Taking matters into one’s own hands
The High Court has held that a member of a limited liability partnership (LLP) was entitled to act alone in expelling the only other member of the LLP for serious and persistent breaches of the LLP agreement.
The case raises interesting points on the following questions.
- When will a breach of contract be “serious” or “persistent”?
- To what extent will the meaning of an LLP agreement be influenced by the default rules that apply to LLPs?
- In what circumstances can one LLP member expel another?
Commercial agreements often allow a party to take action if the other party commits a serious (or material) breach or a persistent breach of the contract. A breach must still be serious to be persistent, and whether a breach is serious will depend on all the circumstances, including the nature of the breach and its effect.
Trivial departures from the strict requirements of a contract are unlikely to be serious or persistent and might not even amount to a breach of contract at all.
- In the context of an LLP, a breach may justify expelling another member. Unless the LLP agreement states otherwise, an expelled member will not be able to vote on their own expulsion, but the other member(s) will need to act in good faith when deciding to exercise any power to expel.
THJ Systems Ltd v Sheridan  EWHC 927 (Ch) concerned a joint venture between Mr Mitchell, a software developer, and Mr Sheridan, a former options trader turned mentoring services provider.
Mr Mitchell had developed a platform called OptionNET Explorer (or ONE) to assist with trading options. After enrolling in a mentoring package offered by Mr Sheridan, the two individuals saw an opportunity to work together. Mr Sheridan would use ONE to display information to his, which would in turn benefit Mr Mitchell by promoting the ONE platform.
To this end, Mr Mitchell, through a company owned by him and his wife (THJ), and Mr Sheridan became members of an LLP. Mr Sheridan, THJ and the LLP entered into an LLP agreement governing the LLP’s affairs.
The LLP agreement contained a number of terms that are important to the dispute.
- The agreement defined the LLP’s business as “the sale, supply and support of the ONE Software together with option training strategy to end users of the ONE Software”.
- Clause 13.1 stated that THJ would carry out the “day-to-day running” of the LLP and make day-to-day decisions for its smooth running.
- Non-routine decisions would be taken by a majority of the members. Because the LLP had only two members, this meant decisions needed unanimous agreement. However, should the number of members ever grow beyond two, these decisions would require only a majority vote.
- Clause 13.6 set out certain decisions that would always require unanimous approval by the members. These included materially changing the LLP’s business and appointing new members, but not expelling members.
- Clause 19.1 gave the LLP the right to expel a member on seven days’ notice if the member committed “any serious breach or persistent breaches” of the LLP agreement.
Alongside these governance provisions, the LLP agreement imposed obligations on the parties. Clause 15.2 imposed specific obligations on Mr Sheridan.
- Clause 15.2.1 required Mr Sheridan to personally deliver a one-hour live Webex session every other week to each ONE subscriber.
- Clause 15.2.4 required Mr Sheridan to ensure that appropriate copyright marks were displayed on all educational material relating to ONE, including “website content, webinars, seminars, and presentations containing images of the ONE Software”.
- Clause 15.2.5 required Mr Sheridan to ensure that, if he advertised his own business in webcasts, seminars or presentations, he would also advertise ONE by displaying the ONE logo in a prominent and visible position and providing a slide with details of ONE and copyright marks.
Finally, the LLP agreement imposed reciprocal obligations on both parties.
- Clause 15.1.4 required each member to show the utmost good faith to the LLP and each other in relation to the LLP’s dealings and to give the LLP a true account of all dealings.
- Clause 15.1.7 required each member to keep “proper accounts, diaries and records” and ensure that all members had free access to them and could take copies.
Over time, the relationship between the two individuals deteriorated as Mr Mitchell perceived that Mr Sheridan had not been making sufficient efforts to promote the ONE platform, in particular, by failing to display prominent logos and copyright notices in his materials.
Over time, Mr Mitchell raised his concerns with Mr Sheridan and asked for information on Mr Sheridan’s activities. This included a list of and links to recent Webex presentations to allow Mr Mitchell to review whether the presentations complied with the requirements in the LLP agreement.
Despite repeated requests, Mr Sheridan never provided the information Mr Mitchell requested.
The expulsion and the dispute
This culminated in THJ serving a notice on behalf of the LLP notifying Mr Sheridan that he was being expelled as a member of the LLP for serious and persistent breaches of the LLP agreement.
Mr Mitchell claimed that Mr Sheridan had committed the following breaches of the LLP agreement (among others).
- He had failed to deliver the required number and duration of Webex presentations, in breach of clause 15.2.1.
- He had failed to display the correct copyright information, in breach of clause 15.2.4.
- He had failed, in his materials, to advertise ONE in a prominent place and to include a slide with details of the ONE platform and a copyright notice, in breach of clause 15.2.5.
- He had failed to keep records and provide information (namely, the list of and links to Webex presentations), in breach of clauses 15.1.4 and 15.1.7.
Mr Sheridan effectively mounted two defences.
- In each case, either he had not committed a breach at all or, if he had, it was not a “serious” or “persistent” breach.
