This document discusses defective incorporation and promotor liability. It identifies three common scenarios: 1) both parties know no corporation exists, imposing liability on the promoter; 2) both parties mistakenly believe a corporation exists, allowing for equitable defenses like de facto corporation or corporation by estoppel; 3) a corporation is administratively dissolved but later reinstated, retroactively limiting liability. The key concepts are that a promoter is presumed liable if no corporation exists, but equitable defenses may apply if parties were unaware, and reinstatement can restore a dissolved corporation's legal status retroactively.

1. BUSINESS ORGANIZATIONS
MODULE III: ENTREPRENEURSHIP
LESSON 4: DEFECTIVE
INCORPORATION
Professor Seth C. Oranburg
Duquesne University School of Law
Spring 2020

2. Learning Objectives
■Identify when a defective incorporation
may occur
■Analyze whether the corporate
promotor has liability in these
situations
■Apply equitable defenses to promotor
liability for defective incorporation

3. Defective
Incorporation
Concepts
■ A corporation comes into
existence at the moment
when the Article of
Incorporation are filed
■ What happens when
someone makes a deal
with a corporation that
doesn’t legally exist yet?
■ The legal results
depends on facts such
as what the parties to the
deal knew or believed
Promotor Liability
De Facto Corporation
Corporation by Estoppel

4. Common Facts Patterns in
Defective Incorporation
1. Both parties know there is no
corporation
2. Both parties believe a
corporation exists
3. A corporation is reinstated after
administrative dissolution

5. Scenario 1-A: Both parties
know there is no corporation
■If corporation is not formed it
then it does not exist
■It cannot be party to contract
■The Promoters have a
presumption of liability

6. Presumption of Liability:
Restatement (2nd) of Agency §
326
Unless otherwise agreed, a person
who, in dealing with another,
purports to act as agent for a
principal whom both know to be
nonexistent or wholly incompetent,
becomes a party to such a contract

7. Common Facts Patterns in
Defective Incorporation
1. Both parties know there is no
corporation
2. Both parties believe a
corporation exists
3. A corporation is reinstated after
administrative dissolution

8. Scenario 1-B: Corporation forms
later and adopts the agreement
■The promoter is still liable
unless all the parties
(including the corporatin)
agree to a novation

9. Contract Law Concept:
Novation
■ A novation is a substituted contract that
includes as a party one who was neither the
obligor nor the obligee of the original duty
■ Substitutes a new obligation for an existing one
– Parties destroy the old obligation in
consideration of the new obligation
■ The only way in which it is possible to transfer
contractual duties (e.g., of a promotor) to a third
person (such as a corporation)

10. Common Facts Patterns in
Defective Incorporation
1. Both parties know there is no
corporation
2. Both parties believe a
corporation exists
3. A corporation is reinstated after
administrative dissolution

11. Scenario 2: How might both parties
mistakenly believe a corporation exists?
■ Jessica and Lindsay agree to go into business
together
■ They read a DIY website that says there is a
cheaper way to form a company: simply by
acting as a corporation
■ Believing everything they read on the Internet,
the entrepreneurs begin acting as “co-CEOs” of
this corporation
■ They form an Office Depot account under the
name “J&L, Inc.” and order office furniture and
supplies

12. Distinguish Scenario 1 and Scenario 2
■Unlike Scenario 1, where both
parties know the truth, what
happens if both parties are
innocently mistaken as to the
reality of corporate formation?

13. Equitable Leniency
■De facto corporation
■Corporation by estoppel

14. De facto corporation
Applied if promoters:
– Made good faith effort to incorporate;
– Unaware that incorporation did not
occur; and
– Used the corporate form in transaction
with 3rd party

15. Corporation by Estoppel
■No personal liability if the
third party believed that her
only recourse would be
against business assets

16. Statutory Approaches to
Promoter Liability
■MBCA § 2.04. Liability for
Preincorporation Transactions
– 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.

17. Common Facts Patterns in
Defective Incorporation
1. Both parties know there is no
corporation
2. Both parties believe a
corporation exists
3. A corporation is reinstated after
administrative dissolution

18. Scenario C: Corporation is
administratively dissolved
■ Corps are sometimes dissolved by admin
order
– Failure to pay taxes, report agent
change, file reports, etc.
■ Corps can be reinstated
– Retroactive limitation of liability with
regard to contracts

19. Conclusions
■ If parties are aware that no corporation has been formed,
then promoter is presumed liable, unless agreed otherwise
■ If parties are unaware that no corporation has been formed
and act as though there is a corporation, then a court may
construe corporate attributes through the doctrines of de
facto corporation or corporation by estoppel
■ If the corporation is formed, but dissolved by the state for
not paying franchise taxes, the corporation can be
retroactively reinstated