The Insolvency of Limited Liability Partnerships
Sebastian Kokelaar, Thirteen Old Square
1. Limited Liability Partnerships (“LLPs”) have been with us for more than a decade
now. Since their introduction by the Limited Liability Partnership Act 2000 they
have become increasingly popular as a vehicle for carrying on a wide variety of
businesses. According to the latest statistics from Companies House there are
currently more than 50,000 LLPs on the register1.
What is an LLP?
2. Before looking in more detail at how insolvency law operates in relation to LLPs
it is worth reminding ourselves of the key characteristics of an LLP. The best
place to start is section 1 of the LLP Act 2000. Subsection (1) contains the
moment of creation itself: “there shall be a new form of legal entity to be known
as a limited liability partnership”.
3. Section 1 then goes on to list the key characteristics of an LLP:
a. It is a body corporate with legal personality separate from that of its
members, which is formed by being incorporated under the LLP Act 2000:
section 1(2);
b. It has unlimited capacity: section 1(3);
c. The members of the LLP have such liability to contribute to its assets in
the event of its being wound up as is provided for by virtue of the Act:
section 1(4).
4. The basic condition that has to be satisfied in order to incorporate an LLP is that
there are two or more persons associated for carrying on a lawful business with a
view to profit, who have subscribed their names to an incorporation document:
section 2(1). A copy of the incorporation document must have been delivered to
the registrar. The incorporation document must state the name of the LLP, the
1
http://www.companieshouse.gov.uk/about/busRegArchive/businessRegisterStatisticsOctober2012.pdf
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address of its registered office, and give certain information about its members:
section 2(2).
5. An LLP is often described as a ‘hybrid’ vehicle. This is clearly an apposite
description. It is like a company in that it has a separate legal personality. It
carries on the business for which it was formed and acquires its own rights and
incurs its own liabilities in doing so. The liabilities of individual members are
limited to whatever they have agreed with the other members to contribute.
6. As has already been noted, the Act provides that an LLP has unlimited capacity.
This means that, as with a company, the validity of an act done by it cannot be
challenged on the grounds of a lack of capacity by reason of any limitation in the
LLP agreement: compare section 39(1) CA 2006.
7. Like a company an LLP will continue to exist as a separate legal entity, even if its
membership is reduced to one or none, until such time as it is wound-up and
dissolved.
8. On the other hand, an LLP is like a partnership in that there is no distinction in the
internal structure between the owners of the business (the shareholders, in the case
of a company) and the managers (the directors). The decision making structure of
an LLP and the terms of association are purely a matter of agreement between the
participants (although there are certain default provisions in the legislation which
apply in the absence of agreement: see Part VI of the Limited Liability Partnership
Regulations 2001/1090). Like a traditional partnership agreement the LLP
agreement is a private document. It is not publicly available, unlike the articles of
association of a company.
9. As in a traditional partnership every member of the LLP can act as its agent and
can therefore bind the LLP: section 6(1). The Act specifically provides, however,
that an LLP is not bound by anything done by a member in dealing with a person
if (a) the member in fact has no authority to do that thing, and (b) that person
knows that he has no authority or does not know or believe him to be a member of
the LLP: section 6(2).
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10. Furthermore, an LLP will be liable for the wrongful acts and omissions of any of
its members if they were done in the course of the business of the LLP or with its
authority: section 6(4).
11. Another important difference between a company and an LLP is that, for taxation
purposes, the separate legal personality of the LLP is ignored. Section 1273(1) of
the Corporation Tax Act 2009 provides that, if an LLP carries on a business or
trade with a view to profit, all its activities are treated as carried on in partnership
by its members and its property is treated as partnership property.
12. This means that the profits of an LLP will be taxed in accordance with the
taxation rules that apply to the members of the LLP. In the case of members who
are natural persons, that means the income tax rules. Corporate members have
their share of the LLP’s profits calculated in accordance with the corporation tax
rules. The LLP itself is not liable to pay corporation tax (except possibly in the
context of a winding up, see below).
