Track 704Major Legal Issues in Managing

International Subsidiaries

ACC International Legal Affairs Committee18 October 2016

Outline• Before You Establish a Foreign Subsidiary• Form of Entity and Ownership Percentage• Management Issues and Control• Governance• Business Management• Back Office Support• EU Employment• Employment Laws in Asia• Support for Manufacturing Facilities• Terms and Conditions for the Sale and Movement of Goods• US Laws and Regulations with Extraterritorial Impact• Crisis Created by Adverse Publicity, Natural Disasters and Civil &

Criminal Actions• Exit Strategy• Addendum: Model Plan and Checklist

Before You Establish a Foreign Subsidiary

• Have a decision-making and approval process and follow it.• Is this a new jurisdiction or just a new subsidiary?• Do you really need a new subsidiary?

– Weigh alternatives such as billing from another country, using billing/office services of an existing local company.

– Consider the time is takes to set up a new subsidiary, do not start too early or too late...

– Consider not only the setup costs but also operations, maintenance and exit expenses.

Before You Establish a Foreign Subsidiary• Some things to consider:

– Business purpose.– Type of entity.– Ownership structure/governance/management.– Permits and licenses to do business.– Visas and work permits.– Taxes.– Capitalization and currency issues.– Law, regulations and intellectual property protection.– Anti-corruption controls; compliance.– Culture.– Risk management.– Exit Strategies.– What else can go wrong?

Form of Entity and Ownership Percentage• Things to consider:

- Entity’s business.- Wholly-owned subsidiary or branch?- JV or other form of multi-owner entity?- Identity of shareholders (avoid personal share-holding).- Understand local ownership requirements.- Financing requirements; ease of fund repatriation.- Regulatory requirements.- Control: from headquarters or local/regional?

Management Issues and Control• Wholly-owned/Branch.

– Parent company’s requirements, policies, procedures, accounting practices, etc.

– Ensure compliance with parent company standards• Tone at the top

– At a minimum, establish standards.• Global standards or local?

• Joint Venture (partnership or other form of multi-owner entity).– Each party typically has a different view of how the venture should

operate.– Anything from “hands off” by owners to one owner taking a

predominate position.

Management Issues and Control• Establish the rules up front. Considerations:

– Know your partner.– Financial contribution.– Local laws and regulations.– Risks

Management Issues and Control• Avoid disproportionate responsibility.

– Example: own 33% of a venture and have contractual responsibility to appoint and employ the entity’s general manager.

• Can you really have a “hands off” relationship?– Danger of parent/owner involvement without control. – Who’s responsible in time of crisis?

• Some US laws such as sanctions and export controls have extra-territorial application.

• Management: ex-pats, local residents or combination?

Governance• Creating New Entities.

– Form of entity.– Selection of officers and directors.– Liability of directors, officers, managers and legal representatives.– Authority of individuals, especially signatory rights and cash control.– Local residency requirements for directors.– Background checks.– Compliance and anti-corruption training.

Governance

• Managing Existing Entities.– Annual meetings, filings, local representatives, coordination of legal,

tax and finance issues. – Selection of legal counsel:

• In-house or law firm?• Privilege issues?• Is there no attorney privilege in the jurisdiction?

– Compliance with corporate policies.– Reporting procedures; e.g. legal proceedings (threatened or

existing).– Differences in level of formalities:

• Required (actual vs telephone meetings, written consent, approval of financial statements).

Governance• Coordination with headquarters:

– Establish clear reporting lines.– Establish communications expectations, especially if local

management.• Frequency of communications.• What must be communicated.• Crisis communications and management.

– Remote control/supervision of ban accounts, checks and petty cash.– Data privacy rules.

• What information can be transferred across borders.• Set up appropriate procedures to facilitate data transfers.

Business Management• Local laws and customs.

