Explanatory Notes to Limited Liability Partnerships Act 2000

1.These explanatory notes relate to the Limited Liability Partnerships Act 2000, which received Royal Assent on 20 July 2000. They have been prepared by the Department of Trade and Industry in order to assist the reader in understanding the Act. They do not form part of the Act and have not been endorsed by Parliament.

2.The notes need to be read in conjunction with the Act. They are not, and are not meant to be, a comprehensive description of the Act. So where a section or part of a section does not seem to require any explanation or comment, none is given.

3.The Act’s main purpose is to create a new form of legal entity known as a limited liability partnership (“LLP”). The essential feature of an LLP is that it combines the organisational flexibility and tax status of a partnership with limited liability for its members. This limited liability is possible because an LLP is a legal person separate from its members.

4.The Act provides powers to apply the provisions of company law and insolvency law, with appropriate modifications, to LLPs. These powers will be used to put safeguards in place for those dealing with LLPs. It is intended that the safeguards will include provision for the public disclosure of information about LLPs, particularly their finance, and provision for what happens when an LLP becomes insolvent.

5.The Act creates a new form of legal entity, the limited liability partnership, which will be a body corporate and exist as a legal person separate from its members. In general, the Act extends to England, Wales and Scotland. Sections 10 - 13 (taxation and class 4 national insurance contributions) and section 19 (commencement etc.) also extend to Northern Ireland.

6.In Great Britain businesses operate in the main as limited companies, sole traders or partnerships. Each of these is subject to different regulatory and tax regimes reflecting their organisation and ownership.

7.The only option for many professions, in the past, was to operate as partnerships, as either statute or the rules of their professional body denied them the ability to incorporate. For example, accountancy firms have only been able to incorporate since 1989. The fact that professional bodies were required to operate as partnerships meant that they were subject to the particular rules relating to the liability of partners.

8.The Partnership Act 1890 sets out special rules relating to the liability of partners to persons dealing with them. First, every partner is liable jointly, and in Scotland severally also, with his other partners for all the debts and obligations of the partnership incurred during his membership. Second, every partner is jointly and severally liable for any loss or damage arising from the wrongful acts or omissions of any of his partners (as well as his own) which were done in the ordinary course of the partnership’s business or with the authority of the partners. When the members are liable jointly and severally for any loss or damage this has the effect that an injured person may sue one or more of the members separately or all of them together at his option.

9.These arrangements were generally appropriate when all partnerships were small and the partners were of the same profession working closely one with another. However, unlimited liability for partners has become an increasing cause for concern in the light of:

1. a general increase in the incidence of litigation for professional negligence and in the size of claims;

2. the growth in the size of partnerships (since in a very large partnership not all the partners will be personally known to one another);

3. the increase in specialisation among partners and the coming together of different professions within a partnership; and

4. the risk to a partner’s personal assets when a claim exceeds the sum of the assets and insurance cover of the partnership.

9.Although these concerns arise most acutely in very large professional partnerships they are relevant to partnerships generally.

10.The limited liability partnership goes some way towards addressing these concerns. Its members benefit from limited liability because the LLP is a separate legal person. In general the LLP and not its members will be liable to third parties (but see paragraphs 13-16 below).

11.The idea that there should be the opportunity in Great Britain to organise as an LLP emerged out of a review of the law of joint and several liability. In 1996 the DTI published a feasibility investigation of joint and several liability carried out by the Common Law Team of the Law Commission (HMSO ISBN 0 11 515 452 3). The investigation focused particularly, but not exclusively, on the joint and several liability of professional defendants, seeking to ascertain whether there was an arguable case for replacing joint and several liability by, for example, a system whereby each defendant might be liable for only a proportionate share of the loss. Although the remit did not extend to the question of joint and several liability within partnerships, the DTI took the opportunity to consult on the distinct but related question whether to amend the law in Great Britain to allow limited liability partnerships. This question was asked in the knowledge that the concept of LLPs was well known in some overseas jurisdictions, particularly the USA. Jersey too was working on implementing its own LLP legislation in response to representations from the accountancy profession, with a view to attracting offshore registrations.

