New York’s Burdensome LLC Publication Requirement: Relief May be on the Horizon

Commentators widely agree that New York’s LLC publication requirement hurts both small businesses and the state itself. It hurts small businesses by increasing the startup costs for businesses that can benefit from the flexible management structure that an LLC can provide. It hurts the state because the existence of the onerous publication requirement has led to fewer LLCs being formed per capita in New York than in comparable states (such as Delaware, New Jersey, Nevada and Connecticut). As a result, New York State has lost out on the filing fees that accompany new business formation.

Thankfully, relief may be on the horizon.

In February 2009, a bill repealing the publication requirement was introduced in the New York legislature (S1667/A4496). In the memo accompanying the bill, the sponsors explain:

The intent of the Legislature when enacting the LLCL in 1994 was to allow businesses to enjoy the advantages of incorporation, without requiring them to adopt the organizational constraints of the business corporation law. This is particularly useful for small businesses. §206 of the LLCL requires that after the articles of organization have been filed, the LLC must publish a copy of the articles or a notice of their substance, once a week, for six consecutive weeks, in two newspapers from the county where the LLC is located. The LLC is then required to file affidavits of publication within 120 days and pay an additional fee of $50.00. These requirements are both unnecessary and very expensive sometimes prohibitively so. Also, there are no similar requirements in the Business Corporation Law. The transparency that publishing this information allows can be better achieved today through the internet. Indeed, the Department of State already maintains an excellent publicly-accessible online database. It is extraordinarily difficult to find this published information when or after it appears in print in a daily or weekly local print publication . . .

To improve access to LLC information, the bill also requires that department of state promulgate rules and regulations for the on-line filing of articles and certificates, and establishes a fee of $50.00 for the on-line filing of documents with the department of state. This filing fee is much more reasonable than the cost of publication in the least costly county. Moreover, the fee will be the same regardless of where the LLC is located. The fee will help fill the state’s coffers, not those of private media interests such as the huge Incisive Media (publisher of the New York Law Journal, which is one of the papers designated for publication in New York County).

Currently, the bill is stuck in the legislature’s corporations, authorities and commissions committee. With more pressing matters to deal with—New York’s budget is currently more than three months overdue—it’s unclear when S1667/A4496 will make it back to the Senate and Assembly floors. To help encourage the legislature to act on S1667/A4496, we encourage you to sign the “Why 2K?” petition, which you can find here.

What Happens if You Ignore New York’s LLC Publication Requirement?

Our last post about New York’s LLC publication requirement drew some heated comments from small business owners who are frustrated by this anachronistic requirement. Although we advise our clients to comply with the requirement, we know that many do not do so.  We decided to investigate whether non-compliance has any practical consequences.

A Brief Refresher

In New York, §206 of the Limited Liability Company Law requires an LLC to publish, within 120 days of its formation, a notice in two general-circulation newspapers (one daily, one weekly) in the county where the LLC was formed. The notice must run once a week for six weeks and include a number of facts concerning the company and its formation. If an LLC doesn’t fulfill the publication requirements, the company’s authority to do business in New York can be suspended. The costs of publication vary widely from county to county, ranging from around $300 in some upstate counties to over $1,600 in New York County (Manhattan).

The LLCs That Have Been “Caught” Haven’t Suffered Any Negative Consequences

In re Equities Capital Corp., is recent bankruptcy case involving the publication requirement. In that case, a foreign LLC (which is subject to publication requirements that are nearly identical to those applicable to New York LLCs) sought to retain a contract deposit after the debtor (Equities Capital) failed to close on a transaction involving an option contract. The debtor argued that the foreign LLC—which did not fulfill the publication requirement within 120 days of qualifying to do business in New York—couldn’t recover for breach of the option contract because: (1) it didn’t have the authority to enter into the option contract in the first place; and (2) therefore couldn’t sue to keep the deposit. The court rejected the debtor’s argument on two grounds.

First, the court noted that §802 of the Limited Liability Company Law (which is substantially identical to §206) explicitly says that the failure to comply with the publication requirement “shall not limit or impair the validity of any contract or act of such . . . limited liability company, or any right or remedy or any other party under or by virtue of any contract, act or omission of such . . . limited liability company.”

