Partnership and LLP disputes

Publication April 2016


Introduction

In recent times, an important focus of the cases concerning Limited Liability Partnerships (LLPs) has been the status of LLP members and, specifically, whether an individual can have the dual status of member and employee (or worker) under certain circumstances. Many of these cases have also involved the more commonplace LLP agreement construction and breach of contract issues to which the expulsion of a member can give rise.

In Flanagan v Liontrust Investment Partners LLP & Ors [2015] EWHC 2171 (Ch), however, the High Court was required to consider an altogether different question: whether the common law doctrine of repudiatory breach can apply to multi-party LLP agreements implemented under section 5 of the Limited Liability Partnership Act 2000 (the ‘LLPA 2000’). Framed in such terms, this might appear to be a rather esoteric point. However, the implications of the Court’s decision for LLPs are significant.

In the Flanagan case, the claimant’s argument was that the service of an invalid retirement notice, determined without following the proper procedure, was a repudiatory breach of contract which terminated the LLP agreement. As a consequence, it was said that the default provisions of the Limited Liability Partnership Regulations 2001 (the ‘LLPR 2001’) applied, entitling the claimant to a pro rata share in the LLP’s capital and profits. As the claimant had only been entitled to a fixed income allocation and a performance-linked allocation under the LLP agreement, the practical result of a finding that the default provisions applied would, in all probability, have been a windfall for the claimant in the order of many millions of pounds.

Ultimately, the Court decided against the claimant on this issue. However, the judgment creates new law, runs contrary to the views expressed previously by most commentators in this area and therefore warrants close attention.

The law of LLPs

LLPs were established as a new form of legal entity under the LLPA 2000, with members as opposed to partners. Under section 1(5), the general position is that the law relating to partnerships does not apply to LLPs, with the result that the legal basis for LLPs is to be found in the LLPA 2000 and the regulations made pursuant to that legislation (which include the LLPR 2001).

As for the relationship between the members of an LLP, the relevant principles are located in section 5 of the LLPA 2000 and Regulations 7 and 8 of the LLPR 2001, and are as follows:

Section 5 (1) LLPA 2000

Except as far as otherwise provided by this Act or any other enactment, the mutual rights and duties of the members of a limited liability partnership, and the mutual rights and duties of a limited liability partnership and its members, shall be governed –

(a) by agreement between the members, or between the limited liability partnership and its members, or

(b) in the absence of agreement as to any matter, by any provision made in relation to that matter by regulations under section 15(c).

Regulations 7 and 8 LLPR 2001

Default provision for limited liability partnerships

7 The mutual rights and duties of the members and the mutual rights and duties of the limited liability partnerships and the members shall be determined, subject to the provisions of the general law and to the terms of any limited liability partnership agreement, by the following rules:

(1) All the members of a limited liability partnership are entitled to share equally in the capital and profits of the limited liability partnership.

Expulsion

8 No majority of the members can expel any member unless a power to do so has been conferred by express agreement between the members.

By section 994 of the Companies Act 2006 (as applied to LLPs), an LLP member may apply to court if his interests are being unfairly prejudiced by the LLP or the other members. While many LLP agreements exclude this right, that was not the case in Flanagan.

The facts

In 2011, the claimant, Mr Flanagan, joined the defendant LLP where he managed a hedge fund with an emphasis on emerging markets equities (the ‘Fund’). His relationships with the LLP and its other members were governed by an LLP Agreement and a Side Letter. Amongst other matters, the LLP Agreement:

  • provided for the LLP to be managed by a Management Committee (of which Mr Flanagan was a member)
  • prescribed a procedure whereby members could be compelled to retire from the LLP pursuant to a decision by the Management Committee at a meeting
  • expressly excluded the default provisions under Regulations 7 and 8 of the LLPR 2001.

The Side Letter:

  • dealt with Mr Flanagan’s remuneration, which was to be a fixed allocation of £125,000 in each financial year and a variable allocation linked to performance
  • specified a compulsory membership period of two years, coupled with a notice period of six months (with such notice to expire ‘no earlier than the 24 month anniversary’).

