Choice Of Business Entity - Registered Limited Liability Partnership

A. General. An LLP is a general partnership in which the individual liability of partners for partnership obligations is substantially limited. This new species of general partnership represents a dramatic innovation and was first authorized by provisions (the "LLP Provisions") added to the Texas Uniform Partnership Act ("TUPA") by Sections 83-85 of House Bill 278. The LLP Provisions were refined and carried forward as § 3.08 of the Texas Revised Partnership Act ("TRPA") passed in 1993, and then were substantially expanded by SB 555 effective September 1, 1997.

B. Background. The LLP Provisions of TUPA originated in a separate bill, S.B. 302 (by Sen. John Montford). That bill was conceived as an alternate means for allowing professionals of the LLP Provisions to be applicable to all partnerships, and to the addition of the requirements of LLP registration, use of the limitation of liability already available to them under the Texas Professional Corporation Act. Although that statute allows professionals to limit their liability, the federal income tax consequences of joining and separating from professional corporations often made this avenue unavailable as a practical matter. The solution embodied in S.B. 302 was to amend TUPA to allow professionals to achieve through a new kind of partnership the same liability limitation already available in corporate form. Thus, the proposed amendments to TUPA that were contained in S.B. 302 applied only to certain kinds of professional partners: physicians, surgeons, other doctors of medicine, architects, attorneys at law, certified public accountants, dentists, public accountants and veterinarians. S.B. 302 passed the Senate but encountered criticism in hearings before the House Business and Commerce Committee on grounds, among others, that the Bill was discriminatory against non-professional partnerships, that the Bill did not tell persons dealing with a partnership whether the partnership had the liability shield, and that the Bill did not require any substitute source of recovery for a person injured by partnership misconduct. These criticisms led to the enlargement LLP status words or initials in the partnership name and maintenance by LLP's of liability insurance. In this form, the LLP Provisions were added to H. B. 278 in the Senate, and the House concurred in H.B. 278 as so amended. With the adoption of TRPA in H.B. 273, the LLP Provisions of TUPA were refined and carried over into TRPA.

The LLP Provisions originated as part of a liability limiting trend that has included (i) the LLC Act, (ii) amendments to the Texas Professional Corporation Act in 1989 and in H.B. 278, (iii) the passage of TRPA in H.B. 273, maintaining the LLP entity created by H.B. 278, (iv) the 1989 and 1993 amendments to TBCA art. 2.21 to clarify non-liability of shareholders for corporate contractual obligations, (v) the passage of TRLPA in 1987, which allowed limited partners to engage in widely expanded activities without sacrificing their limited liability, and (vi) the 1987 enactment and subsequent amendment of art. 1302-7.06 authorizing the limitation of liability of directors. These legislative changes were made during a period of increasing litigation against individuals for actions that they allegedly took, or failed to take, while serving as directors, officers or partners of a firm that failed or provided services to a firm that failed. This litigation often involved amounts that dwarfed the net worth of the individuals involved.

The LLP has spread beyond its Texas roots and now every state but Vermont and Wyoming has adopted an LLP statute. As the adoption of LLP statutes became more widespread, the LLP statutes of an increasing number of states protected partners from liabilities arising other than from the negligence, malpractice, wrongful acts or misconduct of other partners and employees. The "full shield" LLP statutes of a number of states (including Colorado, Georgia, Idaho, Indiana, Maryland, Minnesota and New York) insulate a partner from personal liability for any debts, obligations or liabilities of, or chargeable to, the partnership, if such liability would exist solely by reason of their being partners, rendering professional services, or participating in the conduct of the business of the LLP, but do not protect a partner from liability arising from the partner's own negligence, wrongful acts or misconduct, or from that of any person acting under his direct supervision and control. Sections 113 and 125(e) of SB 555 are intended to make Texas a "full shield" state, and have the effect of limiting the liability of an LLP partner for contractual obligations incurred after September 1, 1997, the effective date of SB 555, without impairing partners’ obligations under contracts existing prior to that date.

