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U.S. markets are without a doubt among the most lucrative in many industries – foreign entrepreneurs and well-established foreign companies constantly seek to find new ways to become a part of the flourishing U.S. economy and take advantage of the high consumption that automatically causes high demand. Due to globalization and advancing technologies as well as regulation related thereto, expansion to the U.S. is becoming a very realistic goal of many foreign businessmen, especially the ones based in the European Union. Even though multiple options are available for entrepreneurs seeking to do business in the U.S., legal requirements and regulatory strain limit such options for foreigners and often result in the inevitable need to establish a corporate presence in the U.S. This is often done by establishing a corporation in the state of Delaware.
Why Does the State Matter?
U.S., being a federation, consists of multiple different jurisdictions, therefore in most cases it does matter what state to incorporate a new company in (even if the main goal of the incorporator is to establish a legal presence in the U.S. overall). Even though U.S. federal law applies to all states and businesses established in any part of the U.S., state law is much more important for business owners and entrepreneurs as it directly regulates the corporate governance rulesn each state. Most companies established in the U.S. do not have significant federal obligations (except for federal tax obligations and such) but are subject to state regulations that determine procedural rules, fiduciary duties, stockholder rights, as well as various filing requirements. As a result, a state to establish corporate presence in must be carefully picked by any entrepreneur seeking to do business in the U.S.
Why Corporation?
Corporations are a common form of companies that have a formal management structure, in some cases are or strive to be public companies, have stockholders or managers who seek a predictable and recognized legal structure, limited liability and usually perpetual existence. Certainly, a corporation is not always the best type of legal entity for foreigners in the U.S. as different types of entities fit different business needs (for example, some of you may have heard about the Delaware LLC and its tax haven-like qualities when it comes to foreign members). However, corporations, especially the Delaware C corporation, present a variety of advantages and therefore in many cases are one of the most desired options for establishment in the U.S. among foreigners.
Corporations, as well as the incorporation thereof, in the state of Delaware are regulated by the Delaware General Corporation Law (DGCL). As set forth in the DGCL, the process of incorporation consists of several mandatory steps and preparation of a set of incorporation documents. The only document that has to be filed with the secretary of state of Delaware is a certificate of incorporation, however, multiple others must be adopted for any corporation to be able to start its operations.
Certificate of incorporation is a fairly short and straightforward document, usually a few pages long, however the length depends on the selected format and information included as some of it is optional. In accordance with DGCL, information that must be provided in the certificate of incorporation includes: name and address of the corporation; nature of the business or purposes to be conducted or promoted; number of shares of stock which the corporation shall have authority to issue and the par value of each of such shares; name and mailing address of the incorporator. Filling out the certificate of incorporation is a pretty straightforward task, however, some important questions must be carefully considered in the process (especially taking into account the fact that in case any of the information contained in the certificate of incorporation needs to be changed, an amended and restated version would have to again be filed with the secretary of state of Delaware). For example, the number of shares of stock (including the par value), has to be determined in the certificate of incorporation, which in certain cases can involve strategizing and planning the future of the corporation in more detail.
Bylaws of a corporation could be described as a set of rules governing the internal life of the corporation and the people involved in it as members of the board of directors, officers, shareholders and such. Bylaws can contain any provision, not inconsistent with law or with the certificate of incorporation of the corporation, relating to the business of the corporation, the conduct of its affairs, and its rights or powers or the rights or powers of its stockholders, directors, officers or employees. Thus, bylaws are among the key documents in the incorporation process setting forth a detailed set of rules the company being incorporated is governed by in the future. In a more practical sense, bylaws are a document that is usually referenced in agreements as a rule-setting source and a document which all further corporate acts of the company must comply with. Bylaws normally set forth the order in which corporate decisions are made within the corporation, list the actions each officer is authorized to take on behalf of the company, set forth the instructions for meetings and votes of shareholders as well as meetings and votes of directors. Even though a template document can easily be used for the sole purpose of ensuring that certain default bylaws are adopted and in fact exist in the newly incorporated company, it is important to understand that bylaws create numerous obligations and rules related to the organization and governance of a corporation.
Corporate Actions are required to formally adopt the bylaws and appoint the members of the board of directors of the corporation, who from that point take over the management of the corporation in accordance with the newly adopted bylaws. Upon election of the members of the board of directors, the board of directors can adopt the initial organizational board resolutions and appoint officers of the corporation, such as president, vice president, CEO, secretary and others, in all cases in accordance with the already adopted bylaws. Furthermore, in the initial organizational board resolutions the board of directors may issue stock and adopt other resolutions relating to the bank account of the company, agreements to be entered into with officers of the corporation and other third parties, as well as other corporate decisions depending on the nature and type of the newly incorporated company. Simply put, the initial resolutions of the board of directors of a newly incorporated company resolve the key issues relevant to ensuring a successful start of operations of the corporation.
