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Smith and Williamson provide an introduction to Limited Liability Partnerships (LLPs) as a possible business structure. 

Advantages of a Limited Liability Partnership

LLP status has a number of advantages over a partnership structure, including the following:

1. Limited liability – by far the most important benefit is that only the LLP will be responsible for its own contractual obligations and only a member who is personally negligent will be potentially exposed to claims in tort, and even this may perhaps be eliminated or significantly reduced through carefully worded engagement letters. This is of course the key reason for adopting an LLP structure.
2. Like a company, an LLP will be able to contract in its own name so that there will be no need to deal with novation of contracts every time partners retire or are appointed. Neither will there be a complex web of indemnities between generations of partners.
3. The LLP will have unlimited capacity, including the ability to grant floating charges.
4. The tax position of members of an LLP is very similar to that of the partners in a partnership. In order to benefit from some of the advantages of practising through a body corporate, individuals who are accustomed to practising through a partnership may feel more comfortable transferring the partnership business to an LLP, rather than a company.

However, there may be a number of reasons why a firm will decide not to convert to an LLP (which is the short-hand phrase often used to describe the process whereby the partnership business is transferred to an LLP), and these are discussed in the following section.

What Might Prevent a Partnership Converting to an LLP?

Potential barriers to conversion include the following:

1. Current partners – most partnership agreements will require a very substantial majority before the partnership can dispose the whole of its business to an LLP, as a separate corporate body, and be dissolved. Some even require unanimity, and unanimity will be required if there is no partnership agreement. Is there a danger that a disaffected minority may use the exercise of an effective veto as a weapon in a dispute on something completely unconnected? It is important to think through the decision that will be required and how to achieve it.
2. Retired partners – in some (increasingly rare) cases, retired partners are entitled to an annuity from the current partners. Sometimes they are even given the right to a lump sum if the firm is ever dissolved or its business transferred, and this may give retired partners an effective veto. In these circumstances their agreement should be obtained, and ideally they should be asked to release the partners from their personal obligations in return for a covenant from the LLP. However, the obligation to pay the annuities will then have to appear on the LLP’s balance sheet (see (e) below) and in many cases it may be appropriate for the members to retain the liability to pay the annuities personally out of their profit shares, with the LLP having no liability at all. Arrangements will have to be made to release retiring members and to bind incoming members.
3. Banks – banks are likely to have two levels of exposure, loans to partners individually to finance their capital contributions and facilities provided to the partnership itself. In an ideal world, from a limited liability standpoint, the bank would be asked to provide facilities to the LLP or company, rather than to each individual member who would then have a personal liability, and to release the partners personally from any continuing liability. However, banks may insist on security and on continuing personal guarantees from the partners.
   Their attitude will depend very much on their perception of the firm and its management. Many larger and better managed firms are often able to take facilities for the LLP without any requirement for personal guarantees, provided that the balance sheet of the LLP is strong enough.
4. Landlords – landlords generally have direct personal covenants from at least some of the partners who, in turn, have rights of contribution from the other partners. In many cases, landlords will be reluctant to give up these rights and may insist on being given equivalent protection in the form of personal guarantees. Some far-sighted firms may have negotiated leases in a form which allows them to substitute an LLP as tenant unilaterally. Either way, the position of landlords needs to be considered.
5. Accounts – the requirement of filing accounts may be a major issue for many firms. Furthermore, the requirement that the accounts comply with UK Generally Accepted Accounting Practice may be a barrier to conversion. For example, if provision has to be made on a capitalised basis for retired partners’ annuities, or vacant property, will this make the LLP’s balance sheet look so bleak as to preclude incorporation at all? Can the offending liabilities be kept off the balance sheet of the partnership and retained by the partners, or will this mean that the LLP does not provide sufficient protection to make conversion worthwhile? Can other steps be taken to address the problem? These issues need to be reviewed with the firm’s accountants.
6. Clients – experience suggests that limited liability in itself is unlikely to lead to the loss of clients, provided that it is handled carefully.
   Clients tend to choose their professional advisers on the basis of the strength of the relationship and their track record, rather than because each partner will be jointly and severally liable if something goes wrong. But, especially if the firm is heavily dependent on a small number of major clients, it will be as well to sound major clients out before incurring substantial expense. The need to enter into new engagements with all clients post-conversion may be a daunting prospect, but is unlikely to be significant enough to be a barrier to conversion. While the process may be laborious, it can present a business development opportunity as contact is re-established with all clients.
7. Tax and regulations – more complex overseas structures may be required if LLP or company status is adopted. For example, a firm with overseas offices which incorporates as an LLP may find that it is treated as a company for tax purposes in some countries and the risk is obviously much higher where a partnership incorporates as a company. Companies and LLPs may also be prohibited from practising at all in other countries by local regulations. This may mean that the business in such jurisdictions will have to continue to be conducted in partnership. Running an LLP and one or more partnerships in parallel gives rise to a number of significant issues. How can it be ensured that clients know when they are being advised by the partnership or by the LLP? How can the ‘holding out’ risk associated with referring to all ‘partners’ by that term whether they are partners in the partnership or members of the LLP, or both, be minimised? How can profits generated by the partnership and the LLP be shared on a combined basis without tax and liability issues arising? How can those practising in the partnership be compensated for the loss of a right to a contribution to losses from those who are no longer partners in the partnership? How can the risk of double taxation be minimised?

Major international professional practices have had to cope with these and many other issues when they have transferred the bulk of their practices to an LLP. Expert advice should be sought at an early stage.

The above is adapted from the Professional Practices Handbook, published by Bloomsbury Professional.