LLPs: You’re not bullet proof

Since its introduction in 2000, the limited liability partnership has become an increasingly popular business model for professional services firms in construction.

It is commonly used by architects, QSs, project managers and other professionals such as solicitors.

But the recent application by commercial law firm Halliwells for an administration order brings into focus the protection the LLP business model does and does not give to partners. Furthermore, there are ways in which the protection given by LLP status can be eroded, such as personal guarantees and partner capital contributions.

In short, LLP stands for limited liability, not no liability.

In the past few years, banks and funders have looked to partners to put more capital into the LLP to reduce the direct lending they make to the LLP … the partner then has to find the money personally if the LLP fails

In general, partners in an LLP are only liable to the extent of their capital contribution to the business. This is an attractive alternative to the open-ended personal liability of a partner in a conventional partnership.

However, in the event of an LLP going into administration, the partners are likely to lose their capital contributions. Other liabilities are paid out first: mortgages, liquidation fees, employees’ wages for the four months prior to the date of the insolvency order, occupational pension schemes and general unsecured creditors.

If the partners introduced money as capital, their claim comes after the unsecured creditors. If they introduced the money as debt, they would be treated as unsecured creditors in respect of this money, along with the other unsecured creditors. The partners would also be unsecured creditors in respect of any profits due to them.

Sometimes partner capital will have been paid in in the form of hard cash, but more frequently it will be money borrowed from a bank or other funder and paid by them into the business. If this device is used, the partner merely pays the interest on the loan while the LLP trades successfully. When the LLP fails, the partner has to find the money to repay the bank or funder. The obvious risk is that the requirement to repay real money will come at the worst possible moment in terms of income stream.

Banks have become more nervous, not just of their financial exposure in the marketplace but of the protection given to partners. In the past few years, banks and funders have looked to reduce the direct lending they make to the LLP by asking the partners to put more capital in. From the bank’s position, lending to the partner is preferable to lending straight to the business, because the partner has to find the money personally if their business fails. It also locks the partner as an individual into the LLP corporate vehicle and gives them a strong incentive to stick with it in tough times.

The practical problem is the willingness of partners to expose themselves to personal liabilities in this way, and of course their ability to raise funding to cover them in a difficult marketplace.

Just because the partnership is an LLP does not mean that the partners have no duties or liabilities beyond their capital in the business. Each partner acts as an agent for the LLP and as such they can represent and bind it.

It is therefore likely - although not stated in the Limited Liability Partnership Act - that the partners’ relationship with the LLP will amount to a fiduciary one. That means the partners must act in good faith and in the best interests of the LLP. It may be the case that the partners have decided to provide for fiduciary duties in the LLP partnership agreement.

One of the issues in relation to Halliwells’ application for an administration order concerned the distribution of a profit share on the sale of a property they rented. Partners need to considercarefully what can and cannot be done with such one-off profits, in particular if they can be distributed among partners when the lease itself is a long-term obligation of the LLP.

Administrators have a right on behalf of creditors to look back two years prior to the winding up of an LLP to see whether any money, particularly capital, was distributed or repaid to partners when the LLP was not solvent. The court cannot make a clawback order where it is satisfied that the members reasonably believed the LLP could trade without becoming insolvent.

So LLPs should not be regarded as bullet proof, nor do they provide complete protection to partners. Limited liabilities they may be but if the partnership cannot continue to trade, those liabilities may still be substantial.

James Bessey is a partner in the construction team at Cobbetts