LLPs fulfil unmet need

“There shall be a new form of legal entity to be known as a Limited Liability Partnership.”

With something of a flourish the Limited Liability Partnerships Act 2000 Section 1 (1) announced the creation of the first new form of business entity since the Joint Stock Companies Act 1844 created the company incorporated and registered under the Companies Acts. The Act became effective on April 6, 2001; Some 900 LLPs have already been registered, of which 42 are in Scotland at the time of writing. Scottish solicitors can practice as LLPs.

A limited liability partnership incorporated under the 2000 Act (hereinafter referred to as an “LLP”) borrows some of the aspects of partnerships and of companies, but is neither of them. The limited partnership registered under the 1907 Act will remain available for those purposes for which it has been found useful, and neither it nor a partnership regulated by the 1890 Act (hereinafter referred to as an “1890 Act Partnership”) are affected by the new legislation.

The Legislation

The substantive legislation relating to LLPs is:

• The Limited Liability Partnerships Act 2000.
• The Limited Liability Partnerships Regulations 2001 (hereinafter the “GB Regulations”).
• The Limited Liability Partnerships (Scotland) Regulations 2001 (the “Scottish Regulations”).

In addition, the Limited Liability Partnerships (Forms) Regulations 2001 prescribe the forms to be used for applying to register an LLP and for providing other information to Companies House. Fees payable to the Registrar are prescribed in the Limited Liability Partnerships (Fees) (No.2) Regulations 2001.

The GB and Scottish Regulations adapt and apply (with modifications) to LLPs existing legislation relating to companies, principally:

• The Companies Act 1985;
• The Insolvency Act 1986;
• The Company Directors’ Disqualification Act 1986;

and, of course:

• The Requirements of Writing (Scotland) Act 1995.

While the Act itself is (mostly) a model of clarity, the Regulations present a nightmare of translation of terms and “scissors and paste” adaptation of the principal legislation. Moreover certain sections of the Insolvency Act 1986 which are applied had already been amended by the Insolvency Act 2000 and were brought into effect on 2nd April 2001, i.e. four days before the LLP Regulations. The nightmare is likely to continue as and when other sections in the Insolvency Act are made effective later this year, and indeed in relation to modifications to the companies legislation which will inevitably happen in due course.

It is ironic that a proposal which was conceived and presented as a method of enhancing competitiveness and efficiency for the benefit of those businesses trading as 1890 Act partnerships should have emerged in a form which requires careful guidance by professional advisers.

The Basic Structure of an LLP

The defining characteristics of an LLP are:

• It is a body corporate with legal personality separate from that of its members
• It has unlimited legal capacity, i.e. it can carry out any lawful act which could be performed by an individual or an 1890 Act partnership without reference to any version of the ultra vires rule as it applies to a company.
• In the event of an LLP being wound up (but not otherwise in the absence of specific agreement) the members have such liability to contribute to its assets as is provided for under the LLP Act, and no more.

Partnership law does not apply to an LLP except so far as provided by the Act or any other “enactment” (i.e. including subordinate legislation).

However, the Act contains provisions whose terminology has been lifted more or less completely from the Partnership Act 1890, such as the requirement that an LLP must “carry on business” and the “default provisions” of the GB Regulations (para. 7). Are the decisions of the courts on the interpretation of provisions in the Partnership Act 1890 relevant to the interpretation of the same (or very similar) provisions in the LLP Act notwithstanding s.1(5)? Common sense as well as the need for uniformity suggests that they should, but it would have been better if the GB Regulations had been quite specific that this was their intention.

Legal Personality

An LLP’s separate legal personality is more robust than that of a Scottish 1890 Act partnership. An LLP exists until it is formally dissolved under a similar process to an incorporated company. It has a registered identity confirmed by a Certificate of Incorporation, and the detailed information prescribed by the LLP Act is available for inspection at Companies House, all characteristics shared with incorporated companies. The conceptual difficulties which are held to prevent the title to heritable property (for example) being taken directly in the name of an 1890 Act partnership do not exist in the case of an LLP. Conveyancers will therefore be grateful that the tangled consequences of taking title in the name of partners in trust for the firm do not arise; title will be in name of the LLP itself, as with a company. 

Incorporation Procedure

The procedure for incorporation of an LLP is straightforward. There is a single document (Form LLP2; the “incorporation document”) which, duly completed and signed, is lodged with the Registrar of Companies in Cardiff (for England and Wales) or Edinburgh (for Scotland) together with the Registrar’s fee of £95. No other documents are lodged with the Registrar; in particular, if there is a partnership agreement, this is not filed at Companies House and remains throughout the life of the LLP a private document.

