THE TEN OLD SQUARE SEMINAR SEASON 2011/12

MELTDOWN! – FACING THE FALLOUT IN LLPs & PARTNERSHIPS

Thursday 17th November 2011 from 6.00pm

The Chancery Court Hotel, Holborn, London.

Thank you for attending this evening’s seminar, which is the second in this season’s series of four seminars centred on our core areas of practice.

We enjoy an outstanding reputation for our Partnership and LLP work with the latest editions of the Chambers UK Guide and The Legal 500 providing exceptional feedback for the barristers (and clerks) that specialise in this interesting and important area of the law.

Tonight’s panel of speakers will be:-

Jeremy Callman (Chairman)

Jeremy is often the first port of call for solicitors seeking advice from Counsel on contentious Partnership and LLP issues. Jeremy has a very strong reputation in Partnership/LLP litigation. Additionally he advises on non-contentious partnership matters. He regularly advises managing partners on internal issues within Partnerships/LLPs. He represents both firms and individual partners, from solicitors, accountants, doctors and dentists to hedge funds, recruitment consultants, architects, theatrical agents and farmers.

Chambers UK 2012 rank him as a "star performer" and describe him as "one of the leading partnership specialists in the field," and as a lawyer who gives "excellent advice and is extremely knowledgeable on complex and untested areas of LLP partnership law". They go on to say "It also helps that he is a team player who is both strong on paper and an excellent advocate. His meticulous attention to detail means that in litigation he covers every angle and leaves the other side no room to escape". The Legal 500 2011 rank him equal first and says he “has an especially strong track record, and is among the best in the market.”

Jonathan Gavaghan

Jonathan has a varied chancery and commercial practice with particular experience in partnership litigation. Property law, Company law (including breach of fiduciary duty claims and shareholder disputes) are further areas in which he specialises.

Recent partnership disputes in which he has acted include……………..

Chambers UK 2012 says: "Enormously talented" Jonathan Gavaghan has "a sharp intellect and is a man who shows a deft touch in court." He has impressed recently both with his effective courtroom manner and his excellent client-handling skills.

Evan Price

Evan’s practice covers a broad range of Chancery and commercial work with particular experience in partnership law. His expertise also covers property (including landlord & tenant) and insolvency (both personal and corporate) litigation. He has also recent and current experience of dealing with matters relating to companies, disqualification of directors, professional negligence, probate, taxation (including Stamp Duty Land Tax), trusts and public law. His arguments in court have been noted by the Legal 500 (2011 edition) as being "strong and well assured".

Naomi Winston

Naomi was called to the bar in 2006 after graduating with a first class degree and the Paul Heim prize for best graduate intending to train and practice as a barrister. She spent the following year working as a research assistant in the Law Commission's Family, Property and Trust Team, largely focusing on the Easements, Covenants and Analogous Rights Consultation Paper. She joined Ten Old Square in 2008, following the successful completion of her pupillage.

Naomi’s practice covers a broad range of Chancery with a particular emphasis on partnerships and LLPs, including litigation, contentious and non-contentious drafting and advisory work. In a relatively short period she has earned a reputation for being a first-class partnership junior, often being instructed in her own right on complex disputes concerning high-profile clients.

Gideon Roseman

Gideon was called to the Bar in 2007 and started at Ten Old Square in October 2010 following the successful completion of his pupillage. He previously lectured Land Law and Personal Property and tutored Trusts and Equity at the University of Bristol. Gideon is developing a practice covering a broad range of Commercial Chancery work. His recent partnership work includes drafting partnership deeds, advising partners in the preliminary stages of arbitration and drafting proceedings in complex partnership disputes.

We hold our seminars not only to showcase the talent at Ten Old Square, but also to say thank you to those who continue to support our Chambers through valued instructions.

Following immediately after the talks will be a reception in The Lounge with wine and hot canapés.

You will earn 2 (SRA) CPD points for attending this seminar so please fill out the questionnaire at the back of this folder and let me have it back, at your convenience.

Keith Plowman, Senior Clerk – November 2011.

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Who Do You Think You Are? Partner or Employee

_______________________________________________

Ten Old Square Partnership Seminar

Naomi Winston

_______________________________________________

Introduction

1. Over the past few years, a number of cases concerned with the true status of people

working for partnerships or LLPs have come before the Courts. The names applied to

these people are numerous – ‘fixed share partner’, ‘salaried partner’, ‘employed

partner’ are a few common examples – and the rights and duties they have within the

firms also vary to a great extent.

2. Why does this matter? In theory, people should be able to agree to work with each

other on whatever terms they want. The difficulties tend to come when the

relationships break down and the question arises of whether partnership or

employment law should be applied to guide the parties through the ‘break-up’ and to

determine each side’s rights. Is there a claim for constructive dismissal? Who gets a

share of residue on winding up? But questions can also arise while the relationship

subsists. Who has to organise payment of tax and what type of National Insurance

should be paid? Who has to contribute to the losses of the business?

3. These are, obviously, all internal issues arising between the partners themselves.

Where clients of the firm are concerned, if someone has been held out as a partner, it

is likely that they (and the other partners) will still be liable as if they were a partner.

Liability arising from holding out is a different issue, beyond the scope of this talk.

The law generally

4. The first point to make is that the name given to a position means very little. The

Court will look at the substance of the relationship between the parties and determine

what the true nature of that position actually is. This was made abundantly clear by

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Megarry J (as he then was) in Stekel v Ellice1 and this is the judgment that is always

returned to by the Courts.

5. So what do the Courts look to when attempting to divine what this ‘substance’ is? The

starting point is always going to be the agreement between the parties and, in theory,

where the agreement is fully and clearly documented there is no need to go further2.

However, as is the way with these things, the matters that end up in court generally

are not the ones where the relationship is clearly spelt out by the agreement (or at

least, the parties do not think that they are) and so the Courts find themselves looking

at what actually happened in practice and at the intentions of the parties, as

manifested, both by the agreement and by practice.

6. An appendix is attached, setting out a number of factors that are often deemed

relevant but, by way of example, a judge will be interested in the way that

remuneration is paid, whether capital has to be injected and the level of control that

comes with the position in question. No one factor has total precedence (though see

the discussion below of Williamson & Soden and the requirement of control) and the

weight to be put on each factor will, of course, vary with the circumstances of the

case. However, section 2(3) of the Partnership Act 1890, does provide that:

The receipt by a person of a share of the profits of a business is prima facie evidence that he is a partner in the business, but receipt of such a share, or of a payment contingent on or varying with the profits of a business, does not of itself make him a partner in the business…

This provision was merely a codification of the previous common law position3 and

does not shift the onus of proof where profit sharing exists4. Nevertheless, older cases

have stated that where there are no other indicators either way, the fact that profits are

shared will be determinative. This may well be true, but in my view it is unlikely that

there will be many cases where there are no other factors present. Indeed, there will

be cases where this element is not present at all, but the person in question is still

found, in truth, to be a partner5. So, for example, in M Young Legal Associates Ltd v

1 [1973] 1 WLR 191. 2 See Ready Mixed Concrete (South East) Ltd v Minister of Pensions and National Insurance [1968] 2 QB 497, at 515; Williamson & Soden v Briars [2011] All ER (D) 101 (Aug), at [27]. 3 See Badley v Consolidated Bank (1888) 38 Ch D 238. 4 Ibid, at 261. 5 see, e.g. Stekel v Ellice, supra.

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Zahid Solicitors (a firm)6, the absence of remuneration directly linked to and

dependent upon its profits, the non-appearance of a requirement for contribution to

capital and the lack of participation in management were not deemed sufficient to

justify refusing to find a partnership. Further, it was clearly stated that there is no

minimum profit share below which you will not be found to be a partner7, though this

should not be taken to absurd lengths. If the profit share is de minimis only, there will

be scope for arguing that it is not, in truth, a profit share at all.

Differences between partnerships and LLPs

7. Generally, the same approach is taken to determining the status of people within a

traditional partnership and within an LLP. Section 4(4) of the Limited Liability

Partnership Act 2000 provides that:

A member of a limited liability partnership shall not be regarded for any purpose8 as employed by the limited liability partnership unless, if he and the other members were partners in a partnership, he would be regarded for that purpose as employed by the partnership.

8. However, the nature of LLPs does mean that some factors will not be relevant. For

instance, the sharing of losses can be a factor indicative of a partnership, though it is

not unusual to have an agreement between partners that: a) they will not take on a

share of loss greater than their respective contributions; or b) that one or more of them

may not share in the losses at all. Conversely, where an LLP is concerned, the liability

is limited and so looking for loss sharing will not help to reach a conclusion.

9. Further, whilst an employee of a traditional partnership cannot also be a partner 9, an

employee of an LLP may be put on its list of members, whether he is a full profit-

sharing member or not10. Where this has occurred, the fact that someone has been

fulfilling a member’s statutory obligations set out in the Companies Act 2006 (e.g.

6 [2006] All ER (D) 227 (May). 7 See also Tiffen v Lester Aldridge LLP [2011] IRLR 105, at [10]. 8 It has been held that ‘purpose’ includes the purpose of determining whether someone has the benefit of the rights contained in the Employment Rights Act 1996: Kovats v TFO Management LLP [2009] All ER (D) 116 (May), at [128]) 9 Ellis v Joseph Ellis & Co [1905] 1 KB 324. Though LLPA 2001, s 4(4) could be read as indicating that a partner can be an employee, this is not the case; it is simply clumsy drafting. 10 Note that in Kovats v TFO Management LLP, supra, the EAT avoided answering the question of whether a member could also be an employee. However, the matter is already made clear by the statutory system and this has been acknowledged to be the case by Lightman J in Re Rogers, deceased [2006] 1WLR 1577. See also, The Law of Limited Liability Partnerships (3rd ed), Whittaker & Machell, paras 8.28 and 8.30.

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duty to preserve accounting records11) or has been permitted to inspect documents

under the default rules of the Limited Liability Partnerships Regulations 200112 will

not advance the case in one direction or the other.

How the Courts approach the question

10. Once the Courts have this plethora of factors set out before them, how do they go

about determining the status of a particular person? Until recently, it seemed that the

approach was to ask whether the person in question was a partner in the partnership

and, if not, to go on to consider whether the common law tests would have conferred

employment status on him13. This involved considering the requirements of both a

partnership and of employment and then identifying which had been fulfilled.

11. The requirements for a partnership are, as is well known, set out in section 1(1) of the

Partnership Act 1890:

Partnership is the relation which subsists between persons carrying on a business in common with a view of profit.

12. In contrast, a contract of employment will exist where:

(i) The servant agrees that, in consideration of a wage or other remuneration, he will provide his own work and skill in the performance of some service for his master. (ii) He agrees, expressly or impliedly, that in the performance of that service he will be subject to the other's control in a sufficient degree to make that other master. (iii) The other provisions of the contract are consistent with its being a contract of service14.

13. An example of this approach can be seen in Tiffen v Lester Aldridge LLP15. Mr. Tiffin

was a fixed share equity partner in an LLP. He was remunerated by way of a fixed

share of the LLP’s profit, plus a small variable payment based on a points system. The

remuneration of fixed share equity partners was to be contrasted both with the

payment of the LLP’s ‘salaried partners’ who were, unsurprisingly, paid a salary and

with the payment of equity partners who took drawings entirely on a points based

system and who had substantially more points than Mr. Tiffin. He contributed capital

11 CA 2006, ss 388-9. 12 Reg. 7(7). 13 See, e.g., Stekel v Ellice, supra; Kovats, supra, at [18(4)]; Tiffin, supra, at [12], where the approach adopted in Kovats was taken as read by the parties. 14 Ready Mixed Concrete (South East) Ltd, supra, at 515, per MacKenna J. 15 Supra.

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to the firm, but it was only 5% of that contributed by equity partners. This mirrored

his entitlement to share in the residue of the LLP on winding up, which existed, but

was significantly smaller than that of equity partners. He had voting and management

rights, but these were, again, lesser than those of the equity partners. He had authority

to sign cheques from the LLP’s accounts. After his membership was terminated, he

attempted to bring various claims against Lester Aldridge LLP, under employment

legislation.

14. The Employment Tribunal found (unsurprisingly) that he was a partner, not an

employee. This was upheld on appeal, the Employment Appeal Tribunal stating that

there was “quite enough material there to… conclude that the claimant carried on

business in association with the respondent”16. One of the grounds of appeal was that

Mr. Tiffin could not be a partner because he was not sufficiently involved in the

carrying on of the business. However, the EAT was clear there is no statutory

requirement that a person has to have a minimum right to participate in management

decisions before they can be said to be a partner and it acknowledged that:

In many large professional partnerships, all but very few of the partners have any right to participate in the overwhelming range of decisions made by the firm and yet they are clearly partners”17.

And that:

There is no particular reason why a partner cannot be under the direction of other partners” 18.

15. (Note that this decision has been appealed. The Court of Appeal heard the matter on 8

November 2011, but reserved judgment.)

A new approach?

16. The most recent judgment dealing with this issue was given in May of this year in

Williamson & Soden v Briars [2011] All ER (D) 101 (Aug) and may signal a

departure from the previous approach.

16 At [20], per Silber J. 17 At [19], per Silber J. 18 At [34], per Silber J.

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17. Mr. Briars had originally been employed as a solicitor by the partnership of

Williamson & Soden. After two years with the firm, he became a ‘salaried partner’,

but it was common ground that, despite this title, he remained an employee. A year

later, new arrangements were agreed whereby, instead of receiving a salary of

£55,000 pa, Mr. Briars was to be paid a “guaranteed profit share” of the same sum,

plus 1/18th of the net profits of the firm, which it was estimated would be in the region

of a further £10,000. He would pay tax and National Insurance on a self-employed

basis19.

18. However, this was the only change. Mr. Briar did not have to contribute capital, he

was not expected to contribute to losses, he was not consulted about significant events

in the life of the firm, his performance was monitored, at one stage it was discussed

that he might be at risk of redundancy and, though the firm had equity partners, this

was not the name given to Mr. Briars’ new position. When Mr. Briars brought

proceedings in the ET the firm challenged the tribunal’s jurisdiction to hear the matter

on the basis that he was a partner.

