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Debt Advice Handbook 14th edition

2. Types of small business

• Sole trader
• Partnership
• Limited company
• Co-operatives and franchises
• Limited liability partnership

It is important to understand the type of business a client has because this determines her/his liability.

Sole trader

A person who is self-employed without business partners is described as a sole trader. Typical sole traders might include joiners, electricians and taxi drivers, and also sales people who work on a purely self-employed basis. Sole traders can work either in their own name or using a business name.

Sole traders are legally responsible for their business debts in exactly the same way as they are responsible for their personal debts.

Partnership

A partnership is the relationship that exists when two or more people carry out a business together in order to make a profit. A partnership can be informal – eg, if musicians perform together and share their expenses and payments. No formal written agreement is required for a partnership to exist, but this is useful if disputes or problems arise. Partnership agreements should cover how any profits are to be distributed (which will be equal unless stated otherwise) and how the partnership can be dissolved. In the absence of a partnership agreement, the Partnership Act 1890 applies. Partnerships may trade under a particular business name or the names of the partners.

A partnership is considered a single legal entity. Unless the partnership rules state otherwise, contracts can be entered into by any one of the partners and all partners are jointly and severally liable. There is one exception to this rule: each partner always has sole liability for her/his own income tax.

A partner is normally only responsible for debts accrued during the period in which s/he was a member of the partnership (although sometimes new partners agree to take responsibility for any partnership debts accrued by their predecessors). Partners continue to be responsible for debts accrued during their partnership, unless they all formally agree otherwise and their creditors agree to transfer their liability – eg, to the remaining partners. However, it is rare for creditors to agree to this. Partners may even be held liable for debts incurred by the partnership after they have left, unless notice was given to the creditors. Outgoing partners should ideally get legal advice when leaving a partnership to ensure they take all necessary action to avoid this happening.

Limited company

A limited company is a separate legal body that is established to trade and make a profit. It is distinctly separate to its directors, shareholders and managers. In most cases, losses usually fall to the company rather than the individuals who have set it up, but there are exceptions and you should obtain specialist advice.

A limited company can be public (ie, where the shares can be bought or sold on the stock market) or private (where shares are owned and transferred among a limited number of people allowed by the company’s rules). Companies are owned by their shareholders. They are run by their directors who may also be shareholders (in most small companies this tends to be the case), but they need not be. Directors are elected by shareholders and are employees of the company.

Companies are governed by legislation, much of which is administered by Companies House, where records of the company, its directors and accounts are kept. Company legislation is intended to encourage entrepreneurship by protecting unsuccessful businesspeople from the individual consequences of corporate debts. Company law is complex and outside the scope of this Handbook – it is vital to advise clients to get specialist advice where appropriate.

Unlike in a partnership, the directors are not personally responsible for the debts of a company unless:

•they have agreed to act as guarantor for some, or all, of the company’s debts. This is often the case with bank loans to small companies; or
•they have acted fraudulently and the company has been liquidated; or
•they have continued to trade while the company was insolvent and the company subsequently goes into insolvent liquidation. Note: From 1 March 2020 to 30 September 2020 and from 26 November 2020 to 30 June 2021, the rules for this type of offence were suspended by the government due to the COVID-19 pandemic to help company directors continue to trade during this period.

The above list is not exhaustive and there are other reasons for a director being held personally liable for a company debt. If liability is not clear, you should always refer a client for specialist advice.

Co-operatives and franchises

These are rare and specialist advice should be sought if liability is in doubt.

Limited liability partnership

Limited liability partnerships have some of the characteristics of a partnership and some of a company. The liability of the ’members’ (not partners) to contribute to the debts of the partnership is limited to its assets. There is no recourse to personal assets unless a member has been personally negligent.

You should refer queries about debts of a limited liability partnership to a legal specialist or an accountant with expertise in this area.