August 31, 2006

Commercial Mortgage Financing and General Partnerships

Each General Partner is Personally Liable for the Debts of the Partnership

Suppose you are making or arranging a commercial real estate loan for a partnership. The important thing to remember about partnerships is that each general partner is personally liable for the debts of the partnership. Yikes!

A partnership is a business entity formed by two or more people or other business entities. Most partnerships involve a handful of real people as the partners; however, it is legally permissible for a corporation or limited liability company (LLC) to "partner up" with a real person or even another LLC.

Partners split the profit or loss of the business according to the terms of the Partnership Agreement. Two partners could easily agree to split the profit and losses 80/20, rather than 50/50. After all, one guy could be doing 80% of the work or could be putting up 80% of the dough.

The good news about partnerships is that partnerships do not have to pay taxes. Suppose Bob and Steve get together and decide to form an energy company in the form of a partnership.

Had they formed a corporation instead, the corporation would have been required to pay taxes on any profits. Yuck. Then, after 35% of the profits had been eaten away by the government in taxes, Bob and Steve would then have been required to pay even more taxes on any remaining profit they distributed to themselves as dividends. Double yuck.

Fortunately Bob and Steve formed a partnership. If the partnerhip made $100,000 in profit in 2006, and the partners had agreed to split profits 50/50, both Bob and Steve would have to add $50,000 in profit to their personal tax returns. However, B&S Energy Company, a California general partnerhip, would not be required to pay taxes on the $100,000 in profits. The full $100,000 would pass through to Bob and Steve, without some grubby government tax collector taking a huge bite.

That's the good news.

Here's the bad news. Each partner in a general (garden variety) partnership is personally liable for the debts of the partnership incurred in the regular course of business. Steve is a great guy but a dummy. He makes a contract to deliver 200,000 gallons of gasoline to local gas stations for $2.50 per gallon, and the wholesale price suddenly jumps to $4.00 per gallon. B&S Energy Company can't buy gas at $4.00 per gallon and deliver it at $2.50 per gallon. The company folds. Steve skips town. The gas stations get together and sue Bob personally. Can they seize his bank accounts, his boat, and his valuable coin collection? You betcha. Bob is personally liable for the debts of the partnership.

If you are making or arranging a commercial real estate loan to a general partnership, you will need to ask the borrowers for, in addition to the normal paperwork, a copy of their partnership agreement, a financial statement on the partnership, and two years' tax returns on the partnership. If the partnership defaults on the debt, and the bank takes a loss on the deal, the bank can go after the personal assets of each general partner.