VENTURE CAPITAL LIMITED PARTNERSHIPS

Transcription

1 VENTURE CAPITAL LIMITED PARTNERSHIPS PROPOSED AMENDMENTS TO STATE AND TERRITORY PARTNERSHIP STATUTES TO DEVELOP A WORLD BEST PRACTICE VENTURE CAPITAL INVESTMENT STRUCTURE REVISED SUBMISSION: 24 APRIL 2003

2 VENTURE CAPITAL LIMITED PARTNERSHIPS DEVELOPMENT OF A WORLD BEST PRACTICE VENTURE CAPITAL INVESTMENT STRUCTURE 1. EXECUTIVE SUMMARY Limited Partnerships the issue Proposed amendments Policy considerations development of world s best practice legislation National consistency Overview of limited partnerships across Australia Australian Funds of Funds and Venture Capital Management Partnerships 7 2. KEY AMENDMENTS 8 PROPOSED AMENDMENT 1: SEPARATE LEGAL ENTITY STATUS 8 PROPOSED AMENDMENT 2: MUTUAL RECOGNITION OF STATE LAWS 13 PROPOSED AMENDMENT 3: LIMITATION IN RESPECT OF ALL LIABILITIES 15 PROPOSED AMENDMENT 4: CLARIFYING THE AMOUNT TO WHICH LIABILITY IS LIMITED 17 PROPOSED AMENDMENT 5: CONSEQUENCE OF PARTICIPATION IN MANAGEMENT 20 PROPOSED AMENDMENT 6: SCOPE OF SAFE-HARBOUR PROVISIONS 24 PROPOSED AMENDMENT 7: EXPRESS LIMITATION OF AGENCY 33 PROPOSED AMENDMENT 8: PROPER PARTY TO ANY ACTION 35 PROPOSED AMENDMENT 9: PARTNERSHIP PARTNERS OF A LIMITED PARTNERSHIP 37 PROPOSED AMENDMENT 10: WESTERN AUSTRALIAN, TASMANIAN AND TERRITORY STATUTES 40 PROPOSED AMENDMENT 11: MINOR AND CONSEQUENTIAL AMENDMENTS COMPARISON BETWEEN JURISDICTIONS CONCLUSION 41 APPENDIX A VENTURE CAPITAL 42 What is venture capital? 42 AVCAL, GILBERT + TOBIN and FREEHILLS SEPARATE ENTITY 40 PAGER Page i

3 Why is venture capital essential? 42 Venture Capital Act 2002 and the VCLP 42 What is a VCLP? 43 Employment and economic growth 43 Opportunity loss and Federal government remedy 44 APPENDIX B LIMITATION OF LIABILITY APPENDIX C SAFE HARBOUR PROVISIONS APPENDIX D DEALINGS OUTSIDE STATE OF REGISTRATION AVCAL, GILBERT + TOBIN and FREEHILLS SEPARATE ENTITY 40 PAGER Page ii

4 1. EXECUTIVE SUMMARY The Australian Venture Capital Association Ltd (AVCAL) is seeking amendments to the state limited partnership statutes that will provide institutional investors investing in Australian Venture Capital Limited Partnerships (VCLPs) with certainty concerning the limitation of their liability. These changes are imperative to ensuring that amendments to tax laws passed by Federal Parliament in December (the VCLP reforms) are successful in achieving their objective - securing international foreign capital for the growth and development of innovative Australian companies. Studies commissioned by AVCAL 2 indicate that the introduction of these reforms will lead to investment of more than $1 billion in Australian growth companies, add $350 million to Australian GDP and add $120 million to net exports each year. This document represents a submission to each of the Australian states and mainland territories highlighting the amendments required to ensure that each state and territory benefits from the opportunity presented by the VCLP reforms. Further information about venture capital and its benefits is set out in Appendix A. 1.1 Limited Partnerships the issue The limited partnership statutes of each state purport to constrain the liability of limited partners to the amount recorded in the relevant register of limited partnerships. However there is uncertainty as to whether the limitation of liability is effective in all circumstances and in all jurisdictions. AVCAL seeks amendment of the limited partnership statutes of each state to remove this uncertainty. Without that assurance, international investors may not invest in high growth Australian businesses through Australian VCLPs. Internationally, limited partnerships and variations of limited partnership structures (such as the limited liability company in the United States) prevail as the most common vehicle for venture capital investment. The appeal of these structures lies in 2 key features which they provide to investors flow-through tax treatment and limited liability. The Commonwealth s VCLP reforms have delivered the first of these features flow-through tax treatment and have in addition created federal tax incentives for investment through a VCLP. With these reforms, and the familiarity of the limited partnership structure to foreign investors, Australia now has a commercially realistic way of attracting additional foreign capital. Without effective limited partnership law reform to address the second of these features, there is a risk that some states or territories may not capture VCLP investment and 1 Taxation Laws Amendment (Venture Capital) Act 2002 and the Venture Capital Act Econtech, 2001 AVCAL, GILBERT + TOBIN and FREEHILLS SEPARATE ENTITY 40 PAGER Page 1

