The limited liability partnership (LLP), widely used by professional services firms such as lawyers and accountants, is increasingly finding favour as a vehicle for trading entities in other sectors, particularly financial services. Whilst LLPs have historically adopted a largely collegiate approach to decision making, in the current climate empowering management to respond quickly to external opportunities and threats and internal challenges is increasingly essential for the efficient operation of a LLP. It is important for firms carrying on business as a LLP to grapple with the next wave of required changes to their Members Agreements, to give management an effective toolkit for achieving a competitive advantage against the backdrop of continuing economic fluidity.

Issues in the Managing Partner’s in-tray which may need to be addressed include:

1.  Who should have the ability to veto a merger or material change to the business?: Whilst transactions outside the ordinary course of business historically required unanimous consent, a stated majority is generally the norm.

The trend is shifting further however, as a result of a variety of structural changes needed by today’s responsive management, so that only transactions significant in the context of the LLP as a whole are referred to Partners for approval (equity only or all classes of member). It is a decision for individual firms whether the Members Agreement reflects this approach and whether it expressly provides a minimum threshold relative to the overall size of the firm, below which structural changes outside the ordinary course of business may be reserved to the Management Board.

2.  What restrictions should there be on the ability of a Partner to give notice to retire?: The frequency with which Partners are able to retire and period of notice, in particular, for an Equity Partner, requires consideration of a number of inter-related issues.

Maintaining stability has always been the perceived wisdom, with many firms allowing notice of retirement to be given on only one or two dates in the financial year, with the notice period for Equity Partners generally between six to twelve months. Additionally, some firms provide a cap on the number of Equity Partners who may retire in any financial year. This creates certainty and allows in turn for an orderly handover of client relationships. The downside of this can be an expensive Partner with no guarantee as to strong performance during the notice period. 

Views differ as to how you should deal with this. Whilst management may often be able to reduce the notice period by agreement or place the Partner on “garden leave”, firm’s are increasingly opting to allow greater flexibility in relation to the terms on which a Partner may retire, with the peace of mind of well drafted restrictive covenants and the potential ability to claim liquidated (pre-determined) damages from a Partner acting in breach.

3.  Abolition or change to annuity payments: Where a traditional partnership has converted to LLP status, it is not uncommon for annuity provisions of the former partnership to be retained in their Members Agreements. These provisions recognise the ongoing benefit for current members of a former Partner’s work for the firm. The annuity payments can be a significant potential drain on a LLP’s resources and are increasingly seen as commercially unviable. However, their removal is frequently contentious.

The immediate hurdle to phasing out annuity payments (if desired), requires a judgment call on the part of management to compensate in some way those Partners on the cusp of retirement for example, on a sliding scale for Partners within an agreed number of years from retirement and, allowing for a wind down to retirement through a clearly managed process, which might include an agreed reduction in points or change of Partner categorization. 

4.  Recalibration of lockstep pure lockstep to performance based lockstep and beyond: Firm’s also need to ask other long overdue questions: Is the underperformance of a service line cyclical or is there evidence of a downward trend? For how long are stronger service lines prepared to support underperforming areas? At what point is the underperforming area wound down or sold off? Even if a collegiate mindset, should there be real impact on individual Partner profits for those Partners operating within underperforming service lines? At the crux of the debate, is the fact that the current marketplace is unsupportive of profit awards not strongly linked to individual Partner contribution.

5.  Who should have the ability to make senior management appointments within the LLP: Historically a Partner vote, but given tougher economic times a shift towards “tight of hand” control, means that many more LLP’s are providing that Board members and roles such as Chief Operating Officer and Heads of Department are made by appointment of the Management Board.

6.  What additional “best practice” provisions need to be considered: More routine but equally important issues to health check would be, for example, the need for a provision placing an obligation on a Partner to disclose to management the plans of any other Partner or employee to join a competitor or to set up in competition. On the same theme, increasingly common are clauses allowing an LLP, where it believes actions of a member may result in material damage to the business and subject to appropriate safeguards, to monitor communications sent or received by such a member.  

As well as grappling with some of these thornier issues in order to create operational flexibility as part of prudent management, it is wise in any event for a financial services firm to keep abreast of best practice in terms of corporate governance, and to ensure it is doing all it can to enhance the firm’s financial and human capital through the provisions of its Members Agreement.

How well does your firm pass the stress test?

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