C. Liability Shielded. Partners in a general partnership that is not an LLP are individually liable, jointly and severally, for all partnership obligations, including partnership liabilities arising from the misconduct of other partners, although under TRPA § 3.05(d) a creditor generally must first seek to satisfy the obligations out of partnership property. Although an LLP is a general partnership, the general partnership joint and several liability scheme is dramatically altered by the LLP Provisions when LLP status is attained.

1. TRPA § 3.08. The essence of the LLP Provisions, as amended by SB 555, is to relieve a partner from individual liability for partnership obligations, except to the extent that they are attributable to the fault of the partner, and is set forth in TRPA § 3.08(a), with changes effected by SB 555 marked, as follows:

2. Limits to LLP Shield. The LLP Provisions, as amended by SB 555, expressly do not relieve a partner for any liability imposed by law or contract independently of his status as a partner, including torts committed by him while acting on behalf of the partnership. In addition, there are three situations under TRPA, as amended by SB 555, in which the LLP Provisions do not shield a partner from liability for a partnership obligation arising from the specified misconduct of a copartner or representative of the partnership:

All three situations involve fact questions as well as legal interpretations of the statutory language.

In situation (1), the supervision should be direct, or the direction should be specific, for the exception to apply. The language in situation (1) was not intended to deny the liability shield to someone (such as a managing or senior partner) who exercises indirect supervision over all partnership activity or over a particular segment of the partnership's business or who generally directs other partners by establishing policies and procedures or by assigning responsibilities.

In situation (2), the direct involvement should relate to the particular aspect of the endeavor in which the misconduct occurred. The language in situation (2) was not intended to deny the liability shield to someone who was directly involved in one facet of a multifaceted matter (e.g., one involving several different areas of expertise) but did not participate in that facet of the matter that gave rise to the liability.

Neither exception (1) nor (2) should denude someone who had direct supervisory responsibility for, and therefore was directly involved in, a particular project but was not directly supervising the person who engaged in misconduct or directly involved in the aspect of the project in which the misconduct occurred. For example, an environmental lawyer who negligently rendered legal advice with respect to the environmental law aspects of a real property acquisition would not ordinarily be viewed as "working under the supervision or direction" of a real estate lawyer having overall responsibility for the acquisition (which means that exception (1) would not be applicable), and the real estate lawyer would not ordinarily be viewed as "involved in the specific activity" (i.e., advising with respect to environmental law) in which the misconduct occurred (which means that exception (2) would not apply).

3. Burden of Proof. The liability shield of the LLP Provisions is an affirmative defense, with the burden of proof on the partner claiming its benefit to show that the partnership is an LLP (i.e. that it complied at the relevant time(s) with the registration, name and insurance requirements). The plaintiff would then have the burden of proving that one or more of the three exceptions applies to remove the liability shield from particular partners.

4. LLP Status Does Not Affect Liability of Partnership. LLP status does not relieve a partnership itself from liability for misconduct of its partners or representatives or prevent its assets from being reached to satisfy partnership obligations. A partnership may still be sued as an entity in its common name under Tex. R. Civ. P. 28, with or without the partners. Citation or other process against a partnership may still be served on a partner under Tex. Civ. Prac. & Rem. Code § 17.022, regardless of whether the partner is shielded from liability by the partnership's LLP status.

5. Shielded vs. Unshielded Obligations. The LLP shield only applies to the liability of partners for the covered partnership obligations incurred while the partnership is an LLP. The partners remain jointly and severally liable for all other partnership obligations. A partnership at any time may have both shielded and unshielded obligations.

The LLP Provisions do not deal with the right of a partnership to pay unshielded obligations before paying shielded obligations or whether partner contributions may be earmarked to cover particular unshielded obligations. These matters are left to fiduciary principles and laws pertaining to creditors rights.

6. Contractual Obligations Incurred Prior to September 1, 1997. The amendment to TRPA § 3.08 making Texas a full shield state does not apply to contractual obligations incurred prior to the September 1, 1997 effective date of SB 555 by virtue of SB 555 § 125(d), which provides as follows:

Thus, the partners of an LLP which was subject to a long term lease entered into prior to September 1, 1997 will remain personally liable for those lease obligations notwithstanding the amendment of TRPA § 3.08, although the same obligation incurred thereafter would be shielded unless the partners had agreed to be liable therefor.