5 the benefit of the federal legislation. Accordingly, AVCAL needs the cooperation of the states and territories to ensure that investors exposure to loss through a limited partnership is no greater than the amount of their investment. In particular, investors will require assurance in respect of the following issues: 1. that the limitation of liability provided in the relevant limited partnership statute limits all amounts for which the investor may be found liable; 2. that the effect of the limitation is that limited partners are not liable for the debts and obligations of the partnership, except in certain circumstances where a limited partner has participated in the management of the business of the partnership - ie, that creditors recourse is limited to the assets of the partnership and of the general partner; 3. that investors do not lose their limited liability status if they participate in the management of the business of the partnership within certain safe harbours. Those safe harbours should include provisions allowing activities consistent with the practices and obligations of venture capital investors, in light of modern concepts of sound corporate governance; 4. that if investors do participate in the management of the business of the partnership (eg, by inadvertently exceeding the limits of a safe harbour ), they will be liable only for debts incurred to third parties who reasonably believed that they were managing or acting on behalf of the partnership (and not for all the debts and obligations of the limited partnership); 5. that unless expressly agreed, investors do not become personally liable, as principals, for the acts of the general partner, as their agent, in relation to the management of the business of the partnership; 6. that the general partner and the partnership are the proper parties to an action against the partnership or any partner in relation to the business of the partnership; and 7. that the limitation of liability provided for under the Act is effective under the laws of each jurisdiction in which the limited partnership invests or acts (whether those are the laws of another state or territory, of the Commonwealth or of another country). AVCAL, GILBERT + TOBIN and FREEHILLS SEPARATE ENTITY 40 PAGER Page 2

6 1.2 Proposed amendments AVCAL has analysed the use of limited partnerships in each Australian jurisdiction to determine what amendments to the various state and territory statutes are necessary or desirable to ensure: that a VCLP registered in the state or territory is an effective business structure; and consequently, that venture capital investment is attracted to each Australian state and territory following the tax amendments legislated by the Federal Government in Those amendments are summarised in the following table. Number States Amendment Required Affected 1 All states Establishment of a limited partnership as a separate legal entity. Specification of the capacity and powers of such a limited partnership. Clarification that acts preparatory to the establishment of such a limited partnership and its business do not give rise to a common law partnership. Various consequential amendments. 2 All states Mutual recognition of the limitation of liability of limited partners under other state and territory statutes and the laws of recognised foreign jurisdictions 3 NSW, SA, Tas and WA Limitation of liability of limited partners in respect of all liabilities of the limited partnership (whether contractual, statutory or otherwise) 4 All states Clarification of the nature of the limited partners limitation of liability being that limited partners have no separate liability for the debts and obligations of the partnership 5 All states Inclusion of a reliance element before limited partners are deemed liable for the debts, obligations and liabilities of a limited partnership 6 All states Adoption of safe-harbour provisions (activities which are not participation in the management of the business of the partnership) consistent with the practices and obligations of venture capital investors, including appropriate corporate governance actions and intervention in cases of crisis AVCAL, GILBERT + TOBIN and FREEHILLS SEPARATE ENTITY 40 PAGER Page 3

7 Number States Amendment Required Affected 7 All states Clarification that unless expressly agreed neither the general partner nor the limited partnership (if a separate legal entity) nor any of their respective officers, employees or agents is an agent of, acts on behalf of or is otherwise able to bind any limited partner 8 All states Clarification that the limited partnership (where a separate legal entity) and any general partner are the only proper parties to any action by or against the limited partnership 9 All states Clarification of the position where a limited partnership (which is not a separate legal entity) becomes a partner in another limited partnership 10 WA, Tas, Territories Adoption/replacement of limited partnership statute with a statute in the form of that used in either NSW or Victoria. 11 All states Various minor and consequential amendments The tables in Appendices B, C and D compare the relevant legislation in New South Wales, Victoria, Queensland, the United Kingdom, California (US) and Delaware (US). 1.3 Policy considerations development of world s best practice legislation AVCAL believes that there are very strong policy reasons in favour of the proposed amendments. The Commonwealth and the venture capital industry have devoted substantial efforts to implementing the Commonwealth VCLP reforms, with the stated aim of achieving a world s best practice structure for venture capital investment. Those reforms have been announced to potential investors around the world and are being actively promoted by both industry players and Commonwealth agencies. For example, the VCLP reforms are being actively promoted to potential investors by: Invest Australia see and AusIndustry see (following the commercialise a venture link). However, the benefits of these reforms and promotional efforts cannot be achieved without a satisfactory legal structure for Australian limited partnerships. The limited partnership form was chosen as the vehicle for the Commonwealth s venture capital tax reforms because of its international predominance as the vehicle of choice for this form of investment. AVCAL, GILBERT + TOBIN and FREEHILLS SEPARATE ENTITY 40 PAGER Page 4

