Doing Business Outside Your State: Critical Principles of Foreign Qualification
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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? What are the legal ramifications? If you are a corporate attorney, are you prepared to advise clients on the matter?
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? What are the legal ramifications? If you are 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 Darnell Clayborn of Dykema Gossett, on state foreign qualifications, recent case law, and critical principles of conducting business outside your state.
The webinar will bring Qualifying to Do Business in Another State: The CSC® 50-State Guide to Qualification to life. Attendees will have the opportunity to ask our presenters about formations and qualification guidelines as they review qualification guidelines in general, their impact on your business, and what you can do to protect yourself. We’ll also touch on some common CSC customer qualification questions.
Anu: Hello, everyone and welcome to today's webinar, "Doing Business Outside Your State: Critical Principles of Foreign Qualification." My name is Anu Shah and I will be your moderator.
Joining us today are Darnell Clayborn and Darrell Pierce. Darnell is an associate in Dykema's Chicago office and focuses his practice on mergers and acquisitions and corporate finance. Darrell has offices in Chicago and Ann Arbor and focuses his practice in the areas of commercial and corporate finance law. With that, let's welcome Darnell and Darrell.
Darrell: Thank you, Anu. Welcome, everyone to the conference. This is Darrell speaking. Nice to have you all here and hopefully we'll be able to help you out through at least some of the issues that arise in the course of interstate economic activity. Darnell, would you like to say hello for a minute?
Darnell: Hello, my name is Darnell Clayborn. I am looking forward to speaking on state foreign qualification and working with CSC to do so.
Darrell: Thanks. Thanks, Darnell. A little bit of housekeeping on our end—as is typical in these kinds of events, no one should imagine that this is legal advice. Our contact information is available. We're available to be hired under appropriate circumstances, including us getting a chance to know our client and understand the specific factual circumstances.
Today should be thought of as a string of hypotheticals and not specific legal advice tuned to a specific client. In addition, please note that we're going to be discussing the relevant concepts in a generic, if you will, kind of way. We are not going to have the time, frankly, to cover all 50 states even if Darnell and I were up to speed on all the details of all 50 states. Darnell's licensed in Illinois. I'm licensed in Illinois and Michigan. For what that's worth, we're pretty adept with the laws of those two states.
We have some other ideas of some other states where we've had regular contact in the course of our legal career, but we're not going to be able to speak to the specifics of Louisiana law because Louisiana is special, of course, tends to be a little bit different in the first place, but even if it were on the same contours, we don't know all the precise ins and outs of each and every of the 50 states.
But with that, we'll go ahead and proceed here. The first overall concept I'd like to address is the fundamental constitutional notion that in a federal system like ours, we do have 50 sovereign states. I'm going to keep referring to 50 states—sorry, District of Columbia, and other folks who may act as states for this purpose—but we have 50 sovereign states who are each entitled to regulate activities within their states.
This is not going to be a comprehensive discussion and federal preemption and what constitutes a federal question, but we note that in terms of interstate commerce, that is an activity that is protected by our constitution with the federal government standing there to protect those activities.
So, there is some tension as to how far as state can go to claim jurisdiction over a business organization to claim that a business organization owes the state taxes of one type or another or to claim that the business organization ought to register and qualify to do business, identify itself to the state, provide for a registered agent for service of process in the state, and provide other information including maybe an annual report and pay franchise taxes or some kind of fee, typically on an annual basis.
So, what are the types of sufficient—I want to go back for a second and just mention there are different types of contact for the three different types of state regulation. We're going to find that in order to be sued, the context might be fairly minimal, for example, an organization who's entered into a contract where they've agreed that jurisdiction, they would consent to jurisdiction in a particular state even though the organization has no contacts with that state other than the fact that they have contracted with somebody there, contracted across state lines. But if you've consented to jurisdiction by contract, that's going to be sufficient for your counterparty under that agreement to sue you in that state.
