In the past, virtually all business entities were in the forms of either that of a sole proprietor, a general partnership or that of a limited liability company. However,

In the past, virtually all business entities were in the forms of either that of a sole proprietor, a general partnership or that of a limited liability company. However, April 6 2001 saw the advent of a new form of business organization, that of the Limited Liability Partnership (LLP). As its name may suggest, it possesses several characteristics of a general partnership, with the added bonus of limited liability. Nevertheless, it has its own distinct features, features that we will look into below. In addition, we will look into the emergence of this new business entity; we will look into its raison d’etre.

The Limited Liability Partnership Act 2000 sets out the key features of the LLP business entity. Section 1(2) of the act states that a limited liability partnership is a separate corporate body with a legal personality separate to that of its members. This means that an LLP can (i) hold land and other assets with its own name (ii) enter into contracts with its own name (iv) employ staff (iii) sue and be sued. These are characteristics similar to that of a limited liability company, and most importantly, like the limited liability company, members of an LLP have limited personal liability with regards to the liabilities of the LLP. In the case of an LLP being wound up, its assets and funds will be used to repay its creditors. Furthermore, because an LLP does not have any share capital, on the advent of insolvent liquidation, the liquidator will be able to examine all withdrawals from the LLP’s funds and pursue such funds through a court of law.

The LLP does not have share capital. Hence the LLP is not bound by the rules on capital management as a limited liability company is. The LLP’s tax treatment is similar to that of a general partnership rather than that of a limited liability company. It does not have to pay corporate tax on its profits. Rather, members are taxed individually. This is a major advantage of the LLP to that of the limited liability company. Members of an LLP can expect to retain much more of the profits made by its business entity than shareholders of a limited company (where shareholders are taxed individually for the dividends they receive after the company has been taxed for the profits it has created).

An LLP needs at least two members. Furthermore, the LLP need not have an annual general meeting. This is a requirement of companies. Though not a major issue, it is absurd to think of a situation where the directors of a company are also its shareholders and, particularly in a company with only a handful of shareholders, an annual general meeting has to be held by the directors to themselves as shareholders. Hence, an LLP with only a handful of members need not hold such absurd meetings.

The LLP also has greater flexibility in its internal governance. Though there are default provisions in the Limited Liability Partnership Regulations 2001, these can be overridden by members’ agreements. Hence, the LLP can define its own rules on its management and regulating relations between its members. This contrasts from that of other business entities. Companies are required by law to have directors and a secretary. Limited Partnerships, a form of business entity rarely used, require the persons financing the business to not take part in the management of the business. The fact that an LLP is more flexible means that it can organize its governance structure in a way that suits it best.

The LLP also has unlimited powers. That is, should members of an LLP enter into transactions with third parties, it can be assumed that the members of the LLP and hence the LLP itself has the legal right to enter into such a transaction. This way, the complications that have arisen in the past with regards to the transaction powers associated with limited liability company directors are avoided.

So far we have looked at the advantageous features of the LLP. The truth of the matter is that the LLP also has its downsides. The key disadvantage being that ...

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So far we have looked at the advantageous features of the LLP. The truth of the matter is that the LLP also has its downsides. The key disadvantage being that of financial disclosure, a major element of all forms of limited liability business entities in the UK. The LLP has to disclose its financial status. Unlike general partnerships and like companies, the LLP has to disclose its financial information to the public. They have to follow a statement of recommended practice (SORP) as per the Limited Liability Partnership Regulations 2001. In accordance with the UK GAAP, the LLP will have to prepare “true and fair” accounts and file them as if they were limited liability companies. Such information will thus be available to the competitors of the LLP, in addition to the LLP’s (potential) creditors and clients. The situation is made worse by the fact that the LLP will have to disclose its unfunded obligations as per FRS12. Particularly for firms with former partners receiving firm benefits through annuity payments, this will show up in the accounts as a major liability, the net result being that the firm’s “true and fair” accounts will show a balance sheet figure much less than the probable value of the firm. In addition to that, the highest paid member of an LLP will have to disclose his/her aggregate profit, if the member’s income surpasses £200,000.

