Limited Liability Partnerships - Down to detail

In the second of two articles, Richard Linsell looks at the practical issues for firms converting to LLP status

Having incorporated the LLP it is necessary to deal with the internal relationships between the LLP's members. While similar to a company, an LLP will not have a share capital. In addition, there is no equivalent to Table A that will apply to the internal relationships between LLP members.

The regulations include provisions that will apply, by default, if the members of an LLP do not adopt their own agreement. The default regulations draw on areas of partnership law, although partner-ship law expressly does not apply to LLPs. The default regulations provide for equality of profit sharing and capital contribution, and unanimity on admissions.

To cover the fact that the LLP cannot be dissolved in the same way as a partnership, the regulations also provide that the minority shareholder protection provisions of the 1985 Companies Act will apply, unless negatived, to LLPs. The effect of this is to give aggrieved members of an LLP the right to seek relief from the court if they are the victims of unfairly prejudicial conduct by a majority of the LLP's members. Relief will usually be given by an order that the member's interest in the LLP be acquired for fair value. Obviously this concept will be alien to most partnerships, and it is therefore imperative for any firm adopting LLP status to have a prop-erly drafted and fully considered members' agreement.

The members' agreement

While partnership law does not apply to LLPs, the basis of an LLP members' agreement will, of course, be the firm's existing part-nership agreement. Many of the elements of that agreement can be replicated with minimal amendment on conversion to an LLP. For example, the financing of an LLP by its members will be very similar to the financing of a general law part-nership by its partners. Tax relief will continue to be available on loans to provide capital to LLPs, as it is for loans to partnerships. While the members' agreement will have to deal with the powers and duties of designated members, the firm's existing provisions on governance are likely to require only minor modification in order to comply with the new law.

However, the members' agreement will have to consider the impact of company and insolvency law on the LLP. This will require a careful review of the regulations. As a body corporate, the LLP is required to file statutory accounts in the same way as private limited companies and within the same time limits. So it is necessary to provide in the members' agreement a procedure for drawing up, approving and auditing the LLP's accounts within the prescribed time limit. One of the designated members' obligations is to ensure that these accounts are filed on time, and it is they who face penalties if time limits are not met.

One of the profound changes to a firm's partnership agreement that will arise on LLP conversion is in the area of insolvency. A partner-ship agreement should contain provisions dealing with what happens in the event of the firm being dissolved, either by the act of its partners or as a result of its insolvency. In the case of the LLP, much of the Insolvency Act 1986 and the corporate regulations apply to liquidating and winding up the LLP. It is possible to have a members' voluntary liquidation of an LLP, and the powers of reconstruction set out in the 1986 Insolvency Act also apply to LLPs. The members' agreement must therefore deal with these new concepts.

The LLP has the capacity to create fixed and floating charges in the same way as a limited company. Again, the members' agreement will need to deal with how this can be effected, and what authority a third party should look to to see that a valid security has been created. These are but a few examples of the changes that are necessary as a result of the impact of company and insolvency law on the LLP.

The members' agreement is a private document. Given the novelty of LLP status it would be advisable to make sure that the agreement can be changed without the unanimous consent of all members. One of the great attractions of partner-ship status was the minimal involvement of government in the affairs of partnerships. LLPs are creatures of statute. The secretary of state has power to amend, extend or revoke the regulations without the need for formal Parliamentary consent. In the light of changes to the regulations, firms adopting LLP status may want to change their members' agreement at relatively short notice.

Becoming an LLP may be an opportunity for many firms to update their internal arrangements. Many professional firms have been looking at their provisions for partner retention, removal and retirement in considerable detail in the light of market experience in the last decade. Other firms have found the more modern methods of dispute resolution attractive and have adopted mediation as the primary basis for resolving most disputes that are likely to arise within the firm. Other firms have been looking at early retirement schemes for partners in order to free up equity for the next generation. There is a constant need to be aware of 'best practice' in areas such as maternity leave, career breaks and other provisions that are necessary to ensure that firms attract and retain the best talent.


