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Can an LLP member ever be an employee of the LLP? The hard questions from Reinhard v Ondra

Can an LLP member ever be an employee of the LLP? The hard questions from Reinhard v Ondra

This year Mr. Justice Warren has handed down two lengthy judgments in the matter of Reinhard v Ondra([2015] EWHC 26 (Ch); [2015] EWHC 1869 (Ch)), a dispute between an M&A banker (Mr. Reinhard) and a start-up financial advisory LLP (Ondra). The central dispute related to Mr. Reinhard’s status on joining the LLP and the terms on which he did so. There were also claims for misrepresentation, for a PILON payment, wrongful dismissal, bonus and expenses, as well as a counterclaim for breach of fiduciary duty.

This alert first summarises in brief the findings made about the nature of a partnership share and then focuses on the question of whether Mr. Reinhard was an employee, a member or both.

What constitutes a partnership share?

The Judge confirmed that a “share” in an LLP is made up of:

  • the rights and obligations;
  • both statutory and contractual; and
  • both financial and administrative;

which membership carries with it. It does not refer to a direct interest in the assets of the LLP.

Any of the rights (save where prohibited by statute) may be limited by agreement  – e.g. there may only be a right to income, not to capital profit – and, importantly, depending on the agreement, the share may pass automatically to the remaining members without payment when the member stops working for the LLP.

Is it possible to have dual status?

Under the common law in a traditional partnership, you cannot be both a partner and an employee. This is because a traditional partnership is not a separate legal entity; it is just a collection of individuals carrying on business together. An individual cannot be both a partner and an employee because no one can employ himself. Given that an LLP has a separate corporate identity, until recently, most assumed that it was possible to both an employee and a member of an LLP. This seemed to be borne out by the judgments of Rimer LJ in Tiffin v Lester Aldridge LLP [2012] 1 WLR 1887 and, more particularly, Elias LJ in the Court of Appeal in Clyde & Co LLP v Bates van Winkelhof [2012] IRLR 992.

In an LLP, membership is governed by section 4 of the Limited Liability Partnerships Act 2000. Section 4(4) purports to set out how you decide if someone is a partner or an employee and provides that:

A member of a limited liability partnership shall not be regarded for any purpose as employed by the limited liability partnership unless, if he and the other members were partners in a partnership, he would be regarded for that purpose as employed by the partnership”.

Both sides in Reinhard argued the case on the basis that dual status was possible. Mr. Reinhard and Ondra clearly also thought a person could be both; the court found, in its first judgment, that this had been their intention when contracting.

However, after trial, but before judgment, the Supreme Court made its ruling in Clyde (at [2014] 1 WLR 2047). In that decision, Lady Hale commented that section 4(4) simply provides that the position of members in an LLP reflects the position of partners in a traditional partnership. The corollary of this is that you cannot be both a member and an employee. Despite argument that her comments were obiter, the Judge in Reinhard found that it is not possible in law to give someone dual status because of section 4(4) and, indeed, that this was the law as set out in Tiffin.

How will the court deal with an agreement which was meant to give dual status?

In the first judgment, the court decided that, given that Mr. Reinhard could not be both a member and an employee, it had two options; Mr. Reinhard was either a member with shadow employment rights, or an employee with shadow membership rights.

In assessing which, the court took into account the fact that the parties, at the time of entering into the contract (mis)understood that it was possible to make someone both a member and an employee. On this basis, the court was looking for the construction which comes closest to achieving, in commercial terms, the result which would have ensued had it been possible for Mr. Reinhard to be both an employee and a member. However, in case this was wrong, the Judge also carried out a careful analysis of all of the indicators in the contractual documents which pointed towards one status or the other, looking to find whether “the substance of the rights and obligations of the parties overall” fitted more closely with Mr. Reinhard being a member or an employee.

In the second judgment, the court decided that on the facts Mr Reinhard looked more like a member than an employee. This meant that the ‘employment style’ terms of his agreement had to be given effect to on a contractual basis, even where the origin of that right was statutory.

What to do with current agreements that try to give dual status

Many LLP agreements say on their face that individuals are both members and employees. Even if that is the intention of the parties, it is not legally possible. This obviously has implications for the statutory employment rights that those people might have and, potentially, for the rights they have to profit or capital (though this will usually be governed by the agreement in any event). The alternatives for resolving this seem to be to either come to a conclusion, now, as to their true status, and re-write the agreement or wait to see if any disputes arise and run the risk of having to go through potentially lengthy (and expensive) litigation.

If the matter does escalate to litigation, the courts/employment tribunals will have to go through the cumbersome process of assessing, on the facts, which single status, they in fact hold. In our view, despite the introduction of specific tests for HMRC to determine status for tax purposes, the tax status of a person will not be the only factor that judges will take into account, although it may be that more weight will be placed on it now that LLPs have to go out of their way to meet or fail to ‘tick boxes’ in relation to tax status.

Summary of key points on dual status:

  • the law is now clear – you cannot be both a member and an employee, even if that is what all the parties to the agreement wanted to do;
  • if you have an agreement that aims to create dual status, then think about rewriting the agreement so that it sets out which single status each person has, rather than face potential uncertainty and legal disputes.
Partners in a general partnership, along with LLP members, are protected from unlawful discrimination.  Whilst partners (and in this alert we use the word ‘partner’ to refer to both partners in a general partnership and LLP members) do not have the benefit of the full spectrum of employment law rights which apply to employees, they are protected against unlawful discriminatory treatment on a number of specific grounds.

