How to Keep Your United States Subsidiary Out of Legal Trouble

by Michael Volkov

Stephen I. Siller from LeClariryan is our guest contributor today.  Stephen is a member of the corporate services and international transaction practices.  His bio can be viewed here.

For international companies seeking to tap into the American market through U.S.-based acquisitions or existing subsidiaries, the cost of compliance slipups can be high indeed. This is true whether the parent is a tech start-up from Asia or a 100-year-old multinational from Europe, South America, Australia or Africa. In rare cases, in fact, a subsidiary’s missteps can bring financial ruin to the parent. 

Regardless of whether they are publicly traded or privately owned, international companies face the challenge of making sure their U.S.-based subsidiaries comply with internal corporate governance structures as well as those of the United States and the home country. Public companies must also pay heed to the rules of any stock exchanges to which they or their subsidiaries belong. Much of the risk resides in the differences between and misapplication of the rules and regulations of the various authorities by which the entity is governed.

Subsidiaries operating in the United States, for example, become subject to the quite-broad U.S. laws dealing with bribery, bans on dealing with prohibited organizations and countries, and more. Both parent companies and their U.S.-based subsidiaries need to be as sensitive to these differences as possible. They can ill afford to operate based on unquestioned assumptions – for example, “we have always done it this way; surely, it’s the same in the states.” 

Establish the scope of authority

Establishing the scope of authority for the U.S. subsidiary—essentially, what its officers and directors can and cannot do without approval from the parent—is a good foundation for a compliance strategy. In the run-up to the 2008 financial collapse, for example, some parent companies basically gave their U.S. subsidiaries blank checks for things like capital expenditures, or unwittingly allowed subsidiaries to double-down on risk by doing sketchy deals involving the likes of derivatives, swaps, currency hedges and foreign-exchange contracts. Particularly if the parent company is in a commodities-based business, it should place unambiguous limits on hedges. In the aftermath of the Wall Street meltdown, some foreign companies were ruined by their U.S. subsidiaries’ unsupervised involvement in high-risk deals and in some cases, failing to hedge in a volatile commodity market.

Pay attention to systemic differences

Generally speaking, international companies are well aware of tax strategies when making investments in the United States and of the basic pitfalls of the U.S. litigation system. Less well understood, however, are the differences between the principles-based legal system of, say, Europe or South America, and the rules-based, common law-derived system that prevails in the United States. International parent companies might want to make sure the terms and conditions of their U.S. entities’ contract forms comport with American law and business norms.

For example, the employment rules in Europe and South America are a world apart from those in the United States. If the American subsidiary relies on a European contract form in an employment negotiation, the employee may well walk away from the table with an unnecessarily favorable contract in hand.  Likewise, it is imperative that subsidiaries understand basic concepts of corporate law as practiced in the United States. In Europe, for example, directors act for the company. In the United States, officers take the active, day-to-day role. When subsidiaries are structured as though they were European entities, asymmetry and confusion can result. 

Because their legal systems may rely more on broad principles than thickets of specific rules, non-U.S. companies usually need far more accountants than attorneys. In stark contrast, the United States now boasts one lawyer for about every 340 citizens. Thus, foreign companies would be well-served to align their U.S. operations with American norms which, for better or worse, means engaging more lawyers. It is much less expensive to invest in a lawyer as you go on a “preventative maintenance” basis than to try to do “damage control” after an acquisition goes bad or a major lawsuit ensnares the parent.

Understand the nuances

Part of the challenge here is to make sure decision-makers at both the parent and its subsidiaries truly understand the nuances of doing business in the United States. For example, whenever a multinational wishes to make an investment in a foreign country, it might consider whether the U.S. government offers any benefit (such as political risk insurance) to making that investment through the U.S.-based subsidiary. One of the best ways to avoid high-risk mistakes is to rely on an American participant who understands the foreign company’s culture, values, legal system and way of doing business and—equally important—is empowered to help the parent and the subsidiaries understand U.S. business and legal norms. As liaison, the American participant needs to know how to point out that which needs to be changed, and how to implement change, without giving offense.

In many spheres of life, both business and personal, bad communication or miscommunication is often the cause of many problems. At the end of the day, the parent will want to put a priority on making sure the subsidiary—whether homegrown or acquired—truly is informed, sensitive and culturally (or cross-culturally) compatible. The channels of communication must stay open and clear. Ultimately, this will help the subsidiary be better prepared to engage in the delicate balancing act of complying with the dictates of multiple governing entities. Informed corporate governance should be a substantial part of any company’s risk-management strategy. The problem, in other words, is not the differences between our respective legal systems or business cultures; it is ignorance of those differences and failure to understand and cater to them

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Michael Volkov, The Volkov Law Group | Attorney Advertising

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Michael Volkov

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