CORPORATE GOVERNANCE FRAMEWORK - A NEED OF THE HOUR FOR LLPs

Introduction

The term ‘Corporate Governance’ became a buzzword in early 2000’s due to introduction of series of legal and

regulatory reforms by the Indian government to instil and to improve the level of responsibility, accountability,

exception to this. The belief that a good governance is required to be followed only by companies and not by any

other form of entities would be conceptually wrong. In fact, to compete in the corporate environment by entities,

an effective corporate governance is very much essential to gain the confidence of stakeholders and achieve

the objectives.

Broadly, the term ‘corporate governance’ describes the processes, practices and structures through which an

entity manages its business affairs and at the same time work towards meeting its financial, operational and

strategic objectives and achieving long-term sustainability. The concept of corporate governance can be

described as a set of principles, rules, regulations, system, process, laws governing a corporation. It is important

that a corporation is fair in its dealing and transparent to its stakeholders at large.

LLPs are unique form of legally recognized corporate entities which integrates the features of both the limited

company under the Companies Act, 2013 (the “CA 2013”) and the traditional partnership firms under the Indian

Partnership Act. LLP is a hybrid combination of a limited company and a partnership firm with a blend of limited

liability on the partners and flexibility like partnership firms. Though, LLP was initially conceptualised for providing

opportunities to professionals like Chartered Accountants, Company Secretaries, Cost Accountants and service

sector, it is now even preferred by small to medium level manufacturing enterprises, captive units, closely held

enterprises, etc.

As the LLP is becoming more preferred type of entity to conduct business, one should also be aware of how LLPs

are more prone to oppression and mismanagement, disputes in the absence of established corporate

governance and the kind of flexibility it provides for partners.

Following are few factors which warrants the need for corporate governance framework in LLPs as well:

1. To define the exact role, power, duty and responsibilities amongst each partner to avoid any conflict /

disputes between the partners;

2. To ensure that objectives of the business are met, and economic growth is achieved;

3. To maintain transparency and induce confidence among partners, who are not active in day to day

management;

6. It helps in brand formation and development;

7. It ensures organizations growth and management which fits the best interests of all the stakeholders;

8. To avoid any partners inter-se liabilities;

9. To avoid any oppression and mis-management on minority partners; and

Overall, it may be noted that the LLPs which exhibit sound corporate governance framework, generate

significantly greater returns when compared to LLPs with a poor corporate governance framework.

Corporate Governance framework for LLPs

Currently, none of the regulations including Limited Liability Partnership Act, 2008 (the “LLP Act”) have a robust

Having said that, the LLP Act does contain certain provisions related to nature and extent of liability of a partner

of an LLP. A partner is not personally liable, directly or indirectly, for an obligation of an LLP solely by reason of

being a partner. The personal liability of a partner arises only for his own wrongful act or omission and he is not

be personally liable for the wrongful act or omission of any other partner of an LLP. The obligation of an LLP

whether arising in a contract or otherwise, is solely the obligation of an LLP and any liability of an LLP shall be

met out of its own property.

There are also few exceptions to the rule of limited liability of a partner as explained in the LLP Act. A person by

holding out (i.e. who by words spoken or written or by conduct, represents himself, or knowingly permits himself

to be represented to be a partner in an LLP) is liable to any person who has in good faith and based on such

other specific regulations, they will have to also comply with the relevant SEBI regulations apart from the LLP Act

and hence, such LLPs are guided to a certain extent to ensure standard quantum of corporate governance.

However, other LLPs generally lacks guidance for establishment of corporate governance framework under the

applicable laws. In the absence of a robust framework of governance, the partners are generally prone to

mismanagement of affairs, breach of fiduciary duty, irresponsibility, lack of discipline in their approach, conflict

of interest issues and internal disputes.

Although the LLP Act itself do not provide for a detailed corporate governance framework, it is possible for the

partners to increase the governance by incorporating detailed mechanisms in the LLP Agreement in line with

those provided in the CA 2013 for the companies.

Accordingly, we believe that LLP could also benefit by adopting some of the following practices for an effective

corporate governance:

1

very comprehensive to cover various situations and hence it is necessary to cover various aspects of relevant

business including the framework of corporate governance in the LLP agreement. As explained above, the

LLP Act has certain provisions as to inter-se partners liabilities, personal liabilities of partners, how the

liability will be met and in case of fraud and when the principal of limited liabilities is not available

drafted LLP agreement will pave many more ways and means to mis-interpretation, mis-management,

oppression, disputes, etc. and thus having a well drafted and comprehensive LLP Agreement is crucial for

smooth running of the business

To list a few clauses which can be incorporated in the LLP agreement from a good governance perspective

as well as limiting the liabilities among the partners inter-se for any fraud etc.:

