A real estate fund closes its first institutional raise. Two founding principals split the promoted interest equally. Three years into the investment period, one of them leaves. Maybe the departure is amicable, the product of a genuine life change. Maybe it is contentious, the end of a relationship that deteriorated over disagreements about deal strategy, expense allocation, or credit. Either way, the fund still has properties to manage, investors to report to, and carry to earn. And the question of what the departing principal keeps, and what the remaining principal retains, is now determined entirely by whatever the governing documents say.
If those documents addressed the question carefully, the answer is clear and the transition, however difficult personally, is orderly. If the documents addressed it vaguely, the transition becomes a negotiation conducted under the worst possible conditions: real money at stake, a relationship already strained, and lawyers on both sides reading ambiguous language to their clients’ advantage.
The good leaver and bad leaver framework is the mechanism that governs promote economics when a principal departs. It determines what portion of the promoted interest the departing principal keeps, what is forfeited, what the transfer price is for any interest that must change hands, and how the clawback obligation is handled going forward. Getting that framework right is not a detail that can be deferred until someone is actually leaving. It is governance work that belongs at formation, when everyone still has incentives to be thoughtful rather than strategic.
What Promote Forfeiture Is Designed to Do
The promoted interest represents compensation for ongoing value creation, not simply a reward for having been present at the fund’s formation. A sponsor earns carry through the work of managing assets, executing business plans, maintaining investor relationships, navigating lender relationships through difficult markets, and ultimately positioning investments for exit at returns that clear the waterfall’s performance thresholds. A principal who departs years before the fund realizes its portfolio has not done all of that work. Whether they have done enough of it to justify keeping all of their carry allocation, some of it, or none of it is the question that forfeiture provisions answer.
Forfeiture is also an LP concern, not just an internal one. ILPA’s Principles 3.0 place alignment, governance, and transparency at the center of the GP-LP relationship, and ILPA’s due diligence questionnaire asks specifically about key person provisions, leadership departures, succession planning, and the treatment of economic rights during transitions. Institutional investors conducting diligence on a real estate fund want to know whether the people earning carry are the people actually running the fund, and whether the governing documents deal intelligently with the scenario where they are not. A fund without coherent departure economics does not just have an internal governance problem. It has an investor relations problem.
The most important framing for forfeiture, and the one that produces the most defensible documents, is that forfeiture is not a penalty. It is an alignment mechanism. Vested promote is compensation that has been earned. Unvested promote is compensation that has not yet been earned. Forfeiture of unvested promote is not punishment for leaving. It is a recognition that the carry associated with work that has not yet been performed belongs to the people who will perform that work, not to the person who will not.
The Good Leaver and Bad Leaver Framework
Good Leaver: The Favorable Treatment Category
Good leaver status is reserved for departures that are unavoidable, planned, or not attributable to any conduct on the departing principal’s part that harms the platform. The categories most commonly treated as good leaver events are death, permanent disability or incapacity, retirement after a defined service period, termination by the sponsor without cause, and in some agreements resignation for good reason, meaning resignation triggered by a material adverse change in the departing principal’s role, compensation, or responsibilities that the principal did not consent to.
A good leaver typically retains vested promoted interest, receives fair market value treatment for any required transfer of their GP entity interest, and in some agreements receives partial acceleration of unvested economics when the departure results from death, disability, or involuntary termination. The specific outcome in any given situation depends entirely on what the governing agreement says, because the phrase good leaver is only as generous as the drafting makes it. An agreement that says good leavers “retain vested carry” but does not define what vested means relative to the fund’s waterfall timing has not solved the problem. It has relocated it.
Bad Leaver: The Forfeiture Category
Bad leaver status is reserved for departures that reflect fault, misconduct, or a voluntary exit that damages the sponsor’s interests in a way that the agreement treats as disqualifying. The most common bad leaver triggers are termination for cause, voluntary resignation before defined milestones or during critical fund phases, breach of fiduciary duty, and violation of restrictive covenants including non-compete and non-solicitation obligations.
A bad leaver typically forfeits both vested and unvested promoted interest, or at minimum receives materially less favorable treatment than a good leaver on the transfer price for any interest that must change hands. The severity of that treatment is not arbitrary. It reflects the view that a principal who leaves in circumstances that harm the platform has not earned the economics associated with the work they were supposed to perform, and that preserving those economics for the remaining team and the investors they serve is a legitimate governance objective.
