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Limited Liability Partnership
This
book was written in 2005 and aims to cogitate the raison d'être, which beget the evolution of the
limited liability partnership (LLP) form of business structure. It discusses
the LLP Statutes in United States of America, Channel Island of Jersey, United
Kingdom, United Arab Emirates, Singapore and Australia. It further draws a
comparison of the limited liability partnership laws prevalent in these places
and identifies the best practices, which with apposite adaptations can be made
a part of a similar legislation in India.
Methodology
This
book adopts a desk research method, which involves Internet research,
literature review and analysis, and correspondence with the relevant
authorities in the places studied.
Acknowledgement
I would like to acknowledge the valuable contributions made by a
number of people who helped me in the development and refinement of this text.
First I would like to thank Prof. Prem Sikka, Professor of Accounting,
Department of Accounting, Finance and Management, University of Essex, UK for
his guidance on the subject.
Special thanks go to Ms. Toh Wee San, Senior Assistant Registrar ACRA, Singapore who
gave my queries a patient listening and guided me in understanding the most
technical issues of the subject.
CHAPTER 1: INTRODUCTION
INTRODUCTION
The
inclination to collaborate to accomplish certain commercial objectives has a
long history. The commercial magnetism of such collaborations and a need to
govern their business ultimately led to the codification of corporate and
partnership laws.
Corporations
and Partnerships have been a primary form of business structure for a long time
now. For more than a century, partnership law has offered an all-embracing and
lucid alternative to corporate law. Although, the two bodies of law have much
in common, historically they differed sharply on the role of the contract and
private ordering in structuring the firm.
Partnership
law encourages private ordering through bargaining by providing a set of
statutory default norms that, with only a few exceptions, yield to agreements
negotiated by partners. In contrast, corporate law historically has provided a
mandatory framework for firm structure highly resistant to shareholders’
attempts to define their relationships through bargaining[1]. Proponents of private ordering within firms prefer the freedoms
of partnership law to the mandates of corporate law, and over time they have
enjoyed success in extending the bargaining model from partnership law to
corporate law.
However,
the inherent limitations of both these forms of businesses have made them
unsuitable for certain businesses and ultimately hybrid forms of business structures
such as limited partnerships, limited liability partnership, limited liability
limited partnerships etc. evolved.
GENESIS AND DEVELOPMENT OF PARTNERSHIP LAWS
Partnership
laws around the world have evolved over a period of time in consonance with the
changing business requirements. Broadly, the partnership laws can be classified
in three generations viz. General Partnership Laws (First Generation), Limited
Partnership Laws (Second Generation) and Limited Liability Partnership Laws
(Third Generation).
First Generation
The UK
Partnership Act, 1890 is an archetypal example of first generation of
partnership laws. A general partnership firm is not a separate legal entity. A
partner is considered as the agent of the firm and of other partners for the
purpose of the business of the firm. Further, every partner is liable, jointly
and severally with all the other partners, for all acts of the firm done while
he is a partner. Where, by the wrongful act or omission of a partner acting in
the ordinary course of the business of a firm, or with the authority of his
partners, loss or injury is caused to any third party, or any penalty is
incurred, the firm is liable therefore to the same extent as the partner.
General partnership is regarded
by the public as the type of business structure providing the optimal protection
to members of the public, because partners are not protected by limited
liability and the claimants can always go after the personal assets of each
partner to meet his or her claim.[2]
The characteristic of
"unlimited liability" ensures that the partners maintain a direct
interest in the affairs of the partnership and conduct of its partners,
especially in small practices where the partners are likely to work in the same
location. For large practices, they may have offices in several places, and
thus partners may not be able to keep track of all aspects and transactions of
the partnership. Nonetheless, under a general partnership, partners still have
to share the liabilities for the negligence of those partners whom they may
barely know or meet.[3]
The advantage of this
structure is that its business affairs are entirely private. A partnership
agreement is also a private confidential document providing the flexibility in
which the partners can determine how the internal structure and relationship
between partners and between partners and the partnership are governed.[4]
Second
Generation
The UK Limited Partnership Act, 1907 is an archetypal example of
second generation of partnership laws. A limited partnership is different from
a general partnership to the extent that it classifies the partners into two
classes: a general partner and a limited partner. Limited partnerships must
have at least one general and one limited partner. The essence of a limited
partnership is that it bestows on the partnership the benefit of limited
liability to a certain extent. In a limited partnership, the liability of the
limited partner is limited to the amount of his contribution. He is like an
investor and usually does not take part in the management or day-to-day running
of the firm.
However, if a limited partner takes part in the management, he can
be held liable for all debts and obligations of the firm incurred while he so
takes part in the management, as though he were a general partner. As against
this, the general partner is responsible for the management of the firm and has
unlimited liability. Further, limited partnerships do not specifically deal
with the issue of joint and several liabilities. Partners can still be held
liable for the wrongful acts or omissions of their fellow partners. For tax
purposes, a limited partnership is not considered as a taxable entity and its
income and capital transactions flow through to the partners. Limited
Partnerships are increasingly being used for private equity and fund investment
businesses.
Third Generation
The UK
Limited Liability Partnership Act, 2000 is an archetypal example of third
generation of partnership laws. A limited liability partnership (LLP) is an
alternative corporate business vehicle that not only provides the benefits of
limited liability but also allows its partners the flexibility of organizing
their internal structure as a general partnership. The limited liability
partnership is a separate legal entity and, while the LLP itself will be liable
for the full extent of its assets, the liability of the partners will be
limited. In LLP, each partner is the agent of the LLP but not of other
partners.
The
limited liability partnership structure has gained importance in the last one
decade and is now available in United States of America, Channel Island of
Jersey, United Kingdom, United Arab Emirates, Singapore and Australia.
The push for the creation of limited liability partnership grew
from several factors, such as general
increase in the incidence of litigation for professional’s negligence and the
size of claims; the risk to a partner's
personal assets, when the claim exceeds the sum of the assets and insurance
cover of the partnership; the growth in the size of
partnerships; increase in specialization among partners and the coming together
of different professions within a partnership.
There are also concerns
about the shifting of the business structure of a firm from a general
partnership to an LLP, albeit there is no empirical data supporting them. One
of the concerns is about the impact upon the culture of a law firm. For instance, the
practice of law in high-risk areas often yields high rewards commensurate with
the increased risk of liability. Partners in a general partnership usually
share both the risk and risk-related gains with their fellow partners. If a
shift to an LLP causes a member/partner to shoulder a higher risk of liability
than others, he or she may demand a larger share of the rewards. Similarly, the
risk of some members/partners may increase where the legislation provides that
members/partners of LLPs have to be liable for the acts of those under their
direct supervision; in particular, if some members/partners have to supervise
less experienced lawyers or staff.[5]
Some consider that
shifting from the general partnership status to the LLP status may result in
less incentive for members/partners to monitor and control the quality of work
by other members/partners of the firm, as they are no longer liable for the
acts of their fellow members/partners. The breakdown of internal procedures at
Arthur Andersen, the accounting firm operating as an LLP, in connection with
the collapse of the Enron Corporation, is often quoted as an example of such
disincentive.[6]
However, the
level of protection that an LLP affords partners of a LLP is an important
factor in why LLP is fast becoming the preferred structure for major
professional services firms.
