BILL ANALYSIS
SENATE JUDICIARY COMMITTEE
Senator Joseph L. Dunn, Chair
2005-2006 Regular Session
AB 2914 A
Assembly Member Leno B
As Amended June 22, 2006
Hearing Date: June 27, 2006 2
Corporations Code 9
GWW:rm 1
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SUBJECT
Architects: Limited Liability Partnerships
DESCRIPTION
This bill would extend until January 1, 2012 existing law
that allows architectural firms to form limited liability
partnerships (LLPs) and foreign limited liability
partnerships to engage in the practice of architecture.
The bill would also increase, on January 1, 2008, to
$1,000,000 (from $500,000) the minimum amount of insurance
that an architectural LLP must obtain in order to gain the
LLP status.
(This analysis reflects author's amendments to be offered
in committee.)
BACKGROUND
Under the Beverly-Killea Limited Liability Company (LLC)
Act, a foreign or domestic limited liability company is
prohibited from rendering professional services in this
state unless expressly authorized under applicable
provisions of law. Professional services are those
services for which a license, certification, or
registration is required under specified statutes.
The rationale for the exclusion was that service providers
who harm others by their misconduct, incompetence or
negligence should not be able to limit their liability by
(more)
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operating as a LLC or LLP and thus become potentially
judgment-proof.
In general, operation as a LLP offers both liability and
tax advantages. As a general rule, LLPs combine the
limited liability attributes of a corporation with the
federal tax advantage of operating as a general
partnership. For liability purposes, partners in a LLP
have no personal liability for the torts of the partnership
and stand to lose only the amount he or she has contributed
or is obligated to contribute under the terms of the
partnership agreement. In a general partnership, however,
the partner would be jointly and severally liable with the
other partners for any tort of the partnership, including a
tort of one of the individual partners. In both settings,
the individual wrongdoing partner would be personally
liable for his or her tort.
In 1998, AB 469 (Cardoza), Chapter 504, Statutes of 1998,
was enacted to allow licensed architects to operate as LLPs
for a trial period. Like other professionals (such as
licensed accountants and licensed attorneys) that are
allowed to operate as a LLP, the entity is required to
carry a specified minimum level of insurance as a condition
of operating as a LLC.
CHANGES TO EXISTING LAW
Existing law , until January 1, 2007, authorizes registered
LLPs to be formed for the practice of architecture when the
LLP maintains liability insurance of at least $500,000 or
an amount equal to $100,000 multiplied by the number of
licensees in the firm, whichever is greater, up to a
maximum of $5 million, for claims arising from acts, errors
or omissions arising out of the practice of architecture.
In lieu of the insurance coverage, the LLP may maintain in
trust or bank escrow, cash, bank certificates of deposits,
US Treasury obligations, or bank letters of credit in the
required amount as security for payment of tort or contract
liabilities.
This bill would extend that sunset date five years to
January 1, 2012.
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This bill , on January 1, 2008, would increase the required
minimum amount of insurance to at least $1 million for a
LLP with 5 or fewer licensees. For additional licensees
above 5, an additional $100,000 per additional licensee
would be required.
COMMENT
1. Stated need for bill
According to the author's office, more than 100
architectural firms have registered as LLPs. Allowing
the law to sunset would require these existing LLP firms
to undergo considerable expense to reorganize.
The author also asserts that licensed architectural firms
have had a successful eight-year experience operating as
LLPs, and that the current law allowing architectural
LLPs allow California offices of national firms to
parallel their business structure in other states such as
New York and Illinois. Extension of the law would also
avoid anomalous results for partners in national firms
when they engage in projects across state lines.
2. Increase in minimum required insurance coverage appears
appropriate in light of increased claims experience
California's LLP law has always sought to strike a
balance between allowing professional licensed service
providers to operate in a mode offering both tax and
liability-limiting advantages while preserving to an
appropriate degree the ability of a party injured by
professional negligence to recover damages for that
injury. Thus, an insurance requirement has always been
imposed upon professional licensees wishing to operate as
a LLP.
The rationale behind the insurance requirement is to
ensure that a person who is injured by a LLP is likely
able to collect his or her judgment. Because of the
limited liability attributes of a LLP, the injured person
can no longer rely on the joint and several liability of
the partners and their personal assets, but must look to
the assets of the LLP. To ensure adequate but not
necessarily complete recovery in all claims, the
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insurance requirement is added as a condition of being
permitted to operate as a LLP. Thus, even if the LLP has
few assets because the profits are regularly distributed
to its members, the required insurance is available to
pay tort damages.
The difficulty has always been in the setting of the
minimum level of required insurance in an appropriate
amount. While the law has never sought to cover all
potential claims, since that would obviate the need and
benefit for operating as a LLP, the law has always sought
to ensure that most predictable claims are covered.
Hence, committee staff has always sought and used the
available insurance claims data in proposing the
recommended minimum insurance requirements.
When the original LLP law for architects was enacted in
1998, the scanty insurance data then available (see,
also, Comment 3, below) did not provide a clear picture
of the types and amounts of judgments assessed against
architects for professional negligence. According to the
Senate Judiciary Committee analysis of that enabling
measure, AB 469 (Cardoza) of 1998, the available
information suggested that the average payout on claims
against architects between 1993 and 1997 was about
$32,000.
