California Law Provides LLP Status

With the passage of Assembly Bill 469 (Cardoza) in 1998–one the AIACC’s sponsored pieces of legislation–architects can now join accountants and lawyers in forming limited liability partnerships (LLPs). A hybrid of a corporation and a general partnership, an LLP offers its owners limited liability and pass-through income tax treatment, yet can be run without the formalities generally required of a corporation.

How LLPs Operate

Functionally, an LLP is managed, operated and taxed on its income like a general partnership. Unless an agreement between the LLP partners provides otherwise, every LLP partner has an equal right to participate in the management and affairs of the LLP. This contrasts with a corporation which, typically, is managed by a Board of Directors elected by the shareholders. Also, LLPs are not required to have officers and directors, hold annual meetings, or keep formal records such as minutes or resolutions.

While an LLP must file an informational tax return, its income is passed through to its partners and taxed at the individual partner level, without any income tax assessment at the LLP entity level. Corporations are taxed on their income at the entity level and their shareholders are then taxed again at the individual level when the income is distributed as dividends. Although a corporation may avoid this result by making an election under Subchapter “S” of the Internal Revenue Code, eligibility restrictions imposed on shareholders and limitations on the deductibility of certain expenses may render the “S” status undesirable.

Notwithstanding pass-through tax treatment, for state tax purposes, an LLP is subject to an $800 annual California franchise tax for the privilege of doing business as an LLP.

Restriction on Ownership

Like a professional architectural corporation formed pursuant to the Moscone-Knox Professional Corporation Act (in contrast to those formed under California’s General Corporation Law), ownership in an LLP is limited to licensed professionals. Thus, business managers, financial experts, financial investors, or others who are not licensed as architects are disqualified from participating in the ownership of an LLP.

The Scope of Limited Liability

Perhaps the greatest benefit of becoming an LLP is the rule that an LLP partner’s personal assets will generally NOT be at risk in the event of a financial disaster resulting from business losses, or errors and omissions or other tortious conduct of an employee or a co-LLP partner. Thus, the LLP law eliminates personal exposure for vicarious tort liability as well as liability for partnership debts and obligations such as bank loans and lease obligations. The LLP law does not, however, change the fact that an LLP partner will still be personally liable for his or her own errors and omissions; whether arising from his or her own acts or failures to act, or negligent supervision of associates and staff. This differs markedly from general partnership law which imposes joint and several liability on general partners for all tortious acts of their co-partners acting within the scope of their actual or apparent authority, and joint liability for all other partnership debts and obligations.

Security and Insurance

To mitigate the public’s concern over the limitation of liability discussed above, LLPs must maintain some form of security against potential malpractice claims. The LLP must maintain this security at all times during which it transacts business.

For architects, the security may consist of any one or a combination of: 1) professional liability insurance policies with minimum limits of $100,000 per claim, multiplied by the number of licensed persons rendering profession services on the LLP’s behalf, up to a maximum of $5 million, but in no event less than $500,000 even if there are fewer than five licensed persons; or 2) a trust, bank escrow, cash, or other similar and relatively liquid assets in an amount of at least $100,000, multiplied by the number of licensed persons rendering professional services on behalf of the LLP, up to a maximum of $5 million, but in no event less than $500,000 even if there are fewer than five licensed persons. In lieu of the above, an LLP may annually file a statement with the Secretary of State certifying that it had a net worth equal to or exceeding $10 million as of the most recently completed fiscal year.

If insurance is selected as the security mechanism, such insurance must, if reasonably available, be maintained for a minimum of three years following the LLP’s dissolution, or, the LLP must obtain an extended reporting period endorsement for the same period.

Unless the LLP has satisfied the security requirements through a certification of its net worth, each LLP partner, by virtue of his or her partnership status, is automatically deemed to guarantee payment of any claim to the extent security in the form of insurance and/or liquid assets at the required level is not provided.

Conclusion

The LLP law as it applies to architects became effective January 1, 1999. To form an LLP, architects need to file a certificate of registration with the California Secretary of State and pay a $70 filing fee. As of the date of this writing, the Board of Architectural Examiners has not implemented any rules requiring registration at the entity level.

Jennifer Wong Suzuki, Esq. is a partner of the San Francisco law firm of Long & Levit LLP. Ms. Susuki specializes in corporate and partnership law as it relates to design professionals and construction law.

For details regarding this new law, please contact AIA California’s Director of Government Relations Scott Terrell at (916) 448-9082.