If you’re considering expanding your business into other states, you will need to know about “foreign qualification”. The terminology can be confusing. Foreign qualification can sound like an international concept, but it isn’t. In this context, "foreign" refers to a state or jurisdiction other than the entity's state of formation.
What is foreign qualification?
Foreign qualification is the process of registering to do business in a state other than the one where you incorporated your corporation or formed your LLC. When you "foreign qualify" your business, you are filing an Application for Authority to allow your business to legally operate in that other state.
A business is considered domestic only in the state where it was incorporated (for corporations) or formed (for LLCs and other entity types). For example, if you form a limited liability company in Delaware, it is “domestic” in Delaware and considered a “foreign LLC” in any other state. If you wish to do business with your LLC or corporation in other states, you will need to foreign qualify in those states and obtain a Certificate of Authority.
Why does a company have to foreign qualify?
A corporation, LLC, LP, or LLP cannot just transact business in states other than its home state. A company doing business in another state needs the other state’s permission to engage in business activities there.
From the state’s point of view, foreign qualifying (also known as foreign registration) ensures that the public has access to basic information about the business entity it may be dealing with, such as its legal name, business address, and name and address of its registered agent for service of process. Knowing who is doing business is one of the reasons why states require qualification.
States also require out-of-state businesses to foreign qualify to prevent them from gaining an unfair advantage over domestic entities, which are already subject to tax and reporting requirements. Qualification allows states to apply those same requirements to foreign LLCs, corporations, and other entities. It also makes service of process easier by requiring foreign entities to maintain a registered agent and office in the state.
When does your company have to foreign qualify or register in another state?
If you are currently deciding whether to operate in a state other than your home state, the first question to ask is, do you need to foreign qualify in the target state(s)?
The answer to that question is “yes” if your corporation, LLC, or other entity is “transacting business” (or “doing business”) in that state, and is therefore considered a foreign entity.
The answer is “no” if it isn’t doing business in that state.
This leads to the next question: What constitutes “transacting business”?
Unfortunately, there is no easy answer to that question. Few corporation, LLC, LP, or LLP statutes define the term. Instead, most statutes list activities that do not count as doing business, such as maintaining a bank account or engaging in interstate commerce.
The courts are the ones that primarily decide what counts as doing business. They weigh many factors to determine whether a business's activities in the state were localized enough to require foreign qualification. These include the following:
- Does your company have a physical presence (like a factory or stores) in the state?
- Does your company have employees in the state?
- Does your company accept orders in the state, or have liability to collect sales tax?
Be aware that this is not a complete list, and the state statutes and the courts have different criteria for what constitutes transacting business. To determine whether your business needs to foreign qualify in a particular state, it is best to get the advice of an attorney.
For more information, see What constitutes doing business in a state?
What are the consequences of not registering a foreign entity?
Foreign qualifying comes with added costs for your corporation, LLC, LP, or LLP. You'll face initial and ongoing fees, plus reporting obligations, in both your state of formation and each state where you qualify.
These extra obligations can feel burdensome, but if your growth plans involve expanding into new states, they become a necessary cost of doing business. State laws require foreign corporations, LLCs, LPs, and LLPs operating within their borders to register, and states penalize businesses that fail to comply.
The most serious penalty is losing access to the state's court system. A non-compliant company cannot bring or maintain a lawsuit there, meaning it can't sue to recover damages or enforce a contract. (It can, however, still defend itself if sued.)
Here’s an example. A manufacturer sued a customer for failure to pay for $300,000 worth of goods (Drake Manufacturing Company, Inc. v. Polyflow, Inc.). The customer didn’t claim that the products were defective. It didn’t deny that it hadn’t paid. Instead, it argued that the manufacturer had no right to sue because it hadn’t registered to do business in the state. The customer won.
Generally, you can fix this problem by registering with the state before bringing a lawsuit. Furthermore, once the lawsuit has been brought, the courts will usually stay the proceeding and give the company a chance to qualify.
But that isn’t always the case. And even when it's allowed, your lawsuit will be delayed, and your company will owe the state penalties and interest for the time it operated without authority. Given how easy it is to prevent, this situation isn't worth the risk.
Failing to qualify carries another financial risk. If your business meets the state's registration criteria, the state can assess fines, penalties, and back taxes covering the entire period your company transacted business without a Certificate of Authority. In some states, individual officers or agents may be fined as well.
How to foreign qualify your business
Make sure your company has the proper authority to do business in every state where it operates. Foreign qualification gives your company the legal standing it needs to conduct business within a state's borders and helps you avoid penalties down the road. Here are four basic steps to obtain a Certificate of Authority before your company begins doing business in a state other than its home state.
Step 1: Check that your business name is available
As part of the foreign qualification process, a name availability search should be conducted in the state of qualification. This will tell you if the legal name is available for your company to qualify and do business under. (A legal name is the name listed on your company’s formation document.) Being available generally means that the name is not already on the records of the Secretary of State (or other business entity filing office) as belonging to another domestic or foreign business entity — or, in some states, that the name is not deceptively similar to another name on the state’s records.
