Legal Matters: Addressing New LLP Rules

Many UK-based private equity and venture capital funds use limited liability partnership (LLP) structures as their management vehicles for a variety of legal and tax reasons, so the developing law that applies to these structures is important.

Last year, the UK's Supreme Court ruled that LLP members can qualify as “workers”, which means that they can benefit from a number of important statutory rights. In practice, the private equity industry appears to have paid little attention to this issue, however subsequent cases have extended the potential scope of worker protections such that LLPs would be wise to address this issue now.

WHISTLE-BLOWER PROTECTION

The first right potentially available to LLP members who fall within the definition of workers is whistle-blower protection. Whistle-blowing is not a new phenomenon; legislation was enacted as far back as 1777 during the American War of Independence, and more recently enshrined in the UK Public Interest Disclosure Act 1998. However the concept of protection for whistle-blowers is not confined to UK law; the most notable being the stringent rules and protections set out under the US Sarbanes-Oxley legislation. And, in recent years, as a result of the considerable publicity surrounding the cases of Edward Snowden and Julian Assange, the awareness of the general public regarding the rights afforded to whistle-blowers has risen significantly.

Looking to the future, further focus will be directed at the protections for whistle-blowers by various regulators in the UK and EU, primarily those responsible for the financial sector. For example, on 23 February, a consultation commenced over changes to whistle-blowing obligations for insurers regulated by the Prudential Regulation Authority (PRA), deposit-takers and PRA-designated investment firms. Proposals include requirements for firms to appoint a “whistle-blowers' champion” who would be responsible for ensuring the integrity, independence and effectiveness of the firm's policies, including protecting those staff who blow the whistle from suffering detrimental treatment, and an obligation to inform the regulator in the event that such detrimental treatment is found by an employment tribunal to have occurred.

The majority of whistle-blowing cases within the private sector arise in the context of a dismissal of an employee who may assert (with or without good reason) concerns relating to the conduct of their employer's business as a tactical lever to extract increased severance compensation. The reason that this tactic often works is because, if proven, compensation for detrimental treatment due to whistle-blowing is uncapped. Often, even if there is no substantive basis to the whistleblowing allegations, many private organisations will pay a premium to avoid the bad publicity which may result from having such matters, however, spurious, dealt with in a public forum. Against this background, in the context of the LLP, the right not to be subjected to a detriment for having blown the whistle is a broad-ranging and powerful weapon in the hands of a disgruntled or departing LLP member and such claims from LLP members who fall within scope of being a “worker”, are very likely to increase.

HOLIDAY PAY

Holiday pay is the second tricky area for LLPs to consider. Workers are entitled to minimum holiday entitlements prescribed by UK and EU law, and therefore if an LLP member is a worker his/her annual holiday quota must equal or exceed these limits. In practice, this is seldom a problem as frequently LLP deeds/policies will already afford members the right to take the same amount of holiday (or more) than they would otherwise be entitled to if they were an employee of the LLP. 

However, while the amount of holiday a member is entitled to take may in practice be less of a problem, recent case law has prescribed the pay a worker is entitled to receive for each day of holiday taken. Specifically, workers have the right to be paid holiday pay at a rate that includes variable and not just fixed compensation. The actual rate of holiday pay for workers is calculated by reference to a twelve week look-back period. This means that if a worker receives a large variable payment related to his/her performance during the twelve weeks prior to jetting off to Martinique (or some other exciting holiday destination), the holiday pay the worker is entitled to receive will, in some cases, be significantly greater than their normal basic drawings. While current case law has focussed on cash payments received by workers during the reference period (guaranteed overtime, commission payments etc.) UK courts will be obliged to consider other types of variable remuneration, which could include bonuses, allowances or even stock awards if they relate to personal performance. Therefore, an analysis of the new rules and how they interplay with the intricate remuneration structures of LLPs will need to be undertaken to identify which elements could fall within scope of a holiday pay claim from a disgruntled worker. Indeed, given the right to claim potentially substantial “back pay”, such analysis should be undertaken sooner rather than later. However, many organisations are avoiding active steps to address this risk until after 1 July 2015, when such back pay will be limited to two years under legislation introduced by the outgoing Coalition Government.

AUTO-ENROLLMENT RIGHTS

Finally, the other key area relevant to workers relates to auto-enrollment pension rights. Pensions auto-enrollment is a mechanism introduced in October 2012 whereby, from an organisation's specific “staging date”, its employees and workers must be enrolled into an auto-enrollment compliant pension scheme (unless such employee/worker elects to opt-out). Having been auto-enrolled into a pension scheme, both the employer/engaging entity and employee/worker are required to pay a percentage of the individual's remuneration into a pension scheme. The percentage of remuneration that the employer/engaging entity will have to contribute will increase over time and there are anti-avoidance penalties for failing to comply.

Fortunately for many LLPs, the specific staging date for each organisation is based on organisation's PAYE scheme as at 1 April 2012. Many LLPs will not in fact have had a PAYE Scheme on that date and so their staging date will be 1 April 2017, giving them time to consider the financial impact of the change as well as options for dealing with this requirement.

As with the salaried member rules introduced by last year's Finance Act, LLPs would be well advised to undertake a careful assessment of each class of LLP member. Firms cannot simply rely on a previous assessment undertaken to identify who may be salaried members for tax and PAYE purposes, as the rules regarding worker status are more far-reaching. Most LLP members are likely to be workers, save where they fall within the realm of the genuinely self-employed, and so strategies for dealing with worker rights for (and potential worker claims from) LLP members should be devised now. 

As Sun Tzu in the Art of War wrote: “Every battle is won before it's ever fought.” Now is the time to consider the impact of this change as timely action may allow matters to be structured in a way that prevents worker status from applying, or permit time to mitigate cost and risk if it does.