What is the current status and proposed impact of the Legislative Reform (Private Fund Limited Partnerships) Order 2017 (LRO)? Sharon Ayres, partner, and Alastair Dolman, associate, both at Gowling WLG, explain that the changes the LRO could initiate when it comes into force in April 2017 are, overall, to be welcomed. However, they point out that the changes may ultimately be short-lived, considering the call for a review of the UK limited partnership framework from the Department for Business, Energy & Industrial Strategy. Original news Legislative Reform (Private Fund Limited Partnerships) Order 2017 SI 2017/Draft: Limited partnerships which are collective investment schemes may now be designated as a private fund limited partnership (PFLP). Provision of legislation regarding limited partnerships is also amended. These changes come into force on 6 April 2017. What is the background to the LRO Proposals for reform of the law governing limited partnerships have been touted for many years. This is not surprising because the applicable legislation is over a century old (being the Partnership Act 1890 (PA 1890) and the Limited Partnerships Act 1907) and simply cannot deal effectively with the demands of businesses today. In November 2003, the Law Commission and the Scottish Law Commission published a report on partnership law and the government announced in 2006 that it intended to implement a number of its key recommendations. In August 2008, a consultation was launched, largely based upon the Law Commission’s recommendations, and the response to the consultation was published about a year later in March 2009. However, in a peculiar U-turn, none of the useful recommendations were taken forward. There followed a few years in which very little happened, save for the continued growth in the use of limited partnerships as private fund vehicles. Other countries, such as Jersey and Luxembourg, continued to react to the demands of the market and introduced limited partnership vehicles that addressed many of the concerns that the Law Commission and Scottish Law Commission raised in their 2003 report. However, in the 2013 Budget, the government announced that it would launch a consultation on amendments to partnership legislation as it applies to private funds, with a view to improving the UK’s competitiveness as an asset management centre. This led to the consultation, issued in July 2015, entitled ‘Proposal on using Legislative Reform Order to change partnership legislation for private equity investments’. The consultation ran through until 5 October 2015 and ultimately led to the issue of the LRO on 16 January 2017. What type of vehicle can benefit from the changes and will the apply automatically? The LRO is due to come into force on 6 April 2017. It will benefit limited partnerships that meet the private funds limited partnership (PFLP) conditions (listed below) and are so registered. A limited partnership may only be a PFLP if it satisfies the following two conditions: it is constituted by an agreement in writing—this should be easily satisfied as a limited partnership agreement is always put in place for private funds, and it is a collective investment scheme (CIS) for the purpose of section 235 of the Financial Services and Markets Act 2000 (FSMA 2000)—most private funds will be a CIS and even if such a fund has opted to take advantage of an exemption to FSMA 2000, s 235 it is still able to be a PFLP pursuant to the terms of the LRO Practically speaking, a private investment fund structured as a limited partnership will therefore virtually always satisfy the above requirements and will have the option to be designated as a PFLP. However, an existing limited partnership will not automatically be reclassified as a PFLP; an application will need to be made after 6 April 2017 using the new Companies House form LP8. The general partner will need to confirm that the limited partnership satisfies the requirements of a PFLP (as set out above). There will be no time limit as to when an existing limited partnership may file form LP8 and be designated as a PFLP. But limited partnerships established after 6 April 2017 may elect to be designated as a PFLP by filing new Companies House form LP7 upon formation. What are the main changes that are being introduced? There are five main changes to be introduced. They are as follows. The introduction of a ‘white list’ of activities that can be undertaken by limited partners As the name suggests, limited partners have the benefit of limited liability in respect of the partnership’s losses and liabilities. However, this benefit is secured only to the extent that a limited partner does not take part in the management of the business of the partnership. If its actions amount to taking part in the management then it loses its limited liability during such period. This rule has been criticised as it does not confirm what actions a limited partner can legitimately take in order to monitor and protect its investment. The white list is a non-exhaustive list of activities that limited partners can undertake without automatically being considered as taking part in the ‘management’ of the partnership’s business and risk losing their limited liability status. By way of example, the white list includes (among other matters) the following: taking part in a decision about the variation of the partnership agreement, whether the general nature of the partnership business should change, and partners joining and leaving the partnership appointing a person to wind up the partnership enforcing rights under the partnership agreement appointing or nominating persons to represent the limited partner on a committee (or revoking any such appointment or nomination) taking part in a decision approving an action proposed to be taken by the general partner in relation to the disposal of all or part of the partnership business (or the acquisition of another business by the partnership) or the acquisition or disposal of a type of investment or a particular investment by the partnership The white list confirms that actions such as the above can be