Tag: piercing corporate veil

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.

 

 

Judgment Creditor Can Recover Attorneys’ Fees Spent Pursuing Successful Veil Piercing Suit Versus Corporate Officers

Q:           Can a judgment creditor recover attorneys’ fees incurred in both its post-judgment discovery efforts after a default judgment against a defunct corporation and a subsequent piercing the corporate veil action to enforce the prior judgment where the contract with the defunct entity contains an attorneys’ fees provision?

A:            Yes.

That’s the salient and nuanced holding from Steiner Electric Company v. Maniscalco, 2016 IL App (1st) 132023, a case that’s a boon to creditor’s rights attorneys and corporate litigators.

There, the First District held in a matter of first impression that a plaintiff could recover fees in a later piercing the corporate veil suit where the underlying contract litigated to judgment in an earlier case against a corporation has an attorneys’ fees provision.

The plaintiff supplied electrical and generator components on credit over several years to a company owned by the defendant.  The governing document between the parties was a credit agreement that had a broad attorneys’ fees provision.

When the company defaulted by failing to pay for ordered and delivered equipment, the plaintiff sued and won a default judgment against the company for about $230K. After its post-judgment efforts came up empty, the plaintiff filed a new action to pierce the corporate veil hold the company president responsible for the earlier money judgment.

The trial court pierced the corporate veil and found the company president responsible for the money judgment against his company but declined to award plaintiff its attorneys’ fees generated in litigating the piercing action.

The First District affirmed the piercing judgment and reversed the trial court’s refusal to assess attorneys’ fees against the company President.

The Court first affirmed the piercing judgment on the basis that the company was inadequately capitalized (the company had a consistent negative balance), commingled funds with a related entity and the individual defendant and failed to follow basic corporate formalities (it failed to appoint any officers or document significant financial transactions).

In finding the plaintiff could recover its attorneys’ fees – both in the underlying suit and in the second piercing suit to enforce the prior judgment – the court stressed that piercing is an equitable remedy and not a standalone cause of action.  The court further refined its description of the piercing remedy by casting it as a means of enforcing liability on an underlying claim – such as the prior breach of contract action against the defendant’s judgment-proof company.

While a prevailing party in Illinois must normally pay its own attorneys’ fees, the fees can be shifted to the losing party where a statute or contract says so.  And there must be clear language in a contract for a court to award attorneys’ fees to a prevailing litigant.

Looking to Illinois (Fontana v. TLD Builders, Inc.), Seventh Circuit (Centerpoint v. Halim) (see write-up here and Colorado (Swinerton Builders v. Nassi) case precedent for guidance, the Court found that since the underlying contract – the Credit Agreement – contained expansive fee-shifting language, the plaintiff could recoup from the defendant the fees expended in both the first breach of contract suit against the company and the second, piercing case against the company president.  The Court echoed the Colorado appeals court’s (in Swinerton) depiction of piercing the corporate veil as a “procedural mechanism” to enforce an underlying judgment.

The combination of broad contractual fees language in the credit application and case law from different jurisdictions that fastened fee awards to company officers on similar facts led the First District to reverse the trial court and tax fees against the company president. (¶¶ 74-90)

Afterwords:

An important case and one that fee-seeking commercial litigators should look to for support of their recovery efforts.  A key lesson of Steiner is that broad, unequivocal attorneys’ fees language in a contract not only applies to an initial breach of contract suit against a dissolved company but also to a second, piercing lawsuit to enforce the earlier judgment against a company officer or controlling shareholder.

For the dominant shareholders of dissolved corporations, the case spells possible trouble since it upends the firmly entrenched principle that fee-shifting language in a contract only binds parties to the contract (not third parties).