Business and trade have remained as one of the most important occupations throughout the history of civilizations. With the emergence of new challenges with time, new business forms evolved to counter the challenges and to address the difficulties of the economy. Partnership form of business, where two or more people do business jointly while sharing both the profits and the losses, has remained as one of the top choices of business form. However, with the changing times and the increase in the litigations sought against businesses, the unlimited liability that Partnership form of business model contains has made it un-attractive for new entrepreneurs. There was a need of a new form of organization which provided the flexibilities of a partnership but without the unlimited liability it entails.
The concept of limited liability was thought upon and introduced for meeting this very disadvantage of the general partnership. A limited liability partnership or a limited liability company both offer the same protection towards the liability which is limited to a certain extent, the difference lies in the ownership, taxation etc.
The debate for the introduction of limited liability in the partnership laws, started way back in 1837. However, the it was in 1991 that the concept was introduced for the first time in Texas, US. Soon afterwards many countries like UK, Singapore, Japan and even India introduced the concept of limited liability in its partnership laws.
In India, right from 1997, there was huge debate on the introduction of limited liability and several committees like Naresh Chandra committee and JJ Irani committee were formed to look into the possibility of its introduction in Indian laws and its advantages. Both the committees recommended the introduction and as a result, the Limited Liability Partnership Act was passed in 2008.
Limited Liability Partnership works on a mutually decided agreement of the members and hence provides much more flexibility to organize the management than what is allowed in a general partnership or a company. Also, LLP becomes the only viable option for professionals, particularly like auditors and accountants who are not permitted to operate as company, and small-scale businesses so that they can also increase their field of trade and compete globally.
About Limited Liability Partnership
Business has been the oldest occupation and of the most important foundation of any civilization. Partnership has been an effective form of business relation for a long period of time and all the complex ventures are based on this business relation. However, partnership relations have its own disadvantages, of which the unlimited liability of the partners is one of the major factors which resulted in foundation of Limited Liability Partnership or LLP. LLP has the flexibility of a partnership and also the advantages of a limited liability company at a low compliance cost.
Meaning of Limited Liability Partnership (LLP)
Limited Liability Partnership is exactly like what the name suggests, it is a partnership where partners have a limited share in the liability of the business venture as a whole. It is like a partnership that has been protected by the outer shell of limited liability. It is a hybrid corporate business vehicle that has a perpetual succession and separate legal entity. LLP is a corporate entity with a distinct legal and continuous existence just like a company. However, its members are limited in regards to their contribution to be made towards a liability, except in cases of fraud, malpractice, wrongs etc. LLP also allows the partners to manage their business directly, so they can’t be considered as shareholders, and also limits their personal liability with regards to deeds of error, omissions, incompetence, or negligence done by the employees or other agents. As LLP has separate legal entity and is considered an artificial person in the eyes of law, therefore it can sue and be sued and can directly enter into contracts and deeds in its name, unlike general partnerships.
A member’s liability is limited to the amount of money he has invested in the company. If he acknowledged a personal duty of care or a personal contractual responsibility, a lawsuit against a member who is directly at fault (for example, in a claim for negligence) would not be covered by the limited liability. A bespoke members agreement, which is a private document, is highly recommended for an LLP, or else the default LLP regulations, that are already present, are considered. Since there is no share capital, therefore an agreement has to contain the level of capital contribution by the different partners.
For the purpose of taxation, an LLP is considered as a partnership i.e., it is not taxed as an entity on its share of profits, instead its members are taxed individually for their profit shares. This was done so that, if an existing partnership business wanted to convert to an LLP, there would arise no legal trouble for the purpose of tax collection.
One of the most important features of an LLP is that it retains the internal versatility of a general partnership. The addition and removal of shareholders, as well as changes to benefit shares and capital contributions, are all simple to arrange and have limited tax and legal ramifications. LLPs are a fun new framework for a variety of business circumstances that aren’t limited to specialist firms.
Nature of LLP
- Corporate Body: Limited Liability Partnership is considered a separate legal entity and is considered under a corporate body under the legislation in which it is incorporated.
