The Law Student Blog

Introduction to Limited Partnerships

Limited Partnerships (LP) are formed and regulated in accordance with the Limited Partnerships Act 1907 (LPA) (although common law and the PA 1890 are still applicable to LPs). Essentially, an LP is an ordinary partnership but with certain modifications under the LPA.

The main difference between an ordinary (traditional) partnership and an LP is that some partners in an LP have limited liability for the debts and obligations of the partnership. Like partnerships (but unlike LLPs), LPs are not separate legal entities.

The PA 1890 applies to LPs except where inconsistent with the LPA. For example, if there is no agreement as to a profit sharing ratio, all partners share equally under s.24(1) PA 1890.

LPs require the involvement of at least two partners:

• at least one general partner; and
• at least one limited partner.

Nature of liability

A general partner’s liability is always unlimited. This reflects the fact that the general partner manages the business.

Limited partners have limited liability, up to the amount of their contribution to the LP (s.4(2) LPA). Importantly, however, this only applies if they are not involved in the day-to-day management of the partnership (s.6 LPA).

This makes LPs a useful vehicle for investment funds, where the general partner manages the fund and investors are protected from any liability by becoming only limited partners.

Roles of general and limited partners

The LPA does not describe what the general partners may do. Rather it focuses on what the limited partners cannot do. For example, the limited partners have no power to bind the firm. It is important that the management of the business is in the hands of the general partner(s) only. (Contrast the position of an ordinary partnership where management is in the hands of all the partners under s.24(5) PA 1890). If a limited partner takes part in the management of the partnership business he shall be liable for all debts and obligations during this period as if he were a general partner (s.6(1) LPA).

A general partner in a limited partnership is more akin to a managing director than to an ordinary partner on equal terms with the other partners.

The limited partners must agree before any changes are made to matters such as profit share, expulsion of partners, alteration in the nature of the partnership business and variation in the partnership agreement. These cannot be changed by the general partner alone.

Registration of LPs

LPs must be registered at Companies House under ss.5, 8 and 8A LPA. Limited partners in an LP that fails to be correctly registered forfeit their limited status and will be treated as partners in ordinary partnerships.

The information which needs to be filed (and updated when it changes) by an LP includes the firm’s name, the general nature of its business, the principal place of business, the names of the partners and the sum contributed by any limited partner (s.9 LPA). Under s.8B LPA all new limited partnerships must expressly include ‘Limited Partnership’ or ‘LP’ or the equivalent at the end of their names. The Registrar is required to issue a certificate of registration as conclusive evidence that the LP has been formed and registered (s.8C LPA). As with the Companies Register, the register of LPs is available for public inspection. LPs are registered with form LP5, which can be viewed on the www.gov.uk website.

Importantly, an LP need not file annual accounts or confirmation statements.

Dissolution of LPs

A limited or a general partner may dissolve the LP under a provision in the partnership agreement and the law relating to ordinary partnership dissolution will generally apply to LPs. One exception is that a limited partner may not dissolve the LP by notice if the LP is a partnership at will, without agreement from all the other partners (a general partner may however do so (s.6(5) LPA)).

Use of LPs

You may encounter LPs only rarely in practice unless you work with venture capital funds, private equity or real estate investment vehicles, which are often run through LPs.

In a venture capital partnership, investors (the limited partners) advance money, to be placed for them by the general partner (often referred to as a manager) in commercial ventures in need of finance. The manager will charge a fee and will receive a share of the profit. The LP vehicle is suitable as the majority of investors in a venture capital fund are passive investors and will not participate in the management of the fund.

LPs are the vehicle of choice for private equity fundraising. They are tax transparent and highly flexible: the partners can write their own internal partnership rules without having to conform to the detailed requirements of CA 2006.

In recent years, the limited partnership regimes in other jurisdictions have become more attractive to fund managers. The Treasury proposed a number of reforms to the UK regime to improve the UK’s competitiveness in this market. As a result, in April 2017 a new sub-type of LP, the Private Fund Limited Partnership (PFLP), was created (under the Legislative Reform (Private Fund Limited Partnerships) Order 2017) to reduce some of the administrative burdens on private investment funds which are structured as LPs.

Each partner is liable to tax as an individual on his share of the income or gains of the partnership. This is described as tax transparency.

Even though a partnership is not a distinct legal entity, HMRC requires a partnership to make a single tax return of its profits which must be agreed with HMRC (as with sole traders, partnerships choose their own accounting period). Partners submit their own individual tax returns containing all income received from the partnership as well as other income receipts (including, for example, from savings, dividend and/or rental income).

Each partner is personally liable for the tax on his share of the partnership profits. Unlike with other partnership liabilities where each partner is jointly and severally liable, a partner is not liable for the tax on other partners’ shares of partnership profits.

Normal capital gains tax principles apply on disposal of a capital asset by a partnership. Each partner is treated as owning a fractional share of the asset. On disposal by the partnership, each partner is treated as making a disposal of his fractional share and will be taxed on this fractional share of any gain, subject to the availability of any reliefs available to individuals. A partner’s fractional share shall be based upon the agreed PSR or, if there is no agreed PSR, then equally in accordance with s.24(1) PA 1890.

