Legal Entity

Article byJyotsna Suthar
Edited byprarthana Khot
Reviewed byDheeraj Vaidya, CFA, FRM

A legal entity is a judiciary term for a company, entity, or organization that has certain rights, responsibilities, and liabilities under the law of a particular state or country. The primary purpose of this entity is to work under a single name and execute its rights during lawsuits or significant decisions.

Legal Entity

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A legal entity allows a group of individuals to carry business under a common name. It also gives them the right to borrow, lend, and sue. Also, it provides a specific type of protection against tax burdens. However, it can also cause a loss of goodwill in some cases.

Key Takeaways

  • A legal entity is a company or firm registered with the country’s law that allows the owners to run the business under one common name. In addition, they get certain rights and responsibilities to conduct trade.
  • The types of legal entities are – sole proprietorship, limited liability company (LLC), partnership, and corporations.
  • The LEI is a 20-digit code with 18 unique characters assigned to the corporation, and the rest two refer to the checksum digits.
  • The LEI codes started in 2011 during the group of 20 committee forum. Later, on January 3rd, 2018, it became mandatory to obtain it.

A legal entity is an organization with a collective group of individuals working together under a common identity with some rights and obligations. They get to exercise these responsibilities under the business legal entity. Also, it allows them to borrow, lend, or sue other parties as per the law. However, this separate legal entity concept started in the 17th century.

A sole proprietorship, for instance, has the benefit of being straightforward and inexpensive, but the owner has no asset protection. Therefore, any debt can ultimately be settled using individual assets. Shareholders’ obligations and liability exposure are constrained in corporations.

Legal entity trust works in compliance with the laws governing the country. Therefore, they get a high degree of protection against lawsuits damaging assets. Also, the legal entity can enter into multiple contracts simultaneously. However, this right does bring simultaneous obligations with it. For example, Amakon company supplies goods to Wallkart Ltd, but the goods need to be fixed. Then, Wallkart Ltd. can sue (file a case) Amakon for compensation for the loss incurred.

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History

The origin of the legal entity dates back to the 1600s when England’s judge Lord Coke declared a corporation as a separate legal entity entitled to certain obligations. However, the concept came into the limelight in the 19th century. During 1840 and 1844, most firms and joint stock companies came into existence. Also, there was the emergence of the London Stock Exchange. As a result, it became necessary for firms to register under the law to continue operations. Likewise, introducing the Registration Act of 1844 made the incorporation work easy.

Types

Let us look at the types of legal entities to understand the concept better:

#1 – Sole Proprietorship

It is a business entity that is easy to establish as a single person is needed to manage and run the operations. A sole proprietorship is one of the simplest forms of organization. Besides, the profits earned in it solely belong to a single person. In case of losses, the single owner handles them. Although a single person oversees the operations, it does have a different legal status as per the law. For example, while recording accounting transactions, the owner will use the legal entity trust of the business, not his name.

#2 – Limited Liability Company (LLC)

In a limited liability company, the rights and obligations are limited to the extent of the partner’s share. However, in times of lawsuits, the liability gets distributed among the partners equally. No one partner has to bear all the losses. Federal law states that more than two partners must register under Form 1065. However, to form LLC, owners should pay a fee of $100-$800 to the registrar.

#3 – Partnership

A general partnership legal entity is a formation of more than one person coming together and working as a partner. Here, the partners earn profits as per their share mentioned in the partnership agreement. Since it is a tax-reporting entity, it must file Form 1065 to report annual income to the government. However, every country will have a different law for reporting the returns of a partnership legal entity.

#4 – Corporations

Corporations have a complex business structure compared to other business entities. Here, the person running the business is different from the owners. Therefore, the shareholders are the owners, and the board of directors is the management. In addition, S Corporations must fill out Form 1120S, while C corporations must file as per Form 1120 as they are subject to double taxation.

