Follow the leader

In May 2003 Eversheds became the largest international law firm so far to trade as a UK limited-liability partnership (LLP). One year on and other big players are starting to follow suit, but uptake is slow and there are many issues still surrounding conversion.

Firms mainly convert to gain limited liability. This protects individuals from catastrophe claims and can mitigate the consequences of an Arthur Andersen-type disaster. Increasingly, however, firms are feeling the pressure to become LLPs simply because everyone else is. Anyone who does not convert will face recruitment problems, as other firms will seem more attractive. This is already an issue for accountants and will be for legal practices as more firms move over.

There are, though, a number of practical issues to be considered before a firm can take the plunge.

A conversion involves a transfer of the firm’s assets to the LLP and requires a lot of planning. Some assets, typically leases and software licences, can only be transferred with the consent of the other party, but it may refuse consent or be operating on a different timescale.

Contracts with clients also need to be transferred. Most contracts allow a party to transfer the right to be paid, but few allow the transfer of the obligations. If a firm transfers the obligation to perform services to the LLP, it will probably be in breach of all its client contracts. It is not practicable to seek consents for each contract and the usual approach is to send out mailshots and hope nobody objects. However, it may be sensible to speak to major clients first.

It is worth noting that conversion is more complicated for some practice areas than others. For example, lawyers advising pension trustees have to be appointed formally, so new appointments will be needed. If a client’s will appoints the partners of a firm as executors and the firm becomes an LLP, the appointment is likely to be invalid and codicils may be needed.

New partnership (or rather membership) agreements will be needed. These can be based on the existing agreement, but some changes will be required and the timescale must allow for discussion.

The main issue is likely to be indemnities. Most partnership agreements require an incoming partner to share in the firm’s historic liabilities and give retiring partners and salaried partners an indemnity. Although partners will hopefully not be liable for future debts of the LLP, they will remain liable for claims against the old
firm and leases may be in the name of an individual partner or be subject to partner guarantees that are still running.

If new partners have to accept liability for these matters, they will not be completely safe. This could be a disincentive to join, but if new partners do not accept liability, the other partners may not want to release retiring partners. A retiring partner may, therefore, be in a worse position.

Furthermore, it is not yet clear whether individual members will be personally liable for their own negligence, or whether the courts will only allow claimants to pursue the LLP. The partners’ positions can be improved by changing the firm’s terms of business to excuse partners from liability, and it is important that firms do not forget to issue the terms in the first place.

If a partner is individually liable, the partners may not want to rescue them, as they may then lose the benefit of limited liability – but the lack of a rescue obligation may undermine the partnership ethos. Therefore, firms might want to consider a limited bail-out commitment or buying extra insurance, to be held by a trust for partners or their dependents. This might provide cover for a partner’s assets so that a partner’s spouse can buy the marital assets back from a trustee. An insurance product is coming on to the market to cater for this.

However, the main reasons why most of the largest UK firms have not yet converted are financial. For a UK-based LLP, tax ought to be neutral, but tax can be a major problem for those with interests overseas, as different countries treat LLPs in different ways. There may be ways around this, so firms should seek advice.

In addition, an LLP’s accounts must be published, with a resulting loss of confidentiality, and must comply with accounting standards for companies. Partners can share profits using different accounting policies to those in their filed accounts, but this can be confusing and most firms will want to avoid this.

Particular problems may arise over annuities and old premises that are sublet at a loss. Most firms are likely to treat these as an expense which they pay as they go along, but accounting standards require an LLP to make a reserve. If, for example, an LLP is paying
an index-linked annuity of £100 and the recipient is expected to live 10 years, it might have to make a provision for £1,000, which could affect its balance sheet and make its published figures look less attractive.

Other things to remember that will require some forward planning for large organisations include registering the LLP with the Law Society before the conversion and notifying Companies House of any changes afterwards. It will also be necessary to amend insurance policies and transfer bank accounts. These things take longer than you think.

While these points can be problematic, careful planning should make the transition to LLP status fairly straightforward. Eversheds’ change has worked well and, as more firms follow suit, LLP status will become easier to adopt and more distinctly defined under the law.
The many benefits of the LLP will see the legal industry heading in the same direction as accountancy.

Bruce Gripton is a commercial partner in the London office of Eversheds and acted for the firm on its conversion to an LLP