Similarly, but not a function of agreement, long-arm statutes are statutes designed by each state to fully implement the state's constitutional power to bring its legal system to bear when there are causes of action that arise in the state, typically torts that might arise out of purely interstate commerce where a defective product is shipped into a state.
There may be a jurisdiction for a tort claim to be brought particularly by a consumer plaintiff even though the selling organization is not required to qualify to do business or is otherwise amenable to state regulation. Taxes, we're talking about income tax, sales, and excise taxes a little bit more about that in a moment. Then, of course, we've got the qualification to do business when one is "doing business" in a state which is the focus of our presentation.
With respect to the tax issues, qualification usually creates a presumption, that qualification to do business and registering usually creates a presumption that the organization is subject to various taxes, particularly income tax. Now, it's not absolutely necessarily the case that qualification means you are subject to tax, but states are aggressive in seeking revenue.
They're going to push the constitutional limits of what they can get their arms around in terms of taxing authority and the state Departments of Revenue have a habit, in our experience, of looking to the list of new companies who qualified to do business in the state and then imagining that you're engaging in certain activities that require you to so qualify, those are likely going to be sufficient to require you to pay taxes in the state.
So, they will use the list of newly qualified companies as a roadmap to identify potential tax payers who ought to be paying sales income or excise taxes to the state. An example in Michigan—the laws keep changing on this constantly—but as of a couple of years ago, Michigan was taking the position that a lender—normally lenders can engage in interstate loans. They don't need to qualify.
There are good arguments that income is generated where it's received and not where it's sent from, but lenders would take the position they're engaging in interstate commerce. Michigan will reply, at least on a tax basis to the effect that if you make more than $60,000 a year in interest in Michigan, you're amenable to being taxed on the portion of your income that's attributable to your Michigan activity. So, pretty aggressive stance and the state may or may not be successful in identifying all the potential tax payers and maybe even less successful in enforcing the full reach of the state's intentions in this regard.
As a result of all this, getting a legal opinion that one, is not subject to tax in a particular state is very difficult. Those opinions are not routinely given in transactions. They can be had but there's a significant price to be paid. They're incredibly qualified and at the end of the day, as I indicate in the slide, they're almost never satisfying because you may get an opinion that says it's not absolutely certain that you're subject to tax but it's going to be very hard for the opinion giver to go all the way to saying it is absolutely certain you will not be subject to tax.
Okay. Darnell, I'm going to hand it over to you on this one.
Darnell: While qualification allows for service of process, it does not confer general jurisdiction for all cases. General jurisdiction arises only in the entities' state of organization and entities' principal place of business. A state may not subject an unqualified foreign corporation to the jurisdiction of its courts unless there is a statutory basis for asserting jurisdiction and the assertion satisfies the requirements of due process. Entities will be subject to personal jurisdiction in a state through which such states the statute applies.
Next, I want to just provide an example of a case where general jurisdiction was not determined where a company has qualified to do business. When defective goods were manufactured in New York and shipped to a Mexican buyer, the state of Michigan did not have jurisdiction over the buyer even though the buyer had qualified and its parent was located in the state of Michigan. On the other hand, a corporation need not qualify and subject itself to franchise tax and possibly other taxes in order to consent to jurisdiction by contract. As Darrell mentioned earlier, parties can just agree without qualifying.
Darrell: Darnell, I suppose that in the Magna case, Magna, the parent being a Michigan company, they were probably very eager to have the Michigan courts litigate what was undoubtedly an auto supply contract where it's thought that the Michigan courts deferred to traditional automotive industry standards and practices. But why would they think product that moved from New York to Mexico, albeit ultimately shipped up here, I supposed, in components could result in jurisdiction in Michigan. Any thoughts other than they just preferred to be here?
Darnell: Yeah. I think it's because those manufacturers of the cars are there and ultimately they know that the big players are there in Michigan. So, maybe they felt like the manufacturer would have—the courts are more lenient towards manufacturers in those cases.
