What does it mean to qualify to do business in a foreign state? Is it something your company or client needs to do? What happens if a company that should qualify does not do so? What regulatory issues should be considered?
Not all business activities require you to qualify, but failure to do so can leave your company facing negative consequences. Are you prepared to properly advise your clients on the matter?
View this recorded webinar, by Lisa Jacobs and Keith Greenberg of DLA Piper and Helena Ledic of CSC, on doing business outside your state, and pointers for foreign qualifications.
The webinar will bring to life Qualifying to Do Business in Another State: The CSC 50-State Guide to Qualification. Attendees will have the opportunity to learn about best practices, ask our presenters about formations and qualification guidelines during a general review, learn their impact on your business, and understand what to do to protect clients. We’ll also touch on some common CSC customer qualification questions.
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's 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: The Nuances of Foreign Qualification." My name is Annie Triboletti and I will be your moderator. Joining us today are Helena Ledic, Associate General Counsel from CSC, and guest speakers Keith Greenberg and Lisa Jacobs from DLA Piper. And with that, let's welcome Helena, Keith, and Lisa.
Helena: Hello, everyone. This is Helena speaking. Before we actually launch into anything anymore, what we just want to let everyone know is that the views that are being expressed today are only by our presenters and are not necessarily the views that are shared and endorsed by DLA Piper, LexisNexis, or CLE. And of course, our presentation is for information purposes only and does not constitute legal advice.And with that, what I'm going to do is turn things over now to both Lisa and Keith to start us with our CLE. Thank you.
Lisa: Hi, everybody. This is Lisa Jacobs. And I understand we have a rather large group, so, hopefully, everybody can see and hear.
Two more cautionary notes. This presentation is really intended to constitute an overview of the foreign qualification process. We should note that every state is unique, not only in its statutory scheme but also in case law interpreting that statutory scheme. Every situation presents a very unique issue and requires a careful analysis of relevant facts and circumstances as well as applicable state law, both regarding foreign qualification and otherwise.
Accordingly, we're going to try to stay away from specific situations and specific questions you may have regarding your state and encourage you to learn all about your state's own qualification statutes. So with that, we'll launch into this from a more generic standpoint.
Just about every state and jurisdiction in the United States has adopted some sort of statutory scheme that requires an entity to be qualified or registered to do business under certain circumstances. Most of the states have adopted some form of the listing of what is and isn't doing business schemes that comes out of the Model Business Corporation Act or the Revised Model Business Corporation Act.
But some states do deviate substantially. For example, Alabama doesn't have any guidance whatsoever, does not have a statutory scheme on what constitutes doing business. Ohio does but it's not from the RMBCA. Delaware and Oklahoma have adopted just a small portion of the MBCA standards and have otherwise filled in very similarly to each other. I think Oklahoma mirrors Delaware. And then, Massachusetts does deviate significantly, in many ways, from those things that the MBCA says is not doing business. That formulation, "not doing business," we'll get to in just a moment. But every state does have a requirement that says, "If you're an out-of-state entity and you want to do business in our jurisdiction, you need to be registered."
So the real question is, "What is doing business?" Foreign qualification or registration, which is the statutory language used in many states now following the Uniform Law Commission's formulation of entity acts, is the procedure by which a corporation, LLC, or other business entity receives a grant of authority from a state to actually transact business in a state other than its formation state.
It is often referred to as registration. I think that the preferred language for this presentation will be "qualification," but if your state says registration, please just replace it in your mind as we go through the slides.
There is almost always a fee. Of course, it's a revenue-generating process. And the entity will file with the state-filing office, typically a secretary of state, a document that is generally known as an application for authority.
Typically, these forms are short, one or two pages, although I've just learned that at least one state has one that is six pages long. So again, check your state's filing requirements.
Once qualified, the company will then be subject to some ongoing, typically annual, compliance requirements. For example, if it doesn't have a physical presence, it will have to maintain a registered agent and a registered office and, in many cases, will need to file an annual report.
Each of those things is revenue generating, so those things are going to be monitored carefully. Certain jurisdictions will kick a state out of qualification if it loses either its registered agent or fails to timely file an annual report. Delaware is one that quickly comes to mind. There is very little grace accorded in Delaware.
Okay. I mentioned physical location just a moment ago. If a company does have a physical location in a jurisdiction other than its state of formation or incorporation, it need not have a separate registered office, and one of its own officers may be appointed as its registered agent.
But even if it does, oftentimes, a company will use a service company, such as CSC, for both convenience and to avoid disclosure of an individual's name, if it really doesn't feel like doing that.If a company is supposed to be registered or required to be registered or qualified in a foreign jurisdiction, it will almost always be subject to the maintenance requirements I mentioned before and oftentimes will find itself subject to taxation, service of process, and ongoing other maintenance requirements.
Helena, I think you've got some points to add on some of these things.
