Borrowing Clause in LLP Agreement: Meaning and Rules

A borrowing clause in an LLP agreement is a vital part of any Limited Liability Partnership contract. The clause clearly defines how the LLP can raise funds, take loans, or manage financial responsibilities. This clause helps partners understand borrowing limits, approval procedures, and authorized signatories.

In India, LLPs have a separate legal identity, which allows them to borrow funds in their own name. However, without a well-drafted borrowing clause, partners may face disagreements, and banks might hesitate to provide loans due to unclear internal authority. A clear borrowing clause ensures smooth financial operations, compliance with Indian law, and reduces the risk of disputes among partners. As per Section 18 of the Limited Liability Partnership Act, 2008, partners can define these rights and obligations in the LLP agreement itself.

In this blog, we discuss borrowing clauses and how to stay compliant with LLP annual compliance.

Legal Context: LLP Agreement and Borrowing Rights in India

A borrowing clause in the LLP agreement specifies the decision-making process, borrowing limits, and authorized signatories. Section 18 of the LLP Act, 2008, empowers partners to include these rules clearly in the agreement. These clear provisions help prevent disputes among partners and give lenders confidence in the LLP’s internal governance. They also ensure smooth financial operations and legal compliance.

Key aspects of borrowing rights under Indian law include:

• Authority to Borrow: Only the partners or designated signatories authorized in the agreement can legally bind the LLP to a loan.
  
• Limit on Borrowing: The LLP agreement can specify maximum borrowing limits without requiring additional partner approval.
  
• Sources of Borrowing: LLPs can borrow from banks, financial institutions, or even from partners themselves if permitted in the agreement.
  
• Legal Compliance: The LLP must follow Indian banking, tax, and disclosure rules to stay legally compliant.

Without a clearly defined borrowing clause, disagreements among partners or issues with loan approvals may arise.

Can an LLP Borrow Without Amending the LLP Agreement?

An LLP can borrow without amending its LLP agreement only if the draft already allows borrowing. It must also clearly state who can borrow and how much can be borrowed. The need to change an LLP agreement depends on the wording of the existing agreement.

• When the LLP Agreement Already Allows Borrowing: If the LLP agreement contains a borrowing clause, the LLP can take loans within the stated limits. The clause must also define approval rules and signing authority. Banks and NBFCs check this clause before approving a loan.
  
• When the LLP Agreement Does Not Mention Borrowing: If the LLP agreement does not refer to borrowing powers, the LLP should amend the agreement first. Without this provision, lenders may refuse funding. Partners may also question the validity of the loan later.
  
• When the Borrowing Limit Must Be Changed: The LLP must update the agreement if it wants to borrow more than the permitted amount. This ensures that all partners approve the higher risk and helps prevent disputes in the future.
  
• When the Authorized Signatory Changes: If the partner or designated partner who can sign loan documents changes, the LLP must amend the agreement. It helps lenders avoid confusion and ensures that the correct person signs the loan.
  
• When New Types of Lenders Are Added: The LLP must amend the agreement if it plans to borrow from NBFCs or private lenders and the agreement does not allow it. This keeps borrowing within approved limits while protecting partner interests.

In conclusion, an LLP can borrow without amendment only when borrowing powers are clear and up to date. If authority, limits, or lender types change, the LLP should update its agreement before taking a loan.

Can LLP Provide Loans to Its Partners?

Yes, an LLP in India can provide loans to its partners, but this must be explicitly allowed in the LLP agreement. The agreement should either include this in the borrowing clause or as a separate provision. 

Key considerations when an LLP lends to its partners include:

• Explicit Consent in Agreement: The LLP agreement must authorize loans to partners, as per Section 18 of the LLP Act, 2008. Without this, such loans could be legally challenged or lead to disputes.
• Authorized Borrowers: The borrowing clause should clearly specify which partner(s) the LLP authorizes to borrow on its behalf: a single designated partner, a group of partners, or any partner with consent from all partners. This ensures clarity on authorized partners for loan execution and signing.
• Interest Rates: Loans should mention interest rates, either at prevailing market rates or as mutually agreed. The law allows interest-free loans, but they may trigger tax implications under the Income Tax Act. 
• Repayment Terms: Clearly define repayment schedules, including timelines, interest (if any), and repayment sources. Proper documentation maintains accountability and transparency.
• Collateral and Security: The borrowing clause can specify whether LLP assets can be used as collateral and under what conditions. This protects both the LLP and its partners while providing transparency for lenders.
• Approval Process: Typically, loans to partners require the consent of all partners to prevent conflicts of interest and maintain fairness.
• Tax and Legal Compliance: Loans to partners may attract taxation if interest is not charged at market rates. 

