Legal requirements

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Rebecca, James, and Tessa plan to start a property investment venture and are comparing possible business structures under UK law. Tessa prefers to provide a significant capital contribution but remain a silent investor, only exposing her capital to risk. James and Rebecca want to be actively involved in day-to-day management. Another friend, John, suggests adopting a structure that grants the new venture a separate legal personality for operational efficiencies, enabling all members to share management if they wish. They have not yet entered a formal agreement and want to ensure Tessa’s liability is limited while preserving maximum flexibility for everyone else.


Which of the following structures best meets Tessa’s desire to remain a silent investor with limited liability, while providing separate legal personality for the business and allowing James, Rebecca, and John to participate in management?

Introduction

Partnerships and Limited Liability Partnerships (LLPs) are business structures governed by specific statutory frameworks in UK law. Partnerships are regulated by the Partnership Act 1890, whereas LLPs are governed by the Limited Liability Partnerships Act 2000. A partnership is defined as the relation which subsists between persons carrying on a business in common with a view to profit (s.1 Partnership Act 1890). An LLP is a body corporate with a legal personality separate from its members. Understanding the legal requirements for forming these entities involves examining their formation processes, registration obligations, and the liabilities of partners and members. This analysis provides important knowledge of the statutory obligations and legal implications associated with each structure.

General Partnerships

Formation and Governance

A general partnership is formed when two or more persons carry on a business in common with a view to profit, without the need for formal registration or documentation. Although a written partnership agreement is not legally required under the Partnership Act 1890, it is prudent for partners to formalize their arrangement through a partnership deed to define their rights and obligations clearly and to prevent disputes.

Key Legal Principles

Unlimited Liability

Under s.9 of the Partnership Act 1890, partners in a general partnership have unlimited liability for the debts and obligations of the firm. They are jointly liable for the firm's debts incurred while they are partners and severally liable for wrongful acts or omissions. This means that creditors can pursue any or all partners for the full amount of the partnership's debts, and each partner's personal assets are at risk.

Agency Principle

According to s.5 of the Partnership Act 1890, every partner is an agent of the firm and the other partners for the purpose of the business. Consequently, any partner can bind the firm and the other partners when acting within the scope of the partnership's usual business. This principle highlights the importance of trust among partners, as actions by one partner can create obligations for all.

Fiduciary Duties

Partners owe fiduciary duties to each other and to the firm. These duties require partners to act in good faith, to account for any benefits derived from partnership business without consent, and to avoid conflicts of interest. Breach of these duties can result in legal action and potential dissolution of the partnership.

Default Provisions Under the Partnership Act 1890

In the absence of an agreement to the contrary, s.24 of the Partnership Act 1890 provides default rules for the governance of partnerships:

  • Equal sharing of capital and profits, and equal responsibility for losses.
  • Every partner may take part in the management of the business.
  • No partner is entitled to remuneration for acting in the partnership business.
  • Ordinary business decisions may be decided by a majority, but changes to the nature of the partnership business require unanimous consent.

Understanding these default provisions is important for partners who have not formalized their arrangements, as they will govern the operation of the partnership by default.

Limited Partnerships

Structure and Legal Implications

Limited partnerships are established under the Limited Partnerships Act 1907 and consist of one or more general partners and one or more limited partners. General partners manage the business and have unlimited liability, while limited partners contribute capital and have liability limited to the amount of their contribution, provided they do not participate in management.

Formation Requirements

  • Registration: A limited partnership must be registered with the Registrar of Companies by delivering a signed and completed Form LP5, along with the appropriate fee.
  • Partnership Name: The name of the limited partnership must not be the same as an existing registered company or LLP.
  • Contribution of Limited Partners: Limited partners must make a contribution to the partnership, which can be in the form of money or property.

Restrictions on Limited Partners

Limited partners may not take part in the management of the business. If a limited partner participates in management, they become liable as a general partner for the duration of their involvement. This restriction is essential to maintaining the limited liability status of limited partners.

Advantages and Considerations

Limited partnerships are often used in investment funds and real estate ventures where investors wish to contribute capital without engaging in day-to-day management. The structure allows for flexibility in capital raising while limiting the liability exposure of passive investors.

