Yoganandh & Ram Chartered Accountants Walk Through Limited Liability Partnerships.

Yoganandh & RamChartered Accountants

Walk Through Limited Liability

Partnerships


Concept paper on LLPs in India

Based on the recommendations of the NC Gupta committee, and the Irani committee, the Govt had come out with a concept paper and a draft of the LLP bill in late 2005

LLP Bill has been placed before Lok Sabha on 7th Dec 2006 Rajya Sabha on 15th Dec 2006.

LLP Bill approved by Lok Sabha on 15th Dec 2008


Concept paper on LLPs in India

First LLP in India expected by 1.4.2009 The Constitution (entry 44, List 1 of

Seventh Schedule) has put “corporations law” in the Union List: As LLP’s are to be given an

incorporated status, they will fall under this list


Concept of LLPs The word “partnership” in LLPs is a misnomer, as the entity is not merely a

collective coming together of two persons: Results into creation of a new entity with its own

existence

LLPs are a hybrid between a company and a partnership: Externally, they have all features of a company Internally, they are run and managed by the members,

hence they are like partnerships The idea is to clothe a partnership with

Limited liability Incorporated existence and therefore personality of

its own

The concept of LLPs has inherent inconsistencies, as it has not had benefit of seasoning over centuries:

US law also relates to 1990s – Delaware model is the most commonly used one.


LLP legislation in other countries

In UK, LLP law was passed in 2000

The campaign for LLPs was initiated by accounting firms (PwC and E&Y) to limit their liability:

Though UK Companies Act did allow professions to register as companies, accounting firms were reluctant to publish accounts subject to inspections etc

The UK move set the ball rolling in other countries too: Canada (Ontario) introduced LLP law in 1998 Singapore issued consultation paper in 2002, enacted the law in

2005

In UK, the LLP model is available for all businesses; in New York, it is open only for selected professions.

Yoganandh & RamChartered Accountants6

Advantages of LLP

o Easy to incorporate, very little paper work required

o Low cost of incorporationo Lot of flexibilityo Very little accountability, in terms of legal

complianceo All benefits of a partnership business,

though with a new entityo Taxation as general partnerships


Overview of the UK LLP law

Most obvious feature: the law is very short, very simple: Just 19 sections, no schedules

Owners and managers are the same: one member designated as “designated member”

May be a founding member or may change Unlimited business capacity Principle of agency/principalcy applicable:

Every member is an agent of the LLP Limited liability must always come with protected capital:

The law provides for capital of each partner, but does not restrict drawing

Capital or liability not mentioned in incorporation documents


Salient features of the LLP Bill - Constitution

Indian law seems based on the Singapore law LLP is a body corporate, separate entity, perpetual succession:

To ensure perpetual succession, transferability of membership is a must

Persons constituting it are members: Individuals and corporates may be members:

Since body corporate will include an LLP, an LLP may also be a member

At least 2, maximum not specified Existing firms and Companies may convert themselves into LLPs –

Schedule 2 (Firm),3(Private Company) and 4(Unlisted Public Company) provide for the same:

Eligibility in case of a company – no charge subsisting on the assets of the company or in force at the time of winding up

No such eligibility condition in case of firms Partners of newly incorporated LLP comprise only:

Shareholders in case of company Existing partners in case of partnership firm


Management of LLPs The law requires at least two designated partners

Who are individuals At least one shall be a resident of India The position of designated partners seems to be the same

as in case of directors The designated partner has the ultimate responsibility. He is:

Answerable for all acts matter or things, done or to be done by the LLP, and shall be personally liable for all penalties on the LLP

The LLP is liable for only the contravention of this section (appointment of a manager)

This section has serious implications: by not appointing a designated partner, penalty not less than

Rs. 10000 but up to Rs. 500000 UK law talks of designated member; if no member is

designated, then every member is a designated member


Preservation of capital One of the most important pillars of the limited liability is definite capital:

Capital is the foundation on which the assets are built The LLP law, limiting liability, leaves the issue of preservation of capital very

vague: Capital is not mentioned in the Incorporation document; hence

not disclosed to the public Capital of partners may be drawn Sec 65 leaves the issue of contribution on winding up completely

open to be provided in the partnership agreement – which is not a public

document The Act provides the liability of the partnership to be met solely from

the property of the partnership: Property means, net property, that is, net worth, which is the capital If there is no capital maintenance clause, the whole concept may be totally

flawed The basis of contracting external liabilities is only a declaration of solvency:

Which does not serve the purpose of credit evaluation, as solvency is only as on the date on which it is made

In absence of capital maintenance, LLP might be NLP – no liability partnership


Preservation of capital or capital insurance

UK law requires partners to contribute to the extent of drawings made within 2 years prior to winding up

Insolvency rules in India are applicable to only individuals

LLPs may be subject to corporate bankruptcy rules: Undue preference rules may require

returning of drawings made 1 year before winding up [sec 531A]


Partners and their relationship

Initial partners are subscribers to original document

Any one can be partner in accordance with agreement: Individuals and bodies corporate may be partners

o Designated partners must at least be two individualso In case of bodies corporate as partners, at least two

individuals to be designatedo Insistence comes from the need for individuals to be directors

Partnership interest is not a transferable security but requires agreement with all partners

Mutual rights of partners are allowed to be governed by the partnership deed


Partners and their relationship

Cessation: Death, etc Mutual agreement Resignation by 30 days’ notice A retiring partner shall be entitled to receive the credit of

his capital and share of accumulated profit determined to the date of his cessation:

