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Legal Matters

Dodge the Partnership Potholes

Three reasons to avoid general partnerships when you set up a practice.

By David B Mandell, JD, MBA and By jason m o’dell

1. Partners Have Unlimited Liability for Partnership Debts

This tragic fact goes unrealized by many physicians, professionals, and other entrepreneurs when they are 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 physician colleagues who wanted to increase their income by buying “fixer upper” houses, renovating them, and then selling them. Events went well for a while, but when the real estate market went sour, 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 (or is convicted of) malpractice, gets into a car accident while on partnership business, defrauds someone through the business, sexually harasses an employee, wrongfully fires an employee, etc. Multiply this risk times the number of partners in your partnership. You have a lawsuit liability nightmare! An example:

Case Study: Michael Gets Burned By His Partner

Michael was the founding partner in a successful three-owner surgery center near Portland, Oregon. One of firm’s employees sued the firm for sexual harassment.

Settlement negotiations were unsuccessful and the trial jury awarded an extremely large verdict against the partnership, which was, of course, not covered by the malpractice policy. Since Michael was the wealthiest of the partners, the plaintiff’s lawyer pursued him first, forcing Michael to pay the entire $250,000 amount from his personal savings. Although Michael had less contact with this employee 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 perceives 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 services. 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.

Corporation as partner

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. Many medical professionals and attorneys heed this advice by using professional corporations (PCs). Each doctor or lawyer sets up a PC and the PC is the official partner in the partnership, not the physician 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, the corporate formalities must be followed for asset protection. g

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David B. Mandell, JD, MBA is an attorney, lecturer, and author of the books The Doctor’s Wealth Protection Guide and Wealth Protection, M.D. Jason O’Dell is the author of the upcoming book FOR DOCTORS ONLY: Work Less, Make More. Both Jason and David are principals of the wealth advisory firm, Odell Jarvis Mandell, LLC, which specializes in working with physicians. Reach them at odell@ojmgroup.com and mandell@ojmgroup.com.