- Partner: Any individual or body corporate may be partner in LLP. A person who has been found unsound mind insolvent shall not be capable becoming a partner of LLP.
- Number of Partners: Every LLP shall have at least two partners and there is no limit of maximum number of partners.
- Use of word LLP: Every LLP shall strictly use the word LLP after their firm’s name.
Advantages of LLP
- No minimum capital requirement for the formation of an LLP, it can be formed using least amount of capital possible.
- No limit on maximum members, only a minimum of two members are required.
- Low cost, in comparison to incorporating a company.
- Protects the members personal assets from the liability of the firm as a whole.
- Provides more flexibility to organize the internal structures more efficiently.
Disadvantages of LLP
- Instability among partners: An LLP can be formulated in such a way that some partners have more powers than the others which can cause several problems in the functioning of the firm.
- An LLPs compliance are minimal but if you don’t complete them you could end up Paying more in fines than you would with a private limited company.
- Unable to share capital from the public.
- Venture capital firm generally prefer not to invest in LLP.
Limited Liability Partnership in India
In India, with the increase in economic growth, various businesses and ventures took off which resulted huge economic success. However, as the need for further growth was realized, a new form of business relation was required that would not only provide flexibility but also limit the liabilities of the partners to a certain extent, so that they may take more risks to ensure further growth without much thinking about the risk affecting their personal assets.
Limited Liability Partnership, which is a separate legal and corporate entity, was created for these reasons only. LLP contained both the features of a corporate and non-corporate entity, which could help the entrepreneurs and professionals to organize and manage the corporate sector more efficiently. LLPs, in India, were introduced by the Limited Liability Partnership Act, 2008, which created, as the name suggests, a partnership form of business where the liability of each partner was fixed beforehand.
A Limited Liability Partnership, as defined by section 2(n) of the Limited Liability Partnership Act, 2008, is a partnership established and registered under the Act. A limited liability partnership is a body corporate created and incorporated under this act that is a legal entity independent from its partners, according to section 3(1) of the Act.
The biggest advantage of an LLP form of business is that it offers, apart from limited liability, more flexibility in matters of arranging and organizing the management of the firm by of mutual agreement. It is a model which amalgamates in it the features of both of a corporate structure’ as well as ‘a partnership firm structure’ providing an efficient combination of professional expertise and entrepreneurial initiative in an innovative manner.
LLP is be a Body Corporate formed and registered under the LLP Act 2008 that gives the flexibility of a partnership firm. It is to be organized and operated on the basis of an agreement known as “LLP Agreement” and shall have the following characteristics:
- Perpetual succession
- Capacity and power of suing and being sued
- Capacity to buy and sell property in its own name
- Common seal
History of LLP in India
LLP structure in India is highly influenced by those that are practiced in the U.K. and Singapore. The importance of LLP in the Indian context is immense, therefore, its origin and development in India becomes important to be understood properly.
1957: The idea to introduce the concept of LLP in India was first floated in 1957. The suggestion, made by the iron, steel and hardware merchants’ chamber, was made to the Law Commission (7th) which rejected it at that time due to the inherent shortcomings of the LLPs which might weaken the provisions of the Companies Act, 1956 which were recently made stricter.
1997: LLP was recommended for the Small-Scale Industries by the Abid Hussain Commission.
2003: The Naresh Chandra Committee was setup to provide a report on Regulation of Private Companies and Partnership. The Committee was charged with undertaking a wide-ranging examination of the legal regime then-applicable to private companies and partnerships, with a particular focus on how to streamline legal risks and regulatory compliance costs for certain partnerships and small private companies’ regulatory compliance costs for certain partnerships and small private companies. The committee in its report discussed the genesis of the LLP in US and UK and of the advantages it could provide to Indian business, therefore, it recommended for the introduction of LLP in India.
2005: Like the Chandra committee, the JJ Irani Committee on Company Law also recommended for a separate LLP Law that should be adopted in India. The committee emphasized the importance of flexible laws for the professional partnerships. It also recommended the introduction of LLP to small industries that are not seeking access to capital markets through stock exchange. The Irani Committee recommendations appeared to at least contemplate foreign direct investment (FDI) in entrepreneurial projects carried out through the LLP model, encouraging entrepreneurs to explore business ventures with foreign investment and collaboration.