Helena: Yes. You know, as we were discussing this, as we were preparing things . . . Lisa, why don't you tell us a little bit more about why entities want to avoid qualifying? I mean, it's the really obvious one, right? But it's something that bears repeating again.
Lisa: Yeah, there are, again, three main reasons. They're on the bottom half of this slide, and we will get into a little bit more detail later as to why, if you register and a state decides, "Well, now that you're doing business here, you are therefore subject to the jurisdiction of our courts for all purposes," you've waived certain defenses you might otherwise have. We'll talk about the Daimler case and it's progeny and some of its outgrowths later.
The taxation issue is another obvious one. In certain circumstances, it may very well be that taxation drives registration. For example, if a company has employees in a jurisdiction, it's going to have to pay certain employment-type taxes. Typically, that means you're going to have to have some sort of revenue account with your foreign jurisdiction.
And once you have a revenue account, the Revenue Department is going to talk to the State Department and say, "Hey, we've got this entity paying employment-withholding taxes but we don't see them qualified here." And then, there's the dunning letter, and fines, and penalties, so one drives the other. And of course, at that point, one Department of State is going to talk to one Department of Revenue, and now you'll have to be qualified to do business.
So employees are a very unique issue, and we'll get to the implications of that in a moment. But to avoid taxation and to avoid being subject to long-arm jurisdiction are the two biggest ones that come to mind.
Helena: Very good. Thank you.
Lisa: You're very welcome.
It took me a little while to delve into the sort of history of foreign qualification. So I was not all that surprised to see that one of the reasons why states like to enforce registration requirements is, of course, revenue. If somebody is required to file an annual report and pay an annual fee, it's revenue for the state. If they're required to pay fees to be registered, it's revenue for the state. If that allows the state then to start building a case for taxation, it's revenue for the state. So that one was all pretty obvious to me, but some of these other ones were less obvious.
Facilitation of service of process, which is the middle bullet on this slide, is an important state interest to be furthered by a registration process. Clearly, a state wants to protect its citizens from the actions of "foreign entities." So to the extent that there can be service of process effected because a foreign company is registered to do business, whether it's through a company like CSC or not, then it makes it easier for the state to protect the interests of its citizens and protecting their rights via lawsuit.
There is also a very paternalistic protectionist view, which is that by requiring a few extra hurdles for a foreign company to jump through, there is some semblance of protecting the domestic state doing business in the state and not permitting an unfair advantage to foreign companies over the state companies, particularly when it comes to the burden of doing the registration and annual report filings and the payment of taxes.
And then, finally, there's transparency. More and more states these days are modifying their foreign qualification requirements to move into some of the more intrusive requirements of naming an individual versus an owner that may be an entity, requiring the disclosure of Social Security Numbers of individuals versus a company corporate number to get things like state authorization to do a business number.
So, along the lines of Big Brother intrusion everywhere, and you can understand where my views are coming from, this whole registration process, together with the increasingly burdensome requirements states are imposing, does create a layer of transparency, which, if it doesn't go too far, can be good.
So what does require foreign qualification? The concept is "doing business." And I typically put "doing business" in quotes because it really is a term that is not easily defined.
So what is "doing business"? You really do have to look at each statute in your own jurisdiction. Each state defines it just a tiny bit differently. And while, again, there is some similarity in the standards for each state, and many of them are adopting close to whole cloth the requirements created by the MBCA, they're not identical. And we'll get into a few of the distinctions in slides to follow.
There's no state that I know of, however, that actually defines what is doing business. They almost always define what is not doing business in a particular state. And this could lead to confusion, but, as you can imagine given the last slide, states want the flexibility to be aggressive and to take a position and support a position that an entity is doing business. So that's why this formulation exists.
There are some pretty clear thresholds though, and if a company, an entity, is meeting these thresholds, you can be pretty comfortable that it is going to be required to be registered to do business in a different state. And those are listed on this slide.
If there is a physical office, a warehouse, a press office, a store, a restaurant, then you can rest assured you are doing business in that state. Sometimes warehouses that are just housing inventory for further distribution might not meet that standard, depending on a state's statutory scheme. But a physical location, a physical presence within a jurisdiction, will almost always require an entity to be registered qualified to do business in that state.
Another one that's close to universal is employees. If a company has employees in a jurisdiction, then the company is going to be paying those employees and paying the relevant state and federal taxes with respect to their salaries.
And as I mentioned before, typically, that requires setting up an account with the Department of Revenue, or whatever it's called in your jurisdiction, and almost always that triggers a requirement to be qualified to do business. In many cases . . .
Helena: Lisa . . . I was going to say, Lisa, if I may interrupt for just a moment here. We talked about this. What about those companies that have home-based employees, you know, maybe that somebody works remotely in the mountains or they're on the beach and they're that one-off from that company? What is your perspective on that? How do you counsel your clients?