– Language requirements and practical needs• Terms and conditions for purchase and sale of goods and services:

practices vary greatly by jurisdiction. – Parent’s/owner’s terms or the subsidiary’s terms?– Credit arrangements?– What happens when customers don’t pay?– What happens when the subsidiary doesn’t pay?– Do non-negotiated terms and conditions apply to a transaction?– enforceability of specific terms such as limitation of liability.

• Germany: limitation of liability without exclusion for personal injury and death not enforceable.

• Turkey: if document is not signed by both parties it has no effect.

Business Management• For the entity:

– Physical location requirements– Licenses required– Taxes in addition to corporate entity requirements

• For the business– Additional licenses (manufacturing, import, or industry related)– Understanding statutory and customary terms that apply to

contractors, distributors and advisors– Restrictions on expatriating cash

Business Management

• Statutory liability issues for manufacturers and distributors vary, and particularly with respect to consumer products.

• Collections procedures in the country.– Evaluate credit checks and payment terms differently in the

jurisdiction.– Simple processes such as use of Dun & Bradstreet.

• Credit/business reports may not always be readily available.

Back Office Support• Handling the day-to-day needs.

– Including human resources, accounting, financial control, legal, purchasing, sales & marketing.

– Are there requirements for in-country licensing of certain professions?

– Is it practical to provide back-office support from afar?

• Remote access to the parent company’s systems and third parties.– ERP.– Financial institutions. – Expense of redundant system if access not provided.

EU Employment

• EU labor law defines rights and obligations of workers and employers.• EU labor law covers two main areas:

– working conditions:• working hours, part-time & fixed-term work, posting of

workers.• informing & consulting workers about collective redundancies,

transfers of companies, etc.• EU policies in recent decades have sought to achieve high

employment & strong social protection, improve living & working conditions, and protect social cohesion.

Source: European Commission

EU Employment

• The EU complements policy initiatives taken by individual EU countries by setting minimum standards.

• In accordance with the Treaty (Article 153), the EU adopts laws and directives that set minimum requirements for:– working & employment conditions,– informing & consulting workers.

• Individual EU countries can provide higher levels of protection.

Source: European Commission

EU Employment• The EU adopts directives which its member countries incorporate in national

law and implement. – National authorities (labor inspectors and courts) enforce the rules.

• The European Court of Justice & labor law– Whenever a dispute before a national court raises a question of how to

interpret an EU directive, the court can refer the issue to the Court of Justice of the EU.

– The European Court then gives the national court the answers it needs to resolve the dispute.

• The Commission confirms that EU directives are incorporated into national law and ensures through systematic monitoring that the rules are correctly implemented.

• When the Commission considers that an EU country has not incorporated a directive into national law correctly, it may decide to start infringement proceedings.

Source: European Commission

Employment Laws in Asia• As many sets of laws and regulations as there are countries.• What is required in one country isn’t in another.• Examples of recent changes:

– China: PRC Employment Contract Law, strict enforcement of labor dispatch regulation, and impact of two-child law on female employees.

– Japan: amendments to the Worker Dispatching Act, Act to Advance Women’s Success in their Working Life.

– Korea: draft guidelines for greater labor flexibility.– Malaysia: increased minimum wage.– Singapore: enhanced employment rights, changes in court

enforcement of post-termination injunctions.

Support for Manufacturing Facilities

• Reliance on third parties to obtain or renew licenses, approvals, certifications to operate.

• Selecting suppliers for the entity.• Who’s responsible for due diligence of third parties?• Are third parties retained by parent/owners or by the legal entity?• Are goods produced only from materials sourced locally? • Transportation and storage.

US Laws and Regulations with Extraterritorial Impact

• Foreign Corrupt Practices Act (15 U.S.C. §§ 78dd-1, et seq.)• Export Administration Regulations (15 CFR Chapter VII, Sub-chapter C)• International Traffic in Arms Regulations (22 U.S.C. 2778; 22 CFR 120-

130)• SEC reporting requirements (17 CFR 210, et al)• Depending upon your products:

– DEA regulations– FDA regulations– EPA regulations– CITES– Conflict Minerals

• And many others.

