Partnerships
The law governing partnerships is codified in Texas Business Organizations Code title 4. Texas allows four types of partnerships: general partnerships, limited partnerships, limited liability partnerships, and limited liability limited partnerships. The practice notes in chapter 6 in this manual contain basic information regarding the structures of these partnerships and the situations that can inform decisions to use them.
Texas has a long history of recognizing general partnerships. At common law, a general partnership was recognized where multiple individuals jointly shared interest, control, profits, and losses of a business enterprise. The Texas Business Organizations Code (TBOC) defines a general partnership as “an association of two or more persons to carry on a business for profit as owners.” Tex. Bus. Orgs. Code § 152.051. The secretary of state does not require any formal filings to form a general partnership. The TBOC states that a general partnership is created, whether or not individuals intend for the business relationship to be considered a general partnership, if the following factors are met:
(1)receipt or right to receive a share in profits of the business;
(2)expression of an intent to be partners in the business;
(3)participation or right to participate in control of the business;
(4)agreement to share or sharing:
(A)losses of the business; or
(B)liability for claims by third parties against the business; and
(5)agreement to contribute or contributing money or property to a business.
Tex. Bus. Orgs. Code. § 152.052(a). Individuals engaging in business together must be cognizant of these factors as they may form a general partnership regardless of intent. In situations where a different type of organization or structure (for example, a limited liability company or joint venture) is expressly intended, a “No Partnership” clause should be inserted into any contracts.
While a general partnership is formed de facto, the best practice is for the partners to execute a partnership agreement. A partnership agreement should contain all the essential terms governing the function of the partnership. Keep in mind that even a partnership agreement will not offer any personal liability protection to the partners. For liability protection, consider using one of the associations discussed below.
General partnerships have flow-through taxation. All partners share in the profits and losses pursuant to their pro rata share of the partnership. The pro rata share is, by default, equally split among the partners, but can be changed in a partnership agreement.
A limited partnership (LP) is created by filing a certificate of formation (SOS Form 207, www.sos.state.tx.us/corp/forms/207_boc.pdf) with the secretary of state. An LP must have at least one general partner and at least one limited partner. See Tex. Sec’y of State, SOS Form 207 cmt. (2015); see also Tex. Bus. Orgs. Code § 3.011. Unlike the general partnership, a limited partnership often has partners who are not actively participating in the business enterprise. An LP is commonly used to shield these passive investors from liability. The passive investors become limited partners while all the liability is assumed by the general partners.
The general partners are the active partners in the business enterprise, assuming the managerial role of the partnership while allowing for a retention of control vested in the limited partners. The amount of limited partner control and the general partners’ obligations are outlined in the limited partnership agreement. A general partner can be an individual or an entity. Practitioners commonly see general partners with a small ownership interest in the LP—usually 1 percent, with the limited partners comprising the other 99 percent—however, contrary to popular belief, a general partner is not required to hold an ownership interest in the LP. The TBOC provides that “[a] written partnership agreement may provide that a person may be admitted as a general partner in a limited partnership, including as the sole general partner, without acquiring a partnership interest in the limited partnership.” Tex. Bus. Orgs. Code § 153.151(d).
As with a general partnership, the LP partners’ tax liability flows through to each partner’s individual tax return. Also as with a general partnership, the apportionment can be altered via the limited partnership agreement. The major tax difference between a general partnership and a limited partnership is that the limited partnership is an actual entity with ownership interests. This is important because any change in apportionment of profits and losses that does not equal the ownership interest is subject to the IRS special allocation rules in Internal Revenue Code section 704.
§ 6.3Limited Liability Partnerships
Limited liability partnerships (LLPs) are familiar to most attorneys, at least by name, as this organizational structure is common to law firms. LLPs shield partners from each other’s liabilities. An LLP is registered by filing a limited liability partnership application (SOS Form 701, www.sos.state.tx.us/corp/forms/701_boc.pdf) with the secretary of state. A limited liability partnership is not a formed legal entity like a limited partnership, a limited liability company, or a corporation, but is instead the registration of an already-existing general partnership or limited partnership in which the general partners of the underlying entity want to gain personal liability protection. “Except as provided by the partnership agreement, a partner is not personally liable to any person, including a partner, directly or indirectly, by contribution, indemnity, or otherwise, for any obligation of the partnership incurred while the partnership is a limited liability partnership.” Tex. Bus. Orgs. Code § 152.801(a).
PRACTICE TIP: An underlying LP must be formed before the LLP filing, and the LLP application must be signed by at least one general partner of the LP, or the secretary of state will reject the application. See Tex. Bus. Orgs. Code § 153.352.
One thing to consider is that LLP fees are charged based on the number of general partners in control on May 31 of each year rather than singularly on the entity upon formation. The secretary of state’s initial LLP filing fee is $200 per general partner, with an annual report filing fee of $200 per general partner. This is important when looking at the cost to maintain the LLP compared with other entity types.
§ 6.4Limited Liability Limited Partnerships
A limited liability limited partnership (LLLP) is designed for instances where the general partners want to shield themselves from liabilities incurred by the partnership, unlike the structure of a limited partnership, where the general partners take on all of the liability. LLLPs are relatively new entity structures, statutorily authorized by TBOC section 5.055. There is no specific form for the certificate of formation for an LLLP in Texas; rather, SOS Form 701 is filed, and the applicant uses an entity abbreviation of “LLLP” when entering the partnership name.
As with a limited partnership, an LLLP will have at least one general partner and at least one limited partner. See Tex. Sec’y of State, SOS Form 701 cmt. (2015). Also as with a limited partnership, an LLLP is governed by a partnership agreement.
Although Texas recognizes LLLPs, many states do not. LLLP use is risky in that doing business as a foreign entity in other states may result in unintended liability placed on the general partners in the form of a judgment. It is far better to use a limited partnership with a shell entity set up as a general partner than to establish an LLLP. A common structure for this type of arrangement is a shell C corporation with no assets taking 1 percent ownership as a general partner.
For additional content relevant to the topic of this chapter, see the following:
Application for Registration of a Foreign Limited Liability Partnership (SOS Form 307), www.sos.state.tx.us/corp/forms/307_boc.pdf
Application for Registration of a Foreign Limited Partnership (SOS Form 306), www.sos.state.tx.us/corp/forms/306_boc.pdf
Application for Registration of a Foreign Professional Association (SOS Form 311), www.sos.state.tx.us/corp/forms/311_boc.pdf
Application for Registration of a Foreign Professional Corporation (SOS Form 303), www.sos.state.tx.us/corp/forms/303_boc.pdf
Application for Registration of a Foreign Professional Limited Liability Company (SOS Form 305), www.sos.state.tx.us/corp/forms/305_boc.pdf
Application for Renewal of Registration of a Foreign Limited Liability Partnership (SOS Form 308), www.sos.texas.gov/corp/forms/308_boc.pdf
Certificate of Formation—Limited Partnership (SOS Form 207), www.sos.state.tx.us/corp/forms/207_boc.pdf
Certificate of Formation—Professional Association (SOS Form 204), www.sos.state.tx.us/corp/forms/204_boc.pdf
Certificate of Formation—Professional Corporation (SOS Form 203), www.sos.state.tx.us/corp/forms/203_boc.pdf
Certificate of Formation—Professional Limited Liability Company (SOS Form 206), www.sos.state.tx.us/corp/forms/206_boc.pdf
Registration of a Limited Liability Partnership (SOS Form 701), www.sos.state.tx.us/corp/forms/701_boc.pdf