Darrell: Yeah. It would be interesting to understand why the Mexican company thinks it is doing business in Michigan, something we might think about as we get further in the presentation and discuss what doing business means. I'll add finally on this slide. That last point is very handy. We've had clients who have been engaged in transactions like project finance or ownership of projects, real estate developments or whatever where they really don't think they're normally doing business in Michigan.
For example, we had a client whose parent company who was outside the state guaranteed obligations to a local government authority in a project finance transaction. The local government authority was very concerned that it was not going to have to go sue the parent in an out of state jurisdiction and insisted that they be able to sue the parent on their guarantee where the project was located.
That is possible through a consent to jurisdiction and consent to service a process that did not require a parent to fully qualify to do business in the state, which could have subjected it to the scrutiny of the tax authorities and other potential issues because other than providing this guarantee, the had no contacts with the project state.
Darnell: Thanks, Darrell. I just wanted a note regarding specific jurisdiction. Generally, it's easier to prove that a corporation or entity is transacting business such that it is subject to personal jurisdiction that it is to show that the corporation is transacting business such that it's required to qualify a certain state's laws. Therefore, a foreign entity may be required to defend the suit in a state where it would not be required to qualify to do business in such state.
When we speak about qualifying to do business in a state, we are talking about the business activities an entity is participating in that might subject such an entity to state statutory qualification requirements. In most states, the test of doing business is defined in the negative. That is to say the statues describe what is not deemed as doing business. At times, this tends to lead to confusion.
As we will discuss in further detail later, typical activities that do not constitute doing business are an entity maintaining its bank account, holding shareholder meetings, defending litigation, maintaining a depository with respect to securities, owning real estate or rental property, engaging independent contractors to sell products, and engaging in interstate commerce.
While there is a Model Corporations Act, the Model Limited Liability Company Act, another model acts, there are no uniform standards across state lines to determine what qualifies as doing business in the state. Accordingly, an entity must always look at each state's qualification requirements to determine whether an entity needs to qualify to do business in such states.
Although state qualification requirements are not very expensive, failing to comply with state qualification requirements can open non-compliant entities to make material adverse consequences, such as monetary fees, personal liability, and just making it costly to enforce contracts. Darrell is going to tell us a bit more about monetary fees for failing to qualify to do business.
Darrell: Thanks, Darnell. The affirmative definition of doing business is pretty generic and pretty plain vanilla. Most states, it boils down to the business organization is conducting a substantial portion of its ordinary business activities in the state, whatever the heck that means. Then the statutes will typically tell us what's not doing business, which provides some guidance, but let's assume we do have a significant presence in a state. We're not debating the issue. We understand we should have qualified but we didn't and now, yikes, what are the potential problems that us or our client might be facing.
There is a possibility that there can be some significant monetary penalties. Now, that's at least significant in terms of the kind of money I have or I suppose many of us have, a few thousand dollars may not be a significant amount of money to a large publicly traded company, but I guess I would respectfully suggest that a large publicly traded company has more of an embarrassment factor to worry about than withstanding the cost of the penalties, but for a small, privately-held business organization, small, medium business, these numbers might be significant.
Particularly, as you can see from this slide, we've got a number of examples of particular companies that should have qualified in various states in 2000. They don't wake up to the fact that they should have qualified until 2015. When one has to go back and qualify later, the first thing the state is going to ask you is, "How long have you been doing business here?" When they find out that now, you're going to have to admit that what you've been doing here is doing business and you've been doing that since the year 2000, you're going to have to pay all of the franchise and other taxes that you would have had to pay had you been properly qualified in the state.
In addition to those taxes, you're going to have to pay interest, which is usually at a statutory rate that's not terribly high or terribly low. Plus, potential penalties—this can all add up, particularly in a state like Illinois that doesn't base its tax on a fixed dollar amount per year but instead the tax you owe is a percentage of the paid in capital of the corporation or business entity. Paid in capital is the amount paid by equity holders in exchange for their newly issued equity in the company. It doesn't mean current value of the stock but if you will the issuance value of the stock or membership interests in the company.