Partner leaving

If there is no partnership agreement or if the agreement is silent on retirement or termination (i.e. there is a ‘partnership at will’), the effect of a partner leaving is that the partnership is dissolved (see s.26 PA 1890). This is because ‘partnership’ is a collective noun meaning ‘all the partners’ and so the continuity of a partnership is broken when there is a change in the identity of the individuals who constitute it. In most cases this is a ‘technical dissolution’. This means that a new partnership is formed by the remaining partners who continue the business. However, it is open to any of the partners to apply to court to have the old partnership wound up (i.e. sale of the assets for the repayment of the partnership debts and for the distribution of the assets or liabilities amongst the partners).

To prevent dissolution when a partner leaves, the partnership agreement should state explicitly that the partnership will continue as between the remaining partners and should contain details of how a partner can leave (which may include a provision in the event of death) or be expelled without the partnership being wound up. This would usually include a mechanism for the remaining partners to buy out a departing partner’s share.

Dissolution of partnership

A partnership can be dissolved in a number of ways:

• automatic dissolution under s.32(a) and (b) PA 1890 (expiry of fixed term/completion of specific venture), s.33 PA 1890 (death or bankruptcy of partner) or s.34 PA 1890 (if the partnership business becomes unlawful). The provisions of ss.32 and 33 are subject to contrary agreement;
• dissolution of partnership at will (i.e. with no fixed duration) by notice from any partner (ss.26 and 32(c)); and
• dissolution by the court as a last resort under s.35 PA 1890.

If an event occurs which causes a partnership to be dissolved, the partnership relationship ceases and any partner may demand that the assets of the business are realised.

Winding up partnership: Collecting in/distributing assets (s.44 PA 1890)

Subject to any written partnership agreement, where a partnership is wound up, once all debts and liabilities have been paid, any money/assets left will be distributed so that each partner is paid back his/her original capital first (s.44(b)(3)). It is common for a partnership agreement to have a provision dealing with the proportion in which any surplus assets are to be shared out following dissolution. This is called the asset surplus ratio or ‘ASR’. If there is no agreed ASR then s.44(b)(4) applies and surplus assets are shared in accordance with the agreed profit sharing ratio PSR. If there is no PSR then they are shared equally in accordance with s.24(1) PA 1890.

Because a firm has no legal personality separate from the partners, the partners are personally bound under, and hence liable on, contracts which are binding on the firm. The PA 1890 contains provisions relating to the nature and extent of such liabilities. In some circumstances, non-partners can also become personally liable.

Nature of partners’ liability (ss.9, 10 and 12 PA 1890)

Contractual Liability: Every partner in a firm is liable jointly with the other partners for all the debts and obligations of the firm incurred whilst he is a partner (s.9).

Tortious Liability: In tort the partners’ liability is joint and several (ss.10 and 12).

Liability of non-partners: new and former partners (ss.17 and 36 PA 1890)

Under s.17(1) a new partner will not automatically be liable in relation to any debts incurred by the partnership before he joined.

Under s.17(2) a partner will still be liable after he retires in respect of debts incurred by the partnership whilst he was a partner. In order to relieve a partner from an existing liability once he retires, a partnership may novate the relevant agreement; this must be with the consent of the creditor (s.17(3)).

It is also possible for a former partner to become liable for new partnership debts incurred after he has left under s.36. If a partner leaves, a third party can treat all apparent partners of the firm as it was before the change (i.e. including the departing partner) as jointly liable to pay any new debt incurred by the partnership UNLESS that third party has been notified of this change either by:

• actual notice (s.36(1)) – for those who have had actual dealings with the partner before departure; or
• constructive notice by virtue of publication of the departure in the London Gazette (s.36(2)) – for those who have not had actual dealings with the partner before departure.

However, a former partner will not be liable for debts to any third party who did not know him to be a partner before he left. No notice at all has to be given to such persons.

Liability of non-partners: ‘holding out’ (s.14 PA 1890)

Generally, a person who is not a partner has no personal liability for partnership debts. However, s.14 sets out circumstances where a non-partner may be personally liable on a partnership debt if he has held himself out as a partner (or has knowingly allowed himself to be so held out).

The elements required for s.14 to have effect are (i) a representation to a third party to the effect that a person is a partner, (ii) the third party’s action in response (‘giving credit to the firm’, e.g. by supplying goods or services to the firm) and (iii) the third party’s state of mind (‘believing (having faith in) the representation’).

It is important to appreciate that s.14 relates to the liability incurred by the NON-PARTNER, not the liability of the firm. The liability of the firm for the acts of a non-partner is established by applying the common law principles of agency.

In practice, you may need to decide whether or not the partnership is bound by a contract which an individual has purported to make on its behalf. In a partnership context, the approach to answering the question of whether or not a firm is bound by a particular contract will differ depending on whether the individual acting on the firm’s behalf is a partner or not. This is because s.5 PA 1890 introduces a special statutory rule of agency which applies only when the agent in question is a partner in the firm. Where the purported agent is not a partner, you apply rules from the common law. We will consider each of the ‘partner’ and ‘non-partner’ approaches separately below.

