Critical Principles of Foreign Qualification
What does it mean to qualify to do business in a foreign state, and is it something your company needs to do? What happens if you don’t qualify and what are the legal ramifications? If you’re a corporate attorney, are you prepared to advise clients on the matter?
Not all business activities require you to qualify, but failure to do so can leave your company facing negative consequences.
Join CSC for a complimentary webinar by Darrell Pierce and Beth Lyden of Dykema Gossett PLLC, on state foreign qualifications, recent case law, and critical principles of conducting business outside your state
Disclaimer: Please be advised that this recorded webinar has been edited from its original format, which may have included a product demo. To set up a live demo or to request more information, please complete the form to the right. Or if you are currently not on CSC Global, there is a link to the website in the description of this video. Thank you.
Annie: Hello, everyone, and welcome to today's webinar, "Doing Business Outside Your State: Critical Principles of Foreign Qualification." My name is Annie Triboletti, and I will be your moderator. Joining us today are guest speakers Darrell Pierce and Beth Lyden from Dykema. And with that, let's welcome Darrell and Beth.
Darrell: Thank you.
Beth: Thank you.
Darrell: As you all know, and welcome everyone to today's webinar on state qualification and doing business. As we all know, we are a country of 50 sovereign states. And that has some good effects and some bad effects. Without debating those today, we can observe that there's the possibility at least that on a given issue, there might be 50 different rules that are applicable.
And at the same time, we do need to smooth things out, and there are various steps that are taken to do that, one of which is in our constitution that protects interstate commerce and prevents states from impairing interstate commerce. So a state cannot regulate outside of its own borders or impair the business between two states too much.
Even though, as we will see, states do want to regulate, they want to regulate substantively, they want to protect their citizens' contract rights. Injuries from ports need to be addressed. States, of course, want to maximize their ability to tax even to some extent, as we will see, what might otherwise be thought to be interstate commerce because the states, of course, need revenue.
And then we get down to qualification to do business in order to have the opportunity to pay franchise taxes and to register to be amenable to service of process in the state.
So today's discussion primarily is going to be, given this tension and the constitutional framework, when is there sufficient contact with a given state, such that that state can regulate?
I'm sorry, I'm going to interrupt myself, because just outside my window, there's a turkey walking by, which is pretty fascinating.
At any rate, let's take a little time to discuss a couple of key constitutional cases that were decided by the Supreme Court. I'm going to talk about the Daimler case, that was decided in 2014. That involved an injury with an automobile, a Mercedes, in California. The Mercedes U.S. entity was, of course, a party to that lawsuit as were various other folks. But the plaintiff attempted to bring in Daimler, a German company, not just a foreign state entity, but a total foreign country entity into the litigation.
And the case went up to the U.S. Supreme Court, and in a somewhat maybe surprising, maybe not decision, but finally, the Supreme Court addresses this issue at least in the context of long-arm service of process of jurisdiction for tort, and whether Daimler through its economic activity, indirectly in the United States and particularly California, had done enough to make itself subject to general jurisdiction in the State of California, because noting the product, the tort alleged there did not occur in the State of California.
At any rate, the Supreme Court held that a corporation needs to be essentially at home in order for a state to have general jurisdiction. And that means for the foreign state, i.e., "it's got to be the jurisdiction of organization and principal place of business," said the court.
Now, I'm not sure if we should read too much into that end, because, as we all know, many of our larger corporations are incorporated in Delaware, but their principal place of business is not in Delaware.
I suspect what Daimler tells us is that the state of incorporation and the state of principal place of business has general jurisdiction over a corporation, but other states do not, where the corporation is not "essentially at home." Indeed, the Supreme Court said that "substantial, continuous, and systematic course of business" is not enough.
So regular, actual doing business isn't enough to confer general jurisdiction over a corporation. So let's bear that in mind as we move forward. And also there's another Supreme Court case, Beth, that involved taxation.
Beth: Yeah, so we are going to be discussing Wayfair. It's about two years old now, and it involved the state wanting to be able to collect tax and revenue from sales, online sales to their residents. They constructed an act that would require out-of-state sellers to collect and remit sales tax, even if they did not have a physical presence, which was the precedent being placed by the Supreme Court.
