On April 9, 2020, the Securities and Exchange Commission (“SEC”) announced temporary, conditional relief until December 31, 2020, allowing business development companies (“BDCs”) flexibility to issue and sell senior securities, and invest alongside certain affiliates that would otherwise be prohibited by Section 57(a)(4) of the Investment Company Act (“IC Act”) and Rule 17d-1 thereunder. The SEC recognizes that certain BDCs may face challenges in continuing to provide credit support to portfolio companies impacted by COVID-19 if (i) it is unable to satisfy the asset coverage requirements under the IC Act due to temporary mark-downs in the value of the loans to such portfolio companies, or (ii) certain of its affiliates are prohibited from participating in additional investments in the BDC’s portfolio companies due to restrictions in its current exemptive order permitting co-investments. We recap this relief below.
Issuance and Sale of Senior Securities by BDCs
Section 18 of the IC Act, as modified by Section 61 of the IC Act, prescribes asset coverage and calculation requirements which BDCs must follow when issuing or selling a senior security that represents indebtedness or that is a stock (“covered senior securities”). Under the SEC’s relief, BDCs may continue to issue or sell covered senior securities provided the following:
- Adjusted Portfolio Value
The BDC may meet Section 61’s 200%/150% asset coverage ratio by relying on an “adjusted asset coverage ratio.” The “adjusted asset coverage ratio” must be calculated in the same manner currently required by Section 18, but a BDC may use an “adjusted portfolio value” for certain portfolio company holdings if:
- they were held by the BDC at December 31, 2019;
- the BDC continues to hold at the time of such issuance or sale of the senior security; and
- the BDC is not recognizing a realized loss on.
To calculate the “adjusted asset coverage ratio,” a BDC must reduce its asset coverage ratio using the “adjusted portfolio value” by an amount equal to 25% of the difference between the asset coverage ratio calculated using the “adjusted portfolio value” and the asset coverage ratio calculated in accordance with Section 18(b).1
- Limitation on New Investments
BDCs shall not, for 90 days from the date of a disclosed election on Form 8-K of reliance on the SEC’s relief, make an initial investment in any portfolio company in which the BDC was not already invested as of the date of the SEC’s relief, provided that a BDC may make an initial investment in such a portfolio company if at the time of investment its asset coverage ratio complies with the asset coverage ratio applicable to it under Section 18, as modified by section 61.
- Board Approval
The BDC’s board of directors (or trustees) (“Board”), including a required majority of the Board (a “Required Majority”), must determine that the issuance or sale of covered senior securities is permitted by the SEC’s relief and is in the best interests of the BDC and its shareholders.
The Board must obtain and consider a certification from the BDC’s investment adviser that the issuance of covered senior securities is in the best interests of the BDC and its shareholders; such certification should include not only the advisers’ recommendation and reasons, but also whether other reasonable alternatives were considered that would not result in the issuance of a covered senior security. Additionally, the Board must obtain and consider advice from an independent evaluator regarding whether the terms and conditions of the proposed issuance or sale of a covered senior security are fair and reasonable compared to similar issuances, if any, by unaffiliated third parties in light of current market conditions.
- No Sunset Period
The Board of any BDC that has elected to rely on the SEC’s relief needs to receive and review, no less frequently than monthly, reports prepared by the BDC’s investment adviser regarding and assessing the efforts that the investment adviser has undertaken, and progress that the BDC has made, towards achieving compliance with the asset coverage requirements under Section 18, as modified by Section 61, by the end of the exemption period. Upon expiration of the exemption period, any BDC not in compliance with the asset coverage requirements applicable to such BDC at that time shall immediately make a filing on Form 8-K that includes information such as the BDC’s current asset coverage ratio, reasons why the BDC was unable to comply with the asset coverage requirements, time frame within which the BDC expects to come into compliance with the asset coverage requirements, and the specific steps that the BDC will be undertaking to bring itself into compliance with the asset coverage requirements.
- No Compensation or Remuneration of any Kind
Except what is permitted by section 57(k) of the IC Act, no affiliated person of the BDC, or any affiliated person of such a person, may receive any transaction fees (including break-up, structuring, monitoring or commitment fees) or other remuneration from an issuer in which the BDC invests, during the period in which the BDC is relying on the SEC’s relief. This condition does not apply to the receipt of investment advisory fees by an investment adviser to the BDC under an investment management agreement.
Expansion of Relief for BDCs with Existing Co-Investment Orders
BDCs that have existing exemptive relief orders permitting co-investment transactions in portfolio companies with certain regulated funds or affiliated funds may, during the exemption period, participate in a follow-on negotiated or non-negotiated investment with one or more affiliates. Such transactions are permitted provided that:
- such participant is a regulated fund, it has previously participated in a co-investment transaction with the BDC with respect to the issuer,
- such participant is an affiliated fund, it either has previously participated in a co-investment transaction with the BDC with respect to the issuer, or is not invested in the issuer,
- any such transactions are otherwise effected in accordance with the BDC’s existing co-investment exemptive relief including periodic reporting to the Board, and
- the Board reviews the proposed follow-on investments other than non-negotiated follow-on investments both on a stand-alone basis and in relation to the total economic exposure of the BDC to the issuer.
For BDCs that rely on this SEC relief, it is imperative that the Board and investment adviser carefully review the relief’s undertakings, calculations and considerations when issuing and selling covered senior securities. Further BDCs should work closely with their administrators to ensure proper asset coverage calculation and reporting. With regards to expanded relief for existing co-investment exemptive orders, care should be taken to map the relief to current representations and definitions made and used in the current exemptive orders the BDC has to ensure proper implementation of the new relief.
ACA would expect that BDCs and industry groups continue to engage with the SEC on other possible relief that may assist BDCs to fulfil their statutory mandate. ACA will continue to monitor developments as we navigate through the COVID-19 pandemic.
For More Information
For more information about this relief, please reach out to your ACA consultant or Erik Olsen.
ACA's COVID-19 Resources
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1 The SEC provided the following example: A BDC has a 220% asset coverage ratio on December 31, 2019. Its asset coverage ratio declines to 160% on March 31, 2020, not using the “adjusted portfolio value,” and 200% if it calculates the ratio (without the 25% decrease) using the “adjusted portfolio value.” This BDC would have an “adjusted asset coverage ratio” of 190% (200% minus 10% (25% of the difference between 200% and 160%)).