Divided Loyalties - An overview of duties in limited liability partnerships following the decision in F&C v Barthelemy and Culligan

June 7, 2012

This article by Jeremy Callman of Ten Old Square and Molly Ahmed of Fox Williams LLP first featured in Issue 34 of the Association of Partnership Practitioners Newsletter - May 2012.

The global financial crisis of 2008 resulted in a number of surprising events: the collapse of Lehman Brothers, the forced rescue of the Royal Bank of Scotland by the UK Government and at long last judicial clarification of the law relating to what, if any, fiduciary duties are owed by members of limited liability partnerships. The 303 page judgment of Mr Justice Sales in F&C Alternative Investments (Holdings) Limited v Francois Barthelemy (1) Anthony Culligan (2) [2011] EWHC 1731 (Ch) is well worth a read; on the rash assumption that members may struggle to find a spare 24 hours, this article seeks to summarise key aspects of the decision.

The facts

In 2004, Francois Barthelemy and Anthony Culligan (referred to in Mr Justice Sales’ judgment as the “Defendants”) approached F&C, one of the world’s largest and oldest asset management companies, with a proposal to set up a Fund of Hedge Funds (“FoHF”) business in which they would have shares as part owners of the business alongside a financial institution. That proposal was attractive to F&C, as it had a gap in its product range for a FoHF.

And so, in December 2004, F&C Partners LLP (the “LLP”) was formed, and was governed by a members’ agreement dated 3 December 2004 (the “Agreement”).  The members of the LLP were the Defendants and F&C Alternative Investments (Holdings) Limited (“Holdings”), a wholly owned subsidiary of F&C PLC.  Each of the Defendants had a 20 per cent interest in the LLP’s profits and capital and each held 20 per cent of the members’ voting rights.  The remaining 60 per cent interest in profits and capitals was held by Holdings, who had a corresponding 60 per cent share of the voting rights.  Pursuant to the Agreement, the Defendants were entitled to exercise Put Options requiring Holdings to buy out their interests at a favourable price should Holdings breach the Agreement.

In 2008 and 2009, the global equity and bond markets suffered huge losses as a result of the credit crunch and the LLP, along with the great majority of hedge funds, sustained severe losses.  As Mr Justice Sales observed a major part of the dispute stemmed from the different view of the Defendants and F&C about how the LLP should react to the LLP’s deteriorating performance.  In order to exert pressure on the Defendants to conform to F&C’s strategy, F&C threatened to cut off the Defendants’ income to which they were guaranteed under the Agreement.  That and other breaches of the Agreement led the Defendants to serve Put Option Notices.  The Defendants also contended that F&C PLC and Holdings had conducted the affairs of the LLP in a manner which was unfairly prejudicial to them.

Three sets of proceedings were brought: (i) a claim by Holdings for a declaration that the exercise of the Put Options was invalid; (ii) an unfair prejudice petition by the Defendants for relief under section 994 of the Companies Act 2006 (as applied to limited liability partnerships); and (iii) a cross-petition by Holdings for relief under section 994 again asserting unfair prejudice.

Legal questions addressed by the Judgment

A number of key legal questions were addressed in the 303 page judgment.  The ones which will be examined in this article are:

·    Whether the members of the LLP owed fiduciary duties to each other.

·    Whether fiduciary duties were owed by the members to the LLP.

·    What fiduciary obligations were owed by the LLP board members, management committee and compensation committee, and to whom (including the dichotomy faced by corporate LLP board members).

·    The operation of section 994 of the Companies Act in the LLP context.

The source of duties in limited liability partnerships

In general, there are six main sources of duty in the law of limited liability partnerships:

1.  Expressly agreed terms of the LLP Agreement.

2.  Terms implied into the LLP Agreement.

3.  The default rules derived from the LLP Regulations 2001.

4.  Tortious duties.

5.  Statutory duties.

6.  Fiduciary duties.

Expressly agreed terms

In F&C Alternative Investments there was an express contractual clause in the Agreement, which read: “each Member shall at all times show the utmost good faith to the LLP.” Importantly, despite this obligation looking like a fiduciary obligation, it was a contractual duty.  Sales J analysed the contractual duty as being “analogous” to a fiduciary duty, owed by Holdings, in effect, as a representative of the F&C Group. He held that it  was a form of contractual duty requiring the obligor to have regard to the interests of the obligee, while also being entitled to have regard to its own self-interest when acting[1].

Implied terms

In F&C Alternative Investments, the Defendants sought to imply a term: “to the effect that Holdings was obliged not to take steps to procure the LLP not to pay the Defendants their monthly drawings due under… the Agreement.”  Sales J concluded (applying usual contractual principles for implying terms) that the parties could reasonably expect Holdings to be bound by an obligation not to take active steps to prevent the Agreement being performed.

Commentators[2] have suggested that Courts might imply a contractual term of mutual trust and confidence into an LLP Agreement and indeed a duty of good faith in decision-making. If the Court did so, then the potential ramifications are significant in widening the scope of duties owed by members to the LLP.

