Operating as a sole trader is not without its risks. While easy to set up and manage, the pitfalls become apparent should the business fail. Crucially, a sole trader faces unlimited liability for their business’ debts; if your business falls into debt, you, as an individual sole trader, will be liable for those debts. In short, a sole trader has one legal personality as the owner and the business are the same.
By comparison, establishing a limited company provides a business with a legal personality separate from the owner and directors. Different legal personalities allow companies to own property, enter contracts under their names, borrow money, and provide security independent of their owners and directors. Yet crucially, the company is only liable for its debts, which protects owners and directors should it fall into financial difficulties. Under most circumstances, a company’s creditors cannot sue or seize the assets of the owners or directors to pay off those debts. However, the relationship between owners, directors and companies can be complicated, giving rise to disputes and litigation and on these occasions, professional advice should be sought.
The rule of separate legal personality is one of the steadiest rules of corporate law. Conversely, it has also experienced a turbulent history and is one of the most litigated aspects of corporate law.
The corporate veil
The critical case in developing this rule is Saloman v A Saloman & Co [1897]. Mr Saloman, a bootmaker, transferred his business to a company, with members comprising himself and his family. Mr Saloman placed a floating charge on the company’s assets as part of the transfer. When the company was placed into liquidation, the liquidator, on behalf of the company’s creditors, alleged that the company was a sham and that Mr. Saloman, as the majority shareholder, should be personally liable for the company’s debt.
The House of Lords, on appeal, ruled that the company was an independent person with rights and liabilities of its own. The fact that Mr. Saloman was a primary shareholder was “absolutely irrelevant”, and he could not be pursued for the company debt. The case established the concept of the “corporate veil”, i.e. that owners/directors are separate from their companies, which remains a crucial unpinning of corporate law today.
There are however circumstances where the separate legal personality of a company and its owners/directors can be circumvented, and an owner/director can be pursued personally for matters about their company. This concept is called “piercing the corporate veil” and will be examined in a future article.
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