The Inform Direct specimen LLP agreement: a resource for LLPs

While it’s not a legal necessity, most limited liability partnerships will choose to put in place an LLP agreement. This is a legally binding contract between the LLP members which details their respective rights and responsibilities, duties and liabilities, as well as how the LLP should be managed. It varies and supplements the default statutory position, which is often felt to be inadequate.

Capital

The LLP agreement assumes each member will introduce some capital, however small an amount, which will be there from the commencement of trading. The reason for this is that HMRC have been known to assert that employees were being misrepresented as being self-employed. So, having each member contribute some capital strengthens any argument that each member is indeed a bona fide member. If there is no capital then the member would be missing one of the key characteristics of a member, namely: capital, remuneration based on a variable share of profits and a right to vote.

Profit share

The LLP agreement provides that the profits of the LLP will be split in accordance with any formula which the LLP members agree but in default of agreement, they will share profits pro rata to their capital contributions. Most partnerships have some kind of formula for sharing profits so the wording allows for that but has a contingency of pro rata sharing in case an alternative is not agreed. The statutory provisions assume that profits are shared equally even if different amounts of capital have been added.

Drawings

Some LLP agreements provide a detailed drawings policy. The Inform Direct specimen agreement simply provides that members will determine their drawings level from time to time.

Designated members

LLP legislation provides the concept of “designated members” and “ordinary members”. There is very little definition around their distinction other than “designated members” are the ones who are responsible for statutory compliance. The LLP agreement provides that all the members will be designated members.

Management

In the absence of an alternative agreement statute provides that all members are equally engaged in management with equal voting rights. The LLP agreement gives members an enabling provision to appoint a managing partner or a management board. However, this is purely an enabling provision and it envisages that the LLP would have to decide the management structure required, the authority levels and other such matters before they set it up.

Decisions reserved for a special majority

Whereas most management decisions require a simple majority it is generally prudent to require a special majority (defined in the agreement as 75%) for certain matters.  The LLP agreement requires a special majority for the following:

• the admission of any Member (statute would require unanimous approval);
• the suspension or expulsion of any Member (see below);
• the approval for a Member to devote only part and not the whole of his time and attention to the business of the LLP;
• the establishment or change of a profit sharing formula;
• the approval of the accounts;
• any increase in the LLP’s aggregate borrowings and/or giving of any guarantees;
• the winding up, merging or dissolution of the LLP;
• any substantial change in the nature of the business;

Expulsion and retirement

Under statute there is no power to expel a member without his or her consent, for any reason. It is probably this reason more than any other which warrants an LLP agreement being put in place. The Inform Direct LLP agreement provides that members retire on reaching 65 but they can give 6 months notice to retire earlier. There are also the usual expulsion provisions for misfeasance and non-performance etc. However, whereas lot of partnerships these days also include a “no fault” expulsion – the kind of expulsion where a person hasn’t actually broken the agreement but the other members just want them out – it should be noted that the LLP agreement does not contain such a provision.

Outgoing members

The LLP agreement provides that an outgoing member will get their capital repaid, and the balance of their accrued but undistributed profit share (or current account as it is known). Since most professional partnerships these days do not confer a goodwill payment on a departing member there is no provision in the LLP agreement to value and pay out goodwill.

Incoming members

Incoming members – those who join after the LLP Agreement is executed – will need to sign a Deed of Adherence,  agreeing to be bound by the LLP agreement, given that it only binds signatories. The LLP Agreement includes a model Deed of Adherence as one of the schedules.  It is important that incoming members sign a Deed of Adherence because whereas an incoming shareholder into a company is bound by the articles of association, that is not the case with a partnership deed.

Tax

LLPs are transparent for tax purposes.  Therefore, if the LLP makes a profit which is allocated to the members then the members will pay income tax on their share of the profits but, unlike a company, the LLP itself does not pay any tax on the profits. The LLP agreement provides the LLP can make a tax reserve and pay the tax to HMRC on behalf of the members. That is what many partnerships do. However, the LLP agreement also provides that the members can decide to pay out the profits without any tax reserve being withheld if they choose to do so. In this case, the members must ensure that they pay the tax personally on all profits allocated to them.

Other provisions

The LLP agreement provides general provisions around meetings including that there should be a minimum of one meeting each year and a quorum for a meeting is not less than half of the members eligible to vote. The members’ duties and restrictions are set out including a holiday entitlement. There is a mediation clause in event of a dispute and the agreement mirrors the statutory requirement to indemnify members in respect of expenses they incur in relation to the LLP.

When should the LLP agreement be signed?

The LLP agreement is drafted to make the Effective Date of the agreement the date the agreement is signed. Accordingly, members should sign and date the agreement when the business is commencing, as it is quite common for people either to start trading and then get an agreement sorted out,  or vice versa.