 

In this partnership alert we look briefly at:
  • pregnancy discrimination; a complex and often confused area of law owing to the lack of case-law and legislation specifically relevant to partners; and
  • the practical steps firms can take to help prevent pregnancy and sex discrimination claims arising in the first place, which in turn can help to create a fair and supportive workplace for partners.

What pregnancy protection is available?

Partners have the right not to be discriminated because of their pregnancy or pregnancy-related illness.  A firm will also be obliged to comply with certain health and safety obligations to pregnant and breast-feeding partners.

Specifically, a partner has the right not to be treated unfavourably because of her pregnancy.  This protection applies from the point at which her pregnancy begins, to the end of the 2 week period following the birth of her child.

This protected period is much shorter than the protected period available to female employees.  Female employees will be protected from pregnancy and then maternity discrimination from the point of their pregnancy to, potentially, the end of any additional statutory maternity leave period taken (i.e. up to 52 weeks post-birth, as opposed to just the 2 weeks post-birth applicable to partners).

Nevertheless, this does not mean that a female partner has no discrimination protection once her pregnancy and 2 week protected period is over. If she is treated less favourably because of her pregnancy after the protected period (or any maternity-related absence, if applicable), she may have sex discrimination protections (as opposed to pregnancy discrimination protections).  However, she would need to show that her treatment during this time is less favourable than, for example, that of a male partner on sick leave.  In contrast, during the protected pregnancy period no comparator is required: if the female partner is treated unfavourably then it will automatically be deemed pregnancy discrimination. In practice this has the effect that female partners have a lower level of discrimination protection following the birth of their child than female employees.

 

Are partners entitled to maternity leave?

Partners are not employees and therefore are not entitled to ordinary or additional statutory maternity leave. Nor are partners entitled to the ‘compulsory maternity leave period’ which applies to employees (when employees are prohibited from working for the two weeks immediately after birth).

Partner discrimination protections during any pregnancy or the 2 weeks following birth are as outlined above.  However, if a firm does not offer a female LLP member maternity leave this could, as indicated above, arguably be indirect sex discrimination (as caring for a child tends to be undertaken by more women than men) and if so the policy would have to be objectively justified by the LLP. It could also be direct discrimination if a male partner absent on sick leave can take extended leave of absence and the female partner is not allowed to take an equivalent extended period of maternity leave absence.

What is payable to partners whilst they are on maternity leave?

As they are not employed under a contract of service, a partner is not entitled to statutory maternity pay (although LLP members deemed employed for tax purposes under salaried members’ rules may qualify).  Partners are likely to be entitled to statutory maternity allowance provided they fulfil a number of conditions.  Maternity allowance is a social security benefit payable for 39 weeks, traditionally provided to self-employed or lower-income workers. It is currently around £140 a week or 90% of the partner’s average weekly earnings, whichever is less.

There may be scope to argue that treating a female LLP member on maternity leave less favourably on the basis of pay during such leave than a sick male LLP member on extended sick leave, may amount to direct sex discrimination.  Equal pay law is also likely to be relevant to female LLP members (but potentially not to partners in a general partnership) and the pay they receive during their maternity leave period. However, both of these aspects of partner maternity leave are complex and presently uncertain and outside the scope of this brief alert.

Do Firms offer contractual maternity pay and leave?

Putting a partner’s strict legal entitlement to one side, many firms typically offer their female partners enhanced contractual maternity pay and leave.

Maternity pay and leave details are usually set out in the partnership, LLP deed or related policies, and this is certainly recommended.  Firms tend to offer anywhere between 3 and 12 months’ maternity leave (depending on the size and resources of the firm), with it varying as to what proportion of this leave is paid and unpaid. Between 3 and 6 months paid leave is typical in our experience (with 6 months more usual in mid to larger firms), often with an additional equivalent amount of unpaid leave.

Common examples of sex and pregnancy discrimination

Firms are becoming increasingly familiar with those areas of their workplace which are susceptible to discriminatory practices relating to pregnancy and/or sex, including for example (amongst others):

  • not returning clients to a female partner on her return from a pregnancy/maternity related absence (the clients are passed to another LLP member during pregnancy/maternity leave);
  • not providing all necessary training and coaching opportunities missed during a period of maternity leave;
  • delaying the partner’s progress up the lockstep by the period of their maternity absence; or
  • not providing an annual partner development review  whilst on maternity leave (which could in turn affect a female LLP member’s right to receive a profit share increase, and also her relative assessment compared to male peers when members are being selected for compulsory retirement from the LLP).

What can firms do in practice to avoid pregnancy discrimination claims?

There are a number of steps firms can undertake to avoid their exposure to pregnancy and maternity related claims by their partners, these could include (but are not limited to):

  • documenting a female partner’s maternity and associated rights.  By clearly stating these rights in writing, this is less likely to lead to disagreement in the future about entitlement.  It can also help evidence a firm’s ambitions of retaining and attracting female talent;
  • offering a reintegration and support programme for female maternity returners, including  a coaching and mentoring programme;
  • having in place detailed equality and diversity policies (which are regularly reviewed and updated where necessary);
  • training for senior management and heads of department in handling issues related to pregnancy and sex discrimination and female partner retention; and
  • when complaints do arise dealing with them proactively.

Steps as outlined above should go a long way to significantly reduce the risk of pregnancy and sex discrimination claims by partners.

In our next alert we will consider the family-friendly rights to which partners are entitled.