MFN, Fees, and Step-Downs: Precision English for Side Letters with Most Favored Nation Clarity

1) Anchor Concepts and Risk Map

Most Favored Nation (MFN) in fund side letters is a promise that a Limited Partner (LP) may elect to receive terms that are as favorable as those offered to other LPs, subject to the limits stated in the Limited Partnership Agreement (LPA) and the side letter architecture. In practice, an MFN is not a blanket right to copy anything; it is a structured election right that depends on scope, comparability, and timing. When drafting for fee step-downs, MFN sensitivity is high, because small drafting errors can unlock fee economics that were never intended for a broad group of LPs.

To understand MFN, start with three elements:

• Scope: Which provisions are eligible for election? Some categories (e.g., regulatory-specific accommodations) are carved out. Others (e.g., economic terms like management fee rates) may be within scope but limited by comparability or size thresholds.
• Carve-outs: Exceptions that cannot be elected, often including terms tied to unique legal constraints, seeding arrangements, advisory relationships, or operational impossibility. Carve-outs prevent unequal or unmanageable obligations across the investor base.
• Election mechanics: How and when an LP can choose equivalent terms. This includes timing windows (often after a MFN disclosure package), comparability filters (e.g., only for LPs with similar commitment sizes), and procedures for notifying and documenting elections.

Fee step-downs are particularly MFN-sensitive because they alter the fund’s fee revenue across the investor pool. If one LP receives a fee rate reduction triggered by, for example, commitment size or time since initial closing, imprecise MFN language might allow a different LP, with a smaller commitment or different timing, to elect the same reduction even though the commercial basis does not match. This is what practitioners call economic leakage: economics intended for a discrete set of conditions spreading to unintended LPs through MFN.

Sources of risk arise at several drafting choke points:

• Triggers: If a step-down is tied to vague triggers like “time-based” or “close-based” without precise definitions (e.g., “Second Closing,” “Final Closing,” or a dated milestone), LPs may claim equivalence under MFN by reinterpreting the trigger.
• Comparability: Without “like-for-like” language, smaller LPs may elect large-investor pricing, arguing functional comparability. Clear size bands and thresholds reduce this risk.
• Confidentiality vs. Transparency: MFN packages disclose eligible terms, but the underlying confidential arrangements (e.g., strategic co-invest side letters) may be shielded. If confidentiality carve-outs are not drafted carefully, the boundary between what is disclosed and what is electable can blur.
• Revocation: If an LP defaults, transfers, or downsizes its commitment, the step-down might be inappropriate going forward. Without explicit revocation and clawback mechanics, the fund may be stuck with an unintended permanent discount.

Ultimately, MFN discipline is about aligning the side letter to the LPA’s economic framework. The LPA sets the baseline; the side letter conforms to it and is filtered by MFN. The more precisely the fee step-down is defined, the less room there is for MFN to expand it beyond its intended audience.

2) Model Clauses with Annotation

Below are drafting patterns for fee step-downs and MFN clauses. The aim is clarity and MFN-compatibility. Read the annotations after each segment to understand the function of each part.

— Fee Step-Down (Commitment Size Trigger) “From and after the date on which the Investor’s aggregate Commitment equals or exceeds [X currency amount], the annual Management Fee rate otherwise applicable to the Investor pursuant to the LPA shall be reduced to [Y%] with respect to such Investor’s Commitment, provided that: (a) the foregoing reduction applies only while the Investor maintains a Commitment at least equal to [X]; (b) in the event of any partial transfer, withdrawal, or default resulting in the Investor’s Commitment falling below [X], the Management Fee rate shall automatically revert to the rate otherwise applicable under the LPA as of the effective date of such event; and (c) this provision is intended to operate solely with respect to an Investor maintaining a Commitment at or above [X] and shall not be available by election to any other investor lacking an equivalent commitment size.”

Annotations:

• “Aggregate Commitment equals or exceeds [X]” defines a precise, objective trigger.
• Clause (a) states the reduction is conditional on continuing eligibility, preventing permanent leakage after downsizing.
• Clause (b) establishes automatic reversion upon a default or transfer event.
• Clause (c) signals MFN limits by tying availability to an equivalent commitment.

