UK: Welcome News For LLPs

Last Updated: 2 September 2015
Article by Richard Isham

Under the terms of an LLP Agreement, each individual member will usually have a profit share. Some members (e.g. founders) will have a significantly higher profit share than others and will also have a share in the capital of the LLP (ie: over and above the amount of their own capital contribution). Individual members will also be subject to certain notice provisions, garden leave obligations during notice and restrictive covenants that govern what they can do once they cease to be a member (e.g. non-compete, non-solicitation of and non-dealing with clients of the LLP).

Up until now, disgruntled members who claimed that the LLP (and sometimes other members) had committed a repudiatory breach of the LLP Agreement have asserted that the breach discharges the member and the LLP from any further performance of the contract (ie: the LLP Agreement). In accordance with the doctrine of repudiatory breach, rights that have already accrued continue unaffected. However, and here is the mischief from an LLP's perspective, the discharge from further performance under the LLP Agreement extends to: notice provisions (the disgruntled member can walk away immediately), the post termination restrictive covenants (the disgruntled member is not bound by them, so is free to compete with, solicit and act for the LLP's clients) andallows the disgruntled member to rely on Regulation 7 of the default provisions in the LLP Regulations (LLPR) to gain a (very) substantially increased share in both the capital and profits of the LLP – the argument being that a repudiatory breach of the LLP Agreement means that that agreement falls away so there is "no agreement" for the purposes of the LLP Act 2000 (LLPA).  In those circumstances, the default provisions in Regulation 7 of the LLPR apply to give that member an equal share in the capital and profits of the LLP.  Allowing repudiatory breach to operate in this way can result in a minority member who, for example, may, under the LLP Agreement, only have an entitlement to 1% of the profits of the LLP and no entitlement to the capital, suddenly sharing equally with, say, 10 other members in both the capital and profits. Such a minority member would get a huge windfall – an extra 9% of the profits plus 10% of the capital. Such a scenario makes the use of LLPs potentially very unattractive and could result in businesses deciding not to operate in England.

Flanagan v Liontrust Investment Partners LLP and Others [2015] EWHC 2171 (Ch) cures the mischief.

Facts

Mr Flanagan was a member of Liontrust, an LLP that ran a hedge fund.  Under the terms of the LLP Agreement,  he was entitled to a fixed "profit share" of £125,000 per annum, plus a variable share, the amount of which depended on his own performance and the contribution of his team.  He had no entitlement to any interest in the capital of Liontrust, beyond the return of his own capital contribution. The default provisions in Regulations 7 and 8 LLPR were expressly excluded.

In addition, under the terms of a side letter, Mr Flanagan was entitled to an initial period of engagement by Liontrust of 24 months. He had a six months' notice period but that could not expire prior to the end of the 24 months, which meant that the earliest notice could be served was after 18 months service with Liontrust.  Liontrust served Mr Flanagan with notice to terminate his membership before this time. The notice also purported to remove him from the Management Committee and place him on garden leave (thus depriving him of his ability to earn any additional profit share over and above his fixed share of £125,000). 

After careful analysis of the law and the facts, the Judge concluded that Liontrust were in repudiatory breach of the LLP Agreement. Liontrust had, by the terms of and the words used in its letter serving notice on Mr Flanagan, renounced its intention to perform its obligations that it owed to Mr Flanagan. The Judge also found that Liontrust had, by purporting to exclude Mr Flanagan from the Management Committee, acted in such a way as to deprive Mr Flanagan of "substantially the whole benefit which he was objectively intended to obtain under the LLP Agreement" and so the notice also amounted to a repudiatory breach that went to the root of the contract (i.e. the LLP Agreement).

The £8 million Question – is the common law doctrine of repudiatory breach ("the doctrine") excluded in relation to LLPs?

Having found Liontrust to be in repudiatory breach, the Judge went on to consider whether the doctrine is excluded, as Liontrust submitted, because of the LLPA and the fact that LLPs are creatures of statute. If the doctrine was not excluded, Mr Flanagan stood to make £8 million, being his valuation of his equal share in the profits and capital of the Liontrust LLP.