So they did set certain parameters. The business that would be taxed, they have to deliver more than $100,000 goods or services into the state or engage in 200 or more separate sales transactions. The Supreme Court decided, yes, sales within the state supplied a sufficient nexus that would support state taxing and sales, regardless of whether or not the seller had a physical presence in the state.
Yeah, so taxation, states are highly motivated to collect revenue. And the Supreme Court has decided that, given our economic realities, that online sales, if you're selling to the residents of that state, we'll be able to tax you. Assuming that they're able to make, they're able to satisfy other requirements, protection under [inaudible 00:07:51].
In this case, the act was limited by the revenue or number of transactions. So it'd be interesting to see in the next couple of years additional litigation based on other state statutes that are not so well-defined.
Darrell: In any event, there's three types of nexus with states for different purposes as to what might be sufficient. First is for general jurisdiction. As we can see from the Daimler case, that is somewhat limited and not a big topic. It's important and we'll touch on it again, but it won't be a focus of our conversation today.
The second kind of nexus is sufficient nexus for taxes. And as Beth explained in the Wayfair case, maybe in part because of the practical considerations of the internet these days, they're more liberal on allowing sufficient nexus for tax purposes, even though Wayfair had no contact with the State of Pennsylvania, I think it was in that case, or no, it's South Dakota.
And then finally, there is so what's sufficient nexus where a corporation is required by statute in order to qualify as a foreign corporation, because it's "doing business in the state," which usually means the corporation signs up. It needs to have a registered agent. It's now amenable to service of process in the state. It ends up paying franchise taxes, annual reports, and the like. And that is going to be the focus of our presentation.
If we could hit the next slide. I'm not seeing the slides, by the way, as to what's up, but I'm headed into slide number four right now. Slide number four, we're discussing the relationship between qualification and the tax nexus. If you qualify to do business, as a result of doing business, that usually creates a presumption that you're taxable by the state. It will usually at least notify the state authorities that you may have sufficient nexus for tax, and they may be on the lookout as a result for you.
Obviously, states are aggressive in seeking revenue, particularly these days. And for example, Michigan, while Michigan like many states, as we will, see doesn't really define in an affirmative way what constitutes doing business, in Michigan, it does say that lending, mere lending, mere taking collateral, merely acting as a mortgagee, for example, is not a sufficient nexus that requires one to qualify to do business.
On the other hand, though, the tax authorities in the state have taken the position that if you earn $60,000 a year in income from Michigan borrowers, that's sufficient for the out-of-state lender to be taxed, even though the lending itself is not doing business.
That is not a very large . . . $60,000 a year worth of interest income is not a very large dollar amount of loans, particularly in the commercial lending area. As a result, it's almost impossible to give not subject to tax opinions, particularly in states like Michigan, and all states have their own courts because the states are being aggressive.
So to get the opinion, if you can, it's not a very satisfying opinion because it assumes away so much that it doesn't give the recipient much comfort at the end of the day.
So let's move on to our focus of foreign qualification. Beth, do you want to talk about doing business?
Beth: Sure. So foreign qualification, basically that's when a corporation applies for authority to transact business in a state that is not the state of formation. The process is fairly simple. The formed corporation will first check to see if their name is available. If not, they'll pick on an assumed name. They will pay a qualification fee and file an application for authority with the state filing office, usually secretary of state.
The specifics for what fees get paid, what needs to be filed, what supporting documents are required to be submitted, those will vary from state to state. So you have to take a look at each requirement. But generally, if you're a foreign corporation and you want to transact business within that state, you need to qualify.
So in addition to the initial filing, you'll typically have ongoing maintenance and filing requirements. So annual reports, as Darrell mentioned, all this is motivated by revenue. They want to be able to get payments for filings. You'll have franchise tax payments in Illinois.
Also, as Darrell mentioned, there is a process. You will either identify a physical location within the state, your own offices, or you can hire a service company that will act as your agent for service of process within the state. So that provides an avenue for an address for that state's citizens.
So fairly simple procedure. When do you do have to do it? And that all depends on what is doing business within the state? This is going to be very fact-specific. Each state will have little quirks. But for the most part, the scheme is the definition of doing business is more in the negative than anything else. They will list out activities that are not doing business. This allows them more flexibility to say that, "No your activities do amount to doing business within the state. You should have qualified and provided a revenue stream."
