As the subscription credit facility (each, a “Facility”) market has evolved further from its real estate fund roots and deeper into the buyout fund and private equity world, lenders (each, a “Lender”) active in the space have increasingly found overcall limitations (“Overcall Limitations”) in the partnership agreements or other governing documents (collectively, “Fund Documentation”) of their prospective fund borrowers (each, a “Fund”).

These Overcall Limitations take various forms, but in each case limit the ability of the Fund to call capital (each, a “Capital Call”) from its limited partners (each, an “Investor”) to make up for shortfalls created by other Investors’ failure to fund their Capital Calls (each, a “Defaulting Investor”). Such Overcall Limitations fundamentally conflict with a Lender’s general expectation in a Facility that each Investor is jointly and severally obligated to fund Capital Calls up to the full amount of its unfunded capital commitment (“Unfunded Commitment”). Therefore, Lenders have naturally taken a skeptical view of such Overcall Limitations due to the credit implications of such provisions. As described below, there are three primary forms of Overcall Limitations and one particular form that is linked to a Fund’s investment diversification or concentration limits (a “Concentration-Linked Overcall”) that has proved especially troubling for Lenders. This is because the application of such limit means that the degree of overcollateralization afforded to the Lender varies with the size of any particular Fund investment (each, an “Investment”). This variation in the overcollateralization cushion complicates the credit analysis, adding another variable required to be modeled in order to assess the actual credit impact of the Overcall Limitation on a Facility. This Legal Update provides background on Overcall Limitations generally and proposes structural solutions to address some of the issues presented with certain Concentration-Linked Overcalls.

Background

The collateral for and expected source of repayment of...