A partnership is a relationship which exists between two or more persons carrying on business together with a view to making profit. Unlike a company, a partnership has no separate legal personality and so cannot be the subject of any legal proceedings on its own merits. Partners, who can be either individuals or companies, will therefore be personally liable - usually without limit - for the debts of the partnership.
It should be noted, however, that a limited liability partnership (LLP) is a hybrid entity with characteristics falling between those of a company and those of a partnership. Like a company, an LLP is considered to be a body corporate and so a separate legal entity from the individuals or companies making up the partnership. However, the partners' individual liability is limited. Like a partnership, the relationship between the members of an LLP is governed by a partnership agreement and it does not have shareholders or directors.
Partnership relationships do no neatly fall into the regimes for either personal or corporate insolvency. Traditionally the law and practice of bankruptcy was applied to partnerships. Later, an unsatisfactory approach of applying the relevant provisions of UK personal and corporate insolvency law to insolvent partnerships - with some modifications - was taken. In 1994 the law surrounding partnership insolvency was consolidated under the Insolvent Partnerships Order (the Order). It was further modified by Amendment Orders in 2005 and 2006.
Under the Order, partnerships can be treated as legal entities in their own right for insolvency purposes. Importantly, the Order has extended procedures relating to voluntary arrangements and administrations to insolvent partnerships and the Amendment Orders enforce a new out-of-court administration procedure introduced by the Enterprise Act in 2002.
Due to the unique nature of a partnership, a creditor can pursue any one or more of the partners individually – as well as the partnership itself – for any partnership debt.
On the basis that in most respects LLPs are treated as corporate entities in the same way as companies, the insolvency regime applicable to them is governed by the legislation that applies to companies.
Tests for insolvent partnerships
The tests for an insolvent partnership are similar to the two generally accepted tests for an insolvent company. If a partnership is:
- unable to pay its debts as they fall due; or
- its assets, when realised in cash, would be insufficient to pay off its debts and other liabilities
then the partnership is insolvent for the purposes of UK law.
A partnership will not be insolvent solely on the basis of one of its members being individually insolvent if it is itself able to pay its debts as they fall due or its assets are greater than its liabilities.
Partnership liquidation and partner bankruptcy
As explained above, partners are personally liable for the debts of a partnership. This means that the partnership can itself be wound up and bankruptcy orders can be made against the individual partners.
A creditor of a partnership can petition for either:
- the winding up of the insolvent partnership as an unregistered company, with no action taken against the individual partners; or
- the winding up of the insolvent partnership as an unregistered company, with bankruptcy petitions also presented against one or more of the partners.
Alternatively, a creditor may choose to only pursue the partners for the debt by petitioning for the bankruptcy of one or more of the partners without petitioning for the partnership to be wound up. The partnership debt will be treated as the debt of the partner against whom the bankruptcy petition is presented.
A member of a partnership may also petition for the insolvent partnership to be wound up as an unregistered company with no action against the insolvent partners, or with action taken against the insolvent partners individually.
A creditor can only apply for a winding-up order against the partnership if that partnership has traded in England and Wales at any time in the three years before the petition is presented.
The concept of putting a partnership into administration was introduced by the Order. Before 1994, partnerships in financial difficulties were either liquidated or each partner individually was made bankrupt. Now, a viable partnership business may be able to survive as a going concern or can obtain the creditors' approval to enter into a voluntary arrangement for its debts.
Partnership administrations which began on or after 1 July 2005 now follow the corporate administration procedure, allowing for an administrator to be appointed out of court.
A partnership may be put into administration in one of the following ways:
- by the court, on application of the members of the insolvent partnership;
- by the court, on application of a creditor of the insolvent partnership; and
- out of court, by the members of the insolvent partnership.
Under the court procedure an administrator will only be appointed if the court accepts that the partnership is actually unable to pay its debts, unlike in the case of corporate insolvency where the court only needs to be satisfied that the company is likely to become unable to pay its debts. Where the administrator is appointed out of court, the members of the partnership have to sign a statutory declaration that the partnership is unable to pay its debts.
The effect of administration generally, and the procedures for stopping partnership activity – or moratorium - in relation to an insolvent partnership, closely resemble those that apply to corporate administrations. However, moratorium will not prevent a creditor from bringing proceedings against a partner in respect of a partnership debt for which that partner is liable.
