Limited Liability Partnerships, by Brenda Hannigan
http://www.companieshouse.gov.uk/about/busRegArchive/RegIssue56.pdf

Background

It is now more than two years since the Limited Liability Partnership Act
2000 (LLPA 2000, in effect 6 April 2001) made limited liability partnerships (LLPs) available to any 'two or more persons associated for carrying on a lawful business with a view to profit' by simple registration with the registrar of companies (LLPA 2000, s 2(1)). This new form of legal entity, though now available to all, was introduced followed years of intensive lobbying by accountancy firms for a business vehicle which protected their partners' personal assets against
ever-increasing liabilities with respect to negligent audits.

The governing legislation is the LLPA 2000 together with the LLP Regulations 2001 (and their Scottish equivalent). The LLPA 2000 is brief and supplemented by the Regulations which in turn apply to LLPs certain provisions of the Companies Act 1985 (especially on accounts and audit), the Insolvency Act 1986 (provisions relating to corporate insolvency) and the Financial Services and Markets Act 2000 (provisions on insolvency).

Legislation by cross-referencing is unsatisfactory as it means that there is no single statute which contains the legislation applicable to LLPs. However, the Government thought this option preferable to an LLP statute of several hundred sections. The Company Directors Disqualification Act 1986 is also applied by the Regulations to LLPs so a member of an LLP may face disqualification proceedings in the same manner as a director of a company. Also, a disqualified
director cannot be a member of an LLP and a member of an LLP who is disqualified cannot be a company director.

Current position

The latest DTI Report, Companies in 2002-2003 (for the year ended 31 March 2003) showed that there
were approximately 4,500 LLPs on the register. These numbers are modest, especially when contrasted
with the number of limited companies on the register (approximately 1.6m: Companies in
2002-2003) and partnerships (approximately 568,000: DTI, SME Statistics for UK 2002). Of course, at
this early stage in the development of LLPs, possible users may still be adopting a 'wait and see' approach.

We consider below the key features of an LLP which will help us assess the advantages and disadvantages of this new business vehicle. As a preliminary point, it should be
stressed that the decisive consideration in deciding whether to adopt an LLP structure may be the
taxation position (an LLP is taxed as a partnership rather than a company which may be more advantageous for all concerned). However, this article is concerned solely with the
legal rather than the taxation position.

Key features

The key features of an LLP include:

■ It is a body corporate, i.e. a separate legal entity distinct from its members. The LLP can own and hold property, employ people and enter into contractual obligations. Debts incurred are the debts of the LLP.
■ An LLP has unlimited capacity which means that third parties need not be concerned about any
restrictions on its activities.
■ An LLP has members but no directors or shareholders. An LLP has no share capital and is not
subject to the company law rules governing the maintenance of capital.
■ The members of an LLP have limited liability (a point discussed further below). The LLP is liable
for all its debts to the full extent of its assets.
■ An LLP has complete flexibility as to the internal structure which it wishes to adopt: there are no requirements for board or general meetings or decision-making by resolution. An LLP does not have a memorandum or articles of association.
■ As the members have limited liability, the protection of those dealing with an LLP requires that
the LLP maintains accounting records, prepares and delivers audited annual accounts to the
registrar of companies, and submits an annual return in a similar manner to companies.
However, the exemptions available to companies, for example with respect to the delivery of abbreviated accounts and exemption from audit also apply to LLPs.

Limited liability

As noted above, the liabilities incurred by the LLP, as it is a separate legal entity, must be met
from the assets of the LLP. To the extent that the members have contributed to those assets, a
member risks losing that amount should the creditors claim those assets.

A broader issue is whether a member has any liability to make a contribution to the assets in the
event of the liquidation of the LLP. In the case of a company limited by shares, it is well understood that a member's liability is limited to the amount due (if any) on his shares. In
the absence of share capital in an LLP, the matter is less clear but it is governed by the Regulations which modify the application of Insolvency Act 1986, s 74.

The modified section provides that a member's liability to contribute on winding up is limited to suchamount as the member has agreed with the other members or with the LLP that he will contribute. However, there is no requirement for any contribution. In the interests of clarity, therefore, the LLP agreement (discussed below) should specifically state the required contribution on liquidation or state that no contribution is required on liquidation.

Members are exposed to potential liability for wrongful or fraudulent trading, just as directors and others are under the Insolvency Act. Also, there is a potential liability under the
claw back provision (IA 1986, s214A) which provides that, in certain specified circumstances, any
amounts withdrawn by members in the two years before the commencement of winding up can be clawed back). A member may also be exposed to liability under the general law, as where he gives negligent advice; where he does so in the course of the business of the LLP, the LLP is liable to the same extent as the member, see LLPA 2000, s 6(4).

Members and designated members

As noted above, there are no shareholders in an LLP. Instead there are members and they are identified in the initial incorporation document with subsequent changes to the membership being notified within 14 days of the event occurring.

Any person, meaning any natural or legal person, may be a member of an LLP and the registrar of
companies is not concerned with whether an individual member is acting in a personal or representative capacity (although the LLP agreement, discussed below, may address such issues). For entities other than individuals, the key issue is whether they have legal personality. If they have, they may be a member of an LLP, so any body corporate, such as a company registered under the Companies Act 1985, whether limited by shares or limited by guarantee, and whether acting on its own behalf or as a trustee, may be a member. 

