Limited partnerships (LPs) are a flexible form of business entity commonly used in complex transactions. They allow an acquirer of an existing business, or developer of a new project, to seek financing from passive investors and create a custom structure to run the business. This can be attractive to passive investors, because they gain access to the financial upside of the investment, obtain some degree of certainty regarding their maximum downside, and enjoy the benefits of flow-through profits and losses.
Generally speaking, LPs are managed by the general partner, who: (1) will not share directly in the profits of the LP; (2) is responsible for managing the business; and (3) transacts on behalf of the LP (including holding property and signing contracts). Tax obligations (in respect of income) and tax deductions (in respect of losses) are flowed-through to the limited partners and not taxed at the partnership level, which is particularly attractive for companies in industries where significant write-offs are normal (such as oil and gas, mining, research and development). However, limited partners’ tax deductions are generally capped to the extent of their “at-risk-amount” (as governed by the Income Tax Act (Canada)). In terms of liability, the general partner has unlimited liability for the debts and obligations of the LP, while each limited partner’s liability is limited to its capital contribution. These features are typically further refined by way of a Limited Partnership Agreement, and in all cases are subject to the partnership laws of each jurisdiction.
One important qualification is that limited partners cannot participate in management or control of the business. If they do, they will gain unlimited liability as if they were a general partner. The exact wording of this limitation varies in the partnership statutes of each Canadian jurisdiction, but ultimately is a factual matter and may not be entirely clear ahead of time. This can be a major concern for investors, as loss of limited liability status would fundamentally change the value of the position they invested in.
An exception to this general rule in Canadian jurisdictions is Manitoba. The Partnership Act(Manitoba) provides that where a limited partner takes an active part in the business of the LP, they only lose their limited liability status if dealing on behalf of the LP, and only if the other party was not aware that the limited partner was in fact only a limited partner. In such case, the limited partner would only be liable for the period of time starting when they began dealing with the other party and ending when the other party actually became aware that they were dealing with a limited partner.
Although these exceptions are technical in nature, a Manitoba LP reduces the risk that limited partners who play a role beyond that of a purely passive investor will lose their limited liability status and become responsible for the debts and liabilities of the LP. Depending on the nature of your proposed acquisition, development or other investment, it could be worthwhile to consider using a Manitoba LP. However, please note that other aspects of Manitoba LP law are less favourable; for example, the liability of limited partners for false statements in partnership declarations and the lower priority of limited partners who are creditors of the LP. In all cases, expert tax and legal advice should be obtained based on your specific situation, as the foregoing is a summary of basic principles only.