Scottish Law Commission (Reports)

PART XIX

SPECIAL LIMITED PARTNERSHIPS

Introduction

19.1     In this Part we discuss the case for a special form of limited partnership in English law which will not have separate legal personality.

Background

19.2     The background to this proposal is as follows. In the Joint Consultation Paper (LP)^[1] we discussed how, since 1987, limited partnerships have become the standard structure used by venture capitalists not only for the United Kingdom but also for European funds. Scottish limited partnerships, which have separate legal personality, have been used as vehicles for investment in underwriting at Lloyd's since 1997. English limited partnerships (which do not have legal personality) and Scottish legal partnerships have both been used as vehicles for venture capital investment funds. The choice of a limited partnership with legal personality or a limited partnership without legal personality depends on the structure of the proposed investment which in turn will generally be the product of tax planning.
19.3     We have referred^[2] to the increasing competition between jurisdictions to produce business organisations which will be attractive to businessmen who operate internationally and have suggested that the decision of the Court of Justice in Centros Ltd v Erhvervs-og Selskabsstyrelsen^[3] has encouraged jurisdictional competition within the European Union. In the Netherlands, legislation was introduced in December 2002 to establish a public partnership which would give the partners the right to opt either for separate legal personality or to have no legal personality. Guernsey amended its Limited Partnerships Law to allow the partners in a limited partnership to elect that the partnership should have legal personality.^[4]
19.4     Several consultees who responded to the Joint Consultation Paper (LP) voiced concerns about jurisdictional competition and fears that the United Kingdom would be at a competitive disadvantage if it did not modernise its law on limited partnerships as other jurisdictions had done.
19.5     We have discussed with the Inland Revenue our proposal to introduce separate legal personality for partnerships and limited partnerships and have received a statement of their intention to maintain the present tax policy of generally treating partnerships as transparent for tax purposes.^[5] There remains, however, the issue of the treatment of partnerships by overseas tax authorities.
19.6     In their joint consultation response the APP and BVCA suggested that the tax effectiveness of the English limited partnership in the United Kingdom and in most other jurisdictions together with UK expertise were the principal reasons for the United Kingdom's success as a centre of European private equity investment. In order to preserve the benefit of tax transparency overseas, they suggested that a limited partnership should be able to elect to have legal personality or to be an aggregation as in Guernsey.
19.7     We have been greatly assisted by the advice of Mr John Avery Jones, who has, with others, studied host States' characterisation of other States' partnerships for tax purposes,^[6] Mr Ross Fraser, and also representatives of the APP with whom we have had further discussions. It appears that separate legal personality in many jurisdictions is only one factor which tax authorities will take into account in deciding whether a partnership is transparent for tax purposes and that it is rarely determinative of that issue. In certain States, including Belgium and Australia, a foreign body will be taxed as a corporation if it is a legal person in its own country. In certain other jurisdictions, including France and Germany, it appears that the tax authorities would not alter their treatment of a British partnership or limited partnership, if separate personality were introduced.
19.8     We recognise that, if separate legal personality were mandatory, the existence of problems in some jurisdictions and uncertainty as to the response of tax authorities in other jurisdictions could severely restrict the continued use of English limited partnerships as vehicles for investment overseas.
19.9     In order to address this problem we have decided to develop the suggestion of the APP and BVCA and introduce in English law an option to have either a limited partnership with legal personality or a special limited partnership without legal personality.
19.10     We have not recommended the introduction of the special limited partnership in Scots law. Scottish partnerships have separate legal personality and do not offer the tax advantages overseas which are available to aggregate partnerships. The introduction of a partnership without legal personality into Scots law would involve a major reform of Scottish bankruptcy law which is otherwise broadly satisfactory in this area. We consider that it is sufficient, where we are simply preserving the status quo in English law for a specialised form of limited partnership, to have the special limited partnership available in one of the British jurisdictions.
19.11     As some time may elapse between the publication of this report and the introduction of a Partnerships Bill, there will be an opportunity to obtain rulings from overseas tax authorities on the taxation treatment of the proposed limited partnership which has separate legal personality. Some of the uncertainty which surrounds any law reform may therefore be removed. It may be the case that many investors will not need to use the special limited partnership. But the existence of the special limited partnership and transitional provisions which allow existing limited partnerships to re-register either as limited partnerships or special limited partnerships should protect the use of English limited partnerships by the venture capital industry.

Reform recommendations

19.12     As the people who use limited partnerships for private venture capital investment usually prepare detailed partnership agreements to govern the rights and duties of the limited partners and the general partners as between themselves, there is no need to create a specific default code for the special limited partnership. We consider that all that is needed is the adaptation of the provisions of the draft Bill to allow for a special limited partnership which has no legal personality and to set out the rules by which the special limited partnership comes into existence, transacts with third parties and eventually ends.
19.13     At the same time, our recommended reforms in relation to the overriding duty of good faith and the statutory statement of duties of disclosure on joining a partnership^[7] are as applicable to the special limited partnership as to any other partnership as are many default rules, for example, in relation to the sharing of profits and losses and the management of the business.

