Limited Partnerships Bill - still room for improvement

Proposed changes to the Bill establishing limited partnerships in New Zealand will make the structure more appealing to investors but, as Bell Gully partner Andrew Abernethy points out in this article, there are still some key issues to be sorted.

In December 2007 the Commerce Select Committee reported back to Parliament on the Limited Partnerships Bill introduced in August to establish a new regulatory and tax regime for New Zealand for limited partnerships - the internationally preferred legal structure for investing in venture capital.

The Commerce Select Committee's key changes

The committee has recommended several changes which improve the attractiveness of New Zealand limited partnerships as an alternative investment vehicle. Key changes include:

Contracting out obligations

The fiduciary obligations of a general partner to the limited partners may now be contracted out of through the relevant Limited Partnership agreement. A new clause also provides that a limited partner does not have any fiduciary obligations to the limited partnership or to any other partner. While fiduciary principles may have their place in contractual dealings, they are not ideal as mandatory principles for participants in limited partnerships. It is encouraging to see that these principles are now "default" rules, which may be contracted out of by relevant partners. The overseas experience has been that mandatory inclusion of fiduciary principles into a structure such as the limited partnership creates operational uncertainties and inefficiencies.

Information disclosure

The select committee has also proposed a change in requirements around the provision of limited partnership information. While certain information regarding limited partners must be provided to the Registrar of Companies, it is now not to be made available to members of the public (and is not to be subject to Official Information Act requests). The disclosure of limited partnership information, in some jurisdictions, goes beyond basic information and into details of capital commitments. Given that limited partners are not responsible for the debts of the partnership, other than for unpaid capital, details of the identity of the partners rarely provides useful information to members of the public (and is often sensitive).

Business restrictions

Restrictions on limited partnerships engaging in banking and insurance or on listing on securities markets have been deleted from the Bill. The place for these restrictions is in industry-specific regulation (such as banking and insurance legislation or in stock exchange listing rules) rather than an entity-type regulation. There is nothing in the nature of a limited partnership that makes it more or less suitable for listing on the stock exchange, for example, than any other sort of entity.

Remaining areas for improvement

While the amendments are an improvement, there are still several areas where the Bill could be significantly improved.

Control rule

The so-called "control rule", which provides that limited partners are responsible for the debts of the limited partnership if they engage in "control type" activities, is not a good idea even when it is coupled, as anticipated, with a long list of authorised "safe harbour" activities. The Commerce Committee has recommended only that the list of safe harbours be moved from regulations to be made under the Act into the body of the Act itself.

The "control rule" creates uncertainty around limited partners exercising veto, voting and other control rights over the management and operation of the limited partnership and therefore requires elaborate and often exhaustive lists of permitted activities. The rule has led, in its application, to uncertainty and costs for market participants in the administration of limited partnerships worldwide.

A better approach has been adopted by the National Conference of Commissioners on Uniform State Laws in the United States. It does away with the control rule altogether and provides that limited partners are not liable for the obligations of the partnership even if they do engage in the management and control of the limited partnership. The National Conference of Commissioners adopted this principle because it believed that the control rule had become an anachronism in a world with limited partnerships, limited liability companies and other flow through entities and that eliminating the control rule would allow for the "next logical step in the evolution of the limited partnership".

In its submission, Bell Gully recommended that the draft Bill be amended to remove the control rule and with it the need to draft (and continue to keep updated in line with international jurisdictions) the list of safe harbours.

Limited partnership agreement

The Bill has moved from requiring that limited partnerships have a limited partnership agreement to requiring that the limited partnership agreement itself covers certain specified matters. To save time, litigation costs and uncertainty for participants, it would be preferable to create a default set of rules that apply in the absence of agreement to the contrary.

Given the sophisticated nature of participants who are likely to use limited partnerships, almost all limited partnerships established will have detailed limited partnership agreements. Even so, we do not consider that it is good use of public funds to have courts dealing with situations in which the partners to a limited partnership have not addressed a matter that could have been dealt with in default rules.

Taxation of capital gains

One of the principal benefits of limited partnership structures internationally is the ability to compensate the general partner through its "carried interest" profit participation. A key element of this is that the character of the partnership gains (i.e., capital gains or ordinary income) are preserved in the hands of all partners (whether limited partners or general partners). In theory, this allows a general partner to receive a "performance fee" as a non-taxable capital gain (and on which no value added or sales tax) would be assessable.

However, under New Zealand income tax law partnership gains derived from realisations of portfolio securities will, where those securities are held on revenue account, be taxed at marginal income tax rates, to all partners - thereby making the structure less attractive in some respects than a "portfolio investment entity" which pays no tax on sales of New Zealand (and some Australian) equity securities.

Next steps

The Bill is currently awaiting its second reading in Parliament. If it passes into law as planned, the Bill will come into force on 1 April 2008. In the meantime, regulations (provided for in the Bill) will need to be enacted before the Bill comes into force. We will keep you informed of any further developments.

For further information on the Bill contact your usual Bell Gully adviser.

To access a copy of the Select Committee's Report on the Limited Partnerships Bill visit Parliament's website www.parliament.nz or click here. To access a copy of the consultation document for the Limited Partnerships Bill: Safe Harbours and Fees Regulations visit the Ministry of Economic Development's website www.med.govt.nz or click here.

Enquiries and information

For more information on any of the cases, articles and features in Commercial Quarterly, please email Diane Graham or call her on 64 9 916 8849.