By: Ananya Hindupur

When an entrepreneur has a viable product or service offering, most often, her next step is to organize as a formal entity under state law. The default entity, when none has been affirmatively formed, is a sole proprietorship or a partnership.[1]  Sole proprietorships and partnerships are pass through entities where any liabilities that it takes on is attributable to the entrepreneur. Therefore, a corporation or an LLC, both entities that shield the entrepreneur from personal liability, are popular choices for entrepreneurs looking to grow their startups.

The entrepreneur formalizes her startup as a corporation or LLC under state law by filing the requisite documents with the state. A certificate of good standing verifies that the entity is registered and authorized to conduct business in that state.[2] This certificate is not required in order to operate as a business, much like an operational license would be required. It simply shows that an entity has properly maintained status with the relevant state agency.

Typically, on an annual basis, the entity is required to file documentation and pay fees associated with operating the business. If the entity performs these duties on time with the state, it maintains in good standing.[3] However, if the entity fails to execute these duties, it falls out of good standing. The entity may be considered “void”, “suspended”, or “dissolved”, depending on the state and the amount of time that it has not been in good standing.[4] In certain cases, an entity is not in good standing with the state, cannot engage in certain valid business transactions and may face administrative dissolution. An entity may also face reputational harm and irreversibly lose its name.

This post will take a closer look at the relevant statutory provisions that a startup entity must abide by in order to maintain good standing with the state. Specifically, this post will focus on corporations and LLCs formed under Delaware and Michigan law.

Delaware Entity Law & Good Standing

Delaware Corporations

Delaware corporations are required to pay an annual tax of at least $175[5] in order to maintain good standing.[6] This tax may increase depending on the size of the Delaware corporation, reaching as high as $200,000.[7] Additionally, a Delaware corporation is required to file an annual report and pay an associated $25 fee[8] to maintain good standing.[9] On or before November 30, the Secretary of State will notify any corporation that has not paid taxes or failed to file an annual report.[10] The corporation has until March 1 of the following year to pay all outstanding taxes and submit the outstanding documentation.[11] Failure to do so will result in the loss of good standing. Losing good standing does not mean the business is dissolved, but that the business is liable for all unpaid taxes and unfiled paperwork.[12] Delaware corporations can restore good standing by paying the annual tax, filing the annual documentation, as well as paying any fees associated with late filings.[13]

At the extreme, however, failure to file taxes and documentation with the state for two consecutive years[14] results in the charter of the corporation becoming void and a loss of all powers conferred.[15] Such a voided Delaware corporation loses among its powers conferred, the ability to sue in all courts, purchase or receive real or personal property, lend money, invest its funds, appoint officers and agents, adopt, amend, and repeal bylaws, have limited liability for its shareholders, and make contracts.[16] Further, when a business is voided, the business may lose its name.[17] This means that another business may assume that same name and generate reputational harm.

Delaware LLCs

Similarly, to maintain good standing, Delaware LLCs are required to pay an annual tax of $300[18] due on or before June 1 of the following year.[19] The Secretary of State mails an annual tax statement at least 60 days prior to June 1 notifying the business of any unpaid tax.[20] If unpaid by the due date, the business accrues a monthly interest fee of 1.5%.[21] If a business has not paid the annual tax, when due, it ceases to be in good standing.[22]

If an LLC is not in good standing following three months after the annual tax is due, the Attorney General of the State can apply to the Court of Chancery for an injunction that prevents the entity from transacting any business for the duration of the injunction.[23] More importantly, if a Delaware LLC loses good standing, the owner becomes vulnerable to liabilities associated with the business.[24] A creditor of the LLC can come after the LLC’s owner’s assets as a means of settling any outstanding liabilities.[25] An LLC that does not pay the annual tax by the due date may not maintain any suit, action, or proceeding in any Delaware court until good standing has been restored.[26] However, failure to maintain good standing will not impede the validity of any contract, deed, mortgage, security interest or impair the company from defending any action in a court in the State of Delaware.[27]

To restore good standing, the LLC has to pay the outstanding annual tax and any penalties and interest accrued.[28]