The above provided analysis of the incorporation process as well as steps and documents involved should be quite clear and straightforward to an individual or entity having even minimal experience in the corporate world in the U.S. As nowadays template corporate documents are very easily accessible on the internet, and various online electronic platforms are emerging every day offering affordable help in the incorporation process, entrepreneurs planning to incorporate in the state of Delaware can find themselves debating whether a U.S. attorney is really necessary to successfully incorporate a company in the state of Delaware. As many start-up businesses seek to cut costs as much as possible and it is no secret that legal costs can reach significant heights, oftentimes founders of new corporations are tempted to turn to more affordable alternatives, including, but not limited to, online platforms that produce (and file with the secretary of state of Delaware) the incorporation documents at a very low or no cost at all. As the set of documents produced in the incorporation process is fairly similar in most corporations and, it may seem, only plays a role in the internal governance of a corporation never being examined or challenged by outside parties, a cost-cutting automated incorporation service may seem like a perfect solution, especially to startup companies. However, it is important to understand that the incorporation process is not only a formality and each document produced in order to incorporate a new company and set up its structure for future operations has its own purpose (more about automated incorporation here).
Even though with the help of a qualified U.S. attorney the incorporation process in the state of Delaware can be smooth and fairly easy, the individuals involved, including the entrepreneur and the attorney, may fail to discuss some critical issues that might arise due to the differences between the incorporation process in the U.S. and the standard incorporation process in the EU. Such miscommunications and thus – misunderstandings under certain circumstances can create additional issues in the further development and management of the company as well as international business dealings and such.
Delaware incorporation process is quite modern and can be accomplished entirely online. This means that all the documents analyzed in the beginning of this article can be drafted and signed electronically, which is still not possible in some EU countries. Furthermore, a number of EU countries have strict and detailed regulation in place setting forth requirements for new corporations that must be met before officially registering, including, but not limited to, requirements referring to share capital, corporate name, legal structure as well as form requirements for certain incorporation documents. The regulation in the state of Delaware, however, seems to be designed to ensure easy and painless incorporation process, even for companies that are still in very early stages of operations.
Furthermore, a number of EU countries still require hard copies of some of the corporate documents to be submitted physically by authorized persons of a newly incorporated company to a certain register of companies or other government institution for them to be considered to have been properly adopted and thus – effective. Even though the state of Delaware has an official company register where all Delaware corporations and other types of companies can be found publicly, the filing requirements, especially in the incorporation process, are minimal. This saves time and eliminates the inconvenience of having to physically travel to an institution to report certain information to the government.
Finally, the state of Delaware does not have many material requirements for new corporations: there is no minimum required capital to incorporate a company, no detailed description of planned operations required to be submitted, no personal information collected about the founders and other persons involved in the company at the time of incorporation – some of which is still very common or even mandatory in the EU. The lack of the aforementioned formalities creates a legal environment where incorporation of a new Delaware corporation can be finalized with minimal to no planning and, most importantly, remotely and electronically. Furthermore, the above described situation results in significantly faster incorporation process in the state of Delaware than some countries in the EU as it skips multiple steps in preparation for incorporation that are mandatory when incorporating in EU member states.
On the same note, the involvement of notaries in the incorporation process cannot be ignored as one of the major differences between the incorporation processes in the U.S. and EU. In the state of Delaware, the participation of a notary is simply not required when incorporating a new company. A notary is not involved in the preparation or signing of any of the above analyzed corporate documents or otherwise consulted during the incorporation process. In the EU, however, the regulation differs and participation of a notary in the incorporation process is required in most cases.
In the EU, notaries are public servants working to ensure the validity of certain documents, legal acts and signatures and act as an additional level of security in various legal dealings. Whenever a notary is involved in a process, there is an additional person or persons, highly qualified, experienced and authorized to fulfill their duties by the government, checking legal documents, legal acts and the compliance thereof with regulatory requirements. In case of incorporations, notaries are responsible for checking the content of incorporation documents and ensuring that everything required by law has been included therein. Furthermore, notaries check and collect information about shareholders, incorporators and other persons involved in the new corporation, confirm the authenticity of signatures on the incorporation documents as well as the authority of signatories to act on behalf of the company in executing such legal acts.
