International Business Law Advisor : International Business Lawyer & Attorney : Santiago Cueto Law Firm : Global Business Litigation & Finance Commentary

The International Law Prof Blog has passed along details about an upcoming teleconference, “Doing Business with Japan,” sponsored by the American Bar Association Section of International Law.

The conference could not come at a better time. Businessweek’s Daniel Kruger reported this week that Japan has overtaken China as the largest foreign holder of U.S. Treasury securities. The number is staggering--Japan is now holding $768.8 Billion in U.S. T-Bills.

Folks, the conference is a great first step towards bridging the trade gap and getting back some of those T-Bills.

Here are the details:

90-Minute ABA Teleconference on Doing Business with Japan

Are you interested in getting a better understanding of the legal system in Japan?  Or in the advantages (and dangers) of selecting Japanese law or Japan as a place to arbitrate?  Or other issues relating to doing business with (and in) Asia? 

There's a teleconference on "Doing Business with Japan" on Wednesday, February 24, 2010 from noon to 1:30 p.m. Eastern US Time.  The program is organized by the Asia/Pacific Committee of the American Bar Association Section of International Law.  Click here for the program description, speaker bios, and registration form.  Download Japan.  There is an extremely modest fee to call in ($15 for section members and $25 for non-members).  Register by Monday, February 22, 2010.

Looks like an excellent program. Will you be attending?

    -Santiago

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And Why Relocating to Switzerland May be the Best Corporate Strategy

There’s nothing more annoying than finding hidden fees buried deep inside obtuse and mangled contract language. The only thing worse than finding hidden fees is learning about these punishing provisions from someone else—after you’ve signed the agreement. 

If you thought hidden fees provisions were the exclusive craft of credit card and cable companies, I’ve got bad news. The biggest offender just might be the drafters of the proposed federal budget making its way through Congress.

International Tax Increase Buried in Proposed Bill

Thanks to the keen eyes of the Wall Street Journal’s Matthew Slaughter, U.S. based Multinationals have a chance to lobby against what may be the largest hidden fee--an obscure tax provision--ever levied against them. Matthew writes in the article “How to Destroy American Jobs:”

Deep in the president's budget released Monday—in Table S-8 on page 161—appear a set of proposals headed "Reform U.S. International Tax System." If these proposals are enacted, U.S.-based multinational firms will face $122.2 billion in tax increases over the next decade. This is a natural follow-up to President Obama's sweeping plan announced last May entitled "Leveling the Playing Field: Curbing Tax Havens and Removing Tax Incentives for Shifting Jobs Overseas."

A proposed $122 Billion international tax burden? Placed on pg. 161? On a chart? Apart from the obvious lesson to carefully scrutinize the details of everything, and I do mean e.v.e.r.y.t.h.i.n.g., that comes across your desk, the substantive point of the article is absolutely correct—the proposed tax hike on U.S. based MNCs will bankrupt those that earn a significant amount of their revenue overseas.

Proposed Tax Will Force US-based MNCs to Relocate Overseas

As one commenter noted, it is the fiduciary responsibility of the board of a company to protect the investors in that company, and to provide them with the maximum safe return on their investment. In the new tax and regulatory environment the U.S. is in the process of imposing, any company that earns a large percentage of their revenues outside of the US simply cannot remain U.S. based.

Under the proposed tax hike on U.S. based MNCs, what incentive is there for Coca-Cola to remain a US based multinational? Why not move the corporation to Switzerland, where the favorable corporate tax structure has long been lured the operations of large MNCs such as Johnson & Johnson and Burger King Holdings Inc.

Switzerland Offers Optimal Tax Environment for MNCs

The timing could not be better for companies looking to relocate their operations overseas-- and to Switzerland in particular.  The Wall Street Journal recently reported on an emerging trend among Swiss cantons to compete for the business of MNCs by lowering their corporate tax rates. In the article Switzerland’s States Compete on Tax Cuts, the cantons of Zug, Schaffhausen (just north of Zurich) and Lucerne have all cut their tax rates in a heated battle to lure more MNCs.

