A business often operates as a separate legal entity, such as a corporation or limited liability company, which protects its individual owners from personal liability for the company’s debts or obligations. The liability shield (called a “corporate veil”) encourages business investment by limiting the investors’ potential losses to the funds they put directly into the company. However, the corporate veil is not always impenetrable.
Under certain limited circumstances, a creditor of a corporation may be able to obtain payment from associated individuals. However, piercing the corporate veil is usually a difficult task. Imposing personal liability on corporate owners is a viable strategy only when the corporation is undercapitalized — that is, unable to satisfy the debt or obligation. In addition, the creditor must have sufficient evidence to meet a strict legal test.
Illinois law uses a two-prong test for corporate veil-piercing. First, the creditor must demonstrate a unity of interest between or among the business entity and the individuals who own or manage its affairs. Unity of interest means there is no real separation between the entity and the individuals. Second, the creditor must show that recognizing the legal separation of the company and the individual owners would be fraudulent or manifestly unjust.
Many circumstances may justify disregarding a corporate veil. For example, some company owners comingle personal and business funds, which indicates the lack of a real delineation between the company and the individuals. Similarly, ignoring the legal requirements for running a separate entity (i.e. holding official owner meetings, filing corporate income tax returns, etc.) shows that the business entity exists in name only. In addition, keeping only a minimal amount of assets or available capital in the business can show that the company is being used to avoid exposure to valid legal claims.
Piercing the corporate veil in Illinois can be quite complicated and requires a skilled commercial litigation attorney. A creditor might allege that the corporate veil should not be recognized in the original debt collection suit. However, sometimes the creditor will be unaware that the company is insolvent until after obtaining a favorable judgment on the underlying claim. In these situations, the creditor must commence a new lawsuit against the company and the individuals.
Historically, a creditor could pierce the veil only against the owners of a corporation. However, recent judicial decisions have expanded the reach of the remedy. Now, the state allows piercing the corporate veil against a party who does not have an official interest. Those who have no legal ownership but who substantially provide funding for or exercise great control over the business (equitable owners) may be held personally liable for its debts.
Schwartz & Kanyock, LLC in Chicago provides commercial legal services throughout the metropolitan area. If you have a corporate debt issue, please feel free to contact us online or call 312-436-1442 for an initial consultation.