All too often practitioners encounter the insolvent corporate entity, often in the scenario where the entity is controlled by a non-equity holder specifically for purposes of avoiding liability. Whether it is an entity created for a designated purpose and limited duration with limited assets, the entity that functions as a façade for the benefit of the interest holders, the underinsured entity or the under-funded entity, the result is the same. The practitioner representing a plaintiff, corporate or individual, is left with the problem of how to advise a client who could be left with an uncollectible judgment. Unless the practitioner can pierce the corporate veil, the client could be left with nothing.
In Illinois, a corporation is a legal entity that exists separately and distinctly from its shareholders, officers, and directors, who generally are not liable for the corporation’s debts.1 A primary purpose of doing business as a corporation is to insulate stockholders from unlimited liability for corporate activity.2 Limited liability will ordinarily exist even when the corporation is closely held or has a single shareholder.3
However, a court may disregard a corporate entity and pierce the veil of limited liability where the corporation is merely the alter ego or business conduit of another person or entity.4 This doctrine imposes liability on the individual or entity that uses a corporation merely as an instrumentality to conduct that person’s or entity’s business.5 Such liability arises from fraud or injustice perpetrated not on the corporation, but on third persons dealing with the corporation.6 The doctrine of piercing the corporate veil is an equitable remedy. As such, it is not itself a cause of action, but rather is a means of imposing liability in an underlying cause of action, such as a tort or breach of contract.7 This article is meant to provide a summary of Illinois law on piercing the corporate veil with a focus on a recent case that holds a non-shareholder personally liable for corporate debts.
Illinois’ Test for Piercing the Corporate Veil
The practitioner seeking to pierce the corporate veil has the burden of making "a substantial showing that one corporation is really a dummy or sham for another" and courts will pierce the corporate veil only reluctantly.8 Illinois uses a two-prong test to determine whether to pierce the corporate veil: there must be such unity of interest and ownership that the separate personalities of the corporation and the individual no longer exist9 ; and circumstances must exist such that adherence to the fiction of a separate corporate existence would sanction a fraud, promote injustice, or promote inequitable consequences.10
Reaching the Non-Shareholder
Under Illinois law, a non-shareholder of a corporation can be held liable for the debts of the corporation.11 In Fontana v. TLD Builders, Ltd., the Illinois Court of Appeals recently held a non-shareholder of a sub-chapter S corporation personally liable for the debts of the corporation.12 Specifically, TLD Builders, Ltd. ("TLD"), owned by DiCosola, started the construction of a home for the plaintiff homeowner, but failed to complete the home pursuant to the architect’s specifications.13 The plaintiff homeowner claimed that the cost to repair the defects caused by TLD and complete construction of the home exceeded its fair market value.14 Accordingly, the plaintiff demolished the home.15
At the conclusion of the bench trial, the trial court held that TLD materially breached the construction contract and failed to cure the breach.16 The trial court also found that the evidence was sufficient to establish that the amount of money the plaintiff paid to TLD, together with the cost to complete the unfinished home according to the plans and specifications referenced in the construction contract, would exceed the $2.2 million value of the home were it completed pursuant to the plans and specifications.17 As such, the trial court held that it was appropriate under the circumstances to demolish the unfinished home, and it calculated the plaintiff’s damages to be $1,271,816.10.18 The trial court entered judgment in that amount in favor of the plaintiff and against TLD and DiCosola, jointly and severally.19
First Prong: Unity of Interest
Affirming the trial court, the Illinois Court of Appeals held that the equitable doctrine of piercing the corporate veil examines substance over form and, relying upon Macaluso v. Jenkins20 , concluded that, with respect to the first prong of the test, DiCosola exercised ownership control over TLD to such a degree that separate personalities of the corporation and the defendant did not exist and the corporation was a business conduit of DiCosola.21 The Court rejected DiCosola’s characterization of Macaluso as applying an exception to the rule requiring stock ownership to pierce the corporation veil.22