Failure to pay the annual tax for 3 years following the due date will result in a cancellation of the LLC’s certificate of formation on the third anniversary of the due date.[29] Cancellation may result in the LLC losing its company name. However, a cancelled LLC can also be revived if the proper steps are taken,[30] but the name cannot be restored if unavailable.[31]

Michigan Entity Law & Good Standing

Michigan Corporations

Corporations in Michigan are required to file an annual report and pay an annual filing fee[32] of $25.[33] The filings are due on May 15 of each year beginning on the year after the entity has filed for incorporation.[34] Failure to do so for two consecutive years starting from the date when the report and fee were due will result in automatic dissolution 60 days after the expiration of the two year period.[35] No less than 90 days before the two year period expires, the state administrator will notify the corporation of the impending dissolution.[36] Until a corporation is dissolved, it is entitled to a certificate of good standing.[37] That is to say, a corporation is in good standing with the state of Michigan, until it fails to pay the required annual fee and file the required annual paperwork for two years and 60 days from when the filings were due. Similar to a Delaware LLC and corporation, a Michigan corporation that is dissolved by the state may lose its name.[38]

Once a Michigan corporation is dissolved, it is no longer validly incorporated as a domestic corporation and is not validly in existence under laws of this state.[39] Therefore, the shareholders of the corporation are susceptible to liability.

After a corporation in Michigan has dissolved, its existence continues only for the purpose of winding up its affairs by collecting and selling its assets (which are not to be distributed to its shareholders), paying its debts and other liabilities, and doing any other activities in the liquidation of its business.[40]

A Michigan corporation can be renewed after the corporation completes and submits all outstanding filings and penalties for each delinquent annual report.[41]

Michigan LLCs

A Michigan LLC is required to file an annual statement and pay the associated $25 fee[42] with the administrator that contains the name of the resident agent and address of the registered office.[43] This statement must be filed by February 15, unless the LLC was formed after September 30 in the previous year.[44]

A Michigan LLC that fails to file the required annual statement and pay the applicable fees for two consecutive years will be notified of the consequences resulting in continued failure.[45] If the LLC does not comply with the requirements for 60 days following the state administrator’s notice, it is no longer in good standing.[46]

If a Michigan LLC is not in good standing, the name of the company becomes available for another’s use.[47] The entity still remains in existence and may continue to transact business in the state.[48] However, the entity will operate without the benefits of limited liability because the entity is no longer validly organized as a domestic limited liability company and is not validly in existence under the laws of this state.[49]

To restore good standing, the Michigan company may file a certificate of restoration of good standing and pay a $50 fee[50] along with the outstanding annual statements and fees due for all years that were not paid.[51] If the LLC has lost its name while it was not in good standing, it will have to select a new name.[52]

Conclusion

In either Delaware or Michigan, a business much maintain good standing to operate with the full privileges to which it is entitled. If a business falls out of good standing, there is a potential risk of reputational harm if the entity loses its name. When the founders of a startup have worked so hard to establish market share and brand recognition, the last challenge it should face is an failure to maintain documents and fees with the state such that it may result in a loss of the entity name. Additionally, in the startup context, business efficiency and agility is important. While it is possible to restore good standing, the extra time and expense required to revive a business not in good standing is an impediment to efficient business practices.

 

Regardless of whether a startup decides to form its entity in Michigan or Delaware and whether it decides to file as an LLC or corporation, maintaining good standing is imperative. A startup entrepreneur may decide to obtain legal help regarding entity selection and filing the initial formation paperwork. However, she must ensure that her business maintains good standing after the initial filings are complete.

