Today we continue on in our Business Entity Selection Series.  If you missed any prior posts, click here.

What is a limited partnership?  Texas law defines a limited partnership as a partnership having one or more general partners and one or more limited partners.  See Texas Business Organizations Code Section 1.002(50).  General partners may participate in the control of the business but are not given any limited liability.  On the other hand, a limited partner is afforded limited liability, but may not participate in the control of the business.  Limited partnerships can be particularly attractive for situations where there is one on-farm heir who needs management control and another off-farm heir who does not need to be involved in the day-to-day operations.

Texas A&M Agrilife Extension photo by Kay Ledbetter

Governing Law:  In Texas, limited partnerships are governed by the Business Organizations Code, Chapter 153.  In the absence of contrary provisions in a partnership agreement, the statute serves to provide the default terms governing limited partnerships.  As with other entities, in the absence of contrary provisions in a limited partnership agreement, the Texas Business Organizations Code’s terms apply.

Formation: In order to form a limited partnership, a Certificate of Formation must be filed with the Texas Secretary of State.  See Texas Business Organizations Code Section 3.011(a).  The Certificate of Formation will include basic information such as the name of the entity (which must include either “limited,” “limited partnership,” or an abbreviation of either of these), a statement that it is a limited partnership, the name and address of each general partner, the address of the registered office and registered agent for service of process, and the address where books and records will be kept.  See Texas Business Organizations Code Section 3.005.  A filing fee of $750 is also required.  Additionally, a limited partnership must have a partnership agreement, but there is no requirement that it be in writing, although having a written, detailed partnership agreement is certainly recommended.

Management:  A general partner has the right to participate in the control of the business just as if it were organized as a general partnership.  See Texas Business Organizations Code Section 153.152, Importantly, however, a limited partner may not be involved in activities that constitute “participating in the control” of the limited partnership, or he or she risks losing the limited liability afforded to limited partners.  See Texas Business Organizations Code Section 153.102(a)(2).  The issue of whether a limited partner participated in control is a factual question, which must be determined on a case-by-case basis.  By statute, there are certain activities that do not, alone, constitute participating in control.  These include: acting as a contractor or agent of the limited partnership, serving as an officer, director, agent, or member of any entity serving as a general partner, consulting or advising the general partner, acting as a surety or guarantor of the limited partnership, involvement with meetings of the partners, or voting on a number of matters.  See Texas Business Organizations Code Section 153.103.

General partners owe a duty of care and duty of loyalty to other partners.  See Hughes v. St. David’s Support Corp., 944 S.W.2d 423 (Tex. Ct. App. – Austin 1997).  Limited partners, however, do not owe these duties.  See Texas Business Organizations Code Section 153.003(b), (c); Strebel v. Wimberly, 371 S.W.3d 267 (Tex. Ct. App. – Houston [1st Dist.] 2012).

Liability:  For a limited partnership, the liability of partners depends on whether the person is a general partner or a limited partner.  A general partner has no limited liability, and are treated the same as a partner of a general partnership.  See Texas Business Organizations Code Section 153.152.  This means that a general partner is personally liable for the debts and obligations of the limited partnership.  On the other hand, a limited partner’s liability for the partnership debts or obligations is limited to that limited partner’s contribution to the partnership.  See Texas Business Organizations Code Section 153.102.  Critically, a limited partner will lose this limited liability if he or she participates in the control of the business, as discussed above.  See Texas Business Organizations Code Section 153.102(a)(2).

Sharing Profits/Losses:  Absent an agreement otherwise, partnership profits and losses are shared by each partner based on the current percentage interest in the partnership records or, if no such records exist, in proportion to their capital accounts.  See Texas Business Organizations Code Section 153.206.  

Tax Treatment:  Although a partnership is a legal entity separate from the individual partners, partnerships are not taxed at the entity level, meaning that each member is responsible for paying the income taxes of the limited partnership.  This is known as a “pass-through entity.”  See TRQ Captain’s Landing L.P. v. Galveston Central Appraisal Dist., 212 S.W.3d 726 (Tex. Ct. App. – Houston [1st Dist.] 2006).

Farm Program Payments:  One potential disadvantage to organizing as a limited partnership for some farmers is that the individual payment limit for the ARC and PLC commodity programs applies to the entity, rather than to each farmer.  So, under the 2014 farm bill, the individual payment limit in the ARC and PLC commodity programs for a person actively engaged in farming is $125,000.  If two brothers were partners of a limited partnership, they would only be eligible to receive $125,000 total as the limit applicable to the limited partnership.  Had they not so organized and had been sole proprietors or a general partnership, each could have received up to $125,000. 

Governing Documents:  A limited partnership must have a partnership agreement.  With limited exceptions, the parties are free to agree to whatever terms and conditions they desire.  See Texas Business Organizations Code Section 153.004.  

Transfer of Ownership/Addition of Partner: Unless the partnership agreement provides otherwise, a partnership interest is assignable and doing so will not cause termination of the limited partnership.  See Texas Business Organizations Code Section 153.251.  The specific rights of the assignee of an interest will depend upon the terms of the partnership agreement, although unless agreed otherwise, the assignee will not have the rights or powers of a partner.  See Texas Business Organizations Code Section 153.251(b)(2).  In order to add a partner, generally, consent of all partners must provide written consent, unless the partnership agreement provides otherwise.  See Texas Business Organizations Code Sections 153.151; 153.101.

Termination of Partnership:  Under Texas law, certain events require the “winding up” of a partnership.  Importantly, the death or withdrawal of a limited partner or assignment of a limited partner’s interest does not trigger winding up, unless the parties agree otherwise.  By statute, the following events trigger “winding up” of a limited partnership:  (1) expiration of a period of duration or completion of the particular undertaking stated in the partnership agreement; (2) voluntary decision to wind up the partnership by all partners; (3) events identified in the partnership agreement as requiring winding up; (4) an event that makes the continuation of the partnership illegal; (5) a court order requiring the partnership to wind up; (6) the withdrawal of a general partner, unless otherwise stated in the partnership agreement; or (7) the event that there are no remaining limited partners.  See Texas Business Organizations Code Section 11.051; 11.058. 

Summary:  A limited partnership must be created by filing a Certificate of Formation with the Secretary of State and required at least one general and one limited partner.  Advantages include limited liability for limited partners, but downsides include no limited liability for general partners and a prohibition on limited partners participating in control.