This module focuses on the practical application of identifying potential Employee Retirement Income Security Act (ERISA) issues within the complex documentation of private equity and venture capital transactions. We will explore common pitfalls and key clauses that require careful scrutiny to ensure compliance.

ERISA is a federal law that sets minimum standards for most voluntarily established retirement and health plans in private industry to provide protection for individuals in these plans. While private equity and venture capital funds are not typically direct ERISA plans, they can inadvertently trigger ERISA obligations through various investment structures and relationships, particularly when investing in or managing companies that do have ERISA plans, or when the fund itself is structured in a way that could be deemed an 'employee benefit plan' or 'plan asset'.

When reviewing fund documents (e.g., Limited Partnership Agreements (LPAs), Subscription Agreements, Investment Management Agreements), several areas are critical for identifying potential ERISA issues. These include provisions related to:

The most significant ERISA concern for private equity and venture capital funds is the 'plan asset' rule. Under the Department of Labor's (DOL) regulations, if a fund's assets are deemed 'plan assets,' the fund manager may be considered a fiduciary, and the fund itself may be subject to ERISA's fiduciary duties, prohibited transaction rules, and reporting and disclosure requirements. This typically occurs when 'benefit plan investors' (including ERISA plans and IRAs) hold 25% or more of any class of equity interests in the fund. Identifying clauses that could influence this percentage or the nature of the investment is paramount.

If a fund is deemed to hold plan assets, its managers become fiduciaries. This means they must act solely in the interest of plan participants and beneficiaries, with the care, skill, prudence, and diligence that a prudent person acting in a like capacity and familiar with such matters would use. Fund documents should be reviewed for any provisions that could lead to prohibited transactions, such as self-dealing, conflicts of interest, or transactions with parties-in-interest, without proper exemptions. Clauses related to indemnification, fees, and related-party transactions are particularly sensitive.

When a private equity fund invests in a portfolio company, it's essential to consider the portfolio company's own ERISA obligations. If the fund exerts significant control over the portfolio company's management, it might indirectly influence decisions related to employee benefit plans, potentially creating indirect ERISA exposure. Clauses in the LPA or shareholder agreements that grant the fund control over board appointments or key operational decisions warrant careful review.

When performing a practical exercise, pay close attention to the following types of clauses within fund documents:

To effectively identify potential ERISA issues, a systematic approach is recommended:

Consider an LPA that defines 'Limited Partners' broadly and includes a clause stating that 'any investor may be an ERISA plan or IRA.' Further, the 'Investment Strategy' section describes the fund as a 'passive investor' with no intention of actively managing portfolio companies. However, the 'Fees' section details a significant performance fee structure that could be scrutinized. In this scenario, the broad investor definition and the fee structure raise red flags, even if the 'passive investor' description might suggest an exemption. The 25% threshold needs to be carefully monitored, and the fee structure might require closer examination for potential prohibited transactions if the fund manager is deemed a fiduciary.

Identifying potential ERISA issues in private equity and venture capital fund documents is a critical skill. It requires a thorough understanding of ERISA's plan asset rules, fiduciary duties, and prohibited transaction provisions, coupled with a meticulous review of specific clauses within LPAs and other transaction documents. Proactive identification and consultation with legal experts are essential to mitigate risks and ensure compliance.