Top Labor and Employment Law Issues When Taking your Start-Up Global

by DLA Piper

Our colleague Ute Krudewagen has put together a list of some key labor and employment issues to consider if and when you decide to take your US-based emerging company to overseas locations.

So you are ready to expand?

Your start-up is off the ground and running, U.S. offer letters and confidentiality agreements have been signed and compliance policies have been implemented.  It’s now time to hire your first employee outside the U. S.  This seemingly easy task is often easier said than done.  For many emerging companies, the road to a global workforce is paved with potholes.  How can you prepare for the Friday afternoon call from a frantic HR manager who wants to hire a salesperson who will go to a competitor if he doesn’t have an offer in his hands by Monday morning?  Can you afford to lose the candidate, and all the great opportunity that the candidate represents to the business?  How do you respond when asked about a sales representative who received an offer three months ago and has since then been working in Brazil, while being paid directly from the U.S.?  These issues are part of running an international business, however, with the right preparation and planning, these speed bumps can be leveled before they escalate.

The five issues Ute discusses for growing employers to consider before going global are:

  • Doing Business and Tax Considerations, Including Corporate Structure
  • Will you Expand by Hiring Employees, Independent Contractors, Third Party Agencies or Expatriate Employees?
  • Payroll & Benefits Processes and Costs, Including Witholding on Taxes and Social Charges (similar to Social Security)
  • Employment Agreements & Policies
  • Managing the Exit Strategy – Probationary Periods, Lack of At-Will Employment, Notice Periods and Severance

Issue 1: Employment, Doing Business and Tax Considerations.  The discussion about how to properly set-up your business in a foreign jurisdiction starts with corporate and tax considerations.  Many countries have ‘doing business’ laws that require a company that is engaged in business in the jurisdiction to obtain a business license and/or formally set up a corporate presence (such as a subsidiary, branch of representative office) in that country.  Similarly, there is a risk that engaging permanent employees may translate to the creation of a permanent establishment or a taxable presence in the jurisdiction in which the company engaged the employee, with the attendant tax consequences.  Engaging  individuals in sales roles typically creates a higher risk in that regard than engaging non-sales individuals, both because salespeople may actually create revenue in the jurisdiction at issue, and because they may have authority to make binding sales offers on behalf of a foreign entity.

Even if you can overcome any concerns about doing business or tax exposure (or are willing to run the risk after determining that the presence in the jurisdiction is very limited), some foreign jurisdictions still require a local corporate presence before employees can be hired.  For instance, Brazil, China and Russia all require a corporate presence as a prerequisite to enrolling  an employee in their mandatory social security systems.

All that said, as you explore business opportunities in a new jurisdiction, it is not uncommon to “skip” the legal entity set-up, and work on an interim arrangement to get somebody “on the ground” quickly.  Some companies set-up a holding company under their ultimate U.S. parent to at least serve as a “buffer” to some of the liability.  While not ideal, as long as it is carefully monitored, such types of interim solutions are a fairly common way to enter a new market.  The threshold issue is how to classify your first hire.

Issue 2: Type of Hire.  Like in the U.S., it is important to determine how to classify the individual and the engagement. Getting this right from the outset is crucial, or employment liabilities can be significant.

Employees.  Like the U.S., most foreign jurisdictions define an employee as an individual working under the direction and control of the employer, in exchange for compensation.  If you are a start-up, be very cautious when engaging individuals without compensation, or for equity only, since many jurisdictions have minimum wage and overtime requirements.  That said, as mentioned above, not every jurisdiction requires a local entity to be set up to lawfully engage en employee.  Most of Europe, for instance, permits a foreign company to engage a local hire through a foreign company.  In that scenario, all you need to do is to obtain a payroll ID and set-up payroll, and then comply with all applicable labor and employment laws, thereby avoiding the hassle of setting up a corporate presence before you can lawfully bring an employee on board.

Independent Contractors.  Misclassification is one of the few topics in global labor and employment law that is handled consistently around the globe.  If an individual were misclassified in the U.S., that individual is likely misclassified globally as well.  What looks and quacks like a duck is a duck.  In most jurisdictions, the factor of direction and control is most important, so if there is a need to direct and control an individual, integrate her into the organization,  and provide regular supervision, then she is unlikely to qualify as an independent contractor.  Like in the U. S., liabilities for misclassification internationally can be significant, including liabilities for failure to withhold taxes and social charges and liabilities for failure to grant employment rights, as well as criminal liabilities in a few jurisdictions.  If the individual were engaged in sales, be aware of local sales agent rules, which apply all throughout Europe under the Commercial Agents Directive, and in much of Latin America under local sales agent laws, and may impose termination notice and indemnification rights to such individuals.

