Answers to Frequently Asked Questions About California General Partnerships
|Prepared By: Melissa C. Marsh, Los Angeles Business Attorney
Written: March 2009
Q. What is a general partnership?
A. A general partnership is a business owned directly by two or more people that has not filed Articles with the Secretary of State to become a corporation or a limited liability company. A general partnership is the simplest and least expensive way (at least in the short run) two or more individuals can set up a business. No written agreement is required (although strongly recommended), there are no papers that must be filed (although a Statement of General Partnership is a good idea), and there are no required minutes or meetings.
Like the sole proprietorship, all income and losses pass through directly to the partners, even if the partners leave money in the business accounts to keep the business running, and all of the partners are each 100% personally liable (jointly and severally) for the business debts, obligations, and liabilities. The biggest downside and risk faced by a partnership is the ability for any co-owner to unilaterally bind the partnership and all of its owners to a deal with or without the other co-owners knowledge or consent.
Absent a written agreement to the contrary, each partner is authorized to sign contracts, checks, leases, and carry on all the business of the partnership. This means that each partner assumes personal liability for the consequences of, and the actions of, the other partner(s) even when the acts were committed without the knowledge or consent of the other partners.
Q. Why would someone choose to form a partnership instead of an LLC or Corporation?
A. Although the business partners are 100% personally liable for the partnership's debts and obligations, often individuals will opt to form a partnership instead of a limited liability company or corporation to avoid the additional expense and requirements of operating a California corporation or LLC. If limited liability protection is a non-issue, the partnership is an easy, flexible business entity, which with a well drafted partnership agreement can function quite smoothly.
Q. Why should partners consider forming a corporation or limited liability company (LLC)?
A. When operating as a sole proprietor, or as a partnership, the business owner(s) will be personally liable for all the debts and obligations of the business. In addition, all income earned, or losses incurred, are taxable directly to the business owner(s) and reported on personal tax return(s), even when the business is holding on to some of the money for future growth.
Businesses generally should not be operated as sole proprietorships or partnerships. Why? Because both the corporation and LLC are better alternatives. The LLC offers all the benefits of the sole proprietorship and partnership (simplicity and flexibility) without the huge disadvantage of unlimited personal liability for the business debts and obligations. The corporation, albeit being subject to a few more formalities, is often a better alternative to the LLC and can save the business owner(s) from having to declare personal bankruptcy in the event the business unexpectedly fails.
Properly forming and maintaining an LLC or corporation, however can be time consuming and unfortunately 85% of all corporations and LLCs fail to do so. Most do not prepare annual and special minutes of meetings, and those that do often just use some form book, or online document preparer which typically will not suffice. Consequently if there is an audit, or a lawsuit, the IRS and/or claimant is typically able to "pierce the corporate veil" and sue the individual owners anyway.
If you do opt to form a corporation, or a limited liability company, make sure you do it right and use an attorney not only for its formation, but also its maintenance. Just consider it a cost of doing business. If you not willing to use an attorney for both the formation and maintenance of your corporation, then you are probably better off remaining a sole proprietor or partnership. Why? Because at least you won't fall into the trap of having a false sense of security, which so many businesses have.
Before rushing out to form a LLC or corporation, however, take pause and at the very least consult with a business attorney to determine: (1) if the limited liability benefit will outweigh the attorney's fees, filing costs, and annual franchise taxes imposed by your state; and (2) whether LLC or corporation would better fit your particular circumstances.
Q. When is a limited liability company or S-corporation better than a General Partnership?
A. A general partnership works well if all of the partners: (1) are devoting equal time, money, and resources to the partnership, (2) are actively managing the business affairs of the partnership, and (3) have relatively the same economic status or wealth.
That said, a limited liability company (LLC) or S-Corporation is more appropriate if:
- the partners are not devoting equal time and resources to the partnership; or
- the management of the partnership is being conducted by less than all the partners; or
- the partners seek personal liability protection from the partnership's debts and obligations.
Remember, with a general partnership there is no limited liability protection. Each partner is jointly and severally personal liable for all the debts and obligations of the partnership, regardless of which partner actually incurred the debt, or obligation. With an LLC or S-Corporation, all of the members/shareholders will enjoy personal limited liability protection so long as the LLC or S-Corporation is properly formed and maintained.
Q. Can partners agree that only one of the partners will be liable for the partnership debts?
A. Although the partners can enter into such a written agreement, the agreement will not bind any of the partnership's creditors. With a partnership, each of the partners is 100% personally liable to outside creditors for all of the partnership's debts and obligations. That said, if the partners execute such an agreement the partner who was exempt from the debt could sue the other partner if a creditor came after him. Problem is, in most cases, one or more the partners will not be collectible. It is therefore critical to know and understand the person with whom you plan to form a partnership.
