A Brief Note on Limited Partnership (LP), Limited Liability Partnership (LLP)and Limited Liability Company (LLC)
I Background : The Limited Partnership (LP), Limited Liability Partnership (LLP), Limited Liability Company (LLC) are alternative structures for business association that has gained wide acceptance internationally. These structures are commonly used by Venture Funds, as well as by professional services firms (legal, accounting, medical professions) and small businesses. The objective of this note is to outline these structures and their benefits and suggest a framework for implementation in India. While this note is oriented towards Venture Fund operations, the structures would similarly be applicable to other businesses.
II Present Environment : Under the existing regulations, the Trust and Limited Company formats are two alternative structures permissible for establishment of Venture Funds. Both these structures have constraints, with respect to operations of Funds, as well as taxation.
Venture Funds are essentially vehicles that pool long term capital from institutional investors. Typically, specialist asset management companies manage Funds, and investors do not take an active part in the operations. They however, establish prudential norms for Fund investments, as well as procedures for monitoring. The Fund corpus is invested in a portfolio of securities, primarily unlisted, with the objective of divesting over an extended period, and providing capital appreciation to investors
III Need for Alternative Structures : Venture Fund operations have certain specific characteristics that need to be addressed within the structure of the Fund :
(1) Different Classes of Investors : Typically, most Investors are passive, in the sense they do not participate in Fund operations. However, the Fund Manager(s) play an active role, and generate value through productive activities. These roles need to be differentiated with respect to the investors and managers respective shares in Fund profits / losses. Even among passive investors, there could be several classes, relating to entry and exit timing and voting rights.
The ability to have different classes would also allow investors the ability to participate in Fund transactions on a selective basis. Given that venture investors typically are large institutions with varying investment policies and investment timeframes, the ability to segregate fund interests would provide much needed flexibility to attract and accommodate a number of investors into one Fund entity
(2) Limited Liability : Given that most investors are passive, and participate primarily for capital gain, it is important to provide a structure wherein each investors liability is restricted to the amount committed upfront. From this perspective, it is important to provide a corporate personality to the Fund structure
(3) Operational Flexibility : The structure must provide for a wide variety of investment instruments, risk assumptions, rights and obligations among investors. A Venture Capital provider requires the operational flexibility to protect its interests during the investment and divestment process, as well as to allocate returns and risks among co-investors, in an agreed manner. Since such issues would necessarily be specific to each case, the structure must provide flexibility to define the operating norm on a case to case basis, albeit within an overall uniform regulatory framework. Such flexibility is available in the internal organisation of a partnership
(4) Taxation : The Fund structure essentially provides a vehicle for pooling interests of a diverse pool of investors. Each investor understands the risk return equation in relation to its own taxation status. For example, multilateral institutions such as IFC and ADB individually enjoy tax exemption under the respective treaties, but are taxed with respect to their share of gains in a Fund. This provides a disincentive for such agencies to invest through Funds, vis a vis direct investment in larger projects. It is therefore desirable to adopt a structure that is transparent to taxation, and allows taxation in the hands of investors at their respective tax rate.
Under the present regulations, investors are able to achieve tax transparency by basing Funds offshore, in locations such as Mauritius. This not only drives capital offshore, but also places domestic Funds at a serious disadvantage vis-a-vis taxation. Provision of a tax transparent structure within India could therefore help multiply domestic venture funding several fold .
IV Implementation : A broad outline of the modifications that may be required to existing regulations, for implementation of the LP/LPP /LLC structure is as under:
LIMITED PARTNERSHIP (LP)
Origin
The concept of limited partnership has been designed after the Uniform Limited Partnership Act (hereinafter referred to as the U.L.P.A.) which has now been adopted by most states in the U.S. Most states have also adopted the Revised Uniform Limited Partnership Act (hereinafter referred to as the R.U.L.P.A.) which has amended some portions of the U.L.P.A.
Definition
A limited partnership is defined as a partnership formed by two or more persons, having as members one or more general partners and one or more limited partners. The general partners are personally liable for the debts of the partnership, have the power to act on behalf of the partnership, and have control over the partnership. On the other hand, the limited partners, generally do not participate in control, do not have the power to act for the partnership and are not personally liable for the debts of the partnership.
