Joshua Chu & Dominic Wai both feature in the IR Global & ACC collaboration Publication “A Jurisdictional Guide of how to Manage Risk in Multinationals”

QUESTION ONE – When representing a client with significant business activities in foreign jurisdictions, what are some key risk-related concerns that arise in a cross-border context and how can a parent company minimise such risk?

One of Hong Kong’s key competitive advantages when compared with other financial centres within the Asia Pacific Region (“APAC”) lies in Hong Kong being the common law gateway into Mainland China. Aside from being the gateway point into Mainland China, Hong Kong’s commonwealth heritage means that Hong Kong inherited a number of valuable/advantageous tax regimes which can also be found in other commonwealth jurisdictions (e.g. the British Virgin Islands, Cayman Islands).

Unlike the island nations, however, Hong Kong is unique in having a strong reputation for possessing a well-developed regulatory regime (the Securities and Futures Commission (“SFC”)) is a world-class organisation that surrounding regional jurisdictions often look up to.

Thus, Hong Kong’s strong reputation in having a stable rule of law coupled with being the host of APAC’s premier tier 1 financial centre means that most multinational companies (“MNCs”) will come to Hong Kong to establish lay-over entities (e.g. Holding Companies) before setting up Wholly Owned Foreign Enterprises (“WOFE”) in their target jurisdictions.

Just like any union of relationships (e.g. marriages), when MNCs set-up shop in Hong Kong they only envision a bright future with their collaborating partners. Common pitfalls therefore include:

• Lack of a well-defined shareholder’s agreement with dispute resolution mechanisms (e.g. deadlock clause, jurisdiction, etc);
• Lack of clearly defined employment relationship between MNCs and local partners; and
• Lack of clarity of WOFE’s right to use various Intellectual Properties (“IP”) belonging to the MNCs.

The failure to anticipate future disputes means that:

• There exists unrealistic expectations on both sides with MNCs often treating local partners as mere employees; local partners, in turn, see themselves doing most of the work but receiving disproportionate rewards;
• Disputes escalate out of control quickly (there being no mandatory dispute resolution mechanisms – the lack of deadlock mechanisms means lack of clarity for both sides – both sides thinking themselves as righteous party with good prospect of success).
• Upon the breakup of a relationship – common item disputed includes IP (e.g. whether local partner should retain control and right to use IP).

QUESTION TWO – What degree of control should a parent company have over its overseas subsidiaries? How does the degree of control impact the risk exposure level, and how can control issues be managed to minimise liability?

• The degree of control that a parent company should retain vs. autonomy and allocation of risk has been an age-old dilemma faced by many multinational corporations.
• It is trite that the greater the control, the greater the culpability of responsibility. After all, at the heart of all non-contentious legal practices lies the concept of risk allocation.

To illustrate, it goes without saying that the legal representative of, say, a PRC subsidiary will hold substantial power over the PRC subsidiary. A legal representative will essentially be able to represent the PRC subsidiary in transactions, make legal decisions that will be binding regardless of whether the remaining foreign director agrees with their action or not (holding the Emperor’s seal so to say).

On the flip side, the legal representative will also be the first line in terms of absorbing liability, even personally. Hence the phrase, the greater the power the greater the responsibility.

Foreign multinational entities when setting up overseas subsidiaries often make the incorrect decision of minimising their control over their WOFE (no one wants liabilities). This again is often a decision made on hindsight without regards to the possibility that the legal representatives will turn against the MNCs.

The result usually – once there is a dispute, MNCs face a wholly foreign-owned enterprise (WOFE) running amok (with their local partners being able to continue to control and run the WOFE pending resolution of the dispute).

It is, therefore, a balancing exercise for MNCs. From a litigation perspective, it is recommended that risk should be managed at the outset, usually via a properly designed and drafted shareholder’s agreement.

It is also highly recommended that whilst WOFEs are ultimately subsidiaries of the multinational entity, they are separate legal entity nonetheless. To manage the IP risks, the necessary licencing agreements should also be prepared. It is better to spend the resources at the beginning to prevent disputes than to pay for the long and uncertain legal process.

QUESTION THREE – What constitutes the right balance between risk and liability for a company and its overseas subsidiary? What examples can you give?

As explained, the right balance between risk and liability should be allocated by way of a shareholder’s agreements and licencing agreements. The shareholders can also spell out rights, responsibilities and expectations.

Ultimately, the best balancing exercise that a multinational entity can hope for is dispute prevention (which can be prevented when parties enter into a relationship with clarity on role and expectations). The proper procedure for dialogue (e.g. dispute resolution clause) will have a good chance at mitigating conflict at an early stage. After all, it is never good to be penny smart but pound foolish.

In summary, a shareholder’s agreement will remove potential dispute. An employment agreement will give clarity of role. Proper licencing of IP will mean that MNCs will have secured their rights adequately.

Key considerations for multinationals operating in high-risk industries and jurisdictions:

Business agreements are all about risk allocations. Key considerations multinational corporations (MNCs) should include:

• Nature of collaboration relationship between MNCs and local partner. Is the local partner a local person, or is the local partner someone from HQ? Is the relationship that of a partnership or employer/employee?
• Employment relationship. Often times when MNCs become too distant, local partners might see the business like theirs.
• How is the MNC’s IP protected?
• Moreover, the proper forum of adjudication of dispute should be stated (e.g. by way of an arbitration clause) given that local Courts can only deal with the matter within their jurisdiction. A way around this problem is arbitration which can deal with cross border issues.

If you would like to read the full publication, please click here.