Yeah, that'll be our focus for the rest of the presentation of what doing business is and the consequences when you fail to qualify and you are transacting business within a state. Darrell, shall we move along?
Darrell: Okay. Let's talk a bit about a Catch-22 that arises. I know the focus here is doing business, and that seems relatively benign. You register, as Beth explained. You file some annual reports. You've got franchise taxes. Okay, that's not so bad. What's the problem?
Well, one problem is that some states, Pennsylvania, for example, takes the position that if you qualify to do business, you have consented to general jurisdiction to be sued in the state from whatever, regardless of specific contacts or specific actions.
Maybe you didn't ship a defective product into the state, but all the actions you took were service-oriented and taken outside the state, but Pennsylvania says no, you can still be sued in Pennsylvania because you're subject to general jurisdiction, because you qualified to do business here. And our statute says that when you qualify to do business, you consent to jurisdiction. And notwithstanding the Daimler case, there is a long-standing rule that if you agree, by contract or otherwise, that you're submitting to jurisdiction, that works. You can override the other necessary contacts and consent to jurisdiction if you want to do it.
So this is a somewhat often overlooked concern, but I think we're going to suggest through the following discussion that there could be some pretty significant adverse consequences. We're going to talk about some cases that happened in 2019, in the Eastern District of Pennsylvania, which were followed up by two similar cases, also in the Eastern District of Pennsylvania in February of 2020.
Perhaps the reason why the Eastern District of Pennsylvania is the locus of all this litigation is probably a couple of reasons. First of all, the Third Circuit in the Bane case years ago, preceding the Daimler decision, held that consent to jurisdiction occurred as a result of registration. And so that standing Third Circuit law which covers the Eastern District of Pennsylvania, maybe because the Eastern District Philadelphia area has, you know, got a lot of lawyers, so it's a strong legal community and a litigation site. But at any rate, the cases got started.
The first one was the Sullivan case in 2019. And we're not going to go through all of the details, but the salient facts are all these cases involve tort claims, potential plaintiffs who are seeking to use the Pennsylvania court.
In the Sullivan case, it was a Pennsylvania plaintiff who had died of asbestos exposure, and they're suing a company that had not registered and, well, had not been otherwise amenable to jurisdiction in Pennsylvania, except that they had qualified as a foreign corporation. And, as I've described, the Pennsylvania rule says, well, when you qualify, you've consented to jurisdiction.
And the judge in that case, reasoning through the existing Third Circuit decision in light of the Daimler decision, decided that Daimler effectively overruled the Third Circuit, and that for the court to enforce that registration qualification resulted in consent to jurisdiction was implicitly prohibited by Daimler. So the court said, no, you cannot sue this company in Pennsylvania.
Within a few weeks, another case came up. Beth, would you like to talk about the . . . I don't know if I'm pronouncing it right, but the Sciortino case?
Beth: I was not pronouncing it like that, but that sounds right. In that case, another question . . .
Darrell: Sciortino, I don't . . .
Beth: So in that case, it's also a tort case. A resident in Pennsylvania was out on a hunting excursion where he slipped and fell because of his wader boots that were manufactured by Defendant Pure Fishing. In this case, Pure Fishing, they were incorporated in Iowa. They had a principal place of business in South Carolina, and they also had facilities in Missouri and Pennsylvania.
So in this case, the judge reasoned that Daimler did not speak to whether or not an entity could consent to jurisdiction, that this is a third avenue that was not expressly touched in Daimler. So there is nothing wrong with following Third Circuit precedent, and then see by qualifying to do business in Pennsylvania consented to general jurisdiction.
So a few more cases have popped up. As Darrell mentioned, in this past February, just one day apart, two additional opinions came out following the Third Circuit precedent of permitting general jurisdiction by consent, consent being provided by registering as a foreign corporation. But in each of those opinions, the judge stated that they're following precedents. That they're hoping that the Third Circuit Court would see to this issue. So it'd be interesting to follow this set of cases in the next couple of months. Hopefully, they will come down with a firm answer.
