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Limited Liability Partnerships & Limited Liability Limited Partnerships

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PREMIUM LEGAL RESOURCES LEGAL FORMS ASK A LAWYER

by J. William Callison, Esq.

Table of Contents

I. Overview
II. Formation and Operation of Limited Liability Partnerships
III. Liability Protection in Limited Liability Partnerships - Vicarious Liability
IV. Direct Partner Liability in Limited Liability Partnerships
V. Limited Liability Limited Partnerships
VI. Taxation of Limited Liability Partnerships and Limited Liability Limited Partnerships

I. OVERVIEW

The limited liability partnership ("LLP") is a form of general partnership, created under state general partnership laws, in which partners are statutorily relieved of all or part of their personal liability for partnership liabilities, debts and obligations. Although numerous states have enacted LLP statutes, the nature and extent of relief from personal liability and the types of business enterprises that can use the LLP form varies depending on the state of LLP formation.

LLPs are created by filing a registration statement in the manner specified by state statute. When electing the benefits of LLP status, it is not necessary to create a new partnership or to enter into a new partnership agreement. However, since LLP status likely will affect the partners' shares of partnership losses, as well as partners' rights of indemnification and contribution, partnerships which elect LLP status should review their partnership agreement and make changes necessary to appropriately allocate business risks among the partners. For federal income tax purposes a partnership which elects the protection of a state's LLP law is considered the same entity it was before the election. Tax issues concerning LLPs are discussed in Sec. 30A.6 below.

Limited liability partnership ("LLP") statutes have been enacted in numerous states and the District of Columbia.\1 As with limited liability companies,\2 LLP legislation likely will be enacted in most or all states, and third generation LLP statutes likely will expand the protection offered by LLPs in states which have limited LLP protections.

Texas enacted the first LLP statute in 1991. The Texas LLP Act provides liability relief to law and accounting firms which faced large potential liability arising from their professional services, which liability was heightened by bank and savings and loan failures. Because numerous larger firms are organized as general partnerships with individual partners, firm liability exposure created increased personal risk for partners, many of whom were otherwise uninvolved with the professional negligence causing the liability. The Texas LLP Act provides prospective protection\3 from unlimited personal exposure without requiring the significant changes in business structure that would be caused by conversion to a professional corporation or a limited liability company. The Texas LLP statute is limited in scope and does not relieve general partners from liability for the partnership's non-malpractice contractual and tort liabilities. Under the Texas statute partners are insulated from vicarious responsibility for the partnership's malpractice-type liabilities, to the extent not caused by their personal negligence or the negligence of persons under their direct supervision or control, provided that they neither had knowledge of another partner's negligence when it occurred nor failed to take appropriate action. The Texas LLP statute, which extended vicarious liability protection only to professional malpractice liabilities, has served as a model for many other LLP statutes.

LLP legislation was enacted in Louisiana in 1992; Delaware, North Carolina and Washington, D.C. in 1993, and numerous other states in 1994 and 1995. It is important to note that the state LLP statutes are not uniform and have important variations in, among other things, the types of businesses that may use LLPs, insurance or cash reserve requirements, the level of personal involvement that will cause a partner to bear personal liability for another person's negligence, and registration renewal requirements and the effect of a failure to timely renew LLP status. Notwithstanding these variations, the general theme of LLP legislation is uniform: LLPs provide partners with statutory protection from some or all partnership debts, obligations and liabilities.

Several states, including Colorado, Maryland, Minnesota, New York, Oregon and Pennsylvania have extended the liability protection afforded LLP partners to non-malpractice torts and contractual liabilities. While LLPs created under the early LLP statutes typically offer no insulation against non-malpractice liabilities, and more limited insulation against negligence co-partners' negligence than is available to nonprofessionals under other business structures, LLPs formed in states which have extended liability protection provide a corporate-type liability shield.

II. FORMATION AND OPERATION OF LIMITED LIABILITY PARTNERSHIPS

a. Filing Requirement. The various state limited liability partnership ("LLP") statutes require that a general partnership file a document in order to qualify as an LLP. This document is variously called a registration, application for registration or certificate of limited liability partnership, and its contents vary from state to state.

b. Filing Fees. LLP filing fees vary from state to state. Most states impose a flat annual registration fee but several, including Delaware, Illinois, Kansas, Pennsylvania and Texas, base the registration fee on the number of LLP partners.

c. Name Requirement. LLPs generally must use a name including the words "limited liability partnership" or "registered limited liability partnership" or the abbreviations "LLP" or "RLLP." The Ohio LLP statute uses the term "registered partnership having limited liability" to describe Ohio LLPs and mandates the use of the abbreviation "P.L.L."

