Industry News

LLP Conversion the Optimum Legal Structure

18 October 2011

Partners in traditional law firms have always been ultimately liable for any debts. They will, according to many office manuals, especially those following the Lexcel standard:
‘…
keep under periodic review the question of whether the current legal status of the firm remains the optimum legal structure for its operation. Included within this consideration will be the question of whether it is appropriate, desirable and possible to limit the personal liability of the owners of the firm, through a change in the legal status of the firm. (This may be viewed in the light of the ability of the firm effectively to limit its overall liability by agreement with its clients.) This process of review will be an inherent part of the review of the firm’s strategic and business plans.’,

Generally this will be either to a Limited Company or a Limited Liability Partnership (LLP). Originally conceived as a vehicle for use by professional practices to obtain the benefit of limited liability while retaining the tax advantages of a traditional partnership, LLP’s have proved popular as an alternative business vehicle in the legal sector. Led by the conversion of a significant number of large law firms, many small partner managed firms have also decided to convert into LLP’s.

Key features of an LLP:

• A separate legal entity;
• Limited liability for its members;
o Members will lose some benefit of this if they are required to give any personal guarantees, for example to the bank;
• Taxed as a partnership;
• Organisational flexibility;
• Members’ agreement is a confidential document;
• Accounts filing requirements are essentially the same as those for a company with the exception of solicitors’ specific requirements in the SRA Accounts Rules 2011.

A Limited Liability Partnership is a different legal structure to both a traditional partnership established under the Partnership Act 1890 and a limited partnership established under the Limited Partnerships Act 1907. In fact partnership law does not apply to LLPs as a general principle. An LLP has some characteristics of both a traditional partnership and a private limited company which in many ways can be described as a company on the outside and a partnership on the inside. Legally, it is defined as a body corporate with a legal personality separate from that of its members.

The tax treatment of an LLP resembles that of a partnership rather than for that of a company and for this reason smaller partner managed firms have been attracted to the idea of converting to an LLP. Rather than being treated as employees, the members of an LLP are treated as self -employed for tax purposes.

Consequently, income tax and national insurance contributions are payable on a member’s share of profits and because such payments will not fall within the PAYE regime, the member’s earnings will not be subject to employer’s national insurance contributions. Thus key personnel within smaller partner managed businesses can be remunerated more tax efficiently. In addition, because an LLP is transparent for tax purposes, it is the members who pay income tax on their profit shares; the LLP does not pay any corporate tax on any profit it makes.

An LLP will need to prepare an annual balance sheet and profit and loss its position in accordance with the Companies Act. Solicitors must consider the SRA Accounts Rules 2011 and other accountancy implications. (Discussion with your accountant is essential.) The accounts of an LLP with a turnover of more than £6.5m or Gross assets of over £3.26m or employing over 50 staff will be published at Companies House so the public, a firm’s clients and suppliers, will be able to form a view as to how strong an LLP’s balance sheet is. However smaller firms, which will include a majority of legal practices need only submit abbreviated accounts.

Conversion to LLP:
Generally called a conversion, the process is actually the incorporation of a new entity which will be separate from the old partnership or limited company. This new entity, an LLP, will be incorporated at Companies House and the process will then involve transferring all or most of the existing business of the partnership or limited company to this new LLP.

The new LLP must be authorised and recognised by the SRA.
After March 2012 this process will become more expensive and onerous – see SRA Authorisation Rules 2011. Firms who convert now will simply be passported to new authorisation.The existing partners will need to review the existing partnership documents, if any, to check what kind of decision may be required to transfer the business to an LLP. It is important that all the partners of the partnership are in favour of the proposal to convert to an LLP. Careful thought and planning will need to be given as to how best to deal with the concerns of any doubtful partners.

Whatever the size of the firm, it is important to manage the communication process carefully as it will allow a partnership to deal with any objections to the conversion before significant time and money is spent.
All the firm’s clients and suppliers will need to be identified to assign or novate existing contractual arrangements to the new entity. The following are the most important contractual relationships to consider:

Clients:
Existing terms of the retainer will need to be amended or re-drafted so that they specifically state that the services are to be provided to a client by a successor LLP. The manner in which this is conducted will depend on the type of client retainer in place. Letters of notification will have to be prepared and sent to the clients and it is advisable that clients are given advanced notification in order to deal with any queries they may have.

