In this blog post, Ribin Verghese, a student, pursuing his second year LLB at KIIT School of Law, KIIT University and a Diploma in Entrepreneurship Administration and Business Laws from NUJS, Kolkata, and Amritha Priya, pursuing a Diploma in Advanced Contract Drafting, Negotiation and Dispute Resolution from Lawsikho.com. lists the clauses that are needed in an LLP Agreement which may not be prescribed by default under the LLP Act. 

Introduction

Limited Liability Partnership Agreement means any written agreement between the partners of the Limited Liability Partnership or between the Limited Liability Partnership and its Partner which determines the mutual rights and duties of the partners and their rights and duties in relation to that Limited Liability Partnership.

Salient Features of Limited Liability Partnership

1. LLP is a body corporate and a separate legal entity, it has perpetual succession. It can be sued and shall sue others in its own name, which is unlike partnership and like a company. Section 3 of LLP Act. 
2. LLP must be registered unlike partnership. The rights and duties of partners of LLP is decided based on the LLP agreement between the parties, whereas the same is observed in AOA of company (wherein all the by-rules of company is mentioned).
3. The liability of the partners in LLP is limited to the extent of their contribution and not to their personal asset. The contribution can either be intangible or tangible or both. In LLP one partner shall not be liable for the other partners misdeeds. 
4. In partnership there is a ceiling on the number of partners (ie 20 members) in case of LLP there is no ceiling like in case of company. Section 6 of LLP Act.
5. Accounts of the LLP have to be published or audited with the registrar of Companies (ROC). A statement of accounts and solvency shall be filed by every LLP with the Registrar every year.

In M Govinda & Co V Commissioner of IT Andhra Pradesh, the Supreme Court held that where partners have agreed to share the profits in certain proportions, the presumption is that the losses are also to be shared in the like proportions. Where in a partnership the profits are shared in certain proportion, the fair inference is that losses are to be shared in the same proportion in the absence of a contract to the contrary; the onus of proving that they are not liable for the loss lies on persons who are so assertive. This provision is similar to section 13(b) of the Act of Indian partnership act. 

This is one of the key differences because in LLP as agreement is made mandatory the profit and share ratio is pre decided.

Difference between LLP and Partnership 

1. LLP is a separate legal entity unlike partnership. Therefore, LLP can sue others without involving the partners, but in case of partnership partners are party to a litigation.
2. In LLP the partners have limited liability but in case of Partnership the partners have unlimited liability. Section 8 of LLP Act.
3. The partnership would dissolve on the death or retirement of a partner, but in the case of LLP it does not because it is a separate legal entity. 
4. The partnership may be formed orally or through deed, the Partnership Act does not mandate registration of agreement. But in case of LLP it is mandatory the partners must have an agreement and shall be registered with the Registrar Of Companies.
5. There is ceiling/ limit on the number of partners a partnership can have (ie 20 members). But in case of LLP there is no ceiling/ limit for admission of partners. Section 6 of LLP Act.

Difference between LLP and Company

1. In the case of LLP an agreement must be drafted between the partners which would decide the rights and duties. Whereas in the case of company AOA which determines the bylaws of the company.
2. In LLP there is no mandatory requirement for a number of meetings either periodically or annually. Whereas in the case of a company it is mandatory that the directors and shareholders meet periodically or annually. 
3. The partners can take part in day to day activities of the business, there is no separation between management and ownership. But in case of the company there is separation between management and ownership, this is because only directors are allowed and members are not allowed to take part in decision making. 
4. In LLP there is no restriction on borrowing power unless the agreement specifies so. But in the case of company section 180(1)(c) specifies the restriction.
5. Audit is mandatory in a company. But that’s not the case in LLP, only if the turnover exceeds 40 lakhs and capital contribution exceeds 25 lakhs audit is mandatory.

General Clauses in the LLP Agreement

The following items will be included as part of the General Clauses in an LLP Agreement:

1. Name and Location of the Business.
2. Nature of the business.
3. Capital contributed by each partner.
4. Duties, power and obligation of partners.
5. The method of distribution of profit and loss of the business.
6. Provision of admitting new members.
7. Method of valuation of goodwill.
8. Procedures to be followed for the expulsion of a partner.
9. Procedures for the dissolution of the firm and settlement of accounts.
10. Arbitration in case of disputes among partners.

