Business organisations and procedures - Legal personality an...

Learning Outcomes

This article explains legal personality and limited liability in a business context, including:

• Define legal personality and limited liability and compare the main business forms (companies, LLPs, partnerships, and sole traders).
• Distinguish incorporated and unincorporated entities and analyse consequences for ownership of assets, management control, financing options, and continuity on changes of ownership.
• Explain who is entitled to sue or be sued and select the correct parties to contracts and legal proceedings, including in group structures and mixed business arrangements.
• Assess how limited liability operates in practice and identify when owners, members, or directors may incur personal liability through statute, guarantees, pre-incorporation contracts, or common law doctrines.
• Apply doctrines on separate legal personality, wrongful and fraudulent trading, veil-piercing, LLP single-member continuation, and parent company duties in realistic problem-style scenarios.
• Use these principles to structure clear SQE2-style answers on business structures, registration requirements, allocation of risk and liability, and litigation strategy.

SQE2 Syllabus

For SQE2, you are required to understand the law and practice relating to legal personality and limited liability, with a focus on the following syllabus points:

• How different business forms acquire legal personality (or not) and its legal effects.
• The significance of separate entity status for contracts, ownership, and parties to proceedings.
• The principles and consequences of limited liability and unlimited liability.
• When exceptions to limited liability may arise, including piercing the corporate veil and insolvency-related personal liability.
• Identifying parties entitled to sue or be sued, as required when drafting and analysing business transactions and claims.
• Pre-incorporation contracting and the position of signatories; who is liable when a company does not yet exist.
• Authority of directors and the indoor management rule; third-party reliance and s.40 Companies Act 2006.
• Liability of partners under the Partnership Act 1890 including ss.9, 10–12 and 17, and LLP-specific rules on member liability.

Test Your Knowledge

Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.

1. Which of the following business forms has a separate legal personality immediately upon formation?
   1. Partnership
   2. Limited liability partnership
   3. Sole trader
   4. Ordinary partnership
2. Which statement accurately reflects limited liability?
   1. It only protects business assets, not personal assets.
   2. It always prevents a court from finding liability to creditors.
   3. It limits a member's liability to capital unpaid or a guaranteed amount.
   4. It guarantees creditors will recover debts in full.
3. If a company fails to pay a contract debt, who should a creditor normally pursue?
   1. The directors only
   2. The company as legal person
   3. The individual shareholders
   4. Whoever has day-to-day management control

4. True or false? In a general partnership, partners are not personally liable for partnership debts.

Introduction

Understanding legal personality and limited liability is essential for advising clients about the risks and protections of different business forms. These foundational concepts are frequently examined in contractual and contentious business scenarios on SQE2. This section outlines their application and significance in English law.

Legal personality allows an entity to act as a person: it may own property, enter contracts, sue and be sued, and continue despite changes of membership. Limited liability ring-fences the personal assets of owners or members so that, save for exceptions, only the entity’s assets answer for its debts. These twin features explain why companies and LLPs are popular trading vehicles; they also explain why creditors and counterparties insist on collateral (security, guarantees) in small or closely-held businesses.

Incorporated and Unincorporated Businesses

Business organisations can be divided into incorporated entities (such as companies and limited liability partnerships) and unincorporated businesses (such as sole traders and general partnerships). The distinction has major consequences for ownership, liability, and legal proceedings.

Key Term: incorporated business
An entity with its own legal personality, distinct from those who own or manage it. It can own property, enter contracts, and sue or be sued in its own name.

Key Term: unincorporated business
A business that does not have legal personality distinct from its owners. There is no legal separation between the business’s liabilities and those of its proprietors.

Incorporated status arises on registration at Companies House for companies and LLPs. Unincorporated structures exist by operation of law without registration: carrying on business alone makes one a sole trader; agreeing to carry on business in common with a view to profit creates a partnership under s.1 Partnership Act 1890.

Separate Legal Personality

When a business has legal personality, it is treated by law as a “person” for most business purposes. This enables it to own assets, be party to contracts, and be the correct party to legal proceedings—regardless of who its owners are.

Key Term: separate legal personality
The business is a distinct “person” in law, separate from its owners, directors, and managers.

A company or LLP is an obvious example. Upon registration, the entity “comes into existence” as a legal person. English courts have long affirmed this principle: the classic authority is Salomon v A Salomon & Co Ltd, where the House of Lords held that a properly incorporated company is separate from its controller. Practical consequences include:

• Property owned by a company belongs to the company, not to its shareholders (illustrated in Macaura v Northern Assurance).
• A person may contract with the company even if they control it—there is no impermissible “contract with oneself” (Lee v Lee’s Air Farming).
• Rights and duties are structured around the entity: directors’ duties are owed to the company, and the company is the proper claimant when it suffers loss (the rule in Foss v Harbottle).

