Passive limited partner investors in private equity funds that make FERC-regulated investments are not themselves subject to FERC’s corporate regulatory regime.
Those that own interests in businesses that sell electricity in commerce and those that own interests in electric power generation, transmission, and distribution facilities are subject to extensive and microscopic federal corporate and financial regulation and disclosure obligations unique to the electric power sector. On December 22, the Federal Energy Regulatory Commission (FERC) issued an order[1] confirming that passive limited partner investors (LPs) in private equity funds that make FERC-regulated investments are not themselves subject to FERC’s corporate regulatory regime.
Background
Almost every business (whether a corporation, a partnership, a limited liability entity, or even an unincorporated group of persons) that sells or transmits electricity in interstate commerce is a “public utility” under the Federal Power Act (FPA), and in many cases, is a “public-utility company” under the Public Utility Holding Company Act (PUHCA). This applies even to businesses that transmit electricity within a single state (using any interconnection to the interstate power grid), and those that engage in other lines of business. FERC regulates the sale, disposition, or other direct or indirect transfers (for example, by merger) of control of public utilities by voting securities or their equivalents, such as partnership or limited liability company interests.[2] FERC regulation of control transactions can be triggered by sales of voting or equivalent interests as small as 10%, and related-entity owners of interests are aggregated by FERC. Transfers of indirect interests in a public utility (such as acquiring stock or membership interests in a public utility’s parent company) are subject to FERC authorization in the same manner as direct purchases of a public utility’s stock or partnership interests. Typically, FERC analyzes ownership and market power by aggregating the interests of related or “affiliated” entities, such that two funds that are under the ultimate control of a common entity are—to FERC—one single entity.
Investors that own or control 10% or more of a public utility’s voting securities generally become subject to FERC jurisdiction (including the regulation of other energy-sector investments) and to comprehensive FERC disclosure requirements, including the public identification of their US electric and gas-related investments and on-demand FERC access to books and records.
Although some interests in what are typically smaller renewable and cogeneration facilities can be immune from FERC change-in-control requirements, the FERC requirements can attach to both those that purchase interests and to FERC-regulated public utilities themselves. FERC jurisdiction over control-related transactions—even minority-interest transactions—is difficult to avoid. In the last year, FERC reviewed and issued orders on substantially more than 200 applications for approvals of transactions.
Fund Investments in the Electric Sector
Most private equity funds and similar investment vehicles receive capitalization from LPs that do not manage or control that fund or its public utility investments. Such a fund is typically controlled by general partners, frequently through an affiliated fund management entity. LPs[3] have typically been treated by FERC as not holding the equivalent of voting interests, and have not been subject to FERC’s FPA or PUHCA ownership transaction approval requirements, although explicit case law that provided fund and LP comfort has not been abundant.
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In the summer of 2015, FERC was asked to issue a declaratory order regarding funds and LPs subject to the governing documents that contain the following LP rights and limitations:
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Investment restrictions that function to limit fund ability to dispose of assets or redeem interests without consent of a majority of LPs
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Limitations on the general partner’s powers to subject, without consent, the LPs to an act that would have an LP function as a general partner, such as incurring liabilities, making loans, or forming additional partnerships on behalf of the LPs
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Prohibitions on in-kind distributions so that the general partner cannot distribute marketable assets of the fund (such as marketable securities) unless such distribution has been approved either by an advisory committee or LPs
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The approval of two-thirds of the LPs is necessary to remove the general partner upon receiving a “for cause” notice with respect to the actions of the general partner
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Amendments to the fund governing agreement require the majority consent of the LPs
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A requirement that a majority of LPs approve the appointment of the general partner’s candidate to fill a vacancy on the advisory committee
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A requirement that a majority of LPs appoint a liquidation trustee to wind up the affairs of the fund and to liquidate its assets when there is no general partner
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A requirement that a two-thirds vote of the LPs may dissolve the fund
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A requirement that an advisory committee be established comprising a certain number of LP investors or their representatives that will be vested with power sufficient to protect their economic investment in the fund but prohibited from taking part in the control or management of the fund
The Order
FERC ruled that:
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current and future LPs are passive investors; LPs do not manage, direct, or control the activities of the funds nor of the FERC-regulated public utilities in which the funds invest;
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the purchase and sale of LP interests do not require case-specific approval pursuant to the FPA and, to the extent relevant, LP interests are nonvoting securities under FERC’s regulations implementing the FPA;
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the funds and their public utilities need not identify the LPs in filings with FERC that ordinarily would be required to include ownership-disclosure information; and
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a fund itself, and each passive LP, is not a public utility under the FPA, and an LP is not itself a “holding company” under PUHCA, solely by virtue of its fund investment.
Limitations on the Order
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Although the Order confirms that purely passive investors remain largely immune from FERC’s FPA and PUHCA jurisdiction, the Order is not without limitations:
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The Order implies that an LP, to hold the immunities from regulation that the Order sets out, would not have a principal business of producing, selling, or transmitting electric power—in effect prohibiting an entity from claiming immunity from FERC regulation if it simultaneously holds a regulated, “control” position in some investments while simultaneously holding passive fund investments.
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The Order is inapplicable to an LP that exercises any “active role” that goes beyond the passive rights generally outlined in the Order.
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The Order does not provide any immunity to an LP that removes (or, presumably, causes the removal of) a fund general partner or manager, even for cause. Where cause for GP removal exists, LPs will need to consider whether LP removal is worth the price of becoming FERC jurisdictional.
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The LP rights that received FERC assent in the Order are not a minimum floor that investors, and funds, may freely exceed. If an LP’s rights exceed the rights that FERC discussed in the Order, the LP may not be determined to be passive, and the LP (and even the fund in which the LP invests) should not rely on the Order’s declaratory relief from FERC jurisdiction.
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In other proceedings, FERC is in the process of substantially expanding the data that is collected concerning the ultimate holders of economic, rather than control, interests in public utilities. The Order provides no relief from that proceeding whatsoever; it applies only to FERC corporate regulation of LPs and funds under the FPA and PUHCA.
[1] Starwood Energy Group Global, L.L.C., et al., Docket No. EL15-87-000, 153 FERC ¶ 61,332 (2015) (the Order).
[2] Note that some state utility commissions (such as New York’s Public Service Commission) regulate the acquisition of assets and interests in energy businesses located in those states.
[3] The Order strongly suggests that investors in co-investment vehicles that exhibit governance features, and limitations on investor rights, should be viewed as similar to LPs in funds.
[4] As defined by the petitioners, LP investors “consist of a mix of sovereign wealth funds, insurance companies, pension funds, superannuation funds, fund[s] of funds, charitable endowments, family offices, high net worth individuals and banking institutions.” Id. at 6–7. By this definition, none of the LP investors has a principal business of producing, selling, or transmitting electric power.
[5] See, e.g., Notice of Proposed Rulemaking, Docket No. RM15-23-000, Collection of Connected Entity Data from Regional Transmission Organizations and Independent System Operators, 152 FERC ¶ 61,219 (2015).
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