Clifton et. al. vs.

Tomb
Cochran, District Judge
October 18, 1927
21 F. 2d 893
Doctrine
Liability of corporation for promoters contracts.
Since a corporation before its organization cannot have agents, and is unable to contract or be contracted
with, it is not liable upon any contract which a promoter attempts to make for it, unless it becomes so by its
own act after its incorporation is completed.
Cases where a corporation becomes bound for contracts of its promoters The grounds are ratification,
adoption, novation, that the proposition made to promoters is a continuing offer to be accepted or rejected
by the corporation when it comes to being and that the corporation, by accepting the benefits of a contract
is estopped to deny its liability on the contract (last ground relied upon by plaintiff Tomb).

Summary

Facts

Ratio/Issue
s

Tomb had an option to buy all the shares of a Virgina corporation and he sold said option to Clifton.
However, they later agreed that, in lieu of the sum of money to be paid for the option, Tomb would receive
$20,000 in stock of a company that Clifton intended to form. They also agreed that this company would take
over the stock under the option and that Tomb would issue promissory notes, as if he was a bona fide
subscriber without being liable for them. When this corporation was formed, Tomb didnt get these shares
and filed an action for specific performance against Clifton, et. al and the corporation. The trial court ruled
in favour of Tomb. This was reversed by the District Court which held that the corporation is not liable to
Tomb based on their agreement because a corporation, as a general rule, cannot be liable for contracts
entered into by its promoters (Clifton, in this case).
Plaintiff Tomb had an option to buy all the shares of a Virginia corporation (Raven Red Ash Coal
Company).
He sold this option to Clifton for $20,999 (original agreement). But this consideration was changed
to shares in a West Virginia corporation to be organized by Clifton which would also take over the
shares of the Virginia corporation.
Tomb gave promissory notes to cover the value of the shares he got from the West Virginia
corporation but with the understanding that he would not be liable on them. It was understood
between them that the fact that he was to obtain this stock and was not to pay the notes was to be
kept secret (substituted agreement).
The West Virginia corporation was organized and took over the shares of the Virginia corporation but Tomb
did not receive the agreed shares in the West Virginia corporation
Thus, this action for specific performance brought by Tomb against Clifton and the West Virginia
corporation.
Trial court ruled for the plaintiff in the amount of 10,000 dollars.
1. Whether West Virginia corporation was liable to Tomb (NO Corporation was not legally
bound by the original contract made with Clifton)
COURT: A. The substituted agreement, upon which his action was based, was a fraud upon the
corporation and should be unenforceable. This fraud prevents Tomb from enforcing the alleged contract
for the payment to him of the stocks and prevents him from denying his liability upon the notes.
B. Tomb argued for the enforceability of the contract; that when they entered into the original agreement
for the payment in money, both he and the West Virgina corporation became legally obligated and that
the substituted agreement was the same as the original. However, this contention was shot down by the
Court.
C. At the time the original contract was entered into, the corporation had not been formed and Clifton
was merely a promoter and one of its incorporators (See doctrine).
D. His argument is based upon the theory of implied ratification. But, whatever may be the proper legal

theory by which corporations may be bound by the contracts of their promoters, it is necessary that the
corporation should have full knowledge of the facts, or put upon such notice as would lead, upon
reasonable inquiry, to knowledge of the facts.
E. There was no evidence that any of the officers, stockholders or corporators of West Virginia
corporation had any knowledge that the plaintiff was to receive anything for the option under either the
original agreement with Clifton for the payment of money or the substituted agreement for payment in
stock thus they cannot be legally bound by the contract made with Clifton.
F. Also, Tombs argument assumes that the substituted contract calls for the same thing as that of the
original, but the stocks are more valuable than the sum of money.
2. Whether Clifton was an agent of the West Virginia corporation, thus making his knowledge
imputable to the latter (NO)
COURT. A. He cant be an agent of the corporation at the time it hasnt yet been formed. Even assuming
he as an agent, his knowledge couldnt be imputed to the corporation because of his personal interest in
the transaction.
B. The general rule (knowledge of agent is that of principal) rests upon the presumption that the agent
will disclose what it is his principals business to know. But when the agent contracts with his principal
and has a personal interest adverse to that of the latter, the general rule is inapplicable since it cant be
presumed that the agent will impart info which is to his interest to suppress.
C. As a general rule, the knowledge of a mere promoter cannot be imputed to the corporation . It is
obvious that, if corporations could be held bound by all the secret undisclosed contracts of their
promoters, few men would care to risk subscribing to their capital stock.
*Plaintiff cant maintain action against defendant Clifton because both parties are in pari delicto since the
action was based on the substituted agreement that is tainted with fraud.
Held

In the equity case, No. 2582, the decree of the District Court is reversed, and the cause is remanded for
further proceedings in accordance with this opinion. In the law case, No. 2625, the judgment of the District
Court is reversed, and the case remanded for a new trial.
Prepared by: Eunice V. Guadalope [Corporation Law]