Wednesday, July 12, 2006

Establishing a Presence in a Foreign Market - Korea

One of the core beliefs of our InternationalCounsel practice is that a legal advisor's "toolkit" of international law skills is generally of far greater importance to the success of a project than the particularities of a target country's local law.

For example, in the typical international transaction, whether a license, franchise, agency or distribution agreement or manufacturing/sourcing arrangement, substantial legal risk balancing goes into choosing among basic types of arrangements, and a dozen or so key agreement provisions require substantial modification. Local law modifications are important, but someone needs to be asking the hard up-front questions and have a handle on the kinds of issues that cut across many markets.

The same is true when deciding on market entry vehicles in a target country. A recent client project is a good example of factors to consider in establishing an office in another country. Like many projects, this challenge began with a simple message: "we need to distribute our product in Korea and want to establish a subsidiary there to show that we are serious."

1. Is an in-country office really essential? Keep in mind that (a) a local office typcially means that revenues from the country will be taxed by that country, and such revenues will also be taxed in the US or other home country. Yes, a tax credit in the home market may offset the foreign tax, but not always; (b) the cost of setting-up and maintaining the office may not be fully offset by the potential revenues (or margins that might otherwise be taken by a local agenty/distributor); and (c) local parties operating the office will likely be employees subject to laws making them difficult and expensive to terminate. Do such factors cause you to reconsider appointing that local agent or distributor to at least test the market first?

2. If an in-country office is chosen, countries often offer 3 main choices:

(a) a liaison/representative office, if the activities can be structured as non-revenue-producing. For example, it may be possible to route revenues directly from an in-country customer to the parent company and limit the liaison to strictly exploratory/promotional activities;

(b) a branch office, which is an extension of the home office and not treated as a separate entity for liability purposes. Special-purpose US companies can act as a firewall to protect against liabilities; and

(c) a subsidiary in corporate form, which will limit liabilities but be more expensive to maintain and may prevent a company from offsetting profits and losses against parent company income. Consider forming an in-country entity that will be treated as a corporation for local purposes but will have flow-through tax treatment for US purposes.

Yes, each country has local-law nuances, though this example of a "toolkit" of issues is meant to show that the overall structuring issues and interplay between the two countries can have even greater importance.