Cayman Islands: The Evolution Of The Partnership As A Business Vehicle

At its most basic level a partnership requires no formalities or registration and is the simplest manner in which to carry on a business. Partnerships have been used for many centuries and were initially governed by common law rules that evolved to regulate both the dealings of the partnership with third parties, and the dealings of the partners with one another. These rules were largely codified in England by the Partnership Act 1890 (the "1890 Act").

In addition to simple partnerships ("General Partnerships") other forms of partnership have evolved; the limited partnership was established in England by the Limited Partnership Act 1907 (the "1907 Act") and more recently the limited liability partnership has become common in various jurisdictions including the UK. Although the names are confusingly similar, the limited partnership ("Limited Partnership") and limited liability partnership ("LLP") are very different vehicles, as explained in more detail below.

The 1890 Act is still in force in England and Wales in relation to General Partnerships and, where not specifically amended by the 1907 Act, in relation to limited partnerships.

The common law rules encapsulated by the 1890 Act form the basis of the partnership laws in most common law jurisdictions including the Cayman Islands.

In the Cayman jurisdiction partnerships are regulated by the Partnership Law (2002 Revision) (the "Partnership Law") and the Exempted Limited Partnership Law (2003 Revision) (the "ELP Law"). As well as General Partnerships, which are governed by the Partnership Law, the Cayman jurisdiction has two types of limited partnership: the "ordinary" limited partnership ("OLP") which is similar to a UK limited partnership and is regulated by the Partnership Law; and the exempted limited partnership ("ELP"), which is designed to be more appropriate for the Cayman jurisdiction. ELPs are regulated by the ELP Law.

Each type of partnership is discussed in more detail below.

Under the laws of most common law countries (including the English and Cayman laws) General Partnerships have the following attributes unless varied by the terms of the relevant partnership agreement:

• each partner has an equal right to participate in the management and control of the partnership business, and is jointly and severally liable for the partnership’s liabilities;
• partnership is defined as "the relation which subsists between persons carrying on a business in common with a view of profit";
• a General Partnership has no separate legal personality under the law. It exists in aggregate with each of the partners acting as agent of the others;
• General Partnerships are treated as being transparent for tax purposes, meaning the activities of the partnership are treated as carried on by the individual partners and not by the partnership as a body. The partners are taxed individually on their share of the profits or losses; and
• a general partnership is automatically dissolved on the death or bankruptcy of any partner.

A Limited Partnership is similar in many respects to a General Partnership. However, unlike a General Partnership, a Limited Partnership has one or more partners that cannot participate in the management and control of the partnership's business and that (generally) have limited liability in respect of the debts and obligations of the partnership (a "Limited Partner"). Each Limited Partnership must also have at least one partner that has unlimited liability for the partnership’s debts and obligations and responsibility for most of the management of the partnership’s business (a "General Partner"). A General Partner can be either an individual, a corporation or in some jurisdictions another partnership. A Limited Partner that for any reason becomes involved in the management and operation of the partnership can be deemed to be acting as the General Partner and thereby lose its limited liability status, although in some jurisdictions (including Cayman in relation to ELPs) this rule has been relaxed.

The Limited Partnership did not exist at common law and was created in England by the 1907 Act. According to sections 5 and 6 of the 1907 Act:

• a Limited Partnership must be registered with the Registrar;
• a Limited Partner may not withdraw his capital contribution during the life of the partnership (and remains liable to repay it if he does);
• a Limited Partner loses his limited status if he takes part in the management of the partnership business;
• a Limited Partner does not have power to bind the firm;
• a Limited Partner has the right at any time to inspect the books of the partnership;
• the partnership is not automatically dissolved if a Limited Partner leaves the partnership and, unless otherwise specified in the partnership agreement, a Limited Partner may assign his share of the partnership with the General Partner’s consent;
• the General Partner has responsibility for winding up the partnership unless otherwise ordered by the Courts; and
• a Limited Partner shall not be entitled to dissolve the partnership by notice unless otherwise stated in the partnership agreement.

The provisions of the 1890 Act continue to apply to LPs to the extent that they are not specifically modified by the 1907 Act. Therefore a Limited Partnership under English law continues to exist in aggregate and to have no separate legal personality, and continues to be transparent for the purposes of taxation.

OLPs under Cayman law are very similar to limited partnerships under English law, and the rules governing them (set out in the Partnership Law) largely mirror those of the 1907 Act. An OLP therefore must register with the Cayman registrar; its Limited Partners must not participate in the management of the business, and a Limited Partner's right to share in the profits or withdraw capital is restricted.

A Limited Partnership is often used to structure investment funds, with the individual investors each acting as a Limited Partner whose partnership interest (and therefore liability) is the amount invested, and the investment manager acting as General Partner. In the US and the UK LLPs were designed in part to better meet the needs of the investment funds industry. In Cayman, ELPs were introduced to provide more flexibility and to better suit the specific needs of the jurisdiction, including those of Cayman’s significant investment funds industry. The ELP Law is similar to the Limited Partnership legislation in many US states, such as that of Delaware. The ELP Law stipulates that:

