This article originally appeared in Private Equity Manager.
Overseers not proxies
THE CHALLENGE:
A dichotomy appears to be emerging in the LP community regarding limited partner advisory committees (LPACs); some LPs are questioning whether LPACs are actually effective or whether they are a means for rubberstamping a GP’s desired course of action. So the question is, what is causing some LPs to examine the roles and responsibilities of LPACs? And, are they right to be concerned?
NOEL AINSWORTH AND SAMIA LONE’S RESPONSE:
GPs are reducing the number and type of matters that all LPs are entitled to consider, in favor of obtaining advice or approval from a subset of LPs, i.e. the LPAC. GPs prefer having to revert to the LPAC rather than the fund’s LP base at large, because it is an easier forum to manage and is much quicker than the full LP process.
Whilst an LPAC’s role has traditionally been focused on conflicts of interest and general oversight, some LPs are becoming increasingly concerned by the ever-widening scope of the LPAC’s responsibilities for two key reasons: (1) when matters fall beyond an LPAC’s scope of expertise or when the LPAC is stacked with GP allies, LPs are finding that LPACs are submitting to the GP’s desired course of action too easily, and (2) an LP’s increased service on an LPAC has the potential to cause the LP to become a fiduciary to the other LPs. Some LPs are viewing this as undermining the very protection offered by the LPAC to LPs, causing them to request various best practices as part of their negotiations.
Namely, there are certain matters that some LPs would like for all LPs to vote on rather than just the LPAC. Examples we’ve seen include key person replacements, and extension of the fund’s offering period, investment period and term. And to counteract a LPAC that may contain too many GP allies, more investors are asking to increase LPAC voting thresholds and seat a certain number of voting members not affiliated with the GP.
Whilst, in practice, a trend is forming that LPACs are increasingly serving as proxies for the fund’s LP base, some LPs are actively questioning the effectiveness of the LPAC as part of their negotiations. GPs should be prepared to discuss their LPAC strategy with investors and respond to their concerns. Some of those concerns specifically are ensuring that the LPAC member (and the LP represented by such member) is exculpated from liability and is indemnified, and furthermore owes no duty to the fund or any other partner other than the duty to act in good faith. Another concern is seeing that the LPAC is able to benefit from external counsel’s advice at the fund’s expense when needed.