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Promoter Liability. Part 1: Theories. Rule. PROMOTERS ARE PERSONALLY LIABLE ON A CONTRACT UNLESS THE OTHER PARTY AGREES TO LOOK TO SOMEONE ELSE. CORPORATION CANNOT RATIFY ACTION AFTER THE FACT SINCE IT DID NOT EXIST AT THE TIME THE CONTRACT WAS ENTERED INTO. Primary  Secondary Liability.

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promoter liability

Promoter Liability

Part 1: Theories

slide2
Rule
  • PROMOTERS ARE PERSONALLY LIABLE ON A CONTRACT UNLESS THE OTHER PARTY AGREES TO LOOK TO SOMEONE ELSE. CORPORATION CANNOT RATIFY ACTION AFTER THE FACT SINCE IT DID NOT EXIST AT THE TIME THE CONTRACT WAS ENTERED INTO.
primary secondary liability
Primary  Secondary Liability
  • PRESENT CONTRACT WHERE THE CORPORATION BECOMES LIABLE AND PROMOTER REMAINS LIABLE AS THE SURETY OR GUARANTOR. 
  • Effect: Promoter is personally liable on the contract and is not relieved after or if corporation is formed and adopts the contract (guarantor or surety)
primary liability no liability
Primary LiabilityNo liability
  • BINDING PRESENT CONTRACT WITH THE PROMOTER WITH THE AGREEMENT THAT PROMOTERS LIABILITY WILL BE TERMINATED AFTER CORPORATION IS FORMED AND A NOVATION TAKES PLACE. A NOVATION IS A SUBSTITUTION OF PARTIES. 
  • Effect: Promoter is personally liable on the contract until the corporation is formed and a novation, i.e. substitution occurs. (can't ratify)
revocable offer
Revocable Offer

REVOCABLE OFFER TO A NONEXISTENT CORPORATE AND WILL BE A CONTRACT IF THE CORPORATION IS FORMED AND ACCEPTS CONTRACT.

Effect: Not personally liable but view transaction as a revocable offer that is binding only after corporation is formed and adopts the contract

irrevocable offer
Irrevocable Offer

 IRREVOCABLE OFFER FOR A LIMITED TIME WITH THE CONSIDERATION AS A PROMISE TO FORM A CORPORATION IF CORPORATION IS FORMED THEN BINDING CONTRACT.

Effect: Not personally liable on the contract but irrevocable offer with promise to form the corporation. (Liable if fail to take steps to incorporation but not liable on the contract.)

rules
Rules

1) Promoters must make full disclosure of the consideration paid for stock if they become shareholders in the new corporation. (Frick)  

2) If a 3rd party agrees to look to the corporation to be formed for payment and not the promoter, the promoter is not liable. Look to 3rd party's action. (Quaker)

3) Shareholders can adopt the contract made by promoter by acquiescence if they know of the contract and fail to object.

MacArthur- Contract is effective on date of adoption, not original date before incorporation.

cases
Cases
  • Stanley How: RULE: PROMOTERS ARE PERSONALLY LIABLE ON A K UNLESS THE OTHER PARTY AGREES TO LOOK TO SOMEONE ELSE. CORP. CANNOT RATIFY ACTION AFTER THE FACT SINCE IT DID NOT EXIST AT THE TIME K ENTERED INTO.
was the signator liable
Was the Signator Liable?

1)Corvette of Miami (typed)

Howard Betz (written & seal)

2) Supreme Construction co (typed)

By Sam Capitino, Sr. Pres. (written)

Sam Capitino Sr. Pres (written)

3) First Management Co. Inc. (typed)

By Katy Vallas, Secy

By Claude Wilson Jr. Personal

promoter question
Promoter Question

1) Does exchange between promoter & 3rd party constitute a binding contract or an offer?

Factors:

- Expressions by the parties,

- Manner of signing, and

- Actions of parties impacting the expectations.

Ask:

a) If it is a contract, will promoter remain liable?

b) If it is an offer, is there consideration to make offer irrevocable?

promoter question11
Promoter Question

2) Does the promoter have an obligation to incorporate as part of offer?

