Scottish Law Commission (Reports)

PART XVIII

THE RIGHTS AND OBLIGATIONS OF PARTNERS IN A LIMITED PARTNERSHIP

Introduction

18.1     In this Part we consider principally the rights and obligations of partners. In a limited partnership, these are normally regulated by a written partnership agreement. While we see less need to create default rules for limited partnerships than for general partnerships, there are a number of issues where statutory provision may give greater certainty to those who draw up partnership agreements for limited partnerships.
18.2     We also consider issues which may affect third parties, namely whether the limited partner should have power to apply to the court to wind up the partnership and whether he may vote in relation to the appointment of a partnership liquidator.

Matters requiring the consent of the limited partners

18.3     We invited views on the proposition that (as at present),^[1] unless there were agreement to the contrary, the consent of the limited partners should be needed for any change to the partnership agreement or any change to the nature of the business.^[2]
18.4     Almost all consultees agreed with the proposition. One suggested that the default rule might be qualified so that it would not be necessary to obtain the consent of limited partners to any change to the partnership agreement which affected only the rights and duties of general partners between themselves. We think that this is an unnecessary complication in a context where default rules are rarely relied on. Consultees also agreed with our proposal that no further consent requirements should be imposed as default provisions.^[3]
18.5     Under the existing law the consent of all the general partners is required for the appointment of another general partner.^[4] Limited partners have no default rights to consent to such an appointment. Similarly, additional limited partners can be introduced without the consent of limited partners. While the partners in a particular limited partnership may choose to confer on its limited partners wider powers of control over the appointment or introduction of new partners, we saw no need for default rules on this matter. In addition it appears to be the existing law that where a partnership agreement does not permit a general partner to retire, all the partners must consent to his retirement.^[5] We proposed that there should be no further default provisions relating to the rights of limited partners over the admission or dismissal of general partners.^[6] Consultees almost unanimously supported the proposal.^[7]
18.6     We propose to give effect to consultees' views. There seems to be little concern that limited partners should have a role in choosing a general partner. Thus a limited partner who is unhappy with the management of the partnership must either assign his interest or, more drastically, seek the winding up of the partnership. We have already recommended default rules (a) that the consent of the general partner or general partners is required for a person to become a partner and (b) that a majority of general partners should decide differences as to ordinary matters connected with the partnership business.^[8]
18.7     We therefore recommend that it should remain a default rule that the consent of limited partners should be needed for (a) any change to the partnership agreement and (b) any change to the nature of the business and (c) the retirement of a general partner. (Draft Bill, cls 4, 6(4) and 28(1))

Fiduciary duties and other duties

18.8     In a limited partnership it is the duty of the general partner to manage the business. It is important that he should owe fiduciary duties to limited partners who are largely passive investors in the partnership. In theory, the same fiduciary duties apply to limited partners although they are unlikely to be of practical relevance.
18.9     We therefore asked consultees if there should be any statutory qualification to the existing fiduciary duties which a limited partner owes to his partners or the partnership.^[9]
18.10     Consultees were divided in their responses. Many favoured no qualification to the existing fiduciary duties but almost as many thought that it was anachronistic for a limited partner, who is essentially an investor, to be under a duty not to compete. The latter argued that there should not be a duty on a limited partner to account for profits from a competing business.
18.11     A limited partner will normally take no active role in the day to day business and affairs of a limited partnership. Involvement in management will deprive him of the privilege of limited liability. Under our recommended regime a limited partner will be subject to the overarching duty of good faith to which all partners are subject. As the limited partner will normally have only a limited role, the content of that duty will generally be narrower than that owed by general partners. This will be so particularly if the partnership agreement excludes limited partners from participation in certain of the strategic decisions which they otherwise could take without involving themselves in management. In such circumstances the limited partner will be a purely passive investor and the practical scope of the duty of good faith will be very limited. Where a limited partner participates in strategic decisions it is important that he should act in good faith in his decision making. We also consider that certain of the specific fiduciary duties of a partner should not apply to a limited partner unless it is otherwise agreed in the partnership agreement. Investment in a competing business or active involvement in that business should not in many circumstances result in a conflict of interest with his status as a limited partner. We think that there is a case for removing the default rule that a limited partner should account to the partnership for profits from a competing business. We also think that there should not be a default rule requiring him to keep the other partners informed of partnership matters and help maintain partnership records.^[10] If a limited partnership wished to impose such a duty on its limited partners it could always do so. Under the default rules, the limited partner would still owe a duty of good faith to the partnership and the duty to account for private profits derived from, among other things, a transaction affecting the partnership.^[11]
18.12     We therefore recommend that:

(1) In the absence of an agreement to the contrary, a limited partner should not be under a duty to keep the other partners fully informed of partnership matters or a duty to account to the partnership for profits made by him in a competing business; and

