Pre-Incorporation Activities
Because the corporation entity is often formed after the idea has started being put into action, there are activities that may occur before incorporation. A person engaging in these activities is called the promoter. So who is liable for any contracts signed by the promoter? The individual promoter or the corporation?
The general rule is that the promoter will be personally liable for the contract. However, there could potentially be an exception to this rule if the other party knew the corporation was not yet formed and contracted specifically with the future corporation.
Additionally, a corporation can later become liable if they “acquiescence” to the contract. In other words, the corporation ratifies the action. Typically a promoter will add a “novation” clause into the contract saying that once the corporation is formed, the corporation will automatically substitute as the party in the contract (instead of the promoter).
Jurisdiction of Incorporation
So, where should the corporation incorporate? Typically, there are two options, the state where the corporation is going to be headquartered or Delaware. If the corporation is only going to do business in one state, it would be better to be incorporated in that state. However, if the corporation seeks Venture Capitalists or wishes to go public in the future, it might be worth spending the extra money to incorporate in Delaware.
Incorporating in Delaware is more expensive because you essentially have to pay doing business in multiple states (getting a registered agent and office in Delaware and the home state). However, VCs like Delaware because of the laws governing the corporation, the respect, and knowledge of the the court system.
Mechanics
First, file articles of incorporation – often called the charter. Required information is outlined in DGCL § 102 or MBCA § 2.02(a). The articles contain:
- Note that the name of the corporation needs to be distinguishable from other business entities within the state (and also the USPTO office).
- Authorized shares = the maximum number of shares the corporation is authorized to issue. Typically set to the highest amount possible while paying the least amount of fees (more shares = more fees).
- Shares outstanding = the number of shares held by a corporation’s shareholders.
- Par value = the minimum amount of consideration that must be received to issue a share. Thus, if the par value is set at $10 and sells 100 shares, the corporation must receive $1,000. Today, this value is hardly relevant because it can be set as a nominal amount or not set at all.
- Purpose – which can be narrowed but is usually broad. Broad = avoiding invalidation of decisions that go beyond a narrow scope.
The articles of incorporation need to also list the address and the incorporator (usually the attorney doing the filing). The articles also only meet the required elements and everything else is put into the bylaws because bylaws are cheaper and easier to amend.
After the articles of incorporation are completed, the directors need to be elected to finish completing the organization of the corporation. This includes, adopting bylaws, appointing officers, and approval of issuing stock.
If the corporation wishes to do business in states other than where they are incorporated, they need to become a “foreign corporation by qualifying to do business in that state. Typically this involving filling out a form, filing a fee, and maintaining a registered agent. This has to occur if the corporation is “transacting business,” an imprecise term.
Harold Lang Jewelers, Inc. v. Johnson
576 S.E.2d 360 (N.C. App. 2002).
Facts
Lang Jewelers (a Florida corporation) sued Johnson saying that Johnson had not paid them. The lawsuit was filed in North Carolina and Johnson moved to dismiss because Lang did not have a certificate to do business in NC. Lang argues that there was no need because they were not “transacting business.”
Analysis
A party is transacting business if they are “engaging in, carrying on or exercising some of the functions for which the corporation was created.” Here, the jewelers were in the business of selling and consigning Jewelry and did so frequently and consistently within NC. As such, Lang was transacting business in NC and should have obtained the requisite certificate. Because he failed to do so, the case is dismissed.
Defective Incorporation
What happens if the corporation is running but (for whatever reason) fails to actually become incorporated? Under partnership law, individuals would be personally liable. However, courts have often sided that the corporation is either de facto incorporation or a corporation by estoppel.
Pharmaceutical Sales and Consulting Corp. v. J.W.S. Delavau Co.
59 F. Supp. 2d 398 (D.N.J. 1999).
Facts
PSCC sued JWS because JWS failed to make payments under the contract. During discovery, JWS discovered that PSCC had not incorporated before the signing of the July contract (nor had ever been incorporated). All that was discovered was a handwritten notation on an article of incorporation saying that it was sent in August of that same year. Using this information, JWS made a motion to dismiss, saying that the contract was not valid because PSCC was not incorporated.
Analysis
De facto corporation requires (1) a law that allows the doctrine, (2) a bona fide attempt to become incorporated, (3) use of corporate powers.
PSCC cannot be a de facto corporation because the bona fide attempt to become incorporated occurred too late (Aug. comes after July).
A party that engages with the defective incorporation and acts as if the company is a corporation may be estopped. This is especially true if the party is tying to get out of liability as a defendant. Here, the defendant is trying to escape liability, and it makes sense that (for purposes of this contract) PSCC should be afforded corporate by estoppel status.
Ethical Issues
First, is multiple founders come to the same lawyer for the incorporation process, there is the potential of a conflict of interest. Consequently, lawyers will often provide informed consent and obtain a conflicts waiver from each founder.
Second, because founders are low on money, they often offer stock in exchange of legal services. Not advisable, but acceptable as long as the terms are “fair and reasonable” to the client.
Third, if the incorporation occurs in another state where the lawyer is not licensed, the lawyer may help with getting everything set up (temporary), but nothing else.
Disclaimer
The content contained in this article may contain inaccuracies and is not intended to reflect the opinions, views, beliefs, or practices of any academic professor or publication. Instead, this content is a reflection on the author’s understanding of the law and legal practices.
