Physicians should never operate any business or practice as a general partnership. Why? Because a general partnership is a creditor or plaintiff's dream and a partner's liability nightmare. This article will consider three of the hidden dangers of a general partnership.
1. Partners have unlimited liability for partnership debts.
Many business people, professionals and other entrepreneurs fail to realize this when they're involved in general partnerships. They, in effect, personally guarantee every partnership debt and personally assume the risk for malpractice, accidents and other liability sources of the entire partnership. They fail to consider that their liability as a partner is "joint and several" with other partners. A plaintiff who successfully sues the partnership can collect the full judgment from any one partner. An example:
Case Study: Jane and Ted's Real Estate Venture. Jane and Ted were friends who decided to go into a real estate venture together to refurbish old three-family homes and sell them as condominiums. Events went well for a while, but their real estate market went sour and they defaulted on a $650,000 loan to the bank. Jane was much wealthier than Ted, so the bank pursued Jane for the full amount, ignoring Ted.
2. Partners have unlimited liability for their partners' acts.
With a partner in a general partnership, you assume all the risk that the partner will cause a lawsuit. When the lawsuit arises from one partner's act or omission in the ordinary course of business, every other partner is personally liable. The dreaded joint and several liability then applies—if one of your partners gets into trouble, you can be personally liable for the entire amount, even if you were neither involved in the alleged incident, nor aware of it.
Think of the many ways a partner could get you into trouble: He commits malpractice; gets into a car accident while on partnership business; defrauds someone through the business; sexually harasses an employee; wrongfully fires an employee; and so on. Multiply this risk times the number of partners in your partnership. You have a lawsuit liability nightmare. A real-world example:
Case Study: Michael gets burned by his partner. Michael was the founding partner in a successful three-partner software development firm near Portland, Ore. One of firm's customers sued the firm when a program malfunctioned, causing a loss of valuable data. The lawsuit alleged breach of contract, product liability, and even punitive damages.
Settlement negotiations were unsuccessful and the trial jury awarded an extremely large verdict against the partnership, exceeding its liability policy limit. Since Michael was the wealthiest of the partners, the plaintiff's lawyer pursued him first, forcing Michael to pay the entire $250,000 amount (above the insurance policy limit) from his personal savings. Although Michael had less contact with this customer than his partners, he now understands the risks of a general partnership.
3. You may be an "unaware" general partner.
A general partnership does not require a formal written agreement, as does a limited partnership. You can verbally agree to start a venture with another and create a general partnership, with all of its liability problems. Think about this whenever you start a new business venture with someone.
Even if you make no agreement to partner with another person, the law may impose general partnership liability on you if the general public reasonably perceive you as partners. You may already be part of a liability-ridden general partnership and not even know it.
Case Study: Roger inadvertently has partners. Roger was one of four physicians who used a common office arrangement. They each had their own patients, which they did not share. They did, however, share a common waiting area, support staff and accounting. Each professional had his own practice methods, set his own hours and was not otherwise accountable to the others.
When one of the doctors was sued by a client for professional misconduct, Roger and the two others had a rude awakening. Although only the client's physician was negligent, all four were defendants in the lawsuit. The court found that the patient could reasonably conclude the four professionals were partners together because of their office set-up and common support staff. Therefore, the court allowed the plaintiff to proceed with the suit against all four —as a general partnership, with each jointly and severally liable for the plaintiff's losses.
What business form should you use, if not a general partnership? Consider a limited partnership, a C or S corporation, or a limited liability company. These entities have limited liability provisions for their owners.
If you do use a general partnership, each partner should set up a corporation and the corporations should become the partners in the general partnership. This advice is followed by many medical professionals and attorneys using professional corporations (PCs). Each doctor or lawyer sets up a PC and the PC is the official partner in the partnership, not the professional personally. Structuring the partnership this way, the underlying corporate owner's personal assets remain protected from claims against the partnership. However, as with any corporation, corporate formalities must be followed for asset protection.
Mr. Mandell is an attorney, lecturer and author of The Doctor's Wealth Protection Guide and Wealth Protection, M.D. He is a co-founder of the Wealth Protection Alliance, a nationwide network of legal, accounting and financial firms. Mr. Smith, a partner of George W. Smith and Co., provides business planning to physicians. To reach them or the Wealth Protection Alliance, call 1 (800) 554-7233 or e-mail info@wealthprotectionalliance.com.
This information is general in nature and should not be construed as comprehensive financial, tax or legal advice. Consult your qualified securities, tax or legal representative before taking action.