taken, provided that the exercise of the right does not involve the taking part in the management of the partnership business. The intention of the list is to confirm that limited partners can advise and consent to actions taken by the general partner but not to act on behalf of the partnership. Capital contributions Limited partners are currently required to commit a capital amount to the limited partnership and notify Companies House of the amount. Their liability to the partnership is limited to the amount of that capital commitment and it is not possible to withdraw the capital committed until the partnership is wound up. This rule has led to a peculiar practice in which limited partners typically advance a nominal amount of capital to the partnership and advance the balance as a loan. Details of the loans committed are private and not notified to Companies House and the terms can be drafted flexibly to allow easy repayment. The requirement for capital contributions will be abolished for limited partners in a PFLP set up after 6 April 2017. Capital contributions will remain a requirement for typical limited partnerships. Furthermore, if an existing limited partnership converts to a PFLP, existing capital contributions will remain available to creditors and cannot be withdrawn by limited partners. Winding up A number of difficulties can arise in practice with regard to the winding up of a limited partnership—especially if the general partner has been removed. The LRO provides that if there is no general partner, then the PFLP may be wound up by a third party appointed by the limited partners (subject to any express or implied agreement between the limited partners as to the winding up of the partnership). This will reduce both the time and cost of a winding up. Removal of certain statutory duties Limited partners in a PFLP will not be subject to a number of the requirements of PA 1890. The government acknowledged that these duties were not consistent with the role of an investor within an investment fund. As such, the following sections of PA 1890 are disapplied in respect of PFLPs: PA 1890, s 28 (being the duty of the partners to prepare full accounts and provide these accounts to the other partners within the partnership), and PA 1890, s 30 (being the restriction on partners from carrying on any business of the same nature or competing with the partnership and the duty to account to the partnership for any profits made in connection with such similar/competing business) In addition, PA 1890, s 36(1) is disapplied where a partner in a PFLP ceases to be a member of the partnership and therefore no notice is required in respect of a change in the partners within a PFLP. Administration and information requirements A PFLP will not be required to file changes with Companies House that relate to: the nature of the partnership’s business the term of the partnership, or the sum of capital contributed by any limited partner to the partnership There will also be no requirement, in respect of a PFLP, to advertise certain matters in the Gazette (such as the transfer by a limited partner of its partnership interest). This is a welcome change as the requirement can often be overlooked and, while it ultimately served little purpose, it can have some potentially serious consequences. Which changes do you think will have the most impact on the private equity industry? The introduction of the white list will be welcomed by investors. Investors are often keen to oversee and monitor the performance of their investments—especially if an investment is not performing as expected. Fund managers will be keen to work with their investors but will be more cautious on the level of involvement because they will not want to see any unnecessary delays in their being able to take decisions in light of market opportunities and developments. Employees of private equity managers that take an interest in the fund as limited partners, meanwhile, will also welcome the clarification that their investment attracts limited liability. The white list also includes the ability for limited partners to appoint a representative to an investor committee of a PFLP. Most private funds are established with some form of investor committee but there were previously some concerns that participating on such a committee may involve a degree of management and hence pose a potential challenge to limited liability status. Partnership agreements have typically been drafted in order to try to emphasise that participation on such a committee was not management and ultimately provide an indemnity to those participating on the investor committee. The LRO now legitimises this very useful investor body. The removal of certain administration requirements in respect of PFLPs (as noted above) will also be particularly useful for both the private equity industry and other private funds. The amendments will save time and costs for fund managers and investors alike. Do you think the 'white list' of activities covers the typical activities carried out by limited partners? Many investors want minimal involvement with their investments—they pay a significant fee to the fund manager to deliver the investment objective of the fund and they are happy to receive periodic updates. However, this position alters significantly if a fund is not performing as expected, plus there are a number of investors who are more ‘hands on’ in monitoring their investments. On the whole, the white list covers the majority of the areas in which investors will typically seek to be involved. How will the white list affect the extent to which investor limited partners are involved in decision making for a PLFP and do you think it will encourage them to demand more rights? The activities listed in the white list are not automatic rights granted to limited partners—they will need to be included within the partnership agreement. However, the white list provides greater clarity on what they may and may not do without risking their limited liability status and will provide investor limited partners with more confidence in requesting the rights