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Case Law References
Business law at it relates to breaching the corporate veil is changing rapidly in state and Federal Courts throughout the United States.
LB&S is presenting these case links and quotes to provide business owners and corporate secretaries, relevant information to assist them to avoid having their company's veil breached and inadvertently exposing the personal assets of the business owners to creditors and others trying to get to those assets
These case links and associated information are presented for informational purposes only and are not intended to constitute legal advice, and may be considered advertising under applicable state laws. Please always consult qualified legal counsel in your state before undertaking any actions.
FACTORS IN BREACHING THE CORPORATE VEIL IN ILLINOIS
In 2014, in Buckley v. Abuzir, an Illinois case, the Buckley court reiterated the eleven factors an Illinois court will consider in determining whether there is a unity of interest and ownership sufficient to Breach the Corporate Veil. Those factors include:
|
Item # |
Buckley Criteria |
Commentary |
|
1 |
INADEQUATE CAPITALIZATION |
What is inadequate capitalization and what is Entrepreneurial spirit? |
|
2 |
FAILURE TO ISSUE STOCK |
Issuing shares when funds are received is critical |
|
3 |
FAILURE TO OBSERVE CORPORATE FORMALITIES |
Book & Seal Information needs to be kept with Minutes referencing Approved Actions of Board & Shareholders (as required). Should be housed in secure location, encrypted and available to inquiring shareholder with “just cause”. It is required by law. |
|
4 |
NONPAYMENT OF DIVIDENDS |
Pay dividend and be sure tax records and Corporate Book are clean as to who is in ownership and Pari passu distribution. In writing, signed by Officers, BOD or Shareholders. |
|
5 |
INSOLVENCY OF THE DEBTOR CORPORATION |
Clean records of in depth discussion on corporate indebtedness and the importance the BOD put on solving the issue. Minutes should be in the Company Book and needs to reflect regular (at least quarterly for BOD and annually for shareholders) meetings. |
|
6 |
NONFUNCTIONING OF THE OTHER OFFICERS OR DIRECTORS |
Officers are not just names in a Book. The Minutes and regular meeting show working interaction among the officers, BOD and staff. |
|
7 |
ABSENCE OF CORPORATE RECORDS |
Book & Seal records should be digitized, placed in a secured, encrypted, Digital Vault accessible on a password system, with controlled access approved by officer and recorded. |
|
8 |
COMMINGLING OF FUNDS |
This has always been an issue when the separation from owner and company is not clean. Loans need to be shown in Promissory Notes and approved by management or BOD. The debt is then booked as debt on the financial records of the Company with a paper trail showing a fair, arms-length transaction. |
|
9 |
DIVERSION OF ASSETS FROM THE CORPORATION BY OR TO A STOCKHOLDER OR OTHER PERSON OR ENTITY TO THE DETRIMENT OF CREDITORS |
Another issue we see regularly. Owners dipping into the assets for personal gain. In single shareholder a company or a sole Member LLC’s, this is a very bad practice. If the sole party has no paper trail, the deal can look very “crooked” under the harsh light of a Courtroom. |
|
10 |
FAILURE TO MAINTAIN ARM’S-LENGTH RELATIONSHIPS AMONG RELATED ENTITIES |
Owners that have other businesses and comingle work between them, without proper pricing and written documentation, can easily fall into this trap. |
|
11 |
WHETHER, IN FACT, THE CORPORATION IS A MERE FACADE FOR THE OPERATION OF THE DOMINANT STOCKHOLDERS |
Did the owners issue any share? Did they have regular meetings (of BOD and shareholder)? Did they elect officers? Do they have By-Laws? Many other “corporate formalities” that must to be completed, or you risk losing the protection of the corporate veil to keep your personal assets from becoming available to debtors, IRS or hostile shareholders or employees. |
A number of other cases shown below may assist you in understanding the factors and tests used by various courts throughout the US to determine if they will breach the corporate veil.
Piercing the corporate veil is always said to be a drastic remedy by those who do not want it to be pierced.
In fact, however, as recognized as recently as April 10, 2014 by the First District, Illinois courts pierce the veil over half---52.5%--of the time that the issue comes up. Buckley et al v. Abuzir, 2014 11 App (18t) 130469 at 5 (citing with approval Plaintiffs expert Stephen Presser)…
Note: Names have been modified to protect the parties, but the case references are to the case as cited.
