Veil Piercing Claims

Introduction

Let’s say you have a judgment against a corporation, and you cannot collect the judgment, what steps can you take? Normally, corporate shareholders are shielded from liability for the corporation’s debts. One main reason to use a corporation is to shield the shareholder or investor from liability. As the Illinois courts have recognized, “[a] corporation is a legal entity that exists separately and distinctly from its shareholders, officers and directors, who are not generally liable for the corporation’s debts.” Peetoom v. Swanson, 334 Ill. App. 3d 523, 778 N.E.2d 291, 294 (Ill. App. 2d Dist. 2002). The principle of limited liability will protect a shareholder of a corporation even if there is only one shareholder of the corporation. Id.

If you have good reason to believe that the opposing party transferred assets to another party to avoid having to pay the judgment, you can file a claim to pierce the corporate veil.

The piercing the veil claim, if successful, breaks through the shield of the corporation and imposes liability on the owners of that corporation including shareholders. If you pierce the veil of a subsidiary (a corporation owned by another corporation), you can then impose liability on the parent corporation.

A piercing the veil claim is a new proceeding against the debtor corporation. To prevail, the creditor must show that the “corporation is merely the alter ego or business conduit of another person or entity.” Id. at 295 (quoting In re Rehabilitation of Centaur Insurance Co. 238 Ill. App. 3d 292, 299. The court goes on to explain that the doctrine of piercing the veil “fastens liability on the individual or entity that uses a corporation merely as an instrumentality to conduct that person’s or entity’s business. …Such liability arise from fraud or injustice perpetrated not on the corporation but on third persons dealing with the corporation.” Id. at 295. This legal language can be murky, but the key concept is whether or not the shareholders of the debtor corporation used it to defraud their creditors. Was the corporation a shell with no real business? Did it have real assets sufficient to incur the debts that it incurred or guaranteed?

Under Illinois law, the creditor has five years from the date on which the corporation was dissolved to file the piercing the veil action. See Peetoom, 334 Ill. App. 3d at 297-98. A plaintiff also has five years from the date when an LLC was dissolved to file a piercing the veil action. See 805 ILCS 180/1-50 (b)(3).

A piercing the veil claim can be brought where the defendant uses multiple entities to improperly shield himself from liability. The Illinois courts have recognized that “the doctrine of piercing the corporate veil is not limited to the parent and subsidiary relationship; the separate corporate identities of corporations owned by the same parent will likewise be disregarded in an appropriate case.” Main Bank of Chicago v. Baker, 86 Ill. 2d 188, 205, 427 N.E.2d 94 (1981).

The Main Bank case rejected the piercing the veil claim filed against the Bank by Baker, a former officer of the Bank. The court noted: “[t]he evidence clearly supports the trial court’s findings that the parties operated at arm’s length, that there was no evidence of a misrepresentation of any kind, that no one attempted to deceive defendants or conceal anything under corporate names, and that Baker, who was represented by counsel, had a total understanding of the transactions. Nor was there any evidence that [Main Bank} failed to maintain adequate corporate records or to comply with corporate formalities, that it was undercapitalized or that corporate funds were commingled.” Id at 205-06.

Thus, the some of the elements supporting a piercing the veil claim are:

• The corporation was undercapitalized;
• The corporation did not maintain orderly books and records;
• The corporation and the shareholder or owner commingled funds;
• The transaction was deceptive;
• The transaction was fraudulent;
• There was evidence of the concealment of a material fact.

The Main Bank case is notable because Baker was not successful in showing that even one of the factors was present.

Illinois courts now use a two-step test to determine whether the veil should be pierced:

(1) there must be such unity of interest and ownership that the separate personalities of the corporation and the individual no longer exist; and (2) circumstances must exist such that adherence to the fiction of a separate corporate existence would sanction a fraud, promote injustice, or promote inequitable consequences.

To determine whether the “unity of interest” test has been met courts examine many factors, including (1) inadequate capitalization; (2) failure to issue stock; (3) failure to observe corporate formalities; (4) nonpayment of dividends; (5) insolvency of the debtor corporation; (6) nonfunctioning of the other officers or directors; (7) absence of corporate records; (7) commingling of funds; (9) diversion of assets from the corporation by or to a stockholder or other person or entity to the detriment of creditors; (10) failure to maintain arm’s length relationships amount related entities; and (11) whether, in fact the corporation is a mere facade for the operation of the dominant stockholders. Jacobson v. Buffalo Rock Shooters Supply, Inc., 278 Ill. App. 3d 1084, 1088 (1996). Fontana v. TLD Builders, Inc., 362 Ill. App. 3d 491, 840 N.E.2d 767 (Ill. App. 2d Dist. 2005)

We will also discuss Fontana in which an Illinois court used the piercing the veil doctrine to hold a non-shareholder of a corporation liable for its debts.

