Separate Legal Entities (Advantages & Benefits) in Business

The term “separate legal entity” is a fundamental concept in law that underlies business law and legal liability.

Not getting it right means that you could:

1. trade in a way which makes you personally liable for the activities of a company, rather than the company itself
2. sign contracts which make you jointly and severally liable on a contract, when you don’t intend to
3. sign a contract with a non-existent legal entity, and make the contract unenforceable
4. sign a contract with the wrong company within a group of companies
5. lead to unwanted legal proceedings. The proceedings could be brought for say breach of contract, fraudulent misrepresentation, a claim on an indemnity or some other cause of action against you, rather than the legal entity. If it's successful, it can lead to personal liability on the claim.

And it’s all avoidable.

Unless you're already a lawyer you might want to read on, because they're some things that you may not know, that may make a difference to your business and what you do next.

 

What does "separate legal entity" mean?

A separate legal entity is a person recognised by law - a "legal person". The entity has its own legal rights and obligations, separate to those running and/or owning the entity.

That person could be a company, limited liability partnership, or any other entity recognised by law as having its own separate legal existence.

An “incorporated” entity - such as a company - is a separate legal entity. That’s a separate legal existence to its:

1. founders: the natural persons that caused it to be formed
2. directors: those that control the company
3. shareholders: those that own the company.

In HL Bolton Engineering Co Ltd v TJ Graham Sons Ltd 1957 1 QB 159, Denning LJ described companies like this:

A company may in many ways be likened to a human body. It has a brain and nerve centre which controls what it does.

It also has hands which hold the tools and act in accordance with directions from the centre.

Some of the people in the company are mere [employees] and agents who are nothing more than hands to do the work and cannot be said to represent the mind or will.

Others are directors and managers who represent the directing mind and will of the company, and control what it does. The state of mind of these managers is the state of mind of the company and is treated by the law as such.

The law takes a flexible approach to recognising separate legal entities.

Telling the difference when it will - and when it won't - can matter.

 

What is a Legal Entity?

The hallmarks of a separate legal entity are that it can:

• buy, sell and own property of any kind in its own name
• agree to legally binding contracts, and
• sue and be sued in its own name.

As a consequence of these features, separate legal entities can:

• incur debt (which is created by a contractual relationship)
• become creditors, by lending to others
• own assets - ie property:
  • tangible: desks, chairs, pens and paper
  • intangible: such as intellectual property rights: copyright, designs, trade marks and confidential information
• own real property, ie land, and
• be liable to pay taxes (a statutory obligation)

All the things that human beings can do (and are legal entities), from a legal perspective.

This terms “separate legal entity” means the same thing as “separate legal personality”, “separate legal existence”, and “separate legal person”. It’s an entity with the features described in bold above and recognised by law as having those features.

It’s this separate legal personality that makes companies attractive vehicles for business ventures. 

Sometimes, to identify what a legal entity is, it's more important to know when it's definitely not a separate legal person.

That's next.

What isn't a separate entity?

Although it may seem like it, a separate legal entity is not:

1. a trade mark: trade marks are personal property owned by a legal entity, whether it's an individual, a company or other form of legal entity
2. a domain name: a domain name is registered in the name of a legal entity. The legal entity is entitled to use it does not own it. The legal entity rents it from the relevant domain name registrar. 
3. a brand or trading name: these are in essence aliases for a legal entity. Like trade marks, the only true reference to a company for instance includes the use of the suffix with the company name. 
4. a group of companies: each company within the group is a legal entity. Just because there is a collection of companies with subsidiaries and parent companies does not mean that they have one single legal existence. They are all separate legal persons.
5. a business: "a business" could be:
   1. a number of legal entities trading as a single business,
   2. a single legal entity trading by itself without cooperation of other legal entities.

It depends upon what is meant by use of the term "business".
Below, we go through some of the possible interpretations, with subsidiaries, joint ventures, branches of a business, divisions of a business and accounting entities.

There is a consequence of all this.

If you see an email using a particular domain name, it could be used so as to designate one or more legal entities within a group of companies.

It becomes a question of law decided on the facts of the case which separate legal entity on whose behalf the email was sent. Same with letters, and any other communication. 

Changes of Name

Here's a common trap. 

