MINIMUM CAPITAL CONTRIBUTION IN LLP – MANDATORY OR DISCRETIONARY ?

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Introduction

The term “capital” connotes some form of asset of an organisation. It is usually linked or understood to be known as the initial monetary contributions made by the founders in their organisation.

Investopedia defines the term capital as “Capital” can mean many things. Its specific definition depends on the context in which it is used. In general, it refers to financial resources available for use. Companies and societies with more capital are better off than those with less capital. Capital may mean:

Financial assets or the financial value of assets, such as cash.The factories, machinery and equipment owned by a business and used in production”.

In the context of present write up, capital shall be construed as financial assets including money and financial value of assets, contributed by partners before, during or after the formation of LLP. The statement “after the formation of LLP means and includes the situation where an individual becomes partner after the LLP has already been formed and makes contribution towards capital during his appointment as a partner.

The term “minimum capital” stipulates the minimum amount of capital contribution which is required from the founders during the time of incorporation of LLP or form individuals during their entry as a partner in an already existing LLP.

The basic pre-requisite for setting up of any commercial structure for trade is the requirement of capital and with the definition given above the importance of same can’t be denied or overlooked. Almost all the legislations governing different business vehicles mandates for certain level of initial capital contribution initially or during the incorporation or setting up of the stipulated business vehicles.

One such example is the Companies Act, both 1956 and 2013 stipulates that the minimum capital that is required to incorporate a private limited company is Rs. 1 lakh and Rs. 5 lakh for the incorporation of public company.

But with the onset of new Companies (Amendment) Act, 2015, such provision for minimum requirement of capital, even for companies, has been done away with.

In this write up, the focus is on the business vehicle i.e. LLP and to find out whether there is some mandatory need for the partners of LLP to contribute some sort of minimum capital, before, during or after the incorporation of an LLP. Therefore in order to get a clear picture of same, we need to evaluate the provisions mentioned regarding same in the LLP Act, 2008 and its rules thereon and find out if provisions are clear or ambiguous on this aspect and if ambiguous then what form of interpretation shall be applied in order to ascertain the Actual intent of the parliament.

The LLP Act, 2008

The LLP Act 2008 is great step taken by the legislature, towards the development of commercial space, by providing for a business structure which was highly awaited and is proving to be of immense importance for the service providers. Therefore, by keeping in mind the growing need of a business structure where benefit of partnership can be availed with the advantages of having the liability like corporations, the legislature enacted this Act. Now this Act is the sole legislation that governs the Limited Liability Partnerships and further enshrines all the requisite rules and regulations required for the proper working of the said business structure. The very first provision that we should examine is the definition of a partner as is given under Section 2(q) of the Act.

Section 2(q): “partner”, in relation to a limited liability partnership, means any person who becomes a partner in the limited liability partnership in accordance with the limited liability partnership agreement.

The definition portrays that a partner can be anyone, who becomes partner, in accordance with the LLP agreement. Therefore what becomes clear from the definition is that for any person to be included in the definition of the partner as is given under Act, the only requirement is to become the partner in accordance with the terms of LLP agreement and the Act does not specify any kind of capital requirement here.

Then we head to the provision which provides for the requisite essentials on the fulfilment of which, an individual shall be barred from making the partner and the said essentials are listed u/s 5 of the Act.

Section 5: Any individual or body corporate may be a partner in a limited liability partnership: Provided that an individual shall not be capable of becoming a partner of a limited liability partnership, if—

He has been found to be of unsound mind by a Court of competent jurisdiction and the finding is in force;

He is an undercharged insolvent; or

He has applied to be adjudicated as an insolvent and his application is pending.

From the above section the provisions that are relevant for this write up are those listed under part (b) and (c) above. The relevant provisions stipulates that an individual shall not be capable of becoming a partner of an LLP if he is an undischarged insolvent or he has applied to be adjudicated as an insolvent and his application is pending.

Therefore what we can gather form this is that for becoming partner in an LLP what is required is that the person must be a solvent. Now since these provisions makes it mandatory for an individual to be solvent, can it be said that these provisions in a way implies that the individual need to contribute mandatorily, some form of capital during his making of partner?

