Modelling gel

The designation ‘LLP’ (limited-liability partnership) has become the new fashion accessory for the trendsetting professional firm, both in the UK and further afield. Barely a day goes by without the announcement of the conversion of yet another law firm or accountancy practice to LLP status.

Although they are forbidden in some jurisdictions (Japan requires lawyers to practise via unincorporated associations), the use of the LLP as management vehicle for professional firms can be found in the US and Canada. In Singapore consultations that would make that destination a more than favourable home for the professional LLP in South East Asia are well underway. An extensive study was also conducted in 2004 by a working party of the Law Society of Hong Kong into the feasibility of allowing solicitors to practise as LLPs, although a decision has not yet been announced.

What these examples illustrate, however, is that it is not just individual firms that wrestle with the pros and cons of conversion to LLP status. Such problems also beset a number of legal regulators as they try to decide which model of LLP should be utilised.

Despite using the same letters, all LLPs are not the same; they all have different legislative make-up. The dominant US and Canadian models are derived from the Partnership Act 1890. The UK LLP is the progeny of the Companies Act (1985) and at present provides the only corporate LLP model.

Yet even the UK model LLP is a hybrid. Its management skeleton is that of a corporation, but it has no shareholders or directors; essentially it is a partnership housed in a limited-liability bubble.

Limited-liability partnerships
The advantages are well known. The UK LLP is a corporate body with a separate legal identity from its members. As long as it remains registered, it has a continuing existence.

An LLP can enter into contracts in its own name and sue (and be sued) as such; and the liability of each member is limited to the amount of capital they have put into the firm.

The LLP is not taxed itself, rather the members are taxed on their shares of the profit. Finally, the UK LLP is not restricted to professional firms, as in some jurisdictions.

So what is not to like? Well, according to some, there are a number of problems endemic to the UK LLP model: increased financial disclosure, conversion, tax status and a potential gap in the liability shield. But are such concerns credible?

Financial disclosure
This may be something of a nine-day wonder. Although accounts must be filed at Companies House, some smaller firms may be able to take advantage of an exemption that allows for an abbreviated form of financial disclosure if the firm is able to satisfy certain criteria regarding turnover, size and assets. Even the larger LLPs do not have to disclose details of the most sensitive of issues – namely, individual partner drawings.

Problems on conversion
There is no doubt that conversion is costly both in terms of management time and additional fees. However, the Law Society’s new Code of Conduct is set to come into force over the next few months, and the structures, accounting hygiene and reporting practices of the UK LLP model may assist firms to comply with the evidence-based regime required by the Code of Conduct’s Rule 5 on business management.

Although only an issue for global law firms, the potential for any transfer to be treated as taxable outside the UK has led many LLPs to leave a number of foreign offices outside the LLP party. It is for this reason that a number of US and Canadian law firms have opted for the partnership LLP.

However, even here some efforts are being made abroad to be more accommodating to the UK LLP, most notably in Australia, where the government announced just before Christmas 2006 that it would bring in regulations to ensure that LLPs fell within the Australian ‘foreign hybrid laws’ exemption. This exemption, enacted in 2004, is supposed to ensure that the Australian treasury does not tax a foreign hybrid entity as a corporation when in its home jurisdiction it is treated as a partnership.

As UK LLPs must actually become a corporation, in contrast to their Canadian and US cousins, the hybrid law exemption did not apply, although this was purely unintentional, and UK LLPs were still treated as companies in Australia. This anomaly looks set to be rectified very soon.

Liability shield
Members of a UK LLP are protected from personal contractual liability, but they can potentially still fall victim to personal liability in tort. The decision of the House of Lords in Williams v Natural Health Foods (1998), as well as the in Hong Kong in Yazhou Travel v Bateman Starr (2004) have stalked firms like Banquo’s ghost. However, the risk that a member, acting as the agent for the LLP, may drift into the assumption of an additional personal duty of care to the client of the type in Yazhou can be at least reduced by use of contractual exclusion clauses and procedures to ensure that all advice is given as an agent for the LLP, not in a personal capacity.

The mind games that could be played with a solicitor subject to a professional negligence claim have abated with the advent of LLP status. Although there may be tactical advantage to be gained in adding a named member, such a strategy may backfire if its aim is merely to harass a member to no real monetary effect.

The advantage of the UK LLP model is that it provides almost a complete liability shield, subject to the limited exceptions discussed above. This can be contrasted the limited protection offered by the Ontario LLP model, which only shields the partners from liability for claims arising from the negligence of other partners. However, in October 2006 the government services minister in Ontario introduced an amendment to the Partnerships Act, extending the liability shield to encompass debts and other liabilities. Although a partner would still be liable for their own negligent act or omission, that of any person under their direct supervision, or where the partner knew or ought to have known of the act or omission and did not take steps that a reasonable person would have taken to prevent it, it is nevertheless a step closer to the UK LLP.

Despite the fact that many law firms have taken the LLP plunge in the UK, the sky has not fallen in on partnership culture; bespoke members’ agreements seem to be sufficiently flexible. Furthermore, the greater management and fiscal ‘hygiene’ inherent in the UK LLP structure should assist firms as they gear up to comply with Rule 5 of the Code of Conduct.

Indeed, most LLP practices may already be fully compliant as a consequence of conversion. While the residual problems, especially those relating to the taxation of UK LLPs abroad, must not be underestimated, the Australian government’s attitude may presage a new, more pragmatic approach elsewhere. Finally, it is instructive that Ontario, the high watermark of the partnership LLP, has at least nodded in the direction of a greater liability shield for the UK corporate LLP. Perhaps one day all LLPs may be made this way.
Jane Jarman is a senior lecturer in law at Nottingham Law School