Partners content with agent’s act (whether partner or non-partner)

In many cases, an individual acting as a firm’s agent (whether a partner or not) will simply have put into effect the wishes of the partnership as a whole. If all the partners are happy for the firm to enter into the contract and have given actual, express or implied authority to bind the firm, then the firm will be bound. In any event, if the partners are happy to be bound, the situation is not problematic even if the agent had no authority at the time the contract was made. The partners are able to ratify the agent’s act and adopt the contract, either expressly or simply by going ahead and performing it.

Partners not content with agent’s act

Either s.5 PA 1890 or the common law rules of agency will determine whether or not the firm is bound, depending upon whether the agent is a partner or not.

Power of a partner to bind the firm against the partners’ wishes: s.5 PA 1890

Section 5 makes provision for the firm to be bound in certain circumstances, even where the other partners are not happy to be bound by the contract made by the agent. Since s.5 is intended to protect the third party to the contract, it is that third party’s view of what is happening that counts.

Following s.5, a partner’s unauthorised act will bind the firm if, viewed objectively:

• the act is for carrying on business of the kind carried on by the firm (for example, “is this the kind of contract that one would expect to be done in the course of business of this kind?”); and
• the act is for carrying on such a business in the usual way (for example, “is this the kind of contract that a partner acting alone would usually make on the firm’s behalf or is it a contract of the kind an outsider would expect all partners in a firm to sign individually?”).

The firm will not be bound, however, if:

• the third party actually knew that the partner in question was not authorised to enter into the contract on behalf of the firm; or
• the third party did not know or believe that the partner was a partner.

A partner who binds his firm without actual authority may be liable to the other partners for breach of contract.

Power of a non-partner to bind the firm against the partners’ wishes: apparent authority at common law

Section 5 does not apply at all if the person entering the contract is not in fact a partner. In that case, the common law rules of agency establish whether or not the firm is bound as principal.

At common law, an agent who has no actual authority may still bind the firm if he has apparent authority to enter into a contract. Apparent (sometimes called ‘ostensible’) authority arises when the principal (here the firm) represents or permits a representation to be made to a third party that a person has authority to bind the firm. For example, if a firm employs somebody under the title ‘marketing manager’, that title confers on that person apparent authority to bind the firm on marketing decisions. Once the principal’s representation has been made to, and relied upon by, the third party, the principal is bound by the actions of that person.

If the representation is that a particular person is a partner (when, in fact, they are not), then the firm is said to be ‘holding out’ that person as a partner. A person who has been held out as a partner has apparent authority to bind the firm in the same way as a real partner can. An example of holding out is in relation to an ex-partner, when the firm carries on using old letterhead (including his or her name) after he or she retires.

Section 5 is always the first place to look when deciding whether or not an act of a partner binds a firm but does not displace the application of ordinary common law agency entirely. In some circumstances, s.5 alone will not get you to the end of the story. If a partner has purported to form a very unusual kind of contract on behalf of the firm, a s.5 analysis may lead you to conclude that the firm is not bound under statute. However, the particular facts and circumstances of the case may mean that this partner did have his partners’ apparent authority at common law to conclude the contract.

In practice, you will sometimes find that clients ask for your help to avoid creating a partnership, rather than asking you to create one for them. One reason for this is that the legislation governing partnerships is over 100 years old and the default provisions, which will be implied by that legislation, are often unsuited to the modern business environment. Additionally, clients may have concerns about being subject to unlimited liability.

Nevertheless, there are some advantages. For example, it costs nothing to create a partnership, because no formality is required to create one. In fact, there are almost as many partnerships in the UK as there are companies and many of them are professional partnerships such as lawyers, accountants, surveyors and architects. Many businesses start as partnerships before they convert to a limited company.

The Partnership Act 1890 (PA 1890)

The PA 1890 provides the framework for regulating traditional partnerships. However, there is case law to supplement the PA 1890, and I will cover a small number of cases in later posts.

Whilst the PA 1890 and case law provide a framework for governing traditional partnerships, they are really ‘fall-back’ provisions in the absence of a partnership agreement or where the agreement is silent on any matter. Most traditional partnerships will have a formal written partnership agreement.

Existence of partnerships

As mentioned previously, a partnership is a relationship between persons carrying on a business in common with a view of profit (s.1(1) PA 1890).

Section 2 PA 1890 contains a list of rules for determining the existence of a partnership. The purpose of s.2 is to provide more detailed guidance in determining if the criteria in s.1(1) have been met. For example, evidence of profit sharing will be prima facie evidence of a partnership but not necessarily conclusive evidence (s.2(3) PA 1890). Case law provides that if there is an agreement to share losses as well as profits this makes the existence of a partnership more likely (Northern Sales (1963) Limited v Ministry of National Revenue (1973)). A loan of money by one party to another does not create a partnership.

Case law has also held that if the person is not being “held out” as a partner this makes the existence of a partnership less likely. In Walker v Hirsch (1884) a clerk lent money to the partnership, was paid a fixed salary and took 1/8th of the profits and of the losses but was never held out as a partner. No partnership was found to exist.