You can see here in this example that a relatively modest amount that might been paid in Illinois, had one qualified on time, grows pretty quickly with the interest in penalties into a reasonably significant amount. Even if the ultimate amount of the fine is not so high, for those of us who may be charged with responsibility to manage these things, why put yourself or your client in a position where they have to spend a significant multiple of what they would have otherwise been obligated to spend?
There's also the possibility of personal liability. What do you think about that, Darnell?
Darnell: Well, in addition to the fees that an entity will be charged for failing to comply with the state's qualification requirements, some states will impose fines on individuals, including their officers and their employees who are acting on behalf of the company when they were doing business in a certain state. Among these states—California, Delaware, Louisiana, Maryland, North Dakota and others. Penalties can range between $20 and $5,000 per occurrence.
In addition, some of the aforementioned states, if you fail to qualify in some of the aforementioned states, one can be subjected to a misdemeanor in such states. That means criminal penalties for acting on behalf of a state without being properly registered to do business under such state's laws.
Now, Darrell is going to tell us a little bit about how it can hinder an entity's ability to sue.
Darrell: Note that we do have some experience in California and we think it's fair to say that states aren't running around aggressively trying to find corporate actors and their officers, directors, and agents and prosecute them for criminal activity in this area, but it is a possibility and it would be horribly embarrassing to have yourself or a client have to face this kind of a problem in a particular state when it's easy to figure this out, relatively easy and cheap to comply.
Defending lawsuits—this used to be a little more significant back many years ago, although I think the most recent year Alabama still had this problem was only 2013. But historically, there was a handful of states that would make your problems with respect to prosecuting or defending litigation continue forever. It was a non-curable problem. That can be very significant.
When I started to practice, we would routinely exclude Alabama account debtors from borrowing bases because if your borrower wasn't qualified in Alabama, they might never be able to enforce their contracts against obligors.
The problems we're going to discuss right now are now curable in some cases right up to the completion of litigation. For example, in Michigan, defense, you can't sue, avail yourselves of the Michigan courts as a plaintiff if you're not properly qualified here if you should have been qualified here. A defendant can defend by asking for the suit to be dismissed.
But if you qualify prior to the effectiveness of the dismissal, your qualification cures the problem. It's pretty open-ended. As soon as they plead the action, you can go qualify, fix the problem probably before the judge has to rule.
At any rate, we start with the proposition that if you're not properly qualified in a state where you're doing business, you cannot maintain legal action in that state, there may be an exception for taking advantage of the federal courts to the extent you have subject matter jurisdiction in that a federal question is presented to the federal courts and they may entertain an action for the federal courts located in the state but the state courts but the state courts are just going to send you packing until you qualify or at least you'll be open to a defense from the defendant that the case ought to be dismissed until you appropriately qualify.
The failure to qualify applies to your successors and assigns. If you have a successor or assign who's otherwise qualified in the state on their own, the original company was not qualified suing on the original company's contract will require a cure of the original company's failure to qualify before the successor or assign can sue.
In the state of Vermont, your inability to avail yourselves of the courts includes affirmative defenses by statute and in many states, not just affirmative statutes but counter claims are prevented. This is on a case by case, state by state, actually, basis, but generally, one should assume if you're not properly qualified, you can't be a plaintiff and you can't bring an affirmative counter claim. You can make your other defenses and you can make affirmative defenses shields but not swords in all states except for Vermont.
This is all curable at some point in some states like Michigan, even after litigation is filed, but again, in order to cure any defect here, you have to pay all of the taxes that you would have otherwise had to play plus interest plus penalties. That's going to be a significant task on your ability to avail yourselves of the courts. Now, can you defend? Yes, generally, you can defend, but as I noted, a counterclaim may be barred, affirmative defenses may be barred and you'll have to look on a state by state basis to figure out how counter claims are treated.
