State Foreign Qualification; Pitfalls for the Unwary
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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? Are there 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 free webinar by Dan Jacobson and Alan Aronson of Akerman LLP, on the topic of state foreign qualifications and pitfalls for the unwary
In this recorded webinar, we will highlight early access to Qualifying to Do Business in Another State: The CSC 50-State Guide to Qualification, while bringing the handbook to life. Attendees will have the opportunity to ask our presenters about formations as they review qualification guidelines, their impact on your business, and what you can do to protect yourself. We’ll also touch on some common CSC customer qualification questions.
Presented by: LexisNexis®, CSC, and Akerman LLP
Anu: Hello, everyone and welcome to today's webinar, "State Foreign Qualification: Pitfalls for the Unwary." My name is Anu Shah and I will be your moderator. Joining us today are guest speakers from Akerman LLP, Alan Aronson, Dan Jacobson along with CSC's Pat Nolan. And with that, let's welcome our presenters.
Alan: Okay. Hello, everyone. My name is Alan Aronson. I'm from Akerman and I'm here with Dan Jacobson and it's a pleasure to be here today. Before we begin, we have a disclaimer that we're sort of obligated to give you that the views expressed by the presenters today are not necessarily the views shared or endorsed by each presenter's respective firm. In the slide material, they included a slide of our pictures, so you can see the Adam's Family live here. I'm in the center, the one with a lot of hair. Please don't hold this slide against us.
So, today's presentation is "State Foreign Qualification: Pitfalls for the Unwary." We supposedly have a large number of people on the phone. If the co-sponsors would have listened to me and provided high quality snacks, we probably would have had a lot more people on the phone. Irrespective of that, they've assured me that most people that have registered for this event have registered not for the CLE credit but because of their qualifying interest in state qualification and no pun intended there.
So, let's begin. What is state foreign qualification? Basically, it's doing business in the state other than the state of formation. So, you form the company in Delaware and you do your business in California. Do you have to qualify? State foreign qualification is defined by state statute, all 50 state statutes. You have to review each particular state statue. The genesis of the majority of the state statutes are from the model act of the ABA as regards to the revised Model Business Act.
The problem is that each state puts its own gloss on it. Though the language may seem similar among the states, you can get a wrong answer if you don't research that particular state that's at issue. Pay very careful attention to the states. Those that practice securities laws, it's almost equivalent to the blue sky laws, that you really can't make an assumption from one state to the other, the same with the corporation laws or LLC laws of various states. They have a similar genesis, but there are distinct differences among the states.
State foreign qualification, however, which is unique in some respects, is typically defined in the negative. What the state statutes say is that it's what is not deemed doing business in a particular state. So, it doesn't tell you what foreign qualification requires or what's required to have to qualify in a foreign jurisdiction. It's in the negative. In my mind, that leads to a lot of confusion, a lot of grayness.
You look at the cases, they're all over the map and it's a lot of head scratching as to what you have to do in a particular jurisdiction. Moreover, there are no uniform standards across state lines when you have to qualify. Just when you think you have a common thread among states, there's always a case that throws a wrinkle in that or always a case that there's another issue that pops up.
So, as we go through the presentation, as Anu said at the beginning, if there are any questions, please don't wait until the end necessarily to send it to us via that little button in the webinar. If you can figure out how to use it, more kudos to you. And if it's appropriate to the particular topic at hand, we will seek to address it.
One of the problems with webinars is I feel like I'm speaking into a mirror because I have no idea what the reaction is if I'm getting through to people. I have a tendency to talk fast. That's part of my Bronx background. If I'm talking too fast, please let me know and I'll try to slow it down. But again, feel free to ask any questions and even if the presentation is over, you can ask us a question. If you can't use the computer, you can raise your hand for a question. My partner, Dan Jacobson, here, using his psychotic army, his psychic power can definitely see when a hand is raised so we can address your question.
So, state qualification--this slide, it's often overlooked but not without the potential for material adverse consequences. When you think about state qualifications, I've been practicing law for over 37 years and for the last 37 years, I can say that I've never picked up a contract or a corporate document that has reps and warranties in it that doesn't have a rep and warranty that an entity is qualified as a foreign corporation in all applicable states. Usually it goes hand in hand with a material qualifier, unless the [inaudible 00:05:31] qualify won't have a material adverse effect, but then you get into a whole argument as to what materiality is and whether it's included within a max definition, etc.
But it's in every document. It's sort of like a cornerstone of good corporate governance. Think about it. Think about the last time you did a transaction or you entered into a contract where reps and warranties were not included or if you failed to include it, why someone asked you why it's not there. There are consequences. In my experiences, people really don't tend to focus on what's the consequence for not complying and not qualifying to do business. We'll see that in a moment.
So, the first one is like yikes. You're sitting at your desk and it dawned on you--or someone comes into your office to say, "I need to get a good standing in a state and it turns out you're not qualified." You have a panic moment, "I forgot to qualify." So, in a nutshell, there's a potential for significant monetary penalties and fines depending on the jurisdiction. When you look at the fines, a lot of people poo-poo them because they're saying, "My client has a deep pocket. It's like pocket change for them."
