Limited Liability Partnerships Bill [H.L.]

3.31 p.m.

Read a third time.

Clause 4 [Members]:

Lord Goodhart moved Amendment No. 1:

    Page 3, line 7, at end insert--

("( ) A person shall cease to be a member of a limited liability partnership on--
(a) death;
(b) commencement of winding up;
(c) becoming bankrupt or having his estate sequestrated; or
(d) granting a trust deed for the benefit of his creditors.").

The noble Lord said: My Lords, we apologise for moving amendments to deal with technical
issues at this late stage, in particular because we warmly welcome the Bill in principle. I say that
without fear of dissent because my noble friend Lord Phillips of Sudbury is not here. The reason
why these amendments are tabled today is that it was only during

6 Apr 2000 : Column 1421

the debate at Report stage that I became aware of a serious lacuna in the Bill which I had not
previously noticed. The lacuna is that the Bill makes no provision for what happens to the
property rights of a member of a limited liability partnership who ceases to be a member.

In most cases, what happens on the death or retirement of a member is covered by an agreement
between the members. Obviously, that is so in the case of large professional partnerships, such as
KPMG or Clifford Chance, but the Government see LLPs as a vehicle not only for professional
partnerships but also small businesses. Not all small businesses will obtain proper advice before
incorporation; and there will be some agreements to set up LLPs which fail to make proper rules
to cover the rights of outgoing members. The Bill, or regulations made under it, needs to make
proper default provision in those cases where the agreement fails to provide an answer; otherwise,
the matter will have to go to court. The court will have the impossible task of deciding how to
allocate LLP property without any guidance.

Take the simple situation in which three people form an LLP to run a restaurant and agree to split
the profits equally. One of them dies and ceases to be a member, or becomes incapacitated and
wants to retire, or simply gets fed up with the business and wants to get out of it. Meanwhile, the
restaurant has been successful and is worth a considerable amount of money. Under the present
law the restaurant business could be carried on by a limited company incorporated under the
Companies Act 1985 or by a partnership. Each of them contains default provisions for what
happens when somebody ceases to work for the company, but those provisions are very
different. If a small business like this is carried on by a company the outgoing director is likely to
have share capital. If there is a market for the shares the outgoing member can sell them; if not, he
or she is locked in. If the company pays a dividend the former director, or his executors, will
receive a dividend on those shares.

Normally, however, one cannot recover the capital unless and until the company is wound up,
which is an indefinite time in the future. There is an exception. If the business is carried on in a
way which is unfairly prejudicial to a member he can apply to the court for a remedy under
Section 459 of the Companies Act 1985. The usual remedy is a court-ordered buy-out. But
applications under Section 459 are notoriously long and expensive. If the business is run as a
partnership the death or retirement of one partner dissolves the partnership, in the absence of any
agreement to the contrary, and the outgoing partner gets his or her share of the partnership
property immediately. If the LLP adopted the partnership system it could not do so completely
because the property of the LLP would belong to the LLP, not the individual members jointly.

I accept that it would not be right to wind up the LLP if one member left, but it would be possible
to require the LLP to buy out the outgoing member's share of the capital. However, that has

6 Apr 2000 : Column 1422

First, it might put the LLP into financial difficulties which could be serious or even fatal.
Secondly, no doubt there would be difficulty in deciding on the valuation of the buy-out,
especially if the business had valuable goodwill which might or might not be affected by the death
or retirement of the outgoing partner.

But the use of the company precedent also has drawbacks. The lock-in of capital is unfair to the
outgoing member and, over the long term, creates an acrimonious relationship between the
outgoing member and the continuing members and also conflicts of interest. As LLPs have no
share capital there is no possibility of a dividend. It appears that the continuing members would
simply be entitled to split the profits between themselves. It might be possible to provide by
regulation that Section 459 applies where the continuing members refused to pay for the use of the
former member's capital. I understand that currently the DTI is consulting on the application of
Section 459 to LLPs. I suppose that there is a third possibility; namely, that the only people
interested in the net assets of LLPs are the current members and, therefore, in the absence of
agreement on a buy-out, the outgoing member has no claim at all. I believe that that result would
be wholly unacceptable.

