HEDGE FUNDS
By Robert J. Kiggins, Esq. of
McCarthy Fingar, White Plains, NY
Presented on June 10, 2005
INTRODUCTION & SURVEY“Hedge Fund” History
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Many think of this industry as a fairly new innovation, but its history began in the late 1940s and
perhaps even the early 1930’s
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Alfred Winslow Jones was the first fund manager to combine a leveraged long stock position with a
portfolio of short stock positions in an investment fund.
Using a private limited partnership structure for his fund, Jones was paid on an incentive fee basis.
Investors in Jones' little known fund enjoyed very handsome returns as his fund outperformed all mutual
funds of the time.
However, Karl Karsten came up with the technique (in concept) in 1931 in a book entitled “Scientific
Forecasting” published that year.
For example, Karsten’s theory for small funds that could not diversify across entire markets was “Buy the
stocks in the group predicted to rise most in comparison with the others, and sell short the leading stocks
in the group predicted to fall most”
The hedge fund idea started as a risk reduction technique – to reduce risk with respect to the
direction of the market or individual securities (either entirely long, or entirely short). Hedge
funds used hedging tactics (e.g. a combination of short and long positions) to pool investors'
money and invest those funds in financial instruments in an effort to make a positive return
However, the chance for higher investment returns increased the popularity of hedge funds in the
1960s;
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The nature of hedge fund management was shifting and managers took more risk by leveraging instead
of hedging their positions.
When markets took a turn for the worst, these riskier strategies did not pay off, and hedge funds hit a
difficult period from the mid 1960s to the end of the 1970s.
Hedge Funds Aren’t Usually
Hedged
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This history shows that even fairly early on the fact that something was referred to as a “hedge
fund” did not mean that it was hedged with regard to all, or any, of its positions.
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By 1980 and throughout the 1990s, with the arrival of derivatives, new styles of management
were developed.
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That is the case to this day.
In short, a hedge fund is descriptive of a type of entity – an investment limited partnership (although
offshore funds are typically corporations) that invests in securities.
A “hedge” fund typically is not actually hedged.
Consequently hedge funds became a more mixed group.
The hedge fund industry started to offer a greater array of products, using more complex strategies.
This was the start of a growth industry. Hedge funds became the investment world’s Holy Grail.
Big winner – George Soro’s Quantum Fund – allegedly made more than $1B contra ER II Regina (Great
Britain) by betting against the £ (i.e. Pound) in Euro Exchange Rate Crisis of 1992
From 1994 to 1999, hedge funds performed phenomenally well as the Clinton bull market unparalleled since the 1920’s - was pushing returns to record highs. Many traditional money
managers were becoming hedge fund managers. It seems that hedge funds could do no wrong.
Then reality struck when the Tech Bubble burst in 2000. Even the high and mighty were struck
down. My personal pick, albeit a 1998 event which did not result in the Fund going bust, was the
Long-Term Capital Management fiasco.
The Story of Long Term Capital
Management
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Long-Term Capital Management, LLP (LTCM) was founded in March 1994 by
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John Meriwether, the former head of the Salomon Brothers bond –arbitrage trading group,
an extremely profitable venture
 along with a small group of associates most notably economists Robert Merton and Myron
Scholes (of Black Scholes Options Pricing Formula Fame) who received the Nobel Prize in
economics in 1997.
Organizationally, LTCM was a Delaware LLP which operated a Cayman Island Partnership called
Long Term Capital Portfolio LP
Meriwether had left Salomon after its 1991 bond scandal. A Salomon bond trader illegally tried to
corner the primary Treasury auction market by bidding in excess of the firm’s limits.
A ban threatened by the Fed prompted a run on Salomon which almost brought down the highly
leveraged firm.
The situation was salvaged only by Warren Buffet taking over Salomon and the Fed reversing the
ban.
Meriwether was fined a rather puny $50K for failure to supervise his traders
The Story of Long Term Capital
Management (Cont’d)
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The core strategy of LTC can be described as “relative value”, or
“convergence – arbitrage” trades try to take advantage of small
differences and prices among closely related securities.
