Analysing LLP (Amendment) Act 2021: A Revolutionary Reform in the Start-Up Era?
[Mainak is a student at National Law University and Judicial Academy, Assam.]
At a time when India is going through a start-up revolution, entrepreneurs and other professionals in the start-up ecosystem need the limited liability partnership (LLP) laws to be flexible. This has been addressed in the recent amendment of the Limited Liability Partnership Act 2008 (Act). The Limited Liability Partnership (Amendment) Act 2021 (Amendment Act) was introduced in the Rajya Sabha, the Upper House of the Parliament, on 30 July 2021. After being approved by both houses of the Parliament, the Amendment Act received the assent of the President on 13 August 2021.
The amendment focuses on facilitating ‘ease of doing business’ by making provisions of the Act less stringent. By allowing more flexibility, it will develop an equal playing field for LLPs and encourage more start-ups across the country. Moreover, it has brought key changes, such as introducing the concept of ‘small LLPs’, decriminalisation of certain offences, the government’s power to establish special courts.
What is a Limited Liability Partnership?
LLPs are corporate entities that work on a hybrid model, that is, they enjoy the flexibility of a partnership firm and, at the same time, the benefits of a limited liability company. The partners in an LLP firm are liable only to the extent of their agreed contribution to the capital. They cannot be held liable for any unauthorized action of the other partners in the firm. When it comes to enjoying the benefits of a partnership firm, LLPs have an internal governing structure governed by the LLP agreement itself.
LLPs have risen to prominence in recent times, bringing about refinements in the prevailing corporate structure. Given the hybrid model, the LLP laws serve as a great platform for entrepreneurs and other professionals to form an entity without falling victim to the problems of a partnership firm, and enjoy the benefits of a company.
Key Changes and Comments on the Amendment Act
As discussed earlier, the Amendment Act will start a new chapter of LLPs in the corporate framework in the country. The amendments primarily aim to improve the ease of doing business and encourage more start-ups in the country. The key changes in the Amendment Act are:
Decriminalisation of certain offences
The Act previously made the contravention of certain compliances punishable with a fine only - ranging from INR 2,000 to INR 5,00,000. These included failure to: (i) report changes in the partners of an LLP, (ii) report changes in the registered office, (iii) filing of statement of accounts and solvency, and (iv) reporting of arrangements between LLP and its creditors or partners and reconstruction or amalgamation of an LLP. The Amendment Act converts these offences into civil defaults. It further decriminalises specific provisions by imposing a monetary penalty on them instead of fines, which connote criminality.
Criminal proceedings are time-consuming, costly and complex. The Amendment Act separates minor non-compliances from serious fraudulent offences that jeopardise public interest, thereby allowing for better governance of punishments with cost-effective and less time-consuming methods.
In-house adjudication and establishment of special courts
The Amendment Act allows for offences relating to minor non-compliances to be adjudicated by an in-house adjudication mechanism, instead of being treated as criminal offences. Moreover, it enables the central government to establish special courts for trial offences under the Act. These special courts will consist of: (i) Sessions Judge or Additional Sessions Judge in case of offences punishable with three years or more; and (ii) a Metropolitan Magistrate or a Judicial Magistrate in case of other offences. Appeals against orders passed by these special courts will lie with the High Court.
The Amendment Act de-clogs the criminal courts by allowing matters and disputes to be resolved through an internal adjudication structure or special courts. It seeks to introduce a system similar to the prevailing internal adjudication mechanism (IAM) under the Companies Act 2013 (Companies Act) wherein the Registrar of Companies (ROC) is authorised to adjudicate on minor offences which do not require any subjective assessment. Now, LLP stakeholders will not have criminal charges framed against them due to a minor technical or procedural default in the ordinary course of business. These offences can now be resolved internally by levying a monetary penalty. Therefore, it will increase the confidence of the stakeholders in the prevailing ‘self-sufficient’ adjudicatory system.
