Second Edition

Partnership Agreements for Law Firms Nicholas Wright

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Chapter 1: Partnerships, LLPs and limited companies In the first edition of this report, this chapter opened with the words, “Solicitors with the appropriate practising certificate and insurance may practise as sole principals, in partnership, as limited companies, in limited partnerships under the Limited Partnerships Act 1907 or as members of a limited liability partnership under the Limited Liability Partnerships Act 2000.” This is no longer strictly true. Although the basic structures under which solicitors may practise remain the same, the implementation of the Legal Services Act 2007 has resulted in solicitors being required to be authorised bodies if they wish to practice. However, the advent of Alternative Business Structures (ABSs), for which application can be made from 10 August 2011 and the new Solicitors’ Code of Conduct which has been designed to suit ABSs, means that the consideration of what form a practice should take is more open than before. Limited partnerships under the Limited Partnerships Act 1907 consist of one or more general partners who are liable for all debts and obligations, and one or more limited partners, essentially investors, who are not liable for debts and obligations beyond the amount contributed. Limited partnerships are registerable under the Limited Partnerships Act 1907. There are only a small number of firms of solicitors practising in this manner at present, but the structure may have some attractions for those seeking an outside investor. The Department for Business

Enterprise and Regulatory Reform issued a consultation document in August 2008 with a view to making amendments to the Limited Partnerships Act 1907. Essentially, the Limited Partnerships Act 1907 has been modified and new provisions about limited partnerships inserted through the Legislative Reform (Limited Partnerships) Order 2009 under the Legislation and Regulatory Reform Act 2006. The changes are designed to harmonise the registration procedures with those applicable to limited liability partnerships (LLPs) and companies and were implemented from 1 October 2009. LLPs have become much more popular in recent years for various reasons. Like limited companies, they require registration and have a corporate structure, but they are intended to work as a hybrid of partnership and corporate governance. They offer a degree of limited liability (although this is not absolute), a taxation regime which is similar to that of a partnership and the opportunity for the designated members to set out, in the same way as they could if they were partners in a normal partnership, the rules by which the LLP will be governed. An LLP is not a partnership and should not be treated like one. To begin with, it has a separate legal identity, whereas a partnership consists of a number of individuals trading under a firm name. A partnership exposes its partners to potentially unlimited liability whereas an LLP is theoretically liable only to the extent of its own assets and not those of its members.

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It is the theoretical limit of liability which has not only caused the popularity of LLPs among solicitors, but is also partly responsible for the significant cultural difference between them and partnerships. LLPs are advised to ensure that all their contractual relationships are in the name of the LLP and not in the name of any individual member, as there is a fear that an individual member who has been negligent or has entered into some other catastrophic obligation, could become personally liable. Such an avoidance of liability will depend on whether or not there has been an assumption of personal responsibility by an individual member and whether the exclusion of any duty of care is reasonable under the Unfair Contract Terms Act 1977 and, if the client is an individual, under the Unfair Terms in Consumer Contracts Regulations 1999. On the assumption that these tests are passed satisfactorily, the LLP could, if inadequately insured, still go bankrupt if a successful major claim is made against it, and it is at this point that a major difference between the corporate culture of an LLP and the collegiate culture of a partnership can become most exposed. A bankrupt LLP could take action against a member who has breached their duty of care to the LLP, and thus they could become personally liable to the firm’s creditors, even though they may have escaped direct liability in the first instance by sheltering behind the semi-corporate structure of the LLP. For this reason, many LLPs exclude the duty of care between members of the LLP and the LLP itself, although this exclusion may, depending on the terms of the LLP agreement, be limited in scope. By contrast, the partners in a partnership all bear responsibility for acts of other partners committed with the firm’s express, implied or apparent authority. Because of

