If a General Partnership Fails, Who Is Responsible for the Debts?

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The virtues of the general partnership include its ease of formation when compared with forming a limited liability company (LLC) or corporation. The informality of operation and the flexibility in decision making are appealing. But what about unlimited personal liability? What about the safety of one’s personal assets should the business of the general partnership fail? What if a key partner exits?

As the person who runs the business, you are probably going to be a general partner, which affords only slightly more protection than operating as a sole proprietorship but less than an LLC. If a general partnership fails, the general partner is responsible for the debts.

What Debts Are the Responsibility of the General Partner?

Let’s specifically define what a debt is. In contrast with an asset, a debt is a financial obligation, or liability. If you are the general partner in a partnership, you have a personal liability for debts of the partnership in the event the partnership cannot repay its debt. That responsibility means creditors can legally attempt to go after your personal assets: your bank account, cars, even your homes.

Because of this potential pitfall, it’s very important — no matter what structure you use for your business — that you maintain a formal legal separation between your personal and business assets and financial dealings. Otherwise, when a general partnership fails, you could be on the hook for any debt or unpaid bills taken on by the business.

These unpaid debts could involve payroll, taxes due, unpaid contractors, or judgements as the result of accidents and personal injury. It sounds bad. The good news is, with careful initial planning, these personal liabilities and risks can be mitigated.

One way to mitigate these risks is with a comprehensive business insurance policy. However, you’ll want to review this policy carefully. Read on to learn how to protect your assets.

What to Look for in Your General Partners Liability Insurance Policy

Even with insurance, it’s important to review any policy carefully for exclusions. A standard general partners liability (GPL) policy will contain similar exclusions for bodily injury and property damage, dishonest or fraudulent conduct, personal profit or advantage, and pollution.

Other normal exclusions in GPL insurance policies eliminate coverage for claims based on the commingling of funds, claims arising from changes in federal, state or local tax law, claims against inaccurate valuation of assets, and claims arising from actual or attempted liquidations or reorganization of the partnership.

The solution to all this risk is simple, and worth the time and effort, especially in light of the potential upside and reward. The solution is due diligence and careful planning at every step in the process of forming and maintaining the business entity or corporation, and in the acquisition and management of the commercial properties. Seriously evaluate your potential partners, the form of business structure, and the project itself.

The partnership has usefulness for a small managerial group desiring substantial control over their enterprise, but unlimited liability. Even with adequate protections like insurance in place, a general partnership can be riskier than a limited liability company, limited partnership or other business structures.

The Exit Plan: How to Leave a General Partnership

Because each partner is liable for all the partnership’s debts, one way out if you see trouble coming is to exit the partnership. Depending on the wording in your partnership agreement, if you exit the partnership, you may or may not be liable for the debts of the continuing business. The answer is in the original partnership agreement.

If your timely exit means you are not liable for the debts of the partnership, you don’t have to worry about the continued use of the name of the company, which may or may not include your name. Conversely, you may remain with the partnership when another partner exits. In some cases, keeping the goodwill associated with its name is more valuable than changing it.

Is a Limited Partnership or LLC Best for You?

If you want to restrict your potential losses to the amount you’ve invested, and not be personally liable for debts, you may want to consider organizing your enterprise as a limited partnership or an LLC.

In a limited partnership, typically there is at least one partner who is passive and at least one partner whose liability extends beyond monetary investment.

Better yet, LLC owners are most often not responsible for the debts of the company.

7 Provisions You Might Need If You Move Forward as a GP

If you do decide to go ahead and form a general partnership, these are some of the standard provisions you might include.

  1. Each partner is expected to share equally in the profits and losses proportionate to the capital invested.
  2. Each partner is indemnified by the partnership for any partner payments and liabilities incurred in the ordinary and proper conduct of the partnership’s business.
  3. Each partner may participate in the management of the business.
  4. No partner is entitled to any remuneration for acting in the business.
  5. The consent of all existing partners is required to bring in a new partner.
  6. Ordinary matters connected with partnership business may be decided by majority vote, but a change in the nature of the business requires unanimous consent.
  7. Partners cannot expel a partner unless that has been specifically allowed in the partnership agreement.

Go Big or Go General Partnership

In summary, for the simplest real estate venture — perhaps two or three trusted partners investing in a small multifamily rental — it’s possible that a general partnership affords the easiest way forward. However, when getting involved in commercial real estate it usually makes sense to seek out expert advice on property management, insurance, law, and finance.

General Partnership FAQs

If a general partnership fails, who is responsible for the debts?

The general partner is responsible for the debts if a general partnership fails.

What is a general partnership?

A general partnership is a business entity made of two or more partners. A general partnership agreement is not needed to form a general partnership, but it’s a good idea.

If a limited partnership fails, who is responsible for the debts?

The general partner is responsible for the debts of a failed limited partnership.

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