Limited Liability Partnerships

TheLawStudent

Introduction to Limited Liability Partnerships

A Limited Liability Partnerships (LLP) is a hybrid vehicle. This means it has elements of both a company (legally it is a body corporate and is treated as a separate legal entity from its members: s.1(2) Limited Liability Partnerships Act 2000 (LLPA)) and a partnership (it is treated as tax transparent).

Consequently, an LLP has the flexibility of a partnership with the added advantage of limited liability for its members. Because an LLP is a body corporate, it has a legal personality which is separate to that of its members. As a result, it is liable for its own debts and is able to contract with third parties.

The LLPA was enacted for several reasons, chief of which was the perception amongst professional partnerships that as a result of the growth in litigation, the current partnership model, whilst having many commercially useful features, did not provide the kind of protection that was available to limited liability corporations (this is because partners in traditional partnerships have unlimited liability for the debts of the partnership). Other jurisdictions, such as the USA, had already led the way in dealing with these concerns by creating a hybrid business vehicle and the UK LLP model was drafted along broadly similar lines.

LLPs are increasingly important and many law firms are now run as LLPs. There are approximately 53,000 LLPs registered at Companies House (although this is still a small number in comparison to the number of companies so registered, approximately 4 million).

Applicable legislation

LLPs are incorporated pursuant to the LLPA. The LLPA is supplemented by two statutory instruments: the Limited Liability Partnerships Regulations 2001 (SI 2001/1090) (as amended) (the 2001 Regulations) and the Limited Liability Partnerships (Application of Companies Act 2006) Regulations 2009 (SI 2009/1804) (as amended) (the 2009 Regulations). The 2001 Regulations deal with insolvency and the internal governance of LLPs; the 2009 Regulations govern the corporate law aspects of LLPs. In particular, the 2009 Regulations apply provisions of CA 2006 to LLPs (with appropriate amendments). LLPs are primarily governed by a company (rather than partnership) law framework.

The Insolvency Act 1986 (IA) and the Company Directors Disqualification Act 1986 have, since LLPs were introduced, applied to LLPs in modified form. This has important consequences, so that, for instance, s.213 IA (fraudulent trading), s.214 IA (wrongful trading), as well as the disqualification of director provisions and the greater part of the insolvency and winding up procedures apply equally to LLPs and their members as for companies.

Setting up an LLP

Section 2(1)(a) LLPA states that two or more persons associated for carrying on a lawful business with a view to profit can incorporate an LLP. A ‘person’ in this context can be a company as well as an individual. The use of the word ‘business’ requires that there must be some commercial activity, so LLPs are not normally used by non-profit organisations as business vehicles.

Registration at Companies House

Form LL IN01

The subscribing members fill out a Form LL IN01, which is sent to Companies House with the relevant fee. The form must state, inter alia, the name of the LLP, its registered office’s address and which members, if not all of them, are to be designated members (s.2(2) LLPA).

A copy of a form LL IN01 can be viewed on the www.gov.uk website.

Certificate of Incorporation

Once registered, the Registrar of Companies issues a certificate of incorporation as conclusive evidence that all legal requirements have been complied with. The name of the LLP will be entered on the index of company names and it will be given a number.

Continuing Registration Regime

Once registered, LLPs are obliged to continue to file information with Companies House i.e. change of name, change of registered office, changes in membership, creation of a charge and annual confirmation statement. LLPs are subject to the Limited Liability Partnerships (Accounts and Audit) (Application of Companies Act 2006) Regulations 2008. These require LLPs to file accounts at Companies House.

In addition to its obligations to file information at Companies House, an LLP must maintain certain in-house records, including registers of its members and of its ‘people with significant control’ ([b]PSCs[/b] who are, broadly speaking, those with at least a 25% interest in the LLP).

The LLP Agreement

An LLP has no Memorandum and no Articles of Association. The LLPA and the 2001 Regulations do not lay down any particular management structure to be adopted, in contrast to companies. There is, therefore, greater flexibility with the management of an LLP.

Therefore, it is necessary in practice to have an LLP or Members’ Agreement stating how these issues are to be dealt with by the LLP and its members, in a very similar way to how a partnership agreement is designed to operate.

If there is no Members’ Agreement, various default provisions in regulations 7 and 8 of the 2001 Regulations will apply. Note that any other gaps will not be filled by partnership law, which is disapplied with respect to LLPs by s.1(5) LLPA.

Members of an LLP: Rights and Duties

As referred to in paragraph 4.3 above, the obligations that members of an LLP have to each other are best dealt with in a formal written Members’ Agreement. Such an agreement is a private document and would set out formal procedures and arrangements to which the members had agreed.

However, members of an LLP are not obliged to have a formal Members’ Agreement to regulate their relationship and in the absence of any such agreement, the 2001 Regulations contain eleven default provisions as set out below.

