Take a stroll down the office hallway and you may encounter the receptionist – who, for all legal intents and purposes, is an employee of the firm. Further down you spot the mail clerk sorting letters, also an employee. Just to the left is the executive board room, where two of the firm’s senior portfolio managers are discussing the next big deal. Unlike the first two, these are partners under the firm’s limited liability partnership (LLP) structure, meaning they don’t enjoy all the same legal rights afforded to employees (a trade-off for certain tax advantages).
In late 2013, that perception began to be rattled. The UK government started cracking down on GPs and others who use the LLP structure to avoid paying national insurance contributions. Beginning last April, tax authority HMRC said all members of the LLP would be taxed as employees unless certain tests were met, sparking a flurry of restructuring activity in the first few months of 2014. Soon after, the UK Supreme Court handed down a decision confirming that LLP partners can be “workers” for the purposes of whistleblowing legislation. Consequently, members of the LLP (and not just employees) can now claim wide-ranging whistleblowing rights, in addition to all the other rights available to “workers” (unless proven otherwise).
But here’s the crux of the issue: the blurring of the lines between partner and employee was taken seriously by firms when the HMRC guidance was released, but it appears less attention is being given to the Supreme Court ruling; perhaps because GPs “decided that their priorities lay elsewhere, given that the likelihood of substantial claims was low, and that many had just completed restructurings,” says King & Wood Mallesons (KWM) partner Hilary O’Connor, an employment law specialist.
Some firms also mistakenly believed that the restructuring work done in response to the HMRC guidance was wholly applicable to the Supreme Court decision. Across the industry, “the HMRC guidance led to the roles, basis of pay and levels of capital contributions of LLP members, especially junior-level partners, being reviewed carefully to ascertain whether those who had previously been treated as partners could continue to be treated as partners for tax purposes,” says a second EU employment law lawyer. But the lawyer says that even where someone is considered as a partner or self-employed for tax purposes, under the Supreme Court ruling, they can nonetheless fall within this third legal category of worker.”
Heightened awareness and new legal developments are prompting GPs to reconsider their reaction to the ruling. Fellow KWM employment law partner Carl Richards says that the legal concept of “worker” is still a relatively recent invention derived from EU law “which does not define the term, so the idea that it applies to a wider range of people than previously thought may yet spread to other EU member states.”
More pressing for senior management’s attention are the new statutory rights granted to certain partners, who before last year’s Court ruling didn’t enjoy all the same legal protections provided to workers, including the right to paid annual leave, limits on working time and pension auto-enrollment.
GPs may first start appreciating the impact of the ruling during member disputes and departure negotiations.
Imagine a junior-level partner who notices some financial irregularity in the accounts. Fearing retribution from senior management if he blows the whistle, he keeps quiet about the matter. Things start to escalate, and he considers claiming whistleblower protections to save his career and blow the lid on the bad behavior, but then realizes doing so would jeopardize his partner-status tax treatment by citing legal protections restricted to firm employees. The ruling erases that fear.
What’s more is that compensation in whistleblowing cases is uncapped in the UK, and even if it turns out that a whistleblower report was wrong, or didn’t uncover any illegal activity, the whistleblower still enjoys a wide range of protections, making it “a broad-ranging and powerful weapon in the arsenal of a disgruntled LLP member,” says Richards. Not surprising to cynics, the threat of whistleblowing lends itself “to tactical manipulation and exploitation by well-advised workers,” Richards adds.
The financial and reputational risks presented by a disgruntled LLP member with powerful whistleblowing rights can be staggering. More so than receptionists and other employees, partners as workers in disguise can have far-reaching knowledge of how the firm is run – including access to financial documentation and management information – making it far easier for them to know where any skeletons in the closet are hidden.
Accordingly, LLPs will need to “follow procedures and document business decisions carefully in relation to members, so they have evidence to defend any whistleblowing claims brought by disgruntled former members,” warned law firm Sidley Austin in a client memo reacting to the court ruling.
The other major issue is how workers disguised as LLP members are paid and take time off. Private equity lawyers are warning GPs that, under UK law, workers can refuse any deduction on their wages unless authorized in writing, meaning LLP agreements will need to be reviewed to check that clawbacks are permissible.
Certain workers are also entitled to paid holiday at a rate that includes variable compensation over a 12-week reference period prior to the vacation. In practice, it could mean a junior-level partner strategically plans a holiday shortly after collecting his or her big annual bonus, which becomes part of the calculation for the average holiday pay rate if awarded during the 12-week look back. Lawyers are also expecting that the look back period might be extended by impending cases or a change in the law, which could bring more bonuses within scope.
Then there is the obligation to offer workers a pension scheme. As required by law, many large firms already auto-enroll employees into a pension scheme, but it “should be checked whether partners as workers, who may manage their own pension plan, also need to be auto-enrolled as well or opt out,” warns the second EU employment law attorney. For smaller firms collectively run by a handful of partners – and so never had an obligation to provide pension schemes because no employees were ever hired – it may mean having to identify a pension scheme and begin auto-enrolling any worker who elects not to opt out.
All told, the legal repercussions of certain partners gaining employee statutory rights remains to be seen. It might take years for the true impact of the Supreme Court decision to be felt, but the uncertainty now is creating an invisible risk to the firm’s legal and human capital strategies.