• an ELP may be formed for any lawful purpose "to be carried out or undertaken either in or from within the Islands or elsewhere" provided it does not undertake business with the public of the Islands;
• an ELP must maintain a registered office in the Cayman Islands;
• all ELPs must have at least one Cayman resident General Partner (which can be an individual, company or another partnership registered under the Exempted Partnership Law);
• an ELP may not be managed or controlled by a Limited Partner, however some specific activities are deemed not to offend this principle;
• an ELP is not dissolved by a change in the identity of the partners, the assignment of a Limited Partnership interest or the death or bankruptcy of a Limited Partner, and a Limited Partner has the right to assign his Limited Partnership interest;
• ELPs must be registered with the Registrar via a statutory statement signed by the General Partner;
• it is the responsibility of the General Partner(s) to ensure that a register showing partnership interests and particulars including the name and address and contribution of each partner, the amount of any capital returns and the dates thereof is maintained at the registered office and is open to public inspection;
• unless provided otherwise in the partnership agreement, a Limited Partner may demand and shall receive accounts from the General Partner;
• legal proceedings may be instituted by or against the General Partners and not by or against Limited Partners;
• the return of capital contributions made by Limited Partners is permissible so long as the partnership remains solvent following such return however there is a contingent liability to repay such returned contribution the partnership becomes insolvent within 6 months;
• a partner or creditor can apply to the court for an order for dissolution on just and equitable principles. The death, bankruptcy or incapacity of the last remaining General Partner by law determines the partnership unless the Limited Partners replace him within 90 days;
• the General Partner is required to make an annual return to the Registrar regarding compliance with the Exempted Limited Partnership Law;
• a partner can deal with the partnership in which he has an interest in the same way as if he were dealing with a third party but any right to repayment of a debt must be subordinated to all other creditors; and
• a Limited Partnership registered under the Partnership Law is unaffected by the ELP Law but it may be re-registered as an ELP if it so chooses.

The ELP Law does not specifically give ELPs a separate legal entity, and in fact section 21(2) of the ELP Law indicates the contrary is true. OLPs are governed by the Partnership Law and therefore subject to the same definition of "partnership" incorporated from the English 1890 Act. As discussed above, such partnerships exist only in aggregate. Under Section 21(2) of the ELP Law the act of re-registering an OLP as an ELP does not have the effect of creating any new entity. This is supported by the provisions discussed above which state that i) legal proceedings may only be brought against the General Partners; and ii) a Limited Partner is specifically entitled to transact with the ELP itself, an acknowledgement that such a transaction would not be possible in the absence of a specific legislative provision.

Since the beginning of the 1990s a third category of partnership, the Limited Liability Partnership ("LLP"), has become common in many jurisdictions. LLPs are widely recognised at the state level in the US and were established in the UK by the Limited Liability Partnerships Act 2000 (the "LLP Act"). The LLP Act specifically provided that an LLP is a separate legal entity distinct from its members and must be individually incorporated as a corporate body.

An English LLP retains the tax-transparent features of a general partnership and combines that with many features of a limited liability company. Partners may be ordinary partners or "designated partners" which act on behalf of the partnership in the same way as a company director or secretary.

At present LLPs cannot be created under Cayman law and there are no plans to introduce legislation to permit the incorporation of LLPs.

Under both Cayman and English law, the following rules are implied to govern the relationship between the partners of a General Partnership unless otherwise specified in a partnership agreement:

• the partners are entitled to share equally in the capital and profits of the business, and must contribute equally towards the losses whether of capital or otherwise sustained by the firm;
• the firm must indemnify every partner in respect of payments made and personal liabilities incurred by him in the ordinary and proper conduct of the business of the firm, or in relation to anything necessarily done for the preservation of the business or property of the firm;
• a partner making, for the purpose of the partnership, any actual payment or advance beyond the amount of capital that he has agreed to subscribe, is entitled to interest at a specified rate per annum from the date of the payment or advance;
• a partner is not entitled, before the ascertainment of profits, to interest on his capital contribution;
• every partner may take part in the management of the partnership business;
• no partner shall be entitled to remuneration for acting in the partnership business;
• no person may be introduced as a partner without the consent of all existing partners;
• any difference arising as to ordinary matters connected with the partnership business may be decided by a majority of the partners, but no change may be made in the nature of the partnership business without the consent of all existing partners; and
• the partnership books are to be kept at the place of business of the partnership (or the principal place, if there is more than one), and every partner may, when he thinks fit, have access to and inspect and copy any of them.

In relation to a Limited Partnership under English law, and an OLP under Cayman Law the above rules are modified. No limited partner may participate in the management of the business and, unless otherwise specified in a partnership agreement:

• any difference arising with regard to ordinary matters of the partnership business are decided by a majority of the General Partners;
• a Limited Partner may assign his partnership interest with the consent of the General Partners;
• the General Partners may introduce new partners without requiring the consent of the Limited Partners; and,
• a Limited Partner is not entitled to dissolve the partnership by notice.

For a Cayman ELP the rules are similar with regard to the partners dealings with one another, however in an ELP a Limited Partner may perform certain specific activities, set out in section 7(3) of the ELP Law, in relation to the partnership without being deemed to be taking part in the management of the partnership and thereby losing his limited liability status.

Usually the statutory default provisions will not be sufficient to meet the needs of the partnership and a well-drafted partnership agreement is strongly recommended. Because a partnership does not have memoranda or articles of association, a partnership agreement is the one document where all the rules relating to the activity of the partnership are set out and therefore has greater significance than a shareholder’s agreement does to a corporate body. In addition, for many investment funds that are required to register with or be approved by a national regulator such approval or authorisation may only be forthcoming upon submission of an appropriate executed agreement.

Recently the Law Commission of England and Wales, in conjunction with the Scottish Law Commission (the "Commission") published a report recommending reform to UK partnership law. In it, the Commission proposed replacing the 1890 law with new legislation that would specifically give partnerships (both general and limited) a separate legal personality, while also preserving the tax treatment and liability that partnerships currently enjoy. On July 20, 2006 the UK Government announced that it would be adopting the Commission’s recommendations in relation to limited partnerships but not in relation to general partnerships, which will continue to be regulated by the 1890 Act. The UK government is expected to publish its proposed amendments to the 1907 Act in the near future. There is no indication whether similar reforms are considered in the Cayman jurisdiction.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.