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Definitions:
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On-the-Run Bond the most recently issued U.S. Treasury bond or note of a
particular maturity. These are the opposite of off-the-run treasuries
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The on-the-run bond or note is the most frequently traded Treasury security
of its maturity. Because on-the-run issues are the most liquid, they typically
are a little bit more expensive and, therefore, yield less than their off-the-run
counterparts.
The Story of Long Term Capital
Management (Cont’d)
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Off-the-Run Bond . All Treasury bonds and notes issued before the most recently
issued bond or note of a particular maturity. These are the opposite of on-the-run
treasuries.
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Once a new Treasury security of any maturity is issued, the previously issued security
with the same maturity becomes the off-the-run bond or note.
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Because off-the-run securities are less frequently traded, they typically are less expensive
and therefore carry a slightly greater yield.
For instance, an off-the-run treasury bond might yield 6.1% versus 6.0% for a
more recently issued on-the-run.
The yield spread represents some compensation for liquidity risk.
Over a year of trade a long off the run and short on the run will be expected to
return 10 basis points per dollar invested. The key is that eventually the two
bonds must converge to the same value.
The Story of Long Term Capital
Management (Cont’d)
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The strategy was used in a variety of markets
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long swap government spreads,
long mortgage-backed securities versus short government,
long high-yielding versus short low-yielding European bonds,
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Barring Market Disruptions these trades generally prove profitable
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The problem of convergence strategies is it they generate tiny profits so that
leverage has to be used to create attractive returns.
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In the case of LTCM to control risk, the target ceiling risk level was set to the
volatility of an unleveraged position in US equities.
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Positions were obtained by portfolio optimization with a constraint on volatility,
with some additional constraints such as liquidity and concentration of positions.
Leverage had to be quite large.
The Story of Long Term Capital
Management (Cont’d)
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The fund was initially very successful
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However in 1997 the Fund’s return was down to only about 17%
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by the end of 1995-96 it achieved annual rates of return around 40%
this was achieved largely through successful bets on convergence of European interest rates
that and the glitter of the sponsors made the fund very popular on Wall Street.
the fund was charging for this – 2% of capital fixed fee plus 25% of profits
The Fund was very highly leveraged $125B assets over $5B equity
This gave the fund a 25:1 ratio of assets to equity
Fund leveraged through very favorable repo financing
Repo A contract in which the seller of securities, such as Treasury Bills, agrees to buy them back at a specified time and
price. also called repurchase agreement or buyback.
The US Stock return that year was 33%
Credit spreads had narrowed accounting in large part for the lower return.
Leverage had decreased from 25:1 to 18:1 due to asset growth
Management concluded that the capital base was too high to earn the rate of return on capital of which they
were aiming
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$2.7 billion was returned to the investors
This cut in the fund’s capital to 4.8 billion and increasing its leverage ratio to around 28:1
This amplified returns to investors who stayed in the fund.
This also made the Fund much riskier
The Story of Long Term Capital
Management (Cont’d)
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Troubles Begin
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In May and June, 1998 there was a downturn in the mortgage
backed securities market
There was a 16% loss of capital to the Fund
Capital dropped from $4.7B to $4B
Leverage increased from 28:1 to 38:1
Disaster then struck in August 1998:
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the Russian government devalued the ruble and declared a
moratorium on future debt repayments
those events led to major deterioration in the credit
worthiness of many emerging-market bonds and
corresponding large increases in the spreads between prices
of Western government and emerging-market bonds.
The Story of Long Term Capital
Management (Cont’d)
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Those elements were very bad for the Fund because the fund had bet in
mega fashion on the spreads narrowing. This was exacerbated by the
fund sustaining major losses of other speculative positions as well. So:
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By the end of August, 1998 Fund capital was down to 52% of the equity
capital the Fund had at the start of that year.
