What is Unlimited Liability?
Definition: Unlimited liability refers to the uncapped responsibility of business owners to cover the liabilities of a business. A business owner of a sole proprietorship or a general partner of a partnership has the obligation to cover the liabilities of the business in case the business runs out of money.
By unlimited liability, it means that creditors can stop at nothing to get their money back from a business. Even if they have to auction the personal assets of business owners and general partners.
Unlimited Liability Explained
Each country has its set of laws that govern the private sector called company law. The company law includes all legal explanations of the business sector, including business formation and company incorporation. One of the things that company law explains is liability. Typically, people come together to form companies as a means of growing their wealth. However, the law provides that anyone that ventures into business must be willing to suffer the risk of the business collapsing. This is what liability is all about.
Liability refers to the financial obligations that a business owes its creditors. It could be payment for supplies or loans from banks. During operations, a business may accrue a certain number of liabilities. Typically, larger businesses like corporations accrue huge liabilities. From the perspective of unlimited liability, the business owner has the obligation to settle all the liabilities of the business in full. In many jurisdictions around the world, sole proprietorships and general partnerships carry unlimited liability.
Unlimited Liability Example
Karim was a sports journalist before he saw an opportunity to open a pizzeria in his neighborhood. Short on capital, Karim took a $3 million loan from a local bank with a condition to pay it full in five years but has a grace period of one year. In addition, Karim hired an interior designer whose dues would be paid in four three-month installments of $25,000. The table below shows the liabilities of the pizzeria after six months of operation.
| Total Liabilities after Six Months of Operation | |
| Interior Designer | 50,000 |
| Wages And Salaries | 75,000 |
| total current liabilities | 125,000 |
| Bank Loan | 3,000,000 |
| total longterm liabilities | 3,000,000 |
| total liabilities | 3,125,000 |
After the six months, business tanks and Karim want to wind down the business. Unfortunately, the proceedings from liquidation of the business amount to just $1.56 million. Therefore, the business is unable to fulfill its obligations to creditors.
In this case, Karim is under obligation to clear the remaining sum of liabilities. Under unlimited liability, the law gives latitude to Karim’s creditors to seize his personal properties to recover their money. Therefore, the bank, the interior designer, and the workers can auction off Karim’s car, the house, and any other personal property to recover their dues.
What if the pizzeria were a general partnership involving Karim and four other people? In this case, the general partners would share the liabilities equally. This is because typical general partnerships include partners with equal shares in the business. Here, personal properties of each of the general partner of the business would be seized to cover the remaining liabilities. However, each general partner would contribute (through property seizure) an equal amount. In this case, Karim and his partners would contribute $313,000.
Unlimited Liability vs Limited Liability – What’s the Difference?
On the contrary, a limited liability arrangement shields the business owner in case the business collapses. In the US, the Small Business Administration (SBA) allows people to form limited liability companies. This is possible in many other jurisdictions across the world. As per the US SBA, a limited liability business structure protects the business owner in the same way owners of big corporations.
A limited liability company (LLC) is a small business but the owners are protected from personal liability. That means the personal property of an LLC owner will not be seized in case the business collapses. Although the protection from liability for an LLC owner is similar to owners of corporations, the individual is not subject to hefty taxes that owners of corporations face.