Q. How do we form a general partnership?
A. California law does not require any specific act, not even a written agreement, to form a partnership. All a general partnership requires is at least two individuals who have agreed to go into business with each other. Even if you do not intend to form a partnership, as long as you intended to carry on a business for profit, you will have formed a general partnership.
Under the default partnership rules, known as the Revised Uniform Partnership Act (RUPA) each partner has an equal right to make decisions affecting the business, an equal share in revenue, profits and losses, and an equal right to manage and operate the business. While there is no requirement to file any document with the state, partners may file a "Statement of General Partnership Authority" and if they have selected a company name (other than their own personal names), then they must file and publish a Fictitious Business Name Statement with the county.
Although general partnerships can be formed by a simple verbal agreement, we strongly recommend you have a well written partnership agreement, especially if you do not intend each of the owners to have an equal share of the profits and losses or an equal right to manage and operate the business.
Q. What paperwork do I need to file for a California partnership?
A. California law does not require any specific act, not even a written agreement, to form a partnership. However, like every other business a partnership should: (1) get a federal taxpayer identification number (EIN) by completing IRS Form SS-4; (2) get a local city business licenses; and (3) file and publish a fictitious business name statement (a.k.a. DBA). In addition, a partnership should consider filing a Statement of General Partnership Authority and executing a well written partnership agreement.
Q. Does a partnership require a written partnership agreement?
A. No, but you would be a fool not to have one prepared by an attorney. Mind you I am not a great fan of generic form partnership agreements despite the fact that they generate tens of thousands of dollars to my practice when there is a dispute. A properly written partnership agreement that details the major points of your relationship, each partner's duties and responsibilities, how profits (and losses) will be distributed, and an exit strategy can save you tens of thousands of dollars in attorneys fees later if problems arise. Without such an agreement, misunderstandings are likely to turn into disputes, which in turn can lead to large legal bills when one partner locks out the other, or sues.
Q. How is a partnership taxed?
A. A partnership is considered a pass through tax entity. This means the partnership itself does not pay any taxes. Instead, all of the profit and losses of the partnership pass though and are reported by the individual partners on their personal tax returns.
While the partnership itself does not pay any taxes, the partnership is required to IRS Form 1065 (K-1 Return), which sets forth each partner's share of the partnership profits (or losses).
Q. What is a limited partnership?
A. A limited partnership has one general partner who carried the full personal liability of the business, and one or more limited partners who are only liable up to the extent of their investment. With the limited partnership only the general partner has the right to manage and control the business. If a limited partner starts making decisions, or engaging in the limited partnership's business, the limited partner will become a general partner in the eyes of the law.
If a limited partnership becomes insolvent or declares bankruptcy, the general partner will still be personally liable for the debts and obligations of the partnership, but the limited partners will only lose their investment.
The limited partnership is rarely used unless the general partner is a corporation which will provide its owners with the limited liability protection afforded to the corporation, but not to general partners. Most businesses seeking the benefits of a limited partnership opt to form a limited liability company which is less expensive to form that both a corporation and a limited partnership.
Q. How long do I have to sue for breach of a partnership agreement?
A. Generally, the statute of limitations for breach of a WRITTEN contract is 4 years from the date of the BREACH; while the statute of limitation for a breach of an ORAL contract is 2 years from the date of the BREACH. Thus, within four, or two, years following the first breach of the agreement, you must have a lawsuit filed.
As long as the partnership exists, the partners are fiduciaries of one another and have a high duty of fair dealing, the breach of which could also be cause for a lawsuit, in addition to or perhaps instead of a contract action on the partnership agreement. If the amounts now involved don't warrant hiring an attorney, you may be best off just negotiating the best terms you can and moving on, or filing a claim in Small Claims Court.
If the partnership has terminated, either by agreement or by operation of law, your rights are limited by the California Revised Uniform Partnership Act. Partnerships are rather fragile entities, and the withdrawal of all but one partner would doubtless cause a termination.
Q. What is the difference between a Partnership and a Joint Venture?
A. Generally speaking, a joint venture is considered a form of partnership and is governed by partnership principles, including the Revised Uniform Partnership Act (RUPA). A joint venture, like a partnership, exists when the owners of a business agree to share the profits, losses, and control of a business. So what is the difference? Well a partnership connotes an ongoing business, while a joint venture typically involves a single transaction of limited duration.
If you would like our office to prepare a well written general partnership agreement for your business, dissolve a partnership, assist with the buyout of one or more the partners, or if you would like to discuss the possibility of forming a corporation or LLC, please call 818-849-5206 or Send us an Email.
California business lawyer, Melissa C. Marsh, is based in Sherman Oaks and West Hollywood, and serves individuals and businesses throughout Los Angeles County, including: West Hollywood, Miracle Mile, Beverly Hills, Century City, Santa Monica, Burbank, North Hollywood, Valley Village, Toluca Lake, Studio City, Sherman Oaks, Van Nuys, Encino, and Woodland Hills.
© 2009 Melissa C. Marsh. All Rights Reserved.