Pros and cons of Limited Liability partnerships (LLPs)

Pros and cons of Limited Liability partnerships (LLPs)


 


19.03.04


 


 


Solicitor Stephen Philips of Burness and Co. is the acknowledged expert in Scotland on legal structures as they relate to social enterprises and the third sector in general. He has cast his expert eye on the pros and cons of the Limited Liability Partnership (LLP) model. Below he shares his comments with Senscot.


 


 


18 March 2004


 


Dear Laurence


 


LIMITED LIABILITY PARTNERSHIPS (LLPs)             


 


I was very interested to read the extract from Regeneration & Renewal Magazine – on the topic of LLPs – which was attached to a recent Bulletin. Ever since the LLP emerged as a new legal form in 2001, I have been trying to interest people in the new possibilities which it opens up – but with limited success to date. It is good to see, therefore, that there are people out there who are looking actively at the use of an LLP in the context of a wide range of projects with a social/public dimension.


 


Before commenting on the particular proposals which are referred to in Antonia Swinson’s article, it might be as well for me to set out the basic features of an LLP – which perhaps might not have been immediately apparent to people trying to detect a common thread in relation to the various legal frameworks referred to in the article. The essential point, I think, is to recognise that an LLP is really a form of partnership (in the private sector business partnership sense) which has the status of a legal entity. To create the legal entity, a registration process at Companies House is involved – but, unlike a company,


 


·           an LLP is not tied to the traditional company framework, as involving two tiers of decision-making (members/shareholders and directors); linked with that, there is also much less detailed regulation in relation to procedural matters


 


·           an LLP is not tied to the concept of splitting financial returns of an equity/investment nature (the realm of shareholders) from issues of management control (the realm of directors); where corporate bodies are involved as members of the LLP, it is perfectly possible for those bodies to be directly involved in decision-making of a type normally done by a board of directors (rather than the classic arrangement of corporate investors appointing individuals as directors to oversee the management of the company)


 


·           it is normally the members of the LLP, rather than the LLP itself, who are liable for tax in relation to income which they derive from the LLP; that means that if the member has special tax status (eg a charitable body or a local authority) the financial returns which it obtains from the LLP could potentially be tax free


 


·           the fairly complex provisions within the Companies Acts which restrict the withdrawal of equity capital do not apply to LLPs (but with one safeguard within the LLP legislation, which might mean that capital withdrawn from an LLP which subsequently went into liquidation would have to be paid back).


 


As compared with an industrial and provident society, an LLP is certainly much more flexible; there is much more scope for tailoring the constitution of the LLP – and with none of the expense and delay which can arise in the registration of an IPS which departs significantly from established model rules.


 


These various features undoubtedly introduce very interesting new possibilities for any project where a legal entity, involving participation by two or more parties, is considered to be appropriate. It is important to bear in mind, though, that an LLP will not represent the appropriate solution in all, or even most, instances within the public or third sector. In particular, the LLP is specifically identified in the legislation as being a structure for two or more parties engaging in business ‘with a view to profit’. An LLP is therefore not the structure to use where the parties are not intending to draw financial surpluses from the project vehicle – and in those cases, the structure of choice is likely to remain the company limited by guarantee. Where limited profit distribution is envisaged, the new community interest company (CIC) may be preferred, on the basis that it will maintain a statutory lock on dividends and distribution of surplus assets. Where there is the prospect of achieving charitable status for the project vehicle, the likelihood is that a company limited by guarantee (or possibly a trust) will be used; it is extremely unlikely that an LLP would be eligible for recognition as a charity given its essential nature as a ‘for profit’ body.


 


Turning to the material within the article itself, I have a number of comments:


 


1.         I think it is slightly misleading to suggest that an LLP is necessarily a simple structure, or one that is significantly easier to create as compared with a limited company.  Certainly, it is true that there is no requirement to file the Partnership Agreement with Companies House.  I would suggest, though, that it would be very unwise to use that as a reason to dispense with a Partnership Agreement.  In the absence of a Partnership Agreement, the LLP will be governed by the default provisions set out in the LLP regulations; that is likely to be some way removed from the position which people would want to apply in the context of a project falling within the public or social economy sector. 


