A guarantee from a vehicle that cannot give one.

A lender to an asset company asks for support from above. A guarantee from the fund, or a letter of comfort, or an undertaking to fund cost overruns, or an equity commitment letter, or a keep-well. The request is natural, because the fund is where the money is and the asset company is a thin vehicle with one asset and a facility. Whether the fund may give what is asked is a question of power, and the answer is in three documents the lender's counsel reads after the term sheet and should have read before: the constitution, which says what the fund may do with its assets and its commitments; the tier's rules, which cap its leverage and may treat a guarantee as leverage; and the regulator's requirements, which for some tiers and some sizes require notification or approval of a contingent liability. A guarantee given without power is voidable, and a lender that relied on it has relied on nothing, which it discovers on the day it calls.

This note sets out what the lender is asking for and why, the constitution's powers and their limits, the tier's leverage cap and the guarantee's place in it, the regulator's position, what a guarantee does to the register and the committee, the forms of support that fit the fund's power, the asset-level alternative, the developer's completion guarantee, a comparison, a worked support package as a type, cases, what each party holds, the sequence, questions, terms and what to read.

What the lender is asking for

A lender to a thin asset company wants recourse to a person with assets if the asset company cannot pay: the fund, whose undrawn commitments and other assets are the money the lender can see. The forms differ in what they commit. A guarantee is a promise to pay the borrower's debt if the borrower does not, up to a stated amount, on demand or after a process. A letter of comfort is a statement of intention with no legal obligation, or with a weak one, which lenders accept from parents they trust and from funds rarely. An undertaking to fund cost overruns commits the fund to contribute equity to the asset company up to a cap on stated events. An equity commitment letter commits the fund to subscribe a stated amount of equity on demand, usually for a stated purpose such as completing a development. A keep-well commits the fund to keep the borrower solvent. Each is a contingent liability of the fund, and each is read against the fund's power to incur it.

The constitution's powers

The constitution states what the fund may do with its assets and its commitments. Most constitutions permit the fund to borrow within a cap expressed as a share of commitments or of net asset value, and to grant security for its own borrowing. Many say nothing about guaranteeing another person's debt, which is a different act from borrowing: the fund incurs a liability without receiving the money. A constitution silent on guarantees is read by counsel for whether the general powers imply one, and lenders do not advance on implication. Some constitutions expressly permit guarantees of the debts of the fund's own holding companies within the borrowing cap; some expressly forbid them; most are silent because nobody thought about it at formation. The constitution also says what the fund's undrawn commitments may be called for, and a commitment letter that promises to call capital for a purpose the constitution does not permit is a letter the fund cannot honour.

The tier's leverage cap

The tier's rules cap the fund's leverage, and a guarantee is leverage for the purpose of the cap in most readings, whether or not the constitution calls it that: it is a contingent liability that may become a debt, and the cap exists to limit the fund's exposure to debt. A fund near its cap that gives a guarantee may be over the cap on the day it signs, and a fund within the cap at signing may be over it when the guarantee is called and becomes an actual liability, or when the valuation on which the cap is expressed falls. The facility's representation that the fund meets its tier covers the cap, and a guarantee that breaches it is a breach of the tier and of the facility at once.

The regulator's position

For a public fund, and for some categories of exempt fund in some circumstances, the regulator requires notification or approval of a contingent liability above a threshold, or of any guarantee of a third party's debt, because the liability reaches the register's protection. For a qualified investor fund the requirement is lighter or absent, but the tier's leverage cap still applies and the regulator's review reads the fund's contingent liabilities against it. A guarantee given without the notification the tier requires is a breach found at the review.

What the guarantee does to the register

A guarantee converts the asset company's risk into the fund's, and the fund's risk is the holders'. A register that subscribed to a closed-ended fund with borrowing within a stated cap has not subscribed to a fund that stands behind every facility in the chain, and a call on the guarantee is a demand on the register's undrawn commitments, or on the fund's other assets, for a purpose the register did not underwrite. The investors' committee has a view, because a guarantee to an asset-level lender is commonly a reserved matter or a related-party matter where the developer is affiliated; the side letters may have a view, because a holder's excuse right may reach a call for a guarantee; and the administrator has a calculation to make about undrawn commitments that are now encumbered by a contingent claim, which changes the capital-call lender's borrowing base.