When you look at it, it may or may not be pocket change. First of all, it depends on the extent of the activities and how many states are in play. Though we have an example here that CSC was gracious enough to provide based on some experience they had where a client should have qualified in 2000 but now it's 2015 and it dawned on someone, maybe they were doing an extraordinary transaction and there was a question about giving them their requisite rep.
So, the question was really for 15 years, they were delinquent. So, look at these four particular states. So, in Texas, the fine went from $600 in 2000 to $9,800 in 2015. Illinois, it went up from $1,800 in 2000 to about $21,500 in 2015. Florida was more generous in terms of the fee wasn't that great. That's why I guess they call it the Sunshine State down here. I don't know. Maybe there was something else going on because usually Florida in terms of fee is not that generous. Then Georgia, again, it was like four times from $225 to $825. So, basically kudos for the southern states in this example because their fees weren't too onerous.
But you can see that the fees went up significantly. You're sitting there and you're saying, "Well, it's a $1 million transaction. Do I really care that much for a $1 million transaction that I have to pay a few more thousand dollars in fees?" The question really is how material is it. It's no one fit solution to everyone. So, I'm sure most of us on the phone have had transactions with smaller clients or even with particularly large clients where there was a cash flow shortage or there were some financial issues and every dollar becomes relevant.
So, I hate to be the messenger in that regard to go tell the CFO or the CEO of a company that, "Guess what, you have to pay all these fees because someone forgot to qualify to do business years ago." Other companies may say, "No, just the cost of doing business." But it's not just the only factor. And the problem I think a lot of people have had with dealing with qualification to do business over the years is they think in terms of monetary penalties because that sticks out because if you forget to do it, you call a corporate service like CSC and they'll be happy to help you and they'll give you the bad news of what the expenses are.
But there's only one thought in the whole process as to what these problems are. I have a question about fees. Are these fees for 15 years or a single year? No. It's a cumulative fee. When you qualify to do business in 2015 in this example--we'll see in a few minutes when Pat from CSC goes through the qualification process--on the form itself in most jurisdictions, there's a question you have to answer that states when did you first--when were you required to qualify to do business.
So, if you qualify 15 years, when they process, they will calculate the fees based on the penalties and whatever interest or however they calculate these fees. It's not based on the capitalization or the size of the company. It's like a one-size fits all kind of fee. That's what you get into difficulty with. It becomes problematic. This is what I call potentially a CTC moment or call the carrier moment. If you practice in this area and you disregard qualification issues, you may want to have the carrier on your speed dial. You may have a lot of issues.
So, I have a laundry list of potential issues and I would like to go through them. We're going to circle back a little bit as we go through it. So, one potential effect would be if you do not qualify in states where you're required to qualify, what is the impact on legal opinions that were issued in connection with a transaction or in connection with that particular entity? So, we'll come back to that in a moment.
The other issue which I've been thinking about a lot when I was asked to do the seminar because most people don't is reps and warranties. I mentioned earlier that for 100 years, these reps and warranties were being contracts. When I first started and there wasn't even electronic typewriters, it was, I hate to say, portable typewriters, those Underwood manual kind of typewriters and the contracts were in long paper and everyone didn't want to make a change because they didn't want to type the whole page. The reps and warranties section would have that you were newly qualified.
So, think about that if there's a breach of a rep. What happens if you're not qualified and you have to relegate to a materiality standard if you have that materiality carve out or if you have a basket or a cap or if it's not an M&A transaction and just a contract where you may be in breach because you made a rep that was not correct. How do you deal with that? It would just not affect the rep and warranty basically on qualification.
So, let me posit this to you guys. Say you're doing an M&A transaction and you have contracts out there, you do business in certain states you're not qualified and you're willing to take the risk from a materiality standpoint that failure to qualify is not going to cause a problem with that particular rep. But there are other reps in the agreement with respect about the ongoing business.
What happens if when you eventually decide that you have to qualify after the closing, say the buyer decides to qualify and then they find out when they qualify in a particular state that they can't use the name of the company because it's already taken by someone else and you would have to qualify under a fictitious or assumed name, could that hurt the business?
If the name is very important to the branding of the business--we're not going to go into trademarks and patents and all that--that's a whole nother discussion--but if the name if very important and you can't get that name and you have to operate under a fictitious name in an important state, how is that going to impact on a rep or warranty or again on the legal opinion, if the legal opinion issued in the transaction catches some of these and whether or not the assumptions in the legal opinion, whether it's under the accord or not, carry forward to assume certain qualifications and organizational issues. That could be a problem, losing the name.
Then you have other licensing requirements. For example, if you're in a licensed business, an accounting business, a contracting business, anything that requires any kind of state or governmental issued license, how is that going to be affected by failure to qualify.
In a lot of jurisdictions, it goes hand in hand in order to get a professional license or a particular business license, you have to make sure you have to show evidence that the company is qualified to do business and if you've got that and you didn't provide that evidence, could that call into jeopardy any of your licensing requirements? Certain states have obligations that once you have a licensing obligation in this particular professional field that you have to make sure you're qualified to do business.
Then we come to our standing contracts including enforceability of certain contracts. Think about this. Qualification, I believe, is a cornerstone of good corporate governance. So, a lot of contracts have reps and warranties that certain outstanding contracts are enforceability in accordance with their terms or there is language in particular contracts about enforceability.