The Fontanas alleged that they entered into a contract with TLD under which TLD agreed to construct a single family home in Clarendon Hills for the sum of $1,475,800. The Fontanas alleged that TLD breached the contract by failing to construct the home as specified in the contract and “by abandoning all work on the home in February 2001, leaving the home incomplete and uninhabitable.”

After a bench trial, the court held that TLD breached the contract and failed to cure the breach. As to damages, the court held that it would be too costly to complete the home, so the unfinished home should be demolished. The court held that the Fontanas had been damaged in the amount of $1,271,816.10. The trial court entered judgement against TLD and DiCosloa jointly and severally.

DiCosola appealed and argued that piercing the veil did not apply to him because he was not a shareholder of TLD. Plaintiffs alleged that DiCosola was the alter ego of TLD and that, after the lawsuit was filed, he caused TLD to cease its business operations so that it had no funds with which to compensate plaintiffs. DiCosola was not a shareholder of TLD.

Theresa DiCosola was called as a witness by the Plaintiffs. Mrs. DiCosola admitted that she was the incorporator of TLD. She could provide no evidence that the corporation had any start-up capital. There was no evidence that she or DiCosola ever paid for the stock issued by the corporation. The purported owner of the corporation, Theresa DiCosola, knew nothing about the corporation, did not sign checks, kept no records and did not know whether the corporation had ever earned a profit or a loss.

Theresa “said that she has never received a dividend from TLD and did not know if TLD had profits or losses in the years, 1998,1999, 2000, 2001 and 2002. However, Theresa did sign TLD’s income tax returns for those years.” She also admitted that she had no idea where the company’s assets of $1.8 million went after the lawsuit was filed.

TLD had almost no financial records, and almost no records of payments that it made to vendors and subcontractors.

As a result, the trial court found that “Mr. DiCosola is the dominant force behind this corporation” and that the corporation “was little more than a shell which was established to shield him from liability.” Id. at 775.

In Illinois a party seeking to pierce the corporate veil has the burden of making a substantial showing that the corporation is really a dummy or sham for another person or corporation. In re Estate of Wallen, 262 Ill. App. 3d 61, 68 (1994). The doctrine “imposes liability on the individual or entity that uses a corporation merely as an instrumentality to conduct that person’s or entity’s business.”

The court first rejected the argument that DiCosola could not be held liable because he was not a shareholder. There is authority in Illinois and other states that a non-shareholder can be held liable if the other elements of the test are met.

Illinois uses a two-step test to determine whether the veil should be pierced:

“(1) there must be such unity of interest and ownership that the separate personalities of the corporation and the individual no longer exist; and (2) circumstances must exist such that adherence to the fiction of a separate corporate existence would sanction a fraud, promote injustice, or promote inequitable consequences.”

To determine whether the “unity of interest” test has been met courts examine many factors, including (1) inadequate capitalization; (2) failure to issue stock; (3) failure to observe corporate formalities; (4) nonpayment of dividends; (5) insolvency of the debtor corporation; (6) nonfunctioning of the other officers or directors; (7) absence of corporate records; (7) commingling of funds; (9) diversion of assets from the corporation by or to a stockholder or other person or entity to the detriment of creditors; (10) failure to maintain arm’s length relationships amount related entities; and (11) whether, in fact the corporation is a mere facade for the operation of the dominant stockholders.” Jacobson v. Buffalo Rock Shooters Supply, Inc., 278 Ill. App. 3d 1084, 1088 (1996).

The factors, when analyzed, strongly favored plaintiffs:

(1) There was no evidence of adequate capitalization; (2) failure to issue stock; (3) failure to observe corporate formalities; … (5) insolvency; (6) no evidence that Theresa functioned as a real officer or director; (7) almost total absence of corporate records.

Our Chicago Commercial Litigation lawyers are familiar with and experienced in handling piercing the veil claims. Please call us for a free consultation if you believe that a debtor has taken action to defraud you.