• You and I have our own names
• We could sign a contract with one another 
• You could change your name
• I could change mine

Does that change who we are from a legal perspective? Are we no longer legally bound with one another under the contract, because we changed our names?

Well, no. We're the same people.

And so it is with say, companies.

When they're formed, private limited companies ("Limited" or "Ltd" suffix), public companies ("plc" suffix) and limited liability companies ("LLC" suffix) are assigned a company number.

That company number never changes.

Ever.

However, the company's name could be changed many times throughout its period of existence, and even during its liquidation or administration. 

Those changes of name don't change the legal identity or existence of the company. Only its name.

It stands to reason therefore, that the only reliable way to identify a company is by checking its company number.

 

Why is this legal concept important?

Two main reasons. There are many others.

Liability rests with the company, rather than the shareholders, directors or company officers.

Also, other legal concepts in law are based on this separate entity concept.

That includes these legal concepts:

• limited liability
• ownership of property. What if a director claims ownership to property - say software - when it is really owned by the company?
• piercing the corporate veil, of a single company, or a company operating within a group of companies
• making legal binding contracts, and to determine:
  • to which entity legal obligations are owed
  • the legal entity in breach of contract, and
  • which legal entity is liable to pay damages
• an agent has exercised ostensible authority for another legal person, and legally bound that legal person
•  whether an agent is in breach of their fiduciary duties
• common designs, which give rise to joint and several liability
• the separate participating parties in a conspiracy
• the legal entity which carries strict liability for a tort, such as intellectual property infringement  
• the person which has vicarious liability for another
• shareholders, and how their roles and responsibilities are divorced and separate to the roles and duties of directors – even if they are the same individual 
• the different roles, powers of directors and fiduciary duties for directors
• which party is an agent and which is the principal
• when partnerships arise by operation of law

They all pretty much start with the concept of separate legal entities.

Top of the list for most businesses is to take advantage of limited liability. Business activities can be structured using different legal entities, as subsidiaries or connected companies. Each of the shareholders in each of those entities has limited liability when they're incorporated.

The basic concept is straightforward.

But in motion, things can get confusing if you don't know what you should be looking for. 

 

Why have a separate legal entity?

Primarily, businesses trade as companies.

The company - which is a separate legal entity - insulates the individuals participating in the business from personal liability which may arise as a result of doing business.

In this way, the company:

• generates revenue, which is owned by the company
• incurs expenses, which are payable by the company
• attracts legal liability to pay taxes to taxation authorities, and
• typically pays tax at lower rates than individuals.

The business owners and directors are protected from liability other than in limited circumstances (which essentially involve some sort of fraudulent conduct).

The insulation of shareholders and liability usually top the reasons why consider it important.

Joint Ventures

Joint venture companies are a common tool to enable distinct projects, separately from existing companies.

Two or more independent businesses (ie: separate legal persons) may wish to cooperate to start a special project.

Joint venture companies are often referred to as "special purpose vehicles", as they have a specific purpose for formation they:

• are jointly owned by the founding companies
• may make profits which are owned by the joint venture company
• buy and own assets
• buy and lease property
• licence intellectual property rights, such as software
• have their own customers and suppliers
• pay expenses, taxes, employees and consultants
• return profits to the founding companies in agreed percentages
• are sold off when successful
• isolate the liabilities to the joint venture
• can be made to fail gracefully, and be dissolved without affecting the founding companies

 

Subsidiary Companies

Some businesses operate as groups of companies - one parent company, with many subsidiaries which in turn have their own subsidiaries. 

Subsidiary companies might be setup below a parent company for a variety of reasons:

• As a means to organise the operations of a business
• To siphon off risk to legal entities other than the parent company
• Manage operations
• Isolate specific assets and liabilities
• Run a separate businesses within a larger company group. Each company might have a different function or specific role within a group of companies
• Offset profits and losses between different companies within the group
• To trade in a foreign jurisdiction to obtain benefits of a company within that country, such as:
  1. the ability to trade without tariffs, such as in the European Union
  2. obtain the benefit of lower tax rates.
• Attract outside investment without giving proprietary rights in the entire group of companies or in a parent company

Whatever the reasons may be, subsidiaries also attract all the benefits of other separate legal entities – insulation of personal liability of the people that run them, work for them, and own them.

