Foreign Corporations and the Application of California Nonprofit Laws

Map of CaliforniaA foreign corporation, a corporation formed under the laws of another state, that conducts business in California may be subject to more of California’s laws and jurisdiction than one might think. Generally, activities occurring in California are regulated by California laws (e.g., employment, health and safety, revenue and taxation). California’s Nonprofit Integrity Act of 2004, for example, applies to foreign nonprofit corporations doing business or holding property in California for charitable purposes (Government Code Section 12582.1) and imposes audit and reporting requirements on such organizations.

However, the California Attorney General (the “AG”) asserts that foreign nonprofit corporations transacting business in California are subject to provisions of the California Nonprofit Corporation Law, which includes laws relating to standards of conduct, investments, and examination by the AG. It’s not precisely clear how much business in California would trigger application of the Nonprofit Corporation Law, but the AG has informally stated that a foreign nonprofit corporation operating substantially all of its activities in California will be subject to the Nonprofit Corporation Law, including on any statutory restrictions on how the corporation’s board is composed.

Internal Affairs Doctrine

In general, the internal affairs of a corporation are governed by the laws of the state of incorporation. (Edgar v. MITE Corp. (1982) 457 U.S. 624, 645.) This principle, known as the Internal Affairs Doctrine, applies primarily to issues related to the corporation’s structure or internal administration, such as, the steps required to incorporate, adopt bylaws, elect officers and directors, hold meetings, and take board or membership actions. Thus, a not-for-profit corporation formed under New York’s Not-for-Profit Corporation Law should refer to such law when drafting its bylaws.

However, when a foreign corporation enters California, it is also required to comply with state laws in the conduct of its business. (Black v. Vermont Marble Co. (1905) 1 Cal. App. 718, 720.) California courts may apply its laws to a foreign nonprofit corporation doing business in California, maintaining an office in California, or holding property in California for charitable purposes. “Doing business” can mean a number of activities including, soliciting donations in California by mail or advertisements, having directors or officers perform work in California, or conducting any charitable programs in California.

Courts may be particularly interested in applying local laws to a foreign nonprofit corporation when an important public policy is at issue, such as the protection of donors, members, or residents. In addition, the Internal Affairs Doctrine described above does not generally apply to situations where torts, transfer of assets, or contract disputes are involved. California courts have, in the past, extended the reach of California laws to apply when corporate actions involve California citizens and residents, and impacts the sale or disposition or transfer of shares of stock. (Western Air Lines, Inc. v. Sobieski (1961) 191 Cal. App. 2d 399). According to the California AG, the trend here is that California courts are less likely to apply the Internal Affairs Doctrine when important state interests are at stake.

Furthermore, the less contact the organization has with its state of incorporation, the less likely the courts will apply the laws of that state of incorporation. If the organization formed in New York has little to no contact with New York while maintaining its only office and conducting all of its charitable work in California, the courts are more likely to apply California law to disputes that arise.

Authority Asserted by the California Attorney General

The California AG cites to California Corporations Code Section 6910 to assert authority over foreign corporations transacting business in California. The AG interprets Section 6910 to mean that foreign nonprofit corporations transacting business in California are subject to all of California Nonprofit Public Benefit Corporation Law, which may, in many cases, be different than, and in conflict with, the laws of the state of incorporation.

However, Section 6910 does not make it clear when the California Nonprofit Public Benefit Corporation Law applies. Section 6910 provides as follows:

Foreign corporations transacting intrastate business shall comply with Chapter 21 (commencing with Section 2100) of Division 1, except as to matters specifically otherwise provided for in this part and except that Section 2115 shall not be applicable.

Note that the “Chapter 21” reference is to the Corporations Code provisions otherwise applicable to for-profit corporations, which generally deal with matters such as obtaining a certificate of qualification to do business in California with the Secretary of State, maintaining a resident agent for service of process, filing an annual statement of information, and making unauthorized distributions. The remaining part of Section 6910 provides “except as to matters … provided for in” the Nonprofit Public Benefit Corporation Law. The AG reads Section 6910 as an authorizing statute providing that the Nonprofit Public Benefit Corporation Law applies. A plausible alternative is that it only conditions where Chapter 21 doesn’t apply.

Specific California laws that the AG has asserted against foreign corporations include:

  • 49% Limitation on Interested Directors (Corp. Code §5227) – In California, not more than 49% of the board of a nonprofit public benefit corporation may be “interested persons,” which includes any person receiving compensation from the nonprofit for services rendered within in the past 12 months and anyone related to the compensated person.
  • Self-Dealing (Corp. Code §5233) – Under California law, a director of a nonprofit public benefit corporation cannot engage in a self-dealing transaction (a transaction in which he or she has a material financial interest) with the nonprofit except under certain conditions and pursuant to certain procedures. The transaction must be fair and reasonable and a majority of the directors (not including the vote of the interested director) must approve such transaction after disclosure of the director’s interest. In addition, either (1) the board must have considered and in good faith determined after reasonable investigation under the circumstances that the corporation could not have obtained a more advantageous arrangement with reasonable effort under the circumstances or (2) it must be shown that the corporation in fact could not have obtained a more advantageous arrangement with reasonable effort under the circumstances. More information here.

It is still not clear under what specific circumstances the courts will agree with the AG and apply California Nonprofit Public Benefit Corporation Law over the corporate laws of the foreign state. In the past, a California court opined, “actions taken in California concerning the administration of [a] charity should not escape the scrutiny of California law, merely because the founders chose to incorporate elsewhere.” (American Center for Education, Inc. v. Cavnar (1978) 80 Cal. App. 3d 476).