- The seller has threatened to sue your client personally. What is your client's strongest argument against liability? Select one.
Answer: The execution of the new agreement between the seller and the corporation constituted a novation.
The strongest argument is that a novation occurred. A novation is an agreement to substitute a new party for an existing one, extinguishing the obligations of the original party. The signing of a new agreement with the corporation that explicitly states it "supersedes all prior agreements" is strong evidence of the parties' intent to create a novation, thereby releasing the promoter. (A) is incorrect because ratification or adoption alone does not release a promoter. (C) is incorrect because an agent for a nonexistent principal is personally liable. (D) states a conclusion but provides no legal basis; the mere fact the corporation used the equipment establishes its own liability (through adoption) but does not release the promoter without more.
- Is the promoter liable to the seller? Select one.
Answer: Yes, because a person who contracts on behalf of a nonexistent principal is personally liable on the contract.
The general rule is that a promoter is personally liable on contracts made before the corporation is formed. This is because the promoter is acting as an agent for a nonexistent principal. The fact that the corporation is never formed does not change this result; in fact, it solidifies the promoter's liability because there is no other entity to look to for performance. (A) is incorrect unless the contract explicitly made formation a condition precedent, which is not stated here. (B) is incorrect; the third party's knowledge of the corporation's nonexistence does not release the promoter. (D) is incorrect; the liability is for breach of contract, which allows for expectation damages.
- A disgruntled shareholder later files a derivative suit to void the transaction. What is the likely outcome? Select one.
Answer: The transaction will be upheld if it was fair to the corporation at the time it was approved.
This question combines promoter fiduciary duty with the rules for interested director transactions under the MBCA. A transaction with a promoter (who is now a director) is not voidable simply because she is interested, provided there is disclosure and approval by a majority of disinterested directors OR the transaction was fair to the corporation. Here, the promoter disclosed her interest, but the vote was not approved by a majority of disinterested directors (it was 1-1 among them). Therefore, the transaction can be challenged. However, it will be upheld if the promoter can prove that the transaction was fair to the corporation. (A) is incorrect because disclosure alone is not enough if the vote is improper. (B) is incorrect as modern statutes often allow interested directors to vote, though their vote might not be counted for approval purposes. (D) is incorrect; self-dealing is not a per se breach if it is disclosed and fair.
- What is the promoter's liability to the landlord? Select one.
Answer: The promoter is liable for the full amount of the rent due for the entire three-year term of the lease, subject to the landlord's duty to mitigate.
A promoter is personally liable on pre-incorporation contracts. When the corporation is never formed, the promoter remains the sole liable party. The liability is based on the contract itself. Therefore, the promoter is liable for breach of the entire three-year lease, which would entitle the landlord to contract damages (the remaining rent), subject to the landlord's duty to mitigate damages by trying to re-let the premises. (B) suggests a quasi-contract or unjust enrichment theory, which is incorrect because there is an enforceable contract. (C) is incorrect because the contract is not automatically contingent on formation unless explicitly stated. (D) is irrelevant; her reason for using the space does not alter her contractual liability to the landlord.
- What is the corporation's best remedy against the promoter who sold the building? Select one.
Answer: Compel the promoter to disgorge his $100,000 secret profit.
Promoters owe a fiduciary duty of loyalty to the corporation, which prohibits them from making secret profits on transactions with the corporation. When a promoter sells property to the corporation, they must disclose their personal interest and any profit. If they do not, the corporation's remedy is to compel the promoter to disgorge the secret profit. Here, the secret profit was $100,000. (B) is a possible remedy, but it is less practical and thus not the 'best' remedy here because the corporation has already made significant renovations. (C) is incorrect; piercing the veil is a doctrine used by outside creditors, not for internal disputes over fiduciary duty. (D) is incorrect because the measure of damages for a secret profit is the amount of the profit, not the difference from fair market value.
- Is the third promoter, who did not sign the contract, personally liable to the consultant? Select one.
Answer: Yes, because as a co-promoter, she is treated as a partner and is jointly and severally liable for the obligations entered into by the other promoters within the scope of the venture.
Promoters who work together to form a corporation are often treated as joint venturers or partners in the pre-incorporation activities. As such, agency principles apply. One promoter can bind the other co-promoters on contracts entered into within the scope of the joint venture. Here, hiring a consultant for the business plan was within the scope of forming the software company. Therefore, the third promoter is liable along with the two who signed, based on their relationship as co-promoters. (B) is incorrect because becoming a shareholder does not automatically ratify pre-incorporation contracts. (C) is incorrect because agency principles can create liability without a personal signature. (D) is incorrect because formation of the corporation does not extinguish promoter liability.
- Is the corporation likely to prevail in its lawsuit? Select one.
Answer: No, because the promoter fully disclosed her interest in the transaction to an independent board of directors, who approved it.
