Business and organisational characteristics - Limited liability partnerships

Learning Outcomes

After reading this article, you will be able to identify the main characteristics of a Limited Liability Partnership (LLP), understand its formation requirements, and appreciate the concepts of separate legal personality and limited liability as they apply to LLPs. You will also recognise the roles and responsibilities of members, particularly designated members, and understand the implications of an LLP agreement (or lack thereof). This knowledge will assist in comparing LLPs with other business structures for client advice.

SQE1 Syllabus

For SQE1, you are required to understand the key characteristics of different business structures and how they are formed and operate. This article covers the following aspects of the syllabus:

• Business and organisational characteristics (Limited liability partnerships (LLPs))
• Legal personality and limited liability
• Procedures and documentation required to form an LLP and other steps required under companies and partnerships legislation to enable the entity to commence operating:
  • Constitutional documents
  • Companies House filing requirements
• Partnership decision-making and authority of partners (applied to LLPs)
  • Common provisions in LLP agreements

Test Your Knowledge

Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.

1. True or False? An LLP requires a formal written agreement between members to be validly formed.
2. What is the minimum number of designated members required for an LLP?
3. Explain the concept of 'separate legal personality' in the context of an LLP.
4. Are members of an LLP personally liable for the LLP's debts?

Introduction

Limited Liability Partnerships (LLPs) offer a business structure combining features of both traditional partnerships and limited companies. Governed by the Limited Liability Partnerships Act 2000 (LLPA 2000) and associated regulations, LLPs provide flexibility alongside protection for members' personal assets.

Formation Requirements

Establishing an LLP involves a formal registration process with Companies House. This contrasts with general partnerships, which can arise informally.

Key Term: Limited Liability Partnership (LLP)
An incorporated business structure offering limited liability to its members, governed by the LLPA 2000. It possesses separate legal personality.

The key steps for incorporation include:

1. Minimum Membership: At least two persons (which can include individuals or companies) intending to carry on a lawful business with a view to profit must agree to form an LLP.
2. Incorporation Document (Form LL IN01): This form must be submitted to the Registrar of Companies, containing:
   • The proposed name of the LLP (which must end with "Limited Liability Partnership" or "LLP").
   • The location of the registered office (England and Wales, Wales, Scotland, or Northern Ireland).
   • The address of the registered office.
   • Details of the initial members, including specifying who the designated members are.
   • A statement of compliance confirming adherence to registration requirements.
3. Registration Fee: The requisite fee must accompany the application.

Upon successful registration, Companies House issues a certificate of incorporation, confirming the LLP's existence as a legal entity from the date specified.

Separate Legal Personality

Once incorporated, an LLP acquires its own legal identity, distinct from its members.

Key Term: Separate Legal Personality
The principle that an incorporated entity (like an LLP or company) is legally distinct from its owners (members/shareholders) and managers. It can own property, enter contracts, sue, and be sued in its own name.

This separation means the LLP itself is responsible for its debts and obligations. It can own property, enter contracts, and continue indefinitely, irrespective of changes in membership (perpetual succession).

Limited Liability

A significant advantage of the LLP structure is the limited liability afforded to its members.

Key Term: Limited Liability
A legal protection where members' personal liability for the debts and obligations of the LLP is restricted, typically to the amount of their agreed capital contribution (if any). Personal assets are generally protected if the LLP fails.

Members are generally not personally responsible for the LLP's debts. If the LLP becomes insolvent, creditors usually cannot pursue the members' personal assets. However, liability protection is not absolute. Members can face personal liability in specific situations, such as for fraudulent trading or wrongful trading (continuing business when known to be insolvent).

Designated Members

Every LLP must have at least two designated members.

Key Term: Designated Member
A member of an LLP with specific statutory responsibilities for administrative and compliance tasks, such as signing accounts and filing documents with Companies House.

If the LLP fails to nominate specific designated members, all members are deemed to be designated members. Their duties include:

• Appointing an auditor (if required).
• Signing and filing the LLP's annual accounts.
• Filing the annual confirmation statement.
• Notifying Companies House of changes in membership or registered office address.
• Acting on behalf of the LLP if it is wound up.

Internal Governance and Management

While the LLPA 2000 and related regulations provide a default framework, LLPs typically formalise their internal operations through an LLP agreement.

The LLP Agreement

This private agreement between the members governs their mutual rights and duties and the internal management of the LLP.

