Limited liability refers to a party’s liability in any given formal partnership or company structure. Below you will find the various limited liability arrangements and the parties involved in a limited liability partnership.
Limited liability refers to a form a liability whereby the maximum liability the partner holds is equivalent to the amount they invested and nothing more. In other words, if a partner owes a debt, the other partners will not be responsible for that debt because their liability is limited only to their portion of the investment. An investor who puts their money in stocks is an example of a party that has limited liability. In this scenario the investor would be entitled to the rate of return earned by the company, however not be liable for any debts of the company.
Any party that invests with limited liability, whether it be a company or individual investor operates only as a limited partner and not a main decision maker. The fact that they do not have decision making abilities also eliminates their liability in the venture as well. In many instances this might apply to a silent partner, party that invests in stocks, and others. Any assets, income, net worth, or other assets of a party that has limited liability is the investment of only themselves and no one else.
Any investment not directly associated to the limited liability investor or partner are subject to seizure in the event of bankruptcy. Money invested towards the purchase of ownership rights such as a stock are subject to seizure. Company assets including real estate, inventory, equipment, and other company property can also be seized in the event the company becomes insolvent.
Types of Partnerships
Limited Liability Partnership (LLP)
A limited liability partnership (LLP) is a business partnership formed by two or more individuals whereby one of the individuals is a general partner. Partners cannot be corporations.
Typically, limited partnerships are utilized for agreements with a limited timeframe.
Although being a partner in a partnership guarantees the same rights, one partner may hold more authority or liability than the other. Roles are defined based on a partner’s level of skill, capital contribution, and activity in the partnership.
Both partners can contribute financially to a partnership, as well as purchase real property on behalf of a partnership.
Parties In a Limited Partnership
A general partner is an active partner who is responsible for the day-to-day operations and management of a partnership’s business, including financial and developmental aspects. LLPs must have at least one general partner who bears liability for the partnership’s actions and obligations. A general partner is legally liable in the same way that owners of a simple partnership are liable.
A limited partner is a “silent partner” who is not involved in the management of the business. Typically, such a partner only invests capital into an LLP. It is illegal for a limited partner to indicate that he or she is a general partner, as such a statement is misleading to consumers and potential investors. Limited partners are protected from liability if they not engage in management duties. If they do increase their role in an LLP, they may be treated as a general partner.
For example, assume Jon and Henry form a general partnership for the purpose of purchasing real estate. Henry contributes real estate expertise and connections to find properties, while Jon’s capital is used to purchase properties. In this scenario, Henry would likely be the general partner.
A partnership in which all partners have equal liability — and share in profits and losses equally — is called a general partnership.
LLPs must be made in writing and clearly indicate each partner, its share, and its contribution towards the partnership. An LLP cannot advertise their business as a corporation, or in another manner not consistent with the true nature of its business. LLPs must include the term “A California Limited Partnership” when referencing the partnership.
LLPs must be registered with the Secretary of State’s office. Foreign partners must file additional applications and have a principal office and agent of record in the state. All LLPs must pay yearly franchise dues to the state in order to conduct business in California. Cancellation of an LLP requires partners to complete the LLP certificate of Cancellation (LP-4/7). There is no filing fee for cancellation.
Case Law As It Relates to Limited Liability
Case Review: BT-1 v. Equitable Life Assurance Society (1999)
The case, BT-1 v. Equitable Life Assurance Society (1999) 75 Cal.4th 1406., involved an LLP partner’s breach of fiduciary duty.
A partnership consisted of a general partner (Equitable Life Assurance Society) and a limited partner (BT-1). The partnership purchased a building with a sizable mortgage debt ($60 million). Later, Equitable Life was able to purchase the partnership’s mortgage debt at a reduced price of $38.5 million. It then demanded payment from BT-1, positioning itself as a lender in the partnership. When BT-1 could not pay, Equitable Life terminated the partnership. It foreclosed on the debt and the deed of trust, thereby becoming the sole owner of the building.
BT-1 brought legal action against Equitable Life for violating its fiduciary duties. The Superior Court argued that the partnership agreement granted a partner the right to purchase mortgage debt. Therefore, Equitable Life’s actions were permissible. The court ruled in favor of Equitable Life.
BT-1 appealed. The Court of Appeals ruled that a partner did not have the right to act as a lender on behalf of the partnership, unless otherwise noted in the agreement. Therefore, Equitable Life had violated its fiduciary duties in the partnership. The court ruled in favor of BT-1.
Limited Liability Company (LLC)
A limited liability company (LLC) is a business partnership formed by two or more parties that provides members with the tax advantages of a partnership, while giving them limited liability.
Owners of an LLC are referred to as members. Unlike LLPs, these members can be individuals or corporations. An LLC does not require there to be a general partner who is liable for the partnership’s obligations.
The advantages of an LLC include:
“Pass through” taxes
Legal protection: an LLC’s business assets are legally separated from members’ personal assets, which protects members’ real and personal property, and business income. LLCs are not liable for business debts.
No residency requirement: Unlike LLPs, LLCs do not need to be created by permanent residents of a state or county.
In order to form an LLC, members must do the following:
Choose a business name that is currently not in existence
File Articles of Incorporation. It will include the business name, address, and member names.
Create an Operating Agreement. This lays out the roles and responsibilities of each member, the division of profits, and the specifics of the partnership’s business operations.
