Corporations & LLCs: Formation — Business Associations

Priya and Devi mail articles of incorporation for Franklin Bakehouse, Inc., reasonably believe they are now incorporated, and start operating. They sign a lease with a landlord who contracts with Franklin Bakehouse, Inc. Unknown to them, the secretary of state rejected that filing over a name conflict. The bakery fails. The landlord sues the two women personally for the rent. Are they on the hook?

No. And the reason is the idea this whole topic turns on. A corporation is not born when the founders shake hands. It is born when the right paper hits the right government desk. Until that moment, whoever is signing contracts is personally exposed. So what happens when the paper never lands?

Two halves, and the same two-document structure in each. First the corporation. A public charter filed with the state, a private rulebook called the bylaws, the shareholder agreement that can rewrite both, and what happens when formation goes wrong. Then the LLC, where the public filing is nearly bare and the private agreement is the star of the show.

A corporation is formed by one or more incorporators. The people who sign and deliver the articles of incorporation to the secretary of state for filing. An incorporator is just the organizer who gets the entity off the ground. They need not be a future shareholder, director, or officer. A paralegal doing it as a favor is a perfectly valid incorporator.

Under the MBCA, the corporation legally exists the instant the articles are filed, unless the articles pick a later effective date. Not when the organizational meeting happens. Not when stock is issued. On filing. And that is exactly Priya and Devi's problem. Theirs never were.

The Act adds a shortcut. The act of filing is conclusive proof that the corporation was validly formed, except in a proceeding brought by the state itself. After filing comes the organizational meeting, where the corporation adopts bylaws, appoints officers, and issues stock.

The articles of incorporation are the corporation's constitution. The foundational public document that brings it into existence. Under MBCA § 2.02 the statute demands only four things. A corporate name that satisfies the naming rules. The number of shares the corporation is authorized to issue. The initial registered office and registered agent. And the name and address of each incorporator.

That is the whole list. Notice what is not on it. No purpose clause. No initial directors. No par value. Those are optional.

And because the charter is public, and because changing it later takes a shareholder vote, founders keep it lean. Put in what the statute requires, plus the few terms you want locked into the public record, and leave the operational detail to the bylaws.

One naming trap. The MBCA calls this document the articles of incorporation. Delaware calls the very same thing the certificate of incorporation. Same instrument, two labels. Under both, existence begins on filing.

The content differs in two ways the exam likes. Purpose. The MBCA presumes a corporation may engage in any lawful business, so a purpose clause is optional. Delaware requires one, even if it is only the catch-all. Par value. Delaware still uses it and wants the stock described. The modern MBCA has abandoned it, and asks only for the number of authorized shares.

If the charter is the constitution, the bylaws are the operating manual. How many directors there are and how they are elected. When meetings are held, and what notice and quorum they need. What officers exist and what they do. And crucially, bylaws are not filed with the state and are not public.

When documents collide there is a clear pecking order. The governing statute sits at the top. A bylaw or charter provision contradicting a mandatory statutory rule is void. Next come the articles. A bylaw that conflicts with the articles loses. Bylaws sit at the bottom.

So the articles say the board has seven members, and a bylaw says five. Which wins? The articles. Two consequences follow. Entrenched terms belong in the harder-to-change public charter, and some provisions only work if they appear in the charter at all.

Amending the articles is a two-step, shareholder-involving process. First the board adopts the proposed amendment and submits it to the shareholders. Second, the shareholders vote. Shareholders cannot rewrite the charter on their own, however many shares they hold. The board step is mandatory.

Now a distinction the exam quietly tests. The default shareholder vote differs by jurisdiction. Under the modern MBCA an amendment passes if the votes cast in favor exceed the votes cast against, with a quorum present. Under Delaware's general rule it needs the affirmative vote of a majority of the outstanding shares. An absolute majority of everything. A higher bar.

Watch it decide a case. Franklin Coffee Corp. has 1,000 voting shares. Holders of 600 appear, so there is a quorum. On a charter amendment, 350 vote yes and 250 vote no. Under the votes-cast rule it passes. Under Delaware's rule it needs 501 and fails. Same facts, opposite result.

Bylaws are meant to be nimble. Under MBCA § 10.20 the shareholders may always amend or repeal them, and the board ordinarily may as well. The board's power switches off in only two ways. The articles reserve bylaw amendments to the shareholders, or the shareholders lock a specific bylaw when they adopt it. No filing either way, because bylaws are internal.

The default structure fits a big company with passive investors. It fits badly for three owners who all want a hand in running things. MBCA § 7.32 is the fix. It lets the shareholders, by unanimous agreement, rearrange the governance rules for their corporation, even in ways the statute would otherwise forbid.

They can shrink or eliminate the board and manage directly. Dictate who serves as directors and officers. Fix how profits are distributed. Provide for a buyout on deadlock. A partnership-style operating deal bolted onto the corporate form.

And the signature requirement is the trap. Such an agreement rewrites the deal for everyone, so the statute demands sign-on from all the shareholders. Not a majority. All of them. Two of three owners signing is not a § 7.32 agreement, and the third owner is not bound.

Back to Priya and Devi. Sometimes founders try to incorporate and something slips. The filing is rejected, a fee bounces, or they start doing business before the paperwork clears. Now a creditor is unpaid and wants to reach them personally. Three concepts sort out who wins.

A de jure corporation is one formed in full compliance with the statute. Bulletproof, good against everyone including the state. When that fails, two rescue doctrines can still shield the founders. De facto corporation, and corporation by estoppel.

De facto has three elements. A valid incorporation statute existed. The organizers made a good-faith, colorable attempt to comply with it, a real effort and not a sham. And they actually exercised corporate powers, running the business as though it were a corporation. Hit all three and the entity is treated as a corporation against everyone except the state.

Corporation by estoppel comes at it from the other side. It looks at the party trying to impose liability. A creditor who dealt with the business believing it was a corporation is estopped from denying that later just to reach the owners' personal assets. It bargained for the corporation's credit, and it gets exactly that.

Two limits. Estoppel is generally a contract doctrine, not a tort one. An accident victim never relied on any belief about corporate status. And modern statutes have reshaped the field.

MBCA § 2.04 makes personal liability turn on knowledge. Only those who act on behalf of a corporation knowing there was no incorporation are jointly and severally liable. Someone who honestly and reasonably believed the corporation had been formed is protected. Which is why Priya and Devi walk away.

Flip one fact. Say they had learned of the rejection and kept signing contracts anyway. Now § 2.04 exposes them, because they acted knowing there was no corporation.

Part two, the LLC. It combines the limited liability of a corporation with the internal flexibility of a partnership. Its owners are called members. Same two-document structure, different names, and a very different balance of power.

The public document is the certificate of organization, and it is deliberately bare-bones. Under § 201 of the Uniform LLC Act it need state only three things. The name of the company, carrying an LLC designator. The street and mailing address of the principal office. And the name and address of the registered agent.

Notice what it need not say. It does not have to state whether the company is member-managed or manager-managed. That choice lives in the operating agreement, not the public record. And different states call this same document a certificate of formation, or articles of organization.

Here is the rule the exam builds questions on. An LLC is formed only when the certificate becomes effective and at least one person has become a member. A certificate sitting on file with no member does not yet create an LLC.

The operating agreement is the heart of the company. It governs relations among the members, the duties of any manager, and how the agreement itself may be amended. Its most tested feature is its form.

Unlike a corporation's bylaws, it need not be a signed writing at all. The Act defines it as the members' agreement, whether oral, implied, in a record, or any combination of those. A handshake understanding, a course of dealing, or conduct showing how the members intend to run the business can all be the operating agreement.

Maya and Ben file a certificate for a landscaping company and start work. They never sign an operating agreement, but from day one they split profits evenly and share every decision. A dispute later erupts over profit shares. Their conduct created an operating agreement implied from how they ran the business. Nobody defeats Maya's claim by saying there was never a signed contract.

One caution. Even though the agreement can be oral, the ordinary Statute of Frauds still applies to particular promises inside it.

