Legal Service India - The Concept of Limited Liability Partnership -  Application of the LLP Regime in India and its feasibility
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The Concept of Limited Liability Partnership -  Application of the LLP Regime in India and its feasibility

Written by: Garima Tiwari and T.Priyadarshini - Students, Fourth Year, National Law Institute University, Bhopal
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Limited Partnership - This is term that is heard once in a way in this country as a concept that is worthy of consideration for introduction. This is unfortunate because it is one reform that, if introduced in a proper form, would help small businesses, including small-scale industries (SSIs) and small service enterprises. It is known that more than 90 per cent of SSIs are proprietorships and partnerships. Thus the vast majority of small entrepreneurs are exposed to unlimited liability for debts of their businesses, which operate in a highly competitive environment.

This is in stark contrast to the perennial talk about reform and liberalization of law governing companies. Numerous committee reports and many draft laws and amendments have been seen and some changes actually introduced in the company law over the 14 years since the beginning of economic reform. Though simplification of the company law and dispensing with outdated controls and procedures have not kept pace with much proclaimed intentions of policy-makers, this is still a much better picture compared to the nil progress on one simple reform – introduction of a law on limited partnership -- that would have made a substantial difference to small entrepreneurs.

The concept of limited partnership prevails in many countries, especially developed countries. Under this provision, "general partners", including those in actual control of operations of a partnership business, alone would be exposed to unlimited liability to debtors of the business, while the enterprise would be able access capital from other partners whose liability would be limited to their contribution of capital. (Their share of profits would be in proportion to their share in the capital). Thus, limited partnership would help SSIs and other small businesses overcome one of their major constraints – inadequate access to finance, and provide them with a partial "level playing field" vis-à-vis bigger corporates. Introduction of a separate piece of legislation for small private companies or a separate chapter for them in the Companies Act to govern small private companies should be helpful to Small Scale Industries. Under the LLP, all members of the professional outfit would not be liable for claims arising from alleged wrongs of individual members, who alone would be liable. Professionals are also demanding legal amendments to enable professionals from different disciplines (like law, accountancy or engineering) to form a single outfit to render services under a "single window".

The need for Limited Liability Partnerships

In India, the businesses operate mainly as companies, sole partnerships and partnerships. Different laws of the country govern these. However, there is a gap in the business structure, which needs to be filled so as to enable high growth in the service sector especially that related to the professionals. This gap is sought to be bridged by introducing a Limited Liability Partnership Law. This subject has been dealt in the Naresh Chandra Committee on Regulation of Private Companies and Partnership Concerns and the Expert Committee on Company Law[4]. In foreign countries, LLPs have been important vehicles that have catered to the needs of small-scale sector and venture capital funds. Even though the concept of limiting the financial liability of non-active partners to the capital investor has been debated in various forums of the Government for more than a decade, the case for having LLPs has been strengthened by the new business environment and initiatives of the Department of Small-Scale Industries.

Recent aspect added has been a proposal to include Small Scale Industries in the ambit of Limited Liability Partnership Act (30-May-06). The ministry of Small Scale Industries (SSI) is inclined for bringing small enterprises in the ambit of the proposed Limited Liability Partnership Act. The ministry of company affairs has agreed principally to the proposal. The Enactment of the Bill will help more small enterprises to get organized either get organized either as companies or limited liability partnerships or improve their capability to access institutional credit as the LLP system combines the advantage of traditional corporate structure and entrepreneur-centric proprietary/partnership structure.

