Side Letter Archives

Recently, the Delaware Chancery Court ruled on a dispute that heated up between a hedge fund manager and the fund’s seed investor.  First, a quick summary of the events leading up to the case: A seed investor provided a large initial investment in a hedge fund.  Pursuant to a seeder agreement, the investor had a three-year lockup period, which provided that the investor could not withdraw its capital for three years.  However, there was also a “gate” provision in the fund’s limited partnership agreement which permitted the fund manager to stop outflows of capital if it would result in more than 20% of the total assets of the hedge fund being withdrawn in any six-month period.  Gate provisions are designed to prevent a situation where some investors withdraw such a large amount of capital from the fund that the investors who remain are harmed by the capital flight.  The intent behind the seed investment was that the fund manager would solicit other investors to join the fund during the three-year lockup period.  Because the fund manager was unsuccessful at soliciting additional investors, the seed investor desired to withdraw their capital at the end of the third year.  The fund manager decided to apply the gate provisions to that withdrawal, restricting the withdrawal to 20%.  As a result, litigation ensued. [Read more…]