Considering Liability of the Business Owners When Choosing a Business Type

Sole Proprietorship

The sole proprietor is personally liable for the debts of the business, even if those debts exceed the owner’s investment in the business. All of the owner’s assets – both those used in the business and personal property (subject to certain exemptions) – can be attached by creditors and sold to pay business debts. The sole proprietor may be able to minimize certain risks such as property loss, personal injury or product liability by obtaining adequate insurance. Partnership. In a non-LLP general partnership, each partner may be personally liable for up to the full amount of the debts of the business, even if the debts exceed the owners’ investment in the business. This is because, unless care is taken in the partnership agreement to limit a partner’s authority and potential creditors are notified of the limitation, any partner may bind the partnership. The partner with greater personal assets thus risks losing more than a partner with fewer personal assets. As with a sole proprietorship, many business risks can be lessened by obtaining adequate insurance.

Partnership

In a non-LLP general partnership, each partner may be personally liable for up to the full amount of the debts of the business, even if the debts exceed the owners’ investment in the business. This is because, unless care is taken in the partnership agreement to limit a partner’s authority and potential creditors are notified of the limitation, any partner may bind the partnership. The partner with greater personal assets thus risks losing more than a partner with fewer personal assets. As with a sole proprietorship, many business risks can be lessened by obtaining adequate insurance.

However, in a Minnesota limited liability partnership, partners are not personally liable for the wrongful acts or omissions in the ordinary course of business of other partners, for the misuse of money or property of anon-partner by another partner,o rfor the debts or obligations of the partnership, subject to certain exceptions. It is uncertain how this kind of partnership will be treated in other states, although most states have adopted some form of limited liability partnership legislation.

In a limited partnership, so long as the statutory formalities are met and the limited partner is not relied upon by others as a general partner, the limited partner generally is not liable for the obligations of the limited partnership. Thus the limited partner risks loss only up to the amount of his or her investment. The general partner retains full liability as in any other partnership. In limited liability limited partnerships general partners will enjoy the same protections from liability enjoyed by limited partners.

Corporation

The corporation is a separate legal entity, and in most cases is the entity that is liable for the debts of the business. The shareholders generally are exempt from personal liability for those debts and thus risk loss only up to the amount of their investment in the corporation. This is the case for both the C corporation and the S corporation. It should be noted, however, that in a small, closely held or newly created corporation without an established credit history, some or all of the shareholders may be expected to personally guarantee repayment of certain corporate debts as a condition of obtaining a loan or credit.

Also, under certain circumstances such as fraud or personal wrongdoing, shareholders may be held personally liable for wrongful acts. Finally, it is possible for courts to “disregard” the corporate entity and make shareholders liable under certain circumstances.

Limited Liability Company

Liability of the owners of a limited liability company generally is the same as for shareholders of a corporation; that is, absent fraud, personal wrongdoing or disregard of the entity, they generally are not held personally liable for the debts and obligations of the business. They therefore risk loss only up to the amount of their investment. As is the case for corporations, owners of small, closely held, or newly organized limited liability companies may be required to give personal guarantees of repayment to secure financing or credit.


CREDITS: This is an excerpt from A Guide to Starting a Business in Minnesota, provided by the Minnesota Department of Employment and Economic Development, Small Business Assistance Office, Twenty-eighth Edition, January 2010, written by Charles A. Schaffer, Madeline Harris, and Mark Simmer. Copies are available without charge from the Minnesota Department of Employment and Economic Development, Small Business Assistance Office.

This is also part of a series of articles on How to Pick the Right Business Entity Type. These articles help you select the right business type for your circumstances.