The Limited Liability Company (LLC) vs. Limited Partnership

Clients often ask us to articulate the benefits and drawbacks of forming and operating a business as a Limited Liability Company as opposed to a Limited Partnership. LLCs and LPs share certain common features however; they differ in a number of important ways.

LLCs and LPs are similar in that they are, and were intended to be, flexible business forms. The terms governing an LLC or Limited Partnership’s operations can be tailored to the needs of a specific business. For instance, to provide only a few examples, investors in an LLC or LP can provide for whatever voting or economic terms they desire, and can alter the standard of care and fiduciary duties that participants in the business owe to one another. Delaware law provides certain limited default terms that will govern in the event that the operating agreement of the entity is silent on an issue, but the LLC and LP forms are each intended to give maximum effect to the participants’ freedom to contractually provide for terms they deem appropriate.

The LLC and LP are also similar in a much more practical way: each provides its investors with pass-through tax treatment. Pass-through tax treatment means that the business itself is not subject to federal income tax, but each investor will be required to report separately on its income tax return for each year its distributive share of items of the business’s income, gain, loss and deduction, and will be taxed currently on that distributive share, regardless of whether the investor has received or will receive a distribution of cash or other assets from the company.

The most important difference between the LLC and LP form relates to the personal liability of the participants. A Limited Partnership is managed by one or more general partners that control the day-to-day operations of the business. These general partners have unlimited personal liability for the debts and obligations of the Limited Partnership, meaning that they can be held personally liable for those debts and obligations. A limited partner does not have personal liability for partnership obligations, but is not permitted to participate extensively in the day-to-day management of the Limited Partnership. If a limited partner participates in a significant way in management, a court may treat that limited partner as though it were a general partner if the Limited Partnership is sued, and impose personal liability upon the investor. To avoid the personal liability of a General Partner, an entity such as a Corporation or an LLC may serve as the general partner of a Limited Partnership. However, creating a separate entity to serve as general partner adds additional cost and complexity, and could have adverse tax consequences.

The LLC was created by the Delaware legislature to provide the flexibility of a partnership while providing corporation-like protection against personal liability. One or more of its members can manage an LLC. Unlike in a Limited Partnership, however, a participant engaged in the management of the business is not personally responsible for the liabilities of the entity.

Given the personal liability applied in a Limited Partnership, many clients ask why a person would choose the Limited Partnership form. As noted above, the LLC is a relatively new type of business form (since 1992) and, as a result, the case law regarding LLCs is far less robust and settled than that applicable to Limited Partnerships. The predictability that a settled body of case law provides leads some to select the Limited Partnership form. However, the LLC has gained a lot of ground in popularity. In 2008, 67% of the State of Delaware’s new formations were LLCs while only 6 % are LPs.