Why constitutions are silent on guarantees

Constitutions are drafted from precedents written for funds that borrow at the fund level and hold assets through companies that borrow at theirs, and the precedents address the fund's own borrowing and say nothing about the asset companies' because, in the precedent's world, the asset companies' lenders had no recourse to the fund. The world changed when development lenders, financing thin companies with one asset, began asking for the fund's support, and the precedents did not. A manager that drafts its constitution from a precedent has a constitution that permits what the precedent contemplated, and a lender that asks for more has asked for a power the document does not contain. The cure at formation is a clause that states the fund's position on guarantees and other support: permitted within a cap for the debts of its own holding companies, or forbidden, with the register subscribing to either; the cure afterwards is an amendment by the holders' vote, which most decline.

The voidable guarantee and the signatory

A guarantee given outside the fund's powers is voidable at the instance of the fund or its holders, and the lender's reliance on it is reliance on the signatory's authority, which the signatory did not have. The signatory, the manager or the general partner, may be personally exposed to the lender for a warranty of authority it could not give, and to the holders for an act outside the constitution. Lenders' counsel therefore ask for an opinion on the fund's power before accepting a guarantee, and a fund's counsel that cannot give the opinion tells the lender so before the signature rather than after the call. The opinion is the lender's protection and the fund's, and a guarantee without one is a document both sides should be worried about.

The capital-call lender's view

A capital-call lender counts the undrawn commitments as its borrowing base, and a commitment letter or an overrun undertaking that encumbers a reserve of those commitments is a claim on the base the lender did not count. The two facilities are read together: the capital-call facility's covenants on the use of commitments, the commitment letter's call on the reserve, and the intercreditor or the acknowledgement between the two lenders that says which is paid first from a call for the reserved purpose. A fund that gave a commitment letter to a development lender without telling its capital-call lender has encumbered a base the capital-call lender thought was its own, and the capital-call facility's representation about the commitments is untrue.

Where it surfaces

At the term sheet, when the development lender's standard request includes a fund guarantee.

At the opinion, when the fund's counsel cannot confirm the power.

At the call, when the guarantee is disputed by the holders as outside the constitution.

At the tier's cap, when a guarantee within the powers breaches the cap on a fall in value.

At the capital-call lender's review, when a commitment letter is found to have encumbered the base.

At the committee, when a guarantee of the developer's performance is discovered to have been given without approval.

The cost of getting it wrong

A guarantee outside the powers costs the lender its recourse and the signatory its exposure. A guarantee within the powers but over the cap costs the fund its tier. A completion guarantee given in place of the developer's costs the fund the developer's risk, priced at nothing. A commitment letter unknown to the capital-call lender costs a facility's representation. The reading of the constitution, the tier's cap and the two lenders' positions before the support is offered costs a week, and the support that fits costs the fund nothing it had not already committed to invest.

The forms of support that fit

Support that holds is designed to the fund's power, and three forms commonly fit.

An equity commitment letter, limited to a stated amount, for a stated purpose the constitution permits capital to be called for, such as completing a named development, with the lender's ability to call it written into the subscription agreements so that the holders have acknowledged a call for that purpose. The letter commits the fund to subscribe equity to the asset company, which is an investment the fund may make, rather than to pay the lender, which is a guarantee it may not give.

A cost-overrun undertaking, capped, for a development, with the cap inside the fund's reserved commitments and the purpose within the constitution's investment power.

A larger equity contribution at the asset level at the outset, so that the facility is sized to a borrower that does not need support from a party that cannot give it. The cheapest form is often the one that needs no document: the asset company is capitalised enough that the lender does not ask.

The asset-level alternative

Where the lender needs more than the asset company can give, the support is sought from a party that can: the developer, under a completion guarantee in the development agreement, priced into the developer's promote; a parent or a sponsor outside the fund with its own balance sheet; or a third-party guarantor whose charge is the asset company's cost. The fund's own support is the last resort, not the first, because it is the support with the most constraints and the widest consequences, and because every other party in the chain can give it more cheaply than the fund can.

The developer's completion guarantee

A development facility's lender commonly requires a completion guarantee: that the scheme will be completed to the programme and the budget, with the guarantor funding the shortfall. The natural guarantor is the developer, whose skill is the programme and whose promote is the price of its guarantee; the development agreement carries the guarantee and the step-in that goes with it. A fund asked to give the completion guarantee instead has been asked to guarantee the developer's performance, which is a guarantee of a third party's obligation and the act the constitution most often does not permit. The structure puts the completion guarantee with the developer, the cost-overrun undertaking with the fund within its power and its cap, and the facility sized to both.

