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Illinois Allows Piercing the Corporate Veil to Hold Non-shareholder Liable
Piercing the corporate veil is the most litigated issue in corporate law. It is also one of the most confusing and least understood, according to at least one Illinois appellate court. Corporate veil piercing is an equitable doctrine by which a court can hold an individual or entity personally liable for the debts of a corporation (or other legal entity such as a limited liability company). The typical situation in which a court resorts to veil piercing involves a closely held corporation with a single owner who has intentionally undercapitalized the corporation or failed to observe corporate formalities. In such instances, courts have found that the corporate entity is merely an “alter ego” of the individual and recognizing the corporate distinction would result in fraud or an unjust result. Under a line of cases from the Illinois First District Appellate Court, it may be possible to use the corporate veil piercing doctrine to hold an individual liable for a corporation’s debt even though the individual was not a shareholder, officer, or employee of the corporation.
What started out as a run-of-the-mill trade secrets misappropriation case turned out to be a precedent setting case with potentially wide-ranging implications on limited liability law. In 2006, Momma Gramm’s Bakery and its owner, John Buckley, filed a lawsuit against Palos Heights-based Silver Fox Pastries Inc., a competitor of Momma Gramm’s, alleging that Silver Fox Pastries hired away Momma Gramm’s head baker in order to steal its recipes, processes, techniques, formulas, and customer list. The plaintiffs ultimately won a default judgment against Silver Fox Pastries in the amount of $421,582.
After the plaintiffs were unable to collect the judgment from Silver Fox Pastries directly, they turned their sights on Haitham Abuzir and sought to hold him personally liable for the judgment. In 2010, the plaintiffs filed a lawsuit against Abuzir in an attempt to collect the judgment against Silver Fox Pastries from him despite the fact that he was not and had never been a director, officer, shareholder, or employee of Silver Fox Pastries.
That is not to say that Abuzir had no connection to the bakery. Abuzir’s sister, Suna Abuzir, was the owner of Silver Fox Pastries, and his brother-in-law, Ali Alsahli, was Silver’s Fox Pastries’ president and registered corporate agent. When Silver Fox Pastries was formed Abuzir had loaned the company $45,000. Despite not owning or being employed by the bakery, the plaintiffs alleged that Silver Fox Pastries was simply the corporate “alter ego” of Abuzir. The plaintiffs argued that Abuzir funded Silver Fox Pastries, made all business decisions, and exercised ownership control over the corporation to such a degree that separate personalities of the corporation and Abuzir did not exist.
Abuzir filed a motion to dismiss the complaint arguing that the corporate veil should not be pierced as he was never a director, officer, employee or shareholder of the corporation. The trial court judge considered the motion and agreed with Abuzir, dismissing the case with prejudice. On appeal, the First District reversed the dismissal of the plaintiffs’ complaint and remanded the case for further consideration.
The appellate court began its opinion by recognizing the general principle that corporations are legally distinct from individuals and the people behind them. This principle is the basis for the concept of limited liability: a shareholder is not personally liable for the debts of the corporation. In acknowledging this the court noted that “the primary purpose of corporations is to insulate stockholders from unlimited liability.” Despite this general principle, the court noted that it was not without its exceptions. Piercing the corporate veil is one of those exceptions.
The court explained that “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.” The bulk of the court’s opinion was devoted to the first “unity of interest and ownership” prong.
In considering whether this first prong was satisfied, the court laid out a non-exhaustive list of factors that courts consider 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; (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 façade for the operation of the dominant stockholders.”
Acknowledging limited Illinois precedent on the matter, the court looked largely to corporate law jurisprudence from other jurisdictions. The court found that these other jurisdictions generally consider shareholder status as a factor rather than a prerequisite to veil-piercing, which it reasoned “makes good sense.” Because piercing the corporate veil is an equitable remedy that looks to substance over form, the court ultimately concluded that “the lack of shareholder status—and, indeed, lack of status as an officer, director, or employee—does not preclude veil-piercing” because “equitable ownership may satisfy the unity-of-interest-and-ownership prong.”
A copy of the court’s opinion is available here.
Following remand, Abuzir moved for summary judgment on the second prong of the veil-piercing test. The trial court granted summary judgment to Abuzir on this point which was upheld on appeal. Despite Abuzir’s ultimate victory, the legacy of this case is the First District’s decision that veil piercing does not require being a shareholder, officer, director, or even an employee of the corporation.
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