UK: Converting a Partnership to an LLP: Why Convert?

The benefits of converting to a limited liability partnership ("LLP") should outweigh any other considerations. In particular, in an LLP, each partner, or "member" (as they should be called) will in most cases have no personal liability for obligations of the LLP or the other members - unlike in a general partnership, where a partner can be sued personally for the full amount of a claim and could risk losing all his personal assets.

An LLP is a form of legal entity created by the Limited Liability Partnerships Act 2000. The LLP is a body corporate, separate from its members, and can enter into contracts and take on obligations in its own name, usually without the members of the LLP exposing themselves to any personal liability.

In this respect, the LLP is similar to a limited company, where shareholders are not personally liable for the company’s debts, but one fundamental difference is that the LLP is tax-transparent, so its members are taxed in the same way as the partners of a traditional partnership.

Subject to the exceptions described below, the members of an LLP will be less exposed to personal liability than the partners in a general partnership. It is true that if the LLP is sued, cannot pay and is wound up (remember that there is no limit on the liability of the LLP itself – it is the members’ liability that is limited), each member will lose the amount he has invested into the LLP, but in most cases he will have no other liability and his personal assets (savings, car, home, etc) will be safe.

• Liability for debts and obligations: In a traditional partnership, every partner is "jointly" liable with all the other partners for all the debts and obligations incurred by the partnership while he is a partner. This means, for example, that if one partner incurs a contractual debt in the name of the partnership in the ordinary course of business, all of the partners are together liable for that debt. If the creditor succeeds in its claim, then each partner must pay his share of the debt and could stand to lose all his personal assets if the debt is substantial. In an LLP, a member will not be personally jointly liable for contracts entered into by the LLP or by another member, so if a member enters into a contract in the name of the LLP, then provided that the LLP is clearly shown as the party to the contract, the LLP will be liable, and the members will have no personal liability. In these situations, therefore, the members of an LLP have less exposure than the partners in a general partnership.
• Liability for wrongful acts or omissions of others: Similarly, in a traditional partnership, every partner is "jointly and severally" liable for any loss or damage arising from wrongful acts or omissions of any of the partners (or, in practice, the staff) in the ordinary course of the partnership business or with the authority of the partners. This means that, for example, if one partner gives negligent advice, then the third party who has suffered loss can sue any of the partners separately, or all of them together, for the full amount of the loss. In other words, even if a partner had nothing to do with the advice that was given, he can still be sued for the full amount of any claim, and a client is likely to sue the partner who has the "deepest pockets". Each partner therefore risks losing all his personal assets, although he may be able to claim contributions from the other partners. In an LLP, no member should be personally liable for the negligent advice given by the LLP itself or the other members, so in this respect, members of an LLP are much better protected than partners in a general partnership.
• Liability for members’ own wrongful acts or omissions: The position is not quite so clear-cut in the case of a member’s own acts or omissions. The intention behind the LLP legislation is that the LLP is a separate entity so, if the LLP is engaged to provide advice and does so negligently, then in principle, it should be the LLP that is liable and not any individual member. However, a member can be liable for his own negligence if he assumes a personal duty of care to the third party, he breaches that duty (e.g. by giving negligent advice) and the third party suffers loss as a result. Recent cases involving professionals suggest that, in deciding whether a member of an LLP should be personally liable, a court will consider (a) whether or not he has assumed personal responsibility for the advice given by him in the name of the LLP; (b) whether or not the client or other third party relied on the fact that the member had assumed personal liability; and (c) whether or not it was reasonable for the third party to rely on that assumption. The third party therefore has various hurdles to overcome before it can sue a member personally. None of these hurdles normally exists in the case of a traditional partnership, where a partner will always be personally liable (subject to insurance) for any negligent advice he gives to clients of the partnership. In this way, the members of an LLP should be less exposed than the partners in a partnership.

• Other specific situations: Personal liability can also arise where a member gives a personal guarantee or undertaking on behalf of the LLP – for example, a bank lending to the LLP may require the members to guarantee that the LLP will repay the debt – so this should be avoided wherever possible. In addition, if the LLP becomes insolvent, members could become personally liable for the LLP’s debts if they allow it to continue trading while insolvent. Members will also be personally liable if they commit a fraud or other criminal offence. These situations should not often arise in practice. If your members do have to give personal undertakings to clients, make sure your insurance covers them against personal liability.

For the reasons given above, each person in the LLP dealing with a client or other third party must make it absolutely clear that he is acting on behalf of the LLP, rather than in his personal capacity, and that the LLP is the party giving the advice or incurring the debt. For example, all letters or other communications with the client or third party should be signed "For and on behalf of " the LLP. In addition, any retainer letter should state that the person signing it is acting on behalf of the LLP and not on his own behalf and should contain wording excluding any personal liability of members.

If you follow these steps, then each member should have no personal liability for the debts, obligations or negligence of the LLP or the other members. In the case of a member’s own negligent advice, then a client would have to show that it reasonably believed that the member was giving the advice in his personal capacity, despite the fact that the retainer letter and all subsequent communications suggested that the client was dealing with the LLP, not the member.

