As seen in the New York Law Journal
Applying the Doctrine of
Incorporation by Estoppel
by George Bundy Smith and Thomas J. Hall
Corporate existence can be critical to the capacity of corporate plaintiffs to bring claims, particularly when the claims are for breach of contract. Since a nonexistent entity cannot acquire
rights or assume liabilities, a corporation that has not yet been formed under New York law normally lacks capacity to enter into a contract.1 Consequently, breach of contract claims brought
by corporate plaintiffs that were not fully formed at the time the contact was executed are
vulnerable to dismissal under CPLR 3211(a)(3) on the ground of lack of capacity to sue.2 Several
Commercial Division cases make clear, however, that at times a non-existent corporation can
be deemed to exist, and thus possess the legal capacity to contract and bring suit on that contract, pursuant to the common law doctrine of incorporation by estoppel.3
Incorporation by Estoppel
The doctrine of incorporation by estoppel,
sometimes called “corporation by estoppel,” provides that, if an opposing party
has recognized an entity’s corporate status
and has dealt with it as such, and if those
past dealings are not dependent on the entity’s corporate status, the opposing party
will be precluded from arguing that the
entity lacks the capacity to bring suit on
the grounds it was not a fully formed corporate entity at the time the contract was
executed.4 Thus, a party that has entered
into a contract with what it believed was
a properly formed entity may not thereafter avoid responsibility on the contract on
the ground that the entity had not existed
at the time the contract was made.5 Since
estoppel is at bottom an equitable doctrine,
* George Bundy Smith is an arbitrator and mediator
with JAMS in New York City, and is a former associate
judge of the New York Court of Appeals. Thomas J.
Hall is a partner at Chadbourne & Parke. Jacob Laksin,
a law clerk at Chadbourne, assisted in the preparation
of this article.
concerns over fairness will often guide a
court’s determination of whether application of the doctrine is warranted in a particular case.6
Although the doctrine of incorporation
by estoppel has long been recognized in
corporate law, as recently as 2005 at least
one Commercial Division case appeared
to consider a corporate plaintiff’s status
dispositive of whether it had the capacity to bring a breach of contract claim.
In Boslow Family Ltd. P’ship v. Glickenhaus & Co., the Boslow family signed an
initial certificate of limited partnership to
form the plaintiff Boslow Family Limited
Partnership and entrusted its counsel to
file the initial certificate with the Department of State.7
Unbeknownst to the Boslow family, its
counsel failed to do so. Thereafter, the
plaintiff opened an advisory account with
the defendant, an investment advisory firm.
Plaintiff later closed that account because
it allegedly was unhappy with certain investments made by the defendant, and
commenced an action seeking damages
for breach of contract and negligence in
managing the plaintiff’s funds. Justice
Richard B. Lowe of the New York County
Commercial Division dismissed the complaint, and the First Department affirmed,
holding that “Plaintiff’s failure to file a
certificate of limited partnership at any
time prior to the alleged breaches of contract rendered it nonexistent at the time
of such breaches, and therefore without
capacity to sustain damages by reason of
the existence of the contract.” Likewise, in
the First Department’s analysis, the lack of
corporate existence was fatal to the plaintiff’s breach of contract claim.
The Court of Appeals reversed, holding
that, under the doctrine of incorporation
by estoppel, the defendant was estopped
from raising the plaintiff’s alleged lack
of capacity to sue. The court stated that
“one who has recognized the organization as a corporation in business dealings
should not be allowed to quibble or raise
immaterial issues on matters which do
not concern him in the slightest degree
Reprinted with permission from the December 18, 2015 edition of the New York Law Journal © 2015 ALM Media Properties, LLC. All rights reserved.
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or affect his substantial rights.”8 Since the
defendant conceded that the investment
services it provided the plaintiff were not
dependent on the plaintiff’s limited partnership status, or lack thereof, the defendant was estopped from contending that
the plaintiff was not a limited partnership
“because defendant is using that sword to
escape liability after it benefitted from its
contract with plaintiff.” The court further
stated that the incorporation by estoppel
doctrine does not depend on the presence
of the “technical elements of equitable estoppel,” such as a misrepresentation and a
change of position in reliance thereon.