The drafting of bad leaver provisions requires particular care on the definition of cause. An overly broad cause definition, one that gives the remaining principals or the board discretion to classify any inconvenient departure as for cause, creates a forfeiture mechanism that departing principals will contest regardless of the circumstances. A narrow cause definition, one limited to fraud, material breach of fiduciary duty, conviction of a felony, or similar specific and objectively verifiable conduct, produces a result that is both more likely to be respected by courts and less likely to be challenged in the first place.
Intermediate Categories for Gray-Area Departures
Not every departure fits cleanly into good leaver or bad leaver territory. A founding principal who becomes progressively less engaged over time, who stops contributing at the level the platform requires but does not engage in conduct that rises to the level of bad leaver treatment, presents a situation that an all-or-nothing framework handles poorly. An intermediate leaver category, used by many sophisticated carry plans, addresses this by preserving a portion of the departing principal’s economics based on the timing and circumstances of the departure without extending the full favorable treatment reserved for good leavers.
The intermediate category can also reduce litigation risk. When a departure is contested, the parties to a carry dispute are frequently fighting not about whether the departing principal did something wrong but about which category they fall into. An intermediate category that acknowledges nuance and provides a defined economic consequence for the situations that fall between the extremes gives both sides a framework for resolving the dispute without litigation, because the outcome is calibrated rather than binary.
| 📌 The Constructive Dismissal Gap: Why Good Reason Provisions Matter A principal who is effectively forced out through a material reduction in their responsibilities, authority, or compensation, but who is not formally terminated, faces a classification problem in agreements that do not include a good reason provision. Without such a provision, the departing principal’s only options are to remain in a role that has been materially diminished or to resign voluntarily, which under most agreements triggers bad leaver or at best intermediate leaver treatment. A good reason provision specifies the employer-side actions that permit a principal to resign and still claim good leaver status. Common good reason triggers include a material reduction in the principal’s role, compensation, or authority; a relocation that was not agreed to; or a change in control of the management company or GP entity that the principal did not consent to. Without a good reason provision, a sponsor can effectively force a principal out by making the role untenable while avoiding the formal termination that would trigger good leaver treatment. The principal is left choosing between accepting an untenable situation and accepting bad leaver economics. A good reason provision prevents that outcome and protects principals against constructive dismissal that circumvents the forfeiture framework’s intent. The good reason provision should define the triggering conditions with sufficient specificity that the classification does not depend on the remaining principals’ goodwill. Generic language referring to ‘material adverse changes’ without defining what is material, who determines materiality, and what process applies creates the same vagueness problem as an imprecise cause definition. |
The Delaware Legal Framework: Why Precise Drafting Is the Primary Defense
Most real estate fund GP entities and carry vehicles are organized in Delaware. That choice has significant consequences for how forfeiture provisions are interpreted and enforced, because Delaware’s approach to entity agreements is strongly contractarian. The Delaware LLC Act and the Delaware Revised Uniform Limited Partnership Act both give maximum effect to freedom of contract, treating the entity agreement as the primary source of governance for disputes among members or partners.
The practical consequence of that contractarian approach is that Delaware courts begin with the agreement’s text, apply it according to its plain meaning, and are generally reluctant to override clear contractual provisions on fairness grounds. A forfeiture provision that is unambiguous, was voluntarily agreed to, and applies to a situation that the agreement clearly addresses will generally be enforced by a Delaware court without significant modification. The court’s job is to interpret the contract, not to correct it.
Cantor Fitzgerald v. Ainslie and the January 2024 Delaware Supreme Court Decision
The January 29, 2024 decision of the Delaware Supreme Court in Cantor Fitzgerald, L.P. v. Ainslie confirmed an important aspect of Delaware’s approach to forfeiture provisions in partnership agreements that is directly relevant to real estate fund GP structures. The case involved a limited partnership agreement that conditioned a withdrawing partner’s right to receive certain deferred payments on that partner’s not competing with the partnership during a four-year payment period. The Delaware Court of Chancery had previously held that this forfeiture-for-competition provision was an unreasonable restraint of trade subject to a reasonableness review.
The Delaware Supreme Court reversed that holding. The Supreme Court held that forfeiture-for-competition provisions in partnership agreements are not subject to the same reasonableness review applied to affirmative non-compete covenants. The court distinguished between an affirmative non-compete, which restrains a departing partner from taking a job and can be enforced by injunction, and a forfeiture-for-competition provision, which conditions receipt of a deferred benefit on not competing. The latter, the court held, operates as a condition precedent to a deferred economic benefit rather than a direct restraint on competition, and is therefore governed by freedom of contract principles rather than by a reasonableness standard.
