I often receive questions from small business owners or folks thinking about starting a new business about how best to protect themselves from liability. Not surprisingly, from a legal standpoint, it’s usually the primary concern of new business owners. In the age of Google, it’s possible for curious entrepreneurs to look into that question on their own before coming to me for my opinion. No doubt your trusty search engine is a wonderful source of information, but as the saying goes, “don’t believe everything you read on the internet.”
Eventually, those inquiring minds come across the term, “piercing the corporate veil.” The term refers to a court’s ability to disregard a corporate entity in order to reach the individuals behind that company in order to impose liability on them personally for acts of the company. This can be done for a number of reasons, but the most likely is that the corporation does not have sufficient assets to settle a debt or judgment against it.
So, what’s scary for business owners is that, even if they create an entity specifically meant to separate their business affairs and liability from their own, they still could be liable for the business’s actions.
The concept of piercing the corporate veil has a long and relatively developed history for various reasons beyond the scope of this post. But, everything from the history behind the creation of the corporation concept in American law to the wording of state statutes relating to their creation and a long line of court decisions dealing with a wide range of factual scenarios has provided a substantial base from which courts are able to apply long-developed concepts and principals.
So, how is a business owner supposed to best protect herself from the risk that she may be held liable for the actions of her business? Well, the answer really depends. That’s because the laws around piercing have been developed, at least in Illinois, as the concept specifically relates to corporations.
Piercing the Corporate Veil in Illinois
Generally, a court in Illinois will apply a two-pronged test to determine whether a business owner should be liable for actions of the company. The test is whether:
1) there is such a unity of interest and ownership that the separate personalities of the corporation and the parties who compose it no longer exist, and
2) circumstances are such that adherence to the fiction of a separate corporation would promote injustice.*
In determining whether those prongs are met, Illinois courts may consider a number of factors like:
· Whether the corporation was adequately capitalized (had sufficient assets in relation to its debts and operations);
· Whether it issued stock;
· Whether it followed corporate formalities, like holding meetings, keeping minutes, keeping accurate books and records, providing required notices, etc.;
· Failing to pay dividends or make other distributions;
· Comingling of business and personal assets;
· Generally, whether the corporation is merely a façade for personal operations.
Given the lengthy history of piercing the corporate veil of Illinois corporations, it’s no wonder that new business owners would have questions about whether they are opening themselves up to unnecessary liability simply by starting a business.
But, while it may seem like a high-risk proposition, in general, an owner who treats his business as legitimate will typically not have an issue. Though, it is still important to be aware of the risks and ways to alleviate them.
For the business owner or entrepreneur that may really be worried about the issue, there may be an even safer way to structure the company. That is by creating an Illinois Limited Liability Company.
Piercing the LLC Veil in Illinois
Admittedly, as a practitioner, I generally tended to view the issue of piercing an LLC veil in the same light as piercing the veil of a corporation until very recently.
In the July 2015 issue of the Illinois Bar Journal, Sandra Mertins, of the Chicago firm of Dale & Gensburg, P.C. laid out a convincing case that courts may not have the same ability or willingness to pierce an LLC veil as they commonly have when their actions relate to corporations. Ms. Mertins explains that the language of the Illinois Limited Liability Company Act may specifically prohibit courts from piercing the LLC entity to reach its members and managers. Specifically, 805 ILCS 180/10-10 provides:
“(a) Except as otherwise provided in subsection (d) of this Section, the debts, obligations, and liabilities of a limited liability company, whether arising in contract, tort, or otherwise, are solely the debts, obligations, and liabilities of the company. A member or manager is not personally liable for a debt, obligation, or liability of the company solely by reason of being or acting as a member or manager….
… (d) All or specified members of a limited liability company are liable in their capacity as members for all or specified debts, obligations, or liabilities of the company if:
(1) a provision to that effect is contained in the articles of organization; and
(2) a member so liable has consented in writing to the adoption of the provision or to be bound by the provision. (emphasis added).
As the statute states, members and managers are not liable for company debts or obligations unless either 1) the articles organizing the company specifically make them liable, or 2) they consent in writing to liability.
Ms. Mertins notes that since the adoption of that section in 1998, Illinois courts have struggled with piercing LLC veils, as the statute seemingly expressly prohibits it. The majority of Illinois cases dealing specifically with the issue have come to that conclusion while citing the above section. While there have been a handful of cases that have reached a different conclusion, they have not specifically been on point to solely dealing with the Illinois statute at its core (for example, as Mertins notes, Westmeyer v. Flynn, where the court found piercing permissible dealt with an Illinois LLC but the Delaware LLC Act, which does not expressly prohibit piercing, while in On Command Video Corp. v. Roti, the court indicated that piercing may be permissible, but it is noteworthy that neither party argued it would be impermissible.)
So, the takeaway for business owners worried about potential piercing is that LLC’s may provide a level of protection that corporations may not necessarily provide, at least in Illinois. Of course, LLCs have only been around in the state for less than twenty-five years so they don’t enjoy the long history of legal analysis and development that corporations do. Given that, it remains to be seen how courts may develop the concept of piercing as it relates to Illinois LLCs, but at least for the time being, they seem like a relatively safe option for the new business owner worried about personal liability.
*Fontana v. TLD Builders, Inc., 362 Ill App. 3d 491, 500 (2d Dist. 2005).
Michael F. Brennan is an attorney at the Virtual Attorney™ a virtual law office helping clients in Illinois, Wisconsin, and Minnesota with estate planning and small business legal needs. He can be reached at email@example.com with questions or comments, or check out his website at www.thevirtualattorney.com.
The information contained herein is intended for informational purposes only and is not legal advice, nor is it intended to create an attorney-client relationship. For specific legal advice regarding a specific legal issue please contact me or another attorney for assistance.
By Michael Brennan
Image courtesy of FreeDigitalPhotos.net