BUS 670 Week 1 Assignment

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Chapter 29

Limited Partnerships The limited partnership form of business organization was primarily created to address one of the worst shortcomings of the traditional partnership form: unlimited personal liability for �inancial obligations incurred by the partnership (see Chapter 28 (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/ch28#ch28) , Sole Proprietorships and Partnerships). Although such liability of partners protects the general public against losses when dealing with a partnership, unlimited personal liability can make individuals less willing to become partners. What the limited partnership form of business organization accomplishes is to create a special class of partner who is merely an investor but does not become involved in the actual running of the business. As an investor, the limited partner is in a position similar to that of a shareholder in a corporation: The only money the partner can lose is his or her investment or capital contribution if the enterprise should fail or be sued.

Unlike the sole proprietorship and partnership forms of business organization, which were recognized at common law, the limited partnership is a creature of statute. This means that a limited partnership can be formed only in accordance with the speci�ic requirements of each state’s limited partnership act. With the exception of Louisiana, all states, Washington, D.C., and the U.S. Virgin Islands have adopted the 1916 and 1976 versions of the Uniform Limited Partnership Act (ULPA). This chapter will concentrate on the 1976 version of the ULPA (as amended in 1985) as it represents the law in the majority of jurisdictions. For the sake of simplicity, the act will be referred to simply as the ULPA from this point on. As always, keep in mind that the law in the individual states may vary and is always subject to change.

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29.1 Formation of a Limited Partnership A limited partnership is a special type of partnership made up of both general and limited partners. There must be at least one or more general partners who manage the business and have unlimited personal liability for partnership debts. In addition, limited partners contribute capital to the business and share in its pro�its, but their liability is limited to their investment in the business. Being a limited partner is desirable because the limited partnership is an investment device. The limited partner is loaning money to the business and is not interested in helping to run or manage it; instead, he or she is doing something more like buying shares of stock with the expectation of a return, as in an oil and gas venture.

Filing a Certificate of Limited Partnership

In order to form a limited partnership, a certi�icate of limited partnership needs to be executed and �iled with the appropriate state of�ice, usually the of�ice of the secretary of state. Once it is �iled, the limited partnership comes into existence. The certi�icate usually includes the following information:

1. The name of the limited partnership;

2. The address of the of�ice;

3. The name and the business address of each general partner; and

4. The latest date upon which the limited partnership is to dissolve

As should be apparent from these requirements, the main purpose of requiring the limited partnership certi�icate to be executed and �iled is to give notice to the general public of the existence of the partnership and the identity of its general partners, who will ultimately retain unlimited personal liability. Once a certi�icate of limited partnership is �iled, it can be amended by duly notifying the secretary of state of any desired changes. Amendments to the certi�icate are mandatory and must be made within 30 days after the admission or withdrawal of a general partner or the continuation of the business after the happening of an event that requires its dissolution, such as the withdrawal of a general partner.

Admission of New Partners

A person may become a limited partner at the time of the original formation of the limited partnership or "at any later time speci�ied in the records of the limited partnership for becoming a limited partner" (ULPA § 301(a)(2)). After originally �iling the certi�icate with the secretary of state, a limited partner may be admitted as provided for in the partnership agreement. Or, if no provision is made in the agreement, that person can be brought in by the unanimous consent of all partners.

General partners may also be admitted after �iling the original certi�icate of limited partnership, either as provided in writing in the partnership agreement or with the written consent of all partners. In most states, corporations are allowed to be general or limited partners in limited partnerships.

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29.2 Rights and Obligations of General and Limited Partners The rights and obligations of general partners in a limited partnership are similar to those of partners in a traditional partnership (see Chapter 28 (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/ch28#ch28) ). General partners are co-owners of the business who owe the business the �iduciary duties of agents and who share in the management and the pro�its of the business, as well as in its debts. Limited partners, on the other hand, share only in the pro�its of the business and are liable for its debts only up to the limit of their capital investment. They are prohibited from participating in the control of the business.

Purported Limited Partners

If a limited partner participates in the control of the business, he or she will be "liable to persons who transact business with the limited partnership reasonably believing, based upon the limited partner’s conduct, that the limited partner is a general partner" (ULPA § 303). In addition, he or she can lose his or her special status and be subject to unlimited liability for the debts of the business to persons who, in the course of good-faith business dealings, believe the limited partner to be a general partner. In other words, a limited partner who becomes involved in the management of the business is estopped from denying he or she is a general partner with regard to persons who might have reasonably believed him or her to be a general partner because of his or her involvement in managing the business. A limited partner who allows his or her name to be used in the name of the partnership (a privilege reserved to general partners) will be liable as a general partner to any person who extends credit to the partnership without actual knowledge that the partner so named is only a limited partner (see also the subsection titled "Purported Partners" in Chapter 28).