7. Other State LLP Statutes. In the other states that have LLP statutes, the scope of liability from which an innocent partner in an LLP is protected varies from state to state. Some LLP statutes only protect partners from vicarious liability for tort-type liabilities ("partial shield"), while others provide a "full shield" of protection from both tort and contract liabilities of the partnership, perhaps in recognition that some malpractice claims could be pled in contract as well as in tort. Under most LLP statutes, including that of Delaware, a partner is liable not only for his own negligence, malpractice, wrongful act or misconduct, but also for that of someone under his direct supervision and control. The Maryland LLP statute preserves liability for a partner who is negligent in appointing, supervising or cooperating with the partner, employee or agent who was negligent or committed the wrongful act or omission. At least two states, Kentucky and Utah, have adopted LLP statutes providing that a partner is personally liable only for his own negligence, malpractice, wrongful acts and misconduct.

D. Requirements for LLP Status. Each of the three requirements described below must be satisfied in order for the LLP shield to be in place. Creditors seeking to break the shield can be expected to require proof of satisfaction of each of the conditions and to challenge any noncompliance.

1. Name. The LLP Provisions require that an LLP must include in its name the words "registered limited liability partnership" or the abbreviation "L.L.P." as the last words or letters of its name. Neither "R.L.L.P" nor "L.P." is acceptable.

2. Filing with the Secretary of State of Texas. To achieve domestic LLP status, a partnership must file with the Secretary of State of Texas an application accompanied by a fee for each partner of $200. The application must (a) state the name of the partnership, the address of its principal office, the number of partners and the business in which the partnership engages, plus the federal tax identification number of the partnership, and (b) be executed by a majority in interest of the partners or by one or more partners authorized by a majority in interest of the partners. The LLP Provisions do not require than an LLP filing with the Secretary of State have any express authorization in the partnership agreement, but changing the name to include the required words or abbreviation required by TRPA § 3.08(c) would ordinarily require that the partnership agreement contemplate LLP status.

If the required information is supplied in the application and the fee is paid, the LLP registration becomes effective on filing. There is no requirement for the Secretary of State to issue a certificate. As evidence of the filing, the Secretary of State will return a file-stamped duplicate of the application. The LLP Provisions now permit electronic filings of LLP documents as soon as the Secretary of State’s procedures will permit.

Registration remains effective for a year, regardless of changes in the partnership, unless the registration is earlier withdrawn or revoked or unless renewed. Because the registration is a notice filing and no listing of partners is required in the application, partnership changes due to withdrawals or to admissions of new partners do not require any refiling with the Secretary of State until the next renewal filing. Caution suggests an amendment to the application if the partnership changes its name. Registration expires after one year unless earlier withdrawn, revoked or renewed, and registration can be renewed. LLP's should arrange their own reminders, since the Secretary of State is not obliged to send renewal notices.

3. Insurance or Financial Responsibility. The third requirement for LLP status under TRPA is that the partnership must:

The insurance requirement (and the option under TRPA to provide $100,000 of funds instead) is intended to provide some source of recovery as a substitute for the assets of partners who are shielded from liability by the LLP Provisions. The $100,000 figure is arbitrary and may or may not be greater than the partners' individual assets otherwise available to partnership creditors. The $100,000 figure refers to the liability limit of the insurance, above any deductibles, retentions or similar arrangements; thus, deductibles, retentions and the like are permitted so long as the coverage would allow aggregate proceeds of at least $100,000.

The statute is not explicit about the effect on one claim of exhaustion of the policy limits by a prior claim. The intent is clear that exhaustion by one claim does not remove the liability shield for the same claim. If an LLP had the requisite insurance in place at the time the error or omission occurred, the insurance requirement should be satisfied even though subsequent events made the coverage unavailable to the aggrieved party. For example, if there were a number of lawsuits pending against an LLP at the time an error or omission occurred and judgments subsequently entered depleted the insurance available for the aggrieved party, the subsequent events should not retroactively deny the LLP shield to the partnership. Renewal or replacement of policies on their periodic expirations is probably enough to satisfy the insurance requirement of TRPA § 3.08(d).