13. Here, however, the similarities with a traditional partnership end. Section 1(5) of
the LLP Act 2000 expressly provides that, except as otherwise provided by the
Act or any other enactment, the law relating to partnerships does not apply to a
limited liability partnership. One of the consequences of this is that members of an
LLP do not owe one another a duty of the utmost good faith. The relationship
between them is purely contractual, although it would of course be possible for
the LLP agreement to impose an express duty of good faith: see Brown v
InnovatorOne Plc [2012] EWHC 1321 (Comm) at paragraph 1306 per Hamblen J.
The statutory framework
14. The LLP Act 2000 itself is quite short: it comprises a mere 19 sections and a
Schedule. Section 14 of the Act, however, creates a power to make regulations
about the insolvency and winding up of LLPs by applying or incorporating Parts 1
to 4, 6 and 7 of the Insolvency Act 1986.
15. Similarly, section 15 creates a power to make regulations, which apply the law
relating to companies to LLPs.
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16. The principal regulations made under sections 14 and 15 are the Limited Liability
Partnership Regulations 2001/1090. In their original form these applied certain
provisions of the Companies Act 1985, the Insolvency Act 1986 and the
provisions of the Company Directors Disqualification Act 1986, subject to certain
modifications. The regulations provide that references in those statutes (insofar as
they apply to LLPs) to a company include references to an LLP and that
references to a director or officer of a company include references to a member of
an LLP.
17. The general consensus seems to be that the statutory provisions applied by the
2001 regulations apply as amended from time to time: see Feetum v Levy [2006]
Ch 585 (CA), paragraphs 27-28.
18. However, when most of the Companies Act 1985 was repealed, the regulations
that applied parts of that Act to LLPs were also repealed. New regulations, called
the Limited Liability Partnerships (Application of Companies Act 2006)
Regulations 2009/1804, were passed to apply certain provisions of the Companies
Act 2006 to LLPs.
19. The application of the relevant parts of the IA 1986 by the 2001 LLP Regulations
means that all of the formal corporate insolvency procedures are available in
respect of LLPs, that is to say: compulsory and voluntary liquidation, the
voluntary arrangement, administration and administrative receivership.
Administration
20. The 2001 LLP Regulations were made before the administration procedure was
extensively amended by the Enterprise Act 2002. For reasons which are not
entirely clear, when those changes were brought into force (on 15 September
2003), it was specifically provided that the old administration regime would
continue to apply to LLPs2.
2
Article 3(3), Enterprise Act 2002 (Commencement No 4 and Transitional Provisions and Savings)
Order 2003/2093
4
21. The new administration regime (contained in Schedule B1 to the IA 1986) was,
however, eventually applied to LLPs by regulation 3 and Schedule 2 of the
Limited Liability Partnerships (Amendment) Regulations 2005/1989, which came
into force on 1 October 2005.
22. As a result, an administrator may now be appointed to manage the affairs,
business and property of an LLP in one of two ways3:
a. By an administration order of the court made on the application of the LLP
itself, one or more of its creditors, the designated officer for a magistrates’
court in exercise of the power conferred by section 87A of the
Magistrates’ Court Act 1980, or a combination of these persons4;
b. Out of court by the holder of a qualifying floating charge or by the LLP
itself5.
23. The statute provides that an administrator has to perform his functions with the
objective of6:
a. Rescuing the LLP as a going concern; or
b. Achieving a better result for the LLP’s creditors as a whole than would be
likely if the LLP were wound up (without first being in administration); or
c. Realizing property in order to make a distribution to one or more secured
or preferential creditors.
24. An administrator may only perform his functions with the third of these objectives
in mind if:
a. He thinks that it is not reasonably practicable to achieve either the first or
the second objective; and
b. He does not unnecessarily harm the interests of the creditors as a whole7.
