Limited Liability Partnerships – the hidden danger for Members

9 September, 2009
by: Cripps

The main advantage of limited liability partnerships over traditional partnerships is of course the protection that LLPs confer on members against personal liability for negligence claims.  But despite this being a key motivating factor behind many LLP conversions, the legal principles involved are often not well understood. 

 

Introduction

Partners in practices converting to LLP status are likely to be advised that LLP membership does not entirely eliminate the risk of personal liability because individual members may still be personally liable for the consequences of their own mistakes (although thankfully not for the mistakes of their fellow members).  But they may not realise that a negligent mistake may also expose them to the risk of liability to their own LLP.

If their LLP members’ agreement does not deal with this issue, individual members may not be as well protected as they could be.  This article explains the implications.

 

LLP members’ personal liability to clients

The risk of becoming personally liable to a client for your own mistake is not easy to evaluate because the relevant principles are still being developed by the courts.  In a leading House of Lords judgement it was held that the test for personal liability is a threefold one: (i) whether the individual assumed personal responsibility to the client, (ii) whether the client then relied on that acceptance of personal responsibility and (iii) whether it was reasonable for the client to do so.

What is less clear is whether the assumption of personal responsibility is a voluntary act (which would imply that it could just as easily be denied) or whether it will be taken to have arisen in certain circumstances in which the law implies a duty of care.  The latter principle was in evidence in a subsequent Court of Appeal decision in which a surveyor was found personally liable for a negligent survey report largely because he signed the report in his own name, rather than that of the surveyors’ practice of which he was an employee.  There was no evidence that he intended to accept legal responsibility by doing this and indeed the claimant did not even know his identity until later.

Many of the decided cases to date have involved the directors of limited companies and were decided before the advent of LLPs.  It is clear that the same principles apply to members of LLPs but it remains to be seen whether the courts will more readily assume the existence of a personal duty of care in the context of professional practices.

For the time being, the risk is best addressed by using suitable terms of business to exclude personal liability (although these may be subject to the reasonableness test of the Unfair Contract Terms Act) and by taking steps to avoid language or conduct that implies the acceptance of personal liability.  However, LLP members should also consider what provisions the members’ agreement should contain to address the possibility of a claim being made against them personally, bearing in mind that even successfully defending a claim could involve considerable expenditure.

 

Members’ personal liability to the LLP

Assuming that the LLP has a contractual relationship with the claimant, the member’s mistake will amount to a breach by the LLP of an express or implied contractual obligation to exercise reasonable skill and care in the performance of its duties.  Subject to any exclusions or limitations of liability in the contract, the LLP will therefore be liable for the claimant’s loss arising from that breach of duty.

Even if there is no contract with the LLP and the claim is founded in tort (probably negligence), the LLP is still likely to be liable to the claimant.  Under the LLP legislation, where an LLP member is liable to any person (other than another member of the LLP) for any wrongful act or omission of his in the course of the LLP’s business or with its authority, the LLP is liable to the same extent as the member.

This potentially exposes the negligent member to a claim by the LLP.  Because each member is the agent of the LLP he will owe a duty of care to the LLP in the carrying out of his functions as an LLP member.  Causing the LLP to become liable for a negligence claim could be a breach of that duty of care.

Of course in practice most claims will be met by the LLP’s professional indemnity insurers.  But claims are not without financial consequences for the LLP and hence all the members.  The LLP will have to meet the cost of the usual deductible or excess.  The level of claims in one year will affect the amount of premium payable in subsequent years (and in extreme cases may make insurance unobtainable).  A significant claim may exceed the insurance limit. 

In more prosperous times (and in the absence of a major claim) these costs may not cause any problem.  Many professional practices accept that a modest level of claims is part and parcel of professional practice, so that the associated costs are met by the LLP and hence shared between all the members.  But in difficult trading conditions this approach may not survive in the face of a claim that threatens to seriously dent already depleted profits or if a member is considered to be culpable for the mistake leading to the claim.

 

Considerations for the LLP members’ agreement

There is no single right answer to this issue, but members should consider what is appropriate in the context of their own practice and the members’ agreement should then reflect this.

Members’ agreements typically provide that the LLP will indemnify each member in respect of payments made and liabilities incurred in the ordinary and proper conduct of the LLP’s business.  In other words, any liability of the individual member will be met by the LLP and hence shared by all the members collectively.  This is also one of the default provisions implied by the LLP legislation in the absence of express terms.

But this alone may not be adequate because:

• The circumstances of a claim may arguably fall outside “ordinary and proper conduct of the LLP’s business” leading to the LLP refusing to indemnify the member concerned

• It leaves open the question whether the LLP could claim against the member concerned for breach of his duty of care, thus undermining the indemnity.

• The LLP could exercise its statutory right to seek contribution from the negligent member under the Civil Liability (Contribution) Act 1978.

LLP members should therefore consider extending the typical indemnity to ensure that it covers any liability for an innocent mistake and to exclude any right of the LLP to claim against the member concerned for breach of duty or for contribution.

Defining an “innocent” mistake may be done simply by excluding deliberate fault or dishonesty, although some practices go further and seek to exclude conduct that is reckless.  However, the concept of recklessness (and the alternative “gross negligence”) can give rise to difficulties because English law generally recognises these terms only in the context of criminal behaviour, rather than civil liability.  It may be that these issues are more appropriately dealt with as a matter of performance management.

The members’ agreement should also address the right of a former member to be indemnified by the LLP in respect of any claim that comes to light after their retirement.  Some practices do not indemnify ex-members as a matter of principle, although this can seem harsh.  It may seem unfair that the right to indemnity should depend on what could simply be an accident of timing.  On the other hand, the continuing members will be contributing to the uninsured part of a claim through a reduction in their profit share.  A former member will not be this position and it may seem fair that the person who actually caused the claim should bear some part of the uninsured loss.  If this is a concern it can be addressed by retaining the former member’s right to indemnity but providing for him to bear an appropriate share of the cost.  Other practices may prefer to give retiring members a “clean break” from the risk of this kind of liability.

 

Conclusion

It may seem odd to have to devote consideration to personal liability issues when the point of LLP conversion is to leave such liabilities behind.  But within LLP membership, just as in partnership, there is a balance to be struck between the interests of individuals on the one hand and those of the practice as a whole on the other.  In particular, it remains important for everyone to understand the limits of collective responsibility when things go wrong.  With the right professional guidance it is possible to find an appropriate solution for the practice.

 

 

Reviewed in 2015