Second, the court pointed out that, under the same statute, when an LLC files documentation of its substantial compliance with the publication requirement, the previous suspension of its authority to do business in New York is annulled. Since the debtor complied with the publication requirement after the litigation over the deposit commenced, the suspension was revoked, retroactive to the date the LLC started doing business in New York; in other words, it was as if the suspension had never happened.

A handful of New York state courts have been faced with similar arguments in cases involving New York LLCs, and all have reached the same conclusion. Thus, an LLC that wishes to enforce a contract doesn’t even have to wait until publication is complete to sue for breach of contract: it can cure its failure to publish even after it files a lawsuit.

So, while we can’t advise you to ignore the law, we can tell you that our legal research hasn’t revealed a single case in which an LLC suffered any negative consequences because it failed to comply with the New York LLC publication requirement.

Incorporated in the wrong jurisdiction? Now what?

Let’s say you are an entrepreneur who lives in Arizona, so you decide to incorporate your web-based business in Arizona. A few years later, your wife’s company transfers her to New York.  To operate your company in New York as a foreign (i.e., out-of-state) corporation, you would qualify to do business in that state. When that happens, your company becomes obligated to pay franchise taxes and file tax returns in both Arizona and New York. Ouch!

To continue your business venture without having to pay Arizona taxes and fulfill Arizona corporate compliance requirements, the traditional options are: (1) dissolve the Arizona company and form a new corporation, or (2) form a new corporation and merge your existing Arizona corporation into it.  Although many believe that it is possible to reincorporate the company as a “tax free reincorporation” under Internal Revenue Code Sec. 368(a)(1)(F), until now, there has been no simple transaction to do so.   See, RR96-29. The traditional options required forming new companies, resulting in a new tax ID number and bank accounts, and re-establishing (or at least massaging) vendor relationships.

On August 1, 2009, Delaware came to the rescue by broadly enabling existing entities to convert to Delaware entities (without a cumbersome merger).  The new law even permits the conversion of one entity type to another entity type (e.g., the conversion of an Arizona LLC to a Delaware corporation). See Section  265 and 266 of the Delaware General Corporation Law, DE Conversion Statute.

To convert your Arizona corporation to a Delaware corporation, you would simply file a Certificate of Conversion along with a Certificate of Incorporation.  The resulting Delaware corporation would then be qualified to do business in New York.

Delaware is a jurisdiction of choice for many reasons, including low annual fees and well founded corporate law. Small business owners are fans of Delaware for an altogether different reason – mobility.  See http://www.eminutesonline.com/delaware-jurisdiction-of-choice-for-mobile-generation/.  Let’s say your spouse can’t stand the New York winters and wants to move to Florida.  In that case, you would simply surrender the right to do business in New York and qualify the Delaware corporation to do business in Florida, a process which inexpensively maintains the continuity of your corporation.  For more on this topic, watch http://www.eminutesonline.com/what-is-the-benefit-of-incorporating-in-delaware-watch-video/.

Delaware: Homerun for Celebrities and Investors Concerned About Anonymity

Limited information collected by Delaware makes it an ideal jurisdiction for clients who are concerned about protecting their identity.  For celebrities or investors who prefer not to be publicly identified, forming a company in Delaware is a homerun.

When a California investor acquires property through a LLC and acts as the manager, the report that must be filed with the California Secretary of State (Statement of Information) identifies the investor (publicly) as the manager of the company.  The investor who forms a corporation or a second LLC to act as the manager is no better off, as the manager would be identified (publicly) on the Statement of Information for the second LLC.

Delaware, like most states, collects information when a company is formed and annually thereafter.  However, Delaware is unique in the limited amount of information requested.  First, when a new LLC is formed, the Certificate of Formation only identifies the name of the company, the resident agent, and the name of an authorized person who signs the form.  The authorized person is typically a lawyer who is handling the formation of the company.  Delaware LLCs must pay the $250 LLC tax on June 1.  When filed online and paid with a credit card, unlike most other jurisdictions, no member, manager, or address information is requested or confirmed; and no signature is required.  In short, the annual filing requirements for a Delaware LLC can be handled without a trace of the person handling the filing.

