Adjustment
of withdrawals in 1998
48. The 1998 paper proposes to make the clawback
regime "neither more lax, nor more severe, than that for
companies", while recognising the difficulties of applying
equivalent rules, in particular because member withdrawals share
the character of both salary and dividends.[73]
It is therefore proposed to apply s214 of the 1986 Act, which
deals with wrongful trading, and gives the court power to order
directors to make such contributions as it thinks proper in the
case of insolvent liquidation. The DTI however considered that
this was insufficient, since it could only cover the equivalent
of distributable profits, whereas an LLP can distribute its profits
"without let or hindrance". To plug this "potential
lacuna", it is therefore proposed to add an additional clause
214A, entitled "Adjustment of withdrawals", to enable
a court to order a member to make a contribution if he made withdrawals
when he knew or had reasonable grounds for believing that the
LLP was or would thereby become insolvent, subject to a defence
of there having been objectively a reasonable prospect at that
time that the LLP would avoid insolvency.
49. This new provision has attracted a number of
comments, generally unfavourable. Some feel that any additional
provision beyond the terms of s214 is unnecessary.[74]
It is not unreasonable to expect that a member of an LLP found
by a court to have made reckless or mischievous withdrawals in
the face of insolvency should have to meet creditors' demands
for clawback from those withdrawals. Under s214 it must be shown
that a director "knew or ought to have concluded that there
was no reasonable prospect that the company would avoid going
into insolvent liquidation", given their previous general
knowledge and skills, and those that s/he might reasonably be
expected to have. The ICAEW noted that this phraseology had been
introduced in order to encourage directors to trade out of difficulties,
and considered that s214A in contrast was a more stringent test.[75]
Ernst & Young opposed what it described as "making the
inevitability of liquidation an objective test for clawback".[76]
On the other hand, ACCA suggested that creditor protection may
be weakened, since a member of a large LLP could all too easily
plead ignorance of its financial circumstances and claims against
it, so that s/he could not be said to have known or had any reasonable
grounds for believing that it was facing insolvency.[77]
50. By no means all commentators are opposed to the
regime set out. Deloitte & Touche regard the provisions as
"a sensible and fair set of proposals balancing the interests
of creditors and members".[78]
Some commentators question the 2 - year limitation, given the
time it takes for major claims to be settled:[79]
one can imagine the indignation of creditors at evidently inappropriate
withdrawals in the relatively recent past escaping any clawback.
We have also noted that in the 1981 proposals developed by Professor
Gower, the Department's then research adviser on Company Law,
for a code for incorporated firms, in which the liability of members
to contribute covered also transfers to a spouse or any other
person without full consideration.[80]
51. Although there will inevitably be insolvencies
among LLPs, it is to be hoped that they will be the rule rather
than the exception. Only a few LLPs will be vast multi - member
bodies: and those that are will have to learn to balance the advantages
of their status with the duty of members to take an intelligent
interest in the source of their income. Knowledge of such matters
is imputed to partners now: the limitation on liability proposed
is not intended to reduce LLP members to the happy state of presumed
ignorance of an employee. There are also commonsense limits to
what can usefully be laid out in law, given the unique complexion
of any case to come before a court. It is also common ground that
the last outcome which anyone desires is that a major claim could
precipitate a massive departure of members from a firm: but we
do not believe that the attractions of the very significant reduction
in personal liability which an LLP offers are likely to be outweighed
by the distant prospect of clawback in the event of insolvency.
The detailed provisions for clawback may well require some
adjustment: but we share the view of many that some such provision
as is set out in s214A, equivalent to the payment of unlawful
dividends, is indeed required. We recommend that the
Department consider the case for a statutory provision to enable
the court to pursue money transferred to a spouse or others as
a means of avoiding clawback. We look forward to the production
of revised proposals on insolvency which retain the basic principle
of parity with the companies regime, combined with the clear message
that members of an LLP have responsibilities towards potential
creditors which if necessary can and will be enforced.
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