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On
6 April 2001, the Limited Liability Partnerships Act 2000 took effect in the
United Kingdom, introducing a completely new form of incorporation for business,
midway between a partnership and a limited company. What were the reasons for
the passing of the Act? How does the limited liability company differ from a
partnership or a limited company? How does this affect the liability of the firm
or its members? Philip Britton answers these questions and more.
Introduction
On 6 April 2001, the Limited Liability Partnerships Act 2000 took effect in the United Kingdom, introducing a completely new form of incorporation for business, midway between a partnership and a limited company. The new limited liability partnership ('LLP') is available to businesses with registered offices in England, Wales or Scotland; following devolution, only the tax aspects of the new Act apply to Northern Ireland. This change has been keenly advocated by large numbers of professional firms and it is therefore likely that many will opt to incorporate under the new statute within a short time. The UK is now following many other jurisdictions which permit a combination of partnership structure and limited liability (notable among common law jurisdictions are the US State of Delaware, Canada and Australia). What then does general partnership law fail to provide, and how is the LLP, as just introduced in the UK, significantly different?
Liability under General Partnership Law
The key difference between a LLP and a general law partnership relates, as its name suggests, to the issue of the liability of the firm and of its members or partners (in the UK version of the LLP, those who would in a general law partnership be called partners are instead called members). The main English statute is the Partnership Act 1890, which lays down the basic principles but maintains scope for the common law and equitable principles already grown up in case law to continue and evolve alongside. This Act was itself in force in Singapore, until the Singapore Partnership Act (Cap 391) was adopted, which it very closely resembles. English partnership law, like that in Singapore, adopts the approach that every partner is personally liable for the debts and liabilities of all his or her co-partners (the principle of mutual agency). In addition, under the principle of joint and several liability, a partner – even in some circumstances an ex-partner – can be sued for the whole extent of a claim, have judgment executed against his/her own assets for the full amount and then have (if possible) to recover contributions from his/her colleagues. In this worst case scenario, the partner or ex-partner with the most assets may also be left holding the lion's share of the liabilities, up to and including bankruptcy or the equivalent. Of course, this personal liability can be – under the rules of many professions must be – covered by professional indemnity ('PI') insurance cover. But what about the 'Armageddon claim' which is over the limit of the PI cover in force?
Unlimited personal liability for all one's partners causes many professionals to fear a risk which they cannot easily measure or control under the legal structures of general partnership law. This risk is significantly greater, the larger the number of partners, of places or countries where the firm practises and of disciplines which the partners represent – so the trend towards multi-partner, multinational, multi-disciplinary partnerships offering professional services feeds this anxiety. This is underlined by the fact that, at least in English law (Scots law takes in some respects a different line), 'the firm' does not exist as a legal entity, so there is no real protection against personal liability to satisfy a claim which arises out of the professional work of other partners. There are other negative consequences of this doctrine, notably the problems of partnerships acquiring and disposing of land, but liability is the crucial one.
Pressure on Partners
The recession in the late 1980s in the UK left many whose security over property proved to be illusory, who had acquired companies worth less than expected or whose buildings developed defects. They chose increasingly to claim against the professionals involved – surveyors, accountants, auditors, architects, engineers and lawyers. Firms responded to this wave of litigation in different ways. A few abandoned partnership structures altogether, opting for incorporation as limited companies; some moved their legal base offshore to a jurisdiction which offered partnership combined with limited liability; but most stayed put as partnerships in the UK and hoped for legal reform, if the Government could be persuaded to lend a sympathetic ear. It was, they said, becoming difficult to attract and retain talent in this very important sector of the economy, if ideas developed at the time of Queen Victoria continued to be the basis of the law.
