LPs Don't Sue GPs. Or, Why Private Funds Lawyers Are Shamanistic Priests

In an otherwise litigious society, why don't we see legal action between fund managers and their investor base? What does legal academia have to say about it?

Hey everyone - been a few weeks! I’ve been taking some time to think about new ways of engaging you on the world of private funds. And I’ve been itching some to discuss academic work on the topic, which is still in its nascency here in the United States.

Luckily, some good people are doing amazing work. Today’s discussion is dedicated to a relatively new piece in this growing corpus of scholarship, and it touches on LP / GP litigation.

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Back in my Sidley days, I recall one of the townhall-style meetings for the investment funds group where the chair showed the results of a survey taken of partners at the firmwide annual retreat they have in Scottsdale or Miami or some sunny place that isn’t California.

One of the questions was, “What do you [the partners] think clients care about the most?”

The number one answer was “legal knowledge.”

I am no expert, but I knew even then that was the wrong answer. Knowledge is not why the largest legal clients in the world pick one mega law firm over the other.

It’s largely relationship-based. The GC knew a partner from law school or something like that. And then there are other things too.

It was so bizarre to see intelligent lawyers think about clients in that way.

I was reminded of this townhall meeting while reading a new paper by an academic duo familiar to the world of private funds, Yaron Nili and Kobi Kastiel.

The paper, Opting Out of Court? Reputation and Informal Norms in Private Equity, kind of forces the reader to grapple with a reality that practitioners intuited long ago: private markets run on reputation first and law second (possibly third).

Their central question is pretty simple. In a multi-trillion industry that locks up capital for a decade or more, where fiduciary conflicts are pervasive and exit rights are limited, why is litigation between limited partners (LPs) and general partners (GPs) almost nonexistent?

They aren’t exaggerating. The paper’s empirical review of litigation against major private equity firms finds that just 4% of lawsuits over the past 40 years were initiated by investors. And even those tend to involve publicly traded entities where individual shareholders (not institutional LPs) are plaintiffs.

Investment management litigation, to the extent that fancy lawyers are involved, typically involve actions implicating the portfolio companies of private funds. Fund-level LP / GP litigation is kind of impolite to talk about in public.

As a general note, litigation carries obvious reputational costs. No LP wants to be seen as a litigant. Future allocations matter more than winning a lawsuit. And many disputes can be (and often are) resolved “offline” in a conversation between senior investment staff. But reading the paper’s thrust is a little less gentile (in a good way): beyond mere cultural preference, the private funds capital arrangement is architected to steer participants away from courts.

Unexercised Rights in the LPA

The limited partnership agreement (LPA) is the first signal. Nearly every LPA contains broad indemnification and exculpation provisions. Many GPs have safe harbors tied to LPAC approvals. Delaware permits fiduciary duty waivers, and the authors observe that from about 2008 onward, most agreements explicitly eliminate those duties (this is very not good for LPs; see page 15 of the paper). Removal rights generally require supermajority LP consent, which is practically unattainable. Information rights often include confidentiality carve-outs where the GP can withhold information it “reasonably believes” would harm the partnership. And arbitration provisions, while not universal, add another procedural hurdle.

At some point, you ask yourself: what does it mean to negotiate rights that nobody intends to exercise?

This is where side letters further distort the analysis. In theory, LPAs reflect the bargain among all investors; in practice, the most important terms live outside the four corners in private negotiations with the largest LPs.

Kastiel and Nili quote the concern directly: bespoke side letters split LP economics and governance rights across investors in ways that leave the largest indifferent to GP behavior that harms smaller LPs.

William Clayton at BYU (I have discussed his excellent scholarship in earlier posts) has made this case already, arguing that the myth of “negotiated” LPAs obscures how little incentive dominant LPs have to push for collective rights.

If governance protections bifurcate along tiers of committed capital, then the deterrent value of contractual rights becomes purely symbolic. I agree with the authors on this point, but nary a law firm partner would do so openly (for obvious reasons).

