Tag: piercing the corporate veil

Illinois Agency, Ratification and Alter-Ego Basics: Case Snapshot

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Photo credit: passionateproject.blogspot.com

Several recurring commercial litigation issues are examined in Saletech, LLC v. East Balt, Inc., 2014 IL App (1st) 132639, a case that chronicles a dispute over a written distribution agreement for the sale of bakery products.

The plaintiff entered into the agreement with a Ukranian subsidiary  of various U.S. companies.  The plaintiff sued these U.S. defendants, claiming they were bound by the foreign subsidiary’s breach, that they were alter egos of the subsidiary, or at least ratified the subsidiaries’ conduct.  The trial court granted the U.S. companies’ motion to dismiss for failure to state a cause of action on all counts and the plaintiff appealed.

Held: Affirmed.

Rules/Reasons: Finding for the defendants, the court applied black-letter agency law, ratification and corporate liability rules.

Agency Law and Ratification

– agency is a fiduciary relationship where a principal has the right to control the agent’s conduct and the agent has the power to act on the principal’s behalf;

– an agent’s authority can be actual or apparent.   Actual authority can be (a) express or (b) implied and means that the principal has explicitly granted the agent authority to perform a certain act;

– apparent authority arises where (a) the principal holds the agent out as having authority to act on the principal’s behalf and (b) a reasonably prudent person would assume the agent has authority to act in light of the principal’s conduct;

– to show apparent agency, the plaintiff must prove (1) a principal’s consent or knowing acquiescence in the agent’s exercise of authority; (2) the third party’s good-faith belief that the agent possessed such authority; and (3) the third party’s detrimental reliance on the agent’s authority;

– apparent agency must be based on conduct of the principal; not the agent;

– ratification applies where a principal manifests an intent to be bound by an agent’s unauthorized act, after the fact;

– ratification can be shown mainly by a principal retaining the benefits of the unauthorized act.

¶¶ 14-15, 21

Here, the Court found the plaintiff failed to establish that the foreign subsidiary (who signed the contract) was the agent for the solvent U.S. defendants.  The plaintiff made only naked allegations of a principal-agent relationship between the domestic and foreign entities.

Without allegations that the defendants knew of the subsidiaries’ distributor agreement or that they held out the foreign firm as having actual or apparent authority to bind the defendants, the plaintiff’s agency allegations were too conclusory to survive a motion to dismiss under Illinois fact-pleading rules.

The plaintiff also failed to plead facts to show the defendants ratified any unauthorized conduct of the foreign company.  For example, plaintiff didn’t allege that the defendants accepted benefits from the distributorship contract after plaintiff alerted defendants to the foreign firm’s misconduct.

Alter-Ego

The plaintiff’s alter-ego allegations were also lacking. The plaintiff claimed that the signing foreign company was an alter-ego of the U.S. companies.

The alter ego doctrine affixes liability to a dominant person (or company) that uses a sham entity as a front or “conduit” in order to avoid contractual liability.  An alter ego plaintiff must make a “substantial showing” that one corporation is a dummy or “front” for another.

In breach of contract cases, the required showing for alter ego (piercing) liability is even more stringent than in tort cases.  This is because a party to a contract presumably entered into the contract with another company voluntarily and is presumed to suffer the consequences if the counterpart breaches and has no collectable assets. ¶ 25

The court found that here, the plaintiff failed to plead sufficient facts to demonstrate a unity of interest between the foreign company and the U.S.-based defendants that would permit the court to impute liability to the U.S. defendants.

Additionally, the plaintiff’s bare allegation that the defendants were “commingling funds” in order to defraud creditors lacked factual support and wasn’t enough to state a breach of contract claim predicated on an alter ego theory. ¶¶ 17-18, 22, 29.

Afterwords:

(1) Illinois fact-pleading rules require more than bare parroting elements of a cause of action to survive a motion to dismiss;

(2) Ratification only applies where plaintiff can plead facts showing a principal retained benefits of an improper agent transaction;

(3) Piercing the corporate veil based on alter ego allegations is difficult to prove; especially in breach of contract setting.

 

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.

Illinois ‘Reverse Piercing’ Law: Can You or Can’t You?

image“Reverse piercing” involves the creditor of an individual shareholder attempting to reach assets of a corporation operated by that shareholder.  Illinois reverse-piercing law is unsettled.  Some cases allow  the remedy; others don’t.  When it is allowed, it usually involves a one-person corporation.

In Fish v. Hennessy, 2013 WL 577012 (N.D.Ill 2013), the Northern District rejected a creditor’s attempt to reverse-pierce in supplementary proceedings. The plaintiff obtained a nearly $1 million judgment against the defendant in Ohio Federal court and registered the judgment in the Illinois Northern District.  The plaintiff then filed a motion to reverse-pierce the corporate veil in order to reach the assets of two companies controlled by the debtor.  The debtor argued that the Court lacked jurisdiction to reverse-pierce the debtor.

Result: The Court dismissed the plaintiff’s reverse-piercing motion for lack of jurisdiction.  Plaintiff is given leave to file separate reverse-piercing action.

Rules/reasoning:

Illinois law (735 ILCS 5/2-1402, SCR 277) governs supplementary proceedings in Northern District cases.  FRCP 69(a).  Because Illinois supplementary proceedings are limited to finding assets of a debtor – either in his possession or in the hands of a third party -creditor piercing efforts are usually beyond the scope of supplementary proceedings.  Because of this, Illinois law requires the creditor to sue separately to pierce the corporate veil; naming the shareholder as a defendant in the underlying claims that would normally lie against a corporation.

The Court held that while some Illinois courts permit reverse-piercing, the creditor must file a  stand-alone action against the shareholder. Fish, *2.  Here, since the creditor tried to reverse-pierce in post-judgment proceedings, the motion was improper and the Court dismissed it for lack of jurisdiction.  Id.

The plaintiff creditor argued that after its 2008 amendment, Code Section 2-1402(c)(3) allows a creditor can bring a (straight) piercing motion in supplementary proceedings against a corporate debtor.  However, since defendant was an individual, not a corporate debtor, this section didn’t apply.  In addition, the Court found no Illinois case reading amended Section 2-1402(c)(3) to allow reverse-piercing in post-judgment proceedings.  Id., *2.

Take-aways: A creditor of an individual can’t reverse-pierce (to attach corporate assets of companies run by the debtor) in judgment enforcement proceedings.  Instead, the creditor must file a separate lawsuit against the corporate entity controlled by the shareholder.  Fish‘s discussion of Code Section 2-1402(c)(3) suggests that a judgment creditor may now be able to bring a piercing-type claim against a corporate debtor in supplementary proceedings.  While this is welcome news to creditors’ counsel (since they won’t have to file entire new piercing suits), it still runs counter to “good” Illinois caselaw (see Pyshos (above), Conserv v. Von Bergen Trucking, 2011 IL App (2d) 101225U (2011)), that clearly disallow piercing claims in supplementary proceedings.  Even so, the Fish Court didn’t have to categorically rule on this issue since the defendant was an individual and not a corporate debtor.  As a result, amended Section 2-1402(c)(3) didn’t apply to the case’s facts.