Over the next few weeks, I’m going to be discussing some of the issues that lawyers need to consider when they are starting a law firm. This week, the topic is entity choice.
When forming a law firm, lawyers must first decide the entity type they want to use. Law firms historically operated as general partnerships, which opened up each partner to joint and several liability for all partnership debts and obligations. Now, the use of entities offering limited liability protection is the norm.
Lawyers may operate as sole proprietorships, general partnerships, limited liability partnerships, professional associations, professional corporations, or limited liability companies. Each entity brings with it different issues regarding liability, tax consequences, and dissolution issues. I won’t be discussing those details here.
All entity types (excluding sole proprietorships) offer the same limited liability protection for their lawyer owners. None, however, can shield lawyers from negligence or malpractice committed by themselves or by others under their supervision. See Henderson v. HIS Financial Servs., Inc., 266 Ga. 844, 845 (1996); Centrust Mort. Corp. v. Smith & Jenkins, P.C., 220 Ga. App. 394, 396 (1996). And no matter what form chosen, legal ethics rules always apply.
A sole proprietorship is an unincorporated business owned by one person. Only solo practitioners can operated as a sole proprietorship. Because an “unincorporated sole proprietorship is not a separate legal entity from the proprietor,” a lawyer operating under such a business form is personally liable for all debts of the law practice.
In other words, all of the lawyer’s personal assets are at risk to creditors of the law firm. With the availability of other limited liability entity forms, sole proprietorships should be avoided.
Limited Liability Partnership
A limited liability partnership is in essence a general partnership with a liability shield. Limited liability partnerships can only be formed with two or more lawyers. A solo cannot operate under a limited liability partnership, because a partnership by definition requires two or more persons.
In a professional corporation, lawyer owners are shareholders. A solo is allowed to operate a firm as a professional corporation. Generally speaking, the body of law applicable to normal corporations will apply to law firms operating as professional corporations. At a minimum, a professional corporation should adhere to general corporate requirements, e.g., hold annual meeting, have bylaws, use board and corporate resolutions to act.
Limited Liability Company
In a limited liability company, lawyer owners are called members. As with professional corporations, a solo is allowed to operate a firm as a limited liability company. The body of corporate law generally does not apply to limited liability companies, and courts typically defer to the rights and obligations contained in the operating agreement governing the company. Limited liability companies generally give lawyers more flexibility in how they operate it, than do professional corporations.