d. Insurance Requirements. Several of the early LLP statutes, including those in Delaware, Georgia, Pennsylvania, Texas and Virginia,\4 mandated that an LLP have insurance or an escrow account to cover liabilities as to which partners do not bear personal liability. More recent statutes typically do not mandate insurance, but instead leave insurance issues to the statutes specifically governing professions and occupations.

e. Foreign Qualification. Most LLP statutes permit the registration and qualification of foreign LLPs, and provide that the laws of the formation jurisdiction determine the LLP's internal affairs and the partners' liabilities for LLP debts and obligations. Several LLP statutes, including those in Delaware, Illinois, Iowa, Louisiana, North Carolina, Ohio, Texas and Virginia, do not address foreign LLP qualification. In these states there is a question concerning the liability rules that apply to LLPs registered under the laws of another state. Therefore, it is possible without a statutory declaration to the contrary that the laws of the state in which LLP debts and obligations arise will govern the partners' rights and obligations, and LLPs which do business in states that do not provide for foreign qualification should ascertain the nature and extent of partner liability under the foreign state's LLP statute.

In addition, states which limit the use of LLPs to, for example, professionals frequently do not recognize limitations on liability afforded by other states to "limited liability partnerships" not comprised of professionals or that otherwise fail to meet eligibility standards. Instead, such LLPs may be treated as non-LLP general partnerships for liability purposes.

III. LIABILITY PROTECTION IN LIMITED LIABILITY PARTNERSHIPS - VICARIOUS LIABILITY

a. "First Generation" LLP Statutes. The original limited liability partnership statutes protected partners from malpractice claims resulting from a partner's negligence or malfeasance. These statutes provided protection against professional malpractice while leaving LLP partners jointly, or jointly and severally, liable for other partnership liabilities, debts and obligations. In addition, under the early LLP statutes partners continue to have a contribution obligation if a partner has an indemnification right against the partnership.\5

While the early LLP statutes provide liability protection against malpractice claims pled as torts, it is uncertain whether they provide broader protection to cover malpractice-type claims pled under theories other than tort (e.g., breach of contract or breach of fiduciary duty).\6 To the extent that liability is asserted on a contractual basis for conduct which could also be claimed to have been improper on a negligence theory (e.g., through the assertion of a breach of an implied warranty in a contract), it is reasonable to argue that all liability arising from such conduct is protected through LLP status. If the policy underlying LLP legislation is to protect partners in connection with certain types of conduct, conduct for which protection is afforded in one area (tort claims), should be afforded parallel protection in another area (contract claims based upon implied warranties). This conclusion is based on the use of the word "negligence" in LLP legislation, and on the argument that protection in an implied warranty contractual setting has been furnished through the use of the term "wrongful acts" in most LLP legislation.

b. "Second Generation" LLP Statutes. Subsequent LLP statutes attempt to resolve the issues of whether malpractice-type claims are based in tort or in contract and whether partners are liable on a negligent partner's indemnification claim. The statutes generally state that LLP partners do not bear personal liability for any partnership obligations or liabilities arising from the malpractice of a co-partner or other person not under the partner's supervision and control.

Several unresolved issues remain under the second generation LLP statutes. First, because general partners traditionally have joint and several liability for partnership obligations, the Uniform Partnership Act (UPA) does not contain any provisions concerning distributions made when the partnership is insolvent or which render the partnership insolvent.\7 It is uncertain in the LLP context whether partner distributions made after partnership liability arises will be subject to a recontribution obligation. Further, if the courts impose a recontribution obligation, the boundaries of that obligation are uncertain. The Minnesota LLP statute addresses this issue and states that a partner is liable for two years with respect to distributions that would have been improper had the LLP been a corporation.\8 The Colorado LLP statute states generally that LLP partners may not receive distributions to the extent that the LLP is insolvent and provides that LLP partners who receive wrongful distributions are liable for a six- year period.\9

Second, the effect of LLP statutes on other partnership liability sharing arrangements under the UPA and by agreement should be considered. Traditionally, partners in general partnerships share the risk of loss from malpractice liabilities. In many partnerships, a negligent partner would not be required to indemnify or reimburse the partnership for partnership losses resulting from the partner's negligence. Further, partners generally are entitled to be indemnified by the partnership for personal liabilities incurred due to the partner's negligence in the scope of the partnership business, and indemnified partners have a contribution right against the other partners. In states that have addressed the indemnification-contribution question, the LLP statutes change the result and leave the negligent partner to bear the personal cost of his or her malpractice without any right of contribution. To the extent that an indemnification right remains under UPA Sec. 18(b), a partner entitled to indemnification can recover only if the partnership has sufficient assets.