Crisis Created by Adverse Publicity• Who controls the process? HQ or local?• Yellow journalism.

– The truth isn’t there and the facts are distorted or missing.• Do you respond and if so, how?

─ PR firm?─ Press conference?─ News release?

• Official action such as prosecutorial investigation instigated by false or misleading reporting.─ Meet and explain?─ Avoid danger; use local law firm to handle inquiry?

Crisis Created by Natural Disasters

• Who controls the process? HQ or local?• Recovery plan.

– Get facilities and offices stabilized and operational.• Personal protection and security plan.

– Identify employees’ locations, safety and health status. • Obtain insurance against natural disasters, human threats (e.g., Kidnap

and Ransom insurance) and report immediately when crisis happens.)• Emergency financial plan.

– Obtain cash/credit as needed to stabilize the business and support employees’ needs.

Crisis Created by Civil and Criminal Actions

• Who controls the process? HQ or local?

• Civil Actions:– Shareholder lawsuits.– Allegations of environmental damage.– Claims of supply chain malfeasance; i.e. child labor, indentured servitude, etc.

• Government criminal investigations:– US: FCPA– UK: UK Bribery Act– Germany: German Criminal Code (Strafgesetzbuch) Sections 331-338 (bribery in

public office), 299-302 (bribery in commercial business transactions) and 108b-198e (electoral bribery), China:

– China: Anti-Unfair Competition Law and China Criminal Code

Exit Strategy

• Terminating contracts.- Beware of potential statutory damages.

• Providing required notices to and obtaining permissions from government agencies.

• Providing required public notices. • Terminating employees.

- Beware of potential statutory damages.• Settlement of debts and disputes.• Disposition of facilities.• Liquidation of local entity / sale of shares / merger.

AddendumModel Plan and Checklist

Model Plan

• From time to time, Company ABC considers hiring an employee in a new jurisdiction, developing a sales and marketing function in a new jurisdiction, or considering other business activities in a country in which Company ABC does not own an entity.

• Legal, Finance and HR and the business will work together to analyze the various issues and develop a check list for forming the new entity.

• The following summarizes the issues to be considered, to make sure the issues, costs and risks are reviewed before making a final decision.

Model Plan• Identify business justification for new entity:

– Common justifications include needing to hire a new sales employee or develop a distribution center or new project in the country.

– Justification should include whether sales/invoicing will be done by the entity or whether the activity will be solely marketing.

– The business may also consider the projected rate of return for the new entity.

– When estimating start-up costs, expenses to consider include, legal fees, tax consulting fees, registration/government fees, ongoing payroll administration, annual reporting/taxes, lease/registered agent fees, bank fees, financing costs and insurance premiums.

Model Plan• Selection of type of entity:

– Tax and Legal will consider the various entity types available in the jurisdiction (such as corporation, LLC, representative or branch office).

– In addition to the tax consequences, legal issues such as liability of directors, governance requirements, logistics and fees will be considered.

– Corporate Finance should be notified of plan to create a new entity so that global reporting systems will be updated.

• Consultants:– Legal will identify of outside counsel in the local jurisdiction.– International Tax, the business and HR will determine if other

consultants are necessary (Tax, HR, etc.)

Model Plan• Ownership structure:

– Tax and Legal will determine the proper ownership structure for the entity.

– Considerations include withholding taxes on dividend payments, tax treaty availability, capital gains taxes on disposal of the entity and withholding taxes imposed on the capital gains, impact and availability of the disregarded entity rules (including on merger and reorganization provisions), APB 23 assertion utilization and availability of foreign tax credit relief at the parent company level.

Model Plan• Governance:

– Company ABC has a standard list of directors for new entities.– In some jurisdictions, a specified number of directors must be

resident in the jurisdiction and this list may need to be adjusted.– Regional management must also decide what level of authorization a

local employee should have.

• Trademarks:– Review with business leaders which products and trademarks are

expected to be used in the region. Check with Legal for trademark registrations in the jurisdiction.

