limited liability partnerships - vinod...

Emerging trends in Company law by

Vinod Kothari 1

Limited Liability Partnerships

Vinod Kothari

1012 Krishna

224 AJC Bose Road

Calcutta 700 017. IndiaPhone 91-33-23233863/23233864/22811276/22817715/22813742

Fax: 91-33-23233863

E-mail:[email protected]; [email protected]

Recent Global trends in Company law by Vinod Kothari 2

Concept paper on LLPs in India

Based on the recommendations of the NC Gupta committee, and the Irani committee, the Govt had come out with a concept paper and a draft of the LLP bill in late 2005.

LLP Bill has been placed before Lok Sabha on 7th Dec 2006

Rajya Sabha on 15th Dec 2006.

The Constitution (entry 44, List 1 of Seventh Schedule) has put “corporations law” in the Union List: As LLPs are to be given an incorporated status,

they will fall under this list.


Concept of LLPs

The word “partnership” in LLPs is a misnomer, as the entity is not merely a collective coming together of two persons: Results into creation of a new entity with its own existence

LLPs are a hybrid between a company and a partnership: Externally, they have all features of a company

Internally, they are run and managed by the members, hence they are like partnerships

The idea is to clothe a partnership with Limited liability

Incorporeal existence and therefore personality of its own

The concept of LLPs has inherent inconsistencies, as it has not had benefit of seasoning over centuries: US law also relates to 1990s – Delaware model is the most

commonly used one.


LLP legislation in other countries

In UK, LLP law was passed in 2000

The campaign for LLPs was initiated by accounting firms (PwC and E&Y) to limit their liability: Though UK Companies Act did allow professions to register as companies,

accounting firms were reluctant to publish accounts, be subject to inspections etc

The argument was first rejected by the Law Commission

The accounting firms used their power to have this law passed in Jersey in the midst of political uproar: In view of the agreements between Jersey and UK, the accounting firms

could still do business in UK

This forced the DTI to put the LLP bill on the agenda in 1996

After a series of consultations, the Bill was passed in 2000; with tax clarity, the structure got into offing in April 2001

The UK move set the ball rolling in other countries too: Canada (Ontario) introduced LLP law in 1998

Singapore issued consultation paper in 2002, enacted the law in 2005

In UK, the LLP model is available for all businesses; in New York, it is open only for selected professions.


What happened after the LLP law

In UK, accounting firms were quick to capitalise on the new law: Major accounting firms (KPMG, PWC, E&Y)

registered themselves as LLPs

Of the top 50 law firms, 14 already registered as LLPs, and 24 more have plans to convert [Legal Week, 25th Aug 2005]

Advantages of LLPs: Very cheap to incorporate

Lot of flexibility, very little accountability

All benefits of a partnership business, though with a new entity

Taxation as general partnerships


Overview of the UK LLP law

Most obvious feature: the law is very short, very simple: Just 19 sections, no schedules

The law could afford to be simple, as chunk of the corporate law provisions arise from separation of ownership and management

Owners and managers are the same: one member designated as “designated member” May be a founding member or may change

Unlimited business capacity

Principle of agency/principalcy applicable: Every member is an agent of the LLP

Limited liability must always come with protected capital: The law provides for capital of each partner, but does not restrict

drawing

Capital or liability not mentioned in incorporation documents


Overview of the Singapore model

Singapore LLP Act of 2005 has 61 sections and 5 schedules, fifth schedule being elaborate with provisions on winding up

Provides for transferable partners’ interest, eligibility to convert a partnership and private company into an LLP

Requires manager

Requires declaration of solvency Makes debt owed to partners to be subordinated to the claim

of the outsiders

Surprisingly, however, a loan made by a partner is not so subordinated

Provides for disqualification of persons who have managed insolvency partnerships


Salient features of the LLP Bill - Constitution

Indian law seems based on the Singapore law

LLP is a body corporate, separate entity, perpetual succession: To ensure perpetuality, transferability of membership is a must

Members constituting it are members: Individuals and corporates may be members:

