Technology companies are riding the wave to global expansion faster than firms in most other industries. Whether they make enterprise software, gene tests or consumer apps, as soon as tech firms have a viable product they can turn to global markets hungry for the latest and greatest innovation.
On the quick trip from the garage to foreign markets, tech businesses face a number of common legal issues. Startups cannot always address these issues proactively due to limited time and resources. Thus, having a checklist of important issues to keep in mind is key to navigating the early days of international expansion.
Intellectual Property
To exploit their intangible valuables, tech businesses need to own, perfect and protect their intellectual property rights. Like property rights in real estate and chattels, intellectual property rights are territorial and subject to different legal regimes in every country. When entrepreneurs pick names for their company and products, they should think ahead about whether trademark registrations and domain names are available, how the chosen names sound in other languages and what connotations a term may have abroad.
While copyrights are as territorial as other intellectual property rights, they are largely harmonized by international treaties. Authors tend to acquire copyrights simultaneously in their home country and around the world simply by writing their works down, be it text or software code. Patents, however, require local filings, prosecution and greater budgets; thus, companies must be more selective and strategic about where to obtain patents.
In choosing a home base for their company, entrepreneurs are often focused on customer demand and costs of doing business. However, they should also consider the tax and overall regulatory environment most favorable for their business. If they start in a suboptimal jurisdiction, companies can still migrate intellectual property ownership to low tax jurisdictions later, but this comes at a price that increases quickly as the business expands and its valuation increases.
Taking international orders as they come
Most startups focus initially on domestic success. At this stage, unsolicited purchase orders or requests for trial arrangements from abroad may start arriving. Why not seize the opportunity for extra revenue and to establish the product internationally?
A company that is unsure of the foreign legal, tax and customs regimes that apply to its products can contractually shift most foreign compliance and tax burdens to a foreign business customer. Many companies refer to their primary place of business in sales terms, including in the choice of law, dispute resolution forum, and place of delivery or performance, like for example the ‘Incoterm Ex Works.’ In some cases, however, a choice of a foreign law can be just as good or better for a company, so if a foreign buyer insists on a contract governed by their domestic law, a comparative analysis may prove helpful.
Companies have to ensure compliance with export control laws before they sell any products or transfer technical know-how to foreign buyers, even if the buyers come to their jurisdictions. Sales to embargoed countries or ‘denied parties’ and transfers without the required prior approvals or notifications can result in serious sanctions, particularly in the United States.
Going global online
Once a company goes ‘live’ with a web or mobile site, it immediately becomes subject to various foreign laws. Under public international law, every country can and does enact laws that apply worldwide, including trade laws, competition regulations, data privacy laws, content restrictions and consumer protection laws. While countries generally have neither the interest nor the resources to enforce these laws outside their borders, a few types of laws tend to cause companies trouble if not addressed early on.
A company that sells to consumers in other countries should clarify to visitors of its web or mobile site that it is intended only for residents of jurisdictions for which the company has conducted at least some basic legal due diligence. Firms should try to keep out consumers from other jurisdictions by limiting credit card acceptance, delivery locations for physical products or geo-targeting. For specifically targeted jurisdictions, consumer site operators should familiarize themselves and comply with tax obligations, translation requirements and restrictions on contract terms.
Data privacy laws in Europe and other countries require affirmative opt-in choices for marketing emails and cookies placement, specific disclosures in privacy notices, data subject access rights and adequate safeguards for international data transfers. An operator of a passive dotcom site can relatively safely rely on a disclosure that it complies only with the laws of its home jurisdiction. But an interactive site that places cookies on foreign computers, ships abroad and targets consumers in other countries with translated websites should consider additional compliance steps to satisfy data privacy laws in the targeted jurisdictions.
A company that delivers products to specific foreign countries needs to familiarize itself with local compliance requirements relating to its products. Those include restrictions on material composition like rules on hazardous substances such as RoHS and REACH in Europe, as well as product safety, warnings, labeling, recycling, registration requirements for medical devices, import bans or license requirements for encryption products and technical standards.
Signing up suppliers and distributors
A company that buys components, products or services like contract manufacturing and web hosting from abroad needs to consider import restrictions like customs laws, as well as comply with local withholding tax obligations at home and adjust its contracts. Additionally, those firms should consider numerous tax and legal issues when selecting the best distribution model. Options include buy-sell models, involving sales to wholesale distributors, resellers, franchisees and referral agent models, where intermediaries receive a commission for referring buyers. Each distribution model has pros and cons in terms of risks, opportunities and the degree of control preserved by the company. The tradeoffs vary from jurisdiction to jurisdiction, subject to the following general principles:
• By appointing dependent agents in other jurisdictions, companies can establish a taxable presence with resulting tax reporting and remittance burdens, known as a “PE problem.”