The insurance must be "designed to cover the kinds of" acts for which partner liability is shielded by TRPA § 3.08(a)(1). The quoted phrase contains some flexibility; actual coverage of the misconduct that occurs is not an absolute necessity. The partner claiming the shield from liability, however, has the burden of proof that the insurance satisfied this statutory requirement.

Insurance coverage for particular conduct is not always available. TRPA § 3.08(d) allows an LLP the option of providing $100,000 in funds in lieu of obtaining insurance, but requires one or the other. The burden of proving that insurance is not reasonably available under TUPA is on the partner claiming the liability shield of TUPA § 15(2).

The LLP Provisions provide that the LLP insurance requirements "shall not be admissible nor in any way made known to the jury in determining the issue(s) of liability for or extent of the debt or obligation or damages in question." These LLP Provisions are intended to keep the existence of insurance from influencing a jury decision on liability or damages. TRPA § 3.08(d)(3) specifically states that if compliance with the insurance or fund provisions of § 3.08(d)(1) is disputed, "compliance must be determined separately from the trial or proceeding" to determine liability or damages.

1. Federal Tax Classification. If a domestic LLP has two or more members, then it can be classified as a partnership for federal income tax purposes under the Check-the-Box Regulations.

2. Texas Franchise Tax. As a species of general partnership, an LLP is not subject to the Texas franchise tax.

3. Self-Employment Tax. Partners in an LLP generally will be subject to self-employment tax on their share of the trade or business income of the LLP.

1. Advertisement of LLP Status. Although not required by the LLP Provisions, an LLP should include the LLP words or initials wherever the partnership's name is used, e.g., on directory listings, signs, letterheads, business cards and other documents that typically contain the name of the partnership. Although the LLP designation is part of the partnership's name and should be used as such, it is common and should be permissible for some partnership communications to be shorthanded and omit the designation. A rule of reason should apply in deciding how far a partnership should go in using the LLP designation. Thus, a partnership should in answering the telephone be able to use a shortened version of its name that does not refer to its LLP status and, when an existing partnership elects to become an LLP, it should have a reasonable period of time in which to implement the use of the LLP status words or symbols in printed matter and should be able to use up existing supplies of letterhead, etc.

There is no requirement, beyond the name change, that a partnership that becomes an LLP notify its customers, clients or patients of the partnership's new status. Further, there is no requirement that a partnership publish notice of its becoming an LLP comparable to the notice required of certain incorporations.

2. Assumed Name Certificate. Since an LLP is a species of general partnership, prior to H.B. 1239 which became effective September 1, 1993, an LLP was required to make filings under the Texas Assumed Business or Professional Name Act (the "Assumed Name Statute") like any other general partnership. H.B. 1239 §§ 1.29-1.31 amended the Assumed Name Statute so that LLP's, LLC's and limited partnerships are not deemed to be conducting business under an "assumed name," and do not have to make filings, under the Assumed Name Statute if they conduct business in the same name as shown in their documents on file in the office of the Secretary of State, although a general partnership which is not an LLP would have to file under the Assumed Name Statute if it conducted business under a name that does not include the surname or legal name of each general partner. If an LLP, LLC or limited partnership regularly conducts business under any other name (an "assumed name"), it would be required to file in the office of the county clerk of each county in which it maintains a business or professional premises a certificate setting forth the assumed name of the firm and the name and residence address of each general partner. Failure to comply with the filing requirements of the Assumed Name Statute should not affect the partnership's LLP status but would subject the partnership to the penalties specified in the Assumed Name Statute. Although under the Assumed Name Statute it would be possible for an LLP to adopt an assumed name that did not include the LLP designation, failure to include the designation is inadvisable since it would frustrate the LLP Act requirement that the designation be in the firm name.