Key Term: LLP Agreement
A contractual document outlining the internal rules, responsibilities, profit sharing, decision-making processes, and other governance matters agreed upon by the members of an LLP.

Key areas typically covered include:

• Capital contributions.
• Profit and loss sharing arrangements.
• Management roles and decision-making authority.
• Procedures for admitting new members or handling member exits (retirement, expulsion).
• Dispute resolution mechanisms.

In the absence of an LLP agreement, default provisions from the LLP Regulations 2001 apply, which mirror many aspects of the Partnership Act 1890, such as equal sharing of profits and capital, and equal rights in management.

Flexibility vs. Formality

Compared to companies, LLPs offer greater internal flexibility. There is no statutory requirement for board meetings or the rigid separation between directors and shareholders found in companies. Members can tailor the LLP agreement to suit their specific business needs. However, LLPs face more administrative and filing requirements than general partnerships due to their incorporated status.

Worked Example 1.1

Alex, Ben, and Chloe want to set up a consultancy business. They are concerned about potential personal liability if a client sues them for negligent advice. They want a flexible management structure where all can participate equally. They anticipate needing external finance in the future. Which business structure might be most suitable?

Answer: An LLP could be highly suitable. It offers limited liability, protecting their personal assets from business debts and negligence claims (unlike a general partnership). The structure allows for flexible internal management defined by an LLP agreement, accommodating their desire for equal participation. As an incorporated entity, an LLP can grant floating charges, potentially making it easier to secure finance compared to a general partnership. While more formal than a partnership, it avoids the stricter corporate governance of a limited company.

Liability and Duties

Members of an LLP have specific duties and potential liabilities.

Members' Duties

Members act as agents of the LLP (s 6 LLPA 2000) and owe fiduciary duties to the LLP, similar to partners in a general partnership. These include:

• A duty of good faith.
• A duty to account for benefits derived from the LLP's business without consent.
• A duty not to compete with the LLP without consent.

Designated members have additional statutory administrative duties.

Liability of the LLP

As a separate legal entity, the LLP is liable for its own debts. It is also liable for wrongful acts or omissions committed by a member acting in the ordinary course of the LLP's business or with its authority.

Clawback Provisions

In an insolvent liquidation, sums withdrawn by members (e.g., profit distributions, capital repayments) within two years prior to the winding-up can potentially be 'clawed back' if the member knew, or ought to have known, the LLP was or would become insolvent as a result (s 214A IA 1986, applied by regulation).

Taxation

For tax purposes, LLPs are generally treated as transparent entities, similar to general partnerships.

Key Term: Tax Transparency
A principle where the business entity itself is not taxed on its profits; instead, the profits are allocated to the owners/members who are then individually taxed on their share.

This means the LLP itself does not pay corporation tax. Profits are distributed to members, who are then individually responsible for paying income tax and National Insurance contributions on their share.

Termination

An LLP continues to exist until formally dissolved. Dissolution typically occurs through:

• Voluntary Striking Off: If the LLP is no longer trading, members can apply to Companies House to have it struck off the register, provided certain conditions are met (e.g., no trading for three months).
• Winding Up/Liquidation: An LLP can be wound up either voluntarily (if solvent, by the members) or compulsorily (usually by creditors, if insolvent), following procedures similar to those for companies under the Insolvency Act 1986.

Summary

LLPs provide a valuable structure, particularly for professional services firms, offering the benefits of limited liability and separate legal personality while retaining much of the operational flexibility of a partnership. Key considerations include the formal incorporation process, the distinction between members and designated members, the importance of an LLP agreement, and the implications of tax transparency.

Key Point Checklist

This article has covered the following key knowledge points:

• LLPs are incorporated bodies formed under the LLPA 2000, requiring registration at Companies House.
• LLPs possess separate legal personality and offer limited liability protection to members.
• At least two members are required, including a minimum of two designated members with specific administrative duties.
• Internal governance is flexible, often detailed in a private LLP agreement; default regulations apply otherwise.
• Members owe fiduciary duties to the LLP.
• LLPs are tax transparent, with profits taxed in the hands of individual members.
• LLPs face more formal compliance and filing requirements than general partnerships but fewer than companies.
• LLP members can face personal liability in cases of wrongful or fraudulent trading.

Key Terms and Concepts

• Limited Liability Partnership (LLP)
• Separate Legal Personality
• Limited Liability
• Designated Member
• LLP Agreement
• Tax Transparency