KEY POINTS
- Relying on unwritten understandings can be disastrous. A properly drafted partnership or members agreement is essential
- Where there is no written agreement, it is not possible unilaterally to expel a partner
Are you a member of a limited liability partnership which does not have a written members agreement? In our experience, a surprising number of firms do not, or rely on out-of-date agreements which do not reflect their current business requirements.
Gavin Foggo and Molly Ahmed of Fox Williams’ dispute resolution team recently acted in a case which serves as a salutary reminder of what can happen when relationships turn sour, but the members are not protected by a written agreement.
The case involved a three man recruitment consultancy. Prior to the incorporation of the LLP, the three of them had been working together under a common brand. In 2007, in order to formalise their business relationship, they incorporated an LLP, but crucially never agreed a written LLP members agreement.
The relationship between the two key members gradually disintegrated, culminating in an incident in early 2008, when one member sought summarily to expel the other from the LLP. He effected this by, amongst other things, locking the other member out of the office, blocking his access to the IT system, removing his profile from the LLP’s website, and informing clients and candidates that the other member no longer worked at the LLP.
The expelled member sought legal advice from Fox Williams. We advised that, in circumstances where there is a purported expulsion of a member from an LLP with no express agreement in place, the so-called ‘default rules’ under the Limited Liability Partnerships Regulations 2001 (the “Regulations”) apply.
These are statutory default provisions which govern, amongst other things, the sharing of capital and profits; participation in the management of the LLP; inspection of the LLP’s books and records; and the joining and retirement of members in the absence of a written members agreement. In addition, without written agreement to the contrary, section 994 of the Companies Act 2006 will automatically apply. This is a provision of company law which has been applied to LLP’s which permits a member to bring a claim against the LLP and the other members on the grounds that he has been subject to ‘unfairly prejudicial’ conduct.
Because there was no written members agreement and the members had not reached any express agreement as to expulsion, Regulation 8 of the Regulations applied, which states that: “no majority of the members can expel any member unless a power to do so has been conferred by express agreement between the members”. The remaining members had to show that a power of expulsion was expressly agreed and the circumstances in which such a power could be exercised. They could not do so, with the result that the unlawfully expelled member was vindicated and the other members ordered to buy out his share of the LLP (one of the remedies available in an unfair prejudice petition).
In addition, the Judge found that there had been a complete breakdown in the relationship between the members and that the unlawfully expelled member was entitled to have the LLP wound up on a just and equitable basis.
Because the unlawfully expelled member was successful in the Court proceedings, the other members and the LLP were ordered to pay the majority of his legal costs.
We haven’t got a written members agreement in place, but we need to expel a member!
The Petitioner for whom we acted in the case referred to above had plainly been wronged. He was a hard-working and successful member of the LLP. But what do you do if you have a member who is underperforming and who should be expelled?
If all the members of the LLP have not expressly agreed a power of expulsion, then Regulation 8 will apply. It is possible orally to agree a power of expulsion, but it is much better to have a written agreement in place because there is likely to be a dispute over what exactly has been agreed orally.
If no power of expulsion has been agreed, then you cannot expel a member. In those circumstances, your options are either to try to secure his voluntary retirement from the LLP or to apply to the Court to wind up the LLP. The latter option will be hugely damaging to the business, in addition to being costly.
If the member you want to expel will not leave voluntarily, the best protection which you can give yourselves and the LLP is to make an open offer to buy out his share of the LLP at a fair value before any Court action is commenced. This may save the LLP and other members from a significant costs order if the member you want to expel commences Court action.
If you are contemplating expelling a member and you have no express agreement in place, you would probably be acting in bad faith if you were suddenly to cause all the members to agree to a written members agreement with the intention of expelling one of the members.
I think that we need a written members agreement …
It is crucial for limited liability partnerships to have a written members agreement in place which ensures that the business in run in a way which everyone agrees. Regulations 7 and 8 need to be considered carefully as they will govern any matters which have not been agreed upon.
A well-drafted members agreement will contain an express power of expulsion and the grounds upon which that express power can be exercised; it will prevent the members from presenting a petition under section 994 of the Companies Act 2006; it will describe how management decisions are to be taken; it will set out how profits are to be shared and capital contributed; and it will set out what happens on a member’s departure.
Having a well-drafted members agreement in place can ultimately prevent costly, disruptive and time-consuming litigation about issues which could have been agreed in an amicable fashion at a time when all the members hope for a profitable and successful business.
Molly Ahmed is a Partnership Law specialist and part of Fox Williams LLP’s dispute resolution team.
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