Author: Khushboo Nahar, Research Associate
Limited liability partnerships are relatively new creations that commonly are used for financial protections. With a general partnership, individuals may be personally responsible for a partner’s actions. Limited liability partnerships, or LLPs, limit the amount that may be recovered in a lawsuit to partnership assets alone. This led to the rapid success of the LLP. By combining aspects of partnerships and corporations, limited liability partnerships offer several advantages and disadvantages from both ((Available at http://www.ehow.com/facts_4851942_advantages-disadvantages-limited-liability-partnerships.html)).
A limited liability partnership (LLP) is a business structures that operates similar to a partnership organizational structure. The difference is the limited personal liability afforded to each member of the company. Each partner is responsible for their own actions while conducting business. LLPs are tailored for professionals, such as doctors, lawyers and accountants.
A limited liability partnership (LLP) limits the scope of exposure that general partners must face due to partnership debts, liabilities and malpractice. Countries have enacted LLP law in response to the growing number of general partners present in large partnerships. This growing number of general partners added to the complexity of doing business as a partnership and increased the number of lawsuits brought against the partners, thereby increasing malpractice insurance costs.
The key advantage of a LLP compared with a traditional partnership is that the members of the LLP (it is very important that they should not be called partners but members) are able to limit their personal liability if something goes wrong with the business, in much the same way as shareholders in a company have always been able to do. Of course anyone lending money to the LLP such as a bank may still require personal guarantees from the members, as they frequently do with directors/shareholders in a company.
Characteristics of LLP
Every Partner Equal
Each partner is an equal member in a LLP company. They decide together on various company issues, such as the name of the business, where it is located and how it is going to be operated. Partners also share equally in the profits and losses of the business. There are no limits to the number of partners a LLP can have.
Limited Liability Protection
Each partner in this type of partnership is protected against the actions of the other partners which results in a lawsuit. For example, if one partner is subject of a malpractice claim and loses in court and have to pay damages, the other partners are not held financially responsible. However, partners in a LLP are liable for the obligations of the company such as loans used to purchase equipment and utility expenses. Due to the liability protection afforded to partners in this type of partnership, some countries such as USA allow only certain licensed professionals to form LLPs ((According to LegalZoom)).
The law shields the general partners of LLPs from personal liability for debts and court judgments that come about because of poor decisions or malfeasance on behalf of other partners in the organization.
Pass Through Taxation of Profits
A limited liability partnership company is taxed similar to a business formed under the partnership and sole proprietorship organizational structures by a process called pass-through taxation. The company profits are not taxed at the company level but instead are “passed through” to the partners to be reported on their individual tax returns. This prevents the double taxation that occurs in corporations where profits are taxed at the company and shareholder levels.
Where business owners have wanted to limit their personal liability in the past, they have normally set up companies and any profits made by those companies are subject to corporation tax. Dividends paid by the companies can then be taken as income of the shareholders. LLP’s are taxed quite differently in that the profits are treated as the personal income of the members as if they had run their business as a partnership.
Individuals in a partnership are normally liable for filing personal income taxes, self-employment taxes and estimated taxes for themselves; the partnership itself is not responsible for paying taxes. The credits and deductions of the company are passed through to partners to file on their individual tax returns. Credits and deductions are divided by the percentage of individual interest each partner has in the company. This can be beneficial for partners who have a limited interest in the company or special tax requirements due to their interests in other businesses.
Flexible Structure
LLPs can choose to appoint an executive team to take care of daily operations and management decisions resulting in a centralized structure similar to that of a traditional corporation. Alternatively, they can opt to allow all partners equal participation in decision-making and management of business operations leading to a decentralized management structure.
Limited liability partnerships offer participants flexibility in business ownership. Partners have the authority to decide how they will individually contribute to business operations. Managerial duties can be divided equally or separated based on the experience of each partner. In addition, partners who have a financial interest in the company can elect to not have any authority over business decisions but still maintain ownership rights based on their percentage interest in the company. Flexibility in business operations can become a disadvantage when partners make decisions based on personal interests and not the interest of the partnership as a whole.
Choice of Compensation Structure
With a traditional corporation, shareholders receive profits based on the percentage of capital they invested in the organization. LLP members may distribute profits in the form of compensation without taking into account the ratio of each partner’s capital investment. This flexibility allows the proper compensation of partners who may not have invested much capital, but contribute to the business in other material ways.
Registration and Malpractice Insurance
The laws regarding LLPs vary by country, but most countries require LLPs to register periodically with the authority in the country and that they carry insurance to cover lawsuits arising out of professional error.
Partner’s Transferable Interest:
A partner can transfer wholly or partly his right to share of profit and loss of limited liability and to receive distributions in accordance with the limited liability partnership agreement ((Available at http://www.helplinelaw.com/business-law/LLPI/limited-liability-partnership.html)).
The transfer of rights does not cause dissociation of partner from LLP or dissolution of the LLP. It does not either entitle the assignee to participate in the management or conduct of the business of the LLP.
Incorporation
At least two people are required to form a Limited Liability Partnership. The Limited Liability Partnership is a legal personality .They associate for the purpose of doing a lawful commercial activity with a view to earn profit. To become a legal person, the members of Limited Liability Partnership are required to provide their names to a document called an “incorporation document”. In this document, name of Limited Liability Partnership, location and address of registered office, names and addresses of minimum two members must be mentioned in the incorporation document. After completing all these necessary legal requirements, the incorporation document must be sent to the registrar ((Available at http://www.lawteacher.net/company-law/essays/characteristics-of-limited-liability-partnership-company-law-essay.phphttp://www.lawteacher.net/company-law/essays/characteristics-of-limited-liability-partnership-company-law-essay.php)).
Membership
It is a legal requirement that the first members must sign an incorporation document. After signing that incorporation document, any new member can join the partnership by agreement with the existing members. The membership of a member would cease on his death. Additionally, the partnership dissolution or any agreement among partners would also cease the membership of a member. The members of partnership can decide the rights and duties of members by mutual consent and agreement ((The Limited Liability Partnership Act 2008)).
Name
The incorporation document must include the name of Limited Liability Partnership. The name must end with “Limited Liability Partnership, or LLP.”
Piercing the LLP Veil:
In certain limited instances, creditors or litigants can attempt to impose personal liability on principals in a LLP by claiming that the LLP is a sham, a device created merely to defraud creditors, or is being run as a sole proprietorship (e.g. the LLP has not been properly formed or there has been a commingling of corporate and individual property). The process of imposing individual and personal liability is referred to as “piercing the corporate (or in this case ‘partnership’) veil” or “disregarding the corporate entity.” Ordinarily, a party seeking to pierce the partnership veil will have a heavy burden in attempting to persuade the courts to disregard the partnership entity ((Available at http://www.startup-legal.com/Limited-Liability-Partnership-%28LLP%29.htm)).
WINDING UP:
The LLP may be wound up either voluntarily or by the Tribunal . Winding up of LLP may be either voluntary or by the Tribunal. LLP so wound up may be dissolved. It may be wound up by the Tribunal if:
- The limited liability decides so,
- If the minimum number of partners had reduced to less than two for a period of more than six months,
- If the LLP is unable to pay its debts,
- If the LLP had acted against the sovereignty and integrity of India, the security of state and public order,
- If the LLP had failed to file statement of accounts and solvency with the Registrar for five consecutive financial years,
If the Tribunal is of the opinion that it is just and equitable to wind up the LLP ((Textbook on Indian Partnership Act with Limited Liability Partnership Act -By Dr. Madhusudan Saharay Pg 243)).