According to the latest data gathered by the sponsors
from insurers representing less than 50% of the market in
preparation for this bill, the average payment of claims
against small firms with gross billings of $500,000 has
at least doubled, averaging $65,526 in the last 10 years.
For firms with between $500,000 and $5 million in gross
billings, the average payout over the 10 years studied
was $141,699, with the average reaching $216,279 in 2004
and subsiding lightly to $206,335 in 2005. For firms
with gross billings over $5 million, which likely involve
firms with a large number of architects, the average
claims paid over the 10-year period was $422,657, with a
spike in 1998 of $1.6 million and a low in 2004 of
$119,970. (Under the LLP law, a 50 licensee
architectural firm would be required to carry the maximum
$5 million in insurance.)
In addition, the limited claims data showed the 10
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largest claims paid on behalf of California architects
were as follows:
$2,302,214 in 1998
$1,802,443 in 2004
$1,218,857 in 2003
$1,181,596 in 1999
$1,103,049 in 1998
$1,000,000 in 2002
$987,161 in 2002
$971,056 in 2001
$955,735 in 2002
Given the increase in average claims paid over the course
of years since the enactment of the original LLP law for
architects, the proposed increase in the minimum
insurance requirements from $500,000 to $1,000,000 for
LLP firms with five or fewer licensees seems appropriate.
The numbers also justify the step-up for larger LLPs.
3. Incomplete data is not a new problem
In 1998, the Senate Judiciary Committee analysis for AB
469 stated:
The scanty available claims data provided by the
sponsor does not provide a clear picture of the types
of judgments assessed against architects for
professional negligence.
Again in 2001, that precise information is not available.
And in 2006, only partial information is made available.
At the very least, the lack of complete data justifies
the policy of extending the sunset for the LLP law for
moderate periods of time, to enable periodic review,
rather than its complete repeal.
4. Potential future issue
The current insurance coverage required in all the LLP
laws provide that "the impairment or exhaustion of the
aggregate limit of liability by amounts paid under the
policy in connection with the settlement, discharge, or
defense of claims applicable to a designated period shall
not require the partnership to acquire additional
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insurance for that designated period."
In short, the required insurance is a "wasting assets"
policy that could be well be depleted by defenses costs
and multiple claims in a coverage year so that the more
difficult claims to resolve, usually the larger claims,
could result in no payment at all to the tort victim
because the required insurance assets for the covered
year has been exhausted.
This possibility of the required insurance being
exhausted in a coverage year also justifies the proposed
increase. However, the issue of the "wasting asset"
insurance policy and whether there should be an
obligation on LLPs to replenish the policy during the
course of the year deserves re-visiting in the future as
defense and claims costs increase year after year.
5. Related legislation
AB 180 (Horton), on the Senate Inactive File, would allow
engineers and land surveyors to operate as LLPs if the
partnership maintained at least $1.5 million in insurance
for a LLP with up to five licensed persons rendering
professional services, and $2 million for a LLP with up
to 10 licensed persons rendering professional services.
If there are more than 10 licensed persons rendering
professional services on behalf of the LLP, the bill
would require an additional $1 million for every one to
five additional licensed persons rendering professional
services on behalf of the partnership. However, the
total aggregate limit of liability under the policy or
policies of insurance for the LLP is not required to
exceed $7.5 million, less amounts paid in defending,
settling, or discharging claims, provided that a minimum
of two-thirds of each policy or policies of insurance is
reserved for payment of claims and not more than
one-third of each policy or policies of insurance may be
used for payment of costs for defending, settling, or
discharging claims.
AB 180's insurance requirements are higher than that
proposed by architects in light of the high liability
payouts in that practice area. According to the provided
insurance data, the highest claims paid in 5 of the last
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10 years surveyed exceeded $1,000,000. The highest were
$3.5 million in 2002, $1.45 million in 1995, $1.15
million in 1994, $1,100,000 in 2003, and $1,086,500 in
1998. There also was no data available for claims
resulting from the recent disasters involving landslides
in Southern California.
Complicating the analysis for AB 180 was the fact that
data showing the frequency of such high payouts was
requested but denied by all but one insurer on the
grounds that such information is proprietary. That one
insurer, representing about 40% of the market, indicated
that in the past five years, one claim exceeded $1.5
million (but did not indicate by how much), two claims
were within the $1 million to $1.25 range, and two were
within the $500,000 to $1 million range (out of 234
claims).
Support: None Known
Opposition:None Known
HISTORY
Source: American Institute of Architects, California
Council (AIACC)
Related Pending Legislation: AB
180 (Horton), noted above in Comment 5, On
Senate Inactive File
AB 2235 (Parra), would permit
commercial
mortgage brokers to operate as a LLP, pending in
this Committee
Prior Legislation:AB 469 (Cardoza), Chapter 504, Statutes
of 1998
AB 1596 (Shelley), Chapter 595, Statutes of
2001
Prior Vote:Assembly Floor (75 - 0)
Assembly Business and Professions Committee (10 -
0)
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