House of Commons - Trade and Industry

Select Committee on Trade and Industry Fourth Report

III ELIGIBILITY

1997 proposal

30. The 1997 paper was drafted on the assumption which then pervaded discussion of the LLP concept, that it was a vehicle intended for regulated professions, and in particular for accountants. The detailed proposals reflected that view, although it was noted that any kind of business was eligible in some overseas jurisdictions.[38] This proposed limitation of eligibility was presented as one of the basic safeguards for those doing business with an LLP.[39] The department proposed a system of recognised regulators to set and enforce standards, listing those criteria to be met in order for a regulator to be recognised by the Secretary of State. These criteria included regulation of both members and firms, since an LLP would have a separate legal personality from its members, and the existence of a requirement for minimum levels of professional indemnity insurance or similar.

31. Many respondents to the 1997 proposals did not query this proposed restriction on eligibility, although several bodies and firms questioned whether the legislation was trying to bring in statutory regulation of the professions by the backdoor. Several professional bodies, including the ICAEW and ICAS, did however question the rationale behind such a restriction, noting that there were no such restrictions on the activities of limited companies, nor indeed of partnerships. Several respondents saw it as potentially unfair, particularly in those areas of business where a firm of regulated professionals could enjoy a status denied to its competitors if not in such professions. Accountancy firms registered as LLPs would potentially have an unfair advantage in competing for unregulated work such as tax advice or management consultancy with firms to whom LLP status would be denied. Macfarlanes expressed the point pungently —

"Should a furniture dealer be prohibited from trading in a limited liability partnership when the fine art auctioneers next door can obtain the desired protection?"

It was suggested that if the other safeguards were robust enough, there was no need to impose such a restriction on eligibility. Other professional bodies expressed doubts as to their ability to meet all the criteria proposed, and several respondents feared that multi-disciplinary partnerships would sit awkwardly within such a regime.

1998 Paper

32. As a result of these responses, the 1998 paper, while maintaining in the draft Bill and Regulations the machinery necessary for restricting eligibility to regulated professions, consulted further on this proposal, asking first if respondents had any objections to restricting eligibility, and secondly if there were objections to widening access to non regulated firms, once the new entity had been fully tested in an appropriate "inaugural phase". The impression conveyed is that the Department is uneasy at the prospect of unrestrained eligibility. In oral evidence the DTI assured us that they still had a genuinely open mind on the subject.[40]

Responses

33. Our interpretation of the responses to the 1998 paper is that the weight of informed opinion has swung firmly against any restriction on eligibility. Several respondents have changed their original view supporting such restrictions.[41] One reason has been some alarm at the criteria proposed for recognition as a regulatory body, which as set out in Part II of Schedule 1 to the draft Regulations seemed significantly more onerous than those foreshadowed in 1997.[42] Several of the major accountancy firms now seek open access, in view of the undue constraints of the system proposed, and apparently out of a dawning sense for fairplay in competing on non-audit work with unregulated professionals. It should also be recorded that a number of respondents still favour restriction on eligibility, as giving what is variously described as an "assurance of quality", "a respectable profile" and "status and credibility".[43]

Difficulties

34. A number of problems have been identified with operation of the proposed system of regulation —

The requirements for recognition, taken from the statutory audit provisions of the 1989 Companies Act as had indeed been foreshadowed in the 1997 paper,[44] include provisions on technical standards, monitoring, complaints investigation and enforcement which even the largest professional bodies would find real difficulties in meeting.[45]
Once detailed thought is given to multi-disciplinary partnerships, which account for a significant and probably growing proportion of partnerships providing professional services, and which may well include members not in any recognised profession, it is apparent that the structure proposed is at best unwieldy and potentially confusing and at worst unworkable.[46]
There is seen to be a fundamental flaw in the concept of regulation of firms as a result of their corporate form as opposed to regulation by reference to defined activities, such as insolvency, actuarial work, statutory audit or investment advice, carried on by individuals and firms.
The provisions in the event of either an LLP, or a member, losing eligibility for whatever reason are tortuous to a degree, allowing a 6 month period of grace, with uncertain effects in practice for a member who has, for example, been disqualified by a regulatory body: if eligibility were to be restricted, Clause 8 and Regulation 2.3 would require re-casting.

