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A Comprehensive Analysis of 'Small LLPs' and MSMEs

Analysis of the traditional and theoretical concept of Limited Liability Partnership in light of the recently amended and inserted class of ‘small limited liability partnerships’ under Section 2(1)(t) of the Limited Liability Partnership Act, 2008 and the legislative impact of such a definition on the Micro, Small and Medium Enterprises Development Act, 2006 (MSME) Act, 2006 and its provisions

Introduction

This scope of this blog extends to tracing the 2021 amendment to the Limited Liability Act, 2008 [“LLP”] which has introduced a novel or new category of ‘small LLPs’ by purging the concept at the altar of traditional LLPs and their practical understanding, in so far as its role for compatibility is questioned, where the doctrinal form of research methodology has been followed. This blog argues that not only does the new class of ‘small LLPs’ dilute the very idea and theoretical basis of LLPs that have developed so far, since its inception and evolution in the 19th century – but also potentially and possibly, encroaches on the provisions of the MSME Act, 2006 and its Micro and Small enterprises who are the targeted beneficiaries in the new class. This is because of the lack of clarity that exists in the Indian sphere that uses startups and MSMEs as connotations interchangeably, without there being a proper differentiation or delineation of the same as well as no mention of the two in either of their respective acts with separate individuals, bodies and mechanisms. Lastly, the blog concludes on the potential courses of action that can be taken to ensure that there is no spill-over between the two due to the lacuna involved and progressively allow this provision to benefit the individuals that is aimed at.


Analysis

1.1 Traditional comments on the definitional contents of LLPs - determining whether the core of the concept of LLPs has been subjected to any evolution since the 1930s

Commercial and industrial revolution in the seventeenth and eighteenth centuries propelled various economic activities to consider the most profitable model of business that could be involved towards profit-maximization. The conceptualization of the model of limited liability arose and was apprehended in the nineteenth century, as a result of a political and economic upheaval that was designed to bolster commercial activity and its allied benefits in the respective economies. Limited liability has its genesis in England, as per the Bellenden Ker Report on partnership law of 1837. There was also the French system of societes en commandite to consider that was reviewed. Under this system only those with direct control of the undertaking were fully liable for its debts and obligations while those who put up the capital were liable only to the extent of their contribution. There was discussion and deliberation on the benefits of the French system, but there was no adoption of the same. This is because the risks of limited liability and its subsequent partnership model in corporate law, were seen as too great to permit its general availability as a matter of law. Despite this the government pressed on to adopt limited liability. 1855 was the first year in which the first Limited Liability Act was passed. It was clear at the very outset that limited liability had been created to avoid the possibility of an externalization of risk, which led to an initial hostility and introduction of restrictive conditions in the 1855 Act.


In the nineteenth century the implications of this approach were far more prospective to be ignored for much longer, as the need for limited liability as a device for the reduction of investment risk was decided to be of paramount importance, in view of promoting economic activity in the economy. In this case, the 1855 Act appeared to have worked. Hence, it is not a surprise that soon after its passage the number of incorporations grew at a staggering pace. Simply put, without the legal jargon, a limited liability partnership (‘LLP’) is viewed as an ‘alternate’ corporate vehicle. Not only is it an alternate corporate vehicle, it has hybrid characteristics that borrows the best of both worlds from a ‘company’ and a ‘partnership’. Some of the prevalent LLP models borrow more of the latter, while the others borrow from the former, but it must be understood that from the inception – limited liability partnership is unique in so far as the other two models and an amalgamation of their features is considered. Speaking per se, that is where it derives its ‘separability’ as a model from.


On the other hand, a general partnership is a partnership in which the partners share responsibility and liability equally. There is no ‘limit’ as such, in terms of representation, liability or the organization as a liability. The difference between an LLP and a general partnership is that a general partnership has no legal existence separate from the partners who constitute it, while an LLP exists as a legal entity separate from its partners. The reason why many individuals find LLPs to be more agreeable is because LLPs combine limited liability with the tax advantages and lower disclosure requirements of partnerships, which has been cited as one of the reasons for its vast popularity. In the most conventional legalistic sense, a limited liability corporation is usually 'double-taxed' through corporate tax on the company and tax paid by shareholders on their dividends. In partnerships, the partners' share of earnings is taxed, but the partnership itself is not taxed, which makes it a popular choice. LLPs, or also known as LLCs have flourished in the USA[1] or for that matter even in the UK, and constitute a hybrid between LLPs and fully quoted limited liability corporations. Differently from LLPs, there is no ceiling on the number of limited partners/shareholders, and they are allowed to be active in the management of the company. Thus, business owners can avoid corporate tax while fully enjoying the advantages of limited liability. Limited liability in the context of corporate group structures grants enormously beneficial and facilitative essentially encourages irresponsible investment strategies.[2]