The LPA formalizes a relationship already governed by power and custom. The negotiation dance is less about rights than about preserving long-term access to capital, a sort of ritualized thingy of ongoing cooperation.

The paper also explores mechanisms meant to support collective action—like LPACs or ILPA guidelines (which are more policy oriented)—and acknowledges what market participants concede privately, that these tools often carry limited weight. LPAC members are selected by GPs and tend to be repeat investors, which introduces loyalty issues. ILPA recommendations rely on voluntary adoption. And when disputes arise, LPs typically pursue internal escalation rather than public enforcement. The norm is accommodation, not confrontation.

But don’t we love a good legal drama!

Useless Lawyers

The authors summarize the pattern succinctly: “law plays a relatively minor role in long-term contractual relationships with recurring interactions.” We—private-fund lawyers, negotiators, redliners—spend our days drafting recitals of duties, enumerating discretionary rights, calibrating consent thresholds, debating managemen fee breaks, all to produce agreements that rarely serve as litigation roadmaps. The governing constraint, more often than not, is reputation.

This raises a question that has bothered me for some time: what are fancy fund formation lawyers at the largest firms really paid to do? We justify fees on the premise that we are structuring enforceable rights. But if enforceability rests not on courts but on custom and fear of exclusion from future funds, legal drafting is more like Dancing with the Stars or some entertainment show where there’s lots of clapping. Its purpose is to signal legitimacy to participants, but not necessarily to place constraints on future behavior.

I’m not sure this makes the role of lawyers illegitimate. Reputational systems still rely on shared expectations, and contracts encode those expectations in accessible form. Without formal documentation, there is no baseline against which deviations can be measured, even informally.

But we should be honest about what the work is and is not. We are not delivering enforceable instruments in the way corporate lawyers draft shareholder agreements for litigation-sensitive environments. We are facilitating rituals that sustain an extralegal governance regime.

This leads to the fairness problem lurking beneath Kastiel and Nili’s analysis. Informal enforcement works best among repeat players with similar bargaining power. The top sovereign wealth funds, pensions, and endowments can discipline GPs privately. They possess negotiating leverage, access to information, and the ability to credibly threaten future capital withdrawals. Smaller LPs cannot. They may never see side letters that protect larger investors. They may struggle to interpret reporting that obscures conflicts or fee leakage. And they likely cannot bear the reputational or financial cost of litigation.

If the contract does little to equalize governance rights across LPs, the system relies on trust without really assuring it. Informal norms can discipline opportunism, but they can also entrench inequity.

The paper hints at this asymmetry. Litigation is rare not because everything works smoothly, but because the actors who might sue lack incentive—or capacity—to do so. The equilibrium may hold for now, but what happens as private markets expand retail access, or when performance compresses and LPs seek accountability?

What Do GPs Say?

The natural response from sponsors is that the market already disciplines misconduct. A GP who abuses investor trust will struggle to raise Fund IV. And historically, that feedback loop has kept bad actors in check. But growth, concentration of capital among a few mega-firms, and the opacity of fund economics complicate this story. When the largest GPs control scarce access to performance, LPs may continue funding even when governance frays.

Reputation loses bite when the cost of exclusion > the benefit of discipline.

All of which circles back to litigation. The paper’s provocation is that litigation does more than remedy misconduct. It produces doctrine, and some of it can be bad. Public markets rely on Delaware jurisprudence to articulate fiduciary norms. Without cases, private-fund governance evolves without judicial interpretation. The system lacks precedents to benchmark fairness or clarify ambiguous duties. Everything becomes opportunistic private negotiation, constrained only by the prospect of capital withdrawal in the next fundraising cycle.

I finished the article with mixed feelings. On the one hand, it captures the elegance of a relational governance system that has enabled trillions of dollars to move efficiently without constant legal intervention. On the other hand, it reveals how fragile that balance is.

Contracts that function primarily as symbolic agreements can work only as long as the underlying social fabric holds. If that erodes, the industry may rediscover law not as ornament but necessity.