What is a limited liability partnership agreement?

A limited liability partnership (LLP) agreement is a legal contract entered into by the members of an LLP. The agreement will determine their rights and duties. Members in an LLP are taxed in the same way as partners in a partnership, except that in certain circumstances they may be deemed to be employees and their income tax calculated as such.

Advantages of a written LLP agreement

Although there is no legal requirement to create an agreement, it's advisable to do so. An agreement will clarify the relationship between the members.

If there is no written agreement, there are some basic terms in legislation that govern LLPs. However, relying on them is risky and can lead to serious conflict sometimes. Therefore, most professional LLPs enter into a formal written agreement.

Main clauses

The specific terms of an LLP agreement will be determined by the individual requirements of each LLP. However, an LLP agreement will usually address the following:

LLP capital

The capital of an LLP is the amount or value that each of you has agreed to invest in the LLP. It can be made in cash, assets or in kind (e.g. a member's skills, connections or reputation). The amount or value that is contributed is recorded on a capital account for each member.

LLP profit and losses

The profits and losses of an LLP will be split between you and the other members after planning and agreeing annual accounts. The amount of profit that each member receives or the amount of the loss that they're liable for will be set out in the agreement. This could vary depending on the LLP's performance. The agreement could also provide for part of the profits to be paid as interest calculated on the members' capital contributions.

Drawings

The members may have their own financial requirements that they might not be able to meet if they had to wait until their profit share was determined at the end of each year. As a result, they can take a set amount of money from the LLP funds each month. This is a payment on account of their annual profit share. This payment is called 'drawings'.

LLP goodwill

The difference in value between the assets of the LLP and its value as a running business is called 'goodwill'. Certain items add value to the goodwill of a business. These include contacts, geographical location, the reputation of a business or product, monopoly rights and development potential.

The calculation of goodwill is far from scientific, and you may need help from an expert like an accountant. It's frequently excluded from the annual accounts, since it represents only an estimated, insubstantial value. If you leave the LLP, you may be entitled to a goodwill share and the agreement should provide for this.

Duties of members

The agreement might set out the general duties of members to the LLP, e.g. the duty to act in good faith towards it.

Indemnities

The LLP agreement should contain indemnities. These are clauses that say the LLP will be responsible for and protect its members against any liabilities, or claims that they incur while carrying out the business of the LLP. The members should also agree to repay the LLP any loss caused by them breaching the LLP agreement.

Dismissing a member

There is no right to dismiss a member from the LLP if there is no express agreement stating this. The members might decide that they want to be able to dismiss a member if that member does specific things. These should be set out clearly in the agreement and the method to dismiss should also be stated.

Rights to payment on termination

The agreement should say how much you'll be paid if you stop being a member of the LLP. It should state your share of the LLP capital, undrawn profits and goodwill.

Property

You need to distinguish between property that belongs to the LLP and property that belongs to an individual member. The LLP can use an asset that a member owns. However, that arrangement must be clearly stated in the agreement, so that ownership of the assets is clear.

LLP management

There are 4 main ways that a LLP can be managed on a day-to-day basis:

• A managing member: Members will choose one member to manage the LLP on a day-to-day basis. This approach is best suited to larger LLPs.
• A management team: Members will vote to choose members to form a management team. This team will manage the LLP together on a day-to-day basis. This approach is best suited to large LLPs and/or those that wish to give the management burden to several members.
• A management group: Members choose a managing member and a managing team known collectively as a management group. The managing member will delegate their responsibilities to the management team as appropriate. The management team can't act independently of the managing member without permission. However, if the managing member acts inappropriately, the management team must tell the other members.
• All of the members: The LLP is managed on a daily basis by all of the members together. This approach is most suited to small LLPs where there is little or no point in selecting either a management team or a managing member.

When considering which type of management structure would be most appropriate, you should consider factors such as the size, approach and ethos of your LLP. Also bear in mind that if the LLP is managed by a managing member and/or management team, the other members can't restrict their activities or interfere with the management of the LLP (except in certain situations, such as misconduct).

Restrictive covenants

After a member leaves the LLP, you may want to prevent them from competing with you. In order to achieve this, you can restrict the type of work that they can do after they leave. These restrictions will prevent them from competing with you, soliciting customers and poaching your staff. These restrictions are known as 'restrictive covenants'.

Restrictive covenants are only enforceable if they go no wider than necessary to protect legitimate interests of the LLP, and these interests would be damaged without the restrictive covenant.

The main types of restrictive covenants are:

Non-compete covenants

These covenants aim to prevent a member from competing with the LLP in a particular field and particular geographic area. However, courts are reluctant to uphold these covenants and they won't be upheld if they're designed only to restrict competition. You must show that the former member had influence over their customers. Generally, it'll only be upheld if there is no other way to protect confidential information.

The area within which you bar the member from competing and the type of work they're prevented from doing must be reasonable. These mustn't be wider than is necessary to protect the LLP from damaging competition.

Non-soliciting and non-dealing of customers' covenants

After the member leaves the LLP, these covenants aim to prevent them from soliciting the business or customers of the LLP, and soliciting employees, consultants or members of the LLP.

Dispute resolution

It's essential for members to be able to resolve partnership disputes. Therefore, a dispute resolution clause is essential in any LLP agreement to avoid disputes that result in lengthy and expensive litigation.