Key Takeaways:

  • General partners are personally liable for business debts and legal claims, including those caused by other partners.
  • Limited partnerships protect limited partners from personal liability as long as they do not participate in management.
  • Liability in limited liability partnerships (LLPs) is limited to individual actions, providing additional protection against other partners' misconduct.
  • Partnership agreements and proper business practices can reduce liability risks.
  • Creditors can pursue individual partners' personal assets to settle business debts in general partnerships.
  • Joint and several liability allows creditors to sue one or all partners for the entire debt.
  • It’s crucial to regularly review and update the partnership agreement and consider insurance to mitigate partnership liability.

Partnership business liability is one of the main considerations for entrepreneurs who wish to start a partnership. While it offers certain tax advantages, a partnership exposes its owners to liability for its debts and other financial obligations, putting their personal assets at risk. Depending on which type of partnership you own, your personal liability can be limited or unlimited.

Liability in a General Partnership

Each partner in a general partnership is subject to unlimited personal liability. According to partnership rules, all partners are legally responsible to pay off all the debts incurred by their business. In some states, a partner in a general partnership is severally liable. This means that the partner is liable for the company debts if another partner cannot afford to pay them off.

Unlike some other business entities, a general partnership does not have to be officially set up. It can be formed without any specific intent. As long as two or more people agree to start a business together, there is sufficient proof that a partnership exists.

Joint and Several Liability in General Partnerships

In a general partnership, each partner is jointly and severally liable for the business's debts and legal obligations. This means creditors can pursue any one partner for the full amount of the partnership's liabilities, regardless of who incurred the debt. For example, if a business loan goes unpaid, a creditor can sue just one partner and collect the entire amount owed, even if the other partners were responsible for managing that loan.

This principle extends to tort liability as well—if one partner is sued for negligence or misconduct committed during business operations, all partners may be held financially responsible. Because of this, general partners should consider liability insurance or forming a business entity that provides personal asset protection.

Liability in a Limited Partnership

A limited partnership differs from a general partnership in that its partners are not unlimitedly liable for its debts. Similar to shareholders of a corporation, the partners can only lose up to the amount they invest in the partnership. As long as it has a minimum of one general partner, a limited partnership can have any number of each type of partners.

In this type of partnership, a limited partner is not allowed to take part in the company's managerial decisions or day-to-day operations. As such, the general partners are typically regarded as the original founders while the limited partners are considered outside investors.

The main advantage of a limited liability partnership is that a partner's liability is limited to his or her actions. This means that the partner will not be held liable for issues that result from other partners' misconduct or negligence. Additionally, a limited partnership is easier to form than other types of business entities. It does not have to comply with the state filing requirements that apply to other types of businesses. State laws also do not require the recreation of a partnership if an existing partner leaves the company or a new partner is added.

Each partner will be protected from the company's debt obligations. Although they are not liable for the actions of other partners, all partners in a limited partnership assume the general obligations of the company. Individual partners are responsible for the limited partnership's operating expenses and debt obligations, including:

  • Property leases
  • Vehicle leases
  • Business loans

Also, a limited liability partnership does not provide liability protection against fraud claims or the negligent actions of employees. It also does not protect partners who are a part or witness of the criminal actions of another partner.

Risk of Losing Limited Liability Protection

While limited partners generally enjoy protection from personal liability, this protection can be lost if they become actively involved in managing the partnership. Activities such as signing contracts, supervising employees, or representing the partnership publicly may expose a limited partner to the same risks as a general partner.

To maintain liability protection, limited partners should avoid managerial duties and ensure that their role is clearly defined in the partnership agreement. If a limited partner acts like a general partner, courts may "pierce the veil" and hold them personally liable.

Differences Between Partnership Liability and Personal Liability

In a limited partnership, one or more partners have limited liability. This kind of partnership must be formed with a minimum of one general partner and one limited partner. A general partner is different from a limited partner in that the partner has full management power and unlimited personal liability. In this sense, a limited partnership's partnership agreement is similar to that of a general partnership.

In contrast, the liability of a limited partner is determined by the amount he or she has invested in the company. Also, a limited partner is limited in his or her involvement in management. He or she is not always protected. In the event that the limited partner plays a more active role in the company, he or she will have the same level of liability as a general partner. Unlike a general partnership, a limited partnership is formed through registration with the state.

In a limited partnership, partners receive more protection against each other's mistakes. For instance, if several accountants set up a limited partnership and a customer sues one of them, the other partners will not be liable for the judgment. Nevertheless, as in other types of partnership, the partners in a limited partnership are legally bound by the contracts they sign when the company is formed.

How to Limit Partnership Liability

There are several strategies that can reduce liability exposure in a partnership:

  1. Form a Limited Liability Partnership (LLP): This structure protects each partner from liability for another partner’s negligent or wrongful actions.
  2. Draft a comprehensive partnership agreement: Include clauses that clarify the scope of each partner’s authority and responsibilities, dispute resolution methods, and exit procedures.
  3. Maintain separate finances: Ensure that personal and business finances are not commingled to reinforce the separation between personal and business liabilities.
  4. Purchase liability insurance: Business liability insurance, including general liability and professional liability coverage, helps shield partners from personal financial harm.
  5. Consider indemnity clauses: These clauses in contracts can limit liability in the event of disputes or legal claims.

Consulting with a qualified attorney can help you structure your partnership to minimize legal exposure. You can find experienced attorneys for this purpose through UpCounsel.

Key Legal and Financial Risks Partners Should Be Aware Of

Even with limited or shared liability, partners face several legal and financial risks:

  • Contractual liability: Any partner can bind the business contractually. If one partner signs a contract, all partners may be held to its terms.
  • Tax obligations: Partnerships are pass-through entities, so partners are individually responsible for paying taxes on their share of income—even if the profits are not distributed.
  • Misconduct by partners: A partner’s wrongful or negligent acts in the course of business may expose the entire partnership and all partners to liability.
  • Dissolution risks: If the partnership dissolves due to death or withdrawal of a partner, remaining partners may still be liable for unresolved debts and obligations.

Having a detailed partnership agreement, adequate insurance, and sound accounting practices are essential strategies for mitigating these risks.

Frequently Asked Questions

1. Can a general partner be held liable for another partner's actions? Yes. In a general partnership, each partner is personally liable for the actions of the other partners conducted within the scope of the business.

2. What happens if a limited partner takes on a management role? They may lose their liability protection and be treated as a general partner by the court, which can expose them to personal liability.

3. Are partners liable for business debts after the partnership dissolves? Yes. Partners may still be liable for existing debts unless they are explicitly resolved or assumed through a dissolution agreement.

4. How can I protect my personal assets in a partnership? Use a limited partnership or LLP structure, maintain separate personal and business finances, and consider liability insurance.

5. Is a partnership agreement legally required to form a partnership? Not always, but having one is highly recommended to define responsibilities and reduce liability disputes among partners.

If you need more information or expert advice on partnership business liability, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.