The new Limited Partnership Fund regime of Hong Kong

Private Equity (“PE”) funds play a critical role in providing growth capital to companies especially pre-IPO companies and unicorns. The past few years have witnessed the burgeoning development of PE funds across Asia-Pacific, in particular Hong Kong and Mainland China. PE funds have also gained popularity among high-net-worth individual investors and have become a key driver in the growth of the asset and wealth management business in Hong Kong. As the second largest PE hub in Asia, Hong Kong is well-positioned to expand its PE market.  

The more common form of PE funds is a limited partnership. However, the existing legislation for partnership law in Hong Kong is lagging behind the development of many other jurisdictions. As an initiative to make Hong Kong a more attractive jurisdiction for PE funds, the Hong Kong government gazetted the Limited Partnership Fund Bill (the “Bill”) on 20 March 2020. The aim of the Bill is to facilitate the development of the PE fund industry while maintaining market integrity and investor protection. The Bill is expected to come into effect on 31 August 2020.

River Stone, a partner from the Corporate and Commercial Practice Group and the head of China Practice Group of Tanner De Witt shares some insights on the proposed regime.

The current regime does not adequately protect private equity funds

The existing Limited Partnership Ordinance (Cap.37) was enacted a century ago and has not been materially updated since its inception. It is no surprise that the existing regime does not meet the needs of modern funds. The existing legislation does not cover issues such as capital contribution, distribution of profits, contractual flexibility and winding-up mechanism. As a consequence, despite PE managers raising capital and managing the funds in and from Hong Kong, it is common practice for them to establish the funds in offshore jurisdictions such as the Cayman Islands.

The Hong Kong Government acknowledged industry concerns that the current system needed to be revamped to provide a more flexible and business-friendly regime governing matters pertaining to modern investment funds, and to offer alternatives and diversify the structure that a fund can take to be established in Hong Kong.

Key features of the new limited partnership fund regime

The new limited partnership fund (“LPF”) regime will be a comprehensive registration scheme administered by the Companies Registry in Hong Kong (“CR”).

(a) Establishing a LPF

To be registered as a LPF under the new regime, the fund must be constituted by a limited partnership agreement with at least one general partner (“GP”) and one limited partner (“LP”).  The name of the LPF must contain the words “Limited Partnership Fund” or “LPF”. The Bill specifically prohibits the registration of a LPF in which all the partners are corporations in the same group unless a special statement is made in the application.

The GP must be one of the following:

• a Hong Kong private company;
• a registered non-Hong Kong company;
• a limited partnership;
• a LPF; or
• an individual over 18.

It is also compulsory for a LPF to:

• appoint an investment manager (which could be the GP itself);
• appoint a Hong Kong auditor;
• appoint a responsible person for anti-money laundering purposes; and
• maintain a registered office in Hong Kong.

(b) Freedom of contract among the partners

The new LPF regime grants the partners of a LPF freedom with regard to the key operations of the LPF. 

A wide range of matters can be incorporated into the limited partnership agreement, including:

• the admission and withdrawal of partners;
• the transfer of interests;
• the management structure and decision-making procedures;
• the investment scope and strategy;
• the rights and obligations of the partners;
• the scope of the fiduciary duties of the GP; and
• the dissolution procedure. 

In particular, the partners enjoy the freedom to agree among themselves the financial arrangements in the fund. This will include matters such as capital contributions, withdrawal of capital contributions, distribution of proceeds, and clawback obligations provided that withdrawal of capital contributions and distribution of profits are only permitted if the LPF remains solvent following such withdrawal or distribution. 

(c) Legal liability

As expected, a LPF structure is not granted a separate legal personality. Within a LPF, the GP has the ultimate responsibility for management and control and, accordingly, has unlimited liability in regards to all the debts and obligations. 

LP(s) will not have day-to-day management rights or control over the assets held by the fund. Accordingly, liability of LPs will generally be limited up to their contribution. If a LP takes part in the management of the fund, then the LP and the GP will be jointly and severally liable for all the debts and obligations of the fund incurred.

(d) Safe harbours for LPs

To balance between the risk of the LP losing its limited liability and the commercial reality of the operation of a fund, the LPF regime provides a non-exhaustive list of safe-harbour activities for a LP.  A LP will not be considered as “managing” the LPF, if the LP is engaged in these safe-harbour activities.  Some illustrations of the safe-harbour activities are:

• acting as an agent, member, officer or employee of the LPF; 
• acting as or authorising a person to act as a director, shareholder, member, officer or employee of the GP;  
• discussing with or advising the GP or another LP or the investment manager; and
• taking part in decisions of the LPF including change in the investment scope and appointment and cessation of GP or LP. 

(e) Dissolution of the fund

The new LPF regime simplifies the dissolution mechanism for funds.  The partners can simply dissolve the LPF in accordance with the terms of the limited partnership agreement. 

Alternatively, a court ordered dissolution may take place on application by a partner or a creditor of the LPF in the following circumstances:

• the court is of the view that a partner has done any act or made any omission which prejudice the business of the fund;
• a partner willfully or persistently commits a breach of the limited partnership agreement; 
• the business of the fund can only be carried on at a loss; or
• it is just and equitable that the fund be dissolved.

(f) Tax and stamp duty

As an incentive, the new LPF regime also allows a LPF to enjoy profits tax exemption if certain exemption conditions are met. An interest in a LPF is not considered as a “stock”; therefore no stamp duty is required when the interest is contributed, transferred or withdrawn.

In February 2020, Financial Secretary Paul Chan Mo-po also announced the Hong Kong government’s plan to provide tax concession for carried interest issued by PE funds operating in Hong Kong upon the fulfilment of certain conditions.

(g) Registration and Migration of LPF

A fund wishing to register under the LPF regime must submit an application to the Registrar of Companies.  The application must be submitted by a Hong Kong law firm or a solicitor on behalf of the proposed GP. 

In parallel, a fund already registered under the Limited Partnership Ordinance can migrate to the LPF regime with a streamlined procedure which ensures that the migration will not affect the identity and continuity of the fund. The migration process will not incur profits tax and stamp duty as it does not amount to transfer of assets of the fund nor to a change in the beneficial ownership. Funds registered in foreign jurisdictions, however, are not permitted to migrate to Hong Kong under the new LPF regime.

The registration of an LPF will not disclose the identities of the LPs to the public. However, records with that information must be kept at the registered office in Hong Kong, and be accessible to law enforcement officers when necessary. 

Looking ahead

Amid the economic slowdown, the Hong Kong government is stepping up efforts to boost the city’s role as a PE hub in Asia. Meanwhile, various new laws have been enacted in offshore jurisdictions increasing the costs for PE funds operating there, and encouraging them to consider the choice of moving onshore.  The new LPF regime provides significant contractual flexibility and simplified procedures. We expect this will be an incentive for PE players to choose Hong Kong as their new home.

The impact of the Bill is yet to be seen.  We will provide more information of the LPF regime as future developments take place and look forward to being of assistance in matters related to the new LPF regime.

River Stone

River Stone Partner | E-mail

Eddie Look Partner | E-mail

Tim Drew Partner | E-mail

Edmond Leung Partner | E-mail

Pádraig Walsh Partner | E-mail

Disclaimer: This publication is general in nature and is not intended to constitute legal advice. You should seek professional advice before taking any action in relation to the matters dealt with in this publication.