Illinois
Because HoldCo and LoanCo were incorporated in Delaware, Delaware law applies, see Westmeyer, 382 Ill. App. 3d at 957, but Delaware and Illinois law governing piercing the corporate veil are nearly identical so the distinction is not critical, Retzler v. Pratt and Whitney Co., 309 Ill. App. 3d 906, 917 (1st Dist. 1999).
The Court. undoubtedly is well aware of the factors that should be considered to determine whether to pierce the corporate veil: "(l) inadequate capitalization; (2) failure to issue stock; (3) failure to observe corporate formalities; ( 4) nonpayment of dividends; (5) insolvency of the debtor corporation at the time; (6) nonfunctioning of other officers or directors; (7) absence of corporate records; and (8) whether the corporation is a mere facade for the operation of dominant stockholders. The court may also consider whether the dominant individuals commingled corporate funds with personal funds or preferred themselves as creditors." Ted Harrison Oil Co. v. Dokka, 247 Ill. App. 3d 791, 795 (4th Dist. 1993) (citations omitted)(emphasis added).
Federal
Applying Illinois law, the United States Court of Appeals for the Seventh Circuit noted:
"Courts that properly have pierced corporate veils to avoid promoting injustice have found that, unless it did so, some wrong beyond the creditor's inability to collect would result. Instead, some element of unfairness, something akin to fraud or deception, or the existence of a compelling public interest must be present in order to disregard the corporate fiction. Canvassing Illinois law, the [Sea-Land Services, Inc. v. Pepper Source, 941 F.2d 519 (7th Cir. 1991)] court found that Illinois had pierced corporate veils to avoid injustice when failure to do so would: unfairly enriched one of the parties; allow a parent corporation, that had created a subsidiary's liabilities and was the cause of the subsidiary's inability to meet them, to escape responsibility; allow former partners to ignore obligations; or uphold a corporate arrangement to keep assets in a liability-free corporation while placing liabilities on an asset-free corporation." Hystro Products, Inc., 18 F.3d at 1390 (quotations omitted).
Although OpCo was a corporation and PE is a limited liability company, courts apply the same analysis to determine whether the entities' respective veils should be pierced. See Westmeyer v. Flynn, 382 Ill. App. 3d 952, 958 (1st Dist. 2008)
("[F]or liability purposes, a limited liability company should be subjected to the same treatment as a
corporation."); NetJets Aviation, Inc. v. LHC Commons., 537 F.3d 168, 176 (2d Cir. 2008).
Given the similar liability shields that are provided by corporations and LLCs to their respective owners, emerging case law illustrates that situations that result in a piercing of the limited liability veil are similar to those that warrant piercing the corporate veil."
DeWitt Truck Brokers, Inc. v. W. Ray Flemming Fruit Co., 540 F. 2d 681, 687-88 (4th Cir. 1976) (quotations omitted) (affirming the piercing the corporate veil under South Carolina law where the only director other than the owner was "nothing more than a figurehead who had attended no directors meeting·, and even more crucial, never received any fee or reimbursement of expenses or salary of any kind from the corporation.")
The United States Supreme Court has noted that ''[a]n obvious inadequacy of capital, measured by the nature and magnitude of the corporate undertaking, has frequently been an important factor in cases denying stockholders their defense of limited liability." Anderson v. Abbott, 321 U.S. 349, 362 (1944).
The Seventh Circuit upheld the piercing of the corporate veil in Hystro Products v. MNP Corporation, 18 F.3d 1384 (7th Cir. 1994), when the parent had to transfer money into the subsidiary in order for it to pay its bills. 18 F.3d at 1389; see also De Witt Truck Brokers, Inc., 540 F.2d 681, 688 (4th Cir. 1976) (upholding the piercing of the corporate veil where the comi concluded that the undercapitalization of the corporation "seems obvious" and it "appear[ed] patent that the corporation was actually operating at all times involved here on someone else's capital.")
