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Piercing the Corporate Veil
By Saper Law | October 21, 2008
In conjuction with our November Seminar at Saper Law, we have prepared this article explaining the importance of maintaining corporate formalities. Several demonstrative cases are highlighted.
Piercing Corporate Veil Doctrine
When a business operates as the alter ego of an individual/other entity, the corporate veil shielding the individual from liability can be pierced.[1] Generally, courts are reluctant to pierce the corporate veil. Thus, the burden is on the party seeking to do so to make a substantial showing that the corporation is really a sham for another entity or individual.[2]
To pierce the corporate veil, two requirements must be met: (1) there is such unity of interest and ownership that the separate personalities of the corporation and the individual no longer exist (the corporation is the alter ego for the individual);[3] and (2) adherence to the fiction of a separate corporate existence would sanction a fraud, promote injustice, or promote inequitable consequences.[4]
While actual fraud is not necessary, an element of unfairness must always be present before the corporate veil may be disregarded.[5] In determining whether corporation is merely the alter ego of an individual, a court will look at a number of factors. It is important to remember that no single factor will generally be determinative and the cases that explain this doctrine tend to look at the totality of the circumstances. These factors include: (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 determinant of creditors, (10) failure to maintain arm’s length relationships among related entities, and (11) whether, in fact, the corporation is a mere façade for the operation of the dominant stockholders.[6]
The failure to maintain corporate records, specifically bank and financial statements, is not determinative in and of itself in the analysis. However, this factor is significant in weighing the totality of the evidence. The following cases involve fact patterns where such failure to maintain corporate records was important in the ultimate decision to pierce the corporate veil.
In its discussion of the absence of corporate records, the court noted that although the defendant TLD maintained a separate bank account and financial records, filed all necessary paperwork with the secretary of state, and filed all tax returns, the company nonetheless failed to document the terms of loans and there was no evidence of repayment of any indebtedness. There were no corporate records showing the amounts borrowed by TLD to purchase properties in the financial and banking statements. Additionally, TLD failed to make any written record of payments made to subcontractors.[8] Based on these facts, the appellate court found the trial court’s determination that TLD failed to keep and maintain corporate records was not against the manifest weight of the evidence.
Additionally, the court addressed the commingling of funds. Funds were transferred from the business account into an individual’s personal checking account. This money was not labeled as salary, wages, dividends, or distributions, and thus established commingling of TLD’s funds with personal funds. There was no documentation supporting the transfers as expenses or expense reimbursement to the individual in the financial books.
Europaper B.V. v. Integrated Material Management Services, Inc.[9]
During its existence, the only corporate book or record maintained by the defendant company IMMS was an incorporation document. IMMS never filed tax returns, issued a dividend or paid a salary. Additionally, the defendant relied on an oral lease to rent office space, used company money to buy a car for his wife and pay a babysitter. The sole employee of IMMS admitted to comingling funds from the company to his own personal funds, and the court noted that adherence to the fiction of a separate corporate existence would promote injustice and inequitable consequences.
McCracken v. Olson Companies, Inc.[10]
After addressing a number of factors that suggested unity of interest, the court noted that the defendant Olson failed to produce business records relating to the financial status of the company. Without a legitimate or reasonable excuse for the inability to product such documents, the court noted that an unfavorable evidentiary presumption arose. Because defendant failed to produce these documents or explain their unavailability, it was inferred that such documents would have revealed the company’s poor financial standing, or lack of financial documentation altogether.
Dimmit & Owens Financial v.
Citing precedent in
Frank Ix & Sons, Inc. v. Phillip Textiles, Inc.[12]
The appellate court affirmed that the disregard of financial formalities and inadequate recording of financial transactions were significant in supporting the piercing of the corporate veil. The defendant habitually withdrew money from company and paid personal car payments using corporate funds, without recording such transactions as compensation or income in the financial books. Additionally, while the company was technically insolvent, the defendant made variety of large transfers of money to himself.
W. Fentress v. Triple Mining, Inc.[13]
In the instant case, the company was undercapitalized and corporate formalities were not followed. Although there may have been some initial corporate financial books or records, the defendant was unable to produce such documents at trial. Thus, the court inferred that the records either did not exist. Even if initial records existed, it would not have precluded the court from disregarding the corporate entity. Because the defendants did not regard the existence of the corporation as significant by following formalities, the court readily found unity of interest.
Ted Harrison Oil Company, Inc. v. Dokka[14]
Court noted that the defendant “practically admitted” that there was a complete lack of corporate formalities. The company failed to maintain records and defendant received cash distributions from the company that were not reflected in the financial books. The defendant had received monetary benefits from the company, including the cash, while the company was defaulting on its debt to plaintiff. Thus, the record as a whole supported a finding that there was a failure to observe corporate formalities such that the corporation was a mere façade for the operation of defendant.
