Limited Liability Partnerships by Ten Old Square

LIMITED LIABILITY PARTNERSHIPS: MEMBERS’ INTERESTS This document is published by Practical Law and can be found at: uk.practicallaw.com/3-543-7226 Request a free trial and demonstration at: uk.practicallaw.com/about/freetrial

A note on the law and practice relevant to limited liability partnership (LLP) members’ shares or interests in the LLP, including whether such shares or interests can be transferred to others, granting options, drag along, tag along and other aspects of dealing with interests in an LLP as well as the LLP purchasing an interest from a member. Jeremy Callman, Ten Old Square, Aster Crawshaw, Addleshaw Goddard LLP, and Practical Law Corporate

RESOURCE INFORMATION RESOURCE ID 3-543-7226

RESOURCE TYPE Practice note

CONTENTS •

Share or interest in an LLP

– Revised LLP agreement

•

Capital contributions

– Other ancillary documents

•

Retirement from an LLP

•

Drag along or tag along provisions

•

Expulsion from an LLP

•

Granting of an option over an LLP member’s share

•

Transfer of a member’s interest (entirely or in part) to a new member

•

Transfer of a member’s interest (entirely or in part) to someone who is not to become a member

•

Documents for transfer of an LLP interest

LAW STATED DATE 9 October 2013

– Granting an option to existing member(s) – Granting an option to a third party •

LLP’s purchase of a member’s interest

•

Payment for an LLP member’s share – Payments for goodwill

– Member’s Interest Purchase Agreement

– Timing and payment mechanics

– Deeds of retirement and admission

For details on LLPs generally, see Practice note, Limited liability partnerships (LLP): overview (www.practicallaw. com/4-107-3913).

SHARE OR INTEREST IN AN LLP One of the key areas where the law governing LLPs is unhelpfully vague is as regards what interest or share a member has in an LLP and how that member may transfer or deal with that interest. Neither the Limited Liability Partnerships Act 2000 (LLPA 2000) nor the Limited Liability Partnership Regulations 2001 (SI 2000/1090) (LLPR 2001) contains a definition of an LLP member’s interest or share in the LLP and there are no statutory restrictions on how an LLP may divide its undertaking into shares or interests.

There are no share certificates issued as there would be for a limited company. The LLPA 2000 and sections of the company and insolvency legislation (as applied by statutory instrument to LLPs), make reference to shares and interests in LLPs. They are not created by the LLP agreement and exist even without any such document. Regardless of the LLP agreement, members will have: •

Financial rights and obligations, for example, a right to a share in capital and profits (and, if the LLP agreement imposes it, an obligation to contribute capital (see Capital contributions below)).

•

Administrative rights and obligations, for example, the right to attend and vote at meetings and the obligation to fulfil statutory requirements.

Reproduced from Practical Law Corporate with the permission of the publishers. For further information visit practicallaw.com or call 020 7202 1200.Copyright © 2013 Practical Law Publishing Limited and Practical Law Company, Inc. All Rights Reserved.

JURISDICTION United Kingdom

ESSENTIAL CONTENT FROM PRACTICAL LAW

A share or interest in an LLP would probably cover all of these rights and obligations. Some experts suggest that a share is the totality of rights and obligations and that the term “interest” should be used to describe one or more components of a member’s share (see Whittaker & Machell, The Law of Limited Liability Partnerships (Bloomsbury Professional, 3rd edition), Chapter 8 – Membership: general matters, 8.18: A member’ s share and interests (http://uk.practicallaw. com/books/9781847663221/chapter08)). This may be a useful distinction but in practice the words appear to be used interchangeably both in legislation and in LLP agreements. It is sensible to avoid any need to assume some clear distinction between these two terms; if the draftsman of a document wishes to draw a distinction between what is meant by “share” and “interest”, then this should be made clear by way of definitions. When drafting any documents dealing with shares and interests in LLPs, the wording should include careful and wide definitions. Typically, a member’s interest (or share) will be defined broadly as the entire legal and beneficial interest and share of the member of whatsoever nature in the LLP and may then go on to list (saying that it is non-exhaustive) some specific rights and obligations.

way that profits are divided and income profits may be apportioned on a different basis to capital profits. Neither the LLPA 2000 nor the LLPR 2001 refers to initial contributions. If, as is usual, any unequal division of capital contributions or capital profits is proposed, this should be provided for in the LLP agreement.

