Watch Out When Contracting With Foreign Companies

Many startups have contracts with foreign-based or multinational entities.  Contracting with companies based in foreign countries is getting more common every day.

But when contracting with a company based in a foreign country, watch out!

Foreign laws may be radically different than the laws in the United States, including laws relating to:

• contract formation, interpretation and enforcement;
• IP ownership;
• available protection for confidential information or trade secrets;
• types of rights for copyrights and patents;
• scope of IP rights, especially “Moral Rights” for copyrightable works;
• contract prohibitions regarding reverse engineering; and
• the range of damages and potential liability for breach of contract and related claims.

If foreign laws apply to your agreement, you may be in for some nasty surprises.  You may not be agreeing to what you thought you were and the rights and legal remedies will be different than those in the United States, sometimes radically so, and not usually in a good way.

Moreover, it’s important to consider what will happen if the relationship sours and disputes about the terms of the agreement arise.  What will you do if you don’t get paid and they keep your products?  What will you do if the foreign company reveals your trade secrets?  What will you do if the foreign corporation uses or resells the source code they allegedly created specifically for your company?

What country’s law governs?  Where can you sue or be sued?  Will you be at the mercy of foreign courts or bound by foreign law?

The beauty of contract law is that in the actual contract between the parties you can specify what law governs the agreement and the contract’s interpretation.

The “Governing Law” section is typically at the end of the contract.  To some extent, the parties can choose the applicable law.  For many claims, they can specify that the law of a particular country and state will govern disputes arising out of or relating to the agreement.

Watch out for contracts drafted by foreign companies who slip in a term specifying governance by the law of their country.  A contract governed by foreign law may not mean what you think it means and your rights may be radically different than what you’ve come to expect under our laws.

When asked, foreign corporations who frequently do business in the US, even very large ones, will usually agree to specify United States law as the governing law.  They usually already have US legal counsel and are familiar with US laws.

Whether you can force the issue with a company who initially refuses to agree to US law will depend on your bargaining power and their desire to do the deal.  You should carefully consider the subject matter of the contract, its value, and its relationship to your business when considering whether to do the deal with the risk of foreign litigation.

I’ve represented numerous domestic and foreign corporations in international disputes and I would balk at signing any agreement that designates the governing law to be anything but the law of the United States.  It can be extremely difficult to really understand the ramifications of foreign law without consulting a foreign attorney.  You may end up paying for lawyers in both countries.

Pragmatically, sometimes a small company doing business with a foreign corporation has to cave on the issue of the governing law to get a deal done.  But the business people should understand that there are very expensive risks to agreeing to foreign law.  Unless the startup has beaucoup capital, foreign litigation could severely jeopardize the company’s financial viability.  If the company’s key intellectual property is involved, it may pay to consult with a foreign lawyer when negotiating to better understand your risks and potential liability.

Further, in a contract, the parties can specify what courts or dispute resolution organizations will have the power to decide future disputes. This term is usually called “Jurisdiction and Venue” or “Dispute Resolution.”  It may be combined with governing law in a section called “Governing Law & Jurisdiction.”

Jurisdiction is different than the governing law, which determines what law applies. Technically, jurisdiction has to do with the rights and power of the courts to apply the law.  Venue is the specific location for the resolution of the dispute by a court with jurisdiction.

In a contract, to some extent, the parties can specify the specific jurisdiction and venue where resolution of future disputes between the parties related to the agreement will take place.  They can also specify whether the agreement must be decided by alternative dispute resolution like arbitration.  Generally, courts will uphold arbitration agreements and the court may decline to exercise their power to hear the case based on the arbitration term in the agreement.

In international agreements, arbitration may be the best way to fairly resolve disputes with foreign corporations.  It is common to specify international arbitration in a location that is neutral and mid-way between the companies.  Hawaii, Hong Kong and Singapore are popular with companies located in Asia.

When a foreign company has no assets in the United States, it may be judgment proof because our courts lack the power to reach the foreign company’s assets.  In this scenario, an arbitration award may be easier to enforce than a US court’s judgment and can be enforced through the New York Convention treaty in participating countries.

International arbitration and judgment enforcement may be very expensive.  Arbitration may be somewhat more expensive than litigation in a US court in part because you usually need to designate three arbitrators, one from the country of each party and one from a neutral country.  The arbitration process usually involves travel for all parties and it may also involve translators.  Discovery costs in arbitration can be lower but this cost savings may be offset by the lack of other judicial procedures, like motions to dismiss, that can expedite resolution of the dispute and limit attorney preparation and fees.

If a company has assets in the United States and your agreement involves IP rights, I would try to get an agreement to jurisdiction and venue in the US courts.  You will want the power of the courts to protect your IP and enforce any judgment.  Injunctions are important remedies in many types of IP cases.  Additionally, if you win in court and the foreign company won’t pay the damages award, a US court may have the power to seize assets of the foreign corporation in the US for payment.

In any event, it pays to consider potential costs of a dispute with a foreign company when estimating the costs and benefits of a potential deal.  It may be far more costly to do business with a foreign company than you anticipated.