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Limited liability partnership agreements

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What is an LLP agreement?

A Limited Liability Partnership (LLP) agreement is a legal contract entered into by two or more companies, LLPs or individuals who intend to form, or who have formed, a limited liability partnership to carry out a business with a view to making a profit. The agreement will determine the rights and duties of the members of the LLP.

Is an agreement essential?

Although there is no legal requirement that an LLP is governed by an agreement, it is advisable to do so. An agreement will serve to clarify the relationship between and bind the members that enter into it. Furthermore, although the LLP legislation makes no provision at all for such an agreement, it assumes that there will be one.

In the absence of a written agreement, there are some basic provisions in legislation that govern LLPs. However, relying on them is risky and can lead to serious conflict sometimes resulting in litigation. Therefore an overwhelming majority of professional LLPs choose to enter into a formal written agreement.

Main clauses

The specific provisions of an LLP agreement will be determined by the individual requirements of each LLP. However, the following matters must be dealt with in every case:

a) LLP capital:

The capital of an LLP is the amount or value that each member has agreed to contribute towards the business. In other words, it is the sum of their total investment in the LLP and can be made in cash, assets or in kind (e.g. a member's skills, connections or reputation). The amount or value so contributed is recorded on a capital account for each member.

b) LLP profit and losses

The profits and losses of an LLP will be split between the members following the drawing up and agreement of annual accounts. The amount of profit that each member receives or the amount of the loss that they are liable for will vary on a yearly basis in accordance with the performance of the LLP, but the share of the total profit or loss which each member will receive or be responsible for will be as set out in the LLP agreement.

c) Drawings

Each member will be entitled to take a set amount of money from the LLP funds each month. This is a payment on account of each member's annual profit share and is a recognition that members will have personal financial requirements which they might not otherwise be able to meet if they were obliged to wait until their profit share was determined at the end of each year. This entitlement is called drawings.

d) LLP goodwill

The difference in value between the assets of the LLP and its value as a running business is called goodwill. Items that add value to the goodwill of a business are those such as contacts, geographical location, the reputation of a business or product, monopoly rights or development potential. The calculation of goodwill is far from scientific and may require the skills of an expert, such as an accountant. It is frequently excluded from the annual accounts, since it represents only a notional value which the LLP has not realised. On a member leaving the LLP he or she may be entitled to a share of the LLP goodwill.

e) Indemnities

The LLP will shield its members from and against any liabilities, demands or claims (legal or other) incurred whilst they are performing their LLP duties.

f) Termination finances

When a member ceases to be a member of the LLP for any reason he or she will be entitled to receive his or her share of the LLP capital, any undrawn profits due to him and a share of goodwill depending upon the terms of the LLP agreement.

g) Property

There is a need to distinguish between property which belongs to all of the members as members (i.e. to the LLP) and property which remains that of an individual member. It is also possible for one asset to be owned by one member and to be used by the LLP under some form of agreement or even for it to be owned by all of the members and be used under some similar arrangement. It is important to identify this clearly in the agreement so that the true owner of the property is identified and it is excluded or included in the partnership's assets as appropriate.

h) LLP management

There are four main ways that a LLP can be managed on a day-to-day basis:

A managing member

This is where one member is elected by the other members to manage the LLP on a day-to-day basis. This approach is best suited to larger sized partnerships where it is far more convenient for one member to make managerial decisions on behalf of the LLP.

A management team

This is where the LLP elects more than one member onto a management team. Members of that team will manage the LLP together on a day-to-day basis. This approach is best suited to large partnerships and/or those that wish to give the management burden to several members.

A management group

This is where the members vote to elect both a managing member and a managing team known collectively as a management group. The managing member will be assisted by the management team and shall delegate his/her responsibilities to them as appropriate. The management team cannot act independently of the managing member unless he or she has delegated responsibilities to them. The only exception to this is if the managing member is found to be acting inappropriately; in which case, the management team must inform the other members.

All of the members

This is where the LLP is managed on a daily basis by all of the members together. This approach is most suited to small partnerships where there is little or no point in electing either a management team or a managing member.

When considering which type of management structure would be most appropriate, you should consider factors such as the size, approach and ethos of your LLP. You should also bear in mind that if the LLP is managed by a managing member and/or management team, the courts will usually find that the other members have no right to restrict their activities or to interfere with the management of the LLP, subject to minimal exceptions such as misconduct.

i) Non-solicitation clauses

When a member leaves the LLP you should seek to stop him/her by preventing him/her from:

  • Soliciting the business or customers of the LLP after he or she ceases to be a member
  • Soliciting employees, consultants or members of the LLP after he or she ceases to be a member
In legal terms these clauses are a type of 'restrictive covenant'. A restrictive covenant is an express term in a contract that prevents a member from undertaking certain activities once he/she has left the LLP. The idea behind restrictive covenants is that the LLP will be protected from competition brought about by the outgoing member's departure from the business.

The basic legal position is that restrictive covenants are unreasonable and therefore are void because they are in breach of the public interest in everyone being able to carry on their trade or profession freely. Therefore in order to establish a valid clause, the remaining members must show that it is 'reasonable' between the parties and also that it is in the public interest.

There are three requirements for such restrictions before they are capable of being interpreted as being reasonable:

1.1. Is there a legitimate interest that is capable of being protected? (i.e. is the firm still trading?)

1.2. Is the restriction no more than adequate to protect that interest in terms of area, duration and prohibited activities? (i.e. it needs to be reasonable - they will consider the scope of activities prohibited, duration of ban and geographical radius).

1.3. Without the enforcement of the restriction, could that interest be damaged?

A court is able to grant an interdict or injunction to enforce its terms against a member should they find it to be reasonable. What is reasonable depends on the circumstances of every individual LLP. For further information please seek legal advice.

j) Non-compete clauses

A restrictive covenant can include a clause whereby a member is not allowed to compete with the LLP for a period of time, in a specific field and within a specific area. The law is very strict in the interpretation of restrictions of this kind. A restriction will only be valid if the restriction is designed to protect the partnership's legitimate business interests, if it extends no further than is reasonably necessary to protect those interests and the restriction is not simply to stifle or prevent competition. For further information please seek legal advice.

k) Dispute resolution

It is essential for members to be able to resolve partnership disputes. Therefore a clause relating to dispute resolution is an essential clause in any LLP agreement so as to avoid protracted disputes that result in lengthy and expensive litigation.