An LLP agreement could also provide for different classes of members with different rights in the LLP and for shares or interests to be transferable or redeemable.

More generally, an LLP may purchase the economic interests of one or more of its members. This is subject to the potential claw-back and other provisions of the Insolvency Act 1986 as amended for LLPs (see especially 214A Insolvency Act 1986 (as applied to LLPs by Schedule 3 to the LLPR 2001). See LLP’s purchase of a member’s interest below.

CAPITAL CONTRIBUTIONS The requirements for incorporation of an LLP are set out in the LLPA 2000 (see Practice note, How to incorporate a limited liability partnership under the Limited Liability Partnerships Act 2000 (www. practicallaw.com/6-517-6703)) and do not include an obligation on LLP members to contribute capital to the LLP. An LLP member therefore cannot be required to contribute capital unless required to do so under an LLP agreement.

The terms of the relevant LLP agreement may set out the terms and schedule for any further contributions to capital to be made by the members. The LLP agreement may also set out the process for contributing capital and the members’ entitlements to a return of capital on a winding up of the LLP. Where further capital contributions are made in accordance with the LLP agreement other than on a pro rata basis, any corresponding changes should be made, where necessary, to the members’ entitlements to profits under the LLP agreement to reflect the new capital contributions. There are no restrictions on returning to a member any capital contributed and no equivalent to the capital maintenance rule that restricts return of capital and profit distributions for limited companies.

RETIREMENT FROM AN LLP A person may cease to be a member of an LLP by: •

Death or dissolution;

•

In accordance with an agreement with the other members; or

The default provisions in the LLPR 2001 provide that all LLP members are entitled to share equally in the capital and profits of the LLP (regulation 7(1), LLPR 2001). This applies to both any initial capital contributed to the LLP and future capital contributions. As with all the default provisions, this is subject to agreement (written or otherwise) to the contrary. Most LLP agreements will provide for unequal shares in both capital and profits. There is no necessary connection between capital contributions and profit sharing (either income or capital). The way in which capital is apportioned may be totally different from the

•

In the absence of agreement with the other members as to cessation of membership, by giving reasonable notice to the other members (section 4(3), LLPA 2000).

2 Practical Law

Almost all LLP agreements provide for a member to voluntarily retire on a specified number of months’ notice. It is also common for an LLP agreement to provide for a member to be required to retire on a number of months’ written notice (see Standard document, Limited liability partnership agreement (www.practicallaw.com/1-107-4829), clause 20.1).

ESSENTIAL CONTENT FROM PRACTICAL LAW

These clauses are usually referred to as compulsory retirement clauses and are usually drafted so that there need not be a cause for exercising the power. All that is needed is the requisite vote and that other stipulated procedures (such as notice period) are followed. LLP agreements may also contain an expulsion clause (that is, terminating membership for cause in accordance with the grounds identified in the LLP agreement) (see Expulsion from an LLP below). A well drafted LLP agreement will usually provide for the financial (and other) consequences of a member’s retirement, such as for the outgoing member’s share to vest in the continuing members and for payment to the outgoing member of his share of undrawn profits and a sum representing his capital and/or his share of the LLP’s assets (see Standard document, Limited liability partnership agreement (www.practicallaw.com/1-1074829), clause 22.3(b) (www.practicallaw.com/1-1074829) and Payment for an LLP member’s share below).

