Compulsory retirement: avoiding the partner pitfalls

Compulsory retirement: avoiding the partner pitfalls

Compelling an individual to retire from a business they co-own can be a challenging process. What are the rules and processes involved?

One of the most difficult issues accounting firms which are limited liability partnerships (LLPs) will face is a decision to compel one of its members to leave the business. Unlike an expulsion where the individual has “done something wrong”, seeking to compel an individual to “retire” is commonly referred to as a “no fault retirement”.

Quite simply, compelling an individual to retire from a business they co-own can be a challenging process and is fertile ground for an acrimonious dispute.

Can an individual be forced to retire?

There can be many reasons for pursuing the compulsory retirement of a member – not least to facilitate upward mobility of younger talent into the partnership.

No matter what the reason, as a matter of law no LLP member can be compelled to retire unless a power to compel has been conferred by express agreement between the members.

Most well drafted modern LLP Agreements will contain a power to force a retirement and will identify individual, management group or majority of members that have the power to force an individual to retire and the procedure that must be followed. So, if compulsory retirement is contemplated, the first point to consider must always be whether the power exists to make it happen.

Assuming the power exists, there should be a “sense check” as to whether the power can in fact be exercised. For example, if the power requires a vote in favour of by all members of the LLP other than the individual in question, but it is known that one or two members would never support such action, a compulsory retirement cannot be achieved. In such a scenario, an alternative strategy will need to be explored.

Will the LLP be able to fulfil its obligations to the retiring member?

Assuming there is a power to force an individual to retire and that it is anticipated that sufficient support exists for the exercise of that power, a further “sense check” should be made regarding whether the firm can fulfil any contractual obligations owed to an individual who is forced to retire.

LLP Agreements containing a power to compel an individual to retire will almost always contain provisions detailing the entitlements of the individual in such a situation. Commonly, the LLP Agreement will include provisions regarding the timing of the repayment of capital, payment of current account balances and unallocated profits, release of tax reserves, etc. In certain cases, there may also be provisions regarding the calculation and payment of goodwill based on a valuation of the firm at the date of retirement. Whatever the entitlements, before any compulsory retirement process is formally initiated it is important that consideration is given to what obligations will be owed to the retiring individual and whether the firm can fulfil those obligations.

The exercise of a power of compulsory retirement

The potential severity of the consequences for the individual in a forced retirement are such that a court will take a very strict approach to the construction of the provisions granting the power and to the manner in which the power is exercised. Any ambiguity in the wording and any failure to follow precisely the procedure laid down in the LLP Agreement may give the individual grounds to challenge the validity of any decision to compel them to retire.

It is prudent to assume that the exercise of a power to compel an individual to retire will be subject to subjective and objective constraints to ensure that the power is not abused. In an LLP, those exercising the power must do so in good faith for the purpose for which the power exists, do so in the best interests of the LLP as a whole, do so lawfully (thus avoiding any unlawful discrimination) and not in a manner which (when looked at objectively) is irrational, arbitrary or capricious.

Where the LLP Agreement specifies a process for the exercise of a power of compulsory retirement that process must be followed to the letter. That is likely to include circulating papers for meetings, giving valid notice of meetings to all those entitled to receive the notice, recording the resolutions of meetings, serving the requisite notice on the individual being compelled to retire etc. Any failure to adhere strictly to the contractual process gives the individual an opportunity to challenge the validity of a forced retirement.

The consequence of getting it wrong

If the decision to compel an individual to retire is found to be invalid, then the decision is a nullity – it is of no effect. The result is that the individual remains a member of the LLP under the terms of the LLP Agreement and is in the same position they were in prior to the entire process being commenced.

Final thoughts

There may be perfectly proper grounds to seek to require a member to retire but unless a power to compel has been conferred by express agreement between the members an individual cannot be compelled to retire against their wishes. While it may never be used, our view is that an LLP Agreement should include such a power. If the power exists, before commencing what may be a long and difficult process, sense check whether for all practical purposes the power can be exercised – is it likely that the required votes in favour can be obtained; does the LLP have the funds to fulfil the obligations to the individual that will be triggered by the decision? Finally, follow the contractual procedure to the letter – any misstep could invalidate the decision and leave the firm dealing with a very disaffected individual.

Clive Greenwood is a partner, and Frances Simm a senior associate, in the disputes resolution team at law firm Lewis Silkin

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