New York-based private equity firm CapGen has taken the rare step of filing lawsuits against two limited partners for allegedly defaulting on capital calls.
The suit, which was filed in Delaware Chancery Court earlier this month, alleges that Chalice Fund and WK CG Investment failed to make the required capital contributions to three CapGen funds raised in 2007 and 2008. The funds have $500 million in combined capital commitments, with Chalice and WK CG allegedly having committed $3.5 million and $1 million, respectively.
CapGen is seeking payment of the outstanding commitments with interest, as well as a court order requiring the LPs to make all future capital contributions.
While suing an LP for a default is unusual by itself, the lawsuit comes less than three months after CapGen issued its original capital call in late December, requiring payment to be due in early January, with a final notice and intent-to-sue statement coming in late February.
In addition to the relatively quick time frame from the capital call to lawsuit, CapGen also chose to pursue legal recourse rather than utilise the self-help remedy allowed under the funds’ partnership agreement, whereby it could have forfeited all or a portion of Chalice and WK CG’s interest in the funds. Other remedies that sponsor will usual take advantage of include trying to find a buyer for the interest or help facilitate a credit line so that the LP can make the capital call. Some firms, such as Permira and Candover, have allowed LPs with liquidity issues to reduce their commitment sizes and thus have downsized their buyout funds.
CapGen’s action also comes against two of its smaller LPs, as their commitment sizes are well below the average $6 million to $7 million investment size. According to the suit, at the time of the capital call CapGen had called down slightly less than one-third of its LP’s total capital commitments.
Andrew Wright, a partner at Kirkland & Ellis, said one reason a GP might feel compelled to take such unusual steps is to send a message to LPs that no one is going to get special treatment. “It certainly puts everyone on notice that the GP is going to take these things seriously and enforce the default provisions,” he said. “Generally speaking though, LPs want sponsors to enforce default provisions, and it’s in everyone’s interest to make sure that everyone honors their commitment obligations.”
While the lack of defaults in the private equity industry has made cases such as CapGen rare, the current financial crisis is putting pressure on many more investors. “It is certainly more likely that we will see lawsuits like this, because of the current economic environment and there is so much concern about defaults, but I still think that in the majority of cases an alternative solution would be found,” Wright said.