Voting Rights

Despite the prohibition on limited partners managing the partnership, limited partners can be granted the right to vote along with general partners on some partnership matters by express provision in the limited partnership agreement. Note, however, that even if they vote on any of the following matters, that does not constitute participating in management of the business:

1. The dissolution and winding up of the limited partnership;

2. The sale, exchange, lease, mortgage, pledge, or other transfer of all or substantially all of the assets of the limited partnership;

3. The incurrence of indebtedness by the limited partnership other than in the ordinary course of its business;

4. A change in the nature of the business;

5. The admission or removal of a general partner;

6. The admission or removal of a limited partner;

7. A transaction involving an actual or potential con�lict of interest between a general partner and the limited partnership or the limited partners;

8. An amendment to the partnership agreement or certi�icate of limited partnership; or

9. Matters related to the business of the limited partnership not otherwise enumerated in this subsection that the partnership agreement states in writing may be subject to the approval or disapproval of limited partners. (ULPA § 303(b)(6))

When corporations are involved as partners, the liability of the corporation for partnership debts will encompass either all assets of the corporation (if the corporation is a general partner) or the capital invested in the partnership (if the corporation is a limited partner). As you will see in chapter 30 (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/ch30#ch30) , in either case, the corporate shareholders (the owners of the corporation) will be insulated from personal liability beyond their investment in the corporation.

Sharing Profits and Losses

Recall that, in a general partnership, the partners shared the pro�its and losses equally unless the partnership agreement stated otherwise. In a limited partnership, by contrast, the pro�its and losses of the limited partners are distributed in proportion to their respective contributions. ULPA states that unless the partnership agreement states otherwise, "pro�its and losses shall be allocated on the basis of the value . . . of the contributions made by each partner."

Withdrawal by General and Limited Partners

A general partner may withdraw from a limited partnership at any time by giving written notice to the other partners. If the partnership agreement prohibits withdrawal, a general partner may still withdraw but in doing so will be in breach of the partnership contract and can be sued for damages by the other partners. Upon the withdrawal of a general partner, the partnership will be dissolved unless the partnership agreement provides for continuation by the remaining partners in such a situation.

Limited partners may also withdraw at any time upon the happening of events noted in the partnership agreement, or at any time by giving not less than six months’ prior written notice of their intention to all partners. If the limited partner’s right to withdraw is limited in the partnership contract, and the limited partner withdraws in violation of such a contract, then he or she may be liable for breach of contract. The withdrawal of a limited partner will not automatically dissolve the partnership unless the limited partnership agreement so provides.

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Assignment of Partnership Interest

General and limited partnership interests are personal property that may be freely assigned in whole or in part in the absence of an agreement to the contrary. Assignment of a partnership interest will not cause dissolution of the partnership. If a limited partnership interest is assigned, the assignee can become a limited partner of the business with all the rights and responsibilities of the assignor (limited partner).

Dissolution of a Limited Partnership

This section will explore the actions and events that may result in the end of a limited partnership, keeping in mind again that the entity is a creature of state statute. Dissolution of a limited partnership may be divided into two types: judicial and nonjudicial.

Nonjudicial dissolution refers to the termination of a limited partnership as the result of the occurrence of an event under ULPA § 801 as follows:

At the time speci�ied in the certi�icate of limited partnership;

Upon the happening of events speci�ied in writing in the partnership agreement;

With the written consent of all partners; or

By an event of withdrawal of a general partner, unless at the time there is at least one other general partner and the written provisions of the partnership agreement permit the business of the limited partnership to be carried on by the remaining general partner, and that partner does so. (The ULPA continues on to state that the limited partnership is not dissolved and is not required to be wound up by reason of any event of withdrawal if, within 90 days after the withdrawal, all partners agree in writing to continue the business of the limited partnership and to the appointment of one or more additional general partners if necessary or desired.)

The second way to terminate a limited partnership is by going to court and requesting that the court intercede and terminate the partnership. In such a case, the court must �ind that "it is reasonably impractical to carry out the business in conformity with the terms of the limited partnership agreement."