Partnership voluntary arrangements
The Order has also introduced the concept of the partnership voluntary arrangement (PVA). A partnership can enter into a binding debt-forgiveness arrangement or repayment schedule with its creditors instead of liquidation. This will likely result in an improved outcome for the creditors, and may allow the company to survive.
The partnership alone may be the subject of a PVA, or both the insolvent partnership and one or more of its partners can enter into a voluntary arrangement. This can be either an individual voluntary arrangement (IVA) if the partner is a person, or a company voluntary arrangement (CVA) where the partner is a company. If an IVA or a CVA is entered into alongside a PVA, the partners will be liable for their own debt as well as that of the partnership. The Order does not provided for a combined arrangement covering the partnership and its members, but this may be achieved by each of the members proposing interlocking voluntary arrangements with that of the partnership.
There is no moratorium available where a PVA is entered into, so this has proved an unattractive option for partnerships in financial difficulties. Consequently, they have only really been useful when dealing with large partnerships where entering into IVAs or CVAs with each partner would be too time-consuming and costly.
Limited Liability Partnerships
In many ways the process of insolvency for an LLP reflects that of a limited company. LLPs can enter into administration, go into receivership, be voluntarily or compulsorily wound up or propose a voluntary arrangement.
The process for appointing administrators for an LLP which has entered into administration is the same as that for a company. An administrator may be appointed by the court on the application of the LLP itself, a creditor or both and may be appointed out of court by the LLP itself or by a creditor who holds a qualifying floating charge over the company. A qualifying floating charge holder must first give notice to any other floating charge holders before appointing an administrator out of court.
The effect of administration generally, and the moratorium provisions in relation to LLPs, follow those that apply to corporate administrations. However, as is the case for an ordinary partnership, the moratorium will not prevent a creditor from bringing proceedings against a partner in respect of a partnership debt for which the partner is liable.
Almost the same procedures apply to the winding-up of an LLP as do to the winding-up of a limited company. The LLP can be placed into members' voluntary liquidation if the members of the LLP declare insolvency. If such a statement cannot be made, the creditors of the LLP can propose a creditors' voluntary liquidation.
There are special provisions, which are only applicable to LLPs in liquidation, which may allow an appointed liquidator to claim back any money withdrawn from the LLP by its members. This includes distribution of profit shares, salary, loan repayments, interest payments or any withdrawal of property belonging to the LLP. The liquidator's power to 'claw back' in this way applies when:
- within a two-year period before the LLP was liquidated, any person who is or was a member of the LLP withdrew property of the LLP; and
- at the time of the withdrawal the member knew, or had reasonable grounds to believe, that the LLP was unable to pay its debts or would become unable to pay its debts once the property was removed, considered in conjunction with any property removed at the same time.
When considering whether these claw-back provisions should apply, the courts will take into account the level of knowledge, skill and experience that could be reasonably expected of a member of an LLP at that level as well as the individual member's own knowledge, skill and experience.
However, the member will not be liable unless that person knew or ought to have concluded that after each withdrawal there was no reasonable prospect of the LLP avoiding going into insolvent liquidation.
Liability of partners on insolvency
Partners and persons who have management control of partnerships or LLP businesses face the same sanctions as directors of limited companies for specific misconduct, and may be disqualified from office by virtue of the Order.
The court may disqualify a partner from office if that person is or was a partner in an insolvent partnership and his conduct as a partner - either taken alone, or together with his conduct in any other partnerships or as a director of a company - makes him unfit to be involved in the management of another company or partnership. Similarly, a member of an LLP may be disqualified from being a member of an LLP or a director of a company if that LLP has become insolvent and the court considers that the conduct of that member was such as to make that member unfit to be involved in the management of another LLP or company.
Partners and members of LLPs may also, in addition to their personal liabilities, be liable in the same way as directors of limited companies if they are found guilty of wrongful or fraudulent trading and liable top make a contribution to the assets of the partnership.
In the same way as there are restrictions on the reuse of company names, to prevent so-called phoenix company practices, restrictions will also apply on the reuse of LLP names where the original LLP has gone into insolvent liquidation.