We explore “doing business” considerations for statutory entities with employees working from homes located outside the entity’s formation state.
Even before COVID-19 forced businesses to close their offices and send employees home to work, there was a shift in how businesses were deciding to operate. No longer does the automatic response to starting a business include leasing office space to which the employees commute each day and from which business is conducted. Technology has made it possible for companies to save all that money on rent, utilities, taxes, and other expenses associated with a physical location and instead have their employees work from home.
When the employer with a “work-from-home” workforce is a statutory business entity such as a corporation, LLC, limited partnership (LP), or limited liability partnership (LLP) — whether for-profit, not-for-profit, or professional service — one issue that the statutory entity must address is whether it will be considered doing business in those states other than its formation state. If it is transacting intrastate business in these so-called “foreign” states, it will be required by the foreign state’s business entity statute to qualify to do business — which could be an unanticipated expense for the employer.
This article will describe one method of determining whether a corporation, LLC, or other statutory entity is doing business for foreign qualification purposes in states in which its employees are living and working. This article will also discuss what to do if it is determined that a business entity is required to qualify to do business in a foreign state.
Note: The term “employee”, as used in this article, also includes other natural persons through which artificial persons act — such as a corporation’s sole shareholder, an LLC’s member, or an LP or LLP’s partner — who may not technically be employees.
Also, the determination of whether any particular statutory entity is doing business for foreign qualification purposes is a legal determination and depends upon the facts of each specific situation. This article discusses general concepts and should not be considered as providing legal advice as to whether any specific statutory business entity would be considered doing business.
Why does it matter if a statutory entity is doing business in a foreign state?
All corporations, LLCs, LPs, and LLPs have one domestic state. That is the state under whose laws they were formed. All other states are considered “foreign” states.
In order to transact business in a foreign state, statutory entities are required by the foreign state’s business entity statute to obtain the state’s authorization first. Qualification is the term traditionally given to the procedure through which the authority to do business is obtained. (However, some states use the term “registration” for some or all of their statutory entities.)
A statutory entity doing business without authority is subject to penalties that can be severe. There are monetary penalties for the entity, and under some statutes, for the people doing business on its behalf. Additionally, it will not be able to maintain an action in the courts of the state until it is properly qualified. This is known as the “door closing” penalty.
How do you determine what constitutes doing business?
The trigger for the foreign qualification requirement is the corporation, LLC, LP, or LLP doing business in the state. Or, to use the common statutory language, “transacting intrastate business”.
Determining whether a statutory business entity is doing or transacting business in a foreign state is more art than science. The business entity statutes do not have bright-line rules like you might see in, for example, a sales tax law — which requires registration based on a threshold number of transactions or amount of revenue in the state.
Furthermore, the courts that have dealt with the “what constitutes doing business” issue have not provided bright-line rules either. One frequently cited definition of doing business comes from the Alabama Supreme Court, which stated: “it is established by well-considered general authorities that a foreign corporation is doing, transacting, carrying on, or engaging in business within a state when it transacts some substantial part of its ordinary business therein”. Royal Insurance Co. v. All States Theatres, 242 Ala. 417, 6 So.2d 494 (1942).
The three-step method of analyzing the “doing business” issue
So how can you determine if a corporation, LLC, LP, or LLP is doing business in a foreign state based on the activities of its local, home-based employees? One helpful technique is to use the following three-step plan of attack.
Step 1: Consult the qualification provisions
The first step is to consult the qualification provisions of the foreign state’s business entity statute. The approach of these statutes is not to set forth the activities that do constitute doing business, but instead to have a list of activities that do not constitute doing business.
This list includes activities such as maintaining a bank account, bringing or defending a legal proceeding, conducting activities related to internal affairs, soliciting or obtaining orders that require acceptance outside the state, owning property, creating or enforcing mortgages or other security interests, and doing business in interstate commerce.
If the activities that the employees are doing on behalf of their employer fall solely into these exempted activities, the employer probably would not be considered doing business there.
Step 2: Consult case law precedent
The next step would be to consult the case law precedent on the issue of what constitutes doing business for foreign qualification purposes.
There is a fairly large body of case law on the issue. Most of this precedent arises out of lawsuits filed by corporations or other entities in states where they are not qualified. The defendant will move to dismiss on the grounds that the plaintiff lacks the capacity to sue because of the state’s door-closing penalty. The plaintiff will argue it is not doing business in the state and therefore not required to qualify. The court will then analyze the plaintiff’s activities and decide if it was doing intrastate business.
