Members only

There are important liability issues for partners to consider before their firms convert to LLP status. By Peter Garry and Peter Ashford

More and more professional partnerships are converting to limited liability partnership (LLP) status, but the members of an LLP continue to face personal liability in a number of different ways, some of which are not widely understood.

One of the oft-quoted reasons for not converting to LLP status is that the ‘partnership ethos’ will be lost. Members may not be so willing to lend a hand for fear of being sued personally in the event of a catastrophic claim.

The duty of good faith between partners is the cornerstone of all partnerships and their ethos. Members of LLPs owe duties to the LLP as agents. Members of LLPs also owe the LLP certain duties equivalent to elements of the duty of good faith applicable in partnerships, for example not to compete – although this is capable of being excluded. Furthermore, members owe a duty to other members – again, this is capable of exclusion – to render true accounts and full information. Courts have jurisdiction to wind up the LLP on just and equitable grounds, and jurisdiction to grant remedies arising out of unfair prejudice. Again, this is capable of being excluded, and often is. This dual jurisdiction in effect gives rise to concomitant duties as between members. There is, however, no default general duty of good faith as between members.

Intending LLP members may wish to preserve part of the partnership ethos by incorporating into their LLP agreement an express general duty of good faith, as between members. But however laudable the intention, this may defeat LLP protection. A negligent member sued alongside the LLP might seek contribution from their co-members based on an alleged breach of that duty of good faith.

Implied and/or oral terms of the LLP agreement

There is no requirement for an LLP agreement to be in writing, no bar on implied terms, and no bar on oral or implied variation. The ordinary rules of contract apply. A member faced with personal liability may be consoled by other members with words such as: “We’ll make sure you keep a roof over your head.” Indeed, on the formation of the LLP, members may have had an unwritten understanding that they would, for example, “make sure no one gets cleaned out”. Evidence of such discussions or understandings may be adduced in the course of claims brought by one member, or their trustee in bankruptcy, against one or more others, seeking indemnity or contribution.

Entire agreement clauses and provisions limiting the manner in which variations can be effected are accordingly very important.

Negligently not preventing negligence

An LLP might take on work that it cannot handle properly and such matters may not always be within the control of individual members who carry out the work. Another possibility is that members might put in place or preside over working practices or guidelines that they ought to know are deficient. Such members could find themselves liable to contribute to a claim when matters not being conducted by them personally go wrong. It does not appear likely that such members could be sued successfully by the client, see Williams v Natural Health Foods (1998). Nonetheless, members with personal liability may allege against other members breaches of implied or express oral terms or variations of the LLP agreement.

The existence and breaches of duties to the LLP or to other members may well be easier to establish than the existence and breaches of duties to clients, opening up the possibility of members being liable to the LLP or to co-members even though they are not liable personally to a client in respect of the same act or omission.

Personal liability insurance

There is now at least one insurance product designed to enable named beneficiaries to acquire a member’s home or other assets in the event that a member becomes personally liable in relation to a claim in excess of the LLP’s cover and net assets. Putting in place such insurance may reduce the propensity of members to seek remedies against their co-members.

Fraud by members – the consequences for innocent members

In a partnership, the innocent partners will be liable for fraudulent acts or omissions by co-partners that are “in the ordinary course of the business of the firm” (Limited Liability Partnerships Act 2000 Section 6(4)). This phrase was given considerable width in Dubai Aluminium Co Ltd v Salaam (2002), so that it included drafting legal documents with knowledge that they would be used as part of a fraudulent transaction.

An LLP will be liable for wrongs comm-itted by a member “as a result of a wrongful act or omission of his in the course of the business of the [LLP]” (Partnership Act Section 10). One assumes the same width would be given to those words if similar facts to those in Dubai Aluminium came to the court in the context of an LLP. Innocent members, though, will not be personally liable.

Depredations against office accounts

That said, if the LLP suffers a calamity it may have to pay out money that otherwise would have been paid out to members. It is small consolation not to be personally liable if the LLP loses to a claim what would otherwise have been a year’s profit for the members.

In most circumstances, LLPs will be insured in respect of a claim, even where a member has acted fraudulently – although clearly the fraudulent member will not benefit from the cover. Most professional practices are scrupulous to ensure that cover is adequate and claims are duly notified.

Despite such precautions, there are circumstances in which insurance cover will not respond to a claim. For example, members stealing from a client account may find it easier to transfer the money first to the office account, perhaps by raising a bogus bill, before then transferring the money out of the office account, which may not have such rigorous safeguards applied to it.

The fraudulent routing of money via office accounts normally results in there being no professional indemnity cover for the loss of the money. Insurers will normally assert that there is no loss to the insured when money is transferred to an office account, as the LLP still has the money, albeit in the wrong account. When the money is then transferred out of the office account it creates a claim by the LLP against the member, but not a claim by the client – the client’s claim having arisen on the transfer from client account. Thus, the LLP is left uninsured and having to pick up the whole of the claim if it cannot recover it from the fraudulent member.

Peter Garry and Peter Ashford are partners in Cripps Harries Hall’s partnerships group