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LLPS: Advantages & Challenges

Despite being a relatively new development in the realm of business, there has been a noteworthy growth in the number of entrepreneurs opting for Limited Liability Partnerships (LLPs) in recent years. There are a variety of reasons for this trend, including inexpensive formation costs, less restrictions and compliance requirements, and, most crucially, the freedom that an LLP provides as compared to other company structures. In the world of business law, the limited liability partnership (LLP) represents a breath of fresh air. The LLP is regarded as an “alternative corporate vehicle” that aims to combine the best features of both partnership and corporation structures. This is accomplished by giving LLP members the liberty to organize their internal managerial structure as a partnership based on mutual consent, while restricting the partners’ liability to the level of their partnership interests, which is similar to a company’s distinct legal identity.

Limited Liability Partnerships (LLPs) are flexible legal organisations that allow partners to benefit from a joint, collaborative venture while limiting their liability for the other partners’ actions or inactions. This structure combines the advantages of a partnership firm and a corporation in that it limits partners’ liability to their contributions and creates a separate legal entity, much like a corporation, while also operating on an agreement and allowing partners to decide on the finer points of the business, such as the internal managerial structure, mutually. An LLP is defined as a “distinct corporate body that is being constituted under this act and will be treated as a separate legal entity from that of the partners,” according to Section 3 of the LLP Act, 2008. Though the creation of both companies and LLPs appears to be aligned, the nature and future course that the founders wanted to pursue may ultimately determine the business structure. So, while it may appear advantageous to organize a startup as a private company in some unusual circumstances, organizing it as an LLP is preferable because of certain advantages such as a low incorporation charge, fewer compliance obligations, unfettered ownership, and low tax and penalty. Despite the flexibility and lack of formalities, many entrepreneurs were hesitant to use an LLP structure. As a result, the government has made substantial revisions to this statute in order to make it easier for entrepreneurs to pick LLP as their company form.

History of LLPs

The notion of a limited liability partnership was born in unincorporated form in Texas in 1991, as a result of government lawsuit against legal and accountancy firms that had worked for bankrupt savings and loan institutions. The claims were made against all partners, including many who had nothing to do with the failed businesses, underscoring the fact that partners are jointly and severally liable for each other’s actions. The possibility that all members of an attorney or accountant firm could be held liable for hundreds of millions of dollars prompted the creation of procedures to limit partners’ vicarious liability. The LLP is the tool that was created to achieve that goal. It has received a lot of positive feedback.

The Iron, Steel and Hardware Merchants’ Chamber of India made a concrete suggestion in 1932 that limited liability partnerships should be recognized in India either by a special enactment or as a part of the Partnership Act, 1932: Given the recent amendment to the Indian Companies Act, we believe that a provision should be made in the Indian Partnership Act, 1932 by which Limited Liability Partnerships Act. The Indian Companies Act has gotten so complicated that it is hard for a small corporation to comply with all of its regulations without hiring a full-time secretary. Two or three partners used to find it convenient to create a private limited company and carry on the work before the change to the Indian Companies Act. People will prefer to form a partnership rather than forming a limited liability company because there are so many restrictions on directors or shareholders taking loans in private limited firms. Only by establishing a limited liability partnership can the danger be reduced. But, the proposition was rejected because, given the situation in India, it was deemed neither necessary nor expedient to provide for limited liability partnerships in the country.” 

However, the situation quickly changed, and numerous committees presented proposals for LLP legislation in India:

(i) The Bhatt Committee in 1972;

(ii) Naik Committee in 1992;

(iii) Expert Committee on Development of Small Sector Enterprises headed by Sh. Abid Hussain in 1997;

(iv) Study Group on Development of Small Sector Enterprises (SSEs) headed by Dr S.P. Gupta in 2001;

(v) Naresh Chandra Committee Report in 2003 highlighted the grave need to introduce LLPs in the service industry, which finally succeeded in launching the concepts of LLPs in India;

(vi) J.J. Irani Expert Committee on Company Law in 2005 recommended to enact a separate legislation for LLPs in India, and also to extend the scope of LLPs to the small enterprises.

