New hope for foreign investment: the Limited Partnerships Act comes into force

After a long period of consultation and consideration, the Limited Partnerships Act 2008 came into force on 2 May 2008. In this article, partner Anna Buchly explores the key features of limited partnerships under the Act.

In the 1980s, the investment vehicle of choice for many venture capitalists was New Zealand's special partnership structure. Times moved on and, for some time now, special partnerships have been considered too restrictive and outdated.

Through the introduction of the new limited partnership regime, New Zealand's regulatory regime has been bought into line with a number of other jurisdictions.

Limited partnerships are recognised by many as the internationally preferred vehicle for investment into a foreign country for two principal reasons. First, most allow investors to limit their exposure to liability to the amount of their investment. Second, there is usually a corresponding tax regime in place to provide flow-through tax treatment to partners of gains and losses. This allows the foreign investor to recognise those gains and losses in their home jurisdiction.

The nuts and bolts of New Zealand's new limited partnership regime have been assembled by reviewing and adopting the "best practice" from jurisdictions which have had similar regimes in place for some time. These include the United States (Delaware and California), Australia (New South Wales), Jersey, Guernsey and the United Kingdom.

Principal features of a limited partnership under the Act

Status

Under the Act, limited partnerships are treated as a hybrid of a company and a partnership. Limited partnerships are separate legal entities but are transparent for New Zealand tax purposes (like general partnerships).

Subject to the Act, a limited partnership can carry on any business or activity and enter into any transaction and, for the purposes of doing so, the limited partnership has full rights and privileges.

Partners

For a limited partnership to be registered it must be composed of general partners and limited partners. A partnership must have at least one general partner and one limited partner at all times. A person may not be both a general partner and a limited partner of a limited partnership at the same time.

The general partners are responsible for the management of the limited partnership, whereas limited partners are passive investors and are not entitled to take any part in management outside certain specified activities or "safe harbours". The general partner may however change to a limited partner, and vice versa, at any time.

General Partners

A person will become a general partner once their name is entered as general partner on the register of limited partnerships maintained by the Registrar of Companies. Consequently the names and addresses of each general partner are publicly obtainable.

As well as being responsible for managing the particular business of the limited partnership, the general partner has a number of specific administrative responsibilities under the Act. Failure to carry out these responsibilities is an offence, subject to a summary conviction and a fine.

A general partner also has fiduciary duties under the Act, unless these are excluded by the limited partnership agreement. These fiduciary duties mirror the fiduciary duties of partners in a standard partnership under the Partnership Act 1908. In addition, partners in a general partnership have been held to owe each other an overriding duty to observe the utmost good faith and fairness in dealings with each other. Arguably this will also apply to general partners in a limited partnership.

A general partner will be jointly and severally liable with the limited partnership and other general partners for debts and liabilities or for any wrongs or omissions of the limited partnership while that person is in the role of general partner. Unless a limited partnership agreement stipulates otherwise, this liability will be residual and the general partner will only become liable if the limited partnership itself is not able to satisfy the unpaid debts or liabilities.

The general partner has the authority to bind the limited partnership and acts as an agent of the limited partnership for the purpose of business. This authority only extends to where the transaction comes within the business of the limited partnership as determined by the general partners, the Act and the limited partnership agreement. However, the general partner is not an agent of any limited partner or other general partners.

Limited Partners

Like a general partner, to become a limited partner a person's name must be entered on the register of limited partnerships maintained by the Registrar of Companies. However, the details of a limited partner are not publicly available and are subject to strict confidentiality requirements, with only the Registrar being able to search them. This anonymity exists to encourage greater investment in the limited partnership.

A limited partner has no authority to bind the limited partnership and is not an agent of the partnership or any other partner. Further, a limited partner does not owe a fiduciary duty to the limited partnership.

One aspect of the Act which is the subject of some uncertainty provides that a limited partner must not be involved in the management of the limited partnership (the so-called "control rule"). Although management is not defined in the Act, some guidance is provided through the provisions of the Act. The Schedule to the Act lists activities which do not constitute taking part in management of a limited partnership (known as "safe harbours"). These activities can generally be characterised as high-level supervisory or consulting activities, rather than day-to-day management activities.

Where the limited partner does not take part in the management of the limited partnership, the liability of the limited partner is limited to the extent of their contribution to the partnership. However, when a debt or liability to a third party is incurred, a limited partner will be liable to the same extent as a general partner if:

• the limited partner took part in management;

• the third party knew that the limited partner took part in management; and

• the third party believed on reasonable grounds that the limited partner was a general partner.

The limited partner will not have the benefit of residual liability that the general partner has. The limited partner will also be liable to the other partners if the limited partnership suffers loss from the breach. This full liability for any losses incurred creates a substantial risk to the limited partner, although the third party will have to show that it knew that the limited partner took part in management and it believed on reasonable grounds that the limited partner was a general partner. It may be hard to satisfy those conditions.

The limited partners are somewhat protected by the "safe harbours". But these "safe harbours" must be listed in the limited partnership agreement for the limited partners to have the right to participate in them.

Capital contribution and the partnership interest

The Act entitles both general partners and limited partners to make capital contributions to the limited partnership. A contribution is not mandatory and will be subject to the terms of the limited partnership agreement. The capital contribution is the share of the assets contributed by a partner, and the contribution can take any form. However, any loan by a partner to the limited partnership is not a capital contribution.

Upon a capital contribution, a partner has a right to distributions and any other benefit conferred by the limited partnership agreement. This partnership interest will be classified as a participatory security under the Securities Act 1983. Consequently, when an offer to participate as a limited partner is made to the public, that offer must comply with the Securities Act requirements of an offer of participatory securities, and the limited partnership will require a statutory supervisor to be appointed under the Securities Act. This requirement is likely to mean that limited partnerships will be limited to investment vehicles for habitual investors and other investors who would not be considered members of the public.

