While LLPs remain the preferred structure for closely held family run businesses, professional services and consulting firms, the jurisprudence around LLP disputes remains uncrystallised. Unlike companies, where the governance and management structure are statutorily legislated, the LLP Act, 2008 (the “LLP Act”) provides for flexibility around LLPs' governance for ease of conducting business.1 Though most issues in an LLP must be contractually determined and agreed, partners often execute LLP agreements without negotiating critical provisions around rights, obligations and governance framework.
In this article, we cover some key considerations that are relevant in the context of a dispute involving an LLP and its partners.
1. Absence of negotiated LLP agreement
Akin to a company's articles of association or shareholders' agreement, the LLP agreement is an LLP's constitutional document. However, LLP agreements are often drafted without adequate thought or consideration on critical items such as - (i) mechanism for admission and removal of partners and designated partners, (ii) management, governance and decision making, and (iii) restrictions on transfer of partner's interests, etc. In our experience, LLP agreements are also often affected by legacy drafting issues or overreliance on the First Schedule of the LLP Act.
In the absence of specific agreement to any matter, contractual rights and obligations of the partners are governed by the provisions of First Schedule of the LLP Act.2 First Schedule provisions are broadly worded and may not be best suited in all scenarios. Some instances are below.
- Partner's expulsion - First Schedule provides that no majority of the partners can expel any partner unless empowered through an express agreement.3 It does not provide the grounds for expulsion (i.e., on default or mala fide actions against the LLP's interest, etc.) nor the mechanism to expel a partner or buy-out partnership interest.
- Management of LLP - In absence of clearly identified responsibilities, every partner may seek the the right to participate in management.4 Such broad enabling language may result in minority partners (for e.g., those with 5% of capital contribution or so) seeking a say in all management decisions. The First Schedule specifies that the LLP's decisions will be passed by a majority resolution with each partner having a single vote.5 In the absence of a well negotiated LLP Agreement, minority partners, having limited interests and capital contribution, can collectively block or even outnumber a partner holding majority ownership interest.
2. Light touch regulations under the LLP Act – lack of definitive statutory provisions.
LLP Act's light-touch regulation remains the biggest gap during disputes. Compared to the Companies Act, 2013 (the “Companies Act”), the LLP Act is limited in what it mandates around an LLP's management and operations. For example, LLP Act does not detail provisions around critical items such as infusion of additional capital, granularities around meetings of partners and designated partners, duties of designated partners, related party transactions, principles around conflict of interest etc.
When the LLP agreement is not well fleshed-out or is not adequately customised to reflect the parties' interests, critical issues may end up being governed under the First Schedule principles or by the broader principles of common law and equity.
3. Designated partners – critical for LLPs operations but limited responsibilities.
LLP's designated partners are viewed similarly as directors in a company. However, unlike in a company where directorial duties (including a director's fiduciary duty) are clearly laid out under the Companies Act6, LLP Act merely requires the designated partners to be responsible for acts necessary for compliance with the LLP Act - such as filing annual returns, statement of account and solvency, etc. Designated partners may not be strictly required to act under fiduciary duties, exercise due and reasonable care, and independent judgement, avoid conflict of interest etc., unless specified in the LLP agreement.
If responsibilities are not clearly demarcated, there may be some practical challenges as well, such as, conflicts in day-to-day operational items between designated partners and the LLP. To avoid such uncertainty, LLPs and its partners must clearly demarcate the roles and responsibilities of each designated partner in the LLP agreement.
4. Meetings of partners and designated partners and recording of minutes – a neglected facet.
Partners' and designated partners' meetings are not mandatory under the LLP Act. That said, the first Schedule does require that the LLP shall ensure that its decisions are recorded in the minutes within 30 days of such decisions and minutes are maintained at its registered office.7 Meeting procedures and protocols (which are mandatory for companies under Companies Act) such as: (i) requirement of notice with explanatory statements, (ii) presence of a quorum, (iii) special resolution requiring approval of three-fourth of members (for critical governance items and structural decisions) etc., are absent in the LLP Act although could be agreed in the LLP agreement. In a contentious scenario, this could play out in a manner where certain partners or designated partners have limited visibility in the LLP's decision making.
First Schedule provides that matters will be decided by a resolution passed by majority of partners, and each partner will have one vote. The First Schedule does not clarify that the voting weightage is not proportional to partner's capital contribution or profit share. Consequently, partners who do not have numerical majority (though having significant majority capital contribution and profit interest) may be potentially side-stepped by partners having numerical majority.
LLP agreement must legislate for the requirement and procedure for partners' and designated partners' meetings and voting rights. Negotiated ‘affirmative voting rights' or ‘reserved matters' (AVM) in the LLP agreement for critical business items are also typical. These AVMs, such as change in LLP's business8, alteration of profit-sharing ratio, winding-up, inclusion of new partners, any transaction beyond ordinary course of business, are matters which cannot be given effect to without consent of all or a higher threshold of partners.
Typically for LLPs, meetings are not formally conducted, and minutes of meetings are not maintained. Parties often end up relying on electronic correspondences (including email correspondences or WhatsApp exchanges) in the absence of documented evidence around LLP's meetings. The absence of minutes is also the reason as to why Parties often struggle to back up their claims before the courts in disputes involving LLPs.
5. Related party transactions.
LLP Act does not regulate related party transactions (RPTs) – unlike the norms governing RPTs in a company.9 Although flexibility could be beneficial in closely held LLPs, RPTs without adequate scrutiny may potentially result in value erosion for the LLP. This risk is particularly heightened where the controlling partners engage in RPTs that are not at arms' length and there is no documentation to record the basis for entering into such RPTs.