These provisions help LLPs maintain transparency, prevent disputes, and ensure loans to partners are legally compliant and well-documented.

Sample Draft of a Borrowing Clause in an LLP Agreement

Below is an illustrative example of how a borrowing clause in an LLP agreement may be worded:

“The Limited Liability Partnership (LLP) may borrow money from any bank, financial institution, Non-Banking Financial Company (NBFC), or any other person at the prevailing rate of interest, subject to the approval of the Designated Partners.

The LLP may provide security for such borrowings, whether secured or unsecured, if considered necessary by the partners.

Any partner may lend money to the LLP or enter into other commercial transactions with the LLP, provided such transactions are permitted under this Agreement and applicable law.

Interest on partner loans or capital contributions shall be payable at a rate not exceeding the limits prescribed under Section 40(b)(iv) of the Income Tax Act, 1961.

In case of financial difficulty, losses, or business requirements, the partners may mutually agree to reduce or waive interest payable on capital or loan accounts.”

Difference Between Borrowing Clause and Capital Clause in LLP Agreement

Both the borrowing clause and the capital clause deal with LLP finances, but they regulate different types of funds and serve distinct legal purposes. 

The table below highlights the key differences between a borrowing clause and a capital clause in an LLP agreement:

Basis of Comparison	Borrowing Clause	Capital Clause
Nature of funds	Deals with money raised through loans or credit	Deals with money contributed by partners as capital
Purpose	Regulates how the LLP can take debt and who can authorize it	Governs ownership interest, profit-sharing ratio, and partner contributions
Source of money	Banks, NBFCs, financial institutions, or partners as lenders	Only partners as investors
Repayment obligation	The LLP must repay the borrowed amount as per the agreed terms	Capital is not repayable like a loan
Authority and approvals	Defines who can bind the LLP to a loan and the borrowing limits	Defines how much each partner contributes and how additional capital will be introduced
Accounting treatment	Recorded as a liability in the LLP’s books	Recorded as partners’ capital
Legal impact	Affects external obligations with lenders	Affects internal rights and profit distribution among partners

Keeping these clauses separate avoids confusion between partner investment and external debt.

Common Mistakes to Avoid in the Borrowing Clause of an LLP Agreement

A borrowing clause is essential for LLPs, but drafting errors can lead to legal or financial issues. Clear and accurate drafting ensures smooth operations and protects partner interests:

• Failing to specify a maximum borrowing limit can result in excessive debt and internal conflicts. Clearly define how much the LLP can borrow without additional partner approval.
  
• If the agreement doesn’t state whether loans require unanimous or majority consent, partners may disagree on borrowing decisions, delaying funding and disrupting operations.
  
• Not specifying who can sign loan documents creates confusion for both partners and lenders. Banks may reject applications if the authority is unclear.
  
• Leaving out repayment schedules, interest rates, or repayment sources can cause defaults and misunderstandings. Clear repayment terms maintain financial discipline.
  
• Lending to partners without explicit approval in the agreement can create legal and tax complications. All such transactions should be formally authorized.
  
• Ignoring tax implications or banking regulations can attract penalties and scrutiny. Ensure all borrowing transactions comply with Indian financial laws.
  
• Pledging LLP assets without partner consent increases financial risk. The agreement should regulate or restrict the use of LLP property as security.

Avoiding these mistakes helps LLPs maintain transparency, protect partner interests, and ensure that borrowing is legally compliant and well structured.

Are you unsure how to draft a borrowing clause in your LLP agreement or worried about complying with the law? RegisterKaro supports businesses from LLP registration to borrowing clause drafting and compliance. Our professionals provide guidance at every step, ensuring your LLP can borrow with confidence. Contact us today for reliable and stress-free assistance.

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