For U.S.-based MNC’s looking to dodge the proposed international tax bullet, Switzerland provides the most favorable corporate tax environment in which to relocate U.S. based operations.

Conclusion

According to KPMG’s Corporate and Indirect Tax Survey 2009, the current effective U.S. Corporate tax rate is 40%, while in Switzerland the effective tax rate is 21.2%--and considerably less in some cantons. Under the proposed bill, the tax gulf will only grow wider.

It will be interesting to see what happens with the proposed tax. Until then, MNCs should take a look at Switzerland.

Trend to Watch: If the Proposed International Tax is Enacted Look for an Exodus of U.S.-based MNCs to Switzerland and to Other Favorable Tax Climates.

       --Santiago

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Hey Brazil--Take Your Time With Those BITs, I Can Get Them Somewhere Else!

Today we’re launching the first in a series of posts on the BRIC countries in a fast, quick read format. While  the late John Hughes would have appreciated the titular tribute to his Breakfast Club classic, the series is meant to stimulate a robust discussion among those interested in the subject.

For the uninitiated, BRIC is an acronym coined by Goldman Sachs to refer to the red-hot economies of Brazil, Russia, India and China. According to the investment group’s projections, the BRIC countries could become among the four most dominant economies by the year 2050.  Let’s get things started with Brazil.

Our first topic picks up on an article I wrote Hey Brazil: It's Time to Ratify Those Bilateral Investment Agreements. The article centered on Brazil’s reluctance to enter into any Bilateral Investment Treaties (BITs). I promised I’d follow-up with a post on how to do business with Brazil and still enjoy the benefits of a BIT.

But Brazil does not have a BIT, you say?

Fortunately, Brazilian investors do not have to wait for changes in government policy to get the benefit of BITs. Investors can seek to structure their Brazilian investments to take advantage of the protection of BITs between other states.

Here’s how:

Establish a subsidiary in another Country. In many cases, a Brazilian investor can establish a subsidiary in a country that has a BIT with the host state through which to channel investments. Some BITs require only that the investor be established or incorporated in the home jurisdiction in order to acquire the protection of the BIT.

Here’s an Example:

Nationalization of Bolivian Energy Industry. When Bolivia took steps to nationalize the energy industry, Brazilian gas company Petrobras considered bringing investment claims against Bolivia for treaty violations by invoking the rights of its subsidiaries in Argentina and the Netherlands. Unlike Brazil, both Argentina and the Netherlands have BITs with Bolivia.

Conclusion

Brazil is increasingly emerging as a global leader and expanding its investment abroad. Brazilian Investors should take full advantage of BITs by establishing a subsidiary in another country. Doing so will ensure that their investments are protected.
 

Trend to Watch: A Surge in Investment Activity in Brazil Will Ultimately Lead to the Adoption of International Investment Agreements

     -Santiago

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The Wall Street Journal and the Heritage Foundation released its annual 2010 Index of Economic Freedom.   Of the world's 20 largest economies, Hong Kong ranked first while the U.S. came in at number eight.  

According to the Wall Street Journal article, The U.S. is Not as Free as It Used to Be,  a number of factors contributed to the United States’ ranking lower than in previous years. The federal government's heavy-handed intervention in the financial and economic crises of the last two years was cited as the main factor.

There is another factor not mentioned in the article that I believe contributed to the US’ lower ranking--the lack of confidence in our nation’s dispute resolution regime.

Businesses are unwilling to wade into a pool of uncertainty to either prosecute or defend valid claims given the exorbitant cost of litigation. While inroads were made in the past decade towards the arbitration of business disputes, the trend has reversed itself under mounting pressure from special interest groups.

While I have no empirical proof, I have a feeling that the top 7 nations have made great strides in their dispute resolution regimes. It's no surprise Hong Kong is number one given its focus on arbitration, which I wrote about in an earlier post.