The aggregate approach to partnership

19.14     Because the special limited partnership will not have legal personality we consider that we should define it as "the relation which subsists between persons carrying on a business together under a partnership agreement".^[8] This accords with the aggregate approach.

Mutual agency

19.15     In accordance with the aggregate approach to partnership the partners require to be the agents of each other for the purpose of the partnership business. But the limited partner in a special limited partnership will have no implied power to bind the special limited partnership.^[9]

Liability of partners

19.16     We consider that it is appropriate to apply the recommended rules as to the joint and several liability of partners and the secondary nature of that liability to the special limited partnership.^[10] Thus, where a partner in a special limited partnership^[11] is liable for a partnership obligation, that obligation may be enforced against him when the amount (or the existence and amount) of the liability has been established in proceedings against the special limited partnership.

Liability through holding out

19.17     We consider that the recommended rules about liability through holding out (including the restrictions on the continuing liability of a former partner) should apply in relation to special limited partnerships as they do in relation to limited partnerships.^[12]

Changes in partners

19.18     We do not propose to apply to the special limited partnership the rules relating to the admission of partners, the grounds on which a person ceases to be a partner and the terms on which an outgoing partner realises his share. These matters can and usually are expressly provided for in the partnership agreement of a limited partnership and are not necessary in a statutory code for the special limited partnership. In addition, there is no need for special provisions on this matter as, under the existing law, where the partners contract for the firm to continue on a change of membership, a partnership undergoes a "technical dissolution" when a partner leaves the firm. In other words, the firm breaks up but is not wound up.

The break up of the special limited partnership

19.19     Because the aggregate approach to partnership is not conducive to continuity of partnership, we consider that there should be simple default rules (which are consistent with the default regime in the 1890 Act) that (a) a partnership of defined duration breaks up if the specified period expires or the venture for which it was formed is accomplished, (b) in the case of any other partnership, a general partner gives notice to the other partners of his intention to break up the partnership, and (c) in the case of any special limited partnership the firm breaks up if a partner dies or (if not an individual) is dissolved. As default rules, these are subject to any agreement to the contrary. In addition, a special limited partnership breaks up if the court pronounces an order breaking up the partnership.
19.20     Because the special limited partnership will not be an entity, there is no need for the concept of dissolution; the partnership relationship will end when the partnership breaks up and no entity holding property will survive. After break up, the special limited partnership would be wound up by its partners or by a partnership liquidator.^[13] Although in many cases a well-drawn partnership agreement will provide for the distribution of the partnership's assets on winding up, we consider that there is a case for retaining the important default rules on this subject. The rules are also relevant to the duties imposed on the partnership liquidator.^[14]

Registration of a special limited partnership

19.21     It is necessary to adapt the registration provisions which apply to limited partnerships. First, the application should be for registration as a special limited partnership and the registration and registration certificate should record that the partnership is registered as a special limited partnership. Secondly, as the special limited partnership will not have continuing legal personality, it should be provided that there is no need to re-register a partnership merely because of a change in the partners. Otherwise, our recommended registration and de-registration regime will apply with minor amendments to the special limited partnership.
19.22     We therefore recommend that in English law there should be a special limited partnership which does not have separate legal personality. (Draft Bill, cl 73 and Schedule 10)

Note 1    Joint Consultation Paper (LP), para 1.4.    [Back]

Note 2    See para 3.30 above.    [Back]

Note 3    Case C-212/97 [1999] ECR I – 1459.    [Back]

Note 4    See the Limited Partnerships (Guernsey) (Amendment) Law 1997. We are not persuaded that the Guernsey model is appropriate as it lacks any provision, for example, as to the way a general partner will be liable for the entity’s debts. Nevertheless, the Guernsey initiative and the recent Netherlands legislation are further evidence of the emergence of jurisdictional competition.     [Back]

Note 5    See para 3.53 above.    [Back]

Note 6    See John Avery Jones and Others, “Characteristics of Other States’ Partnerships for Income Tax” (2002) British Tax Review No 5 375; (2002) 56 Bulletin for International Fiscal Documentation 288.    [Back]

Note 7    Draft Bill, cls 9 and 10.    [Back]

Note 8    Draft Bill, Sched 10, para 3(3). This is consistent with the definition in the 1890 Act.    [Back]

Note 9    This is the same rule as that applied to limited partners in a limited partnership. See paras 16.22 – 16.23 above.    [Back]

Note 10    Draft Bill, cls 23-25.    [Back]

Note 11    This is usually only the general partner.    [Back]

Note 12    Draft Bill, cls 26 and 35.    [Back]

Note 13    Draft Bill, cls 43, 50, 51 and Scheds 4 and 5.    [Back]

Note 14    See the draft Bill, Sched 4, Part 1, para 2.    [Back]