LIMITED LIABILITY PARTNERSHIP: A Critical Analysis

Shivani Maurya

Shivani Maurya

Shivani Maurya is a Corporate lawyer who has done her masters in Law from ILS Pune. She is an avid researcher with a keen interest in academics. She is fond of research and pens down her thoughts in her free time.
Shivani Maurya

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A critical research analysis of Limited Liability Partnership in the wake of the Limited Liability Partnership Act, 2008.

LLP is a composite representation of business organization in India that synthesizes the positive aspects of both the Traditional Partnership and Company. As the name advocates, it permeates the benefits of Limited Liability and allows its members the pliability of categorizing their internal structure on mutual agreement based on Partnership. In this world of globalization and privatization everyone wants to dwindle their liabilities and wants to reside in a flexible yet valuable domain. Considering the same ligature the new concept of Limited Liability Partnership (LLP) has advanced. In an LLP, the liability of its members will be limited while the LLP itself will be accountable to the full degree of assets.

In India, the need of Limited Liability Partnership Act 2008, (LLP Act) was described by the Ministry of Corporate Affairs:

“With the growth of the Indian economy, the role played by its entrepreneurs as well as its technical and professional manpower has been acknowledged internationally. It is felt opportune that entrepreneurship, knowledge and risk capital combine to provide a further impetus to India’s economic growth. In this background, the need has been felt for a new corporate form that would provide an alternative to the traditional partnership, with unlimited personal liability on one hand, and statute based governance structure of the limited liability company on the other, in order to enable professional expertise and entrepreneurial initiative to combine, organize and operate in flexible, innovative and efficient manner”

Genesis:

The idea for the LLP has been attributed to “a twenty odd person law firm from Lubbock,” Texas. Their idea, which led to the enactment of the first LLP statute in Texas in 1991, was a reaction to the adverse legal result of an economic catastrophe. This form of partnership distribute proposal to all partners with respect to the right to participate in the management and the functioning of a partnership without forcing them to undergo unlimited personal liability like the case in Traditional Partnerships.

Indian Debut:

The Indian Legislature following the international business drift where various professional and businesses in the form of Limited Liability Partnership offered a horizon of services, has sanctioned the much awaited Limited Liability Partnership Act 2008. Keeping in mind the requirement of international norms, on November 2, 2005 the ministry of Company Affairs had introduced the “concept paper” on Limited Liability Partnership with a view to stimulating public debate over ideas which will be incorporated in the proposed Limited Liability Partnership Bill.

As this introduction depicts a qualified perspective which provide a premise for analysis, promoting cognizance about the effectiveness of alternative dominion in fabricating new firms and business models. Traditional partnership are trivial and much dispensable channel for delivering modern traditional practice. The LLP agreement between the members is very flexible. Following trends, predominantly those in the United States of America, United Kingdom, and Singapore, the debate on Limited Liability Partnership (LLP) structure in India has evolved recently. This structure recognizes the “world’s best practice” model design not only to attract venture capital from offshore institutional investors but also to retain domestic investment. Few  advantage of this form of business structure include low cost of incorporation, unlimited capacity, limited Individual liability, flexible management structure, tax benefits and less audit and filing requirements.

However, it can be found out that this form of business structure likely to be misused also. After the Enron Collapse, it can be seen that Limited Liability has a magnitude of association with professional error and malpractices. The Enron scandal, revealed in October 2001, eventually led to the bankruptcy of the Enron Corporation, an American energy company based in Houston, Texas, and the dissolution of Arthur Andersen, which was one of the five largest audit and accountancy partnerships in the world. Many executives at Enron were indicted for a variety of charges and were later sentenced to prison. Enron’s auditor, Arthur Andersen, was found guilty in a United States District Court, but by the time the ruling was overturned at the U.S. Supreme Court, the firm had lost the majority of its customers and had shut down. Arthur Andersen, not only turned a blind eye to improper accounting practices, but was actively involved in devising complex financial structures and transactions that facilitated deception.

Even in India the Organization of Economic Co-ordination and Development (OECD) recognize Limited Liability Partnership as being a corporate vehicle, which is unguarded to misuse, predominantly for the reason it is less supervised than corporations.

