Reinforcing Separate Legal Personality of AN LLP — Avoiding Claims by Partners Over Assets of the LLP

Introduction

A limited liability partnership (LLP) is a hybrid legal structure combining the flexibility of a partnership with the corporate personality of a company. While the Limited Liability Partnership Act, 2008 (LLP Act) unequivocally establishes that an LLP is a distinct legal entity from its partners capable of holding assets in its own name, disputes frequently arise where partners assert ownership rights over assets of the LLP. Such disputes are often rooted not in statutory ambiguity but in deficient drafting of LLP agreements, which are later exploited to expand rights of partners beyond permissible limits. This article examines the legal framework while analysing the validity of such claims.

Nature of an LLP

The foundational principle governing LLPs is their status as separate legal entities, which differentiates them from a traditional partnership. Section 3, LLP Act provides that an LLP is a body corporate, a legal entity separate from its partners, having perpetual succession. Section 14, LLP Act provides that upon registration, an LLP shall, by its name, be capable of inter alia suing or being sued as well as acquiring, owning, holding and developing or disposing of property, whether movable or immovable, tangible or intangible. In these respects, the legal status of an LLP is akin to a company under the Companies Act, 2013 inasmuch as both are: 1) body corporates having perpetual succession, 2) legal entities separate from its partners/shareholders as the case may be, 3) capable of suing and being sued in their own name, and 4) capable of acquiring, owning, holding and developing or disposing of property in their own name.

As such, the law laid down by the Supreme Court of India in the context of companies in Bacha F. Guzdar v. CIT¹ that a shareholder does not have any right or title over the company’s assets, should apply squarely even in the case of LLPs.

These facets of an LLP have also been judicially recognised in a few cases, both in India and in foreign jurisdictions. The Supreme Court of Texas in Allcat Claims Service, In re², held that the income of a limited liability firm enjoying the status of a separate entity belongs to the entity alone and not to either the partners individually or collectively, till the same is distributed. The Calcutta High Court in Rajesh Baid v. Mohd. Ibrahim³ refused to grant relief over the assets of an LLP to satisfy the claims against its partners. Conversely, in Proteus Ventures LLP v. Archlab Designs⁴, the Bombay High Court partially set aside an arbitral award which extended the liability of the LLP to its designated partners.

LLP agreement

While the statutory status of an LLP is clear as above, issues often arise due to the ambiguous and flawed drafting of LLP agreements which are statutorily recognised under Section 23, LLP Act. Under this provision, mutual rights and liabilities of the LLP and its partners are governed by their inter se agreement. These agreements can tend to use imprecise language regarding rights of partners in the assets of the LLP and fail to distinguish between economic interest of the partners in the LLP and proprietary/ownership interest in the assets of the LLP.

For instance, in Metal ARC Agri. LLP v State of Haryana⁵ a loosely worded provision in the LLP agreement providing for all partners to have rights, title, and interest over the assets of the LLP in proportion to their contribution was observed as conferring the status of a joint decree-holder on a partner in a land acquisition claim by the LLP in respect of an immovable property held by the LLP.

Even in England, while the general principles distinguishing LLPs from traditional partnerships have been recognised and affirmed in Reinhard v. Ondra⁶, wherein it was held that an LLP, being a separate legal entity, owns all the firm’s assets both legally and beneficially to the exclusion of the members of the LLP, the Court also observed that members possess only such rights as are conferred by their membership. These rights are to be ascertained in accordance with the relevant LLP agreement read together with the applicable statutory default provisions.

Therefore, it becomes crucial to ensure that the LLP agreements are drafted in an accurate manner to ensure clarity regarding the inter se nature and extent of rights between the LLP and its partners and between the partners over the assets of the LLP to avoid adverse proprietor claims from the partner/s over the assets of the LLP.

Validity of ownership claims of the assets of the LLP

Like any agreement, an LLP agreement is indeed the foundational and primary document in the adjudication of disputes between the partners of the LLP or between the LLP and its partner/s — much like the Articles of Association of a company in the case of shareholder disputes.

However, just like the Articles of Association cannot override the non-derogable provisions of the Companies Act, 2013, even an LLP agreement cannot override the non-derogable provisions of the LLP Act, particularly when the conflicting provisions can potentially render some salient features of the LLP structure otiose.

No agreement arrived at amongst the partners of an LLP can override the provisions of the LLP Act in view of the language of Section 23, LLP Act, which starts with the phrase “save as otherwise provided by this Act”. Therefore, Sections 14 and 58(4), LLP Act, which vest the property of an LLP in the LLP itself, cannot be overridden by any agreement to the contrary.

It may not be out of place to mention that even in case of a traditional partnership firm under the Partnership Act, 1932, partners do not have an aliquot right over the assets of the firm as has been categorically held by the Supreme Court of India in Addanki Narayanappa v. Bhaskara Krishtappa⁷ that a partner cannot claim or exercise any exclusive right (even to the extent of his share in the partnership) over any partnership property. His right during the subsistence of the partnership is to get his share of profits from time to time as may be agreed upon among the partners, and after the dissolution of the partnership or with his retirement from the partnership, the value of his share in the net partnership assets as on the date of dissolution or retirement, after a deduction of liabilities and prior charges.

The principle laid down in the Addanki case has been followed by the Supreme Court of India even in a recent judgment in Sachin Jaiswal v. Hotel Alka Raje⁸. Therefore, even in the case of a traditional partnership, the individual partners cannot claim any aliquot rights over the assets of the firm.

A contrary interpretation of such clauses may also lead to other unintended practical consequences, including the violation of the provisions of the Transfer of Property Act, 1882, the Stamp Act, 1899, as well as the Registration Act, 1908. For instance, a person would be able to acquire and claim ownership of an immovable property by merely being inducted as a partner in an LLP without complying with the requirements of the above legislations, including execution of a registered conveyance and payment of stamp duty. Moreover, if all partners are held to own ownership interests over the assets of the LLP to the extent of their share in the LLP, the same would imply that the partners would hold 100 per cent ownership rights over the assets of the LLP to the exclusion of the LLP itself, which is contrary to the scheme of the LLP Act.

Conclusion

While there are adequate legal arguments and logical reasoning which may successfully repel adverse claims of ownership by partners over the assets of an LLP, it is necessary that due care is exercised while drafting LLP agreements to avoid such issues, which can lead to prolonged disputes significantly draining the resources of the LLP. Like any other incorporated venture, even an LLP is a business venture aimed at providing commercial gain and profits to its partners. The LLP agreement should be drafted to capture that essence of partnership and nothing more — partners to merely have rights over the ultimate profits made by the LLP in the ratio of their contributions rather than direct rights over its assets.