PracticeAccounting FirmsLLP: the final straw or the post-Enron panacea?

LLP: the final straw or the post-Enron panacea?

With the huge potential liabilities faced by Andersen following its disastrous audit of Enron, more and more firms will be considering a switch to LLP status. Butis the new structure little more than a poor relation of partnership and limited company structures?

As the familiar adage goes, ‘a camel is a horse created by a committee’.

These are the words that spring to mind after a cursory glance through the reportage, commentary and often harsh critique that has followed the arrival of the new alternative business structure, the limited liability partnership, which came into force last year.

By producing legislation and regulation that cross refer to swathes of different other Acts, rather than set up specific LLP provisions, the government has created a beast that makes the camel look rational and attractive by comparison.

Seeking to provide an ideal blend of the ‘see-through’ tax advantages of partnership with the limitation on personal liability inherent in incorporation, LLPs were always intended as a hybrid between the two models. But in reality, critics say, is the hybrid really a fudge?

The IOD’s deputy head of policy, Richard Baron, says that ‘the idea is suitable for businesses that might prefer a partnership to a company but don’t want all their assets on the line … under the new scheme you can be actively involved in the business but have liability limited, like shareholders.’

However, critics have suggested that the current LLP model was released prematurely and point to two facts – that the Law Commission is reviewing partnership law and the Department of Trade and Industry continues to review company law. Neither reported before the Act took effect.

Others have intimated that the government was under severe pressure to act and the legislation was rushed through with perhaps less care to the detail than originally planned.

However, for those of us who have an additional role as business advisors, as well as custodians of our own businesses, we should not let all of the above cloud some clear benefits to our clients in other sectors. Indeed, to give our best, objective advice, perhaps we need to take a big step back.

A closer look at our camel/horse analogy could be instructive. The camel is held up as a paragon of all that is ugly, ungainly and unsuitable, derided for being something that it is not – a thoroughbred racehorse.

But let us consider whether the LLP committee came up with was possibly a very capable camel, able to function better than a horse in certain environments.

Take the LLP issue as it applies to the property world; businesses here have been constrained in the past because the only practical vehicle to own land and create floating charges – obviously central to their business – has been a limited company. Many have longed for the benefits – particularly as regards tax – that partnership could offer.

Whatever the problem of property investment vehicles, the new LLP now gives property companies access to partnership tax benefits, without compromising their commercial ability to enter into property contracts.

The key question thus becomes: ‘To what extent are the LLP benefits overshadowed by the complexities and expense of paying professional fees to find a practical way to through the “compromise” legislation to deliver the best of both worlds?’

Having ourselves been involved in forming several LLPs since the Act came into force – for ventures as diverse as branded sales, technology development and portfolio realisation – we are confident that, in certain circumstances, LLPs have much to offer.

However, in working through the complexities, not to say vagaries, of the legislation in its current form, there are some important points that could be all too easily missed by the uninitiated.

First, an LLP structure will not protect individual members from personal liability for their own negligence, even for work done in the LLP’s name.

Indemnity insurance with run-off cover remains vital for personal security.

Second, be aware of the ‘clawback’ provisions. LLP members, like company directors, may be forced to make repayments if the LLP carries on trading after the members should have known that insolvency was unavoidable.

Third, there is no model constitution for LLPs, unlike ready-made limited companies. In the absence of express wording to the contrary, members fall back on very limited default provisions, which mean sharing profits and losses equally, having equal rights to manage, unanimous approval for membership changes and no right to remuneration.

In anything other than a two equal partner deadlock relationship this could be a disastrous position. A ‘members’ agreement’, a private document, should be prepared by your lawyer to cover these and other issues.

The fourth point is that members have no ‘shares’ in an LLP, but rather an ‘interest’, subject to obligations, under the members’ agreement or the default provisions.

You therefore need to deal with how and when that interest can be transferred and assess the implications in terms of voting and control. This is where value issues can arise, such as buy-backs from members leaving the LLP and decisions to sell the main business.

There are some tax issues still to be resolved. In addition, as there is no power for a LLP to convert to a limited company, any potential float would require a transfer of the business to a PLC as a first stage. A full cost/ benefit analysis would clearly be advisable before a final decision is made, but the discipline of defining objectives in a suitable members’ agreement can itself help clarify expectations.

The signs are that LLPs are valuable additions to other business models and there may be substantial benefits for many in the new regime. Flexibility and informality are to be encouraged, but there is still scope for the government to provide some alternative default provisions and to encourage the Inland Revenue not to undermine the new tax regime!

A last word on our hardworking camel. He may never be a racehorse, but he will get the job finished – and for some journeys there is no creature that can serve you better.

In the words of the management academic, Dr Thomas E Ollerman, give the camel a little water now and then, exercise some care about the number of straws you put on his back and the camel will serve you well.

  • Charles Boundy is a senior corporate partner at commercial law firm Fladgate Fielder.

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