• Legal Risk Management Manual For Foreign Business Startups In The United States
  • June 25, 2007 | Author: Ole R. Sandberg
  • Law Firm: Carlsmith Ball LLP - Los Angeles Office
  • This "manual" provides a foreign high tech company (hereinafter referred to as the "Foreign Parent" or "Parent") that is planning to attack the U.S. market a concise blueprint for dealing with the various and sundry legal issues it will typically be faced with in the startup phase. The time sequence reflected in the manual is no more than a rough approximation of the actual sequence of events in a typical case. The nature of the Foreign Parent's business, whether and to what extent it has already conducted U.S.-related business in the past, the budget available for legal risk prevention and many other factors may dictate deviations in any given case from the sequence we have chosen to follow here. Moreover, the various risk prevention measures we describe may overlap and are to a certain extent interdependent. They will therefore often have to be implemented concurrently rather than in sequence.


    There are some legal issues the Foreign Parent should ideally address well before it begins operations in the United States. Among them are certain immigration issues, some measures designed to insulate the Foreign Parent from the U.S. legal system, and certain measures designed to protect the Foreign Parent's intellectual property in the United States. Each of these issues will be discussed below. However, the very first thing the Foreign Parent should do is to establish a "Legal Risk Management Plan" in cooperation with a U.S.-based attorney.


    B. Establishing a Legal Risk Management Plan.


    It is impossible to eliminate all legal risk in connection with a business venture in the United States. Nevertheless, much of the risk can be neutralized, even for a Foreign Parent operating on a very limited risk management budget. The Foreign Parent and its local attorneys will not be able to assess the legal risk attached to business operations in the United States. It is therefore essential to obtain the services of a an attorney based in the United States who has experience in helping foreign companies navigate the U.S. legal system. Ideally, the attorney should be consulted at an early stage and if possible before the Foreign Parent does any business in the United States. The attorney should be asked to help the Foreign Parent establish a risk management budget, identify the most cost-effective risk reduction measures under the given budget constraints and allocate the risk management budget among the various measures. Almost without exception, the plan will call for the creation of a U.S. subsidiary in the form of a corporation or other limited liability entity (hereinafter, the "U.S. Subsidiary" or "Subsidiary").

    C. Immigration Issues.


    Immigration issues should be addressed at an early stage. While the United States is awash in marketing and management talent, there is a significant shortage of technical, engineering and scientific personnel. Some of the shortfall is eliminated by importing scientific and engineering talent from foreign countries. However, the U.S. immigration quotas available for such personnel are chronically inadequate. It can therefore be a significant advantage to have one's own home-grown supply of technical, scientific and engineering manpower. Many European countries, including all of the Scandinavian countries, have a built-in advantage in that regard in that they have a "treaty trader" arrangement with the United States. That means that individuals hired by the Foreign Parent who are citizens of the Foreign Parent's home country are likely to qualify for what is referred to as a "treaty trader" visa, or "E" visa. Such visas are generally far easier, faster and cheaper to obtain than other U.S. work visas. They are issued by the U.S. embassy in the foreign nation without the involvement of the U.S. Immigration and Naturalization Service, and do not require significant attorney assistance.


    It follows that the Foreign Parent can bypass many visa and employment problems by recruiting technical and engineering personnel for its U.S. operation among its country's own citizens. If, for example, a Norwegian company establishing a subsidiary in the United States has a choice between a Norwegian and a Swedish engineer for its U.S. subsidiary, immigration considerations would strongly favor the Norwegian candidate.


    D. Measures to Insulate the Foreign Parent from the U.S. Legal System.


    Most Foreign Parents doing business in the United States want to insulate themselves and their assets from the vagaries of the U.S. legal system. There are three layers of insulation available to a Foreign Parent that plans ahead: (1) the Foreign Parent may conduct its business so as to avoid direct exposure to the jurisdiction of U.S. Courts; (2) the U.S. Subsidiary may operate in such a way that the Foreign Parent avoids incurring liability for the U.S. Subsidiary's acts and omissions; and (3) the Foreign Parent may take advantage of the difficulty of enforcing judgments of U.S. courts outside U.S. territory.


    1. A Foreign Parent subjects itself to U.S. law and jurisdiction when it establishes certain "minimum contacts" with one or more states of the United States. For a business entity such "minimum contacts" will typically consist of sales to U.S. customers. Other activities, such as entering into a joint venture with a U.S. partner may have the same effect. Marketing to and solicitation of sales from U.S. customers by means of the internet or by other means (for example through magazine advertising directed to potential U.S. buyers) may be considered minimum contacts sufficient to create jurisdiction. Given the increasing use of the internet as a marketing medium, foreign business entities risk inadvertently subjecting themselves to U.S. jurisdiction by conducting business with U.S. customers even though they have no physical presence in the United States.