It is essential that the Bill, or regulations made under it, should choose either the company or
partnership model. As between them, I strongly prefer the latter. I do so, at least in part, because I
believe that that is what people would expect. Let us return to the three person restaurant. Get the
three of them together at the time they set up the business and ask what should happen if one of
them dies, has a row with the other two and wants to leave or simply becomes unfit to carry on.
Most people would say that in that case the outgoing member, or his executors, should get back
his share of the LLP's assets. They might well go on to say that the continuing members of the
LLP should have a reasonable time to arrange a buy-out. Frankly, I do not believe that many
people engaged in setting up an LLP would deliberately opt for a long-term lock-in. The
Government might, nevertheless, prefer the company model, but they would be wrong to do so. I
believe that an even worse outcome would be to have no rule at all. How on earth could a court
decide on the rights of a former member in the absence of some guidance provided by statute or

I do not claim that the amendments which I have tabled can simply be accepted as they stand. I
have been persuaded in discussions with the Minister that the bankruptcy of a member should not
lead to his automatically ceasing to be a member. We should like the Government to accept that
there is a need to include a default provision to cover the property rights of a former member, to
consider what those rights should be and to introduce the necessary amendments when the Bill
goes to another place. I beg to move.

6 Apr 2000 : Column 1423

Earl Ferrers: My Lords, so far I have not taken any part in this Bill and do not profess to
understand it. I rise merely to question the English of the amendments in the names of three
distinguished noble Lords. Amendment No. 1 provides that,

    "A person shall cease to be a member of a limited liability partnership on--

    (a) death".

If he has died, ipso facto how can he possibly be a member? I would have thought that that was
common sense. If the individual has died the future tense--"shall cease to be a member"--is
incorrect. I was glad that the noble Lord, Lord Goodhart, realised that the amendments could not
be accepted as they stood. I rather agree with him.

Lord Goldsmith: My Lords, throughout past debates I have been impressed by the care and
thoughtfulness of the amendments proposed. I have been privileged to play a small part. However,
I cannot agree with the noble Lord's proposal.

There seem to be two different questions. First, what, if any, part should be played in the
management of an LLP by the representative of a deceased, bankrupt or otherwise insolvent
partner? That is dealt with adequately by Clause 7 which provides that there shall not be
interference in the management of the business by such a representative. That deals with the
management side.

Secondly--it is the question to which the noble Lord draws attention--what should happen to the
share of such a person? Both as a matter of principle and of practice the proposed amendment is
not right. As a matter of principle it does not seem obvious that those who have chosen a method
of corporate entity through a limited liability partnership should necessarily receive back either in
their interests or the interests of their creditors what they have put into it. Even in the example of
the three-person restaurant to which the noble Lord refers, it may be hard on the other two to
provide by a default provision that the restaurant may have to come to an end because one of
them has got fed up with the idea of being involved.

As a matter of practicality, the proposal creates enormous difficulties. The noble Lord was
concerned that the court would have an impossible task (if I noted his words correctly) in
deciding what should happen. I regret to say that from my perspective the court would have at
least a very difficult task in following through the ideas proposed by the amendment. It proposes
that the partnership member shall be entitled to receive from the partnership an amount equal to
the value of his share of the capital. From my professional experience--I have dealt with a number
of cases of valuation of shares in businesses--such valuations are particularly difficult to achieve.
On what basis? On the net asset value basis? Is that a forced sale? Is it a going concern? Is it a
share if it were sold on the open market? What account is to be taken of the fact that, as the
amendment proposes, there is to be a reduction in the value resulting from someone ceasing to be
a member? Who is to do the valuation: the court; a valuer? In my experience such matters are dealt
with in

6 Apr 2000 : Column 1424

a well-regulated organisation by a clear and detailed clause which often provides for an expert to
deal with them.