If the application is in order the Registrar will file the incorporation document and issue an incorporation certificate with the LLP’s registered number. The Registrar’s certificate is conclusive evidence that the requirements for incorporation of the LLP have been met and that it is incorporated under the name specified. The LLP can then commence trading.

Name

The proposed name of an LLP is subject to the same rules as the name of a company incorporated under the Companies Act. The names register for companies and LLPs is unified. An LLP cannot have the same name as that of an existing LLP or company (and vice versa), and if the Registrar considers that it is “too like” an existing name or misleading he may require the LLP to change its name. It is therefore prudent to check whether there is any possible conflict with an existing name before applying for incorporation, ordering stationery, etc. It cannot be assumed that an existing 1890 Act partnership name will be acceptable for the same business incorporated as an LLP. As with a company, however, the LLP may choose to operate under a trading name. The provisions of the Companies Act and the Business Names Act apply to the registered name and any trading name of an LLP, and the display of such names at places of business and on stationery.

The name of an LLP must end with the words “Limited Liability Partnership” or its permitted abbreviations “llp” or “LLP” (or their equivalents in Welsh for LLPs registered in Wales).

If an LLP changes its name it must file LLP3 with the Registrar (for which there is a fee of £20) and a fresh certificate of change of name will be issued. The change of name does not affect the existing business of the LLP.

The concept of a “firm name” familiar in the context of 1890 Act partnerships does not apply to LLPs, any more than it does to incorporated companies.

Registered Office

The incorporation document must state the jurisdiction within which the registered office of the LLP is to be situated, i.e. Scotland, England and Wales or Wales. This cannot be altered and determines the legal system which applies to the LLP. It must also state the postal address of the registered office at incorporation. Any subsequent change is intimated to the Registrar on Form LLP287.

Members

The incorporation document must give the name and address of each person who will be a member of the LLP and which members are to be “designated” (see below). “Person” includes legal persons such as incorporated companies and Scottish partnerships. Section 4 provides that the members who subscribed the incorporation document (other than any who have died or been dissolved before incorporation) are its members with effect from the certificate of incorporation. Additional members are admitted in accordance with any agreement among the members (or by consent of all if the default provisions apply).

A member of an LLP is not regarded ‘for any purpose’ as employed by it, unless he would be so regarded if the LLP were a partnership under the 1890 Act (s.4(4))

Although there have to be at least two members of an LLP at the time the incorporation document is signed, the LLP continues to exist (unlike a partnership under the 1890 Act) until it is dissolved following the winding up processes referred to below. Under Section 24 of the Companies Act 1985 as adapted by the UK Regulations, if an LLP carries on business without having at least two members for more than six months, the person carrying on business incurs personal liability for the debts of the LLP contracted during that period. This gives ample time for the surviving member to assume the necessary additional member, who could of course be his own nominee company.

Each proposed member must sign a form of consent to be a member on the incorporation document, also indicating whether (if relevant) he consents to be a “designated member”. There are forms for intimating to the Registrar the appointment of an additional member, the termination of membership, and the alteration of particulars (including a member becoming or ceasing to be a “designated member”). The form for a new member requires the member’s signed consent.

“Designated Members”

Section 8 introduces the concept of a “designated member” of an LLP. The Act provides that some or all of the members may be “designated”. Those members are responsible for ensuring that the LLP complies with the legislation, e.g. making returns to the Registrar. The default position is that all members are “designated” but the incorporation document can state that only specified members are to have this status. In an LLP where some members are “salaried partners” it would be appropriate to complete the documentation on the basis that only the equity partners are “designated” and salaried partners do not, therefore, have personal responsibility for compliance.

Eligibility for LLP Status

The incorporation document contains a statement that the persons whose names appear “are associated for carrying on a lawful business with a view to profit”. This can be signed either by a solicitor engaged in the formation of the LLP or one of the persons named as a member.

The 1890 Act defines “partnership” as a subsisting relationship, which of course may exist without the partners being aware that they are, as a matter of law, in partnership. No such

relationship requires to exist prior to the incorporation of an LLP. Since an LLP does not exist until the Registrar issues his certificate, it cannot commence trading until that date, or at some point thereafter. Membership of an LLP requires signed consent and cannot, therefore arise by unconscious involvement in a “relationship”.

The legislation does not limit the period an LLP can wait after incorporation before it actually commences trading. It is impossible to form a “shelf” LLP as with companies, because the nominee members cannot be said to be associated for the purpose of carrying on a business with a view to profit. However, if the members are genuine members of the LLP, the fact that it does not commence business until some time after incorporation is irrelevant, although a member or creditor could petition for its winding up if it does not commence business within one year. Indeed if the LLP is the incorporation of an existing firm there will need to be an interval during which the transfer of employment contracts and other engagements and liabilities can be arranged.