In order to implement Limited Liability Partnerships in India, as recommended by the above-mentioned committees, the Cabinet approved the LLPS Bill on December 7, 2006, and it was subsequently brought to the Rajya Sabha on December 15, 2006. On the 1st of May 2008, the Cabinet approved the Limited Liability Partnership (LLP) Bill. The bill was passed by both Houses of Parliament with no amendments. On January 7, 2009, the President gave his assent to the bill. The Limited Liability Partnership Act, 2008, was published in India’s official gazette on January 9, 2009, and it went into effect on March 31, 2009. The LLP Act of 2008, as amended, governs the establishment and regulation of limited liability partnerships, as well as matters related to them.

Many startups and entrepreneurs, on the other hand, were wary of the LLP format due to a lack of incentives for startups, flexibility in the issuance of instruments such as debentures, and criminalization of many procedural lapses such as delay in designating a designated partner, failure to maintain a registered office, and so on. As a result, the government has launched the Limited Liability Partnership (Amendment) Bill, 2021, in an effort to make conducting business easier and promote more entrepreneurs.

The bill proposes to create the notion of a small LLP, which is similar to the concept of a small business. Small LLPs are those with a contribution of less than Rs 25 lakhs, which can be increased to Rs 5 crores, and a turnover of less than Rs 40 lakhs, which can be increased to Rs 50 crores. In the Act, the concept of startup LLPs is introduced. While the government has yet to announce the definition of a start-up LLP, the decision is being hailed as a boon to the start-up ecosystem, since it provides an alternative operational structure for businesses that do not want to register as corporations.

The Bill also proposes to reduce the penalty charged on the Act for any non-compliances under the act to only one-half of the amount of penalty prescribed subject to thresholds, in order to incentivize small and fledgling LLPs. However, unless tax breaks are made accessible to small and startup LLPs in the same way that they are for small and startup businesses, this plan will be a flop.

