China's Partnership Enterprise Law Revised

Nature of Partners. While the original Partnership Law only permitted natural persons to be partners, Article 2 of the Revised Partnership Law will allow any legal entity to be a partner. Article 3 provides a notable exception in that the Revised Partnership Law prohibits wholly state-funded companies, SOEs, publicly-listed companies, institutions for public welfare, and social organizations from being general partners, although they can participate as limited partners.

Tax Classification. Article 6 of the Revised Partnership Law confirms that partnership enterprises are exempt from corporate-level income tax. Pass-through tax treatment twinned with limited liability is a key feature of limited partnerships established in offshore jurisdictions like the Cayman Islands for pooled investment funds.

Foreign Participation. Another significant development is that the Revised Partnership Law specifically contemplates foreign entities and individuals participating in partnership enterprises in China. Implementation of this provision of the law is subject to further administrative measures being issued by the State Council, and it remains to be seen whether and when such measures will be issued.

Bankruptcy. Another notable addition is Article 92, which provides a simple set of bankruptcy procedures which reflect the principles and procedures of the newly promulgated Bankruptcy Law. This allows a partnership enterprise's creditors to apply to a People's Court for bankruptcy liquidation or to demand repayment of the debts from the general partners personally. If a partnership enterprise is declared bankrupt, the general partners will bear joint and several liability for all debts of the partnership enterprise.

Special General Partnership Enterprises

One of the most notable changes to the Revised Partnership Law is the introduction of special general partnership enterprises (SGPs). Under Article 55, these permit "professional service providers who provides clients with paid services on the basis of professional knowledge and special skills" to organize themselves as SGPs, which are subject to distinct rules governing the liabilities of participating partners. Organizationally, an SGP is required to include the term "Special General Partnership" ("特殊普通合伙") in its enterprise name.

Article 57 provides the key liability provisions for SGPs. If one or more partners commit an intentional or grossly wrongful act that results in liability on the part of the SGP, those partners bear unlimited joint and several liability. In connection with other types of liability on the part of the SGP, all partners bear joint and several liability. Additionally, Article 58 provides that if an SGP incurs liabilities due to the intentional or grossly wrongful act of one or more of the partners, if provided in the partnership agreement those partners shall be liable to compensate the losses of the partnership enterprise.

One additional unique aspect of an SGP is that Article 59 requires it to allocate a proportion of its revenue to a risk fund and to purchase professional liability insurance. The risk fund is to be used to repay the debts incurred by the partners during their practice. The SGP is required to open a separate bank account to administer these funds. The State Council is to issue detailed implementing measures for the handling of such risk funds.

Limited Partnership Enterprises

The second major structural change in the Revised Partnership Law is the creation of Limited Partnership enterprises (LPs), which is widely anticipated to provide a vehicle for more flexible structuring of investment structures. The new LP form is seen as permitting greater structuring flexibility by permitting the combination of institutions or individuals who have management experience or R&D capabilities, and those with capital.

Organizationally, Article 61 requires an LP to have at least one general partner and one limited partner. The total number of partners cannot exceed 50. Article 62 requires LPs to include the term "Limited Partnership" ("有限合伙") in their enterprise name.

General partners have managerial power of an LP but also bear unlimited joint and several liability for the debts of the LP. Limited partners' liability is limited to the amount of their capital contributions. The Revised Partnership Law includes detailed provisions for the protection of minority and limited partners. Article 68 permits limited partners to make capital contributions in money, in kind, and of intellectual property, land use rights, or other proprietary rights. However, a partner's services cannot be counted towards capital contributions. Limited partners are allowed to participate in certain actions, including making decisions about the admission or withdrawal of a general partner, making a proposal for the management of the LP, selecting the partnership's certified public accountant, reviewing the financial reports of the partnership, and acting as a guarantor to the partnership as allowed by other laws.

A limited partner's interest in the partnership is assignable and may be pledged as security in relation to other transactions, unless otherwise restricted in the partnership agreement. Likewise, a limited partner can transfer its interest in an LP to a third party simply upon 30 days' notice to the other partners.

Conclusion

Overall the Revised Partnership Law holds the promise of greater flexibility in structuring ventures in China, even though various implementing measures remain to be drafted. We anticipate that general partnerships will become more commonplace now that all forms of legal entity can be partners and partnerships clearly have flow-through tax treatment. More importantly, we would expect to see strong growth in professional services firms due to the SPG structure, while the availability of LPs ought to permit the use of true pooled investment fund financing models in connection with onshore private equity and venture capital financings; something of particular advantage to both domestic and foreign investors.