A key question many people ask when deciding to incorporate their business is which state should they incorporate in. As a general rule, a corporation is generally subject to the laws of the state it was incorporated in. Accordingly, it is not uncommon for people to shop around for a state with the most favorable laws. However, for companies based in California, California’s pseudo-foreign corporation law, Cal. Corporation Code § 2115, may vitiate the benefits of filing elsewhere.
Under Section 2115, foreign corporations doing business in California that are characterized as “pseudo foreign corporations” may be treated as if they had incorporated in California, with California law superseding the law of the jurisdiction in which the corporation was incorporated in many important respects. These include:
• Annual election of directors (Corp Code §301);
• Removal of and filling of director vacancies (Corp Code §§303-305);
• Directors' standard of care (Corp Code §309);
• Liability of directors for unlawful distributions (Corp Code §316);
• Indemnification of directors, officers, and others (Corp Code §317);
• Limitations on corporate distributions in cash or property (Corp Code §§500-505);
• Liability of shareholders for unlawful distributions (Corp Code §506);
• Shareholder meetings (Corp Code §600);
• Shareholders' right to cumulate votes at any election of directors (Corp Code §708(a)-(c));
• Supermajority vote requirement (Corp Code §710);
• Limitations on sales of assets, mergers, conversions, and reorganizations (Corp Code §§1101, 1151-1152, 1200-1203);
• Dissenters' rights (Corp Code §§1300-1312);
• Records and reports (Corp Code §§1500-1501);
• Action by the attorney general (Corp Code §1508); and
• Rights of inspection (Corp Code §§1600-1604).
To determine whether a foreign corporation will be treated as a “psudo foreign corporation,” two tests must be met:
1) the average of the property factor, the payroll factor, and the sales factor (as defined in Sections 25129, 25132, and 25134 of the Revenue and Taxation Code) in California compared to the company’s total property, payroll, and sales is more than 50 percent during its latest full income year; and
2) more than one-half of its outstanding voting securities are held of record by persons having addresses in California on the record date for the latest meeting of shareholders held during its latest full income year or, if no meeting was held during that year, on the last day of the latest full income year. Cal. Corp. Code § 2115(a)(1),(2).
Corporations which are listed on the New York Stock Exchange or the American Stock Exchange or quoted on the NASDAQ National Market System are exempt from Section 2115.
While California courts have upheld Corp. Code Section 2115, see, e.g., Wilson v Louisiana-Pacific Resources, Inc. (1982) 138 CA3d 216, courts in other states may decide to apply the law of their own state. For example, courts in Delaware have refused to apply Section 2115 to Delaware corporations doing business in California. See VantagePoint Venture Partners 1996 v. Examen, Inc., 871 A.2d 1108 (Del. 2005). For businesses located in California but incorporated elsewhere, this may mean that they may still be subject to the California Corporations Code in the event they are sued in California.
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