How to prevent employment claims by fixed-share equity partners

It has always been black and white that full equity partners of a limited liability partnership (LLP) are partners, whereas salaried partners are more likely to be deemed employees, with statutory employment protection by the courts.

What has been a grey area, up until the recent landmark Court of Appeal decision in Tiffin v Lester Aldridge LLP, is the employment status of fixed-share equity partners (FSEPs). The legal position is that, if an FSEP would have been a partner in a traditional partnership, he will be deemed a partner in the LLP and cannot be an employee.

Martin Tiffin tried to argue that, despite being an FSEP, the reality was that he was an employee of Lester Aldridge. However, the court made short shrift of that argument, meaning that FSEPs will not be able to have their cake and eat it too.

FSEPs will now find it nigh on impossible to bring statutory employment claims for unfair dismissal, wrongful dismissal or a statutory redundancy payment (other than for discrimination – which applies equally to partners) if they make a capital contribution to the firm, share in the profits of the LLP, have a say in the firm’s management and would share in the LLP’s surplus assets upon a winding up (even if only to a very limited degree). The first three factors are common attributes shared by most FSEPs in LLPs, but the last factor is more unusual.

The Court of Appeal reached the right decision in my view. FSEPs cannot take the tax, status and other benefits of being a FSEP on the one hand, yet at the same time claim to be an employee in order to sue their firm if the relationship between them sours.

The commercial interests of FSEPs and full-equity partners (FEPs) in their firms are materially different. FEPs inject a higher level of capital into their firms and can legitimately expect to receive a higher profit share than a FSEP by way of return, much like the way a shareholder receives dividend levels dependent on the number of shares he owns. Higher risk leads to greater reward. As owners of the business, FEPs should and do have a greater voice in its management.

However, the character of interests which both classes of partner had in ?Lester Aldridge was substantially the same. Both classes of partner contributed capital, shared in the LLP’s profits, had ?a say in the firm’s management and had the prospect of sharing in the LLP’s ?assets upon a winding up (albeit to ?varying degrees).

Parties’ intentions at the time of entering into an LLP members’ agreement regarding the type of business relationship into which they understand themselves to be entering, and whether the agreement is intended to govern the relationship between them, will be key to resolving similar disputes in future. Before issuing his employment tribunal claim, Tiffin never asserted to his firm that he was an employee, or that the members’ agreement was a sham.

Previous case law, which was upheld in Tiffin’s appeal, has established that one can still be a partner, even if:

• one has no right to share in the firm’s profits;

• has not made a capital contribution to the firm; and

• does not have a minimum number or specific type of right to vote or participate in management decisions.

However, to be on the safe side, LLPs should ensure that at the very least their members’ agreement provides for their FSEPs to:

• make a capital contribution to the firm (however small);

• share in the LLP’s profits (to whatever limited degree is appropriate); and

• have some say in the firm’s management. This usually applies to minor and non-time critical decisions, the most important decisions being reserved for the management committee and sometimes also the FEPs (depending on the size and nature of the firm).

As a belt and braces measure, the LLP agreement could also provide for FSEPs to share in the firm’s surplus assets upon a winding up, but they would rank behind FEPs in relation to this.

The recent Court of Appeal decision is good news for LLPs, particularly those contemplating early adoption of an alternative business structure. Law firms will be run more like corporate entities when accepting outside capital and non-lawyers will play a key role in firms’ management. Law firms can now move forward with these exciting new possibilities, safe in the knowledge that FSEPs will not be able to bring statutory employment claims against them, just because their involvement in management decisions is limited or even non-existent.

mchance@kingsleynapley.co.uk