For real estate fund sponsors and their counsel, the Cantor Fitzgerald decision confirms that a well-drafted forfeiture provision in a Delaware limited partnership agreement or LLC operating agreement, one that conditions a departing principal’s right to receive carry on compliance with defined obligations, including non-compete obligations, can be enforced without requiring the sponsor to demonstrate that the provision meets a reasonableness standard. The court applied the “employee choice doctrine,” under which an informed partner who voluntarily withdraws and then competes is presumed to have made a knowing choice to accept the economic consequences.
LKQ Corp. v. Rutledge: December 2024 Extension Beyond Partnership Agreements
The December 18, 2024 decision in LKQ Corp. v. Rutledge extended the Cantor Fitzgerald framework beyond the partnership agreement context. The Delaware Supreme Court held in LKQ that forfeiture-for-competition provisions are not restricted to limited partnership agreements and can be enforced in other equity compensation contexts as well, applying the same freedom-of-contract analysis. The court declined to treat economic hardship alone as an extraordinary circumstance that would override enforcement.
Taken together, Cantor Fitzgerald and LKQ confirm that Delaware law treats forfeiture provisions in entity agreements as enforceable contractual conditions rather than regulatory restrictions subject to external reasonableness review. That enforcement posture is valuable to sponsors who draft forfeiture provisions carefully and apply them consistently. It is also a reminder that the same courts that enforce clear provisions will interpret ambiguous ones against the drafter and that poorly drafted forfeiture language that produces outcomes the parties did not intend will not be rescued by equitable intervention.
Economic Consequences: Transfer Pricing, Clawbacks, and Reallocation
Pricing the Departing Principal’s Interest
Once the leaver category is established, the economic consequence of the departure depends on the valuation mechanics that apply to any interest that must be transferred. Good leavers typically receive fair market value for their economic interest, which in a real estate fund context requires a determination of the value of the promoted interest at the time of departure. That determination is complicated by the fact that carry value at any given point in a fund’s life depends on unrealized portfolio performance, the fund’s distance from waterfall thresholds, and the timing of expected realizations. All of those variables are genuinely uncertain at the time of most departures.
Bad leavers typically receive the lesser of fair market value or cost, or in some cases are required to transfer their interest at cost without any recognition of current market value. That pricing differential is the primary economic consequence that distinguishes bad leaver treatment from good leaver treatment in many agreements, and it is the provision most likely to be contested in a departure dispute where the facts are genuinely ambiguous.
The governing agreement should specify the valuation method with enough precision that neither party has significant room to manipulate the outcome. Where discretionary valuation is used, an independent appraisal process with defined standards and a defined dispute-resolution mechanism is more defensible than a process that gives the remaining principals authority to determine the departing principal’s interest value. Where formula-based pricing is used, the formula should be tested against realistic scenarios before adoption to ensure it does not produce outcomes that are absurd relative to the fund’s actual economics.
Clawback Allocation After Departure
A departing principal who has already received carry distributions during the fund’s life remains potentially exposed to the GP-level clawback obligation if the fund’s waterfall later reverses those distributions. The governing agreement must address whether that clawback exposure survives the departure, how much of the clawback obligation is allocated to the departed principal relative to the remaining principals, and what mechanism exists to secure or enforce the obligation against a person who is no longer actively affiliated with the platform.
ILPA’s model materials contemplate carry escrow accounts and personal guarantees from ultimate carry recipients as mechanisms for securing the clawback obligation, and ILPA’s due diligence questionnaire asks specifically about clawback guarantees and escrow policy. A departure that occurs after significant carry distributions have already been made creates exactly the scenario those provisions are designed to address: a person who has received distributions from the fund is no longer subject to the platform’s ongoing discipline and oversight but may remain liable for a portion of those distributions if the fund’s later performance does not support them.
Reallocation of Forfeited Promote
Forfeited promote does not simply disappear. It is recycled into the sponsor’s internal economics, typically through one of three mechanisms: redistribution to the remaining principals in proportion to their existing allocations, allocation to a reserve pool that can be used to compensate new hires or reward principals whose responsibilities have expanded following the departure, or a combination of both. The governing agreement should specify where forfeited promote goes rather than leaving that question to a negotiation among principals who have different interests in the answer.