When our real estate investor in California wishes to protect his or her identity, the solution is to form a Delaware limited liability company to own the property, which is then qualified to do business in California. A second Delaware LLC is formed to act as the manager.  As Delaware does not collect information on the identity of its managers, there is no public record that identifies the real estate investor.

Over the years, there have been a lot of schemes designed to conjure up identity protection, but these schemes have been mostly hocus pocus.  Many clients have asked about using “nominees”, which are essentially hired guns who will act as a corporation’s officers or as the manager of the LLC.  However, these schemes are expensive, and wrought with risk associated with appointing a complete stranger as the CEO of your company.  Using Delaware for anonymity purposes carries none of these risks.  Delaware has a sophisticated judicial system, and is a preferred jurisdiction for the flexibility and mobility it provides to those who form businesses there.  See, http://www.eminutesonline.com/what-is-the-benefit-of-incorporating-in-delaware-watch-video/; http://www.eminutesonline.com/delaware-jurisdiction-of-choice-for-mobile-generation/.

Although Delaware has been criticized as the “world’s most secret financial location” (http://www.guardian.co.uk/business/2009/nov/01/delaware-first-choice-tax-haven), and there is undoubtedly room for abuse, celebrities, public figures, successful investors, and others have a legitimate interest in safeguarding their personal information.

Converting to a California Corporation: Why Risk Getting Stung Twice?

Let’s say you’re an actor in New York who forms a New York corporation.  When the draw of California is no longer resistible, you pack up your car and go west!  What do you do with your New York Corporation?  To operate your company in California as a foreign (i.e., out-of-state) corporation, you would qualify to do business in California. When that happens, your company becomes obligated to pay franchise taxes and file tax returns in both New York and California (which happen to be two of the highest taxed states in the nation).  To continue to use your corporation without having to pay New York taxes and fulfill New York corporate compliance requirements, the knee-jerk solution would be to “convert” the corporation to a California corporation.  As explained in this article, the better choice might be to convert the corporation to a Delaware corporation.

The California Conversion Process is Straightforward

California allows foreign entities (see, Cal. Corp Code Sec. 1150 et seq. for corporations and Cal. Corp Code Section 17540.01 et seq. for LLCs)  to convert into California entities (as long as the state you are exiting also permits the conversion). Conversion effectively moves the entity from one jurisdiction to another, resulting in the same exact entity existing in an alternative home jurisdiction, while ending its existence in the original jurisdiction. Once the entity is converted to a California entity, it will retain the employer identification number that was originally assigned to it. Similarly, there is no need to assign royalties, intellectual property, or any other assets because the entity maintains a continual existence.

Under California law, to authorize the conversion, the converting entity must prepare and execute a Plan of Conversion. The Plan of Conversion essentially serves as a road map for the conversion. It includes the terms of the conversion, the manner of converting the shares of each of the shareholders of the converting corporation into securities or interests in the converted entity,  the provision providing for the governing documents for the converted entity to which  the holders of interests in the converted entity are to be bound (Bylaws for a corporation, Operating Agreement for LLCs,  etc.), any provisions  that are required by the jurisdiction in which converted entity was originally organized.  The Plan of Conversions must be approved by the Board of Directors and a majority of the outstanding shareholders, if it is a corporation or membership interest if it is a LLC.

Once the Plan of Conversion is approved, the converting entity must file the appropriate Certificate of Conversion or Statement of Conversion with the California Secretary of State, which will effectuate the change with the California Secretary of State. The converted entity must also notify the Secretary of State in the original jurisdiction of the change by filing the appropriate form.

But You Would Have To Be Nuts to Get Stung Twice

So, now you’re an actor with a California corporation; and you decide to move to Las Vegas.  You have to deal with the exact same problem all over again.  In other words, after moving to Nevada, you would still be obligated to pay California franchise tax and file a California tax return.

Instead of converting to a California corporation when you moved from New York, converting to a Delaware corporation and qualifying to do business in California would have given you the flexibility to pick up and move your corporation from state to state with relative ease.  To read how this works, see http://www.eminutesonline.com/incorporated-in-the-wrong-jurisdiction-now-what/.