From the above described functions, it is obvious that involvement of notaries in the incorporation process in the EU makes it significantly more time consuming and slightly more complicated. However, at the same time, it is extremely helpful as a review of the incorporation documents by a notary eliminates the risk of major mistakes in the incorporation process as well as major misunderstandings and obstacles in the future of the operations of the corporation. As notaries are not involved in the incorporation process in the state of Delaware, it makes the process much faster, more flexible and therefore more convenient, especially for foreign individuals and entities. However, the lack of involvement of notaries in the incorporation process also leaves more room for errors and mistakes in the incorporation documents.
Due to the possibility to sign and file all incorporation documents online and no participation of a notary in the incorporation process, incorporating in the state of Delaware can be completed entirely online. This means that the certificate of incorporation, as well as the rest of the incorporation documents, can be signed by individuals involved in the corporation (incorporator, members of the board of directors, officers) no matter where they are located at the time of incorporation. The existence and credibility of online electronic signature platforms in the U.S. such as Hellosign, Docusign and numerous others, makes it extremely convenient and quite safe to sign legal documents for persons located anywhere in the world, which nowadays is a priority in many global businesses. Furthermore, the corporate documents can be filed with the secretary of state of Delaware via mail and even fax, hence not even having to be printed at any point in the incorporation process. Due to the abovementioned reasons, if not preferred otherwise, incorporating in the state of Delaware can be completed electronically and therefore entirely remotely as well.
The above described advantages, of course, are not obvious and taking advantage of the favorable rules of the DGCL requires a certain degree of skill and know-how. Furthermore, some of the concepts, such as the described type of electronic signatures, not being very widely accepted or common in the EU, may be confusing to foreign entrepreneurs and cause a feeling of not knowing where to start. Therefore, participation in the incorporation process of a U.S. attorney experienced in corporate law is often inevitable not only in the context of preparing the material content of the incorporation documents, but as a guarantee of the best possible outcome of the incorporation process for the foreign entrepreneur as well.
When talking about the modern aspects of incorporating in the state of Delaware, it is important to also mention the fact that incorporation is one of the legal services that is highly likely to be soon replaced entirely by AI (some may even argue that it already is). Automated online incorporation is lucrative to U.S. residents as it significantly simplifies the incorporation process, however it is extremely convenient for foreign entrepreneurs who are not knowledgeable about the U.S. corporations regulation, are not physically in the U.S. and are in fact only able to incorporate remotely. When using an automated incorporation service, an entrepreneur simply has to answer a number of questions and provide basic information to be included in the offered set of incorporation documents. The service provider’s system then automatically picks out the templates of documents to be used, modifies them and inserts the information about the company being established. A set of documents is then generated to be signed by the entrepreneur that becomes the foundation of the newly incorporated business.
What is more, even though in most cases U.S. states require to provide the address of the company being incorporated in that particular state (which most foreign entrepreneurs and online businesses lack), it is common practice to use registered agents – companies specializing in providing such address for a small annual fee – for this purpose. Most of the automated incorporation services currently available in the U.S. include the registered agent service in their package therefore making the process even easier for foreign entrepreneurs. Finally, even if still considering consulting with an attorney, in absence of recommendations and knowledge of the corporate culture in the U.S., a foreign entrepreneur is likely to struggle searching for a trustworthy and credible legal services provider. This problem, however, is eliminated when an automated incorporation service is used. This and multiple other advantages make automated electronic incorporation seem like an easy all-inclusive solution for foreign entrepreneurs, however it is not exactly the case (but more about automated incorporation here).
Another major advantage of incorporating in the state of Delaware for foreign individuals and entities is flexibility in structuring the corporation. Structuring here should be understood as setting up the managing bodies of the corporation, determining the responsibilities thereof as well as setting other corporate governance rules in place. Most of such rules are generally provided in the bylaws of the corporation and/or resolutions of the board of directors of the corporation. For the purpose of clarity, it is important to mention that any and all corporate governance rules existing in a Delaware corporation must comply with the DGCL, however the regulation provided in the law is flexible and leaves many major aspects of corporate structure up to the entrepreneurs.
Members of the board of directors.
The business and affairs of every corporation organized under DGCL is managed by or under the direction of a board of directors, except as may be otherwise provided in the DGCL or certificate of incorporation of that corporation. The Delaware board of directors could be compared to the management board common in the EU – it is a governing body of a company, in most cases elected by the shareholders, and having the power to elect officers of the corporation. Similarly, a management board is usually elected by the shareholders and is responsible for the overall governance of the corporation, including the election of a director or sole manager of the company. In accordance with the DGCL, a board of directors must consist of at least one natural person.