Limited Liability Partnerships (LLPs)

Legal Characteristics

An LLP is a corporate body formed under the Limited Liability Partnerships Act 2000, possessing a legal personality separate from its members. This means the LLP can own property, enter into contracts, and sue or be sued in its own name. Members of an LLP benefit from limited liability, protecting their personal assets from the debts and obligations of the LLP.

Formation Process

  • Incorporation Document: To form an LLP, at least two persons (individuals or companies) must subscribe to an incorporation document.
  • Registration: The incorporation document, along with Form LL IN01 and the registration fee, must be submitted to the Registrar of Companies.
  • Name Requirement: The LLP must have a name ending with "Limited Liability Partnership" or "LLP".

Members' Agreement

Although not required by law, it is advisable for members to enter into a Members' Agreement. This agreement outlines the rights and duties of the members among themselves and between the members and the LLP, covering matters such as profit sharing, decision-making processes, and procedures for introducing or removing members.

Legal Framework

LLPs are governed primarily by the Limited Liability Partnerships Act 2000 and the Limited Liability Partnerships Regulations 2001. Where the legislation is silent, partnership law or company law may apply by analogy, although this can be complex. Members of an LLP owe duties similar to fiduciary duties in partnerships, requiring them to act in good faith towards the LLP.

Advantages of an LLP

  • Limited Liability: Members are generally not personally liable for the LLP's debts beyond their capital contribution.
  • Separate Legal Entity: The LLP can hold assets and enter into contracts in its own name.
  • Taxation: LLPs are taxed as partnerships rather than as companies, meaning profits are taxed as income of the members.

Comparative Analysis

Liability Exposure

  • General Partnership: Partners have unlimited personal liability.
  • Limited Partnership: General partners have unlimited liability, limited partners have liability limited to their contribution.
  • LLP: Members have limited liability.

Management Participation

  • General Partnership: All partners may participate in management.
  • Limited Partnership: Only general partners may participate in management; limited partners must not.
  • LLP: All members may participate in management.

Legal Status

  • General Partnership: No separate legal personality.
  • Limited Partnership: No separate legal personality.
  • LLP: Separate legal personality.

Practical Considerations

When choosing a business structure, considerations include liability exposure, management involvement, tax implications, and regulatory obligations.

Example 1: Professional Practice

Professionals such as solicitors or accountants may choose to form an LLP to benefit from limited liability while retaining the flexibility of a partnership structure. The separate legal personality of the LLP protects members' personal assets, and the tax transparency avoids the double taxation associated with companies.

Example 2: Investment Fund

An investment fund may use a limited partnership structure to attract investors as limited partners who contribute capital without participating in management. The general partner manages the fund and bears unlimited liability, which may be mitigated by incorporating the general partner as a limited company.

Legal Precedents

Hurst v Bryk [2002] 1 AC 185

This case addressed the dissolution of a partnership and the continued liability of partners for obligations incurred prior to dissolution. The House of Lords held that partners remain liable for antecedent debts even after the partnership has ended, emphasizing the enduring nature of partnership obligations.

Inversiones Frieira SL v Colyzeo Investors II LP [2012] EWHC 1450 (Comm)

In this case, the court considered whether a limited partner's actions amounted to taking part in the management of the business, which would result in the loss of limited liability. The court examined the nature of the limited partner's involvement and reinforced the principle that limited partners must avoid management activities to retain their limited liability status.

Conclusion

Limited Liability Partnerships, governed by the Limited Liability Partnerships Act 2000, represent a complex combination of corporate and partnership principles, providing members with limited liability and operational flexibility. This structure interacts with agency principles and fiduciary duties, allowing members to participate in management without increasing their personal liability. Limited partnerships under the Limited Partnerships Act 1907 offer limited liability to investors who refrain from management, balancing capital infusion with risk allocation. General partnerships, formed under the Partnership Act 1890, impose joint and several liability on partners and rely on mutual agency and trust among partners. Understanding the legal requirements for forming these entities, including their formation processes, liabilities, and statutory obligations, is essential for understanding the legal implications associated with each business structure.

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Saptarshi Chatterjee

Saptarshi Chatterjee

Senior Associate at Trilegal