So this separate legal entity concept can be applied to obtain advantages in a number of different ways:

1. to insulate the directors and owners of a single company from liability
2. in larger businesses, to separate out new projects and joint ventures in special purpose vehicles
3. trade in different countries with subsidiaries formed under local law

And there are others.

Also, parent companies are not liable for the debts of subsidiaries companies. The subsidiary is liable for its own debts.

That's usually the case.

But if there has been series mismanagement of the subsidiary - the sort that attracts legal liability, such as sham companies - the parent company can be made liable for the debts of its subsidiary.

 

Different Types of Companies

In the UK, you have:

1. private limited companies, whether limited by shares or by guarantee, that use the suffix “Limited” or “Ltd”
2. private unlimited companies, which use the suffix “Unlimited”
3. limited liability partnerships, which use the suffix “LLP”
4. public companies, which use the suffix “PLC”
5. limited partnerships, and
6. community interest companies. These use the suffix “CIC”.

Is a partnership a separate legal entity?

The word "partnership" is often used in the business context which isn't the same as in the legal sense.

We're talking about a partnership under the Partnership Act here.

Under the Partnership Act, English law deems business relationships that meet a particular description to be a partnership. When the defined description of partnerships is satisfied, a partnership is deemed to exist automatically.

A partnership:

• is not an incorporated legal entity
• exists when two or more entities "carry on a business in common with a view of profit". That means a lot of business relationships are partnerships when they don't intend them to be - and probably don't know they are
• does not have a legal personality separate from each of its individual partners (whether those partners are individuals or companies). 

So the short answer is "no": a partnership (in the legal sense) is not a separate legal entity. That's because it's not an incorporated legal entity. 

Companies are just as susceptible to becoming partners in a partnership as well. It most often happens when joint venture agreements aren't set up properly or are administered in a way that falls into the definition of a partnership under the Partnership Act.

All of the participants in the partnership maintain their separate legal identity and are jointly and severally liable for contracts which one of the members of the partnership signs up to. That's one of the reasons partnership and agency clauses are used in contracts.

Foreign Separate Legal Entities

English law also recognises legal entities which are accepted as legal entities in their country of formation.

In Bumper Development Corp Ltd v Commissioner of Police of the Metropolis [1991] 4 All ER 638, the UK Court of Appeal held that a Hindu temple was a separate legal entity. It had legal personality under the law of the state where it was created, India.

In the US, an LLC (a limited liability company) is a separate legal person and entity, in the same way as an English PLC, limited company or limited liability partnership.

Is a trust a legal entity?

Well, yes and no. We think it depends on how it is set up:

• The trustees of a trust hold assets on trust for the beneficiaries of the trust
• The trustees are entitled to use the assets of the trust to satisfy debts of the trust 
• A trust will be liable to pay tax and when the HMRC is notified of it, it will have a tax reference
• It's probably yes when the trustee is set up as a company
• It's probably not when the trustee(s) are individuals. 

 

Example: Separate Legal Entity

When a company is formed it becomes a legal entity in its own right. That formation is known as “incorporation”.

The company has its own “legal personality”:

• it is a legal person;
• with its own legal identity;
• separate to the individuals involved with the company.

This legal separation means that the legal liability of the company is not the liability of:

• the shareholders
• the directors
• its employees, or
• its consultants or contractors.

Companies have perpetual existence, subject to ongoing filing formalities to keep the company on the register of companies in the place it was formed.

Its legal existence survives the existence or participation of any directors and shareholders. That perpetuity of existence is a trait of the entity itself. The company’s existence ends when it is wound up and dissolved.

The documents which establish the company set up the legal relationship between the shareholders and the directors is known as its “internal constitution”. It governs the legal relationship between the company, its directors and the shareholders. The internal constitution won’t affect the continued legal existence of the company as a separate legal entity.

Origin of Separate Legal Entities

This separate legal personality concept was first recognised by courts in case law in the famous case named Salomon v A Salomon & Co Ltd, decided in 1897.

In that case the House of Lords decided:

Once a company is incorporated, it has a separate legal existence to the shareholders of the company…

[the company] must be treated like any other independent person with its rights and liabilities appropriate to itself …, whatever may have been the ideas or schemes of those who brought it into existence.