In small corporations, members of the board of directors very often are shareholders, in other words, owners of the corporation themselves, however as the number of shareholders grows, the corporation and the operations thereof expand, or in situations when major shareholders are investors that do not want to be involved in the governance of the corporation, members of the board of directors are elected and hired as professionals, not necessarily having any prior connections to the corporation.
The minimum number of members of the board of directors of a Delaware corporation is one, and the number is fixed by, or in the manner provided in, the bylaws (unless the certificate of incorporation fixes the number of directors). Unless set forth otherwise in the incorporation documents, any action required or permitted to be taken at any meeting of the board of directors or of any committee thereof can be taken without a meeting if all members of the board or committee consent thereto in writing or by electronic transmission. Therefore, all major decisions within a Delaware corporation can be made without an actual meeting of the board of directors, as long as, if required by the DGCL or bylaws of the corporation, all directors express their consent in writing. The abovementioned is especially convenient to foreign entrepreneurs as in case the members of the board of directors are not all in close proximity, they can express their stands regarding any issue concerning the corporation in writing, and, thanks to the available electronic means already discussed earlier in this article, even sign any required document entirely electronically.
Officers.
Every corporation organized in the state of Delaware can have such officers with such titles and duties as is stated in the bylaws or in a resolution of the board of directors of the corporation which is not inconsistent with the bylaws. In other words, officers are executives of the corporation having certain rights and obligations within the company – usually, rights to represent the company in a scope defined in the bylaws or resolution of the board of directors of the corporation. Such rights can be defined very specifically or, in a more generic manner, however the executive element always stays in place.
The most common titles of officers in Delaware corporations are president, vice president, chief executive officer, chief financial officer, however the titles, as well as rights and obligations connected thereto, can vary significantly depending on the corporation. For example, some companies might prefer the title of “president” while others the title of “CEO” even though the positions of such officers in their essence can be exactly the same. The rights and obligations of particular officers to be appointed in a corporation are normally set forth in the bylaws – as in many similar cases, bylaws of the corporation act as a base set of rules and guidelines for the appointment and actions of officers. DGCL does not provide any restrictions on the nationality or place of residence of officers, therefore all officers of a Delaware corporation can be foreign individuals if chosen so.
Shares of stock.
Every Delaware corporation can issue one or more classes of stock or one or more series of stock within any class thereof, with par value or without par value and with full or limited voting powers, or no voting powers, as well as optional or other special rights and qualifications, limitations or restrictions thereof, as is stated and expressed in the certificate of incorporation. The number of shares of stock which the corporation has the authority to issue and the par value of each of such shares is indicated in the certificate of incorporation. Due to the mechanism set forth in the DGCL, the maximum number of shares of stock the board of directors of a corporation can issue is the amount set forth in the certificate of incorporation. As the certificate of incorporation can only be amended by the stockholders, DGCL ensures that without the approval of the existing stockholders, the board of directors will not issue more shares of stock than the corporation was initially intended to issue.
As for the issuance itself, a corporation usually issues stock to its stockholders after or during the first meeting of the board of directors. Typically, each stockholder enters into a subscription agreement with the company setting out the payment and other agreed upon terms such as a representation and warranty that the stockholder is an accredited investor, which is required to duly comply with the U.S. Securities and Exchange Commission’s regulation as related to private sales of stock (more about registration of securities here). The state of Delaware also does not require stock to be certified therefore, depending on the corporation, shareholders might not be issued any stock certificates. Other terms and conditions of the sale of stock, such as price per share, transfer time, vesting conditions (if any) are entirely up to the corporation and future shareholder – as long as the terms agreed upon comply with legal requirements of the state of Delaware and other applicable regulation.
It is important to mention that the DGCL does not set forth any requirements as related to the number of authorized shares of stock or the price thereof. The only thing to keep in mind when determining the number of shares to be authorized is the fact that the annual franchise tax of a Delaware corporation is calculated based on the total number of authorized shares of that corporation or the total number of shares of no-par value stock. Such numbers in practice are usually determined by incorporators depending on the future vision for the corporation – in case the corporation is not intended to grow large with a future possibility of several rounds of financing or selling shares to the general public, but is rather a formal corporate tool in operations of a parent company or similar, it is not unusual for the number of shares indicated in the certificate of incorporation to be quite low (as all the shares in such case are usually intended to be owned by the parent company). On the other hand, if the new corporation has the potential of growing, the number of shares indicated in the certificate of incorporation of such company is likely to be higher, often – in millions, for the purpose of convenience in distribution of shares to employees, investors and other persons involved in the corporation.
