Limit Practice Liability: Select Your Form of Business and Your Associates with Care
Since the litigation explosion of the mid-1980s CPA-firm partners have looked for ways to limit personal liability. Firms operating in multiple states have had special concerns, given the geographic, cultural and jurisdictional disparities they must manage. This article will explore some of the litigation risks of operating an accounting practice as a limited liability partnership (LLP) or limited liability company (LLC), clarify LLP and LLC similarities and differences and recommend strategies that help minimize exposure. LIABILITY BY ENTITY Until 1992 accountants could practice only as sole proprietors or in general partnerships or in professional corporations. Each had drawbacks: Sole owners risked liability for employee violations through the legal doctrine respondeat superior (literally "let the master answer"). General partnerships faced unlimited personal liability for partner negligence and partnership debts. Professional corporations offered protection that varied greatly by state and was not available to all multistate practices. S corporations limited the number of shareholders, curtailing growth, and conversion to a corporate form had significant tax consequences. Those shortcomings, exacerbated by a deluge of litigation, led the AICPA in January 1992 to overwhelmingly approve an amendment to Rule 505, Form of Organization and Name, of its Code of Professional Conduct's Rules of Practice to permit the practice of accountancy in any form permitted by state law or regulation, including the then-emerging LLCs and LLPs. Although more than a decade has passed since the rule change, there still is confusion about the difference in the scope of liability protection these forms offer. What is certain is that whether a firm is an LLC or LLP, each principal remains liable for individual misconduct under civil and criminal laws, and the veil of limited liability can be pierced in some circumstances. Moreover, the protection limited liability offers differs according to whether the firm's state provides a "full" or "partial" shield (see "LLP Statutes by State" in the online version of this article at www.aicpa.org/pubs/jofa/sep2005/miller.htm). THE LLC AND LLP LANDSCAPE LLC or LLP agreements contain provisions affecting a partner's obligations to the entity or to other partners, and those terms may create liability. While state statutes pertaining to LLCs and LLPs provide a shield against certain civil suits, they may differ significantly, and they don't protect a partner from prosecution for criminal or securities violations. CPAs forming or revising a partnership should develop the firm's governing documents with care and after consultation with legal counsel. An LLC practice offers a full shield, subject to exceptions. Like a sole practitioner or general partner, each member of an LLC is liable for his or her own acts of negligence and/or civil and criminal violations. LLC statutes generally protect owners from personal liability for the ordinary business debts of the entity, though there are exceptions. Because laws change constantly it's wise to monitor LLC statutes and related state legislation. For example, the Rhode Island General Assembly amended its workers' compensation law to impose personal liability' upon corporate officers, LLC managers and members, and partners in general or limited partnerships for knowingly failing to provide workers' compensation insurance. In exceptional cases courts may hold an individual LLC owner personally liable for LLC debts by piercing the so called "corporate veil" of limited liability. This may occur when an owner has used the LLC to commit a fraud, has not properly capitalized the LLC or has misled third parties into believing the practice is being conducted by individuals rather than by the LLC. The law is just beginning to develop in this area. The LLC shield is not a complete bar to personal liability. …