The Hedge Fund Law Report

The definitive source of actionable intelligence on hedge fund law and regulation

Recent Issue Headlines

Vol. 3, No. 23 (Jun. 11, 2010) Print IssuePrint This Issue

  • Strategies for Avoiding Valuation Disputes in Connection with Breakups of Hedge Fund General Partnerships

    In many cases, domestic hedge funds are structured as limited partnerships with a general partner receiving the performance allocation and a separate limited liability company serving as the investment manager and receiving an asset-based investment management fee.  In such structures, the general partner itself may be a limited partnership or limited liability company, with the principals of the hedge fund manager serving as the limited partners or general partner, or members or managing member.  (Such limited partners, general partner, members or managing members are collectively referred to herein as “GP limited partners.”)  The formulas by which GP limited partners are compensated are complex, and the stakes are frequently high.  In the best case scenario, the complexity inherent in valuing many of the assets held by hedge funds makes it challenging to accurately effectuate the compensation formulas for GP limited partners.  However, the challenge is compounded when a GP limited partner seeks to leave a hedge fund general partnership, and the challenge is further compounded when the hedge fund holds illiquid or esoteric investments.  Business “divorces” are always difficult.  But in the case of a hedge fund, the difficulties are much greater than in the termination of other business arrangements.  Redeeming the holdings of GP limited partners, and estimating the impact on investors, requires an accurate valuation of the fund’s current assets and a reliable estimate of its future performance.  Both, and especially the latter, are extremely hard to arrive at.  A typical and often effective solution is to apply a series of alternative valuation methodologies.  But this approach creates added challenges because it can produce widely disparate results.  Yet the worst case is to leave the valuation methodology and the terms of the distribution rights unaddressed or unclear in employment agreements or other documents embodying the formulas for compensating GP limited partners.  The combination of illiquid investments, ambiguous general partner distribution, redemption or compensation rights, and unclear valuation methodologies is a perfect recipe for litigation.  And litigation among GP limited partners can be especially costly to hedge funds and their managers: it may lead to disruption of the fund’s trading strategy and may also result in a loss of investor confidence.  To achieve an efficient and harmonious breakup, guidelines are needed.  With the goal of helping hedge fund managers structure and implement such guidelines, this article discusses: the process by which hedge fund general partnership interests and hedge fund assets are valued; the valuation implications of the departure of a GP limited partner; three specific alternative valuation methods for valuing GP limited partnership interests; consequences of ambiguously drafted or nonexistent distribution agreements; specific guidelines for drafting valuation guidelines in hedge fund general partnership agreements (including a four-part taxonomy of hedge fund strategies for valuation purposes); and two case studies in which GP limited partners took opposing approaches to providing a valuation methodology for departing partners, with radically different results.

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  • Delaware Chancery Court Permits Limited Partner in Defunct Hedge Fund Parkcentral Global to Obtain a List of Names and Addresses of Other Limited Partners in the Fund

    In early 2008, plaintiff Brown Investment Management, L.P. (Brown) and its affiliates purchased an aggregate $16 million of limited partnership interests in defendant hedge fund Parkcentral Global, L.P. (Fund).  Despite the Fund’s representations that it would not invest more than five percent of its assets in any one of its investment strategies, and that it sought to preserve capital and garner returns comparable to long term equities, throughout 2008 the Fund suffered “catastrophic” losses, resulting in its collapse.  Brown’s lost its entire investment and the entire Parkcentral fund complex ceased to do business.  In 2009, following the commencement of a class action against the Fund in Texas, Brown requested a list of the Fund’s limited partners so that it could communicate with other limited partners about the collapse and their potential remedies.  When the Fund refused, Brown sued to compel disclosure under the Delaware limited partnership law.  The Delaware Court of Chancery ruled in favor of Brown, based on its reasoning that investors in Delaware business entities have a statutory right to access a list of their fellow investors and that Delaware public policy favors the prompt production of the list.  The Fund then appealed and sought a stay of execution of the Court’s disclosure order.  The Court refused to stay execution of its disclosure order.  We outline the background of the case and the Court’s reasoning.  Also, we discuss the 2002 decision of the Delaware Court of Chancery in Arbor Place L.P. v. Encore Opportunity Fund, L.L.C., which involved similar facts and legal questions in the context of a Delaware LLC.  In addition, we address whether, in the view of the Delaware courts, the privacy provisions of the Gramm-Leach-Bliley Act of 1999 preempt Delaware law regarding access by limited partners or members to the names and addresses of other limited partners or members of, respectively, Delaware LPs or LLCs.