The Amendment Act introduces the concept of small LLPs to encourage entrepreneurs. Partners’ contribution in a small LLP is up to INR 25,00,000 or such a higher amount but not exceeding INR 5,00,00,000, as may be prescribed. The turnover for the preceding financial year is up to INR 40,00,000 or such a higher amount but not exceeding INR 50,00,00,000. Small LLPs will be subject to fewer compliances and relatively minor penalties when it comes to civil defaults.
Small scale start-ups rarely have the wherewithal to understand and grasp the complicated rules and regulations of the system. The Amendment Act addresses this issue and makes rules, compliance, and regulations of the start-up ecosystem more conducive to incorporating these small-scale start-ups and making LLPs more flexible. Corporate enterprises are a combination of professional expertise and risk-taking appetite. Regular partnerships have professional expertise, but they lack the risk-taking factor as liability is borne equally among all the partners.
On the contrary, due to their nature, LLPs have both professional expertise and risk-taking appetite, which makes them more suitable for start-ups as one can enjoy the fruits of both a partnership and a company. Furthermore, the concept of small-scale LLPs is in line with the concept of a ‘small company’ under the Companies Act.
The Amendment Act now allows LLPs to issue fully secured non-convertible debentures from investors regulated by the RBI or SEBI.
Non-convertible debentures have a fixed date of maturity. The interest is paid along with the principal amount either monthly, quarterly or annually. The assets of the enterprise back secured non-convertible debentures. Thus, in the event of an enterprise failing to pay on time, the investors can recover dues by liquidating the enterprise’s assets. From an investor’s perspective, secured non-convertible debentures of an LLP will be a safe investment option in this start-up era. On the other hand, the issuance of non-convertible debentures will facilitate LLPs to raise more capital and financing of operations swiftly.
Standards of accounting and auditing
A new provision, Section 34A has been introduced to empower the central government to prescribe the ‘Accounting Standards’ or ‘Auditing Standards’ for a class or classes of LLPs.
Previously, LLPs never experienced the benefits of standard accounting systems that companies registered under the Companies Act did. The introduction of Section 34A will standardise the entire system, and bring uniformity in accounting and auditing systems. It will help avoid frauds and manipulations, enhance reliability towards financial statements and most importantly, facilitate comparability in this era of cut-throat competition in the market.
Other key changes
The Amendment Act makes fraudulent activities liable for higher penalties. Moreover, the central government can now allot a new name to an LLP if the previous name is ‘undesirable’ or identical to a trademark pending registration. Furthermore, a Regional Director to be appointed by the central government, will now have the power to compound any offence under the Act, punishable by a fine. However, in the event an offence by an LLP or by any of its partners is compounded, future offences cannot be compounded for the next three years, starting from the date of compounding of the previous offence. These provisions will bring about more discipline in practice and the operation of all LLPs in the corporate framework. Moreover, the central government will now enjoy a more prominent and integral role in the start-up ecosystem, ensuring better surveillance and scrutiny of operations.
The reforms will encourage entrepreneurs and other professionals to consider forming LLPs as they offer a secured business environment. The amendments are similar to the amendments recently brought in the Companies Act. This is further evidence that the central government wants to level the corporate playing field in the country. Furthermore, small-scale entrepreneurs will now look at LLPs as a more suitable option for starting a small business involving lesser risks. Additionally, the start-up ecosystem, for this matter, is expected to see a boost as the idea behind a corporate entity will no longer depend on the existence of a partnership and survive beyond it. Thus, partners in a small-scale start-up, who risk falling apart after a certain point, will no longer face the risk of seeing the idea behind the partnership die with the partnership firm.
In future amendments, there should be a focus on improving ease in accessing angel investors. Small-scale start-ups usually operate with minimal capital, which makes them conducive for angel investments. Compliance rules make it very difficult for angel investors to invest in small-scale LLPs. Thus, existing compliance rules must be eased for angel investors and LLPs, which can benefit a large number of small-scale start-ups and angel investors.
Furthermore, LLPs should be allowed to issue employee stock options which will help them retain key personnel. ESOPs not only increase employee productivity by motivating them to work hard, but also help the entity raise new equity to refinance debt and acquire assets. Thus, it is an attractive proposition that benefits both the employer and the employee and should be considered in the future.