10 things to do if you are being sued by LPs

Settling disputes early and confidentially is crucial, say Lydia Danon, a partner and Andrew Flynn, an associate at Cooke, Young & Keidan.

Lydia Danon

No one likes falling out with an investor, but handled poorly a dispute will be a drain on a fund’s resources. Reputational risk and the ability to attract further investment must also be taken into account if a dispute makes it to the courts. You could even end up attracting increased regulatory scrutiny, investigation and sanction as a result. If possible, disputes should settle early, confidentially and with minimal impact on the fund.

10 things to do if you are being sued by LPs

  • Read the limited partnership agreement and any related documents as soon as a dispute is in contemplation. You want to ensure that you and the opposing partner have met and are meeting each of your legal obligations. Any breaches of the LPA can be used by your opponent as ammunition later down the line, so it is especially important during this time to do everything by the letter of the agreement and to document and communicate in writing that you are doing so where appropriate.
  • If necessary disclosures regarding conflicts of interest or calculations of fees or other matters have not been made, consider taking curative actions in a dialogue with investors and doing so behind closed doors. Great care should be taken as how these issues are raised with investors.
  • You need to be clear as to what information your opponent is entitled to. You could be criticised later for withholding documents or information from your investors. First look at the LPA as to what they are entitled to. If this is not clear then the relevant statute provides the default position. Depending on the drafting of the LPA such information can, if not careful, extend to documents relating to the fund’s affairs, such as advice from advisory committees. You also need to ensure that you are not providing information to which your opponent is not entitled, as this could bolster their ammunition against you in any future litigation.
  • Be clear who the claim is against. If the GP, then it should seek and pay for its own legal advice. Fees should not be reimbursed by the fund through management fees, or sought by or paid by the fund directly as then there is the real risk that the advice relating to the dispute can be provided to the investors.
  • Act quickly in securing and collating documents that might be relevant to the dispute.
    Andrew Flynn

    This will help ensure that you receive prompt and effective legal advice, and that there is a lower risk of “nasty surprises” later down the line. You should also consider putting in place a “litigation hold” policy so that relevant documents are not inadvertently destroyed as part of routine document management. 

  • Do not destroy any documents. It is practically impossible to permanently delete electronic files, and it will only serve to prejudice your position if this is discovered later when the parties have to disclose documents as part of any litigation or arbitration.
  • Think carefully before putting anything in writing or in an otherwise permanent form. This includes emails, text messages, voicemails, hand-written notes, instant messaging and even WhatsApp messages; you might have to disclose any of these later as part of any litigation.
  • Any written communications/documents dealing with the dispute should be marked “Privileged and Confidential”. Where possible use personal emails when dealing with a dispute. You should not the email address of the fund as these emails could be disclosed to investors.
  • At the same time, it is also important to keep careful and accurate notes of any relevant discussions that occur as your potential opponent may make some helpful admissions and concessions. Include the time and date and, if it is handwritten, make a typed-up note as soon as possible and store the two notes together. An email summary sent to yourself or, even better, your potential opponent shortly after the discussion can be a quick and easy way of ensuring there’s a contemporary record.
  • Seek legal advice from a specialist partnership disputes lawyer. Once you are legally represented your solicitors can shoulder part of the burden and free you up to focus on key strategic priorities, both in terms of how to deal with the dispute and in continuing to achieve value for all of your investors.

Where disputes arise:

The imbalance of power between the GP and the LPs provides ample breeding ground for discord and dissension. Typically, disputes might relate to:

  1. fund performance and claims of mismanagement, negligence and/or fraudulent conduct made against the GP;
  2. conflicts of interest where the GP is managing a number of funds, including the GP’s allocation of investment opportunities and expenses;
  3. alleged misrepresentations relating to the valuation of the fund;
  4. alleged excessive management and performance fees particularly when these exceed performance-based earnings; and/or
  5. key-man provisions – if the fund loses money, were the key individuals referred to in the fund documentation spending sufficient amounts/most of their time on the Fund?

While LPs were once under-resourced to pursue a claim against the GP or manager, in recent years we have seen the rise of the litigation funder, who can offer a source of capital for the LPs to pursue their claims. The choicest of claims for this breed of funder are class actions where the rewards are high. If and when Brexit takes place, the predicted economic downturn could lead some LPs to turn to these alternative sources of funding to claim compensation from GPs for their losses.

If you come up against litigious investors, it’s important to proactively invest the time and resources upfront to analyse and defend your legal and commercial position. It is better to be prepared and on the front foot as opposed to firefighting a well-resourced opponent.