Expanding Your Business? Foreign Qualification Protects Your Rights in a New State
In July 2015, Floyd Mayweather was stripped of his boxing welterweight world title—a title that he'd won only two months earlier with a victory over Manny Pacquiao. Mayweather didn't lose his title for improprieties in the ring or outside of it. He lost the world title because he failed to pay the required sanctioning fee for the fight. The amount of the fee ($200,000) was trivial when measured against his earnings from the fight, which amounted to at least $180 million.
How does this relate to expanding your business beyond your home state, your state of formation or incorporation?
If you neglect to obtain a certificate of authority to conduct business in a new state, you can forfeit valuable rights—and put your assets and your company at risk. Any corporation or LLC that does business in any state other its home state needs to obtain a certificate of authority from that state. This process, often known as foreign qualification, puts foreign companies on the same footing as domestic companies and ensures that the public has access to information about the company.
To motivate companies to comply with the foreign qualification requirements, states generally limit access to their court system to domestic and properly registered foreign corporations and LLCs. While you’re usually able to defend yourself whether or not you’ve registered in the state, you won’t be able to bring a lawsuit to assert a claim against someone who has wronged you. This can prove costly.
Just recently, a manufacturer sued a customer for failure to pay (Drake Manufacturing Company, Inc. v. Polyflow, Inc.). The purchaser 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. And, the purchaser won—getting $300,000 worth of goods for free. Generally, you can “cure” the problem by registering with the state before bringing a lawsuit—or it the early stages of the proceeding. But, it’s risky to count on curing a problem that is so easy to prevent.
Even though a company generally is able to defend itself when sued, the company must be aware of the lawsuit in order to do so. When you foreign qualify, you must appoint a registered agent who will ensure that you receive notice of a lawsuit. Without this protection, you might not learn of the lawsuit until a default judgment has been entered against your company. Again, you may be able to set aside the default judgment, but quite often the courts are unwilling to get you out of a mess that you got yourself into by not following the state’s rules.
There can be unfortunate consequences other than lack of access to the court system. The corporation or LLC could be hit with fines, penalties and back taxes for the time it was transacting business without obtaining a certificate of authority to do so. And, in some states, individual officers or agents may be fined as well.
Don’t let your company be stripped of its rights by failing to foreign qualify in each state where you are doing business. The best practice is to make sure that you take steps to obtain a certificate of authority as soon as you begin doing business in a state other than your home state.