Legal considerations for private credit funds encompass fund formation, ongoing investment documentation, and the regulatory framework governing lending activities. The legal architecture of a private credit fund must support the investment strategy while addressing the specific requirements that arise from engaging in lending rather than equity investing. Working with experienced legal counsel throughout the fund lifecycle helps managers navigate these complexities effectively.
Fund Formation Structure
Private credit funds are typically structured as limited partnerships or limited liability companies, with structural choices driven by investor preferences, regulatory considerations, and operational requirements:
- Domestic Partnerships: Delaware limited partnerships remain the most common structure for U.S. private credit funds. The Delaware LP structure offers flexibility in economic arrangements, established legal precedent, and familiarity among institutional investors.
- Parallel Fund Structures: Funds often establish parallel vehicles to accommodate different investor types. A domestic partnership may be paired with an offshore feeder for non-U.S. investors or a blocker structure for tax-exempt investors seeking to avoid UBTI from debt-financed investments.
- BDC Structures: Some private credit managers operate as business development companies, which are publicly registered closed-end funds subject to the Investment Company Act of 1940. BDC structures offer access to retail investors but impose regulatory constraints on leverage, affiliated transactions, and asset coverage.
- Co-Investment Vehicles: Many private credit managers establish dedicated vehicles for LP co-investment alongside the main fund, requiring additional documentation and allocation policies.
Limited Partnership Agreement Provisions
Private credit LPA provisions address both standard fund terms and credit-specific considerations:
- Investment Period and Fund Term: Credit funds may have longer investment periods than buyout funds to accommodate the ramp-up of loan portfolios. Fund terms should account for loan maturities that may extend beyond typical PE fund lives.
- Recycling Rights: The ability to reinvest principal repayments affects portfolio construction and fund duration. LPAs should clearly specify recycling parameters, including time limitations and reinvestment criteria.
- Distribution Provisions: Credit funds often distribute income more frequently than private equity funds. Distribution waterfalls and timing provisions should reflect the income-generating nature of the strategy.
- Leverage Limits: LPAs typically specify permitted fund-level leverage, including both subscription facilities and asset-based facilities. Clear definitions and calculation methodologies prevent disputes.
- Valuation Procedures: Given the judgment involved in credit valuations, LPAs should establish governance around valuation determinations, including the role of valuation committees and third-party valuators.
Credit Documentation
Private credit investments require extensive legal documentation that differs significantly from equity investments:
Credit Agreements: The credit agreement establishes the fundamental terms of the loan including principal amount, interest rate, maturity, repayment provisions, covenants, and events of default. Credit agreements for middle-market loans can run hundreds of pages and require careful negotiation of terms that protect lender interests while remaining commercially acceptable to borrowers.
Security Documents: Secured loans require documentation perfecting the lender's security interest in collateral. This may include security agreements, pledge agreements, intellectual property security agreements, and UCC financing statements. Proper perfection is essential for recovery in distress scenarios.
Intercreditor Agreements: When multiple tranches of debt exist, intercreditor agreements establish priority of payments, voting rights, and standstill provisions. These agreements significantly affect recovery prospects and should be negotiated carefully.
Guarantees: Loans may be supported by guarantees from parent companies, subsidiaries, or individual sponsors. Guarantee documentation must be enforceable and properly authorized by guarantors.
Regulatory Considerations
Private credit managers face regulatory requirements at both the fund and transaction level:
- Investment Adviser Registration: Most private credit managers register as investment advisers with the SEC or state regulators, triggering compliance obligations under the Advisers Act.
- Lending Licenses: Certain jurisdictions require lending licenses for loan origination activities. While institutional lending is often exempt, managers should evaluate licensing requirements for each state where they lend.
- ERISA Considerations: Funds accepting investments from benefit plan investors must address ERISA's prohibited transaction rules, typically by qualifying as a venture capital operating company (VCOC) or relying on other available exemptions.
- Anti-Money Laundering: Fund managers must implement AML programs and conduct appropriate investor due diligence, with specific procedures for higher-risk investors.
Workout and Enforcement
When borrowers experience distress, legal considerations become critical:
- Remedies Analysis: Understanding available remedies under loan documents and applicable law, including acceleration, collateral enforcement, and guaranty calls.
- Bankruptcy Considerations: Evaluating creditor rights in potential bankruptcy scenarios, including preference exposure, equitable subordination risks, and the impact of intercreditor arrangements.
- Restructuring Documentation: Negotiating amendments, forbearance agreements, or comprehensive restructurings that protect lender interests while providing borrowers a path to recovery.
Questions to Ask Legal Counsel
- What fund structure best accommodates the anticipated investor base and investment strategy?
- How should LPA provisions address credit-specific issues like recycling, distribution frequency, and leverage?
- What standard credit documentation terms should the fund seek, and where is flexibility appropriate?
- What lending license requirements apply to the fund's anticipated geographic scope?
- How will the fund address ERISA considerations and maintain VCOC or other status?
- What legal resources should be available for workout situations and restructuring negotiations?