Collateral beauty: taking security in fund finance

Subscription Line Facilities vs NAV Facilities

Subscription line facilities remain the backbone of fund finance – the dependable old workhorse. They are typically secured against unfunded investor commitments and the bank accounts into which those commitments are deposited. This structure provides lenders with strong credit support, given the contractual obligation of investors to fund capital calls.

NAV facilities, by contrast, are secured against the fund’s assets. In Cayman structures, this often involves security over equity interests in vehicles such as ELPs, limited liability companies or exempted companies. NAV facilities allow funds to unlock liquidity from their portfolios, providing financing at the fund level rather than relying solely on investor commitments. The ability to take robust security over limited partnership interests (LP Interests) under Cayman law has been central to the growth of NAV financing.

Understanding Cayman Exempted Limited Partnerships

An ELP is the standard vehicle for private equity and investment funds in Cayman. Formed under the Exempted Limited Partnership Act (as amended) (the ELP Act), an ELP does not have separate legal personality. Its business is conducted by the general partner (GP), which enters into contracts on behalf of the partnership.

Investors participate as limited partners, contributing capital in exchange for LP Interests under a limited partnership agreement (LPA). LP Interests are recorded in the register of limited partners, which the GP is required to maintain. This register may be inspected with the GP’s consent during usual business hours.

Crafting the Security Package

Form of Security

Lenders typically secure limited partnership interests through an equitable charge. This arrangement allows the investor to retain legal title in the interests during the life of the loan, while giving the lender a contractual right to step in if the borrower defaults. On enforcement, the lender can compel a transfer of the interests, ensuring practical control without disturbing the fund’s day‑to‑day operations.

GP Consent

Under the ELP Act, a limited partner cannot charge or transfer its LP Interests without the GP’s approval, unless the LPA expressly relaxes that requirement. To safeguard against uncertainty, lenders typically insist before closing that the GP issues written consents covering both the creation of the security and any subsequent transfer if enforcement becomes necessary. Absent those consents, a lender’s ability to enforce its rights could be materially hindered.

Perfection and Priority

In Cayman, priority is basically a sprint. Whoever gets their notice of charge to the ELP’s registered office first wins the bragging rights (and the legal protection). Priority is determined by the time of valid service of the notice. That notice should clearly identify the security agreement, its execution date, the parties involved and the partnership interests subject to the charge.

The GP must maintain a register of security interests at the ELP’s registered office. Chargees should ensure the register is updated post-closing to evidence their interest. To safeguard their position, lenders generally request evidence of service together with a written confirmation from the GP at closing, ensuring that priority is both documented and acknowledged.

To facilitate enforcement, the limited partner is usually required to deliver ancillary documents such as undated transfer instruments or assignment agreements executed in blank. The lender will also expect GP consent letters and confirmation that the LPA does not impose restrictions that could impede enforcement.

Enforcement Considerations

Remedies Available

When a borrower defaults, the law does not leave the lender helpless. The chargee may step in. They may sell the LP Interests, or may appoint a receiver to collect the distributions. These remedies are not locked behind the doors of the court, they can be exercised directly, provided the documents allow it.

But here lies the rub: the GP is the ringmaster of the limited partnership circus, juggling duties to investors while lenders wave enforcement papers. If the LPA gives the GP too much discretion, enforcement can feel like trying to run a marathon on a floor covered in banana peels, technically possible, but the lender would spend most of its time slipping.

Consequently, the prudent lender does not wait until trouble strikes. Instead, it would insist at the outset that the LPA is drafted with enforcement in mind. The lender would ensure that the GP’s consent is secured, that transfer mechanics are workable and that the GP cannot frustrate the process. In this way, the lender’s rights are not only valid in law but effective in practice.

Commercial Context and Market Practice

The Cayman Islands regime for taking security over LP Interests is deliberately straightforward, balancing flexibility for investors with certainty for lenders. As NAV facilities continue to grow alongside traditional subscription lines, careful due diligence, GP consent and precise drafting of security documents remain critical.

From a market perspective, lenders are increasingly comfortable with NAV facilities secured against Cayman vehicles, provided that the security package is properly perfected and enforceable. Fund managers, meanwhile, recognise the importance of negotiating LPA terms that facilitate security arrangements without unduly restricting investor protections.

Conclusion

Cayman continues to offer a robust and flexible framework for fund finance. Subscription line facilities remain dominant, but NAV facilities are now firmly established as a complementary financing tool. The ability to take enforceable security over LP Interests in an ELP is central to this evolution.

By conducting thorough due diligence, obtaining GP consent and ensuring compliance with the ELP Act, lenders can achieve both legal validity and practical enforceability. Addressing LPA mechanics and GP dynamics at the outset ensures that security over LP Interests is not only valid but commercially effective. This reinforces Cayman’s position as the jurisdiction of choice for sophisticated fund finance transactions, where investor commitments and portfolio assets alike can be leveraged to provide liquidity across the fund lifecycle.