Clearly, an LLP will still need proper professional indemnity ("PI") cover. Indeed, many contracts will require proof that you have a specified minimum level of cover in place and may oblige you to keep it in place for a fixed period. Even if the contract is silent on the point, under the general law, you can be sued for up to six years (simple contracts or appointments), twelve years (contracts by deed) or even fifteen years (latent defects) after completion of a project, so you could require insurance for many years. When things are going well, you can notionally spread the cost of the premiums over a number of projects, but if you experience a downturn in work, or if your practice is being wound down (or has ceased) due to retirement, you may find it difficult to meet the cost of premiums.

Whilst converting to an LLP will not reduce your insurance premiums in the short term, it could give you more flexibility with the insurance you arrange. For example, if two partners are both planning to retire, they may have to maintain insurance for up to 15 years after completion of their last project, because they know they can be sued personally for any debts or claims arising from the partnership business. If they convert to an LLP now, each of them may be able to reduce his insurance after a few years, as he knows he cannot be sued for the debts or negligence of the LLP or the other members, and it will be more difficult for clients to sue him for his own negligence, for the reasons given above.

In certain circumstances, you may be able to negotiate a reduction of cover with your clients. If you are trading as an LLP and your insurance premiums become unaffordable, the LLP may have to go into liquidation unless you can persuade your clients to allow you to reduce your insurance cover. For example, if you have had to increase your general cover to allow you to take on a specific project, the client on that project will have an incentive to allow you to reduce your cover: if the LLP is wound up, they will be left with no one to sue (unless they can overcome the difficulties outlined above and sue the members personally), but if you are a general partnership, the client will have no incentive to negotiate, because it can still sue the individual partners even after the partnership has been dissolved.

Converting to an LLP could also affect your choice of projects. For example, if you are a general partnership, the partners will all be jointly and severally liable for any negligence, so you may have to turn down a high-risk project, rather than taking the chance of being sued personally for claims which exceed your cover. In an LLP, the risk should be lower (as explained above), so you may feel able to take on the project.

It is important to remember that the partners in the general partnership will continue to be personally liable for any work carried out before the conversion to an LLP (or for any pre-conversion contracts which are not properly transferred or "novated") so you will need to make sure that your insurance covers both the partners individually and the LLP. The limits on liability will only apply to future work carried out by the LLP under existing contracts or any new contracts entered into by the LLP.

If you convert to an LLP now, your liability for contracts taken on under the former partnership will expire in due course and your liability for any new contracts taken on by the LLP will be limited to the amount you have contributed to the assets of the LLP (unless you have assumed personal liability, as discussed above).

On conversion to an LLP, you must notify all clients and other third parties so they know they are dealing with the LLP going forward and you can preserve your limited liability status.

Some professionals we have advised have expressed concern that their own clients might react negatively when they were told that the partnership was converting to an LLP – they might be suspicious about the change, or even see it as an attempt by the partners to avoid their responsibilities. Experience has shown that clients tend to be relatively indifferent to the change of status, but if the issue does arise, there are a number of ways to reassure your client:

• First, you can simply say that your solicitor or accountant has advised you that converting to an LLP is a sensible commercial step.
• Secondly, you can point out that, although the LLP will become the party to the contract with the client, the work will still be done by the people who usually deal with the client, so there should be no change in the day-to-day performance, or quality, of your services.
• Thirdly, given that the client’s first port of call for any claim will normally be against your PI cover rather than your personal assets, you should be able to reassure them - particularly if you have a good claims record - that your PI cover will normally be sufficient.
• Finally, you can also point to the number of other partnerships who have recently converted to LLPs and explain that this is becoming more common in your profession. Your client may even regard it as a positive step: you are keeping up to date with current trends.

You may find that the change of status brings additional benefits:

• The LLP may be able to take on assignments involving risks that would be too high for a general partnership, given the personal exposure of individual partners.
• It may be easier for you to attract or retain high-calibre colleagues who might otherwise be put off by concerns over their personal liability for potential claims.
• The LLP can give a wider range of security over its assets to its bankers, which may help with raising finance, depending on the amount of the LLP’s assets.

• Public records: LLPs must file their accounts at Companies House, and have them audited if the turnover of the business exceeds certain thresholds. Your business profits will therefore become public knowledge. Moreover, the accounts must be prepared on a "true and fair view" basis, which could for certain partnerships mean a more rigorous (i.e. lower) definition of profit. In addition, you will have to pay the cost of preparing and filing the accounts (together with an annual return), although most partnerships already use accountants to prepare their accounts, so this change may not be significant.
• The conversion process: Forming the LLP itself is cheap and straightforward, as it simply involves filing a form at Companies House, and paying a fee (currently £20). However, the assets of the existing business will need to be transferred to the LLP, which will need careful thought (and legal documentation). We would also recommend that you draw up a formal members agreement governing the future relationship between the members.
• Tax and accounting: There could be tax implications (including stamp duty land tax and VAT) and you should ask your tax adviser about how to minimise these. There will also be additional accounting work, including preparing final accounts for the partnership and/or first accounts for the LLP.
• Administrative costs: As well as accountants’ and solicitors’ fees, the process will involve a certain amount of management time in planning and implementing the change of status, and there will be other administrative expenses, such as the cost of new stationery for the LLP.
• Insurance issues: All insurance issues will need to be carefully considered and addressed.

Converting to an LLP will mean that the LLP’s members can be safe in the knowledge that, in most cases, their personal assets will not be at risk in the event of a claim against the LLP.

© RadcliffesLeBrasseur

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.