So, what impact does this have on the enforceability of one's agreement. An unqualified entity can't sue. So, you can't enforce your contracts if your counterparty is located in a state where you're not qualified and they're not doing business elsewhere, like in your home state, so you can sue them at home or they haven't entered into a consent jurisdiction agreement with you, so you can sue them other than in their home state.
If you do have contract language that says you can go ahead and sue them there, that's nice, but that may not be adequate to overcome the statutory rule that says you can't avail yourselves of the courts until you're qualified. So, if consent to jurisdiction may not be enough to avoid other tests, indeed, if you're incoming on a consent to jurisdiction, it may not work.
If you're trying to get your counterparty sued in your home state so you don't have to qualify in your counterparty's state, you may not be able to avail yourselves of a consent to jurisdiction because your counterparty may raise issues like inconvenient forum that allow a court to run a balancing test and decide you really ought to bring in the litigation in your counterparty's home state and that gets you right back into the soup on the qualification question.
So, as we said, even though the failure to qualify can be cured, your back taxes, interests, and penalties are taxed on enforcement and this means that litigation expenses go up. Indeed, if you're staring down the typical significant expensive litigation in the first place, adding on to that, another $10,000 or $20,000 of franchise tax payments all of a sudden, it becomes apparent that you could have damages of up to maybe $50,000, $60,000 that you don't have a meaningful way to enforce your rights. So, then you may develop a pattern of letting go of rights of that order magnitude, which, again, may not be terribly significant on a standalone basis, but these things can add up.
What do you think about other potential problems that might arise, Darnell?
Darnell: In addition to the monetary fees, potential personal liability and the adverse effect on litigation, failing to qualify can impact legal opinions that were issued, reps and warranties and M&A transactions and some licensing requirements. Commercial transactions such as mergers, acquisitions, and financing transactions, lawyers are often asked to opine as to whether an entity is qualified to do business in all states in which the ownership property or the nature of the business requires such a qualification.
Opinions provide recipients thereof assurance about state qualification because of the adverse consequences that we discussed earlier throughout the presentation of failing to qualify. When an opinion letter is false, law firms can be sued for claims such as negligence, negligent misrepresentation and misrepresentation. So, to avoid such claims, lawyers should pay attention closely to the activities of different entities before issuing such opinions.
Similarly, in mergers, asset sales, stock sales, and similar transactions, sellers in such transactions represent and warrant that they were lawfully transacting business in each state in which the seller operates. Typically, these are fundamental representations of the warranties and are not subject to purchase agreements, caps, and buckets and other indemnity provisions that protect the seller. They are typically incorporated in the purchase agreement indemnity section and will therefore, like I said, not be subject to those.
As you all know, term professions such as lawyers, doctors, accountants require individuals to become licensed before practicing. Typically these professionals organized as professional entities which also required them to qualify to do businesses in such states. As we know, there are many law firms and accounting firms to organize as professional limited liability companies and professional corporations.
In doing so, as part of that organizing under as a professional corporation, a professional limited liability company need to qualify to do business in such states.
Darrell: Darnell, this might include other professions too like regulated industries like hairdressers, well drillers, anybody that gets a license from the department of registration and education or in Michigan law.
Darnell: That is correct, Darrell.
Darrell: Even though you're not going to be doing much business in a state, if you're engaged in a licensed activity, it's not at all uncommon for the state to require you to qualify to do business in the state as a precondition to obtaining the license. So, even if the volume of your licensed activity might not normally rise to the level of conducting a substantial part of your ordinary business or on a regular basis in the state, you can get caught by these licensing requirements.
Darnell: That is true regarding licensing requirements. Regarding financial statement impact, an entity that fails to comply with state qualification statutes that Darrell has alluded to, they have to pay state taxes owed, interest on such taxes, franchise taxes, and other penalties. After paying such amounts and qualifying to do business, such entity will be allowed to bring a suit in question.
If these amounts our material to an entity, such expenses and taxes could affect the entity's financial statements and as Darrell mentioned earlier, this sort of depends in large part on how big the entity is that we're referring to. If they're a big Fortune 500, probably it's immaterial but for a smaller company, especially those looking for funding or something, you might have to revise your financial statements and disclose the material misstatements.
