What is unlimited liability?
What does it mean to be exposed to unlimited liability in business?
What’s the difference between limited and unlimited liability?
In this article, we will break down the notion of “unlimited liability” so you know all there is to know about it!
We will look at the unlimited liability definition, the meaning of unlimited financial liability, limited vs unlimited liability, different types of unlimited liability business entities and structures, we’ll look at examples and more!
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What is unlimited liability
Unlimited liability is a term used in business, law and accounting to refer to a person’s exposure to all types of financial liability.
In other words, unlimited liability means that a person can be potentially held responsible for all debt or financial obligations related to owning and operating a business, contractual obligations or legal transaction.
In business, we typically refer to the notion of unlimited liability in the context of how much a person is exposed to personal financial risk when operating a business as a general partnership, sole proprietorship or other forms of unlimited liability legal entities.
A person running a business in the form of a sole proprietorship is exposed to unlimited liability.
This means that the sole proprietor’s personal assets can potentially be seized to pay any outstanding debt or financial obligation owed to the business creditors.
If the sole proprietor’s business does not have the ability to pay back its debt or defaults on its financial obligations, the business creditors can pursue the sole proprietor’s personal assets to recover what is owed to them.
A person running a business as a corporation or a limited liability company (LLC) will not be exposed to unlimited liability for operating the business.
The corporation and LLC thus offer limited liability protection to the business owner.
This means that the shareholder of the corporation or member of the LLC will not be personally exposed to the debt and liability exposure of the corporation or LLC.
If the corporation or LLC owes money to its creditors and defaults on payment, the creditors cannot seize the shareholder or LLC member’s personal assets or tap into their personal wealth to recover the outstanding debt.
Definition unlimited liability
How do you define unlimited liability?
According to the Cambridge Dictionary, unlimited liability is defined as:
A situation in which the shareholders of a company are responsible for all of its debts if the company fails financially
Limited vs unlimited liability
What is the difference between limited and unlimited liability in business?
What are limited and unlimited liabilities?
Limited liability means that a person’s exposure to economic losses, financial risk, debt, liability, unexpected lawsuits claims, judgments or any other form of monetary obligation is limited.
If you are a shareholder in a corporation, you are not responsible to pay for the company’s debt or assume losses in the event of a claim made against the corporation.
Your personal liability is limited.
If the company goes bankrupt, the only thing you lose is your investment in the corporation.
Limited liability entities are separate and distinct entities from their owners shielding them from business liability.
On the other hand, we can define unlimited liability as a business structure where a person can be held responsible for any financial loss, liability or monetary claim.
Operating a business where you are exposed to unlimited liability is not favourable to the business owner.
If the business becomes insolvent, not only you lose your initial investment in the business but you can also potentially lose your house, personal investments or other personal asset registered in your name.
In most cases, entrepreneurs and business owners opt for a limited liability company, limited liability partnerships or corporations instead of operating a general partnership or acting as a sole proprietor.
Running a business inherently comes with risk.
You must evaluate your risk tolerance in assuming unlimited personal liability to cover your business debt.
Based on that, you’ll be able to make an informed choice whether you should operate under a limited or unlimited liability structure.
Unlimited liability entities
There are business entities that offer the business owner limited liability protection while others do not.
The business structures that do not offer business owners liability protection are referred to as unlimited liability companies.
The following individuals operating a business are exposed to unlimited liability:
- General partners in a general partnership have unlimited liability
- General partners in a limited partnership have unlimited liability
- Sole proprietors in a sole proprietorship have unlimited liability
Unlimited liability partnership
If you are involved in partnerships, it is possible that you are exposed to unlimited liability.
There is unlimited liability in general partnerships.
The general partners all assume the risk of being personally sued to cover the partnership liabilities.
Typical, the partners in a general partnership are personally liable for the partnership debts in equal share.
John, Mary and Suzanne form a general partnership where they each invest $10,000 to start the business (they each have an interest of 33% in the partnership).
They borrow $30,000 from the bank in the name of the partnership and are unable to pay it back.
Since the general partnership does not have enough to pay the bank, John, Mary and Suzanne are liable to pay $10,000 each to cover the bank’s loan.
In other instances, the partners may have a partnership agreement in place where the partners define their liability exposure.
In such cases, you may have general partners (with unlimited personal responsibility) and limited partners (with limited personal responsibility).
Under the partnership agreement, a partner will be responsible to the extent of the partner’s investment in the capital account of the partnership.
Sole proprietorship unlimited liability
A person operating a business in his or her name using a fictitious name or DBA (doing business as) as a sole proprietor is personally responsible for all the financial and commercial risks of the business.
A sole proprietorship is the simplest type of business structure to operate but with the disadvantage of exposing the business owner to unlimited liability.
