What is a de facto corporation?
What is the difference with a de jure corporation or corporation by estoppel?
How does it work?
In this article, we will break down the notion of “de facto corporation” so you know all there is to know about it!
We will look at what is a de facto corporation, compare it to a de jure corporation and a corporation by estoppel, we will look at how a de facto corporation is formed, the legal consequences of it, the requirements to achieve a de facto corporation status, examples and more.
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Table of Contents
What is a de facto corporation
The term de facto corporation is typically used in common law jurisdictions to refer to a company that has failed to become a de jure corporation (legally formed entity) but existing in fact and recognized as a corporation under the state laws.
“De facto” means something that exists “in fact”.
In other words, a de facto corporation is a corporation existing in fact.
What constitutes a de facto corporation
A de facto corporation is:
- A company that has not respected the filing requirements (example: issues with its articles of incorporation or certificate of incorporation) but is recognized as a corporation by the state
- A company that has not completed its incorporation process but is carrying out business just like a corporation
- A company suspended or dissolved by the state but still carrying out business
When a company can prove and achieve a de facto corporation status under the applicable state law, its shareholders, incorporators and representatives will acquire limited liability protection just like a full-fledged incorporated business.
A de facto corporation is when the law or courts grant a “corporation” status to a defectively incorporated corporation
A de facto corporation will not be protected by the state in quo warranto proceedings but will provide some protection against third parties.
De facto corporation legal definition
According to Cornell Law School’s Legal Information Institute, de facto corporation is defined as:
Legal recognition of a corporation, even if the articles of incorporation for a corporation are not properly filed. To be granted de facto corporation status, there must be: a relevant incorporation statute, a good faith attempt to comply with it, and evidence that the business is being run as corporation.
What is notable with this definition is that a de facto corporation is considered to be a company that has not properly filed its incorporation papers but is given the status of a corporation.
This doctrine is typically invoked when a person enters into a contract with another party thinking in good faith that he or she was acting on behalf of a corporation while no corporation legally existed.
What is a de jure corporation
“De jure” means “legal” or “something that is rightful”.
A de jure corporation is a legal entity or corporation duly incorporated under state laws.
In other words, you have a rightfully incorporated corporation.
De jure corporation is a duly incorporated legal entity
When a person completes the incorporation process and obtains confirmation from the state that the corporation has been legally formed, then you have a de jure corporation or a valid corporation.
The law recognizes a de jure corporation as a legally constituted corporation and authorizes the corporation to perform civil acts and operate a business.
When operating a de jure corporation, the shareholders are fully protected from personal liability.
Third parties dealing with the corporation cannot pursue the shareholders or company representatives personally as they benefit from the limited liability protection.
What is a corporation by estoppel
A corporation by estoppel is a doctrine that can be used to achieve some protection against third-party liability regardless of whether you were attempting to form a corporation in good faith or not.
This doctrine can be invoked to offer some protection in equity when your business cannot be considered as a de jure corporation or de facto corporation.
A corporation by estoppel is an equitable remedy protecting a person who acted “as if” he or she was binding a corporation
A corporation by estoppel is a company that does not legally exist (or that did not meet all the incorporation requirements to be recognized as a corporation) but can be considered by the court as a corporation for a particular transaction or contract dealing.
A corporation by estoppel doctrine can shield those who acted for the non-existing corporation and provide some protection against personal liability when dealing with third parties.
Let’s use an example to see how.
Mary signs a contract with Company A represented by John.
May believes that Company A is a duly incorporated business and John is effectively acting on behalf of the corporation.
However, Company A was never legally formed and did not legally exist when Mary signed her contract.
Based on the corporation by estoppel doctrine, Mary cannot invoke John’s personal liability as she did not transact with John personally but believed she transacted with Company A.
John can estopp Mary from invoking personal liability based on the corporation by estoppel doctrine.
For a court or the law to consider a company as a corporation by estoppel, what’s important is that the person operates the business “as if” it was operating a corporation or a limited liability entity.
The good faith effort to file incorporation documents is not relevant here.
Forming a de facto corporation
A de facto corporation is not something that you form intentionally the same way as when you decide to incorporate a business.
Rather, when you fail in your incorporation attempt due various formation irregularities, you invoke the de facto corporation status to benefit from the same statutory and legal protection offered to corporations (such as limited liability protection).
Your business can be considered as a de facto corporation if it did everything it had to do to incorporate a business but due to certain issues or technicalities, the corporate charter or certificate of formation was not issued when it transacted with a third party.
This common law doctrine was initially created to protect individuals from liability who thought they were doing business with a corporation in good faith.
Essential elements of de facto corporation
For an enterprise to achieve a de facto corporation status, it must meet the following requirements:
- There must be a relevant law relating to the company incorporation
- The founders must have attempted, in good faith, to incorporate but failed to fully comply with the state’s incorporation requirements
- There’s evidence to show that business is being carried out as a corporation
Relevant state laws
The first element to consider is whether or not there was a relevant law under which a corporation could be incorporated.