23rd July 2005: The 2nd Naresh Chandra Committee submitted its report and made the following observations: “In increasing litigious market environment, prospect of being a member of a partnership firm with unlimited liability is, to say the least, risky and unattractive. Indeed, the chief reason why the firms of professionals, such as accountants, have not grown in size to successfully meet the challenge of the international competition. This makes an L.L.P a most attractive vehicle for partnership among professionals such as lawyers and accountants.” As a result, on November 2, 2005, the Ministry of Company Affairs introduced a concept paper on LLPs with a view to stimulate a public debate over idea, which finally led to the promulgation of the proposed Limited Liability Partnership Bill, 2006.
2006: The Bill, which allowed the establishment of a new form of corporate body, the LLP, was introduced in the Rajya Sabha on December 15, 2006 and referred to the Standing Committee on Finance.
2007: The LLP bill of 2006 was referred to Parliamentary Standing Committee (PSC). On November 27th, PSC submitted its report to the Parliament with recommends for some changes to the 2006 LLP bill.
2008: The Union Cabinet approved the implementation of a new bill (2008 LLP bill) on May 1st, replacing the 2006 LLP bill. The LLP bill was introduced in Parliament on October 21st. The LLP bill was passed by the Rajya Sabha on October 24th. The LLP bill was passed by the Lok Sabha on December 13th.
2009: The LLP Bill obtained the President’s assent on January 7, 2009, and was subsequently informed in the Official Gazette in 2009, with the Central Government putting the LLP Act into effect on March 31, 2009. The Central Government made the LLP Rules effective on April 1, 2009. The rules in respect of conversion of a partnership firm, a private company and an unlisted public company into LLPs were made effective w.e.f. 31st May, 2009. The Government has also launched a website namely, www.llp.gov.in on 1st April, 2009 for operationalization of various processes provided under the LLP Rules, 2009.
Need for LLP in India
With the highly competitive market, at the global level, where the businesses have done comparatively level and are giving constant competition to the international businesses, the services of Indian professionals have remained the same and have not grown much in comparison to other businesses. One of its most major reason is the increasingly litigious environment, where being a member of a partnership firm with unlimited liability is considered too risky and hence unattractive. As a result, it was believed that a new corporate entity with limited liability and a flexible business environment is required to organise and operate in a flexible and efficient manner as an alternative to the traditional partnership. Entrepreneurs, professionals, and service providers will be able to join forces and operate more efficiently in order to compete in the global market.
Since many professionals cannot practice through companies, LLP becomes especially helpful for them and can help those who are unable to use the corporate structure or those who find partnership structure not viable. Also allowing FDI in LLP-based entrepreneurial projects will also enable small Indian entrepreneurs to pursue business opportunities with foreign investment or collaboration. It can also be considered for small businesses that do not wish to access capital markets through a stock exchange listing. Additionally, foreign entities with project offices in India will want to consider using the LLP framework to reduce risk. Furthermore, the LLP framework can be used in any structure where different members choose to manage different segments while still bearing full responsibility for their behaviour. This involves special purpose vehicles (SPVs) for infrastructure projects, in which various partners bring different skills to the table.
Therefore, an LLP has many advantages, including a lower cost of creation, less regulatory requirements, ease of management and operation, as well as ease of winding up and dissolving, no provision for minimum capital investments, and partners are not responsible for the actions of their fellow partners. However, there are also some disadvantages present with the traditional system of business venture that also contribute for the immediate need of an LLP form of business venture in India.