The Supreme Court affirmed the fundamental importance and authority of the principles in Salomon v Salomon in Prest v Petrodel Resources Ltd (2013).

What happened in Salomon v A Salomon and Co Ltd?

The facts of the case are more complicated than we’d like for example purposes.

Stripping back a lot of the detail (and glossing over a lot of it), this is what happened in Salomon v A Salomon:

Aron Salomon ran a leather and boot-making business in his own name.

He incorporated a business for his leather and boot-making business. He named it “A. Salomon and Co Ltd”. 

So, he incorporated a previous business and contracted through the defendant company rather than in his own name.

When he incorporated the company, Mr Salomon took a series of security interests (essentially mortgages) over the assets of the company.

Business in the boot trade declined, and the company went into liquidation.

Salomon and Co Ltd defaulted on payment of the securities. Mr Salomon was sued by the liquidator (in the name of the company), claiming that Mr Salomon was liable for the debt. 

The company was a separate person from Mr Salomon. Mr Salomon could not be made personally liable for the debts of the company. 

As a result, the company was liable on the contract sued on, and not the shareholders or directors.

That’s the essence of a company’s own separate legal existence.

The directors aren’t the company. Nor are the shareholders. Nor are the employees.

 

Difference between Sole Proprietors and Companies

In this example, we use a company as a separate legal entity. It could be any other form of entity with a separate legal existence.

Trading as a sole proprietor

When someone trades as an individual, they’re a “sole proprietor” or a "sole trader”.

Here are some assumed facts in a simple example:

• Bob Roberts is a sole trader.
• He provides IT services in his own name as a sole proprietor.
• He trades as “Bob’s IT Services”
• Bob is the legal entity which owns the business
• Bob runs the business.

Bob signs all of the contracts, insurance contracts, contracts with customers and suppliers in his own name. Bob “is” the business.

• Tax returns are filed in Bob's name
• If a fine is imposed on the business, it is Bob that has to pay it
• If an employee of Bob makes a mistake that gives rise to legal liability, it is Bob that’s liable for the employee’s mistakes.
  That’s because employers are vicariously liable for acts of employees

• If something goes wrong – say there is a breach of contract – Bob is personally liable to pay damages.

Bob’s liability in all of these situations is unlimited: all of his personal assets are at stake to pay taxes, the fine, damages for breach of contract, and the employee’s mistake.

It’s different if Bob forms a company and trades as a company, as was the case with Mr Salomon, above.

Trading as a Company:

The company will have its own separate legal identity to Bob.

Like so…

• Bob Roberts forms a company. He names it “Bob Roberts Limited”.
• Bob Roberts Limited is a company limited by shares (just like in Salomon v A Salomon & Co Ltd)
• Bob Roberts is a director and shareholder of Bob Roberts Limited
• Bob Roberts Limited is the legal entity. 

What are the consequences of setting up the business for Bob?

It’s the company Bob Roberts Limited that is liable:

• to pay taxes
• to pay the fine
• make good the wrongdoing caused y the employee
• pay the damages arising from the employee’s mistake,

and not Bob.

Trading Names & Business Names

A trading name or business name is a name used by a business which is not its real name. It’s an alias for the legal entity. It’s analogous to a nickname for a natural person.

A few examples:

1. Coca-Cola trades as “Coca-Cola”, not “The Coca-Cola Company Inc”.
   “Coca-Cola” is a trading name.
   “The Coca-Cola Company Inc” is the company name. 

2. Microsoft Corporation is known as “Microsoft”. "Microsoft" is the business name.
3. Facebook Inc trades as “Facebook”. Again, "Facebook, Inc" is the company name, and "Facebook" is the trading name

These companies became known and famous by their trading names, rather than by their formal company name. Who wants to use the full company name anyway?

Answer: When it gives rise to legal consequences if you don't.

Why use a Trading Name?

Different companies adopt trading names for different reasons, the usual ones are:

1. that’s how people are going to commonly refer to the company
2. trade names will be protected by registered and unregistered trade marks, not the full company name.

Rare is the occasion when companies apply for registered trade mark protection for the full company name.