The LLP is not a public company, and unlike them, they do not subscribe their ‘shares’ to the open market. One of the fundamental reasons why public companies have to publicly disclose their financial information is because investors and potential investors will be interested in the state of affairs of the company. Nevertheless, it can be argued that because of the advantage of limited liability, and the risks that creditors face in dealing with limited liability business entities, it should only be fair that the public at large, and hence creditors, should be able to obtain the accounts of an LLP, if only at least to evaluate the risks involved in dealing with the LLP. The disclosure of an LLP’s accounts also has its plus side though, on the assumption that the LLP is doing well, it could very well boost the credit ratings of the LLP. Of course, the opposite holds true to that of an LLP that is doing poorly or apparently doing poorly.

Now that we have gone through the basic elements of the LLP, it is now essential that we explore the reasons as to the creation of this novel business entity. There have been no new major additions to the forms of business entities that exist in the UK since the introduction of Joint Stock Companies in 1844. Although the variant form of the general partnership, that of the limited partnership, was introduced by the Limited Partnerships Act 1907.

Thus, the business entities existed either as that of a sole proprietor, general partnership or a company. The company being the only business form that provided for limited liability on the business’ owners, so that, should the company wind up, its owners will only be liable to the effect of their share of the company or up to the amount they have guaranteed. The concept was created due to the need for industrial development in the 19th century; this needed large amounts of capital to be invested by persons with the finances, though not the know-how in the running of the business. Hence, to encourage such investments, to encourage such risky ventures, those that contributed to the business would at least be safe in the knowledge that only the sums they have contributed or guaranteed could be lost through the venture, and nothing more. Of course, a drawback of the limited liability company was that its financial status had to be audited and publicly available accounts had to be disclosed. This was, and still is, not very popular to those that do not wish to reveal the nature of their finances. Hence, the general partnership allowed groups of people to pool their resources together, while keeping the exact nature of their financial status away from the public eye. The drawback here was that, partners had unlimited liability. That should the partnership be wound up or should it meet heavy debts, its partners would have to meet such liabilities, even if it meant selling their homes. In a general partnership, a partner can be held joint and severally liable for the negligence of another partner. Partners were also liable for the wrongful acts or omissions of other partners during the course of proper business activity. This meant that, if one partner during the course of his business actions incurred heavy liabilities to the firm, all the other partners would be liable as well.

Such laws on the liability of partners within a general partnership were definitely problematic. Some partners did not even take part in the running of the firm; they were just present as the financial backbone of the partnership. As such, unfair situations could occur where the operational partners of a firm would squander the resources and create liabilities to other partners who did not even take part in the running of the firm. This then led to the creation of the Limited Partnership. In this form of the partnership, partners who were only the financial contributors of the firm would only be liable to amounts that they have contributed. The problem with the Limited Partnership, as we had mentioned earlier, was that these limited partners could not take part in the management and running of the firm. Hence, this form of partnership did not prove to be too popular, as even limited partners would want to have a say in at least the management if not the operational functions of the firm.

The onslaught of a litigious culture meant that the general partnership was not a convenient form of business entity. Even then, partnerships were reluctant to convert to limited liability companies. They simply did not favour the exposure of their financial information and probably most importantly, they did not want to pay corporate tax. In February 1997, the UK government finally looked at the proposition to create a form of partnership that limited the liability of the partners, and then in May 1997, the government finally announced that they intended to create a new form of business entity in the UK – the Limited Liability Partnership. A draft bill and draft regulations were published in September 1998. And after the passing of the Limited Liability Partnership Act 2000, LLPs officially came into existence on April 6 2001. On the same day, 18 firms, including the accounting firm Ernst & Young, registered as LLPs. Many more firms are expected to start up or convert to this new form of partnership. Several firms though, have already registered themselves as LLPs only to hold on to the name of their company/partnership. The drawback to this is that many firms continue to operate outside the realm of the LLP and there is a 12-month exemption period from stamp duty on the registration of the LLP for transfers of assets between the previous business and the new LLP. If transfers are not made in time, they will have to pay the stamp duty on the asset transfers.

