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The legal lens: key issues on converting to LLP

Conversion to a Limited Liability Partnership (LLP), which often refers to a change in the legal form of an existing general partnership or a limited company to a limited liability partnership, can bring significant benefits but it is a process which can go very wrong if poorly handled.

It is not as simple as a straightforward switch from one status to another but requires a much more forensic, considered, and structured approach. Failure to take due time and consideration when converting to LLP can cause significant risk, fallout, and instability – not to mention that in some circumstances it could be voted down by partners.

In this article, we look at some of the key aspects of converting to an LLP.

Why Convert?

LLPs are a popular structure for professional practices, for example the accountancy and legal sector. There are key differences between LLPs and traditional partnerships (established under the Partnership Act 1890) and limited companies. The LLP enjoys certain advantages such as separate legal personality and limited liability for its members (similar to the position for companies), whilst retaining some of the features of a traditional partnership, such as governance flexibility, tax transparency  and the absence of capital maintenance restrictions (which apply to companies).

The tax transparency of the LLP structure means that the income profits/capital gains of the firm are taxed in the hands of its members and are not subject to corporation tax. Furthermore, provided the members of the LLP meet certain criteria, they will be treated as self-employed for tax purposes; the members’ earnings will consequently not be subject to employer’s national insurance contributions (which is a significant saving for the firm).

However, when the leadership team are considering a conversion to LLP, they must carefully consider their objectives, because the move to a LLP is not without its drawbacks. An LLP is obligated to comply with disclosure and filing requirements under the Companies Act 2006 (including public disclosure of the identity of the LLP’s members and persons with significant control over the LLP), as well as undertaking to file a copy of the LLP’s annual accounts, which may also need to be audited, with Companies House. This greater level of transparency may be a significant operational and cultural change for firms which are traditional partnerships and not currently subject to public disclosure requirements.

There may also be a degree of unease about converting to an LLP given the significant costs, time, and administration involved, as well as the perception of ‘rocking the boat’.

The transfer process

There are a number of practical issues that arise when converting to a LLP. One of the first steps that the leadership team should consider is determining what the decision-making powers are for the purpose of approving the conversion, including consideration of any third-party approval that might be required. In the absence of any provision requiring a majority vote to approve the conversion, it is likely that a unanimous vote will be required, which may be problematic.

LLP Agreement

The LLP Agreement itself becomes vitally important. It is not actually a requirement to have one, but certainly advisable, and it provides the firm with the ideal opportunity to modify or improve its constitutional terms within a new LLP members’ agreement. It should be noted that there is no requirement to file the LLP members’ agreement with the companies registry (as required for the articles of association of a company) and therefore the agreement can remain confidential. An LLP members’ agreement typically contains the governance and financial provisions relating to the LLP, such as profit-sharing arrangements, benefit entitlements, decision making powers and retirement provisions.

The proposed terms of the LLP members’ agreement may be substantially similar to the partnership agreement (in the case of a general partnership) or the shareholders’ agreement (in the case of a limited company) of the existing firm. However, firms often view the LLP conversion as an opportunity to introduce changes to the firm’s constitutional arrangements. If changes are to be made, management may need to invest significant time and effort in consulting with partners to ensure they are onboard with the proposed changes.

Poor communication or failure to adequately involve the partners can result in considerable issues at a later date (sometimes unnecessarily so) and it is key to achieve a level of consensus among partners at the earliest opportunity, particularly if substantial changes are to be made to existing constitutional terms. Consultation with partners can flush out any objections, particularly if changes have been made to some of the more significant terms such as post-termination restrictions, exit terms and profit-sharing arrangements. This process can of course be time consuming, stressful and difficult as some partners may use the situation as leverage to negotiate more favourable terms.

Transfer Agreement

As part of the conversion, a Business Transfer Agreement is also prepared which documents all the aspects of a business that are being transferred including the assets, goodwill, property, liabilities, work in progress, and employees (if there are any). If there are employees being transferred, the firm needs to ensure that an appropriate consultation process is complied with. Communication with employed staff is also key, without which it can cause unnecessary instability amongst the employees who may not fully appreciate the implications of the conversion.

Further consideration would need to be given to contractual issues and whether material contracts (including client engagements) can be assigned or novated to the LLP. The firm will also need to prepare for operational changes and satisfy administrative requirements, including preparing relevant notifications to the firm’s bank, landlord, insurers, any applicable regulatory body and/or HMRC; registering a VAT number; appointing designated members; and updating the website/emails/letterhead.

Dissolution and winding-up

The process of conversion typically involves the incorporation of a new LLP that is separate from the old partnership or limited company. You are then left with the existing firm, which will usually be dissolved and wound-up at the end of a run-off period.

In the case of a general partnership, dissolution may be by the agreement of the partners in the partnership and will require a public notice of the dissolution. The business is then wound up by valuing any remaining assets and settling any remaining liabilities. Any surplus assets will then be distributed to the remaining partners.

If you are interested in converting to an LLP or have any queries regarding the issues discussed in this article, you can email: [email protected]

About the authors

Zulon Begum is a Partner and Nicholas Hawkins is Senior Associate at CM Murray LLP,  CM Murray are leading specialist employment and partnership law advisers to multi-national companies, professional partnerships, senior executives and partners.

 

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