Lisa: Well, the first thing I ask my clients is, "Is that person really an employee or are they an independent contractor?" and that creates confusion altogether. But hypothetically, if they're an employee then there's no getting around having to pay the employment tax and creating that revenue account. So from a conservative standpoint, I typically counsel my clients who have remote employees, even if they're just home-based, web-based employees, that they need to be registered in that jurisdiction.
Now how do we register them? Well, once again, we could use a service company like CSC to act as a registered agent, or since we actually have a physical person, we could use that employee as the agent. And if that employee doesn't mind disclosing his or her home address, we can use that home address as its location. But a lot of times, they don't want to do that, so once again, CSC to the rescue.
Did I answer your question?
Helena: Oh, yes. Thank you.
Lisa: Okay. You're welcome.
I did get to the question of independent contractors, and obviously, there's a continuum on a scale of what is and is not an independent contractor. Clearly, a distributor, a wholesaler, a fulfillment house, other agencies that are separate entities, they're independent contractors and they could be contracted to function in a quasi-employee-type status. But that doesn't turn them from an independent contractor into an employee.
Then you get, let's say, the computer expert who's on call 24/7 but doesn't work 24/7, and may have one or more clients. Now it starts to smell a little bit more like a remote employee. And then you get the same version of that character who doesn't have any other clients, just your company. And yet, they call that person an independent contractor.
I would caution anybody who is using that artifice to avoid having an employee, and therefore, avoid having to have a company qualified or registered. You may have to think twice about that because if you get it wrong, you'll hear all about the penalties later. Not only the penalties you would expect, i.e. taxation and other issues, but in this context.
Then we get to the more nuanced pieces of are you or are you not actually doing business in another jurisdiction. If there is a single one-off contract, there's a good argument you're not generally doing business in another jurisdiction. But if you're generally entering into binding contracts in some state outside your state of formation, and if it's repeated, and if they're long-term, then you start to become clearly doing business in another jurisdiction.
One way that we often avoid having to be qualified to do business . . . and you might think of businesses like banks that say, "Okay, we're going to loan to this company, and this company is doing business in Pennsylvania, but we're a New Jersey bank and we're not doing business in Pennsylvania. So the contract has to be paid in New Jersey, it's being entered into New Jersey, and it is really being completed in New Jersey. We're making sure you, borrower, have a bank account in New Jersey, in our bank."
And so, there's an effort on a comprehensive basis to have New Jersey become the nexus of activity. So just because your customer is in Pennsylvania doesn't mean you're doing business there.
And this is an issue that, unfortunately, we lawyers often have to opine on. That's an opinion I'll typically, 99 times out of 100, say, "Not my [inaudible 00:17:21], bank. You figure out if you need to be qualified here." But that is a question that comes up.
So entering into a contract that has to be approved by an office outside the jurisdiction often will prevent a company from being deemed to be doing business in another jurisdiction. But sometimes you've got to look beyond that, and we can get into that in a moment.
If there is a regular frequent arrangement to have meetings with clients or customers in a foreign jurisdiction, that is likely to trigger a registration requirement. But if it's just by phone or just by e-commerce, mail, email, whatever, less likely to rise to the level of doing business.
The whole issue of the internet e-commerce and what is doing business is likely to become a huge problem going forward, especially after the Wayfair case and its impact on taxation. So I expect that there will be a lot more to come on the impact of electronic business and electronic communications going forward.
And then, finally, there's the significant revenue stream analysis. Let's say you're a company, again, headquartered in the East Coast but you have one client in Texas, and you sold a $200,000 whatever, set of widgets to them, and then you're done. That may be significant to some, but it's not necessarily going to be significant enough to require a company to qualify or register.
But if there's now 14 or 15 of these companies in Texas for whom you're doing the same thing or you're doing this same thing for that company on a repeated basis, well, now they're steady and significant.
So isolated, not necessarily doing business. Steady and significant, multiple parties, multiple issuances, multiple occurrences, likely very much to require qualification.
And states will start also looking at the level of revenue and, after a while, you'll get one of those nasty letters saying, "You should've been registered seven years ago and you owe us $1.5 million in back taxes." So not a place you want to be.
All right, moving forward here. How do you actually know if you're doing business in another state? So I just mentioned the taxation problem, but just because you may be subject to tax in a different state does not necessarily mean you need to be registered.
And there is a fairly recent Delaware case on this, Genuine Parts v Cepec. This says exactly that. "We're going to tax you, but we don't necessarily have jurisdiction over you nor do you necessarily need to be qualified." So again, it depends on which part of the government is really looking at a company.
Pennsylvania does have a statute. It's 15 Pa.C.S., section 403(c), and the third part of the statute details what is not doing business. And what it specifically said is, "But just because you're not doing business for these 11 articulated items doesn't mean we can't tax you or doesn't mean we can't regulate you or doesn't mean we may not have jurisdiction over you." So it's the vice versa. "You may not have to register, but we might still be able to tax you."