[1] Matt Swartz & Daniel Lee, The Corporate, Securities, and M&A Lawyer’s Job, Chapter 9, page 68

[2] https://www.legalzoom.com/articles/what-is-a-certificate-of-good-standing

[3] https://www.legalzoom.com/articles/what-is-a-certificate-of-good-standing

[4] https://ct.wolterskluwer.com/resources/corporate-compliance-losing-good-standing-consequences

[5] https://corp.delaware.gov/paytaxes/

[6] Delaware General Corporation Law (tit. 8 of Del. Code) §510

[7] https://corp.delaware.gov/paytaxes/

[8] https://corp.delaware.gov/paytaxes/

[9] Delaware General Corporation Law (tit. 8 of Del. Code) §510

[10] Delaware General Corporation Law (tit. 8 of Del. Code) §510

[11] Delaware General Corporation Law (tit. 8 of Del. Code) §510

[12] https://blog.shoobx.com/getting-to-know-delaware-what-does-it-mean-to-be-in-good-standing

[13] https://blog.shoobx.com/getting-to-know-delaware-what-does-it-mean-to-be-in-good-standing

[14] https://blog.shoobx.com/getting-to-know-delaware-what-does-it-mean-to-be-in-good-standing

[15] Delaware General Corporation Law (tit. 8 of Del. Code) §510

[16] Delaware General Corporation Law (tit. 8 of Del. Code) §122(1)-(17)

[17] Delaware General Corporation Law (tit. 8 of Del. Code) §311(d)

[18] Delaware Limited Liability Company Act (tit. 6 of Del. Code) §18-1107(b)

[19] Delaware Limited Liability Company Act (tit. 6 of Del. Code) §18-1107(c)

[20] Delaware Limited Liability Company Act (tit. 6 of Del. Code) §18-1107(d)

[21] Delaware Limited Liability Company Act (tit. 6 of Del. Code) §18-1107(c)

[22] Delaware Limited Liability Company Act (tit. 6 of Del. Code) §18-1107(h)

[23] Delaware Limited Liability Company Act (tit. 6 of Del. Code) §18-1107(j)

[24] https://www.incnow.com/faq/what-is-delaware-franchise-tax/

[25] https://www.incnow.com/faq/what-is-delaware-franchise-tax/

[26] Delaware Limited Liability Company Act (tit. 6 of Del. Code) §18-1107(l)

[27] Delaware Limited Liability Company Act (tit. 6 of Del. Code) §18-1107(m)

[28] Delaware Limited Liability Company Act (tit. 6 of Del. Code) §18-1107(i)

[29] Delaware Limited Liability Company Act (tit. 6 of Del. Code) §18-1108(a)

[30] Delaware Limited Liability Company Act (tit. 6 of Del. Code) §18-1109

[31] Delaware Limited Liability Company Act (tit. 6 of Del. Code) §18-1109(a)(1)

[32] Michigan Business Corp Act 284 of 1972 §450.922(1)

[33] https://www.michigan.gov/documents/lara/BCS_CD_267_08-15_527656_7.pdf

[34] https://www.michigan.gov/documents/lara/BCS_CD_267_08-15_527656_7.pdf

[35] Michigan Business Corp Act 284 of 1972 §450.1922(1)

[36] Michigan Business Corp Act 284 of 1972 §450.1922(1)

[37] Michigan Business Corp Act 284 of 1972 §450.1922(1)

[38] https://www.northwestregisteredagent.com/reinstate-renew-michigan-corporation.html

[39] Michigan Business Corp Act 284 of 1972 §450.1922(1)

[40] https://www.michigan.gov/documents/lara/8007_528147_7.pdf

[41] https://www.michigan.gov/documents/lara/BCS_CD_267_08-15_527656_7.pdf

[42] https://www.michigan.gov/lara/0,4601,7-154-89334_61343_35413_60200-140882–,00.html

[43] Michigan LLC Act 23 of 1993 §450.207(3)

[44] Michigan LLC Act 23 of 1993 §450.207(3)

[45] Michigan LLC Act 23 of 1993 §450.207(a)(2)

[46] Michigan LLC Act 23 of 1993 §450.207(a)(3)

[47] Michigan LLC Act 23 of 1993 §450.207(a)(3)

[48] Michigan LLC Act 23 of 1993 §450.207(a)(3)

[49] Michigan LLC Act 23 of 1993 §450.207(a)(1)

[50] https://www.michigan.gov/lara/0,4601,7-154-89334_61343_35413_60200-140882–,00.html

[51] Michigan LLC Act 23 of 1993 §450.207(a)(4)

[52] Michigan LLC Act 23 of 1993 §450.207(a)(4)(a)