Overview
Determining the type of legal structure a business will adopt is one of the most important considerations when establishing a business. This article provides a general overview of the Limited Partnership structure.
In Manitoba, there are three common business structures: sole proprietorship, corporation, and partnership. Each structure has its own benefits and limitations. A limited partnership (LP) is a unique form of partnership that integrates certain attributes from corporate and partnership law.
A limited partnership is an entity created under and regulated by The Partnership Act (Manitoba) (the Act) and registered pursuant to The Business Names Registration Act (Manitoba) (the BNRA).
Similar to an ordinary partnership, an LP must be formed by at least two or more persons. However, an LP consists not only of at least one “general partner” but also one or more persons referred to as “limited partners” whose liability for the debts of the partnership is limited.
Therefore, an LP can provide limited partners with a degree of liability protection which is typically associated with corporations. While limited liability is often attractive to business owners, several other factors must be considered to determine whether this legal structure is suitable for your business and its owners.
Limited Liability
Generally, the limited liability afforded to an LP’s limited partners comes at the cost of taking a more passive role in the management of the partnership.
Similar to an ordinary partnership, general partners of an LP (if more than one) are jointly and severally responsible for the debts and obligations of the partnership. All actions in relation to the LP may be brought against the general partner(s) in the same manner as if there were no limited partners.
Limited partners contribute a specific or determinable amount to the partnership, typically in money or property, as capital of the partnership. A limited partner’s liability for the debts of the LP is typically restricted to this “contributed capital” — akin to a shareholder of a corporation, whose losses are typically limited to their investment. This characteristic of the LP structure shields a limited partner’s other assets from seizure to cover debts that surpass their investment. Nonetheless, it is important to note that this limited liability is not absolute.
Limited partners risk losing the liability protection in the event that they take an active role in the business. In some jurisdictions, limited partners risk losing limited liability where they take part in the control of the business to an extent that is not sanctioned under the equivalent partnership statute. In Manitoba, the provisions are somewhat more lenient, which incentivizes out-of-province businesses to form an LP in Manitoba.
If a limited partner in a Manitoban LP takes an active part in the business, they will risk becoming liable to a third party if that person does not know that they are a limited partner acting on behalf of the LP. This liability exposure extends only to liabilities incurred from the initial interaction with the third party until the time that the third party acquires actual knowledge that they were dealing with a limited partner. As such, limited partners can take both proactive and reactive measures to minimize liability exposure. A carefully drafted partnership agreement can assist limited partners in managing risk by, for example, dictating when and how the identity of limited partners should be disclosed to third parties dealing with the LP.
Beyond the management activities of limited partners, there are other circumstances in which a partner’s limited liability status may be lost, including where the LP’s name includes all or part of a limited partner’s name or where a false statement is made in the LP’s declaration under the BNRA.
Formation, Maintenance and Dissolution
A limited partnership is a creature of statute. As such, adherence to the statutory requirements for the formation and maintenance of an LP is essential to preserve its “limited” status.
A partnership does not become a limited partnership until a declaration has been created and registered under the BNRA. For LPs, this declaration must include the name and usual place of residence or the registered office of each general and limited partner, as well as the amount of capital contributed by each limited partner. The partnership is required within the prescribed time frame to renew or, when certain changes occur (e.g., increase or decrease in the capital contribution of limited partners), amend the declaration. Until such time that the declaration is registered or renewed as required, the partnership is deemed to be carrying on business as a general partnership (i.e., without limited liability). Similarly, an LP must register a declaration in order to dissolve the LP; however, the declaration may only be registered after a notice of intention to dissolve the partnership has been publicly disseminated in accordance with the BNRA.
Given the complexities of the LP structure and filing requirements, it is imperative that partners of an LP have a thorough understanding of their legal rights and obligations. Most importantly, the LP must duly maintain its books, records and filings, or engage a professional for that purpose, to ensure the LP’s ongoing compliance with the Act and the BNRA at every stage of the LP’s lifespan.
Management
Although the Act provides general parameters respecting the relationship between general and limited partners, it provides limited guidance for many significant aspects of a partnership’s operations.
The Act provides that typically only a general partner of an LP is authorized to bind the partnership. Subject to the specific terms of the LP’s partnership agreement, a general partner will be responsible for resolving issues related to ordinary business matters and will have the right to introduce new partners to the LP without requiring the consent from existing limited partners.
While a general partner retains the primary control and management authority within an LP, they remain accountable to all partners for their management decisions and actions. Additionally, all limited partners retain the right to advise as to the management of the partnership business, access the partnership’s books, and inquire into the state and progress of its operations.
As there is limited guidance under the Act, partnerships of all kinds often rely on partnership agreements to define and clarify the rights and obligations of the partners. An agreement can place restrictions on the ability of limited partners to transfer their interests, stipulate decisions which require the approval of limited partners, determine the allocation of profits and losses, and/or impose restrictions on the return of capital contributions. It is essential that an LP’s partnership agreement is carefully drafted in order to address the unique interests and priorities of the partners and the business and to effectively minimize the limited partners’ exposure to liability.
Contribution, Returns and Tax
A limited partnership can be an appealing investment vehicle for its limited partners.
A limited partner may be entitled to receive annual interest on their capital contribution as well as share in profits of the LP. Pursuant to the Act, a limited partner has the right to demand the return of any part of their contribution if the LP is dissolved, six months' notice in writing is provided, all of the partners consent, or as otherwise provided in the partnership agreement. In addition to their capital contribution, a limited partner may also become a creditor of the LP — which may produce interest income. However, in the event of the LP’s insolvency or bankruptcy, the Act prohibits all partners, under any circumstances, from claiming as a creditor until the claims of all the other creditors of the limited partnership have been satisfied.
Income taxes are calculated at the partnership level, but the partnership itself is not taxed as a separate entity. Therefore, an LP is considered to be a flow-through entity, allowing income, losses, and credits to pass directly to the individual partners according to the law, their partnership interest, and any existing partnership agreement. Partners should be aware that the Income Tax Act (Canada) imposes specific restrictions on LPs, including limitations on how limited partners may deduct losses from their income. For personalized guidance on the tax implications of LPs or other tax-related matters, we encourage you to contact a member of Fillmore Riley LLP’s Taxation Practice Group.
Fillmore Riley LLP’s Business Law Practice Group
This article provides a high-level overview of some of the key considerations for business owners when assessing whether a limited partnership aligns with their organization’s needs. If you are considering the suitability of a limited partnership structure for your business or for more information on other business-related matters, please contact a member of Fillmore Riley LLP’s Business Law practice.