All right, here's the magic slide. I mentioned the MBCA and RMBCA standard exceptions to doing business, and these 11 are the ones that Pennsylvania adopted. But Pennsylvania basically adopted all of them that existed at the time. Again, I'm from Pennsylvania so I know these well. Most states have a lot of these. The few that I mentioned, Delaware, Massachusetts, Alabama, Louisiana to a degree, Ohio, and Oklahoma, deviate significantly from these 11.
Number one, "Maintaining, defending, mediating, arbitrating, or settling an action or proceeding does not mean you're doing business." Basically, one of the benefits to registering to do business is that a company may then resort to the courts of that jurisdiction to commence a lawsuit. But if it's not registered to do business and it is then sued by someone, it can still defend. The nuanced question then becomes, "Can it maintain a counterclaim?" And the states are not unified on whether or not the answer is yes.
"Carrying on activities concerning internal affairs." So what does that really mean? That really means the internal operations of an entity, board meetings, making budgets, actions among owners, whether they're shareholders, members, partners, holding meetings of those shareholders, owners, partners, anything relating to the internal affairs of an entity all by itself is not doing business.
But if it's that together with other things, then one has to, again, look at the facts and circumstances as a whole to determine whether the company has an adequate nexus to . . . if its activities have an adequate nexus to the jurisdiction to be deemed to really be conducting business there.
"Maintaining accounts in financial institutions." This is a standard exemption that has been adopted by all but five jurisdictions. And the five jurisdictions, I'll just flip to the next page real quick, are Alabama, Delaware, Washington, D.C., Ohio, and Oklahoma. Those don't include this exception in their listings of what is not doing business. That doesn't mean you can't argue that. So once again, a facts and circumstances test is going to apply. There's not a statutory safe harbor.
Going back to this list. "Maintaining offices or agencies for transfer and exchange of securities, depositories with respect to securities." Basically, anything relating to securities. A lot of companies have, you know, security-transfer-type agents in a jurisdiction, such as Delaware, where there are a lot of companies that do that for them or set them up. And if that's all that's going on, almost universally that is not enough to constitute doing business.
But once one has that nice little location to do those kinds of things, other things creep in. Books and records get stored. Sometimes inventory gets stored. Sometimes sales logs and other things like that get maintained and adopted and adjusted. So when you start to have business-functionality creep, this exception is going to quickly go by the wayside.
"Selling through independent contractors" we touched on before. You've got some very clear examples of what isn't an employee: a dealer, a wholesaler, a broker, an independent-contractor company that is doing for you what it does for 4 or 5 or 6 or 25 other customers. But when you move to the other side of the continuum where an independent contractor is really nothing but a de-facto employee, you very well may lose the battle, both on the taxation side and on the registration side.
"Soliciting or obtaining orders by any means if the orders require acceptance outside the Commonwealth," this is Pennsylvania's version, so outside the state, "before the orders become contracts." This actually is a very effective exception and many companies use it effectively, especially if the volume of business is not so huge as to generate taxation questions. So that is something to consider if there's flexibility in the way your organization, or your client's organization, accepts business.
I'm going to take seven and eight together. "Creating or acquiring debt, securing or collecting debt." Many states do consider them together and many states draw a distinction between creating debt, i.e. making loans or buying notes, and what happens when they default and then you have to foreclose on them. What happens when you become an OREO owner, an owner of real estate, because of a foreclosure or have to institute suit in a jurisdiction and you're not qualified and therefore can't institute suit? The cases are not identical on this and there could very much be a finding that that suit is going to be dismissed.
So, for example, in a case called SMS Financial v Gallagher, a New Jersey 2019 case, a foreign lender had made a series of loans to a bunch of New Jersey residents, different residents, and then attempted to sue them in New Jersey courts to enforce them. The court, upon the defendant's objection, dismissed the lender's complaint because the lender had not registered to do business.
So, in this case, the creation of the debt was not the problem, but the enforcement was because an entity not qualified was attempting to use a court of the jurisdiction to enforce its rights.
However, the exact opposite result occurred in Florida in a case of Bank of America against Nash, a 2016 case. Very similar fact pattern, exactly opposite result. So once again, you really need to be familiar with your jurisdiction, what the exception says, and what the case law is concluding.
"Conducting an isolated transaction not in the ordinary course" we talked about a little bit. What really deviates among the states though is the period. The MBCA suggested period is if you can complete a transaction within 30 days, you're within the safe harbor. In Illinois, that safe harbor is 120 days. In California and North Carolina, it's six months. In Maryland and Massachusetts, there's no time limit. So, once again, you can see how similarly-worded statutes have wildly different implications depending on where you are.
"Owning more without property," this one is a very popular one. Thirty-three states have adopted some semblance of this exception. But then there's Massachusetts, and Massachusetts says exactly the opposite. It says, "Owning property, period, the end, is doing business in the jurisdiction and requires you to be qualified." I know, Keith, you had some things to say about this one.
