Introduction
Historically, private investment funds (such as onshore hedge funds and private equity funds) have relied on the limited partnership as the primary organizational form of choice, despite the existence of a number of different organizational forms through which a private investment fund could, in theory, conduct its activities. The limited liability company, for example, exhibits characteristics that make it both similar to and more attractive than the limited partnership. A limited liability company can be structured to mimic the centralized management of a limited partnership, yet it can also protect all of its members (including its managing member) from personal liability for the obligations of the company solely by virtue of being members. Given that in the limited partnership context the general partner (i.e., the fund sponsor or manager) faces unlimited liability for the debts and obligations of the partnership, the additional liability shield provided by a limited liability company solves the unlimited liability problem and, thus, alleviates the need for a fund sponsor to establish a separate limited liability entity to serve as a general partner in order to gain liability protection.
Despite the potential benefits of the limited liability company form, private investment funds have continued to opt for the limited partnership for two reasons. First, unlike the limited liability company, the fundamental nature of a limited partnership as a "partnership" means that it is more likely to be afforded pass-through tax treatment with respect to its equity holders in a variety of foreign (non-U.S.) jurisdictions. Second, and perhaps more importantly, the limited partnership is a relatively well-established business form and is one with which fund sponsors, investors and courts alike have become well accustomed.2 Accordingly, there are significant marketing advantages associated with fund raising through an organizational form that prospective investors are more likely to understand and therefore accept as the entity in which to invest their capital.
Recent trends in the market for private investment fund formation, however, warrant another look into whether the limited partnership is, indeed, the optimal organizational form. The advent and development of the modern limited partner advisory committee, as well as the increased public and regulatory scrutiny of fund sponsors, make the search for an organizational form with more of the benefits of both the limited partnership and the limited liability company all the more relevant today than it was perhaps a few years ago. One particular form that is likely to achieve this is the Delaware limited liability limited partnership (the "LLLP"). The LLLP is essentially a limited partnership, but offers limited liability protection for its general partners similar to the limitation on liability offered to managing members of a limited liability company. In addition, the conversion of an existing limited partnership into an LLLP is a relatively straightforward procedure. This article offers a simple introduction to the LLLP and explores its relative advantages and disadvantages in comparison to other business organizational forms.
LLLP Defined – A Different Liability Shield
As its name suggests, the limited liability limited partnership is a special form of limited partnership in much the same way that a limited liability partnership is a special form of general partnership. In fact, neither the Delaware limited liability partnership nor the LLLP can be found in independent statutory regimes, but rather, both are based on supplements to existing statutes (the Delaware Revised Uniform Partnership Act, in the case of the limited liability partnership, and the Delaware Revised Uniform Limited Partnership Act (the "DRULPA"), in the case of the LLLP). As such, the fundamental characteristics of limited liability partnerships and LLLPs (such as governance) are consistent with their underlying general partnership and limited partnership organizational forms, respectively.
Unlike a limited partnership, however, under §17-214(c) of the DRULPA there is no unlimited liability exposure for a general partner of an LLLP. Importantly, this additional liability shield prevents each general partner of the LLLP from being personally liable, on an unlimited liability basis, for the debts and obligations of the LLLP. This shield also provides an extra layer of liability protection for the limited partners. That is, in addition to having their personal liability limited to the amount of their capital investments while remaining passive limited partners, the additional liability shield provided by the LLLP would also extend to limited partners who have participated in the control of the business of the partnership and who may have exposed themselves to unlimited liability as general partners.
Although Delaware limited partnership law enumerates a number of management activities in which limited partners can be engaged without being considered as participating in the control of the business (such as advising the general partner with respect to matters of the limited partnership's business or making determinations in connection with investments), the prospect of this additional liability protection for limited partners means that the governance structure of the LLLP can be substantively, if not significantly, different from that of a limited partnership. Advisory board members once reluctant to render binding determinations may be willing to (or may in fact desire to) assume greater oversight responsibilities in exchange for adopting an organizational form that limits the liability of the general partner.
