The use of partnerships as investment vehicles

The structuring of a joint venture arrangement will have implications for the participants in terms of liability, tax treatment, regulatory status, management and control, equity and profit-sharing flexibility, and the ability to enter into contracts and hold property and assets.

Participation may be through a corporate vehicle, partnership, or a purely contractual arrangement. Either a limited company or a limited liability partnership (LLP) may be chosen as a corporate vehicle, and a partnership may be organised as either a general partnership or a limited partnership. In this article, we consider the options available to joint venture participants and in particular, investors.

Liability

Particularly in large infrastructure projects or other high-risk ventures, exposure of the participants to potential liabilities will be the most significant consideration.
In a general partnership, formed under the Partnerships Act 1890 (the 1890 Act), the partners will be jointly and severally liable for the debts and obligations of the firm. Creditors will be at liberty to pursue the partner with the deepest pockets, leaving that partner to seek contributions from the others.

Similarly, creditors will have full recourse to the parties in a contractual joint venture, and the exposure of each party will depend upon the terms of the various agreements. Whilst indemnities may provide some structure to the potential exposure to losses and liabilities, ultimately the participants have unlimited liability.

Short of a compelling reason to the contrary, other than in a straightforward, low-risk transaction, both the contractual joint venture or general partnership route are discounted at an early stage in planning.
Corporate vehicles – limited companies and LLPs – offer the participants liability limited to the amount of their capital contributed to the vehicle. The familiarity of limited companies makes these a popular choice but the additional benefits of an LLP should be considered before settling the form of the joint venture vehicle.

In a limited partnership formed under the Limited Partnerships Act 1907 (the 1907 Act), the partners will be a general partner, to manage the business of the firm, and limited partners, typically investors. The general partner has unlimited liability for the debts and obligations of the firm, whilst a limited partner’s liability will be limited to the amount of their capital contribution.

That said, the limited liability status of limited partners is fragile, and will be lost if they participate in the management of the business. There was no legislative guidance on this point and only some piecemeal caselaw on which to draw.

For reasons considered below, limited partnerships have for many years been a popular and familiar choice as joint venture vehicles. A significant level of certainty was welcomed in 2017 when a new form of limited partnership – a Private Fund Limited Partnership (PFLP) – was introduced by the Legislative Reform (Private Fund Limited Partnerships) Order 2017 (the LRO 2017). This amended the 1907 Act to provide clarity on the issue of participation in the management of the business.

A non-exhaustive “white list” of permitted activities set out in the LRO 2017 provides the PF limited partners with an ability to monitor the performance of both the general partner or fund manager and the underlying contracts and assets. They can also approve the actions of the general partner on core constitutional issues, without losing limited liability. While this stops some way short on participating in the management of the business, it does bring the PFLP in line with similar limited partnership vehicles in, for example, Jersey and Luxembourg.

Careful drafting within the limited partnership agreement will be required to ensure that the participation of the PF limited partner is consistent with the “white list” but for a passive investor, the PFLP will remain a popular joint vehicle structure.

Collective Investment Scheme (CIS)

Consideration of the regulatory issues in respect of JV structure are beyond the scope of this article, but suffice to say that certain structures require the management of the business to be conducted or delegated to an appropriately regulated entity.

Neither contractual joint ventures, nor limited companies, are collective investment schemes. PFLPs must be CISs, and partnerships and LLPs may be CISs, depending upon whether all the partners or members take part in the business. It is, however, relatively easy to establish the appropriate level of participation, taking the vehicle outside of the CIS regime.

Management and control

The operation and management of the structure will be governed by the terms of the contractual arrangement, or the constitutional documentation of the vehicle.

The restrictions on management inherent in the limited partnership structure are considered at length above. By contrast, in all other JV structures, the participants may all manage and control the business and the entity.

Subject to any matters delegated to a management body, broadly speaking, in a limited company, the voting rights are attached to shareholding, and exercised proportionately to ownership. In a partnership or an LLP, there is no such linkage required, and it is easy to reserve specific matters for determination by one or a class of members.

This makes partnerships and LLPs attractive options where, for instance, participants contribute capital in kind – such as real estate in an infrastructure fund – or provide services under the JV arrangements.

Equity and profit sharing

In the absence of special share classes, in a company, dividend payments are linked to shareholdings. This is not so in a partnership, general or limited, or in an LLP. In these cases, the profits may be allocated entirely independently from the capital, and may be drafted so as to be determined by the performance of certain underlying assets of the partnership or LLP, and are amended periodically without causing a taxable disposal of interests.

In addition, unlike in a limited company, it is possible in a partnership or LLP to adjust equity shares from time to time, or admit new participants, again without triggering a taxable disposal.
This unrivalled flexibility in relation to equity and profit sharing makes these structures particularly attractive in investment or project-based JVs.

Separate legal personality

Both limited companies and LLPs have separate legal personality. Not only does this protect the interests of the participants against unlimited liability to third parties, it ensures that the ability to enter into contracts and hold assets is straightforward.

In a contractual joint venture, the absence of a corporate holding vehicle requires a web of contractual arrangements, trusts and indemnities to replicate joint ownership of assets and contracts, adding an unnecessary level of complexity.

Partnerships, both general and limited, do not have separate legal personality, although the relationship of the partnership itself provides rights and obligations of the partners in respect of the use and ownership of partnership assets.

Typically, assets would be held in trust for the other partners as partnership property, and contracts entered into by one partner – the general partners in a limited partnership – in their capacity as partner.

This does, however, facilitate the rights of a third party to pursue one of the partners for liability and losses, leaving, in the case of a general partnership, that partner to seek contributions from the others.

Tax transparency

Tax planning is similarly outside the scope of this article, however, it is important to appreciate that the choice of vehicle will of itself have financial consequences. In a contractual JV, partnership and LLP, the arrangements are tax transparent. This means the participants are taxed directly on the profits and gains as they arise.

By contrast, in a limited company, profits and gains are taxed at corporate level in the form of corporation tax, and then in the hands of the shareholders on dividend income.

Separate advice should be sought as to the most desirable outcome from a tax perspective, although in a joint venture, participants often favour a tax transparent structure.

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