A promoter owes a fiduciary duty to the corporation, including a duty not to make a secret profit. However, a promoter may profit from a transaction with the corporation if there is full disclosure of the material facts to, and approval by, an independent board of directors. Here, the promoter disclosed her interest (that she was selling the option) and the material terms. The independent board, after due diligence, approved the transaction. This disclosure and approval insulates the transaction from being set aside or the profit being disgorged. (A) is incorrect; profiting is allowed with disclosure. (B) is incorrect because disclosure of the promoter's self-interest and the transaction terms to an independent board that conducts due diligence is sufficient; the board was able to evaluate the fairness of the transaction. (D) is incorrect as the fiduciary duty applies to transactions the promoter brings to the corporation.
- What is the promoter's legal position regarding the $10,000? Select one.
Answer: The promoter is an unsecured creditor of the corporation, with a claim for $10,000.
Promoters are not automatically entitled to compensation or reimbursement for their services and expenses. However, a corporation may choose to reimburse a promoter for reasonable expenses incurred on its behalf. Here, the corporation's board explicitly voted to reimburse the promoter for the $10,000 retainer. This created a legal obligation of the corporation to the promoter. In insolvency, the promoter is a creditor. As there are no facts indicating he secured the debt, he is a general unsecured creditor of the corporation. (A) is incorrect as there is no security agreement. (C) is incorrect because the corporation expressly agreed to the reimbursement. (D) is incorrect; the claim is against the corporation, not the other shareholders personally.
- Is the promoter personally liable for the breach of contract? Select one.
Answer: No, because the corporation's use of the services constituted an implied adoption, triggering the novation clause in the contract.
This fact pattern describes an agreement for a novation. The parties agreed in the contract that the promoter would be released upon the corporation's adoption of the contract. While the corporation did not expressly adopt the contract, it did so implicitly by knowingly accepting the benefits (using the web hosting services). This implied adoption fulfilled the condition of the novation clause, thereby releasing the promoter from liability. (A) is incorrect because adoption can be implied. (B) is incorrect because parties are free to agree to a novation. (D) is incorrect as incorporation alone does not release a promoter.
- What is the likely outcome of the landlord's lawsuit against the promoter? Select one.
Answer: The promoter will be held liable because the corporation's implied adoption of the lease did not extinguish the promoter's personal liability.
A promoter who enters into a contract on behalf of a corporation not yet formed is personally liable on that contract. A corporation may become liable by adopting the contract, which can be done expressly (e.g., board resolution) or implicitly (by knowingly accepting the benefits of the contract). Here, the corporation implicitly adopted the lease by occupying the space and paying rent. However, adoption by the corporation does not, by itself, release the promoter from liability. The promoter remains liable until a novation occurs, which is an agreement among the promoter, the corporation, and the third party to substitute the corporation for the promoter. As no novation occurred, the promoter remains personally liable.
- Is the corporation liable to the CTO for breach of contract? Select one.
Answer: Yes, because the corporation implicitly adopted the contract by knowingly accepting the CTO's services.
A corporation becomes liable on a pre-incorporation contract if it adopts it. Adoption need not be formal or express. It can be implied from the corporation's conduct. By knowingly accepting the benefits of the contract—allowing the CTO to work, providing her an office, and paying her salary—the corporation implicitly adopted the employment contract. Having adopted the contract, the corporation is bound by its terms and can be held liable for breaching it by firing the CTO without cause. (B) is incorrect; a corporation is not automatically liable. (C) is incorrect because formal ratification is not required for an implied adoption. (D) is incorrect because the doctrine of adoption binds the corporation to the pre-incorporation agreement signed by the promoter.
- If the corporation later breaches the contract, is the promoter personally liable to the supplier? Select one.
Answer: No, because the contract terms created a valid novation that was completed upon the corporation's assumption of the contract.
The language in the contract constitutes an agreement for a future novation. The supplier agreed in advance to release the promoter on the condition that the new corporation would assume the contractual duties. The promoter fulfilled these conditions by forming the corporation, assigning the contract, and having the corporation assume the obligations. This sequence of events executed the novation contemplated by the contract, thereby releasing the promoter from liability. (A) states the general rule for assignments but ignores the specific contractual language providing for a release. (B) is incorrect because the release was part of the original contract; a separate document is not required. (D) is incorrect because assumption alone does not release a promoter; the release is effective here because of the specific contractual provision.
- Will the supplier's suit against the promoter likely succeed? Select one.
Answer: Yes, because a promoter is liable on a pre-incorporation contract unless and until a novation occurs.
A promoter is personally liable on pre-incorporation contracts. This liability continues unless there is a novation. A novation requires an agreement by all three parties (promoter, corporation, third party) to substitute the corporation for the promoter. Here, the corporation never became a party to the contract because it expressly rejected it. Therefore, there was no adoption, and certainly no novation. The promoter's original liability remains fully intact. The supplier's suit against the promoter will succeed.
- What advice should you give your client to best achieve her goal? Select one.
Answer: Advise her to include a clause in the contract stating that the supplier agrees to release her from liability upon the future corporation's adoption of the contract.
