Friday Letter Limited, not Powerless

London's High Court reminded a group of LPs this week that with limited liability comes limited control.  

With great power comes great responsibility. And with little power? Limited liability.

That, in essence, was what London’s High Court this week told 22 limited partners angry over the performance of a Henderson infrastructure fund.

The court case has been followed keenly by the private infrastructure investment community, but it should be making waves in the private equity industry, too, for it strikes at the core principles underpinning the LP-GP relationship.

What Henderson’s LPs are trying to do – aghast at seeing their £573.5 million (€718.4 million; $912.7 million) investment in Henderson PFI Secondary Fund II now worth 30 percent less and delivering an internal rate of return (as at June this year) of minus 8 percent – is subvert the general principle of passivity by proving Henderson breached its mandate. In order to do that, they’ve unleashed a barrage of arguments against Henderson, ranging from the persuasive to the less convincing.

On the persuasive side is LPs’ claim that Henderson convinced them to buy into the fund on the premise that it would invest in low-risk private finance initiative (PFI) assets. Instead, they argue, Henderson used all the money raised to purchase UK developer John Laing. Now, it’s true John Laing has a significant portfolio of PFI assets. But it’s also much more than a mere holding company – John Laing is a fully fledged firm, with several lines of business and a pension deficit.

On the more doubtful side of the argument is LPs’ contention that they didn’t know Henderson was intending to buy John Laing. This despite Henderson’s involvement in a three-month bidding war against insurer Allianz over John Laing. If true, that shows a surprising cavalier attitude towards monitoring their investments.

Either way, London’s High Court has effectively told LPs that – whatever they think of Henderson’s strategy – the fund manager did not breach its mandate. While the investor group can still appeal, the court has effectively underlined the long-standing fundamentals of the GP-LP relationship: LPs have to accept that, once they put their money into a fund, their role is mostly passive.

In exchange for that relative passivity, LPs get enhanced protection: should disaster strike, they are only liable on debts incurred to the extent of their investment in a firm. GPs, on the other hand, are fully exposed and personally liable, meaning they stand to lose much more than their investment – if things get really nasty, they can lose their shirt.

As victories go, this is a pyrrhic one for Henderson. The court’s legal absolution cannot protect the fund manager against the reputational damage associated with disillusioned LPs taking a GP to court over investment decisions.

Henderson PFI II will only unwind in 2016. Theoretically, that means LPs can still make money out of their investment. But even if they do, they are unlikely to thank Henderson for the ride. Despite the court ruling, the message coming from Henderson’s LPs rings loud and clear: ‘L’ may stand for limited, but ‘P’ does not stand for powerless.