Setting Up In Business – Choosing a Trading Style of Business

Introduction

Setting up in business is a serious matter that should be made after consideration of the advantages and disadvantages of each of the methods of doing business. Many businesses trade as companies, due to the protection of limitations of liability of the shareholders and directors created by the Companies Act; these limitations of liability come at the price of preparing and filing statutory accounts, adhering to provisions of articles of association and holding general meetings to report to the shareholders. At the other extreme, any person (subject to limited exceptions), may trade in their own name with minimal formalities.

From a commercial perspective, the decision should be made after having regard for the priorities of the owners of the business and the intended size, scale and nature of the undertaking that will be the business.

There are various types of legal entities which exist in England, including:

1. Sole Traders

A sole trader runs their business in their own name, as an individual. Sole traders have unlimited liability, therefore their business assets as well as their personal assets are at risk if liability arises, say in the deficient performance of a contract. For instance, if a builder were to trade in their own name, and cause damage through the negligent performance of their work, the claimant suing them would be entitled to recover against all their business assets and assets owned by them that are not used in the business to satisfy an adverse judgment.

1. Partnerships

A English partnership is an association of two or more people formed for the purpose of doing business together with a view to making a profit. It is an unincorporated association.

A partnership is a group of sole traders coming together to run a business with a view to making a profit. As the partners are doing business together, the law imposes obligations of trust and fidelity upon each of the in the affairs of the business in the partners’ relationships with another. Each partner’s relationship with third parties has implications for each of the third parties. For example, a partner of a business has the ability to bind each and every other partner to contracts entered into by them in the ordinary course of business. This is in turn places the partnership’s assets at stake in the event of liability on a contract with third parties, and all of the assets of all the other partners in the event of liability

In terms of legal liability, partnerships and sole traders may be contrasted with a company. These forms of trading do not have the separate legal personality of their own, which gives rise to the liability in each of the partners, as opposed to a company (where the liability of each of the shareholders’ and directors’ liability is limited). Therefore, partners have joint unlimited liability for the debts and liabilities of the partnership. Even where partners leave the partnership, they are still liable for debts incurred prior to their departure.

2. Limited Liability Partnerships (‘LLP’)

An LLP is a body corporate and has its own legal personality like a company, which is separate from that of its members. An LLP is subject to similar incorporation requirements as a company. Limited Liability Partnerships are a relatively new form of business entity which has come about due to the concern surrounding the negligence claims of large partnerships.

The LLP is liable to the extent of its own assets, but the members themselves only have limited liability and their own assets are not at risk in the same way as for traditional partnerships (see above). However, where an LLP is wound up, if a member of the LLP has withdrawn property from the LLP within two years of the winding-up, having reasonable grounds to believe that the LLP could not pay its debts, that member may be subject to a form of ‘claw-back’ and risk facing a claim.

3. Unlimited Company

An unlimited company is a registered company whose shareholders have unlimited liability and will therefore be liable for all of the company’s debts and liabilities.

4. Limited Company

An English limited company is a company incorporated by registration under the Companies Act. Shareholders (referred to as ‘members’ in the Companies Act) of a limited company only have ‘limited liability’. Where a company is limited by shares, members liability is only limited to the value of their shares. Where a company is limited by guarantee, members pay an agreed nominal amount, usually between £1.00 – £5.00, to their company if it is wound up.

A limited company’s name must either end with ‘Ltd’ if it is a private company or ‘Plc’ if it is a public company. That suffix must be used on all business paper of the company. This requirement is so that people dealing with the company are put on notice that they are dealing with a entity that has limited liability.

A registered limited liability company is legally distinct and separate from the individuals who formed it, the shareholders and the people who run it, and so are not liable for the debts and other liabilities for the company. Thus a company has an independent and separate personality from that of its directors and shareholders. The law recognises the company as an entity which has the capacity to enter into contracts, commit torts and crimes and which is responsible and answerable for all of its own actions, capable of suing and being sued. A company owns its own property and assets, and not the shareholders and directors. These are the incidents of the separate legal liability. The significance of a company having its own separate legal personality is that it is only the company itself which is liable for its own debts and liabilities. Such liability is unlimited as against the company.

Depending on the type of company, the shareholders liability will usually be limited and is referred to as ‘limited liability’. This does not apply to unlimited liability companies.

Corporate veil

Having been incorporated in England, a company is protected by the ‘corporate veil’. The principle of the corporate veil is that as the company itself is a separate legal entity with an independent personality of its own, property of the company’s shareholders or members is protected and proceedings can not be brought directly against them, except in very limited circumstances.

The leading case on this point is Salomon v A Salomon & Co. Ltd (1897) where Lord Macnaughten stated:

‘The company is at law a different person altogether from the subscribers and, although it may be that after incorporation the business is precisely the same as it was before, and the same persons are managers, and the same hands receive the profits, the company is not in law the agent of the subscribers nor trustee for them. Nor are the subscribers as members liable in any shape or form, except to the extent and in the manner provided by the act.’

Piercing the corporate veil

The principles outlined in the case of Salomon are not always applied and there are circumstances where the independent personality of the company is ignored. When this happens, the company is not treated as a separate legal entity and the court is said to ‘pierce the corporate veil’, effectively looking behind the corporate veil at the individual members of the company, making them personally liable for the company’s actions and debts.

The following situations are examples where the corporate veil is lifted:

Fraud

Where members of a company hide behind the company for the purposes of committing a fraud or to further some other wrongful, inequitable or improper conduct, such as evading certain legal obligations or to create a sham company for the purposes of avoiding personal liability, the court will lift the corporate veil to prevent this from happening.

In the case of Trebanog Working Men’s Club v MacDonald (1904), an incorporated company was treated as an unincorporated association where sales of alcohol were treated as matters of internal accounting between members as opposed to a criminal retail sale without a valid licence.

b) Agency

The courts will lift the veil of incorporation where an agency relationship can be established in fact, usually where the controlling shareholder of a company is in fact another company and there is a tendency to ignore the separate legal personalities of all of the companies in a group.

c) Trust

Where the company is considered to hold its property on trust for its members, the corporate veil may be lifted.

d) Group enterprises

The court may treat the separate companies in a group as one legal entity. This only usually happens where members of a group are acting as a façade and an attempt is being made to conceal certain facts.

The courts are reluctant to lift the corporate veil and are strict in their approach to this. Attempts have been made to broaden the circumstances in which the corporate veil is usually lifted, but without notable success.

Conclusion

Many businesses elect to trade as sole proprietors to ease administrative expenses and statutory accounting requirements. The Limited Liability Partnership is of increasing popularity, as it offers the limited liability of a company, but with a reduced taxation burden on the owners of the business. Statutory accounting requirements apply nonetheless.

It is for the intended owners of the business to select the most appropriate style of trading for their purposes; planning for the form of the entity should begin with the business plan.