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International Operations Audits

While some companies build global compliance procedures into their business operations from the very beginning, the more common situation is that the decision to implement a formal compliance program is not made until the company already has some level of international activities.  At that point, the first action that should be taken is to conduct a comprehensive audit of the company’s international operations to identify the business and legal risks that will arise in connection with existing and proposed cross-border activities and transactions.  This report outlines the steps that should be taken to conduct an international operations audit as the initial step in establishing adequate policies and procedures for complying with domestic and foreign laws, including US export control, anti-boycott, and foreign corrupt practices laws.


Challenges of Project Management for Small Companies

Smaller organizations, such as emerging companies in their early stages of development, typically lack the resources to fund a full-time project manager position for the entire length of a particular project.  In most cases, the project manager has multiple responsibilities and also must discharge line management responsibilities at the same time he or she is coordinating a project.  Obviously this creates a substantial risk of conflicts with respect to the time that the manager devotes to the project and how resources under the manager’s control are allocated between a project and the day-to-day activities that the manager normally oversees.  If possible, the responsibilities of the project manager should be limited to horizontal coordination of the activities necessary for completion of the project and  line managers would remain focused on their vertical (i.e., functional) duties and lending the requisite support necessary for completion of the project.

Due to the lack of resources, project managers in small companies are forced to juggle several projects at once and may encounter difficulties in planning and scheduling when there are significant differences in priorities among the projects.  Resource limitations are also an issue with respect to what the project manager can expect to obtain from the functional managers in a smaller organization.  Unlike a larger company where the project manager can negotiate with functional managers during the course of a project to obtain more resources, smaller companies generally do not have any resources in reserve that can be redeployed to a project once it has been launched.  Another resource-related issue is the lack of administrative support for project managers in smaller companies.  Smaller companies generally do not have a separate project office while larger companies, particularly in industries where projects are commonplace (e.g., aerospace or construction), may have a separate project support office or department with several full-time project managers and full-time administrative personnel to collect and organize information about the activities and procedures of the company that can be used in the project management process.  Without this type of support the project manager in a small company must invest additional personal time in collecting information on top of the activities necessary to simply manage the project.

For smaller companies projects are generally much more mission critical for the success and growth of the business simply because smaller companies typically have fewer projects and each of them represents a significant percentage of the company’s business.  Therefore, the consequences of failure on a project are much greater for smaller companies than for larger organizations that are able to spread their risk over a larger number of projects and customers.  While success with a large project can vault the business of a smaller company forward much more rapidly, senior management must be rightly concerned about whether it will need to invest in additional resources or jettison smaller customers in order to take a chance on the large project.  For these reasons, plus the fact that smaller companies are often slow to engage in wholesale delegation of authority, project managers in smaller companies can expect a higher degree of interference in the management of the project from senior management than is normally the case in larger companies.



Prohibitions on Insider Trades During Pension Fund Blackout Periods

The senior officers of a corporation, notably the president, chief executive officer (“CEO”) and chief financial officer (“CFO”), are typically vested with all power and authority required for the day-to-day operation of the business, subject to oversight by the board of directors. See the chapter on Corporate Directors and Officers in my Westlaw Next online database Business Transactions Solution (§§ 9:1 et seq.). While this general concept has survived the wave of corporate governance reforms, a number of new rules and regulations were adopted to curb the incentives for senior managers of public companies to engage in activities that might be harmful to investors. Examples include the following: 

• Officers are prohibited from exerting, or attempting to exert, improper influence on the conduct of an audit, including any attempt to fraudulently influence, coerce, manipulate or mislead any public or certified accountant engaged in the audit.

• The CEO and CFO will be required to forfeit certain bonuses and profits in the event their company is required to restate its accounting results due to material noncompliance by the company, as a result of misconduct, with any financial reporting requirement imposed under the securities laws.