Salient Features of LLP
  • The LLP is a legal entity that is distinct from its partners and has a perpetual succession.
  • The LLP of 2008 governs LLPs in India, and the provisions of the Indian Partnership Act, 1932 do not apply to them.
  • As the last words of its name, every Limited Liability Partnership must use the words “Limited Liability Partnership” or its acronym “LLP.”
  • An LLP is formed as a consequence of a partnership agreement, and the reciprocal rights and responsibilities of its partners are governed by that agreement, subject to the restrictions of the LLP Act, 2008.
  • The LLP, as an independent legal organization, is responsible for all of its assets, with the partners’ liability limited to the amount they invested, just like a corporation. No partner shall be held personally accountable for the actions of other partners. 
  • However, if the LLP was formed with the intent of cheating creditors or for any other dishonest purpose, the partners’ responsibility will be unlimited.”
  • Every LLP must have at least two designated partners, one of whom must be a resident of India.
  • Every LLP must keep annual accounts to indicate its genuine financial situation. Every year, it must produce and file a statement of accounts and solvency with the Registrar.
  • According to the Act’s requirements, a firm, a private company, or an unlisted public corporation can convert to an LLP. The Registrar will issue a certificate confirming the conversion. 
  • All of the property of the firm or company, as well as all assets, rights, and responsibilities connected to the company, will be vested in the LLP formed when the certificate of registration is issued, and the firm or company will be dissolved.
  • The firm’s or company’s name is then removed from the Registrar of Firms or Registrar of Companies, depending on the situation.”
  • An LLP, like a corporation, can be wound up voluntarily or by a Tribunal constituted under The Companies Act, 1956.
  • The LLP Act 2008 also gives the Central Government the authority to apply the Companies Act’s provisions whenever it sees fit, and to do so, it must issue a notification to that effect, which must be laid before each house of Parliament for a total of 30 days and subject to any modifications approved by both Houses.
Advantages of LLPs
  1. Separate Legal Entity: 
  • In the eyes of the law, an LLP is distinct from its partners, just as a corporation is distinct from its stockholders.
  • The LLP is not the same as its partners. A limited liability partnership (LLP) can sue and be sued in its own name.
  • “This enables the company to enter into contracts with other businesses, possess assets, and borrow money in the name of the LLP, which is not feasible with a standard partnership firm.”
  • In addition, if the number of partners falls below two for a short period of time, the LLP does not need to be wound up.
  • The LLP can stay in business, and the surviving partner has six months to find a new partner.
  1. Limited Liability:
  • The partners’ liability is limited to their contributions, and they are not personally liable for any business losses.
  • This means that if an LLP becomes insolvent, only the LLP assets are liable for its debts at the time of winding up, and the partners’ personal assets cannot be attached.
  • This differs from a proprietorship or a regular partnership, in which the proprietor/partners’ personal assets are not safeguarded if the company goes bankrupt.
  • This is one of the key reasons why people choose LLPs to sole proprietorships and traditional partnerships as their preferred company structure.
  1. Cheap cost of incorporation and compliance: 
  • When compared to the expense of founding a public or private limited company, the cost of incorporating an LLP and the cost of compliance is low. Annually, the LLP must file only two statements: an Annual Return (Form 11; due date is May 30) and a Statement of Accounts and Solvency (Form 8; the due date is 30th October).
  • Only if the contribution exceeds INR 25 lakhs or the turnover exceeds INR 40 lakhs is a statutory audit required for a Limited Liability Partnership.
  • Audit is optional if contribution/turnover is below the defined levels. LLPs, unlike corporations, are exempt from regulations governing board meetings, annual general meetings, the creation and keeping of minutes, and board resolutions.
  1. There are no valuation standards for transferring ownership: 
  • In comparison to a Private Limited Company, transferring ownership of an LLP is simple.
  • If the valuation rules are not followed, the sale of a company’s share is subject to income tax value and will result in unfavorable tax consequences.
  • This is usually the situation when a company is in financial crisis and the actual valuation is significantly lower than the asset valuation.
  • In the case of an LLP, there are no such valuation standards.
Disadvantages of LLPs
  1. Public Disclosure:
  • The most significant disadvantage of an LLP is public transparency.
  • The materials submitted through the MCA portal are open to the public. Anyone can obtain a copy of the LLP’s incorporation documents (but not the LLP agreement) and financial statements for a nominal cost of INR 50.
  • In the event of a sole proprietorship or a typical partnership firm, when records and financials are not open to public examination, this is not an issue.
  1. Limited Funding Options: 
  • When it comes to raising capital, LLPs have few options. LLPs can take out loans from partners or take out debt from financial institutions. 
  • An LLP structure would be unattractive to venture capitalists (VCs), angel investors, and private equity (PE) firms. 
  • This is due to the fact that all LLP shareholders’ (those with an ownership position) must be partners with specific responsibilities toward the LLP, and there is no distinction between ownership and management.
  • No venture capitalist, angel investor, or private equity firm wants any of these duties, thus they will only invest in a private limited business.
  • Foreign Direct Investment (FDI) is also more restricted in LLPs than in corporations.
  • Employee Stock Options cannot be issued by either an LLP or a corporation (ESOP).”
  • As a result, LLP isn’t the best option for firms looking to scale quickly, raise seed or venture money, or provide their workers stock options.
  1. Non-compliance is costly: 
  • While an LLP’s compliance requirements are minor, it is critical to follow them. Failure to do so can result in severe penalties.
  • Even though an LLP has no activity, it is required to file Forms 8 and 11 on a yearly basis.
  • Non-compliance will result in an extra cost of INR 100 per day, per form.
  • The additional charge has no cap, and it might be in the thousands if an LLP hasn’t submitted them in a few years. 
  • In addition, the LLP and its DPs may be subject to a punishment of up to INR 5 lakhs.
  • There is no necessity for a proprietorship or traditional partnership firm to file annual forms, and non-compliance expenses are not incurred.
Conclusion

LLP has now found its place in India, despite the fact that it was late to recognises the notion. Small and medium-sized businesses benefit from LLPs, which are a hybrid of a corporation and a partnership. The government supports the LLP concept since it offers several tax benefits and allows businesses to focus on their core business activity. It’s the type of business that’s simple to run while also limiting the owners’ liabilities. LLPs are one of the most straightforward business structures to set up and operate.

References

https://blog.ipleaders.in/flexibilities-of-llps-over-other-business-structures

http://www.llp.gov.in/aboutllp.htm

http://www.mca.gov.in/MinistryV2/applicabilityofthellpact.html

https://blog.ipleaders.in/the-ease-of-doing-business-for-startups-in-the-light-of-recent-amendments-to-llp-act-2008/

https://www.lexology.com/library/detail.aspx?g=79c8dd4c-f580-494a-a27f-8d2fb3fa1072#:~:text=The%20Amendment%20Act%20has%20expressly,that%20may%20be%20prescribed%3B%20and

By Arryan Mohanty