Promoters — Business Associations

Two weeks before she files anything with the state, Dana signs a two-year lease for a bakery. She signs it Rise Bakery, Inc., by Dana, President. The landlord knows the corporation does not exist yet. Eight months after she incorporates, the bakery fails and the rent stops. The landlord sues Dana personally. She protests that she signed as a corporate officer. Is she liable?

Yes. And that one word hides the idea running through this whole topic. When Dana signed there was no corporation to bind, so the law made her the party. Everything after this is a variation on that. Whether the company ever has to honor her deal. Whether incorporating gets her out. And what she owes the business she is building.

Here is the route. First, who counts as a promoter, and why the promoter is personally on the hook. Then whether the corporation, once it exists, is ever bound, which is a question about adoption, not ratification. Then how a promoter actually gets released. And last, the fiduciary duty a promoter owes, and the secret profit rule.

Start with the label, because it does two jobs at once. A promoter is a person who takes the initiative in founding and organizing a corporation before it exists. No title, no appointment, no salary required. Being a promoter switches on personal exposure on the contracts you sign, and fiduciary duties to the corporation you are creating.

The work is finding investors, signing leases, optioning property, lining up suppliers, and filing the incorporation documents. Promoter status turns on what you do, not on what anyone calls you.

Now the rule that generates almost everything else. When a promoter signs for a corporation that has not been formed, the promoter is personally liable. The logic is pure agency. An agent binds a principal, and here there is no principal. The corporation does not exist, so it cannot be a party and cannot have an agent. The law treats the person who signed as a principal in their own right.

The Restatement (Third) of Agency puts it in one sentence at § 6.04. Unless the third party agrees otherwise, a person who contracts while purporting to act as an agent becomes a party personally. That is so where the person knows, or has reason to know, that the principal does not exist. Knowledge is the trigger.

Which is why the signature block did not save Dana. Rise Bakery, Inc., by Dana, President is a label on a promise that only a real person is standing behind.

It cuts both ways, though. Because the promoter is a party, the promoter can usually enforce the contract too. Steel prices spike, and a manufacturer refuses to deliver the tanks, saying the deal is a one-way street. It is not. The promoter can hold it to the price.

And here is the trap. Personal liability does not vanish when the corporation is later formed. Incorporating is not a rewind button. Once bound, you stay bound until something affirmatively lets you out.

There is one exception, and it turns entirely on intent. Suppose the third party knows the corporation does not exist, and the parties agree the promoter is not to be personally bound. Everyone will look only to the future corporation if it arrives. Then the promoter is not liable, and a contract that says so in writing settles it.

But courts do not presume it. Try this one. A promoter signs in the corporate name, the vendor knows the company is unformed, and nobody discusses who answers for the bill. Released, or liable? Liable. A corporate-style signature and the third party's mere awareness are not enough. Knowledge is necessary. It is not sufficient.

Same instinct, modern statute. Under MBCA § 2.04, everyone who purports to act for a corporation, knowing that no incorporation has occurred, is jointly and severally liable for the liabilities created. Two co-promoters order $60,000 of inventory for a company that is never incorporated, and the supplier sues one of them alone. Half, or all? All. The one who overpays can seek contribution from the other.

Second question. Is the corporation itself ever liable? A brand-new corporation is a stranger to the deals its promoters struck before it existed. It inherits nothing automatically. It becomes liable only if, after formation, it adopts the contract.

Listen to that word. Adoption, not ratification. Ratification relates back to the moment of the original act, but you can only ratify something done on your behalf while you already existed. The corporation was not there when the promoter signed, so true ratification is impossible. Adoption runs forward. There is no relation back.

The timing is a whole exam question. Signed March 1, corporation formed May 1, adopted by resolution June 1. It owes from June forward, not back to March, unless it separately agrees to take on what accrued before.

How does a corporation adopt? Two ways. Express, by board resolution or a fresh writing embracing the contract. Implied, by knowingly accepting the benefits with knowledge of the terms. A company that takes delivery of the ovens its promoter ordered, uses them daily, and pays two of the vendor's invoices has adopted, resolution or no resolution.

And now the most important sentence in this episode. Adoption adds an obligor. It does not subtract one. The corporation becomes directly liable, and the promoter is still liable too, so the creditor can look to both.

Assignment and assumption are only mechanics. Assignment moves the promoter's rights to the corporation, the benefit side. Assumption is the corporation taking on the promoter's duties, the burden side. Neither releases the promoter as against the third party. The promoter may earn indemnity. Indemnity is not a release.

Picture a ladder with four rungs. Signed before the corporation exists: promoter liable, corporation not a party. Formed but not adopted: promoter liable, corporation still not a party. Adopted: promoter liable, corporation liable too. Novation: promoter released, corporation alone. Three rungs leave the promoter exposed. Only the fourth gets her out.

So how does she reach that fourth rung? This is a contract discharge problem, the same family of doctrines you meet in Contracts. The star player is novation. A novation is a new agreement in which the third party agrees to release the promoter and accept the corporation in her place, as the only party responsible.

It takes four things. A valid earlier obligation. The agreement of all three parties. The third party's assent to release the promoter and look only to the corporation. And a new contract that immediately replaces the old one. That assent is the indispensable piece. You cannot force a creditor to swap out its debtor.

A novation can be express, three signatures on one new agreement, or implied from conduct. Say the third party starts billing only the corporation, deals solely with it, returns the promoter's deposit, and writes that it will look to the company from now on. That can add up to a novation.

Now contrast Dana. After her board adopts the flour contract, the supplier is happy to be paid by the corporation. But it has never said a word about letting Dana go, and it still treats her as a backstop. That is adoption. Dana stays on the hook.