Delaware
Under Delaware law, courts will pierce the corporate veil "upon proof either of fraud or that the corporation simply functioned as a facade for the dominate shareholder." Ill. Bell Tel. Co., Inc. v. Global NAPS Ill., Inc., 551 FJd 587, 597 (7th Cir. 2008) (emphasis added) (disregarding the corporate form to exercise jurisdiction over parent); see also Geyer v. Ingersoll Pub! 'ns Co., 621 A.2d 784, 793 (Del. Ch. 1992) (stating "a court can pierce the corporate veil of an entity where there is fraud or where a subsidiary is in fact a mere instrumentality or alter ego of its owner.")
The Court. undoubtedly is well aware of the factors that should be considered to determine whether to pierce the corporate veil: "(l) inadequate capitalization; (2) failure to issue stock; (3) failure to observe corporate formalities; ( 4) nonpayment of dividends; (5) insolvency of the debtor corporation at the time; (6) nonfunctioning of other officers or directors; (7) absence of corporate records; and (8) whether the corporation is a mere facade for the operation of dominant stockholders. The court may also consider whether the dominant individuals commingled corporate funds with personal funds or preferred themselves as creditors."
Michigan
See NetJets Aviation, Inc., 537 F.3d at 179 (quotations omitted) (applying Delaware law and considering that there was only one officer other than the owner working for the company, and the only other employee was CFO for a number of companies owned by the owner and that employee was paid by the owner "or one of his corporations"); In re Brentwood Golf Club, LLC, 329 B.R. 802, 809 (Bankr. E.D. Mich. 2005) (applying Michigan law, concluded entity was alter-ego, in part, based on fact that the two companies shared, among other things, employees).
Other
Wells Fargo Bank, NA., 2013 WL 5753805, *9 (concluding that a group of LLCs were shell companies controlled by their parent limited partnership where the LLCs "have no employees" and do not compensate their officers).
In Gadsen v. Home Preservation Co.; Inc., 2004 WL 485468 (Del. Ch. Feb. 20, 2004) (Mem. Op.), the court pierced the veil of a shell corporation to impose liabilities on its owner based on it undercapitalization:
In Gadsen v. Home Preservation Co.; Inc., 2004 WL 485468 (Del. Ch. Feb. 20, 2004) (Mem. Op.), the court pierced the veil of a shell corporation to impose liabilities on its owner based on it undercapitalization:
"From its inception, and by design, [the company] never had any economic worth. The company was never capitalized with any funds, and its stock has never had any value. At no time did [the company] own assess, tools, equipment, inventory or vehicles. [The owner], who was [the company's] sole stockholder and employee, made sure that at all times the corporation's bank account contained minimal or no funds.
The court in Fontana v. TLD Builders, Inc., 362 Ill. App. 3d 491 (2d Dist. 2005), The consideration of whether a corporation is adequately capitalized is based on the policy that shareholders should in good faith put at the risk of the business unencumbered capital reasonably adequate for the corporation's prospective liabilities. It is inequitable to allow shareholders to set up a flimsy organization just to escape personal liability.
HoldCo and PE's failure to observe corporate formalities is another factor that militates in favor of disregarding their sham existence.
See Hystro Products, Inc. v. MNP Corp., 18 F.3d 1384, 1389 (7th Cir. 1994) (applying Illinois law) (stating that "stock control" is "generally" a "prerequisite" to piercing the corporate veil).
HoldCo and PE did not observe corporate formalities.
PE had complete and unchecked control over them. See Hystro Products, Inc. v. MNP Corp., 18 F.3d 1384, 1389 (7th Cir. 1994) (applying Illinois law) (stating that "stock control" is "generally" a "prerequisite" to piercing the corporate veil). ZZZ and. YYY XXX's officers and directors ·cannot recall attending any formal meetings, ... and never produced any documents reflecting any actions taken at a meeting.
XXX's failure to hold any corporate meetings, at all, further supports piercing their corporate veils. See Albert v. Alex Brown Mgmt. Servs., Inc., 2005 WL 2130607, *9 (Del. Ch. Aug. 26, 2005) (Mem. Op.).
