BILL ANALYSIS �
SENATE JUDICIARY COMMITTEE
Senator Noreen Evans, Chair
2011-2012 Regular Session
AB 560 (Gorell)
As Amended April 6, 2011
Hearing Date: July 5, 2011
Fiscal: Yes
Urgency: No
RD
SUBJECT
Professional Limited Liability Partnerships
DESCRIPTION
Existing law authorizes limited liability partnerships (LLPs)
for the practice of architecture until January 1, 2012. This
bill would remove that sunset date, thereby providing licensed
architects the ability to organize as LLPs indefinitely.
BACKGROUND
Under the Beverly-Killea Limited Liability Company Act (the LLC
Act) (SB 469 (Beverly, Killea, Ch. 1200, Stats.1994)), a foreign
or domestic limited liability company (LLC) 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. Thus,
law, accountancy, and architectural firms could not take
advantage of the legislation. With the creation of LLPs in
1995, however, some business entities are able to combine the
limited liability attributes of a corporation with the federal
tax advantage of operating as a general partnership. As a
result, for liability purposes, a partner in an LLP has no
personal liability for the torts of the partnership and stands
to lose only the amount he or she has contributed or is
obligated to contribute under the terms of the partnership
agreement.
In 1995, SB 513 (Calderon, Ch. 679, Stats. 1995), sponsored and
supported by law and accountancy firms, authorized the
(more)
AB 560 (Gorell)
Page 2 of ?
establishment of LLPs for licensed attorneys and licensed
accountants, as long as the LLP purchased a liability insurance
policy or maintained bank deposits of at least $100,000 per
limited liability partner (or an aggregate of not less than
$500,000 for fewer than five partners and not more than $5
million for all others). Only partnerships with a net worth of
$10 million or more were allowed to become LLPs. In 1998,
architects were allowed to form LLPs under the same conditions
as accountants and attorneys, for a trial period of ten years
(AB 469 (Cardoza, Ch. 504, Stats. 1998)).
Most recently, in 2006, AB 2914 (Leno, Ch. 426, Stats. 2006) was
enacted, extending the sunset date of LLPs for architects until
January 1, 2012. As introduced, AB 2914 would have deleted the
sunset date on licensed architects' ability to organize as an
LLP. That bill was eventually amended in the Senate to include
a sunset date of January 1, 2012. The bill also changed the
level of insurance required of architectural LLPs, doubling the
minimum amount from $500,000 to $1 million.
An LLP can be either a registered LLP or foreign LLP. These are
partnerships, other than a limited partnership, formed on an
agreement governed by the California's Corporation Code Sections
16951 et seq. and registered under Corporations Code Section
16953 (if a registered LLP), or governed by the laws of another
jurisdiction and registered under that jurisdiction's laws (if a
foreign LLP). Each of an LLP's partners must be a "licensed
person" in architecture, accountancy, law, engineering or land
surveying in California, or a person licensed or authorized to
provide those services in another jurisdiction. Unlike
accountants and lawyers who may elect the LLP status
indefinitely, the inclusion of architects, engineers, and land
surveyors as permissible professional LLPs extends only through
the end of their respective sunset dates. At this time, that
sunset date remains as January 1, 2012 for architects.
This bill, sponsored by the American Institute of Architects,
California Council (AIACC), would delete the sunset date on
licensed architects' ability to organize as an LLP, providing
them the ability to organize as such, indefinitely.
CHANGES TO EXISTING LAW
Existing law provides that a partner in a registered limited
liability partnership (LLP) is not liable or accountable,
directly or indirectly, including by way of indemnification,
AB 560 (Gorell)
Page 3 of ?
contribution, assessment, or otherwise, for debts, obligations,
or liabilities of or chargeable to the partnership or another
partner in the partnership, whether arising in tort, contract,
or otherwise, that are incurred, created, or assumed by the
partnership while the partnership is a registered limited
liability partnership, by reason of being a partner or acting in
the conduct of the business or activities of the partnership.
(Corp. Code Sec. 16306(c).)
Existing law defines "foreign LLP" to include partnerships
licensed to engage in the practice of architecture, engineering,
land surveying, public accountancy, or the practice of law.
(Corp. Code Sec. 16101(6)(A).)
Existing law defines "registered LLP" to include persons
licensed to engage in the practice of architecture, engineering,
land surveying, public accountancy, or law. (Corp. Code Sec.
16101(8)(A).)
Existing law defines "professional LLP services" to include the
practice of architecture, engineering, land surveying, public
accountancy, or law. (Corp. Code Sec. 16101(14).)