In 2012, the LLP’s senior management decided to close the Fund and part company with Mr Flanagan. To that end, a notice to retire was served which purported to place Mr Flanagan on garden leave and terminate his membership of the Management Committee with immediate effect. However, the notice was served more than six months prior to the 24 month anniversary date and the decision to expel Mr Flanagan had not been taken at a meeting of the Management Committee. The LLP subsequently attempted to reinforce its position by serving two further retirement notices, in case the preceding notices were non-compliant.

The issues

Mr Flanagan brought proceedings against the Fund in the Chancery Division, claiming declarations as to the status of the LLP Agreement and side letter, and as to the application of the default rules under the LLPR 2001. He also concurrently petitioned for unfair prejudice under section 994 of the Companies Act 2006.

Mr Flanagan’s claim turned on two key issues:

  • whether the first retirement notice and decision to place him on garden leave were invalid, amounting to a renunciation (i.e. a repudiatory breach) of the LLP Agreement and Side Letter
  • if the LLP Agreement and Side Letter had been renounced, whether the default rules under the LLPR 2001 applied so that Mr Flanagan was entitled to an equal share of the LLP’s capital and profits and could not be expelled by a majority of the LLP’s members.

On this basis, Mr Flanagan maintained that he was still a member of the LLP and that the appropriate remedy should be an order that the LLP buy out his ‘share’. Conversely, the LLP’s position was that the doctrine of repudiatory breach does not apply to multi-party LLP agreements under section 5 of the LLPA 2000 and, accordingly, that Mr Flanagan did not remain a member and his only remedy was damages, calculated by reference to the non-payment of his annual fixed allocation of £125,000 since the date of the first retirement notice.

Judgment

The Court rejected Mr Flanagan’s claim, holding as follows.

  • The first retirement notice and decision to place Mr Flanagan on garden leave were invalid. This was because, for a notice of retirement to be valid, the language of the Side Letter required that it be given for a period of precisely 6 months expiring on or after the 24 month anniversary date. However, the notice had been served early and the Side Letter (and LLP Agreement) did not permit a longer notice period. The LLP Agreement also required a resolution of the Management Committee, which there had not been. As to the effect of this breach, the LLP had evinced a clear intention not to be bound by the LLP Agreement, going to the root of the contract between Mr Flanagan and the LLP. The breach was therefore repudiatory and Mr Flanagan had accepted it. 
  • However, Parliament cannot have intended the doctrine of repudiatory breach to apply to LLP agreements under section 5 of the LLPA 2000, except perhaps if the LLP has only 2 members. If it did, the default rules under the LLPR 2001 would apply to the wronged member and his relationship with the LLP, whereas the other members of the LLP and their relationship would continue to be governed by the LLP Agreement. Amongst other matters, this outcome would lead to legally incoherent results, ran contrary to commercial common sense and contradicted the express exclusion of the default rules under the LLP Agreement. This decision was reached in the absence of any preceding authority on the operation of the doctrine in relation to multi-party LLP Agreements.

The general effect of the Court’s decision was, therefore, that once an LLP agreement under section 5 of the LLPA 2000 had been made, it will continue to bind the LLP and its members until the agreement is terminated by common agreement or is varied in accordance with an agreed procedure.

Comment

Mr Flanagan’s was not the only attempt by an expelled LLP member to obtain an enhanced interest in 2015. That was also the claimant’s aim in Reinhard v Ondra LLP and others, although in that case the arguments centred on the construction of the LLP agreement and what had been agreed when the member joined the LLP. By contrast, the Flanagan case decides, for the first time, a question of more general application, concerning the operation of LLP agreements and their interaction with the default rules. It is submitted that the Court’s decision is a reasonable answer to this question, avoiding the confusion which would have followed from the application of mutually inconsistent rules.

For multi-party LLPs with carefully drafted LLP agreements, the decision delivers comfort that retired members may not circumvent their contract with the LLP in order to take advantage of more generous provisions under the default rules. In addition, it brings home the importance of LLP agreements being comprehensive and where appropriate including standard clauses, such as express exclusions of the default rules and the right to claim unfair prejudice. A similar message follows from the Reinhard case, where the dispute arose (in part) due to a dispute as to which version of the LLP agreement applied at the relevant time.

Finally, it is worth noting that the application of the doctrine to two-member LLPs is still to be decided. For those LLPs, it would seem that there is more of a case for arguing that the doctrine should apply, as there would be no risk of two sets of rules applying (unlike the multi-party situation).


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