3
Para. 2, Sch. B1, IA 1986
Para. 12, Sch. B1, IA 1986
5
Paras. 14 and 22, Sch. B1, IA 1986
6
Para. 3(1), Sch. B1, IA 1986
7
Para. 3(1)(c), Sch. B1, IA 1986
4
5
Court appointments
25. An administrator may only be appointed if the court if it is satisfied that8:
a. The LLP is or is likely to become unable to pay its debts9
b. It is reasonably likely that the purpose of administration may be achieved.
26. Two relatively recent cases concerning insolvent partnerships illustrate the
approach taken by the courts to the second of these threshold conditions. The case
of DKLL Solicitors v HM Revenue & Customs [2007] BCC 908 concerned a firm
of solicitors, which was hopelessly insolvent. The firm was a traditional
partnership (rather than an LLP) and the administration application was made by
the two equity partners10. The proposal was for a “pre-pack” administration
whereby the partnership’s business would be sold immediately upon the
appointment of the administrators for the sum of £400,000 without first
summoning a creditors’ meeting for the purpose of approving the proposal. The
applicants argued that the proposed sale would achieve a better result for creditors
than in a winding up and relied upon an estimated outcome statement prepared by
the proposed administrators, which showed that only about £105,000 would be
realised on a forced sale of the assets in a liquidation.
27. The application was opposed by HMRC, who were the majority creditor. They
contested the estimated outcome statement relied upon by the applicants, and
argued that the court ought not to make an administration order in circumstances
in which it was known that the majority creditor opposed the proposed sale and
would, in effect, be disenfranchised by a pre-pack sale without a creditors’
meeting taking place.
28. The judge (Mr Andrew Simmonds QC sitting as a deputy judge of the High
Court) held that there was no good reason not to proceed on the basis that the
estimated outcome statement produced by the proposed administrators was
reasonably likely to prove accurate. He noted that, although it was ultimately for
8
Para. 11, Sch. B1, IA 1986
As defined in s.123, IA 1986
10
Under art. 6, Sch. 2, Insolvent Partnerships Order 1994/2421
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the court to decide if the threshold conditions for making and administration order
had been made out, the court placed great reliance on the expertise and experience
of impartial insolvency practitioners.
29. Equally, the judge was not persuaded by the argument that an order should not be
made because HMRC as the majority creditor objected to the proposed sale. He
noted that a majority creditor does not, in fact, have a veto over the
administrator’s proposals because the court has the power under paragraph 55(2)
of Schedule B1, IA 1986 to authorise the implementation of those proposals. He
did not therefore accept the premise that, if the case had not involved a pre-pack,
the Revenue’s opposition would have meant that it was not reasonably likely that
the purpose of administration could be achieved.
30. The judge held that, in this context, “reasonably likely” meant that the court
considers that there is a real prospect that the objective will be achieved. This does
not equate to more than 50 per cent probability. He was satisfied that there would
have been a real prospect of the court authorising the proposed sale despite
HMRC’s opposition. The fact that the case involved a pre-pack did not put the
applicants in a worse or HMRC in a better position.
31. Re Halliwells LLP [2011] BCC 57 involved an application for an administration
order by a national law firm, which carried on its business through an LLP. By the
time the application was made the proposed administrators had come to the
conclusion that it was not reasonable practicable to rescue Halliwells as a going
concern or to achieve a better result for the creditors as a whole than would be
likely if the LLP were wound up without first being in administration.
Accordingly, they proposed realising the assets of the LLP through four prepackaged sales of parts of the business in order to make a distribution to one or
more secured or preferential creditor. In addition to making the administration
order, the court was asked to approve those four sales.
32. An unusual feature of the proposed sales was that a significant part of the
consideration received would be paid into a trust set up for the purpose of
honouring undertakings given by the LLP to various banks to repay the
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partnership practice loans taken out by some of its members, who would be
transferring to the purchasers. This structure was devised at the insistence of the
purchasers, who were concerned that a failure by the LLP to honour its
undertakings would result in members transferring to them becoming personally
insolvent and therefore no longer able to practise as solicitors.
33. The judge (Kitchin J) reminded himself of the guidance given in Re Kayley
Vending Ltd [2009] BCC 578 concerning the approval by the court of pre-packs.