8 That predominance has arisen because the structure, as in use overseas, has delivered certainty to investors in respect of both flow-through tax treatment and limitation of liability (the effect of the latter being that limited partners have no separate substantive liability for the debts and obligations of the partnership). State limited partnership statutes in their current form, while clearly intended to do so, do not provide investors with certainty as to the limitation of their liability. For the limited partnership laws of a state or territory to accommodate VCLPs, they must provide, as far as possible, certainty in respect of the limitation of all potential liabilities in all relevant jurisdictions (including under the laws of the States and Territories, of the Commonwealth and of other countries). The proposed amendments seek to achieve this goal, making the statutes operative and useful. In the process, they would lead to each of the states and territories adopting modern, effective and appropriate limited partnership laws which genuinely represent, in combination with the Commonwealth s VCLP reforms, world s best practice for investment vehicle structures. AVCAL submits that there are no sound policy reasons against these proposals, as: the limited partnership statutes of the various states, in their current form, are little used (in part, it is submitted, because they are in need of substantial modernisation and clarification of the kind proposed in this submission); and the purpose of the amendments is to achieve the clear intention of the existing laws, being to provide a viable legal structure for partnerships which include passive partners whose contribution is primarily financial and whose liability is limited accordingly. 1.4 National consistency AVCAL is seeking amendments to the partnership statutes of each Australian state and the adoption of similar statutes in each Australian territory so that all partnership statutes operate in a consistent way. We understand that the proposed amendments were on the agenda for the early April meeting of the Standing Committee of Attorneys General. AVCAL estimates that there is approximately A$400 million being raised on the basis of forming a VCLP at the time of writing. In the interests of securing this capital investment now, AVCAL proposes that each state and territory should consider and adopt the amendments set out in this document as soon as practicable. AVCAL is appreciative of the constructive dialogue that has been opened with each of the states, and recognises that many of the proposed changes are already being discussed at the Standing AVCAL, GILBERT + TOBIN and FREEHILLS SEPARATE ENTITY 40 PAGER Page 5

9 Committee of Attorneys General. AVCAL also recognises the time that it will take to align the interests of all the states, as against the pressing need to harness the current opportunities. We would highlight, therefore, that the adoption of the proposed amendments by one state would allow use of the VCLP structure to begin before the passage of uniform laws in all states and territories. 1.5 Overview of limited partnerships across Australia Each Australian state has a limited partnership statute. Those statutes are set out in the following table (and the abbreviations for those statutes in the following table are used in this document). Abbreviation NSW Act Qld Act SA Act Tas Act Vic Act WA Act Statute Partnership Act 1892 (NSW) Partnership (Limited Liability) Act 1988 (Qld) Partnership Act 1891 (SA) Limited Partnerships Act 1908 (Tas) Partnership Act 1958 (Vic) Limited Partnerships Act 1909 (WA) Neither of the mainland territories has a limited partnership statute. Both the Northern Territory and the Australian Capital Territory would need to adopt a statute before a VCLP could be formed in the relevant territory. AVCAL proposes that each territory adopt a limited partnership statute in the form of the Vic Act or the NSW Act, in each case amended as contemplated in this document. Although the limited partnership provisions in most Australian states are in similar form, the provisions in Western Australia (and to a certain extent in Tasmania) are in an older form and do not contain many of the provisions of the statutes of other states. In 1992, the Partnership Bill 1992 (WA), which provided for similar provisions to the NSW Act to be adopted in Western Australia, reached second reading speech, but was not adopted once amendments were passed to the Income Tax Assessment Act 1936 (Cth) altering the taxation treatment of limited partnerships which had encouraged the use of limited partnership business structures. Accordingly, substantial amendments are required to remove uncertainties in the WA Act and ensure that the WA Act is able to be used for venture capital funds. For the purpose of consistency with other states and to reduce the number of required amendments, AVCAL has proposed that Western Australia adopts the provisions of the Partnership Bill 1992 (WA), AVCAL, GILBERT + TOBIN and FREEHILLS SEPARATE ENTITY 40 PAGER Page 6

10 and that Tasmania adopts an equivalent statute, in each case amended as contemplated for the NSW Act in this document. 1.6 Australian Funds of Funds and Venture Capital Management Partnerships The proposed amendments have also been prepared contemplating the use in the VCLP structure of Australian Funds of Funds (AFOFs) and Venture Capital Management Partnerships (VCMPs). Both AFOFs and VCMPs are contemplated under the Venture Capital Act 2002 (Cth) as part of the VCLP structure. An AFOF is a limited partnership which pools investment for the purpose of investing in or alongside VCLPs. Essentially, it is a flow through vehicle, designed as the structure for gatekeeper funds (ie, funds which invest in other funds), but which could also be used as the principal fund (using its investee VCLPs to invest in particular types of companies). Importantly, an AFOF can only be formed under the laws of an Australian state or territory. A VCMP is a limited partnership which is the general partner of a VCLP or an AFOF. The general partner of the VCMP is in effect the manager of the VCLP or AFOF. The limited partner in the VCMP receives a carried interest in the VCLP. This carried interest is a performance-based return earned by achieving a defined rate of return for the limited partners in the VCLP. In order to receive the carried interest, the executives and associates of general partner, or their nominee vehicles (eg, companies which they own or trusts of which they are the beneficiaries), are made the limited partners in the VCMP. AVCAL, GILBERT + TOBIN and FREEHILLS SEPARATE ENTITY 40 PAGER Page 7

