Limited liability partnership

What Is Limited Liability Partnership?

A limited liability partnership (LLP) is a business structure that provides partners with limited personal liability for the debts and obligations of the partnership, particularly those arising from the professional negligence or misconduct of other partners. It is a type of business organization that combines elements of both traditional partnerships and corporations, belonging to the broader category of business structures. Unlike a general partnership, where each partner typically bears unlimited liability for all partnership debts, an LLP offers a shield that protects individual partners' personal assets from the liabilities incurred by the actions of other partners or the partnership itself. An LLP generally requires two or more partners.²³

History and Origin

The concept of the limited liability partnership emerged in the United States in the early 1990s, driven by a need for liability protection for professionals. This need became particularly evident in the aftermath of economic downturns, such as the collapse of real estate and energy prices in Texas in the 1980s, which led to a wave of bank and savings and loan failures. Attorneys and accountants who had advised these institutions faced significant liability claims, highlighting the risks inherent in traditional general partnerships. To address this, states began enacting statutes allowing for the formation of LLPs, providing a new form of business entity that limited personal exposure. By 1996, LLPs were incorporated into the Uniform Partnership Act, with many states adopting their own specific laws governing their formation and operation.²²

Key Takeaways

• A limited liability partnership (LLP) offers partners protection from the debts and liabilities arising from the negligence or misconduct of other partners.
• LLPs are typically treated as a pass-through entity for federal tax purposes, meaning profits and losses are reported on individual partners' tax returns.
• This structure is commonly favored by professional service firms, such as law firms, accounting firms, and architectural practices.
• Partners in an LLP retain the ability to manage the business directly, unlike shareholders in a corporation.
• The specific liability protections and operational requirements for an LLP can vary significantly by state.

Interpreting the Limited Liability Partnership

In a limited liability partnership, the primary interpretation revolves around the extent of each partner's liability. While partners are generally shielded from liabilities arising from the acts of co-partners, they remain personally responsible for their own professional malpractice or negligence. This distinction is crucial for professionals operating within an LLP structure. The partnership agreement of an LLP will detail the rights, responsibilities, and profit-sharing arrangements among partners. This agreement is vital for defining the internal governance and financial structure, and nearly all decisions, except fundamental changes to the agreement, can be allocated among partners.²¹ Understanding the nuances of liability protection offered by an LLP is essential for all partners involved, particularly concerning individual fiduciary duties.

Hypothetical Example

Consider "Apex Architects LLP," a firm with three partners: Alice, Bob, and Carol. They formed an LLP to design large commercial buildings. One day, Bob makes a significant error in the structural calculations for a new skyscraper, leading to design flaws and substantial financial damages for the client.

In this scenario:

1. Bob's Liability: Bob is personally liable for the damages resulting from his own professional negligence.
2. Alice's and Carol's Liability: Due to the limited liability partnership structure, Alice and Carol's personal assets are generally protected from the claims arising solely from Bob's mistake. Their liability for this specific error is limited to their capital contribution to Apex Architects LLP.
3. Partnership Liability: Apex Architects LLP, as a legal entity, is liable for the damages.
4. Operational Debts: If the LLP incurs general business debts, such as office rent or equipment loans, all partners typically share in the liability for these contractual obligations, though the specifics can depend on state law and the partnership agreement. This contrasts with a sole proprietorship where the individual owner bears all debt.

This example illustrates how the LLP structure can protect innocent partners from the specific professional failings of their co-partners, while still holding the responsible partner and the entity itself accountable.

Practical Applications

Limited liability partnerships are most commonly utilized by professional service firms where partners face significant exposure to malpractice claims. These include:

• Law Firms: Attorneys frequently organize as LLPs to protect partners from the professional negligence of their colleagues.
• Accounting Firms: Certified Public Accountants (CPAs) often form LLPs to manage the risk associated with audits and financial reporting.
• Medical Practices: Doctors and other healthcare professionals may use LLPs to limit liability among partners in group practices.
• Architectural and Engineering Firms: These firms often adopt the LLP structure to shield partners from design or construction errors made by others within the partnership.

From a regulatory standpoint, an LLP must file an information return (Form 1065, U.S. Return of Partnership Income) with the Internal Revenue Service (IRS), even though the partnership itself does not pay federal income tax. Instead, profits and losses are "passed through" to the individual partners, who then report their share on their personal tax returns.²⁰,¹⁹ This avoids the corporate taxes that a traditional corporation would incur. The choice of business structure significantly impacts tax obligations and personal liability, as detailed by the U.S. Small Business Administration (SBA).¹⁸

Limitations and Criticisms

Despite its advantages, the limited liability partnership structure has several limitations. The extent of liability protection can vary significantly by state. While LLPs generally protect partners from the malpractice of other partners, individual partners typically remain personally liable for their own wrongful acts or negligence.¹⁷ Some states may also limit the types of professions that can form an LLP, often restricting it to licensed professionals.¹⁶

Furthermore, the liability shield for partners may not extend to all partnership debts. In some jurisdictions, partners may still be held liable for certain contractual debts or other obligations incurred by the partnership as a whole. Courts may also "pierce the veil" of limited liability in cases where partners engage in fraudulent activities or attempt to undermine creditors through improper distributions.¹⁵ This means that the protection is not absolute, and specific circumstances can lead to partners being held personally responsible for partnership liabilities. The American Bar Association (ABA) highlights how the liability shield primarily negates status-based liability, but does not immunize an individual from direct liability for their own tortious conduct.¹⁴

Limited Liability Partnership vs. Limited Liability Company

While both a limited liability partnership (LLP) and a limited liability company (LLC) offer their owners limited liability protection, they differ in their structure, flexibility, and typical use cases.

The primary confusion often arises from the "limited liability" aspect. An LLP limits liability primarily concerning the actions of other partners, whereas an LLC provides a broader shield against most business debts and obligations for all its members. The tax classification flexibility of an LLC, allowing it to choose treatment as an S corporation or a C corporation, is a notable distinction from an LLP, which is consistently taxed as a partnership.³

FAQs

1. Who typically forms a limited liability partnership?

Limited liability partnerships are most commonly formed by groups of licensed professionals, such as lawyers, accountants, doctors, and architects. This structure helps protect partners from the negligence or malpractice of their fellow partners.

2. How is an LLP taxed?

For federal income tax purposes, an LLP is treated as a pass-through entity. This means the LLP itself does not pay income tax; instead, its profits and losses are passed through to the individual partners, who report their share on their personal tax returns. Partners are typically responsible for self-employment taxes on their share of the business income.²

3. What is the main difference between an LLP and a limited partnership?

A key difference is that in an LLP, all partners typically have some form of limited liability, even if they are involved in management. In contrast, a limited partnership (LP) has at least one general partner with unlimited liability for the partnership's debts and at least one limited partner whose liability is restricted to their capital contribution and who typically has limited involvement in management.¹

4. Can a single person form an LLP?

No, a limited liability partnership requires at least two partners. If a single individual wishes to have limited liability, they would typically form a sole proprietorship with limited liability (e.g., a single-member LLC in some states) or a corporation.

5. Do all states recognize LLPs?

No, state laws vary. While LLPs are recognized in many U.S. states, some states do not have specific LLP statutes or may restrict their use to certain professions. It is important to consult state-specific regulations when considering forming an LLP or understanding its entity classification in a particular jurisdiction.