A Ltd, B Ltd and C Ltd are partners in a partnership, each
having initially put up capital of £1 million. Under the terms
of the partnership agreement, any of the partners can withdraw from
the partnership by giving notice in writing. If it does so, the
partnership is obliged to pay the withdrawing partner, in cash, the
balance standing to that partner's capital account.
The partner's capital account represents a financial
liability of the partnership, because there is no way in which the
partnership can avoid the outflow of cash. It is immaterial that
the amount repayable to the partner will represent that partner's
residual interest in the partnership assets, and will therefore be
more or less than the £1 million interested. The same
principle applies where an investor has an unfettered right to
redeem for cash his or her interest in an open-ended investment
company, unit trust or similar entity.
A company issues perpetual debt, repayable only at the issuer's
option (unless the issuing company goes into liquidation). The
terms of the debt impose no contractual obligation on the company
to make coupon payments: on the coupon dates the company may make
an interest payment, but it has the discretion to defer payment of
interest until such time as it chooses to redeem the debt.
It may be appropriate for the company to classify the
instrument as equity, rather than as a financial liability, since
it has no legal or contractual obligation to part with cash (except
in the event of a liquidation). There will, however, be a
commercial obligation on the company to make regular coupon
payments, otherwise investors would not subscribe for the debt. It
is likely to be a matter of judgement for the company and its
auditors whether the true substance of the arrangement is debt or
equity.