- Expelling a member from the LLP was not a “day-to-day” decision. As a result, THJ had no power to expel Mr Sheridan without his approval.
The court had to decide, in each case, whether there had been a breach of the LLP agreement and, if so, whether that breach was “serious” or “persistent” and so justified expulsion. It also had to decide whether Mr Mitchell had the power to act unilaterally in expelling Mr Sheridan from the LLP.
What are “serious” or “persistent” breaches?
The judge took each allegation in turn to decide whether it amounted to a breach and, if it did, whether it was “serious” or “persistent”.
We look at the court’s decision in each case below. First, however, the court usefully summarised the principles that apply when deciding whether a breach of contract is “serious” or “persistent”.
- A serious breach (or “material breach”) is one that is more than trivial but less than repudiatory (i.e. it does not merit termination of the contract).
- A breach is serious if it has a serious effect on the benefit the innocent party expects from the contract. This will depend on various factors, including the nature of the contract, the particular term that has been breached and the breach itself, and the consequences of the breach.
- To be persistent, a breach needs to be repeated, but it must also have an element of “gravity” to it. In other words, it must be more than trivial.
- In addition, the persistent breaches must amount collectively to something “serious in all the circumstances”. So, a “persistent” breach also needs to be serious, although probably not as serious as a “serious” breach. The same factors apply as described above.
There is logic to this, but it can be conceptually confusing, particularly given that a breach also needs to be “serious” in order to be “persistent”. One might summarise the position (somewhat tongue in cheek) in lay terms as follows.
- A serious breach is a breach that is very bad but not extremely bad.
- A persistent breach is a breach that happens repeatedly and which is bad, but not as bad as a serious breach.
- A breach which is not that bad (i.e. which is trivial) is neither serious nor persistent.
These principles underpin the court’s decisions on the individual allegations, which in turn illustrate how the principles work in practice.
Failure to deliver the Webex presentations
Clause 15.2.1 required Mr Sheridan to provide a Webex presentation every other week (amounting to 26 Webex presentation a year), each lasting for one hour.
In fact, over a sample period of 123 weeks, Mr Sheridan delivered 59 presentations (rather than 61, as required). Most sessions were a few minutes shorter or longer than 60 minutes (with two sessions notably shorter). The average presentation length was 56 minutes and 33 seconds.
Over a longer period (between the date when the presentations should have started and the date on which Mr Sheridan was expelled), he delivered 14.5% (or 6.6 sessions) fewer than the LLP agreement required. In addition, the interval between the sessions was not always 14 days.
This did not align with the requirements of the LLP agreement. However, the judge found there was no breach of the LLP agreement at all, let alone a “serious” or “persistent” breach.
He felt that an “over or undershoot of a few minutes” was not a breach of contract, and there was nothing unusual with irregular intervals between sessions, particularly when they were needed to take account of holidays and provide “catch-up” presentations.
All that mattered was that Mr Sheridan delivered 26 presentations per year with the general pattern being that they were delivered in alternate weeks. This is what had happened.
The court found that Mr Mitchell had taken an “over strict analysis” of the LLP agreement that took “no account of the ordinary gave and take to be expected between business partners”.
Failure to display a copyright information
The LLP agreement required Mr Sheridan to display appropriate copyright marks on all educational material relating to the ONE software.
In several instances, however, Mr Sheridan did not ensure that the copyright marks were displayed. Users were instead presented with a short-form “copyright notice” that had been produced by Mr Mitchell and generated automatically by the ONE platform.
The judge found that Mr Sheridan had breached the LLP agreement, but the breach was not serious or persistent (and so did not amount to grounds for expulsion).
Although Mr Sheridan had not displayed the information required by the LLP agreement, users still saw a “clear and concise” notice that provided essentially the same information as was just as effective.
Moreover, Mr Sheridan’s failure to display the contractually required notice did not deprive THJ of any commercial benefit under the LLP agreement or result in its copyright being infringed. And, although the breach happened repeatedly, it was capable of remedy before THJ’s copyright was infringed (which never in fact happened) and so was not serious enough to be “persistent”.
As a result, although Mr Sheridan had breached the LLP agreement, that breach did not justify his expulsion from the LLP.
Failure to advertise
The LLP agreement required Mr Sheridan to advertise ONE prominently, and to devote an entire slide to ONE, every time he advertised his own mentoring business.
The court found that Mr Sheridan had breached this obligation. Out of 77 videos published by his business, 74 did not contain the required slide advertising ONE but did include a slide advertising Mr Sheridan’s business.
The judge regarded the slide advertising Mr Sheridan’s business as a “call to action” for potential subscribers. It was not surprising that Mr Mitchell would want a similar “call to action” for ONE. Although Mr Sheridan had promoted ONE orally in his videos, this was a different promotion from a visual slide and did not satisfy the requirements of the LLP agreement.
The judge also found that this breach was both serious and persistent.