The evidence before him contained a draft letter to creditors prepared in
accordance with SIP 16, which contained a detailed explanation of why it was not
considered appropriate to trade Halliwells in administration and offer the business
for sale as a going concern, full details of the marketing that had been undertaken
and a complete explanation of the terms materially affecting the consideration
paid. The judge was satisfied that the administrators’ proposals were SIP 16
compliant and that there was no evidence of any abuse of the process.
34. He accepted that the four proposed sales represented the best that could be
achieved in the circumstances. Although the repayment of some of the partnership
practice loans undoubtedly put some creditors in a better position than others, this
was a necessary evil in order to get the deals done. Accordingly, he concluded that
the interests of the creditors as a whole were not harmed unnecessarily and made
the orders sought.
Out of court appointments
35. The process for appointing an administrator out of court is no different for an LLP
than it is for a company. The appointment takes effect when a notice of
appointment is filed at court by a floating charge holder or the LLP itself, along
with such documents as may be prescribed11.
36. In the case of an appointment by a floating charge holder such a notice can only
be filed after at least two days’ written notice has been given to the holder of any
11
Paras. 19 and 31, Sch. B1, IA 1986
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prior floating charge, or the holder of such a charge has consented to the
appointment in writing12.
37. In the case of an appointment by the LLP itself a notice of intention to appoint
must first be given to anyone entitled to appoint an administrative receiver or an
administrator of the LLP13. A copy of the notice of intention to appoint must also
be filed with the court14.
38. In both cases the notice of appointment must contain a statement by the proposed
administrator that he consents to the appointment and that in his opinion the
purpose of administration is reasonably likely to be achieved15
39. It should be noted that it is only the LLP itself, which has the power to appoint an
administrator out of court or the standing to make an application for an
administration order. The members themselves cannot do so. The decision to
appoint an administrator or apply for an administration order will have to be taken
in accordance with the terms of the LLP agreement. In the absence of a specific
provision in the LLP agreement, it seems that a decision to appoint an
administrator or apply for an administration order may be taken by a simple
majority of members attending a meeting of the members at which more than half
of all the members are present16.
40. Once the administrator is an office, the moratorium on enforcement action by
creditors applies17 and the administration is conducted in the same manner as the
administration of a company. The administrator’s appointment comes to an end
automatically after 12 months, subject to extension by agreement with the
creditors and thereafter by order of the court18.
12
Para. 15(1), Sch. B1, IA 1986
Para. 26, Sch. B1, IA 1986
14
Para. 27, Sch. B1, IA 1986
15
Paras. 18(3) and 29(3), Sch.B1, IA 1986
16
See paragraph 15.11, Whittaker & Machell, The Law of Limited Liability Partnerships (3rd edition,
2009 (reprinted 2010)), which cites Merchants of the Staple of England v Governors & Company of the
Bank of England (1887) 21 QBD 160 at 165.
17
Paras. 42-43, Sch. B1, IA 1986
18
Paras. 76-78, Sch. B1, IA 1986
13
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Liquidation
41. Part IV of the IA 1986 applies to LLPs in modified form. An LLP can therefore be
wound up voluntarily or by order of the court.
Voluntary winding up
42. Section 84(1) (in its modified form) provides that a voluntary winding up is
initiated by a determination of the LLP. It does not, however, say how an LLP is
to make such a determination. This is a matter, which ought to be covered by the
LLP agreement. If it is not, it seems that the position is governed by the common
law rules on decision-making by corporate bodies. As indicated above, that would
mean that a determination to wind up an LLP voluntarily could be made by a
simple majority of members attending a meeting of members at which more than
half of all members were present.
Winding up by the court
43. The circumstances in which the court may order that an LLP be wound up are set
out in section 122 of the IA 1986 (as modified), i.e.:
a. The LLP has determined that it be wound by the court;
b. The LLP does not commence its business within a year of its
incorporation, or suspends its business for a whole year;
c. The number of members is reduced below two;
d. The LLP is unable to pay its debts;
e. The court considers that it is just and equitable that the LLP should be
wound up;
f. At the time at which a moratorium for the LLP under section 1A of the IA
1986 comes to an end, no voluntary arrangement approved under Part 1
has effect in relation to the LLP.
