The High Court has ruled largely against a group of institutional investors on preliminary issues in proceedings brought against the manager and general partner of an infrastructure fund alleging breach of investment mandate.
The ruling is of interest not only for its consideration of the investment mandate allegations but also for its acknowledgment that, in certain circumstances, investors in a partnership vehicle may be able to pursue claims against a fund manager by bringing an action on behalf of the fund itself.
In Certain Limited Partners in Henderson PFI Secondary Fund II LLP v Henderson PFI Secondary Fund II LP & Ors  EWHC 3259 (Comm), the fundamental allegation was that the fund did not invest exclusively or principally in private finance initiative (PFI) concession companies, as the investors allege it was required to do, but instead acquired a corporate group which also held interests in other types of assets, exposing them to substantial losses.
In a preliminary hearing, the Court was called upon:
- to rule on whether the investors could bring claims against the fund's Manager and General Partner as derivative actions – that is, standing in the place of the General Partner to bring an action on behalf of the fund; and
- to interpret the relevant contractual documents with respect to the scope of the investment mandate and the Manager's liability.
It was held that:
- as against the General Partner, the investors were not entitled to pursue derivative claims;
- as against the Manager, there were sufficient ‘special circumstances’ to permit derivative claims but, if the investors elected to pursue such claims, they would forfeit their limited liability for the entirety of the partnership debts for the period in which they did so; and
- all of the contractual interpretation issues were determined in favour of the defendant managers, including a finding that the relevant corporate acquisition was within the scope of permissible investments.
In September 2006, Henderson Equity Partners launched the Henderson PFI Secondary Fund II (the Fund), for the purpose of investing in PFI and public private partnership concession companies.
The key governing documents were a partnership agreement and a management deed under which the General Partner appointed one of its sister companies as Manager.
The Fund raised £573.5m, the majority of which was used in the £1bn public to private acquisition of the Laing group of companies (Laing). Laing owned shares in numerous PFI concession companies but also had substantial interests in other assets. By June 2009, the value of the Fund had fallen by 60%.
In December 2011, 22 of the 29 limited partners in the Fund (the Claimants) filed proceedings against the Fund, the General Partner and the Manager.
In relation to the fundamental allegation regarding the unauthorised acquisition of Laing, the principal claims are for damages:
- against the Manager for breach of the management deed;
- against the General Partner for breach of the partnership agreement and in equity; and
- against the Manager for alleged misstatements in the relevant private placement memorandum (PPM).
The Claimants sought to bring the first two of those claims by way of derivative actions on behalf of the partnership since s6(1) of the Limited Parnterships Act (LP Act) prevented limited partners from taking part in the management of the partnership business - including the conduct of proceedings, which was a matter for the General Partner.
The preliminary hearing did not address the PPM misstatement allegations or a number of additional allegations concerning unauthorised allocation of assets and liabilities as between the Fund and a parallel fund.
Could the Claimants bring derivative claims?
Derivative claims are effectively an exception to the usual rule that only the party in whom a cause of action vests can bring a claim in respect of that action. They are most commonly used to allow a party to pursue an action on behalf of the body in whom the action vests in circumstances where the controllers of that body are unable or unwilling to bring the claim (often because of a conflict of interest).
The classic example is a minority shareholder seeking to bring action on behalf of a company against wrongdoers in control of the company. However, while it is clear that derivative claims are not limited to that corporate context, there is no previous example in English law of a limited partner seeking to pursue such an action on behalf of a limited partnership.
Derivative claims will only be available where there are 'special circumstances'. The categories of 'special circumstances' have never been defined but a claimant must be able to show that it has a legitimate interest in the relief being claimed and that an injustice would arise if the relief was not able to be pursued.
Applying that test to the present case, Cooke J refused to allow derivative claims against the General Partner on the basis that there was no bar to the Claimants suing the General Partner under the partnership agreement in their individual capacities (as the majority of them were in fact doing, alongside the derivative claims). There was therefore 'no need and no room for a derivative claim'.
However, in the case of the claims against the Manager, the Court accepted that 'special circumstances' existed, warranting a derivative claim. In particular:
- It was undisputed that any claim against the Manager, as a third party, was a partnership asset owned jointly by the limited partners and could, in the normal course, only be brought by the General Partner.