Worked Example 1.1

Rosa is the sole shareholder and director of R Farm Ltd, which leases land and sells produce. A wholesaler, Rivers Ltd, contracts with R Farm Ltd but is unpaid. Who may Rivers Ltd sue to recover the debt?

Answer:
Rivers Ltd should sue R Farm Ltd, which is the separate legal person and party to the contract. Rosa is not personally liable simply because she owns or manages the company.

Legal Personality: Implications for Contracts and Claims

An incorporated business enters into contracts in its own name. If sued, it is the named party in litigation. Assets, debts, and obligations belong to it, not to the individuals behind it. In practice, this means:

• The correct defendant in a claim on a company’s contract is the company.
• Shareholders do not have proprietary rights over company assets, and cannot sue in their own names for losses suffered by the company (absent statutory routes such as derivative claims).
• Directors bind the company by acting with actual or apparent authority. Under s.40 Companies Act 2006, a third party dealing in good faith may rely on directors’ ostensible power free of internal limitations.

By contrast, in unincorporated businesses (sole traders, general partnerships), contracts and obligations fall personally on the proprietors. The “firm” has no separate personality in English law, so the partners are the contracting parties.

Key Term: sole trader
A single person who owns and runs their business. There is no distinction in law between the business and the person.

Key Term: partnership
A relationship in which two or more persons carry on business in common with a view to profit, as defined in the Partnership Act 1890. The partnership is not a legal entity separate from the partners.

Authority in partnerships arises under ss.5–6 PA 1890: each partner is an agent of the firm and may bind it (and therefore the other partners) in the usual course of business, subject to agreed limitations.

Liability for Debts: Unlimited and Limited

The type of business organisation determines whose assets are at risk if the business cannot pay its debts.

Key Term: unlimited liability
Owners are personally liable for all business debts and obligations. Their personal assets can be seized to satisfy creditors.

In sole trader and traditional partnerships, business obligations are the personal liabilities of the proprietor(s). Partners’ liability extends to wrongful acts (ss.10–12 PA 1890), and a partner remains liable for debts incurred while they were a partner (s.17), with rules on release and notice to creditors when they retire.

Conversely, limited liability means that losses are generally confined to what has been invested or agreed as a guarantee.

Key Term: limited liability
The liability of a shareholder or member is restricted to a specified amount—usually unpaid capital on shares or a stated guarantee.

In an LLP or limited company, creditors cannot (in general) reach the personal assets of members or shareholders to cover the entity’s contracts or debts.

Worked Example 1.2

Derek and Anita run a general partnership operating a club. The partnership borrows £40,000 from the bank. The business collapses with no assets and the loan is unpaid. Who can the bank sue for repayment?

Answer:
The bank can sue Derek and Anita personally. The partners are jointly and severally liable: each may be required to pay the full debt, with a right to recover a share from the other.

Limited Liability in Companies and LLPs

A company limited by shares or guarantee, or an LLP, is primarily liable for its debts and contracts. Members' or shareholders' liability is limited to:

• Any unpaid amount on shares (for a company limited by shares).
• The amount promised in a guarantee (for a company limited by guarantee).
• Any agreed capital under the LLP agreement (in the case of an LLP).

If the shares are fully paid or the guarantee met, the member or shareholder will not usually owe creditors anything further if the business fails. In LLPs under the Limited Liability Partnerships Act 2000, the LLP’s debts are the LLP’s responsibility. Members are not personally liable merely by virtue of membership, though they can incur liability in specific situations (see exceptions below).

Key Term: company limited by shares
A company where shareholder liability is limited to amounts unpaid on shares subscribed.

Key Term: limited liability partnership (LLP)
A business, registered under the Limited Liability Partnerships Act 2000, with separate legal personality. Members’ liability is limited, but management structure resembles a partnership.

Key Term: company limited by guarantee
Usually a non-profit entity where liability is limited to whatever members agree to contribute (eg £1) in the event of the company's winding up.

In financing terms, limited companies can raise capital by issuing shares and can grant floating charges over undertaking and assets, making them attractive to lenders. LLPs can also grant fixed and floating charges.

Protection by the Veil of Incorporation

Legal personality creates a “veil of incorporation,” which means the entity is distinct from those behind it. Usually, courts will not disregard this principle.

Key Term: veil of incorporation
The legal separation between the incorporated business entity and those who own or manage it.

