LLPs as a corporate structure were introduced after lobbying from the large accountancy practices as a solution to reduce their exposure to possible negligence claims against their partners.
With an LLP, the liability of its members is limited to the funds that they agree, in the LLP agreement, to contribute. This compares to an old style partnership whereby the partners potentially have unlimited personal liability for the debts of the partnership.
LLPs have proved a very popular alternative to the well understood limited company structure for certain businesses. However, when choosing to trade in an LLP structure, the impact in the event of insolvency is likely not to be a key consideration, other than that LLPs do offer limited liability to their members. LLPs are still a relatively new concept and following the recent recession, a number of the risk factors have been highlighted.
Members’ drawings are generally determined as a share of LLP profits, in accordance with the LLP agreement. In practice, most LLP members will be allowed to take monthly drawings on account of their share of profits and then at the end of the year, once profits have been determined, a balancing payment can be made to meet any amount due to each individual member. Conversely, if a member is overdrawn, the LLP agreement will usually confirm how this should be repaid.
In an insolvency scenario, it may be that no profits were made in the final period. In that case, the appointed liquidator or administrator will recall any drawings taken where there were no supporting profits.
An LLP is tax transparent with individual members personally responsible to pay tax on their drawings.
It is not unusual for LLPs to hold monies to one side to meet the personal tax obligations of their members when they fall due. However, unless such funds are held in trust, when trading conditions require, there may be a temptation to utilise these monies to support trade.
If subsequently the LLP becomes insolvent and the members’ tax provision has been spent, then the individual members will still be personally liable for the tax due on their share of profits. Albeit, in mitigation, the members may be able to submit a terminal loss relief claim to HMRC.
TRADING WHILST INSOLVENT
If it can be determined that an LLP continued to trade at a time when it was known or it ought to have been known that the LLP was insolvent, a liquidator can seek to recover the following from the LLP members:
Whilst LLPs do share many characteristics of a limited company, in the event of insolvency, there are indeed some key differences to bear in mind that can increase the risk of personal liability to the LLP members. However, as in the case of all business structures, these risks only present themselves when members act to serve their personal interests ahead of creditors and other stakeholders.
Whatever the business structure it is important that it has been properly considered, documented and that all participants are aware of their responsibilities. Should things take a turn for the worse, those involved should seek specialist insolvency advice as early as possible to maximise the chance of recovery and minimise the potential for personal liability.