EXPULSION FROM AN LLP A person may cease to be a member of an LLP by the LLP expelling him. Without an express power to expel having been agreed (usually recorded in writing in an LLP Agreement) then a member cannot be expelled (regulation 8, LLPR 2001). See also Eaton v Caulfield [2011] BCC 386 in which there had been no written LLP agreement and so no express power of expulsion. In that case, the High Court held that the petitioner had been unlawfully expelled from the LLP and that the expulsion had been unfairly prejudicial. An expulsion clause usually includes the expropriation of a member’s interest or share and some provision for payment out of capital and unpaid profit share. See Standard document, Limited liability partnership agreement, clauses 21 and 22 (www.practicallaw.com/1107-4829).

TRANSFER OF A MEMBER’S INTEREST (ENTIRELY OR IN PART) TO A NEW MEMBER The default rules in the LLPR 2001 and section 7 of the LLPA 2000 contemplate the voluntary assignment of an “interest” in the LLP, subject to the consent of the other members. Under section 7 of the LLPA 2000, where a member has assigned (all or part of) his share in the LLP (absolutely or by way of charge or security), his assignee may not interfere in the management or administration of any business or affairs of the LLP.

Under this default rule, effectively, not all of the “share” or “interest” can be transferred (that is, the rights of management and administration may not be transferred but the financial interest may be assigned, as under section 7(2) of the LLPA 2000 the assignee will still be entitled to receive an amount from the LLP). Arguably, section 7 is subject to contrary agreement of the LLP members. It is suggested that, despite the section not actually saying so, it must have been intended that members be able to agree otherwise. The statute envisages members assigning their shares; it must have been envisaged that the terms of such assignment would set out the basis and effect of such assignment, which could extend to members expressly allowing a transfer of administrative rights (as well as financial rights) and in effect agreeing to the assignor become a nominee (while remaining a member). But for the potential problems this may create, see Transfer of a member’s interest (entirely or in part) to someone who is not to become a member below. If an LLP member wants to transfer all of his financial rights and obligations and his administrative rights and obligations, the most appropriate course will be for the transferee to be admitted as a member to the LLP at the same time as the transferor leaves it (subject, of course, to the terms of the existing LLP agreement). The sensible course is, at the stage of admitting the new member, for careful documentation to be drafted providing for one member to retire and assign his financial interest to a new incoming member who would become a member simultaneously, with all the administrative rights of a member. The LLP agreement will usually provide for the outgoing member to receive a repayment of his capital contribution in the LLP together with any outstanding share of profits at the same time as the incoming member makes a contribution to capital. The transferee could of course make a payment to the transferor in return for the transferor procuring the admission of the transferee as a full member. A well drafted LLP agreement will usually contain detailed provisions on how a person’s membership of an LLP terminates. It will provide the mechanism for dealing with the outgoing member’s financial entitlements (see Payment for an LLP member’s share below), his obligations of confidentiality and other restrictive covenants that the LLP wishes to impose on him to preserve the LLP’s business. See Standard document, Deed of retirement from a limited liability partnership (www.practicallaw.com/5-385-8020) and Checklist, Retirement from a limited liability partnership (www.practicallaw.com/9-386-0808).

Practical Law 3

ESSENTIAL CONTENT FROM PRACTICAL LAW

Under the LLPR 2001, the default provision is that consent of all the LLP members is required for the admission of a new member (regulation 7(5), LLPR 2001). This provision is subject to contrary agreement. The members may agree other admission criteria in an LLP agreement and provide for the new member to execute a deed of adherence to the LLP agreement (see Standard document, Limited liability partnership agreement: 12. Admission of Members (www. practicallaw.com/1-107-4829), Standard document, Deed of adherence to a limited liability partnership agreement (www.practicallaw.com/3-386-0811) and Checklist: joining a limited liability partnership as a member (www.practicallaw.com/1-386-0812)). The LLP must notify the registrar of companies of changes in membership within 14 days (section 9(1)(a), LLPA 2000). Appointment of an individual member must be notified on Form LL AP01 (www.practicallaw. com/9-422-2007) and appointment of a corporate member on Form LL AP02 (www.practicallaw.com/9422-2007). The forms must be signed by a designated member and by the incoming member whose details appear on the form to confirm his consent (section 9(3), LLPA 2000). Form LL TM01 (www.practicallaw.com/3422-2005) must be signed by a designated member to notify the termination of appointment of a member (individual or corporate).

