Understanding Corporation by Estoppel and Its Legal Impact

Key Takeaways:

• Corporation by estoppel prevents a party from denying an entity’s corporate status if they previously treated it as a corporation.
• It serves as a legal defense, primarily protecting organizers of defective corporations from personal liability.
• The doctrine applies based on principles of fairness, reliance, and equitable estoppel.
• It differs from de jure (properly formed) and de facto (imperfectly formed but functioning) corporations.
• Courts often invoke the doctrine in breach of contract cases, especially where one party acted in reliance on the other’s asserted corporate status.
• Good faith, representations made, and the nature of third-party reliance are key to its application.

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.

Key Elements of Corporation by Estoppel

For a corporation by estoppel to apply, certain factors must typically be present:

• Representation of Corporate Status: The business must have held itself out as a corporation.
• Third-Party Reliance: The other party must have relied on that representation when entering into the agreement.
• Injustice Without Estoppel: It would be unfair or unjust to allow the third party to later deny the business’s corporate status.

This doctrine functions as a form of equitable estoppel, used to prevent opportunistic behavior that contradicts a party’s prior actions or representations.

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.

When Courts Apply Corporation by Estoppel

Courts typically apply this doctrine when one of the following occurs:

• A contract was entered into under the assumption that the entity was a corporation.
• One party seeks to avoid contractual obligations by asserting that the other party lacked corporate capacity.
• An entity made good-faith efforts to incorporate but failed to fully comply with legal requirements.

Courts evaluate:

• Whether the third party had actual or constructive knowledge of the business's corporate status.
• Whether the third party benefitted from the agreement.
• Whether it would be unjust to permit the third party to deny the corporate status now.

This doctrine can prevent a plaintiff from bypassing limited liability protections by targeting the individuals behind a business that was treated as a corporation during dealings.

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.

Limitations of Corporation by Estoppel

Corporation by estoppel is not without boundaries. Its application is typically limited to specific scenarios:

• It is generally not recognized in tort cases. For example, if a third party is injured by an entity that isn’t legally incorporated, the estoppel doctrine may not bar a claim against the individuals.
• Governmental challenges are not barred. The state can still pursue actions against a noncompliant entity regardless of how private parties treated it.
• Not a substitute for actual incorporation. The doctrine offers a defense but doesn’t create a legally recognized corporation for all purposes.

Additionally, courts may be reluctant to apply the doctrine if there is evidence of bad faith or intentional misrepresentation by the parties claiming corporate status.

Differences Between De Jure, De Facto, and Corporation by Estoppel

While all three doctrines—de jure, de facto, and corporation by estoppel—deal with corporate validity, they serve different legal functions:

Key distinction: De jure and de facto status depend on the entity's conduct and formation efforts. Corporation by estoppel, however, depends on the actions and beliefs of third parties interacting with the business.

Frequently Asked Questions

1. What is a corporation by estoppel? It is a legal doctrine that prevents a party from denying the existence of a corporation when they have previously treated the entity as a corporation in their dealings.

2. When does corporation by estoppel apply? It applies in situations where a third party entered into a contract with a business, believing it to be a corporation, and it would be unfair to allow that party to deny the corporate status later.

3. Is corporation by estoppel the same as de facto corporation? No. De facto corporation focuses on the internal efforts of the business to incorporate, while corporation by estoppel is based on third-party recognition and equitable fairness.

4. Can corporation by estoppel apply in tort cases? Generally not. The doctrine is most commonly applied in contract disputes, not in tort cases involving negligence or personal injury.

5. Does this doctrine offer the same protections as formal incorporation? No. It offers limited protection based on specific interactions and is not a replacement for legally forming a corporation.

If you need help with a corporation by estoppel, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.