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29.3 Foreign Limited Partnerships A foreign limited partnership, despite its name, is merely a domestic limited partnership that is doing business in a state or states other than the one in which it was organized. Foreign limited partnerships must register and submit a form in duplicate to the appropriate of�ice (generally the secretary of state’s of�ice) in every state where they wish to do business and pay the requisite fees. The ULPA requires that the following information be provided in the application for registration to the secretary of state:

1. The name of the foreign limited partnership and, if different, the name under which it proposes to register and transact business in this state;

2. The state and date of its formation;

3. The name and address of any agent for service of process on the foreign limited partnership whom the foreign limited partnership elects to appoint;

4. A statement that the secretary of state is appointed the agent of the foreign limited partnership for service of process if no agent has been appointed;

5. The address of the of�ice required to be maintained in the state of its organization by the laws of that state or, if not so required, of the principal of�ice of the foreign limited partnership;

6. The name and business address of each general partner; and

7. The address of the of�ice at which is kept a list of the names and addresses of the limited partners and their capital contributions, together with an undertaking by the foreign limited partnership to keep those records until the foreign limited partnership’s registration in this state is canceled or withdrawn.

The registration requirements above are meant to protect the citizens of the state in the event that they have claims against a foreign limited partnership by making it easy to sue both the partnership and its individual members. In addition, the registration fee (which varies by state) is a source of income for state governments. If an application to register as a foreign limited partnership is properly completed and accompanied by the appropriate fee (which varies from state to state), the secretary of state issues a certi�icate of registration to transact business to the applicant, returning a copy of the application to the applicant and keeping one on �ile.

When a foreign limited partnership does business in a state without �iling the required certi�icate, ULPA provides that, until it completes the registration process, the partnership will not be allowed to bring any lawsuit in the state seeking civil relief for alleged breaches in contract or torts committed against it. It can, however, enter into valid contracts notwithstanding the failure to register and can be sued by third parties in the state’s courts.

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29.4 Right of Limited Partners to Bring Derivative Actions Like shareholders of a corporation (see chapter 30 (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/ch30#ch30) ), limited partners in a partnership have the right to bring derivative actions on behalf of the limited partnership if the general partners refuse to do so. A derivative action is an action by a limited partner to enforce a partnership cause of action against third parties that the general partners are unwilling to enforce themselves. ULPA provides that if a derivative action by a limited partner on behalf of the partnership succeeds, a court has the power to award reasonable costs, including attorney’s fees, to the limited partner bringing the lawsuit on the partnership’s behalf. Any recovered amount beyond the costs of litigating the case is then turned over to the partnership. A derivative action can be brought only by a limited partner (while still a partner) for any action that accrued after he or she was admitted as a partner to the limited partnership. In order to bring a derivative action, the limited partner must show that the general partners have been unwilling to bring the action themselves on behalf of the limited partnership and that they are unlikely to do so on their own.

The following case excerpts exemplify the circumstances under which a derivative lawsuit might arise.

Cases to Consider: Day et al. v. Stascavage et al.

Day et al. v. Stascavage et al., Colorado Court of Appeals

The entity at issue is HMC, Ltd., a Colorado limited partnership formed to invest in real property in the Gar�ield County Town of Parachute. Investors hoped a referendum would allow gambling in the nearby City of Ri�le. But the referendum failed. Some of the partnership’s properties were sold in prior transactions that are not challenged. Two limited partners, Judith Day and Bryan Barnes, brought the derivative claims against general partners Hayden C. W. Rader, Michael P. Stascavage, and Chalmers I. Morse. The claims involve the sale of the remaining partnership lots (the property) to general partner Rader. The contract was signed in November 2005, and the sale closed in September 2007. Rader paid $258,000 and also assumed obligations of $66,000.

The limited partners alleged that the sale price was far below the property’s fair market value. Though Gar�ield County had assessed the property at $258,000, the limited partners alleged this tax assessment was formulaically discounted and based on outdated information. They alleged the property was worth well in excess of $1 million and perhaps as much as $4 million. The limited partners asserted several derivative claims, including breaches of �iduciary duty and civil theft. Each veri�ied claim alleged that the property had been sold to Rader for less than its fair market value. The limited partners alleged it would be "futile" to demand that the general partners pursue the claims, as "it is the wrongdoing of the general partners which is at issue."

The general partners responded by agreeing to a court order appointing an SLC (Special Litigation Committee). Ultimately, a Vail, Colorado, lawyer served as the SLC to decide whether the partnership should pursue the claims asserted in the derivative lawsuit. The lawyer’s investigation spanned ten weeks, totaling some thirty hours, and yielded a fourteen-page report recommending that the claims be dismissed. Relying on the SLC report, defendants moved to dismiss the derivative claims. To respond to that motion, the limited partners were allowed to depose the SLC. The court concluded the attorney SLC (1) was "independent and disinterested" and (2) followed "appropriate" investigative procedures. Accordingly, as the SLC had recommended, the court dismissed the limited partners’ derivative claims. The court issued a C.R.C.P. 54(b) certi�ication allowing immediate appeal.

