The limited partnership agreement: why should lenders care about?
Iulia Gay, Senior Associate, SJL Jimenez Lunz
The fund finance market has experienced in the past years a strong development as the diversification of products may testify it. While subscription facilities have been leading the lending product, lenders have expanded their offer to NAV facilities, hybrid and umbrella facilities.
Subscription facilities, also referred to as “capital call” credit facilities, are short-term loans (generally 12 months or less) provided to a fund and secured by the fund’s right to call the undrawn capital commitments made by the investors. The aim is to bridge the time laps in between the capital calls and the actual funding by the investors. The borrowing base for such facilities is determined by reference to the uncalled commitments of the investors. The credit risk analysis will be based on the creditworthiness of the investors. The usual security package would cover the (i) pledge over the uncalled capital commitments and the accessory rights and (ii) pledge over the bank accounts into which the investors are required to fund their commitments.
NAV facilities, also referred to as “asset backed” facilities, are loans provided to the fund itself or at a level below to a special purpose vehicle (SPV). They aim to supply liquidity needs of the fund, notably after the acquisition of the investments when the portfolio becomes illiquid and also used as a leverage tool. Such facilities are secured by the underlying portfolio and the related distributions. The borrowing base is calculated on the net asset value (NAV) of “eligible” underlying assets. A strong component of such financing is the loan to value ratio (LTV Ratio), meaning the ratio of outstanding loans under the NAV facility to the borrowing base as adjusted from time to time. The security package will focus on the underlying assets and can be structured either at the level of the fund itself or, more commonly, at the level of the SPV(s). It will include for example, a pledge over 100% of the equity interests of the fund in the SPV and over the SPV’s bank accounts where the distributions are made, as a portfolio investment payment.
Hybrid facilities combine both “capital call” facilities and “asset backed” facilities and are a good opportunity for the lenders to have a full “look-up” and “look-down” security package. Moreover, in case of a hybrid facility, the pledge over capital commitments can be structured at a double level, (i) a first ranking security securing the obligations under the subscription line and (ii) a second ranking security securing the obligations under the NAV facility.
With the introduction of (i) the common limited liability partnership (SCS) and the special limited partnership (SCSp), (ii) the law on alternative investment fund managers, both in 2013, as well as, (iii) the reserved alternative investment fund law in 2016 in the legal framework, Luxembourg has become a top choice jurisdiction for unregulated funds. Limited partnership agreements (LPA(s)) governed by Luxembourg law are, among others, fine-tuned to adapt to the continuously growing fund finance market. They include a full range of “bankable“ financing provisions with the aim of accommodating the lenders’ concerns and requests and providing more comfort to the latter, as from the inception of the fund.
What are the key provisions to be analysed by the lenders?
Independently of the type of facility to be put place, the lenders will seek to ensure from a legal point of view, that (i) the fund has the capacity to borrower money and secure its obligations and (ii) their related rights under the facility derive from the provisions of the LPA and the other fund documents.
The key provisions of an LPA due diligence (without this being an exhaustive list) are: the capital commitments, borrowing, guaranteeing, power and authority, investment period and early termination or suspension, waivers of counterclaim, defenses and setoffs, excuse/exclusion and overcall provisions.
Capital commitments: The LPA includes an irrevocable commitment of the investors to fund capital when called by the general partner or the investment manager (as applicable). This provision should be analysed in light of all the limitations included in the LPA and in the other bespoken fund documents binding the investors individually, e.g. the side letters. More generally, the LPA should provide that the fund can specifically make capital calls in order to repay borrowings.
Borrowing/guaranteeing/security grating: Borrowing should be expressly permitted by the LPA. Some LPAs may limit the borrowing to a certain level (e.g. certain percentage of the total commitments), amount (e.g. the aggregate amount of all uncalled capital commitments), duration and/or purpose (e.g. short term borrowings lesser than 12 months, which correspond to the bridging subscription lines and/or long term borrowings, which correspond to the leverage strategy of the fund). In the same line, giving guarantees to secure obligations of affiliates or other third-party (which can also be subject to similar limitations) should be expressly permitted by the LPA.
