Piercing the Protective Corporate Veil Part 1: Factors 1-3

barrierA Corporation is a separate entity, distinct from its shareholders, officers and directors.  Similarly, other Limited liability Entities are also separate entities from their members and managers.  By forming one of the above-referenced entities, you avoid personal liability from the consequences of the entity’s actions and decisions.  However, courts have held that when a business operates as an individual’s or another entity’s “alter ego,” then the protective veil between individual and entity is pierced, imputing personal liability for the business’s wrongdoing.  When determining whether an entity is merely an alter-ego of another entity or individual, Illinois courts look at eleven factors, none of which are given more or less weight than others.  In this post, we will analyze the first three:

1) Inadequate capitalization

Historically, Illinois courts consider it inequitable to allow shareholders or members to set up sham organizations in an effort to escape personal liability.  When formed, an entity should be adequately capitalized to cover foreseeable expenses and liabilities.

2) Failure to issue stock

In the case of a corporation, if stock is not issued the appropriate time or at all, courts will give this factor some weight in determining whether to pierce the protective veil.

3) Failure to observe corporate formalities

Courts have found several instances of corporations failing to comply with corporate formalities, and thus leading to piercing of the protective veil.  For example, failing to maintain proper registration with the Illinois Secretary of State,  and failing to hold annual meetings.

This post is not intended to be legal or tax advice.  Formeller & Formeller LLP’s Chicago startup attorneys have helped numerous clients form their businesses.  Our skilled Chicago attorneys can help counsel you on avoiding personal liability for your corporation or other limited liability entity’s actions.  Please contact our law firm today for a free legal consultation if you would like to discuss a new business venture or business ownership.