Check out the rankings below--what do you think? 

   -Santiago

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Recession? What recession? Business in India is booming. Forbes is reporting that India's Billionaire Club nearly doubled in the past year. According to the Forbes special report, India's 100 Richest, the nation is now home to 52 Billionaires, up from 27 last year. According to the report:

The combined fortune of India's 100 richest is $276 billion, almost one-fourth the country's GDP. That is well below the total worth of $775 billion for the 100 richest Americans, but well ahead of the equivalent sum for China's top 100. Although China has more billionaires--79 vs. India's 52--India's wealthiest are worth over $100 billion more than the $170 billion total net worth of their Chinese counterparts.

You can read more about India's good fortune in the Financial Times in the article India Billionaires Outstrip US Counterparts.

Proposed Business Laws May Undercut India’s Recent Performance

While India’s robust economy continues to outpace much of the world, proposed legislation may undercut its recent performance. Starting next month, the Indian Parliament is set to consider a major overhaul of the nation’s business laws. There are three legislative proposals in particular that will fundamentally change the way business is conducted in India. These proposals are the Goods and Services Act, the Companies Bill and the Direct Taxes Code.

1. The Goods and Services Act: Slated to take effect in April, 2010, the Goods and Services Tax (GST) will abolish the 'central sales tax' and include services under 'value added tax' (VAT).  For the first time, state governments will be able to tax services. The GST will have a uniform tax rate structure throughout the country and will create a common market within India for the first time.
2. The Companies Bill: Currently being examined by a parliamentary committee, the new bill seeks to overhaul several issues such as insider trading, independent directors, class action suits, public deposits, fair valuation, consolidation of financial statements, mergers & acquisitions and special courts.
3. The Direct Taxes Code: India’s Income Tax Code is set for a major overhaul with the introduction of the Direct Taxes Code proposed to be launched by April, 2011.  In its current form, the Code proposes lower tax rates on the basis that lower rates improve compliance. However there are significant disagreement concerning income from salaries and capital gains; taxation of charitable organisations, minimum alternate tax based on assets and international taxation.

The Proposals Are Silent on Key Issues

While I welcome any change that will eliminate red tape, reduce tax liability and allow businesses to operate more efficiently, these proposed laws are silent on key issues. For example, how will state tax revenue be allocated to overhaul India’s impossibly overburdened infrastructure--considered among the worst in the developed world?

Also, does the introduction of the Direct Taxes Code translate into higher taxes on capital gains, assets and international taxation?  Finally, how will an overhaul of the securities laws impact the robust  pace of mergers and acquisitions—one of the primary mechanisms for business expansion and wealth accumulation?

Conclusion

The increase in the number of India's Billionaires is a sure sign of the nation's economic strength. However, the proposed business laws are silent on key issues that may affect the vitality of India's economy.  It remains to be seen whether the proposed changes will have an immediate impact on the growth of business in India.

 Trend to Watch: India will continue on its current path unless the proposals burden the business sector with higher taxes and increase restrictions in the securities markets.

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Brazil is on a roll.  Yesterday’s Financial Times included a special 10-page section devoted to Brazil. One of the articles, Olympic Accolade Sets Seal on Progress, written by Jonathan Wheatly, succinctly describes the “exuberant optimism” that has gripped the country since it was awarded the 2016 Olympic Games.  And the Wall Street Journal recently reported on the Brazilian stock exchange making spectacular gains in the article Brazilian Stock Scores Spectacular Gains on US GDP Growth.  This is following last month’s IPO of Banco Santander’s Brazilian unit, the world’s largest IPO so far this year, as reported in the New York Times article, Banco Santander's Brazil Unit Raises $8 Billion in I.P.O.