(2) In the absence of an agreement to the contrary, a limited partner should not be under duties to ensure that accounting records are maintained and to co-operate with persons keeping partnership records. (Draft Bill, cl 59(1))

Profits and losses

18.13     In the Joint Consultation Paper (LP), we asked consultees whether a revised 1907 Act should provide, in the absence of agreement to the contrary, that a limited partner's share of any losses should be debited against his share (if any) of future profits.^[12] We thought that there might be some advantage in such a provision as it would articulate the difference between partners in a general partnership and limited partners. While both types of partner would, under the default rules, share equally in profits and trading losses,^[13] limited partners do not have to contribute to the firm beyond their capital contributions in order to meet the firm's liabilities to third parties.^[14] Thus during the continuance of the partnership business a limited partner's share of future profits may be reduced by his allocated share of past losses. As there is less need for default rules in relation to limited partnerships than for general partnerships, we made no provisional proposal.
18.14     While some consultees favoured such a provision, there was strong opposition from, among others, the Chancery Bar Association. They and several others thought that the matter could be left to an express partnership agreement. It was suggested that most limited partnerships have agreements which provide that each partner has an account to which partnership losses are debited and partnership profits credited.
18.15     On reflection, while the provision would represent the general understanding of how a limited partnership would operate, we think that there is no need for such a default rule. We therefore do not propose such a provision.

Assignment/assignation by, and retirement of, limited partners

18.16     We proposed that the rights of a limited partner to assign his share should be set out in a single section, generally reproducing the existing law.^[15] In particular we proposed that the rights, liabilities and obligations of the assignee and assignor, following an assignment (assignation) should be expressed in the new section, and that there should be a default rule requiring the consent of all the general partners for an assignment of a limited partner's interest where it involves substitution. We also proposed that, as between partners, consent to the retirement of a limited partner should be left to agreement.^[16] Consultees generally supported these proposals. One consultee argued that the default rule should be that a limited partner may assign his interest without the consent of the general partners. But most consultees expressed satisfaction with the present law.^[17]
18.17     We think that the present law should be re-enacted in a clear way. In clause 36 of the draft Bill we have provided that the assignee of a partner's share may not take part in the management of the partnership business,^[18] but that this provision does not prevent the assignee from becoming a partner in place of the assignor if either all the partners agree to the substitution or the substitution is in accordance with the partnership agreement. This provision, so far as it relates to consent to substitution, requires to be adapted for limited partnerships by substituting the consent of the general partners for the consent of all the partners.
18.18     We therefore recommend that an assignee of a partner's share should be able to become a partner in a limited partnership in place of the assignor if either (a) the general partner agrees to the substitution or, if there is more than one general partner, all of them agree to it, or (b) the substitution is made in accordance with the partnership agreement. (Draft Bill, cl 60(3))

Miscellaneous proposals

18.19     In the Joint Consultation Paper (LP) we discussed the existing rules governing the dissolution and winding up of partnerships.^[19] We did not propose any alteration to the existing rule that the death or bankruptcy of a limited partner does not dissolve the limited partnership.^[20] We proposed no change to the existing default rule that the other partners cannot dissolve a partnership if a limited partner has allowed his share to be charged for his own debts.^[21] This proposal has been altered by our recommendation to allow the expulsion of a partner who allows his share to be charged.^[22]
18.20     We therefore recommend that the power to expel a partner against whom a charging order is made or whose share is arrested in execution should not apply to a limited partner. (Draft Bill, cl 60(2))
18.21     We also expressed the provisional view that the grounds for dissolution of a partnership did not require to be modified for limited partnerships. In the reformed partnership regime which we propose, we describe what is presently called "dissolution" as the "break up" of a partnership. We propose that, in place of the rule in general partnerships that the partnership breaks up if at least half of the partners agree to end the partnership, a limited partnership should break up if the general partner decides, or if there is more than one general partner at least half of them agree, to end the partnership. If there are no general partners, at least half of the limited partners must agree before the limited partnership breaks up. Otherwise the events which break up a partnership which are set out in clause 38 of the draft Bill should apply also to limited partnerships.
18.22     We therefore recommend that a limited partnership should break up (a) if the general partner decides, or if there is more than one general partner at least half of the general partners decide, to end the partnership, or (b) if there are no general partners, at least one half of the limited partners decide to end the partnership. (Draft Bill, cl 61(1))
18.23     We also propose certain rules in relation to the winding up of a limited partnership. As we have said, it is consistent with our approach to the role of the general partner that, in the event of a break up of the limited partnership, the general partner or general partners should have the responsibility for winding up the partnership business and affairs, unless the court orders otherwise.^[23]
18.24     Several rules which apply to partners in a general partnership are appropriate also in relation to both general partners and limited partners in a limited partnership. As a limited partner has an interest in the outcome of a winding up, he should be able to apply to the court for the appointment of a partnership liquidator or a provisional liquidator. Where a liquidator or provisional liquidator is appointed, a limited partner should be under a duty to co-operate with him. In addition, a limited partner should have the right to seek an account and to refer to the court questions arising in the winding up of the limited partnership. A liquidator who wishes to resign should give notice of his intention to do so to the limited partners as well as the general partners.
18.25     There are other provisions where we think that there should be special rules in relation to limited partnerships. Normally, a liquidator should be required to notify only the general partners of meetings which he calls in order to present his accounts. But where a partnership agreement empowers limited partners to participate in decisions relating to the winding up of the partnership and to attend meetings which the liquidator calls, the liquidator should be under a duty to notify the limited partners of such meetings. The liquidator should be under the same duty when there are no general partners.
18.26     In our recommendations in relation to general partnerships, the liquidator or provisional liquidator requires the approval of the partners or the sanction of the court to exercise certain powers, such as the power to carry on the partnership business. We think that the normal rule should be that the general partner or partners should give that approval. But if the partnership agreement provides otherwise or the partnership has no general partners, limited partners should be entitled to take part in the decision to approve the exercise of such powers.
18.27     We therefore recommend that:

(1) The general partner or general partners should have responsibility for winding up the partnership business and affairs, unless the court orders otherwise or there are no general partners; (Draft Bill, cl 61(2))

(2) A limited partner should not have the right to take part in a decision by the partners to approve the exercise by the liquidator or partnership liquidator of powers which require the approval of partners, unless the partnership agreement provides otherwise or the partnership has no general partners; (Draft Bill, cl 61(3) and (4))

(3) Unless the partnership agreement provides otherwise or there are no general partners, the persons entitled to attend meetings to consider the liquidator's annual accounts or final accounts should not include a limited partner, former limited partner or personal representatives of, or insolvency practitioners for, former limited partners. (Draft Bill, cl 61(3) and (5))

Note 1    1890 Act, ss 19 and 24(8).    [Back]

Note 2    Joint Consultation Paper (LP), para 5.6.    [Back]

Note 3    One consultee suggested that there was a case for making the default provisions coincide with those applying to LLPs. We are not persuaded of the need to assimilate the rules of limited partnerships and LLPs as an LLP is far removed from a normal partnership.     [Back]

Note 4    1907 Act, ss 6(5)(d) and 7, 1890 Act s 24(7).    [Back]

Note 5    SeeLindley & Banks, para 31-21.    [Back]

Note 6    Joint Consultation Paper (LP), para 5.11.    [Back]

Note 7    Again one consultee argued for the assimilation of the default rules of limited partnerships with those of LLPs. Another thought that a limited partner required to be confident about the management of the partnership and that there should be default rules about the involvement of limited partners in the appointment and dismissal of general partners.    [Back]

Note 8    See para 16.19 above.    [Back]

Note 9    Joint Consultation Paper (LP), para 5.15.    [Back]

Note 10    See the draft Bill, cls 9(2)(a) and 15.    [Back]

Note 11    See the draft Bill, cl 9(1) and (2)(b).    [Back]

Note 12    Joint Consultation Paper (LP), para 5.19.    [Back]

Note 13    1890 Act, s 24(1).    [Back]

Note 14    See Reed v Young [1986] 1 WLR 649, 655-656, per Lord Oliver.    [Back]

Note 15    At present the default rule for the assignment of a limited partner’s share, leading to his substitution as limited partner by the assignee is that such assignment requires the consent of all of the general partners. See the 1907 Act, s 6(5)(b). The rules for assignment of a partner’s share, without the substitution of the assignee as partner are contained in the 1890 Act, s 31.     [Back]

Note 16    Joint Consultation Paper (LP), para 5.28.    [Back]

Note 17    Consultees almost unanimously supported our proposal to repeal s 10 of the 1907 Act, which requires advertisement in the Gazette when the share of a limited partner is assigned. See para 15.48 above.     [Back]

Note 18    See para 13.17 above.     [Back]

Note 19    Joint Consultation Paper (LP), paras 5.29 – 5.42.    [Back]

Note 20    1907 Act, s 6(2). This has been subsumed in our recommendation that for all partnerships, the death or bankruptcy of a partner does not automatically cause the break up of the firm. See paras 8.101 – 8.110 above.    [Back]

Note 21    Joint Consultation Paper (LP), para 5.36; 1907 Act, s 6(3)(c).    [Back]

Note 22    See para 8.110(6) above and the draft Bill, cl 31.    [Back]

Note 23    See para 16.19(6) above.    [Back]