***

Derivative actions provide shareholders an equitable remedy "to protect the interests of the corporation from the misfeasance and malfeasance of ‘faithless directors and managers.’" [citations omitted]. Derivative suits raise two distinct issues: "�irst, the plaintiff ’s right to sue on behalf of the [entity] and, second, the merits of the [entity] claim itself." The �irst is for the court to decide, while the second is for a jury if the claims are otherwise jury-triable. There are prerequisites—including making a demand (or showing futility of a demand) on directors or general partners—to such actions. The limited partners here indisputably complied with these procedures, and no one challenged their allegation regarding the futility of a demand. The question in this case is whether the SLC’s report required dismissal of the derivative claims. Under Colorado law, which follows the New York rather than Delaware approach, a "court may not second-guess [the SLC’s] business judgment in deciding not to pursue the derivative litigation." But before deferring to the SLC, a court must determine that the SLC "was independent, and did employ reasonable procedures in his or her analysis." As our supreme court has explained, "[u]nlike evaluation of a business judgment, trial courts are well equipped to evaluate the methodology and procedures best suited to conduct such an investigation." [citation omitted]

***

The issue thus is whether the SLC’s investigation was suf�iciently thorough to support his or her conclusion. The undisputed facts of this case show the investigation was legally inadequate. The "cornerstone of a court’s review of the SLC’s procedures" is "the thoroughness of that committee’s investigation." Relevant factors include "the length and scope of the investigation, the use of experts, the corporation or defendant’s involvement, and the adequacy and reliability of information supplied to the committee." Courts will not defer to an SLC whose "‘investigation lacked the thoroughness which is necessary for a truly objective and meaningful recommendation.’" Here, the SLC was charged with evaluating the essential fairness of a self-dealing transaction between the partnership and a general partner. Under Colorado

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law, such a transaction is not categorically precluded, but it must be "demonstrate[d] that the transaction took place in good faith, was fair to the [entity], and was accompanied by full disclosure."

There is no dispute that the critical issue in evaluating whether pursuing the derivative claims was in the partnership’s best interests was the value of the partnership property sold in the insider transaction. The derivative claims alleged that the general partners had sold the property to one of their own for much less than the property’s fair market value. The SLC’s report recognized that the focus should be on the transaction’s "fairness" and "whether full value was received in the transaction." And the district court recognized "[t]he key factor" in evaluating fairness was "the price" at which the property was sold.

Despite spending some thirty hours (including general legal research) and writing a fourteen-page report (including general legal discussion), the SLC conducted no independent investigation into this critical point. In a case that cried out for an expert appraisal of the property’s value, the SLC never sought an appraisal.

The district court wrote that the SLC "did not have the Property appraised because such an appraisal would re�lect today’s value, and not the value . . . in November 2005" when two general partners agreed to sell it to the other. That reasoning ignores the availability of "retrospective appraisals," which are necessary and appropriate in a variety of legal contexts. ("Retrospective appraisals [effective date of the appraisal prior to the date of the report] may be required for property tax matters, estate or inheritance tax matters, condemnation proceedings, suits to recover damages, and similar situations."); see generally Hice v. Lott, 223 P.3d 139, 144 (Colo. App. 2009) (noting that Colorado’s "Division of Real Estate adopted USPAP [Uniform Standards of Professional Appraisal Practice] as ‘the generally accepted standards of professional appraisal practice’") (quoting regulation). Here, for example, the limited partners presented the SLC with a historical market analysis of allegedly comparable land. While the SLC was not required to accept that analysis, he could not decline to investigate the property’s fair market value at the time of the insider sale.

The SLC simply accepted, without any independent scrutiny or any expert opinion, the general partners’ reliance on the tax assessment. The limited partners, however, presented the SLC with information that this assessed value was signi�icantly lower than the property’s actual fair market value because it was outdated and based on a statutory formula arti�icially discounting the value of vacant land. Again, the SLC was not required to credit those contentions. But neither could he blithely accept the tax assessment as a fair appraisal of then-current market value.

The SLC admittedly made no effort to investigate whether the county’s tax assessment accurately depicted the property’s fair market value at the time of sale. He was unfamiliar with a possible statutory discounting formula, and he never contacted the Gar�ield County Assessor’s Of�ice to investigate this issue.

It is not our role to consider whether in fact the property was worth more than general partner Rader paid for it. But "courts are well equipped to evaluate the methodology and procedures best suited" to an SLC investigation. Plainly, the SLC’s investigation was procedurally inadequate to support any independent determination of the critical issue whether a general partner bought the property at a price that was fair to the partnership as a whole.