LLP in accordance with the assignee’s directions. This would be an impractical solution for both parties but particularly for the assignor who would continue to have contractual obligations to the other LLP members under the LLP agreement, as well as statutory obligations (such as those relating to auditors and accounts) and potentially fiduciary duties. If this approach were adopted then issues of shadow and de facto members may arise in respect of the assignee. •

Obtain the consent of all the other members (or such proportion of the members as the LLP agreement specifies) to the assignment of not only the financial interest in the LLP but also the managerial interest.

In principle, there can be a separation between membership on the one hand and interests in the LLP on the other. It is clear from the drafting of section 7 of LLPA 2000 that non-members could have interests in an LLP. Section 432(4) of the Companies Act 1985 (as applied to LLPs by Schedule 2 to the LLPR 2001) also specifically says, for the purposes of unfair prejudice: “The reference in subsection 2(a) to a limited liability partnership’s members includes any person who is not a member but to whom a member’s share in the limited liability partnership has been transferred or transmitted by operation of law”.

Someone who ought to have been registered as a member, but has not been, may use section 1113 of the Companies Act 2006 (as applied to LLPs by regulation 69, Limited Liability Partnerships (Application of Companies Act 2006) Regulations 2009 (SI 2009/1804)) to enforce the LLP’s filing obligations. What has been filed at Companies House is not, however, determinative of who is and who is not a member.

DOCUMENTS FOR TRANSFER OF AN LLP INTEREST

TRANSFER OF A MEMBER’S INTEREST (ENTIRELY OR IN PART) TO SOMEONE WHO IS NOT TO BECOME A MEMBER

Although transfers of shares in a limited company are technically effected by execution of a stock transfer form, in all but the most simple of share sales a range of additional documents will be required.

If a member wanted to assign his share in the LLP, or a part of it, to someone who is not (and will not become) a member, he could:

Other than the absence of a stock transfer form, the core documents for a transfer of LLP interests may not be that different to that for an acquisition of shares in a limited company, but care should be taken in drafting as, unlike companies, LLPs do not have separation of ownership and management. There will be key technical differences (for example, identification of the assignor’s member’s interest, admission of the assignee as a member and cessation of membership of the assignor), but the principal transaction document will look quite similar to a share purchase agreement

•

Assign or charge or secure part or all of his financial interest in the LLP, in accordance with the terms of the LLP agreement (or in the absence of any such terms, with the unanimous agreement of all the other members), but agree with the assignee to continue as a member of the LLP and to exercise his management and administrative rights in the

4 Practical Law

The LLPA 2000 and LLPR 2001 are silent on how a transfer of an LLP interest should be documented.

ESSENTIAL CONTENT FROM PRACTICAL LAW

(SPA) and many of the ancillary documents will differ only in minor technical respects.

•

Conditions precedent: As with a share transfer, there are a range of commercial, tax and regulatory issues that may give rise to a gap between exchange and completion. Member approvals under the LLP agreement may also be required, and where large numbers of members are involved this could be a major aspect of the transaction. Control issues between exchange and completion will need to be addressed (see Practice note, Share purchase agreement: Conditions precedent (www. practicallaw.com/4-107-3753)).