Partners may consider documenting provisions around partners' duty to act in good faith and contractual safeguards where any RPT beyond a monetary threshold must be authorized by specified majority of the partners, excluding interested partners, in the LLP agreement.
6. Oppression and mismanagement – limited remedy before the NCLT.
Unlike the Companies Act which protects minority shareholders from oppressive acts and mismanagement by the majority, LLP Act lacks an identical statutory relief. Minority interest holders of an LLP do not have the recourse for relief against oppression and mismanagement or similar protection.10 In the absence of such a statutory remedy, minority interest holders are only entitled to contractual remedies for breach of the LLP agreement, and the limited remedies to approach National Company Law Tribunal (“NCLT”) seeking an investigation, as detailed below. NCLT has made it clear that elements from Section 241 of the Companies Act (application to NCLT for relief in cases of oppression etc.) cannot be imported to LLP Act in exercise of NCLT's inherent powers.11
That said, the LLP Act allows a minimum of one-fifth partners to make an application to the NCLT or directly approach the Central Government to investigate into the affairs of an LLP.12 The application must be supported with evidence to indicate a good reason for requiring investigation. Inspectors appointed by the Central Government are empowered to call for information, inspect books of accounts and conduct inquiries into the LLP's operations.13 However, the effectiveness of such remedy for the minority partners remains untested.
7. Introduction and removal of a partner – challenges
LLP agreement must clearly indicate the parties' intent around induction and removal of a partner. In the absence of an agreement, First Schedule provisions would kick in. Introduction of a new partner would require consent from all existing partners14, and a partner cannot be expelled by any majority of existing partners unless expressly allowed under the LLP agreement.15 This typically results in a tricky situation where – (i) a single partner may block introduction of a new partner, and (ii) bona fide partners will have no contractual remedies to buy-out or even remove a belligerent partner who may have acted in bad faith against the LLP or been involved in mala fide, fraud against the LLP.
Even if the LLP agreement provides for the process of removal of a partner, statutory form filings and intimations with the Registrar of Companies (“ROC”) (sectoral regulator) remain a sticky point. Statutory returns around removal of partners may not necessarily be auto approved / taken on record in a straight through process, and such filings are likely subject to ROC's scrutiny, and requests for information and further documentation. The ROC is mandated to examine every application, e-form or document filed under the LLP Act. The ROC may call for further information if such document or e-form is defective or incomplete in any respect and may also seek the LLP to re-submit forms within a period not exceeding 30 days. In the absence of such information or the LLP's failure to rectify or re-submit documents to the satisfaction of the ROC, the ROC is empowered to reject or mark such statutory filings as “invalid”.16
That said, the ROC's authority remains restricted as constitutional courts have held ROC must act as an administrative authority and its role is ministerial in nature i.e., limited to considering compliance with the LLP Act and LLP Rules, 2009 and nothing beyond. In other words, the ROC cannot adjudicate on the substantive contractual rights and similar disputes between the parties.17
8. Some operational challenges – banking authorizations
Disputes involving LLP also require foresight and preparedness on an operational front. For instance, as a part of their internal policies, banks often require all partners and designated partners to sign the bank onboarding and authorisation documents. If dispute arises between LLP's partners, certain partner may not cooperate in executing the banking transactions and documents, resulting in potential operational challenges in securing loans and financing, maintaining cash flows, etc. LLPs are suggested to have clearly designated signatories for bank transactions and have the necessary pre-consultation with the banks around change in signatories necessitated by disputes and removal of partners / designated partners.
Footnotes
1. Report of the Parliamentary Standing Committee on Finance dated 22 November 2007; The legislative intent of the LLP Act is to provide a framework with minimal dependence on the LLP Act for internal arrangement between the partners
2. Section 23(4) and First Schedule, Limited Liability Partnership Act, 2008
3. Entry 13, First Schedule, Limited Liability Partnership Act, 2008
4. Entry 5, First Schedule, Limited Liability Partnership Act, 2008
5. Entry 8, First Schedule, Limited Liability Partnership Act, 2008
6. Section 166, Companies Act, 2013, which inter alia provides that directors shall (i) act in good faith to promote the objects of the company and in the company's best interests, (ii) exercise duties with due and reasonable care, skill and diligence, and exercise independent judgement, (iii) not involve in conflict of interest, etc
7. Entry 9, Limited Liability Partnership Act, 2008
8. Entry 8, Limited Liability Partnership Act, 2008; requires consent of all partners for carrying out any change in the nature of LLP's business
9. Section 188, Companies Act, 2013
10. Aanchal Mittal v. Ankur Shukla, 2022 SCC OnLine Del 633. The Hon'ble Delhi HC held that the NCLT's jurisdiction under the LLP Act is limited to Section 60, 61, 62 and 63 which deal with: (i) compromise, arrangement or reconstruction of LLPs, and (ii) winding up and dissolution – matters around which jurisdiction has been explicitly conferred upon NCLT
11. Anirudh Kumar v. M/s Hydraulics and Pneumatics India LLP, 2024 SCC OnLine NCLT 3427
12. Section 43, Limited Liability Partnership Act, 2008
13. Provisions of Section 206 and 207 of the Companies Act, 2013 have been made applicable to LLPs under the LLP Act vide MCA Notification dated 11 February 2022 G.S.R 110 (E) in exercise of powers of the Central Government under Section 67(1) of the Limited Liability Partnership Act, 2008
14. Entry 7, First Schedule, Limited Liability Partnership Act, 2008
15. Entry 13, First Schedule, Limited Liability Partnership Act, 2008
16. Rule 36, Limited Liability Partnership Rules, 2009
17. Neeraj Kumarpal Shah v. C2R Projects and others, 2017 SCC OnLine Guj 1441
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.
