Limited PartnershipsChapter 5

Limited Partnerships Designed to eliminate the risk of losing personal

assets to business debts and/or judgments.

Takes the basic arrangement found in a general partnership and adds the protection of limited liability.

Under limited liability, a person who qualifies as a limited partner limits his or her maximum possible legal obligation to the total amount of investment in the business.

In a limited partnership, there are general partners and limited partners.

Limited partners do not face liability for business debts.

They also have no control over day-to-day operations within the business.

In a limited partnership, general partners fulfill the same roles and perform the same duties as they do in a general partnership; they also face personal liability.

Limited partners are protected by limited liability.

Limited Partnerships Authorization by State Statutes

Old common law cases and interpretations do not apply to limited partnerships because they are creatures of statute, not of case law.

Researching limited partnerships should concentrate on state statutes and the cases that apply to them.

Uniform Limited Partnership Act

The Uniform Limited Partnership Act was created in 1916, with major revisions to the act since its creation.

However, the basic formulation of a limited partnership remains the same: general partners manage the business and limited partners share the profits and losses of the business but have no input on day-to-day management.

Differences between Limited Partnerships and General Partnerships The most important difference between general

partnerships and limited partnerships is the issue of limited liability.

However, with this protection come limitations. Limited partners are prohibited from taking an active role in the business. They cannot manage the day-to-day affairs, negotiate contracts, or hire and fire employees.

A general partner in a limited partnership operates almost in the same way as a regular partnership.

They face extensive liability but counterbalance that with the rights to conduct the business, including the right to make decisions affecting the course of the business without seeking approval from the limited partners.

Advantages of Limited Partnerships

The advantage of a limited partnership is that it provides a vehicle for individuals to invest money in a business without the threat of personal liability for business losses and debts.

Limited partners share in both profits and losses of the business, but only to the extent of their investment.

The limited partnership structure also has important advantages when it comes to personal income taxes.

Tax Consequences of Limited Partnerships

Limited partners are permitted to "pass through" business losses on their personal income tax returns or pay income taxes on business profits.

If a business shows a loss, that loss may actually improve the limited partner’s overall tax liability for the year.

Sidebar: Limited partnerships are still very popular, especially in ventures such as real estate purchase and development, where the chances of profits are very high but where legal liability often prevents individuals from risking their personal assets to engage in the business.

The Limited Partner's Contribution

In order to enter into a limited partnership agreement, the limited partner must invest in the company. This investment is normally referred to as a contribution.

The extent of the contribution reflects the percentage of the limited partner’s rights to profits from the enterprise.

Although a limited partner’s contribution usually comes in the form of a cash investment, the law allows other types of contributions.

The Uniform Limited Partnership Act is liberal on the topic of what constitutes a contribution, so long as the contribution consists of something of value. (Revised Uniform Limited Partnership Act § 101 1976 version.)

Creation of a Limited Partnership

A limited partnership comes into existence only after complying with the strict statutory guidelines.

The most important of the statutory requirements is the certificate of limited partnership.

The Certificate of Limited Partnership

All states require that any business considering operating as a limited partnership must file appropriate documentation with the state.

One of the most important of these documents is the certificate of limited partnership.

State governments require the following minimum information in the certificate of limited partnership:

The name of limited partnership The street and mailing address of the agent

for service of process The street and mailing address of the

designated office of the limited partnership The name, street, and mailing addresses of all

general partners

Naming of a Limited Partnership States have different approaches to the names that can be used in limited partnerships. The most common limitations include:

They cannot contain the name of a limited partner;

They can bear the name of a general partner; The name of the partnership must include the

words "Limited partnership" or the letters “LP” or “L.P.”

The limited partnership cannot use a name that is substantially similar to a preexisting business.

Reserving a Name

In most states, the secretary of state’s office allows businesses to reserve names for a period of 120 days prior to filing the certificate of limited partnership.

In this way, a business can prevent others from taking the name that the business intends to use. (Revised Uniform Limited Partnership Act § 103 (1976 Revision)

Agent for Service of Process

An agent for service of process is a person or business that is designated by the limited partnership in its certificate to accept service of process.

This means that if anyone wishes to sue the business, they will have a specific person designated to receive the pleadings.

Because a limited partnership enjoys the protections of limited liability, limited partners cannot be served with lawsuits seeking redress against the partnership.

Instead, the limited partnership must designate an agent who will receive the pleadings.

Individuals Who Qualify as an Agent for Service of Process

An agent for service of process can be an individual who is a resident of the state or can be another form of business, such as a corporation, which is authorized to do business in the state.

Regardless of the identity of the agent, the agent must be listed in the certificate of limited partnership so that the agent can be located and served with the appropriate paperwork.

Designated Office Address

Limited partnerships must provide information to the state about the location of the main office for the partnership, known as the business address.

