Choosing a Business Form 245Sole Proprietorships
With the sole proprietorship, the owner has essentially traded off limitation of
risk in favor of simplicity of operation. Since there is no difference between
the entity and its owner, all the liabilities and obligations of the business are
also liabilities and obligations of its owner. Thus, all the owner ’s personal assets
are at risk. Failure of the business may well mean personal bankruptcy for the
owner.
Partnerships
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 his or her partners.
Each partner is jointly and severally liable for the debts of the partnership re-
maining after its 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 f led the jurisdiction, the targeted partner
may end up holding the entire bag.
If our three consultants operate as a partnership, Jennifer is 100% per-
sonally liable not only for any contracts she may enter into but also for any con-
tracts 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 appar-
ent 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 partner-
ship’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 heav y 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. Un-
like the sole proprietorship and partnership, the corporation is recognized as
a legal entity separate from its owners. Its owners are thus not personally li-
able 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 at-
tractive as it sounds, because sophisticated creditors, such as the corpora-
tion’s bank, will likely demand personal guarantees from major stockholders.