The primary confusion with regards to the concept of LLP is the distinction between partnership (in the general sense) and a LLP. Precisely, the broad distinction between a General Partnership and an LLP can be outlined as under:
(a) General Partnership – The partnership simpliciter constituted under the Indian Partnership Act, 1932. Each of the partners is jointly and severally liable for any liability arising out of or in respect of the partnership.
(b) Limited Liability Partnership – The LLP is a separate legal entity with unlimited capacity where no member or partner is liable on account of the independent or unauthorized actions of one’s partner, and whose liability is limited to the respective stake of each in the LLP. The members of an LLP would have the option to have a general partner or more with unlimited liability, but it would not shield the partners from legal liability arising out of their own personal acts which are not done for and on behalf of the LLP, that is, any act done beyond the acts and powers of the partners as laid down in the incorporation document. Further, a partner’s liability is not limited when the misconduct is attributable to him or to an employee under the supervision or control of that partner. An LLP only protects a partner, other than a general partner from the liability arising from the misconduct or personal acts of other partners.

United Kingdom Limited Liability Partnership Act 2000- Forerunner of LLP concept in India.

This is a relatively new creature to English law, and was introduced in 2001 by the Limited Liability Partnership Act 2000. The LLP is a halfway house of sorts between a partnership and a limited company, having some of the characteristics of each. The UK Limited Liability Partnership Act 2000 came into effect in April 2001 and introduced an exciting new vehicle for international business. The essential features of the UK LLP include:• An LLP is a body corporate and has a separate legal personality.

• An LLP can own any property and undertake any contract;
• The liability of Members is normally limited to the extent of the amount contributed;
• Partnership law does not apply

Report of The Committee On Regulation Of Private Companies And Partnership (Naresh Chandra Committee-II)
It is of high significance that the LLP concept was introduced in India through the Naresh Chandra Committee Report. Therefore, it is important to understand the various aspects dealt by the Committee with respect to this concept. The broad areas of analysis with respect to LLPs as provided under the Committee Report are:
Ø application of the LLP regime;
Ø incorporation, registration and number of partners;
Ø limited liability;
Ø financial safeguards; and
Ø tax treatment of LLPs.

Application of the LLP regime

In the Committee’s view, the scope of LLP should, in the first instance be made available to firms providing professional services, as opposed to trading firms and or manufacturing firms, for several reasons. Firstly, because Indian professional firms are precluded from practicing under any other legal form in view of the restrictions imposed by their respective regulatory laws; trading firms or manufacturing firms, however, have the option to carry on business as a private limited or public company under the Companies Act, 1956. Secondly, as the professionals are also governed and regulated by their respective professional, regulatory bodies, which also control and monitor professional conduct, extending the LLP structure only to professionals minimizes the risk inherent in testing new waters. Thirdly, there is no special advantage that small private companies or SSI units would derive from being an LLP, especially in light of the fact that this Committee itself is simultaneously recommending a considerable easing of regulations on private companies, especially small private companies. It was felt that extending the LLP structure to professionals, in the first instance, would help evaluate its advantages and risks; and based on such evaluation and experience, the LLP form can be considered for extension to small-scale manufacturing and/or trading firms as well in the future.

As incorporated under Proposed Concept Paper of Limited Liability Partnerships:

An LLP is a body corporate having perpetual succession and a legal personality of its own. It shall have at least two partners but there is no limit on the maximum number of partners that it can have. If at any time the number of partners of an LLP falls below two and the business is carried on for more than six months, a person who is a partner of the LLP during the time that it so carries on business after those six months and is cognizant of this fact shall be liable jointly and severally with the LLP for the obligations of the LLP incurred during that period.

Any individual or body corporate may be a partner in an LLP. An LLP being a body corporate, the law relating to partnerships is generally not applicable to a limited liability partnership. Similarly, any change in the partners does not affect the existence, rights and liabilities of the LLP.

Every LLP shall ensure that it has a manager who is an individual and is resident in India. The role of a manager is to perform the administrative and filing duties of the LLP and will be held personally liable for all penalties imposed on the LLP unless he satisfies the Tribunal that he should not be held liable. Further, in all cases where the manager is liable the LLP shall also be liable to the same extent for such defaults. A manager need not be a partner of the LLP. However, if no manager is appointed, each partner who is resident in India shall be treated as a manager. The LLP shall appoint another person as the manager within sixty days from the date on which a person ceases to be a manager.