If partners in an LLP seek to retain a full or contractually limited contribution right, the partnership agreement must provide that right.\10 Inclusion of a contribution right in the partnership agreement raises other issues. First, there is a question concerning whether it is possible to create a contribution obligation that is enforceable by the negligent partner but not by his or her creditors. If the partner is in bankruptcy, the trustee probably can enforce the contribution obligation. Otherwise, the answer is uncertain but the better conclusion is that creditors cannot enforce the contribution obligation unless they have third-party beneficiary status. Second, there is an issue as to whether the partners' contribution obligation should be limited in order to protect non-negligent partners from significant and potentially ruined judgments while making negligent partners whole with respect to less significant judgments. Third, recognizing that formal contribution agreements will increase a creditor's dispute settlement leverage, there is a question whether it is preferable to rely on less formal assurances that partners will provide for one another, and whether there are noncontractual means to establish a climate where partners can rely on such assurances. Finally, if partners use formal or informal contribution arrangements, there is a question concerning the circumstances under which contribution should be available. A common approach is that partners should contribute toward ordinary negligence judgments, but not toward judgments which involve a co-partner's gross negligence, willful misconduct, fraud, harassment, acts involving moral turpitude, misappropriation of assets, breach of fiduciary duty and other extreme acts. Finally, a lack of contribution rights or limited contribution rights should cause professional firms to reexamine the extent of their malpractice insurance.

Third, in the event there are insufficient partnership assets to pay all partnership obligations, there is an issue as to whether non-negligent partners may cause the partnership to use its assets to pay liabilities for which the non-negligent parties are jointly and severally liable (e.g., lease payments). If partnership assets are used to pay such liabilities, a negligent partner will more likely need to use his or her separate assets to pay the liability. Such conduct likely would raise substantial questions concerning the non-negligent partners' breach of their fiduciary duties of loyalty, good faith and fair dealing.

c. "Third Generation" LLP Statutes. Some of the most recent LLP statutes, including those enacted in Colorado, Maryland, Minnesota, New York, Oregon and Pennsylvania, avoid many problems remaining under the first and second generation LLP statutes by providing LLP partners with full protection from vicarious liability. The Colorado, Maryland, Minnesota, Oregon and Pennsylvania LLP statutes limit liability for all claims and are not limited to professionals. The New York LLP statute provides full protection but limits LLPs to professional firms.\11

d. Effect of Vicarious Liability Protection on Firm Culture. A final issue concerns the effect of LLP status on firm culture and professional representation. An initial question is whether LLP status is fair for partners in practice areas which pose the highest risk of large malpractice judgments, (and which are typically the most lucrative for the partnership), such partners likely will "bear the liability risk alone, rather than share the risk with partners in less risky practice areas in which malpractice judgments are unlikely or are within the partnership's insurance limits and asset base. A related question is whether, and to what extent, partners who bear disproportionate loss risk should be compensated for that risk. A third question concerns the meaning of "direct supervision and control," and the effect of supervisory responsibility on non-negligent partners, including whether service on committees (e.g., management, opinion, recruiting, training, associate committees) creates a risk of liability; whether business generators, who have apparent supervisory responsibilities on many matters but who may not participate in the underlying work, have inordinate risk; and whether partners will be willing to supervise and train associates. A fourth question is whether LLP partners will be less willing to assist their co-partners on matters not within their complete control. A fifth question is whether LLP partners will take a less active role in policing their co-partners' performance, since knowledge of nonperformance creates liability risk. All these questions pose the final question of whether changes in personal liability will affect the sense of common interest and cooperation that is a desirable part of firm culture and whether LLP partners will become isolated and independent economic units. All of these questions should be examined in light of the goals of the professional partnership: client representation and service.

