LLP Insolvency & Wrongful Trading

Where an LLP goes into creditors' (i.e. insolvent) voluntary liquidation, the liquidator will be able to investigate the circumstances prior to the firm's winding up in order to assess whether any of the firm's members should be ordered personally to pay some contribution (to be decided by the courts in light of the circumstances of the case) towards paying off the company's debts to its creditors. If the liquidator can identify a point at which, in his or her opinion, a member knew or ought to have known that the limited liability partnership would not be able to avoid insolvent liquidation.

It will be a defence for any members, in court, to be able to demonstrate that they took "every step" to minimise potential losses to creditors. In other words, in a situation where the members of an LLP conclude (or, in retrospect should, in the circumstances, have concluded) that their firm cannot avoid insolvent liquidation; they should take some form of remedial action forthwith. As is the case with respect to the application of s. 214 to companies, the courts, when assessing whether an individual member knew or ought to have known the likely fate of the firm, will be able to apply both a subjective test and an objective test.

In the former case, the courts will consider whether the member concerned, given their particular expertise and experience, could have been expected to understand the firm's situation and take appropriate action on the strength of it. In the latter case, the member's conduct will be assessed against an objective test of what a reasonable person could have been expected to know and do as a member of an LLP.

Adjustment of withdrawals

Popularly referred to as the "claw back" rule, this new provision, which is inserted into the Insolvency Act 1986, has been drafted exclusively for application to the special position of LLPs. The liquidator of an LLP may investigate all withdrawals of property made from the firm by any member in the two-year period leading up to the commencement of the LLP's winding up. Withdrawals for this purpose include profit share, salary, repayment, or payment of interest on a loan to the firm.

The liquidator may make an application to the court where he or she considers that at the time of making any withdrawal, the member concerned knew or had reasonable grounds for believing that the LLP was unable to pay its debts (as defined by s. 123 of the Insolvency Act) or would become unable to pay its debts following the withdrawal (either on its own or in conjunction with other withdrawals being made by other members at the same time). The court, if it upholds the application, may order a member to make a financial contribution to the liquidator of up to the value of all the property withdrawn by him or her during the two-year period.

In considering an application, the court will assess whether each member referred to knew or ought to have concluded that, after each withdrawal, there was no reasonable prospect of the LLP avoiding insolvent liquidation. In making its assessment of the facts that a member should know and the conclusions that they ought to have reached, the court will make reference to a benchmark of a reasonably diligent person, having (i) the general knowledge, skill and experience that may reasonably be expected of a member of an LLP; and (ii) the knowledge, skill and experience that the member in question actually has.

How the courts will to a great extent define the level of skill and care that the law will expect of members. The introduction of the "objective" test in connection with liability for wrongful trading has had a significant impact on the level of skill and care which the law expects of company directors. If, as many believe, the LLP structure is adopted overwhelmingly by professional firms, the courts might well take the view that the standard of conduct to be expected from LLP members should be higher than that which is expected of company directors.

The liability in tort or contract

As discussed in the Introduction, the LLP legislation was developed largely in response to concerns expressed by professional firms about the exposure of themselves and their partners to liability. The protection which the corporate structure of the LLP offers to individual members should not, however, be taken entirely for granted.

In a House of Lords debate, during the course of the progression of the LLP Bill, Lord Goldsmith, a former chairman of the Bar Council, suggested that, where members of an LLP acted in a substantive way as if they were (still) partners in a partnership, the courts might decide to "pierce the veil" and treat the LLP's members as if they were in fact partners and outside the protection of the LLP structure. It will be noted that whereas an LLP or a company must be incorporated by a formal procedure, a partnership can be created informally.

The courts have also considered whether, in certain circumstances, a director of a limited company may assume a personal duty of care and therefore personal liability. Ordinarily, of course, a director acts on behalf of their company but the distinction between a company and its directors may become blurred, especially since limited companies have been able to function with just one director/member. In the case of Williams v Natural Life Health Foods Ltd (1998 BCC 428), the House of Lords considered an appeal against a ruling that a company director owed a personal duty of care to a customer of his company.

The Lords overturned the earlier ruling but gave guidance on the circumstances in which a personal duty might arise. In order to establish a personal duty of care, there must be not only a special relationship between a director and a client or customer, but a clear assumption of responsibility. Further, for the courts to impute a personal duty of care to a director, it is necessary for there to be objective evidence that, in the circumstances, it is reasonable for a customer to rely on the director's assumption of personal responsibility. Such evidence would include oral or written statements and the actual conduct of the director.

In light of the above, members of LLPs should ensure that, in all their dealings with clients or customers and the public, they do not give cause to believe that the activity being undertaken is undertaken other than by its experts on behalf of the LLP. In the case of a professional firm, the engagement letter should be precise as to the contracting parties.

Criminal and civil liability under the LLP Act and Regulations

The LLP Act and Regulations set out a large number of offences for failure to comply with the statutory responsibilities placed on them by or under the Act. In the case of members generally, their responsibilities are invariably collective. For example, they are collectively responsible for appointing auditors and preparing accounts. Designated members are additionally responsible for filing information and providing information to third parties. For example, they are required by law to file the LLP's annual accounts and to make a statutory declaration in the case of the LLP's members voluntary winding up. Financial penalties are provided for any breach of any of these requirements.

Limited liability partnership' disqualification

The Company Directors Disqualification Act 1986 (CDDA) is applied to members of LLPs. Accordingly, the courts can make a disqualification order against any member (or shadow member) of an LLP if it feels that their conduct in that capacity warrants such action. A disqualification order made against a member of an LLP will preclude the person concerned from acting as a director of a company as well as a member of another LLP (and vice versa).

Disqualification orders can be made under the CDDA in respect of breaches of on-going obligations, for example, following prosecutions for failing to deliver statutory documents to the Registrar, and also on the specific ground of "unfitness", as initiated by the liquidator following the winding up of the LLP. One additional paragraph is added to the list in Schedule 1 of the CDDA of matters which the court is required to take into account when considering whether any individual member of an LLP is "unfit".

This new provision requires the court to consider the extent to which the member has been responsible for the finding by a court that any member of the LLP concerned is required to make a contribution under s. 214A of the Insolvency Act (this is the "Clawback" rule referred to previously).