Subscription Finance: Rated Note Feeder Funds and Debt Capital Commitments | Perspectives & Events

Insurance company investors are increasingly looking to invest in private equity and similar private investment funds via debt capital commitments (as opposed to traditional equity capital commitments) to take advantage of improved regulatory capital treatment, including under the risk-based capital system established by the US National Association of Insurance Commissioners (the “NAIC”). Fund sponsors have responded to this request by using a rated note feeder structure, where a feeder fund issues notes under a note purchase agreement to an investor (instead of requiring a traditional equity capital commitment) and obtains a strong credit rating on such notes that results in a much more favorable NAIC risk-based capital treatment.

As noted in our prior Legal Updates, debt capital commitments have historically been classified as ineligible for borrowing base inclusion in subscription facilities. This is due to the uncertainty of whether such debt capital commitments would be enforceable under Section 365(c)(2) of the US Bankruptcy Code if the applicable fund was ever subject to a bankruptcy proceeding.¹ The concern centers on whether the debt capital commitment would be determined to be an “executory contract” to “make a loan, or extend other debt financing or financial accommodations to or for the benefit of the debtor.” If so, the obligation could be rendered non-assumable by the fund or its bankruptcy trustee (and thus non-enforceable by…