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LLPs – You may lose a lifeline if you do not have an LLP agreement

LLPs – You may lose a lifeline if you do not have an LLP agreement

This article considers how an LLP can enter into administration if there is no LLP agreement governing how the members put an LLP into administration.

Administration of a company

The process of administration can be used to avoid closure of an insolvent business and rescue or restructure it in a way that benefits creditors.  Administration therefore provides a potentially valuable lifeline to struggling businesses.

When a company or LLP enters into administration, a qualified and licensed insolvency practitioner is appointed as its administrator. This appointment can be made either by an application to court or, more usually in a quick and simple “out of court” process.

Following their appointment, the administrator takes control of the company or LLP and its business from its directors or members (as the case may be) in order to try to achieve one of the three statutory purposes of an administration. In brief, these are either to:

a)     rescue the company / LLP as a going concern;

b)     achieve a better result for the creditors than would be the case if the business were immediately wound up; or

c)     realise some or all of the property of the business to make a distribution to one or more secured or preferential creditors.

In addition, whilst the business is under the control of the administrator, it is subject to a statutory moratorium. This moratorium prevents a claim or enforcement process by any outstanding creditor, which can provide the business with valuable breathing space. Administration can therefore provide a very useful and appropriate rescue mechanism for the business and result in a better outcome for the creditors of that business.

Out of court appointments

Looking at the more common method of an “out of court” appointment in respect of a company, the appointment can essentially be made by a director, a creditor of the company, the company itself or by a qualified floating charge holder (a holder of a floating charge over substantially the whole of the assets of the company).  In respect of an LLP, the appointment can be made by the LLP itself, a creditor of the LLP or a qualified floating charge holder.

This article focuses on the decision of members of an LLP to put an LLP into administration.

Decision by directors of a company to appoint

In respect of a company, in the absence of express provision in a company’s articles, the default position under both the Companies Acts 1985 and 2006 is that a decision by directors to put a company into administration must be made by a majority of directors.

Decision of members of an LLP to appoint

In the absence of an LLP agreement, the default position under which the decision by members to put LLPs into administration is less certain.

In the absence of an LLP agreement, the Limited Liability Partnerships Regulations 2001 (LLPR) will apply. These permit matters of ordinary business to be decided by a simple majority of the members, but require unanimity for any changes made to the “nature of the business”. There is scant guidance on whether entering into administration constitutes such a change to the nature of the business. However, given the nature of an administration process (which usually involves selling the business and assets of the business, a change in control and leads to liquidation of the legal entity), there must be a strong argument that it would constitute a change to the nature of the business and would therefore require unanimity of the members to put the LLP into administration.

There is therefore a risk that the decision of any single member (or even a majority of members) would be insufficient for the purpose of appointing an administrator and as such the appointment could be invalid. In cases where an administrator has already been appointed, it also does not rule out the risk of a challenge to the validity of that appointment. This risk could be greater for larger LLPs, where the members may number in their tens or even hundreds.

No-one likes to plan for an insolvency process but this issue clearly shows the need for appropriately drafted LLP agreements to ensure that the stakeholders have the best chance of a rescue or minimising loss in an insolvency situation.

Practical tips

  1. Make sure that if you are creating an LLP a formal agreement is entered into and seek legal advice;
  2. Within that formal agreement ensure that insolvency procedures, including the decision to appoint an administrator is explicitly dealt with i.e. by the majority of members rather than all members; and
  3. Review existing LLP agreements.

Hopefully this will ensure that a valuable lifeline for a business is not lost inadvertently.

By Emma Davies and Jeff Rawson

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