19. It was found at first instance, and on appeal, that the agreement imposed obligations

on Mr. Briars to serve the firm and that those obligations were indicative of a

significant degree of control being retained by the firm over the Claimant and his

work. Mr. Briars was, therefore, an employee, not a partner. In coming to this

conclusion, the ET made no specific reference to the Partnership Act 1890 and took

no steps to consider whether the relationship between the Claimant and the firm was

one in which he and they were carrying on business in common with a view of profit.

This was questioned on appeal, the method in Tiffin, being propounded as the

appropriate approach.

20. The EAT took the view that “the question to be determined for the purposes of

jurisdiction is not whether a given individual is a partner; it is not whether he is self-

employed. It is whether he comes within the definition of employee”20 and that there

was no rule of law which stated that “a tribunal should generally have regard to the

19 Note that it is not clear from the judgement whether Mr. Briars had always paid his income tax and NI in this way or whether this was a change. 20 At [25], per Langstaff J.

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terms of the Partnership Act 1890 in resolving any disputed question of employee

status”21.

21. Rather, it was an issue that it might be appropriate to consider in the particular

circumstances of a case where logic dictated that the legislation should be taken into

account. Where logic did so dictate, the issue could be considered when looking at

the third limb of the Ready Mixed Concrete test (i.e. whether the other provisions of

the contract are consistent with its being a contract of service). This limb should be

dealt with by looking for inconsistencies, rather than consistent provisions and, where

it appears that the relationship is one falling within section 1(1) of the 1890 Act, this

will negate a finding of a contract of employment. Quite why it was not appropriate to

consider the matter in circumstances such as these, where a) it was being argued that

Mr. Briars was a partner and b) he had a share of the profits, thus bringing section

2(3) of the 1890 Act into play, is perhaps difficult to understand.

22. However, whilst the application of the method set out in Williamson may have left

something to be desired, the method itself is not entirely disastrous; one would

generally hope to be able to persuade a Court (where partnership was clearly an issue)

that the 1890 Act (and, indeed, other indicators of partnership) should be taken into

account. However, in my view, what is more difficult to assimilate into a workable

test is the emphasis placed by the EAT in Williamson on ‘control’22.

23. The EAT stated that:

It may be said that those persons who truly “carry on business in common with a view of profit” are persons who are central to the business itself; that the role so described reflects the distinction between those who are bosses and those who are bossed, which is broadly the difference between those who are not employees but who employ, on the one hand, and those who are not employers but are servants (to use the old-fashioned phrase) on the other23.

24. This is both contrary to previous decisions which have made it clear that no one factor

will be overriding and does not sit with the practical reality of operating a large 21 At [27], per Langstaff J. 22 I.e. “the power of deciding the thing to be done, the way in which it shall be done, the means to be employed in doing it, the time when and the place where it shall be done. All these aspects of control must be considered in deciding whether the right exists in a sufficient degree to make one party the master and the other his servant”: Ready Mixed Concrete, at 515, per MacKenna J. 23 At [31], per Langstaff J.

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firm/LLP. Organisations of any size will necessarily have management structures set

up which have the effect that a large number of partners will be ‘bossed’ by the

management team. This does not automatically mean that the more subservient

partners are not true partners, but just that, in order for the firm/LLP to function, a

large amount of the decision making has to be delegated to the few.

25. As stated above, this was acknowledged by the EAT in Tiffin. The fact that the test of

control may not always be the appropriate one in the circumstances was also clearly in

the mind of Lightman J when giving his judgment in Horner v Hasted24 where he

stated that the test of control:

does not have the significance today that it once may have had as the litmus test for a contract of employment. It most certainly is not a universal litmus test, and its importance (and indeed relevance) must depend in particular on the role to be played by the ‘employee’ in the ‘employer’s’ business25.

26. It may be that the relevant question to ask where larger firms are concerned is whether

the person in question has any say in who takes on the decision making roles but this

was not the reason given in Williamson for permitting such emphasis to be placed on

control. If this emphasis continues, many partners/members in large firms/LLPs may

find that there is scope to a) take advantage of the employment legislation but that b)

they could be done out of the benefits of partnership.

27. As stated above, the appeal in Tiffin has been heard by the Court of Appeal. It has to

be hoped that the panel take the opportunity of tempering the judgment in Williamson

& Soden to fit with the realities of partnerships and LLPs today. It may be that they

will have been assisted in this by counsel for Lester Aldridge LLP who also appeared

for the appellants in Williamson but, despite making all the right noises, had his

arguments rejected.

24 [1995] STC 766. 25 Ibid, at 799. In that case an employee was given all of the trappings of a partner and it was the clear intention of all the parties that he should be treated as a partner but that he should remain an employee because the relevant regulatory body would not permit him to be partner. This case was not cited to the EAT in Williamson & Soden, though counsel for the firm did make the point which was resoundingly rejected.

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Practical precautions

28. So, when we are drafting partnership/LLP agreements, what can we do to try to

ensure that the position of the person in question is not open to dispute?

29. As should already be clear, attributing a particular name to the role will not resolve

the problem, though ‘salaried partner’ is probably best avoided as its ambiguity is

well-canvassed. Where it is used, it is particularly important that the nature of the

position is clear internally. ‘Fixed share partner’ is often used to try to get away from

the connotations of employment that attach to the term ‘salaried partner’ but even

with this moniker, the Courts are still going to look at the substance of the

relationship.

30. If the intention is that the person should be a partner, remuneration should be paid out

of the profits and should not be payable if there is a loss.

31. Declarations one way or the other are unlikely to be effective; they do not remove the

duty of the Court to look at the actual situation, though, in cases of doubt, they might

be a relevant factor26.

32. However, that is not to say that every attempt should not be made to set out the rights

and duties of each position in appropriate agreements. It may be that separate

agreements will be needed for each type of position because to include terms relating

to employees in a partnership agreement may well be inappropriate. Further, where

partnerships (rather than LLPs) are concerned, who the agreements are between will

provide an indication as to the nature of the position. I.e., a partner’s agreement will

be between each and every partner, but an employee’s agreement will not be between

each and every employee. Further, if it is intended that there should be a change of

status from employee to partner (or, indeed, vice versa), it is, again, important to

make sure that it is properly documented.

33. This should, of course, go without saying, but time and again, we all find that our

clients have failed to set out the agreement or, at least, write things down. Langstaff J

26 Ready Mixed Concrete, supra, at 513.

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noted in Williamson that “it would be surprising, given the onerous responsibilities

that rest upon a partner, that the paperwork did not more clearly reflect that change”27.

34. There should be clarity within both the documentation and in practice as to the role in

the firm that are part of the position; e.g. who is entitled to attend various types of

meetings, who has voting rights and who can see certain types of information. If this

is not clear, the danger is that certain expectations will attach to the name given to the

position in question which could result in disappointed expectations and messy

internal politics.

35. Finally, caution should be exercised if the primary purpose of attributing

partner/member status to someone is to avoid the tax implications. HMRC appear to

take a fairly lenient approach in assessing the true status of tax payers, but this

position may not persist.

14 November 2011

Naomi Winston

Ten Old Square

Lincoln’s Inn

27 At [39], per Langstaff J.

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Appendix For the avoidance of doubt, unless the context indicates otherwise, The term ‘salaried partner’ is used below as a generic name covering all questionable positions, but the content is intended to apply equally to any position, the status of which is disputed. Partner Employee Case Remuneration stated to be by way of share of profits. This is relevant, even if partner waives right to those profits.

Remuneration by salary or share of profits that will not be affected by the overall profits.

Williamson & Sodeni; M Young Legal Associates Ltd v Zahid Solicitors (a firm)ii; Hodson v Hodsoniii; Burgess v O’Brieniv.

Remuneration shown in the accounts as part of the profits.

Remuneration shown in the accounts as, e.g., an outgoing.

Horner v Hastedv.

Losses shared. No risk of lossesvi. Note that it can be argued that losses are not being shared but that a loan has been made to the firm/LLP.

Williamson & Soden; Stekel v Ellicevii; Bower v Hughes Hooker & Co Solicitorsviii; Badley v Consolidated Bankix; Chahal v Mahalx.

Capital injected into the firm/LLP. No capital stake and no obligation to build one up. Williamson & Soden; Stekel. A right to share of the residue on dissolution No right to a share of the residue on dissolution. Stekel; Tiffen v Lester Aldridge LLPxi. Party to the partnership/LLP agreement. Party to one agreement with a separate agreement

applying to ‘true’ partners, but not the ‘salaried’ partner.

Williamson & Soden.

The partnership agreement to which the person has signed up is made between the each of the partners (including the ‘salaried’ partners). Note this only applies to partnerships, not LLPs.

The partnership agreement to which the person has signed up is made between each salaried partner and the true partners but not between the salaried partners.

Horner.

There is mutuality of obligations between all partners/profit-sharing members, whether ‘salaried’ or not.

The duties and rights found in the partnership/LLP agreement favour the ‘true’ partners/profit-sharing members over the salaried partners.

Entitled to attend meetings/be consulted about partnership/LLP decisions.

Not entitled to attend meetings/be consulted about partnership/LLP decisions.

Williamson & Soden; Cobbetts LLP v Hodgexii; Tiffin.

Voting rights. No voting rights. Bower. Not controlled by other partners/profit-sharing members.

Elements of control, e.g. requirement to achieve targets and monitoring of performance.

Williamson & Soden.

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The name of the documents the person is asked to sign are indicative of employment, e.g. a ‘compromise agreement’.

Williamson & Soden.

Called a partner/profit-sharing member. Called an employee.xiii Ownership of joint property.xiv No discussion of employment. No discussion of partnership/profit-sharing

membership. O’Kelly v Darraghxv; Kovats v TFO Management LLPxvi.

Held out as a partner/profit-sharing member to third parties – e.g. on website, letterhead.

Held out as an employee to third parties. Davis v Davisxvii; Nationwide BS v Lewisxviii.

Pays own tax and NI. Firm/LLP pays tax and NI. Stekel; Kovats. Ability to terminate the partnership/LLP. Stekel. Required to make own pension arrangements. Person contributes to an employees’ pension

scheme. Horner; Tiffin.

Meetings of the partners/members are not quorate, unless the person is in attendance.

Horner.

Can sign cheques on behalf of the firm. Not permitted to sign cheques on behalf of the firm. Horner; Cobbetts; Tiffin. Acts within the person’s authority bind the acknowledged partners and their such acts bind him.

M Young Legal Associates Ltd.

Shares the same benefits (e.g. health insurance) as the true partners/profit-sharing members.

Has a different set of benefits from the true partners/profit-sharing members.

Tiffin.

Receives only information sent to partners/profit-sharing members.

Receives only information sent to employees. Tiffin.

Person is permitted/required by the regulatory body of the relevant profession to be a partner/profit-sharing member.

Person not permitted by the regulatory body of the relevant profession to be a partner/profit-sharing members.

Horner; M Young Legal Associates Ltd; Hodson.

Removal by expulsion. Removal by dismissal/at risk of redundancy. Williamson & Soden. The factors set out in this table are just that – factors. No one factor is determinative. Some will weigh in the balance more than others and some may have no weight at all, in the context of a specific case (e.g. in some firms/LLPs, all persons may be subject to targets, whether they are true partners or employees).

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i [2011] All ER (D) 101 (Aug). ii [2006] EWCA Civ 613. iii [2009] EWHC 430 (Ch). iv [1966] ITR 164. v [1995] STC 766. vi Remember that this relates to partnerships only, not to LLPs. vii [1973] 1 WLR 191. viii [2003] All ER (D) 143 (Sep). ix (1888) 38 Ch.D. 238. x [2004] All ER (D) 190 (Sep). xi [2011] IRLR 105. xii [2010] 1 BCLC 30. xiii Note that the EAT in Williamson & Soden (at [30]) found that this could be a relevant factor, but was in no sense determinative. xiv But note that this is not a requirement of a partnership: Lindley & Banks on Partnership, para 5.27. xv [1988] ILRM 309. xvi [2009] All ER (D) 116 (May). xvii [1894] 1 Ch 393. xviii [1997] 1 WLR 1181. Appealed (and overturned) on a different point: [1998] Ch 482.

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1

MELTDOWN! FACING THE FALLOUT IN LLPs AND PARTNERSHIPS

“NEXT!” THE PERILS OF THE WAITING

ROOM CLAUSE

By Jonathan Gavaghan Ten Old Square

INTRODUCTION

1. Partnership advisors spend much of their time considering the forced removal of

partners and LLP members. We pour over the provisions of expulsion clauses

spotting whether the requirement for showing “cause” have been met; we await

the decision of the Supreme Court on Seldon with baited breath. Enforced

removal remains a hot topic.

2. However in a market for professional services that remains challenging, the

question of the validity of those clauses with the opposite effect also becomes one

of importance. Firms may wish to stop key people leaving and protect themselves

from haemorrhaging members or partners. Provisions in LLP Agreements and

Partnership Deeds can often therefore seek to tie people in rather than kick them

out. For example:

a. Restrictions can occur at the start of the agreement rather than at the end.

Thus when a merger occurs, members of one or both firms might be

locked in for two or three years1 post merger either by being banned from

retiring or else suffering financial penalty if they leave.

1 Reportedly this happened recently in the merger between Clyde & Co. and Barlow Lyde & Gilbert which took place on 1/1/11: Legal Week on 4/8/11 stating that the Barlows partners were locked in for three years and faced a financial penalty if they left early.

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b. One then turns, when looking at exiting rather entering a firm, to what is

probably the universal example of a provision that ties members and

partners in: the requirement for notice periods. No one bats an eyelid at a

notice period of 6 months, perhaps not at a 12-month period. Those

provisions tie people in to allow an orderly arrangement both financially

and commercially for their departure, as well as giving both parties an

element of comfort when predicting their future. But what about other

provisions which give longer periods of notice, either expressly or more

subtly like a provision which states that a partner can retire on giving 6

months notice expiring on the accounting year end date, thus resulting in a

potential notice period of 18 months if the outgoing partner times things

badly?

c. Finally, and the focus of the title of this paper, there are “waiting room”

clauses. These clauses are primarily designed to prevent the sudden

meltdown of a firm and/or teams being poached. Depending on the size of

the LLP or partnership they will typically prevent say more than 2 to 5

members or partners (usually “equity” members or partners) retiring in a

particular time period. If too many members or partners seek to leave at

the same time, they then have to enter the “waiting room” with only a

certain number allowed to exit at any one time. Often only the most senior

are allowed to go, with the more junior members or partners having to

wait. Some clauses are drafted in such a way that those people left in the

waiting room have to give fresh notice the following year, but still have to

wait if other more senior members/partners decide to leave.

