Walk Through Limited Liability Partnerships

1. Walk Through Limited Liability Partnerships

2. Concept paper on LLPs in India • Based on the recommendations of the NC Gupta committee, and the Irani committee, the Govt had come out with a concept paper and a draft of the LLP bill in late 2005 • LLP Bill has been placed before • LokSabha on 7th Dec 2006 • RajyaSabha on 15th Dec 2006. • LLP Bill approved by LokSabha on 15th Dec 2008

3. Concept paper on LLPs in India • First LLP in India expected by 1.4.2009 • The Constitution (entry 44, List 1 of Seventh Schedule) has put “corporations law” in the Union List: • As LLP’s are to be given an incorporated status, they will fall under this list

4. Concept of LLPs • The word “partnership” in LLPs is a misnomer, as the entity is not merely a collective coming together of two persons: • Results into creation of a new entity with its own existence • LLPs are a hybrid between a company and a partnership: • Externally, they have all features of a company • Internally, they are run and managed by the members, hence they are like partnerships • The idea is to clothe a partnership with • Limited liability • Incorporated existence and therefore personality of its own • The concept of LLPs has inherent inconsistencies, as it has not had benefit of seasoning over centuries: • US law also relates to 1990s – Delaware model is the most commonly used one.

5. LLP legislation in other countries • In UK, LLP law was passed in 2000 • The campaign for LLPs was initiated by accounting firms (PwC and E&Y) to limit their liability: • Though UK Companies Act did allow professions to register as companies, accounting firms were reluctant to publish accounts subject to inspections etc • The UK move set the ball rolling in other countries too: • Canada (Ontario) introduced LLP law in 1998 • Singapore issued consultation paper in 2002, enacted the law in 2005 • In UK, the LLP model is available for all businesses; in New York, it is open only for selected professions.

6. Advantages of LLP • Easy to incorporate, very little paper work required • Low cost of incorporation • Lot of flexibility • Very little accountability, in terms of legal compliance • All benefits of a partnership business, though with a new entity • Taxation as general partnerships

7. Overview of the UK LLP law • Most obvious feature: the law is very short, very simple: • Just 19 sections, no schedules • Owners and managers are the same: one member designated as “designated member” • May be a founding member or may change • Unlimited business capacity • Principle of agency/principalcy applicable: • Every member is an agent of the LLP • Limited liability must always come with protected capital: • The law provides for capital of each partner, but does not restrict drawing • Capital or liability not mentioned in incorporation documents

8. Salient features of the LLP Bill - Constitution • Indian law seems based on the Singapore law • LLP is a body corporate, separate entity, perpetual succession: • To ensure perpetual succession, transferability of membership is a must • Persons constituting it are members: • Individuals and corporates may be members: • Since body corporate will include an LLP, an LLP may also be a member • At least 2, maximum not specified • Existing firms and Companies may convert themselves into LLPs –Schedule 2 (Firm),3(Private Company) and 4(Unlisted Public Company) provide for the same: • Eligibility in case of a company – no charge subsisting on the assets of the company or in force at the time of winding up • No such eligibility condition in case of firms • Partners of newly incorporated LLP comprise only: • Shareholders in case of company • Existing partners in case of partnership firm

9. Management of LLPs • The law requires at least two designated partners • Who are individuals • At least one shall be a resident of India • The position of designated partners seems to be the same as in case of directors • The designated partner has the ultimate responsibility. He is: • Answerable for all acts matter or things, done or to be done by the LLP, and shall be personally liable for all penalties on the LLP • The LLP is liable for only the contravention of this section (appointment of a manager) • This section has serious implications: • by not appointing a designated partner, penalty not less than Rs. 10000 but up to Rs. 500000 • UK law talks of designated member; if no member is designated, then every member is a designated member

10. Preservation of capital • One of the most important pillars of the limited liability is definite capital: • Capital is the foundation on which the assets are built • The LLP law, limiting liability, leaves the issue of preservation of capital very vague: • Capital is not mentioned in the Incorporation document; hence not disclosed to the public • Capital of partners may be drawn • Sec 65 leaves the issue of contribution on winding up completely open • to be provided in the partnership agreement – which is not a public document • The Act provides the liability of the partnership to be met solely from the property of the partnership: • Property means, net property, that is, net worth, which is the capital • If there is no capital maintenance clause, the whole concept may be totally flawed • The basis of contracting external liabilities is only a declaration of solvency: • Which does not serve the purpose of credit evaluation, as solvency is only as on the date on which it is made • In absence of capital maintenance, LLP might be NLP – no liability partnership

11. Preservation of capital or capital insurance • UK law requires partners to contribute to the extent of drawings made within 2 years prior to winding up • Insolvency rules in India are applicable to only individuals • LLPs may be subject to corporate bankruptcy rules: • Undue preference rules may require returning of drawings made 1 year before winding up [sec 531A]

12. Partners and their relationship • Initial partners are subscribers to original document • Any one can be partner in accordance with agreement: • Individuals and bodies corporate may be partners • Designated partners must at least be two individuals • In case of bodies corporate as partners, at least two individuals to be designated • Insistence comes from the need for individuals to be directors • Partnership interest is not a transferable security but requires agreement with all partners • Mutual rights of partners are allowed to be governed by the partnership deed