Delaware is a jurisdiction of choice for many reasons, including low annual fees and well founded corporate law. Small business owners are fans of Delaware for an altogether different reason – mobility.  See http://www.eminutesonline.com/delaware-jurisdiction-of-choice-for-mobile-generation/.  Let’s say your spouse can’t stand the New York winters and wants to move to Florida.  In that case, you would simply surrender the right to do business in New York and qualify the Delaware Corporation to do business in Florida, a process which inexpensively maintains the continuity of your corporation.  For more on this topic, watch http://www.eminutesonline.com/what-is-the-benefit-of-incorporating-in-delaware-watch-video/.

How to Form a California Corporation: A Step-By-Step Guide

This article is a step-by-step guide to forming a California corporation.

1. Reserve the corporate name.  The first and most exciting task is to select a corporate name.  In California, if the name is available, it can be reserved for 60 days.  See, http://www.eminutesonline.com/are-there-any-restrictions-on-the-name-of-my-corporation-watch-video/.
2. Prepare and file the Articles of Incorporation.  The Articles of Incorporation is a simple document, typically a single page, that sets forth key organizational information regarding the company (e.g., name, number of authorized and issued shares, agent for service of process, provisions limiting the liability of officers and directors, etc.).  To learn about the optional provisions that can be set forth in the Articles, see http://www.eminutesonline.com/what-optional-provisions-may-be-included-in-the-articles-of-incorporation/.  The Articles are filed with the California Secretary of State.  See, http://www.eminutesonline.com/california-experiences-extreme-filing-delays/.
3. Prepare a IRS Form SS-4 and Obtain a Tax Identification Number.  To obtain a Federal Tax Identification Number, a IRS Form SS-4 must be completed.  Once signed, the FEIN can be obtained online on the IRS website.  See, http://www.eminutesonline.com/what-is-a-federal-employer-identification-number/
4. Prepare Bylaws.  The Bylaws, among other matters, provide the date and time of the annual meeting of the Shareholders. The requirement for Bylaws is governed by the Corporations Code of the jurisdiction of incorporation. Bylaws are the rules under which the Shareholders and Directors of the corporation agree to operate. In the event of a conflict between the Bylaws and the Articles of Incorporation, the Articles of Incorporation will govern, and, in the event of a conflict between the Articles of Incorporation and the General Corporation Law, the General Corporation Law will govern.  See, http://www.eminutesonline.com/what-are-bylaws/.
5. Minutes of the Organizational Meeting.  The Minutes of the Meeting of the Incorporator and the Board of Directors cover a wide range of topics, including adoption of the previously filed Articles of Incorporation, adoption of the Bylaws, election of Officers, approval of a form of Share Certificate, designation of an agent for service of process, the authorization for the filing of the Statement of Information, the designation of the corporation’s principal office and corporate bank account, authorization to file the Application for Employer Identification Number, for the issuance of shares, and if the corporation elects to be taxed under subchapter “S”, the authorization for filing of the Election by a Small Business Corporation (Form 2553) (Subchapter “S” corporation).
6. Issue the stock certificates and qualify the shares with the Department of Corporations.  Physical share certificates are next issued, evidencing each shareholder’s ownership of shares in the company.  Typically, a Notice of Transaction Pursuant to California Corporations Code Section 25102(f) is filed to exempt shares from qualification or registration.
7. Prepare and file IRS Form 2553 if a S-Corporation.  The Election by a Small Business Corporation (Form 2553) is the federal tax form by which the corporation elects to be taxed under Subchapter “S” of the Internal Revenue Code. There is a deadline within which the form must be submitted to the IRS. In addition, the spouses of married shareholders must, in most cases, be identified on the federal “S” election form. Some states require an additional filing to be treated as an “S” corporation under state law (e.g., see form CT-6 for New York).
8. Prepare and file the Initial Statement of Information.  Each corporation must file a Statement of Information within 90 days after the date of incorporation and annually thereafter. The Statement lists the Officers, Directors, Agent for Service of Process and the principal place of business for each domestic and foreign corporation qualified to do business in California. The failure to file the Statement of Information by the deadline will result in a penalty.
9. Prepare any applicable ancillary documents: Finally, additional documents should be drafted to reflect the business and corporate matters that are key to the operation of the corporation.  Examples include: medical expense reimbursement plans, employment agreements, promissory notes, shareholders agreements, and investors rights agreement.
10. Qualification to do Business.  Filing a registration to do business in a state other than the state where the company is formed “qualifies” a corporation to do business in the particular jurisdiction. If a corporation does substantial business in a jurisdiction where it is not qualified, it may be subject to fines and penalties and will not have the protection of that jurisdiction’s court system.

