Minimise Risks Of An Insolvent Partner

Question:

How can a general partnership minimize the risks of an insolvent partner if a liquidation occurs later?

All partners in a partnership are jointly and severally liable for all liabilities of the partnership.¹ This means, as a partner you can be liable for debts incurred by another partner on behalf of the partnership.²

Every partner is an agent of the firm. The acts of every partner carrying on in the usual way of business of the kind carried on by the firm, unless the partner has no authority to act for the firm in the particular matter, and the person whom being dealt with knows there is no authority, is binding on the firm (Cf. 1891, No 6, s.8; Partnership Act 1890, s.5 (U.K).)

"Where one partner pledges the credit of the firm for a purpose apparently not connected with the firm's ordinary course of business, the firm is not bound unless the partner is in fact specially authorised by the other partners; but this section does not affect any personal liability incurred by an individual partner." (CF. 1891, No. 6, s10; Partnership Act 1890, s.7 (U.K))

There is no protection of limited liability in a partnership that is available in a company structure. As a result, personal assets can be called upon to satisfy debts incurred by the partnership.

To minimise your risks, you should consider using an asset protection trust to hold your personal and investment assets and/or restructure your business. A trust structure is often effective set up in conjunction with another structure.

A company structure is recommended for any commercial activity involving a potential exposure to commercial liability. The advantages of a company structure include limited liability. In other words, if a company fails, the owners of the company potentially lose only the value of the shares that they had in the company. In practice however, this is often reduced by personal guarantees. Another obvious advantage in the company structure is lower tax rates for income in excess of $60,000 per annum.

In summary, the solution to minimizing the risks of insolvency in a partnership is to rethink your structure. Perhaps forming a company structure and holding personal and investment assets in a trust would be wiser.

Notes:

¹ Partnership Act 1908, 12. Every Partner in a firm is liable jointly with the other partners for all debts and obligations of the firm incurred while he is a partner; and after his death his estate is also severally liable in a due course of administration for such debts and obligations as far as they remain unsatisfied, but subject to the prior payment of his separate debts. Cf. 1891, No. 6, s. 12; Partnership Act 1890, S. 9 (U.K).

² Partnership Act 1908, 9. Partners bound by acts on behalf of firm - An act or instrument relating to the business of the firm, and done or executed in the firm name, or in any other manner showing an intention to bind the firm, by any person thereto authorised, whether a partner or not, is binding on the firm and all the partners. Cf. 1891, No 6, s.9; Partnership Act 1890, s.6 (U.K).