As we have seen in our discussion on the features of the LLP, it finally allows members of a partnership business entity to be liable only to a limited degree and still be able to take part in the activities of the partnership. This should cause many more firms to switch to LLP status. Furthermore, because an LLP does not have to pay corporate tax, its members can then take home a larger share of the firm’s profits. There are no restrictions on what type of businesses can form LLPs, or to the participation level of the members of an LLP. This is thus a major attraction to companies (who do pay corporate tax) to switch to the LLP business entity. They already have to have their accounts audited and made public, this way they can avoid corporate tax. Of course, where huge amounts of capital is needed for a business, and such a business cannot obtain such capital readily, a public company would still be the best way to raise capital. Nevertheless, the LLP could very well spell the end of the era of private limited companies. But as of yet, many firms are still reluctant to jump onto the LLP bandwagon because of its relative novelty.

http://www.golds.co.uk/articles/articles_corp_llp_oct2002.htm

Bibliography

Anonymous, Limited Liability Partnership Bill Consultation Document, Department of Trade and Industry Homepage, July 1999, URL: http://www.dti.gov.uk/cld/llpbill/condoc99/1_intro.htm

Anonymous, LLP SORP in trouble, Accountancy, London, May 2001, Vol. 127 Iss. 1293

Auster, R, Malpractice exposure and choice of business entity, The National Public Accountant, Washington, April 2000, Vol. 45 Iss. 2

Davies, J, The LLP: About to take off, Credit Management, Stamford, March 2001

Dine, J, Company Law, 4th edn, 2001, Palgrave, New York

Foster, R, Limited liability partnerships – could they save your home?, New Law Journal, London, June14 2002, Vol. 152 Iss. 7036

Hancock, S, London firms spurn big chance to limit liability, The Times, London, July 9 2002

Hodgson, R.D, & Zabrosky, A.W, LLPs in Great Britain, Consulting to Management, Burlingame, June 2002, Vol. 13 Iss. 2

Lee, M, LLPs – why wait?, Accountancy, London, April 2002, Vol. 129 Iss. 1304

Linsell, R, Early Experiences, Accountancy, London, April 2002, Vol. 129 Iss. 1304

Davies; see bibliography.

Rules relating to how a company may distribute its share capital and rules as to how the company may finance its activities.

Foster, see bibliography.

s. 2(1)(a) Limited Liability Partnership Act 2000

Foster, see bibliography.

s. 282 Companies Act 1985 states that a public company must have at least two directors; and that public companies registered before November 1 1929 in addition to private companies must have at least one director. s. 283 states that companies must also have a secretary.

s. 6 Limited Partnerships Act 1907

In Limited Liability Partnerships, the ‘owners’ of the business entity are referred to as “members”. This contrasts with the terms “partners” in general partnerships and “shareholders” in companies.

Developed by and approved by the accounting profession.

Hancock, see bibliography.

Generally Accepted Accounting Principles

Hancock, see bibliography.

Financial Reporting Standard requiring the disclosure of unfunded obligations.

Income derived from the member’s salary and share of the LLP’s profits.

Davies; see bibliography.

s. 9 Partnership Act 1890

s. 12 Partnership Act 1890

But do note that certain acts of negligence by extremely careless partners or independent acts not pursuant to the welfare of other partners would only cause liability to the particular partner.

Through the Limited Partnerships Act 1907

Department of Trade and Industry Homepage; see bibliography.

“LLP SORP in trouble”; see bibliography.

Ibid. It is expected that by 2004, there will be around 8,000 LLPs in the UK.