On the trail of a new animal.

  • Source: Regeneration & Renewal Magazine
  • Date: 20 February, 2004
  • Author: Antonia Swinson

Almost by accident, the Government has created a legal structure that could transform the work of regeneration. Antonia Swinson meets a strange hybrid named the Limited Liability Partnership.

Throughout the regeneration sector, people are looking for organisational structures that can trade freely whilst protecting community interests. The Government?s attention lies with Community Interest Companies (CICs), a new legal form designed for social enterprises. But at the cutting edge of economic thinking lurks a new animal; the curious hybrid of a commercial company and a partnership, known as a Limited Liability Partnership (LLP). This model could revolutionise the ability of the voluntary sector and social enterprises to make an impact in regeneration ? and there is an irony here, given that the legal form was born at the very sharpest edge of commerce.

During the early 1990s, professional partnerships such as Arthur Andersen became concerned that their individual partners? acceptance of liability for their company?s actions put them at risk of bankruptcy. Long before Enron?s demise was a twinkle in regulators? eyes, the City persuaded Jersey?s parliament to draw up an Act creating the LLP ? and the British Government, fearing an exodus of partnerships to Jersey, passed the Limited Liability Partnership Act in April 2001. For the first time anywhere in the world, it became possible to form a corporate body ? an entity with a legal existence independent of its individual members ? which had both collective limited liability and the mutual, co-operative characteristics of partnerships.

There are now some 7000 LLPs around the country, including one notable example established by Hilton Hotels in 2002. The group handed ten of its hotels to an LLP in which it shared ownership with three investors, themselves linked together in a second LLP, who paid ?350 million to Hilton for a cut of the hotels? turnover over the next 27 years. In part, the growth of LLPs is because they?re so easy to create: two designated members must complete an application downloaded from the Companies House website, and pay ?95. There is no Memorandum of Incorporation; no Articles of Association; no Shareholder Agreement.

Consultant Chris Cook, a civil servant turned City regulator and, latterly, director of the International Petroleum Exchange, was the first to grasp just what an extraordinary beast is the LLP. It has, he says, created a new asset class: not equity, not debt, but a co-operative, community-based medium of exchange.

?When I pointed it out, I don?t think that civil servants in Whitehall were very pleased to find that they had accidentally created the essence of ethical economics,? says Cook. ?The LLP makes it possible for all stakeholders in an enterprise ? staff, management, investors, suppliers and clients ? to be members of an Open Capital Partnership (OCP), which replaces the usual adversarial contracts of debt- and equity-based models.? In essence, all these stakeholders are brought inside the partnership, meaning that their interests are aligned; it?s quite a change from traditional structures, which pit stakeholders in competition against each other. The LLP delivers an ideal combination of the collective and the individual; it?s flexible and easy to establish for social enterprises, whilst its partnership system is robust enough to make it attractive to the private sector.

To understand how an LLP operates, it?s best to consider a theoretical example. Let?s say that Bloggside Regeneration holds a brownfield site, whilst Bloggshire Islamic Community Arts (BICA) needs a workshop in which to train local people to produce patterned Islamic tiles for the growing UK market. BICA becomes the first ?occupier member? and Bloggside Regeneration becomes the ?capital member? of the new Bloggside Community LLP, with BICA paying Bloggside Regeneration a peppercorn land rent.

A new workshop, costing ?100,000, is acquired using money from a Community Development Finance Initiative (CDFI), which becomes the LLP?s second capital member. The CDFI then receives two per cent of BICA?s total revenue: as a ?capital rental? paid for the use of finance, equivalent to those paid for the occupation of land, this payment does not count as interest, making an LLP an acceptable financial structure for strict Muslims. Hence, rather than a contract whereby a debtor organisation pays interest to a creditor, or an investor buys part-ownership of a company in the form of shares, both financier and beneficiary join a partnership whose revenues are then shared. In time, BICA may acquire ownership of the capital asset by paying in excess of this rental; the fee will then decline with the size of the outstanding capital.

The same structure, says neighbourhood renewal adviser Stephen Hill, could benefit future community land trusts. ?Imagine you had a local authority, keen to develop an area it part-owns with another public sector land-owning body, such as the MoD,? he says. ?The local housing authority, the developer and social enterprises would find it easy to be partners of an OCP, as opposed to other more off-putting, expensive company structures. Lots of different partnerships can come together and pool resources. It?s surely only a matter of time before the regeneration industry wakes up to this.?