 Basis the percentage of contribution and controlling stake, list of reserved matters giving rights to

 Clause on framework for redressal of oppression and mismanagement amongst partners;

 Clause enabling the LLP to borrow monies, provide security, guarantee, make loans and investments

2. Periodical meetings of partners and designated partners:

It is important that partners of the LLP convene meetings periodically and maintain the recording of such

meetings in form of minutes. The rationale is to spread good governance discipline and ensure that LLPs

adopt uniform practice in convening meetings, agenda items which would be placed before the partners,

circulation of drafts minutes for comments etc. This would also enable the LLP to create records of the

decisions undertaken and provide adequate disclosures to all the stakeholders.

partners and the legal heirs/representatives of the deceased partner or between partners and the LLP, the

mechanism to be followed to resolve the same shall be incorporated in the agreement.

4. Rights of minority partners:

3

To have a balanced LLP model, it is important that the minority partners interest is not neglected. To ensure

effective corporate governance, it is important to have a clause in the LLP agreement regarding rights

available with minority partners and framework for redressal of oppression and mismanagement.

5. Policies and Reports:

Just like CEO/CFO of a company certify to its Board that they have reviewed the financial statements and

the same contains true and fair view in all material respect in accordance with the applicable laws and

regulations, similar declaration or certification may be issued by designated partners that the financials of

the LLP contains true and fair view in all material respect in accordance with the applicable laws and

regulations.

7. Following the best practices on corporate governance:

The corporate governance framework should ensure strategic guidance to LLPs, for effectively monitoring

An LLP may incorporate in its annual reporting with the Registrar, a report on issues like prevention of sexual

harassment guidelines at workplace, sustainability reporting, practices leading to conservation of energy,

absorption of technology that has reduced carbon footprint / emission etc.

9. Partners/Designated Partners Responsibility Statement:

To promote better accountability and transparency in the functioning of the LLP. The partners / designated

partners of the LLP may include a Partners/Designated Partners Responsibility Statement / Declaration

along with the filing of Annual Financial Statements stating the following:

(a) Applicable accounting standards had been followed in the preparation of the annual accounts;

(b) The partners/designated partners have selected such accounting policies and applied them consistently

10. Establishing Code of Business Conduct:

The Code of Business Conduct can set the standards by which employees and officers should conduct the

business of the LLP. The same applies to partners and designated partners of LLP as well, except to the

extent it conflicts or is inconsistent with any provision of the LLP Act and the LLP agreement. Such code may

address certain potential conflicts of interest inter-se between the partners and the partners with the LLP.

11. Orientation for designated partner and continuing education:

The designated partners should also have access to educational programs related to their duties to enable

them to perform their duties efficiently and to recognize and deal with issues that arise appropriately.

12. Annual Performance Evaluation:

The designated partners may undergo an annual evaluation of performance to determine how their

functioning as designated partners collectively / individually has helped the LLP in achieving its business

objectives by the partners of the LLP.

The partners may coordinate and oversee such evaluation. This evaluation will focus on the contribution to

the overall governance of the LLP and its assessment of how the performance of the designated partner as

a unit might be improved.

the entities is opaque. Hence it is suggested to incorporate the concept of identification of ultimate beneficial

owner in LLP structure as well.

Takeaways:

Having a good corporate governance framework in place will not only help in assuring compliances, smoother

running of operations, cost reduction, efficient processes, streamlined procedures, visibility of errors, better

control, but also instills a culture, leadership behaviour, increase the reputation and credibility of the firm and

brings financial sustainability.

governance framework. Numerous studies indicate that the payoff from good corporate governance manifests

greater investor and stakeholder confidence which ultimately results in maximizing the valuation of the LLP,

attracts various investment opportunities and nurturing indigenous talent and development of cutting edge,

competitive technology and products. In fact, good firm-level governance often makes up for weaknesses in a

country’s corporate laws or the enforcement of such laws.

Considering that LLP is one of the preferred form of entity for the business entrants due to its flexibility and less

governance structure from compliance perspective, it also needs to inculcate the behavior of self-governance

for longer sustainability making it more attractive from investment perspective as well. Given long-term trends,

regulatory monitoring, investment opportunities and efficient governance and management of business, devising

an effective mechanism in the LLP agreement is indispensable.

Hence, corporate governance in LLP is not just a need but a “need of the hour”

The contents of this article should not be construed as legal opinion. View detailed disclaimer.

This article provides general information existing at the time of preparation. The article is intended as a news

update and Swift India Corporate Services LLP neither assumes nor accepts any responsibility for any loss arising

to any person acting or refraining from acting as a result of any material contained in this article. It is

recommended that professional advice be taken based on the specific facts and circumstances. This article does

not substitute the need to refer to the original pronouncements.

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