• Any officer who violates Section 10(b) of the Exchange Act or Section 17(a)(1) of the Securities Act, including the rules and regulations promulgated thereunder, can be barred from acting as a director or officer of a reporting company if a court determines that the person's conduct demonstrates “substantial unfitness” to serve in such capacities.

• Executive officers of reporting companies are prohibited from engaging in certain trading activities in securities of such companies during pension fund blackout periods. 

• Personal loans to officers of reporting companies have essentially been prohibited.

Each of the prohibitions listed above applies with equal force to directors of public companies, including outside directors that are not employed as managers of the company.

As noted above, directors and officers are prohibited from trading in equity securities they received as compensation for services to the company during any “blackout period” of an “individual account plan.”  The term “individual account plan” is defined by reference to ERISA and would include a company's 401(k) plan or other profit-sharing or retirement plan.  A blackout period generally exists in those situations where the issuer or plan fiduciary suspends the ability of at least 50% of the plan participants to buy or sell the issuer's securities.  Any profit from trades that are made in violation of this restriction may, regardless of the intent of the seller, be recovered by the company through a civil action brought by the company or through a shareholder derivative suit.  Such blackout periods must be disclosed to officers, directors, the SEC, and plan participants.  For a form of notice to be distributed internally regarding prohibitions on trading during pension blackout periods, see Specialty Form at § 91:232.50 in Business Transactions Solution.  This form is based on a model released by the US Department of Labor (DOL) and while use of the model is not mandatory, it is recommended as a means for ensuring the minimum level of compliance.  Regardless of the form of notice used, plan administrators must be sure that the notice describes participants’ and beneficiaries’ rights otherwise available under the plan during the blackout period and its projected duration, including the expected start and end dates, and that the notice provides the name, address and phone number of the plan administrator or other person responsible for answering participants’ questions about the blackout.


Establishing an Effective Outside General Counsel Relationship

Every new business must deal with various legal and regulatory requirements; however, technology-based companies looking to grow and expand must be particularly mindful of the potential problems and issues in this area.  While many entrepreneurs believe they can do their own contracts and use “self-help” books to form and organize their business, an experienced attorney can be invaluable member of the launch group for any fledgling business.  While the role of counsel varies depending on the specific type of business and related activities, good legal advice will be essential in each of the following situations: 

  • Selection of the proper form of legal entity for the new business and completion of formal legal requirements to properly form and organize the chosen entity.
  • Advice to the founders and other senior managers on their ongoing legal duties and responsibilities to current and former employers and practical assistance in helping the founders make the transition from their current employment activities without violating any general legal or contractual duties they might have to their employers.
  • Preparation of shareholders’ agreements among the founders and among the founders and outside investors.
  • Preparation and negotiation of key contracts between the company and its vendors, customers, employees and consultants.
  • Development and implementation of strategies for perfecting and protecting the company’s intellectual property rights.
  • Advice regarding compliance with statutory financial reporting and other disclosure requirements.
  • Advice regarding compliance issues in other substantive legal areas, including laws and regulations pertaining to taxation, labor and employment, real estate, antitrust and competition and securities offerings.

Assuming the attorney has the requisite skills and experience to advise the founders on each of the matters mentioned above (e.g., selection of the proper form of entity, preparation of agreements among the founders and among the founders and outside stakeholders; contract drafting and compliance requirements), the actual terms of engagement may provide that the attorney will render “outside general counsel services” to the selected legal entity and the engagement letter will typically enumerate specific tasks and activities such as business/legal advice, securities law compliance and preparation of offering documents, contract review and negotiation, employment matters, corporate governance counseling, management of intellectual property rights and selection and oversight of outside counsel handling litigation matters.  The engagement letter should identify the attorney who will be principally responsible for managing the engagement and he or she should be the person that the senior managers of the entity can turn to for advice on how to address a specific legal or business issue.  Other attorneys working with the “principal attorney” may be involved in providing certain services under the engagement letter; however, the principal attorney must be committed to staying involved with the engagement and carefully monitoring the work of all attorneys involved and making sure that the work adheres to mutually agreed schedules and budgets and that the relationship is proceeding as expected.


