CJ and RA Eade LLP, Re

Members of a limited liability partnership may agree informally that the LLP will assume liabilities incurred to acquire and operate its business. Payments made under that agreement are not transactions at an undervalue merely because the lender is also a member. However, members cannot set off drawings on account of anticipated profits against debts owed to them in their capacity as members.

When insolvency is established or probable, designated members performing directors’ functions must have regard to creditors’ interests. Continued trading and payments to a member-creditor may remain permissible for a limited period where reasonably expected to preserve or improve value, but payments cease to be justified when an insolvency remedy should be implemented and creditors’ interests are paramount. Section 214A permits compensation for qualifying withdrawals, subject to the statutory discretion.

The liquidator of an LLP sought recovery from its two designated members of drawings on account of anticipated profits and payments made towards a bank loan. The loan had been made to the members personally but was used to acquire the former business and provide working capital. The members contended that the LLP had agreed to assume the loan, that the loan had been capitalised or could be set off against the drawings, and that the payments were justified while attempts were made to rescue or sell the business.

The court considered whether the payments constituted misfeasance, transactions at an undervalue, preferences, or withdrawals engaging section 214A of the Insolvency Act 1986; whether limitation applied; and whether relief was available under section 1157 of the Companies Act 2006.

1. The members had informally agreed that the LLP would assume liability for the Lloyds Bank Loan. The agreement was established by conduct and performance. The Duomatic principle applied to LLPs unless the members agreed otherwise. Payments to the bank therefore discharged a contractual liability and were not transactions at an undervalue.
2. The loan had not been capitalised. The accounts were opaque and failed to distinguish equity from debt, but the agreement, the LLP’s continuing payments and the surrounding evidence showed that the loan remained debt. Members’ capital could not be treated as debt or set off against liabilities contrary to section 107 of the Insolvency Act 1986.
3. The drawings were payments on account of anticipated profits, not remuneration or payments giving rise to a quantum meruit. They were loans repayable on demand if profits were absent or insufficient. There was no right of set-off against the members’ creditor claims.
4. The creditor-interest duty applied to the designated members because they performed functions equivalent to directors. Applying Eurosail and Sequana, insolvency included inability to pay debts as they fell due and, depending on the circumstances, balance-sheet insolvency with proper allowance for prospective and contingent liabilities. The duty was triggered when the LLP was insolvent or likely, meaning probably, to become insolvent.
5. The duty arose at the latest by January 2010 and continued until liquidation. Continued trading and loan payments remained justifiable until about the end of April 2011 because the business had some prospect of being preserved or sold through an insolvency procedure. From May 2011, after further finance had been refused and creditor pressure had intensified, the payments were made in breach of fiduciary duty. The members’ interests had become subordinate to those of creditors.
6. The drawings were misfeasance throughout the relevant period. Section 214A applied to withdrawals made from 1 October 2010. The court exercised its discretion to order compensation for all drawings and for loan payments from May 2011 to liquidation, but not for earlier loan payments.
7. The preference claim failed because the evidence rebutted the statutory presumption of a desire to prefer. The payments were made to maintain trading or facilitate an insolvency sale, not to improve the members’ position in a liquidation. The limitation defence, ex parte James principle and section 1157 relief also failed.

The members were ordered to pay the LLP the drawings and the qualifying later loan payments. The claims concerning earlier loan payments were dismissed.