44. Section 124 of the IA 1986 sets out who has standing to present a winding up
petition. There is some uncertainty over precisely how this section applies to
LLPs. There is no doubt that a petition may be presented by the LLP itself and by
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any creditor or creditors of the LLP. What is less clear is whether individual
members of the LLP have standing to present a petition.
45. By virtue of the general modification in regulation 5(2)(b) of the 2001 LLP
Regulations the reference to ‘directors’ in section 124 is to be read as a reference
to the members of the LLP. However, the better view would seem to be that this is
a reference to the members collectively rather than any individual member19.
46. If that is right, the only basis upon which an individual member (who is not also a
creditor of the LLP) could present a petition would be as a contributory. Section
79(1) of the IA 1986 defines a ‘contributory’ as every present or past member of
the LLP liable to contribute to the assets of the LLP in the event of its being
wound up.
47. The liability of present and past members to contribute to the assets of the LLP on
a winding up is governed by section 74 of the IA 1986 (as modified). This
provides that when an LLP is wound up every present and past member who has
agreed with the other members or with the LLP that he will be liable to contribute
to the assets of the LLP in the event that the LLP goes into liquidation is liable, to
the extent that he has so agreed, to contribute to its assets any amount sufficient
for payment of its debts and liabilities, and the expenses of the winding up, and
for the adjustment of the rights of the contributories among themselves.
48. Thus, it can be seen that the position of a member of an LLP is quite different
from that of a shareholder in a company limited by shares: he will only be liable
as a contributory if he has agreed to contribute to the assets of the LLP in the
event of a winding up. If an individual member has never been party to such an
agreement, or if he was party to such an agreement but his liability did not survive
the cessation of his membership, it would seem that he would not come within the
definition of a ‘contributory’ and would therefore not have the necessary standing
to present a winding up petition.
19
See paragraph 29.16, Whittaker & Machel, op. cit.
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49. It seems unlikely that this result was intended, given that the circumstances in
which a petition may be presented are not limited to the insolvency of the LLP. A
winding up order can of course also be made in respect of a solvent LLP on the
just and equitable ground.
50. It has been the long-standing practice of the Companies Court to require a
contributory to show that he has a sufficient interest in the winding up of the
company before he can be heard on a petition. Usually, this involves the
contributory showing that, if the company were wound up, there would be surplus
assets available for distribution to members. The application of this practice to
LLPs was considered in the case of Charit-Email Technology Partnership LLP v
Vermillion International Investments Ltd [2009] BPIR 762. This involved an
appeal against a decision of the chief registrar that the appellants were not entitled
to appear on a winding up petition brought against an LLP by one of its creditors
because they were unable to show that a contingent surplus would be available for
distribution to members. The appellants sought to argue on appeal that members
of an LLP should be heard as a matter of course in winding up proceedings
because their position was different to that of shareholders in a company limited
by shares in certain important respects.
51. The Chancellor accepted that there might have to be some changes to the practice
of the court to reflect the different interests and liabilities of members of an LLP.
He stated that, depending on the terms of the LLP agreement, members were
liable to contribute to the assets of an LLP so that its debts might be paid. They
were agents of the LLP and had a closer interest in its business than members of a
limited company holding fully paid up shares. However, he dismissed the appeal
on the facts because the appellants had consistently maintained that they were not
in fact contributories.
Misfeasance and adjustment of prior transactions
52. Although the liability of members of an LLP to contribute to its debts in the event
of a winding up is limited to whatever they have agreed amongst themselves and
with the LLP, once a liquidator is in office, he has the same statutory powers as a
liquidator of a company to pursue claims against members personally, including:
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a. The summary procedure under section 212;
b. Claims for fraudulent and wrongful trading under sections 213 and 214;
c. The adjustment of transactions at an undervalue, preferences and
transactions defrauding creditors under sections 238, 239 and 423;
53. A liquidator of an LLP has an additional weapon in his arsenal, which is contained
in section 214A of the IA 1986 (inserted by the 2001 LLP Regulations). This
section creates a means for a liquidator to claw back withdrawals made by
members within a period of two years prior to the commencement of the
liquidation.