Some of the Clauses that needs to be included in an LLP Agreement are:

Clause regarding Non-Competition: A clause can be added to the agreement which restricts partners to start invest or mentor any entity which includes partnership firms, LLPs and Company. This is to avoid conflict of interest among the partners and for the best interest of the LLP.

Clauses regarding protection of business secret: Every Billion dollar company was started in a small scale. For a business to flourish, the business should have a Unique Selling point which can be a different product, a change in service or an innovation to an existing problem. The partners are bound to protect the business and its assets, and the clause can be used to protect the LLP from external threats. For example, KFC Recipe was held a secret from its investors by its creator Col Sanders and was passed on to the Company which purchased the brand.

Clauses related to induction of next generation to the LLP: There have been a lot of problems in firms where the next generation of the partners joins the firm without the right qualification or ability to run a business. A Clause can be added to the agreement which restricts the successor to join the firm without the right qualification. The Successor will have all rights on the LLP, and he can decide to transfer the business to another person or appoint a person to run a business. Unless the partnership is transferred to another party, the person will have all rights on the partnership. He is entitled to a profit and other benefits enjoyed by his predecessor.

Clauses regarding stand on legal issues: This is an essential clause in an LLP Agreement. This will avoid unnecessary conflict in the day to day management of the film. This clause describes the manner in which the company should sue or face trial in any legal matters. It can also fix a partner who will deal with the legal issues faced by the firm.

Clause describing when an LLP can be converted into a company: This clause is beneficial for the LLP as it avoids ambiguity regarding when to take the LLP into the next position. The clause can be framed in such a way that the LLP can be converted on the basis of time or on the basis of the financial target. For example-

• An LLP can be converted to a company after it completes a pre-fixed time period in the industry. For instance, a Film producing LLP can be converted to a company after five years from the date of inception.
• Another manner to convert the LLP into a company is when it achieves a financial target in a financial year. The clause can be written to convert the LLP when it reaches a decided amount of revenue in a year. For instance, an LLP can be converted into a company when it earns more than 5 Cr revenue in a financial year.

Clause regarding ESOP to the employees once the LLP is converted into a listed company: The LLP can add a clause that decides stock options to its founding employees as a goodwill gesture for being a part of the company from the inception. This gives a clear path of the long-term goal of the LLP to the various stakeholders of the firm. It also ensures higher employee morale. It also avoids confusion for future investors of the company.

Clause which describes the Bank, Auditor, and other service providers: This is another important clause which leaves no room for ambiguity regarding the preferred banker or auditor or tax consultant to the firm. All the transactions should be through the particular current Account held in the Bank and it applies to the function of Auditor and Tax Consultant. A sub-clause can also be added which requires a unanimous vote of the partners to change the bank or other service providers to the LLP.

Clauses which describes the obligation of a retiring member: Clauses can be added which restricts a member from doing or acting anything on behalf of the firm which can jeopardize the smooth functioning of the firm. The clause of confidentiality should also be read with this clause and thereby protecting the interest of other members of the firm. It can prescribe legal measures to prevent an outgoing member from disclosing or acting upon something which directly cause loss or decline in growth of the business.

Clauses which restricts personal interest in the firm: A clause can be added to restrict any member from using company resources for personal gains without the permission of other members. It can also restrict decisions that are based on personal connection or which benefits the immediate family members of the partner. For example, the firm can restrict the partner from ordering and procuring raw material at a higher rate from a relative who is in the business of selling the raw materials. The members can, however, ratify deals which bring financial gains to the firms even if the third-party is related to one of its members.

Clauses regarding alternative dispute resolution (ADR): A clause can be added to the agreement which clearly specifies the alternative dispute resolution when the arbitration fails. This removes the ambiguity related to the dispute resolutions. This lays down a clear path on what is to be done when a dispute arises amongst the party. The dispute can be resolved by means of mediation or negotiation. This is only applicable once the arbitration fails. This ensures fair and fast justice to the members of an LLP.

Clauses that are Important in an LLP Agreement 

Recitals: In any contract/ agreement the Recital is important. It always started with the word ‘WHEREAS’. This clause sets out the background or the purpose of the contract.

Definition Clause: It is very important for one to understand how a specific term has to be interpreted in a contract. This is important because the general meaning of the term would be different from what the drafter intended to (to avoid ambiguity).

For example: “Contribution” generally means a gift or payment; but contribution in LLP ‘means the amount brought in by each partner during the inception of this partnership agreement’.