I believe that the matter would have to be dealt with by agreement between the individuals at the
time they set up the limited liability partnership. It would seem difficult to lay down any
satisfactory default provision. I cannot support the amendment.

3.45 p.m.

Lord McIntosh of Haringey: My Lords, the noble Lord, Lord Goodhart, has no need to
apologise to the House for bringing forward these amendments at this stage. Clearly these are
matters which he considers important which did not arise in our earlier considerations. It is entirely
proper for him to bring them forward.

Perhaps I may say this to the noble Earl, Lord Ferrers. In this case I do not think that the word
"shall" implies the future--or, in the circumstances of which he speaks, the after-life. This is an
imperative "shall" rather than a future "shall".

I understand well the desire of the noble Lord, Lord Goodhart, for members to be able to leave a
limited liability partnership receiving on departure a fair value for their interest in the firm. We
would expect, as he expects, that in most cases the members of an LLP would include in their
agreement the terms on which a member may depart. But his concern is that in firms where no
agreement exists between members, a departing member may be forced to accept unfavourable
terms if he wants to be bought out. I hope that I have that right.

The comparison has been made with the position of a partner in a partnership where, subject to
agreement, the partner has the power to dissolve the firm and therefore achieve a fair result. We
believe that to provide a member of a limited liability partnership with the right to dissolve the firm
would be inappropriate. The LLP will be a separate legal entity which might itself have contractual
obligations. There is the rub. The noble Lord, Lord Goodhart, would like to see partnership law
applied to what will be a corporate entity in circumstances where we think it would be
inappropriate. Instead, as he has said on many occasions during the passage of the Bill, we have
looked to the treatment of companies.

It is perhaps worth emphasising the point that the problem identified here is a general one which
does not arise only for members of limited liability partnerships. The prospect of a buy-out
provision has been considered for companies by the Law Commission and the Company Law
Review. The Law Commission stopped short of suggesting a statutory entitlement to buy out in
its report on shareholder remedies and instead proposed an article for Table A which would
require the shareholders to make positive choices, in particular on valuation, in order to bring the
article into effect.

The recently published consultation paper of the Company Law Review thought that even this was
undesirable on the ground of the impossibility of

6 Apr 2000 : Column 1425

prescribing a fair exit regime which would satisfy the full diversity of companies and on the basis
that it would be a trap for ill-informed founders. Clearly, while the problems the noble Lord, Lord
Goodhart, described do exist in companies, the potential desirability of a statutory provision has
not yet been considered to outweigh the considerable practical difficulties it might create. It would
be unwise in the concept just of LLPs to try to decide this issue.

Perhaps I should touch on some of the difficulties as they would affect limited liability
partnerships. The amendment to Clause 5 would have the effect of placing an obligation on the
LLP to buy out the departing member's share. How would we take account of the fact that in
some LLPs the members' interests may be structured so that members have different entitlements
to profits and capital, or have entitlements which may be deferred? How should a member's share
be valued? My noble friend Lord Goldsmith raised the point. Who should make the valuation?
How does one deal with goodwill? A statutory provision will inevitably not provide an answer to
these questions that is appropriate in the large variety of circumstances which may arise. There is a
considerable danger that a statutory provision which provides the right to be bought out but which
does not provide a clear mechanism for calculating the buy-out price will simply give rise to

We need also to recognise the interests of the firm. How would we prevent the risk that the value
of an outgoing member's share was sufficient to put the LLP into financial difficulties? That is
exactly applicable to the example given by the noble Lord, Lord Goodhart, of three members of
an LLP running a restaurant. This could have undesirable consequences for the employees of the
LLP. Creditor protection is also an issue since there could be a conflict with the provisions
designed to secure creditor protection, such as Section 214(4)(a) of the Insolvency Act 1986
which we intend to apply by regulation.