3. Time of Compliance. The LLP Provisions as originally enacted were not explicit regarding the time at which a partnership must be in compliance with their requirements in order to raise the liability shield with respect to a particular obligation, but probably required that the partnership have been in compliance with these requirements at the time of the misconduct giving rise to the obligation. This conclusion is based on TUPA § 17, which provides that an incoming partner is liable only out of partnership property for obligations of the partnership arising before his admission. The limited liability available to equity holders under corporation and limited partnership law also turn on when the obligation arises. The liabilities of a general partnership that incorporates or becomes a limited partnership remain the individual liabilities of the former general partners notwithstanding the assumption of those liabilities by the new entity. Likewise, dissolution of a corporation or limited partnership does not result in the liability of its shareholders or limited partners for the entity's obligations. Thus, for example, if an LLP were to dissolve, its partners should not lose the liability shield in an action brought during winding up for misconduct that occurred before dissolution.

Any temporal uncertainty originally existent under TUPA was removed by TRPA § 3.08(a)(1) which provides that the shielded partners are not liable for misconduct incurred "while the partnership is a registered limited liability partnership." This result is buttressed by the Bar Committee Bill Analysis of H.B. 273 which at 14 states that TRPA § 3.08(a)(1) "clarifies that the partnership must be a registered limited liability partnership at the time of the errors and omissions for which partner liability is limited."

4. Effect on Pre-LLP Liabilities. An LLP is the same partnership that existed before it became an LLP. Since the shield of TRPA § 3.08(a)(1) protects partners only against liabilities incurred "while the partnership is a registered limited liability partnership," attainment of LLP status has no effect on pre-existing partnership liabilities. In Medical Designs, Inc. v. Shannon, Gracey, Ratliff & Miller, L.L.P., 922 S.W.2d 626 (Tex. App.--Fort Worth 1996, writ denied), a law firm was sued for malpractice and obtained a summary judgment that was upheld on appeal on the basis that a "successor partnership" is not liable for the torts of a predecessor partnership, although the liabilities of the prior partners would remain their liabilities. The law firm defendant had, subsequent to the time the alleged malpractice occurred, merged and unmerged with another law firm, and the miscreant partner of the prior partnership was not associated with the defendant law firm. Under these facts the court of appeals wrote, "Texas does not recognize that successor partnerships are liable for the tortious conduct of predecessor partnerships." There is nothing in the court’s opinion suggesting that registration as an LLP is enough to make the partnership a different partnership.

5. Limited Partnership as LLP. TRPA § 3.08(e) states that a limited partnership can become an LLP simply by complying with the applicable LLP provisions of TRPA, in which cae it would be a "LLLP." In addition, TRLPA § 2.14 provides that a limited partnership is an LLP as well as a limited partnership if it (i) registers as an LLP under § 3.08(b) of TRPA, as permitted by its partnership agreement or with the consent of partners required to amend its partnership agreement to so permit, (ii) complies with the insurance or financial responsibility provisions of TRPA § 3.08(d), and (iii) has as the last words or letters of its name "Limited Partnership" or "Ltd." followed by "registered limited liability partnership" or "L.L.P."

In an LLLP the general partners should have the same liability shield as partners in any other LLP. In a limited partnership, a limited partner is not liable to creditors unless (i) the limited partner participates in the control of the business and (ii) the creditor reasonably believed that the limited partner was a general partner. Under TRPA § 2.14(c) a limited partner in an LLLP whose conduct would otherwise render it liable as a general partner has the benefit of the LLP shield.

6. Indemnification and Contribution. As amended by SB 555, the LLP Provisions eliminate the usual right of a partner who is held personally liable for a partnership obligation to obtain indemnification from the partnership under TUPA § 18(1)(b) or contribution from copartners under TUPA §§ 40(a)(II) and 40(b) or TRPA § 8.06(c). It seems inconsistent with the LLP Provisions to allow a partner to recover, directly or indirectly, from copartners who are shielded from liability by the LLP Provisions, absent a specific agreement of indemnification, and TRPA § 3.08(a) expressly provides that a partner is not individually liable "by contribution, indemnity, or otherwise" for partnership obligations except as otherwise provided. Quite apart from the LLP Provisions, there is authority that a partner who commits malpractice cannot recover from his or her non-negligent copartners. It would certainly be inconsistent with the LLP Provisions to let a plaintiff reach those copartners through some theory of subrogation based on an alleged indemnification or contribution right of the misfeasant partner.

