Formation

Question 1

Formation - Pre-Incorporation Transactions

Answer 1

Pre-Incorporation Transactions

• Promoter
  
  • A promoter is a person who, prior to formation of a corporation, procures capital and enters into contracts to bring the corporation into existence.
• Liability for pre-incorporation agreements
  
  • A promoter is personally liable for a contract entered into pre-incorporation, even after the corporation comes into existence.
  • Exceptions:
    
    • Novation: If the corporation and the other party to the contract agree to substitute the corporation for the promoter in the contract, the promoter will no longer be liable.
    • Adoption: If the corporation adopts the contract (expressly or by using the benefits of the contract), the promoter may no longer be liable.
• Corporation’s Liability
  
  • A corporation is not liable for pre-incorporation contract entered into by a promoter, unless a novation occurs, or it adopts the contract.

Question 2

Formation - Incorporation

Procedure

Answer 2

Procedure

To form a corporation, a document (articles of incorporation) must be filed with the state. The articles must include a statement of the corporation’s purposes; a broad statement is acceptable.

Question 3

Formation - Incorporation

Ultra Vires

Answer 3

Ultra Vires

If a corporation has a narrow business purpose in its articles of incorporation and engages in activities outside the purpose, it has engaged in an ultra vires act. If an ultra vires act occurs, a shareholder can file a suit to enjoin the action and/or the corporation can take action against a director, officer, employee who engaged in the act.

Question 4

Formation - Incorporation

De Jure Corporation

Answer 4

De Jure Corporation

When the statutory requirements for incorporation are met, a “de jure” corporation has been formed. The corporation is then liable for activities (not the individuals).

Question 5

Formation - Incorporation

Failure to meet requirements

Answer 5

When a person makes a good faith effort to incorporate, but does not meet the requirements, that person may still be able to escape personal liability.

1. De Facto Corporation
   
   • If the owner made a good faith effort to incorporate and operates the business without knowing that the requirements were not met, the business will be treated as a “de facto” corporation by the court. The individual owner will not be individually liable.
2. Corporation by Estoppel
   
   • A party who deals with an entity as if it were corporation is estopped from denying its existence and is thereby prevented from seeking personal liability against the business owner. This is limited to contractual agreements. The owner must have made a good faith effort to incorporate and operated the business without knowing that the requirements were not met

Example 1: Based on a past bar essay: L and M improperly file articles of incorporation. They acted in good faith and they are now operating “Data, Inc.” as a business, believing it is incorporated. L and M obtain a business loan from Big Bank who looks at the Data, Inc.’s business records prior to issuing the loan. L and M’s business eventually fails and is unable to repay the loan. Big Bank will be estopped from arguing that Data, Inc. is not a corporation because it dealt with Data, Inc. as if it were a corporation and had an opportunity to discover that is was not actually incorporated. Big Bank will not be able to recover from L and M as individuals.