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Franchise
Tax:
The Problem of Foreign
Corporations Consider the following common fact patterns: No. 1. Acme
Company is a Delaware corporation, which is not authorized to transact
business in New Jersey, and which maintains its sole office in New York
City. Acme is in the business of making consumer bans, and accepts mortgages
on New Jersey residential properties as security for certain of those
loans. Following default, Acme acquires title to one of those properties
by sheriff's deed. It now enters into a contract of sale. The vendee's
title company orders corporate status and franchise tax searches against
Acme. When received, the former states that there is no record of the
corporation in the Secretary of State's off ice; the latter indicates
that the amount of tax due is undetermined because no returns have been
filed. No. 2. Same facts as No. 1, but Acme is in the municipal bond brokerage
business, serving clients in both New York and New Jersey. Acme acquires
this to a residential property in New Jersey for use as a residence for
its President and CEO. If a corporation is found in the chain of title,
title insurers are forced to confront status ("good standing") and franchise
tax issues when asked to insure a conveyance, lease or mortgage of the
really. The customary underwriting practice is to order corporate status
and franchise tax searches against all corporations found in the chain
of title for the preceding ton (10) years. The significance of each is
discussed in turn below. Corporate status ("good standing") searches are
used to verity that the corporation was duly incorporated and that its
charter has not been revoked. Where a foreign corporation is involved,
the search will reveal if the corporation has obtained a certificate of
authority to transact business in New Jersey. SeeN.J.S.A.14A.133. his
true that the failure to obtain a certificate of authority does not invalidate
a deed, lease or mortgage made by the corporation. N.J.SA. 1 4A:1 3-11.
Nevertheless, the certificate serves as prima facie evidence of the the
corporation's formation and existence. Thus, title insurers will frequently
require that a corporation obtain a certificate of authority if it has
not previously done so. Failing this, the corporation will be required
to present proof of its valid formation and continued existence in its
State of incorporation. See Fineberg, Handbook of N.J. Title Practice,
¤4905 (1995 Rev'n). The so-called "franchise tax" is properly known as
the Corporation Business Tax ["CBTI"], and was created by the Corporation
Business Tax Act ["CBTA"], N.J.S.A. 54:10A-1 at sea It derives its popular
name - "franchise tax" - from N.J.S.A. 54:10A-2, which imposes a tax upon
each domestic and foreign corporation ... for the privilege of having
or exercising Its corporate franchise In this State, or for the privilege
of doing business, employing or owning capital or property, or maintaining
an office, In this State. However, certain corporations (notably savings
banks and insurance companies) are exempt from franchise taxes. N.J.S.A.
54:10A-3. Also exempt (at least in theory) are foreign corporations which
are not "doing business" in this State. See Avco Fin. Services v. Dir.,
Div. of Tax., 100 N.J. 27 (1985). What constitutes "doing business"? This
is a diff icult question to answer. In Somerset Apartments, Inc. v. Dir.,
Div. of Tax., 134 N.J. Super. 550 (App. Div. 1975), tax liability was
imposed upon a domestic corporation which hold title to an apartment complex
as a nominee. Therefore, most title insurers (as a matter of course) assume
that any corporation found in the chain of title is subject to the tax.
See Fineberg, Handbook of N.J. Title Practice, ¤5002 (1995 Rev'n). As
a practical matter, all domestic corporations formed under Title 14A are
subject to the tax. Foreign corporations which obtain a certificate of
authority to transact business in New Jersey, are also subject thereto.
A foreign corporation which is "doing business" in New Jersey may not
avoid taxation by refusing to obtain a certificate of authority. Thomson-Leads
Co. v. Tax. Div. Dir., 8 N.J. Tax 24 (Tax Ct.1985). The fact that a foreign
corporation does not maintain an office within the State does not necessarily
mean that it is not "doing business" here. Mark Andy, Inc. v. Tax. Div.DIr.,
8 N.J. Tax 593 (Tax Ct. 1986). Our courts will analyze the nature and
extent at the corporation's presence within the State to determine if
taxation is appropriate. Silent Hoist & Crane v. Tax. Div. Dir., 100 N.J.