The firms who were unhappy wanted to retain the perceived advantages of the partnership structure under English law – eg the extreme flexibility of management, capital raising and profit-sharing systems within a firm, the tax and social security benefits (principally from partners' self-employed status), the light burden of compliance (no need to register a partnership or to file audited accounts publicly in a particular form). In all these areas the contrast with company structures is striking, where regulation and accountability to stakeholders and to the public in general are both much more developed and impose a significant practical and administrative burden. However, there is a prize which compensates for that burden – the liability for employees of a company acting as such attaches to the company itself, through the doctrines of agency and vicarious liability. And that liability is in normal circumstances limited to the assets identified as the company's own. What if similar principles could be extended to partnerships?
Reform under Way
In 1995 the then Conservative Government launched a study on limited liability partnerships, which in February 1997 resulted in a consultation document that won widespread support. After the General Election of May 1997, the Department of Trade and Industry ('DTI') in the incoming Labour Government committed itself to continuing the reform process, eventually tabling a Bill which in July 2000 became the Limited Liability Partnerships Act – a statute with only 19 short sections and one brief Schedule at the end. Unfortunately, however, further technical detail is necessary, to be contained in regulations made by the DTI and approved by Parliament; the initial set of these (SI 2001/1090) runs to 60 pages, including more than 50 pages of highly indigestible Schedules which cross-refer to companies, tax and insolvency legislation.
What's New about LLPs?
Section 1(2) of the 2000 Act says: 'A limited liability partnership is a body corporate (with legal personality separate from that of its members) which is formed by being incorporated under this Act'. So a LLP is conceptually closer to a limited company than a general law partnership – indeed, the general partnership law (including the 1890 Act) does not apply to LLPs unless otherwise provided. The similarity to a company is shown by two fundamental features of the LLP: (1) the existence of the LLP as a legal entity separate from its members (just as a company exists as a legal body distinct from its directors and shareholders); and (2) the process of creating such an entity through incorporation. As seen above, a general law partnership is unlike both a company and a LLP, having no legal personality in English law. Again by contrast, such a partnership needs no formal steps to come into existence: if two or more individuals fulfil the tests for acting as partners, the law so treats them. And in theory one partnership ends and another begins when a partner retires or a new partner joins (unless there is a partnership deed providing for these events). However, a company or a LLP, both creatures only of statute, can only be brought into life through a series of prescribed steps, ending in registration with a branch of Government (in both cases, Companies House). This official coming into the world is just the start of ongoing requirements to report publicly, which apply (though with many differences of detail) to both a company and a LLP. And once a company or LLP does exist, the entity thus created can continue potentially indefinitely, so long as it remains registered. It can hold property and be the subject of rights and duties (including granting fixed and floating charges over its assets); it can also survive changes in the identity of its key personnel.
It is from the fact of the legal personality of the LLP that the limited liability flows, as the members of the LLP are not agents of each other but are (in principle) agents only of the LLP itself. It is therefore the assets of the LLP alone which may be put at risk by the actions of its members (and employees); the members' personal assets not committed to the LLP are in the normal situation not at risk. If the LLP does become insolvent, modified aspects of both partnership and company procedures will apply, so there is the risk of 'clawback', under which certain transactions transferring capital from the LLP to a member or ex-member up to two years before the insolvency may be challenged. Equally, when insolvency strikes, a member of a LLP may be accused of wrongful or fraudulent trading and be disqualified from future involvement with a LLP or company. Also, like a company director, there are exceptional situations where a LLP member may take on personal liability to a client of the LLP: but these will be rare.