The modern position emphasises that the veil is rarely pierced. In Adams v Cape Industries plc, the Court of Appeal reaffirmed that group companies are separate legal persons. In Prest v Petrodel Resources, the Supreme Court clarified that veil piercing is confined to cases where a company is interposed to evade or frustrate an existing legal obligation or liability; other doctrines (trusts, agency, attribution, and direct tort duties) often provide the necessary remedy without piercing.

Worked Example 1.3

Priya is the sole shareholder of a dormant limited company. The company owes £1,000 to a supplier. Can the supplier recover the debt from Priya personally if the company cannot pay?

Answer:
No, the supplier’s claim is against the company. If Priya’s shares are fully paid, she is protected by limited liability—the “veil” will not be lifted except in exceptional cases.

Exceptions and Personal Liability

There are narrow exceptions where courts or legislation allow a creditor to pursue those behind an incorporated entity:

• Fraudulent or wrongful trading in insolvency (Insolvency Act 1986 ss.213–214). Wrongful trading does not require dishonesty; fraudulent trading does.
• Use of a company or LLP as a façade to evade existing obligations (rare, and typically involving equitable doctrines rather than veil piercing).
• Direct personal liability by contract (personal/directors’ guarantees) or tort (eg, negligent misstatement or a parent company’s duty of care to subsidiary employees on Chandler v Cape principles).
• Pre-incorporation contracts: a purported company party does not exist; the signatory may be personally liable (s.51 Companies Act 2006).
• LLP single-member rule: if an LLP carries on business with only one member for more than six months, that person can be jointly and severally liable with the LLP for debts incurred after the six-month point until another member is admitted.

Personal liability can also arise for misfeasance, breach of fiduciary duty (where duties are owed to the company), or where statutes impose obligations on officers.

Worked Example 1.4

Tariq signs “for and on behalf of FutureBuild Ltd” on a supply agreement. The company has not yet been incorporated. The supplier delivers goods and is unpaid. Who is liable?

Answer:
Under s.51 CA 2006, the contract takes effect as one made with Tariq personally. FutureBuild Ltd did not exist at the time, so Tariq is liable unless the agreement expressly excluded personal liability or the parties novated after incorporation.

Exam Warning

Do not assume that limited liability is absolute. If a director acts fraudulently or is required by statute (as in wrongful trading), they may be liable beyond any shareholding or guarantee.

Worked Example 1.5

MetroTech Ltd defaults on a bank loan. The bank holds a signed personal guarantee from the managing director. Can the bank sue the director?

Answer:
Yes. A personal guarantee creates a direct contractual obligation. The director is liable under the guarantee irrespective of limited liability, alongside any claim against the company.

Registration and Publicity Requirements

Most incorporated businesses must be registered at Companies House. This registration creates the entity’s legal personality and triggers compliance with requirements on filing, accounts, registers, and public disclosure. Registered entities must keep their details up to date (including directors/members, registered office, and significant control information), file confirmation statements annually, and prepare accounts for each financial year. Failure to comply can be an offence.

Unincorporated businesses have no such corporate filing requirements, although they must register for tax with HMRC and comply with regulatory regimes as applicable.

Key Term: Companies House
The official registry for incorporated companies and LLPs in England and Wales. Filing with Companies House is required for a company or LLP to come into existence.

In corporate practice, once a company is incorporated, the board will typically convene an initial meeting to adopt practical arrangements (bank mandates, accounting reference date, insurance, use of trading name, share allotments, etc.)—all actions taken by or for the company as the legal person.

Comparisons: Effects on Ownership, Management, and Legal Proceedings

The distinction between incorporated and unincorporated forms has practical implications:

Choice of medium also affects financing and publicity: only incorporated bodies can grant floating charges, and companies/LLPs have more onerous public disclosure obligations.

Worked Example 1.6

Lionel, Simon, and Chloe establish an LLP for their design firm. The LLP is sued for breach of a client contract. Chloe personally has no involvement in the contract. Who is the correct defendant in the claim?

Answer:
The LLP. As an incorporated entity with legal personality, only the LLP is sued. Chloe is not personally liable for the LLP’s breach.

When Limited Liability Does Not Apply

Limited liability can be overridden in specific circumstances:

• A member or director provides a personal or directors’ guarantee for a debt.
• The business trades fraudulently or wrongfully when insolvent.
• The incorporated entity is structured for the purpose of deceit or evasion.
• Pre-incorporation contracts bind the person purporting to act for a non-existent company (s.51 CA 2006).
• LLP single-member continuation beyond six months can expose that member to joint and several liability for certain debts incurred during that period.

