Farmers who want to work together to make a profit might risk their personal assets if they form a general partnership. General partners are jointly and severally liable for the business debt. The problem is that a group of farmers can form a partnership without ever realizing they’ve just taken on that liability.
What’s the situation?
Farmer Chad is starting up a little vegetable operation this spring. Since he’s not yet confident in his growing skill, he’s growing veggies for his friend Nell. Nell wants to take it easy this season, so Chad is responsible for half the veggie production for Nell’s Ruddy Duck Farm CSA. Chad thinks his risk is low–nobody will visit his farm and hurt themselves, he won’t go into debt, and so forth–so he decides to form his business as a quick, easy sole proprietorship. But is that all Farmer Chad needs to think about?
Where does the law come in?
Although Farmer Chad might have made a reasonable decision for himself alone, if he is forming a partnership with Nell he could be liable for all of her business obligations as well.
My post a couple of weeks ago introduced how a “business entity” is the legal structure under which a business forms. The sole proprietorship is the easiest business entity to form, but it’s also the riskiest because the owner is personally liable for all the debts of the business. This post delves into a very similar entity: partnerships.
A “general partnership” is similar to a sole proprietorship owned by two or more people. It’s easy to form a partnership: The owners file their trade name with the state so people can determine who owns the business. It also makes it relatively easy (or, I should say, less difficult) to handle income taxes since the business’s income passes straight through to the owners. The business itself doesn’t file to pay income taxes on its profit; only the owners file income taxes for the business’s profit.
It might be easy to start a general partnership, but, like the sole proprietorship, the general partnership has a dark side. Each partner is jointly and severally liable for the debts of the business. I explained before that if a school group tours a farm and a kiddo slips on a knife that was negligently left in the field, the farm might end up paying a judgment. As another example, a farmer might take out a loan to get going in the spring. The bank can go after the farmer’s personal assets to recover the loan.
Let’s say Nell and Chad agree to start a farm together. They file as a general partnership and the farm is off and running. Then Nell decides not to make Ruddy Duck Farm’s payments anymore. Both Nell and Chad are liable for that debt, and the bank can choose whose assets they want to go after. Or it could go after both partners. If Nell only has $100 of a $500 loan, Chad might have to make up the difference. It doesn’t matter if Chad receives a smaller proportion of the profits from Ruddy Duck Farm; he is also liable. That’s the meaning of “joint and several” liability. Clearly, if a couple of farmers are considering a general partnership, they both need to think long and hard about whether they really want this kind of liability.
The tricky thing is that a couple of farmers might be jointly and severally liable even though they didn’t formally agree to do business together. It’s possible to enter into a partnership without signing an agreement or even realizing a partnership has been formed. I led with the story of Farmer Chad growing half the veggies for Farmer Nell’s Ruddy Duck CSA. Is that a partnership? Are Farmer Chad’s personal assets potentially on the line for Farmer Nell’s business debts? The answer lies in the details of their operation: Are Chad and Nell acting like they co-own a business for profit? Who makes what decisions, and where does income go? Their actions, not necessarily a formal agreement, will determine if they have a partnership. Say Chad has more money and property than Nell. If someone is trying to collect on a debt, they will try to convince the court that Chad and Nell are in a partnership so they can reach Chad’s assets.
This all sounds risky. Who wants to try and evaluate a partner’s risk exposure along with their own? Who wants to worry about whether they’ve formed a partnership and if they might be liable? Farmers have better things to do. Fortunately, forming a business entity that offers a lot more protection than sole proprietorships or general partnerships is easy. We’ll get to those soon.