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  • Bankruptcy Court Finds Swedbank AB Violated Automatic Stay in Lehman Brothers’ Bankruptcy; Rules Safe Harbor Provisions Do Not Override Setoff Mutuality Requirement

    In bankruptcy parlance, a “setoff” refers to the ability of a creditor and a debtor that owe each other money to apply their claims against one another, if called for under non-bankruptcy law.  As a prerequisite to exercising setoff rights, Section 553(a) of the Bankruptcy Code (the Code) requires “mutuality” between debtor and creditor and debt and credit.  Mutuality exists when “the debts and credits are in the same right and are between the same parties, standing in the same capacity.”  In the absence of mutuality, a creditor’s refusal to pay amounts due to a bankrupt estate may violate various sections of the Code, including Section 362, the automatic stay, even if the estate also owes the creditor money.  Exceptions exist, however.  For instance, in 2005, Congress amended Section 560 and enacted Section 561 of the Code, to provide safe harbors for, inter alia, any pre-existing contractual right of a swap participant to offset or net termination values from the swap agreements in another participant’s bankruptcy.  On May 5, 2010, Judge James Peck of the United States Bankruptcy Court for the Southern District of New York, presiding over the Chapter 11 Bankruptcy of Lehman Brothers Holdings Inc. (LBHI) and its affiliates (collectively, Lehman), squarely addressed whether these Code amendments erased the requirement of “mutuality” for a party to a swap agreement to engage in a “setoff” under Section 553(a).  The Court held that “A contractual right to setoff under derivative contracts does not change well established law that conditions such a right on the existence of mutual obligations.”

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  • New York State Supreme Court Dismisses Intentional Infliction of Emotional Distress Claim in Suit by Former Employees Against Hedge Fund Manager Touradji Capital

    As previously detailed in The Hedge Fund Law Report, Gentry Beach (Beach), and Robert A. Vollero (Vollero, and collectively, the plaintiffs), two former employees of Touradji Capital Management, LP (Touradji Capital), filed a lawsuit in 2009 in New York State Supreme Court against Touradji Capital and its founder Paul Touradji (collectively, the Defendants).  See “New York State Supreme Court Upholds Former Portfolio Managers’ Claims Against Hedge Fund Manager Touradji Capital for Breach of Contract and Intentional Infliction of Emotional Distress; Dismisses Remaining Causes of Action,” The Hedge Fund Law Report, Vol. 2, No. 39 (Oct. 1, 2009).  In that lawsuit, Beach and Vollero, each of whom has since started his own hedge fund management firm, asserted that the defendants owed them almost $50 million in bonuses and profit sharing, and that Touradji had threatened Beach’s welfare.  On November 4, 2009, Touradji filed a countersuit against Beach and Vollero, claiming that, while employed by Touradji Capital, the two breached their fiduciary duties to the firm, and that after they left, they committed unfair competition, tortiously interfered with Touradji Capital’s business relationships, stole its trade secrets and defamed the firm.  See “Touradji Capital Management Countersues Ex-Hedge Fund Portfolio Managers,” Vol. 2, No. 46 (Nov. 19, 2009).  Then, on May 18, 2010, Judge Richard B. Lowe of New York State Supreme Court granted summary judgment with respect to Plaintiffs’ claim of intentional infliction of emotional distress.  Four of Plaintiffs’ other claims were dismissed in September 2009 and a remaining claim relates to breach of contract.  The instant ruling confirms that the pleading burden for a claim of intentional infliction of emotional distress in the hedge fund context is nearly insurmountable; adequate pleading of such a claim requires physical manifestations of egregious psychological harm of a sort rarely, if ever, encountered in the business world.  We summarize the background of the action and the court’s legal analysis.

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  • UBS Names David Forsyth Head of Singapore Prime Brokerage

    On June 7, 2010, UBS announced that it had named David Forsyth head of Singapore prime brokerage, replacing Alastair Sclater who held the post for less than a year.

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