Viewpoint: Limited partnerships offer new investment vehicle opportunity

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The limited partnership has its origins in the Middle Ages when it was considered below the dignity of an Italian nobleman to dirty his hands in trade. A limited partnership allowed him to invest in the name of a trusted mercantile partner and share the profits of the venture while capping liability at an agreed amount.

The modern concept of limited partnership was recently introduced to China through a new partnership enterprise law. It is too early to tell how the business community will take to it.

It has been greeted as a means to raise limited partnership funds, but could it instead become a vehicle for investing in China that will assume a place alongside the equity joint venture, co-operative joint venture and wholly foreign-owned enterprise?

Specific rules applicable to limited partnerships are set out in the law. General rules applicable to partnerships also apply. The ministry of commerce is drafting rules that will apply to foreign-invested partnerships.

The obvious questions are these. For fund formation, what advantage does the limited partnership offer over the foreign-invested venture-capital “partnership” enterprise, a business form that has not really taken off? Secondly, as an investment vehicle, what flexibility does it offer compared with a joint venture or WFOE?

The answers are finely balanced, with the flexibility granted by the partnership law clipped unfortunately by the ministry of commerce’s draft rules.

Foreign investors will find that China’s limited partnership has features similar to those of limited partnerships under the laws of the Cayman Islands and Delaware.

China’s law provides for the basic distinction between “ordinary” or general partners, who are jointly and severally liable for the debts of the partnership, and limited partners, whose liabilities are capped at their agreed capital contributions.

Under Cayman Islands and Delaware law, a limited partner’s limited liability is at risk if it participates in running the business, but certain consultative and participatory acts do not constitute descending into the fray. China’s law has a similar provision although it does not expressly state the consequence if a limited partner does manage the business.

There appears to be almost complete freedom granted for the parties to decide on profit shares, but the rules change where a foreign investor is involved. So where sectoral regulations provide that the Chinese party to a venture should have a controlling interest, the allocation of profits must reflect that. In such a case, decision making also rests with the Chinese partner, although the foreign investor is protected in statutorily specified matters that require unanimous consent.

There is general flexibility to decide when capital contributions have to be made, but in the case of a foreign-invested partnership the law imposes a rigid 90-day deadline. There is thus little flexibility for contributions to be made on a commitment basis. Ordinarily, a limited partner can withdraw capital during the continuance of the partnership but again, this is not possible in a foreign-invested partnership.

On the positive side, new partners can be admitted without the consent of existing partners if the partnership agreement allows. An assignment of interest by one partner to another does not require the consent of other partners, but notice must be given. An assignment to a third party does require consent.

A limited partnership is not a legal person. This means that partners will be taxed on a see-through basis. It is unclear how certain foreign investment restrictions will be applied, such as those requiring real estate to be held through a Chinese entity. Will the existence of a single foreign partner disqualify a limited partnership from making such an investment?

Finally, a state-owned enterprise cannot be a general partner so it would appear that the limited partnership will have a greater role in the private sector than the public.

The writer is a partner at White & Case in Hong Kong and the author of The Law and Practice of Mergers & Acquisitions in the People’s Republic of China, to be published by the Oxford University Press in October

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