Many small business owners and non-profits are unaware that their organization may not have the legal right to enter into contracts, prosecute a lawsuit, or defend against a lawsuit if their business does not maintain a qualified status with the California Secretary of State’s office (SOS) or the Franchise Tax Board (FTB). Contracts entered into during a period of disqualification are typically voidable by the other party or parties, and, in some instances, criminal penalties may apply. To avoid these and other pitfalls, call the trusted business law attorneys at Gehres Law Library for a complimentary consultation.
- Domestic Companies
Pursuant to California case law, a company which was formed in California but subsequently suspended or otherwise disqualified by the FTB or SOS to do business in the state not only loses the ability to enter into contracts, but it also forfeits the ability to defend against one as well. See Damato v Slevin, 214 Cal. App. 3d 668, 673 (1989). In Tabarrejo v. Superior Court, the California court of appeals recognized that:
“A corporation’s powers, rights, and privileges may be suspended if a corporation fails to file annual statements of information pursuant to Corporations Code section 1502…” (See Corp. Code, § 2205). And, “[a] corporation suspended under the Corporations Code, like a corporation suspended under the Revenue and Taxation Code, is also disabled from participating in litigation activities.” Citing Palm Valley Homeowners Assn., Inc. v. Design MTC (2000) 85 Cal.App.4th 553, 556, 560.
Therefore, a disqualified company could be subjected to a judgment against it without having the opportunity to defend. A result many small businesses, non-profits, and start-ups can ill afford.
- Foreign Companies
For companies formed in another state but doing business in California, the pitfalls are similar. If the foreign company does not register to do business with the SOS, fails to pay an annual franchise tax, or fails to pay income taxes owed, they may forfeit all “corporate power, rights and privileges” in California, including the right to enter into contracts and to maintain a lawsuit in the State. See Cal. Corp. Code §§2105, 2203 and Cal Revenue and Tax Code §23304.1. While a foreign company which is disqualified to do business in the State may defend itself in a lawsuit filed against it here, service of process may be achieved in any such suit by servicing the SOS instead of the company directly. See Cal. Corp. Code §17708.07. Therefore, a default judgment could be obtained against a foreign company which is not qualified to do business in the State even before it is aware of the lawsuit.
- Criminal Prosecution
In addition to the risks already mentioned, misdemeanor charges may also be filed against any person attempting to exercise “the power, rights and privileges of a corporation that has been suspended pursuant to the California Revenue and Tax Code, § 23301, or who transacts or attempts to transact…business in this state on behalf of a foreign corporation.” See Cal. Rev. & Tax Code, § 19719.
- Effect of Reviving a Company
If your company has been disqualified from doing business in California, it may regain its rights by complying with a process known as revivor, which includes the payment of any fines and penalties assessed by the State. Once a company is revived, it regains the power to enter into valid contracts, as well as to prosecute and defend against lawsuits. Any court pleadings that were filed during the period of disqualification may thereafter be found valid by a court. However, any contracts entered into during the period of disqualification remain voidable by the other party or parties, which can potentially devastate a small business.
This article includes just a few of the pitfalls inherent in doing business in California, whether you operate a for-profit or not-for-profit company. To avoid these and other potentially costly pitfalls (including failing to maintain corporate meeting minutes or other corporate governance records, or inadequate capitalization), seek counsel from the business attorneys at Gehres Law Library With offices in downtown San Diego, La Jolla and Irvine, California, our team can help keep your organization on track. Schedule a free consultation today for more information.