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Some LPs seek to punish GPs for unresolved key-man issues

  • Some emerging markets LPs ask for tough key-man provision
  • Provision would classify unresolved key-man issue as “for cause” event
  • Could lead to loss of carried interest for GP

Some emerging markets limited partners are asking for a “draconian” provision meant to punish managers who don’t resolve key-man issues, according to panelists at a recent conference in Washington, D.C.

The provision in question classifies any unresolved key-man issue as a “for cause” event.  Such an event could lead to a “for cause” removal of the general partner, which typically leads to some loss of carried interest — either one-fourth or the entire amount of carry after removal, said Mara Topping, a partner at law firm White & Case who focuses on domestic and international private equity funds. Topping led the panel discussion at the IFC EMPEA Global Private Equity Conference on May 11.

“It’s extraordinarily rare. I’ve never seen it in developed markets, only in emerging markets,” Topping said in a subsequent interview with Buyouts.

LPs on the panel said they heard of LPs asking for the provision. GPs on the panel reacted with indignation.

“This feels somewhat insane to me,” said Stuart Barkoff, managing director and general counsel at the Global Environment Fund, one of the panelists. “At the end of the day we’re trying to align incentives. With a key-person event, [a GP is] trying to manage through a problem into a solution and do it in a way that’s collaborative … To have this hammer over our head of a for-cause event … [is] very draconian.”

Sharif El Akhdar, a partner at BPE Partners, said a solution to avoid key-man issues is to have multiple key people.

It’s not clear which LPs are asking for this provision or why they believe such a punitive measure is needed. Topping said emerging markets LPs — such as development finance institutions — usually have more of an activist slant than their developed market counterparts. “Traditionally emerging markets’ terms and documents have been more investor favorable,” Topping said.

Usually, when a key-man provision is triggered, the LP base gets the option to end the investment period. The issue becomes murkier after the investment period ends. In emerging markets funds, some common methods of dealing with key-man issues after the investment period include provisions for LPs to restrict follow-on investments, reduce the management fee, or even lower the threshold for a “no fault” GP removal, said panelist Elizabeth Tirone, associate general counsel at the CDC Group.

Tirone said she has seen LPs ask for the “for cause” removal provision, but called it a “nuclear option.”

“Just because you have the rights doesn’t mean LPs are going to exercise them,” she said during the panel discussion. “In most cases we work with managers collaboratively to help resolve the problem.”

All of these provisions meant to protect LPs can backfire by limiting a GP’s ability to maximize value in the fund or by handing a disproportionate level of power to a key executive thinking of leaving, sources told Buyouts in prior interviews.

For example, if a key executive thinking of leaving knows the firm will face severe penalties if she leaves, she could try to squeeze the GP for more economics, according to a fund-of-funds LP who had not heard of the “nuclear option.”

Overall, key-man provisions in the limited partner agreements of emerging markets funds are becoming more complex, panelists agreed. This can include setting up different tiers of executives with different remedies that kick in if key-man provisions are triggered, Tirone said.

“Everything is bespoke to the relevant fund. There is no once-and-for-all definition,” said panelist Francois Felli, senior counsel with the International Finance Corporation.

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Photo of Mara Topping courtesy of White & Case