Fiduciary Duties and the Nature of an LLP

While the position of law in relation to the inter-se relationship between partners of a firm is fairly well-settled, there is no great clarity on similar issues arising in the context of LLPs. It is clear that the “double agency” rule of partnerships does not apply to LLPs: but, if LLPs are seen as a hybrid form of a partnership and a company, does the law impose any fiduciary duties on members of an LLP? To what extent can features of partnership law be applied to LLP as being based on general principles? This question arose before the England & Wales High Court in Barthelemy v. F&C Investments [2011] EWHC 1731 (Ch).

 

The Court held that a member of an LLP does not as such owe fiduciary duties to other members. The Court held that the LLP Act established a wholly new form of entity, which “may be expected to have its own corporate governance structures”. Referring specifically to Section 1(5) of the LLP Act 2000, the Court held that the general law of partnerships does not apply to LLPs at all, unless specifically stated to apply. Insofar as the question of fiduciary duties was concerned, the Court relied on the classic paragraph in White v Jones [1995] 2 AC 207 where Lord Browne-Wilkinson explains how fiduciary duties arise:

“The paradigm of the circumstances in which equity will find a fiduciary relationship is where one party, A, has assumed to act in relation to the property or affairs of another, B. A, having assumed responsibility, pro tanto, for B's affairs, is taken to have assumed certain duties in relation to the conduct of those affairs, including normally a duty of care. Thus, a trustee assumes responsibility for the management of the property of the beneficiary, a company director for the affairs of the company and an agent for those of his principal. By so assuming to act in B's affairs, A comes under fiduciary duties to B. Although the extent of those fiduciary duties (including duties of care) will vary from case to case some duties (including a duty of care) arise in each case. The importance of these considerations for present purposes is that the special relationship (i.e. a fiduciary relationship) giving rise to the assumption of responsibility held to exist in Nocton's case [Nocton v Lord Ashburton [1914] AC 932] does not depend on any mutual dealing between A and B, let alone on any relationship akin to contract. Although such factors may be present, equity imposes the obligation because A has assumed to act in B's affairs. Thus, a trustee is under a duty of care to his beneficiary whether or not he has had any dealing with him: indeed he may be as yet unborn or unascertained and therefore any direct dealing would be impossible…”

Noting the principle laid down in this paragraph, the Court in Barthelemy nonetheless held that in the context of LLPs, no such general assumption of responsibility could arise. It was also held, following the typical reluctance of the common law to impose good faith obligations, that there was no duty of good faith owed by the members of an LLP to one another. 

The Court noted the view in Palmer on LLPs that there was a general fiduciary obligation; noting (with some understatement) that “the discussion in Palmer proceeds a little too quickly here”. It was held that the view that ‘as a general rule, members of an LLP owe fiduciary duties to one another’ may not be appropriate. This is because under s 1(5) of the English LLP Act, the general principles of partnership law cannot be read in to the law governing LLPs. Further, an LLP has a separate corporate personality unlike a typical partnership, and the Act leaves open a large window of flexibility for structuring relationships through the LLP form. In such a scenario, the Court held that a general rule would not be appropriate. Thus, the Court seems to leave open the issue that there may be cases where the Agreement between the members is such that an “assumption of responsibility” situation arises: in such cases, based on White v. Jones, fiduciary duties may well arise. The Court held, refusing to lay down a rule of general application, “it is necessary to look at the specific roles and responsibilities [of the member] arising in the particular context in question in order to assess whether and what fiduciary obligations might arise…”

The decision of the English Court also contains a discussion of the general content of fiduciary obligations in the common law. Another excellent discussion of fiduciary duties is available in J. Edelman, “When Do Fiduciary Duties Arise?” (2010) 126 LQR 302.

CA firms with LLPs can now act as statutory auditors

(The following post is contributed by Rohan Bagai)

A limited liability partnership (LLP) of chartered accountants (CAs) can now act as a statutory auditor of a company notwithstanding Section 226 (3) (a) of the Companies Act, 1956, which stipulates that a ‘body corporate’ is disqualified from such an appointment.