3) Is the promoter also going to be a shareholder?

Ask:

a) Has there been full disclosure to other shareholders or promoters?

b) Has a disinterested board approved action?

shareholder liability

Shareholder Liability

Part 2: Piercing the Corporate Veil

shareholder liability13
Shareholder Liability

1. Defective incorporation: Court will extend protection of corporate entity if there was a good faith attempt to incorporate and carrying on as if are corporation, and statute permits to recognize-limited liability upheld.

2. Disregarding corporate entity: fraud perpetuated vs 3rd parties by sole shareholder-personal liability attach

3. Alter ego doctrine: Based upon actions of parties as individuals, attribute actions of corp. to individual-personal liability attach

premature incorporation
Premature Incorporation

1. De Jure: recognized by state as being incorporated because there is conformity with the mandatory conditions precedent under the statute, but there are minor statutory requirements that have not been fully complied with; certificate has been issued.

2. De Facto: defective incorporation which is defectively formed and is subject to attack by the Secretary of State

Must show 1) valid law under which to incorporate; 2) good faith effort to incorporate; 3) holding self out as corporation--States do vary on the specific language.

premature incorporation15
Premature Incorporation

3. Corporation by Estoppel: equitable doctrine that relies upon the existence of defacto corporation but focuses on acts and intent of the parties;

--Defense where third party is estopped to deny the existence of corporation based on the actions and reliance of the party that is dealing with the corporation;

-Often requires a failure to hold individual as guarantor or primarily liable.

corporation by estoppel
Corporation by Estoppel
  • Arises where
  • association sues 3rd party and third party is estopped from denying P is a corporation;
  • 3rd party sues association as a corporation and association is precluded from denying it was a corporation;
  • 3rd party sues association and members of association cannot deny its existence 'cause it participated in holding it out as a corporation (Whatley, Cantor);
  • 3rd party sues individual behind association but is estopped from denying the existence of corp. (Robertson, Cranson);
  • 3rd party or assoc. is estopped to deny corp. existence 'cause prior pleadings
disregard corporate entity
Disregard Corporate Entity
  • Arises when a fraud has been perpetrated on a corporation by shareholders for their sole benefit--in such cases the court with disregard the corporation entity and find shareholder liable.
  • N/A if simply fail to satisfy formalities but good faith effort to operate as a corporation
    • (Same rules apply re defacto)
critical factors
Critical Factors

a. Undercapitalization or inadequate capital to run the corporate business;

b. Failure to observe corporate formalities (elect officers, hold meetings, resolutions, maintain corp. records);

c. Nonpayment of dividends;

d. Debtor/corporation is insolvent;

e. Siphoning funds by dominant shareholder /treating corporate assets as their own and withdrawing them;

f. Non-functioning officers and directors;

g. Corporation is a facade for the operations of a dominant shareholder; and/or

h. Hold yourself out as personally liable for corporate debts.

cases rules
Cases Rules
  • DeWitt Truckers- SHAREHOLDERS WHO ACT IN SELF-INTEREST WHICH IS FUNDAMENTALLY UNFAIR TO A THIRD PERSON, WILL BE HELD PERSONALLY LIABLE WHERE THEY FAIL TO COMPLY WITH THE CORPORATE FORMALITIES. DETERMINATION SHOULD BE MADE ON THE FACTS OF EACH CASE, CONSIDERING ALL RELEVANT DEFICIENCIES.
      • Note: extension of apparent authority doctrine.
  • U.S. v. Best Foods- Parent is liable for acts of sub if parent controls the activity of facility at issue and uses the corporate form to achieve some wrongful or illegal purpose.
alter ego
Alter Ego

Person asserting claim must show unity of interest and ownership between the corporation and shareholder (dominant) such that no separate identities exists; and if the acts are treated as the corporation’s alone, it will lead to an inequitable result.

- Applies to contract claims

- In tort claims, must also show individual shareholder was negligent.