Enforceability Of Capital Commitments In A Subscription Credit Facility

Originally published July 7, 2011

Keywords: enforceability, capital commitments, subscription credit facility, capital commitments, capital contributions

Introduction

A subscription credit facility (a "Facility"), also frequently referred to as a capital call facility, is a loan made by a bank or other credit institution (the "Creditor") to a closed end real estate or private equity fund (the "Fund"). The defining characteristic of a Facility is the collateral package: the obligations are typically not secured by the underlying assets of the Fund, but instead are secured by the unfunded commitments (the "Capital Commitments") of the limited partners of the Fund (the "Investors") to fund capital contributions ("Capital Contributions") when called from time to time by the Fund or the Fund's general partner. The loan documents for the Facility contain provisions securing the rights of the Creditor, including a pledge of (i) the Capital Commitments of the Investors, (ii) the right of the Fund to make a call (each, a "Capital Call") upon the Capital Commitments of the Investors after an event of default and to enforce the payment thereof, and (iii) the account into which the Investors fund Capital Contributions in response to a Capital Call.

As we come out of the recent financial crisis, Investors appear willing to again make Capital Commitments to Funds, and the number of Funds in formation and seeking Capital Commitments appears to be up markedly from the recent past. Correspondingly, Fund inquiries for Facilities are also on the rise. As Creditors evaluate these lending opportunities, they naturally inquire into the enforceability of Investors' Capital Commitments in the event of a default under a Facility. This Legal Update seeks to address the current state of the law on point.

Enforceability of Capital Commitments

Although the subscription credit facility product has been around for many years, the volume of published case law precedent on point is limited. Creditors typically see this as a good thing: few Facilities have defaulted and thus there has been little need for litigation against Investors seeking to compel the funding of Capital Contributions. Anecdotal evidence during the financial crisis certainly supports this positive performance, as very few Investor defaults, let alone Facility defaults, have been reported by active Creditors in the market.

There is, however, published legal precedent supporting Creditors' enforcement rights, and it is generally accepted that a Creditor can enforce the Capital Contributions of the Investors under two separate theories of liability: state statutory law and general contract law. We examine each in turn below. Additionally, a Creditor's rights to the Capital Commitments of the Investors should not be materially impaired by a Fund's bankruptcy proceeding. While there is not definitive legal authority negating all possible defenses an Investor could raise, there is sufficient law on point to give Creditors' ample comfort that the collateral supporting a Facility is enforceable.

STATE STATUTORY RIGHT OF CREDITORS TO CAPITAL COMMITMENTS

Delaware Statutory Law.

Most Funds are formed as either limited partnerships or limited liability companies, and the vast majority of stateside Funds are organized under Delaware law. Delaware statutory law contains specific provisions addressing the obligations of an Investor to a Fund: "Except as provided in the partnership agreement, a partner is obligated to the limited partnership to perform any promise to contribute cash or property or to perform services, even if that partner is unable to perform because of death, disability or any other reason."1 In addition, an Investor's obligation to honor its promise to make Capital Contributions explicitly extends for the benefit of Creditors, and although an Investor's obligations to the Fund can be "compromised" by consent of the other Investors, this compromise will not excuse the liability or obligations of the Investor in question to Creditors of the Fund. Title 6, Section 17-502 (b)(1) of the Delaware Code provides:

Unless otherwise provided in the partnership agreement, the obligation of a partner to make a contribution or return money or other property paid or distributed in violation of this chapter may be compromised only by consent of all the partners. Notwithstanding the compromise, a creditor of a limited partnership who extends credit, after the entering into of a partnership agreement or an amendment thereto which, in either case, reflects the obligation, and before the amendment thereof to reflect the compromise, may enforce the original obligation to the extent that, in extending credit, the creditor reasonably relied on the obligation...