Stakes raised for breach of the members’ agreement

November 11, 2016

A member of an LLP who, in breach of obligations in the LLP Agreement, discussed with employees the possibility of starting a new business, has been ordered to forfeit 50% of the profit share paid to him during the period in which the discussions took place. The member had to repay £10.3 million.

This decision may give firms another weapon with which to deter team moves. Partners will be surprised to learn that their profit share may be at risk of forfeiture and be repayable to their firm. Firms will need to decide whether to exclude this remedy by contract through the members agreement, or retain it as a possible deterrent to breaches of the members agreement.

The case (Jeremy Hosking v Marathon Asset Management LLP) concerned an appeal from a decision of an arbitration on a point of law in relation to forfeiture of profit share. The judge has refused permission to appeal. For the moment this decision is the law.

The LLP operated as an investment manager. One of its founding members gave notice to leave. The LLP initiated arbitration proceedings against the member after giving notice. The member had produced a business plan and discussed it with four employees. Three decided to leave the LLP.

The arbitrator decided that this gave rise to two financial consequences for the member and the LLP.  The LLP had lost the chance of retaining the three employees, with the lost chance being put at 5%. Compensation ordered for the loss of this chance was £1.38 million. The second consequence was that the member should forfeit 50% of his profit share during the period when he was in beach of the LLP agreement. This amounted to £10.3 million.

The forfeiture arose from a remedy for breach of fiduciary duty, which was the loss of remuneration arising from the relationship. Many of the cases in which this remedy was awarded were concerned with agents and the forfeiture of a right to commission. The judge agreed that the profit share of a partner or an LLP member could potentially be subject to forfeiture but noted that “it will often be impossible to characterise all or any particular part of the profit share of a partner or LLP member as remuneration”. Where it was possible, however, profit share would be subject to the forfeiture principle.

The profit share arrangements of the LLP in this case made identifying profit share as remuneration easier than it might be in other organisations. When the member ceased to be an executive member, he became a non-executive member entitled to 50% of the profit share of an executive member. This made it convenient to analyse the additional 50% of profits which the member received as an executive member as remuneration for the services which the member was obliged to undertake under the members agreement as an executive member. The forfeiture also satisfied the requirement that it should be proportionate and equitable.

This case raises a number of issues. Will this apply to all breaches of a members’ agreement?  Where a member has been in breach for a number of years will this mean forfeiture of many years profit share? A member’s profit share may be made up of different elements, for example, interest on capital or profit share may be guaranteed for a set period. In these circumstances it would be difficult to characterise this as remuneration. Conversely, where all members of an LLP are obliged to carry out services, it would seem that all of their profit share could be treated as remuneration in the absence of a special arrangement. Will a 50% forfeiture level be an equitable amount? The arbitrator acknowledged that in the case, some of the member’s forfeited profit share would return to him due to his right to the residual 50%.

We anticipate that many firms will not want to be subject to the uncertainty which this decision creates and will exclude the operation of this remedy through the partnership or members’ agreement.


Related pages:

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Douglas Preece
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dpreece@foxwilliams.com

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