Applicable taxes and rates thereof are one of the main aspects any foreign individual or entity seeking to incorporate in the U.S. should take into account. Many global businesses choose complicated corporate organizational structures for the sole purpose of minimizing the tax burden imposed on the business overall. It is not uncommon for global businesses to manage multi-continental structures of entities set up to ensure the lowest possible tax rates, including corporate income tax, taxes imposed on corporate transactions such as sales of shares and other financial instruments, as well as sales tax and others. In the U.S., taxes are collected at both federal and state levels, therefore even though regardless of the state of incorporation falling under the federal taxation system, state taxation system in case of incorporation of a new U.S. entity is somewhat up to the incorporators.
As already mentioned earlier, the state of Delaware does impose a franchise tax. The tax is due every year a corporation is registered in the state of Delaware and is calculated based on the total number of authorized shares of a corporation or the total number of shares of no-par value stock. More specifically, Delaware franchise tax is due on or before March first every year and together with an annual report is required to be filed electronically. Failure to file the report and pay the required franchise tax can result in a penalty of $200.00 plus 1.5% interest per month on tax and penalty. The amount of tax due, however, depends on the selected calculation method – for corporations having no par value stock, the authorized share method always results in lesser tax. Thus, simply by manipulating the tax calculation method and properly filing the Delaware franchise tax, a corporation (even corporation having authorized millions of shares), has the ability to significantly decrease its franchise tax burden, if all required conditions are met.
Corporations registered in the state of Delaware are also subject to the state’s corporate income tax. The corporate income tax in the state of Delaware is 8.7% of federal taxable income allocated and apportioned to Delaware based on an equally weighted three factor method of apportionment (property, wages and sales in Delaware). The state of Delaware does not impose a state or local sales tax which means that no in-state purchases are subject to sales tax. It must be mentioned, however, that in case business activities of a Delaware corporation take part in another U.S. state, certain taxes are imposed on the corporation in that state as well.
Even though in most cases, regardless of the state of incorporation, a U.S. entity provides access to markets all over the country, there are certain technical and legal requirements that must be fulfilled if in fact the target place of operations of the newly incorporated company is outside of the state of Delaware. This issue might be clearer through an example of incorporating a company in a country member of the EU, when actually seeking to access markets in multiple EU member states. Even though EU is a union of a single market, incorporating in a single member country does not ensure the ability to directly operate and (or) target customers located outside of the member state of incorporation without first meeting certain regulatory requirements. Similarly, even though theoretically incorporating in the state of Delaware provides access to U.S. markets overall (there is no incorporation on a federal level), such access does not come automatically, and certain additional actions must be taken in case the center of the planned economic activities of a corporation is factually in a state other than Delaware.
Even though presented as an issue of incorporating in the state of Delaware, the issue in question is inevitable when incorporating in any other state as well, unless the company being incorporated is only planned to conduct business in one state. A company that is not incorporated in a particular target state, but wishing to conduct business in that state, is usually considered to be foreign in the target state and is likely to be required to separately be authorized through the office of the secretary of state of the target state. For the purpose of clarity, it is important to mention that typically, a company is considered to be conducting business activities in a state when: the business has a physical presence in that state, in-person meetings are often held with clients in that state, a significant portion of the company’s revenue comes from that state or any of the employees of the company work in that state. The list of activities that trigger the requirement to register in other states is relatively broad, therefore if incorporating in the state of Delaware when a significant part of operations is planned to be conducted in another state, additional legal actions are going to have to be taken.
The process of registering or getting authorized in a state other than Delaware when already having established a legal presence in the state of Delaware varies depending on the state in question, however, the process is not likely to be overly complicated and challenging. Usually foreign qualification involves checking the name availability of the corporation in the targeted state, preparing and filing any necessary documents and payment of applicable fees. For example, when authorizing a Delaware corporation in the state of California, a single form filled out by an authorized official of the corporation being authorized, together with a certificate of good standing obtained from the secretary of state of Delaware, must be filed with the secretary of state of California. Such authorization in the state of California can be completed entirely electronically and neither the process of filling out and obtaining the required documents, nor the authorization process itself, is significantly time consuming.