Darrell: Yeah, I think at first blush we kind of thought maybe these cases were distinguishable on the fact that Pure Fishing indeed had a facility in Philadelphia with 48 employees, which creates some contact with the state. Albeit it was a different division than the Hip Wader Manufacturing Division. But they also availed themselves of the benefits in Pennsylvania because they took down tax credits for research and development, which was another factor.
But the more recent cases, one involving a plaintiff who resides in Delaware has his law office in Philadelphia is the only Pennsylvania contact. The plaintiffs spend their time between their homes in Delaware and Florida, and they're suing because Equifax was allowing phone calls to be made, you know, those annoying calls to be made to their Florida home. So the distinguishing features between Sullivan and Sciortino are really apparently not salient enough to resolve the does Daimler implicitly override Bane?
And the argument, you know, it makes some sense that if you have to qualify to do business and qualification means consent to jurisdiction, haven't you just backdoored an overrule of the Daimler case? But other courts are following the notion that, you know, Daimler did not decide that issue. It was a completely different set of facts, a German company, and it did not address the issue at all of whether if you qualify as a foreign corporation and then you end up consenting to general jurisdiction, is that somehow a problem? That issue was not in front of the Supreme Court in Daimler.
It leads us to speculate a little bit about what if the cases were so clean? And I think the answer is there's probably still a split. It's a fascinating set of issues. And we'll keep posted and see if the Third Circuit speaks to the issue, and that may, you know, send the issue back to the Supreme Court in one way, shape, or form.
At any rate, now we've kind of talked about these different types of nexus, what's at stake for those. Beth, why don't we continue with that and talk about the impact on your ability to sue if you're not qualified?
Beth: Thank you. Okay, so ability to sue. Most states they will prohibit an unqualified foreign corporation from maintaining lawsuits in that state until they obtain qualification. So, in that case, a plaintiff foreign corporation that is not qualified within that state, that case can be dismissed on the grounds that it lacks status to bring that lawsuit.
Most states, either by statute or case law, will permit that corporation to continue litigation after properly qualifying. Other states, they will actually look to restrict the potential pool of plaintiffs by using unless and move until. So at the time that they institute the lawsuit, they have to be in compliance with the qualification requirements of that state. So states, Louisiana is one of them, North Carolina, Texas, and Maryland. Those are the group of states that will try to limit the plaintiffs' pool.
Another variant of this would be a unqualified corporation can't maintain a lawsuit unless and until they have complied with the state's qualifications statutes. But that will generally have the same result as the until. So typically, the court in the unless and until situations, they will allow that corporation to cure its qualification, non-compliance issues. And sometimes they'll have to pay fees and penalties associated with that. But then, afterwards, they can either reinstitute the lawsuit if it was dismissed, or they'll permit the lawsuit to continue. So they've maintained throughout the process.
Just about half of the states have adopted the Revised Model Business Corporation Act, and those states will have provisions in their statutes that gives the court the right to state proceedings until the corporation has complied with the qualification requirements of that state.
That's going an extra mile. An example of that would be South Dakota. So, in the first stage, they can, the court is able to stay proceeding while they determine whether or not the corporation needs to qualify. And then, if so, they can further stay the proceedings until that corporation has qualified. This goes back to those non-doing business exceptions, safe harbors.
One of them, which we'll discuss later, is litigation. So that corporation, the unqualified foreign corporation will argue that they're just litigating the suit and that their actions within that state aren't sufficient to trigger qualification requirements. So that can be debated and argued. Failing that, they'll have to qualify.
Generally, this rule that foreign corporations will need to qualify in order to maintain the lawsuit, this will apply to successors in interest. There are two exceptions to this for Kansas and Oklahoma. Those will allow successors in interest to maintain a lawsuit without their predecessor having qualified.
A big question here, you can always defend a lawsuit if you're a foreign unqualified corporation, but whether or not you can raise affirmative defenses, that's a hard no. There's very express language in their statutes saying that an unqualified corporation is not able to affirm those defenses.
Whether or not you can assert counterclaims, that's going to vary from state to state, and we'd have to take a look at the case law because the statutes are not clear on this.
Yeah, I think that covers it. Darrell, would you like to move toward impact on contracts?