If there were however an overriding reason to support restriction of eligibility to regulated professions either permanently or for the "inaugural phase" referred to by the Department, we are confident that these problems could be overcome. [47]

Professional indemnity insurance

35. In considering whether there is any such overriding reason, it must be recognised that side by side with the maintenance of professional standards and ethics, a crucial part of the "reassurance" felt by those now dealing with professionals is provided by the knowledge that many are obliged by their professional bodies to carry professional indemnity insurance (PII) at a level sufficiently high to cover all but the vastest conceivable claims for damages. In the case of the sort of mega-suits running into tens or hundreds of millions, the level of PII may do no more than influence the eventual level of settlement of claim:[48] but for most third parties it provides confidence that, should mistakes be made, they will recover their losses. There are limits to the assurance provided. It does not cover trading losses. Premiums have to be paid. Some professions do not have compulsory PII.[49] In broad terms, however, as is recognised by the proposed terms to be met for recognition as a regulatory body, a third party's sense of reassurance in dealing with professionals may have as much to do with confidence in their level of professional indemnity insurance as with the maintenance of professional integrity and competence.

36. Those professionals now required to take out professional indemnity insurance will continue to be under that obligation, under whatever corporate regime they trade. It may be that the minimum levels will be raised for those operating within an LLP, as is the case for solicitors who have opted for corporate status.[50] Premiums will no doubt continue to be a significant expense:[51] but there does not seem to be any doubt that professionals in LLPs will continue to be able to find cover in the market. The BIA indeed felt that rates would not be widely different from those applicable to partnerships.[52] Mr Linsell, a solicitor, told us that -

"The incentive for individuals carrying on business in an LLP to maintain the highest available professional indemnity cover is great ...."

and that in the experience of practitioners professional firms who had incorporated had never used incorporation as a limited company as a reason to reduce their cover.[53] The Law Society suggested in oral evidence that the enhanced minimum level of insurance cover required of solicitors practising in limited liability companies would be applied to LLPs.[54] The APP suggested that " incorporation as an LLP will not be a good reason to reduce PI cover".[55] The Vice-President of the ICAEW told us that he expected that the Institute would wish to apply the same requirements to its members practising in LLPs as were applied to those in limited liability companies.[56] Mr Banks, however, while not expecting the preference of professionals to have insurance cover to be affected, accepted that there was some possibility of change.[57]

37. There is some logic in anticipating that moving to a regime in which liability is reduced or at least constrained in its scope could lead to a reduction in the level of professional indemnity insurance deemed to be necessary, not least as " innocent " partners will not have to be covered for the potential errors of their colleagues. Those elements in existing professional regimes which give reassurance to third parties, including in particular the levels of professional indemnity insurance, must however continue to do so whether or not they are trading as an LLP. We would welcome specific assurances from those professions currently requiring professional indemnity insurance that required levels will be at least maintained and preferably increased for those operating through LLPs.

Conclusion

38. We can see no good reason to restrict eligibility for LLP status to regulated professions, nor for the sort of two-stage process of opening up LLPs apparently envisaged. There is no inherent reason to suppose that the vehicle proposed is unsuitable for non-professionals. No doubt some LLPs outside the standard professions will get into difficulties and there will no doubt be some rogues who avail themselves of the status: but there is no obvious reason why they would be more likely to do so as LLPs than as partnerships or companies. Professionals may also get into difficulties. It may be that the structure is inherently more suited to service providers, with many clients but few trade creditors, than to those dealing with trade or manufacture, requiring a large trading capital and with many trade creditors and debtors. But the choice can be made by those concerned. We have some sympathy with the sense of anxiety at launching a new corporate vehicle more or less explicitly provided for one relatively narrow and circumscribed class of business into the rough seas of all business activities. If Ministers are unwilling to do this, however, it must be questioned if the vehicle should be launched at all. We recommend that there be no restrictions on eligibility for limited liability partnerships.

Regulation

39. There were those who — rightly or wrongly — saw in the proposed introduction of a regime for statutory recognition of regulatory bodies for the purposes of LLP eligibility and in the severity of the proposed criteria to be met a foreshadow of statutory regulation of professions. They will have been confirmed in that suspicion by the manner and timing of the publication in September 1998 of the Government's outline proposals for independent regulation of the accountancy profession, at the same time as the draft LLP Bill, and presented as part of a package of measures "to provide for better independent regulation of the accountancy profession and to address concerns about the professional liability of accountants."[58] Following publication of the profession's proposals, the Government published its detailed proposals in a Consultation Document in November 1998.[59] The gradual erosion of some of the traditional ethos and practices represented by professionals acting in partnerships, and of the public perception of professions as having an ethical and even vocational significance lends weight to the move towards introduction of a more independent and transparent system of professional regulation.

38 1997, 1.4 et seq Back

39 ibid, eg 2.10, 3.2, 3.19-3.22 Back

40 Q 24 Back

41 Eg Q 70; Q 194 Back

42 Eg Q 107; Qq 161ff Back

43 1998, 17: 23: 27 etc Back

44 Q25: 1997, 3.21 and 6.2.13ff Back

45 eg Qq161-2: 196-7: 207-9: Ev, p37, para 6 Back