This business address is where the partnership records are maintained.

The General Partners

The certificate of limited partnership must also identify the general partners.

These partners must be listed by name and address.

Individuals Who Qualify as a General Partner

One feature of limited partnerships is that a single person may be both a general partner and a limited partner at the same time.

However, such an arrangement does not protect the general partner to any greater degree.

The general partners would still face unlimited liability for business debts and judgments.

When the certificate is presented and the state has determined that the certificate is in substantial compliance with state law, the certificate is filed, and a limited partnership is created. In most states, the office responsible for maintaining these records is the secretary of state’s office.

Limited Partnership Agreements

The individuals involved in the business will draft an agreement called the Limited Partnership Agreement.

This agreement determines how the business will be run and how profits and losses will be shared among general and limited partners.

State law governs the drafting of the agreement but allows the parties flexibility in drafting specific provisions.

The parties are free to negotiate any terms that they like, as long as their agreement does not run counter to the law, public policy, or the established parameters of the partners’ rights and obligations.

Construction of the Language in a Limited Partnership Agreement

Limited partnership agreements are contracts between the partners and are construed like any other contract.

Elements of a Limited Partnership Agreement

Duties and responsibilities of general partners Remedies available for breach of those duties Qualification as a limited partner Distribution of profits and losses Classification of contributions Partnership meetings Dissolution and winding up

Duties and Responsibilities of General Partners

General partners owe a fiduciary duty to the other partners, both general and limited, meaning that a partner must act in the best interests of the other partners and the business.

Among the fiduciary duties owed by general partners to the other partners are:

Duty to Act in Good Faith Duty of Fairness Duty of Loyalty

Duty to Act in Good Faith

General partners must not attempt to personally enrich themselves at the expense of the business.

They must keep the best interests of the business and partners foremost in their minds.

They cannot engage in self-dealing, which is the practice of using information, assets, or other company property to personally enrich themselves.

Duty of Fairness

The duty of fairness is closely tied to the duty to act in good faith.

A general partner must act fairly towards other partners.

Duty of Loyalty

Partners must be loyal to one another and avoid practices that put the individual’s interests ahead of the company’s interests.

Remedies for Breach of Fiduciary Duty

The parties can dissolve the partnership.

They can also file suit against the partner, asking the court to rule that the general partner’s unauthorized personal gain should be seized and redistributed among the partners.

In such a situation, courts often rely on the constructive trust doctrine.

Constructive trust doctrine: The theory that a partner who acquires profits for his or her own enrichment holds such funds for the benefit of the company as a whole and can be ordered to return such funds to the other partners.

Distribution of Profits

One of the most important elements of the limited partnership agreement is the issue of distributing profits.

The profits distributed among the limited partners are generally determined by the limited partner’s percentage of ownership in the business.

Classification of Contributions

Classification of contributions becomes important when the limited partnership is dissolved. A partner may be entitled to return of specific property or remuneration of actual value of any contribution.

Partnership Meetings

Partnership meetings are important for both general and limited partners because they set protocols and establish the direction of the business.

The partnership meeting is also where the official decision to terminate the partnership is made.

Dissolution of a Limited PartnershipLimited partnerships can terminate in a number of

ways: The partnership may terminate when a certain

event occurs, or Courts may dissolve the partnership under the

doctrine of judicial dissolution, or The secretary of state may dissolve a

partnership that has failed to pay appropriate fees and taxes or failed to file an annual report with that office.

Judicial dissolution: A court’s determination that a company should be dissolved for the good of the partners, creditors, or because the business has engaged in illegal activities.

Winding Up Business Affairs

The dissolution of a limited partnership only occurs after a period of “winding up” the business affairs.

This period includes finalizing any payments, accepting shipments, reconciling accounts receivable, and any other routine business matters.

Once all creditors have been paid, the partners are free to distribute the remaining assets among themselves according to the terms of the limited partnership agreement.

Summary

Limited partnerships enjoy the protection of limited liability.

Limited liability means that the most that a party can lose in a particular business transaction is the amount of his or her investment.

Summary

The Uniform Limited Partnership Agreement Act has been adopted in all states and provides a mechanism for creating a limited partnership.

Before a limited partnership can be created, the appropriate documents must be completed and filed with the state.

A limited partnership consists of one or more general partners and one or more limited partners.

Summary

General partners have duties and obligations including running the day-to-day operation of the business, making business decisions, and hiring and firing employees.

Limited partners have no such authority and are not permitted to control the actions of the general partners.

General partners in a limited partnership are not protected by limited liability any more than general partners in any other type of business.

Summary

Limited partnerships can dissolve by their own terms or by judicial interaction.

Once dissolved, there is a period of winding up business affairs before profits can be distributed to the partners.