If you're not qualified to do business in a state, one of the ramifications are that you cannot maintain a lawsuit in that particular state. There are some exceptions to that. Think about it. Say you are doing business and there's a contract in, say, Nebraska. I'm not saying Nebraska for any particular reason, it just came to the top of my head, not because there's any particular issue with Nebraska law. I haven't looked at that.
But say you have a contract in Nebraska but you're not a Nebraska entity and you're not qualified to business and there's a breach by the other side, you cannot maintain an action in Nebraska unless you're qualified. So, at the time you make that rep or issue that opinion, if you're not qualified, can you really say that contract was enforceable at the time you made that rep because you can't enforce it?
So, it's sort of like a catch-22. There are all kinds of other issues, ancillary issues and I'm sure that opinion gurus on the phone today will weigh in and have their own particular thoughts in terms of opinions. But think about the reps. Think about the potential problems on a rep that their contract is enforceable but you don't have access to that state court. Some people will say, "Yeah, but it's somewhat of an easy remedy in a sense because you can always qualify late and pay whatever fee."
And again, you have that issue with the potential name, but it depends on the state. Some states will throw out the lawsuit until you qualify, some will say it. But it's also a question of timing. So, when you made that rep, that that contract was enforceable but you can't enforce it. Is that rep at that point in time a problem and are there damages or potential damages as a consequence of that?
That's really an interesting thought where a lot of people don't think about it because it's sort of like plain vanilla, "Oh, we'll qualify to do business." It's an afterthought. It's sort of like blue sky laws where a lot of people don't pay any attention to the blue sky laws, but they can really come back and bite you just like this qualification stuff can.
Then you have the whole issue of state taxes, which state by state it varies. Sometimes when you qualify to do business, they put you on the state tax roll. There are some additional fees and taxes you would have to pay depending on the level of business in that particular jurisdiction. That's a fear that a lot of CFOs have that they don't want to qualify because they don't want to subject their business to state taxes.
But it's a balancing act. If you're basically not complying with the law because the fear of paying taxes and then it catches up to you, then you're going to have all these back taxes and penalties and interest already that are going to come and get you and they could add up pretty quickly depending upon the number of states, the number of years and the volume of business that's done.
Again, it could easily violate certain reps and warranties and any kind of material contracts or any contracts that you have. So, it becomes like a house of cards in some respects that could really come down and fall upon you if you don't pay attention to it.
And then the worst possible thing is you can have a financial statement impact. What do I mean by that? A lot of you remember not too long ago the whole crisis over the back dating of stock options that people chose pick the date when the stock was low to issue the options so therefore they get a lower exercised price but they really did it through the benefit of hindsight. So, when it came to light, it was revalued as the date of actual grant.
So, between the exercised price and the . . . I don't know if any could hear me because there was a strange beep on my phone. But anyway, there was an exercised price spread and therefore as a consequence of that, there were all kinds of back taxes they had to pay and therefore, all these auditing firms pull their audit letters from these firms and a lot of them were listed companies and as a consequence of the listing, all these companies were thrown off the stock exchange. The lawsuits were flying fast and furious and they were delisted and it was a whole mess.
So, the issue really is on all this stuff with respect to it that there is so much adverse consequences of potential. You can dice and slice these adverse consequences, try to rationalize them away, but why bother? It's a really easy fix to qualify and you won't have to worry about it. Unless you have a real compelling reason not to qualify, why are you taking this risk and why are you risking the compliance and the overarching sanctity basically and the corporate entity.
Finally, you have the litigation risk. I told you you can't bring an action in state court, but you can have a litigation as a result of not qualifying based on what I just went through that list. There are probably more as you think about it. So, I think you really have to think about what are the consequences and it's an individually based kind of consequence, it's all facts and circumstances.
So, I hope I'm making sense to everyone. I know there are a bunch of questions coming in as I'm talking and I'll try to go through them. But hopefully I'm not going too fast and that you're able to follow my concerns in qualification and why I call it a potential call to carrier moment. If you keep on disregarding it, I recommend you have your carrier, your insurance carrier, on your speed dial.
Now, this slide really would attract a lot of people's attention because it's their personal liability. They say, "What are you talking about?" Their corporation is limited liability, their LLC is limited liability. But there are some states out there, believe it or not, that impose fines on individuals, officers, directors and agents acting for non-complying foreign corporations. Last I looked, the fines weren't that big, but they were fined and we all have clients that, let's just say, are very frugal and if you have to tell them that, "Guess what, you individually can't pay it and the corporation can't pay it," and then there's a question whether they can be indemnified and all that, that's an issue.
So, here are a bunch of states listed that I found that can impose fines on individuals and at one time, some of them could have been potential criminal, but most states have gone away from that, but these are fines that can be imposed, not to mention any fallout from any potential litigation, which may or may not be protected under any kind of D&O indemnity policy. So, just be careful.
Now, we talked about enforceability of contracts. I just wanted to emphasize this again. If an un-qualified entity is denied access to a state court, it may not be able to enforce contracts made in that state, so that calls into question the whole enforceability issue. But it may be enforceable. In some states, you can find some case law, it may be enforceable if the contract was entered into outside of that state.
