The underlying credit decision of a subscription line lender is based on the contractual relationship between a fund and its investors; and in particular on the obligation of investors, pursuant to that contractual relationship, to pay their committed amounts when called upon to do so (their capital commitments). Given this, the constituent documents of a fund are of great importance to a lender.
Historically US and European lenders have had different approaches to the provisions included in such constituent documents. Customarily, European lenders have been comfortable to accept a broad variation of constituent documents and limited partnership agreement (“LPA”) language, provided that such documents permit security to be granted over the right to call committed amounts from investors (also known as the right to issue drawdown notices) and permit the proposed borrowing. US banks, on the other hand, have historically pushed the fund formation market to establish vehicles with detailed LPA provisions that support subscription facilities and protect the interests of subscription lenders.
As fund financing has become ever more prevalent in Europe, lender requirements and preferences as to the form of constituent documents are increasingly considered when a fund is established. This has led to a convergence of approaches, and in turn has led to an increase in the number of “lender friendly” LPAs. Terms typically found in a lender friendly LPA include:
- Express Authorisation: an express authorisation of borrowing by the fund, as well as an authorisation for the fund, acting through its general partner/manager (as applicable), to grant security to lenders (or a security agent on their behalf). Such authorisation typically covers security to be granted in respect of capital commitments of investors including the right of the general partner and/or manager (as applicable) to deliver drawdown notices and take enforcement action against defaulting investors as set out in the LPA as well as over the account into which funds from investors are to be received. Whilst such express authorisation clearly provides comfort to a lender, regard should still be had to any limitations on borrowing levels, duration or purpose set out in the LPA.
- Investment Period: confirmation that calls can be made on investors after the end of the investment period (however defined), if such calls are being made in order to repay lenders. Historically, LPAs have provided that, following the end of the investment period (whether by effluxion of time, or as a result of early termination or suspension), calls from investors may only be made for limited purposes, and such purposes have not necessarily expressly contemplated the repayment of a lender(s). A friendly LPA will often however expressly address this point.
- Drawdown: an express confirmation that investors will honour a drawdown request made by a lender (or security agent). As noted above, a friendly LPA will typically authorise the general partner/manager to grant a security interest over the right to issue drawdown requests to investors, and over each investor's obligation to meet capital calls. However, lender friendly LPAs often see provisions go further than this, and expressly confirm that investors will comply with any drawdown request made by a lender (or security agent on their behalf).
- Set-off/Counterclaim: confirmation that investors will fund a drawdown request made to repay a facility by a lender without defence set-off or counterclaim. Such a confirmation helps provide further assurance that nothing will cut across the lenders' credit decision of undrawn capital commitments being available to repay the facility.
- Information: a requirement that investors provide specific information to lenders (directly, or via the general partner/manager) if requested to do so. Lenders will likely require certain details in respect of investors (their names, address details for service of drawdown notices and commitment amounts to name but a few). LPAs tightly control the dissemination of information and have not historically expressly permitted a third party, such as a lender, to receive such information. A lender friendly LPA however typically permits such information to be provided, although in some circumstances the flow of information is limited in scope, and a careful review of such information provisions are still required, even where friendly language is included.
- Cross-collateralisation: express cross-collateralisation rights allow the lenders to make a credit decision on the investor commitments across all parallel vehicles and treat the investor commitments across all vehicles as one large borrowing base. Without the same, there may be a need for the lenders to make a credit decision on each fund vehicle separately. Increasingly, express cross-collateralisation rights are set out in LPAs.
- Overcall rights: there are increasing limits on overcall rights generally (calling on other investors to make up for a shortfall due to defaulting or excused investors) including expressly removing overcall rights for Priority Profit Share/Management Fee. At the same time, funds that wish to borrow for the same are expressly stating that these overcall limitations do not apply to repay borrowings.
The move to include friendly LPA provisions is on its face beneficial to fund finance lenders. However, as the number of friendly LPAs has increased, so too has the number of side letters entered into with investors (and the breadth of issues they cover). Side letters supplement and modify the terms of an LPA in respect of a specified investor, or group of investors, and in many cases cut across friendly LPA provisions. What might appear to be a friendly set of constituent documents on its face, may be far from that once a close analysis of all side letters entered into with investors has been carried out.
Our next primer in this series will consider some of these side letter provisions.
With special thanks to Elizabeth Street-Thompson, Associate, for her contribution.
