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A Consultation Paper from the Law Commission and the Scottish Law Commission

The consultation paper is available from the Law Commission's web site at http://www.lawcom.gov.uk.

Comments from the Association of Chartered Certified Accountants

January 2001

Executive Summary

The Association of Chartered Certified Accountants (ACCA) is pleased to have the opportunity to respond to the consultation paper on Partnership Law issued by the Law Commission and the Scottish Law Commission.

ACCA welcomes the publication of the Commission's very thorough review of UK partnership law. While the 1890 Partnership Act still seems to be a largely effective regulator of partnership activity, the consultation paper makes clear that revision and up-dating of the statute is overdue.

The paper appears at a time when the law as it applies to limited companies is being subjected to a comprehensive re-assessment under the aegis of the DTI, and shortly before a brand new form of partnership - the Limited Liability Partnership (LLP) - is to be made available to the business community. These developments are likely to produce significant innovations in the way in which business activity is conducted in the UK. Even in the face of these other developments, the partnership vehicle should remain attractive, to professionals and businesspeople alike. It is important, however, that the partnership retains its own distinctive character, one which is more flexible and less regulated than either the company or the LLP. The reform of the law should aim to ensure that this goal is achieved. We agree that the reform of the 1890 Act should retain a form of 'default' code which will apply to all partnerships in the absence of a separate agreement. The relative informality of the partnership vehicle, and the fact that so many partnerships (by intention or otherwise) do not have separate written agreements, mean that a statutory default code is essential.

Legal personality (Part IV)

1 We believe that to confer separate and continuing legal personality on partnerships would be a sensible reform and one which would be popular not only among businesses which currently operate as partnerships but among many of those which currently operate as private limited companies.

2 Of the 1.2 million companies on the register at Companies House, all but 11,000 are private companies and the great majority of these are, in financial terms, classified as 'small'. For many of these companies, the benefits of the limited company vehicle are not as attractive in practice as they appear to be in theory. As the paper acknowledges, for most small private companies, the personal guarantees which are demanded of their directors by providers of finance effectively invalidate the legal protection of limited shareholder liability. It appears from the report conducted for ACCA by Andrew Hicks, and which is quoted in the paper, that many owner/managers of small private companies only realise this drawback after they have incorporated and started to carry on business. Hicks' survey suggested that, for those with experience of conducting business in the company format, its biggest advantage is seen not as limited liability as such but the separate legal personality which the company enjoys.

3 For many small companies, however, even the advantage of separate legal personality tends to be offset by the various compliance obligations of the Companies Act (which are nonetheless, in our view, a legitimate corollary of the acquisition of corporate status). We suspect that the circumstances of many small companies would be more suited to a business vehicle, such as the partnership, which offered them the real advantage of separate personality but which allowed their owner-managers greater freedom in the management of their firms' internal affairs.

4 Of the two possible methods put forward in paragraphs 4.19 and 4.20 for the implementation of separate legal personality, we would support the second (i.e. attribution of legal personality without separate registration). We suspect that, if there were to be a new register, and associated registration formalities, many potential partnerships would not register, either because they did not wish to go through such a process, or because they were put off by the cost, or, as in some cases at the moment, because they did not realise that they were, in legal terms, a partnership and subject to partnership law. Either way, non-registration would be contrary to the purpose of the proposed reform. The administration of the procedure would also be extensive and expensive, and there would need to exist, side by side, two regimes for partners' liability.

5 We therefore favour the attribution of separate legal personality to all firms which qualify as partnerships under the statutory definition. We suggest that all partnerships should, as a 'default' provision, have continuing legal personality but that this could be overridden by a firm's separate agreement.

Definition, Formation and size of a partnership (Part V)

Definition (paras 5.2 - 5.26)

6 We support the various proposals put forward for up-dating the definition of 'partnerships' under paragraph 5.26. As a general comment, we believe it is desirable that the existence of a partnership should be determined by a clear intention on the part of individuals to form a legal partnership.

The partnership agreement (paras 5.27 - 5.29)

7 With regard to the question posed in paragraph 5.29, we consider that it is desirable to provide that, subject to separate agreement, a change in composition of the partners does not invalidate the pre-existing partnership agreement.