Partnership Agreement/Default Provisions

An LLP does not require to have a “partnership agreement”. Where the LLP is the incorporation of an existing partnership, any partnership agreement which does exist does not automatically “carry over” to the LLP. Section 5 provides that the mutual rights and duties of its members are to be governed either by agreement among them or by default provisions found at paras 7 and 8 of the GB Regulations. The default provisions are modelled on those which apply to an 1890 Act partnership, and are in very similar terms. In many cases the members of the LLP will require these default provisions to be modified as with 1890 Act partnerships.

An agreement among the members of an LLP ought also to deal with retiral. A person ceases to become a member on death or dissolution or in accordance with what has been agreed among the members or in the absence of such agreement by giving “reasonable notice” to the other members (Section 4(3)). It is advisable to define “reasonable notice” of retiral, since the Act contains no such definition; it is to be hoped that the courts will require something more than a notice taking instant effect as under s.26 of the 1890 Act.

Members as Agents

Section 6 applies to LLPs the familiar principles of agency which apply to an 1890 Act partnership. Every member is to be regarded as an agent of the LLP, and the LLP is bound by the ultra vires acts of one of its members unless the person dealing with him knows that he has no authority.

Taxation

From the outset, the Government stated that LLPs would be taxed on the same basis as 1890 Act partnerships, and that the incorporation of an existing partnership as an LLP would have no adverse tax consequences. Sections 10-13 of the Act fulfil that undertaking in respect of trading LLPs in relation to income tax and chargeable gains, inheritance tax, stamp duty and national insurance contributions. This concession does not however apply to LLPs which are not carrying on a trade or profession, e.g. investment businesses. In these cases it is understood that the LLP will be subject to corporation tax rules, and the incorporation of an existing partnership of this nature will involve the usual tax consequences of cessation and new business. This Inland Revenue view is based upon the consistent reference in Sections 10-13 to an LLP “carrying on a trade or profession”. Note also that the tax-neutral effect of incorporating as an LLP does not operate if the LLP ‘disincorporates’.

The stamp duty concession in Section 12, which deals with the transfer of property from an existing partnership to its LLP successor is subject to a number of conditions which mean that, in most cases, if there are to be changes in membership these should be carried out before the incorporation.

The tax concessions referred to above do not apply to a sole trader incorporating an existing business, who would be subject to the normal “cessation” rules of the taxing statutes. However, it should be possible to avoid this problem by first assuming a ‘captive’ company as a partner, trading as a partnership for a short period and then incorporating as an LLP.

In the case of VAT, an LLP formed as a new business will be subject to the normal registration rules. The VAT rules for the transfer of a business as a going concern should normally mean that an existing partnership will be able to continue its VAT registration as an LLP.

Securities and Floating Charges

An LLP will require to register securities granted by it at Companies House as with the registration of charges by a company.

An LLP can grant a floating charge on the same basis as a company, and the holder can appoint a receiver. For many partnerships this will be an important advantage, enabling the business to grant security over assets which would not otherwise be possible, or only with difficulty, such as book debts and the value of the business as a going concern.

From the perspective of the firm’s bankers, an LLP is likely to be regarded in the same light as a private limited company. The bank will no longer have automatic recourse to the assets of all the partners and although a floating charge may substitute for this to some extent, personal guarantees may be required. A firm contemplating incorporation as an LLP will therefore require to review its banking arrangements to accommodate the change.

Execution of Documents

As has already been noted, an LLP does not have a “firm name” and therefore documents running in its name cannot be executed in this fashion.

Schedule 4, para. 5 of the Scottish Regulations inserts as para.3(A) new provisions in Schedule 2 of the Requirements of Writing (Scotland) Act 1995 specifically dealing with the execution of documents by LLPs. These apply to the exclusion of the provisions of that Act which relate to partnerships and to companies.

Except where the statutory presumption of authenticity of the signature is desired or required a document is signed by an LLP if it is signed on its behalf by any member of an LLP. If the statutory presumption is required there must be signature by either (a) a witness or (b) two members of the LLP.

Accounting and Disclosure

LLPs are subject to the same regime (with suitable adaptations) in relation to accounting, audit and the publication of financial information as a private limited company of similar size. The need for publicity may deter firms which would otherwise be attracted by the benefits of LLP status, although the climate of secrecy surrounding many professional partnerships has notably relaxed. Moreover, a business which qualifies a “small” for the purposes of the accounting rules may feel that the limited disclosures required are acceptable.

