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Companies expanding their operations across state lines may be subject to the new state’s registration or “foreign qualification” requirement. It’s important for business owners, managers, and advisors to understand this requirement because there are penalties if the company doesn’t comply.
A company, whether doing business as a corporation, LLC (limited liability company), or other statutory business entity, is a “domestic” company in one state – its formation state. It is considered a “foreign” company in all other states. States have the power to prohibit foreign companies from doing business within their borders unless they comply with certain conditions the states think are necessary. And every state has taken advantage of this power by enacting foreign qualification provisions in their state business entity laws.
Foreign qualification is the procedure by which a corporation, LLC, or other statutory business entity receives the authority to do business in a state other than its formation state. (It is also sometimes referred to as “registration”). The company pays a fee and files a document with the state business entity filing office. The document is generally known as an application for authority. Typically, it is a short form that asks for certain basic information about the company. Once qualified, the company will be subject to a few other compliance requirements, like having to maintain a registered agent and file an annual report.
The states’ Constitutional right to enact foreign qualification statutes was established many years ago in Paul v. Virginia, 75 U.S. 168, 8 Wall. 168 (1869), where the U.S. Supreme Court stated that a corporation was a “mere creation of state law” and that it had “no legal existence beyond the limits of the sovereignty where created.” This meant a state could refuse to recognize the existence of another state’s corporations when they carried on business within its borders, or could condition its recognition upon the corporations’ compliance with certain requirements. The federal government does retain some Constitutional authority over these state-created entities.
The Commerce Clause reserves to Congress the power to regulate interstate commerce. The states may not enact laws that place an undue burden on interstate commerce. However, state laws that regulate even-handedly to effectuate a legitimate local public interest, and whose effect on interstate commerce is merely incidental, are usually upheld.
If a company transacts business in a state without having qualified it can be penalized by the state. Often, a fine is imposed.
CT Corporation Observation: Under some state statutes, the people doing business on behalf of the non-complying company can be fined too.
In addition, the state can prevent the company from bringing a suit or proceeding in the state’s courts until it qualifies. This is referred to as a “door closing” provision and the states close the courthouse doors because they don’t think a foreign company should benefit from the aid of a state’s courts in enforcing its rights when it is (a) violating state law and (b) not paying its fair share.
The benefits of conducting business activities across state lines are numerous for many businesses. But compliance obligations increase when companies expand their horizons. Remember to comply with these obligations, particularly the foreign qualification requirement.
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