Limited Liability - Deep pocket syndrome

Just as new technology from around the world can take several years to filter through to the UK, so, it seems, does the prospect of limited liability partnership legislation for the accountancy profession.

The debate rages as hotly as ever. Will Deputy Prime Minister Michael Heseltine make his much-heralded announcement on mainland reform, even though the issue was not raised in last week’s Queen’s Speech? Will Price Waterhouse and Ernst & Young pack their bags and jet off to Jersey to take advantage of the island’s new LLP law? Or will the Isle of Man and Guernsey make late bids for registrations based on quid pro quo disclosure? The nation must wait and see.

Across the Atlantic, however, a total of 38 American states have successfully introduced LLPs, with New York, Pennsylvania and Colorado the latest state legislatures to permit asset-protection for partners of accountancy and legal firms. Non-liable partners can sleep a little easier at nights now, safe in the knowledge that their homes and personal assets are protected from legal claims against the firm.

In fact, legal reforms in the US – the home of litigation for litigation’s sake – have been so extensive and so efficient that not one major lawsuit has been lodged against the American Big Six since December last year.

Key to this success has been a three-pronged reform attack that has helped introduce a level playing field for the accountancy profession.

It was Texas that pioneered LLP legislation back in 1991. The Lone Star state created its LLP Act after a string of high-profile bank and savings and loan failures threatened to sink a number of partnerships as aggrieved claimants made desperate bids to recover losses by setting their sights on the legendary ‘deep pockets’ of the accountancy profession.

Ernst & Young International’s executive partner Paul Ostling explains that reform was urgently needed both to restore confidence among accountants already practising and to woo potential newcomers to the profession turned off by the threat of losing everything they worked for.

Ostling, who also helped draft Jersey’s new LLP law, says: ‘There were some pretty frightening moments for the profession. People were insulting accountancy and college students simply did not want to join. The LLP legislation put those fears to rest. It provided a psychological feeling of security.’

The new law gave ‘innocent’ partners in accountancy and law firms a safe haven of ‘liability relief’, but without the significant changes to the structure of the practice that a switch to professional corporation or the creation of a limited liability company would have demanded.

Texas’s stab at creating LLP law was far from perfect. Other states sat back and watched to see how it would enact the law before committing themselves to legislation. Natural teething problems emerged, with criticism centring on the fact that the Texan statute failed to provide relief from the partnership’s non-malpractice contractual and tort liabilities.

Partners were, in effect, still liable for day-to-day problems such as lease disputes over the firm’s offices.

However, the Texas model served as the granddaddy of all other LLP legislation and other states were quick to enact their own versions. Louisiana followed in 1992, with Delaware, North Carolina and Washington DC coming on board in 1993. By the end of last year, just a dozen US states had failed to join the party.

Each new law features subtle twists on the Texas base. Differences include the type of businesses that can transfer to LLP status, the insurance or bond requirements, registration demands and, most importantly, the level of personal involvement which would cause a partner to share in liability for a colleague’s negligence.

So how did the American campaign come to bear fruit and what lessons can the Stateside accountants teach their UK cousins?

Surprisingly, razzmatazz was definitely not on the agenda when it came to lobbying for reform. There was no big ad spend or television campaign to bolster the beleaguered profession’s cause.

The federal structure of the US forced a multi-level approach. Professional persuaders a la Ian Greer, favoured by American action groups as a lever to political reform, were not involved. Instead, the profession used its own muscle to lobby on several fronts, including individual state legislatures, as well as winning the support of Congressional deputies and Senators, to secure changes to the liability rules.

State accountancy societies, backed by the Big Six, formed powerful coalitions with lawyers and other professional groups to bolster their campaign.

Allen Weltmann, Washington DC government relations partner at Coopers & Lybrand, said the Big Six, except Arthur Andersen which registered in Illinois, waited for the tiny but ‘corporate friendly’ Delaware to enact fine-tuned LLP legislation before registering.

He highlights the main hurdle. ‘The States’ fears were that LLPs would create a revenue loss for them. We had to provide detailed economic analysis to show that wouldn’t be the case and taxation of partners would continue whatever the system.’

Peter Horowitz, Price Waterhouse’s senior US managing director for communications, adds: ‘LLPs for small firms had been around for years in some states but the challenge was to protect partners in large firms practising in many or all states. They could not be protected unless all of the states agreed to recognise LLPs as a bona fide structural entity.’ It was an argument that the profession won.

But the introduction of LLP status on its own was not enough. Innocent partners secured freedom from the threat of major personal loss but the shadow of a massive ‘Armageddon’ claim against firms still loomed large over the profession. Homes without jobs was not an attractive prospect for partners.

‘The reality is that the United States has suffered from a surfeit of litigation for years,’ Horowitz continues. ‘It’s a disease – a failure to accept a degree of individual responsibility for your own actions.’

Weltmann explains the law-changes demanded by accountants: ‘We had to reform the Federal Securities Litigation Law to disincentivise lawyers from filing lawsuits. They were so easy and popular to file because the lawyers knew we would rather settle than take a chance and go to court – it was classic deep-pocket syndrome. Since we won the law change there hasn’t been a single major suit filed against the Big Six.’

The third front of the reform campaign was to radically alter the law on joint and several liability – a move which was backed by Congress. Under J&S, liable partners could suffer 100% losses even though other parties, particularly a company’s directors, were often to blame for things going wrong. Proportionality, argued American accountants, was the final plank of reform needed to ensure fairness.

The American system is now hurtling towards a nationwide unification: the National Conference on Unified State Laws has already issued draft proposals. Martin I Lubaroff, chairman of Delaware State Bar Committee, predicts uniformity within 10 years. ‘The bottom line is that there’s been broad acceptance nationwide of the LLP entity and the use of it.

There’s been a maturation in people’s understanding of it, and over the years we have seen a refinement leading to the conference proposals.’

Detractors and opponents of LLPs argue that the system is primed to explode the cherished partnership ethos. But three years on, supporters of the American model, including PW’s Horowitz, beg to differ. ‘It does not change the way you govern yourself. We did not want to give up the partnership structure or culture,’ he said. ‘LLP status in itself does not change the litigation possibilities. Anyone is still free to seek to recover damages from an accountancy firm and negligent partners.’

The lesson to be learned by UK accountants from the US experience is clear – LLP reform on its own, although welcome, is not enough. It must come hand-in-hand both with new laws to make ‘deep pocket’ litigation harder and reform of the existing joint and several legislation.

As E&Y’s Ostling says: ‘The real battle is not over whether LLPs, corporate structures or general partnerships are best. It is the need for legal reform of the joint and several liability laws which encourage litigants and regulators to use the accountancy profession as a sacrificial lamb after financial disasters.’

Whatever happens, America has so far had almost 40 chances to get its LLP legislation right. The UK government will have just one.

Two conferences next month aim to tackle the thorny issue of limiting partners’ liability. The first, organised by the FT, is at the London Marriott Hotel on Monday. A second, sponsored by Clark Whitehill and Allen & Overy, on 18 November, follows at The Hyde Park Hotel. Experts from the accountancy, legal and financial services professions will seek to solve the LLP riddle.