Darrell: Sure. Thanks, Beth. Generally speaking, contracts are still valid contracts even though a party to the contract is not qualified to do business in a particular state. You might not be able to enforce as a plaintiff, as Beth explained. You may not in Vermont, at least, to advance affirmative defenses or affirmative counterclaims in a number of states, but that doesn't mean that your contract is invalid.
You may or may not have language in your contract that also creates the nexus. As I noted earlier, it's quite possible to create jurisdiction by consenting to jurisdiction. And as we all know, it's not uncommon for contracts to have provisions in them that say, you know, the contract's governed by this law, and everybody agrees that if we initiate litigation, we're going to do it, or we at least consent to the jurisdiction of a particular state that opens that state up for the litigation, even if it's not an exclusive choice of forum. But those various provisions can affect this by contract.
And even, and throughout all of that, through your ability to cure, pay your past sins, pay your franchise taxes, interest, penalties, whatever, you can put yourself back into a position of fully enforcing all your contracts.
There's a case out of Idaho in the last year, the McGimpsey case that illustrates both this principle that contracts are still valid contracts, as well as the prior principle that Beth articulated, that you can cure, you know, confess your sins, pay your back taxes, and then proceed to enforce.
In the McGimpsey case, we had a landlord-tenant dispute. The landlord who was out of state and had never qualified to do business in Idaho. Under the terms of the lease that the tenant had defaulted on, the tenant had also contracted at the end of the lease to purchase the property for an agreed-upon price. And now the landlord comes and tries to enforce the contract to purchase. And the tenant argues that the landlord, because they had not qualified in Idaho, they couldn't maintain the action and they couldn't enforce a contract that was entered into when they were not qualified.
In order to maintain that litigation, of course, the landlord did indeed pay up all their back taxes to Idaho. They paid for their prior sins. And that enabled the lawsuit, and the court, of course, upheld both the ability to sue as well as the validity of the contract.
Another interesting feature of the case was that the court explained some of the history of this, and the early laws on qualification to do business were not intended to confer general jurisdiction. But the real thing that folks in the early 1900s were concerned about was getting corporations to appoint an agent for service of process, so at least when they came back to the state in some way, shape, or form, you could serve them or they'd be served, and then you could get some other jurisdiction, and you could proceed with your lawsuit. But at least you could serve them in your home state if you're willing to travel to the foreign state to sue.
And the case that was quoted from 1906, I love this. It's a quote from the court. "It was the practice of many tramp, predatory, rapacious foreign corporations, organized under the laws of nobody knew where, to violate contracts or injure folks in our state and yet avoid process."
Well, that's been solved these days. With that, Beth, why don't you talk a little bit about the financial impact of the franchise taxes, what's at stake there. And I know there's an interesting Illinois case.
Beth: Sure. And actually going back to service of process, if you were to cure the non-compliance of qualification in order to maintain the lawsuit, and you want to get out as quickly as possible after and end that litigation, you should probably take a close look at that state's laws regarding termination, authority do business, and whether or not, when you're terminating, you've appointed the secretary of state as your agent for accepting service of process. Some states do that, some don't. So check the fine print when you're terminating, just in case.
For penalties, so there is a lovely Illinois case, Global Mail v. White. It was in the First District Court of Appeals this past year, where a corporation, originally a Delaware corporation had applied for authority in Illinois. They paid their initial filing fees. They paid qualification fees, and they were operating on an annual basis delivering their reports, paying franchise taxes, no problem. After a couple of years, they create a wholly-owned Ohio subsidiary and merged into that Ohio subsidiary.
So the Delaware corporation was no longer existing. The Ohio Corporation was the surviving entity, which is fine. But they never filed the certificate of merger and applied for authority as the surviving Ohio corporation with Illinois Secretary of State. They did, however, continue to file annual reports and pay their franchise taxes each year, self-identifying as a Delaware corporation rather than an Ohio corporation.
Eventually, after a couple of years, they changed their description and identified themselves as an Ohio corporation, which went unnoticed for a year, and then they were late in filing their annual report after operating in Illinois for about 15, 5 years at that point.
And so once two months, this is very fast, because the state will be monitoring these annual reports because they get filing fees and they also get franchise taxes in Illinois. So if you miss an annual filing, the State is going to let you know. And Illinois Secretary of State reached out to Global Mail and said "Hey, you owe us franchise taxes this year, and you need to file your annual report."