Scope
In addition to confirming the existence
of the incorporation by estoppel doctrine
under New York law, Boslow provided
a foundation for limiting the doctrine’s
scope in future cases. The court stated that
the identity of the party being estopped is
critical, and that incorporation by estoppel
applies only “[w]hen a defendant seeks to
escape liability to a corporation plaintiff by
contending that the plaintiff is not a lawful
corporate entity.”9 Additionally, the court
indicated that incorporation by estoppel
may apply when “neither of the parties [to
a suit]is aware that corporate status has not
been achieved.”
As a result, subsequent cases have generally limited the incorporation by estoppel
doctrine to instances where a defendant
is seeking to avoid liability to a plaintiff
corporation, generally based on a contract
from which the defendant had benefited
in some way, and where neither of the
parties knew that corporate status had not
been achieved.
Defendant Limitation
The doctrine’s limitation to defendants
seeking to avoid liability on a contract underlies the Second Department’s decision
in Rubenstein v. Mayor. In Rubenstein, an
individual plaintiff and a plaintiff corporation, formed by the individual plaintiff and
the defendants, sued for tortious interference with contract based on the defendants’
alleged role in terminating a commercial
lease with the plaintiff corporation.10 The
individual plaintiff alleged the defendants
terminated the lease in order to squeeze
out her ownership interest in the corporation and to form a new business without
the plaintiff.
The defendants moved to dismiss based on
the fact that the company’s certificate of
incorporation was not filed with the Secretary of State until the day after the lease
was executed, and thus it lacked the legal
capacity to enter into the lease pursuant
to New York Business Corporation Law
§403, which provides that corporate existence begins “[u]pon the filing of the certificate of incorporation by the department
of state.”
The Second Department rejected that
argument, holding that the defendants
were estopped from denying the plaintiff
corporation’s corporate status because
they engaged in business dealings involving the corporation during which they
recognized its status, including by signing
a lease, a lease modification agreement,
and a lease termination agreement on
behalf of the corporation. One of the
defendants had even referred to himself
as the corporation’s “President” in signing
these agreements. The defendants therefore could not deny the plaintiff corporation’s corporate status.
Lack of Awareness Limitation
The doctrine’s requirement that neither
party be aware that corporate status has
not been achieved was decisive in the
refusal by Justice Leonard Austin of the
Nassau County Commercial Division to
apply incorporation by estoppel in Black
Car & Livery Ins. v. H&W Brokerage.11 In
Black Car, a corporate plaintiff and its principals sued the defendant for fraud relating
to certain automobile insurance transactions. The defendant moved to dismiss on
the ground that the corporate plaintiff did
not exist at the time of the transactions.
The principals conceded that the plaintiff corporation Black Car & Livery Ins.,
Inc. never existed, and sought to amend
the complaint to substitute what they
claimed was the actual name of the corporation, H&W Black Car, Taxi & Livery
Insurance Brokerage.
In granting the motion to dismiss, the
court found the doctrine of incorporation by estoppel to be inapplicable. Justice
Austin stated that incorporation by estoppel does not apply where the party relying
on the doctrine was aware that corporate
status is lacking, noting that the principals
in Black Car “must have been aware that
Black Car [& Livery Ins., Inc.] was not incorporated,” since they conceded it never
existed. Justice Austin further noted that
the doctrine is applied only where a defendant is seeking to avoid liability on a contract from which the defendant benefited.
Defendants’ Lack of Existence
Although the incorporation by estoppel
doctrine is generally used to preclude defendants from arguing that a corporate
plaintiff lacks capacity to sue, at least one
recent Commercial Division case indicates
that it may be applied against defendant
corporations seeking to escape liability by
hiding behind their own lack of corporate
status. In Bomb First Productions v. Hustla,
the plaintiff alleged that the defendants
breached a contract to record, market and
promote a music album.12 The defendants
failed to appear in the action, and the
plaintiff moved for a default judgment.
Justice Peter Sherwood of the New York
County Commercial Division noted that
the defendants had admitted that defendant Hustla, Inc. was never formally incorporated, either at the time the contract
was executed or subsequently, and so it
was unclear whether the defendant corporation had the capacity to enter into the
contract. Nonetheless, Justice Sherwood
granted default judgment, finding that although the defendant corporation was not
fully formed, “it may, as here, ‘be deemed
to exist, and thus possess the capacity to
contract, pursuant to the doctrine of incorporation by estoppel.’”