That's a hard one because it's facts and circumstances and a question of proof as to where the contract was entered into and you get into all kinds of questions as to whether qualification was retired or not, which we'll see in a minute. But there is that little wiggle room out there. It ultimately depends on the nexus with the standing question. Some people have argued that . . . wait, there is a question, "Are the presentation slides changing?" I'm changing the slides. I don't know if there's . . . I'm changing it forward. It should be changing and I apologize if it's not. I don't know if there's a technical glitch. Maybe Anu can look into this while I'm talking. Okay. Someone wrote slide changing looks fine. I hope that's the case.
Okay. So, as I said, it depends on the nexus of the state. There is some language in some cases out there about contract language and people try to rely on that, "Well, if the contract says it's going to be made in a particular state, it has no nexus with that state and question that you have to qualify, may that be sufficient?" But some state courts have looked at this and say it's not sufficient and they don't credence to the language in the contract itself with respect to enforceability of contracts and qualification issues.
Okay. Now, what about defending a lawsuit? You're not qualified as a foreign company but you're sued in that state. Generally, the states are generous and they allow you to . . . you're allowed and you're permitted to defend your lawsuit even if not qualified. However, there's an interesting side note to that, whether or not you can bring a counter-claim. I'm not a litigator, but most lawsuits, there may be a counter-claim involved. If you're not qualified, it goes back to the issue of whether or not the counter-claim may be barred. There's a Vermont statute you can take a look at. There are other statues. I must say it's a gray area regarding counter-claims.
This is an area, qualification, where it's not fun to research. A lot of the cases are tied into jurisdictional-based cases. They're tied into questions of whether a lawsuit can go forward because of non-qualifications. It's hard to do it and it's really a question whether you want to devote the resources and the time necessary to do the research on your own and have someone in your office.
So, CSC has this publication which is coming out which is tied into this presentation and why they're doing this. It's called qualifying to do business in another state and it's a 50-state guide. I know there are other services that have this too. The point I'm saying is I'm not trying to plug anything in particular, but there are resources out there where you can get a handle on this and you can drill down into your particular state.
If you're going to start on ground zero and try to do the research on the state cases yourself, you're going to find the case is going all over the map, all over sideways because it's so factually specific that there's not Excedrin out there that's going to help you. You may want to think about getting some resources in terms of doing whatever research you need or do it in-house and have it update periodically based on any new state laws that come or state cases.
The question is--we looked at the effects--so, do we have to qualify? Okay. You throw up your hands because the definition is worded in the negative. So, let's just take a look at that briefly. Okay. What does not constitute doing business? This is what the statutes typically say. Bank accounts--but the answer to that is maybe, which we'll say in a minute. Having a meeting of shareholders and directors--so, shareholders and directors or the company decides, "We're going to have a meeting in Las Vegas, we'll have fun," you don't have to qualify in Nevada just because you're having a meeting there. But if you're doing other kinds of business, maybe, but just having a meeting is not required to qualify.
Defending litigation, which we just talked about, most states you can't maintain an action in state court, but you can defend it and there's a question of counter-claims. Maintaining depositories with respect to securities--you're really not doing business. Owning real property, owning the property in and of itself is not doing business, but it depends if you're doing other things. You can't look at this stuff in a vacuum.
Engaging independent contractors to sell products--independent contractors to me is one of those things that's always worrisome because are these people truly independent? Are they employees or are they independent? You go into that whole analysis and if you guess wrong or if you're questioned as to whether they're really not an independent contractor, then you're out of this bucket of not doing business, but you may be in the bucket of having to qualify. And there's a dichotomy between interstate commerce and intrastate commerce. Interstate commerce, you don't have to do business, which we'll see in a minute.
So, then it's, "What is doing business?" So, if this is not doing business, what is doing business? Generally, you have to qualify to do business if you have a physical presence. Makes sense. Have employees--this is the employees/independent contractor dichotomy with some exceptions--engaged in intrastate commerce. Then there's a note I have here that doing business for purposes of foreign qualification is different for taxation or jurisdictional purposes. Don't confuse this, they're saying they may not be the same.
So, be careful. When I started out from law school back in the George Washington days, I thought maybe I'd be a litigator, then I was like assigned to do all these memos on jurisdictional basis of litigation and that cured me of wanting to practice litigation. But it's different jurisdictional basis than foreign qualification and taxation reasons and so you have to examine each from each particular state.
Okay. Interstate versus intrastate--interstate, you do not generally have to qualify. Intrastate, you generally have to qualify. Now, I'm going to take you back to law school days. Interstate--the commerce clause of the US Constitution, remember when you were sitting on con law class and you had all these interstate classes, they were all result-oriented. They were good results, in my view, of all these Supreme Court cases to get rid of certain segregational issues. But they're used under the interstate and the commerce clause.
But your head would explode because what is interstate and what is not interstate? Growing corn in a field, is that interstate because it affects interstate commerce as opposed to not affecting interstate? So, you're back in that realm. Those who are not on the phone and didn't go to law school, be happy you didn't have to sit through those kinds of classes. But the question is what is the nexus on interstate with a particular state? That's the question on interstate.
