A basic principle of corporate law, indeed the very reason why individuals incorporate or organizations create subsidiaries, is to insulate stockholders (whether corporations or individuals) from the corporation’s liabilities. However, this insulation from liability is not absolute.
“Piercing the corporate veil” (“PCV”) is the legal doctrine that allows a plaintiff to hold the entities or individuals who control a corporation personally liable for that corporation’s wrongdoings, debts, or other liabilities. As a result, PCV poses a significant threat to parent organizations, corporate shareholders, or, as recently held in Buckley v. Abuzir, any individual, regardless of title or position, who in reality dominates the corporation.
In addition to clarifying the long-contested issue of whether non-shareholders may be held personally liable under PCV, the First District’s decision in Buckley also provides a helpful summary of Illinois case law regarding the doctrine. In order to avoid the potentially dire consequences of being found personally liable, Illinois business owners should understand this significant aspect of business law, including how to avoid it.
A SUMMARY OF PIERCING THE CORPORATE VEIL
In its decision in Buckley, the First District noted that PCV is the most litigated issue in corporate law. Indeed, the situation frequently arises in which a corporation itself is insolvent or otherwise judgment-proof, and the wronged plaintiff has no option to recoup its loss other than to go after the individuals or entities who own the corporation. Despite the frequency with which this doctrine appears in Illinois courts, it is poorly understood. Case in point, Illinois judicial opinions regarding PCV frequently comment that Illinois courts are “reluctant” to pierce the corporate veil, and that the plaintiff must make a “substantial showing” that the doctrine should apply. In reality, statistical analysis shows that Illinois courts apply the doctrine roughly 42%-52% of the time it is alleged. Additionally, it is almost always alleged with respect to a closely-held corporation, particularly those corporations with only one shareholder.
THE BASIC TEST
As the Buckley court stated: “Illinois courts will pierce the corporate veil ‘where: (1) there is such a unity of interest and ownership that the separate personalities of the corporation and the parties who compose it no longer exist, and (2) circumstances are such that adherence to the fiction of a separate corporation would promote injustice or inequitable circumstances.’” Each of these two elements requires its own separate analysis, and a plaintiff seeking to pierce must establish both of them for the doctrine to apply.
Unity of Interest and Ownership
The Buckley court reiterated the eleven factors[1] an Illinois court will consider in determining whether there is a unity of interest and ownership:
(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; (8) 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 among related entities; and (11) whether, in fact, the corporation is a mere facade for the operation of the dominant stockholders.
While the above factors are relatively straight-forward, the less-clear issue addressed in Buckley was whether the unity of interest and ownership prong of PCV necessarily requires that the individual against who PCV is sought was a shareholder of the underlying corporation.
In Buckley, the plaintiffs obtained a default judgment against the underlying corporation for wrongfully acquiring plaintiff’s trade secrets. In collecting that judgment, the plaintiff sought to hold Haitham Abuzir – an individual who was not a shareholder, officer, or employee of underlying corporation – personally liable. The Buckley plaintiff alleged that, despite his non-shareholder status, Abuzir so dominated the corporation’s funding and business decisions that the corporation was effectively his “alter–ego,” and the individuals identified as the corporation’s “owner” and “president” in fact played no significant role in running the corporation. The Buckley defendant countered that Abuzir could not be held liable under PCV because he was not a shareholder, officer, director, or employee of the corporation, which is necessary to satisfy the first prong of PCV.
In resolving the parties’ dispute, the Buckley court first examined the positions other jurisdictions have taken on the issue, and concluded that a vast majority of states recognize PCV against individuals who are not shareholders, officers, or directors. More importantly, the Buckley court recognized that Illinois had recently adopted the exact same position in Fontana v. TLD Builders, Inc., which was decided in 2005. In light of these persuasive and binding authorities, the Buckley court held that the plaintiff’s complaint sufficiently alleged a PCV claim against Abuzir who, despite his non-shareholder and non-employee status, dominated the corporation under the facts alleged.
In sum, in both Buckley and Fontana, the First and Second District courts of Illinois respectively adopted an equitable approach in PCV cases which focuses on the individual’s actual domination of the corporation; therefore, the individual does not need to be a shareholder, officer, director, or even an employee in order to be held liable under PCV.
Promote Injustice or Inequitable Circumstances
The second element of PCV – whether insulating the individual or entity from liability would promote injustice or inequitable circumstances – more specifically requires that the court consider whether there is some unfairness, such as fraud or deception, or the existence of a compelling public interest that justifies piercing.
In Buckley, the court noted that the plaintiff’s threadbare allegations of promoting injustice were insufficient because those allegations lacked supporting facts. However, the court ultimately determined that plaintiff had alleged unfairness and/or inequity because the allegations in the complaint provided an inference that Abuzir violated the Illinois Trade Secrets Act when he hired plaintiff’s head baker and misappropriated plaintiff’s trade secrets. The Buckley court found this allegation was just enough for plaintiff’s complaint to survive dismissal, noting that it’s standard of review required assuming that all the complaint’s allegations were true and to draw all inferences in the plaintiff’s favor.
THE PRACTICAL IMPORT OF BUCKLEY
Both Buckley and Fontana make clear that Illinois has adopted an equitable approach to who may be held liable under PCV; therefore, what matters most is the degree of domination an individual exerts over a corporation. For closely-held corporations, especially ones with a single shareholder, this means that distributing responsibilities, delegating decision-making authority, and generally avoiding centralized power in one individual may help to evade potential piercing in the future. Additionally, corporations should make sure that they are observing corporate formalities; monitor where, to whom, and why corporate funds are being sent; and protect against undercapitalization. Finally, although it is certainly not determinative, commingling of corporate funds, which should be avoided regardless of PCV concerns, is typically a factor that – standing alone – strongly favors piercing. Although taking these steps may seem superfluous to a corporation whose main goal is to make profits, they can help to assure that individuals or parent corporations do not have their insulation from liability stripped.
[1] Unlike “elements,” “factors” are not required components of a claim that must each be individually proven; rather, “factors” are circumstances that a court will consider in weighing whether to apply the doctrine. Therefore, if some but not all of the factors favor applying the doctrine under the facts, the court will likely find that PCV is appropriate.