Since body corporate will include an LLP, an LLP may also be a member

At least 2, maximum unlimited

Existing firms and Companies may convert themselves in LLPs – Schedule 2 and 3 provide for the same: Eligibility in case of a company – no security interest on the assets

of the company

No such eligibility condition in case of firms


Management of LLPs

Singapore law requires a manager: Manager to be an individual

Indian law requires at least two designated partners Who are individuals

The position of designated partners seems to be the same as in case of directors

The designated partner is the scapegoat: Answerable for all acts matter or things, done or to be done by the

LLP, and shall be personally liable for all penalties on the LLP The LLP is liable for only the contravention of this section (appointment

of a manager)

This section is ridiculous: by not appointing a designated partner, the only implication is the

penalty of this section,

appointing one, the designated has all implications of all laws

UK law talks of designated member; if no member is designated, then every member is a designated member


Preservation of capitalOne of the most important pillars of the limited liability is definite capital: Capital is the foundation on which the assets are built

The LLP law, limiting liability, leaves the issue of preservation of capital very vague: Capital is not mentioned in the Incorporation document; hence not a public

knowledge

Capital of partners may be drawn

Sec 26 leaves the issue of contribution on winding up completely open to be provided in the partnership agreement – which is not a public document

Sec 19 (4) provides the liability of the partnership to be met solely from the property of the partnership:

Obviously, property means, net property, that is, net worth, which is the capital

If there is no capital maintenance clause, the whole concept may be totally flawed

The basis of contracting external liabilities is only a declaration of solvency: Which does not serve the purpose of credit enhancement, as solvency is

only as on the date on which it is made

In absence of capital maintenance, LLP might be NLP – no liability partnership


Preservation of capital or capital insurance

UK law requires partners to contribute to the extent of drawings made within 2 years prior to winding up

Insolvency rules in India are applicable to only individuals

LLPs may be subject to corporate bankruptcy rules:

Undue preference rules may require returning of drawings made 1 year before winding up [sec 531A]


Partners and their relationship

Initial partners are subscribers to organic document

Any one can be partner in accordance with agreement: Individuals and bodies corporate may be partners

Designated partners must at least be two individuals

In case of bodies corporate as partners, at least two individuals to be designated

Insistence comes from the need for individuals to be directors

Partnership interest is not a transferable security but requires agreement with all partners

Mutual rights of partners are allowed to be governed by the partnership deed

Cessation: Death, etc

Mutual agreement

Resignaion by 30 days’ notice

A retiring partner shall be entitled to receive the credit of his capital and share of accumulated profit determined to the date of his cessation: The law should provide – subject to mutual agreement

Changes in partners to be notified to the registrar


Partnership principle

Every partner to be agent of the LLP, not of other partners

Partnership interest interestingly split into: Economic interest

Non economic interest

Economic interest defined in sec. 2 (8) means right to share in profits

Economic interest assignable, but assignee is not treated as a partner, nor gets any right of participation in management: Creates interesting situation:

Partner may be X, assignee of economic interest may be Y

X incurs liabilities, Y has all economic interest, but no obligation, as does not have any partner status

Companies Act, on the contrary, recognises no trusts or equities on the shares


Transferability of partners’ interest

Seems the share of the partner in the

capital of the firm, and share in profits,

are two separate interests

Share in profits a transferable interest:

sec 41

This has clearly followed the Singapore

model


Accounting and reporting

LLPs are required to maintain records,

but not:

Hold meetings and lay accounts

File accounts

Publish accounts

They only make an annual declaration

of solvency

Liability for the declaration is on the

manager


Taxation

In line with UK law, Bill for provides for

taxation of income as in case of general

purpose partnerships


Inspection and investigation

Provisions analogous to sec. 234 and

235/ 237 of Companies Act

Prosecution powers of the Central Govt


Winding up

Winding up may be either voluntary or

mandatory:

Regulations to be provided

Notably, Singapore has a huge set of

rules applicable to winding up of LLPs,

almost on line of Companies Act


Applicability of Companies Act

UK has extended a large chunk of

Companies Act provisions to LLPs too:

Power contained in sec. 57 to extend

Companies Act provisions:

Very likely that several of the administrative

provisions may, over time, be extended


Penalties and prosecution

The power to impose penalties has

been granted to the Tribunal


Comparing LLPs and private companies-

similarities

LLPs Small companies

Incorporated

personality

Yes Yes

Perpetual existence,

winding up by law

Yes Yes

Plurality of owners yes Yes

Limitation of

contributory

liability

Yes Yes

Limits on trading

powers

None None – professional

companies are

normally not

allowed


LLPs and small companies -differences

LLPs Small companies

Segregation of management

and ownership

Indian law requires

designated partners; UK

law does not.