The Judge started with an analysis of Hurst v Bryk, which held that the doctrine could not be used to bring about the dissolution of an ordinary (Partnership Act 1890) partnership. The court reached this conclusion mainly because of Section 35(d) of the Partnership Act 1890 which gives the Court discretionary, not mandatory, powers to order the dissolution of a partnership under the Act. This discretion would be rendered otiose if a partner could accept a repudiatory breach and, by doing so, invoke the doctrine to bring about the dissolution of the partnership.

Even though there is no equivalent to s35(d) in the LLP Act, the Judge in Flanagan agreed with the court's analysis in Hurst that, if the doctrine could apply to partnerships (and hence to LLPs), you could get "three camps" within a multiparty partnership:

  1. those partners who are guilty of repudiatory conduct;
  2. those innocent partners who have accepted the breach; and
  3. those partners who have not.

In the context of an LLP, if the doctrine applied, then:

  1. the LLP would be in repudiatory breach of the  LLPA Agreement (the Liontrust LLP Agreement) and Mr Flanagan, by accepting the breach, would have his relationship with the LLP governed by the default rules and Regulation 7 LLPR above;
  2. the relationship between the LLP and the other members would continue in accordance with the terms of the Liontrust LLP Agreement; and
  3. Mr Flanagan's relationship with the other members of the Liontrust LLP Agreement (but not the LLP itself) would be governed by that agreement.

Furthermore, the judge observed that matters could become more complicated if the other members, or at least some of them, had participated in, or had adopted the breach by the LLP and, if their breaches were accepted by Mr Flanagan, then his relations with those "guilty members" would be governed by the default provisions as well.  You would then have a situation in which, as between the members of the LLP, Mr Flanagan would have different and contradictory relations with the other members – some governed by the LLP Agreement and some governed by the default provisions.

In the Judge's view, such a situation was untenable, against what Parliament could have intended and so self-evidently "the co-existence of two different contractual regimes governing the same LLP is likely to lead to results which are legally incoherent and could only be resolved by further agreement between all the members".  In his view, the statutory scheme for LLPs, as set out in the LLP Act, should and could be construed to avoid this "incoherence".  Accordingly, he concluded that the doctrine of repudiatory breach is implicitly excluded from the statutory scheme governing LLPs, namely the Limited Liability Partnership Act 2000, at least where there are more than two members of the LLP.   Indeed, the Judge went on to say that he was fortified in reaching his conclusion by a number of further considerations, including the fact that "it would in my judgment be offensive to commence sense, and contrary to the reasonable commercial expectations of the parties, if the effect of the doctrine were to permit Mr Flanagan to share in the profits of the LLP on a basis of notional equality with the other members, when the LLP Agreement itself gave him only a fixed allocation of income profits and no entitlement to any capital profits...the appropriate remedy for a member in Mr Flanagan's position is a declaration as to his continuing membership of the LLP and a right to damages, if he can establish that he has suffered any loss as a result of his exclusion [from the management of the LLP]".

Comment

This is the first case that has considered the application of the doctrine of repudiatory breach of contract in the context of a multiparty LLP Agreement; the decision contradicts a number of leading text books that had argued that a repudiatory breach could bring an LLP Agreement to an end.

The decision does prevent outgoing members from obtaining an unintended and unfair financial windfall (by relying on the default provisions to argue an entitlement to share income and capital profits equally) and also avoids the impractical situation arising whereby the relationship between the members themselves and between the members and the LLP is governed by two different contractual regimes – one, being the terms of the LLP Agreement itself and the other, being the default provisions set out in Regulations 7 and 8 LLPR.

The decision and clarification of the law is to be welcomed by multiparty LLPs which go to the trouble and expense of drafting comprehensive LLP Agreements that specifically exclude the default provisions as it is now clear that, in relation to an outgoing member, his or her entitlements will be governed by the LLP Agreement that they originally signed up to, rather than having that agreement displaced by the default provisions.  A victory for common sense – and for the continued attraction for businesses to use the flexible LLP structure.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.