Regulations 7 and 8 of the 2001 Regulations

  • Members share equally in capital and profits (Reg.7(1)).
  • An LLP must indemnify its members for payments made and personal liabilities incurred by them in the ordinary and proper conduct of the business of the LLP (Reg. 7(2)).
  • Every member may take part in management (Reg.7(3)).
  • No member is entitled to remuneration for managing the LLP (Reg.7(4)).
  • No person can become a member or assign their membership without the consent of all existing members (Reg.7(5)).
  • Ordinary decision making may be by the majority of the members. Any proposed change to the nature of the business requires the consent of all the members (Reg.7(6)).
  • The books and records of the LLP must be available for inspection by the members at the registered office (Reg.7(7)).
  • Each member must give true accounts and full information of all things affecting the LLP to any member or his legal representative (Reg.7(8)).
  • If a member (without consent) carries on any business of the same nature as, and competing with, the LLP then he must account for and pay over to the LLP all profits made by him in the business (Reg.7(9)).
  • Every member has a duty to account for benefits derived from transactions with the LLP and its business or property (Reg.7(10)).
  • There is no implied power of expulsion of a member by the majority unless the members have expressly provided for such a power in a Members’ Agreement (Reg.8).

Members

The members of an LLP are those who subscribed to the incorporation document and those who became members at a later date by agreement with the existing members. Section 4(2) LLPA provides that persons, not just individuals, can be members of an LLP. Therefore, corporate bodies may be members of an LLP.

An LLP must have at least two formally appointed members at all times. There is no limit on the maximum number of members an LLP can have.

At least two members of the LLP must be ‘designated members’. Their obligations include, amongst other things, appointing an auditor, signing the accounts on behalf of the members, making filings at Companies House and acting on behalf of the LLP if it is wound up.

Section 4(3) LLPA states that a member will cease to be a member of the LLP upon:

  • his death;
  • agreement with the other members of the LLP;
  • giving notice to the other members of the LLP; or
  • dissolution (if the member is a body corporate).

Summary of the Characteristics of LLPs

LLPs are a hybrid form of a partnership and a company, taking characteristics from both forms of business media.

Corporate Characteristics:

  • separate legal personality;
  • limited liability for members, subject to the restrictions mentioned above;
  • LLPs have to file accounts at Companies House on much the same basis as companies, leading to a loss of financial privacy (which is one of the main attractions of using a partnership structure);
  • LLPs, like companies, are capable of creating a floating charge (an important type of security interest) over the assets of the LLP, unlike a partnership; and
  • some provisions of company law (in particular CA 2006) and corporate insolvency law (as contained in the Insolvency Act 1986 and the Company Directors Disqualification Act 1986) apply to LLPs in modified form.

Partnerships Characteristics:

  • LLPs have no share capital or capital maintenance requirements;
  • no real distinction between members and the management board (unlike a company, in which the members/shareholders and board of directors have very distinct roles);
  • members can agree amongst themselves how to share profits, management duties, how decisions are to be made, how new members are to be appointed and what retirement provisions shall apply;
  • the Members’ Agreement (if there is one) is like a partnership agreement, i.e. a private document which need not be filed at Companies House; and
  • although broadly, as stated above, the corporate insolvency regime also applies to LLPs, there exists an important disadvantage for members of an LLP compared to those of a company. LLPs are subject to the ‘clawback’ rule, which means that in certain circumstances money taken out of the LLP by members up to two years before commencement of a winding up of the LLP can be clawed back into the pool of assets available to repay LLP’s creditors (s.214A IA). By contrast, no equivalent provision applies if a shareholder disposes of shares in a company.

Taxation of LLPs

One important difference between an LLP and a company is that, for tax purposes, the LLP is treated as a partnership.

If two individuals set up an LLP, each will be taxed as an individual, i.e. liable to income tax or capital gains tax on their share of the income or gains of the LLP. In other words, an LLP is ‘transparent’ for tax purposes. This means the LLP is not taxed but the partners are.

By contrast, a company, established by the same two individuals, would pay corporation tax on its own income profit and chargeable gains. If the individual owners then receive dividends out of the company’s profits (after corporation tax), they may be liable to pay income tax on their dividend income. This could be significant, for example, because different rates and reliefs might apply.

A trade, profession or business carried on by an LLP with a view to profit will be treated as being carried on in partnership by the members (not the LLP itself). Many of the same reliefs available to partners also may be available to LLP members, such as relief on interest or set off of losses against other income.

Assets held by the LLP will be treated as being held by the members as partners for capital gains tax purposes. Accordingly, a disposal of an LLP asset, such as land, will be regarded by HMRC as a disposal by the members of the LLP while it is trading.

The LLPA gives relief from stamp duty where a partnership is incorporated as an LLP and assets of the partnership business are transferred to the LLP, subject to strict tax avoidance conditions. In some circumstances, stamp duty and/or SDLT is payable on the transfer of an interest in an LLP at the relevant rate.

As regards VAT, the LLP itself may register for VAT, not the members.

Commercial Uses for LLPs

Apart from being more and more commonly used for professional partnerships, such as solicitors, surveyors or accountants, it is also a flexible business vehicle for joint ventures, certain investment schemes and some venture capital
investments.

LLPs are particularly useful for investment structures (despite certain tax avoidance measures being applicable to LLPs which may impinge on private investors who are members of an LLP). This is because, as stated, LLPs are tax transparent, so they allow a high level of participation in management by the members whilst giving the members the benefit of limited liability. Furthermore, there is no need for a ‘general partner’’ with unlimited liability, in contrast to a limited partnership.

LLPs are increasingly being used by property developers involved in one-off joint venture development projects.