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Limited Liability Partnerships – CertainShops newsletter June 2007

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John Halton, Cripps Harries Hall LLP – Commercial Contracts

So what is an LLP anyway?

The Limited Liability Partnerships Act 2000 came into force on 6
April 2001 and provides a totally new business vehicle. Limited
Liability Partnerships (LLPs) are designed to combine the benefits of
limited liability provided by limited companies with the benefits of
flexibility and tax transparency enjoyed by traditional partnerships.
Now that LLPs have been possible for some time, they are becoming
an increasingly familiar part of the business landscape.

What is an LLP?

Key features : An LLP is a corporate body which exists as a legal ‘person’
independently from its members. In this respect it is just like a
limited liability company. This contrasts with a traditional
partnership, which has no separate legal identity.

LLP membership combines both ownership and the right to manage
the business. This contrasts with companies, where a strict
distinction is made between the role of the owners (shareholders)
and the managers (directors) even though these are often the same
people.

There are no memorandum and articles of association and the
constitution is governed by a ‘members’ agreement’, which is in many
respects similar to a partnership agreement. Members have
considerable freedom to agree whatever terms they wish. They may,
for example, choose to replicate many of the terms of an existing
partnership agreement, including the financial terms and
management structure. Members are free to alter these terms in the
future if they wish.

Members of an LLP are taxed in the same way as partners in a
partnership. The LLP itself is tax-transparent and members will be
taxed on their share of the profits. No employers’ national insurance
is payable on members’ profit shares. The conversion of a
partnership to an LLP will usually be tax neutral.
An LLP is fully liable for its own debts and obligations but the liability
of the members is limited to the capital they have contributed or
committed.

Although an LLP has several of the features of a partnership, it is not
really a partnership at all, but is more akin to a company. The
legislation provides that partnership law does not apply to LLPs,
except in a very limited way.

When can an LLP be used?

There must be ‘two or more persons associated for carrying on a
lawful business with a view to profit’. ‘Business’ includes every trade,
profession and occupation, but not mere co-ownership of an asset if
this does not involve commercial activity. The requirement for a ‘view
to profit’ means that LLPs are not suitable for charities and other not-
for-profit organisations.

LLPs can be incorporated in England, Wales and Scotland, but not in
Northern Ireland. Members can include any individual or a company or another
LLP so group structures are possible. There is no limit on the maximum
number of members.

LLPs are not suitable for anyone who is disqualified to act as a
company director, because the disqualification also extends to being
a member of an LLP .

Benefits:

The position of partners and LLP members contrasted
Partnership means sharing in the firm’s profits. It also means being
personally liable for the firm’s obligations. A partner is agent for
every other partner and can bind them into contracts. All partners
are potentially liable, not just for their partnership share of the firm’s
obligations, but for all of its obligations to the full extent of their
personal assets. If some partners cannot pay their share, the other
partners have to meet that liability. If a partner is negligent and a
client makes a claim, then all partners are liable to meet that claim
on the same basis.

On the other hand, the LLP is liable for its debts and other
obligations, but its members are not. If an LLP becomes insolvent
and is wound up, members cannot be required to contribute from
their personal assets to make up any shortfall unless they previously
agreed to do so. This is likely to be rare. It also means that if a
member is negligent, then fellow members are not personally liable to
meet a claim for compensation. The position is much like owning
shares in a company. An LLP member risks his or her investment in
the LLP becoming worthless (and of course losing their livelihood)
but does not risk losing their house and other personal assets.
But there are some potential inroads into the concept of limited
liability, as follows.

Contract:

Some third parties, such as bankers and landlords, may require
personal guarantees from members.

Negligent advice:

Members are not personally liable to meet a claim arising from
another member’s negligence. But the negligent member himself or
herself may be personally liable for any negligent advice given by
them. This liability can only arise where the member assumes
personal responsibility for the advice. But the law is currently unclear
whether this responsibility depends on the conduct of the member
concerned or whether it will be assumed to arise in certain
circumstances.

