Cayman fund finance: investor letters in subscription line facilities

In subscription line (capital call) facilities, lenders rely on the uncalled capital commitments of a fund’s investors as their primary collateral. As a result, the enforceability, scope and reliability of those commitments are central to the lender’s credit analysis. In certain circumstances, investor letters can play an important role in mitigating risk and strengthening enforceability.

Where used properly and effectively, investor letters can:

• help alleviate credit risks associated with lending against a single or small pool of investor(s)
• provide additional comfort and clarity with respect to an investor and its capital commitment in a fund
• enhance the enforceability of a lender's rights to call capital in an enforcement scenario

This briefing touches on a number of the legal, commercial and practical points for lenders and sponsors when considering the provision of investor letters in capital call facilities.

For the purposes of this content, reference to a "fund" means an investment fund established as an exempted limited partnership under Cayman Islands law and reference to a "limited partner" or an "investor" means a reference to a limited partner in such fund.

The due diligence process

With the collateral used in subscription line financing being "upward" looking (that is, over the uncalled capital commitments in a fund), the due diligence process on the fund and its investors is a critical part of the transaction. This is especially true where the fund has a concentrated pool of investors or the fund is a separately managed account (SMA), as this will inherently expose the lender to heightened concentration risks.

From a lawyer's perspective, the documentation involved in the due diligence process can broadly be split into three categories: constitutional documents, fund documents and investor documents.

Constitutional documents

When we are thinking about constitutional documents, we are referring to the statutory documents that are necessary for the fund to be validly formed and existing. Under Cayman law, these are the:

• certificate of registration
• registration statement (and any amendments thereto)
• limited partnership agreement (LPA)
• constitutional documents of the fund's general partner (which will vary depending on the type of entity acting as general partner of the fund)

Out of these items, the LPA will be the most closely analysed document as this will set out the contract between the fund and its investors (as well as many of the operative provisions relating to the fund and the capital call process). The LPA will also typically include any restrictions or limitations on the ability of the fund to incur indebtedness in accordance with a subscription line facility (and any other forms of leverage and / or indebtedness).

Fund documents

In terms of fund documents, these would cover items such as the:

• investment management agreement
• administration agreement
• offering documentation

Investor documents

As for the investor documents, the main items here will be the subscription agreement and any side letters. In both cases, it is important to consider these documents alongside the LPA as this will establish an investor's obligations to pay capital calls and, in respect of any side letters, any specific terms which have been agreed directly between the fund and an investor which might deviate from the terms set out in the LPA.

For further information on the LPA and side letter review process, see our earlier briefing:

Capital call facilities – LPA and side letter review

What are investor letters and why are they useful?

So where do investor letters fit into all of this? Generally speaking, an investor letter is a letter addressed to a lender (or a facility / security agent) which is issued by an investor. The fund in question is often a party to the letter to acknowledge the terms therein.

In terms of what might be included in an investor letter, this can range from a simple acknowledgement by the investor that a fund's rights to call undrawn capital has been secured in favour of the lender, to a comprehensive letter agreement that supplements the provisions of the LPA and pursuant to which an investor gives a variety of representations and undertakings in favour of the lender. In each case, the investor letter creates a direct contractual relationship between the lender and the investor which the lender may not otherwise have (where no such document is put in place). It is recommended that the governing law of the investor letter should generally be the same as that of the LPA.

How can investor letters support lenders?

There are various drivers for a lender wanting to have an investor letter. In some cases it is simply a requirement for credit approval in deals involving SMAs or funds with concentrated investor pools. Even where a fund has a diversified pool of investors, there may be reasons why a lender requires an investor letter, such as:

• supplementing provisions in the LPA: if there is any ambiguity in the LPA which might affect the subscription line financing, an investor letter can provide clarity as well as directly enforceable obligations against the investor(s)
• overriding provisions in side letters: if a side letter is in place and contains provisions which might adversely affect the lender's ability to enforce its capital call rights, an investor letter could be used to override or waive such provisions
• where an investor is a sovereign entity: an investor letter can be used to mitigate any legal uncertainties in a scenario where the investor might be able to seek sovereign immunity
• enhancing enforceability of payment of capital calls: by creating a direct contractual relationship between the investor and the lender, an investor letter which includes undertakings and confirmations with respect to capital call rights can streamline a lender's enforcement rights
• fraud mitigation and supplementing due diligence: similar to the above, creating a direct relationship between the investor and the lender can provide the lender with added comfort in terms of validating an investor's status, existence, knowledge of the facility and quantum of undrawn capital commitments (where such representations or confirmations are included in an investor letter)

In the same way that the finance documents will include ongoing obligations and representations of the fund and monitoring of the same by the lender, where an investor letter has been put in place there will need to be some ongoing monitoring of compliance of the obligations set out therein. Typically, it will form part of the undertakings given by the fund to ensure that the fund does nothing contrary to the terms of the investor letter. We would also expect that non-compliance with the provisions of the investor letter would constitute an event of default (subject to the relevant provisions in the finance documents).

Key takeaways for lenders and sponsors

In the current climate of increased use of SMAs / concentrated funds, challenging fundraising conditions and generally accepted usage of capital call facilities, many investors are likely to appreciate that investor letters are "part of the process" when it comes to investing in such funds.

Investor letters can also boost transparency between a fund and its investors since sponsors will need to be up-front with their investors when seeking to put subscription line financing in place. Provided that lenders are clear from the outset in terms of their requirements when it comes to investor letters, a sponsor is typically able to approach their investor(s) in a constructive and collaborative manner.

As is commonly the case, the devil is in the detail. A properly constructed investor letter should enhance the credit-worthiness of a deal, but it is not a substitute for proper diligence on the fund, the sponsor and the investor(s). Where a lender is working with a fund structure that inherently exposes it to greater concentration risks, it should not come as a surprise to the fund, the sponsor or the investor(s) that the lender will seek to mitigate these risks through the use of investor letters.

How can Ogier’s Fund Finance specialists help?

Ogier’s experienced Fund Finance experts in the Cayman Islands advise clients across the whole range of fund finance matters, including capital call facilities.

For any questions on this content or to discuss a specific fact pattern, contact our team. 

About Ogier

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.

Disclaimer

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.

Regulatory information can be found under Legal Notice