The person operating a sole proprietorship is personally responsible for all the business debt.
Unlimited liability corporation
In some jurisdictions, you can form an unlimited liability company or unlimited liability corporation.
In the United Kingdom, unlimited liability companies can be formed under the Companies Act of 2006.
You should do your homework before incorporating an unlimited liability corporation or forming an unlimited liability company.
Even though it is not logical to form a business entity that does not provide you with limited liability protection, it may be done strategically to benefit from certain non-disclosure requirements.
For instance, an unlimited liability company will not have to make certain financial disclosures.
Nonetheless, major brands and companies around the world operate as corporations giving the shareholders limited liability.
If you are looking to form an unlimited liability, you should evaluate the pros and cons so you know how to maximize value for your business.
In the United States, you can form a joint-stock company or a JSC that resembles an unlimited liability company to a certain extent.
In the jurisdictions that authorize it, you can register a joint-stock company.
However, they do not offer their shareholders limited liability protection.
Again, before you register a JSC, you should verify if this is the right business structure for you.
Unlimited liability example
Let’s assume that you have a general partnership formed between Joe, Helen and Betty to operate a bakery.
They each invest $25,000 to start the business operations.
To open a store, purchase equipment and start business operations, they borrow $300,000 at the bank.
A year later, unfortunately, the business is not doing well.
They still owe the bank $270,000 and they incurred an additional $90,000 of liability for a total of $360,000.
They decide to close the shop.
However, since they are operating a general partnership, Joe, Helen and Betty have unlimited liability.
This means that the bank and the bakery creditors can pursue all or any of them to collect the full $360,000 that is owed.
Between Joe, Helen and Betty, they are each equally responsible to pay $120,000 to cover company losses.
However, towards the bank and business creditors, they are potentially liable up to the fullest extent of the liability ($360,000 in this case).
In other words, if Joe does not have any money, Helen and Betty will be held responsible for the full $360,000.
If Joe and Helen do not have any money, Betty can be held responsible for the full $360,000.
At the end of the day, Joe, Helen and Betty will not only lose their initial investment of $75,000 but they are also responsible to pay the business debt for an additional $120,000 each to cover the business losses.
Unlimited liability FAQ
Define unlimited liability in business
Unlimited liability in business represents the extent to which company founders or business owners can be personally responsible to pay company debt or assume financial obligations of their company.
Having unlimited liability means that you may be responsible to pay any and all company debt, financial loss, expense or liability.
Do partnerships have unlimited liability
Partners in a general partnership (GP) have unlimited liability for the debt and losses of their business.
General partners in a limited partnership (LP) are also exposed to unlimited liability.
A limited liability partnership (LLP) on the other hand affords limited liability protection to its members.
What does unlimited liability mean in business
What are unlimited liabilities?
How does this matter in business?
Simply put, having unlimited liability is to have the potential to have to personally assume any and all business liability or loss.
Typically, sole proprietorships and general partners have unlimited liability as these business structures do not afford the business owner the “limited liability protection”.
In essence, under these business structures, the owners do not form a separate entity thereby legally separating the business from their personal affairs.
What is an example of unlimited company
An example of an unlimited liability company is either a sole proprietorship or general partnership.
Let’s look at an example.
Let’s say John wants to start a landscaping company as a sole proprietor.
To do that, he’ll need to borrow $20,000 from the bank and put $5,000 of his own money to start the business.
John signs a contract with a client to do some landscaping work.
Unfortunately, John does a very bad job and is sued for breach of contract where the client is claiming $50,000.
If John loses the lawsuit, he will personally have to pay $50,000 to cover the losses resulting from the landscaping contract.
What is the difference between limited and unlimited partnership
A limited partnership, like an LLC, is a type of partnership where the members form a separate legal entity by filing their articles of organization with the state, set up their LLC operating agreement and maintain their LLC in good status with the state.
By doing so, the partners benefit from the limited liability protection.
If the LLC becomes insolvent, the partners can bankrupt the LLC without running the risk to be held personally responsible for the debts of the LLC.
An unlimited liability partnership, like a general partnership, is a type of partnership where the owners and the business are one and the same.
They do not have a separate legal entity protecting their personal assets from lawsuits and business claims.
Should something go wrong in the business, the partners will be personally held accountable to pay for the company’s financial liability.
Why is unlimited liability a disadvantage
The biggest disadvantage of an unlimited liability business structure is not having the limited liability protection that limited liability partnerships and corporations have to offer.
Unlimited liability can include any of the following types of liabilities:
- Short-term liabilities
- Long-term liabilities
- Business loans
- Business line of credit
- Rent owed under a commercial lease
- Rent owed for leasing equipment
- Bank loans
- Money owed for purchasing supplies
- Money owed for purchasing inventory
- Financial liability resulting from an unexpected lawsuit
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