The legislation also requires that two or more of the members be identified as the designated members. The designated members have statutory responsibility for certain tasks and are subject personally to sanctions (typically a fine) in the event of default. The designated members are not the management team of the LLP (management is discussed below)but are responsible for these defined statutory tasks which include:

■ signing the accounts;
■ delivering the accounts to the registrar of companies;
■ appointment and removal of the auditors (if required);
■ notification of membership changes (and changes to the
registered office) to the registrar of companies;
■ preparing, signing and delivering the annual return;
■ applying for the LLP to be struck off the register.

In default of notification to the registrar of companies of the designated members, all members
are designated members. Given this default position and the tasks imposed on designated members,
anyone who is a member of an LLP should check that there are designated members.

Members' obligations

All members, not just the designated members, are agents of the LLP, and as such owe the duties of an agent to the LLP, although the precise content of those duties (given the novel nature of the LLP) will need to be developed by the courts. The typical obligations of agents include obligations to act in the interests of the principal (i.e. the LLP), to avoid conflicts of interests and a prohibition on the making of secret profits, and some elements of these
requirements are reflected in the default provisions(Regulations, reg 7) While members are the agents of the LLP, they are not agents of one another and the legislation does not regulate the relationship between the members. The reason for the omission was the potential for conflict between the duty which the members owe to the LLP (as agents) and any duty which they owe one
another. The solution adopted was to impose the former duty as a matter of statutory obligation and to leave it to the members to address their internal relationship in a separate LLP agreement.

An LLP agreement
As noted above, the statute makes no provision for directors or a board structure or any of the management structures familiar from company law. The management structure (and other matters) should therefore be addressed by the members in a separate LLP agreement. Any such LLP agreement is not registered at Companies House and it remains a private document. The legislation envisages that an LLP agreement will be the norm (LLPA 2000, s 5). There are two main reasons for this:
(i) the default provisions provided by the Regulations are unlikely to be appropriate in many instances. For example, the default position in the absence of an LLP agreement is that
every member may take part in the management of the LLP; all the members are entitled to share
equally in the capital and profits of the LLP and no member is entitled to remuneration for acting in the business or management of the LLP;
(ii) the default provisions are limited in scope and there are many issues which they do not address, such as the nature and extent of the capital contributions to be made by the members and how disputes between the members are to be resolved.

A comprehensive LLP agreement governing the duties and responsibilities of the members is a
necessity, therefore, and it will need to make provision for:
■ the management of the LLP;
■ the decision-making process;
■ the capital contributions required of the members, both while a going concern and (if any) on
liquidation;
■ the division of profits;
■ changes to the membership;
■ dispute resolution;
■ termination of the LLP; and
■ provision for the amendment of the LLP agreement;

The internal flexibility conferred on members of an LLP by leaving it to them to devise their own
management structure must be weighed, therefore, against the need to draw up an LLP agreement.
An additional difficulty will be that few advisers will have much experience of LLPs and the 'novelty' factor will have cost implications for those seeking advice. To sum up, a member of an LLP will be subject to obligations under the statute (as an agent of the LLP) and under the LLP agreement or, in the absence of any agreement, under the default provisions contained in
the Regulations. A member who is a designated member will have the additional responsibility of
compliance with the statutory obligations imposed on designated members which were noted above.

Making a choice

The advantages of an LLP include:
■ Limited liability: reduced risk to personal wealth from creditors' claims;
■ Internal flexibility: facilitates participation in management and maintenance of ethos of partnership.

The disadvantages include:
■ Lack of privacy - financial information must be disclosed (subject to exceptions);
■ Requirement for an LLP agreement: needed to avoid default provisions applying and to
cover situations not addressed by default provisions;
■ Legal uncertainly - novel structure - uncertainty is undesirable in commercial entities.

If the position of an LLP is compared with a private limited company, such companies have:

■ Limited liability - same as LLP.
■ Internal flexibility - the impact of the company law requirements for formal board and
management structures on small companies can be overstated. In fact, the law facilitates informal
and flexible decision-making in such companies, for example, allowing meetings to be called on
short notice, use of written resolutions and acceptance of informal unanimous assent.
■ Privacy - same as LLP - disclosure subject to exemptions.
■ No need for LLP agreement - the memorandum and articles of association act as default standard
provisions.
■ No legal uncertainly - tried and trusted business mechanism with high degree of legal certainty -
structure familiar to advisers and well-developed and sophisticated body of law applicable.

Conclusion
For the moment, going by the numbers of LLPs registered, most business seeking limited liability are continuing to opt for a limited company registered under the CA 1985. The LLP structure will appeal to some, most notably the professions, in that it meets their need for limited liability while offering the possibility of retaining internally the ethos of partnerships. The LLP structure is also attractive for some venture capitalists because of the ability of members to participate in management without the risk of losing limited liability, the absence of
capital maintenance rules and the advantageous tax position. Outside of those groups, in the short term at least, it is difficult to see the LLP becoming a mainstream business vehicle.

Even in the long term, it may be that there will only ever be modest uptake of LLPs. The Law Commission is expected to report shortly on a revamp of general partnership law which may make that vehicle more attractive for many businesses; and, in the fullness of time, a new Companies Bill may emerge to reduce further the formalities associated with the limited liability company.

Brenda Hannigan writes in a personal capacity