Mercedes Clavell & Roger Canals 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?

When any company is planning to invest abroad, risks to be taken into consideration vary depending on the scheme chosen: risks related to direct investment schemes – incorporating a subsidiary abroad – differ significantly to those related to indirect investment schemes.

In a direct investment scheme, the main risks to be considered are:

• To meet regulatory requirements to carry out any given business activity at the destination. The proliferation of macro-economic regions around the globe has entailed a significant rise in regulatory requirements to set up almost any kind of activity – not only those traditionally regulated. Thus, a preliminary regulatory due diligence at the destination is highly advisable.
• Labour statutes: when planning to engage employees abroad, it is crucial to know the local statutes and regulation on labour and social security, as there may be significant differences in the regulations of countries belonging to the same economic region.
• To create a corporate scheme to protect parent companies from potential contingencies arising out of investments abroad. As there is an inherent financial risk in investing abroad, it is important to implement a corporate scheme at a destination that provides firewalls to the parent company in case of subsidiaries’ failure/bankruptcy. For instance, under EU insolvency statutes, a mother company may become liable for subsidiaries’ debts if they become bankrupt.

Tax issues and cost of profits’ repatriation.

In an indirect investment scheme through a contractual framework other risks, in addition to regulatory requirements, that should always be carefully studied, must be considered, include:

• As commercial agreements could be a source of litigation, efficiency and independence of local state courts should be carefully looked at in terms of length of procedures, judgements’ enforceability and injunctions of debtor’s assets. Depending on the reliability of local courts, it is highly advisable to opt for arbitration.
• Setting up contractual provisions to ensure an adequate degree of control over the local partners – suitable auditing procedures on sales and income, payments’ insurances, caps to indemnifications/compensations in case of early termination, etc.
• Transfer of risks conditions and customs.

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 answer is, in principle, easy: the degree of control should be as high as possible, being limited only when the controls become a hindrance for the business itself.

We could find different degrees of control in multinational groups, mostly depending on the age or seniority of the group:

• Nowadays, thanks to globalisation and technology, many start-ups quickly become a multinational group. In general, this type of group grants wide authorities to the local management, as they focus more on growing than controlling. My advice to these groups is to implement this very easy control measure: the accounting and legal services providers should be different and independent companies appointed by the parent company, not by local management, and these service providers should report to the parent company, not to local management, except for day-to-day matters. When auditing services are needed, they should also be appointed by and report to the headquarters.
• In big and well-consolidated groups controls are implemented usually at four levels: management, accounting, banking and legal (apart from the operations itself):

1. Local management is usually granted limited authority.
2. A single but sophisticated accounting tool is implemented in all subsidiaries, allowing the parent company to verify directly each subsidiary’s accounts.
3. Thanks to online banking, the parent company has access to and can operate all subsidiaries’ accounts.
4. The parent company’s legal counsel, which has wide and deep knowledge of the company’s activities, and experience obtained from the challenges faced in different jurisdictions, co-ordinates the work of the foreign legal advisors to align them with the company’s goals.

The implementation of these control measures requires a certain degree of experience at the headquarters’ management and staff to avoid becoming a hindrance, because of an excess of control or control wrongly applied for the development of the group’s activities.

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

In our experience business opportunities abroad may create tensions between business managers who seek turnover and income and tend to minimise the potential impact of legal risks at the destination, to in-house legal departments, who in such contexts tend to be set aside by business managers.

In these sorts of contexts, it is key to provide appropriate legal counsel to managers to give them a clear picture of the potential risks involved in any given transaction, and the feasibility/possibilities that such risks occur. Depending on the degree of risks detected, it is even advisable to waive the transaction. For instance, high-risk for the parent company to be fully liable of subsidiaries’ debt, regulatory requirements implying disproportionate investment costs, failure of the contractual counterparty to provide adequate collaterals to ensure payments.

Examples of such risks – not properly assessed before starting activities abroad – include:

• Unexpected costs to meet local regulatory requirements (environmental standards, urban planning requirements, etc).
• Unexpected labour costs when dismissing key managers/employees at the destination.
• Financial losses due to lack of suitable collaterals provided by debtors to ensure contractual payments.
• Financial losses due to inefficiency and/or unreliability of local courts (or not subjecting disputes to arbitration).

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

Map your risks: Legal risks could come from regulatory issues, customers, purveyors, management, workforce, minority shareholders or other stakeholders, other business matters like competition from other players, the political situation, financial crashes or lack of judiciary independence.

The risk from regulatory issues is probably one of the biggest threats and could vary widely depending on the business sector. These include authorisations to develop the activity, data protection, environmental, land planning, corruption, exchange controls, customs duties, taxation, etc.

Risks from customers and purveyors could be reduced – but in general never completely avoided – through good quality legal documents. Disclaimers and general sale conditions are essential in agreements with clients.

Choose the correct legal counsel: easily available, clear and concise in their answers, understanding when practical advice is needed or when a thorough analysis is requested, aligning with the company’s goals in each transaction and finding the right balance between avoiding risks and getting the deal done.

To read the full publication, please click here.

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Contributing Advisors