Capital Contribution Clause: this means the capital contributed by each partner while entering into the business. The contribution can be intangible or tangible. This clause is important in order to determine the extent of liability of each partner in event of dissolution or creditors repayment of loans. 

For example: ‘The initial contribution of  ABC LLP shall be 5,00,000 which shall be contributed by the partners in the following proportions: 

1. FIRST PARTY 25% ie, Rupees 1,25,000
2. SECOND PARTY 25% ie, Rupees 1,25,000
3. THIRD PARTY 25% ie, Rupees 1,25,000
4. FOURTH PARTY 25% ie, Rupees 1,25,000 

Any further contributions if required by the LLP shall be brought by the Partners in such ratio as may be decided with the consent of all the present partners from time to time. The Partners shall be entitled to profits in the ratio of 25% each or in proportion of their capital contribution as existing in a particular Financial Year. The voting rights of partners shall be in ratio of their respective contributions in the LLP’.

Profit-Sharing Ratio: this clause specifically states the percentage of profit and loss to be shared by whom in the event of profit and loss. 

For example: ‘The profit-sharing ratio of the partners of ABC LLP will be in proportion to his contribution made to the ABC LLP. This ratio is subject to change only with the approval of the partners’. This approval shall be through voting. 

Admission of New Partners: a new partner can be admitted only with the permission of existing partners. This can happen with 75% approval.

For example: ‘No person or body corporate may be introduced as a new partner without the consent of all the existing partners. Consequently to the admission of a new partner, the LLP agreement shall be suitably modified with the consent of all the partners. The partners of the LLP may terminate or expel any partner from the LLP by passing 75% majority vote’.

Retirement of Partners: this is essential to understand the terms as to how a partner shall be retired. As LLP agreement shall only be responsible to govern such clauses. Normally the partner intending to retire must give a prior notice, preferably 30 days prior notice. 

Rights and Duties of Partners: The rights and duties of partners are set in the LLP agreement. Right to inspect books of account; right to have equal share over the profit, title of the business; right to represent and obtain loan; right to carry business in name of the LLP; duty to account benefit obtained form such LLP; duty to indemnify other partners; duty to render true and full information about his accounts; duty not to assign, lease, mortgage the LLP without the consent of other partners etc. This list is not exhaustive, the parties can negotiate them before entering into the agreement. They can also appoint one or how every partner to carry on specific business activity and they are known as designated partners. 

Indemnity Clause: as we know in LLP the liability of a partner is limited and not unlimited as in the case of a partnership. Thus, it is important to have indemnity clauses in an LLP where all partners indemnify each other to the extent of their liability. They shall also indemnify the LLP if he has acted in capacity he was not authorised to or the person dealing with him has sufficient knowledge about his capacity.  

Meetings: In LLP meetings are not mandatory or made statutory. But if the partners decide to meet, this can be included into the agreement. This clause shall include how many times should the partners meet; can there be proxy if so then how; the notice for meetings; requisition of meetings; place and manner; quorum for meetings; etc. 

Designated Partners: this is decided by all the partners collectively by voting. The number of partners to be designated shall also be decided. They shall be responsible for the day to day functions of such partnership. They shall be authorised to act on behalf of other partners. So, drafting a clause mentioning their duties, admission, powers, removal become important in a LLP.

Borrowing Power: this is an essential clause, normally the designated partner shall have the right to represent other partners and obtain funds from any financial institution, banks, lenders, body corporate etc. Normally every LLP fixes a Cap on the borrowing capacity, if there is requirement beyond it then the designating partner shall obtain permission from the other partners. Such borrowing shall be maintained by the designating partner. 

Auditors: As it is made mandatory by the government that for every establishment there must be an auditor and a lawyer. For such establishments it is important there must be an auditor, however it shall be audited when the LLP has turnover more than 40 lakhs and capital contribution more than 25 lakhs. The designated partner shall with permission from other partners appoint an auditor. 

Conclusion

However, these clauses are not exhaustive, there can be many clauses like winding up, finance, non-compete, accounts etc. These are few important clauses that should be kept in mind while drafting a LLP agreement. Also LLP is feasible for small and medium firms or establishments because the registration is simpler; and the safety/ secured when compared with the Partnership Act.

---

LawSikho has created a telegram group for exchanging legal knowledge, referrals and various opportunities. You can click on this link and join: