THE

DE FACTO CORPORATIONS.

If

HE formation of corporations solely by the mutual agreement of the members is prohibited by the common law. In the American states to-day corporations are organized almost exclusively under general incorporation laws authorizing their formation. the requirements prescribed by the statute are not observed there are three conceivable alternatives open to the courts. First, they may place the resulting association on the same basis as those which have fully complied with the law. Second, they may refuse to recognize the existence of the association and consider all its acts null and void. Third, they may take a middle ground and give the corporation a qualified recognition.

To adopt the first alternative in some cases would violate the common-law prohibition upon the formation of corporations by private contract and nullify the statutes of incorporation. The courts have, therefore, not found this first alternative a good rule to apply in all cases. But where the above-mentioned objections do not obtain they have adopted this alternative and have treated the corporation, though not organized in the manner outlined by statute, as a corporation de jure. The courts do this, for example, where the provisions of the statute have not been literally complied with, but have been substantially followed,' or even where the provisions of the statute have not been followed at all if the provisions are merely directory or constitute conditions subsequent to incorporation.2

To adopt the second alternative and deny existence to a corporation existing in fact and refuse to give validity to any of its acts would be illogical and frequently work injustice, so the courts have used this alternative only where there has been no, or very little, compliance with the statute.

Where the corporation has fallen a little short of substantial compliance, the courts have adopted the third alternative and have recognized the legal existence of the corporation for most purposes.

1 20 HARV. L. REV. 467, note 16; Machen, Modern Law of Corporations, § 264. 2 20 HARV. L. REV. 467, notes 17 and 18; Machen, Modern Law of Corporations,

If "the associates have made an attempt to incorporate resulting in a colorable corporate organization; [under] a law authorizing the formation of such a corporation as was attempted; [and] there had been use of some of the powers which such a corporation would possess; [and] the persons seeking to prevent collateral attack [have] acted in good faith," facto corporation is created.3

The state may annul its charter for failing to comply with the statute, but no one else can take advantage of its defective incorporation to increase his own rights or vary the obligations of the corporation's stockholders. The American decisions are authority for the proposition that a corporation de facto, as defined above, is equivalent to a corporation de jure except for those legal consequences which necessarily result from the possibility of the de facto corporation having its existence forfeited by the state for failing to comply with the statute under which it was organized. This is the de facto doctrine. To the broad statement that the de facto corporation is just as good as the de jure corporation except as against the state, there are two well-known classes of cases which are exceptions. These classes of cases, for the purposes of brevity, may be designated as the eminent-domain and the stock-subscription cases. These cases, while they are exceptions to the broad statement made above, are not, as will be shown later, exceptions to the de facto doctrine. In fact there are very few, if any, defensible American decisions, involving the question, which cannot be explained by an unqualified application of the de facto doctrine.1

In spite of the vast array of authority to the contrary, it is still contended in numerous dicta5 by the courts and in the occasional ipsi dixit of legal theorists that there is no distinct doctrine of de facto corporations. They admit the doctrine is applied but not that it has ever had an independent application. It cannot stand on its

3 20 HARV. L. REV. 464.

4 "Cases not seldom arise in which some condition precedent to the legal organization of a corporation has been omitted, and in which no conclusive certificate of due incorporation exists, and in which no estoppel to deny the company's existence can be invoked. In such cases, the American courts generally will, under certain conditions, hold that the association although not legally incorporated is nevertheless a corporation de facto, that is to say, an association whose right to corporate functions and attributes is complete as against all the world except the sovereign." Machen, Modern Law of Corporations, § 284.

5 Slocum v. Providence Steam & Gas Pipe Co., 10 R. I. 112, 114 (1871). 1 Machen, Modern Law of Corporations, 242, note 1, cites cases.

own legs, they say, but must be propped up by other theories. Its sole application is made in conjunction with "extenuating circumstances." As there is regularly no refusal by the courts to apply the de facto doctrine wherever a de facto corporation exists, the zealous advocates of restriction have busily occupied themselves in the search for "extenuating circumstances" as the basis for invoking the doctrine. They find the doctrine of de facto corporations applied where there has been dealing on a corporate basis. Dealing on a corporate basis then becomes the "extenuating circumstance" warranting an application of the doctrine. In such cases they say not only that the de facto corporation, but also the one who dealt with it, is conclusively estopped from asserting defectiveness in the incorporation of the company. But dealing on a corporate basis is not an "extenuating circumstance" found in all the cases where the de facto doctrine is applied. For example, one who has taken title to land from a de facto corporation may eject a stranger to that title from possession of the land. An opponent of the de facto doctrine finds an "extenuating circumstance" justifying an extension of the doctrine to cases such as that just alluded to in the fact that relief is sought by a "third person." The doctrine of de facto public officers, he observes, affords relief to "third persons," but never to the public officers themselves. To his mind the application of the doctrine of de facto corporations for the benefit of "third persons" and for the denial of relief to the associates is analogous.8

Furthermore, the "extenuating circumstances" of dealing on a corporate basis and the "third person" seeking relief do not include or explain all the cases where the de facto doctrine is applied. The de facto corporation, itself, is frequently given relief where there has been no dealing on a corporate basis, and therefore in cases where, admittedly, the elements of estoppel are not present. Thus the de facto corporation may maintain ejectment against a stranger to the title or an action of tort against a trespasser. The resources of these adversaries of the doctrine are again taxed, and they come

• Professor E. H. Warren, De Facto Corporations, 20 HARV. L. REV. 456.

