First-time Funds Series – Video #9: Remedies

Aaron Hunt (00:05): Welcome to the ninth installment of our First-time funds discussion. My name is Aaron Hunt, I'm an Associate in Torys' Private Equity Group, and I'm here today with my colleague Batya Nadler to discuss first-time funds, focusing on investor remedies.

Batya Nadler (00:17): Thanks so much, Aaron, and thanks to everyone tuning in. I'm a Senior Associate in Torys' Private Equity Group, and I'm excited to kick off our discussion today on investor remedies—so let's get right into it with an exploration of the different type of remedies, typically available to investors that are displeased with the actions of certain key individuals at, or generally with, the general partner, including some remedies that are less standard. The first type of remedy that is included in almost every fund is the key person remedy. Generally, limited partners expect certain key persons, being those investment professionals critical to the execution of the fund's strategy, to devote a significant amount of time to the fund. The market standard delineation of such time is often described as "a substantial amount of such person's business time". If a predetermined number of the key persons identified in the fund's governing documents fail to satisfy the delineated time commitment requirements, there is generally an automatic suspension of the investment period, subject in most cases to reinstatement following a "cure" event whereby a new key person is appointed, generally with LPAC consent. Of concern for investors when it comes to key person provisions is ensuring that the devotion of time requirements are limited, such that the relevant business time is being devoted to the specific fund itself, or when dealing with a larger manager, the specific area of focus for multiple funds managed by that manager—let's say credit or infrastructure—again, as appropriate. As noted previously, limited partners expect that key persons should not be replaced without consultation with and/or approval from the LPAC, or in some cases, a certain percentage in interest of the limited partners.

Aaron Hunt (01:53): The second set of remedies we will address are those triggered by the occurrence of a "cause" event. The "cause" event construct enables the investors to remove the general partner and/or terminate the investment period or the fund itself upon the occurrence of certain bad acts or omissions by the general partner or other key parties, for example, the investment manager and the key persons. We would generally look for a "cause" event to be triggered by actions or omissions constituting fraud, willful misconduct, bad faith, or gross negligence, as well as breaches of securities laws, criminal convictions (such as felonies), breaches of fiduciary duties, and material breaches of the fund documents. Upon the occurrence of cause, investors are often given the right to replace the general partner, or to terminate the fund, by majority in interest vote of the investors in the fund. In some cases, investors will also have the right to elect to terminate the investment period upon the occurrence of an event constituting cause—but this is less common, especially given that most fund documents include separate key person remedies. A general partner removed for cause will be entitled to a payout of their interest in the fund, as well as any carried interest earned up to the removal date. However, such carry payout is typically subject to a haircut, ranging from 25% to 50% of the carry that would otherwise be payable to the general partner.

Batya Nadler (03:10): Thanks Aaron. The final remedy we will cover are the "no-fault" termination rights. These rights enable investors holding a supermajority and interest in the fund to terminate the fund, terminate the investment period or remove the GP for any or no reason. Because the "no-fault" remedies allow investors to terminate without any specific bad act having been committed, they often follow a honeymoon period at the beginning of the life of the fund, during which time investors cannot effect such a "no-fault" remedy. Honeymoon periods generally range from one to two years from either the launch of the fund or the final closing date. It is quite uncommon to have the ability to remove the GP without fault and to the extent such remedy is available, there is typically no carry haircut assigned to it and the general partner remains committed to all carry receipts in such circumstance; however, we would note that we do see "no-fault" GP removals more often when it's a first-time fund.

Aaron Hunt (04:00): Thanks Batya. That's all we have for today. Hopefully this was a helpful summary of the typical investor remedies packages found in fund documents that we come across often in the market.