By form · by fit	What it commits	The fund's power	The tier's cap	The register's position
Guarantee of the asset company's debt	Payment of another's debt on demand	Usually absent; voidable if given without it	Leverage; may breach	A liability the register did not underwrite
Letter of comfort	Intention, or a weak obligation	Within general powers	Usually outside the cap	Little, if no obligation
Equity commitment letter	Subscription of equity for a stated purpose, capped	Within the investment power if the purpose is permitted	Not leverage in most readings	A call for a purpose the holders acknowledged
Cost-overrun undertaking	Equity contribution on stated events, capped	Within the investment power if reserved	Not leverage if drafted as equity	A call within the reserve
Keep-well	Maintenance of the borrower's solvency	Usually absent	Leverage	An open-ended liability
Developer's completion guarantee	Completion to programme and budget	Not the fund's	Not the fund's	None

A timeline, as a type

Month one: the development facility's term sheet asks for a fund guarantee, a completion guarantee and an overrun undertaking. Month one, week two: the fund's counsel reads the constitution and the tier's rules and writes the position: no guarantee; an equity commitment letter within the reserve for completion; the completion guarantee with the developer. Month two: the developer accepts the completion guarantee against its promote; the lender's counsel reads the letter as an investment the fund may make and accepts it; the capital-call lender is told and acknowledges the encumbered reserve. Month three: the committee approves the letter as a reserved matter; the facility is signed and sized to the letter and the developer's guarantee. Year three: the programme slips; the lender calls the letter; the fund subscribes the equity from the reserve under a call the holders acknowledged for that purpose; the developer's guarantee funds the rest; the register's position is unchanged.

The structure paper's page

The structure paper's support page carries: the constitution's powers quoted, on borrowing, security, guarantees and the purposes for which capital may be called; the tier's cap and its base; the regulator's requirements on contingent liabilities; the support requested and the support offered, form by form, with counsel's opinion on the power behind each; the developer's completion guarantee and its pricing in the promote; the capital-call lender's acknowledgement of any encumbered reserve; and the committee's approval. The page is the answer to every lender that asks for more than the fund can give, and it is prepared once.

Reading the support with the register

The register reads the support page for the one question it cares about: can any lender in the chain reach the holders' commitments for a purpose the holders did not subscribe to. A page that shows no guarantees, an equity commitment letter within a reserve the holders acknowledged, and a completion guarantee with the developer answers no. A page that shows a guarantee the constitution did not permit answers yes, and the holders' counsel reads the whole chain for what else was given.

The parallel vehicle and the co-investor

Where the asset company is held by two funds in parallel, or by the fund and a co-investor, a lender's request for support reaches both, and each reads its own constitution. A parallel vehicle at a tier with a different cap, or a co-investor with its own rules, may be able to give what the main fund cannot, and a lender that takes support from one and not the other has support from a party that did not take the whole risk. The co-ordination agreement or the shareholders' agreement says how support to the asset company is shared, and a fund that gives an equity commitment letter for the whole when its co-investor gives nothing has funded the co-investor's share. The support is pro rata, or the one that gives more is compensated in the waterfall, and the document says which.

The landowner's contribution class and the support

On a land platform with a contribution class, a landowner that contributed a parcel for units holds a class whose distribution position differs from the cash class's, and a call for an equity commitment letter is a call the landowner's class may not be obliged to fund, because the owner contributed land rather than cash and the constitution says what its further obligations are. The support is designed with the classes in view: the cash class funds the letter, the contribution class is diluted or not as the constitution provides, and the lender reads the classes before it relies on the letter.

The lender's own view of the letter

A development lender prefers a guarantee because a guarantee pays the lender; an equity commitment letter pays the borrower, which then pays the lender, and the lender has a step between itself and the money. Lenders accept the letter when it is drafted for them: the lender may call it directly on the borrower's default, the equity is subscribed into an account the lender controls, the fund's obligation is irrevocable and unconditional on the stated events, and the holders have acknowledged a call for the purpose. A letter drafted that way is, to the lender, a guarantee in effect and an investment in law, and the difference in law is the difference between a document the fund may sign and one it may not.

A support package, as a type

A lender to a parcel company developing a scheme beneath a centre fund asks for a fund guarantee, a completion guarantee and a cost-overrun undertaking. The fund's counsel reads the constitution: borrowing within a cap, security for the fund's own borrowing, no power to guarantee a third party's debt, and a power to call capital for investments including follow-on equity within a reserved proportion. The fund declines the guarantee, offers an equity commitment letter capped at the reserve for the purpose of completing the scheme with the holders' acknowledgement already in the subscription agreements, and puts the completion guarantee with the developer under the development agreement with the step-in. The lender's counsel reads the three documents, accepts the letter as an investment the fund may make, takes the developer's guarantee as the completion support, and sizes the facility to both. The tier's cap is read at the letter's amount and found unaffected, because the letter is equity rather than leverage. The committee approves the letter as a reserved matter, and the administrator notes the encumbered reserve for the capital-call lender's base.

