Obtaining Foreign Business Qualification in a State (Part 1 of 2)

Each state imposes an obligation on companies formed in a different state to obtain approval from the state to conduct business within its borders.  This approval is typically obtained by filing for “foreign qualification” (also known as a certificate of authority or certificate of registration).

When should a corporation or limited liability company seek foreign qualification in a state?

The answer depends on the laws of the state and the nature and extent of business activities in the state.  Many states provide a safe harbor list of activities that do do not require a company to obtain foreign qualification.  Below are some permitted activities provided for in the Model Business Corporation Act, which have been adopted, in part, by several states:

– participating in lawsuits, settlements or other legal proceedings;
– selling through independent contractors;
– soliciting orders from customers, but only if the orders are accepted by the company in its home state prior the orders becoming binding contracts;
– acquiring indebtedness, mortgages, and security interests in real or personal property;
– transacting business solely between states in interstate commerce (e.g., transportation).

If a company’s activities fall outside any version of the safe harbor list adopted by the state in question, then a detailed fact inquiry and review of applicable case law, administrative rules and state agency legal opinions is required to determine whether foreign qualification is necessary.

What are the consequences for failing to obtain foreign qualification?

The answer, of course, depends on the state.  Most states impose two penalties on noncompliant companies: (1) the company may not sue anyone in any court in the state, and (2) the company is liable for all applicable fees and penalties going back to the initial date it transacted business in the state.  Many states impose a per-day or per-occurrence penalty for transacting business without foreign qualification.

Companies anticipating investment, merger or acquisition activity should be aware that the company may be required to make a contractual representation that it is duly qualified and is in good standing in each jurisdiction in which the company transacts business. Under this representation, there may be contractual liability to an investor or acquirer for failure to obtain foreign qualifications.