Piercing the Corporate Veil - Part II

In a previous article we examined the doctrine known as piercing the corporate veil. The article concluded by noting that a recent Illinois Appellate Court opinion affirmed the lower court’s decision to allow a claimant (itself a corporation) to pursue collection from the owner and companion company where the claimant was unable to collect from the first corporation itself. Steiner Electric Co. v. Maniscalco and Sackett Systems, Inc., 2016 IL App (1st) 132023.

Steiner Electric Company was a supplier of electrical products. Maniscalco was the sole owner of Delta Equipment Company and Sackett Systems, Inc. Delta sold and serviced batteries and generators. Sackett sold battery storage systems. Steiner sold some generators to Delta but was not paid. After several failed attempts to collect, Steiner sued and obtained a default judgment against Delta. When discovering it could not collect on the judgment because Delta had been dissolved, Steiner sued Maniscalco individually and Sackett. The circuit court pierced the corporate veil and entered judgment in favor of Steiner against Maniscalco and Sackett, jointly and severally. Upon appeal, the Illinois Appellate Court recited the salient facts and then affirmed the judgement. The court reviewed the law in Illinois governing whether a corporation’s veil should be pierced such that its owners, or other parties closely aligned with the corporation, may be held liable for the corporation’s obligations. 

The court on appeal affirmed the circuit’s finding that both Maniscalco and Sackett should be liable for Delta’s debt to Steiner. Several factors influenced the appellate court. Delta had been inadequately capitalized, with no equity capitalization, or unencumbered capital; it had only funds loaned from Maniscalco, and it consistently had negative equity. Delta failed to observe corporate formalities. Despite being required by its bylaws, Delta had no vice president, and had no bona fide officers other than Maniscalco. It failed to document financial transactions, including loans from its owner with no promissory notes. Maniscalco engineered a $600,000 management fee scheme which resulted in the funds going from Maniscalco to Delta to Sackett and then back to Maniscalco. This transaction lacked any documentation and no record of corporate action. The record reflects the transaction’s purpose was income tax avoidance. When Delta was dissolved, corporate action to support its ceasing operations and liquidating was lacking. Delta and Sackett had a joint bank account, which contributed to the court’s finding of a commingling of funds. Another significant factor was that when Delta was dissolved, its list of customers, totaling over 400, and with a value of $200,000, was transferred to a new company run by Maniscalco’s son-in-law for no payment or other consideration to Delta. A related factor found by the court was a failure to maintain an arms-length relationship among related entities and persons.

The appellate court also affirmed the circuit court’s extension of Delta’s liability to Sackett, a separate corporation but co-owned by the same person (Maniscalco). The main factor was that one corporation was merely a dummy or sham for another, such that the two will be treated as one. The management fee of $600,000, running through both corporations, was important evidence supporting this finding. The commingling of funds in a joint bank account was another factor. The appellate court quoted the circuit court’s statement that Maniscalco’s two corporations had a “unity of interest and ownership that the separate personalities of the corporation and the parties who compose it no longer exist.”

Lastly, the appellate court affirmed a finding that adherence to the fiction of a separate corporation, and not allowing piercing of the veil in this case, would promote injustice or perpetuate a fraud or deception. The court found it significant that Maniscalco closed Delta in response to Steiner’s attempts to collect what it was owed, and his stripping of Delta’s assets, leaving nothing for Steiner to obtain. In conclusion, the appellate court held that the circuit court’s decision to pierce the corporate veil and hold Maniscalco and Sackett liable for the judgement against Delta was not against the manifest weight of the evidence. 

Crowdfunding Rules Set to Kick In

Crowdfunding sites like Kickstarter have become popular for technology and other business start-ups to raise funding from individuals. The funding has been in the form of donations, typically where the donor receives an item, such as a sample product or other item, in exchange for the donation. But starting May 15, new SEC regulations become effective that permit non-traditional investors to invest in, and not just donate to, start-ups. Members of the general public will be able to an equity ownership or other financial interest in a company through a crowdfunding portal. Companies that utilize the new rules must comply with specified disclosure requirements, and may raise no more than $1 million in investments during a 12-month period. 

