From conflicts of interest to subscriptions lines, lawyers flag up the five issues most likely to trigger court action to Victoria Robson.
Litigation is rare in the private funds industry. For both GPs and LPs, a public dispute runs the risk of reputational damage that could, not least, threaten a GP's ability to raise its next fund and an LP's ability to commit capital to other managers. The preference has been to resolve any conflicts behind closed doors.
However, while managers and investors have been reluctant to go to court, regulators in the US and Europe have stepped in to police the industry with some violations carrying a criminal liability, says Samuel Kay, head of investment funds at Travers Smith.
With regulators increasingly willing to fight the LPs' corner, key dispute triggers include:
Conflicts of interest
Conflicts of interest and valuations are areas of dispute that are commonly resolved privately and as a consequence, “the regulator has taken more of an interest,” says Kay.
In relation to conflicts of interest specifically, regulators are scrutinising the allocation of investment opportunities between different funds in a family of funds, whether that is transparent, whether GPs are treating investors fairly and whether GPs are allocating costs correctly.
There have been a “number of disputes” between the regulator and GPs relating to co-investments and the allocation of deal expenses, Kay adds.
As firms grow in size and diversify into different strategies, the potential for conflicts of interest rises, says Eamon Devlin, managing partner at MJ Hudson. “Ten years ago very few investment firms had more than one strategy,” he says. Today the situation is very different. In a big firm, “it's quite easy to find conflicts,” such as managers hiring services from an affiliate company, he adds.
As firms become more complex, the risk of friction between GPs and LPs will also rise and “the scope
for litigation increases”, Devlin says. That could manifest, for example, in disputes over key-man provisions and whether the executive cited in fund documentation was integral to the performance of
“If the fund loses money, were the individuals that were supposed to be spending most of their time
there present? There are many mid-sized groups where individuals are named on different funds. The key-man person is getting stretched across different business lines,” he adds. Profit sharing, carried interest and fees and expense calculations are also more complex in larger firms. Put simply, “the opportunity for mistakes is higher,” says Devlin.