3. There is a dearth of authority on the validity of these sorts of clauses. This paper

will therefore examine in outline some of the major issues that affect such

provisions’ validity and enforcement, as well as the pros and cons of having such

provisions in your LLP agreement or partnership deed.

3

RESTRAINT OF TRADE?

4. The first question to consider is whether these sorts of provisions are potentially

caught by the restraint of trade doctrine. In the writer’s view they clearly are.

5. The classic restraint of trade doctrine harks back to Lord MacNaughten in

Nordenfeldt v Maxim Nordenfeldt Guns and Ammunition Co Ltd [1894] AC 535: “The public have an interest in every person’s carrying on his trade freely: so has the individual. All interference with individual liberty of action in trading, and all restraints of trade of themselves, if there is nothing more, are contrary to public policy…”

6. The other classic formulation is given by Lord Morris of Borth-y-gest in Esso

Petroleum Co Ltd v Harper’s Garage (Stourport) Ltd [1968] A.C. 269: “In general, the law recognises that there is freedom to enter into any contract that can lawfully be made. The law lends its weight to uphold and enforce contracts freely entered into. The law does not allow a man to derogate from his grant. If someone has sold the goodwill of his business, some restraint to enable the purchaser to have that which he has bought may be recognised as reasonable. Some restraints to ensure the protection of confidential information may be similarly regarded. The law recognises that if business contracts are fairly made by parties who are on equal terms such parties should know their business best. If there has been no irregularity, the law does not mend or amend contracts merely for the relief of those for whom things have not turned out well. But when all this is fully recognised yet the law, in some circumstances, reserves a right to say that a contract is in restraint of trade and that to be enforceable it must pass a test of reasonableness. In the competition between varying possible principles applicable, that which makes certain covenants and in restrict of trade unenforceable will in some circumstances be strong enough to prevail. Public policy will give it priority.”

7. There are two key points to remember when deciding whether the sort of

provision we are considering here are a restraint of trade.

8. The first is that the restraint of trade doctrine applies not just at the termination of

an agreement, but also during its currency: see e.g. McEllistrim v The

Ballymacelligott Co-op [1910] A.C. 548, English Hop Growers Ltd v Dering

[1928] 2 K.B. 174 and Foley v Classique Coaches Ltd [1934] 2 K.B. 1.

9. The second is that the Court is not concerned with the form of the provisions but

with its substance and practical effect: see Stenhouse Australia Ltd v Phillips

[1974] A.C. 391, PC.

10. A clause that prevents someone for leaving will have the obvious potential effect

of restraint of trade. However, so too might a clause where the member or partner

4

is free to leave, but suffers some financial detriment (or lack of a benefit which

would otherwise have been received) as a result of leaving earlier than was set

out.

11. Scrutton L.J. stated in Wyatt v Kreglinger and Fernau [1933] 1 K.B. 793 at 807-

809 (emphasis added): “a stipulation by the employer that he will pay the plaintiff so much a year if the plaintiff does not enter into the wool trade for the rest of his life in any part of the country or world, appears to me to be a contract in restraint of trade which is unenforceable just as much as a contract by the employee not to trade in the wool trade for the rest of his life in any party of the world… The public policy which has to be considered, the interest of the community, seems to me to be affected quite as much by an agreement that a person will give up a benefit which he would otherwise receive if he enters into a particular trade, as it is by a direct agreement not to enter into that trade.”

12. Likewise, Thesiger J stated in Bull v Pitney-Bowes Ltd [1967] 1 WLR 273, at 282: “So far as the individual is concerned, I appreciate the distinction relied upon by the defendants between (1) a covenants not to take up certain skilled work and (2) the discontinuance of a pension if one does choose to take up that work. The latter does not involve the breach of any promises; but from the point of view of the public and of the reason behind the rule at common law there is little, if any, distinction in principle. The relevant factor is the inducement not to take up work in which one is skilled.”

13. Thus, it is not enough simply to say that a clause does not actually prevent

someone working for another firm, if in fact the financial detriment inflicted under

a clause as a result is in effect a restraint of trade.

REASONABLENESS OF THE RESTRICTION: PARTNERSHIP LAW

14. If the clauses may fall foul of the restraint of trade doctrine, the burden of proving

that the clauses were reasonable would fall on the firm.

15. It would need to show:

a. It had a legitimate interest capable of protection.

b. That the restriction being imposed is not in excess of what is needed to

give that protection.

c. (There is a third part of the test, when the Court goes on to consider the

question of public interest. However, this is rarely relevant in these sort of

cases).

5

16. It is well recognised (thought not always outside those who have had reason to

consider restraint of trade in the partnership context!) that partnerships are

different from employer/employee relationships when it comes to the enforcement

of restrictions and considerations as to whether they are in unlawful restraint of

trade.

17. The key case is of course Bridge v Deacons [1984] AC 705, the rationale of which

is based primarily on the concept of mutuality, a factor absent (at least usually)

from an employer/employee relationship. Thus Lord Fraser of Tullybelton in that

case (when addressing the question of reasonableness in a partnership case) stated

at p. 716: “On this question the mutuality of the contract is a most important consideration. The contract applied equally to all the partners. None of them could tell whether he might find himself in a position of being a retiring partner subject to the restriction in clause 28, or of a continuing partner with an interest to enforce the restriction.”

18. Bridge v Deacons remains controversial, or at least the result does. The Privy

Council held that the restriction in the deed affecting Mr Bridge was valid, the

covenant preventing Mr Bridge for five years for working in Hong Kong for any

person who had been a client of Deacons in the three year period running up to his

departure for five years. However, one would have thought that the concept of

mutuality and its effect on the Court’s assessment of reasonableness is likely to

stay certainly in respect of clauses where the member does not know whether they

would be relying on the clause to keep a fellow member in the firm, or seeking to

leave the firm despite the clause. (Note the Court of Appeal in Seldon v Clarkson

Wright & Jakes [2011] 1 All E.R. 770 approved the EAT’s reference by analogy

to the major justification in Bridge v Deacons [1984] AC 705 of mutuality given

to support the enforceability of the restriction against competition by Mr Bridge:

perhaps giving further support to the argument that Bridge v Deacons remains

good law in the restraint of trade cases2.)

2 Seldon is off to the Supreme Court, but it has to be doubted that their Lordships would see that appeal as being an appropriate opportunity to revisit the question of restraint of trade in Bridge v Deacons (supra) in depth, although their treatment of mutuality in the context of age discrimination may be worth watching for any collateral effect their reasoning may have on the approach to restraint of trade.

6

19. While Bridge v Deacons was a decision about a traditional partnership there

seems little reason to distinguish it from the case of an LLP, there will be

mutuality in respect of the members’ obligations under the LLP agreement in the

same way as there would be under a partnership deed.

20. One caveat should however be kept in mind generally in respect of Bridge v

Deacons. It is likely that members who are the equivalent of salaried partners

may effectively be treated as employees when considering whether a covenant is

an unreasonable restraint of trade: the lack of mutuality between “equity” and

“salaried” was not a matter considered by the Privy Council in that case.

WILL THE PROVISIONS BE ENFORCEABLE?

21. We will look at the three examples given in the introduction of this paper in

respect of enforceability.

(a) MERGER LOCK-IN

22. The merger lock-in, depending on its duration, is likely, one would have thought,

to satisfy the reasonableness test. There is a reasonable requirement for the

merged firm to “bed down” by making sure that there is no exodus of partners in

its early years.

23. The mutuality argument in favour of upholding the provision would dissipate if

only one side of the merger was bound, especially if it was the members or

partners of a smaller firm being effectively taken over by a larger firm. Having

said that, if the larger firm is taking on liabilities of a struggling smaller firm, then

there is something to be said for ensuring that the goodwill that is being

effectively bought remains at the disposal of the larger firm, therefore what may

appear to be one-sided restrictions might be justified despite the lack of mutuality.

(b) LENGTHY NOTICE PERIODS

24. Truly lengthy notice periods might also be susceptible to challenge. Firms of

course require an element of time to allow for an orderly transition when a

member or partner leaves. However, whether anyone really needs more than a

7

year to arrange for the retirement of someone must be questionable. The

provisions about leaving an exit to the end of an accounting year have some

rational basis, but one wonders whether the accounting difficulties and the need to

pro-rata profit etc. for a non-accountancy period really is a sufficient justification

for tying someone in for a long period.

(c) WAITING ROOM CLAUSES

25. Then one turns to the waiting room clauses. The legitimate interest sought to be

protected by such clauses would include the following:

a. A need to promote medium to long term planning for a firm;

b. A need to prevent financial instability from a sudden significant departure

of members or partners, leading to a fall in income at the same time as a

sudden and unexpected call for the return of capital for leavers;

c. A need to protect the firm from predatory competitors who seek to

encourage team moves.

26. As stated above, despite waiting room clauses not being uncommon, there has

been no recorded decision relating to their validity. If one were to analyse the

aims set out above one would have to be a little sceptical about whether the firms

would be able to withstand a sustained assault on their validity, particularly on the

second limb of the test which requires the restriction not to be in excess of what is

need to give that protection:

a. In terms of the need for medium to long term planning, normal notice

periods would appear to provide all the reasonable protection that a firm

would need.

b. The fear of financial instability might justify some form of delay in paying

out capital to outgoing members or partners if a more than a certain

number left. Extra time would allow for a firm to reorganise its funding

or recruit replacement equity members/partners.

c. A waiting room clause does delay a mass exodus from a particular

department, thus if the clause was valid and enforceable it would assist a

firm by protecting it from a predator seeking to steal the entire team (or at

least the partners making it up). However, a waiting room clause is

8

somewhat of a blunt instrument unless it specifies that it applies to a

number of members/partners leaving a specific department. Even then, the

effect of a departure would depend on the size of the department – three

members leaving a department with four members is a different matter

from three leaving a department of twenty. Given that reasonableness is

determined at the time the relevant agreement is entered into though, it is

difficult to see a Court being able to determine the validity of the clause by

reference to how it was later being applied in respect of a particular

department. If (as is likely) departments varied in size then defending the

clause may be difficult unless each department was dealt with differently.

In addition, the firm is already protected by the fact that LLP members

would owe a duty of good faith to the LLP, and any involvement in a team

move unless unwitting is likely to be a breach of that duty – which means

that the law already provides protection to prevent such teams moves.

(Having said that, there is a difference in the theoretical position at law,

and the practical position of trying to monitor and enforce it!)

27. Furthermore, waiting room clauses perhaps make more sense in an LLP with a

relatively small number of members or a small partnership governed under the

1890 Act. There the exiting of more than one or two partners could lead to a

catastrophic period if very significant levels of income were to suddenly

disappear. However, the larger the firm, the less necessary the provisions seems

to be. Thus there is a danger if earlier in a firm’s history it had such a clause, but

maintained it as it expanded without properly analysing whether its original aims

were still legitimate or proportionately achieved.

28. Having said all that, one then falls back to Bridge v Deacons style mutuality point.

The key argument in upholding such clauses is that everyone went into the LLP or

partnership expecting it to be protected from sudden departures – no one would

have known whether they would be the one trying to leave or be the one trying to

avoid being the one left to turn the lights out. Everyone was prepared to agree the

provisions accepting that it might slow down their departure but the quid pro quo

being that they would not risk ever been left as one of a small number of surviving

members or partners facing large liabilities when everyone else had jumped ship.

9

That may be enough to salvage the clauses from being struck down as invalid

restraints of trade.

THE OTHER REMEDY: DISSOLUTION (A.K.A. THE NUCLEAR OPTION!)

29. Assuming that the firm were able to stave off an attack alleging invalidity by

reason of restraint of trade, they may still be in peril.

30. The classic application of the restraint of trade principle is of course when a leaver

is attempting to poach clients, having left the firm. He or she has no further

influence on the internal workings of the firm. Waiting room clauses however

throw up another issue and it is this which creates the danger for firms unique to

this situation: if the member or partner is tied in under the agreement, he or she

may seek to apply to the Court to wind up the firm on the just and equitable

ground.

31. As stated above, reasonableness of a restraint of trade clause is determined as at

the time the LLP Agreement or Partnership Deed was entered into. Determination

of the just and equitable ground is determined at the time of the application – and

a member or partner stuck in the waiting room may say that whatever the parties

thought about the position historically when they first entered into the agreement,

times have changed. If someone was being told they were locked into the waiting

room for many years, and they had to sit and watch more senior partners leave and

salvage their capital from a struggling firm, one can see that the Court would have

some sympathy for the partner(s) stuck. Of course, the counter argument would

be that they signed up to the agreement, but that can only have so much weight

attached to it

32. In respect of a traditional partnership, a partner who is locked in against his or her

will could seek to apply to the Court for an order for the dissolution of the

Partnership under section 35(f) of the Partnership Act 1890 on the ground that it

was just and equitable to do so.

10

33. The equivalent right of a member of an LLP is a little more complicated. There

would be two potential options.

34. Firstly, in the absence of any provision excluding the LLP from the Court’s

jurisdiction under section 994 of the Companies Act 2006 a member would have

the right to bring a petition for unfair prejudice. However, this right is of course

generally excluded by well-drafted LLP agreements. Any LLP which has sought

to be so restrictive as to contain a waiting room clause is likely to have excluded

the Court’s jurisdiction under section 994.

35. The second option cannot be excluded under the LLP agreement: i.e. the right to

apply to the Court under section 124(1) of the Insolvency Act 1986 to wind-up the

LLP, and in particular to seek it on the just and equitable ground.

36. However the rights of a member to petition for the winding up of an LLP are not

free from doubt. Section 124(1) of the Insolvency Act It states that a petition can

be presented by: “the company, or the directors, or by any creditor or creditors (including any contingent or prospective creditor or creditors), contributory or contributories…”

37. Under Company law, the reference to “directors” requires the directors to act

unanimously or by valid resolution of the board of directors.