The agreement may vary most of the Act's rules, but § 105 sets a non-waivable core. It cannot eliminate the duty of loyalty or the duty of care, though it may reasonably narrow them. It cannot eliminate the obligation of good faith and fair dealing. And it cannot excuse bad faith, intentional misconduct, or a knowing violation of law.

It cannot unreasonably restrict a member's access to records, or the right to bring a derivative action. It cannot alter the registered-agent or state-filing requirements. And it cannot cut off the rights of third parties.

Two defaults to finish. An LLC is member-managed unless the operating agreement chooses manager-managed. And amending the operating agreement takes the consent of all the members, unless the agreement itself sets a different bar. Which it is entirely free to do.

A word on authorities, because this episode named no cases, and that was deliberate. This topic is not starred. It is recognition-level, and the exam often hands you the governing statute and tests whether you can read it and apply it. So the skill is spotting which document or doctrine is in play, not reciting section numbers cold.

If you keep only three, keep these. The two-document structure, a public charter and a private rulebook, which repeats in both entities. The hierarchy, statute over articles over bylaws. And the two rules that hinge on a conjunction. A shareholder agreement needs all the shareholders. An LLC needs a certificate and a member.

Now the traps the examiners set. One. Treating articles of incorporation, certificate of incorporation, and certificate of organization as three different things. The first two are the corporate charter under two labels. The third is the LLC's public filing. Two. Using Delaware's majority-of-outstanding-shares vote when the governing law is the MBCA, which uses the lower votes-cast standard for charter amendments.

Three. Forgetting that a bylaw amendment usually needs no shareholder vote and no filing, while an articles amendment needs both a board step and a shareholder vote. Four. Assuming a shareholder agreement binds on a majority. It requires every shareholder to sign or approve. Five. Believing an LLC exists the moment its certificate is filed. It also needs at least one member.

Six. Thinking an operating agreement must be a signed writing. It can be oral or implied from conduct. Seven. Applying corporation by estoppel to a tort victim. It is generally a contract doctrine. And eight. Ignoring that § 2.04 keys personal liability to knowing there was no incorporation, so a good-faith founder is protected.

Time for the quick check, and this one comes straight from the BARGO question bank. An organizer files a certificate of organization for a real-estate LLC, and the secretary of state makes it effective on June 1. The people who intend to be members do not actually become members until June 15. On June 8, a third party who sent a letter of intent claims the company already existed and was bound by it.

Had the LLC been formed as of June 8? Option one. Yes, because the certificate had become effective on June 1. Option two. No, because an LLC cannot exist until its operating agreement has been signed. Option three. No, because forming an LLC needs both an effective certificate and at least one member. Pause here if you want a moment.

The answer is option three. Formation takes two things, and the statute joins them with an and. The certificate must be effective, and at least one person must have become a member. On June 8 the certificate was effective, but nobody was a member. So there was no company to bind.

Option one is the trap. Filing alone does it for a corporation. It does not for an LLC. Option two invents a signed-writing requirement that does not exist. An operating agreement can be oral or implied from conduct, so its absence proves nothing. There are thirty plus more questions on this topic alone, each with every option explained like that.

Five things to take away. One. Both entities run on the same two documents. A public charter that creates them and lists a few basics, and a private rulebook that actually governs. Two. When they collide, the statute beats the articles, and the articles beat the bylaws.

Three. Amending the charter takes a board step plus a shareholder vote, and the vote standard splits. Votes cast under the MBCA, a majority of all outstanding shares in Delaware. Bylaws need neither a filing nor, usually, a shareholder vote at all.

Four. A shareholder agreement can rewrite the entire governance structure, even dropping the board, but only with every shareholder on board. And on the LLC side, the certificate is bare, the operating agreement carries the weight, and it can be oral or implied from conduct.

Five. When formation fails, run the trio. De jure, de facto, corporation by estoppel, and then the statutory knowledge test. Which brings us back to Priya and Devi, who never knew their filing had been rejected. That is exactly why they keep their shield. Next time, Promoters.

Practice this topic with more than 2,900 exam-style questions, free to start, at nextgenbargo.com. This episode is for education and exam preparation only, not legal advice, and we are not affiliated with or endorsed by the NCBE or any bar examining authority.