The Institutional Limited Partners Association (“ILPA”) has recently issued a publicly available model private equity limited partnership agreement (the “Model LPA”) as part of its simplification initiative. ILPA is an international organization that represents the limited partner community, although it also works with managers of private equity funds and other practitioners when publishing its model texts and guidelines. One of ILPA’s principal aims in publishing the Model LPA is to standardize a document that is generally negotiated on a bespoke basis.

Efficiency is a potential benefit to the Model LPA. In addition, to the extent an investor ‘friendly’ document such as this is used, it is also likely that the time spent negotiating side letters (and administering them) would also be reduced. However, before agreeing to use the Model LPA (or aspects of it), managers should be aware of the potential strategic, commercial and contractual implications of using this new template. Similarly, while it might seem counterintuitive, a focus on terms perceived to be favorable to investors can actually be harmful to investors as a whole as the manager may find its hands tied in managing a problem with an investor, to the detriment of other investors. For these reasons we would envisage that over time the Model LPA may serve more as guidance as to what investors are looking for than a precedent used by many.

While the Model LPA focuses on private equity (specifically, the Model LPA is tailored to a Delaware limited partnership for a U.S. buyout strategy), we would anticipate that investors will treat it as informative with respect to other closed-ended fund structures and across asset classes (including private debt and real estate).

The Model LPA follows a recent update to ILPA’s Principles for Fostering Transparency, Governance and Alignment of Interests for General and Limited Partners (the “Principles”)¹ and is generally consistent with them (and other guidelines issued by ILPA).

High-Level and Strategic Concerns

The selection of the base limited partnership agreement for a fund launch will inevitably set the tone for negotiations with investors and ultimately the terms agreed. Therefore, managers should be aware of some strategic points in this respect before agreeing to use the Model LPA.

• A private fund is a long-term proposition and accordingly the right balance needs to be struck between manager and investor interests to ensure a fair and well-aligned deal over the life of the fund. It may be argued that the Model LPA is less market balanced and too skewed towards investors.
• ILPA suggests that the Model LPA may be particularly helpful to emerging managers, presumably as they will not have precedent documents, are likely to have less resources for extensive negotiations and are less likely to be able to insist on sponsor-favorable terms. However, the Model LPA is not a complete first draft and requires further input. Emerging managers should also bear in mind that, to the extent they anticipate successor funds and/or repeat investors, they are likely to be tied to the base limited partnership agreement used for their first fund for some time. There is also no optionality for seed investor language in the Model LPA and managers would need to seek specific advice to the extent this was relevant. ILPA also recommends the Model LPA as a point of reference for existing managers, although we would not anticipate established managers wishing to move to this template as this would involve surrendering terms already agreed with prior investors.
• As with the Principles, it is likely that investors looking at funds beyond the U.S. buyout market are likely to request the Model LPA or certain of its terms. However, in many instances the terms of the Model LPA are not appropriate for different asset classes or a broader array of structures. Different structures may be selected for a variety of reasons relevant to the fundraise in question (including tax, anticipated investor base, manager infrastructure, etc.) and the limited partnership agreement used will need to be adjusted for the particular structure in question. For example, even if operating as parallel funds, Delaware, Cayman Islands and Luxembourg partnerships will require different terms relevant to their respective jurisdictions. Notable examples include specific Luxembourg requirements with respect to the treatment of defaulting investors and the scope of powers of attorney.
• While the Model LPA contemplates parallel fund structures, in reality, it is not appropriate for the sophisticated structuring that most large fundraises demand today. In particular, the Model LPA is unlikely to be appropriate for managers who manage (or anticipate managing) multiple accounts (including separately managed accounts and co-investment structures) or cover multiple strategies. The Model LPA could not be used for umbrella structures with multiple sub-funds (which are often used in Europe). Commonly requested features such as the ability to apply leverage to the underlying investments and the ability to allow investment through different currencies are also not fully provided for.
• While relatively comprehensive, the Model LPA still needs specialist assistance with respect to the regulatory and tax aspects. Although some language is unlikely to change significantly between funds, these should always be checked with regard to the investment strategy, the manager’s specific circumstances and other factors. For example, with respect to ERISA issues, the Model LPA assumes that the “venture capital operating company” (“VCOC”) exemption will be used if there is significant investment from Benefit Plan Investors – bespoke advice should be sought with respect to this technical area of law, particularly as this specific route is not available for a number of strategies. Similarly, European funds would need to take into account the provisions of the EU Alternative Investment Fund Managers Directive (“AIFMD”) and other EU legislation but would not necessarily be concerned by some of the U.S. regulation cited in the Model LPA (for example the provisions relating to the U.S. Federal Communications Commission’s rules may not be applicable to non-U.S.-focused investment strategies). Other specialist advice should also be sought to the extent a capital call or leverage facility is envisaged or certain types of investors are targeted (such as German regulated investors). With respect to the carried interest, the Model LPA also assumes that the recipient will be the general partner, which is frequently not the case, especially outside of the United States. As a general matter, carried interest structuring is likely to require further specialist input given that the structuring will be bespoke to the manager’s concerns, particularly if the firm spans multiple jurisdictions or the founders have complex personal affairs.