1.2 Testing the Amendments brought in to LLP Act, 2008 in 2021 on the altar or touchstone on the limits and scope of traditional LLPs and its modern implications

The main policy reason for the adoption of limited liability was to ensure the availability of capital for major industrial developments such as the building of railways through the narrower objective of protecting rentier investors has also been proposed as an explanation for its introduction. As per the new 2021 amendments made to the LLP Act, 2008 there are 7 new sections that have been inserted, 5 sections that have been substituted and a total of 3 sections that have been omitted. The object of discussion in this blog i.e. the new class of ‘small LLPs’ has been defined under Section 2(1)(t) of the Act wherein, it is aimed to cover the micro and small enterprises for converting them as an enterprise into an LLP. It has been the legislature’s intent as well as in its reports and writings that this classification would organize and lead to a galvanization of the small LLP from ‘unregulated partnerships’ of all kinds and give the required boost to form uncomplicated small LLPs under the aegis of the Act. Non-Convertible Debentures (NCDs) have also now been allowed and additionally, the Act also provides an establishment of special courts for the purpose of speedy trial of offenses that are extremely specific in nature and not more than four in total, that would have to be read with the newly inserted Section 67 of the Act.


Compounding is another interesting phenomenon that has been prevalent but heavily borrowed from the jurisprudence of company law, however left unrendered in the hands of central government officials and regional officers only. This has been extended to the LLP Act 2008 even in cases where the name may have to be changed, and there is a violation of the conditions or provisions of Indian Trademarks Act 1999 as being undesirable or being identical to a trademark pending registration with adequately applicable fine. Additionally, the amendment in Section72 of the Act provides that the appeals against the order of the tribunal will lie to the National company law tribunal from an order made by the tribunal with the consent of the parties, which is again a matter of debate because this creates an extra pressure on the Tribunals that have company and insolvency matters to deal with, in its units as well.


All of this have immense and varied contributions[3] when understood from the perspective of this blog, i.e. there have been deviations from the traditional notions of LLPs with incorporation from the jurisprudence of company law and insolvency law; creating newer dimensions of the law for further benefits to the LLP business model in order to make it the most lucrative model in society for better governance which some may point at the cost of its own traditional notions and idea whether it is the partner(s) involved as well as not just restrict itself to the features of company or partnership law for that matter to create the ‘hybrid’ model it wishes to under the grab of LLPs.


1.3 Different prevailing models internationally in so far as LLPs are concerned vis-à-vis the Indian Model – similar or vastly different from each other and the theoretical or practical model

Considered to be a convenient hybrid between a partnership and company, the Indian limited liability partnership is a business association that merges certain advantages of a partnership with those of a company. As would be seen later, India has borrowed from the UK model as well as the Singapore model[4] more than the American Texan model. The concept of limited liability in India is not new, rather been subject to various committees and recommendations such as the Bhatt Committee (1972), the Naik Committee (1992), and the most prominent one of J.J. Irani Expert Committee (2005). In India, not only there was an acute need felt for the Limited Liability Partnership Act, 2008 (‘LLP Act’), but the question had been tackled and described by the Ministry of Corporate Affairs in the following words: “With the growth of the Indian economy, the role played by its entrepreneurs as well as its technical and professional manpower has been acknowledged internationally. It is felt opportune that entrepreneurship, knowledge and risk capital combine to provide a further impetus to India's economic growth. In this background, a need has been felt for a new corporate form that would provide an alternative to the traditional partnership, with unlimited personal liability on the one hand, and, the statute-based governance structure of the limited liability company on the other, in order to enable professional expertise and entrepreneurial initiative to combine, organize and operate in flexible, innovative and efficient manner.”