    Ideally, a Foreign Parent should therefore not do any business with U.S. customers until it establishes a U.S. Subsidiary through which to channel all its U.S. business. If the Parent conducts all of its U.S.-related business through its U.S. Subsidiary and maintains the Subsidiary as a distinct legal entity strictly separate from the Parent (see below), liability arising from the operations of the U.S. Subsidiary will normally be limited to the Subsidiary and its assets, while the Foreign Parent and its assets will be insulated from such liability.


    Even for a Foreign Parent that has already done enough business in the United States before it establishes a U.S. Subsidiary to create "minimum contacts" and subject itself to the jurisdiction of U.S. courts in whole or in part, it is still important to limit the Foreign Parent's direct U.S.-related business to a minimum. If the Parent's contacts with the United States are limited, the Parent may only be subject to "restricted jurisdiction", which is jurisdiction encompassing only claims arising directly from the Foreign Subsidiary's specific business transactions in the United States. However, if the Parent's business contacts are more frequent and occur over a longer period of time, the Parent may become subject to "general jurisdiction" which means that it can be sued in the United States courts based on any claim connected to the United States.


    2. Whether or not the Foreign Parent has transacted business with the United States in the past sufficient to establish jurisdiction, once the Parent decides to establish a business presence in the United States one of the first things to do is to form a U.S. Subsidiary in an appropriate state of the United States.


    How elaborate the construction of the U.S. Subsidiary should be initially will depend on a number of factors, among them (1) the budget available for "legal risk reduction" measures; (2) the amount of business the Foreign Parent anticipates in the United States; (3) how much of the Foreign Parent's total business activity will actually occur in the Unites States, (4) the potential liability already incurred as a result of the Parent's pre-incorporation business activities in the United States, etc. The formation of a U.S. Subsidiary is not an all-or-nothing proposition. There may be considerable protection in a mere shell corporation, if that is all the Foreign Parent can afford or is prepared to spend, because to "pierce the corporate veil", i.e. to persuade a U.S. court to disregard the corporate construction, is difficult and expensive under the best of circumstances. The "shell" may be gradually filled, as the business grows and the means become available. The protection the corporate form of the U.S. Subsidiary offers the Foreign Parent is strengthened as the Subsidiary takes on more and more of the trappings of a separate and independent business organization, such as increasing capitalization, a separate non-overlapping board of directors, employees who are not at the same time employees of the Foreign Parent, etc.


    3. Judgments issued by U.S. courts have traditionally been difficult or impossible to enforce in foreign countries. To the extent a judgment against the Foreign Parent is unenforceable outside the United States, the Foreign Parent's risk exposure in the United States is limited to the Foreign Parent's assets in the United States. If all U.S.-related business is conducted through the U.S. Subsidiary, such assets should ideally be nil.


    However, the protection inherent in the unenforceability of U.S. judgments outside of U.S. territory has shown some signs of erosion in recent years. Some countries (the four Scandinavian countries among them) now routinely enforce against its own citizens U.S. judgments resolving contractual disputes arising from contracts containing forum selection clauses designating the U.S. tribunal as the forum for dispute resolution. Moreover, the decisions of U.S.-based arbitration tribunals have long been enforceable in most foreign countries.


    If and to the extent the protection against enforceability of U.S. judgments abroad continues to erode, it obviously becomes increasingly important to insulate the Parent from liability by means of a fully distinct U.S. Subsidiary as discussed in Section D.2, above.


    E. Measures to Maintain the Legal Distinction Between Parent and Subsidiary.


    The guiding principle for a Foreign Parent that wishes to preserve the legal distinction between the Subsidiary and the Parent for liability purposes is to conduct the commercial interactions and transactions between the Parent and the Subsidiary "at arm's length", i.e. as nearly as possible in the manner that two independent entities of roughly equal bargaining power would transact business between themselves.


    Normally, the Subsidiary will, at least initially, act as the Parent's U.S. distributor. If so, there should be full-fledged contractual arrangements between the Foreign Parent and the U.S. Subsidiary similar to the arrangement one would expect to see between the Parent and an independent distributor. Thus, there should be a written distribution agreement spelling out the parties' rights and duties and providing commercially reasonable compensation to the Subsidiary for its sales in the United States.


    All corporate decisions affecting the Subsidiary should at least formally be made by means of the Subsidiary's corporate apparatus rather than by the Parent directly. Contracts with U.S. customers should all be in the Subsidiary's name. Customer support, service, etc. should be conducted by or in the name of the Subsidiary. To the extent that it becomes necessary to involve employees of the Foreign Parent in activities such as customer service and maintenance, the Subsidiary should purchase the services from the Parent for a commercially reasonable consideration. The Parent should conduct no direct business transactions in the United States.