Which Gobal Mail did. They paid their franchise tax for the year, filed their annual report, and both were rejected by the Illinois Secretary of State. The Illinois Secretary of State maintained that you incorrectly identified yourself as an Ohio corporation because you did not file a certificate of merger, so you owe us taxes for both the Delaware corporation and the Ohio corporation. And it was pretty substantial. The Secretary of State asserted that Global Mail owed them close to $700,000 for franchise taxes, filing fees, a penalty on the months that were owed, and an interest charge on the franchise taxes that weren't paid.
So this was litigated obviously, and Global Mail said that we're not going to pay you twice. When we merged into the Ohio corporation, the Delaware corporation no longer existed. But franchise taxes and the annual reports were continuing to be filed and paid. They were incorrectly attributed to the Delaware corporation, but the Delaware corporation no longer exists. And the Court of Appeals agreed with them on this case.
So there's no requirement to pay franchise taxes for both entities because, under Delaware law, that corporation no longer existed. And that's the controlling law, not Illinois law. It does not matter they did not file a certificate of merger, because the laws of Illinois do not control the inner workings of a Delaware corporation.
So the Secretary of State lost in that count. But what's interesting is they still tried to collect a penalty interest charges of 2% on the franchise taxes that were owed. The problem is this, the provision they're relying on, and the amount was about $80,000. For this 2% interest charge, it's a 2% interest charge per month that you're late in paying this.
That really applies for paid-in capital. And they're asserting that the application for authority for Global Mail, which was eventually filed as the Ohio corporation, that that would be a statement for the paid-in capital.
The Court of Appeals disagreed with them on that front, because that's really just for domestic corporations that you'd be relying on the certificate of applicants, the application for authority. And so that was no longer an issue, but there was a penalty of 10% on the original filing fee of $150 for the Ohio corporation and on the thirty odd thousand dollars for the initial franchise tax that they should have paid when they became the Ohio corporation.
So, as a result, they ended up owing about $35,000, because they had paid already the franchise taxes throughout all those years. If not, then it would have been significant tax liability of about $400,000 I think. So it adds up pretty quickly.
Again, Illinois is kind of special because they have a franchise tax based on the paid-in capital, but other states . . . They're not so unique that they're the only state that has franchise taxes. So it's not like . . . but this is a really good example for just how quickly those amounts can add up and the penalties that get added on to back taxes.Yeah. It helps to be aware of each jurisdiction's requirements and penalties for failing to qualify. I think that wraps . . .
Darrell: Yeah, there's some other numbers illustrated on the slide here that, you know, the point is that a relatively small number can rapidly grow because of the interest and penalty charges. It struck me as a little bit shocking that Illinois took the position that they did in the Global Mail case. It smacked of double-dipping, and I think that's where the court came out to the state's entitled to its taxes, but for one company, not two, that indeed there was only one operative foreign corporation in existence at any point in time.
I wonder, however, if the original corporation had been an Illinois corporation that merged into a Delaware corporation, you might have a little different outcome, because while under Delaware law, the Illinois corporation ceases to exist and is merged into the Delaware corporation. Under Illinois law, until the certificate of merger is filed, that's not the case. So I don't know. I guess the moral of the story is make sure you file all your certificates of merger when you undertake those transactions.
In addition to the possibility of increased franchise tax exposure, some states impose personal liability on officers if you do business in a foreign state without qualifying. Those states are listed here. California being a notable one. Delaware I suppose, somewhat ironically, because they're wide open for their own corporations, generally speaking, but if you come into Delaware as a foreign corporation, your officers can be personally liable. Louisiana, Maryland, North Dakota, Ohio, Oklahoma, Utah, Virginia, and Washington.
This may be a civil situation with a fine. It may be criminal. It is in some states, although just a misdemeanor. But generally speaking, our officers and directors like to avoid criminal liability.
It's not a big issue. As you can see Louisiana, for example, the fine is $25 to $500, but you could be in jail for three days to four months if you don't pay. And in Delaware, the agent can get fined for each offense. So it's again, it's not that it's such a draconian penalty, but it is a criminal or a civil violation, and folks would be well advised to avoid that, of course.