Keith: Yes, exactly. And so, I think it'd be an opportunity for us to transition to the next slide. So why don't you close out on number 11 and I'll talk to the implications for real-estate transactions, number 10?
Lisa: Okay, that sounds great. So number 11, "Doing business in interstate or foreign commerce," is actually a requirement that is based on the Commerce Clause of the United States Constitution, which prohibits states from regulating entities involved in interstate commerce.
So once again, this is a very popular exception in many of the statutes. However, regardless of whether it's a stated exemption in a statute, the U.S. Constitution is going to override just about anything. So this exception is going to apply regardless of whether your state actually adopted it. And we'll get into inter- versus intrastate business in a much later slide.
There is another one that some states have started to adopt and it's a fairly new exception. Basically, state-declared emergency exception. So if a company is responding to a state-declared emergency, these new statutes, and I think there are six states so far that have enacted it, are saying, "That is not subjecting you to the jurisdiction nor the requirement to be registered to do business in that state." It almost smells to me like a public policy one, but if I'm allowed to comment, I think it's a good one.
We talked about the bank accounts. All right, now we get to the real-estate case. Keith, it's all yours.
Keith: Great. So, Lisa, you mentioned before how owning real property without more is generally an exception to a registration or qualification requirement. But now, what are the implications for commercial real-estate transactions? When can owning real property constitute doing business in a state?
So Lisa mentioned a corporation or other entity is generally not required to qualify to do business in a foreign jurisdiction merely by purchasing or owning real estate. Although over 30 states have codified the principle by statute, there's a scarcity of court interpretation about what this language means.
Typically, activities such as operating a property, or operating an entity's own business from the real property, leasing the real property, or otherwise entering into contracts relating to that property, that is doing more than just purchasing or simply passively owning it, will trigger a qualification or registration requirement.
In commercial real estate transactions, we always advise clients to qualify or register to do business in the foreign jurisdiction in which the real property is located.
Now, which is the entity that must qualify? It's generally the real-property-owning entity. Now, if that is often a special purpose entity whose sole purpose is to own and lease out the property. Thus, the property-owning entity must qualify and, generally, any upper-tier entities in the holding structure do not have to.
Commercial contracts in the real estate sphere contemplate this. Whether they're purchase agreements, leases, loan documents, they virtually always require that the property owner to be qualified or registered to do business in the state in which the building is located.
And Lisa will speak more about naming conventions in a later slide, but please watch out for clients who do not purchase real estate through an SPE, particularly foreign, that is international clients. The entity may be required to register or qualify in a particular U.S. jurisdiction even if the real estate is only a very small portion of its entire business or portfolio.
Now, another potential hiccup. Some of these real estate investors from other countries that acquire real estate in the United States may be known by names such as Germany Real Estate Investment Fund or France Bank Fund, and qualification or registration may require an additional approval from the state's banking commission, for example, or an insurance commission. And the secretary of state of the particular jurisdiction may not accept your registration application if you have not first received that approval from the state banking or insurance commission. And that can take several weeks and perhaps even delay your transaction.
Now, Lisa, do you want to take back control?
Lisa: I guess I could. There was a question from the audience about, "Are there states where insurance companies are not required to register due to their licensure with the division of insurance?" And based on a transaction I just recently completed, almost every state . . . and I say almost because I don't remember looking at two states, I think this company didn't do business in two states . . . required both a license and a registration. So I suspect that there won't be any state that doesn't require both. The registration will be a precondition, if you will, to licensure.
And I tried to get this to go but I'm not sure I got it to go. There we are. We're going to let it go.
Okay. Yes, let's move on. So, as I said before, the general statutory scheme is you must register if you're going to do business in a state other than that state in which you are formed. However, there are some states that won't let you do business, even interstate commerce, before you are registered. And three of which I'm aware of are Maryland, New Jersey, and Minnesota.
New Jersey has a pretty onerous registration process. It requires not only registration at the equivalent of a secretary of state's office, but an immediate registration with the Department of Revenue, whether or not you have employees there. So it's a multi-faceted process.
And once again, if this is not your home state, it really does help to have the assistance of a knowledgeable guide, CSC being one of them, to walk you through the intricacies of a registration process in a different jurisdiction.
So these cases, even if it's not sufficient contact, even if you don't have employees, even if you don't have a place of business, if there's any interstate commerce being conducted there, you've got to register.
So, in addition to registration requirements, we're focusing on some of the ancillary effects of an entity doing business in another state. A state can tax or regulate an entity even if it isn't required to be qualified, as we talked about before. And we also mentioned that the Constitution protects interstate commerce. So once again, there's this nuanced analysis of, "How much business is sufficient? How much contact is sufficient? What nexus is sufficient?" so that a state can regulate or tax regardless of the qualification impact.
So there are three types of sufficient contact. The first is sufficient contact to be sued, long-armed statutes, consent to jurisdiction, whether it's contractual or otherwise.