- Disadvantages of a traditional partnership firm
The Indian Professionals such as, auditors, lawyers, doctors, accountants etc., are not allowed to practice through incorporating companies and therefore, they can only use partnership firms or to be a solo proprietor. The partnership firms in India are incorporated under Indian Partnership Act, 1932 and though they offer the professionals a chance trade or business at international level, the disadvantage that it possesses is quite a lot in comparison to its advantage. Such as:
- Unlimited Liability
Unlimited Liability in cases of partnership is one of the major reasons for the professionals to reject it. The unlimited liability of partners in a partnership firm, as well as the growing number of lawsuits worth more than the firm’s assets, make this risky and, at times, unfeasible choice. It ignores the distinction between a relationship and its members (i.e., the partners) and imposes limitless liability on each partner for the actions of every other partner as well as the partnership itself.
Sec. 25, Indian Partnership act, 1932, states the liability of a partner, till the time he is a partner, to be joint with all the other partners and also severally for all acts of the firm or of any other partner. It is a general principle of liability and stresses on three main points:
- Liability of partners joint as well as several
- Liable only for acts of the firm
- Liable for acts of the firm only when he was a partner at the time the act was done.
However, an LLP, apart from the limited liability it offers, has the advantage of a separate legal entity, which partnership firms do not have. An LLP exists independent of the existence of its members, whereas a firm is not a separate legal entity but is only collective or compendious name for all the partners.
- Limited Membership
Sec. 11 of the Companies Act provides that no company, association or partnership consisting of more than 20 persons shall be formed for the purpose of carrying on a business unless it is registered under the Companies Act or is formed in pursuance of some other Indian Law. In a partnership of banking business there cannot be more than 10 partners while in any other kind of business there cannot be more than twenty. Therefore, no general partnership firms can be formed with more than 20 members. This has a depressing effect on the economy and the development prospects of the firm, as every business organization would ideally need to grow to reach and acquire a larger client base around the world.
However, in an LLP, there is no limit on the number of members. Also, an LLP does not have a perpetual existence as in case of partnerships, where It is dissolved by the admission, retirement, death, etc. of any of the partners. The partnership can be dissolved by the death of any partner, unless the articles provide (as they frequently do) for the continuance of the business by the survivors, either alone, or in partnership with the representatives of the deceased.
- Disadvantages of Limited Companies
Companies Act cannot be used to regulate the matters of an LLP and a separate legislation was required, as was also the recommendation of Irani committee. The Act is used to regulate widely held limited companies which are not only different but also have some disadvantages:
- Structure of company governed by a legislation
Companies Act is state made legislation that is used to govern and regulate the companies. However, LLP requires contractual agreement between its partners, therefore an LLP is much more flexible than a limited company, it can allow any internal organisation in the structure or the management whereas, the companies governed by statute does not provide such flexibility.
However, in an LLP, there are no complicated procedure that have to be followed for the management, also the partners have the right to manage their business directly, unlike the companies where they have to manage it through directors.
- Dichotomy of management-ownership
There is no dichotomy of management-ownership in LLP as prevalent in a company. There are lesser requirements for compliance in LLP which makes it more flexible.
An LLP, thus provides a level playing field for not only the professionals but also to small-scale industries which helps in increasing the global competitiveness. An LLP is an entity that acts as an intermediary between a partnership firm and a limited company, on one hand, an LLP offers the benefit of limited liability to its partners, while on the other hand it does so by minimizing the onerous procedures that an incorporated company is required to follow. Furthermore, an LLP eliminates the ownership-management divide that is a required consequence of being incorporated. Every LLP partner is an agent for the LLP, but not for the other partners. As a result, no partner is responsible for the actions of the other.
LLP in International Jurisprudence
With the realisation of the risks involved in a general partnership and the restrictions imposed on the companies, there was a need for a new business structure that offered flexibility and limited liability. As early as 1837, a commission was formed to consider the elements of limited liability that could be introduced in the partnership laws headed by Bellenden Kerr. In 1851, a select committee of the House of Commons also considered whether limited liability should be introduced but on neither occasion was there a clear conclusion. In U.K., during 1890s, there was much commotion and debate on the partnership laws that were present that time and it was urged that the introduction of limited liability concept was important in the partnership laws.
However, it was only in 1991, that the limited liability partnership came into existence in Texas. The LLP was thus developed as a mechanism and as a device to limit the vicarious liability of partners as the prospect that all the members in a partnership of attorneys or accountants may be exposed to hundreds of millions of dollars in liability was too risky and dreary.
