Article published in VODE 21 - The Journal of "Devolve!"

Radical potential of the LLP
~ Chris Cook answers questions

In VODE 19, Chris first exposed Devolve! members to the new possibilities opened up by Limited Liability Partnerships. He argued that this cross between a company and a partnership has some special features that can be used to undermine the dog-eat-dog economic system that created it. However, these ideas take a bit of chewing at first – especially if, as for most of us, economics has always been a bit of a turn off. The original essay is repeated (in smaller type) for quick reference. The questions (put by Bill) are in bold type and the explanations by Chris follow each question. Ready to go?

If it is true that the road to Hell is paved with good intentions, then perhaps the road to Heaven is paved with bad ones. The innovation now threatening the existing “Western” form of Capitalism is an unintended consequence: proof positive of the “cock-up” theory of History. The story begins in that bastion of democracy – Jersey.

In the early 1990s major professional partnerships such as Andersen became increasingly concerned at the risks run by individual partners of bankruptcy caused by their unlimited liability for actions or omissions by their fellow partners. Two of the leading UK professional partnerships commissioned a major City law firm – at a rumoured cost in excess of £1m - to draw up an Act of the Jersey “States” Parliament establishing a new form of Limited Liability Partnership (“LLP”). Suitably placed UK press articles raised the spectre of a mass migration by professional firms to Jersey and the Conservative Minister Michael Heseltine then in office ordered the commencement of the consultative and legislative process subsequently continued by New Labour that eventually resulted in the UK’s Limited Liability Partnerships (2000) Act, which came into effect on 6 April 2001. The outcome is an economic entity or “Enterprise” which is both novel and supremely simple. For the first time anywhere (unbelievably) it is possible to form a corporate body (i.e. an entity with a legal existence independent of its individual Members), which has:

(a) collective limited liability (not to be confused with the pre-existing form of UK “Limited Partnership” or the US LLP, both with individually limited liability);

Does this collective limited liability mean that a group of people, say the members of a credit union, has a liability limited only to the stake, the capital, they have put into the partnership? This still means, however, that if the LLP fails, goes bankrupt, then the credit union loses all its funds.
Yes, you can only lose what you put in. If an LLP were acting as a Credit Union then it would be subject to whatever the FSA regime prescribes, which I THINK includes compensation for depositors. Not that I advocate deposit taking or interest in any form.

(b) the mutually beneficial collaborative and co-operative characteristics of Partnership.

It would be helpful if these characteristics were spelt out so that would-be partners know the advantages of joining an LLP.
Members of an LLP are "all on the same side" – there is no "Profit" and no "Loss" as between the Members WITHIN a partnership, merely the creation, exchange and accumulation of economic value - in whatever form, "Money" or "Money's worth" members choose to use. [1]

There are already over 7,000 LLP’s: which is not surprising when it is considered that all that is necessary to form one is for two “Designated Members” to complete an application downloaded from the UK Companies House web-site and submit it with a £95 fee.

If an LLP is formed by two Designated Members, is it possible to include other stakeholders having equal status?
Yes indeed: Membership of the LLP and adherence to the LLP Agreement can extend to anyone, irrespective of whether or not they choose to be "Designated". There is nothing special about Designation except for responsibility to Companies House. Many LLP's "Designate" everyone.

There is no requirement for the Victorian era “Memorandum of Incorporation” or “Articles of Association” and no need for a Shareholder Agreement. The voluminous and complex Companies statutes, the massive body of interpretative case law and all the regulatory issues in respect of corporate governance and “corporate social responsibility” (an oxymoron if ever there were one) are irrelevant because the conflict of interest between shareholders and all other stakeholders does not apply. All that is necessary in an LLP is an agreement between Members that need not even be in writing since regulations based upon existing UK partnership law are the “default” provision.
However, there are two properties of this “new” UK LLP that are radically new.
Firstly, it is possible for all stakeholders, whether staff, management, investors, suppliers, service providers or customers to subscribe to a suitably drafted Member Agreement, rather than to complete adversarially negotiated Contracts of Employment, Supply Agreements and the like - thereby putting the “Open” in the proposed “Open” corporate partnership.

See the comment above about two Designated Members. If these stakeholders are not party to the original partnership, are not Designated Members of the original agreement (which appears to be limited to two), what is the relationship between “a suitably drafted Member Agreement” and the original LLP agreement between only two Designated Members? Do the stakeholders, who were not included in the original partnership, have equal rights with the Designated Members or is the Member Agreement inferior to the original LLP? What is included in these Member Agreements?

