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Repudiation and LLPs

At the end of last week, the High Court handed down an important ruling in the case of Flanagan –v- Liontrust Investment Partners LLP [2015] EWHC 2171, addressing the long debated issue of whether the doctrine of repudiation applies to LLP Agreements.

Whilst it is well established that the doctrine does not apply to general partnerships, the position in relation to LLPs was unclear.   Indeed, a number of the leading textbooks in relation to LLPs argued that the doctrine of repudiation should apply to LLP agreements. 

You may be wondering why any of this matters.   The question is, however, an important one for two principal reasons:

(i)   members of LLPs involved in disputes with their LLP (or indeed with fellow members) have sought to rely on alleged repudiatory breaches of the LLP Agreement to walk away from often lengthy notice periods and from onerous post-termination restrictive covenants;

(ii)   members have also sought to use the doctrine of repudiatory breach to argue that they are no longer subject to the relevant LLP Agreement’s terms but remain members of the LLP on the basis of the default rules set out in the LLP Regulations 2001.   Under the default rules, members are, by way of example, entitled to equal shares of the LLP’s profits and more junior members, who had been on a lower profit share under the terms of the LLP Agreement, have therefore advanced this line of argument to try and gain a greater share of the LLP’s profits, based on those default rules.

In the case of Flanagan, Mr Flanagan was an experienced fund manager and, following attempts by Liontrust to end his LLP membership early, was advancing arguments based on (ii) above.  He argued that, under the default rules, he should be entitled to an equal share of the profits in the LLP and claimed that this equity share was worth around £8 million.

In considering Mr Flanagan’s argument, Henderson J ruled that the doctrine of repudiatory breach is impliedly excluded by the legislation governing LLPs (where the LLP has more than two members).   He reached this conclusion based on a view that, if the doctrine did apply, you could end up in a situation where (in the context of LLPs with more than two members) the relationship between some of the members of the LLP was governed by the default rules (i.e. the members in repudiatory breach and those members who had then accepted that repudiatory breach), with the relationship between other different groups of members still being based on the terms of the LLP Agreement.   Henderson J stated that:

In my judgment, it is all but self-evident that the co-existence of two different contractual regimes governing the same LLP is likely to lead to results which are legally incoherent and could only be resolved by further agreement between all of the members.

He then referred to two examples where such incoherency might arise.  One of the two examples, dealing with the profit share issue, was as follows:

The first example is of an LLP with five members, one of whom (A) is in repudiatory breach of [the LLP Agreement], and another of whom (B) accepts the breach.   Under the [LLP Agreement], B has a small profit share of 1% but an equal share [under the default rules] would entitle him to 20%.   How, then, are the profits to be distributed after B has accepted A’s repudiation?  As between A and B, B would now be entitled to share equally in the profits under the default rules; but the other members retain their original entitlements, so if both A and B were paid 20% the combined profit shares of the five members would exceed 100%.  Nor would there be any contractual mechanism which would enable the additional 19% now payable to B to be deducted from A’s share and, even if there were, the other members would presumably still be entitled to say to B that his only right was to receive 1% and if he received more than that, he should repay it.

Henderson J held that the LLP legislation should be construed to try and remove such incoherency and, as stated, therefore concluded that the doctrine of repudiation should not apply to LLP Agreements (where the LLP had more than two members).

Whilst very significant, it is worth emphasising that the judgment is not binding on other courts, given it is only a first instance decision.   However, it will still be extremely helpful for LLPs involved in contractual disputes with members and will create significant difficulties for claimant members to have to overcome.  

Finally and as something of an aside, the case also readily demonstrates the flexibility and skill of leading counsel (given Liontrust’s counsel argued against the arguments put forward in his own textbook on the subject of LLPs).

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