European funds are four times as likely to include a no-fault general partner removal clause than their US counterparts, according to new research.
Almost three-quarters (73 percent) of Europe-based vehicles feature a provision enabling limited partners to remove the manager without establishing culpability, compared with 18 percent of US funds, fund lawyer MJ Hudson’s Private Equity Fund Terms Research report found. No-fault provisions enable LPs to circumvent lengthy court processes, but require a higher consensus threshold to pass.
US funds often offer a no-fault suspension of the investment period, which is relatively rare in European funds, the report noted. Such provisions do not allow another manager to be appointed to rescue the fund.
“Even when the limited partners in a fund might have cause – and the required consensus – to force the removal of the incumbent manager, they may not wish to do so,” partner Shervin Shameli said in the report. “The impact on the portfolio of removing the manager may be perceived to outweigh even the consequences of the situation that predicated that idea.”
While 53 percent of funds include a no-blame clause, this represents just 39 percent of capital sought by those surveyed, the report said. This can be attributed to a number of the largest funds not including such terms, with 70 percent of mega-funds (targeting more than €5 billion) in the sample originating from the US. Just 14 percent of these offered a no-fault removal right.
More than half (56 percent) of funds with no-fault clauses provide a grace period in which managers are given one or two years post-final close to recoup fundraising costs and demonstrate their skill. The majority (74 percent) with no-fault provisions entitle the GP to management fee compensation if removed, with 56 percent of funds doing so for 12 months.
Funds typically need 75 percent of LPs, a qualified majority, to agree on a no-fault removal. In some funds, a higher voting threshold only applies if the vote to remove the GP is cast during the very early life of the fund, the report said.
“Whilst LPs are often keen to encourage GPs to put ‘more skin in the game’, where the GP commitment to the fund is above 10 percent, this can have a significant impact on the possibility of voting thresholds being reached,” partner Ted Craig added.
“In this instance, where a GP’s LP position in the fund is conflicted, a higher GP commitment may erode rather than protect alignment. LPs should ensure that the GP (and any affiliated parties that hold LP interests in the fund) are excluded from any votes.”