Partnerships and Limited Liability Partnerships (LLPs); partnership exits during and after COVID-19
Andrew Cromby looks at just how easy it may or may not be to dispense with unwanted partners.
One thing is sure, the effects of the COVID-19 pandemic are going to be with us for some time. Partnerships which ran effectively and profitably right up until March 2020 have found it necessary to reorganise. The question is, when and if things return to “normal” after the pandemic, will partnerships be putting the jigsaw back together the way it was? Or will some pieces have been lost forever?
Andrew Cromby looks at just how easy it may or may not be to dispense with unwanted partners…
Partner performance in the spotlight
As businesses take a downturn those running partnerships (including LLPs) will be taking a hard look at themselves and asking who amongst the partners is unlikely to cut the mustard as the business moves forward. Some partners may never recover from the impact of COVID-19 on their clients. Others ceased to perform adequately long before the pandemic – but the need to pare back expenses during a time of crisis has thrown their poor performance into the spotlight. The consequence is that partnerships will be considering whether they have partners who must be asked to leave.
The relative ease with which partnership exits can be managed depends on a number of factors but, first amongst these, are the terms of any partnership agreement to which the partners have signed. It also depends on how the partnership is structured.
The default position – LLPs and the LLP Regulations 2001 (“the Regulations”)
Most modern partnerships are run as LLPs – corporate vehicles which only look and feel like ‘old fashioned’ partnerships. Absent an agreement between the members (a term used interchangeably with ‘partners’ in LLP parlance) the Regulations set out a default regime which must be excluded, to the extent that the parties do not wish to be bound by its terms. The default provisions include, amongst other things, the following:
- All the members of an LLP are entitled to share equally in its capital and profits.
- Every member has the right to take part in the management of the LLP.
- All the differences arising as to ordinary matters conducted by the business of the LLP may be decided by a majority of the members.
- No majority of the members can expel any member unless the power to do so has been confirmed by express agreement between the members.
So, unless you have an agreement between the members which expressly permits it, you cannot expel or compulsorily retire a partner/member from an LLP.
The default position – partnerships under the Partnership Act 1890 (“the Partnership Act”)
Sections 24 and 25 of the Partnership Act set out a very similar default regime in relation to ‘old fashioned’ unincorporated partnerships. Again, that default regime can be varied by the partners but it is worth noting:
- Unlike most LLPs, partners owe each other a duty of good faith. This is significant and is referred to further below. Exclusion of that duty in an ‘old fashioned’ partnership is unheard of.
- If a partner retires, is expelled or otherwise excluded without agreement being reached that the partnership will continue, notwithstanding that departure, then he or she will be able to rely on that fact as dissolving the partnership and will have a claim in respect of their share of its worth.
Terms in Partnership Agreements
These default positions are clearly unsatisfactory for those wishing to run commercial operations. They are typically modified by agreement and there are many ways that mechanisms can be adopted which permit partnerships to require partners to leave.
In an LLP, provided the procedure to compel a partner to leave is clear and operated in accordance with its terms, there is little to stand in the way of asking a partner to move on. Typically, in an LLP, there is no duty of good faith owed to partners, although they may owe one to the LLP, which is a separate corporate ‘person’. The LLP will, however, wish to avoid acting in a way which may expose it to workers’ rights claims, for instance claims discrimination, bullying and harassment, all of which can be made (and can’t be excluded) under partnership law.
That is also true for a Partnership Act partnership. The existence of a duty of good faith, owed to all partners by each other, means that extra caution needs to be exercised. Bringing a claim for breach of that duty is usually the first stop for badly treated partners.
Points to remember
If you are considering the compulsory retirement or expulsion of any partner:
- Review the partnership agreement first. Don’t start the process of expulsion or compulsory retirement without knowing what you need to do to ensure the departure is dealt with lawfully.
- Only proceed with the exit on a mandatory basis if you have the right to do so. If you do not, acting unlawfully may give the outgoing partner the whip hand and create another crisis for your business.
- Stick to the agreed procedure. If you don’t, you will probably be subjected to a claim.
- Continue to deal with the partner fairly and lawfully.
- Where you can, consider what concessions you may be able to offer to the outgoing partner, perhaps a relaxation of post termination restriction or something similar. An agreed retirement, governed by a deed of retirement, is usually best for all.
Partnership exits in difficult times are unwanted and unpleasant. All of that is hugely exacerbated when partnerships go about things the wrong way. No partnership will benefit from further uncertainty and argument in the current (or future) financial climate. Before you get rid of a piece of the jigsaw that is your partnership, make sure you appreciate what the consequences will be and how the picture will look after you have done so.
Andrew Cromby is a partner at Weightmans and specialises in partnership law. If you have any questions, you can contact Andrew at email@example.com or 020 7822 1962.