Incorporator

Corporate compliance: The consequences of losing good standing status

Forming a business: Rights & responsibilities

When business owners choose to form a corporation or LLC they must file the proper formation document with their home state and the proper registration document in any other states in which they do business. The states then essentially grant the right to conduct business as a statutory business entity with all the advantages this brings. To maintain this right, the corporation or LLC becomes subject to a host of state laws and requirements. These include appointing a registered agent, making timely filings of required forms, and paying fees and/or franchise taxes – which are requirements of the state corporation or LLC statute.

As long as the corporation or LLC complies with all these requirements, it is designated as being in “good standing” on the state’s records, and keeps all the rights and privileges of doing business as a statutory entity.

However, entities that don’t stay on top of their compliance obligations can lose their good standing status. The corporation or LLC will instead be considered “delinquent,” “void,” “suspended” or “dissolved.” The meaning and severity of these terms vary depending on the state, which compliance requirements were failed, and the duration of the failure.

Loss of good standing can damage your ability to do business

All corporations and LLCs should be aware of the serious consequences that losing good standing status can have, including these:

  • Possible loss of access to the courts. This may be one of the most serious consequences and one that many are not aware of. In many states, a company that is not in good standing may not bring a lawsuit in that state until good standing is restored.
  • Difficulties in securing capital and financing. Most lenders view a loss of good standing as an increased risk and may not approve new financing to a company that is not in good standing..
  • Tax liens. Adverse entity status due to non-payment of taxes can result in a tax lien. Lenders are extremely wary of tax liens since they take priority over other liens.
  • Loss of name rights. Once an entity loses its good standing status, it risks losing the right to use its name in the state. Other companies may be able to acquire the rights to its name while a company is sidelined due to loss of good standing.
  • Administrative dissolution or revocation. In a worst-case situation in which a corporation or LLC repeatedly fails to respond to requests for required filings, it can be administratively dissolved by the home state or revoked by the foreign states.
  • Fines and penalties. States impose fines and penalties on companies that don’t comply with the requirements that led to the loss of good standing.
  • Personal liability. In addition to fines and penalties levied on a company not in good standing, some states also hold individuals personally liable for conducting business on behalf of a company while it has a “revoked” status. These penalties can be severe and levied on each officer, director or employee who knowingly acted on behalf of the non-complying company.
  • Business identity theft. Business identity thieves look at the state’s records to see which companies are not in good standing, assuming that no one is paying attention. They then “use” the company’s identity to buy goods, borrow money or take other harmful actions.

What causes the loss of good standing?

The primary reason a corporation or LLC loses its good standing status is that it lets annual reports or franchise tax obligations lapse. There are many ways this can happen, and many reasons these issues can remain undetected until the worst possible time – for example, at the closing table for an expansion or financing deal or when applying for a government backed loan that is first come first served.

  • Voluntary status changes. An entity’s status can change several times during its business life-cycle. Status changes that are driven by the business itself frequently trigger new annual report or franchise tax requirements; these include mergers, acquisitions, expanding into new locations or converting entity types. It’s also important to note that when closing a business, owners remain liable for all required filings, taxes and penalties until they file official dissolution or withdrawal forms with every relevant state.
  • States change requirements. States often change deadlines, raise fees, or issue new forms. For various reasons, businesses may not know about the changes – notifications may not be sent or are directed to the wrong person, or the importance of the communication is overlooked.
  • Weak internal processes. Maintaining entity status is often not a core responsibility, and is sometimes spread across different departments such as legal, tax and finance. Even in businesses that have designated entity maintenance teams, employees may be relying on tools and processes that are inadequate for monitoring both entity information and state laws and requirements.

Regardless of how the compliance failure happened, in the eyes of the state, a corporation or LLC has either met all its compliance obligations and is in good standing, or it hasn’t.

Summary

Take a proactive compliance stance to keep your corporation or LLC healthy and on track. Businesses have many options today, ranging from web-based tools that support a do-it-yourself approach, to partnering with an expert full-service registered agent to create customized best practices. Evaluate the complexity of your compliance situation. Businesses with simple entity structures may consider interactive, collaborative compliance calendars offered by companies that specialize in corporate compliance. Businesses with many entities doing business in multiple states have exponentially more complex compliance needs. Consulting with specialized service providers can head off status problems before they occur, and empower compliance professionals to proactively manage the risks.