Tips for foreign-owned U.S. companies to reduce legal costs and risks as recovery takes shape.
All companies large and small, domestic and international, have been affected by the international Covid-19 pandemic. The pandemic has caused extensive disruption to international travel and commerce, led to delinquencies in rental payments and other debt obligations, lay-offs, international visa and tourism restrictions, and numerous other economic hardships.
In the United States, two rounds of Small Business Administration Paycheck Protection Program (PPP) loans have been granted to many companies, including foreign-owned U.S. companies. In many cases, the loans have been forgiven by the SBA and do not need to be repaid, alleviating some of the financial strain from the pandemic.
Although some industries have been hit much harder than others, the pandemic has put particular stress on international businesses operating in the U.S. There is, however, light at the end of the tunnel.
With the mass Covid-19 vaccination efforts in the United States and around the world, there is every reason to expect that many foreign-owned companies may be able to ramp up or expand U.S. operations soon. As the world opens back up, foreign-owned U.S. companies can take steps to rein in costs and sidestep potential landmines in a post-Covid environment.
Reduce tax costs related to Delaware incorporation
Most foreign-owned U.S. businesses are incorporated in Delaware for various corporate and tax reasons. Not every Delaware-incorporated entity, however, is paying the appropriate Delaware franchise tax.
If a foreign parent is the sole or primary owner of the U.S. subsidiary, there is no reason why the U.S. subsidiary should pay more than the minimum franchise tax of $175. There are numerous instances of small- to medium-sized U.S. subsidiaries that are paying much more than $175 in annual taxes, in some cases as much as $40,000 in annual franchise taxes.
This excessive tax is the result of the type of share structure used when the U.S. subsidiary was formed. A share structure which encompasses separate classes of stock, such as common and preferred, or having millions of authorized shares, will generally result in a high franchise tax bill from Delaware. While such a share structure may be appropriate for a growth company that is raising capital from venture capital and private equity investors, it is usually a poor choice for a foreign parent-owned U.S. subsidiary.
Any U.S. subsidiary that is paying more than $175 in annual franchise tax should strongly consider changing its share structure with an amendment to the certificate of incorporation. Cost savings can also accrue in having the U.S. subsidiary serve as its own registered agent, rather than paying a third-party for such services. While not possible in all states (including Delaware), it is an option in many states and can result in substantial savings, especially if the U.S. subsidiary is qualified to do business in multiple U.S. states.
Capture state business tax incentives
It is tempting to view the United States as one large nation, but from a legal and corporate perspective, the United States is more like fifty smaller nations. States often compete against each other, using tax incentives and rebates to attract businesses that plan to create jobs in that state. This includes foreign-owned businesses who should compare and contrast the cost of doing business in one state versus another. Foreign companies who take advantage of tax incentives and rebates can substantially lower their costs to enter new markets and accelerate growth.
Adopt WCAG 2.0 standards for websites
Unfortunately, in some areas in the United States, law enforcement has become the province of aggressive plaintiff's lawyers rather than federal or state government attorneys. One such instance is digital website accessibility compliance.
In short, many U.S. courts have ruled (and the Department of Justice has taken a similar position) that websites are public accommodations under the Americans With Disabilities Act (ADA). This means that websites used in the U.S. should have screen reader technology to accommodate blind individuals, among other things.
While to date there is no definitive legal requirement that websites must comply with WCAG 2.0 industry guidelines (Guidelines), many courts have ruled that such Guidelines provide the required accessibility standard. Furthermore, many U.S. states have issued guidance adopting WCAG 2.0 as the required accessibility standard.
While the WCAG Guidelines are not inexpensive to implement, failure to comply with them gives aggressive plaintiff's lawyers an opportunity to demand a quick settlement with the threat of a costly legal action against the foreign-owned company. While each circumstance will be different, plaintiff's lawyers threaten, and sometimes commence, legal actions against companies that they believe are violating the public accommodation requirement of the ADA. Therefore, every foreign-owned U.S. business should consider adopting the WCAG Guidelines to reduce long-term risk.
Comply with California's Proposition 65
Enforcement of California's Proposition 65 is another example of predatory plaintiff's attorneys' taking advantage of foreign-owned U.S. companies. Formally known as the Safe Drinking Water and Toxic Enforcement Act of 1986, this broad law requires businesses to add warnings and disclaimers for a wide variety of substances, products and goods. For example, California consumers must be provided with a "clear and reasonable warning" of exposures to certain chemicals determined by California's Office of Environmental Health Hazard Assessment (OEHHA) that have been found to cause cancer, birth defects, or other reproductive harm.