IV. DIRECT PARTNER LIABILITY IN LIMITED LIABILITY PARTNERSHIPS

All limited liability partnership ("LLP") statutes provide that LLP partners will be personally liable for their own negligence or malfeasance. In addition, most LLP statutes provide that LLP partners are liable for the negligence, wrongful acts and misconduct of any person under the LLP partner's "direct supervision and control," although the statutory terminology differs in this regard.\12 The various state LLP statutes do not define what is meant by "direct supervision and control," and this question is left to judicial interpretation. For supervisory liability to be imposed upon a LLP partner, both "supervision and control" must exist, and the mandated supervision and control must be "direct." It is probable that the LLP statutes contemplate immediate, close supervision and control by a LLP partner, rather than a casual level of supervision or control is contemplated. The direct supervision and control standard should require an intimate involvement in supervision and control in connection with actual work with respect to a matter, rather than mere responsibility for a matter or client. Thus, for example, a LLP partner in an accounting firm who is working on a day-to-day basis in supervising and directing the activities of an employee would appear to have liability exposure. On the other hand, the chair of a department in a law firm, the members of the governing body of law firm or the managing partner of a law firm, who have established general policy for their firms but who are not personally involved in a client representation would appear not to have liability exposure. Similarly, two LLP partners working on a matter independently of each other, neither of whom is viewed as supervising and controlling the other, should be able to argue that since they acted independently of each other, they should not be exposed to liability for the other's conduct.\13 However, the lack of authority on this issue creates risk, which likely will affect the actions of LLP partners.

V. LIMITED LIABILITY LIMITED PARTNERSHIPS

A limited liability limited partnership ("LLLP") is a limited partnership, formed under the applicable state limited partnership statute, which specially registers and thereby provides liability protection to the general partners. Texas,\14 Colorado, and Delaware\15 expressly recognize limited liability limited partnerships.

VI. TAXATION OF LIMITED LIABILITY PARTNERSHIPS AND LIMITED LIABILITY LIMITED PARTNERSHIPS

a. Tax Classification as Partnership. Limited liability partnerships ("LLPs") should be based as partnerships for federal income tax purposes since they will lack the corporate characteristics of continuity of life, free transferability of interests and centralized management.\16

No rulings have been issued concerning the tax classification of limited liability limited partnerships ("LLLPs"), and the tax classification of LLLPs will rely on the presence or absence of the free transferability characteristic. Generally, LLLPs will possess the corporate characteristics of limited liability and centralized management (unless the general partners own more than 20% of the interests), and will lack the continuity of life characteristic.

b. Taxation on Conversion to Limited Liability Partnership. The Internal Revenue Service has ruled that registration of a general partnership as a LLP does not cause termination of the partnership.\17

c. Method of Accounting. A LLP should be entitled to use the cash method of accounting if the LLP partners actively participate in the partnership business.

d. Self-Employment Income. A LLP partner should be treated as a general partner for self-employment tax purposes and, therefore, generally will have self-employment earnings, or his or her distributive share of LLP income\18

FOOTNOTES

Note 1: LLPs exist by virtue of amendment to a jurisdiction's general partnership statute. States which have enacted LLP legislation include Arizona (Sen Bill 1341, 41st Legis - 1994 Reg Sess (approved April 19, 1994)); Colorado (H.R. 1061 (enacted May 24, 1995)); Connecticut (Sen Bill 360, 1994 Reg Sess (approved June 7, 1994)); Delaware (6 Del Code Ann Sec. 1544); District of Columbia (DC Code Sec. 41-143 through 148 (approved July 29, 1993)); Florida (Sen Bill 2296 1995 Reg Sess (became law without governor's signature on June 9, 1995)); Georgia; Idaho (House Bill 192 53rd Legis - 1st Reg Sess (approved March 13, 1995)); Illinois (Sen Bill 2489 88th Gen Assem - 1993-94 Reg Sess (approved August 11, 1994)); Indiana (Sen Bill 475 109th Reg Sess (approved May 1, 1995)); Iowa (House File 2280 75th Gen Assem - 1994 Reg Sess (approved April 8, 1994)); Kansas (Sen Bill 582 75th Legis - 2d Reg Sess (approved April 7, 1994)); Kentucky (House Bill 717, 1994 Reg Sess (approved April 11, 1994)); Louisiana (La Rev Stat Sec. 9:3431); Maryland (Sen Bill 513 408th Legis Sess - 1994 Reg Sess (approved May 26, 1994)); Michigan (House Bill 5933 87th Legis - 1994 Reg Sess (approved October 11, 1994) amending Mich Comp Laws Ann Sec. 449.1 through 449.48 (1994)); Minnesota (House File 1985, 78th Legis Sess - 1993-94 Reg Sess (approved April 29, 1994)); Mississippi (House Bill 1032 1995 Reg Sess (approved March 14, 1995)); Missouri (House Bill 558 88th Gen Assem (approved July 5, 1995)); Montana (Sen Bill 340 54th Legis Sess (approved April 14, 1995)); New Jersey (Assem Bill 1860 206th Legis - 2d Ann Sess (approved May 1, 1995)); New Mexico (House Bill 632, 42d Leg - 1st Reg Sess (approved March 30, 1995)); New York (Sen Bill 7511, 215th Gen Assem - 2d Reg Sess (approved July 26, 1994)); North Carolina (NC Gen Stats Sec. 59-84.2 (approved July 15, 1993)); North Dakota (Sen Bill 2343 54th Legis Assem (approved April 11, 1995)); Ohio (permitting "registered partnerships having limited liability") Sen Bill 74 120th Gen Assem - 1993-94 Reg Sess (approved April 1, 1994)); Oklahoma (House Bill 1357 45th Legis - 1st Reg Sess (approved June 9, 1995)); Oregon (Sen Bill 484 68th Legis Assem (sent to Governor on June 14, 1995)); Pennsylvania (Sen Bill 1059 (approved December 7, 1994)); South Carolina (Sen Bill 996, 1993-94, Statewide Sess (approved June 16, 1994)); South Dakota (House Bill 1252 70th Legis Assem - 1995 Reg Sess (approved March 3, 1995)); Tennessee (Sen Bill 193 99th Gen Assem - 1st Reg Sess (approved June 6, 1995)); Texas (Tex Rev Civ Stat Ann Title 32 Art 6132b Sec. 3.08(a) (VERNON 1993)); Utah (House Bill No 5 50th Leg, 1994 Gen Sess, amending Utah Code Ann Sec. 48-1-1 et seq (approved March 16, 1994)); Virginia (Va Code Ann Sec. 50-32.1 (1994) (approved April 5, 1994)); and Washington (Sen Bill 5374 1995 Reg Sess 55th Legis (approved May 11, 1995)). Back to text.

