Legal entity and managing your personal risk

You might run your business as a sole trader or a partnership, or the business might trade as a limited company or limited liability partnership.

But why did you choose this format? Is this just historical and the way the business has evolved? Or consciously, on advice for tax or other liability reasons?

For the most part, owner-managed businesses will tend to be sole traderships, partnerships, or limited liability companies. A business may typically start with a single family member and other family members may then become part of it. A partnership may be formed. Further down the line, a decision will be made (or rejected) to trade as a limited company. Legal and tax advice may be sought (and be accepted or rejected).

So, what are the advantages and disadvantages and, crucially, the risks attached to different trading formats?

Risk factor: personal liability

A sole trader is a real human legal person who is personally liable for the liabilities of the business. This includes criminal liability.

Partners are similarly personally and jointly, and severally liable.

A limited liability company is not a human being but still a legal persona in its own right. Like sole traders and partners, it trades, employs staff, pays tax and VAT, and, crucially, is responsible for its actions. It must have licences, authorities and permits too, in its name to lawfully cover its activities, i.e. environmental permits/waste licences, premises licences, road transport operators’ licences, etc.

Criminal liability

Those trading as sole traders or partners should very carefully consider their exposure to personal criminal liability if something goes wrong. This can happen, possibly as a matter of chance or entirely unforeseen events. It may also occur through poor management systems and inadequate compliance. There is a fair prospect that every business (however it trades) will encounter some adverse event at some stage in its trading lifetime.

Sole traders and all partners within a partnership have personal criminal responsibility for their actions. They are exposed to the personal risk and consequences of things that may go wrong. If, say, there is a workplace accident, the person is personally investigated and may be prosecuted. Any conviction is a personal one. Put starkly, a person can also be imprisoned but a limited company cannot.

If the business has no licence or permit, the sole trader or partner is prosecuted by the relevant agencies such as the HSE, Environment Agency, local government or the police. This may have profound personal consequences, including DBS barring, the compromising of attempts to win new contracts and banking problems, and travel restrictions. They may be subject to significant fines and prosecution costs that can be enforced against them personally.

This can bite in other ways – for example, if such an entity fails to identify a driver of their vehicle, then they will have their personal driving licence endorsed with six penalty points – whereas a limited company has no driving licence to endorse. The employer of an unroadworthy vehicle used in the business may have points endorsed on their licence – though they were not even driving!

The vital point is this: those who trade are exposed to risk whereas there is some protection where the business operates as a limited company. In that case, it is normally the company alone that is investigated and prosecuted – and against which any criminal sanction is imposed. A director of a limited company will normally be interviewed under caution on behalf of the company, not in a personal capacity.

However, it is also the case that trading as a limited company does not provide an absolute ring of protection, such that the business owners are untouchable by any enforcement authorities – directors can be investigated prosecuted in tandem with companies, where they are deemed to have “permitted” offences to have occurred. “Permitting” can be a very wide legal definition, in some cases akin to slight negligence.

When considering the best trading entity, there may be trade-offs – on the one hand, individuals will want to avoid personal criminal liability and the risk of potential massive financial penalties (fines for health and safe-related and environmental law breaches fines can now be astronomical) – but other factors may counterbalance this: accounting and tax advice; reticence to trade as a limited company out of fear that the business will lose its history and provenance and ‘family-feel’.

However, if the best form of protection from criminal liability is being sought, then limited company (or limited liability partnership) status will be the best trading platform. Indeed, even if there are financial advantages of not trading as a limited company, is personal protection via that type of entity not a price worth paying?

Case study

The Environment Agency investigate an agricultural business for polluting a watercourse. Significant downstream damage is caused to fauna and acquatic life. It is a partnership. All three partners are active partners. The managing partner is invited to attend an interview under caution. Ashtons Legal advises them not to attend but instead to provide a written statement, as is commonplace. In due course, the partnership is prosecuted and significant fines and costs are imposed after all the partners plead Guilty.

Had the business traded as a limited company, the likely prosecution would have been against the limited company alone and any conviction would be one recorded against that entity. No director or other employee would have been convicted.

Right entity, wrong licence

As businesses grow, there may be a number of separate legal entities. For example, it is entirely commonplace for an agricultural business to have, say, a partnership that owns land and the same family members running a limited company that operates agricultural transport or other farming operations. This is entirely in order, although the same risk factors arise as outlined above.

A common error here is for the legal boundaries to become blurred and messy. It is commonplace for licences and permits to be in the name of the wrong entity or in fact in law not what the owners intended. For example, in our example here, the agricultural transport company must be controlling the transport operations be engaging the drivers and be carrying out all its operator’s licence obligations – it must hold the operator’s licence. They must be transparent, without blurred legal edges.

It is also commonplace for businesses that trade as one entity and then form a limited company to forget to apply for new licences with permits, either being neglectful or believing, in error, that since it is the same family and business it is all one and the same thing. It is not. They are distinct entities.

Ashtons Legal has recently dealt with two separate cases where the licencing was held by the wrong legal entity – both cases happened to involve road transport operator licensing – however, the type of licence does not matter – the concept is the same: the licence or permit must authorise the legal entity that is carrying out the relevant activity.

In our two recent cases (one involving a goods operator and one a passenger operator), the businesses comprised more than one trading entity. Both had a sole tradership and a limited company, but in both cases, vehicles were being operated by the sole tradership when the true operator of the vehicles was the limited company that did not hold the correct or large enough licence. On the surface, everything appeared to be well; however, the transport activity was entirely unlawful. The operators were formally called to disciplinary proceedings before a Traffic Commissioner in a forum known as a Public Inquiry, where action was taken.

Review

So, it is wise to stop and review your current trading arrangements:

• How do you trade at the moment and are you comfortable that it meets your requirements?
• Have you conducted a risk-based assessment of our trading status? What are your personal exposure risks, as business owners?
• Should you change? e.g. should you incorporate (former limited company or limited liability partnership)?
• Do you have good reason to retain your current business model?
• Do you have all licences, permits and permissions in the correct trading name?

It is a good idea to stop and address these issues before an event occurs. The outcome may be less favourable than it could have been, had limited liability status been adopted.

Contact our regulatory law solicitors today

If you have any questions regarding any of the issues raised in this article, please do not hesitate to contact our specialist Regulatory Law team by using our online enquiry form or by calling 0330 191 5713.