Third Party Agency / PEO Employees.  If an individual were misclassified, engagement through an agency or professional employer organization can provide some relief, since that agency may be properly compensating that individual.  Such an engagement is not without pitfalls globally, though, since many foreign jurisdictions impose limitations and requirements on the engagement of employees through agencies.  For example, under the EU Directive applicable to temporary agency workers, agency workers are entitled to equal pay rights.  Other jurisdictions impose limitations on the time period for which agency workers can be engaged, or what types of roles can be filled with agency employees.

Expatriate Employees.  Seconding an individual from the U.S. appears to be an easy solution, but often creates pitfalls as well.  For instance, a business visa may not be appropriate if the individual is going to work in the foreign jurisdiction full-time, and without a local sponsor, a work permit is usually hard to get. Most tax treaties require payment of local taxes after 183 days or more in the foreign jurisdiction.  In those cases, both the employee and the employer may be subject to local withholding liabilities.  Also, most jurisdictions will deem that local labor and employment laws apply to foreign individuals regularly performing services (there is no bright-line rule as to what that “regularly” means, but it could be as little as 1 day or as much as 1-2 years).

Issue 3: Payroll & Benefits.  In virtually all jurisdictions, there is a requirement for the employer, whether a foreign company or a locally registered corporate presence, to set up payroll in the jurisdiction at issue, and to make mandatory withholdings for applicable income taxes and social charges.  This can result in significant additional employer cost, with up to 46% employer social charges in jurisdictions such as France, for instance.  Costing this out early through a local payroll provider, or U.S. payroll provider with international operations, is crucial.

The good news is that additional benefits are often not mandatory or expected overseas, since the statutory social welfare systems in many countries will provide protections that are not necessarily commonplace in the U. S.  That said, various jurisdictions (e.g., France, Italy, Spain, Brazil, just to name a few) have mandatory industry-wide collective bargaining agreements that may impose requirements to enroll employees in specific pension funds or provide yearly mandatory salary increases (in Brazil in the last few years usually around 10% or more).  Thus, it is essential to be aware of country-specific nuances.

Issue 4: Employment Agreements & Policies.  While short at-will offer letters are common in the U.S., the concept of at-will employment is not recognized internationally.  Instead, most employees will receive a much longer formal employment agreement.  Various jurisdictions (e.g., Belgium, France, Russia) require translations or the agreement will not be enforceable.  Often, the agreement needs to be signed before the commencement of the employment relationship so that certain restrictive clauses (such as post-termination non-competes or probationary periods) are enforceable against the employee.  Accordingly, issuing that U.S. offer letter on a Friday night may not be wise.  If the situation is such that you need to send “something” to a potential hire very soon, then your best option is to make your offer clearly contingent upon execution of a proper employment agreement.

Duplicating the employee handbook that you use in the U.S. is not a good idea either.  U.S. policies simply do not translate globally, and, in the worst case, give the employee the possibility to “double dip” seeking both contractual rights under U.S. law plus local statutory rights.  In most instances, there is no need for a handbook until you have grown significantly (e.g., France requires internal regulations at 20 employees, Belgium does at 1 employee, and Japan and Korea require work rules at 10 employees), or you can use a more limited set of policies in line with what is required or expected under local law (such as a UK disciplinary and grievance policy).

Issue 5: Manage the Exit Strategy.  And what if, six months down the relationship with that wonderful sales person you just had to hire, he actually turns out to be just a terrible employee?  No sales made, no relationships forged, meaning it’s time to part ways.  And to add insult to the injury, this typically happens just a few weeks after the probationary period has expired (if you were prudent enough to issue a proper employment agreement containing such a provision).  As mentioned, the concept of at-will employment just doesn’t exist outside the U.S. and (with the exception of just a handful of jurisdictions, there is nothing even close to it).  Instead, all terminations require proper grounds (for instance, performance issues – which must often be excruciently carefully documented; redundancy – which often requires a look at global lack of profitability, not only a desire to restructure the role; or misconduct – which typically requires something as bad as documented bribery or proven theft from the employer).  In addition, employees are typically entitled to notice, severance and some form or other of termination process.  You may be left with no option other than to carefully negotiate an exit, typically with significant payouts.  Releases are not enforceable in all jurisdictions either (e.g., Brazil).  Lessons learned?  Implement a probationary period where permissible (and track its expiration!), carefully monitor and document performance issues early on, and simply be prepared to slow down instead of overhire.

A client of mine once said that her mantra since starting to deal with international workforce issues is to take off her hat as a U.S. employment lawyer, put on her international hat, and assume that nothing she takes for granted when dealing with her workforce domestically will apply abroad.  There is quite some truth to this approach.  The good news is, though, that with some basic understanding of how things are different internationally, and foresight when expanding abroad, global labor and employment issues can be handled successfully.

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.

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