Legal: Partnership plans that don't add up

LIMITED liability is an issue that has been exercising the minds of many partners in both legal and accountancy firms as the risk of commercial failure has become all too real for some practices.

Last February the outgoing government published a consultation paper, "Limited Liability Partnerships - A new form of business association for professions". The consultation period ended in May. It is understood that the Government has plans to include references to legislation on LLPs in the next Queen's Speech. No doubt this will discharge the Labour Party's manifesto commitment to the provision of adequate protection to the professions through incorporation.

The push for change has come more from the accountants, and in particular the Big Six, who have found it increasingly difficult to obtain sufficient indemnity cover at an affordable cost. However, the issue is equally relevant to legal firms, especially in the current climate of debate and discontent about the Solicitors' Indemnity Fund.

The current law on joint and several liability does not discriminate between the relative culpability of the clients and the professionals; professional life has become much more competitive.

The recession of the early Nineties caused headlines not seen before in the profession - many partners entered individual voluntary arrangements for the benefit of their creditors and there were several "fire sale mergers", plus a few well-documented bankruptcies. Until the introduction of the LLP, the only protection from commercial risk is incorporation.

Historically, the professional bodies were set up under an Act of Parliament or by Royal Charter with the principal objectives of serving the public interest. The partnership model has worked tolerably well in that context over many years, with an ethos based upon balanced advice and fine judgements; not as a platform for decisions solely concerning the financial advantage of the partners. That is a reason why the good partner is valued by his clients. Hence, growth rates, profits before tax and earnings per share have clear merit for the financial well-being of the shareholders, but they should not be the sole determinant of success for the professional firm. For these reasons, and others, it is essential that the partnership model, property managed in the public interest, should be perpetuated.

The planned UK model for the LLP, however, is unattractive to the professions. While the shareholder of a limited liability company is exposed only to the extent of the share capital, the limited liability partner is to be required to put up a guarantee of between pounds 25,000 and pounds 100,000 per partner. Furthermore, any excessive earnings will be subjected to a clawback in the event of insolvency. Partnerships will also be required to produce audited accounts. In comparison incorporation seems almost idyllic.

The situation in the United States is very different. The law on joint and several liability in respect of claims was changed and a system of proportionate liability introduced last year. Almost all the states now have limited liability partnerships. To become an LLP, the partnership simply files a statement that it had become an LLP with the requisite authorities and advises clients and suppliers. It must make sure that the letters LLP are printed after its name on all stationery and make appropriate press announcements. For the US LLP there is no minimum capital requirement, no financial disclosure and no clawback or guarantees.

US professionals can, of course, still be sued individually under their equivalent to the partners' own negligence but, otherwise, the US LLP structure means that the partners' private assets are secure from claims on the LLP. The UK LLP too, will not protect the negligent partner.

Despite the litigious nature of US business, the balance of advantage seems to have moved significantly in the direction of the US professional. The UK LLP proposals need to be re-thought. The rethink should concentrate on two key areas:

There would be significantly more onerous liabilities upon insolvency for partners in LLPs compared with those which apply to the shareholders in limited liability companies. In addition, there is no need for clawbacks and guarantees - a fixed minimum capital is all that is required.

Also, the disclosure of partners' income could be damaging to firms or for those which have a below-average expectation of reward or for firms with unusual profit cycles of trend and also for those with exceptional results - balance sheet disclosure should be sufficient for third party needs.

The way forward should be to find a balance between the DTI proposals and the US position, which is attractive to the members of the LLP and to those who do business with it. Without a significant improvement to the proposals, there is a real danger that the commercial threats to partners and partnerships will deprive the professions of future talent. In the absence of a satisfactory UK solution, there will be a continuing consideration of the possibilities of Jersey, Delaware and New York. Alternatively, firms will be forced to incorporate with a structure which in most cases will be far from suitable.

James Gemmell is Chairman of Horwath Clark Whitehill, Chartered Accountants. He was also Chairman of the Institute of Chartered Accountants of Scotland's Working Party on Auditors Liability.