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.