1 (1985); see also Avco Fin. Services v. Dir., Div. of Tax., supra. Why
are title insurers concerned about franchise tax? The answer is simple.
Unpaid franchise taxes "... constitute a lien on all of the [corporation's]
property... " for a period of ten (10) years. N.J.S.A. 54:10A-16. Thus,
a title company which insures a purchaser whose immediate or remote predecessor
in title has failed to pay the tax assumes a risk. When the seller corporation
is not a New Jersey corporation, and has not obtained a certif icate of
authority to do business in Now Jersey, the franchise tax report will
(of course) reveal that no returns have been filed. The seller corporation's
attorney will frequently object to the title company's insistence on addressing
franchise tax issues. If the seller is a mortgagee which has acquired
title by foreclosure (as in hypothetical No. 1 above) , the holding in
American Bank & Trust Co. of Pa. v. Lott, 99 N.J. 32 (1985) may be cited
in support of its position. The Lott decision involved a bank chartered
under the laws of the Commonwealth of Pennsylvania. The bank did not "transact
business" in Now Jersey, although it did accept mortgages upon New Jersey
real estate as security for loans made in Pennsylvania. When the bank
attempted to foreclose such a mortgage, the mortgagors argued that it
should be barred from access to our Courts, because it had not complied
with the provisions of the Corporation Business Activities Reporting Act
["CBARA"], N.J.S.A. 14A:13-14 of sea, The Supreme Court rejected this
contention, holding that banks chartered under the laws of other States
are not "foreign corporations" within the meaning of the Act, and thus
the failure to comply therewith was note bar to foreclosure. By way of
dictum, the Court cited with approval Atty. Gen'l's Op. No. 5 (1961) and
Atty. Gen'l's Op. No. 17 (1975). The former states that activities reasonably
related to the foreclosure of a mortgage on New Jersey really do not subject
a foreign bank to th CBTA. The latter concludes that a foreign bank may
lawfully make loans to Now Jersey residents secured by New Jersey real
estate mortgages, provided that the loan is originated and closed out-of-State.
In Avco Fin. Services, supra, the Supreme Court construed the Corporation
Income Tax Act ("CITA"], N.J.S.A. 54:10E-1 et seq., to apply to the activities
of a foreign corporation which had a minimal presence within the State.
The Court distinguished Lott in a footnote, stating Of course, we recognize
that activities reasonably related to the foreclosure of a mortgage on
Now Jersey realty do not subject a foreign bank to the Now Jersey Corporation
Business Tax Act because of such activities. [100 N.J..at 38, Note 3.]
Thus, although Lott did not construe the CBTA (but rather the CBARA),
It is frequently cited for the propositions that: (a) foreign lenders
do not have to quality to do business in order to make mortgages on New
Jersey real estate; (b) the foreclosure of a mortgage does not constitute
"doing business" in this State; and (c) owner ship of real estate as the
result of a mortgage foreclosure does not subject the lender to the CBT.
However, many (if not most) mortgage loans made by foreign entities involve
mortgage companies, not banks. These corporations may be chartered as
business corporations under the equivalent of Title 14A in other States.
Thus, they may not be "banks" within the meaning of the Lott decision.
