For LPs and similar legal entities, kick-out rights are defined as:
Definition from ASC 810-20-20
Kick-Out Rights (Voting Interest Entity Definition): The rights underlying the limited partner’s or partners’ ability to dissolve (liquidate) the limited partnership or otherwise remove the general partners without cause.
Since an LP would be a VIE if the limited partners do not have kick-out rights or substantive participating rights, the assessment of the kick-out rights and substantive participating rights are generally performed when determining whether the LP is a VIE. If the LP is not a VIE, these same rights are then considered in assessing whether a single limited partner, if any, has a controlling financial interest in the LP. That is, the assessment performed during the VIE determination is carried over to the assessment of whether a single limited partner, if any, has a controlling financial interest in the LP.
By definition, kick-out rights are limited to the rights held by limited partners to remove the general partner(s). As mentioned in ASC 810-10-15-14(b)(1)(ii)
, in order for an LP to not be a VIE, the kick-out rights must be exercisable by a simple majority or lower threshold of limited partner(s). In determining the simple majority required to kick-out the general partner(s), any kick-out rights held through voting interests by general partner (regardless of whether they are embedded in the general partner interest or through any limited partner interest held by the general partner), by entities under common control with the general partner, and by others acting on behalf of the general partner should be excluded. Also, in determining the simple majority required to kick-out the general partner, the reporting entity needs to calculate and ensure that all possible combinations that represent a simple majority of the limited partners’ voting interests allow for the limited partners to kick-out or remove the general partner. See CG 18.104.22.168 for further analysis and examples of the impact of kick-out rights on the VIE model.
Kick-out rights must be substantive in order for them to be assessed under the VIE model pursuant to ASC 810-10-15-14(b)(1)(ii)
, as well as under the voting interest model. For kick-out rights to be considered substantive, the partners holding the kick-out rights must have the ability to exercise those rights if they choose to do so; that is, there are no significant barriers to the exercise of the rights. If the general partner or one of its related parties is in a position to block the exercise of the kick-out right, the limited partners will likely not have a substantive kick-out right. Refer to CG 22.214.171.124 for more discussion about evaluating whether kick-out rights (including liquidation rights) are substantive.
Kick-out rights are required to be assessed continuously. This is especially important when limited partners are investing in or divesting from the LP. If the limited partners fail to have a kick-out right that meets the requirements described in ASC 810-10-15-14(b)(1)(ii)
and ASC 810-10-25-2
through ASC 810-10-25-14C
, the LP would become a VIE. This could lead to a change in any consolidation conclusion.
Rights held by general partners to buy out limited partners are not considered kick-out rights as illustrated in Example CG 7-5.
EXAMPLE CG 7-5
Buy/sell right between general partner and limited partner
Partnership X was formed to acquire a single commercial real estate building and to lease the space to multiple tenants. The sole general partner owns 20% of the LP and the sole limited partner (a party unrelated to the general partner) owns 80% of the LP. The partnership agreement states that either partner has the right to offer to buy the other partner’s interest. The buy/sell provision is as follows:
- Offeror can request that offeree sell its interest to offeror at a price determined by the offeror
- Once an offer is made, offeree must either (1) sell its interest to the offeror, or (2) buy the offeror’s interest at the same price per unit
Once the buy/sell provision is triggered, either the offeror or the offeree would end up owning the partnership assets. The limited partner does not have substantive participating rights or unilateral kick-out rights over the general partner as described in CG 7.3.2.
Does the buy/sell right qualify as a kick-out right or a liquidation right?
A buy/sell right is generally not a kick-out right or a liquidation right that enables the limited partner to remove the general partner without cause. If the limited partner initiates the buy/sell right, the general partner would control the ultimate outcome of the transaction. The general partner would have the right to either sell its interest to the limited partner or buy the limited partner’s interest. The determination that the general partner has the financial ability to buy out the limited partner’s interest requires careful consideration. If the general partner has the financial ability to buy out the limited partner’s interest (e.g., the general partner is financially capable of purchasing the limited partner’s interest or attracting new limited partners), the buy/sell right would not be considered a kick-out right.
In this case, the LP would be a VIE because the buy/ sell right does not represent a kick-out right or liquidation right. The partners would apply the guidance in CG 5 to identify the primary beneficiary of the VIE, if any. (See the guidance in ASC 360-20-55-21A
for further discussion on the accounting implications of real estate agreements that include a buy-sell clause.)
Definition of “without cause”
Kick-out rights must be exercisable “without cause” in order to be a valid kick-out right. ASC 810-10 includes the following definitions:
Definition from ASC 810-10
With cause generally restricts the limited partners’ ability to dissolve (liquidate) the limited partnership or remove the general partners in situations that include, but that are not limited to, fraud, illegal acts, gross negligence, and bankruptcy of the general partners.Without cause means that no reason need be given for the dissolution (liquidation) of the limited partnership or removal of the general partners.
Based on the definition of without cause, a provision would only be a kick-out right if it gives the limited partners the right to remove the general partner for no reason, without regard to probability or any condition. Rights to remove the general partner with cause do not meet the definition of a kick-out right (unless the specified causes lack substance). For example, agreements with provisions that give limited partners the right to liquidate the partnership when there is a change in the LP’s key executives, but the general partner controls the change in executives, would not meet the definition of a kick-out right since it can be exercised only with cause.