Repudiatory breach implicitly excluded in multi-party LLP agreements

Summary
Background
Facts
Decision
Comment

Summary

In the recent decision in Flanagan v Liontrust Investment Partners LLP(1) the High Court held that the doctrine of repudiatory breach is excluded in multi-party limited liability partnership (LLP) agreements that fall under Section 5 of the Limited Liability Partnerships Act 2000. However, the court did not confirm whether the doctrine would be similarly excluded in the case of a two-member LLP.

The court held that the claimant, a member of a multi-party LLP, could not claim that the service of an invalid notice of retirement on him constituted a repudiatory breach which he had accepted as terminating the LLP agreement, such that default provisions under the Limited Liability Partnerships Regulations 2001 applied. To do so would have had the effect of making the claimant entitled to a pro rata share in the LLP's profits. In arriving at this decision, the court underlined that it would defeat common sense for one or more members of the LLP to abide by the terms of the LLP agreement while the others were subject to the default provisions. The LLP agreement in question had in fact expressly excluded the operation of the default provisions and the court stated that it was implicit in the statutory regime that all members of LLPs should remain subject to the same set of rules.

Background

LLPs
LLPs are governed by the Limited Liability Partnerships Act. This provides that the mutual rights and duties of the members of an LLP, and those of the LLP and its members, shall be governed by an agreement between the members or between the LLP and its members.

In the absence of an express agreement between the members, the default provisions under the Limited Liability Partnerships Regulations apply. These include stipulations that all members of an LLP are entitled to share equally in its capital and profits, and that every member of the LLP may take part in the management of the LLP.

Under Section 994 of the Companies Act 2006, an LLP member has the right to apply to the court if his or her interests are being prejudiced by the LLP or the other members. The members of an LLP can nevertheless expressly exclude this right under the terms of their LLP agreement.

Repudiatory breach and renunciation
A repudiatory breach of contract is a breach which is sufficiently serious to permit the innocent party to accept the breach, treating the contract as terminated. Alternatively, the innocent party can affirm the contract. Affirmation is possible only if the innocent party knows of the breach and of its right to choose between affirmation and repudiation of the contract. If the innocent party chooses to accept the repudiatory breach, his future obligations under the contract are discharged. In either case, damages can be sought.

Renunciation occurs when one party displays an intention not to perform or expressly declares that it will be unable to perform its obligations under a contract in some essential respect, either before or at the time of performance. In the absence of an absolute refusal to perform, the test is to ascertain whether the actions of the defaulting party would lead a reasonable person to conclude that the other party no longer intends to be bound by the contract and whether the non-performance of such an obligation entitles the innocent party to treat the contract as discharged.

Facts

Mr Flanagan became a member of hedge fund Liontrust Investment Partners LLP in 2011, following the LLP's acquisition of an asset fund managed by Flanagan. The terms of Flanagan's participation in the LLP were governed by an LLP agreement and a side letter which stated that Flanagan had a compulsory initial term of two years as a member of the LLP, which could not be terminated until at least 18 months had elapsed. The six months' notice of retirement stipulated under the LLP agreement could not expire before the end of the initial two-year period.

In 2012, before the end of Flanagan's initial two-year term, the asset fund became economically unviable and the LLP decided to close down. The LLP sent Flanagan a notice of retirement more than six months before the end of the two-year term purporting to place Flanagan on garden leave. The notice also stated that Flanagan would automatically cease to be a committee member, cease to perform his normal duties and would no longer be entitled to any share of the revenue profits.

Under the terms of the LLP agreement, a decision of the management committee was necessary to require a member of the LLP to retire. It transpired that no committee meeting had actually taken place and that two of the LLP members had in fact fabricated management committee minutes in respect of the notice. The LLP therefore served two further notices of retirement on Flanagan, although without prejudice to the first.

Flanagan applied to the court under Section 994 of the Companies Act for declarations that the LLP agreement and side letter had been terminated and that in their absence, the default provisions contained in the Limited Liability Partnerships Act and the Limited Liability Partnerships Regulations now governed his relationship with the LLP and his membership of the LLP. Flanagan argued that:

• The LLP had renunciated the LLP agreement by serving an invalid notice which purported to place Flanagan on garden leave in breach of its terms and by continuing to rely on the notice;
• The notice was invalid and the LLP's conduct amounted to a repudiatory breach of the LLP agreement and side letter. Flanagan had accepted the repudiation and had brought the LLP agreement and side letter to an end; and
• As a result of the repudiatory breach, the default provisions of Regulation 7 of the Limited Liability Partnership Regulations applied. These provisions gave Flanagan the right to:
  • take an equal share in the profits of the LLP;
  • take part in the management; and
  • not be expelled by a majority of the members.

Flanagan claimed that he remained a member of the LLP and given that the relationship between the members had clearly deteriorated, the court should order the LLP to buy out his interest.

Decision

The court found that the notices of retirement served on Flanagan were invalid and, as a consequence, Flanagan remained an LLP member. Flanagan's exclusion from participation in the LLP was a renunciation of the LLP agreement as well as a continuing repudiatory breach of Flanagan's contractual rights, and Flanagan had accepted that breach.

However, the court rejected Flanagan's claim that the doctrine of repudiatory breach applied to the LLP Agreement. Under the statutory regime, all of an LLP's members are subject to the same set of rules, whether under an agreement or by operation of the default provisions or a combination of the two. It would be contrary to common sense and commercial expectations:

"if the effect of the doctrine were to permit Mr Flanagan to share in the profits of the LLP on a basis of notional equality with the other members, when the LLP agreement itself gave him only a fixed allocation of income profits and no entitlement to any capital profits."(2)

Under the terms of the LLP agreement, Flanagan had no equity interest of a capital nature in the business beyond the right to return of his initial capital contribution on retirement and he was permitted only a fixed profit allocation of £125,000 per year with a performance-based variable allocation.

As such, Flanagan remained a member of the LLP and his relationships with the LLP and his fellow members continued to be governed by the LLP agreement. There was no scope for the operation of the default provisions. The most that Flanagan could do was to claim damages for the period of his exclusion.

Comment

This decision clarifies a previously uncertain area of law and is especially significant, given that it contradicts a number of leading textbooks that suggest that a repudiatory breach would bring an LLP to an end. LLPs can gain comfort from this decision demonstrating that the courts will seek to uphold the terms of their carefully drafted LLP agreements, although it remains unresolved whether the same repudiation argument could work in relation to LLPs with only two members.

For further information on this topic please contact Sarah Shaul or Geraldine Elliott at RPC by telephone (+44 20 3060 6000) or email (sarah.shaul@rpc.co.uk or geraldine.elliott@rpc.co.uk). The RPC website can be accessed at www.rpc.co.uk.

Endnotes

(1) [2015] EWHC 2171 (Ch).

(2) [2015] EWHC 2171 (Ch), Paragraph 239.