But that time the asset-base was about $126 billion (an over 55:1 asset to
capital ratio)
The fund was running short of high-quality assets for collateral to maintain
its repo positions
The fund’s management spent the next few weeks looking for assistance
in an increasingly desperate effort to keep the fund afloat
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no immediate help was forthcoming
by September 19 the fund’s capital was down to only $600 million
fund had an asset-base of $80 billion to appoint its leverage ratio was
approaching astronomical levels
doom was imminent
The Story of Long Term Capital
Management (Cont’d)
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Bailout
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In a highly controversial move the US Federal Reserve put together a “bailout”
Many Wall Street firms had large stakes in the Fund and it was deemed that failure of the
fund could lead to disastrous effects on the financial markets (the classic “too big to fail”
case)
A liquidation of the Fund would have required dealers to sell of 10’s of Billions of securities
and to cover their numerous derivatives trades with the Fund
In addition since the Fund was organized in the Caymans it was not certain if US
Bankruptcy Law would apply
14 banks and brokerage houses including UBS Goldman Sachs and Merrill Lynch but not
the Fed agreed to invest $3.6 5 billion of equity capital in the Fund in exchange for 90% of
the firm’s equity
Existing investors would therefore retain 10% holding valued at about $400 million (a
competing offer from a wholly private group led by Warren Buffet would have cashed out
the investors at $250 million)
Control of the fund passed to a new steering committee and the announcement of the
rescue eased concerns about the fund’s immediate future
By the end of the year the Fund was making profits.
Eventually the fund was unwound and by the end of 1999 all money was repaid to investors
Anatomy of a Hedge Fund
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The Fund
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The Sponsor
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typically (to limit liability) an entity:
often an LLC or occasionally corporation
The Manager
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the individuals or entity (might be a financial institution) who have organized and
promote the Fund
The General Partner
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typically organized as a limited partnership,
although off-shore funds are often corporate entities
investment adviser to the Fund.
The General Partner might be the Manager
or a separate entity might serve as the Manager.
Investors
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they contribute virtually all of the capital to the Fund.
typically high net worth individuals or institutions
Anatomy of a Hedge Fund – Cont’d
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Limited Partners. In a Fund which is in the form of a limited partnership this is the
investors.
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Capital Contributions.
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The capital invested or to be invested in the Fund by the investors
to a limited extent, by the General Partner.
the general partner and the investors would each have commitments to make capital
contributions in a specified maximum amount.
Uses of Capital.
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liability is limited to their capital commitments to the Fund.
LP’s do not manage or operate the Fund - that is the role of the General Partner
Under the sole control of the General Partner
However, generally to pay fund expense and to make investments for the Fund
Investment Guidelines or Investment Policies.
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These are the road rules to be followed by the General Partner in directing Fund
investments.
Anatomy of a Hedge Fund - –
Cont’d
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Management Agreement – where the Manager is different from the General Partner
there is a management agreement spelling out the duties of the Manager – generally
involving finding investments , monitoring investments and advising on strategies
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Management Fee – It is intended to pay for salaries of management personnel and
costs of management.
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Generally this will fall in the range of 1.5% to 2.5% of the amount of the value of the Fund.
Taxed as Ordinary Income
Carried Interest – This is the incentive compensation paid to the General Partner out
of Profit generated by the Fund investments
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Amount varies but generally is 20% of the Funds Profits
Taxed as Capital Gain
Anatomy of a Hedge Fund - –
Cont’d
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Preferred Return – In many cases the Investors are entitled to receive a specified return on their
capital (e.g. 7% per year) before the General Partner receives Carried Interest.
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Pure Preferred Return – Investors get their Preferred Return and thereafter Profits are split in the ratio
determined (typically 80%-20% on the excess)
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Hurdle Rate –
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After the Investors get their Preferred Return then there is a a Make Up to the General Partner
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in the form of an incremental share of the Profits in excess of the Preferred Return
until the General Partner has receive the Carried Interest on all Profits
The term “hurdle” comes from the perception that the hurdle rate is the rate of return that will get someone "over
the hurdle" to invest their money in the deal.
Clawback
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As result of early portfolio gains followed by later significant losses
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At the end of the Fund
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managers may receive carried interest distributions
in excess of their share of the fund's cumulative profits,
the Fund’s cumulative profits are calculated
and compared with the distributions of carried interest made to the general partner during the life of the fund
To the extent the general partner has
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received more than its agreed-upon share of the Fund's cumulative profits,
the excess must be returned.
Types of Funds – Venture Capital
Funds
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Basic Features:
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Invest in development stage businesses
Often are in the form of preferred stock
The hope is to cash out at profit on an IPO or sale of the business to a strategic
buyer.
