Play Fair: Gavin Foggo and Molly Ahmed explore unfairly prejudicial conduct in LLP's

March 8, 2011

This article first featured in Solicitors Journal 
Eaton v Andrew Caulfield (1) Ian Holloway (2) Caulfield Search (Legal) LLP (3)

The recent judgment in Eaton v Caulfield and others [2011] EWHC 173 (Ch) is the first reported case of which we are aware that deals with the application of section 994 of the Companies Act 2006 (unfairly prejudicial conduct) and section 122 of the Insolvency Act 1986 to LLP's. While the case raises a number of interesting issues, there are three key practical lessons to be learned.

Power to expel
If the members of an LLP would like the right to be able to expel a member, then the power to do so must be expressly set out and expressly agreed to, preferably in a written members agreement by all of the members. If it is found that there has been no express agreement as regards the power to expel, then regulation 8 of the Limited Liability Partnerships Regulations 2001 will apply. The default position is 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".

In Eaton, the petitioner's case was that the only express (orally) agreed terms related to profit sharing, the sharing of costs and the way in which capital contributions were to be dealt with. The first respondent had sought summarily to expel the petitioner from the LLP after a heated discussion and had prevented him from being able to carry on his work as a headhunter by, among other things, locking him out of the office building and denying him access to the LLP's computer system.

The respondents' case was that the first respondent had the power to expel any other member. Their case, however, shifted numerous times on what the precise terms were on which the petitioner could be expelled, and how and when it was said that those terms were expressly agreed.

Proudman J affirmed the decision in Blisset v Daniel and emphasised the dictum that the power to expel is expropriatory in nature and must be construed strictly both as to the power itself and the circumstances in which the power is exercised. The unlawful expulsion meant that Mr Eaton was prevented from being involved in the management of the LLP this was held by Proudman J as being "one of the clearest examples of conduct which equity regards as unfair prejudice".

Greater certainty
A well-drafted members agreement will usually, pursuant to section 994(3) of the Companies Act 2006 (as applied to LLP's), exclude the right of a member to present an unfair prejudice petition. The agreement to exclude section 994 must be recorded in writing. This contrasts with the position in relation to limited companies in which the operation of section 994 cannot be excluded at all.

In Eaton, had section 994 been excluded, the petitioner would only have been able to sue for specific sums owed to him and would have had to have established theexistence of a large number of individual contracts. He would not have been able to sue for compensation for the value of his share of the LLP.

Excluding section 994, therefore, can give the LLP and remaining members a greater degree of certainty as to what will be claimed, and by avoiding the inevitably expensive and difficult process of determining exactly what a member’s share in an LLP is and what value should be ascribed to that share.

Costs advantage
The usual position is that the remaining members (the respondents) can protect their position in respect of the costs of litigation by making an offer of a buy-out under the O’Neill v Phillips principles set out by Lord Hoffmann (namely, a buy-out of the petitioner’s share of the company/LLP at fair market value).

If the petitioner unreasonably rejects such an offer to buy out his share, the presentation of a petition will be held to be an abuse of process as any prejudice which might have been suffered will be cancelled out by the making of the offer.

Before the petition is presented, the petitioner in Eaton made an open offer to the respondents for them to buy out his share of the LLP. This offer (in effect, a reverse O'Neill v Phillips offer) was rejected. This led to indemnity costs being awarded against the respondents for a large percentage of the trial costs on a similar basis to that for a part 36 offer made by a successful claimant, who beats his own offer at trial.

Related pages:

Litigation, Arbitration and Alternative Dispute Resolution more

Partnership and LLPs more

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