This lack of consistency in recent case-law is not satisfactory because
it is not clear what LLP members can do to avoid the risk of personal
liability. It remains to be seen how the courts will resolve these
doubts. But in the meantime, bear in mind that even if personal
liability for negligence does arise, this will usually be covered by
professional indemnity insurance. Also, that having no personal
liability for fellow members’ negligence is a considerable
improvement on having unlimited liability within a partnership. Being
a member of an LLP will also protect against business risks, which
may also be significant. LLPs, (particularly professional LLPs) will
want to make it clear in their engagement letters with clients that no
personal responsibility is intended, although this alone is no
guarantee that personal liability will be avoided.

One issue that partners contemplating LLP status must consider is
whether the possibility of personal liability might adversely affect
team-working and other co-operative working arrangements.

Insolvency:

LLP members are broadly subject to the same Insolvency Act 1986
liabilities as company directors in relation to insolvent winding up. So,
for example, the court may order LLP members to contribute to the
LLP’s assets if they have been involved in fraudulent trading or
wrongful trading. The legislation also introduces a new power for the court to order an
LLP member to repay money or assets withdrawn from the LLP (in
whatever form) during the two years preceding insolvency. This power,
which applies only to LLPs, can only be exercised if the member
knew or had reasonable ground for believing that the LLP was
insolvent at the time of the withdrawal, or would become so in
consequence of it. Also, the court may not order any repayment
unless the member knew or ought to have concluded after each
withdrawal that there was no reasonable prospect of the LLP avoiding
going into insolvent liquidation.

Practical benefits:

A number of practical advantages arise from the LLP’s legal status.
There are no restrictions on the number of members an LLP may
have. Being a separate legal person means there is no need for
business assets to be transferred whenever members retire or new
members join. Retiring members will not need to obtain releases
from contracts that they might have had to sign personally as
partners in a traditional partnership.

Organisational flexibility includes freedom to create, through the LLP
members’ agreement, whatever management or profit structure is
desired, with no need to distinguish rigidly between directors and
shareholders. This agreement remains private. An LLP has unlimited
legal capacity so, unlike companies, there are no technical concerns
about whether a transaction is within its legal powers.

Taxation:

Conversion of a traditional partnership does not generally entail any
alteration in tax status. The LLP is treated for tax purposes as a
traditional partnership and the members will be taxed as partners,
each being liable for tax on their share of the income or gains of the
LLP No employers’ national insurance contributions are payable by
the LLP on pre ofits paid to members. The process of conversion from
a traditional partnership to an LLP is also tax neutral.

Disadvantages:

Financial transparency. An LLP must file annual accounts with Companies House,
where they will appear on a public register in the same way as for companies.
They must be prepared in accordance with strict accounting
standards and they must be audited. If the LLP’s profits exceed
£200,000, the remuneration of the highest-paid member must also
be disclosed.

The requirement to prepare accounts on a ‘true and fair’ basis may
pose practical difficulties for some partnerships – for example,
partnerships which have special arrangements to allocate outgoings
between different generations of partners. It may also present them
in a less flattering light than at present. Firms considering adopting
LLP status should seek advice from their accountants on the
accounting implications.

Small LLPs benefit from the same exemptions as small companies.
So any LLP that can satisfy two of the following criteria, need only file
an abbreviated balance sheet and is exempt from the audit
requirement.

Exemption criteria

• Turnover £5.6m or less
• Balance sheet total £2.8m or less
• 50 employees or fewer

Administrative requirements :

This is an administrative burden more than anything else. Broadly
speaking, LLPs are subject to the same filing obligations at
Companies House as companies. Two or more members must be
appointed to act as ‘designated members’, a role which carries with
it responsibility for ensuring that these filing obligations are complied
with.

Members’ home addresses must also be filed at Companies House
just as company directors’ home addresses are. For members whose
work is particularly sensitive, it is possible to apply for a
confidentiality order which, if granted, enables home addresses to be
kept off the public register. If this is likely to be an issue for you, it is
essential to apply in good time before the LLP is incorporated
because there is no provision to have names removed from the public
domain in retrospect. A confidentiality order will only be granted
where disclosure of a member’s home address will place the member
or their family at serious risk of being subject to violence or
intimidation.

Cripps Harries Hall have an experienced team of solicitors who have
expertise in all areas of business law.

For further information, please contact John Halton

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