Applying the Doctrine of Incorporation by Estoppel in New York

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., 23 A.D.3d 248 (1st Dept. 2005), rev'd, 7 N.Y.3d 664 (2006), 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.

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. The 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 or affect his substantial rights.” 7 N.Y.3d 664 (2006).

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.

The Doctrine's 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.” Id. 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 New York's Appellate Division, 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. The individual plaintiff alleged that the defendants terminated the lease in order to squeeze out her ownership interest in the corporation and to form a new business without her.

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 times 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, 15 Misc.3d 1111(A), *1, 839 N.Y.S.2d 431 (Nassau Co. 2007). 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 was 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, No. 65173/2012(N.Y. Co. June 24, 2015), the plaintiff alleged that the defendants breached a contract to record, market and promote a music album. 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.'”

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. 8 Fletcher Cyc. Corp. ' 3763. 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.” 19 Steven Lane Corp. v. Kovar, 34 Misc.3d 1243(A), (Dist. Ct. Nassau Co. 2012) (citing Boslow).

On the other hand, to be a de facto corporation, the corporation must establish that it “made a colorable attempt to comply with the statutes governing incorporation.” Supra, 7 N.Y.3d at 668. For example, in Bankers Trust Co. of W. New York v. Zecher, 103 Misc.2d 777, 781 (Monroe Co. 1980). 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. 8 Fletcher Cyc. Corp. ' 3763. Conversely, estoppel to deny corporate existence may be found even where there is no de facto corporation. Id. 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.” Supra' 7 N.Y.3d at 668.

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.

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.

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, which also appeared in the New York Law Journal, an ALM sibling publication of this newsletter.