GENESIS OF LIMITED LIABILITY PARTNERSHIP

“The Limited Liability Partnership (LLP) is a form of separate legal business entity that gives the benefits of limited liability but allows its members the flexibility of organizing their internal structure as a traditional partnership. They are intended for businesses which carry on trade or profession, and particularly attractive to larger professional partnerships”[1]

Unlimited liability of the partners is the main shortcoming of the general partnership. Traditional English partnership law fails to shield the partners’ personal assets even in the case of the innocent partners. The danger side of the unlimited partnership heavily felt in the early 1990s in US. The need for reform in the orthodox partnership law was initiated by group of professionals in Texas with a direct economic or personal interest in obtaining some financial benefit for themselves.[2] In this case the groups of professionals were Texas lawyers concerned that their personal assets may be at risk because of negligence or malpractice by other partner(s) over whom they have no control.[3] Moreover, following the collapse of Texas’s bank and saving loan associations in the late 1980s, the US Federal government begun to start the recovery by brought suit against shareholders, directors and officers of theses failed financial institutions, however, the recovery rate was considered insufficient.[4] The government then turn to lawyers and accountants who had represented the failed financial institutions before they collapse and brought malpractice claim against them, being the reason are these professional usually protected by substantial malpractice insurance and had numerous wealthy partners.[5] Some of the partners in these suits, however, were persons who had nothing at all to do with representation of the various thrift institutions, held liable on account of their personal assets.[6] These incidents necessitated the emergence of a convenient business engine which should offer benefits of the both limited company and partnership. As a result, the seed for the concept of LLP finally incepted in US. The first limited liability partnership act was enacted by State of Texas in 1991.[7] Through this act innocent partners were guarded from the vicarious personal liability for co-partner’s malpractice, negligence or omission. But this statute not release the partner from liability in case of partnership’s non-malpractice contractual and tort liabilities. After this enactment, by the end of 2001, all other states in US enacted the LLP statutes and share the LLP theme. However, the structure of LLPs varies from state to state. Some states have adopted very expansive approach to free the partner from any liability in tort or contract. For example, Delaware Revised Uniform Partnership Act.

In UK also the path for the introduction of LLP was taken same way as in US. Major auditing and accounting firms in UK involved in campaign for limited liability in conducting their business activities. However, in 1996, the U.K. Law Commission rejected the suggestion that the law on joint and several liability should be changed.[8] The successful implementation of LLP in providing limited liability for professional firms in the US has further motivated them to press the legislature to introduce LLP in the UK.[9] Finally, in response to calls from professionals firms faced with the possibility of negligence claims for ever-increasing amounts, the UK LLP Act has been enacted in July 2000 and came into force in April 2001. Limited liability of partners, corporate personality and partnership flexibility are the underpinnings of the UK LLP act. In addition, UK also has enacted the LLP regulations 2001 to regulate the activities of LLPs. It is important to note that the law relating to general partnership does not applied to a LLP[10] and provisions of the Companies Act relating to the preparation, audit and publication of accounts and the delivery of annual returns, provisions of the Company Directors Disqualification Act 1986, and provisions of the Insolvency Act 1986 are applied to LLPs.[11]

After the enactment of UK LLP Act of 2000, the LLP theme has rapidly spread to several states particularly in the major commercial states.[12] However, Sri Lanka still follows the Partnership Act of 1890 since colonial period even UK has modernized their partnership law by way of introduction of the Limited Partnership Act of 1907 and the LLP Act of 2000.

LLP STRUCTURE IN THE UK

LLP AS A BODY CORPORATE

The original intention was that availability of LLP in the UK only to the professional firms as were LLPs in the US. However, given strong opinions in the consultation process against restricting LLP to professionals, the LLP Act 2000 finally devised the LLP as a body corporate that can be used by not only professional firms but also by small enterprises as an alternative to the ordinary partnership and private company.[13] According to the Sec 1 (1) of the UK LLP act 2000: there shall be a new form of legal entity to be known as a LLP which has the following basic feature, it is a body corporate[14] and it has unlimited capacity.[15]

Unlike the general partnership, a LLP requires the formal incorporation process to come in to existence. In general partnership, the existence depends on the agreement of the partners whether it is formal or informal. There are three conditions must be satisfied in order to incorporate a LLP: (a) two or more persons associated for carrying on a lawful business with a view to profit must have subscribed their names to an incorporation document; (b) there must have been delivered to the registrar either the incorporation document or a copy authenticated in a manner approved by him, and (c) there must have been so delivered a statement in a form approved by the registrar, made by either a solicitor engaged in the formation of the limited liability partnership or anyone who subscribed his name to the incorporation document, that the requirement imposed by paragraph (a) has been complied with.[16]

