LPA default remedies priced as a present value, and compared with the routes an investor under liquidity stress actually has.
Far more than the call. Under an illustrative but typical set of LPA remedies, a limited partner with a capital account of 16.0 that misses a call of 2.0 forfeits half its account and receives the rest only at liquidation, five years out: a position worth 4.97 today instead of 16.00. The default destroys 11.03, or 5.5 times the missed call, where a secondary sale at 85 per cent of NAV would have raised 13.60.
Worked in full in How to Read a Limited Partnership Agreement by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
Default clauses are written to be punitive, because a fund that cannot rely on its calls cannot close its deals. They are rarely invoked, and most investors read them once, at subscription, as boilerplate. They are worth pricing, for two reasons: an investor under liquidity stress needs to know what the alternative to defaulting is worth, and a non-defaulting investor needs to know what it may be asked to fund in the defaulter's place.
| Input | Value |
|---|---|
| Commitment | 20.0 |
| Paid in to date | 14.0 |
| Capital account (NAV) at the default date | 16.0 |
| Unfunded commitment | 6.0 |
| The call missed | 2.0 |
| Default interest on the unpaid amount, a year | 10% |
| Share of capital account forfeited | 50% |
| Retained balance paid at final liquidation, no further profit | 5 years |
| Forced sale price set by the GP, buyer takes the unfunded | 50% of NAV |
| The LP's own discount rate | 10% |
LPAs differ widely in which remedies they list and how hard they bite. This menu, interest during a cure period, then forfeiture of a share of the account or a forced sale at the GP's discretion, is a common shape; read the actual clause before using any of these figures.
Default interest = unpaid call × rate × days ÷ 365
= 2.0 × 10% × 30 ÷ 365 = 0.016
If the investor pays within the cure period, the default costs almost nothing. The whole cost sits behind the end of the cure period, which is why an investor in difficulty should talk to the GP before the notice expires, not after.
Retained balance = capital account × (1 − forfeiture share) = 16.0 × 50% = 8.00
Value today = retained balance ÷ (1 + r)years to liquidation = 8.00 ÷ 1.105 = 8.00 × 0.6209 = 4.97
Loss against continuing to fund: 16.00 − 4.97 = 11.03, or 69% of the account.
Three things stack. Half the account is reallocated to the other investors. The other half earns nothing further: the defaulter is cut out of future profits on the companies it already paid for. And it waits for the end of the fund to be paid. The unfunded 6.0 is cancelled, which is the only thing the investor gains, and at a fair entry price new investment is worth roughly what it costs, so cancelling it saves nothing in value.
| Route | Value today | Loss against funding | Loss against a secondary sale |
|---|---|---|---|
| Fund the call | 16.00 | 0 | −2.40 |
| Borrow 2.0 for a year at 9% to fund it | 15.82 | 0.18 | −2.22 |
| Sell on the secondary market at 85% of NAV | 13.60 | 2.40 | 0 |
| Forced sale by the GP at 50% of NAV | 8.00 | 8.00 | 5.60 |
| Default with 50% forfeiture | 4.97 | 11.03 | 8.63 |
Read it as a ladder. Borrowing the call costs 0.18. Selling the interest costs 2.40 of discount but transfers the unfunded commitment with it. Defaulting costs 8.63 more than selling. Expressed as a rate, even the gap to a secondary sale, 8.63, is 432 per cent of the 2.0 call: one year's financing on the call would have to cost more than that before defaulting became the cheaper route, which is another way of saying there is almost no financing the investor should refuse.
| Capital account at default | Value kept, today | Secondary sale | Loss from defaulting |
|---|---|---|---|
| 4.0 | 1.24 | 3.40 | 2.16 |
| 10.0 | 3.10 | 8.50 | 5.40 |
| 16.0 | 4.97 | 13.60 | 8.63 |
| 22.0 | 6.83 | 18.70 | 11.87 |
The penalty is proportional to the account, not to the call. An investor that defaults late in the investment period, with most of its commitment paid in and marked up, loses the most for the same missed cheque. Under a 25 per cent forfeiture the retained balance is worth 7.45 today; under a full forfeiture, nothing.
The other side of the ledger. The non-defaulting investors receive the forfeited 8.00, about 1.67 per cent of their commitments if the rest of the fund is 480. They may also be asked to fund part of the missed call themselves, within the limits the LPA sets; see whether a fund can call more than your commitment.
The common mistake is to compare the default with the call: "we save 2.0 now and 6.0 later". The unfunded commitment is not a liability with no matching asset; it buys investments at their price. The right comparison is between the value of the position under each route, and on that comparison default is the worst route by a wide margin, below even a forced sale at half of NAV.
Price the default clause at subscription: forfeiture share, what the retained balance earns, when it is paid, and whether the GP can force a sale and at what price. Then keep the cheaper exits ready: a credit line for calls and a secondary sale process. The remedies page and the commitment page with a stressed call profile are among the free working documents for this book.
The LPA's default remedies apply after a cure period: typically default interest, then forfeiture of part of the capital account, loss of future profits, or a forced sale. In the illustrative case, a 50 per cent forfeiture on a 16.0 account, with the rest paid in five years, leaves a value of 4.97.
Almost never. In the worked case a secondary sale at 85 per cent of NAV raises 13.60 and transfers the 6.0 unfunded commitment, while defaulting leaves 4.97. Even a forced sale by the GP at 50 per cent of NAV, 8.00, beats the forfeiture route.
Little, if it is cured in time. Default interest of 10 per cent a year on a 2.0 call paid 30 days late is 0.016. The large penalties apply only once the cure period ends, which is why an investor in difficulty should speak to the GP before the notice expires.
This article is one calculation from How to Read a Limited Partnership Agreement. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
Get the book on Amazon →Free companion files
Also on Amazon UK · Amazon Germany · Amazon France · Amazon Canada
Reading guide: private equity and private markets → · All 453 articles →
If this book helped, or didn’t, a few lines on Amazon are worth more than they look: they are what the next reader goes on. Write a review. The workbook stays free either way.