Samantha Stainburn

(Crain’s Chicago Business, 22 September 2008)

In 1996, a U.S. company hired Eric Hargan to help it buy a factory in Asia. Mr. Hargan, a corporate lawyer working in Jakarta, Indonesia, called the manufacturer to set up a tour, due diligence he considered “a normal, check-the-box thing.”

But the response was far from normal. First the factory manager said the site was inaccessible because the only train that went there had derailed. Mr. Hargan said he would rent a jeep. The manager claimed the roads had been washed away by heavy rains.

The factory’s contracts appeared to be in order, but the manager’s reluctance to let Mr. Hargan see the facility made him suspicious. On closer inspection, he noticed the numbers in the work contracts did not match the financial statements. Ultimately, he and his client, whom Mr. Hargan declines to identify for confidentiality reasons, concluded the factory didn’t exist.

U.S. companies walk away from acquisitions all the time after performing due diligence, but how often does a deal fall apart because the buyer concludes the asset doesn’t exist? “That’s rare in the U.S.,” says Mr. Hargan, now a partner at McDermott Will & Emory LLP in Chicago.

Along with finding the right partnerships, deciphering cultural nuances and bridging communication gaps, navigating legal differences is a major hurdle to doing business abroad. Bumping up against those differences happens more often these days as more Chicago companies expand abroad.

“The most common misperception that U.S. companies have is that their experience doing business transactions with other U.S. companies gives them the ability to do those same type of transactions in foreign jurisdictions,” says Susan Greenspon, a partner in Chicago at Kelley Drye & Warren LLP, who has advised U.S. clients on corporate transactions in the Bahamas, Vietnam and Eastern Europe.

Foreign laws often punch loopholes into routine transactions, favoring local companies and costing American businesses time and money. In the Bahamas, for example, a foreigner can’t buy land — even private property — without permission from the government, a process that can take up to a year if the government is distracted by elections or has concerns about the buyer’s reputation.

Under Western law, joint-venture partners are largely left alone to negotiate a purchase price and share value. But in China, joint-venture agreements can be subject to government approval, even for non-state assets.

And resolving an international dispute is not as straightforward as filing a lawsuit in Cook County. Some foreign courts are at worst corrupt and at best biased toward local companies. Even if you win, there may not be a process or the will to enforce the judgment.

STEERING CLEAR

So how do you avoid all this trouble?

First, tap U.S. law firms to help you assemble a team of well-connected foreign attorneys. They can advise you on whether agreements with suppliers and other business partners will be protected under their laws.

In places like China, where laws are evolving, go a step further and retain lawyers with government contacts who can provide warnings on upcoming legal changes.

You’ll still need U.S. lawyers on your team to interpret the information coming from their foreign counterparts. But your U.S. lawyers must be careful not to step on anyone’s toes.

“The last thing you want to do is show disrespect for your local counsel, because they’re critical in the ability to get transactions done,” Ms. Greenspon says. “When it comes to communicating with opposing counsel abroad, that’s their job.”

Second, avoid unpleasant surprises by getting to know your foreign business partners away from the negotiating table. Go to lunch or have drinks at the bar to equip yourself to evaluate their motivations and expectations.

Finally, slow down.

“The road is littered with U.S. investors whose Chinese operations have been unprofitable, in part, because they’ve plunged into equity investments or contractual arrangements with Chinese parties without carefully considering Chinese laws on investments, the repatriation of capital contributions or other regulations,” says Philip Stamatakos, a partner at Jones Day in Chicago, who represents companies in cross-border transactions.

Lawyers agree: Cutting corners to get a deal done may be a risk worth taking in the United States, where businesses are more transparent and it’s relatively inexpensive to take a troublemaker to court. But when you’re a stranger in a strange land, it’s just asking for trouble.

©2008 by Crain Communications Inc.

Four years ago, one of Jeffery Duncan’s clients was having trouble with copycats in China.

The client, a well-known U.S. audio-equipment maker, found that Chinese companies were duplicating its receivers’ and CD players’ faceplates, slapping them on garbage electronics and selling the fakes on the Internet as the American brand.

So Mr. Duncan, an intellectual property lawyer at Brinks Hofer Gilson & Lione in Chicago, had associates in China file for a patent that prevents anyone from duplicating the U.S. company’s design. Since then, they have succeeded in shutting down several of these companies by sending them cease-and-desist letters. The online solicitations have disappeared.

“They may be surfacing somewhere else, but at least the most visible harm we’re seeing, listing these things on the Web as ‘a genuine xyz receiver,’ is coming down,” Mr. Duncan says.

Chinese officials have become more vigilant in enforcing patent and trademark laws as they seek to safeguard foreign investment and protect local companies, which increasingly are manufacturing products of their own.

