by Mahesh H. Nanwani
Daily Business Review, August 30, 2005
In the three years that have passed since the adoption of the Sarbanes-Oxley Act, Corporate America has experienced a system wide transformation in corporate governance matters and internal operating procedures. One unexpected byproduct of the new corporate environment is the growing trend among foreign private companies to adopt systems of internal controls and variations of select Sarbanes procedures in cross-border joint ventures, contracts and subcontracts with U.S. companies. In most instances, the U.S. stakeholders are negotiating these procedures into cross-border agreements. In other cases,the foreign companies voluntarily adopt the provisions to gain credibility in a new venture or cross-border relationship.U.S. businesses have routinely sought better transparency when dealing with foreign parties. The current trend exemplifies foreign businesses’ recognition ofthe importance of transparency at a time when U.S. companies have a high level of leverage in the contract negotiation process.
This trend is particularly evident in business-process and back office out sourcing relationships between U.S. companies and companies in India, the Philippines and the emerging South and Central American outsourcing centers, as more U.S. companies become stakeholders in foreign service vendors through joint ventures and other forms of equity ownership. For the foreign companies, the consequences of resisting Sarbanes-like actions is lost business. Failure to comply withrequirements in an existing cross-border joint venture agreement with a U.S. company could trigger various remedies for breach, including termination and non-compete provisions that restrict the foreign company’s ability to provide similar services. Even worse, such companies facethe potential of being ostracized.Traditionally, many joint venture agreements required the foreign operating venture partner to deliver periodic financial statements of some kind to other joint venture partners. Depending on the projector business venture and budgeted costs, the requirements ranged from annual uncertified statements to a combination of unaudited monthly or quarterly statements and audited annual financial statements.
Today, most international joint ventures with U.S. partners regularly require the foreign operating partner to prepare and deliver quarterly and annual financial statements. In many cases those reports are to be accompanied by a certificate of an executive officer of the foreign partner confirming that he or she has reviewedthe financial statements, that the financial statements are accurate and fairly present the financial condition of the joint venture, and that approved procedures for gathering and assembling financial information and preparing financial statements were properly implemented, along the lines of the requirements imposed on U.S. public companies under Sarbanes. Many U.S. companies are also requiring foreign partners to implement a system of internal controls for developing and reporting financial information that is used to prepare the periodic financial statements, along the lines that management in U.S. public companies are called upon to establish under Sarbanes.
Expanding on this concept, U.S. stakeholders are securing additional rights and opportunities for more frequent access to information during the joint venture relationship. And the procedures and time tables that have been developed under the agreements are being used as checklists to gauge performance and compliance in random and spot tests.In many foreign jurisdictions, it is no longer offensive or suspect for the U.S. company to ask for information, access and monitoring rights from a prospective foreign business partner.The concept of controls has also been adapted to nonfinancial internal controls in many cross-border transactions,including procedures for ensuring compliance with the confidentiality and privacy requirements under applicable U.S. and foreign law.Frequently, U.S. companies entrust valuable proprietary informationto foreign joint venture partners orvendors, or personal information regarding its customers, such as credit or health information, that is protected by agreement between the U.S. company and its customers or by U.S. privacy regulations. Many contracts require the parties to establish procedures to protect confidential and regulated information and to provide access to U.S. companies to monitor compliance with these requirements.While these concerns are not central to Sarbanes-Oxley, the application of the concepts of controls to these expanded areas directly results from the broader legitimization of the expectation of transparency in the new corporate environment. Features such as internal controls, continuous access and information delivery serve as an early warning system that enables parties to spot problems and resolve issues as they arise and before they lead to major disputes that sour the relationship.
Courts in many outsourcing and technology centers such as India are increasingly upholding contract provisions that seek to protect privacy andtransparency in recognition of the importance of cross-border business relationships to their economies. These earlywarning systems have proven to be critical in international transactions where formal dispute resolution and the enforcement of contractual rights between parties in multiple jurisdictions involve complex procedural challenges and are costly and time-consuming.
Mahesh H. Nanwani is a Gunster Yoakley shareholder and a member of the firm’s corporate department. He focuses on securities, mergers and acquisitions, and international law, with emphasis on Asian markets.