When the ability for traditional partnerships to become Limited Liability Partnership (LLP) moved from debate to reality in April 2001, there was concern that the first few firms to convert might be seen as vulnerable by rushing to limit their liability. Today, however, LLP is considered an appropriate vehicle through which to operate and is increasing in popularity. In the surveying marketplace, some firms have already converted, such as Knight Frank, some are in the process of converting, such as Donaldsons, and others have it clearly on their agenda. But why might a firm choose to convert?
The basic principle of LLP means that the financial exposure of a partner may be capped so that he/she does not suffer the consequences of unlimited liability caused by the misdeeds of fellow partners. With litigants no longer able to pursue the individual assets of all partners, they may allow firms to trade through their difficulties. This is likely to produce a higher yield for the litigant compared to ‘busting’ the firm. Nevertheless the partner’s entire interest in the LLP will remain at risk and there may be additional exposure in respect of any personal guarantees given and ‘excessive drawings’ made in the previous two years.
The protection that the LLP structure affords does not negate the need for professional indemnity (PI) insurance. It merely prevents the ‘firm busting claim’ from bankrupting all partners/members. A number of firms thought LLP conversion would provide the opportunity for lower levels of PI cover in the future. In most cases, lower levels of PI cover are unlikely to be obtained in year one. Going forward, however, firms may not seek to raise their top level of PI cover except where necessary due to a particular client or commercial driver.
Therefore, it could be argued that in reality the change to LLP status will have little noticeable business effect. So why convert? The simple fact is that a partner in an LLP will be in a stronger personal position than a partner in a partnership. If a firm were to fail, how would the partners explain the decision not to limit their liability to their spouses? So perhaps the question we should be asking is why should a firm not become an LLP?
The downside of becoming an LLP is the public disclosure of accounts, remuneration levels, and names and addresses of partners.
There are strong arguments both for and against the public filing of accounts. Certainly, it makes it easier for the press to compile details about the financial position of surveyor firms and is likely to generate interest when first made publicly available. However, this interest is likely to be short term as far as the public is concerned and the information published is not as detailed as some fear.
‘Fat cat’ salaries could be said to apply to some firms where substantial profits are being generated. Initially at least, this might deter a firm from seeking LLP status. However, poor profits are more likely to discourage practices from becoming LLPs as this sensitive fact would obviously be disclosed.
Ultimately, firms will need to weigh up the advantages and disadvantages of public reporting against the added comfort of limited liability which, no matter how you view it, is a significant improvement on the unlimited liability to which a partner in a partnership is exposed.
Firms should also consider the attractiveness of a job offer coming from an LLP vis-à-vis a partnership, where the package is identical in all other respects. Unlike those who have been in a partnership and are accustomed to unlimited liability, a new partner may prefer the protection an LLP affords. Senior staff members who are offered a partnership could find themselves thinking the same thing, so it’s no longer something firms can ignore.
Improving risk management
Another advantage for firms converting to LLP status is the opportunity to modernise their risk-management processes.
Conversion inevitably requires some client involvement and should be accompanied by a review of the firm’s engagement terms. It is essential that the terms are appropriately worded, clearly stating that the contract is between the LLP and the client, and that any partner/member is responsible purely as an agent of the LLP. Failure to introduce appropriate terms can negate the benefit of LLP status and may, in certain circumstances, result in the member owing a duty of care to the client, such that the member has unlimited liability in relation to the work performed.
This is also a suitable time to consider other aspects of risk protection, such as liability caps and proportionality clauses. Experience of conversions in both the accounting and legal markets show that these aspects are now part of everyday professional business.
Talking costs
To avoid the cost of development time incurred at the client’s expense, when LLP legislation was first introduced, it was suggested that some firms first wait for advisers to establish ‘precedents’. There are now several quality firms with standardised, yet adaptable, documentation available, having advised on a number of LLP conversions.
At present, advisers are regularly involved in LLP conversions. This means that professional fees associated with them are highly competitive. However, in reality, the cost of conversion is not dominated by the fees of external advisers but the cost of internal management time. Much like the fees of external advisers, if management time is not properly project managed, internal costs can spiral out of control.
The shape of things to come
In my view, LLPs will become standard among unlisted surveying firms over the next few years. The marketplace has shifted to such an extent that all professional partnerships should now be considering whether LLP conversion is right for them.
Firms that have already converted are demonstrating their responsiveness to changes in the business environment and this, together with limited liability, makes them less of a risk to the partner promotee or lateral hire.
Firms may be pleasantly surprised at how readily the business community will accept LLP status. During the recent incorporation of a professional practice firm, a client was amazed when he approached his landlord about converting to an LLP and the landlord said he could not understand why a business would hold a lease with unlimited liability; he referred to partnership holdings as archaic and uncommercial. Interestingly, this landlord had the most to lose from the transfer of the lease to a limited entity yet preferred to be dealing with a corporate entity. Simply put, LLPs have arrived, and there is little doubt that they will be the norm over the coming years.
Colin Ives is a tax director at accountants and financial advisory group Smith & Williamson. He has particular experience in advising professional partnerships and individual partners.
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The treatment of salaried partners
A significant issue in the conversion process is the handling of salaried or ‘fixed-share’ partners/members. The Inland Revenue currently classes these individuals as ‘self employed for taxation purposes’ based on clause 13 of the LLP Act 2000. However, clause 4(4) of the LLP Act 2000 states:
“A member of a limited liability partnership shall not be regarded for any purpose as employed by the limited liability partnership unless, if he and the other members were partners in a partnership, he would be regarded for that purpose as employed by the partnership.”
Therefore, individuals intending to be treated as self-employed for taxation purposes should satisfy the recognised criteria for the self-employed rather than rely on the current Revenue view, which may be subject to change. There are also employment law issues to be considered in relation to both the status of the individuals concerned and their employment rights.
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LLPs and accounting rules
Another area that will need to be considered when converting to an LLP is presentation of the firm’s balance sheet and profit and loss account following incorporation.
First the firm will need to convert its accounting policies to those that qualify under UK Generally Accepted Accounting Principles. The impact of such changes may significantly affect how the firm’s solvency and reported profitability are perceived.
In addition the timing of profit allocations to members may affect the firm’s balance sheet. If all profits are allocated at year-end they will be treated as a liability to members. Consequently the balance sheet could appear weaker than that of a traditional partnership. In order to improve the look of the balance sheet, some firms delay the allocation of profits until after the accounts have been signed, thus delaying recognition of the liability and, in theory, strengthening the shape of the firm’s balance sheet.
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