Employees:
The Transfer of Undertakings (Protection of Employment) Regulations, widely known as TUPE, will apply on conversion. This means that all employees will automatically transfer to the LLP and their employment contracts will not be taken to have terminated but will be deemed to have been made by the LLP. The employees’ continuity of employment remains unaffected. In larger firms it may be necessary to comply with the consultation requirements under the TUPE regulations. Good practice is to write to all employees early in the process.

Property:
Where a firm leases offices it is normal to obtain the consent of the landlord to transfer the lease to the LLP. It is possible that a landlord may seek personal guarantees from the members. Any freehold property may have to be transferred to the LLP or a lease drawn up for the LLP to rent the property from the present owner(s). Consideration needs to be given to securing the exemption from stamp duty and from stamp duty land tax on transfers of property from the partners of a partnership to an LLP.

Suppliers and others:
Bank accounts, overdrafts (if any) and banking facilities will have to be transferred to the LLP. This will require the consent of the bank and it is possible the bank may insist on ongoing personal guarantees from the members.
HMRC will need to be advised of the change of status of the firm and registration with such as the Information Commissioner for Data Protection also needing to be advised.
Any contracts with important suppliers, such as IT providers, consultants, hire-purchase providers etc. will need to be reviewed carefully to ascertain whether they need to be novated in favour of the LLP.

Retired personnel:
A partnership may have obligations to pay former partners annuities. If so, consideration will need to be given to whether the conversion to LLP will terminate the annuity which may involve a breach of contract. It is possible annuitants may not be prepared to accept the LLP in place of the partnership and may insist on personal guarantees from the members of the LLP. From an accounting perspective, thought will also have to be given to the impact which the annuity liability will have on the LLP’s balance sheet. Whereas a partnership can keep such liabilities off its balance sheet, LLP accounts have to comply with accounting principles as referred to above and therefore have to include such liabilities on their balance sheet. (Advice should be sought from the firm’s accountants.)

Main documentation:
The main documentation required for a conversion is as follows: -

Transfer Agreement:
This will document the transfer of the business of a partnership or limited company to the LLP. It will set out the assets and liabilities that are to be transferred to the LLP and will usually contain an indemnity from the LLP in favour of the partners of the transferring partnership or the transferring company against all the liabilities taken on by the LLP. In the case of a conversion from a partnership, typically no financial consideration will be provided for the contribution of assets to the LLP but the contractual requirement for consideration in the transfer agreement will be fulfilled by:
(a) The LLP’s agreement to procure that each partner becomes a member of the LLP;
(b) The LLP’s agreement to credit certain accounts maintained by the LLP for partners in their capacity as members of the LLP.
In the case of a conversion from a limited company, the company will often contribute its business in consideration for its appointment as a member and the crediting to its capital account with the LLP of an amount representing the value of the business.

LLP Agreement:
The terms of the existing partnership agreement will have to be redrafted as an LLP Members Agreement. In relation to companies converting to an LLP, a review of the company’s articles of association and/or shareholders’ agreement will be necessary in order to ascertain which provisions will be retained in the LLP Agreement.

An LLP Members Agreement is a private document, and it need not be filed at Companies House. It is important that the LLP Agreement is comprehensive and properly drafted as otherwise the default provisions prescribed by law will take effect which may lead to unintended consequences, for instance that all members will share equally in the capital and profits of the LLP. There are significant differences between the Partnership and LLP Members agreements. The main fundamental difference is that whereas a partnership agreement deals with the relationship between individual partners, the LLP Agreement will cover not only the relationship between individual members, but also the relationship between the members and the LLP itself.
Solicitors Regulation Authority:

Forms will need to need completed and further information supplied to the SRA in order that the firm’s new status as an LLP can be authorised and recognised.
This needs to be planned well in advance due to the slow reactions of the SRA. This especially applies for recognition for 1 April (the new accounts year for many firms) or 1 October (PII renewal) as the volume of applications at those times causes severe delays.

LBS Legal has assisted many firms in the conversion process and will undertake all the letter writing and form filling processes for a client to enable them to continue fee earning.

Please contact our Business Development Manager, Brian Greevy to arrange a preliminary discussion. 0755 337 1383.

Ian Braithwaite
Client Relationship Manager

T: 0113 385 4483
M: 07432 695 289
E: ian.braithwaite@lbslegal.co.uk

For General Enquiries: Email enquiries@lbslegal.co.uk
24 hour Helpline 0845 0563949
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