Howdy, I'm Professor Michael Conklin from Texas A&M University School of Law. Our last video went a little long, so this is going to be a more concise video here focused on the topic of corporate promoters. Imagine you and a friend have a great idea for a corporation, a restaurant selling flame broiled burgers named Hindenburg GERV. You are all set to meet with an exceptional attorney next month who is going to file all of the paperwork to form the corporation.
And the great news is that in the meantime, you are already taking on investors, signing contracts, and hiring employees. What potential problem might you need to be cautious of here? What do you think?
Well, starting a business is always dangerous, so there's likely a lot that you should be cautious of. But one of the more significant issues is that until that paperwork for incorporation is filed next month, you and your friends are, quote, an association of two or more persons to carry on as co-owners a business for profit. Hmm.
That's. That phrase sounds familiar, right? Where have we heard that before?
Oh, yeah, it was in the previous module where I described how bad general partnerships are. So until your corporation is created, you have a general partnership, which is very dangerous. This illustrates that there's a little bit of a chicken and an egg problem here. You may need to start conducting some preliminary business activities before the corporation is finalized.
But you don't receive the liability protections until after the corporation is finalized. And unlike some of the other problems I've pointed out in prior videos, there's really no good solution here. Now, this doesn't mean that one should never under any circumstances engage in business before a corporation is formed. It just means that extraordinary caution should be exercised.
A promoter is what we call someone who develops and organizes a new business. In addition to making arrangements so that the business can hit the ground running, they also acquire startup capital. Contracts entered into by a promoter before the corporation is formed are referred to as pre-incorporation contracts, and in many instances, the corporate promoter can be held liable for these. This is consistent with what we learned in Module 2. Recall that an agent is personally on the hook for contracts entered into on behalf of an undisclosed agent. Well, that's basically what's going on when a promoter enters into a contract on behalf of a corporation that does not exist.
And to make matters worse, note that mere formation of the corporation does not automatically release the promoter of liability under a pre-incorporation contract. The promoter will remain liable until there is a novation by the corporation that they will take over the contract. To mitigate this risk, promoters should enter into pre-incorporation contracts as, for example, ABC Corporation, a corporation not yet formed.
Instead of, you know, Joe Smith or on behalf of this corporation, you want to make clear that the other side knows this corporation has not yet been formed. Although, note that even this is not a 100% guarantee of avoiding liability. Because of the unique position of a corporate promoter, the law may impose special duties on them.
Some states follow what's called the secret profit rule. It essentially states that a promoter must divulge to the corporation she is promoting any profit the promoter is making in dealing with the corporation. Note that it's called the secret profit rule.
not just the profit rule. In all states, promoters are allowed to make a profit in dealing with the corporation if they inform the corporation first. All right, let's look at an example here.
After returning from a five-day vacation to Thailand, you decide to open a giant Thai food restaurant in America named Thai-tanic. You recall what you learned in this class. So you cautiously hire an attorney to create the corporation before conducting any business. The attorney tells you that everything will be finalized on the 12th. Out of an abundance of caution, you wait until the 15th to start entering into contracts on behalf of the corporation.
Unfortunately, you later learn that the attorney you hired graduated from one of those other Texas law schools, and they completely forgot to file the paperwork. While at first you might think that your ship has sunk, there might just be a lifeboat or maybe even a wooden door that you can metaphorically climb on. to avoid personal liability.
And that's because this would fall under the de facto corporation doctrine. It requires the following two elements. First, you must show a good faith attempt to comply with the incorporation rules of whatever state you selected.
Second, you must have used the corporate privilege in the meantime. In other words, you acted consistent with the existence of a corporation in all of your other dealings. So you can't try to have it both ways where you act like there wasn't a corporation when that benefits you.
And then you turn around and act like it was a corporation in instances where that would benefit you. You have to be consistent. However, note that not all states follow the de facto corporation doctrine.
And in a state that does follow it, even in a generous scenario such as in the Titanic, you may be personally liable. Although. Any judgment that you had to pay out of this scenario, you could, of course, sue the lawyer to recover that amount. I mean, that's an extra hassle, but you could pursue that.
It's best just to hire lawyers who graduated from Texas A&M in the first place. In conclusion, serving as a corporate promoter can be a lucrative role, but you must be extremely careful to avoid personal liability.