In a case that will be of interest to those in the fund management industry and all other areas of business in which corporate structures regularly involve LLPs (including, for example, professional services firms), the High Court has held that the doctrine of repudiatory breach of contract is implicitly excluded in LLP agreements, at least where they have more than two parties: Flanagan v Liontrust Investment Partners LLP [2015] EWHC 2171 (Ch).

In this case, the result was that the LLP member claiming there had been a repudiatory breach could not take advantage of the default statutory rules applicable to LLPs to obtain a pro rata share of the LLP’s assets and profits.

Gary Milner-Moore and Andrew Cooke, a partner and associate respectively in our dispute resolution team, consider the decision below.

Background

Statutory provisions

Under section 5(1) of the Limited Liability Partnerships Act 2000 (“the Act”), the rights of the members of an LLP are governed by agreement, save as otherwise provided by the Act or any other enactment, including the Limited Liability Partner Regulations 2001 (“the Regulations”). Under Regulation 7, except as otherwise agreed, LLP members are entitled to share equally in the capital and profits of an LLP. Under Regulation 8, a member cannot be expelled from the LLP unless a power of expulsion has been expressly agreed between the members.

Section 1(5) of the Act provides that the law relating to partnerships does not apply to LLPs.

Factual background

In October 2011, Mr Flanagan became a member of Liontrust Investment Partners LLP (“Liontrust”), a fund management business. In addition to the agreement between the members of Liontrust, Mr Flanagan entered into a side letter with Liontrust under which his initial term of membership was fixed for two years. If Mr Flanagan’s membership was to be terminated, Liontrust was required to give him six months’ notice, which could not expire before the end of the two year minimum term.

The agreements entered into by Mr Flanagan expressly provided that “Regulations 7 and 8 of the [Regulations] and any other default provision mentioned in section 5(1)(b) of the [Act] will be excluded in their application to Liontrust. Instead, the agreements contained bespoke provisions for the division of capital and income between the members and the expulsion of members.

Under the agreements, Mr Flanagan contributed nominal capital and was entitled to a fixed profit share of £125,000 per year.

In August 2012 (ie approximately 10 months into the two year period), Liontrust wrote to Mr Flanagan giving him notice of termination as a member. The letter referred to the fact that Mr Flanagan’s notice period was six months but could not expire until two years after he became a member. Mr Flanagan’s termination date was therefore given as October 2013 but, in the meantime, he was put on gardening leave for approximately 14 months, purportedly in accordance with the terms of the agreement between Liontrust’s members. Mr Flanagan commenced proceedings against Liontrust and its members, arguing (among other things) that:

  1. His notice period was precisely six months, not the 14 months given by Liontrust.
  2. If the notice of termination was invalid, he had been unfairly excluded from the business in breach of the relevant agreements, which Liontrust should be treated as having repudiated.
  3. As the agreements had been terminated for Liontrust’s repudiation, the contracting out of Regulations 7 and 8 could no longer apply. He therefore could not be expelled and, moreover, was entitled to an equal share of Liontrust’s capital and profit, not his fixed share under the agreements.

Decision

The court (Mr Justice Henderson) held that Liontrust had breached the agreement by purporting to give Mr Flanagan 14 months’ notice, and that in terminating Mr Flanagan’s involvement in its business affairs Liontrust had evinced a clear intention not to be bound by the LLP agreement or side letter.

Ordinarily, this would mean that Mr Flanagan was entitled to terminate for Liontrust’s repudiatory breach. An orthodox contract law analysis would then conclude that, as between Mr Flanagan and Liontrust, the agreement would fall away and, accordingly, default Regulations 7 and 8 must apply in its place. Mr Flanagan would therefore be entitled to an equal share of Liontrust’s capital and profits.

Mr Justice Henderson did not however accept this analysis. He noted that the case law had not previously considered in detail whether the doctrine of repudiatory breach applies to agreements governing an LLP, but it appears that it does not apply to a traditional partnership, even if there are only two members. That was the opinion of the House of Lords, obiter, in Hurst v Bryk [2002] 1 AC 185, which has been followed a number of times at first instance. The judge accepted Liontrust’s submission that, like in the case of a traditional partnership contract, the doctrine of repudiatory breach can have no application to an LLP agreement, at least where there are more than two members.