listed in the white list. In fact, with large (or otherwise powerful) investors, we should expect to see reference to most, if not all, items in the white list appearing in partnership agreements (or side letters) in due course. It is worth noting, however, that the LRO is very clear that the role of the white list is not intended to prejudice the role of the general partner—the intention is to provide the limited partners with sufficient scope to monitor and assess the performance of investments and to approve the actions of the general partner. It is not to enable the limited partners to act and take decisions on behalf of the partnership. The distinction may not always be clear, but a useful example is referred to in the explanatory document issued with the draft LRO. It states that with respect to a specific investment, the general partner is responsible for researching and selecting investments and representing the partnership in respect of dealings with investee companies. The limited partners are only able to advise the general partner and consent to specific investments but cannot be involved in the selection process or execution of the investment. As a result, some care will still be needed to ensure that limited partners that wish to be more actively involved with decision making of the PFLP do not step over the line into taking part in the management of the business of the partnership. How has the private equity industry reacted to the proposals and do you think there will be much take up of the PFLP status? Broadly, private equity investors have reacted very positively to the proposals and have strongly endorsed the reforms. In particular, the British Private Equity & Venture Capital Association (BVCA) commented in their response to the consultation that the proposals will ensure the continued viability of English limited partnerships as private fund vehicles and, in turn, the competitiveness of the UK as a jurisdiction of choice for private fund sponsors. While it may have been anticipated that there would be some reluctance of fund managers to embrace the wider rights of investors, the LRO has expressly confirmed that the intention behind the white list is not to permit limited partners in a PFLP to carry on new activities (which would otherwise amount to taking part in the management of the partnership’s business). Rather, it should provide certainty to limited partners that they are able to carry on certain activities without risking their limited liability status. We would anticipate that there will be a positive take-up of PFLP status. Do the changes go far enough to maintain the UK limited partnership structure as a competitive option for European private equity and venture capital funds? The provisions contained in the LRO have been needed for some time in order to keep the UK attractive to investors and to ensure it remains competitive globally with the investment vehicles offered by other jurisdictions (particularly Jersey and Luxembourg). The white list will remove a great deal of uncertainty in this area in respect of PFLPs and reduce some of the unnecessary administrative burdens. Nevertheless, there were several additional amendments proposed by certain groups within the private equity industry during the consultation that have not been included within the LRO. These include: a separate legal personality for English limited partnerships (as Scottish limited partnerships already have) a simplified process for the registrar to remove inactive limited partnerships, and the removal of the requirement to notify Companies House of the identity of limited partners—the rationale behind this being that limited partners are passive investors and would welcome the additional confidentiality this would offer While the white list did not extend to some of the more far reaching provisions, we feel that, on the whole, the list is useful. Is there any indication that similar changes may be made in respect of all limited partnerships? On the same day that HM Treasury published the LRO, the Department for Business, Energy & Industrial Strategy (BEIS) also published a call for evidence to consider whether the current UK limited partnerships (UKLP) framework needs to be reviewed, with a view to increasing transparency and reporting requirements, or possibly by amending some of the legal characteristics of partnerships. The call for evidence principally stems from reports that Scottish limited partnerships are potentially being used as vehicles for criminal activity. BEIS also reports that there has been a sharp increase in the number of registrations of limited partnerships in Scotland since 2010 when compared to the numbers established in England, Wales and Northern Ireland. There is little evidence to explain why there has been such a disproportionate increase in Scottish limited partnerships or information to demonstrate that such increase is benefitting the Scottish economy (or the UK as a whole) as a result. In addition to the above, BEIS are also looking more broadly at the regulation of limited partnerships with respect to transparency requirements, the arrangements for the ending of a limited partnership, the role of formation agents, and the limited partnership’s principal place of business for the purposes of registration and service of legal documents. The call for evidence closes on 17 March 2017. It is therefore likely that the new PFLP regime will come into effect before any of the issues in the BEIS paper become formal proposals to amend the law on UKLPs. Therefore, the reduction in the compliance and administrative burden under the new PFLP regime may be short-lived and may well be replaced by other initiatives to increase the accountability for UKLPs more generally. Only time will tell as to whether we can therefore expect similar changes on the horizon for all UKLPs. When do the changes come into effect? If approved by the government, the changes will come into effect on 6 April 2017. Interviewed by Giverny Tattersfield. The views expressed by our Legal Analysis interviewees are not necessarily those of the proprietor.