10 Must Have Clauses In An LLP Agreement That Are Not Prescribed By Default Under The LLP Act

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, lists the clauses that are needed in an LLP Agreement which may not be prescribed by default under the LLP Act. 

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

• LLP shall have perpetual Succession. Any change in the partners of a Limited Liability Partnership shall not affect the existence, rights or liabilities of the Limited Liability Partnership.
• LLP has at least two designated partners who are individuals, and at least one of them shall be a resident in India.
• A new partner has to be inducted within 30 days as such when there is a vacancy arising in the partnership.
• Conversion from the following entities are allowed to LLP
  • Conversion from a Firm into an LLP
  • Conversion from a Private Company into a Limited Liability Partnership
  • Conversion from an unlisted Public company into a Limited Liability  Partnership

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 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.

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