Incorporation, registration and partners

An LLP must be incorporated by using a formal mechanism of filing the incorporation document with the Registrar. Further, there should be no restrictions on the number of partners in an LLP.

As incorporated under Proposed Concept Paper of Limited Liability Partnerships:

To form an LLP, there must at the outset be at least two persons who are associated for carrying on a lawful business with a view to profit and who subscribe their names to a document called an "incorporation document".

The incorporation document must be delivered to the Registrar in the prescribed form and manner. A statement must also be delivered to the Registrar that there has been compliance with all the requirements of this Act and Regulations with respect to incorporation and matters precedent and incidental thereto. The statement must be made by a subscriber to the incorporation document and by either an advocate, or a Company Secretary, or a Chartered Accountant in whole time practice in India, who is engaged in the formation of the LLP. If a person makes a statement under Section 8 (1) (c) that he knows to be false or does not believe to be true he shall be punishable under the Act. When the registrar receives the incorporation document, he will retain and register it. Once the documents have been registered, the registrar will issue a certificate that the LLP is incorporated by the name specified in the incorporation document. A statement that is delivered under Section 8(1) (c) may be accepted by the registrar as sufficient evidence that the requirement in section 8(1) (a) has been complied with. The certificate issued by the registrar is an evidence that all the requirements have been complied with.

An LLP, shall by its name has the power to sue and being sued, hold and dispose property, have a common seal and to do and suffer such other acts as bodies corporate may lawfully do and suffer. Every LLP is required to have either the words “limited liability partnership” or the acronym “LLP” as the last words of its name. An LLP shall not be allowed to register with a name, which is undesirable or identical to a name of any other LLP or body corporate or to a registered trade mark, or a trade mark which is subject of an application for registration, of any other person under the Trade Marks Act, 1999. The name shall be printed on all its invoices and official correspondence along with a statement that it is registered with limited liability.

Limited liability
As opposed to the concept of joint and several liability, applicable in general partnerships, the liability for partners in a LLP should be limited. In other words, the LLP would assume liability in the event that a partner of the LLP commits an act of commission or omission for and on behalf of the LLP, that results in such liability. The partners would be liable only to the extent of their respective agreed contribution to the LLP without any recourse to the personal assets of a partner. Provisions dealing with insolvency, winding up and dissolution of an LLP should be similar to those provided for private companies in the Companies Act, 1956. There should also be provisions detailing the liability of partners to contribute to the assets of the LLP in the event of its being wound up.

As incorporated under Proposed Concept Paper of Limited Liability Partnerships:

Each partner of the LLP is an agent of the LLP but not of other partners. Therefore, a partner shall be held personally liable for his own wrongful act or omission, but will not be liable for the wrongful act or omission of any other partner of the LLP. An LLP is however, not bound by the actions of a partner where that partner has no authority to act for the LLP, and the person dealing with the partner is aware of this or does not know or believe that the partner was in fact a partner of the LLP.

Further, where a partner of an LLP is liable to a person for a wrongful act or omission in the course of business of the LLP or with its authority, the LLP will be liable to the same extent as the partner. An LLP being a separate legal entity is liable for an obligation arising in contract or otherwise and the liabilities of the LLP shall be met out of its property. However, this liability shield will be withdrawn in case of an act carried out by a LLP with the intent to defraud creditors or for any other fraudulent purposes.

Financial safeguards
The Committee Report mentions that the standards of financial disclosure as applicable to private companies should also be made applicable to an LLP. The advantages gained from having the privilege of limited liability should be coupled with the responsibility of making adequate financial disclosures so as to minimise the chances of fraud and mismanagement. This should be subject to such privilege as may be available to a professional in his relationship with his or her client in maintaining confidentiality, and it may be different for different professions.

