Protecting the business in troubled times – key considerations for partnerships and LLPs

Many will have been following the news unfolding around Axiom Ince (formerly Ince Gordon Dadds), which filed a notice of intention to appoint an administrator on 2 October 2023.  This was quickly followed by an SRA intervention to close down the practice the following day.

Ince was once the UK’s largest listed law firm but had faced various pressures, including a March 2022 ransomware attack, which required several millions of pounds to be spent to resolve the situation. In early 2023, Ince was forced to suspend trading of its shares after continued delays in the publication of its FY2021/22 audited accounts. By April 2023, Ince announced its intention to appoint an administrator as one of its major creditors confirmed that it would no longer support the business.

Support in the form of a quick asset rescue acquisition by law firm Axiom DWFM in May 2023 seemed to signal hope for the flailing law firm, but the relief was short-lived.

Most professional services firms do not have the same pressures that a listed company might face, but with economic headwinds growing stronger, it is a timely reminder of the importance of having robust constitutional protections in place in case of disaster.

Most professional services firms will not have external shareholders, but they often have major creditors and need to keep partners happy. If they were to face a similar situation to Ince, the partnership will undoubtedly face a series of questions, likely to the tune of:

1. Partnership and Members’ Agreements

• What, if any, is the personal liability of the members in the event of insolvency or administration?
• How does the LLP put a stop to members defecting en masse?
• How does the LLP combat disputes between members, should they arise?
• What happens when there is a proposed merger with another firm?

It is unlikely that members’ agreements are crafted specifically with the above in mind. Although having a different constitutional arrangement to a partnership or LLP, Ince would have certainly had some of the same considerations.  

Members’ agreements should therefore contain protections for both the members and the LLP, particularly in regard to the partners’ liability for partnership debts. This might involve including a threshold provision on the limit of the partners’ liability, for example.

In respect of controlling an exodus of partners, it may also be sensible to include a “departure lounge” clause, which limits the number of members who are able to give notice of their intention to retire from the partnership. LLPs should be minded, however, that clauses such as these risk being held to be unenforceable as a restraint of trade and require careful drafting. Perhaps a more simple mechanism  to combat the issue of partners leaving en masse would be to increase notice and garden leave periods.

Likely to follow in a situation of insolvency or administration, particularly if the first questions above are not adequately dealt with by the members’ agreement, is how to diffuse disputes between members. The members’ agreement should include clear dispute resolution mechanisms and be mindful of the financial burden on the LLP of being responsible for bearing any costs of arbitration (or similar alternative dispute resolution avenues).

2. Insolvency Act obligations

Certain obligations under the Insolvency Act 1986 apply to LLPs through the Limited Liability Partnerships Regulations 2001. As a result, LLPs can be subject to various action by an administrator of the LLP to recover property for the benefit of creditors. These include:

1. Challenging floating charges;
2. Challenging transactions at an undervalue;
3. Challenging preferences;
4. Actioning transactions defrauding creditors;
5. Prosecuting wrongful trading;
6. Prosecuting fraudulent trading; and
7. Clawback under section 214A of the Insolvency Act.

LLPs should be particularly conscious of the consequences of section 214A, which only applies to LLPs and not companies or partnerships.  This enables a liquidator to claw back any withdrawals of funds (such as drawings) made by members in the two-year period prior to the commencement of the liquidation.  The liquidator must satisfy the court that, at the time of making the withdrawal, the member(s) knew or had reasonable grounds for believing that the LLP was, or was likely to become, unable to pay its debts with no reasonable prospect of avoiding liquidation.

3. Decision-making powers

Although it is important to have a robust members’ agreement to weather any storm, the members’ agreement may not always give all the answers. The members’ agreement will be the starting point for understanding the powers of the management board. There are other legal duties layered on top of the authority granted to the board by the agreement and these must be complied with. For example, most board members will be well aware that they must take care to avoid direct or indirect discrimination when making decisions.  Fewer board members will be aware that a board discretion must ordinarily be exercised in good faith, rationally and for the purpose for which it was conferred.

If a board acts when it does not have the requisite authority to do so, or it does so in a manner that fails to meet the standard for proper decision-taking, the decision risks being ineffective.  For the board member taking the decision, the act might amount to a breach of the partnership or LLP agreement for which he or she may be sued personally by the other partners. This liability may be outside the scope of any indemnity in favour of board members from the partnership or LLP. As noted above, this stresses the importance of having adequate dispute resolution mechanisms in the members’ agreement and carefully defining partners’ personal liability when disaster strikes.

To minimise these sorts of risks and to ensure that the board acts within the scope of its powers, the board should always:

1. act on the best information they can reasonably obtain;
2. consider both the express terms of their powers under the members’ agreement and whether any implied restrictions may have been breached in the course of decision-making;
3. where matters need to be referred to a vote of the partnership as a whole, ensure the necessary processes under the members’ agreements are followed, including sufficient notice of the meeting being given; and
4. always act in good faith and avoid any appearance of improper motives or bad faith.

Conclusion

In the current climate, it is important that partnerships and LLPs are well prepared to navigate the various managerial and financial responsibilities required to tackle the worst-case scenarios. In doing so, the board should always consider taking specialist legal advice to protect the business from the unexpected.