LegalTech for Asset Management 4. Contract Metadata for Smart Investment Funds.

In a very near future, all contracts will be digital, machine-readable, collaborative and exist as code. As it is exceptional to find these days a contract written on paper with a pen, it will be unusual to see contracts drafted and negotiated using Microsoft Office and PDF. Contracts in Word or PDF don’t have usable structured metadata like a web page.

Law students will learn in law schools and universities how to use Contract Life Management (CLM) software like Clauz, Juro or Ontra[1] and how to code or make machine-readable contracts. There will be no more static contracts with unstructured data in them. Legal counsels and other teams will not need to read the entire contract again to find a specific data point or extract the key metadata points manually after the execution. All metadata will be extracted and tagged automatically by the computer. Contracts will not be inert PDF files, but rich coded data sources.

Equally, looking to the near future, all operational clauses will be self-executing with Smart Legal Contracts relying on the structured data format of digital machine-readable contracts. Smart Legal Contracts embedded in Distributed Ledged Technologies (DLTs) will create Smart Investment Funds as Distributed Autonomous Organisations (DAOs).

To set up a DAO, it is essential to determine the metadata in the relevant traditional contracts. This metadata will enable to code Smart Legal Contracts in the DLT. All the rights and obligations contained in their operational clauses will be automated to power the DAO. This exercise is at the interface of law, data, contract optimisation, technology, and digital transformation. It could also be seen as Legal Engineering, because we intend to create legal standards and procedures to code in computer systems such as DLTs. Thus, it is necessary to organize and model specific legal processes so legal operations are standardized and automated. Operational Contractual Obligations will be examined and extracted as standard operating practices to be embodied in the DLT. ?

Each legal counsel, legal engineer or Contracts Operations Professional has their own method to assess and extract the list of key metadata from a contract such as a Limited Partnership Agreement (LPA). I participated to several rich discussions on LikedIn trying to establish an average number of key metadata points in a standard contract. The numbers given by practitioners went from a few dozens, to few hundreds or even thousands, depending on the complexity of the contract and the level of detail wanted.

First of all, the most important is to understand the Contract Purpose to extract its meaning and minutiae. Secondly, a Contract Management Plan can be designed, with a list of Key Activities relevant to the management of the LPA and the incidence of any repeating events. This is already a good overview of what is intended and can be correlated with the Key Contract Events. Implied and resulting Key Contract Events can be listed, and anything else that is triggered by date, in a Contract Events Calendar.

Another crucial source of metadata is Contract Obligations and Rights. An Obligation is something that must or must not be done by the General Partner (GP) or the Limited Partners (LPs). A Right is something that might be done, i.e. the GP may charge interest to LPs on late payments. Thus, the main Contract Obligations and Rights must be identified in relation with the Key Contract Events. As discussed in our previous Newsletter number 3, Contractual Obligations in Operational Clauses must be branded and separated from Non-Operational Rights and Obligations. Contract Value, Term, Start/End Date, and internal/external Key Contacts may also be noted.

The Contract Purpose in a LPA is to stablish a contractual relationship of trust between the GP and the LPs, where LPs give money to the GP and the GP engages to invest this money in Private Equity (PE) target companies (the “Companies”) to generate profits from the investments for the LPs and for itself.[2]

Thus, investors become LPs by funding the Limited Partnership (the “Partnership”). This is an example of a Key Contract Event triggering the Contract Event Calendar. It seems to be an Operational Clause that can be coded to be automated. As discussed in previous Newsletters, the GP and one Initial Limited Partner can agree to set up the Partnership, with the remainder of the LPs being admitted to the Partnership by signing a Subscription Document, if possible, a Subscription Agreement and not a ?deed which sets out their agreement to adhere to the terms of the LPA.

LPs subscribe to pay an amount of capital and to lend a specific amount (Operational Contractual Obligations). These amounts are called in tranches when investments are to be made in Companies (Key Contract Events for the Contract Event Calendar). Cross boarder Investments in Companies may be particularly complex these days. It is necessary to set up several intermediary Special Purpose Vehicles (MidCos, BidCos, TopCos, NewCos…) that may serve as blockers. They also organise the investment in equity and debt to make investments as tax efficient as possible. We will study how to automate those complex processes in future Newsletters and it would also be interesting to study how to simplify them. ?

The Partnership needs to be registered as a Limited Partnership with the Registrar of Companies in accordance with the Limited Partnerships Act (Key Contract Event). Otherwise, the LPA will have effect as a simple partnership agreement and investors will not benefit from limited liability. In Luxembourg, the Sociétés en Commandite par Actions, Simple ou Speciale, have already legal personality as companies, specially when they take the form of Sociétés d’Investissement a Capital Variable and they need to be registered with the Registre de Commerce et des Sociétés (RCS). Like the English Limited Partnership, Luxembourgish Sociétés en Commandite, in particular the Sociétés en Commandite ?Speciale, are tax transparent. Thus, investors are treated as investing directly in each portfolio company while benefiting of the protection of limited liability.

The Partnership must have a name. The name and the principal place of business, together with other details, must be registered with the Registrar of Companies. This kind of data, with other clauses identifying the GP and each LP bound by the LPA, the general introduction with the reasons why the LPA is being entered into by the Parties, can be stored and come from off-DLT in Oracles. We will analyse Oracles as external sources of data in the next Newsletters.

Defined terms used throughout the LPA can be gathered together in natural language in a separate agreement or, when necessary, be agreed in binding comments in the code. Capitalise defined terms can be drafted in natural language, in the comments and even in code, so that they can be recognised as having a defined meaning. Further rules may be set out on how the hybrid Smart Legal Contract LPA ought to be interpreted.

As other examples of Operational Clauses later on, disposal proceeds will arise from the realisation of investments (Key Contract Events). LPs’ loans will be reimbursed first and any profit beyond will be divided between the GP and the LPs in accordance with profit sharing provisions. This seems to be a Contractual Operational Obligation. The GP will be paid a management fee from the outset and will be entitled to a performance related share of profits on realisation of investments (the “Carried Interest”). This could be automated and may be the Value of the Contract from an Asset Manager perspective. At the end of the fund’s life, the Partnership will be wound up and any residual investments will be transferred to LPs and the GP to hold direct.

We will continue analysing one by one LPA clauses in future Newsletters. The next Newsletter will be an introduction on coding for lawyers. ?

Louis Sanchez de Lozada

[1] As a disclaimer, I am not sponsored by any of the three companies mentioned, they just kindly gave me full access to their respective LegalTech services and information so I am referring to them only as an example.

[2] For a complete explanation of the legal substance of fiduciary relationships, please read my PhD book in comparative law called “Anglo-american express private trusts, latin-american fideicomiso and french fiducia”, published by European University Editions, 2012. (in French).