11 ILPA Principles 3.0 • Provisions related to the functioning of the waterfall should be drafted in terms that are readily compre- hensible to a non-legal professional. Preferably, investors are provided with a model for how fees, expenses and carried interest will be calculated over the life of the fund. Recycling of Distributions The amount of total distributions that are subject to recycling provisions should have either a mutually agreed cap, or a monitoring threshold such that LPs can more accurately project their cash requirements. The amount of the cap or monitoring threshold should be established based on factors such as the GP’s track record and the strategy of the fund. Furthermore, recycling provisions, including the classification of any unused, recallable distributions, should expire at the end of the fund’s investment period. Clawback Carry clawback situations present one of the more challenging circumstances for the GP/LP relationship and, as such, should be avoided whenever possible. The best approach to minimize clawback liabilities is an “all capital back” waterfall structure. However, in the event of a clawback situation, the following guid- ance should be considered: • Actual and potential clawback liabilities should be determined and clearly disclosed to the LPs as of the end of every reporting period. At minimum, annual audited financial statements should include such disclosures along with a plan by the GP to resolve the clawback. • All clawback amounts should be gross of taxes paid and paid back no later than two years follow- ing recognition of the liability. • Where it is excessively burdensome or impractical to require clawback gross of tax, the hypothetical marginal tax rates applied should reflect the actual marginal rate that would apply to the individual members of the GP impacted and account for: n Loss carryforwards and carrybacks; n Thecharacterofthefundincomeanddeductions attributable to state tax payments; n Any ordinary deduction or loss as a result of any clawback contribution or related capital account shift. • Where the clawback formula is calculated net of tax, the tax amount should not be simply subtracted from the amount owed and should take the preferred return into account. • Repayment obligations should directly track carry distributions impacted by the clawback. • The clawback period must extend beyond the term of the fund, including liquidation and any provision for LP giveback of distributions. • ILPA strongly encourages joint and several liability of individual GP members as a best practice. In cases where joint and several liability is not provided, a potential substitution would be a creditworthy guarantee of the entire clawback repayment by a substantial parent company, an individual GP member, or a subset of GP members. Where practicable, the clawback should be guaran- teed by the parent company’s balance sheet. • The conditions triggering interim clawbacks should be well defined in fund documents, e.g., at defined intervals and upon specific events such as key person, removal notice date or insufficient NAV coverage. • The NAV coverage test should be established to ensure a sufficient margin of error on valuations, e.g., at last 125% of NAV. Note that an escrow account of at least 30% may provide a sufficient mechanism for the clawback guarantee. • LPs should have robust enforcement powers, including the ability to directly enforce the clawback against individual GPs. • The cost of enforcing clawback guarantees should be a GP, not a partnership, expense. GP AND FUND ECONOMICS