By: Natalie LaRue

For entrepreneurs, coming up with a viable, novel idea is just the first difficult part of starting a business. They must also deal with the important – although less exciting – decision of what kind of entity they’d like to form to grow their business, and in what jurisdiction they would like to form it. The pros and cons of each entity type are well established and easily accessible, however figuring out what states a company must be registered to do business in is a bit of a murkier question that is unique to each business’s set of circumstances. Although there isn’t a universal answer, it’s helpful for entrepreneurs to have a general sense of this requirement, the registration process, and the possible consequences of noncompliance. The purpose of this blog post is to provide entrepreneurs with a little more background about the landscape of these requirements so they can properly weigh the risks and better approach these questions in their own unique businesses.

Foreign Qualification Basics

A company is considered “domestic” in the state in which it was formed and “foreign” in any other state that it registers in. Every state has a different process and procedure for registration, but generally companies become registered after filing an application with the state and paying the corresponding fee. To become foreign qualified in Michigan for example, an entity needs to obtain a Certificate of Authority.[1] The Certificate of Authority requires the entity to provide information including the entity’s name, registered agent, description of the business, date of incorporation, authorized shares, and principal place of business address. The entity must also be in good standing in its home state. There is a different form for different entity types, however they cover mostly the same substantive questions. These requirements are typical of most states.[2]

Required Registrations

Companies generally have to become foreign qualified in a state if they are considered to be “doing” or “transacting” business in that state, as defined by statute.[3] The confusion facing a lot of entrepreneurs here is what exactly constitutes doing business. Every state has different rules, but it is typical for states to define “transacting business” by listing items that alone do not qualify. For example, Michigan notes that a “foreign corporation is not considered to be transacting business in this state…solely because it” is involved in a legal proceeding, holds meetings, maintains a bank account, or owns property, among a number of other items.[4] As Delaware is in the spotlight for most conversations about corporate governance, it is worth noting their policy as well. Delaware notes that if a company is simply in the mail order business, the only presence in the state is employing salespeople, is just delivering goods to the state, is an insurance company, if it creates or acquires mortgages or liens on real estate, or if it secures or collects debt, then it is not required to register; thus, Delaware is in the same boat as Michigan as it defines by exclusion, but it does include different services that alone are not sufficient to qualify.[5] New York similarly defines transacting business by exclusion – you are not considered to be doing business there solely on the basis of being involved in a legal proceeding, holding shareholder or board meetings, having a bank account, or “maintaining offices… only for the… registration of its securities.”[6] California, on the other hand, defines transacting business as “entering into repeated and successive transactions of its business in this state, other than interstate or foreign commerce.”[7]

Consider a startup, organized as a Delaware corporation, with founders based in Michigan, but their business is app-based and thus their consumers are nationwide. This entity should register in Michigan – although Michigan defines “transacting business” by exclusion, given that the founders that live, work, and are paid in Michigan, they file taxes in the state, use their Michigan address on all correspondence, and conduct client meetings in Michigan, this all together seems sufficient to constitute doing business. However, just because someone in another state downloads and uses their app, they do not have to qualify in that other state. This would simply constitute “interstate” business, which cannot be regulated by an individual state.[8] This example, and a discussion of various states’ rules above, illustrate the importance of reviewing each state’s requirements. If a startup has any activity at all within a state, it is wise to review those states’ statutes to confirm the business is complying, but this is ultimately a state-by-state, case-by-case determination.

Penalties for Noncompliance

Like the registration requirements themselves, the consequences of noncompliance also vary by state. Although generally the lack of registration doesn’t affect the validity of contracts, the consequences of not registering include civil penalties and inability to bring suit.[9] The inability to bring suit is troubling for startups, as companies can lose their right to enforce contracts in state court. Access to the courts can generally be reinstated if the company registers in that state within a certain time period; in Michigan for example, “an action commenced by a foreign corporation having no certificate of authority shall not be dismissed if a certificate of authority has been obtained before the order of dismissal.”[10]

States can also enjoin companies from doing business in a state if they are not properly qualified,[11] and companies also can be liable for backpay of fees to the state for however many years they transacted business there without a license.[12]

There’s also the possibility of criminal penalties being levied upon the company’s directors and/or officers. In California, “any person who transacts intrastate business on behalf of a foreign corporation which is not authorized to transact such business in this state, knowing that it is not so authorized, is guilty of a misdemeanor …”; Ohio and Maryland consider unauthorized transaction of business a misdemeanor as well.[13]

Recommendation

Before an entrepreneur starts operating in a state, they should review its statutes and determine whether or not what they are doing constitutes “transacting business” to the extent that registration is required. Starts ups come with a lot of costs and typically the beginning stages of a company are wrought with important legal decisions that could potentially lead to litigation, so the last thing that a new company wants to do is lose its right to sue or start accumulating avoidable fines and penalties. However, startups also don’t want to be on the hook for extra filing fees, franchise taxes, and/or annual reports, as may be required by these additional registrations. Registering in a foreign state where you transact business is just the first step – remember to keep your entity in good standing and comply with any upkeep requirements the state may have.

[1] Foreign Corporations, Michigan Department of Licensing and Regulatory Affairs, https://www.michigan.gov/lara/0,4601,7-154-89334_61343_35413_35426-120069–,00.html#:~:text=A%20foreign%20corporation%20is%20one,conducting%20affairs%22%20in%20this%20state.

[2] Visit https://www.dos.ny.gov/corps/buscorp.html#appauth for information about New York’s Application for Authority, for example.

[3] For example, see Michigan’s registration requirements. http://www.legislature.mi.gov/(S(2cpiw1bgw0uhpa4me3yyzroa))/mileg.aspx?page=getobject&objectName=mcl-450-2012

[4] http://www.legislature.mi.gov/(S(2cpiw1bgw0uhpa4me3yyzroa))/mileg.aspx?page=getobject&objectName=mcl-450-2012

[5] 8 Del. C. § 373(a).

[6] New York Consolidated Business Laws § 1301(b); see also “Doing Business” in New York: An Introduction to Qualification, https://www.dos.ny.gov/cnsl/do_bus.html, for detailed information about what is sufficient in NY to constitute “doing business.”

[7] Cal. Corp. Code § 11708.03(a).

[8] See 8 Del. Code § 373(a)(4) for an example of a state that notes that purely interstate business does not require qualification. This is typical.

[9] For example, see Michigan’s statute. http://www.michiganstatecapitol.com/(S(yp4x3fwtesk0dmdr5qq2eygg))/mileg.aspx?page=getobject&objectname=mcl-450-5007#:~:text=1007.,obtained%20a%20certificate%20of%20authority.

[10] Michigan Comp. Laws, Sec. 450.2051.

[11] NY CLS Bus. Corp. §§ 1303.

[12] See Alaska Stat. § 10.06.710 (2018); A.R.S. § 10-1502 (2019); Cal. Corp. Code § 2203.

[13] Cal. Corp. Code § 2259; ORC Ann. § 1703.99; Md. Corporations & Associations Code Ann. § 7-302.