Business and organisational characteristics - Legal personality

Learning Outcomes

After reading this article, you will be able to explain the concept of legal personality and its significance in business law. You will distinguish between incorporated and unincorporated business structures, identify the consequences of separate legal personality, and recognise when the courts may disregard it. You will be able to apply these principles to SQE1-style questions and practical scenarios.

SQE1 Syllabus

For SQE1, you are required to understand legal personality in the context of business organisations. This includes recognising the legal status of different business forms, the implications of separate legal personality, and the circumstances in which the courts may set aside this principle.

As you work through this article, focus your revision on:

• the distinction between incorporated and unincorporated business structures
• the meaning and consequences of separate legal personality
• the concept of limited liability and its relationship to legal personality
• the rare circumstances in which the courts may "pierce the corporate veil"
• the practical effects of legal personality for contracts, property, and litigation

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 types has separate legal personality?
   1. sole trader
   2. ordinary partnership
   3. limited company
   4. limited liability partnership
2. Which statement best describes the effect of separate legal personality?
   1. The business and its owners are the same legal person
   2. The business can own property and sue in its own name
   3. The owners are always personally liable for business debts
   4. The business ceases to exist if an owner leaves
3. In what circumstances may a court "pierce the corporate veil"?
   1. Whenever a company owes money
   2. Only when required by statute
   3. Where the company is used to commit fraud or evade obligations
   4. Whenever a shareholder requests it

4. True or false? A partnership has the same legal personality as a limited company.

Introduction

Legal personality is a fundamental concept in business law. It determines whether a business is recognised as a legal person, distinct from its owners or managers. This distinction affects liability, property ownership, contracts, and the ability to sue or be sued. For SQE1, you must be able to identify which business structures have separate legal personality and understand the consequences for clients and third parties.

Incorporated and Unincorporated Business Structures

Business organisations in England and Wales fall into two main categories: unincorporated and incorporated.

Key Term: unincorporated business
A business structure that does not have its own legal identity. The business and its owners are legally the same person(s).

Key Term: incorporated business
A business structure that has its own legal identity, separate from its owners and managers.

Unincorporated Businesses

Sole Traders

A sole trader is an individual carrying on business in their own name. There is no distinction between the person and the business. All contracts, assets, and liabilities belong to the individual.

Key Term: sole trader
An individual who owns and operates a business personally, without separate legal personality.

Partnerships

An ordinary partnership is formed when two or more people carry on business together with a view to profit. The partnership itself is not a separate legal person. Partners are jointly and severally liable for the debts and obligations of the partnership.

Key Term: partnership
A business relationship between two or more persons carrying on business in common with a view to profit, without separate legal personality.

Incorporated Businesses

Limited Companies

A limited company is created by registration at Companies House. Once incorporated, the company is a legal person, distinct from its shareholders and directors.

Key Term: company
An incorporated business with separate legal personality, able to own property, enter contracts, and sue or be sued in its own name.

Limited Liability Partnerships (LLPs)

An LLP is a hybrid structure with features of both partnerships and companies. It is incorporated and has separate legal personality.

Key Term: limited liability partnership
An incorporated business structure with separate legal personality, where members have limited liability.

Consequences of Separate Legal Personality

The principle of separate legal personality was established in Salomon v A Salomon & Co Ltd [1897]. Once incorporated, a company (or LLP) is a legal person distinct from its members.

Key Term: separate legal personality
The legal recognition of a business as a person distinct from its owners and managers.

Key consequences include:

• The business can own property in its own name.
• The business can enter into contracts and employ staff.
• The business can sue and be sued in its own name.
• The business continues to exist despite changes in ownership (perpetual succession).
• The liability of members is limited to their investment (limited liability).

Key Term: limited liability
The principle that members of a company or LLP are only liable for the business’s debts up to the amount unpaid on their shares or agreed capital.

Worked Example 1.1

Scenario:
Anna is the sole shareholder and director of ABC Ltd. The company borrows £100,000 and later becomes insolvent. Anna has paid for her shares in full. The company’s assets are insufficient to pay its debts.

Answer:
Anna is not personally liable for the company’s debts. ABC Ltd is a separate legal person. Anna’s liability is limited to the amount unpaid on her shares (which is nothing). Creditors can only claim against the company’s assets.

Worked Example 1.2

Scenario:
Ben and Carla run a business as a partnership. The partnership owes £50,000 to suppliers. The partnership’s assets are worth £10,000.

Answer:
Ben and Carla are personally liable for the partnership’s debts. As the partnership is not a separate legal person, creditors can claim against the personal assets of both partners for the full amount owed.

Piercing the Corporate Veil

Although separate legal personality is the general rule, in rare cases the courts may disregard it and hold members personally liable. This is known as "piercing" or "lifting" the corporate veil.

Key Term: piercing the corporate veil
The court’s decision to disregard separate legal personality and impose liability on members or directors, usually in cases of fraud or evasion of legal obligations.

Courts will only pierce the veil where:

• The company is used to commit fraud or evade existing legal duties.
• Statute expressly provides for personal liability (e.g., wrongful or fraudulent trading in insolvency).

Exam Warning

The courts will not pierce the corporate veil simply because it would be fair to do so or because the company is a "one-man company." The principle in Salomon is strictly applied except in cases of abuse.

Worked Example 1.3

Scenario:
Derek is the sole shareholder of D Ltd. He transfers all company assets to himself to avoid paying a company creditor. The creditor sues.

Answer:
The court may pierce the corporate veil and hold Derek personally liable, as the company was used to evade its obligations to creditors.

Legal Personality and Business Operations

Separate legal personality affects many aspects of business law:

• Property: The company owns its assets. Shareholders have no direct interest in company property.
• Contracts: The company enters contracts in its own name. Members are not parties.
• Litigation: The company is the proper claimant or defendant in legal proceedings.
• Succession: The company continues to exist even if members or directors change.

Worked Example 1.4

Scenario:
XYZ Ltd owns a warehouse. The shareholders sell their shares to new owners. Who owns the warehouse?

Answer:
XYZ Ltd continues to own the warehouse. The change in shareholders does not affect the company’s ownership of its assets.

Summary Table: Legal Personality in Business Structures

Key Point Checklist

This article has covered the following key knowledge points:

• Legal personality determines whether a business is a separate legal person from its owners.
• Sole traders and partnerships do not have separate legal personality; companies and LLPs do.
• Separate legal personality allows a business to own property, enter contracts, and sue or be sued in its own name.
• Limited liability is a consequence of separate legal personality in incorporated businesses.
• The courts may only pierce the corporate veil in rare cases, such as fraud or evasion of obligations.
• Understanding legal personality is essential for advising clients on business structure and liability.

Key Terms and Concepts

• unincorporated business
• incorporated business
• sole trader
• partnership
• company
• limited liability partnership
• separate legal personality
• limited liability
• piercing the corporate veil