Part 2: Enhancing corporate governance of a foreign subsidiary – a case study

Read part one of the case study here.


Causes of issues


The incident illustrated is only one the many similar cases in existence, which our firm is dealing with on a regular basis. We summarise hereinbelow some of the causes of the issues:


First and foremost, issues often arose from the insufficient control over management of a foreign subsidiary. The lack of comprehensive internal supervision system and insight from headquarter on information of the Chinese subsidiary led to unnecessary and avoidable delays in communication. Issues associated with X were only discovered months if not years later through tipping off by external third parties (such as customers of our client), which should have been discoverable through employees of the company and/or internal vetting in the first place.


Secondly, the problem was worsened by the headquarters’ inability to trust and rely entirely on local management, even the members of the board who seemingly had the closest connection with the headquarter. There was a lack of “eyes and ears” of the headquarters in the local subsidiary who was able to supply insider information and provide insight in the subsidiary’s internal structure and management team.


''...most corporate documentation of the subsidiary were prepared only in Chinese language, which presented obstructions on our client’s ability to apply close supervision on the entity.''

Thirdly, the language barriers that often exist between the headquarters and the subsidiaries also played a part in the ineffective communication. For instance, our client was a conglomerate headquartered in Germany and its management was comprised mainly of Germans who were proficient in German and English languages, whereas most of the senior personnel in the subsidiary in question were Chinese nationals who could speak only Mandarin. What was worse, was that most corporate documentation of the subsidiary were prepared only in Chinese language, which presented obstructions on our client’s ability to apply close supervision on the entity.


Fourthly, the lack of a grievance procedure system in place must not be overlooked. Should there be a set of comprehensive internal emergency guidelines and protocols on how to deal with a situation analogous with that of X’s, additional and substantial time, manpower and legal costs incurred could have been avoided. This had not been properly done in the case of our client, which resulted in prolonged dealings with legal team on intended termination, calculations of compensation, and decision on settlement offers.


Lastly, throughout the decision-making process, our client did not follow recommendations of the legal teams and the settlement offer was not in line with what was proposed and considered advisable from a legal standpoint, which resulted in a hostile negotiation environment and ultimately unsuccessful settlement. For instance, following the initiation of a proceeding at the Labour Court by X, the costs of defending the same are most likely more costly than the settlement amount originally calculated and proposed by legal advisors. These costs could easily have been avoided by adhering to the proposed offer, resulting in a more cost-efficient and win-win situation. All in all, this reflects that an entity’s unwillingness to appreciate the legal reality and act in accordance with the advice of its legal representatives may take a toll on the efficiency of its corporate governance.


Tips & Takeaways


Firstly, instead of dedicating all powers to the local management, headquarters should consider retaining control over critical assets, such as access to online banking, of a foreign subsidiary. “Four-eye principle” should be applied on all online transactions, and that payment with the use of cash and cheques should be avoided as far as possible. Company seals of a foreign subsidiary should be deposited with a trust-worthy and an independent external third party, such as a law firm or an accounting firm, to avoid misuse of the same by the local management.


Even though local management is trusted, headquarters should still consider stationing a trusted member in their subsidiary.


Secondly, trust-worthy persons from a headquarters level, ideally with bilingual capability, should be appointed to station at and oversee a foreign subsidiary. Crucial corporate documents such as certain board and shareholders resolutions, audit reports, and legal opinion should be prepared in bilingual manner or translated to facilitate oversight by the headquarters.


Thirdly, a holding entity should consider implementing detailed grievance procedures and internal guidelines on how best to handle these situations. Setting up a whistle blower hotline and offering seminars and trainings to staff and management are also essential, which ensure that its personnel are well equipped with the requisite knowledge and tool in case of emergency.


Lastly, employment of local in-house counsel stationed at a foreign subsidiary and regular consultation with external local legal advisors may help prevent or mitigate the adverse effect of these crisis. It is also essential to establish connections with legal service providers in all places and regions where subsidiaries are located to serve as a first point of contact and expedite the reaction time in a contingency.


Disclaimer: This publication is general in nature and is not intended to constitute legal advice. You should seek professional advice before taking any action in relation to the matters dealt with in this publication.


For specific advice about your situation, please contact:


Authors

Stefan Schmierer

Managing Partner

+852 2388 3899

sschmierer@rs-lawyers.com.hk


Chloe Lau

Associate

+852 2388 3899

clau@rs-lawyers.com.hk