38. The relevant provisions of the Insolvency Act are applied to LLPs by para 5 of the

Limited Liability Partnership Regulations 2005 (SI 2005 No. 1090) with

modifications set out as follows in paragraph 5(2): “(2) The provisions of the 1986 Act referred to in paragraph (1) shall apply to limited liability partnerships, except where the context otherwise requires, with the following modifications— (a) references to a company shall include references to a limited liability partnership; (b) references to a director or to an officer of a company shall include references to a member of a limited liability partnership; (c) references to a shadow director shall include references to a shadow member; (d) references to [the Companies Acts], the Company Directors Disqualification Act 1986, and the Companies Act 1989 or to any provisions of those Acts or to any provisions of the 1986 Act shall include references to those Acts or provisions as they apply to limited liability partnerships by virtue of the principal Act; (e) references . . . to the articles of association of a company shall include references to the limited liability partnership agreement of a limited liability partnership; (f) the modifications set out in Schedule 3 to these Regulations; and (g) such further modifications as the context requires for the purpose of giving effect to that

11

legislation as applied by these Regulations.”

39. When applied to LLPs, it is clear that the LLP itself can present a petition (in

place of the “company”) as can creditors.

40. However, a decade after the creation of LLPs. it is still unclear how the rest of the

definitions will be applied to them. By analogy to the cases on directors’

petitions, it would appear that the reference in the section to directors should be

translated over to the LLP context by referring to the members acting collectively,

either unanimously or by way of a vote. It would not, it would appear, refer to an

individual member applying to Court. In the circumstances it appears that in

order to have status to present a petition a member would need to come within the

definition of contributory or creditor.

41. Section 79(1) of the Insolvency Act 1986 defines contributory as follows

(amended for application to LLPs): “79 Meaning of “contributory” (1) In this Act . . . the expression “contributory” means every person liable to contribute to the assets of [an LLP] in the event of its being wound up, and for the purposes of all proceedings for determining, and all proceedings prior to the final determination of, the persons who are to be deemed contributories, includes any person alleged to be a contributory.”

42. Section 74 further sets out the following (likewise amended): “74 Liability as contributories of present and past members (1) When [an LLP] is wound up, every present and past member is liable to contribute to its assets to any amount sufficient for payment of its debts and liabilities, and the expenses of the winding up, and for the adjustment of the rights of the contributories among themselves. (2) This is subject as follows— (a) a past member is not liable to contribute if he has ceased to be a member for one year or more before the commencement of the winding up; (b) a past member is not liable to contribute in respect of any debt or liability of the company contracted after he ceased to be a member; (c) a past member is not liable to contribute, unless it appears to the court that the existing members are unable to satisfy the contributions required to be made by them . . .; (d) in the case of a company limited by shares, no contribution is required from any member exceeding the amount (if any) unpaid on the shares in respect of which he is liable as a present or past member; (e) nothing in [the Companies Acts] or this Act invalidates any provision contained in a policy of insurance or other contract whereby the liability of individual members on the policy or contract is restricted, or whereby the funds of the company are alone made liable in respect of the policy or contract; (f) a sum due to any member of the [LLP] (in his character of a member) by way of dividends, profits or otherwise is not deemed to be a debt of the company, payable to that member in a case of competition between himself and any other creditor not a member of the company, but any such sum may be taken into account for the purpose of the final adjustment of the rights of the contributories among themselves.

12

(3) In the case of a company limited by guarantee, no contribution is required from any member exceeding the amount undertaken to be contributed by him to the company's assets in the event of its being wound up; but if it is a company with a share capital, every member of it is liable (in addition to the amount so undertaken to be contributed to the assets), to contribute to the extent of any sums unpaid on shares held by him.”

43. When looking at the position of a member of an LLP, trying to draw an analogy

with a shareholder of a limited company is not entirely fruitful. As has been

seen, under section 74(2)(d) of the Insolvency Act 1986 a shareholder of a limited

company is liable to contribute to the company’s assets to any amount sufficient

for the payment of its debts and liabilities, and the expenses of the winding up,

and for the adjustment of the rights of the contributories amongst themselves, but

the liability is limited to the amount unpaid on his shares. A shareholder or

indeed a past shareholder, whose shares are fully paid up is still a contributory,

even though he has no further liability on a winding up: see Re Anglesea Colliery

Company (1866) LR 1 Ch App 555 and Re Consolidated Goldfields of New

Zealand Ltd [1953] Ch 689.

44. However, that approach does not assist LLP Members, who do not hold shares as

such. The question of whether a member is a contributory depends upon the terms

of the LLP Agreement. If the LLP Agreement makes members liable to

contribute to the assets of the LLP in the event of a winding up (even if it is a

nominal amount) then they will be a contributory and have standing to present a

petition. However, the difficulty arises if (as is not uncommon) there is no duty to

contribute on a winding up. It is difficult to see therefore how such a member

would be a “contributory”.

45. Whether they can call themselves a creditor may depend on the financial situation.

That causes particular problems in the “meltdown” situation – if a mass exodus is

planned from an LLP the chances are that it may be facing financial problems of

its own. If the LLP is struggling, members current accounts may be overdrawn

with drawings outpacing profit shares and money ending up being owed by the

member to the LLP rather than the other way round. It would appear that a

member cannot point to the fact that the firm owes him or her capital and use that

to say they are a creditor: the argument being that a (current) member cannot

prove in the winding up of an LLP for his or her capital – in a winding-up capital

13

will only be revered if there is a surplus after all debts and obligations have been

satisfied (see s. 74(1)(f) of the Insolvency Act 1986). That in turn might be said

to prevent a member presenting a winding up petition, because they were neither a

contributory nor a creditor. This may apply to unpaid profits as well by reason of

the same provision.

46. Despite all of the above, it would appear to be the case that the Courts would be

expected to try their hardest to reach the conclusion that a member of an LLP

could bring a petition, irrespective of whether they had to contribute or were a

current creditor of the LLP. It would be surprising if Parliament did not intend to

allow a member to petition for a winding up on the just and equitable ground.

The answer may be that the Courts will take a wide view of “directors” and say

that in the case of LLPs this equates to an individual member: relying on the

sweeper provision in para 5(2)(g) allowing such further modifications as the

context requires for the purpose of giving effect to that legislation.

47. If however the correct law is that they cannot bring a petition, then this may add

weight to the other argument to the effect that a waiting room clause is a restraint

of trade - if the LLP Agreement’s effect is both that a member cannot leave for

years and cannot petition the Court under section 994 of the Companies Act or

Section 79(1) of the Insolvency Act 1986, then a Court might well be driven to the

conclusion that the waiting room clause was an unreasonable restraint of trade

after all.

CONCLUSION: THE ADVANTAGES AND PERILS OF THE WAITING ROOM CLAUSE

48. The advantages of waiting room clauses is that people seem to accept them as

being valid – and their existence has an effect on behaviour without anyone

carrying out an in-depth analysis of them. Their simple existence may discourage

a team move (“What’s the point, they can stop us all going?”). They may also

stem a haemorrhage of individuals and allow a firm to negotiate a more spaced

exit than would otherwise occur before there is any risk of winding up petition.

14

49. However, the perils would emerge if someone stuck in the limbo of the waiting

room decided to call the firm’s bluff. An application to Court could bring with it

horrendous publicity and if fought could end up in the firm being wound up – with

all the unwelcome side effects that would have. The mere threat of presentation

of a winding up petition against an LLP may be enough to make the firm change

its position, not least because of the potentially disastrous publicity that would

occur if the petition were proceeded with.

50. That creates a considerable bargaining chip for the partner/member who wishes to

leave and means that a firm that relies on a waiting room clause may put itself in

some peril.

Jonathan Gavaghan 10 Old Square Lincoln’s Inn

London

jonathangavaghan@tenoldsquare.com

15th November 2011

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REPUDIATION – HE’S NOT A MEMBER; HE’S A VERY NAUGHTY BOY!

________________________________________________

NOTES TO ACCOMPANY SEMINAR 17 NOVEMBER 2011 JEREMY CALLMAN

________________________________________________ A. WHAT IS REPUDIATION?

1. Dredging back to the days of university and basic contract law a neat definition

is given in Halsbury’s Laws of England Vol 9(1) paragraphs 997-8:

“Instead of merely failing to provide due performance at the stipulated time, one party (A) may put himself in breach by evincing an intention, by words or conduct, of repudiating his obligations under the contract in some essential respect. Repudiation is a serious matter, not to be lightly found or inferred. Such repudiation may occur at the time fixed for performance or before that time; in the latter case it is known as 'anticipatory breach' or 'anticipatory repudiation'. Repudiation will give the innocent party (B) the right to treat the contract as discharged and claim damages. Repudiation may be express or implied. Not every refusal by A to perform a part of the contract amounts to a repudiation which entitles the other party (B) to treat the contract as at an end; there must be a refusal to perform something which goes to the root or essence of the contract. Thus it is not just any delay in breach of contract which amounts to a repudiation, but only such delay as would frustrate the adventure.”

2. Faced with conduct of that nature the innocent party is entitled to elect to treat

the contract as no longer binding upon him and thereby he is discharged from

further performance of the contract (albeit that rights are not divested or

discharged which have already been unconditionally acquired). Alternatively

the innocent party is entitled to affirm the contract and seek damages for the

breach.

3. What sort of conduct might we be talking about in the partnership context?

Lindley & Banks paragraph 24-09 talks about1 conduct which is of a “fairly

1 Lindley & Banks Edn 19 has retained the earlier passages on repudiatory conduct which had been written by Roderick Banks on the pre-Hurst v Bryk assumption that repudiatory breach applied to

2

extreme nature, amounting to a denial of the partnership agreement or of the

partnership itself”. For the many years during which repudiatory breach of

partnerships was assumed to apply to traditional partnerships, the type of

conduct that one would talk about would be for example where partners

purported to exclude one of their number without a power of expulsion, placing

a partner on garden leave without a power to do so, exclusion from partner

decision making, or otherwise effectively treating that person as if he was no

longer a partner.

B. WHY DOES THIS ALL MATTER?

4. It is tempting to think this is just dry academic games. It is not. If repudiatory

breach brings to an end a partnership then the future performance of the

partnership agreement goes with it2. Therefore if the partnership agreement

contains eg a lengthy notice period or a ‘waiting-room’ clause, if repudiatory

breach worked then it would bring to an end the operation of such clauses.

Likewise the effectiveness of restrictive covenants3. In the LLP context, for

example, a statutory exclusion of section 994 of the Companies Act 2006

(unfair prejudice) would disappear if the repudiatory breach concept worked.

This amounts to a huge potential weapon in the hands of an individual partner

faced with the overbearing might of the firm.

C. DOES IT WORK IN TRADITIONAL PARTNERSHIPS?

5. First I want to look at the ‘orthodox’ position and then to consider some recent

challenges to that position, one home-grown and one antipodean.

traditional partnerships. This section of the book is introduced at para 24-09 under the heading “factors which would be relevant if the doctrine applied”. 2 There may be some nuances to attach to this bold statement. In the judgment of Phillips LJ in Rock Refrigeration Ltd v Jones [1997] ICR 938, there is discussion of restrictive covenants which might survive repudiation (see 959 C-G). 3 See the preceding footnote, by way of caveat.

3

(I) The ‘Orthodox’ view – Lord Millett and Neuberger J

6. Historically the position was established by Mr Justice Harman in Hitchman v

Crouch Butler Savage Associates (best reported at in the Law Society Gazette

1983 at page 550) :-

“Harman J said that logically, the first question, was whether the doctrine of repudiation could apply to a partnership at all; a passage in Lindley on Partnership, 14th edition (1979) pp.611-612, suggested that a fundamental breach would not entitle a partner, without an order of court, to treat the partnership as at an end. The following sentence appeared at first to contradict that statement, but ended with the latin tag, ‘sed quaere’, and it appeared to be incomprehensible. The first sentence was unconvincing, and was not good law. The doctrine of repudiation and other contractual provisions applied to a partnership contract, whether made by deed or orally, in the same way as it did to all other contracts. Equity had acted in aid of the law, and the Partnership Act 1890 was not a complete code; it did not rule out the laws of contract which equity had been acting in aid of”.

Indeed in support of Harman J’s proposition, under section 46 of the Partnership

Act 1890 :-

“46 The rules of equity and of common law applicable to partnership shall continue in force except so far as they are inconsistent with the express provisions of this Act”.

7. This then was the established position for many years4 and repudiatory breach

was regularly run in the context of a traditional partnership.

8. Indeed it was run through the court at first instance and the Court of Appeal in

Hurst v Bryk. It was only when the matter reached the House of Lords ([2002] 1

AC 185) that Lord Millett, in three carefully framed pages of reasoning,

demolished the principle.

9. Firstly he identified that repudiatory breach principles applied in the context of

“a simple contract”. He makes it clear that :

4 See also Fulwell v Bragg (1983) 127 SJ 171.

4

“there is no reason why it should not apply to an agreement to enter into partnership or to the contractual obligations which the partners mutually undertake to observe after the partnership has come to an end. But I have considerable doubt that it can be employed to bring about the automatic dissolution of the partnership itself”.

10. It seems clear from this that in principle one could have repudiatory breach of

(a) an agreement to enter into a partnership or (b) an agreement that is to take

effect at the end of a partnership. Both these types of agreements are nothing

above and beyond a simple contract. What Lord Millett questions is whether or

not repudiatory breach can be used to bring about the dissolution of the

partnership itself5.

11. He concludes that it cannot. This is essentially for the following reasons :

(a) The relationship of partnership is “more than a simple contract... it is a

continuing personal as well as commercial relationship”. Indeed he

refers specifically to section 1 of the Partnership Act which defines

partnership as “the relation which subsists between persons carrying on

a business in common with a view of profit” (my emphasis). In a

slightly confusing passage he states:

“The question, however, is not whether the doctrine applies to the contract of partnership, but whether it operates to bring about the automatic dissolution of the partnership relationship”.

(b) The most important reasoning leading to his conclusion is the operation

of section 35 of the Partnership Act 1890. This provides a statutory

framework under which the court may (ie discretionary) decree a

dissolution of the partnership including on the terms set out at paragraph

35(d), namely :

5 This firm statement is subject to one further caveat. It is conceptually possible that the parties to a traditional partnership might have expressly agreed in their partnership agreement that repudiatory breach shall be an agreed means by which the partnership relationship shall be brought to an end. This is postulated by Roderick Banks as being a potential way in which repudiatory breach might operate but it seems almost theoretical to think that any such clause could ever be inserted in a partnership agreement.

5

“wilfully or persistently commits a breach of the partnership agreement, or otherwise so conducts himself in matters relating to the partnership business that it is not reasonably practicable for the other partner or partners to carry on the business in partnership with him”.