Upon the issue of the incorporation certificate, the LLP becomes as a body corporate[17] with its own rights and duties, separate from its members as like a company. It can own partnership’s properties and can enter into any contract or transection with third parties. As price for the separate legal personality status, the LLP is subject to a regulatory regime as like companies, such as public disclosure requirements and insolvency procedures.[18] Its members will also be regulated by the Company Directors Disqualification Act 1986.[19] On the contrary, in the UK, for the taxation purpose only a LLP will not be treated as a separate legal entity, will be treated as a general partnership.[20]

Sec 1 (1) of the Partnership Act 1890 defines it is the relation between the partners but sec 2 (1) of the LLP Act expresses partnership is the association of partners for carry their business. Thus, Sec 2 (1) of the LLP Act effectively follows the format in the companies, but injects the Partnership Act requirement that there must be a business which is intended to be carried on with a view to profit.[21]

In traditional partnership, there should be at least two partners for the existence of partnership relationship. However under the LLP Act, even a LLP has only one member that LLP can continue to carry its business. Nevertheless, it carries business with only one member for more than six months and if that single member knows that he is the only member, he is liable jointly and severally with the LLP for debts.[22] The rationale behind is that, after the incorporation of LLP in UK which will become as a separate legal personality distinct from its members. The admission and removal of the members shall not affect the perpetuity of the partnership. Whereas, the admission and removal of the partners make the death of the partnership agreement in the general partnership.

THE LIABILITY OF THE LLP

Like a company, the LLP cannot act itself, it can only act through its members. Section 6 (1) of the LLP Act provides that, every member of the LLP is the agent of the LLP and they carry out the partnership’s business and management. In the traditional partnership, there is a mutual agency relationship between the partners. In contrast, in the LLP, partners are only agent to the LLP (principal) not to other partners. Thus, one of the underpinning feature of the traditional partnership has been disregarded in the UK LLPs.

The liability of LLP for the acts committed by its members (agents) with third party will depend on the actual authority of the member. If the acts of a member within his actual authority the LLP will be bound to those acts. The LLP Act 2000 leaves the general law of agency to apply to these matters.[23] The LLP will be vicariously liable to third parties for the torts and other wrongs of its members if they committed those torts and wrongs in the course of the LLP’s business.[24] Like Sec 10 of the Partnership Act 1890, sec 6 (4) of the UK LLP Act 2000 excludes the vicarious liability of the partnership for the tort or wrongful act committed by its member to another member of that partnership.

However, a LLP is not bound by anything done by a member in dealing with a third party if (a) the member in fact has no authority to act for the limited liability partnership by doing that thing, and (b) the third party knows that he has no authority or does not know or believe him to be a member of the limited liability partnership.[25]

MEMBERS AND THEIR LIABILITY

The persons whose names appeared in the incorporation document of the LLP become the first members of the LLP. The persons forming a LLP are named as members and not as partners in the UK. The first members can add another person as member after the incorporation. Any other person may become a member of a limited liability partnership by and in accordance with an agreement with the existing members.[26] As like the traditional partnership, admission of a new member in the LLP is a matter of contract which will be determined by the LLP agreement. If there is no any provision in the LLP agreement regarding the admission of new members then the default rule under the UK LLP regulations 2001 will be applied. That default rule is that, new member cannot be admitted without the consent of all existing members.[27]

Moreover, an important feature of the LLP compare with the ordinary partnership, the LLP Act has created the new role named as ‘’Designated member”.[28] In the incorporation document the members can specify the designated members or after the incorporation, members may nominate the designated member accordance with their agreement[29], if not every member is a designated member[30]. Their functions and responsibilities are enumerated in the LLP Act 2000 and the Insolvency Act. For example, responsibilities for compliance with the statutes concerning with LLP if not they may personally liable, signing and filing the accounts, control the appointment, removal and remuneration of auditors, notice the fundamental changes in LLP to the registrar, etc. In the LLP, members can transfer their share or interest to any other person[31] but it is not possible under the Partnership Act 1890. Moreover, like companies’ directors, the members of a LLP also will be governed by the UK Companies Directors Disqualification Act 1986.

