Fund finance is exploding, with total committed deal value now exceeding $2trn across all types of European financing arrangements, according to research by Maples Group. According to the same research, NAV deals account for almost a third of those volumes.
In any evolving asset class, the gritty legal realities are often overlooked in favour of flashy headlines. But not by Jennifer Passagne, global finance partner at Paul Hastings.
She focuses on fund-level financing transactions, including NAV, hybrid facilities, SMA deals, GP support lines, and capital call facilities. She’s built a career understanding the complex legal frameworks that make these deals tick.
9fin sat down with Passagne to discuss documents, distress, and doubt in the context of NAV lending. She explained how NAV deals come together, and the legal realities if they ever fall apart.
1. As a fund finance lawyer, what’s your role when it comes to NAV lending?
We’re involved from the ground up. We’re there to plan for the scenarios where things could go wrong, making sure our lender clients have the legal protections they would expect. While we’re not involved in pricing or portfolio management, we have an important role to play.
A big part of what we do is protecting the lender’s primary security: the cash distributions from underlying asset sales. For example, when we’re putting a bank account pledge in place, we structure triggers that restrict standard operating use at the first sign of distress. Put simply, we ensure that if an event of default occurs, those vital asset sale distributions legally flow up the structure as the lender expects.
2. How much does the legal side differ from deal to deal?
NAV is a very bespoke product, and its nature depends heavily on the underlying asset class. Real estate, infrastructure, private equity, private credit, and secondaries NAVs, all have distinct legal quirks which directly impact the documentation.
NAV facilities are often put in place during the later stages of a fund’s life cycle, but the legal framework looks different whether you are looking at a private equity fund NAV facility with 12 portfolio companies underneath securing the financing, or a NAV facility for a continuation vehicle where there might only be three flagship assets left.
Anything with a naturally diverse portfolio, such as credit fund NAVs, secondaries, fund-of-funds, is generally seen in the market as a little bit safer. A NAV into a venture fund, on the other hand, where cash flows traditionally are not as predictable, could be viewed as higher risk.
While standard market practices set the baseline security requirements, the final documentation varies quite significantly depending on the borrower, the asset class, and the relative bargaining strength of the counterparties.
3. What are the legal realities around NAV if a fund hits some distress?
The big thing to remember is that a NAV lender sits at the top of the fund structure, which actually makes them structurally junior to any debt financing the underlying assets. Any debt sitting closer to those assets gets paid out first, even if there isn’t an intercreditor agreement in place, simply due to that structural seniority.
When a fund hits distress, it forces the NAV lender to look closely at their enforcement options. Do they hold a share pledge over an intermediate holding company? Can they replace board members to implement decisions? The answers look quite different depending on the asset class, the sponsor, and the commercial risk a lender is willing to tolerate post-enforcement.
Also, because a lender’s security is tied to a bank account instead of the assets themselves, they are dependent on the fund manager to sell assets and route the cash into those pledged accounts. Even if a share pledge exists and the bank legally can replace board members using a power of attorney, banks aren’t fund managers. Taking over a distressed holding structure creates substantial operational liability and runs the risk of triggering an asset fire sale.
4. Has any of this actually been legally tested in a real-life scenario?
We haven’t really seen a high-profile, publicly litigated NAV default yet. The significant growth in this market has mostly happened over the last few years, meaning many of these structures haven’t been tested through a full economic downturn.
A risk is a potential gap between what a lender thinks their legal position is and the negotiated position in the documentation. When a deal is put together in a hot market, people don’t always fully clock the practical reality of how a specific clause will play out under distress. The focus changes completely when a deal becomes contentious.
Now, I’m not predicting an impending wave of failures. But I expect there will be cases where lenders realise after the fact their documentation could have been tighter. Credit funds distinguish themselves by being more flexible and nimbler than traditional banks, which often results in more streamlined facilities to meet compressed borrower timelines. That speed is great for getting deals done, but it can become a vulnerability if protections are lacking in an enforcement scenario.
5. How has the rise of private credit changed the way NAV is structured?
NAV facilities have always existed as a liquidity tool, they’ve simply become a much more utilised instrument in a fund manager’s toolkit. A lot of sophistication we’re seeing today stems in part from the sizeable influx of new market entrants.