However, it’s the company itself that owns the goodwill in the trading name or the registered trade mark. The trading name can’t own property because it’s not a legal entity.

But when it comes to legal relationships – such as signing contracts or filing documents with regulatory authorities, these companies have to use their proper legal name – with the “Limited”, “Inc” or whatever the appropriate suffix for the company is.

We run through an example on how to sign contract below and show the difference.

 

Implications in Law 

There are a series of recurring problems which are easily avoided.

A few careful steps here and there and you should remain in the clear, and avoid personal liability and other problems.

Properly identifying the legal entity

There is no substitute for doing a company search to locate the legal entity on the relevant register of companies.

Companies, LLPs and other incorporated legal entities are formed when the UK Registrar of Companies (trading as "Companies House") says so here.

Doing a company search quickly and easily removes any doubt about:

• the continued existence of the company
• its registered address
• its registered company number 
• who controls it 
• whether it has filed what it is meant to have filed with the Registrar of Companies.

It also shows the status of the company.

If the company is not listed on the Register, it doesn't exist. That means the company can't enter into any contract - again, because it doesn't exist as a separate legal entity.

Seem obvious?

Well yes, but...

Contracts signed before a Company is formed

Sometimes business people sign contracts before companies are formed in anticipation of the company being formed. 

Contracts signed in the name of the company can't be enforceable against the company, because it didn't exist at the time.

Just because the company comes into existence at a later date, after the contract was signed doesn't validate the contract. 

Also, if the company has ceased to exist - ie dissolved - or is in liquidation, the Companies Register will show that. 

If a company is dissolved, it has ceased to exist.

Again, it can’t enter into contracts with others after it has ceased to exist.

The contract might be enforceable however against the individual signing it.

Contracting parties: Who am I contracting with?

Back when companies were first made available over 100 years ago, incorporated companies were required to use the suffix “Limited” or the alternative “Ltd”.

This was so that customers and suppliers knew that they were dealing with a company that had limited liability.

That requirement still applies today, undiminished.

The name of a company must end with the suffix "Limited", "Ltd.", "P.l.c.", as the case may be. "LLP" applies to limited liability partnerships.

You might think that that's just for the purposes of registering the company. 

But it goes further.  When it is a company trading, company suffix “Limited” or its permitted abbreviation, “Ltd” must be used.

Using our example above, “Bob Roberts” and “Bob Roberts Limited” are completely different legal entities.

So when a natural person signs a contract in their own name – and not that of the company – they become personally liable on the contract.

Suppose then that you run a business online. You have a website. But you do not:

• identify the company name in your terms of business
• or in your privacy policy
• or anywhere else on the site.

The question is, what is the legal entity that hosts or owns the website? Who "is" the business? 

Without reference to the full name of the company, it can't be the company that's trading.

When do you use the full company name?

If you’re trading as a company, you can’t leave out the reference to the “Limited” or “Ltd”. The company is legally required to identify itself properly.

Also, leaving out the full name of the company can lead to personal liability on the contract.

Also, the UK Companies Act requires companies to use its proper company name, registered company number, and registered address on all paperwork of the company.

This includes on:

1. its paperwork, such as:
   1. letters
   2. invoices and business cards
   3. email correspondence, usually in footers
   4. purchase orders
   5. statutory filings
2. its website(s), in fact any communication
3. applications for registration of intellectual property rights, whether its trade marks, designs or patents
4. registering domain names
5. contracts to:
   1. preserve confidentiality
   2. licence know-how
   3. enter a lease for property
   4. buy or sell property
6. contracts of employment

Not doing so means the directors and employees expose themselves to the risk that they will be found to be trading as individuals, particularly when email is used to enter into contracts with customers and suppliers.

Don't take my word for it. A specific piece of legislation says so.

Once you start using a company, it’s important to use the company name, in the form appears on the Register of Companies, and observe the requirements for execution of contracts and other documents to create legally binding  contracts.

What if you don't use the company name when you should?

There's a (very) good argument that it's not the company trading. It is someone other than the company that is trading.

If that's a director of the company, it's an express route past limited liability otherwise available to directors and shareholders of companies.

That's because it's not the company in the legal relationship. It's probably the individuals organising the business activity.