Liability for Partnership Obligations (Part X)

Joint and Several Liability (paras 10.8 - 10.10)

8 We do not dispute the proposal to make individual partners in English firms jointly and severally liable for the debts of their firm. As the paper acknowledges, this would mean little change in practice.

Separate Personality (paras 10.13 - 10.20)

9 We agree with the proposed approach, summarised in paragraph 10.20, to determining the liability of partners in cases where the partnership has separate legal personality. The firm should have the primary liability and that of individual partners should be subsidiary; partners meeting the whole or part of a claim should have a right of indemnity against the partnership and other partners. While we do not dispute that individual partners should be prepared to meet the debts of the firm, we consider, in principle, that it would be appropriate for a creditor to be required to exhaust enforcement remedies against the assets of the partnership before enforcing a judgement against the assets of a partner.

Financial responsibilities (Part XII)

Partnership accounting (paras 12.5 - 12.12)

10 The paper raises the question of whether partnerships should be required by law to ensure that their internal accounts are prepared in accordance with accounting standards, thereby complying with Generally Accepted Accounting Practice (GAAP).

11 A requirement along these lines would have the theoretical benefit of standardising the approach of partnerships to the valuation and presentation of their assets and liabilities. It could also reduce the scope for internal disputes over the calculation of profit and the treatment of individual assets.

12 Against this, however, it must be considered whether the involvement of the law in this respect is justified, given the nature of the partnership vehicle. Legislation currently requires a true and fair view to be given in the accounts of, inter alia, limited companies, LLPs, charities and pension schemes. A modified version of true and fair applies to the accounts of public sector bodies. In all these cases, annual accounts are required to be prepared because the entities concerned are seen as owing a duty of accountability, first and foremost to their non-manager members but also to the general public and creditors and potential creditors. In the interests of these stakeholders, the accounts are required to disclose information concerning the efficiency with which the controllers of the body have exercised their responsibilities of stewardship and the extent which they have complied with specified legal obligations.

13 The particular status of the partnership does not demand that a partnership should account for its performance to persons other than partners (apart from the tax authorities). The accounts of all the entities referred to in paragraph 12 above are required to be submitted to designated parties and, in the case of companies, LLPs and charities, filed with the appropriate regulator. The opportunity therefore exists, with respect to these types of entity, for interested parties to compare the performance of individual entities. To a great extent, GAAP is concerned to facilitate the effective comparison of the financial position and performance of entities of the same size and character. Given that partnerships will not be required to publish their accounts (we accept that a few do so voluntarily), there will be no scope for any outside party to compare the results of different partnerships. Hence, one of the main objectives of GAAP will be incapable of being met. In the absence of any suggestion that partnerships should make their accounts public, therefore, we do not believe that it would be reasonable for a revised Partnership Act to oblige partnerships to prepare their internal accounts in accordance with GAAP. Given also that the bulk of partnerships are small trading firms, such a requirement would, we suggest, be an unreasonable curb on their freedom of manoeuvre.

14 We are not convinced, in any case, that the application of accounting standards would lead necessarily to the harmonisation of accounting practice within partnerships. Even under accounting standards, such as SSAP 9 which deals with work-in-progress (WIP), there is significant scope for directors to use their own judgement with respect to the treatment of particular transactions. Disputes can, for example, arise over whether overhead costs have been calculated correctly and allocated appropriately, whether a long-term contract is at a stage where attributable profit may be recognised and whether provision should be made for irrecoverable costs.

15 The paper suggests that there could be a 'default' provision that partnerships should comply with accounting standards, but from which each firm would have the right to opt out if it wished. In the context of encouraging standardised accounting practice among partnerships, this would not, we feel, be helpful. If such a provision were to be introduced, however, it will be important for the fundamental accounting principle of consistency of treatment to be followed by each firm: with this in mind, we recommend that the opt-out be enshrined in a firm's partnership agreement, thereby committing it to cash-based accounting on a consistent basis.

