Question

Carson, Chen and Tate are recent college graduates who want to form a corporation to manufacture and sell computers. Peter tells them he will set in motion the formation of their corporation. First, Peter makes a contract for the purchase of land for $75,000 from Owen. Owen does not know of the prospective corporate formation at the time the contract is signed. Second, Peter makes a contract with Bobby to build a small plant on the property being purchased. Bobby's contract is conditional on the corporation's formation. Peter secures all the necessary subscription agreements and capitalization, and he files the articles of incorporation. A charter is issued.
(a). Discuss fully whether the newly formed corporation, Peter, or both are liable on the contracts with Owen and Bobby.
(b). Also, discuss fully whether the corporation is automatically liable to Bobby on formation.

Answer 1

Explanation:

A. As a general rule, a promoter is personally liable for all pre-incorporation contracts made by the promoter. The basic theory behind such liability is that the promoter cannot be an agent for a nonexistent principal (a corporation not yet formed). It is immaterial whether the contracting party knows of the prospective existence of the corporation, and the general rule of promoter liability continues even after the corporation is formed. Three basic exceptions to promoter liability are:

(1) The promoter’s contract with a third party can stipulate that the third party will look only to the new corporation, not to the promoter, for performance and liability.

(2) The third party can release the promoter from liability.

(3) After formation, the corporation can assume the contractual obligations and liability by novation. (If it is by adoption, most courts hold that the promoter is still personally liable.)

Peter is therefore personally liable on both contracts, because (1) neither Owens nor Baby has released him from liability, (2) the corporation has not assumed contractual responsibility by novation, and (3) Peter contract with Boby did not limit Boby to holding only the corporation liable. (Peter liability was conditioned only on the corporation’s formation, which did occur.).

B.

Incorporation in and of itself does not make the  newly formed corporation liable for pre-incorporation contracts. Until the newly formed corporation assumes Peter contracts by novation (releasing Peterson from personal liability) or by adoption (undertaking to perform Peter contracts, which makes both the corporation and Peter liable), BOBBY cannot enforce Peter contract against the corporation.