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To Avoid Personal Liability: Follow Corporate Formalities

By: David B. Pogrund

Recently, the Illinois Court of Appeals allowed a homeowner to pierce the corporate veil of a construction company known as TLD Builders, Inc. and to obtain a $1.2 Million Judgment against its principal personally in the case of Fontana v. TLD Builders, Inc., case no. 2-05-0045.

In Fontana, the homeowner filed a two count complaint first seeking damages of 2 million dollars against TLD Builders and seeking 2 million dollars against the Principal in his personal capacity by piercing the corporate veil.

The Illinois Appellate Court held that TLD Builders was “little more then a shell” which was established to shield (Mr. D. Kosola) from liability and therefore entered judgment against him and the corporation jointly and separately.

Generally speaking, Illinois Courts are not apt to allow plaintiffs to pierce the corporate veil and seek damages against the shareholders, officers or directors of a corporation. In Illinois, a corporation is a legal entity which exists separate and distinct from its shareholders, officers, and directors, who are not, as a general rule, liable for the corporation’s obligations. This is the case even where there is a small corporation, one in which the stock is held in a few hands or a single individual’s hand. There is no specified or required minimum number of stockholders for a valid corporate existence. However, Illinois courts have held that a corporate entity will be disregarded and the veil of limited liability pierced where it would otherwise present an obstacle to the protection of private rights or where the corporation is merely an alter ego or business conduit of a governing or dominating personality. Gallagher v. Reconco Builders, Inc., 415 NE 2nd 560, 563 (1980).

However, the Gallagher court also recognized that in order to pierce the corporate veil two (2) requirements must be met:

First there must be such unity of interest and ownership throughout that the separate personalities of the corporation and the individual no longer exist; and

Circumstances must be such that adherence to the fiction of separate corporate existence would sanction a fraud or promote injustice.

The Gallagher court set forth the factors necessary to disregard the corporate entity involving several of the following factors, and not any single factor, and they are as follows:

Inadequate capitalization of the corporation;
Failure to issue stock;
Failure to observe corporate formalities of holding Annual Meetings of the Shareholders and Board of Directors;
Non payment of dividends;

Insolvency of the debtor corporation at the time of incurring the debt to the plaintiff;

Non functioning of other officers or directors in addition to the individual shareholders sought to be charged with liability;
Absence of corporate records and a corporate minute book;
Whether in fact the corporation is only a mere facade for the operation of the dominant shareholders, all of which in addition must generally present an element of injustice or fundamental unfairness.

In the Fontana v. TLD Builders, Inc. case Mr. D. Kosola’s wife who was the sole shareholder, officer and director of TLD Builders testified that:

Up until her deposition she did not know she was the sole shareholder of TLD;

She did not know when TLD was incorporated or how many shares it issued or how much was paid for the shares of stock;

She had no knowledge of what happened to the 1.8 million dollars in corporate assets that disappeared while the litigation was ongoing;

She never received a paycheck from TLD; yet her household bills were paid from the corporate checkbook (commingling of personal and corporate assets);

She never received any salary or dividend;

The corporation had been run at a loss since it’s inception and yet Ms. D. Kosola had no real role in the company business, yet she was the sole shareholder, officer and director; and

There were virtually no records indicating how the business had been run.

Based upon the foregoing, coupled with the fact that Mr. D. Kosola was in actuality running the company, and based upon the inadequate capitalization of TLD, failure to observe corporate formalities, failure to pay dividends, commingling of corporate and personal assets, non-functioning officer or director (Ms. D. Kosola) and absence of corporate records, the court entered a Judgment for $1.2 million in favor of the homeowners and against Mr. D. Kosola as well as TLD Builders, Inc.

In conclusion, in order to protect the officers, directors and shareholders from personal liability and from the corporate veil being pierced by a plaintiff in litigation, it is essential that the corporation follow all corporation formalities by:

Having a corporate minute book and conducting annual meetings of the shareholders and board of directors at least once per year;

Always placing the full corporate name on the contract and by the officers signing each contract by indicating that they are the president, vice president, etc. of the corporation;

Never commingling personal funds of shareholders, officers and directors with corporate funds;

Making sure that the corporation is adequately capitalized;

Filing of Annual Reports with the Secretary of State;

Filing of a separate tax return for the corporation;

Issuing stock to the shareholders;

Having functioning officers and directors.

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