General partnership?
3 reasons to 'just say no'
By David B. Mandell, JD, MBA, and Greg Rever, CWP

You should never operate any business or practice as a general partnership. Why? Because a general partnership is a creditor or plaintiff's dream and a partner's liability nightmare.

Consider three hidden dangers of a general partnership:

1. Partners have unlimited liability for debts. This tragic fact goes unrealized by many business people, professionals, and other entrepreneurs who are involved in general partnerships. They, in effect, personally guarantee every partnership debt and assume the risk for malpractice, accidents, and other liability sources of the entire partnership.

They fail to consider that their liability as a partner is joint and several with other partners. A plaintiff who successfully sues the partnership can collect the full judgment from any one partner.

Consider the case of Jane and Ted's real estate venture:

Jane and Ted were friends who decided to go into a real estate venture together to refurbish old three-family homes and sell them as condominiums. Events went well for a while, but the real estate market went sour and they defaulted on a $650,000 loan to the bank. Jane was much wealthier than Ted, so the bank pursued Jane for the full amount and ignored Ted.

2. Partners have unlimited liability for their partners' acts. With a partner in a general partnership, you assume all the risk that the partner will cause a lawsuit. When the lawsuit arises from one partner's act or omission in the ordinary course of business, every other partner is personally liable.

The dreaded joint and several liability then applies — if one of your partners gets into trouble, you can be personally liable for the entire amount, even if you were neither involved in the alleged incident, nor aware of it.

Think of the many ways a partner could get you into trouble: He may commit malpractice, get into a car accident while on partnership business, defraud someone through the business, sexually harass an employee, or wrongfully fire an employee.

Multiply the risk times the number of partners in your partnership. You have a lawsuit liability nightmare!

Consider this real-life case:

Michael was the founding partner in a successful three-partner software development firm near Portland, Ore. One of the firm's customers sued the firm when a program malfunctioned and caused a loss of valuable data. The lawsuit alleged breach of contract, product liability, and even punitive damages.

Settlement negotiations were unsuccessful and the trial jury awarded an extremely large verdict against the partnership, which exceeded its liability policy limit. Since Michael was the wealthiest of the partners, the plaintiff's lawyer pursued him first, and forced Michael to pay the entire $250,000 amount (above the insurance policy limit) from his personal savings.

Although Michael had less contact with this customer than his partners, he now understands the risks of a general partnership.

3. 'Unaware' general partners are at risk. A general partnership does not require a formal written agreement, as does a limited partnership. You can verbally agree to start a venture with another and create a general partnership, with all of its liability problems. Think about this whenever you start a new business venture with someone.

Even if you make no agreement to partner with another person, the law may impose general partnership liability on you if the general public reasonably perceives you as partners. You may already be part of a liability-ridden general partnership and not even know it.

The following case study illustrates:

Roger was one of four physicians who used a common office arrangement with a shared waiting area, support staff, and accounting.

Each doctor had his own patients, practice methods, and set hours, and was not otherwise accountable to the others.

When one doctor was sued by a client for professional misconduct, all four were named defendants in the lawsuit.

The court found that the patient could reasonably conclude the four professionals were partners because of their office setup and common support staff. Therefore, the court allowed the plaintiff to proceed with the suit against all four — as a general partnership, with each jointly and severally liable for the plaintiff's losses.

WHAT'S THE BEST STRUCTURE?

Which business form should you use, if not a general partnership? Consider a limited partnership, a C- or S-corporation, or a limited liability company (LLC). These entities have limited liability provisions for their owners.

Or, choose the alternative of setting up a general partnership, with each partner setting up a corporation and the corporations becoming the partners in the general partnership.

This advice is followed by many healthcare professionals and attorneys using professional corporations (PCs). Each doctor or lawyer sets up a PC and the PC is the official partner in the partnership, not the professional.

With this type of partnership, the corporate owner's personal assets remain protected from claims against the partnership. However, as with any corporation, corporate formalities must be followed for asset protection.

David B. Mandell, JD, MBA, is an attorney, lecturer, and author of The Doctor's Wealth Protection Guide and Wealth Protection, M.D. He is also a co-founder of The Wealth Protection Alliance (WPA). Greg Rever, CWP, is principal of Select Producers, Inc., and provides business planning to physicians around the country. To reach David, Greg, and the Wealth Protection Alliance, call 800-554-7233.

DISCLAIMER: The information contained in this article is general in nature and should not be construed as comprehensive financial, tax, or legal advice.