By Heather Huston, Assistant Service Manager, BizFilings
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 in the eyes of the state governing authorities for all entity types—including U.S. corporations, limited liability companies (LLCs), limited partnerships (LPs), and limited liability partnerships (LLPs)—“foreign” in this case doesn’t mean operating outside of the United States. Foreign refers to a state or jurisdiction other than the entity’s state of formation.
Foreign qualification is the process of registering to do business in a state other than the one in which you incorporated or formed your business.
Corporations and LLCs are considered domestic only in their state of incorporation (for corporations) or formation (for LLCs and other entities besides corporations). 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.
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 corporation doing business in another state needs the other state’s permission to transact business 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 a 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. That is one of the reasons why states require qualification.
Foreign qualification is also required so that foreign entities do not get an unfair advantage over the state’s domestic entities, which are subject to tax and reporting requirements. By requiring qualification, the states can also impose these requirements on foreign entities. Qualification also facilitates service of process by requiring the continued maintenance of a registered agent and office in the state that can be easily located.
When Does Your Company Have to Foreign Qualify (or Register to Do Business) in Another State?
If you are currently evaluating 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 they mostly include a list of activities that do not constitute doing business – such as having a bank account or doing business in interstate commerce.
It is the courts that mainly deal with the issue of what constitutes doing business. They look at many factors to determine whether the business was localized to the extent that qualification was necessary. 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.
What Are the Consequences of Not Foreign Qualifying?
There are additional costs to your corporation, LLC, LP or LLP if you have to foreign qualify. You will have initial and ongoing fees and reporting obligations not only from your state of formation but from the state of qualification as well.
You may consider these additional obligations burdensome. But if your growth plans include expanding into new states, these fees and additional reporting requirements will become a necessary ongoing cost of doing business because state laws require foreign corporations and LLCs (as well as LPs and LLPs) doing business within their borders to register. And they will penalize those that don’t comply with their foreign qualification requirements.
The most serious consequence is that states deny non-compliant companies the right to bring or maintain a lawsuit or other legal proceeding in their court system. This means that a company wouldn't be able to sue to recover damages or to enforce a contract. (Although it will be able to defend itself.)
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 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.
Generally, you can “cure” the 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 if you are allowed the option, you will have delayed your lawsuit, and the corporation, LLC, limited partnership or limited liability partnership will have to pay penalties and interest to the state based on the time you were doing business without authority in order to qualify.
It’s risky to consider letting this situation take place, when it is so easy to prevent.
Another costly consequence to failing to qualify if your business entity meets the state’s registration criteria is that states will assess fines, penalties and back taxes for the time the company was transacting business without obtaining a certificate of authority to do so. In some states, individual officers or agents may be fined as well.
What Is the Foreign Qualification Process?
Don’t let your company be penalized by failing to foreign qualify in each state where the company is doing business. Qualification is necessary to provide your company with the authority it needs to conduct business within a state’s borders. 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 – Determine if the 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 (that is the name on the company’s formation document) is available for your company to qualify and do business under. 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 its name is not deceptively similar to another name on the state’s records.
If your legal name is available, you should reserve it. 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: Do not confuse the fictitious name a company is forced to qualify under because its name was not available with an “assumed or dba name”, which is a name, other than its legal name that a company voluntarily decides to do business under.
- Step 2 – Appoint a registered agent in that state 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, sole proprietorship or other business entities 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 existence or certificate of good standing from your home state
Before granting approval for the certificate of authority, many states want to ensure your company is in "good standing" in the state of formation. Most states require submission of a certificate of good standing (also known as a certificate of existence or certificate of status) which states that your company has met all the necessary requirements for corporations, LLCs or other entities imposed by your state of formation.
Companies fall out of good standing most frequently by failing to file their annual reports or failing to pay their franchise taxes. If your company is not in good standing, you will have to return it to good standing by filing any reports that are due and paying any taxes that are due, along with interest and penalties (if any).
- Step 4 – File qualification documents After taking care of the name, registered agent and certificate of good standing issues, you can fill out and file an application for a certificate of authority in that state. The process is similar to filing Articles of Incorporation or Articles of Organization. The appropriate documents must be prepared and filed, and the appropriate state fees paid. In some states this can—or has to be done online—while in other states the documents can be mailed.
Each state requires different information to be included in this document. Common information includes 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
Additional information is often required in certain states. Examples of this include the following:
- 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
Turnaround time for receiving state approval for a foreign qualification varies greatly by state. Most states will allow you to expedite the filing for an additional charge. This can significantly reduce the turnaround time.
Foreign Qualifying vs. Incorporating in Every State: Pros and Cons
An alternative to foreign qualifying is to incorporate your business or form your LLC in the other state(s) in which you plan to do business. The primary difference is that when you incorporate or form your LLC in multiple states, your company becomes domestic in each of those states, thereby creating separate business entities. Consider these important implications if you make this choice:
- Increased corporate formalities. For corporations, the increase in corporate formalities is the biggest disadvantage of forming separate domestic corporations. Corporate formalities include drafting and maintaining bylaws; issuing stock and recording all stock transfers; holding initial and then annual meetings of directors and shareholders; and keeping minutes of all director and shareholder meetings with the corporate records. LLCs do not face the extensive formalities imposed on corporations.
- Separate owners and management. When you create a separate corporation in each state, each has its own stock, shareholders, directors, and officers. Even if they are the same people for each, the formalities apply for each domestic corporation, greatly increasing the annual record-keeping requirements.
- One company versus separate companies. Conversely, if you foreign qualify, only one corporation or LLC exists. For corporations— regardless of the number of states in which it foreign qualifies—it needs only one set of bylaws, stock, shareholders, directors, and officers. Bylaws will need to be adopted only once, and the holding of and record-keeping for the initial and annual meetings of directors and shareholders happens only once. This can make foreign qualification more attractive.
- Separation of liability between businesses. Forming a new corporation or LLC in each state provides liability separation. This can be a big advantage, depending on your situation. Say for example, you own two stores in two different states. You form two separate LLCs to own them. One of the stores goes bankrupt. The assets of the LLC owning the solvent store cannot be used to pay off the debts of the LLC that owned the bankrupt store. If you formed just one LLC and qualified in the second state all of the LLC’s assets can be used to pay off the debts caused by the bankruptcy of the one store.
As you can see, expanding your business into new states raises many considerations. Will you have to qualify? And if so, do you know all the steps involved? If you have questions regarding your specific business situation, such as whether you should foreign qualify or incorporate in other states, it’s best to contact your business attorney for advice. And if you need help with any of those steps, such as checking or reserving a name, appointing a registered agent, obtaining a certificate of good standing, or filing the qualification documents you might seek the assistance of a corporate service company such as BizFilings.
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