11 2. KEY AMENDMENTS PROPOSED AMENDMENT 1: SEPARATE LEGAL ENTITY STATUS AVCAL proposes that limited partnership statutes be amended to provide that a limited partnership may be a separate legal entity. State or Territory Section and Statute Proposed Amendment New South Wales New sections At the election of the persons or structures forming the limited partnership, the limited partnership may be formed as a separate legal entity. Consequent amendments will be required to specify the capacity and powers of such a limited partnership, and to clarify that acts preparatory to the establishment of such a limited partnership and its business do not give rise to a common law partnership. Queensland New sections The same amendments as proposed for the NSW Act. South Australia New sections The same amendments as proposed for the NSW Act. Tasmania New sections The same amendments as proposed for the NSW Act. Victoria New sections The same amendments as proposed for the NSW Act. Western Australia New sections The same amendments as proposed for the NSW Act. (present position) At present, a limited partnership formed under the limited partnership statute of a state is not a separate legal entity, rather it is a partnership with some of its partners accorded limited liability status. The source of the limited liability status is state based statute. Those statutes provide that the liability of limited partners to contribute to the debts and obligations of the relevant partnership is to be limited to the amount recorded in the register in respect of that limited partner. The liability of any general partner is not limited. (proposal) AVCAL proposes that limited partnership statutes be amended so that, at the election of the parties applying for registration, the limited partnership could be established as a separate legal entity. Separate legal entity status would be at the election of those forming the limited partnership as there may be circumstances where either VCLP or non-vclp partnerships, either in existence or to be AVCAL, GILBERT + TOBIN and FREEHILLS SEPARATE ENTITY 40 PAGER Page 8

12 formed, may not seek separate legal entity status. Further, if the relevant state government wishes to preserve the legal status of existing limited partnerships, the provision enabling election of separate legal entity status could be made available for use by VCLPs, AFOFs and VCMPs only. In the case of VCLPs, for instance, as VCLP registration will not be known at the time of formation of the limited partnership, formation as a separate legal entity could proceed on the basis of intent to register as a VCLP, possibly coupled with a requirement that if the limited partnership is not registered as a VCLP (conditionally or unconditionally) within a reasonable period, the limited partnership may be required to be wound-up and deregistered. A provision will be required specifying the capacity and powers of such a limited partnership (including all the powers of a natural person and all the powers of a body corporate). Consequential amendments would restate, with appropriate changes, key provisions of the statute as applicable to a separate legal entity (for example, restated versions of ss 5 and 9 of the NSW Act would be required, to the effect that the acts of the general partner (as agent) bind the limited partnership and that the general partners are jointly liable with the limited partnership for all the debts, obligations and liabilities of the firm). A further provision would clarify that acts preparatory to the establishment of such a limited partnership and its business do not give rise to a common law partnership. Transitional provisions may be required to accommodate an election to convert a limited partnership formed under current laws to a separate legal entity limited partnership. (purpose of amendment) Limitation of liability: Under the current law, a limited partnership is first a general law partnership, with the general partners as agents for all other partners, such that acts of the general partners are at law the acts of each limited partner. The limitation of liability of limited partners is provided by the relevant state statute and is exposed to the risk that a court outside of the state of formation of the limited partnership, or a court applying Commonwealth laws, may not recognise the limitation of liability of the limited partners. The effectiveness of the limitation in a jurisdiction other than the limited partnership s home state is dependent upon the conflict of laws rules of that jurisdiction giving effect to the limitation of liability provisions in the relevant home state s statute. The matter has rarely been considered by common law courts and there is no precedent on point which confirms that a state statutory limitation of limited partner liability would be recognised outside the jurisdiction of the statute. Lindley & Banks on AVCAL, GILBERT + TOBIN and FREEHILLS SEPARATE ENTITY 40 PAGER Page 9

13 Partnership 3 indicates that there is no certainty that a court outside the jurisdiction of formation of a limited partnership would accord limited partners with limited liability. Similarly, there is uncertainty as to the effectiveness of the limitation under a state statute in respect of liabilities incurred under Commonwealth laws. AVCAL has received senior counsel s advice to the effect that this limitation (absent the proposed amendments) will not prevent each limited partner becoming personally liable (without limitation), for instance, for a general partner s misleading and deceptive conduct in contravention of the Trade Practices Act (including by reason of s84(2) of that Act and s109 of the Constitution). A similar consequence will follow, for example, under each other Commonwealth Act which attributes liability to a principal for acts done by another on its behalf or with its actual or ostensible authority. These consequences which obviously would not attach to a shareholder in a company, nor to a unit holder in a unit trust are sufficient to render the limited partnership an unacceptable structure for institutional investors. As VCLPs will necessarily have dealings outside their state of formation (eg, because a company in which they invest has subsidiaries or shareholders outside the state of formation), and as VCLPs could obviously incur liabilities under Commonwealth laws, institutional investors will not support the VCLP structure unless the limitation of their liability (as limited partners) is effective in these other jurisdictions and in respect of liabilities under Commonwealth laws. AVCAL has received advice that separate legal entity status, combined with clarification that the general partner acts as agent of the limited partnership, and that neither the general partner nor the limited partnership acts as agent for the limited partners, is essential in order to clarify the limitation of liability of limited partners. In respect of other jurisdictions, there is a substantial body of precedent in common law jurisdictions recognising the liabilities of a separate legal entity as distinct from those who contribute capital to that entity 4. If the proposed amendments are made, application of this principle will attribute liability to the limited partnership rather than the limited partners. In respect of Commonwealth laws which attribute liability to principals for the acts of their agent, as the general partner (if the proposed amendments are made) will act as agent only of the limited partnership (as a separate legal entity), it will again be the limited partnership to which these liabilities will be attributed, rather than the limited partners individually. As the relevant state statute will not purport to limit the liability of the limited partnership, no question of any s109 inconsistency will arise. In each case this will be the appropriate result, as it will also be the limited partnership as an entity (and not the limited partners) which owns the assets of the firm. 3 see R.C. I Anson Banks, Lindley & Banks on Partnership, th Ed, Sweet & Maxwell London, at page See Nygh P, Conflicts of Laws in Australia, th Ed, LexisNexis Butterworths Australia, at page 660 also Dicey & Morris, The Conflict of Laws th Ed, Sweet & Maxwell London, at page 1105 AVCAL, GILBERT + TOBIN and FREEHILLS SEPARATE ENTITY 40 PAGER Page 10

