Conversions
§ 20.1Overview of Conversions under Texas Law
Texas allows a business to convert from one entity type to another, including converting from a foreign (non-Texas) entity to a Texas entity or from a Texas entity to a foreign entity. The process for both intrastate and interstate conversions is similar, although the formation documents for the new entity will differ based on the converted entity structure.
The Texas Business Organizations Code (TBOC) defines “converting entity” as the business that existed before conversion and “converted entity” as the resulting entity after conversion. Tex. Bus. Orgs. Code § 1.002(11), (12). A foreign business is a “non-code organization.” Tex. Bus. Orgs. Code § 1.002(56).
The conversion process generally requires several steps:
1.prepare—
a.the plan of conversion,
b.the certificate of conversion, and
c.the formation and organizational documents for the converted entity type;
2.have the conversion authorized by the required number of owners of the converting entity;
3.obtain tax clearance (if the converting entity is a Texas entity); and
4.either—
a.for an intrastate conversion, file the certificate of conversion followed by the formation document for the converted entity or
b.for an interstate conversion, file the certificate of conversion and formation document first in the state where the converted entity will be formed and then, once formed, file the certificate of conversion in the state where the converting entity previously existed.
PRACTICE TIP: Additional hurdles exist for conversions of non-code organizations. Texas, and many other states, requires that the conversion process for both Texas and the non-code entity’s formation state be followed. Tex. Bus. Orgs. Code § 10.102. This may mean the documents required (certificate of conversion, plan of conversion, and so on) will be slightly different. Many practitioners find it easiest to include the information required by Texas as well as any other state from the outset, to ensure ease of filing. In some jurisdictions, a conversion from one state to another is called a domestication rather than a conversion.
§ 20.2Applicability of Conversion Provisions of TBOC
The conversion provisions in TBOC chapter 10 are applicable to all entities (other than unincorporated nonprofit associations). The secretary of state imposes one filing fee for the certificate of conversion and another fee for filing the certificate of formation for the converted domestic entity. See Tex. Bus. Orgs. Code § 4.151.
The conversion provisions do not apply when a domestic limited liability company changes its purpose to become a professional limited liability company and vice versa. A certificate of amendment is sufficient to effectuate this change, because the term “limited liability company” includes professional limited liability companies, so the type of entity does not change.
An unincorporated nonprofit association is not authorized to engage in a statutory conversion under TBOC chapter 10. TBOC section 252.017 specifically provides that the only statutes that apply to an unincorporated nonprofit association are chapters 1 and 4 and, if a nonprofit association has designated an agent for service of process, the provisions of subchapter E of chapter 5. Accordingly, a Texas unincorporated nonprofit association cannot convert to a nonprofit corporation.
Although the elements of a plan of conversion are dictated by TBOC section 10.103, the plans have no uniform form. Often the plan will be contained in resolutions, a written action, or meeting minutes. The owners of the converting entity (whether shareholders, members, partners, or something else) must approve the conversion, as well as the management group (whether board of directors, managers, member-managers, or partners). The certificate of conversion and the formation document for the new entity will typically be included in the plan of conversion. As with a plan of merger, the plan of conversion can but is not required to be filed with the certificate of conversion. See forms 20-16 through 20-19 in this manual for sample plans of conversion for different entity types.
§ 20.3:2Certificate of Conversion
The certificate of conversion is the document filed with the Texas secretary of state. The certificate must include the statements required under TBOC section 10.154(b)(1), including the following:
1.the name, organizational form, and jurisdiction of formation of the converting entity;
2.the name, organizational form, and jurisdiction of formation of the converted entity;
3.that the plan has been approved;
4.the address of the principal place of business of the converting entity, and that the plan is on file there;
5.the address of the principal place of business of the converted entity, and that the plan will be on file there during and after conversion; and
6.that a copy of the plan will be furnished by the converted entity on written request and without cost to any shareholder or comparable interest holder of the converting or converted entity.
See Tex. Bus. Orgs. Code § 10.154(b)(1).
The certificate of conversion also must contain a statement that the approval of the plan of conversion was duly authorized by all action required by the laws under which the converting entity was incorporated, formed, or organized and by its constituent or governing documents. See Tex. Bus. Orgs. Code § 10.154(b)(2). The Texas secretary of state provides standard certificate of conversion forms that include the required information. These forms are specific to entity types, from conversion of a corporation to a general partnership to conversion of a foreign entity to a domestic entity. See section 20.4 below for further information.
While the organizational documents of the converted entity are included as part of the plan of conversion and are not required to be filed independently, the statutes anticipate that separate organizational documents for any domestic entity formed by conversion (other than general partnerships) will be submitted with the certificate of conversion.
Where an entity is converting from a Texas entity to a non-code entity, the conversion will also need to comply with the rules and requirements of the new jurisdiction’s laws, including the formation documents.
