Companies expanding their operations across state lines may be subject to the new state’s registration or “foreign qualification” requirements. It’s important for business owners, managers, and advisors to understand this requirement because there are penalties if the company doesn’t comply.
Domestic companies and foreign companies
A company, whether doing business as a corporation, LLC (limited liability company), or other statutory business entity, is a “domestic” company in one state—its formation state. It is considered a “foreign” company in all other states. States have the power to prohibit foreign companies from doing business within their borders unless they comply with certain conditions the states think are necessary. And every state has taken advantage of this power by enacting foreign qualification provisions in their state business entity laws.
What is foreign qualification?
Foreign qualification is the procedure by which a corporation, LLC, or other statutory business entity receives the authority to do business in a state other than its formation state. (It is also sometimes referred to as “registration”). The company pays a fee and files a document with the state business entity filing office. The document is generally known as an application for authority. Typically, it is a short form that asks for certain basic information about the company. Once qualified, the company will be subject to a few other compliance requirements, like having to maintain a registered agent and file an annual report.
Constitutionality of foreign qualification provisions
The states’ Constitutional right to enact foreign qualification statutes was established many years ago in Paul v. Virginia, 75 U.S. 168, 8 Wall. 168 (1869), where the U.S. Supreme Court stated that a corporation was a “mere creation of state law” and that it had “no legal existence beyond the limits of the sovereignty where created.” This meant a state could refuse to recognize the existence of another state’s corporations when they carried on business within its borders or could condition its recognition upon the corporations’ compliance with certain requirements. The federal government does retain some Constitutional authority over these state-created entities.
The Commerce Clause reserves to Congress the power to regulate interstate commerce. The states may not enact laws that place an undue burden on interstate commerce. However, state laws that regulate even-handedly to effectuate a legitimate local public interest, and whose effect on interstate commerce is merely incidental, are usually upheld.
Three main state interests furthered by the qualification requirement
- Transparency. An important function served by the foreign qualification requirement is to require foreign companies to disclose information about themselves to state officials and to citizens who may interact with them. In most states, this information is publicly shared through the application for authority and the annual report. Foreign companies are required to keep the information in these documents up-to-date and can be penalized if they fail to do so.
- Facilitating service of process. Another important state interest furthered by foreign qualification provisions is the facilitation of service of process. Qualified foreign companies are required to appoint and continually maintain a registered agent and registered office in the state. Without this registered agent requirement, state citizens, in serving process, would have to find an officer, manager, or other agent or employee authorized by the company and the law to receive service of process. In the case of foreign business entities, locating a proper person to serve can be extremely difficult. The qualification requirement ensures that an in-state agent and location for service of process can easily be found.
- Protect domestic companies. The foreign qualification statutes also allow the states to make sure that foreign companies doing business in the state do not receive an unfair advantage over the state’s domestic companies. For example, if domestic corporations are required to pay a franchise tax, file annual reports, and maintain a registered agent while foreign corporations transacting business in the state are not, it would give the foreign corporations an unfair advantage.
How do you know if you are “doing business” in another state?
There are consequences when a corporation or LLC does business outside its formation (domestic) state. It may find itself 1) subject to taxation by the state, 2) subject to service of process and suit in the state, or 3) required to (foreign) qualify to do business in the state.
The level of business activity that will constitute doing business is different for each category and varies by state.
Although it can be hard to determine whether a company is “doing business” for qualification purposes, there are a few tip-offs, including whether it has a physical location, employees, or regular binding contracts in that state. For more information on what is involved in foreign qualification, read What Constitutes Doing Business in Another State.
What are the penalties for not registering your business?
If a company transacts business in a state without having qualified it can be penalized by the state. Often, a fine is imposed. Under some state statutes, the people doing business on behalf of the non-complying company can be fined too.
In addition, the state can prevent the company from bringing a suit or proceeding in the state’s courts until it qualifies. This is referred to as a “door closing” provision and the states close the courthouse doors because they don’t think a foreign company should benefit from the aid of a state’s courts in enforcing its rights when it is (a) violating state law and (b) not paying its fair share.
The benefits of conducting business activities across state lines are numerous for many businesses. But compliance obligations increase when companies expand their horizons. Remember to comply with these obligations, particularly the foreign qualification requirement.