Critical Appraisal:

The Act has various loopholes if compared with the international norm, Company Act 2013 and Partnership Act. Inadequacies of Act 2008 are as follows:

Section 7 lays down that every LLP shall have at least two designated partners who are individuals and one of them is the resident of India. Section 8 of the Act 2008 says that the designated partner shall be responsible for the statutory compliance with the provision of the Act. Clause (b) makes him liable to all the penalties imposed in the event of non- compliance. He is also responsible for filing of account of solvency and under various other provisions. Hence only conditions laid in Section 7 of the Act is not enough there is no any qualification nor disqualification as similar to those regarding directors under Section 274 of the Company Act, 1956 for the designated partners. The managing director under company law called director of the company he entrusted with ‘substantial powers of management by virtue of agreement with the company or of a resolution passed by the company in general meeting or by board of directors or by virtue of memorandum or articles of association but a designated partner has no managerial powers for a LLP all partners are equal and can manage the affairs of the LLP but designate partner may be vested with managerial powers under the LLP Agreement. It is expected that the manager should be qualified one and not merely a dummy. While Act does not lay down any qualification of designated partner, Rule 9 of the LLP Rules, 2009 lay down the disqualification of designated partners. Therefore it is very much possible that the partners may appoint same body who is not qualified enough and that person in due course becomes a scapegoat for the activities of the partners.

Consider the scenario where the person appointed as the manager is an insolvent. In such a situation nothing can be realised from the manager so ultimately the purpose of thereby making manager personally liable is not served, thereby making the provision redundant.

Section 67 of the Act 2008 authorizes the Central Government to apply the provisions of Companies Act 1956. Thus central government made the following rules further to amend the LLP Rules 2009 as mention under the LLP (Amendment) Rules 2010. As per the statement of the object and reasons appended to the bill limited partnership assumed to be new business vehicle auxiliary to the present business model. The main attractions of LLP is absence of the arduous statute based on governance and unhandy procedures. If the provisions of the companies act are applied to LLP, it might take away the said advantage and furnish the very object of the Act dispensable. Under this section of the Act, no framework have been defined under which the government is supposed to act. So an unbridled authority by the legislature especially when it is coupled with a power to apply with modifications and exception amount to excessive delegation and thus is ultra vires.

Chapter VII of the LLP Act deals with the financial declaration and requires the LLP to prepare a statement of accounts and solvency for a given financial year and file it with the Registrar. Need for financial declaration has been accepted as non-discriminatory for the limited liability defence provided by the LLP. But Section 36 provides that the incorporation document filed with the registrar, including the account of solvency, will be open to inspection by any person. This means that the financial whereabouts of the LLP be open to complete public dissection which may not be advantageous in the interest of the business particularly when LLP is facing financial issues. Therefore, it would be preferable if the word ‘any person’ is removed from Section 36 and selected set of authority should be allowed to have ingress to it.

Appointment of Auditors is an important requirement. There is a separate provision mentioned under Rule 24 of LLP Rules, 2009 but the provision mentioned there in just lays down the procedure for appointment of auditor and its re-appointment. The right to appoint them is given in the hands of designated partner which can in many situations be misused for the gainful purpose of the designated partner himself. There is no strict scrutiny on the appointment of the partner as mentioned in Section 139 of the Indian Companies Act 2013 which is more comprehensive and follows a stringent pattern for appointment of auditor. The auditor is required for the reason that there should be somebody who could be made responsible in law for accounts of LLP. The provision similar under companies act can be adopted as it is necessary to fortify that the accounts of the said LLP is audited fairly and the interest of the creditors and all other persons dealing with it could be maintained.

Section 23(2) provides that the LLP agreement should also be filed with the registrar. Such a provision is not essential as the agreement is for the internal affairs and the same should not be made public. Even in UK the LLP agreement is not required to be filed with the authorities or any registrar and hence is not public. Therefore, LLP agreement should be dispensed from the documents required to be filed by an LLP because such filing is needless and it further makes the working and internal affairs of LLP public which may not be expedient.

Section 33 of the LLP Act provides that the responsibility of partners to contribute money for other property shall be in conformity with the LLP agreement. But there is no corresponding provision in the first schedule or anywhere which can administer the situation in the absence of agreement. Therefore, it is suggested that a default provision should be included which shall operate in the event of the absence of an LLP agreement to this consequence.