•

Warranties and indemnities: Warranties and indemnities will commonly be given by the assignor members only. Continuing members and the LLP itself may be asked to give warranties under the MIPA, but they should only do so for good consideration. Title warranties will need to be tailored to reflect the LLP interest being transferred, and implied covenants can also be included (full title guarantee or limited title guarantee). Other technical changes to warranties commonly used for share sales will need to be considered (for example, those relating to insolvency and winding-up), but generally the warranty schedule could look very similar to that used in an SPA for an equivalent transaction. Specific indemnities will need to be considered and negotiated on the same basis as on a share sale. Limitations on liability will need to be considered, and where there are multiple assignors the allocation of liability between the assignors will need to be addressed (see Practice note, Warranties and indemnities: acquisitions (www.practicallaw.com/2-107-3754)).

•

Restrictive covenants: The assignor may be asked to agree to similar restrictive covenants to those asked of a selling shareholder (see Practice note, Share purchase agreement: Restrictive covenants (www.practicallaw.com/5-107-3762)). These restrictions will be of particular significance in the context of professional services businesses where the goodwill will often reside primarily with the key members. If the assignor is ceasing to be a member of the LLP, restrictive covenants under the LLP agreement may also apply.

•

Execution: The general position is that a member of an LLP can sign a simple contract on behalf of an LLP, and a deed can be executed by two members (see Standard clauses, Execution formalities: limited liability partnerships: 1 October 2009 (www.practicallaw.com/9-500-2160) and Practice note, Execution of deeds and documents by LLPs, partnerships and limited partnerships (www. practicallaw.com/8-530-6176)). An LLP, or its

Member’s Interest Purchase Agreement There is as yet no settled name for the LLP equivalent to an SPA. “Member’s Interest Purchase Agreement” (MIPA) seems as good a name as any. There is no reason why it could not be called a “Share Purchase Agreement”, though this may cause some confusion. Some practitioners have used “Change of Membership Agreement” or “Change of Ownership Agreement”, which may better describe the actual transaction. The name of the document is of course entirely irrelevant, and a market standard will no doubt emerge over time. The key provisions of a MIPA will broadly track those of an SPA, though with key technical differences: •

Parties: The assignee and assignor will be parties to the MIPA. Where corporate groups are involved, consider whether parent company or other guarantees might be required. The LLP agreement should be reviewed carefully to determine whether the LLP itself and other members should be parties, for example to ensure that all relevant admissions and terminations can be effected at completion.

•

Transfer of interest: The nature of the member’s interest being transferred will need to be carefully defined, though as important will be the rights and obligations that the new member will have under the LLP agreement on completion. The completion mechanics will usually provide for the assignor to be admitted as a new member, the assignee’s membership to cease (assuming his entire interest is being transferred), and (if necessary) a new LLP agreement to be adopted.

•

Consideration: As with a share sale, the consideration for the purchase of an LLP member’s interest could comprise cash, equity, debt or a combination of any of the three. Deferred payments and earn-outs are also available, and the issues relating to completion accounts and locked box mechanisms are the same for LLPs as for limited companies, though the accounting treatments will vary (see Practice note, Completion accounts: acquisitions (www. practicallaw.com/5-107-3762)). Where there is more than one selling member, the allocation of the consideration will need to be clearly provided, as well as the impact on the allocation of any post-completion actions (such as breaches of restrictive covenants).

Practical Law 5

ESSENTIAL CONTENT FROM PRACTICAL LAW

members, can also grant powers of attorney (see Standard clauses, Execution formalities: attorneys under a power of attorney (www.practicallaw. com/4-380-6833)). The LLP agreement should be checked to ensure that any additional authorisation requirements are complied with. Where multiple members are involved in a transaction, consider obtaining comprehensive powers of attorney from all members well in advance of signing. Deeds of retirement and admission In most cases where a member’s entire interest is being transferred that member will retire and the assignee will be admitted as a member. A deed of retirement will not always be required as retirement could be provided for in the MIPA. Where there are multiple assignors, separate deeds which allow for variances between members may be expedient. The matters to be covered in a deed of retirement will depend in part on what is addressed in the MIPA and the LLP agreement. Consideration should be given to the following issues: •

Return of capital (amount and timing).