Contact sufficient to be taxed, and Wayfair kind of lured everybody out of the water on what that looks like, so we'll have to see how the next five, six, seven years of post-Wayfair analyses come out. And again, states are going to push any boundary, constitutional, statutory, or whatever, in order to generate additional revenues in an environment where states are losing revenue.
And then, the third is whether it has to qualify to "do business" as a foreign entity, which is what we've spent most of our time on, but we're going to divert a little bit now.
So the Wayfair case, which is now about a year old, was a very articulate overturning of close to a century of history. An out-of-state seller no longer needs a physical presence in a taxing state in order for that state to collect and remit sales tax. So now the states are going to look to this evanescent, difficult to describe, substantial nexus with the taxing state.
As I'm sure everybody knows, Wayfair was all about e-commerce, whether doing business over the internet was going to create a presence sufficient to tax. But it's now being morphed into a whole bunch of other things.
One very interesting note, and this is where I think litigation is going to continue to be hot and heavy, is that the decision did not address excise taxes, VAT taxes, value-added taxes, or any kind of local tax. So I suspect there will be quite a bit of additional litigation in many jurisdictions that push the envelope on those types of taxation issues.
Helena: And certainly the other thing to be aware of is that there's no bright-line standards. You know, it's completely new right now and things are simply not clear. As I think that you've said, Lisa, we will be seeing continued litigation over this area.
Lisa: Exactly. So, as you'll see, we will talk later about whether qualification to do business creates a presumption of jurisdictional nexus, but for the moment, we're going to talk about whether qualification to do business creates a presumption for taxation.
And states are taking more and more aggressive positions on this. Sixty thousand dollars, which to me would not have been a very large amount, has been alleged by the state of Michigan to be sufficient for a non-Michigan lender to be taxed, even though Michigan has that standard of making loans in a jurisdiction is not enough to be doing business.
So I don't know about anybody else on this phone call, but we will not give an opinion that says that an entity is not subject to tax. We often used to give an opinion that said, "Just making a loan isn't enough to require a lender to be qualified based sheerly on that statutory exemption." But even now, we're not taking that position. We tell the lender to do their own analysis, and you don't need that from the borrower's counsel. So these issues create major heartburn for people who have to render legal opinions on a transaction.
Now to the jurisdictional nexus. In most states, qualification does not confer general jurisdiction. General jurisdiction arises only in the state of incorporation, or formation, and a principal place of business. In addition, if there is a physical presence in a state, which, once again, requires qualification in almost all instances, that often is enough for jurisdiction. But jurisdiction only with respect to activities conducted in that separate jurisdiction will give rise to that jurisdiction.
So, hypothetically, and this is, unfortunately, hypothetically close-to-home, a car company sells cars in seven states across the Eastern Seaboard. It has a physical office in, let's say, Virginia. A person in Virginia buys a car, something's wrong with the car, it explodes, they sue from Virginia. I think there is going to be deemed sufficient jurisdiction there.
But take a slightly different hypothetical where the office in Virginia of the car dealer is teeny, tiny, but there's a huge one in D.C. Same jurisdictional issue. That plaintiff can say, "Well, that company is doing business in D.C. I want to sue them there because there are more assets there," and the jurisdictional question will likely fail because the activity on which the suit was brought was not conducted in that foreign jurisdiction.
Now, no harm, no foul because there's a whole different statutory scheme that allows you to get your judgment in Virginia and domesticate it into D.C., but that's a totally different seminar for a totally different day. So it can get to the same place. And the Magna Powertrain case is a similar response to the Virginia and D.C. hypothetical I just gave you.
On the other hand, you also have to look at the contracts into which the parties entered. So if the contracts into which the parties entered de facto state what is appropriate jurisdiction and there is any nexus whatsoever to back that up, then whether or not the entities would have needed to qualify, did in fact qualify, whether or not they were subject to taxation doesn't really matter. Parties are free to contract, and in most cases, that contract will be upheld.
So take a look at your contracts carefully, your clients' contracts, and make sure you're not agreeing to things that you might not otherwise wish to agree to.
Pennsylvania, here we go again. We take a very different approach and, unfortunately, we are representing clients that are on the wrong side of this approach right now.
It is one of four or five states that hold that registration to do business within a state does indeed subject that foreign entity to general jurisdiction. There's a line of cases starting with Murray v LaFrance and the Mallory v Norfolk decision, both of which are currently on appeal. And they all derive from a two-year-old decision called Daimler, which is another e-commerce case. Daimler, as in Mercedes-Benz Daimler, wound up overturning another century of case law based on somebody buying things through the website.
So Pennsylvania right now is undergoing a serious attack on a line of cases that do say, "An entity that submits to registration in that jurisdiction has opened its entire kimono up to full jurisdiction." So I, for one, am carefully following that line of cases.
All right. So now we've decided we have to qualify. How do we do that? And since we have our experts from CSC on the phone, Helena, pipe in wherever you think you can add some value here.
