Pre-Incorporation Contracts: Avoiding Promoter Liability

A corporation must file the necessary paperwork with the Secretary of State to be incorporated. The incorporation process might take some time, and while this process is pending, the individuals forming the corporation may need to sign purchase orders, leases, or other necessary contracts. The individual who signs any of these contracts lists the corporation’s name, but the corporation is not technically in existence and will not be liable until the corporation adopts the contract.

Any contract entered into prior to the incorporation of a business entity is a possible liability for the “promoter.” A promoter is a person or entity acting on behalf of the corporation not yet formed.[1] Presley v. Ponce Plaza Assocs., is an appellate case that involved a final summary judgment imposing personal liability upon the appellant for accelerated rent due under a lease agreement in which the appellant supposedly executed on behalf of a professional association.[2] The court reasoned that “[a]lthough the named professional association utilized by the appellant on the lease agreement was not a duly incorporated entity, the appellant maintained that the parties understood that it was merely an abbreviated name for appellant’s duly incorporated entity.”[3] The appellee, however, countered that, at all times, its lease agreement was with the appellant solely as an individual and that, in any event, where the appellant knowingly executed a contract on behalf of a non-incorporated entity, the appellant was individually liable as a matter of law.”[4] The court found that this created a sufficient dispute of material fact to preclude summary judgment and thus summary judgment was in error.[5] The lesson in this case is to avoid potential liability as a promoter, parties to a contract and contract drafters should always use the exact name of the entity already formed to avoid the accusation that the agreement was a pre-incorporation contract with a yet to be formed entity.

The promoter remains personally liable for pre-incorporation contracts he enters into, even after corporate adoption, unless and until there has been a novation.[6] A novation is a legal agreement between the promoter, the corporation, and at least one other contracting party in which each party agrees that the other contracting party that the corporation will replace the promoter under the contract.[7] Therefore, without a novation, if a corporation is formed and the contract is adopted by the business, both the promoter and the business will be liable on the contract. A corporation will become liable on a contract when it adopts the contract by either an express board of directors’ resolution or an implied adoption through knowledge of the contract and acceptance of its benefits.[8] This is known as ratification.[9]

Promoters are personally liable for pre-incorporation contracts because at the time of the formation of a pre-incorporation contract the corporation was non-existent. One strategy is to avoid contracting as a promoter altogether and simply to wait until the corporation is officially formed to enter into agreements on its behalf. However, there may be situations in which pre-incorporation contracts are unavoidable. Determining the possible liability for pre-incorporation contracts is something that should be discussed with an attorney and the promoter and all liabilities should be analyzed thoroughly before signing on the dotted line. Such contracts should be carefully drafted to limit the danger that the promoter will be held personally liable.

According to Presley v. Ponce Plaza Assocs., in Florida, a creditor seeking to recover from an individual who has supposedly acted on behalf of a nonexistent corporation, the creditor must prove that the individual knew or should have known of the corporation’s nonexistence when he or she so acted.[10] It is, therefore, advisable to consult with an attorney and inquire about the possibility of including in pre-incorporation contracts a novation clause. This would include an explicit acknowledgement by the other contracting party that it understands it is contracting with an individual and the not yet formed corporation and that the contracting party will look only to the corporation, not the promoter, for performance if and when the corporation adopts the contract. Including such a provision in a true pre-incorporation contract can help avoid misunderstanding and save contracting parties, creditors, and debtors alike a great deal of money and frustration.