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Sole Trader and Limited Liability Company - liability compared

By Gibson Sheat

Sole Trader and Limited Liability Company - liability compared

A sole trader is a common ownership structure that can be used to operate a small business. The main operator of the business may be one person, supported by a family member such as a spouse. Operating a business may be risky if the right asset protection and insurance is not in place to support the sole operator. The extent of their liability is that they are personally liable for any business debt or loss, including taxes.

 

For debt owing to a creditor, a claim can be made against the personal assets of the sole trader, including funds in bank accounts, and the personal family home. Liability on behalf of the sole trader will end when the sole trader has passed away, unless a Will provides for the business to carry on.

 

Should the sole trader cease to operate their business, then there is a statute of limitation of between 6 to 15 years for creditors to make a personal claim, and therefore liability after this time may not apply.

 

When borrowing funds there may be a linked personal guarantee from the sole trader. When the debt is repaid to the bank, it will remain in place unless the lending organisation agrees in writing for its release. Liability can continue onto the sole trader’s executors and assignors under their Will.

 

 

The difference between a sole trader and a limited liability company is that the latter acts as an entirely separate legal entity from its shareholders, who are the company owners. As such, liability on behalf of the shareholders is limited only to the amount left unpaid on any of their respective shares. In addition to this limited liability, shareholders also have the ability to receive a share of the surplus funds (if any) in the case of liquidation.

 

As liability can be dependent upon many things, directors can still be held personally liable for the company debt if trading while it is insolvent and if they have given personal guarantees.

 

It is important for directors and shareholders to remember to have personal guarantees released in writing when changing lending institutions or retiring from the company. Personal liability on behalf of directors may also apply where the director(s) have not acted in the best interest of the company, and may have failed to act in accordance with the Companies Act.

 

 

If a company is acting as an independent trustee of a family trust, liability can be limited again through the use of a ‘limited liability clause’. These clauses simply cap the liability of the company (usually to the value of the trust assets) and outline the time at which such value will be determined.

 

It is important when entering into business to receive proper advice regarding the ownership structure, and consider how much risk and liability you are willing to accept when deciding to become a sole trader, director and or shareholder of a limited liability company.