The reallocation decision is also a strategic one. A departure that increases the remaining principals’ carry allocations creates an incentive structure that is different from one where the forfeited economics are reserved for future talent acquisition. A platform that is growing and expects to recruit senior talent benefits from a reserve pool that can be used to bring in new principals without diluting the founding team’s economics from scratch. A platform where the founding team will manage the existing portfolio without adding senior talent has less need for that flexibility. The reallocation mechanism should reflect the sponsor’s actual succession and retention plan rather than a generic template.
What the Documents Must Say to Make the Framework Work
The good leaver and bad leaver framework operates across multiple governing documents simultaneously: the GP entity’s operating agreement or limited partnership agreement, the fund’s LPA, any standalone carry plan among the principals, employment or service agreements, and potentially side letters that address specific circumstances for named principals. All of those documents must tell the same story. An LPA that describes the GP’s clawback obligations in one way, a GP operating agreement that allocates that obligation differently among principals, and employment agreements that address restrictive covenants without reference to either the LPA or the operating agreement’s departure provisions are documents that will produce contradictory results when all three are invoked at the same time.
The minimum required content for a coherent departure framework includes: a definition of cause that is specific enough to be applied without significant discretion; a definition of good leaver events that covers death, disability, termination without cause, and, if the agreement includes the concept, resignation for good reason; a definition of good reason triggers that is specific enough to be applied to concrete employer actions; an intermediate leaver category if the agreement intends to calibrate consequences for gray-area departures; the vesting schedule and how it interacts with the leaver classification to determine what is forfeited; the transfer pricing mechanism for each leaver category; the clawback allocation among current and former principals and whether it survives departure; the reallocation destination for forfeited promote; and the dispute resolution process that applies when the classification is contested.
| ⚠️ The Four Provisions Most Commonly Left Vague Cause. Agreements that define cause as ‘conduct detrimental to the fund’ or ‘actions inconsistent with the interests of the partnership’ give the remaining principals effectively unlimited discretion to classify a departure as for cause. That broad discretion produces the same result as no definition at all: the classification becomes a negotiation. Cause should be defined as an enumerated list of specific conduct categories, not as a general standard. Good reason. Agreements that omit good reason provisions leave departing principals with no protection against constructive dismissal. A principal who is stripped of responsibilities, excluded from investment decisions, or subjected to a compensation reduction that was not agreed to has no contractual path to good leaver treatment in an agreement that does not include a good reason trigger. Clawback allocation post-departure. Agreements that describe the GP-level clawback obligation without addressing how it is allocated among former and current principals leave a significant financial question to be answered in a future dispute. That question becomes exponentially more difficult to resolve when the former principal has moved to a different city, entered a different industry, or taken the position that they bear no ongoing obligation for distributions received during their tenure. Reallocation destination. Agreements that say forfeited carry is ‘retained by the partnership’ or ‘redistributed to remaining principals’ without specifying the precise mechanism leave room for a secondary dispute among remaining principals about how the windfall should be divided. That dispute arises at exactly the moment when the platform most needs its remaining team focused on managing the portfolio rather than fighting over carry redistribution. |
A Departure Framework Built at Formation Is Worth Considerably More Than One Negotiated at Departure
The most expensive version of the good leaver and bad leaver conversation is the one that happens after someone has already left. At that point, the parties’ interests are maximally misaligned, the relationship has already deteriorated, and any ambiguity in the governing documents becomes the raw material for a dispute that neither side wants to fund with legal fees. The documents that govern the outcome were drafted at formation, when everyone was optimistic, the relationship was functional, and the incentives for careful thinking were high.
The Delaware Supreme Court’s 2024 decision in Cantor Fitzgerald confirms that well-drafted forfeiture provisions in partnership and LLC agreements will be enforced in Delaware courts without a reasonableness review. That is valuable enforcement certainty for sponsors who draft carefully. The same court will begin with the agreement’s text for sponsors who draft poorly, which means ambiguous provisions will be interpreted against the drafter and may produce outcomes no one intended.
The principals who agreed to a fair departure framework when everyone was optimistic about the fund deserve a document that enforces that agreement without requiring them to litigate it later. And the platform that built its forfeiture framework carefully, with precise cause and good reason definitions, calibrated leaver categories, explicit transfer pricing mechanics, and a clear clawback allocation rule, is the platform that can navigate a leadership transition without the governance drift and investor relations damage that poorly documented departures produce.