Capital contributions (paras 12.13 - 12.18)

16 We believe that, as far as partners' rights to return of capital are concerned, the law should expressly provide that each partner's rights are proportionate to the contributions that he/she has contributed. While the comments of Nourse LJ, quoted in paragraph 12.16, suggest that a common sense interpretation of the current law would always recognise any form of implied agreement as to respective rights of capital return, there should, we consider, be no room for doubt on this issue.

Other financial rights (paras 12.28 - 12.29)

17 We suggest that the rate of interest payable on capital contributions beyond the agreed level is best dealt with through the partnership agreement. We agree, however, that should a 'default' rate be set by statute, the reference used should be the base rate.

Management rights (paras 12.30 -12.39)

18 A term such as 'ordinary matters', if undefined, will always have the potential to create uncertainty. It appears to be the case that, under present legislation, the vast majority of activities of a partnership are deemed to be 'ordinary', and thus can be decided by majority vote. We suggest, however, that the potential uncertainty surrounding this issue could be best addressed by providing, in a 'default' clause, for the type of activities which are extra-ordinary and thus subject to unanimity. Changes in the location of the partnership premises and a selective restriction on partners' authority would both count as extra-ordinary activities for this purpose.

19 As regards the possibility of relaxing the unanimity rule for decisions such as the admission of new partners, we do not consider that the difficulty, in a modern multi-partner firm, of securing unanimity is sufficient reason to merit change to the current rule. Aside from the fact that each partner is the agent of all other partners and agrees to assume financial liability for the acts of each of his partners, the partnership vehicle, if it is to survive after the introduction of the LLP, must remain one which is characterised by a particular ethos. We believe that, subject always to alternative arrangements agreed to, the right of each partner to veto the admission of a new partner should be retained.

Partners' Duties (Part XIV)

Duty of good faith (paras 14.9 - 14.17)

20 Although the paper suggests that the basis of the traditional duty of good faith is somewhat suspect, we consider that it is a concept which is very widely understood, at least in general terms, as underlying partners' duties to each other. For this reason alone it would be sensible to retain it and set it out in a reformed Act, without prejudice to other, specific duties.

Duty of care (paras 14.25 - 14.32)

21 We acknowledge that a new, statutory statement of a partner's duty of skill and care would be consistent with similar moves being undertaken by the Company Law Review with respect to directors of limited companies. A subjective test would cause no problems. We do not, however, consider that it would be feasible or desirable for the Commissions to emulate the Company Law Review's plan to devise an objective standard of skill and care for partners. The development of an objective standard of skill and care in the case of directors of a limited company is, arguably, justified by reference to the following factors.

1. All directors, whatever the size of their company, assume a role in the company governance process which is broadly similar.
   
   
2. Directors act in a separate capacity from shareholders in their company, whether or not they are shareholders themselves. The law, therefore, has a legitimate expectation that they should act responsibly and competently in exercising their functions.
   
   
3. All companies, as a consequence of the protection of limited liability, are required to comply with statutory rules and legal principles regarding capital maintenance, public disclosure and protection of creditor interests.

22 An objective standard of skill and care for partners is more difficult to justify given the different nature of the partnership. First, no partner can be admitted to the partnership, at present, without the unanimous approval of existing partners: by virtue of this, partners are quite able to satisfy themselves that an incoming partner is likely to have whatever skills and character they require of a partner in that firm. Second, partnerships will not benefit from limited liability, so there is no overriding public interest in demanding an objective standard. Third, one of the great qualities of the partnership vehicle, and one which will in future be its defining characteristic, is that it can be adopted by all sorts of enterprises across the whole range of business activity and on a formal or highly informal basis, as appropriate. Given the variety of circumstances in which partnerships operate, we do not see that it would be possible for statute law or the courts to identify the standard of skill and care by which all partners should be judged.

Full or reasonable time or attention (paras 14.33 - 14.38)

23 In keeping with the flexibility of the partnership format, we believe that any express requirement for partners to devote full or a reasonable time or attention to the firm should be a matter for firms' own internal agreements. The law should concentrate on empowering firms to expel partners whose performance is judged to be unsatisfactory.

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