LLPs have to file audited accounts prepared on a true and fair view basis and compliant with UK GAAP. Few professional firms are audited at present. Accountants will have to educate their clients about the difference between a set of partner-ship accounts that may have been prepared with a view to fair treatment and equity between different generations of partners, and a set of audited accounts prepared on corporate principles.

The accounts, once filed at Companies House, are a matter of public record. Firms will need to consider the sensitivity of this financial disclosure. How will their clients view their performance? How will their staff, landlords, bankers and principal suppliers react to this financial transparency? How accurate is the information that some firms have given to the professional media? Will their competitors be able to achieve some advantage in terms of client gain or staff recruitment from the figures that are published?


A major difference between the US LLP laws and the UK LLP law is this requirement for financial disclo-sure. No US LLP is required to file accounts. The government made it clear from the outset of consultation that the price for limited liability would be financial disclosure. There has been much discussion of professional incomes in the media in the last five years, and successful figures from professional firms are unlikely to be surprising. During that period corporate incomes have increased greatly, as have those of bankers and other professional advisers who already enjoy limited liability status.

It is perhaps the fear of the bad year that will hold some firms back from converting. A contrary view I have heard expressed is that the best time to convert is when the market is strong so that the first set of figures that are commented on are good ones showing a successful practice. The argument then runs that in the next year the numbers will attract some further attention but nothing like as great as the initial set of figures. Thereafter more firms will have adopted LLP status for the first time, and their numbers will be fully scrutinised with only passing comparison with those of the firms that converted earlier. After perhaps three years, the media will continue to comment, but the level of interest among readers and the wider audience of clients and introducers will become minimal.

A quirk of the LLP law is the requirement to disclose the income of the highest paid member of an LLP. This provision of company law, which is designed to protect shareholders from the excesses of their executive, will apply to LLPs, despite heavy lobbying that it was inappropriate. I believe that this will lead to some very strange financial reporting. In some firms where partners are being removed, it is quite common to pay an enhanced profit share to those partners in the year in which they leave. Sometimes such individuals can, just for the year in which they depart, be the highest-paid partner. Were this practice to continue in LLPs, there could be some significant upward and downward movement in the reported highest-paid member's income.


A particular concern is annuities. If a body corporate has unfunded liabilities to pay annuities on its balance sheet, they could point to the LLP being insolvent. In a partner-ship, those liabilities will be expensed out of profit each year and no provision would be made. For firms with annuity liabilities there is a need to review their precise terms and understand the accounting implications of LLP conversion. Many of these provisions were written long ago. They are sometimes unclear and could never have envisaged a partnership converting to an LLP. To vary them is likely to require the consent of all beneficiaries, some of whom will be loyal to the firm and will co-operate, while others will not. This is perhaps the most difficult issue to manage in LLP conversion if a firm has a considerable exposure to annuities.

A draft Statement of Recommended Practice is understood to have been sent to the Accounting Standards Board for approval. This may, when approved, assist in the reporting of these annuities on an LLP's balance sheet, but the issues are wider than just those problems. Why should a retired partner, his widow or dependants, release the present partners from their obligations to pay the annuities?

Financing LLPs

Banks are used to lending to partnerships, both for partners' capital and general working capital, and do so relying on principles of joint and several liability that lie at the heart of partner-ship law. They also often lend on the basis that the partnership as a whole gives an undertaking to repay individual partners' borrowings when they leave the firm.

The LLP is a separate legal entity and will require finance of its own. Part of this will no doubt be supplied by the members, who will look to banks and other institutions to lend them money to subscribe for their members' interest in the LLP. The LLP itself could certainly undertake to repay this money if a particular member leaves or dies. However, the bank will, in the absence of guarantees from the other members, only be able to look to the strength of the LLP's covenant, as a corporate entity, and not to the combined resources of its members.

The LLP can borrow working capital, and give security, in the same way as any company. But that security may not be particularly attractive to a bank. It is well known that when professional firms enter periods of financial difficulty, their members consider leaving, their clients are likely to argue over the value of work in progress and their book debts become more difficult to collect.