California Eliminates Mass Mailings of Statements of Information

In an effort to save money (and to eliminate confusion with the widespread, bogus solicitations bombarding California small businesses), effective December 1, 2009, the California Secretary of State began sending reminder postcards to California corporations and LLCs rather than Statements of Information. Now, 90 days in advance of the corporate/LLC filing deadline, the Secretary of State will send out a postcard with the corporate name, corporate number, renewal date, and filing instructions. This means that California businesses may no longer simply check the box and send in a check. Instead, California corporations and LLCs must (a) file the Statement of Information online, (b) download the Statement of Information from the Secretary of State website, prepare the form, and mail it to the Secretary of State, or (c) request the Statement of Information form by phone.

California Experiences Extreme Filing Delays

California is experiencing extreme delays in the time it takes to process Articles of Incorporation and Articles of Organization for new business entities. Historically, a filing would take about 7 to 10 business days to process. Presently, it is taking anywhere from 7 to 27 business days for the Secretary of State to process these filings, with wild fluctuations within that range. The delayed processing time is a direct result of budget constraints plaguing the State. To cope with a decrease in funds budgeted to the Secretary of State, the Fresno and San Francisco satellite offices have been closed, diverting all filings to the Sacramento office. The delays are not expected to improve, and worsened with the recent closing of the of the San Diego satellite office on April 2, 2010. Further, the Secretary of State has been experiencing some technical computer issues resulting in additional delays. While we have discouraged our clients from paying the additional filing fees for expedited filings in California due to the high cost, expedited filing may be the only option for our clients with time sensitive filings.

LLCs formed for Web Productions, Short Films, Not Exempt from New York’s Absurd Publication Requirement

In New York, a Limited Liability Company must publish, within 120 days of its formation, a notice in two general-circulation newspapers (one daily, one weekly) in the county where the LLC was formed. The notice has to run once a week for six weeks and include a number of facts concerning the company and its formation. If an LLC doesn’t fulfill the publication requirements, the company’s authority to do business in New York can be suspended. (See, http://www.eminutesonline.com/new-york%e2%80%99s-irrational-llc-publication-requirements-hurt-business-owners-and-benefit-special-interests/#more-44). 

Fortunately, there is a narrow exemption for “theatrical productions” (see, http://www.eminutesonline.com/theatrical-production-llcs-and-the-new-york-publication-requirement/#more-295)

Despite the growing number of small web productions, the exemption does not apply to LLCs formed for short films, web series, or webisodes.  The law (see,http://codes.lp.findlaw.com/nycode/ACA/F/23/23.03) provides that a LLC that is a “theatrical production company” is exempt from the requirement for publishing its articles of organization, application for authority or notice containing the substance thereof … so long as the words “limited liability company” appear in its name”.  The term “theatrical production company” is defined narrowly by the statute to refer only to entities formed for “live-staged dramatic productions, dramatic-musical productions and concerts”.

Because of the costs imposed by the publication requirement, business owners should think twice before forming an LLC in New York, particularly in the downstate counties.  In many cases, the solution is to form a corporation, which is not subject to the publication requirement, rather than a LLC.

How Many Directors Are Required?

The answer turns on where you incorporate.  In most states, one director is required:  Delaware (one director required, see, http://delcode.delaware.gov/title8/c001/sc04/index.shtml),  Nevada (one director required, see, http://leg.state.nv.us/NRS/NRS-078.html#NRS078Sec115), New York (one director required, Bus Corp Law Sec. 702.  See, http://public.leginfo.state.ny.us/menugetf.cgi?COMMONQUERY=LAWS).  California, on the other hand, marches to the beat of its own drummer.  In California, the number of required directors depends on the number of shareholders. Under California law, a corporation is required by law to have at least three directors. However, the corporation may have one director if the corporation has only one shareholder; and the corporation must have at least two directors if the corporation has only two shareholders. See, http://www.eminutesonline.com/how-many-directors-are-required/

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