Company vs Shareholder

You may need to sign a contract as a shareholder of a company. In those cases, you'd sign in your own personal name. It's important to get the signing provisions correct. 

 

FAQs: Separate Legal Entities

1.   What are “divisions” of a legal entity?

Sometimes you might see wording such as “[Division Name], a division of [Legal Entity Name]”.

What does this mean?

Sometimes it means that “[Division name]” is a reference to a business unit within “[Legal Entity Name]”.

So the division equates to a business name for the [Legal Entity Name].

Other times “division” can mean a reference to one or more legal entities.

It’s really anyone’s guess – you need to make enquiries to find out for sure.

You’d do that in part by doing company searches to find out information on the true name of the business that is trading and holdings itself out as a “Division”.

 

2.     What are "branches" of a separate legal entity?

Many businesses have many branches or multiple offices, at separate physical addresses. 

There's usually nothing in principle preventing a business from incorporating a subsidiary of the parent company for each branch, and each branch being owned by a single subsidiary.

Take the banking industry. It’s highly regulated.

UK banks are required to be owned by the legal entity which is regulated by the Financial Services Authority. A single bank might have dozens or 100s of branches.

As a result of the regulations governing the banking industry, banks are not able to form companies for each branch it may have – disregarding the administrative inefficiency of doing so.

Each branch is usually a property owned by the regulated bank. They’re owned by the same legal entity, such as HSBC Bank UK PLC, Lloyds Bank plc, Barclays Bank UK plc.

 

3.     Does changing the name of a company create a new separate legal entity?

When a UK company is formed, it's assigned a company number. It's a registration number which uniquely identifies the company .

That registration number never changes. It's a permanent unique identifier for that company.

The company name however, can change. All it takes is a resolution of the board of the company.

That does not change the legal identity of the company. It doesn't create a new separate legal entity.

It's the similar situation when an individual changes their name by deed poll. They are the same person. it does not change any legal relationships the person has with others.

See for example this company. It has changed its name, but the company number did not change.

It's the same legal entity.

 

4.     Are there differences between accounting entities and legal entities?

An "entity" for accounting purposes can mean different things.

There’s room for confusion between an accounting entity and a legal entity.

A legal entity or number of companies within a larger group can be grouped for accounting purposes in whatever way suits the companies, provided it complies with applicable regulatory requirements.

Likewise, a single company can be broken up into any number of accounting entities to track the profitability of different business units within it.

 

Conclusions

All of this may seem a bit basic. It is.

But when it's in motion, it can be difficult to spot. 

We've seen judges enter judgment against individuals for signing contracts in their own name, rather than in the name of a separate legal entity. Without much discussion. That's because the law is so crystal clear.

It's so easy to make a mistake a cause serious down the road. And even trainee solicitors have been known to not have a clear understanding of legal entities and how they're properly identified.

Don't make the same mistakes as others before you.

Process

Adopting a process to identify separate legal entities and the capacity in which you may need to sign a contract is a formula for success. 

If you don't have a clear understanding of "the why" you are about to sign a contract in a particular way, you shouldn't.

You may not need to speak to a lawyer, but you need to speak to someone to talk it through to get that clear understanding.

Don't make the mistake of signing a business contract:

• in your own name, when you intend to sign for the company
• in the name of the company, when you intend to sign on your own behalf, such as in your capacity as a shareholder
• sign on behalf of one company when you intend to sign on behalf of another company.

And use the "Limited", "Ltd" or "Plc" to identify the company as a company.

Our Business Solicitors

We're long serving business solicitors that have advised companies and individuals avoid problems such as those referred to above, often at the last minute.

We've also helped companies pull themselves out of a bad spot after it would seem to be too late.

We advise small and medium-sized businesses on:

• business contracts to fix them, such as terms and conditions of business (aka T's and C's)
• setting up joint ventures properly, with risk management in mind to reduce business risk 
• regulatory compliance issues, such as disclosures required under the Ecommerce Regulations, Consumer Rights Act, GDPR, other legislation
• minimising - and avoiding - liability when possible, and
• business disputes in the UK, from our offices in London.

For business legal advice, call us on +44 20 7036 9282 to speak with a business solicitor, or email us at contact@hallellis.co.uk.