Doing Business in California: "Quasi-California" Corporations Made Subject to California's Corporate Laws

LOS ANGELES, Nov. 15, 2016 /PRNewswire/ -- Many, but not all, provisions of the California Corporations Code expressly apply if a private, out-of-state corporation has a sufficient "presence" in California (called a "quasi-California" corporation.) An out-of-state corporation is treated as a "quasi-California" corporation, and thus subject to specified provisions of California Corporations Code, if (1) more than half its business (based upon a three-factor formula including property, payroll, and sales) is done in California (the "doing-business" test); and, (2) more than half of its voting securities are held of record by persons having addresses within the state of California (the "voting-shares" test).^[1]

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For analysis, hypothetical SmallCorp, Inc. is incorporated outside of California with substantially all of its business performed inside California.

Hypothetical Illustration: Does SmallCorp, Inc. Satisfy the Requirements of § 2115(a) to Qualify as a "Quasi-California" Corporation?

 A.    The "Doing-Business" Test

To satisfy the "doing-business" test, a corporation must do more than half of its business in California. The three "doing-business" factors are: (1) property, (2) payroll, and (3) sales. The first question is whether the proportion of a company's property, payroll, and sales in California compared to the company's total property, payroll, and sales is more than 50 percent during its latest full income year. (See Corp. Code §2115(a)(1).)

To determine whether the factors meet the one-half doing business requirement, sections 25129, 25132, and 25134 of the Revenue and Taxation Code define the factors as follows and provide the necessary equations:

• the property factor is a fraction, the numerator of which is the average value of the taxpayer's real and tangible personal property owned or rented and used in this state during the taxable year and the denominator of which is the average value of all the taxpayer's real and tangible personal property owned or rented and used during the taxable year;
• the payroll factor is a fraction, the numerator of which is the total amount paid in this state during the taxable year by the taxpayer for compensation, and the denominator of which is the total compensation paid everywhere during the taxable year; and
• the sales factor is a fraction, the numerator of which is the total sales of the taxpayer in this state during the taxable year, and the denominator of which is the total sales of the taxpayer everywhere during the taxable year.

Thus, if the average of the property factor, the payroll factor, and the sales factor is greater than 50 percent during its latest full income year, the "doing-business" test is satisfied.

Assume SmallCorp owns property such as products, machinery, office equipment, and also rents office space in California. SmallCorp does not own or rent any property in any other state. So, the equation is as follows:

(1) Property ----> property in CA / all property    =   1/1       = 100%

SmallCorp has several employees, 90% of whom live and work in California. Accordingly, SmallCorp pays 90% of total compensation paid to all SmallCorp employees to those who live and work within California, as demonstrated below:

(2) Payroll --->   amounts paid in compensation in CA / total amounts paid in compensation =  9/10  = 90%

For this hypothetical, because the first two factors result in 100% and 90% of business performed in California, even if 0% of sales, the next factor, occurred in California, SmallCorp would still do more than one-half of its business in California, satisfying the "quasi-California" requirements. Assuming SmallCorp has no sales in California, the equation is as follows:

(3) Sales --->  sales in CA / all sales   =  0/1   =    0%

This conclusion is reached by taking the average of 100%, 90%, and 0%, then dividing the total sum (190%), by the count (3) which equals 63.3% of SmallCorp's business is done in California.

For a more representative hypothetical, assume that SmallCorp does 70% of its sales in California. If sales are 70% in California, the amount of total business performed in California is 86%, using the same formula: (total sum ÷ count). Accordingly, the proportion of a SmallCorp's property, payroll, and sales in California compared to the company's total property, payroll, and sales is more than 50 percent and the "doing-business" test is satisfied.

B.     The "Voting-Shares" Test

The second test is whether the corporation's outstanding voting securities held of record by persons with California addresses is greater than 50 percent. (See Corp Code §2115(a)(2)).

Assume there are two voting shareholders in SmallCorp: Arnold and Ford. Arnold's address is in Hermosa Beach, California. Ford's address is in Orange County, California. Thus, both shareholders of voting securities have addresses in California. The "voting-shares" test is satisfied because 100% of SmallCorp's shareholders have addresses in California.

SmallCorp will qualify as a "quasi-California" corporation under section 2115(a) because more than 50 percent of its business is done in California and more than 50 percent of its voting shares are held by shareholders with addresses in California. As such, corporate counsel should consider the additional requirements that California will place on a corporation that is "doing business" in California pursuant to section 2115(b), including the imposition of specific sections of the California Corporations Code.[2] For that reason, this long-arm statute's constitutionality has been called into question by courts of other jurisdictions.

____________________________________ 

Gina Correia is a litigation associate of the Stubbs Alderton & Markiles, LLP. Gina's practice focuses on all stages of business litigation. 

[1] Cal. Corp. Code § 2115(a).

[2] Including provisions for: election and removal of directors (§§ 301, 303-04), indemnification of officers and directors (§ 317), voting requirements (§ 710), dissenter's rights (Ch. 13), and rights of inspection. (Ch. 16).  For the full enumerated list of provisions applied to quasi-California corporations, see Cal. Corp. Code § 2115(b).

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SOURCE Stubbs Alderton & Markiles, LLP

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