Reading time: 3 minutes

One of the most attractive features of being a sole trader is the freedom, flexibility and low set up and administration costs. However, one of the biggest disadvantages is the personal liability which comes with running an unincorporated business.

This article discusses this personal liability and how you may further protect yourself by forming a company.

What is the liability profile of a sole trader?

The liability of sole traders is unlimited. As a sole trader, you are the business and this means that any business expenses, debts, loans or other liabilities belong to you and not the business. If you cannot satisfy a debt, the creditor could sue you personally to recover the debt and, if successful, the creditor may be able to access your personal assets, such as the family home.

Moreover, many loans provided by banks and other lenders to sole traders are often secured by the sole trader’s personal assets. These personal assets often include the family home, which means that the bank could force the sale of your home to repay the loan.

What is the liability profile of a director of a company?

On the other hand, a company is an independent legal entity, separate from its directors, shareholders and employees. The company’s assets and liabilities belong to it. As such, one of the advantages of operating a company is the restriction regarding liability of shareholders and directors.

Shareholders have limited liability; they are not responsible for the company’s debt and usually, the most they would be liable for would for would be the unpaid amount on any shares.

Directors are generally free from personal liability for the company’s debts, but can be liable in a number of different scenarios, for example where that director:

  • signs a personal guarantee;
  • commits an act of fraud or negligence or other civil or criminal laws; and
  • breaches their duties as a director (including running the company whilst the business is insolvent).

When would personal guarantees be required of a director?

Personal guarantees are sometimes required of directors, especially when the company is small and has a short track record. Personal guarantees are often required in the context of a company opening or extending a credit facility or enterinto into a lease agreement. This guarantee means that the director will need to meet the debt owed to the creditor if the company is unable to meets its obligations.

The upshot of this is that simply forming a company will not absolve a director of personal liability or the financial responsibilities of running a business.

Conclusion

The question of liability is an important factor to consider in determining the best structure for your business. There are a number of advantages and disadvantages to operating as a sole trader or forming a company, but if you plan to grow your business, you may wish to benefit from the limited liability of a company structure.  However, as noted above, a director will still not be completely absolved of personal liability and it is therefore critical for a director to keep up-to-date on the financial position and performance of the company and make informed decisions accordingly.

We are able to give you specific advice, tailored to your circumstances, on the most suitable structure for your business.

Contact LegalVision on 1300 544 755 to get an obligation-free, fixed-free quote today.

Webinars

How to Protect and Enforce Your Trade Mark

Wednesday 11 May | 11:00 - 11:45am

Online
Protect your business’ brand from copycats and competitors. Register for this free webinar to learn how.
Register Now

Corporate Governance 101: Responsibilities for New Directors

Friday 13 May | 11:00 - 11:45am

Online
If you are a new company director, join our free webinar to understand your legal compliance obligations. Register today.
Register Now

How Franchisors Can Avoid Misleading and Deceptive Conduct

Wednesday 18 May | 11:00 - 11:45am

Online
Ensure your franchise is not accused of misleading and deceptive conduct. Register for our free webinar today.
Register Now

New Kid on the Blockchain: Understanding the Proposed Laws for Crypto, NFT and Blockchain Projects

Wednesday 25 May | 10:00 - 10:45am

Online
If you operate in the crypto space, ensure you understand the Federal Government’s proposed licensing and regulation changes. Register today for our free webinar.
Register Now

How to Expand Your Business Into a Franchise

Thursday 26 May | 11:00 - 11:45am

Online
Drive rapid growth in your business by turning it into a franchise. To learn how, join our free webinar. Register today.
Register Now

Day in Court: What Happens When Your Business Goes to Court

Thursday 2 June | 11:00 - 11:45am

Online
If your business is going to court, then you need to understand the process. Our free webinar will explain.
Register Now

How to Manage a Construction Dispute

Thursday 9 June | 11:00 - 11:45am

Online
Protect your construction firm from disputes. To understand how, join our free webinar.
Register Now

Startup Financing: Venture Debt 101

Thursday 23 June | 11:00 - 11:45am

Online
Learn how venture debt can help take your startup to the next level. Register for our free webinar today.
Register Now

About LegalVision: LegalVision is a commercial law firm that provides businesses with affordable and ongoing legal assistance through our industry-first membership.

By becoming a member, you'll have an experienced legal team ready to answer your questions, draft and review your contracts, and resolve your disputes. All the legal assistance your business needs, for a low monthly fee.

Learn more about our membership

Need Legal Help? Submit an Enquiry

If you would like to get in touch with our team and learn more about how our membership can help your business, fill out the form below.

Our Awards

  • 2020 Excellence in Technology & Innovation Finalist – Australasian Law Awards
  • 2020 Employer of Choice Winner – Australasian Lawyer
  • 2021 Fastest Growing Law Firm - Financial Times APAC 500
  • 2020 AFR Fast 100 List - Australian Financial Review
  • 2021 Law Firm of the Year - Australasian Law Awards
  • 2019 Most Innovative Firm - Australasian Lawyer