7 Finch v. Ullman, 105 Mo. 255, 16 S. W. 863 (1891). For other cases holding that the de facto corporation may be a conduit of title see 20 HARV. L. REV. 457, note 2. 8 Professor Warren, De Facto Corporations, 20 HARV. L. REV. 458. See cases cited in 20 HARV. L. REV. 471, note 24.

forth with the suggestion of another "extenuating circumstance." To explain such cases, they say if the associates are asserting a right in the name of the corporation which they would be entitled to assert in some form, they should be allowed to assert it as an artificial person.10 There are two obvious faults to be found with this suggestion: It would apply as well to an association which had not met the requirements of the de facto doctrine as to the de facto corporation, but the courts do not give such an association relief;" and to give such association relief in its artificial name would run counter to well-established precedent in partnership law.12

But there are still other cases where the de facto doctrine is applied, and for which these opponents of the doctrine have not yet suggested an "extenuating circumstance" to warrant its application. "Under a statute punishing criminally embezzlement from an 'incorporated company' a conviction may be sustained if the company is a corporation de facto." 13 Numerous other instances of the doctrine's application may be cited,14 but enough has been said to show that there is still need for ingenuity in suggesting further "extenuating circumstances."

Since the American decisions involving the de facto doctrine are uniformly explainable by an application of that doctrine alone, the query naturally suggests itself whether a search in each instance for extenuating circumstances as a basis for invoking the doctrine is not, after all, superfluous labor?

The arguments used to show that the doctrine is and should be restricted in its application may be grouped under four heads. 1. Judicial legislation. 2. The analogy of the doctrine of de facto public officers. 3. Estoppel. 4. The eminent-domain and stocksubscription cases. A very exhaustive and cogent presentation

11 Jones v. Aspen Hardware Co., 21 Colo. 263, 40 Pac. 457 (1895). See cases cited in Cook, Corporations, 6 ed., 1818, note 1.

12 Parties cannot sue in the firm name but must sue collectively as individuals in the absence of statute. Mechem, Elements of Partnership, § 225.

13 People v. Carter, 122 Mich. 668, 81 N. W. 924 (1900). The statement is quoted from Machen, Modern Law of Corporations, § 292.

14 A corporation de facto cannot be wound up as a partnership. Its dissolution is governed by the same principles as the dissolution of a de jure corporation. A statute applicable to unincorporated companies does not apply to de facto corporations. See cases cited in Machen, Modern Law of Corporations, § 292.

of these arguments against the unlimited application of the doctrine of de facto corporations, the fullest the writer has met with, is made in an article on De Facto Corporations by Professor E. H. Warren in volume 20 of this Review. It will be sufficient for the purpose of this paper, which is to show that these arguments are unsubstantial, to confine our discussion almost wholly to his statement of them.

1. Judicial legislation.

The argument that the doctrine of de facto corporations is judicial legislation, Mr. Warren states substantially in this way. It is not for the courts to create a corporation. The franchise to be a corporation can be granted only by the legislature. The legislature has prescribed certain conditions precedent to incorporation, and if these are not fulfilled the resulting organization is not a corporation authorized by the legislature. If its existence is legally recognized by the courts, it is a creation of the courts, not of the legislature.15

It must be observed that this statement of the argument of judicial legislation goes against the whole doctrine of de facto corporations and not merely against applications of it in particular instances. Mr. Warren admits this, but he thinks the doctrine should be applied wherever the existence of "extenuating circumstances" warrant it, but not in the absence of such "extenuating circumstances." In order to make the argument of judicial legislation favor a restricted application of the de facto doctrine Mr. Warren's contention, novel as it is, amounts to this. The courts should deliberately "take to themselves powers belonging to the legislature" whenever they think the considerations for so doing are sufficiently urgent, but they should in each case use great care in determining whether the encroachment will be proper.16

Where a doctrine is presented to a court for the first time the argument that its adoption will constitute judicial legislation, if sound, is of the greatest weight, for clearly no court should consciously usurp legislative functions. But after such a doctrine has become established law the courts are not exercising a legislative power in applying the doctrine to the cases that come before them.

15

20 HARV. L. REV. 468, 469.

16 Ibid. 469.