If your legal name is available, you should reserve the name for your business. That makes sure no other entity takes it before you have had a chance to file your qualification documents. If your desired name is not available, your company will be required to qualify under and use a "fictitious name" in that state.
Tip: Don't confuse this required fictitious name with an “assumed name or DBA”. A company is required to use a fictitious name only when its legal name isn't available in the new state. An assumed name or DBA, by contrast, is one a company voluntarily chooses to operate under in addition to its legal name.
Step 2: Appoint an in-state registered agent
The registered agent is an individual or company whose main function is to receive service of process and other important court documents on behalf of the corporation, LLC, or other business entity for which it acts as agent. The registered agent’s location in the state is often called the registered office.
The registered agent also receives important communications from the Secretary of State. It is often a good idea to appoint a professional registered agent company rather than an owner, employee, or other individual. With a professional registered agent, you can be sure there will be someone at the registered office during business hours to receive the documents. And professional registered agents have experience and expertise in handling these important documents and forwarding them quickly to the people who can take action on behalf of the corporation, LLC, or other company.
Many people or organizations who are suing a corporation, LLC, or other business entity will serve process on the registered agent, as it helps ensure proper service that’s less likely to be challenged in court.
Without competent registered agent services, you might not learn of the lawsuit until a default judgment has been entered against your company, and the person suing seeks to collect on the judgment. And while the courts will overturn default judgments, they are less likely to do so when the default was caused by the company’s own failure to comply with the registered agent requirement.
Step 3: Order a Certificate of Good Standing from your home state
Before approving your Certificate of Authority, many states want proof that your company is in "good standing" in its state of formation. Most require you to submit a Certificate of Good Standing (also called a Certificate of Existence or Certificate of Status). This document confirms that your company has met all the requirements your formation state imposes on corporations, LLCs, or other entities.
The most common reasons companies fall out of good standing are failing to file annual reports or failing to pay franchise taxes. If your company isn't in good standing, you'll need to restore it by filing any necessary reports and paying any outstanding taxes, plus any interest and penalties that have accrued.
Step 4: File qualification documents
Once you've addressed the name, registered agent, and Certificate of Good Standing requirements, you can complete and file an application for a Certificate of Authority in the new state. You prepare the required documents, submit them, and pay the applicable state fees. Some states allow or require online filing, while others accept documents by mail.
Requirements vary by state, but most applications ask for the following:
- Company name (and if required, the fictitious name it will qualify and do business under)
- Date and state of incorporation/organization
- Address of the business in the state
- Principal address wherever located
- Name and address of the 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), of a member or manager (for LLCs), or general partner (for LPs or LLPs)
Some states require additional information, such as:
- 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
Foreign qualify or incorporate in each state?
An alternative to foreign qualifying is to incorporate your business or form your LLC in each state where you plan to do business. The key difference is that when you incorporate or form an LLC in multiple states, your company becomes domestic in each state, creating separate business entities. Here are some factors to consider when comparing the two approaches.
Reasons for foreign qualification
- Fewer corporate formalities. Incorporating separately in each state significantly increases the number of corporate formalities. Each corporation must draft and maintain its own bylaws, issue stock and record all stock transfers, hold initial and annual meetings of directors and shareholders, and keep minutes of those meetings with the corporate records. With foreign qualification, only one corporation or LLC exists, so these formalities apply only once, regardless of how many states the company qualifies in. LLCs aren't subject to these extensive formalities in either scenario, but the principle of having a single entity still simplifies recordkeeping.
- Lower administrative overhead. Maintaining multiple LLCs means managing multiple sets of Articles of Organization, multiple operating agreements, separate bank accounts, separate federal EINs, and (in most cases) separate federal tax returns. Foreign qualification keeps all of this under a single entity, reducing the ongoing administrative burden.
- Simpler ownership and management. With foreign qualification, your business operates as a single corporation or LLC across all states. For corporations, this means just one set of bylaws, stock, shareholders, directors, and officers. Bylaws are adopted only once, and initial and annual meetings happen only once. Incorporating separately, by contrast, creates multiple distinct entities, each with its own stock, shareholders, directors, and officers. Even if the same people serve in these roles across all your corporations, the formalities still apply to each one, significantly increasing annual recordkeeping.
Reason for incorporating separately
- Separation of liability. Forming a separate corporation or LLC in each state creates liability protection between your businesses. For example, suppose you own two stores in two different states, each held by its own LLC. If one store goes bankrupt, the assets of the LLC owning the solvent store cannot be used to pay the debts of the bankrupt one. But if you formed a single LLC and foreign qualified in the second state, all of that LLC's assets could be used to cover the bankruptcy debts.
Summary
Expanding your business into new states involves several important considerations. Will you need to foreign qualify? If so, do you understand each step in the process?
If you need help along the way, whether it's checking or reserving a name, appointing a registered agent, obtaining a Certificate of Good Standing, or filing the qualification documents, you can count on BizFilings to guide you through every step.