As stated above Designation is a merely administrative title. Any number of people (or organisations, or even LLP’s!) can come together to form an LLP and draw up any form of membership agreement for any legal activity or purpose. One of the key clauses of any LLP agreement will relate to the membership provisions: i.e. when and how people join and leave the LLP. In the absence of any provision, then partnership law applies by way of default: i.e. all Members must agree to changes. For a big LLP, that would get unwieldy pretty quickly.

Secondly, the existence of a corporate body that also has the beneficial characteristics of a partnership is capable of literally changing the nature of Capital itself. How so? It is now possible - through suitable provision in the Member Agreement - to create a new form of “Open” Capital in the form of proportional shares/partnership interests (e.g. one half, five tenths, 500 thousandths - as opposed to fixed shares of say £1.00 “Nominal” or “Par” value). So everyone gains if the enterprise increases in value. No party can gain at the expense of others. [2]

It seems from this that the employees, say, or any stakeholders of an LLP, can, if they wish, subscribe a proportionate share of the capital. If they do, does this increase the number of Designated Members of the LLP? If it doesn’t then the questions asked above have to be answered.
If you are an "employee" then you are outside the LLP and with a contract: the only financial relationship you would have is as either a debtor or creditor. Similarly for a supplier, customer or financier. If you are a "Member" within the box, then your work or other contribution will give you a guaranteed revenue share and/or returns on any "Equity" Capital held in the LLP, as laid down under the agreement.

This model has already been (albeit unwittingly) demonstrated by the Hilton Group in its recent sale for £350m of 10 hotels to an LLP in which it is the 40% owner and “Occupying” Member (or Capital User), while another LLP – itself with three Members including Bank of Scotland – owns the balance of 60% and is the “Financing” Member (or Capital Provider).

This is not a model of stakeholders joining an LLP but of an original two partner LLP.
True, but a radical demonstration of an entirely new risk-sharing form of finance nonetheless. Neither Debt nor Equity, but a unique synthesis.

The Hilton pays to the financiers each year for the 27 year term £3m plus 28.8% of the hotels’ gross revenue, subject to a “floor” of £17.5m pa. There is no debt, and no mortgage: equally there is no Freehold/ Leasehold “sale and leaseback” either of which would have given rise to a fixed overhead to the Hilton group and therefore to a divergence of interest between the Provider of Capital and the User.

If The Hilton has entered into an agreement to pay £3M + to the Financing Member this is a debt, an obligation, even if is not as a result of a loan. What happens if The Hilton can’t pay what it has agreed to pay? I have already asked what happens if The Hilton have a bad year? Is not the original agreement then broken and, if so, what penalties are incurred?
In fact the Hilton deal is an imperfect example in the sense that because a Bank was involved a lower (fixed) limit was agreed. So the outcome was in fact a lower than normal rate of interest with a sharing of risk on the up side. That is not the point. Banks LEND: they do not invest. Worse than that they lend money that they create with a stroke of a pen, but that is another story. Had the Bank been exposed on the downside then they would have had (under Basel Capital requirements) to put aside a large amount of risk capital to cover it. Other than the outline of the Hilton deal I have no idea as to the details: had I been involved I would even now be sitting on a beach somewhere. The example merely illustrates the possibility of TRUE investment by those (you, me, pension funds) interested in a proportional "share" in a productive asset and the revenue streams that it produces. A new asset class less risky than "Shareholder Value" style "Equity" yet more remunerative (potentially) than interest-bearing Debt. [3]

The outcome is that sharing of risk and reward characteristic of a true partnership: if Hilton has a good year the financiers do too. One interesting consequence of the model is of a method of financing property purchases that is Islamically sound, being outside the debt/interest paradigm.

