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This content first appeared as a chapter in Global Legal Insights Fund Finance 2022.
In this chapter, we have tried to set out some of the key issues that a lender and its counsel need to consider when entering into a typical subscription or capital call finance transaction.
We have looked at these issues from the perspective of a lender and as its local fund finance counsel. In other words, we have assumed that the fund has been formed in an international fund domicile, such as the Cayman Islands, Luxembourg, Jersey, Guernsey or the British Virgin Islands, and have set out some of the issues that will be relevant for a lender in order to establish that:
The issues outlined in this chapter are not intended to be exhaustive. In particular, there will be jurisdictional and deal-specific issues that will need to be considered and dealt with. Nor is this a substitute for legal advice. Lenders and funds would be well advised to seek the advice of their legal counsel at the outset of any transaction to ensure these matters are properly addressed on a deal-by-deal basis.
Framework of the fund and its investment structure
Of course, where the fund (and, if applicable, its general partner) is formed will determine: (i) the legislative framework of the relevant jurisdiction that underpins the fund; and (ii) which local fund finance counsel (if any) will need to be involved in the transaction. This will therefore be an important issue for the lender (or its lead counsel) to establish.
However, prior to undertaking a detailed legal analysis of the fund and its constitutional documents, it is important for the lender to understand the fund framework and the way in which the investors’ capital commitments are to be contributed to the fund. The significance of understanding the fund framework is increasingly important, as fund structures become more complex and bespoke. The fund framework will likely influence a lender’s analysis on the scope of the obligor group and the security required in order to ensure there is no leakage of value out of the lender’s collateral. Some relevant considerations will be:
If the fund has parallel funds, AIVs or co-investment vehicles, the lender may wish to treat them in the same way as suggested for feeder funds above. Alternatively, if no parallel funds, AIVs or co-investment vehicles have yet been established, but if the fund has the right to establish them in the future under the fund’s constitutional documents, the lender may wish to include a restriction in the subscription line facility agreement prohibiting their establishment unless: (i) the lender provides prior written consent; and/or (ii) those vehicles become obligors and grant capital call and account security upon their establishment. The subscription facility agreement can also be “future-proofed” to provide that upon formation, such vehicles accede to the facility agreement and provide the required security.
These points will also be relevant from a capacity and due authorisation perspective, as any such feeder funds or AIVs that are introduced into the obligor group will need to be diligenced by the lender in the same way as the main fund. Whilst it may therefore be possible that the obligor group extends to other entities in the fund group, for simplicity, we have discussed various points in this chapter by reference to the fund (and, where relevant, its general partner) only, on the assumption that the fund (and, if applicable, its general partner) is the only obligor and security provider.
Legal personality of the fund entity
In addition to the fund structure, it is important for the lender to understand the legal personality of the fund and any other relevant entities in the fund group and, if relevant, any regulatory regime applicable to them. The type of legal personality will determine the relevant steps and processes that the fund will need to complete to ensure that it has the capacity and authority to enter into the transaction. For example, some relevant questions will be:
Any delegated authority or investment committee
The type of legal personality of the fund will, in its relevant jurisdiction, largely dictate the steps that the fund is required to take to ensure it has capacity to enter into, and has properly approved and authorised its entry into, the transaction. However, the lender will need to be aware of other points that may influence this. Some relevant points include:
As a general point, a significant part of a lender’s due diligence analysis will likely be focused on an assessment of the identity and credit quality of each investor in the fund. This will allow the lender to establish which investors will be included in the borrowing base calculation and then set the borrowing base at the appropriate level. 
However, to ensure that the financing and the fund’s obligations under the relevant finance documents will not conflict with the law of its jurisdiction of formation or, more pertinently, with the constitutional documents of the fund and (if any) its general partner, a detailed documentation review and analysis should be undertaken. We set out below some of the key documentary due diligence points a lender and its counsel should consider when reviewing a limited partnership agreement (LPA), investor subscription documents and related side letters.
Deconstructing the LPA
Some key points a lender should consider in the LPA in order to determine whether the proposed subscription financing transaction does not conflict with (or, indeed, is not prejudiced by) the terms thereof, are:
Is borrowing/indebtedness permitted?
The LPA should specifically permit the fund to incur indebtedness (be that borrowing or guaranteeing obligations of an affiliate, should the financing structure require), and any limitations on the purpose, amount or term of such indebtedness should be noted. The lender will need to be aware of any such limitations when agreeing the parameters of these in the facility agreement.
What are the mechanics for capital call notices?
The provisions setting out how capital can be called (including the notice provisions and time frame for payment by investors) and the purpose for which the general partner is permitted to issue capital call notices to the investors need to be understood: specifically, whether the LPA permits capital call notices to be issued in order to repay principal debt, interest accrued thereon and costs related thereto is a relevant consideration, as is whether the LPA makes it clear how the total amount specified in a capital call notice issued in order to fund the repayment of indebtedness would be allocated among the investors.
