Drawing on recent cases which he has pursued for clients in the High Court, Keystone partnership and LLP specialist Peter Garry advocates pursuing claims against partners and members to final judgment, rather than entering into low level compromises or writing off debts.
Very often the enforcement of legal rights has as much to do with the practical application of the law by the courts as it has to do with the law itself. It is one thing to have a theoretical legal right, but understanding the best way to enforce it, and the best way to present it in court, can make the difference not only between success and failure, but also to the cost of the exercise and the extent of the recovery.
One area in which this comes very much to the fore is the recovery of indebtedness from partners or LLP members who have drawn more out of their partnership or LLP than their share of profits permits. Not only will a business want and need to recover indebtedness owed by one or more of its proprietors, but also, if there is a failure to take a robust approach against one, others may be tempted to try to avoid complying with their obligations, resulting in a cascade of defaults.
Examples of situations in which this might arise are where:
- Members/partners overdraw against lower than expected profits. In some cases this can continue over more than one financial period, at least until reserves or overdraft facilities have been fully depleted, or for so long as management believes that there will be a turnaround, or investors are prepared to fund an apparently promising start-up.
- A substantial, unexpected loss is made, perhaps because of an adverse event such as an uninsured claim. Unlike partners, LLP members are often protected from losses in a winding up. But even in an LLP if the business continues rather than being wound up (with a view to trading out of difficulty) LLP members may either be required by their LLP members agreement to accept a debit to their current account, or they may agree to do so in order to avoid the often worse outcome of their only source of income coming to an abrupt halt when the LLP goes into liquidation or administration.
The problem will be aggravated if indebted partners or members retire or are expelled before they have paid back the amount that they owe.
Partners or members against whom demands for repayment are made may raise defences, counterclaims or cross-claims such as:
- Allegations that when they joined the business one or more misrepresentations were made to them, for example as to the strength or resources of the business, resulting in them seeking damages and/or a declaration that they are not bound by the terms of a partnership or LLP agreement.
- In an LLP, assertions to the effect that they are not liable for losses, on the basis that LLP members are supposed to enjoy limited liability. (Contrary to a popularly held view, this purported defence is not always a valid one.)
- Challenges to the basis on which the accounts have been drawn up, asserting that a detailed account needs to be taken by the court. (This is often an expensive and long-winded exercise, but again contrary to a popularly held view, this route is not always required.)
- Raising issues of fact which they assert require a trial to resolve them, thus supposedly ruling out any kind of summary resolution of the claim or the use of statutory demands. For example, there may assertions as to what was said at key meetings.
In both the Chancery Division and the High Court Bankruptcy Registry we have found that Masters and Registrars are increasingly willing to explore and challenge quite complex factual allegations and if appropriate reject the basis of the defences, counterclaim or cross-claims, before going on to enter summary judgment or give permission to present bankruptcy petitions.
Such outcomes save considerable expense by avoiding the taking of detailed accounts and/or having to give full disclosure of documents and conduct a lengthy trial.
Furthermore, both in the Chancery Division and in the High Court Bankruptcy Registry there is a pragmatic approach to summary assessment of costs which can result in reasonable or in some cases above average costs recovery without the delay and expense of detailed assessment of costs.
It is all too common for managers of a partnership or LLP to take what might be regarded as a pragmatic or “commercial” approach when faced with a (usually ex-) partner or member who owes substantial sums to the business, even where the partner or member undoubtedly has sufficient resources to enable him or her to pay in full.
Given the willingness of the courts to deal with partner and LLP member indebtedness robustly, there is every reason for managers of LLPs and partnerships to consider the alternatives carefully before contemplating substantial write-offs or unacceptably low compromises.
This article is for general information purposes only and does not constitute legal or professional advice. It should not be used as a substitute for legal advice relating to your particular circumstances. Please note that the law may have changed since the date of this article.