In his view allowing a repudiatory breach to bring about an end to a

partnership agreement without the discretionary involvement of the

court under section 35 would “circumvent the discretionary power of the

court under section 35”.

12. This is indeed plainly correct. Even if one was to say that Lord Millett was

merely talking about repudiation of the partnership contract itself and that

somehow the relationship persisted separately, then the persisting partnership

would be a partnership at will which could then be dissolved by any partner.

Lord Millett left matters on the basis that this was not something that he needed

to decide because the parties had proceeded in the courts below on the

assumption that the doctrine of repudiatory breach did apply to traditional

partnerships. The matter was not strictly before the House of Lords6.

13. There then ensued ferocious academic debate about the rights and wrongs of

Lord Millett’s (obiter) views. Neuberger J (as he then was) addressed the

position in Mullins v Laughton [2003] Ch 250 at 272 :

“This indicates to me that he was suggesting that accepted repudiation could not determine the contract (or the partnership) while the partnership was in existence. That certainly seems to have been the view of the editors of the current edition of Lindley & Banks on Partnership, 18th ed (2002), para 24-06. Unlike a lease, where there is an interest in land which is effectively detached from the contract which created it, a partnership cannot be detached from the partnership agreement: the relationship is contractual, but is subject to equitable principles and the provisions of the Partnership Act 1890. Accordingly, I am unconvinced

6 As per Lord Millett at 196D: “The courts below, however, found that the dissolution of the partnership was brought about by the acceptance by Mr Hurst of his partners' repudiatory breach of contract and not by mutual agreement. That finding, and the assumption on which it is based, have not been challenged before your Lordships. In these circumstances I am content to proceed on the basis of the same assumption while reserving for future consideration the question whether it is correct.”

6

that the continuing contract can be determined without the relationship being determined”.

Essentially the contract of partnership cannot be detached from the partnership

relationship.

14. He analysed the arguments against and took the view that Lord Millett’s

reasoning was correct: “Lord Millett’s provisional view should prevail”.

Essentially he turned what had been previously obiter into a decision of the

court. It is notable that in the earlier unreported decision of Goodchild v

Chadwick 18th September 2002, Kevin Garnett QC sitting as a deputy judge of

the High Court had likewise said that “the reasoning in that case is extremely

powerful, and in any event I would feel bound to accept it”.

(II) The Moncaster attack

15. In a recent unreported decision of Golstein v Bishop 15th July 2011, Master

Moncaster refused to give summary judgment on the basis of Roderick Banks

arguing that repudiatory breach did not operate in respect of a traditional

partnership. His reason for so doing was essentially paragraph 14.13 of Mark

Blackett-Ord’s book on Partnership (Edition 3) :

“The speech of Lord Millett and the judgment of Neuberger J mentioned in the last paragraph may overstate the case. There is no reason why the doctrine of repudiation should not apply to the partnership relationship provided that all the partners are either on the giving or the receiving end of the repudiatory behaviour. To require every such case to go to court for the dissolution to be determined as a matter of discretion would be inconvenient. Indeed Lord Millett himself may have accepted this when he said :

The contractual doctrine of repudiatory breach is essentially bilateral. It could work if you had two partners, or if the partners fell into two rival camps. But it could not possibly work with (say) 25 partners …

The conclusion must be that the doctrine of repudiation may apply to the partnership (as rescission undoubtedly may) where, but only where, there is a two-partner firm or where every partner can be classed as either a partner who is committing (expressly or vicariously) the repudiation or suffering the repudiation. The existence of any neutral partner makes the doctrine inoperable”.

7

16. Master Moncaster having set out Roderick Banks’ conclusion in Lindley &

Banks Edn 19, accepting7 the application of Lord Millett’s position (as adopted

by Neuberger J), went on to set out the passage in Mark Blackett-Ord’s book

quoted above. Master Moncaster concluded :

“On that state of the law, as put in the two pleaded textbooks on partnership, it seems to me that it is possible that a judge at first instance might in a case such as this of a two partner firm where it is alleged that one of the partners has repudiated the agreement and the other partner has accepted that repudiation, he might, although obviously he would pay very great regard to Mr Justice Neuberger’s decision, he might consider that he could reach a different conclusion. Even if a judge at first instance would feel that it was his duty to accept Mr Justice Neuberger and leave the matter open to the higher court, it does not seem to me that it would be right for me on this application to give summary judgment. Even if it has to go to a higher court it seems to me that it would be desirable for the higher court to learn the facts before reaching a decision rather than being faced with a sort of exam question in pure law without knowing the actual facts on which the question arises. Therefore, it is my view that that is another reason for there not being summary judgment on this issue, even if one thought that it was impossible for any first instance judge [inaudible] follow Mr Justice Neuberger. Therefore, although I can see that there are serious difficulties in Mr Golstein’s way in pursuing this claim for damages, I think it is impossible for me to say there is no real prospect of success and therefore, regrettable though the amount of costs that have been spent on this dispute is, I consider that this issue will have to go to trial” (emphasis added).

17. With the greatest of respect to my friend Mark Blackett-Ord, it seems to me that

his paragraph 14-13 is profoundly wrong. The very position that Mark

contemplates is expressly dealt with by Lord Millett in Hurst v Bryk when he

says (at 195C-D):

“It is true that a partnership may also be dissolved by mutual agreement, and it may be objected that this is not mentioned either; but in fact it is catered for by section 19 taken in conjunction with section 32(a). This cannot be relied on to support the admission of an accepted repudiation as an automatic ground of dissolution. The theory that a repudiatory breach of contract is an offer to terminate the contract which can be accepted by the offeree, thereby bringing the contract to an end by mutual consent, is discredited. The contract is brought to an end by the

7 Albeit rather grudgingly!

8

exercise of a right conferred by law on the parties to the contract from the outset, not by virtue of a new agreement between them”.

If all the partners in a traditional partnership are either on the repudiating side or

on the side of those accepting the repudiation, there is effectively a mutual

agreement as to the dissolution of the partnership. This is however not the

operation of the doctrine of repudiatory breach. The partnership arrangement is

brought to an end by all parties agreeing to dissolve the partnership. Indeed a

similar principle applies in the context of retirement in that even if there is no

express entitlement to retire, if all the parties impliedly consent to a retirement

then it can be found to be binding upon them: see Sobell v Boston [1975] 1

WLR 1587. The statutory basis for dissolution by mutual agreement can be

found in a combination of section 19 and the preamble to section 328.

18. That dissolution can occur by mutual agreement is not the same as saying that

the doctrine of repudiation applies. This is not a ‘hole’ in the analysis in the

Hurst v Bryk reasoning. Dissolution by mutual agreement is conceptually totally

distinct from repudiation. If anything it supports Lord Millett’s analysis in

which dissolution is the mechanism for bringing a traditional partnership to an

end.

(III) The Australian attack

19. The courts of Australia are normally a well respected legal jurisdiction where

carefully thought through judgments often pioneer the law. However in Ryder v

Frohlich [2004] NSWCA 472 the judgment of the court is not (with respect) an

impressive piece of jurisprudence. It does consider in terms the decision of Lord

Millett in Hurst v Bryk and that of Lord Neuberger J in Mullins v Laughton. The

judges seemed to prefer the views of academics (Peden and Carter) in their

article “The Bonds of Partnership” (2000) 16 Journal of Contract Law page 275.

On the facts of that case, firstly the parties did not argue the point and secondly

8 Section 19 reads: “The mutual rights and duties of partners whether ascertained by agreement or defined by this Act may be varied by the consent of all the partners and such consent may be either express or inferred from a course of dealing.” Section 32 commences: “Subject to any agreement between the partners, a partnership is dissolved....”.

9

in any event the decision in this case to uphold the judge below was “I have

concluded that the primary judge’s decision can be sustained both on the basis

that Mr Frohlich elected to accept Mr Ryder’s repudiatory conduct as well as on

the basis that the partnership had been determined by abandonment, so it is not

necessary to explore this fascinating point further”.

20. Essentially given that this was a two partner firm, we were talking here about

dissolution by mutual agreement. This is referred to by the Australian court as

“abandonment”. They indicate this at paragraph 135 of a judgment where, they

talk, albeit in contractual terms, of neither of the parties (ie neither of the

partners) intending that the contract should be further performed. Essentially

this is no more than a different way of putting Mark Blackett-Ord’s point at

paragraph 14.13 of his book9.

21. It seems to me that the legal analysis of Lord Millett and Mr Justice Neuberger

remains undented and that the simple position is that, in a traditional

partnership, repudiatory conduct cannot10 bring a partnership to an end.

D. WHAT ABOUT THE APPLICATION OF THESE PRINCIPLES TO AN LLP?

22. Does the doctrine of repudiation apply to an LLP? One immediately asks why

should the position be different from a traditional partnership? The answer is

several-fold :

(a) Under section 1(5) of the Limited Liability Partnerships Act 2000 the

statute states in clear terms :

“except as far as otherwise provided by this Act or any other enactment, the law relating to partnerships does not apply to a limited liability partnership”.

(b) More importantly the factors that lead to the decision in Hurst v Bryk are

simply not present in the context of an LLP. Section 35 of the

9 Which I have addressed at paragraph 17 above. 10 See however the caveat at footnote 5 above.

10

Partnership Act 1890, which was so central to the decision of Lord

Millett, does not apply to an LLP nor is there any equivalent provision11.

The relationship underlying an LLP is not one based on equity. Indeed

the underlying relationship is that of agency as between the member on

the one hand and the LLP on the other (see section 6(1) of the LLP Act).

The LLP agreement is a creature of contract.

23. It is for these reasons that Whittaker & Machell in their book on the Law of

Limited Liability Partnerships 3rd Edition stated simply (at paragraph 9.23):

“The authors suggest that the reasoning which applies to preclude traditional partnership agreement (and resultant partnership relationship) from being terminated by an acceptance of a repudiatory breach does not apply in relation to an LLP agreement; and that, in principle, the doctrine of acceptance of a repudiatory breach (resulting in termination of the agreement) applies to an LLP agreement”.

E. ENTER MR JUSTICE BRIGGS!

24. There perhaps matters could comfortably have rested but for a fateful moot that

took place at Serle Court in which Mr Justice Briggs argued that repudiatory

breach ought not to apply to LLPs either. In other words he was suggesting that

just as you could not have repudiatory breach of a traditional partnership, you

ought not to be able to have repudiatory breach of an LLP agreement.

25. His arguments were (with respect) deceptively attractive. He stated as a point of

principle :

“The doctrine of repudiation can apply in pure form only to relationships where the parties are bound by contract alone, rather than by a mixture of contract and statute. If the parties’ relationship is also regulated by statute, then repudiation will not work if its common law consequences would conflict with the statutory regime: see Hurst v Bryk [2002] 1 AC 185, at 195-6”.

11 The nearest process that one adopts is that of a just and equitable winding up under section 122 of the Insolvency Act 1986. This is however very different in character from a dissolution under section 35 of the Partnership Act 1890.

11

26. He correctly observed that one cannot have repudiation of the relationship

between shareholders and a company in the sense of the repudiation of the

articles of association of a company. He went on to reason that given that an

LLP was a hybrid between a traditional partnership and a company it seemed

extraordinary that the ‘child’ of those two parents should be capable of being

discharged by repudiatory breach, when the doctrine did not operate as regards

either its ‘mother’ or its ‘father’.

27. At first blush this seems like a plausible argument. However the reasons why

repudiatory breach does not apply to a company’s articles of association are

very specific to the nature of articles of association. The principle is well

expressed in Bratton Seymour Service Co Ltd v Oxborough [1992] BCC 471 at

475 :

“By virtue of sec.14 the articles of association become, upon registration, a contract between a company and its members. It is, however, a statutory contract of a special nature with its own distinctive features. It derives its binding force not from a bargain struck between parties but from the terms of the statute. It is binding only in so far as it affects the rights and obligations between the company and the members acting in their capacity as members. If it contains provisions conferring rights and obligations on outsiders, then those provisions do not bite as part of the contract between the company and the members, even if the outsider is coincidentally a member. Similarly, if the provisions are not truly referable to the rights and obligations of members as such it does not operate as a contract. Moreover, the contract can be altered by a special resolution without the consent of all the contracting parties. It is also, unlike an ordinary contract, not defeasible on the grounds of misrepresentation, common law mistake in equity, undue influence or duress. Moreover, as Dillon LJ has pointed out, it cannot be rectified on the grounds of mistake”.

28. Articles of association are fundamental to the existence of the company. They

are registered at Companies House and are available for public inspection. They

are a matter of public record and they amount to the constitution of a separate

legal entity. Misrepresentation, mistake, undue influence and duress are

‘ordinary’ contractual concepts and simply do not apply to articles of

association, which is a statutory contract. Although repudiatory breach is not

specifically listed by the court in Bratton Seymour Service Co Ltd v Oxborough

12

in the penultimate sentence of the passage quoted above, it seems to be quite

clear that the same would apply to repudiatory breach.

29. By contrast, an LLP agreement is not a statutory creature it is merely a

contract12. Indeed if it falls away, then under section 15 of the LLP Act 2000

the regulations made by way of Limited Liability Partnership Regulations 2001

kick in. As per Regulation 7 :

“The mutual rights and duties of the members and the mutual rights and duties of the limited liability partnership and the members shall be determined, subject to the provisions of the general law and to the terms of any limited liability partnership agreement, by the following rules”.

Thus where there is no LLP agreement agreed expressly between the parties

(whether in writing or orally) the default regime governs the relationship.

Likewise, where there are gaps in what has been agreed, the default regime

comes in to fill those gaps.

30. The second of Mr Justice Briggs’ arguments was that the idea of the default

regime coming into play was antithetical to the concept of repudiatory breach.

Again, with respect, I do not think this is correct. The mere fact that there is a

default regime does not of itself mean that the LLP agreement cannot come to

an end. Indeed there is a similar default regime spelt out under section 24 of the

Partnership Act 1890 and this was not part of the reasoning of Lord Millett in

Hurst v Bryk.

31. Part of Mr Justice Briggs’ analysis is to refer to the principles by which primary

obligations are replaced by secondary obligations. This is well described in the

case of Moschi v Lep Air Services Ltd [1973] AC 331 at 350 :

“Generally speaking, the rescission of the contract puts an end to the primary obligations of the party not in default to perform any of his contractual promises which he has not already performed by the time of

12 Despite Briggs J reference to section 5(1) of the Limited Liability Partnerships Act 2000, the reference to “governed” in that section is not, in my view, equivalent to the way the Companies Act 2006 makes the articles of association of a limited company a constitutional document. The s.5(1) sense of “governed” is consistent with a simple contract.

