Corporations: Formation, Promoters, and Piercing the Corporate Veil
Key Takeaways
- A de jure corporation is formed when articles of incorporation are filed and accepted by the secretary of state; the articles (CA Corp. Code §202) must state the corporate name, agent for service, and authorized shares.
- A promoter is personally liable on pre-incorporation contracts made on the corporation's behalf and remains liable after incorporation unless there is a novation; the corporation is bound only if it adopts the contract.
- De facto corporation and corporation by estoppel are equitable doctrines that can shield owners from personal liability despite a defective incorporation; California has largely limited these common-law doctrines.
- Veil-piercing allows creditors to reach shareholders personally where the corporation is the shareholders' alter ego (unity of interest plus inequitable result) or undercapitalized/used to perpetrate fraud (Walkovszky v. Carlton).
- California uses the alter ego test (Minton v. Cavaney) requiring unity of interest/ownership and that adherence to the corporate fiction would sanction fraud or promote injustice.
Formation: Articles, Bylaws, and the De Jure Corporation
A corporation is a creature of statute, and a de jure corporation comes into existence only when the articles of incorporation are filed with and accepted by the secretary of state. The articles are the corporation's foundational charter.
Under California Corporations Code §202, the articles must set forth the corporate name, a statement of purpose (California permits the broad statement that the purpose is to engage in any lawful act for which a corporation may be organized), the name and street address of the corporation's initial agent for service of process, and the number of authorized shares the corporation may issue (and, if more than one class or series, the designations, rights, preferences, and restrictions of each). The persons who sign and file the articles are the incorporators.
Filing requires payment of fees and triggers the corporation's legal existence; the secretary of state's acceptance is conclusive evidence of due incorporation for most purposes.
The articles are distinguished from the bylaws, which are the internal operating rules of the corporation (notice of meetings, number of directors, officer duties, quorum requirements). Bylaws are adopted by the incorporators or the board and are not filed with the state; they may be amended more easily than the articles, which generally require board and shareholder approval to amend. Where the articles and bylaws conflict, the articles control. After filing, the corporation holds an organizational meeting to adopt bylaws, elect directors, appoint officers, and authorize the issuance of stock.
The corporation is a separate legal person with perpetual existence, the capacity to sue and be sued, to hold property, and to contract in its own name — and, most importantly for clients, it provides limited liability: shareholders are generally not personally liable for corporate debts, risking only their investment. That limited-liability shield is the prize that veil-piercing doctrine threatens.
Promoter Liability and Pre-Incorporation Contracts
A promoter is a person who acts on behalf of a corporation not yet formed — lining up investors, leasing space, hiring employees, and signing contracts before the entity legally exists. Because the corporation does not yet exist, it cannot be a party to these pre-incorporation contracts, and the promoter is personally liable on contracts she enters on the corporation's behalf.
The default rule is that the promoter remains personally liable even after the corporation is formed, unless and until there is a novation — a new agreement among the promoter, the corporation, and the third party releasing the promoter and substituting the corporation. Mere adoption of the contract by the corporation does not release the promoter; it simply adds the corporation as a liable party. The third party can then look to both.
The corporation, for its part, is not automatically bound by pre-incorporation contracts; it becomes liable only if it adopts the contract, either expressly (by board resolution) or impliedly (by knowingly accepting the benefits of the contract). Adoption is not the same as ratification because, strictly, ratification presupposes a principal that existed at the time of the act, and the corporation did not exist — so courts speak of adoption.
A promoter also owes fiduciary duties to the corporation, to its shareholders, and to co-promoters, including duties of good faith and full disclosure; a promoter who sells property to the corporation at a secret profit, or who fails to disclose material facts to the investors or an independent board, breaches that duty and may be required to disgorge the profit.
Where a promoter intends that only the corporation be liable and the third party agrees the promoter is not personally bound, the agreement may be treated as a mere offer or revocable continuing offer to the corporation, relieving the promoter — but absent such an understanding, personal liability is the default.
Defective Incorporation: De Facto and Estoppel Doctrines
Sometimes businesspeople operate as a corporation but fail to perfect a de jure incorporation — the articles were never filed, were rejected, or contained a fatal defect. Two equitable doctrines historically protected the good-faith owners from personal liability.
The de facto corporation doctrine treats a defectively formed entity as a corporation for liability purposes where (1) a valid incorporation statute existed under which the entity could have incorporated, (2) the organizers made a good-faith, colorable attempt to comply with it, and (3) the entity actually exercised corporate privileges by operating as a corporation. If the doctrine applies, the business is treated as a corporation against everyone except the state, which alone may challenge its existence in a quo warranto proceeding. The owners thereby retain limited liability despite the defect.
The corporation by estoppel doctrine prevents a party who dealt with the business as if it were a corporation from later denying its corporate existence to reach the owners personally — a creditor who contracted believing it was dealing with a corporation, and who looked only to the corporate entity for payment, is estopped from holding the owners personally liable when the entity proves defective.
The estoppel can run both ways and is generally confined to contract claims, since a tort victim never chose to deal with a "corporation." Importantly, California has largely abrogated the common-law de facto and estoppel doctrines by statute: under the California scheme, corporate existence begins on filing of the articles, and persons who purport to act as or on behalf of a corporation, knowing there was no incorporation, are jointly and severally liable for the resulting obligations.
Thus a California bar answer should note that these equitable shields are disfavored and that knowing pre-incorporation actors face personal liability, reserving de facto/estoppel for the rare innocent, good-faith error.
Piercing the Corporate Veil
Even a properly formed corporation's limited-liability shield can be set aside through piercing the corporate veil, an equitable remedy that lets a creditor reach shareholders personally. Courts pierce reluctantly and most readily against closely held corporations with few shareholders (rarely against public-company shareholders) and more readily for tort creditors (involuntary victims) than for contract creditors (who could have bargained for protection).
The dominant test is the alter ego doctrine: the veil is pierced where (1) there is such a unity of interest and ownership that the separate personalities of the corporation and the shareholder no longer exist, and (2) adherence to the corporate fiction would sanction a fraud or promote injustice — an inequitable result. California's leading statements come from Minton v. Cavaney and Automotriz del Golfo de California v. Resnick, which articulate this two-prong unity-of-interest-plus-inequitable-result standard.
The factors that establish unity of interest include commingling of corporate and personal funds, failure to observe corporate formalities (no meetings, no minutes, no separate records), inadequate capitalization relative to the risks of the business, siphoning of corporate funds by the dominant shareholder, treating corporate assets as one's own, and use of the corporation as a mere instrumentality or shell. The classic case is Walkovszky v. Carlton (N.Y.
1966), where a cab company was split into numerous corporations each owning two cabs carrying only minimum insurance; the court declined to pierce based on undercapitalization alone, holding that the plaintiff had to allege the shareholder was conducting business in his individual capacity (an alter ego theory) rather than merely that the corporate structure was thinly capitalized — though the dissent and many later courts treat gross undercapitalization as strong evidence supporting a pierce.
A related theory, enterprise liability, consolidates affiliated corporations under common ownership that operate as a single business so their combined assets answer for a claim. The practical lesson: maintain separate finances, adequate capital, and corporate formalities, or risk personal exposure.
| Veil-Piercing Factor | What It Shows |
|---|---|
| Commingling of funds | No separate identity |
| Ignoring corporate formalities | Shell, not a real corporation |
| Inadequate capitalization | Inability to meet foreseeable obligations |
| Siphoning funds / personal use of assets | Domination by shareholder |
| Fraud or inequitable result | Second prong required to pierce |
A promoter signs a lease 'on behalf of NewCo, Inc., a corporation to be formed.' The corporation is later validly formed and its board votes to accept the lease and occupies the premises, but the landlord never agrees to release the promoter. NewCo later defaults. Who is liable to the landlord?
A single shareholder forms a corporation, never holds meetings, pays personal expenses from the corporate account, and capitalizes it with only $500 despite operating a hazardous business. A tort victim obtains a judgment the corporation cannot pay. Under California's alter ego doctrine, what must the victim show to reach the shareholder personally?