Default rules derived from the LLP Regulations 2001 (the “Regulations”)

Sales J referred to the duties imposed by Regulations 7(9) and (10) of the Limited Liability Partnership Regulations 2001 as “specific duties owed by members to the limited liability partnership”. The fact that specific duties are imposed under the default rules was said by Sales J not to imply that there is some more general duty of good faith.

Regulations 7(9) and (10) relate to the accounting of profits made by a member, without the consent of the limited liability partnership, from a competing business or from a transaction concerning the limited liability partnership or its property, name or business connection.

Tortious duties

The usual principles will apply to decide whether a member owes a duty of care to the limited liability partnership or to his fellow members.  Often an express term will be inserted into the members’ agreement imposing a duty of care on a member carrying out his functions on behalf of the limited liability partnership. If there is no such express term then it may be implied either in contract or in tort.

In F&C Alternative Investments, Sales J had no difficulty in stating firmly: “the LLP Board members also owed duties of reasonable care to the LLP in conducting its business.”

It is probably correct to say that the extent of the duty of care is broadly the same as that owed by a director to a company. 

Likewise, a tortious duty of care may be owed by a member to another member or members, which will turn on usual common law principles which govern when such duties will be imposed.

Statutory duties

A number of statutory duties imposed on the members as a whole, on individual members and designated members arise (mainly) from the Companies Act 2006, including duties: to prepare accounts complying with CA 2006; to approve annual accounts before filed; to appoint auditors; to preserve accounting records for three years from date made; and not to misuse a seal.

FIDUCIARY DUTIES

What are fiduciary duties?

Relying upon Lord Browne-Wilkinson in White v Jones[3], Sales J described fiduciaries duties as: “obligations [that] arise from particular circumstances, where a person assumes responsibility for the management of another’s property or affairs.” This was the central test for fiduciary duties to which Sales J returned repeatedly in his judgment.

The fiduciary duties that may arise are varied and numerous. Sales J identified the following ‘usual’ duties that arise:

·   A fiduciary must not put himself in a position of a conflict of interest (whether a conflict by way of a duty to promote the interests of another or a conflict with his own self-interest) without informed consent.

·   A fiduciary must not make a profit from his position without informed consent.

·   A fiduciary is required to act in the best interests of his beneficiary.

·   A fiduciary must act in good faith.

The duty to act in good faith can be regarded as a compendious expression of duty, comprehending each of the three duties referred to in the first three bullet points above. It may also be taken to add a general obligation of openness and fair dealing as between fiduciary and beneficiary. But, again, the precise content of that obligation will vary depending on the particular circumstances and what is reasonably to be expected of the person acting in those circumstances.

Do members of the LLP owed fiduciary duties to each other?

The short answer to this question is not necessarily.  The position is not the same as that applying as between partners in traditional partnerships who do owe each other fiduciary duties from the mere relationship of (traditional) partnership.  However, if a member has assumed responsibility for another members’ affairs or property, then he is likely to owe that member fiduciary duties by virtue of that assumption.

The argument was run in F&C Alternative Investments that Holdings and the Defendants each owed the others fiduciary duties as co-partners in the LLP in addition to the contractual obligations set out in the Agreement. That proposition was rejected by Sales J.

In making that finding, Sales J first contrasted the position of partners in a traditional partnership with that of members of a limited liability partnership.  He observed that a limited liability partnership is not a partnership in the traditional sense, in which the individual partners owe fiduciary duties to each other in relation to the management of the affairs of the partnership and when acting as agents for the partners and that the general law of partnerships does not apply to limited liability partnerships.

The Limited Liability Partnership Act 2000 (the “Act”) established a new form of entity, with its own separate legal personality and corporate governance structures.  Together with the Regulations, the Act does not provide for the members in a limited liability partnership to owe each other fiduciary duties (indeed the DTI expressly declined to include a general duty of good faith when formulating the Act). However, the statutory provisions do lay down a minimal legal framework for the operation of a limited liability partnership.  However, most of the detailed rules for the operation of a limited liability partnership are to be worked out by the parties to the agreement which establishes it, with a considerable degree of freedom of contract.

Sales J then went on to reason that because the parties are free contractually to agree a wide range of governance structures, it would be difficult to generalise the circumstances in which a duty of good faith or other fiduciary duties as between the members in a limited liability partnership may arise.  Sales J referred back to the basic equitable principles in order to decide whether and what fiduciary obligations arise in the context of a limited liability partnership (ie the White v Jones test set out above).

Applying that test to the facts of F&C Alternative Investments, he held that Holdings had not undertaken responsibility to act as agent for the LLP nor for the Defendants.  In addition, Holdings had not undertaken responsibility for the management of the LLP’s or the Defendants’ affairs.  Accordingly, neither by operation of statute nor by operation of general principles of law was there any basis on which a fiduciary obligation of good faith arose between the Members themselves in relation to the conduct of the LLP’s affairs.

Do the members owe fiduciary duties to the LLP?

