Are you putting all of your personal assets at risk every time you undertake any activity related to your business?  Without setting up and properly maintaining the business form that best serves your needs, you may be doing just that.  The form under which your business is organized makes all the difference.

In most states business owners have a number of different choices for their business formation.  These forms of ownership fall into two general categories.  The first category includes those in which the owner is personally responsible, or liable, for all of the obligations of the business.  The second general category allows the owner to shield personal assets from most of those obligations.

Previous articles discussed the characteristics of the sole proprietorship and the general partnership, the two business forms that put personal assets at greatest risk.  In this article, we will explore the characteristics of the form of business known as the limited partnership. This series of articles on business forms will continue in the next issue with a discussion of corporations.

What is a Limited Partnership?

The limited partnership first appeared in the civil law tradition of France.  Our English-based law later embraced the elements of the limited partnership on the way to the evolution of corporate law.  The cornerstone of the limited partnership is that partner’s personal liability is no greater than the amount invested in the business.

The limited partnership has three key provisions that distinguish it from its cousin, the general partnership.  First, limited partnerships are created by statute, not just by contract and require the filing of a certificate of limited partnership with the state’s registration authority.  Second, there are two distinct classes of partner.  Every limited partnership includes at least one general partner and at least one limited partner.  The general partner retains the unlimited personal liability of a traditional general partnership while the limited partner’s personal liability is limited to the amount of the capital contribution.  Third, the limited partner’s opportunity to participate in the management of the business is restricted in exchange for the liability limitation.

Formation of a Limited Partnership

Limited partnerships require certain formalities when they are created.  The two or more partners must execute a certificate of limited partnership and register with the state in which the business is formed.  The certificate includes the name, general purpose of the business, address of the principle place of business, latest date for dissolution, and the identity and contact information of the agent.  The name, address, and capital contribution of each partner is also provided on the certificate.  When any of the information provided on the certificate changes, an amendment must be filed within 30 days of the occurrence of that change.

The name of the business may only include the surname of a limited partner if it is also the surname of a general partner.  The name must include the words “limited partnership.”

If a mistake is made when the certificate is filed, it may be corrected by filing an amendment or by withdrawing from participation and filing a certificate of withdrawal.  If a limited partner is mistakenly listed as a general partner, she will remain personally liable for all business transactions until the amendment or withdrawal is filed.

The partners in a limited partnership should draft and sign a limited partnership agreement.  When people decide to become partners, it is because they are convinced that they can work together profitably and for the duration of the partnership.  Unfortunately, life often gets in the way and circumstances change.  Anything from a falling out of the partners, a change in organizational goals, a divorce, or a death can change the relationship between the partners.  The time to address the way these events will be handled is long before they do, when the partners are still enthusiastically cooperative.

The agreement will cover such matters as how profits and losses are allocated, the partners’ rights to company information, and how new partners will be admitted.  Absent an agreement or terms within the agreement that address specific issues that arise, the partnership statute of the state will control the outcome of any disputes.

Dissolution of a Limited Partnership

At formation, a limited partnership may be established for a specified period of time such as five years, for a specific purpose such as the development of a new software package, or at-will with no specified event causing termination.  After formation, the partners may by unanimous written consent or withdrawal of a general partner choose to dissolve the partnership.  A judicial decree might also be entered where a general partner shows a court that it is not reasonably practical to carry on the business in conformity of the limited partnership agreement.

After dissolution, windingup is the process of liquidating the assets of the partnership and distributing the proceeds.  First in line are the secured creditors followed by the unsecured creditors.  If any of the members have loaned money to the partnership, their position as a creditor is generally subordinated to all other third party creditors, yet their credit position is superior to any member claims for return of their capital contributions.  Should the resources after liquidation be insufficient to satisfy all of the claims any partner may petition the court to administer the windingup process.

Conclusion

A limited partnership is created when two or more parties agree to operate a for-profit business together and two classes of partners are created, general partner and limited partner.  Due to the limitations on personal liability provided to limited partners, there are more formalities required to create and maintain the partnership than there are for a general partnership.  It is still easier and less expensive to establish and maintain a limited partnership than it is for a corporation, the next step in the progression from simple to complex business forms.  In the next article, we will explore the corporation, a truly autonomous legal entity that exists independently from its owners.

© Copyright 2009 by Bill Gschwind, inPURSUIT Consulting, LLC.