Limited and Unlimited Partnerships

Advantages of the Limited Liability Partnership status over Unlimited liability Partnership status.

1. Limited Liability. It is responsible for its own contractual obligations. Only a member who is personally negligent will be potentially exposed to claims in Tort. Even this may be eliminated or significantly reduced through carefully worded engagement letters.

2. Like a company an LLP will be able to contract in its own name, so that there will be no need to deal with novation of contracts every time partners retire or are apponted. Also imdemnities between generations of partners can be avoided.

3. The LLP will have unlimited capacity, including the ability to grant floating charges.

4. The tax position of members of an LLP is very similar to that of the partners in a partnership.

In order to benefit from some of the benefits of practising through a body corporate, individuals who are accustomed to practising through a partnership may feel more comfortable transferring the partnership business to an LLP, rather than a company. However there may be a number of reasons why a firm will decide not to convert to an LLP.

1. Current partners – most partnership agreements will require a very substantial majority before the partnership can dispose the whole of its business to an LLP, as separate corporate body and be dissolved. Some even require unanimity, and unanimity will be required if there is no partnership agreement.

2. Retired partners – in some (increasingly rare) cases, retired partners are entitled to an annuity from the current partners. Sometimes they are even given the right to a lump sum if the firm is ever dissolved or its business transferred, and this may give retired partners an effective veto. In these circumstances their agreement should be obtained, and ideally they should be asked to release the partners from their personal obligations in return for a covenant from the LLP. However the obligation to pay the annuities will then have to appear on the LLP’s balance sheet and in may cases it may be appropriate for the members to retain the liability to pay the annuities personally out of their profit shares, with the LLP having no liability at all. Arrangements will have to be made to release retiring members and to bind incoming members.

3. Banks – banks are likely to have two levels of exposure, loans to partners individually to finance the capital contributions and facilities provided to the partnership itself. In an ideal world, from a limited liability standpoint, the bank would be asked to provide facilities to the LLP or company, rather than to each individual member who would then have a personal liability, and to release the partners personally from any continuing liability. However, banks may insist on security and on continuing personal guarantees from the partners. Their attitude will depend very much on their perception of the firm and its management. Many larger and better managed firms are often able to take facilities for the LLP without any requirement for personal guarantees, provided that the balance sheet of the LLP is strong enough.

4. Landlords – landlords generally have direct personal covenants from at least some of the partners who, in turn, have rights of contribution from other partners. In many cases, landlords will be reluctant to give up these rights and may insist on being given equivalent protection in the form of personal guarantees. Some far-sighted firms may have negotiated leases in a form which allows them to substitute an LLP as tenant unilaterally. Either way, the position of landlords needs to be considered.

5. Accounts – the requirement of filing accounts may be a major issue of many firms. Furthermore, the requirement that the accounts comply with UK Generally Accepted Accounting Practice may be a barrier to conversion (though the actual figures in an ordinary partnership must also be based on UK GAAP, but without the disclosures required for LLPs). However personal liabilities for retired partners’ annuities will effect the LLP’s balance sheet.

6. Clients – experience suggests that limited liability in itself is unlikely to lead to the loss of clients, provided that it is handled carefully. Clients tend to choose their professional advisors on the basis of the strength of the relationship and their track record, rather than because each partner will be jointly and severally liable if something goes wrong. But, especially if the firm is heavily dependent on a small number of major clients, it will be as well to sound major clients out before incurring substantial expense. The need to enter into new engagements with all clients post-conversion may be a daunting prospect, but is unlikely to be significant enough to be a barrier to conversion. While the process may be laborious, it can present a business development opportunity as contact is re-established with all clients.

7. Tax and regulation – more complex overseas structures may be required if LLP or company status is adopted.

8. There must be two designated members in an LLP who are responsible for things such as filing of annual accounts and annual returns.

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© A.D.Smith, 2012