Intrastate, within the state, generally the definition is regular, systematic, extensive and continuous contact. In other words, at least a part of the business is conducted entirely within that particular state. It has to be of a local nature. So, there are certain exceptions, like you sell through an independent contractor, to customers in the state, mail order or telephone sales, national advertising campaign, websites, provided you have no presence in that state.
Let me give you some examples. I didn't put it on the slides because I wanted you to listen to my melodious tones to just get a feel for it, but actually the real reason was I did the slides too late to be included in this deck, so I apologize. But I'm going to give you a couple of examples and you can see what you're dealing with.
Massachusetts corporation leased equipment through a satellite office in Georgia. The satellite office employed one sales person who solicited offers on orders from Georgia residents. He's up in Massachusetts in the cold. They have a little office in Georgia where they have a sales person who's getting orders from Georgia people. The orders, however, were subject to final approval from the home office in Massachusetts. So, you have an employee in Georgia. So, I would think that right away you think an employee in a foreign jurisdiction in Georgia potentially has to register because you have an employee.
In the Georgia office, they maintain blank forms and they had an active phone listing. So, my sense was if I was a betting person, which I'm not, probably more gray area could probably have to register because you have a Georgia employee. The court said you don't have to qualify because the orders had to be accepted outside the state in the home office of Massachusetts and the Georgia salesperson did not have authority to sign. Okay, facts and circumstances.
Change that fact a little bit and give that Georgia person, that salesperson, the ability to accept an order from a Georgia person, all bets are off and that company would have to qualify to do business in Georgia. So, you can see slight change, facts and circumstance analysis, very easy to reach a wrong conclusion. So, you've got to be really, really careful.
Here was an employee which sort of surprised me because as we said, not having to qualify as an independent contractor, but if you incorrectly characterize that person as an independent contractor other than employee, you're into this analysis as opposed to an analysis where it's not doing business.
So, think of it. You're sitting at your desk, the client calls or someone runs into your office or sends you an email and says, "I need a contractor immediately, an employment contract, XYZ company is hiring somebody as an employee in this particular state." So, right away, you can draft it, a paralegal or whoever is on the team can draft it. Maybe they have basically a standard template they're using for this particular company for employees.
What do you have to think about? Not just the actual contract and maybe the specific term, but if that company had never had an employee in that particular state, do they have to qualify to do business? What is that employee going to do? Is it like this case in Georgia where they're soliciting orders but they have no authority to sign? Make sure you need to put that in the contract so you have an argument that you don't have to qualify to do business.
California corporation has a salesperson in Wisconsin and they have two people from outside of Wisconsin as sales managers that go into Wisconsin periodically. The in-state salesperson in Wisconsin could not accept orders because they're subject to approval in California and when the sales manager goes into Wisconsin, they're engaged in training other sales force in Wisconsin.
Not clear from this fact. I really didn't look up, so I don't know whether this salesperson was an independent contractor or an employee, but the court in Wisconsin applied similar analysis to Georgia and said they didn't have to qualify since the orders were accepted outside of Wisconsin and could not be accepted within Wisconsin. The question I had in this case was you had these sales managers who go into the state periodically and if they have the authority to accept it while they're in the state of Wisconsin, would that change the result? That case didn't really deal with that.
But change the fact slightly, different answer. The whole problem I have with this is why are you going to take that risk? Because what happens, as we know, with clients, they give you a certain fact pattern, "We're having this employee, they're never going to accept orders," and in reality, as time goes on, as they get comfortable with that person, that person starts accepting orders and they don't tell you.
So, the question is are you better off to bite the bullet and qualify and the answer to that is to really figure out what are the unintended consequences of qualifying in terms of the monetary amount that you have to pay yearly, which is probably not a big deal, and what kind of tax roll do you go on for qualifying. If you have an employee in Georgia anyway, you probably are subject to some Georgia taxes anyway, which are probably subject to Georgia payroll taxes. So, really, you have to ask yourself those questions. To me, I always like to take the easy way out and the more conservative way out and when in doubt, qualify.
Here's another example and then we'll continue. This one, I think, was somewhat interesting. Out of state corporation leased an MRI machine to an Alabama healthcare facility. Then they transferred an out of state employee to Alabama on a temporary basis to service the machine and train the Alabama employees. They had this really expensive machine going into Alabama. They leased it. And of course the company that owns the machine is nervous about this expensive machine.
So, they want to make sure the people handling it are properly trained and so they send one of their folks in there to train the people, they also reserve the right to correct the bills, set the rates that were used and to basically terminate anybody who's working on that machine locally who they feel is not using the machine properly. So, they want to protect that investment in the machine and make sure that machine is handled absolutely correctly. Do they have to qualify to do business in Alabama?
And the court said that qualification was necessary because the use of the employee from the out of state corporation was not a necessary, essential or integral part of the interstate contract. So, here, they said it's an interstate commerce kind of thing but you went beyond interstate commerce and you converted it to intrastate because you had this guy employee sitting there helping to maintain this machine and train the people to protect the investment and you had to qualify. So, you know, you scratch your head after all these things--slight change, slight analysis differential, what is the hot button for a particular court? You really don't know.
Let me just see what kind of questions are coming in. Okay. There's a Georgia employee sitting at the Georgia office, the Massachusetts corporation did not have to register for those two reasons. The reasons were because the orders were not signed in Georgia but had to be approved in Massachusetts by the Massachusetts company. I hope that answered the question. Okay.
