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Partnerships
If possible, the result may be even worse within a general partnership. There, each owner is liable not
only for personal mistakes, but also for those of the other partners. Each partner is jointly and
severally liable for the debts of the partnership remaining after the partnership‟s assets have been
exhausted. This means that a creditor may choose to sue any individual partner for 100% of any
liability. The partner may have a right to sue the other partners for their share of the debt, as set forth
in the partnership agreement, but that is of no concern to a third party. If the other partners are
bankrupt or have fled the jurisdiction, the targeted partner may end up holding the entire bag.
If our three consultants operate as a partnership, Jennifer is not only 100% personally liable for any
contracts she may enter into, but also 100% personally liable for any contracts entered into by either
Jean or George. What‟s more, she is liable for those contracts, even if they were entered into in
violation of the partnership agreement, because, as was demonstrated earlier, each partner has the
apparent authority to bind the partnership to contracts in the ordinary course of the partnership‟s
business, regardless of the partners‟ internal agreement. Worse, Jennifer is also 100% individually
liable for any torts committed by either of her partners, as long as they were committed within the
scope of the partnership‟s business. The only good news in all this is that neither the partnership nor
Jennifer is liable for any debts or obligations of Jean or George incurred in their personal affairs. If
George has incurred heavy gambling debts in Las Vegas, his creditors can affect the partnership only
by obtaining a charging order against George‟s partnership interest.
Corporations
Thus we have the historical reason for the invention of the corporation. Unlike the sole proprietorship
and the partnership, the corporation is recognized as a legal entity, separate from its owners. Its
owners are thus not personally liable for its debts; they are granted limited liability. If the
corporation‟s debts exhaust its assets, the stockholders have lost their investment, but they are not
responsible for any further amounts. In practice, this may not be as attractive as it sounds, because
sophisticated creditors such as the corporation‟s institutional lenders will likely demand personal
guarantees from major stockholders. But the stockholders will normally escape personal liability for
trade debt and, most important, for torts.
This major benefit of incorporation does not come without some cost. Creditors may, on occasion,
be able to “pierce the corporate veil” and assert personal liability against stockholders, using any one
of three major arguments. First, to claim limited liability behind the corporate shield, stockholders
must have adequately capitalized the corporation at or near its inception. There is no magic formula
with which to calculate the amount necessary to achieve adequate capitalization, but the stockholders
normally will be expected to invest enough money or property and obtain enough liability insurance to
offset the kinds and amounts of liabilities normally encountered by a business in their industry. Thus,
the owner of a fleet of taxicabs did not escape liability by canceling his liability insurance and forming
a separate corporation for each cab. The court deemed each such corporation inadequately capitalized,