Insolvency and Winding Up

The provisions dealing with the insolvency and winding up of an LLP follow those of the Insolvency Act. The processes available in the case of a company (company voluntary arrangements, administrations, receiverships and voluntary or compulsory liquidation) are all available with minimum procedural modification in the case of an LLP. The details are to be found in the GB Regulations and the Scottish Regulations.

Voluntary winding-up of an LLP is initiated by the “determination” of its members. The legislation does not, however, clarify how such a determination is to be reached, i.e. whether unanimously, by simple majority or by qualified majority. Accordingly, the members should include in their agreement procedure for arriving at such a determination, which might be a 75% majority, as required for companies.

Members’ Liability

Limitation of the members’ liability to contribute to the debts of the firm is of course at the heart of the LLP concept.

Unless by agreement or the law of delict, an individual member is not responsible for the debts of the LLP except to the extent of his liability to contribute to the assets of the LLP in the event of it being wound up as provided for by the Act through the application of Sections 212 – 217 of the Insolvency Act 1986 by the Scottish Regulations. Apart from the re-use of a prohibited name, personal liability requires the LLP to have gone into insolvent liquidation, and in the case of fraudulent trading (s.213) or wrongful trading (s.214) liability can only be imposed by court order on an application by the liquidator.  Other insolvency office holders or individual creditors cannot obtain such an order. In applying the provisions of the Insolvency Act “director” is replaced by “member” and “shadow director” by “shadow member” (similarly defined).

The Regulations add a further ground of liability against members or shadow members of an LLP by new section 214A in the Insolvency Act. Again, this only applies if the LLP has gone into insolvent liquidation, and the liquidator must apply to the court for an order. The grounds of the order are similar to a contribution order under the wrongful trading provisions of s.214 but the payment which the court may order is limited to any withdrawal of assets (of whatever kind) made in the two years prior to the commencement of the winding up. In practice therefore, so long as a former member was not party to fraudulent or wrongful trading his exposure to liability to contribute to the assets of an insolvent LLP will cease after two years.

The defences which are available to a company director under Section 214 are also available to a member of an LLP who is faced with a claim under s.214 or s.214(A).

Payment of his “salary” to a salaried partner may count as a “withdrawal of assets” for the purposes of s.214A. Apart from the possibility of mounting a more justifiable defence than his equity partner colleagues (who presumably control the business) this is less of a risk to a salaried partner than his exposure to unlimited liability under the 1890 Act.

Disqualification

The GB Regulations apply with modifications to the provisions of the Company Directors Disqualification Act 1986. For this purpose, as with the Insolvency Act, “director” means “member” and likewise “shadow director” means “shadow member” and references to a company include references to an LLP.

A Disqualification Order is generally seen as the penalty for abusing limited liability status, and it is therefore logical that this should apply to an LLP as it does to a company. In providing that the Company Directors’ Disqualification Act 1986 shall apply to LLPs23 the legislation intends that a Disqualification Order in relation to a company also prevents that individual from being a member of an LLP, and an order in relation to an LLP also prevents that individual from being a director of a limited company. A disqualified individual can obtain the sanction of the court to act as a director of a particular company or as a member of an LLP. There is building up a considerable body of case law on such applications in relation to companies. Presumably the courts will adopt a similar approach in relation to LLPs.

A serious omission in the legislation, however, is the absence of any provision dealing with the consequences of an individual being disqualified from membership of an existing LLP. In the company context a disqualified director cannot take part in management but he would retain any shareholding and rights associated with it. In the case of an LLP, however, disqualification from membership has much more drastic results: Prima facie, the effect of a Disqualification Order on a member of an LLP is that he must take steps to relinquish his membership, which may be impossible. There may be no person available to acquire his membership, or his forced retiral may result in the dissolution and winding up of the LLP, with consequential damage to its employees and creditors. Surely these are unacceptable, and presumably unintended, consequences? In the present author’s opinion, however, it is open to a court when making a Disqualification Order to provide that the individual shall not act as a director of a company nor be involved in the management of an LLP, leaving it open to such a person to be or to remain a member of an LLP.

Conclusion

The steady take-up of LLP incorporation, particularly in England, suggests that the creation of LLPs has fulfilled an unmet need. The decision for each firm will of course depend on its individual circumstances, and the balancing of the advantage of limited liability against the disclosure requirements and the attitude of the firm’s bankers. Businesses which have already taken advantage of LLP status range from a major international accountancy firm (Ernst & Young) to a husband and wife corner shop in Leamington Spa. Solicitors and accountants advising on the choice of business medium will be expected, therefore to offer their clients the choice of LLP status as well as partnership and incorporated company.

David A Bennett, WS Bennett & Robertson, solicitors, Edinburgh is convener of The Law Society of Scotland’s company law committee