets under management.
18
Daines, Does Delaware Improve Firm Value?, 527.
19
Daines, Does Delaware Improve Firm Value?, 541.
20
Daines, Does Delaware Improve Firm Value?, 541; Bebchuk and
Hamdani, Vigorous Race or Leisurely Walk, 55556.
21
Daines, Does Delaware Improve Firm Value?, 547.
22
Robert Kessler, The New Uniform Limited Partnership Act: A Cri-
tique, 49 Fordham Law Review 159 (1980), 159. Kessler also notes, how-
ever, that New York enacted limited partnership legislation as early as
1822.
23
See, e.g., Elf Atochem North America Inc. v. Jaffari, 727 A.2d 286, 290
(Del. 1999); 6 Del. Code Ann., ch. 17; Stephen Glover and Craig Was-
serman, Partnerships, Joint Ventures & Strategic Alliances (New York: Law
Journal Press, 2003), 12-7.
24
Glover and Wasserman, Partnerships, Joint Ventures & Strategic Alli-
ances, 12-7, 12-8.
25
26 USC 182 (available at http://constitution.org/uslaw/sal/053_
itax.pdf).
26
See, e.g., Guillermo Gil D az, A Basic Outlook on Hedge Fund
Structure and Taxation Issues, 2 U.P.R. Business Law Journal 265; Wil-
liam Curbow and Kathryn King Sudol, United States in Getting the
Deal Through Private Equity 2010 (London: Law Business Research,
2010), 279.
27
Martin Lubaroff and Paul Altman, Delaware Limited Liability
Companies in Delaware Law of Corporations & Business Organizations
(3d ed.) (New York: Wolters Kluwer, 2012), 20-2.
28
Jeffrey Burr, Entity Choice: Just Check-the-Box, 5 Nevada Lawyer
12 (August 1997).
29
Joshua P. Fershee, LLCs and Corporations: A Fork in the Road in
Delaware?, 1 Harvard Business Law Review Online 82 (2011).
30
Fershee, LLCs and Corporations, 82.
31
Elf Atochem, 727 A.2d 290.
32
See, e.g., Curbow and Sudol, United States, 279; D az, A Basic
Outlook, 26667.
33
BARRA RogersCasey, An Introduction to Hedge Funds (white pa-
per, 2001), 2. BARRA RogersCasey notes that [m]ost U.S.-based
hedge funds are structured as limited partnerships while hedge funds
outside the U.S., or offshore funds, are typically structured as limited
liability companies.
34
Dominick Gattuso, Series LLCs, 17 Business Law Today (July/
August 2008).
7
WORLD SECURITIES LAW REPORT ISSN 1357-0889 BNA 08/12
35
Prop. Treas. Reg. sec. 301.7701-1(a)(5).
36
Wendell Gingerich, Series LLCs: The Problem of the Chicken and
the Egg, 4 Entrepreneurial Business Law Journal 193 (2009).
37
See, e.g., D az, A Basic Outlook, 26667.
38
The Law Commission and The Scottish Law Commission, Limited
Partnerships Act 1907: A Joint Consultation Paper (London: The Station-
ary Ofce, 2001), 32.
39
Advisers Act, sec. 202(a)(11).
Robert Schwartz is a London-based, New York-qualied Se-
nior Associate at Allen & Overy LLP in the law rms invest-
ment funds and asset management practice. The author
wishes to thank Andrew Leveson and Craig Cohen for their
assistance with this Special Report. The author may be con-
tacted at robert.schwartz@allenovery.com.
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08/12 COPYRIGHT 2012 BY THE BUREAU OF NATIONAL AFFAIRS, INC., WASHINGTON, D.C. WSLR ISSN 1357-0889