    In order to preserve the Parent's protection from liability for the acts and omissions of the Subsidiary, it is also important to comply strictly with all corporate formalities. Meetings of the Subsidiary's board of directors and annual shareholders' meetings should be thoroughly documented, all important decisions should be documented as board resolutions, and so on. The Parent's control and supervision of the Subsidiary should be exercised pursuant to the Parent's rights as a shareholder and in accordance with the procedures prescribed by U.S. law and the bylaws of the U.S. Subsidiary.


    F. Contractual Structure.


    Both because of (1) the importance of maintaining the separation between the Foreign Parent and the U.S. Subsidiary, (2) the importance of limiting the contractual liability of the Subsidiary, and (3) in order to protect the Parent's intellectual property rights under U.S. law (see discussion below), it is of particular importance for the Parent and the Subsidiary to pay close attention to their commercial practices, and in particular to the form of transactions between the Parent and the Subsidiary.


    1. The maintenance of the legal separation between Parent and Subsidiary requires one or more contracts governing the commercial relationship between the Foreign Parent and the U.S. Subsidiary. In the typical case, the principal contract will be a distributorship agreement appointing the Subsidiary the Parent's distributor for the United States. It is important that the contract not have the effect of making the Subsidiary the Parent's sales agent because if the Parent conducts business by means of a sales agent it will ipso facto be doing business in the United States and thus become subject to U.S. jurisdiction.


    There may also be a need for other contracts between Parent and Subsidiary. For example, if the Subsidiary must rely on the Parent for customer support, product maintenance and updates, etc., the Parent's services should be governed by a written contract which should provide for commercially reasonable compensation from the Subsidiary to the Parent for services rendered.

    2. The need to limit the Subsidiary's liability vis à vis U.S. third parties requires an appropriate standard contract between the Subsidiary and its U.S. customers. It is essential to have at least the liability disclaimers in such contracts be prepared by a U.S.-based attorney. U.S. law governing a seller's right to disclaim liability ("warranty disclaimers") in some respects differs radically from that of "civil law" countries.


    3. For a discussion of the contractual and other protection of trade secrets and other intellectual property, see discussion in Section H, below.


    G. Insurance.


    Liability insurance is another high priority item. U.S.-based insurance companies provide "commercial (or "comprehensive") general liability" policies that provide surprisingly broad coverage for liability arising from commercial activity. For example, liability for infringement of patents, copyrights, trademarks and other intellectual property will often be covered. More importantly, the right to a legal defense at the insurer's expense is very broad. The mere possibility that a claim may be covered by the policy obligates the insurer to undertake the insured's defense, and the insurer must bear all the costs of the defense even if it is ultimately determined that the claim, in fact, was not covered by the insurance policy. Such policies are therefore often referred to as "litigation insurance" since they, above all, protect against the risk of having to pay litigation costs. In the early stages, the maximum coverage amount per occurrence may be kept at a fairly modest level - a coverage limit of, say, $50,000 or less may well be sufficient to cover the cost of litigation in most types of litigation. By keeping the coverage amount low, the cost of the insurance will initially be modest. As the Subsidiary's activities increase and its assets grow, the coverage limits may be increased correspondingly.


    H. Protection of Intellectual Property.


    The four main types of intellectual property that a Foreign Parent company may want to protect in the United States are (1) trade secrets; (2) trademarks and related rights, such as "trade dress"; (3) copyrights; and (4) patents.


    1. U.S. law provides much stronger protection for trade secrets of all kinds than most "civil law" jurisdictions. Just about any item of information, whether technical or commercial in nature, that is valuable to a business because it is not available to its competitors qualifies as a trade secret. Examples abound: production methods, recipes, customer lists, and business methods can all constitute trade secrets (or, as such information is often referred to in the United States, "proprietary information"), i.e. information that is not intended to be shared or made public.

    In order to preserve trade secret protection for its proprietary information, both the Parent and the Subsidiary must take reasonable steps to keep the information secret. Thus, all employment agreements, licensing agreements and other agreements requiring access to trade secrets must contain appropriate confidentiality provisions. Those confidentiality provisions must be carefully tailored in order not to be deemed invalid; otherwise the confidentiality, and thereby the trade secret, may be lost.


    Because of the extensive protection U.S. law accords trade secrets, whether to rely on trade secret protection rather than patent or copyright protection of intellectual property is often a much more difficult decision in the United States than in other jurisdictions. That is because a choice of either copyright protection or patent protection (you cannot get both) will usually require disclosure of a significant portion of the trade secrets associated with the patented device or the copyrighted software. Given the strong protection of trade secrets under U.S. law, trade secret protection is frequently the protection of choice over patent and copyright protection.