With respect to the remainder of the first prong, the Illinois Court of Appeals concluded that TLD’s purported initial capitalization, Theresa’s $1,000 check from her personal checking account to purchase 1,000 shares of TLD stock was unreasonable, arbitrary, or not based on the evidence.23 The court was persuaded by her deposition testimony that she would obtain a copy of her cancelled check showing the $1,000 capital contribution to TLD.24 Yet, at trial eight months later, Theresa failed to produce the check or a reasonable explanation for her failure to do so.25 Further, the court was unimpressed by the loans made to TLD by DiCosola and Theresa, and the $4 million line of credit TLD had at a bank as evidence of capitalization. The Court considered the loans evidence of TLD’s lack of capitalization rather than evidence of its initial capitalization.26
Further, the Illinois Court of Appeals agreed with the reasoning of the trial court that TLD’s failure to observe corporate formalities weighed in favor of piercing the corporate veil.27 The Court cited two criteria: TLD’s failure to attach the legal descriptions of the properties sold to the corporate resolutions concerning those properties, and the absence of corporate resolutions authorizing notes to be paid to the DiCosolas to satisfy the loans the DiCosolas purportedly made to TLD.28
With respect to the "non-functioning of the other officers or directors" factor, the Illinois Court of Appeals again agreed with the trial court finding that the evidence did not show that Theresa was active as a director or officer of TLD, that Theresa’s testimony established that she had no real decision-making role in TLD, and that her role was in the selection of amenities for the spec homes and other de minimis tasks.29 Theresa’s testimony that she did not know that she was the sole shareholder in TLD and its sole director was also persuasive to court as evidence that the first prong was satisfied.30 Rather, Theresa thought that she and DiCosola were co-owners and directors of TLD.31 When asked about her knowledge of the corporate records she signed, Theresa testified that she signed whatever her lawyers told her to sign.32 Theresa had no idea how much money was loaned to TLD, and she had no knowledge of a $532,000 loan allegedly owed to her.33 Theresa also lacked knowledge of how funds were deposited into her and DiCosola’s personal checking account, but knew that the money came from the business.34
The court further reasoned that TLD’s "failure to keep and maintain corporate records is legion."35 There were no corporate resolutions whatsoever regarding the loans DiCosola and Theresa made to TLD, or the terms of these loans.36 In fact, there are no corporate records of the shareholder loans listed on TLD’s tax returns, no notes or other evidence of claimed indebtedness, and no evidence of repayment of any indebtedness.37 Moreover, despite DiCosola’s claim that all of the proceeds from the sales of TLD’s assets in 2002 went to repay TLD’s indebtedness, there are no corporate records of the amounts borrowed by TLD to purchase the properties and build the homes sold.38 Additionally, DiCosola admitted he has never had a written contract with a subcontractor, never takes bids from subcontractors, never issues written change orders to his subcontractors, does not keep written work schedules for projects, and keeps no financial records for any payments that TLD makes except for draw schedules filed with title companies.39
Theresa also testified that she lacked any knowledge concerning how funds were deposited into her and DiCosola’s personal checking account, but she knew that they "cut a check from the business."40 As such, funds from TLD’s accounts went into DiCosola and Theresa’s personal checking account.41 However, the Court reasoned that since the funds were not salary, wages, dividends or distributions, the deposits demonstrated commingling of TLD’s funds with DiCosola and Theresa’s personal funds.42
Second Prong: Inequitable Consequences
Although the trial court did not address the second prong of the test, the Illinois Court of Appeals determined that it was satisfied. The second prong requires that "adherence to the fiction of a separate existence would sanction a fraud, promote injustice, or promote inequitable consequences . . . actual fraud is not necessarily a predicate." 43 In reaching the conclusion that the second prong was satisfied, the Court considered: TLD began 2002 with approximately $1.8 million in assets and ended the year with no assets; TLD was DiCosola’s alter ego; once the possibility of a substantial judgment was evident, DiCosola sold TLD’s assets; neither DiCosola nor Theresa received salaries or distributions from TLD and had no other sources of income; during the pendancy of the lawsuit TLD repaid undocumented loans to Theresa; and during the pendancy of the lawsuit DiCosola began building homes under a newly formed entity. In short, after considering the evidence that was before the trial court, the Illinois Court of Appeals held the second prong of the test was satisfied thereby holding DiCosola, a non-shareholder, personally liable for the judgment obtained by the plaintiff homeowners against TLD.44
In sum, the Illinois Court of Appeals has clarified the process for piercing the corporate veil and made clear that a non-shareholder of an Illinois corporation can be held personally liable for the debts of the corporation.
