Limited Partner Advisory Committees (LPACs) serve an important role in management of private funds. While some LPACs serve only a non-binding consultative role, many are vested with veto powers over conflict transactions involving the fund sponsor and its affiliates, and have the right to challenge sponsor valuations of fund assets distributed in kind to the fund’s investors.
One unfortunate by-product of authority vested in LPACs is the recent trend seen in fund legal documents of treating LPAC approval of a conflict transaction as a waiver of liability of the fund sponsor and its affiliates with regard to the approved transaction. Language reviewed in a recent fund limited partnership agreement states as follows:
Whenever a potential conflict of interest exists or arises between [the Fund], the General Partner, a Principal or any of their respective Affiliates, any resolution or course of action by the General Partner shall be permitted and deemed approved by all Partners, and shall not constitute a breach of this Agreement or of any duty stated or implied by law or in equity, if the resolution or course of action is approved by the Advisory Committee.
The main concern is that the LPAC could be given limited information or very little time to decide whether to approve the conflict transaction. Approval under this scenario may not rise to the level of informed consent. Another concern is that members of the LPAC may not adequately represent the potentially different interests of different types of fund investors.
Broad liability waivers pose another risk. Language like that above suggests that once the conflict transaction is approved by the LPAC, the fund sponsor and its personnel are entitled to indemnification from the fund in connection with the transaction, even if they engaged in conduct that constitutes fraud, willful misconduct or gross negligence. It seems counter-intuitive that the fund’s investors would be willing to indemnify the fund sponsor and its personnel without qualification in connection with a conflict transaction, while reserving the right not to indemnify such persons in connection with non-conflict transactions.
Language in limited partnership agreements waiving sponsor liability for LPAC-approved conflict transactions should require that all material information with regard to the transaction and its associated conflicts be given to the LPAC a reasonable time in advance of the requested approval. Investors may also wish to clarify in a side letter that LPAC approval of a conflict transaction in no way entitles the fund sponsor or its personnel to be indemnified by the fund for fraud, willful misconduct or gross negligence in connection with the transaction. Without qualifications of this sort, potential LPAC members should reflect on whether they are being exposed to significantly higher liability risk because of the inability of limited partners to hold the sponsor liable if the conflict transaction results in a significant loss to the fund.
Kristen M. Chatterton