If not, the de facto corporation doctrine cannot be invoked.
Typically, the state incorporation statutes outline the requirements to observe to validly incorporate a business.
Good faith attempt to incorporate
To establish the existence of a de facto corporation, the most important element to prove is the “good faith attempt” to incorporate.
This means that the founders have acted in such a way that they believed, in good faith, that the corporation was formed and authorized to carry out business on behalf of the corporation.
John retains the services of an attorney to incorporate a company.
The attorney confirms to John that the certificate of incorporation is filed and the corporation is formed.
However, due to some technicalities, the state does not incorporate the business.
In the meantime, John signs a major contract on behalf of the corporation (that in good faith he does not know is not yet formed).
This is an example, John can be considered to have attempted to form a corporation in good faith.
If a person was aware that the filing of his or her articles of incorporation was defective and did nothing to rectify it, the law will likely not recognize the company as a corporation-in-fact.
Other examples of good faith attempts are:
- Articles of incorporation papers were sent by mail but addressed to the wrong person
- The articles of incorporation lost in the mail
- The incorporator was told that everything is good by counsel when it was not due to a clerical error
- Articles of incorporation was not filed on time when the incorporator or company representatives acted on behalf of the company
Evidence of business operations
Providing evidence that you’ve carried out business as if you had a corporation should be pretty straightforward.
Typically, you can demonstrate that you’ve carried out business as a corporation by:
- Showing contracts signed under the corporation’s name
- Advertisements under the corporation’s name
- Job postings under the corporation name
- Website created using the company’s name and logo
- Evidence that you did not act personally but acted as a representative of the company in signing contracts or dealing with others
- Software license purchases under the company’s name
The evidence of any commercial activity can demonstrate that your intention was to operate a corporation.
De facto corporation vs corporation by estoppel
A de facto corporation is a company that did not regularly file its articles of incorporation but had attempted, in good faith, to complete the incorporation process.
It also has evidence to show that it acted as a limited liability corporation.
A corporation by estoppel is when a person acts “as if” he or she was acting on behalf of a corporation although the corporation did not legally exist at the time.
In this context, the law may recognize that a transaction took place with the non-existing corporation and not the individual personally.
The de facto corporation doctrine and corporation by estoppel doctrine apply in contract law and in contractual dealings.
However, such doctrines do not apply in tort or when allegations of tortious acts are brought forth against an individual even though the individual was acting on behalf of a de facto corporation or corporation by estoppel.
De facto corporation FAQ
Why should you seek a de facto corporation status
The major benefit of seeking a de facto corporation status is to ensure that you acquire limited liability protection under the law.
One prime reason why individuals incorporate a business is to protect their personal assets and shield themselves personally from liability or creditors of the business.
Invoking a “corporation” status is important to shield personal assets from business creditors
Without a legal entity, an individual may be exposed to personal lawsuits and even lose his or her home in the hands of the company creditors.
When a person tries to incorporate a company but the incorporation process is not completed (due to good-faith reasons, errors or technicalities), it may be beneficial to invoke the status of a de facto corporation.
This way, the incorporators, shareholders and company representatives can be protected from personal liability if they’ve signed on behalf of a company that did not exist.
What is the difference between de facto corporation and corporation by estoppel
A “de facto corporation” is when the law recognizes a company as a “corporation” and offers its shareholders limited liability protection to the same extent as another company that was duly incorporated in compliance with state laws.
If a bona fide attempt was made to incorporate, the law can protect the individual from personal liability
If the incorporators or shareholders had made a bona fide attempt to incorporate the business but due to certain irregularities or defects their corporation was not officially formed, the de facto corporation doctrine will grant them personal liability protection as if the corporation was duly formed.
A “corporation by estoppel” is an equitable legal remedy to protect individuals who acted “as if” they were acting on behalf of a company when their corporation cannot be considered as a de jure or de facto corporation.
Equitable remedy when a company is not a de facto company or de jure company
Under this doctrine, if a third party believes they were doing business with a corporation (even if the corporation did not legally exist at that moment), the third party will be estopped from alleging they did business with the company representative personally instead.
What is the difference between de jure corporation and de facto corporation
How do you distinguish between a de jure and a de facto corporation?
It’s actually quite simple.
A “de jure” corporation is a company legally formed in compliance with state laws
As such, if a company representative acted on behalf of a legally formed company, the representative will be afforded full limited liability protection.
A “de facto” corporation is a company that took the steps to incorporate but the process complete all the legal steps
Typically, due to technicalities or other issues, the corporation was not officially formed when the representative entered into contracts or legal obligations on behalf of the company.
As a result, at the moment of the signing of the contract, a legal entity did not exist to protect the representative from personal liability.
To protect the representative who believed in good faith that the incorporation was completed, the law can recognize a company as a de facto corporation giving the representative limited liability protection from potential liability during the period the corporation started doing business in fact and the moment it was fully incorporated.
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