While these events are certain to fund rapid expansion in Brazil’s capital sector, the exuberance is tempered by a look at the long road ahead. Yet it is impossible not to be blinded by the bright future that seemed out of reach not long ago.  Antonio Quintella, country manager at Credit Suisse Sao Paulo put it succinctly:

Nothing is guaranteed. But it is reasonable to assume that [Brazil] won’t repeat the mistakes of the past…it is very difficult not to be bullish”

Brazil Should Ratify Bilateral Investment Agreements

Brazil has emerged from the global recession as the darling of international investors; this has created a wealth of investment opportunities.  However, it lags behind all other Latin American countries in one important respect: it has yet to ratify any bilateral investment agreements (BITs).  These agreements protect international investors when disputes arise in host countries. In light of Brazil’s recent good fortune, the time has come for Brazil to rethink its approach to BITs and implement measures to protect foreign investors.

Bilateral Invest Agreements Provide Important Safeguards

BITs obligate host countries to provide safeguards for foreign investment. If host governments fail to heed these safeguards, investors maybe awarded money damages. The following safeguards are among those afforded by BITs:

1. host countries are prohibited from expropriating foreign investment without compensation.
2. The agreements often include national treatment provisions, which require a government to treat foreign investors no less favorably than they treat domestic investors. They also often include most favored nation provisions, which extent the same protections afforded to foreign investors from one country to foreign investors from other countries.
3. foreign investors have the right to transfer funds into and out of the host country without delay.
4.  In addition to substantive protections, BITs provide powerful dispute resolution mechanisms. Under these mechanisms, Foreign investors may choose to resolve disputes in binding international arbitration such as in the International Center for Settlement of Investment Disputes (ICSID) and arbitral tribunals organized under the United Nations Commission of International Trade Law (UNCITRAL).

These agreements provide important safeguards against government mistreatment, mitigating some of the political risks associated with making investments in foreign countries.

Conclusion

Although Brazil’s reluctance to ratify BITs may help to protect it against claims by foreign investors, the recent surge in outbound Brazilian investment should cause Brazil to reconsider its position against international investment agreements. 

While Brazil is busy contemplating this proposition, there is a way investors can structure their investments to take advantage of BITs between other states. Stay tuned, and I’ll let you know how in a follow-up post.

Trend to Watch: A Surge in Investment Activity in Brazil Will Lead to the Adoption of International Investment Agreements

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While my posts are usually technical discussions centered on international business law, I'm going off topic today to write about a concept quickly gaining traction as a viable alternative to private banks in providing capital to impoverished entrepreneurs across the globe.

On a recent trip to India, I caught a glimpse of the future as I walked down Connaught Circle in downtown New Delhi. Entrepreneurs seemed to be everywhere providing an endless array of goods and services. This is the world imagined by Nobel Laureate Muhammad Yunus, founder of Bangladesh-based Grameen Bank, a microfinance organization that makes small loans to impoverished entrepreneurs without requiring collateral. 

My recent experience was echoed in an article in today’s Wall Street Journal. According to the article, Microlending in India Continues Macro Growth, Microlenders recorded a 60% increase in clients in India, to 22.6 million up from 14.1 million the previous year. In sharp contrast, the formal banking system in India recorded only 15% growth over the same period in the number of clients it serves.

As reported in the article, the surge in microloans has been fueled by a brisk flow of funds in the third quarter of this year, with about $130 million in global private-equity funds funneled into Indian microfinance institutions.

"In the middle of last year, we thought for a while the meltdown would strike this sector, but we've seen that it's been largely unscathed," said Vipin Sharma, chief executive of Access Development Services. "Growth is as frenetic as it was before."

Mainstream banks, in both the private and public sectors, are increasingly considering channeling funds into microfinance banks rather than directly to India's poor. Four public-sector banks and three private-sector banks entered microfinance this year, making for a total of roughly 30 banks invested in Indian microfinance. Total bank funding for microlenders nearly doubled to $2.526 billion from $1.281 billion in the year ended March 31 from the previous year.

