A lawsuit filed in Pulaski County Circuit Court challenges the secretary of state’s ability to block tens of thousands of individuals from establishing new corporations when they owe debts for old ones.

Using a statute passed into law in 2001, the office refuses to accept new papers of incorporation filed by individuals who have significant interests in former corporations whose statuses were revoked for not paying franchise taxes, said Alex Reed, a spokesman for Secretary of State Mark Martin.

There are 147,094 entities currently in revoked status. According to a report from October 2012 that listed 155,643 entities with revoked statuses, the total amount of taxes, late fees and interest owed was about $81 million.

A corporation doing business in Arkansas is required to pay franchise taxes based on the nature and value of the company. Even the smallest corporation pays at least $150 a year in franchise tax.

When a company’s certificate of good standing is revoked, it can still operate in the state but its standing may affect its ability to obtain loans and conduct other business transactions, Reed said.

To dissolve a corporation,a representative must file an application with the secretary of state’s office and pay any due franchise tax. It’s a formality that many in Arkansas have skipped.

Sherwood attorney A. Vaughan Hankins argues in the lawsuit that the statute and policy “seek to unlawfully restrict the freedom of citizens to participate in lawful activities to coerce the payment of delinquent taxes from individual persons who are not liable for the payment of such taxes.”

“Franchise taxes are taxes on an entity; they are not taxes for which individual persons are responsible. Furthermore, individual stockholders, members or officers of the entity are separate and distinct from the entity,” Hankins wrote.

Hankins is representing Pulaski County real-estate developer Byron McKimmey in the lawsuit. McKimmey tried to form a limited-liability company under the name Miller’s Heights Development LLC, and submitted the paperwork and a $50 filing fee on July 11, according to the lawsuit.

Martin’s office refused to file the Articles of Organization to create the corporation, and an employee informed McKimmey that he was a member of another corporation, CR Investments of Arkansas LLC, that owed delinquent franchise taxes, the lawsuit states.

After paying the delinquent franchise taxes, as well as late fees and interest, from 2011-13 totaling $578.74, McKimmey and his business partners tried a second time to file the Articles of Organization with the secretary of state’s office, according to the lawsuit.

Martin’s office again refused the documents, stating that they had found additional companies that listed McKimmey as a member and which owed delinquent franchise taxes, the lawsuit states.

McKimmey responded by filing the lawsuit Wednesday.

Reed said the office is working to file an answer to the lawsuit in court. But, he said, the office was operating under the authority of Arkansas Code Annotated 26-54-114, which states that “no person shall be allowed to file any initial forms or documentation with the Secretary of State to create any legal entity in the State of Arkansas or to obtain authority to do business in the State of Arkansas if that person is substantially connected to any corporation or limited liability company that owes past-due franchise taxes to the Secretary of State.”

Janet Harris, a spokesman for state Auditor Charlie Daniels who worked under Daniels when he was secretary of state before Martin, said the policy was also used during his administration.

Harris said companies were responsible for the franchise taxes from only the previous three years - the same look-back period used by Martin’s office and outlined in the statute.

“That was consistent with what the law required,” Harris said.

Robert Steinbuch, a professor at the W.H. Bowen School of Law at the University of Arkansas at Little Rock, said Hankins’ filing is “intriguing” and that he had raised some important issues.

In most cases, “the individual is not subject to liability of the corporation,” Steinbuch said. “Here we see a bleed over between the identity of the business entity and its owners.”

Steinbuch said he was not familiar with the statute used by the secretary of state before reading the lawsuit but that the reasoning behind it, on its face, is good.

“I appreciate the thinking behind the policy because we have seen historically that the existence of a corporation can give rise to wrongdoing by individuals,” he said.

But Steinbuch said the judge hearing the case may address only whether McKimmey was connected enough to the corporation to be held responsible for the taxes under the statute and not answer the question of whether the tax is an “illegal exaction” that would violate the Arkansas Constitution.

“I strongly suspect that the court will address the first question and not need to address the second question, which is the more complicated question,” Steinbuch said.

Reed said the office is moving forward with a franchise tax amnesty program, approved by the Legislature this year, which is designed to shrink the rolls of companies with revoked statuses.

Act 1041, sponsored by Sen. Eddie Joe Williams, R-Cabot, allows the office to waive penalties and interest for delinquent franchise taxes if a company’s representative takes part in the program between Sept. 1 and Dec. 31.

Reed said he wasn’t sure how many companies would take part in the program but he hoped for 100 percent participation.

“I hope that everybody who wants to take advantage of it will,” Reed said.

Front Section, Pages 1 on 09/02/2013