Limited Partnership : The key requirements outlined above point to the need for a structure, that combines the limited liability corporate format with the operational flexibility of a partnership. The Limited Partnership (LP) structure can be adopted to satisfy these requirements. While there are several variants of the LP structure in usage, we have outlined below the key attributes of a model LP structure, as defined under the Laws of the State of Delaware in the United States
(1) Nature of Business : A LP may carry on any lawful business, with the exception of writing insurance policies or accepting insurance risks, or banking
(2) LP Agreement : An LP agreement, executed among the members, defines all the affairs of the LP, and stipulates the manner of conducting its business. Since each agreement is specific to the group of members of a particular LP, it provides for maximum flexibility in operations
(3) Classes of Members, Managers or LP interests : An LP agreement may provide for designated classes of members, managers or interests, having separate rights, powers or duties with respect to the assets, liabilities, profits and losses of the LP. The interest of each class of member may be restricted to the extent defined in the LP agreement, and may have a separate business purpose or investment objective
(4) Limited Liability : The liabilities and obligations of each member are restricted to their share of interest, as defined in the LP agreement. Collectively, the liability of all members is restricted to the total assets of the LP. However, a member or manager may, under the agreement, agree to be obligated personally for all the liabilities of the LP, or of one or more Class of members
(5) Voting Rights : An LP agreement may grant to all or certain identified members the right to vote separately or with a class of members. Voting may be on a per capita, number, financial interest, class, group or any other basis
(6) Manager(s) : A person may be designated as a manager of the LP. The Manager may be chosen / replaced by Members, in a manner defined in the LP agreement. A Manager may make contributions to the LP and share in the profits or losses or distribution from the LP, as a member
(7) Form of Contribution : The contribution of a member to the LP may be in the form of cash, property or services rendered, or an obligation to contribute cash or property or perform services
(8) Allocation of Profits and Losses : The profits and losses are allocated among members in the manner provided in the LP agreement. If the agreement does not so provide, these are allocated on the basis of the agreed value (as stated in the accounts of the LP) of the contributions made by each member, to the extent they have been received and have not been returned
(9) Allocation of Distributions : Distributions of cash or assets of an LP shall be allocated among members, as defined in the LP agreement. If the agreement does not so provide, these are allocated on the basis of agreed value of contributions, as above
(10) Limitation on Distributions : An LP shall not make a distribution to members to the extent that after making the distribution, the third party liabilities of the LP exceed the fair value of its assets
(11) Dissolution : An LP shall stand dissolved, and its affairs wound up as per the time specified in the LP agreement, or on the occurrence of events specified in the agreement
(12) Tax Transparency : For taxation purposes, an LP is treated as a Partnership, wherein the members are individually liable for taxation, to the extent profits / losses are allocated against their interests
Limited partnership vis-à-vis general partnerships
In a general partnership the liability of all partner is unlimited. Each and every partner is jointly and severally liable for the partnership’s undertakings and is also personally liable for the total amount of any debts of the partnership that has not been satisfied from the assets of the partnership.
In a limited partnership, though the liability of the general partners is unlimited and is the same as that of a partner in a general partnership, the liability of the limited partners is limited. In states which have adopted the U.L.P.A., the limited partners have the right to vote on certain matters, so long as they do not participate in the control of the business. This is because if a limited partner participates actively in the control of the partnership beyond the powers granted to him, he will be deemed to be a general partner.
Assignment of interest of limited partner
The interest of the limited partner in the capital and the profits of the partnership is assignable. Under the U.L.P.A., the assignee can only receive the assignor’s share of his profits or other compensation in the form of income or the return of his contribution, but he does not have the right to become a substituted partner.
On the other hand, under the R.U.L.P.A., the assignee can become a substituted partner subject to the partnership agreement.
Process of registering as an LP
In order to form an limited partnership, a certificate of limited partnership must be executed and filed in the office of the Secretary of State in the state where the partnership is based.
The certificate has to contain certain details regarding the partnership, such as the name of the limited partnership, the general nature of the business undertaken by the partnership, etc.
Taxation
A limited partnership is generally taxed as a partnership in the U.S. In the U.S., only the partners are taxed and not the partnership firm.
Term
A limited partnership is dissolved under similar circumstances under which a general partnership is dissolved such as death of one of the partners, etc.
LIMITED LIABILITY PARTNERSHIP(LLP)
Origin
The first LLP Statute (LP Statute was enacted in Texas in 1991. The statute was basically enacted in response to the liability that had been imposed on partners in partnerships that had been sued by government agencies in relation to massive savings and loan failures in the 1980s.
This statute protected partners from personal liability for claims related to another partner’s negligence, error, omission, incompetence or malfeasance. It also limited permanently, the personal liability of a partner for the errors, omissions, incompetence or negligence of the partnership’s employees or other agents.
As of today, as many as 21 states have enacted LLP statutes.
Definition
LLPs have been defined as a form of general partnership that provides an individual partner protection against personal liability for certain partnership obligations.
LLP vis-à-vis general partnership
Though a LLP is quite similar to a general partnership, there is one important difference between the two. In the case of general partnerships, individual partners are liable for the partnership’s debts and obligations. However in an LLP the individual partners are protected against personal liability for certain partnership obligations.
Liabilities of the partner’s in LLPs
The limitation of a partner’s liabilities varies from state to state. For instance, some states provide protection only against tort claims and do not protect the partner from liability with respect to his/her own negligence or incompetence or to the extent of the partner’s involvement in the wrongful conduct. On the other hand, some states like Minnesota, provide expansive protection against contractual claims brought by the creditors of the partnership.
In North Carolina a partner in an LLP is jointly and severally liable for the acts and obligations of the partnership. However a partner’s liability is limited to the extent the professional malpractice does not involve that partner.
However, the LLP statute enacted by Minnesota in 1994 further provides that a partner in an LLP is personally liable to the partnership and other partners for any breach of duty. A creditor is allowed to pierce the limited liability shield of a partner in a manner which is similar to the manner in which a creditor is allowed to lift the corporate veil of a company and sue an individual member of the company.
Process for registering as an LLP
In states that have enacted LLP statutes, a partnership is recognised as an LLP if it is registered with the appropriate state authority and fulfils certain requirements. All states also require that a partnership which wishes to be recognised as an LLP must include the words "registered LLP" or the abbreviation LLP in its name.
For instance, in the state of North Carolina, a partnership is recognised as an LLP if it files the appropriate form with the Secretary of State by paying the filing fee. Also the words "registered limited liability partnership" or the abbreviation "LLP" must be added to the business name of the partnership. The registration has to be renewed annually for the partnership to continue to be treated as an LLP.
Partnerships that can register as an LLP
Any general partnership can register as an LLP after completing the above mentioned formalities.
Even a partnership that renders specific professional services may form an LLP and register as a professional limited liability partnership (PLLP). A PLLP is generally the same as an LLP except that it is an association solely of professionals. Every state specifies certain qualifying professions which can form PLLP’s. This form is generally available to attorneys, doctors, engineers, etc.
Taxation of an LLP
An LLP is generally taxed as a partnership in the U.S. In the U.S., only the partners are taxed and not the partnership firm.
Term of an LLP
The term of an LLP is similar to that of a general partnership.
Liquidation of an LLP
There are different ways to terminate an LLP under the different state LLP legislations. For instance, under the partnership laws of the state of North Carolina, in order to liquidate a partnership, the following must be done:
Origin
The first LLC law became effective in New York. The New York statute is flexible and allows an entity to determine the liability, tax, membership and management structures of the organization. As of today, 17 states in the U.S. including Delaware have LLC statutes.
Definition
An LLC is also referred to as the statutory partnership association and is a relatively new entity in the U.S. An LLC (if structured properly) has the benefits accorded to a limited liability corporation as well as the tax benefits of a partnership.
LLCs vis-à-vis other companies
The only difference between an LLC and any other company is that an LLC in addition to the limited liability enjoyed by the company also enjoys the tax benefits (in the U.S., only the partners are taxed and not the partnership firm) accorded to a partnership.
Liability
As mentioned earlier, the LLC offers the limited liability of a company with the tax benefits of a partnership, if it is structured properly. The liability of members is thus restricted to their capital investments. It gives the investors the opportunity to participate actively in the business, like general partners in a partnership.
Registration
In most states the LLC law requires that the company must file a statement setting forth all the information concerning the company that might interest the creditors, with the Secretary of State in the U.S. The minimum capitalization requirements for LLCs vary from state to state.
Taxation
The LLC would be accorded the tax benefits that are accorded to a partnership in the U.S. In the U.S., only the partners are taxed and not the partnership firm.
One of the biggest advantages of carrying on business through this entity is the avoidance of taxation at two-levels, that is at the hands of the company and at the hands of the members. The LLC is considered to be a "pass-through" entity as the income of the company "passes-through" to the members and is taxed only after it has been distributed to them. However, in order to obtain these benefits, the LLC must be structured in a manner resembling a partnership, rather than a company. For instance, the transferability of the member’s interest could be limited instead of making the interests freely transferable.
Term
The duration of an LLC’s existence is limited by statute, but it may
be renewed after complying with the required formalities.