14 AVCAL submits that separate legal entity status for limited partnerships clearly represents world s best practice. It is the position in Delaware (and many other US jurisdictions), the effect of which is to enable limited partnerships to operate effectively in the various jurisdictions (and under both Federal and State laws) in the United States. Proposed amendment 1, in combination with the related changes under proposed amendments 4, 7 and 8, will have the result that creditors of the limited partnership will have recourse against both the assets of the limited partnership and the assets of each general partner. It is important to note, in this regard, that in a venture capital fund, investors typically make a binding commitment of some nature to provide moneys to the fund, up to an agreed maximum commitment amount, which moneys can be called or drawn down by the manager upon demand from time to time. The commitment may be one to contribute capital or to make non-advances or loans, and will typically be subject to certain conditions (for example, a manager may not be able to call funds for investment purposes after a defined investment period, and an investor who is a trustee will typically be obliged to meet such a call only to the extent that it is entitled to be indemnified in that regard out of the assets of its trust fund). Investors may also indemnify the fund, in agreed terms, against certain liabilities incurred in the conduct of its business. For a fund structured as a VCLP registered under a state limited partnership statute (amended as outlined in this submission), these commitments and rights of indemnification (in the terms negotiated between the general partner and the limited partners and set out in the partnership agreement) will effectively form part of the assets of the limited partnership, to which creditors will have recourse by way of suit against the limited partnership. Partnerships as partners: Separate legal entity status is also fundamental to providing a workable mechanism for one limited partnership to become a partner in another limited partnership. As noted above, this is exactly what is contemplated in the VCLP context, for both VCMPs (limited partnerships intended to act as the general partner of VCLPs and AFOFs) and for AFOFs (limited partnerships intended to act primarily as limited partners in VCLPs). Where a limited partnership (the first partnership) does not have separate legal entity status, the effect of it purporting to become a partner in another partnership (the second partnership), while less than certain, is probably that each partner of the first partnership becomes a partner in the second. This produces a number of difficulties, as further discussed below in relation to proposed amendment 9. For a VCMP, for example, it has the unfortunate effect of the current law that each limited partner in the VCMP becomes a general partner of each VCLP or AFOF (for which the VCMP is general partner) and therefore incurs unlimited liability for the debts and obligations of these VCLPs and AFOFs. Other benefits: Separate legal entity status also has the following benefits: AVCAL, GILBERT + TOBIN and FREEHILLS SEPARATE ENTITY 40 PAGER Page 11

15 it removes any uncertainty concerning continuity of the partnership, that is, there is no doubt that the partnership continues to exist regardless of the admission of new partners or the retirement or death of existing partners; it clarifies that the partnership may hold securities in its own name, without requiring the partners to construct a nominee arrangement where a person holds the investments of the partnership as nominee for the partners; it gives certainty to third parties dealing or contracting with the partnership as the counter-party need only be the partnership (using the firm-name) without requiring the identification of each partner of that partnership to be a counter-party to the contract or confirming the appointment of an attorney by those partners for the purpose of executing contracts and other instruments; and a litigant against the partnership, seeking satisfaction in respect of any court order, need not rely on the capacity of one or more limited partners to contribute at the time of enforcement of the order, but may be able to obtain satisfaction in respect of the amount from the assets of the partnership (which, as a legal entity, would hold assets relating to the contributions of limited partners). The amendment would also state that a limited partnership (as a separate legal entity) exists only as a creature of statute and that acts preparatory to formation of a limited partnership do not constitute a general law partnership. This will clarify a present ambiguity as to whether a limited partnership is formed under the relevant limited partnership statute for the purpose of the 20 partner limit under section 115 of the Corporations Act At present, it is arguable, in spite of express provisions in a majority of state limited partnership statutes that a limited partnership is formed by registration (and express provisions in the various state limited partnership statutes that a limited partnership may have any number of limited partners), that a general law partnership (which could have more than 20 partners) exists prior to registration of the limited partnership. AVCAL, GILBERT + TOBIN and FREEHILLS SEPARATE ENTITY 40 PAGER Page 12