In this regard, the Ministry of Corporate Affairs (MCA) has recently issued a clarification vide General Circular No. 30A/2011 that detaches LLPs of CAs from the definition of ‘body corporate' for the limited purpose of Section 226(3) (a) of the Companies Act.

The release comes pursuant to representations from the Institute of Chartered Accountants of India (ICAI) to the MCA wherein ICAI had submitted that an LLP of CAs being a ‘body corporate’ under Section 3 (1) of the Limited Liability Partnership Act, 2006 would not be qualified for appointment as auditor by a company.

This Government move is sure to trigger conversion of CA firms into LLPs by seeking to address the limit on the number of partners (which is presently restricted to a maximum of 20 partners under the Partnership Act, 1932). More so, this would enable these firms to form multidisciplinary LLPs with cost and works accountants, company secretaries, lawyers as well as chartered engineers whilst suitable amendments are being carried out in the legislations governing their regulators like the ICAI, the Institute of Company Secretaries of India (ICSI) and the Institute of Cost and Works Accountants of India (ICWAI).

- Rohan Bagai

Government Nod to FDI in LLPs

(The following post is contributed by Rohan Bagai)

The Cabinet Committee on Economic Affairs (CCEA) recently approved foreign direct investment (FDI) in limited liability partnership (LLP) firms whilst setting out a few disclaimers in its press release dated May 11, 2011. This follows from a consultation process initiated last year pursuant to a discussion paper.

As such, an LLP is a crossbreed business structure, which fuses the characteristics of a partnership firm with that of a corporate entity. Besides, it bestows the pluses of a company and elasticity of a partnership.

The LLP model was first introduced in India through the Limited Liability Partnership Act, 2008 (LLP Act) that was notified on March 31, 2009. Later, the LLP Act was amended to clear way for companies and firms to convert into LLPs. As per the Government website for LLPs, as on May 2, 2011, 4,670 LLPs have been registered in India.

According to the cabinet announcement, FDI in LLPs, “will be implemented in a calibrated manner, beginning with the ‘open’ sectors where monitoring is not required, subject to certain stipulations”. In view of the same, FDI in LLPs would be permissible through the Government route i.e. Foreign Investment Promotion Board (FIPB) approval, in those sectors/activities where 100% FDI is allowed.

That said, FDI in LLPs would not be allowed in agricultural/plantation activity, print media and real estate businesses. In addition, such FDI funded LLPs would not be eligible to make any downstream investments or avail external commercial borrowings (ECBs). Other restrictions are that FDI will be allowed only against cash consideration, and that foreign institutional investors (FIIs) and venture capital investors (FVCIs) cannot invest in LLPs.

Interestingly, even foreign investors with existing investments by means of joint ventures and wholly owned subsidiaries can now restructure and convert themselves to LLP as long as they meet the pre-requisites provided for in the said release.

“This approval will benefit the Indian economy by attracting greater FDI, creating employment and bringing in best international practices and latest technologies in the country”, the government acknowledged in its release.

However, given the wide array of restrictions, it is unlikely that a wave of FDI will flow into the sector. But, if the initial experience is smooth, it may provide justification for gradual withdrawal of some of the restrictions that may then make a meaningful impact on the growth of LLPs.

- Rohan Bagai

More Hurdles for LLPs

As we have previously noted on this Blog, the popularity of limited liability partnerships (LLPs) has not met with expectations since introduction of that business vehicle in April 2009. While the Government has taken certain steps to boost the utility of LLPs, such as by considering the possibility of foreign investment into LLPs discussed in this paper issued by the Department of Industrial Policy & Promotion, more recent steps taken and views adopted by the regulatory may amount to a retrograde step.

First, as the Economic Times reports, it is currently not possible for various corporate groups to restructure their holding companies so as to convert them into LLPs. The reasoning is as follows:

But, corporates planning to convert their holding companies into LLPs have been told by the registrar of companies (ROC) to get a no-objection certificate (NOC) from RBI; and the central bank is unwilling to give one. "There is a concern that the moment a company becomes LLP, it will be out of the RBI radar. These companies are core investment companies and under new rules they will be monitored, like non-banking finance companies (NBFCs), by the regulator," said an RBI official.
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Currently, the definition of NBFC under the RBI Act does not specifically cover LLPs. Only companies registered under the Companies Act can form NBFCs. "We have told RBI that the law has to be changed to enable recognition of LLPs as core investment companies under the NBFC format," said an official in the registrar of LLPs in Delhi. An RBI spokesperson confirmed that the central bank is in discussion with the ministry of corporate affairs on the subject.