Tax Considerations in the Entity Selection Process: IRS Form 8832

Traditional analysis of entity selection focused on comparing and contrasting the tax and non-tax characteristics of a limited group of prospective business forms, namely proprietorships, general and limited partnerships and corporations (C and S forms for tax purposes). In recent years, however, the creation and acceptance of new business forms, such as limited liability companies (“LLCs”) and limited liability partnerships (“LLPs”), that can be used to control and limit non-tax liability, and the easing of prior regulations by the Internal Revenue Service (“IRS”) to facilitate entrepreneurial flexibility (i.e., the check-the-box regulations), has dictated a transformation of the analytical process. The preferred sequence for legal and tax professionals at this point is to first identify for clients the four main types of “tax treatment” for businesses and then take the clients through a series of common organizational, operational and exit transactions to determine how the choice of a specific treatment will impact the principals of the business. Once that process is completed, the professional can focus on some of the more subtle issues that must be considered in selecting a specific entity or structure (i.e., if two or more related entities are needed) within a group of entities or structures that offer the desired tax treatment. 

As part of this entire process, the legal or tax professional should be able to explain the default rules that apply under the tax laws with respect to classification of business entities and the steps that can be taken to elect a non-default classification by completing and filing Form 8832 (Entity Classification Election) with the IRS.  The form must include all of the information requested. Failure to include required information will render the election void. 

• A copy of the form must be attached to the entity's federal income tax or information return for the year in which the election is made.

• Where the entity is not required to file a return, a copy of the form must be attached to the return of any direct or indirect owner of the entity.

• Failure to attach a copy of the form will not render an election void, but may subject the non-filing party to penalties.

• The entity may specify an effective date for the election, but the date cannot be more than 75 days before or 12 months after the election is filed.

• Once an election is made, the entity may not change its classification for five years, unless there is a more than 50 percent change in ownership of the entity and the IRS consents to the new election.

• The election must be signed by each member of the entity or by any officer, manager, or owner who is authorized to make the election and who makes a representation under penalty of perjury that he has the authority to make the election. 


Creating a Strong Relationship Between the Founders and their Attorney

A good attorney is an important piece of the start-up team and time needs to be set aside to select an attorney and formally establish the attorney-client relationship.  Both the founding group and the attorney will want to enter into some form of agreement for services, such as an engagement letter, that sets out the scope of the representation, the fee arrangements, and billing procedures. While founders often view engagement letters as boilerplate contracts, the engagement process should be seized by both sides as an opportunity to delve into the scope and terms of what inevitably turns into a significant relationship and achieve a meeting of the minds regarding the goals of founders and their expectations regarding the services to be performed by the attorney.  The table below, which appears in the Growth-Oriented Entrepreneur's Guide to Entrepreneurship available from the Growth-Oriented Entrepreneurship Project, provides a good checklist to guide founders and their attorneys in creating a powerful partnership. 

Table 1.5

Matters to Consider Regarding Scope and Terms of Attorney-Client Relationship 

  • Who specifically will be the client of the attorney?  Attorney-client relationships may be created with business entities and/or with one or more of the individual founders of the entity and identification of the client is an essential step in identifying potential conflicts of interests.
  • What are the goals of the founders with respect to the proposed engagement?
  • What are the expectations of the founders with respect to the specific role the attorney will play with respect to achieving the company’s goals?
  • What are the most significant risks and challenges that may undermine achievement of the goals set by the founders?
  • What are the specific tasks and activities that will be expected of the attorney during the course of the engagement?
  • Are there any areas of law and/or specific tasks or activities that are outside the competence of the attorney?  If so, the attorney should discuss alternative sources of services in order to achieve the client’s goals.
  • What are the major responsibilities of the founders and the company with regard to the engagement?  Among other things the founders and company should expect the need to fulfill certain duties relating to payment of bills on time; providing certain information to the attorney; completing specifically identified portions of the work which is the subject of the engagement; and keeping the attorney informed about the company's address, telephone number and whereabouts so that the attorney can fulfill his or her duties.
  • What is the schedule, if any, for completion of the work, including any significant deadlines?
  • What will be the fee arrangements and billing procedures, including responsibility for expenses incurred by the attorney in the course of performing the services?
  • What will be the understanding of the parties with respect to procedures for discharge and withdrawal from the engagement?



