Q & A Related to Class 1

Question: When you were talking about the liability for the promoter of a corporation for pre-incorporation activity, you presented a question that asked once the articles of incorporation are filed, is the promoter liable if the corporation breaches any pre-incorporation contracts? I took from that discussion that the promoter is liable for those pre-incorporation contracts, (under MBCA 2.04) but why? Is it because the promoter created an arms-length transaction with the person at the other end of the contract (since the corporation didn’t exist at the time) and thus is directly tied to the transaction?

Answer: Yes. The Model Business Corporation Act (MBCA) § 2.04, Liability for Preincorporation Transactions, provides:

“All persons purporting to act as or on behalf of a corporation, knowing there was no incorporation under this Act, are jointly and severally liable for all liabilities created while so acting.”

Note that the promoter can disclose the corporation does not yet exist and that he or she has no intention of being bound. If made expressly part of the agreement, the promoter should be able to escape personal liability. Because the corporation did not exist, there is no other party to be bound; as such, knowing no corporation had been formed, the promoter remains bound unless released. The message – form the corporation first, then sign contracts!


Question: Under the fourth example, if the articles are not filed or are defectively filed, can the defectively formed entity enforce the contract? Is the answer to that question, it depends…as in the courts will only allow the enforcement of such a pre-incorporation contracts where equity demands (such as part-performance)?

Answer: We will discuss this more in some of the cases we’ll cover, but the short answer is, yes, sometimes a defectively created company can enforce a contract. In fact, that’s kind of what happens in the first case we’ll discuss. There are two concepts that can allow this to happen: (1) de facto corporation doctrine and (2) corporation by estoppel. A court will often find a de facto corporation where the promoters (a) tried in good faith to incorporate, (b) had a legal right to incorporate, and (c) acted as a corporation. For corporation by estoppel, courts will enforce the contract where (a) the party claiming it is not a corporation thought it was a corporation all along and (b) that party would earn a windfall if allowed to claim the corporation did not exist. There can, in some situations, be some overlap between these two concepts. Either one can suffice.