Partnership Agreements – Managing, General and Limited Partners
Every partnership consists of at least two or more partners. In many partnerships, there are dozens of partners. Each partner is classed into a particular group. There are Limited Partners, General (sometimes referred to as Operating) Partners and of course somebody who is in charge – the Managing Partner. Each of these classes of partners has some form of financial, fiduciary and appointed powers.
The following sections explain the relationship the respective class has to the other classes and to the partnership. For the reader it seems to appear as definitions of terms used. But in reality, the sections are explaining in detail the particular responsibilities and the rights these partners have to all the other partners.
Limited Partners
Limited partners are strictly in the relationship for the financial value risk. Basically a limited partner invests money referred to as their capital investment and recorded in their capital account. In exchange for this investment, the limited partners are in hopes of financial return on the investment. On the flip side of this is the fact that the limited partner is limited to his investment if the partnership financially fails.
This investment is used by the operating partners to conduct business. Many large scale partnerships have limited partners. There are even publicly traded partnerships whereby the limited holders (equity investors) can trade their ownership rights. The most common publicly traded partnerships are in the mining and extraction industries (oil, natural gas, metal extraction and precious stones). Numerically, most partnerships are referred to as general partnerships. But the large capital intensive partnerships include limited partners.
By law, the name of the partnership includes the term ‘Limited’ in its title. This means that the partnership includes this class of partners. In addition, the partnership agreement is written differently by incorporating certain rights and obligations of the limited partners. The following list of rights and obligations is just a short list but hits on most of the major points related to limited partners:
- No Financial Obligation in Case of Bankruptcy or Insolvency;
- No Control over Management – many of your smaller limited partnerships provide for some form of voting rights in an annual election, but the larger capital intensive partnerships, no rights at all;
- Can Vote to Admit New or Replace General Partners;
- Can Vote to Amend the Partnership Agreement.
The partnership agreement has clauses (sometimes referred to as articles or covenants) that spell out the exact powers granted to the limited partners. In many limited partnership relationships, the initial dynamic relates to the losses the business will incur in regards to operations. Many of these limited partnerships are structured to comply with the tax code allowing the losses to pass to the limited investors. Later on as the partnership begins to generate profits and make market gains, the limited partners are sometimes restricted to their share of the wealth. In other agreements, the limited partners get preferred status as success builds and there is some form of a buyout or termination of the limited partner’s rights to the earnings.
Each situation is different and the partnership agreement spells out the legal rights and the associated financial relationship.
General Partners
All partnerships (regular and limited) have at least one general partner. In a regular partnership, all the partners are referred to as general partners. You see this frequently in the professional arrangements such as law firms, accounting practices, medical arrangements, and engineering firms. Every partner is considered a general partner. The partnership agreement is usually structured to set the control elements of the relationship between the partners by granting voting and financial restrictions.
In some partnerships, the relationships may have levels, such as associate partners, general partners and senior partners. Each of these subgroups is assigned voting rights and financial rights in the partnership relationship. Even though this relationship exists, the one single most important characteristic is the fact that every partner has some level of financial obligation in case of failure. The following illustrates this importance of this financial obligation:
In the late 70’s and throughout the 80’s mergers were the rage in business. One particular accounting firm (7th in the nation at that time), Laventhol & Horwath did many of these mergers and was in the process of merging with smaller accounting firms too. The problem was that in bringing in these smaller firms into the practice, their standards of care were nowhere near the level of quality Laventhol & Horwath needed. Thus any existing client issues were transferred to Laventhol & Horwath. Lawsuits began and by 1990, the partnership had reserved $37 Million to pay off these claims. The most noted case related to the televangelist Jim Baker scandal. In addition, the firm was facing $2 Billion of lawsuits related to other cases (those merged into the firm from the smaller accounting firms). The firm filed for bankruptcy. The result was that 629 partners were assigned $67,000,000 ($67 Million) of responsibility related to the debt. That’s $75,000 each (many partners were assigned more). Many of the partners had no wherewithal to pay the debt (remember, this is in 1990, 27 years ago). The court ordered all prior partners back to 1984 included in the bankruptcy order. In addition, the firm had no reserve for its retirement plan or an outside insurance policy to cover these errors. Thus, those retired partners had to not only ante up for their share of the debt, but they also had no retirement income. Laventhol & Horwath no longer exists.
The partnership agreement spells out the financial obligations each partner has to the partnership.
The most important right held by the general partner is the right to vote. Most often this right mirrors their respective percentage of ownership based on their capital account. Partners with more capital in the equity section of the balance sheet have more control over the operation of the partnership. This control is exercised via the election of the managing team. The management team is referred to as the managing partner(s).
Managing Partner
Unlike what most folks think when they read the term managing partner, it doesn’t mean that they are necessarily the boss. What it really means is that this person or team is responsible for the partnership as a whole. They have to make sure the accounting is completed, contracts are negotiated, human resources management is carried out and so on. In general, they only receive higher compensation usually through guaranteed payments or a straightforward bonus. There are no additional voting rights or other positive attributes provided unless written in the partnership agreement. You will rarely see any special privileges granted to this person or team.
One final note, the managing partner(s) do have the right to vote as a general partner, but not as a managing partner. Remember, all managing partners come from the pool of general partners.
Summary – Limited, General and Managing Partners
The following chart illustrates the various fiduciary, financial and appointed powers related to each of the three classes of partners:
Voting Financial Powers
Limited None Beneficial None
General Full Restricted Limited
Managing None Limited to Service Full
Although the general partner as full voting rights, they take on the full responsibility related to the financial well-being of the partnership. In their case, they are liable for any financial deficiencies with the partnership when they exist. Prior to entering into a partnership agreement, I implore upon you to do your research by reading more articles. I have more information available on my legal page on the website. Act on Knowledge.
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