Note 2: J.W. Callison and M.A. Sullivan, Limited Liability Companies: A State-by-State Guide to Law and Practice (1994).

Note 3: LLP status will not provide protection against partnership debts, obligations and liabilities which predate the LLP filing.

Note 4: See 6 Del. Code Ann. Sec. 1546 ($1,000,000); Ga. Code Sec. 14- 8-44 ($1,000,000); 15 Pa. Consol. Stat. Sec. 8206 ($100,000 per partner, but not exceeding $1,000,000); Tex. Rev. Stat. Art. 6132b, Sec. 45c ($100,000); Va. Code Ann. Sec. 50-4-3.2 ($500,000).

Note 5: Uniform Partnership Act (UPA) Sec. 18(b) states that a partnership must indemnify partners for payments made and personal liabilities incurred in the ordinary and proper conduct of the partnership's business. The partnership indemnification obligation is contractual in nature, and LLP status would not protect co-partners from joint and several liability.

Note 6: See FDIC v. Clark, 978 F.2d 1541 (10th Cir 1992) (indicating that even if a professional malpractice claim is pled as a breach of contract, it still is based in tort); Collins v. Reynard, 607 N.E.2d 1185 (Ill. 1992) (legal malpractice action can be maintained in tort or in contract).

Note 7: Compare Revised Uniform Limited Partnership Act (RULPA) Sec. 608(b) (limited partner who receives return of contribution in violation of RULPA is liable to return the contribution).

Note 8: Minn Stat Sec. 323.14(5).

Note 9: C.R.S. Secs. 7-60-146, -147.

Note 10: Existing partnerships which elect to be LLPs, should consider amending their partnership agreements.

Note 11: N.Y. Partnership Law Sec. 26(b).

Note 12: The concept of supervisory responsibility is consistent with the holding in FDIC v. Nathan, 804 F. Supp. 888 (S.D. Tex. 1992), in which the court refused to dismiss a claim that a law partner was directly liable for malpractice when he failed to supervise attorneys and to deter negligent and unethical conduct by his partners.

Note 13: For a discussion of partner liability for "failure to monitor" co-partners, see Fortney, Am I My Partner's Keeper? Peer Review in Law Firms, 66 Univ Colo L Rev 329 (1995) (raising questions concerning LLP and limited liability company protection of partners and members from liability for failure to monitor the activities of their co-partners).

Note 14: Tex. Rev. Civ. Stat. Art. 6132a-1, Sec. 2.14(a).

Note 15: 6 Del. Code Ann. Sec. 17-214.

Note 16: In Priv. Ltr. Ruls. 9229016 (April 26, 1992) and 9325043 (March 29, 1993), the Internal Revenue Service ruled that LLPs would be taxed as partnerships. See Rev. Rule. 95-55.

Note 17: See Priv. Ltr. Ruls 9229016 (April 16, 1992), 94200
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