QUESTION ONE When representing a client with significant business activities in foreign jurisdictions, what are some key risk-related concerns that arise in a cross-border context and how can a parent company minimise such risk?
BACG’s experience working with subsidiaries of many foreign companies in the Azerbaijani market has found that the main risk-related concerns for foreign companies before entering into a new country can be classified under the following categories:
- Legal framework risks – this mainly implies deficiencies in the legal system of the country including lack of preciseness and legal certainty in law and other normative legal acts that regulate almost all aspects of any business, i.e. from establishing a subsidiary to a company’s day-to-day operations.
- Financial and compliance risks – exchange rate fluctuations, changes in tariffs and other compulsory state payments, restrictions in profit transfer rules and/or the introduction of new taxes etc. are some of the main risk concerns for any international company trading in another market. Along with financial risks, entering into agreements with unknown trading partners without proper due diligence checks may lead to delays in performance and execution of contracts and, in the worst case, government sanctions and financial or other forms of liabilities.
- Political situation and business climate – it is always worth analysing the political stability of a country over the past few years and evaluating mutual business and commercial relations between hosting country and the parent company’s country of origin or registration.
- Cultural barriers and differences – for an international company with an intention to establish a subsidiary office in a new market or operate through its other tax residents, it is important to conduct research and understand the peculiarities of local traditions, beliefs and cultural habits beforehand.
To get around issues associated with any of the aforementioned complexities or uncertainties (e.g. from taxation and tax compliance rules, trade and customs restrictions, licence and permits requirements up to political and cultural awareness), it is recommended to research the country’s business climate first, to the extent possible, and use the services of foreign experts during initial phases of cross-border expansion to get as much information on the key aspects of the business to be run by the parent company in the new market as possible.
QUESTION TWO – What degree of control should a parent company have over its overseas subsidiaries? How does the degree of control impact the risk exposure level, and how can control issues be managed to minimise liability?
As mentioned, during the initial stages of the newly established subsidiary, the parent company will need an appropriate level of control over the contractual and financial transactions run via the local unit. This is important for being compliant with local laws and vigilant in terms of choosing counterparties because, depending on the laws and regulations of the local jurisdiction, not only the subsidiary but also the parent company may be held responsible for the deeds of the subsidiary and become subject to civil, criminal or administrative liabilities etc.
Therefore, to manage and minimise the risks the parent company may implement its operation system and strategy for its subsidiary in line with local requirements to allow smooth control, as well as use, verified third party agencies/companies to service out some of the activities/operational duties of the subsidiary and carry out internal audits as and when required.
QUESTION THREE – What constitutes the right balance between risk and liability for a company and its overseas subsidiary? What examples can you give?
When it comes to finding the right balance between risk and liability, as a starting point, it will be important to understand whether an entity established in a host jurisdiction is registered as a subsidiary or a “separate company” where the international company is only its founder or one of the founders.
In most jurisdictions, including the Republic of Azerbaijan, subsidiaries (i.e. branches, representative offices) are usually treated as a separate entity from a taxation and accounting point of view, even though they have been founded by a parent company and their activities may easily be linked to that company. In the case of a separate company founded by an international company it usually acts independently in almost all of its transactions and corresponding risks and liabilities, so the level of liability of the founding company in most cases is limited to material and/or immaterial assets in charter capital.
Going back to the subsidiary case, the risk and liability pertaining to the subsidiary, depending on the issue, may become related to the parent company as well. For example, pecuniary or non-pecuniary liability of the subsidiary for any damage or loss to any third party or failure to pay debts, in case of a subsidiary’s inability to incur damages or insolvency, depending on circumstances, the liability and/or compensation for damage may be directed to the parent company, where the subsidiary does not have a completely independent standing and all of its activities and results directly or indirectly related to the parent company.
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