Often diversify by making numerous small investments.
The limited partners often
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lack expertise in a certain industry or
do not have the information or capacity to make direct investments in privately held
companies.
rely on the general partners to select and monitor appropriate investment opportunities
through the venture capital fund
Economics
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GP’s Carried interest.
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Based on realized capital gains plus the unrealized gains on marketable securities
distributed to investors.
Typically range from 15% to 35% of the gains attributable to the investors capital
contributions
Types of Funds – Venture Capital
Funds
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Example:
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Preferred return
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If GP provides 1.5% of the total capital and the investors 98.5%
GP will receive 1.5% of the gains as a return on its capital investment plus 20%
of the gains on the 98.5% of the capital contributions provided by the investors
Total profits interests of the general partner is 20.12% representing
 20% of the total profits as carried interest and
 The GP’s pro rata share as an investor of the 80% profits share going to the
investors (1.5% of 80% equals .12%).
Not usually provided to investors
If provided, may vary from 6% to 12% depending on risk and interest rates
If provided, a GP Makeup is almost inevitable
Management Fee.
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1.5% to 3.0% of Capital Commitments
Generally, no decline in rate when Fund is fully invested
Types of Funds – Venture Capital
Funds (Cont’d)
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Leverage
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VC funds rarely have the ability to borrow money
Exceptions (on a short-term basis):
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Transferor and redemption
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VC Fund interest are highly illiquid
transfers are generally prohibited without the consent of the general partner.
Redemptions and withdrawals are rarely allowed
Reinvestment
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to cover expenses
make up for gaps in capital contributions.
proceeds from sales of investments
rarely subject to reinvestment
Additional investors.
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Generally closed to new investors within six to 12 months after initial closing
Where allowed, subsequent investors often contribute their share of the cost of prior investment by the
Fund (often with interest).
Closed to new money
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is designed to keep things simple
and avoid the need for valuations of investments early in their life
valuations are imprecise (which can lead to disputes), complex and costly
Types of Funds – LBO and
Investment Banking Funds
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General Features.
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LBO/IB funds purchase all or significant portion of stock or
assets of a target company.
investments takes the form of equity securities of a newly
formed corporation which will acquires stock or assets of the
target company.
borrow money to fund a large portion the purchase price
Cash flow from the acquired company is used to service and
repay acquisition indebtedness.
Likely candidates for LBO's
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stable cash flow
good market share.
Types of Funds – LBO and
Investment Banking Funds
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Economics
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Carried interest - typically consists of 20% of the gains
attributable to capital commitments
Preferred return – generally 8% to 12% with a GP Makeup
Management fees 1.5 to 2.5%
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Based on Capital Commitment during Investment Period
Thereafter, based on capital not retuned to investor
Transaction fees
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Management is quite likely to have opportunity to receive fee income
directly from target companies.
Types of Funds – LBO and
Investment Banking Funds (Cont’d)
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Thus the question of whether fee income should be
treated as Fund income is often intensely negotiated
Transfer and Redemption
Investors generally prohibited from transferring their
interests without the consent of the GP
 redemptions and withdrawals are rarely allowed
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Reinvestment - reinvestment is rare
Additional investors – same polices as with VC
Funds discussed above
Types of Funds – Hedge Funds
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General Strategies
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Invest in listed securities, options, futures, and currencies
Or other liquid financial assets
The ability to invest in illiquid securities is sometimes also given
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However, often there are caps on investments in illiquid securities
Organization
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Many different types of structures are used
Short-term trading is involved
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So not as geared toward capital gains as other types of funds
This makes partnership qualification less critical provided entity level tax can be minimized
Generally the structure depends on the investor group to whom the fund will be sold
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US taxable investors
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generally domestic limited partnership structure is used to avoid entity level tax
Non-US investors and US Tax Exempt Investors
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Entity level tax is undesirable
However, pass thru is often not wanted either (e.g. UBTI for tax exempts)
So many hedge funds organize in tax havens such as Cayman Islands and Bermuda
Types of Funds – Hedge Funds
(Cont’d)
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Economics
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Carried interest
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Preferred returns
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most hedge funds do not provide preferential returns
however funds which do often adopt a floating rate of return such as LIBOR -- the
London Interbank offered rate
Management fees
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Determined by reference to net asset value which takes into account unrealized as well
as realized gains and losses.
