What Is Unlimited Liability?
Unlimited liability refers to the full legal responsibility that business owners and partners assume for all business debts. This liability isn't capped and obligations can be paid through the seizure and sale of the owners’ personal assets without the protection that the popular limited liability business structure provides.
Key Takeaways
- An unlimited liability company includes general partnerships and sole proprietors who are equally responsible for all debt and liabilities accrued by the business.
- Most companies opt to form limited partnerships in which a partner's liability can't exceed their investment in the company.
- Nondisclosure is a benefit of forming a foreign unlimited liability subsidiary for many companies.
Understanding Unlimited Liability
Unlimited liability typically existsin general partnerships and sole proprietorships. Itprovides that each business owner is equally responsible for whatever debt accrued within a business if the company is unable to repay or defaults on its debt. An owner's personal wealth can be seized to cover the balance owed.
Most companies opt to form limited partnerships or limited liability companies instead where one or more business partners are only liable up to the amount of money they've invested in the company.
An Example of Unlimited Liability
Consider four individuals who are working as partners. Each invests $35,000 into the new business that they own jointly. The company accrues $225,000 in liabilities over one year. All four partners are equally liable for repayment of the $225,000 if the company can't repay and/or defaults on these debts. The owners would be required to come up with $56,250 each to alleviate the $225,000 in debt, in addition to their initial investment of $35,000.
Unlimited Liability Laws Worldwide
Unlimited liability companies are typically found in jurisdictions where company law stems from English law. Unlimited liability companies are incorporated or formed through registration under the Companies Act of 2006 in the United Kingdom.
Other areas where these companies are formed under English law include Australia, New Zealand, Ireland, India, and Pakistan.
Germany, France, the Czech Republic, and two jurisdictions in Canada are also areas where unlimited liability companies are commonly formed, but they're referred to as unlimited liability corporations in Canada.
Despite the number of companies and countries in which they exist, unlimited companies are an uncommon form of company incorporation due to the burden placed on owners to cover a company's debt, specifically when the company faces liquidation.
One of the benefits of forming an unlimited liability subsidiary may be nondisclosure. Etsy, an online crafts marketplace, created an Irish subsidiary in 2015 that's classified as an unlimited liability company. Public reports on money that the company moves through Ireland or tax payment amounts are therefore no longer required.
Joint Stock vs. Unlimited Liability
A joint-stock company (JSC) is similar to an unlimited liability company in the U.S. because shareholders have unlimited liability for company debts. JSCs operate under associations in New York and in Texas under the Texas Joint-Stock Company/Revocable Living Trust model, as well as in other states.
This model has some basic differences from a general partnership, including a lack of limited liability for shareholders, formation through a private contract that creates a separate entity, and the fact that one shareholder can't bind another shareholder regarding liability because each is equally responsible.
What Is a Sole Proprietorship?
A single individual has complete control over a sole proprietorship. All business assets are the proprietor's personal assets, and the individual is 100% responsible for business debts and liabilities. This business structure is most suited to low-risk enterprises.
What Is a Corporation?
A corporation is owned by its stockholders who are completely protected from the business's liabilities. Forming a corporation requires filing articles of incorporation with the state in which the business is located. A small business corporation (S-corporation) is similar but tax obligations pass through from the corporation to the owners who must report their share of the business's income and losses on their personal returns.
What Is a Disregarded Entity?
"Disregarded entity" is a tax term. Like an S-corporation, a limited liability business structure allows income and losses to pass down to its owners' personal tax returns. The business structure itself is "disregarded" by the IRS for tax purposes.
The Bottom Line
Each business owner is equally responsible for any and all debts that accrue within an unlimited liability business structure. Their personal assets are at risk if the business is unable to repay or defaults on its debt. This type of structure is typically suitable for small businesses with limited assets and debts.
Consult with a financial advisor or attorney in your state if you're considering forming and operating this type of business entity.
