| 1. | The interests of members in an LLP are typically governed by the LLP's members' agreement. Compared to the articles of association for limited companies, LLPs have considerable flexibility over how that agreement is drafted, and there is wide diversity in practice. The absence of standard arrangements makes it necessary to analyse each members' agreement with care so that members' equity and liability interests are properly reflected in the financial statements. |
| 2. | The members' agreement will specify what members are expected to provide to the LLP and what they will receive in return. Depending on the nature of the LLP and what has been agreed, members may or may not provide services or expertise to the LLP, and they may or may not be required to provide cash, or other assets, as members' capital. They may receive equity or liability interests in the LLP or a combination of the two. One purpose of the examples below is to illustrate that there need not be symmetry between the treatment of amounts subscribed as members' capital and the 'returns' arising. For example, a member may be able to demand repayment of capital subscribed (liability, unless the conditions for the puttables exception are met) but the LLP may have discretion over the division of profits (equity). |
| 3. | It will generally be necessary when analysing members' interests between equity and liabilities, to ascertain the rights that may be exercised by an individual member against the LLP. For example, where the profits are only divided if the LLP30 so decides, an individual member will not be entitled to a share of those profits unless and until a decision to divide them is taken; accordingly, the profits will constitute an equity interest (and will continue to do so even if a decision by the LLP to divide the profits is taken during the year in which the profits are earned; although, so far as the balance sheet is concerned, the taking of such a decision will convert the profits into a liability owed by the LLP to its members).31 By contrast, where the members have agreed in the LLP agreement in force at the time to an automatic division of profits, such that no further decision needs to be made to determine the amount of profit to be divided among members, the individual will be entitled to a share of those profits based on his percentage profit share, and accordingly his profit share will fall to be treated as an expense in profit or loss (and also as a liability in the balance sheet insofar as the profit remains unpaid at the balance sheet date). |
| 3A. | For example, the LLP agreement may require that all profits are divided (often the term 'allocated' is used in LLP agreements) such that the LLP has no discretion as to how much profit is divided but does allow the LLP discretion as to how the divided profit is shared between members. There may be different 'layers' in this sharing process whereby some members only have a fixed share, others only have a discretionary share (or have both fixed and discretionary share) and others only a share in the balance. Even though the LLP has some discretion as to member's profit share entitlements it cannot avoid the obligation to divide all the profits as this decision is automatic. Such an arrangement is called automatic division. This would also be the case where there is a requirement to divide some or all profits but the basis upon which those profits are shared between individual members is not determined until after the balance sheet date. This is because for an obligation to exist at the balance sheet date it is not necessary to know the precise identity of the parties to whom the obligation is owed or how the amounts to satisfy the obligation are to be shared.32 |
| 3B. | Another common example seen in practice is where the LLP agreement specifies that the profit to be divided is that as stated in the LLP's audited accounts as approved by the members. Although the amount of the profits to be divided will not be known until the audit is complete, the LLP cannot avoid the obligation to divide all the profits reported in the LLP's audited accounts as this decision is automatic. In addition, the fact that members have to approve the audited accounts does not mean that the LLP can avoid the obligation to divide all the profits. Once the members approve the accounts the LLP has to divide all the profits as this decision is automatic. The LLP is a body corporate with legal personality separate from that of its members. The LLP agreement in force at the time determines the contractual obligations of the LLP. Therefore, the requirement for members to approve the LLP's accounts does not enable the LLP to avoid its obligation. |
| 3C. | Some LLP agreements specify that the profit to be divided is that as stated in a 'distribution account'; this being distinct from the statutory accounts. The basis of preparation of the 'distribution account' is usually set out in the LLP agreement. Although the amount of the profits to be divided will not be known until the amount in the 'distribution account' is determined, the LLP cannot avoid the obligation to divide the profits in the 'distribution account' as this decision is automatic. |
| 30 Members as whole or a committee of the members with relevant authority. |
| 31 See Appendix 1 Exhibit E and Exhibit G. |
| 32 See Appendix 1 Exhibit A and Exhibit D. |
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