As credit funds compete with banks for private equity NAV mandates, often at different margins, the documentation naturally becomes more flexible. What a credit fund is comfortable underwriting has pushed the envelope beyond a traditional bank’s risk tolerance. This has driven a shift toward “security-lite” structures, such as waiving an equity pledge in favour of bank account security over upstream distributions or scaling back the guarantor package.
That flexibility extends directly into how distress is managed, too. Following an event of default, a credit fund may be more willing to give the sponsor a longer window to orderly liquidate assets. They might build in phased milestones: for example, launching a formal sales process within 60 days, entering into a letter of intent with a purchaser within 120 days, and execution of a Sale and Purchase Agreement (SPA) within 180 days. Banks usually don’t have that same room to manoeuvre when distress hits.
6. NAV lenders depend on accurate valuations, how do lawyers interact with that?
The valuation is a fundamental piece of the deal architecture, and there is always debate around the methodology and detail.
We are responsible for ensuring the documentation accurately reflects the agreed valuation parameters and methodology, which are often hammered out at term sheet stage. Crucially, we also define the exact triggers that allow a lender to step in and mandate an independent, third-party valuation if a dispute or distress arises.
Banks tend to have more prescriptive requirements when it comes to valuation frameworks. Conversely, private credit funds operate with greater structural flexibility and frequently possess the internal capability to model and run their own valuations.
At the end of the day, lenders do rely on borrower-reported valuations. Even with rigorous lender underwriting, these facilities are benchmarked against sponsor metrics that inherently lag behind the market. They’re often calculated on a trailing quarterly basis rather than reflecting real-time asset pricing.
7. When would a lender actually go and get their own number?
Independent valuations are usually only sought when there is an underlying issue with the fund’s performance or a specific breach. In standard market conditions, specialised credit funds utilise internal capability to avoid third-party appraisal costs, drawing on specific sector knowledge of their target asset classes.
But, if distress or a covenant breach occurs, the documentation provides a mechanism for the lender to mandate an independent valuation at the borrower’s expense. Of course, nothing stops a lender from commissioning a report out of their own pocket at any time if they spot a red flag.
If that valuation does uncover an issue, the lender can typically recoup those costs through standard expenses and indemnity provisions. Ultimately, the documents are structured to give lenders comprehensive information rights and cost coverage when things start looking shaky.
8. Two years ago, the Institutional Limited Partners Association (ILPA) warned that NAV could be a tool for misleading investors, do you see that as a problem now?
ILPA’s guidelines sparked significant debate across the industry when they were first released. But I don’t think the primary driver behind these facilities is intentional distortion of performance metrics.
What ILPA was really targeting was transparency. Older, pre-pandemic limited partnership agreements (LPAs) were often completely silent on NAV facilities or top-level fund leverage. ILPA was specifically warning about scenarios where a NAV facility is used to fund distributions back to investors, which can artificially inflate internal rate of return (IRR) or distributed to paid-in capital (DPI) ahead of an actual asset realisation. In those instances, LPs are essentially receiving borrowed money that carries an ongoing interest burden.
Only a small proportion of NAV facilities are used this way; maybe something like 10% to 15%. Most are deployed defensively to support follow-on investments when assets are performing well but the realisation market is soft. LPs are highly sophisticated; they easily look past the headline IRR and DPI metrics to analyse the underlying asset health.
While modern LPAs have evolved to provide better disclosure and Limited Partner Advisory Committee engagement, fund documentation naturally faces challenges to keep pace with rapid financial innovation. A critical point to monitor is whether future LPAs can flexibly accommodate new liquidity tools while ensuring sufficient investor protection and transparency.
9. You spend a lot of time thinking about the legal architecture of fund finance. What do you do to unwind?
I have two boys, 10 and six. My 10-year-old has recently become fascinated by cooking. I, personally, am not a very proficient cook, but through his new love for it we are doing a lot more of that at the end of the day, and I’m learning just as much as he is.
I realised what I really dislike about cooking is all the prep work and cutting, whereas he loves it. He loves dicing the garlic and is quite methodical. So, I am like, great, at 10 you can do all of the intricate bits, and I will throw in the spices at the end.
