and entity. The judge in Labadie Coal Co. v. Black said it better than I ever could: “Faithfulness to the formalities is the price paid to the corporation fiction, a relatively small price to pay for limited liability.”
If you ever sell your business, a potential buyer and his or her professional team will examine your records. If those records are in a poor state, it will tend to lower the price you’ll get or delay the sale.
Good records can ward off action by the IRS. The IRS imposes its own standards for recordkeeping; generally those standards are higher than the statutory minimum.
So, you should venture to maintain formalities and keep appropriate records. Key concepts in maintaining LLC liability protection are separateness, as mentioned above, and control and domination . (One of the elements considered in disallowing liability protection is whether LLC members exercise such complete control that the entity is merely the “alter ego” of its members.) So, if you are an owner of a single-member LLC, you must strive even harder to observe formalities and keep appropriate records.
LLCs are required to keep the following records, and we discuss some of these specific topics later in the book:
• Minutes of all member and manager meetings, as well as copies of all notices to members and managers, and any proxy voting materials
• A record of all material and substantive actions taken by the managers or owners without a meeting (We’ll discuss later the sorts of actions that are material and substantive and should be submitted to a proper vote and recorded.)
• A record of all actions taken by any committee of the managers
• A list of the names and addresses of current managers and owners
• All written communication by the LLC to its owners within the last five years
• All periodic reports of the LLC submitted to the secretary of state
With respect to financial statements, there is generally no requirement that an LLC provide formal financial statements to its members. Such a practice would tend to develop by the practices that an LLC chooses to follow. Providing such information, however, is good company governance and can be very good for owner relations.
The financial statements should contain the report of the public accountant who prepared the statements or, if prepared by the LLC without the use of a public accountant, a statement of the person preparing the report indicating whether or not the report was prepared in accordance with generally accepted accounting principles (GAAP). Finally, the LLC must provide a written summary to owners of any indemnification or loans or advances to managers and of any decision by the managers to issue ownership shares in exchange for promissory notes or future services. This notice must be provided with or before any notice of owners’ meetings. LLC records are a major topic in this book that we’ll cover at length throughout.
FOREIGN LLCS
As mentioned earlier, an LLC conducting business in a state other than its state of organization is deemed a foreign LLC in the state in which it is a “guest.” States require foreign LLCs conducting business within their borders to register. This process of registering as a foreign LLC is known as qualification. What constitutes “conducting business” for the purposes of determining the qualification threshold differs from state to state, but universally states will define “conducting business” broadly.
But why do states require foreign LLCs to suffer the expensive and burdensome task of filing for qualification? There are several reasons.
First, foreign LLCs must pay for the privilege of doing business in a particular state. After all, an Oregon LLC competing for sales in California competes with California corporations and Californian LLCs—all of which have paid organizational fees in California. If out-of-state businesses were not required to qualify, they would enjoy a competitive advantage over domestic businesses. Thus, requiring all to register or qualify evens the playing field.
The second reason is for consumer protection. Once an LLC qualifies as a foreign LLC, it admits to jurisdiction in the foreign state, it appoints an agent for service of legal process, and it can be sued there. It is much easier to serve a company with legal process in one’s home state than in the state in which it was organized. Thus, consumers in the state where the LLC is qualified are more protected from any misdeeds committed by the LLC. Consequently, foreign LLCs are more accountable to consumers.
Qualifying as a foreign LLC closely mirrors the process of organization. LLCs must typically file their articles of organization in the foreign state, along with an additional filing that includes information specific to the foreign state, such as the resident agent in the foreign state. Every state’s procedure for foreign qualification will differ slightly. The filing fees for qualification are always at least as high as for filing articles of organization and often higher.
The decision whether to qualify in a foreign state must be made cautiously. Once qualified, an LLC must file periodic reports in the foreign state, will likely need to file tax returns and pay taxes there, and must appoint a local agent. Also, qualification in a foreign state makes it much easier for creditors to serve process and bring lawsuits against the LLC in the foreign state.
While the requirements of foreign qualification are clear and obvious, in practice such requirements are routinely ignored by smaller companies. Smaller companies simply lack the resources to register in each state in which they do business. Even though every state requires foreign LLCs to qualify, no state makes a meaningful effort to enforce its requirement. However, this is not to say that it is wise to ignore the obligation to qualify as a foreign LLC. The law is the law and you should always endeavor to obey it.
The Concept of “Doing Business”
This raises an important question: what constitutes “operations” or “business activity” in a particular state? As mentioned above, all states define it somewhat differently—but universally they define “doing business” broadly. For example, California defines it as “actively engaging in any transaction for the purpose of financial or pecuniary gain or profit.” It does not take a lawyer to get the crux of the meaning of that phrase. Quite simply, California interprets a single transaction taking place within its borders as “doing business.”
Why do states define business activity so broadly (thereby requiring local registration of foreign LLCs)? There are two reasons. First, registered LLCs pay lucrative filing fees and franchise fees. Second, as mentioned above, each state has an interest in protecting its consumers from unscrupulous out-of-state companies, LLC or otherwise. A state can better protect its consumers from misconduct by out-of-state businesses if the state has registration and contact information on file for each company operating within its borders. Furthermore, by registering, a company automatically submits to the jurisdiction in which it is registered, so it can be sued more easily.
The ULLCA provides a partial list of individual acts that do not constitute doing business. You will note that the ULLCA is far more lenient than California. It includes:
• Maintaining, defending, or settling any proceeding
• Holding meetings of the board of managers or members within the state or carrying on other activities involving internal governance matters, such as committee meetings
• Maintaining bank accounts
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