Are You Liable for Your Business Partner’s Wrongdoing or Fraud?

Business partners don’t always share the same level of legal liability. Your responsibility for another partner’s fraud, tort, contract breach, or other civil wrongdoing depends on several factors, including whether you operate as a general partnership, limited partnership, LLC, LLP, or corporation. The partner’s role, the authority they exercised, and whether you had any involvement in the conduct can also make a significant difference.

You didn’t commit the fraud. You didn’t sign the questionable contract. You didn’t misuse company money. So why might someone still try to hold you responsible? Your exposure can depend on your business structure, your partner’s authority, and the relationship between the wrongdoing and the business.

If your business partner has crossed a legal or financial line, the Super Lawyers directory can help you find a business litigation attorney.

Business Structure Affects Liability

The type of business structure can directly affect a partner’s potential personal liability when another owner commits fraud or other wrongdoing. Each structure has different rules governing owners’ responsibilities, protections, and exposure to business debts and claims.

Partner Liability in General and Limited Partnerships

The liability rules for partnerships depend largely on whether you are dealing with a general or limited partnership. General partners generally have personal exposure for the partnership’s obligations, including obligations created when another partner acts with authority on behalf of the business.

Limited partnerships have at least one general partner who generally remains personally liable for partnership obligations. Limited partners generally receive greater protection from personal liability. That protection doesn’t necessarily cover a limited partner’s own wrongful conduct.

The applicable state partnership law and the partnership agreement can also affect how liability is allocated.

Partner Liability in a Limited Liability Partnership (LLP)

Partners in an LLP generally receive greater protection from personal liability than partners in a general partnership. Other partners generally aren’t personally liable for another partner’s wrongful conduct solely because they are partners.

The partner who committed the wrongdoing can still face personal liability, and the LLP itself may also be responsible for certain claims. The exact rules depend on state law.

Partner Liability in a Limited Liability Company (LLC)

An LLC is a separate legal entity, so its members generally aren’t personally liable for the company’s debts or obligations simply because they own an interest in the business. If one member commits fraud or other wrongdoing, the other members typically aren’t personally liable for that conduct just because they are members.

There are exceptions, however. A member may face personal liability for personally participating in the wrongdoing, guaranteeing a business obligation, or in certain circumstances where a court pierces the LLC’s veil. State or federal law may also impose personal liability in specific situations.

Partner Liability in a Corporation

A corporation exists as a legal entity separate from its shareholders. As a result, shareholders generally aren’t personally liable for corporate debts or obligations solely because they own shares.

That protection doesn’t necessarily extend to a shareholder who personally commits fraud, negligence, or another wrongful act. In some cases, a court may also disregard the corporate entity and impose personal liability through veil piercing.

Keeping corporate finances, records, and other formalities separate from the shareholders’ personal affairs can help protect the corporate structure.

When Can You Be Personally Liable for Your Business Partner’s Actions?

Your business structure can provide important liability protection, but that protection has limits. You may still face personal liability for your business partner’s actions in certain circumstances, particularly when the conduct creates obligations for the partnership, or you have some direct connection to the wrongdoing.

Some common situations include:

• Your business partner acted on behalf of the partnership
• The partnership is responsible for a partner’s tort
• You personally participated in the wrongdoing
• You personally guaranteed the business obligation
• The business structure is disregarded

Common Types of Business Wrongdoing

Business wrongdoing can take many forms. Misconduct may create both disputes between owners and liability to outside parties. Common examples include breach of fiduciary duty, embezzlement, and misappropriating company funds for personal use.

A partner may also engage in self-dealing, misrepresent to a customer or business associate, commit negligence, or breach a contract. These actions can quickly lead to partnership disputes, financial losses, and litigation.

What Should You Do When a Business Partner Commits Fraud?

If someone discovers that their business partner has committed fraud or another wrongdoing, they should act quickly. Preserve emails, contracts, financial records, account statements, and other relevant evidence. Avoid destroying, altering, or concealing business records. Review the partnership, operating, shareholder, or other governing agreement.

Be proactive about notifying the other partners and other affected parties. Consider if legal action is appropriate to recover damages. Evaluate the legal remedies that may be available.  

Acting quickly can help prevent further harm to the business, its owners, or others. However, rushing into action can create its own legal problems. Speak with legal counsel before taking steps that could unintentionally expose you to personal liability.

How Can You Protect Yourself From a Business Partner’s Wrongdoing?

Business partners can take several steps to protect themselves. First and foremost, put the partnership and business agreement in writing. This is called an operating agreement.

The agreement should clearly define each partner’s role and responsibility. It should define how the business makes decisions, financial responsibilities, approval requirements, and how it resolves conflicts. Most importantly, it should explain how to handle situations if a partner violates the agreement.

Talk to a Business Litigation Attorney

A business partner’s wrongdoing can create liability for the business without necessarily making you personally responsible for the damage. An attorney can assess the facts, explain your potential liability, and help you protect your interests.

Use the Super Lawyers directory to find a business litigation attorney who handles business disputes.