Protecting Your Assets as a Business Owner
Updated: Sep 9, 2020
Written by Jonathan M. Rosenthal
If a corporate entity is indicted or involved in a lawsuit, will its shareholders, officers, or board members be prosecuted or held liable?
‘The Corporate Veil’ is a legal doctrine referring to protection for individuals of a corporate entity from the corporation’s liabilities and obligations. This means the corporation's shareholders, officers, and directors are generally shielded from the corporation's debts and legal claims against the company. However, courts recognize an exception, known as Piercing the Corporate Veil, where a court may impose the company's liabilities and obligations upon individuals of the company. Attempts to pierce a corporate veil are governed by the law of the state of the company's incorporation (1). Illinois courts generally do not favor implementing this doctrine and will pierce the corporate veil only reluctantly (2).
To determine whether to pierce the corporate veil, an Illinois court will consider eight factors. There is no set number of factors that must be met but they are instead considered together.
An Illinois court will consider the following elements:
1. Is your company sufficiently funded relative to its size?
2. Does your company properly distribute and account for shares among the shareholders?
3. Does your company observe corporate formalities, such as holding board meetings and keeping meeting minutes?
4. Does your company distribute profits among the owners such as through dividends?
5. Was your company solvent when entering into the disputed agreement?
6. Do all officers of your company play a functioning role?
7. Does your company maintain corporate records, such as accounting documents and voting histories of the board?
8. Is your company operating for the financial benefit of all its stockholders rather than only the dominant stockholders?
Let’s look at a hypothetical scenario where all eight factors weigh in favor of an Illinois court piercing the corporate veil:
John Doe is the president and majority share owner of a general contracting company called General Company. The remaining minority shares are owned by John’s family members. Unfortunately, General Company did not pay one of its subcontractors and the subcontractor sued to recover the amount owed. Typically, under the corporate veil doctrine, neither John nor any of the shareholders would be personally liable if the court ruled in the subcontractor’s favor and ordered General Company to pay damages.
However, during litigation, the subcontractor discovered that General Company was engaged in several irregular business practices. Typically, general contractors of the size of General Company maintain between $20,000 and $50,000 of cash to cover operational expenses. However, from its beginning, General Company consistently maintained between $1,000 and $2,000 in cash. Additionally, John did not know how many shares were owned by each of General Company’s shareholders nor did General Company issue any stock certificates. There were also no formal meetings among the company’s shareholders or records kept to document meeting agendas or votes. The only occasions when the shareholders talked about the business were during family dinners when the minority owners complained about not receiving compensation from the company.
John Doe also admitted during litigation that General Company was insolvent at the time the Company entered into the business agreement with the subcontractor. This was a difficult fact for the subcontractor’s lawyers to investigate because General Company’s financial records were virtually nonexistent and John’s brother, who officially held the position of Chief Financial Officer, was not aware of the company’s financial position. It was discovered, as well, that John was making payments to subcontractors from his personal checking account and received payments to him personally rather than directly to General Company.
This hypothetical illustrates all eight factors weighing in favor of piercing the corporate veil and hopefully provides guidance for how you can best avoid an Illinois court holding you personally liable for your company’s liabilities and obligations.
If you need legal counsel in drafting structures for your business in order to avoid situations like this, contact Mauck & Baker today at 312-726-1243.
(1) A.G. Cullen Const., Inc. v. Burnham Partners, LLC, 29 N.E. 3d 579 (1st Dist. Ill. 2015).
(2) 13 Ill. Law and Prac. Corporations § 10.
The information contained here has been prepared for informational purposes only and is not legal advice. This material describes issues in general terms, and good legal advice required detailed analysis of particular facts and circumstances. You can contact a Mauck & Baker attorney at (312) 726-1243.