So, now the question is do we have to qualify? As we mentioned earlier, whether an entity needs to qualify in a given state depends on whether an entity is doing business in that state. State statutes regarding qualification are typically drafted in negative, which means the statute tells us what activities do not constitute doing business.
Generally, the following do not constitute doing business—maintaining bank accounts, meetings of shareholders and directors, defending litigation in the state, maintaining depositories with respect to securities, owning real property, engaging independent contractors to sell products, making loans and taking security, interstate commerce, and isolated and temporary activities.
Regarding bank accounts, in a New York case where a foreign corporation maintained a bank account and an address in the state of New York, the foreign corporation sold its interest in a [horse 00:36:59] and the buyer failed to make the final payment on such sale. Subsequently, the selling corporation brought suit for the final payment and buyer failed to file the motion to dismiss, arguing that the foreign corporation had not complied with the state's foreign qualification law. But the court disagreed, stating that maintaining a New York bank account and address was not systematic and regular and thus did not constitute doing business.
The real question regarding the bank accounts extension is what other actions in addition to maintaining a bank account is the entity in question engaging in. Later, we will highlight five states where bank accounts may require an entity to qualify to do business.
The meetings of shareholders and directors exception has been construed to allow the corporation to attend a convention and foreign states without triggering the qualification. Regarding defending a litigation, there is no need to defend a suit. It may even be entitled to defend itself if its business acts otherwise require qualification. In a California case, the court stated that even though the foreign corporation was required to qualify to do business and failed to do so, it was allowed to defend an action brought against it in state court.
When determining whether the maintaining offices and agencies for transfer securities exception applies, of course we'll consider the purpose and the character of the office and whether the office is maintained solely for the transfer of stock and securities. In a Utah case, a Connecticut corporation was prohibited against bringing a suit against the Utah corporation in a Utah court for recovering the balance owed on an order for heat and air conditioning equipment because the Connecticut corporation failed to register to do business in the state of Utah.
The court determined the Connecticut corporation was transacting business because the Connecticut corporation maintained an office in the state of Utah, maintained telephone listings, maintained a local bank account, kept permanent personnel in the Salt Lake City office, service Utah customers and maintain a warehouse in Utah from which merchandise was delivered.
While generally owning real and personal property is allowed without qualification, several state statutes have little quirks regarding owning real property and personal property. So, like you should in every instance, you must review each state's statutes regarding real and personal property and whether such activities will require you to qualify to do business in a given state.
Regarding engaging independent contractors to sell products, an entity is not transacting business for qualification purposes if it sells goods in a foreign state through independent contractors. So, as long as the sales transactions maintain interstate characteristics. Therefore, courts consider not only the business relationship between the parties in question, but also the manner in which transactions occur in order to determine whether the exception applies.
States also make exception for lenders, making loans and taking securities such that lenders are able to maintain suits against defaulting borrowers in various states. Lenders should pay attention, however, to their agency relationships with other banks because in an Ohio case the court determined that the agency relationship between a foreign entity bank and the bank organized under the laws of the state of Ohio were more than casual and sporadic and determined that the foreign bank should have qualified to do business in that state based off that relationship before bringing suit.
As mentioned earlier, interstate commerce does not constitute doing business. Lastly, isolated transactions and temporary activities generally do not constitute doing business. When such transactions are completed within 30 days and are transactions that one does and does not do in the course of a repeated nature.
So, now, we want to turn to what does constitute doing business. The widely accepted definition of doing business in a particular state is regular, repeated, and continuous business context of a local nature. Furthermore, you have to qualify to qualify to do business if you have a physical presence in the state, have employees in the state, and engage in and trust state commerce. As we mentioned earlier, doing business for foreign qualification purposes may be different from doing business for taxation and jurisdictional purposes.
Next, Darrell is going to elaborate on interstate versus intrastate commerce.