"Formation"
In order to become an LLLP, a limited partnership must satisfy the four requirements of §17-214 of the DRULPA. First, the limited partnership's partnership agreement must permit it to become an LLLP, or if such a transformation is not expressly permitted, it must be approved by all of the general partners and by a majority-in-interest of the limited partners (or each class of limited partners if more than one class exists). Second, the limited partnership must file a Statement of Qualification containing: (i) the name of the partnership; (ii) the address of its registered office; (iii) the name and address of its registered agent for service of process; (iv) the number of partners at the time the statement is effective; (v) a statement that the partnership elects to be a limited liability limited partnership; and (vi) the date or time upon which the statement is to be effective (if it is not to be effective upon filing). Third, the limited partnership must pay certain filing fees.3 Fourth, the limited partnership must include as the last words or letters in its name "Limited Liability Limited Partnership," "L.L.L.P." or "LLLP." The limited partnership's status as an LLLP and the protection provided by the additional liability shield are effective upon the filing of the Statement of Qualification (or future effective date, if one is specified).
In order to retain its status as an LLLP, by June 1 of each calendar year following the year in which a limited partnership becomes an LLLP, the LLLP must file an Annual Report (setting out its name, the number of partners, the address of its registered office and the name and address of its registered agent for service of process) and remit the applicable fee. Failure to file the Annual Report or pay the required filing fee authorizes the Secretary of State of the State of Delaware to revoke the limited partnership's status as an LLLP. 4
Further Comparisons to Similar Forms
The DRULPA provides that, with the exception of LLLP-specific registration and liability shield provisions, LLLPs are governed by the same statutory provisions that apply to limited partnerships. As such, there are a few significant differences between limited partnerships and limited liability limited partnerships, apart from those referenced above, as a matter of Delaware law. From that perspective, LLLPs are (or, at least, should be) more familiar to lawyers and business people in the private investment funds world than at first glance. Similarly, the registration of a limited partnership as an LLLP has no impact on the membership requirements or governance of the partnership in question.
Furthermore, both limited partnerships and LLLPs require at least two partners (one general partner and one limited partner). The general partner is responsible for managing the business of the partnership (and is the only partner authorized to bind the partnership), while the limited partner largely does not participate in the management or business of the partnership (in order to avoid the risk of assuming the liability of a general partner). This limitation is moot as a practical matter upon registration as an LLLP, however, as the additional liability shield protection ensures that even if a limited partner participates in the management or business of the partnership, that partner would not face unlimited liability for the obligations of the partnership.
General partnerships and limited liability partnerships, of course, also require at least two partners (although all partners are general partners). Under these forms of partnerships, each partner is an agent of the partnership and any act engaged in by one partner that appears to advance the interests of the partnership can bind the partnership. Each of the foregoing forms can be distinguished easily from the limited liability company, which only requires a single member. The limited liability company can be managed either by an appointed manager (or management team) or by the members themselves, and all members and managers, individually, have the ability to bind the company, unless the company's operating agreement specifies otherwise.
With respect to U.S. tax treatment, general partnerships, limited partnerships, limited liability partnerships and LLLPs are all subject to tax treatment as partnerships (i.e., neither the registration of a general partnership as a limited liability partnership nor the registration of a limited partnership as an LLLP will change the tax rules applicable to the underlying partnership). As such, income generated by each of these partnerships is generally not subject to entity-level tax and the character of such income (which is determined at the entity level) passes through to the individual partners to be included in their personal tax returns. The default U.S. tax treatment for limited liability companies with two or more members is the same as that applied to partnerships. It must be noted, however, that each of these organizational forms has the ability to elect to be treated as a separate corporate entity (and thus subject itself to entity-level tax).
