Draft legislation put before parliament late last year offers firms the opportunity to protect themselves by becoming limited liability partnerships. They will be able to trade as LLPs by the end of this year or early next year.
Why might a firm become an LLP?
To limit liability For many, limiting partners' liability will be the main attraction of becoming an LLP. Although some partnership agreements are drawn up to try to protect certain parties, such as salaried or junior partners, senior equity partners are always at risk.
Professional indemnity insurance is generally available to cover most risks and is required by many professional associations. However, there is a limit to the amount of protection afforded and the partners must bear the excess risk themselves (which can be considerable).
To attract new partners Most professional firms are "people" businesses and LLP status may help recruit new partners. Indeed, some individuals may prefer not to be promoted to partner level because of the financial risks, opting instead to remain highly-paid employees. Knowing that liability may be limited could provide the lure to attract high-flying young professionals.
To review practice management This kind of structural change will give partnerships an opportunity to review the way they operate. If, as with many partnerships, there is no partnership agreement, the change to LLP status will mean preparing new documentation, not only in terms of the relationship between partners, but also third parties such as landlords, banks and creditors. It is possible that some of these groups may continue to insist on the perceived security afforded by unlimited liability.
What else will the change of status mean?
Declaration of financial detail It is very likely that the new legislation will require the submission of financial statements to the Registrar of Companies. If the disclosure requirements are similar to those for limited companies, partnerships will have to publicly declare their turnover, gross and net profits and partners' earnings. At present, partnerships provide this information at their discretion and may not wish to disclose information that has traditionally been treated as confidential.
No change in tax status The Inland Revenue has suggested that the treatment of LLPs will not differ from the way existing partnerships are treated, so there are likely to be few, if any, gains or losses in terms of tax.
More red tape LLP legislation is likely to draw heavily on existing regulations contained in the Companies Act and the Insolvency Act. Whereas the Partnership Act of 1890 had only 50 sections and no schedules, those wishing to trade as LLPs will have to cope with more than 76 pages of regulations. The proposed regulations may also include an audit requirement.
What are the alternatives to LLP?
First, firms can opt to retain their partnership status under the current rules and ensure that, as far as possible, the partnership and each partner are fully insured against potential risks. If you can be confident of anticipating all risks, it might be preferable to keep the status quo.
Second, firms may convert to a limited liability company. This would involve changing the way in which a business is operated because a limited company is a distinct legal entity. The relationship and responsibilities of the owners and directors (former partners) towards the business would also change. The way in which the owners and directors of a limited liability company are taxed also differs from the tax treatment for partners. This has advantages and disadvantages, the discussion of which, unfortunately, goes beyond this article.
The limited company does offer other opportunities, however, in that senior employees can be given directorships without devolving ownership. Holding shares in a limited company can also be more flexible than a partnership as shares can (with agreement) be held by a spouse or other members of the family.
The table sets out the differences between operating a traditional partnership, an LLP and a limited company.
The introduction of LLPs gives all partnerships a viable alternative to incorporation. There are financial and other costs to limiting liability and each partnership must decide whether or not it wishes to incur these. However, these partnerships also should reflect on the possible costs of not converting.