Bruce Loren features 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?

The largest risk is protecting the parent company (or other subsidiaries) from exposing itself to liability for the debts and improper actions of its subsidiaries. When creating parent companies and various subsidiaries, a significant goal is to protect the parent and other subsidiaries from the liabilities of another entity in the chain. If created correctly, and managed correctly throughout the life of the entities, exposing one entity to the liability of another should be a manageable process, although it may not stop an adversary from including other related parties in a lawsuit.

The most significant risks are claims of fraudulent conveyance and/or piercing the corporate veil. Fraudulent conveyances are transfers of assets between entities for, among other things, less than fair market value. These assets are typically monies, but can also be customer lists, intellectual property and contracts. Entities may be susceptible to piercing the corporate veil claims when they ignore the typical corporate processes, such as annual meetings and documenting votes for corporate decisions.

The best way to avoid this risk is to treat each entity as completely separate and independent. Separate bank accounts, financial records and payroll are most important and often examined by a creditor. If sharing employees, overheads or office space, there should be written agreements (e.g. sub-leases, employee leasing agreements) between the related companies that include reasonable fees to be exchanged. Any transfers between related companies should be documented and consistently tracked through the accounting procedures of both entities. Loans should be documented with promissory notes and some rate of interest.

Required corporate procedures should be followed for each entity, including meetings of the owners and officers, timely creation of meeting minutes and resolutions and consistent, complete record keeping. The bottom line is to treat each entity as if it has no relation to the other to avoid the risk that one entity may be liable for the problems of another.

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?

Control by a parent over its subsidiary is not necessarily a problem, but the parties must avoid the appearance – and reality – that the subsidiary is not a separate legal entity with its own required corporate processes. Again, establishing the initial corporate structure and the processes for decision-making, and consistently following those requirements for the life of the separate entities is crucial.

First, the parent must consider the corporate form of entity of the subsidiary (i.e. corporation, limited liability company, etc.). Research and analysis should be complete before this initial decision is made to evaluate the risks and requirements of the governing jurisdiction. Assumptions and quick decisions should be avoided.

Second, the creation of the entity’s by-laws (i.e., the document governing how the entity operates and makes decisions) should be drafted with consideration of how much control the parent company desires over its subsidiary. Control should not be total. Unanimous decisions of owners, including the parent, may be used for some ultimate decisions, such as adding or terminating an owner – either through the purchase of interest or involuntarily – or selling all or most of the subsidiary’s assets. Other operational decisions and day-to-day events and operations should be left to the discretion of the subsidiary, although limits may be placed on those decisions through a majority vote of the owners.

Lastly, the more control the parent desires over a subsidiary, the greater the need for the appointment of an independent director or manager of the subsidiary. Independent directors or managers are not involved in the day-to-day operations but oversee the management through periodic reporting and evaluation of major decisions and the company’s financial position. The independent director, with his or her corresponding fiduciary duties, will provide a significant level of protection to the parent should a creditor, bank or governmental entity investigate whether a parent should be responsible for the actions or debts of its subsidiary.

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

The parent should understand that the more control it has over the subsidiary, the greater the risk that the parent may be held responsible for the debts or improper actions of the subsidiary. However, the parent should maintain as much control as possible, while insulating itself from the risks. After discussing the risks and benefits with the parent, the attorney should create the strategy in conformity with the parent’s goals. There is no standard answer to implement this strategy; a customised plan should be created after careful consideration of all relevant factors, including the level of trust in the management of the subsidiary, and the ability and ongoing desire of the parent to consistently follow that strategy.

In reality, the parent will want as much control over the subsidiary as possible. Some of the following examples may be used to gain control but manage the risk of subjecting the parent to the liabilities and improper actions of the subsidiary:

• Employment agreements with all the subsidiary’s management whereby individuals may be terminated without cause upon some notice period.
• Parent companies should never sign agreements relating to the subsidiary’s business, such as a lease. At most, the parent may sign a guarantee of the subsidiary’s obligations under agreements.
• If the subsidiary is using the employees or rental space of the parent or any of the parent’s equipment or services, there should be a written agreement between the two for fair compensation. This way, the parent may have some control over the expenses of the subsidiary without the risks of too much control.
• The parent company may have a majority representation on the subsidiary’s board of directors, so long as it is not full control.

Key considerations for multinationals operating in highrisk industries and jurisdictions:

• Educating the client regarding the length of the dispute process. Resolution of disputes through the judicial process in the US, and particularly Florida, will likely extend for many years. Scheduling court hearings may take months and is often used by parties as a tactic for the delay and to avoid complying with rules and court orders.
• Understanding the expected attorneys’ fees and costs to resolve disputes, even simple disputes of modest amounts. The judicial process is often only available to clients with significant financial resources. Attorneys’ fees are most often billed on an hourly basis, creating the need for the client to recognise and timely object to inefficient billing.
• Understanding the adversarial nature of the US judicial system and the extensive time that a client must devote to participating in that process. Clients and their personnel must gather and review a vast number of documents, respond to written questions, appear for sworn testimony before and during a trial with the expectation of cross-examination.

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