Key issues and a possible fix for capital call financing

By Stacey Overholt and Lorraine Pao, Maples and Calder (Hong Kong)
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Cayman Islands private equity (PE) funds are often established using a Cayman Islands (CI) exempted limited partnership (ELP). It has become increasingly common for an ELP to use credit facilities secured by the right to call and receive capital contributions from its limited partners (LPs) to provide liquidity and enable it to seize investment opportunities.

This article explores key issues that arise when an ELP is putting capital call facilities in place, and explores a possible solution to issues in these transactions.

Stacey Overholt Maples and Calder (Hong Kong)
Stacey Overholt
Maples and Calder
(Hong Kong)

A challenge in fund financing is balancing the legitimate commercial concerns of the general partner (GP) for confidentiality and not wanting to approach the LPs against the lender’s need for disclosure and certainty of cash flow.

How do you take security over the right to call capital? Usually an assignment by way of security of the right to call capital is taken, and this agreement may be governed by foreign or CI law.

Since the rights being assigned arise from a CI law-governed limited partnership agreement (LPA), you need to take the steps required by CI law to obtain priority. To do this, the GP gives written notice of assignment to the LPs. Priority between competing interests will be determined according to the date upon which written notice is given to the LPs, and so, from a lender’s perspective, it is critical that notice be given immediately after the grant of security.

DUE DILIGENCE

Lenders taking security over the right to call capital will want to review as much documentation – such as side letters, registers and GP constitutional documents – as is made available to identify issues that could impact the value of the security. Many GPs, in particular in developed fund markets, may not agree to such disclosure and instead lenders will rely on representations or other comfort from the GP, such as legal opinions from fund and lender counsel. Where the balance is struck, and what documents are provided, ultimately will vary in different markets and with the size and influence of the GP and the LPs.

Lorraine Pao Maples and Calder (Hong Kong)
Lorraine Pao
Maples and Calder
(Hong Kong)

The LPA should be reviewed to see whether the GP has an express power to borrow and grant security over its right to call capital, and what limits there may be on these powers. Other consents required by the LPA, such as advisory board consents, should also be identified.

The review of the LPA may also identify potential blocks to the ability to call for capital and excuse or withdrawal provisions that could shrink the pool of commitments available to a lender. In some cases, the review may discover drafting inconsistencies that inadvertently create uncertainty as to whether a general partner has the power to grant security over its right to call capital. These issues can increase the complexity of, and legal fees associated with, these transactions.

‘HELL OR HIGH WATER’

While lenders may be able to cater for and structure around excuse provisions in LPAs, in some markets the LPAs can contain absolute draw stops on the ability to call for capital, which pose a risk for lenders.

While the market has not yet adopted this approach, one way for GPs to offer comfort to lenders and reduce negotiations in a financing would be to include a modified “hell or high water” clause in the LPA. It would provide that where a call is issued in order to repay any indebtedness secured by the right to call capital, LPs must be required to make their contributions to the ELP in the amount called, notwithstanding the offending provisions of the LPA, which potentially block the LPs’ obligation to pay. Since the CI has third-party rights legislation, secured parties can be given third-party rights to enforce these clauses of the LPA.

Each ELP and its investor base is unique and so a “hell or high water” provision will never be a one-size-fits-all solution. It will need to be adapted and modified on a case-by-case basis – for example, to reflect excuse rights relating to certain types of investments or to match terms agreed in side letters – but may provide parties with a way to simplify their capital call financings.

STACEY OVERHOLT and LORRAINE PAO are partners at Maples and Calder (Hong Kong)

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Maples and Calder (Hong Kong)
53/F, The Center, 99 Queen’s Road Central

Hong Kong
www.maplesandcalder.com

Contact details:

Tel: +852 3690 7441

Email: stacey.overholt@maplesandcalder.com

Tel: +852 2971 3096

Email: lorraine.pao@maplesandcalder.com