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Danby Bloch: Why are advisers overlooking the safety of limited liability?

The costs of unlimited liability can be catastrophic, so advisers who are sole traders or in full partnerships should reconsider their position

It is an astonishing fact that 14 per cent of the 14,000 or so advice firms in the UK operate without limited liability.

This is according to Apfa’s (now part of Pimfa) excellent report, The Financial Adviser Market: In Numbers, which was published earlier this year and provides data up to the end of 2016.

There are four main ways in which advisers can trade: as limited liability companies (either private “limited” or public “PLC”), limited liability partnerships, sole traders and full partnerships.

The breakdown of firms is 79 per cent limited companies, 7 per cent limited liability partnerships, 10 per cent sole traders and 4 per cent partnerships.

The number of advisers operating without limited liability protection has declined over the years from 22 per cent in 2009. The number of full partnerships has halved from 8 per cent but sole traders have only declined from 14 per cent to 10 per cent of the total.

Of course, firms that do not have the protection of limited liability are virtually all at the smaller end of the spectrum.

This means the number of individual advisers they represent is far less than 14 per cent of the 24,761 there were at the end of 2016. Larger firms almost all work in limited liability entities, sole traders are almost all very small and many of the partnerships are probably husband and wife firms, or similar.

So three questions about this metric occur:

  • Why is this figure of 14 per cent of firms choosing to spurn limited liability so very astonishing?
  • Why do these advisers hang onto unlimited liability?
  • What should they do about it?

First, why is it so astonishing 14 per cent of firms have unlimited liability? The answer is in the name; business entities 101. A sole trader business is owned by a single individual, who is personally responsible for all the debts and liabilities of the business. So if a sole trader business makes a mistake and gives incorrect advice or perhaps fails to put a client on risk and the client subsequently dies, the adviser is potentially personally liable.

The position with partnerships is arguably even worse. The individual partners could be personally responsible for the liabilities of the business if the partnership cannot meet its debts. So an adviser could find themselves picking up the tab for their partners’ mistakes. They are potentially jointly and severally (individually) liable.

Limited liability protection in a limited company in principle means shareholders’ losses are limited to the amount of unpaid shares that may be outstanding. An LLP is similar to a limited company in they cannot normally lose more than they have invested and, in particular, they are not normally individually or severally responsible for other partners’ actions.

Why would these advisers hang onto unlimited liability? Well, some are very confident they will not make mistakes. And some seem to be just as confident that their partners will not slip up either.

Professional indemnity insurance provides valuable protection – and advisers have to hold it. But it may not turn out to be a perfect protective shield, as some have found out to their cost.

The level of cover may be insufficient, perhaps because the total claims exceed the sum insured. In some cases, the aggregate cost to the business of the excess payments on claims can add up to terrifying amounts where individual cases are treated as separate claims, each subject to a substantial excess.

Of course, there are also circumstances in which the protection of limited liability is not perfect. Fraud or wrongful trading can lead to directors/shareholders or LLP partners having personal liability for corporate debts.

More relevant in this context is the possibility that the regulator could find individual senior managers personally responsible and liable for their actions. This could become rather more common under the new senior managers’ regime due to be introduced for advisers very soon.

What is more, the courts can occasionally decide that directors have acted in an egregiously blameworthy way and made them personally liable for corporate debts – but that is very rare.

It may not cover every possible eventuality but most advisers should feel hugely safer behind the protection of limited liability than without it.

That said, there are tax and National Insurance advantages to being self-employed as a sole trader or a partnership, compared with trading through a company or LLP. Some advisers might feel optimistically that they have traded so long without limited liability that a few more years probably would not lead to much harm.

All in all, though, advisers who are sole traders or in full partnerships should almost certainly convert to a limited company or limited liability partnership. The tax and other costs of rolling the business across is typically not enormous. The potential costs of unlimited liability, on the other hand, could be catastrophic.

Danby Bloch is chairman of Helm Godfrey and consultant at Platforum

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Comments

There are 6 comments at the moment, we would love to hear your opinion too.

  1. Danby

    I really hesitate to make points in view of your far greater expertise, but perhaps you may have overlooked a few issues.

    1.Regulatory and audit fees are cheaper for the non incorporated.(indeed an audit is not required)
    2. Non incorporated don’t generally pay bank charges.
    3. Capital adequacy means that you can have all your money working for you personally instead of having funds sloshing around in a Limited company and for which one has to pay corporation tax and when one withdraws the money pay income tax and possibly NI.
    4. Expenses are far more generous to the non incorporated. For example I can claim relief on my car (for business purposes) whereas if owned by the Ltd firm I would get taxed on my P11D. Indeed with careful attention the tax position for the unincorporated is far more lenient.
    5.Even directors can now be held responsible, both by the regulator and HMRC. The sole trader can take care not to have too much in personal assets and ensure that any great excess is held by the wife. (Of course always assuming that divorce is not an issue in the future and even then it may well work itself out at the financial settlement).

    Perhaps (assuming that the foregoing is technically sound)this might explain why non-incorporation is the preferred route for many. Risk is something that can be controlled and being non-incorporated does tend to concentrate the mind in this respect. Indeed I myself (as you know) was an unincorporated sole trader for 25 years and have no regrets. Of course selling the firm was made so much easier as a consequence.

    naturally I also assume that most unincorporated traders are sole or with very small staff.

    • Ok Harry let’s dispel a bit of your misinformation.

      1. Companies Act 2006 – most small companies are exempt from audit requirements.
      2. I do my banking with Santander (formerly Alliance&Leicester Giro Bank) – no bank charges for my Ltd Co. for over 13 years !
      3. Money doesn’t need to be “sloshing” around the Ltd Co. Also, withdrawals can be taken as dividends with no liability to NICs or base rate tax – just the new dividend tax.
      4. Expenses are expenses in or out of a Ltd Co. However, I have noticed quite a lot of people are not going for Co. Car any more because of the onerous tax & therefore looking at own car & claiming mileage – same in & out of ltd co. ? Indeed, my personal experience is Ltd Co./Director(s) has been far more tax efficient up to the recent introduction of the dividend taxation.
      5. You seem to suggest go self employed but live like a ltd co. ?

      I would suggest quite number of Advisers do not go incorporated because keeping the status quo is more preferable. Constant Regulatory change is enough to keep up with ?

  2. Very wise words Danny.

    Given all of the potential risks inherent in being an adviser I’m amazed, or perhaps that should be dismayed, that any of my peers would risk their financial future by acting without limited liability.

  3. I understand your points Harry but I have to try to defend clients who have long since retired. They have no PI and no resources to meet any claim except, perhaps their home.

    Worse, I have found the widow of an adviser having to defend a claim simply because she was a business partner although she had nothing to do with the actual business. The event would be covered by the long stop but FOS ignores that defence.

    And as far as tax advantages are concerned, two of the best tax planning tools available to anybody are getting married and dying because they allow you to transfer loads of assets tax free.

    I do not recommend you do either just for the tax breaks, though.

    • “…she was a business partner although she had nothing to do with the actual business…”

      Married or not, that’s shockingly naive behaviour. What do people think “partner” means?

      And you do have to wonder where the FSA authorisations process broke down on that case too. Rhetorically, what in her background made her suited to exercise a governing function in a financial advice business?

  4. Harry, Thanks for your contribution on this. I wondered if you would join this debate.
    I am well aware of the tax advantages of not being incorporated and I mentioned them in the article – though not in the detail you have.
    I just don’t think they are worth the huge risk they let you in for. Advisers should mitigate risk for their clients – but also for themselves. Danby

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