Side letters in Australian private funds, and what the deed will not allow.

The equal treatment duty most often quoted at sponsors is a registered scheme provision. Section 601FC(1)(d) of the Corporations Act 2001 (Cth) requires the responsible entity of a registered scheme to treat members holding interests of the same class equally, and members holding interests of different classes fairly. Most Australian private funds raising wholesale money are unregistered schemes, so that section does not reach them at all.

In an unregistered wholesale trust the constraint comes from three other places, and it is not softer for sitting outside Chapter 5C. The deed almost always provides that units of a class confer identical rights and that the trustee deals with the class rateably. General trust law imposes a duty of impartiality between beneficiaries, which permits differential treatment where the trust instrument confers different rights and makes it a breach of trust where it does not. Where the trustee or the manager holds an Australian financial services licence, section 912A of the same Act requires the services covered by the licence to be provided efficiently, honestly and fairly, and requires adequate arrangements for managing conflicts of interest.

When a letter promises what the deed does not support, two mechanics decide the outcome. The first is the rule against fettering: a trustee cannot bind itself in advance as to how it will exercise a discretion held for the beneficiaries as a whole, so an undertaking that it will always consent to this investor's transfers, or never apply a gate to its redemptions, tries to contract away a discretion held on trust. An undertaking about how the discretion will be exercised, such as the criteria the trustee applies and the time it takes to decide, survives that objection, while one fixing the answer in advance does not.

The second is the trustee's indemnity. A trustee contracts in that capacity and limits its liability to its right of indemnity out of the fund's assets, and the indemnity does not reach liabilities incurred through its own breach of trust. A term performable only in breach of the deed therefore has no good outcome: performing it puts the trustee's own indemnity at risk, and declining leaves the investor with a claim under the letter that can only be met out of the assets the other unitholders own.

The terms that belong in a letter oblige the trustee or the manager toward one investor without changing what any other unitholder receives. Most are informational or procedural, or promises the manager makes out of its own resources. Reporting and excuse rights carry a qualification.

Enhanced reporting looks like the safest term in the letter until the fund is open ended and offers redemptions. Information about a deteriorating asset delivered to one investor ahead of the rest of the class gives that investor the practical ability to redeem first, so an informational right has become an economic one. In a closed ended fund the same term is routine, so the clause has to be read against the fund's liquidity terms.

Excuse rights are negotiated as though they concern only the investor asking for them. Excusing an investor from an asset increases every remaining investor's proportionate exposure to it, shifts the allocation of that asset's costs, and can push the fund through a concentration limit in the deed. The mechanics also collide with the capital call provisions, because an excused investor is not a defaulting one and the deed has to distinguish them. Where the deed does not contemplate excused investors, the accommodation belongs in the deed itself, or in a parallel vehicle that does not take the asset.

Economics are the main category, and fees are the clearest case. A management fee is charged to the fund and reduces the value of every unit in the class equally, so an undertaking to charge less on one investor's units cannot be delivered inside a single class. The form that works is a rebate paid by the manager out of its own entitlement, because that is the manager's money and the fund's accounts do not move. The tax treatment of a rebate received directly differs from that of a lower fee borne by the fund, a question for the investor's own adviser.

Several things have to exist before a separate class does, and a letter agreeing to one creates none of them. The deed must permit units of different classes, specify how their rights differ, and set out how income, gains and expenses are allocated between them. The unit pricing policy needs a methodology for pricing at class level, and the administrator's system has to support class level expense allocation and a separate price per class. Sponsors regularly agree a class before checking that it does.

For a registered scheme, section 601GC governs the change, either by special resolution of members or by the responsible entity where it reasonably considers the change will not adversely affect members' rights, with a copy lodged with ASIC before it takes effect. That pathway is narrower than sponsors assume, because a class carrying better economics or redemption terms is hard to characterise as leaving existing rights unaffected. For an unregistered trust the deed's amendment clause governs, commonly requiring a unitholder resolution at a stated threshold or a trustee certification that the change is not prejudicial.