For comparison, to authorize a foreign corporation in the state of Delaware, a certificate of existence as well as a statement signed by an authorized officer of the corporation containing required information must be filed with the Delaware Division of Corporations. As already mentioned above, the additional actions that might be required to be taken to legally conduct business in another state depend on the regulation in that particular state, but in most cases, the solution to the issue in question does not extend beyond several additional relatively simple corporate documents that have to be adopted and filed with respective government authorities. However, it is an inconvenience that must be taken into account when making the decision of which U.S. state to establish a company in.
Transparency as related to the organizational and ownership structure of a Delaware corporation is another important point to be discussed when analyzing the critical issues of incorporation of a Delaware corporation when the incorporator is a foreign individual or entity. Transparency here should be understood as the availability of public information about the corporation as well as its directors and officers. The availability of such information is important not only as related to the credibility of the corporation, anti-money laundering purposes and otherwise prevention of illegal activities, but also as a tool of making sure the corporation is being represented by appropriately authorized individuals in business deals and is otherwise duly fulfilling its legal obligations.
The official website of the state of Delaware (Delaware.gov) provides a section where information about any corporation registered in the state of Delaware is available upon entering the name or file number of that particular corporation. The information that comes up is limited to file number, entity name, entity kind, residency, incorporation or formation date and entity type as well as information about the corporation’s registered agent: name, address and phone number to be used for service of process. In case trying to determine the credibility and reliability of a corporation or persons involved in it, the information available on the website of the state of Delaware is not especially helpful. Additional information about corporations registered in the state of Delaware is, however, available on Delaware.gov for a fee, including information whether the corporation is in good standing, franchise tax assessed and due, identity of only one officer that is disclosed in the annual report of the corporation, identities of directors, number of shares authorized and preferences and limitations of stock classes. The list of information available for a fee seems quite extensive and, except for information about the shareholders of the company, seems to include all the key elements concerning the corporation. There are, however, a few additional issues to take into account when analyzing such information: companies have no obligation of immediate revision of the annual report upon changes of members of the board of directors therefore the list of members accessible on the website of the state of Delaware might be outdated. Furthermore, even though the number of authorized shares of the corporation is available on the website, the number of shares issued to date is not (but more about Delaware corporation search – here).
The issues related to the lack of transparency and public information available about Delaware corporations are not only important when conducting general research about corporations to verify their credibility or identity of persons authorized to act on behalf of the company. The issues in question cause most problems when dealing internationally with corporations registered in the EU and especially in cases when government institutions are involved. For example, very often share purchase deals in the EU require the involvement of notaries. Notaries, as state representatives, upon confirming a business transaction such as share purchase agreement, must collect information not only about companies involved in the deal, but also their shareholders. Companies, of course, are able to provide such information themselves, however the problem that arises is that there is no official government register in Delaware to confirm the information is accurate. Furthermore, certain EU regulation, such as AMLD5, provides even more detailed requirements for collecting personal information about shareholders of companies. As the purpose of AMLD5 is prevention of money laundering and terrorist financing, financial institutions and other EU companies accepting payments (therefore most service providers and manufacturers) must follow the regulation set forth therein. Due to the lack of transparency as related to organizational and ownership structure of Delaware corporations, such regulation is likely to cause additional issues and in certain cases even prohibit execution of international business deals.
Even though due to advancing technologies and changing perceptions, businesses are becoming more and more global, there are still some technical inconveniences involved in having to manage a corporation located in a foreign country, especially when it is being done entirely remotely. The issue in question is only relevant when a foreign individual or entity is incorporating a new company in the state of Delaware as an effort to access U.S. markets meanwhile the physical location of the company and (or) employees is not being changed. Such situation is not uncommon especially in the industries of online services and similar, where physical location for an office, manufacturing plant or warehouse is not necessary to run the business. A Delaware corporation in such case, however, can be necessary as a legal and structural gateway to U.S. markets as certain activities, such as obtaining licenses and permits, executing local business transactions and others cannot be conducted without the existence of a local corporate entity. Furthermore, many U.S. businesses tend to prefer to deal with partners and companies registered within the U.S. – in such case, they can be sure that the activities of that particular company are regulated by U.S. authorities and in case of a conflict it will not be entirely impossible to enforce the legal rights violated, if any (which can be quite difficult and even impossible when dealing with foreign corporations).