Model Plan

• Bank Account: – Some jurisdictions require a local bank account before an entity can

be registered. – In other cases, the bank account can be opened when it is

convenient. – Treasury coordinates bank accounts for our subsidiaries.

• Leases:– Some jurisdictions require that office space be leased before an

entity can be formed.– In some cases, a service organization can provide the lease. In other

cases actual space must be identified. – Other jurisdictions do not have a physical presence requirement, and

we can delay decisions about leasing space until after the entity is formed and employees are engaged.

Model Plan• Employees:

– Payroll: HR resources for the region will work with Tax and Legal to determine if a payroll service will be required, and if not, how payroll will be handled including number of payroll payments per year .

– HR will select payroll service provide and Legal will provide input on service provider agreement.

• Legal:– Legal and HR will work with outside counsel to determine whether

an employment agreement is appropriate (or required) and understand the local employment laws applicable to the new employee (probation periods, termination issues, visas (if applicable), benefits and holidays).

– HR will work with the business on the various employment agreement issues (such as job title, duties, probation period, expenses, and compensation), considering the differences when an employee will be hired locally or will move from an existing location.

Model Plan• Employees:

– Pension Plan: HR will determine whether to offer a supplementary pension plan and its subsequent structure following a review of local market practices

– Insurances: HR will determine whether to offer insurances (disability, life) in accordance with local market practices.

– Company car: HR to decide on the allocation of a company car and liaise with a local lease company to make the necessary arrangements.

Model Plan• Initial capitalization issues:

– International Tax and Legal will determine the minimum initial capitalization required and the appropriate source and currency for funding.

– International Tax and Treasury will determine the proper mix of capital or debt funding, based on local country requirements and thin capitalization rules.

– If debt will be used, International Tax and Treasury will determine the best source for intercompany lending based on Company ABC’s cash positions and on withholding rates for interest payments.

Model Plan• Other treasury issues:

– Treasury and Legal will determine what currency exchange controls exist and whether the new entity will participate in cash pooling arrangements.

– International Tax will determine if payments can be made and deducted for regional headquarter services.

– Corporate Finance will determine the appropriate source (cost center) for funding pre-formation expenses.

– Treasury will determine whether to add the subsidiary to global insurance policy and whether to investigate local insurance.

Model Plan• Timing issues:

– Legal typically will engage outside counsel in the jurisdiction. This may take several weeks.

– The amount of time required to form an entity, and to begin operations varies from jurisdiction to jurisdiction.

– At the beginning of the process, legal will obtain input from outside counsel to assist the business in developing a timeline.

– Jurisdictions vary whether the new entity must be established before an employee is hired, or whether an employee is necessary for the formation.

Model Plan• Post Formation Issues:

– Treasury will determine functional currency and consolidation needs.– Reporting: An individual or third party service provider will be

identified to be responsible for accounting for the new entity as well as meeting annual reporting requirements.

– Intercompany services agreement: • if appropriate, intercompany agreements for services, or HQ

services will be put in place. – Internal notifications:

• Provide location information to GTC, Tax, and any additional employee who participated in the formation process once entity or representative office is registered.

• Provide entity information to Corporate Finance, Regional Finance, HR.

ChecklistIssue Timing Responsible Function (also identify individual)

Identify Business Need

Identify project team

Pre-Formation notifications: International Tax, Regional Finance, Legal, Corporate Finance,

Selection of Outside Counsel Legal

Entity Choice Legal International Tax

Entity Formation (including determination of governance, capital requirements, ownership structure)

Legal, International Tax, HR

Trademark review Global Marketing, Legal

Budget

Hiring; including employment agreement if applicable HRLegal

Payroll HR, Legal

Lease

Benefits (to the extent applicable: car; insurance; pension) HR

Bank Account Treasury

Insurance

Determination of exchange controls

Loan agreement (if applicable)

Internal Company ABC notifications

Intercompany Agreements

Entity Accounting

Entity annual filings (tax, corporate)

Summary Check list