Loss of Limited Liability Protection for Limited Partners – Different Rules in Different Provinces
Limited partnerships are a commonly used investment structure in Canada as, generally speaking, they provide a more tax efficient investment vehicle than corporate structures. In Canada, dividends from corporations are subject to two layers of taxation - corporations are taxed on their income before paying dividends to their shareholders and shareholders are taxed on dividends that they receive from the corporation. However, in Canada, unless the partnership is listed on a recognized stock exchange, the limited partnership itself is not taxed but rather the taxable income and losses of the limited partnership flow through to the partners. In other words, the same dollar is only taxed once in a limited partnership structure (in the hands of the limited partners) whereas it is taxed twice in a corporate structure (in the hands of the corporation and then again in the hands of the shareholder).
Another benefit of limited partnerships is that they provide limited liability protection to the limited partners of the partnership.
However, the degree of limited liability protection and the circumstances under which that protection can be lost is not the same in all of the Canadian provinces. Therefore, consideration of those differences should be given before choosing the jurisdiction of formation and operation of a limited partnership.
In most Canadian provinces, the general partners of a partnership are responsible for all of the obligations of the partnership whereas a limited partner is not liable for the obligations of the limited partnership except in respect of the value of money and other property that the limited partner contributes or agrees to contribute to the limited partnership. But the limited partner can lose that limited liability protection and be treated as a general partner (i.e. responsible for all of the debts of the partnership) in certain circumstances.
For example, under the limited partnership statutes in Ontario and Alberta, a partner loses its limited liability protection, and becomes liable as a general partner, if the partner, in addition to exercising its rights and powers as a limited partner, takes part in the “control” of the business of the partnership. The partnership legislation in British Columbia goes a step further and provides that a limited partner loses its limited liability protection, and becomes liable as a general partner, if the limited partner takes part in the “management” of the business of the partnership.
There has been limited judicial consideration of these provisions but suffice to say that limited partners need to be careful about taking any actions that might be considered to be “control” or “management” of the business of the partnership.
However, the Manitoba Partnership Act contains three key differences that provide significantly greater limited liability protection to limited partners of partnerships governed by that statute. That act provides that when a limited partners takes an “active part” in the business of the partnership:
- The limited partner is liable as if a general partner of the partnership but only to any person that the partner itself deals with on behalf of the partnership;
- The limited partner will only be liable to such a person if that person does not know that the partner is a limited partner; and
- The liability of the limited partner to such a person will only extend to liabilities incurred between the time that the limited partner first dealt with such person and the time that such person acquires actual knowledge that the partner is a limited partner.
This allows a limited partner of partnership governed by the Manitoba Partnership Act to take a more active role in the management and control of the partnership, including steps to protect the partner’s investment, without fear of losing the partner’s limited liability protection (provided the limited partner takes certain precautions such as identifying itself as a limited partner of the partnership to any person with whom the limited partner is dealing with on behalf of the partnership).
There is an open question as to whether the courts in a jurisdiction outside of Manitoba would apply the legislated principles of the Manitoba Partnership Act to a partnership formed under that act if the partnership itself did not have a significant connection (i.e. investors or operations) to Manitoba. While the answer should be yes, unfortunately the issue has not yet been judicially considered.
Invitation for Discussion:
If you would like to discuss this or any other business law matter, please do not hesitate to contact one of the lawyers in the Business Law group at Nerland Lindsey LLP.
Note that the foregoing is for general discussion purposes only and should not be construed as legal advice to any one person or company. If the issues discussed herein affect you or your company, you are encouraged to seek proper legal advice.