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Naresh Chander Committee
Limited Liability Partnerships ( Introduction and Scope )
3.01 A Limited Liability Partnership (LLP) is a form of business entity which permits individual partners to be shielded from joint liability created by another partner’s business decision or misconduct. In an increasingly litigious market environment, the prospect of being a member of a partnership firm with unlimited personal liability is, to say the least, risky and unattractive. Indeed, this is the chief reason why partnership firms of professionals, such as accountants, have not grown in size to successfully meet the challenge posed today by international competition. This makes an LLP a most suitable vehicle for partnerships among professionals such as lawyers and accountants. A LLP enters into contracts in its own name in the same way as a limited company, but its members have the advantage of limited liability similar to the shareholders of a company. Thus, in the event of a business failure or a tortuous complex of disputes and claims, the liability would be limited to the partner responsible. There would be no recourse to attach the personal assets of the other members, except the member who was personally responsible to negligent. Similarly, a partner’s liability is not limited when the misconduct takes place under his supervision or control. In other words, an LLP only protects a partner from liability arising from the incorrect decision or misconduct of other partners or any of its employees not under his control. The partnership is not relieved of the liability of its other obligations as a partnership.
3.02 Major accountancy firms, wanting to limit the liability of an individual partner to acts specifically related to that partner, launched a campaign for the creation of the LLP vehicle in the UK in the 1980s. As a result, the UK Companies Act, 1989 was amended to allow accountancy firms to work as limited liability companies. The joint and several liabilities of general partners, however, remained. In the 1990s, the accountancy firms in the UK again campaigned to end this, and to secure proportional liability in the LLP. This led to the passing of the Limited Liability Partnership Act, in the year 2000.
3.03 Under the LLP Act of 2000 of UK, a LLP has been defined as a body corporate, with a legal personality independent of its members without restriction on the number of partners, and with each partner’s liability limited to the contribution made and liability accepted by that partner to the LLP. The law relating to general partnerships was made inapplicable to LLPs. An LLP is required to register the deed of incorporation with the Registrar. The subscribers to the incorporation documents are the initial members/partners; any other person may become a member by entering into an agreement with the existing members. Any change in the agreement, or indeed in the partnership, have to be duly intimated to, and registered with, the Registrar.
3.04 Every member is an agent of the LLP, and the LLP is responsible for the actions of its members, unless a particular member lacks the authority to act for the LLP for doing what he has done. In that case, the liability would be of that individual, and would be unlimited. The Committee noted that in this regard, the Texas LLP statute does not relieve a general partner from liability for the partnership’s non-malpractice contractual and tort liabilities; the partners are insulated only from the vicarious responsibility for the partnership’s malpractice-type liability. The Texas LLP statute has served as a model for many other LLP statutes in the USA. In some states of the USA, the LLP regime is more liberal. For example, the State of Delaware, famous for its laissez-faire approach to company law, has established a regime where any obligation of a LLP, whether arising in contract, tort or otherwise, is solely the obligation of the LLP. A partner is not personally liable, directly or indirectly, by way of indemnification, contribution, assessment or otherwise for such an obligation solely by reason of being or acting as a partner. Interestingly, the Delaware law also provides for, and permits, foreign limited liability partnerships: a prospect not likely to be welcomed by any body of professionals in India.
3.05 In India, some bodies of professionals have been prohibited from practicing under any incorporated form. The ‘general partnership’ or partnership simpliciter (General Partnership) has traditionally been the entity of choice to provide services by professionals such as lawyers, accountants, doctors, architects, and company secretaries.
3.06 It was strongly represented before the Committee that in an increasingly competitive and litigious business environment, there are several disadvantages attaching to the general partnership form. The larger implications of unlimited liability firms responsibilities were first seen in the 1990s, when many US law firms went insolvent in the wake of a $980 billion Loan and Savings scandal as a result of suits decreed in malpractice litigation. Not only were the firms’ assets completely liquidated, under standard principles of partnership law, the partners were jointly and severally liable for the entire liabilities of the partnership. The prospect of being a partner in a partnership with unlimited personal liability is, as stated before, not an attractive proposition.
3.07 The Committee feels that with Indian professionals increasingly transacting with or representing multi-nationals in international transactions, the extent of the liability they could potentially be exposed to is extremely high. Hence, in order to encourage Indian professionals to participate in the international business community without apprehension of being subject to excessive liability, the need for having a legal structure like the LLP is self-evident. Provisions which restrict the number of partners to twenty prevent the growth of professional firms to the large entities operating on an international scale. Such inhibiting conditions have to be removed. Otherwise, Indian professionals may well get excluded from taking their rightful place in the international community, that their skills otherwise entitle them to.