The amount is typically 20% of the increase in NAV from one period to the next.
Generally paid annually
Clawbacks are unusual.
Higher Carried Interest rates of 25% or very exceptionally 30% are sometimes seen
usually an amount equal to a fixed percentage of NAV.
Typically these are paid quarterly in advance.
The general rate is 1% per annum
Transaction fees
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these are not often present
Types of Funds – Hedge Funds
(Cont’d)
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Leverage
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Transfer and Redemption
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leverage ratios of three to one are common
funds which pursue arbitrage opportunities in financial assets
may have significantly higher leverage
general partner consent is required to transfer
redemptions are typically allowed after perhaps an initial
lockout from one to two years
redemptions - made quarterly or semiannually
Reinvestment - universal
Additional investors - most hedge funds are open to
new investors on redemption dates
Types of Funds – Fund of Funds
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Definition
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This is a fund which invests in other funds
Rationale
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Access to deals
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Many Funds require minimum investments that are beyond the reach of many individuals.
Regulatory reasons can restrict individual investors to those with net worth of $5 million+
Expertise
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access to deals
expertise
economies of scale
diversification
lack of transparency in some markets
the only way to obtain certain market information is often to be an active market participant
fund of funds can bridge the information gap for investors
Economies of scale
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Sponsor can the review prospective investments that would be prohibitively expensive if undertaken by
each investor in paragraph
Types of Funds – Fund of Funds
(Cont’d)
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Investment strategy.
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Organizational structure
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Better investment returns relative to mid-to long-term public equity market returns.
Most funds of funds focus on a particular category of underlying private equity funds
typically limited partnerships.
The partners have capital commitments in specified amounts
The general partner is often organized as a limited partnership or an LLC
General partner of the fund sponsors typically do not organize a separate entity to serve as
manager
Carried interest
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Many of the funds of funds forego
Carried interest is still typical for a majority.
Generally arrived at by formula consisting of realized gain plus unrealized gain associated
with marketable securities which are distributed to investors.
Carried interest is generally around 5%
Types of Funds – Fund of Funds
(Cont’d)
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Preferred return
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most funds of funds provide preferred returns.
generally a fixed percentage annual rate of return
general range - from 6% to 12%
preferential returns are almost overly combined with a general partner makeup
Management fees
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Usually an amount equal to a fixed percentage of capital commitments
Management fees are typically paid by a fund of funds quarterly in advance
ranges - .75 to 1.5% of capital commitments
Often management fee rates decline when the fund is fully invested.
If no carried interest
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a higher management fee
less likely to be reduced if the fund is fully invested
Types of Funds – Fund of Funds
(Cont’d)
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Transaction fees
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Unlikely
Size
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certain critical mass is needed
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typically capital is $50 million to 100 million
Investor
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to have access to deal flow
and to achieve economies of scale.
profile high net worth individuals and small institutional investors
paragraph
Leverage
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fund of funds really has the ability to borrow money
except in short-term to cover expenses or bridge contributions
Types of Funds – Fund of Funds
(Cont’d)
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Transfer redemption
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Transfer only on the consent of the general partner
Redemptions and withdrawals are rarely allowed
Reinvestment
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typical fund of funds calls for capital contributions as needed for
investments or to pay expenses
once fully invested or after a specified investment.
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A fund of funds ordinarily goes into monitoring and liquidation stage.
Proceeds from underlying
Additional investors
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most funds of funds are closed to new money within six to 12 months
after the initial closing
investors after initial closing contribute pro rata share of costs of prior
investment (often with interest)
Types of Funds –Real Estate Funds
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What they Do
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These generally invest in large real estate assets
generally sponsored by experienced real estate owners or investment advisers
Investment strategy
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superior return and risk reduction relative to direct real estate investments
generally structured with a specific investment focus such as
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may also focus on specific real estate asset types such as
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acquisition of real estate directly.
Acquisition of interests in properties on a joint-venture basis
investment in public or private operating companie
real estate loan origination or acquisition of real estate debt instruments
commercial office buildings
retail shopping mall facilities.