In fact, the case most directly relevant to the activities of such out-of-state
mortgage lenders is not Lott, but rather First Family Mtge. Corp. v. Durham,
108 N.J. 277 (1987). Durham, as suggested above, involved a mortgage company
incorporated in Florida, which had not obtained a certificate of authority
to transact business in New Jersey. It attempted to foreclose a mortgage
on New Jersey reeky, but was barred from doing so by the Chancery Division,
because it had failed to comply with the CBARA. The Supreme Court was
called upon to decide if the CBARA violated the commerce or supremacy
clauses of United States Constitution. U.S. Const., Art. 1, ¤¤, 13 and
Art. VI, ¤2, respectively. It concluded that: (a) the CBARA is not unconstitutional;
but (b) once a corporation has complied with the CBARA by filing the required
reports, and paying any taxes due to the State, it may not be barred from
access to the courts. Thus, the Durham court recognized that a foreign
corporation in the business of making loans secured by mortgages on New
Jersey realty maybe subject to payment of franchise taxes. If First Family
Mortgage Corporation desired to continue its foreclosure suit, It would
be required to tile business activity reports. If the reports indicated
that the corporation was "doing business" in New Jersey, the State would
look to the corporation for the payment of franchise taxes, income taxes,
or both. Only when the required tax payments were made (or a determination
was made that no taxes were due), would If be permitted to prosecute the
suit. This situation is quite different from the one addressed in Lott,
because restrictions on interstate banking generally prohibit a foreign
bank from obtaining a certificate of authority in Now Jersey. Thus, the
plaintiff in Lott could not have complied with N.J.SA. 14A:13-3 even it
it had wished to. Similarly, a foreign bank cannot be liable for franchise
tax, because It may not lawfully" do business' in Now Jersey so as to
subject itself to the tax. Finally, the plaintiff in Lott was not required
to comply with the CBARA, bemuse (as noted above) the statute was construed
to exclude foreign banks from the meaning of foreign corporations". In
contrast. there is no prohibition on compliance with U.S.A. 14A 3-3 or
the CBARA by foreign corporations in general. Thus, to return to hypothetical
No. 1, the question is whether Acme is "doing business" in New Jersey
by conducting activities in this State other than those related to the
mortgage foreclosure. If it is not, there is no tax liability under Durham.
Of course, if Acme applies for a certificate of authority, it would Ipso
facto subject Itself to franchise taxation. This would neatly resolve
the issue for the this insurer. Turning to hypothetical No. 2, Acme cannot
rely on Loft or Durham, because Its acquisition of title does not result
from a mortgage foreclosure. Acme's counsel will probably argue that the
purchase of a residence for its President does not constitute "doing business"
in New Jersey. However, it is hard to reconcile this position with the
wording of N.J.S.A. 54:10A-2 and the holding in Somerset Apts., supra.
Furthermore, how is the title company to determine 4 Acme carries on other
business activities in Now Jersey? Once again, if Acme obtains a certif
icate of authority the problem will be solved, at least to the title company's
and purchaser's satisfaction. The foregoing discussion is intended to
illustrate the some of the diff iculties arising from the ownership of
real property in this State by a foreign corporation. Clearly, franchise
tax issues are often complex and fact- sensitive, and must therefore be
addressed on a case-by-case basis. However, the preceding analysis demonstrates
that a corporation may not avoid tax liability simply by refusing to obtain
a certif icate of authority, or by making its own self serving determination
that it is riot "doing business" in this State
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'Fair
Foreclosure Act' Construed
In the first reported decision to discuss the so-called "Fair Foreclosure
Act", N.J.S.A. 2A:50-53 at seq., the Chancery Division was called upon
to construe the effect of alleged noncompliance with certain of its notice
provision. In Fed. Nat'l Mtge Ass'n v. Bracero, 297 N.J. Super. 105 (Ch.
Div. 1996), Judge Boyle (Union County) was faced with the following situation.
Plaintiff commenced a foreclosure action under the Fair Foreclosure Act.
As required by N.J.S.A. 2A:50-58(a)(1), its counsel mailed notice of its
intent to apply for entry of final judgment to defendant mortgagor. The
notice provided, inter alia, that defendant could, within ton (10) days
after receipt thereof, mail to the plaintiff's counsel a statement indicating
that there was a reasonable likelihood that defendant mortgagor be able
to cure the default. No such response was received from the defendant
mortgagor, and plaintiff's counsel submitted 'As application for entry
of final judgment to the Foreclosure Unit of the Superior Court Clerk's
Off ice in Trenton. The Foreclosure Unit rejected plaintiff's application,
because the notice mailed to defendant mortgag o rfailed to comply with
N.J.SA. 2A:50-58(aX2), which states [in pertinent part]: A debtor may
... mail to the lender a statement in which the debtor in good faith certifies
... that there is a reasonable likelihood that the debtor will be able
... to cure the default. ... This statement shall be sent ... to the address
of the lender who gave notice. [Emphasis added.] The notice, as discussed
above, advised the defendant to respond to the lender's counsel, and not
to the lender..Judge Boyle overruled the Foreclosure Unit and entered
judgment in favor of the plaintiff lender. He reasoned that the Legislature
did not intend that the statute should be read literally, so as to preclude
the mailing of notice to the lender's counsel. In support of its view,
the Court noted that elsewhere in the same section, it is said that"...