When any existing company or Partnership firm is converted into an LLP, the assets of such firm is transferred to LLP but to corroborate this inter- transferability of the assets not pernicious, the dual barrier of stamp duty and capital gain tax under the Income Tax Act must be removed. A more liberalized policy must be brought about. The UK incorporates provision for consolation from the charge of stamp duty. India must incorporate the same provision offering tranquility of stamp duty which should be made available upon conversion of existing of firms into LLP. And also the of Act 2008 contains conversion procedure for existing business entities like firms and companies and it is accepted but the Act does not say anything about what happen when existing firm transfer themselves in to an LLP and can transferred firms and corporation have the option to go back. Here it is suggested that a provision must be inserted where firm/companies who transferred themselves into LLP can turn themselves back to prior position. If required, give them its prior identity what it had before converting themselves in to LLP.

Taxation on LLP is one area which has been left completely by the Act 2008. The success of the LLP largely depends upon the kind of tax jurisdiction it is subjected to. There have been various advocacy to adopt UK model of taxation for LLP where for purposes of tax the business carried on by the partners shall be treated as being carried on by the partners, this amounts to give a pass through status to the LLP’s in the taxation matters and taxing in the hands of partners. One of the major drawback of having this sort of taxation could be in the case of small LLP. For example, if the overall profit of a firm consisting of five partners amounts to 10 lakh and 10 lakh is equally divided amongst all partners. In this case each partner will get a sum of Rs. 2 lakh which is mostly exempted from taxation. This will lead to loss of revenue which shall not happen if the same income is charged at the firm level itself. Another option of taxation is to tax LLP as a company. A third way of taxing the LLP is the model followed in the US where it is left up to the firm to decide on how it wants to be taxed- as a company or by pass through method.

This methodology will also ensure that the same is on par with other countries leading to eligibility to the tax benefits to such LLP in terms of the tax treaties entered in to by India with other countries. These are sphere of paramount importance which do not even find a raise in the act even though they are issues of highest importance.

Indian LLP’s will no way be put to any disadvantage and will have a level playing field with other similar bodies outside the country if the major concerns mentioned above are taken care of by amending the LLP Act 2008. In its present form, the LLP Act in the nature of small companies. Unless suitable changes are made, it may defeat the very objectives for which LLPs were thought of and may not receive the contemplated response expect, perhaps, from professionals. Because of vast regulatory contrivance provided in the Act, Small and Medium level businesses would be inhibited in making use of this system of managing business.

The LLP system can be seen as “marriages between brains and bank balances” that take place within the small enterprise/business sector, just as is meant to happen every time in a company in which the organized corporate sector issues capital to the public in the form of equity shares or debentures. The LLP will valve funds not from the public but from a section of slothful co-partners of an enterprise whose liability to repay debts of the business be limited to their investment and who will be entitled to a share in the profits of the business will.

The Ministry of Company Affairs has made efforts to do away with the loophole in the legal system of our country concerning LLP’s, but it is yet in a rudimentary stage. Yet a great deal of thought needs to be put into certain strands of the law, wherein some features can be embraced from the laws of other countries. Notwithstanding, even a law that is tried and tested in any other country has to be configured to suit Indian conditions and incidents.

LLP is a new concept and will require a lot of contemplation. The Centre must try to involve more and more people in the law-making process. The content of the law and its manner of implementation must fortify maximum sway to everyone involved, and efforts must be made to make the LLP form of corporate governance widely accepted and popular, as it is in U.S.A and in U.K. As for now, it can be denoted with a universal saying, “a project well begun is half done”. The Ministry has given a great genesis.

NOTES

The statement of Objects and Reasons appended to the Limited Liability Partnership Bill 2006, introduced in the Rajya Sabha on 15th December by Mr Prem Chandra Gupta, the Minister of Company Affairs, explains the object of this new device of organization.

Ravi Sharma, Limited Liability Partnership – Evaluation of the new business vehicle, Corporate law Adviser, Vol. 90/3, 15 June 2009

Arthur Andersen LLP v. United States [544 U.S. 696 (2005)]

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