Existing law provides that general partners of LLPs are jointly
and severally liable for all obligations of the limited
partnership. (Corp. Code Sec. 15904.04.)
Existing law requires that every registered LLP and foreign LLP
provide security for claims, as specified. (Corp. Code Sec.
16956.)
Existing law requires all LLPs, at the time of registration and
continuously while transacting intrastate business to provide
security for claims, as specified. For claims based upon acts,
errors, or omissions arising out of the practice of
architecture, a registered limited liability partnership or
foreign limited liability partnership providing architectural
services shall comply with one, or some combination as
specified, of the following:
maintaining a policy or policies of insurance against
liability imposed on or against it by law for damages arising
out of claims as follows:
o the total aggregate limit of liability under the policy
or policies of insurance for partnerships with five or
fewer licensees rendering professional services on behalf
of the partnership shall not be less than one million
AB 560 (Gorell)
Page 4 of ?
dollars ($1,000,000),
o for partnerships with more than five licensees rendering
professional services on behalf of the partnership, an
additional one hundred thousand dollars ($100,000) of
liability coverage shall be obtained for each additional
licensee;
o however, the total aggregate limit of liability under
the policy or policies of insurance is not required to
exceed five million dollars ($5,000,000); or
in lieu of insurance coverage as specified above, maintaining
in trust or bank escrow, cash, bank certificates of deposit,
United States Treasury obligations, bank letters of credit, or
bonds of insurance or surety companies as security for payment
of liabilities imposed by law for damages arising out of all
claims as follows:
o the maximum amount of security for partnerships with
five or fewer licensees rendering professional services on
behalf of the partnership shall not be less than one
million dollars ($1,000,000);
o for partnerships with more than five licensees rendering
professional services on behalf of the partnership, an
additional one hundred thousand dollars ($100,000) of
security shall be obtained for each additional licensee;
o however, the maximum amount of security is not required
to exceed five million dollars ($5,000,000). (Corp. Code
Sec. 16956(a)(3)(A)-(B).)
Existing law provides 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 insurance for that designated
period. (Corp Code Sec. 16956(a)(3)(A).)
Existing law sunsets the ability of architects to organize as
LLPs on January 1, 2012. (Corp. Code Sec. 16101(19).)
This bill would remove the above January 1, 2012 sunset date.
COMMENT
1. Stated need for the bill
According to the author:
Existing law allows attorneys, accountants, architects,
AB 560 (Gorell)
Page 5 of ?
engineers, and land surveyors to organize as Limited Liability
Partnerships. Unlike attorneys and accountants, the architect
LLP law (and the engineer and land surveyor law, enacted last
year) contains a sunset date. AB 560 proposes to eliminate
the sunset date on the architect LLP, giving it the same
status as the law for accountants and attorneys.
Without AB 560, the architect LLP law would expire, forcing
the nearly 200 architect LLPs to reorganize their businesses
to another business structure, and most likely require them to
rewrite their existing contracts to reflect that change.
Also, the sunset date serves as a disincentive for
architecture firms to organize as an LLP. Many architectural
firm principals dismiss the LLP structure as a viable option
because of the sunset date; they do not want to risk having to
reorganize their firm and rewrite existing contracts.
The sponsor of this bill, the AIACC, adds that by removing the
sunset date, this bill "�brings] this law into parity with the
law that authorizes attorneys and licensed accountants to form
LLPs. . . . While the 1995 legislation that authorized attorneys
and licensed accountants to form LLPs did not include a sunset
date, the 1998 legislation to add licensed architects to the LLP
statutory framework did include a sunset date �later extended
twice]."
2. Liability and tax advantages of LLP status warrants caution
in authorizing business entities to organize under the LLP
designation and justifies the continued use of a sunset date
This bill would remove the sunset date for licensed architects
to organize as LLPs, which is currently set to expire on January
1, 2012. As described in more detail below, this raises the
concern that there is not sufficient claims data to support the
statutory structure of the architect LLPs indefinitely, without
the periodic oversight of the Legislature to ensure that
consumers are not unjustifiably harmed and left without proper
compensation from the wrongdoing LLP. To mitigate this concern,
significant claims data is called for; unfortunately, that data
is also largely unavailable or difficult to obtain.
Accordingly, the author has agreed to extending the sunset by an
additional seven years.
The ability to organize as LLPs carries with it enormous legal
significance, namely that the operation of a business as an LLP
offers both liability and tax advantages. As a general rule,
LLPs combine the limited liability attributes of a corporation
AB 560 (Gorell)
Page 6 of ?
with the federal tax advantage of operating as a general
partnership. For liability purposes, partners in an 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.