The rules also limit the amount an individual may invest, measured over a 12-month period in the aggregate for all crowdfunding investments. Two classes of investors are created for determining the investment limit. Class One investors are those who have an annual income or net worth under $100,000. They may invest the greater of (1) five percent of their income or net worth, whichever is less, or (2) $2,000. Individuals with an annual income and net worth that are each equal to or greater than $100,000 are Class Two investors. They may invest the lesser of (1) ten percent of their annual income or net worth, whichever is less, or (2) $100,000. 

All crowdfunding offerings and investing must be done on line through registered intermediaries, either a funding portal or broker. Intermediaries must keep detailed records of offeror disclosures and transactions. Companies utilizing the new regulations may offer common stock, preferred stock, other equity ownership, or debt. The regulations mandate certain specific types of disclosures, which the intermediary must maintain and make available to prospective investors. These disclosures include: (a) the name of each officer, director, and 20% or greater owner, and number of employees; (b) the issuer’s business plan; (c) description of issuer’s financial condition and selected financial data for previous two years; (d) purpose of the offering and intended use of proceeds; (e) targeted amount to be raised, the expected date to reach that amount, and regular progress reports, as well as the maximum amount that will be accepted; (f) the price of the securities being offered and how the price was established; (g) description of issuer’s ownership and capital structure; and (h) description of risk factors. The issuer may not advertise the crowdfunding offering other than providing notice that direct investors to the portal or broker.

Piercing the Corporate Veil in Illinois

Greta Jones contracts with Malovan, Inc. to provide equipment and services. Malovan is owned by Mark McDonald, its sole shareholder. Jones fully performs her obligations and submits an invoice to Malovan. After numerous unsuccessful attempts to collect, Jones sues both Malovan and McDonald. Can Jones obtain a judgment against McDonald? Under prevailing Illinois law, McDonald is shielded from liability for debts of his corporation. A corporation is a legal entity separate and distinct from its shareholder, directors and officers. One of the benefits of forming a legal entity such as a corporation is to protect the owners, directors and officers of the corporation from having their individual assets exposed to a party who has a claim against the corporation. But exceptions exist.

Under the doctrine, piercing the corporate veil, a person may hold others liable for debts and liabilities of a corporation. The issue becomes significant, for example, when the claimant is unable to collect on a judgment against the corporation, because the corporation has insufficient assets to satisfy the judgment.

Illinois courts have addressed various circumstances and decided when the corporate veil may be pierced. A corporation may be organized and controlled by another such that maintaining the fiction of separate identities would result in a fraud or promote injustice. Courts have imposed liability on owners, separate from the corporation, when the court finds a unity of interest and ownership so that the separate identities no longer exist; and that preserving the separateness of the corporation would promote injustice.

In finding a unity of interest and ownership, courts have considered the following factors: (1) inadequate capitalization; (2) failure to issue stock; (3) failure to observe corporate formalities; (4) nonpayment of dividends; (5) insolvency of the corporation; (6) directors and officers are nominal and nonfunctioning; (7) absence of corporate records; (8) commingling of corporate and personal funds; (9) diversion of corporate assets to an owner or other person to the detriment of creditors; (10) failure to maintain an arms-length relationship among related entities and persons; (11) whether the corporation is a mere façade for the operation of dominant owners.

It is rare that a corporate veil will be pierced; the separate identities of the corporation and its owners, directors and officers is normally upheld, such that the individuals may not be held liable for the corporation’s debts and liabilities. In a recent decision, however, the Illinois Appellate Court affirmed the lower court’s decision to allow a claimant (itself a corporation) to pursue collection from the owner and companion company where the claimant was unable to collect from the corporation itself. Steiner Electric Co. v. Maniscalco and Sackett Systems, Inc., 2016 IL App (1st) 132023. A subsequent blog entry will describe the decision in Steiner.