— Fee Step-Down (Time/Close Trigger) “Effective as of the [Second/Final] Closing (as defined in the LPA) and continuing thereafter, the Management Fee rate for the Investor shall be [Y%], provided that the Investor was admitted to the Partnership at or prior to such [Second/Final] Closing. If the Investor is admitted after the [Second/Final] Closing, this provision shall not apply. In the event of the Investor’s default or transfer of all or any portion of its interest, the Manager may reinstate the fee rate otherwise applicable under the LPA prospectively from the effective date of such default or transfer.”

Annotations:

• Uses defined LPA terms for timing to avoid ambiguity.
• Restricts eligibility to investors admitted by a specific closing.
• Includes prospective reinstatement on default/transfer to preserve economics.

— Fee Step-Down (Duration and Floor) “The step-down described herein shall apply only during the Investment Period (as defined in the LPA) and in no event reduce the Management Fee below [minimum floor]% of the fee computed under the LPA’s standard schedule.”

Annotations:

• Limits the temporal scope to the Investment Period.
• Adds a floor to prevent accidental over-discounting due to multiple overlapping concessions.

— MFN Clause (Scope and Like-for-Like) “Subject to the exclusions and procedures described below, if the Partnership grants to any other investor in the Fund a side letter provision that (i) is within the economic scope of fee rate, fee base, or duration, and (ii) is comparable to the Investor’s circumstances on a like-for-like basis, the Investor may elect such provision by written notice within [30] days after receipt of the Manager’s MFN disclosure package. For purposes of the foregoing, ‘like-for-like’ means that the Investor meets all objective eligibility criteria of the elected provision, including, without limitation, commitment size thresholds, admission timing, regulatory status, and other factual predicates expressly stated in such provision.”

Annotations:

• Precisely defines the electable domain (fee economics) without opening broader categories.
• Introduces a “like-for-like” test linked to objective eligibility criteria.
• Creates a fixed election window linked to a disclosure package.

— MFN Carve-Outs (Confidentiality and Non-Comparable Arrangements) “The following categories shall be excluded from election: (a) terms required to address an investor’s specific legal, regulatory, tax, or policy constraints; (b) arrangements based on seed, strategic, co-investment, advisory, or distribution relationships; (c) provisions that are operationally impracticable to extend to all investors; and (d) confidential commercial terms the disclosure of which is restricted by law or contract, provided that any directly comparable economic concessions that are not dependent on such confidential relationship shall be disclosed on a no-names, anonymized basis to permit like-for-like elections.”

Annotations:

• Carves out special-case terms while preserving transparency for truly comparable economics via anonymized disclosure.

— MFN Procedure and Documentation “The Manager shall provide the Investor with a written MFN disclosure package within [X] days following each Closing and within [Y] days of the Final Closing, describing electable provisions and identifying objective eligibility criteria. The Investor shall elect by written notice within [Z] days of receipt. Elections shall be effective prospectively from the date specified by the Manager, and the Partnership may require the Investor to execute a short-form amendment acknowledging any conditions precedent to effectiveness.”

Annotations:

• Defines cadence of MFN disclosures and sets election windows.
• Makes elections prospective, protecting against retroactive fee refunds unless expressly agreed.
• Requires documentation to ensure administrative clarity.

Together, these elements build a tight system: fee step-downs are precise and conditional; MFN is limited to comparable circumstances; elections are time-bound, documented, and prospective; carve-outs avoid creep beyond the LPA’s framework.

3) Negotiation Dialogue Patterns

When negotiating with LPs, the goal is to maintain economic discipline and LPA consistency while being respectful and solution-oriented. The following language patterns help you push back politely and align outcomes.

• Align to the LPA and objective criteria: “We’re happy to accommodate where we can. To remain consistent with the LPA, any fee step-down needs to be anchored to objective triggers—commitment size and admission timing. That structure ensures fairness across the investor base and preserves MFN integrity.”

