How to Conquer Conversion Aversion

You have made the decision to convert your limited liability company to a corporation (or vice versa) – congratulations!  You have filed your conversion/merger document in the entity’s domestic state and all is well. It doesn’t end there, however!  As with any change to a company that affects its public record, notification needs to be made to all of the states where that entity is qualified to do business. The dread of this process can lead to “conversion aversion”. Arming yourself with knowledge is the best way to avoid this malady.

A Quick Rundown of Conversion Types

The most common types of conversions are from a corporation to a limited liability company (LLC) or from an LLC to a corporation. Of course, there are others, such as a corporation to a limited partnership, limited liability partnership or partnership to name a few. (For more examples, visit Delaware.gov.)

There are two primary types of conversions:

1. Statutory conversion – This is a streamlined procedure, available in many states, that allows you to convert your corporation to an LLC (or other entity type) by filing a few forms with the Secretary of State’s office. This tends to be the easiest and preferred method to convert. Each state that permits statutory conversions has its own state specific forms and requirements, so please always refer to the state’s statutes. 

2. Statutory merger is used if the state does not allow for a statutory conversion. The specific requirements will also vary from state to state.

For example, California has a conversion statute that allows a corporation to convert to an LLC by filing state form LLC-1A, while Arizona does not have a conversion statute. In Arizona, you cannot simply convert, but based on Arizona law, a corporation, for example, can merge with or into an LLC. 

There is also a more complex option called nonstatutory conversion.  Under nonstatutory conversion (which is different than a statutory conversion or merger) your corporation’s assets and liabilities are not automatically transferred to the new LLC. You will need special agreements to both exchange corporate shares for LLC membership interests, and to transfer assets and liabilities. 

One Entity, Two State Statutes

Although a conversion involves only one entity, it involves two state statutes; one governing the company’s existing business structure (e.g., a corporation), and the other governing the entity into which it will convert (e.g., a limited liability company). It is important to check both statutes to make sure each authorizes the proposed conversion and to find out what steps have to be taken to complete the transaction.

How Conversion Affects Periodic Compliance Report Requirements

It is also very important to stay on top of your periodic/annual report due dates in all states in which you are authorized to do business. When an entity does business in many states, this can prove to be an exhausting and daunting task in and of itself --- and even more so during the process of a conversion. As documents are filed to provide notification to the various states in which your entity is qualified to do business, the reports and their due dates are likely to change. A company could easily miss a report that was due during this period and may be charged with hefty late fees and penalties.

Many states have statutory rules for annual report due dates that vary depending on the entity type. Let’s say we have a Delaware corporation that has converted to a Delaware limited liability company. Once the Certificate of Conversion is officially filed with the company’s domestic state (Delaware), the entity has now officially changed from a corporation to an LLC. The corporation is no longer “alive”. The states that the corporation was qualified to do business in, however, still consider the entity to be a corporation and they are calculating the periodic reports based on that entity type.  All of these foreign states must be notified in accordance with their state statute of the conversion. Without notification to the qualified states, one could argue as to whether it is a viable company in good standing and authorized to do business in that state, since the corporation in its domestic state of Delaware is no longer in existence.

It is important to notify these foreign jurisdictions based on each state’s statutory requirements, which can vary greatly.  Some states will allow you to file a copy of the Certificate of Conversion from the domestic state evidencing the change. Others may require a filing of their own state-specific document, and yet others may not allow for a conversion to occur at all. Some states may require you to withdraw the corporation and then qualify as an LLC.

A Delaware Corporation Converts to an LLC

An example is the best way to describe the above process:

A domestic Delaware corporation files a Certificate of Conversion from a Delaware corporation to a Delaware LLC on 7/1/2016. As a corporation, they were required to file an Annual Report and Franchise Tax payment on March 1st of each year, but now that they are an LLC, they will be required to pay a Franchise Tax Payment on June 1^st of each year following the conversion.

Let’s compound the example and say that the domestic Delaware corporation was qualified to do business in Michigan, North Carolina and Rhode Island. As the notices of the conversion are filed in the three states, the due dates and requirements change for the annual reports. The chart below outlines the annual report due dates before and after conversion.

HOW CONVERSION CHANGES ANNUAL REPORT DUE DATES

Let’s also add the state of Florida as a state where the corporation is qualified to do business. Both corporate and limited liability company annual reports are due on May 1^st of each calendar year, so it seems like it should be a simple transition. However, a corporation files a Foreign Profit Corporation Annual Report and is required to update its principal place of business and mailing address as well as list the officers’ and directors’ names, titles and addresses.  An electronic signature from an officer or director of the company is also required. Whereas, an LLC files a Foreign Limited Liability Company Annual Report that requires updating the principal place of business and mailing address. An authorized person of the LLC is required to electronically sign the document. If you file a corporate report in Florida when the legal entity in Delaware is an LLC, are you in fact keeping the LLC in compliance? An argument can be made that you are not.

Conversion Best Practices

In summary, to avoid filing a wrong report, filing a report late, paying fines/penalties and losing good standing, the best practice is to immediately research state statutes and notify each state where the company is qualified of the conversion, determine when the annual/periodic report is due for the new entity type and update your compliance tracking/tickler system to reflect the due dates for the new entity in each of those states. 

Before you undertake a conversion, it is best to consult with an attorney so that you can receive appropriate legal advice for your particular situation.  Knowing you are handling the process correctly can rid you of your conversion aversion! 

This article is provided for informational purposes only and should not be considered, or relied upon, as legal advice.