Uncle Pennybags plans to build a hotel on Marvin Gardens, but to do so, he needs to acquire adjacent properties on Atlantic Avenue, owned by Charles Darrow, and Ventnor Avenue, owned by George Parker. Pennybags knows that if Darrow or Parker knew of his plans, they would demand a higher price for their properties and a still higher price would be demanded by the last lot owner to sell. So Pennybags forms a dummy company called Acme Acquisitions, LLC and appoints his good friend, Lizzie Magie, as its president. Magie approaches Darrow and Parker, who both agree to sell their properties to Acme Acquisitions on favorable terms. After the contracts have been signed, Pennybags announces that he is the true purchaser and that he plans to build his hotel. Furious, Darrow and Parker refuse to consummate the transaction, so Pennybags sues. Are Darrow and Parker out of luck?
Probably. Using a dummy company, whose sole purpose is to conceal the purchaser’s identity, is a well-established and generally legal practice. The most famous example is The Walt Disney Company’s use of multiple dummy companies to buy large tracts of land in Central Florida, which eventually became Walt Disney World. By concealing its identity, Disney was able to purchase the land at average price of $180 per acre—an incredible feat in light of the fact that a nearby acre sold for over $300,000 after the theme park was announced.
Companies seeking to purchase real estate (or enter into any other contract) may seek to conceal their identity for any number of reasons. Like Disney, they may seek to obtain a lower price. Or they may desire to discourage competitive bidding by rival businesses. Or they may simply seek to strike a deal that they may not otherwise be able to strike due to the other party’s personal idiosyncrasies or animosity to the purchaser. Whatever the purchaser’s objective, setting up a dummy company to negotiate and sign the contract can help accomplish it.
Who Can Enforce Contracts Signed by a Dummy Company?
Although the contract between the seller and the dummy company appears to have two parties, it actually has three: the seller, the dummy company, and the true purchaser. Under principles of agency law, both the dummy company and the purchaser are parties to the contract signed by the dummy company. Both can sue to enforce the contract’s terms, and both are liable for any breach.
The dummy company was acting as the purchaser’s agent in the transaction, and the principal is a party to any contracts entered by its agent acting within the scope of that agent’s authority. Whether the principal was a signatory or was identified as a party in the contract is irrelevant.
As I explained in a previous post, the rules governing the agent’s liability for contracts that it signs on behalf of its principal turn on the level of disclosure:
- Fully Disclosed – The other party to the contract knows that the agent is acting on behalf of a principal and that principal’s identity. In these circumstances, the contract is the principal’s. Unless the parties agree otherwise, the agent is neither a party to the contract nor liable for its breach.
- Partially Disclosed – The other party to the contract knows that the agent is acting is acting on behalf of a principal but does not know whom. This often occurs when the agent has either withheld the information or misidentified his principal. In these circumstances, the agent is a party to the contract and liable for its breach.
- Undisclosed – The other party to the contract does not know that the agent is acting on behalf of another. The agent is a party to the contract and liable for its breach.
Because revealing the purchaser’s true identify would defeat the purpose of using a dummy company, the purchaser will either be partially disclosed or undisclosed, and the dummy corporation will be a party to the contract too. As a result, in the hypothetical above, either Pennybags, Acme Acquisitions, or both could sue Parker and Darrow and force them to perform their contracts and sell the properties.
Is Using a Dummy Company Fraudulent?
Using a dummy company is generally not fraudulent. To support a fraud claim or defense, the misrepresentation must be material, that is, “a reasonable person would attach importance to and would be induced to act on the information in determining his choice of actions in the transaction in question.” And Texas courts have concluded that an undisclosed principal’s involvement in the transaction is immaterial. Parties commit themselves to a contract based on its terms and their assessment of the likelihood that the other party will perform. The fact that the dummy company was contracting on behalf of an undisclosed principal does not affect the contract’s substantive terms, such as price and time for performance. The third party has also implicitly determined that the dummy company is likely to perform according to those terms and, as discussed above, the dummy company is liable if it does not. Courts in other states agree.
Although Texas courts have not considered the issue, some courts have recognized two narrow exceptions. First, they will allow the other party to rescind the contract if: (1) the dummy company’s representatives misrepresented that it is not acting on behalf of an undisclosed principal; and (2) either the dummy company or the principal knows that the other party to the contract would not have dealt with the principal at any price. This will most likely occur due to the other party’s personal idiosyncrasies or animosity to the principal. Second, courts will allow the other party to rescind the contract if the principal’s identity materially changes the contract’s terms, such as outputs or requirements contracts or personal-service contract.
In the hypothetical above, an argument by Darrow and Parker that they were defrauded would likely be unsuccessful. After all, Darrow and Parker were not wholly unwilling to deal with Pennybags. They would have just attempted to extract more onerous terms from Pennybags if they knew that he was interested in purchasing the land.
Tilting the Scales in Your Favor
The lesson is obvious to companies that want to conceal their identity in a transaction: set up a dummy company to negotiate and sign the contract.
On the other hand, parties who are concerned about contracting with a dummy company and signing a contract with less-than-ideal terms can take steps to protect themselves. First, they can insist on a specific provision in the contract excluding any undisclosed principal—or any specific principal with whom it has no desire to deal—from asserting any right under the contract. Second, they can include a provision prohibiting the assignment of the contract.