Four cases, as types

A lender takes a guarantee from a fund whose constitution permits borrowing and is silent on guarantees. The asset company defaults; the lender calls the guarantee; the fund's counsel advises that the guarantee was outside the fund's powers; the holders' counsel agree and decline to fund a call for it; the lender's recourse to the fund is a claim the fund's own directors may be personally exposed for having signed.

A fund gives a guarantee within its powers but near its tier's leverage cap. The valuation falls; the cap, expressed on net asset value, is breached by the guarantee's amount; the regulator's review finds the fund outside its tier and the facility's representation untrue on the same day.

A fund gives a completion guarantee to a development lender in place of the developer, because the developer would not. The programme slips; the lender calls the guarantee; the fund funds the completion from commitments the constitution permitted to be called for investments, and the committee, which was not asked, asks why the fund guaranteed the developer's performance.

A fund declines the guarantee, gives an equity commitment letter within its power and reserve, puts the completion guarantee with the developer, and capitalises the asset company enough that the facility is sized without further support. The lender lends; the register's position is the position it subscribed to; the cap is unaffected; the committee approved what it was asked.

What each party holds

The manager holds the reading of the constitution's powers before the term sheet, the decision to decline what the fund cannot give, and the design of the support that fits.

Counsel holds the opinion on the fund's power, the drafting of the letter to the constitution's investment power, and the reading of the tier's cap.

The lender holds the support it can rely on, and its counsel's reading of the power behind it.

The developer holds the completion guarantee and the promote that prices it.

The committee holds the approval of the support as a reserved matter.

The administrator holds the encumbered reserve and the capital-call lender's base.

The register holds the constitution's limits, which are its protection against a liability it did not underwrite.

The sequence

1. The constitution's powers to borrow, to grant security, to guarantee and to call capital for purposes are read before any support is offered.
2. The support requested is compared with the powers, and what the fund cannot give is declined.
3. The support that fits, an equity commitment letter or a cost-overrun undertaking within the reserve, is drafted to the constitution's investment power, with the holders' acknowledgement.
4. The completion guarantee is placed with the developer in the development agreement.
5. The tier's cap is read at the support's amount and at a stressed valuation.
6. The committee approves the support as a reserved matter; the administrator notes the encumbered reserve.

Questions a manager asks

Can the constitution be amended to permit guarantees. It can, by the holders' vote, and the holders will ask why they should underwrite every facility in the chain; most decline, and a manager that wants the power drafts it at formation with a cap.

Is an equity commitment letter really different from a guarantee. It commits the fund to invest rather than to pay a debt, which is an act the constitution permits, and it is drafted so that the lender's call is a call for equity into the asset company for a stated purpose.

Does the tier count an equity commitment as leverage. In most readings no, because it is equity rather than debt; the reading is confirmed against the tier's rules, and the cap is tested at a stressed valuation.

What if the developer will not give a completion guarantee. Then the developer is pricing its own performance at nothing, and the platform reads that as a fact about the developer before it reads anything else.

Who signs for the fund. The manager or the general partner, within the constitution's powers, and a signature outside the powers exposes the signatory.

Does the capital-call lender care. Its borrowing base is the undrawn commitments, and a reserve encumbered by a commitment letter is a reserve the lender may exclude; the two facilities are read together.

Terms used

Guarantee: a promise to pay another's debt if the other does not.

Equity commitment letter: an undertaking to subscribe a stated amount of equity for a stated purpose.

Cost-overrun undertaking: an undertaking to contribute equity on stated events up to a cap.

Keep-well: an undertaking to maintain the borrower's solvency.

Completion guarantee: the developer's undertaking to complete the scheme to programme and budget.

Leverage cap: the tier's limit on the fund's debt and, in most readings, its contingent liabilities.

Reserved matter: a decision the constitution requires the committee to approve.

What to read

The constitution's provisions on borrowing, security, guarantees and the purposes for which capital may be called; the tier's leverage rules and the regulator's requirements on contingent liabilities; the subscription agreements' acknowledgement of calls for the support's purpose; the development agreement's completion guarantee and step-in. On this site, the financing room under Structures and the funds rooms for each centre under the restricted reading.