Hidden Dangers of a Limited Liability Partnership - as published in Global Banking & Finance Review

If you are an employee offered promotion, being asked to become a member of an LLP may seem like a no brainer when the tax advantages are the sole consideration. However, there are down sides to giving up employee status that need to be weighed in the balance.

LLPs or Limited Liability Partnerships are a hybrid corporate business vehicle offering the benefits of limited liability but allowing members the flexibility of organising their structure as a traditional partnership.

LLP members are self-employed for tax purposes and therefore save the business the cost of employer’s National Insurance Contributions (NICs). In addition, the LLP member also obtains the cash flow benefit of a delayed payment of tax compared to an employee taxed under PAYE. The flip side is that an LLP member has fewer protections in law if things go wrong.

Rather than an employment contract, an LLP member’s rights and obligations are based on the terms of the LLP agreement. This is a written agreement recording what has been agreed about the internal workings of the LLP. Among other things, it will cover profit-sharing, admission of new members, management and decision-making, retirement and expulsion and the entitlements and obligations of outgoing members, including confidentiality obligations and restrictive covenants to protect the business when members leave.

An LLP member may be an equity member who has invested capital in the LLP and is to receive a share of profits or a fixed share member who has a fixed share of the equity and guaranteed minimum drawings of the LLP.

In the recent case of Tiffin v Lester Aldridge LLP the courts looked at the status of a fixed share LLP member. Mr Tiffin was a fixed share partner who was remunerated by way of a small fixed share of profit; he was entitled to extra profit based on a number of profit points; he contributed some capital and had voting rights. He unsuccessfully claimed employment rights and alleged unfair dismissal. Had Mr Tiffin been paid by way of a fixed share of profit without contributing capital and without voting rights, the result may well have been different. The case makes it clear that the status of individuals within an LLP will depend upon what was intended at the time of joining i.e. whether or not a relationship of partnership or akin to partnership was to be created. The starting point will often be the Membership Agreement and any relevant documents from the time of joining.

Whilst LLP members do not qualify for many employment protection rights, they have similar rights to employees not to suffer unlawful discrimination on the grounds of race, sex, age, sexual orientation, religion or belief and disability.

A common area for dispute, not surprisingly, is money – both in terms of what the member must put in, their entitlement to profit and their rights on leaving, such as repayment of capital, payment of their profit share, repayment of loans and payment for their share of the goodwill. These aspects need to be covered in the agreement to avoid disputes occurring.

Problems commonly arise when members want to force another member to leave. An LLP member cannot be required to leave unless the agreement includes a power of expulsion, even if there are good grounds for forcing them out. It is therefore important that before becoming a member an individual reviews the LLP agreement and makes themselves familiar with any clause covering the expulsion grounds that the LLP may rely upon such as incapacity, bankruptcy or gross misconduct. Expulsion clauses must be complied with otherwise the individual may challenge it on grounds that (i) the procedure has not been followed; (ii) it was discriminatory; (iii) it was done in bad faith; or (iv) the grounds that the LLP relied upon do not justify the expulsion.

LLP agreements should also include a compulsory retirement clause which allows the LLP to require a member to retire after a set period of notice for no particular reason. Retirement will generally mean that the member receives more notice and is entitled to more money on leaving than is the case with expulsion.

Take the case of several members considering that one of the others is not performing to the required standard and wanting him to leave. The agreement will need to be looked at to see what it says about retirement and expulsion. Misconduct will normally be a ground for expulsion but, depending on how misconduct is defined, it may not cover a member not pulling his weight. Likewise, if expulsion has to be agreed by all the other members, it will not be possible if one of the other members does not agree. If expulsion is not an option, then the retirement provisions will need to be considered. If there is no express term, the LLP’s options for forcing a member to leave are limited. It can agree terms for a voluntary retirement but cannot simply take the individual’s share – he is entitled to be paid his share. In the absence of any LLP agreement provisions and where no agreement can be reached, the only way to remove the member is the drastic step of winding up the business.

When disputes do arise which cannot be resolved, litigation may be the only course. However, LLP agreements often require disputes to be resolved in private by arbitration or mediation.

There are obvious advantages to joining a limited liability partnership, but it is important to understand the consequences of changing from employee to partner and not to overlook the potential hidden dangers. Individuals should consider whether becoming an LLP member is appropriate for them, whether it will benefit them in the long-run and seek legal advice as necessary.

This Article was originally published in Global Banking & Finance Review at  http://www.globalbankingandfinance.com/the-hidden-dangers-of-a-limited-liability-partnership/