Question

With an increasing amount of business taking place electronically or over the Internet, what special considerations do you see when businesses are contemplating whether they should qualify their corporations to transact business in a foreign state? Research at least one case involving foreign businesses doing business in the state of Pennsylvania. Explain and cite the case. Be sure to comment on your classmates' posts.

Answer 1

Doing Business Out-of-State: Foreign Qualification

If a company is going to do business outside of its state of formation, then it must register to do so. This process is known as foreign qualification. It is usually straightforward, but nearly always requires filing documents and paying fees.

When considering whether to form a corporation or a limited liability company (LLC), don't be confused by the term foreign qualification. Most of us, when we hear "foreign," think of something outside the United States; however, in the world of U.S. corporations and LLCs, the word foreign has a different meaning.

Foreign qualifying a company means that you are registering it to do business in a state other than your state of formation. Corporations and LLCs are considered domestic only in their state of formation. For example, if you formed your LLC in Delaware, it is only domestic in the state of Delaware. If your LLC is transacting business outside the state of Delaware, it would be considered a foreign LLC in those other states.

When you foreign qualify a business, you register for a certificate of authority in the state or states where your company will be transacting business, and pay the necessary state fees. By doing this, the state knows that a foreign corporation or LLC is conducting business within its borders.

When evaluating whether to form your business as a corporation or LLC in a state other than one where you are transacting business, keep in mind that your business will be subject to ongoing reporting requirements, fees and taxes in both your state of formation and state of qualification. If your business is expanding into new states and you need to qualify it as part of this growth, these initial and ongoing fees should be considered a necessary part of doing business.

What is Considered Transacting Business?

Many factors are used to determine whether a company is transacting business in a state, and therefore needs to foreign qualify. Some of the common criteria evaluated include whether the company:

• Has a physical presence in the state.
• Has employees in the state.
• Accepts orders in the state.

Tip

This is not a complete list, and different states may have different criteria. To determine whether your business needs to foreign qualify in a particular state, it is best to seek the advice of an attorney.

Consequences of Avoiding Foreign Qualification

While you may consider the extra fees and reporting requirements to be troublesome, the consequences of not foreign qualifying your business could be much worse. First, you could lose the right to bring a lawsuit in state court. This means that you wouldn't be able to sue to recover damages or to enforce a contract. In most (but not all cases), you can foreign qualify and then bring the lawsuit--but you will lose valuable time before you can enforce your rights.

In addition, the company could be subject to fines, penalties and back taxes for the period of time in which your company transacted business within that state.

Foreign Qualifying Versus Incorporating in Every State

There is an alternative to foreign qualifying: You can incorporate your business or form your LLC in the other state(s) in which you intend to transact business. The primary difference is that when you incorporate or form your LLC in multiple states, your company becomes domestic in each of those states, thereby creating separate entities.

For corporations, the increase in corporate formalities is the biggest disadvantage of forming separate domestic corporations. Corporate formalities include drafting and maintaining bylaws, issuing stock and recording all stock transfers, holding initial and then annual meetings of directors and shareholders, and keeping minutes of all director and shareholder meetings with the corporate records. LLCs do not face the extensive formalities imposed on corporations.

When you create a separate corporation in each state, each of these corporations will have its own stock, shareholders, directors and officers. Even if the shareholders, directors and officers are the same people for each corporation, the formalities must be followed for each domestic corporation, thereby greatly increasing the annual record-keeping requirements.

When you foreign qualify, there is still only one corporation or LLC. For a corporation, regardless of the number of states in which it foreign qualifies, it will require only one set of bylaws, stock, shareholders, directors and officers. Bylaws will need to be adopted only once, and the holding of and record-keeping for the initial and annual meetings of directors and shareholders happens only once.

The advantage of forming a new corporation or LLC in each state is the separation of liabilities. For example, if one of your companies is forced into bankruptcy in one state, the assets of the companies in the other states typically would not be used to pay the debts of the bankrupt business. If you have foreign qualified your business in each state, only one corporation or LLC exists, so there is no separation of liabilities.

Of course, whether you foreign qualify or form a new entity, you'll have to select a registered agent for each state in which the company has a presence.

The Foreign Qualification Process

As part of the foreign qualification process, a name availability search must be conducted in the state of qualification. This helps to ensure that the name of your company is not already in use in that state by another domestic or foreign corporation or LLC, or that its name is not deceptively similar to another name already in use. If your desired name is not available, your company will be required to use an assumed name in that state.

Next, you'll have to select a registered agent to represent your entity in that state. The registered agent serves as an in-state liaison for your out-of-state business.

Then you must register for a certificate of authority in that state. The process is similar to filing articles of incorporation or articles of organization. The appropriate documents must be prepared and filed, and the appropriate state fees paid.

Each state has different requirements for the information to be included in this document. Common information includes:

• Company name.
• Date and state of incorporation/organization.
• Principal or legal address of the business.
• Name and address of registered agent in the state of qualification.
• Name and addresses of officers (for corporations) or members (for LLCs).
• Number of authorized shares and a listing of the different classifications of stock (for corporations).
• Type of management (for LLCs).
• Signature of a corporate officer, often the president (for corporations), or of a member (for LLCs).

Additional information is often required in certain states. Examples of this include:

• Names and addresses of directors (for corporations).
• Duration of the corporation or LLC.
• Number of issued shares of stock (for corporations).
• Financial information, including information on assets.
• Specific business-purpose clauses outlining the type(s) of business the company will undertake.

Before granting approval for the certificate of authority, many states want to ensure your company is in "good standing" in the state of formation. In order to do this, they require submission of a certificate of good standing which states that your company has met all the necessary requirements for corporations or LLCs imposed by your state of formation. Failing to file your annual statements, or failing to pay or being delinquent in paying your annual statement fees and franchise taxes could cause your company to be in bad standing with the state. Being in bad standing will most certainly cause the intended state of qualification not to grant you a certificate of authority.

The prepared certificate of authority, the certificate of good standing or certified copy of your formation documents should be submitted to the appropriate state agency and the necessary state filing fees paid. Turn-around time for receiving state approval for a foreign qualification varies greatly by state, but you should typically allow six to eight weeks. Most states will allow you to expedite the filing for an additional charge. This often reduces the turn-around time to two to four weeks.

As always, if you have questions regarding your specific business situation, such as whether you should foreign qualify or incorporate in other states, you should contact an attorney for a legal opinion.