Finance Fund Friday has previously reported on the continued increase of public pension money into private equity. Typically, these investments are made in mixed funds with a diverse group of investors, but we also commonly see these public pension and retirement funds (each, a “public fund”) invest in a single fund vehicle where all or substantially all of the assets are derived from the public fund (a “fund”). These funds are commonly known in the industry as “SMA” (separately managed account). For the purposes of this article, I will refer to these funds as SMAs.
Finance Fund Friday has also before covered SMA and related documentary considerations – for example, the (very) famous Investor Consent Letter is often critical from a lender’s underwriting perspective.
In this article, I will focus on the recommended scope of due diligence to be performed when the only investor in an SMA is a public fund to ensure that the public fund has the authority to invest in the SMA (the “ investment”) and confirm that there is no obvious prohibition on investment under state law.
At Cadwalader, the recommended scope of due diligence involves a review of (i) the applicable Limited Partnership Agreement (“LPA”), Investment Management Agreement, Private Placement Memorandum, Subscription Agreement and Letter (collectively, the “Fund Documents”), (ii) the constitution and applicable state laws (the “State Documents”) and (iii) publicly available documents (“Public Documents”). “, as well as the State Documents, the “State Reference Documents”). Although a public fund’s due diligence in an SMA is often limited to fund documents, lenders should consider expanding the scope of due diligence to include state reference documents.
In all subscription credit facilities, we recommend due diligence on fund documents to ensure that the documents are valid, binding and enforceable against the investor(s) and to identify any issues that may result in disqualification. of a borrowing base investor.
It is common for a public fund to make representations in various agreements regarding its authority to enter into fund documents and that this does not violate applicable law. For example, an LPA might provide that: “[t]the Investor has all the power, authority and capacity necessary to acquire and hold the Interest and to execute, deliver and observe the terms of each of the instruments to be executed and delivered by the Investor under the subscription of the Investor for the Interest, including the partnership agreement and this subscription agreement, and such performance, delivery and compliance does not conflict with, or constitute a default under, any instrument governing the Investor, or violates any law, regulation or ordinance, or any agreement to which the Investor is a party or by which the Investor may be bound.”
Additionally, we would expect to see in the investor’s consent letter standard language such as “[w]We hereby represent and warrant that as of the date hereof… (c) the Subscription Agreement (as amended by the Covering Letter) and this letter have been duly authorized, executed and delivered by us and confirm the accuracy of statements made by us here and here; (d) the Subscription Agreement (as amended by the Side Letter), the Partnership Agreement (as amended by the Side Letter) and this letter constitute our valid and binding obligations, enforceable against us pursuant to their terms, subject to applicable bankruptcy, insolvency, fraudulent conveyance, reorganization, moratorium and other laws generally affecting the rights of creditors from time to time in effect and to general principles of equity; and (e) we have full power and authority to execute and deliver the Subscription Agreement (as amended by the Side Letter) and this letter, and to perform our obligations hereunder and present.”
Overall, it is clear that a public fund has declared that it may enter into fund documents and that entry into fund documents will not violate applicable law. It should be noted that it is always the case under these circumstances that these representations are somewhat circular. If there is a breach of representations because the public fund cannot make its investment under state law, there is no one the SMA (and, by extension, the lenders) could go to. a remedy in the absence of compensation from the investment manager, which is unlikely to be given by a public fund (or most other investors).
A common problem that arises when reviewing Fund documents when dealing with government instruments such as public funds is the reservation of sovereign immunity, which Finance Fund Friday has previously discussedand should be flagged for review by the lender.
State constitution and statutes
Each of the 50 US states has its own constitution and code of laws, which provide for the formation of one or more retirement systems for public employees in that state, such as public funds. The statutes of the State will also define and establish the governance of the Public Fund. Due diligence will identify whether the public fund has been properly formed in accordance with state law and ensure that the board of directors or other competent authority has the authority to (i) control the public fund , (ii) contractually bind the public fund or, if applicable to the proposed investment, to delegate such authority to an investment manager, (iii) enter into and execute the proposed investment on behalf of the public fund, and (iv ) disburse funds belonging to the public fund to the SMA. This due diligence will provide greater certainty and comfort to the statements made in the Fund documents discussed above. As mentioned above, it is also possible that as an instrument of government, the Public Fund may have a claim for sovereign immunity, and such a claim should be flagged for review by the lender.
Public funds are generally subject to certain legal requirements regarding diversification and investment restrictions. Unfortunately, law firms cannot determine whether, in fact, a public fund meets all of these requirements or not.
Due diligence on state documents is generally limited to state law and will not otherwise include local or municipal law, which is a more time-consuming and expensive process that goes beyond what is generally of concern to many lenders (that is to say, authority and capacity) with respect to such public funds. Lenders should consult with both their external counsel and their internal legal and credit teams to determine if there is an internal need or policy requirement to further expand the scope of due diligence to include local and/or municipal law. . If a lender wishes to include local and/or municipal law as part of the due diligence, then it will be necessary to retain the services of a local attorney to undertake a substantive analysis of all issues raised in the due diligence or if other issues need to be considered.
As a public fund, the public fund’s investment policies and board minutes will generally be publicly available. Investment policies should be reviewed to ensure that the investment, as well as any delegation to an investment manager (if any), complies with the investment guidelines and restrictions applicable to the public fund. The minutes should be reviewed to ensure that the investment and commitment amount proposed in the SMA has been recommended to the board and that the board has voted, authorized and approved – ideally, unanimously – the proposed investment. Holding board meetings and keeping minutes is just one of many aspects of good governance and may also be legally required for a public fund. The minutes will often note the investment practices and policies of the public fund and indicate how the investment (i) complies with applicable investment guidelines and restrictions, including (if applicable) any delegation made to a manager investment in connection with the investment and (ii) is in the interest of the Public Fund to achieve and satisfy its investment objectives.
Finally, lenders should work closely with attorneys to determine when it makes sense to broaden the scope of due diligence from only fund documents to include state reference documents as well. This is both prudent and practical given the role of the Public Fund in the SMA and the limited investor base.
The content of this article is intended to provide a general guide on the subject. Specialist advice should be sought regarding your particular situation.