Prem Sikka, Professor Accounting, University of Essex
(From PASS, October 2000, pages 22-23)
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The Limited Liability Partnership (LLP) Act 2000 received its Royal Assent in July. It is likely to come to into force later this year and the first raft of LLPs are expected to be formed in early 2001. The Limited Liability Partnership is a new business vehicle. It is the first new business vehicle to be introduced in Britain since the introduction of the Limited Liability Partnership Act of 1907. This article discusses the salient features of the LLP legislation.
The Genesis of Limited Liability Partnerships
The campaign to form LLPs has been led by major accountancy firms who have been keen to limit their liability in a variety of ways. Historically, audit firms have been required by law to trade as partnerships. Since the 1970s audit firm partners demanded the right to trade as limited liability companies and thus limit the liabilities. The Companies Act 1989 (subsequently part of the Companies Act 1985) removed the legal constraint and finally enabled accountancy firms, like other enterprises, to trade as limited liability companies. The limited liability company vehicle has a potential to limit the liabilities of audit firm partners, but most firms showed little enthusiasm for the change in law. Some were concerned that as limited liabilities companies they would need to publish audited financial statements, be liable to the more onerous corporation tax regime rather the Schedule D Case I and II regime and generally be subjected to a raft of corporate legislation. With the exception of KPMG most major firms failed to incorporate and continued to trade as partnerships.
In the early 1990s accountancy firms, with considerable support from major accountancy bodies, campaigned to secure proportional liability, a ‘cap’ on their liabilities and an end to the ‘joint and several liability’ of partners, a central feature of partnership structures. Such demands coincided with allegations of audit failures and major claims against audit firms over the demise of Maxwell, Polly Peck and the Bank of Credit and Commerce International (BCCI). In response, the UK government commissioned an inquiry from the Law Commission. The demands for liability concessions are not a ‘zero-sum’ game since concessions to any one party necessarily affects the ability of another party to seek effective redress. The Law Commission rejected the demands of the auditing industry by arguing that they were against the public interest.
In this climate, two major accountancy firms, Ernst & Young and PricewaterhouseCoopers spent around a million pounds to privately draft a LLP Bill. They approached the government of Jersey (part of the Channel Islands) and asked it to enact the legislation. In 1996, the government of Jersey obliged but it led to a huge political row in Jersey as some felt that the Jersey legislature was being hired to big business to enable it to reconfigure international regulation. Under the Jersey law, accountancy firms were not required to publish any information about their affairs and would not have had any local regulator. The Jersey law also proved to be technically deficient as its provisions for dealing with the possible insolvency of LLPs were considered to be inadequate. As a result the Jersey law had to be revised and could not be implemented until 1998. To date, no major firms has taken advantage of the Jersey legislation and located its operation there. It is doubtful that they really intended to relocate their business operations in Jersey. For example, major firms could hardly close their offices in the UK, sack all their staff and move their offices to Jersey. To relocate their operations, they would have needed to (re)negotiate all their business dealings with their clients - a considerable logistical and legal obstacle in itself. The UK government also announced that any UK-based business relocating outside the UK as a LLP, but continuing to trade within the UK would be taxed in the UK as a limited liability company. This threat was powerful enough to deter major firms from exercising the Jersey option.
The action by accountancy firms, nevertheless, placed LLPs on the UK political agenda and in 1996 the Department of Trade and Industry issued a consultation paper. After many revisions, this eventually became the Limited Liability Partnership Act 2000
The UK Legislation
The LLP Act creates a new legal person that can trade, borrow money, sue and be sued in its own name. LLPs are neither partnerships nor limited liability companies. Rather they are a combination of the two previously well established business vehicles. Any two or more persons carrying on a lawful business with a view to profit can form a LLP. The limited liability partnership and its membership must be registered at Companies House. All businesses trading as limited liability partnerships need to have the abbreviation “llp” after their name. Their business letters, order forms and other stationery need to say that they are trading as a limited liability partnership. All LLPs must keep ‘proper accounting records’.
Internally, LLPs will be organised as partnerships. The LLPs will be owned by their members (or partners) rather than shareholders. The LLP will continue to exist independent of the changes in its membership. The partners will be free to reach any agreements for the administration, internal organisation and profit sharing of the LLP. They are not obliged to publicly file such arrangements. All members will be agents of the LLP and the limited liability partnership will be bound by the action of its members, except in some specified circumstances (e.g. fraud, wrongful acts). Each LLP must have at least two designated members (i.e. named administrators) who will carry out a number of administrative functions: these include filing the annual return, the approval and signing of accounts, notifying Companies House of changes in membership and of any change to the address of the registered office. If no designated members are specified in the registration document then all the members will be considered to be designated members.