•

Distribution of accrued profit (amount, or a mechanism for determining the amount, and timing).

•

Treatment of any tax reserve account.

•

Release of claims against the LLP (and vice versa).

•

Indemnity from the LLP to the member (and vice versa).

•

Restrictive covenants.

•

Return of documents.

•

Confidential information.

See Standard document, Deed of retirement from a limited liability partnership agreement (www. practicallaw.com/5-385-8020). A deed of admission may not be necessary. In cases where a reasonably full LLP agreement exists and a deed of admission is considered necessary or expedient, the deed may only provide for adherence to the LLP agreement. See Standard document, Deed of adherence to a limited liability partnership agreement (www.practicallaw.com/3-386-0811).

6 Practical Law

Revised LLP agreement A key part of the due diligence carried out by a potential assignee will be a thorough review of the LLP agreement. An assignor can only transfer those rights and obligations that it has. As a condition to the purchase of the member’s interest, the assignee may require that amendments are made to the LLP agreement. These amendments will need to be negotiated alongside the MIPA and consideration should be given to the approvals required to effect the amendments. In many cases, this will require the consent of other members. The commercial justification for the amendments, and the timing of engagement with the other members, will need to be considered carefully. Other ancillary documents A range of other ancillary documents are likely to be required, including: •

Disclosure letter: This will be similar in form to a disclosure letter for a share sale. The general disclosures will need to be tailored for an LLP. See Standard document, Disclosure letter: share purchases (www.practicallaw.com/5-311-8952).

•

Tax covenant: A new member of an LLP will take on certain elements of the tax profile of the LLP. As an LLP is tax transparent for certain purposes and “opaque” for others, the issues and negotiating positions will be different in comparison with a share sale. Specialist tax advice should always be obtained.

•

Approvals and authorities: The LLP agreement should be reviewed early in the process to determine exactly what approvals will be required, for example from members or any management body. Powers of attorney may also be required to ensure that signing and completion can be effected smoothly (see Practice note, Powers of attorney (www.practicallaw.com/3-107-4654)).

•

Contribution agreement: If there are multiple assignors a contribution agreement may be necessary to deal with the allocation of liability under warranty and indemnity claims. This agreement may also deal with the management of claims, for example, appointing one or more representatives with authority to bring, defend and settle claims. See Standard document, Contribution agreement: share purchases (www.practicallaw. com/8-102-5901).

ESSENTIAL CONTENT FROM PRACTICAL LAW

DRAG ALONG OR TAG ALONG PROVISIONS Given the flexibility of LLPs, it is possible to include in an LLP agreement: •

•

Drag along provisions which would allow a specified percentage/number of members who have agreed to sell their LLP interests to a prospective buyer to compel the other members to also sell their interests and cease to be members, ensuring that a prospective buyer can acquire 100% of the LLP (though bearing in mind the need to have two members). Tag along provisions under which one or more LLP members could require a member who is selling his LLP interest to procure that the proposed buyer extends its offer to purchase the interests of all the LLP members, ensuring that no members are left against their will as minority interest holders.

Drag and tag provisions have for some time been used in the financial services sector (for example, by hedge funds and private equity houses). Until recently, they were not common in the more traditional professional services markets (for example, legal, accounting and surveying). However, more and more firms in these markets are alive to the possibility of selling their businesses and have put their LLP agreements on an M&A footing. Being able to squeeze out dissentient minorities is one of the most important enablers of a sale. Whether drag and tag provisions are appropriate, and if so the triggers and mechanics, will need to be considered in the context of each business. There will in some cases be categories of member, such as third party investors, who would expect to be able to sell their interests without triggering a general sale of all members’ interests. There will be others where it will not be straightforward to establish the terms on which a minority might tag or be dragged, for example where there are multiple membership classes. (See Standard clause, Drag along rights: articles of association: joint ventures (www.practicallaw.com/6380-4866) and Standard clause, Tag along rights on a change of control: articles of association: joint ventures (www.practicallaw.com/0-380-4058) which are drafted for inclusion in the articles of association of a limited company. These standard documents could be adapted for use by LLP members taking into account the difference between a share in a company and a share in an LLP, the terms of the LLP agreement and any possible tax consequences (see Practice note, Limited liability partnerships: tax (www.practicallaw.com/3-107-3918)).)