So, in determining whether you have to qualify, courts will look to state licensing or other state regulatory requirements. Law firm opens up an office in another state, not only dealing with the bar stuff, do you have to qualify to do business? So, you have to be proactive to determine the requirements like anything else in good corporate governance.
Remember, I can't say this enough, that qualification to do business is a cornerstone of good corporate governance that sort of got lost in the shuffle when people were focusing on more Sarbanes kind of issues, which I'm not saying they're not important, or other kinds of issues. It's sort of similar to me what I see over the years in blue sky, sort of half-hearted attention to it.
You must also be proactive in determining the consequences of qualifying or not qualifying. Qualify unless you have a compounding reason not to qualify and that compounding reason would be what are the unintended consequences of qualifying, which is mostly a tax issue or an expense issue.
So, I just want to point out, there are five states that I found out or jurisdictions where a bank account may require you to do business. I know it's on the not list. So, you may want to look at that. Again, some of these states, it just may be one factor in determining whether or not your qualifications are required. It may not be the end all be all that if you have a bank account in Alabama that you automatically have to qualify. It goes usually hand in hand with other types of activities.
Okay. I want to go a little faster so we can get Pat's slides in here. Certain states require--this is interesting--certain states require unqualified entities to register in the state before engaging in interstate commerce. Now, interstate commerce, you don't have to register, but in these states--I don't know if it's been challenged under the commerce clause, but in Maryland, New Jersey and Minnesota, you have some sort of registration you have to do, it's an easy form, before you can engage in interstate commerce in those states. So, again, the bottom line is you have to check each particular estate with respect to that regard.
Qualification versus jurisdiction--we talked about that slightly before, where qualification does not automatically subject a corporation to jurisdiction in every state in which it does business. This was a change from what it was years ago. So, you no longer could sue a foreign corporation, for example, in Delaware form claims unrelated to the corporation's activities in Delaware.
There has to be a nexus and there's Daimler vs Bauman, US Supreme Court, which talked about jurisdiction and the affiliation with a state has to be continuous and systematic as to render it essentially at home in the form state where there will be a jurisdictional base. We're really not dealing with jurisdictional issues today. It's more qualification issues. So, I don't want to go down that. The qualification process.
Patrick: Sure. Thank you, Alan. Thank you very much. This is Pat Nolan. As Alan was saying, qualification is the process of registering an existing domestic corporation which is incorporated in a particular state in any state where that corporation plans to be doing business. So, the state where a company is formed is its domestic state. Any state outside of that where it plans on doing business is considered a foreign state. It really doesn't have anything to do with where the company's headquarters are located, but just the domestic state of incorporation.
So, when you go to qualify in a foreign state, each state requires a separate filing and the payment of taxes and fees with the respective state authority and that's usually the Secretary of State's office. So, just as we found out earlier that what constitutes doing business in each state differs greatly, so does the procedure for qualifying. In the next slide, we're going to take a look at the general qualification steps that are particular to most states. We can turn the slide there, Alan. Thank you.
Okay. The first thing one might want to consider is to check the name for availability. Now, you may be incorporated in Delaware and you've been there for 50 years. You might have a service mark on the name or patents on certain products and services. That does not mean that your corporate name will be available in the state where you wish to qualify. So, a prudent thing to do is to check that name.
Another thing you might want to consider is if you don't plan on filing the paperwork right away is to reserve the name. Every state but the state of Florida permits name reservation. In most cases, the period of reservation is between 30 and 120 days. That's a good thing to do if there's going to be some delay between doing the planning work and the actual filing. Some folks don't want to qualify too soon because you may be susceptible to an annual report filing or something else that's unnecessary if the company hasn't quite yet begun doing business. We'll touch on that in a little while.
The next step would be to prepare and execute the required qualification documents. They vary greatly. They can be a simple one-page form and just have it signed by an officer and off you go. In most cases, they're a little more complex. The other thing is each state has their own filing fees. They can be a flat fee or they can follow a formula. That's something to be mindful of and CSC is delighted to help with all of that.
Most states, touching on the next bullet, require that you provide proof of your corporate existence in your domestic state before they'll accept your application for authority. In other words, you would have to attach to it either a certificate of good standing, which is the document needed by most states or there's about six handful of states that required certified copies of your charter documents to be attached to your application.
The next step is then to file the qualification forms. Another thing I should mention is that on most qualification forms, you have to designate a registered agent. There are very few states that don't have that requirement. That party should be somebody within that state. It should be somebody that's responsible for handling service and process. No offense to janitors or anything like that, but you probably wouldn't want to name the janitor because he's got a house in Florida for your corporation as the registered agent.
CSC, of course, that's the backbone of our business and if you get the forms from us through our forms library, our address is pre-printed on the forms as the registered agents. Some states require that the registered agent accept their appointment. We like that idea because sometimes people get ahold of a form and they appoint an agent not thinking it's very important at all only to find out that since we don't know we've been appointed and they don't know they've been served or sent an important communication from the state, it leads to more problems.
And the last thing in the procedure is just to tend to any publication or recording requirements. So, we'll take a look at the next one now.