Often, the court’s determination comes down to whether the plaintiff has “localized” its operations in the state. If so, qualification is likely to be required.
However, if the plaintiff’s activities are just incidental to its interstate activities qualification is likely not to be required.
Step 3: Analyze activities of employees in foreign states
The third step would be to analyze all of the in-state activities of the employees in every foreign state. Then, keeping in mind the statutory provisions and case law principles, make the determination of whether the statutory entity is doing business in the state based on what those employees are doing for their employer.
It can be helpful to ask certain questions which could help you focus on whether the employees’ activities are localized. These questions could include, but would not be limited to the following:
- What is the business entity’s purpose in the state and how vital are the in-state employees to accomplishing that purpose?
- What percentage of the business entity’s overall sales or revenue comes from the activities of the in-state employees?
- Are the employees meeting with customers or clients in person in the foreign state?
- Are the employees entering into contracts or soliciting orders that are approved in the foreign state?
- Are the employees’ activities incidental to otherwise interstate business transactions?
How does a statutory entity qualify to do business?
If a corporation, LLC, LP, or LLP will be qualifying to do business in a foreign state, the next question is how that is done.
The qualification procedure differs somewhat based on the state and business entity type. This typically requires the filing of a document with the state’s filing office.
The name of the document varies. In the case of a corporation or LLC, it is often called an application for a certificate of authority. In the case of an LP (and in some states an LLC as well) it is often called an application for registration, and in the case of an LLP, a statement of foreign qualification. That document must be accompanied by a certificate of existence. In some states a certified copy of the formation document is required instead of, or in addition to the certificate of existence. Nonprofit and professional entities often have additional requirements such as obtaining the approval of licensing boards or regulatory state agencies.
Registered offices, principal offices, and mailing addresses
As part of the application process, the business entity will be required to provide the name of its Registered Agent and the address of its registered office in the state. It may also be asked for its principal office address in the state, and a mailing address. For business entities that do not maintain a physical office in the state, the issue arises as to how to answer those questions.
Registered Agent and office
Qualified corporations, LLCs, LPs, and LLPs are required by the business entity statutes to appoint and continually maintain in the state a Registered Agent and registered office. Penalties are imposed for a failure to do so.
The Registered Agent is the business entity’s official point of contact in the state and is authorized to receive service of process, and legal and state documents on the business entity’s behalf and to relay those documents and communications to the business entity.
The registered office is the Registered Agent’s location. The registered office must be a physical location. Among other reasons, this is required so that there is someone available during business hours to receive service of process by in-hand delivery.
One option for a business entity without a physical office but with employees working from home in the state is to name an employee as Registered Agent and the employee’s home address as the registered office. Of course that means the employee’s address is on the public records, the employee must be available during business hours to receive process, the employee must be willing to have process servers or law enforcement officers coming to his or her home, and the employee must be trained on the proper handling of these time-sensitive and important documents.
Another option is to appoint a professional Registered Agent. The advantages include that the professional Registered Agent’s address will be the registered office, there will always be someone there to receive the documents, and the person receiving the documents will be trained on what to do with them. And if the employer has to qualify in multiple states it can have the same registered agent in each state — simplifying the billing and administrative burden.
If the application for authority asks for the principal office address in the foreign state, what is an acceptable answer can vary depending upon the state.
One option would be to provide an employee’s address if that is acceptable to the employee and the state filing office. Some states may accept the statement that there is no office in the state.
Other states will allow applicants without a physical office to provide a post office box instead.
What is also important to remember is that if the state is looking for an address where the applicant for authority is actually conducting business, the address of a professional Registered Agent should not be used — as that is not the business office of the corporation, LLC, LP, or LLP.
If the application asks for a mailing address, you should first find out if a street address is necessary and if the address must be in the state. If a street address is not required, then a post office box, or perhaps a virtual office with a mail forwarding service, or even an email address may be sufficient, depending upon the state.
An increasing number of employers are shifting to a “work-from-home” workforce. These employers need to keep in mind that they may have to comply with the requirements of various statutes in the states from which their employees are doing work on their behalf.
In the case of statutory business entities with employees in states outside of their formation state, they need to make sure they are in compliance with the foreign qualification provisions of those states’ business entity statutes.
Learn more: Foreign Qualification Services