CHADBOURNE & PARKE LLP
De Facto Incorporation
It is important to distinguish incorporation by estoppel from the related doctrine
of de facto incorporation, as these doctrines are frequently confused.13 As an
initial matter, the basis for each doctrine
is different. Incorporation by estoppel is
based on the equitable principle that “one
who has recognized the organization as a
corporation in business dealings should
not be allowed to quibble or raise immaterial issues on matters which do not concern
him in the slightest degree or affect his
substantial rights.”14
On the other hand, to be a de facto corporation, the corporation must establish
it “made a colorable attempt to comply
with the statutes governing incorporation.”15 For example, in Bankers Trust Co.
of W . New York v. Zecher,16 although the
certificate of incorporation had not been
filed with the Secretary of State at the time
that the corporation entered into a security agreement, a de facto corporation was
found to exist as of that date because the
de facto corporation had previously filed
a certificate of name reservation with the
Secretary of State, its board adopted resolutions authorizing the security agreement
on the same day it was signed, and the certificate of incorporation was executed on
the same day the security agreement was
signed, and was filed with the Secretary of
State six days later.
Moreover, these doctrines do not depend
on each other for their application. Thus,
a de facto corporation is not created by
estoppel and may exist even though no
elements of an estoppel are present.17
Conversely, estoppel to deny corporate
existence may be found even where there
is no de facto corporation.18 Despite these
key differences, the doctrines are often
invoked together, leading the New York
Court of Appeals in Boslow to caution that
“[t]he doctrine of estoppel is not the same as
that of de facto corporation.”19
Endnotes:
1. Rubenstein v. Mayor, 41 A.D.3d 826, 828,
839 N.Y.S.2d 170, 172 (2d Dept. 2007).
Conclusion
As Justice Sherwood recently reaffirmed
in Bomb First Productions, the incorporation by estoppel doctrine is today well
established in the Commercial Division.
Accordingly, defendants who contract or
otherwise deal with an entity as a corporation run the risk of being estopped from
denying the entity’s corporate existence in
any action arising out of such contract or
dealing.
7. 23 A.D.3d 248, 803 N.Y.S.2d 551 (1st
Dept. 2005), rev’d, 7 N.Y.3d 664, 827
N.Y.S.2d 94 (2006).
To avoid being estopped, defendants’
counsel must be prepared to negate the
element of unfairness on which the estoppel doctrine depends and show either that
they are not using the plaintiff’s alleged
lack of corporate status merely to avoid
liability, or that the individual plaintiff
or corporate plaintiff’s principals knew
or should have known that the corporate
plaintiff had failed to comply with the statutory requirements for incorporation. n
2. N.Y. C.P.L.R. 3211 (McKinney).
3. Supra, 41 A.D.3d 826, 839 N.Y.S.2d
at 172.
4. 8 Fletcher Cyc. Corp. §3889.
5. Supra, 41 A.D.3d 826, 839 N.Y.S.2d
at 172.
6. Timberline Equip. Co. v. Davenport, 267
Or. 64, 71, 514 P.2d 1109, 1112 (1973).
8. 7 N.Y.3d 664, 827 N.Y.S.2d 94 (2006).
9. Id. (emphasis added).
10. Supra, 41 A.D.3d 826, 839 N.Y.S.2d 170
(2d Dept. 2007).
11. 15 Misc.3d 1111(A), *1, 839 N.Y.S.2d 431
(Nassau Co. 2007).
12. No. 65173/2012 (N.Y. Co. June 24, 2015).
13. 8 Fletcher Cyc. Corp. §3763.
14. 19 Steven Lane Corp. v. Kovar, 34
Misc.3d 1243(A), 950 N.Y.S.2d 609 (Dist.
Ct. Nassau Co. 2012) (citing Boslow).
15. Supra, 7 N.Y.3d at 668, 827 N.Y.S.2d
at 96.
16. 103 Misc.2d 777, 781, 426 N.Y.S.2d 960,
963 (Monroe Co. 1980).
17. 8 Fletcher Cyc. Corp. §3763.
18. Id.
19. Supra, 7 N.Y.3d at 668, 827 N.Y.S.2d
at 96.
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