In matrimonial litigation, it is not uncommon for a closely held corporation, owned by one or both of the divorcing parties, to become embroiled in the litigation in some way. Normally, all that is involved is a valuation of the company and a determination of whether it is marital or non-marital property. However, sometimes the corporation is thrust, center-stage, into the proceedings. To that extent, at least a basic knowledge of corporate law becomes necessary.
The “Alter Ego” Theory
Normally, a corporation has status as a separate entity and is therefore a separate party. In certain cases, however, a procedure known as “piercing the corporate veil” can make a big difference in a case. Piercing the veil is something normally done in regular corporate litigation to subject the owners to personal liability. This is also known as the “alter ego” theory. However, there is no reason the doctrine cannot be used in divorce cases. For example, in Geittmann v. Geittmann, 126 Ill. App. 3d 470, 467 N.E.2d 297
, a 1984 Appellate Court of Illinois case, the former husband had his “veil pierced” when his ex-wife was trying to collect past-due support. The husband’s separate identity from his professional corporation was considered, in that case, to be merely a legal fiction, and the court allowed the corporation to satisfy the husband’s maintenance obligation. See also Northwest Suburban Congregation Beth Judea, Inc. v. Rosen, 103 Ill. App. 3d 1137, 432 N.E.2d 335 (Ill. App. Ct., 1982)
(persons failing to comply with corporate formalities could have injunction issued against the individual persons).
In order to pierce the corporate veil, two requirements must be met: (1) there must be such unity of interests and ownership that the separate personalities of the corporation and the individual no longer exist, and (2) circumstances must be such that an adherence to the fiction of separate corporate existence would sanction a fraud or promote injustice. Alpert v. Bertsch, 235 Ill. App. 3d 452, 601 N.E.2d 1031 (Ill. App. Ct., 1992).
Properly Tailoring Your Pleading
If you are attempting to pierce the veil, your pleading should not merely contain the conclusion that the corporation is an alter ego or a sham; you must allege sufficient facts. Courts will normally look to a number of variables as prerequisites to piercing the veil, such as inadequate capitalization, failure to observe corporate formalities, commingling of funds, and an absence of corporate records. Other factors allowing the veil to be pierced would be nonfunctioning directors and nonpayment of dividends. The taking of unusual perquisites, which often comes up in divorce cases, would be another factor leading to a conclusion that the corporate veil should be pierced. The fact that there are few shareholders, or only one, does not normally lead to a piercing of the veil, although it is more likely that the veil will be pierced if one party is a 100% shareholder.
When representing the corporate client, ask about adherence to these formalities. Or, you might be representing someone who is not getting divorced now, but is worried about it in the future and has asked you about setting up a corporation for many reasons. Observing all of the proper corporate formalities is essential. Piercing the veil is somewhat of an estoppel theory; in other words, if someone treats the corporation or the corporate assets as his own assets, he should be estopped from claiming it is a separate entity at trial.
As an example of how the corporate form can be used, in a recent case, I represented a husband who owned a majority interest in a closely held corporation; his wife was the other shareholder. The husband was the president of the corporation and was authorized to conduct the corporation’s business. The judge we were in front of had made substantive rulings so my client could not take his change of venue as a matter of right. In order to restrain a corporate asset, the wife’s attorney joined the corporation as a third party. This enabled me to file an appearance on behalf of the corporation; the corporation, since it was a separate party, then obtained a change of venue as a matter of right. Without pleading adequate facts, the wife’s attorney argued unsuccessfully that the corporate veil should be pierced. There are often good reasons for joining a corporation as a third party, i.e., easier access to discovery, the ability to tie up corporate assets and the like. In this above case, however, joining the corporation had a disastrous effect.
If you practice in an area in which the domestic-relations division is distinct from all others and the judges do not have general experience, it will be incumbent on you to lay out all the facts and the law in your particular case to argue for or against piercing the corporate veil. It may not come up that often, but when it does, as in the case mentioned above, it may make a substantial difference in the ultimate result.
Paul L. Feinstein, a Chicago practitioner with over four decades of experience, practices family law with an emphasis on divorce litigation, consulting, and appeals. Paul is often hired by trial lawyers to handle appeals and to assist them with determining legal strategies and preserving a sufficient record at trial. He has belonged to the American Academy of Matrimonial Lawyers since 1991 and the Appellate Lawyers Association since 2010. He can be reached at (312) 346-6392. View his Divorce Magazine profile.