GRANTING OF AN OPTION OVER AN LLP MEMBER’S SHARE Provided it is permitted under an LLP’s members’ agreement, there is no reason in principle why a member could not grant an option over some or all of his member’s share, either to an existing member of the LLP or to a third party. Granting an option to existing member(s) Where the option is granted to another member of the LLP, the option provisions could be included in the LLP agreement itself or in a separate agreement between the two members involved. If a separate agreement is entered into, the transfer of interests on exercise of the option would need to be permitted under the LLP agreement. Matters such as capital account balances, accrued profits, management positions and voting rights would need to be considered. Where an option is over the entirety of a member’s share, provisions would need to be included for the grantor’s membership of the LLP to terminate. Again, this would need to be permitted and provided for under the LLP agreement. The admission of the option holder would not need to be considered as he (or it) would already be a member. It would be possible for all the LLP members to enter into a cross-option agreement to finance the buy-out of members on death. This would be an agreement under which the members each grant to the others put and call options over their shares in the LLP. The options could be exercisable on death and be financed by life insurance policies taken out by the members, written in trust for the other option holders. (See Standard document, Cross option agreement (www.practicallaw. com/9-202-1614) which is drafted on the basis that it is entered into by all shareholders of a private limited company. This standard document could be adapted for use by LLP members taking into account the difference between a share in a company and a share in an LLP, the terms of the LLP agreement and any possible tax consequences (see Practice note, Limited liability partnerships: tax (www.practicallaw.com/3-107-3918)). Granting an option to a third party The grant of an option to a third party is a more complex issue. If the option was over the entirety of the grantor’s member’s share, on exercise the grantor would be likely to be required to terminate its membership of the LLP

Practical Law 7

ESSENTIAL CONTENT FROM PRACTICAL LAW

and the option holder would wish to be admitted as a member. This would need to be provided for in the LLP agreement, and the same issues would arise as for the transfer of a member’s share. Having to consider these issues and provide for them on a contingent and forward looking basis would be difficult in many cases. Before granting an option, or agreeing that another member may do so, members would need to consider the impact on the LLP of a third party being admitted as a member. For an LLP made up entirely of individual professionals, such as a surveying firm, admitting a third party as a member on the exercise of an option could radically change the culture of the business. For some businesses, including law firms and financial services businesses, provision would need to be made for regulatory issues arising on the admission of new members. An option over part of a member’s interest (for example an income stream or capital interest) that did not entail the admission of the option holder as a member on exercise of the option would also need to be permitted and provided for under the LLP agreement. This would still be complex, and could also give rise to regulatory issues. As with any other option, the restrictions in section 7(2) of the LLPA 2000 relating to an assignee’s right to interfere with the management or administration of any business or affairs of the LLP would need to be taken into account. As with an option over shares, the holder of an option over an interest in an LLP may require protections to preserve the value of his interest pending exercise of the option. These may include imposing restrictions on the financial activities of the LLP or securing consent rights for key issues, such as amendments to the LLP agreement. In some circumstances, the option holder’s rights could be sufficiently extensive as to put it at risk of being considered a shadow or de facto member (see Transfer of a member’ s interest (entirely or in part) to someone who is not to become a member above).

