Engaging in contacts and transactions in another state introduces an additional layer of complexity. This is because such activities can trigger the need for foreign qualification, which means a business must legally register as a foreign entity in that new state to comply with its regulatory requirements.
Consequently, businesses face the prospect of even more compliance responsibilities, as each state has its own specific regulations and procedures for foreign qualification. Failing to comply with these requirements can result in substantial fines and penalties, not to mention the risk of losing your ability to enforce contracts or bring lawsuits within that state if your business is not properly qualified. Therefore, understanding and adhering to these compliance responsibilities is essential for businesses looking to expand their operations across state lines.
What is foreign qualification?
When a corporation or LLC does business outside its home state, it may be seen as a foreign entity that is required to register or “qualify” with the new state. This includes obtaining a Certificate of Authority and appointing a registered agent.
What is the definition of conducting or doing business?
The rule is simple and uniform: If you are doing business in a state, you must follow the business registration rules. What is not simple is the definition of doing business for several reasons:
- States vary on the amount and types of activity that trigger business registration.
- Doing business is defined differently for entity qualification purposes and other purposes, like whether the company is subject to the foreign state’s tax law or the personal jurisdiction of its courts, which makes things even more confusing.
- Most state laws list only those activities that don't constitute doing business—leaving courts to decide what does constitute doing business on a case-by-case basis, based on all the facts and circumstances.
How do I know if my corporation or LLC needs to foreign qualify?
So, in this complicated territory of case law, are there any signs that you may have a significant connection to a state and a need to register (or foreign qualify)?
Yes, there are some indications that you've crossed the compliance border in another state.
Consider these five signs:
- Physical location. You have a physical location, such as a warehouse, office, store or restaurant, in the state. (But, simply owning real property, or holding mortgages on real property, generally isn’t considered doing business.)
- Employees. You have employees in the state. (Many states don’t consider using independent contractors in the state an activity that constitutes doing business.)
- Regular binding contracts. You regularly enter into binding contracts in the state. (Entering into contracts that must be approved by an office located outside of the state before becoming binding is often not listed as an activity considered "doing business".)
- Regular client or customer meetings. You regularly meet with clients or customers to conduct business with them in the state. (Phone meetings and email alone are less likely to rise to the level of doing business.)
- Significant revenue stream. You have a steady and significant revenue stream from activities in the state. (Isolated transactions generally are not considered doing business.)
Did you answer "yes" to any of these questions? It doesn’t necessarily mean your corporation or LLC is doing business but you may want to consult with an advisor regarding the need for foreign qualification.
Why is foreign qualification important? Avoid the “door closing” penalty
A corporation or LLC is subject to fines and penalties for failure to foreign qualify when required to do so. In addition, you could be putting your limited liability at risk.
Also, as an inducement to get corporations and LLCs to comply with the qualification requirement, the statutes provide that a foreign corporation or LLC doing business in the state cannot maintain an action in the courts of that state until it has qualified. This is known as the “door closing” penalty.
If a corporation or LLC files a lawsuit in the courts of a foreign state, the defendant, upon discovering that the plaintiff corporation or LLC was doing business without being qualified, can move to dismiss the lawsuit on the grounds that the plaintiff lacks the capacity to sue.
Every corporation or LLC that files a lawsuit must have the capacity to sue. Capacity involves the right to come to the court. If the defendant moves to dismiss the corporation or LLC’s lawsuit because it is not currently qualified, the courts will generally stay the proceeding and give the foreign corporation or LLC a chance to qualify to avoid dismissal. The corporation and LLC will not only have to pay the filing fee but also penalties and interest for the time it transacted business without authority.
Conclusion
Although the process of registering your corporation or LLC in every state where it is doing business may seem onerous, failure to do so can result in some very unpleasant consequences. If you are planning on doing business outside the state where your corporation or LLC was formed, you should consult with your lawyer to make sure that you remain in compliance.
Learn more
For more information on foreign qualification, contact a CT Corporation specialist today.