***

Because the SLC did not employ reasonable investigative procedures, the SLC’s conclusion that the partnership should not pursue the derivative claims is not entitled to deference. Accordingly, the limited partners’ derivative suit may now proceed. 13 Fletcher, supra, §  6019.50, at 250 (result of de�icient SLC investigation is that "[t]he shareholder-plaintiff may then resume immediate control of the litigation with a view toward prosecuting it to a conclusion regardless of the position taken by the committee appointed by the board"); see also Janssen v. Best & Flanagan, 662 N.W.2d 876, 889 (Minn. 2003) ("the derivative suit proceeds on its merits" after a court concludes that an SLC investigation was inadequate) (citing cases). The order dismissing the derivative claims is reversed, and the case is remanded for further proceedings consistent with this opinion.

Read the full text of the case here (http://www.courts.state.co.us/Courts/Court_of_Appeals/opinion/2010/09CA2488.pdf) .

Questions to Consider

1. Why did the limited partners have to resort to a derivative action in this case?

2. What are the objectives of a Special Litigation Committee (SLC)?

3. Who won the case? What happens next?

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Key Terms

Click on each key term to see the de�inition.

assignment of a partnership interest (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

Transfer of the right to receive pro�its from a partnership to an outside third party. 

certi�icate of limited partnership (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

The initial paperwork �iled with the secretary of state to form a limited partnership.

certi�icate of registration (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

The form that a foreign limited partnership must �ile in order to legally do business in the United States. In some states, this is also the name given to the form that must be �iled by a domestic limited liability partnership.

derivative action (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

A legal action brought by a limited partner to enforce a partnership cause against third parties that the general partners are unwilling to enforce themselves.

domestic limited partnership (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

A partnership is domesticated in the state where it �iled its original certi�icate of limited partnership.

foreign limited partnership (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

A domesticated limited partnership that is doing business in a state or state other than the one it was organized in.

general partners (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

Co-owners of the partnership who owe the business the �iduciary duties of agents and who share in the management and the pro�its of the business, as well as in its debts.

limited partners (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

Co-owners of a partnership who share only in the pro�its of the business and are liable for its debts only up to the limit of their capital investment. They are prohibited from participating in the control of the business.

limited partnership (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

A special type of partnership that comprises both general and limited partners.

Special Litigation Committee (SLC) (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

Legal experts that help decide whether a partnership should pursue the claims asserted in a derivative lawsuit.

Uniform Limited Partnership Act (original act, 1916; amended in 1976, 1985, and 2001) (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

The law governing limited partnerships promulgated by the National Conference of Commissioners of Uniform State Laws. The 2001 enactment, which combined the ULPA and its revised version (RULPA), has been adopted by 18 states and the District of Columbia.

Chapter 29 Flashcards

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Critical Thinking and Discussion Questions

1. How is a limited partnership formed? What information must be contained in the certi�icate of limited partnership?

2. What is the basic difference between a limited partner and a general partner in a partnership?

3. In most states, may a corporation be a limited or general partner?

4. If the partnership agreement is silent as to the withdrawal of members, what is the effect of a general partner withdrawing from the partnership? What is the effect of a limited partner withdrawing?

5. De�ine foreign and domestic limited partnerships.

6. May foreign limited partnerships do business in states other than the one they were organized in? If so, do they need to follow any speci�ic procedures before they can do business?

7. Tom, Dick, and Harriet start a new tax preparation and �inancial planning business together. Their state does not require any special licensing for such businesses, and, since the three partners are good friends, they do not draw up any speci�ic agreement relating to the business. They do, however, verbally agree that all pro�its of the business are to be shared equally, and so are all losses, except that Harriet will be responsible only up to the extent of her capital contribution in the business. They further agree that Harriet will not have any direct role in managing the business but rather will be an investor. a. What form of business organization do the friends have? Explain. b. Is Harriet a limited partner, since that is obviously the role that the parties intended for her to play in the business? c. Assume that Harriet had invested $50,000 in the business, while Tom and Dick had invested $5,000 each in the venture. What is each party’s potential liability should the business fail?

8. Dominick, Jerry, and Joan are partners in a general partnership involving a lucrative used automobile dealership in northern Pennsylvania. Because of the success of their business, they want to expand their operations to New York and New Jersey, opening two new dealerships in those states. a. Can they reorganize the general partnership into a limited partnership to attract new investors? b. What requirements would have to be met by the limited partnership before it could start doing business in New York or New Jersey?

Transfer of the right to receive profits from a partnership to an outside third party.

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