In support of his argument, Mr Flanagan had pointed to section 1(5) of the Act which makes it clear that the law of partnerships does not apply to LLPs. So at the very least, he said, the courts were free to start from scratch when answering the question of whether the doctrine of repudiatory breach applies to LLP agreements. Because an LLP is a separate corporate entity, if the LLP agreement is terminated for repudiatory breach, the LLP is not dissolved as a result. Instead, unlike a partnership, the LLP continues. The Act and the Regulations provide a default position for the rights and obligations of an LLP and its members absent agreement, including (on Mr Flanagan’s case) where there once was an agreement but it has been terminated.

Mr Flanagan’s argument was supported by most of the text book writers.

By contrast, Liontrust pointed to the difficulties of applying the doctrine of repudiatory breach in a multi-party contract. In an LLP with three members (A, B and C) who were party, with the LLP, to an LLP agreement, A could commit a repudiatory breach against B which B accepted. As a matter of contract law, as between A and B the LLP agreement would be terminated and the default statutory provisions apply. But as between B, C and the LLP, the agreement would remain binding. A would remain a member of the LLP entitled as against B to the default rights and obligations under the Act and the Regulations, yet as against C and the LLP to the rights and obligations under the LLP agreement. Practically, the situation would be unworkable.

Liontrust therefore argued that Parliament could not have intended the doctrine of repudiatory breach to apply where more than two parties had entered into an agreement under section 5 of the Act. In essence, Liontrust’s argument was that Parliament must have intended the rights and obligations of all of the members of the LLP to be determined entirely either by agreement or by the default statutory rules, never by a combination of the two.

Mr Justice Henderson described it as “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 the members.” Further, Liontrust’s LLP agreement expressly provided that the default provisions under the Act and the Regulations should be excluded and Mr Justice Henderson considered that it would “fly in the face of this express exclusion…if the result of [Mr Flanagan’s] acceptance of the LLP’s repudiatory breach were to bring the default rules into operation”, particularly if the result of that argument was to permit Mr Flanagan to share the profits of Liontrust equally when upon joining the LLP, he had freely accepted a fixed income.

Mr Flanagan was therefore unable to claim an equal portion of the capital and income of the LLP. The only loss he had suffered as a result of the breach was calculated by reference to the fixed income to which he was entitled.

Comment

This is the first reported case in which the courts have grappled with whether the doctrine of repudiatory breach applies in the context of LLP agreements. The court’s decision is contrary to the view expressed in a number of leading text books but might be said to promote certainty in multi-party LLP agreements.

Difficult questions remain in relation to LLPs having only two members. In those circumstances, the practical difficulties that would arise if one member committed a repudiatory breach which was accepted by the other are less likely to arise. But there may then still be a third party – the LLP itself – and it remains to be seen whether the fact that the LLP is (or is not) party to the agreement makes any difference.

Further difficult questions arise if an LLP started as a multi-party LLP governed by agreement but its membership has been reduced to two – the members would then have entered into an LLP agreement in the expectation that the doctrine of repudiatory breach could not apply but, when only two members remain, those two members might be subject to the doctrine.  Effectively, the two remaining members’ rights will then have been varied without their agreement or consent.

Similarly, Flanagan leaves unanswered the question of whether or not the doctrine of repudiatory breach could apply in the context of an LLP where one member commits a repudiatory breach of every other member’s rights, and all wish to accept the repudiation as terminating the agreement – in Flanagan, the judge found that Liontrust had committed a repudiatory breach only of Mr Flanagan’s rights.

It also remains to be seen whether the doctrine of repudiatory breach in the wider law of contract is under threat, at least in the context of multi-party contracts. There is no reason why many of the practical difficulties identified by Mr Justice Henderson do not arise in a ‘normal’ multi-party contract just as they arise under an LLP agreement. Mr Justice Henderson referred to a surprising dearth of authority on the point, but referred to limited first instance authority which suggests that the doctrine of repudiatory breach cannot apply where it would be unworkable in practice or produce a wholly unreasonable result. Further consideration of this question must wait for an appropriate case.