LSI 2010 Real Estate Joint Ventures conference materials.pdf

John W. Hanley, Jr. of Davis Wright Tremaine LLP Speaker 20a: 10
manager. In short, for at least the real estate fund formed under Delaware’s law, the limited
liability company agreement rules.
Standard of Conduct. The limited liability company agreement for a private equity real
estate fund will frequently specify the standard of care, and level of effort, expected from the
manager by the investors. Absent a contractual standard of conduct, the manager of the LLC
will probably have common law fiduciary duties of loyalty and care to the members analogous to
those owed by each general partner in a general partnership, or to those owed by a director to the
stockholders of a Delaware corporation. 6 These common law duties of due care and loyalty are
subject to interpretation – and reinterpretation – by courts, so they are of uncertain impact on the
fund and its management, if this subject is not explicitly addressed in the contract. 7 Therefore,
the fund sponsor typically seeks to circumscribe the manager’s standard of conduct and scope of
duties in order to provide certainty and limit exposure. In this regard, Delaware’s Limited
Liability Company Act is extremely flexible, and it expressly authorizes the use of a limited
liability company agreement to completely eliminate the possible application of fiduciary duties
to a manager. 8
Key Personnel Provisions. There is a second issue of concern to prospective investors
very closely related to the scope of the manager’s duties: which of the manager’s key executives
will participate in finding investment opportunities for this fund, make investment decisions, and
otherwise manage the fund and operate its assets? Historically, this focus on the sponsor’s key
personnel was much more common in the worlds of hedge funds and “corporate” private equity
funds, but it is not completely unknown among private equity real estate investment funds. The
investors’ focus on key personnel is driven by two related concerns. First, which senior
executives or other key personnel will be dedicated to pursuit of the fund’s objectives, and what
is the time commitment of each such individual? Second, what will be the consequences if one
or more of the identified key executives leaves (or is removed from) the sponsor’s company
during the life of the fund? As to the latter point, in the hedge fund/private equity world of
“superstars,” there is a range of alternative remedies, including a right to terminate the fund or
the fund’s investment period (triggering a partial refund of drawn capital). Key personnel
provisions in the fund’s operating agreement can become quite elaborate, particularly when the
fund sponsor wishes to mitigate their potential impact by reserving to itself a right to hire and
substitute qualified replacement personnel.
Indemnification. Related to these questions of sponsor duty and key personnel
commitment is the question of indemnification of the manager and its team. The basic view of
the fund sponsor is, of course, that liabilities and exposures incurred in a good faith, legitimate
pursuit of fund opportunities or management of fund business are an enterprise cost which
6 See, e.g., Bay Center Apartments Owner, LLC v. Emery Bay PKI, LLC, Delaware Chancery Court No. 3658-VCS,
April 20, 2009, 2009 WL 1124451 (Del. Ch.) at fn. 33.
7
See J.J. Cunningham, “Reforming LLC Fiduciary Law,” Business Law Today (American Bar Association)
November/December 2009 at 51-54.
8 Delaware Limited Liability Company Act § 18-1101(c), authorizing elimination of all such duties other than the
implied contractual duties of good faith and fair dealing.
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Law Seminars International | Real Estate Joint Ventures and Funds | 02/09/10 in Seattle, WA
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