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Understanding the partnership structure (part 2): the limited partnership.

In the last issue, we examined the legal structure of a general partnership. We noted that the partners in a general partnership are jointly and severally liable for the debts and obligations of the partnership. Moreover, in the case of individual partners, their personal assets could be used to satisfy those debts and obligations.

In this issue, we look at a special type of partnership arrangement known as a limited partnership. A limited partnership is special because, unlike a general partnership, a limited partnership grants limited liability to a certain class of partners. Those partners are called the limited partners. Together with the general partner (or general partners), they comprise the two classes of partners in a limited partnership.

In a limited partnership, only the general partner does not have limited liability. That means that a general partner is not only personally responsible for the debts and obligations of the limited partnership, but that recourse can be had to the general partner's personal assets for purposes of satisfying those debts and obligations.

At the same time, however, only the general partner is legally allowed to conduct the business of the limited partnership or contribute services to it. A limited partner cannot do either of these things. If a limited partner does become involved in the operation of the business or contributes his or her services to it, he or she loses the limited liability status under the law.

As you might expect, setting up a limited partnership is not as easy as setting up a general partnership.

To begin, a limited partnership -- unlike a general partnership -- does not simply arise when two or more persons carry on business with a view to profit. To set up a limited partnership, you must comply with the relevant legislation. Among other things, that means you must file the appropriate documentation with the appropriate governmental authority.

You should also enter into a written partnership agreement to provide for the rights and obligations of the various parties, especially regarding matters such as the division of the partnership profits. In the absence of an agreement, the partners' relation will be governed by legislation and the common law.

As noted, every limited partnership is made up of some combination of general and limited partners. Those partners can be individuals or corporations. A typical limited partnership arrangement involves a general partner, usually a corporation, which carries on the business of the partnership, and several limited partners all of whom, generally speaking, function as little more than passive investors.

The general partner is usually a corporation because the limited liability associated with incorporation can be used to offset the unlimited liability of a general partner.

Remember: the general partner conducts the business of the limited partnership. Thus, where the general partner is a corporation, it means that the directors of the general partner are ultimately responsible for the conduct of that business. Of course, the directors can be made up of the same people (or some of them) who are limited partners, thereby placing some control over the limited partnership business back into the hands of the limited partners; but, as you can see, things begin to get complicated, especially where issues of limited liability arise.

The advantages of a limited partnership include the following:

* The limited liability associated with being a limited partner. As a limited partner, your liability is limited to the extent of your contribution to the partnership; and

* As a limited partner, you can be involved in a business enterprise as a passive investor. The actual operation of the partnership business is left to someone else.

The disadvantages of a limited partnership include these:

* Setting up and maintaining a limited partnership can be an expensive and time consuming process; and

* To retain your limited liability status you cannot take a role in the operation of the business of the limited partnership.

Thus, a limited partnership is the ideal form of business association for a passive investor in a business enterprise who is willing to relinquish control over the business in exchange for the right to invest in that business on a limited liability basis. This can occur, for example, where three individuals, two of whom have money available for investment purposes, and a third who is skilled in the art of theatre production, wish to produce a musical.

Nishan Swais is a lawyer with the firm of Miller Thomson in Toronto, Ontario.
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Author:Swais, Nishan
Date:Jun 1, 1999
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