Covid-19 And UK Partnership Models

Could partners be ejected?

Sinead O’Callaghan, Partner at Cooke, Young & Keidan, and James Mather, Barrister at Serle Court
Originally published in the April | May 2020 issue

Hedge funds are no doubt facing significant pressures as the Covid-19 pandemic continues to take a toll on the global economy and the value of investments. The worst affected funds may well be looking at whether individual members need to be expelled or retired to ameliorate their financial positions and keep the boat afloat. In contrast, high performers may be considering jumping ship to different funds which appear to be continuing to function well with little risk of insolvency.

This article examines first, the scenarios in which members might find themselves leaving their current funds; and secondly, the potential consequences associated with leaving, including the impact of insolvency.

Expulsion of members

Many funds are no doubt already taking action to identify and address underlying issues affecting specific individuals. In the current climate, this might result from inadequate performance and/or under-delivering, or it might be due to disagreements in relation to the strategy to be adopted with the aim of surviving the current crisis. 

In these challenging times, there may be a temptation for funds to seek to exploit rights within partnership agreements in order to delay or ultimately refuse to make significant payments due to leavers.

In general terms, the power to expel a member arises only where an express power is included in a written partnership agreement. As a result, most funds will have a clause in their partnership agreement setting out a detailed list of grounds for expulsion as well as provision for compulsory retirement on a discretionary basis, in other words, allowing for members to be dismissed on notice without the need for substantiating grounds. 

Whichever route to expulsion is adopted, it will be important for the leaving member to consider the consequences, which could include financial consequences such as retention of profits or capital, amongst other things. In these challenging times, there may be a temptation for funds to seek to exploit rights within partnership agreements in order to delay or ultimately refuse to make significant payments due to leavers, by, for example, seeking to justify an expulsion for cause with associated financial and other consequences as opposed to exercising a compulsory retirement provision which would not usually have the same detrimental consequences attached. 

Equally, leavers may be more tempted to challenge any expulsion with the aim of increasing their financial package if their employment prospects appear dismal in the current climate. Routes to challenge might include that the grounds for expulsion are so wide that they are without meaning or open to abuse or that the power to expel has not been exercised with good faith. Case law has shown that the court will be alive to the possibility of abuse, particularly where there is an ulterior motive for the expulsion.

Compulsory retirement of members

One perceived advantage of exercising a compulsory retirement provision is that it can be implemented without the need to give substantive reasons for the decision. However, whilst, broadly speaking, this is likely to mean that the procedure is less open to challenge (case law has confirmed that there are no powers available to force a partnership to provide reasons for compulsory retirement), it should also be borne in mind that (as is the case for exercising a power of expulsion), the power of compulsory retirement must be exercised in the utmost good faith for the benefit of the partnership as a whole. 

Separately, in 2014, the Supreme Court held that members of a limited liability partnership are workers for the purpose of whistleblowing legislation and attract legal protections associated with worker status (Clyde & Co LLP and another v Bates van Winkelhof (Appellant) [2014] UKSC 32). Therefore, it will always be open to leavers to raise allegations of victimisation as a result of whistleblowing as well as discrimination (which will include age, race and sex related discrimination). 

Resignation of members

A third scenario is where a member or indeed even a founder of a fund may decide to leave of their own accord, for example, if the fund is not performing and there are better prospects for them elsewhere. For those members, one key consideration which has always applied to leavers (regardless of the current crisis) is whether they will face obstacles in continuing with their professional lives. This may include difficulties in extracting profits and/or capital (or information which would allow them to accurately calculate the amounts due) as well as intransigence in terms of any prohibitions on their professional lives going forward, including the enforcement of restrictive covenants. Another consideration, more specific to the current crisis, may be whether if they depart swiftly whilst the fund is still solvent, they will benefit from a better financial package than if they stay until the bitter end. 

The dynamics of all of these considerations will turn, of course, on the relevant provisions of the partnership agreement and/or the retirement agreement in place.

Common obstacles faced by voluntary leavers

Funds which are not best pleased about losing their star performers may take a strict line in respect of any restrictive covenants. However, in these uncertain times, there may also be a temptation to sabotage the leaver’s position in respect of both their finances and earning potential moving forward. In respect of the former, members may find themselves unable to extract the financial information they require in order to calculate the amounts they are due (or they may be simply denied the payments due to them), which may force the members into commencing proceedings. In respect of the latter, members may be challenged in respect of their future plans and in particular, on whether they have used, or intend to deploy confidential information, or if they intend to target (or have already targeted) existing clients, suppliers or employees for the benefit of their future plans. In those circumstances, members could find themselves on the wrong side of an aggressive application for an injunction, drafted very broadly to ensure compliance with the relevant provisions of their written partnership agreement, which may contain restrictions which are too broad and arguably unenforceable or which are vague in their terms, meaning there is uncertainty in relation to the member achieving compliance. 

Worse still, members could face ongoing proceedings in order to enforce the terms of any injunction obtained if there is dissatisfaction with the member’s efforts to comply. This would obviously be hugely distracting in terms of taking advantage of other business opportunities or indeed moving on professionally in any capacity. Leaving members will no doubt also be conscious of the fact that they have fewer resources to fund litigation or arbitration, particularly if monies due to them have been withheld.

Insolvency implications

A key issue for members retiring from funds with solvency concerns will be the status of their entitlements if an insolvency process ensues. A fairly recent decision (McTear v Eade [2019] EWHC 1673 (Ch)) has cast doubt on whether members can prove in an insolvency for sums owed to them in their character as member. This was because it was held that that the rule applicable to insolvent companies applied whereby dividends and other sums payable to a shareholder in that character are deemed not to be a debt of the company (notwithstanding that the relevant legislation does not encompass limited liability partnerships). In contrast, previous case law, in relation to members of the law firm Halliwells, appeared to give some comfort when it was held that that the terms of the relevant retirement deed precluded a subsequent claim by the liquidator to reclaim profit payments. In summary, this area is a minefield for leavers from funds with solvency concerns who should seek to protect themselves in the event of fund insolvency under their retirement agreements.