De Facto Corporation Doctrine Also Applies to an LLC

One of the main reasons to establish a corporation is to avoid personal liability for the corporation’s debts. However, the protection may not be available if there was some defect in the way the corporation was formed, or the corporation had not yet been formed when a contract is signed.

In Duray Development, LLC v Perrin, the issue was that the defendant had signed a contract and Articles of Organization to create a new limited liability company on the same date. However, the Articles were not officially accepted by the State of Michigan until a month later. The plaintiff tried to hold the defendant individually liable for the contract because the limited liability company did not legally exist on the date the contract was signed.

Michigan Courts have recognized the concepts of “de facto corporation” and “corporation by estoppel” for years as they apply to corporations. The de facto corporation provides that a defectively formed corporation—one that fails to meet the technical requirements for forming a corporation—may still receive the protection of a corporation if the incorporators attempted in good faith to form the corporation, signing the necessary documents.

Corporation by estoppel is not a legal status, but an equitable remedy. The court will hold that when a body assumes to be a corporation and acts under a particular corporate name, and a third party dealing with it under such assumed name believes it Is actually dealing with a corporation, the third party is estopped (prevented) to later deny its corporate existence.

These two concepts typically arise in situations where the court has to assess corporate versus individual liability. The issue of first impression before the Michigan Court of Appeal in Duray Development, LLC v Perrin (decided April 13, 2010) was whether these same legal doctrines apply to limited liability companies, which is a newer type of entity. The Court of Appeals held that because the Business Corporation Act and the Limited Liability Act relate to the common purpose of forming a business and because both statutes contemplate the moment of existence for each, they should be interpreted in a consistent manner. Therefore, the Court of Appeals ruled that the de facto corporation doctrine is also applicable to limited liability companies.

The Court of Appeals did not decide whether the doctrine of “corporation by estoppel” also applies to limited liability companies, because the defendant did not raise the issue at the Circuit Court level, so the issue was not properly before the Circuit Court. However, the Court of Appeals’ reasoning in Duray Development strongly suggests that this legal doctrine will also apply to limited liability companies.