Multi-family properties or hotels.
They may also have an investment strategy that focuses on specific geographic
regions.
Types of Funds –Real Estate Funds
(Cont’d)
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Organizational structure
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Carried interest.
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these are typically either limited partnerships or LLC's
principals organize a controlled entity to be GP or managing member
Principals may organize a separate entity to invest in the fund.
The general partner or managing member entity is typically either corporation or LLC
Principals may organize a separate entity to serve as investment manager or investment
adviser.
Calculate from realized gains which are distributed
May also be calculated at fixed intervals by an appraisal of assets.
Typically consists of 20% after Hurdle Rates are achieved.
Often subject to claw back – final returns are really known until asset disposition
Preferred returns
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a substantial majority of real estate funds provide preferential returns or hurdle rates
The percentage varies depending on the specific investment strategies used
Types of Funds –Real Estate Funds
(Cont’d)
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Management fees
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these are usually annual amount equal to a fixed percentage of capital until 75%
of the capital commitment is funded and invested
thereafter a fixed percentage of the NAV
typically paid quarterly or monthly in advance.
Fees generally range from 1% to 2%
Transaction fees
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affiliates of the principals may receive
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property Management fees,
leasing
or other fees for properties owned by the fund.
These fees are typically not shared with the fund or the investors
Typical investors
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high net worth individuals, pension funds and other institutional investors
generally do not include banks and insurance companies
Types of Funds –Real Estate Funds
(Cont’d)
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Leverage
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Transfer and Redemption
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real estate funds typically employ leverage
additional leverage might be obtained by a fund level credit facility in addition to loans
against assets
transfer requires consent of the general partner.
due to illiquid nature redemptions are not allowed except rarely
Reinvestment
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real estate funds generally provide
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A 2-3 year investment phase
A 1-2 year holding and monitoring period
A 1-2 year liquidation period
Proceeds from sales are generally not subject to reinvestment.
Additional investors
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most real estate funds are close to new investors within 6- 12 months after the initial closing
additional investors leads to expense to value fund assets such as real estate appraisals
Key Structural Features
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Limited Liability
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Enabling state law legislation will provide for limited liability for LLC
E.G. Delaware – debts, obligations and liabilities of an LLC whether
arising in contract or otherwise are the sole responsibility of the LLC
Compare LLP – the limited partners have limited liability but not the GP
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However, keep in mind limited liability only extends to status based
liability
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Solution have an entity GP, e.g. an S corporation
Liability based on the personal conduct of a member or manager is not
protected by the entity’s limited liability
Under US Securities laws liability sometimes extends to persons who control
another person such as a corporation that violates the laws
Veil piercing – A somewhat open issue
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Inadequately capitalized entities ??
Failure to follow formalities ?? – But no real formalities and direct
management by members is envisioned by the laws
Key Structural Features (Cont’d)
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Multi-Tier Structures
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Issue in LP’s is how to organize the GP on account of the
Unlimited Liability of GP
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Classic solution was a corporate GP
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In fact, with hedge funds the GP was often a 2nd LLP with a
corporate GP (three tiers)
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To eliminate entity level tax and for pass through of capital gains – “S”
status elected
This also eliminated entity level tax and preserved capital gains allocated
to principals
Also allow division of Carried Interest and other economic attributes of
the GP to be determined by contract instead of by share ownership
Now LLC (with no member having personal liability) has
become the favored structure for Private Equity Funds
Key Structural Features (Cont’d)
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Incentive Arrangements (Larger Funds)
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Ideally to attract best talent (one notch below top fund
management) is to have flexibility in allocating the Carried
Interest
However, Sr. Fund Management not want to give up control
and management – so preference is for a form of ownership
that separates control & management from economic
interests
Generally too Sr Principals will want ability to frequently
change allocations of Carried Interst.
One structure that is used is LLC, with classes of
membership interests, requiring establishment of separate
capital accounts for each investment, and then allowing
establishment of different sharing %’s for each transaction
Fiduciary Relationships Survey

Why would the limited partnership continue to matter if parties
can obtain similar features along with partnership-type taxation
by forming as LLCs?