The Pros and Cons of LLLPs for Private Investment Funds
Although there is no legal restriction under Delaware law on the potential use of the LLLP form by a private investment fund (other than the restriction on its use for the business of banking), there are a number of advantages and disadvantages that should be considered before an established or prospective private investment fund chooses to register as or become an LLLP. Three advantages are as follows. First, at its core, the LLLP is essentially still a limited partnership. Thus, the limited partnership agreement that lies at the heart of most private investment funds will retain the "look and feel" of the vast majority of its operative provisions, with the exception perhaps of its exculpatory and indemnification provisions which might run to both the general partner and any limited partner that fulfills a "management" role. Moreover, by filing the election to become an LLLP, the partners can obtain the benefits of the additional liability protection while still retaining the business form with which they are familiar (rather than having to convert to another form, such as a limited liability company or limited liability partnership). In addition, even if the election filings for LLLP status are made improperly or are subject to other complications that result in the status being revoked, the investors would still be protected from unlimited liability as they would retain the traditional liability shield attributable to limited partners of a limited partnership.
Second, as the additional liability shield builds upon the established limited partnership framework, the certainty for investors with respect to their traditional liability protection as limited partners is unlikely to change. While there may be uncertainty surrounding the scope of the additional liability protection in an LLLP due to the minimal case law on the subject to date, registration as an LLLP (although involving a higher fee) poses no downside liability risk and only the potential of additional protection in comparison to the traditional limited partnership form.
Third, by obtaining limited liability protection for the general partner through registration as an LLLP, sponsors, when forming new funds, would no longer necessarily have to incur the cost, time and effort involved with establishing and maintaining a separate limited liability entity to serve as the general partner in order to achieve this protection.
Despite these advantages, there are two primary disadvantages associated with the LLLP form. First, the liability shield of an LLLP may encounter difficulties as the partnership engages in activities in states outside of the State of Delaware. While all states have adopted foreign recognition laws enabling foreign limited liability partnerships to register, engage in business (in some instances, in certain professions only)5 and apply the laws of state registration for the purposes of determining partner liability, similar recognition laws have not been adopted throughout the United States with respect to LLLPs. As a result, there is uncertainty about the treatment that a Delaware LLLP would face in states other than Delaware or the ability of a Delaware LLLP to qualify to do business in such states. Other states, such as the State of New York, appear to specifically deny foreign limited partnerships – and Delaware LLLPs qualify as foreign limited partnerships – the benefits of the additional liability shield. Under such circumstances, a Delaware LLLP would only be afforded the status of a foreign limited partnership (or could only seek to qualify to do business as a foreign limited partnership), thus eliminating the benefits of the additional liability shield for both general and limited partners.6
Second, the presence of an additional liability shield may be disruptive to the traditional balance of liability exposure that delineates the role of the general partner (i.e., management) relative to the role of the limited partner (i.e., capital). On the one hand, the presence of the additional shield could increase the extent to which major limited partner investors desire to intervene (or have the right to intervene) in the management of the fund. In a traditional limited partnership, the potential cost to an investor of intervention (i.e., the risk of losing limited liability protection) may have outweighed the potential benefits. With the additional liability protection for limited partners, however, these costs, and thus the disincentive to intervene, may be mitigated.
On the other hand, granting such enhanced management rights could give rise to interinvestor conflicts, pitting major limited partners who may desire such rights against other limited partners who may have little to no desire to see fellow investors taking on a management role. One would also expect major limited partners to resist assuming unwanted fiduciary obligations relative to their fellow investors – a factor that itself might mitigate the desire to obtain those enhanced rights in the first place (unless the fund sponsor and other investors are willing to limit contractually those obligations). The dynamics of such conflicts are likely to play out differently depending on the relative bargaining power of each fund constituency.
Conclusion
The foregoing discussion of the LLLP form, its key differences from other forms of business entities and its applicability to private investment funds, attempts to provide readers with an introduction to LLLPs and the significant issues surrounding their use. This discussion is not, however, intended to be exhaustive. Factors and considerations unique to each private investment fund (or any other business) will be important to the decision-making process that results in the selection of the appropriate form of legal entity. Given the potential benefits, however, existing and prospective private investment funds are encouraged to strongly consider the possibility of this form of entity as an alternative to the traditional limited partnership.
