How bulletproof is your business?

Some people might think that running their business as a limited liability partnership offers full protection from financial liability — after all that’s why there’s a “limited” in its name. Sadly, that is not always the case. 

The advantages of incorporating your business

Once upon a time the most popular business vehicle for professionals was a partnership. Steeped in tradition (the governing legislation for most partnerships was entered onto the statute books in 1890), it is only relatively recently that professionals have embraced alternative business vehicles including companies and limited liability partnerships (LLPs).

Companies and LLPs have a number of advantages for those running a business. They have separate legal personality; this means that they are distinct and separate entities from their owners, employees, directors or members. Consequently, their existence creates a “firewall”, blocking most (but significantly, not all) personal liability for the owners/operators of the business.

For instance, it is entirely possible to limit the personal liability of the owners/operators of a company or LLP in respect of their negligently given advice — provided that the business ensures that its terms of business are properly in place and these provide that clients agree only to bring such claims against the business and not against the individual adviser who may have been responsible for the bad advice. Indeed, this has been the motivation behind many professional practices converting to LLPs and companies from “old fashioned” (unlimited liability) partnerships.

The risks of running a business as an LLP or company

However, that does not mean that LLPs or companies provide an entirely risk-free environment for business owners. Running your business through an incorporated entity is a good place to start if you want to protect your personal position — but there are ways in which the protection afforded by such entities can be pierced.

The main risk to professional business owners comes from the consequences of running their business badly. The risk is that:

• A previously successful business starts to falter
• The finances of the business take a turn for the worse and the business slides towards insolvency
• The owners of the business do not recognise or effectively deal with the situation until too late in the day

Understanding the consequences of business insolvency

The consequence of this is that the owners and operators of the business can find themselves, after an insolvency event, with potentially crippling personal liability. This might arise under s214A of the Insolvency Act 1986, for instance. This gives rise to the possibility that members of an LLP which has become insolvent will have money reclaimed from them (personally) for failing to recognise, when they should, that they continued wrongfully to trade the insolvent business. Virtually identical provisions exist in relation to company directors.

Personal liability and tax implications for LLP members

There is another risk — particularly in relation to LLPs. LLPs are tax transparent. Individual members remain personally liable for their tax. However, many firms operate joint tax reserves, held against the individual members’ liability for tax. If a firm becomes insolvent, those tax reserves may be dissipated by the LLP, leaving the individual out of pocket for substantial tax.

On top of those difficulties sits another element which can pressurise the finances of LLP owners — personal guarantees given by members in respect of borrowing and rent. If an LLP becomes destabilised all of these potential liabilities can descend at once, rendering members of an LLP (and directors of companies in similar positions) staring into a financial abyss.

So, running a business through an LLP or company is a good first step to protecting your position but no owner/operator of a business should proceed on the basis that they are completely fireproof.  It is always worth looking at the circumstances of your business commercially, as well as legally, in case the corporate protection that you thought was in place is swept aside.