This article was produced by Nabarro LLP, which joined CMS on 1 May 2017.
Summary and implications
“Special circumstances” must exist for limited partners (LPs) to bring a claim against a third party in the name of the limited partnership, for instance, an irreconcilable conflict of interest which means the general partner (GP) cannot or will not institute proceedings itself on behalf of the limited partnership. However, conducting litigation constitutes “management” and therefore puts those LPs who pursue any claim in the shoes of the GP, and consequently with unlimited liability for all the debts and obligations of the limited partnership for the period of the claim.
Some key points which arose in a recent High Court judgment are as follows:
- Claims against the GP: LPs can pursue contractual or fiduciary claims on an individual basis against the GP under the limited partnership agreement (LPA).
- Claims against the manager: a third party claim comprises a partnership asset and cannot be pursued by LPs individually. A derivative claim may be brought where there are “special circumstances” and to avoid an injustice.
- No requirement to replace the GP: there may be commercial reasons why any obvious alternative option to claiming against the manager is unrealistic, i.e. the LPs exercising their right under the LPA to remove the GP and a substitute GP being appointed who will then pursue an action on the limited partnership’s behalf. Investors should still be able to seek redress where they choose not to exercise this right.
The recent case also raised some interpretation points on investment parameters in fund documents and on parties’ rights to be indemnified.
Background
Claims were initiated in December 2011 by a number of pension scheme trustee investors against the GP and manager (both Henderson group companies) in Henderson PFI Secondary Fund II (the Fund). The claims related to breach of mandate and misrepresentation over the way money raised for the Fund was invested (and which subsequently resulted in significant losses). A hearing in November 2012* on preliminary issues generally found in favour of the Fund.
*Certain limited partners in Henderson PFI Secondary Fund II LLP and (1) Henderson PFI Secondary Fund II LP, (2) Henderson Equity Partners Limited and (3) Henderson Equity Partners (GP) Limited [2012] EWHC 3259
Bringing claims in a limited partnership structure
A derivative claim – what it is and how it can be brought
The claimants, some of the LPs in the Fund, asked the court if they could pursue derivative claims against the GP and the manager. The classic example of a derivative claim is by a minority shareholder who seeks to bring an action on behalf of a company against wrongdoers who are in control of the company. In the case of a limited partnership, it would involve the LPs pursuing the GP and the manager in the name of the limited partnership. The claimants wanted to do this without potential liability for the debts of the limited partnership or the costs of the actions.
A BENEFICIARY CAN BRING A DERIVATIVE CLAIM ONLY IN SPECIAL CIRCUMSTANCES AND TO AVOID AN INJUSTICE.
Who are you pursuing and what it means
The table below summarises the outcome in respect of the claims brought against the GP and the manager in the Fund.
| Claim against the GP | Claim against the manager |
| The claim was that the GP had breached its obligations under the limited partnership agreement and in equity. | The claim was that the manager had breached its duties under the management agreement. |
| It was held that each LP can bring an individual contractual or fiduciary claim against the GP under the LPA. | It was held that the claim against the manager was a partnership asset (the management agreement was entered into by the GP on behalf of the limited partnership) and could not be pursued by the LPs individually. |
| There was therefore no need for a derivative action. | There were sufficient “special circumstances” for the LPs to bring a derivative action against the manager on behalf of the limited partnership (see below). |
| Pursuing individual claims under the LPA does not amount to “management” under the Limited Partnerships Act 1907. | Pursuing a derivative claim in the limited partnership’s name involves supplanting the GP and constitutes “management” under the Limited Partnerships Act 1907 (and as provided for in the Fund LPA). Consequently the LPs would be liable as if they were the GP for the period of the claim. |
| The claimants had to cover their own costs. | The claimants had to cover their own costs. |
Why not remove the GP and then sue?
Fund documents often allow the investors to remove the GP (for instance, on a 75 per cent vote) and appoint a replacement. This seems a sensible option where there is an inescapable conflict with the incumbent GP taking action against group companies (in the case of the Fund, the manager) on the limited partnership’s behalf. This recent case, however, highlights that there may be valid commercial reasons not to do this. For example:
- the limited partnership is loss-making. A replacement GP may be hard to find, will want to be substantially rewarded and receive an indemnity for any latent potential exposure;
- the new GP would want to assess the merits of the case, which may involve an application to the court;
- the outgoing GP may be entitled to compensation, an additional partnership expense;
- the investment structure is complex, partly controlled by the existing management group and it would be time-consuming and expensive for another to gain control; and
- the parties are otherwise content with the way the GP and/or manager are managing the fund and attempting to ameliorate the issues which gave rise to the claim.
| Claims for losses limited – Springwell and Peekay |
| The decisions in the Springwell and Peekay cases (2009 and 2006 respectively) provide that if sophisticated parties enter into an investment contract governed by English law, the English courts will uphold the certainty of that contractual bargain. As a result, if the contractual documents say that the investor has not relied on any pre-contractual representations; has understood the risks of the investment; and has determined whether the investment was suitable for it, the scope for the investor to argue otherwise at a later date will be limited. Although the hearing in respect of the Fund raises different issues, the judge did note that the parties were of equivalent bargaining power and were sophisticated commercial entities, illustrated by the existence of side letters. |
Broad scope of investment policy
The claimants’ argument in this case was that the investment solely in John Laing plc, a public listed company which specialised in projects arising out of PFI and other infrastructure projects, was outside the Fund’s investment objective – investing in a portfolio consisting exclusively or principally of PFI concession companies. However, the judge disagreed with this and would not narrow the investment policy wording in the Fund LPA by importing concepts of proportionality from other ancillary documentation (the private placement memorandum).
The judge was also satisfied that both the GP and the manager were indemnified under the Fund LPA exculpation provisions in the event of any breach by them of the LPA or management agreement “arising in connection with the services to be performed hereunder” and that this would only not bite in the case of negligence or other culpable conduct. In other words, the indemnity applied in respect of the allegations of the parties exceeding their investment or borrowing powers.
Conclusion
This is an important area of law and there will be many investors in the existing economic climate who will be considering whether and how it is possible to recover losses from third parties including GPs and managers. The merits of each case will depend on its facts but the present message from the English courts is that claims against third party fund managers will need to be advanced with caution.
Whether you are a GP or an LP, we would be happy to discuss with you any issues you may have in relation to existing or potential investments in the light of the issues discussed above.
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