The practical impact of this is that if a person is injured as a
result of any acts, errors, or omissions arising out of the
practice of an LLP, and his or her judgment or claim is worth
more than the amount of the LLP's available insurance and any
potential payout from the personal wealth of the partner who
participated in the tort, the injured person would be prohibited
from recovering the rest of his or her rightfully-owed judgment
from the other partners, even though those partners benefit from
the ability to organize as an LLP. As such, concerns for
potential injured parties and the associated need to have
sufficient coverage of insurance to cover judgments by these
LLPs warrants caution by the Legislature, not just in terms of
providing authorization for licensed professionals in any
particular area of practice to organize under the LLP
designation, but especially in removing the sunset date that
effectively regulates and limits the availability of that LLP
designation.
The advantage of having a sunset date is that the Legislature
can periodically review the claims data available and assess
whether the LLP status is appropriate and whether higher
statutory insurance minimums are necessary to justify providing
business entities such significant liability and tax advantages
in face of the potential for harm suffered by individuals going
uncompensated or under-compensated.
When the original legislation was passed, providing for the
permissible formation of licensed architects as LLPs, this
Committee's analysis noted that:
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. While the
information provided by the sponsor suggests that the average
payout on claims against architects between 1993 and 1997 was
AB 560 (Gorell)
Page 7 of ?
about $32,000, the data does not show the range of the awards,
so that some claims could be for considerably higher amounts.
The sponsor contends that the required levels of insurance
should be adequate to pay any claims against an architect
firm. Depending on the size of the firm, an architect LLP
could have as little as $500,000 in insurance, or as much as
$5 million if there are 50 or more licensees in the firm.
While $500,000 of insurance would appear to be adequate to
cover practically all claims, it may not be adequate to cover
the extraordinary claim which far exceed�s] the norm. In any
event, the proposed three year-sunset would allow the issue to
be revisited should the mandated insurance coverage prove to
be inadequate. (Sen. Judiciary Com., analysis of AB 469
(1997-1998 Reg. Session), July 21, 1998, pg. 3.)
Thus, here, where this bill seeks to remove the sunset date
altogether, the policy question raised by the bill is whether
existing claims data supports a finding that the insurance
requirements are adequate to cover most claims against
architects for professional negligence so that an injured party
does not go uncompensated because the business is operating as a
LLP. Without such assurances based in empirical evidence, it
may be premature to remove the sunset date and allow these LLPs
to organize and operate in perpetuity, as this bill would do.
As a result, the author has agreed to amend the bill to provide
for a seven year sunset as described in Comment 4(c).
3. The policy of wasting assets, and potential future problems
associated with that policy also cautions against removal of
the sunset date
The current insurance coverage required in the LLP statutes
provides 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 insurance for that designated
period." (Corp. Code Sec. 16956(a)(3)(A).) In other words,
assuming the designated period of a policy to be a year for the
purposes of illustration, where one or more claims exhaust an
LLP's entire policy limit for the year, the LLP has no
obligation to obtain additional insurance to "bridge over" or
cover claims that may arise before the new term begins.
In short, because the required insurance is a "wasting assets"
AB 560 (Gorell)
Page 8 of ?
policy that could well be depleted by defense costs and multiple
claims in a coverage year, difficult claims (usually the larger
claims) could result in no payment at all to the tort victim
because the required insurance assets for the covered year had
been exhausted.
The current minimum insurance requirement does not provide a
permanent solution to the above problem, 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. This becomes harder to
do with the removal of the sunset date and it becomes all the
more important there be sufficient data demonstrating that the
depletion of a policy rarely, if ever, becomes an issue for the
existing architecture LLPs. Committee staff notes that none of
the claims data provided and discussed below in Comment 4
contains any information that would fully mitigate that concern.
As such, removal of the sunset date is not appropriate at this
time, and the author has agreed to an amendment extending the
sunset. (See Comment 4(c).)
4. Importance of claims data
By removing the sunset date, this bill would have the effect of
allowing licensed architects to organize as LLPs indefinitely,
without any check by the Legislature on a periodic basis to
ensure that there are no abuses made of that designation or
unjustifiable costs shifted unfairly onto the public in allowing
for these limited liability entities to operate.