§ 20.3:3Franchise Taxes; Tax Clearance
The secretary of state cannot accept a certificate of conversion if the required franchise taxes of the converting entity have not been paid. See Tex. Bus. Orgs. Code § 10.156. If a converting entity is a taxable entity under the franchise tax statutes and the converting entity is not in good standing for purposes of the conversion, the secretary of state must refuse to file the conversion. See section 20.8 below for additional guidance regarding tax issues.
PRACTICE TIP: A printout obtained from the comptroller of public accounts’ online franchise account status search is not sufficient evidence of tax clearance pursuant to TBOC section 10.156. A practitioner must obtain a certificate of account status from the comptroller or include a statement in the certificate of conversion that the converted entity will be liable for the payment of all franchise taxes (see Texas comptroller form 05-359, available via https://comptroller.texas.gov/forms).
§ 20.4Secretary of State Conversion Forms
As noted above, the secretary of state publishes certificate of conversion forms that comply with the provisions of the TBOC. These forms are not designed for cross-statutory transactions and are entity-specific: SOS Forms 631 through 634 are used when the converting entity is a for-profit or professional corporation; SOS Forms 635 through 638 are used when the converting entity is a limited liability company; and SOS Forms 641 through 644 are used when the converting entity is a limited partnership. SOS Form 645 may be used to convert a professional association to a professional limited liability company. A domestic general partnership, including a general partnership that is registered as a limited liability partnership, seeking to convert to a domestic filing entity may use SOS Form 646. (See forms 20-1 through 20-14 in this manual.)
The secretary of state does not have a form for the specific purpose of “domesticating” or converting a foreign entity to a Texas entity of the same type. The secretary of state has, however, a summary (SOS Form 647, form 20-15 in this manual) that includes general information and a checklist for a conversion of this nature.
The secretary of state conversion forms do not include a plan of conversion or a certificate of formation for a converted entity that is to be a domestic filing entity. When drafting the certificate of formation of a converted entity that is a domestic filing entity, include the additional statements required under TBOC section 3.005(a)(7) and see the plan-of-conversion forms 20-16 through 20-19 in this manual.
§ 20.5Abandonment of Conversion
Subchapter E of chapter 10 of the TBOC governs the abandonment of a conversion that has been approved but has not become effective. A certificate of conversion is effective on filing with the secretary of state, unless the effectiveness of the transaction is delayed pursuant to TBOC section 4.052.
The abandonment of the transaction is subject to any contractual rights and would be abandoned in the manner set forth in the plan of conversion. If the plan does not contain a provision regarding the procedures for abandoning the plan, the plan of conversion would be abandoned in the manner determined by the governing authority of the domestic entity. See Tex. Bus. Orgs. Code § 10.201. An abandonment of a conversion need not have the approval of the domestic entity’s owners or members. If the conversion has been filed with the secretary of state, the domestic entity must file a statement of abandonment in accordance with TBOC section 4.057, the general provision applicable to any filing instrument filed with a delayed effectiveness. See Tex. Bus. Orgs. Code § 10.202. The abandonment must be signed on behalf of each entity that signed the certificate of conversion. See Tex. Bus. Orgs. Code § 4.057(c).
PRACTICE TIP: On filing of a conversion instrument with a delayed effective date or condition, the secretary of state records the filing and takes necessary action at that time to create new entities, change the status of converting entities, and change names when amended by the filed document. Consequently, when a statement of abandonment is submitted as permitted by law, the secretary must determine whether the former name of any entity is available or whether the organizational documents need to be amended to change the name. See Tex. Bus. Orgs. Code § 4.057(e); 1 Tex. Admin. Code § 79.82. If the likelihood exists that the parties might abandon a transaction, consider filing a name reservation for the prior or former name of a merged entity that may need to be reactivated.
When the effectiveness of a document is conditioned on the occurrence of a future event other than the passage of time (delayed effective condition), the entity is required to file a statement with the secretary of state within ninety days from the date of execution of the instrument to effect the transaction evidenced by the filing. See Tex. Bus. Orgs. Code §§ 4.052–.055. Failure to file the statement regarding the satisfaction or waiver of the delayed effective condition does not effect an abandonment of the filed document. To abandon the document, a certificate of abandonment must be filed with the secretary of state.
§ 20.6Common Errors to Avoid in Conversions
§ 20.6:1Submitting Certificate of Formation before Certificate of Conversion
Submitting a certificate of formation to form the domestic “converted” entity before submission of the certificate of conversion may require the practitioner to redraft and restructure the transaction as a merger with the newly created entity as the surviving entity. However, for interstate conversions, practitioners should remember to submit the certificate of conversion and the formation documents to the new state in which the converted entity will be formed before submitting the certificate of conversion to the old state (converting entity state).
§ 20.6:2Failure to Include Additional Statements in Formation Document
Failure to include additional statements relating to the conversion in the formation document of the converted entity is a frequent error. The formation document of a converted entity must include—
1.a statement that the entity is being formed pursuant to a plan of conversion and
2.the name, address, date of formation, and prior form of organization and jurisdiction of organization of the converting entity.