The technical inconveniences of having to manage and run a business in a foreign country, especially remotely, are numerous. When incorporating in the state of Delaware, besides being unfamiliar with the regulation in the state and prevalent business practices, foreign entrepreneurs are likely to encounter various technical issues as well. Such inconveniences include the requirement of in-person opening of a corporate bank account for the newly incorporated company, issues as related to validity of electronic documents and signatures outside of the state of Delaware, requirements to comply with local regulation as related to taxes, insurance, employment and requirement to have a registered office address in the state of Delaware. While some of the abovementioned inconveniences can be easily resolved, for example, the requirement to have a registered address in the state of Delaware can be fulfilled by hiring a registered agent service provider, others, such as opening a corporate bank account in a U.S. bank, can be more challenging if residing outside of the U.S.
Business bank account.
It is not uncommon in many countries that a bank account, no matter personal or corporate, can only be opened if the person is physically present in the bank to open the account. This is mainly necessary for banks to be able to conduct proper anti money laundering and “know your customer” processes that are required by local regulation and various international agreements imposed on financial institutions. Even though nowadays it is becoming possible for financial institutions to utilize modern technology for customer identification processes and opening bank accounts remotely is becoming possible, when it comes to corporate accounts in U.S. banks, the traditional approach is still preferred. As a result, the vast majority of U.S. banks do require an authorized officer of a corporation to physically visit the bank and only then are able to open a corporate bank account for the company.
The above described issue, as many other technical regulatory inconveniences, has a way around – a business partner, colleague or otherwise trustworthy person residing in the U.S. can easily be authorized by the company to open the bank account on behalf of the founders or managers of the corporation. However, several issues arise from this solution as well: the person opening the bank account receives access to the account of the corporation and certain management rights which can be difficult to transfer to persons who are actually supposed to be in charge of managing the account. Furthermore, such person often either becomes an officer of the corporation or gets otherwise involved to be able to prove the right to act on behalf of the corporation at the bank. Even though such titles and positions can easily be changed and rearranged, it does create additional time-consuming work for the corporation and is overall inconvenient. As a result, it is not uncommon for foreign founders who do not wish to move to the U.S. themselves, to travel to the U.S. for the main purpose of opening a bank account on behalf of the corporation.
Validity of electronic Delaware documents.
Another issue that is relevant when talking about Delaware corporations and international businesses is the validity of electronic documents, as well as electronically generated signatures, outside the state of Delaware and especially – outside the U.S. As discussed above, incorporation process in the state of Delaware is quite modern and very convenient due to the fact that the entire process can be accomplished, and incorporation documents can be signed, electronically. Electronic signature here should be interpreted as a signature generated automatically by an online platform or other means where the signatory’s consent is expressed by agreeing to the terms of the document via a click-through process and an electronic document is then generated, usually having an electronic track or audit trail.
In the state of Delaware, the described process is entirely legitimate, however in some parts of the EU such signatures have no legal power. On top of the fact that for documents to be valid abroad, they usually must either be legalized through foreign ministries of all participating countries or apostilled in accordance with the 1961 Hague convention (which means that a government institution has to physically authenticate the documents), the validity of such documents can still be questioned due to their electronic nature. EU is not exactly behind as related to utilization of technology in signing and issuing corporate documents, however the concept of an electronic signature in the EU is quite different. Typically, to be able to sign a document electronically in the EU, a person is required to prove his or her identity either through a government issued electronic ID or other alternative means such as online banking (such system minimizes the risks of fraud and false signatures). This difference, however, results in a situation where neither the documents issued in the EU can be signed through traditional electronic means by persons residing in the U.S., nor the documents signed in the U.S. by electronic means are always accepted as valid by foreign individuals and especially – government institutions.
Besides the above described issues of more technical and regulatory nature arising when incorporating in the state of Delaware as a foreign individual or entity, there are also certain material and less obvious issues that must be taken into account before incorporating. As discussed earlier, multiple corporate models require the existence of a U.S. entity to ensure smooth global operations – cases when an already established business is being moved to the U.S. in its entirety, cases when a company is expanding through a new U.S. branch and even cases when a Delaware corporation is necessary merely as a fulfillment of certain regulatory requirements. The corporate structure, shareholder structure and management of the newly incorporated entity highly depends of its purpose and ties to the parent company, if any. Some Delaware corporations are established as entirely new independent corporations while others – as subsidiaries of an already existing entities established outside the U.S.
