Private equity structures often use “blockers” to achieve certain tax benefits. In this Legal Update, we explain what blockers are, how they may be used in a subscription credit facility, and what lenders should consider when blockers are shared among multiple funds.

Background

Private equity fund structures (“Funds”) can take a variety of forms that range in complexity, depending on the investor base and sponsor. In its simplest form, the fund structure can consist of a single investment vehicle (“Main Fund”) to which the investors contribute their capital, and the Main Fund makes investments on their behalf. In its more complex iterations, a fund structure may include parallel investment vehicles (“Parallel Fund”), alternative investment vehicles, feeder investment vehicles (“Feeder Fund”), and blocker vehicles (“Blocker”). Each of these structures serves a particular function and addresses a particular investment strategy. Additionally, in the case of a Blocker, the structure achieves a particular tax effect.

What Is a Blocker and How Are They Used?

In the context of a fund structure, the constituent documents of a Main Fund or a Parallel Fund may permit the formation of a Blocker. Typically, a Blocker is a corporation or a limited liability company treated as a corporate taxpayer for US federal income tax purposes, as opposed to being a pass-through taxpayer. In this context, any US federal income tax liabilities accruing to the direct allocations or distributions received by the Blocker from the investments that sit downstream from it would be paid by the Blocker at the corporate level and would not be passed through to the investors that have a direct or indirect interest in such Blocker. In other words, the Blocker essentially “blocks” the direct US federal income tax liability of its investors, with the liability already paid at the Blocker’s corporate level.

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