A legal entity identifier (LEI) is a global code that recognizes the entities in the international market. The main aim of this identifier was to improve transparency across the global market. Also, it provides worldwide recognition to the business legal entities involved in export and import. According to a report, more than 2,075,000 LEI exist today. Also, every week, more than 3600 LEI were issued. LEI is a 20-digit code that allows businesses to earn recognition across borders.

Now, let us look at the characteristics of the LEI of a legal entity trust:

  • The International Organization for Standardization (ISO) established the LEI system in response to the 2008 debt crisis in the 2011 G20 forum. Later, in December 2012, the first LEI came into existence. By January 3rd, 2018, it was mandatory for all companies for all firms to get their LEI code.
  • The first four characters refer to the Local Operating Unit (LIU) issued by the LEI. The following five to eighteen characters contain a unique alphanumeric set assigned to that organization. In contrast, the rest two characters refer to the checksum digits.
  • Among the significant entities, G20, Financial Stability Board, Local Operating Unit, Global LEI Foundation, and LEI Regulatory Oversight committee handle its operations.
  • Legal entities can quickly obtain LEI codes from the above institutions. It usually takes a couple of weeks, depending on the organization’s efficiency.
  • The validity of this LEI code is one year from the registration date. However, renewal is possible by retaining the same code.

Examples

Let us look at the examples of legal entities to comprehend the concept better:

Example #1

Suppose Steve Johnson has been running a local garment business for a decade. So, now he needs to expand his business in various countries. Thus, after consultation, he decides to start a company with his wife, Melinda, under the family name. He goes to the registrar’s office and incorporates the company under the legal entity name “Johnson Textiles.”

As per the incorporation agreement, he has to maintain a separate account to handle business. Also, Steve’s rights and liabilities will differ from his registered textile business. However, in case of defective goods or fraud, Johnson Textiles and his wife will be responsible, rather than Steve alone.

Example #2

GLEIF recently reported that over 2 million LEI are active worldwide exist. And most of them (11%) belong to the Asian business community. Lately, it has been possible to apply in less than a minute.

According to the most recent data, which covers Q1 2022, more than 65,000 new LEIs were issued globally throughout those three months. 3.3% more LEIs were issued overall, and there are now more than two million active LEIs worldwide. The Global LEI system’s maturity and the value it provides to the world economy and all LEI data users are once again confirmed at this historic time.

Although legal entities and business units belong to the same community, they differ slightly. While the former is a company legally registered with the country’s law, the latter is an independent division conducting the operations. The business unit’s primary focus will be to run the business through trade. However, the former will help the latter conduct the company under a common name.

BasisLegal EntityBusiness Unit 
Meaning A corporation is legally bound to follow the rules, regulations, and obligations.A business unit is a part of a legal entity that handles its operations. 
PurposeTo offer rights and liabilities to the organization to work under a single name. It performs business transactions on behalf of the entity. 
ResponsibilitiesThey try to borrow, lend, supply, and sue under the legal entity’s name. They try to conduct independent, separate business operations. 

Frequently Asked Questions (FAQs)

1. How to find out the legal entity of a company?

To check the legal status of a company, an individual can check the website of the apex institution, which is the Global Legal entity identifier foundation (GLEIF). Among the list of 2 million numbers, the majority of companies have already registered their names in it.

2. Is a natural person a legal entity?

No, both concepts are different as per the law. Legal entities are registered companies under the legal judiciary, while natural persons have the right to conduct business legally.

3. Can a legal entity be a beneficial owner?

A beneficial owner cannot be a business entity because it is a natural person, whereas the latter is a company or corporation.

4. Is a bank considered a legal entity?

Yes, banks fall under the category of legally bound entities. Federal Reserve Act of 1913 led to the formation of banks. They perform similar rights and liabilities with that of a business entity with minor changes.

This article has been a guide to Legal Entity and its meaning. We explain it with its history, types, identifier, examples, and comparison with the business unit. You may also find some useful articles here –

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