Still, when filing for trademark protection in China, it’s a good idea to register the name or symbol using English and Chinese characters, since English is often used in the country’s advertising campaigns. Once you have registered your intellectual property, set up systems to ensure suppliers aren’t violating those patents or trademarks. At minimum, employ an automatic Web crawler program to detect if anyone is advertising knockoffs of your product online.

Other areas where U.S. companies stumble in China:

LACK OF TRANSPARENCY: There are plenty of state-owned companies in China that U.S. firms would like to buy. But Americans often find that Chinese companies won’t disclose how much their assets are worth or whether they are profitable.

“It’s not a question of shady people vs. unshady people so much as there are enormous cultural differences between China and the U.S. and Western Europe,” says Douglas Tucker, a partner at Quarles & Brady LLP in Chicago. “The Chinese are wildly offended when you ask them to open their books. It’s a huge show of disrespect.”

That’s why you need to give yourself double the time you usually would for due diligence to build the relationships that are essential for getting anything done in China.

“The first time you meet the plant manager, you take him out for dinner,” Mr. Tucker says. “The second time, you walk around the plant and tell them how you’re really impressed. The third or fourth time, you start inching over to that topic. Now you’re friends, and he’ll say, ‘Of course you can see our books and records.’ ”

COMPETITION: Unlike in the United States, foreign companies that license the rights to manufacture their products to Chinese distributors cannot forbid these companies from tweaking the product and selling the new version as their own.

To cut down on this practice, Mr. Duncan’s clients use contracts that require the Chinese firm to secure its promises with bonds worth hundreds of thousands of dollars and spell out dire consequences like revoking the distribution license or seizing the bond if the terms are violated.

Also, non-compete agreements in China require companies to make payments to former employees during the period they are prohibited from competing. That can create other problems.

“Sometimes people run from the payments,” says Sharon Barner, a partner at Foley & Lardner LLP. “They don’t want you to pay them because they don’t want the non-compete to be enforceable.”

©2008 by Crain Communications Inc.

India: You don’t want to go to court

Since January, Russian police have searched BP PLC’s Moscow offices several times amid a spat between the London-based energy company and its Russian partners over expansion plans. The government has charged a Russian BP manager who holds an American passport with spying and has withdrawn the visas of 148 other foreign employees.

In another case, businessman William Browder was barred from the country after he and his investment firm, Hermitage Capital Management Ltd., ran afoul of the Putin government. After the Kremlin canceled his visa in 2005, police seized documents and computers from the offices of Hermitage Capital and its attorneys. Then Mr. Browder learned someone had transferred ownership of Hermitage’s Russian holding companies to a convicted murderer.

In cases like these, there’s not much you can do, says George McKann, a partner at Drinker Biddle & Reath LLP in Chicago, who has advised U.S. companies working in Russia since the 1970s.

“There’s nothing to prevent the government from deciding they want you out or they want your Russian partner to be a 60% owner vs. a 50-50,” he says. “That’s the risk of doing business in essentially a totalitarian regime.”

But these are extreme cases, says Arthur George, a partner at Baker & McKenzie LLP in Chicago who co-founded the firm’s Moscow and St. Petersburg offices. “The activities of companies in most sectors of the economy are really below the radar of the authorities,” he says.

More-common predicaments that U.S. companies face in Russia:

CORRUPTION: Russian distributors attempting to circumvent customs duties and taxes often propose shipping to ports in countries like Germany or Finland.

“Sometimes they’ll ask our clients to contract with some other company outside of Russia and then just ship to a designated point,” says Mr. George, whose clients include U.S. automakers and drug companies. “When the payments are not from Russia, there’s some kind of corruption going on there. You have to say no, because there are going to be problems under Russian law as well as U.S. law.”

Fears that organized crime has infiltrated all levels of Russian business are overblown, Mr. McKann says, but mob-run sham companies do exist, so you must be careful.

When embarking on a venture with a Russian company, “you do everything you possibly can to find out its history,” he says, from Googling to checking its reputation with the U.S. Embassy.

EMPLOYEES: As in most of Europe, there is no at-will employment in Russia. To dismiss an employee, the company must explain which article of the Russian labor code permits it. Every Russian has a passport-like document called a “workbook,” which contains a worker’s entire employment history. Anytime an employer promotes, disciplines or fires an employee, it must be noted in the workbook.

“If you don’t have on file that they’ve been warned, you can’t fire them,” Mr. George says.

©2008 by Crain Communications Inc.

In some parts of the world, local companies often give government officials a little extra cash to secure a license or contract. Latin American officials, in particular, are notorious for requesting bribes to move business along.

In fact, 29% of Latin American companies reported that they had experienced corruption and bribery in the past three years, compared with 9% of companies in North America, 14% in Western Europe and 21% in the Asia-Pacific region, according to a 2007 global fraud survey by New York-based risk consultant Kroll.

