The Institutional Limited Partners Association has released a free-to-use ‘model’ limited partnership agreement – a dummy legal contract – in a bid to make it easier and cheaper to negotiate terms and set up a fund, sister publication Private Funds CFO reported.
“The industry has to date lacked freely accessible model documents that can serve as a baseline for reasonable legal terms and conditions associated with private equity funds,” said ILPA CEO Steve Nelson in a statement.
“Consequently, the hundreds of LPAs developed each year are the product of bespoke efforts and one-off negotiations that come with excessive cost to both GPs and LPs. We encourage all industry stakeholders to review the ILPA Model LPA and use it as a basis for a more effective process, with the confidence that the provisions therein are supported by the LP community.”
LPs and GPs will be able to “pick provisions out of it that will work for them,” said Chris Hayes, senior policy counsel for ILPA, speaking on a Private Funds CFO podcast.
The terms of the document reflect those described in ILPA’s Principles 3.0, and as such feature a “whole of fund” waterfall – as opposed to the more GP-friendly deal-by-deal option.
“We obviously think that’s the best model, because it reduces clawback risk and other issues, but we do want to be responsive to the marketplace and our goal in the future is potentially to release a deal-by-deal waterfall down the line,” said Hayes.
The 70-page document was created with input from a taskforce of 20 lawyers.
Notable provisions in the model LPA include:
- A recognition of the GP’s fiduciary duty, including an appropriate standard of care to ensure trust in the long-term GP/LP relationship
- The GP is not permitted to “pre-clear” conflicts of interest in order to ensure LPs’ consent
- Specification that a co-investor should bear its pro-rata share of fees, expenses and liabilities of a portfolio investment in fairness to the other LPs in the fund
- A requirement for GPs to furnish LPs with a list of all the other LPs in the fund on a quarterly basis, in order to ensure that the partners are aware of who their peers are and so they can adequately exercise their governance rights if necessary.
Below are the key terms in full, as per ILPA’s notes
Fund economics in the ILPA model LPA
- Includes a “whole of fund” waterfall to limit the possibility of a clawback and ensure long-term alignment of interest [ILPA intends to release a deal-by-deal waterfall at a later stage];
- Includes a GP catchup and preferred return to drive alignment between GP and LP and focus on investment performance;
- Includes an optional escrow provision to ensure LP protection;
- Includes a GP clawback to ensure LP protection;
- Includes an LP giveback to ensure fairness for the GP;
- Allows flexibility to modify the economic arrangements of the investment opportunity based on the particular GP and strategy;
Standard of care and exculpation and indemnification
- Recognizes a fiduciary duty of the GP and manager and includes an appropriate standard of care to ensure trust in the long-term GP/LP relationship;
- Includes GP exculpation to protect the GP in certain circumstances, but excludes GP indemnification in the case of a breach of the LPA to make the terms of the agreement meaningful;
- Includes a provision for Removal of the GP for material breach of the LPA;
- Does not allow the GP to “pre-clear” of [sic] conflicts of interest in order to ensure LP consent;
- Specifies that a co-investor should bear its pro-rata share of fees, expenses, and liabilities of a portfolio investment for fairness to the other LPs in the fund.
Governance, control and LPAC provisions
- Provides for expanded rights and tools for the LPAC to provide improved governance for the fund including:
- the ability to meet in camera without the GP or its affiliates present;
- the ability to appoint advisers at the expense of the fund to provide expertise in decision-making;
- the ability to be covered by insurance as a fund expense to protect LPAC members;
- Requires that the LPAC approve all affiliate transactions, even if they are at “arm’s length” to ensure informed consent to conflicts of interest;
- Includes a limit on the amount of reserves a GP can hold to ensure all capital is being deployed to maximize performance and returns;
- Includes the LP right, upon a sufficient vote threshold, to terminate or suspend the commitment period of the fund;
- Requires consent of a significant majority of LPs for a change of control of the GP or management company to ensure alignment of interest;
Key person and removal provisions
- Includes a No-fault Removal provision without payment of additional management fees to the GP, upon a LP vote threshold;
- Includes the option to impose a haircut on carried interest to the GP upon the vote of a supermajority of LPs;
- Provides for the reduction of carried interest to the GP by 100% upon a vote of the LP to Remove a GP for cause;
- Provides for the automatic suspension of the investment period upon a Key-Person event occurrence;
- Includes an automatic termination of the investment period of the fund after an optional period of time if LPs do not approve a remediation plan for a Key Person Event.
Information and communication access for LPs
- Includes specific disclosures that can be made by LPs without prior GP approval;
- Explicitly permits LPs in the fund to communicate with one another about fund related issues in order to exercise their governance obligations;
- Requires GPs to furnish LPs with a list of all other LPs in the fund on a quarterly basis to ensure that the partners are aware of who their peers are and can adequately exercise their governance rights if necessary.