It will be interesting to see the banks' attitude towards financing LLPs. Some firms adopting LLP status will be very strong businesses with strong cash flows, strong management and well-known brands. These firms should have no difficulty in attracting competitive offers to finance them. For smaller firms there is the likelihood members will be asked for total or partial guarantees.


At present, partnerships cannot hold leases because they do not have legal personality; therefore up to four named individuals will hold a lease in trust for the firm, and look to the firm to pay the rent and other outgoings, including dilapidations. But an LLP can hold land. One of the primary objectives of many firms will be to remove their partners from existing leases and substitute the LLP as tenant.

There are some good reasons why a landlord should prefer an LLP as tenant to a partnership, principally because it is notoriously difficult to enforce against individual partners in the event of a professional firm's failure. With the LLP as tenant the landlord will be able to proceed directly against the real business and its real assets, rather than seeking to enforce against one group of individuals who may or may not exercise their contribution rights from others.

The landlord will also, often for the first time, have a true picture of the financial strength of the covenant it has entered into. Many professional firms, with their relatively high profit margins, will provide very satisfactory covenants to landlords, measured by the institutional standards that the property community adopts. These negotiations will need careful preparation. Larger institutional landlords will gradually develop a policy towards LLP lettings. Landlords with smaller property portfolios, encountering LLPs for the first time, may simply succumb to inertia.

Client appointments

A primary objective of adopting LLP status will be to have all client appointments, as soon as practicable, in the LLP's name and therefore within the scope of limited liability. For accounting firms this is going to be a major exercise. On general work it will require new client engagement letters to be issued immediately after LLP status is adopted.

Where there are statutory appointments, as in the area of audit, careful consideration will need to be given to the relevant provisions of the Companies Act 1989. It must be decided whether it is possible to extend the existing audit appointment to the LLP or whether it is preferable to leave it with the existing partnership (without its limited liability) and ask the shareholders at the next agm formally to appoint the LLP.

Where elective resolutions have been passed dispensing with the annual reappointment of auditors, those will need to be addressed. Where the appointment of auditors is not governed by the Companies Acts, the relevant legislation will have to be considered. In any event a major client consultation exercise is going to be necessary.

LLP status, when viewed globally, is nothing new. LLPs have been commonplace in America for some seven years. There are LLP laws in Canada, Australia and similar laws, albeit not necessarily under the LLP flag, are emerging in other jurisdictions. As more and more professional firms adopt the UK law, so clients' attitudes should become more sanguine.

Hidden cost

There is a significant hidden cost in becoming an LLP. Part of that is in the area of finance, client appointments, and so on, as mentioned above, but there is also the need to transfer the existing partnership business into the LLP. This exercise, which is similar to incorporating a partnership, will need to be carried out for a number of reasons, including the fact that banks lending to LLPs will expect the LLP and not the predecessor partnership to own all the goodwill and connection of the business.

The stamp duty exemption set out in the Act will need careful consideration. This requires there to be no change of membership between the date of the LLP's incorporation and the business transfer, and for the transfer to be completed within 12 months of the LLP's incorporation. It is therefore inadvisable to form 'shelf LLPs' and necessary to plan the transfer of any stampable assets well in advance of incorporation.

This business transfer exercise will absorb much internal management time. It will, most likely, throw up issues that the partnership should have dealt with long ago. To the extent that it will involve looking at all the firm's major contracts, appointments, etc, it may have hidden benefits in terms of managing risk out of the business and establishing efficiency and uniformity in the supply chain.


My view is that, despite the drawbacks of corporate formality, financial disclosure and the hidden transfer costs, many professional firms will adopt LLP status. I believe relatively few will go during 2001. But in the following two years there will become increasing pressure from partners to take advantage of limited liability.

Within five to seven years a new generation of talent will have been admitted to professional firms where their contemporaries are in LLPs, and firms that have not adopted LLP status will have to come up with some very cogent arguments to explain why they have remained partnerships.

Richard Linsell is a partner in Rowe & Maw, solicitors, and head of its Professional Practices Group. His first article appeared in the February issue of Accountancy, pp 120-121. On the taxation of LLPs, see this issue, pp 122-123.

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