In Ill. Bell Tel. Co., Inc. v. Global NAPS Ill. , Inc., the Court noted that the corporate form could be disregarded under lesser circumstances and noted that the company was a sham entity and had "no assets other than its Illinois certificate of convenience and necessity, no revenues, no income, no financial statements, no payroll accounts, and no -employees besides its three officers." Ill. Bell Tel. Co., Inc., 551 F.3d at 597
The initial officers of HoldCo and LoanCo completely overlapped, and all of them were employed by PE or its affiliates
There is no reasonable way to tell when the officers of [the parent] are acting in their capacity as officers of [the two subsidiaries]. Because they are identical, they cannot represent the independent interests of [the companies and the parent]. Put another way, it is impossible for the three entities to engage in arm's-length dealings with one another.
Under these circumstances, [the parent] has such control over [the subsidiaries] that the two are indistinguishable. Cognex Corp. v. VCode Holdings, Inc., 2006 WL 3043129, * 11 (D. Minn. Oct. 24, 2006).
Transactions between the companies were usually papered by a single person acting on behalf of several companies. They were never negotiated at all, much less at arms-length. All entities used the same lawyers, paid by the same· parent and presented the exact same arguments and defenses as each other, despite the fact that if they were really separate, conflicts among them would abound.
When decisions critical to the interests of HoldCo were made, even those where LoanCo might have had different interests than OpCo’s or other PE entities, it was impossible to determine one whose behalf the different officers were acting, which, as indicated above renders them unable to take refuge in the fiction of corporate separateness. Cognex Corp. v. VCode Holdings, Inc., 2006 WL 3043129, *11 (D. Minn. Oct. 24, 2006).
DeWitt Truck Brothers, 540 F.2d at 688 (affirming the piercing of the corporate veil under South Carolina law where the corporation was not for the benefit of all stockholders or the company, but "only for the financial advantage" of the dominate stockholder).
Defendants claim that the corporate veil must be maintained because this is a matter of contract and the patties had an opportunity to negotiate and bargain. Actually, the most prominent empirical study of piercing the corporate veil cases concluded that there were more instances of courts piercing in contract cases than in tort cases, 174 and it is not at all unusual to find courts piercing the corporate veil in contract cases of misrepresentation or fraud. While actual fraud is not necessary, the Delaware courts have, as Defendants' expert concedes, pierced corporate veils where "fraud or something like it" is present. See, e.g., Mobil Oil Corp v. Linear. Films, Inc., 718 F. Supp. 260, 268 (D.Del. 1999) (refusing to pierce the veil where there was no injustice from the use of the corporate form, but noting that under federal, Delaware, or Oklahoma common law ''fraud or something like it" must be shown to pierce the corporate veil).
In In re Kaiser, 791 F.2d 73 (7th Cir.), applying Wisconsin law, the court noted:
"A common situation in which limited liability is disregarded is where the shareholder has misrepresented his personal assets as corporate assets in order to get some advantage with creditors. Suppose a controlling shareholder such as [the owners] persuades a lender to extend credit on favorable terms to the shareholder's corporation by representing that the corporation has substantial net assets, but in fact, it is a shell, and all the assets ostensibly owned by the corporation are actually owned by the shareholder. The corporation defaults, and when the lender tries to sue the shareholder to collect his loan-for the corporation has no assets out of which to collect it-he is met by the defense of limited liability. This is the paradigmatic case for rejecting the defense." 791 F. 2d 73, 75 (7th Cir. 1986). Likewise, in Illinois Bell Telephone Company, Inc., the court cited this statement to exert personal jurisdiction over a parent under Delaware law. 551 F.3d at 597-98.
In Gadsen, the Delaware Comi of Chancery pierced the company's corporate veil: "the business practices of [the company] and [the owner] constitute a fraud, contravention of contract, and a public wrong. No court should countenance such a misuse of the corporate form, and this Court surely will not. To uphold the corporate status of [the company] in these circumstances would be tantamount to blessing a scheme for business owners to defraud creditors routinely. If ever there were a case where the interests of justice justify piercing the corporate veil, this is it." 2004 WL 485468 at *6. The Delaware Court of Chancery came to the same conclusion in Midland Interiors, Inc.,, 2006 WL 3783476 at *5, where the court pierced the corporate veil after finding that the owner, knowing that the company was inoperative for failing to pay corporate taxes, entered into contracts that the owner knew the company could not fulfill…
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