Novation is not the only exit. A release is the third party giving up its claim, effective when supported by consideration or a signed writing. Many modern statutes make a signed release effective without consideration. A promoter who pays $8,000 of her own money for a signed release is out, and later regret cannot revive the claim.

Rescission is different. Both sides mutually agree to cancel the deal, and the promoter goes with it. Where each side still owes something, surrendering those remaining duties supplies the consideration.

Then the subtle pair. A promoter owes a contractor $90,000. They agree the contractor will take $70,000 from the corporation, and they intend the original duty to stand until that sum is actually paid. Nothing is paid. Is he discharged? No. That is an accord, and an accord only suspends. Discharge comes on satisfaction, when the substitute is performed.

Change one fact and it flips. If the new agreement is complete and expressly accepted here and now in full discharge of the old obligation, that is a substituted contract. The old duty dies the instant it is made. Accord waits for performance. Substitution does not.

Last piece, and it is the one that costs promoters money. A promoter is a fiduciary. The law demands good faith, fair dealing, and full disclosure, owed to the corporation being created, to co-promoters, and to the people who will become its shareholders. Promoters shape the company when nobody is yet watching them. Arm's length is not the standard.

The rule is not that a promoter can never profit. It is that she cannot make a secret profit. She may sell property to the corporation, or earn a fee, but only with full and fair disclosure and informed consent. A promoter who quietly sells her own beachfront parcel at a fair price still breaches, if she never mentions she owns it. Price is not the touchstone.

Consent has to come from a source that can actually protect the corporation. An independent board, one not dominated by the promoter, approving with full knowledge of the facts and of the profit. Or, absent that, all of the shareholders, including those the promoter reasonably contemplates will buy shares in the same promotion. One director who is your financially dependent brother is neither.

If the profit is secret, the corporation can rescind or recover the profit, and how much turns on when the promoter got the property. While organizing Cedar Mills, Inc., Ray buys a parcel for $200,000 and has the corporation buy it for $320,000, disclosing nothing to any independent board or to the incoming investors. He bought it while the duty was already running, so the entire $120,000 spread comes back.

Flip the timing. Had Ray inherited that land years before any promotion, before any duty attached, the corporation could recover only the amount by which the price exceeded fair market value. Acquired before the duty, he keeps the honest gain. Acquired during it, he keeps nothing.

One last point, and it cuts the other way. A promoter has no automatic right to be paid or reimbursed. Nine months of full-time organizing, money out of pocket for filing fees and travel, and the corporation owes nothing. It made no promise while it did not exist. The promoter is paid only if the formed corporation agrees to pay.

A word on authorities. This episode named no cases, and that is deliberate. NextGen questions hand you a fact pattern and ask what the rule produces. They will not ask for case names. This topic is unstarred, so the exam is more likely to hand you the governing rule itself and test whether you can apply it cleanly.

If you keep only three things, keep these. The Restatement (Third) of Agency § 6.04, which makes the signer a party because there was no principal to bind. MBCA § 2.04, which makes everyone who acts knowing there is no corporation jointly and severally liable. And the discharge family from Contracts, because that is where the promoter's only exit lives.

Now the traps, straight from the examiners' favorites. One. The corporation is automatically bound by its promoter's deals. It is not. Only adoption binds it. Two. Once the corporation adopts, the promoter is released. No. Only a novation or a release does that. Three. Ratification relates the corporation's liability back to the contract date. Wrong word, wrong timing. It is adoption, and it runs forward.

Four. A promoter may profit on a sale to the corporation as long as one friendly director signs off. No. Disclosure must reach an independent board, or all the shareholders, including the ones still to buy in. Five. The corporation must reimburse the promoter for start-up work. Not unless it actually agrees to.

And one habit that earns marks. When you see a contract signed for a corporation that does not exist, run the checklist. Is the signer a promoter? The promoter is personally liable, so did anything change that? Did the corporation adopt, expressly or by taking the benefits? Any hidden profit? Naming each mechanism precisely separates the right answer from the distractor.

Time for the quick check, and this one comes straight from the BARGO question bank. Before forming his corporation, Lee signed a year-long cleaning contract and was personally liable on it. After the corporation formed, the cleaning company billed only the corporation and dealt exclusively with its officers. It returned Lee's personal deposit, and told Lee in writing that it would look only to the company. Then the corporation defaulted, and the cleaning company sued Lee.

What is Lee's strongest argument that he has been discharged? Option one. The corporation's adoption of the contract automatically released him. Option two. The return of his deposit rescinded the entire contract for both parties. Option three. The cleaning company's course of conduct manifested a novation releasing him. Pause here if you want a moment.

The answer is option three. A novation can be implied from conduct, and this conduct is about as clear as it gets. Billing only the corporation, returning the deposit, and stating it will look only to the company all manifest the third party's agreement to release Lee. Option one is weaker, because adoption alone never discharges a promoter.

Option two mislabels the facts. Rescission cancels the contract for everyone, and here the contract continues, with the corporation substituted for Lee. That is novation. There are thirty plus more questions on this topic alone, each with every option explained like that.

Five things to take away. One. A promoter who signs before the corporation exists is personally liable, because there was no principal to bind, and the signature block changes nothing. Two. That liability survives formation and survives adoption. Only a novation or a release ends it. Three. The corporation is a stranger to the deal until it adopts, and adoption runs forward, never back.

Four. A promoter may profit, but never secretly. Disclosure goes to an independent board, or to all the shareholders including the ones still to come, and what the corporation recovers depends on when the promoter acquired the property. Five. The corporation owes the promoter nothing for the founding work unless it agrees to pay.

Which is why Dana pays for a bakery lease she signed as president of a company that did not exist. Next time, Management and Control.

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.