Partnerships: Can you protect yourself from liability?

Second in a three-part series

Partnerships: Can you protect yourself from liability?

By Christopher J. Allen, DVM, JD

Contributing Author

Our office was recently working with another law firm putting togethera veterinary practice sale. In a conversation with one of my colleaguesat the other firm (a 50-lawyer monster in Georgia), I asked her how themany attorneys at the large firm manage to work out the inevitable partnershipdisagreements and infighting.

"There's no piece of paper that can keep a partner from acting likea jerk," she told me. "But the paperwork which set up this organizationis specific enough to handle just about any dispute when it gets serious."

This second installment for this partnership series is intended to explainthe types of business organizations that are available to operate a multi-professionalpractice. Selection and design of the business entity is critical to servingthe interests of all partners and to protect them from threats from outsideas well as from within.

All forms of business organization really constitute some sort of partnership,except for businesses that are owned by a single person. These organizationsare formed based on the premise that more can be accomplished by the jointefforts of a number of people working together than can be accomplishedby one person, alone. A two-person medical practice, whether formed as asimple partnership or professional corporation, is really a partnership.The giant accounting firm Arthur Anderson is a partnership. Although theyare organized as corporations, Enron and IBM are effectively partnerships.Large or small, there are only three main variables among these businessorganizations:

1. How are potential liabilities and disputes handled?

2. Who gets to make decisions?

3. How are the profits split up?

Human nature

The concept and law of business organizations is based on a fundamentalprinciple of human nature. Everybody wants to run the show and collect theprofits; but when problems occur, they want to shift those problems ontosomeone else. The goal is always the same: maximize reward; minimize risk.All forms of business organizations are designed to address this goal insome way. I will briefly detail how the generally accepted forms of runninga business attempt to accomplish this goal.

General partnerships can be formed quickly and easily with virtuallyno written documents. Two individuals agree to undertake a business venturefor mutual profit. The two entrepreneurs shake hands and begin working anddecide to split the profits of the business (or practice) evenly or on apercentage basis. General business law provides for such partnerships, andthe key elements of state law provide that each partner is taxed on hisor her share of the profits.

Problems, problems

The biggest problem with general partnerships occurs when a liabilityarises. For example, what happens if one of the partners in a veterinarypractice runs over a farmer with the practice truck? General partnershipsin most jurisdictions could make each partner's personal assets availableto satisfy claims by the farmer against the partnership. The veterinarianwho was back at the office may become bankrupt because his partner droveirresponsibly.

In many states, a simple solution has been created to facilitate theformation of business partnerships while providing a way to sidestep muchof the personal liability attached to general partnerships.

State legislatures have created forms of business known as limited liabilitycompanies (LLCs) and limited liability partnerships (LLPs). Frequently acousin of these business entities also exists for licensed professionalpartners, professional LLCs and LLPs. (These structures operate in the sameway as traditional LLCs and LLPs but membership is limited to persons orentities licensed to practice the profession undertaken by the partnership).

These forms of business organizations help to insulate the partners frompersonal liability for acts of the partnership. They don't protect the partnership'sassets (in the example above, the partnership could still lose the companytruck if the farmer prevailed in a lawsuit in excess of the insurance coverage).However, the innocent partner himself can avoid having his personal propertyattached and sold to satisfy a wrong committed by the partnership.

The other popular form of business organization used for carrying outa professional practice is the professional corporation (PC). A PC operatesmuch the same as any other corporation in that owners hold shares in thecompany and their share of any profit or loss, and their right to vote onbusiness decisions is based on their percentage ownership of the stock.

This form of business also provides a degree of limitation on personalliability. If the PC incurs a judgment against it for negligence when aclient is injured on business property, only the assets of the businessare generally at risk. The shareholders certainly can lose their economicstake in the company, but their assets held personally are usually protected.

The decision to select either a PC or a LLP can go a long way towardprotecting the partners from problems which arise in their dealings withthe outside world; suppliers, clients, contractors and so on. On the otherhand, the use of such a business entity in and of itself is not sufficientto protect the partners from business insiders and those close to the business.

Problems arising with other partners as well as their relatives, ex-spouses,heirs and creditors are not magically solved by incorporation or formationof any type of limited liability entity.

These problems can be minimized, but this is done in setting out thedetails of internal business entity documents when the organization is formed.Those elements will be discussed in the third and final installment of thisseries on partnerships next month.