In the politics of it, there are the libertarians and the followers of democratic socialism that India had followed for the longest time before the LPG reforms in the 1990s. The latter has undertones of protectionism which is avoided by the former, as economic purists which is why pursuing LLP, would have been cathartic, historically speaking. For Libertarians, corporate limited liability is not only a conceptual impediment on their side of their radically individualist and subjectivist free market view of the world, but also a violation of individual rights and economic freedom that might have been otherwise guaranteed. Therefore, it is no surprise that Libertarians are in direct conflict with the contractualist purists, which may have been denied as a faulty theoretical and political ruse. In case there is the call for a return to full liability norms, crucially speaking and partnerships, based on the idea that, in the absence of interference by statutory law and the state into the private affairs of individuals, free markets would cease to be a fiction, it should be understood in no ambiguous terms, that this would have potential advantages and disadvantages, with equivalent objections on both the sides. What is, however, clear is that limited liability served to protect individual investors who might otherwise face personal ruin if they were faced with unlimited liability.


This narrative and realization coincided with the growth of modern mass stock markets composed of large numbers of small investors as well as larger investment entities, which is rather inevitable considering the overall progress that was being made in the economic sector, though the kinds of large institutional investors common in today's market were yet to emerge. Indeed many argue that limited liability is essential to the proper functioning of the stock market as its absence can undermine clarity in the valuation of companies' assets given increased uncertainty over exposure to, and liability for, risks, particularly tort risks. As far as our American counterpart[5] is concerned, the concept of LLP arose in the US in the aftermath of the real estate and energy price crisis in the 1980s which was aggravated further in the 2008 financial crisis, both of the instances during which liability was directed towards the lawyers and accountants who had represented the failed financial institutions and the participants involved.


The first law on LLP came into existence in Texas, through the enactment of Texas House Bill 278 on August 26, 1991. With the promulgation of the Revised Uniform Partnership Act (‘RUPA’) in the US in 1994, a number of states permitted the formation of LLPs, which was followed by the incorporation of comprehensive provisions dealing with LLPs in the RUPA in 1997. By the end of 2001, the concept of LLPs had spread to all 50 jurisdictions of the US. As has been the subject of different research blogs and projects alike, the Texas LLP model, unlike the other models, does not release the partners from liability in cases of the partnership's non-malpractice contractual and tort liabilities; instead the partners are only prevented from being held vicariously liable in cases of a co-partner's negligence, error, omission, incompetence or malfeasance. In fact, the structure of LLPs[6] varies from state to state in the US.


Accordingly, some states, including Delaware, have adopted a more expansive approach that ensures that any liability, in tort, contract, or otherwise will solely be the liability of the partnership. Thus, under such models of LLPs, the partner cannot be held liable simply by reason of being a partner. This is quite innovative in the sense that it is breaking away from the conventional definition that LLPs have been given, even as a ‘hybrid’ model of both companies and partnerships. Following the introduction of the concept of LLPs in Texas, major accounting firms in the UK raised a campaign for the creation of LLPs in order to limit the liability of an individual partner to acts specifically involving that particular partner. Accordingly in the European scenario, the UK Companies Act, 1989 was amended to allow accounting firms to work as limited liability companies, which is again a development in the field of what encompasses a LLP. General partners in charge of the ordinary day-to-day activities of the firm were, however, still held jointly and severally responsible. This was achieved by a campaign in the 1990s calling for proportional liabilityin partnership firms, which is essentially a factor that is aimed at balancing the conventional definition involved.


Owing to the rising demand, the Limited Liability Partnership Act was passed in the UK in the year 2000. The UK LLP Act has been codified and based on three broad principles-limited liability, corporate personality and partnership flexibility. The primary distinction between the US Delaware LLP model and the UK LLP model is that while the former regards the LLP as essentially a partnership, the latter primarily treats it as a company. This is monumental, because the traditional idea has only been to read both and then formulate a general model of LLP on the same.Some of the other differences include the existence of an LLP in the UK as a separate legal entity means that it has its own rights and liabilities, distinct from those of its members. In the UK, an LLP differs from a company to the extent that the former has greater organizational flexibility and is taxed as a partnership. In the UK, LLPs are accorded ‘entity’ treatment whilst partnerships governed by the provisions of the UK Partnership Act are generally treated as aggregates of individuals. Post the enactment of the UK LLP Act, there have been considerable changes in the liability of a firm and partners, with respect to the negligence of a co-partner, which is something that the Indian scenario can work on as well, in so far as designated partners are concerned. In the case of Dubai Aluminium Co Ltd v. Salaam,[7] one of the partners of a law firm (not an LLP) made agreements that were used for fraud/sham contracts. The House of Lords held that even acts not authorized by the co-partners could be said to be done “in the ordinary course of the business of the firm” if, for the purpose of the firm's liability vis-à-vis third parties, it could fairly and properly be regarded as done by the partner while acting in the ordinary course of the firm's business. Such acts would then be capable of attracting[8]personal liability for the other partners also and vicarious liability for the firm.


