By Tuomo Kauttu, Aliant Finland. Beyond the exceptional risks, visible in news over the past few months, what are the general key-risk related concerns that arise in a cross-border context, and how can a parent company minimize such risk? What degree of control should a parent company have over its overseas subsidiaries, and what constitutes the right balance between risk and liability?
As regards contract issues, business activities in foreign jurisdictions generally create similar concerns to the parent company as those of cross-border transactions. Secondly, when estimating the level and importance of the degree of control, it is first necessary to clarify the definition of “control of a foreign corporation”. Thirdly, the parent company and its overseas subsidiaries are separate legal entities, incorporated under the corporate laws of each country, and the character or determination of “corporation” in various jurisdictions is not identic.
When representing a client with significant business activities in foreign jurisdictions, the key risk-related concerns are generally related to the structure of the transaction. Such concerns include risk intensive conditions of the agreement, controversial issues between the agreement and mandatory laws, conflict of laws, implementation, and liability issues.
After agreeing on an optimal structure given the different considerations of the parties, negotiations regarding the business transaction can proceed rationally. When determining the transaction, the parties should consider relevant issues that may influence the structure, including implementation, tax, and liability.
From the parent company’s perspective, governing law, dispute solutions, and liability are typical provisions that need additional consideration in an international context.
Generally, the main focus of negotiations is on comparisons between the courts or arbitration tribunal of the parties’ countries or alternatively, the choice of a third jurisdiction. In addition, the parties may agree on an alternate dispute resolution provision. The ADR provision is also usually favorable to the party most likely to present claims.
In general, the parties have the autonomy to select the law governing their contracts, while the parties are also free to agree on a dispute solution. Nevertheless, such autonomy can be restricted and choice may be invalidated by mandatory local rules of law or applicable conflict law. The same applies to implementation of the resolution or judgement, obtained in the dispute.
Regarding liability, mandatory local rules of foreign jurisdictions, and the recent trend of broadening the bases of liability internationally, also create risks to the parent company, located in another jurisdiction.
In order to estimate the degree of control, it is first necessary to clarify the definition of “control of a foreign corporation”.
While such definitions vary by jurisdictions, there are, however, some basic common rules. Generally, controlled subsidiary refers to a foreign corporation that meets a stock ownership test. In many cases, such a test is met if more than 50 percent ownership of either the total combined voting power of the foreign subsidiary’s stock entitled to vote, or if the total value of the stock is owned by the domestic parent company.
When determining “stock owned”, you can consider only the stock owned directly or also the stock owned indirectly, and you may or may not consider constructive ownership.
Consequently, “control” of the subsidiary may affect the parent company’s immunity regarding the owners’ isolation against liability. Such risk of “piercing the corporate veil” means that the corporate structure with its attendant limited liability of stockholders, may be disregarded and personal liability gets imposed on stockholders in the case of wrongful acts being carried out in the name of the corporation. Among other things, degree of control may be one of the aspects that should be considered regarding such liability. Such “control” has also an influence to taxation aspects. It may result in a tax obligation to the parent company on its foreign subsidiary’s income and earnings tax, even if not distributed.
Thus, the optimal degree of control by parent company over its overseas subsidiaries varies case by case, taking into account on the one hand business reasons, and the risks related to legal aspects, such as liability and taxation on the other. Business reasons may require a maximizing of control and power on the decision making of the foreign subsidiary. Conversely, minimizing risks regarding liability and tax issues may require that the test of “control of a foreign corporation” shall not be met as the case may involve various jurisdictions.
The parent company and its overseas subsidiary are both separate legal entities, incorporated under the corporate laws of each country with a non-identical characterization of “corporation”. However, a business entity known as “corporation” generally includes business entities with factors of centralization of management, continuity of life, free transferability of interests, the objective to carry on business and divide profits, and limited liability.
Limited liability is an essential factor for both the parent company and its subsidiary company. Generally, both companies carry their own liabilities and risks, and the parent company should not be liable for risks related to its subsidiary, nor should the subsidiary be liable for the risks associated with the parent company. Therefore, a total separation constitutes the right balance between risk and liability for a company and its overseas subsidiary.
However, the parent company typically owns 50%-100% of the stock of its subsidiary. Thus, the parent company has always the risk of losing its contribution to the subsidiary’s equity and capital.
Exceptionally, overseas operations and businesses of companies may require that the subsidiary and the parent company share the risks and liabilities. Typically, the parent company may guarantee a loan taken by the subsidiary, or undertakes to answer for the debt, default or miscarriage. On rare occasions, the subsidiary may do the same for the parent company. Furthermore, the parent company may provide security for the subsidiary or guarantee the subsidiary against losses. To the extent that business reasons require such a commitment, this naturally, constitutes the right balance between risk and liability for a company and its overseas subsidiary.