As has already been seen that, the UK LLP Act has adopted the corporate personality doctrine to the partnership. The Doctrine of separate corporate personality means upon the incorporation, the LLP should be treated as a separate juristic person distinct from its members thereby both natural persons and artificial person have different rights and liabilities, members are not responsible for the LLP’s obligations. One of the main advantage of the doctrine of separate corporate personality is the Limited Liability which is the keystone of the company law, now it has extended to the partnership as the form of LLP. Main objective of the limited liability is that, attract or induce the traders to initiate new ventures without fear, and also an incentive of the investment of the public.  Even in the insolvent situation the creditors cannot extend their hands to the personal property of the LLP’s members. Simply limited liability functions as an asset protection mechanism of the members’ personal properties.

The liability of an individual member to the third parties for the debts and liabilities of the LLP in the event of winding up is limited to the sum which he has agreed with other members or with the LLP that he will be liable to contribute, in the circumstances which have arisen, towards what is sufficient for the payment of the LLP’s debts and liabilities.[32] That sum will be expressed in the LLP agreement.  However, the members can’t enjoy the benefit of the limited liability shield for their own wrongful act or omission to third parties.

It should be noted that, in the event of winding up, the LLP and its members will be regulated by UK Insolvency Act 1986 as like companies. Therefore, if a member of the LLP is liable under Section 212 (misfeasance), 213 (fraudulent trading) or, 214 (wrongful trading) of the Insolvency Act 1986, he will be required to contribute to the assets of the LLP in the winding up as the court thinks fit. Furthermore, it also possible to require a member to put back into the LLP any sums which he withdrew from it during the two years prior to the winding up, at the time of the withdrawal if he knew or had reasonable grounds to believe that the LLP was unable to pay its debts or would be unable to pay its debts by reason of his and any other contemplated withdrawals and he knew or ought to have concluded that there was no reasonable prospect that the LLP would avoid going into insolvent liquidation.[33]

Under the general partnership regime, there is no legal entity status to the partnership, the mutual agency relationship prevails between the partners, thereby, each partner is liable for his co-partner’s wrong within the scope of the partnership’s business.  However, under the LLP regime, the LLP is the body corporate. Thus, the members are only agents for the LLP (principal) not for their co-members. This feature of the LLP protects the individual member from personal liability for the acts of another member carried out in the course of the LLP’s business which is the fundamental benefit of the incorporation of LLP compare with traditional partnership.

LLP AGREEMENT

The mutual rights and duties of the members of a LLP, and the mutual rights and duties of a LLP and its members are governed by the LLP agreement[34] between the members or between the LLP and its members and if there is no agreement, that will be regulated by default rules under section 15 (c)[35] of the LLP Act.[36] The LLP agreement which is similar to the company’s articles of association but it is a private agreement not available to the public disclosure as like a general partnership agreement. Moreover, as like the general partnership agreement, the LLP agreement is easily amenable to the requirement of the members and there is no legal requirement that the LLP agreement should be in writing. Based on the core of the LLP, there is a cardinal difference between a LLP agreement and a traditional partnership agreement: the traditional partnership agreement is a bridge only between the individual partners but the LLP agreement is a connection not only between the individual members but also between the members and the LLP.

CREDITOR PROTECTION

On the one hand, limited liability encourage the entrepreneurs to start a business with lower risks but on other hand it increases risks for third parties to claim their money because due to the limited liability, claims are limited to the business assets and creditors cannot extend their hand to the personal assets of owners. In companies, the risks to creditors caused by limited liability have been mitigated by various measures. For example, Insolvency test, capital maintenance rule and piercing the corporate veil in various grounds. In the traditional partnership, creditors have no any problems because partners’ liability is unlimited. Whereas, in the LLP, the protection for the creditors is comparatively in lower position. Thereby, special safeguards have to be addressed by the LLP Act in order to protect the third parties. Accordingly, the UK LLP Act 2000 contains following rules.

In UK, LLPs are required to add the abbreviation of ‘’LLP’’ in the end of their name[37] which may give the information to the third parties regarding the limited nature of the partnership. Moreover, the UK LLP Act contains the “claw-back” provision in which distributions made to members in the two years before insolvency will be clawed back if the member “knew or ought to have realized” at the time of the distribution that there was no reasonable prospect of avoiding an insolvent winding up.[38]

In addition, Personal liability can be imposed on members of the LLP in the cases of misfeasance, fraudulent and wrongful trading provisions.[39] Moreover, although the UK LLP Act does not provide for mandatory insurance to meet potential liabilities, professionals such as lawyers are mandated to purchase professional indemnity insurance.[40] Furthermore, the LLP is created as a body corporate in UK, therefore, it seems necessary for the LLP to file audited accounts.[41] The above said matters aim to protect the creditors in a LLP.

