Aprivate equity fund (PE fund) using escrow services typically pools the capital of investors in the fund to a “fundraising account” before releasing it to an “escrow account” under management of the custodian. However, unlike escrow accounts, fundraising accounts have been attracting controversy about in whose name these accounts should be held.
Pursuant to the Measures for the Administration of Fundraising Activities by Private Equity Funds issued by the Asset Management Association of China (AMAC) in April 2016, which require that “the fundraiser or accountable person as agreed in the relevant contract shall maintain an account used exclusively for fundraising and settlement activities of the PE fund”, the holder of the fundraising account should be the “fundraiser” or “accountable person as agreed in the relevant contract”.
Although neither the fundraising measures nor any other regulatory documents provide a definition about the “accountable person as agreed in the relevant contract”, it is undeniable that this provision allows the fundraising account to be held under the name of the fund manager or, as agreed, under the name of the PE fund partnership.
The authors have reviewed templates of custody and escrow agreements of several banks and consulted them via phone, only to find that they do not have unified understanding and requirements in this regard. The authors find that commercial banks and their branches in some places (especially those in Shanghai) require fundraising accounts to be held under the name of PE fund partnership, while there are others (especially those in Beijing) requiring them to be held in the name of fund managers. More interestingly, the authors have consulted clerks from a Shanghai branch and a Beijing branch of a national commercial bank, and they gave responses that reflected exactly the discrepancy mentioned above.
From the perspective of operations, and as almost unanimously agreed by financial institutions, there is nothing wrong with the fundraising account being held in the name of the fund manager prior to completion of fundraising activities for a contractual PE fund, because the fund is not duly incepted unless fundraising closes. However, there are occasions when a PE fund partnership completes industrial and commercial registration and receives its business licence before investors pay up their subscribed capital, as a result of which it may open an account with independent capacity. So here is the question: Are there any differences in the legal consequences of having the fundraising account held under the name of the respective entities as described above?
According to article 20 of the Partnership Enterprise Law, “all the capital contributions made by partners, the proceeds and other properties acquired in the name of the partnership must be the properties of the partnership enterprise”. In the authors’ opinion, a PE fund partnership is perceived first of all as a partnership, instead of a fund. Therefore, a partner’s capital contribution obligation is not fulfilled unless and until his investment is injected into the partnership. As a limited partner, an investor in a PE fund partnership is not deemed to have fulfilled the capital contribution obligation until his or her committed capital is transferred to the bank account held in the name of the partnership.
As can be inferred from article 31 of the fundraising measures, which prohibit transfer of an investor’s committed capital from the fundraising account to the asset or escrow account of the fund before the investor’s subscription is confirmed successful by a field visitor arranged by the fund, the capital held in the fundraising account is directly transferred to the asset or escrow account.
If capital flows from the account of an investor (limited partner) to the fundraising account held in the name of the partnership, and subsequently to the fund’s asset or escrow account, the process that the limited partner injects capital into the partnership can be clearly identified. However, if the capital flows from the investor’s account to the fundraising account held in the name of the fund manager before being transferred to the fund’s asset or escrow account, it may appear that it is the capital of the fund manager (usually the general partner) that is being injected into the partnership.
The flow of funds in the latter case also gives rise to a few potential challenges. First, there is no ready evidence that the limited partner has fulfilled the capital contribution obligation. Second, it complicates the fund manager’s legal relationship with the investor and the partnership. Third, the limited partner is at the risk of receiving capital contribution default claims. In extreme cases, he or she can be required to take a share in the partnership’s debts to the extent of capital subscribed.
In judicial practice, monies in a bank account are considered to belong to the account holder unless there is sufficient evidence to the contrary. If the fundraising account is held in the name of the fund manager, once the monies of the account are seized, frozen or deducted due to debt enforcement against the manager, investors may risk losing their committed capital, given the current PRC legal framework that does not require complete segregation of proprieties (as required under the Trust Law) between PE funds and their managers. On the contrary, investors are less likely to be exposed to this risk if the fundraising account is held in the name of the PE fund partnership, because as a new entity (in most of the cases) the partnership has a “cleaner” profile of transactions and debts than the fund manager at the stage of fundraising.
Anyway, arrangements under the fundraising measures as to capital contributions by investors in a PE fund partnership must be subject to the Partnership Enterprise Law, which, as the superior legislation, takes precedence over the fundraising measures. In view of compliance and risk control practices, the authors believe that having the fundraising account of a PE fund partnership held in the name of the fund (i.e., the partnership) is more advisable.
Chen Min and Lu Xili are partners at Boss & Young
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