Estate Planning Goals Hinge on Scrutinizing Fund Retitling Rules

Individual investors in private funds often seek to retitle their interests to other vehicles (such as trusts) for estate planning or asset protection purposes. But simply updating a name on a register isn’t enough; it’s important to follow the proper steps when effecting such retitling.

Funds often impose strict transfer requirements investors must comply with to ensure an effective transfer. Similarly, there are regulatory, tax, legal, administrative, and estate planning considerations that require proper compliance with the requirements.

Governing Documents

Fund governing documents typically set forth the requirements, including manager or general partner consent and execution of various documents to ensure that the transferee is qualified to invest in the fund.

Governing documents also set forth the rights and obligations of investors, including capital commitments, distribution rights, and other terms, and each fund investor must formally become a party to the governing documents, agreeing to be bound by their terms.

Therefore, if an investor wants to retitle an interest, the fund needs a formal transfer agreement and joinder instrument so that the transferee is contractually bound by the governing documents following the transfer.

From a contractual standpoint, if an investor retitles their interest without following the Requirements, the investor will likely be in breach of the governing documents, resulting in negative legal and tax consequences. The fund also might not recognize the transferee as the investor, causing a loss of rights otherwise granted to investors in the fund.

Administrative Challenges

If an investor improperly retitles, the fund’s records may not accurately reflect the current ownership of interests. This discrepancy can lead to confusion regarding who is entitled to receive communications, distributions, and reports.

Inaccurate records can complicate the fund’s ability to track capital commitments, outstanding obligations, and voting rights. This can have a materially adverse effect on both the fund and the transfer parties.

Similarly, the fund may be required to report information about its investors to regulators or others. Inaccurate records due to improperly documented transfers can lead to incorrect filings, resulting in regulatory scrutiny, penalties, or loss of exemptions.

Regulatory Compliance

Funds typically rely on exemptions from registration under various securities laws, which require certain investor qualifications. For example, when transferring interests in a fund relying on the 3(c)(7) exemption under the Investment Company Act of 1940, the transferee must be a “qualified purchaser” under the act.

Careful structuring and early coordination with the fund manager and your advisers are essential to confirm qualification requirements, satisfy transfer restrictions, and ensure the transfer is recognized and effective.

When an investor wishes to transfer their interests, the fund must verify that the transferee satisfies these requirements. This verification often is accomplished by requiring the transferee to complete a subscription agreement and provide supporting documentation.

The fund may have or impose additional requirements, including those related to tax and know-your-customer/anti-money laundering. Uncontrolled transfers could cause the fund to violate its various exemptions or fail to meet various tax or anti-money laundering requirements.

Similarly, if the transferee is investing through an individual retirement account, this may raise concerns related to the Employee Retirement Income Security Act of 1974 depending on the fund investor composition. By enforcing the requirements, the fund manager can monitor and control these potential problems.

Estate Planning Considerations

An investor may wish to transfer interests to a trust for several reasons, including benefiting a spouse or descendants, asset protection, or tax planning. For example, the investor may wish to transfer an interest to an irrevocable trust, removing the interest from their estate.

By doing so, the investor makes a gift of the value of the interest at the time of transfer, and any future appreciation of such interest and any distributions payable in connection with such interest are attributable to the trust, not the investor.

In other words, future growth occurs outside of the investor’s estate, such that no additional estate or gift tax would be due on the assets held in the trust upon the investor’s death. If the investor hadn’t made the transfer, that interest and all related appreciation would be included in the investor’s estate and subject to estate tax.

The key feature of this strategy is that the investor actually has transferred the interest to the trust and hasn’t retained any control over or beneficial interest in the interest. If an investor doesn’t properly follow the requirements of the fund, the transfer may be deemed void or ineffective, frustrating the aforementioned tax benefits.

It’s also important that the transfer happens when the investor intends the gift to occur. If the investor believes they’re funding a trust on one date but doesn’t get around to working with the fund manager to effect the transfer until a later date, the value of the interest may have changed in the meantime, changing the gift’s value.

Finally, if the books and records of the fund show payments to the investor rather than to the trust while the investor believes the trust owns the interest, that could serve as evidence that the transfer didn’t actually occur on the date the investor intended.

If an investor is looking to use interests in their estate planning, following good corporate hygiene with respect to the transfer can mean the difference between an effective gift and a failed attempted transfer.

The Bottom Line

Investors seeking to retitle interests must follow a fund’s requirements, including submitting transfer requests, completing a subscription agreement to confirm transferee eligibility, and executing documents to bind the transferee to the governing documents.

These steps are essential to maintain regulatory compliance, protect the fund’s status, and help ensure the orderly administration of the fund. Similarly, these steps are essential for the investor to help ensure they achieve their estate planning goals.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law, Bloomberg Tax, and Bloomberg Government, or its owners.

Author Information

Jeremy Cantor is counsel at Lowenstein Sandler in New York focusing on investment funds and asset management.

Meghan Federman is counsel at Lowenstein Sandler in Washington, DC, focusing on private wealth, trusts and estates, and tax matters.

Ed Nadel and Beth Shapiro Kaufman of Lowenstein Sandler contributed to this article.

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