Could PTP scupper secondaries sales when the covid-19 dust settles?

An overhang of LPs wanting to sell stakes in funds could delay transfers in order to conform with publicly traded partnership rules.

The issue of publicly traded partnership transfer restrictions have long posed threats, both theoretical and real, to secondaries trades.

Under US law, a fund can be deemed a PTP and taxed as a corporation if interests in the partnership are readily tradable on a secondary market.

As of early April, dealmaking in the secondaries market appears to be largely on hold as buyers await a clearer view on valuations amid the covid-19 crisis. When dealmaking returns to normal, could PTP concerns limit the amount of trades executed?

Lawyers whom Secondaries Investor spoke to said PTP is unlikely to prevent liquidity-constrained limited partners from exiting fund positions. According to Proskauer partner Bruno Bertrand-Delfau, one of the reasons for this is overall lower transaction volumes. Bertrand-Delfau said secondaries market transaction volumes are likely to slow in the next two quarters due to the impact of the coronavirus, thereby reducing the chances that funds will breach their 2 percent transfer limits.

Gabriel Boghossian, a partner at Stephenson Harwood, said that even if a large number of distressed sellers come to market at once, their numbers are likely to be countered by opportunistic sellers pulling back due to a weaker price environment.

One exception to this trend will be those funds that are facing a backlog of sellers from the record-breaking level of trades last year. If there is an overhang of people that wanted to make a transfer in 2019 but couldn’t, LPs that want to sell in 2020 might not be able to do so until 2021 or later.

Private equity funds can avoid being designated as PTPs by taking advantage of one of several ‘safe harbours’. These include if the total of stakes traded within the tax year represents less than 2 percent of a limited partnership, if a fund has fewer than 100 partners or if there is only one trade during the tax year regardless of size.

PTP rules were originally designed in the 1980s to protect small retail investors investing in tax shelters. It is not just US-domiciled funds that need to watch out – any entity that is treated as a partnership for US tax purposes, irrespective of where it is formed, is potentially subject to being treated as a PTP.

Most limited partnership agreements allow LPs to sell off the upside and downside risk of a fund investment while technically remaining a partner with ultimate liability for meeting capital calls.

“People can always transfer economic rights, even if the GP won’t approve the transfer until a new PTP window opens,” said Ted Cardos, a partner with Kirkland & Ellis. PTPs did not create a blockage for secondaries sales in the 2008 global financial crisis, he added.