PE funds: Risks to LP limited liability status 

One of the key attributes of an English limited partnership is that the general partner has unlimited liability for the debts and obligations of the limited partnership.

A limited partner by contrast, enjoys limited liability status, provided that such limited partner does not participate in the management of the limited partnership business. Where a limited partnership is not a private fund limited partnership (see below), a limited partner's liability is limited to its capital contribution to the limited partnership. Therefore, in an English limited partnership, a limited partner's investment has been commonly structured as 99.99% loan (or advance) to the limited partnership with the remaining 0.01% as a capital contribution to the limited partnership.

If a limited partner does participate in management of the limited partnership, such limited partner will forego its limited liability for the period during which it participates in the management of the limited partnership. What conduct constitutes 'management' is a notoriously grey area. In recent years, limited partners have been negotiating ever greater consultation and approval rights with the fund manager and/or general partner which will often be documented by way of a side letter with each individual limited partner.

Investors will often negotiate for a place on the Limited Partners Advisory Committee (LPAC), a body usually comprised of representatives of no more than five or so of the largest investors. The LPAC will have additional rights to review, consult on and approve the decisions of the general partner and/or the fund manager.

The powers of the LPAC will vary from fund to fund and often depend on the relative negotiating positions of the limited partners and the fund sponsor. Commonly in fund documentation the LPAC is entitled to:

1. resolve any issues relating to changes to the fund's investment objectives or investment limitations

2. resolve any potential conflicts of interest between the general partner, the fund manager and/or their respective associates and the limited partnership

3. approve any investment by the limited partnership which exceeds any concentration limits set out in the limited partnership agreement

4. approve extensions to the investment period or extend the term of the limited partnership

5. approve the appointment of replacement key persons following a key person event

6. approve the change in the valuer or auditors appointed to the limited partnership, and

7. consult on the termination of the limited partnership.

The majority of matters over which the LPAC has approval rights are largely 'operational matters' and it is not generally expected to see the LPAC have any discretion over the investment decisions of the fund as this is likely to trespass into 'management' of the limited partnership.

In Certain Limited Partners in Henderson PFI Secondary Fund II LLP (a firm) v Henderson PFI Secondary Fund II LP (a firm) [2012] EWHC 3259 (Comm), it was held that a claim brought by the limited partners against the fund manager constituted 'management' of the limited partnership. Therefore, although the limited partners were entitled to bring the claim, in doing so they would forfeit their limited liability and become liable to the creditors of the limited partnership.

In an acknowledgement of the consequences of limited partners participating in the management of a limited partnership and in an attempt to preserve a limited partner's limited liability, limited partnership agreements are frequently drafted to expressly prohibit limited partners from participating in management.

Private fund limited partnerships

The Legislative Reform (Private Fund Limited Partnerships) Order 2017, SI 2017/514 has introduced private fund limited partnerships (PFLP) into the UK limited partnership framework and has amended the Limited Partnerships Act 1907 (LPA 1907) for PFLPs to clarify what constitutes management of a PFLP.

While the principle of limited liability for limited partners also applies to PFLPs, the legislation now provides for a non-exhaustive 'white list' of activities which PFLPs may conduct without jeopardising their limited liability status. White list activities include:

1. taking part in a decision about variation of the limited partnership agreement (LPA) or associated documents

2. taking part in a decision about whether the general nature of the partnership business should change

3. taking part in a decision about whether a person should become or cease to be a partner

4. enforcing an entitlement under the partnership agreement, provided that the entitlement does not involve taking part in the management of the partnership business

5. appointing a person to wind up the limited partnership

6. discussing the prospects of the partnership business

7. consulting with the general partner or fund manager about the affairs of the partnership or its accounts, and

8. taking part in a decision to approve or authorise an action proposed by the general partner/fund manager to sell/buy any business by the partnership.

Although the white list provides safe harbours for PFLPs, it does not create any presumptions for limited partners in limited partnerships. It is worth noting that limited partners are not entitled to carry out actions on the white list if they are otherwise not permitted to do so under the governing LPA.

It is expected that the majority of new private funds will be established as PFLPs and that existing limited partnerships, where eligible, will convert to PFLPs. The white list has provided welcome clarification over the definition of 'management' in a PFLP, and should provide for greater certainty to the extent to which the LPAC may have approval rights in respect of the activities of the limited partnership.