7. Inconsistent Partnership Agreement Provisions. A written or oral partnership agreement can modify or defeat the LLP liability shield. In cases where a partnership agreement sets forth partner indemnification or contribution obligations inconsistent with those described above, a creditor could argue that the partnership agreement supercedes the shield afforded by the LLP Provisions. Thus, if a miscreant partner is entitled to indemnification from the innocent partners in excess of the firm's assets, then a creditor could claim the indemnification right has become an asset of the miscreant partner's bankruptcy estate and the indemnification agreement could lead to a series of payments from the innocent partners, with each payment ultimately being for the benefit of creditors entitled to recover for the actions of the miscreant partner. The partnership could counter that compliance with the LLP Provisions amends or otherwise trumps any inconsistent partnership agreement provisions. Attorneys should exercise care to assure that the partnership agreement of an LLP does not contain indemnification or contribution provisions that would inadvertently frustrate the LLP purpose.

Since under TRPA §1.01(12) a partnership agreement may be written or oral, an LLP should have a written partnership agreement that provides that it may be amended only by a written amendment. Otherwise a creditor might argue that partner contributions to pay unshielded obligations (e.g. rent on a lease executed before September 1, 1997) constituted an amendment by conduct to the partnership agreement that dropped the LLP liability shield.

8. Fiduciary Duties. Partners in an LLP are in a fiduciary relationship and owe each other fiduciary duties just as in any other partnership. In Sterquell v. Archer, 1997 WL 20881, 6 (Tex. App.-Amarillo 1997), the court wrote:

9. Foreign LLP Qualification. Prior to SB 555, there was no statutory provision or Secretary of State procedure for the qualification of a foreign LLP to do business in Texas, as there is for foreign corporations, limited partnerships and LLC's. This is because TRPA § 1.05 provides that a partnership's internal affairs are governed by the law of the state chosen by the partners in the partnership agreement, if that state bears a reasonable relation to the partners or the partnership business and affairs, and that the law governing a partnership's internal affairs also governs its liability to third parties. Although a filing in Texas was not necessary to avail a foreign LLP of the benefits of TRPA § 1.05, the Secretary of State's office would accept filings (and filing fees) from foreign LLP's (the filing fee and the form were the same as if the foreign LLP were in effect organizing in Texas).

SB 555 added a new Article X of TRPA providing for a foreign LLP doing business in Texas to qualify to do business in Texas like a Foreign LLC (the filing fee would be the greater of $200 per resident partner and $750) and that the failure of the foreign LLP to qualify would not affect its LLP shield in Texas. Under new TRPA § 10.01 the laws of the state under which a foreign LLP is formed will govern its organization and internal affairs and the liability of partners for obligations of the partnership.

Thus under TRPA § 10.01 partners may choose the state law, and hence the liability shield, that they wish to apply to their relationship. That choice should not be subject to the general limitation in TRPA § 1.05(a)(1) that the law chosen by the partners to govern binds only "if that state bears a reasonable relation to the partners or to the partnership business and affairs under principles that apply to a contract among the partners other than the partnership agreement."

A determination of whether a foreign LLP must qualify to do business in any particular state must be made on a state by state basis. A number of states, such as Delaware, do not require such qualification, but recognize that the law governing the internal affairs of a partnership also govern its liability to third parties. By contrast, New York and Maryland require foreign LLP's to qualify to do business in the state.

7. Bankruptcy. Section 723 of the Bankruptcy Code addresses the personal liability of general partners for the debts of the partnership, granting the trustee a claim against "any general partner" for the full partnership deficiency owing to creditors to the extent the partner would be personally liable for claims against the partnership. In recognition of uncertainty as to how this provision would be construed to apply with regard to LLP's which had been authorized by a number of states since the advent of the 1978 Bankruptcy Code, the 1994 amendments to the Bankruptcy Code clarified that a partner of an LLP would only be liable in bankruptcy to the extent the partner would be personally liable for a deficiency according to the LLP statute under which the partnership was formed.

8. Federal Diversity Jurisdiction. An LLP is a citizen of every state in which one of its partners resides for the purposes of Federal court diversity jurisdiction. As a result, Big Six accounting firms with offices in most states are likely beyond the reach of the diversity jurisdiction of the Federal courts.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.