Comparable advertising went to the heart of the joint business. The central reason for joining forces was to sell more subscriptions for ONE. That purpose would be undermined if ONE were not advertised in a way that signposted users to find out more about it.
As a result, this breach justified Mr Sheridan’s expulsion from the LLP.
Failure to provide the Webex lists
Finally, the failure to provide the Webex lists did not amount to a breach of the LLP agreement.
Mr Sheridan was contractually obliged to (under clause 15.1.7) keep records and provide information to the LLP. However, this applied only to “accounts, diaries and records” relating to the LLP. It did not extend to a list of Webex presentations given by Mr Sheridan or his business.
In any event, Mr Mitchell already had access to the Webex presentations at all times.
The judge spent more time considering whether the failure to provide the Webex lists amounted to a breach of Mr Sheridan’s contractual duty to act in good faith towards THJ (clause 15.1.4). This required the court to interpret what the parties intended by this contractual duty.
The judge noted that the contractual duty in the LLP agreement “merely [replicated]” the corresponding default duty in the Limited Liability Partnerships Regulations 2001 (the rules that apply where an LLP does not adopt its own rules), which itself followed the default duty for unincorporated partnerships in the Partnership Act 1890.
Previous case law showed that these default duties can require members of an LLP and partners in a partnership to turn over existing documents, but not to “make up … books and records which do not … in fact exist”.
In essence, Mr Mitchell was asking Mr Sheridan to produce a new analysis, rather than to hand over existing books or records, which went beyond Mr Sheridan’s contractual obligations.
Was Mr Mitchell entitled to act alone in expelling Mr Sheridan?
As explained above, Mr Sheridan’s failure to provide comparable advertising for the ONE platform amounted to a serious and persistent breach of the LLP agreement which justified his expulsion.
The next question was whether THJ was entitled to expel Mr Sheridan unilaterally, or whether this required a decision by a majority of the LLP’s members (i.e. including Mr Sheridan).
Strictly read, the decision to expel a member was not a “day-to-day” decision and so THJ did not have authority under clause 13.1 of the LLP agreement to act alone. But equally it was not a matter that required unanimous approval by the members under clause 13.6.
As a result, a decision to expel fell to be decided by a majority of the LLP’s members. This would ordinarily include Mr Sheridan.
However, the judge said the parties could not have contemplated a situation where Mr Sheridan could block his own expulsion from the LLP. This would make a complete nonsense of a power to expel.
Following previous case law, the judge read the power to expel as requiring a decision of a majority of the LLP’s members other than the member being expelled. In this case, that mean the member entitled to make that decision was THJ, who, acting alone, formed a majority.
As a result, Mr Sheridan’s expulsion was valid and effective.
Did Mr Mitchell act in good faith when expelling Mr Sheridan?
As a final defence, Mr Sheridan argued that THJ had been required to act in good faith, both by the LLP agreement and as a matter of LLP law, when deciding whether to expel Mr Sheridan but had failed to do so.
The court agreed that the LLP agreement obliged THJ to act in good faith and that, based on previous case law, this required THJ to behave according to the “highest standard of honour”. This imposed certain minimum standards of fairness before a member of the LLP could be expelled.
However, Mr Mitchell had complied with those minimum standards. His concern about Mr Sheridan’s failure to comply with his advertising obligations was genuine. He had repeatedly invited Mr Sheridan to reassure him but that never happened. He had not acted aggressively or immediately launched into legal proceedings but rather had attempted to find alternative solutions to the dispute. He had not been pursuing any competitive opportunities or acting with any ulterior motive.
What does this mean for me?
This is a prime example of a short and relatively simple case that engages numerous important legal principles.
The court’s analysis of the alleged breaches of the LLP agreement provides a very helpful summary of the key principles. Fundamentally, the meaning of words like “serious” and “persistent” will always be a matter of interpreting each individual contract within its own context.
However, the judge’s comments on the meaning of these terms provide the groundwork for analysing breaches of other types of contract. It is common for commercial contracts to give a party a right to terminate, or some other remedy, in cases of serious or persistent breach.
Parties that are considering bringing a claim for serious or persistent breach should ask themselves the questions posed by the judge in this case. Is the breach more than trivial? If it is a repeated breach, is the culmination of repeated breaches serious in all the circumstances?
Although the court will assess the meaning of words in a contract by looking at the parties’ intentions, the decision in this case shows how judges will be ready to import concepts of LLP and partnership law to fulfil a gap in interpretation.
If parties to an LLP or partnership arrangement wish to impose duties and arrangements that differ from the default position under LLP or partnership law, they will need to make this explicitly clear in the LLP or partnership agreement.
Finally, the judge’s decision that the expulsion notice was valid is significant, particularly for an LLP with only two members.
If a member of an LLP wishes to entrench their position and prevent the other member (or members) from expelling them, they will need to ensure the LLP agreement reflects this. This could, for example, include making expulsion of a member a unanimous decision.
Whether this is appropriate in a given set of circumstances will depend on the complexion of the LLP’s membership base and the circumstances in which expulsion can take place.