Thus, this decision delineated the extent of liability of partners in a general partnership. Further, the Chancery Division of the High Court of England and Wales in the case of Re: Magi Capital Partners LLP[9], was of the view that in matters of dissolution, an LLP is similar to a company rather than a partnership, since it involves the winding up of a separate legal entity, incorporated under a statute. Hence, as a general rule, an LLP cannot be wound up by an arbitrator. Finally, Court observed in Hailes v. Hood[10], that while a member of an LLP will have various interests in the LLP; the extent of these interests of any one member may vary, depending on the point in time at which and the context in which they are being considered. These cases demonstrate that the concept of LLPs is a complex one, which cannot be determined solely on the basis of either company law or law of partnerships


1.4 Doomed from the start - What is an LLP anyway then?

There are two basic models of LLPs[11] witnessed around the globe. The first is the Texas LLP model. Under this model, the partners' vicarious liability is limited to the wrongful acts of the partnership and not for liability arising in the ordinary course of business. The second model, known as the Delaware model, is one where all obligations of the LLP are solely the liability of the LLP and the partners are not personally liable for any action arising in tort, contract, etc. Based on the discussion above, one can come to the conclusion that an LLP may not necessarily always borrow from the company or the partnership model, but take on characteristics that are different from the existing rationale that had been developed about them in the 19th century, since its inception i.e. the Texas Model in comparison to the UK and Indian models. There is no doubt that there has been a change, based on the prevailing economic and political concerns in each decade and century, which is why the definition of LLP has been rather confusing and area or country specific, with the world following and borrowing from these two models. However, one can definitely say that a small LLP then would only dilute and create confusion further, where the contours of startup and LLP may be used interchangeably in the Indian scenario, but may not have the same implications or meanings per se or otherwise, as would be seen further. The general concept of a LLP would exist no doubt, that is less liability and less taxes applicable, but the nuances would be decided by other specifics as well. In the 21st century, the connotation of an LLP is now even more globalized in approach – when there are legal transfers and other economic benefits that are concerned.


1.5 Reconciling interests – whether the start-up business environment is facilitated enough

Globalization has certainly ensured that in the light of the wholesale abolition of corporate limited liability, the wholesale abolition of corporate limited liability would not be feasible. The LLP Act is broadly based on the UK LLP Act, 2000 and the Singapore LLP Act, 2005. Although this new business form carries the designations ‘partnership’ and ‘limited’, an LLP in the UK is governed neither by the Partnership Act, 1890 nor the Limited Partnership Act, 1907, which were already in force at the time of formation of LLPs. In general, therefore, the law of partnership will not be applicable to LLPs in the UK. Nevertheless, for taxation purposes, an LLP is treated as a partnership, so as to ensure that the choice between an LLP and a partnership is a tax-neutral one.


2 The difference between LLPs and MSMEs – Murky waters in so far as definitional contours are concerned

In the Indian context, it is understood that MSMEs are a form of startups which may use the LLP model, with the small LLPs as a category being the newest addition. However, if one were to explore the main central government page of the MSME would be apprised of the fact that MSME are a very limited form of startups if it can be called that[12], simply because they deal with ‘plant and machinery enterprises’. LLP is a business model which may or may not be followed by startups and MSME, where it would be wrong to interchangeably use the contents of the two, because there is no clarity in this regard at least in the Indian model, whether economically or legally and the question of ‘plant and machinery enterprises’ is rather restrictive of startups and characteristic of only the MSMEs. It is argued that not only then does the category of ‘Small LLPs’ prove to be pointless to a certain extent, in its altruistic half of thought – but it also does not throw some light on the more pertinent and poignant question of the distinction between startups and MSME. This is required not only for the category of people who usually opt for the former, but also the legal mechanisms and laws that still do not have adequate clarity, legislatively speaking.[13]