12.In February 1997 the Department published a consultation paper “Limited Liability Partnerships: A New Form of Business Association for Professions” (URN 97/597). The response to the paper confirmed that there was a demand for the new vehicle across a wide range of professions, and agreement in principle from those consultees who are potential clients of and providers of capital to LLPs. The paper was followed by the publication of a draft Bill and regulations (URN 98/874) in September 1998. Revised draft regulations were published again for consultation, together with the draft Bill (URN 99/1025) in July 1999. In February 2000 a further consultation document was published concerning regulatory default provisions governing the relationship between members (URN 00/617), and revised regulatory default provisions were published in May 2000 (URN 00/865).

13.The limited liability partnership will be a separate legal entity with unlimited capacity. This means that an LLP can do anything that a natural person could do. It has the ability to enter into contracts and hold property, and will continue in existence in spite of any change in membership. The LLP’s existence as a separate legal entity makes it more closely akin to a company than to a partnership (except insofar as the internal relations are governed by agreement between the members – see paragraph 17 below). The underlying approach, therefore, was to draw on the principles enshrined in the legislative treatment of companies.

14.The LLP’s existence as a corporate entity means that the effect of the general law is different in comparison with a partnership. For example, it is anticipated that a third party will usually contract with the LLP itself rather than with an individual member of the LLP whereas, in general, a partner contracts as principal and on behalf of the other partners.

15.Should a partner be negligent in the work that he carries out for a client, there will generally be two possible causes of action against that partner: contract and tort. However, because the limited liability partnership will be a separate legal entity with which the client has contracted, only one action (the tort action) is potentially available against the member.

16.Should the courts consider the case of a negligent member of an LLP whose conduct has resulted in economic loss for his client, the courts’ decision cannot be forecast with certainty. But, recent case law suggests that in deciding whether such a member was potentially liable to a client, the courts would have regard to various factors including whether the member of the LLP assumed personal responsibility for the advice, whether the client relied on the assumption of responsibility and whether such reliance was reasonable.

17.As regards the management of the internal affairs of the LLP there is a parallel with the system that operates for partnerships. Members will not be obliged to enter into a formal agreement among themselves and there will be no obligation to publish any agreement which is entered into. As in the case of partnerships, however, there will, in general, be clear advantages in having a formal written agreement between members to regulate the affairs of the undertaking and to avoid disputes between them. The formal procedures needed to establish an LLP, including the need for an application to the registrar of companies, are likely to encourage the members to set up a formal arrangement before the LLP commences business. As noted in paragraph 12, however, we have published regulatory default provisions governing the relationship between the members which would apply where no agreement existed, or the agreement did not include provision to deal with a particular issue.

18.The profits of the business of an LLP will be taxed as if the business were carried on by partners in partnership, rather than by a body corporate. This ensures that the commercial choice between using an LLP or a partnership is a tax neutral one.

19.The taxation clauses in the Act are expressed in broad terms so that the existing rules for partnerships and partners will, in general, simply apply to LLPs, and members of LLPs, which are carrying on businesses, as if these were partnerships and partners respectively.

20.The transfer of an existing business to an LLP will only be treated for tax purposes as giving rise to a cessation of the business of the partnership which is making the transfer if in otherwise identical circumstances a transfer between one partnership and another would do so.

21.The transfer of assets between a partnership and an LLP will only give rise to chargeable gain or capital allowance consequences if, in otherwise identical circumstances, a transfer of assets between one partnership and another would so do.

22.Similarly, Inland Revenue Statements of Practice and Extra Statutory Concessions will apply to LLPs and members of LLPs as they apply to partnerships and to partners.

23.The Act will be brought into force by order made at a later date or dates.