The law should provide – subject to mutual agreement

Changes in partners to be notified to the registrar


Partnership principle Every partner to be agent of the LLP, not of other partners Partnership interest interestingly split into:

Economic interest Non economic interest

Economic interest means right to share in profits Economic interest assignable, but assignee is not treated

as a partner, nor gets any right of participation in management:

Creates interesting situation: Partner may be X, assignee of economic interest may

be Y X incurs liabilities, Y has all economic interest, but no

obligation, as he does not have any partner status Companies Act, on the contrary, recognizes no

trusts or equities on the shares


Transferability of partners’ interest

Seems the share of the partner in the capital of the firm, and share in profits, are two separate interests

Share in profits a transferable interest: sec 42 This has clearly followed the

Singapore model


Accounting and reporting LLPs are required to maintain records, but not:

Hold meetings and lay accounts File accounts Publish accounts

They only make an annual declaration of solvency To be made within 6 months from end

of FY To be signed by designated partners

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Taxation

In line with UK law, Act provides for taxation of income as in case of general purpose partnerships


Inspection and investigation

Provisions analogous to sec. 234 and 235/ 237 of Companies Act

Prosecution powers to the Central Govt. – Sec 50


Winding up Winding up may be either voluntary or

mandated by the Tribunal

Regulations to be provided

Notably, Singapore has a huge set of rules applicable to winding up of LLPs, almost in line with the Companies Act


Applicability of Companies Act

UK has extended a large chunk of Companies Act provisions to LLPs too: Power contained in sec. 67 to extend

Companies Act provisions: Very likely that several of the administrative

provisions may, over time, be extended


Penalties and prosecution

The power to impose penalties has been granted to the Tribunal


Comparing LLPs and private limited companies – Similarities

Incorporated PersonalityPerpetual existence, winding up by lawPlurality of owners Limitation of contributory liabilityLimits on trading powers


Nature of Difference LLP’sPrivate Limited

Companies

Segregation of management and ownership

Indian law requires designated partners; Designated partners generally liable for all compliances

Law does not lay down powers of designated partners

Directors are different from shareholders; different powers are vested

Agency principle Partners represent the LLP Shareholders are distinct

TransferabilityPartnership is transferable only by agreement

Shares are transferable securities

Fixity of capital LLPs need not have fixed capitalLimited liability companies need to have a minimum capital

Reporting, audit, meetings No requirements Elaborate requirements

Comparing LLPs and private limited companies – Differences


Separation of management and ownership

One of the key features of LLPs is that there is no separation of ownership and management:

Hence, the foundations of corporate law, with the owners reposing trust in the management do not apply

Much of the reporting and accountability structure of corporate law arises out of this separation

UK LLP law does not provide for separation of management:

In fact, there is a “designated member” who will be answerable to the regulators


Administrative authorities Incorporation, striking of defunct LLPs: Registrar of

Companies Registry record keeping, inspections, etc:

Registrar of companies Compromise, arrangement, etc

Central Government Rule making powers; powers to notify Companies Act to

be applicable Winding up

Tribunal Prosecution for offences:

Lower courts


Legal Compliance DPIN for designated partners Particulars of designated partners are to filed Incorporation – by filing incorporation document with the ROC Reservation of name, change of name, etc – provisions similar to Companies

Act Partnership agreement and changes therein to be filed with the ROC:

Surprisingly, the partnership deed is not one of the documents available for inspection u/s 35

While the basic rights of the partners are defined in the document

Registration of changes in partnership (names of partners) Filing of annual accounts and declaration of solvency Audit of accounts Filing of annual return Powers of the registrar to call for information, inspection and investigation

largely the same as in case of companies Compromise, arrangements etc as per rules to be made by Central govt.


What may the LLP hold LLPs may hold any property, tangible or

intangible Interestingly, partners may transfer, either

as contribution or otherwise, properties in kind also

Unlike in case of companies, no fetters on transfer of property in kind or a separate disclosure: Valuation of the property not given

the seriousness it deserves


Liberties that the LLP enjoys

Accounting: May write books on either cash or accrual basis

Might lead to a considerable tax advantage Clear conflicts with the audit requirements – cash basis cannot reflect

true and fair value of the state of affairs Accounting standards not applicable

Limitation of liability: Best of both the worlds – limited liability and flexible capital

No minimum capital requirements Audit:

While auditing is mandatory, there is no substantive detailing in the law

Rules are much more liberal than for companies Borrowings:

No restriction on borrowing from partners, or to partners The act puts amounts owned to partners at par with amounts owned

to others No need to create charges

Not in the best interest of lenders


Ultravires, agency rule and LLPs

The doctrine of ultravires is not applicable to LLPs Since the objects are not required to be specified in

the incorporation document

At the same time, the partners are supposed to be agent of the LLP:

Partner exceeding his authority does not bind the LLP

In other words, the LLP escapes liability for anything done in excess of the assigned authority

Authority of LLPs contained in partnership document Those dealing with the LLP cannot get partnership

document as it is not one of the docs that may be inspected

This leaves those dealing with the LLP at a great risk


Conversion into LLPs Firms, private companies and unlisted public companies

may convert Firms:

All partners to continue Amount to dissolution of the firm Transfer of property by way of vestation – may be

stamp duty may be escaped Private companies:

There is no security interest on the property All members of the private company continued as

partners There is no need to seek sanction of the lenders,

etc Public unlisted companies:

Same as in case of private companies

Yoganandh & Ram Chartered Accountants Walk Through Limited Liability Partnerships.

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