54. For a member or former member to be liable to make a contribution to the LLPs
assets under section 214A the following requirements have to be satisfied:
a. Within the period of two years prior to the commencement of winding up
he was a member of the LLP who withdraw property of the LLP, whether
in the form of a share of profits, salary, repayment of, or payment of
interest on, a loan to the LLP, or any other withdrawal of property; and
b. It is proved by the liquidator to the satisfaction of the court that at the time
of the withdrawal the member knew or had reasonable ground for
believing that the LLP:
i. Was at the time of the withdrawal unable to pay its debts within the
meaning of section 123 of the IA 1986; or
ii. Would become so unable to pay its debts after the assets of the
LLP had been depleted by that withdrawal taken together with all
other withdrawals (if any) made by any members
contemporaneously with that withdrawal or in contemplation when
that withdrawal was made; and
c.
He knew or ought to have concluded that after each of these withdrawals
there was no reasonable prospect that the LLP would avoid going into
insolvent liquidation.
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55. Section 214A(6) provides that the facts which a member ought to know or
ascertain, and the conclusions which he ought to reach, are those which would be
known, ascertained or reached by a reasonably diligent person having both:
a. The general knowledge, skill and experience that may reasonably be
expected of a person carrying out the same functions as are carried out by
the member in relation to the LLP; and
b. The general knowledge, skill and experience that that member actually
has.
56. If a member is found liable on an application under section 214A, the court may
declare that he is liable to make such contribution to the LLP’s assets as the court
thinks proper20. Such a contribution cannot, however, exceed the aggregate value
of all the withdrawals that rendered the LLP unable to pay its debts21. It would
seem therefore that a member found liable under section 214A can be ordered to
repay more than he personally withdrew from the LLP.
Taxation of insolvent LLPs
57. As we have already seen, for taxation purposes the separate legal identity of the
LLP is ignored. This is not affected by the LLP going into administration. It is
important to appreciate that this means that the individual members of the LLP
will continue to be personally liable for any tax liabilities arising out of the
activities of the administrator. If the administrator disposes of an asset of the LLP,
and a chargeable gain arises, any tax on such a gain will have to be paid out of the
members’ own resources.
58. Similarly, if the administrator continues to trade the business, any profit made or
interest earned will be liable to income tax. These taxes cannot be treated as an
expense of the administration, as they are not liabilities of the LLP but liabilities
of the members themselves.
59. This may be contrasted with the administration of a company in which any
amount of corporation tax due on chargeable gains accruing on the realisation of
20
21
S.214A(3), IA 1986
S.214A(4), IA 1986
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any asset of the company by the administrator can be treated as an expense of the
administration by virtue of Rule 2.67(1)(j) of the Insolvency Rules 1986.
60. Where the LLP permanently ceases to carry on its business (e.g. after the
administrator has disposed of the business) the tax transparency will continue
during any informal winding up period after the cessation of the business,
provided it is not connected with the avoidance of tax and it is not unreasonably
prolonged22.
61. However, the position changes once an LLP is formally placed in liquidation
(whether voluntarily or by order of the court). Upon the appointment of a
liquidator section 1273(1) of the Corporation Tax Act 2009 ceases to have effect,
so that the LLP is treated as a body corporate for corporation tax purposes. This
raises the possibility of double charges to capital gains tax, for the LLP upon
disposal of any remaining assets by the liquidator and for individual members
upon disposal of their capital interest in the LLP.
62. This possibility is perhaps more theoretical than real in an insolvent liquidation.
However, in deciding whether to adopt liquidation or dissolution as the exit route
from administration, some thought will need to be given to the potential tax
consequences.
© 2012 Sebastian Kokelaar
22
S.1273(3), Corporation Tax Act 2009
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