    A Foreign Parent that expects to do business in the United States in the foreseeable future and wishes to protect its existing trade secrets in the United States should observe the U.S. requirements for the preservation of trade secrets in its own country well before entering the U.S. market.  That is because failure to maintain the appropriate level of secrecy outside the United States will destroy the confidentiality and thereby the trade secret protection in the United States as well. For the same reason, a Foreign Parent that expects to do business in the United States within the foreseeable future may also want to think long and hard about seeking patent or copyright protection in its home country (or in other U.S. jurisdictions) since by doing so, it may forfeit trade secret protection in the United States.


    2. U.S. trademark law differs substantially from the trademark law of most other countries. In the United States, rights to a trademark is acquired through use, not by registration. Even though there are both federal and state registration procedures for trademarks, if the trademark is already in use in the United States at the time of registration, registration alone does not create a right in the trademark, and use of the trademark by the registrant may constitute trademark infringement. A Foreign Parent that wishes to use its trademark in the United States may therefore have to run a very thorough trademark search, not limited to the federal and state public registries but also including unregistered trademarks in actual use, to determine whether the mark is even available in the United States. If it is, then the Foreign Parent may obtain rights to the trademark in the United States in certain prescribed ways. Due to the emphasis on actual use over registration, securing trademark protection in the United States can be difficult and somewhat expensive.


    A recently formed Foreign Parent with plans to enter the U.S. market may therefore wish to consider the availability of a trademark in the United States before it chooses a global trademark, and take the necessary steps to protect the chosen trademark in the United States.


    As with so many other legal rights in the United States, so also for trademark rights - you either "use them or lose them." Failure to use a trademark, whether it has been registered or not will soon make the owner's rights to the trademark vulnerable to a claim that the trademark has been abandoned. It is also necessary to be constantly on guard against uses of the same or similar trademarks in other businesses to avoid "dilution" of the trademark.


    3. Patents and copyrights already acquired in the Foreign Parent's home jurisdiction are relatively easily extended to the United States through various mechanisms established by copyright and patent treaties. However, the mere fact that patent rights or copyrights have been acquired in another jurisdiction does not guarantee that the same or similar rights are available in the United States as well. On the other hand, U.S. patent law is far more liberal than that of other jurisdictions in granting patents for software and business methods than the law of other jurisdictions. Also, it should be kept in mind that for industries of international scope such as the computer industry and the internet industry, patent rights and copyrights can be of limited value if it does not include the United States.


    I. Employment Law Issues.


    Liability in employment matters has become of increasing concern for U.S. businesses. Parent and Subsidiary should therefore consider their employment strategies in the United States at an early stage. Clearly articulated employment policies and procedures are becoming increasingly important in order to avoid liability. It is also tempting to use independent contractors rather than employees to the extent possible, in order to avoid potential liability.


    J. Tax Law Issues.


    The Scandinavian countries all have Income Tax Treaties with the United States that resolves many potentially tricky tax issues for a Foreign Parent. The first tax issue that commonly arises is the issue of acceptable "transfer pricing." If the Parent and Subsidiary manipulates pricing for the exchange of goods and services between them for the purpose of minimizing taxes, the pricing may not withstand scrutiny by the federal U.S. tax administration, the IRS. To avoid those problems the best solution may be to engage an experienced Certified Public Accountant ("CPA"), who is ordinarily well informed about nuts and bolt tax issues. Moreover, it is wise to avoid too blatant "transfer price" manipulation for the additional reason that it could erode the wall separating Parent and Subsidiary and consequently bring the Parent under the jurisdiction of U.S. courts or make it liable for the acts or omissions of the Subsidiary, or both.


    K. Regulatory Issues.


    Any Foreign Parent planning to do business in the United States is well advised to conduct a survey of the regulatory landscape surrounding the proposed business. The regulatory regimen various from industry to industry, and here it is not possible to do any more than provide an example. Thus, one set of regulations that often comes as a surprise to Foreign Parents in the software business is the U.S. export control regime. Under the current rules, export of just about all software and related technical information from the United States requires an export license. Moreover, "export" is very broadly defined. If, for example, a Foreign Parent in the software industry sets up a software development subsidiary in the United States and then shares software developed in whole or in part by the Subsidiary with non-U.S. employees of the Foreign Parent, that is considered "export". Also, it would be a mistake to assume that only the export of particularly complex software or software of particular importance to the United States' military security is subject to export controls. U.S. authorities in charge of export controls have frequently applied the export control rules to products that were easily commercially available at the time.


    L. Conclusion.


    Given the right amount of planning, the Foreign Parent's connection to a foreign country may provide the Foreign Parent significant competitive advantage over its U.S. competitors with respect to the part of the Foreign Parent's business conducted in the United States. To secure these advantages, and to avoid fatal missteps, it is essential to prepare and implement a risk management plan at an early stage. Even in a rudimentary form, such a plan may mean the difference between success and failure of a foreign-based U.S venture.