The protection provided by a limited liability company (“LLC”) is often described as a veil or protective layer between an entity and its owners/shareholders/members and officers. The existence of the entity shields these individuals from the debts, obligations and liabilities of the entity. Piercing the veil effectively sets aside this protection allowing the owners or members of an entity to be held personally liable for the obligations and liabilities of the entity.
The two-pronged test for the corporate veil piercing is well established at common law and requires that: (1) that there must be such a unity of interest and ownership that the separate personalities of the corporation and the individual no longer exists and (2) circumstances must exist such that adherence to the corporate existence would sanction a fraud, promote injustice, or promote inequitable consequence.[1]
When deciding to pierce the veil of an entity the court will consider a number of factors to determine if a unity of interest and ownership exists, including: (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 other officers or directors, (7) absence of corporate records, (8)commingling of funds, (9) diversion of assets from the entity to the detriment of creditors, (10) failure to maintain arm’s length relationship among related entities, and (11) serving as a mere facade for the operation of the dominant shareholders.[2]
Unlike a corporation, the theory of piercing the veil of an LLC is not fully decided in Illinois. Since the Illinois Limited Liability Act was modified in 1998, the courts have yet to definitively determine whether an LLC can be pierced or not. Section 10-10 of the Illinois Limited Liability Act discusses the liability of members and managers and states:
- 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.
- (Blank).
- The failure of a limited liability company to observe the usual company formalities or requirements relating to the exercise of its company powers or management of its business is not a ground for imposing personal liability on the members or managers for liabilities of the company.
- 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.[3]
Many courts have considered the theory of piercing the veil of a LLC. Some have determined that the theory does not apply to LLC at all while other courts have determined that the theory does apply and have gone as far as to conduct an analysis of factors support piercing. Notable, the Illinois Appellate Court held in January 2015 that members and managers of an LLC cannot be held personally liable as a matter of law, unless the exception in subsection (d) is met.
Despite the recent the Illinois Appellate Court ruling, the topic of piercing the veil of an LLC is far from decided in Illinois. As such, it is extremely important that entitles and their controlling individuals make ensure that the LLC is maintained so that there is no question as to the separate identities of the LLC and those who manage or own it. Care should be taken so that the LLC does not appear to be the alter ego of the member, an entity formed to act as instrument to conduct that member’s personal business.
Should you have any questions about how to make sure your LLC is properly protected against piercing, please contact Waltz, Palmer & Dawson, LLC at (847)253-8800 or contact us online.
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[1] Fontana v. TLD Builders, Inc., 362 Ill. App. 3d 491, 500 (2005)
[2] Id.
[3] 805 ILCS § 810/10-10 (2015).