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In entering into a fund financing, both the Lender and the Fund have expectations that the relationship will be a success. The Lender is appreciative of the association, and the Fund is confident in its ability to raise capital, invest and pay back any borrowings as and when due under the credit documents with the Lender.
But what happens when things are not working out and the investment manager/management company needs to operate?
Delaware remains the most popular jurisdiction for the domestic formation of private equity and venture capital funds as either a limited partnership or limited liability company. In fact, 54.8% of the deals closed by Cadwalader in 2023 had a Delaware component. A myriad of reasons could be cited as the basis for this fact, but lenders are generally fine with this choice based on specific protections a lender is afforded under Delaware statutory law related to the obligations of an investor to a Fund. In particular, Title 6, Section 17-502(a)(1) of the Delaware Code provides “Except as provided in the partnership agreement, a partner is obligated to the limited partnership to perform any promise to contribute cash or property or to perform services, even if that partner is unable to perform because of death, disability or any other reason.”
Even more important, an Investor’s obligation to honor its promise to make capital contributions expressly extends for the benefit of creditors and Delaware law provides a statutory basis for a lender to assert a reliance claim to avoid a financial loss.
When an investor chooses a private equity fund, it is a calculated gamble on that fund’s general partner and more specifically its managing principals and the members of the investment team. The Key Persons are the individuals who the investors believe are critical to sourcing, making, managing and exiting from investments to maximize the investor’s return. A lender providing a subscription facility to a fund is also concerned with that fund’s management. These are the individuals that the lender is partnering with to provide liquidity and the Key Persons provide stability, predictability and, most important to the lender, instill confidence to incentivize an investor to fund its capital commitment to repay obligations under a subscription facility.
The Cadwalader team shares their insights into some of the conversations and topics from last week's Finance Forum.
A search of the term “discretion” in virtually any credit agreement will yield numerous results. It is the word or words preceding that result that often is a point of much consternation. Many borrowers prefer the use of “reasonable,” which connotes the idea that an objective standard must be utilized in making a determination and such standard would be applied in a manner that is consistent with the standard a lender employs in exercising rights and remedies with other borrowers and loans of similar structure, size and complexity. Most lenders, on the other hand, favor the use of “sole” or “sole and absolute,” which implies that the lender has the ability to exercise a greater degree of preferential discretion in deciding whether to approve an action (or inaction). Preferences aside, what does this distinction really mean when a contract vests the right to make a determination in a party to that contract? That answer lies in a small body of case law that varies by jurisdiction.
At the outset of every credit agreement negotiation, the implicit goal is to reach an agreement on representations and covenants that allows the Fund to operate as needed while also protecting the lender(s) against current and potential risks. Despite these best laid plans, there are times when the Fund is unable (or will be unable) to comply with the credit agreement. Virtually all credit agreements have a reporting covenant that requires the Fund to provide notice of any potential default or event of default at such time that a covenant has not been complied with or a representation was inaccurate when made. It is at this point that the Fund will inevitably ask for a waiver or a consent. These terms are often used interchangeably, but they have differing uses in different contexts.
A common feature included in credit agreements is a limitation on the amount of the unfunded capital commitment of a single investor (or the aggregate unfunded capital commitments of a class of investors) that can be included in the calculation of the borrowing base on any date of determination. Such feature serves to protect a lender against too great of an exposure to a single investor (or class of investors) and better ensures that the borrowing base is comprised of a diversified pool of unfunded capital commitments. In the early stages of fundraising, the investor pool may be limited in number and largely comprised of a short list of anchor investors. The application of a concentration limit can significantly diminish the calculation of the borrowing base under these circumstances.
In the days leading up to the closing of a credit facility, it is not uncommon for the administrative agent to ask each lender a simple question, “do you need a note?” For many lenders, the response is in the affirmative, but such an answer sometimes seems to be given out of instinct and without a thorough contemplation of the potential headaches that are being obtained. An understanding that the note may need to be amended, must be retained for future return to the borrowers, and may impose taxes that could change the direction of future responses.
In recent months, we have seen several requests to include a swingline facility in the capital call loan documentation for syndicated facilities. Swingline loans are normally made available as a component of a revolving credit facility by one of the lenders designated as the “swingline lender.” Swingline loans are designed to give the borrower more rapid access to funds than would otherwise be permitted by the notice periods prescribed in the credit agreement, which typically require at least three business days notice for eurocurrency loans and one business day notice for base rate loans. In addition to affording same-day funding, swingline facilities also grant a borrower greater flexibility by permitting swingline loans to be requested at a later time on the date of funding. Swingline loans can be funded with shorter notice because they are being advanced by only one lender, which is often the lender serving as the administrative agent.
In a prior article, we highlighted common issues contained in side letters that are concerning to Lenders. Whenever a problematic side letter provision is included, a Lender is faced with either excluding the applicable investor from the calculation of the borrowing base or developing a workaround to allow the Fund to keep its contractual arrangement with the investor in the side letter intact while also protecting the Lender’s interest.