One of the most frequently asked questions we get at our business law firm is the difference between a partner in a general partnership versus one in a limited partnership. While we already wrote a blog on limited partnerships, today we will discuss the personal liability of partners in general partnerships versus limited partnerships.
To learn more about limited partnerships, read about it here.
What is Personal Liability in a Partnership?
A partner incurs personal liability for a partnership debt, which is debt that binds the company and its partners. This means that partners will be responsible for certain decisions or actions taken by the partnership.
For example, imagine Alex and Taylor, co-owners of a photography studio operating as a general partnership. They decided to lease high-end equipment for a major project. However, the project encounters unexpected challenges, making it impossible to pay the leasing company. As general partners, both Alex and Taylor are personally liable for the outstanding lease payments.
Who is Personally Liable in a General Partnership?
In a general partnership, every partner is seen as a representative of the partnership when dealing with third parties in good faith [1]. So, any action done in the partnership's name as part of its regular work will affect all the partners [2]. This rule also includes silent partners [3].
Moreover, if a partner makes a commitment in their own name, it'll tie the partnership if it's related to the business or property being used by the partnership [4].
In certain cases, partners will be jointly and severally liable (meaning they are each responsible for the full amount) for certain debts. These include:
obligations entered into by the partnership for the service or operation of the company [5];
An obligation that contains a joint and several liability clause;
An obligation the law declares as being solidary.
With respect to third parties, partners are jointly liable for obligations contracted by the partnership. In this case, creditors may bring an action against a partner for payment. But they can only do this if they have tried to get payment from the partnership first. If the partnership does not have enough money or assets, then they can go after the partners personally.
In another scenario, let’s consider Chris and Jordan, partners in a software development firm. They secure a joint credit line to fund their expansion plans. Unfortunately, the market experienced a sudden downturn, affecting their business revenue. The firm struggles to make the credit line payments, leading to legal action. Since Chris and Jordan are general partners, they share joint and several liability. Creditors can pursue either partner individually for the entire debt left over after having gone after the partnership.
Who is Personally Liable in a Limited Partnership?
The situation is different in a limited partnership. In this case, there are general partners and special partners. Each general partner is jointly and severally liable for the partnership’s debt to third parties when the partnership’s assets are insufficient [6]. So their liability will only be triggered where there is a shortfall in the partnership’s assets. By contrast, special partners are only liable up to the amount of their contribution to the partnership.
Consider Tech Innovators LP, a special partner investing $100,000. If the business faces financial distress and accumulates a debt of $150,000, the special partner is only liable for the initial investment of $100,000, shielding their personal assets from the remaining debt.
As always, there are exceptions to this rule. For example, if the name of the special partner is used in the partnership’s name without mentioning they are special, they will be responsible for the obligations in the same way as general partners [7].
Moreover, special partners must tread carefully if they decide to negotiate business on behalf of the partnership. Should they do so, they may be "liable in the same manner as a general partner for the obligations of the partnership resulting from such acts and, according to the importance or number of such acts, [he] may be liable in the same manner as a general partner for all the obligations of the partnership” (our emphasis) [8].
Let’s consider an example to help clarify this idea. Imagine in a limited partnership named BioTech LP, a special partner, Joy, actively negotiates a contract with a supplier for research equipment. Without specifying her limited liability status, Joy signs the contract. If the partnership defaults on payments, the supplier can hold Joy personally accountable, as she appeared to act as a general partner in the transaction.
Conclusion
As entrepreneurs, your choice of partnership structure influences your exposure to financial risks. Remember, the key to mitigating personal liability lies in comprehensive legal understanding, transparent communication, and strategic decision-making.
If you have further questions or need tailored advice regarding your specific partnership situation, we are here to assist you. Empower your business journey with knowledge and secure partnerships.
Reach out today via info@astrelegal.com to ensure you’re making the best decisions for your unique circumstances. Your business deserves the best possible protection.
This blog post is not legal advice and is for general informational purposes only. Always speak with a lawyer before acting on any of the information contained herein.
[1] section 2219 Civil Code of Quebec
[2] section 2219 Civil Code of Quebec
[3] section 2233 Civil Code of Quebec
[4] section 2220 Civil Code of Quebec
[5] sections 2221, para. 1 and 2254 Civil Code of Quebec
[6] section 2246 para 1 Civil Code of Quebec
[7] sections 2196 and 2247 Civil Code of Quebec
[8] section 2244 para 2 Civil Code of Quebec