None of this is to say that we do not recognise the concerns expressed in the amendments; but it
must be a question of balance. The aim of the noble Lord, Lord Goodhart, is to deal with the
situation where not only is there no agreement between members but members have been unable
to reach reasonable agreement when presented with the difficulty of one of them wanting to
depart. He is not concerned with the generality of LLPs but with a small, poorly-run LLP which
finds itself in an intractable position of disagreement. Would it be right in those circumstances to
overlook all the difficulties I have set out and impose an entitlement to buy out the departing
member's interest?

Again, as my noble friend Lord Goldsmith said, why should someone who has entered into
business with others, setting up a registered legal entity with a recognised name and publicly
notified membership, think that at will he can walk away with his investment intact? We must not
forget that in establishing the LLP, the members created an entity which has a legal life
independent of their own, not only in the interests

6 Apr 2000 : Column 1426

of the departed and existing members which need to be considered, but also those of the LLP
itself and, as I have said, its clients and employees.

More generally, minority protection is something we have been considering in the context of the
consultation of the draft regulatory default provisions governing the relationship between
members. The noble Lord, Lord Goodhart, referred to Section 459 of the Companies Act 1985. It
may reassure him to some degree if I say that we are minded to apply by regulation this section
which would have the effect that a member of an LLP would be able to apply to the court for an
order on the ground that the affairs of the LLP were being, or had been, conducted in a manner
which was unfairly prejudicial to the interests of its members generally or of some part of its
members, including at least himself.

Lord Goodhart: My Lords, I am grateful to the Minister for giving way. If that is to apply to
members, how can it possibly assist former members?

Lord McIntosh of Haringey: My Lords, I am sure that it can be applied with such variation as is
appropriate to deal with the particular circumstances of an LLP. It does not have to be introduced
without the necessary tweaking.

The consultation period does not close until tomorrow, so we cannot conclusively commit
ourselves until all the responses have been considered. In particular, there is the question of
whether Section 459 may be disapplied by unanimous agreement between the members of the
LLP. But we have not yet seen anything which would lead us to believe that the application of
Section 459 would be inappropriate.

It might save time if I observe that the noble Lord did not speak to his other amendments relating
to bankrupts or to Clause 7. Perhaps I may conclude with those observations on the amendments
to which he spoke.

Lord Goodhart: My Lords, I regret to say that I find the Minister's reply distinctly unsatisfactory.
His speech was directed almost entirely to explaining why, in his view and that of the noble Lord,
Lord Goldsmith, the partnership buy-out was inappropriate. My real point was the fact that there
is no default provision on the partnership or company model. The Minister made no attempt to
justify that.

I believe that we shall find ourselves in the situation in which the courts will have to construct for
themselves, by implication of what the members would have decided to do had they thought
about it at the time they formed the LLP, the results of the break-up on the retirement or death of a
partner. I believe that for many years that will be a source for uncertainty and confusion and
expensive litigation.

Lord McIntosh of Haringey: My Lords, before the noble Lord decides what to do with the
amendment and in response to his question asking how Section 459 of the Companies Act could
apply to a former

6 Apr 2000 : Column 1427

member, I am advised that the member would remain a member until a satisfactory solution of the
problem, and therefore none of the tweaking to which I referred would be required.

Lord Goodhart: My Lords, I am grateful to the Minister, but I am still not sure how a member
who has died can remain a member. I agree with the noble Earl, Lord Ferrers, on that point.

As the Minister knows, we approve of a great majority of what the Bill does and we have no
intention of seeking to delay its progress into law. I hope that the Government will take the
opportunity to think seriously about the points that have been raised before the Bill arrives in
another place. I beg leave to withdraw the amendment.

Amendment, by leave, withdrawn.

[Amendment No. 2 not moved.]

Clause 5 [Relationship of members etc.]:

[Amendment No. 3 not moved.]

Clause 7 [Ex-members]:

[Amendments Nos. 4 to 7 not moved.]

An amendment (privilege) made.

On Question, Bill passed, and sent to the Commons.