What Does Unlimited Liability Mean?
Unlimited liability refers to the full legal responsibility that business owners and partners take on for all the debts of their business. This liability isn’t restricted in any way, and obligations can be settled through the seizure and sale of the owners’ personal assets, unlike the limited liability that other popular business structures offer.
Key Insights
- An unlimited liability company includes general partnerships and sole proprietors who share equal responsibility for all business debts and liabilities.
- Most businesses choose to form limited partnerships, where a partner’s liability doesn’t exceed their investment in the company.
- Forming a foreign unlimited liability subsidiary can offer the benefit of nondisclosure for many companies.
Understanding Unlimited Liability
Unlimited liability typically exists in general partnerships and sole proprietorships. It means that each business owner is equally responsible for the debts accrued by the business if it defaults or can’t repay. Personal wealth can be used to cover the company’s debt. To mitigate such risks, most companies prefer forming limited partnerships or limited liability companies where liability is restricted to the extent of their investment.
An Example of Unlimited Liability at Work
Imagine four individuals come together as business partners, each putting in $35,000 into a jointly owned venture. The business incurs $225,000 in liabilities over the year. All partners are equally liable to repay this $225,000 if the business defaults. This means each partner would need to come up with $56,250, over and above their initial $35,000 investment, to offset this debt.
Unlimited Liability Laws Around the Globe
Unlimited liability companies are commonly found in jurisdictions where company law is derived from English law, such as the UK, Australia, New Zealand, Ireland, India, and Pakistan. These companies are formed through registrations under the Companies Act of 2006 in the United Kingdom. Germany, France, the Czech Republic, and parts of Canada also recognize unlimited liability companies, known in Canada as unlimited liability corporations. Although they exist in many regions, they are a rare form of incorporation due to the significant burden they place on owners when the company faces liquidation.
A Strategic Use Case: Nondisclosure
A key benefit of forming an unlimited liability subsidiary is nondisclosure. For example, Etsy established an Irish subsidiary classified as an unlimited liability company in 2015 to avoid public reporting of money movement or tax payments through Ireland.
Joint Stock vs. Unlimited Liability Structures
A Joint-stock company (JSC) in the U.S. resembles an unlimited liability company due to shareholders’ unlimited liability for company debts. JSCs in states like New York and Texas operate within private contract associations. This model differs from general partnerships, notably in not providing limited liability for shareholders and allowing for private contracts that create separate entities, without enabling one shareholder to bind another.
Quick Glance at Business Structures
What Is a Sole Proprietorship?
A sole proprietorship is where a single person has total control. All business assets are the owner’s personal assets, and they hold 100% responsibility for business debts and liabilities, making it suitable for low-risk enterprises.
What Is a Corporation?
A corporation is owned by stockholders who are completely protected from business liabilities. It is formed by filing articles of incorporation in the state of operation. Small business corporations (S-corporations) pass tax obligations directly to the owners, who report their share of income and losses on personal returns.
What Is a Disregarded Entity?
A disregarded entity refers to a tax scenario where income and losses pass to the owners’ personal tax returns while the business structure itself is ignored for tax purposes, similar to how an S-corporation works.
Finishing Thoughts
In an unlimited liability business structure, each owner is equally responsible for all accrued debts, risking personal assets if the business defaults. This is usually best for smaller businesses with limited assets and obligations. It’s advised to consult with a financial advisor or attorney before opting for this business structure.
Related Terms: liability, limited partnership, sole proprietorship, general partnership, corporation, disregarded entity
References
- Small Business Administration. “Choose a Business Structure”.
- UK Legislation. “Companies Act 2006”.
- CFO. “Etsy Avoids Disclosure With Irish Tax Haven”.
- Texas Workforce Commission. “Tax Law Manual: Chapter 1: Employing Unit”.
- The New York State Senate. “Section 7-A Incorporation of joint-stock association”.
- American Speech-Language-Hearing Association. “Types of Business Entities”.
- Internal Revenue Service. “Limited Liability Company (LLC)”.
