When structuring the membership of the LLP, a frequently asked question is whether the partners or members must be individuals or whether a company can be a partner or a member.
An LLP is, of course, flexible enough to accommodate both or a combination of the two. In professional services firms, typically the members would be the individuals themselves. As a revenue-centric and capital neutral model, use of a corporate adds an unnecessary level of complexity and additional regulatory requirements.
There may also be tax benefits of participating as a natural person in an LLP, for example, the individuals will pay Class 2 NIC and the LLP will not be paying employer’s NICs, representing a saving of approximately 13% (depending on the prevailing tax rates) on income. In the professional services sector, use of a corporate member is usually only driven by other factors, such as professional regulation, for example, under the French bar rules, avocats are required to be employed by a French company or be partners in a French partnership.
In other areas, however, the use of a personal company as the member or partner has several alternative advantages. In general partnership structures, where the partners have unlimited joint and several liability for the debts of the partnership, the use of corporate partners provides a degree of protection from this exposure for the individuals involved.
Estate planning may also be a consideration; for example, in farming partnerships, shareholders in a corporate partner may include spouses, issue or family trusts. Personal wealth planning is often also a driver, typically in the fund management sector where the members’ interests include an investment element, such as a carried interest, exit payment, or anti-embarrassment provisions.
Private equity investment and corporate joint ventures will invariably involve at least one corporate member.
Obligations in the LLP deed
The key issue – from an operational element where corporate members are used – is to bind the individual participants in the corporate members (typically the sole director) to the obligations of members in the LLP deed. Given the lack of statutory or contract accountability to the LLP, it is critical that the individuals are bound by replicate fiduciary duties, disciplinary procedures and grounds for expulsion, for example. Individuals themselves will also want the benefit of, for instance, holiday entitlement, sick pay and incapacity provisions in the LLP deed.
Curiously, this aspect of participation by a corporate member is so often omitted or dealt with at only a cursory level in the LLP deed. A well drafted constitutional document will have accommodated this issue thoroughly.
There are a number of ways in which an individual director of a corporate member or partner may be bound into the provisions in the deed. At a basic level, the partnership or LLP deed should provide for powers of the corporate member (for example, voting rights) to be exercised by any director of the corporate member.
Each corporate member should undertake to the other members that it will procure that the individual director enter into an agreement with the company (often the director’s service agreement) to be bound by the duties and obligations of the members, as if they were a direct participant. The terms of their service agreement should provide for the same disciplinary grounds or termination provisions as those in the LLP deed. Such an event at corporate/director level will simultaneously trigger a disciplinary or expulsion provision under the LLP deed.
This works well to a degree and may on a practical level be sufficient to bind the individuals to most of the operative provisions of the constitutional document. It will not, however, allow the other members to exercise any form of discretion regarding the individual’s conduct. This may well become essential t in the context of disciplinary action, garden leave, expulsion, or even some of the more nuanced provisions regarding undertaking external roles and accounting for profit to the LLP.
If this is felt necessary, it will be important for the individual director to be bound by the LLP or partnership deed, as if they were a direct participant. It may be that they are also members with no entitlement other than a token profit share, and that their behaviour, rights and implication will be deemed those of their ‘connected company’. Alternatively, they may be party to the LLP deed for the purposes of direct enforcement/benefit of specific provisions.
In a pure corporate deal, PE investment or a corporate joint venture, this aspect may be less of a consideration. Nevertheless, it cannot be disregarded in its entirety, as is too often the case, and each LLP or partnership deed should be considered on a more granular basis to reach the appropriate commercial position.
This often-neglected aspect of the preparation of a partnership or LLP deed, should not slip through the net at structuring phase. It is only when adverse circumstances arise that many firms only wish they had been advised to consider this aspect at an earlier stage.