16 PROPOSED AMENDMENT 2: MUTUAL RECOGNITION OF STATE LAWS AVCAL proposes that the limited partnership laws of each state mutually recognise the limitation of liability of limited partners under the comparable laws of each other Australian state and territory, whether by amendment to regulations or order of the relevant minister (as applicable). State or Territory Section and Statute Proposed Amendment New South Wales Regulations under The comparable statutes of each other Australian NSW Act jurisdiction be included in the regulations as corresponding laws for the purposes of the mutual recognition provisions of the Act. Queensland South Australia Regulations under Qld Act Regulations under SA Act The comparable statutes of each other Australian jurisdiction be included in the regulations as corresponding laws for the purposes of the mutual recognition provisions of the Act. The comparable statutes of each other Australian jurisdiction be included in the regulations as corresponding laws for the purposes of the mutual recognition provisions of the Act. Tasmania Order of Governor An order be made by the Governor recognising the comparable statutes of each other Australian jurisdiction as corresponding laws for the purposes of the mutual recognition provisions of the Act. Victoria Western Australia Order of Governor in Council New section to WA Act and new regulations An order be made by the Governor in Council recognising the comparable statutes of each other Australian jurisdiction as corresponding laws for the purposes of the mutual recognition provisions of the Act. A new section be included providing that the limited liability of limited partners under corresponding laws be recognised in Western Australia. If necessary, regulations passed recognising the limited liability statutes of each other Australian state and territory for the purposes of the new section. AVCAL, GILBERT + TOBIN and FREEHILLS SEPARATE ENTITY 40 PAGER Page 13

17 (present position) At present, the limited partnership statutes of each state, other than Western Australia, provide that any limitation under a corresponding law on the liability of a limited partner in a recognised limited partnership extends to any debt or obligation incurred in connection with the conduct of the partnership s business in the relevant state. For this purpose, corresponding laws are those that have been recognised either by regulation or order of the relevant state Governor. However, our review of regulations and the relevant government gazettes indicates that no states have mutually recognised any other jurisdiction except in the case of Victoria, where South Australia is recognised, in the case of Tasmania, where Victoria is recognised and in the case of New South Wales, where each state of the United States and Québec, Canada are recognised. (proposal) AVCAL proposes that each state recognise the limited partnership statutes of each other state and territory as corresponding laws for the purpose of that state s limited partnership statute. (purpose of amendment) As stated above, there has not, as yet, been confirmation by an Australian court that the limitation of liability applying to limited partners of a limited partnership formed in one Australian jurisdiction applies in respect of actions brought against the partnership or that partner in another jurisdiction. Commentators have indicated that the requirement under the NSW Act, Qld Act, Vic Act, Tas Act and SA Act for recognition of limited partnership status may mean that unless executive recognition is given or that requirement is regarded by a court as supplementary and not exclusionary, the limitation of liability will not be recognised outside of the state of formation of the limited partnership 5. To ensure that no Australian state or territory is excluded from potential venture capital investment, AVCAL proposes that each Australian state and territory mutually recognise the limitation of liability applying to limited partnerships formed in each other state and territory. Proposed amendment 1 and proposed amendment 2 overlap in respect of Australian jurisdictions. However, even for limited partnerships which are a separate legal entity, an express provision in each state and territory statute recognising the limitation of liability of limited partnerships formed in another state or territory removes any doubt concerning recognition of that limited liability. 5 Fletcher, K, The Law of Partnership in Australia & New Zealand, 8 th Ed, LBC Information Services at 275 AVCAL, GILBERT + TOBIN and FREEHILLS SEPARATE ENTITY 40 PAGER Page 14

18 PROPOSED AMENDMENT 3: LIMITATION IN RESPECT OF ALL LIABILITIES AVCAL proposes that each statute be amended to clarify that the limitation of the liability of the limited partners extends to all liabilities, of whatever type and however incurred. State or Territory Section and Statute Proposed Amendment New South Wales s49 of NSW Act New definition: Debt includes any debt, liability or obligation, of any kind and however incurred. Queensland s4(1) of Qld Act Amend definition of liability: Liability includes any debt, liability or obligation, of any kind and however incurred. South Australia s49 of SA Act New definition: Debt includes any debt, liability or obligation, of any kind and however incurred. Tasmania s3 of Tas Act New definition: Debt includes any debt, liability or obligation, of any kind and however incurred. Victoria s49 Amend definition of debt: Debt includes any debt, liability or obligation, of any kind and however incurred. Western Australia s3 of WA Act New definition: Debt includes any debt, liability or obligation, of any kind and however incurred. (present position) Under state limited partnership statutes, the liability of limited partners is limited: in the case of the NSW Act, the SA Act, the Tas Act and the WA Act, in respect of the debts and obligations of the partnership; and in the case of the Vic Act and the Qld Act, in respect of the debts, obligations and liabilities, however incurred of the partnership (under the Vic Act, the words derive from the provision of the statute and the definition of Debts), to the amount shown in respect of that partner in the Register of Limited Partnerships kept by the relevant registrar. (proposal) AVCAL proposes that the limitation of liability under each Act operates in respect of any debt, liability or obligation of the limited partnership, of any kind and however incurred. AVCAL, GILBERT + TOBIN and FREEHILLS SEPARATE ENTITY 40 PAGER Page 15