The LLP structure was introduced primarily keeping in mind operating companies, and not holding and investment companies.

Although there is no restriction under the LLP Act as to the activities that an LLP can carry out, the lack of acceptance of the new business vehicle under other legislation such as the RBI Act has given rise to such ambiguities, thereby curtailing the utility of the LLP and its benefits.

Second, although FDI into LLPs is being actively considered, it has been reported that there is no momentum to permit LLPs to raise overseas debt in the form of external commercial borrowings:

The finance ministry and the Reserve Bank of India have opposed changes in the external commercial borrowings (ECB) policy to allow overseas borrowings by LLPs, while responding to a discussion paper on this form of business put out by the department of industrial policy and planning (DIPP), the policymaking body on foreign investment.

The ECB regime should be identical to the one applicable for partnerships, the finance ministry said in response to the paper. The finance ministry is of the view that while FDI can be allowed in this form of business entities, but not overseas debt, said a government official privy to the discussions.
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The current policy allows companies to raise ECBs, but sole proprietorship firms and partnerships are prohibited from accessing such debt. Though, LLPs combine features of the corporate form of business and partnerships, they are closer to partnerships. …

Proposal for FDI in Limited Liability Partnerships

Limited liability partnerships (LLPs), which are a relatively novel concept to India, have been recognised since April 1, 2009. LLPs are different from general partnerships in several ways, but there are two prominent differences. First, partners in LLPs carry limited liability for acts of the firm. Second, the partnership firm possesses separate legal personality and to that extent it has distinct existence from its owners/partners. In that sense, an LLP is a hybrid entity. While it has the key features of a limited liability company, it has the flexibility of management and operations, small size and tax status similar to a general partnership.

Although LLPs have been in existence for over a year now, the FDI policy has not provided for separate treatment for foreign investment in LLPs. The Consolidated FDI Circular issued on April 1, 2010 permits non-resident Indians and persons of Indian origin to invest in partnership firms and proprietary concerns. Under relevant RBI guidelines, other foreign investors are required to obtain prior approval of the RBI to invest in partnership firms. The absence of specific treatment of LLPs in the FDI policy makes it unsuitable to attract foreign investment in those entities.

In this background, the Government yesterday issued a discussion paper on foreign investment in LLPs. Although the paper does not set out any specific position, it seeks views from the public on various aspects starting from whether FDI should be permitted at all in LLPs to what factors are to be considered while permitting FDI (such as issues of ownership, control, downstream investments, valuation, and the like).

The LLP as a business entity is yet to drum up the impetus it was expected to generate when the LLP Act was passed and later notified in 2009. It appears that the number of LLPs being registered is growing at a slow pace, and the present effort is an additional step to confer benefits on that entity so as to attract more entrepreneurs and professionals to utilise it as a vehicle to carry on their business or profession.

At a more general level, the practice of the Department of Industrial Policy and Promotion (DIPP) in issuing discussion papers on various topics is welcome. It makes the policy-making process transparent and inclusive. The use of policy arguments, the comparative study of position in other similarly situated countries, and in some cases the reference to empirical evidence certainly enhances the quality of policy-making. It is hoped that these discussion papers will be taken to their logical conclusion with a definition pronouncement made one way or the other. Failing this, there is a risk that it will only cause greater ambiguity and confusion in the minds of foreign investors and the Indian recipients of such investment.