13. Partners and their relationship • Cessation: • Death, etc • Mutual agreement • Resignation by 30 days’ notice • A retiring partner shall be entitled to receive the credit of his capital and share of accumulated profit determined to the date of his cessation: • The law should provide – subject to mutual agreement • Changes in partners to be notified to the registrar

14. Partnership principle • Every partner to be agent of the LLP, not of other partners • Partnership interest interestingly split into: • Economic interest • Non economic interest • Economic interest means right to share in profits • Economic interest assignable, but assignee is not treated as a partner, nor gets any right of participation in management: • Creates interesting situation: • Partner may be X, assignee of economic interest may be Y • X incurs liabilities, Y has all economic interest, but no obligation, as he does not have any partner status • Companies Act, on the contrary, recognizes no trusts or equities on the shares

15. Transferability of partners’ interest • Seems the share of the partner in the capital of the firm, and share in profits, are two separate interests • Share in profits a transferable interest: sec 42 • This has clearly followed the Singapore model

16. Accounting and reporting • LLPs are required to maintain records, but not: • Hold meetings and lay accounts • File accounts • Publish accounts • They only make an annual declaration of solvency • To be made within 6 months from end of FY • To be signed by designated partners

17. Taxation • In line with UK law, Act provides for taxation of income as in case of general purpose partnerships

18. Inspection and investigation • Provisions analogous to sec. 234 and 235/ 237 of Companies Act • Prosecution powers to the Central Govt. – Sec 50

19. Winding up • Winding up may be either voluntary or mandated by the Tribunal • Regulations to be provided • Notably, Singapore has a huge set of rules applicable to winding up of LLPs, almost in line with the Companies Act

20. Applicability of Companies Act • UK has extended a large chunk of Companies Act provisions to LLPs too: • Power contained in sec. 67 to extend Companies Act provisions: • Very likely that several of the administrative provisions may, over time, be extended

21. Penalties and prosecution • The power to impose penalties has been granted to the Tribunal

22. Comparing LLPs and private limited companies – Similarities • Incorporated Personality • Perpetual existence, winding up by law • Plurality of owners • Limitation of contributory liability • Limits on trading powers

23. Comparing LLPs and private limited companies – Differences

24. Separation of management and ownership • One of the key features of LLPs is that there is no separation of ownership and management: • Hence, the foundations of corporate law, with the owners reposing trust in the management do not apply • Much of the reporting and accountability structure of corporate law arises out of this separation • UK LLP law does not provide for separation of management: • In fact, there is a “designated member” who will be answerable to the regulators

25. Administrative authorities • Incorporation, striking of defunct LLPs: Registrar of Companies • Registry record keeping, inspections, etc: • Registrar of companies • Compromise, arrangement, etc • Central Government • Rule making powers; powers to notify Companies Act to be applicable • Winding up • Tribunal • Prosecution for offences: • Lower courts

26. Legal Compliance • DPIN for designated partners • Particulars of designated partners are to filed • Incorporation – by filing incorporation document with the ROC • Reservation of name, change of name, etc – provisions similar to Companies Act • Partnership agreement and changes therein to be filed with the ROC: • Surprisingly, the partnership deed is not one of the documents available for inspection u/s 35 • While the basic rights of the partners are defined in the document • Registration of changes in partnership (names of partners) • Filing of annual accounts and declaration of solvency • Audit of accounts • Filing of annual return • Powers of the registrar to call for information, inspection and investigation largely the same as in case of companies • Compromise, arrangements etc as per rules to be made by Central govt.

27. What may the LLP hold • LLPs may hold any property, tangible or intangible • Interestingly, partners may transfer, either as contribution or otherwise, properties in kind also • Unlike in case of companies, no fetters on transfer of property in kind or a separate disclosure: • Valuation of the property not given the seriousness it deserves

28. Liberties that the LLP enjoys • Accounting: • May write books on either cash or accrual basis • Might lead to a considerable tax advantage • Clear conflicts with the audit requirements – cash basis cannot reflect true and fair value of the state of affairs • Accounting standards not applicable • Limitation of liability: • Best of both the worlds – limited liability and flexible capital • No minimum capital requirements • Audit: • While auditing is mandatory, there is no substantive detailing in the law • Rules are much more liberal than for companies • Borrowings: • No restriction on borrowing from partners, or to partners • The act puts amounts owned to partners at par with amounts owned to others • No need to create charges • Not in the best interest of lenders

29. Ultravires, agency rule and LLPs • The doctrine of ultravires is not applicable to LLPs • Since the objects are not required to be specified in the incorporation document • At the same time, the partners are supposed to be agent of the LLP: • Partner exceeding his authority does not bind the LLP • In other words, the LLP escapes liability for anything done in excess of the assigned authority • Authority of LLPs contained in partnership document • Those dealing with the LLP cannot get partnership document as it is not one of the docs that may be inspected • This leaves those dealing with the LLP at a great risk

30. Conversion into LLPs • Firms, private companies and unlisted public companies may convert • Firms: • All partners to continue • Amount to dissolution of the firm • Transfer of property by way of vestation – may be stamp duty may be escaped • Private companies: • There is no security interest on the property • All members of the private company continued as partners • There is no need to seek sanction of the lenders, etc • Public unlisted companies: • Same as in case of private companies