A promoter is personally liable on pre-incorporation contracts unless the contract provides otherwise. The best way for a promoter to avoid future liability is to secure a novation. A novation can be agreed to in advance. A clause in the original contract where the third party agrees to look only to the corporation and release the promoter upon the corporation's adoption of the contract is an effective way to achieve this. This clause essentially pre-authorizes the novation. (A) is incorrect because such agency language is typically insufficient to release a promoter. (C) is incorrect because adoption alone does not release the promoter. (D) is not responsive to the client's desire to sign the contract now before incorporation.
- Is the corporation obligated to indemnify the promoter if the supplier recovers a judgment against him? Select one.
Answer: Yes, because the corporation accepted the benefits of the contract, creating an implied duty to indemnify the promoter.
When a corporation adopts a contract made by its promoter, it becomes liable on the contract. If the promoter is subsequently forced to pay on that contract, he generally has a right to be indemnified (reimbursed) by the corporation. This right arises from the fact that the corporation has accepted the contract as its own. Here, the corporation implicitly adopted the contract by accepting, processing, and profiting from the raw materials. This adoption creates the corporation's liability to the supplier and a corresponding duty to indemnify the promoter. (B) is too absolute; the right depends on the corporation's adoption. (C) is incorrect; while the promoter remains liable to the third party (absent novation), the corporation that adopted the contract owes a duty to the promoter. (D) is incorrect because the corporation cannot accept the benefits and then reject the burdens; its actions constituted adoption.
- Which parties are liable to the engineer for payment? Select one.
Answer: Both the promoter and the corporation are liable, because the corporation's adoption made it liable without releasing the promoter.
The promoter is liable because he signed the pre-incorporation contract personally. The corporation is also liable because it expressly adopted the contract through a board resolution. A key rule of promoter liability is that the corporation's adoption of the contract makes the corporation liable, but it does not, by itself, release the promoter from his original liability. The promoter remains liable along with the corporation until a novation occurs. Since there was no novation, both parties are liable to the engineer.
- What is the most likely result of the lawsuit against Jane Doe? Select one.
Answer: She will be liable because the corporation's adoption of the contract does not by itself extinguish her liability.
The promoter (Jane Doe) is personally liable on the pre-incorporation contract. The corporation clearly adopted the contract by its actions (using the jet, painting its logo, making payments). However, adoption only makes the corporation liable; it does not release the promoter. Release requires a novation, which is a specific agreement to substitute the parties. There are no facts to support a novation here. (A) is too strong; a novation can be implied, though it's rare. (B) correctly states the standard rule. (C) is incorrect; this agency language is generally not enough to absolve a promoter of liability when the principal does not exist. (D) uses incorrect terminology; there is no such thing as a 'de facto novation,' and the facts don't support an implied agreement to release her.
- What is the promoter's strongest defense against personal liability? Select one.
Answer: That the marketing firm should be estopped from denying the corporation's existence because it dealt with the business as if it were a corporation.
While a promoter is generally liable on pre-incorporation contracts, the doctrine of corporation by estoppel might provide a defense. This doctrine prevents a third party who dealt with an enterprise as if it were a corporation from later denying its corporate status to sue an individual. Here, the marketing firm contracted for services for the restaurant business. The promoter's strongest argument is that the firm should be estopped from denying the existence of the entity it contracted with. (A) is incorrect because an agent for a non-existent principal (the unformed corporation) is personally liable. (C) is incorrect because the de facto corporation doctrine, where recognized, generally protects shareholders from liability, not a promoter on a contract she personally signed. (D) is incorrect as there is no factual basis for this condition.
- Which of the following represents the most significant legal risk to the company arising from these facts? Select one.
Answer: The corporation may have a claim against the promoter to recover the secret profit made on the patent sale.
The most significant legal risk is that the promoter breached his fiduciary duty of loyalty by failing to disclose his profit on the sale of the patent to the corporation. The corporation has a cause of action to recover the secret profit, which appears to be $950,000. This could lead to a derivative lawsuit, destabilize the company's capitalization, and create significant liability for the promoter. (A) is incorrect; property like a patent can be validly transferred to a promoter who then transfers it to the corporation. (C) is incorrect; the promoter has no grounds to rescind a profitable sale. (D) describes watered stock, which is a related but distinct issue; the primary and most direct claim is for the recovery of the secret profit.
- The promoter's best defense to the supplier's lawsuit is that the corporation: Select one.
Answer: and the supplier agreed to a novation, releasing the promoter.
The promoter's only complete defense that would absolve him of liability is a novation. While the other options describe related concepts, they do not release the promoter. The promoter's liability is the default rule. His best defense is to argue that an agreement to release him existed. The most plausible, though not explicitly stated, defense to argue would be a novation, perhaps implied from the parties' conduct. (A) is factually unsupported. (B) and (D) describe adoption/ratification, but adoption by the corporation makes the corporation liable in addition to the promoter; it does not release the promoter. Therefore, arguing that a novation occurred is the only defense listed that would fully shield the promoter.
