In July 2020, the Institutional Limited Partner's Association (ILPA) published a revised draft of its whole-of-fund model limited partnership agreement, as well as introducing a new deal-by-deal limited partnership agreement (LPAs) to the market. These agreements build upon the concepts established in the third edition of the ILPA Principles, which seek to promote the alignment of interests between GPs and LPs. This article sets out some of the key concepts contained in the LPAs around governance and alignment, which will be of particular interest to investors. 

Limited partner rights

The LPAs reflect a pro-investor viewpoint. They allow for LPs, with the consent of 75% in interest (based on relative commitments) for any or no reason, to terminate the fund’s investment period, to remove and replace the GP, and to terminate the fund. On a removal without cause, the entitlement to a management fee will immediately terminate, though the GP will remain entitled to a percentage of the carried interest for investments made prior to its removal. 

The model LPAs provide for the consent of a majority in interest of the LPs to be obtained for certain matters, such as decisions to extend the fund's investment period, to waive investment restrictions that are subject to a waiver, or to continue the fund's liquidation process beyond one year of dissolution. 

The most favoured nations (MFN) provisions allow (with customary, narrow exceptions) for all LPs to automatically receive the benefit of more favourable side letter terms. This attempt to equalise rights amongst investors will likely get pushback from GPs or larger LPs. The side letter is not consigned to the virtual recycle bin just yet.

Advisory board terms

The model LPA provides the investor advisory committees (IAC) with an enhanced role in the governance of the fund. Rather than being primarily a consultative body, the intent is for the IAC to provide advice on matters which have been identified and submitted to them by the GP, and those which they have self-identified. The GP is required to disclose to the IAC all actual and material conflicts of interest before undertaking such transactions. This applies even when the transaction is on an arm's length basis. This may prove to be a step too far for some managers. 

Approval of the IAC is needed for some key decisions such as replacement of auditors and waiving a default by an affiliated partner. Also, as well as being required to routinely disclose specific financial information to the IAC such as all fee income received, the GP is required to disclose to the IAC any valuations determined by or on behalf of the GP or the fund and the IAC can require an independent firm to check the relevant valuation. As one would expect, protections for IAC members are strong e.g. full indemnification and insurance at the fund's expense, as well as ensuring there are no fiduciary duties owed to others when exercising rights, whether for the individual or the LP appointing them.

Standard of care

A new standard of care is introduced to supplement the fiduciary duties applicable to the GP or investment manager. The GP and investment manager must act reasonably and in good faith, and are required to use the care that an ordinarily prudent person would exercise under similar circumstances. This standard applies to all investment decisions, delegations of authority, exercises of discretion, and all other acts or omissions of the GP or the investment manager under the fund documents (including side letters). Importantly, the LPA's standard of care takes priority in any conflict of provisions within the fund documents, including exculpatory and indemnity provisions. 

Conclusion

There can be little doubt that the fund industry benefits from organisations such as ILPA providing template documents such as the model LPAs and other guides of best practice. 

As well as allowing LPs to set their expectations, they allow managers to understand how terms may have changed since their last fund closed and why it may not be suitable to follow the terms agreed on prior vintages. Negotiations ought to be accelerated and, as interests of GPs and LPs are closer aligned, it is hoped that returns of funds will be enhanced. As a means of setting the benchmark for transparency and good corporate governance, these documents, which will evolve with the market, are crucial. 

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