The possibility of property purchase through an LLP needs to be elaborated in detail. How, for example, would a couple trying to get on the housing ladder find an LLP partner who would provide the necessary capital which is not a debt? What would this partner gain if there were no collecting of interest on a debt?
The investor - typically a pension fund and quite likely the one that the Occupier is already a Member of - would become the "investor" member of the LLP that owns the property. The occupier (also a partner-member) simply rents the Capital they do not own. So that if the house is worth £100k with a market rental of £5k pa then if Mr and Mrs X own 10% of the Equity (because they could only raise 10k) they must pay a rental of £4.5k pa (= rent on the 90k they don’t yet own). If they pay more than that then they acquire more Equity (own more of the house) at the prevailing market value. If they pay less, they do not get repossessed (as a borrower would if s/he failed to pay the mortgage or were a tenant who did not pay the rent). They simply reduce their share – transfer some bricks back to the financing partner. The Occupier only gets repossessed if her/his Equity runs down to zero and s/he STILL does not pay the Rent. For the Investor there is a combination of the market rental on the Equity they own, plus Capital Gain or Loss as property prices rise or fall: "virtual " property really. Both parties cut out the market "middle man" who borrows cheap and lends dear.

Moreover, the fact is that any Enterprise or economic entity: from a co-habiting couple to a government sponsored PPP or PFI; from a football club to a software firm; may be constituted using one or more UK LLP’s.

Why would a cohabiting couple want to form an LLP? All the examples mentioned need to be explained, in detail, so that readers will understand just how an LLP works in these circumstances. How, for example, would a Private Finance Initiative enterprise benefit by changing to an LLP? What agreements and arrangements would such an LLP have?
A co-habiting couple secure the assets they jointly enjoy, so that we do not see cases where so-called "common law" wives see themselves on the street when their partner dies having omitted to make a will. There are moves imminent towards the registration of civic partnerships that accomplish some of this. I believe that "Family Corporation" LLP's will essentially make most Trust/ Inheritance Law redundant, in addition to large chunks of law relating to Wills.

As for PFI, simply put:
(a) the cost of finance comes down dramatically - probably to "inflation linked" (revenues will be regulated on a formula linked to inflation more often than not) giving "real" returns of the order of 3% to 4% while:
(b) risk sharing between PFI parties becomes much more straightforward. [4]

An “Open” Corporate Partnership is an optimal Enterprise model in the way that it allows all stakeholders to work together to co-operatively and collaboratively maximise the Value created by the enterprise: as opposed to the current model, where one constituency of stakeholder competitively attempts to extract value from the others.

Even in an LLP there could be conflicting interests. The workers of an LLP who have not entered a stakeholders’ agreement but remain employees would want to maximise their wages and conditions as they would in a traditional firm. The partners in an LLP, their employers, would want to maximise their profits, perhaps in order to honour their agreements. These competing interests would lead to conflict. It seems to me that this can only be avoided if the employees form their own LLP within the existing one and form a partnership with it, so that they have a vested interest in co-operating rather than being in an adversarial relationship.

As before, you are either "inside the box", and party to the consensual/collaborative LLP agreement or "outside the box" negotiating employment etc contracts adversarially as now. Sure, there will be negotiations as to the revenue shares when joining/setting up/operating LLP's, but these will be subject to provisions set out from the beginning in the agreement. A workers’ LLP within the main LLP would be one way of doing it, and trade unions may come to recommend this. We are looking at "pre-distribution" rather than "redistribution".

Due to its optimal nature, commercial enterprises that adopt the model will in due course be able to undercut those enterprises that do not – the “Co-operative Advantage”. “Profit” and “Loss” give way to a mutual creation and exchange of economic value created by individuals collaboratively and co-operatively working together.

This seems to imply that the costs of an LLP will be lower than a traditional enterprise. Why are they? Inputs to the LLP (materials, electricity, transport and so on) have to be paid for. Where are the savings made? From initial set-up costs? This needs to be spelt out.
It's what the Co-op movement call the "Co-operative Advantage" i.e. no need to pay returns to "rentier" capital (people who make money from money). The use of "productive" Capital will still have to be paid for using the Capital Partnership model I describe. The outcome I see is for a model where we could see LLP's bringing together Co-ops of customers ("retail co-ops") and Co-ops of staff/service provider/suppliers ("worker co-ops") within the same framework…

The outcome will be a plethora of “networked” and non-hierarchical partnerships and a new capital and monetary market infrastructure based upon an “open” and transparent architecture.

