Default drama

A recent ruling could set a precedent for GPs considering taking action over LP defaults, writes Jenna Gottlieb.

The UK high court ruling this week that Robert Adair, chairman of Melrose Resources, was in breach of contract for having refused to honor commitments to Advantage Capital, could set a precedent for GPs wanting to take action over defaults.

London-based Advantage Capital will seek compensation for lost fees and expected carried interest, an amount totaling in the “eight figure range”, according to a source familiar with the matter. The fund's unique circumstances – Adair committed more than 90 percent of the £40 million raised for Advantage's second fund – will leave the buyout fund “suspended”.

Adair committed £37.5 million (?45 million; $59 million) to Advantage's fund and had been a member of the firm's advisory board; he will now face a hearing to determine damages.

These situations are typically handled privately, and most GPs try to work out ways to help a struggling LP out of its commitment, usually through a secondaries transaction.

If Advantage wins a large award, it would send a strong signal to other investors. The outcome will potentially provide managers that expect greater LP defaults in the near future an important precedent when deciding whether or not to take legal action against investors.

Defaults have largely remained more of a threat than a reality, aside from a few high profile cases.

Jenna Gottlieb

Among those cases, CapGen Capital Advisers sued two of its LPs, Grail Partners and WK CG, in the Delaware Chancery Court last March for missing an $800,000 payment and a $200,000 payment, respectively. According to the Wall Street Journal, a managing partner at Grail said the firm missed the payment because of a liquidity squeeze. A partner at WKCG, memorably, said the payment was “on my list of things to get around to”.

Defaults have a lasting impact for limited partners and GPs alike.

An LP who has defaulted may find it tough to get access to future funds, either with the GP whose fund they've defaulted on, or any other GP, who may be wary of an LP with a record.

“When you get into a default situation, you become a less desired investor from a GP standpoint,” said a source. “And in most situations when that happened it was really symptomatic of LPs who were not suitable investors for this asset class.

“I've not seen any LPs default and come back afterward to pursue their private equity programme,” the source said. “It's generally a very strong signal about what they intend to do.”