Fund Terms and Other Commercial Points

Disenfranchising the Manager
Under the Model LPA, investors have a variety of options to disenfranchise the manager. Importantly, the general partner may be removed and the commitment period can be terminated in a no-fault situation. Combined with a lack of manager protections within them (such as so-called ‘honeymoon’ periods, during which a provision cannot be invoked), these provisions put the manager at risk of a loss of revenue or losing ‘control’ of the fund without cause.

Managers should also be aware of the definition of ‘Removal Conduct’ in the Model LPA, which is particularly relevant in the context of the general partner removal provision. This is expansive and, again, does not build in customary manager protections. In particular, there is no requirement for a final court decision with respect to any removal conduct leading to a potential removal for cause notice, leaving the point open to debate. The removal conduct circumstances also apply to the fund’s key persons and in some instances a wider scope of removal conduct is applied to these individuals (all of which should be carefully reviewed).

Other Accounts
The Model LPA limits a manager’s activities with respect to other accounts it manages (or intends to manage). For instance, a successor fund is broadly defined, limiting a manager’s ability to launch similar accounts (including separately managed accounts and, potentially, co-investment vehicles) without the consent of the majority of investors. A better approach may be to include a covenant in the governing documentation to allocate deals in accordance with the manager’s established allocation practices (which would be consistent with the requirements that many managers, specifically those registered with the U.S Securities and Exchange Commission (“SEC”), are already subject to).

Economics
The Model LPA includes a whole of fund waterfall, rather than a deal-by-deal waterfall which can be more beneficial to managers. While this point may be more controversial in the U.S. buyout market, many funds, particularly those with European sponsors,² already adopt this approach. In any event, ILPA have confirmed that they intend to release a version of the Model LPA that uses a deal-by-deal waterfall in due course.

Consistent with the Principles and other guidance issued by ILPA, a footnote to the Model LPA notes that, to the extent the fund utilizes a subscription line of credit, the preferred return should be calculated from the date on which the facility was drawn (on the basis that capital is at risk from this date). However, many sponsors do not consider this appropriate, and it is not the market position.

In terms of expenses, the list of expenses borne by the fund could be more expansive and should be scrutinized by managers before agreeing to them. Being clear on fund expenses is beneficial to both the manager and investors and is also a focus of regulators such as the SEC.

Investor ‘Friendly’ Provisions
As a general matter (and unsurprisingly), the Model LPA includes a number of starting provisions that are more favorable to investors than we would otherwise expect to see in the market. In this vein, the Model LPA integrates a number of provisions that investors might typically request in side letter negotiations.

Managers (and investors) should also note that investor ‘friendly’ provisions may not be beneficial to the investor body as a whole. Similarly, over-defined processes and an over-reliance on consent procedures could cause practical issues in running the fund.

ILPA cite the reduction of the time and costs associated with side letters as a benefit of the Model LPA applicable for both investors and managers. Whilst there is some merit in this, there are a few points for managers to keep in mind. Firstly, by permitting terms that would otherwise be applicable only to investors with the relevant side letter provision (or the appropriate most favored nations (“MFN”) rights³) to go into the fund’s limited partnership agreement, the manager is accepting that the provision will now apply to all investors. Secondly, the Model LPA follows the (albeit not uncommon) practice of including an MFN provision in the limited partnership agreement, rather than deferring to an individual investor to negotiate this on their own behalf. In doing so, this provision is also applicable to all investors, widening its effect. Clearly some investors will have bespoke concerns that will not be applicable to other investors, such as the need for certain U.S. government-related investors requiring specific sovereign immunity clauses. The scope of the MFN provision is also increased by two significant factors – the application of the MFN is not affected by the size of an investor’s commitment (commonly investors only benefit from provisions agreed with investors with an equal or smaller commitment to them; this is not included in the Model LPA) and, while there are some carve outs to the MFN (such as confirmation of an advisory committee seat), a number of common carve-outs are missing from the provision. In addition, since any more favorable side letter rights automatically apply (there is no election process), any manager that does choose to adopt the Model LPA should be particularly disciplined in what they grant to investors. For example, a confirmation that an investor would be offered a defined portion of co-investments would not work if the Model LPA is used.⁴

Finally, while the Model LPA does include some square brackets and footnotes to accommodate an element of tailoring, it does present a number of terms as a ‘done deal’, when in reality these mechanics can be achieved quite differently in the market. The terms of the management fee in the Model LPA (including the basis of its calculation and the period of time during which it applies) is one such example. Similarly, the reinvestment provisions may need to be adapted to suit the relevant strategy (and other fund terms) and the key person/manager time and attention requirements will need to be adapted to the manager’s circumstances.

