Subscription facilities, or loans made by a bank or a financial institution to a private equity fund, which are typically secured by unfunded commitments of limited partners of the fund and the right to receive proceeds of capital calls, continue to dominate Asia’s fund finance market. The Cayman Islands exempted limited partnership (ELP) is commonly used for structuring private equity funds and, where so structured, the security package will typically include an assignment of these rights as per its limited partnership agreement (LPA) and the relevant subscription agreements.
This article addresses key issues that lenders should consider before advancing a subscription facility to an ELP.
Permission to incur debt
Partner
Loeb Smith Attorneys
The LPA must expressly permit the incurrence of debt, the giving of any guarantee and/or the granting of any security. In addition, it should permit payment of capital contributions into any bank account over which the lender takes security. Lenders should be alert to any conditions or restrictions in the LPA that need to be obtained, satisfied or waived, such as an advisory committee consent and/or a restriction on the maturity or amount of any permitted indebtedness.
Commitment period
If an ELP’s commitment period is suspended or has expired, the general partner may be unable to call capital from its investors. Lenders should ensure the LPA contains a carveout with respect to capital calls to fund repayment in that situation.
Leakage
If the LPA permits the ELP’s general partner to set up parallel funds, blockers and alternative investment vehicles, these provisions may allow the ELP to divert investor commitments to other vehicles. In this case, lenders should ensure these commitments are included in the security package.
Confidentiality restrictions
Lenders should consider excluding an investor from an ELP’s borrowing base if the LPA contains any restrictions preventing the disclosure of investor information to the lender. This is because a lender may be unable to enforce its security without details of the investor. The lender may also be unable to complete legally required “know-your-customer” checks.
Transfer of LP interests
Legal director at Loeb Smith Attorneys’ investment funds group in Hong Kong
An investor may have the option to transfer its limited partnership interests to a third party under the LPA. Lenders should consider excluding any such third party from the ELP’s borrowing base from a credit perspective. A compromise may be to take into account transfers to an investor’s affiliates, as long as this does not breach the ELP’s borrowing base.
Excuse rights
An investor may wish to be excused from honouring a drawdown notice with respect to an immoral investment, or in a location or industry that is politically sensitive to the investor. These types of rights are relatively common and typically accommodated by most lenders. However, lenders should consider excluding an excused investor from an ELP’s borrowing base and potentially insist on a default event if the excused commitments exceed a specified threshold. This is typically negotiated, as excuse rights are investor-specific and generally unrelated to an investor’s creditworthiness.
Termination and dissolution
Lenders should ensure the proposed maturity date of a subscription facility falls within the term specified in the LPA, as the ELP is dissolved at the end of that term. Furthermore, to the extent that the LPA includes a contractual “waterfall” for distribution of ELP assets after liquidation, a secured lender should ensure it has priority.
Side letters
Lenders should review any side letters to the LPA, to ensure its terms do not impact its credit assessment or adversely affect its ability to enforce the security package. Any adverse consequences of side letter terms may be multiplied if a most-favoured nation clause is included. Lenders may be able to mitigate this issue by requesting a carveout with respect to any matter that detrimentally impacts their interests in the subscription financing.
Priority of security
Priority of the security over unfunded capital contributions is achieved by giving written notice of its creation to investors. Lenders may ask investors to acknowledge receipt of the notice, but this is not necessary to achieve perfection or priority. Details of relevant security interests should be entered in the register of mortgages and charges maintained by the general partner of the ELP, but failure to do so does not invalidate the security or prejudice its priority.
Peter Vas is a partner at Loeb Smith Attorneys, and Wendy Au is a legal director at the firm’s investment funds group in Hong Kong
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