Private equity funds are almost always formed as limited partnerships, but in Britain the statute that governs limited partnerships wasn’t originally drafted with fund managers or investors in mind and it has barely changed in the last 110 years. Until now.
Following a lengthy process of examination and consultation, the UK has just launched a new type of structure custom-designed for the alternative funds industry – the Private Fund Limited Partnership (PFLP). Any new or existing fund that has a written partnership agreement and is a ‘collective investment scheme’ under the UK Financial Services and Markets Act is eligible to be registered as a PFLP. In practice, most UK private equity funds will meet these criteria.
The PFLP remains a limited partnership, but with several notable advantages over the traditional limited partnership:
One reason that limited partnerships are suited to funds is that investors, who join as limited partners, benefit from limited liability, akin to shareholders in a company. Unlike shareholders, however, LPs cannot participate in managing the partnership or its business without incurring unlimited liability for the partnership’s debts during the period in which they are considered to be involved in its management.
The PFLP maintains the principle that limited partners have limited liability, but enhances it in the form of a non-exhaustive ‘whitelist’ setting out permitted actions that LPs can take without sacrificing their limited liability. By contrast, the traditional limited partnership offers no ‘safe harbours’ to LPs seeking to play a greater role in partnership decision-making without the loss of their limited-liability privilege.
In many ways, the PFLP is merely catching up with established market practice. Some of the whitelisted actions are already commonplace in fund LPAs (e.g. investors appointing LPAC representatives, approving extensions of the fund’s term or removing the GP), while others are perhaps more mundane (e.g. the approval of partnership accounts). However, some items on the whitelist (e.g. the power to approve the GP’s decisions to buy or sell investments) signal a significant extension of investors’ reach, and are often contentious whenever raised in GP/LP negotiations in the past.
It’s worth noting that the whitelist does not guarantee LPs any actual new powers over the fund – it merely safeguards the status of an LP who exercises powers granted to it in an LPA if those powers fall under the whitelist. It is still up to the investors and manager to commercially agree the inclusion of such powers in the LPA in the first place.
The traditional limited partnership imposes some slightly peculiar rules on investors’ capital. For instance, an LP must contribute capital at admission and it remains liable during the partnership’s entire life for its capital contribution, even if it later withdraws from the partnership. These rules led to a fair deal of lawyerly contortion in LPAs, with LPs’ formal capital contribution generally fixed at a tiny nominal percentage of their overall commitment, with the vast bulk of it consisting of (interest-free) loan commitment.
The PFLP bins these capital rules. Indeed, an LP is no longer required to contribute capital in a PFLP at all – instead, it can fund entirely by way of loan commitment. And an LP is no longer statutorily liable for capital that it withdraws from the partnership.
Occasionally, the LPs in a fund may vote to wind up the fund before the end of its term over the objections of the GP. Early termination of this kind is generally treated as a ‘nuclear option’, exercised only if the relationship between manager and investors has broken down irretrievably and there is no agreed replacement for the manager.
In a traditional limited partnership, the winding up process has to be completed by the GP itself or, if the GP has been removed by investors’ vote and there is no new general partner, by court order. Neither option is attractive – the court process can be expensive and time-consuming, whereas a GP holding on to office may dawdle or be tacitly obstructive if it had objected to the early termination in the first place.
In the PFLP regime, a court order is no longer necessary. The LPs are empowered to appoint any third party (such as a professional liquidator/administrator) to carry out the process on their behalf. This can be done irrespective of whether the GP is in office or has been removed. Making winding-up a more realistic route in this way should improve the investors’ overall negotiating position vis a vis the GP, particularly if they are able to corner the GP into conceding to other LP demands (e.g. on economics or governance) as an alternative to winding-up.
Setting up a PFLP should be quicker compared to a traditional limited partnership, with less information needing to be disclosed to Companies House in the application form. In the same vein, the PFLP is not required to notify Companies House of any changes to partners’ capital contributions or the partnership’s term or business. The PFLP also does away with the slightly archaic requirement to gazette any transfer of a partner’s interest before the transfer can take effect, but it will still have to gazette the termination of the GP.
It is an ancient precept of partnership law that partners owe a general duty of good faith toward their fellow partners. This applies in a traditional limited partnership, too. In particular, a partner is bound to disclose all information affecting the partnership to the other partners, and to account to the other partners for profits made in competition with the partnership. These duties are seldom appropriate in the context of a private fund investor, and it has become customary to disapply them in the LPA – which will be the default position in a PFLP.
Once a fund opts into PFLP status, it is permanent – the same fund cannot later switch to being a traditional limited partnership. But it’s unlikely that funds choosing to register as PFLPs would want to switch away. The PFLP model resolves many of the issues that both GPs and LPs have had with the traditional limited partnership. It updates the law to reflect the evolution in the role and responsibility of investors within private funds, while also bringing the UK into line with other popular European fund jurisdictions (such as Jersey, Guernsey and Luxembourg) that already offer partnership structures with ‘safe harbours’ and other PFLP-style protections.
If you have any queries or would like more information, please contact: Mark Silveira or Jacob Freeman
This document is written as a general guide only. It is not intended to contain definitive legal advice, which should be sought as appropriate in relation to a particular matter.
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