See Tex. Bus. Orgs. Code § 3.005(a)(7).
PRACTICE TIP: If the converted entity is a domestic filing entity and you are using an SOS form for the converted entity, the additional required statements may be set forth in the “Supplemental Provisions/Information” section of the promulgated form.
§ 20.6:3Failure to Ensure Tax Clearance for Converting Entity
Avoid failing to ensure tax clearance for the converting entity (if a Texas entity) either by including the appropriate tax certificate or by including a statement relating to the payment of such taxes by the converted entity.
§ 20.6:4Failure to Comply with Other Jurisdiction’s Requirements and to File Documents in Correct Order
For conversions that involve a foreign jurisdiction, both the Texas and the foreign jurisdiction’s requirements must be met. It also should be noted that, for a conversion from one state to another, generally the conversion paperwork should be filed in the new state first, followed by the correct paperwork in the old state to convert out and terminate the entity in the old state. Failure to follow the proper sequencing can result in delays in processing with one state or another.
PRACTICE TIP: Some jurisdictions call certain types of conversions “domestications” and others “conversions.” Practitioners should always check the governing statute of the jurisdiction to confirm which type of conversion or domestication requirements apply based on the type of conversion.
PRACTICE TIP: Conversions are not a common type of filing, and many states do not allow them to be filed online. Additionally, state agencies handling filings (for example, secretaries of state) are not always familiar with filing requirements. Allow extra time for questions as well as for mailing or hand delivering the conversion documents. If you are unsure how to file the required documents or if documents were rejected, call the secretary of state, department of state, or similar organization.
§ 20.7Tax Results of Converting Entities
For domestic as well as foreign entities, a conversion may result in a change in tax status. A CPA should be consulted during the conversion process to advise on any tax consequences for the entity.
PRACTICE TIP: Conversions of companies taxed as partnerships to corporations and vice versa present particular challenges because this type of transaction may be deemed a sale and liquidation of the company (with income tax due on the gain to the owners). In some situations, from a tax perspective, forming a new entity, a merger, or both may be the better choice than converting the company.
§ 20.8Problems with Tax Clearance
Failure to obtain tax clearance for the transaction is a common reason for rejection. Texas law requires the secretary of state to determine that a merging or converting entity subject to franchise tax has paid all taxes due before the merger or conversion can be accepted and filed. See Tex. Bus. Orgs. Code § 10.156. The secretary of state will require tax certification or the alternative statement for merging and converting taxable entities. Tax clearance also is a condition for acceptance under the merger and conversion provisions of prior law. The requirement for tax clearance is not limited to specific entity types; consequently, this requirement applies to any taxable entity that is a nonsurviving party to the merger or the converting entity in a conversion.
The secretary of state suggests two alternatives to avoid last-minute refusal to file the merger or conversion for tax reasons:
1.Submit the merger or conversion with a certificate of account status from the comptroller of public accounts for each merging or converting filing entity that is a taxable entity. If the merging or converting entity is a passive entity, provide a statement or certification from the comptroller that the entity is not a taxable entity. A certificate of account status provided for a merging or converting entity must specifically indicate that it is for the purpose of merger or conversion.
2.Include in the plan of merger or conversion, or in the alternative statement provided in lieu of a plan of merger or conversion, a statement that one or more of the surviving, new, or acquiring entities will be responsible for the payment of all fees and franchise taxes and that all of such surviving, new, or acquiring domestic or foreign entities will be obligated to pay any fees and franchise taxes if not timely filed.
§ 20.9Corrections to Mergers or Conversions
The usual correction to a filing instrument concerns only a single entity. In the case of a filing instrument that involves multiple entities as parties to the transaction evidenced by the instrument, however, certain procedures should be taken to facilitate processing.
Only one correction filing is required to correct errors in a merger, conversion, or exchange filing instrument. If the practitioner is using SOS Form 403 (form 4-6 in this manual) to submit the certificate of correction, the best practice is to enter the name and file number of any surviving entity to a merger, the converted entity in a conversion, or the acquiring entity in an interest exchange in the field that asks for the name of the entity submitting the correction instrument.
The certificate of correction should also include the name and file number of any merging filing entities, the name and file number of the converting entity, or the name of each acquired domestic filing entity, as applicable. The additional names and file numbers may be included on the form itself or provided as an attachment to the form. Failure to include the names and file numbers of the other filing entities will not be grounds for refusal of the correction instrument; however, providing the additional information saves the secretary of state time and ensures that the correction instrument is properly indexed.
Even though the correction instrument may apply to multiple entities, the certificate of correction need not be signed by all parties that were required to sign the instrument being corrected. It is sufficient if the correction instrument is signed on behalf of a surviving party to the merger, the converted entity in a conversion, or an acquiring entity in the interest exchange.
The fee for filing the certificate of correction is $15 regardless of the number of entities that may be affected by the correction instrument.