UK: LLPs - A Safer Haven?

6 April 2001 was a special date. It saw the coming into force of the Limited Liability Partnerships Act 2000 (the "2000 Act") which created the first new legal entity in over 100 years, the Limited Liability Partnership ("LLP"). The need for this new commercial vehicle arose out of the fear of massive professional claims particularly against accountants in the wake of high profile collapses in the 1990s such as Maxwell and BCCI and which Enron and Worldcom have brought back into the headlines. The LLP was therefore designed to protect the personal assets of partners against potentially catastrophic claims in excess of their insurance cover whether that cover be £1 million or £100 million.

In an insurance market where premiums continue their upward surge, representing multiples of the sums paid only twelve months ago and where the ability to secure insurance at excess levels becomes increasingly difficult, LLPs have taken on greater significance. We look at the reality of LLPs in this context.

The LLP has added to four existing legal structures for carrying on business of which the only two serious alternatives for larger businesses are:-

• incorporation as a limited company; and
• a traditional partnership under the Partnership Act of 1890.

All of the professions are now permitted to operate as limited companies provided that they maintain adequate professional indemnity insurance but whereas accountants and solicitors have been reluctant to break away from traditional partnership structures a larger proportion of surveyors, architects and engineering practices already operate as limited companies.

The primary advantage of operating as a limited company is, of course, the limitation of liability achieved through a separate legal entity leaving the shareholding participants with no greater financial exposure than the loss of their shareholdings. In practice the protection of limited liability can be eroded by the need for directors to give personal guarantees and the power of the Court occasionally to require directors to make a personal contribution to the assets of their company in liquidation. But the comfort of limited liability is still extremely valuable particularly in respect of the type of one-off claim against which it is impossible to legislate.

By comparison a traditional partnership is not a separate legal entity. The partnership is responsible for the acts of every partner and every partner is individually liable for all of the liabilities of the partnership. Limiting liability by agreement with clients for individual pieces of work is a possibility but one which is still rare in practice because of perceived client resistance. Insuring to a high level has traditionally been seen as an answer but increasingly it can only be a partial answer because of the spiralling costs of insurance and the size of claims. From a surveyor’s perspective, for example, claims arising out of commercial property transactions can involve almost limitless losses particularly where environmental liabilities are involved.

LLPs address the problems of traditional partnerships in the following ways:-

• An LLP has its own independent legal personality – it is a corporate body registered at Companies House.
• It has members who act as its agents – obligations will fall on the LLP and not on the individual members. (On the other hand there is no direct equivalent of shareholders because LLPs do not have share capital.)
• The liability of members of an insolvent LLP will be limited to their share of the LLP’s capital. Their liability to contribute in the event of the LLP being wound up is akin to that of a company director under the wrongful trading provisions of the Companies Act.

In light of these advantages it seemed reasonable to assume that there would be a rapid take-up of LLP status by existing partnerships especially among the larger professional partnerships. In practice there has been a slow movement rather than a mad rush with firms weighing up the pros and cons and waiting to see whether others make the move. However, at least in the legal world LLPs are beginning to gain momentum with around 15 firms having adopted the new status since April last year. Among the big accountancy practices, Ernst & Young converted in June last year and others are likely to follow. With regard to surveyors it is not possible to say because although the RICS has issued a detailed paper on the subject it does not keep a record of firms which have transferred over to LLP status.

It is true that there are disadvantages of LLP status which some partnerships are not yet ready to embrace. The red tape and publicity requirements for LLPs include the following:-

• Registration with Companies House (including a register of members although with less incorporation documentation than is required for a limited company).
• Annual returns – although again with fewer internal procedural requirements between returns.
• Nomination and registration of "designated members" with special administrative obligations similar to company directors.
• Disclosure requirements in relation to accounts similar to those which apply to companies. This means that for all but the smallest LLPs audited accounts must be filed at Companies House annually and the income of the highest paid partner must be disclosed.

The last of those requirements has undoubtedly put some partnerships off. The formal audit requirements for LLPs are also more onerous than the equivalent regime for partnerships.

What about insurance? Will those partnerships which take on LLP status decide that it is now safe to underwrite themselves for less than they did as traditional partnerships? I think not – particularly in the case of larger organisations – although whether such insurance will be available at affordable rates is another matter. Quite apart from client sensitivity which would make under-insurance commercially unacceptable in most circumstances there are at least three other grounds for thinking that LLP’s will not reduce their PI cover if they can avoid it.

(1) The main advantage of an LLP is to protect its members against the disastrous consequences of a catastrophic claim which might breach its insurance defences and attack personal assets. That does not mean that members will view the insolvency of their LLP as a mere occupational hazard. The insolvency regime for LLPs is not soft (even if it is not as strict as was at first expected) and, in any case, members will not wish to risk the loss of their business and livelihood.

(2) Professional bodies such as the RICS and the Law Society will not look kindly at members of insolvent LLPs who damage both the interests of their clients and the reputation of their professions by leaving genuine Claimants high and dry.

(3) Consideration must also be given to the position of the individual member(s) of the LLP who may have been responsible for the negligent valuation, advice or whatever else may have given rise to the claim. Although the client’s contract will have been with the LLP negligence claims against professionals may also be brought in tort. A number of commentators have assumed that individual members of LLPs are therefore still exposed to personal liability for their own negligent act. If that is right then for the simple reason that no one knows what the future holds, every member will surely want the LLP to maintain insurance at the highest affordable level.

On this final point I must say that I am not sure that the analysis is correct. Given that the purpose of the 2000 Act is to create a level playing field between limited companies and LLPs it should be possible to look to existing case law in relation to limited companies for guidance. There is House of Lords authority in the form of Williams v Natural Life Health Foods Limited (1997) which indicates that unless (a) a director of a company intends to undertake personal liability to the client and (b) the client reasonably relies upon that intention then the director will not have personal liability imposed upon him. As Lord Steyn said in the leading speech:-"

By extension, there is a good argument that members of LLPs should be safe from personal liability provided that the LLP makes it abundantly clear in its engagement letters and even perhaps on its notepaper that its members will have no personal liability for any of their acts or omissions as members of the LLP. However, until the point is clarified either by case law or further legislation members of LLPs are unlikely to take the risk of lowering their insurance cover.