Limited Partnerships - Cengage



Chapter 7

Limited Partnerships:

Managers and Investors Working Together

Introduction

This chapter introduces the limited partnership. Limited partnerships are designed to protect investors from personal liability for the debts and obligations of a partnership business. Investors, who serve as limited partners, do not bear any risk beyond their investment, because they do not participate in the management and operations of the partnership business.

However, as you review these materials, keep in mind that management and control create liability. Thus, if a limited partner participates in the management and control of the business, that person may forfeit his or her limited liability protections.

Lecture Notes

□ Limited Partnership Defined

A limited partnership is an association of two or more persons or entities carrying on business as co-owners for profit with

one or more general partners (managers)

and

one or more limited partners (investors)

Advantages

relative simplicity of organization

limited liability for investors

continuation upon withdrawal or incapacity of limited partner(s)

Disadvantages

unlimited personal liability of general (managing) partners

involuntary termination upon the death, withdrawal, or bankruptcy of one or more general partners, absent agreement for continuation

General Partners

1. manage partnerships

2. personally liable for partnership obligations

Limited Partners = Investors

1. no management/participation rights

2. no personal liability for partnership debts

(Liability is limited to investment in partnership.)

Key: If a limited partner participates in partnership management, he or she loses liability protections.

□ Formation

✓ Register an assumed business name.

✓ File a notice of partnership association, if required by state law.

✓ Obtain the required business or professional licenses and permits.

✓ Draft a comprehensive partnership agreement.

✓ Review taxation filings.

✓ Apply for sales tax permit, if goods will be sold.

✓ Apply for a tax identification number with the IRS, the state, or both.

✓ Establish employee withholding as well as unemployment and workers’ compensation coverage.

Plus, limited partnerships must

✓ Include designation “Limited Partnership” in partnership name.

✓ File a certificate of limited partnership with secretary of state.

✓ Address limited partnership in partnership agreement.

✓ File an application for foreign limited partnership if transacting business in foreign jurisdiction.

➢ Name

Requirements for Limited Partnerships

1. Name must include designation “Limited Partnership”.

Purpose: notifies creditors that not all partners are personally liable for partnership obligations

2. Name may not include surname of limited partner.

Rationale: limits apparent authority of limited partners

➢ Certificate of Limited Partnership

A certificate of limited partnership must be filed with the secretary of state in order for limited partners to have liability protections.

Rationale: The certificate of limited partnership puts third parties (e.g., creditors) on notice of limited liability of limited partners.

□ Taxation

Pass-through taxation

Caveat: Although no taxes are due, partnerships must file an informational tax return with IRS, which is used for tracking the profits and losses assignable to partners.

□ Changes in Partnership Association

➢ Admission of New Partners

General Partners

General partners may be admitted to the partnership by unanimous written consent of all partners. Unanimous consent is required because the admission is a change in management.

Note: This change in partnership association is a dissolution of the existing partnership and the creation of a new partnership.

Limited Partners

Additional investors may be admitted without dissolution.

Rationale: additional capital investments in the partnership without a change in management

□ Termination of Limited Partnership

Limited partnerships may terminate when

1. All partners agree.

2. Partnership agreement has ending date.

3. Duration or purpose of partnership is complete.

4. Court orders dissolution.

5. General partner withdraws or dies.

General Partners

Withdrawal = dissolution

The admission or withdrawal of a general partner is a dissolution of the existing partnership and the creation of a new partnership.

Limited Partners

Withdrawal does not require dissolution, because limited partners are not active participants in the partnership.

Comment: In this way, limited partners are like corporate shareholders (investors).

Answers to Study Questions in Review

1. How is a limited partnership different than a general partnership?

In a general partnership, all partners have the right to participate in the management of the partnership. However, in limited partnerships, there are two types of partners: those who manage (general partners) and those who invest (limited partners).

2. Explain the distinction between a general partner and a limited partner.

A general partner participates in the management of the partnership, and a limited partner invests in the partnership’s business venture.

3. What is a limited partner’s liability for the debts and obligations of the partnership?

A limited partner’s liability for partnership obligations is limited to the amount of his or her investment in the partnership.

4. How does a partnership notify the public of its status as a limited partnership?

The partnership name must include the designation “Limited Partnership.”

5. Does a limited partnership dissolve automatically if a limited partner leaves?

No. The withdrawal of a limited partner generally does not cause the dissolution of the partnership, because limited partners are not involved in the management and operations of the partnership.

6. Can a limited partnership continue if a general partner withdraws? Explain your answer.

Yes. The Revised Uniform Limited Partnership Act provides that a limited partnership can continue after the withdrawal of a general partner if (1) the partnership agreement provides for the continuation of the partnership or (2) if the partners agree in writing, within 90 days following the withdrawal, that the partnership will continue.

7. What does it mean for a partnership to “wind up”?

The winding up of a partnership is the termination of its business. Before the business can end, the business must liquidate its assets, pay its creditors, and distribute any remaining partnership assets to the partners.

8. Is a limited partnership required to notify the secretary of state of its termination?

Yes. Limited partnerships are creatures of statute and are created by filing a formal notice of their existence and are terminated by canceling their limited partnership certificate.

9. Can a limited partnership use the same partnership agreement as a general partnership?

No. A limited partnership agreement should contain additional provisions regarding the rights and duties of the limited partners.

10. What types of businesses should consider forming limited partnerships?

Businesses that require a lot of investment capital (e.g., real estate leasing) but do not have significant liability concerns should consider forming limited partnerships.

Answers to Case Studies in Review

1. Ashley and Rebecca own a small floral shop known as Daisy’s Bouquet. They became business partners two years ago when they opened their shop in downtown San Francisco. The shop was an instant success and a favorite of the Embarcadero businesses. Ashley’s parents always knew that their daughter had great artist talent, so when she asked them for financial backing for her business, they were happy to provide it. Ashley told her parents that they wouldn’t need to be involved in the business; in exchange for their investment, she offered to pay them 25 percent of the business’s monthly receipts. Ashley’s parents don’t participate in her business, although her mother often stops by to order flowers. Ashley and Rebecca have never made any formal arrangements with Ashley’s parents. Are Ashley’s parents limited partners in this partnership? Explain your answer.

No. In order for a limited partnership to be created, the partnership must apply or register its status with the secretary of state. This puts the state, and theoretically the public, on notice that all of the partners do not have the authority to make management decisions for the partnership.

2. Five years ago, David and Stephen started a children’s book publishing company. In order to start up their business, they needed $50,000.00. Although both David and Stephen had a lot of publishing know-how, neither one had any money in the bank. David asked his best friend, a Hollywood producer, to invest in his business idea. His friend gave David the entire $50,000.00 to start the publishing company, on the condition that his name be listed first in the partnership’s name. David asks your firm, which is preparing the partnership agreement, for advice on his friend’s request. What would you tell your advising attorney regarding this matter?

The name of a limited partnership generally may not contain the surname of a limited partner. Therefore, it would not be appropriate for David to agree to include his friend’s name in the partnership’s name.

Project Applications

Jason Ice and his friend Carsey Cavern want to open an ice-skating rink in their hometown. Jason and Carsey own the building—worth $25,000.00—for the ice rink, but they need additional financial backing. The friends convince the owner of a local hotel and restaurant located near the ice rink that his business would increase if they opened an ice rink. The owner agrees with Jason and Carsey and agrees to contribute the remaining $75,000.00 needed for the opening of the ice rink to be called the Ice Cavern, located at the hottest mall in town—Southfront Mall, Anytown, (your state) 55555. The owner deposits the money into Jason and Carsey’s bank, First Mountain Exchange, 789 Brooks, Anytown, your state) 59801. They don’t have an accountant to handle the books, but they think that they are going to hire Carsey’s sister, Barbara. In exchange for his investment, the hotel manager wants the partnership agreement to reflect that he is to receive 35 percent of the net receipts from the rink.

Your supervising attorney has asked you to prepare the limited partnership agreement for Jason and Carsey. The file contains the following:

Jason Ice Carsey Cavern

987 Bitterroot Drive 789 Seven Mile Road

Anytown, (your state) 59833 Anytown, (your state) 59833

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