LLP was created due to an odd person law firm from Texas, where due to the collapse of real estate and energy prices in 1980s. The first law on LLP came into existence in Texas, through the enactment of Texas House Bill 278 on August 26, 1991. With the promulgation of the Revised Uniform Partners Partnership Act (‘RUPA’) in the US in 1994, a number of states permitted the formation of LLPs, which was followed by the incorporation of comprehensive provisions dealing with LLPs in the RUPA in 1997. Soon after Texas, all the other states followed suit and in 1996, the Uniform Limited Liability Company Act was adopted by the National Conference of Commissioners on Uniform State Laws.
The LLP is considered as a special type of partnership in US, one where the all the partners are allowed to manage the partnership, only after filling with the particular state. LLP provides them with the full rights of operation as that of a general partnership without subjecting them to the unlimited liability of the general partnership.
The UK Department of Trade in 1997, investigated in the prospect of replacing the joint and several liability of professional defendants by a system of proportional limited liability. Though, the focus was not on Limited Liability Partnership but DTI took the opportunity and consulted to amend the laws of UK to include limited liability partnerships.
In 2001, the Limited Liability Act, 2000 was passed in UK and it provided more organizational flexibility and taxation status of a partnership along with limited liability for its partners. The main distinction between the US LLP model and the UK LLP model is that while the former regards the LLP as essentially a partnership, the latter primarily treats it as a company. The existence of an LLP in the UK as a separate legal entity means that it has its own rights and liabilities, distinct from those of its members. In the UK, an LLP differs from a company to the extent that the former has greater organizational flexibility and is taxed as a partnership. In the UK, LLPs are accorded ‘entity’ treatment whilst partnerships governed by the provisions of the UK Partnership Act are generally treated as aggregates of individuals.
The LLP Act, 2005, governs LLPs in Singapore, and it is similar to the UK legislation. This law is based on both the US and UK LLP models, and, like the latter, defines the LLP as a legal entity. However, for tax purposes, it is treated as a general partnership, which means that the partners, not the partnership, are taxed (tax transparency).
With the increase in the litigious atmosphere, limited liability partnership has proved immensely effective. The features of flexibility as that of a partnership combined with the limited liability, on part of the partners, has proved to be highly advantageous for the small-scale companies and the professionals, especially auditors and accountants who are restricted from practicing through companies.
The concept of limited liability partnership has been discussed and debated on long before in 1800s. However, it was only in 1990s, that a working concept was introduced into the partnership laws. With its introduction in Texas, it was rapidly adapted in all the states of US and soon in 1996, Limited Liability was adopted throughout US through the Uniform Limited Liability Company Act. Similarly, following US, UK also adopted the concept and introduced it in its partnership laws in 2000. Singapore, also following UK’s example, adapted a similar concept of limited liability as adopted by UK in 2005.
In India, the debate on the introduction of the concept started, as early as in 1957, where the talks of introducing the concept was first started. However, the 7th Law Commission Report reject it and decided against it, because of its various shortcomings. However, with the changing times and as the concept of limited liability evolved, several committees such as the Naresh Chandra Committee and the JJ Irani Committee advocated for the introduction of the concept in the Indian partnership laws, as they believed that it would grant greater advantage to the small-scale industries and the professionals and would also help in bringing foreign investments in the form of FDI. As a result of the efforts of these committees, a working paper was published by the MCA which led towards the introduction of the Limited Liability Partnership Bill in the Rajya Sabha in 2006. And after a detailed debate and discussion on the bill, the Limited Liability Act was passed in 2008.
The concept of limited liability, as adopted by India, is based on the concepts adopted by UK and Singapore. In India, the concept was so adopted because of its various advantages over the traditional methods of partnership and company and particularly of its feature of limited liability, its flexibility in management, and the unlimited number of partners, an LLP can have. Though there are some disadvantages to LLP too, its advantages far outweigh them and make them an important concept in India.
This article is written by Mr. Abhishek Srivastava a 3rd Year student at National Law University and Judicial Academy, Assam
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