A Reassessment of General Partnership Law

General partnerships are a puzzling form of business in the modern world. A well-established business form with a deep history and sophisticated uniform laws, the general partnership finds itself in a strange position today:  Virtually nobody would be well advised to create one.

As a result, general partnerships come about mainly by accident.  Indeed, probably the most often litigated question in general partnership law is simply whether one exists in the first place, with the putative organizers trying to claim that they didn’t in fact create one.

General partnerships are the only multi-person business organization that can arise accidentally under modern law — that is, without a formal filing, merely as a matter of background legal processes.  The reason that businesspeople try to avoid the “accident” is that general partnerships lack a liability shield.  The business forms that entrepreneurs and businesspeople tend to create purposely today — LLCs, corporations, LLPs, and LPs — all provide liability shields for the members, owners, investors, or operators.  Thus, if an LLC or corporation fails, the business is simply bankrupt, and the creditors cannot recover for their losses.  If a general partnership fails, however, then the individual partners will all potentially be liable for the obligations of the business, whether they arise from contract liability, tort liability, or anything else.

Because of this difference, people setting up a business ordinarily will choose one of the other forms, like a corporation.  In the past, despite the consequences for personal liability, the organizers of a business might stick with general partnerships to avoid extra work and expenses (corporations used to be relatively difficult to set up and maintain) or for tax reasons (corporations lead to a well-known type of “double taxation,” whereas partnerships do not).  There were a variety of sophisticated tricks that organizers could use to try to get the best of both worlds — say, the tax benefits of a partnership but the liability benefits of a corporation — and these tricks were one of the main things business lawyers learned about the subject.

Modern organizational law has made many of the tricks unnecessary.  For better or worse — public-choice theory is one explanation — modern law has increasingly given the organizers of businesses everything they want.  Initially, state judges and legislatures made corporate law less cumbersome for small businesses, so that they were easier to create.  The IRS developed rules (under Subchapter S) to let some corporations be taxed like partnerships.  States and the drafters of uniform laws increased the liability protections for investors in limited partnerships and made the “limited liability partnership,” or LLP, available outside its original province of professional organizations like law firms and accounting firms.

This trend has culminated in the rise of the limited liability company, or LLC.  The LLC can be taxed in a variety of ways, ordinarily at the organizers’ choice.  It provides a liability shield.  It can function exactly like a partnership — or however else the involved parties want it to function.  It costs virtually nothing to maintain an LLC; it’s not expensive to produce the organizational documents for one (although legal planning in advance is of course still often useful to avoid ambiguous relationships and reduce the likelihood of lawsuits).  In many states, for about $100, anyone can create an LLC in a matter of days, without even calling a lawyer.  It is literally easier and cheaper to create an LLC than to book many airline flights.  While “choice of business form” questions were once a delicate balancing act even for the most sophisticated lawyers — involving questions of tax, liability, structure and control, and so on — today the vast majority of business organizers can get all this virtually for free simply by creating an LLC.

The rise of the LLC and similar forms is what has made general partnerships puzzling today.  To put the puzzle simply:  If anyone can avoid being vicariously liable for a business’s legal obligations simply by paying the state $100 in advance, it seems strange to subject them to the possibility that they’ve accidentally created a general partnership and force them to face vicarious liability for their business partners’ actions.  In other words, the modern state of the law of vicarious business liability is that business partners are liable for each other’s actions unless they politely ask the government in advance not to be.  That seems like a strange state of affairs.

Many people have criticized the liability shields that LLCs and similar forms provide.  But if they’re here to stay, I think it’s at least worth asking whether general partnerships ought to be given a similar liability shield.  On one hand, that would reduce liability for plaintiffs who have been wronged by businesses, and that is a problematic result.  On the other, it would prevent general partnerships from being a dangerous trap for the unwary, thus arguably making the law of vicarious business liability somewhat fairer.  And perhaps there are other ways of compensating plaintiffs; for example, at least in the case of tort plaintiffs, maybe businesses should face greater insurance requirements.

In any event, with the rise of the flexible LLC that gives business organizers whatever legal structure they want, it becomes useful to ask why we should have any other business forms anymore.  The LLC is flexible enough to act like a small corporation, a large corporation, a partnership, a limited partnership, or even (in many states) a not-for-profit organization, and perhaps it’s strange to have a business form like that but let all the others continue to exist.  It isn’t hard to imagine a future in which there is just one type of organization in US states — a “Registered Organization,” say — that has all the characteristics of modern LLCs and replaces the other business forms. What we have now is a hodgepodge that nobody planned for — one form imported from France for one purpose, another developed at ancient common law, and so on.  Better coordination between the communities that know the laws of different business organizations would probably lead to more rational debates and policies.

The preceding post comes to us from Shawn Bayern, the Larry & Joyce Beltz Professor at the Florida State University College of Law and author of Closely Held Organizations.

2 Comments

  1. Theodore M. Weitz

    I would note that another huge disadvantage of a general partnership is that each general partner has actual authority to bind the partnership, a governance regime that is troubling, particularly in the accidentally created partnership.

  2. jesus alfaro

    Partnership Law is a mess in the US, Much more coherent in Continental Law, take a look at German Law I don’t think it is a good idea to give partnerships a liability shield. If partners start acting as members of a partnership why should they be privileged vis à vis a single individual?

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