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If a General Partnership Fails, Who is Responsible for the Debts?

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Interested in starting a general business partnership but not sure what to expect?


Nobody thinks about debt at the onset of a new business partnership, or when business is booming and revenue is on the rise. But when business slows or one partner files for bankruptcy, it can leave a lot of unanswered questions about how to deal with the financial repercussions.

 

What to Expect When Entering Into a General Business Partnership

General business partnerships are incredibly easy to form. They do not require any of the formal paperwork associated with a corporation or a Limited Liability Company (LLC). For the same reason, they can be very difficult to manage or dissolve, which is why it is important to know what to expect when entering a financial contract with a friend.


When entering into a general partnership, there are certain responsibilities you must agree to

 

1. Duty of Loyalty + Fiduciary Duty

Loyalty and Fiduciary Duty simply means that each person must act in the best interest of the partnership. Neither partner can make decisions for their own advantage if those decisions harm the partnership.

 

2. Equal Profit Sharing

Unless there is a written agreement that says otherwise, each partner is expected to share profits equally.

 

3. Equal Control and No Salary

Unless a written agreement says otherwise, each partner agrees to divide management responsibilities equally and cannot be paid a salary.


These rules are intended to establish general guidelines for how to behave in a general business partnership. Unfortunately, none of them will help you if your business fails and your business partner defaults on their portion of the debt.

 

One partner cannot transfer ownership of the company to a third party.

Without a written agreement that states otherwise, one partner cannot transfer their stake in the company without prior consent from all remaining partners. Even if you aren’t meeting your financial goals, you cannot cut and run unless your partner is willing to take on your debt or agrees to sell.


Partners are bound to contracts signed by each other on behalf of the partnership.

Thanks to the loyalty and fiduciary rules outlined above, a single partner cannot make a deal to purchase inventory at an inflated price in exchange for a personal kick back. If they do, they can be sued and stripped of all profits associated with that deal. However, if there is no ulterior motive, any poor decisions made by one partner are still the responsibility of the other.


Unless one of the few rules associated with general business partnerships is violated, there is no way to lay blame on one partner or the other. This is a good reason to choose your partners wisely and keep an eye on your day to day operations.  

 

Any debt that is owed can be collected from a single partner.

If you invested 50% of the money to help get your business off the ground, you should only be responsible for 50% of the debt if the business fails, right? Wrong.

In a perfect world, creditors would be sympathetic to your position and let you off the hook for the remaining debt. Unfortunately, that’s not how it works. No matter who invested what, creditors can go after either partner’s personal assets, including bank accounts, cars, and homes.

The good news? If you end up getting stuck with the bill, you can always sue your partner for their share. However, if they were already unable to meet their financial obligations, there’s no guarantee you’ll get what’s owed to you.

 

If the partnership is terminated, everyone already involved is still responsible for the debt.

It is almost as easy to terminate a partnership as it is to create one, but that won’t do much to get you off the hook financially. Known as a “dissociate,” the partner who chooses to terminate his involvement and leave the business can do so at any time. However, they will still be liable for any outstanding debt that the business carried at the time the partnership was dissolved.


How to Protect Yourself Against Personal Liability When Entering Into a General Business Partnership

The best way to protect yourself when entering a general business partnership is with a written agreement. There are two types of agreements you should be aware of: Partnership Agreements and Buy Sell Agreements.

 

What is a Partnership Agreement?

The beauty of general partnerships is that there are very few rules. This is a blessing when business is booming but can get complicated when problems arise.


A Partnership Agreement overrides the general agreements that come with any business partnerships. This gives you greater flexibility to determine how profits, losses, and draws will be allocated, further defines the rights and responsibilities of each partner, how to resolve disputes, and more. This is also where you can set specific guidelines as to how the debt will be handled if the partnership is dissolved.


A Partnership Agreement will not protect you if your business partner declares bankruptcy or passes away, but it will give you more clout in the courtroom if they try to avoid paying their portion of the outstanding debt.


What is a Buy Sell Agreement?  


A Buy Sell Agreement, also known as a Buyout Agreement, is a contract between all the partners in a business that deals with the future ownership of the business and partnership change.


Similar to a Prenuptial Agreement, a Buy Sell Agreement determines when your partners can leave and how. This agreement establishes rules regarding who the partner can sell his interests to and what will occur in extraordinary cases like bankruptcy, retirement, divorce, and death.


Without a Buy Sell Agreement, creditors who are attempting to collect personal assets of a partner who has defaulted may liquidate the business to get what’s owed them. A Buy Sell Agreement protects that business from third-party debt incurred by any partner that is not directly associated with the business.


If a General Partnership Fails, Who is Responsible for the Debts?


So what’s the final answer? If a general partnership fails, everyone is responsible for the debts, including you. Partnership Agreements and Buy Sell Agreements go a long way in protecting you from unusual circumstances, but they do not absolve you of the entire debt associated with your business.


That’s why it is extremely important to weigh your options carefully, choose your partners wisely, and get legal advice regarding your financial situation before signing a contract and establishing a general partnership agreement that you will be liable for.


Planning to start a general partnership?

Already dealing with partnership debt and need advice on how to move forward?

Affordable Debt Solutions offers expert legal advice and provides you with the tools to consolidate your debt, reduce your interest rates, and reclaim your financial freedom.


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