Foreign Qualification: What you Need to Know

The term foreign qualification can often be confusing to business owners, we break it down for you in this article.

The term foreign qualification can often be confusing to business owners. The first thing most of us think of when we hear the term “foreign” is something outside the United States; however, in the world of US corporations and limited liability companies (LLCs), the word foreign has a different meaning.

Foreign qualifying a company means that you are registering it to transact business in a state other than the state of formation. Corporations and LLCs are considered domestic only in their state of formation. For example, if you formed your LLC in Delaware, it is only domestic in the state of Delaware. If your LLC is transacting business outside the state of Delaware, it would be considered a foreign LLC in those other states.

When you foreign qualify a business, you register for a certificate of authority in the state or states where your company will be transacting business, and pay the necessary state fees. By doing this, the state knows that a foreign corporation or LLC is conducting business within its borders.

If you are currently evaluating whether to form your business as a corporation or LLC in a state other than one where you are transacting business, and you may need to foreign qualify in that state, keep in mind that your business will be subject to ongoing reporting requirements, fees and taxes in both your state of formation and state of qualification. If your business is expanding into new states and you need to qualify it as part of this growth, these initial and ongoing fees should be considered a necessary part of doing business. 

What is Considered Transacting Business?

There are many factors used to determine whether a company is transacting business in a state, and therefore needs to foreign qualify. Some of the common criteria evaluated include:

  • Whether the company has a physical presence in the state
  • Whether the company has employees in the state
  • Whether the company accepts orders in the state
  • Whether the company has a bank account in the state

This is not a complete list, and different states may have different criteria. To determine whether your business needs to foreign qualify in a particular state, it is best to seek the advice of an attorney.

Consequences of Not Foreign Qualifying

One of the questions you may be asking is, “What if I don’t foreign qualify with a state in which my company is transacting business?” You’ve read that there are additional costs to this process, since your company will face initial and ongoing fees both from your state of formation and state of qualification. Maybe this seems like an unnecessary burden; however, state laws require foreign corporations and LLCs that are transacting business within their borders to foreign qualify.

The consequences of not foreign qualifying your business outweigh the costs associated with foreign qualifying. One consequence is loss of access to that state’s court system. For example, if an employee or customer within a state in which you are transacting business sues your company, you would not be able to defend the lawsuit in that state’s courts, because your company is not recognized as a business there. Another consequence of not foreign qualifying is the possibility of facing fines, penalties and back taxes for the period of time in which your company transacted business within a state without being foreign qualified there.

Foreign Qualifying Versus Incorporating in Every State

There is an alternative to foreign qualifying: you can incorporate your business or form your LLC in the other state(s) in which you intend to transact business. The primary difference is that when you incorporate or form your LLC in multiple states, your company becomes domestic in each of those states, thereby creating separate entities.

For corporations, the increase in corporate formalities is the biggest disadvantage of forming separate domestic corporations. Corporate formalities include drafting and maintaining bylaws; issuing stock and recording all stock transfers; holding initial and then annual meetings of directors and shareholders; and keeping minutes of all director and shareholder meetings with the corporate records. LLCs do not face the extensive formalities imposed on corporations.

When you create a separate corporation in each state, each of these corporations will have its own stock, shareholders, directors, and officers. Even if the shareholders, directors and officers are the same people for each corporation, the formalities must be followed for each domestic corporation, thereby greatly increasing the annual record keeping requirements.

When you foreign qualify, there is only one corporation or LLC. For corporations, regardless of the number of states in which a corporation foreign qualifies, it will require only one set of bylaws, stock, shareholders, directors, and officers. Bylaws will need to be adopted only once, and the holding of and record keeping for the initial and annual meetings of directors and shareholders happens only once.

The advantage of forming a new corporation or LLC in each state is the separation of liabilities. For example, if one of your companies is forced into bankruptcy in one state, the assets of the companies in the other states typically would not be used to pay the debts of the bankrupt business. If you have foreign qualified your business in each state, only one corporation or LLC exists, so there is no separation of liabilities.

The Registered Agent

Whether you qualify or incorporate your business in each state, you will need to name a registered agent in that state. Virtually all states require corporations and LLCs formed or foreign qualified in their state to have a registered agent there. The registered agent is the party responsible for the receipt of important legal and tax documents for the company. The registered agent must have a physical address (no P.O. boxes) in the state of formation or qualification and must be available during normal business hours.

Examples of documents sent to the registered agent include Service of Process (or notice of litigation), which is the document that initiates a lawsuit; mail from the state; and often taxation documentation from the state’s department of taxation.

If you do not have a physical address in the state where your business is forming or qualifying, you can enlist the services of a professional registered agent service provider, such as BizFilings, which serves as registered agent in all 50 states and Washington D.C. Even if you do have a physical address in that state, you, like many business owners, may still choose to use a registered agent service provider, with one of the key reasons being to ensure these important documents are handled professionally.

As always, if you have questions regarding your specific business situation, such as whether you should foreign qualify or incorporate in other states, you should contact an attorney for a legal opinion.

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