LLP’S PURCHASE OF A MEMBER’S INTEREST

2009/1804) (Petition by LLP member against unfair prejudice)) specifically provides that the court may make an order for the purchase of the rights and interests of any members in the LLP by other members or by the LLP itself. There will usually be provisions in the LLP agreement for the return of capital on a member ceasing to be a member and, in most circumstances, if the LLP buys a member’s share it is clearer to think in terms of a return of a capital contribution or a member ceasing to be a member rather than the transfer of an interest in an LLP. In determining whether it is possible for the LLP to buy a member’s interest, the terms of the LLP agreement should be considered. An LLP agreement may be drafted with provisions allowing for the LLP to buy a member’s interest, including provisions for: •

Calculation of the price of the interest (for example, linked to the performance or value of the business).

•

Extinguishment of the member’s rights following the purchase.

•

Repayment to the member of his capital contribution and undrawn profits.

Unlike a company, an LLP is transparent for tax purposes and so if the LLP purchases a member’s share, for tax purposes, the purchase will be treated as made by the members. For further details, see Practice note, Limited liability partnerships: tax (www. practicallaw.com/3-107-3918). If capital is returned to a member then under section 214A Insolvency Act 1986 (as applied to LLPs by Schedule 3 to the LLPR 2001) a liquidator may be able to claw back withdrawals made by members within the two years prior to the commencement of the liquidation (see Practice note, Insolvent LLPs: reviewable transactions and liability of members: Clawback of drawings from the LLP (www.practicallaw.com/7-5081021)).

PAYMENT FOR AN LLP MEMBER’S SHARE There are no statutory restrictions on the reduction of capital of an LLP or on preventing the LLP from “buying” an economic interest in the LLP from a member. Indeed, section 996(2)(e) of the Companies Act 2006 (as applied to LLPs by regulation 48 of the Limited Liability Partnerships (Application of Companies Act 2006) Regulations 2009 (SI

8 Practical Law

It is important that the LLP agreement deals with a member’s rights on ceasing to be a member, covering matters such as: •

Share of profits for previous and current financial year.

ESSENTIAL CONTENT FROM PRACTICAL LAW

•

Repayment of capital.

Timing and payment mechanics

•

Share of goodwill.

•

Share of the surplus value of other assets.

The timing and mechanics for making payments to an outgoing member vary considerably between LLPs. Some of the key considerations include the following:

•

Repayment of loans made by the member to the LLP.

•

Calculation of amounts payable: Some amounts are likely to be straightforward to determine, such as the balance on the outgoing member’s capital account. Others will be more complex, such as goodwill values where no simple mathematical formula is included in the LLP agreement. Some amounts may not be calculable immediately, such as the member’s share of profits for open accounting years.

•

Timing of payments: It is common for different categories of entitlement to be paid separately. Capital, for example, may be repaid immediately on termination, or may be repaid over a number of months or years. Accrued profits may be paid at the same time as equivalent amounts are paid to continuing members. Goodwill payments may be subject to a profit hurdle, so could be delayed significantly or paid out over a number of years. Loans may be paid over their original term, irrespective of the member’s termination.

•

Good leaver/bad leaver: Some firms will distinguish between good leavers and bad leavers. A bad leaver may forfeit part of his financial entitlement as an outgoing member, or may be paid out later than a good leaver.

Where no such provisions are included, there is some uncertainty as to what the entitlements of the outgoing member might be. Payments for goodwill A key issue will be whether outgoing members receive a payment in respect of the goodwill of the business and its surplus assets. Other amounts, such as accrued profit, capital and loans, should in most cases be available to pay to the outgoing member or be affordable out of the trading income of the LLP. A buy out of goodwill could be a material burden for the on-going members or the LLP, particularly on the retirement of a member with a significant ownership interest in the LLP or the simultaneous retirement of a number of members. For this reason, many professional services firms operate a “tenancy” model of partnership – members do not buy in to the goodwill on admission, and are not paid out for it on retirement. Where goodwill models are used, some LLPs will apply an extended payment period for the goodwill value, or apply a profitability hurdle to ensure that continuing members have access to a reasonable income before the outgoing member is paid out.

Practical Law 9