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Who Is Bound by a Pre-incorporation Contract?

Logo for Avvo, where Dana Shultz answered a pre-incorporation contract questionThis post about entering into a pre-incorporation contract is based on a question I answered on Avvo. See Can I legally speak as my company in things like terms & conditions if I have not officially registered the company yet?

The term “pre-incorporation contract” properly should apply only to corporations, because that is the only type of business entity that is incorporated. Other types of business entities, such as limited liability companies (LLCs), are formed, rather than incorporated. However, as is discussed below, a pre-formation contract (in California, at least) is treated like a pre-incorporation contract. See 02 Development, LLC v. 607 South Park, LLC .

Pre-incorporation Contract Principles

The founders of a business may enter into contracts for that business before they complete the incorporation process. In such a situation, the following principles apply. (This discussion refers to California law, though the laws of other states should be similar.)

  • Generally, the founders will be personally liable for performance obligations under the pre-incorporation contract. Because the corporation does not exist, it cannot perform those obligations.
  • Once the corporation is formed, it may ratify, and thus be bound by, the pre-incorporation contract. California Corporations Code Section 208(b) (“Any contract or conveyance made in the name of a corporation which is authorized or ratified by the board…binds the corporation, and the corporation acquires rights thereunder….”)
Releasing Personal Liability

Once the corporation ratifies the pre-incorporation contract, the founders would like to be released from personal liability.

The best way to accomplish this – if the other party agrees, of course – is to include in the pre-incorporation contract a provision by which the other party will look solely to the corporation for performance and the founders will be released from further liability.

In addition, once the corporation exists, it and the founders should enter into an agreement by which the pre-incorporation contract is assigned from the founders to the corporation.

In summary, if you are going to enter into a pre-incorporation contract, you should do as much as possible to limit your personal liability for that contract.

Related post: Pre-formation Contracts: Avoiding Personal Liability

Dana H. Shultz, Attorney at Law  +1 510-547-0545  dana [at] danashultz [dot] com
This blog does not provide legal advice and does not create an attorney-client relationship. If you need legal advice, please contact a lawyer directly.