1 Peetoom v. Swanson, 334 Ill. App. 3d 523, 526, 778 N.E.2d 291 (2002). See also 805 ILCS 180/10-10.
4 Id. at 527.
7 Id. A party who has secured a judgment against a corporation may not seek to pierce the corporate veil in supplementary proceedings. Basil v. Heart-Land Development Co., 258 Ill. App. 3d 618, 624; 630 N.E.2d 1054, 1058 (1st Dist. 1994).
8 In re Estate of Wallen, 262 Ill. App. 3d 61, 68, 633 N.E.2d 1350 (1994) (holding that the plaintiff could not seek to pierce the corporate veil to collect a foreign judgment from the sole corporate shareholder.)
9 In determining whether the "unity of interest and ownership" prong of the piercing-the-corporate-veil test is satisfied, an Illinois Court generally will not rest its decision on a single factor, but will examine many factors, including: (1) inadequate capitalization; (2) failure to issue stock; (3) failure to observe corporate formalities; (4) nonpayment of dividends; (5) insolvency of the debtor corporation; (6) nonfunctioning of the other officers or directors; (7) absence of corporate records; (8) commingling of funds; (9) diversion of assets from the corporation by or to a stockholder or other person or entity to the detriment of creditors; (10) failure to maintain arm’s-length relationships among related entities; and (11) whether, in fact, the corporation is a mere facade for the operation of the dominant stockholders. Jacobson v. Buffalo Rock Shooters Supply, Inc., 278 Ill. App. 3d 1084, 1088, 664 N.E.2d 328 (1996); Estate of Wallen, 262 Ill. App. 3d at 69.
10 See People ex rel. Scott v. Pintozzi, 50 Ill. 2d 115, 128-29, 277 N.E.2d 844 (1971); Wallen, 262 Ill. App. 3d at 68-69; See also Cosgrove Distributors, Inc. v. Jim Haff, 343 Ill. App. 3d 426; 798 N.E.2d 139 (3rd Dist. 2003).
11 Fontana v. TLD Builders, Ltd., 840 N.E.2d 767; 2005 Ill. App. LEXIS 1258 (2nd Dist. 2005).
19 Id. at 771-772.
20 95 Ill. App. 3d 461, 420 N.E.2d 251 (1981).
21 Fontana, 840 N.E.2d at 776.
22 The Fontana Court held that Macaluso is Illinois authority for the proposition that a nonshareholder can be held liable for a corporation’s debts through the equitable remedy of piercing the corporate veil. Id. at 777. The Fontana Court further noted that Illinois has never required that an individual be an officer or director of the pierced corporation in order to hold him liable for the debts of the corporation. Id. The key factor in any decision to disregard the separate corporate entity is the element of control or influence exercised by the individual sought to be held liable over corporate affairs. Id. Thus, while the usual case involves a director, officer or shareholder of a corporation, the lack thereof, in an unusual case such as Fontana, does not preclude an Illinois court from imposing liability upon an individual by piercing the corporate veil if the evidence demonstrated the requisite level of control. Id. (citing Establishment Tomis v. Shearson Hayden Stone, Inc., 459 F. Supp. 1355, 1366, n.13 (S.D. N.Y. 1978) (declining to find that under no set of circumstances could defendant husband be shown to be an alter ego of corporation simply because 100% of the corporation’s stock was held in his wife’s name instead of his).
23 Fontana, 840 N.2d at 779.
35 Id. at 780.
39 Id. at 774.
40 Id. at 780.
43 Id. at 783; Pintozzi, 50 Ill. 2d at 128-29; Wallen, 262 Ill. App. 3d at 68-69.
44 The Illinois Court of Appeals reversed the trial court on the plaintiff homeowner’s request for attorneys’ fees. The trial court denied the plaintiff homeowners request relying upon the American Rule and the Illinois Court of Appeals reversed, citing the agreement between the parties. Id. at 785.
Cameron H. Goodman received his undergraduate degree from the University of Wisconsin-Madison in 1999; J.D. from Chicago-Kent College of Law in 2000. He practices in the following areas of law: Commercial Litigation Products Liability, Franchise Litigation, Professional Negligence, Creditor’s Rights, Insurance Defense.