LLP agreements: can a member terminate if the LLP commits a repudiatory breach?
Is an LLP member entitled to terminate the LLP agreement by accepting a repudiatory breach of the LLP agreement committed by the LLP? Before the recent decision in Flanagan v Liontrust Investment Partners LLP, the majority of commentators considered that an LLP agreement could be terminated in this way. The uncertainty over this now appears to be resolved by the Liontrust case.
The relationship between an LLP and its members is governed by the terms of the LLP agreement entered into between them. In the absence of an LLP agreement, the relationship is governed by the default provisions contained in the Limited Liability Partnerships Regulations 2001 (“the LLP Regulations”).
Under the terms of the Liontrust LLP agreement, the bulk of the capital (£5m) was contributed by Liontrust Investment Services Limited (“LIS”). The individual members, including Mr Flanagan, contributed just £5,000 each. The income profits of the LLP were divided between the individual members. They received a fixed amount and a variable amount, corresponding in broad terms to the basic salary and bonus they would have been entitled to under a contract of employment. Any remaining profits, and all capital profits, were allocated to LIS.
Under the notice provisions, Mr Flanagan could be required to retire on six months’ notice by the LLP, but the notice could not expire earlier than 4 October 2013. It was also entitled to put him on garden leave for all or any part of his notice period.
The LLP gave Mr Flanagan notice to retire on 20 August 2012, to expire on 4 October 2013. It placed him on garden leave with immediate effect. He argued that the LLP was not entitled to give him more than six months’ notice, the notice of termination was therefore invalid, it was not entitled to place him on garden leave and his exclusion from any future active involvement in the affairs of the LLP was a repudiatory breach of the LLP agreement. He said he was accepting the breach, the LLP agreement was therefore terminated (at least as between him and the LLP) and the relationship between him and the LLP going forwards was governed by the default provisions. This meant that he was entitled to an equal share of the capital and profits of the LLP.
The High Court held that the notice provision required the LLP to give notice of precisely six months. As the LLP gave more than six months notice, the termination notice was invalid. The LLP had not therefore been entitled to put him on garden leave and exclude him from any future active involvement in the LLP’s affairs. By doing so the LLP had committed a repudiatory breach of the LLP agreement.
However the High Court ruled that the doctrine of repudiation does not apply to LLP agreements, or at least not to an LLP agreement where there are more than two members. It was not therefore open to Mr Flanagan to accept the breach, terminate the LLP agreement and argue that he was entitled to an equal share of the profits of the LLP. His remedy for breach of the LLP agreement was a declaration that he remained a member of the LLP and a right to damages for any loss suffered as a result of his exclusion.
The Court said that if the doctrine applied, this could result in the relationship between the LLP and some members (those who have not accepted the repudiation) being governed by one regime (the provisions of the LLP agreement), and its relationship with other members (those who have accepted the repudiation) being governed by a different regime (the default provisions). This cannot have been what Parliament intended and was unworkable. It is implicit in the statutory regime for the internal governance of LLPs that, in relation to any particular matter, an LLP and all its members must be subject to the same set of rules, whether they are the rules contained in the LLP agreement or in the default provisions.
It would also be “offensive to common sense and contrary to the reasonable commercial expectations of the parties” if the effect of the doctrine were to permit Mr Flanagan to a share in the profits of the LLP on the basis of notional equality with the other members, when the LLP agreement itself only gave him a fixed allocation of income profits and no entitlement to any capital profits.
Disgruntled LLP members will be disappointed by the High Court’s decision which closes the door on some creative arguments that have been run on their behalf. LLP agreements will remain binding, even where the LLP acts in repudiatory breach. The decision does not just put paid to arguments about rights to an increased profit share. LLP members will not, for example, be able to argue that a repudiatory breach by the LLP frees them from other provisions of the LLP agreement, such as notice provisions and restrictive covenants which limit their activities going forwards.
The High Court’s decision does leave open the possibility that the doctrine of repudiation may still apply in the case of an LLP with only two members. This will be a matter for another case to determine.
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