Since 1977, the Foreign Corrupt Practices Act has forbidden U.S. companies, their partners and employees from paying bribes to foreign officials and has required public companies to record financial transactions accurately, which means no labeling bribes as “toner cartridges.”

Until five years ago, U.S. officials didn’t aggressively enforce the law. But priorities have changed as the feds have received more tips from U.S. companies, which are taking a closer look at their operations under Sarbanes-Oxley, and from officials in the other 29 Organisation for Economic Cooperation and Development countries, which have embraced new anti-bribery laws.

“The Americans sitting in America know not to pay bribes to foreign government officials, and they have training for their U.S. employees who operate overseas,” says Charles Smith, a partner at Skadden Arps Slate Meagher & Flom LLP in Chicago. “The problem usually comes when they buy into a local business that doesn’t have that history.”

To avoid problems, lawyers advise U.S. companies to review their Latin American partners’ financial records for unexplained commissions, suspicious donations to charities and fake or incomplete invoices. If they find a company is paying bribes, they should ask how critical those payments are, says Margaret Gibson, a partner at Kirkland & Ellis LLP in Chicago.

“It’s all well and good for a U.S. investor to say, ‘I’m going to buy this business and you’re going to stop and run clean,’ ” she says, but, “It may be that the company will not get the business it used to get without those payments.”

Other areas in which U.S. companies trip up:

INDEPENDENT CONTRACTORS AND EMPLOYEES: Many Latin American countries require foreign companies that want to fire their local distributors to cover investments the sales reps have made to develop the market, even if those dealers haven’t done a good job.

Those laws prevent foreign companies from using new distributors until the old dealers are paid. The three-year old Central American Free Trade Agreement released U.S. companies from that obligation in the six signatory countries: Costa Rica, the Dominican Republic, El Salvador, Guatemala, Honduras and Nicaragua.

But “if you are dealing with a country like Paraguay, which has a strict law that is not subject to relief by any treaty, then you need to make a call as to whether it makes sense for the growth of your product line to risk non-performance by a dealer there,” says Miguel Noyola, a partner at Baker & McKenzie LLP in Chicago.

Also, Latin American countries generally require companies to give employees benefits American workers don’t get.

In Brazil, for example, each employee must be given a yearly bonus totaling one-third of annual salary. Employers also must put 8% of every employee’s salary into an interest-earning “employment security fund.” If the employee is laid off, that money plus 40% of his or her annual salary goes toward a one-time severance payment.

POLITICAL INSTABILITY: Latin American countries started opening up to international trade and investment in the late 1980s. But in recent years, some countries have reintroduced protectionist regulations.

In Venezuela, for example, President Hugo Chavez has imposed restrictions on foreign capital ownership in certain industries like petroleum and natural gas.

“If you’re a private-equity investor who’s hoping to sell that company one day, the Latin American political environment is much less stable than in the U.S.,” Ms. Gibson of Kirkland & Ellis says.

©2008 by Crain Communications Inc.

Michael Hanna learned the hard way that European labor laws are more employee-friendly than those at home.

Eight years ago, he owned a Chicago technology consulting firm that opened an office in Milan, Italy, after acquiring a company there. When he decided to fire an Italian employee for poor performance, he discovered local law required a severance package equal to about one year’s pay. It was money he was sorry to lose.

“We get spoiled in the United States because we don’t have all these rules,” he says.

Now CEO of NewMedical Technology Inc., a medical-device manufacturer in Northbrook, Mr. Hanna, 48, outsources distribution in Australia, Europe and South America to avoid hiring employees there. His entire staff is in North America, where they are at-will hirees.

“In the U.S., you have the hire-and-fire mentality and make quick decisions to downsize and right-size,” says Dieter Schmitz, a partner at Baker & McKenzie LLP in Chicago. “The European culture and legal rules really don’t allow that.”

Not only do European countries have severance requirements, which can be hefty in places like France and Belgium, but companies may have to go to labor court — something that doesn’t exist in the United States — to win approval for hirings and firings.

Other potential minefields for U.S. companies in Europe:

INTELLECTUAL PROPERTY: In the United States, you own the trademark you use, whether you’ve registered it or not. In Europe, your trademark is only protected if you register it there. Companies that don’t plan ahead can find their trademarks in the hands of opportunistic European companies and individuals who make money selling them back.

To avoid problems, U.S. companies can apply for a “Community Trademark,” valid in all 27 countries in the European Union. Prices start at $2,345, much cheaper than registering 27 individual trademarks.

Companies working in Europe also must register their patents, keeping in mind that European courts interpret patents differently than U.S. courts. In Europe, you have to prove the patented material or process is the result of an “inventive step” not obvious to a skilled person in that field — another concept that doesn’t exist in the U.S. That’s one reason Pfizer Inc.’s patent for the active ingredient in its cholesterol drug Lipitor was revoked by the Federal Patent Court in Munich, Germany, last fall.

©2008 by Crain Communications Inc.