LLPs & Partnerships - Exit issues

Siobhan Bishop: Welcome to the second podcast in our series on LLPs and Partnerships. In this podcast, Martin Chitty, a partner in our Employment, Labour & Equalities team at Gowling WLG discusses the risks and options when someone leaves the partnership or LLP. These issues will be relevant for all sectors operating business through an LLP structure or partnership, as well as individuals who need to understand their rights and obligations arising from their membership or partnership.

So Martin, firstly, when someone is looking to leave an LLP or Partnership and possibly take their team with them what does the organisation have to think about?

Martin Chitty: I think, from an organisational perspective, it is a matter of identifying, firstly, the fundamental nature of that organisation, then looking who owes what obligations and to who those obligations are owed. And thirdly, deciding how you take those obligations and then use them for the benefit of the wider organisation in managing the exit process or the behaviour of the individuals involved.

Siobhan: OK, so if we look at Partnerships first, what are the main issues there?

Martin: The old form, or historic partnership, which you tend to see in businesses which are "& Co", meaning "and Company", are governed by the provisions of the Partnership Act and that is based on some very historic concepts.  Essentially, partnerships are a series of interpersonal obligations. So each of the members of the partnership owes obligations, not to the entity itself, because the entity is merely a sum of the parts involved, but to each other. And as a result of that, the obligations on partners under Partnership Act situations are much more onerous in many ways. So, by way of example, there is an inherent duty of good faith as between partners in an old form partnership. There is an obligation not to make a profit from anything which the partnership could otherwise have done. And going back to the very basic issue that is just an extension of the fact that these are essentially personal relationships rather than something more corporate in its personality, or more reflective of something which you might see in the more modern situation with an LLP or even in terms of the employer/employee relationship.

Siobhan: So if Partnerships are less common these days, what are the differences with an LLP structure?

Martin: Well the LLP is a creature of statute, rather than a creature of common law, and from a lawyer's perspective that is all very interesting but in practice what it means is this; that rather than contracting as between themselves, so I might contract with you under an old form partnership, with an LLP I have a relationship with the organisation and my obligations are to the organisation. So if you constitute an LLP under the relevant legislation, the underlying position is that you owe limited obligations to the entity and no obligations to other members. So the starting point, if you are looking at one of these situations, or if you are looking at a situation where you're thinking of setting up a new business, is how do you get that degree of control and that range of obligations onto the individual? And the answer, of course, in those situations is that you make sure that the LLP agreement covers all of these things explicitly. So, if you want to impose an obligation of good faith on people and govern their behaviour as members, or as partners, as we tend to be called, then you need to have it set out in the LLP agreement. If you have someone who is thinking of leaving or you suspect is up to something, like taking a team out or filching clients for a future business opportunity, then the issue is well, "let's start with the contract". What is this person committed to do or to refrain from doing and then, from the organisation's perspective, how can we then use those obligations to make sure that they cannot damage us too much?

Siobhan: So, depending on which structure it actually is, can you run through the different options that each may have?

Martin: Yes, with old form partnerships there is an underlying set of rules and obligations. In the majority of cases though there will still be some form of partnership agreement. So, the starting point with an old style partnership is still to say well what does the partnership agreement give us? What has this person done which they should not have done? What rights do we have in terms of suspending them from active participation? What rights do we have to expel them? Have they done something which is so fundamentally against the obligations imposed on them, as a partner, that we can legitimately expel them? Can we, to take an employment concept, can we put them on garden leave? So can we retain them within the partnership, which might actually protect the position of the other partners, but exclude them from the operation of the business? Can we limit their ability to draw income or their right to accrue a profit share throughout the period of that notice period? So there's always a balance there between control on the one hand and restriction of activities, income flow to the individual and also their exclusion from the market more generally. Now, under the Partnership Act there are some restrictions on solicitation, for instance. They are brought in by reason of the legislation, but you might still need to look if somebody is really, really set on going and whether you would be prepared to litigate and how you are going to run that sort of argument and you might end up having to get an injunction.

One point to think about is the position of the organisation to which they are going, or if they are trying to form some form of team lift, what is it that that other organisation has done to induce them, or to persuade them, either to leave or to take people with them? It might be that you have an opportunity, not only to restrict what your soon to be ex-partner is doing, but also to try and recover the costs and damages from the organisation which has induced that breach. So you would have to show that they have offered some benefit for behaving in this way, having an idea of, or knowing, what the underlying partnership agreement says.

The position in LLP isn't actually very different to the position under an old form partnership. So, as a starting point, look at the LLP agreement. What are the obligations that are owed? What evidence do we have that somebody has acted in breach? What are the consequences of that breach and then what are our options? It is much more likely in an LLP agreement that whoever drafted it will have looked at; can we suspend? Can we put on garden leave? What rights do we have? To what extent can we exclude this individual from the activities of the partnership? To what extent can we defer money coming out? So there are very much the same issues that we have with the old form partnership, it is just that we are much more reliant upon the LLP agreement, as a contract, than we were in an old form partnership, simply because we don't have the statutory provisions which are brought into play automatically.

Siobhan: Thank you very much Martin and as we mentioned at the beginning this is the second in our series of three podcasts on LLPs and partnerships. The first podcast, which is already available on our website, is covering the employment status of partners and LLP members and how to manage those risks. The third podcast will cover team moves in more detail and also how do you get compensation for the damage caused.

We hope you found this podcast useful and if you have any queries on the topics we have covered today, or generally, please do give Martin a call. Thank you.