Corporations and Law

Liability for Promoters

Corporate promoters are generally jointly liable for a contract if the new corporation adopts the contract, unless a third party agrees to release the promoter from liability. Promoter liability convinces creditors to enter into agreements with businesses that have no proven track record or credit history.

A corporate promoter is a firm or person who organizes the formation of a corporation by soliciting investors to take an interest in the company. There are several types of corporate promoters.

  • Professional promoters specialize in promoting corporations and pass the corporation over to shareholders once incorporation and other tasks are complete.
  • Occasional promoters do not promote on a regular basis, but they take an interest in promoting some companies.
  • Entrepreneur promoters formulate the idea for the corporation, promote the corporation, and sometimes become members of management.
  • Financial promoters promote the corporation as an investment opportunity and are usually financial institutions.

The role of the corporate promoter involves making sure that interested individuals know about the corporation, formally incorporating the corporation with the relevant secretary of state, finding directors and shareholders for the new corporation, negotiating business contracts, and recruiting investors.

Corporate promoters owe a fiduciary duty to the corporation, investors, and any copromoters. A fiduciary duty is a requirement or responsibility to work in the best interest of a person or organization. In other words, promoters have a legal responsibility to act in good faith and always put the interests of the corporation and shareholders above their own interests. Also, corporate promoters must exercise reasonable care when carrying out activities as a corporate promoter. A breach of any of these duties gives rise to a cause of action for fraud, where the corporation or shareholders would be entitled to any losses suffered as a result of the promoter's breach.

A corporate promoter is personally liable—in other words, legally responsible—for any contract that they signed before the corporation was formed. When the corporation is formed, it may adopt the contract that the promoter helped to create. The board of directors may approve a contract that creates a corporation or accept a previously existing contract.

However, a promoter can only be released from liability for a preincorporation contract by a novation. A novation is a new agreement between a corporation, promoter, and creditor stating that the corporation is substituted in for the promoter as the person to carry out the contract. The novation takes the place of the previous contract. A novation requires consent from the creditor because the promoter may be more creditworthy than the newly formed corporation. Corporate promoters play an important role in forming corporations. Promoters convince creditors to enter into preincorporation contracts when the corporation does not have a proven track record or credit history.

Suppose a business, EQUTI Inc., has been incorporated. Before the business was incorporated, the founder, Emilio, was its sole employee and owner. As the company grew, Emilio, hired employees and signed contracts. Emilio was liable for these agreements, so when he incorporated, he became an entrepreneur-promoter and transferred the contracts to the company through novation. The creditors agreed to these actions, so Emilio is no longer personally liable for these contacts—though, as the CEO, he is liable for working on behalf of the company.