The requirements, that at least are in Pennsylvania, are fairly emblematic of the requirements everywhere. So I'm just going to use the statute with which I'm most familiar. I, once again, will tell you that these requirements emanated from the MBCA and have been adopted in most jurisdictions for all types of entities.
The first question is, "What name are you going to use in that jurisdiction?" In some cases, the name that your company has and has been using in its date of formation is not available in a foreign jurisdiction. Therefore, to properly register or qualify to do business in a foreign jurisdiction, one needs to file a fictitious name, DBA your real name. So the first line of questioning one does when you decide you need to qualify is to make sure your name is available.
Helena: And this is Helena, if I may pipe in. Most states have an online database that you can look up to see whether or not a name is available. If you work with one of the service companies, you can also check with your customer service rep through the service companies. They can do that look for you. And then in some cases, you may actually be able to do name reservations. That's a whole different other topic, but it is very important to make sure that that name happens to be available.
Lisa: Right. Another very interesting nuance is that, in most jurisdictions now, names have to have a designator, an Inc., or an LLC, or an Ltd., or an LP. And they're not interchangeable. They're specific to the type of entity. This often becomes an issue when there is an existing entity that is actually fairly old and does not have a designator. So, in order to qualify to do business in a new jurisdiction, you have to add a designator. Just a little nuance to be aware of.
The filing requirements are also similar from jurisdiction to jurisdiction. Very few jurisdictions are going to be asking for a whole lot more. In some cases, as I mentioned before, jurisdictions are now getting a little peculiar about making sure there's a human being somewhere on the application. But for the most part, these are going to be similar across every state.
So there does need to be an initial registered office, and it does require street address and number. P.O. boxes are not acceptable in almost every jurisdiction. If there is no physical location, one can use a commercial registered agent, once again, a CSC.
So, Helena, do you want to comment a little bit about how CSC looks at these?
Helena: Yes. And so, what CSC will do is, if we are the appointed registered agent, we actually have a physical address within a given jurisdiction. That's where any service of process is brought to, any of those official mailings, and things like that that go to. And of course, we're not the only service company that does this, you know, but that is certainly one of the services that we offer.
Lisa: And once again, a commercial registered agent can be used where there is no physical office. It can also be used where there is and one would prefer not to list the physical location or an individual.
The application has to be executed, meaning signed, by an authorized officer or representative. Oftentimes, it could be the paralegal who's forming the entity. And the application has to be filed and there is almost always . . . I would actually say there is always a fee. In some jurisdictions, publication may be required, Pennsylvania being one of them, for corporations but not for any other entity type.
Helena: And also New York. That's the other one for folks to remember, is that New York has that publication requirement also for LLCs.
Lisa: And not for corporations?
Helena: LLCs. Yeah, not for corporations.
Lisa: Okay. There you are. So, in Pennsylvania, to become an LLC, you don't have to do that. In New York, to become a corporation, you don't have to do that.
What are the penalties? So the penalties, in most states, are cumulative and go back, and the fines, they're cumulative and go back. So there's a hypothetical here that I actually borrowed from somebody else that talks about what the fees would have been for a company that should've qualified in 2000 but waited 15 years to do so.
But this is just the tip of the iceberg. So I will tell you, for example, that in Tennessee you would pay your fees the years due, you would pay the penalties, taxes, interest for all 15 years multiplied by 3. There are treble damages, in Tennessee, for failing to do this.
Then there are other states that go a slightly different direction. Alabama has no dollars but could charge you a late fee. Pennsylvania has no stated dollars but does charge interest. Delaware says it's $200 to $500 for each offense. Okay, what's an offense? Every year you didn't file? Every action you did for which you weren't registered? That's the tough one for me to figure out. And then Indiana says you may be fined up to $10,000 per year for accumulative battery of these failures.
New York is, I think, the most onerous. It absolutely may enjoin further business if you should've been qualified and don't, until you qualify and cure. For the most part, the failure to qualify simply means you can't use the courts.
There are some jurisdictions, and they're listed here on this chart, that will impose fines on individuals, officers, directors, agents if the company has failed to comply. Some of these states may even call the activity criminal, but it would at most be a misdemeanor.
Again, look at the statutes in your jurisdiction to determine what would be the implications for failing to file. I haven't seen one that yet says, "The lawyer responsible should've done it," so it's typically going to be a company representative if there's going to be an individual. If, however, the lawyer is engaged in a pattern and practice of defrauding . . . I don't even want to go there. Let's not go there.
So the primary implication of not being registered when one needs to be registered is you can't maintain a legal action in your name until it's qualified. Yes, there are some federal question issues that are a level of nuance beyond the scope of our remaining 10 minutes.
This does apply to successors and assigns. So just because you sell to somebody else doesn't mean they're cured. And in Vermont, affirmative defenses and counterclaims may also be precluded on a case-by-case basis if a company has not qualified where it needs to be qualified.
