Equity commitment letters (“ECLs”) are a type of credit support that lenders often rely on to facilitate repayment when providing financing to a private investment fund. In this Legal Update, we explain the purpose and structure of ECLs and discuss how they differ from guaranties, and specifically, limited guaranties.

A commonly used form of credit support in the fund finance market, an ECL is an agreement that documents the commitment to contribute capital or other financial support by one entity (“ECL Provider”) in favor of another entity (“ECL Recipient”). In the fund finance market, the ECL Provider is typically a parent entity or an investor in the fund, and the ECL Recipient is often a subsidiary holding or operating vehicle that is the borrower or primary obligor under a credit facility.

ECLs may be used when the ECL Provider is unable or unwilling to enter into a guaranty. The organizational documents of the ECL Provider may include restrictions or limitations on the incurrence of indebtedness that prevent the entry into a guaranty, or the ECL Provider may prefer that the obligation be reflected on its balance sheet as a contingent contractual obligation to make an equity contribution via an ECL rather than as debt in the form of a guaranty. The ECL is used to demonstrate to a lender that the ECL Recipient—the borrower in the credit facility—has additional resources and liquidity options to meet its repayment obligations under the credit facility if its assets are at some future point in time insufficient to meet those obligations.

The obligation to provide capital runs in favor of the ECL Recipient, not the lender, so only the ECL Recipient can enforce the terms of the agreement; however, the ECL Recipient and ECL Provider can specifically designate the lender as a third-party beneficiary...