13

the rescission. It deprives him of any right as against the other party to continue to perform them. It does not give rise to any secondary obligation in substitution for a primary obligation which has come to an end. The primary obligations of the party in default to perform any of the promises made by him and remaining unperformed likewise come to an end as does his right to continue to perform them. But for his primary obligations there is substituted by operation of law a secondary obligation to pay to the other party a sum of money to compensate him for the loss he has sustained as a result of the failure to perform the primary obligations. This secondary obligation is just as much an obligation arising from the contract as are the primary obligations that it replaces: see R.V. Ward Ltd v Bignall [1967] 1 QB 534, 548.

Although this is the general rule as to the effect of rescission of the contract upon obligations of which it was the course, there may be exceptional primary obligations which continue to exist notwithstanding that the contract has been rescinded. These are obligations that are ancillary to the main purpose of the contract – which is, of course, that the parties should perform their primary obligations voluntarily. Mutual promises to submit to arbitration disputes arising as to the performance by the parties of their other obligations arising from the contract may be expressed in terms which make it clear that it was the common intention of the parties that their primary obligation to continue to perform these promises should continue notwithstanding that their other primary obligations had come to an end: Heyman v Darwins Ltd [1942] AC 356”.

As will be apparent from that analysis, there is no reason in principle why one

cannot have the imposition of the secondary obligation to pay a sum of money

to compensate for the failure to perform, with the continuance of ancillary

obligations. That is pretty well what is happening in the context of a repudiation

of an LLP agreement. One could have a claim for damages arising from the

repudiatory breach and the existence of ancillary rights and obligations under

the default regime13.

32. Briggs J goes on to consider as a final argument that repudiatory breach of an

LLP would ignore the LLP and its stakeholders. With respect I do not think that

is correct. The LLP continues to exist as a separate legal entity. All that has

13 It is also right to note that it ought to be impossible to have repudiatory breach of a default regime under the relations because again this is a creature of statute which simply cannot be removed by operation of the contractual principle of a repudiatory breach. The reasoning in this context is akin to that in the limited company articles of association context.

14

fallen away is the LLP agreement itself which may operate either between the

members and the LLP and/or the members inter se.

33. I do not respectfully think that the arguments put forward by Mr Justice Briggs,

while superficially attractive, are compelling.

F. WHAT THEN IS THE CONSEQUENCE FOR LLPS?

34. Most important in this analysis is to set out the fundamental point as to the

effect of repudiatory breach identified by Lord Millett :

“The contractual doctrine applies to multiparty as well as to two party contracts, but it merely effects the mutual discharge of reciprocal obligations. It necessarily operates bilaterally as between each party in breach and each party accepting the breach as repudiatory by discharging them from their reciprocal obligations. It is difficult to see how it can operate to discharge the parties in the same camp, whether guilty or innocent, from the obligations they owe each other. This can only be achieved by agreement” (emphasis added).

35. This creates potential chaos. It seems clear in principle that the repudiatory

breach only operates bilaterally as between the party or parties in breach and the

party or parties accepting that breach. It follows therefore that one needs to

analyse quite carefully whether the breach is a breach by :

(a) one individual member;

(b) a series of members;

(c) the LLP;

(d) the LLP and one or more members.

36. Just to add to complexity applying normal agency principles, one also needs to

see whether the actions of the member were with the authority of the LLP and

therefore bind the LLP. There is also the question of whether other members or

the LLP itself ratify or adopt the repudiatory conduct such that they too become

15

bound by it. All of this requires careful analysis and thought, based upon normal

agency principles.

37. Once one has analysed who the repudiating parties are and who the accepting

parties are, the LLP agreement comes to an end bilaterally as between those two

groups. As between those two groups therefore the default regime would come

into play. However as regards everybody who is not part of that bilateral

repudiatory breach, the original LLP agreement remains in place. One therefore

ends up in the “twilight zone” of having a situation where you have two

alternative and potentially conflicting regimes running alongside each other.

38. Take the most obvious example of a clash between, on the one hand, default

regulation 7(1) “all the members of a limited liability partnership are entitled to

share equally in the capital and profits of the limited liability partnership” and

the fact that the LLP agreement may well (and in many cases does) spell out

unequal shares of profits and capital. These are matters which have simply not

been thought through. A court would be required to work through how to make

an interrelationship between two alternative regimes operate as a matter of

practice.

39. The important decision in F&C Alternative Investments (Holdings) Limited v

Barthelemy & Others [2011] EWHC 1731 (Ch) [2011] All ER (D) 42 (Nov),

goes some way into analysing situations where the decisions of a management

board may be binding upon the LLP (at paragraphs 221-225 especially).

40. It is also right to say that given that section 4(3) of the LLP Act 2000

specifically states :

“A person may cease to be a member of a limited liability partnership (as well as by death or dissolution) in accordance with an agreement with the other members or, in the absence of agreement with the other members as to cessation of membership, by giving reasonable notice to the other members”.

16

Thus there is a statutory regime by which a member ceases to be a member. It

cannot be said that the acceptance by the innocent party of the wrongdoing

party’s repudiatory conduct is in some sense an agreement by the innocent party

to cease to be a member. Given that there is a specific statutory regime by

which a member ceases to be a member, and given that repudiatory breach does

not fall within either of the ways in which this happens under section 4(3) of the

LLP Act 2000, it would seem to follow that if there is repudiatory breach of an

LLP agreement, the member remains a member. You therefore end up in a

position where you have a member not governed by the terms of the LLP

agreement but rather governed by the default regime.

41. Perhaps most useful of the many powers that that member can then weald is

firstly to assert his equal right to profits and capital (default regulation 7(1)) and

secondly to deploy default regulation 7(3) and assert that “every member may

take part in the management of the limited liability partnership”. These are

powerful weapons indeed to use to terrorise the LLP.

G. THE STING IN THE TAIL FOR LLPS

42. One has to be cautious to remember that a member’s right to recoup capital

when he ceases to be a member is a creature of contract. I respectfully agree

with the views of Whittaker & Machell that in the event that there is repudiatory

breach and the LLP agreement falls away, on its face there is no way in which a

member can recoup his capital, save by way of a winding up of the LLP (see

paragraphs 17.28-17.32). This would not stop the member from seeking to use

the just and equitable winding up mechanism under section 122 of the

Insolvency Act 1986 (indeed the member may be driven to do so14). The

reasoning of Whittaker & Machell in support of this proposition has been

confirmed in the unreported decision of Hailes v Hood [2007] EWHC 1616

(Ch).

14 However whether a court would be prepared to wind up on this basis, given that the member himself had, in part, brought about the situation, is questionable.

17

H. HOW THEN DOES ONE DEPLOY THIS?

43. There is no doubt that deploying these repudiatory breach arguments is a

powerful weapon in the hands of an individual member. Faced with conduct

which may be repudiatory that member needs to be careful not to affirm the

continuing existence of the contract and thereby prevent15 himself from using

repudiatory breach. He needs to accept the repudiatory conduct (if that is what

he decides to do) and to do so unequivocally. Unless and until accepted there is

no repudiation. On the other hand before exercising this power and accepting

repudiatory conduct so as to discharge the contract, the member needs to

carefully weigh up whether the benefits (removing restrictive covenants, notice

periods, waiting room clauses, the exclusion of section 994 etc) outweigh the

disadvantage of losing the contractual entitlement to capital and losing any

other prospective contractual rights. It may well be that the member decides that

by exploiting the repudiatory breach argument he is able to attain a powerful

position. When accepting the repudiatory conduct the member needs to be

careful to make it clear whether he is, or is not, giving notice for the purposes of

section 4(3) of the LLP Act. If he decides to remain a member (making it clear

that he is not giving notice under section 4(3)) then he will need to consider

whether at any subsequent point in time he does want to give that notice under

section 4(3).

44. On the LLP’s side of the fence, the LLP needs to be ever vigilant for conduct

which might amount to an affirmation. Obviously the firm will often wish to

contest the conduct as repudiatory in any event. The firm will need to work out

who is bound by the repudiatory conduct (if it is repudiatory) and as between

whom the repudiation might operate. Furthermore the firm can quickly assert

that it is viewing the discharge by repudiation as bringing to an end the

member’s entitlement to recoup capital. The firm may also wish to assert that if

the default regime is in play then it will rely on default regulations 7(9) and (10)

to seek an account of profits/the benefit earned by the ‘member’ elsewhere.

15 Once the innocent party affirms, that affirmation is irrevocable: see Chitty at paragraph 24-004.

18

45. It is of little surprise that in my experience the deployment of the arguments as

regards repudiatory breach in the LLP context has, without exception, been

resolved by some form of compromise being reached. Perhaps the most

powerful aspect of this whole line of thought is its ability to bring the parties to

a deal. The effect of repudiatory breach is almost messianic!

Jeremy Callman, Ten Old Square.

1

Meltdown! Facing the Fallout in LLP’s and Partnerships __________________________________________________________________________________________________

UNFINISHED BUSINESS: WHEN IS IT ‘NECESSARY’ FOR PARTNERS TO BIND THE

FIRM POST-DISSOLUTION? __________________________________________________________________________________________________

A. INTRODUCTION

1. This talk discusses Section 38 of the Partnership Act 1890 and its current application

in light of the recent decision of Boghani v Nathoo1.

B. THE POTENTIAL CONFLICT

2. On the dissolution of a traditional partnership the partners may differ as to how

the affairs or business of the partnership should be wound up. This raises

numerous questions, including:

(i) Should existing contracts be renewed or completed so as to realise their

full value?

(ii) Should the partnership try to wind up its business quickly so as to allow

the partners to realise the value of their shares in the capital without too

much delay?

(iii) What is the extent of a partner’s authority to bind the firm or his duty to

complete pre-dissolution transactions during the winding up process?

1 [2011] EWHC 2101

2

3. This has proven to be a difficult task for the courts, which has led to conflicting

judgments and uncertainty in the law.

C. THE LAW PRIOR TO THE ENACTMENT OF SECTION 38 OF THE PARTNERSHIP ACT 1890

4. Prior to the Partnership Act 1890 it was settled that partners could carry out the

following acts2 after the dissolution of a partnership:

(i) Charge partnership property as security for a debt incurred before

dissolution3;

(ii) Sell the partnership’s shares4; and

(iii) Bind the firm by admission of liability5.

D. SECTION 38 OF THE PARTNERSHIP ACT 1890

5. Section 38 of the Partnership Act 1890 (“Section 38”) provides:

“After the dissolution of a partnership the authority of each partner to bind

the firm, and the other rights and obligations of the partners, continue

notwithstanding the dissolution so far as may be necessary to wind up the

affairs of the partnership, and to complete transactions begun but

unfinished at the time of the dissolution, but not otherwise.”

2 The list is not exhaustive. 3 Re Clough (1885) 4 De GM & G 542. 4 Lewis v White (1863) 2 New Rep 81. 5 Brown v Macallum (1848) 10 LTOS 482.

3

6. On a preliminary reading this provision appears straightforward; partners can

continue to bind the firm post-dissolution and their obligations to one another

and to third parties continue to the extent it is necessary to wind up the affairs of

the partnership. Section 38 also enables the partners to pre-dissolution

transactions if this is necessary to wind up the partnership’s affairs.

7. But when it is ‘necessary’ for a partner to bind the firm and how far must a

partnership go in completing pre-dissolution transactions?

E. APPLICATION OF SECTION 38

The Duty of Partners during the Winding up Process

8. In Re Bourne6, the deceased partner’s personal representatives were seeking to

claim priority over the partnership’s bankers in respect of some land which the

surviving partner had charged in order to secure an overdraft, which was in

existence prior to death of one of the partners and, therefore, a pre-dissolution

debt.

9. The Court of Appeal held that the bank was entitled to enforce its security

interest which took priority over the personal representative’s claim to the land

in question.

6 [1906] 2 Ch 427

4

10. Vaughan Williams LJ stated7:

“the real truth of the matter is that, leaving out all questions of legal estate,

there is, as between the surviving partner and the representative of the

deceased partner, an overriding duty to wind up the partnership assets

and to do such acts as are necessary for that purpose, and if it is

necessary for that winding up either to continue the business or

borrow money or to sell assets, whether those assets are real or

personal, the right and the duty are co-extensive.” (emphasis added)

11. Romer LJ stated8:

“When a partner dies and the partnership comes to an end, it is not only the

right, but the duty, of the surviving partner to realise the assets for the

purpose of winding up the partnership affairs…”

12. What is interesting about Re Bourne9 is the surviving partner had continued the

business for the purposes of winding up the partnership until his death over 18

months after the death of the other partner. The court took no issue with the

length of time the winding up process was taking and accepted as ‘necessary’ the

surviving partner’s action of entering into a new arrangement with the

partnership’s bank, giving them security in respect of a pre-dissolution overdraft.

13. A reasonable inference from this factual scenario is that the reason the surviving

partner continued to carry on the partnership business, albeit for the purposes of

winding the partnership up, was to maximise the value of the partnership’s 7 ibid at 430 to 431. 8 ibid at 431 to 432. 9 ibid.

5

‘assets’ which the personal representative and the surviving partner would share

in accordance with the partnership agreement. Indeed, Blackett-Ord10 endorses

the view that Section 38 in light of Re Bourne should be interpreted widely.

14. As stated above, Vaughan Williams LJ held that, if ‘necessary’ for the purposes of

winding up the partnership’s affairs, a partner could carry on the partnership’s

business, sell assets and borrow money. However, there remained some

uncertainty regarding the extent a partner can bind the firm whilst winding up

the partnership’s affairs. For example, to what extent can a partner during the

winding up process enter into new bargains or transactions?

New bargains or transactions?

15. In Inland Revenue v Graham’s Trustees11, a dispute had arisen between the

Inland Revenue and the personal representatives of a former partner of a

farming partnership. The issue was whether the surviving partners had

succeeded under security of tenure legislation so as to continue occupying the

farm under the partnership’s former lease. If the partnership continued to

occupy the farm, of which the deceased partner was the freeholder, pursuant to a

lease then the freehold would have a lower value than if it was otherwise

unencumbered for the purposes of Inheritance Tax.