Noting that subscription facilities are secured by a pledge over the uncalled commitments, it is very important to check whether the LPA authorises the fund acting through its general partner or the investment manager (as applicable) to pledge, mortgage, assign, transfer and grant security interests over (i) all capital contributions of the investors, the right of the general partner and/or investment manager (as applicable) to deliver drawdown/capital call notices and collect the capital contributions thereunder, (ii) the investors’ obligations to make the capital contributions and (iii) the collateral account into which the payments by the investors of their uncalled capital commitments are to be made.
If the LPA does not specifically allow the pledge of the claims against the investors in relation to the uncalled capital commitments, the lenders will seek the acknowledgment and acceptance from the investors of such pledge via side acceptance letters. In Luxembourg, in particular, it is usual for the lenders to require that the investors are notified and accept the pledge over the uncalled commitments, such notification and acceptance not being necessary for the security to be enforceable but rather to ensure that the debtor of the claim i.e. the investor can no longer be validly discharged from its obligation to pay towards the security taker by invoking its ignorance of the pledge granted by the fund and, the transfer of the claim to the lenders.
Power and authority: The general partner of the fund is vested with the broadest powers and authority to act on behalf of the fund and to do all things necessary to carry out the purpose of the fund. The general partner may be authorised by the LPA to delegate certain powers to an external manager (in the case of an alternative investment fund, to an alternative investment fund manager) notably, powers to make capital calls from investors, pledge the assets of the fund and exercise remedies against defaulting investors. The lenders should review the LPA and the investment management agreement and have a clear view of the powers attributed to each of the general partner and the investment manager.
Waivers: In order to ensure full enforcement of the pledge over uncalled commitments, particular attention should be paid to the waivers of counterclaim, defenses and setoffs included in the LPA. The Luxembourg law of 5 August 2005 on financial collateral arrangements provides that a debtor of a claim subject to a financial collateral arrangement (in the case at hand, the investor) may waive in writing its set-off rights as well as all other exceptions with regard to the creditor of the claim provided as collateral and with regard to the persons in favor of whom this creditor has granted a pledge. It is therefore customary to include waivers of defenses and setoffs in the LPA or the subscription agreement.
Third-party beneficiary provisions: Unlike the French market which has developed the third-party beneficiary provisions practice giving direct capital call rights to the lenders and providing adequate remedies against defaulting investors in the LPA, the Luxembourg market provides for a transfer of such rights via pledges. However, should the LPA expressly prohibit third parties to the LPA from the benefit of its provisions, the lenders may wish to have them carved out from such prohibition.
Investment period, termination or suspension: During the investment period as described in the LPA the fund can make capital calls for specific purposes. As the uncalled commitments are pledged to the benefit of the lenders, the latter should check when the capital calls can be made and for which purposes. The same applies to the early termination or suspension of the investment period where the rights of the lenders to claim the uncalled commitments can be impacted.
Excuse or exclusion provisions: Excuse or exclusion provisions contained in the LPA allow certain investors under certain circumstances to be excused or excluded from funding following the receipt of a capital call. The lenders may wish to have a clear view of these exceptions in order to exclude such investors from the borrowing base.
Overcall provisions: The overcall provisions and percentage limitations allow under certain circumstances an investor called to fund to cure shortfalls from other defaulting investors not to actually do it. These provisions have a direct impact on the options of the lenders to seek capital on a joint and several basis among the investors. As per the above excuse and exclusion provisions, the lenders should have a clear view of these limitations of obligations mechanisms.
Other fund documentation: Besides the LPA other fund documentation should be taken into consideration when conducting the due diligence. The subscription agreements, the investment management agreement, the depositary agreements but not less important the side letters signed in between a specific investor and the fund should be considered. Side letters are individual agreements that supersede the general terms of the LPA and provide bespoke terms in between a certain investor and the fund. The lenders should in particular investigate on the most favorite provision (MFN) which specifies that the fund agrees to give an investor the best terms it makes available to any other investor.