Non-Shareholder of ‘Belly Up’ Bakery Can Be Personally Liable on Piercing Claim – IL Court Rules

I’ve seen no hard data to support this but it seems that piercing the corporate veil – as a concept – has seeped into the cultural lexicon and consciousness.  I say this because many people – lawyers and nonlawyers alike – appear to have at least a nodding acquaintance with piercing.  Over and over I hear some variation of:  “Oh, that company’s out of business you say?  Just do that piercing thing.”  (Sigh) If only it were that easy.

Yet, for its perceived prominence in legal and business circles, veil-piercing’s mechanics and elements remain largely shrouded in mystery.  Piercing breeds misinformation and a flurry of questions: is piercing a remedy or a cause of action?  Whom should you sue? Do you sue the officers, directors, employees, shareholders? All of them?  Can you pierce in post-judgment enforcement proceedings?  Or do you have to file a new lawsuit once you find out a company is out of business?  The cases are inconsistent and unclear on these important veil-piercing questions.  See http://paulporvaznik.com/piercing-the-corporate-veil-in-illinois/71 (discussion of piercing generally).

The First District recently answered some of these questions in Buckley v. Abuzir, 2014 IL App (1st) 130469, a trade secrets-cum-veil-piercing case involving rival Chicago-land bakeries.  The plaintiff sued a corporate defendant (a competing bakery) alleging it hired away plaintiff’s top employee and stole plaintiff’s customers and secret recipes.  The court entered a default judgment of over $400,000 against the corporate defendant on the plaintiff’s trade secrets claim.  When collection efforts failed because the corporation was defunct, plaintiff filed a piercing claim against the individual that funded and controlled the judgment corporate debtor.

The trial court granted defendant’s motion to dismiss under Code Section 2-615 on the basis that plaintiff failed to allege sufficient facts to make out a piercing case and because the individual defendant wasn’t a shareholder, director or officer of the corporate debtor.  Plaintiff appealed.

Held: Reversed.  Plaintiff sufficiently pled grounds for piercing under fact-pleading rules and a veil-piercing claim can be brought against a nonshareholder.

Rules/Reasoning:

In reversing the trial court’s dismissal order, the First District aligned itself with multiple jurisdictions which allow a piercing remedy against nonshareholders of a defunct corporation.  The Court’s analysis was informed by the salient piercing principles:

Corporate Formation and The Basic Nature of Veil-Piercing

A corporation is a separate entity from its constituent shareholders, directors and officers and the whole purpose of incorporating is to shield shareholders from unlimited personal liability;

– Veil-piercing applies where a corporation is dominated by an individual or entity to such an extent that the “separate identity” doesn’t exist and it’s a sham to continue to recognize a separation between company and the controlling agent;

– piercing the corporate veil is not a cause of action; instead, it is a means of imposing liability on an underlying cause of action (here, the underlying cause of action was the trade secrets claim plaintiff initially filed against the competing bakery concern);

– BUT, a plaintiff may bring a separate piercing action to pierce the corporate veil for a judgment previously entered against a corporation;

– Veil-piercing applies almost exclusively in disputes involving close corporations (think Mom and Pop businesses) or one-man corporations.

Buckley, ¶¶ 7-9, 12.

Veil-Piercing’s Elements

The Court also stated and applied Illinois’ familiar veil-piercing elements:

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 component dominant parties doesn’t exist and (2) adhering to the concept of separation between corporate entity and dominant agent would promote injustice or inequitable circumstances;

-the unity of interest element (number (1) above)) alone involves a multi-factored analysis of whether there is evidence of (i) inadequate capitalization; (ii, iii) a failure to issue stock, failure to observe corporate formalities; (iv)-(vi) nonpayment of dividends, insolvency of the corporate debtor, non-functioning corporate officers, (vii)-(xi), absence of corporate records, commingling of funds, diversion of corporate assets to shareholders instead of creditor’s, no arm’s-length dealings with related entities; and whether the corporation is a façade or front from the dominant shareholders.

Application:

The Complaint, while sparse and conclusory, alleged enough facts to satisfy the two overarching piercing elements.  On the unity of interest piercing element, the First District exhaustively (an understatement) canvassed over 20 states’ piercing decisions that permit a piercing plaintiff to bind a nonshareholder to a failed corporation’s judgment debt.  The First District aligned itself with those jurisdiction that allow piercing against individuals who aren’t officers, directors, shareholder or employees of a corporation.  All that’s required is that the defendant be an “equitable” or de facto owner.  If the individual controls a company “behind the scenes” and makes the key funding, hiring and firing decisions, then that individual’s personal assets can be reached via a piercing claim.

The plaintiff’s complaint allegations met the main unity of interest criteria: he hired, fired, funded and managed the corporation that plaintiff sued in the underlying trade secrets case.  The “officers” of that corporation had little or nothing to do with the day-to-day operations of the corporation.  The plaintiff also alleged that the corporation issued no stock and had no shareholders.  If this was true, then defendant not being a shareholder is an illusory defense: there are no shareholders.  (¶¶ 15-33).

The Court also sustained plaintiff’s promotion-of-injustice element allegations.  While the plaintiff’s unadorned allegations were conclusory, they still contained just enough facts to state a piercing claim under Illinois pleading rules.  Plaintiff alleged that the defendant hired away plaintiff’s key employee to gain access to secret recipes and data to unfairly compete with and siphon business from the plaintiff.  These allegations were enough (but not by much) to plead that refusing to pierce would result in unfairness to the plaintiff.  (¶¶ 34-41).

Take-aways: Even though the ultimate ruling is simply a reversal of a Section 2-615 pleadings motion to dismiss, the case’s importance lies in its endorsement of using piercing to reach assets of individuals who aren’t corporate officers, shareholders or employees yet in reality, control and fund the corporate entity.  It’s important to recognize though that the Court didn’t rule on the merits of the plaintiff’s claim.  All that is settled is that a plaintiff can allege facts against an “equitable owner”/nonshareholder of a corporation that can lead to personal liability for that nonshareholder.

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PaulP

Litigation attorney at Fisher Kanaris, P.C. representing businesses and individuals in all types of commercial disputes.