19 (purpose of amendment) Australian courts have not expressly addressed whether the words debts and obligations include all forms of liability, however incurred (for example, statutory liability), or whether those words are to be interpreted narrowly to refer only to contractual debts and obligations. AVCAL s legal advice, based in part on senior counsel s analysis of New Zealand case law and English commentary 6, is that the words encompass only contractual debts and obligations. Interpretation of those words is confused by the various uses of those words in other sections of the relevant statute (see, for example, sections 9 and 12 of the NSW Act and SA Act). Investors will be reluctant to invest in limited partnerships unless there is certainty that their level of personal liability protection is no less effective than that under a unit trust or company structure. Accordingly, it is essential that the limitation operates in respect of all debts, liabilities and obligations of the limited partnership. 6 see NZ High Court case, Estate Realties Ltd v Wignall [1992] 2 NZLR 615 citing Lindley & Banks on Partnership (16th ed 1990) at paras and and Halsbury's Laws of England (4th ed) at para 66. AVCAL, GILBERT + TOBIN and FREEHILLS SEPARATE ENTITY 40 PAGER Page 16

20 PROPOSED AMENDMENT 4: CLARIFYING THE AMOUNT TO WHICH LIABILITY IS LIMITED AVCAL proposes that: (a) where the limited partnership is a separate legal entity, all statutes clearly state that limited partners have no separate liability for the debts, liabilities and obligations of the limited partnership; and (b) rather than recording an amount to which the liability of a limited partner is limited, the register records the actual amount of capital which each limited partner has contributed to the limited partnership from time to time. State or Territory Section and Statute Proposed Amendment New South Wales ss54, 56, 60, 61 and 65 of NSW Act Amendment of the recordal provisions (ss54, 56) such that the limited partnership must notify to the registrar, and the register must record, the actual amount of capital which each limited partner has contributed (or, in the case of contributions other than in the form of money, the value of those contributions) to the assets of the partnership. Amendment of the liability provisions (ss60-61 and s65) to provide that a limited partner has no liability to contribute to the debts and obligations of the limited partnership (except, subject to Proposed Amendment 5, where the limited partner has participated in the management of the business of the limited partners). Queensland South Australia Tasmania Victoria Western Australia Amend corresponding sections as per NSW Act. Amend corresponding sections as per NSW Act. Amend corresponding sections as per NSW Act. Amend corresponding sections as per NSW Act. Amend corresponding sections as per NSW Act. (present position) Under state limited partnership statutes, the liability of limited partners is limited by a somewhat complex and uncertain set of provisions. Taking the NSW Act as an example: AVCAL, GILBERT + TOBIN and FREEHILLS SEPARATE ENTITY 40 PAGER Page 17

21 the register must record, for each limited partner, an amount to which that partner s liability is limited, being the amount of any capital, or the value of any property, that the limited partner has agreed to contribute (ss54(g), 56); the liability of a limited partner to contribute to the debts and obligations of the limited partnership is, subject to the following rules, not to exceed the amount stated in the register (s60(1)); that liability amount as recorded in the register is reduced by the amount of any contributions which the limited partner has already made to the debts and obligations of the limited partnership (s60(2)); such contributions may be in the form of money only (s65(1)); reductions in the liability amount as recorded in the register apply on a prospective basis only (s61(1)) ie, they do not limit liability for debts and obligations arising before the reduction is made; increases in the amount apply in respect of all debts and obligations (s61(2)); and if a limited partner receives any capital back from the limited partnership, its liability is restored accordingly (s65(2)). (proposal) AVCAL proposes that the limitation of liability under each of the state statutes clearly states that where a limited partnership is a separate legal entity, limited partners have no liability to contribute to the debts, liabilities and obligations of the limited partnership. (There is one exception to this proposal, being the rule regarding participation in management, which is addressed below). As a consequence, the register would record, rather than an amount to which liability is limited, the actual amount of capital which each limited partner has contributed from time to time. (purpose of amendment) The purpose of these amendments is to confirm, as outlined under proposed amendment 1, that liability for the debts, liabilities and obligations of the limited partnership rests only with the general partners and the limited partnership itself, and that the limited partners (absent participation in management) have no liability to third parties for these debts, liabilities and obligations. This is consistent with overseas limited partnership law and practice (particularly in the venture capital area). By comparison: in the United States, under the limited partnership statutes of the various states, a limited partner is not liable for the debts and obligations of the partnership unless it participates in the control of the business of the limited partnership (see Appendix B); in the United Kingdom, a limited partner s liability is limited to the amount of capital which it has contributed to the limited partnership as recorded in the register (see Appendix B). As a matter AVCAL, GILBERT + TOBIN and FREEHILLS SEPARATE ENTITY 40 PAGER Page 18

