No-fault divorce provisions increasingly popular, except in U.S.: survey

Limited partners generally like to see private equity funds that include provisions allowing them to remove the manager without cause, with the proper amount of LP votes.

However, in the U.S., the majority of private equity funds don’t include this type of rule, known as a no-fault divorce clause.

A recent survey from MJ Hudson found that only about 23 percent of U.S. funds included no-fault removal provisions, compared to 85 percent of European funds. This is up from 18.2 percent of U.S. funds that included such provisions in last year’s survey.

Overall, no-fault divorce clauses appear to be on the rise around the world, despite the U.S. sluggishness in adopting such measures, the survey found. Around 63 percent of all funds contained no-fault removal rights, an increase from 2018, when 53 percent of all funds contained such provisions.

Around 31 percent of 42 North American buyout funds have no-fault removal provisions, according to Buyouts’ 2018-2019 Private Equity/Venture Capital Partnership Agreements Study. For funds that have such provisions, a majority mandate that 75 percent of the LP base agree to proceed with the no-fault removal, Buyouts’ study said.

With a no-fault divorce clause, “you don’t need a smoking gun” of bad behavior on the GP’s part, according to Eamon Devlin, partner at MJ Hudson. “No-fault divorce is linked to getting enough votes from LPs.”

No-fault divorce clauses enable LPs to remove the GP for any reason. For-cause removals require the GP to engage in certain behavior, like fraud, spelled out in the partnership agreement. Generally, fund contracts don’t permit a no-cause GP removal until the manager has a few years to run the fund without threat of removal, a fund formation attorney previously told Buyouts.

Some funds have weaker provisions that instead of GP removal enable LPs to suspend or pause the investment period for any reason. Around 54 percent of 41 North American buyout funds have provisions for no-fault investment period suspensions, Buyouts’ study found.

Actual triggering of no-fault divorces are extremely rare. One veteran LP, when asked how often they’ve seen such a situation, said: “Maybe once in 20 years.”

Sycamore Partners, in its third fund, included a provision to bar no-fault removals until the 10th anniversary of the fund. Instead, LPs could terminate the fund without cause from inception, Buyouts previously reported. Sycamore closed Fund III on $4.75 billion last year.

The difference was that instead of LPs removing the GP while keeping the fund alive, they could instead choose to kill the entire fund.

Action Item: Check out the survey here: