In Hill v. County Concrete Co., Inc., Hill and Newman hired an attorney to form a construction services corporation to be known as “C&M Builders, Inc.” (C&M).[1] The attorney advised Hill and Newman that the corporate name was available and that they could proceed with their business preparations, upon which Hill and Newman ordered checks, painted trucks, and opened a bank account, all imprinted with, or in the name of, C&M. But for whatever reason, the attorney did not attempt to file the Articles of Incorporation until the end of February 1989, more than 3 months later, and when he did, the corporate name C&M was no longer available. So in May 1989, Hill and Newman incorporated under another name, “H&N Construction, Inc.” (H&N), opened a bank account under that name, and filed an application for a construction license with a notation that the entity was trading as C&M. In other words, H&N complied with all legal requirements to commence its existence. Nevertheless, Hill and Newman continued to use the name C&M and the previously purchased vehicles and supplies bearing that name, citing the cost of obtaining new supplies and repainting the vehicles.
In February 1989, County Concrete Company, Inc. (“County Concrete”) received an order in the name of C&M. Not recognizing that name, County Concrete sent someone to the job site identified in the order and learned that Hill and Newman were involved with C&M. Because that person knew Hill by reputation, County Concrete agreed to establish an account in the name of C&M without requesting a personal guaranty from Hill or Newman. By 1991, over $200,000 worth of product was purchased and paid for by C&M. County Concrete believed that it was dealing with a corporation, was never advised of Hill and Newman’s failure to incorporate their company as C&M or the existence of H&N, and did not know that there was another entity with the name C&M unrelated to Hill and Newman.
When County Concrete sued Hill for C&M’s balance due, Hill argued that he should not be held personally liable because County Concrete knew that it was dealing with a corporate entity and that the use of a wrong name did not matter because C&M was H&N’s assumed name. Hill argued that the doctrine of corporate estoppel should apply, if the court did not find a de facto corporation, citing Cranson v. I.B.M. Corp., which we discussed in our previous post. The court disagreed, saying that Hill lacked good faith—Hill did not just fail to disclose the identity of H&N, the principal contracting party, but misled as to whom County Concrete was dealing. Even after Hill found out that he could not operate as C&M because there was another entity using that name, he continued to conduct business using that name, essentially as an entity that was someone else, which, under state law, was not allowed. This, in the court’s view, demonstrated the absence of good faith and allowed County Concrete to pursue Hill individually.
As you can see, the doctrines of de facto corporation and corporation by estoppel can be useful when a corporation fails to come into legal existence due to some defect in the formation process. In recent years, however, some courts have abolished these doctrines on grounds that incorporation under modern statutes is easy and straightforward. In Texas, for example, by statute, the existence of a filing entity commences when the filing of the certificate of formation takes effect, and it is easy to obtain an acknowledgement of the filing issued by the filing officer.[2] Still, the doctrines of de facto corporation and corporation by estoppel continue to exist, and business owners would be well served by knowing about them.
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This posting is intended to be a planning tool to familiarize readers with some of the high-level issues discussed herein. This is not meant to be a comprehensive discussion and additional details should be discussed with your transaction planners including attorneys, accountants, consultants, bankers and other business planners who can provide advice for your circumstances. This article should not be treated as legal advice to any person or entity.
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[1] Hill v. County Concrete Co., Inc., No. 975 (Md. Ct. Spec. App. Mar. 4, 1996). Unless otherwise noted, all references to the case are to this citation.
[2] Tex. Bus. Org. Code § 3.001.