Darrell: Thank you, Darnell. As you can see the pattern by now, certainly pure intrastate activities are not going to bring another state's jurisdiction for any purpose into question, but once you cross the state line, one has issues. Generally speaking, if you're purely interstate across the state line, you don't have to qualify, but anything that you're doing within a state is grounds for qualification.
Intrastate—the courts use words like regular, systematic, extensive, and continuous activity. Going back to that initial definition of conducting a substantial part of your ordinary business, in the state, at least part of it is of a local nature. I think it may be an easier way to think about this is look, everybody has a home.
They're incorporated in a state and that's probably going to be what you're obviously qualified where you're incorporated and you're thought to generally consent to jurisdiction and taxation, and while you may have most of your income allocated to a different state other than the one in which you're incorporated in, it's likely the state of incorporation is going to imagine it has jurisdiction for all relevant purposes.
But if you think about it, everybody has either a principal place of business or if they have more than one place of business, the chief executive office, where they may have employees and if one has a physical presence, a physical office and/or employees, one is doing something in that state and one might imagine that anything you're engaged in activity in that state with others in that state is intrastate commerce and it's going to subject you to qualification and other jurisdictional requirements.
You only have the opportunity to avoid a state if it's not your home, your home being a place where you're incorporated or the place where you have your chief executive office. Now, there are exceptions. You may be able to sell through independent contractors, mail orders, or telephone sales, a national advertising campaign or just maintaining a website in a state may not be enough to say that you're engaged in that state.
But again, a physical presence, employees, and you'll have something like that somewhere unless it's purely a shell holding company, at which point one might imagine that its ordinary course of business is to hold interests in other organizations. If those are physical, one might think one is doing business where the stock is held by a depositary or intermediary, although that's an interesting question if that's the only contact with the state and it's a third-party intermediary like US Bank or something. You may only be doing business where you're organized and really have no physical presence anywhere other than we'll find it in the desk drawer of some other affiliated organization.
Let's take a little bit more look at the interstate commerce stuff. This is where you do get some protection under the US Constitution. Just because you have contact, it needs to be a sufficient nexus in order for a state to force an organization to become qualified.
One of the features that one might use to avoid being engaged in commerce elsewhere is to have as much of your activities, even though they cross state lines in certain aspects, to have other aspects of those activities located in your home state. For example, if you're shipping goods by common carrier, the goods are sold free on board.
The carrier at the seller's location and the seller's location state—I'm trying to come up with a hypo that's as pure interstate commerce as possible, it still would be helpful to have your contracts provide that your contracts don't exist until they're accepted by you in your home state. So, everything, other than the pure shipping of the goods across interstate lines, which is done not by you but by common carrier is handled in your home state. That's about as clean an interstate scenario as one might find.
Of course, the world doesn't turn quite that way. There's always more. You may be shipping on your own trucks. You may have a warehouse in the other state. You may have a person who works for you as an independent contractor to supervise drop shipping from the warehouse from the other state, etc. and you keep turning the dial on the facts closer and closer where at some point, the other state's courts are going to conclude that you're doing business there.
This will be a facts and circumstances analysis, very fact-specific. It's sometimes easy to reach a wrong conclusion or at least a conclusion that the judge might not agree with, not that they are easily and obviously wrong, but the judge may have a different feeling about the weight of the various factors taken into account.
What happens if you mischaracterize on one of your sub facts, that for example, you're treating a person as an independent contractor and it's later determined that that person should've been treated as an employee. There have been a number of folks who have been found to have made that mistake, had to recharacterize relationships and that reopens the door to a new revised analysis of where one might be doing business. It will also depend on how much control one exercises over one's assets or other activities in the foreign state.
For example, what about a consignment? A consignment, while treated as a purchase money security interest in most cases is a relationship where the consignor, who retains title to goods places the goods with a consignee, who sells the goods, presumably at the direction or subject to the ultimate control maybe within written parameters set by the consignor.
