Best Practices: The Importance of “Foreign Qualification”

A startup company may elect to file its preliminary corporate documents, such as the articles of organization (limited liability company) or incorporation (C-corporation), in a state other than the one in which the company intends to conduct actual business operations.  However, such companies, including Borrowers applying for SBA loans, must also be authorized to conduct business operations in the state in which the active business operations will occur.  The company obtains such authorization by registering as a “foreign entity,” i.e. obtaining a certificate of authority, in the state of operations.

So, for example, an entity organized under the laws of the state of Wyoming which intends to operate a manufacturing facility at a location in Georgia must file not only its Articles of Organization with the State of Wyoming, but also a foreign entity registration in the State of Georgia.

The main reason for requiring foreign registration is to ensure that the company accounts for and pays all taxes due to the state of operations – including sales and use taxes, among others. Additional reasons include compliance with state labor laws and state unemployment insurance, and to ensure that a registered agent is identified in-state for legal service of process on the company itself.  

Procedure

While the process of registering as a “foreign” entity varies from state to state, generally, the company must pay a fee and file documents similar to those filed in the home state when applying for articles of organization or incorporation.  This starts the process of the company receiving a valid registration from the foreign state’s secretary of state, so the company can then register and receive an account number with the state’s taxing authority to file income, sales and use, employment taxes, etc. 

Exceptions 

While the general rule is that a company may not “conduct business operations” in a state until it obtains a certificate of authority / foreign registration with that state, there are limited exceptions to the rule which are described in that state’s statutes on foreign entity registration.  Such examples may include:

• the activities of a passive real estate holding company, without more;
• the holding of corporate meetings (internal affairs) in that state;
• an out-of-state company which serves only as the manager of a limited liability company located in the state;
• conducting an isolated business transaction;
• an out-of-state company serving as a trustee, executor or guardian within the foreign state.

The list of exemptions from the foreign registration requirement, even as described within a state’s statutes, may not be exhaustive.  It should be noted that SBA rules prohibit the financing of most of the types of activities described in the exemption list above.  So, where an SBA borrower will be conducting business activities in a state other than its home state, lenders should carefully review the state’s requirements to conduct business, and ensure that the foreign entity registration has been completed prior to loan closing.

The state of operations may impose additional requirements, depending on the state and type of industry, including regulations imposed by the state’s Department of Revenue, Department of Labor, and Department of Insurance.  If a borrower has been formed in one state but is not following the rules to register appropriately in the state of operations, the borrower may end up out of compliance with state tax rules, as well as employment and insurance regulations, right from the start.  

For corporate compliance issues, contact the attorneys at Starfield & Smith at 215.542.7070.