Are General Partners Personally Responsible for Business Debts?
Updated: Jan 27, 2021
As the coronavirus pandemic drags on, more people are considering bankruptcy as an option to attempt to save their businesses. We have spoken to several businesses that are partnerships and the question becomes whether the partners are personally liable for their company’s debt or is their personal property protected.
There are Four Types of Business Partnerships
The answer depends upon how the business was formed. It is worth taking some time out to review the different types of business partnerships that are available and what are the pros and cons of each of them
A General Partnership (GP) is the easiest type of partnership to form since it is the default setup and doesn’t require any formal set up with the state or federal government. A GP doesn’t require any sort of formal agreement other than a, “Hey let’s start to sell something!” and a, “Sure! Great Idea!”
The biggest “pro” of a General Partnership is that there is little or no start-up costs. Even without forming a corporation, you can still request that your business be taxed as a business with a Form 8832, which is an Entity Classification Election. Note: Before you consider any forms or classifications, you should speak with a CPA to get proper advice to make the proper decision.
By far, the biggest point against a General Partnership is that without any sort of corporate entity being formed, the partners have no corporate protections and they are personally responsible for all of the debt accumulated by the businesses and each of the General Partners.
You are not just responsible for your debt and your actions in a General Partnership, you are responsible for the actions of your partners as well. If you have a partner that was a spendthrift and accumulated a lot of debt, you do not have the option of saying that his debt is not your problem. As general partners, his debt becomes your problem, and vice versa.
Before individual owners are responsible, there is a question of solvency. If the business is solvent, any creditors would have to attempt to receive payment from the partnership entity before going after the individual owners. If the business is insolvent, the owners become 100% liable.
From a point of view of liability and risk, a General Partnership is a very high risk.
In a Limited Partnership (LP) there are two types of partners, General Partners, and Limited Partners. General Partners, just as in a General Partnership, are the owners who do the day-to-day work of the business and make all the decisions. Limited Partners, sometimes called Silent Partners, are usually investors or others who have provided capital or start-up funding.
Just as in a General Partnership, the general partners are personally responsible for the business, the debts, and the actions of other general partners. There are no legal protections for general partners.
Limited Partners are legally protected and are not personally responsible for the debts or actions of the general partners.
For limited partners, it is important that they do not act on behalf of the company in any way or they may lose the limited partner status. Even signing a contract on behalf of the company is proof of being active in the business, and can cause a limited partner to be considered a general partners, and therefore, responsible for the company’s debt and actions of the other general partners.
For general partners, the risk level of a Limited Partnership is identical to that of a general partnership. The risk is very high for a general partner. If a limited partner does not make any decisions or act on behalf of the company in any way other than providing capital, the risk of personal exposure is low.
Limited Liability Partnership (LLP)
In a Limited Liability Partnership, the owners of the company are not held personally responsible for the debts or obligations of the business, and they are not responsible for the actions of other partners.
The protection of an LLP is not absolute in that that a partner can be held personally liable for negligent actions or perpetrated some form of malpractice.
In New York, a Limited Liability Partnership is limited to businesses that required state licensing or certifications. Lawyers, Doctors, and Accountants can form an LLP. Business partnership for other industries would form a multi-member Limited Liability Company.
Unlike General Partnerships or Limited Partnerships, which can be owned in whole or in part by another company, a Limited Liability Partnership can only be owned by individuals that hold the required certification or licensing.
The risk level to individual owners of an LLP is low if they do not act in a way that could be considered negligent.
Limited Liability Company
A Limited Liability Company, or an LLC, is a common type of business for both sole proprietors and partnerships. In an LLC, partners are called Members, and it is fairly easy to add and remove members from the partnership.
Under an LLC, there is a legal shield between the business and personal assets. Generally speaking, members cannot be held personally liable for the debts of the business. We say “generally” since there are always exceptions. These exceptions are related to negligence. A member of an LLC may also be held liable for the negligent actions of another member if they knew about the actions or made a management decision that led to the negligent behavior.
As with an LLP, if there is no negligence, the risk of personal exposure in an LLC is very low.
The difference between an S Corporation and an LLC comes down to how taxes are handled. An LLC is a pass-through entity, which means that the taxes are passed through onto the member’s personal taxes. A corporation with a subchapter S election files taxes with the IRS as a separate entity with owners reporting income on a W2 or a K1.
Owners of an S Corporation are also protected from personal liability and are only at risk to the level of investment made into the business. As with every other form of business, the exception to that protection is related to negligence and illegal personal actions.
When it comes to bankruptcy, the level of your responsibility depends on the business entity that has been formed and the personal actions of the owners or members in question. If you have any questions or concerns about possible personal exposure during a bankruptcy proceeding, contact Kamini Fox, PLLC at 516-493-9920.