When a business entity does business in a state other than in its state of organization, the business entity may be required to “qualify.” Qualify means nothing more than obtaining a certificate of authority and appointing a resident agent upon whom legal process may be served. Although all states require an entity “doing business” within the state to qualify, this article attempts to address the issue of what constitutes “doing business” within a state when there is no permanent (e.g. lease of premises) presence.
As a general rule, an out-of-state (“foreign”) entity is “doing business” if that foreign entity is transacting, carrying on or engaging in business within a state when the entity transacts some substantial part of its ordinary business therein. Thus, the purpose for which the entity is organized may be a decisive factor in resolving the qualification question. Moreover, every state has enacted a statute dealing with the question of what activities will be considered doing intrastate business.
The emphasis is on intrastate activities, because if a foreign entity’s activities are entirely interstate, then federal law prohibits the imposition of the qualification statutes. However, most of the statutes list certain intrastate activities that a foreign entity may engage in without having to qualify. In analyzing any situation, all of the relevant facts must be considered because a particular act of an entity may not constitute doing business by itself. However, it is the cumulative effect of all of the activities which determine the necessity of qualification.
The following discussion applies the general concepts to specific activities to determine whether the activity constitutes “doing business” within a state.
Isolated Transactions
Transacting of some substantial part of the entity’s business within a state is generally considered sufficient to require the foreign entity to qualify. However, because an isolated transaction is less than a “substantial part,” an isolated transaction will not require qualification. The difficulty arises in determining what is an isolated transaction. Generally, a foreign entity will not be exempt from qualification, even though one or two contracts are involved, if the transactions are of a long duration or if the transactions indicate a general plan to continue to do business in the state. If it is a case of only one limited contract of a relatively short duration, then it is considered an isolated transaction.
Company Secondary Activities
Activities incidental to the foreign entity’s main business do not require qualification. It is especially important as to this class of activities to look at the sum total of the entity’s activities that occurred within the state. Typical “secondary activities” include preliminary acts performed by the entity to determine whether or not the entity should begin business in the state, maintaining bank accounts, holding director’s meetings, or collecting accounts. These types of activities alone do not constitute “doing business.”
Holding Interests in Resident Businesses
This type of activity comes about through the franchisor-franchisee relationship, forming an entity to hold interests in a domestic entity, or having a subsidiary entity operating in the state and acting as a partner, member, manager or joint venturer in a partnership, limited liability company or joint venture doing business in the state.
As to the franchisor-franchisee relationship, it is the degree of control the foreign franchisor exercises over the franchisee which determines whether or not the foreign entity must qualify. The less control exercised, the less likely the foreign entity will be required to qualify.
A holding company is organized for the purpose of owning interests in other entities. A foreign holding company will normally have to qualify in the state in which it votes the stock, holds meetings, directs its subsidiaries’ affairs and does any other acts necessary to the holding company’s function. However, a foreign entity will not be required to qualify in a state merely because its subsidiary is doing business in the state. Generally, mere ownership of the controlling ownership of a subsidiary is not sufficient to require qualification.
As for partnerships, limited liability companies and joint venturers, the state’s statute is controlling. In Missouri, a foreign corporation will not be deemed to be transacting business in Missouri solely by reason that it is a member of a limited liability company.
Sales
Solicitation of orders within a state that are accepted and paid outside the state, with delivery of the product from without the state, generally does not constitute “doing business” in a state. In these instances the sales are generally considered interstate commerce and outside the qualification statutes. As long as solicitation of the orders is the only activity being done by the foreign entity, qualification will not be required. However, when soliciting orders is mingled with other activities, such as the taking of the orders, the shipment of the goods and advertising, qualification may be required. The method of sales, the type of sales agent employed in the state and the amount of control exercised over the sales agent are all factors which might take the case out of the ordinary solicitation rule and require qualification.
Consequence of Not Qualifying
The issue of having to qualify usually comes before a court when the foreign entity brings an action in the state’s courts, because unqualified entities transacting intrastate business are generally barred from maintaining a lawsuit in a state’s courts. If an unqualified entity is denied access to a state’s courts, the entity cannot bring an action to enforce its contracts made in that state. However, even though the foreign entity is denied the ability to bring or maintain a lawsuit, these entities are permitted to defend suits brought against it. Furthermore, in some instances the foreign entity may be allowed to bring a counterclaim if the counterclaim is equivalent to a defense to the action and arises out of the same series of transactions as the main claim.
In addition to being shut out of the state’s court system, a foreign entity that is not qualified can also face monetary penalties. Most states impose monetary penalties on foreign entities that do business without qualifying. In a number of states, however, liability is not limited to the entity, but is imposed on the individuals acting on behalf of the entity. Upon whom such sanctions fall, vary from state to state. The fines and penalties for failure to qualify vary substantially from state to state, as well. Fines may be based upon the number of years, months or even days during which the foreign entity transacted business in the state without a certificate of authority and may include all fees and franchise taxes that would have been imposed by the state upon the entity if the entity had applied for and received the certificate of authority.
Conclusion
Before considering transacting any business as a foreign entity, it is always necessary to review the state’s qualification statute to determine whether your entity is required to qualify in the foreign state.