The LLP structure is taking some of its biggest steps in Scotland, where the West Lothian Chamber of Commerce is planning a Guarantee Society LLP for members. ?The Guarantee Society LLP will offer our members a critical tool in their entrepreneurial tool-box, ensuring stability and growth,? says the Chamber?s chief executive Stuart Duffin, noting that it is designed to help businesses build capacity and cash flow.

All Chamber members will be eligible to join Guarantee Societies, themselves members of the West Lothian Guarantee Society LLP. Each Society has a ?common bond? based on location or profession, and guarantees the credit of its members through a collective guarantee of an agreed percentage (in this case, 25 per cent) of each member?s turnover.

For example, let?s say the IT workers? Guarantee Society has a collective turnover of ?100 million and therefore a total guarantee value of ?25 million ? the sum which may be loaned at any one time. Members grant one another trade credit without interest, and up to credit limits ? based on members? trading history, type of business and turnover ? set by the service provider, a bank, which levies a percentage charge (say 0.25 per cent) to members for use of the guarantee. Half of this charge goes to the bank to defray administrative costs, and the rest to a pool in case of defaults. In the event of a default, the pool pays the creditor half the loss, with the rest paid by the bank ? this latter provision is a built-in disincentive, to stop the bank from granting guarantees to all comers in order to boost income. The bank?s profit, then, is limited to half of 0.25 per cent of all the money advanced, and some of that will probably be lost to defaults ? yet because default rates are so low in this kind of scheme, whilst a bank?s participation brings it the goodwill of the entire membership, banks are keen to get involved in such emerging credit systems.

Members of the Societies, then, gain access to guaranteed credit at a minimal cost, and can offer credit to other members without risking the loss of their cash. Within a community-based system like this, peer pressure is a powerful force against defaulting; but if a business does go under, its member creditors can claim their money back from the pool and bank. Should the pool run dry, members are liable for defaults up to the full guarantee value, but costs and credit ratings are set up to avoid the need to call on this facility.

Perhaps the most potent application for LLPs, however, is their ability to draw in private finance for public projects, offering an alternative to private finance initiatives (see box). By drawing the users and stakeholders of a service into its ownership, LLPs could build community links and ensure that the aims of a service?s financiers are aligned with those of its providers and users.

?I see a role here for council and trade union pension funds,? says Cook. ?The rate of ?rent? paid for use of the capital could be set perhaps 4 per cent above inflation. This would be unaffected by Bank of England interest rate decisions; it?s not lending, but taking a proportionate share of gross revenues. With risk spread among the partners, it would be less risky than shares, more profitable than gilts, and more accountable and transparent.?

At present the LLP animal is young, untested, and just lurking at the outer edges of the economy. But, given its consensual and pragmatic nature, it is surely only a matter of time before its tracks are more widely seen. How extraordinary it would be if, just as crocodiles outlived dinosaurs, the wee beastie of the LLP one day replaces the old debt and equity models of global capitalism.

A PFI replacement?

A theoretical example best demonstrates how an LLP could do the work of a PFI: drawing private cash into a public project, with the promise of repayment from the public purse over many years. Let?s say that Bloggshire Local Education Authority (LEA) funds ten schools held by five different boroughs, which require a ?20 million refurbishment. The boroughs transfer the schools? land to an LLP named Bloggshire Land Partnership (BLP) and the school buildings to another named Bloggshire Schools Partnership (BSP), becoming capital members of both. BLP then becomes a capital member of the new Bloggshire Education LLP, whilst BSP becomes an occupier member and agrees to pay BLP a peppercorn rent for use of the land.

BSP, which will carry out the refurbishment, then negotiates an agreement by which Bloggshire LEA pays BSP ?600,000 annually, linked to inflation. Over the 25-year life of the refurbished buildings, this will repay the ?20 million capital. BSP is divided into ten million ?partnership interests? ? or shares ? each valued at two pounds, and these are offered for sale to Bloggshire residents. Buyers become capital members: priority buying rights could be given to parents, Government ?baby bond? money could be used to purchase interests on behalf of pupils, and institutions such as the teachers? and Bloggshire LEA employees? superannuation schemes could also invest. Thus buyers will receive a share of the LEA payments, recouping all their money over 25 years along with inflation compensation and a return on capital.

Wednesday, 24 April, 2019
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