Most private equity (PE) firms in the Western PE industry are organized as limited partnerships or limited liability companies. Therefore, since the time that China’s Partnership Enterprise Law ("new Partnership Law") was amended in 2007, China’s domestic PE funds have established a large number of limited partnerships.
The new Partnership Law introduces a system of limited partnerships formed by both general partners and limited partners, provided that the number of partners does not exceed fifty. General partners run the business and are personally liable for debts of limited partnerships. Limited partners do not have managerial or agency powers, and they are responsible for debts of limited partnerships to the extent of the limited partners’ capital contributions. Moreover, serving as the legal basis for a limited partnership, the partnership agreement can specify the compensation of general partners, the manner in which returns are shared among partners, and other issues.
The introduction of limited partnerships was hailed by China’s PE managers as a significant legislative development for the PE industry in China. However, they ignored a legal issue they would face when their portfolio companies attempted to go public. Article 166 of China’s Securities Law stipulates that securities accounts shall be set up by Chinese citizens or artificial persons, and it contains an exception rule that the government may further regulate the securities accounts. The Operation Rules of Securities Accounts adopted by China Securities Depository and Clearing Corporation accordingly define "domestic investors" as Chinese citizens or artificial persons. Apparently, limited partnerships are neither natural persons nor artificial persons, and the government has never applied the exception rule of Article 166 to domestic partnerships. Therefore, domestic limited partnerships cannot establish securities accounts. The China Securities Regulatory Commission (CSRC) has recently banned the applications of some corporations to go public in China because the subject applicants have certain shareholders who are limited partnerships. This has blocked the exit strategies of the PE funds via the IPO in China and provoked discouragement and rage in the domestic PE industry. In practice right now, two alternatives are to transfer the subject equities from limited partnerships to others who meet the requirements of Article 166, or to go public in other jurisdictions, such as Hong Kong.
It is reported that the CSRC has attempted to address this issue at the regulatory level through the exception rule of Article 166. This, however, may require higher authorization from the State Council. It is difficult to estimate when this issue will be addressed. Therefore, PE funds should take into account suitable exit alternatives if they have chosen or are planning to select limited partnerships in China.