The right to distributions on the basis of a capital contribution is broadly dealt with under the Act. It could include payment to a general partner to cover costs for the day-to-day running of the limited partnership. As a consequence, it is recommended that the size, manner, and frequency of distributions are dealt with in the limited partnership agreement. The Act requires that a distribution be authorised in writing by each general partner, who must be satisfied on reasonable grounds that immediately after the payment of the distribution the limited partnership will be solvent. A solvency test that must be considered before there can be an authorised distribution is specified in the Act, and is in substance the same as the solvency test of the Companies Act 1993. A partner who receives a distribution, knowing that immediately after the distribution the solvency test would not be satisfied by the limited partnership, is liable to repay that distribution. The period of liability to repay the distribution can be specified in the limited partnership agreement.

A general partner will be responsible for ensuring that financial statements for the limited partnership are completed within five months of the balance date of the limited partnership. The limited partnership will not have to report the prepared financial statements unless deemed an "issuer" under the Financial Reporting Act 1993.

Limited Partnership Agreement

A limited partnership must, upon registration, have a written limited partnership agreement. The agreement has the effect of a contract between the limited partnership, each general partner and each limited partner. The Act requires that certain matters must be provided for in a limited partnership agreement, including:

• any restrictions on assignment or disposal of a partner's partnership interest and the nature of those restrictions;

• any restrictions on the business or other activities of the limited partnership;

• the entitlement of partners to distributions;

• whether and in what circumstances a general partner can compete with the limited partnership;

• when meetings are required and the procedure for meetings;

• how partners can leave the limited partnership, whether a partner can be expelled and how a new partner is admitted; and

• how and when the limited partnership can be terminated.

The limited partnership agreement can provide for other matters, so long as they are consistent with the provisions of the Act.

Any partners entering into the limited partnership after initial registration will be bound by the limited partnership agreement. The new partners may be required to acknowledge this by signing a deed of adherence.

Registration

Setting up a limited partnership is relatively easy. The Companies Office is responsible for administration of the Act and maintaining the electronic register of partnerships. To protect the liability of its limited partners, a limited partnership should not commence trading or incur debt until it is registered. Failure to register may result in the partnership being treated as a standard partnership.

To register the limited partnership, the Companies Office requires a consent form from the general partner and a certificate from the applicant that a limited partnership agreement has been entered into that complies with the Act.

A limited partnership has unlimited duration subject to the terms of its limited partnership agreement and the termination events listed in the Act. To come to an end, it must be deregistered.

Termination and deregistration

A limited partnership will end when it is deregistered on the completion of a winding up or termination. Certain terminating events are outlined in the Act and act as automatic triggers towards dissolution. If the limited partnership wishes to terminate at a specific point it may specify its own terminating event within the limited partnership agreement. Upon a terminating event, the general partner retains limited authority to bind the partnership, and the rights and obligations of the partners will remain only as far as necessary to wind up the limited partnership and complete any unfinished transactions at the time of the terminating event.

Where the limited partnership has no debts or liabilities and the surplus assets have been distributed, it can be wound up by a general partner. However, where debts and liabilities do exist upon a terminating event, the limited partnership can only be wound up by appointment of a liquidator either by a resolution of the limited partnership or by the court upon an application of a general partner, a limited partner, a creditor or the Registrar. The limited partnership will be deregistered when its name has been removed from the register by the Registrar of Companies. Such deregistration may be requested by a limited partner (upon resolution of the limited partnership) or a general partner.

The Registrar can restore a limited partnership to the register on application of either a general partner, a limited partner, a creditor of the limited partnership, a liquidator or receiver of the property of the partnership. The Registrar of Companies must be satisfied that at the time the limited partnership was deregistered it was still carrying on business, was a party to legal proceedings, or was in receivership, or liquidation or both.

Tax considerations

The introduction of the limited partnership regime in New Zealand led the Government to amend the provisions of the Income Tax Act 2007 dealing with partnership taxation. As a result, the Taxation (Limited Partnership) Act 2008 was enacted at the same time as the Act, and deals with tax treatment of both general and limited partnerships. The key changes include:

• clarification of the flow-through taxation approach for partnerships (including limited partnerships);

• no longer any ability to stream different types of income/gain to different partners;

• new rules clarifying the effect of the entry and exit of partners;

• partners are deemed to have the status/intention of the partnership in relation to partnership property; and

• net loss flow-through restrictions will apply to limited partners of a limited partnership. Generally, a limited partner's share of the partnership net loss can only be utilised to the extent of the amount at risk in the partnership.

New regime for overseas limited partnerships Part 3 of the Limited Partnerships Act 2008 also introduces new requirements for overseas limited partnerships which carry on business in New Zealand. This includes a requirement for such overseas limited partnerships to register with the Registrar of Companies and to file an annual return. The Act provides a three month "grace" period for the registration of overseas limited partnerships that were carrying on business in New Zealand prior to the commencement of the Act. All other overseas limited partnerships carrying on business in New Zealand must register with the Companies Office within 10 working days of commencing business in New Zealand. Prescribed forms for registering an overseas limited partnership and for filing an annual return are available online at the Companies Office website. Each annual return must also be accompanied by the relevant additional prescribed form if there are any changes to the partners, addresses or name of the overseas limited partnership. For further information, refer to the new Limited Partnerships website launched by the Companies Office in February 2008 (www.limitedpartnerships.govt.nz).

Enquiries and information

For more information on any of the cases, articles and features in Commercial Quarterly, please email Diane Graham or call her on 64 9 916 8849.