What is Unlimited Liability?
Definition: A business owner who has unlimited liability is personally liable for the debts of the business. Sole proprietorships and general partnerships fall within this category. The sole proprietor of a proprietorship or a general partner of a partnership will have to pay creditors from personal funds if the business runs out of money.
What does Unlimited Liability mean?
New businesses often have a high failure rate. A company that runs up substantial losses and debts may have to wind down its operations. If this happens, it is likely that there will be unpaid suppliers and other creditors who are owed money by the defunct business. There could also be financial institutions like banks that have advanced funds to the company. These debts will need to be repaid.
The entire responsibility of repayment will fall on the sole proprietor. If the business is structured as a partnership, the general partners will be responsible. Business funds will be used to pay off the debts. But a company that has become unviable and closed operations may not have the money to pay all its creditors. In this situation, the sole proprietor/general partner would need to pay out of personal funds.
In certain circumstances, personal assets like bank accounts, cars, and even the home that the business owner lives in, may be seized and sold to pay off the company’s debts.
Example of Unlimited Liability
Nicolas Hernandez decides to get into the restaurant business. He identifies a suitable location and takes it on lease for a year. He also buys kitchen equipment and furniture under a financing plan. The restaurant is established as a sole proprietorship.
In the initial days, the restaurant does well. It attracts many customers and even gets favorable reviews in the local paper. But soon business starts declining. Three months after the launch, Nicolas decides to shut down the restaurant. He cancels the lease on the property and returns the furniture and kitchen equipment.
After using all the funds that the restaurant has generated, Nicolas still needs to pay $7,000 to his creditors. As a sole proprietor, he has unlimited liability. Fortunately, Nicolas has some money in a personal checking account. He uses these funds as well as the cash that he gets by selling his car to pay off all his business dues.
If a business is structured as a sole proprietorship or a general partnership, the owner/partner has unlimited liability. Personal assets including the owner’s/general partner’s car and home may be seized and sold to pay off business dues.