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August 29, 2012 | Law Alert

Limited Liability Partnerships as an Entity Choice for Engineers and Land Surveyors

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Together with accountants, lawyers, and architects, engineers, and land surveyors in California have the ability to choose limited liability partnerships (LLPs) as a business form.  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 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. LLP income is taxed at the individual partner level, without any income tax assessment at the LLP entity level other than the California minimum annual franchise tax of $800.  Corporations are also subject to the annual minimum franchise tax and are taxed on their income at the entity level; 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, limitations on the deductibility of certain expenses, and the potential for phantom income tax liability may render the “S” status undesirable.

Restriction On Ownership

Unlike a corporation formed under California’s General Corporation Law, ownership in either an engineering or land surveying LLP is limited to licensed engineers (engineering LLPs) or land surveyors (land surveying LLPs) or to those who are lawfully authorized to provide professional LLP services in this state.  Thus, business managers, financial experts, financial investors, or others who are not licensed as engineers 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, errors and omissions or other tortious conduct of an employee, consultant, 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.  Nor will an LLP partner’s personal assets be protected if he or she has personally guaranteed the entity’s obligations under a loan or lease.  In contrast, general partnership law imposes joint and several liability on every general partner 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 engineers or land surveyors, the security may consist of any one or a combination of:  1) a professional liability insurance policy with minimum limits of $100,000 per claim, multiplied by the number of licensed persons rendering professional services on the LLP’s behalf, up to a maximum of $5 million, but in no event less than $2 million even if there are fewer than five licensed persons; or, 2) a trust or bank escrow, bank certificates of deposit, bank letters of credit, U.S. treasury obligations, cash, or bonds of insurance or surety companies, 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 $2 million 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.  Note that the insurance or liquid asset formulas for satisfying the minimum security requirements is based on the number of licensed persons rendering professional services on the LLP’s behalf and not based on the number of partners.

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 levels is not provided.

Sunset Date; Public Agency Filings

The current LLP law as it applies to engineers extends until January 1, 2016.  This is known as a “sunset” date.  Unless the LLP law is timely renewed, engineers and land surveyors will not be authorized to practice in the LLP form after January 1, 2016.  

In California, an LLP is formed upon the filing of a certificate of registration with the California Secretary of State and payment of a $70 filing fee.

The entity is not required to register with the California Board for Professional Engineers, Land Surveyors and Geologists. However, individual licensees who offer civil, electrical, or mechanical engineering or land surveying services through a business entity must file an Organization Record form with the Board. The information that must be provided in the form includes the name of the business; the addresses of the primary and branch offices (if any); the types of professional services provided through the business; the names of all of the owners, partners, or officers (both licensed and unlicensed); and the names of all of the licensed engineers and/or land surveyors who are in responsible charge of the professional services provided.

Please click here to review the chart in a pdf format, for a comparison of requirements for the formation of an LLP, Corporation, General Partnership, or Sole Proprietorship.  This comparative overview may help guide you in determining the best method to pursue for your particular business endeavors and circumstances.

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

 

Requirements

LLP

General

Corporation

General Partnership

Sole Proprietorship

Number Of Owners

Two, minimum

One, minimum

Two, minimum

One, maximum

Qualification of Owners

Each partner must be licensed to practice either in California or in another state

Must have at least one shareholder or officer who is licensed in California.

Must have at least one partner who is licensed in California.

Sole owner must be licensed in California unless otherwise exempt under B&PC[1] or a California licensee is designated as the officer in charge.

Limited Liability

Yes

Yes

No

No

Management And Control

Decentralized; all partners have equal rights to manage and control business, unless agreement provides otherwise.

Centralized in Board of Directors.

Decentralized; all partners have equal rights to manage and control business, unless agreement provides otherwise.

N/A

Free Transferability Of Interests

Can transfer right to economic interest without consent of others, but cannot so transfer right to participate in management and control.

Absent a buy/sell or other agreement, shares are freely transferable.

Can transfer right to economic interest without consent of others, but cannot so transfer right to participate in management and control.

