To What Extent Can a Hedge Fund Manager Hold Back Redemption Proceeds for Contingent Liabilities?

Contingent or unforeseen liabilities can present numerous problems for hedge fund managers because it can be extremely difficult to determine the amount of such liabilities as well as the timing of payments to cover any such liabilities.  This is why many hedge fund managers have historically built into their fund governing documents the right to “hold back” amounts that would otherwise be distributed to fund investors to account for such liabilities.  Unfortunately, although the fund documents may give a hedge fund manager unfettered discretion in exercising its right to hold back distributions, its fiduciary obligations may trump such rights, particularly if it is determined that the hedge fund manager is not acting in accord with its obligation of good faith and fair dealing owed to all fund investors in making distributions.  A hedge fund manager’s decisions as to how to address contingent liabilities can be particularly difficult when a fund is in liquidation, where there may be only limited resources to cover contingent or unforeseen liabilities.  A recently-filed complaint has initiated a lawsuit relating to the amount of discretion hedge fund or hedge fund of funds managers have to hold back distributions to a single investor where there are contingent liabilities arising out of such investor’s investment in a liquidating hedge fund.  This article summarizes the complaint in that case.

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