Excuse me. The right button. And so to finish up with what's at stake, and I'll hand it back to Beth to talk about, you know, at least what's not doing business.
Even without a lawsuit exposure, general jurisdiction problems or heavy franchise tax penalties, there can be some other consequences, that if you haven't paid other taxes that you should have paid, that you would have been exposed to as a result of qualification. Of course, you're going to have to make good on those, like sales taxes, local business licenses, and so forth.
You may also create problems under your other transactions. For example, it may not be a big deal, but you're probably making representations in loan documents, merger transactions, and commercial contracts that your company exists, is duly organized, validly existing, and qualified where it needs to be qualified. And while it may not end up being terribly material, having to go through the process of addressing a violation of rep and getting a waiver or a modification is something to be avoided.
This may also in appropriate circumstances if there's some level of materiality which may arise as a result of lawsuit exposure, this could have an impact on SEC disclosures for public companies and/or require additional disclosure.
And I hope that it doesn't impair transactions because of legal opinions, mostly because the practice of opining on foreign qualifications has essentially ended. We realized that nobody ever says you don't need to qualify. That's an impossible opinion to give. Firms would just give the affirmative, they're qualified in the following states, with the qualification to that opinion that it's based solely on good standing certificates or other appropriate certificates they've received from the state officials.
So people came to realize pretty quickly that the opinions were not worth very much. Anybody can read the good standing certificates as well as anybody else. And paying a law firm to essentially list what they've reviewed is probably not very cost-effective.
So I have not seen a foreign qualification opinion in a long, long time, and no one ever in my experience gave the opinion, except in rare circumstances, I shouldn't say ever. Maybe once or twice I've seen the opinion that a lender did not need to qualify in a particular state as a result solely of engaging in that particular loan transaction.
So with that, I'm going to hand it back to you, Beth, and let's start down the easy path of at least defining what's not doing business.
Beth: Thanks. So, generally, there's going to be about a dozen or just under exceptions that are safe harbors. These activities alone do not constitute doing business.
So the first one would be maintaining a bank account within that state. This is a fairly standard exception. There are a handful of states that do not have this exception. I'm just going to flip forward. These are going to be Alabama, Delaware, D.C., Ohio, and Oklahoma. And you can still argue it, but there's not going to be a statutory safe harbor for those guys.
Generally, cases will look to whether or not there's additional activities that would require qualification. So bank accounts by themselves, not an issue. Bank accounts plus, that's very fact-specific and will depend on that particular case.
The next one would be meetings of shareholders and directors, generally internal affairs of that corporation. So this would be for isolated business events, such as like conventions or conferences, meetings of the directors and shareholders. That would not constitute doing business if they're just meeting there.
For more of a question, let's say there's an employee in that state, but you're going to have to look at what activities that employee is doing. Are they dealing with matters that are essentially internal affairs of that corporation, or are they doing something more? So examples of internal affairs would be business plans, what the corporation's priorities are, the high-level business plans, hiring recommendations. Those are really internal affairs. So, again, very fact-specific and will be determined on a case-by-case basis.
Next one would be engaging in litigation. If the only activity you're doing is maintaining that lawsuit, you should be safe. But if there are additional activities, then you cannot use the safe harbor. Maintaining your lawsuit alone will not trigger the qualification requirements. But again, case-by-case basis. You really have to pay attention to what other activities could possibly be tied in.
Some courts make a distinction between commencing a lawsuit and maintaining a lawsuit. So if the statue says an unqualified foreign corporation may not maintain a lawsuit until they've cured their non-compliance, then most courts have interpreted this to be that they commence it. That's not prohibited, but they do need to qualify in order to continue maintaining that lawsuit.
The next one would be maintaining depositories or transfer agents for the securities of that corporation. If that's all you're doing at that location within the state, you should be fine. But once there's an office and a physical presence in the state, things slide. So you have to keep track of what activities are actually being transacted at that office.
If it's just securities related, then this is a good safe harbor. If there's more going on via books and records, inventory, additional staff and employees, they're conducting ordinary business, then this will not be a safe harbor. So it's something to keep track of.