• Preserve like-for-like comparability: “We understand your request for MFN access to fee terms. Our practice is to permit elections where the factual predicates match on a like-for-like basis, including the same commitment band and closing date criteria. That way, similarly situated investors receive the same treatment without extending bespoke concessions beyond their intended scope.”

• Manage election timing and prospectivity: “To keep administration straightforward, we provide an MFN disclosure package after each closing. Elections within the stated window take effect on a prospective basis. This avoids retroactive recalculations and is consistent with how the LPA contemplates fee adjustments.”

• Address carve-outs without appearing opaque: “Some provisions relate to investor-specific regulatory or strategic relationships. Those are excluded from MFN to reflect their unique constraints. Where an economic term is directly comparable, we’ll include it in the MFN package in anonymized form so you can assess eligibility.”

• Handle default/transfer consequences: “The fee step-down is dependent on maintaining the stated commitment. If there’s a transfer or default that reduces the commitment below the threshold, the step-down would revert. This keeps the economics tied to the original commercial bargain.”

• Offer principled compromises: “If a commitment-threshold step-down is not feasible at [your current size], we could consider a smaller reduction within a lower band, provided it’s clearly defined for MFN purposes. Alternatively, we can look at duration adjustments limited to the Investment Period with an explicit floor.”

These patterns let you defend structure without sounding inflexible. They emphasize fairness, operational clarity, and LPA compliance, which are persuasive in institutional negotiations.

4) Mini-Application: MFN Clarity and Fee Discipline in Action

Imagine finalizing a side letter in a fund with multiple closings and a diverse LP base. Your LPA already defines “Investment Period,” “Second Closing,” and “Final Closing.” You want to grant a fee step-down to a large early LP without exposing the same economics to smaller or later investors via MFN elections.

First, anchor the step-down in objective triggers. State that the rate reduction applies only if the LP maintains a commitment at or above a specified threshold, and only during the Investment Period. This pairs economic benefit with commercial contribution and timeframe. Next, build in reversion on default or transfer to stop the benefit when conditions change. By linking to defined LPA terms (e.g., Second Closing), you remove room for interpretive disputes.

Second, craft the MFN with a strong like-for-like filter. Make clear that elections are available only to investors matching all eligibility criteria, including commitment size and admission timing. Limit economic scope to fee rate, base, and duration, and exclude non-comparable arrangements. Provide a precise election window following a formal MFN disclosure package, and specify that elections take effect prospectively. Include anonymized disclosure for comparable economics to balance transparency and confidentiality.

Third, anticipate negotiation pushback. If an LP asks for the same rate without meeting the size threshold, offer a calibrated alternative—perhaps a modest reduction within a lower band—and keep it explicitly tied to that band for MFN purposes. If an LP requests retroactive application, explain that prospectivity avoids operational friction and retroactive refunds, preserving alignment with the LPA and protecting other investors from unintended cost shifts.

Finally, lock in administration. Require short-form acknowledgments for elected provisions and keep a central register of MFN elections, with eligibility criteria noted. This administrative discipline makes audits and investor reporting easier and reduces the risk of inconsistent application across the investor base.

By following this sequence—objective triggers, clear duration, reversion mechanics, like-for-like MFN scope, defined procedures, and principled negotiation language—you create text that is both precise and workable. You protect fee economics from spreading unintentionally while offering fair access to truly comparable terms. The outcome is a side letter that aligns with the LPA, withstands MFN scrutiny, and remains administratively manageable over the life of the fund.

In summary, the key to MFN clarity in fee step-down drafting is precision. Define what triggers the benefit and for how long. Tie eligibility to facts that can be verified—commitment size, closing dates, and Investment Period boundaries. Limit MFN elections to genuinely comparable circumstances, and ensure that elections are time-bound, prospective, and documented. Use polite, outcome-focused negotiation language to keep discussions constructive while maintaining discipline. With this approach, you minimize economic leakage, keep investors treated fairly according to their contributions, and maintain the integrity of the fund’s agreed economics.