De facto corporation and corporation by estoppel
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De facto corporation and corporation by estoppel are both terms that are used by courts in most common law jurisdictions to describe circumstances in which a business organization that has failed to become a de jure corporation (a corporation by law) will nonetheless be treated as a corporation, thereby shielding shareholders from liability.
De facto corporation[ edit ]
In order for a de facto corporation to be created, the following elements must exist:
- There must be an incorporation statute that lays out the various requirements under which legal incorporation can be accomplished;
- There must have been a good faith attempt to comply with the statute by the intended incorporators;
- For example, if the articles of incorporation were mailed to the appropriate office, but addressed to the wrong person, lost in the mail, or not filed by the corporation by the time the corporation began acting in an official capacity.
- There must have been an act made on the corporation’s behalf by its purported officers or agents .
If all of these requirements are met, then the business will be treated as a corporation for all purposes, except with respect to acts by the state itself. However, most states will not apply this doctrine to protect a person who was aware that the incorporation effort was defective at the time that they purported to act on behalf of the corporation.
Corporation by estoppel[ edit ]
Corporation by estoppel, on the other hand, applies against someone who operates a business as if it were a limited liability entity or corporation, irrespective of whether there was a good faith effort by the business to incorporate. The person doing business with such an entity, as if it were a limited liability entity or corporation, may later be estopped from arguing that it is not in fact a limited liability entity, in an attempt to reach the assets of the incorporators. For the same reason, defendants who had acted as a corporation will be estopped from denying liability as a corporation when sued by a plaintiff who had relied on the defendant’s corporate form when dealing with the defendant.
Differences between de facto corporation and corporation by estoppel[ edit ]
Both doctrines are applicable in the contract context but the estoppel concept typically does not apply where tort liability is sought because knowledge of corporate existence is irrelevant to the commission of tort. The harm caused by a tortious act normally does not depend on knowledge, or lack thereof, of a corporation’s existence.
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Corporation by Estoppel: Everything You Need to Know
Corporation by estoppel refers to someone contracting and dealing with a business as if it were a corporation.3 min read
Corporation by estoppel refers to someone contracting and dealing with a business as if it were a corporation. In so doing, it is an admission that the entity is a corporation and therefore estopped to deny its incorporation should an action arise out of the contract or course of dealing. It is a concept applied in equity to avoid unfairness and injustice.
Overview of Corporation of Estoppel
The corporation by estoppel is often used as a defense by an individual or individuals who have organized a corporation in a defective manner. In cases such as these, when the corporation enters into a contract, the counterparty may attempt to enforce the contract against the individuals of the corporation. The grounds for this action would be that no corporation existed at the time the contract was drawn.
The doctrine stipulates third parties dealing with the defectively organized corporations as if it were a properly formed corporation are estopped from denying the corporation’s validity.
The reasoning for the corporation by estoppel doctrine is that a plaintiff would receive a monetary windfall by suing the individuals who organized the corporation due to the defective incorporation.
The concept of corporation by estoppel doctrine overlaps the de facto corporation doctrine. It is used in most cases serving as the second line of defense to the de facto doctrine.
In summary, the doctrine of incorporation, also referred to as corporation by estoppel, addresses the situation in which an entity presents itself as a corporation under a specific name. If a third party has dealings with the corporation using the assumed name and is operating on the belief it is, in fact, a corporation, the third party is estopped from denying the corporate existence.
The doctrine stipulates that if an opposing party recognizes an entity’s corporate status and deals with it on those terms, the party cannot argue that the entity lacks the capacity to bring suit based on the grounds that it wasn’t a fully-formed corporate entity when the contract was executed.
Applying the Doctrine of Incorporation by Estoppel
For plaintiffs who bring claims, especially when it’s for a breach of contract , corporate existence is critical to the impact the plaintiffs will have. Since nonexistent entities cannot acquire rights or assume liabilities, a corporation that has yet to be formed does not have the ability or capacity to enter into a contract in New York, for example.
There are situations where a nonexistent corporation can be deemed to exist. When this occurs, it has the legal capacity to bring suit on that contract according to the incorporation by estoppel doctrine. Parties entering into a contract on the belief they are dealing with a properly formed entity may not avoid responsibility to the contract on the grounds the entity did not exist when the contract was made.
The court often determines whether the doctrine applies to a case based on fairness.
De Jure Corporation
A de jure corporation is one that has been organized following the requirements of the relevant statute. It is considered a de jure corporation when everything that needs to be done has been done to become a corporation. It has fulfilled all requirements and granted limited liability protection under the law.
Once the corporation is viewed as a de jure company, the officers are free to hold a board of director’s, issue stock to shareholders, and begin conducting business.
De Facto Corporation
A de facto corporation exists when an individual or individuals take the steps to incorporate a business, but the steps taken did not comply with all applicable statutes.
In this situation, the corporation has no protection from the state in a quo warranto proceeding. The corporation will be protected against third parties.
Courts usually make a determination of a de facto case if the following requirements are met by the corporation:
- A statute that makes incorporation legally possible
- Attempts by the company to comply with the statute
- A use of exercise of corporate privileges
De facto corporations are basically considered good faith attempts at trying to become a corporation.
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