16. Lord Reid, giving judgment for the Inland Revenue, inter alia, stated12:

10 Partnership law, the Modern law of Firms, Limited Partnerships and LLPs 3rd Edition 2007, paragraph 18.2. 11 [1971] SC (HL) 1. 12 ibid at 20 to 21.

6

“What is meant by “transactions begun but unfinished” when the

partnership was dissolved? If the common law had been clearly settled

before 1890, I would interpret this section in light of the earlier law. But it

appears that there was then little authority on this matter. So this section

should, if possible, be construed so as to reach a reasonable result. It was

argued that “transactions” means bargains. But that would deprive this

provision of all content, for it is clear that surviving partners have no

right to bind the assets of the dissolved firm by making new bargains

or contracts. Their right and duty is to wind up its affairs. In my view

this must mean that the surviving partners have the right and duty to

complete all unfinished operations necessary to fulfil contracts of the

firm which were still in force when the firm was dissolved. Otherwise

the position would be intolerable. Suppose the firm was employed to build a

bridge and the bridge was half finished when the firm was dissolved. The

surviving partners must be bound to finish the work, for otherwise they

could not hold the employer to ransom by refusing to proceed unless he

made a new contract more favourable to them, and conversely the employer

could refuse to allow the work to proceed unless the surviving partners

made a new contract more favourable to him. That could not be right.”

(emphasis added)

17. Although the textbooks refer to the aforementioned part of Lord Reid’s speech, in

an attempt to explain the ambit of Section 38, it is suggested that this rather

unhelpful. It must be remembered that the dispute revolved around a Scottish

partnership, which has a distinct legal personality13. Therefore, it is unsurprising

that Section 38 in respect of Scottish partnership, which is a separate legal entity,

has the effect of remedying the lacuna of legal rights and obligations on the

dissolution of such a partnership. However, Lord Reid’s statement that “surviving

partners have no right to bind the assets of the dissolved firm by making new

13 See section 4(2) of the Partnership Act 1890.

7

bargains or contracts” appears to be in direct conflict with the Court of Appeal’s

decision in Re Bourne, where the surviving partner did in fact bind the assets of

the dissolved firm by entering into a new contract so as to give the partnership’s

bankers security in respect of a pre-dissolution overdraft.

18. A further difficulty in applying Lord Reid’s interpretation of Section 38 concerns

how the said section actually operates to achieve the result of enabling the

surviving partners to complete unfinished transactions. Lord Reid held that the

surviving partners did not succeed into the agricultural tenancy but also held

that the surviving partners had an obligation, which did not include the right to

enter into new bargains or contracts, to continue occupying the farm so as to

enable the partnership’s affairs to be wound up. It would appear, with the utmost

respect to the learned judge, that Lord Reid fudged the issue by stating that the

surviving partner’s obligations we simply “dealt with by section 38 of the

Partnership Act, 189014.”

19. As a matter of Scottish law, the importance of Section 38 cannot be understated,

however, under English law a partnership does not have a distinct legal

personality. Therefore, on a strict interpretation of Lord Reid’s judgment, Section

38 would be of limited utility in England if partners could not enter into ‘new

bargains or contracts’ but remained jointly and severally liable in respect of

uncompleted pre-dissolution transactions.

14 ibid at 20.

8

20. Lord Upjohn in Inland Revenue v Graham’s Trustees stated15:

“In England it may be that it is not often that this section is required to

justify the completion of the contracts with other parties, because such

rights and obligations can normally and usually be dealt with by reference

to the general law. Thus, for example, if a firm contracts to build a bridge,

that contract is not affected by its dissolution. The remaining partners and

the outgoing or the estate of a deceased partner will normally remain both

entitled and jointly and severally liable under the general law to complete

the bargain.”

The Utility of Section 38

21. In Don King Productions Inc v Warren and others16, Morritt LJ appeared to

accept that Section 38 would entitle the partners of a dissolved partnership to

renew existing contracts where he stated17:

“The duty of a partner to renew a management or promotion agreement for

the benefit of the partnership so as to facilitate the beneficial winding up of

its affairs, cf. section 38 of the Partnership Act 1890, obviously conflicts with

the interest of the partner seeking to set up in business in the same field to

obtain such contracts for himself.”

22. Morritt LJ’s comment is interesting as it suggests that the partners are under a

duty to renew a contract if this maximises the partnership’s value during its

winding up. However, the idea that a partnership can renew a contract appears

15 ibid at 26-27. 16 [1998] Ch 291 17 ibid at [41].

9

to conflict with the prohibition on entering into new contracts. It also appears to

conflict with the underlying purpose of a winding up, as such a renewal could,

depending on the type of contract, delay the winding up process for a

considerable period of time or even indefinitely.

Is prolonging the winding up process indefinitely by renewing or entering into new

contracts ‘necessary’ for the purpose of Section 38?

23. It is suggested that this question should be answered in the negative. As stated

above the sole purpose of winding up a partnership’s affairs is to achieve finality

between the former partners. It cannot be right for partners to bind one another

under the guise of it being ‘necessary’ to wind up the partnership if the very

actions of the partners in fact delay the winding up process for a substantial

period of time.

24. In Duncan v The MFC Marigold18, Lord Reed stated19:

“From a practical point of view, there may be advantages in enabling the

business of a dissolved partnership to be carried on during the twilight

period of winding up: a business may be realised to best advantage as a

going concern, and the continuation of trading may be necessary to

maintain the value of the goodwill. On any view, however, s.38 cannot

warrant the continuation of the business for more than a temporary

period.” (emphasis added)

18 [2006] CSOH 128. 19 ibid at [43].

10

25. Lord Reed’s comments are useful as they bring out into the open the underlying

conflict which is likely to exist between partners; the conflict between those

wanting to continue the partnership long enough to maximise the value of

existing business and those wishing to ‘call it a day’ and realise their share

sooner rather than later. It is suggested that Lord Reed’s ‘temporary period’

should be adopted as a useful yardstick as to whether the proposed action of a

partner is ‘necessary’ to enable the winding up of the partnership’s affairs.

Has Boghani v Nathoo clarified the position?

26. Boghani v Nathoo20 is the most recent decision concerning the application of

Section 38. The dispute concerned a partnership which carried on the business

of hotel development. At the date of dissolution, the assets of the firm included

two very substantial but uncompleted hotel developments. As one would expect

in any large redevelopment there were various contracts which had been

entered into by the partners, i.e. a contract with hotel chains which would

ultimately manage the development as a hotel, the building contractors and the

financiers of the development. The former partners disagreed on how the

partnership’s affairs should be wound up, i.e. whether the developments should

be sold off in their present state or completed and then sold off; the latter

potentially realising the best possible return for the partnership.

27. Morritt C (“the Chancellor”), in holding that it was not ‘necessary’ for the

partnership to complete the developments for the purposes of winding up its

20 [2011] EWHC 2101.

11

affairs, held21 that the aforementioned authorities stood for the following

propositions:

(i) The obligations of partners to third parties continue notwithstanding the

dissolution of the partners;

(ii) In England, if not in Scotland, the satisfaction of those obligations by

performance, release or novation or the payment of damages will not

usually involve reliance on the terms of Section 38;

(iii) Section 38 does not entitle the surviving partner to engage in new

bargains or contract so as to bind a deceased or former partner;

(iv) Even in relation to transactions, not being new bargains or contracts,

begun but unfinished at the time of dissolution Section 38 applies only if

and to the extent that the completion of such transactions is necessary to

wind up the affairs of the partnership; and

(v) Section 38, if applicable, confers a power; it does not impose any

additional duty.

28. It is arguable that the Chancellor’s propositions tend to raise as many questions

as they purport to answer. However, it was the Chancellor’s application of the

law and his discussion of the law which may have provided some clarity of

Section 38.

29. The Chancellor expressly accepted that partners could enter into new contracts

provided that22:

21 ibid at [27].

12

“they are an inevitable part of satisfying the pre-existing contractual

obligations of the Firm under a “transaction begun but unfinished at the

time of the dissolution.” It would be absurd, if, for example, the unfinished

bridge builder referred to by Lords Reed [sic] and Upjohn in Inland Revenue

v Graham’s Trustees could not buy more steel girders necessary for its

completion.”

30. This passage goes some way to resolving the confusion caused by Lord Reid’s

judgment in Inland Revenue v Graham’s Trustees, i.e. the prohibition of entering

into ‘new bargains or contracts’. It would appear to be the case that a partner can

now bind a firm by entering into a new contract, so long as it is an “inevitable

part of satisfying the pre-existing contractual obligations of the Firm”.

31. In addition, the Chancellor stated that it was23:

“appropriate to consider the ability of the Firm to finance the two

development with which I am concerned. It appears that in each case

procurement of the requisite financial resources will depend on contracts

not made before the dissolution of the Firm…Even if a new facility might be

available it involves further and new post-dissolution contracts…In neither

case would the new arrangement come within the category of being an

inevitable consequence of the development agreement.”

32. In the author’s view the concept of ‘inevitable consequence’ and the refusal of the

Chancellor to accept that a partner could enter into a new contract with a bank to

enable the completion of the developments further resolves the conflict between

maximising the value of the partnership’s assets during the winding up process

22 ibid at [29]. 23 ibid at [30].

13

and the need to avoid prolonging the winding up process for an unreasonable

period of time; the latter appears to have now taken prominence.

33. As stated above, the Court of Appeal in Re Bourne24 expressly accepted that a

partner could enter into new contracts, including a contract for a loan of money,

if this was necessary to wind up the affairs of the partnership. However, it is

clear that a partner’s authority to borrow money is now limited to those

situations where the pre-dissolution business of the partnership makes the said

borrowing an ‘inevitable consequence’ of the pre-dissolution business, i.e.

partners entering into a post-dissolution contract to purchase steel girders so as

to complete a non-assignable pre-dissolution contract to build a bridge.

34. In Boghani v Nathoo25, the Chancellor’s further reason for rejecting the argument

that it was ‘necessary’ for the partnership to complete the developments was

because the contracts could be ‘assigned’ to third parties thereby releasing the

partners from any ongoing liability26. Therefore, even though the partnership

had the option of completing the developments, it was ‘unnecessary’ for the

purposes of Section 38 as they could assign the relevant contracts. This was the

case even if in so doing the partners would reduce the value of the partnership’s

business during the process of winding up its affairs; i.e. losing out on the post-

completion sale price of the developments.

35. Therefore, one can conclude that Boghani v Nathoo27 has clarified, albeit slightly,

the parameters of Section 38.

24 supra n.5. 25 supra n.18. 26 ibid at [32]. 27 Ibid.

14

F. CONCLUSIONS

36. It is suggested that the following propositions summarise the current

understanding of the operation of Section 38:

(i) What action is ‘necessary’ for the purposes of winding up a partnership’s

business depends on the nature of the business in question;

(ii) The remaining partners are entitled to complete contracts with third

parties if this is ‘necessary’ but it will not be necessary if these contracts

can be novated or otherwise compromised so as to release the dissolved

partnership from its contractual obligations28;

(iii) There is no duty to do everything that is necessary to realise the full value

of existing contracts29;

(iv) Although a partnership can renew a contract, it is unlikely that a court

would accept that the said ‘renewal’ is necessary if this results in the

partnership business continuing for a significant period of time30; and

(v) A partnership can enter into new bargains or contracts if these are an

‘inevitable consequence’ of the pre-dissolution business of the

partnership31.

12 November 2011 Gideon Roseman Ten Old Square

Lincoln’s Inn London

28 Boghani v Nathoo ibid. 29 Boghani v Nathoo ibid; See also Duncan v The MFC Marigold supra n.16. 30 Duncan v The MFC Marigold supra n.16.. 31 Boghani v Nathoo supra n.18.

1

"Partnership Injunctions - The Irresistible Force and The Immovable Object"

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Evan Price

Ten Old Square Partnership Seminar

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Injunctions - general issues

1. Definition - A court order requiring a party to either do a specific act or acts

(mandatory or positive injunction) or to refrain from doing a specific act or

acts (prohibitive or negative injunction). Mandatory injunctions are less

common than prohibitive injunctions.

2. Jurisdiction - An injunction can be provisional or final and can be obtained

even where the claimant's legal rights have not as yet been infringed (quia

timet). Mandatory injunctions are less commonly granted provisionally - as

interim orders.

3. The jurisdiction extends to the High Court (all divisions) - section 37(1),

Senior Courts Act 1981 - and to the County Court - section 38, County Courts

Act 1984. In both cases, the court has power to grant an interim or final

injunction "in all cases in which it appears to the court to be just and

convenient to do so". The order can be unconditional or made on such terms

and conditions as the court thinks just - section 37(2), Senior Courts Act 1981.

2

4. Cause of action - The starting point for any application for an injunction is

that there must be a cause of action in law or claim in law entitling him or her

to substantive relief. An injunction is a remedy. There are exceptions to this -

where the application is to restrain the institution of proceedings, for example

- but these are few.

5. An interim injunction must be ancillary to a substantive claim made in the

action, but it does not need to be in the form of the final relief sought in that

claim. A final injunction must be specifically pleaded; an interim injunction

can be made even where a final injunction is not sought or specifically

claimed.

6. However, the court may take a relatively broad view on whether the claimant

has a cause of action. In Re V (A Minor) (Injunction: Jurisdiction) [1996] Fam 1,

Sir Thomas Bingham MR said that "to insist on demonstration of a specific

legal right in this sensitive and socially important area of the law is in my

view to confine the inherent jurisdiction of the court within an inappropriate

straitjacket." (see p.19) The extent to which this will extend to other areas of

law is not certain and I suspect that the less 'sensitive and socially important'

the area of law, the more likely a court will take a stricter view.

3

7. Just and convenient - This phrase must be taken to mean "just, as well as

convenient" - per Jessel MR, Day v Brownrigg (1878) 10 Ch D 294, 307.

8. The House of Lords stated in South Carolina Insurance Co v Assurantie

Maatschappij [1987] AC 24 (a majority decision) that the power of the High

Court to grant injunctions under section 37(1) "has been circumscribed by

judicial authority dating back many years" and that it is limited (with the

exception of injunctions to restrain proceedings overseas) to two situations:

a. where the claimant can show that the defendant has invaded, or

threatens to invade, a legal or equitable right of the claimant, for the

enforcement of which the defendant is amenable to the jurisdiction of

the court; and

b. where a defendant has behaved, or threatens to behave, in a manner

that is unconscionable.