A most favoured nation clause does not upgrade an investor automatically. It is an election right that runs as a process: the sponsor discloses the terms granted to other investors, the holder elects which of them it wants, and the elected terms are documented as amendments to its own letter. A clause providing only that the investor is entitled to any more favourable term granted to another cannot be administered: every step is undefined and the trustee cannot say what it owes to whom.

Running a round is work the sponsor has to resource before promising one. Someone extracts the electable terms from every letter signed since the last round, suppresses identities, confirms each recipient's tier, delivers the package with the window stated on its face, records the elections, and issues an amendment letter to each electing investor. That is buildable where the letters follow one house form with the electable terms in a schedule, and close to unbuildable where each was separately negotiated in free text. Terms granted after the final close are the common gap, because the clause has usually stopped generating rounds while the sponsor is still negotiating with a late investor.

Tiering scopes the electable pool by commitment size: an investor may elect terms granted to investors committing the same or less, and cannot reach terms granted for larger commitments. Bands belong in the letter, so the investor knows its tier when it signs. Two drafting details decide whether tiering survives the fund's later closes. The first is aggregation: whether a commitment includes amounts committed by affiliates, related funds or a feeder, and whether later increases count. The second is movement: whether an investor that increases its commitment at a later close moves up a tier, and from what date.

The carve-out list is the sponsor's other protection, and it does more work than tiering. Without one, the clause transfers every accommodation made for a single investor's legal or tax position to every other investor, which makes it impossible to give at all. The carve-outs belong in the letter.

No statute requires a wholesale fund to publish its side letters. What does apply is the prohibition on misleading or deceptive conduct in relation to financial services under the ASIC Act, which is not confined to retail investors, and the licensee obligations in section 912A. The exposure is rarely the existence of letters. It is an information memorandum describing an investment on terms common to every investor while the trustee has agreed materially different terms with several. The position that holds up discloses the practice in the offer document: that the trustee and the manager may enter side letters, the categories of term they may cover, and whether investors will be offered election rights.

How far beyond that the sponsor goes is a governance decision, running from full disclosure of the letters, through a schedule of terms with identities suppressed, to disclosure only to holders of election rights. The position taken has to match the record the trustee maintains.

That record is a register held by the trustee showing each counterparty, the date of the letter, each term granted, whether it is letter safe or class dependent, whether it is electable, and its election status. The failure mode is consistent: the letters stay in the transaction lawyers' files, the administrator calculating fees and processing redemptions has never seen them, and the fund learns of an obligation when an investor asserts it. The register is what lets the trustee state at any point what it owes each unitholder beyond the deed, which is what an equal treatment complaint asks.

Each promise has to be signed by the entity that can perform it. A fee rebate out of the manager's entitlement is the manager's obligation and the trustee has no part in it, while a consent or a reporting obligation is the trustee's and a letter signed only by the manager does not create it. Where the trustee signs, it signs as trustee, and the limitation of liability clause has to be read against the indemnity position.

The continuity provisions make a letter survive the closes that come after it. A retiring trustee's contract does not travel with the office, so the letter has to state whether it binds a successor trustee and how one accedes to it. Whether the benefit passes on a transfer of units is separate, and where it does a negotiated accommodation becomes a feature of the units in any secondary sale. The termination events matter as much: the investor ceasing to hold units, and a fall below a tier threshold. It states that the deed governs, and still has to say what happens where the two conflict, since giving the letter priority changes the investor's contractual position but not the trustee's duty.

Confidentiality clauses have to be drafted against the disclosure the fund has already promised elsewhere. A clause stopping the sponsor from showing the letter to anyone stops it disclosing the term in a most favoured nation round, and stops the letter reaching the administrator, the auditor and the fund's counsel, which is how a negotiated obligation ends up unperformed. The carve-outs that keep it usable are disclosure to the fund's service providers and advisers, disclosure of terms on a no names basis in an election round, and disclosure required by law or a regulator.