3.08 It would be seen from discussions, in paragraphs 3.01 to 3.04 above, that, in a legal perspective, an LLP is a hybrid between a company and a partnership, but much closer to the private company form. The Committee believes that, to encourage greater professionalism and create commercially efficient, vehicles for providing service of the highest quality, it is essential to create a regulatory regime that would govern the formation of such a hybrid entity between the partnership simpliciter, or general partnership, and a private limited company, that is, an LLP. Such an entity would provide the flexibility of a partnership (allowing the owners to adopt whatever form of internal organization they prefer), and limiting at the same time, the owner’s liability with respect to the LLP. Given the wide acceptability of the limited liability company, a partnership of recognised professionals should be given the choice to opt for a more suitable legal entity, and conferred the privilege of limited liability, especially if sufficient safeguards are put in place. The fundamental difference between an LLP and a limited liability company lies in the internal structure (the management-ownership divide inherent in a company is not there in a partnership), and this difference does not impact on the issue whether to confer the privilege of limited liability on a partnership firm of professionals. Since LLPs are now accepted non-corporate entities in developed countries like the USA and UK, it is appropriate to enhance the global competitiveness of our professional firms by ensuring that India’s company law is flexible enough to provide mechanisms and instruments which foster growth of large professional firms.
3.09 The broad areas of analysis with respect to LLPs are:
(a) application of the LLP regime;
(b) incorporation, registration and number of partners;
(c) limited liability;
(d) financial safeguards; and
(e) tax treatment of LLPs.
3.10 To recapitulate, the broad distinction between a General Partnership and an LLP is as under:
(a) General Partnership – The partnership simpliciter constituted under the Indian Partnership Act, 1932. Each of the partners is jointly and severally liable for any liability arising out of or in respect of the partnership.
(b) Limited Liability Partnership – The LLP is a separate legal entity with unlimited capacity where no member or partner is liable on account of the independent or unauthorised actions of one’s partner, and whose liability is limited to the respective stake of each in the LLP. The members of an LLP would have the option to have a general partner or more with unlimited liability, but it would not shield the partners from legal liability arising out of their own personal acts which are not done for and on behalf of the LLP, that is, any act done beyond the acts and powers of the partners as laid down in the incorporation document. Further, a partner’s liability is not limited when the misconduct is attributable to him or to an employee under the supervision or control of that partner. An LLP only protects a partner, other than a general partner from the liability arising from the misconduct or personal acts of other partners.
Application of the LLP regime
3.11 In the Committee’s view, the scope of LLP should, in the first instance be made available to firms providing professional services, as opposed to trading firms and or manufacturing firms, for several reasons. Firstly, because Indian professional firms are precluded from practicing under any other legal form in view of the restrictions imposed by their respective regulatory laws; trading firms or manufacturing firms, however, have the option to carry on business as a private limited or public company under the Companies Act, 1956. Secondly, as the professionals are also governed and regulated by their respective professional, regulatory bodies, which also control and monitor professional conduct, extending the LLP structure only to professionals minimises the risk inherent in testing new waters. Thirdly, there is no special advantage that small private companies or SSI units would derive from being an LLP, especially in light of the fact that this Committee itself is simultaneously recommending a considerable easing of regulations on private companies, specially small private companies. It was felt that extending the LLP structure to professionals, in the first instance, would help evaluate its advantages and risks; and based on such evaluation and experience, the LLP form can be considered for extension to small scale manufacturing and/or trading firms as well in the future.
Recommendation 3.1 : Application of the LLP regime
Law may be enacted to provide for establishing Limited Liability Partnerships. The LLP form should be initially made available only to those providing defined professional services like lawyers, company secretaries, accountants and the like. To be eligible for this form of partnership, the profession must be governed by a regulatory Act that adequately controls and disciplines, errant professional conduct. Such professions may be notified by the Department of Company Affairs from time to time.
LLP may be extended, at a later stage, to other services and business activities once the experience gained with the LLP form of organisation has been evaluated and tested.
Incorporation, registration and partners
3.12 An LLP must be incorporated by using a formal mechanism of filing the incorporation document with the RoC. Further, there should be no restrictions on the number of partners in an LLP.
Recommendation 3.2 : Incorporation, registration and partners
Two or more professionals who wish to associate for the purpose of providing an identified professional service, may subscribe their names in an “incorporation” document in the prescribed form.
The relations inter se the partners and between the partners and the LLP may be governed by individual agreements between the parties concerned. Such agreement must be filed with the RoC; changes made in the agreement will also have to be filed with the RoC.
The LLP agreement should contain information as may be prescribed by the Department of Company Affairs.
No limit be placed on the number of partners in an LLP. Any person may become a partner by entering into an agreement with the existing partners in the LLP. Further, when a person ceases to be a partner of an LLP he/ she should continue to be treated as a partner unless: (a) the partnership has notice that the former partner has ceased to be a partner of the LLP; or (b) a notice that the former partner has ceased to be a partner of the LLP has been delivered to the RoC. A partner having resigned from an LLP would continue to be liable for acts done by him during his tenure as member of the LLP.
