The Key Building Blocks of an LLP Agreement

6 July 2021

The LLP Agreement of any professional firm is a living document, as it is a constant reference point throughout the business cycle of the firm. As well as containing day-to-day management and decision-making provisions, an LLP Agreement needs to adequately address all of the crucial junctures commonly faced by professional services firms, for example partner admissions, retirements, disputes and capital events.

Our series of pithy articles on the fundamental building blocks of an LLP Agreement will highlight the following key issues to consider when reviewing or drafting your firm’s LLP Agreement:

Decision-making and management structure
Partner “lock-in” provisions
Protection of goodwill
Remuneration structure/profit sharing
Dealing with “problem” partners
Preparing for a capital event
Protecting the LLP in the event of a dispute
Changes in law

Decision-Making and Management Structure in LLP Agreements

The decision-making provisions in an LLP Agreement should ideally accord with the custom, practice and culture of the firm and its management structure.

Larger firms usually have more corporate style management structure with delegated authority given to a Management Board (or similarly named body) which is responsible for the day-to day management and strategic leadership of the firm to facilitate agile decision-making. On the other end of the spectrum, smaller, owner-managed firms will usually have partners involved in most (if not all) aspects of management.

The decision-making provisions in your LLP Agreement will need to be aligned with your management structure (which may have changed significantly since your LLP Agreement was last updated) as well as current custom and practice.

Management Board

If management powers are delegated to a Management Board or other committee, you will need to consider the following:

Constitution/external oversight – who is eligible to be a member of the Management Board? For example, are only partners eligible? Larger firms are increasingly appointing non-executive members of the Management Board who provide a degree of independent oversight and bring to the table wider industry or technical expertise.

Non-partner members of the executive team are also often appointed to the Management Board (for example, the Finance/HR Director), albeit often with limited or no voting rights. This is a vital internal acknowledgement of the importance of those senior operational roles and the need for the individuals holding them to have a credible and recognised voice at the top table.

Representation – you should consider whether the Management Board is representative of the firm, its practice areas, and geography; this is in addition to reflecting important demographic diversity within the firm. Certain parts of the business or categories of partners may feel disenfranchised if they do not have representation at management level.

Appointment/removal – how are Management Board members appointed and removed? This can differ depending on the type of Management Board member. It is common for a certain number of Management Board members to be elected by the partners, whereas others are appointed automatically (for example, if they are officeholders) or appointed by the Management Board. Removal can be automatic (for example, if a person ceases to be an officeholder or partner), by the Management Board or by partner vote.

Conflicts of interest – statutory directors’ duties under the Companies Act 2006 do not apply to members of an LLP. Therefore, it is helpful to include a provision in your LLP Agreement requiring Management Board members to declare any relevant personal interests on any matter to be considered.

Decision-making procedures – you should ensure that decision-making procedures reflect current custom and practice (which may have been impacted by the pandemic) and ideally are designed to facilitate effective decision-making (including the ability to hold meetings and cast votes virtually) and to avoid deadlock (for example, consider whether the chair should have a casting vote).

Remuneration Committee

Some (typically larger) firms appoint a Remuneration Committee (usually independent of the Management Board) which assesses partner performance and/or makes determinations or recommendations regarding partner remuneration and lock-step progression.

If you do not already have a Remuneration Committee, you may wish to consider putting one in place to inject a degree of independence into the partner appraisal and remuneration process. It is also common for at least one member of the Remuneration Committee to be elected by partners.

Designing a clear process and relevant criteria for the Remuneration Committee’s deliberations will be essential to ensure rational and non-discriminatory decision-making in relation to remuneration decisions as far as possible. A right of review or appeal by individual partners to an independent committee, in respect of disputed remuneration decisions may also be considered depending on the firm’s preference and circumstances. Each of these elements though should give partners some comfort that remuneration decisions will be fair and objective.

Some of the issues to consider in relation to a Management Board (as set out above) will also be relevant to the constitution and processes of a Remuneration Committee.

Officeholders

Most professional services firms will appoint key officeholders, for example a “Managing Partner” and/or “Senior Partner” or “Chair”. Senior officeholders tend to be elected for a fixed term (for example three/five years). Consideration should be given to the eligibility, election/appointment and removal, term of appointment and the delegated powers of each officeholder.

Reserved Matters

Notwithstanding the delegated powers given to a Management Board, Remuneration Committee or other committee or any officeholder, certain fundamental decisions will still be put to a partner vote. Reserved matters typically include:

admission/compulsory retirement of partners;
merger/acquisition or other capital event;
changes to scope of the business;
increase in capital and/or debt financing; and
winding up.

When reviewing reserved matters, you should consider:

Whether each decision which is a reserved matter is appropriate – can some of those decisions be delegated to the Management Board or office-holders? Do certain other decisions need to be included?
Is the voting threshold for each reserved matter suitable? For example, if the firm has grown significantly, does this make a particular threshold too difficult to attain?
Should voting be weighted (for example, according to equity points held by partners)?
Is there an ability for partner decisions to be made swiftly (for example, on short notice and/or by a written resolution) and virtually/in a remotely held meeting?
Do partners have a right to appoint a proxy?
Are partners who have given or received notice of termination or who are suspended excluded from voting?
Are “interested” partners excluded from voting?

Deadlock

Deadlock in decision-making can often be an issue for smaller firms, particularly those with a handful of “founder” partners who hold a majority of the voting rights.

You should think carefully about how any deadlock on a fundamental decision (for example, a sale/merger) should be resolved, especially as deadlock is often an indication that the relationship between partners (or particular constituencies) has broken down.

Typical provisions in an LLP Agreement which are aimed at resolving a deadlock include:

mediation;
arbitration; and
if the firm operates a “goodwill model”, put/call options allowing partners to sell their interest or acquire the interest of other partners. These provisions can sometimes resemble “Russian Roulette” or “Texas Shoot-Out” clauses found in joint venture agreements.

If you have any questions regarding LLP and Partnership law issues, or would like advice regarding modernizing your LLP Agreement, please contact Zulon Begum or Clare Murray or call us on +44 (0) 207 933 9133.

CM Murray LLP is ranked in Tier 1 and Band 1 for Partnership Law in Legal 500 and Chambers & Partners, and is described as “One of the legal world’s strongest offerings in this area” (Legal 500).