Private fund limited partnerships: a new vehicle for investment funds
Thursday, 20th April 2017
In order to maintain the UK’s leading position as the domicile of choice for private investment funds in Europe, the government has recently created a new class of limited partnerships – private fund limited partnerships (PFLPs) – which are subject to a simplified regulatory regime.
The distinctive characteristics of PFLPs are as follows:
- A PFLP must be a collective investment scheme which is governed by an agreement in writing.
- It is not necessary for a limited partner in a PFLP to make a capital contribution to the firm.
- The limited partners of a PFLP may appoint a third party to wind up the firm if there is no general partner available to do so.
- Certain duties under the Partnership Act will not apply to PFLPs unless the partners so choose.
- A whitelist sets out a number of actions which limited partners in a PFLP may take without being regarded as taking part in the management of the firm and so losing their limited liability status.
- A PFLP does not need to file at Companies House a change to the general nature of the business, the term or the character of the partnership, nor (with certain exceptions) does it need to file notice of any sum contributed by a limited partner.
- An arrangement or transaction under which a limited partner’s share in a PFLP will be assigned to another person does not need to be advertised in the Gazette.
It is likely that new investment funds will be structured as PFLPs, rather than as ordinary limited partnerships, in order to take advantage of the new regime. Existing limited partnerships used for private investment funds may choose to be designated as PFLPs if they so wish.
Background: limited partnerships and investment funds
Limited partnerships were created by the Limited Partnerships Act 1907. Like an ordinary partnership, a limited partnership must be formed between two or more persons and carry on a business in common with a view of profit.
Unlike ordinary partnerships, however, limited partnerships have two categories of partner: general partners and limited partners. General partners are responsible for managing the firm’s business, have unlimited liability for its debts and obligations, and have authority to bind the firm. Limited partners, on the other hand, contribute capital to the firm and have limited liability up to the amount of capital they have contributed, but may not take an active role in the firm’s management.
Limited partnerships are required to register at Companies House. Unlike limited liability partnerships (LLPs), however, English limited partnerships are not incorporated, and so do not have separate legal personality. Limited partnerships are subject to few filing requirements; in particular, they are not required to publish their accounts.
In recent decades, limited partnerships have become widely used for private equity and venture capital funds; it was estimated in 2003 that about 64% of English limited partnerships were used as investment fund vehicles.
The limited partnership structure has several advantages for investment funds. It allows investors to participate, as limited partners, without taking an active role in fund management; the limited partners benefit from limited liability; the accounts and any limited partnership agreement are not made public; and limited partnerships are transparent to tax, so that each limited partner is taxed directly.
Private equity and venture capital funds typically have a rather complex structure. As well a general partner (usually a limited company or limited liability partnership), which will be responsible for running the limited partnership, there may also be a managing partner to manage the firm’s investments.
The investors, who will be limited partners, usually contribute funds to the partnership by way of interest-free loans. Because capital contributions made to a limited partnership cannot be withdrawn until the limited partnership is wound up, a limited partner’s capital contribution will often be purely nominal (perhaps £1). The partners’ interest-free loans will be repaid, along with a distribution of any profit, when the firm disposes of an investment in a target company.
The sponsors and managers of the fund typically receive a share in the fund’s profits by way of a carried interest in the fund; this may be paid to a carried interest partner, often itself a Scottish limited partnership of which the sponsors are partners. (Unlike English partnerships, Scottish partnerships, including limited partnerships, have legal personality, and so a Scottish limited partnership can be a partner in an English limited partnership, whereas an English limited partnership cannot.)
Comparable fund structures are found in other jurisdictions, including the Channel Islands and British Overseas Territories, the United States, Luxembourg and France.
Reasons for the reform
Despite considerable growth in the use of limited partnerships, the Limited Partnerships Act has seen little amendment since its enactment in 1907. As a result, certain of its provisions did not reflect the needs of modern investment funds.
Other jurisdictions, including the Channel Islands and Luxembourg, have recently introduced reforms to ensure that private funds can be structured efficiently and avoid unnecessary administrative burdens and costs. There was therefore a risk of the UK ‘becoming a less attractive domicile for funds when compared to other jurisdictions’, as HM Treasury put it in its consultation on the draft legislation to create private fund limited partnerships in July 2015.