The present capital and monetary market is dominated by commercial banks who create money, in the form of debt-carrying loans (they don’t lend existing money), from which they make immense profits. Those profits depend upon their exploitation of those who have borrowed from them. Are you suggesting that this exploitative relationship can be replaced by an LLP one? How? If there is not a hierarchical and exploitative relationship, how do the banks make their profits? What replaces the loans, debts, they create out of thin air? [5]

You are right of course: Banks are a bit like builders who don't have to pay for the Land they build on. Personally I would have no difficulty in paying a Bank its reasonable costs, and my share of defaults, but why should I pay for THEIR use of MY credit? Which is exactly how we break the mould with the "Guarantee Society" form of the LLP currently being put together in Scotland by the West Lothian Chamber of Commerce. Simply put, local businesses and individuals will join "Guarantee societies" probably initially based upon chambers of commerce. Trade credit is granted bilaterally as now (e.g. I buy a computer from you for £1000 with 60 days to pay) but without interest. You do this because you are happy with the price and have the benefit of a collective guarantee from the "Guarantee Society" of which we are both members and which has some sort of "common bond" e.g. geographical, like the Chamber of Commerce or functional, like a Craft Union).

I pay a charge for the use of the Guarantee of which some:
(a) pays for the cost of running the system, working out "Guarantee limits" - a true "value-added" Banking function - to which we are subject, as opposed to Credit limits); and the balance:
(b) goes into a "default fund" which will pay you if I can't - a form of mutualised credit insurance in a sense.
Essentially the Guarantee Society takes the infinitely flexible LLP form to create a rather elegant entity synthesising a company limited by shares with one limited by guarantee since the Society members will be responsible for the guarantee in proportional "shares" based upon turnover.

Moreover, existing political thinking becomes obsolete as the economic assumptions underpinning existing political analyses break down in the face of a new phenomenon. Redistribution through extracting Value from one constituency of stakeholder (however undeserving) and allocation to another becomes irrelevant. The alternative is now pre-distribution whereby the Value generated by “Open” Capital is more equitably distributed through revenue sharing agreements giving rise to a new balance between Equity and Equality.

This assumes that there will no longer be those, the poor, who are in need of redistributed wealth. It also assumes that they, the poor (the unemployed, the unemployable, the aged, the disabled, and so on) will be in the Open Capital sphere as stakeholders or as Designated Partners. Who would enter into such a partnership with them? What would they, the poor, be able to contribute to the co-operative enterprises you envisage?
This is where we enter the realm of the "Community Land Partnership" which those familiar with Henry George would recognise. Those who assert exclusive rights of ownership over a "Common good" such as Land, Intellectual Property or non-renewable energy would compensate – through a rental – those they exclude. The outcome would essentially be of forms of national dividend.

Open Capitalism is an “emergent” phenomenon that will supplant the existing form of Capitalism (which was itself an unplanned, emergent process) and it is emerging in the same manner that a 19 year old single-handedly destroyed the business model of the global music business through his invention of the “Napster” music file-sharing mechanism. Or the same way that the small community of global oil traders commenced trading oil and oil products in Yahoo instant messaging “chat rooms” without their management even being aware of it. [6]

In summary, Capital is and always has been “broken” by the conflict within it between “Permanent” Capital (e.g. Freehold property or “Equity” in the form of shares in a limited liability company) and “Temporary” Capital (e.g. Leasehold property or Debt finance). “Open” Capital using the LLP structure bypasses that conflict.

How would the conflict, between property, capital, owners and borrowers, between the financiers and the financed, be resolved by Open Capitalism? The owners of capital will still want their rake off. What attractions are there for them in LLPs?
Of course they would want their rake off. But they would no longer make money from money as the very nature of money changes organically to comprise revenue streams derived from productive assets in the joint ownership of occupier and financier. Change doesn't happen overnight. But it will rapidly become apparent to current "owners" that by participating in such partnerships they will get a smaller share of a much bigger pie and hence benefit overall. It is a pre-distributive model. As Henry George said, there is no need to take away the Land, merely part of the Rental value. Most of all, it is a model which is "emerging" spontaneously in the commercial world – because those enterprises who do not use it are already beginning to find themselves at a disadvantage to those who do…

“Open” Capital – a proportionate share in an enterprise held for an indeterminate period of time – is a concept so simple that as J.K.Galbraith said of the creation of Money by private Banks: “the mind is repelled”.
“Open” Capital resolves the conflict between the financiers and the financed, to the mutual benefit of both, and thereby opens the way to a truly Co-operative Society.

Chris Cook
Edited in May 2004 by Woody of "Devolve!"
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