How strong is an LLP?

2004 IS SET to be the year of the limited liability partnership (LLP). In May, City giant Allen & Overy became the largest UK law firm to convert to UK LLP status, joining a growing list of top law firms that have already made the move.

Nearly all of the five biggest law firms have now converted to LLPs.

And a recent poll of the top 100 law firms found that a third are likely to convert within the next year.

But conversion comes at price. Individual partners still face the risk of personal liability and some argue that becoming an LLP can corrode the partnership ethos so prized by many firms. The insurance market is reacting to these changes, developing products specifically for LLPs.

For many firms, the move to LLP status has been driven by the desire to limit liability and to facilitate growth as international businesses.

DLA, the UK's ninth largest law firm, converted to LLP status on 4 May.

Julia Graham director of risk management at DLA says: "It had reached a stage where we felt it was necessary to allow us to trade more as an international entity rather than as a local law firm. We also wanted to take the opportunity to have less risk for the business itself and for the partners. LLP status gives us a degree of stability."

Conversion to LLP status removes the unlimited joint and several liability of the partners, characteristic of a general partnership. In an LLP the liability of partners is limited to the amount they have invested.

Marsh Finpro practice senior vice president Sandra Neilson says that the implosion of accountant Arthur Andersen in 2002 over the Enron scandal has encouraged firms to convert.

"It woke professional services firms up to the idea that it (a collapse) could happen to anyone, and that joint and several liability was therefore a real danger (to the partners). If they could operate as LLPs, why would they want to operate with unlimited liability?"

But the fact that members do not have to share jointly the liability of the firm creates new issues. Some argue that the conversion to LLP status will put the collegiality of the partnership under strain. In the absence of joint and several liability partners may not be as motivated to make sure that the whole firm acts responsibly.

Neilson says these messages are starting to filter through to the insurance market. "Professional indemnity insurance underwriters are already becoming concerned that a diminishing of collegiate responsibility could lead to a rise in the risk profile of the firm."

A second issue that arises from the move to LLP status relates to the potential for individual partners to be exposed to liability for their own negligent acts. In a general partnership, all partners stand or fall together, regardless of culpability or innocence. But in an LLP structure if a personal duty of care case is found, one partner can be liable to the full extent of the damages without any recourse to the other partners.

Partners' individual liability is still an uncertain area as to date no cases have been brought against a partner.

Neilson says: "Sophisticated companies will probably not claim against an individual member as they will understand and respect the concept of an LLP. But where a client deals with partners on a individual basis they may be more inclined to act against that partner."

Nonetheless, there is still a nagging fear in the minds of law firms.

"Individual liability is an uncertain area," says Graham. "But I do regard it as a risk."

This view is echoed by research. In a recent poll of law firms carried out by Marsh, 60% of law firms said that the risk of personal liability was a "worry".

The insurance market is reacting to these developments. In May, insurer St Paul launched a product called Lifeboat specifically for LLPs and broker Marsh set to follow suit. Lifeboat provides cover for individual members should the protection provided by the firm be exhausted, while Marsh's product will also protects against the insolvency of the LLP itself.

Neilson says: "Insurance cover can provide a mechanism for filling the gap left by the removal of the umbrella protection provided by joint and several liability. Not only can it provide financial security to protect the assets of the LLP and the partners, it can also help to preserve the partnership ethos of firms."

What is a limited liability partnership

The Limited Liability Partnerships Act 2000 created the framework for conversion to a limited liability partnership (LLP). The Act came into effect in April 2001.

An LLP is a body corporate, like a limited company. If the LLP becomes insolvent, the creditors stand in line and try to gain whatever they can from the receivership.

Conversion to an LLP has the effect that the partners' (technically known as members) exposure is limited to the amount they have invested in the LLP except for their own negligence or default. This is different from the position under a general partnership, where in many cases the partners would have unlimited liability for the acts of the partnership on a joint and several basis. Partners would therefore be liable to contribute to the satisfaction of a claim, even if they themselves were in no way negligent.

Despite the apparent advantages of becoming an LLP there has been a slow take-up to convert. The transition was seen to be complicated. There was also a concern that clients would not view the conversion positively, preferring to deal with a firm where liability was not limited.

Three years on, and the initial scepticism towards LLPs is fading. Professional services firms are converting in ever increasing numbers. Their concern over how it would appear to clients has proven unfounded and, following the demise of Arthur Andersen in 2002, firms have been keen to limit the potentially devastating consequences of joint and several liability.