The government has therefore simplified the regulatory regime as it applies to private fund limited partnerships. The intention is ‘to eliminate many of the uncertainties and inconveniences associated with existing UK limited partnership law’ so as ‘to ensure that the UK limited partnership remains the market standard structure for European private equity and venture capital funds as well as many other types of private fund in an increasingly competitive global market’.
The plan to consult on changes to partnership legislation applicable to funds was first announced in the 2013 Budget as part of the investment management strategy, a package of measures to improve the UK’s competitiveness. After informal consultation with the Investment Association and British Venture Capital Association, a formal consultation on draft legislation was launched in July 2015. A summary of consultation responses was published in March 2016, and the proposed Order and an explanatory document were published in January 2017.
Following review by the House of Commons Regulatory Reform Committee, the Legislative Reform (Private Fund Limited Partnerships) Order came into force on 6 April 2017. Made under the Legislative and Regulatory Reform Act 2006, the Order amends the Limited Partnerships Act 1907 and makes some consequential amendments to other legislation.
Private fund limited partnerships
The Limited Partnerships Act, as now amended, provides that a limited partnership may be designated as a private fund limited partnership (PFLP) if it is constituted by an agreement in writing and is a collective investment scheme, defined in section 235 of the Financial Services and Markets Act 2000 (FSMA) as follows:
‘(1) [… A] “collective investment scheme” means any arrangements with respect to property of any description, including money, the purpose or effect of which is to enable persons taking part in the arrangements (whether by becoming owners of the property or any part of it or otherwise) to participate in or receive profits or income arising from the acquisition, holding, management or disposal of the property or sums paid out of such profits or income.
‘(2) The arrangements must be such that the persons who are to participate (“participants”) do not have day-to-day control over the management of the property, whether or not they have the right to be consulted or to give directions.
‘(3) The arrangements must also have either or both of the following characteristics—(a) the contributions of the participants and the profits or income out of which payments are to be made to them are pooled; (b) the property is managed as a whole by or on behalf of the operator of the scheme.
‘(4) If arrangements provide for such pooling as is mentioned in subsection (3)(a) in relation to separate parts of the property, the arrangements are not to be regarded as constituting a single collective investment scheme unless the participants are entitled to exchange rights in one part for rights in another.’
The exceptions under section 235(5) of FSMA do not apply to the definition of a collective investment scheme for the purpose of designating a limited partnership as a PFLP, and so it is unnecessary to consult the Orders made under that subsection.
Only private investment funds may be PFLPs. The PFLP structure is not available to partnership schemes that are authorised to be promoted to retail customers under Part XVII of FSMA.
Designation as a private fund limited partnership
Any existing limited partnership that meets the criteria that it is constituted by an agreement in writing and is a collective investment scheme (the private fund conditions) may apply at any time to the Registrar of Companies for designation as a PFLP using form LP8 and paying a fee of £10. The form must be signed or otherwise authenticated by or on behalf of each general partner to confirm that the private fund conditions are met. In return, the Registrar will issue a certificate of designation, which is conclusive evidence that the limited partnership has been designated as a PFLP.
A new PFLP should apply for registration using form LP7 and paying a fee of £20. New PFLPs do not have to state the partners’ capital contributions (if any) or the nature or term of the partnership; the general nature of the firm’s business will in any case be evident from its designation as a PFLP. The application should state the name of the firm, the names of the partners and the address of the PFLP’s principal place of business, and each limited partner and general partner must sign the form. It remains the case that all limited partnership forms must be submitted to the Registrar of Companies in hard copy.
There are no special requirements as to the name of a PFLP, which must include the suffix ‘LP’ or the words ‘limited partnership’ (if registered on or after 1 October 2009) in the same way as other limited partnerships. Thus it will not be evident from the name of a limited partnership whether or not is a PFLP, though this can be determined by inspecting the firm’s filing history on the Companies House website.
Once a limited partnership has become a PFLP, it cannot return to ordinary limited partnership status. As the Treasury has explained, this is because ‘there is a risk that the PFLP will no longer fulfil the criteria required to be an ordinary limited partnership, in particular with respect to the declaration and contribution of capital’.
The following simplifications have been made to the law of limited partnerships as it applies to PFLPs.