Sales J’s answer to this question, which again was ‘not necessarily’, has caused considerable consternation to partnership practitioners.

The analysis made by Sales J is as follows.  Section 6 of the Act provides that members of a limited liability partnership are its agents, but it does not follow that members therefore owe fiduciary duties to the LLP in everything they do.  He found that because Holdings did not purport to do anything relevant as agent for the LLP, it did not owe fiduciary duties to the LLP as regards those actions.

The test to be applied, therefore, is first to identify what action is said to be the breach of duty to the LLP relied upon and then to ask whether the member was acting as the LLP’s agent in taking that action.  If the answer is yes, then the member has breached a fiduciary duty.

The Defendants’ Counsel in F&C Alternative Investments also sought to argue that one could derive fiduciary duties owed by members to the LLP on the basis that “the LLP was a joint venture between the Members and that, for that reason, the law would impose fiduciary obligations owed both by them to the LLP and between themselves.” Sales J rejected this general proposition as “the phrase ‘joint venture’ is not in my view a precise term of art which in itself has any particular significance for an analysis of the existence and content of fiduciary obligations.

The issue which concerns many partnership practitioners is that if there is no general fiduciary relationship, what limitations are there on a member acting against the interests of his firm?  For now, the best way to seek to achieve certainty on this point is to make explicit in the members’ agreement those limitations which have up to now often been assumed, and to keep such provisions under constant review.     

Do board members, management committee members, remuneration/compensation committee members etc owe fiduciary duties to the LLP and/or the members?

Again, the answer to this question lies in determining the specific roles and responsibilities of the members making up such committees and assessing the degree of direct control that they have over the limited liability partnership’s affairs or property.  It was held not to be sufficient merely to draw an analogy with the role of company directors.

The correct analysis suggested by Sales J is to “ask what obligations of a fiduciary character may reasonably be expected to apply in the particular context, where the contract between the parties will usually provide the major part of the contextual framework in which that question arises.”

One would have thought that, in many circumstances, management would be in a position (almost by definition) where it did assume responsibility for the management of another’s property or affairs.  In many circumstances, one would therefore expect a management board/a remuneration committee to owe fiduciary duties in discharging its duties. Those duties would be owed to those whose property or affairs they took responsibility over. Depending on the precise facts, one would expect that such duties would be owed to be the limited liability partnership and in some cases the individual members.

Corporate members

In the F&C Alternative Investment case, representatives of Holdings sat on the LLP’s board. It was held, however, that because of the degree of control they were able to exercise over the conduct of the LLP’s business, they owed fiduciary duties to the LLP which overrode the duties owed by those representatives to their appointing corporate member.  Their difficulty was that the very purpose of their appointment was to safeguard the interests of Holdings, which in turn represented the interests of F&C PLC.   Sales J specifically gave as an example that, if a representative of a corporate member on the board of a limited liability partnership were to form the view that a particular action should be taken in the best interests of the limited liability partnership, he could not, in light of the fiduciary duty he owes to the LLP, obey an instruction to him from his appointing member to vote against it. Very clear language in the terms of the appointment might alter the position.

That dichotomy is not usually scrutinised until an entity is in difficulties, as was the case for the LLP in 2008 when the Defendants and Holdings had divergent views as to the best course of action in a very uncertain economy.

The operation of section 994 of the Companies Act

Unusually for a limited liability partnership with a written members’ agreement, the LLP did not exclude the operation of section 994 of the Companies Act 2006  

The most noteworthy aspect of this element of the judgment is that F&C PLC was held to be liable in the Defendants’ petition, even though it was not a party to the Agreement and played no direct part in the management of the LLP.  Sales J identified as the relevant test as: whether the defendant in a section 994 claim is so connected to the unfairly prejudicial conduct in question that it would be just to grant a remedy against that defendant in relation to that conduct.  He went on to say that in practice what the Court is doing is assessing whether, on the facts, the relevant defendant was sufficiently implicated in the unfair conduct to warrant relief being granted against him.  Sales J held F&C to be liable as well as Holdings because he considered Holdings merely to be a “cipher” for F&C.  F&C, although not having a direct role in management, did not stand aloof from its affairs.

The Court has extremely wide remedial powers under the relevant sections of the Companies Act relating to unfair prejudice, which can cut across shields generally afforded by the use of subsidiaries.

Conclusion

When considering duties owed, the starting point is to review carefully the terms of any agreement. In addition one needs to consider implied, fiduciary, tortious and statutory duties as well as those duties imposed under the default rules derived from the LLP Regulations.

In F&C Alternative Investments, Sales J approached the analysis of duties owed by applying conventional methods of analysing contractual and fiduciary relationships. Attempts to suggest blanket duties owed merely because he was dealing with a limited liability partnership, were rejected.

© Jeremy Callman and Fox Williams LLP 2012


Related pages:

Dispute Resolution for Professional Services more

Litigation, Arbitration and Alternative Dispute Resolution more

Partnership and LLPs more

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