Structural Components of Equity Joint Ventures

So-called “equity joint ventures” are collaborations between two or more business partners that involve the formation of a separate legal entity, such as a corporation or LLC, within which the joint activities will occur. An equity joint venture should be contrasted with “contractual” joint ventures, which have become a popular topic among lawyers and managers. The distinction between an equity joint venture and a contractual joint venture can be illustrated by comparing the manner in which a United States manufacturer might enter a new foreign market. If the equity joint venture strategy is used, the manufacturer might form a new corporation jointly owned with a foreign partner. The United States party would contribute a license which would allow the joint venture to manufacture the products. The local party might contribute manufacturing facilities and any needed capital and personnel and agree to act as the local distributor for the joint venture. In that case, the parties will share the profits of the joint venture. Alternatively, instead of forming a new corporation, the United States party might use one or more “contractual” relationships, such as license and distribution agreements with the local party, to achieve the desired result of sales in the new foreign market without using a separate joint venture entity.

The formation and use of an equity joint venture, referred to hereafter simply as a “joint venture,” must take into account all of the same issues which are generally encountered with any new business enterprise. For example, each of the joint venture partners will contribute various resources and skills to the new enterprise, including products; financing; personnel; facilities; raw materials; and marketing, managerial and operational expertise.  These contributions may take the form of direct investment in the joint venture or may be provided under the terms of one or more ancillary agreements between the joint venture entity and the partners. The partners must also agree on a number of issues regarding the management and operation of the enterprise.  

Assuming that the corporate form is elected for the joint venture, the basic structural components would be as follows: articles of incorporation and bylaws; a shareholders’ agreement that would cover essential issues such as formation procedures, capital contributions, governance and termination of the joint venture; and ancillary agreements covering any services to be provided to the entity by the parties, as well as any agreements with respect to the purchase of products developed or manufactured by the joint venture or the use of the assets of the joint venture by the parties in activities that may, or may not, be related to the specific purpose of the joint venture. Among the various agreements are an administrative services agreement; a supply agreement; an equipment purchase agreement; one or more licenses with respect to technology or manufacturing rights; one or more distribution agreements; and an agreement with respect to the lease, acquisition or construction of facilities.

The procedures to be followed regarding the formation of the entity are typically specified by relevant laws in the jurisdiction in which the entity is to be organized. For example, formation of a new general partnership in the United States to conduct the joint venture activities will be governed by the applicable state partnership statutes, formation of a new LLC to conduct the joint venture activities will be governed by the applicable state LLC statutes, and formation of a new corporation for the joint venture requires compliance with applicable corporations law statutes. For larger transactions, the parties may enter into a master formation of joint venture transaction agreement which sets out in detail the steps that will be taken to form and organize the new entity and accept the contributions that each of the parties has committed to the joint venture. This approach may be appropriate when the parties are both public companies contributing a substantial amount of their assets to the joint venture since such a transaction may require regulatory and shareholders' approvals that will take a substantial amount of time.

To learn more about the structural components of equity joint ventures, see Chapter 103 of my Westlaw Next online publication Business Transactions Solution.


