A small manufacturer in Texas shipped goods to a wholesaler in Alabama and received an IOU for payment. When the wholesaler refused to honor the IOU, the Texas corporation sued the wholesaler in Alabama. Much to its surprise, the Texas corporation found that it could not use the Alabama courts to collect payment from the wholesaler because the Texas manufacturer had not registered in Alabama as an out-of-state corporation.

The case hinged in part on the fact that the Texas company leased a warehouse in Jackson, Ala., where it stored goods after shipment. The warehouse was staffed with one or two of its employees. Under Alabama law, this activity was sufficient to require the Texas company to register as an out-of-state corporation and, since it had not registered, to deny the Texas corporation the use of Alabama courts to enforce its contracts.

By contrast, an Ohio consulting firm, which had not registered in Michigan, was permitted to use the Michigan courts to sue Bay City, Mich., for delaying completion of a water project. Bay City raised the lack of registration as a defense, but the court ruled that since all of the plans and designs for the water project were developed at the consulting firm's home base in Ohio, since the firm had no office in Michigan, and since the project was the firm's only contract in the state, the Ohio consulting firm did not have to register in Michigan and was free to use Michigan's courts.

These cases illustrate an important, sometimes overlooked issue that arises when a corporation does business outside of its state of incorporation. Every state, as well as Puerto Rico and the District of Columbia, has laws governing out-of-state corporations that seek to do business within the state. These laws -- usually called "foreign corporation" statutes -- require out-of-state corporations to "qualify," that is, register, to do business within the state, and they frequently carry fines and other penalties for corporations that do not comply.

In some cases, the foreign-corporation statutes provide that the out-of-state corporation cannot enforce its contracts or other legal rights in the courts of the state if it has failed to register. Indeed, in a few states, corporate officers can technically be imprisoned for failure to comply. A brief acquaintance with foreign-corporation statutes is therefore essential to any small businessperson contemplating an out-of-state sale or project. At the very least, businesspeople should know when the issue might require the advice of an attorney.

To Qualify or Not To Qualify.

In general, states may require any out-of-state corporation to qualify under its foreign-corporation statute before the corporation will be allowed to do business in the state. These statutes typically require the out-of-state corporation to provide such information as the corporate name and the names and addresses of officers, directors, and local agents and to pay a fee. In some states, detailed financial data and annual reports are also required.

The qualification process is not particularly burdensome, but it has consequences that some corporations prefer to avoid. For example, a qualified out-of-state corporation usually has to pay state corporation taxes on income generated in that state. The corporation also must comply with special state laws including, for example, state securities statutes. In addition, when a local resident wants to sue a registered out-of-state corporation, he does not have to prove, as he otherwise would, that the corporation comes under the jurisdiction of the state courts.

Finally, in many states, an out-of-state corporation will not be allowed to use a corporate name that is the same as or similar to a name already used by a local corporation. Thus, the out-of-state corporation may be required to change its name or to use an assumed name in order to do business in the state. This can complicate marketing and promotional efforts.

On the other hand, failure to qualify (when qualification is required) can result in drastic consequences.

Are You "Doing Business?"

To decide whether or not your company must qualify in a state to transact business, one question must be asked: Is your corporation "doing business" in the state according to the definition of the local foreign-corporation statute? Qualification usually becomes an issue only when the corporation has some substantial business contacts within the state.

Companies usually need not qualify under foreign-corporation laws if they engage merely in an "isolated" transaction. One-shot contracts or sales, for example, are usually excluded. In the case of the Ohio consulting firm the court found that the firm's contract with Bay City was an "isolated" transaction, even though the company was hired for a three-year project. The firm had no other business dealings in Michigan, and it planned no ongoing presence there beyond the single project at issue.

Even "isolated" jobs, however, may require a company to qualify if the job is of a certain type. Many states hold that any significant construction work done in a state will constitute "doing business" even though the out-of-state construction company does only a single job. As a Georgia court recently stated:

A counsellor would have no difficulty in advising his client that the South Carolina corporation which crosses the Savannah River to construct an outhouse obviously would not have to qualify whereas the building corporation which enters Georgia to build a multistory office or apartment building would have to qualify despite its contract being a single transaction.

Generally, where a company has many transactions in a single state, it is likely that it is "doing business" under state law and thus is subject to the foreign-corporation statute. This would also hold true if the company had an ongoing presence in the state, such as an office or warehouse staffed by permanent employees.

There is one limited, federal exception to the qualification requirement for certain special corporations engaged primarily in "interstate commerce." The United States Constitution provides that commerce between the states is an exclusively federal concern that normally may not be regulated by individual states.

Over the years, the United States Supreme Court has identified a number of specific businesses that qualify for the interstate-commerce exception to state ciualification requirements. Corporations engaged in marketing such commodities as wheat or cotton, for example, are usually considered to be engaged in interstate commerce and seldom need to register as foreign corporations. The Supreme Court has found that the complex national marketing mechanism for such commodities is sufficiently intricate and important to the national economy to justify exemption from state qualifying laws. In addition, common carriers, telegraph companies, and national correspondence schools have been found to be exempt from state qualification statutes in particular cases.

In the end, if your company has an office, has numerous in-state business contacts over extended periods of time, or does any sort of major construction work in a particular state, qualification is likely to be required. If the project is merely an "isolated" transaction, however, or if your business activity is peculiarly "interstate" in nature, you need not qualify before doing business in the state. If you make a mistake and do not qualify when you should, some states will allow you to register after the fact, as long as you pay a penalty.

Since this area of law varies widely depending upon which state you are in, however, you should consult your attorney to determine the laws of the particular state where you do business and to get his or her advice on whether your corporation is exempt because it is conducting an "interstate" business.