While all of the above listed scenarios are entirely feasible and legitimate, some expose the parent foreign entity to certain risks. In this context, it is important to analyze the concept of piercing the corporate veil existing in the U.S. meanwhile not very well known in the EU. Piercing of the corporate veil is a legal term for situations when a court decides that the liability normally limited to the corporation and its assets should be extended to other entities related thereto and even individuals. The event of piercing the corporate veil occurs when a plaintiff seeking, for example, compensation for unpaid debts or other harm, instead of targeting the company party to that particular legal relationship, targets its parent company or a company otherwise affiliated thereto (through management, ownership, control), and court recognizes the fact that the corporate veil should be pierced. The primary reason plaintiffs seek to pierce the corporate veil is to reach the assets of the parent company. If a court pierces a company’s corporate veil, the owners, shareholders and even officers of a corporation can also become personally liable for corporate debts. In other words, the above described concept ignores the independence of a legal entity and extends its obligations to other entities and individuals if certain conditions are met.
The legal theory behind the concept of piercing of the corporate veil is quite extensive and certain conditions must be met if seeking to activate this institute. One aspect of piercing of the corporate veil is especially important in the context of this article – liability of a parent EU-based company for its U.S. subsidiary’s obligations in case the corporate veil is pierced. In accordance with the legal theory and logic applied by courts, such event is likely to happen when the foreign parent company fails to ensure independence of the newly incorporated U.S. entity (independence here should be interpreted as independent shareholder structure, independent managers, assets and other aspects of the business). This independence, however, can be somewhat difficult to ensure, especially in cases of relatively small businesses seeking to expand to the U.S. In such cases the U.S. entity often is in fact simply a subsidiary that is incorporated in the state of Delaware for the main company to be able to operate smoothly in the U.S. Unfortunately, this situation can expose the EU-based parent company to claims from U.S. creditors in case there is a conflict with the U.S. entity (especially taking into account the litigiousness of U.S. individuals and entities). This situation may arise when the main foreign company fails to capitalize its U.S. entity and there are in fact no assets for creditors to go after in the U.S. Thus, without even being aware of it, foreign individuals and entities expose themselves to potential claims and liability originating in the U.S.
Another legal concept that is existent in the U.S. but is not so well known in the EU is the concept of apparent authority. Apparent authority is the power of an agent to act on behalf of a principal, even though not expressly or impliedly granted. In other words, apparent authority is the right of an executive or officer of a company to act on behalf of said company, even if no agreement granting such authority has been entered into, or such authority is not provided in the certificate of incorporation or the bylaws. The concept of apparent authority protects third parties that enter into agreements with companies represented by officers having apparent authority and ensures the future enforceability of such agreements. Usually, if an officer or employee of a company has apparent authority, the company is held liable for the actions of such officer or employee (as long as said actions are within the scope of apparent authority).
The concept of apparent authority protects the rights of third parties and thus simplifies and speeds up commercial transactions in the U.S. However, it is often the case in newly incorporated small companies that most of the members of the initial team of employees and contractors hold important titles within the company. All such employees and officers, under the apparent authority rule, have apparent authority to carry out actions that are regularly and typically expected from persons holding such titles. In other words, apparent authority rule eliminates the need for third parties to question the actions of representatives of corporations when their title or other circumstances present them as having authority to represent the company (such as “vice president”, “president”, “head of operations” and similar).
Due to the fact that the concept of apparent authority is not common or very well known in the EU, foreign owners and managers of Delaware corporations may not know how to (or fail to) limit the risks of persons not actually having the right to act on behalf of the company, committing acts and entering into valid agreements out of the scope of their authority. As mentioned above, under the apparent authority rule, a corporation can be held liable for the actions of its officers and agents even in cases when such officers or agents act outside the scope of their authority. Even though the concept in question is quite beneficial to third parties and provides certain advantages to the overall business circulation in the U.S., it can cause misunderstandings and even losses in newly incorporated companies.
All in all, it can be concluded with confidence that incorporating in the state of Delaware is definitely a feasible and lucrative gateway to U.S. markets for foreign entrepreneurs. Even though different business needs might call for different courses of action, some of which might not even involve incorporation at all, establishment of an entity in the state of Delaware seems like an advantageous option in most cases. As discussed in this article, there are certain disadvantages and issues related to incorporating in the state of Delaware, however the key solution is to simply be aware and knowledgeable about the discussed issues in advance. Such knowledge can be obtained by properly preparing for the incorporation, including doing appropriate research as related to the incorporation process and ideally, consulting with a corporate U.S. attorney. However, overall, establishing a corporation in the state of Delaware is currently one of the most efficient options available to EU-based entrepreneurs seeking to access U.S. markets and become a part of the U.S. economy if the need arises to be locally present or it is not possible to legally conduct business in the U.S. remotely.
By Business and Legal Specialist