- The 'special circumstances' in this case arose from the General Partner's conflict of interest in being a sister company of the Manager - so that there was in reality no way the partnership would bring an action against the Manager unless the existing General Partner was replaced under the mechanism for doing so in the partnership agreement.
- The existence of that alternative remedy of replacing the General Partner was a factor that was relevant but not conclusive. Cooke J accepted factual evidence that, in this case, replacing the General Partner would have such 'drastic consequences' (in terms of likely additional losses to the Fund) that it was not a realistic course. The interests of justice therefore demanded that derivative claims be allowed.
- That conclusion was reached notwithstanding the defendant managers' objection that the General Partner's conflict of interest was built into the architecture of the partnership, to which the investors had freely agreed.
- Cooke J also rejected the defendants' argument that permitting derivative claims in a partnership context would run contrary to the statutory framework – given the prohibition in the LP Act on limited partners participating in the management of the partnership business.
- However, he accepted that, if the Claimants did elect to bring such claims, s 6(1) LP Act would operate so as to require them to forfeit their limited liability status for as long as they were participating in the management of partnership business by pursuing the claims. In this regard, the Claimants were unsuccessul in arguing that such liability should be limited to debts directly linked to the pursuit of the claims. Rather, it was held that they would be liable for all debts and obligations incurred by the partnership during the period in which they were pursuing the claims in the place of the General Partner, in exactly the same way the General Partner would have been.
The investment mandate
A key provision in dispute was a clause in the 'Investment Policy’ section of the partnership agreement which, on its face, appeared to permit the Manager to invest in any type of assets at all during the two year commitment period (provided it used reasonable endeavours to realise or divest itself of any non-PFI assets during that period).
The Claimants accepted that this was the literal meaning of the wording but argued that that could not be what was meant by the parties, because it would be inconsistent with the clear PFI-based purpose of the Fund, as identified in the PPM and in the balance of the stated Investment Policy. They submitted that the clause should be read as being limited to allowing non-PFI investments only as ancillary investments, where the relevant portfolio consisted of principally operational PFI concession companies.
The Court rejected that interpretation, finding that:
- it was simply not what the clause said;
- there was a clear rationale behind the clause as drafted, which was also reflected in other provisions of the partnership agreement - to allow the Manager to achieve a strong income stream during the first two years, while pursuing the overall strategy of building a PFI-based portfolio; and
- there was no reason to read down the wording of the clause by reference to the PPM or to incorporate the PPM into the partnership agreement (which prevailed in any event if there was inconsistency between the two).
Based on that and on its interpretation of other relevant provisions, the Court concluded that the investment in Laing did not fall outside the investment policy and was not a breach of the Manager's obligations under the management deed.
It is also worth noting that the Court was prepared to base its conclusion, in the alternative, on a general clause in the partnership agreement entitling the Manager to undertake all acts
'..as are necessary or desirable in the reasonable opinion of the Manager in furtherance of the foregoing powers and consistent with the terms of this Agreement..'.
The Court confirmed that this meant that, even if the Laing investment was in fact outside the express mandate on a proper construction of the documents, if the Manager reasonably believed that the investment was within those powers, its authority was effectively extended to include that investment. Further, while any such belief must have been objectively reasonable, where there was room for any difference of view in this regard the benefit of any doubt should be given to the Manager.
The decision in respect of derivative claims is notable as perhaps the first acknowledgment by the English courts of the potential for investors in a partnership vehicle to pursue claims against a fund manager by standing in the place of the general partner to bring an action on behalf of the fund itself. However, the likelihood of floodgates being opened in this respect would appear limited given the Court’s unequivocal conclusion that the price of pursuing such a claim is the complete forfeiting of limited liability.
While the Court’s findings on the interpretation of the documents are largely specific to the documents in question in this case, they reinforce the importance of careful drafting on the issue of investment mandate and, in particular, highlight the potential for mandate to be effectively expanded by general clauses giving fund managers broad discretionary powers limited only by their 'reasonable belief'.
Further, the Court's general approach in refusing to depart from the literal interpretation of the partnership agreement, particularly by reference to the placement memorandum, is of potential wider relevance in other cases where parties seek to rely on such information documents to advance their preferred interpretation of their contractual documents.