Designated partners

generally liable for all

compliances

Law does not lay down

powers of designated

partners

Directors are different from

shareholders; different

powers are vested

Agency principle Partners represent the LLP Shareholders are distinct

Transferability Partnership is transferable

only by agreement

Shares are transferable

securities

Fixity of capital LLPs need not have fixed

capital

Limited liability companies

need to have fixed

capital

Reporting, audit, meetings No requirements Elaborate requirements


Separation of management and ownership

One of the key features of LLPs is that there is no separation of ownership and management: Hence, the foundations of corporate law, with the owners

reposing trust in the management do not apply

Much of the reporting and accountability structure of corporate law arises out of this separation

UK LLP law does not provide for separation of management: In fact, there is a “designated member” who will be

answerable to the regulators

The concept paper in India goes the Singapore way in separating management and ownership


Administrative authorities

Incorporation, striking of defunct LLPs: Registrar of Companies

Registry record keeping, inspections, etc Registrar of companies

Compromise, arrangement, etc Central Government

Rule making powers; powers to notify Companies Act to be applicable

Winding up Tribunal

Prosecution for offences: Lower courts


Compliances required by LLPs

PIN nos for designated partners

Particulars of designated partners are filed

Incorporation – by filing incorporation document with the RoC

Reservation of name, change of name, etc – provisions similar to companies

Partnership agreement and changes therein to be filed with the RoC: Surprisingly, the partnership deed is not one of the documents available for

inspection u/s 35

While the basic rights of the partners are defined in the document

Registration of changes in partnership (names of partners)

Filing of annual accounts and declaration of solvency

Audit of accounts

Filing of annual return

Powers of the registrar to call for information, inspection and investigation largely the same as in case of companies

Compromise, arrangements etc as per rules to be made by Central govt


What may the LLP hold

LLPs may hold any property, tangible or intangible

Interestingly, partners may transfer, either as contribution or otherwise, properties in kind also

Unlike in case of companies, no fetters on transfer of property in kind or a separate disclosure:

Valuation of the property not given the seriousness it deserves


Liberties that the LLP enjoys

Accounting: May write books on either cash or accrual basis

Might mean a considerable tax advantage

Clearly conflicts with the audit requirements – cash basis cannot reflect true and fair value of the state of affairs

Accounting standards not applicable

Limitation of liability: Best of both the worlds – limited liability and flexible capital

No minimum capital requirements

Audit: While auditing is mandatory, there is no substantive detailing in the law

Perhaps the rules may be much more liberal than for companies

Borrowings: No restriction on borrowing from partners, or to partners

Sec 62 puts amounts owned to partners at par with amounts onwed to others

Surprising provision – Singapore law subordinates claims of partners

No need to create charges Apparently, not something that lenders will like


Ultra vires, agency rule and LLPs

The doctrine of ultra vires apparently is not applicable to LLPs Since the objects are not required to be specified in the

incorporation document

At the same time, the partners are supposed to be agent of the LLP Partner exceeding his authority does not bind the LLP

In other words, the LLP escapes liability for anything done in excess of the assigned authority

Authority of LLPs contained in partnership document

Those dealing with the LLP cannot get partnership document as it is not one of the docs that may be inspected

This leaves those dealing with the LLP at a great risk


Conversion into LLPs

Firms, private companies and unlisted public companies may convert

Firms: All partners to continue

Amount to dissolution of the firm

Transfer of property by way of vestation – may be stamp duty may be escaped

Private companies: There is no security interest on the property

All members of the private company continued as partners

There is no need to seek sanction of the lenders, etc

Public unlisted companies: Same as in case of private companies

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