United States: Drafting Tips For Limited Partnership Agreements Or Operating Agreements For Companies Seeking Financing

Private equity and venture capital investment funds ("Funds") are increasingly interested in entering into credit facilities to provide these Funds with short-term liquidity. These credit facilities will typically be structured as a capital call credit facility or a subscription credit facility in which the lender will agree to make loans available to the Fund based on some percentage of the Fund's remaining uncalled capital (i.e., the amount of capital the Fund can call from its investors). Although some of these facilities may be unsecured, most of them are usually secured either by a blanket lien or a limited lien on the proceeds of the Fund's capital calls, the right of the Fund and its general partner or manager ("Managing Entity") to call capital, and the Fund's investments.

One challenge that frequently arises when lenders and Funds are structuring a capital call facility is whether the Fund's limited partnership or operating agreement (the "Fund Document") is drafted in a way to satisfy the lender's diligence requirements such that the lender has adequate assurance that (1) the Fund is able to incur and repay indebtedness, (2) the Fund and its Managing Entity can grant security interests to the lender in the applicable collateral, and (3) the Fund can call capital from its investors with limited restrictions. If the lender is not satisfied with the provisions in the Fund Document, the lender may require the Fund to amend its Fund Document, which requires the Fund to approach its investors, often leading to delays in obtaining financing and increased costs for the Fund. Therefore, it is recommended that Funds incorporate certain provisions into their Fund Documents that will satisfy lenders' requirements for such a credit facility.

Below are provisions that lenders will look for in a Fund Document when evaluating whether to extend credit to a Fund, as well as some examples of clauses that are typically flagged by lender counsel, along with alternate suggested language that is usually more amenable to lenders in these credit facilities:

1) Allow for the Fund to incur indebtedness. Although many Fund Documents authorize a Fund to incur indebtedness, they may also put certain restrictions on the type or amount of indebtedness the Fund may incur. For example, a Fund may be prohibited from incurring any indebtedness which exceeds a certain percentage of capital commitments or without the approval of a certain advisory committee or other key person. A Fund should consider specifically carving out these capital call or subscription facilities from such restrictions in order to maximize the amount of indebtedness it may incur and streamline the process needed to obtain a credit facility.

2) Allow for the Fund to secure its borrowings with a pledge of capital commitments. Some Fund Documents are silent on whether the Fund's indebtedness can be secured, and other Fund Documents state that the Fund can borrow but cannot secure its borrowings with a pledge of capital commitments. Lenders are cautious in the absence of clear language that capital commitments may be pledged to secure loan obligations. A Fund should consider adding clear language to its Fund Document, such as the following: "The Partnership and the General Partner may secure any of the Partnership's indebtedness for borrowed money with a pledge or assignment of all or any part of the Partnership's and the General Partner's (i) interest in the Partners' capital contribution proceeds and (ii) right to call and receive capital contributions."

3) Allow for the Managing Entity to pledge to the lender the Managing Entity's right to call capital. Many Fund Documents do not have language adequate to authorize the Managing Entity to grant the liens necessary for these facilities. For example, a Fund Document may authorize the Fund to grant a lien but does not explicitly authorize the Managing Entity to do so. Others may prohibit the Managing Entity from pledging its "interest" or "rights" in the Fund, which presumably would include the right to call capital. And others may permit the Managing Entity to pledge its "interest," but restrict the Managing Entity from pledging its "managerial" or "economic" interest without any indication of whether the right to call capital is included as such an interest. A best practice is to state clearly that both the Fund and the Managing Entity have the authority to grant a lien on the capital contribution proceeds and the right to call capital.

4) Have each investor acknowledges and agrees to fund any capital calls made by a lender or to repay indebtedness. Some Fund Documents do not address whether an investor would be committed to fund capital calls by third parties. Lenders prefer to see a provision in the Fund Document that commits the investors to fund any capital call required to satisfy the Fund's obligations to lenders or to repay indebtedness of the Fund.

5) Draft the "No Third-Party Beneficiary" provision expressly names lenders as third-party beneficiaries. Many Fund Documents include a blanket statement that the Fund Document shall not be deemed to construe any rights to any third party and that no third parties will be entitled to enforce any provision of the Fund Document. Such language decreases lenders' confidence that they will be able to enforce their right to call capital. Instead, Funds should consider adding a provision such as the following: "Except with regard to the rights of a secured creditor in connection with a subscription facility, the provisions of this Partnership Agreement are not intended to be for the benefit of or enforceable by any third party."

6) Limit conditions to investors' commitment to fund capital calls. Lenders prefer to see provisions in a Fund Document that commit a Fund's investors to fund capital calls without restriction except for certain mechanical conditions. The more provisions that excuse investors from funding a capital call, the less likely it is that a lender will agree to provide such a facility. In some cases, the lender may exclude investors from the loan facility's borrowing base if the excuse provisions are too broad; in other cases, a lender may require a reduced advance rate for the borrowing base. Funds should consider the potential impact of any excuse provisions an investor may want to incorporate into the Fund Document or side letters before they agree to include such provisions.

7) Make recallable capital "lender friendly." Funds often have the ability to recall distributions from their investors in certain situations. To the extent the Funds intend to include such recallable capital in their capital commitments, they should consider subjecting recallable capital to as few limitations as possible. Lenders may give Funds credit in the borrowing base for recallable capital, but only if the lender is certain that the Fund or Managing Entity will be able to recall such capital to repay indebtedness. For example, a Fund should avoid limitations on the period of time during which the Fund may recall capital or on the use of the proceeds of such recallable capital.

8) Commit investors to fund capital calls after the investment period. Although a Fund's primary investment activity will end after the termination of the commitment period or investment period, the Fund continues to make follow-on investments and manage ongoing investments and may need to continue to borrow. If the investors are not committed to making capital contributions after an investment period, then a lender may make the termination of the investment period a default or it may terminate any commitment to lend to the Fund once the investment period expires. To ensure continued access to liquidity, Funds should add language to their Fund Documents to expressly obligate their investors to fund capital calls made after the investment period in order to repay any indebtedness.

Funds should consider the above issues when drafting their Fund Documents. Funds often need financing quickly to be able to make investments, so they should consult with counsel to review their Fund Documents well in advance of pursuing a credit facility. A properly drafted Fund Document will help expedite the closing of the debt facility and reduce transaction costs.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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