Revised Limited Liability Partnership Bill on the Horizon

A revised bill on Limited Liability Partnerships (LLPs) has been approved by the Union Cabinet, reports The Economic Times. The LLP Bill is set to be introduced in Parliament soon. The establishment of LLPs would enable professional services firms, such as those constituted by chartered accountants and lawyers, to carry on their activities without risk of personal liability of partners (beyond their share of capital in the firm). This would bring the Indian legal position on par with other developed jurisdictions where LLPs have been permitted for professional services firms. The new Bill replaces the previous Bill of 2006 as it takes into account suggestions given by the Standing Committee

As with many other laws and regulations that seek to establish new types of entities, the tax position regarding LLPs is yet unclear. However, it is expected that necessary changes will be brought about through amendments to the Income Tax Act to clarify the position regarding taxation of LLPs. A thornier issue relates to the payment of stamp duty when companies (mostly private limited) or other entities convert themselves into LLPs. When such conversion occurs, there is notionally a transfer of property of the erstwhile company or other entity to the LLP thereby resulting in a conveyance that is subject to stamp duty. Conversions to LLPs become prohibitively expensive if the stamp duty implications are severe. This scenario gets further complicated because stamp duty on conveyances fall within the state subject, and the Centre cannot legislate on the same. Hence, it becomes virtually impossible to convince all relevant states to impose less rates of stamp duty on conveyances arising out of conversion to LLPs or even to seek an exemption for such transaction. That could impose a hindrance on cost-effective implementation of conversions to LLPs.

These and other implications can be reviewed further once the Bill is introduced in Parliament and its detailed provisions are known.

Limited Liability Partnerships: Some Developments

While it is reported that the Limited Liability Partnership Bill is likely to be cleared during the Budget session of Parliament, there have been some interesting developments that will make limited liability partnerships (LLPs) attractive, at least to some types of business.

The first relates to multi-disciplinary partnerships (MDPs). The Economic Times reports:

“India can soon boast of its own homegrown multidisciplinary majors like Ernst & Young and PwC, comprising professionals like Chartered Accountants, Company Secretaries, engineers, architects and MBAs under one roof, to cater to the rapidly-globalising corporate sector.

Professional institutes like Institute of Chartered Accountants of India (ICAI), Institute of Company Secretaries (ICSI) and Institite of Cost and and Works Accountants (ICWAI) have initiated steps to work out arrangements to form multi-disciplinary partnerships (MDPs), though the big booster would be a formal go-ahead to limited liability partnerships (LLPs), the bill for which is likely to be cleared in the budget session of parliament.”

This would enable professionals to establish multi-disciplinary practices thereby enabling them to provide different types of services to clients under one roof. However, from a legal standpoint, this may require amendments to the legislations governing these professions, such as the Chartered Accountants Act, 1949, the Company Secretaries Act, 1980 and the like.

As to whether lawyers will be a part of MDPs, the news report states:

“However, there are some crucial issues that stand in the way of such MDPs. Currently, the Bar Council has not agreed to be a part of such firms and absence of legal eagles would certainly be a big miss.

Senior corporate law advocate U K Chaudhary said while Bar Council had no objection to LLPs between lawyers, it was yet to permit them to join other professionals in MDPs. "However, I feel that lawyers should be allowed to be part of such multi-disciplinary firms as this would open a whole opportunity for them," Chaudhary added.”

A second development relates to the availability of tax benefits to LLCs. The proposal allows LLPs to choose whether to tax the LLP itself as an entity or to tax its partners directly. Another report by the Economic Times:

“The ministry of corporate affairs has recommended in a Cabinet note that it is an international practice to let LLPs choose the mode of taxation, based on how they are structured. If an LLP’s operations are de-centralised and the partners act autonomously, their income could be taxed in the hands of the partners.

If the LLP has centralised operations and assets, then the LLP itself could be taxed. Outside investors, who form cross-border LLPs with Indian professionals, would prefer taxation at the partner-level instead of at the LLP-level as that would mean taxation only at one level.

If the LLP itself is taxed, the foreign partner in a cross-border partnership may end up paying tax in his country for his income from the partnership registered in India even if the LLP’s entire income has already been taxed in India.

Also, if the LLP generates income here as well as abroad, the entity will have to pay tax here even for the income that is generated abroad. Taxing individual partners will ensure that these disadvantages are eliminated. Taxation at the partner level means paying taxes in the respective countries by the partners for whatever income they get from the LLP. A partner in one country need not bear the burden of taxation in another.”

We could expect announcements on this front in the forthcoming Budget.