LLPs should be regulated and administered by the Central Government to ensure uniform standards, and since many of the State Governments might not have adequate infrastructure and expertise for ensuring effective regulation.
3.13 As opposed to the concept of joint and several liability, applicable in general partnerships, the liability for partners in a LLP should be limited. In other words, the LLP would assume liability in the event that a partner of the LLP commits an act of commission or omission for and on behalf of the LLP, that results in such liability. The partners would be liable only to the extent of their respective agreed contribution to the LLP without any recourse to the personal assets of a partner. However, as discussed in paragraph 3.10 (b) of this Chapter, the partners would still continue to be liable for their personal acts which are not done for and on behalf of the LLP, and were committed in their personal capacity, for example if a partner knowingly causes the LLP to commit a felony or tort.
3.14 Provisions dealing with insolvency, winding up and dissolution of an LLP should be similar to those provided for private companies in the Companies Act, 1956. There should also be provisions detailing the liability of partners to contribute to the assets of the LLP in the event of its being wound up.
Recommendation 3.3 : Limited liability
Every partner of the LLP would be an agent of the LLP. However, an LLP would not be bound by anything done by a partner in dealing with a person if
(a) the member in fact had no authority to act for the LLP by doing that act; and
(b) the person knows that he has no authority or does not know or believe him to be a partner of the LLP.
Where a partner of the LLP is liable to any person or entity as a result of his wrongful act or omission in the course of the business of the LLP, the LLP would be liable in such circumstances. However, the partner would be liable only to the extent of his/her contribution to the LLP.
In the event of an act carried out by a LLP, or any of its partners, fraudulently, the liability would not be limited; it would, in fact, become unlimited as provided for in section 542 of the Companies Act, 1956. i A partner shall not be liable for the personal acts or misconduct of any other partner.
The provisions relating to insolvency, winding up and dissolution of companies as contained in the Companies Act, 1956 may be examined and suitably modified to conform to the philosophy of LLPs. The partners may have to contribute to the assets of the LLP in the manner provided for in this regard
3.15 To protect the interest of persons who might have claims against an LLP, all LLPs should be compulsorily required to take out an insurance policy that would cover its liabilities as an LLP to a reasonable extent. This is necessary as such persons might not get any real relief, since there will be no access to the assets of partners of the LLP except to the extent of his/her liability in the LLP. This would deter the creation of shell LLPs or asset-thin LLPs. Further, an LLP should, on request by persons dealing with them, permit inspection of the register containing the number and names of partners, the pattern and extent of liability of partners, the amount of insurance coverage and other such matters.
Recommendation 3.4 : Compulsory insurance
There should be insurance cover and/or or funds in specially designated, segregated accounts for the satisfaction of judgments and decrees against the LLP in respect of issues for which liability may be limited under law. The extent of insurance should be known to, and filed with the RoC, and be available for inspection to interested parties upon request.
3.16 The standards of financial disclosure as applicable to private companies should also be made applicable to an LLP. The advantages gained from having the privilege of limited liability should be coupled with the responsibility of making adequate financial disclosures so as to minimise the chances of fraud and mismanagement. This should be subject to such privilege as may be available to a professional in his relationship with his or her client in maintaining confidentiality, and it may be different for different professions.
Recommendation 3.5 : Financial disclosures
The standards of financial disclosures would be the same as, or similar to, that being prescribed for private companies subject to privilege already available between a professional and his or her client in maintaining confidentiality.
Tax treatment of an LLP
3.17 Section 10 of the UK LLP Act lays down that a trade, profession or business carried on by an LLP, with the view to profit, shall be treated as carried on in partnership by its members and not by the LLP itself. Thus, any asset held by an LLP, or any tax chargeable on gains made shall be treated as held by the partners, or gains made by the partners, and not by the LLP itself. In other words, an LLP enjoys a pass-through status and is not taxable as such; the taxation liability falls on the partners in their individual capacity. In the USA, too, LLPs enjoy a pass through status for the purposes of taxation. The profits or losses of the LLP pass through the business and are reported on each partner’s personal returns.
3.18 This Committee would like to recommend the same pass through status for LLPs in India. However, the Committee recognises that it has neither consulted, nor got the views of the Ministry of Finance (Department of Revenue) in this regard. While recommending a taxation regime similar to that obtaining in the USA and UK, the Committee urges the Department of Company Affairs to incorporate such a regime in consultation with the tax authorities concerned.
Recommendation 3.6 : Tax treatment of an LLP
The LLPs should be governed by a taxation regime that taxes the partners as individuals, rather than taxing the LLP itself, i.e., the LLPs should be treated in the same manner as the firm under the tax laws.
3.19 Some members of the Committee considered proposals received from experts including the draft of possible legislation. The draft Bill produced by them was discussed in the Committee. Shri Shardul Shroff, member of the Committee, has given a draft of the Bill on LLPs. The Committee has sent a copy of the same separately to the DCA.