 


2.         I also have a feeling that it may be slightly naïve to suggest that bringing people and organisations within a partnership (and remembering that an LLP is essentially a ‘for profit’ partnership) will automatically produce a full alignment of interests.  If one thinks of the classic partnership (ie. the private sector trading partnership), it is evident that stresses and strains can quite readily arise in relation to eg. the split of profits among the equity partners, different approaches to risk based on the differing exposure of equity partners and salaried partners, and so on. The introduction of further elements within the overall framework (such as are illustrated in the examples given in the article) whereby, for example, one of the partners has a property and expects to receive income to reflect the use/occupation of that property by the partnership, must inevitably introduce further divergence of interests.  That is not to say that the fact that the landlord is letting its property to an entity with which it is closely connected as a member will not produce a rather different dynamic to the relationship – but what it does not mean is that the various issues which arise out of the landlord/tenant relationship will no longer have to be addressed in a focussed and specific way, and on the basis of a considered judgement (or negotiation!) with regard to where the balance should lie in each case. I should also say that this is not specific to the context of an LLP; similar considerations would apply if the connection between landlord and tenant related to the landlord being a shareholder in the tenant company.


 


3.         Following on from the above, I think it is important that where there are significant legal relationships which fall outwith the core issues associated with the constitution of the LLP itself, careful consideration should be given to whether these should simply be wrapped up in the Partnership Agreement – or, rather, should be structured as separate documents entered into between the LLP (as an entity) and the particular individual or organisation which is party to that particular legal relationship.  Again, I do not see that as undermining the ethos of an LLP, but rather as producing an appropriate level of detail and definition into legal relationships which might well have wider implications outwith the LLP structure itself. 


 


4.         There is a further aspect where I think I would want to sound a note of caution – and that  relates to the fact that certain types of arrangement will automatically be interpreted in a particular way under the general law ie irrespective of how these are ‘labelled’ within the LLP structure.  To take one example, if a party is making additional payments which are referable to its occupation of premises (and these payments are not of the nature of reimbursement of common expenditure, payment of service charges, etc), then the law will normally regard them as rent, irrespective of whether they are expressed as a percentage of the tenant’s total revenue, are referred to as ‘capital rental’ or whatever.  It should also be recognised that it may in fact be important from the tenant’s point of view to be able to demonstrate that these payments do have the character of rent – eg. in order to ensure that they are clearly tax deductible; or (in the case of a charity) to demonstrate that they represent appropriate expenditure for a charity given that the payments are being made to a non-charitable body. 


 


Similarly, I have reservations about a public share or bond issue being presented as a ‘sale of partnership interests’ if that in essence becomes no more than a rebranding exercise. At the end of the day, there is nothing inherently more co-operative about having a ‘partnership interest’, nor will adopting an LLP as the vehicle in itself deliver an alignment of the interests of financiers, users and providers. The test of whether this really represents a different approach is not to do with the fact that an LLP is being used – but rather involves unpicking the detail of precisely what a partnership interest delivers for the holder (in terms of financial return, participation in decision-making and so on), and then working through how far that will then produce a different dynamic by reference to the interests and motivations of the various players….and then comparing all of that with the position which would apply under a more conventional model.  To take one aspect of this, the question of whether being a member of an LLP brings with it greater participation and involvement than, for example, being a shareholder of a public company, depends on what features are written into the Partnership Agreement – and, then again, one has to consider whether those sorts of arrangements could not very well have been written in to articles of association of a PLC, if indeed there had been a will to do so.  That last point relates to a more general observation – and that is, that the introduction of a new legal model like the LLP has the very real benefit of stimulating some ‘blue sky’ thinking about how particular arrangements might be structured differently – but I think it is important to go on to test those new approaches by reference to how they would fit within existing models as well as how they would look under the new model. 


 


I would hope that the above comments are not seen as negative in nature.  On the contrary, I think that the ideas reflected in Antonia Swinson’s article offer great potential, and I would be very keen to hear more of the detail (which I suspect would address a number of the possible concerns outlined above).  I suppose if there is a particular point which I am wanting to make, it would be that – without detracting from the enthusiasm for the LLP as a new vehicle– it would be wrong to see the LLP as a ‘cure-all’ remedy. It remains the case that when developing the legal framework for a partnership project, the parties do have to go through the difficult (and sometimes tortuous) process of carrying out a systematic analysis of the key components of the legal relationships and then setting the legal checks and balances to fit; that is not something which can be avoided just by adopting an LLP as the vehicle.


 


Best regards.


Yours sincerely


 



Stephen Phillips


Partner