Non-Shareholder Can Be Liable On Alter-Ego and Veil Piercing Theory – IL Bankruptcy Court

Buckley v. Abuzir  will likely be viewed as a watershed in piercing the corporate veil litigation because of its exhaustive analysis of when a non-shareholder can be personally liable for corporate debts.  In that case, the court provides an extensive survey of how nearly every jurisdiction in the country has decided the non-shareholder piercing question.

In re Tolomeo, 2015 WL 5444129 (N.D.Ill. 2015) considers the related question of whether a creditor can pierce the corporate veil of entities controlled by a debtor non-shareholder so that those entities’ assets become part of the debtors’ bankruptcy estate.

The answer: “yes.”  In their complaint, the creditors sought a determination that three companies owned by the debtor’s wife but controlled by the debtor were the debtors’ alter-egos.  The creditors of the debtor also sought to pierce the companies’ corporate veils so that the companies’ assets would be considered part of the debtor’s bankruptcy estate.  This would have the salutary effect of providing more funds for distribution to the various creditors.  After striking the debtor’s defenses to the complaint, the court granted the creditors motion for judgment on the pleadings. In doing so, the bankruptcy court applied some fundamental piercing principles to the situation where an individual debtor controls several companies even though he is not a nominal shareholder of the companies.

In Illinois, a corporation is a legal entity separate and distinct from its shareholders. However, this separateness will be disregarded where limited liability would defeat a strong equitable claim of a corporate creditor.

A party who seeks to set aside corporate liability protection on an alter-ego basis must make the two-part showing that (1) the company was so controlled and manipulated that it was a mere instrumentality of another entity or individual; and (2) misuse of the corporate form would promote fraud or injustice.

The mere instrumentality factors include (a) inadequate capitalization, (b) a failure to issue stock, (c) failure to observe corporate formalities, (d) nonpayment of dividends, (e) insolvency of the debtor corporation, (f) nonfunctioning officers or directors, (g) lack of corporate records, (h) commingling of funds, (i) diversion of assets from the corporation by or to a shareholder, (j) failure to maintain arm’s length relationships among related entities; and (k) the corporation being a mere façade for the dominant shareholders.

Promotion of injustice (factor (2) above)), in the veil piercing context, requires less than a showing of fraud but something more than the prospect of an unsatisfied judgment.

The court echoed Buckley and found that the corporate veil can be pierced to reach the assets of an individual even where he is not a shareholder, officer, director or employee.

The key question is whether a person exercises “equitable ownership and control” over a corporation to such an extent that there’s no demarcation between the corporation and the individual.  According to the court, making shareholder status a prerequisite for piercing liability elevates form over substance.

Applying these standards, the court found the circumstances ripe for piercing. The debtor controlled the three entities as he handled the day-to-day operations of the companies. He also freely shifted money between the entities and regularly paid his personal bills from company bank accounts. Finally, the court noted an utter lack of corporate records and threadbare compliance with rudimentary formalities. Taken together, the court found that the factors weighed in favor of finding that the three companies were the debtor’s alter-egos and the three entities should be considered part of the debtor’s bankruptcy estate.

Take-aways:

1/ A defendant’s status as a corporate shareholder will not dictate whether or not his assets can be reached in an alter-ego or veil piercing setting.

2/ If non-shareholder sufficiently controls a corporate entity, he can be responsible for the corporate debts assuming other piercing factors are present.

3/ Veil piercing can occur absent actual fraud by a controlling shareholder.  The creditor plaintiff must show more than a mere unpaid debt or unsatisfied judgment, though.  Instead, there must be some element of unfairness present for a court to set aside corporate protection and fasten liability to the individual.

 

 

Published by

PaulP

Litigation attorney representing businesses and individuals in business litigation, post-judgment enforcement, collections and real estate litigation.