Other points of note:

• The Model LPA does not include compulsory withdrawal provisions (which would apply if the investor’s status caused a material adverse effect on the fund, for example). Instead, the Model LPA includes a requirement for the relevant limited partner to use commercially reasonable efforts to dispose of its interest in the fund. As the limited partner is involved in the process (and signs off on the sale price), managing an event such as a regulatory breach in respect of the fund is therefore beyond the fund's and the manager’s control. Such a lack of preparation by a GP in managing and addressing the regulatory breach would be harmful to the fund as a whole and to other investors.
• The Model LPA includes an acknowledgement that the disclosure of potential conflicts of interest in the fund’s offering documentation should not be treated as a ‘pre-consent’ should such a conflict arise. Given the level of investor scrutiny given to documentation prior to investment, we would suggest that points that are clearly disclosed should not require revisiting. Requiring repeat consents is also likely to be cumbersome for both managers and investors.
• The Model LPA envisages an advisory committee appointed at fund level but for a fund to operate within a parallel fund structure (which is also envisaged by the Model LPA) advisory committee members should generally be appointed across the parallel fund complex.
• The reporting requested in the Model LPA is extensive and is required to be given in accordance with the ILPA Reporting Template. Many managers do not provide this level or format of reporting.
• The Model LPA adopts the U.S. Generally Accepted Accounting Principles, which makes sense in the context of a U.S. focused buy-out fund. However, the International Financial Reporting Standards (or other local accounting standards) may be more appropriate for alternative structures/strategies.
• The Model LPA makes reference to environmental, social and governance issues – while there is a trend towards taking such issues into account (particularly in Europe), their operationalization through the Model LPA terms will need careful consideration by fund sponsors.

Contractual matters

Manager as a Party
Unusually, the fund’s manager is a party to the Model LPA. This does not work outside the United States, where, unlike the general partner, the manager is generally a regulated vehicle and its role, obligations and compensation arrangements are generally set out in a separate management agreement. As a party to the Model LPA, the manager is subject to a few direct obligations. Notably, the Model LPA imposes a standard of care on the manager (which is discussed in more detail below) and certain deal flow obligations⁵ that require specialist attention, especially in light of legally imposed standards of care.

Definition of ‘Fund Document’
The term ‘Fund Document’ is used throughout the Model LPA and is very broad in scope (it includes ‘any other agreements or understandings, written or otherwise, relating to or otherwise affecting the fund’). Importantly, the term is used in the definition of ‘Removal Conduct’, meaning that a material breach of a range of broadly undefined documents could ultimately lead to the removal of the general partner entity or expand the liability and limit the indemnity provisions. In addition, the term Fund Document is used in the entire agreement clause, meaning that this potentially broad range of documents formally become part of the fund’s contractual arrangements.

Contractual Standard of Care
The Model LPA imposes a contractual standard of care on both the general partner and the manager to manage and control the fund and its business ‘reasonably and in good faith and with the care that an ordinarily prudent person in a like position would exercise under the circumstances’. This has been added following concern that managers are contracting out of fiduciary duties (which can work in some structures/jurisdictions). However, the language goes further and actively imposes a standard in addition to what might otherwise apply under applicable law or regulation. Given that funds and their managers are generally subject to legal and regulatory obligations, fiduciary duties and contractual standards of care, the approach suggested in the Model LPA is atypical.

Conclusion

Fund structures and their managers are more complex than the arrangements envisaged by the Model LPA. For this reason, the Model LPA is likely to be treated as being instructive on investor perspectives rather than form a precedent for the industry going forwards.

In particular, managers should think carefully before agreeing to adopt the Model LPA, as it could impact the manager’s activities elsewhere and result in the manager prejudicing the fund’s bargaining position, while not ultimately benefitting from a quicker and cheaper launch process. Managers should be particularly mindful of the investor bias that the Model LPA represents and a number of the associated issues are highlighted herein (including the fact that investor ‘friendly’ terms can sometimes be counterproductive when viewed in the context of investor relations as a whole). It is also likely that investors contemplating investments beyond the U.S. buy-out market will want to reflect its terms, which is likely to exacerbate the issues described as the template has not been structured with such funds in mind.

Footnotes

1) For commentary on this, please see Dechert’s OnPoint article.

2) In Europe a deal-by-deal waterfall is generally the exception rather than the rule.

3) An MFN right allows an investor to elect to receive the side letter provisions negotiated by other investors. An MFN right can significantly extend the fund’s (or the manager’s) obligations; managers should therefore carefully consider which investors’ terms are likely to be captured by the MFN when negotiating these (and other) side letter provisions.

4) On the other hand, putting ‘side letter-like’ rights in the limited partnership agreement itself and the structure of the Model LPA MFN do make matters simpler for managers who are subject to the fair and preferential treatment provisions of the AIFMD. In addition, for a number of side letter provisions (such as reporting), it often makes little difference to offer a provision to one investor versus all investors.

5) In respect of deal flow, the Model LPA does caveat that this provision would need adjustment where other permitted accounts exist or are contemplated.