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the main distinct limited partnership feature is limited partners’ default nonmanagement involvement
a firm can obtain the same feature in every state by forming as an LLC and
opting for centralized management.
One major reason: a significant amount of case law dealing with
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the fiduciary duties of general partners in limited partnerships
specifically with waiver of such duties
this is especially well developed in Delaware
Fiduciary Relationships (Cont’d)
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Partners have duties to refrain from:
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self-dealing
appropriation of partnership assets and opportunities,
competition with the partnership
mismanagement
Courts have compared general partners to corporate
directors
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Use of the “business judgment” rule.
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See Wyler v. Feuer, 85 Cal. App. 3d 392, 149 Cal. Rptr. 626 (1979);
Trustees of Gen. Elec. Pension Trust v. Levenson, 1992 WL 41820 (Del. Ch. 1992). The Texas Revised Partnership
Act applies an ordinary care standard subject to a business judgment rule taken from corporation law. Tex. Rev. Civ.
Stat. Ann. art. 6132b-4.04(c), (d))
This makes the legion of corporate business judgment rule
cases arguably applicable.
Fiduciary Relationships (Cont’d)
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Waivers
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Delaware statutory law Del. Code § 17-1101 explicitly provides that GP
duties and liabilities may be expanded or restricted by provisions in a
partnership agreement
So in Delaware the keys for a GP are
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Disclosure of conflicts of interest in Fund sales materials
Enumeration of permitted conflicts of interest activities of the GP in the
Partnership Agreement.
Cases have allowed waivers:
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GP to purchase assets of liquidating partnership. See In Re Cencom, Civ A No.
14634, 1996 WL 74726 (Del Ch Feb. 15, 1996)
GP to take advantage of partnership opportunity. See Kahn v. Icahn, Civ A
No. 15916, 1998 WL 832629 (Del Ch Nov. 12, 1998)
Eliminate the duty of substantive fairness in transactions between general
partners and their partnerships, at least as long as the limited partners have
had an opportunity after full disclosure to vote on the transaction. See Sonet v.
Timber Co. L.P, 722 A.2d 319 (Del. Ch. 1998).
Fiduciary Relationships (Cont’d)
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Can’t Go Overboard with This
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a very broad provision in a partnership agreement in effect negating any duty of loyalty
such as a provision giving a managing partner
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complete discretion to manage the business with no liability
except for acts and omissions that constitute willful misconduct
will not likely be enforced
.See, e.g., Labovitz v. Dolan, 189 Ill. App. 3d 403, 136 Ill. Dec. 780, 545 N.E.2d 304 (1989)
Also need to watch provisions allowing management to compete


this sort of provision would be expected in the typical limited partnership, which manages a
portfolio of assets rather than running an ongoing business.
However, its generally a “No-No” where a partner seizes on the provision

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not merely to engage in a different business
but to undercut the other partners and take over the business of the partnership
Laibowitz –
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that the general partner refused unreasonably to distribute cash
thereby forced plaintiffs to continually dip into their own resources in order to pay heavy taxes on
large earnings
in a calculated effort to force them to sell their interests to

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an entity which GP owned and controlled
at a price well below at least the book value of those interests.
Fiduciary Relationships (Cont’d)

Delaware Approach to Waivers

First, the strongly worded statutory protection of “freedom of contract”
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Second, the courts have reserved a category of fundamental, non-waivable
fiduciary duties.
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focuses the courts’ attention on the language and structure of the contract in the first
instance.
This strongly discourages courts from substituting judicial default rules for clearly
articulated contractual duties.
This default category effectively encourages the parties to substitute their own
customized duties
These should reasonably meet the needs of the particular situation rather than risking
invalidation of the waiver.
Third, to the extent that default duties are subject to waiver without displacement,
the waiver must be explicit in order to be enforced.
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
Combined with the disclosure requirements of the federal securities laws and the other
circumstances
serve to call the partners’ attention to the partnership agreement,
this ensures that limited partners are likely to be aware of any fiduciary duty waivers.
The End

If You Have Further Questions Contact:
Robert J. Kiggins, Esq.
McCarthy Fingar
Tel 914-946-3817 Ext. 251
Email rkiggins@mfdds.com