Is Your Out of State Formed Corporation Subject to California’s Pseudo-Foreign Corporation Statute?

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AdobeStock_74836089-300x200A corporation can be formed under the laws of any state, so long as the business and its owners qualify for business entity status. Many business owners use these laws to find a state that offers the most tax and legal advantages. (This is why so many businesses incorporate in the state of Delaware.) But it is important to understand that California law can still apply to your business even if it was formed out of state. Be sure to consult with a California business lawyer about the implications of California law upon your business entity.

What is the Pseudo-Foreign California Corporation Statute?

Section 2115 of the California Corporation Code applies to foreign corporations that have connections to California and satisfy the applicable statutory tests. If both of the following tests are met, the corporation is considered “pseudo foreign,” and it is treated as if it had been incorporated in California in the first place.

  • The Tax Factor Test: This test examines the company’s property, payroll, and sales. If more than fifty percent of the total occurs within California during the latest full income year, this test is met.
  • The Shareholder Residence Test: This test examines the individuals who hold outstanding voting securities in the business. If more than half of these individuals have California addresses, the test is met.

Aspects of California Law Applicable to Foreign Corporations

If both tests are met, and the corporation is considered “pseudo foreign,” there are many aspects of California law that apply to the business. These include:

  • the annual election of directors;
  • the removal of directors without cause or by court proceedings;
  • filling of director vacancies;
  • directors’ standard of care and fiduciary duties;
  • liability of directors for unlawful distributions and shareholders for receiving unlawful distributions;
  • indemnification of directors, officers, and others;
  • limitations on corporate distributions in cash or property;
  • a requirement for annual shareholders’ meeting;
  • voting requirements;
  • limitations on sale of assets, mergers, and conversions;
  • records and reporting requirements;
  • actions by the Attorney General; and
  • rights of inspection.

How to Avoid Being Subject to the Pseudo-Foreign California Corporation Statute

Your business can avoid being subject to the pseudo-foreign corporation statute by avoiding satisfaction of the tests described above. If you diversify your property, payroll, and sales, your business can avoid satisfaction of the Tax Factor test. If you diversify your shareholders to include more shareholders outside the state of California, you can avoid satisfying the Shareholder Residence test. A corporate lawyer can help you determine whether there are ways to structure your company and avoid satisfying these tests under your existing business structure. For example: if some shareholders are residents of more than one state, they might be able to be considered non-residents for purposes of the Shareholder Resident test.

Experienced Silicon Valley Lawyers for All Legal Matters Related to Foreign Corporations

It is important for all business owners who conduct business in California to understand their responsibilities under California’s corporate laws. The experienced Silicon Valley business lawyers at Structure Law Group have helped many out-of-state business owners address the California legal provisions that apply to their operations. Call (408) 441-7500 or visit our website to schedule your consultation.