By Andy Tiwari
If you haven’t been following Texas Supreme Court blogs (and who hasn’t), you probably missed the Court’s February 2015 opinion in American Star Energy and Materials Corp. v. Stowers et. al. But small and large businesses alike should take notice because this decision simultaneously strengthens the concept of an unfiled general partnership while extending how long an individual partner can be held liable for partnership debts.
Business owners often form limited liability companies or corporations for asset protection, and determining organizational structure is typically a threshold question for new ventures. In other instances, owners “go it alone” as a sole proprietor with or without an assumed name. Others enter into an oral or written agreement with one or more individuals as partners. If the partners don’t file for limited liability protection with the state, they effectively have a general partnership.
General partnerships are simply formed by agreement, thus requiring less administration, filings, and paperwork and – in some circumstances – allow somewhat simplified tax filings. General partnerships may also take the form of sophisticated “joint ventures” between larger companies bidding on a project or other undertaking requiring resources and expertise from two companies.
At times, though, general partnerships are created unwittingly. While there isn’t a strict test for when a partnership is formed, the Texas Business Organization Code establishes a guide for courts if there is a dispute. In general, a partnership will exist where two or more people share profits and losses in and control of a business.
The partnership’s assets are distinct from those of its partners because the partnership is treated as a separate entity by law. As such, a partnership can sue or be sued in its own name. But unlike limited liability companies or corporations, each partner is also individually liable for all of the debts and obligations of the partnership. This means that the partner with assets might be forced to pay 100% of a judgment against a partnership.
In American Star, the Supreme Court reinforced the concept of the partnership as a separate entity, in part by recognizing that a judgment against the partnership itself is necessary before attempting to collect from the partners individually. But before 2015, we could reasonably assume that litigation involving a partnership or its partners would need to be filed within the usual statute of limitations for lawsuits, typically no longer than 4 years from the date a claim arose. However in its groundbreaking decision, the Court effectively extended the statute of limitations against individual partners for partnership debt.
In the 1990s, American Star, an energy developer, sued a partnership comprised of four oil and gas partners for breach of contract for nearly $250,000. The case history is lengthy, but in short, after getting a final judgment against the partnership in 2009, American Star couldn’t collect on it because the partnership lacked assets to pay it (a common problem in litigation). In 2010, American Star then sued the partners individually for the partnership debt. The partners argued in court that they couldn’t be sued some 20 years after the litigation first began because the four-year statute of limitations for breach of contract cases meant the claim should have been brought in the 1990s too.
The Court disagreed, noting that the claim against the partners couldn’t “accrue” until a final judgment was obtained against the partnership itself (which didn’t occur until 2009). American Star was thus allowed to pursue its claim.
Most business lawyers traditionally advised clients against general partnerships because of the individual liability each partner faces. For individual partners with sufficient liability protection or shields, it might be appropriate to reconsider options if the general partnership structure is easier to manage.
But while limited liability companies or corporations in partnerships might be comforted by the Court’s confirmation that the partnership is an independent entity, individual partners should be fearful of the fact that litigation involving a partnership – and thus potential liability for partnership debts – can now extend well beyond what we might previously have thought was the cutoff. For small business owners in particular, the Court’s ruling should reaffirm interest in seeking more complete liability protection through a limited liability or a corporation.
The Court’s opinion is likely to result in other appeals and clarification. For now, though, general partners should be mindful that their liability will go on….and on.
If you need legal advice, schedule a meeting with Tiwari + Bell PLLC through our website or by calling (210) 417-4167.