Direct tort liability can arise without veil piercing. For example, a parent company may owe a duty of care to employees of a subsidiary where, on the facts, it assumed responsibility and met the Caparo criteria (Chandler v Cape). Similarly, a director may incur liability for negligent misrepresentation personally if they assumed responsibility to a counterparty (Standard Chartered Bank v Pakistan National Shipping is a helpful illustration in the context of fraud).

Key Term: personal guarantee
An agreement by which an individual assumes personal liability for a specified debt should the business default.

Worked Example 1.7

Orion LLP has only one remaining member from 1 January. A second member joins on 1 October. On 15 August, Orion LLP purchases equipment on credit. The LLP later defaults. Is the single member personally liable?

Answer:
If the LLP carried on business with a single member for more than six months, that person can be jointly and severally liable with the LLP for debts incurred after the six-month point and before another member is admitted. Here, 15 August is after the six-month point and before 1 October; personal liability may arise.

Worked Example 1.8

A UK parent company, P plc, owns S Ltd (a subsidiary). Workers of S Ltd suffer injury due to unsafe processes. Evidence shows P plc set group-wide safety policy and knew S Ltd lacked competence. Can P plc be liable?

Answer:
Without piercing the veil, P plc may owe a duty of care if it assumed responsibility and had the requisite proximity. On Chandler v Cape principles, liability can arise where the parent’s knowledge and control make it fair, just, and reasonable to impose a duty.

Worked Example 1.9

Ewan owns 95% of shares in TimberCo Ltd. TimberCo purchased timber owned by Ewan. Ewan insured the timber in his own name. A fire destroys the timber. Can Ewan claim?

Answer:
No. The timber belongs to TimberCo. Ewan lacks an insurable interest in the company’s property. This reflects Macaura v Northern Assurance: the company’s assets are distinct from those of the shareholder.

Practical Implications for Exam Scenarios

SQE2 questions may require you to identify the correct party for claims and contracts, explain the implications for liability, draft a party clause, or apply the principles where mixed forms might be used (eg, a general partnership alongside a company). Strong candidates work methodically:

• Identify the business form at the time of the relevant transaction (and whether the entity existed).
• Ascertain the contracting party named and the capacity of the signatory.
• Check for personal guarantees, indemnities, or collateral warranties.
• Consider statutory routes to personal liability (fraudulent/wrongful trading) where insolvency is in play.
• For groups, analyse whether the proper claimant/defendant is the subsidiary or parent, and whether separate doctrines (agency, duty of care, trusts) apply.
• For partnerships, check default PA 1890 rules and any partnership agreement; assess authority, joint and several liability, and notice on retirement.

Worked Example 1.10

ABC & Co trades as a partnership but registers a dormant company at Companies House for a future project. The partnership contract is signed by ABC & Co (the partnership, not the company). A supplier sues for invoice payment. Who are the parties?

Answer:
The correct parties are those trading as the partnership, as the company has not contracted or traded. The supplier must pursue the partners personally.

Revision Tip

In exam scenarios, check:

• Has the business form been created or registered (and when)?
• Who is a party to the contract or litigation—entity or individual(s)?
• Has anyone given a personal guarantee?
• If an incorporated form, is it limited by shares, guarantee, or is an LLP?
• Was a contract entered into before incorporation (s.51 CA 2006)?
• In partnerships/LLPs, did the signatory have authority; are partners/members jointly and severally liable?

Key Point Checklist

This article has covered the following key knowledge points:

• Incorporated businesses acquire separate legal personality when registered (company or LLP).
• Unincorporated businesses do not have separate legal personality, and their owners are personally liable.
• Limited liability restricts shareholders’ or members’ liability, usually to their capital or guarantee agreed.
• The “veil of incorporation” normally protects members from liability, except in rare cases of fraud or breach of statutory duties.
• Correct party identification is essential in contracts and claims—against the entity where possible, or against proprietors in unincorporated businesses.
• Pre-incorporation contracts bind the signatory personally unless effectively replaced; a non-existent company cannot be a contracting party.
• Wrongful and fraudulent trading can impose personal liability on directors/members; personal guarantees and LLP single-member continuation can also expose individuals.
• In group contexts, liability can arise without piercing the veil (eg, parent company duty of care); keep distinct the entity, its members, and officers.

Key Terms and Concepts

• incorporated business
• unincorporated business
• separate legal personality
• sole trader
• partnership
• unlimited liability
• limited liability
• company limited by shares
• limited liability partnership (LLP)
• company limited by guarantee
• veil of incorporation
• Companies House
• personal guarantee