To answer this question, since the provisions are not entirely ambiguous, we need to construe them in a literal manner and after applying such rule of construction, what we gather is that the provisions, though provides for the person to be solvent, but that does not necessarily means that he have to contribute some form of capital. Therefore a person can be solvent and yet can be made partner without contributing anything in the LLP.

After construing the definition of partner, another somewhat related but important definition that need to be looked upon is that of Designated Partner. The same has been defined u/s 2(j) of the Act.

Section 2 (j): “designated partner” means any partner designated as such pursuant to section 7.

Since the definition simply provides that the designated partner shall be the partner pursuant to the provisions mentioned u/s 7, let’s have a look at same.

Section 7 (2): Subject to the provisions of sub-section (1),—

(i) if the incorporation document—

(a) specifies who are to be designated partners, such persons shall be designated partners on incorporation; or

(b) states that each of the partners from time to time of limited liability partnership is to be designated partner, every partner shall be a designated partner;

(ii) any partner may become a designated partner by and in accordance with the limited liability partnership agreement and a partner may cease to be a designated partner in accordance with limited liability partnership agreement.

The provisions of the Act provide that a designated partner shall be the partner who will control the functioning of entire LLP. Therefore in a way it can be said that the role of a designated partner is similar to that of a CEO and CFO in a corporation. But there exists a huge line of difference with respect to their roles in both the organisations.

LLPs are more like partnerships and less like corporations and we all know that in partnerships, the managing partner is usually the one who contributes the most in the capital of the firm and sometimes in accordance with the agreement b/w the partners when all the partners contribute equally, then they may decide a method for appointing of a managing partner.

Here according to the provisions listed u/s 7 of the Act, designated partner shall be one who is specified as same in the incorporation document or if incorporation documents specifies that every partner shall be designated partner from time to time then in accordance with their terms or in accordance with the terms of the agreement. Moreover even in this provision, the principle of “higher contributor will be appointed as designated partner is absent” and on the contrary it provides that anyone and everyone of the partners can become a Designated Partner in accordance with the terms of incorporation document or terms of the agreement.

After going through the above mentioned provisions, we need to examine the incorporation requirements as is given u/s 11 of the Act.

Section 11: (1) For a limited liability partnership to be incorporated,—

two or more persons associated for carrying on a lawful business with a view to profit shall subscribe their names to an incorporation document;

(2) The incorporation document shall—

Be in a form as may be prescribed;

  • State the name of the limited liability partnership;
  • State the proposed business of the limited liability partnership;
  • State the address of the registered office of the limited liability partnership;
  • State the name and address of each of the persons who are to be partners of the limited liability partnership on incorporation;
  • State the name and address of the persons who are to be designated partners of the limited liability partnership on incorporation;
  • Contain such other information concerning the proposed limited liability partnership as may be prescribed.

According to the Section 11(1)(a), the Act provides for the existence of an LLP, two or more persons to be associated for carrying on of a lawful business with a view to earn profit, and they shall there by subscribe their names to the incorporation document.

After the subscription, sec. 11(2) lists out explicitly a number of things, which are required to be mentioned in the incorporation document and nowhere in the list the provision explicitly provides for the mentioning of amount of capital contribution by each and every partner.

But at the same time it does not excludes such requirement completely as in the end, it provides for such other info concerning the proposed LLP as may be prescribed i.e. prescribed in the LLP agreement.

Now we should move on to the provisions as are listed u/ss 22 & 23 of the Act, which provides for the appointment of partners and addition of new partners in later stages and govern the relationship between partners.

Section 22: On the incorporation of a limited liability partnership, the persons who subscribed their names to the incorporation document shall be its partners and any other person may become a partner of the limited liability partnership by and in accordance with the limited liability partnership agreement.

This section simply stipulates that whoever subscribes to the incorporation document will become the partner and any other person may also become partner but only in accordance with the LLP agreement. Moreover,here again there exists no requirement for any kind of mandatory capital contribution by any of the partner either while signing the incorporation document nor in the subsequent addition of some other partner.

Section 23. (1) Save as otherwise provided by this Act, the mutual rights and duties of the partners of a limited liability partnership, and the mutual rights and duties of a limited liability partnership and its partners, shall be governed by the limited liability partnership agreement between the partners, or between the limited liability partnership and its partners.