As incorporated under Proposed Concept Paper of Limited Liability Partnerships:

A limited liability partnership is required to maintain proper books of accounts at its registered office relating to its affairs for each year of its existence on accrual basis and according to the double entry system of accounting. An LLP shall take reasonable precautions to maintain the records to prevent loss or destruction, falsification of entries and facilitate detection and correction of inaccuracies. If default is made in complying with these provisions, the manager shall be punishable under the Act.

The manager of an LLP shall lodge with the Registrar a declaration as to whether in his opinion the LLP appears to be able to pay its debts in the normal course of business or not. The declaration is to be lodged within 15 months of registration and subsequently every financial year at intervals of not more that 15 months. If the manager fails to lodge the declaration or makes a declaration without having reasonable grounds for his opinion, he shall be punishable under the Act. Further, if any person makes a statement or furnishes information to a manager that is false or misleading in a material particular, then that person shall also be punishable under the Act.

Further, the Registrar may destroy any document lodged, filed or registered with it, if it is no longer necessary or desirable to retain the same. Regulations to the Act shall prescribe the offences, which may be compounded by the Central Government under this Act. A limited liability partnership shall take all reasonable precautions to maintain the records it is required to maintain under sub-section (1) of section 27 in a manner so as to prevent loss or destruction thereof prevent falsification of entries and facilitate detection and correction of inaccuracies.

Tax treatment of an LLP

Section 10 of the UK LLP Act lays down that a trade, profession or business carried on by an LLP, with the view to profit, shall be treated as carried on in partnership by its members and not by the LLP itself. Thus, any asset held by an LLP, or any tax chargeable on gains made shall be treated as held by the partners, or gains made by the partners, and not by the LLP itself. In other words, an LLP enjoys a pass-through status and is not taxable as such; the taxation liability falls on the partners in their individual capacity. In the USA, too, LLPs enjoy a pass through status for the purposes of taxation. The profits or losses of the LLP pass through the business and are reported on each partner’s personal returns.

As incorporated under Proposed Concept Paper of Limited Liability Partnerships:

The partners of an LLP which is carrying on a business with a view to profit are treated for the purposes of income tax and capital gains tax as if they were partners carrying on a business in partnership, despite the fact that an LLP is a body corporate. It also provides that the property of the LLP shall be treated for those purposes as property of its partners. This ensures that partners will be individually liable to tax on their share of the profits of the trade, profession or business carried on by the LLP. Further, the assets of the LLP shall be treated as assets held by the partners for the purpose of taxing capital gains. This ensures that the partners of the LLP, rather than the LLP itself, will be liable to tax for capital gains on the disposal of LLP assets. The chapter brings LLPs in line with the approach adopted for partnerships, which similarly treats assets as held by the partners rather than by the partnership.

While there could be no objection to any such reform being undertaken after due deliberation, neglected themes like limited partnership and small private companies should be given priority attention in the interest of small entrepreneurs in all sectors. This is likely to happen only if the SSI community takes up and studies the issues in depth and presents a united stand before policy-makers.

The Naresh Chandra committee, which examined the scope for liberalising the company law in the case of private limited companies (viz, companies that are closely held and have not accessed resources from the public in the primary capital market) has proposed that a separate category of "small private companies" (SPCs) be created with a still more liberal legal framework than for private companies in general. This, the committee rightly felt, would enable small businesses operating under the purview of one of the world's most voluminous and tortuous company legislations, to enjoy freedom from rigorous procedures irrelevant to them. However, the committee has not gone into specifics of ways in which SPCs could be given freedom from unnecessary regulation, while it has come out with more elaborate and specific proposals for easing regulations that could be applied to all private limited companies.

This Concept is of high significance in lieu of the fact that in the background of the global economic trends which enable investment and services to flow across borders, the growing role of service & knowledge based enterprises and emerging international competition, it is highly necessary to enable Indian entities also to have the requisite choice in corporate organizations to compete internationally on level playing field.

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