Externally, the LLPs will have most of the attributes of a limited liability company. They need to file audited financial statements about their affairs, equivalent to those filed by limited liability companies. Small and medium-sized LLPs will be granted appropriate exemptions from audits and filing requirements. Unlike limited liability companies, LLPs are not required to publish information about director remuneration. However, the LLPs in which the amount of profit before member remuneration and profit share exceeds £200,000 will have to state the amount of profit attributable to the member with the largest share.
There is no legal requirement to maintain any minimum issued or paid-up capital. The LLP is not required to maintain adequate insurance cover to meet any legal claim against itself or its partners. However, the LLP itself can be pursued for wrongful or fraudulent trading. Any litigant would have to issue a lawsuit against the LLP. The first port of call for any redress would be assets of the LLP. Should they be inadequate then the assets of the so called ‘negligent’ partner would come under threat. There would be no recourse against the assets of the partners not involved in the alleged negligent decision. During the parliamentary passage of the Act, there was a fear that the partners of a business involved in lengthy litigation may be tempted to systematically transfer the assets the LLP. Thus a litigant may eventually win a negligence lawsuit and then find that the business (the LLP) is merely a shell and that most of assets have already been removed. In response, the government indicated that it will introduce ‘tough’ secondary insolvency legislation which could include the requirement to ‘clawback’ the payments made to LLP partners during the two years preceding the demise the of the LLP. The LLPs would be subjected to most of the provisions of the Insolvency Act 1986. This includes making LLPs partners personally responsible for wrongful trading or trading with the knowledge that an LLP was insolvent. The affairs of a LLP can also be investigated by the Department of Trade and Industry (DTI) and its members can be disqualified from being a member of an LLP and from being a director of a company.
For tax purposes, the LLP Act 2000 specifically states that LLPs will be taxed as partnerships. Thus the usual rules of Schedule D Case I and II will apply. Hence, in comparison to limited liability companies, the deduction of expenses for LLP partners will be easier. The transfer of assets from partnerships to LLPs will be tax neutral. Whilst the existing partnerships will be able to transform themselves into LLPs, the same will not easily be possible for limited liability companies. To become LLPs, they will have to go through some tortuous requirements relating to liquidation, transfer of assets and the payments of taxation charges on the same. The implementation of the LLP legislation has been delayed amidst fears that they could be used as tax avoidance vehicles. The government has promised to introduce anti-avoidance legislation in the 2001 Finance Bill. The first LLPs are likely to be formed in early 2001. It is estimated that some 50,000 LLPs will be formed in the first year or so.
The LLP legislation was introduced in response to a campaign by major accountancy firms. They were keen to secure a business structure to enable them to limit their liabilities. Is the LLP structure likely to do that?
The USA introduced LLPs in the 1990s. Most major accountancy firms there now trade as LLPs. This structure has not offered them much protection from litigation or major claims. The same will be the case in the UK. The issue about lawsuits arise because various parties feel aggrieved. They arise from disputes about audit responsibilities and accountability. Some feel that in return for a state guaranteed monopoly of external audit (remember, only accountants can perform external audits), accountancy firms should have responsibilities to a wide variety of stakeholders. Other view the ‘audit’ as a private contract and argue that the responsibility is only to the client (i.e. the company). Such issues cannot easily be resolved.
Major accountancy firms have welcomed the LLP legislation. Not least,
because it enables partners to retain all the tax advantages associated
with partnership taxation. However, they remain concerned about the need
to publish audited accounts. They tried to use Jersey as a lever to squeeze
concessions out of the UK government, but despite the tax concessions they
have not been too successful. The firms forming LLPs will need to publish
full accounts and will also be subjected to most of the corporate and insolvency
legislation. The principle of ‘joint and several’ liability though diluted
has not been abandoned. From the liability perspective, the limited liability
company vehicle probably offers better protection than the LLPs. This is
so because, limited liability company offers protection to all members
whereas the LLP vehicle offers little protection to the so called ‘negligent
partner’. But then one wonders whether ‘liability’ was the real motive
for pursuing LLPs.