LLPs: are they meaningless for international law firms?

As Mayer Brown Rowe & Maw (MBRM) prepares to become the largest law firm to convert to a UK limited-liability partnership (LLP) (The Lawyer, 19 August) serious questions are being raised over the levels of protection the structure will actually provide.
In theory, the purpose of an LLP is to offer protection to partners, to limit their potential exposure to liability – no surprises there. How-ever, many commentators believe that partners in LLPs practising in jurisdictions outside that of their LLP may not be covered. For example, UK firms in a US LLP, such as Clifford Chance, may not be protected at all by the partnership.
Clifford Chance declined to comment on the issue, but a section of the original Clifford Chance Rogers & Wells merger document seen by The Lawyer is revealing: “It remains uncertain whether an English court would accept the limitation on liability should a claim be brought against partners in England.”
It continues: “Clifford Chance has reviewed this area with leading counsel, who confirm that the law is uncertain, and that accordingly partners should not necessarily rely on a New York LLP to provide limitation of liability should a claimant seek to challenge it in an English court, especially where the right of action arises in England.”
However, if the UK partnership had not formed an LLP at the time of its merger with Rogers & Wells, the limited liability of the New York partnership risked being compromised. In effect, offices outside the US became part of the LLP, not to protect themselves, but rather to protect the partners in the US.
“I don't really know to what extent I'm covered,” says an equity partner in a US firm, which is currently a US LLP. His firm, he adds, is currently looking at the option of also becoming a UK LLP.
“Someone may well be a partner in the US LLP, but this may not give protection against a claim brought in the UK for work done in the UK. I know that a number of firms are concerned about the extent to which an LLP would give cover,” says Nigel Davey, head of the professional partnerships tax group at Deloitte & Touche.
The difficulty arises in part because there is no case law as guidance on the issue, although this in itself could deter a possible claimant from bringing a claim. Indeed, there have been few real tests in the US either.
“There have been a few cases, but nothing that's tested the limits [of an LLP for law firms],” says Larry Ribstein, a professor of law at the University of Illinois College of Law and an expert on US partnerships.
“Say a New York LLP has lawyers practising in Chicago, then he's subject to court rules in Illinois [which currently does not allow LLPs for law firms],” he continues. “If a client sued the lawyer, there's a good chance that the Illinois law applies.” Consequently, the liability of the partners would not be limited.
It could be the Enron scandal, which has seen numerous partnerships suddenly look to the LLP model, that could be the first to test the strength of these partnerships. Civil litigation against Enron includes two law firms as co-defendants: Houston-based Vinson & Elkins, organised as a Texas-based LLP, and Chicago-based Kirkland & Ellis, which because of Illinois rules remains as a general partnership. However, as yet allegations are not proved, and it may well be that the cases reach a settlement out of court.
One option for global firms is to become both an LLP in the US and the UK. In such a situation there would be two partnerships, and the firm would have an informal arrangement in regard to pooling its profits. Partners with the UK LLP would then draw profits from the UK earnings, with US partners taking their share from the US earnings. If, however, there is a discrepancy between the two, tax issues arise because partners in one partnership will be drawing their profits from another partnership.
Withers provides a good example of how this works. The firm has a UK LLP, which covers the UK and Milan offices, a Delaware LLP for the US office and a third Delaware LLP which covers the entire partnership. In effect the third partnership acts almost like a holding company, with the two smaller LLPs as subsidiaries. Any extra profits that have not been budgeted for are put into the 'international' LLP, and are then shared out among all the partners of the firm and taxed at source.
But for firms with a larger presence in Continental Europe, difficulties arise on the tax front. As the Clifford Chance document so rightly puts it: “An English LLP is a very unattractive vehicle for a partnership with international operations and non-UK partners.”
In the UK, the incorporation into an LLP is much more complex than it is in the US. The difficulties arise because the structure of a UK LLP is largely based on a corporate entity rather than a partnership.
“In the UK, becoming an LLP is more like transferring the partnership to a company. The law is based on company law,” says Davey at Deloittes. “It would have been better if they'd started from partnership law and added on the limited liability bit. But they didn't do that, so to transfer a partnership to a company is quite a complex process.”
Although this will benefit firms for National Insurance and tax reasons, it is less beneficial to partners in European offices. Currently, partners in Germany, for example, would pay tax at a German rate on a very small percentage of their overall profit share, and most of their profit share would be taxed at the UK rate, which is significantly lower. However, if a firm became a UK LLP, partners in a number of the European offices would be taxed at their local rate, which is often higher than that of the UK.
MBRM for example, which is fully committed to being a UK LLP, has not yet decided on what to do with its European offices. One possibility the firm is looking at is making these firms part of the US LLP, if and when Illinois regulations allow one. “The long-term goal is that we'll end up with a US and a UK LLP,” says Richard Linsell, the firm's partnership expert.
Firms are also seeking dispensation from the European authorities involved. “We've gone to various tax authorities to seek clearance and that's part of what the finance department is working on,” says John Rink, managing partner at Allen & Overy. “We're working with tax authorities to see if a tax treatment can be agreed which does not have adverse tax consequences.” However, until this can be solved, the firm will not proceed with the incorporation.
Linklaters and Freshfields Bruckhaus Deringer, among others, are in a similar situation. Slaughter and May, while having looked at the issue, is one of the few firms not actively pursuing it.
For German partners at Clifford Chance the issue is less thorny, because they are part of a US partnership. Unlike UK LLPs, Germany recognises a US LLP as transparent, so partners are taxed in the same way they would be if they were part of a general partnership. However, the same is not true of other Continental jurisdictions such as France and the Netherlands.
Easiest, perhaps, is an LLP for a firm that is based in the UK alone. Richard Kemp of Kemp Little (then Kemp & Co) led the way in July last year. But he is the first to admit that his was perhaps the easiest type of conversion. “We were converting from being a sole practitioner to a partnership, so there wasn't an original partnership deed in the first place,” he explains.
Even so, the conversion still cost approximately £50,000 and took around a month to complete. The cost for a magic circle firm would certainly be large. But despite all this, LLP status is still firmly on the agenda at many firms. “I'd be surprised if there was any firm that wasn't considering it,” says Virginia Glastonbury, managing partner at Denton Wilde Sapte.
But the final conversion for such firms may be some time off, because the LLP issue is, at the moment anyway, something of a Pandora's box.