Sub lines through a fund’s life cycle: a Cayman Islands perspective

Introduction

The Cayman Islands is the largest domicile for private funds outside of the US, with the vast majority formed as Cayman Islands exempted limited partnerships (ELPs). A large number of these are closed-ended private equity funds, and this guide is written on the basis of such a fund formed as an ELP.

Subscription lines, also known as sub lines or capital call facilities, are typically shorter-term loans (often one year with further single year extensions possible), primarily obtained to allow the fund to act nimbly with respect to investments and manage fund expenses, without the need to make frequent capital calls.

New funds

Historically sub lines were put in place in the early stages of a fund’s lifecycle because a subscription line is based on, and takes security over, the rights of the fund to call capital from investors. The amount that can be borrowed by a fund under a sub line is therefore much higher at the start of its term than towards the end, when most of the capital has been called and deployed.

The investment period of a fund is typically between two to five years. During this period the fund will focus on making investments, and as it does, the outstanding capital commitments will decrease as the amount and value of its investments increase. This has the effect of limiting the capacity for borrowings later in life, as the borrowing base will be much lower. Therefore, if a fund is in need of more finance, it will typically look to transition across to a NAV or hybrid facility at that time.

Mid-life

Notwithstanding the traditional timing for putting subscription facilities in place, we regularly see sub lines continuing past the end of the investment period rather than the fund transitioning to a different type of facility. As the amount of outstanding capital has reduced, the amount that the fund will be able to borrow will also be lower. As such, this will only be appropriate if the level of finance available under the sub line remains sufficient for its borrowing needs.

As security over the right to call capital forms the basis of a capital call facility, the lender will need to ensure that the general partner can call capital to repay borrowings. Due to the success of the subscription line as banking product, it has become commonplace for funds to include specific provisions in their partnership agreement to cover subscription lines, in particular the ability of a fund and its general partner to assign its right to call capital and the ability to make capital calls to repay borrowings.

Conversely, once the investment period has terminated, the ability of a fund to make capital calls will typically be more limited. Whilst it has become usual to see a specific provision in partnership agreements which cover repayment of borrowings (or other obligations), this is not always the case. In particular, for older funds, the permitted uses for capital calls post-investment period are often limited to:

• making follow-on investments;

• making investments which the fund committed to making prior to the termination of the investment period; and

• paying general expenses (which is not always drafted widely enough to cover borrowings).

It should be noted that there is nothing within the Exempted Limited Partnership Act (as amended) of the Cayman Islands (the ELP Act) that regulates what capital calls can be used for and/or at what time; this is all down to the partnership agreement of the relevant fund.

If a lender is to carry on providing a capital call facility post-termination of the investment period (eg, during the mid-life stage of a fund), the limitations in the fund documents must be carefully reviewed. It is important to check whether capital calls are permitted to be made after the end of the investment period to repay borrowings as this is fundamental to ensure that the security can still be effectively enforced.

Whether or not a fund can recall capital/recycle distributions (and in what circumstances) may also be relevant to a lender agreeing to continue (or put in place) a sub line into the mid-stage of a fund’s lifecycle.

Late stages

Less common is a fund that retains a sub line through to its late stages, although this does occur more regularly than may be anticipated. Such a fund would still need to have some capital commitments left to be called or recalled, and the facility size would be significantly reduced as the majority of the capital should have been called and invested by the time the fund reaches this stage in its life cycle. This is therefore only appropriate for a fund with small borrowing needs – for example to manage maintenance costs on illiquid fund assets pending market conditions becoming ideal for divestment.

In addition to the lender confirming that capital calls can still be made or recalled for the purposes of repayment of debt, the lender will need to check whether:

• the scheduled termination date of the facility extends past the term of the fund; and
• the general partner is authorised to incur new indebtedness (ie request new advances under the facility) post-termination date, when the expectation is that the general partner should be conducting an orderly winding down of the fund’s operations.

We often see facilities for late-stage funds drafted so that the maturity date of the facility terminates shortly (often 30 days) before the end of the term of the fund. This is a neat way of dealing with the issue, although the lender will need to have full visibility of when the fund is due to terminate, any possible extensions and the process for which those extensions can be approved (eg the general partner’s sole discretion, limited partner advisory committee (LPAC) approval, etc). Indeed, it is often in relation to facility extensions that the fund’s term becomes relevant as the initial term of the facility will be within the current term of the fund.

End of life

What, however, would be the consequences if the facility were not drafted to terminate automatically prior to the end of the fund’s term and instead continued in place after fund had expired?

The ELP Act does not provide for what happens at the end of the term of an ELP. In fact, an ELP will only need to be wound up (outside of insolvency) if:

• the general partner(s) and the requisite majority of limited partners vote to wind up the ELP; or
• an event specified as a winding up event in the partnership agreement occurs.

The ELP Act is not prescriptive as relates to the mechanics of a voluntary winding up. In fact, the ELP Act specifically states that an ELP shall be voluntarily wound up in accordance with the provisions of the partnership agreement. As a result, until such time as the winding up is complete and a notice of dissolution is filed with the Registrar of Exempted Limited Partnerships, the partnership agreement will determine whether or not capital calls can be made post-term of the partnership during its winding up (but before it is dissolved).

Conclusion

In summary, a sub line can be in place throughout the life of a fund, depending on its borrowing needs and the drafting of its partnership agreement. Due to the flexible nature of Cayman Islands legislation, the provisions of the partnership agreement are paramount and the lender should ensure that the relevant provisions are carefully reviewed both when a facility agreement is entered into and for each extension. This will ensure that no issues will arise should a need to enforce arise.

Contacts

A full list of contacts specialising in Cayman Islands banking and finance law can be found here.