• If a company engages an individual person as commission agent or other intermediary, employment laws and rules on misclassification have to be considered.
• By selling products to intermediaries abroad, companies can exhaust their intellectual property rights with respect to the sold items, which can prompt undesired re-importation and price disruptions.
• Under mandatory dealer protection laws in many countries, particularly Latin America, Europe and the Middle East, intermediaries are entitled to severance and other protections against termination. In some cases, companies can mitigate risks with contractual disclaimers, alternative dispute resolution clauses and or picking a less protected distribution model.
• Franchise laws are often much less developed outside the U.S., but some countries have also enacted disclosure requirements and termination protections. Companies need to clarify to what extent a foreign reseller may use the manufacturer’s marks, company name and domain URL in the reseller business, as well as keep control over foreign trademark and product registrations.
• Under foreign competition laws, particularly in Europe, companies face prohibitions regarding resale price maintenance, territory and customer allocation and other restraints of trade. As a rule of thumb, companies are allowed to exercise more control in the context of commission agency than buy-sell arrangements.
• Commission agents tend to involve greater risks of entanglement with foreign anti-corruption laws and the U.S. Foreign Corrupt Practices Act, particularly in the context of sales to governments or government-owned businesses.
• As a company enters into substantive, riskier, contractual relationships with companies abroad, it is more likely to face disputes. Arbitral awards tend to be enforceable in most developed nations under the New York Convention, whereas court judgments are often not recognized in other countries, particularly not injunctions.
Putting boots on the ground
As companies intensify foreign expansion, they will eventually find it necessary to have full-time, local representatives to supervise and audit suppliers, develop business or engage in direct sales. At this stage, foreign labor, corporate and tax laws will become acutely relevant.
Employees enjoy protections under local labor laws regardless of the contractual choice of law or attempt to characterize a relationship as one of independent contractors. Misclassified employees create increasing exposure each year a firm does not comply with labor laws and payroll tax requirements. Most countries do not recognize the concept of “employment at will” and imply or require employment contracts. Companies should use employment agreements that conform with local law, are translated into the local language, and efficiently protect employers with respect to foreign labor laws by providing, for example, for probationary periods during which termination is relatively less restricted.
Working hours, whistleblower hotlines, computer monitoring and other programs must also be adapted to, and in many cases approved by, local governments to avoid running afoul of mandatory local laws. Granting stock options or other benefits is subject to various mandatory local law restrictions and consequences that need to be carefully considered and addressed to avoid costly surprises down the road.
Employees, offices and other foreign presences usually trigger tax reporting and remittance duties on the basis that they constitute taxable ‘permanent establishments’ of a company in another jurisdiction. This can result in double taxation and administrative burdens that can be avoided or mitigated by the incorporation of a local subsidiary. In this regard, entity options have to be examined.
During trial phases, companies occasionally establish temporary arrangements with the assistance of local ‘employee leasing,’ with businesses or contractors working from home under time-limited contracts. These arrangements have various disadvantages and, as a rule of thumb, companies should seriously consider incorporating a local company or other entity if they engage a sales person, a provider of chargeable service or more than two other kinds of employees for more than six months in a foreign jurisdiction.
Additionally, companies need to document funding arrangements with foreign subsidiaries in intercompany agreements that comply with international transfer pricing principles and reflect arm’s length commercial arrangements.
International M&A
Apart from early organic growth, tech companies frequently expand internationally through mergers, acquisitions, spin-offs, asset sales and other corporate transactions. Companies that buy or sell businesses across borders face a maelstrom of international tax and legal issues. Tax, corporate and securities laws often treat international deals quite differently from domestic ones and companies need to give careful thought to the transaction’s overall structure. Rules on if and when letters of intent are binding vary. Data privacy laws, language barriers, and unfamiliar documentation practices can hamper due diligence investigations. Different rules on antitrust filings, collective labor consultations and acquired employee rights apply in case of business transfers, and in some cases even mere asset transfers or license arrangements.
Lothar Determann is a member of Baker & McKenzie’s international commercial group in the San Francisco/Palo Alto offices and a member of the global steering committee on data privacy. His practice focuses on assisting and counseling multinational companies and startups. He can be reached at [email protected].