But in most cases, one can cure the situation by qualifying or registering, paying your fines and penalties, even the look-back ones, and then proceeding with a fairly clean slate. Hopefully, a statute of limitations hasn't run in the meantime, so that's the issue.
Defending lawsuits, however, is almost always permitted, even if you're not qualified. So that shouldn't be an issue. Vermont, very clearly, "A counterclaim can be barred based on facts and circumstances." And other states may take a similar position. You cannot indirectly avoid what one could have done directly.
Enforceability of contracts and the ability to sue. If an entity should have been qualified and isn't, it will be denied access to the state court. Therefore, it cannot enforce contracts with a counterparty in that state. So, once again, if your contract says, "The jurisdiction to resolve a dispute under this contract is your home state," you at least can bring your suit.
What is a little bit of a gray area here is, okay, so you get your judgment and you want to domesticate that judgment in the state where you weren't qualified. I haven't seen a case yet on this point. So, to me, that's a question. You may qualify. If you want to enforce the significant judgment that you've already obtained in state A, you may want to qualify in state B to enforce it. And finish it, do what you need to do, and withdraw your qualification.
Contract language itself may not be a sufficient nexus to the state where you're not qualified. So once again, it's a facts and circumstances case. So if there is a selected jurisdictional state and there is some nexus, there should be a reasonable expectation that the nexus will be honored, and therefore, the contract language will be honored. Moral of the story is don't pick a state that has absolutely no connection to what you're doing.
And once again, even though you can cure a failure to qualify, it's going to be costly, it might be embarrassing, and you might blow a statute of limitations. So it's certainly an important issue to resolve before a lawsuit is commenced.
Legal opinions clearly can be impacted by qualifications. I know when I started practicing too many moons ago, I used to be asked to give an opinion, "Your borrower or your company is qualified to do business in every jurisdiction in which it should be qualified to do business." That was not a determination I was prepared to make. So now the opinion that I will give is it's qualified where it's qualified. And of course, that's a true statement and I don't get in trouble.
But that doesn't mean the inquiry should stop there. If we're doing our clients' service, we actually should help our clients determine where it makes sense for them to be qualified to ease their doing business everywhere.
And you can see the alternate approaches to the opinion giving in the middle of this slide.
There are certain licenses that absolutely require qualification. We mentioned insurance before. Banking is another one. And most food and beverage operators that have liquor licenses, once again, you're going to need to be qualified because your business is there but the liquor license itself requires qualification. And anything that requires you to pay state taxes, typically employment taxes, anything like that, you're going to need to be qualified.
Failure to qualify could also impact your ability to get a clean opinion, especially if there are meaningful deviations.
We mentioned before the Commerce Clause and interstate versus intrastate. I don't think this is all that magic, but it helped me to put them down on paper. Interstate, general, regular, systemic, extensive, continuous business, entirely within one jurisdiction.
And then, if there's the use of independent contractors . . . and I think of this more like wholesalers, distributors, those kinds of things, not those curious computer geeks who may or may not be employees. That will be an exception to being qualified where those other sales are occurring.
There we are. I think we did this backwards. Okay.
Then facts and circumstances reign supreme. So, as I mentioned before, the statutes are not identical. Some of the statutes deviate significantly from the MBCA standards. Some of them have their own nuances. Many states have adopted most but not all of those 11 factors. Some have adopted the 12th factor of the immediate emergency. The periods change, the quantums change, everything changes. And then, of course, there's case law that changes.
So it's very easy to say, "I don't have to do it," but states are more and more reaching for revenue, so it really does make sense to both be very familiar with the statutory scheme of your state, the case law of your state, and the nature of your clients' business in each jurisdiction in which it may need to be qualified.
If you incorrectly characterize someone as an independent contractor versus an employee, we all know there are significant tax issues with the IRS. But there are also qualification and registration issues. Some cases will never let that happen, like New Jersey. You can't even start business there without setting up the revenue accounts. But others will, and it could go quite a long period before the mistake is captured and there could be significant back-looking, or looking back for fees, penalties, fines.
Degree of control is another area where the facts and circumstances could lead to one conclusion or another conclusion.
Consignments. Is consignment the equivalent of an independent contractor? To me, they smell alike, but not necessarily.
Product support that is more than 30 days or in other jurisdictions, another fact and circumstance. How much activity, and time, and effort is devoted to the support versus the initial sale or installation? A lot of questions come up to how much business is actually being done at a given time.
The regulated industries are going to signal registration. There are very few regulated industries that will not require a concomitant qualification to be filed. Banking, insurance, liquor licenses all require . . . at least the ones that I'm
familiar with, and I do this throughout the country . . . all require concomitant qualifications to do business. And it does help to be very proactive and ascertain upfront what those requirements are so there's no surprise to your state.
Once again, the quantum of business really does become irrelevant. It's the license itself that triggers the requirement.