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The High Court, in two recent cases, has held that, where an LLP is governed by an LLP Agreement, the terms of that agreement bind all members of an LLP. In Liontrust, the Court also held that the LLP Agreement is not a contract which can be terminated by repudiation and acceptance of repudiation but only in accordance with its terms.
The Limited Liability Partnership is a statutory innovation that has raised many issues concerning the terms of membership and the means by which that membership can be terminated. Many individuals have sought to argue that their terms of membership were those set out in the default rules providing for an equal share of profits or that their terms of membership became those set out in the default regulations as a result of the repudiation of the LLP Agreement by the LLP or the other members. The specialist textbooks on LLPs have given credence to these concepts despite the enormous practical difficulties that would be caused by having different members of the same LLP being subject to wholly inconsistent regimes.
In Ondra, the claimant sought to argue that by being offered what on its face was a contract of employment conferring a share in the profits of the LLP by which he was to be employed, he became a member of the LLP on the default terms (i.e. those terms set out in the Regulations 7 and 8 of the LLP Regulations 2001) such that his membership could not be terminated without his consent and that he retained a share of profits in perpetuity.
In the course of two long judgments, Warren J held that, because there was an LLP Agreement in place between the members prior to his contract being entered, and in circumstances where a proposed revised LLP Agreement had been given to the claimant prior to the contract with him having been made, the default rules did not define the terms of his membership of the LLP – the default rules apply only in the absence of agreement but not where there are existing terms. The claimant was held to have become a member of the LLP subject to the terms of the draft LLP Agreement which were expected to apply to all members of the LLP, with his particular entitlements (e.g. as to profit share) being conferred under an LLP Agreement which bound all members rather than under a separate regime applicable only to him.
In the course of the wide-ranging judgments, Warren J also held that a member of an LLP could not at the same time be an employee of the LLP. As such the contract between the LLP and the claimant conferred either membership or employment but not both. Despite the relevant contract appearing on its face to be a contract of employment, and despite the finding in the first judgment that the contract with the claimant had been terminated summarily upon the employer’s election to make a payment in lieu of notice, Warren J held in his second judgment the claimant had been a member and thus had never been an employee.
Both parties were given permission by Warren J to appeal to the Court of Appeal on almost every significant issue in each judgment but no Notices of Appeal have been lodged and the proceedings have been stayed by consent.
Ondra is of particular significance to those who are offered membership of an LLP (or offered something that looks a bit like membership) when the affairs of the LLP have not been put into final form. In the early stages of many corporate entities, management may be more focussed on getting the business up and running than on finalising the paperwork related to the internal affairs of the corporate entity. Ondra is also of significance where the terms offered to a prospective member are hard to reconcile with the terms of an extant LLP Agreement.
In Liontrust, the court was concerned mainly with the termination of membership of an LLP rather than its formation. The claimant had become a member pursuant to the terms of an LLP Agreement. The LLP had purported to expel the claimant in breach of its own procedures as to expulsion and in breach of a term as to the minimum period for which the claimant would remain a member.
The claimant contended that the expulsion was ineffective but that it had amounted to a repudiation of the LLP Agreement. His case was that he had accepted the repudiation of the LLP Agreement and thereafter remained a member but on the default terms, including an entitlement to an equal share of capital and profits rather than the limited entitlement to profits and no entitlement to capital conferred upon him by the LLP Agreement.
Henderson J held that an LLP Agreement was not a contract which could be terminated by the acceptance of repudiatory breach. In essence, to permit a member to accept a repudiation of the LLP Agreement and thereby become a member subject to default terms would result in such chaos that it cannot have been the intention of parliament to permit such a state of affairs. Henderson J held that, as in the contract underpinning traditional partnerships and as in the quasi-contract consisting in the Articles of Association of a limited company, an LLP Agreement within the meaning of section 5 of the Limited Liability Partnership Act continued in effect as against all members notwithstanding breaches which would be considered repudiatory of other contracts.
One example given by him to fortify this conclusion was that the default rules conferred a right to an equal share of profits and capital whereas an LLP Agreement will usually determine how 100% of the profits and capital will be shared between members – if an innocent member (i.e. one not in repudiatory breach nor the victim of such a breach and so still party to the LLP Agreement) was entitled to all of the profits of the LLP under the LLP Agreement, that member’s rights were necessarily inconsistent with there being another member entitled to an equal share of those same profits under the default rules.
Thus, a member who has been the victim of serious breaches of the LLP Agreement may have a remedy in damages for breach of contract but he will remain bound by the terms of the LLP Agreement for so long as he remains a member of the LLP. The breaches may also form the basis for an unfair prejudice petition or even a petition for the winding up of the LLP on just and equitable grounds.
Liontrust provides an effective rebuttal to the commonly-raised arguments of out-of-favour members of an LLP that, by seeking to marginalise or expel such a member, the LLP had unwittingly conferred on that member an equal share of profit and capital and the right to share in the management of the LLP (and lost any express right to expel that member) in place of the far more limited rights held by that member under the LLP Agreement prior to their fall from grace.
The full judgments can be read here:
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