Is the fund permitted to grant security over the investors’ uncalled capital commitments, the right to make and enforce capital calls and its assets generally?
It should be checked that under the LPA, the fund is permitted to grant security over these assets. If the LPA (or any side letter (see below)) designates any investor as a confidential investor, whose identity cannot be disclosed or in relation to whom capital call rights cannot be assigned, these investors will likely be excluded from the borrowing base.
In certain circumstances, in particular for tax, regulatory or ERISA reasons, a feeder fund may be prohibited from guaranteeing and directly granting security to a lender to support the main fund’s obligations under a subscription facility. In such circumstances, a cascading pledge, where the feeder fund grants security over its investors’ uncalled capital commitments to the fund borrower, which in turn grants security to the lender over its rights under the security granted to it by the feeder fund (in addition to the fund borrower granting security over its rights to receive and call for the uncalled capital commitments of its investors, including the feeder fund), may have to be considered.
The LPA should also be checked to establish whether the LPA permits (or at least does not prohibit and permits by way of the general powers) the limited partners paying capital contributions into a specific bank account over which the lender under the finance documents takes a security interest.
What is the term of the fund?
This should be considered in light of the proposed maturity date of the subscription facility. Given that, under the LPA, the fund will be dissolved at the end of its term, the lender should ensure that the maturity date of their subscription facility falls within the term of the fund.
In what circumstances may the fund be terminated and dissolved prior to the end of the term?
The applicable law of the relevant jurisdiction in which the fund is formed will likely set out how a fund can be terminated and the circumstances that result in such termination. For example, in the context of a Cayman Islands exempted limited partnership, Cayman Islands law states that a fund may be voluntarily wound up at the time or on the occurrence of the events specified in the LPA, or otherwise (unless otherwise specified in the LPA) upon the passing of a resolution by all of the general partners of the fund and not less than two-thirds of its limited partners. Similarly, Luxembourg limited partnerships can be liquidated if so resolved by limited partners representing three-quarters of the partnership’s interests, unless otherwise provided in the LPA. The LPA may modify the starting position at law (to the extent permitted in the relevant jurisdiction) and will usually also set out other additional early termination events. The LPA will typically provide a contractual “waterfall” for distribution of the fund’s assets upon its liquidation, and it should be established whether non-affiliated creditors of the fund are at the top of this waterfall.
What is the investment/commitment period and in what circumstances may it be suspended or terminated?
The right of the general partner to call capital from investors will likely be restricted upon expiry, suspension or termination of the investment/commitment period. Examples of potential suspension or termination events within an LPA are: expiry of the investment/commitment period; the occurrence of a key person event; upon the affirmative vote of a majority of investors; and removal of the general partner for cause. It should be established whether, notwithstanding such restrictions, capital may still be called from investors after suspension or termination of the investment/commitment period in order to fund repayment of the principal outstanding under the subscription facility and related accrued interest and costs.
Has each investor agreed that it will honour capital calls without deduction, set-off, counterclaim or defence?
A lender will want to ensure that each investor’s payment obligations to fund capital calls are not capable of being reduced or extinguished by any claim that the investor has against the fund and/or the general partner. If this is not addressed in the LPA, such waivers could instead be provided in investor consent letters. In respect of funds formed in jurisdictions (such as the Cayman Islands) that require notice of security over capital call rights to be delivered to investors in order to fix the priority of such security, such notice will prevent set-offs arising after the date of service of the notice (although it will not affect any potential set-offs that might have arisen prior to the date of service of the notice).
Are there overcall provisions in the LPA for any defaulting investor or excused investor?
These are provisions that mean if an investor has defaulted or is excused from making a capital contribution to fund certain investments, the fund is permitted to call capital from the non-defaulting/non-excused investors up to the amount of such non-defaulting/non-excused investors’ unfunded capital commitments. Often, the overcall obligations of other investors are capped under the LPA. For example, they may be limited to the lesser of the relevant investor’s unfunded capital commitments and a certain percentage of its total capital contribution. Any such limitation should be noted. It is usual for any defaulting investors to be excluded from the borrowing base.
The excuse provisions in the LPA should be checked to understand whether the capital commitment of an investor that is excused or opts out from making a capital contribution to fund a certain investment would remain unaffected (and so available) for the purposes of repayment of the principal outstanding under the subscription facility and related accrued interest and costs.
