Aesop had a good thing going. He had a great family, owned his own home and was operating a small, but successful, construction business doing home additions. Based on a radio advertisement for do-it-yourself, legal work, he decided he should incorporate. The ad said it would protect him from liability. Aesop followed the instructions and filled out the paperwork. He called his company Aesop’s Pretty Good Construction Company Incorporated.
Aesop filed the paperwork with the Secretary of State. Using the form kit provided, he named himself the sole shareholder, director and officer since he was the one running the show. It was pretty simple, and he knew he saved a bundle of money on legal fees. The documents came back telling him he was incorporated, and Aesop was pleased with himself.
Aesop set up a separate bank account with a Federal Employer Identification Number his accountant received from the IRS after he incorporated. His buddies told him that he could have the business pay for many things and then “write them off” on his taxes. He bought a truck, and paid for it with the corporate account. He paid his cell phone bills and many other things from the company account. His accountant told him he should save the receipts, track his miles on the truck and phone usage for the company, but Aesop was not good with paperwork like that and forgot more often than not.
It was very convenient to use the company debit and credit cards to buy things. As time went on, Aesop used them to buy many things both for the business and for personal use. Business slowed down with the economic downturn, and Aesop ran more and more personal purchases through the business, even groceries sometimes. Early on, he made sure the accountant knew what purchases were for the business and what purchases were not, but Aesop really did not know why it mattered. He never used to keep track of those things, and he did not see the necessity of being so picky now. After all, it was his business; he was the only shareholder; he figured it did not matter which pocket the money went into or was paid out of; it all evened out in the end. Accountants just like excuses to bill more time.
Sometimes Aesop would deposit checks he received for job payments right into his personal account because it was needed to make the mortgage payment or for other things. It was also more convenient to do it that way sometimes when he knew he had bills to pay. His accountant got mad at him, but Aesop told his pals, “I pay him too much anyway. He should not complain about having to earn it.”
Aesop’s was busy with work, and his business grew. He hired some employees to keep up. When the annual report forms came from the Secretary of State, it was never convenient. They always came as he was gearing up for the new construction season. At first, he often waited to the last minute. As years went by, he became even busier and a little more lax with the formalities. He discovered that the penalties and interest were not all that expensive if he sent the Annual Report in late.
When Aesop first incorporated, Aesop’s Pretty Good Construction Company Incorporated seemed like a great name. It was catchy, but it took a long time to write out. Aesop wished he had a shorter name so I started using Aesop’s Pretty Good Construction Company for his business cards. Then he started just calling it Aesop’s Construction Company, and then just Aesop’s Construction, which is what he put on his new truck and his third order of business cards. The few contracts he signed used that name too.
At first, Aesop was proud to indicate that he was the “president” of the company. As time went on, however, Aesop was no longer as enamored with the title. He figured everyone knew he was the guy in charge anyway. It was easier just to write in “Aesop’s Construction” and sign his name. Aesop was not really that into the formalities. He had a powerful and outgoing personality that no one could mistake for being anyone but the owner of the company. Aesop was successful, even in a tough economy, because he was a hard worker and did good work.
Aesop did like not being taken advantage of, and he felt that the big construction company that hired him one day to build the stairs and balcony for the rooftop apartment near Wrigley Field was jerking him around. He walked off the job without finishing it when he had enough. He figured that the big company needed him and would cave to his demands. He was not afraid of being sued because he believed the corporation would shield him from liability. If he needed to start over with a new corporation, it would be easy like the first time. Even if he lost a lawsuit, there was very little in the way of assets in the company because the corporation did not own real estate, and his new truck and other vehicles and most of his equipment were actually in his own name.
As luck would have it, the stairs and balcony collapsed that night as throngs of jubilant Cubs fans found access to the partially built structure and crowded the shaky balcony in an attempt to see the Cubs first World Series game in over a century. Many, many people were injured and some died. Aesop found himself being sued personally by the big construction company for breach of contract along with dozens of personal injury and wrongful death suits.
Like Aesop, many business owners incorporate their businesses for the tax benefits and personal liability protection incorporating provides. Aesop thought that the mere act of incorporating was sufficient to protect him from liability. Finding little in the corporation to satisfy the many judgments that were sought (running into the millions of dollars), Aesop was sued, personally, and lost everything he owned.
In order for a corporation (or an LLC) to shield the owners (shareholders) from the liabilities of a business, the shareholders must carefully observe the formalities of doing business as a corporation and respect the separateness of the business entity. It is not sufficient merely to incorporate the business; the business must operate in every way as a corporate entity. A corporation is considered separate, and distinct from its shareholders. A corporation is a legal “person” in the law. When the shareholders do not respect the difference, the courts may also ignore the distinction and impose the business liabilities on the shareholders as if the corporation did not exist. If the shareholders, themselves, do not observe the corporate formalities and respect the difference between the corporation and themselves, the law will not respect the difference either.
The process of attempting to hold the shareholders, members, directors, managers and officers of a corporation personally liable for the debts and obligations of the business is called “piercing the corporate veil.” When determining whether or not to pierce the corporate veil, Illinois courts will look to a number of factors including: 1) the capitalization of the business entity; 2) the issuance of stock; 3) the observance of corporate formalities; 4) the payment of dividends; 5) the solvency of the corporation; 6) the functioning and participation of officers and directors; 7) the presence or absence of corporate records; and 8) the relationship between the business and shareholders. While none of the above factors is controlling, the more carefully the corporate formalities are observed and the more carefully the difference is respected between the shareholders and the business, the more likely that liability shield will be upheld.
Illinois courts have recently applied the doctrine of piercing the corporate veil to LLCs in the same way it has been applied to corporations; with the exception that failure to follow “corporate” formalities is not enough to pierce the corporate veil. Illinois courts have even used the doctrine of piercing the corporate veil to hold non-shareholder officers and directors personally liable in circumstances in which the officer and director exercised control over the business.
Anyone can fill out forms and file them. Understanding the importance of the formalities and carefully complying with them is vital. The best way to ensure protection from the debts and obligations of your business is to treat your business like a business entity from separate yourself in every way. Keep business and personal accounts separate; maintain up to date corporate records; always file annual reports on time; maintain separate and complete accounting of the business with documentation to back it up; authorize the major decisions and happenings with formal corporate actions in writing; hold annual shareholder and director meetings; maintain adequate capital in the business; be careful to use the exact corporate name; and never sign a document without indicating that you are merely a representative of the business.
Business owners should start with a good foundation. Use a good attorney and accountant when you start your business. If you already have a business, but have concerns or questions personal liability, you should contact an attorney and get good advice. The expense of good legal and tax advice is worth the protection it provides.Kevin G. Drendel Drendel & Jansons Law Group 111 Flinn Street Batavia, IL 60510 (630) 406-5440 (630) 406-6179 firstname.lastname@example.org www.batavialaw.com
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This article is not intended to provide legal advice or create or imply an attorney-client relationship. This article contains opinions and general principles of law and should not be considered legal advice to be applied in specific situations. No information contained herein is a substitute for a personal consultation with an attorney. For more information, visit www.batavialaw.com or call (630) 406-5440.