June 27, 2022
Partnerships are popular forms of business organization in Canada. They can be simple to form, and more flexible than corporations, but have the advantage of shared adventure over a sole proprietorship.
We may look at some of these advantages further in other articles, but this article is about some of the risks and liabilities associated with the partnership which differ from either a sole proprietorship or an ownership interest as a shareholder of a corporation.
THE SOLE PROPREITOR
In a sole proprietorship, if you are the owner of the business, you are responsible for all of its debts and liabilities whether in contract, negligence or otherwise. All of your personal assets may be in jeopardy not only for your own mistakes, but for the mistakes of your employees or associates. Although this is the simplest form of business organization, it is the riskiest.
If you choose to conduct your business as a sole proprietorship, you should get professional advice about creditor proofing and make sure that you are well insured. Insurance will not typically protect you from debts or contractual obligations, which is why protecting family assets is important.
If you are a shareholder in a corporation, you are typically not personally responsible for any of the debts or liabilities of the corporation. Although there are a limited number of circumstances where a court will “pierce the corporate veil” even that typically will only extend risk to directors and officers who are active in the events that create the wrongdoing. If you are strictly an investor, your risk is usually limited to the amount of your investment unless you give a personal guarantee.
There are three types of partnerships – a general partnership, a limited partnership or a limited liability partnership.
The most common form of partnership is the general partnership. It has all of the risks associated with a sole proprietorship, and then more risks as well:
- Each partner maybe personally responsible for all debts and liabilities incurred in the name of the business by any partner or even by an agent or employee of the partnership.
- That means that each partner’s personal assets may be at risk for the entire amount of the partnership’s debts or other liabilities.
- Any partner can enter into a contract or pledge the credit of the entire partnership.
- This can put your personal assets at risk for the actions of others.
Because of the potentially unlimited risk, when entering a general partnership you have to engage in all of the careful planning of a sole proprietorship in terms of creditor proofing your assets and insuring the risks you can insure.
In addition, you must be very careful about selecting honest and reliable persons as your partners. Since any of them may commit either a wrongful or foolish act that costs you money, you need to trust their judgment.
As a further layer of protection, it is always advisable, but not legally required, to enter into a written partnership agreement that sets out the responsibilities of each partner. Although this understanding may not protect you from claims by persons outside the partnership, it gives you some assurance as to how internal matters will be organized. Your best protection, beyond insurance, is to maintain active and inquisitive involvement in the partnership, keeping an eye out for any irregular or improper activities or risks.
Although the term “silent partner” is very familiar, being a silent partner – an investor not involved directly in the business – is perhaps the riskiest form of business investment possible. Like a shareholder, you may have limited or no say in the management of the business, but if your partnership investment is disclosed, you become a target for outside creditors. Unlike a shareholder, your liability to outsiders is unlimited, and personal assets may be at risk.
Since partnerships must be registered in Ontario, truly silent or secret partners exist outside of compliance with the law. Anytime you choose to ignore the law, you increase your risks.
A limited partnership is an arrangement much like a corporation where investors contribute to the business without being directly involved in the management of the partnership. Usually as a limited partner, your liability to the partnership or its creditors is limited to the amount invested in the firm. You need to be cautious about the extent to which you become involved in the management of the firm, in which case you may be considered a ‘general partner’ with unlimited liability.
There are also specific situations in which limited partnerships have been held to be agents of the limited partners and the liability flows through to those investors.
If you are considering using a limited partnership as a business structure, you should get specific advice about how to minimize those risks. If your claim is against a limited partnership, you will want to review all the factual background with your lawyer to determine whether you can extend your claim to any of the investors.
Limited Liability Partnerships
A limited liability partnership in Canada is usually only available to professionals such as lawyers, accountants, and doctors. They have specialized rules about different forms of liability. If you are considering forming a limited liability partnership, you want specific advice about the rules that govern your profession. If you are considering suing a limited liability partnership, you need fact-specific legal advice about your rights to sue.
THE BOTTOM LINE
If you are considering entering into a business as a partner, you should obtain legal advice. Ideally, that advice will be from a separate lawyer other than the lawyers advising your perspective partners. This is particularly true if the other partners’ lawyer has a longstanding relationship with them. You want advice that is truly in your own best interests.
That legal advice, together with professional financial and accounting advice, will help you determine how to structure your partnership, and the content of the partnership agreement. In almost every partnership other than a very small short term partnership, we recommend a written agreement.
Even for short term single purpose partnerships, we recommend a simple form of agreement. If nothing else, the partners in that single purpose partnership should want to make the extent to which they are allowed to continue overlapping business activities clear. For example, if two small contractors form a temporary partnership to bid on a larger job, they would want to record it in writing that they are allowed to continue through their regular businesses to bid on other projects as competitors. At law, the duty of loyalty between partners creates a presumption that they will not compete against each other.
That is just one example of why you need good legal advice before you set up your partnership, whether it is in Thunder Bay, Kenora, or any of the many small towns in northwestern Ontario.
The corporate law team at Weilers LLP is not just about corporate law. We deal with all forms of business organizations, including partnerships. We can provide you the advice and assistance that you require.
Should your investment and activity in a partnership lead to claims against you, the litigation team at Weilers LLP will work closely with our business lawyers to vigorously represent your interests and attempt to reach cost effective solution as quickly and simply as possible.
Please contact us at Weilers LLP if you want more information about forming a partnership, about the risks of either a new or existing partnership, or other forms of business organizations.