Alan: Let me just jump in on appointment for a minute. I'm sorry to interrupt, Pat. There's a liability issue on appointment too because historically a lot of law firms, okay, have put the law firm as the agent for service process in this regard. As law firms grow in size and the chaotic moment of the day, service is given to the law firm and it gets lost in interoffice mail or the person who's responsible for it is away from their desk on vacation or sick or whatever, it can go unanswered with the dire consequences.
I'm not trying to plug a corporate service but I'm just saying it's something to be factored into the analysis on the corporate agent that do you have a plan in place whether it's a law firm or someone at the company or individual as to what's going to happen, what happens if that person is away.
These things come out of left field and when these things come out, there are all kinds of emotional issues that are driven, economic issues and problems. The last problem you want is that somehow you get into false judgement because the service agent was not available and was not there to collect the service or process.
Patrick: Thank you very much, Alan. Thank you. Okay. On the next slide here, this slide is going to speak to some of the things that can cause problems in the qualification procedure. Forget the title, Qualifications Gone Wild seemed pretty funny two months ago when I put it on paper, but now that I think I have 600 brave people listening to me, I'm not too sure it's that witty at all.
Anyway, the first state that comes to mind as far as a complex formula for filing fees is the state of Illinois. It's hard to grasp if you have the paperwork in front of you, so doing it over the phone here or over the webinar is a little more difficult. But Illinois, although it's very complicated, it makes a lot of sense. They base their filing fee on your paid in capital number. That in a nutshell is like the number of authorized shares times your par value if you have a par value and can be larger if there's surplus.
But they use that as the basic what they're going to charge you in a filing fee, but they take into consideration how much of that paid in capital is going to be attributed to the state of Illinois. On the form, they're going to ask you an estimate on the property you own in the state of Illinois as well as the business you're going to do in the state of Illinois and that number added together is the numerator in a fraction where the . . . it's been a long time since algebra, but the bottom number is the actual number of business conducted everywhere as well as the property owned everywhere.
I guess it's numerator and denominator. In other words, you're qualified in, say, all 50 states and you're going to do a tenth of your business in Illinois, you're going to do a tenth of your stated capital as opposed to all of it. So, that's about as tough as it gets and even Honest Abe there would be challenged, but we're here to help.
Another thing to be mindful of, especially in my own state of New York are words and names that can prevent problems. At least on the East Coast, most companies choose Delaware as their state of formation and Delaware, as probably most folks on the phone know, is a very liberal state and almost anything goes. They have a Secretary of State department that works like a service company. They're just really there to please. With that said, words don't really bother them. You can form a company with the word "financial," "bank." You might need to get a letter from the Commissioner of Insurance if you use the word "insurance," but for the most part, it's not a procedure that slows it down.
My own state of New York, any of these words on the screen plus about 50 more will cause a problem. What that means is the qualification procedure is slowed down from possible one to two days to six to eight weeks because if you have one of these words, we'll use this example--123 Bank Street Realty Company, Inc. Clearly that is not a bank. It is probably a realty holding company, something like that.
But just because of the appearance of the word "bank," you have to get consent from the Department of Financial Services in New York and that can take about six to eight weeks. Likewise the word "financial," a very simple word that is also problematic and requires consent, as do words that contemplate a professional practice such as "engineer" and "insurance" as well.
We talked earlier about the penalties for failure to qualify. I think there was a question that came over about what that fee was and I believe Alan answered it, but just to touch on it, I did those filings back in 2015 and the fees on the right hand side were the very small ones were what the company would have to pay one time only if they had answered the question if they start a business as upon qualification or put a future date. But because they put a date in the past, all those penalties were added.
The other thing to be mindful of is additional requirements after qualification on the previous slide, we had talked about publication and recording. Publication can be expensive. Again, not to pick on my own Empire State here, but in New York, for example . . . and it doesn't apply to corporations, it only applies to limited partnerships and limited liability companies. Since limited liability companies are lately becoming the choice of the public for a lot of reasons that you folks know more than I, we encounter it a lot.
The thing with New York is you have to publish once a week in two newspapers for six consecutive weeks. That's triggered by what you put in your application for authority as to where your office is located. If it's an outlying county, like I live in a place, Rocklin County, it's pretty reasonable. We have two newspapers and they're cheap. But if your county location is in New York County, you're going to get the Law Journal as one paper and then another one designated by the county clerk for the second paper. And it can be as high as $3,000, so just something to be aware of.
The next slide will wrap it up here and I want to thank you folks for your patience if you're still with us. That Lincoln formula probably had some people's heads banging off the desks. But we'll forge ahead and we'll wrap up here.
Other things to be mindful of is once you've qualified, the work is not really done. There's initial and annual reports that will have to be filed. Some states like California come to mind, within 90 days of filing your qualification form, you have to give them your initial statement and list who your officers are. Most states have a requirement that you file an annual report each year.
Unlike a shareholder annual report for a publicly held company, it's basically just a revenue generating form the state wants filed every year that lists your officers and directors. But if there's one thing in my 35 years of doing this that lassoes up a closing, it's when you go to obtain good standing certificates to that closing. The number one reason why we can't get them is because these little simple annual reports aren't filed.
