When investing in a fund, a key consideration for an investor should be the potential economic impact of management fees being charged during a term extension. While the majority of limited partnership agreements (LPAs) we reviewed include term extensions (Fig. 1), it can be difficult for the investor to determine whether management fees can be charged during the term extension, until when those fees are payable, and the extent of liability. This is largely due to ambiguous drafting in the LPA. Also, certain funds may allow an unlimited number of extensions, and / or for the voting threshold for term extension to be determined by general partner (GP) discretion only, which can leave the investor in an economically exposed position.
Fig. 1: Share of funds with term extensions
Are management fees payable during term extensions?
In the LPAs reviewed, it was at times unclear if management fees were payable during the extensions (Fig. 2). This is because the LPA provided that management fees were payable until the expiration of the ‘term’. While ‘term’ was defined to include extensions in 13% of the LPAs reviewed, in another 13% this was not defined. For that category, the LPA was silent in respect of extensions. The latter may leave the investor unwittingly consenting to pay management fees during any extensions, as the GP may argue that extensions were included by default within the term of the fund.
Fig. 2: Until when are management fees payable?
Additionally, in 56% of the fund LPAs we reviewed, management fees were payable until liquidation, dissolution, or final distribution. Where the first two of these in particular are specified as the end date for payment of these fees, this may again leave the investor exposed economically, as the liquidation and dissolution of the fund may take several years. A total of 19% of the LPAs reviewed failed to use ‘term’ as a time reference, or to specify more generally for how long management fees were payable.
Duration and number of extensions
The ILPA Principles provide that fund term extensions should be permitted only in one-year increments and limited to a maximum of two extensions, a position adopted by 59% of the funds we reviewed (Fig. 3).
Fig. 3: Funds with two one-year extensions, according to ILPA Principles
Of the LPAs we reviewed, more than 90% adhered to the ILPA Principles in respect of one-year increments across extension periods one to three (Fig. 4).
Fig. 4 Duration of extensions
In 36% of LPAs we reviewed, three or more fund extension periods were provided for (Fig. 5). However, certain LPAs allowed for unlimited extensions, subject to achieving a certain voting threshold. They state, for example, that ‘the GP may, in its discretion, extend the term of the Partnership for two additional one-year periods, and thereafter, for additional periods by the General Partner with the consent of the Advisory Board.’
Fig. 5: Total years of extensions, if all are exercised
Other LPAs gave the GP unlimited discretion on term extension providing that ‘the General Partner may extend the partnership term upon notice to the Limited Partners’.
Approval for extensions
The ILPA Principles recommend that fund term extensions should first be approved by the Limited Partner Advisory Committee (LPAC) and then proceed only if approved by a supermajority of LP interests (defined as a vote of two-thirds in interest of LPs) in the fund. However, in 43% of the LPAs we reviewed, the decision on whether to enact the term extension 1 period was solely at the discretion of the GP, with no LP approval required (Fig. 6). As well as contradicting the ILPA Principles, this is noteworthy for LPs, as it provides the GP with unlimited ability to extend the term, and therein potentially the payment period for management fees, while offering LPs no say in the decision-making process.
Fig. 6: Term extension approvals
For term extension 2, the most common source of approval from the LPAs we reviewed was by the LPAC, at 45%. A total of 17% of LPAs reviewed did, however, give the GP the right to extend for a second period at their discretion. The most common approval for term extension 3 was a vote of LPs of various percentages in excess of 50%. In addition, particularly in respect of the second and third extensions, we saw LPAC approval or a majority of LP interests being provided as alternative approvals, again falling short of ILPA’s position. The potential for GPs to extend the term of the partnership for two years with no recourse to LPs should be a concern to LPs. If management fees are payable during extensions, this could be a significant financial burden on LPs, one which they could neither mitigate nor influence owing to the approval process.
Notably, some LPAs made provision for a review of management fee rate and/or basis after a set number of extensions, stating that ‘if the term of the partnership is extended for more than two additional one-year periods, the management fee payable after such time shall be subject to the prior LPAC approval’. Certain LPAs also included provision for agreement ‘between the GP and LPAC in connection with and prior to’ an extension.
The position around payment of management fees during extension periods is often unclear for LPs, primarily because of opaque drafting. It is at times unclear whether such fees are to be charged during the term extension, until when they are payable, and the extent of such liability. Certain funds may also provide for unlimited extensions and / or for GP discretion only to determine the voting threshold for term extension, which can leave the investor economically exposed. While ILPA has set out its principles to address these issues, its guidance is not always followed.
To mitigate against incurring excessive management fee liabilities during term extensions, LPs should consider the following when negotiating the LPA:
- Seek to ensure that LPs are fully involved in the approval process for term extensions.
- Encourage the provision of caps for both the number and duration of extensions.
- If management fees are payable during extensions, include the incorporation of a step down in management fee rate and/or basis following the end of the initial term.
 ILPA Principles 3.0: Fostering transparency, Governance and Alignment of Interests for General and Limited Partners, June 2019 (“ILPA Principles”)