For an investor, a limited partnership is often an attractive proposition. If you like the business plan, believe the public will demand the goods or services, and trust the competency of the general partner, being a limited partner is an easy gig. You invest so much and thus you own so much of the company. You receive your percentage of the profits and pay taxes on your 1040. You don’t have to take any part in the day-to-day operation of the company and, if something goes wrong, you are only liable for an amount equal to your investment in the company. In the best of cases, you simply sit back and collect revenue. But what do you do—what can you do?—in the worst of cases?

By the worst of cases, we don’t mean a good-faith failure of the business to catch on. Rather, what happens when the general partner, who is in absolute control of the business, decides to cheat the limited partners? In a limited partnership, the board of directors, if one exists, may be rather lax about questioning the general partner’s (GP’s) decisions. The limited partners (LPs) usually have limited knowledge, and in most states, when LPs get involved in company management, they are no longer considered LPs. Thus they lose their protection from liability. It is ironic, but it’s possible that by trying to save the company, you could become personally responsible for the misdeeds of the person who was ruining the company. All of this makes it notoriously easy for a criminally minded GP to commit fraud.

Common forms of GP abuse

Take for example what we call “self-dealing.” This is the unscrupulous practice of a GP paying exorbitant fees and benefits to him/herself. This often comes in the form of double-dipping. The GP pays himself a salary for running the company, but bills as “additional services” many tasks that are part and parcel of running the company. Or a GP could “outsource” services to or purchase supplies from another company which he or a close relative owns, paying well above a competitive market rate. Of course, the GP, as a fiduciary, should only enter into contracts that serve the best interests of the investors, the LPs. But when a GP has the power to make a contract and approve it, there are no controls protecting the investors. The situation is rife with fraud potential.

Exercising control in a limited partnership

As with many problems in business, the time to act is before the problem arises. Therefore, before entering into a limited partnership you must:

• Research the GP’s business record and reputation for integrity
• Scrutinize the business plan
• Present the partnership agreement to an attorney for review

The law allows LPs certain “safe harbor” activities which you can engage in without compromising your limited liability. This includes serving on a Board of Directors and as a consultant of the company. Either of these positions would confer a right to review the company budget and business contracts. You can thus identify extraordinary expenses and investigate the nature of various trade partners.