a lender shall apply for entry of final judgment... ". N.J.S.A. 2A:5058(a)(1)
[Emphasis added.]. A literal reading of the word "Iender" is not possible,
because most lenders are corporations, and corporations are prohibited
from practicing law. Therefore, the word "lender" must refer to the lender's
attorney. Similarly, the emphasized words in N.J.S.A 2A:50-58(a)(2) (quoted
above) should be interpreted to mean or include the lender's attorney.
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New
Endorsement Forms Approved by Commissioner
The New Jersey Land Tale Insurance Reding Bureau ["NJLTIRB"] has recently
had the following five (5) endorsement forms approved by the Commissioner
of Banking and Insurance: (1) Creditors' Rights Exclusion; (2) Mortgage
Assignment / Policy Update; (3) Mortgage Modification (ALTA No. 11); (4)
Spousal Transfer; and (5) "Fairway". Each one is discussed in turn below.
The Creditors' Rights Exclusion Endorsement serves to delete Exclusion
No. 4 of the ALTA 1992 Owner's Policy or Exclusion No. 7 of the ALTA 1992
Loan Policy, which are the socalled "creditors' rights" exclusions. The
endorsements have the eff set of transforming an ALTA 1992 policy into
an ALTA 1987 policy, because the sole difference between the 1987 and
1992 policies is the addition of the "creditors' rights" exclusion in
the latter. The exclusion is primarily intended to insulate the insurer
from claims arising from bankruptcy and similar matters, where it is contended
that the insured's title or mortgage may be set aside as a preference
or fraudulent conveyance, etc. See, e.g., 11 U.S.C. ¤¤ 544; 547; 548.
There are, however, a number of instances where the exclusion may be waived,
consistent with sound underwriting practices. For example, an arms' length
transfer to a bona fide purchaser, financed by a purchase money mortgage,
may not require the exclusion. In the past, as suggested above, waiver
of the exclusion was accomplished by the issuance of an ALTA 1987 policy
jacket. This is because N.J.S.A. 17:468-54 forbids modification of previously
approved forms. As result of the Commissioner's action, the ALTA 1992
policy jacket may be issued, with the exclusion deleted by the endorsement.
The charge for issuance of each endorsement is $50.00. The ALTA 1987 forms
have therefore been withdrawn as unnecessary. Of course, use of the endorsement
is not automatic. Each case must be evaluated on its merits to determine
if the underwriting risk is appropriate. The Mortgage Assignment / Policy
Update Endorsement ["MA/PU"], supplements ALTA Endorsements Nos. 10 (Assignment
of Mortgage - Validity) and 10.1 (Assignment of Mortgage - Validity and
Continued Priority). It is intended to be used in cases where a non-simultaneous
mortgage assignment occurs, and the assignee desires that the effective
dads of the policy be changed to the date of recording of the assignment.
It is similar to the ALTA No. 10.1; however, unlike the MA/PU, the ALTA
No. 10. 1 does not state that the effective date of the policy has been
changed. Of course, the assignee of a mortgage generally stands in the
shoes of the original mortgagee. Because the assgnment "relatesback" to
the mortgage's recording date, the assignee usually will enjoy the same
priority as the mortgagee, subject only to super-priority liens, such
as real estate taxes and certain environmental liens. The definition of
"insured" found in the Conditions and Stipulations portion of the ALTA
Loan Policy includes "each successor in ownership of the indebtedness".
Thus, even in the absence of the issuance of endorsement, an assignee
of an insured mortgage may assert a claim which could have been made by
the original insured under the policy, subject to whatever rights and
defenses the insurer may have. However, many lenders who purchase mortgages
feel more comfortable with endorsements reflecting their position. The
ALTA Nos. 10 and 10. 1 and MA/PU endorsements are intended to meet that
need. The Commissioner has approved a charge of $150.00 for the MA/PU
form, plus the reissue examination charge (currently $90.00) and applicable
pass 4 through charges. The additional search fees are needed because
the change in the policy's effective date requires the insurer to continue
the title search through the date of recording of the assignment. The
Mortgage Modificatlon Endorsement (ALTA No. 11) was adopted so that this
form - which is used on a national basis -would be available in New Jersey.
