Thursday, 9 April 2020

SEC provides relief for BDCs affected by COVID-19

By Amanda Maine, J.D.

Business development companies (BDCs) have been granted temporary conditional relief to help enable them to make investments in small and medium-sized businesses, the SEC announced. Under the exemptive relief, BDCs will be permitted to issue and sell senior securities in order to provide capital to these companies. According to the Commission, many BDCs face challenges in the current environment in providing capital to their portfolio companies due to the impact of COVID-19 on the financial and credit markets. The relief includes the method for calculating permitted financing and applies conditions designed to protect investors (Order Under Sections 6(c), 17(d), 38(a), and 57(i) of the Investment Company Act of 1940 and Rule 17d-1 Thereunder Granting Exemptions from Specified Provisions of the Investment Company Act and Certain Rules Thereunder, Release No. IC-33837, April 8, 2020).

In a statement announcing the relief, SEC Chairman Jay Clayton said, “Many small and medium-sized businesses across the country are struggling due to the effects of COVID-19.” The exemptive relief “will enable BDCs to provide their businesses with additional financial support” in light of the challenges arising from the pandemic, Clayton advised.

BDCs and COVID-19. The Commission’s order notes that BDCs were created to provide capital to smaller domestic operating companies (“portfolio companies”) that otherwise may not be able to readily access the capital markets. Under the challenges posed by the effects of COVID-19, BDCs may be unable to satisfy the asset coverage requirements under the Investment Company Act due to temporary markdowns in the value of loans to its portfolio companies. Certain affiliates may also be prohibited from participating in additional investments in the BDC’s portfolio companies due to restrictions on an existing exemptive order permitting co-investments.

Issuance and sale of senior securities by BDCs. The exemptive order provides that during the exemption period, a BDC may issue or sell a senior security that represents an indebtedness or that is a stock (“covered senior securities”) notwithstanding the Investment Company Act’s asset coverage requirement, subject to several conditions. A BDC may use values calculated as of December 31, 2019 (“Adjusted Portfolio Value”) to meet an Adjusted Asset Coverage Ratio. The order outlines how to calculate the Adjusted Asset Coverage Ratio.

A BDC that elects to rely on this exemption must disclose it on Form 8-K and may not for 90 days make an initial investment in any portfolio company in which the BDC was not already invested as of the date of the order, unless its asset coverage ratio complies with Investment Company Act Section 18.

The order also requires that the BDC’s election to rely on the exemption be approved by the BDC’s board of directors or trustees, which must also determine that each issuance of senior securities is in the best interests of the BDC and its shareholders. To make this determination, the BDC’s investment adviser must certify the recommendation and the investment adviser’s reasons for certifying that it is in the best interests of the BDC and its shareholders. The board must also review reports prepared by the BDC’s investment adviser at least monthly to determine efforts the BDC has made towards achieving compliance with Section 18 asset coverage requirements.

In addition, the order imposes certain recordkeeping requirements, including preserving the minutes of board meetings and the investment adviser’s reports to the board. Finally, the order states that no affiliated person of the BDC shall receive transaction fees or other renumeration from an issuer in which the BDC invests during the Exemption Period. The order provides relief only to issue or sell senior securities representing an indebtedness or that is a stock, and does not provide relief in connection with dividends or other distributions.

Expansion of relief for BDCs with existing co-investment orders. BDCs that currently have an existing co-investment order from the Commission permitting co-investment transactions in portfolio companies with certain affiliated persons may participate in a follow-up investment provided that: (1) it has previously participated in a co-investment transaction with the BDC with respect to the issuer (if the participant is a regulated fund); or (2) it either previously participated in a co-investment transaction with the BDC with respect to the issuer or is not invested in the issuer (if the participant is an affiliate fund). This exemption is also conditioned on the oversight of and the review by the board of directors or trustees.

Exemption period. The relief provided is limited to the period from the date of the order to the earlier of: (1) December 31, 2020; or (2) the date by which the BDC ceases to rely on the order. The Commission may extend the exemptive relief as it deems appropriate.

The release is No. IC-33837.

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