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Fiduciary Duties in Private Equity: What Sponsors and LPs Should Know

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Capital Markets and Mergers & Acquisitions Bulletin


What fiduciary duties apply in private equity (PE) structures and, more specifically, as between general partners (GPs) and limited partners (LPs) within a PE fund?

The recent decision of the Ontario Court of Appeal (ONCA) in Extreme Venture Partners Fund I LP v. Varma sheds some light on this important question. In brief, the ONCA stated that both the corporate GP, as well as the GP’s individual directors, were fiduciaries of the limited partnership.

We explore Varma and some practical takeaways for PE funds and the directors of their GPs.

The Dispute

The limited partnership at issue (EVP LP) was a venture capital fund whose GP had five directors.

Two of the directors were held to have engaged in a series of wrongful acts, including (1) establishing a competing fund without disclosing it to the other GP directors, (2) providing the competing fund with confidential information regarding EVP LP’s investment strategy, and (3) covertly orchestrating the sale of certain EVP LP assets at a depressed price and for eventual personal gain.

Moreover, a friend of the two GP directors – a prominent Silicon Valley venture capitalist – was held jointly and severally liable alongside them for knowingly assisting in the sale of certain EVP LP assets at a depressed price.

The Ruling

The directors argued that they only owed fiduciary duties to the corporate entity they were directors of, namely the GP of EVP LP, and that their fiduciary duties went no further. The trial court disagreed, holding that in addition to the immediate fiduciary duties owed by the directors to the GP of EVP LP, they were also ad hoc fiduciaries of EVP LP.

The ONCA agreed, and its reasoning focused on the nature of limited partnerships. It first explained that a limited partnership “is a hybrid organization that combines elements of partnership law and the law of corporations.”[1] It explained:

It would be inequitable if the corporate form could be used to insulate directors who are in breach of their duties to the general partner and who have caused damages to the limited partnership. Given the unique structure of limited partnerships, the common law should impose a fiduciary duty on corporate directors of the general partner towards the limited partnership.[2]

The ONCA also observed that “[t]he general partner owes a fiduciary duty to the limited partners.”[3]

Practical Takeaways

The practical takeaway from Varma is that it is prudent to assume that directors of a PE fund’s corporate GP will be considered ad hoc fiduciaries of the limited partnership in addition to being fiduciaries of the GP. The corporate GP should also be considered a fiduciary of the limited partnership. Finally, third parties that participate in a breach of such fiduciary duty by the GP or the GP’s directors risk being liable for knowingly assisting in that breach of fiduciary duty. For example, in the PE context this could include non-director officers of the GP and/or officers or directors of the PE fund’s other portfolio companies.

That said, certain qualifications are warranted and several questions are raised by the decision.

The ONCA described the conduct in Varma as “brazenly illegal”.[4] Moreover, the court explained that the directors had “acted solely in their self-interest and contrary to the interests of both the general partner and the limited partnership” such that this was “not a situation where they were balancing the corporation's interests against those of the limited partnership.”[5] These comments indicate that, where the directors’ conduct can be reasonably characterized as being in the interest of the GP notwithstanding being against the interest of the LPs, the result may be different.

It is unclear from the decision regarding whether and to what degree fiduciary duties owed by the corporate GP and/or the GP’s directors to the limited partnership can be modified, for example through the terms of the limited partnership agreement (LPA). Canada’s federal and provincial business corporation statutes generally stipulate that directors’ duties cannot be limited by contract, by-law or resolution.[6] From there the waters muddy somewhat. On the one hand, much turns on the conduct at issue. On the other hand, there is a delicate balance between (1) the fiduciary duties owed, and (2) the authority of the GP under the LPA against which such duties are imposed.

To begin to address these questions this bulletin will be followed by two further editions. In the next instalment, we consider two recent cases addressing the possibility of LPs bringing a derivative action on behalf of the limited partnership against the corporate GP and/or the GP’s directors for a breach of fiduciary duty. In the third instalment we take a closer look at how courts have weighed the terms of an LPA in deciding (1) the scope of the fiduciary duty owed, and (2) whether such fiduciary duty was breached.

A Note on Quebec

Regarding Quebec, we note that section 322 of the Civil Code of Quebec imposes a duty on directors to act with prudence and diligence and with honesty and loyalty in the interest of the legal person. While these obligations have parallels with fiduciary duties under common law, caselaw has made distinctions between the two concepts. Therefore, while Varma may provide a high level indication regarding how a Quebec judge might apply Civil Code section 322 in the PE fund context, the degree to which this could be the case remains to be seen.

[1] Extreme Venture Partners Fund I LP v. Varma, 2021 ONCA 853 (CanLII) [Varma] at para. 98 (emphasis added).

[2] Varma at para. 101 (emphasis added).

[3] Varma at para. 98.

[4] Varma at para. 12.

[5] Varma at para. 99 (emphasis added). See also para. 100. 555

[6] See Canada Business Corporations Act, RSC 1985, c C-44 at s.122(3); Business Corporations Act, RSO 1990, c B.16 at s.134(3); Business Corporations Act, SBC 2002, c 57 at s.142(3); Business Corporations Act, RSA 2000, c B-9 at s.122(3). 

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