Should the clouds of a legal action gather, how would you protect yourself from the subsequent downpour? A limited liability partnership could provide additional protection for UK firms, says Nick Carter-Pegg.

It was the large accounting firms that, through lobbying the UK government in the 1990s, built the case for forming a new type of entity through which to carry on their business.

One of their arguments was that the general partnership (which had existed since the Partnership Act of 1890) was no longer an appropriate vehicle for the size of firm and for their businesses.

In particular, the joint and several liability of partners was a key issue, meaning that the mistakes of one partner could impact on the personal assets of other partners and in some cases cause personal bankruptcy.

Since 6 April 2001, firms have been able to register as a limited liability partnership (LLP) at Companies House.

Over the last few years, more and more firms have been converting to LLPs and most professional firms have considered the issue.

Many have decided to put a timetable and programme in place to achieve conversion within a particular timeframe, with a minority deciding that conversion was not right for them.

For most partnerships of chartered surveyors and property consultants the issue is usually not if to convert but when.

For any new firm looking to start up in business the decision would usually now be between setting up as a limited company and setting up as an LLP – so that they achieve limited liability at the start rather than face the risks of operating as an unlimited partnership.

However, for firms of surveyors considering using the LLP entity, there are a number of key issues to consider.

Limiting liability
Unlike a partnership, an LLP is a separate legal entity. Although some LLPs call their members ‘partners’, they are not partners in a partnership – their legal title is ‘members of an LLP’.

The primary purpose of an LLP is to provide additional protection for the members through limited liability. A member will not be personally liable for the acts and defaults of a fellow member.

However, he or she may still be personally liable for his or her own negligence.

A starting point for firms considering conversion may be to review the type and size of work that partners are currently undertaking for clients:

• How effective are the firm’s existing risk management procedures?
• If the firm were to be sued by a client, could the size of the claim be considerably in excess of the current level of professional indemnity (PI) cover?

These are the type of questions that partners should be discussing, to assess whether they are comfortable with the current level of exposure or whether they have a desire to have additional protection.

A frequent area of discussion between partners is the implication for a member of an LLP who is negligent. I

t is only after a firm’s PI cover and the firm’s own resources have been used to settle a case with a client that the client may decide to pursue a negligent member personally.

It is yet to be tested in the courts as to whether such a claim would be successful – it is likely that a member would argue that the advice came from the LLP and not the member personally.

However, the firm is obviously in a better position than a partnership would be, where all partners could be facing personal bankruptcy.

The fact that a surveyor who is a partner in a partnership is jointly and severally liable for all debts and liabilities of the partnership can be a deterrent to becoming a partner.

Now that many firms have converted to LLPs, a member of an LLP might take some convincing to leave limited liability behind and join a partnership with unlimited liability.

There is sometimes discussion in a firm about whether the level of PI cover can be reduced after conversion to an LLP.

Most firms have concluded that they still need to maintain an appropriate level of cover for the type of work they are carrying out, as not to do so would put the assets of the LLP at risk.

In practice I have not seen any evidence of firms reducing the extent of their cover.

‘True and fair’ accounts
LLPs need to file audited accounts, prepared on a ‘true and fair’ basis and in accordance with UK Generally Accepted Accounting Practice (GAAP), at Companies House.

The accounts will need to show a true and fair view, and therefore items that might be treated differently in the accounts of a partnership might need adjusting.

For example, the capital cost of annuities to former partners and future costs of vacant or sublet properties will need to be provided for.

There has been much debate and speculation about the level of disclosure that partnerships, which have previously kept their financial information secret, would have to make in respect of profits, fee income, assets and liabilities.

Over the last few years many of the concerns in this area have gone away, as much more is disclosed in the press and firms have become more open about levels of profitability.

It is often regarded as showing a firm in a good light when it publishes its accounts. While some firms do wish to keep their financial information secret, these firms are now quite small in number.

Generally, partnerships of surveyors are very flexible and subject to little regulation. LLPs are subject to more regulation and the LLP will be subject to future changes in accounting and auditing requirements.

At the present time there is quite considerable change in accounting standards and convergence towards International Financial Reporting Standards (IFRS).

While IFRS currently apply only to listed companies, LLPs need to be prepared for greater regulation in the future.

Tax status
Members of an LLP are taxed as partners in a partnership and therefore, provided certain steps are followed, conversion to LLP should be tax-neutral for a firm in the UK.

For LLPs with offices abroad, however, the tax position is not straightforward. The way LLPs are structured in the UK is more akin to limited liability companies.

This gives added comfort that the UK courts will interpret the liabilities of the members of an LLP in line with the liabilities of directors and shareholders of a company.

However, in overseas jurisdictions it can mean that the LLP and its members are taxed as a corporation rather than a partnership.

In our experience, this is not an insurmountable problem, and several UK LLPs of surveyors (and law firms) are now operating with international structures.

The conversion process
Once there has been sufficient review of the impact of conversion to LLP status, a programme can be put in place leading up to conversion.

It is vital to have a properly managed programme and timetable in place so that individuals are aware of their responsibilities; most firms usually set up a small project team to work towards conversion.

Each firm will have its own issues to deal with and in our experience the timetable for an existing partnership to convert normally takes between three and six months.

Where there are overseas issues to be considered, this timescale is more likely to be six to 12 months.

Many firms have chosen to convert at their year-end, although this is not necessary.

A members’ agreement will need to be prepared, which is a private agreement that governs the relationship of the members between each other and within the LLP.

The new LLP will also have to be registered at Companies House in a similar way to a company.

One of the most time-consuming matters, involving partners and other senior staff, is ensuring that each client engagement is moved across to the LLP, so that each client letter of engagement is no longer with the former partnership.

And of course, keeping clients informed and updated as the process progresses is equally important and will help ensure a smooth conversion.

Nick Carter-Pegg is a partner in the Professional Practices Group at BDO Stoy Hayward.

This article should not be relied upon as a full statement of the law or experience in this area.

For more information on Professional Indemnity Insurance, visit the RICS.org section on this topic.

This article appeared in RICS Business, July/August 2006.