The use of limited partnership structures is widespread in Canada, primarily as a way of achieving favourable tax treatment for joint venture and co-ownership situations. One of the essential features of the limited partnership is that it offers the ability to flow through losses to the owners (partners) while at the same time offering limited liability protection to the owners comparable to the protection enjoyed by shareholders of a corporation.
Limited partnerships in the province of Manitoba, however, differ from those in the rest of Canada in one significant respect. Knowing this key difference can be an advantage for investors in structuring their businesses effectively, and can permit investors to take part in the management of the business beyond what would be permissible in other jurisdictions. This bulletin outlines this key difference and how to best take advantage of it.
1. The conventional limited partnership
In most provinces, the statutory regime for limited partnerships is reasonably straightforward: the general partner is responsible for all of the debts of the partnership, and each limited partner is only liable for the debts of the partnership to the extent of the capital it has contributed or agreed to contribute to the partnership. Beyond that capital contribution, a limited partner is analogous to a corporate shareholder and has no further liability for partnership debts.
The Alberta Partnership Act1 is typical of Canadian partnership statutes:
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There is an important trade-off, however; in exchange for limited liability, limited partners are expected to behave as passive investors, or silent partners, in the business. The intention of the statutes is that the business of limited partnerships should be conducted exclusively by the general partners. Where a limited partner takes part in the management or control of the business, or takes an active role in the business2, that limited partner loses the liability protection referred to above and becomes liable as a general partner for all of the liabilities of the limited partnership.
The Alberta act is also typical of Canadian partnership statutes in this regard:
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The fear of losing limited liability status is a serious concern for investors in limited partnerships. A limited partner who fears that the business is not being well run, or who is concerned about incompetence or malfeasance on the part of the general partner, is incented to stay silent and limit their loss to their original investment, rather than getting involved and risk becoming liable for all of the debts of the limited partnership.
2. The Manitoba limited partnership
Limited partnerships formed under the Manitoba Partnership Act3 are generally similar to those formed elsewhere in Canada: in the ordinary course, the liability of a limited partner is limited to its contribution to the limited partnership.
With respect to the loss of liability, however, Manitoba limited partnerships differ significantly from partnerships formed elsewhere in Canada. A Manitoba limited partner who takes an active part4 in the business becomes liable as a general partner to any person with whom he deals on behalf of the partnership and does not know he is a limited partner. In addition, the liability of a limited partner to such a person is limited to the time until the person has actual knowledge that the limited partner is a limited partner.
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The qualifications provided in the Manitoba statute, which are not provided elsewhere in Canada, are extremely important and offer significant added protection to limited partners of Manitoba limited partnerships.
Where a limited partner in a Manitoba limited partnership takes an active part in the business of the partnership, it is protected in three ways:
- First, each limited partner is only liable to persons with whom that partner deals on behalf of the partnership. The statute does not provide for general unlimited liability to all creditors of the partnership.
- Second, each limited partner is only liable to persons who do not know that the partner is a limited partner. The statute provides continued liability protection if the limited partner, while acting on behalf of the partnership, identifies itself as a limited partner;
- Third, the liability to third parties as set out above extends only to liabilities incurred prior to the third party acquiring actual knowledge that the person is a limited partner.
The “reliance” test
These three qualifications together have been referred to as a "reliance" test – a limited partner may be liable to someone doing business with the corporation relying on the limited partner to be responsible for the debts of the partnership. If a third party creditor either cannot rely on the limited partner (because it never had dealings with the limited partner or because it had actual knowledge that the party's liability is limited), then the limited partner will not be liable to that person.
Elsewhere in Canada, partnership acts do not provide for any form of reliance test. A third party creditor who may not even know that a limited partner has taken part in the control of the business, or who has actual knowledge that a partner is a limited partner, is still entitled to hold the limited partner responsible for the debts of the partnership.
Because there has been no judicial consideration of the reliance test as set out in the Manitoba Partnership Act, it is unfortunate that it is not possible to provide guidance on how this section may be interpreted, or what the limits of the liability protection might be.
One concern that has been raised is whether a court in another Canadian jurisdiction would apply Manitoba law exclusively to the Manitoba limited partnership, or whether such a court would apply its own local rules to determine whether a limited partner has become generally liable. In the case of a corporation, under ordinary principles of corporate law a court would generally apply the statute under where the corporation is formed, and there is no reason to think that the same principle would not be applied to the determination of matters of partnership law.
Nevertheless, in order to obtain the maximum protection of Manitoba partnership law when using a Manitoba limited partnership, it would be prudent to take steps to ensure that the partnership has significant connections to Manitoba, including (for example) designating the registered and records office of the limited partnership in Manitoba, using a Manitoba corporation as general partner, and designating the registered and records office of the general partner in Manitoba.
The ability to manage without incurring risk
Despite uncertainty arising from a lack of judicial interpretations, the ability to take (a limited) part in the management and control of a Manitoba Limited Partnership without the risk of incurring liability to third parties provides significant flexibility to investors. It should provide such investors with the opportunity to structure their affairs in a way that would allow them to take a more active role, thereby allowing them to protect their investment without sacrificing the benefits of ownership through a limited partnership structure.