2.1. Can an LLP become a MSME and vice-versa? When?

An LLP may become an MSME during its lifetime, once there is a bigger goal of the enterprise involved. However that is only possible towards the end of its cycle, as has been noted[14], including financially.[15]


2.2. An inevitable interchange between the LLP Act, 2008 and the MSME Act, 2006 – the way forward

There is no doubt about the fact that both the Acts have separate provisions and their mechanisms to deal with disputes, which would be a problem under the new class, in case the parties decide to engage with forum shopping and manipulate the law to their own advantage[16]. Not only are the bodies separate and the aims of both the acts different from their respective preamble, it would be highly inconvenient for administration of the legal processes involved and the remedies sought, especially when the amendment has been silent on this regard


Conclusion

There is no doubt that the Indian Government has tried to reinforce the benefits of a LLP to a smaller scale when confronted with the new class of LLPs for MSMEs, however that does not mean that there are no enormous challenges that need to be tackled already. The twin questions that do arise is that whether it is still traditionally a LLP, the answer to which is a no and for the second one i.e. whether there is an encroachment on the MSME Act is foreseeable, is a resounding yes. If there can be enough regulations that can balance these twin concerns, the new class of small LLPs can be a big step forward but till that time, the move of the government stands questionable.


Endnotes [1] Jason Broesder & Nicole Cottle, The Wyoming Registered Limited Liability Partnership, 34 LAND & WATER L. REV. 139 (1999). [2] Stephanie Blankenburg, Dan Plesch and Frank Wilkinson, Limited liability and the modern corporation in theory and in practice, Cambridge Journal of Economics , September 2010, Vol. 34, No. 5, Corporate Accountability and Legal Liability: On the Future of Corporate Capitalism, pp. 821-836 (2010) [3] Hetal Doshi, Limited Liability Partnership in the Wake of Start-Up Era, 2018 SCC OnLine Blog OpEd 27 [4] Joseph Li, New Developments in Limited Liability Partnership Law in Hong Kong, 2013 Bus. L. TODAY 1 (2013). [5] Jennifer J. Johnson, The Oregon Limited Liability Partnership Act, 32 WILLAMETTE L. REV. 147 (1996) [6] Yeo Hwee Ying, Liability Of Partners In A Limited Liability Partnership Regime, (2003) 15 SAcLJ 392 [7] Nivedita Sen and Neha Mathen, Decoding The New Business Vehicle of India: The Limited Liability Partnership, (2011) 4 NUJS L Rev 669 [8] H. A. Shannon, The Coming of General Limited Liability, Economic History, Vol. 2, No. 6 (JANUARY, 1931), pp. 267-291 [9] Pranjali Sahni, Starting a Startup: Legal Analysis of a Limited Liability Partnership as the Ideal Business Structure and Available Investment Channels, 5.1 RFMLR (2018) 126 [10] Priyanka Sinha, Foreign Direct Investment in Limited Liability Partnerships: A Dubious Reality, CNLU LJ (3) [2013] 81 [11] Siddh Nath, Responsibilities of Limited Liability Partnership Incorporated under Limited Liability Partnership Act, 2008, 1 INDIAN J.L. & Just. 115 (2010). [12] Ary Zulfikar, Foreign Direct Investment Restriction Policy as an Effort to Empower Micro, Small and Medium Enterprises, 16 Indonesian J. INT'l L. 505 (2019). [13] Surbhi Kapur & Animesh Khandelwal, MSME as Engines of Growth: Exploring the Framework for Rehabilitation and Resolution, 2 CORP. & Bus. L.J. 353 (2021) [14] Michael Dennis & Jose Manuel Pliego Ramos, Creating an Enabling Legal Environment for Micro, Small, and Medium-Sized Enterprises: Simplified Incorporation and Registration, 33 ARIZ. J. INT'l & COMP. L. 71 (2016). [15] Moinak Maiti, Scope for Alternative Avenues to Promote Financial Access to MSMEs in Developing Nation Evidence from India, 60 INT'l J.L. & MGMT. 1210 (2018). [16] Shinoj Koshy & Purvi Khanna, An Examination of the Inapplicability of Limitation to Claims under the Micro, Small and Medium Enterprises Development Act, 2006, 13 NUJS L. REV. 63 (2020).


Submitted by,

Sampurna Mukherjee,

Symbiosis Law School, Pune


Image source https://www.obhanandassociates.com/blog/the-welcome-concept-of-start-up-llps-and-small-llps/

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