Launching a Strategic Alliance

While the parties to a strategic business relationship, or “SBR,” should not abandon the customary practice of preparing a business plan for the alliance and carefully negotiating and drafting contract provisions and other formal management procedures, they must also understand and appreciate that plans, contracts and rules are generally of limited or almost no value when the inevitable disagreements crop up once the SBR is under way.  At that point the problem almost certainly lies in a lack of trust between the participants and an inability to communicate.  As a result, the dispute resolution procedures in the SBR documentation are rendered essentially ineffective, the relationship stalls, and the parties begin to look for other options to achieve the goals that they were originally seeking when the choice was made to entering into the SBR in the first place.


Disagreements and unforeseen events and problems cannot be avoided; however, the parties can do a better job of preparing for choppy waters by taking the time to learn more about one another before the hard work of launching and operating the SBR begins.  A business plan and the contract documentation bring the participants together “on paper” but they do not provide the tools necessary for their managers and employees to immediately and continuously collaborate as if they were employed by the same company.   In order to realistically aspire to the level of collaboration that is required for a successful SBR everyone involved must have sufficient and truthful information about the following:

  1. What is the organizational structure of the alliance partner?
  2. How are decisions made within the alliance partner regarding the allocation of capital, personnel and other resources?
  3. How is information collected and disseminated within the alliance partner’s organization?
  4. Which business units within the alliance partner’s organization will be closely involved in the delivery of resources that will be needed for the alliance relationship to be successful?
  5. What are the regular reporting channels for the senior managers of the alliance partner who will be overseeing the partner’s activities in relation to the alliance?
  6. What are the dominant cultural values and norms within the alliance partner?

There are no “right” or “wrong” answers to the questions listed above and parties should not sit in judgment of the way the other partner operates or the values that influence the behaviors of individuals representing the other partner.  In fact, one of the main reasons for considering a SBR is to have access to and gain leverage from different ways that the partner conducts its business.  For example, a relatively conservative company may seek an alliance with a partner known for having an entrepreneurial culture in order to accelerate development of new technologies and products.  The primary objective is to lay a foundation for greater mutual understanding.


Obviously this type of information is typically not shared in detail during the time that the parties spend on negotiating and finalizing the documentation for the SBR and the business plan that is usually prepared for a SBR tends to focus on quantitative areas such as markets and technical specifications and tactical issues in sales and marketing.  In order for the parties to begin learning how they will actually work together, it is recommended that plans be made earlier on for a “launch period” that would begin soon after the formal documents are signed and before the parties get too heavily involved in specific projects and activities.  The focal point of the interaction during the launch period should be a series of meetings between the key representatives of the parties, which should be hosted by both parties, to explore in detail the challenges that are likely to occur during the SBR due to differences between the parties and to attempt to develop specific guidelines and procedures for managing the potentially harmful effects of those differences on the progress of the SBR.  The goal of these meetings, which typically occur over a period of four to six weeks, is for the parties to work together to define the type of relationship that they want and jointly create the tools that they need for the SBR to play out in the way they anticipate. 


These meetings are also a good time to review when and how important decisions regarding the conduct of the SBR will be made.  Identifying key decision points should be occurring hand-in-hand with the discussion and refinement of the business plan for the alliance and the formal process for making decisions should have already been outlined in general in the SBR documentation.  In some cases one of the parties will be given the contractual authority to make a specific decision; however, it is still important to have a dialogue on what criteria will be used to make the decision and how much input the other party will be allowed to have with respect to providing information and offering opinions.  If representatives of a party must obtain approval from others within their organization the parties need to understand how that approval process is likely to work in practice.  For example, if approval must be obtained from a formal review committee information must be provided regarding the timing of committee meetings and the composition of the committee.  Insight should also be obtained regarding the cultural norms that generally govern decision making within each party—are decisions made based on hierarchy or is it necessary to seek and obtain a consensus.  Knowing how each party makes decisions, and planning in advance for managing how key decisions will be made, should reduce uncertainty and frustration and increase the chances that decisions will be made on a timely basis and that the parties will receive sufficient information regarding those decisions to execute them effectively.