As reported in Forbes, in the article, Microfinance Rides Out Turbulence, microfinance institutions have emerged as more stable than other comparable assets during financial crises. This is partly because their clients are not integrated into mainstream banking and currency markets and are therefore insulated from wild market swings.

Microlending may enjoy enormous success in India, but in other parts of the world, it has yet to flourish. In China, for example, the microlending concept has yet to take root, as reported in the article Microfinancing China in the Wall Street Journal. Let's hope that will soon change.

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As Forbes reported today in the article Dainippon completes tender offer for Sepracor, Dainippon Sumitomo Pharma Co. of Japan agreed to buy Sepracor, based in Marlborough, Mass., for about $2.6 billion, or $23 per Sepracor share. Sepracor makes drugs for respiratory and nervous system disorders. It reported $1.29 billion in revenue in 2008, with almost half of that total coming from sales of its sleep aid Lunesta.

The Dainippon/Sepracor deal is the latest example of the resurgence of tender offers as a vehicle for growth. An insightful article entitled The Peculiarities of Tender Offers appears in today’s New York Times’ DealBook section. According to the article, 26.15 percent of acquisitions so far this year were structured as tender offers, compared with 16.28 percent in 2007 and 23.34 percent in 2008.

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As recently reported in the Wall Street Journal in the article The Last Hurdle for the Lisbon Treaty, Ireland’s Oct. 3 approval of the Lisbon Treaty strengthened the odds for the European Union to gain global clout on issues from the economy and climate change to war and peace. An excellent overview on the Treaty is provided by BBC in its article Q&A: The Lisbon Treaty.

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 As reported by the Wall Street Journal's Lynn Cowan today, China has taken the global lead in initial public offering activity for 2009.

As Ms. Cowan reported, should  the pace continue, China will come out on top of "every other country, and even entire regions such as Europe and North America, for all of 2009." 

Global IPO Dominance

China's global monopoly of the year’s IPOs hardly comes as a shock given the sheer magnitude of the market and the Chinese government's mandate to privatize more companies, according to Thomas B. Fox Jr., head of global capital markets for the Americas at UBS AG. 

"So many areas are still government-held -- natural resources, telecommunications, banks, transportation -- it's hard to imagine a  country having an economy the size of China's with virtually none of the companies being public," he said.

The figures compiled by research authority Dealogic, as reported in this article in Forbes Magazine, illustrate that 38 companies have raised a total of $15.4 billion in their IPOs in China so far in 2009, making China the world's largest IPO market this year.

Although U.S.-based deals were nowhere near the levels seen before 2008, when there were on occasion more than 50 deals in a quarter, it will take some time for more U.S deals to come into the market given the SEC's  three to fourth month processing period. As a result of the lag time, there will be a more significant flow in IPO activity next year, as the companies registering now start to launch.

SEC Application Process to Blame for Poor U.S. Showing?

In light of the SEC's delay in processing new offerings, an argument can be made that the bloated bureaucracy encumbering the pace of applications has made the U.S. less competitive in the global landscape when it comes to raising publicly-sourced funds for flourishing companies.  A quick look at the chart illustrates the glaring divide:  the U.S. can lay claim to only one IPO while China can boast eight (Chart via Wall Street Journal via Dealogic)

Trend to Watch: China Will Boast IPO Dominance Into the 2nd Quarter of 2010

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The economic landscape in emerging markets such as Brazil, China and India are beginning to show signs of life. These “greenshoots” are taking the form of IPOs, which are a leading historical  indication that world markets are springing back to life.

Emerging Market IPOs on the Rise

As reported in the Financial Times in the article Santander Launches Brazilian IPO, the Spanish bank, launched an initial public offering of its highly-successful Brazilian outpost making it one of the world’s largest initial public offerings of the year.

In addition, the Wall Street Journal reported in its article, Sinopharm plans $1.2 Billion IPO, that Sinopharm Group Co., China's largest pharmaceutical company, will attempt to raise up to $1.12 billion in an initial public offering in Hong Kong.