As discussed in Comment 2 above, California's LLP law has always
sought to strike a balance between allowing professional
licensed service providers to operate in a mode offering both
liability-limiting and taxation advantages while preserving to
an appropriate degree the ability of a party injured by
professional negligence to recover damages for that injury. In
trying to strike that balance, the Legislature has imposed an
insurance minimum 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 an LLP is likely able to collect his or
her judgment. Because of the limited liability attributes of an
LLP, the injured person can no longer rely on the joint and
several liability of the partners and their personal assets, but
AB 560 (Gorell)
Page 9 of ?
must look to the assets of the LLP. To ensure adequate but not
necessarily complete recovery in all claims, the Legislature
added the insurance requirement 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. Relatedly, the sunset date requires a periodic
reevaluation by the Legislature of the sufficiency of insurance
in considering any extension of the LLP status into the future
for a particular area of practice. Removal of that sunset,
absent sufficient empirical data demonstrating that the concerns
of an injured person going uncompensated has been eliminated at
least with respect to the most predictable claims, would not be
prudent. This review is especially necessary in light of the
wasting assets policy discussed in Comment 3 above, which leaves
the potential for policies to be completely exhausted and claims
left uncompensated until the new term for the policy begins.
a. Limited claims data available currently supports existing
statutory minimums
In an effort to support both the current level of insurance
minimums and the removal of the sunset date to extend the
availability of LLP status for architecture firms
indefinitely, the sponsor of this bill has provided Committee
staff with three sets of claims data arguably demonstrating
the sufficiency of the insurance in the majority of
circumstances.
By way of background information, the sponsor also explains
that while the statutory scheme provides that each LLP shall
have a minimum of $1 million in insurance coverage for any
firms of five or less architects, with an additional $100,000
over that $1 million for each licensed architect in addition
to the first five, up to a statutory maximum of $5 million,
the insurance market is such that after $1 million of
insurance, levels of insurance automatically rise by $1
million increments. Thus, where the statutory requirement of
minimum insurance for a firm of six licensed architects would
be $1.1 million, the closest amount of actual insurance
available, without going under $1.1 million, would be $2
million. The sponsor also notes that some architect LLPs
carry project specific insurance that is in addition to their
regular policy. Also, due to the proprietary nature of the
information contained in the reports provided to Committee
staff and that the insurers expressly prohibited the
AB 560 (Gorell)
Page 10 of ?
information from public dissemination, Committee staff is
largely limited to describing its analysis of the contents.
The claims data provided by the sponsor reflects the number of
claims per year over a 10 year period by firm size, the
average loss for each year, and, from one insurer, the largest
payment by firm size for each year.
According to this data, the highest amounts paid out by small
firms over the last ten years are as follows ranged from
around $300,000 to $1,009,000. The range from medium sized
firms was from around $99,000 to $1,300,000. And the range
for large firms was from around $8,000 to $2,500,000. On
average, the claims paid by the insurer were approximately
$51,000.
Despite the several figures showing claims over the amount of
$1 million, the limited data that is available appears to
support the conclusion that most of those claims appear to be
with respect to firms that would have greater insurance
coverage due to their size. There were, however, two
instances in which the data shows that firms with revenues
under $1 million saw a "maximum of total loss incurred" in an
amount in excess of $1 million twice since 2001. In both
instances, the portion of the total maximum loss incurred that
was in excess of $1 million was less than $10,000. According
to the sponsor, when those figures are adjusted for
loss prevention (or LP) expenses and unallocated/internal loss
adjustment expenses (or ULAE) which are not counted as part of
the eroding limit of the policy, the actual figure paid by the
insurer to the claimant is in fact at or below $1 million.
Data provided by the sponsor from another insurer included two
payments in excess of $1 million, but the insurer did not
provide information that identifies whether the payment was
for a claim on a small, medium, or large California architect
firm. The majority of claims paid were under $1 million
according to that data.
The third set of data, which contained information that was
collected as a result of a survey conducted among a subset of
architect LLPs, helped further establish that the current
statutory minimums for insurance appear to be appropriate and
there does not appear to be a current need to raise those
minimums.
AB 560 (Gorell)
Page 11 of ?
While Committee staff notes some deficiencies with the data
provided, the data overall suggests that the current minimums
provided for under the architect LLP statutes is sufficient,
given that the majority of payouts were under $1 million and
that the occasions of payouts over $1 million were relatively
infrequent.
b. Claims data does not support removal of the sunset date
Gathering and evaluating necessary data related to the issue
of the removal of the sunset data, however, has proven more
difficult. The same information that may have justified
leaving the status quo in terms of insurance does not rise to
the level of justifying removal of the sunset date, as the
standard of proof under which the latter question is reviewed
must be higher. This is because the greatest harm could come
from the Legislature removing itself completely from serving
as a check on these LLPs. The gaps that were explainable for
insurance minimum purposes, are harder to rationalize here.
