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Corporations • Pre-Corporation Formation
CORP#003
Legal Definition
The promoter remains liable on pre-incorporation contracts until there has been a novation. If the promoter enters a contract and the corporation is never formed, the promoter is solely liable. If the promoter enters a contract and the corporation is formed, but merely adopts the contract (i.e., there is no novation), both the corporation and the promoter are liable at the election of the third party.
Plain English Explanation
Promoters are on the hook until they are legally relieved of their obligations through a novation, which is the legal process of replacing one person in a contract with a different party. If there is no novation, the third party can sue whomever they please.
Hypothetical
Hypo 1: Bob and Sam pool their money to incorporate and start a theme park, Law School Land. Bob finds the perfect parcel of land and tells its owner, Amy, about the plan. Amy agrees to sell it to Bob for $100,000 with 50% due at closing and 50% due 6 months later. The contract states that closing will be held 30 days from the time of signing, which will give Bob and Sam plenty of time to incorporate. Bob signs the contract, "Bob, on behalf of Law School Land, Inc." When Bob tells Sam about it, Sam tells Bob, "That's a stupid idea. In fact, it's so stupid, I don't want to make Law School Land with you anymore!" Result: Bob was a promoter for Law School Land and signed the contract knowing that Law School Land didn't yet exist. Thus, he will likely be found personally liable for the contract he signed with Amy.
Hypo 2: Same facts as Hypo 1, except there is no falling out between Bob and Sam. They continue with the plan and incorporate Law School Land. 30 days pass and it is time to close with Amy. Result: At this time, both Bob and Law School Land are obligated to pay Amy. Why? Because there hasn't yet been a novation, which means the legal parties to the contract are Bob, the individual, and Law School Land, the corporation. In order to relieve Bob of the liability, a novation must occur which legally removes Bob from the agreement he signed and replaces him solely with the legal entity, Law School Land. You can learn more about novations in the Contracts Law deck.
Hypo 2: Same facts as Hypo 1, except there is no falling out between Bob and Sam. They continue with the plan and incorporate Law School Land. 30 days pass and it is time to close with Amy. Result: At this time, both Bob and Law School Land are obligated to pay Amy. Why? Because there hasn't yet been a novation, which means the legal parties to the contract are Bob, the individual, and Law School Land, the corporation. In order to relieve Bob of the liability, a novation must occur which legally removes Bob from the agreement he signed and replaces him solely with the legal entity, Law School Land. You can learn more about novations in the Contracts Law deck.
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