Could You Be Held Liable For Judgments Against Your Corporation?
It's called piercing the corporate veil and the case of Fontana v. TLD Builders, Inc. (2nd Dist. Doc. No. 2-05-0045) is a simple lesson in what to watch out for when you’re running a small business. It is also an excellent read for anyone wanting to know about the factors a court will look to in determining whether or not your choice of operating as a corporate entity will limit your liability.
In Fontana, the Fontanas sued TLD Builders after TLD defaulted on a contract to build the Fontanas' a home in Clarendon Hills, Illinois. The Fontanas had signed a contract for TLD to build the home and TLD started and apparently didn’t finish the project. As a result the Fontana’s had to demolish the partially constructed home because the damage caused by the work stoppage made the cost of completion well in excess of the $2.2 million the home would be worth if it was completed.
The Fontanas also sued the architect who settled with them prior to trial.
The Fontanas sought not only to be reimbursed from TLD, but recognizing that TLD was an underfunded corporation that would likely not have the ability to satisfy the $2 million judgment they were seeking, they also filed an action against TLD’s president seeking to hold him personally liable for any damages – even though his wife was the sole owner of the company and he only ran it.
The Fontanas won their case and the court determined that the president was liable and that the corporation, even though it was properly incorporated, was used as nothing more than a shell where the president ran the operation.
The appellate court upheld the decision… The factors the court looked to in determining whether or not liability would be limited to the corporation or passed on to the president are important factors to watch for in your operations to make sure that the corporate designation you’ve paid for is actually going to protect you:
- The fact that the president didn’t own the company but that all the shares were
in his wife’s name was not a factor that would protect him – he ran the business and acted as though its assets were his own. - There was no record of the initial $1000 check purported to be paid by the wife for the 1000 shares ($1 per share) when the corporation was created.
- The corporation had little to no money in its accounts and even made loans after it was sued – an alleged attempt to divert the assets to try and avoid having any money to pay in satisfying a possible judgment.
- The corporate minutes did not reflect resolutions or votes authorizing some of the loans made to various people and entities.
- The corporate minutes did not attach legal descriptions to resolutions to sell properties.
- The director (owner) had no real decision making power and/or did not exercise it.
- Even though by-laws, resolutions, shareholder actions, and tax returns were filed with the state and a separate bank account and financial records were kept, there were many corporate records that were not kept, like the resolutions regarding loans, notes or claims of indebtedness, nor records of repayments.
- The company never actually paid a salary to anyone, and the tax returns did not show payment to corporate officers – funds were transferred from the corporate account into personal checking accounts.
- Monies were transferred after the suit was filed and the corporation was left with little money at the time of judgment - salaries were paid and monies were loaned when a suit was in place (this was read as an apparent attempt to transfer assets before a judgment was rendered).
For both people going after a corporation that has been less than honest, and for those looking to use their corporate status in order to keep from being held personally liable, paying attention to these formalities is important.
The corporation, or LLC exists as a method of helping us all come together to create more wealth and to take chances on creating capital that we might otherwise not take. Not keeping up the requirements imposed by states for operating those entities will result in losing the protections they offer.
On a different note, this opinion also contains a section on awarding attorneys fees pursuant to a contractual provision that read:
"To the extent Builder or Purchaser fails to comply with provisions of this Contract, the other party may retain an attorney to assist it in the enforcement of the provisions of this Contract, and the party at fault (i.e., not in compliance with the provisions of this Contract), shall pay any and all reasonable expense relating to the enforcement of the provisions of this Contract."
While the court did find that reasonable attorney's fees were recoverable under the contract, the opinion does note that it may be better practice to include the term “attorney’s fees” when drafting a provision for a party to bear the costs of another’s attorney.