But how far does the analogy with company law reach? Not, happily, to the employment, taxation and social security position of members of a LLP. The approach taken – essential, if any firm is to find the LLP vehicle attractive – is transparency, combined with tax neutrality. This means that the LLP itself, though a separate legal entity, is not itself subject to taxation, nor is it the employer of its members. Instead, these members are treated, as far as possible, as if they were still partners under a general law partnership and the real objects and subjects of tax law. So if a firm incorporates as a LLP there should in normal circumstances be no tax arising, nor any change of the basis of taxation. Hence when former partners become members of a LLP, they retain their self-employed status, with all the linked tax and social security benefits, and movements of capital between members of LLPs will not normally attract capital gains tax. (Some of the tax treatment of LLPs is in the 2000 Act itself; other aspects may be legislated shortly.) So the flexibility of management structures, such a cherished feature of partnerships, is carried over to the LLP. The 2000 Act provides a rudimentary default code but allows the founding members of a new LLP wide freedom to adopt appropriate arrangements in a members' agreement – the direct equivalent of the familiar partnership deed. Only the most basic of the requirements of corporate governance which so affect the operations of limited companies have been imposed: for example, a LLP must have a registered address, an up-to-date list of its members and their home addresses must also be on record and it must regularly file accounts at Companies House on a 'true and fair view' basis, which for larger LLPs must also be audited. These fall far short of the onerous compliance regime for companies, but do impose greater publicity than general law partnerships have ever suffered. On financial reporting, a Statement of Recommended Practice ('SORP') specifically for LLPs is awaited from the accountancy authorities; its requirements may cause some firms to hesitate to 'go public' about the state of their business by incorporating as a LLP. Similarly, a partnership likely to attract the attention of protesters or fanatics might hesitate to adopt LLP status for fear of its members' homes becoming easy targets.
Making the Change
It was professional firms who wanted the LLP and they are the most likely candidates for incorporation under the 2000 Act; some have been getting ready while the Bill was going through Parliament and are keen to be in the 'first wave'. Deciding on a change of legal form is not an easy matter and all the experts suggest that strategic issues and needs should drive the decision, which should not be reached without properly researched, careful and time-consuming internal discussions, informed by professional advisers. These debates may range well beyond the narrow questions of limitation of liability and of the legal form most appropriate for the business; a firm operating internationally will also need to know how other relevant jurisdictions would treat a UK-based LLP.
For most firms, the choice is now between staying as a general law partnership, incorporating as a LLP or going further and becoming a limited company. If there is a plan eventually to be listed on a Stock Exchange, the LLP may be an unnecessary diversion and company status may be the more natural next step; on the other hand a firm may have no such aspirations and be happy with its current liability and insurance position as a general law partnership. Those firms who stay as such will find that even general partnership law is evolving, as the Law Commissions is at present reviewing (and will shortly propose reform of) the 1890 Act and its less well-known sibling, the Limited Partnerships Act 1907. Legal personality and continuity for all partnerships, and a softening of the rule that all partners' personal assets are immediately at risk for any default of any partner, are both on the cards.
If change is embraced, there is also the issue of how this should be managed – internally with all employed staff; externally with clients, banks, landlords, insurers, suppliers and others. And there are some technical issues that need addressing if the change to LLP status is to have no unwelcome legal or tax consequences. Crucially, no well-advised firm will make the move to LLP status without its own bespoke members' agreement. This is the real constitution of the business, which must be agreed in principle, drafted into proper form and signed: an agreement between the founding members themselves and between them and the new entity. Finally the incorporation documentation must be prepared and sent to Companies House. There is the question of the name of the new LLP: incorporation offers a fresh start, but a LLP cannot have a name already used by, or likely to be confused with, another LLP, a company on the UK register, a local authority or any branch of central Government. A LLP may even register itself in Welsh, then using the abbreviation PAC (or 'pac') instead of LLP (or 'llp') to denote its legal status.
Conclusions
The LLP is the first really new business form in English law for more than a century, though its underlying ideas are drawn from both partnership and company law. Its gestation period and birth have been quick and easy and the new infant has arrived to a general welcome. The real test comes now: making the Act and the Regulations work, as firms consider going through the process of incorporation as LLPs. The DTI is confident that the new possibilities will be taken up, with a benefit to the professional sector of the economy; and in this respect the UK is the latest convert to what may become a worldwide trend.
Philip Britton
Director, Centre of Construction Law & Management
King's College, University of London, UK
(c) Philip Britton
Philip Britton LLB, BCL, is a contributor to a forthcoming book, Limited Liability Partnerships: A guide for professionals, which analyzes the Limited Liability Partnerships Act 2000 and the new strategic choices it offers. The book will be published shortly; for details, contact susan.hart@kcl.ac.uk.