However, it is not the sole means of effectuating coverage when a mortgage
modification is insured. A now loan policy may be issued. or a form of
endorsement previously sanctioned by local custom may be employed. Although
ALTA No. 11 does riot specifically change the policy's effective date
to cover the recording of the modification, the goal of most lenders in
securing modification coverage is to gain assurance that the mortgage,
as modified, enjoys the same priority that it had prior to modification.
Of course, under N.J.S.A. 46:9-8.1 of seq., the validity and priority
of the mortgage is unaffected by most modifications. The important fact
to remember is that the Rate Manual requires under that a premium (in
accordance with ¤4.6.2 thereof) be charged when mortgage modification
insurance is desired. The charge for this endorsement must therefore be
calculated by using the table found in Rate Manual ¤4.6.2. The Spousal
Transfer Endorsement confirms the continuation of policy coverage in cases
where the original named insureds were husband and wife, and one spouse
subsequently convoys his or her interest to the other. However, the endorsement
is only effective if both spouses originally hold title. The charge is
$50.00. The "Fairway" Endorsement is so called because it addresses the
holding in Fairway Dev't Co. v. Title Ins. Co. of Minn., 621 F. Supp.
120 (N.D. Ohio 1985). In that decision, one of the partners in the named
insured entity, a general partnership, assigned his interest subsequent
to the issuance of the policy. When a claim later arose, the United States
District Court upheld the title insurer's denial of liability on the grounds
that the assignment of the partner's interest caused a dissolution of
the partnership, and thus policy coverage had ceased. There is no single,
standardized version of the "Fairway" Endorsement in use throughout the
country. NJLTIRB has received the Commissioners approval for two forms:
one for partnerships and the other for limited liability companies. In
both cases, the endorsements confirm the continuation of coverage following
a change in the composition of the partnership or LLC (as the case may
be), provided that the change does not cause a dissolution under applicable
State law. Most LLC statutes (including Now Jersey's, N.J.S.A. 42:2B-1
at seq.), permit members to transfer their interests freely, so this should
not present a problem. The continued existence of a general partnership
following a change in its composition is more complex, particularly in
jurisdictions (such as New Jersey) which have enacted the Uniform Partnership
Law. (See N.J.B.A. 42:1-1 at seq.) However, most practitioners believe
that if the partnership agreement permits assignment of partnership interests,
or otherwise provides for the continued existence of the entity following
a change in its composition, the partnership will not be dissolved. In
any event, the charge for issuance of the endorsement is $50.00
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Effective
Dates of RESPA Regulations
Changed In June, 1996, HUD promulgated "final" RESPA regulations which
were to have taken effect on October 7,1996. However, on November 15,
1996, HUD published a revised schedule in the Federal Register. As a result
thereof, the effective dates of the new regulations and related policy
statements are now as follows: Employee Compensation - until further notice,
but not earlier than July 31, 1997. [Thus, HUD's current If 992) regulation
remains in effect until at least July 31, 1997.) AISA ["Affiliates Business
Arrangements"] Disclosures -January 14, 1997. Repeal of CLO ("Computer
Loan origination"] Exemption and Establishment of CLO Standards -January
14,1997. Policy Statements on Joint Ventures (Sham AfBAs), Office Leases,
Employee Retaliation and Lender Lockout - June 7, 1996. For more information
on the RESPA regulations, see "Title Talk" No. 34 (Summer, 1996).
"Title Talk" is published
periodically by the Chicago Title and TICOR Title Insurance Companies,
and is distributed free of charge to their customers and friends. Steven
G. Day, Esq., State Manager, Publisher Lawrence J. Fineberg, Esq., State
Counsel, Editor Chicago Title Insurance Company TICOR Title Insurance
Company 111 Wood Avenue South Iselin (Woodbridge Twp.) New Jersey 08830
(908) 205-0055 - Fax: (908) 205-0330
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