9. However, Lord Goff, supported by all members of the House, stated in

Kirklees MBC v Wickes Building Supplies Ltd [1993] AC 227,

"The power to grant injunctions, which now arises under section

37 of the Supreme Court Act 1981, is a discretionary power,

which should not as a matter of principle be fettered by rules."

(see head-note, per curiam, p229A.)

4

10. The modern trend is for the Courts to consider that they have jurisdiction if it

is required - one text book refers to this as 'the ends are thought to justify the

judicial means' (David Bean, Injunctions, 10th Edn, 1.12, p.7).

11. In his dissenting judgment, Lord Nicholls in the Privy Council in Mercedes-

Benz AG v Leiduck [1996] 1 AC 284, said that the "exercise of the jurisdiction

must be principled, but the criterion is injustice ... to be viewed and decided

in the light of today's conditions and standards." (see p.308F)

12. Discretionary remedy - Remember, injunctions are discretionary remedies.

For a case where it was argued that an injunction should be issued as of right,

that argument being rejected by the House of Lords and the emphasis being

placed on the discretion of the court, see South Bucks DC v Porter [2003] 2 AC

558.

13. Even where a claimant shows that his or her rights have been infringed, the

claimant may be refused an injunction and left with a remedy in damages.

So, where the interference claimed is considered trivial, an injunction may be

refused (see Imperial Gas Light & Coke Co v Broadbent (1859) 7 HL Cas 600). An

injunction may also be refused where the claim to damages is limited to

nominal damages (see Armstrong v Sheppard & Short Ltd [1959] 2 QB 384),

although if the wrong is substantial and the damages limited, an injunction

may still be granted.

5

14. Injunctions are equitable remedies and so the usual equitable maxim that 'he

who comes to equity must come with clean hands' applies. However, care

should be exercised when considering responding to an injunction on this

basis as it is not purity that matters, rather it is clean hands within the context

of the facts of the case and the relief sought. The Duchess of Argyll was not

barred from seeking an injunction to restrain the Duke from selling the secrets

of their marriage after its dissolution by the fact of her own adultery (Argyll

(Duchess) v Argyll (Duke) [1967] Ch 302).

15. The order sought should be capable of being enforced and the court should be

prepared to enforce it.

16. Issues relating to damages - Where the wrong complained of can be fully

compensated for in damages, no injunction should be made. It is uncommon

for a defendant to seek to undermine an application for a final injunction

where the wrong complained of is accepted and the defence is that damages

will be a complete remedy for the claimant; the more common defence

strategy in such cases is to seek to persuade the court not to exercise its

discretion.

17. Under section 50, Senior Courts Act 1981, the court can award damages in

lieu of an injunction even where there is no separate claim for damages.

6

Where the damage to the claimant's legal rights is limited and small, is

capable of being estimated in money, where such a payment would

adequately compensate the claimant and the case is one where it would be

oppressive to the defendant to grant the injunction, then damages may be

substituted for an injunction (see Shelfer v City of London Electric Lighting Co

[1895] 1 Ch 287 and Jaggard v Sawyer [1995] 1 WLR 269).

18. Delay - Two specific problems referred to in the text books and cases as

acquiescence or laches; where a claimant has not taken action for a period of

time, then the right to an injunction may be lost.

19. Acquiescence is where a party stands by and allows his or her rights to be

infringed to such an extent and for such a period that the person committing

the act believes that he or she has consent to it. For a judicial definition, see

Thesiger LJ in De Bussche v Alt (1877) 8 Ch D 286, 314)

20. Where someone has acquiesced, he or she will only be debarred from relief if

it would be dishonest or unconscionable for him or her, after the delay, to

seek to enforce his or her rights. Remember, the discretion of the court

remains.

21. Laches is where there has been unreasonable inaction by the claimant after

the infringement of his or her rights, that makes it unjust to the defendant for

7

an injunction to be granted. Usually, some form of detrimental reliance is

required although this is not mandatory (see Fisher v Brooker [2009] UKHL 41).

22. Issues specific to interim injunctions - These are usually granted after a

summary hearing where there has been no trial of merits. Usually, there is no

oral testimony or cross-examination and pre-trial disclosure and other

processes have not occurred. Often, the issues that are decided at such

hearings resolve the dispute and so many cases that commence with an

interim injunction do not proceed to trial.

23. In almost every case the court will seek a cross-undertaking in damages from

the applicant. A similar undertaking will normally be required where a

respondent offers undertakings in lieu of the injunction being sought by the

claimant. The statement in support of the application should usually contain

some evidence to deal with the claimant's ability to honour the cross-

undertaking in damages (see Staines v Walsh [2003] EWHC 1486, The Times, 1

August 2003), although this is not a requirement in every case.

24. Remember that the absence of means, even where a claimant is legally aided,

is not an absolute reason, in an appropriate case, for the refusal of an interim

injunction (see Allen v Jambo Holdings Ltd [1980] 1 WLR 1252). The court can

order that the cross-undertaking be 'fortified' in an appropriate case; for

example, by a payment into court or the provision of a guarantee.

8

25. The Practice Direction to CPR Part 25 provides that the court will

automatically insert the cross-undertaking in damages into the order of the

court (save in family proceedings) unless the judge orders otherwise (see PD

25.5.1(1)). It is not necessary to give a cross-undertaking in damages that

benefits strangers to the proceedings, although there is discretion for the court

to require such an cross-undertaking in appropriate circumstances (see PD

25.5.1A).

26. American Cyanamid case - The House of Lords set down some guidance for

interim injunctions in the case of American Cyanamid Co v Ethicon Ltd [1975]

AC 396. Some text books refer to this as a revolution, others a clarification -

whatever, Lord Diplock's guidance is considered the leading source of law on

the subject.

27. You should note that the guidance does assume that there will be a trial

subsequently and that subsequent judicial comments have said that the

guidance does not contain any "principle of universal application" (per Kerr

LJ in Cambridge Nutrition Ltd v BBC [1990] 3 All ER 523, 534j).

28. The first thing for a court to consider is whether there is a serious issue to be

tried (see American Cyanamid at 408B-C). There is no need to show a prima

9

facie case and in many cases it will not be possible for the court to determine

that at all.

29. Next the court will consider whether damages would be an adequate remedy

to either side. Where there is doubt as to the adequacy of damages to either

side, the court will go on to consider the balance of convenience (see American

Cyanamid at 408E) - May LJ has redefined this as the "balance of the risk of

doing an injustice" in Cayne v Global Natural Resources plc [1984] 1 All ER 225,

237h - Sir John Donaldson MR as the "balance of justice" in Francome v Mirror

Group Newspapers Ltd [1984] 1 WLR 892.

30. Where the other factors are finely balanced, the court should go on to

consider whether it should take such measures as to preserve the status quo

(see American Cyanamid at 408F).

31. Lord Diplock envisaged that there would be a number of special cases and

categories of case that would justify different or additional considerations.

32. Applications without notice - The basic principle is that a person should not

be subject to an order of the court without an opportunity to be heard. If the

court is to ignore that basic principle, there are two conditions which must be

satisfied.

10

a. First, there must be a risk of injustice to the applicant; either as a result

of delay or as a result of an anticipated act or actions by the respondent

or others before an order is made.

b. Second, the court should be satisfied that any damage to the

respondent can be compensated for in damages or that the risk of loss

that is not capable of being compensated for is outweighed by the risk

to the applicant if the order is not made.

See Re First Express Ltd [1992] BCLC 824 per Hoffmann J.

33. A judge should not make an order where no notice has been given to the

respondent unless either the giving of notice would enable the respondent to

take steps to defeat the purpose of the injunction or there is literally not time

to give notice before the injunction is required to prevent the threatened

unlawful act (see National Commercial Bank Jamaica Ltd v Olint Corp Ltd [2009] 1

WLR 1405, per Lord Hoffmann).

34. Care should be taken in that the applicant and the applicant's representatives

act with utmost good faith giving full and frank disclosure of any material

facts (see R v Kensington Income Tax Commissioners ex parte Princess Edmond de

Polignac [1917] 1 KB 486).

35. Where an interim injunction is sought,

11

"the court is far more reluctant to grant a mandatory injunction

than it would be to grant a comparable prohibitory injunction.

In a normal case the court must, inter alia, feel a high degree of

assurance that at the trial it will appear that the injunction was

rightly granted; and this is a higher standard than is required for

a prohibitory injunction"

Per Megarry J in Shepherd Homes v Sandham [1971] Ch 340, 351G )

36. It should be noted that subsequently, the Court of Appeal has grappled with

this issue and concluded that although a court should be reluctant to grant an

interim mandatory injunction, where the risk of injustice if the injunction is

refused outweighs the risk of injustice if it is granted, the court may still grant

the injunction (see Zockoll Group Ltd v Mercury Commmunications Ltd [1998]

FSR 354). In the National Commercial Bank Jamaica case (supra), Lord Hoffmann

said in relation to interim injunctions that "arguments over whether the

injunction should be classified as prohibitive or mandatory are barren" and

that "Their Lordships consider that this type of box-ticking approach does not

do justice to the complexity of a decision as to whether to grant an

interlocutory injunction" (see judgment at 1410A).

37. Finally, don't forget that you may want to consider a speedy trial in addition

to seeking an interim injunction or even as an alternative to it. This may be

12

particularly relevant in cases where questions relating to restraint of trade are

raised in the dispute - see Lawrence David Ltd v Ashton [1991] 1 All ER 385.

Specific issues - partnerships

38. Many of the cases where partners or members of an LLP are in dispute with

each other and seek injunctions against each other would fall to be considered

under the general principles relating to injunctions as set out above. There

are many other such cases, however, which fall to be considered as special

cases or special categories of case as envisaged by Lord Diplock in the

American Cyanamid case (supra).

39. The partnership may not be a separate legal entity - but all members of a firm

may sue on a contract made in the firm name. As a matter of procedure,

partners carrying on business within the jurisdiction must sue or be sued in

the name of the firm of which they were partners at the time when the cause

of action accrued, unless it is inappropriate to do so - see CPR Part 7.2A and

the practice direction to Part 7, paras 5A.1 and 5A.3. See also paras 5B. and

5C. All partners should be parties to or represented in any claim. Obviously,

different considerations apply where the parties are members of an LLP.

40. Where someone seeks injunctions against partners who have excluded him

from the management of the firm, he will need to show that he is a partner

13

and not merely an employee of the firm - see Walker v Hirsch (1884) 27 Ch D

460.

41. It is not required for a partner of a fixed term partnership when he is seeking

an injunction to also seek a dissolution of the partnership - see Fairthorne v

Weston (1844) 3 Hare 387 and Hall v Hall (1850) 12 Beav 414. However, bear in

mind that if the partnership is merely on at will, the court will be more

reluctant to interfere unless dissolution is also sought and that that would

have consequences for the partnership at will - see Floydd v Cheney, Cheney v

Floydd [1970] Ch 602.

42. Most partnerships will have specific contractual provisions that may be

enforced by interim and final injunctions. Where, for example, there are

express negative covenants in a contract, the questions of the balance of

convenience and damages become irrelevant as the court will merely seek to

enforce the contractual rights that the parties have already agreed - see

Doherty v Allman (1873) 3 App Cas 709. With the advent of the Human Rights

Act, consideration as to whether such enforcement would breach a

defendant's rights set out in the Convention might reduce the apparent

absolute nature of this decision.

43. It is common for partnership agreements to contain express prohibitions on

an outgoing partner from carrying on a similar trade or profession within a

14

specified distance or subject to a specific time limit - see for example, Cooper v

Page (1876) 34 LT 90. Remember that such covenants are usually strictly

construed and that they will only be enforced where they are found to be

reasonable; this is proved where (1) there is a legitimate interest to be

protected, (2) where the covenant is no more that adequate to protect the

interest and is not excessive in terms of area, duration or the activities that are

covered, and (3) where the interest or goodwill could be damaged or injured

without enforcement. While there are authorities that refuse to enforce such

covenants where they seek to restrict a client's freedom to choose a legal

advisor there are authorities where such covenants are upheld - for the

former, see Oswald Hickson Collier & Co v Carter-Ruck [1984] AC 720 and for

the latter, see Bridge v Deacons (a firm) [1984] AC 705 (Bridge v Deacons (a firm)

is considered to be a leading case). Restrictive covenants where they are

capable of being enforced at law, may be enforced by interim and or final

injunctions - such covenants can be included in dissolution agreements and, if

they are capable of being enforced, can be enforced post dissolution by the

person who is entitled as successor to the business of the old partnership.

44. Similarly, a covenant in a partnership agreement restraining competition

between the partners and the partners and the business of the partnership

may be enforced by the court with interim and final injunctions. It is

considered that the same would apply as between members of an LLP and the

15

members and the LLP. This would also apply to a former partner who agrees

to such a stipulation in a dissolution agreement.

45. A continuing partner's right of pre-emption provided for in the partnership

agreement or contract is recognised by the court as a right of great value and

importance, and is enforceable, in proper cases, by injunction and specific

performance - see Homfray v Fothergill (1866) LR 1 Eq 567. If the complaining

party does not act with due diligence on notice, then the right may lapse, even

without considering the doctrines of acquiescence and laches - see Rowlands v

Evans, Williams v Rowlands (1861) 30 Beav 302.

46. Injunctions may be obtained during a dissolution including to preserve the

assets of the partnership - see Investment and Pensions Advisory Service Ltd v

Gray [1990 BCLC 38 (a freezing injunction against a partner to preserve sums

that had been allegedly wrongly paid to a partner during the partnership).

47. After dissolution, the courts may not be interested in proceedings to prevent a

former partner using the name of the old firm, unless there are specific

agreements in the dissolution for the complainants to rely on - see Banks v

Gibson (1865) 34 Beav 566.

48. When considering injunctive relief, remember that each case will turn on its

own facts and that the practicalities of what you are seeking will be

16

considered important by a court considering the matter. So, for example, it

will be very difficult to seek a mandatory injunction requiring the partnership

to require an excluded partner back into the premises and business of the

partnership - and you may well consider that there is an inherent

contradiction between that position and the principle in partnership law that

no single partner or group of partners is, in general, any more entitled to

work in the business and use its assets than any other partner. However,

where the partnership is small and the exclusion is obviously suspect, it may

be possible to obtain mandatory injunctions to restore an excluded partner to

the assets and business of the partnership.

EVAN PRICE Ten Old Square, Lincoln's Inn

14th November 2011