Unless a private fund is organised as a permanent capital vehicle, a limited partnership has a limited lifespan that will, one fine day, come to an end. And while the event of termination is less likely to enjoy the acclaim and publicity accorded to fund closings, the termination scenarios represent an important stage in the private fund life cycle to which investors and managers should pay due heed.
Expiry and extensions
The most common reason to dissolve a fund partnership is that its fixed term has expired. The ‘average’ PE fund has a 10-year term, but the limited partnership agreement (LPA) typically entitles the general partner (GP) to extend the initial term by one, two or three consecutive 12-month periods.
Traditionally, term extensions provide the GP with a window to divest from the last one or two remaining portfolio companies and then wind up the partnership’s affairs. In recent years, however, extensions have come to be viewed as a wholly normal part of the fund life cycle, which often stretches 12 to 15 years after first closing. The potential for misalignment is greater if there is no fixed cut-off date for management fees. Therefore, investors often negotiate to make extensions conditional on majority LP consent.
There is a myriad of reasons why a limited partnership may terminate ahead of schedule. For instance, the GP together with limited partners (LPs) representing some specified threshold of capital commitments (e.g., a simple majority, or 75%) may jointly agree on early termination.
Termination by common consent is an option if the GP disposes of the fund’s last extant investment with time to spare, or if the partners’ relationship breaks down irretrievably. In the latter scenario, LPs can force the issue by voting to remove the GP from office. For most funds, the LPA provides that LPs representing a simple majority of commitments may vote to remove the GP for “cause” without further liability to pay management fees. With “no fault divorce”, the LPs usually need to muster 75-80% of capital commitments, but the ex-GP can expect to receive an extra amount as compensation for removal, usually calculated as 1x or 2x of the annual management fee.
Since a limited partnership cannot lawfully continue without a general partner, the LPs must find, agree terms with, and vote to approve the appointment of a replacement general partner. If they do not, or if the LPA provides for automatic termination on GP removal, then the partnership will be dissolved.
Ending a fund involves three distinct, consecutive steps: first, dissolution; second, the winding-up; finally, termination.
Counterintuitively, dissolution and termination in English partnership law don’t mean the same thing: the date of termination is the last day of a partnership’s life, whereas dissolution denotes an ending of the partnership relationship.
Several grounds exist on which a partnership may be dissolved, including:
(1) expiry of its term;
(2) insolvency or removal of the general partner;
(3) agreement on early termination;
(4) judicial decree of dissolution; or
(5) where an old partner withdraws from and/or a new partner enters the partnership.
Dissolution always precedes a winding-up, but winding-up does not always follow a dissolution. The LPA invariably provides for an automatic reconstitution of the partnership relationship after events like item (5) in the list above, which enables the fund to continue in business uninterrupted by the routine matter of LP transfers.
If the partnership is not reconstituted after a technical dissolution, then the partnership will be wound up. During the winding-up process, the GP (or, if there is no general partner, a liquidating trustee appointed by the LPs) or liquidating trustee determines which investments are to be distributed in specie and which are to be liquidated.
Any final clawback of carried interest required under the LPA must be made from the GP and management team members by completion of the winding-up.
The GP should proceed with asset liquidations as promptly as is consistent with obtaining fair value, but speed varies: it might take one to two years to realise assets. The cash proceeds, to the extent sufficient, are applied in the following order: firstly, to settle the fund’s debts to creditors and other non-partners; secondly, the fund’s debts to partners; and finally, the balance is distributed to the partners in accordance with the distribution waterfall, including the return of investors’ outstanding capital contributions.
If the GP has used reasonable efforts to shift fund assets but still some assets remain unsold, the GP is generally entitled to make distributions in specie at liquidation; some fund LPAs also permit the GP to make distributions in specie at other times, albeit with LPAC/investor consent.
Such distributions usually comprise corporate securities and occasionally real assets. Private fund investors are often wary of distributions in specie, since they transfer the direct ownership of fund investments, and ownership often imposes unwanted additional tax, regulatory, legal and/or administrative burdens on the investor. An LP can pre-empt the matter by requesting the GP to dispose of its pro rata share of the securities, with net sale proceeds going to the investor.
Alternatively, the GP could transfer unsold assets to a continuation fund, assuming that it wins LPAC approval to clear an obvious conflict of interest, since the GP controls both the seller and buyer in such transfer. Continuation funds give management more time to work with portfolio companies and achieve better valuations. The LPs of the old fund are typically afforded an elective right to enter the continuation fund.
After the partnership is wound up, the GP will file a notice of dissolution with the authorities. (Notice should also be given to third parties with whom the partnership had dealings.) Thus, we arrive at the termination of the partnership. In the last words of the Roman emperor Augustus: acta est fabula, plaudite! (“The play has ended, applaud!”)
Oddly, the UK’s Registrar of Companies has no power to deregister a limited partnership and delete it from the register. Proposed reforms will empower the Registrar to strike off limited partnerships which the Registrar believes are not in operation, as well as to reinstate a previously dissolved limited partnership, although these changes are not yet the law of the land.