Importance of Local Partnering In Foreign Projects -- Are Local Partners A Necessity For American Investors? A. Considerations In The Decision Of Selecting A Local Partner
By Mark J. Riedy, Esq.
1. General Considerations
In entering a foreign country, one of the first considerations of an American company is how to ensure financial success in an unfamiliar market. Local partners are often sought to assist in this pursuit, and particularly for maneuvering around the inherent pitfalls lurking in these countries. Oftentimes, foreign investors, such as American companies, are not fully appreciated, or are openly challenged, by the general population of a foreign country. A "local face" can be helpful, if not necessary, in overcoming this perception, particularly when the local partner is projected as the lead developer on the project within the host country.
A local partner is often sought from local companies on the basis of its working knowledge of the particular industry's business practices and the governing statutes and regulations thereto; its ability to work with the appropriate central, state and local governments within that country to obtain permits, decisions and other items necessary for the development of a project; and its standing within the local community surrounding the particular project in that country. Furthermore, American companies may select a local partner to share in the risk and invest in a project. * A local company that is strong in each of these areas can ensure the success of a project.
Other considerations with respect to selecting a local partner are as follows:
(i) Does the foreign country require a local partner under existing laws? In this regard, many foreign countries, by statute, will not permit 100% foreign ownership in certain or any local industries and have express foreign ownership percentage ceilings to restrict foreign companies from owning a majority of, or exerting substantial control over, a project. In the latter instance, foreign countries statutorily may restrict a foreign investor's ability to block certain critical decisions, such as a special resolution to amend the project company's by-laws or change the type of business previously carried out by that company, by setting maximum foreign ownership percentage ceilings below the level necessary to effect such a decision. Similarly, local partners may create this result themselves by restricting unsuspecting foreign investors' voting percentages to levels below statutory thresholds in the project company's Shareholders Agreement. These ownership restrictions frequently are established by a foreign government or effected by a local company notwithstanding the local company's lack of experience in the particular industry.
(ii) Does the local partner provide the infrastructure project opportunity? In this regard, local companies often may obtain, or are offered, infrastructure projects before those projects become known to foreign investors. Local companies then will seek foreign investor participation to acquire industry-specific expertise and operational experience, access to the investor's equity and lines of finance, credibility to obtain additional third party equity and debt, the secondment of a highly skilled workforce, among other needs. Problems also can arise at this early stage, as discussed below, when local companies seek expense reimbursement and "loaned" equity from their foreign partners.
(iii) Are other foreign companies in a particular industry in a particular foreign country selecting local partners? If so, why and for what purpose(s)? Often, projects are unable to proceed through vast and tangled government bureaucracies without a local partner, notwithstanding that the foreign country does not require such a joint venture. This problem is compounded when central, state and local governments have co-existing jurisdiction over development of a particular industry.
The American investor also must determine what the local partner exactly intends to achieve from the proposed relationship. Does the proposed local partner seek additional investment for
(i) financing a project and subsequently creating a substantial equity return thereto, (ii) a bailout on a poor investment decision, (iii) prestige and local standing, (iv) competitive advantages vis-a-vis its local competitors, (v) exclusivity for other similar or dissimilar projects in or out of the host country, and/or (vi) other goals?
2. Project Structuring Considerations -- U.S. Taxation Requirements
Tax issues also can have a significant bearing on who an American company selects as a local partner, or often more importantly whether the local company will consent to a partnership offer.
For example, prior to recent modifications in U.S. tax laws, limited liability project companies would not provide U.S. investors the ability to "bank" their share of project profits offshore and away from U.S. taxes during the host country's tax holiday unless the project company qualifies as a partnership. An American investor seeks to "store" its profits offshore, and until it commences paying foreign taxes, in order to begin offsetting U.S. tax liability with qualified foreign tax credits prior to the repatriation of that income into the United States.
The U.S. Treasury, in 1996, amended the U.S. tax regulations to remedy this adverse foreign investment situation ("check-the box"). The amendment now permits the U.S. taxpayer to invest into a private limited liability project company and, after certain declarations to U.S. tax authorities, bank its profits offshore until tax credits result following a host country's tax holiday.
Still today, U.S. and other jurisdictions' tax treatment may be affected by the existence of local partners. Often, tax treaty benefits are only available if certain local ownership exists. Other times, local partners are important to supporting the economic substance of otherwise complicated international project structures.
These are but two examples of how U.S. tax requirements can have an adverse effect on the selection of local partners for an American investor.
* Often, however, and particularly in developing countries, local partners have little money to invest in a project.