Limited liability partnerships and disputes within them

This guide explains some of the rules surrounding Limited Liability Partnerships (“LLPs”) and disputes within LLPs under English Law in general terms. The intention of the guide is not, however, to advise you on your position and what you should do in the event that you find yourself in a dispute within a LLP (which will depend on the facts of your case). The subject of any partnership dispute is a complex area and no guide can ever set out all the factors relating to a particular case. This guide is not therefore a substitute for detailed advice on your case. If you would like further explanation of any points in this guide, or advice on your particular case, please contact us.

Limited liability partnerships

Nature of an Limited Liability Partnership (LLP) and its legal framework

An LLP is a body corporate which is formed under the Limited Liability Partnerships Act 2000 (LLPA 2000), which came into force on 6 April 2001.

In an LLP, you and your business partners are legally referred to as LLP “members” rather than partners

Unlike a general partnership, an LLP has legal personality separate from its members. This means that like a company: -

it is liable for its own debts
it will contract in its own name with third parties; and
it can sue, and be sued in its own right

The majority of law applicable to LLPs, is modified company law: -

The Limited Liability Partnership Regulations 2001, SI 2001/1090 (LLPR 2001) apply provisions of partnership law to LLPs
The Limited Liability Partnerships (Application of Companies Act 2006) Regulations 2009, SI 2009/1804 (LLPR 2009) apply many parts of the Companies Act 2006 (CA 2006), with appropriate modifications, to LLPS; and
The Limited Liability Partnerships (Accounts & Audit) (Application of the CA 2006) Regulations 2008, SI/20098/1911, apply parts of the CA 2006 in relation to accounts and audit to LLPs.

Setting Up a LLP – Why You Need a Members’ Agreement

Setting up any business is an exciting time. Enthusiasm to get an LLP started can result in shortcuts being taken and insufficient consideration being given to properly setting up an LLP. This can give rise to serious problems, or even litigation, later down the line.

It will almost always be advisable for members of a LLP to enter into a LLP Members’ Agreement in order to avoid the application of any inappropriate default provisions in the LLPR 2001, or to supplement the statutory provisions where they are insufficient.

What Should be Included in your LLP Members’ Agreement

When it comes to drafting your Members’ Agreement, as its provisions will override, or vary, the default provisions of the LLPR 2001, it’s important to make sure that the agreement covers the needs of your particular business and circumstances – and that is properly drafted by an experienced solicitor.

Some of the more essential clauses of that Limited Liability Partnership Members’ Agreement should cover the following issues:

identifying LLP members;
setting out members’ profit shares and their contributions to the capital of the business;
explaining how losses are to be dealt between the members;
describing how money is to be taken out of the business;
setting out how members are expected to act in relation to the business, e.g. are they permitted to have any other business interests – and if so are there any limitations on such outside work;
identifying what happens when one of the members dies;
setting out the arrangements for additional members to be bought into the LLP – including details on how their share of the business is to be valued, and how payments are to be made (e.g. by prearranged instalments);
identifying the rules for leaving the LLP; and
setting out how to resolve a dispute in your LLP.

Members owe the LLP duties of a fiduciary nature, however, it is not currently clear whether members of an LLP owe fiduciary duties to each other, so it is common for an LLP agreement to clarify this issue and set out a list of specific duties to be performed or observed by members of an LLP. These duties may include that each member must:

devote the whole (or a specified amount) of their time to the LLP;
act in good faith towards the LLP and the other members;
conduct themselves in a diligent and professional manner;
serve as a designated member if required to do so;
give a true account of and full information concerning their activities in relation to the LLP;
account for profits made in competition with the LLP;
indemnify the other members against breaches of the LLP agreements;
keep confidential matters relating to the LLP, its business and any of the other members; and
generally comply with policies of the LLP in place from time to time.

What happens when there is no LLP Members’ Agreement

The LLPR 2001 set out default provisions that will apply to the operation of an LLP in the absence of any specific agreement between members to the contrary.

The default provisions of partnership law applying to LLPs are set out in Regulations 7 and 8 of the LLPR 2001, and are as follows:

all of the members of an LLP are entitled to share equally in the capital and profits of the LLP;
the LLP must indemnify each member in respect of the payments made and personal liabilities incurred by them:
- In the ordinary and proper conduct of the business of the LLP, or
- In or about anything necessarily done for the preservation of the business or property of the LLP
every member may take part in the management of the LLP;
no member shall be entitled to remuneration for acting in the business or property of the LLP;
no person may be introduced as a member or voluntarily assign an interest in an LLP without the consent of all existing members;
any difference arising as to ordinary matters connected with the business of the LLP may be decided by a majority of the members, but no change may be made to the nature of the business for the LLP without the consent of all of the members;
the books and records of the LLP are to be made available for inspection at the registered office of the LLP or at such other place as the members think fit and every member of the LLP may, when they think fit, have access to and inspect and copy any of them;
if a member, without the consent of the LLP, carried on any business of the same nature as and competing with the LLP, they must account for and pay over to the LLP all profits made by them in that business;
every member must account to the LLP for any benefit derived by them without the consent of the LLP from any transaction concerning the LLP or from any use by them of the property of the LLP, name or business connection; and
no majority of members can expel any member unless a power to do so has been conferred by express agreement between the members.