Not to be outdone by Brazil and China, India plans as many as 40 initial public offerings on the Bombay stock exchange in the next few months according to this article in Businessweek.

Risk Factors

In reading about these recent deals, I was reminded that, as a corporate lawyer, I am primarily in the risk management business. When a client seeks my advice on the complex legal issues surrounding an emerging market transaction, I always stress temperance over exuberance.  While  it is easy for one to get carried away with an opportunity to participate in a major securities deal,  counsel must advise a client of all the major risk associated with the listing.  As I wrote in an earlier post, due diligence is an integral part of the process. This is particularly true of emerging markets since government oversight can fall short of the standards set by developed markets. Based on experience, market research and analysis, I’ve identified 6 risk factors which can undermine the IPO process in emerging markets:

1. Potential conflicts of interest arising from the involvement of the candidates’ senior management in other competing but not openly disclosed businesses
2.  Litigation history of IPO candidate and key principals being omitted or insufficiently described in the prospectus;
3. Inaccurate statements of academic qualifications and technical expertise when describing senior management background and experience;
4. Undisclosed tax liabilities – a significant problem;
5. Undisclosed environmental problems or fines; and
6. Undisclosed industrial labor disputes in outlying areas

Conclusion

The main objective in this risk analysis framework is to ensure that public information including offering documents contain all material information about the issuer and its financial condition, and that no important information is omitted or understated. Careful analysis of these 6 key risk factors will minimize the likelihood of one succumbing to misplaced exuberance.

Trend to Watch: As the pace of emerging market IPOs picks up, look for more investors to be misled by omission or understatement of material information

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The Financial Times reported in this article that Europe continues to trail behind world markets in IPOs, particularly those in Asia and the United States.  While this may be the current trend, all markets—including—Europe--can expect a significant uptick in IPO activity as the economy begins to rebound. Illustratively, Kohlberg Kravis Roberts is planning at least one major deal in Europe for Danish telecom giant TDC.  As reported in New York Time’s DealBook, Dole Food Company Inc., is also planning a deal in the United States.  According to Craig Coben, head of equity capital markets origination at Bank of America-Merrill Lynch:

If the Market is open for European capital raisings to finance new investment then the market should also be open to IPOs for strong Companies”

Three Key Areas of Focus

As  global competition for IPO activity begins to heat up, those structuring an initial public offering would best serve their clients by focusing on three crucial components of the pre-IPO process: due diligence, valuation and capital structure.

1.       Due diligence:  During this phase, a company, its underwriters, and their attorneys must focus on the registration statement.  An exhaustive auditing of the company’s finances is a crucial step towards substantiating the registration statement and maximizing the likelihood of long-term success for any IPO.  The experience of executives and the integrity of financial forecastsmust  also be painstakingly scrutinized.

2.       Valuation: Because private firms do not have past stock prices, risk estimation must be based on an approach that does not consider past price parameters.  The Relative Valuation Approach is best suited for this purpose because the comparables of similar publicly traded firms are considered. Under this approach, prices are more accurately estimated as a correlation between the revenues or operating incomes of the comparable firm and the firm being valued. If it is positive, then the firms are comparable. 

3.       Capital Structure: The number and class of shares that will be issued play an integral role in the valuation and appeal of an offering.  It is important that the IPO team possess knowledge of and experience in the industry of the issuing company or at least in a related industry to determine how the offering will be structured. If the issuer is a company based outside the US, the team should also know the customs and business practices of the issuer's home country.  

Conclusion

Undertaking an IPO is a monumental and exciting event for a new company. A well received IPO means that the company will have funds to fuel its development and growth. Following these key points will serve as important guideposts for any company planning to go public.

Trend to Watch: The Market for IPOs will Continue to Strengthen. Europe, in particular, Will Post Sizeable Gains Vis à Vis Primary World Markets.

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