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Breaking up is hard to do: Dealing with a departing general partner

The private equity industry is coming under increasing pressure to adapt and restructure. As a result, it is becoming increasingly common for general partners to part company with private equity firms. John Welsh and Robert Kilroy of Testa, Hurwitz & Thibeault explore the practical and legal implications of a GP's departure, including release claims, confidentiality and transition obligations.

As private equity firms and the industry as a whole continue to restructure to adapt to changes in the investing environment, there have been, and likely will continue to be, an increasing number of General Partners departing from private equity enterprises. The departure of a GP raises a myriad of legal and business issues which must be carefully considered and addressed to ensure a smooth and effective transition. Typically, the departing GP is a party to a number of legally distinct, yet often interrelated, legal relationships. These relationships include partnership or shareholder interests in the various legal entities that comprise the private equity enterprise, an employment relationship with the management company, additional contractual side-agreements among various partners, and advisory/director positions with portfolio companies. Special care must be given to address the precise consequences of the departure for each relationship. Simply put, it is imperative that the GP's post-separation status, rights and ongoing responsibilities be made clear to all.

The touchstone for addressing issues raised by a GP's departure is typically the comprehensive separation agreement that is negotiated in connection with the departure. The goal of the agreement is to identify and resolve with specificity and finality all obligations and responsibilities of the departing GP, the private equity enterprise and the remaining partners. The discussion below outlines many of the issues typically addressed in the separation agreement.

Status under Agreements.
All partnerships, corporations, contracts and other business relationships involving the departing GP must be identified, and the operative documents must be carefully scrutinized. Notice periods, removal/resignation procedures, vesting of economic interests and future capital contribution obligations are just some of the provisions which must be analyzed, coordinated and perhaps adjusted by mutual agreement. The parties must be prepared to discuss and resolve claims relating to oral promises, representations or understandings. The parties must also take into account the departing GP's obligation for potential future “clawbacks” of carried interest distributions. In the context of a unilateral separation, strict adherence to removal procedures set out in the operative documents is essential.

Employment Concerns.
While the principal aspects of the typical GP departure involve partnership and other contractual rights and obligations, cessation of an employment relationship with a management company is also an aspect of most GP departures. Employment-related issues that must be addressed include: the date employment ends; the payment of all accrued unpaid salary, bonuses, vacation time and business expenses; the continuation of benefits under COBRA or otherwise; and the return of property such as computers and cell phones.

Severance.
Post-separation compensation, in the form of severance pay and/or accelerated vesting of economic interests, often is a principal area of discussion, especially in circumstances where the separation is at the initiative of the private equity enterprise. Seldom do the underlying contracts specifically provide for severance payments. However, except in the case of a separation due to misconduct, severance is expected. Typically, length of tenure, the cause of the separation, prior practices with respect to other former GPs and standard industry norms are some of the factors which provide guidance in these determinations.

Release of Claims by GP.
A release of all claims usually is required from the departing GP in return for severance, accelerated vesting or other separation benefits bestowed by the private equity enterprise. The release should be all-encompassing, and cover specifically not only all entities that comprise the private equity enterprise, but all
partners and others associated with the enterprise. Care also should be given to
insure that indemnification, subrogation contribution and insurance coverage rights of the departing GP are not compromised.

A vexing issue is whether a mutual release should be given to the departing GP. While the symmetry provided by a mutual exchange of releases seems intuitively fair, such matters as unasserted claims by third parties, undiscovered acts of misconduct or fiduciary duty breach, and other unknown potential claims make
this decision quite difficult.

Confidentiality.
Thorny issues may arise around issues of confidentiality. In the context of a contentious separation, the departing GP often wishes to portray the departure as a voluntary resignation for a better opportunity while the remaining partners wish to communicate that the firm is as strong or stronger due to the departure. In an industry in which reputation is everything, the parties must use utmost care to reach an understanding as to the scope of post-separation communications regarding the departure.

A related area of conflict concerns confidentiality of internal information of the private equity firm. The departing GP may desire to share specific deal information or perhaps his own investment record with prospective partners, employers or investors. The private equity enterprise typically views this information as confidential and desires to prohibit any disclosure or use of this information by the departing GP. Typically, compromises are brokered that will enable limited disclosures with restrictions and safeguards.

Transition Obligations.
Given that the departing GP likely was integrally involved with several portfolio companies, careful attention must be paid to transitionary period obligations. Will the departing GP immediately resign from all board seats with portfolio companies? Will the departing GP fully brief his successor on all portfolio company issues? Will the departing GP be available for additional consultation if problems arise in the future? These issues should be resolved promptly in connection with the separation.

Conclusion.
The above summary is not intended to represent an exhaustive list of the issues that may arise in the context of a departing GP. Each departure is governed by the unique character, history and personal dynamics of the partners involved. However, given that litigation is almost never an acceptable option to any of the parties involved, careful attention must be paid to reach closure on these and other pertinent issues as quickly as possible in connection with the separation.

This article is reproduced with permission of Testa, Hurwitz & Thibeault, LLP.  For more information about Testa, Hurwitz & Thibeault, LLP, please contact www.tht.com
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