N/A

Continuity Of Life

For LLPs with no definite term, withdrawal, incapacity, or death of a partner will not cause dissolution and termination unless agreement provides otherwise. Withdrawal, disability or death of one partner in a two-partner LLP or withdrawal, disability or death of partner(s) holding 50% or more of equity interest in any 12 month period may cause termination.

Withdrawal, incapacity, or death of a shareholder does not affect corporation’s existence.

For General Partnerships with no definite term, withdrawal, incapacity, or death of a partner will not cause dissolution and termination unless agreement provides otherwise.

Withdrawal, disability or death of one partner in a two-partner GP or withdrawal, disability or death of partner(s) holding 50% or more of equity interest in any 12 month period may cause termination.

On incapacity, withdrawal, or death, sole proprietorship ends, but conservator, heirs or estate may continue the business.

Filings Required To Begin Existence Of Entity

File LLP-1 with Secretary of State.

File Articles of Incorporation with Secretary of State.

Statement of Partnership Authority may be filed with Secretary of State.

N/A

Regulation of Entity Name[2]

If business name includes the name of any person, that person shall be licensed as a professional engineer, land surveyor, architect, or geologist.

 

A fictitious name is permitted.

 

Any offer, promotion or ad containing the name of any individual (other than in the business name itself) must clearly and specifically designate the license or registration discipline of each individual named.

 

Name must include the words “limited liability partnership” or abbreviation thereof.

If business name includes the name of any person, that person shall be licensed as a professional engineer, land surveyor, architect, or geologist.

 

A fictitious name is permitted.

 

Any offer, promotion or ad containing the name of any individual (other than in the business name itself) must clearly and specifically designate the license or registration discipline of each individual named. [3]

If business name includes the name of any person, that person shall be licensed as a professional engineer, land surveyor, architect, or geologist.

 

A fictitious name is permitted.

 

Any offer, promotion or ad containing the name of any individual (other than in the business name itself) must clearly and specifically designate the license or registration discipline of each individual named.

 

If business name includes the name of any person, that person shall be licensed as a professional engineer, land surveyor, architect, or geologist.

 

A fictitious name is permitted.

 

Any offer, promotion or ad containing the name of any individual (other than in the business name itself) must clearly and specifically designate the license or registration discipline of each individual named.

 

Minimum Insurance Or Other Security Required

Yes

No

No

No

Operating Documents

Limited Liability Partnership Agreement

Bylaws, and, as appropriate, Shareholder Agreement and Stock Buy/Sell Agreement.

Partnership Agreement

N/A

Public Disclosure Of Owners And Capitalization

Not public information.

Not public information.

Names of partners may be disclosed if fictitious business name statement is published and filed.

Owner’s name disclosed if fictitious business name statement is published and filed.

Applicability Of Minimum Franchise Tax

Yes

Yes

No

No

Dual Level Of Income Tax

No

Yes, for “C” Corporations. No for “S” Corporations.

No

No

Qualifying To Do Business In Other States

May present a problem if other states do not recognize LLPs.

All 50 states recognize corporations, although each state will have differing requirements re licensing of shareholders and may only recognize professional rather than general corporations.

Generally limited to licensing issues.

Generally limited to licensing issues.

Filings Required To Dissolve Entity

File LLP-4 with Secretary of State.

File election to wind up and dissolve, and certificate of dissolution with Secretary of State.

Unless Statement of Partnership Authority was previously filed, no formal filings required; may file abandonment of fictitious business name.

No formal filings required; may file abandonment of fictitious business name.

 



[1] The Board’s Organizational Record form states “At least one [owner, officer or partner] must be licensed in each area branch of engineering or land surveying being provided.”  Business & Professions Code Section 6738(d) provides “Nothing in this section shall be construed to permit a person who is not licensed under this chapter to be the sole owner of a civil, electrical, or mechanical engineering business, unless otherwise exempt under this chapter.”  [Italics added.]

[2] See Business & Professions Code Sections 6738 and 8729 for special rules applying to firms in existence prior to December 31, 1987 (engineers) or June 1, 1941 (land surveyors).

 

Practice Area: Design Professionals Defense & Counseling
Attorney: Jennifer W. Suzuki

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