When two or more people join together to operate a business, they often choose a limited partnership as their legal structure. While it is fairly simple process to start a limited partnership, provisions regarding liability can sometimes pose major challenges to shareholders. Whoever enters into a limited partnership doesn’t just take over a part of the management duties, they also become...
For many company founders, a partnership represents an attractive opportunity to bring a business idea to life. Unlike a corporation, there is no minimum capital requirement and there are fewer other formalities too, like having an informal partnership agreement. However, this also has its disadvantages: unlimited liability for the company’s liabilities. The limited partnership legal format has a special feature, in that not all partners are liable to the same extent. In this article, we will explain “limited partners.” Unlike general partners with unlimited liability, limited partners only have to answer to company debts up to the value of their respective capital contributions.
- What is a limited partner?
- Limited partner liability – not always the same
- Joining and leaving the company
- What rights does a limited partner have?
- What are the duties of a limited partner?
- Profit and loss for limited partners
- What withdrawal options does a limited partner have?
- When and how can a limited partner be fired?
What is a limited partner?
A limited partnership consists of two kinds of partner. On the one hand, there is the general partner, who is liable to creditors without restriction, including their own assets. On the other hand, there is the limited partner, who only participates in the limited partnership with a capital contribution, and therefore contributes to the limited partnership’s equity. The limited partner is only liable for the sum of their capital contribution – also called a liability sum.
Unlike a general partner, a limited partner only has limited liability, regardless of whether they have made the contribution specified in the register. They themselves are directly liable for the share if it is not yet paid.
A limited partner is a limited partnership member who makes a contribution to the limited partnership and is only liable for the company’s liabilities up to the amount of this contribution. The general partner, on the other hand, is liable with all their assets. Unless the articles of association determine otherwise, the limited partner is excluded from management and participation in the enterprise.
Limited partner liability – not always the same
In principle, the same rules apply to limited partnerships as to general partnerships – the partnership legally exists once it is registered with the state registry (usually Secretary of State) and once it begins trading.
If a limited partnership begins trading before having filed with the state registry, this can create a legal gray area for the limited partner. This is because their liability threshold is stated in their state register entry. Before the state register entry is made, the limited partner is considered a general partner, with their entire assets at stake, if the company is active but still unregistered. Confusion can also arise in limited partner liability if the capital contribution stated in the state register entry is higher than that agreed upon in the articles of association. In a debt situation, this could lead to the limited partner not having made their liability contribution in full, despite having paid the capital contribution. They would then be liable for the discrepancy between the two figures.
It is important to remember that each state in the USA has their own laws governing the formation of partnerships, so these regulations may not apply to your business. Please consult with your Secretary of State and a legal professional to ensure that your business is legally compliant.
Joining and leaving the company
If someone joins an existing limited partnership as a limited partner, they are liable for existing liabilities within the company up to the threshold of their investment. Similar difficulties can arise if the limited partner makes their capital contribution before it is registered with the state register. In practice, it is usually agreed that they will not join the company until they have been registered in the state registry.
If you choose to leave a company, it is extremely important to ensure that you draft and file a separation agreement, and ensure that your name is removed from all formal documents and any documents implicating you in ongoing liabilities within the company. Failure to do this may result in you being held liable for a debt, despite having previously left a company. Consulting with a legal professional can help ensure your safety when it comes to these contracts and agreements.
What rights does a limited partner have?
Limited partners are usually not involved in company management and subsequently have neither the right to vote, nor a right to object when it comes to decisions concerning the company’s day-to-day running. When it comes to actions that exceed this, however, a limited partner has the right to pass resolutions like all other shareholders.
If the limited partner was explicitly granted managerial powers in the articles of association, they will then have similar voting and opposition rights to the general managing partners.
In addition, the limited partner has a reduced right to information. They cannot directly form their own opinion about the company’s affairs, nor can they inspect the company’s business books and records. Instead, they are only entitled to a copy of the company’s annual financial statements, the accuracy of which they may check against the business books.
What are the duties of a limited partner?
The first right, but also duty, of a partner is to manage the business functions of the company – something limited partners are excluded from. The primary duty of a limited partner is to provide capital contributions and shoulder company liability. Capital contributions may come in the form of cash, material assets, or services.
In addition, there is a general duty of loyalty towards the company. The limited partner is obliged to promote the company and to refrain from all actions which could damage it. However, the non-competition clause which most general partners are subject to does not apply to limited partners, since they have no significant influence over the limited partnership’s business. However, if the articles of association provide management powers for a limited partner, they usually also contain a corresponding non-competition clause.
Profit and loss for limited partners
Limited partners participate in any profit or loss incurred by the limited partnership, but the participation differs from that of the general partners in some aspects. In principle, all shareholders are entitled to a dividend corresponding to their contributions. Unless otherwise agreed, the remaining profit is to be distributed among the shareholders in an “appropriate ratio” to the contributions. In practice, general partners and managing limited partners are generally provided with higher shares.
Losses are divided among the shareholders in accordance with their contributions. Limited partners are only obliged up to the amount of their capital share, or in some cases, the amount of their contributions still to be made. If capital participation has fallen below the amount of their liability contribution due to losses, it must first be replenished by subsequent profits.
What withdrawal options does a limited partner have?
Limited partners do not have the right to profits paid out per year. They are only permitted to have their profits paid out in a lump sum, provided their participation does not fall short of their liability contribution due to previous losses. Profits that have already been paid out must not be repaid in the case of later losses.
If the capital share exceeds the liability share that needs to be carried out, a limited partner may take money from the limited partnership after a separation agreement is signed by the acting partners. The amount paid out is limited to the difference between the two shares.
When and how can a limited partner be fired?
Like all partners within a limited partnership, limited partners can resign or be terminated, triggering their withdrawal from the company. The guidelines that apply to a resignation are often laid down in the shareholders agreement, but not always. If no specific regulations have been made, a general right of termination applies to limited partners of a limited and indefinite partnership. Creating a separation agreement is very important, regardless of whether there is already an exit process specified. Without one, you could be held financially responsible for debts in the future.
Terminating a limited partner, however, requires a concrete reason. There must be a circumstance that impairs cooperation among the shareholders to such an extent that it risks failing to achieve the business objective. Corresponding scenarios can be agreed upon in advance with a termination clause in the shareholders agreement.
If the outgoing limited partner was the only limited partner in the limited partnership, the limited partnership is then automatically converted into a general partnership. This change needs to be registered with the Secretary of State.