It should be ascertained whether, under the LPA, the general partner has the ability to “recall” distributions that have been made to investors and, if it does, what the limitations and terms of the recall are. The relevant considerations for a lender are likely to be: whether these distributed and recallable amounts increase the amount of the unused capital commitment of the relevant investor; and whether these distributed and recallable amounts will be available for recall to allow the fund to repay principal, accrued interest and other costs in respect of the subscription facility (including in circumstances where the investment/commitment period has been suspended or terminated). If such distributed and recallable amounts are not so available, a lender may consider excluding these amounts from the borrowing base.
Transfer provisions – limited partners and general partner
The transfer provisions in the LPA should be reviewed to understand in what circumstances an investor may transfer its interest in the fund, grant security over its interest in the fund or withdraw as a limited partner in the fund and, for example, whether prior consent of the general partner is required. As noted above, the identity of the investors in the fund will be an important consideration for a lender in its credit evaluation and in setting the borrowing base level. Changes to the identity of a limited partner may also have know-your-customer and compliance issues for a lender.
The circumstances in which a general partner may transfer (“transfer” is usually a defined term within an LPA and it is common for this to be widely defined to include, amongst other things, the granting of a security interest over the general partner’s interest in the fund) its general partner interest in the fund (and whether this needs a certain percentage of investors to give prior consent) or in which the general partner may be removed or replaced (with or without cause) should also be checked. The identity of the general partner will also likely be important to the lender and any change, unless approved by the lender, is likely to trigger an event of default under the subscription facility.
Where these events will cause the investment/commitment period to be suspended or terminated, as mentioned above, it should be established whether capital calls may still be made to repay principal, accrued interest and costs of the subscription facility during such suspension or after such termination (as the case may be).
Are there any key person events under the LPA?
The LPA may name certain key persons who must dedicate a certain amount of their time to the fund during the investment period and/or term of the fund. If any such specified key persons fail to do so, this may constitute a “key person event” under the LPA. The occurrence of a key person event may cause the investment/commitment period to be suspended or terminated. If this is the case, it should be checked whether capital calls may still be made to repay principal, accrued interest and costs of the subscription line facility during such suspension or after such termination (as the case may be).
No third-party beneficiaries/third-party rights provisions
Any “no third-party beneficiaries” or “third-party rights” clauses ought to be checked to ensure that these provisions are consistent with, and do not purport to restrict, the fund and the general partner from granting security over the capital call rights. Under the laws of some international fund jurisdictions (such as the Cayman Islands), it is also possible to confer third-party rights on a person who is not party to a contract in order for that person to enforce contractual rights as if it had been party to the contract, ie in these jurisdictions it is possible that an LPA could be drafted in a way that allows a lender to directly enforce LPA capital call rights against investors in the same manner as if the lender had been party to the LPA.
The terms of any side letters should be reviewed to confirm the absence of provisions that adversely affect any of the findings arising from the LPA due diligence review or any factors that would otherwise conflict with the obligations of the fund or that could potentially prejudice the rights of the lender under the subscription facility or its related security.
For example, we have seen a number of instances where side letters have expressly prohibited the fund from granting a security interest over a particular investor’s uncalled capital commitment.
Some additional points to be considered when reviewing side letters are:
Another important element that a lender and its local fund finance counsel need to consider when entering into a fund finance transaction relates to the security package. Generally, subscription facilities are secured against the uncalled capital commitments of the investors in the fund, including: (i) the right to make capital calls on investors in respect of their uncalled capital commitments, together with rights to enforce payments of them; and (ii) the right to receive the proceeds of such capital calls. It will generally also include security over the bank account into which investors are required to deposit their capital contributions. The type of security to be created over the capital commitments will be a factor of the legal regime in the jurisdiction of formation of the fund and the governing law of the relevant security document.
For example, in the case of a Cayman Islands exempted limited partnership, where the security is governed by the laws of the Cayman Islands, the security over the right to make capital calls and the right to receive proceeds of capital contributions will technically be granted by way of an assignment by way of security by the fund (acting through its general partner) of those rights as they arise under the fund’s Cayman Islands law-governed LPA and any applicable investor subscription documents. For Luxembourg funds the security package is the same, albeit that its legal characterisation is that of a “pledge” rather than an assignment by way of security.
Prior security and/or existing indebtedness within the fund structure
It will be important for the lender to establish whether there is any existing security over the capital call rights and the capital call account they intend to take security over. Given the size of some fund structures, it is not uncommon for certain assets within the fund structure to be subject to existing security in favour of third parties. Clearly to the extent that there is any existing security, this will need to be considered to determine whether it will prejudice the lender’s position. The following ought to be considered:
Priority/perfection of security
A fund finance lender will want to ensure that if the fund defaults on any of its obligations under the facility agreement or becomes insolvent, the lender’s security interests will constitute first ranking and enforceable security interests over the relevant assets of the fund, such that the lender could enforce its security and apply the enforcement proceeds in satisfaction of the obligations that the fund owes to the lender, in priority to the fund’s other creditors.
