For most manufacturers, doing business beyond the lines of the state in which they are incorporated is par for the course; it’s critical if you plan to expand and grow your enterprise.
However, states seek to keep track of companies who are expanding operations into their jurisdictions. It is important for manufacturers to take this into account when they do business in other states and abide by the “foreign qualification” requirements of each state in which they do business. Doing so protects against potentially negative consequences.
What is “Foreign Qualification”?
“Foreign qualification” is the process of formally registering a corporation, nonprofit, or LLC in a state other than its formation state. Generally, foreign qualification is required whenever a company begins doing business in a new state, unless it opts to form a new entity in that state.
Nearly every state requires companies to register before doing significant business in that state. Companies must comply with these provisions in order to receive authority to transact and have access to that state’s courts.
Better Late than Never Is Not Always True
A recent legal case, Drake Manufacturing Company, Inc. v. Polyflow, Inc., reveals one hidden consequence of not registering in a state where you do business – the potential to lose access to that state’s courts. The result of the case, an unfortunate one for Drake Manufacturing, serves as a reminder that it may not always be possible to cure problems created from failure to register.
Drake, a Delaware corporation and supplier of industrial products, sued Polyflow in Pennsylvania Superior Court, over payment for machinery and pipe fittings. Polyflow did not dispute its failure to pay. Nor did it contend that Drake failed to perform its duties. Instead, it claimed that Drake did not have the legal capacity to maintain a lawsuit in state court because it was conducting business in Pennsylvania without a certificate of authority.
Even though Drake eventually provided a belated certificate of authority, in January, 2015, the Pennsylvania Superior Court ruled that Drake’s failure to submit its certificate before the lower court verdict in the case meant that Drake lacked the capacity to maintain a lawsuit in Pennsylvania.
In effect, the Superior Court held that Drake’s attempt to correct its mistake came too late. As a result, Drake could not collect almost $300,000 in damages.
How to Register in Every State Where you do Business
The process of registering in every state where you do business is relatively straightforward. To do so, in general, involves paying a fee and filing a document with the relevant authorities. Upon authorization, the company receives a certificate or other evidence that it is allowed to do business as a qualified foreign entity in that state. For more information on the topic of foreign qualification, see Foreign Qualification Basics.
Another option is to incorporate or form a new LLC when you begin doing business in a new state. When a new corporation or LLC is created, the company is domestic in the new state, making it a separate entity. There are pros and cons to doing this, involving risk, reporting, and compliance requirements, so manufacturers should consult their advisors to determine the best path.
The Devil in the Details
One question that often arises is ‘what constitutes transacting or doing business within a state?’ Generally speaking if your company accepts contracts, has a physical presence, or employs people in a state, you will be required to be “on record” in that territory. However, every situation is unique, and manufacturers should discuss their plans and expansion goals with their attorney for advice.
Another complexity: qualification requirements vary from state to state and, in many cases, from entity to entity within a state. In addition, statutory requirements can change over time. Pennsylvania – home of the Drake case – made a recent change to its qualification statutes effective on July 1st, 2015. Finally, the work does not end after foreign qualification is achieved. Once registered, the company will need to maintain a registered agent, file an annual report, and so on to remain compliant.
In short, the more states in which a company operates, the more complex the scenario can become. The key to maintaining compliance is finding and working with a good registered agent who can keep you informed and up-to-date on the compliance requirements in every state in which you operate.
The Consequences of Failure to Comply
Doing business in a state without registering subjects a company to penalties such as fines for each year that the company should have been registered. Under some statutes, individual officers doing business on behalf of the non-complying entity may be fined. Further, a state may collect all fees and taxes the foreign entity would have owed had it registered when it was required to, plus interest, and in some cases, additional fines.
Finally, foreign qualification provisions prohibit a business from bringing a suit or proceeding in a state’s courts until it has registered in that state. Under most circumstances, companies can seek to remedy this by registering after a case has been initiated. But as we have seen in Drake, this remedy is not always guaranteed.
Foreign qualifying – registering your business in all other states in which you do business – helps you avoid fines, interest and back taxes, preserves your ability to sue and protect your personal assets. Overall, a good investment of your time and attention.
A lawyer and entrepreneur, Director of Strategic Alliances for Small Business at CT Corporation, Jason Erb helps entrepreneurs, and the providers who service them, build their businesses by securing and leveraging strategic partnerships in the areas of compliance and governance.
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