The LLPA 2000 and the LLPR 2001 do not specify the mechanics for the holding of member meetings or the passing of member resolutions.

Disputes within LLPs

Common Reasons for Disputes within LLPs

Disputes can arise within LLPs for a number of reasons. The most common reasons tend to be exclusion from management and issues surrounding the desired expulsion of one or more of the members, unauthorised or negligent actions of individual LLP members, and breaches by members of contractual restrictions.

Exclusion from Management and issues surrounding the desired expulsion of one or more of the members

A common occurrence is for one of the Members to conclude that the business would be better if one or more of their business partners was excluded. They may look for ways of getting those other members removed, or decide to walk away from the existing business and start another similar business in its place. This understandably causes problems for the LLP. In the event of any dispute, the first place to look for the way out of the problem is any dispute resolution clauses contained within the Members’ Agreement.

In the absence of a clause in any Members Agreement permitting members to do so, there is no right to unilaterally exclude or expel another LLP member, or other LLP members. If this occurs, it could result in court action and the risk of a significant legal costs order being made against the LLP Member(s) perpetrating the exclusion.

In the event of any disputed exclusion of expulsion of an LLP Member, specialist legal advice should be sought.

Liability of LLPs and Individual Members

Like shareholders of a company, the members of an LLP enjoy limited liability up to the amount of any financial contribution to the LLP. This is the main way in which an LLP differs from general partnerships.

A member of an LLP is an agent of the LLP, however, an LLP is not bound by anything done by a member if: -

the member in fact has no authority to act for the LLP by doing that thing, or
the person with whom the member seeks to deal with knows he has no authority, or does not know or believe him to be a member of the LLP

Like shareholders of a company, a member may still be personally liable if they, rather than the LLP, are the contracting party in any particular transaction or matter, and also for their own acts of negligence.

Breach of Members’ Contractual Restrictions

As is the case with any Directors’ Services Agreements, Shareholder Agreements and contracts of employment, an LLP Members’ Agreement will usually set out certain obligations and restrictions such as non-solicitation and non-compete covenants and ongoing confidentiality provisions that will apply to an outgoing member.

Any restrictions must be no greater than reasonable required to protect the legitimate interests of the LLP; however, the courts are more likely to uphold extensive restrictions on members than those that may be imposed on employees.

Until recently a common tactic in LLP disputes was for Claimants to assert that a repudiatory breach had occurred which either entitled them to leave the LLP without serving a notice period, or to remain a member of the LLP but on terms governed by the LLP default rules rather than the LLP agreement. This could be particularly advantageous for Claimants with a low profit share, since under the default rules, the members are entitled to an equal share of LLP profits. In Flanagan v Liontrust Investment Partners LLP and others [2015] EWHC 2171 (Ch) the High Court has now, however, held that the doctrine of repudiatory breach does not apply to LLP agreements (although the court left open the possibility that the doctrine may apply to LLPs with only two members).

Protection Afforded to Members of LLPs in the Event of Dispute

Unfair Prejudice

By virtue of Regulations 48 and 49 of the LLPR 2009, the provisions relating to unfair prejudice actions that apply to companies also apply to LLPs, with some modifications, giving a member a potential claim if:

The LLPs affairs are being or have been conducted in a manner that is unfairly prejudicial to the interests of the members generally or to some of the members (including at least himself); or
An actual or proposed act or omission of the LLP (including an act or omission on its behalf) is or would be so prejudicial.

This may give a member of an LLP who is excluded from its management, when he has an entitlement to take part in it, the ability to bring a claim for unfair prejudice.

Regulation 48 of the LLPR 2009 lists the particular types of orders which may be made by the Court if it decides that there has been unfair prejudice, although the court retains general discretion to make any order it thinks fit.

The powers replicate those listed in s996(2) of the Companies Act 2006 and provide that the court can: -

regulate the conduct of the LLPs affairs in the future;
require the LLP to refrain from doing or continuing an act complained of, or to do an act which the Petitioner has complained it has omitted to do
authorise civil proceedings to be brought in the name and on behalf of the LLP by such person or persons and on such terms as the court may direct
require the LLP or the members of the LLP not to make any, or any specified alternations in the LLP agreement without the leave of the court
provide for the purchase of the rights and interests of any members in the LLP by other members or by the LLP itself.

It is important to remember, however, that LLP agreements commonly exclude a right to bring an unfair prejudice claim. This is permitted by Regulation 48 of the LLPR 2009.

For further guidance and assistance in connection with setting up an LLP, please contact Jonathan Croley on j.croley@ashfords.co.uk.