In order to ensure this, the lender should consider at the outset how its collateral is perfected and how it ensures that its rights to the collateral have priority over third parties. The relevant steps that need to be taken will largely depend upon the jurisdiction of formation of the fund (and its general partner), the location of the collateral, and the nature of the collateral (as mentioned above, for a subscription facility the collateral will usually be security over the uncalled capital commitments of investors and security over the bank account into which the capital commitments are deposited). Some issues the lender should consider are:
Enforcement of security
Another crucial point for fund finance lenders is to know how the security interests over the uncalled capital commitments of investors (and the fund’s bank accounts) will be enforced upon the occurrence of an event of default under the facility agreement, and in particular, on the fund’s and/or general partner’s insolvency. Key points to consider will be:
Proper execution of the relevant finance documents is also a key component to ensure that the finance documents are enforceable against the fund and/or its general partner. Generally, the lender’s lead counsel will be responsible for ensuring that the finance documents are enforceable as a matter of the laws that govern them (unless, in the case of any security documents, these are governed by the law of the jurisdiction of formation of the fund, in which case the lender’s local counsel will undertake this task with respect to those security documents). Local counsel input will be needed to ensure that the finance documents are compatible with the laws of the jurisdiction of formation of the fund. The lender’s local counsel will also check that the documents have been executed in accordance with the laws of the jurisdiction in which the fund is formed, the constitutional documents of the fund and the relevant corporate authorisations. The following ought to be considered:
The above outlines some of the structural, legal and practical considerations that lenders and their counsel ought to consider when advising on a subscription facility. As we have mentioned, this is by no means an exhaustive list and there will be many deal-specific issues that arise that will need to be considered on a case-by-case basis. However, the content in this chapter illustrates the myriad of issues that lenders (and their local counsel) need to think about when structuring and documenting a subscription facility in order to ensure that the lender’s position is protected.
 Note: The “borrowing base” broadly caps the amount that may be outstanding under the subscription line facility at any time (together with hedging exposure and non-cash-backed letters of credit) to the lesser of: (a) the available commitments under the facility; and (b) the aggregate of the uncalled capital commitments of each eligible investor as multiplied by a specified advance rate that is attributed to that investor, based on its credit quality. Only “eligible” investors to which the lender attributes a certain credit score will be included in the borrowing base calculations, with other investors in the fund being “excluded” investors, whose capital commitments do not form part of the borrowing base, or only being included (and then at a lower advance rate) if they meet certain additional information and due diligence requirements.
James is a partner in Ogier’s banking and finance team in the Cayman Islands and is the head of Ogier’s Fund Finance Practice.
James has significant experience advising on a wide range of banking, finance and corporate transactions. He regularly advises both lenders and sponsors on all types of fund finance transactions and has extensive experience advising on subscription and capital call financings, fund of fund facilities, NAV and hybrid facilities and GP credit lines.
David is a partner in Ogier’s banking and finance team in Asia, based in Hong Kong. He has extensive experience advising on the BVI and Cayman Islands law aspects of a broad range of debt financing transactions, including leveraged and acquisition finance, fund finance, margin lending, structured finance, real estate finance, and secured and unsecured general corporate lending.
Prior to commencing his practice as a BVI and Cayman Islands lawyer, David worked for a "magic circle" law firm in Hong Kong. There, he advised on several firsts in the Asia fund finance market, including one of the first umbrella facilities for an Asia-based fund manager and one of the first syndicated capital call facilities in Asia.
Daniel is a Luxembourg Advocate, Jersey Advocate and English Solicitor. Daniel co-founded Ogier’s Luxembourg office in 2012, leading Ogier’s Luxembourg finance and private equity teams, prior to becoming practice partner in 2018. He has extensive experience in all aspects of international investment structuring and related financing in Luxembourg, Jersey and the UK.
Having read law at the University of Cambridge, Daniel qualified as an English Solicitor in 1999, practising at Hogan Lovells’ City of London office between 1997−2002.
Since moving to Jersey in 2002 and to Luxembourg in 2012, Daniel has acted for fund managers and banks in relation to the establishment, financing and portfolio investment, by regulated and non-regulated international investment structures across the broad range of alternative asset classes, including private equity, real estate, infrastructure, infrastructure finance, credit and special opportunities.
Ogier is a professional services firm with the knowledge and expertise to handle the most demanding and complex transactions and provide expert, efficient and cost-effective services to all our clients. We regularly win awards for the quality of our client service, our work and our people.
This client briefing has been prepared for clients and professional associates of Ogier. The information and expressions of opinion which it contains are not intended to be a comprehensive study or to provide legal advice and should not be treated as a substitute for specific advice concerning individual situations.
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