There is some degree of influence of direction. Even if the consignee is not an employee, they're an independent contractor, there is some degree of control. How much does it take before the consignee is deemed to be an agent of the consignor, which of course they are for other purposes, but at this point an agent for actually conducting the business of the consigner in the consignee's state. This, again, will be a fact in circumstances analysis.
We have the isolated transactions exception that Darnell talked about. Most states, it can be longer. I think California's version of that goes up to 180 days. But most states, it's a 30-day thing. What happens if you've delivered product, say software, to a customer in another state? You wrote all the software, the only thing you did was have a customer in another state download from your website, maintain in your home state a copy of the relevant software.
But you have agreed to provide product support and go in there and offer them maybe a person who comes on site for a while to help train their users to use the product and certainly maybe somebody who dial up capability or maybe have an independent contractor who makes the rounds for you in that state.
If that activity extends past 30 days, can you rely on the isolated transaction exception anymore or not? Again, that's going to be a difficult issue and hopefully you'll either get comfortable with the independent contractor characterization that these are sufficiently isolated, but at the end of the day, it's going to be the other states' courts that'll make the final and conclusive determination.
When defining what qualifies or what constitutes doing business in a state, states usually define what is doing business in the negative and define it as what is not doing business. As we mentioned, typically, maintaining bank accounts in a state does not constitute doing business. However, we have uncovered five states or jurisdictions because I'm referring to DC, where our bank account may require an entity to do business. Those states are as listed—Alabama, DC, Ohio, Oklahoma, and Delaware.
As we've echoed throughout this presentation, you have to check with each state's qualification laws to determine whether the activities your entity is engaging in constitute doing business under that state law such that you triggered the requirement to qualify to do business in such state.
Next, I will pass it back off to Darrell to discuss the impact on the cumulative analysis.
Darrell: It's very important to remember that we've been talking about certain specific activities which conducted in isolation do not require one to qualify in a state. But the analysis is actually a cumulative analysis. So, it may be that the string of activities that might otherwise be thought to be exempt adds up to a requirement for qualification.
For example, baseball teams, this is actually a real life set of cases, courts, or states were suggesting that visiting baseball teams whose teams would come to a state to play a series of games over a few days and then they leave. They may come back later in the season, but the courts, after observing that baseball had given up its antitrust issues due to the special baseball legislation at the federal level, went on to point out that the Yankees appear in California on a pretty regular basis.
They're going to continue to be coming to California on a pretty regular basis year in and year out, even though most of their games are played outside of the state of California and the upshot was that yes, the Yankees do need to qualify to do business in the state of California and of course, other states have picked up on this. So, baseball teams and I suppose other professional sports teams who do what they do in a variety of states end up having qualify even though their activities in particular jurisdictions may be fairly isolated and last only for a few days out of a given year.
What about having a sales rep in a state? It isn't enough, even if it is an employee, maybe having warehoused goods isn't enough, but you put all that together, you have goods on site, an employee, particularly a full-time employee on site, it starts to look like you're maintaining an outpost that's doing business in the state. So, these types of transactions, which, when isolated, standing alone might have been okay. You put them together and you have a problem.
Courts are going to look at the total volume of activity and all of the factors that apply to the given set of circumstances to determine whether business is being done or not, even if at the end of the day product is manufactured and shipped on common carriers form a home state, one can find themselves with a need to qualify and sadly just to remind everybody, this is 50 different states laws and even within states, sometimes the case law is not uniform.
Finally, in closing so we can allow some time here for questions and answers, we'll just observe that in addition to requiring all states requiring qualification at some point when an organization is doing business, there are some states who ask for you to register. Just advise the state that you're there even if you're only engaging in interstate commerce. Maryland, New Jersey, and Minnesota are examples of that. Frankly, if you're engaged purely in interstate commerce, there might be some constitutional questions if there's any penalties or adverse consequences from these registration requirements, but from what I understand, they're pretty benign and probably a better idea if you're aware of them to just go ahead and qualify.