Piercing the Corporate Veil in Illinois

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In Illinois, a corporation is a legal entity that exists separate and apart from its shareholders, officers and directors.  In fact, a major purpose of incorporating is to insulate yourself from personal liability.  This liability-reducing function of corporations does have its limits though.  If someone is abusing the corporate form, a court can disregard the corporation and “pierce the corporate veil.”

For instance, if I incorporate Paul, Ltd. and you enter a contract with Paul, Ltd. to sell widgets and Paul, Ltd. breaches, generally, you will not be able to sue me personally for Paul, Ltd.’s debts.  Because, the law views me as a separate “person” from Paul, Ltd.  However, if Paul, Ltd. is simply my alter-ego, or a pass-through entity – then the court can pierce Paul, Ltd.’s veil of limited liability and hold me responsible for Paul, Ltd.’s debts!

Illinois courts apply a two-prong test to determine whether to pierce the  corporate veil: (1) unity of interest and ownership is such that separate personalities of the corporation and the other person no longer exist; and (2) adherence to the fiction of separate corporate existence would sanction fraud or promote injustice.  Fontana v. TLD Builders, 362 Ill.App.3d 491 (2005).

Within this two-part framework, courts analyze the following factors: (1) inadequate capitalization (opening a corporate bank account with minimal $); (2) failure to issue stock; (3) nonpayment of dividends; (4) nonfunctioning officers or directors; (5) absence of corporate records (Articles of Incorporation?  What’s that?!!); (6) insolvency of debtor corporation; (8) commingling of funds; (9) diversion of corporate assets to a dominant shareholder, among others.

Afterword: It’s difficult to demonstrate grounds for piercing.  A creditor seeking to pierce has a very heavy burden.  For this reason, when dealing with a corporation with whom you don’t have a prior relationship or that doesn’t have a track record, doing pre-contract due diligence (running credit reports, checking trade references, etc.) is critical.

In addition, getting a personal guaranty from a corporate officer is helpful. This assures that a real live person actually has some skin in the game.  Otherwise, you run the risk of getting an uncollectable judgment.

Like Pulling Teeth: The Struggles of Collecting Judgments from Corporate Debtors

 

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As someone who does some collection work, I experience first-hand how difficult it is to collect on judgments – especially from small corporate debtors.  A 2011 Second District case illustrates in stark relief just how challenging and frustrating enforcing a judgment can be.

In Conserv v. Von Bergen Trucking, 2011 IL App (2d) 101225U (2011), the Court followed Pyshos v. Heart-Land Development Co., 258 Ill.App.3d 618 (1994) and held that a judgment creditor cannot try to pierce the corporate veil of a corporate defendant in citation proceedings.  In doing so, the court narrowly construed post-judgment proceedings (or supplementary proceedings) and clarified that a piercing claim (one where the creditor tries to hold the corporate officer personally liable for the corporate debt) is beyond the scope of a citation/supplementary proceeding.

If ever there was a case for piercing, this was it.  Even when the trial court denied the creditor’s motion to pierce the corporate veil, the court noted that the defendant was “definitely getting away with something.  But the law allows him to get away with something.”  Cold comfort for the creditor indeed.

In Conserv, once the money judgment was entered, the corporate debtor immediately emptied its bank accounts and began operating under a different (though similar) name.  The “new” corporation was grossly undercapitalized, commingled personal and corporate funds and failed to follow any corporate formalities (keeping minutes, filing annual reports, paying required fees, etc).

The reincarnated corporation was a blatant sham or alter-ego of the principal officer.  Still, the court denied the creditor’s piercing motion stating that a citation proceeding’s only relevant inquiries are (1) whether the judgment debtor possesses assets that can be applied toward the judgment; or (2) whether a third party is holding assets of the judgment debtor.  Period.

So – what should a creditor do when it learns that a corporate debtor is an alter-ego of an individual?  The answer:  (1) issue a third-party citation  against the shareholders or against another corporation the creditor believes ha s assets of the debtor corporation; or (2) file a new breach of contract claim against the corporation.

Under option (2) above, you argue that the officer is responsible for the corporation’s debts because that corporation is a hollow front for the officer’s business dealings.

 

 

The Ubiquitous “Excess Rent” Provision

The boilerplate “excess rent” or “rent differential” clause appears in many commercial leases.  Usually buried in a voluminous lease, no one pays much attention to it until the tenant vacates and the landlord sues for damages.  All of a sudden, the excess rent clause assumes critical importance as the landlord tries to prove up its damages.  The rent differential/excess rent section generally provides that when a tenant prematurely vacates commercial property, the landlord can recover the difference between (A) the present value of lease rent owed through the unexpired lease term and (B) the fair market rent for the unexpired term (rent through the balance of lease at lease rate minus market value of rent through lease expiration).  St. George Chicago, Inc. v. George J. Murges & Associates, Ltd., 296 Ill.App.3d 285 (1st Dist. 1998).  In Illinois, these rent differential terms are enforceable and will satisfy the lessor’s statutory duty to mitigate set forth in Section 9-213.1 of the eviction statute.

So if the breaching tenant was paying $1,000 a month under its lease, and the landlord can only find a replacement tenant who pays $600/month – the landlord can recover $400/month ($1,000 minus $600) times the numer of months left on the defaulting tenant’s lease.  Of course, if the market value is now $1,500/month – $500 more than the lease amount – the landlord cannot recover anything.  Instead, the landlord’s recovery will be limited to its damages incurred through the date the replacement tenant begins paying rent.