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that shared responsibility, there has perhaps been less of a tendency for partners to lay the blame on their fellow partners than is the case with LLPs, because there is no apparent gain for so doing. Historically, even before the Partnership Act of 1890, the duty of good faith between partners, both in negotiations for, and during, the partnership has been paramount. The Partnership Act of 1890, although containing a number of flaws, is based on the concept of fairness and good faith between the parties and has had, particularly among solicitors, remarkably few legal challenges considering its age and the complexities of modern partnerships. Until relatively recently, most solicitors’ practices were in the form of partnerships and most assumed that a partner, once admitted, would remain with the partnership at least for a considerable time. Partnerships generally worked on a lockstep principle, which rewarded loyalty and continuity and tended to be run, whether autocratically or democratically, in a collegiate style. Individual partners would be responsible for their own work, their own clients and sometimes even their own staff. Although firms of solicitors could, in practice, be disciplined to a degree for the actions of one of their partners on the grounds of joint and several responsibility and certainly for the actions of their employees for failure to supervise, the principle by which the disciplinary process worked was that of personal responsibility. That position has now been reversed as a result of the redrafting of the Solicitors’ Code of Conduct in order to make it more appropriate to ABSs. Essentially, it is intended that all solicitors, in whatever form their practice is structured, shall be regarded as authorised bodies and, as a result, it is the body itself that will become liable for

Partnership Agreements for Law Firms

any breaches of conduct, either instead of, or in addition to, the solicitor who is actually in breach. Limited companies and limited partnerships have already been mentioned and, although they might be considered by practitioners, are not presently in mainstream use. However, limited partnerships are often used as vehicles for joint venture agreements and it is possible that the type of investor familiar with them might be interested in investing in a legal practice under the new ABS rules. Also, limited companies have attractions for some types of practice and are readily understood by potential investors. They have a recognisable mechanism for defining share capital and, by extension, are suitable vehicles for those trying to create capital or brand value in their practices in order to sell shares to outside investors. However, most firms operate as LLPs or partnerships. The main differences between the two may be summarised as follows: „„ A partnership can be set up informally, although it is always advisable to have the main terms recorded in an agreement. The existence of a partnership is a matter of fact and will depend on whether a business is carried on by two or more persons with a view to profit as defined in the Partnership Act 1890. An LLP, by contrast, must be formally incorporated and registered at Companies House; „„ The fallback provisions of the Partnership Act 1890 generally follow equitable principles and assume that conduct before, during and after the partnership will be conducted in good faith. There is also a reasonable body of case law to assist in determining issues which may not have been specifically agreed by the partners. By contrast, there is no implied

duty of good faith between the members of an LLP, although there is a duty to the LLP itself unless this is removed by agreement. The default provisions for LLPs are contained in the Limited Liability Partnership Regulations 2001 and have been made by the Secretary of State under Section 15 of the Limited Liability Partnership Act 2000 which, incidentally, does not empower the making of such regulations. In any event, the default provisions apply to members and not former members, so those who retire or are expelled may be disadvantaged; „„ A partnership does not have a separate legal personality and cannot enter into contracts or hold assets in its own name. For this reason, properties are normally held by partners on behalf of the firm, which can lead to complications when a partner retires, is expelled or dies, unless proper provision has been made in the partnership agreement to ensure that the equitable ownership is clear. By contrast, an LLP is a body corporate with a separate legal personality. The Law Commission, in its consultation paper on the reform of the Partnership Act,1 proposed that partnerships should develop a separate legal personality but, unlike LLPs, without limiting the liability of the partners. However, there is still no indication that any reform is imminent; „„ Partnerships have unlimited joint and several liability for the debts and liabilities of the partnership incurred while an individual was a partner and potentially after that date where ongoing liabilities have already been incurred. An LLP exposes its members only to the level of their financial interest in it, although the limit on liability may not extend to wrongful or fraudulent trading, personal negligence by a member or liability for

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any personal warranties, undertakings or guarantees; „„ In theory, LLPs and partnerships have similar tax treatment as partners are taxed individually and an LLP is tax transparent; and „„ Public disclosure – partnerships do not have to disclose their financial data (other than to comply with the Solicitors’ Code of Conduct or the Solicitors’ Accounts Rules), whereas LLPs must file annual accounts and annual returns. The accounts should include details of the aggregate drawings of members and the highest remuneration of a member, whereas partnerships make no such disclosure. A partnership must state, or in the appropriate circumstances have available, a list of the names of the partners and an address for service of documents which need not be the partners’ residential addresses. An LLP will have to give the names of all, or none, of the members on the notepaper in a similar way to the obligation of a company to show the names of all, or none, of its directors on its notepaper. Reference 1. ’Partnership Law: A Joint Report’, 18 November 2003; can be found at: http://www.lawcom.gov.uk

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