The law governing the liability of a limited partner, in the event that it chooses to get involved in certain management activities of an English limited partnership, has required clarifying for many years.
The recent decision of Mr Justice Cooke (the 'Judgment'), involving the Henderson PFI Secondary Fund II LP (the 'Henderson Fund'), provides a useful analysis of the issues. The case involved 22 out of the 29 limited partners in the Henderson Fund (all 22 being trustees of a pension scheme or an investment fund).
Background - relevant characteristics of English limited partnerships
English limited partnerships are regularly selected for use as an investment vehicle by fund managers and their use is widely accepted by investors. A limited partnership must have one or more general partners (GPs) who take responsibility for managing the limited partnership, and one or more limited partners (LPs) who do not have any active role in the management of the partnership.
LPs benefit from limited liability and are not generally exposed to the liabilities of the partnership (over and above the amount they have agreed to invest). The GP, on the other hand, remains personally liable for the liabilities of the limited partnership.
It is usual for the GP to delegate certain fund management duties to a fund manager which is often an entity associated with the GP. This was the case with the Henderson Fund; Henderson Equity Partners Limited was appointed by the GP to be the Fund Manager.
Limited partnerships are considered flexible and tax efficient in addition to providing limited liability protection to the LPs. This attractive combination has made them a very popular choice of investment vehicle.
Limited partnerships have, however, been the subject of some criticism in recent years, not least because of the unclear scope of the restrictions placed upon an LP's ability to get involved in the management of the partnership. Section 6(i) of the Limited Partnership Act 1907 states that an LP shall not take part in the management of the partnership business and shall have no power to bind the firm. It goes on to state that if an LP takes part in the management of the partnership he shall be liable for all debts and obligations of the firm incurred while he so takes part in the management as though he were a GP.
In some jurisdictions the LPs can be involved in extraordinary management decisions (as opposed to the day-to-day management activities) without prejudicing their limited liability status. This concept has not been extended to English Limited Partnerships.
Issues raised in the Henderson Judgment
The Henderson Fund was formed to acquire and build a portfolio of mainly PFI and PPP companies. The initial investment was in a publicly listed group, Laing plc. After the deal was done, the LPs alleged that the Henderson Fund's investment criteria had been breached as funds had been used to acquire both PFI/PPP assets and other substantial assets (including a pension deficit of £158.7 million). This did not comply with the investment criteria set out in the Henderson Fund documents.
The GP and the Fund Manager were companies in the same group and, as such, the LPs did not expect that the GP would in practice sue the Fund Manager for breach of the management agreement. The LPs became frustrated and sought a right to bring a derivative action in the name of the partnership against both the GP and the Fund Manager. It was unclear whether the court would agree that a derivative action was appropriate, and if it did whether taking derivative action would amount to management activity which would expose the LPs to liabilities of the limited partnership.
Key conclusions and comments set out in the Judgment
In the Judgement, which runs to more than 40 pages, Mr Justice Cooke held (amongst other things) that:
- The LPs are entitled to pursue a derivative claim against the Fund Manager (as the interests of justice require a remedy where the GP will not act). However, to do so, they must forfeit their limited liability, for the period during which such claims are pursued, and render themselves liable to creditors of the partnership generally, as if they were the GP.
- The LPs were not entitled to pursue a derivative claim on behalf of the partnership against the GP. It was held that there was no need for a derivative action as any claim by the LPs against the GP was governed by the limited partnership agreement. It was also confirmed that enforcement of such rights under the limited partnership agreement would not involve the LPs participating in the management of partnership business.
The fact that the partnership agreement provided alternative remedies (in particular the right to remove and replace the GP with a body which would sue the Fund Manager) was not satisfactory to the LPs. Such action would be complex and expensive. The LPs did not want to replace Henderson given that an alternative GP would charge a premium fee given the circumstances. Also, the limited partnership agreement provided that the GP would be entitled to a compensatory payment if its appointment was terminated.
- The Judgment acknowledges that there are some grey areas in the current law about what might or might not constitute participation in management. The Court, however, supported the statements made in the Inversiones Frieira case of earlier this year and confirmed that an LP is permitted to inspect the books of the firm, examine the state and prospects of the partnership business and advise with the partners thereon.
Such activity will not constitute participation in the management of the partnership business. Having obtained information about the partnership's affairs, an LP who examines and analyses the material and confers with other LPs does not thereby become involved in the management of the partnership. An expression of a view about the performance of the partnership or the strategy or future direction of the partnership, or even a preference about how a particular asset should be dealt with, does not constitute management. However, as soon as there is participation in the decision-making process by requiring notice of individual decisions and commenting upon operational business decisions taken by the GP, the LP will be involved in management. There are potential grey areas but the conducting of litigation on the part of the partnership is not one of them.
- The LPs' claim that the GP and Fund Manager had acted in breach of the investment criteria were resolved in favour of the GP and Fund Manager.
Interestingly, the Court referred to the 2001 Law Commission Consultation Paper on the Limited Partnership Act and the draft Bill that had been produced in consequence of the consultation. It was noted in particular that a number of jurisdictions approach limited partnerships in a different manner and permit LPs to be involved in extraordinary management matters.
Mr Justice Cooke was firmly of the view that nothing in the Consultation Paper or draft Bill would affect his decision. In his view, the pursuit of a dispute between LPs and a third party fund manager was self-evidently management of the partnership business. The proposed reform did not go as far as proposing that LPs could get involved in the litigation of the partnership; such litigation is a management activity and not one that LPs are entitled to participate in, if they wish to have the benefit of limited liability.
The Judgment does not present any ground-breaking new law, but it is a refreshing review of an area of law that is frequently the subject of debate. The clarification it highlights is very welcome.