We disagree. The exemption under 802.65 does not extend to Investor 2’s acquisition.
Question
Dear PNO Staff,
Facts
I am assessing a situation where Investor 1 previously acquired a Preferred Interest in an Unincorporated Entity that resulted in Investor 1 obtaining control of Unincorporated Entity. Investor 1 (a) contributed only cash to an Unincorporated Entity, (b) for the purpose of providing financing, and (c) the terms of the financing agreement were such that Investor 1 would no longer control the Unincorporated Entity after it realizes its preferred return (commonly known as the “flip point”). Therefore, Investor 1’s acquisition was exempt under Rule 802.65.
Investor 1 still controls the Unincorporated Entity because the flip point has not occurred. Now, Investor 2 will acquire the Preferred Interest from Investor 1, resulting in Investor 2 temporarily obtaining control of Unincorporated Entity. In other words, Investor 2 is stepping into the shoes of Investor 1, and the terms of the financing agreement remain such that Investor 2 will no longer control Unincorporated Entity after it realizes its preferred return (i.e., after the flip point).
The Unincorporated Entity at issue holds only an energy generation project and this type of preferred interest financing with a flip point after which the preferred interest holder loses control is a common mechanism to finance energy generation projects.
Analysis
PNPM 166 states in part that “section 802.65 exempts acquisitions of non-corporate interests that confer control of an unincorporated entity if the acquiring person contributes only cash to the entity for the purpose of providing financing and the terms of the financing agreement result in the acquiring person no longer controlling the entity after it realizes its preferred return.” In confirming that an investment in an existing unincorporated entity should satisfy the requirements of Rule 802.65, the 2005 SBP explained that the “Commission agrees that if an interest is acquired in an existing unincorporated entity in a bona fide financing transaction that satisfies the other requirements of this exemption, there is no reason for the exemption not to be available.” Further, the 2005 SBP explained: Rule 802.65 applies to instances where a cash acquisition is an ordinary course of business mechanism of providing financing, and the acquiring person's acquisition of a controlling interest is only temporary. Here, Investor 2’s acquisition of the preferred interest with a flip point that results in the Investor 2 losing control once the preferred rate of return is achieved aligns with the Commission’s intent of exempting this type of ordinary course financing transaction where Investor’s acquisition of a controlling interest is only temporary. Indeed, if the Unincorporated Entity redeemed Investor 1 and reissued the preferred interest to Investor 2 for cash, the exemption appears plainly to apply to Investor 2’s acquisition.
Please confirm you agree that Investor 2’s acquisition of the preferred interest from Investor 1 described above is exempt under Rule 802.65.