While these warnings are beneficial for consumers, they are onerous on companies. Any foreign-owned manufacturer who is selling products in California should assess the need to comply with Prop 65. Plaintiff's lawyers will monitor any company doing business in California who is not providing necessary warnings and disclaimers and try to extract settlements, threaten legal action, and commence costly lawsuits against businesses that they believe have violated Prop 65. In most cases, it will be more cost-efficient for a foreign company doing business in California to, early on, review and take preparatory steps to comply with Prop 65, if applicable.
Negotiate early lease termination provisions
Various states have passed rent relief programs and laws addressing the Covid-19 pandemic and the inability of some lessees to make rental payments. The vast majority of these programs protect residential tenants, not commercial tenants.
Among states that have laws protecting tenants from eviction, these laws protect residential tenants almost exclusively. Commercial tenants largely must fend for themselves.
Many foreign-owned U.S. business do not aggressively negotiate commercial leases before they sign the leases. This is a missed opportunity, as legal clauses addressing early termination and force majeure can, quite literally, save a company tens of thousands of dollars if an early exit is required. Foreign-owned U.S. subsidiaries should take the time to evaluate whether early exit options exist in their leases. Landlords may be more willing to make accommodations in this Covid-19 environment.
Select the correct legal U.S. entity
Foreign companies who enact a corporate structure without the advice and guidance of an international business attorney often select the wrong legal entity. The limited liability company (LLC) is the most popular legal entity for businesses in the United States because (i) income and losses flow directly to the owner thereby avoiding double taxation and (ii) its general flexibility.
LLCs are usually not a good vehicle for initial U.S. entry however (absent some tax consideration in the foreign company's home jurisdiction). A single-member LLC implicates the U.S. branch profit tax, in addition to U.S. income tax. Moreover, an LLC requires the foreign parent to prepare the U.S. tax return and puts the foreign parent at risk of U.S. liabilities for any errors.
Many foreign companies who do not obtain proper legal advice upfront later devote considerable expense and time to converting an LLC to a c-corporation or other legal entity. Any foreign-owned business in the United States who has not yet incorporated a U.S. subsidiary should take time now to evaluate U.S. entity information and make the correct determination.
Hire workers U.S.-style
Many foreign companies are tempted to adopt their existing employment practices in the U.S. to keep administrative costs down, lessen organizational complexity, and make use of existing employment terms and concepts. U.S. employment laws, though, are different from employment laws in most Western countries.
There are several key differences. The United States largely relies on freedom of contract with respect to negotiation of employment terms. Having a properly negotiated U.S.-specific employment agreement is the best way to reduce future legal exposure (many states have enacted separate statutes protecting employees so those should be considered as well).
The United States also has at-will employment. At-will employment means the ability to terminate an employee without notice, without cause, and without severance. While many foreign companies hire employees at-will for their U.S. subsidiaries, the foreign companies often fail to understand that at-will employment can easily be defeated by extraneous promises in emails and other communications.
In addition, foreign—and U.S. — companies sometimes misclassify workers as independent contractors instead of employees. That is a fast way to risk a state audit. Foreign owned business should evaluate all of these employment considerations in the present climate to reduce U.S. legal exposure.
Assemble a mix of foreign and U.S. stakeholders
The United States is a business friendly nation. With some minor exceptions, a foreign company can quickly incorporate a U.S. subsidiary without worrying about residency requirements for its officers or directors.
Many companies operate under a full slate of officers and directors who are residents of their foreign jurisdictions. This practice can potentially reduce U.S. contractual and employment obligations, especially U.S. employment liabilities, which can become a huge cost to a foreign-owned business.
There can be discernible benefits in having at least one U.S. individual as a director, officer or key employee. After the 9/11 terrorist attacks, U.S. banks have become much more reluctant to do business with foreign companies unless the foreign company complies with numerous and cumbersome documentation requirements. These are based on various laws, regulations, and internal policies, such as the "Know Your Customer" anti-money laundering provisions of the USA Patriot Act of 2001.
The most cost-efficient option to continue with a foreign company's U.S. operations is often a combination of foreign and U.S. directors, officers and key employees. Affiliation with a U.S. person can make the interactions with the U.S. bank more efficient and seamless. It can also reduce the number of long-distance visits needed by the foreign company's principals.
Foreign-owned U.S. businesses who follow these tips can reduce costs and legal risk in a post-Covid environment. By timely and accurate execution of a mix of these strategies, foreign-owned U.S. businesses are likely to accelerate their recovery and growth.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.