Among the biggest gaps in information is that the data
provided does not in any way reflect whether there is
sufficient insurance for all legitimate claims made during the
term of a policy. Assuming the insurance is $1 million for a
period of 1 year, as discussed in Comment 3 above, if one
claim happens to cause the payout of the entire policy, any
future claims would not be covered by the insurance policy for
the rest of the year. This problem in particular requires
that the Legislature be able to review the insurance limits
every so often to ensure that claims are not unjustifiably
going unpaid because of the nature of the limited liability
provided by these partnerships.
Committee staff also notes incomplete information in terms of
the total judgment ordered and paid, versus the amount paid
out of the insurance policy on the claim, as well as with the
number of architects in the firms involved in each of these
claims. The limited data available does not reflect the full
payout received by a claim, which would include any deductible
paid by the LLP or any additional amount of the judgment that
would be left to be paid out of the personal liability of the
partner who was personally involved in the tortious conduct.
As a result, while Committee staff can determine that on
average, the insurance levels are appropriate, it is unable to
determine with certainty what the highest judgments are and
whether there was sufficient insurance to cover those
AB 560 (Gorell)
Page 12 of ?
judgments, or whether there was any remaining policy left for
any additional claims made-questions that have to be answered
to justify the policy decision to allow these LLPs to operate
in perpetuity.
In addition, while the survey produced relatively
comprehensive and helpful data where the other data sets
contained gaps, the information produced was only with respect
to a subset of the current number of California LLPs. Without
a greater response by the wider architect LLP community, it is
difficult to make a proper assessment of whether the removal
of the sunset date is appropriate.
Thus, as noted above, while sponsors have made a substantial
effort to provide Committee staff with the needed information,
important gaps in information makes it premature to remove the
sunset date until further documentation can be provided.
c. Proposed amendment in light of information
While there is a great deal of information suggesting that
most architect LLPs carry sufficient insurance for the average
claim, due to significant gaps in the information, as
described in Comment 4 above, the author has agreed to amend
the bill to extend the sunset, set to expire on January 1,
2012, by an additional seven years. The amendments are as
follows:
On page 5, line 31, insert "(19) The inclusion of the
practice of architecture as a professional limited
liability partnership service permitted by this section
shall extend only until January 1, 2019."
On page 5, line 35, strike "(19)" and insert "(20)"
On page 9, line 30, insert "(19) The inclusion of the
practice of architecture as a professional limited
liability partnership service permitted by this section
shall extend only until January 1, 2019."
On page 9, line 34, strike "(19)" and insert "(20)"
As the bill moves through the process, the author and sponsor
may wish to further enhance the reporting requirements.
AB 560 (Gorell)
Page 13 of ?
Support : None Known
Opposition : None Known
HISTORY
Source : American Institute of Architects, California Council
(AIACC)
Related Pending Legislation : None Known
Prior Legislation :
SB 1008 (Padilla, Ch. 634, Stats. 2010), authorized licensed
engineers and land surveyors to organize and operate as LLPs, as
specified, and requires engineers and land surveyors organizing
as LLPs to carry insurance liability coverage, as specified.
This authorization is set to sunset on January 1, 2016.
SB 414 (Corbett, Ch. 80, Stats. 2007), increased the liability
coverage amounts for accountancy and law LLPs.
AB 2914 (Leno, Ch. 426, Stats. 2006), See Background.
AB 180 (Jerome Horton, 2005), was substantially similar to SB
1008 (Padilla, Ch. 634, Stats. 2010) in its provisions of the
organization of engineers and land surveyors as LLPs, and
contained a sunset date. That bill passed this Committee 6-0
and was re-referred to the Committee on Appropriations, but was
ultimately gutted and amended to deal with a different topic.
AB 1265 (Benoit, 2003), would have permitted professional
engineers and land surveyors to organize as an LLP and would
have required that, depending on the number of partners, the LLP
have between $500,000 and $5 million in insurance. This bill
was held in this Committee.
AB 1596 (Shelley, Ch. 595, Stats. 2001), extended the sunset
date of statutes permitting architects to organize as LLPs, to
January 1, 2007.
AB 469 (Cardoza, Ch. 504, Stats. 1998), authorized architects to
form a LLP provided the partnership had between $500,000 and $5
million in insurance depending on the number of partners in the
LLP. This bill also provided that its provisions would sunset
on January 1, 2002. See also Background.
AB 560 (Gorell)
Page 14 of ?
SB 513 (Calderon, Ch. 679, Stats. 1995), See Background.
SB 469 (Beverly, Killea, Ch. 1200, Stats. 1994), See Background.
Prior Vote :
Assembly Floor (Ayes 70, Noes 0)
Assembly Appropriations (Ayes 17, Noes 0)
Assembly Business, Professions & Consumer Protections Committee
(Ayes 9, Noes 0)
**************