Capital contributions and liability
As already mentioned, limited partners have typically split their funding commitments between a nominal capital contribution and an undertaking to fund the balance of their commitment by way of interest-free loans.
In order to remove the administrative costs of having to contribute and declare what is usually a nominal amount of capital, limited partners of PFLPs do not have to contribute capital to the firm, though they may do so if they wish.
If a limited partner has made a capital contribution to a PFLP, they may withdraw it, without being liable for debts and obligations to the amount withdrawn, unless the limited partnership was registered before 6 April 2007 and the capital contribution was made before the firm became a PFLP.
Limited partners in a PFLP who have not made a capital contribution are not liable for the debts or obligations of the firm beyond the amount of partnership property which is available to the general partners to meet such debts or obligations.
The whitelist: actions limited partners may take without taking part in management
The Limited Partnerships Act provides that a limited partner ‘shall not take part in the management of the partnership business’ without losing their limited liability status, though they may ‘examine into the state and prospects of the partnership business and … advise with the partners thereon’ (section 6(1)).
In practice, limited partners in investment funds often need to monitor and the performance of the fund and its investments; they may also have the right, under the partnership agreement, to be consulted about certain matters (either directly or indirectly through representatives) and to approve investments that would not otherwise be permitted. It has often been necessary, therefore, for limited partners to take legal advice as to exactly what actions they may take without breaching the rule that they may not take part in the management of the partnership business.
In order to remove some of the uncertainty surrounding what limited partners may or may not do, and to relieve limited partners of the expense of taking legal advice on this point, the Limited Partnerships Act now includes a whitelist of actions that limited partners of PFLPs may take without being regarded as taking part in the management of the PFLP and so losing their limited liability status. This provision has been modelled on similar lists included in equivalent legislation in the Channel Islands and Luxembourg.
The Treasury has stated that the whitelist is intended to cover two types of investor in particular:
- ‘employees of a private equity manager (the general partner) who are invested in the fund themselves as limited partners’, especially the staff of new fund managers who need to be guaranteed limited liability as investors while still being able to carry out their role as employees of the general partner; and
- ‘institutional or high-net-worth investors who take a strong interest in the fund, and will likely have obligations to their own members or investors’, especially where they form part of a limited partner advisory committee to consent to certain actions proposed by the fund manager.
As the Treasury has explained, the intention ‘is not to enable limited partners to carry on new activities which would otherwise clearly amount to taking part in the management of the business, but rather to give certainty to limited partners that they are able to carry on activities which are usual for investors in these types of funds without losing their limited liability status’. Removing uncertainty in this area should obviate the need for investors to obtain legal advice to get comfort on the position.
The Treasury has confirmed that ‘the distinction between taking part in the management of the business and advising in the capacity of a limited partner is based around the day-to-day running of the business’. For example, ‘the general partner is responsible for researching and selecting investments, and representing the partnership in respect of dealings with the investee company’. On the other hand, ‘the limited partner is only able to advise the general partner and consent to specific investments, but cannot be involved in the selection process or execution of the investment’.
‘The intention is to provide the limited partners with sufficient scope to monitor and assess the performance of investments, and to approve actions of the general partner … [but] not to enable the limited partner to act on behalf of the partnership;’ a limited partner is not able to bind the PFLP.
The whitelist is not exhaustive and does not limit the circumstances in which a limited partner in a PFLP is not to be regarded as taking part in the management of the partnership business. On the other hand, the list does not entitle a limited partner to take an action mentioned if they are not permitted to do so within the terms of the partnership agreement.