(4) In the absence of agreement as to any matter, the mutual rights and duties of the partners and the mutual rights and duties of the limited liability partnership and the partners shall be determined by the provisions relating to that matter as are set out in the First Schedule.

This provides that rights and duties be governed in accordance with the terms mentioned in the agreement and in absence of same, the rights or duties, will be governed by Schedule I of the Act.

Schedule I contains various provisions but the provisions which are relevant for this write up are produced below:

All the partners of LLP are entitled to share equally in capital, profits and losses of the LLP.

Now this provision stipulates that in the absence of any terms with respect to the profit sharing, all the partners shall be entitled to share equally in capital, profits and losses of the LLP. This provision nowhere provides that partners shall contribute equal in capital instead uses the term “entitled” which stipulates that all the partners irrespective of their share contribution, considering if any, will be eligible to take equal share in capital, profits and losses. Hence what can be concluded from here is that irrespective of the fact that who contributed to what extent, all the partners shall get equal share in profits and everything.

Every partner may take part in the management of the LLP.No person be introduced as a partner without consent of all.Any matter related to LLP shall be decided by majority vote and for this purpose, each partner shall have one vote. However no change in business without consent of all.

All these provisions provides for a common thing i.e. irrespective of the amount of capital contributed by any of the partner, all are entitled to equal rights and privileges in the matter of share in capital and profits, participate in management, and every partner gets on vote in the matters dealing with the affairs of LLP.

Hence the provisions does not provides for any special rights or privileges for the partner who has contributed the most in comparison to others.

Now let’s move on to the provisions dealing with the cessation of partnership as is given u/s 24 of the Act.

Section 24 (1): A person may cease to be a partner of a limited liability partnership in accordance with an agreement with the other partners or, in the absence of agreement with the other partners as to cessation of being a partner, by giving a notice in writing of not less than thirty days to the other partners of his intention to resign as partner.

(2) A person shall cease to be a partner of a limited liability partnership—

  • on his death or dissolution of the limited liability partnership;
  • or if he is declared to be of unsound mind by a competent court;
  • or if he has applied to be adjudged as an insolvent or declared as an insolvent.

(5) Where a partner of a limited liability partnership ceases to be a partner, unless otherwise provided in the limited liability partnership agreement, the former partner or a person entitled to his share in consequence of the death or insolvency of the former partner, shall be entitled to receive from the limited liability partnership—

an amount equal to the capital contribution of the former partner actually made to the limited liability partnership; And His right to share in the accumulated profits of the limited liability partnership, after the deduction of accumulated losses of the limited liability partnership, determined as at the date the former partner ceased to be a partner.

Now, with respect to the provisions of this section, what is relevant for the present write up is sub section 5.

Section 24(5): provides that on cessation of partnership of a partner, the former partner or a person entitled to claim under him shall be entitled to receive from the LLP, an amount equal to the capital contribution made by former partner. Now this is an ambiguous provision as it nowhere provides that the capital contributed in accordance with the terms of agreement or anything of that sort, and in the entire discussion we have seen that if there exists some need of capital contribution by partner, then that exists only if the agreement provides for same as the Act, till now nowhere makes the capital contribution a mandatory thing. Therefore by applying the golden rule of interpretation and after reading the statute as a whole, what we can infer is that the intent of parliament under this sub head is to state the “contribution made by former partner in accordance with the terms of the agreement”.

Now let’s move to the express provisions which deals with the part of contributions by partner and the same are listed u/ss 32 and 33 of the Act.

Section 32 (1) A contribution of a partner may consist of tangible, movable or immovable or intangible property or other benefit to the limited liability partnership, including money, promissory notes, and other agreements to contribute cash or property, and contracts for services performed or to be performed.

(2) The monetary value of contribution of each partner shall be accounted for and disclosed in the accounts of the limited liability partnership in the manner as may be prescribed.

Now this section can result in two things i.e. it may come out as a clear provision which provides for mandatory capital contribution in the forms mentioned in the section towards the incorporation of LLP and other is, it may strike as an ambiguous provision where it is just not clear whether the Act tries to make such contribution a mandatory thing or simply a mere obligation which if not complied with will not lead to any noncompliance with the Act. The base of such ambiguity stems from the fact that the provision though provides as to in what form the contribution of a partner may be in, it nowhere provides whether such contribution is mandatory or not as the provision does not entail words like “a partner may contribute and such contribution may be in form… ” nor does it reads like “a partner must contribute and such contribution may be in form… ”.