22 of practice, and because returns of capital are prohibited until the winding up of the limited partnership, investors contribute only a nominal amount of capital (to which their liability to third parties for the debts, obligations and liabilities of the firm is limited). Their substantive contributions are made by way of non-capital advances to the limited partnership, which amounts are never recorded in the register and do not expose the investor to increased liability for the debts and obligations of the partnership; and under the current state limited partnership statutes, if the limitations of liability were otherwise effective, the practice would most probably follow the United Kingdom model. That is, investors would agree to contribute only a nominal amount of capital (to which their liability would be limited), and would provide their substantive contributions by way of non-capital advances (as contemplated, for instance, by ss24(3) and 44(b), item 2 of the NSW Act), again effectively limiting their exposure to third parties for the debts and obligations of the partnership to a nominal amount. This proposal is also consistent with the grant of separate legal entity status to the limited partnership, which has the result that it is the limited partnership (as a separate entity) which holds the assets of the firm (rather than the limited partners). Accordingly, it should be the limited partnership (albeit jointly with the general partners) which is responsible for the debts, liabilities and obligations of the firm. In preparing this proposed amendment, AVCAL has also tried to preserve (if not improve) the level of visibility provided to creditors of the limited partnership by way of amounts recorded in the register, by making the register, in effect, a record of the paid up capital of the limited partnership from time to time. AVCAL also notes that the proposed amendment should be considered in light of the potential activities of the limited partnerships in question. Under the VCLP reforms, VCLPs can only invest in companies and may only engage in activities relating or incidental to such investments. Similarly, AFOFs may only invest in VCLPs, and VCMPs may only function as general partners of VCLPs and AFOFs. Accordingly, the potential counterparties to transactions with these limited partnerships will consist in large part of sophisticated participants in the venture capital and private equity industries: investee companies and their managers, actual and potential vendors and purchasers of securities in those companies, professional advisers, co-investors and financiers. AVCAL, GILBERT + TOBIN and FREEHILLS SEPARATE ENTITY 40 PAGER Page 19

23 PROPOSED AMENDMENT 5: CONSEQUENCE OF PARTICIPATION IN MANAGEMENT AVCAL proposes that if a limited partner is regarded as participating in the management of the business of the partnership, that partner is only liable for those debts, obligations and liabilities which the partnership is unable to pay to (and which are owed to) persons who transacted with the limited partnership to the extent that: (a) the relevant debt, liability or obligation was incurred as a direct result of the conduct of the limited partner; and (b) the person reasonably believed, based on the limited partner s conduct at the time the debt, obligation or liability was incurred, that the limited partner was a general partner. State or Territory Section and Statute Proposed Amendment New South Wales s67(2) of NSW Act The words incurred while the limited partner takes part in the management of that business be replaced with, which the partnership is unable to pay or discharge, which are owed to persons who transacted with the limited partnership to the extent that: (a) the relevant debt, liability or obligation was incurred as a direct result of the conduct of the limited partner; and (b) the person reasonably believed, based on the limited partner s conduct at the time the debt, obligation or liability was incurred, that the limited partner was a general partner. Queensland s16(2) of the Qld Act The same amendments as proposed for the NSW Act. South Australia s65(2) of SA Act The same amendments as proposed for the NSW Act. Tasmania s6 of Tas Act The same amendments as proposed for the NSW Act. Victoria s67(2) of the Vic Act The same amendments as proposed for the NSW Act. Western Australia s6 of WA Act The same amendments as proposed for the NSW Act. AVCAL, GILBERT + TOBIN and FREEHILLS SEPARATE ENTITY 40 PAGER Page 20

24 (present position) Under the NSW Act, Qld Act, SA Act and Vic Act, if a limited partner takes part in the management of the business of the limited partnership, the limited partner is liable, as if the partner were a general partner, for the debts and obligations of the partnership incurred while the limited partner takes part in the management of that business (section 67(2) of the NSW Act, section 16(2) of the Qld Act, section 65(2) of the SA Act and section 67(2) of the Vic Act). (proposal) AVCAL proposes that if, as a result of any act, the limited partner is regarded as participating in the management of the business of the partnership, that partner should be liable only for debts, obligations and liabilities which the partnership is unable to pay or discharge which are owed to persons who transacted with the limited partnership (in respect of the relevant debt, liability or obligation) to the extent that: (a) the relevant debt, liability or obligation was incurred as a direct result of the conduct of the limited partner; and (b) the person reasonably believed, based on the limited partner s conduct at the time the debt, obligation or liability was incurred, that the limited partner was a general partner. (purpose of amendment) AVCAL submits that the sanction imposed on limited partners for participating in management of the limited partnership (unlimited personal liability for the debts, obligations and liabilities of the partnership) is too onerous and inconsistent with sanctions imposed under other business structures on persons with limited liability. Under the provisions of each state s limited partnership statute, a court may determine that a limited partner, by some inadvertent or unrepeated act, is deemed to have participated in the management of the partnership and is liable as a general partner for all of the debts, obligations and liabilities of the partnership. In particular, this determination could be made retrospectively, possibly to assist a litigant in obtaining satisfaction of a claim where the general partner is unable to satisfy that claim. There is no safeguard against the deeming of the limited partner to have participated in the business of the partnership by any unintended conduct. However, the consequences of such a deeming are severe. The limited partner potentially becomes personally liable for all of the debts and obligations of the partnership. This is a very significant risk for a passive investor to assume by reason only of the form of investment structure adopted (and, as further discussed in relation to proposed amendment 6 below, as a result of an historical rationale which has limited validity in the face of modern concepts of sound business management). Section of the Delaware Uniform Limited Partnership Act provides that, if the acts of a limited partner are construed as participating in the management of the business of the partnership, that AVCAL, GILBERT + TOBIN and FREEHILLS SEPARATE ENTITY 40 PAGER Page 21