The list of actions that limited partners of PFLPs may take without being regarded as taking part in the management of the PFLP is as follows:
- taking part in a decision about varying or waiving a term of the partnership agreement or associated documents, whether the general nature of the partnership business should change, whether a person should become or cease to become a partner, or whether the partnership should end or its term be extended;
- appointing a person to wind up the partnership;
- enforcing an entitlement under the partnership agreement;
- entering into or acting under a contract with the other partners in the partnership;
- providing surety or acting as a guarantor for the partnership;
- approving the accounts of the partnership;
- reviewing or approving a valuation of the partnership’s assets;
- discussing the prospects of the partnership business;
- consulting or advising with a general partner or any person appointed to manage or advise the partnership about the affairs of the partnership or its accounts;
- taking part in a decision regarding changes in the persons responsible for the day-to-day management of the partnership;
- acting, or authorising a representative to act, as a director, member, employee, officer or agent of, or a shareholder or partner in, a general partner in the partnership or another person appointed to manage or advise the partnership in relation to the affairs of the partnership;
- appointing or nominating a person to represent the limited partner on a committee, authorising such a person to take action that would not involve taking part in the management of partnership business if taken by the limited partner, or revoking such an appointment or nomination;
- taking part in a decision about how the partnership should exercise any right as an investor in another collective investment scheme (a ‘master fund’), provided this would not cause the partnership to be liable for the debts of the master fund beyond the amount contributed or agreed to be contributed to the master fund; and
- taking part in a decision approving or authorising an action proposed to be taken by a general partner or other person appointed to manage the partnership, including in particular in relation to the disposal of all or part of the partnership business or the acquisition of another business; the acquisition or disposal of an investment or type of investment; the exercise of the partnership’s rights in respect of an investment; the participation by a limited partner in a particular investment; the incurring, extension, variation or discharge of debt by the partnership; or the creation, extension, variation or discharge of any other obligation owed by the partnership.
The actions concerning enforcing an entitlement under the partnership agreement, entering into or acting under a contract with the other partners, and acting or authorising a representative to act as a director etc of a general partner or manager are subject to the proviso that the entitlement, contract or action do not involve the limited partner taking part in the management of the partnership business.
If a decision involves an actual or potential conflict of interest, that is not of itself a reason to regard a limited partner who takes part in the decision as taking part in the management of the partnership business.
The following actions are not included in the whitelist, and so limited partners who take such actions may be regarded as taking part in the management of the PFLP:
- taking part in a decision to alter the powers granted to the limited partners;
- taking part in a decision to extend, suspend or terminate any period within which the partnership can enter into binding agreements to purchase investments, incur other obligations or require limited partners to advance commitments;
- being appointed (or having a representative appointed) to serve as a director of a portfolio company; or
- taking part in decisions (or allowing an advisory committee to take on increased powers) when the partnership is in suspension or in the process of replacing its general partner or manager.
Duties under the Partnership Act 1890
The Partnership Act 1890 generally applies to limited partnerships, except where the Limited Partnerships Act provides otherwise. Many of the mutual rights and duties of partners set out in the Partnership Act may however be varied by the consent of all the partners, and it is common for limited partnerships to have a partnership agreement in which some of those rights are waived.
Certain provisions of the Partnership Act are not considered to be consistent with the role of an investor in an investment fund, who may have investments in several funds which may fund competing businesses. In order to reduce the administrative burden of waiving these rights in the partnership agreement, therefore, the following provisions no longer apply to PFLPs (although the partners may of course agree equivalent provisions if they so wish):
- A limited partner in a PFLP is not subject to the duty to ‘to render true accounts and full information of all things affecting the partnership to any partner or his legal representatives’ (section 28).
- A partner in a PFLP who, ‘without the consent of the other partners, carries on any business of the same nature as and competing with that of the firm,’ is not obliged to ‘account for and pay over to the firm all profits made by him in that business’ (section 30).
Further, the provision that ‘when a person deals with a firm after a change in its constitution he is entitled to treat all apparent members of the old firm as still being members of the firm until he has notice of the change’ (section 36) does not apply where a partner in a PFLP ceases to be a member of the firm.
A partner in a PFLP is, however, subject to the duty to ‘account to the firm for any benefit derived by him without the consent of the other partners from any transaction concerning the partnership, or from any use by him of the partnership property name or business connexion’ (section 29), including transactions undertaken after a partnership has been dissolved by the death of a partner and before its affairs have been completely wound up, unless this duty has been disapplied in the partnership agreement.
Unlike an ordinary limited partnership, a PFLP does not need to notify the registrar of companies of any change to the general nature of its business, the term or character of the partnership, or (with the exception noted below) the sum contributed by any limited partner. This administrative requirement is removed because it is considered that there is no need for these details to be a matter of public record; in most cases, a limited partner’s capital contribution to a venture capital or private equity fund is purely nominal.
