Think Twice Before Forming A California Partnership - Form A California Corporation or LLC Instead
|Prepared By: Melissa C. Marsh, Los Angeles Business Attorney
Written: March 2009
In today's litigious world, few people should knowingly opt to form a general partnership which offers no protection from personal liability. It is far more practical to form either a California corporation, or a California limited liability company, which offers the owners of the business protection from personal liability for the company's debts, liabilities, and obligations.
7 Reasons Not To Form A California General Partnership Without A Well Written Partnership Agreement
1. Pursuant to California law, one partner can legally bind the other, with or without the other partners' knowledge or consent. Each partner has the full authority and legal ability to create debts, obligations, and liabilities on behalf of the partnership for which each of the partners is jointly and severally 100% personally liable. One partner's poor business judgment, management, or decisions can thus expose the partnership, and in turn each of the partners, to a tremendous amount of personal liability.
2. As inferred above, a general partnership does not offer any limited liability protection. Each partner is individually 100% personally liable for each of the partnership's debts and obligations, even if that partner didnít consent, didn't know, and even if that partner only has a minority interest in the partnership. If a 10% partner winds up being sued and holding the bag, the law leaves it up to that 10% partner to sue the other partners for their share of the liability.
3. Regardless of any agreement to the contrary, third parties (e.g. vendors, customers, employees, etc) are not bound by the terms of a partnership agreement that place the liability on any one particular partner. Third parties can sue all of the partners, or just one of the partners, for any debt, obligation, or claim.
4. If one partner mismanages the business, the law does not provide an easy way for the other partner(s) to take over the management responsibilities, to stop that partner, or to remove the partner. The only legal remedy available is to petition a court of law for dissolution of the partnership. Likewise, if a partner just wants out (to walk away), the law doesn't make withdrawal easy either.
5. When a general partnership is formed without a written agreement, California's Revised Uniform Partnership Act (RUPA) sets the rules. Pursuant to RUPA, each partner has an equal share in the profits and losses of the partnership and an equal right to manage the business regardless of the partner's expectations.
6. Without a well drafted detailed partnership agreement, partners who disagree on how the business is being managed, how additional capital can be raised, and how profits should be distributed, can only seek redress from a court of law by asking a court to dissolve the partnership.
7. When filing your annual tax return, each partner must report his or her share of the partnership's profits or losses on his or her personal tax return, even if the profits were retained by the partnership to cover future costs.
Advantages to Operating As a California General Partnership
On the flip side, a general partnership when formed by a well drafted agreement can enable two or more individuals to "test the waters." Before incurring the expense of forming and operating a California corporation, or a California limited liability company, two or more individuals may opt to run their business for a limited time as a general partnership. Often, an attorney will draft a provision providing for the dissolution of the partnership in the event one or more of the partners wants out, and for the formation of a corporation or a limited liability company in the event the partners have reached a predetermined milestone.
Operating a general partnership under these particular circumstances affords the partners the overall flexibility to raise needed capital over a period of time, and the flexibility to manage the business in an unlimited number of ways.
If you would like our office to prepare a well written general partnership agreement for your business, or to discuss the possibility of forming a corporation or limited liability company, 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.