Fact checked for accuracy by Billie Anne Grigg, a bookkeeper and Mastery Level Certified Profit First Professional.
Whether you’re starting a new business or already running one, it’s always a good idea to know all the legal requirements your business needs to comply with. Guidelines such as employment laws, legal protections, tax obligations, and financial regulations can help ensure your personal finances and legitimate interests aren’t affected if the business goes down or faces financial hurdles.
Specifically for general partnerships, legally binding agreements create a level ground where partners can participate voluntarily, enjoy equal rights, and share costs as agreed when surmounting the initial phase of the business.
This article will explain to you the fundamentals of legal protection concerning a general partnership. By the time you’re done reading, you shall have understood what legal protection means, types of legal protections and their benefits, and whether a general partnership offers legal protection.
What Is Legal Protection?
Even after registering your business, keeping it fully compliant with the law may not be an easy task. You’re going to deal with various legal agreements from hiring and dismissing an employee, signing contracts, drawing up, and so forth.
If something goes amiss, a third party may want to file a claim in the court of law and demand compensation. For example, think about an employee you’ve dismissed filing a lawsuit to request total compensation for allegedly wrongful dismissal or breach of contract.
Depending on the strength and nature of the claim, handling such a case can be extremely expensive, especially for small businesses with no litigation lawyers. And should the company lose against the complainant, the negotiated settlements may include steep compensations for economic, non-economic, and/or punitive damages.
Legal protection (also called business legal expenses insurance) is a form of insurance that covers the business against all legal expenses that may result when a third party or another company files a lawsuit against it. The cap of legal business insurance includes three main areas:
- Covering costs for legal advice on intellectual property and branding
- Covering costs of bringing a lawsuit against someone or another company
- Covering costs for legal advice and representation whenever someone sues the company
Types of Legal Protection
There are two types of business legal protection that you need to know. They include general liability insurance and business umbrella insurance.
Commercial General Liability Insurance
Commercial general liability is critical for any company. It is the basis for any protection against third-party claims against the organization. It protects the business against primary operational risks. Additionally, it is necessary to possess a general liability insurance policy before adding umbrella insurance on top.
Additional umbrella insurance can expand the coverage of a general liability policy. For example, it can include extra items that are not part of the general policy or extend the pre-set limits if a company exhausts them during the term. The term umbrella refers to how it will cover the existing insurance and broaden the protection for the organization against any current or future claims.
What Legal Protections Do General Partnerships Have?
A general partnership does not offer any form of legal protection. It does not require a legal charter from the state, nor does it offer legal separateness.
When both of you have agreed to work, you only need to draft terms of service and partnership agreement. These two guidelines will capture requirements such as business names, scopes of functions, capital contribution, and how to split costs.
You must also agree on how to divide assets in case of dissolution or change of ownership. Then, you can take the guidelines to the registrar of business or the office of state office for official registration and licensing.
You can form a general partnership with only a handshake. And once it takes effect, both of you are considered part of the business. In addition, you will enjoy unlimited personal liabilities for any costs and debts the business may accrue or incur while operating.
As a partner, the guidelines on unlimited liability are binding. You will be responsible for any mistake, even those done by your partner. That means you run the risk of double liabilities should anything wrong happen.
And since there is no regulation for separate entities, it’s technically impossible to attain legal protection as a partner. Should the business fail, you suffer as a team.
And if the business accrues debts, the court may seize your valuables (including assets such as car and home) as compensation to the claimant.
What Does That Mean for Your General Partnership Business?
As part of the initial agreement, you will split the costs of running a general partnership based on metrics such as the number of shares each partner owns. However, when the business dissolves, there isn’t any guarantee that you’ll split the costs regarding accrued debts and any other liabilities.
Take, for example, if your creditor files a claim in the court of law to request compensation for a debt agreement or any other agreements your partner or business failed to honor, the judge may order the business to offer an immediate settlement.
If the business coffers are dry, the court will proceed to individual partners and ask them to make legal redress. And if your partner is not financially able to cater to the cost, the court will narrow down to your assets and seize them.
It doesn’t matter whether you were part of the mistake that led to the accrued debt or financial distress. However, you must agree to comply and pay the debt fully—even 100% full.
The Last Word: How to Stay Protected if You’re a General Partnership
The only way to stay protected if you’re a general partnership is to have a written partnership agreement. This agreement will help you narrow down double liabilities should your partner make a mistake.
Alternatively, you can shield yourself from subsequent partnership debts by securing an insurance policy, especially for debts. Also, be sure to have a smooth exit strategy to reduce risks of further legal complications, especially if your partner intentionally breaches the guidelines on the written partnership agreement.
Read our column on how to form a general partnership if you’re interested in this structure. For more information on partnerships, head over to our main partnerships guide: what is a partnership?
Filed under: Advice Columns