The fifth one would be owning real or personal property in the state. More than half the states have this exception. But there aren't too many cases on it in the context of qualification. Some states have added qualifiers to this exception, saying that if it's an executor of the will or administrator of an estate, owning real or personal property will not trigger the qualification requirement.
Others follow completely different formulas. In Louisiana, as long as that property is not part of their regular business activities, then that will not trigger qualification requirements. Each state is going to have a few nuances to it, so you really have to familiarize yourself with any state that you're potentially considering qualifying in or conducting any activities in.
In North Dakota, if you have any income-producing property, other than a few specific exceptions of mortgages, security interest, and liens on real estate, personal property, then you're going to have to qualify. Same with Maryland, actually.
For the sixth exception, engaging independent contractors. So courts are going to be looking at the relationship between the foreign corporation and this contractor, and they're going to be looking at how the transactions at issue actually played out.
So as between the corporation and the contractor, they're going to look at how that person is being paid. Is it on a commission? Is it a salary? Whether or not the corporation supervises the day-to-day operations of this contractor, or is the contractor just able to handle their own business and fairly independent? Whether or not that contractor, their activities for the transaction were localized so it's all within the state. They're truly just acting as an agent for the corporation within the state. There's no decision-making capabilities for that contractor.
The final decision is in the corporation's headquarters. That's a huge one, actually.
Making loans and taking security is a fairly recognized one. Most states agree that creating mortgage and debt, and enforcing mortgages and security interests and collateral does not require that corporation to qualify.
California, as usual, is an outlier. They're generally okay with creating and putting mortgages on property, but they limit who can actually collect on that to foreign lending institutions.
Each state, you're going to have to look at the statute and the case law for that state. Like some, New York, they're going to be focusing on whether or not the activities constitute continuous, ongoing, and regular activities within that state, in which case you'll be doing business. In Virginia, whether or not creation of that debt or collecting on that debt are incidental to their regular business, if you're in the business of lending, then it's only incidental that it happened to be within that state.
Some states have a specific exception that exempts federally chartered banks from these qualification requirements. That's more of a federal preemption question, and they're making that explicit.
For interstate commerce . . . and all these are somewhat related. The big question here is whether or not the interstate activities are merely incidental to the interstate commerce, or if that activity is like routine, local in nature, so it constitutes like carrying on of like their ordinary course business. One example would be of . . . yeah?
Darrell: We're bumping up on time.
Beth: Oh, sorry. So you have to think about the nature of the activity.
Darrell: Let me jump in. And I'm going to take the next two slides and you touch on the last two quickly.
Beth: Yeah, sure.
Darrell: Because I think Beth has actually covered this ground in the detail of topic-by-topic. First of all, it's absolutely clear that if you have a physical presence, an active physical presence in a state you're doing business. Two, it's absolutely clear if you have employees in the state, that's almost certain, unless they're engaged in merely in an isolated activity.
And engaging in intrastate commerce, doing a deal purely within the state is obviously doing business in the state.
And I think as you were aptly illustrating, Beth, as you went through each of these that while this analysis is cumulative, you might engage in an exempt, not doing business activity. But if you engage in that multiple times or you engage in a multiple iterations of not doing business activities, at some point that's going to add up to doing business, even though each separate action on its own was not enough.
For example, a sales rep is not enough, particularly if they're an independent contractor, maybe not just a single employee, and having stuff in somebody else's warehouse is probably not enough. But you start putting those things together, and it may well be enough, and you have to deal with non-uniformity.
And with that in mind, Beth, why don't you just give us the last little bit on bank accounts and other registration requirements? Thank you.
Darrell: Go ahead, Beth.
Beth: Yes, thank you. So these are the five states that don't have a specific safe harbor for bank accounts. You're going to take a closer look at case law and whether or not there are additional activities, so if it's bank account plus versus just bank account.
And this last slide, there are some states that are going to require you to register if your activities are interstate in nature, but they're still happening in that state. So you would have to register or qualify as a foreign corporation in these states even if it's not interstate.
Darrell: You don't have to qualify, but you've got to give them a heads up that you're selling into the state. It's like a heads up to the taxing authorities to keep an eye on you.
Beth: Yeah. That's actually good description of it.
So general rule is if you want to operate in a jurisdiction that's not your hometown, then you really need to take a look at the qualification triggers and requirements.