If, however, the PFLP was registered as a limited partnership before 6 April 2017, it must file any withdrawal by a limited partner of the partner’s contribution which has the effect that the amount of the partner’s contribution is less than it was on the date on which the limited partnership was designated as a PFLP. The Treasury has explained that the purpose of this exception is ‘to ensure that, to the extent that any creditors of the PFLP rely on existing capital contributions, they will be able to continue to rely on those contributions even if the limited partnership becomes a PFLP’.
It is a requirement for a PFLP to file, within seven days, any changes to the firm name, the principal place of business, the partners or the name of any partner, or the liability of any partner by reason of the partner becoming a limited partner instead of a general partner or a general partner instead of a limited partner.
Advertising in the Gazette
In a relaxation of administrative requirements, a PFLP is not obliged to advertise in the Gazette any arrangement or transaction under which the share of a limited partner will be assigned to another person. Consequently, it will not be the case, as far as a PFLP is concerned, that such an arrangement or transaction will take effect only when the advertisement is published.
It is, however, a requirement to advertise in the Gazette any arrangement or transaction under which any person will cease to be a general partner in a PFLP, including where a general partner becomes a limited partner. A third party dealing with the PFLP is entitled to treat that person as still being a general partner until they have notice of the arrangement or transaction, the Gazette advertisement being considered to be notice for this purpose. This is so that third parties will know whether they are dealing with a general partner who is liable for the debts and obligations of the PFLP.
Limited partners commonly have the right, under the partnership agreement, to remove the general partner and dissolve the partnership. If the sole general partner has been removed, however, it is necessary for the limited partners to apply for a court order providing for the affairs of the partnership to be wound up under the supervision of the court.
In order to avoid the need to apply to the court, limited partners of PFLPs may now appoint a person who is not a limited partner to wind up the PFLP if there is no general partner available to do so, subject to any agreement among themselves as to the winding up of the PFLP and provided they are not insolvent themselves. It is necessary for the limited partners to appoint a third party to wind up the PFLP because they might need to take management decisions, and so lose their limited liability, if they were to do so themselves.
If the PFLP has at least one general partner, on the other hand, then it is the general partner who must wind up the PFLP, provided it is not insolvent and subject to any agreement between the partners as to the winding up of the affairs of the partnership.
It remains the case that there is no provision for removing a PFLP from the register at Companies House, so that, like an ordinary limited partnership, a PFLP will remain on the register indefinitely even if it has been dissolved. This is to avoid the possibility that, if a partnership were removed from the register before its dissolution, it would continue in existence as an ordinary partnership, with the limited partners losing their limited liability status and so becoming liable for any debts of the partnership.
While there is no requirement to make a filing if a limited partnership is dissolved, limited partnerships sometimes choose to place their dissolution on the public record by filing form LP6 and writing ‘Dissolved’ under ‘New term’ in box (f) (‘Term or character of the partnership’). It may not be possible for a PFLP to do this: because there is no requirement for a PFLP to file a change to the term of character of the partnership, box (f) is now marked ‘not applicable to a private fund limited partnership’.
Some respondents to the government’s consultation suggested that it would be beneficial for at least some of these reforms to be extended to all limited partnerships.
There have been previous proposals for more extensive reforms to partnership law. In 2003, the Law Commission and Scottish Law Commission published joint recommendations on the law of partnership, including limited partnerships, and in 2008 the government consulted on proposed reforms to the establishment, registration and de-registration of a limited partnership, the liability of limited partners to third parties, and the rights and obligations of general and limited partners.
The government decided not to proceed with those reforms, however. Instead, the Legislative Reform (Limited Partnerships) Order 2009 made more modest amendments to the Limited Partnership Act, clarifying that a limited partnership comes into existence when the Registrar registers it and that the certificate the Registrar issues on registration is conclusive evidence of its formation, and requiring new limited partnerships to include in their name an indication of their status.
We may nevertheless see further reforms in due course. For example, it has been suggested that English limited partnerships should be given legal personality, as is already the case in Scotland and some other jurisdictions. Recently, however, there have been reports that a notable rise in the number of limited partnerships registered in Scotland may indicate increased use of the structure for criminal purposes. The Department of Business, Energy and Industrial Strategy has called for evidence on this point, and it seems unlikely that further proposals for reform will be brought forward until these concerns have been addressed.