Sea-land Services, Inc. v. Pepper Source[15]
In the instant case, defendant ran a number of companies from the same office, with same phone line and expense accounts for all the companies. In his individual capacity, the defendant borrowed substantial sums of money from the companies, interest free. Additionally, the defendant used the bank accounts of the companies to pay for personal expenses like alimony and child support, health care for his pet, and education expenses for his children (meanwhile defendant did not have a personal bank account of his own). Given the totality of the circumstances, the court noted that unity of interest clearly existed and that the first prong of the corporate veil piercing test was met.
In re Polo Builders[16]
Unity of interest existed where company was undercapitalized and defendants did not follow corporate formalities. The company failed to maintain books and financial records throughout the entire course of its existence. Specifically, the defendants did not maintain a bank account for the company from its inception. While a bank account was eventually opened in order to accept deposits, defendants initially deposited funds for the company into a bank account for which one of the defendants was a sole proprietor.
Wachovia Secruities, LLC v. Neuhauser[17]
Defendants failed to produce any records or other evidence regarding the company’s financial status. Furthermore, defendants were unable to calculate the value of the company’s assets or its liabilities. The defendant’s best estimate as to the value of assets was “somewhere between zero and 20 million.” Given the totality of the circumstances and defendant’s ignorance as to basic bookkeeping values, the court held that unity of interest existed.
Torco Oil Company v. Innovative Thermal Corp.[18]
The court noted that defendant company ITC did not maintain corporate records, supporting a finding of unity of interest. The expenses of the ITC were paid entirely by another entity. The company had no capital, and the only corporate records produced at trial were ledger books which purported to record all the case transfers from ITC and another entity as either loans or contributions to capital. Further, there was evidence that these ledgers had been created in one sitting, after the lawsuit began, in an effort to strengthen the defendant’s litigating position.
Plumber’s Pension Fund, Local 130, U.A. v. A-Best Plumbing& Sewer, Inc.[19]
Defendant Best’s bookkeeping was significantly lacking. Legible disbursement records were available for only 15 months of the nearly 10 year’s history of the company. The defendant admitted that disbursements designated as personal actually went toward corporate expenses. Additionally, there was a large gap in the recordkeeping as to what happened to the proceeds from the sale of defendant’s assets. Even though Best maintained its own bank accounts, the court viewed this as merely meeting the bare minimum expected of a company. The maintenance of a bank account alone, absent legitimate bookkeeping, did not overcome the weight of plaintiff’s evidence favoring the piercing of the corporate veil.
Cases From Other Jurisdictions Quad/Graphics Inc. v. Fass[20]
Walton v. Tomax Corp.[22]
Appellate court noted that there was evidence that corporation had made payments: (1) on CEO’s personal credit card; (2) to CEO’s son with no deductions for payroll taxes; (3) to CEO’s wife and daughter-in-law even though they did not participate in the business; (4) had paid more than $7,000 to a ministry headed by CEO’s son; and that the CEO had personally received corporate funds rather than depositing them in the corporate account. Although the CEO attempted to explain the various disbursements, the appellate court concluded there was evidence which, if believed, tended to show the CEO had depleted the corporate assets for personal benefit of himself and his family while disregarding standard bookkeeping practices, leaving the corporation unable to pay its debt.
Hunting v. Elders[23]
Corporation that operated bar that served driver who was already intoxicated did not keep sufficient records, thereby supporting piercing corporate veil to impose damages in motorist’s personal injury case on dominant shareholder as alter ego of corporation. As the court noted, the corporation did not have adequate records of income from bars or video poker machines, and did not have records of cash receipts, cash expenses, sales, inventory, or other profit and loss statements that would normally be expected.
[1]
[2] Id
[3] Jacobson v. Buffalo Rock Shooters Supply Inc., 278
[4] People v. V & M Industries, Inc., 298
[5] Berlinger’s, Inc. v. Beef’s Finest, Inc., 57
[6] Id at 786
[7]
[8] Id at 781
[9] Not Reported in F.Supp.2d, 2004 WL 1243947 (N.D.
[10] 500 N.E.2d 487 (Ill.App. 1 Dist. 1986).
[11] 196 F.Supp.2d 731 (N.D.Ill. 2002)
[12] Unpublished Disposition, 1998 WL 709463 (C.A.7 (
[13] 261 Ill.App. 3d, 200 Ill.Dec. 1 (Ill.App. 4 Dist. 1994).
[14] 247 Ill.App.3d 791, 187 Ill.Dec. 441 (Ill.App. 4 Dist. 1993).
[15] 941 F.2d 519 (7th Cir. 1991)
[16] Bankruptcy No. 04 B 23758, Adversary No. 04 A 04032 (United States Bankruptcy Court, N.D.
[17] 528 F.2d 834 (N.D.Ill. 2007)
[18] 730 F.Supp. 126 (N.D.Ill. 1989)
[19] Not reported in F.Supp., 1992 WL 59098 (N.D.Ill.)
[20] 548 F. Supp. 966, 969 (E.D. Wis. 1982), aff’d on other grounds, 724 F.2d 1230 (7th Cir. 1983)
[21] Id
[22] 632 So. 2d 178 (Fla. Dist. Ct. App. 5th Dist. 1994)
[23] 359 S.C. 217, 597 S.E.2d 803 (Ct. App. 2004)
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