This OnPoint reports on a recent important High Court decision limiting the remedies available for breach of a UK LLP agreement.
Generally, in contract law, if a party to a contract commits a breach which is sufficiently serious to be repudiatory, the "innocent party" can accept the breach and treat the contract as at an end. In Flanagan v Liontrust, a decision of the High Court on 24 July 2015, a fund manager brought claims against the LLP of which he was a member claiming unfair prejudice and breaches of contract on various grounds. He argued that the alleged breaches of contract were repudiatory and that he was therefore entitled to treat the LLP agreement as at an end.
The member also argued that, following his acceptance of the alleged repudiatory breaches of the LLP agreement, he remained a member of the LLP under the "default" statutory rules. These are the rules which, pursuant to the 2001 LLP Regulations, apply in the absence of a formal LLP agreement. If this had been found to be the correct legal position, it would have had very significant consequences both in this litigation and for LLPs more generally — under the default rules Mr Flanagan would have been entitled to a notional equal share with the other LLP members in the equity of the LLP. This would have given him a "windfall" when compared with his annual fixed profit share of £125,000 per annum.
The High Court rejected the manager's claim, taking the view that it was "offensive to common sense, and contrary to the reasonable expectations of the parties, if the effect of the doctrine [of repudiation] 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." The member in question could not therefore rely on a breach of the agreement to ignore the commercial terms of the applicable LLP agreement. For completeness, it should be noted that the judge did leave open the issue of whether this repudiation argument could work in relation to LLPs with only two members.
This decision will be welcomed by LLPs who can now be confident that a member's entitlements — and indeed any damages claim for breach of the LLP agreement and/or the member's terms of admission — will be determined by the terms of those documents, and agreed in the relevant documentation and not the default statutory rules, even if there has been a fundamental breach. Nonetheless, it remains crucial for LLP agreements and terms of admission clearly to capture members' entitlements. The departure of an LLP member must also be handled carefully and in accordance with the applicable agreement provisions in order to minimise the risk of claims of breach of contract. In Flanagan, the validity of termination notices and the ability of the LLP to place the member on garden leave were in dispute. Termination of an LLP member’s membership must also be handled carefully to minimise the risk of a claim of unlawful discrimination by reference to one of the protected characteristics set out in the Equality Act 2010 or, following the Bates Van Winkelhof decision, a claim for whistleblowing.