CONCLUSION

In the UK, Collapse of the major auditing and accounting firms due to the unlimited liability of the partners led to the path for the introduction of UK LLP Act 2000. In a nutshell, the UK LLP Act, provides the corporate personality status to the LLPs, makes the arrangement that partners are the agents only to the LLP not to other co-partners, shields the partners from personal liability for the LLP’s obligations and co-partners’ tort or negligence or malpractice. Moreover, in order to avoid the abuse of limited liability concept, the UK LLP Act provides the following safeguards: disclosure of limited liability status, compulsory insurance policy for professional firms, requirement for audited accounts, and the claw-back provision to restore the unlawfully distributed or withdrawn money.

[1] http://www.breckmanandcompany.co.uk/content/forums_partnerships/limited_liability_part nerships.html.

[2] Robert W. Hamilton, Professional Partnership in the United States, 26 J. Corp. L. 1047 2000-2011, p. 1055. 

[3] Robert W. Hamilton, Registered Limited Liability Partnerships: Present at the Birth (Nearly), 66 U. Colo. L. Rev. 1065 1994-1995, p. 1066. 

[4] Ibid, p. 1069. 

[5] Ibid.

[6] Ibid, p. 1070. 

[7] M.Shaun Mcgughey,limited liability partnership: need only professional apply?,30 Creighton L.Rev.105, December 1996,www.lexisnexis.com.

[8] Judith Freedman, Limited Liability in the United Kingdom – Do They Have a Role For Small Firms? 26 Journal of Corporation Law 897 200-2001, p. 905. 

[9] Ibid.

[10] Sec 1 (5) of the UK LLP Act 2000.

[11] See the Limited Liability Partnerships Regulations 2001 (SI 2001 No 1090).

[12] Singapore, India, Malaysia, China, Hong Hong, etc.

[13] G Morse, Partnership Law, (Oxford: OUP, 2010), 293.

[14] With legal personality separate from that of its members.

[15] Sec 1 (2) of the UK LLP Act 2000.

[16] Sec 2 (1) of the UK LLP Act 2000.

[17] Sec 1 (2) of the UK LLP Act 2000, Salomon v Salomon (1897) AC 22 – An entity with legal personality status distinct from its members.

[18] UK LLP Regulations 2001 (SI 2001/1090.

[19] Part III, LLP Regulations 2001, SI 2001/1090.

[20] Sec 10 of the UK LLP Act 2000.

[21] John Whittaker and John Machell, The Law of LLPs, 2nd edition, pn 15.

[22] Ibid, pn 20.

[23] John Whittaker and John Machell, The Law of LLPs, 2nd edition, 5.3 pn 58.

[24] Sec 6 (4) of the UK LLP Act 2000.

[25] Sec 6 (2) of the UK LLP Act 2000.

[26] Sec 4 (2) of the UK LLP Act 2000.

[27] Regulation 7 (5) of the UK LLP regulations 2001.

[28] Sec 8 of the UK LLP Act 2000.

[29] Sec 8 (1) of the UK LLP Act 2000.

[30] Sec 8 (2) of the UK LLP Act 2000.

[31] Sec 7 of the UK LLP Act 2000.

[32] Sec 1 (4) of the UK LLP Act 2000 and UK Insolvency Act 1986, Sec 74.

[33] Sec 214 A of the UK Insolvency Act 1986.

[34] It is a contract which will be subject to normal contract law.

[35] Pursuant to Sec 15 (c), the LLP Regulations 2001 contain default provisions.

[36] Sec 5 (1) of the UK LLP Act 2000.

[37] Sec 2 (1) of the part one of the Schedule of the LLP Act 2000.

[38] Insolvency Act 1986, s 214 A (inserted by UK LLP Regulations 2001 SI 2001/1090) – In the UK, the partner who knew or had “reasonable grounds” at the time of withdrawal for believing that the LLP was unable to repay its debtors or would become unable to repay its debts after the withdrawal, has to repay the withdrawal made within two years prior to the commencement of the firm’s winding up.

[39] Insolvency Act 1986, S 212. S 213 and S 2014.

[40] “Practice Note: Professional Indemnity Insurance,” Lawsociety.org.Uk, January 30, 2013, http://www.lawsociety.org.uk/advice/practice-notes/professional-indemnity-insurance.

[41] UK Limited Liability Partnerships Regulations 2001, Part II stipules that the accounting and auditing provisions of the Companies Act 1985 should for the most part be applied by LLPs.