The next thing is obviously most states require you to pay taxes. Another thing we'll just touch on real briefly is there may be business licenses that have to be obtained. Let's say you've qualified your company to be a restaurant. It may have to get a liquor license. It may have to register with some city authority where the restaurant is located, etc.
The last thing--this may be obvious to a lot, but it's amazing to me how many times we'll run into a case where a company has need to file an amendment. From time to time, a corporation or an LLC changes its name. You file that amendment in your domestic state, your state of incorporation. If it's a name change, every state will require some type of post-qualification filing, an amended application for authority to alert them to that name change. That's just another thing to be aware of.
So, at this point, I think we're near the end and I guess I will turn it back to either Alan or Anu and maybe we'll field some questions.
Alan: Let me just interject some stuff. The process itself, if you look at the forms on their face, it doesn't look too complicated, but like everything else, in terms of dealing with Secretary of States and governmental authorities, there are some complexities that are hidden within the document itself. Sometimes it's just as easy as a conflict with the name or a problem with how the form was delivered or what was the, as Pat said, what the underlying documentation that had to be submitted was also.
So, again, I'm not pushing anyone to use a corporate service. Some people like to do it themselves. But just bear in mind that if you are not using someone who does this on a day for day basis, you have to build in a time element in case you run into a problem because the Secretary of State's office is not going to reply to you by Federal Express typically or by email or fax, though some states may. So, there may be a time lag if there's a problem and your filing gets bounced until it gets resubmitted. So, it all depends on the urgency of doing the filing.
You've got to be really careful and not rely on the Secretary of State's office to find your mistakes. I just recently discovered an entity that was supposed to qualify in 2016 in a certain state, but when they filled it out, I guess they had New Year's Eve on their mind and they put 2017 as the date instead of 2016. So, it looked like they were qualifying to do business a year ahead of time because most of the forms ask the date when you're going to commence business or when you plan to commence business.
So, even though they thought they were qualified to do business in 2016, their form indicated they were qualified to do business in 2017, which could have certain ramifications and effects. So, you've got to be like everything else, the devil is in the details and you've got to pay particular attention to a lot of this material.
We're sort of out of time. We have a Q&A set up and I know we have 24 questions in the inbox and it's going to be very difficult for us to get to a majority of those. For those who are asking specific factual questions and the questions whether there's qualification issues, the problem is it's a fact and circumstance analysis. I really can't do justification to whether I think you would need to qualify based on a one sentence or two-sentence fact pattern with particular instances because there's always underlying other issues.
So, if you're asking about income producing property that requires qualification, what's associated with that income producing property, whether the activities are involved in the state. If it's solicitation of orders, who's soliciting those orders? Where are those orders being accepted? What other activities--you have to look at the big picture--what other activities are being done in that state? Can you fall within the interstate exemption or is it truly systematic contact to make it intrastate?
Also, what is planned in the future? When you look at it, when you give a client a certain results-oriented answer, you don't have to qualify, you have these case laws or whatever, but bear in mind that you change one little fact or you enlarge the fact pattern and do something different, the whole analysis changes. It's all state-specific.
So, you have to look at the case law in that particular state, which I said is not that easy to research and I recommend that short circuit it by getting some sort of . . . it's like going to law school and getting a horn book to at least help you initially in the research so you save hours and hours of time to try to find these cases, then figure out based upon your fact pattern what are the risks, what's the analysis, do you think I'm still in the gray zone and if I'm in the gray zone, maybe just bite the bullet and register, figure out with your tax people what are the taxable consequences, if any, in that jurisdiction, figure out what the fee, which is usually pretty nominal in that state and you're home free and you don't have to worry about any of this.
And then you just monitor and keep it up to date like Pat said and if you change your underlying corporation, you amend that charter, you have to probably amend the charters or the qualifications in these states because your certificate of incorporation as amended is attached to your qualification papers. So, it's not like one of these dust collectors you throw it in the minute book and forget about it and look at the inch of dust on it and not pay any attention, "Oh, I'm qualified. I don't have to worry." You do have to worry because you have to keep it current. Okay.
Patrick: Alan, can I interrupt for one second? I just want to answer a question posed by Janice. There was an oversight on my part on my Qualifications Gone Wild slide. I skipped the last bullet point, which is executing a qualification form wherein another entity is the member manager. So, again, this pertains mostly to LLCs, maybe exclusively to LLCs.
But a lot of times the member or manager has to sign the qualification form. And it's not uncommon . . . if it's a person, it's no problem. Whoever that person is signs the form. It's not uncommon for that member or manager to be another entity. Sometimes it could be like a tier of entities. So, for example, if ABC LLC is qualifying in Illinois and XYZ LLC is the member, then XYZ LLC would have to sign the form. Again, it's an entity, so that's a problem.
Let's say then that XYZ's member is ABC Corporation, then you'd have to list by ABC Corporation and then have it signed by an officer of that company. So, at some point, the tier has to make logical sense as to the progression so that when the pen is put to paper by the signer, it's an actual party that's responsible ultimately for the tier of companies. Hopefully that addressed it. I apologize. I missed it on the first go around.
So, I'm going to turn it back to Anu if she has any final . . .
Anu: FPresenters, thank you for everything. Folks, thank you for joining us. We hope to see you again in the future. Take care.
Alan: Bye everybody, thank you.
Patrick: Thank you very much.