In order to get a clear picture on such ambiguity, we should try reading this provision in conjunction with section 33 and the same is produced below.

Section 33 (1) The obligation of a partner to contribute money or other property or other benefit or to perform services for a limited liability partnership shall be as per the limited liability partnership agreement.

Now here when, we read both these sections in conjunction with each other, the resulting construction stipulates that the Act of contribution is an obligation which stems from the terms mentioned in the LLP agreement and in absence of any such terms, there exists no mandatoriness for the partners to contribute in capital during the incorporation of the LLP.

Rules 2009

After going through the provisions of the Act, let’s look at the rules which are made under the Act so as to get a much more clear and unambiguous picture with respect to the fact whether there exists any mandatory requirement under the LLP Act for the partners to contribute in some form in the capital during the incorporation of the LLP.

Rule 9 stipulates that a person shall not be appointed as a designated partner if (a) He has at any time within preceding 5 years been adjudged insolvent.

Now here again, what the legislature has provided is that for any partner to be appointed as designated partner, he need to be solvent and at any time during the preceding 5 years, he has not been adjudged as an insolvent. This rule nowhere provides that the designated partner shall be appointed on the basis of amount of capital contributed or anything of that sort and what it entails, clearly implies that any partner, irrespective of the fact as to how much of capital contribution he has made in the partnership, can be appointed as a designated partner and only requirement that need to be fulfilled is that he shouldn’t be adjudged as an insolvent in the preceding 5 years.

Then we come to the rule providing for the accountability and disclosure made with respect to the contribution made by the partners which is listed u/r 23.

Rule 23 (1) the contribution of each partner shall be accounted for and disclosed in the accounts of the LLP along with the nature of contribution and account.

(2) The contribution of a partner consisting of tangible, movable or immovable or intangible property or other benefits brought or contribution by way of an agreement or contract for services shall be valued by a practicing CA, cost accountant or by approved valuer from the panel maintained by central government.

These provisions simply provides that the contribution made by the partners in the capital during the incorporation of LLP shall be accounted for and disclosed in the accounts of the LLP along with the nature of contribution and account and the provision further provides that if any contribution is made in tangible form of property (movable or immovable) or intangible property or other benefits or contribution by way of an agreement or contract for services shall be valued by a practicing CA, Cost Accountant or by an approved valuer from the panel maintained by central government.

Conclusion

The above discussion elaborates the provisions listed under the LLP Act 2008 and the rules made there under to ascertain whether the partners need to contribute a minimum capital during the incorporation of an LLP. The discussion entails all the provisions and rules in an elaborate form with proper commentary with specific interpretation of all the provisions mentioned.

Hence the conclusion that can very well be derived is that there exists no need for the partners to contribute a minimum capital per se and everything relating to the aspect of capital contribution shall be governed solely in accordance with the terms of the LLP agreement and this is not shocking or amusing in any manner because in the entire Act, one thing that becomes very clear, is that, the intention of the parliament while enacting this Act was simply to give the LLP agreement entered into by the parties, utmost importance and hence the basic requirement which always prevails in all the business structures i.e. capital contribution, without which any business structure can’t work, has been left on the discretion of the partners and nothing has been imposed as minimum paid up capital or minimum requirement of capital, by the legislature, in the Act.

But all this in no way stipulates that in a real world scenario as well, partners don’t contribute any capital in the formation of LLP. In fact, the practical situation is very different than the theoretical one and is highly detailed, as every LLP actually stems from an LLP agreement entered into, by the partners and under same, partners include detailed provisions for everything and these provision specially includes the provisions for capital contribution and same is dealt under the head “capital contribution by the partners” in the agreement.

The agreement also entails the provision for various privileges that stems from the amount of capital contributed by the partners hence in actual scenario, partners do include special privileges for themselves in form of special treatment simply because of the fact that they have contributed the most in the capital. Another form of privilege which is very prevalent is the grant of veto power or grant of votes in proportion with the capital contributed and these privileges are added with the sole objective of retaining the control and the management of the business structure in few hands.

Hence it becomes clear that, the requirement of Minimum Capital Contribution in LLP, though a Practical Necessity, yet left Discretionary by the legislature.

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