LLPs and ‘catastrophic’ claims
The Limited Liability Partnerships Act 2000 heralded a new era for many professional firms, but is the individual member really insulated against a multi-million pound claim? Six years on, our corporate & commercial team re-evaluate the issues.
Incorporating as an LLP offered professional firms the chance to receive favourable tax treatment and gain the benefit of limited liability – and a huge number seized the opportunity to do so. But is the individual member really insulated against a multi-million pound claim?
Several high profile LLPs have recently boosted their insurance cover amid fears that members may find themselves on the hook in the event of a so-called ‘catastrophic claim’. The likelihood of such claims materialising has risen sharply, not least because of changes in employment law. For example, the cap on damages has been removed for many offences and increasingly the onus is on employers to prove their innocence – or face severe penalties.
In very many cases the claim will be against the LLP itself, which is a separate legal entity. A third party will usually contract with the LLP, rather than with an individual member, so it is the LLP that will be liable, to the full extent of its assets. There are instances, however, when individual members may be held personally liable.
Members should be particularly wary of assuming ‘personal responsibility’ towards clients. For example, if in his personal capacity a member advises a client and the client reasonably relies on the advice to his detriment, the member may be held personally liable for negligent advice.
Third parties such as banks may require individual members to give personal guarantees to support a loan to the LLP. If the LLP defaults in repaying the loan, the guarantee is likely to be enforced – and members will be required to repay the loan in full. Each member should ensure he is properly advised before giving a guarantee. He should also be aware that his personal assets may be at risk.
Some members have found themselves personally liable after having signed documents which do not contain the correct name of the LLP. It is vitally important that all documents – including letters, emails and cheques – show the full name of the LLP and make clear that its liability is limited (ie it is not a traditional partnership).
Members need to consider carefully whether to continue referring to themselves as ‘partners’. If it is not clear they are trading as an LLP, a court could decide that they are a traditional partnership – meaning the loss of limited liability status.
It is important for members to have a firm grasp of the financial performance of the LLP. Those who do not, run the risk of being found personally liable under a claim for fraudulent and/or wrongful trading (ie where members have allowed the LLP to trade into insolvency when they knew or ought to have known there was no reasonable prospect of avoiding insolvency).
Members must also take care when withdrawing money from the LLP. Taking money out – whether as a share of profits, interest on capital or repayment of a loan, at any time during the two years immediately prior to the winding up, knowing that the LLP was (or would become) unable to pay its debts –may render a member personally liable to contribute towards the assets of the LLP.
There are certain situations where members will never be able to avoid the risk of personal liability. However, in many cases the risk can be greatly reduced by taking greater care with the wording and content of the documentation used in the course of the LLP’s business activities, and by getting the LLP agreement (members’ agreement) correct from the outset.
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